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This memorandum is uncorrected and subject to revision before
publication in the New York Reports.
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No. 49
ACA Financial Guaranty Corp.,
            Appellant,
        v.
Goldman, Sachs & Co.,
            Respondent,
Paulson & Co., Inc. et al.,
            Defendants.




          Marc E. Kasowitz, for appellant.
          Richard H. Klapper, for respondent.




MEMORANDUM:
          The order of the Appellate Division should be reversed,
with costs, the case remitted to the Appellate Division for


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consideration of issues raised but not determined on the appeal
to that court and the certified question answered in the
negative.
            Plaintiff ACA Financial Guaranty Corp. commenced this
action against defendant Goldman, Sachs & Co., alleging that
defendant fraudulently induced plaintiff to provide financial
guaranty for a synthetic collateralized debt obligation (CDO),
known as ABACUS.   In its complaint, plaintiff alleges that
defendant fraudulently concealed the fact that its hedge fund
client Paulson & Co., which selected most of the portfolio
investment securities in ABACUS, planned to take a "short"
position in ABACUS, thereby intentionally exposing plaintiff to
substantial liability; had plaintiff known this information, it
would not have agreed to the guaranty.
            Defendant moved to dismiss the complaint pursuant to
CPLR 3211 (a) (1) and (7), contending, among other things, that
plaintiff failed to sufficiently plead the "justifiable reliance"
element of its fraud in the inducement and fraudulent concealment
claims.   Supreme Court denied the motion, but the Appellate
Division reversed the order, granted defendant's motion and
dismissed the amended complaint.   We now reverse.
            To plead a claim for fraud in the inducement or
fraudulent concealment, plaintiff must allege facts to support
the claim that it justifiably relied on the alleged
misrepresentations.   It is well established that "if the facts


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represented are not matters peculiarly within the [defendant's]
knowledge, and [the plaintiff] has the means available to [it] of
knowing, by the exercise of ordinary intelligence, the truth or
the real quality of the subject of the representation, [the
plaintiff] must make use of those means, or [it] will not be
heard to complain that [it] was induced to enter into the
transaction by misrepresentations" (Schumaker v Mather, 133 NY
590, 596 [1892]; see DDJ Mgt., LLC v Rhone Group L.L.C., 15 NY3d
147, 154 [2010]).   Moreover, "[w]hen the party to whom a
misrepresentation is made has hints of its falsity, a heightened
degree of diligence is required of it.    It cannot reasonably rely
on such representations without making additional inquiry to
determine their accuracy" (Centro Empresarial Cempresa S.A. v
América Móvil, S.A.B. de C.V., 17 NY3d 269, 279 [2011], quoting
Global Mins. & Metals Corp. v Holme (35 AD3d 93, 100 [1st Dept
2006], lv denied 8 NY3d 804 [2007]).     Nevertheless, the question
of what constitutes reasonable reliance is not generally a
question to be resolved as a matter of law on a motion to dismiss
(DDJ Mgt., LLC, 15 NY3d at 156).
          In its complaint, plaintiff alleges that it sought
assurances from defendant about Paulson's role in ABACUS.
Specifically, plaintiff alleges that it e-mailed defendant asking
how Paulson intended to "participate" in the transaction.
Plaintiff further alleges that defendant affirmatively
misrepresented to plaintiff that Paulson would be the equity


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investor in ABACUS.    Thus, at this pleading stage, plaintiff has
sufficiently alleged justifiable reliance.
             Contrary to defendant's claim, our holding in Centro
Empresarial Cempresa S.A. (17 NY3d 269) does not impose a duty on
plaintiffs to insist on a "prophylactic provision" in
agreements.    Centro involved a release that accompanied a
multi-million-dollar purchase agreement (see id. at 274).     The
plaintiffs in Centro "knew that defendants had not supplied them
with the financial information to which they were entitled,
triggering 'a heightened degree of diligence'" (Pappas v Tzolis,
20 NY3d 228, 232-233 [2012], quoting Centro Empresarial Cempresa
S.A. 17 NY3d at 279).    Despite this knowledge, the plaintiffs in
Centro neither insisted on a prophylactic provision nor exercised
due diligence by seeking the information to which they were
entitled.    Unlike in Centro, plaintiff here claims that defendant
knew that Paulson was taking a position contrary to plaintiff's
interest, but withheld that information, despite plaintiff's
inquiries.    Further, unlike the release in Centro, there was no
written agreement between plaintiff and defendant in which a
"prophylatic provision" could have been inserted.
             Accepting the allegations of the complaint as true and
providing plaintiff the benefit of every possible favorable
inference as we must do on a motion to dismiss (see AG Capital
Funding Partners, L.P. v State St. Bank & Trust Co., 5 NY3d 582,
591 [2005]), plaintiff has sufficiently pleaded justifiable


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reliance for the causes of action for fraud in the inducement and
fraudulent concealment.   Additionally, defendant failed to submit
documentary evidence that conclusively established the lack of
justifiable reliance (see CPLR 3211 [a] [1]).




