The opinion of the court was delivered by: Smith, J.
This opinion is uncorrected and subject to revision before publication in the New York Reports.
We hold that plaintiffs in this action for fraud have alleged facts from which a jury could find that they were justified in relying on the representations defendants made to them.
Plaintiffs are four companies that loaned a total of $40 million dollars in March of 2005 to American Remanufacturers Holdings, Inc. and affiliated companies (ARI). ARI was a remanufacturer of automobile parts; it purchased used parts, broke them down into their components, and used the components to make new parts. ARI's stock was owned 45 percent by entities affiliated with Rhone Group L.L.C., and 55 percent by entities affiliated with Quilvest S.A.
After ARI failed to repay the loan, plaintiffs brought a number of claims against Rhone, Quilvest, companies and individuals associated with them, members of ARI management, and ARI's outside accountants. Only the first claim is in issue here. It asserts in essence that Rhone and Quilvest, their corporate affiliates and individuals acting on their behalf (hereafter defendants) defrauded plaintiffs into making the loans.
Plaintiffs allege, among other things, that defendants presented them with ARI financial statements that were false and misleading. More specifically, they allege that the financial statements were designed to inflate the number with which plaintiffs were most concerned -- ARI's earnings before interest, taxes, depreciation and amortization (EBITDA). The allegations on this subject are lengthy, and include some striking details. An e-mail sent to one of the defendants by an ARI executive about two months before the loan closing says: "I understand the financial reason to manipulate earnings." Another e-mail, sent some three weeks later by the same officer to the same recipient says: "I realize we needed to make EBITDA for banks but we should understand . . . what our true EBITDA is."
We need not describe defendants' alleged misconduct fully; we may assume, for purposes of this appeal, that the complaint adequately alleges that defendants made material misrepresentations. The question for us is whether, if the complaint's allegations are true, a jury could find that plaintiffs justifiably relied on those misrepresentations. Defendants argue that plaintiffs failed to make a reasonable inquiry into the truth of what defendants said, and we will describe in more detail the alleged facts that are relevant to that argument.
The complaint alleges that plaintiffs were first solicited to loan money to ARI in July 2004, and that over the next several months they received a number of written presentations by ARI's investment banker, containing financial and other information that later proved to be false or misleading. At the time of the solicitation -- and indeed until the day the loan closed -- ARI's outside auditors had not completed their audit for the year ending December 31, 2003, and it was part of the original proposal that the loans would be "conditioned upon, and made after, the borrower had provided the lenders" with audited financial statements for 2003. It was later agreed that unaudited financial statements for 2004 would also be provided.
During the months before those financial statements were completed, plaintiffs had several conversations with ARI representatives in which they were given reassuring information, and made two calls to participants in the industry to get information about ARI's management, which was also reassuring. In December 2004 and January 2005, plaintiffs were sent drafts of the audit report for 2003, and on March 2, 2005 they were sent the unaudited financial statements for 2004. The final version of the 2003 audit report was provided on March 22, 2005, and the loan closed on the same day.
ARI's unaudited 2004 statements, plaintiffs allege, grossly inflated EBITDA, in significant part through a manipulation of ARI's inventory reserves. Plaintiffs say that they could not have detected this, but, as defendants point out, the 2004 statements contained some features that might have aroused concern in a skeptical reader who examined them carefully. They showed a significant increase in the value of ARI's inventory over the previous year; a modest amount of cash on hand, equal to the amount of ARI's bank overdraft; and a remarkable increase in the company's apparent profitability in the last month of the year. Though December 2004 revenues were below the year's monthly average, gross profit was higher than average, and gross margin was shown as 17.9 percent for the month, compared to 13.5 percent for the year as a whole.
The complaint does not allege that plaintiffs asked questions about these or other aspects of the financial statements, or that they asked to look at ARI's underlying records. Plaintiffs did, however, insist that ARI represent and warrant, in substance, that the financial statements were accurate. Specifically, ARI represented and warranted in the loan agreement (as summarized in the complaint) that the 2004 financial statements "present fairly in all material respects the financial position of ARI as at December 31, 2004 and the results of ARI's operations and cash flows for the period then ended"; that the statements were prepared in accordance with generally accepted accounting principles; that "between December 31, 2003 and March 22, 2005 [the closing date], no event has occurred, which alone or together with other events, could reasonably be expected to have a Material Adverse Effect" on ARI's business, assets, operations or prospects or its ability to repay the loans; and that "no information contained in the loan agreement, the other loan documents or the financial statements being furnished to the Plaintiffs contains any untrue statement of a material fact or omits to state a material fact necessary to make the statements contained therein not misleading in light of the circumstances under which they were made." All of these representations and warranties, plaintiffs say, later proved to be false.
The loan agreement, as defendants emphasize, also provided for a high interest rate: ARI agreed to pay plaintiffs the lower of 10 percent above the LIBOR rate or 9 percent above an index rate derived from the "base rate" charged by United States banks to corporate borrowers.
As we mentioned above, plaintiffs' claim for fraud against defendants was one of several in the complaint. On motions pursuant to CPLR 3211, Supreme Court dismissed all the others, but allowed this claim to stand. The Appellate Division modified Supreme Court's decision and dismissed the claim, emphasizing that "plaintiffs never looked at ARI's books and records" and concluding that, having failed to do so, they "cannot now properly allege reasonable reliance on the purported ...