Opinion ID: 687599
Heading Depth: 2
Heading Rank: 2

Heading: Rachman's Duty to Disclose Material Information

Text: 19 Rachman also challenges the district court's conclusion that Rachman's conduct constituted fraudulent concealment as a matter of law. The district court described a three-part test for determining whether an obligee's failure to inform a surety of material facts amounts to fraudulent concealment. To meet this test, the district court stated, a defendant must show i) facts known to the obligee that materially increase the risk to the surety, beyond that which the obligee has reason to believe the surety intends to assume; ii) knowledge by the obligee that such facts are unknown to the surety; and iii) opportunity on the part of the obligee to communicate the relevant information to the surety. Rachman Bag Co. v. Liberty Mutual Ins. Co., 839 F.Supp. 998, 1003 (E.D.N.Y.1993). The district court's test finds support from the American Law Institute's Restatement of Security. See Restatement (First) of Security Sec. 124(1) (1941). We conclude that under New York law, however, this test lacks an essential fourth element: a duty on the part of the obligee to disclose the relevant information. Because there is a genuine issue of material fact as to whether such a duty exists in this case, summary judgment should not have been granted in favor of the surety. 20 In general, it is the duty of sureties to look out for themselves and ascertain the nature of [their] obligations. Security Nat'l Bank v. Compania Anonima de Seguros, 21 Misc.2d 158, 190 N.Y.S.2d 820, 823 (Sup.Ct.1959), aff'd, 10 A.D.2d 872, 199 N.Y.S.2d 532 (1960). Underlying this duty is the notion that, as stated in Cam-Ful Industries v. Fidelity & Deposit Co., 922 F.2d 156 (2d Cir.1991), [t]he policy behind surety bonds is not to protect a surety from its own laziness or poorly considered decision. Id. at 162. As a result, sureties must usually take the initiative and inquire about information they deem important. Marine Midland Bank v. Smith, 482 F.Supp. 1279, 1287 (S.D.N.Y.1979) (explaining that duties of inquiry and awareness fall upon the guarantor), aff'd, 636 F.2d 1202 (2d Cir.1980). 21 When a surety does request information from an obligee, silence on the part of the obligee can amount to fraudulent concealment. Chemical Bank v. Layne, 423 F.Supp. 869, 879 (S.D.N.Y.1976) (finding fraud by the obligee while noting that the element of inquiry by the proposed guarantor is crucial (emphasis in original)). In this case, however, Liberty failed to make the kind of inquiry of Rachman that arguably would have [led] to disclosure. Rachman, 839 F.Supp. at 1003. The principal question of law in this case is thus under what circumstances an obligee's failure to come forward with information it knows to be material constitutes fraud. 22 New York cases have repeatedly stated that, absent a request from the surety, silence on the part of the obligee will only amount to fraud where the obligee had an affirmative duty to tell what it allegedly withheld. Marine Midland, 482 F.Supp. at 1288; see 63 N.Y.Jur.2d Guaranty & Suretyship Sec. 181. This principle is expounded in First Citizens Bank & Trust Co. v. Sherman's Estate, 250 A.D. 339, 294 N.Y.S. 131 (1937): 23 While in many instances mere silence cannot be made the basis of fraud, yet, where the circumstances are of such a nature as to impose a duty upon one to speak, and where he deliberately fails to do so, his neglect will be deemed a deliberate suppression of the truth, and will amount to constructive, if not actual, fraud. 24 Id. 294 N.Y.S. at 139. The court in First Citizens concluded that the obligee bank had defrauded the surety when it failed to disclose that it no longer held collateral for the principal's loan. Id. 25 In Mohasco Industries, Inc. v. Giffen Industries, Inc., 335 F.Supp. 493 (S.D.N.Y.1971), the court specified that the factor distinguishing First Citizens from cases where silence did not amount to fraud was the affirmative duty to disclose. Id. at 497. This duty is distinct from and independent of the other three parts of the test that the district court utilized. In other words, the fact that an obligee knows information that is material to the surety, is aware of the surety's lack of knowledge, and has the opportunity to communicate the information does not itself give rise to an affirmative duty to disclose it. The court in Mohasco held that the obligee on a contract bond was not required to disclose that it intended to terminate its relationship with the principal despite the surety's manifest interest in such information. Mohasco Indus., 335 F.Supp. at 495-96; see also Cam-Ful Indus., 922 F.2d at 161-62 (reiterating that, generally, an obligee is not bound to disclose information absent an inquiry). These cases suggest that the duty to disclose must arise from something other than the materiality of the information. 26 From the relevant New York caselaw there emerges no definitive test for determining when an obligee's duty to disclose material information arises. And as a federal court sitting in diversity, we are reluctant to predict that New York's highest court would establish one. However, New York courts have generally held such a duty to arise when the obligee had either a relationship of trust and confidence with the surety or some degree of responsibility for the surety's misimpression. More specifically, New York courts have pointed to a number of relevant circumstances in decisions holding a duty of disclosure to arise. 27 First, the duty tends to arise when the obligee deals directly with the surety in obtaining the bond. See 63 N.Y.Jur.2d Guaranty & Suretyship Sec. 180; cf. Farmer's Nat'l Bank v. Van Slyke, 1 N.Y.S. 508, 510-11 (1888). Conversely, where the principal obtains the bond and the obligee's contact with the surety is minimal, the duty of inquiry is presumed to belong to the surety. Security Nat'l Bank, 190 N.Y.S.2d at 823; Howe Machine Co. v. Farrington, 82 N.Y. 121, 126-27 (1880). We note that this consideration taken alone would be unlikely to result in a duty to disclose in the case at bar. Unlike TOA, which obtained the bond directly from Liberty, Rachman had little direct contact with Liberty. 