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Kevin Schlosser Authors, "Court Closely Analyzes Whether Sophisticated Plaintiff Should Have Investigated and Discovered Alleged Fraud for Statute of Limitations Purposes"

Mar 7, 2017Litigation & Dispute Resolution
Photo by Lynn Tilton (Own work) [CC BY-SA 4.0 (], via Wikimedia CommonsSource: In a fraud case involving the high profile investment mogul, Lynn Tilton, and her Patriarch Partners fund management companies (Norddeutsche Landesbank Girozentrale v Tilton, 2017 NY Slip Op 01482 (1st Dep’t Feb. 23, 2017)), the New York Appellate Division, First Department, carefully analyzed whether the fraud claims were timely brought by applying the “discovery rule” to extend the statute of limitations. The Court affirmed the denial of defendants’ motion to dismiss on statute of limitations grounds. Statute of Limitations for Fraud – Discovery Rule The statute of limitations for fraudulent inducement is six years from the time of the fraud or within two years from the time the fraud was discovered or, with reasonable diligence, could have been discovered. CPLR 213(8); Sargiss v Magarelli, 12 NY3d 527, 532 (2009). In Tilton, plaintiffs purchased over $135 million in notes issued by funds (“Funds”) that were supposed to be collateralized debt obligations (CDO). Defendants were engaged to select and manage the collateral to be held by the Funds. Plaintiffs alleged that defendants fraudulently induced them to invest in the Funds by making numerous misrepresentations about the purpose, operation and management of the Funds, and by concealing numerous risks, including defendants’ intent to use plaintiffs’ investments to acquire substantial equity interests in portfolio companies and to manage the Funds for defendants’ own benefit and profit. Plaintiffs asserted causes of action for fraudulent misrepresentation and concealment, and negligent misrepresentation. (The negligent misrepresentation clam was dismissed because “plaintiffs failed to allege a special relationship of trust or confidence between the parties to this arm’s length transaction (see Basis Pac-Rim Opportunity Fund [Master] v TCW Asset Mgt. Co., 124 AD3d 538 [1st Dept 2015]).” Since that was so straightforward, the First Department summarily affirmed.) While plaintiffs commenced the action more than six years after the fraud claim accrued, i.e., when they purchased the notes (Prichard v 164 Ludlow Corp., 49 AD3d 408 [1st Dept 2008]), they asserted that the action was timely under the two-years-from-discovery rule “because the monthly reports from defendants never revealed the Funds’ equity positions and they were not put on notice of defendants’ alleged fraud until on or about March 30, 2015, when the SEC issued an order commencing administrative cease-and-desist proceedings against defendants. In an effort to avoid the fraud claims, defendants took a posture that is a bit backwards, but entirely in line with the analysis of the discovery rule on the statute of limitations. That is, in effect, the defendants argued that, early on, they disclosed to plaintiffs enough information about defendants’ own allegedly fraudulent conduct for plaintiffs to know that they were defrauded. The defendants offered a bunch of detailed statements they made about the true nature of the Funds so that plaintiffs should have known or investigated that the Funds were not typical CDOs, as represented when they invested, but rather equity-based investments. On the other hand, plaintiffs argued that until defendants were actually investigated by the SEC, plaintiffs did not have adequate notice of the alleged fraud. The Court below denied defendants’ motion to dismiss on statute of limitations grounds. First Department Affirms Denial of Motion to Dismiss on Statute of Limitations In affirming the dismissal, the First Department carefully dissected all of the information that defendants claimed put plaintiffs on notice. The First Department concluded that “plaintiffs have adequately established that evidence offered by defendants in support of their motion is not necessarily inconsistent with plaintiffs’ expectations that the Funds could acquire equity, and that in no unambiguous way did that evidence reveal that defendants were using the Funds for the unexpected and deliberate purpose of acquiring controlling interests in companies in the style of a private equity fund.” The First Department emphasized that its determination was strictly limited to the procedural context of a motion to dismiss on statute of limitations grounds: “We merely determine, at this early stage of the litigation, that the evidence presented by defendants can be interpreted in a myriad of ways and does not facially clash with plaintiffs’ position that, even having some knowledge that the Funds had an equity component to them, they could not have known before the SEC proceeding the extent to which defendants used plaintiffs’ investment to acquire and control the Portfolio Companies, or otherwise had an obligation, based on that evidence, to further investigate. Thus, Supreme Court properly declined to dismiss the fraudulent misrepresentation complaint on statute of limitations grounds, and the viability of the defense must await a fully developed factual record, at which point it can be either decided as a matter of law on a motion for summary judgment, or at a trial.” Two justices dissented, believing that “defendants conclusively established that, more- than two years before the commencement of the action, plaintiffs were provided with notice that the funds at issue were not typical CDOs and included the widespread acquisition of controlling equity interests in the portfolio companies, which gave plaintiffs an adequate basis, with due inquiry, to discover the alleged fraud (see Aozora Bank, Ltd. v Deutsche Bank Sec. Inc., 137 AD3d 685 [1st Dept 2016]).” (Aozora is the subject of my earlier post on the statute of limitations.) Guidance This and many cases decided on statute of limitations grounds show that those who wish to bring fraud claims must act in a timely manner and as soon as they have any suspicion of something inconsistent with the information they relied upon and thought was true in entering into a transaction. While the plaintiffs in Tilton dodged the limitations bullet, the question was clearly a close call, especially judging by the two-judge dissent. Indeed, further Court of Appeals review is likely.