Kerusa Co. v. W10Z/515 Real Estate Ltd.

The purported fraud stemmed from supposedly false and fraudulent representations and material omissions in the sponsor defendants’ sales brochures and advertisements; and construction and design defects or problems alleged to have been known to the sponsor defendants but not disclosed in the offering plan amendments filed as construction progressed. On the latter point, while alleging no specific misrepresentations, Kerusa protested that the sponsor repeated in each amendment that “[e]xcept as set forth in this Amendment, there have been no material changes of facts or circumstances affecting the Property or the offering” (see 13 NYCRR 20.5 [a] [2]). According to Kerusa, this statement concealed and omitted various construction and design defects and problems encountered during construction but either ignored or inadequately remedied, as evidenced by minutes of weekly meetings to review construction status, field reports and change orders.

Kerusa further alleged that the sponsor defendants knew that “these statements and representations were false” and “omissions . . . were material”; that “[t]hese misrepresentations and omissions” were made and “the defects were concealed” to induce Kerusa to purchase and close on units in the building; and that Kerusa believed the sponsor’s “statements and representations to be true and reasonably relied on them in deciding to” make its purchases. It is clear that the complained-of “representations” and “misrepresentations” in the amendments were simply representations that nothing material had been omitted. The allegedly undisclosed and concealed defects included holes in the building’s concrete structure; an ongoing “water condition” in the cellars and elevator pits; inadequately insulated pipes that froze; and flooding during construction in November 1999 and January 2000, which caused

The Martin Act makes it illegal for a person to make or take part in a public offering of securities consisting of participation interests in real estate unless an offering statement is filed with the Attorney General (General Business Law § 352-e [1] [a]); details the numerous items of information that an offering statement must include, and also requires disclosure of “such additional information as the attorney general may prescribe in rules and regulations promulgated under [General Business Law § 352-e (6)] as will afford potential . . . purchasers ... an adequate basis upon which to found their judgment and shall not omit any material fact or contain any untrue statement of a material fact” (General Business Law § 352-e [1] [b]); directs the Attorney General to issue within a specified time period either a letter stating that the offering statement has been filed or written notification of the deficiencies in it (General Business Law § 352-e [2]); authorizes the Attorney General to adopt rules and regulations to carry out the provisions of section 352-e, “including regulations for the method, contents and filing

The disclosure regulations adopted by the Attorney General pursuant to General Business Law § 352-e (6) to cover newly constructed condominiums—such as 515 Park Avenue—fill more than 60 pages in the NYCRR (see 13 NYCRR part 20). They detail the format and content of offering plans and filings, including the word-for-word representation that must be made in the certification to be sworn to by the sponsor and the sponsor’s principals in the offering plan (13 NYCRR 20.4 [b]); and the requirements for offering plan amendments, including the direction that “[a]n amendment must include a representation that all material changes of facts or circumstances affecting the property or the offering are included unless the changes were described in prior amendment(s) submitted to but not yet filed with the Department of Law” (13 NYCRR 20.5 [a] [2]).

The Martin Act authorizes the Attorney General to enforce its provisions and implementing regulations (see General Business Law §§ 352, 352-c, 353, 354); he may seek restitution and damages for injured parties (General Business Law § 353; State of New York v Metz, 241 AD2d 192 , 195 [1st Dept 1998]). Indeed, “[t]he Attorney General bears sole responsibility for implementing and enforcing the Martin Act” (Kralik v 239 E. 79th St. Owners Corp., 5 NY3d 54 , 58 [2005]); there is no private right of action under the statute (CPC Intl. v McKesson Corp., 70 NY2d 268 , 276-277 [1987]). This serves the Martin Act’s purpose, which was

“to create a statutory mechanism in which the Attorney-General would have broad regulatory and remedial powers to prevent fraudulent securities practices by investigating and intervening at the first indication of possible securities fraud on the public and, thereafter, if appropriate, to commence civil or criminal prosecution; and that consistency of purpose with the statute includes consistency with this enforcement mechanism” (id. at 277).

