First Department Addresses Duplication of a Fraud Claim with a Breach of Contract Claim and the Justifiable Reliance Element of a Fraud Cause of Action

• Posted on: Jul 10 2019

On July 9, 2019, the Appellate Division, First Department, issued three decisions involving claims of fraud and/or fraudulent inducement that piqued this Blog’s interest.  One case involved whether a fraudulent inducement claim duplicated a contract claim (Man Advisors, Inc. v. Selkoe, 2019 N.Y. Slip Op. 05483 (1st Dept. July 9, 2019) (here), while the other two involved the justifiable reliance element of a fraud cause of action (Mann v. Thomas-Senior, 2019 N.Y. Slip Op. 05496 (1st Dept. July 9, 2019) (here), and OmniVere, LLC v. Friedman, 2019 N.Y. Slip Op. 05494 (1st Dept. July 9, 2019) (here)). We look at each case below.

Man Advisors, Inc. v. Selkoe

In Man Advisors, the Court unanimously reversed the dismissal of a fraudulent inducement claim, holding that the plaintiff “state[d] a claim for fraudulent inducement, which is not duplicative of [its] claim for breach of the guarantee.” Slip Op. at *1.

Plaintiff entered into a $2,040,00 million secured promissory note agreement with Karmaloop, Inc. (“Karmaloop”), that defendants Gregory Selkoe (“Gregory”) and Dina Selkoe (collectively, “Selkoe”) guaranteed. After Karmaloop was unable to meet its obligations under the note and declared bankruptcy (13 months after the initial deal), plaintiff sued defendants for breach of contract, claiming that they were personally responsible for the balance remaining on the note ($1,615,000) plus fees and interest. Plaintiff also sued Gregory for fraudulently inducing it to enter the note by making false statements about Karmaloop’s past defaults, its financial condition, and Gregory’s own history of personal guarantees. Plaintiff sought an additional $1,615,000.00 against Gregory pursuant to that claim.

The motion court held that the fraudulent inducement claim duplicated the contract claim.

In order 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.” GoSmile, Inc. v. Levine, 81 A.D.3d 77, 81 (1st Dept. 2010), lv. dismissed, 17 N.Y.3d 782 (2011). In the context of a case alleging both contract and tort claims, the pleadings must allege misrepresentations of present fact, not merely misrepresentations of future intent to perform under the contract, in order to present a viable claim that is not duplicative of a breach of contract claim. Id. Moreover, the misrepresentations of present fact must be “collateral to the contract and [must have] induced the allegedly defrauded party to enter into the contract.” Orix Credit Alliance v. Hable Co., 256 A.D.2d 114, 115 (1st Dept. 1998). Therefore, “[a]s a general rule, to recover damages for tort in a contract matter, it is necessary that the plaintiff plead and prove a breach of duty distinct from, or in addition to, the breach of contract.” Non-Linear Trading Co. v. Braddis Assoc., 243 A.D.2d 107, 118 (1st Dept. 1998) (internal quotation marks omitted).

Against the foregoing, the motion court held that “the alleged fraudulent statements made by Mr. Selkoe [were] substantially related to the contract and [arose] under the same facts as the breach of contract.” In so holding, the court found that plaintiff had “failed to establish a duty that [was] distinct from, or in addition to, the defendant’s contractual obligations.” Therefore,” held the motion court, “the fraud cause of action [was] duplicative of the breach of contract action.”

Plaintiff appealed.

As noted, the First Department unanimously reversed. The Court held that plaintiff adequately stated a claim for fraudulent inducement because Gregory made two representations that were false: Gregory “had previously given only one other personal guarantee, and that Karmaloop had never defaulted on any loan payment.” Slip Op. at *1. The Court noted that, in fact (as alleged), “[Gregory] had previously guaranteed a loan issued to another Karmaloop executive, and Karmaloop had defaulted on that loan.” Id.

The Court also held that these allegations did not duplicate the guarantee claim, finding that “Plaintiff [did] not allege that [Gregory] misrepresented the intent to perform on the guarantee and underlying promissory note, which would render the fraud claim duplicative, but rather allege[d] that [Gregory] misrepresented his and Karmaloop’s ability to perform.” Id.

