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First Department Decides Two Fraud Cases On Same Day: One That Addresses Duplication with Contract Claims, Justifiable Reliance, and Disclaimer Clauses, and One That Addresses Falsity

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  • Posted on: Mar 20 2019

On March 19, 2019, the Appellate Division, First Department, issued two decisions involving a number of issues related to the assertion of a fraudulent inducement claim – i.e., whether (a) the claim was duplicative of a contract claim, (b) the plaintiff justifiably relied on the alleged misrepresentations, and (c) disclaimer and merger clauses operated to render reliance on the alleged misstatements unreasonable – and a fraud claim – i.e., whether there was falsity. Ohm NYC LLC v. Times Sq. Assoc. LLC, 2019 N.Y. Slip Op. 02034 (1st Dept. Mar. 19, 2019) (here), and SFR Holdings Ltd. v Rice, 2019 N.Y. Slip Op. 02032 (1st Dept. Mar. 19, 2019) (here).

In Ohm, the Court unanimously reversed the dismissal of a fraudulent inducement claim on the grounds that it did not duplicate the breach of contract claim – i.e., the alleged misrepresentations “were not promises of future performance, but misrepresentations of a then present fact” – and the disclaimers and merger clause did not render reliance on the alleged misrepresentation improper because the facts related to those clauses were “peculiarly within defendants’ knowledge.” Slip Op. at *1

In SFR, the Court unanimously affirmed the denial of motions for summary judgment (except as to one plaintiff) related to a fraud claim on the grounds that there were issues of fact concerning the falsity of defendants’ statements.

A Primer on The Law

Contract Claim and Fraud Claim Together in One Action

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). When a fraudulent inducement claim is asserted in the context of a contract case, “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.” Wyle, 130 A.D.3d at 439.  Thus, to maintain a fraudulent inducement claim under New York law, a plaintiff must allege (i) that the fraud was “collateral or extraneous to the contract” or (ii) “a breach of duty separate from a breach of the contract” or (iii) special damages “not recoverable under a contract measure of damages.” Coppola v. Applied Elec. Corp., 288 A.D.2d 41, 42 (1st Dept. 2001).

[This Blog recently wrote on the issue here.]

Disclaimer Clauses

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).

[This Blog recently discussed justifiable reliance here and here.]

Ohm NYC LLC v. Times Square Associates LLC

Ohm involved leased commercial space by the plaintiff, Ohm NYC LLC (“Ohm”). According to the complaint, Ohm entered into a lease agreement for commercial space on the ground floor of a building located on West 43rd Street in New York City (the “Building”). Ohm planned to use the space for “an upscale food hall” in which a number of upscale brands/vendors would offer their food and services.

Ohm alleged that defendants breached the lease by advising it, after the lease had been executed, that a non-exclusive public corridor, known as the “Bridge” area (the “Bridge”), leading from a common, public entrance on West 44th Street in Times Square to the leased space, was not part of the leased space and that the space was, therefore, smaller than the space actually leased.

Ohm sued for, among other things, breach of the lease, fraudulent inducement, and rescission. Defendants moved to dismiss the fraudulent inducement and rescission claims.

Defendants argued that the “No Representations” and “Merger” clauses in the lease negated any reliance on the alleged fraudulent statements. Defendants maintained that, by these clauses, Ohm was not induced to sign the lease by any “warranties, representations, statements or promises” regarding the rentable and usable areas of the space, or suitability of the space for any particular purpose.

Defendants also argued that the fraudulent inducement cause of action was duplicative of Ohm’s breach of contract cause of because it was based upon the same facts underlying Ohm’s breach of contract cause of action.

Finally, Defendants argued that Ohm failed to plead justifiable reliance on the alleged misrepresentations, claiming that the representations did not pertain to facts, but mere expressions of opinion, enthusiasm or future expectation.

The motion court granted the motion, finding that the alleged misrepresentations related to the performance of the contract (i.e., the lease).

On appeal, the First Department reversed.

The Court found that Ohm had alleged “multiple instances” in which defendants misrepresented “that the Bridge, … , would be included in the leased premises.” As such, those “misrepresentations, which the complaint allege[d] were made to induce plaintiff into entering into the lease, were not promises of future performance, but misrepresentations of a then present fact.” Accordingly, the Court held that the fraudulent inducement claim was “not duplicative of the breach of contract claim.”

