Trades between Loan Market Participants ("LMPs") are often completed despite a disparity of information flow relating to the transaction between the counterparties. Contractual disclaimers of reliance ("CDRs"), also known as "Big Boy Provisions," have become a common tool used to protect sophisticated parties from exposing themselves to liability arising under common law or statutory fraud provisions. Generally, a plaintiff in a fraud case must show that the defendant knowingly made a false material statement intended to induce the plaintiff to act, or omitted to state a material fact and that the plaintiff suffered damages because of their justifiable reliance upon such statement or because of such omission.1 A standard CDR undercuts the essential element of justifiable reliance should a plaintiff bring a claim based upon an alleged fraudulent misrepresentation.2 However, a standard CDR is most commonly challenged in cases where the plaintiff's claim is based on the defendant's allegedly fraudulent omission of a material fact. Typically, caveat emptor is the general rule, and a fraud claim based on the defendant's fraudulent concealment of a material fact will fail unless the defendant has a fiduciary relationship with the plaintiff; has made a partial statement requiring disclosure to avoid misleading the counterparty; or was in possession of facts within their peculiar knowledge.3
The Peculiar Knowledge Doctrine
Under New York law, parties to a contract (especially sophisticated parties) are expected to exercise ordinary due diligence in their transactions.4 Caveat emptor notwithstanding, even in an arms-length bargain, a CDR may be rendered unenforceable if the alleged omission concerned information within the "peculiar knowledge" of the defendant.5
Peculiar knowledge is material information that is both "known and knowable only to one party" to a transaction and which "[renders] false the counterparty's basic assumptions about the transaction."6 The "Peculiar Knowledge" doctrine renders voidable a contract where a party was unaware of an omission of material fact which ordinary due diligence could not have revealed.
A potential example of peculiar knowledge within the context of the loan market relates to "Borrower Confidential Information" ("BCI"), also known as Borrower Restricted Information.7 Borrowers often disclose material information to a small group of lenders or just to the Administrative Agent. Such an LMP would, therefore, be in possession of material non-public information that is within their peculiar knowledge. The Loan Syndications and Trading Association's Code of Conduct (the "Code") forbids the practice of trading on the basis of BCI, but the Code is just a guide to LMPs.8 The more pressing concern for a defendant-seller in possession of BCI, which is by its nature, within their peculiar knowledge, is whether a standard CDR will be sufficient to defeat a fraud claim.
Big Boy Provisions are Generally Enforceable and May Be Drafted to Defeat a Claim Based on the Peculiar Knowledge Doctrine
As the name suggests, parties to a contract containing a CDR have expressly agreed that they are not depending upon the counterparty for material information.9 However, CDRs do not provide a limitless safe harbor. Boiler-plate provisions may not always provide a successful defense. In order to be protected, LMPs must carefully draft their CDRs to ensure that they will be enforceable.
In cases involving the actual use of peculiar knowledge, a Big Boy Provision may stand provided that the plaintiff was aware of the extent of their potential disadvantage during the transaction.10 Therefore, it is critical that CDRs are sufficiently specific so as to fully inform a plaintiff about the nature of the information that is not being disclosed.11 Essentially, the seller must make the buyer aware that there is material information beyond the buyer's ability to discover of which the seller is aware.12 The purpose of such language is not to disclose the actual information in question. Rather, the seller is disclosing the fact of the information's existence. For a plaintiff to succeed, the matter which is within the defendant's peculiar knowledge must render the counterparty's basic assumptions about the transaction false. A CDR's specific reference to information beyond the counterparty's ability to discover should make the nature of the transaction clear. The specificity allows a court to impute an assumption of risk upon the plaintiff for deciding to transact despite their clear lack of information.
Big Boy Provisions are the tools of sophisticated parties. Courts use a sliding scale to determine what was "unknowable" to a given party (at the time of contracting) and disfavor the application of the Peculiar Knowledge Doctrine to sophisticated plaintiffs.13 Thus, it is very difficult for a sophisticated party who has engaged in an arms-length bargain that included a well-drafted CDR to later claim justifiable ignorance of material facts.14
Ultimately, a well-drafted CDR seeks to establish that both parties (i) are sophisticated, (ii) have access to information sufficient to make an investment decision, (iii) have made any such investment decision without reliance upon the other, (iv) have not relied on the other to furnish or make available certain enumerated types of material information, and (v) waive and release any claims arising from non-disclosure of material information. CDRs should specifically note a seller or buyer's possession of peculiar knowledge, such as BCI, as well as the respective party's unwillingness to disclose it. An effective and enforceable non-reliance provision involves balancing the risk of liability against preserving the attractiveness of the underlying transaction to the prospective buyer (or seller). Fortunately, New York courts have interpreted the law such that buyers and sellers have the ability to protect themselves to the extent they feel is necessary to confidently conduct business in an efficient market. LMPs should carefully consider their targeted goals and construct contractual provisions appropriate to their individual needs.
1. See,e.g., Cohen v. Houseconnect Realty Corp., 734 N.Y.S.2d 205 (2d Dep't 2001); Barsotti v. Merced, 788 A.2d 802 (N.Y. App. Div. 2002); Sahin v. Sahin, 435 Mass. 396 (2001); Giulietti v. Giulietti, 65 Conn. App. 813 (2001); State ex rel. Brady v. Publishers Clearing House, 787 A.2d 111 (Del. Ch. 2001).
