United States District Court, S.D. New York
March 30, 2004.
ROBERT D. FERGUSON and RALPH MILO, Plaintiff, -against- LION HOLDING, INC., Defendants; ROBERT D. FERGUSON and MILO FAMILY LIMITED PARTNERSHIP, Plaintiff, -against- HANNOVER RUCKVERSICHERUNGS-AKTEIENGESELLSCHAFT, Defendants
The opinion of the court was delivered by: PETER LEISURE, District Judge Page 2
OPINION AND ORDER
These actions arise out of the acquisition by Hannover
Ruckversicherungs-Aktiengesellschaft ("Hannover Re"), a German
reinsurance company, of Lion Holding, Inc. ("Lion"). Plaintiffs were
officers, directors, and shareholders of Lion at the time of the
acquisition in 1999, and remained as executives of Lion after the
acquisition through the end of 2001. Defendants are Hannover Re and Lion.
Plaintiffs bring these actions for breach of contract, alleging that
defendants failed to pay "Earnouts" due under a Stock Purchase Agreement
and Employment Agreements executed when Hannover Re acquired Lion.
Plaintiffs contend that defendants owe them the maximum Earnouts as
provided in the agreements between the parties, which total $100 million.
Defendants counterclaim that any damages caused by defendants' alleged
breach of contract must be set off against monies allegedly owed to them
by plaintiffs pursuant to an indemnification provision in the Stock
Purchase Agreement. Defendants also counterclaim that plaintiffs breached
their fiduciary duty to Lion and Hannover Re.
Plaintiffs now bring a motion for partial summary judgment. Plaintiffs
contend that there is no genuine issue of material fact in dispute as to
one of four Earnouts at issue, that for the year 1999, and ask the Court
to grant summary judgment that defendants owe plaintiffs $25 million.
Defendants respond that genuine issues of material fact remain in dispute
about whether plaintiffs should receive the 1999 Earnout. Defendants also
contend that genuine issues of material fact relating to their
counterclaims remain in dispute, and that this should prevent summary
judgment. For the reasons set forth below, plaintiffs' motion for partial
summary judgment is denied.
I. The Parties
The current summary judgment motion concerns two actions. In the first
action (docket number 02-4258), plaintiffs Robert Ferguson and Ralph Milo
assert a breach of contract claim against defendant Lion Holding, Inc.
("Lion"). Lion is an insurance company for which Ferguson and Milo served
as executives from at least 1996 to the end of 2001. (Plaintiffs' Local
Rule 56.1 Statement of Material Facts, ¶ 2 ("Plaintiffs' 56.1");
Affidavit of Joseph W. Jacobs, ¶ 11 ("Jacobs Aff.").) Plaintiffs also
served as officers of Lion's subsidiary, Clarendon.*fn1 (Plaintiffs'
56.1, ¶ 2-4; Answer and Counterclaim of Defendant Lion Holding, ¶
60-61 ("Lion Answer").) In this first action, the operable agreements
between plaintiffs Ferguson and Milo and defendant Lion are those that
govern plaintiffs' employment as executives of Lion. Plaintiffs claim
that defendant Lion owes them $50 million pursuant to these agreements.
In the second action (docket number 02-4261), plaintiffs Ferguson and
Milo LP*fn2 assert a breach of contract claim against defendant Hannover
Re. Hannover Re is a German reinsurance
company that acquired Lion early in 1999. (Plaintiffs' 56.1, ¶
1.) Plaintiffs Ferguson and Milo LP bring this second action as the
shareholders who sold Lion to Hannover Re. The central agreement between
the selling shareholders and Hannover Re in this action is a Stock
Purchase Agreement ("Purchase Agreement") dated February 16, 1999.
(Jacobs Aff., Exh. E.) Plaintiffs claim that Hannover Re owes them $50
million pursuant to this agreement.
The substance of plaintiffs' claims, defendants' counterclaims, the
applicable contract provisions, and the facts underlying the disputes are
essentially the same for both actions. Plaintiffs move for partial
summary judgment on both actions for identical reasons, and defendants
likewise oppose summary judgment without distinguishing between the
actions. Unless otherwise indicated, references below to the parties
denote the plaintiffs or defendants in both actions collectively.
Likewise, references to agreements and obligations between the parties
refer to the actions and contracts between the parties collectively,
unless the Court indicates otherwise.
II. The Agreements
Four agreements between the parties, governing extensive, competing
obligations for each side, give rise to plaintiffs' breach of contract
claims and plaintiffs' current motion for summary judgment. First,
Hannover Re acquired Lion from the selling shareholders pursuant to a
Purchase Agreement dated February 16, 1999. Second, plaintiff Ferguson
remained employed as an executive of Lion and Clarendon after Hannover Re
acquired Lion, pursuant to an amended employment agreement. (Jacobs Aff.,
Exh. F.) Third, plaintiff Milo also remained employed as an executive of
Lion and Clarendon after Hannover Re acquired Lion, pursuant to an
amended employment agreement. (Jacobs Aff. Exh. G.) The terms of
Ferguson's and Milo's amended
employment agreements are the same for the purposes of this motion,
and are referred to in this opinion collectively as the "Employment
Agreements." Fourth, the parties reached a letter agreement, dated
February 24, 2000 (the "February Letter"), that addresses some of the
parties' obligations that arise out of the Purchase Agreement and the
Employment Agreements. (Jacobs Aff. Exh. I.) The first three agreements
largely provide the basis for the contractual relationship between the
parties, and thus largely provide the basis for plaintiffs' breach of
contract claims. It is upon the fourth agreement, however, that
plaintiffs seek partial summary judgment.
A. The Purchase Agreement
Defendant Hannover Re acquired Lion pursuant to a Purchase Agreement
dated February 16, 1999. (Plaintiffs' 56.1, ¶ 1; Jacobs Aff. Exh. E.)
Article 2 of the Purchase Agreement includes a provision titled
"Additional Purchase Price." (Jacobs Aff. Exh. E, ¶ 2.3.) This
provision entitles Ferguson and Milo LP, the selling shareholders, to
receive additional compensation if Lion's subsidiary, Clarendon, achieves
particular profitability levels for any or all of four periods: 1999,
2000, 2001, and the combined period 1999-2001. (Plaintiffs' 56.1, ¶
3-4; Defendants' Statement of Disputed Material Facts, ¶ 1
("Defendants' 56.1"); Declaration of Herbert Haas, ¶ 6-7 ("Haas
Decl.").) The additional compensation is called an "Earnout." Under the
Purchase Agreement, the maximum Earnout payable to Ferguson and Milo LP
for any one year period is $12,500,000, of which Milo LP would receive
70% and Ferguson 30%. (Plaintiffs' 56.1, ¶ 8.)
The criteria used to determine whether Ferguson and Milo LP would
receive some or all of the maximum Earnout for any time period is
Clarendon's "Combined Ratio." (Jacobs Aff.
Exh. E, ¶ 2.3.) The Combined Ratio measures Clarendon's
profitability.*fn3 If Clarendon attained a Combined Ratio of 75% or less
for any one year period then the maximum Earnout became due to Milo LP
and Ferguson. (Plaintiffs' 56.1, ¶ 5, 9; Defendants' 56.1, ¶ 1.)
Thus, for example, if Clarendon's Combined Ratio for 1999 was 75% or
less, then Hannover Re is obligated under the Purchase Agreement to pay a
$12,500,000 Earnout to Ferguson and Milo LP. Hannover Re was obligated to
pay any Earnout due under the Purchase Agreement by May 15, 2002.
(Plaintiffs' 56.1, ¶ 6, 9.)
