Stryker v. Keelen
Opinion Date: February 19, 2004
CORPORATIONS; SHAREHOLDERS; FRAUD—A shareholder and director of a corporation who buys out the other shareholders should have been in a position to know if the corporation had been paying its taxes; therefore, such a shareholder can't claim reliance on any failure of the selling shareholders to reveal that sales taxes remained unpaid.
A corporate shareholder bought out the remaining shareholders, making him the sole owner. Attached to the final contract was a schedule of outstanding debts which included outstanding sales tax debts for the prior three months. There was no discussion about unpaid sales tax before the three prior months, but it was the buying shareholder's understanding that they had been paid.
Shortly after closing, a tax audit showed that the corporation owed a substantial amount of old sales taxes. As the only shareholder at the time of the audit, the new owner was held solely responsible. Therefore, he brought an action against the old shareholders for breach of contract and common law fraud. He alleged that they intentionally misrepresented that sales tax payments were current, and that he relied on that misrepresentation in agreeing to purchase their interests. After trial, the jury found the old shareholders liable for fraud. They appealed, arguing that the current shareholder failed to satisfy the "reasonable reliance" requirement required to prove common law fraud. The Appellate Division agreed, and reversed the jury's verdict.
Parties are free to contract as they desire and, absent mistake, fraud, duress, unconscionability or illegality, they are bound by the unambiguous terms of their contract. In a cause of action for legal fraud, the claimant must demonstrate that its reliance upon the false representation was reasonable and justifiable. Furthermore, one is not justified in relying on representations made where there had been ample opportunity to obtain the facts beforehand. The Court noted that there was no claim that the buyer was ever denied access to the company's books or records or to the underlying data upon which the corporate financial statements were based. There was also no proof that he was prevented from conducting an investigation of the business. A brief review of the company's records would have uncovered the obvious sales tax problem. Furthermore, even though he took a passive role in the business at the start, he eventually assumed a more active role in the management at least one year prior to purchasing the other shares. Thus, there was ample opportunity for him to obtain an accurate accounting of the company. In addition, he should have seen a red flag during negotiation when the selling shareholders refused to include a "hold harmless" clause in the contract because it would have made them responsible for all claims existing prior to the transfer of their interests.
Furthermore, the Appellate Division found the buying shareholder's reliance to be unjustified. While he was one of the three shareholders, he was a corporate director, and should have had familiarity with the financial status of the corporation. Directors may not shut their eyes to corporate misconduct and then claim that because they did not see any misconduct, they had no duty to investigate. Therefore, given the duty imposed by law on the shareholder in his capacity as an officer and director of the corporation, there was no justification for his blanket reliance.