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Who, What, Where and How – The Foundation of Every Fraud Claim

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  • Posted on: Jun 22 2020

Just recently, we wrote about the importance of pleading fraud with particularity (here). 

As readers of this Blog know, when fraud is alleged, the plaintiff must plead the claim with particularity. Under CPLR § 3016 (b), the circumstances constituting fraud must be stated with sufficient detail “to permit a reasonable inference of the alleged conduct.” Pludeman v. Northern Leasing Sys., Inc., 10 N.Y.3d 486, 491 (2008) (citation omitted). To satisfy the particularity requirement, the plaintiff must allege such facts as the time, place, and content of the defendant’s false representations, as well as the details of the defendant’s fraudulent acts, including when the acts occurred, who engaged in them, and what was obtained as a result. Put another way, the complaint must identify the “who, what, where, when and how” of the alleged fraud.

Notwithstanding, the Court of Appeals has explained that CPLR § 3016(b) “should not be so strictly interpreted as to prevent an otherwise valid cause of action in situations where it may be impossible to state in detail the circumstances constituting a fraud.” Pludeman, 10 N.Y.3d at 491 (internal quotation marks and citation omitted). Therefore, at the pleading stage, a complaint need only “allege the basic facts to establish the elements of the cause of action.” Id. at 492. Thus, as noted, a plaintiff will satisfy CPLR 3016(b) when the facts permit a “reasonable inference” of the alleged misconduct. Id.

Seems easy enough. But, the cases show (including those that we have examined in this Blog (e.g., here, here, and here)), plaintiffs often have their fraud claim dismissed because they failed to plead sufficient facts to permit a “reasonable inference” that the fraud took place. As today’s discussion shows, conclusory statements, dressed up as facts, will not suffice to satisfy CPLR § 3016(b). Patel v. Patel, 2020 N.Y. Slip Op. 31864(U) (Sup. Ct., N.Y. County June 15, 2020) (here) (dismissing fraudulent inducement claim because, inter alia, plaintiff failed to plead fraud with particularity).

Patel v. Patel

Patel involved a dispute over whether plaintiff, Mayuriben Patel, was entitled to a share of the profits generated by the sale and wind-down of M&D Pharmacy, LLC (“M&D”). According to defendant, Paresh Patel, who was alleged to be the managing member of M&D, plaintiff was not a member of the LLC and was, therefore, ineligible to receive any such distribution or to access information about the company’s books and records.

M&D operated a pharmacy, known as Harlem Pharmacy, in New York City. Plaintiff, who claimed to be a member of M&D, alleged that defendant improperly reduced her profit share from 20% to 15%, and misappropriated her share of the proceeds generated from the sale of M&D’s assets in January 2018. Plaintiff said she was entitled to 20% of the profits from that sale, but had not received anything despite repeated demands, because defendant did not consider her to be a member of M&D eligible to receive any such distribution.

According to Plaintiff, she became a member of M&D, with a 20% ownership interest in the company, following a December 17, 2012 transaction. Defendant initially held a 40% ownership interest, but acquired a third member’s interest around January 2015, giving him a total of 80% interest. No formal operating agreement was created for M&D. However, M&D’s Board of Directors and Shareholders allegedly passed resolutions, in January 2015, noting both defendant’s 80% stake and plaintiffs 20% share.

As the controlling member of M&D, defendant had the power to direct and implement corporate decisions, including the payment of distributions to members. Beginning around 2016, defendant allegedly cut plaintiff’s share of the company’s dividends and profits from 20% to 15%, while increasing his own share. Plaintiff claims that she never consented to this reduction, nor did she receive any consideration for it. Between 2016 and 2018, defendant allegedly withheld about $60,000 of distributions from plaintiff.

In December 2017, plaintiff and defendant, as the members of M&D, entered into a purchase agreement with Rite Aid of New York, Inc. (“Rite Aid”) to sell most of M&D’s assets to Rite Aid. The purchase agreement identified plaintiff and defendant as the sole members of M&D. Under the purchase agreement, Rite Aid agreed to pay M&D $483,000.00 for M&D’s files, records, and data. In addition, Rite Aid paid plaintiff and defendant $191,000.00 in exchange for a restrictive covenant barring them from operating a pharmacy within three miles of M&D’s Harlem location for another seven years. Rite Aid also agreed to pay an additional $1,000.00 for M&D’s “fixed assets”, and $94,762.87 for M&D’s “saleable inventory”. The sale was executed on January 16, 2018, at the M&D pharmacy.

Defendant, as controlling member, took possession of all proceeds from the Rite Aid transaction, and allegedly promised plaintiff that he would pay her 20% of the profit. Plaintiff alleged, however, that, ever since the transaction closed, defendant had shut her out of M&D’s affairs. According to plaintiff, the sale proceeds were not deposited into M&D’s operating bank account, and plaintiff had not been allowed to inspect M&D’s financial records or have a say in the management of M&D. Plaintiff maintained that defendant repeatedly refused to give her a share of the proceeds from the sale or the wind-down of M&D and refused to provide an accounting of the proceeds. 

