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Disclaimers and Justifiable Reliance – What a Pair!

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  • Posted on: Dec 6 2021

By Jeffrey M. Haber

As readers of this Blog know, to recover damages for fraud, a plaintiff must allege “a misrepresentation or a material omission of fact which was false and known to be false by defendant, made for the purpose of inducing the other party to rely upon it, justifiable reliance of the other party on the misrepresentation or material omission, and injury.”1 When a plaintiff contends that he or she was fraudulently induced to take some action, such as enter into a contract, the plaintiff must allege “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.”2 

The element that most often spells failure for a plaintiff is reasonable reliance – that is, reliance on the alleged misrepresentation or omission. The cases are brimming with dismissals on this ground.

In prior articles, we have discussed the impact a disclaimer clause in a contract can have on a fraud claim. Seee,g.here. As we have noted, disclaimer clauses often are worded as “no reliance” clauses. In a such a clause, the parties represent that they are not relying on any extra-contractual representations.

Today, we examine Kim v. XP Securities, LLC, a case in which the foregoing principles were present.

Kim v. XP Securities, LLC

[Ed. Note: the background facts have been taken from the motion court’s decision and the briefs submitted by the parties in connection with the subject motion to dismiss.]

Kim involved an employment dispute. Plaintiff is a finance professional and veteran of the foreign exchange industry (“Forex”). Prior to joining defendant, plaintiff led the Asia Forex desk for the Americas at a global financial firm. There, he conceived of a tool, called the “Magic Box”, to facilitate Forex trading.

While considering an offer to join another firm, plaintiff alleged that he was fraudulently induced to turn down that offer and instead work for defendant based on representations about the state of defendant’s technology that was necessary to develop plaintiff’s trading platform. 

According to plaintiff, based upon the false representations, the parties executed an employment agreement (the “Agreement”). Among other provisions, the Agreement contained a merger provision, stating generally that the agreement superseded all prior agreements, as well as a “no representations” clause, stating: “[Plaintiff] has not executed this Agreement in reliance upon any promise, representation, statement or warranty whatsoever, express or implied, which is not expressly contained in this Agreement.”

Defendant moved to dismiss. The motion court granted the motion as to the fraudulent inducement claim.

First, the motion court held that the “no representations” clause mandated dismissal of the fraudulent inducement claim: plaintiff’s “disclaimer of reliance on pre-contractual representations … precludes his fraud claim (see WT Holdings Inc. v. Argonaut Group, Inc., 127 AD3d 544 [1st Dept 2015]).” 

[Ed. Note: In New York, a party’s disclaimer of reliance cannot preclude a fraudulent inducement claim unless: (1) the disclaimer is specific to the fact alleged to be misrepresented or omitted; and (2) the alleged misrepresentation or omission does not concern facts peculiarly within the knowledge of the non-moving party.3 “Accordingly, only where a written contract contains a specific disclaimer of responsibility for extraneous representations, that is, a provision that the parties are not bound by or relying upon representations or omissions as to the specific matter, is a plaintiff precluded from later claiming fraud on the ground of a prior misrepresentation as to the specific matter.”4

Second, the motion court held that plaintiff failed to satisfy the justifiable reliance element of the claim. The motion court noted that plaintiff “did not attempt to verify any of the general claims made about the status of the platform.” “For instance,” said the court, “when he visited Sao Paulo, plaintiff could have stayed for another day or two to conduct due diligence rather than simply accepting the explanation that XPI’s employees were busy at the convention.” “Had plaintiff pressed for more details and insisted on actually verifying the state of the technology before entering into the Agreement, he could have discovered its true status,” said the motion court. As a sophisticated party, his “lack of due diligence render[ed] his reliance unjustifiable as a matter of law,” concluded the motion court.

