Source: https://www.msek.com/publication/kevin-schlosser-in-nylj-grappling-with-fiduciary-duties-in-enforcing-contracts/
Timestamp: 2019-04-18 14:33:46+00:00

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Warning to lawyers tasked with drafting contracts in which fiduciary duties are lurking: Fasten your seatbelts, you’re in for a wild ride!
Oftentimes, in this age of increasingly specialized legal representation, lawyers who write contracts do not also handle the disputes that arise over the meaning or enforceability of those contracts. Thus, those who write the contracts do not typically benefit from how the courts interpret those contracts.
Given the fast-moving case law interpreting contracts involving fiduciaries, those preparing the contracts should understand the evolving law and address the important issues. As discussed below, the Court of Appeals has now indicated that a fiduciary can in fact be relieved of its stringent and unbending duties by virtue of contractual disclaimers and/or releases, but the language used will be carefully scrutinized. Ignoring the latest law could have disastrous results.
While the concepts applicable to fiduciary duties have been recognized for centuries, the First Department’s decision in Blue Chip applied them with eye-opening impact. In Blue Chip, a limited liability company was owned 50 percent by plaintiff and 50 percent by defendant, which also was the managing member and in control of day-to-day operations. The sole asset of the LLC was a valuable piece of real property in Manhattan.
After plaintiff sold its interest in the LLC to defendant based upon an $80 million valuation of the real property, defendant contracted to sell the property for $200 million just two weeks later. Plaintiff acknowledged in the transactional contracts that (i) it was entering into the buyout agreement without receiving any ‘representations or warranties’ from defendant as to the ‘actual or projected value’ of the real property or ‘any other matter affecting or related to’ the property; (ii) defendant had discussed the possible ‘operation, leasing, sale and/or valuation’ of the property with 16 third parties, among whom the ultimate purchaser was identified; (iii) it had been ‘afforded an opportunity to conduct its own due diligence;’ and (iv) it was satisfied with the information made available to it by defendant and otherwise.
Plaintiff also disclaimed any interest in the profit realized by the defendant on a future sale of the property to any of the disclosed third parties and ‘any claim for fraud, breach of loyalty or breach of fiduciary duty’ arising out of the LLC except as to any claim in the event the defendant had sold or leased the property to an unidentified third party if the transaction arose from discussions on or before the buyout date.
After learning of defendant’s deal to sell the property for $200 million, plaintiff sued defendant and its principals for fraud and breach of fiduciary duty, seeking the additional $60 million of profit it would have realized when the property was sold. Plaintiff alleged that it was induced to sell its interest in the LLC for an unfairly low price based upon defendants’ misrepresentations and omissions concerning the discussions they were conducting with third parties to sell the property, including failing to disclose both the true price range in which they were negotiating and the existence of an oral agreement to purchase the property for $200 million.
The trial court dismissed the complaint in its entirety based upon the contractual representations and disclaimers. The First Department reversed and reinstated the complaint.
The principles pronounced by Blue Chip and its progeny have also been followed in other departments. See, e.g., Dube-Forman v. D’Agostino, 61 A.D.3d 1255, 877 N.Y.S.2d 740 (3d Dept. 2009) (‘a specific disclaimer clause cannot serve to defeat a claim of fraud if the seller owes the buyer a fiduciary duty but nonetheless breaches that duty by failing to ‘disclose any information that could reasonably bear on [the buyer’s] consideration of [the transaction]”); Salm v. Feldstein, 20 A.D.3d 469, 799 N.Y.S.2d 104 (2d Dept. 2005) (‘because the defendant had a fiduciary relationship with the plaintiff, the disclaimers contained in the contract, upon which the defendant relies, did not relieve him of the obligation of full disclosure’).
Two other First Department cases recently made their way up to the Court of Appeals, giving the state’s highest court the opportunity to weigh in on the extent to which a fiduciary can be relieved of its legal duties by contract and/or release. In Centro Empresarial Cempresa Sp.A. v. America Movil, S.A.B. De C.V., 901 N.Y.S.2d 618 (1st Dept. 2010), aff’d, 17 N.Y.3d 269 (2011), plaintiffs alleged that they were induced to sell their minority interest in a foreign mobile telephone company by misrepresentations made to them by the majority owner concerning the value of the underlying enterprise. In the purchase agreement, the parties executed and exchanged a broadly worded mutual release, including of any interest in the underlying enterprise. Plaintiffs claimed they were fraudulently induced to sell their interest for less than $130 million, while information they later discovered indicated that their interest allegedly would have been worth more than $1 billion several years later.
The trial court denied defendants’ motion to dismiss, but the First Department reversed.
