A new decision of the Appellate Division, First Department (Burden v Pamplona Capital Mgt. LLP, 2025 NY Slip Op 02716 (1st Dep’t Decided May 6, 2025) affirmed the dismissal of an amended complaint, agreeing with the New York County Commercial Division (Schecter, J.) that the fraudulent inducement claims of the sophisticated plaintiffs did not stand a chance.
The transaction at issue was a bit of a twist from the usual fraud scenario. Typically, it is the buyer in an acquisition transaction who claims the seller somehow misrepresented material facts or information that thereby induced the buyer to acquire the assets, or some other interest, in the selling entity. In Burden, however, plaintiffs sold a controlling interest in their own company, called Logicworks, an internet service provider. At the heart of the alleged fraud was plaintiffs’ claim that the acquiring defendants failed to reveal or otherwise misrepresented “that defendant entities were merely a ‘front for powerful Russian oligarchs.’”
More specifically, plaintiffs asserted “that Logicworks’ value was immediately harmed upon defendants’ acquisition because the Russian oligarchs’ near-complete ownership and full control of defendants subjected Logicworks to various risks” that allegedly reduced its value.
On defendants’ motion to dismiss the amended complaint, Justice Schecter of the Commercial Division seemed to take of a page out of Supreme Court Justice Potter Stewart’s book, in effect, observing during oral argument that she knows what a fraud claim looks like and this one simply did not amount to cognizable fraud. See the transcript of the decision.
As shown by both Justice Schecter and the First Department in Burden, claiming “lost profits” on a fraud claim is nearly always the death knell of the claim. When courts hear that the plaintiff is claiming any sort of lost profits arising from fraud, it appears all kinds of alarms go off.
Measure of Damages for Fraud
Courts often maintain that recoverable damages for fraud are limited to the pecuniary loss or out-of-pocket damages directly resulting from the alleged fraudulent misrepresentations. I have explained these principles in numerous posts. See,e.g., New York’s High Court Has Little Appetite for Fraud Claim Against Chipotle Due to Lack of Pecuniary Damages.
As concisely stated by the New York Court of Appeals in Connaughton v Chipotle Mexican Grill, Inc., 29 NY3d 27 (2017):
In New York, as in multiple other states, “ ‘[t]he true measure of damage is indemnity for the actual pecuniary loss sustained as the direct result of the wrong’ or what is known as the ‘out-of-pocket’ rule” (Lama Holding, 88 N.Y.2d at 421, quoting Reno v. Bull, 226 N.Y. 546, 553 [1919] ). Under that rule, “[d]amages are to be calculated to compensate plaintiffs for what they lost because of the fraud, not to compensate them for what they might have gained…. [T]here can be no recovery of profits which would have been realized in the absence of fraud” (id. at 421, citing Foster v. Di Paolo, 236 N.Y. 132 [1923], AFA Protective Sys. v. American Tel. & Tel. Co., 57 N.Y.2d 912 [1982], and Cayuga Harvester, Inc. v. Allis–Chalmers Corp., 95 A.D.2d 5 [4th Dept 1983] ). Moreover, this Court has “consistent[ly] refus[ed] to allow damages for fraud based on the loss of a contractual bargain, the extent, and indeed … the very existence of which is completely undeterminable and speculative” (Dress Shirt Sales v. Hotel Martinique Assocs., 12 N.Y.2d 339, 344 [1963] ).
As such, when damages alleged are in the nature of a loss of value or lost profits, it is extremely difficult if not impossible to convince a court that such damages are recoverable in a fraud case. And that was one of the principal obstacles facing the plaintiffs in the Burden case.
Affirming dismissal of the fraud claims there, the First Department explained:
Plaintiffs failed to allege loss causation or any cognizable theory of damages with respect to their fraudulent inducement claims. It is uncontested that plaintiffs received a substantial profit from the transactions. However, their allegation concerning damages is that they should have made more money. New York measures damages as “the actual pecuniary loss sustained as a direct result of the wrong,” not the greater profit that could have been made but for alleged fraud (Lama Holding Co. v Smith Barney, 88 NY2d 413, 420-421 [1996] [internal quotation marks omitted]). Plaintiffs’ argument that Logicworks’ value was immediately harmed upon defendants’ acquisition because the Russian oligarchs’ near-complete ownership and full control of defendants subjected Logicworks to various risks is also belied by their allegations that Logicworks “continued to thrive” for years after the 2016 sale.
