Opinion
01 Civ. 6007 (GBD)
April 3, 2003
MEMORANDUM OPINION AND ORDER
Plaintiffs brought suit against defendants alleging violations of §§ 10(b) and 20(a) of the Securities Exchange Act of 1934, and pendent state law claims in connection with plaintiffs' purchase from defendants of all the common stock of Copelco Capital, Inc. Defendants thereafter filed a motion to dismiss. Plaintiffs oppose that motion. For the following reasons, defendants' motion to dismiss is granted in part, and denied in part.
Discussion
Federal Rule of Civil Procedure 12(b)(6) allows a party to move to dismiss a Complaint where the Complaint "fail[s] . . . to state a claim upon which relief can be granted[.]" FED. R. CIV. P. 12(b)(6). In reviewing a motion to dismiss, this Court accepts the allegations in the Complaint as true and draws all reasonable inferences in favor of the non-moving party. See Patel v. Searles, 305 F.3d 130, 134-35 (2d Cir. 2002). However, bald contentions, unsupported characterizations, and legal conclusions are not well-pleaded allegations, and will not suffice to defeat a motion to dismiss. See Leeds v. Meltz, 85 F.3d 51, 53 (2d Cir. 1996). Here, a motion to dismiss will only be granted if the plaintiffs can prove no set of facts in support of their claims that would entitle them to relief. See Citibank. N.A. v. K-H Corp., 968 F.2d 1489, 1494 (2d Cir. 1992). A court may look at the Complaint and any documents attached to, or incorporated by reference in, the Complaint. See Dangler v. New York City off Track Betting Corp., 193 F.3d 130, 138 (2d Cir. 1999).
Defendants contend that plaintiffs' securities fraud, common law fraud, and negligent misrepresentation claims are based upon statements defendants made in documents other than the Securities Purchase Agreement (the "Agreement"). Defendants argue that these claims must fail as a matter of law because the Agreement explicitly precludes plaintiffs from relying on any representations except those included in the Agreement.
By the plain language of the Agreement, plaintiffs are precluded from asserting reliance on any other statements made by defendants except those contained in the Agreement. Section 4.08 of the Agreement states that "Sellers [defendants] make no representation or warranties with respect to . . . any other information or documents made available to Buyer [plaintiffs] or its counsel, accountants or advisors . . . except as expressly set forth in this Agreement." Agreement at § 4.08. Plaintiffs are sophisticated business entities who were represented by counsel, and negotiated the Agreement at arm's length. This Court, therefore, will hold plaintiffs to the agreement to which they bargained. Plaintiffs' securities fraud, common law fraud, and negligent misrepresentation claims cannot be based upon representations outside of the Agreement.
Nevertheless, plaintiffs contend that their securities fraud, common law fraud, and negligent misrepresentation allegations still survive as their Complaint, in fact, also alleges violations of the Agreement. Section 3.08 of the Agreement warrants that Copelco's financial statements were prepared in conformity with Generally Accepted Accounting Principles ("GAAP"), while § 3.09 of the Agreement warrants that the financial statements were prepared consistent with past Copelco practices. At paragraph 21 of the Complaint, plaintiffs quote § 3.08 of the Agreement and then allege that defendants "knew, or should have known, that the 1999 audited financial statements had not been prepared in conformity with GAAP and did not fairly represent the financial position of Copelco." Complaint at ¶ 21. Further, the Complaint alleges in the next paragraph that "[d]efendants' conduct also rendered other statements made by Itochu International in the Stock Purchase-Agreement deliberately false and misleading." Id. at ¶ 22. The Complaint then quotes the portion of § 3.09 of the Agreement where defendants warrant that the financial statements were prepared in accordance with past Copelco practices as an example of one such allegedly false and misleading statement in the Agreement. Id. Consequently, plaintiffs have sufficiently alleged violations of the Agreement, itself. Defendants' motion to dismiss the securities fraud, common law fraud, and negligent misrepresentation claims on the grounds that the Complaint does not allege a violation of the Agreement is therefore denied.
As will be discussed later, plaintiffs' negligent misrepresentation claim ultimately fails on other grounds.
Next, defendants contend that plaintiffs' allegations are subject to the Agreement's exclusive remedy provision, which only provides for indemnification as a remedy in the event of a breach. Plaintiffs do not dispute the existence of the exclusive remedy provision. Rather, they argue that, regardless, a party may not contract out of liability for its own fraud.
Section 11.07 of the Agreement provides that "Sections 8.06 and 11.02 will provide the exclusive remedy for any misrepresentation, breach of warranty, covenant or other agreement . . . or other claim arising out of this Agreement or the transactions contemplated hereby." Agreement at § 11.07. In turn, §§ 8.06 and 11.02 of the Agreement both provide only for indemnification in the event of a breach, and the terms which trigger such indemnification. See Agreement at §§ 8.06 and 11.02.
