Commercial Division Blog
Allegations the Release Was Procured by Fraud Fail When the Alleged Fraud is the Fraud That is the Subject of the Release
On June 2, 2021, Justice Ostrager of the New York County Commercial Division issued a decision in Chadha v. Wahedna, 2021 NY Slip Op. 50509(U), holding that a fraud claim based on allegations that a release was procured by fraud fail when the alleged fraud is the fraud that was the subject of the release, explaining:
Defendants move to dismiss the Amended Complaint on the basis that Plaintiff's claims are barred by a release. After the CSRAs were executed, Plaintiff and Wahed entered into a Settlement Agreement and Release made effective as of February 27, 2017. In the Settlement Agreement, Plaintiff agreed to:
irrevocably release and forever discharge [Wahed Invest Inc.], and its parents, subsidiaries and affiliates, their respective officers, directors, employees, shareholders, partners, members, agents, attorneys and representatives, and the predecessors, heirs, successors and assigns of each of the foregoing (collectively, the "Company Released Parties") from any and all actions, causes of action, suits, debts, claims, complaints, liabilities, obligations, charges, contracts, controversies, agreements, promises, damages, expenses, counterclaims, cross-claims, claims for contribution and/or indemnity, claims of equity ownership, claims for advisory shares, claims for costs or attorneys' fees, judgments and demands whatsoever, in law or equity, known or unknown, the Investor Released Parties ever had, now have, or may have against the Company Released Parties from the beginning of time to the date hereof.
Defendants argue that this release encompasses the entire Amended Complaint.
The controlling authority on whether a signed release bars claims in the face of an allegation that the release itself was fraudulently induced is Centro Empresarial Cempresa S.A. v. America Movil, S.A.B. de C.V., 952 N.E.2d 995 (NY 2011). Generally, a valid release constitutes a complete bar to an action on a claim which is the subject of the release. Additionally, a release may encompass unknown claims, including unknown fraud claims, if the parties so intend and the agreement is fairly and knowingly made.
As a preliminary matter, there can be no dispute here that the above-quoted release encompasses unknown fraud claims as it refers to any and all actions whatsoever known or unknown. Thus, the inquiry is whether the release was fairly and knowingly made.
Once a defendant meets the initial burden of providing an executed release, the burden shifts to the plaintiff to establish that the release is invalid because of traditional contract defenses such as duress, illegality, fraud, or mutual mistake. To invalidate a release for fraud, however, plaintiff must identify a separate fraud from the subject of the release. If the fraud described in the complaint falls squarely within the scope of the release, then that fraud cannot nullify the release. Were this not the case, no party could ever release a fraud claim with any finality.
The Centro Court also held that the existence of a fiduciary relationship does not alter this analysis. A sophisticated principal is able to release its fiduciary from claims — at least where the fiduciary relationship is no longer one of unquestioning trust — so long as the principal understands that the fiduciary is acting in its own interest and the release is knowingly entered into. However, Centro does not go so far as to hold that a relationship of unquestioning trust prevents a party from being able to release fraud claims. Indeed, nothing in Centro (or its progeny Pappas v. Tzolis, 20 NY3d 228 (2012)) requires that the parties have prior business disputes to be able to release fraud claims.
The Centro Court further held that where a principal and fiduciary are sophisticated parties engaged in negotiations to terminate their relationship, the principal cannot blindly trust the fiduciary's assertions. The test, in essence, is whether, given the nature of the parties' relationship at the time of release, the principal is aware of information about the fiduciary that would make reliance on the fiduciary unreasonable. The requirement that the principal is aware of information about the fiduciary that would make reliance on the fiduciary unreasonable means not only subjectively or actually aware but also whether plaintiff should have learned of such information by exercise of ordinary intelligence. If the facts represented are not matters peculiarly within the party's knowledge, and the other party has the means available to him of knowing, by the exercise of ordinary intelligence, the truth or the real quality of the subject of the representation, he must make use of those means, or he will not be heard to complain that he was induced to enter into the transaction by misrepresentations.
Here, the Court finds that Plaintiff has not alleged a fraud separate from the subject of the release as required under the controlling case law cited above. The crux of the Amended Complaint is that Defendant allegedly concealed the existence of a future investment by a third-party that would have been favorable to the Company and presumably increased the value of Plaintiff's stock and that Defendant falsely represented that the Company was in financial trouble. Taking the allegations as true on a motion to dismiss the Amended Complaint, Plaintiff fails to allege a fraud separate from the broad cover of the release which is any and all claims the Investor Released Parties ever had, now have, or may have against the Company Released Parties from the beginning of time to the date hereof. While this failure alone is sufficient to dismiss the Amended Complaint, the Court addresses Plaintiff's arguments below.
