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Note: Midtown Land Partners, LLC (Landlord/Subsidiary) leased commercial property in Richmond, Virginia, USA, to W. Clay Hamner and Brian Fauver, the managing members of Southern Season, Inc. (Tenants/Applicants). Landlord/Subsidiary was a proxy for GGC Associates, LLC (Proxy Subsidiary), being comprised of the same individuals, and both were owed by Gumenick Properties (Parent Company). By amendment, Landlord/Subsidiary assigned the lease to LM Retail, LLC (Assignee/Beneficiary), another entity owned by Parent Company. Because the lease required a security deposit, Tenants/Applicants obtained a USD 550,000 standby letter of credit issued by CertusBank (Issuer) in favor of Assignee/Beneficiary.

Tenants/Applicants struggled to pay rent on time and began discussions with Parent Company requesting that Assignee/Beneficiary reduce the rent obligations or allow a partial reduction of the standby value. When Parent Company refused to allow a partial reduction, Tenants/Applicants agreed to a reduction in monthly rent. In the meantime, Issuer “sold [Tenants/Applicants]’ loan to SummitBridge National Investments IV, LLC” (Summit). After Tenants/Applicants informed Parent Company of the loan transfer by way of a financial review, all parties “believed that the letter of credit transferred with the loan purchased by Summit.” Tenants/Applicants continued to experience financial difficulties, however, and Proxy Subsidiary and Parent Company proposed that Proxy Subsidiary make monthly “equity contributions” to Tenants/Applicants not to exceed USD 300,000, contingent on Tenants/Applicants making timely rent payments to Assignee/Beneficiary and leaving the standby in place (Letter Agreement). Pursuant to the Letter Agreement, Proxy Subsidiary paid Tenants/Applicants USD 25,000 for five months. Despite this, Tenants/Applicants defaulted on their loan to Summit two months after execution of the Letter Agreement and subsequently Tenants/Applicants filed for bankruptcy.

Claiming that Tenants/Applicants fraudulently induced Proxy Subsidiary into making the equity contributions by misrepresenting the status of the standby, Proxy Subsidiary sued Tenants/Applicants for actual and constructive fraud. Tenants/Applicants moved to dismiss the complaint for failure to state a claim. After reviewing the complaint, the trial court dismissed the claim of actual fraud against defendant Fauver but allowed the remaining claims against Tenants/Applicants to proceed. Following a bench trial, the United States District Court for the Eastern District of Virginia, Young, J., entered judgment in favor of Tenants/Applicants.

Applying Virginia law, the Judge noted that to prevail on its claim of actual fraud, Proxy Subsidiary was required to prove by clear and convincing evidence that Tenants/Applicants made (i) a false representation; (ii) of a material fact; (iii) intentionally and knowingly; (iv) with intent to mislead; (v) inducing reliance by the misled party; and (vi) causing damages. Moreover, concealment or omission of a material fact could also constitute a misrepresentation. In examining Proxy Subsidiary’s claim of fraudulent inducement, the Judge stated that “the evidence shows that the status of the letter of credit was at hand and as equally available to [Proxy Subsidiary] as it was to [Tenants/Applicants], and [Proxy Subsidiary] nonetheless failed to conduct a reasonably prudent investigation before entering into the Letter Agreement.” The Judge also found that Proxy Subsidiary failed to prove that Tenants/Applicants misrepresented the status of the standby at the time the parties executed the Letter Agreement. Moreover, because the parties were engaged in “arm’s length negotiations”, Tenants/Applicants and Proxy Subsidiary were not “sufficiently interrelated to give rise to” a duty by Tenants/Applicants to affirmatively disclose the status of the standby.

Regarding constructive fraud, Proxy Subsidiary was required to demonstrate the same elements but prove that the misrepresentation was made “innocently or negligently” as oppose to knowingly. For the same reasons, the Judge concluded that Proxy Subsidiary failed to meets its evidentiary burden for constructive fraud.

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