Opinion ID: 723747
Heading Depth: 2
Heading Rank: 2

Heading: Reasonableness of Reliance

Text: 20 As mentioned above, Count I of Harsco's complaint charged all defendants with violating Sections 10(b) 2 and 20(a) 3 of the Securities Exchange Act, and with violating Rule 10b-5 4 promulgated pursuant to § 10(b). Counts IV and V charged all defendants with common law fraud and negligent misrepresentation. 21 The general rule is that reasonable reliance must be proved as an element of a securities fraud claim. 5 See Azrielli v. Cohen Law Offices, 21 F.3d 512, 517 (2d Cir.1994) (Rule 10b-5 makes unlawful any misrepresentation that would cause reasonable investors to rely thereon ....) (internal quotation marks omitted). See also Paracor Finance, Inc. v. General Elec. Capital Corp., 79 F.3d 878, 886 (9th Cir.1996) (Justifiable reliance is a limitation on a rule 10b-5 action which insures that there is a causal connection between the misrepresentation and the plaintiff's harm.) (internal quotation marks omitted); Harrison v. Dean Witter Reynolds, Inc., 79 F.3d 609, 618 (7th Cir.1996) (The fact of reliance ... is not enough by itself; that reliance must be justifiable, or reasonable.); One-O-One Enter., Inc. v. Caruso, 848 F.2d 1283, 1286 (D.C.Cir.1988) (plaintiffs' allegations must indicate that their reliance on the allegedly fraudulent representations was reasonable) (citing Kennedy v. Josephthal & Co., 814 F.2d 798, 804 (1st Cir.1987)). Reasonable reliance must also be proved under New York law to recover for fraud and negligent misrepresentation. See Channel Master Corp. v. Aluminium Ltd. Sales, Inc., 4 N.Y.2d 403, 407, 176 N.Y.S.2d 259, 262, 151 N.E.2d 833 (1958) (fraud); Heard v. City of New York, 82 N.Y.2d 66, 75-76, 603 N.Y.S.2d 414, 419, 623 N.E.2d 541, 546 (1983) (negligent misrepresentation). 22 The district court held that Sections 2.05 and 7.02 of the Agreement preclude Harsco from establishing reasonable reliance. Section 2.05 specifically disclaims representations that are not in the agreement. It provides that the sellers 23 shall not be deemed to have made to Purchaser any representation or warranty other than as expressly made by [the sellers] in Sections 2.01 through 2.04 hereof.... Without limiting the generality of the foregoing, and notwithstanding any otherwise express representations and warranties made by the [sellers] in Sections 2.01 through 2.04 hereof ..., the [sellers] make no representation or warranty to Purchaser with respect to: 24 (a) any projections, estimates or budgets heretofore delivered to or made available to Purchaser of future revenues, expenses or expenditures, future results of operations, [etc.]; or 25 (b) any other information or documents made available to Purchaser or its counsel, accountants, or advisors with respect to [MultiServ], except as expressly covered by a representation and warranty contained in Sections 2.01 through 2.04 hereof. 26 Section 7.02 is a merger clause, which states that the Agreement contains the entire agreement between the parties hereto with respect to the transactions contemplated by this Agreement and supersedes all prior arrangements or understandings with respect thereto. 27 Harsco argues that Sections 2.05 and 7.02 should not be treated as a bar to establishing reasonable reliance for three reasons. First Harsco claims that giving Sections 2.05 and 7.02 such effect contravenes § 29(a) of the Securities Exchange Act of 1934. Second, Harsco argues that under Turkish v. Kasenetz, 27 F.3d 23 (2d Cir.1994), these Sections of the purchase agreement reflect an impermissible attempt to insulate the defendants from their own fraud. Third, Harsco argues that Sections 2.05 and 7.02 are not sufficiently specific to justify the district court's reliance on them. We reject each of these arguments.