Notably, the Court departed from its customary rulings with regard to alleged duplication, holding that it was premature to make that determination at such an early stage of the proceedings: “At this early juncture, we find that plaintiff should be ‘permitted to plead in the alternative (see CPLR 3014),’ and its claim ‘for fraud, should not be dismissed as duplicative of the breach-of-contract cause of action.’” Id., quoting Citi Mgt. Group, Ltd. v. Highbridge House Ogden, LLC, 45 A.D.3d 487, 487 (1st Dept. 2007).

Mann v. Thomas-Senior

In Mann, the First Department addressed the reasonable reliance element of a fraud claim, holding that the failure to exercise adequate due diligence in ascertaining the truth of a representation was fatal to plaintiff’s fraud claim.

The justifiable reliance requirement is one of the five elements of a fraud cause of action: (1) a misrepresentation or a material omission of fact; (2) which was false and known to be false by the defendant(s); (3) made for the purpose of inducing another person to rely upon it; (4) justifiable reliance of the other party on the misrepresentation or material omission; and (5) damages. Pasternack v. Laboratory Corp. of Am. Holdings, 27 N.Y.3d 817, 827 (2016) (citation omitted).

Because the determination of whether a plaintiff justifiably relied on a misrepresentation or omission is a factually “nettlesome” one (DDJ Mgt., LLC v. Rhone Group L.L.C., 15 N.Y.3d 147, 155 (2010)), “[n]o two cases are alike ….” Id. For this reason, the courts look to whether the plaintiff exercised “ordinary intelligence” in ascertaining “the truth or the real quality of the subject of the representation.” Curran, Cooney, Penney v. Young & Koomans, 183 A.D.2d 742, 743) (2d Dept. 1992). If the plaintiff fails to make use of the means available to discover the truth, his/her claim will be dismissed. ACA Fin. Guar. Corp. v. Goldman, Sachs & Co., 25 N.Y.3d 1043, 1044 (2015).

Mann arose from plaintiffs’ purchase of a luxury condominium apartment in the Schaefer Landing North Condominium complex (the “Complex”) during the spring 2017. The Complex is located at the eastern edge of the East River in Williamsburg. The unit is located in a Northwest corner of the Complex, with windows facing west to Manhattan, as well as windows facing north to the Williamsburg Bridge and a new building that was under construction at the time of purchase. Plaintiffs purchased the unit for $1,900,000.

According to plaintiffs, defendants falsely represented the extent to which the building under construction would obstruct the views from the north side of the building.

Defendants moved to dismiss, claiming, inter alia, that plaintiffs could not demonstrate that they justifiably relied on any alleged misrepresentation. Among other things, defendants contended that plaintiffs explicitly acknowledged in the contract of sale that they did not rely on any representations, and that defendants did not make any representations, other than those specifically identified in the contract documents. Defendants also argued that plaintiffs saw and were aware of the pending construction project to the north of the Complex during their visit(s) to the building and were not precluded from investigating, and did not investigate, the construction plans and the height of the anticipated building. In this regard, defendants noted that there were various publicly available documents from real estate publications and government offices that described the project and contained various depictions of it.

The motion court agreed with defendants and dismissed the complaint. Plaintiffs appealed.

The First Department “unanimously affirmed,” holding that plaintiffs failed to demonstrate that they justifiably relied on “defendants’ representations concerning the view from the apartment that they were purchasing.” Slip Op. at *1 (citation omitted).  In fact, noted the Court, “[t]he complaint [was] devoid of any allegations that plaintiffs exercised adequate due diligence in ascertaining the extent to which the adjacent building would impact the view.” Id., citing Jee Foo Realty Corp. v. Lemle, 259 A.D.2d 401, 402 (1st Dept. 1999).

OmniVere, LLC v. Friedman

In OmniVere, the First Department unanimously affirmed the dismissal of fraud claims in a counterclaim and third-party complaint because, inter alia, plaintiff failed to satisfy the justifiable reliance element of the cause of action.

In February 2014, Intelligent Discovery Management, LLC (“IDM”) and Balint Brown & Basri, LLC (“B3” and with IDM, “IDMB”) and OmniVere LLC, OmniVere Holding Company LLC and Eric S. Post (“Post”) (collectively, “Omnivere”) commenced negotiations in which OmniVere would acquire IDMB. After weeks of due diligence and negotiations, the parties reached an agreement on the terms of a deal, which they memorialized in an Asset Purchase Agreement (“APA”).

