A Case of Negligent Fraud

A recent First Department decision[1] dealt with several troubling issues. The following is a cautionary tale in the tangled, inconsistent web of litigation and appeal. This article is also a tale with a warning: put carve-outs in your legal opinions or you may be accused of fraud.

Background

The issues arose from a $15 million mortgage transaction between a sophisticated lender and two borrowers who represented their wholly owned corporation.[2] Lender was a single member limited liability real estate investment company (LLC), and the $15 million loan was secured by all four corporate Manhattan properties.

The borrowers had become sole shareholders and officers of the corporation within the past year. They submitted, inter alia, stock certificates and corporate resolutions (which contained only their signatures as president and secretary) to verify their ownership and authority.[3] Oddly, many of the documents were notarized in the Kingdom of Cambodia.

While ostensibly wealthy, the borrowers were eager to close and get the cash.. The lender did not inquire why they needed so much cash. Neither did it request their tax returns from the IRS although their financial status was uncertain. The lender was represented by a prominent real estate law firm, but requested an opinion letter from the borrower’s attorney, a solo practitioner.

Transaction Concluded

After the deal was done, the attorney closed the file.

The lender, however, immediately assigned its new mortgage with all rights to a second LLC[4] (assignee LLC) also owned by lender’s single member (the members of an LLC are its owners). Despite common ownership, each LLC was technically a separate legal entity. The reason the lender made this transfer was unclear.

Fraud

The following year, the real owner and president of the corporation sued the lender for, inter alia, declaratory judgment that the mortgage was unauthorized.[5] The borrowers were fraudsters who had forged the corporate documents it gave to the lender and their attorney, including a biennial statement on the website of the Secretary of State. The attorney was not a party to this lawsuit.

Belated Claim Against Attorney

Four and a half years after receiving the legal opinion, the lender abruptly impleaded the attorney, alleging in conclusory fashion negligence and fraud based on the erroneous opinion letter. The negligence statute of limitations had elapsed, making this claim dubious. No new facts were raised. The pleading did not particularize the fraud, nor did the lender allege its own due diligence.

Why this sudden allegation? The lender’s accusation came in the aftermath of an adverse First Department decision reversing a Supreme Court order that had dismissed the corporate owner’s complaint.

An Inference of Lack of Due Diligence

The First Department agreed with appellant[6] that the lender should have inquired further (e.g., requesting the fraudsters tax returns from the IRS). The court concluded there was an “inference” that the lender “failed to take reasonable steps to confirm that the questionable documents. . . . . were valid.”[7]

The lender moved to reargue, claiming the court overlooked its reliance on the attorney’s legal opinion, which made further inquiry unnecessary.[8] The First Department denied reargument.[9] This implied that the lender could not simply rely on the legal opinion. The impleader action against the attorney seemed to defy that decision.

Attorney Moves To Dismiss

Given the First Department ruling and the expired statute of limitations, a motion to dismiss may have seemed a slam dunk.

The attorney argued that the negligence claim was clearly dismissible, while the fraud claim was just “guilt by association” and deficient since not particularized pursuant to CPLR 3016 (b). Further, the case of Fortress v. Dechert absolved an attorney whose false legal opinion was based on forged client documents, making the fraud allegation untenable.[10]

Moreover, a confession by an indicted co-conspirator had fingered the other co-conspirators but had not named the attorney, and this undisputed document was in the court record, making the fraud accusation implausible.

The lender opposed, submitting as “documentary evidence” an affidavit by its single member/owner stating that it relied on the legal opinion, which was a lie.

Cursory Denial

The Supreme Court denied the defendant’s motion in a one sentence order, referring to the hearing transcript. Thus, it upheld both the expired negligence claim and the unparticularized fraud claim. The attorney filed a notice of appeal and moved to reargue.

Assignee’s Foreclosure Action

Meanwhile, after plaintiff owner sued for declaratory judgment to hold the fraudulent mortgage invalid,  the second LLC commenced a separate foreclosure action against the owner, since the fraudulent borrowers had defaulted on the mortgage payments.[11] This was proceeding before a different judge since a motion by the owner to consolidate was opposed by the lender and had been denied.

This set up the possibility of inconsistent decisions. Unlike the judge in the D.J. Declaratory Judgment action, the foreclosure judge emphasized the lender’s due diligence duty of inquiry. Addressing a motion to compel discovery, the court stated,

“This entire case comes down to whether plaintiff was justified in entering into the subject mortgage. . . . A key component of whether plaintiff will ultimately be able to recover is whether it did the proper due diligence and how it evaluated the authority of person who signed the mortgage papers. . . .”[12]

This ruling seemed to adopt the First Department’s “inference” that there was a duty to inquire. (Oddly, at this point, the second LLC no longer held the mortgage, which had been transferred to yet a third LLC, raising an issue of standing that remained unaddressed.)

Reargument

For unknown reasons, the appellant delayed in perfecting the appeal. Shortly after it was filed, the Supreme Court granted the attorney’s motion to reargue, and dismissed the negligence claim as clearly barred by the statute of limitations.[13] The court confessed it had inexplicably “overlooked” the negligence claim[14] although it was extensively briefed. The appellant informed the First Department of this, which mooted the negligence portion of the appeal.

The Costs of Appeal

The First Department denied the appeal and, without explanation, imposed costs.[15] This seems punitive and questionable. If the appeal was frivolous, the court could have denied it without extensive opinion. Instead, the justices systematically refuted appellants arguments.

