As a matter of public policy, we want people to settle their disputes without resort to courts. Enforceability and finality are the twin pillars of settlements. General releases in settlement agreements advance the goals of dispute resolution by encouraging due diligence by the releasor and by fixing the releasee’s exposure.
The law of fiduciaries can complicate dispute resolution among business partners, and occasionally clashes with the settlement goals of enforceability, finality, diligence and certainty.
I wrote about such a clash earlier this year in the case of Littman v. Magee (read here). In Littman, an appellate court permitted a damages suit by a minority member of an LLC, brought over a year after he sold his interest to the controlling members allegedly at an artificially low price, to recover the "true value" of his interest based on financial information allegedly withheld from him at the time of sale. The court refused to give effect to a general release in the buyout agreement, expressly covering claims known and unknown, citing the controlling members’ fiduciary duty to disclose all material facts bearing on the transaction. As I wrote at the time, Littman struck me as "lowering the bar" for claims of tainted buyout by former business partners.
A recent trial court ruling in a case called Arfa v. Zamir illustrates the Littman rationale’s potential reach beyond the buyout context, and raises new questions about the utility of releases in out-of-court settlement agreements between business partners.
Arfa is a convoluted, multi-layered litigation among the controlling members of a series of real estate holding companies organized as LLCs, outside investors who intervened in the case, and a court-appointed temporary receiver. The case is assigned to New York County Commercial Division Justice Charles E. Ramos who wrote a helpful summary of the factual background in an earlier decision dated September 8, 2008 (21 Misc3d 1101(A)).
The plaintiffs, Rachel Arfa and her husband, Alexander Shpigel, filed a 54-page Second Amended Complaint which includes a Fifth Cause of Action for fraud against defendant Gadi Zamir relating to one of the realty venture’s acquisitions known as Academy Street. The plaintiffs allege that in late 2004, Zamir recommended that the parties acquire Academy Street based on various income and expense projections, and that in reliance on Zamir’s recommendation and presentations they approved the deal which closed in April 2005. Plaintiffs allege that in the summer of 2005, they learned of serious problems with the building’s physical condition which allegedly were known to Zamir and withheld from plaintiffs at the time Zamir solicited their approval.
Meanwhile, plaintiffs and Zamir entered into a Governance Agreement dated June 9, 2005, which was intended to resolve growing frictions between them over management and control of the entire real estate portfolio. The plaintiffs allege that they "reluctantly agreed" to Zamir’s "demand" that they enter into the Governance Agreement "to appease Zamir and prevent him from destroying the value of the real estate portfolio . . .." Mutual veto power over management decisions appears to be the main thrust of the Governance Agreement. The Governance Agreement also contains a mutual general release in which the parties release one another from "any and all claims . . . known or unknown" arising from events that pre-date the Governance Agreement.
Zamir moved to dismiss the fraud claim based on the release. As summarized in Justice Ramos’s decision denying the motion dated December 8, 2008 (2008 NY Slip Op 33348(U)), the plaintiffs argued that
to the extent that Zamir owed Plaintiffs a fiduciary duty by virtue of being co-managers, he may not rely upon the Release to insulate himself from liability where he intentionally concealed from Plaintiffs the physical condition of the Academy Street Property, and which misrepresentation was an inducement to enter into the release from the outset.
Justice Ramos agreed with plaintiffs, citing Littman for the proposition that "a fiduciary cannot, by a general release, insulate itself of its fiduciary obligation of full disclosure by wrongfully withholding the very information that a party requires to make a reasoned judgment on whether to agree to the general release at the outset." The decision continues:
As a fiduciary, Zamir was under an affirmative duty to disclose any information that could reasonably bear on Plaintiffs’ consideration to enter into the general release (Littman, 54 AD3d at 18). Accepting the [Second Amended Complaint’s] allegations as true, as the Court must do at this stage, Zamir failed to disclose to Plaintiffs vital material facts in order to permit them to make a reasoned judgment as to whether to agree to the terms of the Release. In addition to failing to disclose to Plaintiffs, it is alleged that Zamir intentionally concealed from Plaintiffs material facts, including the engineering reports’ findings concerning the structural defects in the property, and the Violations Undertaking.
I don’t know whether the plaintiffs were facing potential claims by Zamir when they executed the Governance Agreement with mutual general releases. In any event, I have to assume that Zamir bargained for the release as part of the consideration for whatever concessions he made in the Governance Agreement. Had he understood that the release would not shield him from future claims based on alleged nondisclosures concerning Academy Street or any of their other real estate projects, would he have entered into the Governance Agreement? Obviously I can’t answer the question or speculate whether it would have induced him to make additional disclosures that may or may not have soured the deal. The broader question, which I’ll also leave for others to answer, is whether it makes sense, and at what cost to public policy favoring out-of-court settlement, to expand the fiduciary exception to enforcement of general releases based on an intrinsically amorphous duty of disclosure.
Update July 19, 2010: The First Department handed down two decisions in June and July 2010 significantly pruning Littman‘s broad pronouncements. One of those decisions reverses the lower court’s Arfa ruling discussed above. Read here the first of two posts on the subject, highlighting the First Department’s decision last month in the Centro Empresarial case.
Update July 29, 2010: Read here the second post discussing the First Department’s July 13, 2010, decision reversing Justice Ramos’s above-discussed ruling in Arfa.