Franchise Buyer’s Fraud Claim Bars Seller’s Summary Collection of Note

Introduction

It can be easy for a creditor to obtain a judgment against a debtor that has defaulted on payment of a promissory note. Essentially all the creditor must do is produce the signed note and prove nonpayment. But not in all cases.

The deal

This case involved the sale of a fitness center. During due diligence the seller furnished the buyer the fitness center’s historical revenue performance.

The asset purchase agreement provided that the buyers’ purchase was based in reliance upon the seller’s representations, and that seller warranted that no information or document provided by seller contained any untrue statements of a material fact or omitted material facts, and that the obligation concerning the accuracy of statements of material facts would continue for 1 year beyond the closing.

The buyer never made any note payments, claiming that the buyer discovered after the closing that fitness center’s historical revenue provided by the seller was overstated and that the seller did not disclose to buyer that the revenue for the fitness facility was in sharp decline.

The lawsuit

The seller sued the buyer in a New York state court and filed a motion under New York law to obtain summary judgment in the amount of the note. The seller opposed the motion claiming that the seller had committed fraud and that the buyer is entitled to have the court rescind or unwind the transaction; which would relieve the buyer for liability under the note.

The court noted that in most cases that under New York law, a creditor can obtain summary judgment on a promissory note where the debtor has admitted note default. There are exceptions and this was one of them:

“Where the Note is ‘inextricably intertwined with the obligations contained in the purchase agreement’, and a breach of that agreement is alleged, summary judgment on the Note should not be granted. Here, the Asset Purchase Agreement pertained to the purchase of the fitness facility; the Note was for the money to complete the purchase; and the Asset Purchase Agreement contained warranties by the seller as to the truth and accuracy of information provided, and that the buyer was relying upon the seller’s representation. The Court finds that the Note and asset purchase agreement are inextricably intertwined. Further, Buyer’ claim that they were fraudulently induced into entering into the Asset Purchase Agreement was sufficient to raise triable issues of fact sufficient to defeat Seller’s motion.”

This case is referred to Viveros Fitness, LLC v. JB2 Fitness, LLCDocket No. 2018-2465, Supreme Court, Chemung County, (June 18, 2019)

Comment

The bottom line was that the buyer was given the right to challenge the note by filing paperwork alleging fraud and asking the court to rescind or unwind the deal.

By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million).

Email:             jmccauley@mk-law.com

Profile:            http://www.martindale.com/John-B-McCauley/176725-lawyer.htm

Telephone:      714 273-6291

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Posted in asset purchase agreement, fraud in business sale, promissory note, rescission Tagged with: ,

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