Court Opinion

ID: 9489173
Source: CourtListenerOpinion
Date Created: 2023-08-05 13:07:49.841236+00
Date Added: 2024-06-11T17:53:22.228217
License: Public Domain

JACOBS, Circuit Judge,
dissenting:
There is no question that Gordon & Co. was the victim of a fraudulent misstatement by Ross. I respectfully dissent, however, because I agree with Magistrate Judge Ger-shon that Gordon cannot show reasonable and detrimental reliance upon that misstatement in incurring the loss for which it seeks recovery in this action.
BACKGROUND
At the outset of events, Gordon & Co. had approximately $13 million worth securities in a margin account at Hanover. Gordon had a right to demand that Hanover deliver all the securities in its account, less any debit balance that it owed Hanover. As of October 21, 1983, that debit balance was $4.7 million; so Gordon had a right to immediate delivery of $8.3 million in securities.
On Friday, October 21, Hanover was informed by the New York Stock Exchange (“NYSE”) that it would not be permitted to open for business on Monday, October 24 unless it could shore up its finances. Concerned that all its securities in the Hanover account might be lost if Hanover failed, Gordon agreed on October 23 to lend Hanover $1.95 million by increasing the debit balance it owed to Hanover.1 In turn, Ross (a Hanover principal) agreed on behalf of Hanover that it would return all of Gordon’s securities on Monday, October 24. Ross also represented that none of Gordon’s securities had been hypothecated to third parties. Ross and two other Hanover principals issued personal guarantees on the loan, and agreed to cause the debts that Hanover owed to them to be subordinated to the Gordon loan. In addition, Rooney Pace, Inc. (“RPI”), a brokerage house and creditor of Hanover, tentatively agreed to purchase certain assets of Hanover and to guarantee payment of the Gordon loan. RPI retained the right to rescind the purchase of Hanover’s assets.
Hanover opened for business on Monday, October 24. By November 2, Hanover had returned all but $1.8 million of Gordon’s fully paid securities. On or about that date, Hanover informed Gordon that the remaining *548securities could not be delivered because Hanover had hypothecated them to two banks. As the magistrate judge found, Ross’s prior statements to Gordon — that all of Gordon’s securities would be returned, and that none of those securities had been hy-pothecated — were therefore fraudulent.
On November 7, 1983, Gordon agreed to make a second loan to Hanover in the amount of Hanover’s $1,034 million indebtedness to the two banks. In exchange for their receipt of that sum, the banks agreed to release their claims on the $1.8 million in securities, which were then delivered to Gordon. In early December, Hanover informed the NYSE about a previously undisclosed loan in the amount of $1.2 million owing to yet another bank. That loan was not recorded in Hanover’s books and had been hidden from Ross and the NYSE by one of Ross’s fellow principals. Having exhausted the patience of its creditors, Hanover went into liquidation on December 8,1983, and defaulted on both Gordon loans.
DISCUSSION
The magistrate judge ruled that Gordon could not recover on the first loan because, even if all of Gordon’s securities had been delivered in accordance with Ross’s representations, (i) the initial $1.95 million loan would have remained outstanding, and (ii) Hanover would have defaulted on it anyway. As the court expressed it, relying on our decision in Citibank, N.A. v. K-H Corp., 968 F.2d 1489 (2d Cir.1992), “the misstatements were not causally related to the repayment of the loan.”2
The only compensatory damages that Gordon seeks are in respect of the second loan. As to that transaction, the critical juncture is November 2,1983, and the days immediately following — the time that Gordon learned that Ross’s prior representations were materially false and fraudulent. At that point, Gordon was a creditor on a $1.95 million loan to Hanover, and had failed to recover $1.8 million in securities that Hanover had hypothe-cated. Gordon had a couple of options:
A. As to the remaining $1.8 million in securities, Gordon could have sought recovery in an aetion for fraud against Hanover and Ross. As to the first $1.95 million loan, Gordon could have awaited payment and, in the event of Hanover’s default, commenced suit on the personal guarantees issued by Ross and his fellow principals, or on the guarantee issued by RPI.3 In this way, Gordon could have recovered the full value of its securities and the full amount of the first loan to Hanover, without entering into another transaction with its defrauders.
