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Fraudulent Inducement, Breach of Fiduciary Duty, Statute of Limitations, The Continuing Wrong Doctrine and A Whole Lot More

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  • Posted on: Mar 23 2020

Sometimes this Blog gets to address numerous issues in its examination of a case. In MDK Hijos Trust v. Nordlicht, 2020 N.Y. Slip Op. 30793(U) (Sup. Ct., N.Y. County Mar. 10, 2020) (here), we get the opportunity to do so again.

MDK Hijos Trust v. Nordlicht

Background

Plaintiff, MDK Hijos Trust (“Plaintiff” or “MDK”), sought damages for, among other claims, fraudulent inducement and breach of fiduciary duty in connection with investments by the Katz family (Marcos Katz and Adela Kenner de Katz) in Platinum Partners Value Arbitrage Fund International Ltd. (“PPVA” or “Platinum”). PPVA was managed by Platinum Management LLC (“Management”), whose principals were defendants Mark Nordlicht (“Nordlicht”), Murray Huberfeld (“Huberfeld”), David Bodner (“Bodner”), Bernard Fuchs (“Fuchs”) and Gilad Kalter (“Kalter” and together with Nordlicht, Huberfeld, Bodner and Fuchs, “Defendants”).

MDK is a trust and the assignee of the claims of the Katz family, which invested approximately $39 million in PPVA. Though managed by Management, PPVA was managed by Huberfeld, Bodner and Nordlicht, who were the alleged “primary principals and decision-makers” of Management. 

According to Plaintiff, Defendants repeatedly represented that PPVA had more than a decade of positive returns, averaging 17% between 2003 and 2015, and that PPVA was liquid, thereby permitting investors to redeem their investments on 60 or 90 days’ notice and receive payment of 90% of their redemption requests within 30 days thereafter. As a result, between 2006 and May 1, 2015, the Katz family invested approximately $39.9 million in PPVA.

Plaintiff alleged that unbeknownst to investors, PPVA faced a material liquidity crisis. According to Plaintiff, PPVA’s concentration of illiquid assets made it increasingly difficult for Management to pay investor redemptions as requested. Indeed, said Plaintiff, as early as November 2012, redemption requests overwhelmed PPVA, a phenomenon Defendants described as “daunting” and “relentless.” Nevertheless, claimed Plaintiff, Defendants kept investors in the dark about PPVA’s liquidity crisis, while Management continued to market the fund’s flexible redemption terms even as it struggled to pay redemptions.

According to Plaintiff, Defendants repeatedly represented that PPVA was liquid, had sufficient assets to permit withdrawals and was structurally sound. Plaintiffs alleged that Defendants knew these statements were false, given the extent of PPVA’s illiquidity problems and the amount of redemption requests, which far exceeded PPVA’s overstated assets.

In June 2016, the United States Attorney’s Office for the United States District Court for the Southern District of New York brought criminal charges against Huberfeld in connection with a bribery scheme in which he was alleged to have paid “kickbacks” to a union official to obtain the union’s retirement fund investments in PPVA when it was experiencing liquidity problems. Nordlicht and other members of Management were indicted for fraud, and the SEC sued Management, Nordlicht and others for violating the federal securities laws. 

The Complaint alleged that prior to June 2016, the Katzes were unaware and could not have been aware that Defendants, Management and PPVA were part of a fraudulent scheme, and that Defendants’ statements were knowingly false, given their positions within Management and PPVA and their access to inside information. Plaintiff alleged that it was owed at least $39 million.

Each of the Defendants moved to dismiss, among other claims, the breach of fiduciary duty and fraudulent inducement causes of action. The Court denied the motions.

The Court’s Decision

The Breach of Fiduciary Duty Claim 

To state a claim for breach of fiduciary duty, a plaintiff must allege the existence of a fiduciary duty owed by the defendant, a breach of that duty and resulting damages. Jones v. Voskresenskaya, 125 A.D.3d 532, 533 (1st Dept. 2015). Defendants claimed that Plaintiff failed to satisfy the first element of the claim, arguing that a fiduciary duty “will not be found to exist where the complaint only alleges an arms-length business relationship involving sophisticated business people or where the parties are adversaries,” or where the gravamen of the claim is “advice alone”. EBC I, Inc. v. Goldman Sachs & Co., 91 A.D.3d 211, 214-215 (1st Dept. 2011). Defendants (other than Fuchs (the “Other Defendants”)) also contended that the Complaint failed to allege sufficient facts to show that each of them was a fiduciary to the Katzes; that even though Management was a registered investment advisor, there were no allegations that each of them served as an advisor to the Katzes; that a fiduciary duty cannot be imposed unilaterally; that the losses sustained by the Katzes were due to the underperformance of their investments, which is inadequate to sustain a breach of fiduciary duty claim; and that MDK failed to plead the claim with specificity as required by CPLR § 3016(b).

