Sweetheart Lease of Chocolate Factory is Void, but Integration Clause Still Precludes Oral Agreement

Alphonse Hotel Corp. v. Tran, No. 14 Civ. 3447 (2d Cir. July 11, 2016) (Hall, J.):

Alphonse Hotel Corporation is a New York corporation that owns various assets including the former Franklin Chocolate Factory, a rundown property in Philadelphia.  Eighty percent of the company was owned by Truong Dinh Tran.  The other twenty percent was owned by four women, all mothers of Truong's children.  Truong served as president of the closely held corporation until the autumn of 2010 when one of his sons became president.

In 2012, Truong died without a will and a New York court appointed a temporary administrator of the estate.  The administrator took control of Truong’s share of the company and assumed the roles of president and the company's only director. The company then filed an action in state court against Truong's eldest son, Nam T. Tran, who removed the case to federal court based on diversity of citizenship.  

The underlying facts of the complaint against Nam are that five years before his death, in 2007, the company (through Truong) allegedly entered into a Joint Venture Agreement with Nam to develop the property.  The company also agreed to a lease of the property for twenty years in exchange for twenty dollars.   The company (through the administrator) sought damages for Nam’s use and occupancy of the property and a judgment declaring that the lease and Joint Venture Agreement were void. 

The District Court granted summary judgment in favor of the company.  In affirming, the Second Circuit made several straightforward holdings.  

First, the District Court did not abuse its discretion in denying Nam’s request for additional discovery prior to summary judgment because nothing in the affidavit submitted by Nam under Fed. R. Civ. P. 56(d) was relevant to the issues on summary judgment.  For example, Nam requested documents about the temporary administrator's investigation, various drawings of the property, and documents concerning the value the property and its condition, but these documents would not make a difference in determining if the agreements were void.

Second, while the actions of corporate directors such as Truong are usually protected by the business judgment rule, and thus “subject to judicial review only upon a showing of fraud or bad faith,” Stern v. Gen. Elec. Co., 924 F.2d 472, 476 (2d Cir.  1991) (applying New York law), this rule does not apply where a corporate director has an interest in the decision.  As Nam conceded, Truong ran the company for the benefit of his family and frequently used corporate assets to help family members. Since Nam conceded that the lease was  similar to other transactions that Truong executed to give financial security to his family and to provide for his children, the lease lacked a legitimate business purpose or was tainted by a conflict of interest. Since the business judgment rule did not apply, Nam had to show that the lease was objectively fair and served the best interests of the corporation and its shareholders. 

Third, the lease of the property for twenty years in return for twenty dollars was not a fair or reasonable business decision.  Under New York law, a gift or waste of corporate assets are void acts and cannot be ratified by a majority of stockholders.  "The essence of a claim of gift is lack of consideration and the essence of waste is the diversion of corporate assets for improper or unnecessary purposes.”   Aronoff v. Albanese, 446 N.Y.S.2d 368, 370 17 (2d Dept. 1982).

Nam argued he had also put in the “sweat equity” to develop the property under the Joint Venture Agreement, but this did not constitute consideration for the lease since it was contributed prior to the execution of the lease and could only count as consideration if the lease explicitly expressed that intention.

Fourth, the Joint Venture Agreement was unenforceable under Pennsylvania law by operation of the parol evidence rule because the fully integrated lease discharged any prior‐in‐time oral agreement relative to the property. Nam argued that if the Lease is void as a gift or for lack of consideration, then the lease's terms cannot bar evidence of the Joint Venture Agreement because a void contract has no preclusive effect.

The Restatement (Second) of Contracts (1981) supported the opposite conclusion -- that is, an integration clause in a contract that is void for lack of consideration may still preclude evidence of prior agreements within the scope of the contract's integration clause.  "An integrated agreement that is not binding or that is voidable and avoided does not discharge a prior agreement. But an integrated agreement, even though not binding, may be effective to render inoperative a term which would have been part of the agreement if it had not been integrated."  Id. § 213(3). The Second Circuit also noted that one of the Restatement’s illustrations was analogous to the contract at issue in that case.  See id. cmt. d, illus. 6.

Pennsylvania courts, however, had not adopted this provision of the Restatement and the issue would be one of first impression the state. The Second Circuit decided not to exercise its discretion to certify the question to the Pennsylvania Supreme Court.  Based on its analyses of other courts that have certified questions  and on its reading of Pennsylvania’s codified standards, the Second Circuit concluded that the Pennsylvania Supreme Court had a stringent standard for accepting certification petitions.  For instances, 210 Pa. Code § 3341(c) states:  “The Supreme Court may accept certification . . . only where there are special and important reasons therefor. . . ."  

The Second Circuit decided not to certify the question as it might never arise again in Pennsylvania courts, and if it did it would be rare.  Moreover, the Second Circuit  predicted that the Pennsylvania Supreme Court would have reached the same result if presented with the parol evidence issue.  Finally, the Second Circuit explained that its conclusion was bolstered by the fact that the Pennsylvania Supreme Court generally adopts the principles of the Restatement of Contracts.  

Second Circuit's decision here:  http://cases.justia.com/federal/appellate-courts/ca2/14-3447/14-3447-2016-07-11.pdf?ts=1468247407