The Doctrine of Unconscionability and Fraudulent Inducement

• Posted on: Apr 10 2023

By: Jeffrey M. Haber

In Norman Realty & Constr. Corp. v. 151 E. 170th Lender LLC, 2023 N.Y. Slip Op. 01843 (1st Dept. April 6, 2023) (here), the Appellate Division, First Department addressed the affirmative defense of contract unconscionability, a topic that this Blog has not addressed in quite some time (here).¹ It also addressed plaintiff’s claims for breach of contract and fraudulent inducement. 

As discussed below, Norman Realty involved an action for unconscionability and fraudulent inducement. The Court affirmed the motion court’s order granting defendant’s motion for summary judgment dismissing plaintiff’s complaint, granting summary judgment on defendant’s counterclaims to foreclose on a mortgage and its security interest in the building and for a deficiency judgment against the additional counterclaim defendants, and denying plaintiffs’ cross-motion to amend the complaint and their answers to the counterclaims.  

A Primer on the Applicable Law:

Contract Interpretation

It has long been the law in New York that absent a violation of law, or some transgression of public policy, people are free to enter into contracts, making whatever agreement they wish no matter the wisdom of doing so.² Consequently, when a contract dispute arises, it is the court’s role to enforce the agreement rather than to reform it.³ 

To enforce the agreement, the court must construe it in accordance with the intent of the parties, the best evidence of which is the agreement itself and the terms contained therein.⁴ Thus, “when the parties set down their agreement in a clear, complete document, their writing should be enforced according to its terms”.⁵ 

Moreover, “a written agreement that is complete, clear and unambiguous on its face must be enforced according to the plain meaning of its terms”.⁶ Therefore, courts should refrain from interpreting agreements in a manner which implies something not specifically included by the parties, and “may not by construction add or excise terms, nor distort the meaning of those used and thereby make a new contract for the parties under the guise of interpreting the writing”.⁷ This rule of construction provides “stability to commercial transactions by safeguarding against fraudulent claims, perjury, death of witnesses [and] infirmity of memory”.⁸ 

When a writing is clear and complete, evidence outside its four corners “as to what was really intended but unstated or misstated is generally inadmissible to add to or vary the writing”.⁹ Whether a contract is ambiguous is a matter of law for the court to decide.¹⁰ A contract is unambiguous if the language it uses has “definite and precise meaning, unattended by danger of misconception in purport of the [agreement] itself, and concerning which there is no reasonable basis for a difference of opinion”.¹¹ Thus, if the contract is not reasonably susceptible to multiple meanings, it is unambiguous and the court is not free to alter it, even if such alteration reflects personal notions of fairness and equity.¹² 

Notably, silence, or the omission of terms within a contract, are not tantamount to ambiguity.¹³ Instead, the question of whether an ambiguity exists must be determined from the face of an agreement without regard to extrinsic evidence,¹⁴ and an unambiguous contract or a provision contained therein should be given its plain and ordinary meaning.¹⁵

While the parol evidence rule forbids proof of extrinsic evidence to contradict or vary the terms of a written instrument, it generally has no application in a suit brought where there are claims of fraud in the execution of an agreement or to rescind a contract on the ground of fraud.¹⁶ An exception, however, exists when the agreement between the parties expressly disclaims reliance on any oral representations in the making of the agreement.¹⁷ In other words, when a party disclaims reliance, in writing, on any oral representations in the execution of a contract, he/she cannot assert a claim for fraudulent inducement by claiming reliance on the very statements he/she disclaimed in writing.

In the absence of fraud or other wrongful act, a party who signs a written contract is presumed to know and have assented to the contents therein.¹⁸

The Doctrine of Unconscionability

To form a contract, the plaintiff must establish an offer, acceptance of the offer, consideration, mutual assent and an intent to be bound.¹⁹ A defense to the formation of a contract is its lack of conscionability from both a procedural and substantive perspective.²⁰ 

Under UCC § 2-302(1),²¹ 

[i]f the court as a matter of law finds the contract or any clause of the contract to have been unconscionable at the time it was made the court may refuse to enforce the contract, or it may enforce the remainder of the contract without the unconscionable clause, or it may so limit the application of any unconscionable clause as to avoid any unconscionable result.

