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First Department Addresses Fraud, Justifiable Reliance and the Statute of Limitations

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  • Posted on: Feb 6 2019

Statutes of limitations encourage plaintiffs to pursue the prosecution of their claims as soon as they are known. As the term implies, they are statutory mechanisms that limit the duration of a defendant’s liability for all types of alleged wrongdoing, e.g., fraud, breach of fiduciary and negligence. These statutes “promote justice by preventing surprises through [a plaintiff’s] revival of claims that have been allowed to slumber until evidence has been lost, memories have faded, and witnesses have disappeared.” Railroad Telegraphers v. Railway Express Agency, Inc., 321 U.S. 342, 348-349 (1944); CTS Corp. v. Waldburger, 134 S. Ct. 2175, 2183 (2014).

In Epiphany Community Nursery School v. Levey, 2019 N.Y. Slip Op. 00842 (Feb. 5, 2019) (here), the Appellate Division, First Department, was asked to consider the application of the statute of limitations to two separate claims of fraud and whether the plaintiff pleaded justifiable reliance sufficient to invoke the discovery rule (i.e., the exception to the six-year limitation period that is based upon the time within which the plaintiff discovered or could have discovered the fraud with reasonable diligence).  As discussed below, the Court affirmed the dismissal of the first set of claims and reversed the order as to the second set of claims, finding that Epiphany adequately alleged that it justifiably relied on the alleged misrepresentations.

The Statute of Limitations Relevant to a Fraud Cause of Action in New York

In New York, an action for fraud must be commenced within “the greater of six years from the date the cause of action accrued or two years from the time the plaintiff … discovered the fraud, or could with reasonable diligence have discovered it.” CPLR § 213(8).

The moving defendant has the initial burden of establishing “that the time in which to commence the action has expired.” Zaborowski v. Local 74, Serv. Empls. Intl. Union, AFL-CIO, 91 A.D.3d 768, 768 (2d Dept. 2012). If the defendant meets that burden, the burden then shifts to the plaintiff to “aver evidentiary facts establishing that the action was timely or to raise a question of fact as to whether the action was timely.” Lessoff v. 26 Ct. St. Assoc., LLC, 58 A.D.3d 610, 611 (2d Dept. 2009).

Where a plaintiff relies on the two-year discovery rule of the statute of limitations, “[t]he burden of establishing that the fraud could not have been discovered prior to the two-year period before the commencement of the action rests on the plaintiff who seeks the benefit of the exception.” Von Blomberg v. Garis, 44 A.D.3d 1033, 1034 (2d Dept. 2007); Lefkowitz v. Appelbaum, 258 A.D.2d 563 (2d Dept. 1999) (“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.”). Accord Berman v. Holland & Knight, LLP, 156 AD3d 429, 430 (1st Dept. 2017); Aozora Bank, Ltd. v. Deutsche Bank Sec. Inc., 137 A.D.3d 685, 689 (1st Dept. 2016).

“A cause of action based upon fraud accrues, for statute of limitations purposes, at the time the plaintiff ‘possesses knowledge of facts from which the fraud could have been discovered with reasonable diligence.’” Oggioni v. Oggioni, 46 A.D.3d 646, 648 (2d Dept. 2007) (quoting Town of Poughkeepsie v. Espie, 41 A.D.3d 701, 705 (2d Dept. 2007).

“[W]here the circumstances are such as to suggest to a person of ordinary intelligence the probability that he has been defrauded, a duty of inquiry arises, and if he omits that inquiry when it would have developed the truth, and shuts his eyes to the facts which call for investigation, knowledge of the fraud will be imputed to him.” Gutkin v. Siegal, 85 A.D.3d 687, 688 (1st Dept. 2011) (citation and internal quotation marks omitted). Courts look at whether the plaintiff should have discovered the alleged fraud objectively. Prestandrea v. Stein, 262 A.D.2d 621, 622 (2d Dept. 1999); Gorelick v. Vorhand, 83 A.D.3d 893, 894 (2d Dept. 2011). Mere suspicion will not suffice as a substitute for knowledge of the fraudulent act. Erbe v. Lincoln Rochester Trust Co., 3 N.Y.2d 321, 326 (1957).

This inquiry “involves a mixed question of law and fact, and, where it does not conclusively appear that a plaintiff had knowledge of facts from which the alleged fraud might be reasonably inferred, the cause of action should not be disposed of summarily on statute of limitations grounds.”  Berman, 156 A.D.3d at 430. “Instead, the question is one for the trier of-fact.” Id. See also Sargiss v Magarelli, 12 N.Y.3d 527, 532 (2009).

