The Impact of Assured Guaranty on Claims Against Sponsors

In Assured Guaranty Ltd v. J.P. Morgan Investment Management Inc., 2011 NY LEXIS 3658 (decided Dec. 11, 2011), a unanimous Court of Appeals held that the Martin Act, New York's “blue sky” law, does not pre-empt common law claims for breach of fiduciary and gross negligence. Assured Guaranty itself had nothing to do with real estate; the complaint alleged that J.P. Morgan had invested assets in high-risk securities without diversifying and without advising its client of the true level of risk. But the court's holding may have a significant effect on co-op and condominium purchasers and sponsors, because the Martin Act and its implementing regulations requires sponsors to make numerous disclosures. Whether those disclosures could serve as the foundation for a common law fraud action has been the subject of considerable litigation.

Background

The state legislature adopted the Martin Act in 1921, conferring on the state Attorney General the power to investigate and remedy possible securities fraud. In 1960, the legislature added section 352-e to the statute, requiring the sponsor of a co-operative or condominium plan to file an offering plan with the Attorney General. Certainly the Attorney General had power to enforce the statutory and regulatory requirements, but what about private parties. What rights did they have with respect to errors of omission or commission that appeared in the offering plan?

In CPC Intl v. McKesson Corp., 70 NY2d 268, a case, like Assured Guaranty, that did not involve co-ops or condominiums, the Court of Appeals held that the Martin Act did not create a private cause of action; only the Attorney General had power to enforce the statute's requirements. Several years later, The Vermeer Owners, Inc. v. Guterman, 79 NY2d 1114, made it clear that no claim would like against co-op sponsors for violations of section 352-e of the statute.

Neither CPC nor Vermeer, however, decided whether the Martin Act pre-empted independent common law claims arising out of the same behavior addressed by the statute. In Vermeer, the court dismissed a fraud claim based on false statements in the offering plan because plaintiffs had not established, by clear and convincing evidence, reliance to their detriment on the sponsor's misrepresentation. The court said nothing about pre-emption by the Martin Act.

The Appellate Divisions

In a number of cases, the Appellate Divisions, in both the First and Second Departments, held that the Martin Act pre-empted common law claims brought by co-op or condominium boards or tenants associations against sponsors. In Rego Park Gardens Owners, Inc. v. Rego Park Gardens Associates, 191 AD2d 621, the Second Department held that the Martin Act precluded claims for negligent misrepresentation and for negligent concealment of data the Martin Act required the sponsor to disclose. In Whitehall Tenants Corp. v. Olnick, 213 AD2d 200, the First Department conceded that the Martin Act does not foreclose a cause of action for common law fraud, but dismissed the tenant association's claim against the sponsor because, in the absence of evidence of reliance or intent to defraud, plaintiff's claim was identical to a claim that the sponsor had violated the Martin Act. In oft-quoted language, the court indicated 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.

Kerusa

The First Department retreated from Whitehall in Kramer v W10Z/515 Real Estate Ltd, Partnership, 44 AD3d 457, concluding that Whitehall itself had been correctly decided because there had been no evidence of reliance or intent to defraud, but overruled a series of decisions that had relied on Whitehall to dismiss common law fraud claims in the absence of “a unique set of circumstances whose remedy is not already available to the Attorney-General.” Thompson v. Parkchester Apts. Co., 249 AD2d 68, 69.

Kramer and its companion case, Kerusa v. 10Z/515 Real Estate Ltd. Partnership, 12 NY3d 236, reached the Court of Appeals in 2009, and the Court of Appeals reversed. Because the fraud claims in Kerusa and Kramer were predicated on alleged material omissions from offering plan amendments mandated by the Martin Act, the Court of Appeals held that the claim should have been dismissed. Because only the statute, and not the common law, would have required the sponsor to make the disclosures that served as the basis for the claim, allowing Kerusa's complaint to stand “would invite a backdoor private cause of action to enforce the Martin Act.” Id. at 245. The court, however, explicitly reserved judgment on whether an affirmative misrepresentation “of an item that the Martin Act or the Attorney General's implementing regulations require to be disclosed would support a cause of action for fraud.”

Kerusa generated a new set of inconsistent decisions. In Hamlet on Olde Oyster Bay Home Owner Assocation, Inc. v. Holiday Organization, Inc., 65 AD3d 1284, the Second Department dismissed a complaint based upon allegedly unrealistic budget projections in the offering plan, indicating that because the projections were included in the plan, they could not be the basis for a common law fraudulent inducement or negligent representation claim. But then, in 2011, the same court refused to dismiss a complaint based on affirmative misrepresentations included in an offering plan, concluding that dismissal in Hamlet on Olde Oyster Bay had been appropriate only because the projections were predictions or opinions, not statements of fact. But the court made it clear that affirmative misrepresentations of fact could serve as one of the elements for an adequate common law fraud claim.

Assured Guaranty

Unfortunately, the Court of Appeals opinion in Assured Guaranty does not resolve the question left up in the air in Kerusa. The court distinguished Kerusa by emphasizing that the purchaser's claim in Kerusa “was premised on a violation of the Martin Act and would not have existed absent the statute.” The Assured Guaranty opinion makes it clear that the court is not retreating from the position that omissions that violate the Martin Act do not give rise to a common law fraud claim. But what of affirmative misrepresentations in the offering plan? Many of those representations would never have been made but for the Martin Act. Does that mean, in the court's words, that the claim “would not have existed absent the statute”? Or, once the sponsor makes an affirmative representation that might serve as the foundation of a common-law fraud claim, is it irrelevant that the statement was made in the offering plan rather than in some other document? The answer to these questions must await further litigation.

Stewart E. Sterk, Mack Professor of Law at Benjamin N. Cardozo School of Law, is Editor-in-Chief of this newsletter.

