Court of Appeals Addresses Standard for Pleading "Justifiable Reliance" In Commercial Fraud Cases

On May 7, 2015, the Court of Appeals issued a decision in ACA Financial Guaranty Corp. v. Goldman, Sachs & Co., 2015 NY Slip Op. 03876, addressing an issue that has divided the lower trial and appellate courts: the standard for pleading "justifiable reliance" in the context of commercial fraud claims.

As the Court noted in ACA Fin., to plead a cause of action for fraud, a plaintiff "must allege facts to support the claim that it justifiably relied on the alleged misrepresentations." However, precisely what must be pled to satisfy that requirement has been a point of contention among the lower courts. We previously blogged about this issue here, and in particular noted a trend in which "New York County Commercial Division Justices have usually denied motions to dismiss and for summary judgment in fraud cases, rejecting arguments from defendants that justifiable reliance was not sufficiently pled or that material issues of fact did not exist with respect to justifiable reliance, and the First Department usually reversed these decisions." ACA Fin. came to the Court of Appeals in precisely that posture: Justice Kapnick (then of the New York County Commercial Division, and now a Justice of the Appellate Division) denied defendant's motion to dismiss plaintiff's fraud claim for failure to plead justifiable reliance, and the First Department reversed and dismissed the complaint. The Court of Appeals in a memorandum decision joined by six Judges reversed the Appellate Division and reinstated the complaint.

The plaintiff in ACA Fin. brought suit against Goldman, Sachs, "alleging that defendant fraudulently induced plaintiff to provide financial guarantee for a synthetic collateralized debt obligation (CDO), known as ABACUS." In particular, ACA Financial alleged that Goldman "fraudulently concealed the fact that its hedge fund client Paulson & Co., which selected most of the portfolio investment securities in ABACUS, planned to take a 'short' position in ABACUS, thereby intentionally exposing plaintiff to substantial liability." Observing 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," the Court of Appeals held that plaintiff's allegations that it "sought assurances from defendant about Paulson's role in ABACUS," and that "defendant affirmatively misrepresented to plaintiff that Paulson would be the equity investor in ABACUS," were sufficient, at the pleading stage, to allege "reasonable reliance."

Judge Read dissented, arguing that ACA Financial did not plead justifiable reliance because it failed to take "an obvious and easy step" to uncover the truth – i.e., it did not "simply ask[] Paulson directly what its investment position was in ABACUS." In her view this "failure to consult a source of information that might have revealed the alleged fraud" was fatal to the claim. Judge Read also found ACA Financial's reliance on Goldman's informal "assurances" insufficient because it did not insist on any formal representation and warranty concerning Paulson's role, which it could have done "if assurance that Paulson was taking a net long position in ABACUS was as critical to ACA's commercial decisionmaking as it now claims."

Sophisticated parties alleging fraud in commercial cases face a due diligence requirement that may prove fatal to their claims even at the pleading stage. However, if the First Department follows the Court of Appeals' lead in ACA Fin., it may prove easier for plaintiffs to survive a motion to dismiss on justifiable reliance grounds.