Together We Stand: Court Holds Breach of Contract and Fraudulent Inducement Claims Can Stand Together

• Posted on: Nov 11 2020

A “recurring question” courts in New York grapple with is whether the facts alleged in a complaint give rise to sustainable claims for both breach of contract and fraudulent inducement. Cronos Grp. v. XComIP, LLC, 156 A.D.3d 54, 56 (1st Dept. 2017). Readers of this Blog know that a fraud claim, which “ar[ises] from the same facts [as an accompanying contract claim], s[eeks] identical damages and d[oes] not allege a breach of any duty collateral to or independent of the parties’ agreements[,] is subject to dismissal as redundant of the contract claim.” Id. at 63 (quoting Havell Capital Enhanced Mun. Income Fund, L.P. v Citibank, N.A., 84 A.D.3d 588, 589 (1st Dept. 2011) (internal quotation marks omitted). See also HSH Nordbank AG v. UBS AG, 95 A.D.3d 185, 206 (1st Dept. 2012). As the First Department noted in Cronos Group, “[t]here is no shortage of recent decisions by this Court holding to similar effect.” 156 A.D.3d at 63 & n.8 (citing cases).

Readers of this Blog also know that a plaintiff claiming fraud must demonstrate that he/she justifiably relied on the representation or omission alleged to be false. Whether a plaintiff justifiably relied on a misrepresentation or omission is “always nettlesome” because it requires a fact-intensive analysis. DDJ Mgt., LLC v. Rhone Group L.L.C., 15 N.Y.3d 147, 155 (2010) (internal quotation marks omitted). As the Court of Appeals observed, “[n]o two cases are alike ….” Id. For this reason, the courts look to whether the plaintiff exercised “ordinary intelligence” in ascertaining “the truth or the real quality of the subject of the representation.” Curran, Cooney, Penney v. Young & Koomans, 183 A.D.2d 742, 743) (2d Dept. 1992).

Sophisticated parties have a heightened responsibility. They must use due diligence and take affirmative steps to protect themselves from misrepresentations by employing whatever means of verification are available at the time. If they fail to do so, their complaint will be dismissed. See, e.g., HSH Nordbank, 95 A.D.3d at 194-95. Accord, Ashland Inc. v. Morgan Stanley & Co., 652 F.3d 333, 337-38 (2d Cir. 2011) (“An investor may not justifiably rely on a misrepresentation if, through minimal diligence, the investor should have discovered the truth.”) (internal quotation marks and citation omitted).

Despite the factual nature of the inquiry, the reporters are brimming with cases dismissing a fraud claim because the plaintiff failed to plead justifiable reliance.

In Walleye Power, LLC v. Bay Shore Power Co., 2020 N.Y. Slip Op. 51314(U) (Sup. Ct., N.Y. County Nov. 4, 2020) (here), the foregoing issues were considered by the Court. As discussed below, the Court denied a motion to dismiss contract and fraud claims, finding the plaintiff had stated a claim for breach of contract and fraudulent inducement and that the causes of action were not duplicative of each other.

Walleye Power involved the purchase of the Bay Shore Cogeneration Plant (the “Plant”) in Oregon, Ohio for $38.7 million. The transaction was subject to the terms, conditions and representations of an Asset Purchase Agreement (“APA”) between Walleye Power, LLC and Bay Shore Power Co. and its indirect affiliate, FirstEnergy Generation LLC (“FEG”).

Walleye alleged that it performed its obligations under the APA and that Bay Shore breached its obligations thereunder by falsely representing and warranting that the Generating Facility was in “good operating condition subject to normal wear and tear” and the Plant had been maintained in accordance with Good Utility Practice. Walleye claimed that Bay Shore knew those statements to be false because, among other things, certain major components, including the limestone crusher and the CFB Boiler air heater, needed to be replaced due to causes known to Bay Shore but concealed from Walleye. 

Walleye claimed that after closing it learned that Bay Shore and FEG knew “that (a) the Plant’s most valuable assets would likely fail in the near future, (b) these assets had been poorly maintained in violation of First Energy corporate policy and (c) the Records misrepresented the state of the Plant’s operations.” Walleye further alleged that “[r]ather than disclose what it knew during diligence and before the APA was executed or the Closing, Bay Shore made intentional misrepresentations and omitted key facts, to conceal the true condition and value of the Plant.” 

The Court held that these allegations stated a cause of action for willful breach of contract. Slip Op. at *2 (citing Second Source Funding, LLC v. Yellowstone Capital, LLC, 144 A.D.3d 445, 445-446 (1st Dept. 2016). As a result, the Court denied Bay Shore’s motion to dismiss the first cause of action for breach of contract.

