Opinion
602529/08.
Decided May 10, 2010.
Plaintiffs were represented by Michael B. Carlinsky, Richard I. Werder, Robert S. Loigman and Susheel Kirpalani, Esqs., Quinn Emanuel Urquhart Oliver Hedges, LLP, New York, New York; Tel. 212-849-7000.
Defendant BDO Seidman LLP was represented by Cary Brian Samowitz, Esq., DLA Piper US LLP, New York, New York; Tel. 212-335-4500.
Defendant Wachovia Capital Markets was represented by Harvey Kurzweil, James P. Smith III, Matthew L. DiRisio, Esqs., Dewey LeBoeuf, New York, New York; Tel. 212-259-8000.
Motions sequence numbers 002 and 003 are consolidated for disposition herein.
This action arises out of a massive fraud allegedly orchestrated by Le Nature's, Inc. ("Le Nature's" or the "Company"), a beverage manufacturer, bottler and distributor based in Latrobe, Pennsylvania, that led to the Company's bankruptcy and ultimate demise.
Plaintiffs seek to recover losses that they sustained as members of a syndicate arranged by defendant Wachovia Capital Markets, LLC d/b/a Wachovia Securities ("WCM") that loaned money to the Company. The Complaint sets forth the following causes of action:
(i) on behalf of the initial lenders against defendant WCM for fraud (first cause of action), aiding and abetting fraud (second cause of action); and negligent misrepresentation (third cause of action);
(ii) on behalf of all the plaintiffs against defendant BDO Seidman, LLP ("BDO") for fraud (fourth cause of action), aiding and abetting fraud (fifth cause of action), and negligent misrepresentation (sixth cause of action);
(iii) on behalf of all the plaintiffs against defendants Gregory J. Podlucky and Robert Lynn, both executives at Le Nature's, for fraud (seventh cause of action); and
(iv) on behalf of all the plaintiffs against all the defendants for civil conspiracy (eighth cause of action).
Defendant BDO now moves, under motion sequence number 002, for an order pursuant to CPLR §§ 3211(a)(1) and (7) and 3016(b) dismissing plaintiffs' Complaint against it. Defendant WCM moves, under motion sequence number 003, for an order pursuant to CPLR §§ 3211(a)(1) and 3016(b) dismissing plaintiffs' Complaint against it.
The plaintiffs served an Amended Complaint on or about September 3, 2009, to name additional defendants. The parties to this motion agreed that these motions would be deemed applicable to the Amended Complaint.
Background
The relevant facts, which are drawn from the Complaint except where otherwise noted, are as follows. For the year 2005, Le Nature's reported net sales of over $275 million. However, a court-appointed custodian later discovered that Le Nature's actual revenues were as little as $32 million. On November 1, 2006, just after the public revelation of Le Nature's' fraud, a group of Le Nature's' creditors placed the Company in involuntary bankruptcy. Not long thereafter, the Company ceased operations altogether.
According to the Complaint, the Chapter 11 trustee, following further investigation, has determined that Le Nature's' revenues in 2005 were just $28.2 million.
Plaintiffs claim that Le Nature's' massive revenue inflation, which was accompanied by overstated and false profit reports, had gone on for years, i.e., that the Company had long been reporting sales numbers that had no relation whatsoever to its actual results.
Indeed, as early as 2000, the Company was reporting revenues in excess of $32 million, a number that plaintiffs claim the Company approached only years later, after the Company's production capacity was substantially enhanced with the introduction of a new facility in Phoenix, Arizona. According to the Complaint, the Company falsely reported revenues well in excess of its 2005 post-expansion revenues for many years prior to completion of the Phoenix facility.
Defendant WCM
Just 60 days before the bankruptcy proceedings commenced, on or about September 1, 2006, Le Nature's borrowed $285 million in a loan administered by Wachovia Bank, N.A. ("Wachovia Bank"), an affiliate of defendant WCM.
WCM arranged the loan, underwrote the loan, and orchestrated the "syndication" of the loan, i.e., the sale of the indebtedness to an array of banks and other investors. Through the syndication process, these other banks and investors became lenders to Le Nature's. Plaintiffs claim that because of the syndication, Wachovia Bank ended up owning — and thus, being at risk with respect to — only a small fraction (approximately $7 million) of the overall loan.
Each plaintiff in this action owns a portion of the $285 million Le Nature's bank debt, having purchased an interest either directly from WCM in the syndication process or from a subsequent holder of the debt.
A second group of Plaintiffs (the "Successor Lender Plaintiffs") subsequently purchased interests in the Credit Facility from the original holders of the debt. These plaintiffs had, up to now, been unable to sue WCM in connection with the Le Nature's debt because WCM obtained a preliminary injunction in North Carolina on or about April 12, 2007. However, by Order dated March 15, 2010, Hon. Albert Diaz, Special Superior Court Judge in the General Court of Justice, Superior Court Division, State of North Carolina, County of Mecklenburg, granted the Successor Lenders' renewed motion to modify the preliminary injunction, to the extent of allowing those parties to assert in this action "all claims arising from their acquisition of interests in the Le Nature's Credit Facility." By Stipulation and Order dated March 24, 2010 and so-ordered by this Court on March 26, 2010, all parties agreed that plaintiffs could file their Second Amended Complaint and that these motions shall be deemed applicable to the Second Amended Complaint without any further briefing.
In total, Plaintiffs own more than $168 million of debt issued pursuant to the Credit Facility. Other third parties — i.e., not WCM — own the vast bulk of the remaining debt. Because of Le Nature's' financial distress, the Company is unable to repay the loan, including interest thereon.
Plaintiffs contend that WCM, unlike plaintiffs or their predecessors, knew about Le Nature's' improper practices and struggling finances long before completion of the September 1, 2006 Credit Facility (the "Credit Facility"), yet chose to press forward with the loan and its syndication to advance its own agenda, as well as that of its affiliates.
