Court Finds No Fiduciary Duty Arising From Contractual Relationship Between Sophisticated Parties

• Posted on: Sep 13 2019

It is well settled that when an agreement is clear and unambiguous, the parties’ rights are to be governed exclusively by that agreement and the courts are to give the words of that agreement their plain, ordinary, and usual meaning. It is equally well-settled law that parties engaged in an arm’s-length business transaction are not fiduciaries, especially when the parties are sophisticated businesspeople. Despite the clarity of these principles, they are, nevertheless, tested in litigation. Such was the case in Saltini v. North Sea Dev. LLC, 2019 N.Y. Slip Op. 51456(U) (Sup. Ct., Suffolk County Sept. 9, 2019) (here).

Saltini concerned three properties located in the Town of Southampton, New York (sometimes referred to as Lots 1, 2, and 3, and collectively the “Properties”). In 2015, Saltini and defendant, Coast Development Group LLC (“Coast”), formed defendant, North Sea Development LLC (“North Sea”), to construct high-end homes on the Properties (the “Project”). Coast owns 51% of North Sea and Saltini owns the remaining 49% of the company. Coast has three members – the individual defendants (Richard J. Gheradi, Richard F. Gherardi, and Glenn Callahan) – each of whom has a one-third interest in the company.

In order to obtain financing for the Project, Saltini conveyed title to the lots to three separate LLCs (one for each parcel) in which North Sea had a 100% membership interest (the “Property LLCs”). The Property LLCs then obtained financing from defendants Acres Capital, LLC (“Acres”) and Reliance Standard Life Insurance Co. (“Reliance” and collectively with Acres, the “Lender”). On February 5, 2016, the Property LLCs borrowed a total of $11,580,000 from the Lender (the “Senior Loan”): $4,212,439 as an acquisition loan, $5,048,300 as a building loan, and $2,319,261 as a project loan. Each of the three loans was evidenced by a promissory note and secured by a mortgage on the three parcels, among other things.

Also, on February 5, 2016, Saltini sold the three parcels to North Sea for $8,090,000. At the closing, Saltini was paid $3,829,806, and North Sea executed a promissory note in his favor for the balance, $4,260,194 (the “Mezzanine Note” or “Mezzanine Loan”). The Mezzanine Loan was secured by a pledge agreement executed by Coast granting Saltini a security interest in Coast’s membership interest in North Sea. The Mezzanine Note contained two repayment options: (1) at such time and in such amount as provided in North Sea’s operating agreement, or (2) $784,634 at the closing of the sale of Lot 1, $1,105,860 at the closing of Lot 2, and the balance (unpaid principal and interest) on the sale of Lot 3 or November 1, 2019, whichever was sooner.

The relationship between the Lender and Saltini (the “Mezzanine Lender”) was governed by an Intercreditor Agreement dated February 5, 2016. Among other things, the Mezzanine Lender agreed to subordinate and make junior the Mezzanine Loan, the Mezzanine Loan Documents and the liens and security interests to the Senior Loan and the Senior Loan Documents. Thus, the Mezzanine Lender’s rights to payment of the Mezzanine Loan and the obligations evidenced by the Mezzanine Loan Documents were subordinated to the Senior Lender’s right to payment of the Senior Loan.

The Senior Loan was set to mature on August 5, 2017. In September 2017, the Property LLCs were in default, and the parties to the Senior Loan executed the first modification, which gave the Property LLCs up to three extensions of the maturity date for a period of three months each, provided they met certain conditions. The first modification also increased the release amounts for Lots 1 and 2 from $4,303,500 to $6,000,000, respectively. The Property LLCs received two extensions, but they were unable to meet the conditions for the third extension. The Senior Loan matured on February 5, 2018, and the parties agreed to a second modification, which extended the maturity date to June 5, 2018. A third modification extended the maturity date to August 23, 2019, and increased the principal amount of the loan from $11,850,000 to $13,385,000. The third modification also reduced the release amounts to $5,000,000 each for Lots 1 and 2. The homes on Lots 1 and 2 are near completion and are being marketed for sale at listing prices of $6,495,000 and $6,995,000, respectively.

