On October 22, 2015, Justice Singh of the New York County Commercial Division issued a decision in Katzrin Finance Group, LLC v. Arcapex LLC, 2015 NY Slip Op. 31971(U), dismissing a fraud claim for failure to show due diligence.
In Katzrin Finance Group, plaintiff brought an action against defendants, claiming that it was “invest in Blue King, a doomed-to-fail enterprise, by misrepresenting key aspects of the venture’s financial situation,” including payments Blue King would be making to certain defendants. The court dismissed the fraud claim against the defendants on several grounds, including lack of justifiable reliance, explaining:
In order to succeed on a fraud claim, a plaintiff must show both that they relied upon the defendant’s misrepresentations and that such reliance was justifiable. As the Court of Appeals has repeatedly stated:
If the facts represented are not matters peculiarly within the party’s knowledge, and the other party has the means available to him of knowing, by the exercise of ordinary intelligence, the truth or the real quality of the subject of the representation, he must make use of those means, or he will not be heard to complain that he was induced to enter into the transaction by misrepresentations.
Assuming defendants had a duty to disclose the information contained in the service agreements, plaintiff still needs to show that its alleged reliance was justified given the nature of their relationship.
. . .
[The Court of Appeals decision] in Centro is particularly instructive. As in the current case, the plaintiffs fraud claim partially hinged on the allegation that the defendants failed to disclose financial information necessary to determine the value of plaintiffs investment. As here, the plaintiffs were a sophisticated business entities with the benefit of legal counsel. The plaintiffs were aware that defendants had not supplied all the information that they were entitled to but failed to take actions necessary to protect their interests. In the court’s words, this was an instance where plaintiffs have been so lax in protecting themselves that they cannot fairly ask for the law’s protection. In the current case, plaintiff hired counsel to conduct due diligence, was aware that defendants possessed information that was potentially important to its business decisions, was denied access to that information, and decided to invest anyway.
New York law imposes an affirmative duty on sophisticated investors to protect themselves from misrepresentations made during business acquisitions by investigating the details of the transactions and the business they are acquiring. But at the same time the law does not impose a duty on plaintiffs to insist on a prophylactic provision in agreements in order to protect themselves.
Here, [the plaintiff] had the power to refuse to invest any of its money into Blue King until it had an opportunity to examine the service agreements: It was a sophisticated investor represented by a major law firm considering entering into an industry its own attorneys had warned was risky due to regulatory concerns. But here, [the plaintiff] knew exactly what information it required, knew defendants likely possessed the information, and even knew what specific documents to ask for, but failed to take reasonable steps to protect its investment. Moreover, plaintiff continued investing for months following the last alleged discussion concerning the service agreements, even investing an additional $3 million months after completing the initial investment and months after plaintiffs own documentary evidence indicates it was made aware of the amounts being paid to the service providers and the Indian tribe. Thus, it is not the court’s role to insulate sophisticated businesses entities from the consequences of their own risky investments. The Court of Appeals reiterated in ACA Fin. Guar. Corp. that, the question of what constitutes reasonable reliance is not generally a question to be resolved as a matter of law on a motion to dismiss. However, in contrast to [the plaintiff’s] alleged actions here, plaintiff in ACA Fin. Guar. Corp. made an inquiry regarding its guaranty of a synthetic collateralized debt obligation and alleged that affirmative misrepresentations were made regarding the transaction.
The allegations made by plaintiff here fall squarely within the holding of Centro. Plaintiffs knew that defendants had not supplied them with the financial information to which they were entitled, triggering a heightened degree of diligence. Where no reasonable protective step is alleged, the fraud claim fails, as a matter of law and may be dismissed.
(Internal quotations and citations omitted).