It appears that defendant WCM had by then become a trusted advisor and confidante to the Company and its executives, and had secured tens of millions of dollars in fees over several years by structuring, underwriting, syndicating and managing (both directly and indirectly through its affiliates) at least six Le Nature's bank facilities and securities issuances.
Plaintiffs claim that, among other things, WCM knew — but did not disclose to the solicited lenders — that (i) Le Nature's systematically had been unable to make timely interest payments, a fact that WCM hid from present and potential lenders by covertly fronting the payments for Le Nature's; (ii) Le Nature's was reporting sales data that could not possibly be accurate based on information readily available to, but purposefully ignored by, WCM; (iii) Le Nature's had improperly recorded more than $200 million in capital leases as operating leases, thereby removing these massive liabilities from its balance sheet in order to comply with its debt covenants; (iv) Le Nature's convened a special committee to investigate the sudden resignation of the Company's chief financial officer and other senior financial managers, resulting in a report identifying serious issues with the Company's financial reporting and the CEO's unchecked control over all of the Company's operations; (v) Le Nature's' management was habitually dismissive of requests for information and disregarded specific mandates to improve accounting, inventory, and other financial safeguards; and (vi) Le Nature's' products were being pulled from the shelves at retailers. None of this information, all of which was material and known to WCM, was disclosed to lenders.
Plaintiffs argue that rather than disclose these important shortcomings, WCM published and disseminated to potential lenders, including plaintiffs or their predecessors, Le Nature's' inflated revenue and profit numbers in marketing materials and research reports that WCM had drafted.
Specifically, the Complaint alleges that WCM
(i) provided documents to the initial lenders, including plaintiffs, that stated false and vastly over-inflated revenues, EBITDA, and growth rates for several years prior to completion of the Credit Facility; (ii) presented false asset coverage data to the lenders based on Le Nature's' deflated liabilities resulting from hidden lease obligations; (iii) issued marketing materials which falsely described Le Nature's as a strong, competitively positioned company that was capable of taking on even more debt; and (iv) provided to the incoming lenders copies of periodic market analyst reports which gave the Company consistently positive reviews and assigned a strong "outperform" rating to Le Nature's even though they were issued prior to completion of the Credit Facility. (Compl. ¶ 9).
Plaintiffs contend that WCM knew that had the real situation at Le Nature's been revealed, it would have been unable to syndicate the September 2006 loan.
Defendant BDO
Plaintiffs also claim that defendant BDO, an outside, purportedly independent auditor for the Company, also misrepresented Le Nature's' financial health. For example, plaintiffs claim that BDO issued a clean audit opinion for 2005 to accompany Le Nature's' financial statement (i.e., the statements falsely reflecting net sales in excess of $275 million).
Plaintiffs claim that BDO also assisted Le Nature's in misclassifying its massive capital lease obligations as operating leases, thereby keeping more than $200 million of liabilities off the Company's balance sheet, and in hiding rental expenses for production equipment, thereby overstating the Company's net income by more than 37%.
The Complaint alleges that BDO's conduct enabled Le Nature's to falsely claim that it had complied with financial ratios mandated in the loan documents, and that absent such purported compliance, the Credit Facility would never have closed in the first place.
Plaintiffs contend that BDO knew, or purposefully refused to determine, that the financial statements were grossly misleading. According to the Complaint, BDO knew that the Company was hampered by severe accounting problems, and failed to disclose that: (i) Le Nature's' chief financial officer and two other key accounting personnel resigned and submitted letters detailing the Company's serious financial integrity issues; (ii) a law firm issued a report identifying numerous deficiencies in the Company's accounting methods and internal controls; and (iii) the Company's previous auditor, Ernst Young LLP, was abruptly terminated.
Plaintiffs further claim that BDO knew that the enhanced risk of fraudulent conduct at the Company rendered Le Nature's' audits sensitive. According to the Complaint, BDO's stamp of approval was a key component of the fraud perpetrated on the lenders.
Individual Defendants
Finally, plaintiffs allege in the Complaint that the individual defendants, Gregory J. Podlucky and Robert Lynn, engaged in a conspiracy to fraudulently mislead plaintiffs or their predecessors, thereby generating hundreds of millions of dollars in fraudulent financing.
The individual defendants have not moved for any relief herein.
Discussion
A. Fraud Claim Against WCM
The elements of a claim for fraud under New York law are (1) that the defendant made a material false representation, (2) with the intent to defraud the plaintiff, (3) upon which the plaintiff reasonably relied, and (4) that the plaintiff suffered damage as a result of that reliance. Unicredito Italiano SPA v JPMorgan Chase Bank, 288 F. Supp. 2d 485, 497 (SDNY 2003) (citing Banque Arabe et Internationale D'Investissement v Maryland Nat'l Bank, 57 F.3d 146, 153 (2d Cir. 1995). "In addition to the traditional elements of misrepresentation, scienter, reliance and damages, a plaintiff alleging fraud based upon fraudulent concealment must allege a duty to disclose material information (citation omitted). The duty must be based upon some special relationship between the parties (citation omitted)." Albion Alliance Mezzanine Fund, L.P. v State Street Bank and Trust Co. , 8 Misc 3d 264, 269 (Sup. Ct., NY Co. 2003), aff'd 2 AD3d 162 (1st Dep't 2003).
Defendant WCM argues that the first cause of action for fraud must be dismissed on the grounds that any claim of reasonable reliance is barred by the disclaimers in the Amended and Restated Credit Agreement among Le Nature's, as Borrower, the Domestic Subsidiaries of the Borrower from Time to Time Party Hereto, as Guarantors, the Lenders Party Hereto and Wachovia Bank, as Administrative Agent, dated as of September 1, 2006, (the "Credit Agreement. Specifically, Section 8.6 of the Credit Agreement ("Non-Reliance on Administrative Agent and other Lenders") provides as follows:
Defendant WCM was listed on the Credit Agreement as "Lead Arranger and Sole Bookrunner."
