Earlier today, I got what was hands-down, the most ridiculous phone call seeking legal services in New York that I have ever received. Here are the pertinent facts:

This guy (we’ll call him “A’) was mistakenly over-billed by a company (we’ll call them “C”) for services that they rendered. Simple enough, right?

But this was no ordinary mistake. Instead of billing him $700, they billed him $700,000.

Oops.

C then tries to rectify the situation by reversing the process. Only now, they erroneously credit A with $700,000.

This is where I get called. A asks, “Shouldn’t C have to negotiate with me in order to get their money back?”  After I finish scanning the room for the Candid Camera and my laughter ebbs, I respond, “No; you realize you actually have to return the money because it was never yours to begin with.”

But wait – it gets better. (And here’s the REAL reason for the call).

“Well, Mr. Cooper, what if I told you that I already spent some of the money?” (More laughter ensues).

After my laughter subsides a second time and I got off the phone with this guy (and hopefully convinced him that he has to return every last penny) I was troubled by something he said. You see, he had started off our conversation by telling me that he read a lot of my articles online.  And, if what he said was true, I had to wonder: what – if anything – gave him the impression that I – or anyone for that matter – would help him?

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Lending further credence to our earlier article, “Why Many (If Not Most) Business Fraud Claims Are Dismissed By New York’s Courts,” a New York County trial judge recently dismissed a plaintiff’s fraudulent misrepresentation claims.

You might be inclined to ask, “Isn’t fraudulent misrepresentation materially different than garden-variety fraud (which was discussed in the article above)?”

The short answer is no, it’s not really different.

As the Court noted in North River Restaurant LLC v. Paratoree:

“The elements of a cause of action for fraudulent misrepresentation are the same as for fraud. Mandarin Trading Ltd. v. Wildenstein, 65 A.D. 3d 448, 459 (1st Dept 2009). The elements of a cause of action for fraud are: 1) a material misrepresentation of a fact; 2) knowledge of its falsity; 3) an intent to induce reliance; 4) justifiable reliance by the plaintiff; and 5) damages. Eurycleia Partners, LP v. Seward & Kissel, LLP, 12 N.Y. 3d 553, 559 (2009).”

(For more on the elements needed to prove a fraud claim under New York law, please see “How to Prove a Successful Business Fraud Claim Under NY Law“).

But in this case – as in many cases revolving around fraud, the Court found that the plaintiff failed to meet his burden of proof, stating:

“There is no indication or inference that would lead the court to believe that Plaintiff justifiably relied on Paratore’s statement. Eurycleia, 12 NY3d at 559. “As 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.” DDJ Mgt, LLC v. Rhone Group LLC, 60 A.D. 3d 421, 424 (1st Dept 2009).”

Having established that the plaintiff failed to meet one of the central criteria for a fraud claim, the court was obliged to dismiss the claim. Which it did.

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As you may recall from my earlier articles, “Why Many (If Not Most) Business Fraud Claims Are Dismissed” and “How to Prove a Successful Business Fraud Claim Under NY Law,” it is very tough to prevail on a fraud claim in New York, because the pleadings (i.e., the allegations you make in your court papers) require a lot of specificity, and your evidentiary burden is greater than most cases.

Adding to this pressure is another question: how much time do the courts allow you to start an action based on fraud?  After all, in many cases, the fraud is concealed, and you don’t learn about it until much later. So when does the clock start to run?

Fortunately, New York’s legislature foresaw this difficulty, and allowed for the possibility that some frauds may be hidden. Therefore, they articulated the rule as follows:

§ 213. Actions to be commenced within six years

The following actions must be commenced within six years:

***
8. an action based upon fraud; the time within which the action must be commenced shall be the greater of six years from the date the cause of action accrued or two years from the time the plaintiff or the person under whom the plaintiff claims discovered the fraud, or could with reasonable diligence have discovered it.

Bear in mind, however, that this two-year extension of time for the discovery only applies to cases involving actual fraud, but does not apply to cases involving constructive fraud, which is still limited to a six-year statute of limitations. See, e.g., Orr v. Kinderhill Corp., C.A.N.Y.1993, 991 F.2d 31. An example of this would include a lawsuit brought by creditors to set aside conveyances made without fair consideration.

