Non-Recourse Contract Provisions and The Inducement to Continue Performing Under a Contract as The Basis For A Fraud Claim

• Posted on: Jul 15 2024

By: Jeffrey M. Haber

In Iberdrola Energy Projects v. Oaktree Capital Management L.P., 2024 N.Y. Slip Op. 03798 (1st Dept. July 11, 2024) (here), the Appellate Division, First Department was asked to determine the scope of a no recourse provision in a contract¹ between two sophisticated commercial actors relating to the construction of a power plant, and, relatedly, the extent to which certain non-parties to the contract (defendants) were insulated from liability by virtue of that provision. As discussed below, the Court held (as did the motion court) that the non-recourse provision in the parties’ contract barred the majority of plaintiff’s claims against defendants, and that plaintiff’s fraud claim, which would otherwise have survived the non-recourse provision, was not sufficiently pleaded.

Iberdrola dates back approximately 10 years. At that time, defendants wanted to replace a coal power plant in Salem, Massachusetts with a gas generation power plant. Defendants created a special-purpose entity, non-party Footprint Power Salem Harbor Development LP (“Footprint”), to serve as the company charged with constructing the new plant. Defendants owned, controlled, and managed Footprint, and were Footprint’s majority and controlling equity holders. Moreover, the majority of Footprint’s board of directors and officers were defendants’ employees.

In December 2014, Footprint retained plaintiff to be the project’s engineering, procurement, and construction contractor. The contract between plaintiff and Footprint called for plaintiff to provide services, materials, and labor in exchange for the contract price. The contract also contemplated additional compensation for change orders. Footprint was permitted to terminate the contract for convenience or for a material breach by plaintiff. In the event of termination for the former, Footprint would incur substantial payment obligations; termination for the latter would not. Under the contract, plaintiff was required to post a standby letter of credit in the amount of 20% of the contract price (approximately $140 million) as security for plaintiff’s performance. Footprint was permitted to draw on the letter of credit only “upon any Contractor’s breach or failure to perform, when and as required, any of its material obligations under th[e] Contract with five Business Days prior written notice to Contractor.”

Relevant to the Court’s decision, the contract contained a non-recourse provision. In pertinent part, it provided that Footprint’s obligations under the agreement were intended only to be Footprint’s obligations and those of the corporation that was its sole general partner and that any claim based on those obligations were to be asserted against Footprint, there being “no recourse for any obligation of [Footprint] hereunder, or for any claim based thereon or otherwise in respect thereof … against any incorporator, shareholder, officer or director or Affiliate, as such, past, present or future of such corporate general partner or any other subsidiary or Affiliate of any such direct or indirect parent corporation or any incorporator, shareholder, officer or director, as such, past, present or future, of any such parent or other subsidiary or Affiliate.”

The contract required plaintiff and Footprint to submit to binding arbitration any dispute between those parties arising out of, relating to, or in connection with the contract.

A choice-of-law provision dictated that the contract was governed by and construed in accordance with New York law.

The project began in 2015 but delays and cost overruns ensued. Among the reasons for the problems were plaintiff’s performance, and Footprint’s management approach and sharp business practices. For several months, the parties tried to resolve their disagreements and achieve completion of the project. Plaintiff would come to characterize these efforts as a ruse by defendants to keep plaintiff working on the project, while defendants maintained that they participated in the negotiations in good faith.

On April 15, 2018, at a time when the project was 98% complete, Footprint gave plaintiff notice of termination for cause, citing, among other things, plaintiff’s failure to achieve substantial completion by the required date. Simultaneously, Footprint gave plaintiff notice of Footprint’s intent to draw on the letter of credit. Later, Footprint drew the $140 million afforded by the letter of credit. A replacement contractor was retained by Footprint and the remaining work was completed.

Plaintiff initiated an arbitration proceeding against Footprint, claiming that Footprint breached the contract, engaged in tortious conduct, and violated the Massachusetts Unfair Trade Practice Act. Plaintiff sought $700 million in damages. Footprint appeared in the arbitration proceeding and asserted counterclaims. Following a thorough hearing, the arbitration panel determined, among other things, that Footprint lacked cause to terminate the contract and that it terminated the contract as a pretense to draw on the letter of credit. After offsetting plaintiff’s damages with those of Footprint, the panel issued a final award in plaintiff’s favor of $236,404,377. That award was confirmed by Supreme Court in January 2022.

In the wake of the adverse arbitration award, Footprint filed for bankruptcy, thereby diminishing the possibility that plaintiff would realize a recovery on the award.