The Court notes that because Plaintiff signed the release after selling all his shares in the Company, Mr. Wahedna no longer owed Plaintiff any fiduciary duties and the release was thus an arms-length transaction. However, even if fiduciary duties somehow still applied, the Court's analysis would be unchanged.
In its Opposition to the Motion, Plaintiff argues that it was reasonable to rely on Mr. Wahedna's representations because, unlike in Centro and Pappas, the relationship between Plaintiff and Mr. Wahedna continued during the relevant period as one of trust and reliance. There were no disputes between Plaintiff and Mr. Wahedna during the relevant time period, and the relationship never became antagonistic; nor did Mr. Wahedna ever become intransigent. Plaintiff continued to regard Mr. Wahedna as being trustworthy, from September 2016 through most of August 2017. Put differently, Plaintiff did not understand that the fiduciary, Mr. Wahedna, was acting in his own interests, and diametrically opposite the interests of Plaintiff.
First, as discussed above, a lack of hostility between the parties to a release does not prevent the parties from being able to release claims including fraud claims. Second, Plaintiff's contention that he fully and unquestioningly relied on Mr. Wahedna is belied by the actual allegations in the Amended Compliant which claim that Mr. Wahed withheld compensation for back salary, that Mr. Wahedna failed to make required capital contributions, and that, when negotiating the Settlement Agreement, Mr. Wahedna threatened not to pay Plaintiff moneys owed under the January 2017 Repurchase Agreement. Where the allegations of the Complaint themselves rebut the theory of the case, the action may be dismissed on the pleadings.
Third, and most importantly, contrary to Plaintiff's claim in opposition that Mr. Wahedna had superior knowledge of essential facts, as a corporate officer — the COO of the Company — as a matter of law Plaintiff had access to information relevant to the Company and relevant to valuing his interests. Under Centro, a party must exercise ordinary intelligence to determine the truth or the real quality of the subject of the representation. Where, as here, he fails to do so he will not be heard to complain that he was induced to enter into the transaction by misrepresentations.
Plaintiff should have performed his own diligence as to the value of his shares. Plaintiff sold his shares back at approximately four times the value for which he had bought them one to two years earlier. This fact stands in contrast to Plaintiff's claim that Mr. Wahedna represented the Company as being in dire financial trouble. Practically speaking, it is clear that plaintiffs were in a position to make a reasoned judgment about whether to agree to the sale of their interests to Tzolis. The need to use care to reach an independent assessment of the value of the lease should have been obvious to plaintiffs, given that Tzolis offered to buy their interests for 20 times what they had paid for them just a year earlier.
Plaintiff also attempts to raise issues of fact about Plaintiff's level of sophistication relative to Mr. Wahedna. It is true that much of the controlling authority involves sophisticated commercial entities who were represented by counsel. Nevertheless, there is no requirement that a party be represented by counsel to validly release a fraud claim.
Plaintiff argues that he was only twenty-six years old at the time he signed the release, that he was not as educated as Mr. Wahedna, and that Mr. Wahedna was his childhood friend whom he viewed as a brother. This argument is unavailing. Plaintiff has an undergraduate degree in Business Administration from The American University in Dubai and was sophisticated enough to serve as the Company's COO which inherently involved an understanding of the Company's financial status.
Plaintiff analogizes his position to this Court's decision in MadeOf LLC v Bronson 2019 NY Slip Op. 31058 (NY Sup. Ct. 2019) where this Court declined to dismiss fraud claims based on a release where there were questions about the plaintiff's business acumen and whether plaintiff understood that the released parties were acting in their own self-interest. This case is distinguishable. The plaintiff in MadeOf was the inventor of a product; she did not hold a business degree and did not serve as MadeOf's COO.
Finally, Plaintiff misconstrues the applicable law. A specific release of fiduciary duties is not required where, as here, there is a broad general release, reaching all claims among the parties.
(Internal quotations and citations omitted).
Commercial litigation frequently involves fraud-based claims. Such claims have special pleading requirements or rules, including the rule that a sophisticated businessperson's reliance on a false statement must be reasonable. Contact Schlam Stone & Dolan partner John Lundin at email@example.com if you or a client think you have been defrauded, or if someone has accused you or a client of defrauding them.