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Merger Clause Found Sufficient To Bar Fraud Claim By Sophisticated Plaintiff

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  • Posted on: Aug 16 2017

As a general matter, when parties negotiate an agreement in a clear and unambiguous document, their writing will be enforced according to its terms. Evidence outside the four corners of the document as to what the parties really intended (i.e., parole evidence) is generally inadmissible. Golden Gate Yacht Club v. Societe Nautique De Geneve, 12 N.Y.3d 248 (2009). Among the reasons for this rule is to give “stability to commercial transactions,” and other types of commercial interactions. W.W.W. Assoc. v Giancontieri, 77 N.Y.2d 157, 162 (1990). As the New York Court of Appeals observed, such a rule can safeguard “against fraudulent claims, perjury, death of witnesses … [and] infirmity of memory.…” Id.

Notwithstanding, questions arise about the enforceability of commitments made alongside a commercial transaction.  These questions tend to play out in disagreements over the meaning and effect of a contract, where one party attempts to rely on the extra-contractual statements of the other (e.g., in emails, telephone calls, or meetings) to support an argument, claim or defense.

One way to address such disputes before they happen is to include a “merger clause” or “integration clause,” in the contract or agreement.

What is a Merger Clause?

A merger clause is a provision in a contract that declares the writing to be the complete and final agreement between the parties.  The following is a common example of a merger clause:

The Agreement constitutes the entire agreement and understanding between the parties hereto and supersedes any and all prior agreements and understandings, oral or written, relating to the subject matter hereof.

Merger Clauses: Broad vs. Specific

Merger clauses typically are found at the end of a contract or agreement, among the other “boilerplate” provisions, and, as such, are often neglected or ignored during negotiations. Boilerplate merger clauses are given little weight by the courts. However, when the merger clause evidences a negotiation by the parties, courts accord such clauses more weight in determining the parties’ intent.

In New York, the courts have required the parties to specify the agreements and matters being merged or integrated into their agreement. See Hobart v. Schuler, 55 N.Y.2d 1023, 1024 (1982) (deeming merger clause to be insufficient to bar parol evidence of fraudulent misrepresentation where clause states “all representations, warranties, understandings and agreements between the parties are set forth in the agreement”); LibertyPointe Bank v. 75 E. 125th St., LLC, 95 A.D.3d 706, 706 (1st Dept. 2012) (concluding that merger clause is insufficient to bar claim for fraudulent inducement where it fails to reference particular misrepresentations allegedly made by former president). Without such specificity, the courts have allowed parole evidence to be used to explain the parties’ intent, especially in cases involving claims of fraudulent inducement. Danann Realty Corp. v. Harris, 5 N.Y.2d 317, 320-21 (1959) (holding that fraudulent inducement claim premised upon representations as to building’s operating expenses and expected profits was barred by merger clause that specifically disclaimed plaintiff’s reliance on representations regarding building’s “physical condition, rents, leases, expenses, [and] operation”); Laduzinski v. Alvarez & Marsal Taxand LLC, 132 A.D.3d 164, 169 (1st Dept. 2015) (holding that merger clause was mere boilerplate that was “too general to bar plaintiff’s claim since it makes no reference to the particular misrepresentations allegedly made here by [defendants].”) (internal quotation marks and citation omitted) (alteration in original).

Merger Clauses: Anti-Reliance Provisions

In order for a party to disclaim reliance on extra-contractual representations, an agreement must contain language that makes it clear that the parties are not relying on such representations.

The following is an example of a common anti-reliance provision:

Each of the Parties acknowledges that no other party, nor any agent or attorney of any other party, has made any promise, representation, or warranty whatsoever, and acknowledges that the Party has not executed or authorized the execution of this Agreement in reliance upon any such promise, representation or warranty, that is not expressly contained herein.

Courts will enforce anti-reliance language that identifies the specific information on which a party has relied and which forecloses reliance on other information. Danann, 5 N.Y.2d at 320 (finding that the plaintiff purchaser of a building could not assert that it was relying on oral representations made by the seller outside of a contract in which the plaintiff had specifically agreed in writing not to rely on such representations). See also Laxer v Edelman, 75 A.D.3d 584, 585–86 (2d Dept. 2010) (holding a fraudulent inducement claim concerning flooding and mold issues in building was barred by merger clause that disclaimed reliance on any statements by defendants regarding condition of premises).

