Grappling with Fiduciary Duties in Enforcing Contracts - By Kevin Schlosser

by Meyer, Suozzi, English & Klein, P.C.


October 27, 2011

Publication Source: New York Law Journal

Written By: Kevin Schlosser

Warning to lawyers tasked with drafting contracts in which fiduciary duties are lurking: Fasten your seatbelts, you're in for a wild ride!

New York case law has been moving fast and furiously as to the enforceability of contracts involving fiduciaries where it is claimed that the contract was induced by a breach of the fiduciary's duties. From 2002, when the earth-shattering decision in Blue Chip Emerald LLC v. Allied Partners Inc., 299 A.D.2d 278, 279, 750 N.Y.S.2d 291, 294 (1st Dept. 2002), was handed down by the First Department, the cases have been on a whirlwind of twists and turns. The Court of Appeals recently jumped into the fray,1 only to see the First Department quickly get back onto center stage.2

Oftentimes, in this age of increasingly specialized legal representation, lawyers who write contracts do not also handle the disputes that arise over the meaning or enforceability of those contracts. Thus, those who write the contracts do not typically benefit from how the courts interpret those contracts.

Given the fast-moving case law interpreting contracts involving fiduciaries, those preparing the contracts should understand the evolving law and address the important issues. As discussed below, the Court of Appeals has now indicated that a fiduciary can in fact be relieved of its stringent and unbending duties by virtue of contractual disclaimers and/or releases, but the language used will be carefully scrutinized. Ignoring the latest law could have disastrous results.

'Blue Chip' and Its Progeny

While the concepts applicable to fiduciary duties have been recognized for centuries, the First Department's decision in Blue Chip applied them with eye-opening impact. In Blue Chip, a limited liability company was owned 50 percent by plaintiff and 50 percent by defendant, which also was the managing member and in control of day-to-day operations. The sole asset of the LLC was a valuable piece of real property in Manhattan.

After plaintiff sold its interest in the LLC to defendant based upon an $80 million valuation of the real property, defendant contracted to sell the property for $200 million just two weeks later. Plaintiff acknowledged in the transactional contracts that (i) it was entering into the buyout agreement without receiving any "representations or warranties" from defendant as to the "actual or projected value" of the real property or "any other matter affecting or related to" the property; (ii) defendant had discussed the possible "operation, leasing, sale and/or valuation" of the property with 16 third parties, among whom the ultimate purchaser was identified; (iii) it had been "afforded an opportunity to conduct its own due diligence;" and (iv) it was satisfied with the information made available to it by defendant and otherwise.

Plaintiff also disclaimed any interest in the profit realized by the defendant on a future sale of the property to any of the disclosed third parties and "any claim for fraud, breach of loyalty or breach of fiduciary duty" arising out of the LLC except as to any claim in the event the defendant had sold or leased the property to an unidentified third party if the transaction arose from discussions on or before the buyout date.

After learning of defendant's deal to sell the property for $200 million, plaintiff sued defendant and its principals for fraud and breach of fiduciary duty, seeking the additional $60 million of profit it would have realized when the property was sold. Plaintiff alleged that it was induced to sell its interest in the LLC for an unfairly low price based upon defendants' misrepresentations and omissions concerning the discussions they were conducting with third parties to sell the property, including failing to disclose both the true price range in which they were negotiating and the existence of an oral agreement to purchase the property for $200 million.

The trial court dismissed the complaint in its entirety based upon the contractual representations and disclaimers. The First Department reversed and reinstated the complaint.

Notwithstanding the explicit contractual disclaimers, the First Department found that the trial court "overlooked" the unbending fiduciary "duty of undivided and undiluted loyalty" the defendant owed to plaintiff. The court continued: "Consistent with this stringent standard of conduct, which the courts have enforced with '[u]ncompromising rigidity'…it is well-established that, when a fiduciary, in furtherance of its individual interests, deals with the beneficiary of the duty in a matter relating to the fiduciary relationship, the fiduciary is strictly obligated to make 'full disclosure' of all material facts….

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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