Fraud and the Ice Cream Franchise

• Posted on: Apr 5 2023

By: Jeffrey M. Haber

In today’s article, we examine South Shore D’Lites LLC v. First Class Prods. Grp., LLC, 2023 N.Y. Slip Op. 01769 (1st Dept. Apr. 4, 2023) (here), a case involving the special facts doctrine in the context of a fraud claim, in particular, the justifiable reliance element of a fraud claim. 

[Ed. Note: the factual discussion below is taken from the complaint filed in the action and the parties’ briefs on appeal.]

South Shore D’Lites concerned licenses to sell ice cream. The licenses were sold to plaintiffs, South Shore D’Lites, LLC, D’Lites of West Caldwell, LLC, and HGB D’Lites of Smithtown, LLC, by Defendants, Todd Coven and Magda Coven, the co-members of defendant First Class Products Group, LLC. First Class owns a license to sell “D’Lites” ice-cream products in the tri-state area. 

According to the complaint, in selling the licenses, defendants made numerous statements to certain, or each, of the plaintiffs, including, but not limited to: (a) the expected profitability of the entities, (b) the anticipated sales of the entities during the first year of operation, (c) the anticipated sales of various D’Lites products during “special occasions”, (d) the profitability of existing D’lite stores, (e) the profit margins and daily average sales of defendants’ D’Lites store in Woodbury, New York, (f) offers that defendants received to purchase their D’Lites store in Woodbury, (g) the price of supplies to be purchased by the plaintiffs from the supplier or suppliers to be designated by defendants (which was represented to be (1) the then current price available from the supplier and not a marked-up supply price that included approximately $5.00 per gallon charge of direct profit to defendants (the “Mark-Up”), and (2) the same price as defendants paid for supplies), and (h) the identity of the supplier for the supplies to be purchased by the plaintiffs (which was represented as a third-party dairy and not the defendants or an affiliate of the defendants). Plaintiffs alleged that they these and other representations were materially false and misleading.

Plaintiffs claimed that in reliance on these statements, they purchased the licenses.

In their complaint, plaintiffs asserted five causes of action: (1) breach of the implied covenant of duty of good faith and fair dealing; (2) breach of fiduciary duty; (3) breach of General Business Law (“GBL”) § 349; (4) fraud in the inducement; and (5) breach of the Franchise Act. Subsequently, plaintiffs agreed to withdraw their claims for breach of the implied duty of good faith and fair dealing and breach of fiduciary duty.

On August 27, 2021, Plaintiffs moved for partial summary judgment seeking judgment on their claim for breach of the Franchise Act. Also on August 27, 2021, defendants moved for summary judgment dismissing the complaint in its entirety.

With regard to the fraudulent inducement claim, defendants argued that plaintiffs could not satisfy the justifiable reliance element of the claim. Defendants argued that the statements identified by plaintiffs were merely forecasts or ‘expectations’ of future performance, both of which are not statements of fact. “Mere puffery, opinions of value or future expectations” do not support a fraud claim, defendants argued. 

In addition, defendants argued that plaintiffs failed to undertake any meaningful due diligence before entering into the agreement. As a result, defendants claimed, plaintiffs could not have justifiably relied on any statement they made.

On April 26, 2022, the motion court dismissed plaintiffs’ claims for breach of GBL § 349 and fraud in the inducement. The motion court denied plaintiffs’ claim for summary judgment on their Franchise Act claim. Plaintiffs appealed the denial of summary judgment on the Franchise Act claim and the dismissal of the fraud in the inducement claim. We examine the fraudulent inducement claim below.

The Appellate Division, First Department modified the motion court’s dismissal of the fraudulent inducement claim to reinstate it.

The Court held that there were “[i]ssues of fact” that “preclude[ed] summary judgment dismissal [of the compliant] … based on the evidence adduced in discovery.”¹ The Court explained that these issues were “consistent with plaintiffs’ contention that defendants lied in their statements to plaintiffs concerning the past and present profitability of their D’Lites store and by failing to disclose the ice cream [M]arkup.”² The Court rejected “[d]efendants’ contention that plaintiffs could not have reasonably relied upon the alleged misrepresentations as to defendants’ profits and costs because they did not perform the due diligence with respect to those representations,” holding that such issues were not properly resolved on summary judgment.³ 

Takeaway

The Court’s citation to Swersky reveals that the issue of reliance turned, in part, on the special facts doctrine⁴ and whether there was a disparity in the level of information available to plaintiffs at the time they conducted due diligence. Plaintiffs argued that, in effect, defendants were concealing material information from them, thus making the special facts doctrine applicable to the facts in that case. In essence, therefore, the amount of due diligence performed was not dispositive because there existed a disparity of information between the parties that prevented plaintiffs from discovering the truth. As noted, the First Department agreed.  

Footnotes

1. Slip Op. at *1.
2. Id. at *1-*2.
3. Id. at *2 (citing, Swersky v. Dreyer & Traub, 219 A.D.2d 321, 328 (1st Dept. 1996)).
4. To satisfy the special facts doctrine, a party must satisfy the following two-prong test: “that the material fact was information ‘peculiarly within [the] knowledge’ of [the defendant], and that the information was not such that could have been discovered by [the plaintiff] through the ‘exercise of ordinary intelligence.’” Jana L. v. West 129th Street Realty Corp., 22 A.D.3d 274, 278 (1st Dept. 2005) (citing, Black v. Chittenden, 69 N.Y.2d 665, 669 (1986), quoting, Schumaker v. Mather, 133 N.Y. 590, 596 (1892)). We have examined the special facts doctrine, here, here and here.

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.