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The Duty to Another in the Context of Negligence, Negligent Misrepresentation and Fraud Causes of Actions

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  • Posted on: May 11 2020

This Blog has examined cases involving the duty to disclose information, often in the context of an alleged omission (E.g., here). In today’s article, we primarily look at the duty to another in the context of negligence and negligent misrepresentation causes of action. Shavolian v. Donegan, 2020 N.Y. Slip Op. 31181(U) (Sup. Ct., N.Y. County May 5, 2020) (here).

Negligence and Negligent Misrepresentation

To establish a cause of action sounding in negligence, a plaintiff must establish the existence of a duty on the defendant’s part to the plaintiff, in addition to an actual breach of the duty and damages. See Greenberg, Trager & Herbst, LLP v. HSBC Bank USA, 17 N.Y.3d 565, 576 (2011). 

“A claim for negligent misrepresentation requires the plaintiff to demonstrate (1) the existence of a special or privity-like relationship imposing a duty on the defendant to impart correct information to the plaintiff; (2) that the information was incorrect; and (3) reasonable reliance on the information.” J.A.O. Acquisition Corp. v. Stavitsky, 8 N.Y.3d 144, 148 (2007); see also Mandarin Trading Ltd. v. Wildenstein, 16 N.Y.3d 173, 180 (2011). “‘[L]iability for negligent misrepresentation has been imposed only on those persons who possess unique or specialized expertise, or who are in a special position of confidence and trust with the injured party such that reliance on the negligent misrepresentation is justified.’” Fresh Direct, LLC v. Blue Martini Software, Inc., 7 A.D.3d 487, 489 (2d Dept. 2004) (quoting Kimmell v. Schaefer, 89 N.Y.2d 257, 263 (1996). Notably, the relationship “requires a closer degree of trust than an ordinary business relationship.” Fleet Bank v. Pine Knoll Corp., 290 A.D.2d 792, 795 (3d Dept. 2002) (internal quotation marks and citation omitted). For this reason, arm’s-length transactions between sophisticated parties do not give rise to privity. See Greenberg, Trager & Herbst, 17 N.Y.3d at 579. 

The common thread between the two causes of action is the duty to another.

The Duty to Another

As a general matter, in the context of a fraud cause of action, a duty to disclose arises when (1) the defendant speaks on the subject, in which case he/she must speak truthfully and completely about the matter (see Bank of Am., N.A. v. Bear Stearns Asset Mgmt., 969 F. Supp. 2d 339, 351 (S.D.N.Y. 2013)); (2) there is a fiduciary relationship between the plaintiff and defendant (see Balanced Return Fund Ltd. v. Royal Bank of Canada, 138 A.D.3d 542, 542 (1st Dept. 2016)); or (3) the defendant possesses “special facts” about the matter not known by the plaintiff (Pramer S.C.A. v. Abaplus Int’l Corp., 76 A.D.3d 89, 99 (1st Dept. 2010). 

In the context of a negligent misrepresentation cause of action, the existence of a duty to another is often difficult to plead and prove. As discussed, the plaintiff must plead (and prove) a special relationship approaching privity to establish a duty to another. As the reporters show, this is often a difficult standard to satisfy.

In Glanzer v. Shepard, 233 N.Y. 236 (1922) (Cardozo, J.), the Court of Appeals found that a “public weigher” of beans owed a duty of care to a plaintiff with which it had no prior relationship. The bean weigher was retained by the bean seller but knew that the result of the weighing would be relied upon by the bean buyer (who received a copy of the weighing certificate). On those facts, the buyer’s reliance was the “end and aim of the transaction,” and therefore “assumption of the task of weighing was the assumption of a duty to weigh carefully for the benefit of all whose conduct was to be governed…. Diligence was owing, not only to him who ordered, but to him also who relied.” Id. at 238-39, 242.

Nine years later, in Ultramares Corp. v. Touche, 255 N.Y. 170 (1931) (Cardozo, J.), the Court of Appeals rejected a cause of action in negligence against a public accounting firm for preparing inaccurate financial statements which were relied upon by a plaintiff who had no contractual privity with the accountants. The Court distinguished Glanzer on the ground that the service rendered by the public weigher in Glanzer was “primarily for the information of a third person, in effect…, and only incidentally for that of the formal promisee.” Id. at 183. In other words, in Glanzer, the allegedly negligent party owed a duty of care to a specific party for a specific purpose, compared to Ultramares, where the defendant could not be liable for negligent misrepresentation to a broad and undefined class of persons unknown to the defendant. Id. Notably, the Court made clear that its holding “[did] not emancipate accountants from the consequences of fraud.” Id. at 189.

