The cause of action for fraud does not always recognize legal remedies for what might appear to be inappropriate or even wrongful conduct. For example, even in the face of the most egregious fraudulent conduct, the victim cannot establish a cause of action for fraud if it did not take reasonable steps to protect itself and investigate the fraudulent conduct for itself. That is the fundamental element of “reasonable reliance” – the victim must have acted reasonably or justifiably in relying upon the false information intentionally conveyed to it by the alleged fraudster. I have written often about this. See, e.g., post, topic posts. Fraudulent conduct can also be insulated from a fraud claim where effective disclaimers are contained in contractual documents. See post. Even when the circumstances surrounding the conduct at issue seem particular unfair, a fraud claim may not be available. See post (Federal decision in which the District Court Judge dismissed the fraud claim, commenting: “what occurred here, although unfortunate and unfair, does not constitute fraud.”).
Another frequent scenario in which a fraud claim may not be recognized is where a party conceals or otherwise fails to disclose information that is undeniably material to another party who may have avoided damage if it knew about the withheld information. Courts restrict the circumstances under which fraud claims can be asserted for a failure to disclose. The recent decision of the United States District Court for the Northern District of New York in Southwestern Payroll Service, Inc. v. Pioneer Bancorp, Inc., 1:19-CV-1349 (FJS/CFH) (April 16, 2020) is a good example.
Facts of Pioneer
In Pioneer, the plaintiff was a payroll processing company for employers. Among other things, as part of the contractual services, plaintiff would obtain funds from the employer clients, maintain the funds in a separate escrow bank account, and then when taxes and other fees were due from the employer, plaintiff would make those payments on behalf of the employers. One of the defendants (Michael Mann) purchased a 50% interest in the plaintiff. Mann obtained funding for the purchase by borrowing from defendant bank (Pioneer). A term of the loan required plaintiff to deposit the employer-related advances it received into an escrow account with Pioneer.
Thereafter, the funds plaintiff received were deposited into the Pioneer account, at time of suit amounting to about $10 million. Plaintiff subsequently discovered that Defendant Mann allegedly committed fraud by taking out various fraudulent loans with Defendant Pioneer and other banks and by improperly manipulating various payroll accounts held with Defendant Pioneer. According to plaintiff, Defendant Pioneer froze outgoing payroll tax processing transactions from the escrow account effective August 30, 2019, but it continued to receive and deposit the incoming funds from plaintiff’s employer clients through at least September 4, 2019. In that six-day period, Defendant Pioneer received $6,740,339.63 in employer-related funds from plaintiff. Thus, plaintiff may have been able to stop those employer funds from being deposited into the Pioneer escrow account if it had known that Pioneer was freezing those funds as a remedy for Mann’s alleged fraud against the banks.
Subsequently, plaintiff filed an amended complaint on December 10, 2019, which included six causes of action against Defendant Pioneer and six causes of action against Defendant Mann and his companies. Defendant Pioneer then moved to dismiss only plaintiff’s third cause of action against it for “actual and constructive fraud.” The District Court granted that motion, ruling that the circumstances under which Pioneer withheld the fact that it had frozen the funds did not amount to fraud or constructive fraud.
Concealing or Withholding Information –Special Circumstances
After addressing the standards under FRCP 12(b)(6), the Court concisely summarized the relevant principles on a fraud claim involving alleged concealment of information:
Importantly, an omission or “concealment of facts supports a cause of action for fraud only if the non-disclosing party has a duty to disclose.” Remington Rand Corp. v. Amsterdam-Rotterdam Bank, N.V., 68 F.3d 1478, 1483 (2d Cir. 1995) (citations and footnote omitted). “Such a duty ordinarily arises where the parties are in a fiduciary or other relationship signifying a heightened level of trust.” Id. (citations omitted). “In the absence of a fiduciary relationship, a duty to disclose may arise if: (1) one party makes a partial or ambiguous statement that requires additional disclosure to avoid misleading the other party, … ; or (2) ‘one party possesses superior knowledge, not readily available to the other, and knows that the other is acting on the basis of mistaken knowledge.’ …” Id. at 1484 (internal citation and quotation omitted). “In either case, a disclosure duty ripens only when it becomes apparent to the non-disclosing party that another party is operating under a mistaken perception of a material fact.” Id. (citation omitted).
Applying the facts to this law, the Court found that the special circumstances for a fraud claim did not exist there.
