Fraud Notes: First Department Talks About Misrepresentations of Fact and Justifiable Reliance

• Posted on: Mar 15 2023

By: Jeffrey M. Haber

To establish a cause of action for fraud, a plaintiff must plead a material misrepresentation of a fact, knowledge of its falsity, an intent to induce reliance, justifiable reliance and damages.¹ In Pope Investments II LLC v. Belmont Partners, LLC, Case No. 2022-02632 (1st Dept. Mar. 14, 2023) (here), and RCM/CMG Portfolio Holding, LLC v. Giordano, Case No. 2021-03254 (1st Dept. Mar. 14, 2020) (here), the Appellate Division, First Department addressed the falsity and reliance elements of a fraudulent inducement cause of action. We examine both cases below.

[Ed. Note: the factual discussion for both cases comes from the briefing on appeal and the Court’s discussion of each case.] 

Pope Investments II LLC v. Belmont Partners, LLC

Pope Investments arose from a “Chinese reverse merger,” a complicated transaction enabling American companies to invest in companies in China through the use of offshore shell companies. One of the offshore companies involved in the transaction was controlled by Geoffrey Shao (“Shao”). Through the reverse merger at issue in the case, plaintiffs and others invested approximately $12.5 million in Shanghai Medical Technology Co., LTD. (“SMT”). Defendants received more than $1 million for facilitating the transaction. Before the reverse merger could be fully effectuated, however, the investment funds were wrongfully diverted by Shao to other nonparty entities.

In April 2014, plaintiffs filed an amended complaint, asserting nine causes of action against defendant Joseph Meuse (“Meuse”), an owner of Belmont Partners, LLC (“Belmont Partners”) and Belmont Partners (collectively, the “Belmont Defendants”). In response to defendants’ motion to dismiss, plaintiffs withdrew several causes of action. After the motion court ruled on the motion, several causes of action against defendants survived, including fraudulent inducement and negligent misrepresentation.

With regard to the fraudulent inducement claim, plaintiffs alleged that plaintiffs’ claims centered on defendants’ actions or inactions, which allowed Shao to embezzle the money paid in connection with the transaction. In particular, plaintiffs alleged that defendants fraudulently induced them to invest their money by misrepresenting that they had vetted Shao and/or Kamick Assets Limited (“Kamick”), a British Virgin Islands company solely owned by Shao, and by failing to disclose that Shao and Helen Lv, who allegedly embezzled the funds with Shao, had a close personal relationship with each other.

Upon completion of discovery, the Belmont Defendants moved for summary judgment. To support the motion, the Belmont Defendants submitted, among other things, Meuse’s deposition testimony in which he averred that he and Belmont Partners were never asked to, nor did they provide, any due diligence with respect to the transaction, that he and Belmont Partners relied exclusively on the parties’ legal counsel to structure the transaction, and that he specifically told plaintiff that counsel had instructed him to step back and leave the structuring of the deal to the parties’ attorneys. 

The Belmont Defendants also contended that plaintiffs did not satisfy the justifiable reliance element of their fraudulent inducement claim. Defendants argued that plaintiffs were sophisticated investors and hedge fund managers, who managed hundreds of millions of dollars, and who were represented by counsel throughout the transaction. As such, said defendants, plaintiffs could not exclusively rely on them to shepherd the transaction through to its conclusion. According to defendants, plaintiffs took no steps to safeguard their interests.

The motion court granted in part and denied in part the Belmont Defendants’ motion for summary judgment. In denying summary judgment as to, inter alia, the fraudulent inducement and negligent misrepresentation claims, the motion court found that there were disputed issues of material fact.

The First Department unanimously affirmed.

