Releases and Fraudulent Inducement

• Posted on: Feb 18 2024

By: Jeffrey M. Haber

In New York, “a valid release constitutes a complete bar to an action on a claim which is the subject of the release.”[1] If “the language of a release is clear and unambiguous, the signing of a release is a ‘jural act’ binding on the parties.”[2] 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.”[3]

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.’”[4]

However, if the release was obtained under duress, through illegality, fraud or mutual mistake, it may be invalidated, a burden which is borne by the party seeking to set aside the release.[5] And the party seeking to set aside the release “may later challenge that release as fraudulently induced only if it can identity a separate fraud from the subject of the release.”[6] To allow anything less would undermine a party’s ability to settle a fraud claim with finality.[7]

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.[8] As the Court of Appeals observed, “[w]ere this not the case, no party could ever settle a fraud claim with any finality.”[9]

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.”[10]

In LMM Capital Partners, LLC v. Mill Point Capital, LLC, 2024 N.Y. Slip Op. 00806 (1st Dept. Feb. 15, 2024) (here), the Appellate Division, First Department addressed the foregoing principles.

[Eds. Note: the factual discussion comes from the First Department’s decision and order.]

In early 2020, plaintiff LMM Capital Partners, LLC (“LMM”), a private equity firm, and defendant Martin Kelly (“Kelly”), the CEO and majority owner of defendant E&M Logistics, Inc. (“E&M”), a leading distributor of food and beverages, began discussing and negotiating plaintiff’s acquisition of E&M. As part of the negotiation process, plaintiff and E&M entered into a Letter of Intent (“LOI”). The LOI provided, among other things, that should E&M elect not to close the transaction for any reason, it would pay a “breakup fee” of $400,000.00 to plaintiff. During negotiations with E&M, plaintiff sought an investment partner with which it could complete the transaction. Plaintiff narrowed its search down to two other private equity firms, nonparty Tenex Capital Management (“Tenex”) and defendant Mill Point Capital LLC (“Mill Point”). During the search, Mill Point and plaintiff entered into a Non-Circumvention Agreement (“NCA”) in which Mill Point agreed to not pursue the acquisition of E&M, for a certain period of time, on its own.

Ultimately, plaintiff selected Tenex and moved forward with the transaction. Less than one month later, Kelly told plaintiff’s managing partner, Elisha Aharon (“Aharon”) that Kelly would like to terminate all negotiations with plaintiff and pay the breakup fee. Kelly also informed Aharon that E&M’s two largest vendors, nonparties Nestle and Froneri, would not approve the sale of E&M to any private equity fund. Aharon attempted to dissuade Kelly and asked to speak to someone at Nestle and Froneri to assure them that LMM and Tenex were the right ones for the deal. Kelly declined to arrange such a meeting. A few days later E&M’s attorney sent a Mutual Termination Agreement and Release to Aharon. Both Aharon, on behalf of LMM, and Kelly, on behalf of E&M, executed the release which terminated the LOI and provided that E&M would pay plaintiff a total of $420,000.00. Pursuant to the agreement, plaintiff released: E&M

from and against any and all manner of actions, causes of action, … , claims, demands, damages, … , costs, expenses, reasonable attorneys’ fees, … , and liabilities … of whatsoever kind and nature, whether based on tort (including, without limitation, acts of negligence), contract or any other theory of recovery, whether at law or in equity or otherwise, whether known or unknown, liquidated or unliquidated, suspected or unsuspected and whether or not concealed or hidden, which LMM … had, now has, or hereafter may have against the Company … arising out of, relating to, connected with, or incidental to, the Letter of Intent or the transaction contemplated thereby.

The Termination Agreement defined “Company Released Parties” as, “(a) the Company’s past, present and future Affiliates (as defined below); (b) the Company’s and the Company’s Affiliates’ predecessors, successors, and assigns; and (c) the directors, officers, members, managers, shareholders, employee stock ownership plan, partners, financing and equity sources, trustees, supervisors, employees, agents, and representatives of each Party included within (a) and (b) immediately above.” Affiliates was defined as “with respect to a Party, an entity which, directly or indirectly, controls, is controlled by, or is under common control with such Party.”

Less than two months after signing the Termination Agreement, Aharon learned that Mill Point was pursuing E&M. A mere three months later, E&M and Mill Point announced that Mill Point had acquired E&M for $80 Million, which was six million more than LMM had offered.

Soon thereafter, plaintiff commenced the action, alleging breach of the NCA and tortious interference with plaintiff’s business relations against Mill Point; tortious interference with contract and constructive fraud against Kelly and E&M; and fraudulent inducement against Kelly and E&M. Plaintiff also sought a declaration that the Termination Agreement and release were unenforceable.

Defendants moved to dismiss the complaint pursuant to CPLR 3211(a)(1), (5), and (7). The motion court granted defendants’ motion, with prejudice.

On appeal, the First Department unanimously affirmed.

As an initial matter, the Court noted that the case turned on the release in the NCA and whether plaintiff’s claim for fraudulent inducement fell outside the scope of that release. The reason being that if the release was valid, then the claims asserted by plaintiff would be rendered moot.