28 Section 29(a) of the Exchange Act, 15 U.S.C. § 78cc(a), states that 29 Any condition, stipulation, or provision binding any person to waive compliance with any provision of this chapter or of any rule or regulation thereunder, or any rule of an exchange required thereby shall be void. 30 What the antiwaiver provision of § 29(a) forbids is enforcement of agreements to waive 'compliance' with the provisions of the statute. Shearson/American Express Inc. v. McMahon, 482 U.S. 220, 228, 107 S.Ct. 2332, 2338, 96 L.Ed.2d 185 (1987). The underlying concern of § 29(a) is whether the agreement weakens [the] ability to recover under the Exchange Act. Id. at 230, 107 S.Ct. at 2339 (citations and quotation marks omitted). Furthermore, the voluntariness of an agreement is irrelevant to whether § 29(a) forbids it. Id. [I]f a stipulation waives compliance with a statutory duty, it is void under § 29(a), whether voluntary or not. Id. Thus the question here boils down to whether Sections 2.05 and 7.02 of the Agreement weaken Harsco's ability to recover under § 10(b) of the Exchange Act in a way that § 29(a) prohibits. 6 31 There can be no question that the Agreement weakens Harsco's ability to recover under the Act. As the district court observed the Agreement outline[s], with great specificity, the representations and warranties that Harsco agreed to rely upon--and not rely upon--in purchasing all of MultiServ's outstanding stock. According to the district court, the Agreement limited the bases upon which a fraud action could be brought. 32 Thus, the Agreement can be described as weakening Harsco's ability to recover under § 10(b) of the Exchange Act. We think, however, that in the circumstances of this case such a weakening does not constitute a forbidden waiver of compliance. Here there is a detailed writing developed via negotiations among sophisticated business entities and their advisors. That writing, we conclude, defines the boundaries of the transaction. Harsco brings this suit principally alleging conduct that falls outside those boundaries. 33 Harsco relies heavily on Rogen v. Ilikon Corp., 361 F.2d 260 (1st Cir.1966). In Rogen, the plaintiff, an individual shareholder of the defendant company, sued under § 10(b), alleging that he was induced to sell shares of a company back to the company at an unfair price by nondisclosure of positive information regarding the company's prospects. Id. at 263. The first circuit reversed the district court's summary judgment for defendants. The district court granted summary judgment in part because the sales agreement at issue stated that plaintiff 34 [was] fully familiar with the business and prospects of the corporation, [was] not relying on any representations or obligations to make full disclosure with respect thereto, and ha[s] made such investigation thereof as [plaintiff] deem[s] necessary. 35 Id. at 265. The court held that § 29(a) rendered such a contract provision void. 36 [O]n analysis, we see no fundamental difference between saying, for example, 'I waive any rights I might have because of your representations or obligations to make full disclosure' and 'I am not relying on your representations or obligations to make full disclosure.' Were we to hold that the existence of this provision constituted the basis (or a substantial part of the basis) for finding non-reliance as a matter of law, we would have gone far toward eviscerating Section 29(a). 37 Id. at 268 (footnote omitted). Defendants analogize the contractual provision and the circumstances of Rogen to this case. 38 The analogy fails. First, the court in Rogen emphasized the disparity in bargaining power between the plaintiff, an individual whom a jury could conclude was overtrusting, and the defendant corporation. See id. at 267-68. In contrast, it is apparent from the complaint and the Agreement in this case that both Harsco and defendants were sophisticated business entities negotiating at arm's length. The Agreement here reflects this relative parity. There is nothing in the first circuit's detailed opinion which suggests the presence in Rogen of anything like Sections 2.04, 2.05 and 7.02. In this case, Harsco was apparently content that the detailed disclosures and representations of Section 2.04 were sufficiently complete. Harsco further protected itself by negotiating for two weeks of confirmatory due diligence--the purpose of which was to confirm the accuracy of MultiServ's disclosures. If Harsco had been unable to confirm the truth of the representations in Section 2.04 during the due diligence period, Harsco could have terminated the deal. In short there is nothing in the complaint or the Agreement that indicates that Harsco was duped into waiving the protections of the securities laws. 39 Harsco bought Section 2.04's fourteen pages of representations. Unlike a contractual provision which prohibits a party from suing at all, the contract here reflects in detail the reasons why Harsco bought MultiServ--in essence, Harsco bought the representations and, according to Sections 2.05 and 7.02, nothing else. This means that there are fourteen pages of representations, any of which, if fraudulent, can be the basis of a fraud action against the sellers. But Harsco specifically agreed that representations not made in those fourteen pages were not made. Thus, it is not fair to characterize Sections 2.05 and 7.02 as having prevented Harsco from protecting its substantive rights. Harsco rigorously defined those rights in Section 2.04. 40 This analysis becomes a question of degree and context. Harsco has not waived its rights to bring any suit resulting from this deal. Each representation in Section 2.04 is a tooth which adds to the bite of Sections 2.05 and 7.02. In different circumstances (e.g., if there were but one vague seller's representation) a no other representations clause might be toothless and run afoul of § 29(a). But not here.