Due Diligence

The court said due diligence was not an issue since the respondent “has not admitted that it failed to conduct appropriate due diligence.”[16] This assertion is startling: what lender would admit such dereliction? The lender did not allege due diligence in its pleading but merely asserted reliance on the legal opinion. The court’s holding also seems inconsistent with its prior decision denying reargument. Apparently, its one-word denial was meaningless.

CPLR 3016 (b)

The court said conclusory allegations of fraud were sufficient as an exception to the statute, citing dicta in Pludeman v. Northern Leasing Sys., Inc.[17] However, Pludeman was wildly inapposite. That case (not a unanimous opinion) involved a “nationwide scheme” of fraud by a corporation and its high placed executives where the multiple plaintiffs were unable to specify which executives had done what. However, it was evident that “the officers, as individuals and in the key positions they held, knew of and/or were involved in the fraud.”[18] The instance of a solo practitioner’s legal opinion letter based on forged documents was quite disparate.

Fortress v. Dechert

The First Department said Fortress was distinguishable since the legal opinion there contained a “carve out” – a statement that the document’s validity was assumed without further inquiry. Contrarily, the instant opinion stated it had “reviewed the original or certified copies of documents. . . .” (which were themselves fraudulent) “made such other inquiries with respect to Borrower, and the Loan as we have deemed necessary or appropriate for the purpose of this opinion.”[19]

Of course, if as the court stated, the “original or certified copies” reviewed were fraudulent, didn’t that exculpate the attorney from fraud? If the attorney’s judgment as to what further inquiry was “necessary or appropriate” was faulty, wouldn’t that be negligence, but not fraud?

Duty of Loyalty

This ruling also raises an ethical dilemma not addressed by the court. Absent the carve-out, perhaps negligently omitted, was the attorney bound to assume the documents’ inauthenticity and be forced to investigate his clients? If so, wouldn’t that adverse stance violate the duty of loyalty under the Rules of Professional Conduct ?[20] And what level of investigation would suffice where the key documents were forged? Apparently, nothing short of discovery of the fraud would do.

Conclusion

Sometimes the life of the law is not logic, but illogic.

Sheldon Siporin is a New York attorney, a member of NYSBA, and an adjunct professor of psychology at Pace University.

[1] Lucky of 195 Madison St. Roofing & Contracting v. Creif 109 LLC, 215 A.D.3d 558, 187 N.Y.S.3d 39 (1st Dep’t 2023).

[2] Complaint, Lucky of 195 Madison St. Roofing & Contracting v. Creif 109 LLC, No. 153437/17 (Sup. Ct., N.Y. Co., Apr. 19, 2017). See NYSCEF Document List, New York State Courts Electronic Filing, https://iapps.courts.state.ny.us/nyscef/HomePage.

[3] Id.

4 Complaint, Creif Lender LLC, as Assignee of Creif 109, LLC, v. Lucky of 195 Madison St. Roofing and Contracting Inc., No. 850028/2018 (Sup. Ct., N.Y. Co. Feb. 1, 2018).

[5] Complaint, Lucky , No. 153437/17.

[6], Respondent’s Brief on Appeal, Lucky, Appellate Docket 2020-01398 (1st Dep’t 2020).

[7] Lucky of 195 Madison St. Roofing & Contr. Inc. v. Creif 109 LLC, 189 A.D.3d 481, 482, 139 N.Y.S.3d 1 (1st Dep’t 2020).

[8] Respondent motion to reargue (11) & Reply on reargument (13), Lucky of 195 Madison St. Roofing & Contracting Inc. v Creif 109 LLC, No. 2020-01398 (1st Dep’t 2021).

[9] Order denying motion (14), Lucky, No. 2020-01398 (1st Dept 2021).

[10] Record on Appeal, Third Party Defendant Motion to Dismiss, Lucky, Appellate Docket 2020-01398.

[11] Foreclosure Action, Creif Lender LLC v. Lucky of 195 Madison St. Roofing & Contracting Inc., No. 850028/2018 (Sup. Ct., N.Y. Co.).

[12] Creif Lender LLC v. Lucky of 195 Madison St. Roofing & Contr. Inc., 2022 N.Y. Slip. Op. 30383(U), *4 (Sup. Ct., N.Y. Co., Jan. 20, 2022).

[13] Transcript of proceedings on reargument, No. 153437/17 NYSCEF DOC. NO. 516 p. 39:19-23 (1/12/2023).

[14] See Record on Appeal, citing No. 153437/17 NYSCEF DOC. NO. 516 p. 39:19-23 transcript of proceedings Jan. 12, 2023 on reargument. The court: “I was not aware that you moved under negligence. I thought it was fraud. . . . I am dismissing the negligence cause as being time barred.”

[15] Lucky of 195 Madison St. Roofing & Contracting v. Creif 109 LLC, 215 A.D.3d 558, 187 N.Y.S.3d 39 (1st Dep’t 2023).

[16] Id.

[17] 10 N.Y.3d 486, 492, 860 N.Y.S.2d 422 (2008).

[18] Id. at 493.

[19] Lucky of 195 Madison St. Roofing & Contracting v. Creif 109 LLC, 215 A.D.3d 558, 187 N.Y.S.3d 39 (1st Dep’t 2023).

[20] Rule 1.7 Rules of Professional Conduct, Conflict of Interest: Current Clients:
“(a) Except as provided in paragraph (b), a lawyer shall not represent a client if a reasonable lawyer would conclude that either:
(1) the representation will involve the lawyer in representing differing interests. . . . ”
See Comment [1] Loyalty and independent judgment are essential aspects of a lawyer’s relationship with a client. . . . . https://nysba.org/app/uploads/2023/02/20221020-Rules-of-Professional-Conduct-as-amended-6.10.2022.pdf