The interplay between a breach of contract claim and fraudulent inducement to enter that contract is a topic addressed frequently by the courts.
The key element often missing in these cases is the misrepresentation of a present fact conveyed to the plaintiff to induce the plaintiff to enter into the contract. Often plaintiffs rely on nothing more than promises that the defendant made to the plaintiff as to future performance. If those promises were merely contained in the contract, plaintiff often fails to produce the required evidence that the defendant did not have a present intent to comply with those contractual promises when it made them. Or the plaintiff fails to show that these pre-contract promises were extraneous or collateral to the promises actually contained in the contract. A recent decision of the United States District Court for the Southern District of New York addresses these common issues in a clear and informative manner: Choquette v. Motor Information Systems, Inc., 15-CV-9338, NYLJ 1202794949574, at *1 (SDNY, Decided August 2, 2017).
Plaintiffs entered into contracts with defendant, an operating division of Defendant Hearst Business Publishing, Inc., under which plaintiffs were appointed distributors of defendant’s manuals regarding vehicle service and repairs. As permitted by the contracts, after they were entered, defendant directed plaintiffs not to sell one of the products that had been encompassed within the distribution agreement because defendant no longer had the right to sell that product by virtue of an agreement with the producer of the product.
After plaintiffs unsuccessfully sought to renegotiate the contracts with defendant, they brought suit, which was transferred to the SDNY, attempting to allege breach of contract, fraudulent inducement and a number of other claims. Plaintiffs alleged that defendant breached the contracts in a number of ways. On defendant’s motion for summary judgment, the Court found that plaintiff had not alleged any actual breaches, and dismissed the contract claims. The Court also dismissed the fraud claim.
The Court noted that plaintiffs characterized their claim as “Deceit/Misrepresentation,” which was “not [a] clearly cognizable cause of action under New York law,” so the Court construed the claim as one “for fraud in the inducement of a contract.”
On defendant’s motion for summary judgment, the Court carefully reviewed the required elements for such a claim and found that plaintiffs had failed to raise issues of fact to sustain the claim.
The Court started with the elements as follows:
Under New York law, to state a claim for fraud in the inducement, “a plaintiff must demonstrate: (1) a misrepresentation or omission of material fact; (2) which the defendant knew to be false; (3) which the defendant made with the intention of inducing reliance; (4) upon which the plaintiff reasonably relied; and (5) which caused injury to the plaintiff.”
Additional Factors in Breach of Contract Scenario
The Court next recognized that where the fraud claim relates to an alleged breach of contract, certain additional proof is required:
“Under New York law, a cause of action sounding in fraud cannot be maintained when the only fraud charged relates to a breach of contract.” Ellington Credit Fund, Ltd. v. Select Portfolio Servicing, Inc., 837 F. Supp. 2d 162, 197 (S.D.N.Y. 2011) (citations omitted). In certain circumstances, though, a fraud claim may arise out of the same set of facts as a breach of contract claim. “Under New York law…[b]oth claims will lie when a plaintiff can show either a legal duty distinct from the duty to perform under the contract, a fraudulent misrepresentation collateral or extraneous to the contract, or special damages caused by the misrepresentation that are unrecoverable as contract damages.” Vorcom Internet Servs., Inc. v. L & H Eng’g & Design LLC, No. 12-CV-2049 (VB), 2013 WL 335717, at *4 (S.D.N.Y. Jan. 9, 2013) (citing Bridgestone/Firestone v. Recovery Credit Servs., 98 F.3d 13, 20 (2d Cir. 1996)).
The Court further elaborated:
In assessing whether an alleged misrepresentation is collateral to a contract, New York courts examine “whether the alleged misrepresentation was warrantied or not mentioned by the contract; whether it was the misstatement of a present fact which induced entry into the contract; whether it constituted the failure to perform a duty specified in the contract; and whether it is generally duplicative of the breach of contract claim.” Great Earth Int’l Franchising Corp. v. Milks Dev., 311 F. Supp. 2d 419, 428 (S.D.N.Y. 2004).
Plaintiffs Failed to Satisfy the Requirements for Fraudulent Inducement
Plaintiffs alleged simply that before entering into the contracts the defendant promised them that they would be able to sell the product that was ultimately removed from the distribution contracts through 2016, when in fact defendant discontinued that product earlier. The Court rejected this as “the basis for a fraud in the inducement claim because [plaintiff] has not demonstrated that they were ‘false “representation[s] of present fact.”’ Stewart v. Jackson & Nash, 976 F.2d 86, 89 (2d Cir. 1992) (quoting Deerfield Commc’ns Corp. v. Chesebrough-Pond’s, Inc., 502 N.E.2d 1003, 1004 (N.Y. 1986).”
The Court also rejected additional allegations of fraudulent statements, ruling that plaintiff failed to offer evidence that one such statement was false when made and as to the other, any “evidence that the employee made such a statement ‘with a preconceived…intention of not performing,’ Stewart, 976 F.2d at 89 (emphasis omitted) (citation omitted), or with knowledge that these outcomes ‘[could] not be achieved,’ Cohen v. Koenig, 25 F.3d 1168, 1172 (2d Cir. 1994).”
The Court finished its analysis with noting that plaintiffs failed to establish any special relationship with the defendant – having agreed in the contract that there was no such relationship beyond arms-length, and that the lost profits damages plaintiffs sought were not recoverable in a fraud action. The Court relied upon the recognized “out-of-pocket” rule in so rejecting plaintiffs’ claim for such damages, citing “Ostano Commerzanstalt v. Telewide Sys., Inc., 794 F.2d 763, 766 (2d Cir. 1986) (‘[T]he law of New York is plain that out-of-pocket rather than benefit-of-the-bargain damages are awarded for fraud so that all elements of profit are excluded.’) (citation and internal quotation marks omitted).”