41 Harsco also argues that Sections 2.05 and 7.02 should not be given effect because doing so would run afoul of the policy of deterring fraud which we recognized in Turkish v. Kasenetz, 27 F.3d 23 (2d Cir.1994). But Turkish does not help Harsco. In Turkish the contract (which was a settlement agreement) stated that the parties have had full and complete access to all books, documents, records, litigation files and other sources of information affecting all litigations[.] 27 F.3d at 25. Elsewhere the contract stated that certain representations were based on the advice of accountants, and that in the event those representations proved to be untrue, then plaintiff would only have one remedy (i.e., getting the loans repaid by the defendant). Id. at 25. The fraud alleged was that accountants never reviewed the accuracy of any of the representations. Id. at 27. We held the full disclosure clause to be no bar to suit. We emphasized that plaintiffs do not claim that they relied on defendant's oral representations; rather, they claim that they relied on written representations in the contract itself. Id. at 28. We further distinguished a contract (such as the one here) which specifically disclaims the existence of the representations which plaintiffs claim are fraudulent. Id. Because here Harsco claims that the representations outside the contract were fraudulent, and because the contract clearly delineates what representations have been made, Turkish does not apply.
42 Harsco's last claim is that the no other representations clause of Section 2.05 is not so specific as to put Harsco on notice of what it could not reasonably rely on. Harsco correctly states the rule announced by the New York Court of Appeals in Danann Realty Corp. v. Harris, 5 N.Y.2d 317, 184 N.Y.S.2d 599, 157 N.E.2d 597 (1959): where a party specifically disclaims reliance upon a particular representation in a contract, that party cannot, in a subsequent action for common law fraud, claim it was fraudulently induced to enter into the contract by the very representation it has disclaimed reliance upon. We have recognized a similar principle in the securities fraud context. See Brown v. E.F. Hutton Group, Inc., 991 F.2d 1020, 1033 (2d Cir.1993) (disclosure of risks in prospectus forecloses suit under 10b-5 claiming that the security was unsuited to plaintiff's investment objectives). 43 In Danann the contract (for the purchase of a lease on a building) stated that the seller had not made ... any representations as to the ... expenses [or] operation ... [of the building] and the Purchaser hereby expressly acknowledges that no such representations have been made. 5 N.Y.2d at 320, 184 N.Y.S.2d 599, 157 N.E.2d 597. The New York Court of Appeals held that this language destroys the allegations in plaintiffs complaint that the agreement was executed in reliance upon ... contrary oral representations. Id. at 320-21, 184 N.Y.S.2d 599, 157 N.E.2d 597. 44 Applying the Danann rule to the present circumstances, our task is to compare the language in Sections 2.04, 2.05, and 7.02 to the representations which Harsco claims are fraudulent, keeping in mind the arm's length nature of the negotiation and the sophistication of the parties. The purpose in making this comparison is to determine whether once Harsco entered into the Agreement, it became unreasonable to rely on the allegedly fraudulent representations. 45 To aid this analysis, we restate here the most relevant portion of Section 2.05. After reaffirming representations in article II (including the fourteen pages of Section 2.04 immediately preceding), Section 2.05 states that Defendants make no representation or warranty to Harsco regarding 46 (a) any projections, estimates or budgets heretofore delivered to or made available to Purchaser of future revenues, expenses or expenditures, future results of operations (or any component thereof), future cash flows or future financial condition (or any component thereof) of [MultiServ] or the future business and operations of [MultiServ]; or 47 (b) any other information or documents made available to [Harsco] or its counsel, accountants or advisors with respect to [MultiServ] or the business and operations of [MultiServ], except as expressly covered by a representation and warranty contained in Sections 2.01 through 2.04 hereof. 48 In light of this language, we review Harsco's various factual theories of fraud. 49
