Update: First Department Affirms the Denial of Summary Judgment in Norddeutsche Landesbank Girozentrale v. Tilton

• Posted on: Dec 18 2019

In August of this year, this Blog wrote about Norddeutsche Landesbank Girozentrale v. Tilton, 2019 N.Y. Slip Op. 32470(U) (Sup. Ct., N.Y. County Aug. 20, 2019) (here), a case involving several elements of a fraud claim. (Here.) As we noted at the time, Norddeutsche was a good example of why the courts refrain from dismissing fraud claims – there are issues of fact that are best left to the trier-of-fact to decide.

Shortly after this decision, Defendants appealed the motion court’s order. On December 17, 2019, the Appellate Division, First Department unanimously affirmed the decision. Norddeutsche Landesbank Girozentrale v. Tilton, 2019 N.Y. Slip Op. 08965 (1st Dept. Dec. 17, 2019) (here).

To give context to the First Department’s decision, a brief discussion of the facts of the case follows.

The case arose in 2005 with the investment by Norddeutsche Landesbank Girozentrale, a German financial institution, and Hannover Funding Company, a Delaware LLC and a commercial paper conduit administered by Norddeutsche (together “Plaintiffs”), in one of the two funds managed by Defendant Patriarch Partners (“Patriarch”). The funds at issue, Zohar II and Zohar III (the “Funds”), were created in January 2005 and April 2007, and had maturity dates of January 20, 2017, and April 15, 2019, respectively. Zohar II and Zohar III each issued over $1 billion in notes that were rated at issuance either AAA/Aaa or AA/Aal by S&P and Moody’s, respectively (the “Notes”).

Before purchasing the Notes, Plaintiffs received transaction documents, marketing materials, indentures, and collateral management agreements relating to each fund, as well as an offering memorandum for the Zohar III Fund. In January 2005, Plaintiffs purchased $75 million of Notes in Zohar II. In April 2007, Plaintiffs purchased $60 million of Notes in Zohar III.

The Funds performed poorly. Plaintiffs claimed that Defendants withheld fund performance and related information from them by furnishing fraudulent reports that concealed the actual performance of the underlying loans in the Funds. Plaintiffs sold their Notes for a loss of approximately $45 million in April 2012, before the maturity date of either fund. Plaintiffs claimed that they sold the Notes due to their poor performance, multiple ratings downgrades (of which they were aware), and the increasing capital requirements generated by the investment. Defendants claimed that Plaintiffs sold the Notes for independent business reasons.

Plaintiffs also alleged that instead of running the Funds as represented, Defendants Lynn Tilton (“Tilton”) and Patriarch ran the Funds as private equity funds. Plaintiffs maintained that Defendants used the money from the Funds to purchase equity in distressed assets, contrary to Defendants’ representations. Plaintiffs further alleged that Defendants collected management fees, dividends, preferred share buyouts, and income distributions from the companies that were owed to the Funds.

Additionally, Plaintiffs alleged they were told that Tilton and the Patriarch entities were supposed to pay for and own the underlying equity in the portfolio companies, while the Funds would make loans to the companies. Plaintiffs alleged that they understood the Funds would be entitled to an equity kicker in some cases (to participate in the upside if Defendants were successful in turning the companies around) but would not be exposed to the downside risk of holding equity positions.

Defendants moved for summary judgment on, inter alia, the following grounds: 1) Plaintiffs’ claims were time-barred; 2) Plaintiffs did not justifiably rely on any alleged misrepresentation by Defendants; and 3) Plaintiffs could not prove loss causation. The motion court denied the motion.

Before the motion court, Defendants claimed that Plaintiffs could not prove that their losses were proximately caused by Defendants’ alleged misrepresentations and omissions. According to Defendants, Plaintiffs conceded during discovery that there was an independent reason for their losses – namely, the “heavy capital usage” imposed by the investment. The motion court rejected this contention:

A finder of fact could determine that the decision to sell was causally linked to the alleged fraud, which Plaintiff contends led it to assume a certain level of performance, credit rating, and capital requirements, which in tum impacted whether to hold or sell the notes. A finder of fact could also reasonably conclude that had Plaintiffs known about the actual Fund structure, they would never have entered into the transaction in the first place. While Mr. Weber’s testimony might be fodder for cross-examination, it is insufficient to establish a loss causation defense as a matter of law.

Like the motion court, the First Department held that there were issues of fact “as to whether plaintiffs’ losses were proximately caused by defendants’ alleged fraud.” Slip Op. at *1.

Turning its attention to the justifiable reliance element, the Court said that the case before it was not “the rare circumstance in which the issue of reasonable reliance [could] be resolved at the summary judgment stage of a fraud case.” Id. (citation omitted). The reason, explained the Court, was found in its prior decision in the case in which it held that “much of the information and disclosures that defendants contend triggered a duty of inquiry beyond the inquiry that plaintiffs undertook ‘[could] be interpreted in a myriad of ways and [did] not facially clash with plaintiffs’ position that, even having some knowledge that the Funds had an equity component to them, they could not have known before the SEC proceeding the extent to which defendants used plaintiffs’ investment to acquire and control the Portfolio Companies, or otherwise had an obligation, based on that evidence, to further investigate.’” Id. (quoting Norddeutsche Landesbank Girozentrale v. Tilton, 149 A.D.3d 152, 161-162 (1st Dept. 2017). Nothing “surfaced” after “discovery that would warrant a different conclusion,” noted the Court. Id.

Finally, the Court agreed with the motion court that the fraud claims were not barred by the statute of limitations. Before the motion court, Defendants argued that Plaintiffs were aware of the truth about the structure of the funds from the marketing materials distributed to them in 2004 and 2006. In particular, Defendants maintained that statements in these materials sufficed to inform Plaintiffs that the Funds would hold equity and thus be at risk of suffering a loss. As such, Defendants contended that the claims were time-barred because Plaintiffs knew or should have known of the alleged fraud before 2005 and 2007, when they made their investments in the respective Funds. The motion court rejected this argument. The First Department agreed, holding that “the evidence adduced in discovery as to plaintiffs’ knowledge that the Zohar Funds included equity interests in distressed companies [did] not eliminate [any] issues of fact as to whether the information plaintiffs had was sufficient to place them on inquiry notice of the alleged fraud before May 2013, and therefore [did] not permit a conclusion as a matter of law that the fraud claim [was] barred by the statute of limitations.” Id. (citation omitted).

Takeaway

This Blog has written about numerous cases, both on the appellate and trial court level, in which the courts have dismissed fraud claims on justifiable reliance grounds. Perhaps, the stage of the proceedings plays a significant role in those decisions. After all, in Norddeutsche, the First Department made a point of noting that the case before it came at the summary judgment stage of the proceedings. If the issue of 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)), then it stands to reason that the same should hold true at the motion to dismiss stage. Yet, as noted in this Blog’s August 2019 post about the case, “[t]he law reporters (not to mention the pages of this Blog) are brimming with cases in which the courts have dismissed fraud actions due to pleading and proof deficiencies.” It therefore remains to be seen whether those aggrieved by fraudulent misconduct will survive motions to dismiss, let alone motions for summary judgment because issues of fact prevail.