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They may have been naive, but the plaintiffs were entitled to a shot at vindication before a jury, held New York's Court of Appeals in DDJ Management LLC v. Rhone Group, LLC. In this case, the plaintiffs sued defendants under a fraud theory to recover their losses after learning that the $40 million in loans they extended to the defendants turned out to be based on some seriously cooked books.
Admittedly, the defendants raised what is perhaps one of the most interesting defenses I've ever seen, which can be summarized as follows:
"Our books were so bad that you had no right relying on them to lend us the money."
The Chief Hurdle That Plaintiff Had to Clear in Order to Win Its Fraud Claim
One of the essential elements that a plaintiff must prove in order to establish a fraud claim under New York law is that she reasonably relied to her detriment upon the defendant's representations.
Applying this rule, many New York courts have dismissed fraud claims where the plaintiff's purported reliance on the defendants' representations was clearly unjustified, such as in Global Mins. & Metals Corp. v Holme (35 AD3d 93 [1st Dept 2006]), where the plaintiff fired an officer whom it found to be untrustworthy, and then inexplicably trusted that same officer's verbal assurances that a transaction was completely innocent.
The Court of Appeals Carves Out an Exception to the Reasonable Reliance Rule, Allowing the Fraud Claim to Survive
Importantly, New York's High Court carved out a clear exception, and stated that one way to prove a fraudulent concealment claim under New York law is as follows:
"Where, however, a plaintiff has taken reasonable steps to protect itself against deception, it should not be denied recovery merely because hindsight suggests that it might have been possible to detect the fraud when it occurred.
In particular, where a plaintiff has gone to the trouble to insist on a written representation that certain facts are true, it will often be justified in accepting that representation rather than making its own inquiry."
There is no doubt, at least in my mind, that both the general rule, as well as this exception to the general rule, are logical, and well-grounded.
A Word of Caution
While this decision was undoubtedly significant, there is also no doubt that too much shouldn't be read into the decision; most important, the Court was quick to cite a Federal appellate court decision stating that
"The question of what constitutes reasonable reliance is always nettlesome because it is so fact-intensive" (Schlaifer Nance & Co. v Estate of Warhol, 119 F3d 91, 98 [2d Cir 1997]). No two cases are alike in all relevant ways."
As a practical matter, that means you should not inherently assume that a court will agree, under a different set of facts, that a plaintiff's reliance was reasonable or justified, and therefore allow a fraud claim to survive dismissal.