The Court also rejected defendants’ argument that the disclaimer and merger clauses in the lease precluded Ohm’s fraudulent inducement claim, holding that “[t]here [was] nothing in the record to suggest that plaintiff knew or should have known that the Bridge would not be included in the leased premises, as was originally represented.”

Finally, the Court rejected defendants’ justifiable reliance challenge, holding that “[t]here [was] nothing in the record to suggest that plaintiff could have discovered the terms of the lease of the adjacent premises or any promises about the Bridge that defendants may have made to the tenants of the adjacent premises, which would be facts peculiarly within defendants’ knowledge.”

SFR Holdings Ltd. v. Rice

Plaintiffs alleged that defendants fraudulently induced them to invest in certain partnerships by misrepresenting their investment strategy as based on only asset-based lending (ABL), trade finance, and factoring. Plaintiffs further alleged that defendants assured them that they would not invest plaintiffs’ funds in real estate ventures.

Despite those assurances, defendants allegedly invested more than $150 million of plaintiffs’ funds in subordinated loans to real estate development ventures that were illiquid and high risk. Plaintiffs added that, without their knowledge or consent, defendants funded nonparty Capstone Realty Investment Partnership (“CRIP”) with loans from Capstone Business Credit that were funded by the Capstone Partnerships’ investments. Plaintiffs alleged that defendants fraudulently concealed those unauthorized investments for almost one year after they made the investments and continued to misrepresent to plaintiffs the true magnitude of those investments, even after plaintiffs submitted redemption requests. Plaintiffs further asserted that defendants delayed complying with those requests until no funds were left with which to repay plaintiffs.

In July 2012, plaintiffs commenced the action to recover monetary damages and legal fees on claims for fraudulent inducement, fraud, breach of fiduciary duty, unjust enrichment, actual and constructive fraudulent conveyance, and breach of contract.  Plaintiff also sought a declaratory judgment. Defendants moved to dismiss the complaint.

By decision and order dated November 24, 2014 and entered December 3, 2014, the motion court granted the motion in part and dismissed all claims asserted in the complaint except for the fraudulent inducement claim asserted against Capstone Capital Management, Capstone Cayman Special Purpose Fund, and Capstone Special Purpose Fund (Capstone entities), John Rice (Rice) and Joseph Ingrassia (Ingrassia) (here).

The Appellate Division, First Department, modified, and otherwise affirmed, the November 2014 order to deny the branches of the motion seeking dismissal of the cause of action for fraud asserted against Rice, Ingrassia, and the Capstone entities. SFR Holdings Ltd. v Rice, 132 A.D.3d 424 (1st Dept. 2015) (here).

Following the completion of discovery, defendants moved for summary judgment on the fraudulent inducement, contract and fraud causes of action. Plaintiffs moved for summary judgment on the fraud claim.

The motion court granted the motion with regard to the fraudulent inducement claim and denied the parties’ respective motions with regard to the fraud claim. (SFR Holdings Ltd. v. Rice, 2017 N.Y. Slip Op. 31974 (Sup. Ct. N.Y. County 2017) (here). Regarding the fraud claim, the motion court held that: “There were genuine triable issues of material fact regarding whether, after execution of the Subscription Agreements, defendants expressly stated that they would follow an ABL investment strategy and refrain from investing plaintiffs’ funds in real estate ventures, yet invested plaintiffs’ funds in such ventures, without plaintiffs’ knowledge and consent and hid the fact of such improper investments from plaintiffs for a period of, perhaps, 11 months.”

On appeal, the First Department affirmed the motion court’s order with regard to the fraud claim, except as to one plaintiff. The Court rejected defendants’ argument, advanced before the motion court, that plaintiffs’ “had every piece of information necessary to withdraw from the investments, yet chose not to act until the beginning of February 2008” and, therefore, there could be no falsity. The Court found that the fraud “claim [was] supported by monthly progress reports that failed to reveal the nature and extent of the real estate investments, and testimony and sworn statements about a meeting at which defendants significantly understated the amount of money used to fund real estate deals and about defendants’ assurances that 90% of the improper investments would be transferred to another fund.” Slip Op. at *1.

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