This is the second of two posts analyzing two recent decisions by the Manhattan-based Appellate Division, First Department, in which the court dismissed fraudulent inducement claims by LLC members against co-member fiduciaries arising from agreements that included broad general releases.  Last week’s post examined Centro Empresarial Cempresa S.A. v. America Movil S.A.B. de C.V.2010 NY Slip Op 04719 (1st Dept June 3, 2010), which involved a dispute over a buyout between members of a Delaware LLC that owned an Ecuadorian mobile telephone company.  The second case, discussed in this week’s post, also concerns a dispute between co-members of a Delaware LLC, but this time the business operations are closer to home, involving a series of real estate acquisitions in New York City.  

The case of Arfa v. Zamir is one of those hydra-headed business partnership disputes that takes on a life of its own, generating multiple lawsuits and dozens of motions, decisions and appeals that take up years before anything seems to get resolved on the merits.  I’ve written up decisions in the Arfa family of cases on several prior occasions, most recently on the issue whether LLC promoters are fiduciaries (see here), before that on indemnification rights of LLC managers (see here), and before that on whether a general release of a LLC fiduciary given as part of an inter-member transaction bars a subsequent action for fraudulent inducement (see here). 

The last-mentioned post highlighted a December 2008 decision by Manhattan Commercial Division Justice Charles E. Ramos refusing to dismiss a fraudulent inducement claim by plaintiffs Rachel Arfa and her husband, Alexander Shpigel, as 60% members of the subject LLC, against defendant Gadi Zamir, who held the remaining 40% interest, relating to a real estate acquisition and development venture in upper Manhattan known as Academy Street.  Here’s a short summary of the factual background from my prior post:

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 plaintiffs’ Fifth Cause of Action for fraudulent inducement, arguing that it was barred by the release contained in the Governance Agreement.  Justice Ramos’s December 2008 decision denied the motion, holding that under the First Department’s decision in Littman v. Magee, 54 AD3d 14 (1st Dept 2008),

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.

Zamir appealed.  On July 13, 2010, the First Department handed down its decision, reported at 2010 NY Slip Op 06070, reversing Justice Ramos’s ruling and dismissing the fraudulent inducement claim.  The court’s unanimous decision was authored by Associate Justice David Friedman who also wrote the majority opinion in the First Department’s 3-2 ruling in the Centro case discussed in last week’s post.

Justice Friedman’s Arfa opinion emphasizes factors closely tracking those found critical in Centro.  He notes that the fraudulent inducement claim:

  • “falls squarely within the scope of the general release”;
  • that the Governance Agreement “was the result of rigorous, arm’s-length negotiations between the highly sophisticated parties”;
  • that “by the time the parties began negotiating the Governance Agreement, they had already developed an adversarial, even hostile relationship”;
  • that given the plaintiffs’ own allegations of Zamir’s dishonesty, they had a “heightened” affirmative duty to protect themselves from misrepresentations by investigating all of the circumstances and details surrounding the Governance Agreement;
  • that had the plaintiffs performed the requisite due diligence, the matters concerning the Academy Street Building’s physical condition, about which Zamir allegedly made misrepresentations, “presumably would have been revealed”; and
  • that the plaintiffs could not establish reasonable reliance on Zamir’s alleged misrepresentations when they failed to make “any use of the means available to them to ascertain the truth of the alleged misrepresentations at issue before they entered into the Governance Agreement.”

Justice Friedman, quoting from his Centro opinion, also rejects what he calls the “implication” of the plaintiffs’ position, i.e., that “a fiduciary can never obtain a valid release without first making a full confession of its sins to the releasor,” and then goes on to distinguish Littman v. Magee, writing: 

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. While Littman reaffirmed that even a fraud claim against a fiduciary must establish justifiable reliance on the alleged misstatement, the case held that the alleged misrepresentation concerning the availability of information relevant to the transaction raised an issue as to whether plaintiff justifiably relied on the defendant’s statements without making further investigative efforts (54 AD3d at 19). Here, by contrast, Arfa/Shpigel do not allege that Zamir did or said anything to impede their ability to investigate the truth and completeness of his representations concerning the Academy Street building. On the contrary, assuming the truth of the complaint, Arfa/Shpigel never asked Zamir for even a page of documentation of the condition of the building.

So there you have it.  Two First Department decisions, Centro and Arfa, both of which limit Littman to its specific facts and implicitly reject Littman‘s broader pronouncements suggesting that a release given to a fiduciary does not protect against a nondisclosure-based, fraudulent inducement claim.  As noted last week, the Centro plaintiffs filed a notice of appeal as of right to the Court of Appeals, which will have the last word, so stay tuned. 

Update October 12, 2010:  Today the Appellate Division, First Department, granted a motion by Arfa/Shpigel for leave to appeal to the New York Court of Appeals, where it will join the already pending Centro appeal.   

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