Fraudulent Inducement: Settlement Agreements, Releases, and No Reliance Clauses

• Posted on: Dec 18 2023

By: Jeffrey M. Haber

In Columbia Consultants, LLC v. Danucht Entertainment, LLC, 2023 N.Y. Slip Op. 06439 (1st Dept. Dec. 14, 2023) (here), the Appellate Division, First Department addressed the issues in the title of this article: fraudulent inducement claims in the context of settlement agreements, broad releases and no reliance clauses. As discussed below, the Court found that the release at issue was broad enough to cover the alleged fraud claim and that the no reliance clause in the parties’ settlement agreement barred the claim to the extent it was based on extra-contractual representations. The Court also held that even if plaintiff could overcome the foregoing obstacles, plaintiff nevertheless failed to satisfy the justifiable reliance element of the claim, explaining that in light of the no reliance clause, any reliance on the extra-contractual representations was unreasonable.

Columbia Consultants involved a dispute between two former partners. Plaintiff and defendant previously owned and operated various nightclubs around the world. In 2015, plaintiff requested that defendant buy out his share in the businesses that they owned. The parties entered into an agreement (the “Agreement”) pursuant to which plaintiff was compensated for his share of the businesses and, among other things, granted certain rights to share in potential future revenues, in addition to the upfront payment of money. The Agreement was subject to a provision which granted plaintiff a substantial portion of the excess of any sale by defendant of his membership interests to a third party above the $2.5 million that defendant had paid plaintiff.

Almost immediately after the Purchase Agreement (and related agreements) was executed, the parties began to dispute the various amounts and rights set forth in the agreements. After two years of negotiations and threats of litigation, the parties entered into a settlement agreement to resolve all of their disputes (the “Settlement Agreement”).

Relevant to the appeal, the Settlement Agreement expressly provided that it “superseded,” “extinguished,” and “nullified” the obligations in the Agreement and related agreements. It contained, among other things, a broad mutual release of “all claims … known and unknown,” a no reliance clause whereby the parties expressly agreed that they were not relying on extra-contractual oral representations, a general merger clause, and a statement that each party understood “that it may later discover Claims or facts that may be different from, or in addition to, those that it or any other Releasor now knows … which … may have materially affected this Agreement.”

Plaintiff claimed that defendant made knowingly false and misleading statements regarding the negotiation and consummation of defendants’ sale of the purchased membership interests in 2017. Plaintiff maintained that, although defendant was “knee deep” in negotiations for the sale of the interests, defendant failed to disclose such negotiations to plaintiff, even when asked repeatedly if any negotiations were ongoing.

Plaintiff brought suit, claiming, among other things, fraudulent inducement against defendant. 

Defendant moved to dismiss, among other claims, the fraud cause of action on the grounds that the claim was barred by the broad release, no reliance clause, and other provisions in the Settlement Agreement. The motion court denied the motion (including on reargument). On appeal, the First Department modified the motion court’s order to grant the motion to dismiss the fraudulent inducement claim.

The Court held that “Plaintiffs released their claim that they had been fraudulently induced to enter into the settlement agreement and release.”¹ The Court explained that the “release cover[ed] all claims (with certain exceptions that [were] not relevant to this appeal), whether ‘known or unknown, foreseen or unforeseen, matured or unmatured, suspected or unsuspected, … arising out of or relating to’ the purchase agreements, the businesses covered by the purchase agreements, and the dispute between the parties concerning their obligations thereunder.”² The Court concluded that “[t]his [was] broad enough to cover plaintiffs’ fraud claim.”³

In New York, “a valid release constitutes a complete bar to an action on a claim which is the subject of the release.”⁴ If “the language of a release is clear and unambiguous, the signing of a release is a ‘jural act’ binding on the parties.”⁵ For this reason, “[a] release should never be converted into a starting point for … litigation except under circumstances and under rules which would render any other result a grave injustice.”⁶ 

The Court also held that “[t]he release was ‘fairly and knowingly made.’”⁷ In New York, “a release may encompass unknown claims, including unknown fraud claims, if the parties so intend and the agreement is ‘fairly and knowingly made.’”⁸ 

The Court found it dispositive that the Settlement Agreement was negotiated by counsel and that the Settlement Agreement specifically provided for the release of unknown claims, even if such claims were discovered after the agreement was executed: 

The settlement agreement and release was the subject of negotiations between counselled parties. [S]ection 1.3(b) [of the Settlement Agreement] provides that the release will remain in effect despite that each releasor “may later discover [c]laims or facts that may be different from … those that it … now knows or believes to exist regarding the subject matter of the release’ and which ‘if known at the time of signing of [the] [a]greement, may have materially affected [the] [a]greement and such [p]arty’s decision to enter into it.”