2. CDRs are present in a number of standard trading documents and operate to remove a defendant's duty to disclose information based on an alleged fraudulent omission. E.g., "Standard Terms and Conditions for Par/Near-Par Trade Confirmations," "Proceed Letters," "Participation Agreements for Par/Near-Par Trades- Standard Terms and Conditions," and "Participation Agreements for Distressed Trades- Standard Terms and Conditions," "Purchase and Sale Agreements for Distressed Trades- Standard Terms and Conditions," and "Standard Forms of Assignment and Assumption." Chase Manhattan Bank v. New Hampshire Ins. Co., 749 N.Y.S.2d 632, 647 (N.Y. Sup. 2002) (holding that where a detailed disclaimer had been signed, the plaintiff-insurance company "will not be heard to complain that Chase did not do what the insurers contractually agreed Chase did not have to do, and that Chase is responsible for what the insurers contractually agreed Chase was not responsible").
3. Walton v. Morgan Stanley & Co., Inc., 623 F.2d 796, 799 n.6 (2d Cir. 1980) (holding that "a duty to disclose . . . arises from a specific relationship between two parties and not simply from the fact that some investors have more information than others is now established in both state and federal law."); see also Brass v. American Film Technologies, Inc., 987 F.2d 142, 150 (2d Cir. 1993). Note that the first two exceptions are almost redundant with the general rule. If the parties had a fiduciary relationship, it would seem the "exception" is already incorporated into the overarching rule of a duty to disclose. Also, a partial or misleading statement is essentially a form of misrepresentation. Both of these particular exceptions are beyond the scope of this advisory.
4. Primavera Familienstifung v. Asking, 130 F. Supp.2d 450, 495 (S.D.N.Y. 2001) ("Sophisticated businessmen have a duty to exercise ordinary diligence and conduct an independent appraisal of the risk they are assuming.")
5. Laugh Factory, Inc. v. Basciano, 608 F. Supp.2d 549, 559 (S.D.N.Y. 2009) (where the defendant sold the rights to the name "Laugh Factory" to the plaintiff without revealing that he intended to make the same offer to various other parties).
7. See B.S. Fraser, Big Boys Don't Cry: How "Big Boy" Provisions Can Help Hedge Fund Managers Avoid Liability for Insider Trading Violations, 3 Litigation Community & Rev. 7 (Jan./Feb. 2010).
8. Loan Syndications and Trading Association Confidential Information Supplement Â§Â§ I & III(B). Of course, LSTA transactions are governed by New York law.
9. It is important to bear in mind that the CDRs under discussion are being examined within the context of bank loans, which are not considered securities. Provisions within the Securities Exchange Act of 1934 have given rise to considerably broad rules surrounding the disclosure of material information as well as prohibitions on contracting around the obligations imposed by the Securities Exchange Commission. See Securities Exchange Act of 1934 Â§Â§ 10(b) & 29(a); SEC Rule 14(e). See also AES Corp. v. Dow Chemical Co., 325 F.3d 174, 182 (3d Cir. 2003) (holding that allowing disclaimers to bar relief for fraud in connection with the sale of securities "would be fundamentally inconsistent with Â§ 29(a)").
10. ee Solutia, Inc., 456 F. Supp.2d at 448 ("[W]hen a sophisticated party knows that it is not receiving full information, it may be barred from relying on the peculiar knowledge of its counterparty."); See also Lazard Freres & Co. v. Protective Life Ins. Co., 108 F.3d 1531, 1543 (2d Cir. 1997) ("[W]here, as here, a party has been put on notice of the existence of material facts which have not been documented and he nevertheless proceeds with a transaction without securing the available documentation or inserting appropriate language in the agreement for his protection, he may truly be said to have willingly assumed the business risk that the facts may not be as represented."); DynCorp v. GTE Corp., 215 F. Supp.2d 308, 322 (S.D.N.Y. 2002). Cf. Dimon Inc. v. Folium, Inc., 48 F. Supp.2d 359 (S.D.N.Y. 1999) (where a willfully concealed and manipulated accounting practice was not excused by a non-reliance provision).
11. See, e.g., Harbinger Capital Partners Master Fund I, Ltd. v. Wachovia Capital Markets, LLC, 27 Misc.3d 1236(A) (N.Y.S.D. 2010) ("[T]he plaintiffs have in the plainest language announced . . . that [they] are not relying on any representations as to the very matter as to which [they] now claim they are defrauded. Such a specific disclaimer destroys the allegations in the plaintiffs' complaint that the agreement was executed in reliance upon these contrary oral representations.").
12. See Chase Manhattan Bank v. New Hampshire Ins. Co., 749 N.Y.S.2d 632, 647 (Sup. Ct. 2002) ("[The plaintiff] contractually recognized that there might be misstatements or omissions, waived any obligation on Chase's part to speak, acknowledged that only very limited specified information had been provided by Chase, and agreed that the policy could not be avoided even if, e.g., the broker were guilty of misstatements or omissions. This constituted, in effect, acceptance by AXA of a â€Üredacted' form of the facts, to wit, the very limited information that, under the clause, was acknowledged as having been provided by Chase.").
13. Solutia Inc. v. FMC Corp., 456 F. Supp.2d 429, 448 (S.D.N.Y. 2006); Merrill Lynch & Co. v. Allegheny Energy, Inc., 2005 WL 832050, at *7 (S.D.N.Y. 2005).
14. In Solutia Inc., for example, the court noted that both litigants were "sophisticated parties, represented by experienced counsel, who negotiated a 39-page document defining their relationship." Id. at 447.
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