First Department Finds Half-Truths, Concealment and Justifiable Reliance in Affirming Alleged Fraud-Based Claims in a Mortgage Foreclosure Action

• Posted on: May 16 2019

In today’s post, this Blog takes a look at fraud allegations in foreclosure action involving two commercial mortgages that secured more than $24 million in indebtedness. Orchard Hotel LLC v. D.A.B. Group LLC, 2019 N.Y. Slip Op. 03893 (1st Dept. May 16, 2019) (here). Relevant to today’s article is the motion court’s denial of a motion to dismiss fraud-based cross-claims and the First Department’s affirmance of that decision.

Orchard Hotel LLC v. D.A.B. Group LLC

Background

[Editor’s Note: the facts set forth below are taken from the motion court’s decision.]

In 2007, Defendant, Brooklyn Federal Savings Bank (“BFSB”), granted a loan for property located on Orchard Street in New York (the “Property”) to Defendant, D.A.B. Group LLC (“DAB”), secured by a mortgage (the “Project Loan Mortgage”) in the approximate amount of $5,500,000 (“Project Loan”). In 2008, BFSB granted a building loan to DAB for construction work on the Property, secured by a mortgage (the “Building Loan Mortgage”) in the amount of $19,050,000 (“Building Loan”).

The Building Loan Promissory Note (the “Note”) stated that the Building Loan’s initial maturity date was September 1, 2009. After this date, BFSB had the option to extend the Building Loan for an additional six-month period ending on March 1, 2010 (the “First Extension Date”), provided that all the conditions stated in the Note were fulfilled. After the First Extension Date, BFSB had the option to extend the Building Loan a second time to September 1, 2010 (the “Second Extension Date”), again provided that all the conditions stated in the Note were fulfilled. After the Second Extension Maturity Date, provided that the conditions set forth in the Note were fulfilled, BFSB had the option to extend the Building Loan for a third time to March 1, 2011. BFSB exercised all three options to extend the Building Loan. Therefore, March 1, 2011 became the deadline after which the Note matured (the “Expiration Date”).

In or about June and July 2008, Flintlock Construction Services LLC (“Flintlock”) bid on the construction project of a hotel on the Property (the “Project”). Flintlock’s bid was not selected, and DAB gave the job to Cava Construction & Development, Inc. (“Cava”). Because Cava ceased working on the project, DAB asked Flintlock to complete it. DAB advised Flintlock that it was in the process of securing consent from BFSB for Flintlock to be approved to start construction.

On or about March 30, 2010, Flintlock entered into a contract with DAB (the “Contract”), wherein Flintlock agreed to provide labor, equipment and materials for the Project for $13 million. Flintlock was given 430 calendar days to complete the work.

Thereafter, BFSB contacted Flintlock and represented to Flintlock that its consent was required so that loan monies could be advanced to DAB to pay Flintlock in accordance with the Project Loan Agreement and the Building Loan Agreement. DAB requested that Flintlock cooperate with it to obtain BFSB’s consent. Flintlock started working in early August in anticipation of BFSB’s approval of the Contract.

On or about August 20, 2010, BFSB emailed Flintlock various documents that were needed in connection with BFSB’s approval of Flintlock. Within those documents was a document, titled “Affidavit and Estoppel Certificate” (the “Estoppel Certificate”), which BFSB prepared and which Flintlock needed to sign as a condition of the Contract. DAB and BFSB were copied on the email. BFSB was the beneficiary of the Estoppel Certificate and did not sign it. Flintlock signed the Estoppel Certificate on August 26, 2010.

The Estoppel Certificate represented, in pertinent part that: “[t]he sum of $12,040,000 is available to [Flintlock] which sum may be increased by the amount, if any, by which the Cava Construction mechanic’s lien is resolved, to the satisfaction of [BFSB] for a sum less than $960,000, provided that no assurances are made as to the availability of any such additional funds.”

On August 27, 2010, BFSB emailed Flintlock confirming that BFSB could start processing requisitions for Flintlock’s construction work paid from the Building Loan. Section 1.23 of the Building Loan Agreement defined a requisition as “a written certification and request for an Advance.”