In April 2021, during the pendency of the arbitration, plaintiff commenced the action seeking damages against defendants. In its amended complaint, plaintiff asserted causes of action for tortious interference with contract, fraud, unjust enrichment, and violations of Massachusetts’s deceptive trade practices statute. The gravamen of plaintiff’s claims is that, as plaintiff’s work on the project progressed, defendants were concerned that the projected revenues of the gas generation plant were diminishing; defendants did not want to make significant, additional investments in the project; the confluence of diminishing projected revenues and increasing completion costs caused defendants to face losses on their investment; and, to avoid that eventuality, defendants devised a scheme to force plaintiff, through the funds available under the letter of credit, to pay for completion of the work. According to plaintiff, in the months leading up to their termination of the contract, defendants lied to plaintiff to convince it to continue working on the project until it was approximately 98% complete; defendants then encouraged Footprint to pretextually terminate the contract, ostensibly for a material breach by plaintiff, to access the $140 million available under the letter of credit; and, lastly, defendants used the draw from the letter of credit to pay a third party to complete the remaining 2% of the work.

Defendants moved to dismiss the complaint under, relying principally on the non-recourse provision in the agreement. Plaintiff opposed the motion and informally sought leave to replead or amend the amended complaint.

The motion court granted the motion, denied (sub silencio) plaintiff leave to replead or amend, and dismissed the amended complaint with prejudice. The motion court observed that plaintiff was seeking to hold Footprint’s principals liable for its conduct because it would not be able to satisfy the arbitration award and concluded that the nonrecourse provision barred all of plaintiff’s claims except for plaintiff’s fraud claim. The motion court found, however, that plaintiff failed to adequately plead the element of justifiable reliance necessary to sustain a cause of action for fraud.

After the motion court issued a supplemental order, judgment was entered dismissing the complaint with prejudice.

On appeal, plaintiff argued that the non-recourse provision barred contractual causes of action, not tort claims. Pointing to the particular language of the nonrecourse provision and caselaw addressing the scope and enforceability of non-recourse provisions generally, plaintiff maintained that its tortious interference with contract, fraud, and statutory claims survived the non-recourse provision. Plaintiff noted that, by virtue of public policy, its fraud claim was not subject to the non-recourse provision. Plaintiff further maintained that the “as such” language in non-recourse provision meant that incorporators, shareholders, officers, directors and affiliates — like defendants — were insulated from status-based claims against them, not torts they commit in their individual capacities. Additionally, plaintiff contended that the no-third party-beneficiaries clause established that defendants could not enforce the non-recourse provision because they had no rights under the contract.

Regarding the sufficiency of its pleading, plaintiff maintained that it adequately pleaded justifiable reliance on its fraud claim in the form of forbearance by alleging that it had the right to suspend performance and seek remedies under the contract once Footprint stopped paying it, but continued working and forbore from exercising contractual remedies because of defendants’ misrepresentations (e.g., defendants’ statements to plaintiff to convince it to continue working on the project notwithstanding that it was not getting paid). 

Defendants argued that plaintiff’s claims for tortious interference with contract, negligent misrepresentation, and unjust enrichment, as well as those based on Massachusetts’s statutory law, were covered (and therefore barred) by the non-recourse provision, because they were “based on” or “in respect” of the contract. Defendants noted that the contract not only supplied the necessary context for the claims plaintiff had pleaded, but also the essential predicate for all of the causes of action. Defendants disagreed with plaintiff’s reading of the phrase “as such,” and maintained that those words meant that, for the nonrecourse provision to apply, defendant’s status as a director, officer, shareholder or affiliate must be relevant to the claim, i.e., the claim must arise from actions taken in the listed role. Defendants also claimed that the no-third-party-beneficiaries clause had no bearing on the non-recourse provision because defendants were not seeking to enforce any right under the contract; rather, they were defending themselves from civil liability by observing that the contract limits plaintiff’s ability to sue them.

Regarding the fraud claim, which defendants recognized was not barred by the non-recourse provision, defendants argued that it was nothing more than a repackaged contractual cause of action. Defendants also asserted that plaintiff failed to adequately allege detrimental reliance on defendants’ purported misrepresentations because plaintiff was already contractually obligated to perform the unfinished work, and plaintiff did not relinquish any rights under the contract. 

The Court held that the non-recourse provision was not limited to plaintiff’s breach of contract claims. ²“That provision,” said the Court was “as broad as it is clear: no liability could be imposed upon various individuals and entities for ‘any claim based [on the contract] or otherwise in respect thereof.’”³ The Court noted that the definition of “claims” underscored the lack of ambiguity of the non-recourse provision: “[g]iving the commercial contractual language its plain meaning and effect, defendants are exculpated from any breach of contract liability and any other claims related to or in connection with the contract.”⁴ The Court explained that “[p]laintiff’s causes of action for tortious interference with contract, unjust enrichment, and violations of Massachusetts’s deceptive trade practices statute are all hinged or predicated on conduct taken under or in contravention of the contract.”⁵ Thus, concluded the Court, “those causes of action all relate to or are connected with the contract and are therefore barred by the non-recourse provision.”⁶