Article 7 of the Purchase Agreement, titled "Indemnification," includes
separate provisions governing the selling shareholders' obligation to
indemnify Hannover Re in certain circumstances. (Jacobs Aff., Exh. E,
¶¶ 7.1-7.6; Plaintiffs' 56.1, ¶ 17; Defendants' 56.1, ¶ 6, 7.)
For the purposes of this motion it is useful to note the distinction in
Article 7 between two particular indemnity obligations incumbent upon
Ferguson and Milo LP. First, Article 7 imposes general indemnification
obligations upon the selling shareholders. Article 7 further provides
that, should the selling shareholders become obligated to make payments
pursuant to the general indemnification provisions, that funds for the
payments should be taken from a prioritized list of sources. (Jacobs Aff.
Exh. E, ¶ 7.4(B).) Article 7 includes in this list of sources "any
amount of Additional Incentive Compensation (as defined under the
Employment Agreement Amendments) payable at such time or paid to Milo or
Ferguson after the Closing Date," and "any amounts payable at such time
or paid to Milo or Ferguson under Section 2.3 of this Agreement [the
Earnout provision]." In sum, Article 7 of the Purchase Agreement
specifies that in the event the selling shareholders become obligated to
indemnify Hannover Re, Earnouts payable or paid to Ferguson, Milo LP, and
Milo pursuant to Article 2 or the Employment Agreements are an eligible
source of funds to pay the indemnity.
In February 2001, defendant Hannover Re made a claim for
indemnification from the selling shareholders pursuant to these general
indemnification provisions. (Plaintiffs' 56.1, ¶ 18; Defendants'
56.1, ¶ 6; Jacobs Aff. Exh. J.) Hannover Re claims that the selling
shareholders owe hundreds of millions of dollars in payments for
indemnification pursuant to Article 7 of the Purchase Agreement. The
selling shareholders dispute this claim for indemnification. (Plaintiffs'
56.1, ¶ 18; Defendants' 56.1, ¶ 7; Jacobs Aff. Exh. K.) The
parties are currently engaged in litigation in the Supreme Court of New
York to resolve this dispute. (Defendants' 56.1, ¶ 7.)
The second indemnity obligation incumbent upon the selling shareholders
is described in paragraphs 7.1(C) and 7.4(D) of the Purchase Agreement,
which govern Ferguson and Milo LP's indemnification obligations with
respect to the "LMX Business." (Jacobs Aff. Exh. E, ¶¶ 7.1(C), 7.4(D);
see Defendants' Opposition, at 5 n.4.) The parties have not
developed the substance of this obligation on the current record, as its
substance is largely irrelevant at this stage. It is important to note,
however, that the parties came to dispute the extent of the selling
shareholders' indemnity obligations with respect to the LMX Business. The
February letter, discussed below, reflects an effort by the parties to
address this dispute.
B. The Employment Agreements
Prior to Hannover Re's acquisition of Lion, plaintiffs Ferguson and
Milo served as executives of Lion pursuant to Employment Agreements.
(Plaintiffs' 56.1, ¶ 2; Jacobs Aff. Exh.
F (Ferguson Agreement), Exh. G (Milo Agreement).) When Hannover Re
acquired Lion, it agreed with Ferguson and Milo to keep them employed as
executives of Lion, and agreed to execute amendments to the Employment
Agreements. (Id.) The Employment Agreements between plaintiffs
and Hannover Re, as amended, include provisions titled "Payment of the
Additional Incentive Compensation." These provisions require the payment
of Earnouts to Ferguson and Milo, largely on the same terms as under the
Purchase Agreement. If Clarendon attained a Combined Ratio of 75% or less
for any one year period, then, under the Employment Agreements, Hannover
Re would owe Milo and Ferguson a $12,500,000 Earnout payment.
(Plaintiffs' 56.1, ¶ 5; Defendants' 56.1, ¶ 1.) As with the
Purchase Agreement, under the Employment Agreements Milo would receive
70% of the Earnout and Ferguson would receive 30%, and any Earnout must
be paid by May 15, 2002. The only material difference between the
conditions for the Earnout under the Employment Agreements and the
Purchase Agreement is that the Employment Agreements also required that
Ferguson and Milo still be employed by Lion as of December 30, 2001.
(Plaintiffs 56.1, ¶ 7.) The parties do not dispute that Ferguson and
Milo remained employed by Lion through the end of 2001. (Plaintiffs 56.1,
The compensation provisions in the Employment Agreements were included
to keep Ferguson and Milo on as executives of Lion after its acquisition
by Hannover Re. (Jacobs Aff. ¶ 6; Haas Decl., ¶ 6.) As Ferguson
and Milo were involved in operating Lion's subsidiary, Clarendon, the
Earnout provisions in both the Employment Agreements and Purchase
Agreement provided an incentive for plaintiffs to manage Clarendon at a
profitable level. (Id.) Having acquired Lion, Hannover Re of
course would itself profit by plaintiffs' profitable management of
Clarendon. If, for example, Ferguson and Milo managed Clarendon to a
Combined Ratio of less than 75% in 1999, then Hannover Re would profit,
and in turn would pay Ferguson, Milo, and
Milo LP a combined $25 million in Earnouts pursuant to the Purchase
Agreement and Employment Agreements.
C. The February Letter
While the Purchase Agreement and Employment Agreements are the focus of
plaintiffs' breach of contract claims and defendants' counterclaims, a
letter agreement, dated February 24, 2000 (the "February letter"), is the
subject of plaintiffs' current summary judgment motion. (Jacobs Aff.
¶ 17 & Exh. I.) The February letter was written by plaintiff
Ferguson and sent to Herbert Haas, then the Chief Financial Officer of
Hannover Re. Haas countersigned the February letter on behalf of Hannover
Re. (Haas Decl., ¶ 8.) The February letter describes an agreement
between the selling shareholders of Lion, Ferguson and Milo in their
personal capacities, and Hannover Re. In general, the February letter
memorializes an agreement between the parties on two issues: the
temporary, or immediate payment for indemnity by the selling shareholders
with respect to the LMX business; and the payment of the 1999 Earnout by
Hannover Re to Ferguson, Milo, and Milo LP. The parties dispute virtually
any and all possible implications of the February letter. As plaintiffs
move for partial summary judgment on the February letter, and defendants
contend that the letter is unenforceable for lack of consideration and
because it was procured by fraud, the Court must assess the February
letter's import to resolve the current motion.
1. Plaintiffs' Description of the February Letter
Plaintiffs contend that the February letter is an enforceable contract.
It reflects an agreement between the selling shareholders and Hannover
Re. After entering the Purchase Agreement, the selling shareholders and
Hannover Re came to dispute the selling shareholders' indemnity
obligation with respect to the LMX Business, and particularly the "LMX
The parties apparently agreed that the selling shareholders owed some
payment for indemnity to Clarendon (Hannover Re's newly acquired
subsidiary) in association with the LMX Settlement, but disagreed as to
the proper amount of the payment. According to plaintiffs, prior to the
entry of the February letter, defendants sought a payment of $17.183
million for the LMX Settlement, whereas the selling shareholders asserted
that they owed roughly $4 million less than that. The February letter
purports to resolve, at least temporarily, this discrepancy. Under the
terms of the February letter, the selling shareholders agreed to pay
$17.183 million, but also agreed to continue good faith negotiations with
Hannover Re to resolve the dispute over the proper payment, and to
arbitrate the dispute if the negotiations failed. As defendants argue
that the February letter lacks consideration, plaintiffs stress that the
$17.183 million payment essentially includes a $4 million credit or
temporary forfeiture, which would be returned to the selling shareholders
should negotiations or arbitration eventually vindicate plaintiffs'
position. (See Plaintiffs' Reply Memorandum of Law in Support of Their
Motions for Partial Summary Judgment, at 5 ("Plaintiffs' Reply").)