The Court found Defendants’ arguments and reliance on EBC to be “unpersuasive”. Slip Op. at *12. The Court explained that “until the lawsuit was filed, the Katzes and Fuchs were not adversaries, and Fuchs [did] not allege otherwise.” Id. More significantly, noted the Court, there was no fiduciary relationship in EBC – the case involved an underwriter and an issuer of stock working at arm’s length; no fiduciary duty arose from “the underwriting agreement alone”. Id. (citing EBC, 91 A.D.3d at 214). By contrast, observed the Court, a fiduciary relationship existed between the Katzes and Defendants due to Defendants’ failure “to disclose to the Katzes that PPVA had liquidity issues and that the value of PPVA’s assets were grossly overstated,” and Defendants’ “superior expertise or knowledge regarding the operations of Management and PPVA,” upon which “the Katzes relied … when making their investments.” Id. at **12-13. In other words, held the Court, “the breach of fiduciary duty claim [was] not based on a written agreement with Defendants.” Id. at *12. Thus, concluded the Court, “EBC’s holding and rationale” was “inapplicable”. Id. 

The Fraudulent Inducement Claim

To state a claim for fraudulent inducement, “there must be a knowing misrepresentation of material present fact, which is intended to deceive another party and induce that party to act on it, resulting in injury.” GoSmile, Inc. v. Levine, 81 A.D.3d 77, 81 (1st Dept. 2010), lv. dismissed, 17 N.Y.3d 782 (2011). See also Wyle Inc. v. ITT Corp., 130 A.D.3d 438, 439–41 (1st Dept. 2015); MBIA Ins. Corp. v. Countrywide Home Loans, Inc., 87 A.D.3d 287, 294 (1st Dept. 2011). A plaintiff alleging fraudulent inducement must satisfy each element in order to prevail, whether it be on a motion or at trial. Menaco v. New York Univ. Med. Ctr., 213 A.D.2d 167 (1st Dept. 1995). The failure to satisfy any one element will, therefore, result in the dismissal of the action. Gregor v. Rossi, 120 A.D.3d 447 (1st Dept. 2014).

In addition, the allegations must be stated with particularity to satisfy CPLR § 3016(b). Eurycleia Partners, LP v. Seward & Kissel, LLP, 12 N.Y.3d 553, 558 (2009). Thus, the plaintiff must provide sufficient facts to support a “reasonable inference” that the allegations of fraud are true. Id. at 559-60. Conclusory allegations will not suffice. Id. Neither will allegations based on information and belief. See Facebook, Inc. v. DLA Piper LLP (US), 134 A.D.3d 610, 615 (1st Dept. 2015) (“Statements made in pleadings upon information and belief are not sufficient to establish the necessary quantum of proof to sustain allegations of fraud.”).

Although, CPLR § 3016(b) provides that “the circumstances constituting the [fraud] shall be stated in detail,” the New York Court of Appeals has “cautioned that section 3016 (b) should not be so strictly interpreted as to prevent an otherwise valid cause of action in situations where it may be impossible to state in detail the circumstances constituting a fraud.” Pludeman v. Northern Leasing, Sys., Inc., 10 N.Y.3d 486, 491 (2008) (internal quotation marks and citations omitted). Thus, where the facts “are peculiarly within the knowledge of the party charged with the fraud,” and “it would work a potentially unnecessary injustice to dismiss a case at an early stage where any pleading deficiency might be cured later in the proceedings,” dismissal should be denied. Id. at 491-92 (internal quotation marks and citations omitted). See also CPC Intl. v. McKesson Corp., 70 N.Y.2d 268, 285-286 (1987).

Fuchs argued that the fraudulent inducement claim should be dismissed because it was based on “information and belief” and otherwise failed to allege that Defendants knew their statements were false when made and intended to induce the Katzes to invest and keep such investments in PPVA. The Court found these arguments to be “unavailing”. Slip Op. at *14. 

