United States District Court, E.D. New York
August 26, 2005.
ISAAC LERNER, ELI LERNER, BALLYWARD INVESTMENT COMPANY, LTD., JAIME SOHACHESKI, GASTON LIMITED, HOTEL INVESTORS, INC., PERKY LIMITED, ABRAHAM RAPPAPORT, ESTHER RAPPAPORT, MOSHE COHN, ESTABLISSEMENT SOMER, JOSEPH KOHN, CHANCERY ENTERPRISES, LTD., ROSDEV DEVELOPMENTS, INC., AND MICHAEL ROSENBERG, Plaintiffs,
FLEET BANK, N.A., STERLING NATIONAL BANK AND TRUST COMPANY OF NEW YORK, AND REPUBLIC NATIONAL BANK OF NEW YORK, Defendants. BRUCE BAYROFF, JOSHUA GOLDSTEIN, LAND TECH AT MANALPAN LLC, THEODORE BRODIE, MEYER ROSENBAUM, MR ASSOCIATES LLC, ILANA BLUMKIN, AS TRUSTEE, EMDEE TOURS, INC., ALEXANDER HASENFELD, INC., PROFIT SHARING RETIREMENT PLAN, HASENFELD STEIN, INC, PENSION TRUST, AEG AGENCY, INC., AARON GARFINKEL, RIVKA STEIN, AARON Y. RUBINSON, STEVEN B. ROTHCHILD, P.C. MONEY PURCHASE PLAN, PINCHOS RUBINSON, AKIVA LEIMAN, ESTATE OF BORUCH RUBINSON, CHAIM AND RACHEL LEKOWITZ, NAFTALI AND SARAH LIPSHUTZ, MENDEL AND FEIGY LIPSCHUTZ, REISEL BERGSTEIN, MICHAEL KONIG, ESTHER WERTENTEIL, AARON WERTENTEIL, TEENA RUBINFELD, MARK WERTENTEIL, MORRIS AND SARAH FRIEDMAN, THE REGAL TRADE, S.A., VAVEL CORP., CHADWICK FUNDING CO. L.P., ALLEN SAUSEN AND LEONARD SAUSEN, D/B/A ATASSCO, KEREN HACHESED OF MONSEY, INC., GENEVA PROPERTIES, L.L.C., MT. PLEASANT PARTNERS, HERSCEL KULEFSKY, ALBERT DAVID PEARLS & GEMS, INC., DEFINED BENEFIT PENSION PLAN, CHAI PROPERTIES CORP., ARTHUR KURTZ, CRESFIELD ASSOCIATES, INC., WEINREB MANAGEMENT AND HOWARD MERMELSTEIN, Plaintiffs, v. FLEET BANK, N.A., STERLING NATIONAL BANK AND TRUST COMPANY OF NEW YORK, AND REPUBLIC NATIONAL BANK OF NEW YORK, Defendants.
The opinion of the court was delivered by: FREDERIC BLOCK, District Judge
MEMORANDUM & ORDER
Plaintiffs in two companion actions are investors who were
defrauded into giving millions of dollars to David Schick
("Schick"), an attorney and businessman; Schick deposited a
portion of those funds into escrow accounts held by defendants
Fleet Bank, N.A., Sterling National Bank and Trust Company of New
York, and Republic National Bank of New York (collectively
"defendants" or "banks"), and thereafter drew numerous checks
from those accounts at times when there were insufficient funds
to cover the checks. Plaintiffs claim that defendants are liable
for plaintiffs' losses because they failed to report the bounced
checks to the Lawyers' Fund for Client Protection of the State of
New York ("Lawyers' Fund"). Plaintiffs contend that, as a result,
Schick was permitted to perpetuate his scheme for a protracted
period of time; i.e., had the banks reported the insufficient
funds, Schick's fraudulent scheme would have been revealed
earlier and plaintiffs' losses would have been curtailed.
Initially, the plaintiffs in both actions raised Racketeer
Influenced and Corrupt Organizations Act ("RICO") and state-law
claims. The Court dismissed plaintiffs' RICO claims for lack of
standing and declined to exercise supplemental jurisdiction over
the state-law claims. See Lerner v. Fleet Bank, N.A.,
146 F. Supp. 2d 224, 226, 231 (E.D.N.Y. 2001). The Second Circuit
affirmed the dismissal of the RICO claims but vacated the Court's
declination to exercise supplemental jurisdiction. See Lerner v.