The selling shareholders also agreed in the February letter to exclude
the $17.183 million from Clarendon's financial statement for the purpose
of calculating Ferguson and Milo's 1999 bonus. Plaintiffs contend that
the Employment Agreements provide that Milo and Ferguson were entitled to
a bonus, separate from the Earaouts, that would be calculated as a
percentage of Clarendon's profits. (Plaintiffs' Reply, at 6; Jacobs Aff.
Exhs. F & G.) By agreeing to exclude the $17.183 million payment from
Clarendon's profits, plaintiffs thus diminished the funds from which
their bonus would be calculated.
Plaintiffs contend that in exchange for these considerations,
defendants agreed to pay the 1999 Earnout. Section 4 of the February
letter written by Ferguson, titled "Earn out," reads as follows:
Section 2.3 of the Stock Purchase Agreement
obligates Hannover to pay to Milo L.P. and me
Additional Purchase Price as calculated in that
provision. Ralph and I are separately entitled to
receive Additional Incentive Compensation
calculated on the same basis under our Employment
Agreement Amendments. Hannover has agreed with
Ralph, Milo L.P., and me that (i) Milo L.P. and I
have qualified for and are entitled to receive our
respective shares of the maximum $12.5 million
dollar Additional Purchase Price for 1999 and (ii)
Ralph and I have separately qualified for and are
entitled to receive (subject only to Section II of
Exhibit B of the Existing Employment Agreement, as
amended) the maximum $8.75 million and $3.75
million, respectively, of Additional Incentive
Compensation for 1999 under our respective
Existing Employment Agreement, as amended, in each
case payable as provided in such documents.
(Jacobs Aff., Exh. I, § 4.) In other words, Hannover Re agreed
in the February letter to pay the 1999 Earnout to plaintiffs. (Haas
Decl., ¶ 9.)
2. Defendants' Description of the February Letter
Defendants offer a separate account of the February letter and its
implications. Defendants contend that sections 7.1(C) and 7.4(D) of the
Purchase Agreement required the selling shareholders to indemnify
Clarendon for $17.163 million for the LMX Settlement. Thus the February
letter simply noted the selling shareholders' pre-existing obligation.
Defendants also assert that plaintiffs' agreement to exclude the $17.183
million from the calculation of their bonus "would have had little or no
effect on Ferguson and Milo's bonus for 1999." (Defendants' Opposition,
at 19-20 n. 11.) The February letter, according to defendants, simply
describes the existing relationship between the parties. It does not
create any new obligations to be performed by plaintiffs.
As to the Earnout provision in the February letter, defendants admit
that the February letter reflects their agreement to pay the 1999
Earnout. (Haas Decl., ¶ 9.) The parties appear to
agree on this point that defendants agreed to pay the 1999 Earnout
because they understood Clarendon to have attained a Combined Ratio of
less than 75%. (Haas Decl., ¶ 10; Plaintiffs' Reply, at 6
("Defendants' obligation to pay [plaintiffs] this amount was not
triggered by the February 24 Side Letter, but rather by the GAAP
financial statement of Clarendon from which `it would have been
self-evident . . . that Clarendon's Combined ratio was below 75.'").)
Defendants contend now, however, that Clarendon in fact did not attain a
Combined Ratio of less than 75%, and thus the Earnout section of the
February letter is unenforceable.
To support their contention that Clarendon's Combined Ratio was higher
than 75%, defendants submit the affidavit of a former senior vice
president of Clarendon America, William Roche. Roche states that
plaintiffs Ferguson and Milo served respectively as president and Chief
Executive Officer of Clarendon in 1999 when serious problems with
Clarendon's subsidiary, Eton Management Corporation ("Eton") arose.
(Affidavit of William Roche, ¶ 2-4 ("Roche Aff").) Eton once had the
power to issue insurance policies in Clarendon's name, but Clarendon
terminated this relationship with Eton in March 1999. (Roche Aff. ¶
3-5.) Eton then appeared to enter an agreement with CNA Reinsurance
(Europe) Ltd. ("CNA Re") in August 1999 that would limit Clarendon's
exposure under Eton's insurance policies. (Roche Aff. ¶ 6.)*fn4
Roche states that he subsequently learned that CNA Re entered no such
agreement, and that in October 1999 Eton's owner admitted that he had
forged CNA Re's stamp and the initials of its underwriter. (Roche Aff.
¶ 7-11.) Roche states that Ferguson and Milo were aware of the
forgery. (Id. ¶ 12.) Anders Larrson, Clarendon's Chief
Financial Officer since 2000, states in an affidavit submitted by
defendants that Ferguson and Milo did not change Clarendon's records to
reflect accurately the unenforceable agreement. (Affidavit of Anders
Larrson, ¶ 4-9.) Because
Ferguson and Milo did not change Clarendon's records, Clarendon's
Combined Ratio appeared artificially reduced. (Id. ¶ 10.)
Had Clarendon's financial statements been accurate, Clarendon's Combined
Ratio would have been greater than 75%. (Id. at ¶ 12.)
III. The Disagreements
The parties have brought to this Court one of apparently several
disagreements as to the their mutual obligations under their contractual
relationship. Plaintiffs filed two actions in this Court, seeking $100
million in Earnout payments from defendants for their alleged breaches of
the several contracts between the parties. Defendants counterclaimed that
any damages caused by their alleged breach of contract must be set off
against monies allegedly owed to them by plaintiffs pursuant to the
general indemnification provisions. Defendants also counterclaimed that
plaintiffs breached their fiduciary duty to defendants by manipulating,
among other things, reserves, retention levels, and expenses to procure
defendants' assent to the February letter.
Plaintiffs now move for partial summary judgment. Plaintiffs seek
summary judgment awarding them the full 1999 Earnout, which is $25
million. Plaintiffs contend that the February letter contractually
obligates defendants to pay the 1999 Earnout, and there is no genuine
issue of material fact in dispute on the issue. Defendants oppose the
motion on several grounds.
Plaintiffs' motion for summary judgment presents the straightforward
claim that defendants breached their contractual obligations to
plaintiffs, namely those obligations arising under the February letter,
and that defendants should now be ordered to meet those obligations.
Defendants oppose plaintiffs' motion on essentially three grounds.
First, defendants contend that the February letter is not an enforceable
contract because it imposes no new
obligations on plaintiffs. The February letter, in other words,
lacks consideration according to defendants.
Second, defendants argue that Clarendon did not achieve a Combined
Ratio of 75% or less for 1999, because the Eton transaction in fact was
not enforceable and thus did not reduce the Combined Ratio. Defendants
argue further that Ferguson and Milo concealed this information from
defendants to procure the February letter, which assures that the 1999
Earnout will be paid. The circumstances of the Eton transaction,
according to defendants, raises at least a factual dispute as to
Clarendon's actual profitability for 1999. Defendants contend that this
factual dispute alone prevents summary judgment. Defendants also contend
that because plaintiffs concealed the circumstances of the Eton
transaction from defendants, the February letter is unenforceable.
Defendants style this argument under the law of fraudulent concealment,
and ask the Court for leave to amend their pleadings to the extent that
they fail to allege a sufficient counterclaim with respect to this issue.
Third, defendants argue that genuine factual issues remain in dispute
as to plaintiffs' indemnity obligations under the Purchase Agreement.
Defendants contend that, according to the doctrines of equitable
recoupment or setoff, these factual issues preclude summary judgment. The
Court addresses defendants' arguments in turn.