Although the parties contracted for this exclusive remedy provision, it is well settled that "parties cannot use contractual limitation of liability clauses to shield themselves from liability for their own fraudulent conduct." Turkish v. Kasenetz, 27 F.3d 23, 27-28 (2d Cir. 1994). Further, the federal securities laws have an anti-waiver provision which specifically makes void any contractual clause that allows a party to waive compliance with the federal securities laws. Pursuant to 15 U.S.C. § 77cc(a), "[a]ny condition, stipulation, or provision binding any person to waive compliance with any provision of this chapter or of any rule or regulation thereunder, or of any rule of an exchange required thereby shall be void." 15 U.S.C. § 77cc(a).
The Second Circuit has had occasion to address the scope of the federal anti-waiver policy. In McMahan Co. v. Wherehouse Enter., Inc., 65 F.3d 1044 (2d Cir. 1995), the Second Circuit analyzed the effect of a "no-action" contractual clause upon the plaintiffs' securities fraud claims. The "no-action" clause at issue provided that the plaintiffs could not bring suit against defendants unless certain procedural steps were followed, such as providing written notice to the defendants of a default. Plaintiffs failed to follow the procedural steps outlined, and defendants therefore claimed that plaintiffs waived their right to bring suit under the 1933 and 1934 Securities Exchange Acts. However, the Second Circuit upheld the district court's nullification of the "no-action" clause and found that "[t]he statutory framework of the 1933 and 1934 Acts compels the conclusion that individual security holders may not be forced to forego their rights under the federal securities laws due to a contract provision." McMahan, 65 F.3d at 1051.
Defendants rely on Harsco Corp. v. Segui, 91 F.3d 337 (2d Cir. 1996) for the proposition that a waiver clause is permissible under the federal securities laws. However, defendants mischaracterize Harsco. Harsco did not involve a waiver clause that prohibited any and all fraud suits under the federal securities laws or under the common law. It involved a contract that specifically outlined the representations that plaintiff was relying upon when it bought defendant's company. That plaintiffs fraud claim was based upon representations made outside the contract.
The Second Circuit was careful to distinguish the facts of Harsco from a contract provision which prohibits a party from suing at all under the federal securities laws. The court found that, in light of the carefully negotiated provision in the contract detailing the representations plaintiff relied upon, plaintiff may only bring a securities fraud suit based upon those specific representations included in the contract, and not based upon representations made outside the contract. The court found that "it is not fair to characterize [the representations agreed upon in the contract] as having prevented [plaintiff] from protecting its substantive rights. [Plaintiff] rigorously defined those rights in [the contract]." Harsco, 91 F.3d at 344. The Court found that "[plaintiff] has not waived its rights to bring any suit resulting from this deal." Id. Rather, plaintiff only waived its right to bring a federal securities suit based upon representations made outside the contract. See id.
Unlike the situation in Harsco, defendants here would have this court find that plaintiffs waived their right to bring any and all suits for fraud, even a suit concerning representations made within the contract. Such a broad-sweeping waiver clause is exactly the type of contractual provision that § 77cc(a) and the case law forbid. Therefore, the indemnification clause in the Agreement is void to the extent that it only provides one remedy, and defendants' motion to dismiss the securities fraud, common law fraud, and negligent misrepresentation claims based upon the indemnification clause is denied.
Next, defendants argue that plaintiffs' fraud claims fail because the Complaint failed to both plead fraud with particularity, and adequately plead scienter, as required by Fed.R.Civ.P. 9(b) and the Private Securities Litigation Reform Act ("PSLRA"). It is well settled that a Complaint asserting securities fraud must satisfy the pleading requirements of Rule 9(b). See Ganino v. Citizens Utilities Co., 228 F.3d 154, 167 (2d Cir. 2000). Rule 9(b) requires that "the circumstances constituting fraud or mistake shall be stated with particularity." FED. R. CIV. P. 9(b). Fraud allegations in a Complaint therefore must: "(1) specify the statements that the plaintiff contends were fraudulent, (2) identify the speaker, (3) state where and when the statements were made, and (4) explain why the statements were fraudulent." Shields v. Citytrust Bancorp. Inc., 25 F.3d 1124, 1128 (2d Cir. 1994).
Generally, Rule 8(a)'s liberal pleading standard applies. However, where fraud is alleged, a court must evaluate the allegations under Rule 9(b)'s heightened pleading standard. See Swierkiewicz v. Sorema N.A., 534 U.S. 506, 513 (2002).
