[*1]
| Sterling Natl. Bank v J.H. Cohn LLP |
| 2013 NY Slip Op 51356(U) [40 Misc 3d 1230(A)] |
| Decided on August 20, 2013 |
| Supreme Court, New York County |
| Schweitzer, J. |
| Published by New York State Law Reporting
Bureau pursuant to Judiciary Law § 431. |
| This opinion is uncorrected and will not be
published in the printed Official Reports. |
Supreme Court, New York County
Sterling
National Bank, Plaintiff,
against
J.H. Cohn LLP, Defendant.
|
650879/2012
Melvin L. Schweitzer, J.
This matter arises out of the audited balance sheets and statements
of income (the Financial Statements) of non-party USA Financial Services LLC (USA
Financial) and the related unqualified Audit Reports dated March 27, 2009 and March
30, 2010 (Audit Reports) prepared by J.H. Cohn LLP (J.H. Cohn).
Sterling National Bank (Sterling) raises claims for fraud and gross
negligence tantamount to fraud, alleging that J.H. Cohn falsely stated in the Audit
Reports that the Financial Statements fairly represented the financial position of USA
Financial, and that the Audit Reports were knowingly false and misleading. Sterling
relied upon the Audit Reports in making, renewing, or extending loans to USA Financial
for over $3 million in 2009 and 2010. During the time J.H. Cohn was providing the
unqualified Audit Reports, USA Financial was in fact operating a fraudulent business,
and in October 2010, USA Financial defaulted on its loans to Sterling and other banks,
closed its doors and ceased business.
J.H. Cohn has moved to dismiss both claims pursuant to CPLR 3016 (b) and
3211 (a) (7), alleging that (i) Sterling has failed to plead a claim of fraud with the level of
specificity required by CPRL 3016(b), (ii) New York law does not recognize a cause of
action for gross negligence tantamount to fraud, and, in the alternative, Sterling's gross
negligence claim merely duplicates its claim sounding in fraud, and (iii) Sterling's claim
for punitive damages is unwarranted in the absence of any morally reprehensible
conduct, or any pattern of egregious conduct directed at the general public.
Background
The
following factual allegations in the complaint are accepted as true.
USA Financial was a limited liability company engaged in the business of
leasing equipment and vehicles to consumers nationwide until its dissolution in October
2010. USA Financial borrowed funds from various banks, including Sterling, in order to
finance these leases. J.H. Cohn was retained by USA Financial to prepare the Audited
Reports, which reflected the Financial Statements for years ending December 31, 2007,
2008, and 2009.
As early as 2008, USA Financial covered up the fact that many of its lessees
were in default, and continued to make payments as if no defaults had occurred rather
than accelerate the [*2]debt on the defaulted leases and
report the defaults to the banks that financed the leases.
J.H. Cohn knew from its audits and recorded in its work papers that USA
Financial was making payments on defaulted leases as if the lessees were still
performing. J.H. Cohn did not disclose the defaults in the Financial Statements, despite
knowing that these practices violated the covenants of USA Financial's lender banks. The
effects of these defaults constituted "Events of Default" under the respective financing
agreements and also "red flag" warnings of fraud.
Further, J.H. Cohn knew of Sterling's relationship with USA Financial and
that USA Financial would use the Financial Statements and Audit Reports to induce its
lenders, including Sterling, to make, extend or renew loans to USA Financial. J.H. Cohn
knew Sterling would rely on the Financial Statements and the Audit Reports, as this was
the case in the many agreements between USA Financial and its lender banks.
Pursuant to a Revolving Warehouse Credit Agreement, and in reliance on
the Audited Reports, Sterling extended a $1 million line of credit and made $3 million in
loan advances during 2009 and 2010 to USA Financial.
In October, 2010 USA Financial defaulted on its loans to Sterling and other
banks and ceased business. Numerous civil proceedings have been commenced against
USA Financial by Sterling and other banks for losses believed to total over $80 million,
and Sterling has obtained judgment in the amount of $3,433,422.81, plus interest, against
USA Financial.