By requiring a broad class of sellers of real estate to make disclosures to buyers, the Martin Act dramatically altered the common-law rule. Prior to enactment of article 23-A,

“New York adhere[d] to the doctrine of caveat emptor and impose[d] no duty on the seller or the seller’s agent to disclose any information concerning the premises when the parties deal[t] at arm’s length, unless there [was] some conduct on the part of the seller or the seller’s agent . . . constituting] active concealment. If however, some conduct (i.e., more than mere silence) on the part of the seller [rose] to the level of active concealment, a seller [might] have a duty to disclose information concerning the property. To maintain a cause of action to recover damages for active concealment, the plaintiff [would have to] show, in effect, that the seller or the seller’s agents thwarted the plaintiff’s efforts to fulfill . . . responsibilities fixed by the doctrine of caveat emptor” (Jablonski v Rapalje, 14 AD3d 484 , 485 [2d Dept 2005] [internal quotation marks and citations omitted]; see also 37 Am Jur 2d, Fraud and Deceit § 203).

The question on this appeal is whether Kerusa has any common-law claim for fraud, as distinct from a claim under the Martin Act, which only the Attorney General may bring. We conclude that Kerusa has no such claim.

Kerusa alleges in its proposed second amended complaint that the sponsor defendants did not disclose various construction and design defects in the offering plan amendments, and represented therein that there were no “material changes of facts or circumstances affecting the property or the offering” (see 13 NYCRR 20.5 [a] [2]) when, in fact, problems arising during construction alerted them to the existence of major defects, which they either ignored or inadequately remedied. But for the Martin Act and the Attorney General’s implementing regulations, however, the sponsor defendants did not have to make the disclosures in the amendments. Thus, to accept Kerusa’s pleading as valid would invite a backdoor private cause of action to enforce the Martin Act in contradiction to our holding in CPC Inti, that no private right to enforce that statute exists. It would, as amicus Real Estate Board of New York points out, “expand the already detailed disclosure requirements of the Martin Act by forcing parties to disclose the normal kinds of problems [encountered] in the course of construction that are described in field reports, project meetings and change orders” in order to avoid transforming every potential latent construction defect

Similarly, Kerusa’s claim of fraudulent concealment rests on the theory that the sponsor defendants actively concealed fraud by repeatedly representing in plan amendments that there were no material changes of facts or circumstances, bolstered by the occasional inclusion of only “minor changes” such as “a change in the model of dishwashers installed”—devices which Kerusa says “thwarted . . . efforts to fulfill . . . responsibilities fixed by the doctrine of caveat emptor” (Jablonski, 14 AD3d at 485 ). Again, Kerusa relies on purported omissions from disclosures required by the Martin Act and the Attorney General’s implementing regulations—specifically, 13 NYCRR 20.5 (a) (2)—to make out its case. Although Kerusa somewhat deemphasized section 20.5 (a) (2) in its brief in our Court, the proposed second amended complaint at most alleges only that the sponsor defendants tolerated shoddy construction; Kerusa does not contend, for example, that drywall was painted over or taped over to cover up or prevent discovery of water damage; Kerusa does not allege that walls or bricks were put up to hide or prevent it from finding leaking pipes or holes in the foundation. Nothing in the proposed second amended complaint supports active concealment unrelated to alleged omissions from Martin Act disclosures.

Finally, our decisions in CPC Intl. and Vermeer Owners v Guterman ( 78 NY2d 1114 [1991]) do not support Kerusa. The lawsuit in CPC Inti, arose from McKesson’s sale of the stock of its wholly-owned subsidiary, C.F. Mueller Corporation, a leading producer of pasta, to CPC. The “crux” of CPC’s complaint was that McKesson, its investment bankers, and certain former McKesson and Mueller employees “deliberately and fraudulently prepared false projections of revenues, operating expenses and profits of Mueller and intentionally withheld other accurate projections for the purpose of selling Mueller for more than it was worth” (CPC Intl. 70 NY2d at 274 ). We concluded that CPC had sufficiently pleaded common-law fraud because, given its most favorable intendment, the complaint described a scheme to defraud CPC. Unlike this case, CPC Intl. did not turn on alleged nondisclosure of information required by the Attorney General’s Martin Act regulations. In Vermeer Owners, we affirmed the Appellate Division’s dismissal of a lawsuit arising out of a real estate syndicate offering. Nothing in our writing suggests that the defendants in Vermeer Owners made the