In Credit All. Corp. v. Arthur Andersen & Co., 65 N.Y.2d 536, 545-46 (1985), the Court of Appeals reaffirmed Ultramares, and set forth a three-part test for determining when an accountant may be held liable to noncontractual third parties who relied to their detriment on inaccurate financial reports: “(1) the accountants must have been aware that the financial reports were to be used for a particular purpose or purposes; (2) in the furtherance of which a known party or parties was intended to rely; and (3) there must have been some conduct on the part of the accountants linking them to that party or parties, which evinces the accountants’ understanding of that party or parties’ reliance.” Id. at 551.

“Although this rule first developed in the context of accountant liability, it has applied equally in cases involving other professions,” such as architects, lawyers and engineering consultants. Parrott v. Coopers & Lybrand, 95 N.Y.2d 479, 483 (2000) (citations omitted); see also North Star Contracting Corp. v. MTA Capital Const. Co., 120 A.D.3d 1066, 1069-70 (1st Dept. 2014) (applying rule to construction manager); Sutton Apartments Corp. v. Bradhurst 100 Dev. LLC, 107 A.D.3d 646, 648-49 (1st Dept. 2013) (applying rule to architect).

Consistent with the approach in Glanzer, Ultamares and their progeny, courts have applied the three-part test to appraisers. See Chemical Bank v. National Union Fire Ins. Co. of Pittsburgh, 74 A.D.2d 786, 787 (1st Dept. 1980) (“If it be shown that a real estate appraiser, retained by a property owner to make an appraisal that he knows the owner will use to obtain financing, makes it in a grossly negligent manner so as to inordinately overstate the value, we are not … prepared to hold the appraiser exempt from liability to the damaged financing party.”), app dismissed, 53 N.Y.2d 864 (1981); Federal Home Loan Mortgage Corp. v. Portnoy, 1992 WL 320813 (S.D.N.Y. 1992) (sustaining negligence claim by federal agency that relied on defendant’s appraisal report prepared for a Florida lender); Guildhall Ins. Co., Ltd. v. Silberman, 688 F Supp. 910 (S.D.N.Y. 1988) (sustaining negligence claim by insurer that relied on defendant’s appraisal prepared for owner of certain artifacts specifically for the purpose of obtaining insurance).

Against the foregoing, we examine Shavolian v. Donegan.

Shavolian v. Donegan

Shavolian involved an appraisal that the plaintiff, Dan Shavolian (“Shavolian”), claimed was artificially inflated to benefit the interest of non-party Ben Mokhtar (“Mokhtar”).

According to the complaint, Shavolian agreed to buy out Mokhtar’ interest in an office building located in Great Neck, New York (the “Property”) pursuant to an “arbitration agreement.” Under the agreement, Shavolian and Mokhtar agreed to each retain their own appraiser to “accurately and fairly value the Property.” Per the arbitration agreement, an identified arbitrator would average the two party-tendered valuations to determine the buy-out price.

Shavolian’s appraiser valued the Property at $14 million. Mokhtar retained Defendants to serve as his appraiser under the arbitration agreement. Defendants appraised the Property at $38 million (the “Appraisal”). The arbitrator averaged the two appraisals and set a valuation of the Property in excess of $28 million.

Shavolian alleged that Defendants conspired with Mokhtar to appraise the Property at an inflated amount, so that Mokhtar could receive a larger buy-out price. Shavolian further alleged that Defendants were aware that Shavolian would be relying upon their Appraisal. As a result of Defendants’ allegedly deceptive Appraisal, Shavolian claimed that he suffered damages in excess of $850,000.

Shavolian asserted claims against Defendants for negligence, negligent misrepresentation, and fraudulent misrepresentation. Defendants argued that the complaint should be dismissed because, inter alia, Defendants owed no duty of care to Shavolian (with whom they had no prior relationship, contractual or otherwise) when preparing their Appraisal and because the Appraisal merely reflected an “opinion.”

The Court addressed the negligence and negligent misrepresentation claims first. 