The Court held that “[t]he motion court properly denied dismissal of plaintiffs’ claims for fraudulent inducement and negligent misrepresentation.”² The Court found that “[t]here [were] multiple factual issues present on th[e] record as to whether the Belmont Defendants made material misrepresentations and omissions of fact and whether plaintiffs justifiably relied on them.”³

“Among other things,” explained the Court, “the [motion] court properly found that Meuse’s contention that he would be ‘stepping back’ from the transaction – and that he had relayed this fact to individuals at Pope Investments II LLC (Pope) – were directly refuted by the affidavits submitted by Pope representatives.”⁴ For example, said the Court, the Pope representatives stated that “the Belmont Defendants had not informed Pope or any of the other investors that the Belmont Defendants would not be involved in structuring the reverse merger, and that plaintiffs conducted extensive due diligence and engaged in numerous calls and correspondence with the Belmont Defendants, who were tasked with shepherding the deal.”⁵ Thus, said these representatives, “they would not have recommended entering into the reverse merger had defendants’ disclosed their noninvolvement in structuring and consummating the transaction.”⁶ Such evidence, concluded the Court, was “sufficient to raise factual issues with respect to the fraudulent inducement and negligent misrepresentation claims.”⁷

In affirming the motion court’s order, the Court compared the record before it to the facts in J.A.O. Acquisition Corp. v. Stavitsky, 18 A.D.3d 389, 391 (1st Dept. 2005).⁸ In J.A.O. Acquisition, the plaintiff alleged that prior to its purchase of the subject company, the defendant misrepresented that certain foreign receivables were backed by letters of credit. The defendant moved for summary judgment on the ground that there was no evidence that it made such a misrepresentation. In opposition, the plaintiff submitted an affidavit in which the affiant stated that the defendant and his partner had withheld material information about foreign sales, failed to disclose that said sales were not supported by a letter of credit, and lied to the bank about the existence of letters of credit. The First Department held that the “affidavit [was] plainly insufficient in that it contain[ed] only vague assertions, and nowhere state[d] that [the defendant] told him that the foreign collectibles were supported by letters of credit or were otherwise includable in the Chase availability statement.”⁹ 

RCM/CMG Portfolio Holding, LLC v. Giordano

RCM/CMG arose from the purchase by plaintiff of a portfolio (the “Portfolio”) of legal and medical receivables (the “Receivables”) from Cambridge Management Group, LLC (“CMG”) for more than $24 million, and the subsequent servicing of collections on the Portfolio, initially by CMG and its assignee.

Plaintiff asserted mostly contract-based claims against certain defendants, as well as a fraudulent misrepresentation claim against the corporate defendants’ principal, James Giordano (“Giordano”).  In connection with the fraud claim, plaintiff alleged that Giordano falsely told plaintiff’s representatives that each of the Receivables, which were individually listed on schedules the parties had exchanged during negotiations, and which plaintiff allegedly relied upon to calculate the amount it was willing to pay for the Portfolio, were viable and collectable. Giordano also allegedly told one of plaintiff’s principals that CMG’s auditor had recently examined the Portfolio and written off the Receivables that were no longer viable. Plaintiff claimed that Giordano knew at the time, that Giordano’s assurances were lies, and in reality, more than one hundred of the Receivables that Plaintiff purchased were worthless and uncollectable.

After the closing of the transaction, Giordano dissolved CMG and transferred its assets through a series of successor entities. Moreover, claimed plaintiff, to conceal Giordano’s fraudulent scheme, CMG and its affiliates, which continued to service the Portfolio, submitted bi-monthly servicing reports, falsely representing that the Receivables, which were worthless and uncollectable, were still being serviced.

Giordano moved to dismiss and for summary judgment dismissing plaintiff’s fraud claim against him. Giordano claimed that plaintiff failed to allege any misrepresentation of material fact. In particular, Giordano contended that the alleged misrepresentations were nothing more than a restatement of the representations and warranties in the asset purchase agreement executed in connection with the transaction.