Thus, under UCC § 2-302(1), an unconscionable contract is voidable.²² 

An unconscionable contract is one which “is so grossly unreasonable or unconscionable in the light of the mores and business practices of the time and place as to be unenforceable according to its literal terms”.²³ In other words, an unconscionable bargain is one that “no person in his or her senses and not under delusion would make on the one hand, and as no honest and fair person would accept on the other”.²⁴ 

The gravamen of an unconscionable contract is the “absence of meaningful choice on the part of one of the parties together with contract terms which are unreasonably favorable to the other party.²⁵ Whether a contract is unconscionable requires an examination of the contract formation process so as to determine the absence of meaningful choice.²⁶ To that end, to determine the absence of meaningful choice, courts focus on “the size and commercial setting of the transaction, whether deceptive or high-pressured tactics were employed, the use of fine print in the contract, the experience and education of the party claiming unconscionability, and whether there was disparity in bargaining power”.²⁷ 

UCC § 2-302(2) provides that when a party claims a contract should not be enforced because it is unconscionable, “the parties shall be afforded a reasonable opportunity to present evidence as to its commercial setting, purpose and effect to aid the court in making the determination.” This is because, generally, a claim of unconscionability only exists to protect the commercially illiterate, such that it does not lie in a commercial setting, where the parties dealing at arm’s length have equality of bargaining power.²⁸ Accordingly, where there exist no circumstances establishing that consent to the execution of a contract was not “freely and knowingly given”,²⁹ there is no claim for unconscionability.³⁰ Indeed, when a party is represented by counsel during the formation of a contract, courts have declined to uphold a claim for unconscionability.³¹ 

Whether a party can bring an affirmative claim to void an agreement for unconscionability has been clearly answered by the case law which proscribes it. It is clear that a party cannot bring an affirmative claim sounding in unconscionability in the formation of an agreement.³² In other words, unconscionability can only be asserted as a defense to the enforcement of a contract and not as a claim for money damages.

Fraudulent Inducement

To plead a cause of action for fraud, a plaintiff must allege that the defendant made a misrepresentation or omission of a material existing fact, which was false and known to be false by the defendant when made, for the purpose of inducing the plaintiff’s reliance thereon; that the plaintiff justifiably relied on such misrepresentation or omission; and that the plaintiff was injured thereby.³³ 

One of the more “nettlesome” elements of a fraud claim is justifiable reliance.³⁴ Whether a plaintiff justifiably relied on a misrepresentation or omission is a fact-intensive inquiry.³⁵ As the New York Court of Appeals observed, “[n]o two cases are alike ….” For this reason, the courts look to whether the plaintiff had the “means available to him for discovering, ‘by the exercise of ordinary intelligence,’ the true nature of a transaction he is about to enter into” and whether he made “use of those means”.³⁶ If the plaintiff does not do so, “he will not be heard to complain that he was induced to enter into the transaction by misrepresentations.”³⁷ After all, a plaintiff cannot claim justifiable reliance on a misrepresentation when he or she could have discovered the truth with reasonable diligence.³⁸

Whether a plaintiff exercised diligence in ascertaining the truth should not be determined by hindsight. As the Court of Appeals explained, when “a plaintiff has taken reasonable steps to protect itself against deception, it should not be denied recovery merely because hindsight suggests that it might have been possible to detect the fraud when it occurred.”³⁹ 

Sophisticated parties have a heightened duty to use the means available to them to verify the truth of the information upon which they rely and to use their sophistication to conduct due diligence.⁴⁰ A sophisticated plaintiff cannot establish justifiable reliance on an alleged misrepresentation if the plaintiff failed to make use of the means of verification that were available to him.⁴¹ Thus, to sustain a claim of fraud, sophisticated parties must have discharged their own affirmative duty to exercise ordinary intelligence and conduct an independent appraisal of the risks they are assuming.⁴²

With foregoing legal principles in mind, we examine Norman Realty.

Norman Realty & Constr. Corp. v. 151 E. 170th Lender LLC

Over the course of several years, plaintiff and defendant executed a series of agreements related to real property located in the Bronx, N.Y. (the “Property”). Pursuant to the mortgage and loan transactions governed by these agreements, plaintiff was the borrower and defendant was the lender.

In its complaint, plaintiff asserted three causes of action. The first and second causes of action alleged that the foregoing agreements violated UCC § 2-302, in that the agreements were discriminating, unconscionable, one-sided and oppressive. As a result of the foregoing, plaintiff alleged that it sustained extensive damage totaling $5,000,000. The third cause of action alleged that defendant defrauded plaintiff when it executed the agreements between the parties, that defendant knowingly and willfully failed to advise plaintiff that upon executing the agreements, plaintiff would immediately be in default at an interest rate of 24 percent, and that defendant promised to provide plaintiff with an extension agreement, but then delayed the same for four months in order to charge plaintiff additional interest on the loans. As a result, plaintiff sought to void the agreements between the parties.

In response, defendants filed an answer with counterclaims. The first counterclaim sought to foreclose on the mortgage because plaintiff defaulted thereunder. The second cause of action sought the sale of the property. The third cause of action sought a deficiency judgment against the guarantors of the note.