Each Lender expressly acknowledges that neither the Administrative Agent nor any of their officers, directors, employees, agents, attorneys-in-fact or affiliates has made any representation or warranty to it and that no act by the Administrative Agent hereinafter taken, including any review of the affairs of the Credit Parties, shall be deemed to constitute any representation or warranty by the Administrative Agent to any Lender. Each Lender represents to the Administrative Agent that it has, independently and without reliance upon the Administrative or any other Lender, and based on such documents and information as it had deemed appropriate, made its own appraisal of and investigation into the business, operations, property, financial and other condition and creditworthiness of the Credit Parties and made its own decision to make its Loans hereunder and enter into this Credit Agreement (emphasis supplied). Each Lender also represents that it will, independently and without reliance upon the Administrative Agent or any other Lender, and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit analysis, appraisals and decisions in taking or not taking action under this Credit Agreement, and to make such investigation as it deems necessary to inform itself as to the business, operations, property, financial and other condition and creditworthiness of the Credit Parties. Except for notices, reports and other documents expressly required to be furnished to the Lenders by the Administrative Agent hereunder, the Administrative Agent shall not have any duty or responsibility to provide any Lender with any credit or other information concerning the business, operations, property, condition (financial or otherwise), prospects or creditworthiness of the Credit Parties which may come into possession of the Administrative Agent or any of its officers, directors, employees, agents, attorneys-in-fact or affiliates.
Based on this language, defendant WCM argues that any purported reliance that plaintiffs claim to have placed on any alleged misrepresentations or omissions by WCM is unreasonable as a matter of law.
Plaintiffs argue in opposition that Section 8.6 does not apply to WCM's misrepresentations because the Administrative Agent is defined in the Credit Agreement to be "Wachovia Bank," which is not a party to this action, and not defendant WCM.
However, while § 8.6 does not specifically refer to WCM, § 8.10 of the Credit Agreement affirmatively extends to agents and arrangers all of the "same rights, protections, exculpations and indemnifications" provided to the Administrative Agent in § 8.6 "in their capacity as an agent or arranger." The language of the Credit Agreement demonstrates that WCM was acting in its capacity as an "arranger" for the purposes of the conduct alleged in the Complaint because (1) WCM is listed on the front page of the Credit Agreement as the "Lead Arranger"; and (2) the definition section of the Credit Agreement provides that "Arranger" shall mean WCM. Therefore, § 8.6 is held to apply to defendant WCM.
Plaintiffs further argue that the non-reliance disclaimer is too general to bar a claim for fraud or fraudulent misrepresentation.
Defendant WCM argues that the disclaimer in § 8.6 is well within the specificity requirements imposed by New York law and, accordingly, precludes any claim of reasonable reliance by plaintiffs.
"In assessing the reasonableness of a plaintiff's alleged reliance, we consider the entire context of the transaction, including factors such as its complexity and magnitude, the sophistication of the parties, and the content of any agreements between them." Emergent Capital Inv. Management, LLC v Stonepath Group, Inc., 343 F.2d 189, 195 (2d Cir. 2003). "[W]here a party specifically disclaims reliance upon a representation in a contract, that party cannot, in a subsequent action for fraud, assert it was fraudulently induced to enter into the contract by the very representation it has disclaimed." Grumman Allied Indus. Inc. v Rohr Indus., Inc., 748 F.2d 729, 734-35 (2d Cir. 1984); see also, Danann Realty Corp. v Harris, 5 NY2d 317 (1959). However, a "disclaimer is generally enforceable only if it tracks the substance of the alleged misrepresentation. . .' Caiola v Citibank, N.A., 295 F.3d 312, 330 (2d Cir. 2002) (quoting Grumman Allied Indus., Inc. v Rohr Indus., Inc., supra at 735).
It appears to this Court that in Section 8.6 of the Credit Agreement the plaintiffs have "in the plainest language announced. . .that [they] are not relying on any representations as to the very matter as to which [they] now claim [they were] defrauded. Such a specific disclaimer destroys the allegations in the plaintiffs' complaint that the agreement was executed in reliance upon these contrary oral representations (citation omitted)." Danaan Realty Corp. v Harris, supra .
Plaintiffs next argue that even if this Court finds § 8.6 sufficiently specific, the "peculiar knowledge" exception applies. It has been held that "even where the parties have executed a specific disclaimer of reliance on a seller's representations, a purchaser may not be precluded from claiming reliance on any oral misrepresentations if the facts allegedly misrepresented are peculiarly within the seller's knowledge (citations omitted)" Tahini Invs., Ltd. v Bobrowsky, 99 AD2d 489, 490 (2nd Dep't 1984). See also Danaan Realty Corp. v Harris, supra .
WCM argues that the "peculiar knowledge" exception should not apply here, and is expressly contradicted by a Second Amendment to Credit Agreement dated December 2005 (the "2005 Agreement") to which all of the initial lender plaintiffs were parties, as well as Section 5.6 of the Credit Agreement. Pursuant to these provisions, the lenders were granted nearly unfettered access, up until the closing date of the Credit Agreement and beyond, to Le Nature's' books and records, as well as to its executives, employees and auditors. Specifically, § 5.6 of both Agreements expressly permitted lenders:
during regular business hours and upon reasonable notice . . . to visit and inspect any of [Le Nature's'] properties and examine and make abstracts from any of its books and records . . . at any reasonable time and as often as may reasonably be desired, and to discuss the business, operations, properties and financial and other condition of the Credit Parties and their Subsidiaries with officers and employees of the Credit Parties and their Subsidiaries and with its independent certified public accountants, in each case at [Le Nature's'] expense.
Moreover, defendant WCM relies on Unicredito Italiano SPA v JPMorgan Chase Bank, supra, in which the court held that the application of the "peculiar knowledge" doctrine is generally inappropriate where, as here, the plaintiffs are sophisticated investors and the defendant did not specifically undertake to provide the allegedly concealed information. "Where sophisticated businessmen engaged in major transactions enjoy access to critical information but fail to take advantage of that access, New York courts are particularly disinclined to entertain claims of justifiable reliance." Grumman Allied Industries, Inc. v Rohr Industries, Inc., supra at 737.
