Litigating And Drafting Contractual Disclaimers Of Reliance In A Post-Financial World

In the massive market in unregulated (or at least less regulated) private financial transactions between and among sophisticated institutions, such as transactions in bank debt, bankruptcy claims and structured products, in which disputes are resolved by reference to old-fashioned common-law rules, how do the courts balance the rights of sophisticated parties to transact without fear of a lawsuit from a counterparty with buyer's remorse against a public policy that refuses to reward intentional fraud? That battle, especially in the years since the financial crisis, has played itself out in the use and enforceability of contractual disclaimers of reliance ("CDRs"), otherwise known as "Big Boy" provisions.

Courts in New York and elsewhere will, as a general rule, enforce contractual disclaimers of reliance in which each party specifically disclaims reliance on the other's disclosures or omissions, when the parties to the contract are sophisticated and the CDR is specific as to the information that is not to be relied upon.1 The rule in New York has been expressed this way:

"[W]here the parties to an agreement have expressly allocated risks, the judiciary shall not intrude into their contractual relationship; a party cannot complain of having been misled if the substance of the disclaimer provisions tracks the substance of the alleged misrepresentations, notwithstanding semantical discrepancies. . . . It is not the role of the courts to relieve sophisticated parties from detailed, bargained-for contractual provisions that allocate risks between them, and to provide extra-contractual rights or obligations for one side or the other."

DynCorp v. GTE Corp., 215 F. Supp. 2d 308, 321-22 (S.D.N.Y. 2002) (citing Grumman Allied Indus., Inc. v. Rohr Indus., Inc., 748 F.2d 729, 735 (2d Cir. 1984) (internal citations omitted).

The financial crisis spawned a significant number of cases involving Big Boy provisions, many arising from transactions in mortgage-backed securities and other complex structured products. In some, but by no means all, of those cases, courts have denied motions to dismiss fraud claims despite a sophisticated plaintiff's agreement to a Big Boy provision. Below, we describe the recent trend in the law on Big Boys and provide some guidance derived from the cases for drafting enforceable CDRs.

1. Litigating Contractual Disclaimers of Reliance

   While contractual disclaimers of reliance generally are enforceable between sophisticated parties, especially in New York, the "peculiar knowledge" exception has been applied in some recent cases to prevent dismissal of fraud complaints at an early stage of the litigation. Without early enforcement of the bargained for disclaimer, the value of a CDR diminishes greatly, given the expense of litigation.

   1. General Rule Regarding Enforceability Of Contractual Disclaimers

      To succeed under New York law on common law fraud, the plaintiff must plead and prove:

      1. A material false representation, or material omission with a duty to disclose;2

      2. an intent to defraud;

      3. reasonable reliance on the misrepresentation or omission; and

      4. economic loss arising as a result of reliance.

         Mandarin Trading Ltd. v. Wildenstein, 16 N.Y.3d 173, 178 (2011). A well drafted, specific and detailed CDR that has been negotiated at arms-length between sophisticated parties can destroy subsequent fraud claims in one of two ways: absolving the defendant of any duty to disclose or preventing the plaintiff from demonstrating its reasonable reliance.

      1. Modifying or Negating the Duty to Disclose

         A sophisticated party that has contractually waived the duty to disclose material information cannot then claim fraudulent concealment based on the counterparty's failure to make such disclosure. Under this rule, there can be no concealment—and thus no fraud—if the plaintiff "knew what it didn't know" when he entered the transaction. Harborview Master Fund, LP v. Lightpath Technol., Inc., 601 F. Supp. 2d 537, 546 (S.D.N.Y. 2009). Recent decisions continue to apply this general rule, which remains the lynchpin of the enforceability of Big Boy provisions.

         For instance, in Pharos Capital Partners, L.P. v. Deloitte & Touch, L.L.P., plaintiff's counsel initially objected to a provision in a draft Letter Agreement that limited defendant's disclosure obligations. However, in the final, executed version of the Letter Agreement, the plaintiff represented and acknowledged that (a) defendant was not a fiduciary of plaintiff and (b) defendant may have acquired or may acquire information "which we agree need not be provided to us." 905 F. Supp. 814, 820-21 (S.D. Ohio 2012) (applying Ohio and New York law). The court held that the Letter Agreement's "unmistakable language" defeated any argument plaintiff made about defendant's duty to disclose and "render[ed] unreasonable any expectation [plaintiff] may have had about informational parity." Id. at 825. Likewise, the recent Southern District of New York decision in Harborview Master Fund v. Lightpath Technologies held that plaintiff could not recover under federal law for "omissions to which it contractually agreed," where the parties' purchase agreement provided that defendant had no duty to disclose MNPI. 601 F. Supp. 2d at 547-48.

      2. Negating Reasonable Reliance

         Most recent cases that involve CDRs allege a mix of fraudulent misrepresentations and fraudulent concealment. Of those cases, many allege concealment of defendant's own bad acts or illicit motivations. While these cases also implicate the duty to disclose, the "reasonable reliance" element of the fraud claim figures much more prominently. As such, here we examine the so-called "disclaimer bar" rule, which defeats a fraud claim by preventing a plaintiff from establishing reasonable reliance, and we also discuss an exception which can protract litigation over CDRs

         The disclaimer bar rule provides that where a

         "plaintiff has in the plainest language announced and stipulated that it is not relying on any representations as to the very matter as to which it now claims it was defrauded[,] [plaintiff's] specific disclaimer destroys the allegations in plaintiff's complaint that the agreement was executed in reliance upon these contrary . . . representations"

         Danann Realty Corp. v. Harris, 5 N.Y.2d 317, 320-21 (1959); see Basis Yield Alpha Fund (Master) v. Goldman Sachs Group, Inc., 115 A.D.3d 128, 139, 980 N.Y.S.2d 21, 30 (1st Dep't 2014) (referring to the Danann Realty rule as the "disclaimer bar" rule). Any contrary result would "in effect condone [plaintiff's] own fraud in deliberately misrepresenting [its] true intention' " when it agreed to the CDR in its transaction documents. HSH Nordbank, AG v. UBS AG, 95 A.D.3d 185, 201 (1st Dep't 2012) (citing Danann Realty, 5 N.Y.2d at 323).

         A number of recent cases have applied the disclaimer bar rule to dismiss fraud claims early in the proceedings on a pre-answer motion to dismiss. For example, in ACA Fin. Guar. Corp. v. Goldman, Sachs & Co., the First Department held that plaintiff, "a highly sophisticated commercial entity," could not base fraud claims on defendant's alleged misrepresentations regarding a nonparty hedge fund's position in a CDO transaction because plaintiff's alleged reliance on such misrepresentations "would have been contrary to its acknowledgment . . . that, in entering into the transaction, it was not relying . . . upon any advice, counsel or representations . . . of [defendant]" other than the representations expressly set forth in the parties' written agreement. 106 A.D.3d 494, 497 (1st Dep't 2013).3 Similarly, in MBIA Ins. Corp. v. Merrill Lynch, the First Department barred a fraud claim where specific disclaimers provided that plaintiff "would not rely on [defendant's] advice," had the "capacity to evaluate transactions" and "understood and accepted" the risks of the transaction. 81 A.D.3d 419 (1st Dep't...