50 Paragraphs 48 and 49 of the Complaint asserted that the following allegations, made during the three days of preliminary due diligence in May 1993, were fraudulent: that plants in Italy, Germany, the United Kingdom, France and Austria would experience a financial turnaround in 1993; that MultiServ would place new emphasis on developing its core steel business and phase out other businesses; that MultiServ expected growth in new areas of the world; and that plants in China and Slovakia would be fully operational in 1993 with no significant start up problems. On their face, these representations are projections of ... future business and operations--exactly what Section 2.05 disclaims. In light of Sections 2.05 and 7.02, there is nothing in the Complaint which allows an inference of reasonable reliance on these representations. The district court correctly dismissed the claims relating to these representations. 51
52 In paragraph 52 the Complaint alleges that certain defendants represented in July 1993, during confirmatory due diligence, that the Russian Plant would be operating in the fourth quarter of 1993, and that those same defendants knew or should have known at that time that the main foundations for the Russian Plant had not been poured. 7 The question is whether the disclaimer of information ... with respect to ... operations of [MultiServ], except as expressly covered by a representation and warranty contained in Sections 2.01 through 2.04 hereof put Harsco on sufficient notice that representations regarding the Russian Plant could not reasonably be relied on. This is a closer call than the allegations contained in paragraph 48. Unlike relatively vague expectations of future performance complained of in that paragraph, here the allegation is more detailed: defendants knew the Russian Plant was not going to get built and represented otherwise. 53 Nevertheless, and again relying on the sophisticated context of this transaction, we hold that Harsco must be held to its agreement. There was no representation whatsoever about the Russian Plant in Sections 2.01 through 2.04. We think Harsco should be treated as if it meant what it said when it agreed in Section 2.05 that there were no representations other than those contained in Sections 2.01 through 2.04 that were part of the transaction. Here, as in our analysis of § 29(a) of the Exchange Act, a less detailed Section 2.04 might lead to a different result. But the exhaustive nature of the Section 2.04 representations adds to the specificity of Section 2.05's disclaimer of other representations. We can see no reason not to hold Harsco to the deal it negotiated. Claims relating to the Russian Plant were also properly dismissed. 54
55 The complaint alleges numerous instances of improper conduct by the president of MultiServ's French subsidiary and accuses certain defendants of failing to disclose their knowledge of that misconduct. pp 57-68. The district court properly held that this portion of the complaint was deficient because Harsco's complaint failed to connect the alleged duty to disclose the French self-dealing with any representation from Section 2.04. The district court afforded Harsco an opportunity to fix its pleading. Harsco opted not to. 56 The pleading needed fixing because, again, we hold Harsco to the Agreement it negotiated and entered into. Under the circumstances of this case, no other representations means no other representations. 57 Ironically, in this instance there was a Section 2.04 representation which appears sufficiently inconsistent with the allegations of French impropriety to have allowed this claim to continue past the Rule 12(b)(6) stage. Section 2.04(i)(1) states that MultiServ was not in violation ... of any Law ... where failure to be in compliance would have a Material Adverse Effect. Harsco's general citation to Section 2.04 does not suffice to invoke this small subset of the fourteen pages contained therein. As discussed below, fraud must be pleaded with particularity. Fed.R.Civ.P. 9(b). That requirement is not met by citing to fourteen pages of representations when only a few lines among those fourteen pages consist of a representation which plaintiff claims to be deceitful. 58
