Hedge Fund Suit Fails, but Court Predicts N.Y. Courts Would Recognize ‘Holder’ Claim
In yet another chapter of long running litigation involving Ponzi fraudster Bernard Madoff, the U.S. District Court for the Southern District of New York Nov. 22 dismissed an Israeli charity’s claims over an alleged failed hedge fund investment (Matana v. Merkin , 2013 BL 326842, S.D.N.Y., 13 Civ. 1534 (PAE), 11/22/13).
Although the litigation was dismissed, Judge Paul Engelmayer ruled that New York courts would allow a “holder” theory of fraud–that is, the plaintiffs would be allowed to claim that the defendants made fraudulent misrepresentations that induced the plaintiff to retain or hold, its investments.
The plaintiff, Keren Matana, an Israeli charity, invested $1.5 million in the Ascot Fund Ltd., an offshore hedge fund managed by both J. Ezra Merkin and Gabriel Capital Corp. Ascot Fund, in turn, invested almost all of its assets with Bernard Madoff, court said. KM allegedly lost its investment after the revelation that Madoff was operating “an epic Ponzi scheme.”
In March, KM sued Merkin and GCC, asserting various state law claims, and in July, the court said, it dismissed, granting KM “narrowly limited leave to amend.”
In particular, the court said that it granted KM leave to amend its claim for breach of an implied contractual duty of good faith and fair dealing if it could locate a contract between the parties that would imply such a duty on the part of the defendants. KM, the court said, has failed to locate such a contract.
Instead, the amended complaint bases KM’s renewed claim of implied duty of good faith and fair dealing on two other asserted agreements, the court said. First, the court said, KM asserted that it was an intended third-party beneficiary of the 2002 Ascot Partners Limited Partnership Agreement. Second, KM asserted, there was a previously undiscovered oral contract between Merkin and then KM manager Benjamin Jesselson.
The court said that KM was not a party to the asserted written contract. As to both asserted contracts, KM’s claims could have been brought earlier in this suit and KM has not tried to explain why it did not do so, the court said. “KM’s new contract claim merits dismissal on this ground alone,” the court said.
Even if KM’s “newly articulated claim of a breach of a contractually-implied duty of good faith and fair dealing was properly with the scope of its leave to amend,” the court said, KM’s allegations would still require dismissal for failure to state a claim.
KM’s amended complaint alleged that the defendants made fraudulent representations, or omitted required disclosures that fraudulently induced to KM to maintain its investment in Ascot Fund.
The defendants argued that, “as categorical matter, New York fraud law no longer recognizes such ‘holder claims.’ ” In the alternative, the court said, the defendants argued that even if some form of holder claims are cognizable under New York law, the amended complaint does not adequately allege materially false statements or omissions or otherwise fails to state a claim.
The court said that on the current state of the case law, it cannot predict that the New York Court of Appeals would preclude holder claims altogether. No New York state court has “so held, or even so stated in dicta,” the court said.
The court said that it was compelled to predict that the New York Court of Appeals today would recognize a “limited set of holder claims, specifically, those in which plaintiffs seek to recover out-of-pocket losses, and perhaps, but not necessarily, further limited to those in which there is a “non-conjectural evidentiary basis for asserting causation and tabulating damages.”
Accordingly, the court said, it rejects the defendants’ argument that KM’s fraud claims are non-cognizable on the ground that the New York Court of Appeals would not recognize any holder claim.”
In other specifics, the court said that this not a fraud-on-the-market case in which reliance is presumed. To survive a motion to dismiss, the amended complaint “must instead plausibly plead that defendants’ specific representations caused its injury”–that is, its decision to maintain its investment, “such that had those representations not been made, KM would have redeemed its investment in Ascot Fund.” The amended complaint did not do so.