B. Alternatively, Gordon could have struck a deal with the banks directly by paying them the $1,034 million to discharge Hanover’s debt upon the condition that Hanover direct the banks to release the $1.8 million in shares to Gordon. (If Gordon had taken this course of aetion, I might agree with the majority that the transaction would have been a payment in mitigation of damages and recoverable from Hanover and Ross in fraud.) Again, Gordon could have recovered the $1.95 million loan (in the event of default) by way of actions on the guarantees.
But Gordon instead entered into a new transaction with Hanover and Ross and, after Hanover defaulted on its loans from Gordon, commenced this fraud action. In order to recover in fraud, New York law requires, inter alia, that the allegedly defrauded party show that it relied to its injury on the fraudulent misstatement. Graubard Molten Dan-*549nett & Horowitz v. Moskovitz, 86 N.Y.2d 112, 122, 629 N.Y.S.2d 1009, 1014, 653 N.E.2d 1179, 1184 (1995); Barclay Arms, Inc. v. Barclay Arms Assocs., 74 N.Y.2d 644, 646-47, 542 N.Y.S.2d 512, 514, 540 N.E.2d 707, 709 (1989) (mem.). However, at the time that Gordon entered into the November 7 transaction, Gordon knew that Ross’s prior representations were false. The magistrate judge was therefore correct in ruling that Gordon could not have reasonably (or justifiably) relied on Ross’s prior misstatements in entering into the November 7 transaction. See Clearview Concrete, 88 A.D.2d at 468, 453 N.Y.S.2d at 755 (“With reliance the key element for such recovery, only prediscovery expenses can be recaptured since expenses incurred after discovery have no root in reliance _” (citations omitted)).
The majority holds that, once Gordon learned of Ross’s fraudulent misstatement on November 2, 1983, “it was ‘required’ to expend an additional $1,034,347 to secure the return of its securities.” Maj. Op. at 546. But I can think of no circumstance that actually compelled Gordon to lend more money to its defrauders.' I have outlined two available alternatives Gordon might have adopted. Gordon chose to forgo those options and instead entered into another transaction the effect of which, in my view, was to abandon by settlement or election any claim for fraud that Gordon might have had against Ross and Hanover. The elements of the November 7, 1983 transaction were as follows:
i. Gordon paid the two banks, on behalf of Hanover, $1,034 million.
ii. The banks delivered the remaining $1.8 million in securities to Gordon.
iii. Hanover delivered a promissory note for $1,034 million to Gordon.
iv. Hanover assigned to Gordon, as security for repayment of the promissory note, Hanover’s interest in all cash and securities on deposit at The Depository Trust Company, Midwest Clearing Corp., Midwest Securities Trust Co., National Securities Clearing Corp., and the Options Clearing Corp.4
From that point, Gordon could no longer claim that it was fraudulently dispossessed of its securities, because those securities had been returned. Thus, Gordon’s fraud claim against Hanover and Ross was implicitly released and forgone in exchange for what Gordon then doubtless considered a more satisfactory arrangement.
, Gordon mitigated the risk that its two promissory notes would be discharged in the event of Hanover’s bankruptcy by (i) retaining the personal guarantees of Ross and two other Hanover principals on the first (October 23) loan; (ii) retaining RPI’s guarantee on the first loan; and (iii) taking an interest in Hanover’s deposits with the five depository institutions to secure the second (November 7) loan. Thus, as of November 7, Gordon held guarantees or security interests for each loan.
Gordon then proceeded, for one reason or another, to relinquish each of these guarantees and security interests. For reasons not fully explained in the record, Gordon released Ross from his guarantee of the first loan on November 10, 1983. On November 11, Gordon and Hanover “cancelled, rescinded and revoked” the November 7 promissory note, purportedly at the insistence of the NYSE. On November 14, RPI informed Gordon that it intended to rescind its earlier tentative agreement to purchase the assets of Hanover unless that agreement was modified. Ross, RPI, Gordon, and other creditors of Hanover entered into a modification agreement that, inter alia, released RPI’s guarantee of the first loan from Gordon to Hanover. Also on that date, Gordon, RPI and Citiwide Securities Corporation (another Hanover creditor) entered into an agreement pursuant to which RPI granted Gordon a security interest in expected profits from certain (formerly) profitable Hanover operations that RPI purchased and agreed to operate. However, Hanover was forced into liquidation before any profits from those operations materialized.