There is, however, an exception to the enforceability of an anti-reliance provision – where the defendant has unique or peculiar knowledge of an allegedly misrepresented fact.  Under such circumstances, even a specific contractual disclaimer will not defeat a plaintiff’s contention that it reasonably relied on the misrepresentation. Danann, 5 N.Y.2d at 322.

The exception is designed to address circumstances under which a party would expend significant resources, or find it extraordinarily difficult to determine the truth or falsity of an oral misrepresentation (for example, where the information is not easily verifiable, such as a latent property defect). Schooley v. Mannion, 241 A.D.2d 677, 678 (3d Dept. 1997).  It does not apply, however, where the other party has the ability to learn the truth by the exercise of ordinary intelligence. See ACA Fin. Guar. Corp. v. Goldman, Sachs & Co., 25 N.Y.3d 1043, 1044 (2015).

“In assessing whether reliance on allegedly fraudulent misrepresentations is reasonable or justifiable, New York takes a contextual view, focusing on the level of sophistication of the parties, the relationship between them, and the information available at the time of the operative decision.” JP Morgan Chase Bank v. Winnick, 350 F. Supp. 2d 393, 406 (S.D.N.Y. 2004). Sophisticated parties are held to a higher standard, especially since they have “the means of knowing, by the exercise of ordinary intelligence, the truth, or the real quality of the subject of the representation.” Mallis v. Bankers Trust Co., 615 F.2d 68, 80-81 (2d Cir.1980) (quoting Schumaker v. Mather, 133 N.Y. 590, 596 (1892)). Therefore, “where sophisticated businessmen engaged in major transactions enjoy access to critical information but fail to take advantage of that access, New York courts are particularly disinclined to entertain claims of justifiable reliance.” Grumman Allied Indus. v. Rohr Indus., Inc., 748 F.2d 729, 737 (2d Cir.1984).

In addition, “[a] heightened degree of diligence is required where the victim of fraud had hints of its falsity.” JP Morgan Chase Bank, 350 F. Supp. 2d at 406. This rule applies where the “[c]ircumstances [are] so suspicious as to suggest to a reasonably prudent plaintiff that the defendants’ representations may be false”; in such cases, a plaintiff “cannot reasonably rely on those representations, but rather must make additional inquiry to determine their accuracy.” Id. (citations and internal quotation marks omitted).

Representaciones E Investigaciones Medicas, S.A. De C.V. v. Abdala

On July 31, 2017, Justice Sherwood of the Supreme Court, New York County, Commercial Division dismissed a fraud claim relating to the acquisition of a pharmaceutical company based on a merger clause in the transaction agreements. Representaciones E Investigaciones Medicas, S.A. De C.V. v. Abdala, 2017 NY Slip Op. 31619(U).

Background

The action arose out of two merger and acquisition transactions between sophisticated and well-represented parties, Teva Pharmaceutical Industries Limited (“Teva”) and Representaciones e Investigaciones Médicas, S.A. de C.V. (“Rimsa”), a Mexican pharmaceutical company owned by the defendants Fernando Espinosa Abdalá and Leopoldo de Jesús Espinosa Abdalá (the “Espinosas”). The first transaction involved the acquisition of Rimsa by Teva for $460 million pursuant to a Share Purchase Agreement (“SPA”) with the Espinosas; the second involved the acquisition of certain intellectual property for $1.84 billion that had been licensed to Rimsa by PPTM International S.à.r.l., a company controlled by the Espinosas located in Luxembourg, pursuant to a separate Asset Purchase Agreement.

According to Teva, the Espinosas operated Rimsa as a fraud and took elaborate steps to conceal their wrongdoing from both Mexican regulators and Teva. Under the Espinosas’ leadership, claimed Teva, Rimsa obtained registrations to sell its products from regulators by submitting made-up “paper” formulations and false test results for products not yet developed or tested. When Rimsa actually finished the products, it unlawfully sold them under the guise of those false registrations, even though the actual formulations were often completely different. To conceal the fraud from regulators during audits, Teva alleged that Rimsa concocted an elaborate scheme of “double paperwork” and parallel computing systems. The Espinosas then concealed the fraud from Teva during due diligence by using that same fraudulent double paperwork.