Plaintiff filed suit on October 26, 2018, asserting a mix of individual and derivative claims against defendant: (1) accounting, (2) breach of fiduciary duty (derivative claim), (3) breach of fiduciary duty (individual claim), (4) conversion, (5) fraudulent inducement, and (6) judicial dissolution.

Defendant sought dismissal of all claims on various grounds. Plaintiff opposed, and cross-moved for leave to file an amended complaint. The Court addressed plaintiff’s claims for an accounting, fraudulent inducement, and judicial dissolution. We examine the latter two claims.

The Court’s Decision

To state a claim for fraudulent inducement, “there must be a knowing misrepresentation of material present fact, which is intended to deceive another party and induce that party to act on it, resulting in injury.” GoSmile, Inc. v. Levine, 81 A.D.3d 77, 81 (1st Dept. 2010), lv. denied, 17 N.Y.3d 782 (2011); Lama Holding Co. v Smith Barney Inc., 88 N.Y.2d 413, 421 (1996). And, as noted above, under CPLR § 3016 (b), the allegations must be stated with particularity. Eurycleia Partners, LP v. Seward & Kissel, LLP, 12 N.Y.3d 553, 558 (2009). 

The Court found that the allegations in the complaint failed to set forth “the basic facts to establish the elements of a fraudulent inducement claim.” Slip Op. at *9. The Court noted that plaintiff failed to allege any specificity with regard to her claim that “Defendant represented to [her] that M&D was going to distribute all of the proceeds from the sale of M&D’s assets.” In particular, the Court said that plaintiff failed “to specify, among other things, (i) when Defendant made this representation (whether it was made before or after the sale to Rite Aid, for example), (ii) how Defendant made it, (iii) whether the representation included a promise to distribute to Plaintiff a particular share of the profits, and (iv) how Plaintiff detrimentally relied upon the representation (the Complaint alleges only that the statement was made ‘with the intention of inducing reliance’).” Id. *9-*10. In other words, the Court found that plaintiff failed to provide the who, what where, and how of the fraud.

The Court also held that plaintiff failed to “establish[] that [defendant], at the time of making the promissory representation,” did not intend “to honor the promise.” Id. at *10. “General allegations of lack of intent to perform are insufficient”, said the Court. Id. (quoting Perella Weinberg Partners LLC v. Kramer, 153 A.D.3d 443, 449 (1st Dept. 2017) (internal quotation marks omitted)); Meiterman v Corp. Habitat, 173 A.D.3d 593, 594 (1st Dept. 2019). The Court concluded that “statements of future intent, without more, are not actionable as fraud claims.” Id. (citing Lincoln Place LLC v. RVP Consulting, Inc., 16 A.D.3d 123, 124 (1st Dept. 2005); Cronos Grp. Ltd. v. XCOMIP, LLC, 156 A.D.3d 54, 62-63 (1st Dept. 2017).

With regard to the judicial dissolution claim, the Court dismissed it for particularity reasons, as well. 

In the absence of an operating agreement, the rights, duties and obligations of an LLC member are governed by the default provisions of New York’s Limited Liability Company Law (“LLCL”). See, e.g., Matter of Eight of Swords, LLC, 96 A.D.3d 839 (2d Dept. 2012); Matter of 1545 Ocean Ave., LLC, 72 A.D.3d 121 (2d Dept. 2010). Under Section 702 of the LLCL, a court may dissolve a company “whenever it is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement.” When there are no articles or operating agreement, as in Patel, courts look to the stated purposes for which the LLC was formed to determine if they are being achieved and whether the company’s finances remain feasible. E.g., Matter of Eight of Swords, LLC, 96 A.D. 3d 839, 840 (2d Dept. 2012).

The Court found that systematic exclusion “from the operation and affairs of the company by defendant” was “insufficient to establish that it [was] no longer ‘reasonably practicable’ for the company to carry on its business, as required” by LLCL § 702. Slip Op. at *10-*11 (quoting Doyle v. Icon, LLC, 103 A.D.3d 440, 440 (1st Dept. 2013) (internal quotion marks omitted)). Moreover, said the Court, plaintiff’s “conclusory allegations … that the sale of M&D’s assets to Rite Aid compel[led] judicial dissolution” were insufficient to satisfy LLCL § 702. Id. (citation omitted).

Takeaway

In a prior post, we quoted Stephen King as saying “the truth is in the details. No matter how you see the world …, the truth is in the details.” (Here.) We said that the “quote fairly sums up the pleading requirement that all plaintiffs must satisfy when alleging a fraud.” The reason: courts require plaintiffs to provide sufficient details of the alleged misconduct to support a reasonable inference that the allegations of fraud are true. For this reason, conclusory allegations will not suffice. Eurycleia Partners, 12 N.Y.3d at 558. Neither will allegations based on information and belief. See Facebook, Inc. v. DLA Piper LLP (US), 134 A.D.3d 610, 615 (1st Dept. 2015). Plaintiffs must describe the “who, what, when, where, and how” of the fraud, or “the first paragraph of any newspaper story.” United States ex rel. Lubsy v. Rolls-Royce Corp., 570 F.3d 849, 853 (7th Cir. 2009) (internal quotation marks omitted). In the absence of such detail, as in Patel, even under the reasonable inference standard of the CPLR, a plaintiff cannot maintain a fraud claim.

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