Unlike its cousin, the fraud claim, negligent misrepresentation does not require a showing of malicious intent or recklessness by the defendant; rather, it requires that the plaintiff prove the following by a preponderance of the evidence:

(1) awareness by the defendant that his statement was to be used for a particular purpose or purposes;

(2) reliance by a known party or parties in furtherance of that purpose;

(3) some conduct by the defendants linking them to the plaintiffs and evincing defendants’ awareness of their reliance;

(4) that defendant’s statements or conduct exaggerated or misstated certain facts;

(5) that these misstatements resulted from the defendant’s negligence and/or lack of due diligence;

(6) that plaintiff relied on defendant’s misstatements; and,

(7) as a result, plaintiff suffered damages.

An important caveat bears mention, though.

As a New York Federal Court recently held in Five Star Development Resort Communities v. iStar RC Paradise Valley, “Under New York law, in order to state a claim for negligent misrepresentation, a plaintiff is required to allege that the speaker is bound to the other party ‘by some relation or duty of care’” outside a contract that may be between the parties.

Therefore, the Court continued, “In ordinary commercial contexts…it is imposed only on those persons who possess unique or specialized expertise, or who are in a special position of confidence and trust with the injured party such that reliance on the negligent misrepresentation is justified.”  In other words, “[i]f the only interest at stake is that of holding the defendant to a promise, the courts have said that the plaintiff may not transmogrify the contract claim into one for tort.” JP Morgan Chase Bank, 350 F. Supp. 2d at 401 (quoting Hargrave v. Oki Nursery, Inc., 636 F.2d 897, 899 (2d Cir. 1980)).

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Reading this decision, I can’t say I’m surprised; simply put, the plaintiff had absolutely no proof to support its claims other than rank speculation.

As the Appellate Court stated:

“This argument has no support in the record, which indicates that Tapestry approached defendant about joining its company after plaintiff rejected the partnership proposal. There is no evidence, other than plaintiff’s speculation, that defendant was negotiating during the two companies’ ultimately fruitless discussions (see Abrahami v UPC Constr. Co., 224 AD2d 231, 233 [1996] [fraud must be proven by clear and convincing evidence; "loose, equivocal or contradictory" evidence will not suffice] …

“The court properly dismissed the claim alleging that defendant acted as a faithless employee because there is no evidence that defendant was negotiating for his new position with Tapestry during the pendency of the business discussions between Tapestry and plaintiff. Nor is there any support for plaintiff’s contention that defendant was making use of confidential information while negotiating his employment with Tapestry.”

In fact, after reading this decision, and given how emphatic the appellate court’s opinion is, I can’t help but wonder: why did the plaintiff even bother appealing (or even bringing the claim in the first instance)?

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“Where sophisticated businessmen engaged in major transactions enjoy access to critical information but fail to take advantage of that access, New York courts are particularly disinclined to entertain claims of justifiable reliance.” Grumman Allied Industries, Inc. v. Rohr Industries, Inc., supra at 737. Stated differently, “‘[a]s a matter of law, a sophisticated plaintiff cannot establish that it entered into an arm’s length transaction in justifiable reliance on alleged misrepresentations if that plaintiff failed to make use of the means of verification that were available to it.’ (UST Private Equity Invs. Fund v. Salomon Smith Barney, 288 AD2d 87, 88…[2001]).”

But what if the information that was concealed was within the unique knowledge of the seller?

In that case, the claim may not be D.O.A. after all; in legal terms, this is called the “peculiar knowledge” exception, which applies “not only where the facts allegedly misrepresented literally were within the exclusive knowledge of the defendant, but also where the truth theoretically might have been discovered, though only with extraordinary effort or great difficulty.” DIMON Inc. v. Folium, Inc., 48 F.Supp. 2d 359, 368 (SDNY 1999). See also, JPMorgan Chase Bank v. Winnick, 350 F.Supp. 2d 393 (SDNY 2004).

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The difficulties with this type of claim do not end there.

In many instances, the parties have executed a detailed agreement that contains a disclaimer stating that the purchaser is not relying upon any of the seller representations, which often will sound the death knell to any claim that the plaintiff/purchaser reasonably relied upon the seller’s representations. “[W]here a party specifically disclaims reliance upon a representation in a contract, that party cannot, in a subsequent action for fraud, assert it was fraudulently induced to enter into the contract by the very representation it has disclaimed.” Grumman Allied Indus. Inc. v. Rohr Indus., Inc., 748 F.2d 729, 734-35 (2d Cir. 1984); see also, Danann Realty Corp. v. Harris, 5 NY2d 317 (1959).

