Rescission and Rescissory Damages Unavailable When Defendant is Not Contractual Counterparty

On September 14, 2023, Justice Schecter of the New York County Commercial Division issued a decision in Han v. Kwak, 2023 NY Slip Op. 33207(U), holding that rescission and rescissory damages are unavailable against a defendant who is not a party to the transaction that he fraudulently induced, explaining:

There is a threshold problem with plaintiffs claim for rescission based on Kwak’s fraud that is fatal to her case. Han cannot obtain rescission or rescissory damages from Kwak because he is not her contractual counterparty. Plaintiff was cautioned about the importance of this issue at trial and was directed to provide authority in her post-trial brief demonstrating that privity is not required to obtain rescissory relief. She did not do so. Rather, as explained below, she merely provides authority for the uncontroversial proposition that damages may be sought from a nonsignatory that fraudulently induces entry into a contract. A legal claim for fraud seeking out-of-pocket damages, however, is very different from an equitable claim for rescission. . . .

Both the Supreme Court and the Second Circuit have interpreted a 1928 case from the Court of Appeals to have held that, under New York law, rescission is permitted against a defendant who was not a party to the contract. That is not, however, what the Court of Appeals actually decided and is inconsistent with controlling holdings of the Appellate Division.

Appellate Division cases establish that a rescission claim may only be asserted against parties in privity of contract.

The Court of Appeals did not actually hold to the contrary in Keskal. Rather, it merely explained that a nonsignatory could be held liable for damages. The Court’s statement about restitution was dicta as the claim there was for breach of contract, and not fraud. The Keskal Court relied on Mack v Latta (178 NY 525 [1904]) for that proposition. In Mack, the question was whether a court entertaining an equitable claim for rescission based on fraud against a defendant company in contractual privity with plaintiff could also entertain a claim for damages against the nonsignatory individual defendants that personally made the misrepresentations. In holding that plaintiff could do so as against both parties in one action, the Court explained that the claim asserted against the company is for a rescission of the contract and that the claim against the individual defendants is an action at law for damages for their fraud. The precise ramifications of Mack and its implications on later-more-developed corporate and legal principles are unclear. What is clear, however, in addition to Appellate Division precedent establishing that rescission is unavailable here, is that the Company was never sued and rescission was never sought against the party that was the recipient of the investment.

Plaintiff therefore cannot seek rescission from Kwak.

After all, rescission can be effective only by returning or tendering back the consideration received. A nonsignatory who was not the recipient of the consideration cannot restore the status quo. Restoration of the status quo on plaintiff’s rescission claim would entail her giving back her membership interest in the Company, while receiving back her $1 million investment. Kwak was not personally the recipient of her $1 million investment and is not the party that provided her with a membership interest in the Company. They are not in privity. Rather, plaintiffs money was paid to the Company in consideration for the membership interest and was then used by it to pay debts (including, to be sure, Kwak’s $200,000 loan). Ordering Kwak to pay plaintiff $1 million in exchange for her membership interest as rescission is not permitted under New York law. While plaintiff could have elected to proceed with her legal claim for damages against Kwak, the ship sailed on that long ago. At the time of the October 4, 2022 order, the court was cognizant that plaintiff had elected to forego her claim for out-of-pocket damages against Kwak, which settled law conceptually would permit. In any event, plaintiff had no expert so proceeding to a jury trial would have been absolutely pointless. Where, as here, a party lacks proper evidence of damages on a fraud claim (i.e., the difference between what the interest in the company was worth at the time of the sale due to the fraud and what she paid for it), the claim must be dismissed as a matter of law. That is what would have happened had Kwak moved for summary judgment, and that is what would have happened had plaintiff proceeded to a jury trial on that claim. It was inescapable and plaintiff could not reframe such a claim as one for rescissory damages as an end-run around that rule.

Of course, plaintiff always really wanted all of her money back because she was fundamentally deceived about the nature of her investment and not merely about its worth. Thus, an equitable rescission claim, rather than a legal claim seeking out-of-pocket damages, had more intuitive appeal. The problem is that, from the outset of the case in her pleading, plaintiff never asserted the fraud claim against anyone other than Kwak (perhaps because the Company does not have the money to pay any judgment), even though she asserted claims against other defendants. So while plaintiff may have prevailed if she pleaded the fraud claim against the Company or hired a damages expert at the discovery stage, those possibilities were foreclosed long ago.

Plaintiff protests, based on the procedural developments of this case, that it would be unfair to rule against her on this ground. The court disagrees. Even if this issue were not even raised at trial, since it is a dispositive pure issue of law, Kwak could have raised it for the first time on appeal. This court cannot disregard the threshold legal rule that fundamentally a rescission claim may not be maintained absent privity nor can the court turn a blind eye to the requirements of proving damages.

(Internal quotations and citations omitted).

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