New York Business Divorce : New York Business Dissolution Lawyer & Attorney : Farrell Fritz Law Firm : Buy-outs, Shareholder Disputes : New York, NY

Centro, the more important of the two decisions, involves a Delaware LLC that owned an Ecuadorian telecommunications company known as Conecel.  A company called Telmex, owned by Mexican billionaire Carlos Slim, held a 60% controlling interest in Conecel.  In 2000, the plaintiffs, who held the other 40%, entered into various agreements with Telmex, among other things, giving plaintiffs the right to put their stake to Telmex at a fixed price based on a 1999 valuation.

Plaintiffs alleged that Telmex subsequently dodged their requests for financial information and otherwise falsely painted a bleak picture of Conecel's finances, causing plaintiffs in 2002 to exercise put rights for half their stake for $64 million.  In 2003, after Telmex allegedly continued to obfuscate and provide misleading financial  disclosure, Telmex offered to purchase plaintiffs' remaining stake for another $64 million.  Plaintiffs accepted.  The 2003 purchase agreement included a broad general release in Telmex's favor of all claims relating to plaintiffs' membership interests in Conecel.

In 2008, after a government audit allegedly disclosed that Conecel's financial condition in 2001-03 was significantly better than represented by Telmex, the plaintiffs sued Mr. Slim and his companies for breach of fiduciary duty and fraudulent inducement, claiming that had they known Conecel's true condition, instead of selling their shares they would have exercised certain exchange rights that would have given them shares in a roll-up entity worth over $1 billion in 2008.

The trial court denied defendants' motion to dismiss the suit based on the general release.  Defendants appealed to the Appellate Division, First Department which, by 3-2 vote in a June 2010 decision, reversed the lower court and dismissed the complaint.  (Read here my post about the First Department's ruling.)  Plaintiffs then appealed to the New York Court of Appeals. 

Following oral argument last April (watch it here), the Court of Appeals last week unanimously affirmed the First Department majority's ruling.  In a unanimous decision written by Judge Carmen Ciparick, the court starts its analysis by stating the general rule, that a valid release constitutes a complete bar to an action on a claim which is the subject of the release, and that "a party that releases a fraud claim may later challenge that release as fraudulently induced only if it can identify a separate fraud from the subject of the release."  The alleged fraudulent conduct in Centro, the court finds,

falls squarely within the scope of the release: plaintiffs allege that defendants supplied them with false financial information regarding the value of [Conecel] and that, based on this false information, plaintiffs sold their interests in [Conecel] and released defendants from claims in connection with that sale.  Thus, as the Appellate Division observed: "plaintiffs seek to convert the 2003 release into a starting point for new . . . litigation, essentially asking to be relieved of the release on the ground that they did not realize the true value of the claims they were giving up."

The court then addresses the core issue: does the defendants' status as a fiduciary, standing alone, change the equation?  Prior decisions of the First Department, exemplified most famously by Littman v. Magee, 54 AD3d 14 (2008), and Blue Chip Emerald v. Allied Partners, Inc., 299 AD2d 278 (2002), strongly suggested a "yes" answer, seemingly holding that the controlling owner involved in a transaction with another owner owes a non-releaseable fiduciary duty to disclose to the co-owner all material information bearing on the transaction.  (Read here my post on Littman.)  The Court of Appeals gives a definitive "no" answer, albeit with certain caveats, and in so doing explicitly disagrees with Littman et al.  States the court:

A sophisticated principal is able to release its fiduciary from claims — at least where, as here, the fiduciary relationship is no longer one of unquestioning trust — so long as the principal understands that the fiduciary is acting in its own interest and the release is knowingly entered into (see Alleghany Corp., 333 F2d at 333 ["There is no prerequisite to the settlement of a fraud case that the (fiduciary) defendant must come forward and confess to all his wrongful acts in connection with the subject matter"]; Consorcio Prodipe, S.A. de C.V., 544 F Supp 2d at 191). To the extent that Appellate Division decisions such as Littman v Magee (54 AD3d 14, 17 [1st Dept 2008], Blue Chip Emerald v Allied Partners Inc. (299 AD2d 278, 279-280 [1st Dept 2002]), and Collections v Kolber, 256 AD2d 240, 241 [1st Dept 1998]) suggest otherwise, they misapprehend our case law. Plaintiffs here are large corporations engaged in complex transactions in which they were advised by counsel. As sophisticated entities, they negotiated and executed an extraordinarily broad release with their eyes wide open. They cannot now invalidate that release by claiming ignorance of the depth of their fiduciary's misconduct.