59 Scarfing is the process by which surface defects are removed from slabs cast from liquid steel, before those slabs are rolled. Scarfing is important to maintain the quality of the product. p 69. The offering memorandum stated that MultiServ owned the intellectual property rights to the Androfer scarfing technology. p 70. The sellers also represented that the Androfer technology is superior to other scarfing methods. p 70. In reality, the rights to the Androfer technology were in dispute. pp 71-75. Harsco claims that defendants were aware of this reality and misrepresented it to Harsco. p 76. The self-declared owner of the Scarfing technology has since offered the Androfer rights to Harsco for $3 million. p 79. 60 Notably, other than the general invocation of Section 2.04, Harsco's complaint nowhere directs the reader's attention to any provision in the Agreement that relates to the status of MultiServ's intellectual property rights. Accordingly, this claim was also properly dismissed. 61 As with the claims relating to French improprieties, here too there is a short passage within Section 2.04, Section 2.04(k)(2)(A), which appears sufficiently inconsistent with the allegations relating to the state of the Androfer patent to warrant this claim continuing past a 12(b)(6) motion. Noting this, the district court allowed Harsco an opportunity to replead claims relating to intellectual property rights. Harsco declined in order to take this appeal. 62
63 Harsco claims that two defendants represented that MultiServ would acquire the [Belgium] Plant in June or July of 1993 for approximately $13 million, p 80, and that this representation was fraudulent. Section 2.04(o)(3) of the Agreement incorporated Exhibit 2.04(o)(3) to the Agreement. Exhibit 2.04(o)(3) states that the Belgium acquisition is not expected to be completed until September or October of 1993. Sections 2.05 and 7.02, if they mean anything, mean that the representations in Section 2.04 trump representations outside the Agreement. Here again Harsco's complaint belies any suggestion of reasonable reliance. Dismissal under Rule 12(b)(6) was proper. 64
65 There is one other factual strain of fraud that fails pursuant to Fed.R.Civ.P. 9(b), notwithstanding any of the above analyses. Rule 9(b) requires that allegations of fraud be pleaded with particularity. Thus we have explained that when a complaint charges fraud, it must (1) detail the statements (or omissions) that the plaintiff contends are fraudulent, (2) identify the speaker, (3) state where and when the statements (or omissions) were made, and (4) explain why the statements (or omissions) are fraudulent. Shields v. Citytrust Bancorp., Inc., 25 F.3d 1124, 1128 (2d Cir.1994); Ouaknine v. MacFarlane, 897 F.2d 75, 79 (2d Cir.1990). The policy behind Rule 9(b) is (1) to provide a defendant with fair notice of plaintiff's claim, (2) to safeguard a defendant's reputation from improvident charges of wrongdoing and (3) to protect against the institution of a strike suit. Acito v. IMCERA Group, Inc., 47 F.3d 47, 52 (2d Cir.1995). 66 Harsco's allegations relating to due diligence consist of the following: During the confirmatory due diligence, MultiServ's CEO (Bowden), took an extended vacation. p 44. Harsco did not know Bowden was going to go away during this time. p 44. Also, other key employees, including MultiServ's Comptroller, were absent for substantial parts of the Due Diligence period. p 44. Harsco's requests to speak with MultiServ's internal auditor during due diligence were met with a response that the auditor was unavailable. p 45. MultiServ denied Harsco's requests to see and/or copy certain documents during this period as well. p 46. Lastly, Harsco asked for access to MultiServ's books seven days a week during the due diligence period; MultiServ gave access for only six days a week. p 47. 67 The only representation mentioned in this portion of the Complaint is that the auditor was unavailable. There is no explanation regarding why that representation may be fraudulent. Furthermore it cannot be said that denial of a request to see documents could constitute fraud, unless that denial suggested falsely and deceitfully that those documents did not exist (of which there is no suggestion here). In short, the complaint's recitation of particulars relating to due diligence fall far short of the requirements of Rule 9(b). 68 In sum, all of the fraud and negligent misrepresentation claims were properly dismissed.