Fraud Notes: Fraudulent Inducement With Duplication on Top

• Posted on: Jan 12 2022

By: Jeffrey M. Haber

Yesterday, the Appellate Division, First Department decided three cases involving claims for fraudulent inducement. We examine each of these cases below.

Artemus USA LLC v. Leila Taghinia-Milani Inc.

Artemus involved artwork that was consigned by Artemus USA LLC (“Artemus”) to defendants pursuant to a consignment agreement (“Agreement”). Plaintiffs alleged that the artwork was damaged while consigned to the Defendants. 

[Ed. Note: the arguments advanced by the parties were taken from the briefing before the motion court.]

In their opposition to plaintiffs’ summary judgment motion, defendants argued, among other claims, that they were fraudulently induced to enter into the Agreement. Defendants argued that plaintiffs: (a) failed to disclose evidence that the artwork had substantial prior damage for which conservation and repairs were performed; (b) falsely contended that the Agreement provided that defendants would accept the artwork “as is”, which they would not do because the condition of a piece of artwork is material in terms of the marketability and valuation of the piece and the handling of the artwork; (c) falsely held themselves out as the owner of the artwork at the time of contract when neither was the owner; (d) claimed the artwork was valued at nearly double what was told to defendants; (e) failed to inform defendants of the artwork’s vulnerabilities.

In response, plaintiffs argued that defendants failed to offer any evidence that plaintiffs were asked about ownership, provenance, or previous repairs to the work. Plaintiffs also claimed that defendants failed to show that plaintiffs made any misleading statements or that defendants relied on any statements when entering into the Agreement. Instead, plaintiffs argued, defendants merely alleged that they would not have entered into the Agreement if they had known the truth.

The motion court granted plaintiffs’ motion for summary judgment and denied defendants’ motion for summary judgment.

On appeal, the First Department unanimously modified the decision of the motion court.

With regard to the fraud claim, the Court held that defendants “raised issues of fact as to whether they were fraudulently induced to enter into the consignment agreement.” The Court found that the affidavits submitted by defendants showed that “plaintiff Artemus purchased the subject artwork for half of the estimated value set forth in the consignment agreement, and [that] plaintiffs were aware that the artwork had an extensive restoration history that was not disclosed to defendants.” Consequently, the Court vacated the judgment entered by the motion court in favor of plaintiffs, denied plaintiffs’ motion, and otherwise affirmed the denial of defendants’ motion.

Artemus USA LLC v. Leila Taghinia-Milani Inc., 2022 N.Y. Slip Op. 00115 (1st Dept. Jan. 11, 2022) can be found here.

Dragons 516 Ltd. v. GDC 138 E 50 LLC

Dragons 516 involved a motion to amend. According to plaintiff, Dragons 516 loaned $30 million to defendant GDC 138 E 50 LLC (“GDC”) at 12% annually (with a 14% default interest rate), pursuant to an agreement dated June 1, 2017 (the “Facility Agreement”). GDC intended to use the funds to finance its investment in 50 LEX Development LLC (“Project Co.”). Defendant Shanghai Municipal Investment (Group) USA LLC (“SMI”) guaranteed the loan (the “Guarantee”).

Plaintiff claimed GDC breached the Facility Agreement by incurring more than the permitted amount of debt (taking on three loans, for a total of $239 million, which did not fall into the exceptions to the prohibition in the agreement), by amending organizational documents without Dragons’ consent, and by changing Project Co.’s ownership structure without Dragons’ consent. The motion court found that each of foregoing qualified as an event of default, as defined in the Facility Agreement, making GDC liable for the $30 million balance due plus interest, costs, and fees. 

Thereafter, plaintiff sought to amend its amended complaint to add a new defendant, SMI 138 E 50 ST LLC (“SMI Holdco”), which plaintiff alleged was a holding company that SMI wholly owned. Plaintiff sought the amendment because it learned during discovery that GDC was effectively judgment proof – i.e., it would be unable to satisfy a judgment against it – and, along with SMI, and [SMI] Holdco, fraudulently induced Dragons to extend the $30 million loan.

Plaintiff alleged that SMI Holdco aided and abetted GDC in fraudulently inducing Dragons to loan the money to finance GDC’s investment in Project Co.

SMI opposed the motion to amend, arguing the aiding abetting claim failed for lack of an underlying fraud claim, since there was no underlying fraud cause of action. SMI also argued that had one been asserted, it would be dismissed as duplicative of the breach of contract claim. 