After the transactions closed, Teva received an anonymous email containing allegations of fraud. Teva investigated and, over the following months, uncovered what the Espinosas had known all along – Rimsa was selling numerous products in violation of the law.

As a result of the alleged violations, Teva claimed that it suffered substantial losses because it could not derive any revenue from products it could not lawfully sell. It also claimed that it had incurred costs from idle capacity and employee severance, as well as expenses investigating and attempting to develop and implement remediation plans. Finally, Teva alleged that the fraud imperiled its reputation as a reliable pharmaceutical manufacturer.

The Parties’ Arguments and Motion to Dismiss

Teva sued the Espinosas for fraud and breach of contract. The Espinosas moved to dismiss.

Regarding the fraud claim, the Espinosas argued, among other things, that the claim was barred by the merger clause in the SPA, which provided that Teva was not relying on any statements outside the SPA, itself, including statements made in due diligence.

In this regard, the Espinosas argued that even if misstatements made during due diligence were actionable, the merger clause in the SPA was specific and integrated any statements made during Teva’s due diligence.

Moreover, the information allegedly concealed from Teva was or could have been known to it.  Teva performed its own due diligence, and must have concluded that the issues raised in the complaint were not sufficiently problematic to stop it from making the purchase. According to the Espinosas, Teva failed to allege that the information “could not be discovered through the exercise of reasonable diligence” and that it is not its “own evident lack of due care which is responsible for [its] predicament,” as Teva had access to the Rimsa’s books and facilities during its due diligence.

Teva responded by stating that the merger clause in the SPA was not sufficiently specific to exclude the use of parol evidence to show fraud in the inducement. Teva also contended that, even if the merger clause was sufficiently specific, it would still be unenforceable because the fraud was peculiarly within the Espinosas’ knowledge. TIAA Glob. Investments, LLC v. One Astoria Sq. LLC, 127 A.D.3d 75, 87 (1st Dept. 2015).

The Court’s Ruling

The Court agreed with the Espinosas, finding that the merger clause was specific and directed to the claims asserted by Teva in its complaint:

Here, plaintiff has in the plainest language announced and stipulated that it is not relying on any representations as to the very matter as to which it now claims it was defrauded. Such a specific disclaimer destroys the allegations in plaintiffs’ complaint that the agreement was executed in reliance upon these contrary oral representations.… This merger clause specifies that the purchaser expressly acknowledges and agrees … that it is not relying on any statement, representation or warranty … in any materials made available … during the course of its Due Diligence Investigation, which are the representations and materials providing the basis for the remainder of the fraud claim.

Citation and internal quotation marks omitted; alteration added.

The Court went on to note that since the merger clause was negotiated by sophisticated parties, if Teva wanted to carve-out statements and representations made during due diligence from the merger clause, it could have done so. But, it did not. As such, Teva could not claim the merger clause was unenforceable.

Teva is a sophisticated entity and performed extensive due diligence … before entering into a major transaction, including a site visit and employee interviews. If it had wanted to include a carve-out that it could rely on the materials presented to it, or information included in due diligence, or a representation that the material it viewed during due diligence was correct, it could have done so. It did not.

The Court also rejected Teva’s argument that the exception to the anti-reliance provision of the merger clause saved its fraud claim, noting that Teva failed to “allege[] how the alleged misrepresentations remained particularly in the knowledge of the defendants despite Teva’s access to Rimsa’s personnel, facility, and products.”

Accordingly, the Court enforced the merger clause and dismissed Teva’s fraud claim.

Takeaway

Parties to a transaction should carefully negotiate and consider the content of their merger clauses, and not rely on boilerplate language. In that regard, they should specify the representations and matters being merged or integrated into the agreement. If the parties intend complete integration, then they should ensure that the merger clause clearly articulates their intention. And, if they include anti-reliance language in the merger clause, such language should be specific and identify the representations and matters to be included or excluded.

In Rimsa, many of these takeaways were at play. The merger clause was negotiated by sophisticated parties; it was not mere boilerplate. Because it was negotiated, it was specific in content and scope, thereby demonstrating the parties’ intent as to representations and matters covered by the clause. And, because Teva was sophisticated and had, by its own admission, conducted an extensive and thorough due diligence, it could not escape the anti-reliance provision in the merger clause directed to its due diligence. Rimsa therefore exemplifies the effect of a negotiated and specific merger clause on a dispute between parties to a contract.

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