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Posted: July 4, 2018

Insurance Law 3105 Does Not Relieve RMBS Insurer of Obligation to Plead All Elements of Common Law Fraud Claim

On June 27, 2018, the Court of Appeals issued a decision in Ambac Assurance Corp. v. Countrywide Home Loans, Inc., 2018 NY Slip Op. 04686, holding that Insurance Law 3105 does not relieve an RMBS insurer of the requirement to plead all the elements of common law fraud against its insured, explaining:

The required elements of a common law fraud claim are a misrepresentation or a material omission of fact which was false and known to be false by the defendant, made for the purpose of inducing the other party to rely upon it, justifiable reliance of the other party on the misrepresentation or material omission, and injury. Justifiable reliance is a fundamental precept of a fraud cause of action, as is resulting injury. This Court has previously held, in the context of a monoline insurer suing for fraudulent inducement of a financial guaranty on a transaction involving asset-backed securities, that to plead a claim for fraud in the inducement or fraudulent concealment, plaintiff must allege facts to support the claim that it justifiably relied on the alleged misrepresentations. In apparent recognition of the fact that justifiable reliance and loss causation are required elements of its fraudulent inducement claim, Ambac’s operative complaint pled these well-established elements, alleging that Ambac reasonably relied on Countrywide’s statements and omissions when it entered into the Agreements and issued its Policies, and that as a result of Countrywide’s false and misleading statements and omissions, Ambac suffered, and will continue to suffer, damages including claims payments under the Policies. Nevertheless, Ambac argues it need not make the showing required to substantiate these allegations.

Supreme Court relied on Insurance Law § 3105 in addressing Ambac’s claim that it need not show justifiable reliance or loss causation. Distinguishing this Court’s holding in ACA Financial because the parties in that case did not raise the issue of New York Insurance Law § 3105, under which Ambac seeks recovery here, Supreme Court held that the only pertinent question under Section 3105 is whether the information allegedly misrepresented by Countrywide induced Ambac to take action that it might otherwise not have taken, or, in other words, whether the misrepresentation was material. This was error.

Insurance Law § 3105 plays no role here. Ambac did not, and could not, seek recovery under this section, nor does section 3105 function to relieve Ambac of the burden of showing justifiable reliance. Section 3105 (b) (1) provides that no misrepresentation shall avoid any contract of insurance or defeat recovery thereunder unless such misrepresentation was material, and no misrepresentation shall be deemed material unless knowledge by the insurer of the facts misrepresented would have led to a refusal by the insurer to make such contract. Section 3105 does not provide an affirmative, freestanding, fraud-based cause of action through which an insurer may seek to recover money damages. Nor does it inform a court’s assessment of the longstanding common law elements of fraudulent inducement. By its terms, section 3105 is only relevant when an insurer seeks rescission of an insurance contract or is defending against claims for payment under an insurance contract, relief that Ambac cannot, and does not, seek.

Moreover, section 3105 was intended to overrule prior case law which did not require a showing of materiality for an insurer to avoid its obligations under a policy based on the insured’s misrepresentations. Section 3105, intended to benefit the insured party, does not remove required elements for a showing of common law fraudulent inducement under any insurer-only exception.

Public policy reasons support the justifiable reliance requirement. Where a sophisticated business person or entity claims to have been taken in, the justifiable reliance rule serves to rid the court of cases in which the claim of reliance is likely to be hypocritical. Excusing a sophisticated party such as a monoline financial guaranty insurer from demonstrating justifiable reliance would not further the policy underlying this venerable rule.

Likewise, there is no merit to Ambac’s argument that it need not show loss causation. Loss causation is a well-established requirement of a common law fraudulent inducement claim for damages. This Court long ago noted that to give rise, under any circumstances, to a cause of action, either in law or in equity, reliance on the false representation must result in injury. This Court recently affirmed this requirement, as well as the principle that, if the fraud causes no loss, then the plaintiff has suffered no damages. It applies with equal force to Ambac’s claim.

(Internal quotations and citations omitted).

Commercial litigation frequently involves fraud-based claims. Such claims have special pleading requirements or rules, including the rule that a sophsticated businessperson’s reliance on a false statement must be reasonable and that reliance must have caused the damages claimed. This decision makes clear that those rules apply even to insurers. 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.

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