In a letter dated March 23, 2011, BFSB informed DAB that the Building Loan had matured on March 1, 2011, that BFSB did not consent to any further extension, and that the notes were payable in full as of March 23, 2011. At that point, payments by DAB to Flintlock stopped. Consequently, Flintlock terminated the Contract effective June 7, 2011.

On June 17, 2011, BFSB assigned the Loans and related mortgages to Plaintiff, Orchard Hotel, LLC (“Orchard”). On July 1, 2011, Orchard filed a complaint against DAB, Flintlock, BFSB and other defendants having or claiming to have some interest or lien upon the Property, with Orchard seeking foreclosure of the Project Loan Mortgage and the Building Loan Mortgage.

On August 8, 2013, Flintlock filed an answer, asserting affirmative defenses and counterclaims against Orchard for mechanic’s lien foreclosure, fraud, constructive fraud, negligent misrepresentation, trust fund diversion, and conversion; cross-claims against DAB for breach of contract, quantum merit, account stated, mechanic’s lien foreclosure, fraud, constructive fraud, negligent misrepresentation, and trust fund diversion; and cross-claims against BFSB for mechanic’s lien foreclosure, fraud, constructive fraud, negligent misrepresentation, trust fund diversion, promissory estoppel and conversion.

BFSB and State Bank of Texas moved to dismiss Flintlock’s cross-claims. On May 21, 2018, the motion court granted the motion, except with respect to Flintlock’s fraud and fraudulent concealment cross-claims. An appeal followed.

The First Department’s Decision

To state a claim for fraud, a plaintiff must allege: “(1) a material misrepresentation of a fact, (2) knowledge of its falsity, (3) an intent to induce reliance, (4) justifiable reliance by the plaintiff, and (5) damages.” Eurycleia Partners, LP v. Seward & Kissel, LLP, 12 N.Y.3d 553, 559 (2009). See also Mandarin Trading Ltd. v. Wildenstein, 16 N.Y.3d 173, 178 (2011). A plaintiff alleging fraud must meet each element in order to prevail, whether it be on a motion or at trial. Menaco v. New York Univ. Med. Ctr., 213 A.D.2d 167 (1st Dept. 1995). The failure to meet any one element will, therefore, result in the dismissal of the action. Gregor v. Rossi, 120 A.D.3d 447 (1st Dept. 2014).

To plead a cause of action for fraudulent concealment, a plaintiff must satisfy the elements of a fraud claim, as well as demonstrate that the defendant was under a duty to disclose truthful information. Mandarin Trading, 16 N.Y.3d at 179 (citation omitted). A duty to disclose information arises when there is a fiduciary relationship between the parties, or when the special facts doctrine applies. Jana L. v. West 129th Street Realty Corp., 22 A.D.3d 274, 277 (1st Dept. 2005). A misleading partial disclosure or half-truth also gives rise to a duty to disclose. Basis Yield Alpha Fund (Master) v. Goldman Sachs Group, Inc., 115 A.D.3d 128, 135 (1st Dept. 2014).

“Under the ‘special facts doctrine,’ a duty to disclose arises where one party’s superior knowledge of essential facts renders a transaction without disclosure inherently unfair.” Swersky v. Dreyer & Traub, 219 A.D.2d 321, 327 (1st Dept. 1996) (internal citation omitted). The special facts doctrine requires the satisfaction of a two-prong test: the material fact omitted was “peculiarly within the knowledge” of the omitting party, and the information could not have been discovered by “the exercise of ordinary intelligence.” Jana L., 22 A.D.3d at 278, citing Black v. Chittenden, 69 N.Y.2d 665, 669 (1986). If a party has means of learning the information, then that party must use those means, or its complaint for fraud will not be heard. ACA Fin. Guar. Corp. v. Goldman, Sachs & Co., 25 N.Y.3d 1043, 1044 (2015).

Against this legal background, the First Department held that “Flintlock adequately allege[d] all of the elements of its fraud and fraudulent concealment claims.” Slip Op. at *1.