WCM argues further that the warning signs emanating from Le Nature's — such as the resignation of Le Nature's' chief financial officer in August 2003, the change in auditing firms, the misclassification of leases as operating expenses, Le Nature's' failure to expense rental payments, and Le Nature's' cash flow problems throughout 2006 — that plaintiffs claim should have alerted WCM, were, in light of plaintiffs' alleged broad access to information, equally available to them.
Defendant WCM also points to the fact that when it initially solicited plaintiffs' participation in the Credit Facility, it informed plaintiffs it was doing so because of an event of default under the 2005 Agreement and a shareholder suit against Le Nature's' directors seeking appointment of a custodian. (Compl. ¶ 159.)
During oral argument, defendant WCM also relied on the Appellate Division, First Department's decision in DDJ Management, LLC v Rhone Group, LLC , 60 AD3d 421 (1st Dep't 2009), which was decided after the briefs were submitted, where the Appellate Division reversed the Supreme Court's denial of a CPLR 3211(a)(7) motion to dismiss the fraud cause of action in a case with a similar fact pattern. ( 19 Misc 3d 1124[A] [Sup. Ct., NY Co. 2008]). The Appellate Division held in DDJ that, "[a]s a matter of law, a sophisticated plaintiff cannot establish that it entered into an arm's length transaction in justifiable reliance on alleged misrepresentations if that plaintiff failed to make use of the means of verification that were available to it.' ( UST Private Equity Invs. Fund v Salomon Smith Barney, 288 AD2d 87, 88 . . . [2001])." DDJ Managment, LLC v Rhone Group, LLC, supra at 424.
This Court is very familiar with the DDJ case, having handled the case after the underlying decision was written, and is also aware that leave to appeal to the Court of Appeals was granted on October 27, 2009 ( 13 NY3d 710).
Plaintiffs argue that the fact they agreed to conduct their "own appraisal of and investigation into" Le Nature's does not prevent their fraud claim. They contend that WCM actively prevented any possibility that the lenders could have discovered Le Nature's' true financial condition by, for example, fronting Le Nature's' interest payments and giving the lenders only a few days to decide whether to participate in the 2006 Credit Facility. Thus, plaintiffs claim defendant WCM cannot hide behind § 5.6 to defend against plaintiffs' fraud claim.
At a minimum, plaintiffs assert that whether their reliance was reasonable under all the circumstances is a question of fact, which precludes a 3211 motion to dismiss.
The Complaint in this case alleges a massive fraud orchestrated by Le Nature's wherein Le Nature's reported net sales of over $275 million when, in fact, it turned out that its revenues were almost 90% less than what was represented. WCM was not just one of many bankers or advisors to Le Nature's at the relevant time; it was allegedly Le Nature's "exclusive financial advisor . . . and investment banker . . . responsible for arranging, funding, syndicating and selling an array of credit facilities and a substantial notes offering, all to raise more money to fund Le Nature's' purportedly expanding production and sales." (Compl. ¶ 59). Plaintiffs also claim that WCM was retained, prior to the Credit Facility, to explore a possible sale of the Company "a process through which it obtained even greater access to, and knowledge of, the Company's operations and finances . . ." Id. As a result of its multiple roles, plaintiffs contend that WCM was provided with unusual access to Le Nature's' financial records, personnel and outside accounting and legal firms.
Thus, it is not apparent at this early stage of the litigation that the true nature of the situation would have been revealed even upon inspection. Even if the truth could have ultimately been discerned, there is no way of knowing what efforts this would have entailed.
New York cases recognize that the peculiar knowledge exception applies "not only where the facts allegedly misrepresented literally were within the exclusive knowledge of the defendant, but also where the truth theoretically might have been discovered, though only with extraordinary effort or great difficulty." DIMON Inc. v Folium, Inc., 48 F.Supp. 2d 359, 368 (SDNY 1999). See also, JPMorgan Chase Bank v. Winnick, 350 F.Supp. 2d 393 (SDNY 2004).
Moreover, plaintiffs' allegations that by virtue of WCM's unique position with Le Nature's and this Credit Facility, WCM had crucial information not readily available to plaintiffs, brings plaintiffs' complaint within the "special facts" doctrine. "Under that doctrine, a duty to disclose arises where one party's superior knowledge of essential facts renders a transaction without disclosure inherently unfair.' (citation omitted)." P.T. Bank Cent. Asia, NY Branch v ABN AMRO Bank N.V., 301 AD2d 373, 378 (1st Dep't 2003); see also Swersky v Dreyer Traub, 219 AD2d 321, 328-329 (1st Dep't 1996).
While the evidence might ultimately demonstrate that defendants did not, in fact, have any special knowledge upon which they relied or which plaintiffs could not have ascertained by exercising reasonable diligence, these are issues which are "inappropriate to determine . . . as a matter of law based solely on the allegations in [the] complaint." P.T. Bank Cent. Asia, NY Branch v ABN AMRO Bank N.V., supra at 378.
Thus, although the plaintiffs were sophisticated parties, this Court finds that it would be premature to dismiss the fraud cause of action alleged against WCM here on a pre-answer motion to dismiss.
B. Aiding and Abetting Fraud Claim Against WCM
Defendant WCM argues that, with regard to the second cause of action for aiding and abetting Le Nature's' fraud, there is a clear conflict between New York law and Pennsylvania law because Pennsylvania does not recognize this cause of action ( WM High Yield Fund v O'Hanlon, 2005 WL 1017811, at *15 (E.D. Pa. 2005]; Fleet Nat. Bank v Boyle, 2005 WL 2455673, at *13 [E.D. Pa. 2005]) and New York does. Thus, WCM maintains that Pennsylvania law should be applied here because New York choice of law principles provide that where there is a conflict, a court should apply the law of the jurisdiction where the "underlying . . . fraud . . . w[as] originated and executed." Pension Committee of University of Montreal Pension Plan v Banc of America Securities, LLC, 446 F.Supp.2d 163, 193 (SDNY 2006). See also Cromer Finance Ltd. v Berger, 137 F.Supp.2d 452, 493 (SDNY 2001).
