Kerusa Co. LLC v. W10Z/515 Real Estate Limited Partnership: Placing Limitations on Common-Law Fraud Claims When Martin Act Is at Issue

By Talene N. Megerian  
 

The Court of Appeals of New York held that a purchaser of a condominium apartment may not bring a claim for common law fraud against the building’s sponsor when the basis of the fraud allegation is based solely on alleged material omissions from the offering plan amendments mandated by the Martin Act (General Business Law § 352, et seq.) and the Attorney General’s implementing regulations (13 NYCRR 20, et seq.).

The Martin Act generally authorizes the Attorney General to investigate and prohibit fraudulent practices in the marketing of stocks, bonds and other securities within or from New York State.  In later years, the Legislature added a disclosure approach in the Martin Act for the offer and sale of cooperative apartments and condominiums.  Specifically, the Martin Act makes it illegal for a person to make a public offering of securities consisting of participation interests in real estate unless an offering statement is filed with the Attorney General.  The offering statement requires the disclosure of various information to provide potential buyers a basis on which to make their decision on whether to buy the subject real estate.  This disclosure requirement significantly altered the common-law rule in New York, which followed the doctrine of “caveat emptor,” imposing no duty on the seller to disclose information about the premises when they were dealing at arms’ length.

In this case, plaintiff Kerusa purchased the penthouse apartment, a suite on a lower floor, two storage units, and a wine cellar in the building located at 515 Park Avenue.  Kerusa purchased the penthouse unit as raw space and built it up at its own expense.  Thereafter, Kerusa filed suit against those entities sponsoring, designing, constructing, marketing and selling units in the building alleging breach of contract, fraud and negligence.  Specifically, Kerusa alleged that various construction and design defects caused water damage to the building and led to substantial water leaks, system failures, condensation and levels of mold that posed serious health risks, causing Kerusa to suffer “substantial, if not total, loss in the value of its investment.” 

The Supreme Court dismissed Kerusa’a cause of action for fraud because it lacked particularity.  Kerusa then moved to file a Second Amended Complaint, asserting claims against the building sponsors for fraudulent inducement to sign, fraud and fraudulent concealment in connection with the purchase agreements and closing of the purchases of the units.  The basis of the fraud was alleged false and fraudulent representations and material omissions from the sponsors’ sales brochures and advertisements and construction and design defects that the building sponsors allegedly knew about but did not disclose in the offering plan amendments filed as the construction progressed.  The Supreme Court held that although Kerusa amended the pleadings as to the fraud claims, the Martin Act ruled out this claim because the theory of fraud alleged would enlarge the disclosure requirement beyond what was required under the Martin Act.  The Appellate Division modified the Supreme Court’s Order and stated that the Martin Act does not preclude a private party from prosecuting a valid common-law fraud claim when the alleged fraudulent conduct is one that would be subject to prosecution by the Attorney General.  On appeal, the Court of Appeals determined that Kerusa’s common-law fraud claim was based exclusively on alleged omissions from filings and disclosures required by the Martin Act and the Attorney General’s implementing regulations.  The Court of Appeals thus held that although Kerusa pled the elements of common-law fraud, a private action to enforce the Martin Act disclosure requirements was prohibited.