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ACA Financial v Goldman Sachs
No. 49




READ, J. (DISSENTING):
          In early 2007, Goldman, Sachs & Co. (Goldman)
structured and marketed a synthetic collateralized debt
obligation (CDO) called ABACUS 2007-AC1 (ABACUS).   This product
was tied to the performance of a reference portfolio of subprime
residential mortgage-backed securities, which are pools of home
loans that have been securitized.   Synthetic CDOs are typically
divided into tranches based on the level of credit risk.   Notes
in the most senior tranche have the lowest risk of non-payment
due to defaults in the underlying collateral (here, the
mortgages) and therefore bear the lowest interest rate.
Conversely, notes in the most junior or "first loss" tranche of
the synthetic CDO's capital structure are the first to experience
losses from defaults, and therefore have the highest potential
rate of return.
          Goldman put ABACUS together at the behest of its hedge
fund client, Paulson & Co. (Paulson).   ACA Management, a wholly
owned subsidiary of ACA Financial Management Guaranty Corp., a
bond insurer (collectively, ACA), participated in ABACUS as the
third-party portfolio selection agent responsible for choosing
the portfolio of reference obligations.   Working with Paulson,


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ACA selected a portfolio of 90 subprime residential mortgage-
backed securities that met the transaction's eligibility
criteria; i.e., they were issued in 2006 and early 2007 and rated
Baa2 by Moody's Investors Service.     Paulson allegedly originally
proposed 49 of the 90 securities ultimately selected by ACA for
ABACUS.   ACA unconditionally guaranteed payment for up to $909
million, which referenced the most senior tranche of ABACUS
notes.
           After the housing market collapsed and ABACUS failed,
ACA sued Goldman for common law fraudulent inducement and
fraudulent concealment.   ACA alleges that Goldman misrepresented
that Paulson had "pre-committed to take a long position in
ABACUS" even though Goldman knew all along that Paulson was, in
fact, "the sole short investor."   ACA claims it never would have
insured ABACUS notes if it had known that Paulson had an economic
incentive to select reference obligations that would fail.
           The outcome of this appeal turns entirely on whether
ACA has adequately pleaded the element of "justifiable reliance"
necessary to sustain its fraud claims against Goldman.    The
majority concludes that ACA has done so, pointing to allegations
that ACA "e-mailed [Goldman] asking how Paulson intended to
'participate' in the transaction," and that Goldman
"affirmatively misrepresented to [ACA] that Paulson would be the
equity investor in ABACUS" (majority op at 3).    But it is not
enough for a sophisticated party like ACA to plead that it relied


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on Goldman's alleged misrepresentations; to state a cause of
action for fraud, that reliance must have been justifiable,
meaning that ACA must allege the "reasonable steps" that it took
"to protect itself against deception" (DDJ Mgt., LLC v Rhone
Group L.L.C, 15 NY3d 147, 154 [2010]).   Here, ACA manifestly took
no steps to safeguard its interests.   And there was an obvious
and easy step that ACA might have taken; ACA might have simply
asked Paulson directly what its investment position was in
ABACUS.
          We first articulated our rule over a century ago:
          "[I]f the facts represented are not matters peculiarly
          within the party's knowledge, and the other party has
          the means available to him of knowing, by the exercise
          of ordinary intelligence, the truth or the real quality
          of the subject of the representation, he must make use
          of those means, or he will not be heard to complain
          that he was induced to enter into the transaction by
          misrepresentations" (Schumaker v Mather, 133 NY 590,
          596 [1892] [emphasis added]).
This rule has been "frequently applied in recent years where the
plaintiff is a sophisticated business person or entity that
claims to have been taken in" (DDJ Mgt., 15 NY3d at 154).     Thus,
where a plaintiff alleges that it has taken an arguably adequate
reasonable step to protect itself against the fraud complained
of, we have held that it was for the trier of fact to determine
if the plaintiff's reliance was justifiable.    Conversely, where a
plaintiff has neglected to take and allege a reasonable
protective step, we have held that the complaint failed, as a
matter of law, to plead justifiable reliance.


