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Posted: August 3, 2016

Fraud Claim Survives Despite Merger Clause Disclaiming Extra-Contractual Representations

On July 25, 2016, Justice Singh of the New York County Commercial Division issued a decision in 438 W. 20 St., LLC. v. Bares, 2016 NY Slip Op. 31452(U), denying a motion to dismiss a fraud claim despite a merger clause disclaiming extra-contractual representations, explaining:

A specific merger clause in an agreement entered into by both parties is sufficient to bar any claims of misrepresentation. Where a merger clause is merely general and not specific in its coverage of the exact representations at issue, the parole evidence rule will not bar a claim for fraud in the inducement of contract. A general misrepresentation clause in the contract will not preclude a claim for fraud in the inducement. The distinction between general and specific representation clauses is dispositive under New York law. [A] merger clause stating no reliance on any representations outside of the contract does preclude a fraud claim on such representations.

A claim of fraud turns on whether the defendant actively concealed anything from the plaintiff. A contractual promise made with the undisclosed intention not to perform it constitutes fraud and, despite the so-called merger clause, the plaintiff is free to prove that he was induced by false and fraudulent misrepresentations which are questions necessarily reserved for trial.

In this case, plaintiff and sellers entered into the contract which states,

Purchaser acknowledges and represents that Purchaser is fully aware of the physical condition and state or repair of the Premises and of all other property included in this sale, based on Purchaser’s own inspection and investigation thereof, and that Purchaser is entering into this contract based solely upon such inspection and investigation and not upon any information, data, statements or representations, written or oral, as to the physical condition, state or repair, use, cost of operation or any other matter related to the Premises or the other property included in the sale given or made by Seller or its representatives, and shall accept the same “as is” in their present condition and state of repair, subject to repair, subject to reasonable use, wear, tear and natural deterioration between the date hereof and the date of closing.

In addition, the contract states that “[a]ll prior understandings, agreements, representations and warranties, oral or written, between Seller and Purchaser are merged in this contract; it completely expresses their full agreement and has been entered into after full investigation. Neither party relying upon any statement made by anyone else that is not set forth in this contract.”

This court finds the First Department’s ruling in TIAA Global Investments, LLC v. One Astoria Square LLC, 127 A.D.3d 75 (1st Dept 2015), to be applicable to the circumstances in this case. In TIAA Global Investments, the parties entered into a similar merger clause, and the court held that the contractual right contained in the merger clause, which allowed the purchasing party a ‘virtually unlimited right’ to conduct investigations, studies, and inspections of the property did not relieve the defendant of the requirement that knowledge of the defects not be peculiarly within the defendant’s knowledge. The court was persuaded by the Third Department’s holding in Schooley v. Mannion 241 A.D.2d677 (3d Dept 1997), where the court found a proper cause of action for fraud, overturning a dismissal, even though there were specific merger clauses in the contract because (1) the defect of the insulation was particularly within the defendant’s/seller’s knowledge and (2) reasonable diligence does not include breaking down walls to inspect hidden insulation. More specifically, the court held

Even if the contract had contained specific disclaimers, the fact that the alleged defect regarding insulation was peculiarly within the defendant’s knowledge would be sufficient to salvage plaintiffs’ caµse of action. It is significant that the defendant is alleged to have recently gutted and renovated the entire property and that insulation is a nonvisible component, not easily verified without destructive testing.

Plaintiff here has made a legally sufficient argument to survive a motion to dismiss with respect to having performed reasonable diligence despite the existence of a merger clause. Plaintiff argues that defendant had ‘peculiar knowledge’ of the flaws within the structure of the townhouse, citing as evidence the suit that defendants themselves instigated against a neighboring structure whose construction damaged the soundness of the townhouse. The alleged structural defects included the mold underneath the flooring, a large hole in the brick structural wall behind the sheet rock, and a hole beneath a bathtub. Since these defects were hidden beneath the floors and walls, covered up just like insulation, any amount of diligence required to discover such flaws would not be reasonable. Due diligence does not require a party prior to taking possession of the building, to do the requisite testing, some of it possibly destructive, that would be necessary to reveal the alleged defects. Since efforts to discover these structural defects would, inevitably, entail possible destructive testing to the Townhouse’s walls and floors, such investigation is not within the reasonable diligence required.

(Internal quotations and citations omitted).

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