Investigation of business partners and contracts

High net worth and affluent individuals have a greater expectation of performing proper due diligence when partnering in an enterprise or contracting for a business arrangement. When claiming fraud, courts are more likely to dismiss claims if the defrauded party had an opportunity to have previously discovered red flags of fraud through a due diligence investigation. “In Karfunkel v. Sassower, No. 602244/2009 (N.Y. Sup. Ct. Sept. 12, 2012), Judge Peter O. Sherwood granted a motion for summary judgment dismissing plaintiff’s claim of civil fraud for lack of both scienter and justifiable reliance, holding that sophisticated parties may not justifiably rely on alleged fraudulent misrepresentations when accurate information is readily accessible.” In this case, the plaintiff alleged to have been defrauded through a scheme of commingling invested funds and business inventory. The court dismissed the claims stating that the losses could have been avoided if the contractual representations had been investigated and verified. “Judge Sherwood found that sophisticated parties have an obligation to conduct their own appraisal of risk when the true nature of their investments can be easily ascertained. Therefore, Karfunkel could not establish that he was intentionally misled if he failed to make use of available means of verification.”

Misrepresentations occur even at more visible enterprises. The Huffington Post was surprised to discover that its vice-president of marketing had an open arrest warrant. A background investigation on the executive revealed that he had failed to appear in a DWI case, 9 years earlier. Publicly traded firm Yahoo was made aware that its CEO had lied about his educational background and earned degrees. Yahoo CEO Scott Thompson does not have a bachelors degree in computer science as he had misrepresented. An investigation by investment firm Third Point discovered the fraud.

If executives at high-profile firms are willing to misrepresent their background, it is certain to also occur at mid-size firms and small business. The damage done to a company due to fraud, embezzlement, or even incompetent management can be catastrophic and frequently not covered by business insurance.

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