Not surprisingly, there are exceptions to this rule as well, such as where the concealment pertains to matters that were exclusively within the defendants’ knowledge, and could only have been discovered by the plaintiff through great difficulty (this topic will hopefully be the subject of a separate article that I intend to publish shortly).

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And when you go back to look at the contract you realize that some of the most important things that you had negotiated somehow never made it into the written contract.

Under New York law, this is called the “parol evidence rule,” and here’s the general rule:

“Absent fraud or mutual mistake, where the parties have reduced their agreement to an integrated writing, the parol evidence rule operates to exclude evidence of all prior or contemporaneous negotiations between the parties offered to contradict or modify the terms of their writing. ( Fogelson v. Rackfay Constr. Co., 300 N.Y. 334, 90 N.E.2d 881; Thomas v. Scutt, 127 N.Y. 133, 27 N.E. 961.) Although at times this rule may seem to be unjust, “on the whole it works for good” ( Mitchill v. Lath, 247 N.Y. 377, 380, 160 N.E. 646) by allowing a party to a written contract to protect *** himself from ‘perjury, infirmity of memory or the death of witnesses.’ ( Thomas v. Scutt, 127 N.Y. 133, 142, 27 N.E. 961, supra; see, generally, Richardson, Evidence [10th ed.], §§ 601-634).

In other words, unless there is fraud involved, or both parties made the same mistake, you cannot enforce these additional terms that had been negotiated unless they were reduced to writing and made part of the contract. And while I hate to agree with the Court on this one, it is, in my view, the right result; otherwise, there would be almost nothing to prevent a party to a contract from being able to avoid his obligations by simply saying that the agreement was changed by some other conversation they had.

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On a practical level, that means that there are some important facts that must be in place before a New York court will bar a lawsuit, and compel the parties to pursue arbitration; one such fact is that the party seeking to compel arbitration must actually be a party to the underlying contract – or at the very least,  a tacitly acknowledged third-party beneficiary of the contract (i.e., that the contract was entered into for their benefit).

And, according to a New York Federal judge in a May 20 opinion, that was exactly what was missing in Miness v. Ahuja. In that case, the plaintiff sold to defendants several nursing homes that had been owned by his family. As part of the purchase agreement, the defendants agreed to retain plaintiff as a consultant for a period of two years, providing that the nursing homes met certain performance criteria.

After defendants terminated plaintiff – well before the expiration of the two-year period, plaintiff sued, and defendants predictably sought to dismiss the case on the grounds that it was barred by a mandatory arbitration clause that was in the agreement.

There was one “little” problem with this argument, however; the entities that signed the agreement with the plaintiff were not the same ones that were sued. The defendants’ operating companies – which had signed the employment agreement – were not parties to the lawsuit, and therefore, the Court held, lacked standing to enforce the arbitration provision of the contract, stating:

“[T]he only signatories to the Miness Employment Agreement are Miness and the Operating Companies. The Operating Companies are not parties in this action, and thus cannot invoke its provisions in this case. As for the defendants, none are party to the Miness Employment Agreement, and unless they are explicit third party beneficiaries of the contract, they cannot enforce its terms. See Premium Mortg. Corp. v. Equifax, Inc., 583 F.3d 103, 108 (2d Cir. 2009) (“A non-party to a contract governed by New York law lacks standing to enforce the agreement in the absence of terms that ‘clearly evidence an intent to permit enforcement by the third party’ in question,” quoting Fourth Ocean Putnam Corp. v. Interstate Wrecking Co., 66 N.Y.2d 38, 45, 495 N.Y.S.2d 1, 485 N.E.2d 208 (1985)). Here, there is nothing in the Miness Employment Agreement that suggests that the defendants have a right to enforce the contract as third parties.”

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A word of caution is in order here: this doctrine is only available in limited circumstances, such as where the parties never achieved a “meeting of the minds,” i.e., where both sides understood their respective obligations under the contract, or where one party was fraudulently induced into entering into the contract.

That said, here are some more grounds rules:

(1)               Rescission “is to be invoked only when there is lacking complete and adequate remedy at law and where the status quo may be substantially restored.” (Rudman v. Cowles Communications, Inc., 30 N.Y.2d 1, 13, 330 N.Y.S.2d 33, 280 N.E.2d 867);

(2)              If the other party to the agreement substantially changed their position in reliance on the agreement, and it would prove impractical – if not impossible to restore the other party to the position they were in pre-contract (such as where two companies were merged). (see, e.g., Gravenhorst v. Zimmerman, 236 N.Y. 22, 34-35, 139 N.E. 766; Kamerman v. Curtis, 285 N.Y. 221, 226, 33 N.E.2d 530).