*550But for Gordon’s relinquishment of its guarantees and security interests, the relief sought on the ground of fraud would have been collectible: the first loan would have been recoverable by way of an action on the personal guarantees of Ross, his fellow principals, or perhaps RPI; and the second loan would have been recoverable, at least in part, by way of Gordon’s lien on the secured assets in Hanover’s accounts at the depository institutions. The cause of the loss which Gordon seeks to recover in this appeal was therefore two-fold: (i) the primary obligor (Hanover) became insolvent, and (ii) the security interests in Hanover’s assets held at the depository institutions were released. Moreover, because Gordon had not relied on Ross’s misstatements in making the second loan, Gordon cannot recover that loss in an action for fraud.
The majority analogizes Gordon’s second loan to a ransom payment, which may be recoverable in an action in contract. See, e.g., Kraut v. Morgan & Brother Manhattan Storage Co., 38 N.Y.2d 445, 381 N.Y.S.2d 25, 343 N.E.2d 744 (1976). In Kraut, a bailor who brought a contract action against a commercial bailee was permitted to recover the ransom paid to the thief who stole the bail- or’s property while it was in the bailee’s possession. But even if Hanover could be called a commercial bailee, Gordon has brought a fraud claim against Ross, not a contract claim against Hanover.5 Moreover, a “ransom” is a “sum paid or agreed to be paid for the redemption of captured property.” Black’s Law Dictionary 1260 (6th ed.1990). Here, Gordon made a secured loan to Hanover, and in return Gordon received a promissory note from Hanover that (on its face) created a good claim in contract. It is undisputed that the loan was made with the expectation that Hanover would pay it back or (if not) that Hanover’s property could be attached in satisfaction. Because Gordon was dealing with Hanover as “bailee” rather than with the holder of the property, and because Gordon had an expectation that the supposed “ransom” would be repaid in accordance with the terms of Hanover’s note (secured as it was Hanover’s assets), this transaction has none of the earmarks of a ransom payment.
The majority’s mitigation argument appears to me unsound for similar reasons. Under Den Norske Ameriekalinje Actiesselskabet v. Sun Printing & Publishing Ass’n, 226 N.Y. 1, 122 N.E. 463 (1919), a fraud victim may recover expenses incurred in mitigating its damages. Indeed, as set forth above, if Gordon had actually paid $1,034 million to the banks in return for its securities, I might agree with the majority that Gordon could recover that sum as an expense to mitigate damages from the original fraud. But instead Gordon entered into a new contractual arrangement with parties it knew to be defrauders, and negotiated the security interests it required for that risky undertaking. It is evident to me that Gordon thereby abandoned and settled its original fraud claim, and took in exchange a new obligation that was rendered worthless by business risks that were either disclosed or (at any rate) are not alleged to have been fraudulently concealed. Because Gordon had a contractual right to repayment of the $1,034 million secured loan, that item cannot properly be deemed a mitigating “expense,” and thus cannot be recovered in an action for fraud.

. Several other clients also extended credit to Hanover.

. Although Gordon appeals from that ruling, it seeks a reversal so that a judgment of nominal damages can be entered on remand. See Clearview Concrete Prods. Corp. v. S. Charles Gherardi, Inc., 88 A.D.2d 461, 470, 453 N.Y.S.2d 750, 756 (1982) ("Notwithstanding its failure to establish damages, [a plaintiff]' is still entitled to nominal damages to vindicate its rights deriving from the fraud ... practiced upon it.” (citation omitted)).

. In fact, Gordon brought actions on the personal guarantees of Les Dubitsky and Laris Milonas, the two other Hanover principals who guaranteed the first loan. Gordon recovered $347,-763.06 in settlement of those actions.

. Hanover pledged all cash and securities on deposit at the Depositary Trust Company except for $515,777.

. Unlike the thief to whom the ransom was paid in Kraut, Hanover did not illegally procure Gordon’s property, even though it hypothecated that property to the banks in contravention of Ross’s assurances.