The Martin Act and Common Law Fraud

In Whitehall Tenants Corp. v. Estate of Olnick, 213 AD2d 200, a case in which a co-op sued its sponsor for fraud, the First Department overturned a jury verdict for the co-op, noting that “private plaintiffs will not be permitted through artful pleading to press any claim based on the sort of wrong given over to the Attorney-General under the Martin Act.” Id. at 200. In the Whitehall opinion itself, the First Department allowed that the Martin Act does not foreclose a cause of action for common law fraud, but the court did not indicate how to distinguish cases in which a fraud claim could go forward from those cases in which CPC precluded fraud claims. Relying on Whitehall, a number of cases in both the First and Second Department dismissed common law fraud claims premised on disclosures in the offering plan. See, e.g., Thompson v. Parkchester Apartments Co., 249 AD2d 68 (1st Dept); Shen v. Astoria Federal Savings and Loan, 295 AD2d 319 (2nd Dept).

In more recent cases, however, both departments have construed Whitehall to preclude a common law fraud claim only in those cases where the plaintiff failed to allege one or more of the elements of common law fraud with sufficient particularity. These courts emphasized in particular that proof of scienter is not necessary to establish a Martin Act violation, but is necessary to establish a common law fraud claim. They then concluded that if plaintiff pleaded all of the elements of common law fraud ' including scienter ' with sufficient particularity, then plaintiff's common law fraud claim could go forward. See Kramer v. W10Z/515 Real Estate Limited Partnership v. Real Estate Board of New York, Inc., 44 AD3d 457 (1st Dept); Caboara v. Babylon Cove Development LLC, 54 AD2d 79 (2nd Dept).

Kerusa

Those recent cases set the stage for Kerusa. Indeed, the First Department's Kramer opinion involved two plaintiffs, Kerusa and Kramer, and the sponsor of Kerusa's condominium, after losing at the Appellate Division, appealed to the Court of Appeals.

Stripped to its core, Kerusa's complaint was that the sponsor knew of construction and design problems that had arisen during the process of building the condominium, but nevertheless represented in the offering plan amendments that there were “no material changes of facts or circumstances affecting the property or the offering.” Kerusa alleged that the sponsor knew those representations to be false, and that the statements induced reliance by purchasers and caused injury, making out all of the elements of common law fraud.

Judge Susan Read's unanimous opinion for the Court of Appeals held that Kerusa's complaint could not stand. The court characterized Kerusa's claim as one of fraudulent concealment, as a claim that the sponsor had intentionally omitted to disclose material facts. The court emphasized that “[b]ut for the Martin Act and the Attorney General's implementing regulations ' the sponsor defendants did not have to make the disclosures in the amendments” and noted that “to accept Kerusa's pleading as valid would invite a backdoor private cause of action to enforce the Martin Act in contradiction to our holding in CPC Intl.” The court went on to emphasize that allowing Kerusa's complaint to stand would force parties to make extraordinarily detailed disclosures “ to avoid transforming every potential latent construction defect into a claim for common-law fraud on account of alleged omissions in Martin Act disclosures.”

Analysis

The court's policy reasons for holding Kerusa's complaint insufficient may well be persuasive. But characterization of Kerusa's complaint as one of fraudulent concealment is not entirely accurate. Kerusa contended that in the amendments to the plan, the sponsor made an affirmative misrepresentation ' that no material changes had occurred since the offering plan was filed; Kerusa was not relying merely on omissions or fraudulent concealment.

That, in turn leads to questions about the scope of the Kerusa decision: does it preclude a common law fraud claim when the sponsor makes intentionally misleading statements, for instance, about the size of the units? The court's opinion precludes a fraud claim predicated “solely on alleged material omissions from the offering plan amendments,” but does not speak of affirmative misrepresentations. On the one hand, the court's opinion purports to limit itself to material omissions. And it would certainly be odd to conclude that the court was trying to provide a blueprint for a sponsor who wants to mislead purchasers without incurring fraud liability: Make affirmative misrepresentations in the offering plan. On the other hand, if the court's rationale is that a fraud claim cannot be predicated on disclosures the sponsor would not have to make but for the Martin Act, that rationale applies equally to omissions and affirmative misrepresentations. How the court will ultimately resolve that issue must await another day.

Stewart E. Sterk is the Editor-in-Chief of this newsletter. He would like to thank Lisa Gordon, a Cardozo Student Contributor, who assisted in the preparation of this article.

In Kerusa LLC v. W10Z/515 Real Estate Limited Partnership, the Court of Appeals resolved a question that has plagued the Appellate Divisions over the past several years: May a co-op or condominium purchaser prevail on a common law fraud claim based on material omissions from offering plan amendments mandated by the Martin Act? The court's answer was no, but the court's opinion left some unanswered questions about the scope of the Kerusa decision.

