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Current Developments in the Commercial Divisions of the
New York State Courts
Posted: February 7, 2014

Defendants Succeed in Limiting Most of the Categories of Damages in Lawsuit; Punitive Damages Claim Survives

On January 23, 2014, Justice Marks of the New York County Commercial Division issued a decision in Johnson v. Rose, 2014 NY Slip Op. 30262(U), limiting the categories of damages available in that action.

In Johnson, the plaintiffs brought “fraud, legal malpractice and other claims” against a law firm and two of its partners “arising from plaintiffs’ participation in a failed tax shelter.” Among the issues addressed in the defendants’ motion to dismiss was the extent of the damages the plaintiffs could claim. While the court did not dismiss the plaintiffs’ fraud claim, it did limit the categories of damages available on that claim, explaining:

Plaintiffs assert a wide variety of damages in connection with their fraud claim, including a return of the fees they paid to engage in the transaction, and reimbursement of the penalties assessed against them by the IRS. Defendants move to dismiss or strike plaintiffs’ request for back taxes and interest, lost opportunity, lost dividends, stock appreciation and punitive damages in connection with the [fraud claim].

In a fraud action, a plaintiff may recover only the actual pecuniary loss sustained as a direct result of the wrong. In other words, under New York’s longstanding out-of-pocket rule, damages for fraud are intended to compensate plaintiffs for what they lost because of the fraud, not for what they might have gained absent the fraud.

Plaintiffs cannot obtain a recovery of back taxes. Plaintiffs have had the use and benefit of the proceeds from selling their stock, and presumably owe taxes on whatever profit they have made. They are not entitled to the windfall of reimbursement for back taxes. Nor may plaintiffs obtain reimbursement for interest they paid to the IRS, as interest on taxes untimely paid does not constitute damages sustained by plaintiff but represents merely a payment to the IRS for his use of the money during the period of time when he was not entitled to it. Accordingly, plaintiffs’ request for back taxes and interest is disallowed. Compl., 160-161, l65(iii), and l66(b). The Court notes that these paragraphs are not to be stricken in their entirety, as they also contain a request for penalties imposed by state and federal tax authorities.

Plaintiffs’ claims for damages stemming from other speculative uses of their monies, such as lost opportunities for investment, stock appreciation and dividends, are also unavailable. Accordingly, these requests are disallowed and paragraphs 162 through 164, and subparagraphs 165(iv), 165(v), 166(d), and 166(e) are stricken.

Punitive damages are not available in the ordinary fraud and deceit case. It is not sufficient that a defendant’s wrongdoing was intentional; it must also evinc[e] a high degree of moral turpitude that demonstrates such wanton dishonesty as to imply a criminal indifference to civil obligations. For the purposes of a motion to dismiss, the Court must take the allegations of the
complaint as true. Plaintiffs have sufficiently alleged that defendants’ conduct was not directed solely at plaintiffs, but was part of a larger fraudulent tax shelter scheme targeting hundreds of clients to whom defendants owed a fiduciary duty. Moreover, construed in the light most favorable to plaintiffs, the allegations further suggest that defendants took advantage of confidential financial information of clients in selecting their targets, actively sought to dissuade clients from seeking independent legal or financial advice about the transaction, and used their status as attorneys to cloak the scheme in seeming legality. At this stage of the litigation, it is not necessary for plaintiffs to prove that they will be entitled to punitive damages; it is sufficient that plaintiffs have adequately alleged morally culpable conduct directed at the public. The Court therefore declines to strike plaintiffs’ request for punitive damages at this time.

(Internal quotations and citations omitted) (emphasis added).

This decision is yet another example of the use of a motion to dismiss to limit the potential damages in a lawsuit. Here, the defendants were not able to get the claim for punitive damages stricken at the motion to dismiss stage, but otherwise they were able significantly to limit their downside in the litigation.

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