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Kevin Schlosser Authors, "SDNY Allows Fraud Claim Allegedly Duplicative of Contract Claim to Proceed, Although 'A Long Shot'"

Nov 19, 2019Litigation & Dispute Resolution
The interplay between claims of fraudulent inducement to enter into a contract and the breach of that contract is a topic that gets great attention in the law of fraud. As I have put it before: “Courts frequently dismiss claims attempting to allege fraud because they are nothing more than an ineffective attempt to dress up a breach of contract as a fraud. Cases of this nature can be found on this site using the topics index under ‘Contract Breach, Not Fraud.’” As I also have explained: “When defendant is accused of representing that it would perform a contractual obligation, which it later fails to perform, courts nearly always reject the attempt to assert a fraud claim, ruling that it is nothing more than a breach of that contractual obligation. The sticky part is when there is real evidence that the defendant made the contractual promise with a present, demonstrable, intent not to perform. Can that fly as a fraud, rather than mere breach of contract? Does the promise have to be ‘collateral’ to the actual contractual obligation, and if so, what is considered ‘collateral’?“ In DGI-BNSF CORP v. TRT LEASECO, LLC, 18-CV-3252 (VEC), (SDNY Nov. 6, 2019), US District Court Judge Valerie Caproni of the Southern District of New York recently allowed a fraudulent inducement claim to proceed in the context of a motion to amend a complaint under FRCP 15. The very liberal standard for amending pleadings as interpreted by the Court appears to have played a significant role in the decision, as the Court observed that although ultimately establishing the fraud claim was “a long shot,” it would not be “futile” to allow it. Case Facts of TRT The Court summarized the factual context of its decision rather well upfront. In a nutshell: The parties were two of several entities involved in an elaborate transaction designed to reduce payments of federal income tax. Plaintiff, through intermediate entities, owned and controlled Defendant TRT LeaseCo, LLC (“TRT”). Non-party Kingsway Financial Services, Inc. (and its affiliates) held over $800 million in net operating losses, which could be used to offset otherwise taxable profits. Plaintiff, seeking to take advantage of Kingsway’s unused and expiring tax benefits, entered into an agreement to transfer a majority interest in TRT to a Kingsway subsidiary, so that Kingsway’s losses could be applied to TRT’s profits for tax purposes, even though the entities were otherwise unrelated. According to Plaintiff’s version of their agreement, once the net operating losses were applied and other expenses paid, TRT was obligated to remit a portion of the remaining profits back to Plaintiff in the form of quarterly fee payments. Because TRT failed to make those payments, Plaintiff sued for breach of contract. Plaintiff then moved for leave to amend the complaint to add a fraudulent inducement claim, alleging that Kingsway’s representative, during the negotiation of the tax arrangement, effectively promised that Plaintiff would receive the quarterly payments despite having already made plans to divert those payments. Rule 15 The Court explained the procedural posture of the motion to amend to add the fraud claim by reviewing FRCP 15:

Pursuant to Rule 15 of the Federal Rules of Civil Procedure, “[t]he court should freely give leave [to amend] when justice so requires.” Fed. R. Civ. P. 15(a)(2). “Leave to amend may be denied ‘for good reason, including futility, bad faith, undue delay, or undue prejudice to the opposing party.’” Kim v. Kimm, 884 F.3d 98, 105 (2d Cir. 2018) (quoting McCarthy v. Dun & Bradstreet Corp., 482 F.3d 184, 200 (2d Cir. 2007)). “[L]eave to amend will be denied as futile only if the proposed new claim cannot withstand a 12(b)(6) motion to dismiss for failure to state a claim, i.e., if it appears beyond doubt that the plaintiff can plead no set of facts that would entitle him to relief.” Milanese v. Rust-Oleum Corp., 244 F.3d 104, 110 (2d Cir. 2001) (citing Ricciuti v. N.Y.C. Transit Auth., 941 F.2d 119, 123 (2d Cir. 1991)). TRT contends that DGI’s new claim is futile because it is duplicative of DGI’s existing contract claim and because the alleged fraudulent statements, made by Swets, who was a principal of Kingsway, cannot be attributed to TRT.

