Kevin Schlosser Writes, “First Department Continues to Affirm Dismissal of Fraud Claims Based Upon Lack of Justifiable Reliance”

I have written often about the essential element of justifiable reliance for fraud claims, and the firmly-established case law endorsing the dismissal of a claim for fraud because justifiable reliance was not adequately pled. Last month, I did my part to clarify the authority that exists in New York for dismissing fraud claims at the pleadings stage based upon the failure to allege justifiable reliance.

While the New York, Appellate Division, First Department has at times intimated that it is rare that fraud claims are dismissed at the pleadings stage because justifiable reliance is not adequately alleged, the case law shows that the courts at every level readily recognize that fraud claims can and should be dismissed if the party asserting fraud did not exercise prudence in trying to protect itself against fraudulent conduct. See,e.g., my posts.

The First Department has rendered two more decisions affirming the dismissal of fraud claims based upon the failure adequately to allege justifiable reliance.

In United Natural Foods, Inc. v Goldman Sachs Group, 2021 NY Slip Op 00276 (1^st Dep’t Decided Jan. 19, 2021), the court below granted defendants’ motion to dismiss several claims, including the fraud claim. The First Department affirmed, commenting in relevant part:

The fraud claim was properly dismissed because plaintiff did not sufficiently plead justifiable reliance (see generally ACA Fin. Guar. Corp. v Goldman, Sachs & Co., 25 NY3d 1043 [2015]; Global Mins. & Metals Corp. v Holme, 35 AD3d 93, 99-100 [1st Dept 2006], lv denied 8 NY3d 804 [2007]). Plaintiff could have asked follow-up questions regarding what kind of an effect making Supervalu a coborrower would have and on which “select accounts,” but did not do so. Plaintiff also failed to insist on a final list of investors prior to closing, even though [*2] it is undisputed that plaintiff had the contractual right to do so to facilitate exercise of its right to veto investors. Defendants’ failure to provide such a list was a red flag that triggered a need to make additional inquiries, including with respect to whether any proposed investors had adverse interests to plaintiff.

In Rapaport v Strategic Fin. Solutions, LLC, 2021 NY Slip Op 00511(1^st Dep’t Decided Jan. 28, 2021), the court below granted plaintiff’s motion to dismiss defendant’s counterclaim for fraud. The First Department again affirmed, ruling:

To state a fraud cause of action, a party must plead “a material representation of a fact, knowledge of its falsity, an intent to induce reliance, justifiable reliance . . . and damages” (Eurycleia Partners, LP v Seward & Kissel, LLP, 12 NY3d 553, 559 [2009]). A claim for fraud can be based upon “a material omission of fact . . . made for the purpose of inducing the other party to rely upon it, justifiable reliance of the other party on the misrepresentation, or material omission and injury” (Lama Holding Co. v Smith Barney, 88 NY2d 413, 421 [1996]). “The element of justifiable reliance is lacking where a sophisticated party enters into an arms-length transaction and, with the exercise of ordinary intelligence, could have protected itself through due diligence concerning the transaction” (Vandashield Ltd v Isaacson, 2015 NY Slip Op 31782[U],*11 [Sup Ct, NY County, 2015], affd as modified 146 AD3d 552 [1st Dept 2017]; see also OmniVere, LLC v Friedman, 174 AD3d 443, 444 [1st Dept 2019]).

Dismissal of the fraud counterclaim was proper. Even construing the allegations liberally and drawing all inferences in defendants’ favor — defendants failed to adequately plead that, despite plaintiff’s alleged failure to disclose the future intentions of the Ranger Direct Lending Trust, the principal client of the company plaintiff sold to defendants, they could not have protected themselves through due diligence concerning the transaction. Their allegations in this regard are conclusory and vague, and, contrary to their contention, do not create an issue of fact. Defendants’ fraud counterclaim contains no allegations concerning what, if any, steps defendants took to probe the strength and potential longevity of this critical customer relationship. The absence of any allegations to show that defendants explored the issue is particularly notable, given their contentions that: they were told by plaintiff that Ranger was Peerform’s key customer; that the projections they relied on presumed Ranger’s ongoing customer relationship; and that Ranger’s continued existence as a customer was critical to Peerform’s ability to attract new business.

Commentary

As these new, consistent, First Department decisions show, a party seeking to assert a cause of action for fraud must act reasonably and prudently when faced with possible fraudulent conduct. If there are signs or indications that may give rise to suspicions or if there are ways of investigating a matter to learn the truth, the party asserting fraud must be careful to protect itself. If it fails to do so, its fraud claim is vulnerable to dismissal.