Giordano also argued that plaintiff failed to plead justifiable reliance. Noting that plaintiff is a sophisticated party, Giordano maintained that plaintiff could not simply rely on Giordano’s alleged representations. More was needed. Giordano maintained that plaintiff failed to allege that it could not have discovered the truth had it performed an adequate due diligence. In fact, claimed Giordano, plaintiff alleged that in its own post-purchase investigation, facts were revealed that could have been discovered before the closing had plaintiff engaged a third-party consultant.

The motion court denied the motion. The First Department unanimously affirmed.

The Court found “that issues of fact exist[ed] as to whether … Giordano made any actionable misrepresentations.”¹⁰ The Court explained that deposition testimony (which was reiterated in affidavits) supported plaintiff’s allegation that Giordano “falsely represented … that uncollectable [R]eceivables had recently been written off in accordance with company policy, that the subject [R]eceivables would perform well, and that certain [R]eceivables were valued at a certain (allegedly inflated) amount.”¹¹ The Court further explained that “[a]t least some of these represent false statements of present facts and not just ‘mere puffery, opinions of value or future expectations.’”¹² As such, dismissal was not appropriate.

“To the extent, however, that plaintiff relies on its principals’ assertions in their affidavits that Giordano misrepresented to them that all of the [R]eceivables to be purchased were ‘viable and collectable,’” such reliance, said the Court, was misplaced, especially on a motion for summary judgment: 

They did not reference such a statement at their depositions, despite specific questioning, and “[a]ffidavit testimony that is obviously prepared in support of ongoing litigation that directly contradicts deposition testimony previously given by the same witness, without any explanation accounting for the disparity, creates only a feigned issue of fact, and isinsufficient to defeat a properly supported motion for summary judgment” (see Telfeyan v City of NY, 40 AD3d 372, 373 [1st Dept 2007] [internal quotation marks omitted]).[¹³]

The Court also held that there were issues of fact “with respect to the element of justifiable reliance.” The Court rejected Giordano’s argument that merger clauses in the asset purchase agreement precluded reliance.¹⁴ 

Moreover, said the Court, there was “conflicting evidence in the record regarding whether plaintiff, a sophisticated investor, took ‘reasonable steps to protect itself against deception,’ including through its conduct of due diligence and securing of written representations and warranties.”¹⁵ The Court explained that “issues of fact exist[ed] as to whether plaintiff should have asked for case servicing notes or attributed any significance to the ‘Outstanding-Ineligible’ designation given to certain [R]eceivables, as well as to whether plaintiff’s due diligence efforts were undermined by defendants’ own conduct in labeling cases as ‘open’ that were no longer collectable, limiting plaintiff’s access to information, and/or failing to disclose a prior arbitration.”¹⁶

[Ed. Note: Recently, we discussed sophisticated parties and the justifiable reliance element of a fraud claim, here, here and here.]Ed. Note: In prior articles, we have discussed the impact that a disclaimer clause in a contract can have on a fraud claim. See, e,g., here and here. As we have noted, disclaimer clauses often are worded as “no reliance” clauses. In a such a clause, the parties represent that they are not relying on any extra-contractual representations.]

Footnotes

1. Eurycleia Partners, LP v. Seward & Kissel LLP, 12 N.Y.3d 553, 559 (2009).
2. Slip Op. at *2.
3. Id.
4. Id.
5. Id.
6. Id.
7. Id.
8. Id.
9. 18 A.D.3d at 390–391.
10. Slip op. at *2.
11. Id.
12. Id. (citing, Sidamonidze v. Kay, 304 A.D.2d 415 (1st Dept. 2003), and First Bank of the Ams. v. Motor Car Funding, Inc., 257 A.D.2d 287, 292 (1st Dept. 1999)).
13. Id.
14. Id. (citing, Basis Yield Alpha Fund (Master) v. Goldman Sachs Group, Inc., 115 A.D.3d 128, 137-138 (1st Dept. 2014)).
15. Id. at *2-*3 (citing, DDJ Mgt., LLC v. Rhone Group L.L.C., 15 N.Y.3d 147, 154-155 (2010)).
16. Id. at *3.

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.