The court also emphasizes the plaintiffs' failure adequately to allege justifiable reliance on the defendants' fraudulent statements in executing the release:

Here, according to the facts alleged in the complaint, plaintiffs knew that defendants had not supplied them with the financial information necessary to properly value [Conecel], and that they were entitled to that information. Yet they chose to cash out their interests and release defendants from fraud claims without demanding either access to the information or assurances as to its accuracy in the form of representations and warranties. . .. 

In certain circumstances, a fiduciary's disclosure obligations might effectively operate like a written representation that no material facts are undisclosed, and this might satisfy a principal's obligation to investigate further. Where a principal and fiduciary are sophisticated parties engaged in negotiations to terminate their relationship, however, the principal cannot blindly trust the fiduciary's assertions. This is particularly true where, as alleged here, the principal has actual knowledge that its fiduciary is not being entirely forthright . . ..

Plaintiffs repeatedly and unsuccessfully attempted to hold defendants to their disclosure obligations for years before negotiating and executing the sale of their shares and the accompanying releases. Moreover, the complaint alleges that plaintiffs were driven to sell because they were "wary of the threat that defendants would never negotiate in good faith and would never distribute the Conecel profits." Plaintiffs therefore cannot be said to have reasonably relied on defendants' assertions regarding Conecel's performance in executing the releases.

The 2003 release, the court concludes, "was intended to bar the very claims that plaintiffs now bring."  The plaintiffs, who released defendants "without conducting even minimal dilgence to determine the true value of what they were selling," also "fail to allege that the release was induced by fraud beyond that contemplated by the release."

I won't linger on the court's brief, unsigned opinion in Arfa v. Zamir in which the plaintiffs sued a co-member of a realty holding company for fraudulent inducement concerning an agreement that gave the defendant co-equal management authority, notwithstanding the agreement's inclusion of a broad general release.  The court affirms the First Department's decision enforcing the release and dismissing the case, finding that the plaintiffs failed to allege that the release was induced by a separate fraud or that plaintiffs justifiably relied on defendant's fraudulent misstatements in executing the release.  In addition,

[b]y their own admission, plaintiffs, who are sophisticated parties, had ample indication prior to June 2005 that defendant was not trustworthy, yet they elected to release him from the very claims they now bring without investigating the extent of his alleged misconduct.

(For more background on Arfa and the lower courts' decisions, read here my prior post and watch here the oral argument before the Court of Appeals.)

In my post three years ago I queried whether, after Littman, "business owners [can] pursue and exploit the profitable sale of their business or its assets without risk of liability to a former partner whose interest was acquired at a 'cheaper' price."  With its explicit repudiation of the analysis used in Littman, the Court of Appeals in Centro and Arfa has reinvigorated the purpose and efficacy of negotiated releases in buy-outs and other agreements between co-owners/fiduciaries of closely held companies.  The onus rests on the selling party to perform adequate diligence prior to completing the transaction, or otherwise bargaining for consideration commensurate with its chosen level of diligence.  Be mindful, however, that Centro and Arfa both involved sophisticated business owners on both sides of the transactions with prior histories of strife and mistrust.  Take away those elements and it still may be possible for a business owner to overcome a release given in connection with a buy-out or other agreement based on alleged failure by a fiduciary to disclose material information. 