[Ed. Note: New York courts have found that “[w]here a party has means available to him for discovering, ‘by the exercise of ordinary intelligence,’ the true nature of a transaction he is about to enter into, ‘he must make use of those means, or he will not be heard to complain that he was induced to enter into the transaction by misrepresentations.”’5 “Where, however, 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.”6 “In a fraud action, whether a party could have ascertained the facts with reasonable diligence so as to negate justifiable reliance is a factual question.”7 

Sophisticated parties “must show they used due diligence and took affirmative steps to protect themselves from misrepresentations by employing what means of verification were available at the time.”8 A sophisticated party satisfies this requirement by obtaining a prophylactic provision in a contract or other writing or exercising due diligence to make an additional inquiry into the representation.9 

Whether a plaintiff justifiably relied on a misrepresentation or omission is “always nettlesome” because it requires a fact-intensive analysis.10 As the Court of Appeals observed, “[n]o two cases are alike ….”11]

On appeal, the Appellate Division, First Department affirmed. Kim v. XP Sec., LLC, 2021 N.Y. Slip Op. 06764 (1st Dept. Dec. 2, 2021) (here).  

The Court agreed with the motion court that the disclaimer (or “no representations” clause) precluded recovery for fraudulent inducement: 

Plaintiff’s employment agreement contained a merger provision stating generally that the agreement superseded all prior agreements, as well as a “no representations” clause stating specifically, “[Plaintiff] has not executed this Agreement in reliance upon any promise, representation, statement or warranty whatsoever, express or implied, which is not expressly contained in this Agreement.” In light of these provisions, the motion court properly dismissed the fraudulent inducement claim ….”12

The Court also agreed with the motion court that plaintiff failed to plead justifiable reliance: “plaintiff’s pleadings do not demonstrate that he exercised ordinary diligence in investigating defendant’s representations, despite their alleged importance to the employment agreement.”13

Takeaway

A plaintiff suing for fraud (and particularly a sophisticated plaintiff, such as the plaintiff in Kim) must establish that it “has taken reasonable steps to protect itself against deception.”14 Typically, this means that a plaintiff claiming to have been fraudulently induced to purchase a business, or to lend to a business, must allege that, before entering into the transaction, it availed itself of the opportunity to verify the seller’s or borrower’s representations through an examination of the entity’s books and records. As shown in Kim, plaintiff failed to do so.

Kim also shows the power of the disclaimer clause. A contractual disclaimer that is clear and directly addresses the subject of the alleged misrepresentation, will preclude a fraudulent inducement claim. 


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 Genger v. Genger, 152 A.D.3d 444, 445 (1st Dept. 2017).
  2. GoSmile, Inc. v. Levine, 81 A.D.3d 77, 81 (1st Dept. 2010).
  3. Basis Yield Alpha Fund [Master] v. Goldman Sachs Group, Inc., 115 A.D.3d 128, 137 (1st Dept. 2014). See also Danann Realty Corp. v. Harris, 5 N.Y.2d 317, 323 (1959); MBIA Ins. Corp. v. Merrill Lynch, 81 A.D.3d 419 (1st Dept. 2011).
  4. Basis Yield, 115 A.D.3d at 137.
  5. 88 Blue Corp. v. Reiss Plaza Assoc., 183 A.D.2d 662, 664 (1st Dept. 1992) (internal citations omitted).
  6. DDJ Mgt., LLC v. Rhone Group L.L.C., 15 N.Y.3d 147, 154 (2010).
  7. Country World, Inc. v. Imperial Frozen Foods Co., 186 A.D.2d 781, 782 (2d Dept. 1992).
  8. VisionChina Media, Inc. v. Shareholder Representative Servs., LLC, 109 A.D.3d 49, 57 (1st Dept. 2013) (citation omitted).
  9. ACA Fin. Guar. Corp. v. Goldman, Sachs & Co., 25 N.Y.3d 1043, 1045 (2015); DDJ, 15 N.Y.3d at 154 (holding that in contract negotiations between sophisticated parties, justifiable reliance element sufficiently alleged where plaintiff “has gone to the trouble” of insisting on warranties in the written agreement that certain facts were true).
  10. DDJ, 15 N.Y.3d at 155 (internal quotation marks omitted).
  11. Id.
  12. Slip Op. at *1.
  13. Id.
  14. DDJ, 15 N.Y.3d at 154.
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