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Concealment of Information Helps Save Complaint From Statute of Limitations Dismissal

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  • Posted on: Aug 3 2020

Statutes of limitations limit the duration of a defendant’s liability for all types of alleged wrongdoing. Plaintiffs who do not prosecute their claims within the limitation period will find the courthouse doors closed to their causes of action.

The United States Supreme Court has explained that the reason for such statutes is to free a defendant from stale claims.

Statutes of limitation, like the equitable doctrine of laches, in their conclusive effects are designed to promote justice by preventing surprises through the revival of claims that have been allowed to slumber until evidence has been lost, memories have faded, and witnesses have disappeared. The theory is that even if one has a just claim it is unjust not to put the adversary on notice to defend within the period of limitation and that the right to be free of stale claims in time comes to prevail over the right to prosecute them.

Railroad Telegraphers v. Railway Express Agency, 321 U. S. 342, 348-49 (1944).

In New York, the statute of limitations for a claim based on fraud is the greater of (a) six years from the date when the cause of action accrued or (b) two years from the time plaintiff discovered the fraud or could with reasonable diligence have discovered the fraud. CPLR § 213(8). The cause of action accrues when “every element of the claim, including injury, can truthfully be alleged” (Carbon Capital Mgmt., LLC v. Am. Express Co., 88 A.D.3d 933, 939 (2d Dept. 2011) (citation and alterations omitted)), “even though the injured party may be ignorant of the existence of the wrong or injury.” Schmidt v. Merchants Despatch Transp. Co., 270 N.Y. 287, 300 (1936).

The two-year discovery rule requires an inquiry into “whether a person of ordinary intelligence possessed knowledge of facts from which the fraud could be reasonably inferred.” Kaufman v. Cohen, 307 A.D.2d 113, 123 (1st Dept. 2003) (internal quotation marks and citation omitted); see also Erbe v. Lincoln Rochester Trust Co., 3 N.Y.2d 321, 326 (1957). “[M]ere suspicion will not constitute a sufficient substitute” for knowledge of the fraud. Eberle, 3 N.Y.2d at 326. “Where it does not conclusively appear that a plaintiff had knowledge of facts from which the fraud could reasonably be inferred, a complaint should not be dismissed on motion and the question should be left to the trier of the facts.” Trepuk v. Frank, 44 N.Y.2d 723, 725 (1978).

Moreover, where the circumstances suggest to a person of ordinary intelligence the probability that he/she has been defrauded, a duty of inquiry arises, and if he/she fails to undertake that inquiry when he/she would have developed the truth, and shut his/her eyes to the facts which call for investigation, knowledge of the fraud will be imputed to him/her. Gutkin v. Siegal, 85 A.D.3d 687, 688 (1st Dept. 2011).  The test as to when fraud should with reasonable diligence have been discovered is an objective one. Id. (citation and internal quotation marks omitted). Thus, courts will dismiss a fraud claim when the alleged facts establish that a duty of inquiry existed and that an inquiry was not pursued. See Shalik v. Hewlett Assocs., L.P., 93 A.D.3d 777, 778 (2d Dept. 2012). “The burden of establishing that the fraud could not have been discovered before the two-year period prior to the commencement of the action rests on the plaintiff, who seeks the benefit of the exception.” Celestin v. Simpson, 153 A.D. 3d 656, 657 (2d Dept. 2017).

In Sabourin v. Chodos, 2020 N.Y. Slip Op. 20186 (Sup. Ct., N.Y. County July 30, 2020) (here), the foregoing principles were considered by Justice Andrew Borrok in denying defendants’ motion to dismiss plaintiffs’ fraud claim.

Background

[Ed. Note: the background discussion comes from the Court’s recitation of the facts.]

Sabourin concerned a lawyer’s alleged involvement in a complex fraud perpetrated by William Jack Frost (“Frost”), an investor in a fashion and lifestyle magazine known as Z!NK (founded in 2002), on its founders, Isabelle Sabourin (“Sabourin”) and Sheriff Ishak (“Ishak” and with Sabourin, “Z!NK’s Founders”). Although the alleged fraud dates back to 2008, the facts surrounding the lawyer’s involvement are claimed to have been unknown until discovery in an arbitration conducted in 2013-2014 (the “2013-14 Arbitration”). 