Case History

In CPC Intl v. McKesson Corp. , 70 NY2d 268, the Court of Appeals held that the Martin Act, which prohibits a broad range of fraudulent and deceitful conduct in the distribution and sale of securities, does not confer a private right of action on persons injured by the deceitful conduct. In CPC itself, which did not involve co-op or condominium disclosure statements, the court held that CPC had adequately alleged common law fraud, even while dismissing the Martin Act claim. With respect to the Martin Act itself, which treats condominium interests and co-op shares as securities, the court held that the statute confers on the Attorney General exclusive enforcement powers. The Martin Act's substantive provisions, however, require co-operative and condominium sponsors to make a variety of disclosures in the offering plan as a mechanism for protecting purchasers. If the sponsor made those disclosures intending to defraud, inducing reliance by a purchaser and causing harm to that purchaser, CPC precluded the purchaser from prevailing on a Martin Act claim, but was silent about whether purchaser could prevail on an action for common law fraud.

In Whitehall Tenants Corp. v. Estate of Olnick , 213 AD2d 200, a case in which a co-op sued its sponsor for fraud, the First Department overturned a jury verdict for the co-op, noting that “private plaintiffs will not be permitted through artful pleading to press any claim based on the sort of wrong given over to the Attorney-General under the Martin Act.” Id . at 200. In the Whitehall opinion itself, the First Department allowed that the Martin Act does not foreclose a cause of action for common law fraud, but the court did not indicate how to distinguish cases in which a fraud claim could go forward from those cases in which CPC precluded fraud claims. Relying on Whitehall, a number of cases in both the First and Second Department dismissed common law fraud claims premised on disclosures in the offering plan. See, e.g., Thompson v. Parkchester Apartments Co. , 249 AD2d 68 (1st Dept); Shen v. Astoria Federal Savings and Loan , 295 AD2d 319 (2nd Dept).

In more recent cases, however, both departments have construed Whitehall to preclude a common law fraud claim only in those cases where the plaintiff failed to allege one or more of the elements of common law fraud with sufficient particularity. These courts emphasized in particular that proof of scienter is not necessary to establish a Martin Act violation, but is necessary to establish a common law fraud claim. They then concluded that if plaintiff pleaded all of the elements of common law fraud ' including scienter ' with sufficient particularity, then plaintiff's common law fraud claim could go forward. See Kramer v. W10Z/515 Real Estate Limited Partnership v. Real Estate Board of New York, Inc. , 44 AD3d 457 (1st Dept); Caboara v. Babylon Cove Development LLC , 54 AD2d 79 (2nd Dept).

Kerusa

Those recent cases set the stage for Kerusa. Indeed, the First Department's Kramer opinion involved two plaintiffs, Kerusa and Kramer, and the sponsor of Kerusa's condominium, after losing at the Appellate Division, appealed to the Court of Appeals.

Stripped to its core, Kerusa's complaint was that the sponsor knew of construction and design problems that had arisen during the process of building the condominium, but nevertheless represented in the offering plan amendments that there were “no material changes of facts or circumstances affecting the property or the offering.” Kerusa alleged that the sponsor knew those representations to be false, and that the statements induced reliance by purchasers and caused injury, making out all of the elements of common law fraud.

Judge Susan Read's unanimous opinion for the Court of Appeals held that Kerusa's complaint could not stand. The court characterized Kerusa's claim as one of fraudulent concealment, as a claim that the sponsor had intentionally omitted to disclose material facts. The court emphasized that “[b]ut for the Martin Act and the Attorney General's implementing regulations ' the sponsor defendants did not have to make the disclosures in the amendments” and noted that “to accept Kerusa's pleading as valid would invite a backdoor private cause of action to enforce the Martin Act in contradiction to our holding in CPC Intl.” The court went on to emphasize that allowing Kerusa's complaint to stand would force parties to make extraordinarily detailed disclosures “ to avoid transforming every potential latent construction defect into a claim for common-law fraud on account of alleged omissions in Martin Act disclosures.”

Analysis

The court's policy reasons for holding Kerusa's complaint insufficient may well be persuasive. But characterization of Kerusa's complaint as one of fraudulent concealment is not entirely accurate. Kerusa contended that in the amendments to the plan, the sponsor made an affirmative misrepresentation ' that no material changes had occurred since the offering plan was filed; Kerusa was not relying merely on omissions or fraudulent concealment.

That, in turn leads to questions about the scope of the Kerusa decision: does it preclude a common law fraud claim when the sponsor makes intentionally misleading statements, for instance, about the size of the units? The court's opinion precludes a fraud claim predicated “solely on alleged material omissions from the offering plan amendments,” but does not speak of affirmative misrepresentations. On the one hand, the court's opinion purports to limit itself to material omissions. And it would certainly be odd to conclude that the court was trying to provide a blueprint for a sponsor who wants to mislead purchasers without incurring fraud liability: Make affirmative misrepresentations in the offering plan. On the other hand, if the court's rationale is that a fraud claim cannot be predicated on disclosures the sponsor would not have to make but for the Martin Act, that rationale applies equally to omissions and affirmative misrepresentations. How the court will ultimately resolve that issue must await another day.

Stewart E. Sterk is the Editor-in-Chief of this newsletter. He would like to thank Lisa Gordon, a Cardozo Student Contributor, who assisted in the preparation of this article.