Discussion
On a
motion to dismiss on the ground that defenses are founded upon documentary evidence,
the evidence must be unambiguous, authentic and undeniable. CPLR 3211 (a) (1); Fontanetta v Doe, 73 AD3d
78 [2d Dept 2010]. "To succeed on a [CPLR 3211 (a) (1)]
motion . . . a defendant must show that the documentary evidence upon
which the motion is predicated resolves all factual issues as a matter of law and definitely
disposes of the plaintiff's claim." Ozdemir v Caithness Corp., 285 AD2d 961,
963 (3d Dept 2001), leave to appeal denied 97 NY2d 605. In other words,
"documentary evidence [must] utterly refute plaintiff's factual allegations, conclusively
establishing a defense as a matter of law." Goshen v Mutual Life Ins. Co. of New
York, 98 NY2d 314, 326 (2002).
On a motion to dismiss for failure to state a cause of action, the court accepts
all factual allegations pleaded in plaintiff's complaint as true, and gives plaintiff the
benefit of every favorable reference. CPLR 3211 (a) (7); Sheila C. v Povich, 11 AD3d
120 (1st Dept 2004). The court must determine whether "from the [complaint's] four
corners[,] factual allegations are discerned which taken together manifest any cause of
action cognizable at law." Gorelik v Mount Sinai Hosp. Ctr., 19 AD3d 319 (1st Dept
2005) (quoting Guggenheimer v Ginzburg, 43 NY2d 268, 275 (1977)). Vague
and conclusory allegations are not sufficient to sustain a cause of action. Fowler v
American Lawyer Media, Inc., 306 AD2d 113 (1st Dept 2003).
Fraud
To state a viable claim for fraud, the plaintiff must show (1) a
misrepresentation or omission of a material fact that the defendant knew to be false at the
time it was made; (2) the purpose of inducing the other party to rely upon the
misrepresentation; (3) justifiable reliance; and (4) injury. Lama Holding Co. v Smith
Barney Assoc., 88 NY2D 413, 421 (1996).
A fraud claim must be pleaded with particularity pursuant to CPLR 3016(b).
The purpose of the statute is to give adequate notice and "is not to be interpreted so
strictly as to prevent an otherwise valid cause of action" Houbigant, Inc. v Deloitte &
Touche LLP, 303 AD2d 92, 97-98 (1st Dept 2003), quoting Lanzi v Brooks,
43 NY2d 778, 780 (1977). The [*3]Appellate Division
emphasized in Houbigant that a complaint should survive a motion to dismiss if
it alleges facts that contain some rational basis for the inference that the
misrepresentation or fraud was knowingly made by the defendants. Houbigant,
303 AD2d at 98.
In its initial Decision and Order, dated August 28, 2012, this Court
concluded that Sterling had sufficiently pleaded all the elements of a fraud claim except
for an intent to deceive and instructed Sterling to state facts from which it could be
inferred that J.H. Cohn knew of Sterling's relationship with USA Financial and Sterling's
reliance on the Audit Reports in deciding whether to extend loans to USA Financial.
J.H. Cohen argues that the amended complaint fails to plead intent because it
lacks allegations that J.H. Cohn had any motive to join or support the fraud. Under New
York law, to raise a sufficient specter of the intent to deceive, a plaintiff need only allege
facts from which it may be inferred that the defendant was aware its misrepresentations
would be reasonably relied upon by the plaintiff. Houibigant, Inc. v Deloitte &
Touche, 303 AD2d 92, 100 (1st Dept 2003); Sterling National Bank v Ernst &
Young LLP, 9 Misc 3d 1129(A) (NY Sup Ct 2005).
The amended complaint specifically alleges facts in support of the
allegations that J.H. Cohn knew of Sterling and its relationship to USA Financial,
illustrated by the seventy-five entries in the J.H. Cohn work papers identifying and
analyzing the balances of loans issued by Sterling. The amended complaint also alleges
that J.H. Cohn knew the audited Financial Statements would be used to induce Sterling
and other lenders to make loans to USA Financial, supported by the fact that J.H. Cohn
reviewed the Sterling Warehouse Agreement which required USA Financial to provide
Sterling with certified financial statements. The fact that the Sterling Warehouse
Agreement used the word "certified" rather than "audited" is of no material relevance as
audits customarily go to credit providers, and it could be reasonably expected that USA
Financial would submit audited Financial Statements to Sterling since it had the Audit
Reports prepared for, among other reasons, submission to lenders.
Sterling adequately pleads a claim for fraud with the level of specificity
required by CPLR 3016 (b). Accordingly, the motion to dismiss Sterling's claim for fraud
is denied.
