Fraud Notes: Scienter, Predictions, Promises of Future Performance, Loss Causation, and the Duty to Disclose

Print Article

Posted on: Dec 12 2022

“The elements of a cause of action for fraud require a material misrepresentation of a fact, knowledge of its falsity, an intent to induce reliance, justifiable reliance by plaintiff and damages. A claim rooted in fraud must be pleaded with the requisite particularity under CPLR 3016(b).”¹ The failure to satisfy each element will result in dismissal of the claim.

When a claim for fraud is predicated on a concealment or omission, “there must first be proven a duty to disclose material information.”² In a landlord and tenant relationship, just like any commercial relationship, a duty to disclose is not created simply because of the relationship. (Id.). The reason is because a lease, as well as a commercial instrument, is typically negotiated at arm’s length between the parties. As such, there is no fiduciary relationship upon which the defendant (e.g., the landlord) would have an affirmative duty to disclose information to the plaintiff (e.g., the tenant).³

In Sehera Food Servs. Inc. v. Empire State Bldg. Co., LLC, 74 A.D.3d 542 (1st Dept. 2010), the plaintiff executed a lease with the landlord for the premises that, at the time the lease was signed, was in the path of individuals purchasing tickets to the Empire State Building’s observation deck. The plaintiff alleged that the defendant knew, at the time the lease was signed, that the defendant planned “to relocate the ticket office”. By doing so, such traffic would be diverted away from the premises.⁴ The“lease contain[ed] no provision obligating [the] defendant to direct ticket purchasers past the premises and … during lease negotiations no guarantees were made regarding the route to be followed by such purchasers.”⁵ The First Department affirmed the denial of the plaintiff’s motion for leave to assert a fraudulent inducement claim, holding that the “plaintiff’s claim … for fraudulent concealment, … [was] … not viable, since there [was] no duty to disclose in a non-fiduciary, arm’s length transaction between a landlord and tenant.”⁶

Similarly, in Dembeck v. 220 Central Park South, LLC, the plaintiff sued her landlord for fraudulent concealment for misleading her into thinking she was renting in a “full-service building”. In affirming the dismissal of the fraud claims on summary judgment, the First Department stated:

Here, plaintiff failed to demonstrate such a [fiduciary] relationship requiring any duty of disclosure. A fiduciary relationship does not exist between parties engaged in an arm’s-length business transaction, which is normally the situation between landlord and tenant. Defendant was under no obligation to volunteer any information concerning contemplated future repairs to the elevator or any other systems in the building, and plaintiff has not claimed that defendant made any affirmative misrepresentations in that regard.⁷

Even if a plaintiff can demonstrate that the defendant affirmatively misrepresented a material fact, he or she must still satisfy all the elements of the claim. For example, a plaintiff must allege misrepresentations of present fact, not merely misrepresentations of future intent to perform under a contract.⁸ Under New York law, “[g]eneral allegations of lack of intent to perform are insufficient [to state a claim]; rather, facts must be alleged establishing that the adverse party, at the time of making the promissory representation, never intended to honor the promise”.⁹

Similarly, a claim of fraud that is based on predictions and expectations cannot withstand scrutiny if the complaint contains “allegations that the prediction was contradicted by a concrete, existing fact that defendant either intentionally failed to disclose or negligently failed to discover”.¹⁰

In addition, a complaint alleging fraud must satisfy the scienter element. To allege scienter, a plaintiff must allege with particularity that the defendant had an “actual intent to deceive, manipulate, or defraud.”¹¹ Scienter must be plead with “sufficient detail[]”; “conclusory statement[s] of intent” are insufficient.¹² To succeed, therefore, the plaintiff must allege facts from which there is some “rational basis for inferring that the alleged misrepresentations were knowingly made.”¹³

Scienter is a very difficult element to plead. In fact, the scienter element is the hardest to plead because the evidence of intent most often rests solely with the defendant. Because of this difficulty, intent is often inferred from circumstantial evidence.¹⁴

Finally, the plaintiff must show that the misrepresentation or omission was the direct and proximate cause of the claimed losses.¹⁵ In other words, a plaintiff must show causation. “To establish causation, [a] plaintiff must show both that [the] defendant’s misrepresentation induced [the] plaintiff to engage in the transaction in question (transaction causation) and that the misrepresentations directly caused the loss about which plaintiff complains (loss causation).”¹⁶

Transaction causation is often the easier of the two prongs to satisfy, while loss causation is typically more difficult. As noted by the Appellate Division, First Department in Laub: “[r]egardless of whether plaintiff could establish that he was induced by the alleged misrepresentations to follow [defendant’s] recommendations on purchases of equities, plaintiff’s claims must fail because he has not alleged or produced any evidence that those misrepresentations directly and proximately caused his investment losses.”¹⁷

Against the foregoing, we examine 100 & 130 Biscayne, LLC v. EE NWT OM, LLC, 2022 N.Y. Slip Op. 06985 (1st Dept. Dec. 8, 2022) (here), and Clarke v. Fifth Ave. Dev. Co., LLC, 2022 N.Y. Slip Op. 06991 (1st Dept. Dec. 8, 2022) (here).

