Breach of Contract, Without More, Insufficient to Justify Rescission

On September 26, 2014, Justice Whelan of the Suffolk County Commercial Division issued a decision in Huntington Village Dental, PC v. Rathbauer, 2014 NY Slip Op. 51545(U), explaining the circumstances under which a plaintiff is entitled to rescission of a contract.

In Huntington Village Dental, the court refused to grant the plaintiff summary judgment on its claim for rescission, notwithstanding “evidence of slight, causal and/or technical breaches of the” parties’ contract and instead granted the defendants summary judgment on the plaintiff’s rescission claim, explaining:

As a general rule, rescission of a contract is permitted for such a breach as substantially defeats its purpose. It is not permitted for a slight, casual or technical breach, but only for such as are material and willful, or, if not willful, so substantial and fundamental as to strongly tend to defeat the object of the parties in making the contract. A finding of a material breach must be premised upon proof that the departure from the terms of the contract or defects in its performance pervaded the whole of the contract so as to defeat the object that the parties intended.

The remedy of rescission is thus an extraordinary remedy that is only appropriate when a breach may be said to go to the root of the agreement between the parties. The issue of whether a purported breach by an obligee under a note constitutes a material breach of such note or related agreements that would suspend the payment obligations of the obligor thereunder is generally a question of fact.

A party seeking summary judgment on a contract rescission claim must establish, in the first instance, that a material breach occurred, that it lacks an adequate remedy at law and that the status quo may be substantially restored in the event that rescission is granted. Where a contract has been materially breached, the non-breaching party may elect to continue to perform the agreement and give notice to the other side rather than terminate it. When performance is continued and such timely notice is given, the nonbreaching party does not waive the right to sue for the alleged breach. However, by choosing not to terminate the contract at the time of the breach, the nonbreaching party surrenders his or her right to terminate later based on that breach.

(Internal quotations and citations omitted) (emphasis added). The court went on to find that the plaintiff had not made a prima facie showing of a material breach needed to justify the remedy of rescission.

Forum Selection Clause Not Enforced When Neither Parties Nor Agreement Connected to Chosen Forum

On November 5, 2014, the Second Department issued a decision in U.S. Merchandise, Inc. v L&R Distributors, Inc., 2014 NY Slip Op. 07495, refusing to enforce a forum selection clause.

In U.S. Merchandise, the Second Department reversed a trial court decision dismissing an action because the parties’ contract contained a forum selection clause providing for “the exclusive jurisdiction of the courts of the State of Delaware and the Federal Courts therein.” It explained:

A party seeking dismissal of a complaint under CPLR 3211(a)(1) must submit documentary evidence that conclusively establishes a defense to the asserted claims as a matter of law. A contract provision may constitute documentary evidence under CPLR 3211(a)(1), and a forum selection clause contained in a contract may provide a proper basis for dismissal of a complaint under CPLR 3211(a)(1). A forum selection clause is prima facie valid and enforceable unless it is shown by the challenging party to be unreasonable, unjust, in contravention of public policy, invalid due to fraud or overreaching, or it is shown that a trial in the selected forum would be so gravely difficult that the challenging party would, for all practical purposes, be deprived of its day in court. Accordingly, a forum selection clause will be given effect in the absence of a strong showing that it should be set aside.

Here, the plaintiff has made the requisite strong showing that the forum selection clause in the nondisclosure agreement was unreasonable. Specifically, the plaintiff has contended, without contradiction, that neither the parties nor the agreement has any connection to the State of Delaware: none of the parties is located in Delaware, the nondisclosure agreement was not executed in Delaware, and performance of the agreement was not to take place in Delaware. Accordingly, the prima facie enforceability and validity of the forum selection clause has been rebutted and, therefore, that clause does not conclusively establish a defense to the asserted claims as a matter of law. Thus, the Supreme Court should have denied that branch of the defendants’ motion which was to dismiss the amended complaint pursuant to CPLR 3211(a)(1).

(Internal quotations and citations omitted) (emphasis added). That there are situations in which forum selection clauses will not be enforced is not a new legal principle. It is a bit surprising to see it applied to these facts.

Court of Appeals Holds That, Absent Express Language, “Affiliate” only Includes Existing Affiliates

On October 23, 2014, the Court of Appeals issued a decision in Ellington v. EMI Music, Inc., 2014 NY Slip Op. 07197, affirming a decision of the First Department affirming a Supreme Court dismissal of an action for breach of contract brought by a grandson of music legend Duke Ellington.