In 2007, Frost agreed to invest $8 million in Z!NK Magazine in exchange for a 25% equity stake in a new joint venture known as I.T. Global Media, LLC (“ITGM”), which took ownership over Z!NK Magazine and its intellectual property rights. Up until the 2013-14 Arbitration, Z!NK’s Founders understood defendant, Adam Chodos (“Chodos”), to be Frost’s legal representative in the negotiations leading up to the transaction and later ITGM’s legal representative.

Frost immediately defaulted on his initial funding obligation, causing Ishak to terminate the deal and remove him as a manager of the company. When Frost later came up with the initial payment, Ishak agreed to revive the deal. That payment was made by one of Frost’s companies, F4 Capital Management, LLC (“F4”). According to plaintiffs, Chodos obtained a portion of the payment from an undisclosed source and transferred that money into F4’s accounts from an account that he controlled. The source of the funds and Chodos’ involvement in the transfer were allegedly not disclosed to Z!NK’s Founders.

In June 2008, Frost provided Z!NK’s Founders with a $6 million check drawn on an account in Frost’s father’s name. Frost claimed that his father was a majority equity holder and Chairman of the Board of Synovus Bank in Florida, and that ITGM could earn 1.5% more in interest with Synovus Bank than at any other bank. Z!NK’s Founders agreed to deposit the $6 million check into an account at Synovus Bank. Frost indicated that he would take care of opening the account and depositing the check. Frost allegedly later presented Ishak with forged account statements showing a balance of $6 million. In August 2008, when Sabourin sought to transfer funds from the Synovus Bank account to ITGM’s Commerce Bank account to cover operating expenses, Frost intervened, transferring $230,000 to ITGM’s Commerce Bank account.

According to plaintiffs, they did not know that Frost did not transfer the money out of the account at Synovus Bank. Instead, Frost allegedly transferred the money out of his then wife’s account. In September 2008, when Ishak attempted to withdraw money from the Commerce Bank account for payroll, he allegedly learned that there were insufficient funds in the account and that he had been removed as an authorized person on the account. He then allegedly tried to access ITGM’s account at Synovus Bank only to learn that the Synovus Bank account did not exist. Z!NK’s Founders alleged that the foregoing was part of a scheme engineered by Frost and Chodos to wrest control of the Z!NK business and loot its assets. They alleged that, between 2008 and 2010, Frost, with substantial assistance from Chodos, engaged in a campaign of misrepresentations and forgeries in an attempt to take over Z!NK Magazine.

On January 27, 2010, Z!NK’s Founders commenced a lawsuit against Frost and others. The complaint was amended on March 18, 2011. Before the commencement of discovery on August 19, 2011, the complaint was dismissed as to certain individuals. On September 13, 2012, the matter was referred to arbitration.

Document production in the 2013-14 Arbitration occurred in August 2013 and testimony was taken in September 2013. Through the evidence and testimony adduced in the 2013-14 Arbitration, Z!NK’s Founders alleged that they learned, for the first time, the facts underlying what had transpired. They filed their summons and notice on February 26, 2015, less than two years after the testimony in September 2013.

On April 1, 2014, the arbitrator awarded Z!NK’s Founders $56,400,000.00 against Frost. On February 23, 2015, Z!NK’s Founders entered judgment against Frost in the amount of $62,380,605.50. But by the time the judgment was entered, Frost had allegedly disappeared.

According to plaintiffs, the documents and testimony adduced during the 2013-14 Arbitration revealed that Chodos had an undisclosed and unknown involvement in the fraud. Z!NK’s Founders alleged that the documentary and testimonial evidence was not known or otherwise available to Z!NK’s Founders concerning Chodos’ alleged participation in the fraud.

With the information learned during the 2013-14 Arbitration, Z!NK’s Founders filed suit against Chodos, asserting causes of action for fraud, aiding and abetting fraud, unjust enrichment, aiding and abetting breach of fiduciary duty, civil conspiracy to commit conversion, and tortious interference with economic advantage. Plaintiffs sought damages of not less than $5 million.