In equating the standard on a motion to amend to the same standard as that on a motion pursuant to FRCP 12(b)(6), the Court was correct, but it relied upon a 2001 Second Circuit case citing a 1991 decision, and failed to incorporate the up-to-date pleadings standard pronounced by the United States Supreme Court in Bell Atlantic v Twombly, 550 U.S. 544 (2007) and Ashcroft v Iqbal, 556 U.S. 662 (2009). Query whether that would have made a difference in the Court’s analysis. In any event, the Court proceeded to determine whether the proposed fraudulent inducement claim would be futile. Fraudulent Inducement Claim Not Futile The Court described the applicable law as follows (footnote omitted):

As a general rule, “[m]ere unfulfilled promissory statements as to what will be done in the future are not actionable as fraud” and remain within the ambit of contract law. See, LLC v. Halo Grp., Inc., 174 A.D.3d 682, 683 (2d Dep’t 2019) (internal citation and quotation marks omitted); see also Wyle Inc. v. ITT Corp., 130 A.D.3d 438, 439 (1st Dep’t 2015) (“[A]s a general rule, to recover damages for tort in a contract matter, it is necessary that the plaintiff plead and prove a breach of duty distinct from, or in addition to, the breach of contract.” (citation omitted)). In contrast, a plaintiff states a distinct cause of action for fraudulent inducement if it alleges that “the defendant made misrepresentations of present facts that were collateral to the contract and served as an inducement to enter into the contract.”, 174 A.D.3d at 683.

Although the defendant seemed to argue that the proposed fraud claim was duplicative of the breach of contract claim, it appeared that the alleged promise was not contained in the contract and the real issue was whether the alleged misrepresentation was one of existing fact, or future promise. As to that issue, the Court found there were sufficient allegations as to a present intention not to abide by such promise, which is sufficiently actionable. The Court then applied the facts as follows:

Accepting DGI’s allegations as true, DGI would not have entered into the MSA [contract at issue] had [TRT’s agent] Swets not promised that TRT would not be required to pay Kingsway for the use of NOLs because the absence of such a guarantee from Swets would eliminate DGI’s upside under the agreement. PAC ¶ 48. Because the MSA does not address TRT’s obligation, if any, to pay Kingsway for the use of NOLs, Swets’ promise was “extraneous” to the contract that DGI is seeking to enforce. See Bridgestone/Firestone, Inc. v. Recovery Credit Servs., Inc., 98 F.3d 13, 20 (2d Cir. 1996) (citing Deerfield Commc’ns Corp. v. Chesebrough-Ponds, Inc., 68 N.Y.2d 954, 956 (1986)). As alleged in the proposed pleading, it is plausible that Swets’ contractually extraneous statements induced DGI to enter into the MSA. Thus, the dispositive question is whether Swets’ statements were misrepresentations of future intent, as TRT claims, or of “present facts,” as DGI contends. That question is settled by controlling precedent from the New York Court of Appeals. As the state high court has repeatedly held, “a promise . . . made with a preconceived and undisclosed intention of not performing it” is “a representation of present fact, not of future intent.” Deerfield Commc’ns, 68 N.Y.2d at 956 (citing Sabo v. Delman, 3 N.Y.2d 155, 160 (1957) (“[I]t is settled that, if a promise was actually made with a preconceived and undisclosed intention of not performing it, it constitutes a misrepresentation of ‘a material existing fact.’” (citations omitted))). Because DGI alleges that Swets made promises about TRT’s ability to use Kingsway’s NOLs free-of-charge, when he had already hatched a contrary plan at Kingsway, DGI has plausibly alleged that Swets misrepresented a “present fact.” TRT’s futility argument, based on duplication, is therefore without merit.

Agency in Fraud The Court then went on to find that the allegations were sufficient to hold TRT responsible in fraud for the statements made by Swets: “TRT allowed Swets to choose TRT’s counsel for purposes of the negotiation, and that Swets’ chosen counsel, McDermott Will & Emery, acted on Swets’ instructions during the negotiation and drafting of the MSA. See Dkt. 60 at 2. Those two facts, if true, may fairly be considered a manifestation of TRT’s consent to be bound by Swets’ conduct, at least as to the MSA. DGI therefore, in an amended pleading, may be able to plead sufficient facts to show that Swets was at least a ‘special agent’ for TRT, in that he was ‘an agent authorized to conduct a single transaction,’ rather than a ‘general agent.’ See Restatement (Second) of Agency § 3.” (Footnotes omitted.) Click here for Kevin Schlosser's fraud blog.