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Bankruptcy Court Dismisses Complaint for Failure to State a Claim for Fraudulent Misrepresentation

By GianClaudio Finizio

On May 12, 2015, Judge Christopher S. Sontchi of the United States Bankruptcy Court for the District of Delaware (the “Court”) granted defendants’ motion to dismiss (without prejudice) an adversary complaint (the “Complaint”) for plaintiffs’ failure to sufficiently plead material facts in support of a claim of fraudulent misrepresentation under Delaware common law.  Defendants were A&G Realty Partners, LLC and Michael Jerbich (collectively, “Defendants”).  Plaintiffs were Alamo Group, LLC and Kirin Alamo, LLC (collectively, “Plaintiffs”).

In June 2013, Orchard Supply Hardware Stores Corporation and its affiliates (collectively, the “Debtors”) filed for relief under chapter 11 of the Bankruptcy Code.  The Debtors subsequently sold substantially all operating assets with the exception of certain unexpired leases.  The Defendants, acting as the Debtors’ real estate broker, negotiated a sale of the unexpired leases with Plaintiffs resulting in a Designation Rights Agreement (the “Agreement”) pursuant to which the Debtors would transfer to Plaintiffs the right to accept or reject assumption of any remaining unexpired leases for a specified period of time in exchange for $315,000.  Prior to Court approval of the Agreement, Defendants informed Plaintiffs of a competing bid (the “Competing Bid”) in the form of a binding letter of intent offering $1.1 million.  Plaintiffs were afforded the opportunity to review the Competing Bid only after entering into a nondisclosure agreement which prevented Plaintiffs from contacting the competing bidder prior to the sale approval hearing.  Plaintiffs asserted that their review of the Competing Bid, which concluded that the bid appeared legitimate, coupled with Defendants’ representation that Defendants had not solicited the Competing Bid, led Plaintiffs to believe that the competing bidder had conducted sufficient due diligence.  Plaintiffs, in turn, increased their bid to $1.2 million which ultimately was approved by the Court.

Following Court approval of the Agreement, Plaintiffs contacted the competing bidder and reached the conclusion that the competing bidder had done little due diligence which set the stage for the filing of the Complaint alleging that: (i) the Competing Bid was a sham in that the competing bidder bid entirely at the instruction of Defendants; and (ii) Defendants intentionally misrepresented certain details about the Competing Bid, specifically that the letter of intent was unsolicited and that Defendants did not have any previous contact with the competing bidder.  Plaintiffs asserted that they would not have made the higher offer had they known of Defendants’ earlier communications with the competing bidder.

Applying the pleading standards from the Supreme Court’s decisions in Bell Atlantic v. Twombly1 and Ashcroft v. Iqbal,2 the Court concluded that the Complaint’s factual elements were insufficient to support Plaintiffs’ assertion that Defendants’ misrepresentations were material to its decision to place a second bid.  In addition, the Court found that the Complaint also lacked sufficient details of a deliberate concealment of material facts to support a fraud by omission claim.

As an initial matter, the Court determined that Delaware law was the appropriate law to utilize for its analysis.  The Court reached this conclusion based upon the choice of law provision in the Agreement as well as Delaware’s material relationship to the transaction on account of the lead debtor being a Delaware corporation and the Court, sitting in Delaware, having approved the Agreement authorizing the sale to Plaintiffs.  Turning next to the elements of Delaware common law fraud, the Court needed only to focus on the first element: a false representation of material fact made by the defendant.3  The Court reasoned that, even assuming Plaintiffs’ allegations regarding Defendants’ prior communications with the competing bidder were true, such facts did not support the inference that Defendants’ misrepresentations were material to Plaintiffs’ decision to place a second and higher bid.  As the Court explained, irrespective of whether the Competing Bid was made “out of the blue,” Plaintiffs had to make a higher offer to be the successful purchaser of the lease designation rights.

The Court also found that Plaintiffs’ allegations in support of a fraud by omission claim were insufficient to support the alleged motive that Defendants insisted on entry into a nondisclosure agreement to prevent Plaintiffs from communicating with the competing bidder.  In reaching its conclusion, the Court also took into account that Plaintiffs were sophisticated parties and that nondisclosure agreements are commonplace in bidding and sale proceedings.

A copy of the Court’s opinion is available here.

1 550 U.S. 544 (2007).
2 556 U.S. 662 (2009).
3 The elements of common law fraud under Delaware law are: (1) a false representation of material fact made by the defendant; (2) the defendant’s knowledge or belief that the representation was false, or made with reckless indifference to the truth; (3) an intent to induce the plaintiff to act or refrain from acting; (4) the plaintiff’s action or inaction taken in justifiable reliance upon the representation and (5) damage to the plaintiff as a result of such reliance.

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