I. Summary Judgment Standard
A moving party is entitled to summary judgment if "the pleadings,
depositions, answers to interrogatories, and admissions on file, together
with the affidavits, if any, show that there is no genuine issue of
material fact and that the moving party is entitled to judgment as a
matter of law." Fed.R.Civ.P. 56(c); See Celotex Corp. v.
Catrett 477 U.S. 317, 322-23 (1986); Holt v. KMI-Contintental
Inc., 95 F.3d 123, 128 (2d Cir. 1996). The substantive law
underlying a claim
determines if a fact is material and "[o]nly disputes over facts
that might affect the outcome of the suit under the governing law will
properly preclude the entry of summary judgment." Anderson v.
Liberty Lobby, Inc., 477 U.S. 242, 248 (1986). When considering the
motion, the Court's responsibility is not "to resolve disputed issues of
fact but to assess whether there are any factual issues to be tried."
Knight v. U.S. Fire Ins. Co., 804 F.2d 9, 11 (2d Cir. 1986).
In determining whether genuine issues of material fact exist, the Court
must resolve all ambiguities and draw all justifiable inferences in favor
of the nonmoving party. See Anderson, 477 U.S. at 255;
Holt 95 F.3d at 129. The moving party bears the burden of
demonstrating that no genuine issue of material fact exists. See
Adickes v. S.H. Kress & Co., 398 U.S. 144, 157 (1970);
Gallo v. Prudential Residential Serv. L.P., 22 F.3d 1219,
1223-24 (2d Cir. 1994). "The movant's burden will be satisfied if he can
point to an absence of evidence to support an essential element of the
nonmoving party's claim." Goenaga v. March of Dimes Birth Defects
Found., 51 F.3d 14, 18 (2d Cir. 1995). Once the moving party
discharges its burden of demonstrating that no genuine issue of material
fact exists, the burden shifts to the nonmoving party to offer specific
evidence showing that a genuine issue for trial exists. See
Celotex, 477 U.S. at 324. The nonmoving party "must do more than
simply show that there is some metaphysical doubt as to the material
facts." Matsushita Elec. Indus. Co. v. Zenith Radio Corp.,
475 U.S. 574, 586 (1986). "A `genuine' dispute over a material fact only
arises if the evidence would allow a reasonable jury to return a verdict
for the nonmoving party." Dister v. Cont'l Group,
859 F.2d 1108, 1114 (2d Cir. 1988) (citing Anderson, 477 U.S. at 248).
II. A Genuine Issue of Fact Remains in Dispute About Whether
the February Letter Is an Enforceable Contract
The parties disagree about whether the February letter is an
New York law applies in this case. (Jacobs Aff. Exh. E § 10.9
(Purchase Agreement clause stating that New York law applies); Jacobs
Aff., Exhs. F ¶ 10(e) & G ¶ 10(e) (Employment Agreements
clauses stating that New York law applies); Plaintiffs' Memo, at 4, 5
(stating that New York law applies); Defendants' Opposition, at 7-23
(citing New York law throughout).) The elements of a breach of contract
claim under New York law are (1) the existence of a contract, (2)
plaintiff's performance, (3) breach by the defendant, and (4) damages.
Terwilliger v. Terwilligen 206 F.3d 240, 245-46 (2d Cir. 2000);
Harsco. Corp. v. Segui, 91 F.3d 337, 348 (2d Cir. 1996).
On this summary judgment motion, plaintiffs contend that all the
elements of their breach of contract claim are satisfied with respect to
the 1999 Earnout. Plaintiffs contend that: (1) the February letter is a
contract; (2) they performed by paying defendants $17.183 million; (3)
defendants breached by not paying the 1999 Earnout; and (4) plaintiffs
have suffered $25 million in damages. Defendants contend that, as to the
first element, the February letter is not an enforceable contract because
it lacks consideration, and because plaintiffs fraudulently concealed
material information when the parties agreed to the terms of the February
A. The February Letter Is not Unenforceable for Lack of
Defendants argue that the February letter is unenforceable because it
lacks consideration. Under New York law, "consideration is a necessary
ingredient for an enforceable contract." Roth v. Isomed, Inc.,
746 F. Supp. 316, 319 (S.D.N.Y. 1990) (citing Holt v.
Feigenbaum, 419 N.E.2d 332, 336-337 (N.Y. 1981)). Consideration is
simply a bargained-for exchange of promises or performance. Rest.
(Second) of Contracts, § 71 (1981); see First Federal
Bank v. Nomura Securities, 93 Civ. 2519, 1995 WL 217539,
at *5 (S.D.N.Y. Apr. 12, 1995). Generally, "[p]arties are free to make
their own bargains, and, absent a claim of fraud or unconscionability, it
is `enough that something of real value in the eye of the law was
exchanged.'" Personalized Media Communications, L.L.C. v. StarSight
Telecast, Inc., 2000 WL 1457079, at *4 (S.D.N.Y. Sept. 28, 2000)
(quoting Apfel v. Prudential-Bache Sec. Inc., 616 N.E.2d 1095,
at 1097 (1993)). "A promise to carry out a preexisting contractual
obligation," however, "generally is not sufficient consideration." C.J.S.
Contracts, § 122; see International Paper Co. v. Suwyn,
951 F. Supp. 445, at 448 (S.D.N.Y. 1997); James A. Haggerty Lumber &
Mill Work, Inc. v. Thompson Starrett 256 N.Y.S.2d 1011, 1012-13
(App. Div. 1965).
Defendants argue that the February letter is not enforceable because
plaintiffs promised nothing in the letter that they were not already
obligated to perform under the Purchase Agreement. Specifically, sections
7.1(C) and 7.4(D) of the Purchase Agreement require the selling
shareholders to indemnify Hannover Re's affiliates (such as Clarendon)
for claims connected to the LMX Business. These provisions, defendants
argue, obligated plaintiffs to pay $17.183 million to indemnify
Clarendon, and the February letter merely acknowledges that existing
obligation. Defendants also argue that the term under which plaintiffs
exclude the $17.183 million payment from the calculation of their bonus
"would have had little or no effect on Ferguson and Milo's bonus for
1999." (Defendants' Memo, at 19-20 n.11.) Thus defendants argue that the
February letter is not an enforceable contract because it lacks
Plaintiffs respond that, prior to the signing of the February letter,
the parties disagreed about plaintiffs' obligations to indemnify
Clarendon for the LMX Settlement. The February letter reflects a separate
bargain, by which plaintiffs agreed to pay the $17.183 million sought by
Hannover Re, and by which defendants agreed to return any excess payment
negotiations or arbitration conclude that plaintiffs owed less than
$17.183 million. Plaintiffs therefore contend that by making the $17.183
million payment they assumed a credit risk, and they temporarily
forfeited the right to possession of that sum. Plaintiffs also note that
they agreed in the February letter to exclude the payment from the
calculation of their bonus, and argue that this consideration diminished
their bonus by almost $2 million. (Plaintiffs' Reply, at 6.) Thus
plaintiffs argue that the February letter does not lack consideration.