Further, a Complaint alleging fraud must also allege that the defendants acted with scienter. See Novak v. Kasaks, 216 F.3d 300, 306 (2d Cir. 2000). A plaintiff must allege facts that give rise to a strong inference of fraudulent intent. See Shields, 25 F.3d at 1128; Novak, 216 F.3d at 311. A "strong inference" may be established "either (a) by alleging facts to show that defendants had both motive and opportunity to commit fraud, or (b) by alleging facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness."Ganino, 228 F.3d at 168-69, quoting Shields, 25 F.3d at 1128. The inference may also arise where the Complaint sufficiently alleges that the defendants: "(1) benefitted in a concrete and personal way from the purported fraud; (2) engaged in deliberately illegal behavior; (3) knew facts or had access to information suggesting that their public statements were not accurate; or (4) failed to check information they had a duty to monitor." Novak, 216 F.3d at 311 (internal citations omitted).
In this case, plaintiffs allege in their Complaint that they purchased from defendant Itochu International ("Itochu") in May 2000 all the common stock of Copelco. Plaintiffs allege that in purchasing Copelco, plaintiffs relied upon the accuracy of §§ 3.08 and 3.09 of the Agreement, which warranted that Copelco's financial statements and accounting practices were done in accordance with GAAP and consistent with past Copelco practices. Plaintiffs contend that after the closing, plaintiffs discovered that the accounting methods used by defendants artificially inflated Copelco's financial condition, in violation of GAAP and past Copelco practices.
Specifically, plaintiffs contend that, beginning in 1998 through May 16, 2000, Copelco's Chief Financial Officer and its Chief Operating Officer authorized and managed an accounting scheme by which uncollectible lease receivables were subjected to an internal charge-off limitation (the "Cap") above which no further receivables would be charged-off. Plaintiffs contend that the Cap was in violation of both GAAP and past Copelco accounting practices. The effect of the Cap was to appear to maintain Copelco's compliance with the rolling three month loss-to-liquidation rate required by its funding agreements with its various lenders. Failure to comply with this rate would have permitted Copelco's lenders to stop funding and, correspondingly, would have placed Copelco's access to financing with its various lenders at risk of termination, thereby potentially adversely impacting the value of Copelco's stock. Simply put, plaintiffs allege that lease receivables that should have been charged-off, in compliance with GAAP and past Copelco accounting practices, were not. Plaintiffs then contend that collections managers at Copelco engaged periodically in "horse-trading," where the total available charge-offs under the Cap were divided between the business groups. As a result of the Cap, plaintiffs contend that the overall collectibility of lease receivables was impaired.
Plaintiffs contend that the use of the Cap served not only to misrepresent actual rolling three month loss-to-liquidation rates, but also to overstate Copelco's income for the relevant period. Plaintiffs contend that the alleged misrepresentations caused Copelco's historical losses to be understated by at least $47 million at the time of the closing. Finally, plaintiffs contend that at all times relevant to the Complaint, defendants, by and through Copelco's officers and directors, knew that the Cap produced inflated numbers, and that plaintiffs relied upon the inaccurate information provided in the Agreement.
Plaintiffs' allegations are sufficiently pled to survive a motion to dismiss. First, plaintiffs have pled their fraud claims with particularity, in accordance with Rule 9(b). The Complaint identifies Copelco's allegedly fraudulent statements, namely §§ 3.08 and 3.09 which warranted that the financial statements were prepared in accordance with GAAP and past Copelco accounting practices. Those statements were clearly made in the Agreement, itself. The speakers are the defendants, the direct signatories to the Agreement. Plaintiffs have further explained why the statements are allegedly fraudulent, in that the CFO and COO of Copelco authorized the Cap plan, knew the Cap plan was contrary to GAAP and past Copelco accounting practices, and proffered the inflated numbers produced to plaintiffs with the intent to defraud them. Therefore, the requirements of Rule 9(b) have been met. Plaintiffs have also adequately pled scienter in accordance with the PSLRA, in that plaintiffs have described a set of facts and circumstances that, if proven, give rise to a strong inference of fraud. Therefore, defendants' motion to dismiss the securities fraud, and common law fraud claims is denied.
Defendants' motion to dismiss with respect to plaintiffs' vicarious liability claim brought pursuant to § 20(a) of the Securities Exchange Act is premised solely upon their assertion that the underlying securities fraud offense, § 10(b) of the Securities Exchange Act, also fails. As discussed above, plaintiffs have met the pleading standards for their § 10(b) claim, and therefore, this Court accordingly denies defendants' motion to dismiss plaintiffs' § 20(a) claim.
