Berger Harris Wins Dismissal in Fraud/Contract Action; Superior Court and Court of Chancery Expound Upon Requirements for Pleading Fraud and Contract Claims

The Superior Court has granted a Motion to Dismiss filed by Berger Harris on behalf of the Defendants in the matter of Kostyszyn v. Martuscelli. The order brings to a close hotly-contested litigation that has gone on for over a year and half and taken the participants through two of Delaware’s trial courts.
On December 1, 2011, Plaintiffs purchased a Paciugo Gelato business franchise from Defendant Frozen Endeavors, Inc. located in the Christiana Mall.  Plaintiffs conducted due diligence and negotiated the terms of a transaction involving a fully integrated business purchase agreement, expressly acknowledging in writing that they had sought their own independent advice but declined to seek independent legal counsel.  Nearly two years following the sale of the business, on August 22, 2013, Plaintiffs filed a complaint in the Court of Chancery seeking recovery from the sellers and a number of marginally related parties.  The original complaint contained eight counts: (i) breach of contract; (ii) breach of warranty; (iii) indemnification; (iv) equitable fraud; (v) fraud; (vi) negligent misrepresentation; (vii) intentional misrepresentation; and (viii) breach of the duty of good faith and fair dealing.  Plaintiffs’ original complaint contained nine prayers for relief, requesting declaratory relief, money damages, rescission (denominated as cancellation of the documents underlying the sale of the Business), an accounting, and “[s]uch other and further relief as this Court deems just and equitable under the circumstances.”    
Plaintiffs’ fraud claims were based upon a purported discrepancy between a financial statement showing a nominal net income over a period of seven months and a later email by one of the Defendants asserting that he never made any money from the Paciugo franchise.  Plaintiffs also claimed that Defendants had breached a provision in the sales agreement required Defendants to purchase gelato from the Plaintiffs for a period of ten years following consummation of the sale.  Although it was undisputed that Defendants had, in fact, purchased all of their gelato from Plaintiffs, Plaintiffs asserted that the decrease in gelato purchases from previous years breached terms that should have been read into the contract under the Uniform Commercial Code, and alleged that this decrease was pre-planned and therefore intended to fraudulently induce the purchase of the business.  Plaintiffs further claimed that Defendants’ purchases of competing products, such as ice cream, further undermined the terms of the agreement requiring gelato purchases.
Upon a Motion to Dismiss filed by all Defendants, the Court of Chancery dismissed Plaintiffs’ claims for equitable fraud with prejudice, holding:

Nowhere in the Complaint have plaintiffs pled the existence of a fiduciary, special, or confidential relationship between the parties that would give rise to a claim sounding in equity and, hence, subject matter jurisdiction in this Court. The parties here engaged in an arm’s length business transaction, and courts in Maryland and Delaware are reluctant to impute the principles of fiduciary relationships between parties in cases like this one. ​See Gegeas v. Sherrill, 147 A.223 (Md. 1958); Zebroski, 2014 WL 2156984, at *8 (Del. Ch.) (citing Wal-Mart Stores, Inc. v. AIG Life Ins. Co., 901 A.2d 106, 114 (Del. 2006)). Therefore, under both Delaware and Maryland law, I conclude that plaintiffs’ claim of equitable fraud should be dismissed with prejudice under Rule 12(b)(6) for failure to state a claim.[1]    

The Court of Chancery further held that Plaintiffs were not entitled to the equitable remedy of recission because Plaintiffs failed to allege anywhere in the Chancery Complaint that they stood ready, willing and able to return the parties to the status quo ante, nor did the facts alleged support such an inference.[2]  The Court of Chancery dismissed the balance of Plaintiffs’ claims without prejudice for lack of subject matter jurisdiction.[3]  In declining to hear the non-equitable claims under a discretionary exercise of the “clean-up doctrine,” Master Ayvazian noted:

There are a variety of reasons why this Court may exercise its discretionary jurisdiction to hear legal claims, including to: (i) resolve a factual issue which must be determined in the proceedings; (ii) avoid a multiplicity of suits; (iii) promote judicial efficiency; (iv) do full justice; (v) avoid great expense; (vi) afford complete relief in one action; and (vii) overcome insufficient modes of procedure at law. Shore Investments, Inc., v. BHole, Inc., 2009 WL 2217744, at *3, (Del. Ch. July 14, 2009) (citing Clark v. Teeven Holding Co., Inc., 625 A.2d 869, 881 (Del. Ch. 1992)). See also Zebroski, 1014 WL 2156984, at *9, (Del. Ch.). However, another important aspect to consider is whether the facts involved in the legal and in the equitable claims “are so intertwined that it would be undesirable or impossible to sever them.” Shore Investments, Inc., 2009 WL 2217744, at *3 (Del. Ch.) (citing Clarke, 625 A.2d at 881)).[4]    