Turning to the release, the Court held that the release was “broad” and “encompassed fraud claims, both known and unknown, suspected and unsuspected, which plaintiff had, now had or hereafter may have.”[11] The Court noted that plaintiff’s allegations – that “E&M and Kelly knowingly falsely stated to LMM that Nestle and Froneri would never enter into a deal with a private equity firm or fund” and that they did so “with an intent to cause LMM to enter into the Termination Agreement under false pretenses and to stop pursuing the E&M deal …” – arose out of, related to, were connected with or incidental to the transaction contemplated by the LOI, and constituted claims that plaintiff explicitly released when it signed the Termination Agreement.[12] Thus, concluded the Court, “the fraud described by plaintiff fell ‘squarely within the scope of the release’ and [was] an attempt to convert the release into a starting point for litigation, which is impermissible.”[13]

The Court rejected plaintiff’s argument that it justifiably relied on Kelly and E&M’s misrepresentations when it entered into the Termination Agreement. The Court found that plaintiff “had hints that Kelly’s representation that Nestle and Froneri would not approve of a private equity buyer for E&M were false.”[14] “First,” said the Court, “Kelly had previously informed plaintiff that Nestle and Froneri had approved the deal with plaintiff.”[15] “Second,” noted the Court, “plaintiff knew that Nestle had sold a majority stake in its U.S. ice cream business to a private equity firm in 2019, so it knew that Nestle did not always disapprove of private equity buyers.”[16]

“When a party fails to make further inquiry or insert appropriate language in the agreement for its protection, it has willingly assumed the business risk that the facts may not be as represented,” explained the Court.[17] The Court held that “[p]laintiff ‘should have sought to condition the settlement on the truth of the representations by [Kelly/E&M] that induced [plaintiff] to enter the settlement.’”[18]

The Court also rejected plaintiff’s reliance on the special facts doctrine.[19] The special facts doctrine “requires satisfaction of a two-prong test: that the material fact was information peculiarly within the knowledge of one party and that the information was not such that could have been discovered by the other party through the exercise of ordinary intelligence.”[20] The Court held that plaintiff “fail[ed] to satisfy that test: the fact that nonparties Nestle and Froneri would actually allow a private equity fund to buy E&M was not peculiarly within the knowledge of E&M and there was nothing stopping plaintiff from contacting Nestle and Froneri directly.”[21] The Court noted that “[p]laintiff’s claims on appeal that Kelly precluded it from having contact information for Nestle and Froneri and that its October 2020 call with a Nestle Vice President was not with a decision maker are not supported by the record.”[22]

“In sum,” concluded the Court, “the motion court properly dismissed the fourth through sixth causes of action, which seek to invalidate the release.”[23]

Turning to plaintiff’s “even if” arguments – i.e., the release is valid – the Court held that the parties covered by the release included Mill Point, even if plaintiff did not intend to include it.[24] The Court held that the language of the release was “‘unmistakenly clear’” making plaintiff’s intent as to who was being released “‘irrelevant’”.[25] The release included “Company Affiliates”, said the Court, “which was defined as a party or entity that ‘directly or indirectly, controls, is controlled by, or is under common control with such’ Company and Company Affiliates. Upon acquiring E&M, Mill Point was covered by the release as a Company Affiliate.”[26]

Finally, the Court rejected “[p]laintiff’’s contention that the release did not cover conduct after its date” because “[t]he release covers any claims that plaintiff ‘hereafter may have.’”[27]

__________________________________________

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] Global Minerals & Metals Corp. v. Holme, 35 A.D.3d 93, 98 (1st Dept. 2006).

[2] 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 Empresarial Cempresa S.A. v AmÉrica MÓvil, S.A.B. de C.V., 17 N.Y.3d 269, 276 (2011).

[3] Centro, 17 N.Y.3d at 276 (quoting Mangini, 24 N.Y.2d at 563).

[4] Centro, 17 N.Y.3d at 276 (quoting Mangini, 24 N.Y.2d at 566-567).

[5] Id.

[6] Id.; Silver Point Capital Fund, L.P. v. Riviera Resources, Inc., 198 A.D.3d 432, 433 (1st Dept. 2021).

[7] Centro, 17 N.Y.3d at 276.

[8] Id. (citation omitted).

[9] Id.

[10] Id. (quoting Global Mins., 35 A.D.3d at 98).

[11] Slip op. at *3.

[12] Id.

[13] Id.

[14] Id. “When the party to whom a misrepresentation is made has hints of its falsity, a heightened degree of diligence is required of it. It cannot reasonably rely on such representations without making additional inquiry to determine their accuracy.” Centro, 17 N.Y.3d at 279 (brackets and internal quotation marks omitted).

[15] Id.

[16] Id.

[17] Id. (quoting Global Mins., 35 A.D.3d at 100).

[18] Id. at *3-*4 (quoting id. at 101).

[19] Id. at *4.

[20] Id. (quoting Greenman-Pedersen, Inc. v. Berryman & Henigar, Inc., 130 A.D.3d 514, 516 (1st Dept. 2015), lv. denied, 29 N.Y.3d 913 (2017) (internal quotation marks omitted).

[21] Id.

[22] Id. (citation omitted).

[23] Id.

[24] Id.

[25] Id. (quoting Matter of Schaefer, 18 N.Y.2d 314, 317 (1966)).

[26] Id.

[27] Id.