Furthermore, defendant WCM argues that even if New York law applies, plaintiffs' claim fails for at least two independent reasons: (1) allegations of mere inaction or silence are "insufficient to sustain a claim for aiding and abetting unless the defendant owes an independent duty to the plaintiff" (which WCM argues did not exist), Jebran v LaSalle Bus. Credit, LLC , 33 AD3d 424 (1st Dep't 2006); and (2) plaintiffs fail to allege WCM had the requisite "actual knowledge" of the fraud perpetrated by Le Nature's. See Sterling Nat. Bank v Ernst Young, LLP, 9 Misc 3d 1129(A) (Sup. Ct., NY Co. 2005). Moreover, defendant contends that allegations of "conscious disregard" or that WCM "turned a blind eye" to Le Nature's' fraud are insufficient to establish the high degree of scienter necessary to extend fraud liability under an aiding and abetting theory. International Strategies Group, Ltd. v ABN AMRO Bank N.V., 49 AD2d 474, 475 (1st Dep't 2008); National Westminster Bank v Weksel, 124 AD2d 144, 149 (1st Dep't 1987), lv den 70 NY2d 604 (1987).
Plaintiffs argue that there is no conflict between the laws of the two states, citing two intermediate appellate court decisions in Pennsylvania, i.e. Sovereign Bank v Valentino, 914 A.2d 415, 477 (Pa. Super. Ct. 2007) (in which the Pennsylvania Superior Court held that under § 876 of the Restatement [Second] of Torts, a defendant is liable for aiding and abetting fraud if it "knowingly and substantially assisted [the primary tortfeasor] in his scheme to defraud" the plaintiff); and Koken v Steinberg, 825 A.2d 723, 731 (Pa. Commw. Ct. 2003). The Supreme Court of Pennsylvania has apparently not addressed this issue, and has not expressly adopted § 876(b) of the Restatement.
After the oral argument, Chief Judge Ambrose of the United States District Court for the Western District of Pennsylvania, decided In re Le Nature's Inc., 2009 WL 3571331 (Sept. 16, 2009) in which he declined to dismiss the claims of aiding and abetting asserted by the Liquidation Trustee of Le Nature's Liquidation Trust, predicting that the Supreme Court of Pennsylvania would adopt the Restatement (Second) of Torts § 876(b).
Furthermore, plaintiffs assert that even if there were a conflict, based on New York's "interest analysis" approach to choice of law conflicts, New York law would apply because WCM and the Le Nature's' insiders, in order to fraudulently induce plaintiffs or their predecessors to invest in Le Nature's, conducted marketing presentations in New York, met with lenders in New York on multiple occasions, and specifically targeted investors in New York.
It is well settled that "[t]he first step in any case presenting a potential choice of law issue is to determine whether there is an actual conflict between the laws of the jurisdictions involved." Matter of Allstate Ins. Co. (Stolarz), 81 NY2d 219, 223 (1993). "In the absence of substantive difference . . . a New York court will dispense with choice of law analysis; and if New York law is among the relevant choices, New York courts are free to apply it." International Bus. Mach. Corp. v Liberty Mut. Ins. Co., 363 F.3d 137, 143 (2d Cir. 2004). Here, this Court finds that there is no conflict between Pennsylvania law and New York law with regard to aiding and abetting fraud, based on the holdings of the two intermediate courts in Pennsylvania, supra, and Judge Ambrose's decision declining to dismiss the aiding and abetting claim asserted by the plaintiff in that case which emanates from the same underlying fraud as does this case. Therefore, dispensing with a choice of law analysis, this Court will apply New York law.
The elements of a claim for aiding and abetting fraud under New York law are (1) the existence of a fraud; (2) the defendant's knowledge of the fraud; and (3) the defendant's provision of substantial assistance to advance the fraud's commission. Egnotovich v Katten Muchin Zavis Roseman LLP , 18 Misc 3d 1120(A) at *10 (Sup. Ct., NY Co. 2008). Defendant argues that "[a] high degree of scienter is necessary to extend fraud liability under an aiding and abetting theory" and that "the predominant view is that actual knowledge of the tort is required to establish aider and abettor liability (citations omitted)." Sterling Nat. Bank v Ernst Young, LLP, supra at *8.
While plaintiffs concede that "actual knowledge" must be alleged in a claim for aiding and abetting fraud, see, e.g. Kaufman v Cohen, 307 AD2d 113, 125 (1st Dep't 2003), they contend that they need not allege direct evidence of their knowledge of the fraud and can rely on circumstantial knowledge since "[t]he element of scienter . . . is . . . most likely to be within the sole knowledge of the defendant and least amenable to direct proof." Houbigant, Inc. v Deloitte Touche, 303 AD2d 92, 98 (1st Dep't 2003).
Here, it appears to this Court that the same facts that support plaintiffs' allegations that WCM had "peculiar knowledge" of the fraud and support the applicability of the "special facts" doctrine, also support, with the requisite particularity, plaintiffs' allegations that WCM had actual knowledge of the existence of the underlying fraud.
Specifically, plaintiffs allege in their Complaint that as Le Nature's' long-time outside banker and principal financial advisor, WCM knew, but never disclosed to the plaintiffs, that (1) Le Nature's was unable to make timely interest payments and covertly fronted these payments (Compl. ¶ 6, ¶ 145-48); (2) due diligence by potential purchasers of Le Nature's raised unanswerable questions about Le Nature's' financial integrity and pricing practices (¶¶ 142-44); (3) WCM's own analysts questioned Le Nature's' financials (¶¶ 150-152); (4) internal Le Nature's' investigations indicated "significant" financial control weaknesses (¶¶ 82-83, 86-87, 90); and (5) Le Nature's and its auditors misclassified massive capital leases as operating leases (¶¶ 121-34, 239).
This Court thus finds that defendant WCM's motion to dismiss the cause of action for aiding and abetting fraud at this pre-answer stage is premature and is, therefore, denied.
