12(b)(6) Motions and Fraud Pleading Rules – A Case Note

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Wojcik v. Interarch, Inc., 2013 WL 5904996 (N.D.Ill. 2013), provides a good summary of the factual allegations required to allege fraud and civil conspiracy claims.

The plaintiffs sued a national franchisor and its site development consultant for fraud and other business torts when their Saladworks franchise failed.  Defendants moved to dismiss all claims.

Held: motion granted in part; denied in part.

Reasons:  The Court first recited some key Federal court pleadings and motions rules:

A 12(b)(6) motion tests whether the complaint state a claim on which relief can be granted;

–  FRCP 8 notice pleading requires a complaint to contain sufficient factual matter that states a claim that is plausible on its face;

 a plaintiff doesn’t have to plead facts in his complaint that anticipate possible affirmative defenses  (FRCP 8(c)(1);

– FRCP 9(b) requires heightened pleading specificity for fraud and civil conspiracy claims including the ‘who, what, where, when and how’ of the fraud and the conspiracy;

– FRCP 9’s pleading specificity rules are designed to discourage a ‘sue first, ask questions later’ mentality and to account for the stigma attached to fraud-based claims;

– a negligent misrepresentation claim is not subject to FRCP 9’s elevated pleading rules;

– FRCP 12(b)(6) generally only looks at a complaint’s four corners except where the complaint either attaches or specifically refers to outside documents;

–  a court may consider exhibits to a 12(b)(6) motion if the exhibit supplements a document attached to the complaint or where the defendant relies on the exhibit for the ‘same purpose’ as a document attached to the complaint

*5-6, 11; FRCP 8, 9, 12.

Applying these rules, the Court struck several of defendants’ motion exhibits that either weren’t attached to or incorporated by reference in plaintiffs’ complaint. *8.

The Court then sustained the plaintiffs’ fraud claims against the franchisor defendants.

While a fraud plaintiff must specifically plead the “who, what, when, where and how” of the fraud, allegations of malice, intent, knowledge of falsity and subjective matters can be alleged generally.  FRCP 9(b).

Here, the plaintiffs fraud claims were detailed.  They specifically pled the defendants knowingly misrepresented and omitted material facts involving the restaurant’s projected profits, build-out and construction costs, and general operating expenses.  Taken together, the allegations satisfied the pleading requirements for a valid fraud claim.  Wojcik, *11.

The plaintiffs’ civil  conspiracy claims failed.

An Illinois civil conspiracy plaintiff must plead and prove: (1) an agreement to accomplish an unlawful purpose or a lawful purpose by unlawful means, (2) a wrongful act in furtherance of the agreement, and (3) injury to the plaintiffWojcik, *11.

The agreement is the foundation of the conspiracy and requires proof of a defendant’s knowing and voluntary participation in a “common scheme” to commit an unlawful act or lawful act in an unlawful manner. 

Accidental, inadvertent, negligent or haphazard conduct is not enough to impose conspiracy liability on a defendant.  The plaintiff must plead the agreement’s critical details – including the “who, what, where, when and how” – to survive a motion to dismiss.  *12.

The Court held that plaintiffs’ conspiracy claims were too conclusory.  The plaintiffs merely parroted the elements of conspiracy and failed to plead critical details of the defendants’ agreement or their “common scheme” to harm the plaintiffs.  At most, plaintiffs pled negligence or breach of contract; not a conspiracy. *12.

Take-aways:

A court can consider external submissions on a 12(b)(6) motion where the challenged complaint incorporates or relies on an external document.  Wojcik also illustrates the required factual allegations that will satisfy Illinois state law fraud and civil conspiracy claims under Federal pleading rules.

 

IL First Dist. Examines Punitive Damage Standards In RE Fraud Suit

In K2 Development, LLC v. Braunstein, 2013 IL App (1st) 103672-U, the First District addressed Illinois law’s compensatory and punitive damages guideposts in a convoluted real estate fraud suit filed by an LLC against one of its two members.

The plaintiff LLC – through one of its members (a real estate novice) – sued the LLC’s other member – an experienced real estate developer – for fraud in connection with the defendant’s sale of an undeveloped piece of land to the plaintiff. 

The court awarded compensatory damages of nearly $400K and punitive damages of over $750K after a bench trial and the defendant appealed.

Held: Affirmed.

Rules/reasoning: The Court upheld the trial court’s damage awards based on the  evidence that the defendant orchestrated a fraudulent scheme and took advantage of his neophyte business partner (the other LLC member). 

In Illinois, compensatory damages are awarded as compensation, indemnity or restitution for a wrong or injury suffered by a plaintiff.  The purpose of compensatory damages is to make the injured party whole and restore him to his pre-loss condition. 

Compensatory damages are not designed to provide plaintiff with a windfall or profit.  Damage computations present a fact issue and a damage award will be overturned where the trial court ignores the evidence or the damage calculation is palpably erroneous.  ¶ 28 

The Court held that the trial court’s damage award based on defendant’s ill-gotten profits on the fraudulent deal coupled with the amount of asecret lien and easement defendant recorded/allowed to be recorded against the property had support in the record.  ¶¶ 28- 29

Punitive damages aim to (1) act as retribution against a defendant; and (2) deter the defendant and others from similar conduct.  The defendant’s conduct must be willful, outrageous and evince an “evil motive” or “reckless indifference” to others’ rights.  Punitive damages can be awarded in Illinois fraud actions; particularly where the false statements are made repeatedly and are particularly egregious. ¶¶ 32-34. 

