Treasury Secretary Escapes Fraud Claims
June 15, 2018
On June 5, 2018, in RKA Film Financing, LLC v. Kavanaugh et al., the First Department unanimously affirmed the Supreme Court, New York County’s decision absolving the United States Secretary of the Treasury, Steven Mnuchin, of fraud claims brought by RKA Film Financing LLC (“RKA”), a media financing company.
By way of background, in 2014, RKA, a media financing company, lent money to Relativity, a global media company. RKA alleged that it was misled into believing that it was investing in a low-risk lending facility and that the funds would be used for print and advertising expenses related to the release of motion picture films by special purpose entities (“SPE”). Specifically, RKA alleged that certain representatives of Relativity caused certain SPEs to enter into a print and advertising funding agreement with RKA (“Funding Agreement”). RKA alleged that the Funding Agreement contained misrepresentations, including that the funds would be used for print and advertising expenses for specific movies, to induce RKA to invest large sums of money. However, unbeknownst to RKA, Relativity used the funds to pay for general corporate expenses.
Mnuchin joined Relativity’s board as a non-executive director and chairman in October of 2014 after his private investment firm invested $104 million in Relativity. Mnuchin also served as the CEO and Chairman of OneWest, a commercial lender that lent millions to Relativity. RKA alleged that by way of Mnuchin’s position at OneWest, he was privy to the “inner-workings” of Relativity’s finances.
On April 10, 2015, in response to RKA’s request, members of Relativity informed RKA that only “$1.7 million had actually been spent” on print and advertising. On April 13, 2015, Relativity admitted that it misappropriated RKA’s funds.
Mnuchin, who did not participate in the execution or performance of the Funding Agreement, resigned from the Relativity board on May 29, 2015. Thereafter, on May 30, 2015, after Relativity defaulted on a loan from OneWest, Mnuchin began seizing $50 million from Relativity’s account to recoup OneWest’s loan.
RKA commenced suit against several defendants, including Mnuchin, alleging that they misled RKA into lending Relativity millions of dollars for print and advertising of major movie releases. Mnuchin moved to dismiss. The Supreme Court, New York County dismissed RKA’s claims against Mnuchin.
The Court held that RKA failed to establish its claim for fraud because “absent substantive allegations that Mnuchin was responsible for, aware of, or participated in the purported fraud surrounding the Funding Agreement, liability cannot attach.” Specifically, a plaintiff seeking to recover for fraud must “set forth specific and detailed factual allegations that the defendant personally participated in, or had knowledge of any alleged fraud.” To allege a cause of action for fraud, a plaintiff must also establish causation, showing that “defendant’s misrepresentations were the direct and proximate cause of the claimed losses.” Accordingly, Justice Charles E. Ramos concluded that despite allegations that Mnuchin had inside access to the way in which Relativity used the funds, that was insufficient to establish fraud absent evidence of representations made by Mnuchin.
Similarly, Justice Ramos held that RKA’s negligent misrepresentation claim fails because of an absence of a privity-like relationship between Mnuchin and RKA. To plead a claim for negligent misrepresentation, a plaintiff must show: “(1) the existence of a special or privity-like relationship imposing a duty on the defendant to impart correct information to the plaintiff; (2) that the information was incorrect; and (3) reasonable reliance on such information.” In that regard, the Court also held that RKA failed to allege a relationship between RKA and Mnuchin or that Mnuchin owes a fiduciary duty to RKA.
Finally, Justice Ramos dismissed RKA’s fraudulent inducement claim because it was impossible for Mnuchin to have fraudulently induced RKA to enter into the Funding Agreement, as he had not joined Relativity’s board until months after RKA and Relativity entered into their agreement. To prevail on a fraudulent inducement claim, a plaintiff must establish: 1) a misrepresentation of material fact, 2) known to be false, 3) made with the intention of inducing reliance, 4) that is justifiably relied upon, and 5) results in damages. In light of that, Justice Ramos further held that the Complaint was silent as to any allegations that Mnuchin was involved in the execution of the Funding Agreement or made any representations to RKA.
The First Department came to the same conclusions as the lower court.
First, the Court held that the allegations that the board of directors of Relativity was involved in the financial transactions and the daily operations of the company are not enough to conclude that Mnuchin personally participated in, or had knowledge of, the fraud as a result of his position on Relativity’s board.
Second, the Court determined that the fact that Mnuchin became aware of the fact that RKA’s funds were used for working capital and not solely for print and advertising expenses was insufficient to establish that he was aware that misrepresentations were made by the other defendants or that the other defendants were part of the fraud scheme.
The First Department also affirmed the Supreme Court’s holding that RKA’s negligent misrepresentation claim against Mnuchin was insufficient, because RKA failed to allege any direct contact between Mnuchin and RKA, giving rise to the requisite special relationship.
In sum, mere knowledge or awareness of a company’s finances, without more information, is insufficient to establish that a company’s board member is liable for a fraud committed by the company.