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But what on earth does that mean?

It’s actually rather tricky; in fact, New York’s courts have expressly acknowledged that there is an inherent conflict between the implied good faith in a contract on the one hand, and not allowing plaintiffs to use this implied promise as a sword to create new contractual responsibilities that completely negate the rights that were specifically established by the contract itself.

Perhaps the simplest way to explain this concept – which is concededly more than a bit vague – is that the implied covenant of good faith and fair dealing is breached when the defendant acts to prevent the plaintiff’s ability to perform his end of the contract, or to assure that the benefits of the contract are withheld from the plaintiff. To better illustrate the application of this concept, here’s a few examples from actual cases that were litigated in New York’s courts:

Case #1:         Where a landlord interfered with its tenant’s ability to meet its lease obligation to make repairs, a New York court properly held that the landlord has breached the implied covenant of good faith and fair dealing in their lease agreement. Chemical Bank v. Stahl, 272 AD2d 1, 712 NYS2d 452.

Case #2:           Likewise, in a wrongful termination and breach of contract case, where a consultant who performed work for a corporation in exchange for the option to purchase shares that were exercisable in installments and intrinsically linked to specific events and was then fired without cause, which caused her to forfeit her option (meaning she was not paid at all for her work), her breach of implied covenant of fair dealing was allowed to survive dismissal. Zuckerwise v. Sorceron Inc., 289 AD2d 114, 735 NYS2d 100.

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The facts of this case were – and are – rather fascinating.

In this case, the plaintiff, a Hong Kong garment manufacturer, sold the defendant several large containers of clothing.  But here’s the interesting part:  instead of standard invoicing for the shipments, both parties to the deal used a “double invoicing” method in order to avoid United States customs duties. The first invoice, which understated the amount and value of the clothing, was presented to customs officials for purposes of calculating the amount of customs duties that were owed;  a second invoice which set forth the actual value of the goods seeking payment was then sent by plaintiff to the defendants.

When the defendants failed to pay on these invoices, leaving an outstanding balance totaling nearly $2 million, this lawsuit seeking recovery in breach of contract, business fraud, unjust enrichment, tortious interference and conversion followed.

The defendants in this case definitely merit the “chutzpah” award: they sought to dismiss the claim – and thereby avoid having to pay for the goods that they ordered, received, and presumably profited from – on the grounds that the contract between the parties was illegal, and therefore, unenforceable.

The Court articulated the general rule as follows:

“In New York ‘[i]llegal contracts are, as a general rule, unenforceable.’ Lloyd Capital Corp. v. Henchar, Inc., 80 N.Y.2d 124, 127 (1992) … An agreement which is lawful on its face and which does not contemplate or necessarily entail unlawful conduct in its performance is enforceable by the promisee even though he engages in unlawful activity in the agreement’s performance.”

Applying these rules to reject the defendants’ argument, the Court stated as follows:

“It appears that the double invoicing was only indirectly related to the contract, rather than being “central to or a dominant part of the plaintiff’s whole course of conduct in performance of the contract … Defendants’ invocation of the illegality doctrine is unpersuasive in that they seek to use the doctrine “as a sword for personal gain rather than a shield for the public good.”

I have no doubt that justice was achieved by this decision.

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In granting the defendants’ motions to dismiss these claims, the Court held as follows:

“[F]indings that corporation ‘fail[ed] to observe corporate formalities…had no contracts, no employees, and no independent office space…had no separate bank account…[and] no capital or assets at the time of trial’ insufficient to warrant finding of ‘domination’ … Indeed, plaintiff makes no allegation that the individual defendants intermingled personal and corporate funds, failed to deal with NHP on an arms-length basis, or in any meaningful way abused or disregarded the corporate form.

“Moreover, even if her allegations were sufficient with respect to domination, ‘complete domination of the corporation…standing alone, is not enough … Rather ‘[t]he party seeking to pierce the corporate veil must establish that the owners, through their domination, abused the privilege of doing business in the corporate form to perpetrate a wrong or injustice against that party such that a court in equity will intervene.’ Here, plaintiff makes no such allegation, contending solely that the corporation—as a corporation—perpetrated a fraud. Such allegations do not warrant veil piercing.”

Just another reminder why it is so difficult to pierce the corporate veil.

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