Opinion
651388/2020
11-04-2020
WALLEYE POWER, LLC, Plaintiff, v. BAY SHORE POWER COMPANY, Defendant.
Attorneys: DLA Piper LLP (US)1251 Avenue of the Americas New York, NY 10020(212) 335-4620Counsel for plaintiff, Walleye Power, LLCPatterson Belknap Webb & Tyler LLP1133 Avenue of the Americas New York, NY 10036andBenesch, Friedlander, Coplan & Aronoff LLP39 Broadway, 25th FloorNew York, NY 10006Counsel for defendant, Bay Shore Power Company
Attorneys: DLA Piper LLP (US)1251 Avenue of the Americas New York, NY 10020(212) 335-4620Counsel for plaintiff, Walleye Power, LLCPatterson Belknap Webb & Tyler LLP1133 Avenue of the Americas New York, NY 10036andBenesch, Friedlander, Coplan & Aronoff LLP39 Broadway, 25th FloorNew York, NY 10006Counsel for defendant, Bay Shore Power Company
The following e-filed documents, listed by NYSCEF document number (Motion 001) 29, 30, 31, 32, 33, 34, 35, 36, 37, 38, 39, 40, 41, 42, 43, 44, 45, 46, 47, 48, 49, 50, 51, 52, 53, 54, 55 were read on this motion to/for DISMISS
Upon the foregoing documents, and for the reasons set forth on the record (11/02/2020), Bay Shore Power Company's (Bay Shore ) motion to dismiss Walleye Power LLC's (Walleye ) (i) willful breach of contract (first) cause of action and (ii) fraudulent inducement (third) cause of action pursuant to CPLR §§ 3211(a)(1), (7) and 3016(b) is denied.
I. THE FACTS RELEVANT TO THE MOTION
Reference is made to a certain Asset Purchase Agreement (the APA ), dated as of March 9, 2018, by and among Bay Shore and its indirect affiliate, FirstEnergy Generation LLC (FEG ), as sellers, and Walleye, as purchaser, pursuant to which Walleye purchased the Bay Shore Cogeneration Plant in Oregon, Ohio (the Generating Facility ) for $38.7 million (NYSCEF Doc. No. 39).
Pursuant to Section 3.22 of the APA, Bay Shore represented and warranted that (a) "[t]he Generating Facility is in good operating condition, subject to normal wear and tear, and has been regularly maintained in accordance with Good Utility Practice," and (b) "[t]he records accurately reflect the operational history of the Generating Facility in all material respects" (id. , § 3.22). Although the APA provides that Bay Shore and FEG's liability was generally limited to a $7.75 million escrow (id. , §§ 1.01, 10.02[a] ), pursuant to Section 10.06, the parties nonetheless agreed to a carve-out from this cap for "fraud or willful or intentional breaches of a material representation, warranty, covenant or agreement" (id. , § 10.06).
II. DISCUSSION
Walleye has sufficiently pled a cause of action for willful breach of contract and for fraudulent inducement at this stage of the pleadings.
Walleye alleges that it performed its obligations under the APA and that Bay Shore breached its obligations by knowingly and intentionally falsely representing and warranting that the Generating Facility was in "good operating condition subject to normal wear and tear" and the plant had been maintained in accordance with Good Utility Practice although it knew these statements to be false (NYSCEF Doc. No. 2, ¶¶ 132-137) because, among other things, certain major components, including the limestone crusher and the CFB Boiler air heater, needed to be replaced due to causes known to Bay Shore but concealed from Walleye. To wit, Walleye alleges that it learned after closing that Bay Shore and its indirect affiliate, FEG "knew well in advance of both the execution of the APA and the Closing that (a) the Plant's most valuable assets would likely fail in the near future, (b) these assets had been poorly maintained in violation of First Energy corporate policy and (c) the Records misrepresented the state of the Plant's operations" (id., ¶ 3). Indeed, Walleye alleges that the APA was executed on March 18, 2018 and that on March 31, 2018 FirstEnergy Solutions, a subsidiary of First Energy Corp., and some of FirstEnergy Solutions' subsidiaries and affiliates, including FEG but not including Bay Shore, filed for Chapter 11 protection in the bankruptcy court for the Northern District of Ohio (id. , ¶¶ 71 72) and that in support of FEG's motion to assume the APA as a condition of the closing, FEG submitted a desktop valuation report prepared by Navigant Consulting which relied on an earlier report prepared by Sargent and Lundy and information provided by FEG management, which Navigant Report expressly assumed that the power plant had been operated and maintained with good utility practice, which Bay Shore knew was false. (id. , ¶ 76). Walleye further alleges that "[r]ather than disclose what it knew during diligence and before the APA was executed or the Closing, Bay Shore made intentional misrepresentations and omitted key facts, to conceal the true condition and value of the Plant" (id., ¶ 4).