Fleet Bank, N.A., 318 F.3d 113, 117, 124-25 (2d Cir. 2003). It
explained that the plaintiffs in Action 1 were diverse from the
defendants; thus diversity jurisdiction provided an independent
basis for subject matter jurisdiction, and the circuit court advised that although
there was no diversity jurisdiction in Action 2, "judicial
economy might best be served by exercising supplemental
jurisdiction over the [Action 2] state-law claims" "[b]ecause the
district court must adjudicate identical issues in [Action
1]. . . ." Id. at 124-25, 130. At a status conference held
on June 18, 2003, the Court made a determination to exercise
supplemental jurisdiction over the state-law claims in Action 2
and consolidated the two Actions. See Docket No. 65.
Thereafter, the plaintiffs in both actions filed a combined
Second Amended Complaint, alleging the following state-law
claims: negligence, fraud, breach of fiduciary duty, aiding and
abetting Schick's breach of fiduciary duty, and commercial bad
faith. Defendants now each move to dismiss all of these claims
pursuant to Rule 12(b)(6). For the reasons set forth below,
defendants' motions are granted.
The following sets forth the pertinent facts, which are taken
from the Second Amended Complaint.
A. Schick's Scheme
In 1992 Schick began marketing investment
opportunities based upon mortgage flip transactions.
Schick's "original intentions were good" and "his
modus operandi was not criminal;" however, due to
"unrelated losses stemming from a 1988 `problem'
which came back to `haunt' him," he began to use
fraudulent means to stay afloat. [Second] Am. Compl.
¶ 3. The essence of Schick's scheme to defraud was
the marketing of risk-free investments with high,
short-term yields. In this regard, Schick purported
to bid on distressed mortgage pools at auctions and
sales conducted by the Resolution Trust Company,
Federal Deposit Insurance Corporation, and other
banking institutions. Schick explained to prospective
investors that after being awarded a bid to purchase a mortgage
pool subject to at least a ninety-day due diligence,
he could re-sell the same pool to a "take-out buyer"
for a substantial profit (between twelve and twenty
percent), subject to a due diligence period of fewer
than ninety days. [Id. ¶ 141]. Schick assured them
that if the take-out buyer declined to purchase the
pool, Schick could rescind the original purchase
within his own ninety-day due diligence window, thus
avoiding any risk of loss.
However, Schick told the putative investors that in
order to close on a bid he was required to deposit
substantial sums of cash as evidence of his ability
to complete the purchase. Schick misrepresented to
the investors that their investments would be
protected in escrow accounts covered by restrictive
provisions during the due diligence period, including
a requirement that funds could not be withdrawn
without the signature of plaintiffs' representative.
Using these fraudulent promises as well as his status
in the community, Schick successfully induced
numerous individuals and entities to invest millions
Lerner, 146 F.Supp.2d at 226.*fn1
B. Governing New York Regulations Regarding Attorney Escrow
Several regulations govern the responsibilities and obligations
of attorneys maintaining attorney escrow accounts and the banking
institutions within which they are maintained. In particular,
pursuant to Disciplinary Rule 9-102(B) of the Code of
Professional Responsibility ("DR 9-102(B)"), as codified at
22 N.Y. Comp. Codes R. & Regs. ("N.Y.C.R.R.") § 1200.46, attorneys
may not misappropriate client funds and must maintain those funds
in separate accounts. As the rule states: (1) A lawyer who is in possession of funds belonging
to another person incident to the lawyer's practice
of law, shall maintain such funds in a banking
institution within the State of New York which agrees
to provide dishonored check reports in accordance
with the provisions of Part 1300 of the joint rules
of the Appellate Divisions. Banking institution means
a state or national bank, trust company, savings
bank, savings and loan association or credit union.
Such funds shall be maintained, in the lawyer's own
name, or in the name of a firm of lawyers of which he
or she is a member, or in the name of the lawyer or
firm of lawyers of whom he or she is employed, in a
special account or accounts, separate from any
business or personal accounts of the lawyer or
lawyer's firm, and separate from any accounts which
the lawyer may maintain as executor, guardian,
trustee or receiver, or in any other fiduciary
capacity, into which special account or accounts all
funds held in escrow or otherwise entrusted to the
lawyer or firm shall be deposited.
(2) A lawyer or the lawyer's firm shall identify the
special bank account or accounts required by
paragraph (1) of this subdivision as an "Attorney
Special Account," or "Attorney Trust Account," or
"Attorney Escrow Account," and shall obtain checks
and deposit slips that bear such title. Such Title
may be accompanied by such other descriptive language
as the lawyer may deem appropriate, provided that
such additional language distinguishes such special
account or accounts from other bank accounts that are
maintained by the lawyer or the lawyer's firm.