The Court further held that “Plaintiffs … failed to identify ‘a separate fraud from the subject of the release.’”¹⁰ Under New York law, a party that releases a fraud claim may later challenge that release as fraudulently induced only if he/she can identify a separate fraud from the subject of the release.¹¹ As the Court of Appeals observed, “[w]ere this not the case, no party could ever settle a fraud claim with any finality.”¹²

Finally, the Court noted that “[e]ven if the fraud claim were not barred by the release, it would fail for lack of justifiable reliance.”¹³ A plaintiff seeking to invalidate a release due to fraudulent inducement must “establish the basic elements of fraud, namely a representation of material fact, the falsity of that representation, knowledge by the party who made the representation that it was false when made, justifiable reliance by the plaintiff, and resulting injury.”¹⁴ 

In concluding that plaintiff failed to satisfy the justifiable reliance element of the claim, the Court pointed to the no-reliance clause in the Settlement Agreement.¹⁵ In New York, a party’s disclaimer of reliance cannot preclude a fraudulent inducement claim unless: (1) the disclaimer is specific to the fact alleged to be misrepresented or omitted; and (2) the alleged misrepresentation or omission does not concern facts peculiarly within the knowledge of the non-moving party.¹⁶ “Accordingly, only where a written contract contains a specific disclaimer of responsibility for extraneous representations, that is, a provision that the parties are not bound by or relying upon representations or omissions as to the specific matter, is a plaintiff precluded from later claiming fraud on the ground of a prior misrepresentation as to the specific matter.”¹⁷

In holding that the no-reliance provision of the Settlement Agreement barred plaintiff’s fraudulent inducement claim, the Court pointed to section 3 of the Settlement Agreement, which stated in pertinent part: “‘Each party … acknowledges that in entering into [the] agreement, it has not relied upon any representation or warranty made by the other parties …, except as specifically provided in section 2.”¹⁸ “[A]nd,” said the Court, “section 2 has nothing to do with indication of interest in buying membership interests.”¹⁹ Thus, concluded the Court, “[i]n light of section 3, plaintiffs’ reliance on [defendant’s] misrepresentation is unreasonable as a matter of law.”²⁰

Footnotes

1. Slip Op. at *1.
2. Id.
3. Id. (citing Centro Empresarial Cempresa S.A. v. AmÉrica MÓvil, S.A.B. de C.V., 17 N.Y.3d 269, 277 (2011); Sodhi v. IAC/InterActive Corp., 201 A.D.3d 451 (1st Dept. 2022); Avnet, Inc. v. Deloitte Consulting LLP, 187 A.D.3d 430, 431 (1st Dept. 2020)).
4. Global Minerals & Metals Corp. v. Holme, 35 A.D.3d 93, 98 (1st Dept. 2006).
5. Booth v. 3669 Delaware, Inc., 92 N.Y.2d 934, 935 (1998) (quoting Mangini v. McClurg, 24 N.Y.2d 556, 563 (1969)). See also Centro, 17 N.Y.3d at 276.
6. Id. (internal quotation omitted).
7. Slip Op. at *1 (quoting Centro, 17 N.Y.3d at 276 (internal quotation marks omitted)).
8. Centro, 17 N.Y.3d at 276 (citations omitted).
9. Slip Op. at *1.
10. Id. (citations omitted).
11. Centro, 17 N.Y.3d at 276 (citation omitted).
12. Id.
13. Slip Op. at *1.
14. Centro, 17 N.Y.3d at 276 (quoting Global Mins., 35 A.D.3d at 98).
15. Slip Op. at *1-*2.
16. Basis Yield Alpha Fund (Master) v. Goldman Sachs Group, Inc., 115 A.D.3d 128, 137 (1st Dept. 2014). See also Danann Realty Corp. v. Harris, 5 N.Y.2d 317, 323 (1959); MBIA Ins. Corp. v. Merrill Lynch, 81 A.D.3d 419 (1st Dept. 2011).
17. Basis Yield, 115 A.D.3d at 137.
18. Slip Op. at *2.
19. Id.
20. Id. (citations omitted).

Jeffrey M. Haber is a partner and co-founder of Freiberger Haber LLP.

This article is for informational purposes and is not intended to be and should not be taken as legal advice.