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HA-LO INDUSTRIES, INC. v. CREDIT SUISSE FIRST BOSTON

October 12, 2005.

HA-LO INDUSTRIES, INC., Plaintiff,
v.
CREDIT SUISSE FIRST BOSTON, CORP., Defendant.



The opinion of the court was delivered by: ROBERT GETTLEMAN, District Judge

MEMORANDUM OPINION AND ORDER

Plaintiff HA-LO Industries, Inc. has sued defendant Credit Suisse First Boston Corp. for gross negligence and negligent misrepresentation (Count I), breach of contract (Count II), and breach of fiduciary duty (County III), relating to the services defendant provided to plaintiff in connection with a merger between plaintiff and Starbelly.com, Inc. ("Starbelly"). Defendant has moved for summary judgment on all three counts. For the reasons set forth below, the motion is denied.

FACTS

  Lewis Weisbach started plaintiff as a small promotional products company to support his income as a school teacher. He was successful and began to buy up other small promotional product companies, eventually turning plaintiff into the largest promotional products company in the United States. Plaintiff went public in 1992, was listed on the New York Stock Exchange, and by the end of 1999 had more than $600 million in annual sales. In 1999, however, the tide began to turn and plaintiff's net income began to decline. It had cash flow problems, aging accounts receivables, and duplicate warehouses and other resources. Plaintiff's stock price declined from $25.54 per share on January 4, 1999, to $4.63 per share on October 13, 1999. To counter these problems, sometime in late 1999 or 2000 plaintiff's board of directors decided to transform plaintiff by developing or acquiring an internet-based sales and distribution system for its promotional products business. John Kelley replaced Weisbach as CEO and president. In late summer or early fall 1999, plaintiff's vice chairman introduced Kelley to Brad Keywell and Eric Lefkofsky, the founders of Starbelly, an internet-start-up company that was developing the kind of system Kelley wanted. Kelley began negotiating to acquire Starbelly. By December 18, 1999, plaintiff and Starbelly had entered a non-binding term sheet providing for a purchase price of $240 million; $70 to $100 million to be paid in cash and the remainder to be paid in common stock of plaintiff.

  Due to the size of the transaction, plaintiff retained defendant to advise plaintiff with respect to its potential acquisition of Starbelly. Plaintiff and defendant entered into an engagement agreement ("engagement letter") on December 6, 1999, under which defendant agreed to act as plaintiff's "exclusive financial advisor in connection with a possible acquisition of/proposed merger or other business/strategic combination" with Starbelly. Although the parties dispute the parameters of defendant's role under the agreement, the engagement letter specifically provides that defendant shall, as appropriate:
(a) advise and assist [plaintiff] with respect to defining objectives, performing evaluation analysis and structuring and planning the Transaction;
(b) advise and assist [plaintiff] negotiating the terms and conditions of the Transaction;
(c) advise [plaintiff] with respect to alternatives to the Transaction;
(d) upon request, render an opinion as to the fairness from a financial point of view of the consideration to be paid by [plaintiff] pursuant to the Transaction; (e) advise and assist in the preparation of proxy or information statement materials pertaining to the transaction, including, without limitation, the preparation of summaries of the negotiation history of the [defendant's] opinion to be included in such materials; and
(f) perform such other financial advisory services as [defendant] and the [plaintiff] may from time to time agree upon.
  Defendant's fee under the agreement was dependent upon the purchase price paid by plaintiff for Starbelly. Defendant received a $100,000 non-refundable retainer, and a transaction fee calculated as the greater of $1,500,000 or a variable percentage of the purchase price. Thus, if plaintiff elected not to complete the deal, defendant would receive only the $100,000 plus 10% of any "break up" fee.

  Because defendant had no expertise with respect to information technology systems and infrastructure technology, it recommended that plaintiff hire a third party consultant to evaluate Starbelly's technology. Consequently, plaintiff hired Ernst & Young, which reported that Starbelly's technology was incomplete, and that completion would require significant time and money. The parties dispute whether Ernst & Young's reports were ever provided to defendant.

