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Source: www.nyfraudclaims.com

The New York, Appellate Division, First Department, which hears appeals from New York County, overwhelmingly produces the most substantive decisions concerning civil fraud claims of any of the Appellate Divisions of New York.  A search of this blog for “First Department” shows numerous detailed and informative decisions over the last year from the First Department.

The Third Department has just produced an informative decision analyzing the requirements for alleging and proving a case of constructive fraud as well as other fraud issues in MME. Pirie’s, Inc. v Keto Ventures, LLC, 2017 NY Slip Op 04945 (3d Dep’t Decided on June 15, 2017).

In Keto, an employee (through her Limited Liability Company) purchased the business of her employer, a corset and lingerie shop.  The purchase terms required a down payment and installment payments pursuant to a promissory note.  A few months after the purchase, the employee passed away, and her mother was appointed the administrator of the estate and her sister assumed operation of the shop.  The purchaser then failed to pay the required installments due.  The seller sent default notice and demanded payment and to take back the shop pursuant to a security agreement. When the purchaser failed, the seller sued for such relief.

The purchaser then asserted numerous defenses and counterclaims, including breach of the purchase agreement, fraud and constructive fraud.  The parties ultimately moved for summary judgment.  The court below rejected the defenses and counterclaims, including the fraud-related claims, and entered judgment for the plaintiff-seller.  The purchaser then appealed to the Third Department.

The Third Department ruled that the lower court properly granted plaintiffs’ motion for summary judgment dismissing defendants’ affirmative defense and counterclaim for fraud, but found issues of fact on the breach of contract claim.

Constructive Fraud

The Court started with explaining the difference between fraud and constructive fraud – the elimination of the “intent” element:

“The elements of a cause of action for fraud require a material misrepresentation of a fact, knowledge of its falsity, an intent to induce reliance, justifiable reliance . . . and damages” (Town of Tupper Lake v Sootbusters, LLC, 147 AD3d 1268, 1270 [2017]; see Bynum v Keber, 135 AD3d 1066, 1067-1068 [2016]). “The elements of a cause of action to recover for constructive fraud are the same as those to recover for actual fraud with the crucial exception that the element of scienter . . . is dropped and is replaced by a requirement . . . [to] prove the existence of a fiduciary or confidential relationship warranting the trusting party to repose his or her confidence in [a] defendant and therefore to relax the care and vigilance he or she would ordinarily exercise in the circumstances” (Levin v Kitsis, 82 AD3d 1051, 1054 [2011] [internal quotation marks, brackets, ellipsis and citations omitted]; see Sears v First Pioneer Farm Credit, ACA, 46 AD3d 1282, 1286 [2007]).

The Court continued, to explain what may constitute the required special relationship to support a constructive fraud claim:

In the context of constructive fraud, a confidential or fiduciary relationship will be found “when the relations between the contracting parties appear to be of such a character as to render it certain that they do not deal on terms of equality but that either on the one side from superior knowledge of the matter derived from a fiduciary relation, or from overmastering influence, or on the other from weakness, dependence, or trust justifiably reposed, unfair advantage in a transaction is rendered probable” (Matter of Aoki v Aoki, 27 NY3d 32, 39 [2016] [internal quotation marks, citation and emphasis omitted]). An employment relationship, on its own, will not create a fiduciary relationship (see Lyndaker v Board of Educ. of W. Can. Val. Cent. Sch. Dist., 129 AD3d 1561, 1562 [2015]; Rather v CBS Corp., 68 AD3d 49, 55 [2009], lv denied 13 NY3d 715 [2010]; AHA Sales, Inc. v Creative Bath Prods., Inc., 58 AD3d 6, 21 [2008]; Maas v Cornell Univ., 245 AD2d 728, 731 [1997]).

The Court then ruled that no such relationship existed here.  The Third Department noted that the purchaser’s sole member was an employee of the seller, and the owner of the seller occasionally had drinks and lunch with the employee, and, on one occasion, visited a casino together.  However, the Third Department ruled that such evidence was plainly insufficient to support any such special relationship, especially given that the purchaser had its own attorney for the transaction (upon the advice of the seller): “Even when viewed in the light most favorable to defendants, the evidence establishes that the relationship between [the seller’s owner] and decedent was not ‘grounded in a higher level of trust than normally present in the marketplace between those involved in arm’s length business transactions’ (EBC I, Inc. v Goldman, Sachs & Co., 5 NY3d 11, 19 [2005]; see Rather v CBS Corp., 68 AD3d at 55; Matter of Stalter, 270 AD2d at 597).”

Intentional Fraud Claims

The Third Department also rejected the intentional fraud claims.  Defendant claimed that the seller supposedly committed intentional fraud because it used the word “annually” in describing finances that actually only encompassed the last year.  The Third Department found this lacked indicia of intent to defraud because the seller’s owner testified that she understood this to relate only to the last year, indicating to the Court that she did not intend to misrepresent anything, and because the seller’s attorney recommended that the purchaser engage an accountant to review all the financial information – again signifying a lack of intent to mislead or defraud.

Finally, the Third Department rejected the argument that intentional fraud could be based upon future projections – ruling: “Defendants’ related contention that plaintiffs provided materially false financial projections for 2014 to 2016 is also without merit. Such projections fall squarely within the general rule that ‘predictions, even if proven false, are opinion[s] rather than misrepresentations of fact necessary to sustain a cause of action for fraud’ (Abselet v Satra Realty, LLC, 85 AD3d 1406, 1409 [2011]).”

Of course, if projections are based upon false factual data or other misrepresentations of fact, they would be the proper subject of fraud claims.

Contract Claim Survived

The Third Department did find that there were issues of fact as to whether the seller breached the purchase agreement by depleting inventory leading up to the closing, so apart from the fraud claims, the breach of contract counterclaim survived.