Merger Clauses, Disclaimer Clauses and Derivative Standing

• Posted on: Feb 7 2022

By: Jeffrey M. Haber

In today’s article, we examine three principles of law that can spell the end of a litigation: disclaimer clauses, merger or integration clauses, and derivative standing.

The Merger Clause

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.¹ Among the reasons for this rule is to give “stability to commercial transactions,” and other types of commercial interactions.² As the New York Court of Appeals observed, such a rule can safeguard “against fraudulent claims, perjury, death of witnesses … [and] infirmity of memory.…”³ 

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.⁴ A merger clause is a provision in a contract that declares the writing to be the complete and final agreement between the parties. 

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. 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.⁵ 

The Disclaimer Clause

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. 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.⁶ “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.”⁷ 

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.⁸ 

Derivative Standing: Direct vs. Derivative

A shareholder’s derivative action is a lawsuit “brought in the right of a … corporation to procure a judgment in its favor, by a holder of shares or of voting trust certificates of the corporation or of a beneficial interest in such shares or certificates.”⁹ Derivative claims against corporate officers and directors belong to the corporation itself.¹⁰  

In considering whether a claim is direct or derivative, courts look to the nature of the wrong and the person or entity to whom the relief should go.¹¹ Thus, for a shareholder’s injury to be direct it must be independent of any alleged injury to the corporation. The shareholder must demonstrate that the duty breached was owed to the stockholder and that he/she can prevail without showing an injury to the corporation.¹² 

Derivative claims that are improperly alleged as direct claims will be dismissed for lack of standing.¹³ 

A derivative plaintiff must be a shareholder of the company “at the time of bringing the action,” and at the time of the alleged wrongdoing.¹⁴ “[A] plaintiff who ceases to be a shareholder, whether by reason of a merger or for any other reason, loses standing” to sue derivatively.¹⁵ Accordingly, courts have focused on the plaintiff’s stock ownership during both points in time, and in particular at the time of the alleged misconduct.

In New York, the contemporaneous ownership rule is “strictly enforced.”¹⁶ To satisfy the requirement, the plaintiff must have “acquired his or her stock in the corporation before the core of the allegedly wrongful conduct transpired” and continued to own the stock “throughout the course of the activities that constitute the primary basis of the complaint.”¹⁷

“[F]ailure to satisfy the . . . contemporaneous ownership requirement of § 626(b) is such a fundamental lack of capacity that it results in failure to state a cause of action.”¹⁸ For this reason, courts require the plaintiff to plead contemporaneous ownership with particularity rather than through boilerplate assertions.¹⁹ 

Goldman v. Nerds Broadway Ltd. Liability Co.

In Goldman v. Nerds Broadway Ltd. Liability Co., 2022 N.Y. Slip Op. 00721 (1st Dept. Feb. 3, 2022) (here), the foregoing principles were examined by the Appellate Division, First Department.

Goldman was brought by investors in a failed Broadway musical production provisionally entitled “Nerds” that was to be based upon “the rivalry between the late Steve Jobs of Apple and Bill Gates of Microsoft.” The musical was cancelled before production or previews began. Plaintiffs alleged that because of defendants’ mismanagement and intentional misrepresentations they lost their investment in the musical production.

In or about December 2015, only about $200,000 had been raised towards the costs of staging the production even though at that time production costs were thought to be approximately $7.5 million. Plaintiffs alleged that in early January 2016, defendants decided to enter into a contract with a theatrical organization for over $600,000 despite not having raised sufficient capital to stage the production. Plaintiffs claimed they invested over $600,000 into the production from late January through early March 2016. 

On March 8, 2016, defendants announced they were not moving forward with the production. 

Plaintiffs alleged that “the failure of the venture was the foreseeable and inevitable result of the reckless financial commitments Defendants caused the [Nerds] LLC to make without adequate capitalization, contrary to Defendants’ representations of financial health.” 

Plaintiffs asserted five causes of action. The first cause of action was for breach of contract against defendants Eleven LLC and Halmos LLC, alleging that they “breached the Operating Agreement by failing to render services customary and usually rendered by theatrical producers, devote as much time to the affairs of the LLC as necessary, or perform their duties in good faith and instead performed their duties in a grossly negligent manner and/or through willful misconduct.” The second cause of action against all defendants was for breach of fiduciary duty and the third cause of action was for the same relief purportedly brought on a derivative basis. The fourth cause of action sounded in fraud and misrepresentation. The fifth cause of action sought rescission of the operating agreement. 

Defendants moved to dismiss the complaint.

The motion court held that plaintiffs’ fraud allegations were barred because of a disclaimer clause and a merger clause in the operating agreement governing the parties. According to the motion court, the operating agreement expressly provided that “[e]ach Member represent[ed], warrant[ed], and covenant[ed] that such Member … ha[d] not been induced to enter into th[e] Agreement by any warranties, guarantees, promises, statements or representations, whether express or implied, except those that [were] expressly and specifically set forth [t]herein, and that the Managers [were] not … bound or liable in any manner by any express or implied warranties, guarantees, promises, statements or representations pertaining hereto except as [were] expressly and specifically set forth [t]herein.” Because plaintiffs failed to state a fraud claim, their request for rescission was dismissed.

