Court Finds That Sophisticated Plaintiff Unable to Demonstrate Justifiable Reliance on Alleged Misrepresentation and Omission

• Posted on: May 16 2022

By: Jeffrey M. Haber

As readers of this Blog know, pleading and proving fraud is not easy. The law reporters (not to mention the pages of this Blog) are bursting with cases in which the courts have dismissed fraud actions due to pleading and proof deficiencies. Moskowitz v. Fischer, 2022 N.Y. Slip Op. 50385(U) (Sup. Ct., Suffolk County May 3, 2022) (here), is a recent example of this occurrence.

To plead a viable cause of action for fraud, a plaintiff must allege that the defendant made a misrepresentation or omission of a material existing fact, which was false and known to be false by the defendant when made, for the purpose of inducing the plaintiff’s reliance thereon; that the plaintiff justifiably relied on such misrepresentation or omission; and that the plaintiff was injured thereby.¹ 

One of the more “nettlesome” elements of a fraud claim is justifiable reliance.² Whether a plaintiff justifiably relied on a misrepresentation or omission is a fact-intensive inquiry.³ As the New York Court of Appeals observed, “[n]o two cases are alike ….” For this reason, the courts look to whether the plaintiff had the “means available to him for discovering, ‘by the exercise of ordinary intelligence,’ the true nature of a transaction he is about to enter into” and whether he made “use of those means”.⁴ If the plaintiff does not do so, “he will not be heard to complain that he was induced to enter into the transaction by misrepresentations.”⁵ After all, a plaintiff cannot claim justifiable reliance on a misrepresentation when he or she could have discovered the truth with reasonable diligence.⁶

Whether a plaintiff exercised diligence in ascertaining the truth should not be determined by hindsight. As the Court of Appeals explained, when “a plaintiff has taken reasonable steps to protect itself against deception, it should not be denied recovery merely because hindsight suggests that it might have been possible to detect the fraud when it occurred.”⁷ 

Sophisticated parties have a heightened duty to use the means available to them to verify the truth of the information upon which they rely and to use their sophistication to conduct due diligence.⁸ A sophisticated plaintiff cannot establish justifiable reliance on an alleged misrepresentation if the plaintiff failed to make use of the means of verification that were available to him.⁹ Thus, to sustain a claim of fraud, sophisticated parties must have discharged their own affirmative duty to exercise ordinary intelligence and conduct an independent appraisal of the risks they are assuming.¹⁰

Moskowitz v. Fischer

Moskowitz involved the amendment of a tax return for Quogue Street Development, LLC (“QSD”), a company formed by plaintiff, nonparty Timothy Stevens, and a third party to acquire and develop real property in Quogue, New York. Plaintiff owns a 50% interest in QSD, and Stevens owns a 10% interest in the company. In addition to his capital contribution, plaintiff loaned QSD $1,042,487.11 upon its formation. Stevens personally guaranteed repayment of the loan. QSD defaulted on the loan by failing to pay the principal and interest when they came due in July 2013. The property was sold at auction on or about November 18, 2015, and the loan remains unpaid. 

Following the foregoing events, Stevens and defendant William Fischer amended QSD’s 2014 tax return by converting plaintiff’s loan to equity, thereby eliminating Stevens’ obligation to repay the loan under the guarantee. According to plaintiff, Fischer did not consult with plaintiff before amending the tax return, nor did Fischer send plaintiff a copy of the amended return or an amended K-1 reflecting the change. 

QSD’s 2015 tax returns, which were prepared by Fischer in July 2016, were consistent with the amended 2014 tax return, showing the loan as an equity contribution. Plaintiff contended that he did not discover the change until he received his 2015 K-1 on July 7, 2016. Plaintiff maintained that he immediately telephoned Fischer and asked him, “Why did my equity number increase by over a million?” Fischer allegedly replied, “[It] is exactly the same as last year’s K-1.” Plaintiff alleged that he “took Fischer at his word.”

Defendants prepared and filed QSD’s 2016 tax return in September 2017. The 2016 return was consistent with the 2015 return, showing the loan as an equity contribution. Moreover, because the 2016 return was QSD’s final tax return, plaintiff’s equity was reflected as a loss. Plaintiff included the loss on his personal tax return for 2016, which he filed in September 2017, relying on the 2016 K-1 prepared by defendants. 