The Centro Decision

Centro involved a dispute between minority and majority members of a Delaware LLC that owned an Ecuadorian mobile telephone company known as Conecel.  In March 2000, the majority member Telmex (controlled by Mexican billionaire Carlos Slim) acquired a 60% interest in Conecel.  Telmex simultaneously entered into two agreements with the plaintiff minority members.  The first stipulated that, in the event Telmex rolled up its Latin American telecommunications interests into one entity for the purpose of an equity offering, the plaintiffs would have the right to exchange their interest in Conecel for an interest in the new entity (the "Roll-Up Agreement").  The second agreement gave plaintiffs the right to put their Conecel interests to Telmex at specified intervals spread over 6 1/2 years at a fixed price based on Conecel's 1999 valuation (the "Put Agreement"). 

The plaintiffs alleged that Telmex's formation in late 2000 of a new company known as America Movil triggered their right of exchange under the Roll-Up Agreement.  They further alleged that over the next year Telmex dodged most of their requests for financial information necessary to determine the exchange rate, and that the information they did extract painted a false, bleak picture of the company's finances.

Having been led to believe that Conecel was in financial difficulty, in March 2002 the plaintiffs exercised their first put right under the Put Agreement by selling 50% of their membership interests to Telmex for $64 million.  After another year of alleged obfuscation and misrepresentation by Telmex of Conecel's financial condition, in March 2003 Telmex offered to purchase the plaintiffs' remaining 50% interest ahead of the Put Agreement's schedule at the same floor price of $64 million.  In July 2003, Telmex and the plaintiffs entered into a Purchase Agreement for the remaining 50% which also included a broad general release in Telmex's favor of all claims relating to the plaintiffs' membership interests in Conecel.

Plaintiffs' complaint alleged that, years after the buy-out of their interest, Telmex's alleged dishonesty was exposed as a result of an audit of Conecel by the Ecuadorian tax authority which allegedly revealed that Conecel's true financial results in 2001-03 were considerably better than represented by Telmex when it offered to purchase plaintiffs' interests.  Plaintiffs claimed that, had Telmex honored their right to negotiate an exchange of their Conecel units for America Movil shares, plaintiffs would have owned America Movil shares worth more than $1 billion as of May 30, 2008 (the date of the complaint).

The lower court, in an unreported December 2008 decision dictated on the record by Justice Richard B. Lowe III, denied Telmex's dismissal motion in which Telmex contended that the general release given by plaintiffs barred their claim.  Telmex appealed.

Over a vigorous two-judge dissent, a three-judge majority reversed the lower court's order and dismissed the complaint.  The self-responsibility theme of Justice Friedman's majority opinion is struck early, in his description of the facts, when he notes that

It is undisputed that the Purchase Agreement [including the general release] was the product of rigorous, arm's length negotiations between sophisticated parties, all of whom were advised by their own expert legal counsel.             

The legal analysis portion of Justice Friedman's opinion initially establishes that the plaintiffs' fraudulent inducement claim falls squarely within the scope of the broad release given in the Purchase Agreement, and that "[w]hether or not plaintiffs had reason to suspect that defendants were misrepresenting the value of Conecel in the negotiation of the 2003 transaction, they cannot reasonably contend that they did not intend to release possible fraud claims as to that matter of which they were unaware."

Justice Friedman then strongly rejects the central premise of plaintiffs' Littman argument, keyed to Telmex's fiduciary status as the controlling member of Conecel, writing as follows:

While Telmex LLC, as the holder of the majority interest in TWE (and, through TWE, Conecel) owed plaintiffs certain fiduciary duties, the foregoing principles apply (at least among sophisticated parties advised by counsel) even where the releasee is a fiduciary.  If Telmex LLC's fiduciary status alone sufficed to prevent it from obtaining the dismissal of this action based on the 2003 release, the implication would be that a fiduciary can never obtain a valid release without first making a full confession of its sins to the releasor, regardless of the releasor's sophistication and the arm's length nature of the negotiations from which the release emerged. This is not the law.  Such a rule would render useless and meaningless any release of a party that owed the releasor a fiduciary duty, thereby unjustifiably impinging on the freedom of commercial actors to order their own affairs by contract and, moreover, contravening the public policy favoring the settlement of business disputes. We are not aware of any precedent compelling us to accept such an absurd result.  [Citations omitted.]

