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Kevin Schlosser Authors, "Breach of Contractual Warranty Also Amounts to Fraud"

Aug 30, 2019Litigation & Dispute Resolution
Courts are challenged when trying to decide whether the breach of contractual promises can also amount to a cause of action for fraud. I have written often about this topic. Courts principally focus on whether the “representation” relied upon is merely a promise to perform as required by the contract or a misrepresentation of existing fact that is collateral to the contract. When a contract contains factual representations, or warranties, courts are presented with particular issues. As shown by the recent decision of the Honorable James Hudson, of the Commercial Division in Suffolk County (Dulcette Tech. LLC v MTC Indus., Inc., 2019 NY Slip Op 51384(U) (Sup. Ct. Suffolk Co. Decided August 27, 2019)), the breach of contractual warranties can also amount to a cause of action for fraud. Background of Dulcette Decision First a word about the jurist who wrote the decision: Honorable James Hudson. Justice Hudson is one of three Commercial Division judges in Suffolk County. He is a credit to the Commercial Division and epitomizes what the Commercial Division strives for: He is dedicated, very thoughtful and analytical, and has a keen sense of justice. On top of that, he is a consummate gentleman, respectful of counsel and each party, and is sure to tap his mastery of historical jurisprudence and Latin doctrine to guide his determinations. In Dulcette, the contract was for the sale of goods to plaintiff from the defendant. Plaintiff purchased the artificial sweetener known as “Sucralose” from the defendant for resale to plaintiff’s customers. Plaintiff contended “that a shipment of the sweetener was adulterated, mislabeled and unfit for human consumption.” The Court found that a certificate of analysis of the Sucralose that the defendant provided to plaintiff at the time of contract constituted an express contractual warranty under NY UCC 2-313[1]. Plaintiff alleged that the products in question did not conform with these express warranties. In a non-jury trial, Justice Hudson determined the claims for breach of contract and fraud. Justice Hudson first carefully analyzed the breach of contract claims, including whether there was in fact a breach of the express warranties, presented through competing expert testimony regarding the testing and chemical properties of the Sucralose, and whether the limitation of liability provisions of the contract barred the claims. Justice Hudson found that the plaintiff presented sufficient evidence of the breach of warranties (express and implied) and that the limitation of liability clauses did not bar the contract claims, thereby sustaining the various causes of action for breach of contract. Justice Hudson then turned his attention to the fraud claim. Fraud Analysis On the fraud claim, the Court found that defendant had deliberately misstated the tests that it claimed were performed on the Sucralose that were sold to plaintiff. In addressing the fraud claim, the Court made certain threshold observations. First, the Court noted that the standard of proof to be applied to the fraud claim was more demanding than that applied to the contract claims:

In its analysis of the evidence, the Court must point out that the claims sounding in breach of warranty were held to a standard of proof by “..a fair preponderance of the credible evidence.” (PJI 1:23; Prop. Clerk of New York City Police Dept v. Ferris, 77 NY2d 428, [*8]430, 227, 568 N.Y.S.2d 577 [1991]).

By contrast, the elements of fraud must be proven by clear and convincing evidence (Orbit Holding Corp. v. Anthony Hotel Corp., 121 AD2d 311, 314, 503 N.Y.S.2d 780 [1st Dept. 1986]; PJI 3:20; accord, Colavito v. NY Organ Donor Network, Inc., 438 F.3d 214, 222 [2nd Cir.2006]. It is against this standard that we must set the proof.

The Court then articulated the elements of the cause of action for fraud:

“To establish a claim for fraudulent misrepresentation, a plaintiff must establish that there was an affirmative misrepresentation which was false and known to be false by defendant, 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” (MBIA Ins. Corp. v. J.P.Morgan Sec. LLC, 43 Misc 3d 1221(A), 997 N.Y.S.2d 99 (NY Sup. Westchester Co. 2014) citing Mandarin Trading Ltd. v. Wildenstein, 16 NY3d 173, 178, 919 N.Y.S.2d 465 [2011]; Lama Holding Co. v. Smith Barney Inc., 88 NY2d 413, 421, 646 N.Y.S.2d 76 [1996]; MBIA Ins. Corp. v. Countrywide Home Loans, Inc., 87 AD3d 287, 293, [1st Dept 2011]; Orlando v. Kukielka, 40 AD3d 829, 831, 836 N.Y.S.2d 252 [2d Dept 2007]; see also Banque Arabe et Internationale D’Investissement v. Md. Natl. Bank, 57 F.3d 146, 153 [2nd Cir.1995]; see Pasternack v. Lab. Corp. of Am. Holdings, 27 NY3d 817, 37 N.Y.S.3d 750 [2016]).

