Worthy of reading is a new, thorough and instructive decision addressing a number of aspects on the law of civil fraud rendered by the United States Court of Appeals for the Second Circuit in Meyer v. Seidel, Docket No. 21-221, decided December 21, 2023.
While relevant New York State court decisions have fleshed out the law quite well, if the case is pending in federal court, it is always preferable to rely on and cite federal decisions interpreting the applicable New York substantive law. And, of course, the Second Circuit is the best, most authoritative source in New York. So the Meyer decision is worth reviewing and saving for future use if the relevant issues arise in a federal case.
In Meyer, the Second Circuit confirmed that the “discovery” rule for extending the statute of limitations does not apply to claims of negligent misrepresentation, breach of warranty or rescission based upon alleged mutual mistake of fact. The Second Circuit clarified, however, that for claims of actual fraud, for which the discovery rule does apply, the duty of the fraud claimant to investigate and use diligence to uncover fraud is triggered when the circumstances “suggest to a person of ordinary intelligence that it is probable—i.e., more likely than not—and not merely possible that (a) he has been defrauded and (b) by the defendant.” (Emphasis added.)
Meyer Facts
The plaintiff in Meyer purchased a painting and alleged that defendants represented to him that the painting was a work of abstract-expressionist painter Mark Rothko, but it was subsequently believed that the painting was a forgery. Plaintiff sued defendants (who were dealers in paintings and other fine art) alleging claims of fraud, negligent misrepresentation, breach of warranty and rescission.
The District Court granted defendants’ motion to dismiss the complaint under Federal Rule of Civil Procedure (FRCP) 12(b)(6) ruling that all claims were barred by the statute of limitations, and also determined that the allegations failed adequately to state a claim, including under the heightened fraud standard of FRCP 9(b). Significantly, the District Court refused to grant plaintiff leave to amend his complaint, which turned out to be pivotal on appeal.
On appeal, the Second Circuit ruled that the District Court properly dismissed the claims for negligent misrepresentation, breach of warranty, and rescission as time-barred, as to which the discovery rule does not apply, and that the complaint’s pleading of the fraud claims did not meet the standard set by Ashcroft v.Iqbal, 556 U.S. 662 (2009). The Second Circuit ruled, however, that in deciding the Rule 12(b)(6) motions, the District Court erred in finding that the fraud claims were time-barred because evidence beyond the complaint showed that Meyer allegedly had inquiry notice of those claims longer than two years from filing the action, and, since that was why the District Court concluded that amending the complaint would be futile, it vacated so much of the judgment as denied plaintiff leave to amend the complaint as to the fraud claims.
In addition to affirming the dismissal of the claims for negligent misrepresentation, breach of warranty, and rescission as time-barred, the Second Circuit also rejected plaintiff’s argument that the doctrines of equitable tolling or equitable estoppel served to extend the statute of limitations. The Court correctly observed that these doctrines require plaintiff to prove that he was induced by fraud, misrepresentation or deception to refrain from filing a timely action. Plaintiff cannot simply claim that the same underlying fraudulent conduct somehow automatically extended the limitations period.
A new New York Appellate Division, Third Department, decision in Mehrotra v General Elec. Co., 2024 NY Slip Op 00113 (3d Dep’t Decided Jan. 11, 2024) reaffirmed this point as well: “‘Equitable estoppel may be invoked to defeat a statute of limitations defense when the plaintiff was induced by fraud, misrepresentations or deception to refrain from filing a timely action’ (Doe v Holy See [State of Vatican City], 17 AD3d 793, 794 [3d Dept 2005] [internal quotation marks and citations omitted], lv denied 6 NY3d 707 [2006]). For the doctrine to apply, plaintiff must show that he was ‘actively misled’ by defendants or that he ‘in some extraordinary way had been prevented from complying with the limitations period’ (Shared Communications Servs. of ESR, Inc. v Goldman, Sachs & Co., 38 AD3d 325, 325 [1st Dept 2007] [internal quotation marks and citation omitted]).”
See my post for further commentary on the equitable toll of the statute of limitations based upon fraud.