The plaintiffs, Justice Friedman continues, "entered into the 2003 transaction well aware that defendants had not given them access to the internal financial records of Conecel" and "should have insisted on access to Conecel's internal books and records" and, moreover, should have sued if necessary to obtain the information.  He also notes that during the period in question, "relations between the parties were adversarial, if not outright hostile, thereby negating as a matter of law any inference that business entities as sophisticated as plaintiffs were relying on defendants for an objective assessment of the value of their investment."

Justice Friedman distinguishes Littman in a footnote.  He does not confront Littman's broad pronouncements, but instead focuses on the specific factual allegations in that case, writing as follows:

[In Littman], a general release in the agreement for the sale of the plaintiff's interest in a closely-held business was held not to bar a fraud action against a former fiduciary at the pleading stage because the complaint was deemed to allege that the defendant fiduciary had told the plaintiff that no further documentation bearing on the valuation of the enterprise existed, thereby exonerating the plaintiff from the need to investigate further (54 AD3d at 19). Here, plaintiffs do not allege that defendants told them that no information about Conecel's financial condition beyond the minimal amount that had been shared with plaintiffs was in existence. In addition, the Littman plaintiff alleged that he was induced to sell out in part by a "threat[] that if [he] did not agree to the proposed sale, approximately $1 million in income would be allocated to him for the year 2004, while no distribution would be made to him to cover the taxes resulting from that allocation" (id. at 16). No such threat or duress is alleged here.

Justice Friedman's opinion also distinguishes Littman's doctrinal forebear, Blue Chip Emerald v. Allied Partners, 299 AD2d 278 (1st Dept 2002), where the First Department upheld a fraudulent inducement claim involving a buy-out of a minority partner who alleged that the majority kept secret a third-party offer for the company's sole asset at a substantially higher price.  Here's what he says about Blue Chip:    

It was critical to the result in Blue Chip that the plaintiff in that case did not have "at its disposal ready and efficient means" for ascertaining whether such an oral agreement (or an offer in the relevant price range) even existed (299 AD2d at 280).  Here, by contrast, plaintiffs were well aware that Conecel did have a value, and nonetheless chose to cash out their interests without either insisting on verifying defendants' representations as to that value or, on the other hand, conditioning the deal on the accuracy of the information they did receive.  Indeed, as previously discussed, plaintiffs here were well aware that they were not in possession of all the information they believed they were entitled to when they sold their interests.

In a lengthy dissent, Associate Justice James M. Catterson sharply takes the majority to task for "overlook[ing] the well-established precept that releases 'must be knowingly and voluntarily entered into', and propound[ing], instead, the view that an effective release is one in which the releasor is hoodwinked by the releasee" (citations omitted). Citing Littman, Justice Catterson writes that a general release "will not insulate a tortfeasor from allegations of breach of fiduciary duty, where it has not fully disclosed alleged wrongdoing," and therefore the plaintiffs in Centro

were reasonably justified in their expectations that the defendants would disclose any information in their possession that might affect plaintiffs' decision on their best course of action especially as to signing the release that the defendants now argue bars this action.

Justice Catterson also disagrees with what he calls "the majority's attempt to distinguish Littman," writing that

The majority does so on the basis that the plaintiff in Littman was told that no further documentation bearing on the valuation of the enterprise existed, thus exonerating him from the need to investigate further whereas here the plaintiffs were not so told. I fail to see how being told that no documentation exists provides a better basis for exoneration than receipt of publicly filed documents. In the instant case, whatever message was being conveyed by the defendants' stonewalling, it was not incumbent on the plaintiffs to suspect that the defendants were defrauding a governmental agency by publicly filing false information.

On June 21, 2010, the plaintiffs in Centro filed a notice of appeal to the New York Court of Appeals which they are allowed to do as of right because of the two-judge dissent.  It will be most interesting and important to see how the state's highest tribunal resolves the clash of judicial philosophies evident in the dueling opinions of the Centro majority and dissenters.           

Update May 2, 2011:  The oral argument of the appeal in Centro to the Court of Appeals was heard on April 27, 2011.  Click here to watch the video.