Commercial Division Blog

Posted: December 2, 2013 / Categories Commercial, Fraud/Misrepresentation, Statute of Limitations/Laches

IRS Audit Put Taxpayer on Inquiry Notice of Possible Fraud Claim Against Tax Advisor

On November 19, 2013, Justice Friedman of the New York County Commercial Division issued a decision in Chlsea, LLC v. Gramercy Fin. Servs., LLC, 2013 NY Slip Op. 32946(U), dismissing fraud and related tort claims on statute of limitations grounds because the plaintiff was on inquiry notice.

In Chlsea, the plaintiff made a tax shelter investment that ultimately was disallowed by the IRS. Plaintiff sued its tax advisor for fraud. Justice Friedman ruled that the IRS's audits of the plaintiff placed it on inquiry notice of a possible fraud claim, writing:

[I]n order to start the limitations period regarding discovery, a plaintiff need only be aware of enough operative facts so that, with reasonable diligence, it could have discovered the fraud. Where 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.

Here, the IRS's commencement of the 2005 audit regarding the CHLSEA and BROMLI partnerships, and its specific inquiries regarding Gramercy's pre-acquisition valuation of the distressed debt, were sufficient to give Kelly actual notice of potential problems with the DAD transaction and to trigger Kelly's duty of inquiry as to the validity of the debt.

(Internal quotations and citations omitted).

In sum, plaintiffs considering suits against tax advisors and other professionals should be cognizant that the limitations period may be held to run once they receive a notice of a tax inquiry by regulatory authorities.