Sixth Circuit Affirms Dismissal of Claims Based on “Big Boy” Letter and Evidentiary Failures

October 24, 2013

On October 23, the Sixth Circuit affirmed the Southern District of Ohio’s decision granting summary judgment in favor of Credit Suisse Securities (USA) LLC (“Credit Suisse”) in Pharos Capital Partners L.P. v. Deloitte & Touche, No. 12-4381 (6th Cir. Oct. 23, 2013). The appeal concerned claims asserted by plaintiff Pharos Capital Partners, L.P. (“Pharos”) for fraud, negligent misrepresentation, and violations of the Ohio Securities Act, arising from its failed $12 million private equity investment in National Century Financial Enterprises, Inc. (“NCFE”). As described below, the per curiam ruling by Judges Deborah L. Cook, Richard Allen Griffin and Raymond M. Kethledge upheld the district court’s “well-reasoned” decision that Pharos’s claims should be dismissed for lack of justifiable reliance.

In the Pharos Order, the Sixth Circuit affirmed that summary judgment was appropriate on the fraud and negligent misrepresentation claims because Pharos expressly disavowed any reliance on Credit Suisse in an agreement commonly known as a “big boy” letter (the “Letter Agreement”). Summary judgment was also proper on Pharos’s Ohio Securities Act claims because Pharos failed to adduce any proof it relied on a misstatement in the private placement memorandum (“PPM”) as required under the Ohio statutes.

The decision is significant for the financial industry because it dismisses claims pursuant to a negotiated agreement that allocates risk among sophisticated parties. With Pharos, the Sixth Circuit has now joined the Fifth, Seventh and Ninth Circuits in enforcing a sophisticated party’s express representations that it was not relying on any alleged statements made by another party in connection with a transaction. See, e.g., In re Capco Energy, Inc., 669 F.3d 274, 284 (5th Cir. 2012); Extra Equipamentos e Exportaҫão Ltda. v. Case Corp., 541 F.3d 719, 724 (7th Cir. 2008); Bank of the West v. Valley Nat’l Bank of Ariz., 41 F.3d 471, 477–78 (9th Cir. 1994). Notably, the Sixth Circuit Order blazes new ground on enforcement of “big boy” agreements that are entered into between placement agents and investors.

Background and the District Court’s Opinion and Order

NCFE hired Credit Suisse and The Shattan Group to act as co-placement agents in connection with NCFE’s private offering of convertible preferred stock and subordinated notes. In early 2002, Pharos approached Credit Suisse seeking an investment opportunity in the healthcare industry, and Credit Suisse introduced Pharos to NCFE. Pharos promptly began its due diligence investigation, met with the management of NCFE and received access to a data room of diligence materials. Pharos Capital Partners, L.P. v. Deloitte & Touche, L.L.P., No. 2:03-cv-362, 2012 WL 5334027, at *1–3 (S.D. Ohio Oct. 26, 2012).

After its diligence investigation, but prior to its investment in NCFE, Pharos negotiated and signed the Letter Agreement with Credit Suisse in which Pharos acknowledged certain facts and made particular representations to Credit Suisse regarding its investment. As the district court noted, “[t]he parties referred to the Letter Agreement as a ‘big boy’ agreement because Pharos in essence said that it knew what it was doing and could take care of itself.”1 Specifically, Pharos represented the following:

(a) That we are a sophisticated institutional investor and have such knowledge and experience in financial and business matters and expertise in assessing credit risk; that we are capable of evaluating the merits, risks and suitability of investing in the Securities; that we have conducted our own due diligence investigation of the Company, that we are relying exclusively on our due diligence investigation and our own sources of information and credit analysis with respect to the Securities and that we are able to bear the economic risks of and an entire loss of our investment in the Securities;

(b) That (i) neither [Credit Suisse] nor any Affiliate (as defined herein) has been requested to or has provided us with any information or advice with respect to the Securities nor is such information or advice necessary or desired, (ii) neither [Credit Suisse] nor any Affiliate has made or makes any representation as to Company or the credit quality of the Securities; and (iii) [Credit Suisse] and any Affiliate may have acquired, or during the term of the Securities may acquire, non-public information with respect to the Company, which we agree need not be provided to us;

(c) That, in connection with the issue and purchase of Securities, neither the Agent nor any of its Affiliates have acted as our financial advisor or fiduciary. . . .2

The district court concluded that “the clear language of the Letter Agreement and the surrounding factors render any claimed reliance by Pharos unjustifiable. . . . To allow Pharos to proceed any further with its fraud and negligent misrepresentation claims would upset the risk allocation the parties bargained for.”3

The district court further held:

[D]iscovery has disproved the complaint’s allegations, and the issue is no longer whether Pharos can state a claim for fraud. Credit Suisse has proved the existence of language having greater force than a boilerplate disclaimer in a PPM. It has proved that the parties entered into a bargained-for, retrospective statement of their dealings. Their Agreement establishes that Pharos agreed not to rely on Credit Suisse and agreed that Credit Suisse had no duty to provide information to Pharos.4

Accordingly, the district court granted summary judgment in favor of Credit Suisse on Pharos’s fraud and negligent misrepresentation claims. The court also granted summary judgment on Pharos’s Ohio Securities Act claims because Pharos failed to identify a single statement in the PPM it justifiably relied on as required by the applicable statutes.

The Sixth Circuit Order

On appeal, Pharos attempted to circumvent the Letter Agreement with respect to its fraud and negligent misrepresentation claims by asserting that Credit Suisse “had knowledge of material information about National Century’s fraud that outside investors — like Pharos — could not discover.” Pharos Capital Partners L.P., No. 12-4381, slip op. at 3. Counsel for Pharos persisted at oral argument on October 2, 2013, but the Panel ultimately held, “[e]ven assuming that this scenario could make Pharos’s reliance justifiable, Pharos has not demonstrated that any material information was truly unavailable to a sophisticated investor like Pharos.”5 The Court of Appeals concluded, “the district court correctly held that Pharos could not justifiably rely on any statement by Credit Suisse because Pharos was a sophisticated investor, had substantial adverse information about National Century, and, most critically, signed an agreement disclaiming reliance on any statement by Credit Suisse.”6

The Court of Appeals also affirmed the district court’s ruling with respect to Pharos’s Ohio Securities Act claims. Specifically, the Sixth Circuit held that “[t]he district court thoroughly reviewed the record for evidence that Pharos reasonably relied on material misstatements appearing in the PPM, finding nothing more than a handful of vague assertions of reliance on the PPM. Indeed, the court granted Pharos more review than its proffer required.”7 The Sixth Circuit, therefore, held “[w]e discern no error with [the district court’s] judgment that Pharos failed to present evidence demonstrating justifiable reliance.”8

The Sixth Circuit’s affirmance provides additional support for the proposition that financially sophisticated parties must be held to the allocation of risk they negotiated in “big boy” agreements or otherwise. The ruling also helpfully rejects a plaintiff’s attempt to create a triable issue of material fact based on generic and vague assertions of misstatements.

This Alert was written by Steven Brody and Colleen O’Loughlin of Bingham, along with Zoe Feinberg, formerly of Bingham, all of whom were on the team representing Credit Suisse in this matter.

1 Id. at *8.

2 Id. at *4-5.

3 Id. at *9.

4 Id. at *10.

5 Id. at *3-4.

6 Id. at 3 (emphasis supplied).

7 Id. at 2.

8 Id. at 3.

This article was originally published by Bingham McCutchen LLP.