The Court agrees with plaintiffs that the parties exchanged
consideration in the February letter. In section 3 of the February
letter, plaintiffs agree to exclude the $17.183 million payment to
Hannover Re's subsidiary from the calculation of their bonus under
Exhibit A of the Employment Agreements. (Jacobs Aff. Exh. I.) This
concession is not included, or even referenced, anywhere in the Purchase
Agreement or Employment Agreements, and clearly was made after the
execution of those agreements. Plaintiffs had no pre-existing duty to
undertake this obligation, or, more specifically, to concede this
Moreover, the Court need not resolve the parties' dispute over the
precise value of plaintiffs' concession. When consideration is
forbearance, "it must generally be to refrain from doing that which a
party has a legal right to do." Roth, 746 F. Supp. at 319. The
"adequacy of the consideration," or the value of the forbearance, "is not
a proper subject for the court's review." First Federal 1995 WL
217539, at *5; See Apfel 616 N.E.2d at 1097. It appears to the
Court that under the Employment Agreements the $17.183 million indemnity
payment would affect the calculation of plaintiffs' bonus, as would its
exclusion. In a footnote, defendants aim to contest this point, but offer
only that the payment "would have had little or no effect on Ferguson and
Milo's bonus." (Defendants' Opposition, at 19-20 n. 11.) Defendants'
even if correct, addresses only the value of the consideration, but
does not address whether consideration is present.
Because the February letter elsewhere incorporates plaintiffs'
consideration, the Court need not resolve whether plaintiffs' payment of
$17.183 million qualifies as consideration. In any event, the parties
appear to raise a genuine issue of fact on this point, namely, what is
the proper scope of the Purchase Agreement provision regarding
plaintiffs' obligation to indemnify Clarendon for the LMX loss. If the
Purchase Agreement in fact obligates plaintiffs to indemnify Clarendon
for $17.183 million, then plaintiffs' concession in the February letter
to make this payment perhaps does not qualify as consideration.*fn5
Finally, the Court notes that the February letter, which begins "This
letter confirms our agreement," generally reflects compromises between
the parties as to their rights and obligations under the Purchase
Agreement. It memorializes the parties' agreement on how to proceed in
light of their disagreement about certain of the Purchase Agreement's
terms. Viewed as a whole, it reflects an exchange between the parties
that, while hard to quantify, is nevertheless present.
The Court therefore finds that the February letter reflects a
bargained-for exchange, and is not unenforceable for lack of
B. A Genuine Issue of Material Fact Remains in Dispute as to
Whether Plaintiffs Fraudulently Concealed Information Material to the
Defendants argue that the February letter is unenforceable because
plaintiffs fraudulently concealed information material to its terms.
Under New York law, a party must prove five elements to establish
fraudulent concealment: (1) the opposing party had a duty to disclose
material information, yet (2) made a materially false representation, (3)
intended to defraud, (4) upon which the party reasonably relied and (5)
suffered damages as a result. Banque Arabe et Internationale
D'Investissement v. Maryland Nat. Bank, 57 F.3d 146, 153 (2d Cir.
1995); See Brass v. American Film Technologies, Inc.,
987 F.2d 142, 152 (2d Cir. 1993); Nasik Breeding & Research Farm Ltd, v.
Merck & Co., 165 F. Supp.2d 514, 528-29 (S.D.N.Y. 2001). Each
element of the claim must be proved by clear and convincing evidence.
Banque Arabe, 57 F.3d at 153.
Defendants contend that the elements of fraudulent concealment are met
with respect to the February letter. Defendants initially note that
plaintiffs owed defendants a fiduciary duty, and thus a duty to disclose.
Defendants then contend in their motion papers, and with supporting
affidavits, that plaintiffs concealed information about the transaction
made by Eton purportedly on behalf of Clarendon. According to defendants,
Clarendon's accounting reflected the Eton transaction, and showed a
Combined Ratio of less than 75% at the time the parties agreed to the
February letter. Defendants now argue in opposition to summary judgment
that the Eton transaction was unenforceable, that Clarendon's Combined
Ratio for 1999 exceeded 75% once the Eton transaction is properly
accounted for, and that plaintiffs were aware of this circumstance. The
parties seem to agree that defendants agreed to pay the 1999 Earnout on
the understanding that the Combined Ratio was accurate and below 75% for
that year. (Haas Decl., ¶ 10; Plaintiff's Reply, at 6.) Defendants
thus contend that plaintiffs fraudulently concealed
material information from them prior to the signing of the February
letter, and that the Court must therefore deny plaintiffs' summary
Plaintiffs respond that they did not mislead defendants at the time of
the February letter. According to plaintiffs, defendants were aware of
the problems with the Eton transaction and they agreed to pay the 1999
Earnout anyway. Plaintiffs also respond that defendants have not sought
to rescind the February letter and have not pleaded a defense of fraud.
Defendants have accepted the benefit of the February letter, but have
disavowed their own obligations under the February letter. Plaintiffs
argue therefore that even if defendants have established the elements of
fraudulent concealment, this should not prevent the Court from granting
plaintiffs' summary judgment motion.
1. The Alleged Fraud Must Relate to the February Letter for
the Purposes of Plaintiffs' Motion for Summary Judgment
As an initial matter, the Court must address defendants' suggestion
that the circumstances of the Eton transaction preclude summary judgment
in two ways. Defendants argue first that summary judgment must be denied
because Clarendon did not achieve a Combined Ratio of 75% or less, as
required by the Purchase Agreement and Employment Agreements. Defendants
second argue that summary judgment must be denied because plaintiffs
fraudulently concealed information material to the terms of the February
letter. The factual predicate for each of defendants' arguments is the
Eton transaction and plaintiffs' alleged failure to notify defendants
that it was unenforceable.
The first of defendants' arguments is not relevant to the motion before
the Court. Plaintiffs have asked the Court to grant partial summary
judgment on the claim that defendants breached the February letter by not
paying plaintiffs the 1999 Earnout. While Clarendon's profitability was a
material fact at the time the parties agreed to the February letter, the
letter includes no terms or requirements with respect to
Clarendon's profitability. Defendants' first argument does not address
the substantive law underlying the plaintiffs' claim. Presented as such,
defendants' first argument cannot preclude summary judgment. See
Anderson, 477 U.S. at 248 ("Factual disputes that are irrelevant or
unnecessary will not be counted [in the summary judgment decision].").
Defendants' second argument, that the February letter is unenforceable
because plaintiffs fraudulently concealed material information, suffers
similar infirmities to the first argument, which are discussed below. It
does, however, properly preclude summary judgment.
2. A Genuine Issue of Fact Remains in Dispute About the
Parties' Understanding When They Signed the February Letter
Clarendon's profitability for 1999, and each party's awareness of the
circumstances of the Eton transaction and its impact on Clarendon's
profitability, are in dispute. In submissions to the Court on behalf of
defendants, Herbert Haas and Anders Larrson state, in substance, that
Milo and Ferguson had a duty to disclose material information to
defendants. They further state that Milo and Ferguson were aware that the
Eton transaction was unenforceable, and that Clarendon's Combined Ratio
was artificially reduced because Clarendon recorded the Eton transaction
as enforceable. Defendants claim that concealing the circumstances of the
Eton transaction demonstrates the intent of plaintiffs Milo and Ferguson
to defraud defendants so as to receive the 1999 Earnout when it was not
due. Haas and Larrson further state that had plaintiffs informed them of
the circumstances of the Eton transaction, Hannover Re would not have
agreed to the terms of the February letter.
Plaintiffs respond that Milo and Ferguson communicated whatever
knowledge they had of the Eton transaction to defendants. Plaintiffs
point to the declaration of Anders Larrson, which attaches minutes of a
December 2, 1999, Clarendon meeting. These minutes show,
plaintiffs contend, that defendants were aware of the problems with
the Eton transaction before agreeing to the February letter. Plaintiffs
also submit a reply affidavit of Ferguson, which attaches an internal
memorandum dated November 1999, to show that the actions taken with
respect to Eaton Management*fn6 were reported to defendants. Plaintiffs
also contend that none of defendants' declarants actually state that the
Eton transaction was unenforceable, and argue that it in fact was
It is clear to the Court that, at the very least, defendants have
raised a factual dispute about the circumstances of Clarendon's
profitability at the time Hannover Re agreed to the terms of the February
letter. The parties both understood when they signed the February letter
that Clarendon had a Combined Ratio of less than 75% for the year 1999.