Following this dismissal, Plaintiffs transferred their action to the Superior Court.  Plaintiffs filed a new Complaint substantially identical to that previously filed in the Court of Chancery, with the exception of the omission of their equitable fraud claim.  Defendants promptly filed a Motion to Dismiss.  Unusually for a matter before the Superior Court, and due to the large number of parties and claims, Judge Paul R. Wallace granted the parties leave to fully brief the Motion to Dismiss. 
The briefing can be downloaded here:
After hearing argument on the Motion, Judge Wallace dismissed the remaining claims with prejudice.  Regarding the contract-based claims, Judge Wallace found that Plaintiffs had not demonstrated that the contract terms had been breached, and declined to “engraft” additional requirements to the contract:

Even recognizing the low burden imposed to survive dismissal, Plaintiffs’ pleadings do not demonstrate how Defendants have breached the Agreement and how, on these breach claims, they, Plaintiffs, may recover under any reasonably conceivable set of circumstances susceptible of proof. The contract requires Defendants to purchase gelato for the Chesapeake Inn, Creamery, and La Casa Pasta for ten years. Plaintiffs attempt to engraft to the Agreement a requirement that Defendants purchase gelato in the amounts reflected in the Profit Statement and refrain from purchasing competing products, such as ice cream. But the Profit Statement is just that—an accounting of the business’s profits for a certain period. There is neither an allegation nor evidence it was to be part of the Agreement.

The contract does not specify any amount of gelato that must be purchased. Nor does the contract state that Defendants must continue to purchase gelato for a non-operating business or refrain from purchasing ice cream. Plaintiffs admit that the Chesapeake Inn and La Casa Pasta still purchase gelato from Paciugo, although in smaller amounts. Plaintiffs also admit that Defendants bought gelato for the Creamery following the Paciugo sale. Even drawing reasonable inferences in favor of the Plaintiffs, they could not recover for breach of contract under any reasonably conceivable set of circumstances because Plaintiffs admit that Defendants still purchase gelato according to the terms of the contract for the businesses that Defendants still operate. The Court need not “accept every strained interpretation of the allegations proposed by the [P]laintiff[s].” Plaintiffs here have failed to plead facts supporting a finding of a breach of an obligation under the Agreement, which is, of course, an essential element of their breach of contract claim. The claim must be dismissed.[5]

Regarding Plaintiffs’ fraud claims, the Court found no allegation in the Complaint of an actual misrepresentation.  In dismissing the fraud claims, Judge Wallace elaborated on the pleading requirements of Del. Super. Ct. Civ. R. 9(b), and how the greater particularity requirements of that rule differ from a notice pleading requirement under Rule 12(b):

A plaintiff must state the “time, place, and contents” of the fraud or misrepresentation alleged and allege that the defendant’s representation was false to plead a claim with particularity as required by Rule 9(b). In this case, Plaintiffs have merely stated that Defendants presented them with false financial information using improper accounting methods without pleading adequate facts informing how the records were false. Plaintiffs do not specify the time, place, and contents of the alleged fraud as required. They instead generalize that “information regarding the financial condition, operating results, revenue, income and expenses” of the business was false. Plaintiffs indicate neither how Defendants’ accounting methods were improper nor how the one financial statement Plaintiffs relied on in purchasing the franchise was inaccurate. They have not specified any false statements made by Defendants nor that Defendants knew or believed their statements to be false. In short, Plaintiffs have failed to plead multiple elements of their fraud claims. Accordingly, the fraud and intentional misrepresentation claims must be dismissed.[6]

In essence, this case demonstrates that practitioners and businesspeople alike should pay particular attention to the terms of the deal and conduct whatever due diligence they believe necessary in making decisions regarding business purchases.  The courts of the State of Delaware are disinclined to rescue parties from deals they regret or to countenance the conversion of buyers' remorse into claims of fraud and breach of contract.

[1] Kostyszyn v. Martuscelli, C.A. No. 8828-MA, Master’s Report at 12 (Del. Ch. Jun. 30, 2014).
[2] Id. at 13-14.
[3] Id. at 17.
[4] Id.
[5] Kostyszyn v. Martuscelli, C.A. N14C-08-010 PRW, Mem. Op. at 10-11 (Del. Super. Feb. 18, 2015).
[6] Id. at 14-15.