Epiphany Community Nursery School v. Levey

Background

The complaint alleged two sets of fraudulent acts discovered in a matrimonial action between Wendy Levey (“Wendy”) and Hugh Levey (“Hugh”) that was settled in October 2016.

The first series of alleged fraudulent acts occurred between 2002 and 2003 when Hugh induced Epiphany, a not-for-profit corporation that operates a kindergarten and nursery school on the Upper East Side of Manhattan, to sell its extracurricular programs to nonparty Magic Management LLC (“Magic”) for an unreasonably low price. At that time, Hugh had a 100% ownership interest in defendant January Management, Inc., general partner of nonparty January Partners, L.P., which was the sole member of Magic.

Pursuant to an asset purchase agreement dated February 12, 2003, Epiphany sold its extracurricular programs to Magic for $300,000, $30,000 of which was paid in cash and the remaining $270,000 was to be paid pursuant to a promissory note payable over 10 years in installments of $27,000, plus interest. Magic also agreed to pay monthly rent to use Epiphany’s facilities. Hugh claimed that although Magic occupied less than 10% of Epiphany’s space, Magic’s rent would be $481,026. Magic’s rent was represented to be more than $100,000 above Epiphany’s rent for the building.

Wendy, who did not have a financial background, signed the asset purchase agreement on Epiphany’s behalf without obtaining her own appraisal or verifying whether Magic paid the school what it owed.

The complaint alleged that the $300,000 purchase price was based on a fraudulent valuation commissioned by Hugh, which was “substantially inaccurate.” By applying false figures, Hugh allegedly reduced the purchase price by $1.5 million. The complaint further alleged that if the valuation had been properly calculated, the purchase price would have exceeded $1.8 million.

The second set of fraudulent acts allegedly took place between 2007 and 2013. Hugh made unauthorized transfers of over $5.9 million from Epiphany’s bank accounts to himself and some of the collateral defendants by linking the bank accounts to his private banking portfolio. Hugh, with the assistance of defendant Davie Kaplan CPA, P.C. (“Davie Kaplan”), falsely recorded these transfers in Epiphany’s general ledgers as “loans.” However, there were no documents to memorialize these “loans.” Nor were any loan payments ever made. The “loans” were subsequently characterized as “other receivables.” At the end of each year, the other receivables were offset by fake charges Epiphany owed defendant Gruppo Levey & Co. (“GLC”) or Gruppo, Levey Holdings Inc. (“GLH”), GLC’s parent company, for “consulting fees” and “lease commissions.”

Epiphany commenced the action on August 31, 2016, alleging 13 causes of action, including: (1) fraud by Hugh and Davie Kaplan; (2) aiding and abetting fraud by the collateral defendants and Davie Kaplan; (3) breach of fiduciary duty by Hugh; and (4) aiding and abetting breach of fiduciary duty by the collateral defendants and Davie Kaplan.

Defendants moved to dismiss the complaint. The motion court granted the motion and dismissed the complaint with prejudice.

The motion court held that (1) the first set of fraud claims were time-barred; (2) the second set of fraudulent acts constituted conversion and were time-barred; and (3) the nonfraud claims sounded in accounting malpractice and were time-barred as well. Epiphany appealed.

The Court’s Decision

With regard to the first series of allegedly fraudulent transactions, the First Department affirmed the dismissal of the claims as time-barred, finding that “[t]he action was commenced more than six years after th[e] cause of action accrued.” Slip Op. at *2.

The Court also held that Epiphany could not rely on the two-year discovery rule because it “could have discovered the alleged fraud [with reasonable diligence] when Wendy, as Epiphany’s Executive Director, signed the asset purchase agreement on Epiphany’s behalf in 2003.” Id. The Court observed that even though Wendy did not have a financial background, she signed the asset purchase agreement “without obtaining her own appraisal[,]” did not question the disproportionally high rent, which was the basis for the undervaluation of the asset[,]” and did not “verify whether Magic paid the rent due or made payments on the promissory note.” Id. at *2 (citing Aozora Bank, Ltd, 137 A.D.3d at 689; Gutkin, 85 A.D.3d at 688).

“As for the second set of fraudulent acts relating to the unauthorized bank transfers that occurred between 2007 and 2013,” the Court found that Epiphany’s claims fell within the two-year discovery rule. Id. The Court noted that “Hugh – with assistance from Davie Kaplan’s employee, David Pitcher – devised a fraudulent scheme to intentionally falsify the financial statements and books and records of Epiphany and kept the knowledge of these transfers from the school.” Id. at **2-3. “Hugh made the alleged illicit and unauthorized transfers from Epiphany’s bank accounts and fraudulently concealed them by falsely designating the entries in Epiphany’s books and records as ‘loans’, by falsely manipulating Epiphany’s books and records to convert the purported ‘loans’ into ‘other receivables’, and offsetting the loans by falsely claiming monies owed by Epiphany for consulting services that were never provided.” Id. at *3. The Court concluded that “[s]ince the acts were allegedly concealed from Epiphany, defendants [did] not establish[] a prima facie case that the school was on notice of the unauthorized transfers.” Id. The Court went on to say that “even if defendants ha[d] established a prima facie case, it [did] not conclusively appear that Epiphany had knowledge of the facts from which the fraud could reasonably be inferred.” Id.

