The Duplication of Claims Doctrine Gets Tested in a Dispute Involving an Asset Purchase Agreement and Alleged False Financial Statements

• Posted on: Jul 17 2019

Readers of this Blog know that, as a general matter, New York courts will not permit a fraudulent inducement claim to survive a motion to dismiss when the claim arises from a breach of contract. Indeed, courts routinely dismiss a fraudulent inducement 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 fraudulent inducement 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). See also McKernin v. Fanny Farmer Candy Shops, Inc., 176 A.D.2d 233, 234 (2d Dept. 1991).

What constitutes “a legal duty independent of a contract” is not a question easily answered.  Cronos Group Ltd. v. XComIP, LLC, 156 A.D.3d 54, 56 (1st Dept. 2017) (referring to the question as a “recurring” one). In trying to answer the question, the courts make the distinction between a misrepresentation of intention and a misrepresentation of present fact. Id. at 63. See also Demetre v. HMS Holdings Corp., 127 A.D.3d 493, 494 (1st Dept. 2015) (common law fraud is duplicative of breach of contract where the only misrepresentation alleged concerns an “intent to perform the contractual obligations at the time they were made.”). The former will result in dismissal, while the latter will not. Gosmile, Inc. v. Levine, 81 A.D.3d 77 (1st Dept. 2010).

In Did-it.com, LLC v. Halo Group, Inc., 2019 N.Y. Slip Op. 05644 (July 17, 2019) (here), the Appellate Division, Second Department, reversed the dismissal of a fraudulent inducement claim, holding that the claim contained “misrepresentations of present fact that were collateral to the” contract before it and, therefore, “was not duplicative of the breach of contract cause of action.” Slip Op. at *1 and *2.  

Did-it.com arose from the sale of the Halo Group, Inc.’s (“Halo”) assets to Did-it.com, LLC (“Did-it”). In May 2017, Did-it and Halo entered into an asset purchase agreement (the, “APA”), pursuant to which plaintiff agreed to purchase all of Halo’s assets.

The APA contained a number of representations and warranties, including that: 1) the 2016 financial statements provided by Halo to Did-it were accurate and complete; and 2) there were no adverse changes or events subsequent to the preparation of Halo’s 2016 financial statements that would result in, inter alia, a loss of customers or a reduction in revenues. Did-it claimed that these, and other representations, induced it to pay $1.5 million to purchase Halo’s assets.

According to the complaint, following the closing of the transaction (“Closing”), Did-it learned that the assets (“Assets”) it had purchased from Halo were worth significantly less than what was represented, bargained for, and otherwise agreed upon. The client accounts purchased from Halo generated approximately $5,000 in revenues for Did-it during the first month after the Closing, although Halo’s 2016 financials reflected average monthly revenues in excess of $300,000. Did-it also learned after the Closing that all but one of Halo’s customers listed in defendants’ disclosures had ceased doing business with the company. Defendants also failed to turn over all of the Assets to Did-it as required under the APA.

In June 2017, plaintiff commenced the action. In an amended complaint, plaintiff asserted six causes of action, including the first cause of action, alleging fraudulent inducement, and the third cause of action, alleging breach of contract. Prior to answering, defendants moved pursuant to CPLR 3211(a) to dismiss the amended complaint. The Supreme Court, inter alia, granted that branch of the motion which was to dismiss the first cause of action. Plaintiff appealed.

In seeking dismissal, defendants argued, among other things, that Did-it failed to allege any facts to support its claim that defendants misrepresented the company’s finances, and failed to allege any facts that the financial statements were false and exaggerated or that a material adverse change occurred that Halo failed to disclose. Defendants maintained that Did-it merely made conclusory allegations that were contradicted by the actual facts and the express terms of the APA.

Defendants also contended that Did-it’s fraud claim was duplicative of its breach of contract claim because it was based on representations in the APA; namely, that the 2016 financial statements were accurate and complete and there were no adverse changes or events subsequent to the preparation of the financial statements that would result in, inter alia, a loss of customers or a reduction of revenues. Thus, the false statements alleged in the amended complaint were not, and could not be, collateral or extraneous to the parties’ agreement.

Plaintiff opposed the motion arguing, inter alia, that it stated a viable claim for fraudulent inducement by alleging that defendants made misrepresentations pursuant to the APA by providing 2016 financial statements that reflected a healthy business, providing a warranty that the financial statements were accurate and not misleading, and providing a warranty that no adverse changes had occurred since the financials were prepared. Plaintiff argued that these allegations constituted misrepresentations of present fact that were collateral to the APA.

As noted, the Supreme Court dismissed the first cause of action, finding that the fraudulent inducement claim was duplicative of the breach of contract claim. The court held that the representations cited by plaintiff were “material terms of the APA” and, therefore, “duplicative of express representations made in the APA” that plaintiff claimed defendants had breached.

On appeal, the Second Department reversed. In so holding, the Court found that plaintiff “allege[d] misrepresentations of present fact that were collateral to the APA” and that those “misrepresentations induced the plaintiff to enter into the APA.” Slip Op. at *2. Consequently, said the Court, the Supreme Court “should have denied that branch of the defendants’ motion which was to dismiss the first cause of action.” Id.

Takeaway

Unfortunately, the Court did not provide an explanation for its holding. The absence of such an explanation leaves one trying to determine why the fraudulent inducement claim differed from the breach of the contract claim. In the fraud scenario, plaintiff must prove that the financial statements were not accurate. In the contract scenario, plaintiff must prove that the representation and warranty concerning the financial statements were breached – that is, that the financial statements were not accurate. Under either claim, therefore, the accuracy of the financial statements is at issue.

Perhaps the foundational underpinning of the Court’s ruling is based on the principle that “[a] warranty is not a promise of performance, but a statement of present fact.” First Bank of Ams. v. Motor Car Funding, 257 A.D.2d 287, 292 (1st Dept. 1999). If so, then it stands to reason that defendants’ representation and warranty concerning the financial statements was collateral to the APA.

Regardless of the reason for the decision, Did-it.com stands for the proposition that a fraudulent inducement claim and a breach of contract claim can stand side-by-side when the alleged false statement is collateral to the contract at issue and induces the plaintiff to enter into the agreement.