While the sale of a business is a common occurrence, courts are often looked upon to interpret the terms of the relevant sale documents associated with the transaction when either the buyer or seller is alleged to have breached certain obligations post-closing.

This was the case in a recent decision in the Suffolk County Commercial Division in Huntington Village Dental, P.C. v. Rathbauer, et a. (J. Whelan).

In Rathbauer, plaintiff Huntington Village Dental, P.C. (“HVDPC”) purchased a dental practice from John F. Rathbauer, DMD, LLC (“Rathbauer LLC”), evidenced by an Agreement of Sale, Promissory Note, and Bill of Sale, all dated June 14, 2010.  HVDPC also executed a lease for the first floor of a building owned by another defendant, John F. Rathbauer, DMD, P.C. (“Rathbauer P.C.”).  Of particular significance, the Promissory Note provided that, in the event of a default in payment by HVDPC under the Note, Rathbauer LLC could send a notice of default requiring payment of the balance within 90 days.  Additionally, if the default was not cured within the 90 days, ownership of the dental practice and assets would revert to Rathbauer LLC.

As part of the sale documents, Rathbauer himself remained employed by the dental practice for one year following the sale.  However, shortly after the closing, HVDPC claimed that the defendants breached their obligations under the terms of the sale documents due to “failure to turn over full and complete patient lists, clinical quality copies of x-rays and practice management documents as data which plaintiff purchased from Rathbauer LLC.”  Despite these claims, HVDPC apparently continued performing under the Promissory Note until July 2012, approximately two years after the closing and one year after Rathbauer completed his employment.  Beginning in July 2012, HVDPC refused to pay it obligations under the Promissory Note going forward, essentially based upon the same alleged breaches it claimed back in 2010.

In the Complaint, HVDPC sought rescission of the Promissory Note and the other sale documents on the grounds that the defendants materially breached their obligations and fraudulently induced plaintiff to enter the sale.  HVDPC also sought money damages for alleged tortious interference due to the defendants’ alleged interference between HVDPC and HVDPC’s patients.  Plaintiff further sought a declaratory judgment finding that HVDPC was free from any further obligations under the sale documents and that the provision in the Promissory Note permitting Rathbauer LLC to “take back” ownership of the dental practice and its assets to be deemed null and void.

Defendants then asserted two of their own counterclaims – the first seeking declaratory relief that the “take back” provision in the Promissory Note is valid and enforceable, and the second for money damages due to HVDPC’s failure to pay amounts due under the Promissory Note.

Both parties ultimately moved for summary judgment.  With respect to HVDPC’s claim for rescission of the sale documents due to the alleged “material breaches” by the defendants, the Court noted that rescission of a contract is permitted when a breach “substantially defeats [the] purpose of the contract” when such breach is “material and willful, or, if not willful, so substantial and fundamental as to strongly tend to defeat the object of the parties in making the contract.”  Wiljeff, LLC v. United Realty Management Corp., 82 A.D.3d 1616 (4th Dep’t 2011)(quoting Lenel Sys. Intl., Inc. v. Smith, 34 A.D.3d 1284 (4th Dep’t 2006)).

Based upon the record before it, the Court denied summary judgment and dismissed HVDPC’s claim for rescission, holding that HVDPC failed to satisfy its burden of proof.  Particularly, the Court noted that the breaches alleged by HVDPC were slight, casual and/or technical breaches, with nothing in the record pointing to a material, substantial breach by the defendants.  Furthermore, the parties operated under the agreement for two years after the closing; thus, rescission was not a remedy available to HVDPC at that point.   Given that the Court found no evidence of material breaches by the defendants, the Court also denied summary judgment and dismissed HVDPC’s declaratory judgment claim.

With respect to HVDPC’s fraudulent inducement claim, the Court held that the alleged representations by defendants were not actionable because the representations were promissory and futuristic in nature and HVDPC could not prove justifiable reliance.  The Court also noted that HVDPC essentially waived its rights for rescission under a fraudulent inducement theory by continuing to operate under the agreement for two years despite allegedly having knowledge of the alleged misrepresentations.

In considering the defendants’ separate summary judgment motion on their counterclaims, the Court granted summary judgment to the defendants for money damages as a result of HVDPC’s failure to pay amounts due under the Promissory Note because HVDPC had no bona fide defense to not paying the amounts due thereunder, given the Court’s finding that the defendants’ alleged breaches were non-material in nature.  However, with respect to the “take back” provision that was available to the defendants in the event HVDPC defaulted under the Promissory Note, the Court refused to enforce the provision, noting that no proof had been shown demonstrating the enforceability of the provision, which was actually handwritten into the Promissory Note at the closing.

This case provides an important illustration of how parties’ actions after the sale of a business is completed will affect how a Court interprets certain provisions of the parties’ agreements when the parties later seek to enforce them.  Particularly for HVDPC, while it thought it had a valid basis to rescind the sale agreements and to stop paying under the Promissory Note due to what it claimed were material breaches by the defendants, the Court ultimately found those breaches to be non-material and that HVDPC’s continued performance under the sale documents for two years post-closing resulted in a waiver of its right to rescission and, as a result, it was plaintiff HVDPC that was in default of the Promissory Note, owing money damages to the defendants.