Ellington, presented a type of dispute apparently common in the entertainment industry—a creative artist suing a copyright holder/distributor for engaging in some form of self-dealing in order to reduce the amount of royalties to be paid.

Here, the plaintiff was a grandson of Duke Ellington, who, along with his heirs, was the First Party to a 1961 copyright renewal agreement. The agreement provided that the Second Parties—various music publishers, including EMI’s predecessor in interest as well as “any other affiliate of [the predecessor],” would pay the First Party royalties from the publication of Ellington’s works, including 50% “of the net revenue actually received by the Second Party from . . . foreign publication.” Plaintiff sued EMI for breach of contract, alleging that EMI had at some point begun distributing Ellington’s works through affiliated foreign subpublishers rather than independent foreign subpublishers (as was industry practice when the agreement was signed), thereby effectively increasing EMI’s share of the net revenues at plaintiff’s expense.

However, the foreign subpublishers were retaining the same 50% share of the overall royalties from foreign sales as the previous, unaffiliated subpublishers had. So, it appears that (although not stated explicitly in the opinion) at the time of the contract, the foreign subpublishers would retain 50% of the foreign royalties, with 25% going to EMI and 25% to Ellington. Under the new arrangement, Ellington is getting the same 25%, but EMI and its affiliates collectively get the entire remaining 75%.

In an opinion written by Judge Abdus-Salaam, the majority affirmed the lower courts’ dismissal.

The majority first held that “net revenue actually received” was clear and unambiguous, and that that term did not preclude the use of affiliated foreign subpublishers. The majority also found that the affiliated foreign subpublishers were not included in the term “any other affiliate” because they were not in existence at the time the contract was signed:

Absent explicit language demonstrating the parties’ intent to bind future affiliates of the contracting parties, the term “affiliate” includes only those affiliates in existence at the time the contract was executed. Furthermore, the parties did not include any forward-looking language. If the parties intended to bind future affiliates they would have included language expressing that intent. Absent such language, the named entities and other affiliated companies of EMI’s predecessor which existed at the time are bound by the provision, not entities that affiliated with EMI after execution of the agreement.

(Internal citations omitted.)

The majority dismissed the dissent’s criticism, stating that “the parties merely did not account for the possibility that the publisher would eventually affiliate with foreign subpublishers.”

Concurring, Judge Smith rejected the majority’s reasoning: “As a general proposition, it seems wrong to me that, when a contract is written to bind ‘any affiliate’ of a party, its effects should be limited to affiliates in existence at the time of contracting. That invites parties to create new affiliates, and to have them do what the old affiliates are prohibited by the contract from doing.” He also stated that, if the facts had been different and the foreign affiliates had been keeping a greater overall share of the total revenues, the majority would probably have interpreted the term “affiliate” differently.

Judge Smith concurred in the judgment based upon the plaintiff and his predecessors’ apparent acquiescence with the current scheme since 1994.

In dissent, Judge Rivera, joined by Chief Judge Lippman, thought that the term “affiliate” was not clear and unambiguous, and that EMI’s argument that foreign affiliates were not included “merely begs the question of what is an affiliate.” For the dissent, the majority holding excluding subsequently-created affiliates from the term was inconsistent with the purpose of the agreement and with then-prevailing industry practice, and that the plaintiff’s proposed interpretation of the term was “reasonable, or at least as reasonable as the one proposed by EMI.”

The dissent also shared Judge Smith’s policy concerns, stating that the majority interpretation was “troubling” and “sets the stage for the type of abuse alleged here, namely corporate reconfigurations that avoid the understanding of the parties.”

The most interesting question about this decision is whether Judge Smith is right—if under the new arrangement, if the heirs had been getting less than their previous 25%, would the final outcome have been different? On its face, it also appears to be a victory for the kind of prosy contract drafting that long since went out of favor in law schools and legal writing manuals: if the key provision had only included some phrase like “that now exist or ever have existed since the beginning of the world or ever will exist until the end of the world,” plaintiff would have prevailed.

No Claim for Breach of Covenant of Good Faith and Fair Dealing When Claim Has Same Basis as Breach of Contract Claim

On October 21, 2014, Justice Whelan of the Suffolk County Commercial Division issued a decision in J. Kokolakis Contracting Corp. v. Evolution Piping Corp., 2014 NY Slip Op. 24321, dismissing a claim for breach of the covenant of good faith and fair dealing.

