285 F. Supp. 3d 579
W.D.N.Y.2018Background
- Capax and others purchased Zovy, LLC for $1 plus an earn-out tied to VA contract revenue; dispute arose after Capax alleged Zovy's financials were fraudulently inflated.
- Plaintiffs allege Defendants misstated the nature/value of contracts (VA, CB&I), generated false invoices, overstated intangible assets, and hid liabilities in violation of GAAP and Agreement warranties.
- Plaintiffs sued for fraudulent inducement (rescission and damages), negligent misrepresentation, and breach of contract; defendants removed to federal court on diversity grounds.
- Defendants moved to dismiss: (1) fraud/negligent misrepresentation as duplicative of contract claims and for failure to plead fraud with Rule 9(b) particularity; (2) negligent misrepresentation for lack of a special relationship; (3) breach claims against non-signatories; and (4) to compel arbitration under an earn-out dispute provision.
- Court considered whether fraud claims are barred by merger/disclaimer clauses, whether Rule 9(b) and reliance pleading were satisfied, and whether the earn-out/accountant clause compels arbitration.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether fraud/negligent misrep. are duplicative of breach of contract | Fraud alleges pre-Agreement misstatements/omissions inducing the sale, so tort claims are independent | All complained-of statements are contractual warranties; tort claims merely repackaged breaches | Denied — tort claims allowed where misstatements concern present facts that induced the contract |
| Whether fraud claims satisfy Rule 9(b) particularity | Complaint and incorporated financials identify specific misstatements, speakers, and why false | Allegations are generic and fail to attribute statements/where/when as required by Rule 9(b) | Denied — overall pleadings (including incorporated paragraphs) meet 9(b) notice requirements |
| Whether negligent misrepresentation alleges a special relationship | Plaintiffs relied on defendants' financial information and were intended beneficiaries of that information | No special or privity-like relationship beyond ordinary arm’s-length transaction | Granted dismissal of negligent misrep.; leave to amend — no special relationship adequately alleged |
| Whether breach claims must be arbitrated under the earn-out/accountant clause | Breach claims seek enforcement of warranties and not earn-out valuation | Earn-out dispute provision delegates valuation disputes to independent accountant; thus arbitration/expert procedure applies | Denied — the accountant clause is narrow (earn-out valuation only); breach claims not compelled to arbitration |
Key Cases Cited
- Ashcroft v. Iqbal, 556 U.S. 662 (2009) (pleading standard: legal conclusions vs. factual allegations)
- United States ex rel. Chorches v. Am. Med. Response, Inc., 865 F.3d 71 (2d Cir. 2017) (Rule 9(b) four-part test for fraud pleading)
- Ladas v. Exelis, Inc., 824 F.3d 16 (2d Cir. 2016) (applying Rule 9(b) to fraud claims)
- Luce v. Edelstein, 802 F.2d 49 (2d Cir. 1986) (generally disfavoring group pleading under Rule 9(b))
- Loreley Fin. (Jersey) No. 3 Ltd. v. Wells Fargo Sec., LLC, 797 F.3d 160 (2d Cir. 2015) (group pleading permissible where defendants acted collectively in offering materials)
- Merrill Lynch & Co. v. Allegheny Energy, Inc., 500 F.3d 171 (2d Cir. 2007) (distinguishing misstatements of present fact from promises of future performance; fraud parallel to breach permitted)
- Danann Realty Corp. v. Harris, 5 N.Y.2d 317 (N.Y. 1959) (merger clause does not bar parol evidence of fraud inducing the contract)
- McDonnell Douglas Fin. Corp. v. Penn. Power & Light Co., 858 F.2d 825 (2d Cir. 1988) (FAA: resolve doubts in favor of arbitration; distinction between broad and narrow arbitration clauses)