The Court of Appeals affirmed the First Department’s dismissal of the complaint. The Court acknowledged that a release may be invalidated based on the same grounds any agreement can be set aside, such as duress, illegality, fraud or mutual mistake. The Court, however, rejected plaintiffs’ claim of fraud in an attempt to invalidate the release, because the alleged fraud involved the very subject that the release was intended to cover—the value of the membership interest.
Soon after the Court of Appeals rendered Centro, the First Department reaffirmed the essence of Blue Chip in Pappas v. Tzolis, 2011 NY Slip Op 06455 (1st Dept. Sept. 15, 2011). Pappas involved familiar facts—a member of an LLC bought out the other members, and after the buyout, plaintiffs learned that defendant assigned the lease owned by the LLC for several million dollars allegedly arising from negotiations before the buyout. In the buyout contracts, plaintiffs agreed that defendant ‘has no fiduciary duty to [plaintiffs] in connection with’ the sale of their interests to him.
The motion court dismissed the complaint, but the First Department reversed.
In a compelling reaffirmation of Blue Chip, the court held that there was ‘no discernible difference in the facts’ from Blue Chip, and therefore the court felt ‘compelled to act with the same uncompromising rigidity here as in Blue Chip.’ The court was unpersuaded that plaintiffs acknowledged in the contract that they performed their own due diligence and that defendant had no fiduciary duty to them, concluding that defendant nevertheless had an overriding duty to disclose his dealings with the assignee.
The First Department distinguished the Court of Appeals decision in Centro because plaintiffs there knew they were not provided with relevant information, had given ‘an exceedingly broad release,’ and were no longer in a position of unquestioning trust with the fiduciary, while plaintiffs in Pappas had no such knowledge, gave no broad release and there was no evidence that the relationship was not one of unquestioning trust. The First Department distinguished Afra on similar grounds.
Two justices dissented in Pappas, so there may be further word from the Court of Appeals. In the meantime, these cases cannot be ignored when drafting contracts involving fiduciaries.
Consider whether the contemplated transaction involves a fiduciary relationship, and if so, the ramifications of the duties imposed by law, especially the heightened obligation of the fiduciary to disclose, affirmatively and without request, information that may be deemed material to the transaction. Address these duties directly in the contract.
The Court of Appeals has indicated that a fiduciary may be able to contract away fiduciary duties, but this requires effective drafting, given the qualifications both the Court of Appeals and the First Department have articulated. A simple contract provision disavowing the existence of a fiduciary duty will not be effective; nor will a mere statement that the contract was ‘negotiated at arm’s length.’ If the fiduciary duty is indeed intended to be eliminated, the parties should not only expressly disavow any such duty, but acknowledge in writing that the relationship is not one of ‘unquestioning trust’ and that each party understands it is protecting its own interests.
The cases show that the nature of due diligence, if any, by the beneficiary of the duty is important. If the beneficiary fails to undertake due diligence, especially in the face of missing or suspicious information, claiming that the fiduciary failed to disclose information is unlikely to prevail.
From the beneficiary’s perspective, if bargaining power and leverage allow, the party to whom a fiduciary duty is owed should attempt to preserve any and all rights derived from such fiduciary duties. The fiduciary should be asked to acknowledge the existence of the fiduciary duties, including the duty to disclose any and all material information having any bearing upon the transaction. While the fiduciary is likely to object to such a broad acknowledgment, the request could serve to flesh out relevant information or assist in obtaining specific representations and warranties.
The cases repeatedly refer to ‘prophylactic language’ that the beneficiary should have included in transactional documents, in the absence of which courts may deem the beneficiary to have ‘assumed the business risk that the facts may not be as represented.’ Thus, notwithstanding the duty of a fiduciary to disclose material information, the party to whom such a duty is owed would be well advised to identify and itemize any and all information relied upon, whether by way of disclosure or omission, and include those items in an appropriate representation and warranty. Similarly, where disclaimers or releases of claims are included, specific items of information, representations and/or claims that are intended to be excluded and preserved should be identified explicitly.
Above all, before drafting the contract and formulating the language, the case law discussed above (and all of its permutations) should be carefully analyzed.
Kevin Schlosser is a partner and chair of the litigation department at Meyer, Suozzi, English & Klein.
1. See Centro Empresarial Cempresa S.A. v. Amerca Movil, S.A.B. de C.V., 17 N.Y.3d 269 (June 7, 2011) and Afra v. Zamir, 17 N.Y.3d 737 (June 7, 2011), discussed further below.
2. Pappas v. Tzolis, 2011 NY Slip Op 06455 (1st Dept. Sept. 15, 2011).
3. In a similar case decided the same day as Centro, the Court of Appeals used the same reasoning to affirm the dismissal of fraud claims seeking to invalidate a release. See Afra v. Zamir, 905 N.Y.S.2d 77 (1st Dept. 2010), aff’d, 17 N.Y.3d 737 (June 7, 2011).

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