Walleye also alleged that Bay Shore made multiple affirmative misrepresentations about the condition of the Generating Facility and the accuracy and completeness of the records provided to Walleye during due diligence, which Walleye claimed induced it to enter the APA. Among other things, Walleye claimed that Bay Shore falsely represented that the Generating Facility had been maintained with “Good Utility Practice,” despite its knowledge that it had: (i) failed to follow its Failure Analysis Report and fully inspect and repair its dissimilar metal welds (“DMWs”); (ii) failed to ensure proper water chemistry; (iii) “pad-walled” more than 300 water wall tubes in violation of FEG’s policies; (iv) caused hydrated ash to foul the air heater tubes; (v) failed to properly install and maintain the electrical field voltage transducer; and (vi) failed to install a proper control room alarm for a generator ground. 

In addition, Walleye alleged that Bay Shore knew that the Generating Facility had experienced DMW failures which caused one or more outages, but failed to provide this information in the outage report despite the existence of one or more Generation Availability Data System (“GADS”) codes specifically for DMW-related failures.

The Court held that these allegations sufficed to state a claim of fraudulent inducement, noting that they were “sufficiently stated with particularity to satisfy CPLR § 3016(b).…” Slip Op. at *3.

The Court noted that the alleged misstatements relating to the cause of the shutdowns were also actionable as half-truths. Id. (citing Junius Constr. Corp. v. Cohen, 257 N.Y. 393, 400 (1931); Orchard Hotel LLC v. D.A.B. Group LLC, 172 A.D.3d 530, 531 (1st Dept. 2019)). A half-truth is a deceptive statement because the maker of the statement conceals material facts that makes the statement misleading. Sheridan Drive-In v. State of N.Y., 16 A.D.2d 400, 408 (4th Dept. 1962).

The Court also held that whether Walleye’s reliance on the alleged misrepresentations was reasonable could not “be decided at the motion to dismiss stage based upon the record.” Slip Op. at *4 (“Whether reliance was reasonable based on the codes used, whether the codes themselves are incomplete or incorrect as Walleye alleges, or whether they should have put Walleye on notice of a more serious issue simply cannot be decided at the motion to dismiss stage based upon the record”) (citing ACA Fin. Guar. Corp. v. Goldman, Sachs & Co., 25 N.Y.3d 1043, 1045 (2015)).

The Court further held that justifiable reliance was adequately pleaded and best left for the trier of fact because the information allegedly concealed was claimed to be “in Bay Shore’s exclusive knowledge and could not have been ascertained by Walleye in the course of reasonable due diligence without shutting down the Generating Facility for an extended period.…” Slip Op. at *4. Walleye claimed that Bay Shore concealed the information “because it would have alerted Walleye to the undisclosed problems at the plant and required FEG and Bay Shore to spend additional money.” Id.

Accordingly, concluded the Court, “Walleye has adequately pled material misstatements of fact intended to deceive Walleye to induce them to enter the APA and Walleye’s justifiable reliance.” Id. (citing Basis Yield Alpha Fund (Master) v. Goldman Sachs Grp., Inc., 115 A.D.3d 128, 135 (1st Dept. 2014)).

Finally, the Court held that the duplication of claims doctrine did not bar the fraudulent inducement claim: 

[T]he fraudulent inducement cause of action is not duplicative of the breach of contract cause of action because Walleye alleges a duty separate and distinct from the alleged breach of the APA to provide accurate information and to correct any inaccurate information based on Bay Shore’s superior knowledge of the condition of the Generating Facility, and that Bay Shore made material misrepresentations of the present conditions of the Generating Facility to induce Walleye to agree to a higher purchase price and to enter into the APA in the first place.

Id. (citations omitted).

Moreover, said the Court, “because the APA limits indemnification claims against Bay Shore to $7.75 million, any damages in excess of that cap that Walleye seeks in connection with the fraudulent inducement claim cannot, as a matter of law, be said to be the same damages as are sought in connection with the breach of contract claim.” Id. (citing Avnet, Inc. v. Deloitte Consulting LLP, — A.D.3d — , 2019 N.Y. Slip Op. 05445 (1st Dept. 2020)).

Takeaway

The factual context of Walleye Power is common to many complex commercial transactions: one party is alleged to have breached the representations and warranties in the operative contract and made affirmative misrepresentations that induced the other party to enter into the transaction. Walleye Power highlights the independent duties necessary to withstand a motion to dismiss on duplication grounds.

Walleye Power is also notable because the Court declined to dismiss the complaint on justifiable reliance grounds. As this Blog has noted in numerous prior posts, cases frequently get dismissed because the plaintiff fails to allege enough facts to demonstrate justifiable reliance on the alleged misstatement or omission. Too often, the plaintiff relies on conclusory statements to satisfy this element of the claim. Walleye Power bucks the trend – the claim was sustained because plaintiff provided sufficient facts to demonstrate it had used diligence and taken affirmative steps to protect itself but was, nonetheless, the victim of an alleged fraud.