More specifically, Walleye alleges that Bay Shore knew that (i) a dissimilar metal weld (DMW ) failure had occurred and more DMW failures were imminent, (ii) water wall tube leaks had occurred as a result of poor water chemistry and "Band-Aid solutions" having been applied rather than addressing the water chemistry issues, (iii) the limestone crusher required early replacement due to vibrations rather than normal wear and tear, (iv) the CFB Boiler air heater required refurbishment as dried hydrated ash had fouled the flue gas side of the tubes due to improper maintenance, and (v) Bay Shore had caused a dangerous generator fault to exist at the facility (id. , ¶ 137). Thus, as a result Bay Shore's willful and intentional breaches of the APA, Walleye alleges that damages should not be limited to the $7.75 million escrow cap (id. , ¶¶ 145-146). Accordingly, Walleye has stated a cause of action for willful breach of contract ( Second Source Funding, LLC v. Yellowstone Capital, LLC , 144 AD3d 445, 445-446 [1st Dept 2016] ) and the motion to dismiss the first cause of action is denied.
Walleye also, and separately, alleges that Bay Shore made multiple affirmative misrepresentations about the conditions of the Generating Facility and the accuracy and completeness of the records provided to Walleye during due diligence to induce Walleye to enter the APA. Among other things, Walleye alleges that Bay Shore falsely induced it to enter the APA by representing that the Generating Facility had been maintained with "Good Utility Practice," despite its knowledge that it had: (i) failed to follow its Failure Analysis Report and fully inspect and repair its DMWs, (ii) failed to ensure proper water chemistry, (iii) "pad-walled" more than 300 water wall tubes in violation of FEG's policies, (iv) caused hydrated ash to foul the air heater tubes, (v) failed to properly install and maintain the electrical field voltage transducer, and (vi) failed to install a proper control room alarm for a generator ground (id. , ¶ 139). In addition, Walleye alleges that Bay Shore knew that the Generating Facility had experienced DMW failures which caused one or more outages, but failed to provide this information in the outage report despite the existence of one or more Generation Availability Data System (GADS ) codes specifically for DMW-related failures (id. , ¶¶ 48-55).
Walleye alleges, by way of example, that the cause of a November 2017 shutdown is improperly listed on the due diligence materials because Bay Shore only employed the GADS code "1040" which is for "First superheater" (NYSCEF Doc. No. 33, at B-FB-9) and had in the description "Tube Leak Superheater" indicating that the cause was unknown when in fact other codes or a more complete description should have been used to identify the cause of the shutdown to be a DMW failure or otherwise put them on inquiry notice that this was a serious issue which Bay Shore knew and deliberately did not disclose as Walleye either would not have purchased the plant or would have offered to pay far less:
54. After Closing, Walleye learned that this reported cause code was untrue, because the November 2017 outage was the DMW outage and Bay Shore knew it...
60. As far as Walleye knew, therefore, the outages on the Outage Spreadsheet were not unusual or consequential, and thus, were outages that Walleye could fully account for in its financial model and in negotiation of a final Purchase Price and an escrow amount.
(id. , ¶¶ 54, 60).
For the avoidance of doubt, to the extent that Bay Shore argues that inasmuch as the complaint when discussing the November 2017 shut down example indicates the cause was "unknown" and that the claim should be dismissed because Exhibit I to the complaint lists the cause as a "1040" failure and describes it as a "Tube Leak Superheater" and was therefore not "unknown," the argument misses the point. Walleye's allegation is that the GADS code used on the due diligence materials is incomplete (i.e., a half-truth) because inasmuch as the description merely listed a "Tube Leak Superheater" that failed, essentially Bay Shore was indicating that the cause of the failure was unknown and that, in any event, when Walleye made inquiries during the due diligence period, Bay Shore knew that the cause of the Tube Leak Superheater failure was a DMW failure and failed to adequately disclose it:
12. For example, Walleye learned that the CFB Boiler had experienced an outage in November 2017 because of the critical failure of one of its 672 "dissimilar metal" welds ("DMWs") on a superheater steam tube. Bay Shore knew the cause of that outage and that further DMW failures would likely occur and did not disclose this to Walleye, despite Walleye's inquiries during due diligence. DMW steam tube failures are known to be serious, expensive to repair and capable of causing extended forced outages
82. Immediately after the Closing, Walleye sent a team of engineers and technical personnel to take possession of the Plant, meet the employees who had come over to Walleye from Bay Shore with the Closing of the APA, and arrange for the integration of computer and other systems as well as to access the Records included as part of the sale. The Walleye team arrived in early August 2018 and remained on site for approximately three months.