Attorneys who misuse escrow accounts are subject to disciplinary
proceedings. See 22 N.Y.C.R.R. 1200.46(h).
Furthermore, pursuant to the Dishonored Check Reporting Rules
For Attorney Special, Trust and Escrow Accounts:
(a) Special bank accounts required by
[22 N.Y.C.R.R. § 1200.46] shall be maintained only in banking
institutions which have agreed to provide dishonored
check reports in accordance with the provisions of
this section. (b) An agreement to provide dishonored check reports
shall be filed with the Lawyer's Fund for Client
Protection, which shall maintain a central registry
of all banking institutions which have been approved
in accordance with this section, and the current
status of such agreement.
(c) A dishonored check report by a banking
institution shall be required whenever a properly
payable instrument is presented against an attorney
special, trust or escrow account which contains
insufficient available funds, and the banking
institution dishonors the instrument for the reason.
* * *
(h) Every lawyer admitted to the Bar of the State of
New York shall be deemed to have consented to the
dishonored check reporting requirements of this
section. Lawyers and law firms shall promptly notify
their banking institutions of existing or new
attorney special, trust or escrow accounts for the
purpose of facilitating the implementation and
administration of the provisions of this section.
22 N.Y.C.R.R. § 1300.1.
Each defendant is a banking institution as defined by the
regulations, and each defendant has entered into a dishonored
check reporting agreement with the Lawyers' Fund.
After a banking institution submits a dishonored check report
to the Lawyers' Fund, the Lawyers' Fund "holds [it] for ten
business days," and then "forward[s] it to the attorney
disciplinary committee for the judicial department or district
having jurisdiction over the account holder."
22 N.Y.C.R.R. § 1300.1(f)-(g). Upon receiving a dishonored check report, the
applicable attorney disciplinary committee "in virtually all
cases compels the involved attorney to produce the records of the
account on which the dishonored check is drawn[,]" and "[i]n serious cases involving failure on the part
of the attorney to cooperate in the investigation, or involving
numerous `bounced checks, or large amounts of money, the
[applicable disciplinary committee] seeks immediate temporary
suspension of the attorney." Id. ¶¶ 93-94.
C. Bounced Checks
Schick maintained several accounts with the defendant banks
that were designated as "attorney-at-law", "escrow", "trust" and
"special" accounts; Schick also maintained accounts designated as
"attorney at law", "which [defendants] knew were being used by
Schick to maintain funds belonging to other person(s) and which
he possessed incident to his practice of law[.]" Id. ¶ 113.
Over the course of three years, Schick drew numerous checks from
all of those accounts at times when there were insufficient funds
to cover the checks.
Schick informed the defendants "that outstanding checks drawn
on such accounts `had' to be covered because the funds involved
were the property of others and dishonor of the checks would . . .
result in Schick's own scheme being exposed." Id. ¶ 114. The
banks honored some of the checks despite the insufficient funds
and dishonored others; the banks returned to the payees the
dishonored checks with the designation "insufficient funds" or
"refer to maker." Because "each defendant knew that reporting the
[bounced checks] would result in" Schick closing his bank
accounts, the defendants never reported a single bounced check
from Schick's accounts to the Lawyers' Fund. Id. ¶ 128. "`[B]ut for' defendants' fraud and its corruption of the `New
York State Attorney Disciplinary System,' Schick's financial
defalcations would have been discovered had defendants timely
made the required reporting to the Lawyers' Fund, which would
have resulted in Schick's immediate suspension and/or disbarment
before plaintiffs entrusted their funds with him and/or the funds
were misappropriated and/or plaintiffs suffered damages." Id. ¶
A court may dismiss an action pursuant to Fed.R.Civ.P.
12(b)(6) ("Rule 12(b)(6)") only if "it appears beyond doubt that
the plaintiff can prove no set of facts in support of his claim
[that] will entitle him to relief." Todd v. Exxon Corp.,
275 F.3d 191, 197-98 (2d Cir. 2001). The Court accepts as true a
plaintiff's factual allegations and draws all reasonable
inferences in favor of the non-moving party. See Board of Educ.
of Pawling Cent. Sch. Dist. v. Schutz, 290 F.3d 476, 479 (2d
A. Breach of Fiduciary Duty
Plaintiffs' claims for breach of fiduciary duty cannot survive
because defendants do not owe a fiduciary duty to the plaintiffs.
