First Department Affirms Dismissal of Fraudulent Inducement Claims Due to Disclaimer Clauses and Failure to Plead Justifiable Reliance

• Posted on: Jan 24 2020

On January 23, 2020, the Appellate Division, First Department, unanimously affirmed the dismissal of fraud-based claims alleged in connection with the purchase of a promissory note that memorialized a $1.5 million loan. Cestone v. Johnson, 2020 N.Y. Slip Op. 00495 (1st Dept. Jan. 23, 2020) (here). The decision, though short and concise, addresses a couple of principles this Blog frequently examines: whether contractual disclaimers can preclude a fraudulent inducement claim; and whether the plaintiff justifiably relied on the oral representations supporting the fraudulent inducement claim.

Disclaimer Clauses

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). See also Wyle Inc. v. ITT Corp., 130 A.D.3d 438, 439–41 (1st Dept. 2015); MBIA Ins. Corp. v. Countrywide Home Loans, Inc., 87 A.D.3d 287, 294 (1st Dept. 2011).

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. 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). “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.” Basis Yield, 115 A.D.3d at 137.

Justifiable Reliance

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.”’ 88 Blue Corp. v. Reiss Plaza Assoc., 183 A.D.2d 662, 664 (1st Dept. 1992) (internal citations omitted). “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.” DDJ Mgt., LLC v. Rhone Group L.L.C., 15 N.Y.3d 147, 154 (2010). “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.” Country World, Inc. v. Imperial Frozen Foods Co., 186 A.D.2d 781, 782 (2d Dept. 1992).

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.” VisionChina Media, Inc. v. Shareholder Representative Servs., LLC, 109 A.D.3d 49, 57 (1st Dept. 2013) (citation omitted). 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. 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).

Cestone v. Johnson

Cestone arose from a $1.5 million loan made by defendant, Holly Bartlett Johnson (“Holly”), to nonparty Worldview Entertainment Holdings Inc. (“Worldview”). Plaintiff, Maria Cestone (“Cestone”), claimed that Holly and her sister, Sarah Johnson (“Sarah”), fraudulently induced her into purchasing the note that memorialized the loan, by failing to disclose that Sarah, a guarantor on the loan, had already repaid Holly the loan prior to the purchase.

Defendants argued that Cestone’s fraudulent inducement claims should be dismissed because she agreed in clear and unambiguous terms that she was not relying on any representations other than those set forth in the note agreement. In this regard, under Paragraph 6(b) of the agreement, Celeste represented that she (1) had received and reviewed copies of the note, (2) was a sophisticated party, (3) was able to bear the economic risk associated with the purchase of the note, (4) had adequate information concerning the business and financial condition of Worldview and any other obligor or guarantor under the note necessary to make an informed decision regarding the purchase of the note, (5) had knowledge and experience so as to be aware of the risks and uncertainties inherent in the purchase of the rights and assumption of liabilities contemplated in the agreement, and (6) had independently and without reliance upon defendants, or any agent or representative of defendants, made her own analysis and decision to enter into the note agreement.

The motion court granted defendants’ motion and dismissed Cestone’s fraudulent inducement claims.  The Appellate Division, First Department affirmed.

The Court held that the motion court “properly dismissed the fraud-based claims based on paragraph 6(b) of the note purchase agreement,” pursuant to which Cestone “specifically disclaimed reliance on the alleged misrepresentation or omission that [she] now claims had defrauded her.” Slip Op. at *1 (citing Danaan Realty, 5 N.Y.2d at 320-321). The Court explained that “[u]nder that provision, plaintiff represented that she had ‘adequate information concerning the business and financial condition of Borrower [Worldview] and . . . guarantor under the Note’ and ‘independently and without reliance upon Seller . . . made her own analysis and decision to enter into this Agreement.’” Id. The Court noted that in addition to Paragraph 6(b), Cestone “also disclaimed reliance on ‘any documents or other information regarding the credit, affairs, financial condition or business of or any other matter concerning the Borrower or any obligor.’” Such disclaimers sufficed to preclude Cestone’s fraud-based claims.

The Court also held that “the alleged misrepresentation or omission regarding Sarah’s repayment of the loan was not ‘peculiarly within’ defendants’ knowledge.” Id. (citing Loreley Fin. [Jersey] No. 3 Ltd. v. Citigroup Global Mkts. Inc., 119 A.D.3d 136, 143 (1st Dept. 2014); Basis Yield, 115 A.D.3d at 137). The Court explained that Cestone, “who was admittedly the sole director of Worldview, as well as the chair of Worldview’s sole shareholder, Worldview Entertainment Holdings LLC, occupied a position that afforded her reasonable access to information about Worldview’s finances, including whether the loan had been repaid by Sarah as the guarantor, before plaintiff purchased the note.” As such, she could not “argue justifiable reliance on defendants’ misrepresentation or omission where she had the means available to ascertain the status of the loan.” ACA Fin. Guar., 25 N.Y.3d at 1044; HSH Nordbank AG v. UBS AG, 95 A.D.3d 185, 194-195 (1st Dept. 2012).

Takeaway

Although brief in length, Cestone is notable for its reiteration of the law concerning contractual disclaimers and fraudulent inducement claims. As the Court observed, contractual disclaimers will not preclude a fraudulent inducement claim unless the disclaimers specifically address the subject of the alleged misrepresentation.  In Cestone, the disclaimers relied upon by Cestone were specific enough to preclude the fraudulent inducement claims.

Cestone also reinforces the principle that the 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 the 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, suffices to dismiss a fraud claim. This is especially so when the plaintiff is a sophisticated party. Cestone is the most recent example coming out of the First Department to underscore these principles.