Duty of Inquiry to Investigate Fraud
The so-call “discovery rule” extending the statute of limitations period for actual fraud claims is derived from New York CPLR 213(8)(“the time within which the [fraud] action must be commenced shall be the greater of six years from the date the cause of action accrued or two years from the time the plaintiff or the person under whom the plaintiff claims discovered the fraud, or could with reasonable diligence have discovered it.”). This places a duty on the party claiming fraud to inquire further and try to ferret out the fraud when certain information pertaining to fraud comes to light. As to this duty of inquiry, see my post, Fraud Claim Time-Barred Where Plaintiff Could Have Detected the Fraud Within Statute of Limitations Period.
The Second Circuit in Meyer focused on the District Court’s analysis of this duty of inquiry, honing in on the precise standard that must be applied. The Second Circuit started:
In order to conclude that a plaintiff had inquiry notice, a finding that he had a “‘mere suspicion'” of fraud is “‘not . . . sufficient,'” Sargiss, 12 N.Y.3d 9 at 532, 881 N.Y.S.2d at 654 (quoting Erbe, 3 N.Y.2d at 326, 165 N.Y.S.2d at 111). A 10 duty to inquire arises when the circumstances “would ‘suggest to a person of ordinary intelligence the probability that he has been defrauded.'” Cruden, 957 F.2d at 973 (quoting Armstrong v. McAlpin, 699 F.2d 79, 88 (2d Cir. 1983) (“Armstrong”) (which was quoting Higgins v. Crouse, 147 N.Y. 411, 416, 42 N.E. 6, 7 (1895) (“Higgins”)) (emphasis ours)); see, e.g., Koch, 699 F.3d at 151 n.3 (the duty arises when “a person of ordinary intelligence would consider it ‘probable’ that fraud had occurred”).
The Second Circuit continued:
To constitute inquiry notice, “[t]he fraud must be probable, not merely possible.” Newman, 335 F.3d at 193; see, e.g., Lentell v. Merrill Lynch & Co., 396 F.3d 161, 168 (2d Cir.) (“Lentell”) (“existence of fraud must be a probability, not a possibility” (internal quotation marks omitted)), cert. denied, 546 U.S. 935 (2005); Koch, 699 F.3d at 151 n.3 (“probable, not simply possible”); Staehr, 547 F.3d at 430 (the test is “the probability,” “not just the possibility”). Unaccompanied by a modifier, the word “probable” means “more likely than not.” Citibank, N.A. v. Brigade Capital Management, LP, 49 F.4th 42, 68 n.17 (2d Cir. 2022).
The Second Circuit then took issue with the way the District Court decided that plaintiff was in fact on inquiry notice, finding it erred:
[T]he [District] court proceeded directly to its conclusion, finding …that [certain evidence] ‘alone was sufficient’ to ‘suggest to a person acting with reasonable diligence that there was some “probability that he has been defrauded,” which prompts a ‘duty of inquiry.'” D.Ct.Op., 2021 WL 3621695, at *8 (quoting Cruden, 957 F.2d at 973 (emphasis added)). But Cruden itself and the precedents it applied stated that, to warrant a finding of inquiry notice, the circumstances must have suggested to the plaintiff ‘the’ probability–not merely ‘some’ probability–that he had been defrauded. … ‘[S]ome probability’ is not the equivalent of ‘the probability’; the ‘some’ modifier suggests a standard less exacting than the more-likely-than-not level.
The District Court denied plaintiff’s motion to amend the complaint to attempt adequately to allege an actual fraud claim ruling that such amendment would be “futile” based upon the above erroneous standard it applied. The Second Circuit therefore reversed, thereby permitting plaintiff to amend the complaint.
Commentary
The Second Circuit’s decision in Meyer shows the intense analysis that must be applied to whether a party claiming fraud had sufficient information to “discover” the alleged fraud before bringing a lawsuit based upon actual fraud. The information must indicate the probability of fraud, not a mere possibility. Since federal courts prefer to cite their own decisions in interpreting New York substantive law, the Meyer decision is a keeper for any federally-based case.