C. Negligent Misrepresentation Claim against WCM
Under New York law, in order to state a claim for negligent misrepresentation, a plaintiff must allege "(1) the existence of a special or privity-like relationship imposing a duty on the defendant to impart correct information to the plaintiff; (2) that the information was incorrect; and (3) reasonable reliance on the information (citations omitted)." J.A.O. Acquisition Corp. v Stavitsky , 8 NY3d 144 , 148 (2007).
Plaintiffs argue that there is at least a factual question as to whether or not such a "special relationship" existed between plaintiffs and WCM, since WCM had peculiar knowledge of the facts, and served not only as Le Nature's' financial advisor but also as the lenders' long-time trusted counterparty.
In opposition, defendant WCM argues that plaintiffs have not alleged any "special relationship" between themselves and WCM that would sustain this cause of action. Defendant WCM argues that it did not undertake any obligation to disclose to plaintiffs the status of Le Nature's' business or financial condition since, to the contrary, the Credit Agreement specifically states that WCM owed no fiduciary duties to plaintiffs (Credit Agreement, Section 8) and plaintiffs actually allege that WCM had a unique relationship with Le Nature's.
As set forth in Dobroski v Bank of Am., N.A. , 65 AD3d 882 , 884 (1st Dep't 2009), "[l]iability for negligent misrepresentation has been imposed only on those persons who possess unique or specialized expertise, or who are in a special position of confidence and trust with the injured party such that reliance on the negligent misrepresentation is justified" (citing Kimmel v Schaefer, 89 NY2d 257, 263). The First Department has repeatedly held that "an arms length borrower-lender relationship is not of a confidential or fiduciary nature and therefore does not support a cause of action for negligent misrepresentation [citations omitted]." Dobroshi v Bank of Am., N.A., supra at 884; see also Korea First Bank of NY v Noah Enterprises, Ltd. , 12 AD3d 321 (1st Dep't 2004).
Accordingly, defendant WCM's motion to dismiss plaintiffs' third cause of action for negligent misrepresentation is granted.
D. Civil Conspiracy Claim Against WCM and BDO
Defendant WCM argues that the laws of Pennsylvania and New York differ with respect to claims for civil conspiracy, but that plaintiffs' claim fails under either law because: (i) plaintiffs must show malice' under Pennsylvania law ( Skipworth v Lead Indus. Ass'n, 547 Pa. 224, 690 A.2d 169 [Pa. Sup. Ct. 1997]), which they have not done; and (ii) under New York law, the conspiracy claim is duplicative of the aiding and abetting claim ( Briarpatch Ltd., L.P. v Geisler Roberdeau, Inc., 2007 WL 1040809 (SDNY 2007). Plaintiffs argue that they have adequately alleged that defendant WCM acted with the requisite malice so as to survive under Pennsylvania law, and that its claim is adequate and not duplicative if this Court finds New York law applies.
Defendant BDO also argues that this cause of action must be dismissed against it because 1) plaintiffs cannot satisfy the requirement under Pennsylvania law that there be a showing of malice; 2) plaintiffs have failed to adequately plead an underlying tort and Pennsylvania law provides that "[a] claim for civil conspiracy cannot be pled without alleging an underlying tort" ( McGreevy v Stroup, 413 F3d 359, 371 [3rd Cir 2005]; and 3) even if New York law applies, it also does not recognize civil conspiracy as an independent tort. Steier v Schreiber , 25 AD3d 519 (1st Dep't 2006).
Plaintiffs argue that the Complaint adequately alleges a claim for civil conspiracy against BDO under both New York and Pennsylvania law, because the Complaint adequately alleges the underlying fraud upon which the conspiracy claim is based, and to the extent plaintiffs are required to allege that BDO intended to harm them, plaintiffs have done so.
Once a conflict of law has been established, the next step in the analysis is to determine, through choice of law principles, which state's law applies. K.T. v Dash, 37 AD3d 107 (1st Dep't 2006). The New York interest analysis involves several steps and focuses on which jurisdiction "because of its relationship or contact with the occurrence or the parties, has the greatest concern with the specific issues raised in the litigation." Babcock v Jackson, 12 NY2d 473, 481 (1963).
Defendant WCM argues that because plaintiffs' civil conspiracy claim hinges on the underlying fraud committed by Le Nature's, Pennsylvania would appear to be the state with the greater interest since it is the state where Le Nature's was located.
Defendant BDO asserts that it performed its audits in Pennsylvania, out of its Pennsylvania office, using Pennsylvania-licensed auditors. Since Pennsylvania has an inherent interest in regulating the negligent conduct of their auditors, and since plaintiffs did not specifically argue that New York has a greater interest, this Court will apply Pennsylvania law to the analysis of the civil conspiracy claim.
Pennsylvania courts have held that "[p]roof of malice, i.e., an intent to injure, is essential in proof of a conspiracy." Thompson Coal Co. v Pike Coal Co., 488 Pa. 198, 211, 412 A.2d 466, 472 (Pa. Sup. Ct. 1979) and that this "requires a showing that the sole purpose of the conspiracy is to cause harm to the party who has been injured' (citation omitted)." Fleet Nat. Bank v Boyle, supra at *12. See also Spitzer v Abdelhak, 1999 WL 1204352, at *9 (E.D. Pa. 1999). In this case, however, plaintiffs allege that WCM's goals in conspiring with Le Nature's were wholly self-serving, i.e., "to obtain massive fees, generate substantial public exposure, and to develop its high yield banking business." (Compl. ¶¶ 7, 71). See Guaranty Towers, LLC v Cellco Partnership 2007 WL 2617651, at *6 (M.D. Pa. 2007) (dismissing conspiracy claim on the ground that plaintiff's allegations "that both defendants acted to obtain more revenue . . . are fatal to a civil conspiracy claim under Pennsylvania law.").