The Court observed that these claims did “not fit neatly within the confines of” Glanzer and Ultramares. Slip Op. at *5. “On the one hand,” said the Court, “as in Glanzer et al., Defendants allegedly were aware that their appraisal was to be provided to Shavolian, albeit indirectly, for a narrow purpose that specifically implicated Shavolian’s interests.” Id. Thus, the action did “not present the risk of exposing Defendants to liability from a large and indeterminate group.” Id. at *5-*6. “On the other hand,” said the Court, the action differed “from the above line of cases in that Shavolian cannot be said to have ‘relied’ on Defendants’ appraisal in making a commercial decision. Instead, the appraisal was relied upon by the arbitrator.” Id. at *6. Thus, “[u]nlike the insurers and lenders in the appraisal cases noted above, Shavolian does not claim to have been fooled or misled by the appraisal, which on its face conflicted with the report of his own appraiser.” Id. “His only claim,” explained the Court, “is that he was harmed by the appraisal because it skewed the result of a rigid valuation process – which apparently gave the arbitrator no discretion to do anything other than blindly accept the parties’ appraisals and average them – to which he voluntarily agreed.” Id.

“On balance,” the Court found that “Defendants did not undertake a duty of care to Shavolian.” Id. The Court reasoned that Defendants “were engaged by Mokhtar as part of an arbitration process. Shavolian was affected by the appraisal, but he did not rely upon it.” Id.

Accordingly, the Court dismissed the negligence and negligent misrepresentation claims.

Having addressed the negligence and negligent misrepresentation claims, the Court turned its attention to the fraudulent inducement claim.

To state a claim for fraudulent misrepresentation, a plaintiff must allege that the defendant made material misrepresentations of fact; that the misrepresentations were made intentionally in order to defraud or mislead the plaintiff; that the plaintiff reasonably relied on the misrepresentations; and that the plaintiff suffered damages as a result of his/her reliance on the defendant’s misrepresentations. See Mandarin Trading Ltd., 16 N.Y.3d at 177. Privity is not an element of a fraudulent misrepresentation cause of action. See John Blair Communications, Inc. v. Reliance Capital Group L.P., 157 A.D.2d 490, 492 (1st Dept. 1990).

The Court found that Shavolian “sufficiently allege[ed] facts to support his fraud claim.” Slip Op. at *6. In this regard, said the Court, “Shavolian allege[d] that Defendants, acting in concert with Mokhtar, made misrepresentations of fact in their Appraisal, intending to overvalue the Property for the arbitrator to Shavolian’s detriment.” Id. 

The Court rejected Defendants’ argument that there was no false statement because the appraisal was nothing more than an opinion. “To be sure,” noted the Court, “there is case law suggesting that appraisals ordinarily cannot support a claim for fraud, because an appraisal is a form of non-actionable opinion,” but, said the Court, where the grounds supporting the opinion are alleged to be “so flimsy as to lead to the conclusion that there was no genuine belief” to back it up, a plaintiff can state a claim. Id. at 7 (quoting Ultramares Corp., 255 N.Y. at 18). See also MBIA v. Countrywide, 87 A.D.3d 287, 294 (1st Dept. 2011); Stewardship Credit Arbitrage Fund LLC v. Charles Zucker Culture Pearl Corp., 31Misc. 3d 1223(A), at *5 (Sup. Ct., N.Y. County 2011). That, according to the Court, was what Shavolian alleged:

Here, Shavolian alleges that Defendants’ Appraisal is based on misrepresented facts and does not reflect Defendants’ honest opinion. Shavolian alleges, for example, that Defendants intentionally used an incorrect percent capitalization rate, undertook no rental comparisons, and failed to account for a wide arrange of expenses, including taxes, utilities, used water, all as part of a scheme to harm Shavolian.

Accordingly, the Court denied Defendants’ motion to dismiss the fraudulent inducement cause of action.

Takeaway

As discussed, before a party can recover damages “as a result of another’s negligent misrepresentation[,] there must be a showing that there was either actual privity of contract between the parties or a relationship so close as to approach that of privity.” Prudential Ins. Co. of Am. V. Dewey, Ballantine, Bushby, Palmer & Wood, 80 NY2d 377, 382 (1992). Privity or a privity-like relationship requires an awareness by the defendant that his or her statement is for a particular purpose; reliance on the statement in furtherance of that purpose; and conduct linking the defendant to the relying party and evincing its understanding of that reliance. Sykes v. RFD Third Ave. 1 Associates, LLC, 67 A.D.3d 162, 167 (1st Dept. 2009). In Shavolian, the plaintiff could not establish that he relied on defendants’ conduct as opposed to the appraisal. Slip Op. at *6 (“Shavolian was affected by the appraisal, but he did not rely upon it.”). 

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