In Assured Guaranty Ltd v. J.P. Morgan Investment Management Inc., 2011 NY LEXIS 3658 (decided Dec. 11, 2011), a unanimous Court of Appeals held that the Martin Act, New York's “blue sky” law, does not pre-empt common law claims for breach of fiduciary and gross negligence. Assured Guaranty itself had nothing to do with real estate; the complaint alleged that J.P. Morgan had invested assets in high-risk securities without diversifying and without advising its client of the true level of risk. But the court's holding may have a significant effect on co-op and condominium purchasers and sponsors, because the Martin Act and its implementing regulations requires sponsors to make numerous disclosures. Whether those disclosures could serve as the foundation for a common law fraud action has been the subject of considerable litigation.

Background

The state legislature adopted the Martin Act in 1921, conferring on the state Attorney General the power to investigate and remedy possible securities fraud. In 1960, the legislature added section 352-e to the statute, requiring the sponsor of a co-operative or condominium plan to file an offering plan with the Attorney General. Certainly the Attorney General had power to enforce the statutory and regulatory requirements, but what about private parties. What rights did they have with respect to errors of omission or commission that appeared in the offering plan?

In CPC Intl v. McKesson Corp. , 70 NY2d 268, a case, like Assured Guaranty , that did not involve co-ops or condominiums, the Court of Appeals held that the Martin Act did not create a private cause of action; only the Attorney General had power to enforce the statute's requirements. Several years later, The Vermeer Owners, Inc. v. Guterman , 79 NY2d 1114, made it clear that no claim would like against co-op sponsors for violations of section 352-e of the statute.

Neither CPC nor Vermeer, however, decided whether the Martin Act pre-empted independent common law claims arising out of the same behavior addressed by the statute. In Vermeer, the court dismissed a fraud claim based on false statements in the offering plan because plaintiffs had not established, by clear and convincing evidence, reliance to their detriment on the sponsor's misrepresentation. The court said nothing about pre-emption by the Martin Act.

The Appellate Divisions

In a number of cases, the Appellate Divisions, in both the First and Second Departments, held that the Martin Act pre-empted common law claims brought by co-op or condominium boards or tenants associations against sponsors. In Rego Park Gardens Owners, Inc. v. Rego Park Gardens Associates , 191 AD2d 621, the Second Department held that the Martin Act precluded claims for negligent misrepresentation and for negligent concealment of data the Martin Act required the sponsor to disclose. In Whitehall Tenants Corp. v. Olnick , 213 AD2d 200, the First Department conceded that the Martin Act does not foreclose a cause of action for common law fraud, but dismissed the tenant association's claim against the sponsor because, in the absence of evidence of reliance or intent to defraud, plaintiff's claim was identical to a claim that the sponsor had violated the Martin Act. In oft-quoted language, the court indicated 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.

Kerusa

The First Department retreated from Whitehall in Kramer v W10Z/515 Real Estate Ltd, Partnership , 44 AD3d 457, concluding that Whitehall itself had been correctly decided because there had been no evidence of reliance or intent to defraud, but overruled a series of decisions that had relied on Whitehall to dismiss common law fraud claims in the absence of “a unique set of circumstances whose remedy is not already available to the Attorney-General.” Thompson v. Parkche ster Apts. Co. , 249 AD2d 68, 69.

Kramer and its companion case, Kerusa v. 10Z/515 Real Estate Ltd. Partnership, 12 NY3d 236, reached the Court of Appeals in 2009, and the Court of Appeals reversed. Because the fraud claims in Kerusa and Kramer were predicated on alleged material omissions from offering plan amendments mandated by the Martin Act, the Court of Appeals held that the claim should have been dismissed. Because only the statute, and not the common law, would have required the sponsor to make the disclosures that served as the basis for the claim, allowing Kerusa's complaint to stand “would invite a backdoor private cause of action to enforce the Martin Act.” Id. at 245. The court, however, explicitly reserved judgment on whether an affirmative misrepresentation “of an item that the Martin Act or the Attorney General's implementing regulations require to be disclosed would support a cause of action for fraud.”

Kerusa generated a new set of inconsistent decisions. In Hamlet on Olde Oyster Bay Home Owner Assocation, Inc. v. Holiday Organization, Inc. , 65 AD3d 1284, the Second Department dismissed a complaint based upon allegedly unrealistic budget projections in the offering plan, indicating that because the projections were included in the plan, they could not be the basis for a common law fraudulent inducement or negligent representation claim. But then, in 2011, the same court refused to dismiss a complaint based on affirmative misrepresentations included in an offering plan, concluding that dismissal in Hamlet on Olde Oyster Bay had been appropriate only because the projections were predictions or opinions, not statements of fact. But the court made it clear that affirmative misrepresentations of fact could serve as one of the elements for an adequate common law fraud claim.

Assured Guaranty

Unfortunately, the Court of Appeals opinion in Assured Guaranty does not resolve the question left up in the air in Kerusa. The court distinguished Kerusa by emphasizing that the purchaser's claim in Kerusa “was premised on a violation of the Martin Act and would not have existed absent the statute.” The Assured Guaranty opinion makes it clear that the court is not retreating from the position that omissions that violate the Martin Act do not give rise to a common law fraud claim. But what of affirmative misrepresentations in the offering plan? Many of those representations would never have been made but for the Martin Act. Does that mean, in the court's words, that the claim “would not have existed absent the statute”? Or, once the sponsor makes an affirmative representation that might serve as the foundation of a common-law fraud claim, is it irrelevant that the statement was made in the offering plan rather than in some other document? The answer to these questions must await further litigation.

Stewart E. Sterk, Mack Professor of Law at Benjamin N. Cardozo School of Law, is Editor-in-Chief of this newsletter.