Senior executives of Clarendon and HDI, Hannover Re's parent company,
have now stated, under penalty of perjury, that Clarendon's Combined
Ratio in fact was greater than 75%, and that plaintiffs hid this fact
from defendants. Plaintiffs certainly make compelling arguments about
defendants' awareness of the Eton transaction, and about whether the Eton
transaction was enforceable. The dispute, however, is a factual one,
which the Court will not resolve on a motion for summary judgment.
See Knight v. U.S. Fire Ins. Co., 804 F.2d 9, 11 (2d Cir. 1986)
(holding that, on summary judgment, a court's responsibility is not "to
resolve disputed issues of fact but to assess whether there are any
factual issues to be tried").
3. The Materiality of Defendants' Allegations of Fraud Is not
Ascertainable on the Current Record
Ultimately the pivotal problem confronting the Court on plaintiffs'
summary judgment motion is what to do about defendants' allegations of
fraud, which raise a factual dispute. Defendants' allegations of fraud,
and the factual disputes underlying those allegations, do not preclude
summary judgment by themselves. Rather, the factual disputes must be
material to the legal claims before the Court to preclude summary
judgment. See Western World Insurance Co. v. Stack Oil Inc.,
922 F.2d 118, 121 (2d Cir. 1990) ("The existence of disputed facts that
are immaterial to the issues at hand is no impediment to summary
judgment."). On the current record, any factual issues related to
Clarendon's profitability and the Eton transaction appear immaterial.
Thus, plaintiffs argue, defendants' allegations of fraudulent concealment
cannot preclude summary judgment in plaintiffs' favor.
When a party to a contract suspects that it has been defrauded, the
party may not simply accept the benefit of the bargain and ignore its own
obligations. Although the contract law jargon varies from one authority
to another, the general principle is clear. A contract procured by fraud
is not void, but voidable. See Sphere Drake Ins. Ltd, v. Clarendon
Nat. Ins. Co., 263 F.3d 26, 32-33 (2d Cir. 2001) (discussing void
versus voidable contracts); Restatement (Second) of Contracts, § 164.
"Faced with a voidable contract induced by fraud, the defrauded party has
the option to either disaffirm or affirm the contract." Ladenburg
Thalmann & Co. v. Imaging Diagnostic Systems, Inc., 176 F. Supp.2d 199,
204 (S.D.N.Y. 2001); see Turkish v. Kasenetz,
27 F.3d 23, 28 (2d Cir. 1994) (Lumbard, J.) ("A party who has been
fraudulently induced to settle a claim may either (1) rescind the settlement
or (2) ratify the settlement, retain the proceeds, and institute an action
to recover fraud damages." (citing Slotkin v. Citizens Cas.,
614 F.2d 301, 312 (2d Cir. 1979))); Clearview Concrete Products Corp. v.
S. Charles Gherardi, Inc.,
453 N.Y.S.2d 750, 754 (App. Div. 1982) ("Upon discovering fraud, a
purchaser may tender return of the property and seek rescission or he may
retain the property and seek recovery of damages deriving from the
A party that chooses to affirm the contract may bring a tort action for
fraud against the party that defrauded it. See Keywell Corp. v.
Weinstein, 33 F.3d 159, 165 (2d Cir. 1994); Turkish, 27
F.3d at 28; Slotkin, 614 F.2d at 312; Clearview
Concrete, 453 N.Y.S.2d at 754; Restatement (Second) of Torts, §
550. By electing to affirm and sue for fraud, a defrauded party does not
necessarily incur an obligation to return any consideration it received
under the contract. See Turkish, 27 F.3d at 28;
Slotkin, 614 F.2d at 312; 27 Samuel Williston & Richard A.
Lord, A Treatise on the Law of Contracts §§ 69:47 &
69:53 (4th ed. 2003) ("Williston on Contracts") ("In order
to maintain such an action where benefit has been received by the
plaintiff, it is not necessary that such benefit be returned. The
defrauded party may retain this benefit and sue for the damages he has
suffered."). Fraudulent concealment is such an action for fraud.
Fraudulent concealment, like any fraud action, must be pleaded with
particularity pursuant to the requirements of Rule 9(b) of the Federal
Rules of Civil Procedure, Nasik, 165 F. Supp.2d at 529;
Affiliated FM Insurance Co. v. Jou Jou Designs, Inc., No. 90
Civ. 8262, 1997 WL 473382, at *2-3 (S.D.N.Y. Aug. 19, 1997) ("Fraud
allegations should specify the time, place, speaker, and content of the
alleged misrepresentations or omissions."), and must be proved by clear
and convincing evidence. Banque Arabe, 57 F.3d at 153.
A party that chooses to disaffirm the contract may assert rescission of
the contract as an affirmative defense. See Ladenburg,
176 F. Supp.2d at 204; Clearview Concrete, 453 N.Y.S.2d at 754;
Williston on Contracts, § 69:47; see, e.g., Energy
Capital Co. v. Caribbean Trading and Fidelity Corp., No. 93 Civ.
8100, 1996 WL 157498, at *8 (S.D.N.Y. Apr. 4, 1996) (Keenan, J.)
(dismissing defendants' affirmative defense of rescission based on
fraudulent concealment because defendants failed to show a duty to
disclose). Generally a party seeking rescission of a contract must tender
the return of consideration it received pursuant to the voidable
contract, see Ladenburg, 176 F. Supp.2d at 204 ("To disaffirm
the contract, the defrauded party must offer to return any consideration
received."), although exceptions to this rule are present under New York
law. See Prudential 630 F. Supp. at 1300-03 (citing, among
other things, CPLR § 3004 and ETC Corp. v. Title Guarantee and
Trust Co., 2 N.E.2d 284 (1936), for the principle that retaining
money paid under a contract does not necessarily ratify the contract when
the money is received during the pendency of a rescission action, but
cautioning that when the money is received "[i]n the absence of a formal
pleading requesting rescission, all the circumstances attending a party's
course of conduct are relevant to determining whether an intent to ratify
has been established").
Perhaps even additional actions or remedies remain available to a
defrauded party. The distinctive point for the purposes of the current
motion, however, is that in any event the defrauded party must make a
choice, because the alternative rights to affirm or disaffirm lead to
inconsistent remedies. See Williston on Contracts §§ 69:47,
69:56 (4th ed. 2003) ("[The defrauded party] may in effect affirm the
contract and sue the party who defrauded him for his damages, or he may
repudiate the contract and recover the purchase price paid. As these
rights are inconsistent, he cannot do both."); see also Clearview
Concrete, 453 N.Y.S.2d at 754 ("[The defrauded party] may not,
however, affirm the transaction, keep the property and at the same time
recover the costs of acquiring and maintaining it."). Failure by a
defrauded party to choose a right and remedy may have adverse
consequences. One such consequence of inaction could be tacit affirmance,
particularly in a situation where the defrauded party has an opportunity
a voidable contract. See Restatement (Second) of
Contracts, §§ 380, 383; see, e.g., Clearview Concrete, 453
N.Y.S.2d at 754 ("[Claimant] abandoned its rescission rights when
cognizant of the fraud it accepted the benefits of the contract
and thereby affirmed it.").
Here, defendants have essentially accepted the benefit of the February
letter and ignored their obligations under the same letter. In their
answer to each complaint, defendants plead a confusing counterclaim, a
sort of crossbreed of breach of fiduciary duty and fraudulent
concealment. (Jacobs Aff. Exh C ¶¶ 60-69, Exh. D ¶¶ 50-56.)