[Ed. Note: Under New York law, courts will not permit a fraud-based claim (i.e., fraudulent inducement) to survive a motion to dismiss when the claim arises from a breach of contract. Indeed, courts routinely dismiss a fraud claim where “[t]he existence of a valid and enforceable written contract govern[s] a particular subject matter” and the recovery sought arises out of the same facts and circumstances.¹ However, where “a legal duty independent of the contract itself has been violated[,]” or where the misrepresentation is “collateral or extraneous to the terms of the parties’ agreement,” a fraudulent inducement claim can stand side-by-side with “a simple breach of contract” claim.²]  

 Plaintiff contended that it alleged an underlying fraud in the inducement claim, which could co-exist with the contract claim because the issue of whether the guaranty agreement (by which SMI allegedly guaranteed payment of GDC’s financial obligations pursuant to the Facility Agreement) was a valid and enforceable contract had not been decided. 

The motion court rejected plaintiff’s argument, noting that plaintiff did not assert an underlying fraud claim related to the guaranty agreement, which would support plaintiff’s proposed aiding and abetting claim. Instead, found the motion court, plaintiff “clearly attempt[ed] to allege [that] SMI and [SMI] Holdco aided and abetted GDC’s alleged fraudulent inducement of plaintiff to enter into the Facility Agreement.” That claim, observed the motion court, was dependent upon plaintiff’s claim “against GDC for breach of the Facility Agreement,” a claim that Dragons’ obtained summary judgment with GDC’s consent. Therefore, concluded the motion court, the claim was “without merit.”

On appeal, the First Department unanimously affirmed the motion court’s order.

Like the motion court, the First Department noted that plaintiff’s aiding and abetting claim “hinged” on the existence of an underlying fraud claim against GDC. The Court found that there was no underlying fraudulent inducement claim because it duplicated the breach of contract claim for which plaintiff obtained a judgment against GDC. 

Dragons 516 Ltd. v. GDC 138 E 50 LLC, 2022 N.Y. Slip Op. 00121 (1st Dept. Jan. 11, 2022) can be found here.

Bielsa v. Gonzalez

Plaintiff alleged that defendants, who are siblings, submitted conflicting tax documents regarding the assets of their deceased father, filing one set of documents with Venezuelan tax authorities and a different set with the New York State Surrogate’s Court. Plaintiff also alleged that his ex-wife, defendant Maria Alejandra Kaufman Gonzalez, renounced her inheritance from her father in exchange for other assets from defendants’ mother, disposed of those assets, and then never disclosed the fruits of that disposition to her husband, against whom she initiated divorce proceedings approximately six years later.

Defendant moved to dismiss, arguing that, among other things, plaintiff failed to allege that any misrepresentation was made to plaintiff. According to defendant, misrepresentations were allegedly told to the Venezuelan authorities or to the Surrogate’s Court in New York. But those falsehoods were not told to plaintiff. 

The motion court granted the motion, holding that plaintiff “failed to allege, much less with the particularity required by CPLR 3016(a), the material misrepresentations that defendants allegedly made to him which induced his reliance.” 

The First Department unanimously affirmed.

The Court held that any misrepresentation made to the Surrogate’s Court could not be imputed to defendants because “defendants’ mother, a nonparty, was actually the person who submitted the tax information to the Surrogate’s Court.” 

Moreover, said the Court, “the alleged misrepresentations were made not to plaintiff, but to third parties, thus preventing plaintiff from claiming reliance.” 

[Ed. Note: In Pasternack v. Laboratory Corp. of Am. Holdings, 27 N.Y.3d 817 (2016), the New York Court of Appeals held that third-party reliance does not satisfy the reliance element of a fraud claim unless the third party “acted as a conduit to relay the false statement to plaintiff, who then relied on the misrepresentation to his detriment.”³] 

“In addition,” noted the Court, “the documentary evidence conclusively establishe[d] as a matter of law that [defendant] did not have a duty to disclose her inheritance or disposition of assets to plaintiff. Plaintiff and [defendant’s] prenuptial agreement state[d] that defendant was entitled to keep assets acquired through inheritance or ‘any other means,’ and could dispose of those assets without obtaining plaintiff’s consent.” “As a result,” said the Court, “plaintiff’s fraud claim was properly dismissed.”

Bielsa v. Gonzalez, 2022 N.Y. Slip Op. 00118 (1st Dept. Jan. 11, 2022) can be found 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.