The Special Facts Doctrine and Loss Causation

• Posted on: Jan 10 2024

By: Jeffrey M. Haber

In many of the fraud cases that we examine, the plaintiff alleges that the defendant made an affirmative misrepresentation of fact upon which he/she relied. As we have often noted, fraud does not, however, always concern an affirmative statement. Sometimes a person can perpetrate a fraud through the omission of a material fact. 

Where fraud by omission is claimed, the plaintiff must allege that the defendant had a duty to disclose the omitted fact. 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;¹ (2) there is a fiduciary relationship between the plaintiff and defendant;² or (3) the defendant possesses “special facts” about the matter not known by the plaintiff.³

A fraud by omission claim is not sustainable where information allegedly withheld is ascertainable through publicly available sources.⁴ Nor is an omission case sustainable where the omitted information could have been discovered by the plaintiff through the exercise of ordinary intelligence.⁵ Both of the foregoing circumstances will negate application of the special facts doctrine.

Moreover, if the two-prong test is satisfied, where the party with superior knowledge of essential facts withholds or conceals such facts, the transaction at issue must be “inherently unfair” without such disclosure for the omission to be actionable.⁶

Finally, as in a fraud by misrepresentation case, the plaintiff must satisfy the other elements of the claim – namely, intent to defraud, justifiable reliance and injury. And the plaintiff must do so with particularity.⁷ 

[Ed. Note: we previously wrote about fraud by omission, or fraudulent concealment, e.g., here, here and here.]

The foregoing principles were examined by the Appellate Division, First Department in Supply Co., LLC v. Hardy Way, LLC, 2024 N.Y. Slip Op. 00058 (1st Dept. Jan. 9, 2024) (here).

Supply arose from a license agreement between Supply Co., LLC (“Supply”) and Hardy Way, LLC (“Hardy”). 

The parties entered into the agreement in November 2014, pursuant to which Hardy permitted Supply to manufacture, warehouse, distribute, bill and collect payment for Ed Hardy brand products (“License Agreement”). Under the License Agreement, Supply was required to pay Hardy royalty fees amounting to 20% of its “Gross Wholesale Sales.” Supply was entitled to take certain deductions relating to markups, chargebacks, or returns of Ed Hardy products when calculating its Gross Wholesale Sales. Supply was also entitled to apply a maximum deduction of 18% of its Gross Wholesale Sales for any annual period, and Supply was required to make a minimum royalty payment of $1,500,000.00.

Kevin Yap (“Yap”), Supply’s principal, guaranteed Supply’s performance under the License Agreement (the “Guarantee”). In the Guarantee, Yap agreed to pay all sums due to Hardy in the event of Supply’s default.

Under the License Agreement, Supply was required to “document and accept orders” for Ed Hardy products from the list of “approved” retailers set forth in a schedule attached to the agreement. Nonparty Rainbow Apparel Distribution Center Corp. (“Rainbow”) was one of the pre-approved retailers on the Schedule. Yap testified that Iconix—the brand management company that created Hardy to manage the Ed Hardy trademarks—arranged for the sale of Ed Hardy products to Rainbow at least as early as June or July 2014. Rainbow agreed to purchase, in total, over $4.5 million worth of Ed Hardy products. Iconix—not Supply—placed the orders. Under the License Agreement, the Iconix parties were “solely responsible” for placing sales of the Ed Hardy products. From January to March 2015, Supply fulfilled Rainbow’s orders.

Supply also entered into a markup agreement (“Markup Agreement”) with Rainbow in November 2014 in connection with the sale of Ed Hardy products to Rainbow. Neither Hardy nor Iconix were parties to the Markup Agreement. Under the Markup Agreement, Supply guaranteed Rainbow a minimum maintained markup percentage of 50% on sales of Ed Hardy merchandise. Supply was also required to reimburse Rainbow for Rainbow’s losses – Rainbow had the right to markdown any Ed Hardy products it received from Supply without Supply’s approval, and Supply was obligated to reimburse Rainbow “the difference of what [Rainbow] would have needed in order to achieve the Minimum Maintained Markup percentage target.”

Subsequently, Rainbow submitted a $3,300,000.00 markup reimbursement request to Supply. After Hardy and Iconix declined to reimburse Supply for Rainbow’s reimbursement request, Supply refused to pay Hardy the $1.5 million minimum royalty amount under the License Agreement. Thereafter, Supply brought suit.

Supply asserted causes of action for breach of contract, fraud in the inducement, breach of the implied covenant of good faith and fair dealing, and unjust enrichment. The motion court dismissed all of Supply’s causes of action except for its fraud in the inducement claim. With regard to that claim, Supply alleged that Hardy and Iconix fraudulently induced it to enter into the License Agreement by omitting material nonpublic information regarding the Ed Hardy trademarks’ lack of value. Hardy and Iconix answered the complaint and asserted a counterclaim for breach of the License Agreement based on Supply’s failure to tender the $1.5 million minimum royalty fee.

Hardy commenced another action against Yap for breach of the Guarantee. Yap answered the complaint and asserted counterclaims for declaratory judgment based on Hardy and Iconix’s alleged “deceptive misrepresentations and/or omissions,” which were made “in order to induce Supply Co. and Yap to … enter into the License Agreement.”