Materiality of Alleged Misrepresentations
Adding to the problems in plaintiffs’ case was the fact that they did not seem to care much about the Russian connection of the buyers before and during the transaction. Thus, plaintiffs could not satisfy the element of “materiality” of the alleged misrepresentations. In that regard, to establish the cause of action for fraud, a plaintiff must allege and prove that it reasonably relied upon the false information and that the false information was “material” to their decision. This is often explained in terms of “causation” principles. There are two sub-elements of causation in fraud—transaction causation and loss causation. The Appellate Division, First Department, decision in Basis PAC-Rim Opportunity Fund (Master) v TCW Asset Mgt. Co., 149 A.D.3d 146 (1st Dep’t 2017) succinctly laid out the two concepts as follows:
A fraud claim requires “proof by clear and convincing evidence” as to each element of the claim (Gaidon v Guardian Life Ins. Co. of Am., 94 NY2d 330, 350 [1999]). One such element is causation, and to establish causation, plaintiffs must prove both that “defendant’s misrepresentation induced plaintiff[s] to engage in the transaction in question (transaction causation) and that the misrepresentations directly caused the loss about which plaintiff[s] complain (loss causation)” (Laub v Faessel, 297 AD2d 28, 31 [1st Dept 2002]). “Transaction causation is akin to reliance, and requires only an allegation that but for the claimed misrepresentations or omissions, the plaintiff would not have entered into the detrimental securities transaction’” (Lentell v Merrill Lynch & Co., 396 F3d 161, 172 [2d Cir 2005], cert denied 546 US 935 [2005]).
“Loss causation is the causal link between the alleged misconduct and the economic harm ultimately suffered by the plaintiff’” (id. at 172). To establish loss causation a plaintiff must prove that the “subject of the fraudulent statement or omission was the cause of the actual loss suffered’”(id. at 173). Moreover, “when the plaintiff’s loss coincides with a marketwide phenomenon causing comparable losses to other investors, the prospect that the plaintiff’s loss was caused by the fraud decreases’, and a plaintiff’s claim fails when it has not . . . proven . . . that its loss was caused by the alleged misstatements as opposed to intervening events’” (id. at 174 quoting First National Bank v Gelt Funding Corp., 27 F3d 763, 772 [2d Cir 1994]). Indeed, when an investor suffers an investment loss due to a “market crash [] of such dramatic proportions that [the] losses would have occurred at the same time and to the same extent regardless of the alleged fraud,” loss causation is lacking (see Loreley Fin. [Jersey] No. 3 Ltd. v Wells Fargo Sec., LLC, 797 F3d 160, 186-187 [2d Cir 2015]).
Thus, in the Burden case, the First Department explained plaintiffs failed to allege the required materiality of the misrepresentations:
The court also properly found that plaintiffs failed to sufficiently allege any of the other elements of fraud with respect to the 2016 sale. Even assuming that defendants were at liberty to disclose the identity of their investors as part of the due diligence process, plaintiffs failed to allege that this information was material to them in evaluating the transaction (see e.g. Chase Manhattan Bank v Motorola, Inc., 184 F Supp 2d 384, 394 [SD NY 2002]). Plaintiffs received multiple bids for Logicworks in 2016, and, as they admit, sold to the highest bidder. Plaintiffs also admit that, at the time of the sale, they had information showing that defendants were significantly funded by Russian oligarchs. Further, plaintiffs allege in the amended complaint that they continued to make further investments into Logicworks even after they learned about the extent of the Russian investments, and after sanctions were imposed on those investors following Russia’s invasion of Ukraine. Thus, drawing all inferences in plaintiffs’ favor and accepting all allegations [*2]as true, a fair reading of plaintiffs’ own allegations show that the source of defendants’ funding was not of material concern, so long as they continued to receive the greatest return on their investment.
No Justifiable Reliance
Finally, the First Department pointed out that plaintiff did not adequately allege the element of justifiable reliance on the alleged misrepresentations because they failed to perform adequate due diligence or otherwise investigate defendants’ Russian connections despite being on notice of such:
Plaintiffs also failed to plead justifiable reliance on defendants’ alleged omissions (or affirmative misstatements). Plaintiffs failed adequately to allege that they had conducted due diligence on defendant entities’ investors, despite being on inquiry notice of Russian oligarchs in the entities’ investor chain (see e.g. UST Private Equity Invs. Fund v Salomon Smith Barney, 288 AD2d 87, 88 [1st Dept 2001]). Plaintiffs concede that they were aware of the Russian investments in defendants, yet the amended complaint contains no allegations that plaintiffs sought further information about the extent of that investment during the months of due diligence leading up to the 2016 transaction, in which plaintiffs were assisted by counsel and a sophisticated investment bank.
Commentary
Both the determination of the Commercial Division and the affirming decision of the First Department in Burden show that fraud cases can and are dismissed even at the pleadings stage if the factual allegations do not lay an adequate foundation to support each of the required elements. As the courts there found, in seeking to recover loss in value or lost profits, plaintiffs went beyond the damages recoverable for fraud. Nor did plaintiffs adequately allege the materiality of the alleged fraudulent misrepresentations or that they justifiably relied on the misrepresentations or concealment of that information.