Blogs

Commercial Division Blog

Current Developments in the Commercial Divisions of the
New York State Courts by Schlam Stone & Dolan LLP
Posted: July 20, 2020

Court Upholds Fraud Claim Based on Damages Resulting From Selling at a Fraudulently-Induced Deflated Price

On June 29, 2020, Justice Masley of the New York County Commercial Division issued a decision in Community Assn. of the E. Harlem Triangle, Inc. v. Butts, 2020 NY Slip Op. 32163(U), upholding a fraud claim based on damages resulting from selling at a fraudulently-induced deflated price, explaining:

In New York, as in multiple other states, the true measure of damage is indemnity for the actual pecuniary loss sustained as the direct result of the wrong or what is known as the out-of-pocket rule. Under that rule, damages are to be calculated to compensate plaintiffs for what they lost because of the fraud, not to compensate them for what they might have gained. There can be no recovery of profits which would have been realized in the absence of fraud. Moreover, this Court has consistently refused to allow damages for fraud based on the loss of a contractual bargain, the extent, and, indeed the very existence of which is completely undeterminable and speculative.

The Appellate Division, First Department outlined the procedure for determining whether out-of-pocket damages exist, and for calculating them:

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.

Based on these and other authorities, defendants urge that plaintiffs suffered, at most, a lost opportunity or lost profit. They contend that, under the out-of-pocket rule, all such losses to be inherently speculative and nonrecoverable as a matter of law.

The court concludes that this interpretation overstates the law. Connaughton can best be read as holding that the loss of a contractual bargain or profits is nonactionable only if the losses are in fact completely undeterminable and speculative. The Connaughton Court observed that, although the plaintiff stopped soliciting potential buyers for his restaurant concept in reliance on defendant’s fraud, the complaint fails to allege that, in doing so, he rejected another prospective buyer’s offer to purchase the concept. Other cases have also highlighted a plaintiff’s inability to identify a specific offer alternative offer as a factor justifying dismissal.

Recovery under the rule is precluded only where no alternative offer is outstanding, or where plaintiff is seeking profits comprised of the indeterminable future earnings that, might have flowed from an alternative deal. Here, in contrast, there was a concrete offer made within a few weeks of the closing, memorialized by a written term sheet, which defendants effectively rejected on plaintiff’s behalf by their alleged deception.

Under Kumiva, plaintiffs will be entitled to submit nonspeculative proof demonstrating that they were induced to deliver consideration the Property that was greater than the value of the received consideration $39 million by proffering evidence of the market value of the Property at the time of the sale. Although the court has not located any cases involving a real estate seller fraudulently induced to part with its property at lower price due to the concealment of a better offer, the First Department’s decision in Bernstein v Kelso & Co., 231 AD2d 314 (1st Dept 1997) is instructive. In Bernstein, the plaintiff alleged that the management employees of a company schemed with a potential buyer to sell the company at the lowest price that the principal and other shareholders would accept, furnishing confidential information to aid the buyer in obtaining the most favorable offer for itself (id. at 318-319). The Court found it irrelevant that the plaintiff ultimately made an overall profit from the transaction, noting that the plaintiff was not seeking the undeterminable future profits that might generated by the company after the sale. Rather, the plaintiff sought to recover the difference between the price he received in the sale of the company and the price he would have received had his employees and the buyer not deceived him.

While defendants insist that plaintiffs are seeking an impermissible gain over the price they received for the Property, that is not the case. Plaintiffs allege that they suffered a net loss by parting with a property worth $42 million for only $39 million. While in Kumiva, the alleged loss arose from the buyer’s cash overpayment for the property (corporate stock), a loss may also be established, as in Bernstein, by demonstrating that the seller has been underpaid for its property.

Accordingly, defendants’ contention that an out-of-pocket loss may never be established by a sale at a deflated price is erroneous. None of the cases on which they rely are to the contrary. In Norcast S.ar.I. v Castle Harlan, Inc., 147 AD3d 666 (1st Dep’t 2017), the plaintiffs alleged that they were fraudulently induced to sell at a lower price where the defendant concealed the true identity of the buyer, a competitor business. The Court merely held that the purchase price that would have been agreed upon, had the buyer’s identity been known, was speculative. Furthermore, the Court noted that there was no suggestion that the agreed price was unfair, as it was voluntarily accepted by plaintiffs, who had their own financial advisors, as the result of a competitive bidding process and was $20 million higher than the next highest bid. By comparison, in this case there was an agreed upon purchase price, and plaintiffs were deprived of any bidding process by the alleged concealment.

Sardanis v Sumitomo Corp., 279 AD2d 225 (1st Dept 2001), is distinguishable for the same reasons as Norcast. In that case, the plaintiff alleged that the defendants obtained a unfair advantage in negotiating its purchase of copper by concealing their unlawful use of plaintiff’s confidential information. The Court noted that the plaintiff sold the copper for more than it had paid, and its claim that it might have obtained an even higher price for the copper in absence of the deception was speculative.

In short, the out-of-pocket rule does not bar plaintiffs’ fraud claims. At a minimum, plaintiffs will be permitted to submit evidence of the Property’s true market value on the date of the sale and recover the difference between that amount and the price it received, if any. Furthermore, the court concludes that plaintiffs may be entitled to recover the full $3 million difference between the price received and the Peebles/Integrated offer, even if that offer exceeded the Property’s market value. As illustrated by the cases discussed above, the Courts’ concerns regarding a plaintiff’s receipt of profits appear to be directed at those rooted in speculation, such as future earnings, rather than capital appreciation or gains arising from a single, discrete sale of property pursuant to an offer at a fixed price. And as noted in Cayuga, supra, the out-of-pocket rule was not meant to be an inflexible rule categorically precluding damages based on the market value of plaintiff’s property because such value would include some element of profit.

Finally, defendants assert that the Peebles/Integrated offer was speculative by reason of the possibility that the buyer could have walked away, or that any alleged deal would be barred by the statute of frauds. However, the authorities discussed above do not require proof of an irrevocable or consummated offer as a predicate to recovery, only a prospective one setting forth reasonably definite terms.

(Internal quotations and citations omitted).

Commercial litigation frequently involves fraud-based claims. Such claims have special pleading requirements or rules, including the rule discussed here regarding whether a plaintiff can seek only money lost through the fraud (out-of-pocket damages) or the profits the plaintiff hoped to have earned in the absence of the fraud. Contact Schlam Stone & Dolan partner John Lundin at jlundin@schlamstone.com if you or a client think you have been defrauded, or if someone has accused you or a client of defrauding them.

Click here to subscribe to this or another of Schlam Stone & Dolan’s blogs.

View posts