The intersection between a contract and claims of fraud relating to that contractual relationship is a subject of extensive litigation. See Courts Continue to Traverse the Intersection Between Fraud and Breach of Contract Claims. Courts routinely reject attempts to convert the breach of contractual promises into claims of fraud. For example, simply alleging that a contractual promise was not honored or that the contracting party did not intend to abide by the contract does not amount to fraud. Courts often dismiss attempted fraud claims by finding that they are “duplicative” of the contract claim, allege the same damages, allege a mere breach of a contractual promise to do something in the future, and/or fail to allege a misrepresentation of present facts.
As illustrated by the recent decision of the Appellate Division, First Department in AL Infinity LLC v Innovative Concepts & Design, LLC, 2024 NY Slip Op 05475 (1st Dep’t Decided Nov. 7, 2024), language contained in a contract can also directly refute a fraud claim where the contract itself contradicts the representations that the plaintiff claims to have relied upon and upon which it claims to have been duped.
Al Infinity
In Al Infinity, plaintiff and defendant entered into a license agreement whereby plaintiff gave defendant the exclusive right to manufacture and sell certain audio products using plaintiff’s trademarks. An earlier litigation in which the defendant had sued plaintiff relating to that same license agreement was resolved against the defendant. In this action, the plaintiff was suing to recover amounts it alleged were due from defendant under the license agreement.
Defendant claimed, among other things, that plaintiff fraudulently induced it to enter into the license agreement, requesting that it should thereby be rescinded. The Commercial Division rejected this defense on motions for summary judgment. On appeal, the First Department affirmed that ruling.
Res Judicata and Unreasonable Reliance
First, the First Department ruled that defendant could not argue that the license agreement should be rescinded in this case because in the earlier case it had instituted, that issue was necessarily decided. That is the concept of res judicata or collateral estoppel, otherwise known as claim preclusion. The Court held:
Res judicata (claim preclusion) bars defendant’s rescission defense, which is based on fraudulent inducement and material breach. As to fraudulent inducement, defendant brought a prior action in Supreme Court based primarily on its affirmative claims that plaintiff had materially breached the parties’ license agreement, and that it was entitled to damages for those breaches. Although it did not assert an affirmative claim for fraudulent inducement of the renewal agreement (nor did it seek damages based on rescission), defendant could have raised a fraudulent inducement claim in the prior action. As to material breach, the prior action was based on defendant’s claims of material breach of the underlying agreements, and Supreme Court dismissed the action with prejudice, which this Court affirmed (Innovative Concepts & Design, LLC v AL Infinity, LLC, 202 AD3d 594 [1st Dept 2022]). Defendant’s current assertions of material breach were raised or could have been raised previously, and the application of res judicata does not require that Supreme Court directly rule on each assertion of material breach.
Even apart from that bar to re-litigating the prior case, the First Department ruled that the fraud claim was meritless anyway. The First Department noted that the very terms of the license agreement itself contradicted the defendant’s theory of fraud—that if it had known that plaintiff would impose size restrictions on its licensed products category or prohibit it from selling its best-selling speaker, it would not have signed the renewed license agreement. But the First Department observed that defendant could not have reasonably relied upon that understanding, given the plain language of the license agreement:
However, in an arm’s-length transaction, defendant acknowledged and agreed in the renewed license agreement that the license agreement’s terms were to remain in full force and effect, including a clause that allowed plaintiff, in its “sole and absolute discretion,” to resolve product disputes by imposing size restrictions and directing defendant not to produce or sell products. When defendant signed the renewal agreement, it was on notice that size restrictions on defendant’s licensed products might well be an issue in the [*2]future, because those restrictions had been an issue in the past. Indeed, the issue had been resolved against defendant. Thus, defendant cannot now be heard to complain that it was fraudulently induced to enter the renewal agreement.
Commentary
Two lessons to take away from the Al Infinity decision: One, be careful when instituting a lawsuit over the terms of a contract and not raising all the issues that could relate to that contract or derive from it. Here, defendant had been the party initiating the first lawsuit, but did not preserve a claim that the contract was fraudulently induced. Two, as I often comment about, the party claiming fraud has an affirmative obligation to act prudently in protecting itself—notwithstanding fraudulent conduct of the other party. That is the well-recognized requirement of reasonable reliance. Here, it was not reasonable to claim reliance upon something that was contrary to the very terms of the contractual relationship between the parties. See also my post: Failure to Read Life Insurance Policies or Applications Renders Fraud Claim Against Broker Defective as a Matter of Law for Lack of Reasonable Reliance.