28 An obligee may also have a duty to disclose if silence would amount to an affirmative misrepresentation. See Marine Midland, 482 F.Supp. at 1286-87. In Damon v. Empire State Surety Co., 161 A.D. 875, 146 N.Y.S. 996 (1914), one of two cases on which the district court relied in articulating the test for fraudulent misrepresentation, the obligee and principal signed a contract which stated that the principal had possession of the obligee's promissory notes. In fact, the principal had discounted the notes to a third party at the obligee's request. The court suggested that the obligee's signature on the contract was a representation to the surety that the notes were in the principal's possession, and therefore that the obligee's silence as to the truth constituted fraud. Id. 146 N.Y.S. at 997-98. Similarly, in First Citizens, the obligee bank sent the surety a letter listing in detail the collateral it held for the principal debtor. First Citizens, 294 N.Y.S. at 136-37. The court held that the bank's failure to mention that it had released a large proportion of the collateral amounted to fraudulent concealment. Id. 294 N.Y.S. at 139. The bank had a duty to correct the false impression for which the bank was largely, if not wholly, responsible. Id. In essence, if the obligee affirmatively creates a misimpression, it seems to have the duty to correct it. Here, the issue of whether the communications between Rachman and Liberty or the wording of the January 12 agreement between Rachman and TOA amounted to affirmative misrepresentations must be resolved at trial. 29 If, as in this case, it is the principal rather than the obligee who misleads the surety, the obligee may still be obligated to disclose facts if it colluded in the deception. In Damon, for example, the obligee itself had convinced the principal to transfer the notes to third parties. Damon, 146 N.Y.S. at 998. In General Crushed Stone Co. v. State, 19 N.Y.2d 737, 279 N.Y.S.2d 190, 225 N.E.2d 893 (1967), the Court of Appeals supported the finding of the trial court and the dissenting judges in the Appellate Division that the obligee and principal had schemed to foist deficits in payments to suppliers and laborers onto the surety. 19 N.Y.2d at 737, 279 N.Y.S.2d at 191, 225 N.E.2d 894; General Crushed Stone Co. v. State, 23 A.D.2d 250, 260 N.Y.S.2d 32, 38 (1965) (Gibson, P.J. & Taylor, J., dissenting), rev'd, 19 N.Y.2d 737, 279 N.Y.S.2d 190, 225 N.E.2d 893 (1967). In contrast, the Court of Appeals in an 1874 case denied a fraudulent concealment defense where the obligee was in no way connected with the deception practised upon [the surety]. Casoni v. Jerome, 58 N.Y. 315, 321 (1874). As the record presently stands, we cannot conclude as a matter of law that Rachman colluded with TOA to induce Liberty to cover TOA's debt. 30 Courts have also found a duty to disclose material information when the principal was the obligee's employee or agent. Cf. Grumman Allied Indus. v. Rohr Indus., Inc., 748 F.2d 729, 738-39 (2d Cir.1984) (noting that under New York law a duty to disclose material information generally arises when the parties enjoy a fiduciary relationship and one party possesses superior information). In particular, several cases hold that when an employer obligee obtains a fidelity bond for an employee principal, the employer has the duty to disclose that employee's past acts of infidelity. See, e.g., United States Life Ins. Co. v. Salmon, 36 N.Y.S. 830, 831 (App.Div.1895), aff'd, 157 N.Y. 682, 51 N.E. 1094 (1898); Bostwick v. Van Voorhis, 91 N.Y. 353, 360 (1883). While this principle would seem possibly to lend itself to cases such as the present one, recent decisions have strictly limited the duty to the fidelity bond context. See State v. Peerless Ins. Co., 67 N.Y.2d 845, 847-48, 501 N.Y.S.2d 651, 653, 492 N.E.2d 779, 781 (1986) (explaining that the nature of fidelity bonds is such that the employer requesting one is making an implied representation as to the employee's fidelity). 31 Finally, a duty to disclose may arise if the obligee has unique access to material information. In First Citizens, the court noted that only the obligee bank was in a position to know that the bank had released the principal's collateral, and that as a result the bank had a duty to disclose that fact. See First Citizens, 294 N.Y.S. at 136, 139. Yet this duty arises only if the information is in the obligee's control. That the information is merely difficult for the surety to obtain is not sufficient. In Marine Midland, the surety approached the obligee bank and stated that it was having difficulty obtaining information from the principal. Even so, the court found that the bank's selective disclosure did not constitute an affirmative misrepresentation amounting to fraud. See Marine Midland, 482 F.Supp. at 1286, 1289. 32 The test for fraudulent concealment by a surety bond obligee under New York law in this context thus consists of four elements: 1) the obligee must know facts that materially increase the surety's risk, and have reason to believe that surety would be unwilling to assume such a higher risk; 2) the obligee must have reason to believe that such facts are unknown to the surety; 3) the obligee must have the opportunity to communicate the relevant information to the surety; and 4) the obligee must have the duty to disclose the information based upon its relationship to the surety, its responsibility for the surety's misimpression, or other circumstances. 33 Because the district court's test for fraudulent concealment in the present case omitted the duty to disclose as an element, the district court did not consider the circumstances found in the caselaw that could give rise to such a duty. In our view, genuine issues of material fact exist as to whether sufficient circumstances existed here to trigger a duty on Rachman's part to disclose in this case. As a result, neither Rachman nor Liberty is entitled to summary judgment on the fraudulent concealment defense. We therefore reverse the district court's grant of summary judgment to Liberty on the issue of fraudulent concealment. 34