Plaintiff commenced the action on March 5, 2018, alleging that Coast and the individual defendants (collectively the “Coast Defendants”) assumed full and complete control over all aspects of the Project and made substantial errors in the design and construction of the homes, which caused extensive and unnecessary delays. Plaintiff also alleged that the Coast Defendants misused and converted funds that were to be used for construction of the homes. Plaintiff claimed that, as a result, the homes would be sold at prices well below those anticipated for the Project and that North Sea would be unable to pay him the amounts due under the Mezzanine Loan. Plaintiff further alleged that the Lender aided and abetted the Coast Defendants. Acres and Reliance moved to dismiss the complaint. The Court granted the motion.

Plaintiff contended that a fiduciary duty existed between the Lender and him. Saltini alleged that such a duty existed by reason of his reliance on promises that the Lender purportedly made which caused him to relinquish his position of security and control over the Project in order to become a mezzanine lender. These promises, maintained Saltini, required the Lender to perform its duties such that there would be sufficient funds from the sale of the homes to pay both the Lender and him.

The Court held that there was no fiduciary duty. The Court found that the relationship was simply contractual “whereby one creditor agree[d] to subordinate its claim against a debtor in favor of the claim of another.” Slip Op. at *4. This finding, noted the Court, was supported by the plain language of the Intercreditor Agreement, which specifically disclaimed any fiduciary relationship between the parties:

The Intercreditor Agreement, which is the only contractual agreement between the plaintiff and the Lender, provides, “Mezzanine Lender agrees that Senior Lender owes no fiduciary duty to Mezzanine Lender in connection with the administration of the Senior Loan and the Senior Loan Documents and Mezzanine Lender agrees not to assert any such claim.” Acceptance of the plaintiff’s version of the transaction would require the improper consideration of parol evidence, contradicting the clear terms of the Intercreditor Agreement, which contains a merger clause, precluding any extrinsic proof to add or vary its terms.

Id. (citations omitted).

“In any event,” said the Court, the “parties engaged in an arms’ length business transaction” and as sophisticated businesspeople, they “are not fiduciaries”. Id. (citations omitted).

The Court rejected Plaintiff’s attempt to impute “to the Lender duties to supervise and manage the project that [were] not found in the record.” Id. “The documentary evidence,” said the Court, “establishe[d] that the Lender’s obligation was merely to provide financing. Other defendants, specifically North Sea and the Coast defendants, were responsible for construction of the homes.” Id. The Court, therefore, refused to accept Saltini’s attempt to allege “special circumstances” that would transform “the business relationship between the plaintiff and the Lender into a fiduciary relationship, such as control by one party of the other for the good of the other or creation of an agency relationship.” Id.

The Court concluded by observing the following:

The plaintiff, an experienced architect, was not under the control of the Lender. That he was under financial pressure and had to give up certain things in order to obtain financing for the project does not create a fiduciary relationship. Accordingly, the ninth cause of action is dismissed.

Id. at **4-5.

Takeaway

There are two types of fiduciary relationships: 1) those created by law (e.g., statute) or contract; and 2) those that arise from the circumstances underlying the relationship between the parties and the nature of the transactions at issue. While courts generally look to a statute or contractual arrangement to determine the nature of the parties’ relationship (e.g., the first type of fiduciary relationship), the existence of a fiduciary relationship is not dependent solely upon a statute or contractual relation. See EBC I, Inc. v. Goldman, Sachs & Co., 5 N.Y.3d 11, 20 (2005). Rather, the actual relationship between the parties determines the existence of a fiduciary duty (e.g., the second type of fiduciary relationship). Id. In Saltini, as discussed, the Court looked at the contract to determine the relationship between the parties and determined that the language of the agreement was clear and unambiguous such that there was no fiduciary relationship between them.