In J. Kokolakis Contracting Corp., the plaintiff building contractor sued a subcontractor in connection with work the defendant did on a job site, as well as its insurer. The defendant insurer moved to dismiss the plaintiff’s causes of action against it for breach of the covenant of good faith and fair dealing and for attorney’s fees. In granting the motion, the court explained:

Distinguishable [from tort claims] are claims premised upon a breach of the covenant of good faith and fair dealing which the law of this state imposes upon all contracting parties. This covenant mandates that none of such parties 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. The covenant is breached when a party to a contract acts in a manner that, although not expressly forbidden by any contractual provision, would deprive the other party of the right to receive the benefits under their agreement.

A claim for breach of the implied covenant of good faith and fair dealing is generally actionable only where wrongs independent of the express terms of the contract are asserted and demands for the recovery of separate damages not intertwined the damages resulting from a breach of a contractual are advanced. Where a contractual party is merely seeking to reap the benefits of its contractual bargain, the implied covenant breach claim will not lie, as it is considered duplicative of the breach of breach of contract claim.

Federal appellate authorities have long held that a breach of the implied duty of good faith is a breach of the underlying contract. There is however, recognition of authority to the contrary.

. . .

Here, the court finds merit in the moving defendant’s contention that the plaintiff’s claims for recovery of consequential damages arising from any breach of the implied covenant of good faith and fair dealing and its claims for recovery of litigation costs, including attorneys fees due to the moving defendant’s alleged bad faith denial of coverage are not actionable and are thus subject to dismissal pursuant to CPLR 3211(a)(7). Review of the allegations set forth in complaint reveal that the facts which underlie these claims are the same as those which underlie the plaintiff’s breach of contract claim. There are no allegations of independent breaches of tort duties such as fiduciary duties owing to the plaintiff from the moving defendant which would support a breach of fiduciary duties claim or other tort claim.

(Internal quotations and citations omitted) (emphasis added).

Court Finds No Oral Modification of Written Contract

On September 25, 2014, Justice Whelan of the Suffolk County Commercial Division issued a decision in Air & Power Transmission, Inc. v. Weingast, 2014 NY Slip Op. 32670(U), rejecting a claim based on an alleged oral modification of a written contract.

In Air & Power Transmission, the plaintiffs’ claims were based upon, among other things, the breach of “purported oral promises to indemnify the plaintiffs.” The court dismissed that claim, explaining:

The . . . alleged oral assurances are flatly contradicted by the terms of existing writings between the parties governing the same subject matter . . . .  To be enforceable, a separate, subsequent, additional agreement must address a scenario that was not anticipated and not covered by the terms of the existing written agreements between the parties. There are no allegations that the alleged oral assurances constituted separate, subsequent, additional agreements that addressed a scenario not anticipated or covered by the terms of the existing written agreements. Moreover, the particulars of the oral promises allegedly made by Mass Mutual agents are not alleged with the sufficient particularity to give rise to claims for breach of the alleged oral agreement was a separate, additional agreement.

(Internal quotations and citations omitted) (emphasis added).

Breach of a Contractual Representation or Warranty Occurs at the Time of Signing, Not the Effective Date of the Agreement

On October 21, 2014, the First Department issued a decision in U.S. Bank N.A. v DLJ Mortgage Capital, Inc., 2014 NY Slip Op. 07093, addressing the question of when a claim for breach of a representation or warranty occurs.

In U.S. Bank, the First Department affirmed a trial court’s denial of a motion to dismiss a claim for breach of a contractual warranty on statute of limitations grounds, explaining:

If a contractual representation or warranty is false when made, a claim for its breach accrues at the time of the execution of the contract. This is true even where the contract states that its effective date is earlier. The claim cannot accrue earlier, because until there is a binding contract, there can be no claim for breach of warranty. Additionally, in the residential mortgage-backed securities (RMBS) context, it should be noted that the claim cannot generally accrue before the contract, because the trust that is the recipient of the representations and warranties typically does not come into existence prior to the closing of the transaction. Furthermore, the representations and warranties were made as of the closing date, and the contract, which did not explicitly address the statute of limitations, does not indicate a clear intent to alter the accrual date relating to claims for a breach thereof. As such, the IAS court correctly held that the representation and warranty claims accrued on February 7, 2007, the date the pooling and service agreement, the agreement sued upon, was executed.

(Internal quotations and citations omitted) (emphasis added). It is not unusual for agreements to be executed on a date other than the effective date of the agreement. This decision provides a rule for determining the accrual date of a breach of representation and warranty claim in that situation.