Clarke v. Fifth Ave. Development Co., LLC

Clarke involved allegations that, among other things, the landlord withheld material information about the operability of the elevator in the building in which plaintiffs were renting an apartment.

Plaintiffs were parties to a one-year lease in an apartment in New York City. The building consists of six stories comprising 61 residential apartments, configured into three wings, with each wing serviced by one elevator; there are no freight or service elevators.

Defendants advertised the building to the public as a first-class residence, featuring, among other things, elevator service. Elevator service was important to residents for a number of reasons, including, throwing out the trash and accessing the washers and dryers in the basement. Absent elevator service, residents were obliged to use the stairs to carry up groceries or dry cleaning, walk dogs, retrieve mail or deliveries, and admit cleaning services.

When plaintiffs viewed the apartment before signing the lease, the elevator on their wing was in service. They were not told that it may be taken out of service in the future. At the time they signed the lease, the COVID-19 pandemic was in its initial stage. Plaintiffs alleged, on information and belief, that defendants had planned to replace the elevator in early 2020 but delayed the work due to the pandemic.

Within two months of the commencement of their lease, defendants informed plaintiffs that the elevator would be replaced and that the project was to commence within three weeks, with elevator service being suspended indefinitely. Fearing the loss of the elevator, plaintiffs vacated the apartment and moved into a one-bedroom apartment in Brooklyn, New York with other relatives.

In October 2020, plaintiffs were told that the elevator had been replaced. Thereafter, plaintiffs moved back into their apartment.

Plaintiffs contended that defendants’ failure to provide a working elevator for two months created a health and safety risk, constituted a partial constructive eviction from their apartment, violated the warranty of habitability and denied them their right to quiet enjoyment. Plaintiffs maintained that defendants refused to abate their rent for the two months at issue and reported their rent default to credit reporting agencies.

In their complaint, plaintiffs advanced causes of action for fraud, partial constructive eviction, breach of the warranty of habitability, and denial of quite enjoyment. They sought compensatory and punitive damages, as well as a judgment directing defendants to remove any adverse information from plaintiffs’ credit report and enjoining them from further damaging plaintiffs’ credit rating, abating their rent, and awarding them costs.

Defendants denied plaintiffs’ allegations and asserted as counterclaims that plaintiffs owed five months of rent as of November 2020, and that the lease required them to pay defendants’ legal fees.

Prior to the close of discovery, plaintiffs moved for summary judgment as to the issue of liability only. The motion court denied the motion. Plaintiffs appealed.

The Appellate Division, First Department affirmed.

The Court held that defendants did not owe plaintiffs a duty to disclose anything about the elevator and its replacement. The Court explained that as the landlord, in an arm’s-length transaction, defendants did not have an affirmative duty to tell plaintiffs anything about the repairs to the elevator: “an arm’s length transaction between a landlord and a tenant, as existed here, does not create a fiduciary relationship, and defendant landlord therefore had no affirmative duty to inform prospective tenants that repairs would take the elevator temporarily out of service.”¹⁸

The Court went on to say that even if defendants owed such a duty and failed to disclose the planned repairs, there were issues of fact surrounding defendants’ state of mind (i.e., scienter) that prevented the grant of summary judgment: “Even assuming that the cause of action for fraud rests on a theory that defendants affirmatively misrepresented the elevator’s availability during the lease period by, among other things, advertising elevator service on the building website, plaintiffs still did not sustain their burden on the motion, as the record presents an issue of fact whether defendants had the intent to defraud — a necessary element of a fraud claim.”¹⁹

100 & 130 Biscayne, LLC v. EE NWT OM, LLC

100 & 130 Biscayne arose from a joint venture to acquire and redevelop a 30-story office tower complex in Miami, Florida. Plaintiff holds an 80% membership interest in the joint venture (the “Company”). Defendant holds the other 20%. Under the joint venture agreement between the parties, defendant was charged with managing the day-to-day business operations of the Company.

In a nutshell, plaintiff alleged that its investment in the joint venture lost over $50 million in value as a result of defendants’ “gross mismanagement” of the project. Plaintiff asserted six causes of action: (1) breach of contract, (2) fraudulent inducement, (3) negligent misrepresentation, (4) breach of fiduciary duty, (5) gross negligence, and (6) declaratory relief.

Defendants moved to dismiss the complaint in its entirety for failure to state a cause of action. The motion court granted the motion.

The motion court held that plaintiff’s claims for fraudulent inducement and negligent misrepresentation were deficient because they were premised on subjective, non-actionable statements about predictions, expectations, or future performance. These allegations included, among others, presenting “projections” that turned out to be “out of line” with “norms in the relevant market”.

The motion court also held that plaintiffs’ fraud allegations were deficient because they were based on the failure to disclose future performance: “Similarly, allegations that Defendants had an “undisclosed intention to not comply with” the LLC Agreement, and that they misrepresented, in general terms, their own ability to perform the contract, fail to support a viable cause of action.”

