First Department Revives Claims Against Accountants For Malpractice and Fraud Despite Evidence Showing They Disclosed The Purportedly Fraudulent Transactions In Company’s Financial Statements

On April 4, 2024, the Appellate Division, First Department, reversed a lower court decision to dismiss claims for malpractice and aiding and abetting fraud brought against an accounting firm despite evidence showing the accountants had disclosed the allegedly fraudulent transactions to the plaintiffs. In 1650 Broadway Associates, Inc., et al. v. Kenneth Strum, et al., Index No. 651690/2021, majority owners of the Manhattan 50s-themed Stardust Diner asserted claims against their former accountants after allegedly uncovering years of financial malfeasance by the diner’s minority owner and manager. The wrongdoing included taking unauthorized loans from the diner and forging one plaintiff’s signature on loan guarantees. The plaintiffs sued both the manager and the diner’s accounting firm, arguing the accountants knew of the fraudulent loans and breached their fiduciary duties by failing to alert them of the misconduct.

The lower court (Justice Andrew Borrok) dismissed the plaintiff’s claims under CPLR 3211(a)(1) in light of documentary evidence showing that the accountants had disclosed the loans to plaintiffs in financial statements prepared by the accounting firm. The First Department reversed. The opinion by Justice Dianne Renwick held that the financial statements did not sufficiently refute the plaintiffs’ claims. The Court explained:

[W]hile plaintiffs’ own negligence in monitoring Kenneth’s activities in managing the Diner may have been a factor in enabling Kenneth to continue his alleged fraudulent scheme for several years, the pleadings and documentary evidence submitted do not show that such negligence was the sole proximate cause of the Diner’s loss. It has not been established that such negligence impeded defendant’s duties to reveal to plaintiffs what it knew about Kenneth’s alleged improper conduct regarding the loans.

The attorneys at Schlam Stone & Dolan frequently counsel clients facing professional malpractice claims. Contact the Commercial Division Blog Committee at commercialdivisionblog@schlamstone.com if you or a client have questions concerning such issues.