  Despite Ernst & Young's serious questions about Starbelly's technology, Kelley told plaintiff's board that Ernst & Young's assessment of the technology was positive. At a January 6, 2000, board meeting Kelley stated his belief that Starbelly represented the best option for the "e-transformation" of plaintiff's promotional products division. The board agreed and approved a $5 million loan to Starbelly. Defendant was not present at that meeting. Ten days later, on January 16, 2000, plaintiff's board held a special meeting to evaluate the proposed merger with Starbelly. At that meeting, defendant provided a written presentation that included defendant's analysis of plaintiff's liquidity. The merger was approved the following day. On April 12, 2000, plaintiff issued a proxy statement, a portion of which was reviewed by defendant, in which the board unanimously recommended that the stockholders approved the transaction. The transaction was approved by the stockholders on May 3, 2000. Defendant received a total fee of $2.6 million.

  After the transaction closed, plaintiff tried to integrate Starbelly and to complete development of Starbelly's technology. Despite substantial time and tens of millions of dollars, the technology was never completed. Plaintiff's business declined and plaintiff began to lose money. On July 30, 2001, less than two years after the merger, plaintiff filed a voluntary petition for relief under Chapter 11 of the bankruptcy laws.

  DISCUSSION

  As an initial matter, the court must determine what law governs each of plaintiff's claims. The engagement letter provides that "[a]ll aspects of the relationship created by this agreement shall be governed by and construed in accordance with the laws of the state of New York applicable to contracts made and to be performed therein. Each of [plaintiff and defendant] waives all right to trial by jury in any action, suit, proceeding or counterclaim (whether based upon contract, tort or otherwise) related to or arising out of the engagement of [defendant] pursuant to, or the performance by [defendant] of the services contemplated by this agreement." Defendant argues that all of plaintiff's claims, whether sounding in contract or tort, are governed by New York law. Plaintiff agrees that New York law governs its contract claim, but "does not concede that New York law governs [plaintiff's] remaining claims. . . ." Plaintiff then states that it relies primarily on New York case law because it should prevail under either state's law. The court construes plaintiff's statement as a tacit admission that New York law governs all of its claims. In any event, the court agrees with defendant that all of plaintiff's claims arise out of its relationship with defendant that was created by the agreement. Accordingly, the court will apply New York law to all of the claims.

  Count I

  In Count I plaintiff alleges that defendant was grossly negligent and/or acted in bad faith when rendering its opinion on the acquisition. In particular, plaintiff alleges that defendant: (1) valued Starbelly using a methodology that defendant knew or should have known would overstate the value; (2) disregarded relevant information about the value of Starbelly's technology assets; (3) disregarded public information about the business practices of Starbelly's management team; (4) advised plaintiff that defendant's valuation of Starbelly was correct despite the collapse in the e-commerce market; (5) omitted relevant information about the "limitations" in its fairness opinion from the language it approved for the proxy statement; and (6) permitted its own interest in securing a lucrative fee and anticipating future business to override its exercise of reasonable judgment in performing its obligations.

  Defendant has moved for summary judgment on Count I, raising three separate arguments: (1) New York does not recognize a claim for negligent performance of a contract; (2) economic loss is not recoverable under a theory of negligence; and (3) defendant made no misrepresentation of fact. The court rejects all three arguments.

  First, with respect to a claim for negligent performance of a contract under New York law, defendant is simply wrong when it argues that the cause of action does not exist. Although the law in New York on this subject is somewhat confusing, it is well settled that negligent performance of a contract may give rise to a claim sounding in tort as well as for one for breach of contract, at least in certain circumstances. William Wrigley, Jr. Co. v. Waters, 890 F.2d 594, 602 (2d Cir. 1989). In New York there are two distinct lines of cases addressing the issue, neither of which has been overruled, but both of which recognize the cause of action. The first, typified by Wrigley, recognizes a cause of action for negligent performance of a service contract. Id. The second, typified by Clark-Fitzpatrick, Inc. v. Long Island R. Co., 521 N.Y.S. 2d 653, 657 (1987), takes a slightly narrower view, holding that a negligence claim exists when "a legal duty independent of the contract itself has been violated." As plaintiff notes, although they articulate the standard differently, there is no real substantive difference between the two theories. In Wrigley, 890 F.2d at 602, the court stated that:
Where a person contracts to do certain work he is charged with the common law duty of exercising reasonable care and skill in the performance of the work required to be done by the contract. It is the breach of the duty imposed by law and not of the contract obligation which constitutes the tort.
  Thus, even under Wrigley, the asserted breach was of a duty independent of the contract itself. The defendants had held themselves out as experts in trademark law and ...

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