Under their agreement, OmniVere, LLC would acquire substantially all IDMB’s assets for $9.9 million in cash and $2 million in preferred equity in OmniVere Holding, LLC in the form of 1,153,846 Class B Units (“Units”) pursuant to a simultaneously executed Operating Agreement of OmniVere Holding, LLC.

IDMB alleged that Post told IDMB that Omnivere expected to have a combined $40 million in annual sales and earnings of at least $10 million a year by closing. IDMB claimed that this was a misrepresentation because actual annual sales at the time of closing were only projected to be $33 million. IDMB also alleged that OmniVere falsely claimed to have a $10 million war chest to make additional acquisitions and had secured a $3 million revolving line of credit.

OmniVere moved to dismiss, claiming, among other things, that IDMB failed to plead that it justifiably relied on the alleged misrepresentations. The motion court agreed, stating that IDMB made no effort to determine whether the information claimed to be false was, in fact, false: “IDMB, however, does not explain how these projections were calculated or where the numbers came from, other than in informal emails” and “admitted [at oral argument] that it conducted no projections of its own.” The court explained that “IDMB [did] not demonstrate how its reliance on any representation could be reasonable when it could have obtained background information about the anticipated state of Omnivere on its own through legal and financial advisors” but failed to do so.

The First Department agreed with the motion court, holding that “IDMB failed to sufficiently allege justifiable reliance on the alleged misrepresentations regarding Omnivere’s financial projections and financing since IDMB had the means to discover the true nature of the transaction by the exercise of ordinary diligence but failed to make use of those means.” Slip Op. at *1, citing Ventus Grp. LLC v. Finnerty, 68 A.D.3d 638, 639 (1st Dept. 2009).

Takeaway

As readers of this Blog know, courts will not permit a fraudulent inducement claim to survive a motion to dismiss when the claim arises from a breach of contract. In fact, courts routinely dismiss a fraudulent inducement claim where “[t]he existence of a valid and enforceable written contract govern[s] a particular subject matter” and the recovery sought arises out of the same facts and circumstances. Clark-Fitzpatrick v. Long Is., 70 N.Y.2d 382 (1987). However, where “a legal duty independent of the contract itself has been violated[,]” a fraudulent inducement claim can stand side-by-side with “a simple breach of contract” claim.  Dormitory Auth. v. Samson Constr. Co., 30 N.Y.3d 704 (2018) (citation omitted).

What constitutes “a legal duty independent of a contract” is not a question easily answered.  Cronos Grp. Ltd. v. XComIP, LLC, 156 A.D.3d 54, 56 (1st Dept. 2017) (referring to the question as a “recurring” one). In trying to answer the question, the courts make the distinction between a misrepresentation of intention and a misrepresentation of present fact. The former will result in dismissal, while the latter will not. Gosmile, supra.

In Gosmile, the First Department explained: “that a misrepresentation of present fact, unlike a misrepresentation of future intent to perform under the contract, is collateral to the contract, even though it may have induced the plaintiff to sign it, and therefore involves a separate breach of duty.” 81 A.D.3d at 81 (citations omitted). Thus, a fraud claim that is premised on a misrepresentation of a prior or existing fact will not be dismissed “as an insincere promise of future performance” and, therefore, as duplicative of a breach of contract claim. First Bank v. Motor Car Funding, Inc., 257 A.D.2d 287, 292 (1st Dept. 1999) (citations omitted).

Man Advisors reiterates the foregoing principles. It is notable, however, because the First Department (albeit in dicta) permitted plaintiff to plead its fraud claim in the alternative (Slip Op. at *1 (citing CPLR § 3014)), an approach that some trial court level judges employ.

Readers of this Blog also know that courts will not sustain a fraud claim in which the plaintiff fails to avail himself/herself/itself of the means to discover the truth or falsity of representations and omissions made by the alleged wrongdoer. Although the determination of whether reliance is justified is a fact sensitive one, the courts are clear that failing to conduct any investigation into the veracity of a representation or omission when the aggrieved party has the ability to do so, or ignoring facts that are in plain sight (i.e., facts that are publicly available), are reasons to dismiss a fraud claim. Mann and OmniVere are the most recent examples coming out of the First Department to underscore these principles.