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          DDJ Mgt. is an example of the first kind of case.
There, the plaintiffs were four companies that loaned $40 million
to American Remanufacturers Holdings, Inc. (ARI or the company),
a re-manufacturer of automobile parts.   When ARI failed to repay
the loans, the plaintiffs sued the company's stock owners, their
corporate affiliates and individuals acting on their behalf
(collectively, the stock owners), accusing them of "defraud[ing
the] plaintiffs into making the loans" (id. at 151).   In
particular, the plaintiffs alleged that the stock owners
presented them with false and misleading financial statements
that were designed to inflate ARI's earnings.
          We assumed for purposes of the appeal that the
complaint "adequately allege[d] that [the stock owners] made
material misrepresentations," which meant that "[t]he [only]
question . . . [was] whether, if the complaint's allegations are
true, a jury could find that [the] plaintiffs justifiably relied
on those misrepresentations" (id. at 152).   The stock owners
argued there could be no justifiable reliance because the
plaintiffs did not make a reasonable inquiry into the truth of
their representations.
          The financial documents that the company provided the
plaintiffs "contained some features that might have aroused
concern in a skeptical reader who examined them carefully," and
the plaintiffs did not ask questions about these aspects of the
financial statements or look at ARI's records.   Yet, the


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plaintiffs "insist[ed] that ARI represent and warrant, in
substance, that the financial statements were accurate" as a
condition of closing (id. at 153).
           We concluded that, on these facts, "[the] plaintiffs
made a significant effort to protect themselves against the
possibility of false financial statements: they obtained
representations and warranties to the effect that nothing in the
financials was materially misleading" (id. at 156); and that
"where a plaintiff has gone to the trouble to insist on a written
representation that certain facts are true, it will often be
justified in accepting that representation rather than making its
own inquiry" (id. at 155).   Accordingly, we held that the
plaintiffs had adequately alleged justifiable reliance, and
"whether they were justified in relying on the warranties they
received is a question to be resolved by the trier of fact" (id.
at 156).
           Centro Empresarial Compresa S.A. (17 NY3d 269 [2011])
is an example of the second kind of case -- where the complaint
fails as a matter of law because a plaintiff has neglected to
allege that it took reasonable steps to protect itself against
fraud.   There, the plaintiffs, allegedly relying on false
financial information supplied by the defendants, agreed to sell
business units to the defendants at a set "floor price."
Although they were entitled to the financial information
necessary to value these business units properly, the plaintiffs


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neither demanded access to it nor sought assurances as to its
accuracy in the form of representations and warranties, which we
had recently explicitly held in DDJ Mgt. might substitute for
investigating the facts represented.     The plaintiffs' failure to
take these obvious "reasonable steps to protect [themselves]
against deception" (DDJ Mgt., 15 NY3d at 154) proved fatal to
their fraud claim.
           The majority treats representations and warranties as
unworthy of serious consideration here because, "there was no
written agreement between [ACA] and [Goldman] in which a
'prophylactic provision' could have been inserted" (majority op
at 4).   But if assurance that Paulson was taking a net long
position in ABACUS was as critical to ACA's commercial
decisonmaking as it now claims, ACA surely could have and would
have conditioned its financial guaranty on Goldman (or Paulson,
for that matter) entering into an agreement containing written
representations and covenants.    And in any event, Goldman points
out, the guaranty was effectuated and governed by eight separate
agreements involving ACA, Goldman and the bank that intermediated
the transaction, and "ACA's contracts with [the bank], and [the
bank's] corresponding contracts with [Goldman], could all have
included prophylactic provisions concerning Paulson's investment
position, if that were important to ACA at the time."
           The federal courts, applying our New York rule, have
likewise determined justifiable reliance to be lacking in


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situations where a plaintiff does not bother to consult a source
of information that might have revealed the alleged fraud.
Lazard Freres & Co. v Protective Life Ins. Co. (108 F3d 1531 [2d
Cir 1997]) involved an attempted sale of millions of dollars in
bank debt between two large and sophisticated companies.   The
seller allegedly made false statements with respect to the
content of a certain report on the debtor's financial condition,
and because the deal was time-sensitive, the buyer made an oral
commitment to purchase before reviewing the report.   One of the
questions on appeal was whether the buyer reasonably relied on
the seller's representations of the contents of the report.    The
Second Circuit opined that the buyer should have, and easily
could have, protected itself from misrepresentation by demanding
to see the report as a condition of closing (id. at 1543).
          In discussing the law, the court observed that "[i]t is
well established that 'where sophisticated businessmen engaged in
major transactions enjoy access to critical information but fail
to take advantage of that access, New York courts are
particularly disinclined to entertain claims of justifiable
reliance'" (id. at 1541, quoting Grumman Allied Ind., Inc. v Rohr
Ind., Inc., 748 F2d 729, 737 [2d Cir 1984]).   The Second Circuit
went on to note that this was especially true in "situations in
which the relevant facts were easily accessible to the relying
party," citing instances where the plaintiffs could have "made
simple inquiries" or "examine[d] the corporate records before