The dissent disagreed with this holding, arguing that Epiphany did not justifiably rely on Hugh’s misrepresentations and that Epiphany failed to comply with CPLR § 3016(b) in alleging such reliance. The majority took issue with this position, arguing that Epiphany’s allegations were neither “bare legal conclusions” nor “inherently incredible.” Id. Instead, the Court found that “the complaint state[d] in detail Hugh’s fraudulent misconduct” and identified “the close familial relationship between Hugh and Wendy,” which impacted “Wendy’s reliance on Hugh” to “properly manag[e] Epiphany’s finances.” Id. at *4.  The Court explained as follows:

Epiphany alleges that Wendy relied on Hugh’s representations because of their familial relationship and his position as director of Epiphany. From the mid-1990s, Hugh began to involve himself in the financial matters of Epiphany. He became a member of the Board of Directors and held the position until 2013. Wendy trusted her husband. He was an experienced investment banker who had consulted on multibillion dollar transactions. She believed that Hugh would use his skills to further the financial interests of Epiphany. Wendy had no reason to believe that he would loot Epiphany’s funds, treating it as one of his businesses. Epiphany alleges that Hugh’s explanation for his conduct was that he had helped set up Epiphany and had a 50% interest in it.

Id. at *3.

These allegations – the existence of a relationship of trust or confidence and the superior knowledge or means of knowledge on the part of the person making the representation – said the majority, sufficed to satisfy the justifiable reliance requirement. Braddock v. Braddock, 60 A.D.3d 84, 89 (1st Dept. 2009).

Here, the complaint alleges that Hugh went to great lengths to conceal the unauthorized transfers and therefore, Epiphany – and Wendy, in her capacity as Executive Director of Epiphany – could not have discovered the alleged fraud with reasonable due diligence. In particular, Hugh “caused [Epiphany’s] bank statements to be diverted to the offices of Gruppo Levy and GLH” so that his fraudulent scheme would not be discovered. He also allegedly initiated these transfers at meetings with the employees of Gruppo Levy and GLH, not Epiphany. Additionally, he recorded the transfers as loans on the books and records, before offsetting them by services that were allegedly not provided so that Epiphany would not be alerted to the transfers. The complaint alleges that Hugh and Davie Kaplan’s actions prevented the public and government regulators from uncovering the fraud.

Id. at *4.

The dissent argued that dismissal of the fraud claim concerning the second series of transactions should have been affirmed on statute of limitations grounds, not because the claims sounded in fraud, but because they sounded in conversion: “Plaintiff’s allegations concerning Hugh’s misappropriations from its bank account state a cause of action, not for fraud, but for conversion — a claim subject to a strict three-year statute of limitations that contains no discovery provision (CPLR 214[4]).” Id. at *6. “Accordingly,” concluded the dissent, “plaintiff’s claim is time-barred, since the three-year limitation period for conversion expired no later than June 30, 2016, two months before this action was commenced.” Id.

The dissent noted that even if the claim were one for fraud, Epiphany failed to satisfy the justifiable reliance element of the cause of action. The dissent observed that “[a]bsent from the complaint is any well-pleaded allegation that any faithful agent of plaintiff — whether officer, director or employee — actually read or heard, much less relied upon, a false representation made by Hugh or any other defendant concerning the wrongful transfers.” Id. at *6. While Wendy “relied on Hugh personally to manage [Epiphany’s] financial affairs honestly and competently,” there was “no allegation that any agent of plaintiff actually relied on Hugh’s written misrepresentations — because no such agent is alleged ever to have read those misrepresentations.” Id. Consequently, “the complaint fail[ed] to identify any particular individual acting as plaintiff’s agent who, at any point in time, read and relied on these misrepresentations.” Id. “After all,” noted the dissent, “if plaintiff cannot name any agent through whom it relied on the subject statements, how can it claim to have relied on those statements?” Id.

Takeaway

Epiphany highlights the factual nature of pleading justifiable reliance for statute of limitations purposes.  As this Blog observed previously applying the statute of limitations to a fraud claim is complicated. (Here.) Determining when accrual occurs, and when the claim should have been discovered, is not easy and often contested. Epiphany highlights the fact-intensive nature of the inquiry.

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