Implied Covenant of Good Faith and Fair Dealing Requires Landlord to Consent to Renewal of Sidewalk Cafe Permit

On October 21, 2014, the First Department issued a decision in DMF Gramercy Enterprises, Inc. v. Lillian Troy 1999 Trust, 2014 NY Slip Op. 07110, illustrating the application of the implied covenant of good faith and fair dealing.

In DMF Gramercy Enterprises, the plaintiff sued the defendants over the defendant’s refusal to consent to the plaintiff’s continued operation of a sidewalk café in the space the plaintiff leased from defendants. The First Department affirmed the trial court’s finding that this refusal breached the terms of the lease and, at any rate, “that the implied covenant of good faith and fair dealing would otherwise restrict defendants’ ability to deny consent, and that they have failed to make a satisfactory showing of good faith in this case.” As to the implied covenant of good faith and fair dealing, the First Department explained:

We note initially defendants’ correct assertion that the sidewalk café is not part of the leased premises. . . . Nevertheless, the lease gives plaintiff the right to make use of the sidewalk space. . . .

Having determined that the lease allows plaintiff to use and occupy the sidewalk for the operation of a sidewalk café, it necessarily follows that defendants cannot withhold or revoke their consent to that use absent a good-faith basis. As the Court of Appeals has explained:

In New York, all contracts imply a covenant of good faith and fair dealing in the course of performance. This covenant embraces a pledge 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. While the duties of good faith and fair dealing do not imply obligations inconsistent with other terms of the contractual relationship, they do encompass any promises which a reasonable person in the position of the promisee would be justified in understanding were included.

Because the stipulated facts demonstrate that the sidewalk café existed at the time of the lease’s execution, plaintiff (through its assignor) was justified in understanding that the landlord promised to refrain from unreasonably withholding its consent to operate the sidewalk café. It is of no moment that paragraph 1(d) of the lease refers to the revocable nature of the right, if any, to maintain beyond the building lines, because that language does not go so far as to give defendants the right to revoke their consent for any reason whatsoever. Furthermore, paragraph 1(d) can be viewed alternatively as affirming that the landlord cannot guarantee the right because it is revocable by the City, the entity that owns the sidewalk and has the authority to grant sidewalk café licenses.

To permit defendants to withhold or revoke their consent at will would destroy plaintiff’s right to receive the fruits of the contract inasmuch as those fruits are gained by operating the sidewalk café. As discussed above, the lease permits plaintiff to use the sidewalk for the operation of a sidewalk café, provided, of course, that such use is lawful. Plaintiff’s sidewalk café can only be lawful if it obtains the consent of the landlord (a prerequisite to the grant of a license by the City). Accordingly, the landlord cannot obstruct plaintiff’s operation of the sidewalk café by refusing in bad faith to consent. As the trial court observed, defendants did not reserve the right to terminate consent in their sole discretion. Therefore, their right to deny consent must be bridled by the implied covenant of good faith and fair dealing.

(Internal quotations and citations omitted).

Fraud Claim Dismissed As Duplicative of Breach of Contract Claim

On September 4, 2014, the First Department issued a decision in Beta Holdings, Inc. v. Goldsmith, 2014 NY Slip Op. 06035, dismissing a fraud counterclaim as duplicative of the counterclaim-plaintiffs’ breach of contract claim.

In Beta Holdings, the plaintiffs, entities associated with a private equity fund, filed suit against the principals of a company the fund acquired, asserting claims for fraud and breach of contract arising from alleged misrepresentations regarding the financial condition of the company.  The defendants filed counterclaims, including a claim for fraud, arising from the plaintiffs’ failure to pay amounts due on a note that was issue in connection with the transaction.  New York Commercial Division Justice Jeffrey K. Oing denied the plaintiffs’ motion to dismiss the fraud counterclaim, and the First Department reversed, holding that the fraud claim was duplicative of the breach contract claim because the defendants did not “allege a duty separate from the terms of the agreement that was breached”:

The fraud counterclaims, insofar as based on the alleged misrepresentations by counterclaim defendants that they would honor the terms of the promissory notes, are duplicative of the breach of contract counterclaims; the allegations are essentially that they did not intend to honor the terms of the notes at the time they executed them. The allegations are insufficient to satisfactorily plead that counterclaim defendants, at the time the agreement was entered into, never intended to carry out the terms of the agreement. Neither do they allege a duty separate from the terms of the agreement that was breached by counterclaim defendants so as to support a claim of fraud, or that the damages sought to be recovered are based on lost opportunities arising from counterclaim plaintiffs having been induced to sell their company. Here, plaintiffs claim that counterclaim defendants orally promised to “grow the company” using methods such as geographic expansion, acquisition opportunities and better marketing, and that these promises are specific and not subject to the agreement’s merger provision. However, this overlooks the September 8, 2008 letter of intent, which includes a promise that the buyers “want to continue to grow the Company,” and briefly summaries how this would be done. The terms of the letter of intent are subject to the merger provision. In any event, the alleged promises are of a general nature and insufficiently specific to establish fraudulent inducement, even were they not barred by the agreement’s merger provision.

(Citations omitted.)  This decision illustrates that, under New York law, a claim arising from a failure to perform under an agreement usually sounds in contract not in tort, and the mere allegation that a party “never intended to perform” under the contract is not sufficient to transform a breach a contract claim into a fraud claim.

Claim for Breach of Covenant of Good Faith and Fair Dealing Duplicative When it Arises from Same Operative Facts as Contract Claim

On September 4, 2014, the First Department issued a decision in Mill Financial, LLC v. Gillett, 2014 NY Slip Op. 06039, holding that a claim for breach of the covenant of good faith and fair dealing is duplicative of a breach of contract claim when both claims arise from the same operative facts.

In Mill Financial, a dispute over commercial loans, the trial court denied a defendant’s motion to dismiss. On appeal, the First Department reversed the portion of the trial court’s decision that refused to dismiss the plaintiffs’ “claim for breach of the covenant of good faith and fair dealing” as “duplicative of the breach of contract claim,” explaining:

Where a good faith claim arises from the same facts and seeks the same damages as a breach of contract claim, it should be dismissed. [The plaintiff] argues that the failure to give notice was the breach of contract, and the taking control and sale of the Club is the conduct giving rise to the good faith claim. However, as noted, the only damages flowing from the alleged failure to give notice are from the sale of the Club. The whole theory of the breach of contract action was that [the plaintiff] was prevented from taking steps to protect its collateral, i.e., stopping the sale of the Club. The conduct alleged in the two causes of action need not be identical in every respect. It is enough that they arise from the same operative facts.

(Internal quotations and citations omitted) (emphasis added).

Court of Appeals Accepts Certified Questions Regarding Interpretation of Oil and Gas Leases

On August 28, 2014, the Court of Appeals accepted two certified questions from the Second Circuit in Beardslee v. Inflection Energy, LLC, 12-4897-CV, a case involving the interpretation of oil and gas leases. At issue in Beardslee is the interplay between two provisions in the leases: (1) the so-called “habendum” clause, which sets the duration of the lease, and (2) a force majeure clause, which concerns delays or interruptions in drilling. The habendum clauses at issue provided for a five year initial term, and an option for a secondary term, which would extend “as long thereafter” as the land “is operated by the Lessee in the production of oil or gas.” The force majeure clauses stated: “If and when drilling . . . [is] delayed or interrupted . . . as a result of some order, rule regulation . . . or necessity of the government, or as the result of any other cause whatsoever beyond the control of the Lessee, the time of such delay or interruption shall not be counted against the Lessee, anything in this lease to the contrary notwithstanding.”

After the expiration of the five-year term, the lessee had still not commenced drilling because the only “commercially viable” method of drilling in the property—high-volume hydraulic fracturing, or “fracking”—was subject to a regulatory moratorium in New York (although permits for other unprofitable methods were in theory available). The lessees took the position that the regulations amounted to a force majeure event under the leases, and that the force majeure clause extended the term in the habendum clause. The landowners brought a declaratory judgment action in the Northern District of New York, alleging that the leases expired by their terms after five years because the lessees had not begun drilling. The district judge granted summary judgment to the landowners, declaring the leases expired.

Finding that the case raised novel and important questions of New York law that had not been addressed by the Court of Appeals, or any lower courts, the Second Circuit certified two questions to the Court of Appeals:

1. Under New York Law, and in the context of an oil and gas lease, did the State’s Moratorium amount to a force majeure even?

2. If so, does the force majeure clause modify the habendum clause and extend the primary terms of the leases?

As the Second Circuit noted, the outcome of this case could have “potentially great commercial and environmental significance to State residents and businesses.” We will continue to follow this case as it makes its way through the Court of Appeals.