Update: First Department Affirms Dismissal of Fraud Claim in Unique Goals International, Ltd. v. Finskiy

• Posted on: Dec 27 2019

In November of 2018, this Blog wrote about Unique Goals International, Ltd. v. Finskiy (here), a case involving a fraud cause of action that was dismissed because the plaintiff failed to satisfy the justifiable reliance element of the claim. On December 26, 2019, the Appellate Division, First Department unanimously affirmed the dismissal of the fraud claim. Unique Goals Intl., Ltd. v. Finskiy, 2019 N.Y. Slip Op. 09381 (1st Dept. Dec. 26, 2019) (here).

Background

Plaintiffs, three entities controlled by nonparty Sergey Yanchukov (“Yanchukov”), a wealthy Russian businessman, were allegedly induced by defendants, Maxim Finskiy (“Finskiy”), also a wealthy Russian businessman, and several entities under his control or otherwise affiliated with him, to purchase defendants’ controlling interest in White Tiger Gold, Ltd. (“White Tiger”), a gold-mining company. Plaintiffs alleged that defendants misled them about White Tiger’s financial condition and the gold reserves of its mines, principally by means of (1) Finskiy’s oral statements to his personal friend Yanchukov; (2) a false report publicly filed pursuant to the securities laws of Canada (where White Tiger was listed on the Toronto Stock Exchange); and (3) false information provided to a consulting firm engaged by plaintiffs to prepare a report for them on White Tiger.

Relevant to the appeal (as well as the decision before the motion court), plaintiffs did not undertake an independent due diligence inquiry to verify defendants’ claims about White Tiger. Specifically, before closing the transaction, plaintiffs conducted neither their own review of White Tiger’s books and records nor their own geological survey of White Tiger’s mining properties. Rather, the complaint merely alleged that “plaintiffs were deceived into taking immediate action [in March and April of 2013] . . . to buy defendants out of White Tiger” by Finskiy’s representation that there existed an imminent prospect of the seizure of White Tiger’s assets by a major creditor, which creditor, Finskiy claimed, “had withheld funding to create an exigency.”

After the deal closed, an audit commissioned by plaintiffs revealed that $30 million of White Tiger’s cash, which had been reported as having been used to pay for drilling, had been misappropriated. The audit further revealed that White Tiger’s management had paid itself excessive bonuses. In addition, a post-closing geological survey of White Tiger’s only operating gold mine commissioned by plaintiffs revealed that the previous management had substantially overstated both the amount of ore stored at the mine and the mine’s provable gold reserves. Plaintiffs learned that the mine’s remaining “life” was only four years, which was insufficient to generate enough ore to pay off White Tiger’s major creditor.

[Ed. Note: a fuller discussion of the factual background is set forth in this Blog’s article (here) discussing the motion court’s decision.]

The First Department’s Decision

The motion court found that Yanchukov, who controlled the plaintiffs, “plainly, [was] a sophisticated businessperson with access to plentiful resources to protect himself and his investments, to obtain the requisite inspections and perform the necessary due diligence.” Though Yanchukov “may have lacked experience in the mining industry,” noted the motion court, “he clearly had the resources necessary to obtain expert advice or, indeed, do an investigation.”  Since Yanchukov failed to utilize those resources and conduct any due diligence, he could not claim that he was defrauded, held the motion court.

The First Department agreed with the motion court, affirming the dismissal of the fraud claim on justifiable reliance grounds.

Under New York law, sophisticated parties must show that they used due diligence and took affirmative steps to protect themselves from misrepresentations by employing the means of verification available to them at the time. See, e.g., HSH Nordbank AG v. UBS AG, 95 A.D.3d 185, 194-95 (1st Dept. 2012). Accord, ACA Fin. Guar. Corp. v. Goldman, Sachs & Co., 25 N.Y.3d 1043, 1044 (2015) (if a plaintiff has failed to make use of “the means available to it of knowing, by the exercise of ordinary intelligence, the truth or real quality of the subject of the representation,” that plaintiff “will not be heard to complain that it was induced to enter into the transaction by misrepresentations”) (internal quotation marks and brackets omitted); DDJ Mgt., LLC v. Rhone Group L.L.C., 15 N.Y.3d 147, 154-155 (2010) (a sophisticated investor claiming to have been defrauded must allege that it took reasonable steps to protect itself against deception); VisionChina Media Inc. v. Shareholder Representative Servs., LLC, 109 A.D.3d 49, 57 (1st Dept. 2013) (“[s]ophisticated investors must show they used due diligence and took affirmative steps to protect themselves from misrepresentations by employing what means of verification were available at the time”).

In Unique Goals, the Court agreed with the motion court that plaintiffs were “financially sophisticated investors.” Slip op. at *2. As such, they had an obligation to conduct due diligence “to verify defendants’ representations about White Tiger’s financial condition and gold reserves.” Id. Like the motion court, the First Department found that plaintiffs failed to conduct such due diligence, “or even sought to do so, even though they were aware that White Tiger was experiencing financial difficulties.” Id.  Accordingly, the Court concluded, “the complaint fail[ed] to state a legally sufficient cause of action for fraud.”

Takeaway

In our prior “takeaway” of the case, this Blog said that the motion court’s decision reflected adherence to the message conveyed by the Court of Appeals about assessing the sufficiency of a justifiable reliance allegation: where sophisticated parties are involved, they must verify and investigate the truthfulness of the assurances and representations on which they rely. With the First Department’s unanimous affirmance, that message is reaffirmed – to wit: “where a person or entity, especially a sophisticated one, does not verify and investigate the truthfulness of assurances and representations, or is lax in doing so, the claim should be dismissed for failing to satisfy the justifiable reliance element.”