Applying these rules, the Court held that punitive damages were appropriate based on the defendant’s continuing pattern of fraudulent conduct that saw   him make repeated misstatements and omissions. 

The K2 Court also rejected defendant’s claim that the $750K punitive damage award was unconstitutional.  The constitutional calculus for punitive damages includes (1) the degree of defendant’s “reprehensibility”, (2) disparity between actual or potential harm suffered by plaintiff and the punitive damage award, and (3) the difference between the punitive damages awarded and civil penalties authorized or imposed in comparable cases.  ¶ 37.

The Court addressed factors 1 and 2 above (factor (3) didn’t apply since there was no civil penalty for fraud or breach of fiduciary duty)).  In finding the defendant’s conduct reprehensible, the Court noted the defendant repeatedly made false statements to the plaintiff concerning the nature of property and the investment.  This showed a pattern of deceitful conduct. 

On the actual vs. punitive damage issue, the court noted that the punitives awarded ($750K) were about double the amount of the compensatory damages ($382K).  This 2:1 punitive:compensatory damages ratio clearly fell within reasonable damages bounds under Illinois law where anything more than a 4:1 punitive to actual damages ratio is “close to the line” (e.g. $400,000 punitive on a $100,000 actual damage award) of permissible punitives.  ¶¶ 41-42

Comments: A key factor in the Court’s damage analysis was that defendant owed and breached fiduciary duties to the plaintiff LLC’s other member.  

The disparity in business acumen between the parties clearly led the Court to affirm the trial court’s over $1M aggregate damage award for the plaintiff. 

K2 is particularly instructive on the “ratio issue”: how much a punitive damage can exceed an actual damage award without the court viewing it as excessive.  While there’s no bright-line rule, K2 suggests that anything higher than 4 to 1 can invoke elevated court scrutiny and a possible damage reduction.  

K2 also illustrates that a pattern of conduct – more than an isolated incident – will likely lead to a finding of reprehensible fraud and support a punitive damage award.

 

The ‘Justifiable Reliance’ Element Of A Fraud Claim (Illinois Law)

In Siegel Development, LLC v. Peak Construction, LLC, 2013 IL App (1st) 11973, the First District affirmed summary judgment in favor of a building seller and contractor in the building buyers’ fraud suit.

Facts: The building buyers (plaintiffs) and defendants entered into a contract for the purchase of a four-unit apartment building that plaintiffs planned to convert to condominiums.  Plaintiffs forecasted spending about $700,000 to buy the building and then another $180K in renovation costs.  The renovation figure was based on a spreadsheet provided by the defendant contractor which outlined the projected costs.  The contractor also informed the plaintiffs that it could perform all renovation work under a limited repair-and-replacement permit from the City.

Before closing, an architect repeatedly told the plaintiffs that the building needed more extensive repairs than were estimated by the contractor and that plaintiffs would need a “full permit” (as opposed to repair-and-replacement one) to complete the repairs.  Plaintiffs ignored the architect’s suggestion and  proceeded to closing without securing a full permit and also opted against a pre-closing property inspection.

After plaintiffs bought the building, the contractor informed them that it couldn’t proceed with the spreadsheet repairs and  couldn’t perform the work under a repair and replacement permit.  Plaintiffs also discovered numerous structural defects in the building which required repair costs far exceeding the contractor’s spreadsheet estimates.  Plaintiff sued the seller and contractor (and its agents) for fraud, rescission and breach of contract.

Trial court and appeals court holdings: The trial court entered summary judgment for the defendants.

Reasoning:

Plaintiffs failed to raise a genuine issue of fact on whether defendants made an actionable misrepresentation to plaintiffs concerning the building and failed to show justifiable reliance on any of defendants’ building representations.

Illinois law requires a fraud plaintiff to establish (1) a misrepresentation or false statement of material fact; (2) by one who knows or believes the statement to be false; (3) made with the intent to induce action by another in reliance on the statement, (4) action by the other in reliance on the truthfulness of the statement; and (5) injury resulting from the reliance.  ¶ 111

Plaintiffs’ misrepresentation claim was premised on the contractor’s spreadsheet document that estimated building repairs at about $180K.  The Court found the document too indefinite to bind the defendants since there was no meeting of the minds on the project specifics and scope of work. 

The Court also affirmed the trial court’s finding of no justifiable reliance as a matter of law.  Fraud reliance must be reasonable.  To determine whether reliance is reasonable, the Court considers all facts known to the plaintiff and all facts which the plaintiff could have learned through the exercise of ordinary prudence. A fraud plaintiff cannot enter a transaction “with his eyes closed” and later claim he was deceived.  But where a representation concerns a fact that is uniquely within the speaker’s knowledge, the recipient can rely upon it without investigation.  ¶ 114

In finding no justified reliance as a matter of law, the First District cited record evidence that plaintiffs decided to purchase the property without a signed repair contract or a pre-closing inspection.  ¶ 114.

The Court also found that the sales contract’s written warranty prevented the plaintiff from claiming it relied on the defendants’ oral statements about the building’s structueral integrity.  Note: the opinion references that plaintiff’s breach of warranty claim against the seller remains pending and was not subject of the appeal.

Take-aways: Peak Construction illustrates how difficult it is for a plaintiff to prove fraud; especially where the plaintiff is a sophisticated business person or entity.  The case also shows that proving justifiable reliance is particularly hard where the plaintiff and defendant are on an equal bargaining footing and the plaintiff has an ample opportunity to investigate the truth of a supposedly false statement.