Kevin Schlosser Authors, "First Department Sustains Fraud Claims Where There are Legitimate Issues Whether Claimant Could Have Uncovered Falsity of Alleged Misrepresentations"

The First Department in Orchard Hotel LLC v D.A.B. Group LLC, 2019 NY Slip Op 03893 (1^st Dep’t Decided May 16, 2019) recently affirmed the Commercial Division’s denial of a motion to dismiss fraud cross-claims because there were legitimate issues as to whether the party alleging fraud had the means and ability to ferret out the alleged misrepresentations to avoid injury. As often addressed in this blog, the cases are not always consistent in assessing the critical element of reasonable reliance. Some hold the party alleging fraud strictly accountable for failing to protect itself, while in others, the court appears to be more lenient. Often there is something particularly egregious about the fraudulent conduct that leads the court to let the claim stand.

Case Facts

Orchard Hotel involved a foreclosure action concerning two mortgages originated by defendant Brooklyn Federal Savings Bank (BFSB) against real property formerly owned by defendant D.A.B. Group LLC (DAB). Defendant State Bank of Texas (collectively with BFSB, the Lenders) was a participant in the loans. Defendant Flintlock Construction Services LLC was hired by DAB as the general contractor for construction on the property. Flintlock filed a mechanic’s lien against the real property for nearly $3 million and thus asserted cross-claims in the action. Flintlock claimed that BFSB fraudulently represented in an Estoppel Certificate that certain funds were available to it as payment for its work, while concealing that these funds would no longer be available after the building loan matured. Flintlock alleged that was the reason it was never paid for certain work it performed.

Justice Ramos denied BFSB’s motion to dismiss Flintlock’s fraud and fraudulent concealment cross-claims, and the First Department unanimously affirmed.

The First Department first focused on whether the statement in the Estoppel Certificate was in fact false because at the time it was made, all of the funds to complete the job were in fact available. However, what the Estoppel Certificate did not reveal was that the funds may not be available in the future to pay for the work:

It is not dispositive that the funds were indisputably available when the subject statement was made. The allegations that BFSB knew that Flintlock understood this representation to apply to the entire contract term and knew that the promised funds would not be available during this whole time are sufficient to permit an inference that the statement was an actionable “half-truth” (see Banque Indosuez v Barclays Bank, 181 AD2d 447, 447 [1st Dept 1992] [internal quotation marks omitted]; Sheridan Drive-In v State of New York, 16 AD2d 400, 408 [4th Dept 1962]; Restatement, Torts, § 529).

Reasonable Reliance?

The next portion of the opinion addresses whether Flintlock reasonably relied on the Estoppel Certificate. Flintlock alleged that, in effect, BFSB prevented it from learning relevant information. The First Department emphasized that this issue should not be decided on a summary basis without discovery given the allegations and reasonable inferences from them:

The caveat in the next paragraph of the Estoppel Certificate, that BFSB had “no obligation to provide any Advances . . . except as provided for in the Building Loan Agreement” [*2]is not sufficient to “save” the statement of fund availability, at least not at this pre-discovery stage. Although the loan agreement would have revealed the expiration date of the loans, Flintlock alleges that BFSB intentionally prevented it from gaining access to this document by wrongfully withholding it and insisting upon execution of the Certificate in a compressed time period so that Flintlock would not be able to independently obtain or review it. These allegations are sufficient to permit an inference that BFSB wrongfully prevented Flintlock from verifying whether anything in the loan documents affected its rights. The question whether Flintlock was required to insist upon copies of the loan documents or on more time for investigation cannot be decided as a matter of law at this stage.

The Court also noted that Flintlock had no suspicion that the information concerning availability of the funds was not accurate or “hints of falsity” to lead it to inquire further:

These allegations also are sufficient to permit an inference that Flintlock justifiably relied on the Estoppel Certificate, notwithstanding its failure to read the referenced loan documents, especially in view of Flintlock’s allegations that it sought assurances from BFSB regarding the sufficiency of loan funds during the contract term and understood the statement in the Estoppel Certificate to be a confirmation that the funds were sufficient (see ACA Fin. Guar. Corp. v Goldman, Sachs & Co., 25 NY3d 1043, 1045 [2015]). Flintlock would have been required to make “additional inquiry” if it had had “hints of [a misrepresentation’s] falsity” (Loreley Fin. [Jersey] No. 3, Ltd. v Morgan Stanley & Co. Inc., 146 AD3d 683, 684 [1st Dept 2017] [internal quotation marks omitted]). The Lenders do not identify any such “hints.”

Finally, the Court placed the duty of full disclosure on BFSB:

These allegations are also sufficient to permit an inference that BFSB had a duty to disclose information to Flintlock pursuant to the special facts doctrine (see P.T. Bank, 301 AD2d at 378). The cases cited by the Lenders are distinguishable, because they involved a party’s failure to read materials provided to it or to request materials that were indisputably available (see UST Private Equity Invs. Fund v Salomon Smith Barney, 288 AD2d 87, 88-89 [1st Dept 2001]; Stuart Silver Assoc. v Baco Dev. Corp., 245 AD2d 96, 99 [1st Dept 1997]; 88 Blue Corp. v Reiss Plaza Assoc., 183 AD2d 662, 664 [1st Dept 1992]).

Flintlock’s allegations are also sufficient to permit an inference that BFSB was aware that Flintlock was operating under the mistaken assumption that the funds were available throughout the contractual term, a fact that, if true, would also support a finding that BFSB owed Flintlock a duty of disclosure (see Sterling Natl. Bank v Israel Discount Bank of N.Y., 305 AD2d 184, 186 [1st Dept 2003]; Brass v American Film Tech., Inc., 987 F2d 142, 151 [2d Cir 1993]).

Commentary

In Orchard Hotel there were a host of reasons relied upon by both the Commercial Division and the First Department to allow the claims of fraud to move forward into the discovery phrase. The allegations supported inferences that the defendant was the source of not only the misrepresentations and concealment but the inability to investigate and identify the falsity of the information.

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