150 A.D.3d 192
N.Y. App. Div.2017Background
- Dr. Andrew Carothers formed a professional service corporation (Andrew Carothers, M.D., P.C.) in 2004 to operate three MRI facilities; the facilities and equipment were leased from companies controlled by nonparty Hillel Sher.
- Thousands of MRI scans were performed (many for auto-accident patients) and patients assigned no-fault claims to the corporation; insurers refused payment and the plaintiff sued to recover assigned no-fault benefits.
- Insurers defended under the “fraudulent incorporation” theory from State Farm v. Mallela: they alleged Carothers was a nominal owner while nonphysicians (Sher and executive secretary Irina Vayman) actually owned/controlled the practice and siphoned profits via inflated leases and transfers.
- Trial evidence included expert testimony showing unusually large lease payments and transfers to Sher/Vayman, a forensic accountant tracing substantial funds to Sher’s companies and Vayman’s personal account, and minimal compensation to Carothers; Carothers could not satisfactorily explain the transactions.
- Sher and Vayman invoked the Fifth Amendment in depositions; the trial court allowed reading the deposition transcripts and instructed the jury it could draw an adverse inference against the plaintiff.
- A jury found fraudulent incorporation (by clear and convincing evidence) and that Carothers was not practicing medicine as required; the Appellate Term struck the latter finding but upheld the fraudulent incorporation finding; the Second Department affirmed.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Proper jury charge/elements for fraudulent incorporation | Carothers: defendants needed to prove traditional common-law fraud, including fraudulent intent at incorporation, by clear and convincing evidence | Insurers: Mallela permits inquiry into actual ownership/control; jury may consider totality of circumstances and factors showing de facto ownership or substantial control | Court: Charge was proper — jury instructed to find de facto ownership or substantial control under totality of circumstances; need not prove classic common-law fraud or intent solely at incorporation |
| Permissible factors to assess fraudulent incorporation | Carothers: listing factors allowed jury to rely on mere technical violations or routine administrative acts | Insurers: non-exhaustive factors are relevant to determine whether nonphysicians funneled profits and controlled the corporation | Court: Enumerated factors were proper as non-exhaustive; technical violations alone insufficient but relevant when considered with other evidence |
| Business judgment rule / sham transaction instruction | Carothers: requested instructions on business judgment rule and federal sham-transaction standard to show legitimacy of payments | Insurers: evidence showed lack of corporate formalities and that payments funneled profits to nonphysicians, so those charges were unwarranted | Court: Denial proper — facts did not support a business-judgment or sham-transaction instruction; jury was told not to treat salary/leases as profits if negotiated in good faith |
| Use of deposition transcripts and adverse inference from Fifth Amendment invokes by nonparties | Carothers: allowing depositions and adverse inference unfairly prejudiced plaintiff | Insurers: invocation supported adverse inference and use of transcripts | Court: Allowing transcripts and adverse-inference instruction as to nonparty witnesses was error, but harmless given overwhelming evidence of fraudulent incorporation |
Key Cases Cited
- State Farm Mut. Auto. Ins. Co. v. Mallela, 4 N.Y.3d 313 (Court of Appeals) (fraudulent incorporation bars no-fault reimbursement; carriers may look beyond facial licensing but must show conduct tantamount to fraud)
- United States v. Gabinskaya, 829 F.3d 127 (2d Cir.) (totality-of-the-circumstances approach to ownership/control in licensing-fraud context)
- Auerbach v. Bennett, 47 N.Y.2d 619 (1980) (business judgment rule described; limits inquiry into directors’ good-faith decisions)
- Marine Midland Bank v. Russo Produce Co., 50 N.Y.2d 31 (1980) (rules on drawing adverse inferences from Fifth Amendment assertions in civil contexts)