Defendant moved for summary judgment, seeking dismissal of the complaint and on its counterclaims for (1) foreclosure on the mortgage and the sale of the property; and (2) a deficiency judgment against the guarantors to the extent there was a difference between the amount owed under the note and the proceeds of the sale of the property. 

As noted, the motion court granted the motion.

First, the motion court found that plaintiff expressly waived its right to assert any claims arising from the agreement between the parties. The motion court observed that under the note, plaintiff specifically released any and all “defenses, counterclaims, offsets, cross-complaints or demands” that it could have asserted “to reduce or eliminate all or any part of [its] liability to repay any indebtedness to [defendant] or seek affirmative relief for damages of any kind or nature from [defendant]”. Thus, concluded the motion court, “by executing the agreement, plaintiff clearly and unambiguously waived its right to bring any claims and thus, the instant action is barred”.

Second, the motion court held that the causes of action for unconscionability were improperly affirmatively pleaded in the complaint and, as such, failed to state a claim upon which relief could be granted. The motion court also held that the cause of action failed because the loan documents in question “evince[d] a transaction between sophisticated business people dealing at arm’s length, [who] each were represented by counsel.” In fact, noted the motion court, plaintiff expressly stated and acknowledged in the restated note that it “engages in the business of real estate financings and other real estate transactions and investments which may be viewed as adverse to or competitive with the business of the Mortgagor or its affiliates,” and “that it is represented by competent counsel and has consulted counsel before executing the Loan Documents”.

Third, the motion court held that defendant established that the claim for fraudulent inducement was barred as a matter of law. In this regard, the motion court found that the mortgage contained a disclaimer in which plaintiff expressly asserted that the agreement was entered without reliance on anything told to it by defendant. The court noted that “while allegations that … plaintiff reasonably believed that the representation made [were] true and that plaintiff took justified action as a result thereof [gave] rise to a cause of action for fraudulent inducement,” the use of parol evidence … “to contradict or vary the terms of a written instrument” to “disclaim reliance on any oral representations in the making of the agreement” was prohibited. Thus, concluded the motion court, “none of the claims … regarding oral misrepresentations [were] admissible … to alter the clear and unambiguous terms of the loan documents”.

On appeal, the First Department affirmed.

The Court held that the “claims sounding in unconscionability were properly dismissed, as the doctrine of unconscionability ‘may not be used as a basis for affirmative recovery’”.⁴³ “Even if plaintiff could properly assert the claims,” noted the Court, “the record [did] not support a finding that the note and mortgage were procedurally and substantively unconscionable at the time they were executed”.⁴⁴ The Court explained that “plaintiff was represented by counsel during negotiation of the transaction,” a fact not in dispute, “and, aside from its conclusory allegations, plaintiff [had] not shown how the contract terms were so unreasonable as to render them unenforceable”.⁴⁵ 

The Court also held that “plaintiff failed to state a claim for fraudulent inducement, as it did not plead justifiable reliance”.⁴⁶ The Court explained that the terms of the agreements expressly contradicted any of the alleged false statements, which plaintiff could have easily discovered: “The allegations that defendant failed to advise plaintiff that it would be in default of the original 2018 note and mortgage, and that defendant would include the amounts owed upon that default in the subject 2020 note and mortgage, were contradicted by the express terms of the 2020 loan documents”.⁴⁷ [Ed. Note: this Blog examine the element of justifiable reliance and the hurdle a plaintiff has to satisfy the element when the alleged fraud is contradicted by the terms of an agreement (here).]

