Your initial response to the title question should certainly be ‘No’. In light of a recent case pending in the U.S. Court of Appeals, however, you may want to reevaluate your representations made in contract or settlement negotiations. A bank VP was convicted of fraud based on representations he made in a deal he made with his bank employer, even when the bank acknowledged and waived the obvious conflict of interest. Makes me think any amount of ‘puffing’ in contract or settlement negotiations could turn to a fraud indictment.
Let me set up the facts. Be patient, the complex setup is worth the payoff pitch:
In the U.S. v. Weimert case, Weimert was convicted of wire fraud in a negotiated transaction. Weimert was a bank senior vice president and president of a bank subsidiary, IDI. IDI was a 50% minority owner in CCLP, LLC. The majority owner of CCLP, Burkes, held a right of first refusal on IDI’s shares in CCLP. As the real estate market was crashing in 2008, the bank accepted Troubled Asset Relief Program (TARP) funds from the US government.
In order to gain liquidity and avoid bankruptcy, the bank told Weimert to sell assets to make interest payments. Weimert found a legitimate buyer, Kalka, to make a ‘stalking horse’ offer on the CCLP shares held by IDI. Kalka’s letter of intent included a provision that gave Weimert, personally, a commission on the deal and a buy-in interest of 4 7/8% in CCLP. Weimert took that LOI to Burkes, as he was required to do, and convinced Burkes to match the offer. Burkes matched it (almost, but that’s not an issue in the case).
Weimert then took Burkes’ offer to the bank board of directors. Weimert represented to the board that the buyer would not purchase the asset unless Weimert received the commission and the stake in CCLP. This was factually not true; the buyer made no such requirements to consummate the deal. Weimert’s conflict of interest was acknowledged and signed off by the bank’s attorneys. The bank waived the conflict and approved the sale but was ignorant of Weimert’s misrepresentation about the buyer’s alleged stipulation that he obtain a commission and interest in CCLP.
TARP inspectors investigated the transaction and brought wire fraud claims against Weimert since his negotiations on the deal were communicated across state lines. A jury convicted him on 5 of 6 fraud counts. The jury found that Weimert defrauded the bank by inserting himself in the transaction based on the misrepresentation that the buyer would only buy the CCLP shares if he obtained a commission and interest in it.
Weimert’s case is now on appeal. At oral argument, the judges raised issues of prosecutorial judgment and whether this claim should have ever been brought.
One judge commented: “I’m very troubled by the application of federal wire fraud to statements about parties’ negotiating positions. That is, what terms are important in this deal to whom.” He also noted, “I have not found any case law treating those sorts of representations by anybody under any circumstances as material for purposes of federal fraud statutes.”
Apparently, the judge questioned whether Weimert’s representations about the deal were anything but ‘puffing’ or negotiation tactics. This position appears to make the assumption that the bank could no longer rely on Weimert’s impartiality when it waived the known conflict that Weimert was now personally interested in the deal and whether the reason for his personal interest was because the buyer required it or because he wanted a slice of the pie does not give rise to a claim under the wire fraud statutes.
He’s bluffing, sure. This happens in deals. These are capitalist acts among consenting adults.
The same judge then questioned the prosecutor about his concern that this was just negotiation rhetoric and not fraud. The prosecutor countered with an argument that there was a conflict of interest. The judge responded that “[Weimert] has disclosed the conflict of interest. It is out there for everybody to see. The board brings in its lawyer and says, in essence, eyes wide open. We need to do this deal.” The judge clarified: “Let me be very frank about what concerns me about this … it seems to me that … this case comes very close to making negotiations subject to federal criminal prosecutions at the discretion of the U.S. attorney and the grand jury.”
The judge drilled down on what makes this case fraud when other deal negotiations are dismissed as puffing and rhetoric. The prosecutor responded that this case is different because Weimert “induce[d] [the board] to waive the conflict of interest by misrepresentation” and “inserted [him]self in the deal” by representing to the board that Burkes required it. The judge’s response: “He’s bluffing, sure. This happens in deals. These are capitalist acts among consenting adults” and commented that “[t]his case seems to me to break very new ground.”
If you are really interested, you can search the Seventh Circuit’s oral arguments here.
Negotiating is an art. Parties constantly make representations based on their position and outcome goals. There are fine lines between ‘puffing’ and fraud. Weimert crossed over. Let me see if I can help clarify some of the gray areas.
In negotiations, you will find yourself in differing situations. For example, Weimert was in a position of trust as an employee and senior vice president. Even though his personal interest was disclosed to his employer, the bank, he was not free to lie about the essential facts underlying the transaction. He was still the only person reporting or presenting the deal to the board. Certainly there is still some ‘shame on you’ to be shared with the board. Under the circumstances, if the board had any concerns, it should have assigned another employee to oversee the transaction since Weimert was clearly conflicted.
You need to examine your position in the deal. Do you owe any duty to the other side in the deal? Are you related by blood, employment, or contract? Is the other party relying on your opinion, investigation, or valuation that is not otherwise disclaimed in the written agreement? Are you in a position of trust in relation to the other party? Do you exert control over the other party?
Likewise, the amount of scrutiny a deal will receive is a function of the amount at stake and the parties involved. The bigger the numbers, the more scrutiny, usually. If government funds are involved, such as the TARP funds involved in Weimert, you can expect a certain amount of additional oversight. The IRS also likes to look at big deals to make sure they get their cut. If you are crafting a deal to avoid taxes and your express negotiations are key to entitlement to a preferred tax treatment, be careful. Likewise for family transactions. You may find a sweet deal from your elderly uncle but you have to know that your cousins and siblings are going to look at it very closely and blame you if it goes south or you took advantage. Also, with elderly people, you need to make sure that competency is not an issue. Appearance of fraud is sometimes as powerful as actual fraud. Think about how it would look in front of a jury. Put it in writing and disclose anything you think might make a difference to someone in an armchair quarterback role a year from now.
Another note: you should not rely on your attorney to sanitize your misrepresentations. Attorneys are your agent and you are bound by what they say or agree to on your behalf. Also, take a look at the lawyer rules about representations:
Rule 4.1 of the Utah Rules of Professional Conduct provides:
In the course of representing a client a lawyer shall
(a) Make a false statement of material fact or
law to a third person; or
(b) Fail to disclose a material fact, when disclosure
is necessary to avoid assisting a criminal or
fraudulent act by a client, unless disclosure is
prohibited by Rule 1.6.
The comments to this rule help clarify some of the question about representations in negotiations:
Whether a particular statement should be regarded as one of fact can depend on the circumstances. Under generally accepted conventions in negotiation, certain types of statements ordinarily are not taken as statements of material fact. Estimates of price or value placed on the subject of a transaction and a party’s intentions as to an acceptable settlement of a claim are ordinarily in this category…
(Emphasis added). My partner, Keith Call, recently addressed the subject in the Utah Bar Journal article “Is it Ethical to Be Dishonest in Negotiations?” (see page 40). His article is addressed specifically to lawyers but you may find it interesting.
There are issues and nuances for negotiations that certainly cannot all be addressed here. If you have questions, you should get specific legal advice. If you would like more information about negotiations or how to stay out of trouble, contact me, Utah attorney Ken Reich directly. I have represented both companies and individuals in numerous business matters and disputes since 1999. Using my many years of experience and backed by a firm of legal specialists in nearly every legal field, I can help you evaluate your situation and help you make smart decisions about your business and your life that will best fit your circumstances.