The Court explained that “CPLR 3016 (b) simply require[d] that a complaint allege ‘the basic facts’ to establish a fraud claim, which is met when the alleged facts are ‘sufficient to permit a reasonable inference of the alleged conduct.’” Id. (citing Sargiss v. Magarelli, 12 N.Y.3d 527, 530-531 (2009), quoting Pludeman, 10 N.Y.3d at 491-492). Notably, the Court warned that the particularity requirement “should not be confused with unassailable proof of fraud.” Id. (citing id.) Against these principles, the Court found that the Complaint contained a rational basis for “inferring that the alleged misrepresentation was knowingly made because [Plaintiff] allege[d] that Defendants, including Fuchs, made misrepresentations when PPVA was in fact suffering a liquidity crisis and was unable to pay redemptions.” Id. (citing Houbigant, Inc. v. Deloitte & Touche, LLP, 303 A.D.2d 92, 98 (1st Dept. 2003) (complaint did not need not to prove scienter; sufficient that it contained “some rational basis for inferring that the alleged misrepresentation was knowingly made”)).

The Court rejected Defendants’ argument that Plaintiff failed to plead justifiable reliance because it could have discovered the truth in connection with the many roadblocks encountered in trying to redeem its investment. Slip Op. at *15, *27. The Court held that the “argument [was] insufficient.” Slip Op. at *15. The Court reasoned that “[w]hile it is true that a heightened degree of diligence is needed when a party to whom a misrepresentation is made has hints of its falsity, ‘the question of what constitutes reasonable reliance is not generally a question to be resolved as a matter of law on a motion to dismiss.’” Id. (quoting ACA Fin. Guar., 25 N.Y.3d at 1045, and citing Allenby, LLC v. Credit Suisse, AG, 134 A.D.3d 577, 580-581 (1st Dept. 2015)).

The Other Defendants argued that these claims should be dismissed because they were actually breach of contract claims. In response, Plaintiff argued that it was not seeking contract damages because the Other Defendants “were not parties to any enforcement contract with the Katzes.” Slip Op. at *29. The Court agreed with Plaintiff. In doing so, the Court explained that the PPVA was not a defendant in the action and no breach of contract claim was asserted against it or the Other Defendants. Therefore, concluded the Court, “the fraud and misrepresentation claims [were] not ‘duplicative’ of the non-asserted breach of contract claim.” Id. at **29-30.

In addition, the Court held that Defendants as principals and officers of a corporation or other business entity could be held personally liable for their own fraudulent misconduct or other tortious acts. Id. at *30 (citing Espinosa v. Rand, 24 A.D.3d 102, 102 (1st Dept. 2005) (corporate officer who participated in the commission of a tort may be held individually liable regardless of whether he acted on behalf of the corporation and regardless of whether the corporate veil is pierced); American Express Travel Related Servs. Co. v. North Atl. Resources, Inc., 261 A.D.2d 310, 311 (1st Dept. 1999) (same)). 

Finally, the Court rejected Bodner’s argument that the Complaint failed to meet the particularity requirement of CPLR § 3016(b), because the Complaint suffered from “group pleading”. In that regard, the Court noted that group pleading “is permissible in some circumstances, and that CPLR 3016 (b) only requires that a complaint alleges the ‘basic facts,’ which is met when the alleged facts are ‘sufficient to permit’ a reasonable inference of the alleged [fraudulent] conduct.” Slip Op. at *30 (citing, among other cases, Pludeman). 

The Statute of Limitations and The Continuing Wrong Doctrine 

The statute of limitations for a fraudulent inducement claim is the greater of (a) six years from the date when the cause of action accrued or (b) two years from the time plaintiff discovered the fraud or could with reasonable diligence have discovered the fraud. CPLR § 213(8). The cause of action accrues when “every element of the claim, including injury, can truthfully be alleged” (Carbon Capital Mgmt., LLC v. Am. Express Co., 88 A.D.3d 933, 939 (2d Dept. 2011) (citation and alterations omitted)), “even though the injured party may be ignorant of the existence of the wrong or injury.” Schmidt v. Merchants Despatch Transp. Co., 270 N.Y. 287, 300 (1936).

The two-year discovery rule requires an inquiry into “whether a person of ordinary intelligence possessed knowledge of facts from which the fraud could be reasonably inferred.” Kaufman v. Cohen, 307 A.D.2d 113, 123 (1st Dept. 2003) (internal quotation marks and citation omitted); see also Erbe v. Lincoln Rochester Trust Co., 3 N.Y.2d 321, 326 (1957). “[M]ere suspicion will not constitute a sufficient substitute” for knowledge of the fraud. Eberle, 3 N.Y.2d at 326. “Where it does not conclusively appear that a plaintiff had knowledge of facts from which the fraud could reasonably be inferred, a complaint should not be dismissed on motion and the question should be left to the trier of the facts.” Trepuk v. Frank, 44 N.Y.2d 723, 725 (1978).