Footnotes

1. The defense has been discussed by this Blog in the context of arbitrations and damages clauses (e.g., here, here, and here).
2. Rowe v. Great Atlantic & Pacific Tea Co., Inc., 46 N.Y.2d 62, 67-68 (1978).
3. Grace v. Nappa, 46 N.Y.2d 560, 565 (1979).
4. Greenfield v. Philles Records, Inc., 98 N.Y.2d 562, 569 (2002).
5. Vermont Teddy Bear Co., Inc. v. 583 Madison Realty Co., 1 N.Y.3d 470, 475 (2004) (internal quotation marks omitted).
6. Greenfield, 98 N.Y.2d at 569.
7. Vermont Teddy Bear, 1 N.Y.3d at 475.
8. Wallace v. 600 Partners Co., 86 N.Y.2d 543, 548 (1995) (internal quotation marks omitted).
9. W.W.W. Assoc., Inc. v. Giancontieri, 77 N.Y.2d 157, 162 (1990).
10. Id. at 162; Van Wagner Adv. Corp. v. S & M Enterprises, 67 N.Y.2d 186, 191 (1986).
11. Greenfield, 98 N.Y.2d at 569 (quoting, Breed v. Ins. Co. of N. Am., 46 N.Y.2d 351, 355 (1978)).
12. Id. at 569-570.
13. Id. at 573; Reiss v. Financial Performance Corp., 97 N.Y.2d 195, 199 (2001).
14. Id. at 569-570.
15. Rosalie Estates, Inc. v. RCO Int’l, Inc., 227 A.D.2d 335, 336 (1st Dept. 1996).
16. Danann Realty Corp. v. Harris, 5 N.Y.2d 317, 320 (1959); Sabo v. Delman, 3 N.Y.2d 155, 161 (1957); Adams v. Gillig, 199 N.Y. 314, 319 (1910); Berger-Vespa v. Rondack Bldg. Inspectors Inc., 293 A.D.2d 838, 840 (3d Dept. 2002).
17. Danann Realty, 5 N.Y.2d at 323.
18. Pimpinello v. Swift & Co., 253 N.Y. 159, 162 (1930); Metzger v. Aetna Ins. Co., 227 N.Y. 411, 416 (1920).
19. 22 N.Y. Jur. 2d, Contracts Section 9.
20. Gillman, 73 N.Y.2d at 10 (“A determination of unconscionability generally requires a showing that the contract was both procedurally and substantively unconscionable when made….”) (citations omitted).
21. While the doctrine of unconscionability is recognized by article 2 of the UCC, which applies to transactions for the sale of goods, it has also been applied to other contracts.
22. King v. Fox, 7 N.Y.3d 181, 191 (2006); Gillman v. Chase Manhattan Bank, N.A., 73 N.Y.2d 1, 10 (1988).
23. Gillman, 73 N.Y.2d at 10.
24. Christian v. Christian, 42 N.Y.2d 63, 71 (1977) (internal quotation marks omitted).
25. King, 7. N.Y.3d at 191; Gillman, 73 N.Y.2d at 10.
26. Gillman, 73. N.Y.2d at 10-11.
27. Gillman, 73 N.Y.2d at 10-11; State v. Wolowitz, 96 A.D.2d 47, 68 (2d Dept. 1983).
28. Gillman v. Chase Manhattan Bank, N.A., 135 A.D.2d 488, 491 (2d Dept. 1987), aff’d, 73 N.Y.2d 1 (1988); Equit. Lbr. Corp. v. IPA Land Dev. Corp., 38 N.Y.2d 516, 523 (1976).
29. State v. Avco Fin. Serv. of New York Inc., 50 N.Y.2d 383, 390 (1980).
30. Id. at 391.
31.  FGH Contr. Co., Inc. v. Weiss, 185 A.D.2d 969, 971 (2d Dept. 1992).
32. Super Glue Corp. v. Avis Rent A Car Sys., Inc., 132 A.D.2d 604, 606 (2d Dept. 1987); see Fortune Limousine Serv., Inc. v Nextel Communications, 35 A.D.3d 350, 354 (2d Dept. 2006); Pearson v. Natl. Budgeting Sys., Inc., 31 A.D.2d 792, 792 (1st Dept. 1969).
33. Lama Holding Co. v. Smith Barney, 88 N.Y.2d 413, 421 (1996); see also New York Univ. v. Continental Ins. Co., 87 N.Y.2d 308, 318 (1995).
34. DDJ Mgt., LLC v. Rhone Group L.L.C., 15 N.Y.3d 147, 155 (2010) (internal quotation marks omitted).
35. Id.
36. 88 Blue Corp. v. Reiss Plaza Assoc., 183 A.D.2d 662, 664 (1st Dept. 1992) (internal citations omitted).
37. Id. (internal quotation marks omitted).
38. KNK Enters. Inc. v. Harriman Enters., Inc., 33 A.D.3d 872 (2d Dept. 2006).
39. DDJ Mgt., 15 N.Y.3d at 154.
40. McGuire Children, LLC v. Huntress, 24 Misc. 3d 1202[A], at *12 (Sup. Ct., Erie County), aff’d, 83A.D.3d 1418 (4th Dept. 2011).
41. Id.
42. Id.
43. Slip Op. at *1 (quoting, Avildsen v. Prystay, 171 A.D.2d 13, 16 (1st Dept. 1991), lv. dismissed, 79 N.Y.2d 841 (1992)).
44. Id.
45. Id. (citing, Gillman, 73 N.Y.2d at 10-12; State, 50 N.Y.2d at 390).
46. Id.
47. Id. (citing, A-Pix, Inc. v SGE Entertainment Corp., 222 A.D.2d 387, 389-390 (1st Dept. 1995)). The Court disagreed with the motion court as to the application of the disclaimer, finding that it was too general to bar the fraudulent inducement claim. Id. This Blog addressed the specificity required for a disclaimer to operate as a bar to a fraud claim here and 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.