Does someone defrauded into not selling (“holding”) an asset have a claim against the fraudster?  Intuitively, one might think “of course!” if not for the fraud, the holder would have sold the asset and made a profit.  Why should someone else’s bad acts prevent the asset owner from recovering her would-be profits?  Recent New York state court decisions, however, confirmed the answer in New York is a flat “no,” at least where the asset holder is seeking to recover lost profits.  What happens if a holder is not seeking lost profits, but instead to recover for a complete loss of investment?  The question remains unsettled in New York.

Defrauded holders are in a tough spot.  The securities fraud section of the Securities and Exchange Act of 1934 and Rule 10b-5 promulgated by the U.S. Securities and Exchange Commission require a purchase or sale for a fraud claim and do not provide relief for an owner defrauded into holding.  Aggrieved holders are left with potential common law (i.e. court created rather than statutory) fraud claims.  Common law fraudulent inducement claims in New York are generally limited to “out of pocket” losses and require damages that are not speculative.  In Starr Found. v. Am. Int’l Grp., Inc., 76 A.D.3d 25, 901 N.Y.S.2d 246 (1st Dep’t 2010), the First Department, the appellate court covering Manhattan and the Bronx, confirmed that a defrauded holder may not recover for potential lost profits.  In Starr, plaintiff-charity alleged defendant AIG fraudulently misrepresented the degree of risk attached to AIG’s credit default swap portfolio, which induced plaintiff to hold and not sell its publicly traded AIG shares.  Months later, AIG publicly reported billions of dollars of losses caused by its credit default swap portfolio and its share price plummeted.  Plaintiff sought to recover the loss in value of its shares from Summer 2007 – when it claims it would have sold the shares – to early 2008 after AIG reported its losses.  The First Department dismissed the claim as violative of New York’s “out-of-pocket” rule – a plaintiff is only entitled to recover what it actually lost because of the fraud, not what it might have gained.  The court held holder claims seeking lost profits are impermissible because they require an untenable degree of speculation, including (1) whether the holder would have sold absent the fraud; (2) when the sale would have occurred; (3) the amount of shares the holder would have sold; and (4) the effect truthful disclosure would have had on the market price.

Recently, the New York County Commercial Division, perhaps the most sophisticated commercial state trial court in the country, applied the bar against lost profit holder claims.  In Q China Holdings, LTD. v. TZG Capital Limited, 2018 NY Slip Op 30779(U) (Sup. Ct. N.Y. Co. Apr. 23, 2018), Plaintiff claimed it abandoned a sale of shares to defendant when plaintiff learned defendant lied about the company’s earlier sale of a subsidiary.  Plaintiff sought to recover the profits it would have received had defendant been honest and plaintiff sold to defendant.  Citing Starr, the court dismissed the claim as a prohibited speculative holder claim seeking lost profits.

It is clear that New York courts reject claims seeking lost profits due to a fraud that causes an investor to hold and not sell.  What is not clear is the viability of a holder claim where the investment becomes worthless once the fraud is revealed.  In a decision nearly one century old, Continental Ins. Co. v. Mercadante, 22 A.D. 181, 225 N.Y.S. 488 (1st Dep’t 1927), defendants fraudulently induced the plaintiffs to not sell bonds by conveying false information as to the earnings and solvency of the bond issuer.  Shortly thereafter, the bonds plaintiff did not sell became “substantially worthless.”  The court held plaintiffs stated a claim for recovery against defendants for plaintiffs’ loss.  Eighty years later, the same court in Starr questioned whether Mercadante still represented good law, but assuming it did, distinguished it because the Starr plaintiff was seeking lost profits, not to recover the loss of investment, i.e. an out-of-pocket loss – perhaps a dubious distinction.  More recently, in AHW Inv. P’ship, MFS, Inc. v. Citigroup Inc., 661 F. App’x 2 (2d Cir. 2016), the Second Circuit Court of Appeals, the appellate Federal court covering New York State, noted the contrary decisions by New York courts and acknowledged that whether a holder can recover damages for loss of investment remains an unsettled question in New York.

If you have any questions about potential fraudulent conduct that affected an investment you have made, please do not hesitate to contact us.


What damages may a business recover when its trade secrets are stolen and used by a competitor?  Traditionally, courts have allowed businesses to recover actual losses caused by the trade secret theft – such as lost opportunities for profit.  Are there other potential avenues of recovery?  For example, can a business recover the amount of costs the competitor avoided by not having to develop the stolen trade secret?  After all, the competitor avoided potentially onerous costs associated with years of research, development, trial and error by simply stealing the trade secret.  Recently, the appellate Federal court covering New York State asked New York State’s highest court, the Court of Appeals, this exact question – and the Court of Appeals said “no.”

The misappropriation of trade secrets occurs when a competitor improperly obtains and uses another’s formula, pattern, device or compilation of confidential business information that provides a competitive advantage.  In essence, it is a type of “unfair competition.”  E.J. Brooks Company v Cambridge Security Seals, 858 F3d 744 (2d Cir 2017), presented a quintessential theft of trade secrets claim.  Plaintiff manufactures plastic security seals (as seen here).  Several of plaintiff’s employees jumped ship to defendant, a direct competitor, and brought with them plaintiff’s confidential, fully-automated plastic seal manufacturing process, which defendant immediately began to use.  Plaintiff sued defendant for, among other things, misappropriation of trade secrets.  After trial, the jury found defendant liable to plaintiff for $3.9 million, which represented the amount of costs defendant “avoided” by stealing the manufacturing process rather than developing it.  Following an appeal of the award, the United States Court of Appeals for the Second Circuit asked the New York Court of Appeals whether, under New York law, “avoided costs” were an available form of damages for unfair competition claims.

In addressing the question in E.J. Brooks Co. v. Cambridge Sec. Seals, 2018 N.Y. Slip Op. 03171 (May 3, 2018), the Court of Appeals noted that the “fundamental purpose” of compensatory damages is to “make the victim whole” – in other words, to restore the injured party to the position it would have been in but for the misconduct.  The Court reiterated the long-standing rule that a victim of trade secret misappropriation is not entitled to recover the revenue or profits actually received by a defendant.  While those amounts might be relevant in determining plaintiff’s losses (e.g. “I would have earned what defendant earned”), the Court cautioned that there is “no presumption of law or of fact” that defendant’s profits, revenues, cost savings, etc. will approximate plaintiff’s losses.  Rather, plaintiff’s actual damages must be measured by plaintiff’s actual losses, like lost opportunity for profit and the loss of investment to develop the confidential trade secret.  The Court held a defendant’s “avoided costs” are not an available form of damages because they have no bearing on plaintiff’s lost profits.  The Court further held that while plaintiff’s investment costs in developing a trade secret can show the value plaintiff placed on the secret, defendant’s avoided costs are “wholly unsubstantial and imaginary” (maybe defendant would have been really efficient in developing the stolen secret) and not an adequate approximation of plaintiff’s investment losses.

If you have any questions about theft of trade secrets or other unfair competition that have affected you, please do not hesitate to contact us.