Similarly, plaintiffs cannot credibly contend that BDO acted with an intent "solely to injure" them, particularly given that the loan at issue was not even contemplated when BDO issued its audit reports. Moreover, plaintiffs allege that BDO acted to avoid "jeopardizing [its] relationship with Le Nature's management (Compl. ¶ 271), a charge that precludes a claim that BDO acted "solely" to injure plaintiffs. That plaintiffs assert BDO certified financial statements that it knew (or consciously avoided knowing) were grossly inaccurate and would be relied upon by plaintiffs, does not satisfy the malice standard under Pennsylvania law. Therefore, the eighth cause of action for civil conspiracy is dismissed as against both defendants WCM and BDO.
E. Fraud Claim Against BDO
Defendant BDO argues that the fourth cause of action for fraud against it must be dismissed because (1) plaintiffs have failed to allege with particularity pursuant to CPLR § 3016(b) that BDO knew that plaintiffs would rely on its audit reports in determining whether to enter into the loan, since the last of the three audit reports was issued in March 2006, before the Credit Facility at issue was ever devised or conceived; and (2) plaintiffs do not sufficiently allege that they, in fact, relied upon any statement contained in the audit reports before entering into the loan.
Plaintiffs argue that the Complaint adequately alleges that BDO intended the lenders to rely on its audit reports, and that plaintiffs indeed relied on BDO's audit reports in the process of formulating their investment decision.
The facts in Houbigant, Inc. v Deloitte Touche, LLP, supra are instructive here with regard to assessing the issue of intent. In Houbigant, the Court held that a plaintiff, which licensed the marketing and sales of its perfumes to various subsidiaries of a company audited by defendant accounting firm, stated a valid cause of action for fraud based upon allegations that the defendant knew, from the contractual requirement that the licensee forward audited statements to plaintiff, that plaintiff was relying upon defendant's audits to assure itself that the licensee was satisfying the requirements that it maintain a $10 million net worth and that it remain solvent. The Court specifically stated that
[a]s to the motion court's reasoning that the fraud claim must fail because it cannot be inferred that [defendant] made the misrepresentations with the specific intent to induce [plaintiff's] acts, the law does not require such specific intent for a fraud claim. Rather, the plaintiff must only allege facts from which it may be inferred that the defendant was aware that its misrepresentations would be reasonably relied upon by the plaintiff, not that the defendant intended to induce the particular acts of detrimental reliance ultimately undertaken by the plaintiff (citations omitted).
Houbigant, Inc. v Deloitte Touche, LLP, supra at 100.
Here, as in Houbigant, it is reasonable to infer that BDO knew that its audit reports would be provided to and relied upon by plaintiffs. In paragraphs 101 through 105 of the Complaint, under the heading "BDO Knew and Intended that Its Audit Reports Would Be Provided to, and Relied Upon by, Le Nature's' Lenders", plaintiffs allege that: (1) the Credit Facility was a revision and continuation of prior existing facilities to which the plaintiffs were parties; (2) BDO was aware that the credit facilities were periodically rolled over; and (3) BDO knew that its 2003-2005 audit reports were used to support this ongoing process. Further, plaintiffs allege that as part of its audit work, BDO would have become familiar with Le Nature's' credit facilities, and known that legal documentation in connection with these credit facilities required that annual audited financial statements be provided to Le Nature's' lenders. ( See also Compl. ¶¶ 263 and 265).
"To show reliance, [the plaintiff] must demonstrate that [it] was induced to "act [or] refrain from acting"' to [its] detriment by virtue of the alleged misrepresentation or omission (citation omitted)." Shea v Hambros PLC, 244 AD2d 39, 46-47 (1st Dep't 1998).
Plaintiffs argue that it would be premature, at this stage of the case, to decide whether it is factually possible for plaintiffs to have reviewed BDO's audit reports and the relevant loan documents in the short time period they were given to decide whether to invest in the Credit Facility or whether, in fact, plaintiffs' level of sophistication affected their decision as to whether to review the BDO audit reports. The question at this stage is whether plaintiffs have alleged reasonable reliance.
Plaintiffs pointed out during oral argument that the March 2006 audit report was only one typed page.
In RGH Liquidating Trust v Deloitte Touche, LLP, 17 Misc 3d 1128(A) at *5-6 (Sup. Ct., NY Co. 2007), affd in part, mod in part, 71 AD3d 198 (1st Dep't 2009), the Court held that "the reasonableness of the lender banks' reliance upon the [audit reports] . . . is a question of fact that would be premature to resolve on a motion to dismiss. (citation omitted)." Plaintiffs argue that, in fact, the audit reports would be the first information sophisticated lenders would review because, as plaintiffs point out in their papers, "the purpose of such reports is to give an immediate and (supposedly) accurate view into a company's financial health."
Defendant BDO also argues that it is entitled to particularized reliance allegations as to every one of the plaintiffs, also citing RGH Liquidating Trust v Deloitte Touche, supra . However, the Court in that case found that multiple plaintiffs may make the allegation of fraud collectively, and upheld the claims of one group of creditors, finding that the lenders adequately alleged reliance, even though they collectively alleged they had relied on the auditor's reports in making their investment decisions. Id. at *4-6. The Court only rejected the claims of a separate group of creditors who did not identify themselves by name, making it "impossible for defendants to respond to [their] allegations because defendants do not know which creditors are asserting claims or the factual basis of those claims." Id. at *4. That is not the case here. All of the plaintiffs' identities are clearly set forth in the Complaint. Therefore, this Court denies defendant BDO's motion to dismiss plaintiffs' fourth cause of action against it at this time.
These holdings were not affected by the Appellate Division's partial modification.
F. Aiding and Abetting Fraud Claim Against BDO
Defendant BDO next argues, as did WCM, that the fifth cause of action for aiding and abetting fraud must be dismissed because Pennsylvania law does not recognize such a tort. Moreover, defendant BDO argues that dismissal is required even if this Court should determine that New York law applies because a plaintiff asserting a claim for aiding and abetting fraud under New York law must allege both an intent to injure plaintiff and detrimental reliance. See, Williams v Sidley Austin Brown Wood, L.L.P., 11 Misc 3d 1064(A) at *6 (Sup. Ct., NY Co. 2006); Jordan (Bermuda) Investment Co., Ltd. v Hunter Green Investments LLC, 566 F. Supp. 2d 295, 300 (SDNY 2008).