Plaintiffs appealed. The First Department affirmed.

The First Department’s Decision

The Court held that the disclaimer clause in the operating agreement foreclosed plaintiffs’ request for relief: 

The court, however, properly dismissed the fraud claims as barred by the disclaimers in the agreement, which included an express representation that plaintiffs’ professionals had examined the financial records of the company. Given that the fraud alleged was a misrepresentation of how much money had been raised and invested, this disclaimer requires dismissal.²⁰

The Court also held that plaintiffs lacked derivative standing to pursue the claims on behalf of the company:

Plaintiff investors’ claims for breach of contract and fiduciary duty are based on defendants’ decision to have the company enter into a contract with the Shubert Organization. Because they allege harm only to the company, and not based on some particular injury or right of the plaintiffs, these claims are derivative. As such, they were properly dismissed for lack of standing, because the transaction complained of occurred before any were members of the company.²¹

Finally, the Court held that “[b]ecause plaintiffs’ claims for fraud, breach of contract, and fiduciary duty were properly dismissed, their ‘claim’ for rescission, which is actually a remedy, was also properly dismissed.”²²

Takeaway

The rules concerning derivative standing make sense. They are designed to prevent plaintiffs from buying into a lawsuit or commencing a derivative action by simply purchasing shares after the alleged wrong has occurred.²³ Although there are exceptions to the rule (not applicable in Goldman), the law has long required plaintiffs bringing a derivative action to have a stake in the company on whose behalf the action is commenced.  After all, if the plaintiff is not a shareholder of the company, then he or she has no right to vindicate the company’s rights and obtain a judgment on its behalf. In Goldman, the Court reinforced this common-sense rule.

In Danann Realty, the Court of Appeals noted that “specific disclaimer[s] destroy[] the allegations in the complaint that the [subject] agreement was executed in reliance upon contrary oral representations.”²⁴ Goldman reiterates this basic principle of law. As the First Department observed, the contractual disclaimer at issue was specific to plaintiffs’ allegations and directly addressed the subject of the alleged misrepresentation. Consequently, the contract provision at issue was specific enough to preclude the fraud claim.

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.

1. Golden Gate Yacht Club v. Societe Nautique De Geneve, 12 N.Y.3d 248 (2009).
2. W.W.W. Assoc. v Giancontieri, 77 N.Y.2d 157, 162 (1990).
3. Id.
4. 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).
5. 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).
6. Basis Yield Alpha Fund [Master] v. Goldman Sachs Group, Inc., 115 A.D.3d 128, 137 (1st Dept. 2014). See also Danann Realty, 5 N.Y.2d at 323; MBIA Ins. Corp. v. Merrill Lynch, 81 A.D.3d 419 (1st Dept. 2011).
7. Basis Yield, 115 A.D.3d at 137.
8. Danann Realty, 5 N.Y.2d at 322.
9. Marx v. Akers, 88 N.Y.2d 189, 193 (1996) (quoting Business Corporation Law § 626 (a)).
10. Auerbach v. Bennett, 47 N.Y.2d 619, 631 (1979).
11. Yudell v. Gilbert, 99 A.D.3d 108, 114 (1st Dept. 2012).
12. Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A2d 1031, 1039 (Del. 2004).
13. Abrams v. Donati, 66 N.Y.2d 951, 953 (1985) (“[a] complaint the allegations of which confuse a shareholder’s derivative and individual rights will, therefore, be dismissed.”) (internal citations omitted).
14. See, e.g., BCL § 626(b); Pessin v. Chris-Craft Indus., 181 A.D.2d 66, 70 (1st Dept. 1992).  See also Lewis v. Anderson, 477 A.2d 1040, 1049 (Del. 1984).
15. Lewis, 477 A.2d at1049.
16. Honzawa Holding Co. v. Hiro Enter. USA, 291 A.D.2d 318, 318 (1st Dept. 2002).
17. In re Bank of New York Deriv. Litig., 320 F.3d 291, 298 (2d Cir. 2003).
18. Roy v. Vayntrub, 15 Misc. 3d 1127(A), 2007 NY Slip Op 50868(U) (Sup Ct., Nassau County 2007), at *6 (citing Barr v. Wackman, 36 N.Y.2d 371 (1975)).
19. See, e.g., In re Computer Sciences Corp. Deriv. Litig., 2007 WL 1321715, at *15 (C.D. Cal. Mar. 26, 2007) (“[G]eneral allegation[s] [are] insufficient to allege contemporaneous ownership during the period in which the questioned transactions occurred.”).
20. Slip Op. at *1 (citation omitted).
21. Id. (citations omitted).
22. Id. (citations omitted).
23. See, e.g., Independent Investor Protective League v. Time, Inc., 50 N.Y.2d 259, 263 (1980).
24. 5 N.Y.2d at 320-21.