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assuming the obligations" (id. at 1542 [internal quotation marks
omitted]).
             In Grumman, the plaintiff alleged misrepresentations
and failure to disclose material facts relating to the testing of
buses.   Although the plaintiff "enjoyed unfettered access to [the
defendant]'s plants, personnel and documents; and . . .
possessed the legal, technical and business expertise necessary
to make effective use of that access," it "neither inquired into
the results of [the defendant's] testing, nor asked to scrutinize
testing reports" (748 F2d at 737, 738).       The Second Circuit
therefore rejected the plaintiff's fraud claim based on "the
unambiguous case law and the undisputed facts" (id.).       In doing
so, the court acknowledged the general "principle that access
bars claims of reliance on misrepresentations" (id. at 737
[emphasis added]), and cited cases where experienced businessmen
were barred from claiming fraud when they relied solely on verbal
assurances despite "undisputed access to corporate records" (id.
at 730).
             Here, ACA alleges that, after its first meeting with
Paulson on January 8, 2007, it was unsure how Paulson meant to
"participate" in the transaction.*       But unlike outside investors


     *
      ACA's complaint quotes the following email sent to a
Goldman employee involved in the transaction by an ACA
participant in ACA's initial meeting with Paulson: "I have no
idea how it went -- I wouldn't say it went poorly, not at all,
but I think it didn't help that we didn't know exactly how
[Paulson] want[s] to participate in the space. Can you get us

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in ABACUS, who had no way to know that Paulson was involved in
the transaction in any way, ACA was on the inside.    ACA and
Paulson worked together for a month to assemble the 90 subprime
residential mortgage-backed securities in the reference
portfolio.    Further, ACA's Senior Credit Committee did not give
conditional approval of the financial guaranty until March 31,
2007, and the guarentee was not consummated until May 31, 2007.
Yet, during that five-month stretch of unfettered access to
Paulson, ACA never once asked Paulson about its investment
position in ABACUS.    ACA easily could have done so, and,
optimally, would have demanded a written representation from
Goldman and/or Paulson before issuing the financial guaranty
essential to the transaction.    Instead, like the plaintiffs in
Centro, Lazard Freres and Grumman, ACA merely relied on what it
says Goldman told it without actually checking the source (i.e.,
asking Paulson), or taking any other "reasonable steps to protect
itself against deception" (DDJ Mgt., 15 NY3d at 154).
             ACA, a sophisticated financial entity, protests that it
was not reasonable to query Paulson about its investment position
in ABACUS because Paulson most likely would have lied, and, in
any event, whether Paulson would have disclosed the truth is a
factual issue that cannot be resolved on a motion to dismiss.
But whether Paulson would have lied or not is irrelevant.    The
representations and warranties obtained by the plaintiffs in DDJ


some feedback?"

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Mgt. were, after all, allegedly false.           What matters is that the
plaintiffs there took the arguably adequate reasonable step of
requesting and obtaining representations and warranties to
protect themselves against potential fraud.          The DDJ Mgt.
plaintiffs -- unlike ACA -- therefore were able to allege facts
from which a trier of fact might find justifiable reliance.
            Savvy commercial and financial players and inventive
lawyers abound in New York.   Our venerable rule requiring that
the reliance necessary to establish fraud must be justifiable is
designed to make sure that the courts "reject[] the claims of
plaintiffs who have been so lax in protecting themselves that
they cannot fairly ask for the law's protection" and "may truly
be said to have willingly assumed the business risk that the
facts may not be as represented" (DDJ Mgt., 15 NY3d at 154
[internal quotation marks omitted]).           Because ACA cannot, as a
matter of law, establish justifiable reliance on the basis of the
facts alleged in its amended complaint, I respectfully dissent.
*   *   *    *   *    *   *   *     *      *    *   *   *   *   *    *    *
Order reversed, with costs, case remitted to the Appellate
Division, First Department, for consideration of issues raised
but not determined on the appeal to that court and certified
question answered in the negative, in a memorandum. Chief Judge
Lippman and Judges Pigott, Rivera, Stein and Fahey concur. Judge
Read dissents in an opinion in which Judge Abdus-Salaam concurs.

Decided May 7, 2015




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