Court Sustains Negligent Misrepresentation Claim By A Sophisticated Commercial Entity, Finding A Special Relationship Existed Outside Of The Transaction Agreements
- Posted on: Jul 31 2017
Misrepresentations come in many forms. Some are intentional; others are not. In the former, a claim of fraud may be asserted, while a claim for negligent misrepresentation may be asserted in the latter.
Misrepresentations are also made in many contexts. Some are made in a professional context, while others are made in the course commercial transactions. Kimmell v. Schaefer, 89 N.Y.2d 257 (1996).
Under New York law, a claim for negligent misrepresentation “requires the plaintiff to demonstrate (1) the existence of a special or privity-like relationship imposing a duty on the defendant to impart correct information to the plaintiff; (2) that the information was incorrect; and (3) reasonable reliance on the information.” Mandarin Trading Ltd. v. Wildenstein, 16 N.Y.3d 173, 180 (2011) (citations omitted).
As the first element of the claims indicates, a plaintiff must show a special relationship of trust or confidence between the parties which creates a duty for one party to impart correct information to another. OP Solutions, Inc. v Crowell & Moring, LLP, 72 A.D.3d 622 (1st Dept. 2010). Generally, a special relationship does not arise out of an ordinary arm’s-length business transaction between two parties (Kimmel, 89 N.Y.2d at 264), except where one of the parties “possess unique or specialized expertise, or … [is] in a special position of confidence and trust with the injured party such that reliance on the negligent misrepresentation is justified.” By contrast, professionals, such as lawyers and engineers, by virtue of their training and expertise, may have special relationships of confidence and trust with their clients, which have resulted in the courts imposing liability for negligent misrepresentation when they failed to speak with care. Kimmel, 89 N.Y.2d at 263.
In Kimmel, the Court of Appeals explained:
Since a vast majority of commercial transactions are comprised of such “casual” statements and contacts, we have recognized that not all representations made by a seller of goods or provider of services will give rise to a duty to speak with care. Rather, liability for negligent misrepresentation has been imposed only on those persons who possess unique or specialized expertise, or who are in a special position of confidence and trust with the injured party such that reliance on the negligent misrepresentation is justified.…
The analysis in a commercial case such as this one is necessarily different from those cases because of the absence of obligations arising from the speaker’s professional status. In order to impose tort liability here, there must be some identifiable source of a special duty of care. The existence of such a special relationship may give rise to an exceptional duty regarding commercial speech and justifiable reliance on such speech.
In the commercial context, courts have found that “[a] special relationship may be brought about by either privity of contract between the parties or a relationship so close as to approach that of privity.” JP Morgan Chase Bank v. Winnick, 350 F. Supp. 2d 393, 400–01 (S.D.N.Y. 2004) (internal quotation marks omitted). “[A] duty to speak with care,” therefore, “exists when the relationship of the parties, arising out of contract or otherwise, is such that in morals and good conscience the one has the right to rely upon the other for information and the reliance is justifiable.” Fraternity Fund Ltd. v. Beacon Hill Asset Mgmt. LLC., 376 F. Supp. 2d 385, 411 (S.D.N.Y. 2005) (internal quotation marks omitted). But “the duty attendant to that special relationship ‘must spring from circumstances extraneous to, and not constituting elements of the contract, although it may be connected with and dependent upon the contract.’” JP Morgan, 350 F. Supp. 2d at 400–01 (quoting Clark-Fitzpatrick, Inc. v. Long Island RR Co., 70 N.Y.2d 382, 389 (1987)).
In determining whether justifiable reliance exists (i.e., the third element of the claim), New York courts consider whether the person making the representation held or appeared to hold unique or special expertise; whether a special relationship of trust or confidence existed between the parties; and whether the speaker was aware of the use to which the information would be put and supplied it for that purpose. Kimmel, 89 N.Y.2d at 264. Generally, in the commercial context, a defendant’s superior knowledge and expertise about the transaction at issue is insufficient to satisfy the reliance element, especially where the parties are sophisticated business entities that engage in arm’s-length negotiations. Dembeck v. 220 Cent. Park S., LLC, 33 A.D.3d 491, 492 (1st Dept. 2006) (noting that “[a] fiduciary relationship does not exist between parties engaged in an arm’s length business transaction”); cf. EBC I, Inc. v. Goldman, Sachs & Co., 5 N.Y.3d 11, 19-20 (2005) (finding a fiduciary duty where the complaining party alleged that, apart from the terms of the contract, the other party created a relationship of higher trust than would arise from the agreement alone).