83. On or about August 18, 2018, a representative of Walleye met with a Senior Plant Engineer and Senior Maintenance Manager, now Walleye employees, both of whom had long- term responsibility for the CFB Boiler and Unit 1.
84. The Senior Plant Engineer and Senior Maintenance Manager explained that, almost immediately after the November 2017 outage, Bay Shore knew that it had been caused by a DMW failure. They explained the details of the failure and revealed that FirstEnergy's metallurgy lab had concluded, and provided in a formal Failure Analysis Report, that the November 2017 Outage was caused by "guillotine failure at the dissimilar metal weld Inconel to T-91." This Failure Analysis Report was not provided to Walleye before the Closing.
85. The Senior Plant Engineer explained that, immediately after the November 2017 outage, there were a series of conversations about the cause involving the Senior Plant Engineer, the Senior Maintenance Manager, the Plant Manager, a boiler expert from First Energy, representatives of Foster Wheeler (the original manufacturer of the CFB Boiler) and others.
86. They discussed, among other things, how long a dissimilar weld should last, how the additional stress on the weld from sagging, and excess ash and the thermal shock associated with the practice of "online water washing" employed by FEG and Bay Shore contributed to and accelerated the DMW failure and the imminent prospect of additional DMW failures.
87. Walleye was never informed of these finding or these discussions prior to the deal closing on July 31, 2018.
88. On or about August 18, 2018, the Senior Plant Engineer and Senior Maintenance Manager provided to Walleye for the first time, the Failure Analysis Report from FEG and Bay Shore's investigation of the November 2017 DMW outage, dated January 16, 2018. (the "Failure Analysis Report" annexed hereto as Exhibit N).
89. The Failure Analysis Report was required by FirstEnergy policy and is the result of the analysis by FirstEnergy's internal metallurgy lab of a sample of the metal from the DMW failure. It confirms that the cause of the November 2017 Outage was a tube leak in SH III of the CFB Boiler, resulting from a DMW failure, based on testing that the metallurgy lab performed from December 21, 2017 to January 12, 2018. The tube had severed completely, with a precise, guillotine-like cut along the weld line. (Ex. N at 2.)
90. This event marked the first DMW failure and it was a first-of-its kind event for the CFB Boiler and also in the experience of the senior Plant engineer
96. Documents stored on FEG and Bay Shore servers and obtained by Walleye after Closing confirm what the Senior Plant Engineer and the Senior Maintenance manager told Walleye in August 2018. In addition to the Failure Analysis Report, and the "draft" Boiler Tube Failure Report, documents electronically stored at the Plant reflected the Plant engineers' efforts to research and gather information on DMW failure immediately after the November 2017 Outage to try to determine for themselves the cause and the proper response.
97. These communications and documents, in the possession of FEG and Bay Shore, were never provided to Walleye before the Closing .
98. Although Bay Shore already had concluded that the November 2017 Outage was caused by a DMW failure, the only information it provided to Walleye about the cause was the GADS data excel file that falsely stated that the cause of the November 2017 Outage was "unknown." (id. , ¶¶ 12, 82-90, 96-98 [emphasis added] ).
In other words, Walleye alleges that in response to the November 2017 outage caused by the DMW failure, FEG and Bay Shore had a root cause report prepared which root cause report was never disclosed to Walleye prior to closing. The report confirmed a DMW failure "by complete separation" at a weld juncture on testing performed December 21, 2017 through January 5, 2018, and made certain recommendations which Walleye alleges were not disclosed or followed by Bay Shore and that, as such, the plant was not properly maintained in accordance with Good Utility Practice (id. , ¶¶ 82-102).
