Reno v. . Bull
226 N.Y. 546, 1919 N.Y. LEXIS 899, 124 N.E. 144 (1919)
Rule of Law:
In an action for fraud and deceit, it is essential to prove that the defendant acted with a willful purpose to deceive (scienter), as negligence or mere want of caution is insufficient. The proper measure of damages in such an action is indemnity for the actual pecuniary loss sustained (the 'out-of-pocket' rule), not the difference between the actual value and the value if the representations had been true (the 'benefit-of-the-bargain' rule).
Facts:
- The American Oriental Company, a Maine corporation, was organized with $4 million in capital stock, including $2 million preferred stock.
- The corporation sought to induce the public to buy $1 million of its preferred stock.
- The corporation arranged with Charles D. Barney & Company, prominent bankers, to offer the stock for sale.
- Barney & Company prepared a circular/prospectus, adopted and approved by the corporation's directors (including the defendants), which contained a letter from Ertz, the company president.
- The circular made statements regarding the plant's capacity, crude oil abundance in California, and a profitable Oriental market, which the plaintiff claimed were false.
- Ertz, the president, also told the plaintiff, at or immediately prior to the stock purchase, that the corporation would begin business with $1,000,000 cash capital.
- The plaintiff purchased fifty shares of preferred stock for $5,000, relying on the statements in the circular and Ertz's statement.
- The jury later found the statements contained in the circular and made by Ertz to be false.
Procedural Posture:
- Plaintiff initiated an action in the trial court against the defendant directors for damages due to fraud and deceit.
- The trial court rendered a verdict in favor of the plaintiff for $6,000.
- The defendants appealed the judgment to the Appellate Division.
- The Appellate Division unanimously affirmed the trial court's judgment.
- The defendants were granted permission to appeal to the Court of Appeals of New York.
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Issue:
1. Did the trial court err by instructing the jury that corporate directors could be liable for fraud based on negligence or a reasonable opportunity to discover falsity, rather than requiring proof of a willful purpose to deceive? 2. Did the trial court err by instructing the jury to measure damages in an action for fraud and deceit by calculating the difference between the stock's actual value and its value had the representations been true, rather than the plaintiff's actual pecuniary loss?
Opinions:
Majority - McLaughlin, J.
1. Yes, the trial court erred by instructing the jury that corporate directors could be liable for fraud based on negligence rather than a willful purpose to deceive. An action for fraud and deceit requires proof of "Representation, falsity, scienter, deception and injury." Scienter means the defendants knew the representations were false or made them with a willful purpose to deceive. The trial court's instruction that it was the defendants' duty "to know the truth of the facts stated therein and if they did not know whether such facts were true, they were bound to know if they had a reasonable opportunity to ascertain the same" incorrectly substituted negligence for a purpose to deceive. Negligence and fraud are not synonymous; fraud presupposes a willful purpose, while negligence is an omission of duty without such purpose (Kountze v. Kennedy). The court distinguished Downey v. Finucane, clarifying that it involved agency liability, not a change in the scienter rule for directors acting solely for the corporation. 2. Yes, the trial court erred by instructing the jury on an incorrect measure of damages for fraud and deceit. The purpose of an action for deceit is to indemnify the injured party for their actual pecuniary loss, excluding all elements of profit (Urtz v. N. Y. C. & H. R. R. R. Co., Ochs v. Woods). The trial court's instruction that damages should be "the difference between the value of the stock at the time it was sold to him... and the value of the stock as it would have been at that time if the representations were true" was erroneous. The correct measure of damages is the difference between the amount paid ($5,000) and the actual value of the stock received, plus interest. This "out-of-pocket" rule is consistent with New York, Federal, and English law, and prior inconsistent expressions in other New York cases are overruled.
Analysis:
This case significantly clarifies the elements required to prove fraud and deceit in New York, particularly emphasizing the strict scienter requirement over mere negligence for corporate directors. It also definitively establishes the 'out-of-pocket' rule as the standard for measuring damages in fraud actions, rejecting the 'benefit-of-the-bargain' approach and ensuring that plaintiffs are indemnified for actual losses rather than speculative profits. This decision provides a higher bar for fraud claims against directors, insulating them from liability unless intentional deception can be proven, while also standardizing damage calculations.