The Court then addressed defendant’s argument that the fraud claims should be dismissed because they were merely duplicative of the breach of contract claims. The Court rejected this argument and the cases relied upon by defendant, focusing on the difference between contractual promises of future performance and misrepresentations of present fact:

A clear distinction is drawn between claims for breach of contract and fraud, the former dealing with failure to fulfill obligations created by promises of future actions, and the latter dealing with misrepresented presently-existing facts. Although New York Courts are hesitant to sustain a cause of action for fraud and a breach of contract claim, the two are not necessarily mutually exclusive. “If a plaintiff alleges that it was induced to enter into a transaction because a defendant misrepresented a material fact, the plaintiff has stated a claim for fraud even though the same circumstances also give rise to the plaintiff’s breach of contract claim” (First Bank of Americas v. Motor Car Funding, Inc., 257 AD2d 287, 690 N.Y.S.2d 17, 21 [1st Dept. 1999]; see Wyle Inc. v. ITT Corp. 130 AD3d 438, 13 NY S.3d 375 [1st Dept. 2015]).

In the case of First Solar, Inc. v. Absolute Process Instruments, Inc., No. 17-CV-8518 (JSR), 2018 WL 1166632 (S.D.NY Feb. 8, 2018), the Court opined on separating a fraud claim from a cause of action sounding in breach of contract:

“Unlike a misrepresentation of future intent to perform, a misrepresentation of present facts is collateral to the contract, though it may have induced the plaintiff to sign the contract and therefore involves a separate breach of duty” (First Bank of the Americas v. Motor Car Funding, Inc., 257 AD2d 287, 690 N.Y.S.2d 17, 21 [1st Dept. 1999]; see also Merrill Lynch & Co. Inc. v. Allegheny Energy, Inc., 500 F.3d 171, 184 [2d Cir. 2007]. “New York distinguishes between a promissory statement of what will be done in the future that gives rise only to a breach of contract cause of action and a misrepresentation of a present fact that gives rise to a separate cause of action for fraudulent inducement” (Id. at *3).

A fraud claim is warranted if a party engages in tortious conduct distinct from its failure to perform its contractual obligations (Wyle Inc. v ITT Corp., supraat 378). Furthermore, if a party has “breached a duty of reasonable care distinct from its contractual obligations or when it has engaged in tortious conduct separate and apart from its failure to fulfill its contractual obligations,” then a separate fraud claim is properly made (New York Univ. v. Continental Ins. Co. 87 NY2d 308, 639 N.Y.S.2d 283 [1995]).

In the oft-cited case of First Bank of Ams. v. Motor Car Funding, supra, the Court reinstated a previously dismissed cause of action for fraud, reasoning that “Unlike a misrepresentation of future intent to perform, a misrepresentation of present facts is collateral to the contract (though it may have induced the plaintiff to sign the contract) and therefore involves a separate breach of duty” (Id. at 19). In Motor Car Funding the Plaintiff and Defendant entered into a sales agreement detailing how the Defendant would sell used car loans to the Plaintiff, First Bank of the Americas. This agreement included “warranties to the effect that the loans would comply with certain underwriting guidelines” such as quality of the collateral, the credit history individual borrowers, and their amount in down payments. (Id.). The mere fact that the Defendant’s product also breached the warranties did not preclude it in the action from properly being labeled fraud. (Id. at 21). This is because a warranty does not promise future performance, rather it is a statement verifying existing facts. “Accordingly, a fraud claim can be based on a breach of contractual warranties notwithstanding the existence of a breach of contract claim” (Id.).

Applying the facts before him to this case law, Justice Hudson then succinctly explained why the evidence established the claim of fraud:

The Plaintiff has proven, by clear and convincing evidence, that the Defendant fictionalized the results of organic tests on Sucralose, tests which were never performed, and that they falsely altered the analysis of the previous distributor to improve the Sucralose’s apparent purity. Dulcette’s claims for breach of express warranty, breach of implied warranty of merchantability, and breach of implied warranty of fitness for a purpose, would exist regardless of these misrepresentations. The fraud allegation is not based on mere failure to perform promises of future acts, but on misrepresentations of the analysis already performed on the Sucralose. This is a misrepresentation of a presently-existing fact, and is not duplicative of the breach of contract.

The Court went on to award punitive damages because the misrepresentations concerned the safety of a product intended to be consumed by the public. Commentary As shown by Justice Hudson’s careful analysis in Dulcette, even where factual misrepresentations constitute a breach of contractual warranties, that does not bar an independent claim for fraud. While it is true that a simple breach of contractual promises does not amount to a separate cause of action for fraud, where, as in Dulcette, the defendant misrepresents existing facts that the plaintiff relied upon to enter into the contract, a claim of fraud may be asserted as well. Click here for Kevin Schlosser's Fraud Blog.