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"When can a breach of contract also support a claim for fraud?" This was the essential question faced by the Second Circuit in United States ex rel. O'Donnell v. Countrywide Home Loans, 822 F.3d 650 (2d Cir. 2016) (Countrywide). The court's holding—that contractual obligations can support fraud claims only where there is proof of fraudulent intent at the time of the contract's execution—incorporated common law precedent into federal mail and wire fraud cases in the Second Circuit involving contractual relationships between the alleged fraudster and victim. In its wake, courts in the circuit have had to grapple with the scope and application of Countrywide's holding in criminal and civil fraud cases. Does it provide a possible defense for white-collar defendants alleged to have defrauded their counterparties? Or is it limited to its facts?

'Countrywide' Sets the Stage

In Countrywide, the government brought charges under the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA), which uses the federal mail and wire fraud statutes as predicates. 822 F.3d at 652. The government alleged that the defendants violated the federal mail and wire fraud statutes by selling "poor-quality" mortgages to government-sponsored entities in violation of earlier agreements where the defendants represented that they would transfer "investment quality" mortgages to the government-sponsored entities. Id. at 652-55.

On appeal, the defendants challenged the verdict, arguing that (1) the federal mail and wire fraud statutes must be interpreted by reference to common law fraud; (2) the common law does not permit a fraud claim based solely on contractual breach; and (3) the evidence at trial showed at most an intentional breach of contract.

The Second Circuit agreed. First, the Second Circuit reiterated that the common law "does not permit a fraud claim based solely on contractual breach[.]" Id. at 658. Second, the Second Circuit held that "where allegedly fraudulent misrepresentations are promises made in a contract, a party claiming fraud must prove fraudulent intent at the time of contract execution; evidence of a subsequent, willful breach cannot sustain the claim." Id. (emphasis added). Third, the Second Circuit held that the common law's "contemporaneous fraudulent intent principle [was] incorporated into the federal mail and wire fraud statutes." Id. at 662. Finally, the Second Circuit held that the "Government did not prove—in fact, did not attempt to prove—that at the time the contracts were executed Countrywide never intended to perform its promise of investment quality." Id. at 663. Thus, the Government's proof at trial failed to meet its burden.

'Countrywide' Is Not a Catch-All

At first blush, Countrywide appears to have created a lucrative avenue for white-collar defendants to explore—without "contemporaneous intent," the case is merely one for breach of contract, not fraud. Yet courts in the Second Circuit have been circumspect in their application of Countrywide, and several defendants in recent cases attempting to use this precedent as a shield have failed in their efforts.

In particular, defendants facing evidence that they have made misrepresentations prior to the execution of a contract have found themselves falling out of the Countrywide rule. For example, in United States v. Connolly, the Southern District of New York denied the post-trial motions of defendants convicted of wire fraud charges in connection with their alleged participation in the infamous "LIBOR-fixing" scheme. No. 1:16-cr-00370-CM, 2019 WL 2125044 (S.D.N.Y. May 2, 2019). Rejecting the argument of one of the defendants that he did not have "contemporaneous intent to defraud" because his misrepresentations were made prior to the actual trade confirmations in question, the Southern District found that the "Defendants' fraudulent intent—their intent to try to influence a particular LIBOR setting in an advantageous direction—was contemporaneous with the fraudulent action taken by the Deutsche Bank submitters. That fact takes this case out of the rule of Countrywide." Id. at *15. The Southern District came to a similar conclusion in Kergil v. United States, upholding a defendant's substantive wire fraud and conspiracy to commit wire fraud convictions where there was "plenty of evidence of contemporary fraudulent intent" that the defendants knew their misrepresentations to insurance companies induced them to enter into risky and economically unsound policies. No. 1:17-cv-04675-CM, 2019 WL 3940621, at *4 (S.D.N.Y. Aug. 1, 2019).

The Second Circuit has recently indicated that Countrywide may not apply even where the only evidence of affirmative misrepresentations related to statements made after the contract was executed. Take for example the defendant in United States v. Murtha, an attorney who was convicted of wire fraud for using client funds for his own personal use. No. 18-3492-cr, 2020 WL 563647 (2d Cir. Feb. 5, 2020). There, the defendant argued at sentencing that a particular amount added to the total loss figure—a sum of funds entrusted to him by a client to complete a particular real estate transaction—was mistakenly included, as there was insufficient evidence to conclude he intended to siphon those funds at the outset of the agreement. The court disagreed, finding that the defendant's "misrepresentations in the course of performance, especially considered in connection with [the defendant's] ongoing fraudulent conduct with regard to other victims, are more than sufficient to show by a preponderance of the evidence that [he] had fraudulent intent at the time his agreement with [the victim] was formed as well as thereafter." Id. at *2.

'Countrywide' Persists

Nevertheless, at least one case has indicated that not only is Countrywide still viable, its protections may be even broader than initially described by the Second Circuit. In United States v. Jabar, the Western District of New York overturned the wire fraud and wire fraud conspiracy convictions of defendants alleged to have engaged in a scheme to divert grant money intended to establish a radio station in Iraq for their personal use. No. 1:09-cr-00170-LJV-JJM, 2017 WL 4276652 (W.D.N.Y. Sept. 27, 2017). Relying on Countrywide, the court found that while the government had proven that the defendants intended to deceive the victim from the outset, the government had not proven that the defendants intended to harm the victim, and thus, while there was a breach of contract, there was no criminal intent to defraud. While Jabar is up on appeal to the Second Circuit, it indicates an additional wrinkle in wire fraud cases—that courts may be required to individually consider whether the defendant had both intent to deceive and intent to harm at the outset of the contractual agreement in order to determine if a breach of contract constitutes fraud under Countrywide.

Does 'Countrywide' Extend Beyond Wire and Mail Fraud Cases?

It remains unclear in the Second Circuit whether Countrywide applies outside the wire and mail fraud context, although a recent case in the Southern District indicates it might not. In Securities and Exchange Commission v. Alpert, the SEC alleged that the defendant, a security guard for a board member of Heinz, traded on non-public information in violation both of securities laws and a non-disclosure agreement he signed when taking the job. No. 1:17-cv-01879-LTS-SN (S.D.N.Y. filed March 15, 2017). The defendant moved to dismiss, arguing under Countrywide that the "mere existence and breach of a confidentiality agreement cannot form the basis for a fraud action." Id., Dkt. No. 19 at 12. The Southern District rejected this argument, finding that Countrywide "concerns the mail and wire fraud laws and has nothing to do with a misappropriation claim under the securities laws." 2018 WL 1156012, at *4 (March 2, 2018). Ultimately, the parties settled before trial, and thus the Second Circuit has not yet had the opportunity to opine on the Southern District's restrictive reading of Countrywide.

Conclusion

We are still in the early days after the Second Circuit's Countrywide decision, and its scope—both in terms of its reach and its application—remains murky (with appeals still pending in the aforementioned Connolly and Jabar cases). While it is clear that a Countrywide defense is far from bullet-proof, it remains potentially viable in cases lacking evidence of misrepresentations made prior to the execution of the relevant contracts. As reliance on Countrywide increases, expect to see these guideposts more clearly defined within the next few years.

Moe Fodeman and Michael Sommer, former federal prosecutors, are partners in the New York office of Wilson Sonsini Goodrich & Rosati. They focus on white-collar criminal defense, SEC enforcement defense, compliance and regulatory matters, and complex civil litigation. Associates Kate McCarthy, Zachary Kravat and Adam Toporovsky assisted with the preparation of this article.