With respect to the common law fraud claim, defendants alternatively argue that even if it survives, plaintiffs' demand for punitive damages should nevertheless be stricken as the alleged fraud was not aimed at the public generally. Punitive damages are available in a fraud claim where the plaintiff demonstrates that the harm was directed at the public generally. See Rocanova v. Equitable Life Assurance Society, 643 N.E.2d 940, 943 (N.Y. 1994) (in cases evincing "a high degree of moral turpitude, and demonstrating such wanton dishonesty as to imply a criminal indifference to civil obligations, punitive damages are recoverable if the conduct was aimed at the public generally.") (internal quotation marks omitted); Manning v. Utilities Mutual Ins. Co., Inc., 254 F.3d 387, 400 (2d Cir. 2001) (quoting Raconova). Here, plaintiffs have failed to allege any conduct aimed at the public generally. This was a contract between two private parties, where the alleged harm befell one of the parties. Defendants' motion to strike plaintiffs' demand for punitive damages with respect to the common law fraud claim is therefore granted.
Defendants, further, argue that plaintiffs' claim for negligent misrepresentation fails as a matter of law because plaintiffs have not alleged a "special relationship" between plaintiffs and defendants. Plaintiffs, however, argue that a "special relationship" existed in that a relationship of confidence developed between the parties during the negotiation process and that plaintiffs trusted defendants' representations to be accurate.
In a negligent misrepresentation claim, a plaintiff must establish that the defendant had a duty to use reasonable care to convey correct information due to the existence of a "special relationship," that the information provided was incorrect or false, and that the plaintiff reasonably relied upon the information. See Fleet Bank v. Pine Knoll Corp., 736 N.Y.S.2d 737, 795 (App.Div. 2002). "To that end, a special relationship requires a closer degree of trust than an ordinary business relationship." Id. (internal quotation marks omitted), quoting Busino v. Meachem, 704 N.Y.S.2d 690, 693 (App.Div. 2000); Butvin v. Doubleclick. Inc., No. 99 civ 4727, 2000 WL 827673, at *10 (S.D.N.Y. June 26, 2000) ("a plaintiff may only recover for negligent misrepresentation where the defendant owes him a fiduciary duty"). Here, the plaintiffs' relationship with defendants was merely an ordinary business relationship. There is no allegation in the Complaint to support a finding that a "special relationship" existed. Therefore, defendants' motion to dismiss the negligent misrepresentation claim is granted.
Defendants next argue that plaintiffs' claim for breach of the implied covenant of good faith and fair dealing should be dismissed on the grounds that there was no breach in the course of contract performance. The implied covenant of good faith and fair dealing encompasses the concept that "neither party shall do anything which will have the effect of destroying or injuring the right of the other party to receive the fruits of the contract." Dalton v. Educational Testing Serv., 663 N.E.2d 289, 291 (N.Y. 1995), quoting Kirk La Shello Co. v. Paul Armstrong Co., 188 N.E. 163, 167 (N.Y. 1933). Plaintiffs have alleged that defendants engaged in an accounting plan that was contrary to GAAP and past Copelco accounting practices, that defendants knew the Cap plan was artificially inflating Copelco's financial figures, and that plaintiffs relied on defendants' representations. If these allegations are proven true, it can fairly be said that defendants' conduct had the effect of destroying or injuring plaintiffs' right to enjoy the fruits of the contract. Plaintiffs have sufficiently alleged, at this stage of the proceeding, a cause of action for breach of implied covenant of good faith and fair dealing and defendants' motion to dismiss this claim is therefore denied.
Lastly, defendants argue that plaintiffs' claim for unjust enrichment should be dismissed on the grounds that an unjust enrichment claim can not be maintained where there is a valid, enforceable agreement that governs the dispute. Plaintiffs argue, on the other hand, that an unjust enrichment claim can be maintained where there are grounds for recision of the contract. "Under New York law, unjust enrichment is a quasi contractual claim that ordinarily can be maintained only in the absence of a valid, enforceable contract. Where a contract governs the subject matter involved, however, a claim for unjust enrichment should be dismissed." Ohio Players. Inc. v. Polygram Records, Inc., No. 99 civ 0033, 2000 WL 1616999, at *4 (S.D.N.Y. Oct. 27, 2000) (citations omitted). In this case, a valid, enforceable contract (the Agreement) governs this dispute. Although plaintiffs have argued in their opposition brief to defendants' motion to dismiss that there could be grounds for recision of the contract, they did not include recision as a remedy in their Complaint. Therefore, defendants' motion to dismiss plaintiffs' claim for unjust enrichment is granted.
Conclusion
For the foregoing reasons, defendants' motion to dismiss is GRANTED as to plaintiffs' negligent misrepresentation and unjust enrichment claims, as well as to plaintiffs' demand for punitive damages under the common law fraud claim. The motion to dismiss is DENIED with respect to all remaining claims.