For additional information on constructive fraud, please see “Constructive Fraud: A Lesser-Known, But Powerful Tool in New York to Recover Money That You’re Owed.”

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Reading the appellate court’s rendition of the facts in this breach of contract, breach of non-competition agreement and fraudulent inducement/concealment case, it is clear that the court empathized with the plaintiff, and wanted to allow the plaintiffs their day in court. The sordid details are as follows:

In GoSmile, Inc. v. Levine, the defendant founded the plaintiff corporation, which develops and sells tooth-whitening and oral hygiene products, and, he, together with his wife, were the company’s sole stockholders, directors and employees. In 2003, they sold a majority interest in the company to investors (the plaintiffs).

At that time, the defendants executed confidentiality and non-competition agreements that granted plaintiff exclusive ownership rights of all intellectual property, and prohibited defendants from using this information to compete with the company. In exchange for a cash payment, the defendants became at-will employees, directors and minority owners of plaintiff.

After the parties became embroiled in arguments over the company’s financial difficulties, the defendants were terminated, and later resolved their wrongful termination lawsuit arising therefrom via a settlement agreement with plaintiff and several other parties “which contained a broad mutual release of all claims of all kinds, whether known or unknown, that the parties ever had or now had.”

As part of the settlement agreement, plaintiff insisted upon – and defendant warranted – that he had neither breached the 2003 confidentiality and non-compete agreement in the past, and was also not in breach of those agreements at that time. That settlement agreement resulted in a payout to defendants of over $3 million, and an additional payout of $1 million over the following 4 years in exchange for the remainder of defendant’s stock in the company.

Later plaintiffs learned that defendant had, in fact, breached his fiduciary duties to the company, and used this confidential information to unfairly compete with the plaintiff. In other words, he deliberately lied about (in legalese, misrepresented) his breach of fiduciary duty and breach of the non-compete agreement to the plaintiff company in order to fraudulently induce them into entering into the settlement agreement, and pay him over $3 million.

Although the Court was required to sidestep some general rules in order to reach this result, and allow the plaintiff’s claims for breach of contract, rescission and fraudulent inducement to succeed, are you surprised that they did so?

I thought not.

(But if you’re interested in the legal nitty-gritty of why, see “How Breach of a Non-Compete Can Sustain Both Fraud & Breach of Contract Claims in NY“).

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In GoSmile, Inc. v. Levine, a decision that was handed down on December 21, New York’s Appellate Division, First Department (which covers New York and Bronx Counties) was confronted with the following question:  “whether a plaintiff is permitted to assert claims for both fraud and breach of contract, where the fraud claim is based upon allegations that defendant induced plaintiff to enter into that contract based on misrepresentations of present facts.”

The short answer: yes.

“Isn’t that kind of obvious?’, you ask. No, it isn’t.

Because there are some general rules at play in breach of contract cases in New York that would suggest the opposite conclusion:

(1) You can’t convert a breach of contract claim into a tort, such as fraud (which is an intentional tort); and,

(2) You can’t pursue a breach of contract or fraudulent misrepresentation or concealment claim if you waive those claims as part of a disclaimer or settlement agreement.

So why did the Court go the opposite way in this case?  Two reasons:

(1) “In the instant matter, plaintiff’s allegation that defendant knowingly misrepresented that he did not breach the confidentiality and non-compete provisions of the 2003 agreement is not merely an insincere promise of future performance. It was instead, a misrepresentation of then present facts that was collateral to the contract, and thus plaintiff sufficiently alleged a cause of action sounding in fraud“; and,

(2) The general release did not act as a bar to plaintiff’s fraud and breach of contract claims because plaintiff specifically sought defendant’s express warranty that he didn’t breach his non-compete agreement, and the general release stated clearly that it did not extend to claims which “[plaintiff] does not know or suspect to exist in his favor at the time of executing the release.” After reading the court’s rendition of the facts of this case (for more on this, see “When a Fiduciary Breaches a NY Non-Compete Agreement and Lies About It”), however, no one should be surprised at the outcome.

