The Ball is in Who’s Court?: Commercial Division Denies Plaintiffs’ Attempt to Invalidate Forum-Selection Clause in Promissory Notes
March 19, 2021
Most commercial contracts contain a choice of law provision and/or forum-selection clause. Under New York law, it is well recognized “that parties to a contract may freely select a forum which will resolve any disputes over the interpretation or performance of the contract” (Brooke Group Ltd v JCH Syndicate 488 et al). Recently, Justice Elizabeth Hazlitt Emerson handed down a decision emphasizing that absent a strong showing, forum-selection clauses are generally considered valid.
In Stein v United Wind, Inc. , plaintiffs Howard and Cathy Stein (collectively, the “Steins”) and Jeremy Tark (“Tark”) (the Steins and Tark collectively, the “Plaintiffs”) brought a lawsuit in Suffolk County, New York against defendant United Wind, Inc. (“United Wind”), a Delaware corporation, and various related entities, including Eocycle Technologies (“Eocycle”) (collectively, the “Defendants”). In the complaint, Plaintiffs alleged that they were fraudulently induced to invest into United Wind to the tune of $175,000.00. In formalizing these investments, Plaintiffs entered into two subscription agreements with United Wind and purchased convertible promissory notes in the amounts of $75,000.00 (the “Stein Note”) and $100,000.00 (the “Tark Note”) (collectively, the “Notes”). Specifically, the subscription agreements and the Notes provided that these devices shall be governed by Delaware law. Moreover, the Notes contained a forum-selection clause that provided that “the State of Delaware shall have exclusive jurisdiction over any dispute in connection with [these] Note[s].”
During the course of the investment relationship, United Wind entered into a term sheet with Eocycle, whereby, Eocycle agreed to provide United Wind with an operating loan in the amount of $100,000.00 and additional funding of $766,754.00 to a newly-formed Delaware corporation to purchase United Wind’s assets. Thereafter, United Wind contacted all of its shareholders and noteholders, including the plaintiffs, seeking their consent to the transaction and to enter into a waiver and amendment agreement (the “Waiver Agreement”). Notwithstanding the Plaintiffs refusing to consent and enter into the Waiver Agreement, United Wind was able to obtain approval of the majority holders of outstanding shares to complete this transaction. Subsequently, United Wind entered into an asset-purchase agreement (the “Asset Purchase Agreement” ) with the newly formed Delaware corporation, 18373510, Inc. (“18 Inc.”). The Asset Purchase Agreement provided that as a result of acquiring the assets of United Wind, 18 Inc. would (i) assume certain liabilities of United Wind; and (ii) be required to make payments to United Wind pursuant to an earn out schedule. However, Plaintiffs alleged that 18 Inc., failed to make any payments to United Wind pursuant to the terms of the Asset Purchase Agreement. As a result, Plaintiffs were never repaid any amounts in relation to their Notes.
Following the commencement of Plaintiffs’ lawsuit, the Defendants separately moved to dismiss the complaint, arguing that the forum-selection clause in the Notes required that the state of Delaware had exclusive jurisdiction in deciding any dispute in connection with the Notes. In opposition, the Plaintiffs argued that enforcement of the forum-selection clause would be unreasonable and unjust, based on the fact that: (i) the Plaintiffs never signed the Notes; (ii) there was no nexus between any of the parties and the state of Delaware; and (iii) the Notes were procured by United Wind’s fraud. Justice Emerson rejected each of Plaintiffs’ arguments.
First, the Court rejected Plaintiffs’ argument that they never signed the Notes, explaining that “the plaintiffs may not seek to enforce the notes against the defendants and, at the same time, argue that they did not agree to the terms contained therein.” Moreover, the Court found that because the Plaintiffs had signed the subscription agreements and performed under the Notes, “it was not necessary for the plaintiffs to sign each individual note.”
Second, the Court rejected Plaintiffs’ argument that none of the parties had any significant connection to the state of Delaware, based on the fact that United Wind and 18 Inc., were both Delaware corporations.
Third, the Court rejected Plaintiffs’ argument that the forum-selection clause could not be enforced since the Notes were procured by United Wind’s fraud. The Court concluded that, while Plaintiffs alleged they were fraudulently induced to enter into the Notes, there was no allegation that “the forum-selection clauses themselves were procured by fraud.” In addition, the Court acknowledged that the plain language contained in the subscription agreements provided that Plaintiffs’ investment in United Wind involved a “high degree of risk and should be made only by persons of substantial means … who can bear the economic risk of a total loss of their investment.” Thus, the Court found such representations offered in the subscription agreements “rendered any reliance on alleged contradictory oral representations unjustifiable as a matter of law.”
As shrewdly noted in the dissenting opinion of Bowen v Massachusetts, “nothing is more wasteful than litigation about where to litigate.” These words symbolize the essence of the Stein decision and serve as a powerful reminder to litigators practicing in the Commercial Division that attempting to invalidate the enforcement of an already agreed upon forum-selection clause will be an uphill battle. And so, to avoid this losing crusade, drafters and parties should remain cognizant when choosing which jurisdiction is most appropriate in litigating a potential dispute and carefully review the forum-selection clause before executing any agreement.