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Posted: May 2, 2016

General Merger Clause in Contract for Sale of Business Does Not Preclude Fraudulent Inducement Claim

On April 12, 2016, Justice Demarest of the Kings County Commercial Division issued a decision in Ferris v. Yoon, Index No. 512220/2015, holding that a general merger clause in a contract for the sale of business did not preclude the buyers from relying on parol evidence to support a fraudulent inducement claim.

In Ferris, the plaintiffs purchased a car wash business from the defendants. After the closing, plaintiffs allegedly discovered that the defendants had secretly altered the company’s books to overstate its income. Plaintiffs filed suit seeking to rescind the contract of sale on a fraudulent inducement theory. The defendants moved to dismiss in reliance on a general merger clause in the contract of sale that purported to disclaim reliance on any “representation, warranty, promise, inducement or statement of intention . . . which is not embodied in this agreement.” Justice Demarest denied the motion to dismiss, explaining:

[A] general merger clause is ineffective to exclude parol evidence to show fraud in inducing the contract. To put it another way, where the complaint states a cause of action for fraud, the parol evidence rule is not a bar to showing fraud in the inducement or in the execution despite an omnibus statement that the written instrument embodies the whole agreement, or that no representation have been made. A general merger clause in a contract cannot be used as a shield to protect a party from its fraud. Thus, fraud will vitiate a contract regardless of the fact that it contains a general provision to the effect that no representations have been made as an inducement to enter into the contract.

It is well established that in order to be effective to bar an action for fraud based on extraneous representations, the contractual disclaimer must have the requisite degree of specificity. Moreover, a specific disclaimer will not operate to bar a fraud claim based on statements not addressed by the disclaimer.

. . .

Since none of the [contractual] provisions specifically address representations relating to Car Wash’s income, they are general merger clause provisions, and, thus, do not preclude plaintiffs’ claim of fraud in the inducement or the use of parol evidence to establish reliance upon the representations allegedly made by defendants.

(Citations omitted.)

Justice Demarest went on to explain that apart from the generality of the merger clause, the fraudulent inducement claim survived for the independent reason that the misrepresentations concerned “facts peculiarly within the seller’s knowledge.”

[I]t has been expressly held that under the ‘special facts’ doctrine, a duty to disclose arises where one party’s superior knowledge of essential facts renders a transaction without disclosure inherently unfair. Even a specific disclaimer of reliance on representations cannot bar a fraudulent inducement claim where the facts represented are matters peculiarly within the representing party’s knowledge, and the other party lacks the means to ascertain the truth of the representations.

Here, plaintiffs allege that the income information was controlled exclusively by defendants and the amount of Car Wash’s cash receipts were peculiarly within their knowledge. . . . [D]efendants represented that the income figures were derived from Car Wash’s computer and the computer remained within their exclusive control until the sale of the business closed. [Plaintiff] Ferris’ efforts at due diligence were thus defeated by defendants’ actions since they allegedly gave him manipulated monthly reports, which caused his evaluation of the business to be based upon false information. Plaintiffs, therefore, have sufficiently alleged that defendants possessed peculiar knowledge of the facts underlying their alleged fraud claim.

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