A purchaser of debtors’ lease designation rights filed a complaint in bankruptcy court against the debtors’ real estate brokers for fraudulent misrepresentation. The brokers moved to dismiss the complaint.
After the debtors sold substantially all of their assets, their remaining property included nine unexpired commercial leases. The debtors retained a real estate broker to sell rights to those leases. Specifically, the debtors proposed to transfer to a buyer the right to accept or reject assumption of these leases for a specified period of time.
The debtors negotiated a designation rights agreement to sell these rights for $315,000. Shortly before the court hearing on the proposed sale, the brokers advised that there was a competing bid from two individuals. They indicated that there was a binding letter of intent (LOI) offering to purchase only the most valuable lease for $1.1M.
The brokers required the purchaser to sign a nondisclosure agreement before they would provide a copy of the letter of intent. The purchaser contended that it thought that the LOI appeared to be legitimate, and they believed the competing bidders had done sufficient due diligence to determine that their deal would work. In response, the purchaser increased its bid to $1.2M, and the court approved the amended designation rights agreement with higher price.
Several months later the purchaser sued the brokers in bankruptcy court contending that the competing bid was a sham transaction orchestrated by the brokers. In particular it alleged that the brokers said the LOI was unsolicited and that they did not have any prior contact with the competing bidders when this was in fact not true. Further, the purchaser found out that the competing bidders had done little due diligence and their proposed project was not feasible. The purchaser claimed that it relied on these misrepresentations in increasing its bid, and would not have done so if it had known that the competing bidder had been in contact with the brokers.
After reviewing the standards for a motion to dismiss, the court turned to the question of choice of law. The brokers relied on the contractual choice of law in the designation rights agreement to argue that Delaware law governed. In contrast, the purchaser argued that a tort type analysis was applicable that turned on which state had the most significant relationship to the alleged wrongdoing, which it argued meant that California law should govern.
As a preliminary matter, the court noted that a federal court must apply the choice of law rules in the state where it sits. In Delaware, if there is a “material relationship” to the state, courts will uphold a contractual choice of law even as to tort claims. In this case, the lead debtor was a Delaware corporation, and a Delaware bankruptcy judge approved the sale. Consequently, the court found that there was a material relationship to Delaware as required.
Under Delaware law the elements of common law fraud include “a false representation of material fact made by the defendant.” A false statement is material “if it ‘has a natural tendency to influence, or was capable of influencing, the decision of’ the decision making body to which it was addressed.”
In this case the brokers supposedly said that the competing bid was “out of the blue” and unsolicited, when in fact the brokers had been negotiating with the competing bidder. The purchaser claimed that this was done to induce it to increase its offer, and if it had known of the negotiations it would have maintained its original $315,000 offer.
However, the purchaser had to concede that the brokers were not prohibited from soliciting other bids. Since the purpose of engaging a broker is to obtain the best price, solicitation of a competing offer was to be expected. Whether negotiations were concealed or not, the result would have been the same: the purchaser would have had to make a higher offer to obtain the rights.
The additional allegations that the competing bidders had done little due diligence and the property they were bidding on was not compatible with their business did not relate to specific statements of the brokers. The purchaser received a copy of a binding letter of commitment that appeared legitimate on its face. The LOI specifically stated that there would be no applicable due diligence period, and there was nothing regarding the planned use for the property. The requirement for a nondisclosure agreement (which the purchaser alleged prohibited it from contacting the competing bidder) also did not support a conclusion of improper motive.
Since the purchasers did not sufficiently plead that the misrepresentations were material or that there was a deliberate concealment of material information, the claim for fraud necessarily failed. The court granted the motion to dismiss, but without prejudice.
It is helpful to keep in mind that generally the goal of a broker is to get the deal closed and earn a commission. Although real estate brokers will often do legwork to help move a deal along, a buyer should not mistake a broker for a member of its due diligence team.