In June 2019, QSD retained Grassi & Co. to represent it in connection with an IRS audit of its 2016 tax return. By letter dated August 20, 2019, Grassi & Co. advised plaintiff that the IRS was auditing QSD’s 2016 tax return. The IRS has sought documents related to the amended 2014 tax return that converted plaintiff’s loan to equity. 

Plaintiff filed suit, claiming that defendants wrongfully amended QSD’s 2014 tax return in order to wipe out his loan; the amendment was done without his knowledge or consent; defendants intentionally concealed the amendment from him; and defendants were trying to convince the IRS to ratify the change. Plaintiff asserted causes of action for fraud, accounting malpractice, aiding and abetting a breach of fiduciary duty, and negligent misrepresentation. Defendants moved to dismiss the complaint, inter alia, as untimely and for failure to state a cause of action. The Court granted the motion.

Regarding the fraud cause of action, plaintiff alleged that Fischer knowingly made a material misrepresentation of fact when he told him that his equity in QSD in 2015 was “exactly the same as last year’s” and that Fischer made a material omission of fact at the same time by failing to tell plaintiff that his equity in QSD had been “wrongfully amended” in 2014. Defendants claimed, inter alia, that plaintiff failed to demonstrate that he justifiably relied on the alleged misrepresentation and omission.

The Court held that “plaintiff ha[d] failed to state a cause of action for fraud.”¹¹ The Court found that “plaintiff was on inquiry notice of the alleged fraud when he received his 2015 K-1 on July 7, 2016, and telephoned Fischer, asking him, ‘Why did my equity number increase by over a million?’”¹² The Court noted that “[a]lthough his suspicions were aroused, the plaintiff took Fischer’s reply, which was not false, at face value and made no further inquiry into or attempt to investigate the matter.”¹³ The Court reasoned that “plaintiff [was] a sophisticated businessman who employed his own accountant to prepare his personal tax returns.”¹⁴ As such, plaintiff had the means to verify Fischer’s statement, but took no action.¹⁵ “[U]nder these circumstances,” explained the Court, “plaintiff’s reliance on Fischer’s statement was unreasonable as a matter of law.”¹⁶ 

Finally, because the Court held that plaintiff failed to satisfy the justifiable reliance element of the fraud claim, it also held that the negligent misrepresentation claim should fall for the same reason.¹⁷

Takeaway

A plaintiff suing for fraud (and particularly a sophisticated plaintiff, such as the plaintiff in Moskowitz) must establish that it “has taken reasonable steps to protect itself against deception.”¹⁸ Typically, this means that a plaintiff claiming to have been fraudulently induced to take some type of action must allege that, before entering into the transaction, the plaintiff availed himself or herself of the opportunity to verify the defendant’s representations through some sort of prophylactic action. As shown in Moskowitz, despite having suspicions that something was amiss with the amended tax return, plaintiff failed to inquire further even though he had the means to do so. Such a failure, said the Court, was fatal to plaintiff’s fraud and negligent misrepresentation claims.

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Jeffrey M. Haber is a partner and co-founder of Freiberger Haber LLP.

This article is for informational purposes and is not intended to be and should not be taken as legal advice.

Footnotes

1.  Lama Holding Co. v. Smith Barney, 88 N.Y.2d 413, 421 (1996); see also New York Univ. v. Continental Ins. Co., 87 N.Y.2d 308, 318 (1995).
2.  DDJ Mgt., LLC v. Rhone Group L.L.C., 15 N.Y.3d 147, 155 (2010) (internal quotation marks omitted).
3. Id.
4. 88 Blue Corp. v. Reiss Plaza Assoc., 183 A.D.2d 662, 664 (1st Dept. 1992) (internal citations omitted).
5. Id. (internal quotation marks omitted).
6. KNK Enters. Inc. v Harriman Enters., Inc., 33 A.D.3d 872 (2d Dept. 2006).
7. DDJ Mgt., 15 N.Y.3d at 154.
8. McGuire Children, LLC v. Huntress, 24 Misc. 3d 1202[A], at *12 (Sup. Ct., Erie County), aff’d, 83A.D.3d 1418 (4th Dept. 2011).
9. Id.
10. Id.
11.  Slip Op. at *3.
12. Id.
13. Id.
14. Id.
15. Id.
16. Id.
17. Id. To recover damages for negligent representation, a plaintiff must demonstrate, inter alia, that he or she was justified in relying on the information supplied and, as a consequence, suffered damages. See Goldman v. Strough Real Estate, 2 A.D.3d 677, 678 (2d Dept. 2003).
18. DDJ Mgt., 15 N.Y.3d at 154.