Plaintiffs argue in opposition that there is no conflict between New York and Pennsylvania law with respect to this claim, and thus that this Court should apply New York law. Plaintiffs further argue that the Complaint adequately alleges that BDO aided and abetted Le Nature's' fraud by certifying patently false financial statements and permitting those statements, with its signature and approval, to be distributed to lenders and potential lenders.
See, discussion, supra at pages 20-23 wherein this Court determined that New York law applies to this cause of action.
Here, the Complaint alleges that the provisions of Le Nature's' credit facilities provided that BDO's audit reports would be provided to the lenders in order to induce those lenders to extend credit (Compl. ¶¶ 101-105, 279-281). Further, plaintiffs allege that BDO was familiar with these facilities as a result of its audit work, including the fact that plaintiffs or their predecessors were lenders to Le Nature's before the 2006 Credit Facility. (Compl. ¶¶ 103-104). The Complaint also alleges that by virtue of its long standing work for Le Nature's, and the review of the provisions of the various Le Nature's financing agreements, "BDO knew not only that its audit opinions would be provided to the lenders, but that the lenders would directly and expressly rely on the content of those reports in determining to provide credit to Le Nature's and participate in this Credit Facility." (Compl. ¶ 104).
Therefore, this Court finds that plaintiffs have alleged sufficient facts to defeat defendant BDO's motion to dismiss the aiding and abetting fraud claim.
G. Negligent Misrepresentation Claim Against BDO
Defendant BDO next argues that the sixth cause of action for negligent misrepresentation must be dismissed because plaintiffs have not alleged facts showing their "near privity" or "functional equivalent of privity" with BDO. See, Parrott v Coopers Lybrand, 263 AD2d 316 (1st Dep't 2000), aff'd 95 NY2d 479 (2000).
Plaintiffs, however, contend that Pennsylvania law, which follows a somewhat less restrictive standard as to privity, applies in this case. During oral argument, defendant BDO stated that for purposes of this motion, it was willing to accept plaintiffs' position that this cause of action is governed by Pennsylvania law and that § 552 of the Restatement (Second) of Torts applies.
The Restatement (Second) of Torts § 552 permits negligent misrepresentation claims absent privity as long as the defendant could foresee that the plaintiff would rely on the defendants' misrepresentations. See, Bilt-Rite Contractors, Inc. v The Architectural Studio, 581 Pa. 454, 478-479, 866 A.2d 270, 288 (Sup. Ct. Pa. 2005).
Specifically, the Restatement (Second) of Torts § 552 provides in relevant part as follows:
(1) One who, in the course of his business, profession or employment, or in any other transaction in which he has a pecuniary interest, supplies false information for the guidance of others in their business transactions, is subject to liability for pecuniary loss caused to them by their justifiable reliance upon the information, if he fails to exercise reasonable care or competence in obtaining or communicating the information.
[T]he liability stated in Subsection (1) is limited to loss suffered
(a) by the person or one of a limited group of persons for whose benefit and guidance he intends to supply the information or knows that the recipient intends to supply it; and
(b) through reliance upon it in a transaction that he intends the information to influence or knows that the recipient so intends or in a substantially similar transaction.
Courts in Pennsylvania have specifically held, applying Restatement § 552, that "Pennsylvania law does not require privity to maintain a negligent misrepresentation action against an accounting firm." In re Intelligent Elec., Inc. Secs. Litig., 1996 WL 304852, at *4 (E.D. Pa. 1996); see also Williams Controls, Inc. v Parente, Randolph, Orlando, Carey Assocs., 39 F. Supp 2d 17, 528-529 (M.D. Pa. 1999).
As a result, based on the allegations contained in the Complaint and discussed, supra, in connection with the aiding and abetting claim, plaintiffs argue that they have adequately alleged that BDO could have foreseen that plaintiffs would rely on its audit reports, meeting the legal standard under Pennsylvania law.
Defendant BDO argues that the Restatement rule is still restrictive enough to squarely bar plaintiffs' claim, citing Ellis v Grant Thornton, LLP, 530 F.3d 280, 288-289 and FN 5 (4th Cir. 2008), in which the Court held that "the Restatement approach does not extend to every reasonably foreseeable consumer of financial information.' (citation omitted)." BDO contends that this requires more than an accountant providing yearly audits to a client. Specifically, defendant BDO relies in its Reply Brief, as it did during oral argument, on Illustration 10 to § 552 of the Restatement (Second) of Torts which it contends precludes liability for an accountant under the very circumstances presented in this case.
In Williams Controls, Inc. v Parente, Randolph, Orlando, Carey Assocs., supra, the Court, in analyzing Illustration 10, determined that an auditor could not be held liable to the buyer of a corporate division for negligent misrepresentation with respect to any financial statements the auditor prepared prior to the buyer and seller entering into the relevant purchase agreement, "because there was no evidence that [the auditor] understood that such work would be used in connection with [the contemplated sale] . . . " Williams Controls, Inc. v Parente, Randolph, Orlando, Carey Assocs., supra at FN 10.
Here, BDO did not have direct knowledge that plaintiffs would use the audited financial statements in connection with the 2006 Credit Facility. However, this case is distinguishable because BDO knew of the existence of the prior credit facilities, that the 2006 Credit Facility was merely a revision and continuation of prior existing facilities to which the lenders here were parties, that the credit facilities were periodically rolled over, and that its 2003-2005 audit reports were used to support this ongoing process.
Accordingly, this Court finds that plaintiffs have set forth sufficient allegations to defeat defendant BDO's pre-answer motion to dismiss the negligent misrepresentation claim asserted against it.
The defendants are directed to serve and file answers to the remaining causes of action within 30 days of the date of this Decision/Order.
This constitutes the decision and order of this Court.