Defendants later submitted a letter to this Court explicitly stating that
this counterclaim is for breach of fiduciary duty "and not, as
plaintiffs suggest, for `fraud.'" (Jacobs Aff. Exh. M.) Defendants now
argue in opposing plaintiffs' motion that plaintiffs fraudulently
concealed information material to the terms of the February letter and
that the fraudulent concealment precludes summary judgment. Defendants
also request leave to amend their answers if the Court finds they have
failed to allege fraud with particularity. But for their imperceptible
counterclaim, defendants appear never to have made any effort to affirm
or disaffirm the February letter, even after they became aware of
plaintiffs' alleged fraudulent concealment.
Plaintiffs astutely seize on defendants' apparent failure to affirm or
disaffirm the February letter after becoming aware of plaintiffs' alleged
fraudulent concealment. Plaintiffs contend that "Either Defendants waived
their rights to raise such an argument in the February 24 Side Letter, or
they are alleging that the agreement should be rescinded, in which case
the consideration Plaintiffs paid under that agreement should be
refunded." (Plaintiffs' Reply, at 2.) Indeed, under New York law, a party
may "ratify" a voidable contract by accepting benefits flowing from it,
and thereby waive the right to rescind the contract. See
Prudential, 630 F. Supp. at 1300.
Defendants' conduct with respect to the February letter leaves them
in a conundrum. They allege that plaintiffs procured the February letter
by concealing material information. Defendants, however, accepted
plaintiffs' payment for indemnity under the February letter, and did not
pay the 1999 Earnout promised in the letter. Thus, should defendants
counterclaim fraud, they face an uphill battle to prove damages, an
essential element of fraud. On the other hand, should defendants
counterclaim for rescission, they risk being required to retum any
consideration they received pursuant to the February letter. And should
defendants assert no counterclaim, then nothing precludes the Court from
granting summary judgment in plaintiffs' favor. Cf. Keywell 33
F.3d at 165 ("Keywell's election to affirm the contract rather than seek
rescission impacts Keywell's rights to avoid contractual limitations on
damages for breach of representations and warranties.").
For defendants' part, the answers in this action plead that "The
February 24, 2000 Letter Agreement is therefore null and void as it was
procured by plaintiffs' manipulative conduct, by plaintiffs' self-dealing
and by plaintiffs' deliberate concealment of facts." (Jacobs Aff., Exh. C
¶ 67; see Jacobs Aff., Exh. D ¶ 54.) Moreover,
defendants contend intermittently in their opposition papers that
plaintiffs' motion for summary judgment is premature as discovery is at
an early stage. Defendants' position perhaps would be clearer had the
motion been made at a later stage in the litigation. Also, the February
letter is but one agreement among others between the parties. These other
agreements, the Purchase Agreement and the Employment Agreements, govern
most of the terms of the exchange between the parties, and defendants'
position is that much of what they accepted from plaintiffs under the
February letter was owed under the
Purchase Agreement.*fn7 Defendants' failure to explicitly affirm
or disaffirm the contract reasonably consists with its position that the
February letter is unenforceable and that plaintiffs already owed $17.183
million under the Purchase Agreement.
For these reasons, the Court grants leave to defendants under
Rule 15(a) to amend their pleadings, which currently appear only partially to
make out a claim on the basis of their concealment allegations.
Fed.R.Civ.P. 15(a) ("[L]eave shall be freely given [to amend a pleading] when
justice so requires."). Defendants may choose to amend their pleadings as
they see fit. The scope of the leave now granted by the Court, however,
is limited to the request made by defendants. Defendants may amend their
pleadings only to include allegations of a claim that, if proved, would
render the February letter unenforceable. Defendants shall file and serve
any amended pleadings within thirty days of the entry of this order.
The Court therefore cannot determine on the current record whether the
factual disputes raised by defendants, that is, the circumstances of the
Eton transaction, its effect on Clarendon's profitability, and whether
plaintiffs concealed any of this information, are material to plaintiffs'
summary judgment motion. If defendants assert a counterclaim that, if
proved, would render the February letter unenforceable, then any factual
dispute material to that counterclaim likewise is material to plaintiffs'
summary judgment motion. If defendants cannot make out such a
counterclaim, then the factual dispute is immaterial and does not
preclude summary judgment. As noted above, plaintiffs already have
forecasted that any such counterclaim will either face insurmountable
legal hurdles, or will require defendants to return the $17.183 million
indemnity payment. Plaintiffs' summary judgment motion, however, provides
no opportunity for
defendants to respond to, or the Court to rule upon the accuracy of
these forecasts. Accordingly, the Court denies plaintiffs' motion for
partial summary judgment, because a genuine issue of fact remains in
dispute, and the materiality of that dispute is not ascertainable on the
Finally, as defendants' appeals to the doctrines of equitable
recoupment and setoff are rejected below, the Court now clarifies that
only defendants' allegations of fraud now preclude the Court from
granting summary judgment in favor of plaintiffs on the 1999 Earnout. If
defendants, for whatever reason, do not prevail on a counterclaim that
would rescind or otherwise render the February letter unenforceable, then
plaintiffs are permitted to renew their motion for partial summary
judgment on the 1999 Earnout based on the February letter.
III. Genuine Issues of Fact Related to the Parties'
Indemnification Dispute Do not Preclude Summary Judgment
Defendants also contend that the Court should deny summary judgment
because factual issues remain in dispute about plaintiffs' obligation to
indemnify defendants under the general indemnification provisions of
Purchase Agreement.*fn8 The parties are currently litigating an action
in New York State Supreme Court to resolve the indemnification issues.
Defendants claim that because factual issues remain in dispute with
respect to the indemnification litigation, the Court should deny
plaintiffs' summary judgment motion in this action under the doctrines of
equitable recoupment or setoff.*fn9 Plaintiffs reply that the doctrines
of equitable recoupment and setoff do not apply in these circumstances,
and thus present no bar to partial summary judgment.
A. The Doctrines of Equitable Recoupment and Setoff
The Second Circuit has described clearly and extensively the doctrines
of equitable recoupment and setoff under New York law in three particular
opinions, In re McMahon, 129 F.3d 93 (2d Cir. 1997), In re
Malinowski, 156 F.3d 131 (2d Cir. 1998), and Westinghouse
Credit Corp. v. D'Urso, 278 F.3d 138 (2d Cir. 2002). Equitable
recoupment and setoff are substantively equivalent doctrines. The few
distinctions between the doctrines make a difference primarily in
bankruptcy actions, in which priority among creditors to the bankrupt
entity often presents a pivotal, immediate issue. See In re
McMahon, 129 F.3d at 96 (citing, among other things, Reiter v.
Cooper, 507 U.S. 258, 265 n.2 (1993)); In re Peterson
Distributing, 82 F.3d 956, 959 (10th Cir. 1996). A bankruptcy
petition can trigger an automatic stay of actions against the bankrupt
entity. See 11 U.S.C. § 362. "The automatic stay generally
prohibits creditors from obtaining possession of or otherwise burdening
any property of a bankruptcy debtor without the permission of the
bankruptcy court." In re McMahon, 129 F.3d at 96. Setoff claims
are subject to bankruptcy's automatic stay provision. Id. Thus
a defendant to an action brought by a bankrupt entity may not improve its
priority in the bankruptcy distribution by counterclaiming setoff.
Recoupment, on the other hand, is not subject to the automatic stay
provisions of 11 U.S.C. § 362, "because funds subject to recoupment
are not the debtor's property." In re Malinowski, 156 F.3d at
133; In re McMahon, 129 F.3d at 96. Thus recoupment presumably
offers a preferable doctrine to a creditor defending against an action
brought by the bankrupt entity, because it permits the creditor
potentially to skip ahead of other creditors if the recoupment doctrine
applies. See, e.g., Westinghouse, 278 F.3d at 148 (declining
recoupment because "doing so would give Seller an unbargained-for
position superior to a secured creditor").
