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Posted: February 28, 2020

Material Misrepresentation Justified Rescission of Agreement

On February 18, 2020, the First Department issued a decision in Sabby Healthcare Master Fund Ltd. v. Microbot Med. Inc., 2020 NY Slip Op. 01129, holding that material misrepresentations justified rescission of an agreement, explaining:

The trial record indicates that plaintiffs, two affiliated private investment funds, rapidly negotiated the SPA essentially over the course of a single day, Sunday, June 4, 2017. The material terms called for plaintiffs to purchase 1,250,000 shares of defendant’s common stock (now equivalent to 83,333 shares, subsequent to a 15-to-1 reverse stock split), at $2.70 per share, for a total of $3,375,000. Defendant’s disclosures indicated that one of its stockholders, Alpha Capital Anstalt, held a dominant position in the company, holding preferred shares which were convertible to about 30% of total common stock. Alpha also had a very low basis in its shares of defendant’s stock of no more than 64 cents per share (which had closed at $3.81 on June 2, 2017, the last trading day before the transaction at issue). Alpha’s low basis gave it a strong incentive to monetize its shares, particularly since volume and price had spiked that week in response to a favorable press release. Defendant’s disclosures also indicated that Alpha was an affiliate.

Plaintiffs’ CEO thus testified that Alpha’s status as an affiliate was not merely material, it was everything. As an affiliate, Alpha’s ability to sell its shares would be severely restricted under SEC rules. If Alpha were not an affiliate, then it could rapidly sell shares, adversely impacting the stock price. The trial court credited the CEO’s testimony, which was consistent with the documentary evidence, in the form of the disclosures and emails exchanged between plaintiffs and defendant’s agent . The trial court, therefore, properly found defendant’s misrepresentation that Alpha was an affiliate to be material to the transaction, for purposes of establishing plaintiffs’ claim for rescission.

It is true that the trial record also indicates that Alpha was subject to a blocker, preventing it from holding more than 9.9% of defendant’s outstanding common stock. This does not render Alpha’s affiliate status immaterial, however; if Alpha were not an affiliate, the sale of shares amounting to 9.9% of the company’s shares would obviously have a substantial downward impact on the stock price.

Defendant’s misrepresentation was also substantial in that it strongly tended to defeat the object of the parties in making the contract. Plaintiffs’ CEO testified that their goal in entering into the transaction was to arbitrage the difference between their discounted $2.70 purchase price and the last closing price of $3.81 per share. If defendant’s largest shareholder, which had also acquired its shares for less than a fifth of the latest price, had the ability (and the incentive) to rapidly monetize its position, this would pose a significant potential for impacting plaintiffs’ plans. We accordingly find that the trial court properly granted rescission of the contract.

Nor do plaintiffs have any adequate remedy at law. Indeed, a defrauded party to a contract may elect to either disaffirm the contract by a prompt rescission or stand on the contract and thereafter maintain an action at law for damages attributable to the fraud. Plaintiffs here acted diligently, and elected to demand rescission immediately upon discovering the misrepresentation, which happened less than a week after closing. Defendant, acting in what can fairly be characterized on the trial record as bad faith, refused.

(Internal quotations and citations omitted).

Suits for breach of contract typically seek money damages. As this decision shows, there are other remedies available to a plaintiff, including rescission–that is, rescinding the contract and returning the parties to their positions before the contract was signed. Contact Schlam Stone & Dolan partner John Lundin at jlundin@schlamstone.com if you or a client face a situation where you are unsure how to enforce rights you believe you have under a contract.

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Posted in Commercial, Contracts
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