California Statutes of Limitations and the Discovery Rule

“It’s All in the Timing”: California Statutes of Limitations and the Discovery Rule

Attorneys: Edward Zusman and Elliott Rector

Statutes of limitations are an integral component of the legal system enacted as a matter of public policy and designed “to give defendants reasonable repose, that is, to protect parties from defending stale claims [and] to require plaintiffs to diligently pursue their claims.”[1]  To effectuate such policy considerations, statutes of limitations serve as a deadline for filing a lawsuit affecting the procedural and substantive rights of the parties.  Depending on the claim, most lawsuits must be filed within a certain amount of time after the claim accrues, typically the time at which an injury is suffered.  Generally, once the statute of limitations expires, the legal claim is no longer valid and is barred unless a legal exception applies.  The discovery rule is one such important exception postponing the accrual of the cause of action because in certain circumstances it is not reasonably possible for a person to discover the cause of injury or even know that an injury has occurred until an extended period of time after the act which caused the alleged injury.  Therefore, determining when the statute of limitations begins to run, whether the discovery rule applies upon expiration, and if applicable, whether the plaintiff satisfactorily plead the necessary facts to support the claim is critical to whether the filed claim may proceed or is barred.

  • WA Southwest2, LLC v. First American Title Insurance Company

In WA Southwest2, LLC v. First American Title Insurance Company, 240 Cal. App. 4th 148, 156 (2015), the California Court of Appeals recently issued a decision clarifying the applicability and pleading requirements of the discovery rule as an exception to the general rule of accrual of statute of limitations.  Specifically, the court held that a private placement memorandum provided to investors prior to the investment constitutes sufficient notice to preclude the tolling of statute of limitations under the discovery rule.

In WA Southwest2, real estate investors brought an action against an escrow company, real estate broker, and investment promotors’ legal counsel for breach of fiduciary duty, fraud, legal malpractice, and conversion.  From December 2005 to March 2006, Plaintiffs collectively invested approximately $5 million in the property at which time they were presented with the private placement memorandum detailing the sales load and riskiness of the investment.  Plaintiffs allegedly discovered Defendants’ wrongdoing in September 2012 citing “experts in taxation and accounting reviewed the record related to the discharge of indebtedness issue presented only by the foreclosure [of the property]”.  By the time Plaintiffs filed the complaint in November 2012, each claim was barred by the relevant statute of limitations.  Thus, the issue on appeal was whether the delayed discovery rule applied to postpone the accrual of each cause of action so as not to bar Plaintiffs’ claims.

  • The Discovery Rule

The discovery rule “postpones accrual of a cause of action until the plaintiff discovers, or has reason to discover, the cause of action.”  Id. at 156.  To invoke the discovery rule, a plaintiff must plead: “(1) the time and manner of discovery and (2) the inability to have made earlier discovery despite reasonable diligence.”  Id. at 157 (emphasis in original).  “In order to adequately allege facts supporting a theory of delayed discovery, the plaintiff must plead that, despite diligent investigation of the circumstances of the injury, he or she could not have reasonably discovered facts supporting the cause of action within the applicable statute of limitations period.”  Nguyen v. W. Digital Corp., 229 Cal. App. 4th 1522, 1553 (2014).

Further, “[w]here 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.  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 plaintiff’s burden of discovery is reduced and he is entitled to rely on the statements and advice provided by the fiduciary.’”  WA Southwest2, supra, citing Eisenbaum v. Western Energy Resources, Inc. (1990) 218 Cal.App.3d 314, 324, 267 Cal.Rptr. 5.)

In WA Southwest2, the plaintiffs argued that the statute of limitations only began running when they consulted with tax and accounting experts.  The court rejected plaintiffs’ argument because they had been provided with a private placement memorandum prior to their investments that clearly disclosed the fees, expenses, and commissions that would be paid out of their cash investments, as well as the risky nature of the investments and reasonable diligence does not consist of ignoring a private placement memorandum received prior to making an investment.  Id. at 158.  The court explained that the information and disclosures in the private placement memorandum put plaintiffs on notice of the falsity of any communications they may have received about the sales load, tax advantages, or risk-free nature of the investment and accordingly, the court found that the delayed discovery rule did not apply.

The court also rejected plaintiffs’ argument that they did not receive a clear explanation of the “sales load” for their specific investment (i.e., dollar breakdown), or even an explanation of the “sales load” for each one percent investment share.  The court explained that the disclosures in the private placement memorandum were sufficient to put plaintiffs on notice that the “sales load” exceeded the capital gains tax rate distinguishing the plaintiff’s situation from one in which the party relies on the statements of a fiduciary about the legality of a complicated transaction.  Again, the court found that the plaintiffs failed to adequately plead the applicability of the delayed discovery rule.

  • Lessons from WA Southwest

WA Southwest2 makes clear that the statute of limitations commences with the disclosure an investment prospectus.  Notably, in Footnote 6, the court recognized that the receipt of investment disclosures can trigger the statute of limitations in appropriate cases citing Dodds v. Cigna Securities Inc. (2d Cir. 1993) 12 F.3d 346, 347 [“when an investor is provided prospectuses that disclose that certain investments are risky and illiquid, she is on notice for purposes of triggering the statute of limitations that several such investments might be in appropriate in a conservative portfolio”] and Calvi v. Prudential Secs. (C.D.Cal.1994) 861 F.Supp. 69, 71 [“the statute of limitations begins to run when a plaintiff should have discovered the alleged fraud, and … the receipt of a prospectus disclosing risks puts a plaintiff on notice of any misrepresentations of fraud concerning those risks”].  Plaintiffs cannot rely on the discovery rule to toll the statute of limitations in circumstances where they were provided investment prospectuses disclosing information such as fees, expenses, commissions, and detailing the risks of the investments prior to making the investments.  Further, in circumstances where a fiduciary relationship exists, plaintiffs have a duty of reasonable diligence and inquiry if put on notice of a breach of such duty as is the case when the plaintiff is provided written disclosures of the fees, costs, and risks of an investment contained in an investment prospectus prior to making such investments.

[1] Jolly v. Eli Lilly & Co., 44 Cal. 3d 1103, 1112, 751 P.2d 923, 928, 245 Cal. Rptr. 658, 662-63 (1988) (citing Davies v. Krasna, 14 Cal. 3d 502, 512, 535 P.2d 1161, 1168, 121 Cal. Rptr. 705, 712 (1975).