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Posted: August 13, 2017

Two-Year Discovery Rule Does Not Save Fraud Claim from Being Time-Barred

On August 7, 2017, Justice Kornreich of the New York County Commercial Division issued a decision in Epiphany Community Nursery School v. Levey, 2017 NY Slip Op. 31668(U), holding that the two-year discovery rule did not save a fraud claim from being time-barred, explaining:

[A]ll of the claims in the complaint are dismissed as time-barred. While there are 13 causes of action, they all relate to one of two alleged schemes: (1) underpayment for the School’s afterschool and summer camp programs; and (2) money stolen from the School, justified by the provision of alleged fictitious services.

The first scheme occurred in 2002 and 2003, more than a decade before this action was commenced in 2016. There is no applicable New York statute of limitations longer than 6 years. The School recognizes this, but relies on CPLR 213(8), which provides that in an action based upon fraud, the time within which the action must be commenced shall be the greater of six years from the date the cause of action accrued or two years from the time the plaintiff or the person under whom the plaintiff claims discovered the fraud, or could with reasonable diligence have discovered it. It is well settled that the inquiry as to whether a plaintiff could, with reasonable diligence, have discovered the fraud turns on whether the plaintiff was possessed of knowledge of facts from which the fraud could be reasonably inferred.

Defendants contend that the School has always been in possession of the facts from which Hugh’s fraud could be reasonably inferred. They further aver that a reasonably prudent person, especially one that owes fiduciary duties to a non-profit by virtue of being its director (i.e., Wendy), could have discovered with basic diligence that the School was being defrauded. Defendants are correct. The financial terms of the Purchase Agreement were not a secret, nor was the fact that Magic never paid rent or the amounts due on the note. Magic’s nonpayment could easily have been ascertained by performing a cursory review of the School’s bank records.

Moreover, nothing prevented Wendy from ensuring that the terms of the Purchase Agreement were fair (e.g., by obtaining her own appraisal). Indeed, she had a fiduciary duty of care to do so. Under New York law, a director breaches her duty of care when she causes there to be a sustained or systematic failure to exercise oversight over the corporation’s activities.

To the extent the School complains that the Purchase Agreement’s terms were obviously unfair, the court does not disagree. If anything, that fact demonstrates the complete abdication of Wendy’s fiduciary duties. The most charitable reading of the complaint is that Wendy was asleep at the wheel and seemingly violated her duty of care. No reasonable director can justify being ignorant of the level of malfeasance of which the School complains. That Wendy trusted her husband implicitly is irrelevant. Wendy, as the School’s director, had the duty to ascertain the fairness of the Purchase Agreement’s terms and to make sure the School was paid what it was owed. Her knowledge and access to information is imputed to the School. Hence, the School cannot contend that it was not always in a position to discover Hugh’s fraud with reasonable diligence. Consequently, all of the School’s claims predicated on the Purchase Agreement and Magic’s failure to pay the School are dismissed as time-barred.

Turning now to the second category of claims – Hugh’s theft of money from the School, which was allegedly aided and abetted by Davie Kaplan – such claims also are time-barred. Defendants correctly contend that to the extent the Complaint alleges wrongdoing occurring before August 31, 2010-the vast majority of the Complaint-such allegations are barred by the statute of limitations. s with the first category of claims, the School relies on CPLR 213(8) and contends that the discovery period should not begin to run until the School supposedly discovered the fraud within two years of its commencement of this action. In support of this contention, the School avers that Hugh’s scheme was financially sophisticated and concealed with complex accounting shenanigans that made it impossible to detect by a layman such as Wendy. The court disagrees.

As defendants correctly respond, there is no financial alchemy afoot. A simple review of the School’s bank statements would reveal that Hugh transferred nearly $6 million to himself and his companies. While the School complains that Wendy gave Hugh the power to manage its bank accounts, the School cannot credibly contend that Wendy lacked the ability and legal right to obtain and review such records, which would have revealed Hugh’s defalcations. Nor can the School credibly contend that it could not have determined the sham nature of the pretextual services Hugh proffered to justify the pilfering. A corporation and its board may not claim ignorance of its contractors’ services (or lack thereof). The School and Wendy are charged with the knowledge of the millions taken by Hugh, which would have impelled a reasonable person to inquire of Hugh his justifications for taking such amounts. If the answer, presumably, was his supposed services, Wendy, who ran the School, would have been in a position to know if such services were proffered and if agreements to pay the amounts existed. Simply put, reasonable diligence easily would have revealed the fraud. Consequently, the School cannot avail itself of CPLR 213(8)’s two-year-from-discovery rule.

(Internal quotations and citations omitted).

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