Gross Negligence Tantamount to Fraud
In the previous opinion, the court concluded that the case law is scant as to
whether a plaintiff may assert an independent claim for gross negligence tantamount to
fraud, and that courts must examine the four corners of the complaint using the requisite
liberal standard in order to determine the exact nature of the claim pled. In Ambassador
Factors v Kandel & Co., 215 AD2d 305 (1st Dept 1995), the Appellate Division, First
Department found that the claim pled was actually one for fraud, where a showing of
gross negligence could permit the trier of fact to draw an inference of the defendant's
fraudulent conduct.
A liberal reading of the amended complaint shows that Sterling attempts to
state a claim for gross negligence against J.H. Cohn, with which it is undisputedly not in
privity. To sustain this claim, Sterling must allege facts that show that J.H. Cohn was
aware that the Audit Reports would be used by Sterling for a particular purpose and that
Sterling would rely on them. There must be some conduct "linking" J.H. Cohn to Sterling
to show a relationship approaching privity. See Credit Alliance Corp. v Arthur
Andersen & Co., 65 NY2d 536 (1985). The original complaint failed to allege such
"linking" conduct.
The amended complaint alleges as follows:
There are over seventy-five entries in the J.H. Cohn workpapers that identify
Sterling and make clear the relationship between Sterling and USA Financial.
[*4]
Am. Compl. ¶ 22.
The financing agreements with the banks required that USA Financial
provide its Financial Statements to them.\
Id., ¶ 25.
J.H. Cohn also communicated directly with Sterling concerning Sterling's
loans and as part of its audit of the Sterling Warehouse Agreement . . . which also
demonstrates that it knew of Sterling, its relationship with USA Financial, and that USA
Financial would use the Financial Statements and Audit Reports to induce Sterling to
make, extend or renew loans to USA Financial.
Id., ¶ 27.
J.H. Cohn was heedless and reckless when it disregarded, failed to
investigate and turned a blind eye to these red flags which were obvious indications of
fraud.
Id. ¶ 49.
Although Sterling has alleged some linking conduct between J.H. Cohn and itself as
a non-client third party, it does not reach the standard of near-privity required to plead an
independent claim for gross negligence in the absence of actual privity.
In its reply papers, Sterling argues that gross negligence tantamount to fraud
is an alternative method of pleading scienter, which does not require privity. See Caprer v Nussbaum, 36
AD3d 176, 195 (2d Dept 2006). Courts have allowed gross negligence claims in
various cases, as evidence to support an inference of fraud. See State Street Trust
Company v Ernst, 278 NY 104 (1938) ("[Negligence], if sufficiently gross, may
furnish evidence leading to an inference of fraud . . ."); Ultramares Corp. v
Touch, 255 NY 170 (Fraud includes acts or omissions of accountants where they
made a "reckless misstatement"); Houbigant, 303 AD2d at 100 ("An auditor's
failure to independently verify financial statements may give rise to a claim for fraud")
(internal quotations omitted).
Accordingly, the court is of the view that Sterling should be allowed to
prove gross negligence, not as an independent cause of action, but rather to
permit the fact finder to make an inference of fraud.
Punitive Damages
Sterling argues that a claim for punitive damages is warranted where a
defendant's conduct demonstrates a disregard of the rights of another or where its actions
are willful or intentional. Bishop v 59 W. 12th St. Condo., 66 AD3d 401 (1st Dept
2009); 164 Mulberry St. Corp. v
Columbia Univ., 4 AD3d 49, 60 (1st Dept 2004). Punitive damages are only
appropriate for allegations of a public wrong, or where a defendant's conduct
demonstrates serious moral turpitude. See Simon v Ernst & Young, 223 AD2d
506 (1st Dept 1996). J.H. Cohn's actions are not directed towards the "public generally",
and Sterling has failed to allege any "high morality culpability" by the defendant which
would warrant the award of punitive damages. Walker v Sheldon, 10 NY2d 401,
405 (1961); see Indosuez v Barclay's Banks PLC, 181 AD2d 447 (1st Dept
1992); The Limited, Inc. v McCroy Corp., 169 AD2d 605 (1st Dept 1991). This
court is not persuaded by Sterling's arguments that J.H. Cohn's conduct meets the high
threshold of moral culpability to warrant a claim for punitive damages.
Accordingly, it is
ORDERED that the defendant's motion to dismiss Sterling's claims
for fraud and gross [*5]negligence tantamount to fraud is
denied; and it is further
ORDERED that the defendant's motion to dismiss Sterling's claim
for punitive damages is granted.
Dated:August 20, 2013
ENTER:
/s/Melvin L. Schweitzer
J.S.C.