Disputes in Real Estate Partnerships: How to Excavate Adequate Business RecordsBy Eric A. Kreuter | November 16, 2018
Consider this scenario: A partner in a real estate deal determines that there may have been wrongdoing with respect to the operations of a real estate partnership. Monies are missing, and expenses appear to be excessive and unsupported. He further suspects that the alleged miscreant has been “cooking the books” for years. Available records indicate that transfers of funds occurred using business entities where no transactions were authorized. The partner contacts an attorney and begins the process of making a claim in court. After retention of counsel and the filing of a suit in state court, the attorney engages the services of a forensic accountant, who could conduct an analysis of the records, prepare a report of alleged economic damages and testify as needed. All is good — but is it?
The forensic accountant will routinely inquire first about the nature of the dispute, then, after conducting conflict checks, discuss the availability of business records covering the period of concern with the attorneys, the client and any external sources that can provide financial data. While the accountant can explain what the normal records consist of, sometimes some of these records are not available from the partnership.
- Bank records are not always maintained by businesses for more than a few years, so there may be a need to issue subpoenas to obtain them directly from the banks. That may seem rather straightforward, but some banks place limits on the number of years that they will preserve historic records.
- Similarly, past business tax returns can be requested directly from the taxing authorities, but the older ones tend to be more difficult to obtain.
- The accounting software that is used by the client may be obsolete or unable to transfer data to an external source. There might also be a possibility that there are no accounting records prepared by the client’s office.
- There might be a possibility that the client’s data is stored in obsolete storage devices — for example: floppy disks.
- There is also the possibility that the storage devices are corrupted.
- There may be problems with the statute of limitations which could, potentially, bar use of information to formulate claims that are beyond the reach of the statute. Here, counsel will advise how many years are relevant considering the potential limitations
When older records are available, the cost of reviewing and corroborating them through other business records and other evidence increases, sometimes significantly. It is for this reason that a careful assessment must be made, via collaboration of client-counsel- accountant, to determine how many years back to review and the level of perceived difficulty obtaining adequate records. One strategy that can be helpful is to propose the work be done in distinct phases, each having an estimated cost budget.
Once a suit is filed, counsel for plaintiff will normally demand that all records be preserved. However, destruction of records continues to be possible. If there is doubt that the records demanded during the discovery process will be tendered, then consideration of further steps is warranted, including issuance of subpoenas.
Another concern that might affect cost: if an individual who oversaw the financial records has resigned, or was terminated prior to litigation, then it will be more difficult for the forensic accountant to gather the necessary information and to piece together all the missing parts.
To help deal with the above challenges, it is wise for the real estate investor/business owner to work with the forensic accountant to first develop a theory of damage and then survey what records are available in order to support the damage theory. Some of these will be annexed as exhibits to the expert’s report and all records will discoverable by the defense. The expert retained by the defense can be expected to derive a divergent perspective over the meaningfulness of the records, especially since their client will doubtlessly provide comments. Inferences may be made where there is a lack of data, but the expert may be challenged if there is a bias in the extrapolation.
To help the plaintiff manage in an environment of incomplete records, the best place to begin is with a summary of what normal business records are expected to have been retained. If there is an easily proven wide gap in the records, counsel can plead for a negative inference.
A comprehensive review of available records is warranted. If conclusions can be reached based on the limited available records, then they should be cited in the expert report. If it is not possible to reach conclusions, then this limitation should be cited in the report. The damages expert ought not make leaps as part of his assessment of damages, especially as it pertains to factual evidence upon which opinions are reached.
The owner has a definite role in their own case and should be very involved from planning to conclusion. Such interactive attention to record availability could make the difference between a winnable case and not.
About Eric A. Kreuter
Eric Kreuter, Ph.D., CPA, CGMA, CFE, CBA is a Partner in the Advisory Services group at Marks Paneth LLP. He specializes in litigation and forensic services including commercial damages and fraud investigations. His background also includes management, human resources and other consulting services. He is also a specialist in all facets of the construction industry. Dr. Kreuter has worked in professional services firms since 1983 and was also a founding shareholder in a CPA firm.... READ MORE +