Case Brief: WA Southwest 2, LLC v. First American Title Ins. Co. (2015)

Case Brief: WA Southwest 2, LLC v. First American Title Ins. Co. (2015) 240 Cal.App.4th 148

Main Lessons from WA Southwest 2, LLC

  • Relying on a fiduciary like a real estate agent or a financial advisor reduces your burden of investigation, but it does not remove it completely.
  • Investigate signs of problems early, because the court may stop you from claiming that there is a problem if too much time passes.

Facts Summary:

WA Southwest purchased a commercial property to save money on taxes. They hoped to use a 1031 tax exchange to shelter capital gains from the IRS. But, the amount of money that they saved in taxes was consumed by commissions, closing costs, attorney fees, and other transactional costs.

WA Southwest sues, claiming that had they known the total transaction costs exceeded 15% of the total investment cost, that they would never have purchased the investment property. This combination of commissions and extra fees is referred to as a “sales load.”

Before WA Southwest invested in the shared investment interest, various parties in the transaction framed the investment as follows: The sales loads are less than 10%, and the tax that you would owe on your capital gains is 15%. The representation made the investment attractive because of the 5% difference between the costs of the transaction and the savings. That 5% difference never materialized. Of the $5.5 million that WA Southwest attempted to invest, only $3.78 million made it into the investment, which means that over 20% of the initial investment was consumed by sales loads.

In September 2012, WA Southwest learned of the problem when a bank foreclosed on the shared investment. At that time, tax experts tore apart the numbers and discovered the discrepancies. The purchase occurred in 2005.

Can WA Southwest claim delayed discovery to avoid the statute of limitations?

The statute of limitations normally runs from the date of injury. However, statute of limitations can be tolled (“Tolling” is like hitting the pause button on a timer).

To delay the statute of limitations, one needs to make a valid claim for the delayed discovery rule. This rule requires the plaintiff show two essential factors: “‘(1) the time and manner of discovery and (2) the inability to have made earlier discovery despite reasonable diligence.’” (WA Southwest 2, LLC v. First American Title Ins. Co. (2015) 240 Cal.App.4th 148, 157 [192 Cal.Rptr.3d 423], quoting Fox v. Ethicon Endo-Surgery, Inc. (2005) 35 Cal.4th 797, 807 [27 Cal. Rptr. 3d 661, 110 P.3d 914].) If proved, the delayed discovery rule would set the start date to the date at which the plaintiff first had inquiry notice of a problem.

Here, the time and manner of discovery was in September 2012 when tax experts were consulted to review a foreclosure on the investment property. This is clearly set in the pleadings.

WA Southwest fails to establish element two however. The disclosure documentation clearly describes that the total amount collected exceeded the available equity in the building.

WA Southwest also fails to establish that they did not have inquiry notice as of 2005 when they first read the investors’ memorandum.

When did WA Southwest first have inquiry notice that a problem might exist?

The investors’ memorandum listed the total amount of money to be raised including the $5.5 million in investments and the $8.7 million in financing. It laid out how the $5.5 million would be split, and the investor could see that the total value of $14.2 million was more than the $11.6 million retail cost of the building. This breakdown appeared in different ways at several points of the investors’ memorandum, and “[p]laintiffs only needed the private placement memorandum and a calculator to obtain the information they now deem essential.” (WA Southwest 2, LLC v. First American Title Ins. Co., supra, 240 Cal.App.4th 148, 158 [192 Cal.Rptr.3d 423].)

WA Southwest had notice from the very first moment that they read the investors’ pamphlet.

Can WA Southwest be relieved of a duty to investigate when they hired professionals to act as their fiduciaries?

“’Where a fiduciary obligation is present, the courts have recognized a postponement of the accrual of the cause of action until the beneficiary has knowledge or notice of the act constituting a breach of fidelity. [Citations.] The existence of a trust relationship limits the duty of inquiry. “Thus, when a potential plaintiff is in a fiduciary relationship with another individual, that plantiff’s burden of discovery is reduced and he is entitled to rely on the statements and advice provided by the fiduciary.”’ (Eisenbaum v. Western Energy Resources, Inc. (1990) 218 Cal.App.3d 314, 324 [267 Cal. Rptr. 5].)”

(WA Southwest 2, LLC v. First American Title Ins. Co., supra, 240 Cal.App.4th 148, 157 [192 Cal.Rptr.3d 423].)

“But, even assuming for the sake of argument that each of the respondents had a fiduciary duty to plaintiffs, this does not mean that plaintiffs had no duty of inquiry if they were put on notice of a breach of such duty.” (WA Southwest 2, LLC v. First American Title Ins. Co., supra, 240 Cal.App.4th 148, 157 [192 Cal.Rptr.3d 423].)

WA Southwest cannot claim that they relied entirely on their fiduciaries, as they would like. The documents provided to them included many disclaimers admitting that the investments were high risk and required additional caution. In addition, the court points out that

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