Chodos moved for summary judgment, arguing that the complaint should be dismissed because (i) the statute of limitations had run, (ii) he should not be held liable for his clients’ actions, and (iii) the damages were not ascertainable. The Court denied the motion in its entirety.

The Court’s Decision

The Court held that the Z!NK’s Founders did not know or have reason to know that Chodos was allegedly involved in the fraud prior to the 2013-14 Arbitration. Slip Op. at *7. The Court said that “Chodos fail[ed] to meet his burden of coming forward with evidence establishing ‘what the Z!NK Founders knew’ and ‘when they knew it,’ or that they could have, with reasonable diligence, discovered any such facts necessary to satisfy CPLR § 3016(b) to have brought an action against him previously.” Id. at *7-*8 (paraphrasing Howard Baker’s oft-quoted question: “What did the President know and when did he know it?”).

“In fact,” continued the Court, “the evidence adduced in this case establishe[d] that Z!NK’s Founders were cut-off from records that may have revealed Mr. Chodos’ involvement in the fraud because Mr. Frost literally purloined Z!NK’s business records which theft, based on [Frost’s executive assistant’s] testimony, was perhaps at the direction and upon advice from Mr. Chodos himself, making it impossible for them to have known the nature and extent of Mr. Chodos’ active participation in the scheme.” Id. at *8.

Thus, explained the Court, “Z!NK’s Founders did not know, because they could not have known, about the … conduct by Mr. Chodos until it was disclosed either at the earliest during the document production in August 2013 or when Mr. Chodos and [Frost’s executive assistant] testified on September 18, 2013 during the 2013-14 Arbitration (i.e., in either case, well within the 2 year discovery rule as this action was commenced on February 26, 2015).…” Id. 

“In addition,” said the Court, “Mr. Frost’s former employee … testified that she worked for Mr. Frost as his executive assistant and office manager in 2007 and 2008, during which time she communicated with Mr. Chodos on a weekly and sometimes daily basis and that Mr. Frost took all of his direction from Mr. Chodos and never made any decisions without consulting with him.” Id. As she explained, “Mr. Frost ‘didn’t do anything without calling Adam [Chodos]’ and, Mr. Chodos ‘was the right-hand man with everything. Whether it was money, business advice, anything, he was his guy.’” Id. at *8-*9. “Significantly,” explained the Court, “at some point in Mr. Frost’s absence, Mr. Chodos even took over the company.” Id. at *9. The Court concluded that “without any of this information learned during the 2013-14 Arbitration, the Z!NK Founders could not have known the detailed facts about Mr. Chodos’ involvement in Mr. Frost’s scheme.” Id.

“Accordingly,” the Court held that “there [were] issues of fact precluding summary judgment relating, among other things, to (i) the relationship of Messrs. Chodos and Frost; (ii) the likelihood that Mr. Chodos knew, should have known, or maybe played a role in assisting Mr. Frost in forging the documents or stealing all the business records; (iii) the reasons for the delay in the 2013-14 Arbitration and whether it really took Z!NK’s Founders until the 2013-14 Arbitration to have the facts to satisfy CPLR § 3016(b); and (iv) how Mr. Chodos’ alleged ethical breaches may have further altered Z!NK’s Founders’ ability to learn the facts.” Slip Op. at *9. Under such circumstances, the Court denied the motion for summary judgment.

Takeaway

Inquiry notice is an important component of the statute of limitations analysis. Courts look to whether the facts suggest to a person of ordinary intelligence the probability that he/she has been defrauded. If they do, a duty of inquiry arises. If the plaintiff fails to undertake that inquiry when he/she could have developed the truth and shut his/her eyes to the facts which call for investigation, knowledge of the fraud will be imputed to the plaintiff. 

In Sabourin, the Court found that the facts were concealed from plaintiffs. As explained, plaintiffs “did not know, because they could not have known,” about defendant’s alleged conduct “until it was disclosed either at the earliest during the document production in August 2013 or when Mr. Chodos and [Frost’s executive assistant] testified on September 18, 2013 during the 2013-14 Arbitration.” Without such evidence, plaintiffs could not have been on inquiry notice of the alleged fraud. Since plaintiffs filed suit within two years of 2013-14 Arbitration, plaintiffs timely commenced their lawsuit.

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