The closest the complaint came to pleading misrepresentation of a material existing fact, said the motion court, was the assertion that Talpiot Management, LLC, an affiliate of defendant and the manager of the project, falsely represented its qualifications to do business in Florida. But, said the motion court, the complaint did not allege any facts to support the claim that Talpiot’s representations were false when made. The motion court also found that the complaint failed to specify how Talpiot’s alleged lack of qualifications inhibited its performance under the contract (i.e., caused plaintiffs to incur damages). Instead, noted the motion court, the complaint merely alleged that “upon information and belief … certain services undertaken by Talpiot … would have required Talpiot to be licensed as a real estate broker”: “the allegations fail to trace some reasonable connection between the lack of qualifications, on the one hand, and Plaintiff’s economic injury on the other.”²⁰

On appeal, the Appellate Division, First Department affirmed the dismissal of the fraud-based claims.

The Court agreed that the complaint failed to state a claim for fraudulent inducement and negligent misrepresentation (the second and third causes of action).²¹ “As drafted”, explained the Court, “those causes of action are based on predictions and expectations, which are actionable as fraud only if the complaint contains ‘allegations that the prediction was contradicted by a concrete, existing fact that defendant either intentionally failed to disclose or negligently failed to discover’”.²² The Court found that the “complaint [made] no such allegations”.²³

“Further,” said the Court, “both causes of action were also insufficient to the extent they failed to allege that defendants, at the time of making the promissory representation, never intended to honor their promise.”²⁴

The Court also held that “Plaintiff’s allegations regarding Talpiot were … insufficient to support the misrepresentation claims, as plaintiff [did] not sufficiently plead[ ] that its losses were caused by Talpiot’s lack of a real estate broker’s license” Therefore, concluded the Court, plaintiff “failed to plead loss causation — a necessary element even on a motion to dismiss — with respect to those allegations”.²⁶

Footnotes

Eurycleia Partners, LP v. Seward & Kissel, LLP, 12 N.Y.3d 553, 559 (2009) (citations omitted).
Dembeck v. 220 Cent. Park So., LLC, 33 A.D.3d 491, 492 (1st Dept. 2006).
Sehera Food Servs. Inc. v. Empire State Bldg. Co. L.L.C., 74 A.D.3d 542, 543 (1st Dept. 2010); Dembeck, 33 A.D.3d at 492.
Sehera, 74 A.D.3d at 543.
Id.
Id.
Dembeck, 33 A.D.2d at 492 (citation omitted).
Wyle Inc. v. ITT Corp., 130 A.D.3d 438, 439–41 (1st Dept. 2015).
Perella Weinberg Partners LLC v. Kramer, 153 A.D.3d 443, 449 (1st Dept. 2017); see Cronos Group Ltd. v. XComIP, LLC, 156 A.D.3d 54, 71 (1st Dept. 2017).
Pacnet Network Ltd. v. KDDI Corp., 78 A.D.3d 478, 479 (1st Dept. 2010); see also International Fin. Corp. v. Carrera Holdings Inc., 82 A.D.3d 641, 641-642 (1st Dept. 2011).
Zutty v. Rye (NOR), 33 Misc. 3d1226(A), 2011 WL 5962804 at *11 (Sup. Ct., N.Y. Co. Apr. 15, 2011).
Zanett Lombardier, Ltd. v. Maslow, 29 A.D.3d 495 (1st Dept. 2006) (citation omitted).
Houbigant, Inc. v. Deloitte & Touche LLP, 303 A.D.2d 92, 93 (1st Dept. 2003).
Pludeman v. N. Leasing Sys., Inc., 10 N.Y.3d 486, 488 (2008).
Friedman v. Anderson, 23 A.D.3d 163, 167 (1st Dept. 2005).
Laub v. Faessel, 297 A.D.2d 28, 31 (1st Dept. 2002).
Id. at 31.
Slip Op. at *1 (citations omitted).
Id. (citing, Lama Holding Co. v. Smith Barney, 88 N.Y.2d 413, 421 (1996)).
Citing, Laub, 297 A.D.2d at 31 (holding “there [must] be some reasonable connection between the act or omission of the defendant and the damage which the plaintiff has suffered”).
In so far as defendant EE Operating Member was concerned, the Court held that the misrepresentation claims were duplicative of the breach of contract claim that it found stated a cause of action. Slip Op. at *2 (citations omitted).
Slip Op. at *1 (quoting, Pacnet Network Ltd. V. KDDI Corp., 78 A.D.3d 478, 479 (1st Dept. 2010); and citing, International Fin. Corp. v. Carrera Holdings Inc., 82 A.D.3d 641, 641-642 (1st Dept. 2011)).
Id.
Id. (citations omitted).
Id.
Vandashield Ltd v. Isaacson, 146 A.D.3d 552, 553 (1st Dept. 2017).

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.