Moreover, “where an allegation of fraud is essential to a breach of fiduciary duty claim, courts [apply] a six-year statute of limitations under CPLR 213 (8).” IDT Corp. v. Morgan Stanley Dean Witter & Co., 12 N.Y.3d 132, 139 (2009).

Huberfeld argued that, of the $39 million invested by the Katzes, $26.5 million was invested prior to May 1, 2011 (allegedly induced by fraud and misrepresentation). Thus, the claims related to the $26.5 million portion of the investments were time-barred as they accrued more than six years before commencement of the action in September 2018.

Huberfeld also argued that Plaintiff’s fraudulent inducement claim was time-barred under the discovery rule. In that regard, Huberfeld maintained that the remaining investments were made between August 2014 and May 2015, more than three years before commencement of the action and more than two years after the fraudulent scheme was allegedly discovered by the Katzes in June 2016, when the government brought criminal charges against Nordlicht and other members of Management in connection with the bribery scheme and the securities laws violation. 

In opposition, Plaintiff contended that the continuing wrong doctrine applied to toll the statute of limitations. Plaintiff maintained that, because the last actionable act occurred in May 2016, when the Other Defendants met with the Katzes and misrepresented the liquidity of PPVA and its ability to pay redemption requests, its fraudulent inducement and misrepresentation claims accrued within six years and, therefore, were timely. 

Under the continuing wrong doctrine, “where there is a series of continuing wrongs,” the statute of limitations will be tolled to the last date on which a wrongful act is committed. Henry v. Bank of Am., 147 A.D.3d 599, 601 (1st Dept. 2017).  The application of the continuing wrong doctrine must “be predicated on continuing unlawful acts and not on the continuing effects of earlier unlawful conduct.” Id. The doctrine is inapplicable where there is one tortious act and “continuing consequential damages” that arise therefrom. Town of Oyster Bay v. Lizza Indus., Inc., 22 N.Y.3d 1024, 1032 (2013).

The Court agreed with Plaintiff, finding that subsequent to May 2011 (after the Katzes made their $26.5 million investment), “the Other Defendants continued to defraud the Katzes by, among other things, misrepresenting the asset values of PPVA, concealing or failing to disclose its liquidity problems, and misleadingly representing that PPVA had sufficient assets to honor their redemption requests.” Slip Op. at *24. The Court explained that “[a]lthough the continuing wrong doctrine must be narrowly applied, the Complaint adequately alleges that the Other Defendants continued to defraud the Katzes and made misrepresentations to them, which caused them to maintain their investment in PPVA, invest more money, and sustain additional losses.” Id. “Because these claims are premised upon ‘continuing unlawful acts and not on the continuing effects of earlier unlawful conduct,’” said the Court, “the continuing wrong doctrine is applicable to claims that accrued earlier in May 2011, so long as the Complaint also adequately alleges that the ‘last actionable act’ of the Other Defendants occurred in May 2016, as Plaintiff contends.” Id.

The Court also rejected Huberfeld’s reliance on the discovery rule, holding that “even though the Katzes admittedly discovered the alleged fraud in June 2016, more than two years before this action was commenced, that allegation has no adverse effect because the limitations period is the greater of six years from when the claim accrued or two years from when the fraud was discovered.” Id. 

Finally, the Court held that “the fraud claim [was] essential to the breach of fiduciary duty claim,” and, therefore, the six-year limitations period was applicable to the breach of fiduciary duty claim. Id. at *25. As such, the claim was “timely, even in the context of a May 1, 2015 claim accrual date.…” Id. 

Accordingly, the Court concluded that the fraudulent inducement, misrepresentation and breach of fiduciary duty claims were not time-barred.

Takeaway

As the title of this post indicates, MDK involved several claims and related principles of law. Aside from the number of issues addressed by the Court, MDK reveals a reluctance by the Court to dismiss a fraud- and fiduciary duty-based complaint at the early stages of the litigation – presumably because many of the issues are traditionally ones that are infused with factual disputes that are not ripe for determination on a pre-answer motion to dismiss. This reluctance is consistent with the New York Court of Appeals’ warning that courts should not, in determining a motion to dismiss, consider whether the plaintiff can “ultimately establish its allegations.” J P. Morgan Sec. Inc. v Vigilant Ins. Co., 21 N.Y.3d 324, 334 (2013) (internal quotation marks and citation omitted). 

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