Stated differently, the gravamen of the complaint is that Bay Shore deliberately misled Walleye as to the cause of the shutdowns by telling only half truths (see Junius Constr. Corp. v. Cohen, 257 NY 393, 400 [1931] ; Orchard Hotel LLC v. D.A.B. Group LLC , 172 AD3d 530, 531 [1st Dept 2019] ) and that in the context of this 18 page shutdown report, and given that this was the first DMW failure, there was nothing to put them on notice of the cause of the shutdown which was known to and deliberately concealed by FEG and Bay Shore. To the extent that Walleye made inquiry, Walleye alleges that Bay Shore indicated that it was unknown (NYSCEF Doc. No. 2, ¶¶12, 98) and that Bay Shore failed to disclose the existence of the Failure Analysis Report (NYSCEF Doc. No. 16) to Walleye (id., ¶ 84). These allegations are sufficiently stated with particularity to satisfy CPLR § 3016(b), and Exhibit I does not utterly refute the claim. Thus, dismissal is not appropriate pursuant to CPLR §§ 3211(a)(1) or (7). No expert affidavit is provided by Bay Shore which would otherwise indicate that the 1040 code was proper under the circumstances or that it should have given Walleye any notice of the severity of the issue. Whether reliance was reasonable based on the codes used, whether the codes themselves are incomplete or incorrect as Walleye alleges, or whether they should have put Walleye on notice of a more serious issue simply cannot be decided at the motion to dismiss stage based upon the record ( ACA Fin. Guar. Corp. v. Goldman, Sachs & Co. , 25 NY3d 1043, 1045 [2015] ).
For clarity, the November 2017 shutdown is not the only basis for the claim grounded in fraudulent inducement to enter the contract based on the material misrepresentation that the plant was in good condition subject to ordinary wear and tear and that the plant had been maintained in accordance with Good Utility Practice. Among other examples provided throughout the 171 paragraph complaint, Walleye alleges that (i) the Plant's most essential asset, the CFP Boiler, had suffered numerous DMW failures and water tube leaks and had not been properly maintained , (ii) that the limestone crusher drum would have to be replaced in 2025 due to ordinary wear and tear, even though it knew since 2014 that the limestone crusher drum needed to be replaced immediately and that this was caused not by ordinary wear and tear but cracks resulting from excessive vibration due to improper installation and that no remedial action had been taken (id. , ¶¶ 111-115), (iii) the CFP Boiler's air filter was clogged with concrete-like ash due to improper offline washing (id. , ¶¶ 116-120), and (iv) the electrical voltage regulator was improperly installed and missing a critical alarm (id. , ¶¶ 121-127).
Walleye further alleges that the information that was concealed by Bay Shore was in Bay Shore's exclusive knowledge and could not have been ascertained by Walleye in the course of reasonable due diligence without shutting down the Generating Facility for an extended period, which Bay Shore did not do because it would have alerted Walleye to the undisclosed problems at the plant and required FEG and Bay Shore to spend additional money (id. , ¶¶ 44, 99, 102, 118, 162).
Accordingly, Walleye has adequately pled material misstatements of fact intended to deceive Walleye to induce them to enter the APA and Walleye's justifiable reliance ( Basis Yield Alpha Fund (Master) v. Goldman Sachs Grp., Inc. , 115 AD3d 128, 135 [1st Dept 2014] ) and these allegations are sufficient to state a cause of action for fraudulent inducement at this stage of the proceedings ( GoSmile, Inc. v. Levine , 81 AD3d 77, 81 [1st Dept 2010] ["To state a claim for fraudulent inducement, there must be a knowing misrepresentation of material present fact, which is intended to deceive another party and induce that party to act on it, resulting in injury"] [citation omitted] ).
Finally, and for the avoidance of doubt, the fraudulent inducement cause of action is not duplicative of the breach of contract cause of action because Walleye alleges a duty separate and distinct from the alleged breach of the APA to provide accurate information and to correct any inaccurate information based on Bay Shore's superior knowledge of the condition of the Generating Facility ( GoSmile, Inc., 81 AD3d at 81 ), and that Bay Shore made material misrepresentations of the present conditions of the Generating Facility to induce Walleye to agree to a higher purchase price and to enter into the APA in the first place ( Cohen v. Koenig , 25 F 3d 1168, 1173 [2d Cir 1994] ). In addition, because the APA limits indemnification claims against Bay Shore to $7.75 million, any damages in excess of that cap that Walleye seeks in connection with the fraudulent inducement claim cannot, as a matter of law, be said to be the same damages as are sought in connection with the breach of contract claim ( Avnet, Inc. v. Deloitte Consulting LLP , — AD3d —, 2019 NY Slip Op 05445 [1st Dept 2020] ). Therefore, at this stage of the pleadings, the motion must be denied.Accordingly, it is
ORDERED that the motion to dismiss is denied; and it is further
ORDERED that the defendant is directed to file an answer to the verified complaint within 20 days of this decision and order; and it is further
ORDERED that the parties are directed to appear for a preliminary conference on December 7, 2020 at 11:30 AM.