Pleading and Proving a Fraud Cause of Action - Case Update 2019:  Epiphany Community Nursery School v. Hugh W. Levey, et.al

The recent New York Appellate Division, First Department, decision of Epiphany Community Nursery School v. Hugh W. Levey, et.al, 2019 NY Slip Op 00842 (1st Dept. 2019) sheds light on pleading a fraud claim in 2019.  The case explains and expands upon the required elements to demonstrate a fraud cause of action, including: (i) the “discovery rule,” as applied to both family members and financial professionals; and (ii) the concept of “justifiable reliance” in the context of family businesses, and among families generally.  The following Case Update examines these issues against the backdrop of New York’s six (6) year statute of limitations/two (2) year discovery rule, and Pennsylvania’s two (2) year general statute of limitations/doctrine of “fraudulent concealment”.

Epiphany Community Nursery School v. Hugh W. Levey, et.al

Plaintiff, Epiphany Community Nursery School (“Epiphany”), a not-for-profit that operates both as a kindergarten and nursery school in Manhattan, was founded by Wendy Levey (“Wendy”) (collectively, “Plaintiffs”).  Wendy Levey’s then-husband, Hugh Levey (“Hugh”), an Ivy League-educated investment banker, was the principal defendant.  A number of Hugh’s associates, like his accountant, Davie Kaplan (“Kaplan”), and business partners, are collateral defendants.  Wendy sued Hugh and various collateral defendants for thirteen (13) different causes of action, but the appeal sounded mostly in the four different fraud causes of action brought by Plaintiffs: (1) fraud by Hugh and his accountant Davie Kaplan; (2) aiding and abetting a fraud; (3) breach of fiduciary duty by Hugh; and (4) breach of fiduciary duty.  Plaintiffs brought suit on August 31, 2016.

In New York, a fraud claim must be commenced within six (6) years from the date the cause of action accrued or two (2) years from the time the plaintiff…discovered the fraud, or could with reasonable diligence have discovered it.  CPLR § 213(8).

In Pennsylvania, there is a two (2) year statute of limitations in which one can advance a fraud claim.  See 42 Pa.C.S. § 5524(7).  Like New York, however, Pennsylvania’s doctrine of “fraudulent concealment” tolls the running of the statute of limitations in a fraud-based action if the allegedly-fraudulent defendant “causes the plaintiff to relax his vigilance or deviate from his right of inquiry into the facts.”  Fine v. Checcio, 582 Pa. 253 (2005).  The plaintiff has the burden of proving fraudulent concealment by clear, precise, and convincing evidence.  See Id. 

The Complaint details two separate sets of fraudulent acts.  The first set of fraudulent acts allegedly occurred between 2002 and 2003.  In sum, Hugh induced Epiphany to sell its various extracurricular programs to Magic Management LLC, a company that Hugh was indirectly affiliated with, for significantly under market value.  Magic Management LLC also agreed to pay rent to Epiphany at an extremely elevated rate, given that their programs only encompassed about 10% of the building space (the company never actually made any rent payments).  Wendy – who has no financial expertise – signed a purchase order in connection to the extracurricular programs on February 12, 2003.

The Appellate Court’s Decision

The First Department affirmed the Supreme Court’s dismissal of these claims.  Wendy could have discovered the fraud when she signed the purchase order in February 2003.  Thus, claims related to the alleged fraud committed were dismissed by way of the statute of limitations.

The second set of fraudulent acts relate to events that took place between 2007 and 2013.  Hugh allegedly made unauthorized transfers of close to $6 million from Epiphany’s bank accounts to his own, private bank accounts.  Hugh – with the help of Kaplan, his accountant – allegedly falsely indicated that these transfers were loans.  The “loans” were not documented, nor were loan payments ever made.  Later, the loans were characterized as “other receivables,” which were offset by fabricated charges Epiphany owed to some of the collateral defendants.

The First Department overruled the Supreme Court’s decision that the acts constituting the second set of fraud were time-barred.  The First Department held that Hugh and his accountant went to “great lengths” to “loot Epiphany’s funds,” so much so that Plaintiffs “could not have discovered the alleged fraud with reasonable due diligence.”  The Court held that Plaintiffs’ fraud claims relating to the second set of fraudulent acts are timely per the two-year discovery rule (August 31, 2014 – two years before the Complaint was filed).  The Court also applied this logic when re-instating Plaintiffs’ breach of fiduciary duty claim, given that the discovery accrual rule applies to fraud-based breach of fiduciary duty claims. 

A full copy of the First Department’s Decision can be found here. 

Analysis of Epiphany

One can parse the distinction between the first set of fraudulent acts, and the second set, with regard to Wendy’s appropriate knowledge thereof.  Wendy signed the purchase order in 2003 – she could have investigated the terms of the contract, i.e. the grossly elevated rent figure and incredibly low contract price.  With regard to the second set of fraudulent acts, though, the Court has seemingly drawn a line in the sand.  Hugh and his accountant, the Court held, deliberately hid the transfers from Wendy by manipulating Epiphany’s record keeping books. 

In other words – one does not need to be a financial professional to understand the implications of a contract, like the purchase agreement in 2003.  Wendy could have investigated the contract at greater length – namely, the bizarre rent and contract prices, which any business owner could have  - and perhaps should have - noticed.  Wendy is not, however, expected to uncover the fraud hidden by a company’s accountants when “cooking the books,” so to speak.  Thus, the First Department held that Wendy could not have discovered the alleged fraud with reasonable due diligence.  Epiphany’s holding may have broadened the “discovery rule” as applied to financial professionals.  Wendy’s lack of financial expertise is frequently juxtaposed by the Court against Hugh’s position as a financial professional and “great lengths” taken to conceal the unauthorized transfers.  

Epiphany also sheds light on the “justifiable reliance” element a fraud claim – a necessary element of fraud in both Pennsylvania and New York.  The case stands for the principle that familial relations can create an element of justifiable reliance, as the Court even reasons during its holding, “Wendy trusted her husband.”  Epiphany may well broaden the First Department’s interpretation of justifiable reliance, in that familial relations appear to implicitly create a level of justifiable reliance, specifically if one individual is highly educated and/or a financial professional, and the other is not.    

* This article was prepared by Daniel Butler and Andrew Jones of the New York City-based law firm of Furman Kornfeld & Brennan LLP. Dan and Andrew are part of a team of 15 lawyers and paralegals devoted to the defense of attorneys and other professionals in malpractice and disciplinary matters, as well as the defense of construction and personal-injury accidents. For more information about the above topic or the authors, please visit: www.fkblaw.com

We trust that the above article was useful and thought-provoking; however, please note that it is intended as a general guide and opinion only, not a complete analysis of the issues addressed, and readers should always seek specific legal guidance on particular matters.  For more information on LPL coverage generally, contact USI Affinity today.