In Kortright Capital Partners LP v. Investcorp Investment Advisers Ltd., Case No. 1:16-cv-07619-WHP (S.D.N.Y. June 27, 2017), U.S. District Court Judge William Pauley, III sustained a negligent misrepresentation claim by a sophisticated party, finding that despite the aggrieved party’s sophistication, the parties “had a closer degree of trust…than that of the ordinary buyer and seller” – that is, they had a close relationship apart from their contract. (Citations and internal quotation marks omitted.)
In November 2013, Investment Advisers Limited (“Investcorp”) entered into a “Project Agreement” with Kortright Capital Partners LP and its co-founders, Matthew Taylor and Ty Popplewell (collectively, “Kortright”), pursuant to which Investcorp agreed to invest $50 million of its proprietary capital in Kortright for a minimum of two years and help market the Kortright funds. In exchange for its seed capital and marketing assistance, Kortright granted Investcorp a share of its operating revenue, veto power over certain corporate actions, and access to Kortright’s confidential information.
In January 2015, Man Group plc, an independent alternative asset management company and competitor of Investcorp, approached Kortright to discuss a possible acquisition of Kortright. Their discussions spanned fourteen months and were not disclosed to Investcorp. Ultimately, Man Group and Kortright focused on either bringing the Kortright funds under the Man Group umbrella or winding down the Kortright funds and having Kortright’s employees join the Man Group.
In April 2016, Kortright disclosed to Investcorp that it had been exploring a new business relationship with Man Group. Following discussions between the two entities, Kortright and Investcorp agreed to revise their relationship such that (1) the Kortright funds would become part of the Man Group, (2) Investcorp would redeem its proprietary capital and permit its clients’ capital to continue to be invested in Kortright, and (3) Investcorp would maintain at least 80% of its account balance at closing for six quarters in order to continue to receive its revenue sharing benefits. Following those discussions with Investcorp, Kortright and Man Group structured their transaction to transfer the Kortright funds to the Man Group.
In May 2016, Investcorp withdrew its proprietary capital. One month later, on June 16, 2016, Kortright and the Man Group entered into an agreement (“the Man Transaction Agreement”), under which the Man Group committed to invest at least $300 million of its clients’ capital in Kortright funds, which would be managed by Taylor and Popplewell as employees of the Man Group. A condition of closing in the Man Transaction Agreement required Kortright to bring a minimum level of investment from Investcorp to the Man Group.
Simultaneously, Kortright and Investcorp entered into two new agreements: a “Termination Agreement” and a “Revenue Sharing Agreement.” The former ended the parties’ relationship under the Project Agreement, while the latter set new terms for the parties’ relationship in view of the Man Transaction Agreement. Under the Revenue Sharing Agreement, Investcorp would continue to receive revenue sharing benefits. The Revenue Sharing Agreement also contained a termination provision in the event Investcorp redeemed capital in excess of a threshold amount. Importantly, the Revenue Sharing Agreement did not set a fixed term for Investcorp to maintain its investment.
The day after the Man Transaction Agreement was executed, Kortright notified its investors and sought consent to transfer their investments to the Man Group. The letters to investors also indicated that Investcorp planned to continue its partnership with Kortright. The election form included with the letters provided, among other things, that the investor was making an independent decision to invest in the fund and that the investor had all requisite power and authority to make the investment.
Investcorp, as a client of Kortright, returned its consent forms within a week, and Kortright began to wind down its funds. However, two business days later, Investcorp revoked that consent on the basis that it was required to obtain its own clients’ consents to the transfer of investments. Because Investcorp’s clients declined to consent, the client capital was subject to mandatory redemption. As a result, a condition of the Man Transaction Agreement was not satisfied and
the Man Group was relieved of its obligation to close the transaction. Thereafter, the Man Group informed Kortright that it would not proceed with the Man Transaction or the employment of Taylor or Popplewell.