Apart from the distinct remedies offered by recoupment and setoff in
the bankruptcy context, little of substance distinguishes the doctrines.
"Recoupment is in the nature of a defense, the purpose of which is to do
justice viewing one transaction as a whole." In re Malinowski,
156 F.3d at 133. Under New York law,
Recoupment means a deduction from a money claim
through a process whereby cross demands arising
out of the same transaction are allowed to
compensate one another and the balance only to be
recovered. Of course, such a process does not
allow one transaction to be offset against
another, but only permits a transaction which is
made the subject of suit by plaintiff to be
examined in all its aspects, and judgment to be
rendered that does justice in view of the one
transaction as a whole.
In re McMahon, 129 F.3d at 96 (quoting National Cash
Register Co. v. Joseph, 86 N.E.2d 561, 562 (N.Y. 1949)). "In
recoupment, . . . the claim and counterclaim must arise out of the
same transaction or set of transactions." In re Malinowski, 156
F.3d at 133; see In re McMahon, 129 F.3d at 96. "[A]
transaction may comprehend a series of many occurrences, depending not so
much upon the immediateness of their connection as upon their logical
relationship." In re Malinowski, 156 F.3d at 133. "When," for
example, "the circumstances that gave rise to the credit and those giving
rise to the creditor's obligation to the debtor do not result from a set
of reciprocal contractual obligations or from the same set of facts, they
are not part of the same transaction." Id. at 134. In the
recoupment context, therefore, a Court must not isolate its scrutiny to
the mere meaning of the word "transaction," but must consider the
"logical relationships" between the claim and counterclaim. In both
In re Malinowski and Westinghouse. the Second
Circuit held that the doctrine of equitable recoupment did not apply
even when the obligations at issue arose out of the same contract. In
In re Malinowski, the Court held that "Where the
contract itself contemplates the business to be transacted as discrete
units, even claims predicated on a single contract will be
ineligible for recoupment." 156 F.3d at 135. And in
Westinghouse, the Court found that "although the Agreement
constitutes a single integrated transaction, it is one that comprises
`discrete and independent units,'" and therefore applying the doctrine of
recoupment would be inequitable. 278 F.3d at 148.
Similarly, "the right of setoff allows entities that owe each other
money to apply their mutual debts against each other, thereby avoiding
the absurdity of making A pay B when B owes A." In re
Malinowski, 156 F.3d at 133 (internal quotations omitted). "In
setoff, the debts may arise from different transactions, but they must be
mutual. Debts are mutual when they are due to and from the same persons
in the same capacity." Westinghouse, 278 F.3d at 149 (internal
quotations and citations omitted). Because debts must be due to the
claimant for setoff to apply, "`there is no right to set off a possible,
unliquidated liability against a liquidated claim that is due and
payable.'" Willett v. Lincolnshire Mgmt, 756 N.Y.S.2d 9, 10
(App. Div. 2003) (quoting Spodek v. Park Prop. Dev. Assoc.,
693 N.Y.S.2d 199, 200 (App. Div. 1999)).
Generally, then, outside the bankruptcy context setoff and recoupment
each basically provide a legal ground upon which a party can postpone
paying a sum to another party until the net liability between the parties
is finally determined.
B. Neither Equitable Recoupment nor Setoff Precludes Summary
Regardless of whether genuine issues of fact remain in dispute as to
plaintiffs' general indemnity obligations under Article 7 of the Purchase
Agreement, these issues do not preclude summary judgment, because neither
the doctrine of equitable recoupment nor of setoff applies to this case
at its current stage.
Equitable recoupment does not apply because the obligations arise out
of discrete and independent units. Plaintiffs' general indemnity
obligations arise out of Article 7 of the Purchase
Agreement. Defendants' obligation to pay the 1999 Earnout arises
out of the February letter, the parties' mutual understanding of which is
based in part on the terms of Article 2 of the Purchase Agreement.
Defendants suggest that these obligations arise under an "overall single
transaction between the parties namely, the acquisition of Lion
by Hannover Re." (Defendants' Opposition, at 12.) Defendants'
characterization is reasonable, given that the February letter is not an
isolated agreement, but rather one executed apparently in the midst of
competing claims between the parties arising out of the Purchase
Agreement and Employment Agreements. Defendants' characterization also is
arguable, given that, as plaintiffs point out, "the February letter does
not merely recite that Plaintiffs' qualified for the payments," but
rather memorializes a new agreement between the parties. (Plaintiffs'
Reply, at 19.)
Defendants' characterization, however, that the general indemnification
provisions and the Earnout provisions are part of an overall single
transaction, even if accurate, does not preclude summary judgment. The
Earnout provision and the general indemnification provisions were
transacted as discrete and independent units between the parties. The
obligations refer to completely separate circumstances. They are not, in
other words, "reciprocal," nor do they arise "from the same set of
facts." In re Malinowski, 156 F.3d at 134. Apart from their
mutual coexistence in the lengthy, comprehensive Purchase Agreement, the
obligation of the selling shareholders to indemnify Hannover Re and
Hannover Re's obligation to pay additional incentive compensation to
Lion's executives and selling shareholders for managing Clarendon
profitably share no logical relationship. As in Westinghouse,
the obligations here "are not in any way contingent on one another, and
indeed are not even complementary." 278 F.3d at 148.
The indemnity provisions, in fact, implicitly disclaim any such
contingency between the indemnity obligations and the Earnout provisions.
The indemnity provisions in the Purchase
Agreement specifically provide that funds for indemnification may
be taken from, among other things, "any amount of Additional Incentive
Compensation . . . payable at such time or paid to Milo and Ferguson
after the Closing Date," and "from any amounts payable at such time or
paid to Milo and Ferguson under Section 2.3 . . . of this Agreement
[the Earnout provision]." Defendants argue that this provision
demonstrates that their obligation to pay the Earnouts enjoys some
reciprocal relationship to plaintiffs' obligation to indemnify. The
quoted language demonstrates the opposite, however. It explicitly
provides that plaintiffs may indemnify defendants with funds "paid" to it
under the Earnout provisions. The indemnity provisions thereby implicitly
disclaim any contingency between the payment of Earnouts and the payment
of indemnity. As the obligations arise from discrete and independent
units of the transaction, applying the doctrine of recoupment would be
inequitable, and the Court declines to do so.*fn10
Setoff likewise does not apply to prevent summary judgment at this
phase. Obligations need not arise under the same "transaction" for setoff
to apply. Obligations, however, must be
due for setoff to apply. Here, no payments for indemnity to
defendants are due from plaintiffs. The parties dispute plaintiffs'
obligation to indemnify defendants, and are litigating this dispute in
New York State Supreme Court. Setoff therefore presents no bar to summary
judgment at this stage.
The Court therefore rejects defendants' argument that disputed factual
issues related to plaintiffs' indemnity obligations preclude summary
judgment. Neither equitable recoupment nor setoff precludes plaintiffs'
summary judgment motion.
For the reasons set forth above, plaintiffs' motion for partial summary
judgment is denied. Defendants are granted leave under Rule 15(a) of the
Federal Rules of Civil Procedure to amend their answers in a manner
consistent with this opinion and order, and must serve and file any such
amended answers within thirty days of the entry of this order. In the
event that defendants' amended pleadings fail, for any reason, to prove a
claim that would render the February letter unenforceable, plaintiffs are
permitted to renew their motion for partial summary judgment.