Fraud Notes: The Duplication of Claims Doctrine

• Posted on: Jul 13 2020

It is not uncommon for plaintiffs to assert breach of contract and fraud in the same action. It is also not uncommon for the fraud claim to be dismissed as duplicative of the contract claim. Indeed, the reporters are brimming with cases in which the fraud claim is dismissed because it is nothing more than a breach of contract claim dressed up in the language of fraud. The cases we examine today, East Coast Int’l Tire Group, Inc. v. New York Tire Factory, Inc., 2020 N.Y. Slip Op. 03769 (2d Dept. July 8, 2020) (here), and Rosenthal & Rosenthal of California, Inc. v. Malka, 2020 N.Y. Slip Op. 32165(U) (Sup. Ct., N.Y. County June 30, 2020) (here), are no different.

Quick Primer of the Law

“A cause of action for fraud does not arise when the only fraud charged relates to a breach of contract.” Krantz v. Chateau Stores of Can. Ltd., 256 A.D.2d 186, 187 (1st Dept. 1998) (citations omitted). 

“To plead a viable cause of action for fraud arising out of a contractual relationship, the plaintiff must allege a breach of duty which is collateral or extraneous to the contract between the parties.” Id. (citations and quotation marks omitted). One way to satisfy this requirement is to allege a present intent to deceive. In doing so, however, the plaintiff cannot allege “a mere misrepresentation of an intention to perform under the contract.” WIT Holding Corp. v. Klein, 282 A.D.2d 527, 528 (2d Dept. 2001) (citation omitted); see also Gorman v. Fowkes, 97 A.D.3d 726, 727 (2d Dept. 2012). Another way to satisfy the requirement is to allege a misrepresentation of material fact, which is collateral to the contract and serves as an inducement for the contract. Id. at 528 (citation omitted). 

East Coast Int’l Tire Group, Inc. v. New York Tire Factory, Inc.

East Coast International Tire involved an alleged failure to pay for goods. Plaintiff commenced the action against New York Tire Factory, Inc. (“Tire Factory”), and its president, Richard A. Entel (“Entel), alleging that Tire Factory had purchased a substantial number of tires from plaintiff, and failed to pay the agreed-upon price. In its first cause of action, plaintiff alleged breach of contract by Tire Factory. In its third cause of action, plaintiff alleged that Entel falsely represented that Tire Factory had sufficient funds to pay for the tires, and that he later issued checks on behalf of Tire Factory for which he subsequently stopped payment.

After an apparent bankruptcy stay, plaintiff moved to restore the action to the court’s calendar. Defendants cross-moved, inter alia, pursuant to CPLR § 3211(a)(7) and CPLR § 3016(b), to dismiss the third cause of action. The motion court, among other things, granted defendants’ cross-motion to dismiss the fraud cause of action. Plaintiff appealed.

The Appellate Division, Second Department affirmed, holding that “the third cause of action did not allege any misrepresentation of present fact which induced the plaintiff to enter into the contract …, but only a misrepresentation of a future intent or ability to perform under the contract.” Slip Op. at *1-*2 (citations omitted). Plaintiff alleged that “Entel used his domination and control over [defendant] to defraud the Plaintiff, by accepting delivery of the goods in question and by refusing to pay for them, thereby causing Plaintiff to sustain injury and monetary damages.” (See Compl. ¶ 36.)

Rosenthal & Rosenthal of California, Inc. v. Malka

Rosenthal arose from a factoring agreement (the “Agreement”) between plaintiff and non-party Halston Operating Company, LLC (“HOC”) pursuant to which HOC assigned its receivables to plaintiff in exchange for cash. 

HOC promised that the assigned receivables were “bona fide, existing and enforceable obligations of Customers arising out of sales or services … ,  free and clear of all security interests, liens, claims and Disputes whatsoever other than Permitted Liens.” HOC further warranted that “to [its] knowledge the Customer will accept the Inventory and/or such services without any offset or counterclaim.” 

In early 2017, HOC and a related entity defaulted on a loan given by Bank Hapoalim, B.M. (the “Bank”). Plaintiff alleged that to restructure the debt and generate a payment stream, defendant, among other things, structured a new supply arrangement of product to retailers. Under the arrangement, HOC assumed risks originally borne by the retailers by guaranteeing “minimum gross margins” for the sale of its products. Apart from giving retailers “guaranteed minimum margins and return rights,” the restructuring also increased royalty payments that were “timed to the [Bank] payments” in connection with repaying the debt. Plaintiff alleged that the new structure was “driven solely by a desire” for defendant “to enhance his financial interests” in other related entities by agreeing “to do their bidding” by satisfying the Bank debt.

Plaintiff alleged that the new structure breached the Agreement because customers could claim deductions if the minimum profit margins were not met even after the receivables had been assigned to plaintiff. 

According to plaintiff, a related entity developed “a new secret plan” under which HOC would keep borrowing from plaintiff by falsely representing there were no claims or offsets on the receivables. Defendant allegedly colluded in the “scheme” by “arrang[ing] for customers to defer their chargebacks” to ensure that plaintiff would remain “in the dark about the extent of the margin guarantees” and customer claims while advancing further funds for the misleadingly valued receivables. Plaintiff alleged that defendant falsely told plaintiff that there were no deductions on the receivables. Plaintiff asserted that defendant directed a non-party, Hudson’s Bay, to defer a claim for a $2 million deduction to perpetuate the “scheme” against plaintiff.

In late 2018, defendant advised plaintiff he had resigned from HOC and that HOC had entered into an assignment for the benefit of creditors. Plaintiff attempted to liquidate the collateral but faced “disaster[ous]” “customer dilutions in the range of 75% from one … major customer” (i.e., Hudson’s) and other offsets resulting in “millions of dollars” in losses. In sum, plaintiff alleged it incurred more than $10 million in damages as a result of HOC’s wrongdoing.

Defendant moved to dismiss the complaint. With regard to the fraud the claim, the Court granted the motion.

Defendant argued that plaintiff’s fraud claim was simply a “repackaged claim that HOC breached the Agreement.” Slip Op. at *8. The Court agreed, finding that “Plaintiff [did] not allege facts suggesting that Defendant had an independent duty to provide information regarding HOC’s financial position or to ensure HOCs performance under the Agreement.” Accordingly, the Court dismissed the fraud claim because plaintiff failed to allege “a breach of duty [that was] collateral or extraneous to the contract between the parties.” Krantz, 256 A.D.2d at 187. 

Takeaway

New York courts do not allow a fraud claim to survive a motion to dismiss when the claim arises from an alleged breach of contract or failure to perform an obligation under the 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. Clark-Fitzpatrick v. Long Is., 70 N.Y.2d 382 (1987). 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 fraud claim can stand side-by-side with “a simple breach of contract” claim. Dormitory Auth. v. Samson Constr. Co., 30 N.Y.3d 704 (2018) (citation omitted).

Today’s examination of East Coast International Tire and Rosenthal highlights the difficulty plaintiffs often have identifying a legal duty independent of the contract at issue. As discussed above, in both cases, the plaintiffs were unable to satisfy this standard.