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Editor: Eric C. Chaffee
Univ. of Toledo College of Law

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Tuesday, June 1, 2010

New York Appellate Court Bars Holder Claims as Inconsistent with Out-of-Pocket Rule

A New York appellate court (First Dept.) recently held, in Starr Foundation v. American International Group, Inc. (Download StarrFdnvAIG) that holder claims are not recognized in New York law because they violate the "out-of-pocket" rule governing losses recoverable for fraud.  Starr Foundation, whose primary assets are AIG stock, sought to diversify its portfolio and, beginning in 2006, began gradual sales of its stock. In its complaint against AIG, the Foundation alleges that, in reliance on AIG's fraudulent representations minimizing the degree of risk represented by AIG's credit default swap portfolio, it suspended its sales of stock in October 2007.  But for AIG's misrepresentations, alleged the Foundation, it would have continued to sell 15.5 million shares.  Instead, when the value of AIG stock declined upon revelation of its financial condition, the Foundation continued to hold approximately 15.5 million shares.  Thus it sought to recover the value it would have realized for those shares had defendants accurately made disclosures about the risks, less the stock's value after the fraud was exposed.

The court held that "[m]anifestly, such a recovery would violate New York's longstanding out-of-pocket rule," under which the true measure of damages for fraud is "indemnity for the actual pecuniary loss substained as a direct result of the wrong."  Indeed, the court believed that this action was "virtually the paradigm of the kind of claim that is barred by the out-of-pocket rule," because "a lost bargain more 'undeterminable and speculative' than this is difficult to imagine."

One justice dissented, relying on a 1927 decision by the Appellate Division that allowed a claim for fraudulent inducement to retain securities.

http://lawprofessors.typepad.com/securities/2010/06/new-york-appellate-court-bars-holder-claims-as-inconsistent-with-outofpocket-rule.html

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