Kevin Schlosser Authors, "First Department Dissents Result in Mandatory Review by Court of Appeals of Questionable Majority Decision"

In my February 19, 2019 post, I reviewed a February 5, 2019 decision of the First Department that seemed to find inferences to satisfy the recognized elements of fraud. It seemed the majority opinion wished to preserve the fraud claims because the wrongdoing was particularly egregious, even though the allegations of the complaint on their face did not actually satisfy the traditional elements of fraud. (Epiphany Community Nursery Sch. v Levey, 2019 NY Slip Op 00842 (1^st Dep’t Decided February 5, 2019).) In neither the complaint nor papers in opposition to the motion to dismiss had the plaintiff identified who allegedly relied on the false statements and/or concealment.

Unsurprisingly, the defeated defendants moved for leave to appeal to the Court of Appeals based upon the dissent by two of the Appellate Justices on the panel. The First Department granted the motion as a matter of law (Epiphany Community Nursery School v Hugh W. Levey Claire Gruppo Gruppo Levey & Co. Gruppo Levey Holdings, Motion No: M-1347, Slip Opinion No: 2019 NYSlipOp 69701(U) (1^st Dep’t Decided May 7, 2019).

Unfortunately, the debate between the majority and dissenting opinions was necessitated by inartful pleading of the complaint and the failure to focus on each element of fraud – including the critical element of justifiable reliance. The plaintiff was a legal entity – not a person – but the complaint failed to allege who, acting on behalf of this entity, actually relied on the alleged misrepresentations. The affidavit submitted by the plaintiff’s principal did not shed any further light on that issue.

As Justice Friedman astutely noted in his dissent, the pleading was particularly lacking:

Particularly noteworthy is the complaint’s failure to allege that Wendy — plaintiff’s founder and the director of its school — read or relied upon the alleged misrepresentations in plaintiff’s books and records and financial statements. Presumably, the complaint does not allege reliance on Wendy’s part because Wendy admits, in the affidavit she submitted in opposition to the motion to dismiss, that she did not become aware of Hugh’s scheme until 2016, when it was uncovered by forensic accountants retained by plaintiff’s counsel ^[FN3]. In the affidavit, Wendy does not say that she was misled about the transfers; she says that she was unaware of them. In addition, the record shows that Wendy testified at her deposition in the divorce case that it was not her practice even to review plaintiff’s audit reports.

To be clear, while the false accounting entries and financial statements alleged in the complaint certainly constitute misrepresentations that could support a fraud cause of action, the complaint fails to identify any particular individual acting as plaintiff’s agent who, at any point in time, read and relied on these misrepresentations. In the 36 pages and 172 paragraphs of the complaint, all that is alleged concerning the reception of the falsehoods in plaintiff’s accounting records and financial statements is the unsubstantiated conclusion that plaintiff itself — a legal entity capable of acting only through real-world human agents — “justifiably relied” on the statements of Hugh. Specifically, the complaint alleges in pertinent part:

“83. [Plaintiff] justifiably relied on Hugh Levey’s material misrepresentations and omissions based on his position as a director, his financial expertise, and the expectation that he would act solely in the interests of [plaintiff], its students and faculty, consistent with his fiduciary obligations.”^[FN4]

The following reasoning of the dissent is particularly convincing:

If plaintiff did, in fact, “justifiably rely” on the alleged misrepresentations, the identity of the agent or agents through whom plaintiff placed such reliance is information peculiarly within plaintiff’s knowledge and must be pleaded with particularity under CPLR 3016(b). After all, if plaintiff cannot name any agent through whom it relied on the subject statements, how can it claim to have relied on those statements? Yet, the complaint offers only boilerplate to satisfy the reliance element of a fraud claim. This does not suffice to state a cause of action for fraud (see IDT Corp. v Morgan Stanley Dean Witter & Co., 12 NY3d 132, 140 [2009] [a complaint alleging that the defendant “attempted to deceive” the plaintiff, but failing to allege that the plaintiff “was actually duped,” failed to state a fraud claim]; Cusack v Greenberg Traurig, LLP, 109 AD3d 747, 748 [1st Dept 2013] [no fraud claim was stated where the complaint “failed to allege that (the plaintiff) relied on (the alleged misrepresentation) to his detriment”]). …

I further note that the fraud cause of action cannot be salvaged under the rubric of fraud by concealment or constructive fraud ^[FN6]. The plaintiff is required to have relied on some affirmative statement by the defendant to recover damages on a claim for constructive fraud (see Del Vecchio v Nassau County, 118 AD2d 615, 618 [2d Dept 1986] [in dismissing a constructive fraud claim by an infant plaintiff because the defendants “made no representations, false or otherwise, to (her),” the court noted that constructive fraud, unlike actual fraud, requires that “the parties (be) in a fiduciary or confidential relationship” but “the plaintiff need not prove actual knowledge of the falsity of the representation by the defendant”]; see also People v Credit Suisse [*8]Sec. (USA) LLC, 31 NY3d 622, 640 n 2 [Feinman, J., concurring]). The same requirement applies to a claim for fraud by concealment (see ACA Fin. Guar. Corp., 25 NY3d at 1044 [“To plead a claim for . . . fraudulent concealment, plaintiff must allege facts to support the claim that it justifiably relied on the alleged misrepresentations”]; P.T. Bank Cent. Asia, N.Y. Branch v ABN AMRO Bank N.V., 301 AD2d 373, 376 [1st Dept 2003] [“A cause of action for fraudulent concealment requires, in addition to the four . . . elements (of fraud, i.e., material misrepresentation of fact, scienter, reasonable reliance, and damages), an allegation that the defendant had a duty to disclose material information and that it failed to do so”]).

The majority’s response was less than convincing:

The dissent takes issue with plaintiff’s failure to allege that Wendy, as founder and director, or other agents of the school justifiably relied upon Hugh’s misrepresentations. It views this omission as a failure to plead fraud with particularity pursuant to CPLR 3016(b).

We disagree. CPLR 3016(b) requires that “the circumstances constituting the wrong shall be stated in detail.” The statutory provision is satisfied when the facts suffice to permit a “reasonable inference” of the alleged misconduct (see Pludeman v Northern Leasing Sys., Inc., 10 NY3d 486, 492 [2008]; see also Eurycleia Partners, LP, 12 NY3d at 559; Credit Suisse Fin. Corp. v Reskakis, 139 AD3d 509 [1st Dept 2016]). Further, “in certain cases, less than plainly observable facts may be supplemented by the circumstances surrounding the alleged fraud” (Pludeman, 10 NY3d at 493). This requirement is to inform a defendant of the acts that the plaintiff is complaining about (id. at 491; see also DDJ Mgt., LLC v Rhone Group LLC, 78 AD3d 442, 443 [1st Dept 2010]). Here, the complaint states in detail Hugh’s fraudulent misconduct and meets the requirements of CPLR 3016(b).

Epiphany alleges that it justifiably relied on Hugh’s “material misrepresentations and omissions based on his position as a director, his financial expertise, and the expectation that he would act solely in the interests of [Epiphany], its students, and faculty, consistent with his fiduciary obligations.” The allegations in the complaint are not bare legal conclusions.

If indeed someone relied upon the misrepresentations or concealment, plaintiff could have identified that person. As such, it could have easily been added to the allegations. While it is understandable that the majority of the First Department wanted to find a remedy for the egregious conduct, dispensing with the strict requirements of fraud does not appear to be the way to do it. Justice Friedman’s dissent, joined by Justice Tom, is compelling and persuasive. We will await the final word of the Court of Appeals.

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