As I have explained, the cause of action for fraud affords a host of powerful remedies to the victims of fraudulent conduct. See, e.g., What Do Fraud and Spiderman Have in Common? With Great Power Comes Great Responsibilities. One of those remedies is to rescind an entire contract if it was induced by fraud. The remedy of rescission, however, is not without some hooks and catches. Rescission comes with its own special legal baggage.
One such catch is that the right to a jury trial of the claim may be lost if rescission is sought because rescission is an “equitable” remedy for which a jury trial is not traditionally allowed. See, e.g., When Can Fraud Claims and Jury Trials Coexist?
Another hook is that a party seeking to rescind a contract cannot also try to enforce the very same contract at the same time to obtain remedies for breach of that contract.
A new decision of the Appellate Division, First Department, makes that point rather bluntly: JTED46, Inc. v Espresso Dream, LLC, 2024 NY Slip Op 02986 (1st Dep’t Decided May 30, 2024).
Espresso Dream
The transactions in the Espresso Dream case involved plaintiffs’ purchase of three restaurants from defendants through asset sales agreements (ASAs). Under the terms of the ASAs, defendants were required to indemnify plaintiffs against any outstanding tax liabilities. After the sales closed, plaintiffs discovered outstanding tax liabilities on all three restaurants.
Plaintiffs subsequently sued defendant sellers asserting causes of action for fraudulent inducement and breach of contract, alleging that defendants falsely represented that there were no outstanding tax liabilities and failed to indemnify them for these liabilities as per the ASAs. For the fraudulent inducement cause of action, plaintiffs sought rescission and return of the $766,666.56 paid toward the restaurants. Significantly, plaintiffs also sought damages for breach of contract.
Rescission Deemed Unavailable
At the trial of the action, the lower court determined that plaintiffs were not entitled to a jury trial because of the rescission claim. The court then rendered a decision after a bench trial dismissing the entire action.
On appeal, the First Department ruled that the trial court correctly required plaintiffs to make an election of whether they sought to rescind the ASAs or damages for breach of the ASAs. Plaintiffs sought to hedge, arguing that if rescinding the ASAs altogether were not successful, they could still seek rescissory monetary damages, citing case law that indicated that where completely rescinding the contract may not be feasible, awarding the somewhat equivalent in damages may be an appropriate remedy. The First Department did not buy the argument, ruling:
Contrary to plaintiffs’ argument, the [trial] court properly instructed plaintiffs to elect either recessionary damages under their fraudulent inducement claim at a bench trial or compensatory damages arising from the alleged breach of contract at a jury trial (see Unisys Corp. v Hercules Inc., 224 AD2d 365, 367 [1st Dept 1996], appeal withdrawn, 89 NY2d 1031 [1997]). The fraud claim, which sought rescission of the ASAs, was inconsistent with plaintiffs’ breach of contract claim, which sought enforcement of the terms of the ASAs (see Bowen v Mandeville, 95 NY 237, 240 [1884]; Abramson v Leo, 240 AD 343, 357 [1st Dept 1996]). Notably, plaintiffs did not object to this election of remedies and chose to pursue recessionary damages under their fraudulent inducement claim.
The First Department then ruled that plaintiffs were not entitled to any such damages:
After a bench trial, the court properly rejected plaintiffs’ claim for rescission of the ASAs. Recessionary damages were unavailable because plaintiffs had an adequate remedy in the ASAs for indemnification of the outstanding tax liabilities, which they chose not to pursue (see Financial Guar. Ins. Co. v Morgan Stanley ABS Capital I Inc., 164 AD3d 1126, 1128 [1st Dept 2018]). Plaintiffs’ claim for rescission also ran afoul of the promptness requirement (see New York Tel. Co. v Jamestown Tel. Corp. 282 NY 365, 372-373 [1940]). Plaintiffs first learned of the tax liabilities in 2015. They closed the restaurants in 2015 and 2016, thus extinguishing what they would have returned had the ASAs been rescinded, and then waited until 2019 to commence this action (see Glatt v Mariner Partners[*2], Inc. 66 AD3d 440, 441 [1st Dept 2009]).
As the First Department noted, another one of the catches to rescission is that the party seeking rescission as a remedy act promptly to take that position, lest the interim events could make it infeasible.
Finally, the First Department noted that even if plaintiffs were permitted to pursue their breach of contract claim simultaneously with the fraud claim, they would not have been entitled to rescind the contract because the alleged breach was not material enough so as to render the entire essence of the contract ineffective (as is required for a contractual claim of rescission):
Finally, plaintiffs would not have been entitled to recessionary damages even if they had pursued the breach of contract claim at trial. This was not a case in which the alleged breach, i.e., failure to indemnify plaintiffs for the outstanding tax liabilities, defeated the entire purpose of the contract (cf. Grace v Nappa, 46 NY2d 560, 566 [1979]; City of Schenectady v Edison Exploratorium, Inc., 147 AD3d 1264, 1265 [3d Dept 2017]).
Commentary
Rescission is indeed one the powerful remedies of the tort of fraud. Nevertheless, the rather extraordinary remedy of undoing an entire transaction has special requirements. Seeking the right remedy at the right time is essential, as shown by the First Department in Espresso Dream. There are plenty of pitfalls to get caught up in if the legal terrain is not navigated with precision.