The Court rejected the notion that it could “provide rough justice to plaintiff by dint of distorting the plain meaning of the contract to relieve plaintiff of the consequences of its contractual arrangement.⁷ Indeed, noted the Court, “[h]ad plaintiff wanted to limit the nonrecourse provision to breach of contract claims, it should not have agreed to such a sweeping nonrecourse provision. Plaintiff could have insisted that the nonrecourse provision state expressly that it was limited to breach of contract claims, or that it did not apply to tort claims. Instead of insisting on a narrow nonrecourse provision, plaintiff assented to a broad one.”⁸

Similarly, the Court refused disturb the clear, detailed allocation-of-risk-of-economic-loss scheme agreed upon by the parties under the guise of contractual interpretation.⁹ The Court observed that plaintiff, a sophisticated commercial actor, “knew that it was entering into a significant contractual undertaking with a special-purpose entity, and the contract provided for a specific dispute-resolution mechanism — arbitration — that carried with it a risk that the special-purpose entity would not be able to satisfy an ensuing award.”¹⁰ “Plaintiff could have bargained for protections to avoid or mitigate losses occasioned by the conduct of a judgment-proof special-purpose entity (e.g., conditions on Footprint’s ability to draw on the letter of credit, a payment guaranty from one or more of defendants, a narrow nonrecourse provision),” noted the Court, “but it chose to enter into the contract as written.”¹¹ 

“Ultimately,” said the Court, “plaintiff got the benefit of its bargain: arbitration on its cognizable claims against Footprint, which proceeding yielded a sizable award that was converted to a judgment.”¹²

The Court also rejected plaintiff’s reading of the phrase “as such” in the non-recourse provision, which plaintiff viewed as insulating incorporators, shareholders, officers, directors, and affiliates from status-based claims only, not torts they commit in their individual capacities.¹³ “In light of the otherwise broad language of the nonrecourse provision, the plain, sensible reading of ‘as such’ (and the one that gives the phrase meaningful effect) is the one proposed by defendants: that a defendant’s status as an incorporator, shareholder, officer, director, or affiliate must be relevant to the claim asserted against the defendant in order for the claim to be encompassed by the nonrecourse provision.”¹⁴ The Court also found that defendants’ reading of “as such” comported with the evident purpose of the non-recourse provision, which was to provide Footprint and other covered actors related to it (including defendants) expansive freedom from liability.¹⁵ 

With respect to its fraud claim, plaintiff asserted that it adequately pleaded justifiable reliance because it had the right to suspend performance and seek remedies under the contract once Footprint stopped paying it, but it continued working because of defendants’ misleading statements designed to keep plaintiff working on the project. Defendants argued that plaintiff failed to adequately allege detrimental reliance on defendants’ purported misrepresentations because plaintiff was already contractually obligated to perform the unfinished work. The Court agreed with defendants.

The Court found that “[p]laintiff was obligated to perform all design, engineering, and construction work, and achieve substantial completion of the project by May 31, 2017. And plaintiff was required to continue to perform notwithstanding that Footprint stopped paying plaintiff disputed amounts in 2018.”¹⁶ The Court noted that the parties contemplated a continued obligation to perform notwithstanding any disputes between them.¹⁷

Moreover, noted the Court, “plaintiff did not relinquish any right it otherwise enjoyed as a result of defendants’ alleged fraudulent misrepresentations. To the contrary, plaintiff pursued the remedy afforded it by the contract: arbitration against Footprint.”¹⁸

“Ultimately,” concluded the Court, “the crux of the fraud claim in the amended complaint is that defendants fraudulently induced plaintiff to continue performing under the contract, and that is an insufficient basis on which to rest such a claim.”¹⁹ 

FOOTNOTES

1. A no recourse clause, also known as a non-recourse clause, is a provision in a contract that limits the liability of certain parties to the subject of the agreement. The purpose of the clause is to exclude persons or entities who may have been involved in the subject transaction from being held liable for claims or obligations related to the agreement. ↩︎
2. Slip Op. at *5. ↩︎
3. Id. ↩︎
4. Id. at *5-*6 (citation and footnote omitted). ↩︎
5. Id. at *6. ↩︎
6. Id. ↩︎
7. Id. (citations omitted). ↩︎
8. Id. (citations omitted). ↩︎
9. Id. ↩︎
10. Id. ↩︎
11. Id. (citation and footnote omitted). ↩︎
12. Id. ↩︎
13. Id. ↩︎
14. Id. at *6-*7. ↩︎
15. Id. at *7. ↩︎
16. Id. ↩︎
17. Id. ↩︎
18. Id. ↩︎
19. Id. (citing Megaris Furs v. Gimbel Bros., 172 A.D.2d 209, 212 (1st Dept. 1991) (“Simply put, one cannot be induced to tender a performance which is required as a part of a preexisting contractual obligation”; that is to say, “a plaintiff cannot claim to have been defrauded into doing what it already was legally bound to do”) (internal quotation marks 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.