The Court found that Flintlock properly alleged an actionable half-truth. Slip Op. at *1 (citation omitted). In reaching this conclusion, the Court explained that BFSB, though “not a signatory to the Estoppel Certificate” was, for pleading purposes, responsible for the representations in the Estoppel Certificate, especially since BFSB advised Flintlock that execution of the Estoppel Certification was a condition of being hired. Slip Op. at *1. As such, “BFSB knew that Flintlock understood [the] representation[s in the Estoppel Certificate] to apply to the entire contract term and knew that the promised funds would not be available during this whole time.…” Thus, even though the funds “were indisputably available when the subject statement was made,” they were not available during the duration of the Project, thereby making the statement a half-truth. Id. 

The Court noted that although the Estoppel Certificate provided that “BFSB had ‘no obligation to provide any Advances . . . except as provided for in the Building Loan Agreement,’” that “caveat” was “not sufficient to ‘save’ the statement of fund availability.” Id. at **1-2. The Court explained that “[a]lthough the loan agreement would have revealed the expiration date of the loans, Flintlock allege[d] that BFSB intentionally prevented it from gaining access to this document by wrongfully withholding it and insisting upon execution of the Certificate in a compressed time period so that Flintlock would not be able to independently obtain or review it.” Id. at *2. Such “allegations [were] sufficient to permit an inference that BFSB wrongfully prevented Flintlock from verifying whether anything in the loan documents affected its rights.”  Whether Flintlock was required to insist upon copies of the loan documents or on more time for investigation could not be decided as a matter of law pre-discovery. Id. at *2.

The foregoing allegations, said the Court, were also sufficient “to permit an inference that Flintlock justifiably relied on the Estoppel Certificate, notwithstanding its failure to read the referenced loan documents, especially in view of Flintlock’s allegations that it sought assurances from BFSB regarding the sufficiency of loan funds during the contract term and understood the statement in the Estoppel Certificate to be a confirmation that the funds were sufficient.” Id., citing ACA Fin., 25 N.Y.3d at 1045. See also DDJ Mgt., LLC v. Rhone Group LLC, 15 N.Y.3d 147, 154 (2010) (holding that, where plaintiffs had obtained warranties that financial statements were not misleading, whether they were justified in relying on the warranties was a question of fact); Phoenix Light SF Ltd. v. Credit Suisse AG, 144 A.D.3d 537, 538 (1st Dept. 2016) (holding that the plaintiff could reasonably rely on the offering documentation concerning the purchase of residential mortgage backed securities, and was not required to request actual loan files). Since Defendants did not identify any hints of a misrepresentation, Flintlock was not required to make “additional inquiry” in the sufficiency of the loan funds. Id., citing Loreley Fin. [Jersey] No. 3, Ltd. v. Morgan Stanley & Co. Inc., 146 A.D.3d 683, 684 (1st Dept. 2017) (internal quotation marks omitted).

Finally, the Court held that the misrepresentations and half-truths alleged by Flintlock were “sufficient to permit an inference that BFSB had a duty to disclose information to Flintlock. Slip Op. at *2. These representations created “an inference that BFSB was aware that Flintlock was operating under the mistaken assumption that the funds were available throughout the contractual term.…” Id. Consequently, the special facts doctrine applied. Id.

Takeaway

Like many fraud cases discussed by this Blog, Orchard Hotel involves the justifiable reliance element of a fraud cause of action. The case is notable on this point because Flintlock obtained a written representation in the Estoppel Certificate that the funds were available. As such, much like a plaintiff who can rely on a written warranty, Flintlock could rely on the written statement in the Estoppel Certificate. As the motion court observed, courts rarely find that a plaintiff could not justifiably rely on a written representation unless the plaintiff actually knew the representation to be false.

Orchard Hotel is also notable for its treatment of half-truths and the duty to disclose the full truth that arises therefrom. While the statement in the Estoppel Certificate was “the truth so far as it goes” (Restatement, Torts, § 529), the Court found that BFSB knew that the sum would not be available after the Expiration Date. Thus, the statement in the Estoppel Certificate that $12,040,000 was available to Flintlock without disclosing the Expiration Date was a half-truth, and, therefore, a misrepresentation. As the New York Court of Appeals observed: “Silence may … constitute fraud where one of two parties to a contract has notice that the other … is acting upon a mistaken belief as to a material fact. Bank v. Board of Educ. of City of N.Y., 305 N.Y. 119, 133-134 (1953).