"In maintaining an [escrow account], the lawyer, not the bank, is
charged with a fiduciary duty to the client." Peoples
Westchester Sav. Bank v. FDIC, 961 F.2d 327, 332 (2d Cir. 1992). B. The Remaining Claims
The remaining claims also cannot survive because each requires
proximate causation, and, as a matter of law, plaintiffs cannot
establish that defendants' actions proximately caused their
1. Proximate Causation is an Element of Each Claim
"To establish a prima facie case of negligence under New York
law, three elements must be demonstrated: (1) the defendant owed
the plaintiff a cognizable duty of care as a matter of law; (2)
the defendant breached that duty; and (3) plaintiff suffered
damage as a proximate result of that breach." See Curley v. AMR
Corp., 153 F.3d 5, 13 (2d Cir. 1998).
"To prevail on a fraud claim under New York law, a plaintiff
must establish five elements by clear and convincing evidence: 1)
the defendant made a material misrepresentation; 2) the defendant
knew of its falsity; 3) the defendant possessed an intent to
defraud; 4) the plaintiff reasonably relied on the
misrepresentation; and 5) the plaintiff suffered damage as a
result of the misrepresentation." Kaye v. Grossman,
202 F.3d 611, 614 (2d Cir. 2000).
In regard to the fourth element, reasonable reliance,
"[r]eliance is to fraud what proximate cause is to
negligence. . . ." In re Fifth Judicial Dist. Asbestos
Litigation, 784 N.Y.S.2d 829, 833 (N.Y. Sup. Ct. 2004) (citing Brackett v.
Griswold, 112 N.Y. 454 (1889)). In Brackett v. Griswold, the
New York Court of Appeals explained:
[I]n order to recover in an action for fraud and
deceit, the fraud and injury must be connected. The
one must bear to the other the relation of cause and
effect; . . . it must appear in an appreciable sense
that the damage flowed from the fraud as the
proximate, and not the remote, cause.
112 N.Y. at 469. "It is not necessary for the representation to
have been the exclusive cause of plaintiff's action or
non-action; it is sufficient that . . . the representation was a
substantial factor in inducing plaintiff to act or refrain from
acting." In re Fifth Judicial Dist. Asbestos Litigation,
784 N.Y.S.2d at 833 (emphasis added); see also National Union Fire
Ins. Co. of Pittsburgh, Pa. v. Robert Christopher Assocs.,
691 N.Y.S.2d 35, 42 (1st Dep't 1999) ("[T]he fraudulent conduct must
be related to the resultant damages in order to satisfy the
requirement of proximate causation."); Restatement, Second, Torts
§ 548. Thus, proximate cause, although set forth in a slightly
different manner, is also an element of a fraud claim.
c. Aiding and Abetting Breach of Fiduciary Duty
To establish a claim for aiding and abetting breach of a
fiduciary duty owed by Schick to the plaintiffs, the following
three elements must be established.
The first element is a breach by a fiduciary of
obligations to another, of which the aider and
abettor had actual knowledge. The second element is
that the defendant knowingly induced or participated
in the breach; and the third element is that
plaintiff suffered damage as a result of the breach.
In re Sharp Intern. Corp., 403 F.3d 43
, 49 (2d Cir. 2005)
(internal citations and quotations omitted). In regard to the second element, because Plaintiffs' Second
Amended Complaint does not allege any type of inducement,
plaintiffs must establish that the banks knowingly participated
in Schick's breach. "A person knowingly participates in a breach
of fiduciary duty only when he or she provides substantial
assistance to the primary violator[,]" In re Sharp Intern.
Corp., 403 F.3d at 50-51 (internal citations and quotations
omitted), which "requires a defendant's participation to be the
proximate cause of plaintiff's injury." Dubai Islamic Bank v.
Citibank, N.A., 256 F. Supp. 2d 158
, 167 (S.D.N.Y. 2003).
4. Commercial Bad Faith
Under New York law, a claim for commercial bad faith requires
(1) "allegations of a scheme or acts of wrongdoing," (2)
"allegations of the bank's actual knowledge of the scheme or
wrongdoing that amounts to bad faith or allegations of complicity
by bank principals in alleged confederation with the
wrongdoers[,]" Peck v. Chase Manhattan Bank, N.A.,
593 N.Y.S.2d 509, 510-11 (1st Dep't 1993) (citing Prudential-Bache Sec., Inc.
v. Citibank, N.A., 73 N.Y.2d 263, 275-77 (1989)), and (3) that
plaintiffs' damages were proximately caused by bad faith on the
part of the defendants. See Dubai Islamic Bank,
256 F. Supp. 2d at 167 (commercial bad faith claims, like breach of fiduciary
duty and fraud, require proximate causation).
