New York law is often chosen to govern commercial transactions between sophisticated parties, especially parties located in different regions of the world. It is natural for such parties to expect that, as a global epicenter of commercial activity, New York law would be particularly respectful of the terms to which they agree after an arm's-length negotiation. One oft-ignored or underappreciated aspect of New York law that can undermine this predictability is known as the "special facts" or "peculiar knowledge" doctrine.
Under that doctrine, sellers may be found to have a duty to disclose information beyond what is expressly required by contract, and therefore be subject to unanticipated fraud claims for violating that duty. The doctrine is even considered an exception to otherwise effective disclaimers of reliance on all but the express representations and warranties in a transaction agreement. There are available defenses, but they frequently prove too fact-intensive to achieve early dismissal of claims. Buyers and sellers alike should consider the existence of the doctrine when selecting New York law to govern their agreements and its potential implications.
THE SPECIAL FACTS DOCTRINE CAN GIVE RISE TO AN EXTRACONTRACTUAL DUTY TO DISCLOSE
Arm's-length commercial transactions do not normally create a fiduciary relationship between the parties, or otherwise impose a duty to speak. The parties' disclosure obligations are usually, and fittingly, defined by the agreed-upon terms of the contract. However, New York law recognizes an important exception known as "the special facts doctrine" that surprises many, including, in particular, those parties who select New York as the governing law for a contract when unaware of the doctrine's existence.
According to the doctrine, a party with superior knowledge of a material fact has a duty to disclose when non-disclosure would render the transaction "inherently unfair." While questions of fairness are highly fact-dependent, courts generally focus on the existence of substantial informational asymmetry between parties. Specifically, the doctrine applies when: (1) information is within the non-disclosing party's peculiar knowledge; and (2) the other party could not have discovered it through the exercise of reasonable diligence. When those conditions are satisfied, a failure to disclose by a party with superior access to material information can support a post-closing fraud claim.
Of course, in an M&A deal, the seller always knows, and has access to, considerably more information about the company being sold than the buyer. One important purpose of the diligence process, and the eventual negotiation of written representations and warranties, is to identify the information that the parties agree is material and correct that imbalance with respect to the issues they address.
But because there is plenty of information uniquely in the seller's possession that may not need to be disclosed as a strict contractual matter and might escape even reasonable diligence, the special facts doctrine creates unforeseen risk for sellers (and greater flexibility for buyers to pursue claims post-closing).
THE SPECIAL FACTS DOCTRINE MAY EVEN SUPERSEDE CONTRACTUAL DISCLAIMERS OF RELIANCE
Sellers typically seek protection from post-closing fraud claims through common contractual disclaimers. Among other things, it is commonplace in M&A transactions for sellers to disclaim any representations and warranties beyond those expressly set forth in the agreement, and for buyers to disclaim reliance on all but those express representations and warranties. As reasonable reliance is a necessary element of any fraud claim, these disclaimers can foreclose post-closing fraud claims based on information outside of the contract.
Though New York courts do not categorically enforce all reliance disclaimers to dismiss fraud claims, they are more apt to do so where the disclaimer is either: (1) specific to the subject of the alleged misrepresentation; or (2) part of comprehensive agreement between sophisticated parties that includes detailed written representations and warranties (in which case, a general disavowal of other representations and warranties may also be effective).
But part of what makes the special facts doctrine so significant is that New York courts frequently refer to the doctrine as an exception to the enforceability of such disclaimers. That is, invocation of the special facts doctrine may allow a buyer to avoid a contractual disclaimer that would otherwise preclude a fraud claim based on information outside the scope of an agreement. An unsuspecting seller whose agreement is governed by New York law may, therefore, be exposed to claims it believed to be foreclosed by the agreement's express terms.
At a minimum, the doctrine can prevent early dismissal of such claims. The elements on which the doctrine's application turns—whether information is uniquely accessible to the seller and whether a reasonable buyer would have uncovered the information during the diligence process—cannot, in many cases, easily be resolved as a matter of law at the start of litigation. Invocation of the doctrine will often necessitate costly and time-consuming discovery.
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Transacting parties should account for the special facts doctrine when considering whether to select New York law as their governing law. Delaware does not have an equivalent doctrine, and may therefore provide more certainty with respect to the prospect of post-closing fraud claims based on conduct not encompassed by the written contract.
If New York law is selected, sellers should consider what potentially significant information about the asset may fall outside the scope of the diligence information exchanged and the resulting written representations and warranties. The existence of the special facts doctrine could counsel in favor of additional disclosures and/or the inclusion of additional contract provisions. Such provisions might include, for example, an express prohibition on claims based on the failure to disclose information unrelated to the express representations and warranties in the contract.
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