No Fiduciary Relationship
As to whether a fiduciary relationship between plaintiff and Pioneer existed, the Court relied upon case law that a bank does not have a fiduciary relationship with its depositor customers:
“‘[T]he relationship between a bank and its depositor is one of debtor and creditor[.]’” Greenberg, Trager & Herbst, LLP v. HSBC Bank USA, 17 N.Y.3d 565, 578 (2011) (quoting Brigham v. McCabe, 20 N.Y.2d 525, 530 (1967)); (citing Solicitor for Affairs of His Majesty’s Treasury v. Bankers Trust Co., 304 N.Y. 282, 291 (1952)). “It is well established that absent specific contractual language or circumstances to the contrary, the ordinary relationship between a creditor and debtor does not rise to the level of imposing a fiduciary duty upon the creditor.” Gorham-Dimaggio v. Countrywide Home Loans, Inc., 592 F. Supp. 2d 283, 294 (N.D.N.Y. 2008) (citations omitted). Thus, “the bank-depositor agreement standing alone creates no fiduciary relationship between the parties.” Tevdorachvili v. Chase Manhattan Bank, 103 F. Supp. 2d 632, 640 (E.D.N.Y. 2000) (citing Aaron Ferer & Sons Ltd. v. Chase Manhattan Bank, 731 F.2d 112, 122 (2d Cir. 1984) (holding that under New York law the “usual relationship” of bank and depositor is based on contractual principles, and involves no fiduciary duty from bank to depositor)).
The Court found fault with the amended complaint because it merely alleged that Defendant “Pioneer had a confidential and fiduciary relationship with [Plaintiff] by virtue of its receipt and holding of [Plaintiff]’s [funds]. … Plaintiff did not allege any specific contractual language or circumstances that would indicate the parties intended to impose a fiduciary duty upon Defendant Pioneer. Nor did it cite to any cases showing that a bank’s holding tax trust funds creates a fiduciary relationship with the depositor.”
No “Special Facts”
The Court then found that the “special facts” doctrine did not apply either. Elaborating upon its earlier citations, the Court observed:
“To establish ‘superior knowledge’, [the] plaintiff must prove that the material fact was information peculiarly within the knowledge of the defendant, and that the information was not such that could have been discovered by the plaintiff through the ‘exercise of ordinary intelligence[.]’” Id. (quoting Jana L. [v. West 129th Street Realty Corp.], 22 A.D.3d [274,] 277, 802 N.Y.S.2d 132 [(1st Dep’t 2005)] (citations omitted)). “Where there is no fiduciary relationship that would impose a duty to disclose, a party’s mere silence without some act which deceived the other party cannot constitute a concealment that is actionable as fraud.” Id. at 366-67 (citation omitted).
The Court held plaintiff to a rather strict standard in ruling that plaintiff could have discovered that Pioneer had frozen the funds in the escrow account before or during the six-day window period. The Court accepted Pioneer’s argument that plaintiff did not allege in its amended complaint that the omitted information could not have been discovered by the exercise of ordinary intelligence. The Court also observed that plaintiff did not allege that it made any inquiries to determine whether the account was operating normally or if outgoing payments had been frozen.
The Court then speculated somewhat in concluding that plaintiff could have independently discovered the bank funds were frozen during the six-day period because plaintiff admitted that it found out on its own about the frozen account later: “It’s unclear how, exactly, Plaintiff learned on its own about the frozen account. It could have received notice from the tax collecting authorities, from its clients, or it could have discovered this information on its own after Defendant Mann, Plaintiff’s 51% shareholder, resigned from his officer positions [in related companies].” The Court then concluded: “No matter how Plaintiff discovered that its outgoing payments through the [subject] account were frozen, it was clearly able to discover it using ordinary intelligence. Because Plaintiff has not satisfied this prong of the special facts doctrine, the Court finds that it does not apply to create a duty on the part of Defendant Pioneer to disclose information about the frozen account.
As I have commented in the past, since the cause of action for fraud involves serious allegations and gives rise to substantial remedies, a plaintiff seeking to allege a claim for fraud has strict burdens. See,e.g., “What Do Fraud and Spiderman Have in Common? With Great Power Comes Great Responsibilities”. As shown in the Pioneer decision, where information is not provided, as opposed to where material affirmative factual misrepresentations are made, special circumstances must be present in order to give rise to a fraud claim. Those include the existence of a fiduciary relationship under which a legal duty arises to disclose information or where a party has unique knowledge of information or where statements are made that are incomplete or misleading, in which case a duty arises to correct or explain them.