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From Securities Regulation Daily, April 2, 2019

Merger provision too general to preclude reasonable reliance

By Rodney F. Tonkovic, J.D.

A general disclaimer provision was not enforceable because its language did not track the substance of the alleged misrepresentation.

A Second Circuit panel vacated a district court judgment and concluded that a merger clause did not preclude reliance. The court held that a general merger clause incorporated into a subscription agreement was not the type of specific disclaimer that could prevent reasonable reliance on alleged misrepresentations as a matter of law. The court accordingly vacated the district court's judgment and remanded for further proceedings (FIH, LLC v. Foundation Capital Partners, LLC, April 1, 2019, Lynch, G.).

Membership interest purchased. Plaintiff FIH, LLC purchased a membership interest in Foundation Capital Partners, LLC, the general partner in a private equity fund set up to invest in minority interests in the management companies of large, established hedge funds. FIH alleged that it purchased its membership interest on the basis of misrepresentations that Foundation had an active pipeline of investments and that two of Foundation's key partners were able to work together notwithstanding one partner's divorce of the other’s sister-in-law. Soon after investing, FIH learned that there were far less transactions in the pipeline than represented and that the partners could not stand each other.

In January 2018, the district court granted summary judgment in favor of Foundation. According to the court, FIH was a sophisticated investor, and a merger clause in its subscription agreement with Foundation made FIH's reliance on the alleged misrepresentations unreasonable as a matter of law. This clause provided that "[t]his Agreement constitutes the entire agreement of the Members and supersedes all prior agreements among the Members with respect to the subject matter hereof, including the Original Agreement."

Reliance. On appeal, FIH advanced three arguments concerning the merger clause, but the court only focused on the second: that the clause was only a "general" merger clause, as opposed to a specific disclaimer. The court noted that the Second Circuit has held that general disclaimers are insufficient to defeat reasonable reliance on material misrepresentations as a matter of law, even by a sophisticated investor. In that case, the court explained that a disclaimer is enforceable only if it "tracks the substance of the alleged misrepresentation" (see Caiola v. Citibank, N.A., New York (2d Cir. 2002).

In this case, the court said, there were no disclaimers, that is, no explicit language disclaiming reliance on external representations, sufficiently specific to meet the Caiolastandard. Indeed, the agreement in this case had no clause with language as strong as the general disclaimer found to be insufficient in Caiola. Here, there were no representations in the agreement as to the transaction pipeline or the working relationships between Foundation's principals that might have served as an implicit disclaimer of Foundation's extra-contractual factual representations to FIH, the court said.

The case is No. 18-357-cv.

Attorneys: Samuel J. Lieberman (Sadis & Goldberg LLC) for FIH, LLC. Peter Nolin (Carmody Torrance Sandak & Hennessey LLP) for Dean Barr. Jonathan Paul Whitcomb (Diserio Martin O'Connor & Castiglioni LLP) for Joseph Meehan.

Companies: FIH, LLC; Foundation Capital Partners LLC f/k/a Foundation Managing Member LLC

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