Left holding the bag, Kortright sued Investcorp for negligent misrepresentation, negligence, breach of contract, breach of the implied covenant of good faith and fair dealing, and promissory estoppel. Regarding the claim for negligent misrepresentation, Kortright alleged that Investcorp made multiple misrepresentations to Kortright indicating its willingness to allow its clients’ investments in Kortright to be transferred to the Man Gorup. In this regard, Kortright maintained that Investcorp (1) provided false election forms regarding its clients’ consent to the Man Transaction Agreement, (2) failed to disclose the need to obtain its clients’ consent for the Man Transaction, (3) permitted Kortright to represent in its investor consent letters that Investcorp would remain invested with Kortright, (4) misrepresented that it supported the transfer of Kortright funds into the Man Group in April 2016, and (5) misrepresented its willingness to commit to the Man Transaction by signing the Revenue Sharing Agreement and Termination Agreement. Kortright alleged that it relied on these statements in winding down its business and proceeding with the Man Transaction Agreement.
Investcorp moved to dismiss the Complaint. The Court granted in part and denied in part Investcorp’s motion.
The Court’s Decision
As to the negligent misrepresentation claim, the court rejected most of Kortright’s allegations on temporal grounds – Kortright had entered into the Man Transaction Agreement before certain of the alleged misrepresentations were made and, therefore, Kortright could not have relied upon them to proceed with the transaction – and because Kortright failed to allege how it “was harmed in the two business days before Investcorp revoked its consent,” especially since Kortright had “already begun winding down operations in anticipation of closing the Man Transaction.” (Citation to complaint and internal quotation marks omitted.)
However, the Court sustained the claim based upon its finding that Investcorp misrepresented its willingness to participate in the Man Transaction while failing to explain that the transfer of Investcorp’s client capital was subject to client consent. The Court found that those “statements were made with a degree definitiveness that led both parties to take action.” The Court noted that after their April 2016 discussions, “Investcorp withdrew its proprietary capital in advance of the transfer of the Kortright funds to the Man Group and Kortright structured the Man Transaction Agreement based on Investcorp’s representations.” (Citation to the complaint omitted.) “Thus, construed in the light most favorable to Kortright, those statements reflected Investcorp’s then-present intention to participate in the transfer of the Kortright funds to the Man Group—an intention on which both parties acted—not simply promises of future action.” (This Blog wrote about actionability of false promises in the context of fraudulent inducement here.)
Turning to the special relationship allegations, the Court found that Kortright had satisfied its burden. First, the Court found that there was a special relationship between Kortright and Investcorp that existed outside of their contractual relationship: “Kortright and Investcorp had a closer degree of trust . . . than that of the ordinary buyer and seller. Investcorp was Kortright’s “self-proclaimed strategic partner” and had special privileges, including the ability to veto numerous proposed actions by Kortright.” (Citations and internal quotation marks omitted.) In fact, “Investcorp had access to virtually any and all information regarding the Kortright funds and held itself out as a partner, offering sales and marketing support. (Internal quotation marks omitted.)
Second, the Court found that a special relationship existed because Investcorp held specialized knowledge about is business, as opposed to “generalized, industry knowledge,” that only it could know about: “only Investcorp could have known whether consent from its clients was required. Because [Kortright] could not have obtained that information from anyone else, it had to rely on Investcorp’s specialized knowledge.”
Accordingly, the Court denied Investcorp’s motion with respect to the portion of Kortright’s negligent misrepresentation claim pertaining to the April 2016 discussions and Investcorp’s need for client consent. As to the other claims (breach of contract, implied covenant of good faith and fair dealing, promissory estoppel, and negligence), the Court granted the motion.
The circumstances supporting a special relationship in Kortright appear to be the exception than the rule. Indeed, most commercial transactions take place at arm’s length by buyers and sellers with no prior relationship. Kimmel, 89 N.Y.2d at 263 (noting that the “vast majority of commercial transactions are comprised of … ‘casual’ statements and contacts by buyers and sellers). For this reason, New York courts require “actual privity of contract between the parties or a relationship so close as to approach that of privity.” Ossining Union Free School Dist. v. Anderson LaRocca Anderson, 73 N.Y.2d 417, 424 (1989). While Kortright was able to satisfy this burden, most plaintiffs engaged in arm’s-length transactions will likely fail to do so.