2. Plaintiffs Cannot Establish Proximate Causation As A Matter
"To satisfy th[e proximate-cause] element, a plaintiff must
establish that the defendant[s'] [conduct] was a substantial
foreseeable factor in bringing about his or her injury." Johnson v. Bryco Arms, 304 F. Supp. 2d 383, 395
(E.D.N.Y. 2004) (citing Nallan v. Helmsley-Spear, Inc.,
50 N.Y.2d 507, 520 . . . (1980); Derdiarian v. Felix Contracting
Corp., 51 N.Y.2d 308, 315 . . . (1980)). Although "[t]he issue
of proximate cause is generally a question of fact for the jury,"
when "only one conclusion may be drawn from the established facts
. . . the question of legal cause may be decided as a matter of
law." Johnson, 304 F. Supp. 2d at 385 (citing Alexander v.
Eldred, 63 N.Y.2d 460, 468 . . . (1984)).
In regard to plaintiffs' RICO claims, which were based on the
same conduct underlying the claims in the Second Amended
Complaint, the Second Circuit, in affirming the Court's dismissal
of the RICO claims, held that "the alleged pattern of activity
was not the proximate cause of plaintiffs' injuries[.]" Lerner,
318 F.3d at 117. The Second Circuit explained:
[T]o the extent that plaintiffs' complaint can be
read to allege that defendants engaged in a pattern
of racketeering activity that led to the concealment
of Schick's improper conduct from the Lawyer's Fund,
the connection between the RICO violation and the
injury alleged is too attenuated to satisfy the
proximate cause requirement. . . . Central to the
notion of proximate cause is the idea that a person
is not liable to all those who may have been injured
by his conduct, but only to those with respect to
whom his acts were a substantial factor in the
sequence of responsible causation, and whose injury
was reasonably foreseeable or anticipated as a
natural consequence. The racketeering activities
alleged are not a substantial factor in the chain of
causation that led to plaintiffs' losses. Nor were
those losses a reasonably foreseeable consequence of
The mere recitation of the chain of causation alleged
by the plaintiffs is perhaps the best explanation of
why [there is no proximate cause]. In order to
demonstrate some link between the RICO violations
alleged and the loss of their investments, plaintiffs must show that, if the defendant banks had
not committed the predicate acts of mail and wire
fraud, (1) unspecified third parties would have
become aware that there were insufficient funds in
the escrow accounts to cover Schick's checks; (2) the
Lawyer's Fund, in some fashion, would then have
become aware of these bounced checks; (3) the
[applicable attorney disciplinary committee], upon
receiving the report of dishonored checks from the
Lawyer's Fund, would have recommended to the
Appellate Division that Schick be suspended or
disbarred; (4) the Appellate Division would have
investigated Schick and adopted this recommendation
almost immediately after Schick bounced these checks;
and (5) plaintiffs would have been made aware of
Schick's removal from the practice of law in time to
halt further investments. Each of the assumptions
upon which this theory rests is inherently
speculative. For example, it would be impossible to
determine if and when the Appellate Division would
have disciplined Schick. Thus, there is no rational
way to allocate the damages that flow from the
failure of the Appellate Division to act.
Id. at 123-24.
There is no principled distinction between the basis for
dismissing the RICO claims on proximate-causation grounds and the
basis for similarly dismissing the state claims requiring
proximate causation. The plaintiffs do not argue that they have
established proximate causation; rather, they contend that there
is a causal connection between the defendants' conducts and their
injuries. A causal connection, however, only establishes that
"but for" defendants' actions the plaintiffs would not have been
incurred their injuries; by contrast, proximate causation
requires an additional step that defendants' actions were a
substantial factor in plaintiff's injuries and that those
injuries were reasonably foreseeable to the defendants; thus,
even if plaintiffs could establish but-for causation, that is not
sufficient to establish proximate causation. See Allegheny Gen. Hosp. v. Philip Morris, Inc., 228 F.3d 429, 439 (3d Cir. 2000)
("[W]hile a causal connection is necessary for a finding of
proximate cause, it is not sufficient by itself.").
Defendants' motions to dismiss are granted. Accordingly, the
Second Amended Complaint is dismissed.
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