Commercial Division Blog

Posted: January 25, 2016 / Categories Commercial, Fraud/Misrepresentation

Fraudulent Misrepresentation Requires Out-Of-Pocket Losses, Lost Profits Insufficient

On January 19, 2016, in Connaughton v. Chipotle Mexican Grill, 2016 NY Slip Op 00273, a divided panel of the Appellate Division, First Department, affirmed a decision of the New York County Supreme Court (Kornreich, J.) dismissing the complaint.

The complaint alleged that the plaintiff, a well-known chef, had signed an agreement with Chipotle and its owner to develop a high-end fast food ramen noodle chain. He was hired as an at-will employee to develop his concept. However, soon before the first restaurant was to open, the plaintiff learned that the defendants had entered into a prior agreement to develop a ramen noodle chain with the owner of Momofuku Noodle Bar, that the relationship between the defendants and Momofuku had fallen apart, but that a confidentiality agreement was still in effect, and that the defendants had used designs and information from that relationship in planning their new ramen chain—without paying Momofuku, and that the Momofuku parties would sue the defendants (and also likely him) once the new ramen restaurant opened. The plaintiff confronted Chipotle's owner, who admitted the previous dealings but ordered the ramen plan to continue regardless. Soon thereafter, the plaintiff was fired by the defendants.

The plaintiff did not assert breach of contract—his employment agreement was at-will, and the defendants had paid his compensation. Instead, he asserted (a) fraudulent inducement—the defendants should have disclosed their prior dealings with Momofuku—and (b) unjust enrichment.

The Appellate Division was unanimous in upholding dismissal of the unjust enrichment claim as precluded by the existence of a contract, but the court split 3-2 on the fraudulent inducement claim.

The plaintiff's fraudulent inducement argument was that the defendants should have disclosed the existence of the prior contract (and the fact that they were using confidential information from that relationship), which would have been material to his decision to develop his concept with Chipotle—most likely leading to litigation and professional injury—or elsewhere. The plaintiff alleged that his injuries were lost profits he could have received by taking his plans elsewhere, and the risk that he would himself be sued by the Momofuku parties and suffer severe damage to his professional reputation.

The majority ruled that these damages were insufficient to state a claim, because fraud damages do not extend to lost profits: "damages are calculated to compensate plaintiffs for what they lost because of the fraud, not for what they might have gained in the absence of fraud." They rejected the reputational and litigation risk damages as "undeterminable and speculative" because no such injury had yet been sustained, and also refused to award nominal damages, stating that "in tort, there is no enforceable right until there is a loss, and a claim of nominal damages where no loss has accrued wrests the cause of action in tort from its traditional purposes—the compensation of losses—and uses it to vindicate nonexistence or amorphous inchoate rights."

Although the dissent agreed that lost profits were not an available measure of damages, they noted that CPLR 3016(b) only requires that the circumstances of the fraud be pleaded with particularity, not the damages: "a reasonable inference of general damages may be implicit by the facts alleged and does not need to be explicitly stated." Construing the plaintiff's allegations liberally, a present injury could be inferred. The dissent also maintained that nominal damages can be awarded on a fraud claim "when needed to protect an important technical right," which left the possibility opened and justified construing the allegations in the complaint as liberally as possible.

This opinion shows that every fraud plaintiff needs to allege some kind of actual damages—no matter how limited, even if not plead with particularity—in order to get over the pleading bar.