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As a corollary to our blog article “When You Can Incur Personal Liability for a Debt in New York,” the question arises as to what New York’s courts will do when a claimant tries to hold a corporate officer personally liable in either breach of contract or fraud.

To that end, in a November 18 decision in Liang v. Sollecito, a Civil Court in New York County held that “The officers of a corporation may be held personally liable for torts committed on behalf of the corporation, but cannot be held personally liable on contracts provided that they did not bind themselves individually.” Thus, where there are no allegations that the officer had any direct involvement in the contract, or that he personally made any fraudulent misrepresentations with regard to the contract, then the complaint should be dismissed – even before formal discovery begins.

Which is precisely what happened in Liang.

And this should come as no surprise; After all, how often do you think corporate officers stick out their necks to render themselves personally liable? Even more challenging, of those times that it may have actually occurred, how easy do you think it will be to prove it?

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While it is true that, generally speaking, you can’t recover in fraud or negligence against someone unless you actually have an agreement with them (or in legal terms, are “in privity”), there is a narrow – but important – exception to this rule.

And that is when the relationship is close enough that they’re no longer at arms’ length, or as the Appellate Court in its October 26 opinion in Seaview Mezzanine Fund, LP v. Ramson put it, “approaching privity.”

In Seaview, the Plaintiff, a funding corporation, extended a capital loan to the defendant corporation based, in large part, on the defendant’s accountants’ representations (which turned out to be misrepresentations) about the defendant’s economic situation. After the defendant defaulted, the plaintiff learned that the accountants willfully exaggerated the defendant’s net worth and financial condition, notwithstanding that they knew that the plaintiff intended to rely upon this information in deciding whether to extend the loan to their client (the defendant).

In denying the accountants’ motion to dismiss the claims against them, the Court stated, in pertinent part, as follows:

“[W]e agree with the motion court that plaintiff has alleged the existence of a relationship sufficiently approaching privity so as to allow plaintiff to assert claims against the [accountants] in the absence of a direct contractual relationship … Plaintiff also properly pled  … the causes of action for fraud … alleging that the [accountants] knowingly made false representations regarding the [defendant's] finances … including exaggerating their net worth and financial condition by underreporting a certain loan, failing to disclose the existence of another loan and misrepresenting the status of an arbitration proceeding.”

At this point, something should be made clear: this decision is only Round 1; it does not, by any means, suggest that the plaintiff has won this case.

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If the unsubstantiated claims of this plaintiff are actually true, then I feel bad for the plaintiff.

But, as noted by the Court, therein lies the problem: the allegations are unsubstantiated.

In Lecce Penn Co. SPA v. Adrenaline Marketing & Promotions, Inc., the plaintiff sued in breach of contract and fraud to recover over $300,000 that they were purportedly owed. Fair enough.

But the plaintiff took it a step further: they tried to sue one of the shareholders of the defendant corporation personally.  Unfortunately for the plaintiff, they had no competent proof that this individual did anything that should have resulted in his being held personally liable for the corporate debt; in fact, the plaintiff did not even allege that he did anything that should have entitled them to pierce the corporate veil.

The thing that troubles me about this case is simply this: while I can understand that there are instances where the proof you expected to become available to support your claim doesn’t materialize, I don’t understand how the complaint itself can even fail to have any of the requisite allegations to support a claim seeking to pierce the corporate veil. That’s just poor draftsmanship.

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Before addressing how you prove a negligent misrepresentation claim, we first have to define what it is – and what it isn’t.

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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In a June 15 decision in Callisto Pharm. Inc. v. Picker, New York’s Appellate Division, First Department affirmed the trial court’s ruling that dismissed the plaintiff’s claims that its employee was secretly negotiating with their business partner, and therefore liable in breach of contract, fraud and breach of fiduciary duty. In addition, the plaintiff claimed that the defendant had wrongfully taken their property, and was therefore liable in conversion.

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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