Following discovery, the parties in each of the actions moved for summary judgment. The motion court granted defendants’ motions, dismissed Plaintiff’s complaint, and awarded Hardy attorneys’ fees. The motion court also granted the motion with regard to Hardy’s counterclaim for breach of contract and granted in part Hardy’s motion for attorneys’ fees.

On appeal, the Appellate Division, First Department unanimously affirmed.

“The issue on appeal,” said the Court, was “narrow — namely, application of the special facts doctrine in connection with plaintiff’s claim that it was fraudulently induced to enter into a license agreement with Hardy.”⁸ The Court held that Plaintiff met the “the threshold two-prong test for the special facts doctrine.”⁹ In that regard, the Court found that defendants failed to disclose (i.e., omitted) “the criminal behavior of nonparties Neil Cole (the former chief executive officer of defendant Iconix Brand Group, Inc.) and Seth Horowitz (Iconix’s former chief operating and financial officer) and that such information was peculiarly within defendants’ knowledge.”¹⁰ “[P]laintiff could not have discovered this information through the exercise of ordinary diligence,” said the Court.¹¹ “However,” concluded the Court, “plaintiff did not show that this was an essential fact, or that defendants’ superior knowledge of this fact rendered the license agreement inherently unfair.”¹²

“In addition,” held the Court, “plaintiff did not establish all the elements of fraudulent inducement of contract.”¹³ In this regard, the Court was referring to the causation element. 

“To establish causation, [a] plaintiff must show both that [the] defendant’s misrepresentation induced [the] plaintiff to engage in the transaction in question (transaction causation) and that the misrepresentations directly caused the loss about which plaintiff complains (loss causation).”¹⁴ Transaction causation is often the easier of the two prongs to satisfy, while loss causation is typically more difficult. As noted by the First Department in Laub: “[r]egardless of whether plaintiff could establish that he was induced by the alleged misrepresentations to follow [defendant’s] recommendations on purchases of equities, plaintiff’s claims must fail because he has not alleged or produced any evidence that those misrepresentations directly and proximately caused his investment losses.”¹⁵

In Supply, the Court found that Yap’s deposition testimony showed “that plaintiff was damaged because it entered into the license agreement with Hardy and at a minimum maintained a markup agreement with nonparty Rainbow Apparel Distribution Center Corp,” and not because of an omitted fact.¹⁶ The Court also found that Yap’s “testimony further showed … that plaintiff entered into those contracts because Yap (1) placed orders with factories before he had agreements in place and (2) allegedly relied on an oral guarantee from Iconix that he would have zero losses.”¹⁷ 

Takeaway

Where a party alleges fraud (or fraudulent inducement) based on an omission of information, rather than an affirmative misrepresentation, a special relationship (e.g., a fiduciary relationship) is required to state a claim. However, in the absence of a special relationship, a party may still allege fraud based on an omission where there are special facts such that one party had superior knowledge of certain information, not readily available to the other party. In Supply, there was no fiduciary relationship between the parties, as the parties dealt with each other at arm’s length in a commercial transaction. The special facts doctrine was, however, unavailable to Supply because it could not show that the transactions at issue were inherently unfair, or that the omitted facts were essential to the transactions. With no duty to disclose, Supply could not withstand the challenge to its fraudulent inducement claim.

Supply also demonstrates the importance of satisfying all the elements of a fraudulent inducement claim. As noted, the causation element proved to be the foil. Supply was unable to prove that the omitted facts caused its loss.

Footnotes

1. Bank of Am., N.A. v. Bear Stearns Asset Mgmt., 969 F. Supp. 2d 339, 351 (S.D.N.Y. 2013).
2. Balanced Return Fund Ltd. v. Royal Bank of Canada, 138 A.D.3d 542, 542 (1st Dept. 2016).
3. Pramer S.C.A. v. Abaplus Int’l Corp., 76 A.D.3d 89, 99 (1st Dept. 2010). “The ‘special facts’ doctrine holds that ‘absent a fiduciary relationship between parties, there is nonetheless a duty to disclose when one party’s superior knowledge of essential facts renders a transaction without disclosure inherently unfair.’” Greenman-Pedersen, Inc. v. Berryman & Henigar, Inc., 130 A.D.3d 514, 516 (1st Dept. 2015), lv. denied, 29 N.Y.3d 913 (2017) (quoting, Pramer, 76 A.D.3d at 99).
4. Northern Group Inc. v. Merrill Lynch, Pierce, Fenner & Smith Inc., 135 A.D.3d 414 (1st Dept. 2016).
5. Black v. Chittenden, 69 N.Y.2d 665, 669 (1986); Schumaker v. Mather, 133 N.Y. 590, 596 (1892).
6. Jana L. v. West 129th St. Realty Corp., 22 A.D.3d 274, 278 (1st Dept. 2005).
7. CPLR § 3016(b).
8. Slip Op. at *1.
9. Id.
10. Id.
11. Id. (citing Jana L., 22 A.D.3d at 278); and Solomon Capital, LLC v. Lion Biotechnologies, Inc., 171 A.D.3d 467, 469 (1st Dept. 2019)).
12. Id. (citing Jana L., 22 A.D.3d at 277).
13. Id. (citing Frank Crystal & Co., Inc. v. Dillmann, 84 A.D.3d 704, 704 (1st Dept. 2011)).
14. Laub v. Faessel, 297 A.D.2d 28, 31 (1st Dept. 2002).
15. Id.
16. Slip Op. at *1.
17. Id.

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.