Commercial Division Blog

Posted: January 16, 2017 / Categories Commercial, Fraud/Misrepresentation, Damages

Fraudulent Inducement Claim Fails for Failure to Prove Out-of-Pocket Damages

On January 12, 2017, the First Department issued a decision in Kumiva Group, LLC v. Garda USA Inc., 2017 NY Slip Op. 00235, granting summary judgment dismissing a counterclaim for fraudulent inducement for failure adequately to plead out-of-pocket damages, explaining:

Initially, as to Garda's damages, New York courts for over one hundred years have differentiated between the damages recoverable for a breach of contract action and those recoverable for fraudulent inducement. While a plaintiff alleging breach of contract is entitled to damages restoring the full benefit of the bargain, a plaintiff alleging fraudulent inducement is limited to out of pocket damages, which consist solely of the actual pecuniary loss directly caused by the fraudulent inducement. Out of pocket damages are calculated in three steps. First, the plaintiff must show the actual value of the consideration it received. Second, the plaintiff must prove that the defendant's fraudulent inducement directly caused the plaintiff to agree to deliver consideration that was greater than the value of the received consideration. Finally, the difference between the value of the received consideration and the delivered consideration constitutes out of pocket damages.

Here, to show nonspeculative damages, Garda was required to submit evidence establishing ATI's actual value on February 25, 2007, the date of the execution of the merger agreement setting the purchase price for the company. Next, Garda had the burden to submit evidence that ATI's misrepresentations directly caused Garda to agree to pay consideration to ATI that was greater than ATI's actual value. The difference between these two sums would then constitute Garda's out-of-pocket damages. Garda failed to come forward with such evidence.

In opposition to Kumiva's and the Irvin defendants' motion for summary judgment, Garda submitted, inter alia, the expert affidavit of J.T. Atkins, the head of an advisory firm specializing in mergers and acquisitions. Atkins explained that the conventional manner to appraise a business requires conducting three studies: (1) a comparable company analysis; (2) a precedent transaction analysis; and (3) a discounted cash flow analysis. The results of these three studies are then triangulated to determine the value of the business.

Garda concedes that it failed to conduct a formal valuation of ATI's value on February 25, 2007. Rather, Garda's experts attempted to calculate the first step of the out of pocket damages analysis by assuming that the $341,700,000 purchase price constituted ATI's actual value. Atkins acknowledged that using the $341,700,000 purchase price as a valuation of ATI was not a formal valuation by any stretch of the imagination. Nevertheless, Garda posits that since ATI and Garda negotiated the $341,700,000 price through arms length negotiations, that price constitutes the best measure" of ATI's value on February 25, 2007. Garda further contends that a formal appraisal method may have distorted Garda's damages by including damages solely due to changes in methodology.

Contrary to Garda's arguments, the negotiated price cannot substitute for evidence of ATI's actual value on the relevant date for purposes of a damages calculation. As Garda itself concedes, a formal appraisal of ATI's value may have established that ATI was actually worth either more than or less than $341,700,000. If ATI's value were equal to or greater than $341,700,000 (which cannot be determined on this record), Garda would not be entitled to damages for fraudulent inducement.

Garda also failed to complete properly the second step of the out of pocket damages calculation. Instead of showing that Garda delivered consideration greater than ATI's actual value, Garda asked its experts to calculate the dollar amount by which ATI's misrepresentations inflated the purchase price. Atkins opined that the misrepresentations inflated ATI's price by $81,000,000. Garda also submitted the affidavit of another expert, Simon Platt, a forensic accountant, who opined that the misrepresentations inflated the price by $36,000,000. Based on these opinions, Garda concluded that it suffered out-of-pocket damages in an amount between $36,000,000 and $81,000,000. However, a showing that Garda would have made a lower offer if ATI had not made any misrepresentations does not suffice to demonstrate that Garda suffered any actual pecuniary loss. In fact, Garda essentially concedes that an actual formal valuation might well have shown that ATI was worth more than $341,700,000 on the valuation, in which case Garda would not have suffered any pecuniary damages at all.

In sum, Garda failed to properly calculate out of pocket damages. First, apparently out of a misguided concern that a formal appraisal might show that it had paid a fair price for ATI, Garda conflated the first and second steps by concluding that the agreed-upon purchase constituted ATI's actual value, instead of conducting a formal appraisal to determine that actual value. Second, instead of comparing the delivered consideration to ATI's actual value, Garda attempted to work backwards from the agreed-upon price and to estimate how much lower Garda's offer would have been but for ATI's misrepresentations. These exercises cannot substitute for admissible evidence of ATI's actual value on the relevant date.

(Internal quotations and citations omitted) (emphasis added).