In Karfunkel v. Sassower, No. 602244/2009 (N.Y. Sup. Ct. Sept. 12, 2012), Judge Peter O. Sherwood granted a motion for summary judgment dismissing plaintiff’s claim of civil fraud for lack of both scienter and justifiable reliance, holding that sophisticated parties may not justifiably rely on alleged fraudulent misrepresentations when accurate information is readily accessible. The ruling also reinforced the principle that sophisticated parties must meet a heightened standard for justifiable reliance of alleged misrepresentations.
The defendant Phillip S. Sassower, was manager of a private equity firm that was a 50% owner of JLM Industries, Inc. (“JLM”) — a company that engaged in chemical commodities trading. Plaintiff George Karfunkel was an experienced investor. Sassower offered Karfunkel the chance to invest $5 million in JLM so the company could purchase certain commodities. Karfunkel showed interest, but declined due to doubts about JLM’s financial stability. Instead, Karfunkel proposed an investment through a more secure, new company (“Newco”) that would still benefit JLM. Karfunkel would retain title to the commodities purchased by Newco and the Newco commodities would not be comingled with JLM’s inventory. On August 20, 2008, Sassower responded that he would work with John L. Macdonald, the Chief Executive Officer and Chairman of JLM, to create a “new, clean vehicle” for investment that would still benefit JLM.
On September 5, 2008, JLM’s attorneys sent Karfunkel a draft contract for a proposed commercial partnership between JLM and Karfunkel. The contract made clear that JLM—not Karfunkel—would retain legal ownership of any commodities purchased on Karfunkel’s behalf. Karfunkel did not sign the contract or make any follow-up inquiries into its language.
Independently, on September 9, 2008, Sassower and Macdonald e-mailed Karfunkel about an immediate opportunity to purchase chemicals that were sitting in port. Sassower and Macdonald stated that the purchased chemicals would be JLM’s assets. However, Macdonald asked that Karfunkel make the check payable to Chem Organics, Inc. (“Chem Organics”), a subsidiary of JLM, in an attempt to keep funds clearly separated. Without requesting clarification, Karfunkel assumed that Chem Organics was the “new, clean vehicle” Sassower had mentioned and agreed to invest $1.5 million. The $1.5 million investment was entered into on September 10, 2008.
Following the investment, Sassower twice cautioned Macdonald that they should create a written agreement to clarify the terms, but Macdonald assured Sassower that the funds were segregated. On September 22, 2008, JLM’s attorneys sent Karfunkel a revised contract, which again stated that JLM would retain sole legal title to the chemicals, and included a redlined copy that demonstrated the same. Once again, Karfunkel did not sign or comment on the revised contract. Despite the lack of a written contract, both Macdonald and Sassower advised Karfunkel that his product was separate and not comingled with JLM’s assets. However, Sassower also told Karfunkel that if he was interested, he still had the opportunity to invest through Newco.
JLM had a line of credit with Bank of America (“BOA”) secured by a lien on JLM’s inventory and accounts receivable. In early 2009, several of JLM’s customers defaulted on payments, and BOA called JLM’s line of credit. JLM’s assets, including the chemicals purchased with Karfunkel’s funds, were included in liquidation proceedings and absorbed by BOA.
In July 2009, Karfunkel brought suit against Sassower for fraud. Karfunkel alleged that Sassower intentionally misrepresented: (i) that the relevant funds would be separated from JLM’s control; and (ii) that the entity purchasing the chemical commodities would be Newco, not JLM. Following discovery, Sassower moved for summary judgment on the grounds that the complaint lacked both justifiable reliance and scienter, contending that the e-mails and draft contracts were sufficient notice to Karfunkel that the terms of the agreement were not as Karfunkel believed them to be, and further that the communications with Macdonald illustrated that Sassower had no intent to defraud.
Judge Sherwood found that sophisticated parties have an obligation to conduct their own appraisal of risk when the true nature of their investments can be easily ascertained. Therefore, Karfunkel could not establish that he was intentionally misled if he failed to make use of available means of verification. Here, despite contradictory statements between the discussions with Sassower and Macdonald and the draft contracts, Karfunkel made no inquiries regarding the status of Chem Organics or whether his purchased commodities would be held by JLM. Based on the lack of inquiries and the series of communications, Judge Sherwood therefore held that Karfunkel could not demonstrate justifiable reliance as a matter of law.
Judge Sherwood further found that there was no basis with which to sustain a claim of fraud where there was no reasonable basis to infer scienter. Karfunkel failed to produce a “scintilla of evidence” that Sassower made any misrepresentation with the intent to deceive, or with knowledge of its falsity. Sassower’s e-mails cautioning Macdonald to memorialize the agreement in writing, as well as the final e-mail to Karfunkel regarding the continued ability to form Newco, sufficiently demonstrated that Sassower had no ill intent.