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Can Disclaimers In Transaction Documents Negate A Claim Of Reliance On Misstatements And Omissions?

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  • Posted on: Nov 11 2016

On November 3, 2016, the Appellate Division, First Department revived a case against J.P. Morgan Securities LLC and JPMorgan Chase & Co., the parent company of Bear Stearns & Co. Inc. (“Bear Stearns”), that had been dismissed over losses that the plaintiff, Aozora Bank, Ltd. (“Aozora”), a Japanese lender, suffered after investing in collateralized debt obligations (“CDOs”) it claims Bears Stearns used as a “dumping ground” for its most toxic, risky assets. In Aozora Bank, Ltd. v. J.P. Morgan Securities LLC, 2016 NY Slip Op. 07260, the Court dismissed Aozora’s claims because, inter alia, disclaimers in offering documents put Aozora on notice that Bear Stearns had colluded with the collateral manager to accept into the CDO toxic assets from Bear Stearns’ own balance sheet.

The Facts:

Aozora sought damages against JPMorgan arising from its investment in HG-COLL 2007-1, Ltd. (“HGC”), an asset-backed CDO. Aozora alleged that Bear Stearns portrayed HGC as a legitimate investment vehicle, but in reality, secretly used HGC as a “dumping ground” to “offload” Bear Stearns’ most toxic, risky assets that it no longer wished to own.

Aozora sought damages against JPMorgan under several theories of liability, including fraud, breach of the implied covenant of good faith and fair dealing, tortious interference with contractual relations, and negligent misrepresentation. JPMorgan moved to dismiss the complaint on statute of limitations grounds and for failing to state a cause of action upon which relief could be granted, as well as for failing to plead fraud with the requisite particularity and state of mind.

The Motion Court’s Ruling:

The motion court dismissed Aozora’s fraud claim on the grounds that, among other things,  Aozora could not have relied on any misstatement and omission because it was aware of the information it claimed to have no knowledge of through various offering documents:

 Azora’s admission that it reviewed [the] asset-level information, at the time it invested in HGC, requires dismissal of the fraud claim.…

This conclusion is supported by numerous disclaimers contained in the HGC Offering Circular …. It is well-settled that “a specific (rather than general) disclaimer in a guarantee bars the guarantor’s claim for fraud in the inducement, where the guarantor specifically disclaimed reliance on the very information which it now claims caused it to be misled.” This legal principle is particularly compelling when “the guarantee in question had been the product of ‘extended negotiations between sophisticated business people’ involved in a ‘multimillion dollar’ transaction.”

* * *

The disclaimers in the HGC Offering Circular made clear that, by agreeing to invest in HGC, Aozora was capable of analyzing and assessing the risks associated with the investment, and that it was using its independent judgment in assessing these risks.

Aozora Bank, Ltd. v. J.P. Morgan Securities LLC, Index No. 652274/2013 (Sup. Ct. N.Y. Cnty. Apr. 22, 2015) at 23-24 (citations omitted.)

The motion court also dismissed the claim for breach of the implied covenant of good faith and fair dealing.  Aozora contended that JPMorgan “secretly influenced collateral selection and filled HGC with at least $185.2 million of assets that [it] alone knew [was] toxic and wished to remove from [its] books” thereby making the disclaimers in the offering documents irrelevant. Id. at 36-37. The motion court rejected the argument, noting that it was unsupported by any legal authority.  In doing so, the court declined to “nullify the express disclaimers contained in the HGC Offering Circular.” Id. at 37. This was especially important since Aozora never claimed that “the assets comprising HGC failed to meet the eligibility requirements set forth in the [Offering] Documents” and was required to “conduct an independent investigation of the characteristics of the notes and risks of ownership of the notes.” Id. As far as the motion court was concerned, Aozora essentially alleged an unsustainable breach of contract claim. Id. (citation omitted).

Aozora appealed the dismissal of the fraud and the breach of the implied covenant of good faith and fair dealing claims.

The First Department’s Decision:

In a unanimous decision, the First Department reversed the decision of the motion court as to both claims.

With regard to the fraud claim, the Court found that, notwithstanding the disclaimers in the offering documents, Aozora could not have known that Bear Stearns and Ischus Capital Management, LLC (“Ischus”), the collateral manager, colluded to mix HGC with toxic assets from Bear Stearns’ balance sheet:

Plaintiff adequately stated a claim for fraud. Defendants failed to show that plaintiff’s reliance on statements that the collateral manager would select collateral independently was unreasonable as a matter of law. The complaint alleges that plaintiff, while aware or on notice of the concentration of Bear Stearns underwritten assets in the collateralized debt obligation (CDO) at issue, was unaware of how this compared to other CDOs generally or those managed by the same collateral manager. On this motion, defendants have not shown that the disclaimers in the offering documents put plaintiff on notice that defendants had already colluded with the collateral manager to accept into the CDO toxic assets from Bear Stearns’s own balance sheet.

(Citations omitted.)

With regard to the breach of the implied covenant of good faith and fair dealing, the Court found that Aozora stated a claim because the allegation was based upon a separate tort that was independent of the rights under the offering agreements – that is, it was based on a breach in the performance of the agreements:

Plaintiff adequately stated a claim for breach of the duty of good faith and fair dealing, given the allegation that defendants subverted the collateral manager to favor the interest of Bear Stearns, and given that many of the CDO’s assets were purchased after plaintiff’s investment (see Aozora Bank, Ltd. v Credit Agricole Corporate & Inv. Bank, 2015 NY Slip Op 31426[U], *17 [Sup Ct, NY County 2015]).


The Court’s decision stands as a reminder that a party to an agreement cannot hide behind general warnings of adverse events, such as potential conflicts of interest or collusive conduct, when that party knows, with certainty, and yet fails to disclose, that those events were then occurring.  As a federal court long ago observed: the law “provides no protection to someone who warns his hiking companion to walk slowly because there might be a ditch ahead when he knows with near certainty that the Grand Canyon lies one foot away.” In re Prudential Secs. Ltd. P’ships Litig., 930 F. Supp. 68, 72 (S.D.N.Y. 1996). This is especially so when one of the parties warrants, as in Aozora, that it did not omit to state any material fact necessary to make their statements not misleading.

The Court’s decision is notable because it confirms the long-standing principle that disclaimers and disclosures do not defeat a plaintiff’s reliance when the information necessary to discover the fraud was within the defendant’s peculiar knowledge.  (In September, this Blog posted an article about the justifiable reliance element of fraud.) This makes sense, even if the plaintiff is a sophisticated investor and required to exercise due diligence prior to the subject transaction.  As the facts in Aozora showed, there was no way for Aozora to know from the disclaimers or its diligence that Bear Stearns and Ischus colluded to include toxic assets in HGC.

The Court’s decision also stands as a reminder that a party can breach the implied covenant of good faith and fair dealing by defeating the purpose of the agreement through his/her actions. This is true even when the conduct at issue does not violate the express terms of the agreement. (In September, this Blog posted article about how the implied covenant of good faith and fair dealing can stand as a separate basis of liability.) That is what happened in Aozora. The bank believed that Bear Stearns and Ischus would, in good faith, select the asset portfolio pursuant to the written representations in the offering documents.  Aozora had no reason to believe that Bear Stearns would engage in self-dealing. As the First Department found, such conduct is a separate, actionable wrong.

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