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NY: Due Diligence in Real Estate Transactions: §1031 Exchanges

Winters v. Dowdall 63 A.D.3d 650 (1st Dep’t 2009).

NY: Real Estate Transaction

Student Contributor: Nicholas Tam

Facts: Plaintiff was selling New York real estate in accordance with exchange transactions section 1031 of the Internal Revenue Code. In 2008, plaintiff retained defendant to perform a number of legal services including advising plaintiff regarding the selection of a ‘qualified intermediary’ for the transaction, coordinating with other professionals to facilitate the transaction, and to provide general legal services and advice in connection with the real estate sale. Their retainer agreement listed these terms, and the scope of the defendants’ legal representation was clearly outlined to cover every aspect of the section 1031 exchange transaction. Defendants held themselves out to be experienced attorneys having specialized knowledge and expertise in the area of section 1031 transactions.

Defendants chose Atlantic Exchange Company (“AEC”) as the ‘qualified intermediary’ in the real estate transaction. Upon this advice from the defendants, plaintiffs transferred $604,919.73 to AEC. These funds were to be held by AEC and put into a separate, interest bearing account for the benefit of plaintiff. At no time following the transfer of plaintiff’s funds into the AEC account did defendants take any action to confirm or ensure that the transfer of the funds were actually in compliance with IRS rules and regulations. The funds were not placed in a secured account, and AEC’s principal had free access to the account where he proceeded to loot the plaintiff’s funds for his personal benefit. AEC filed for bankruptcy. After further investigation, plaintiffs found out that the defendant failed to properly investigate AEC prior to selecting it to act as the qualified intermediary in the section 1031 exchange transaction. Moreover, defendants did not uncover the fact that AEC was inadequately bonded if a situation like this arose.

Issue: Whether defendants had performed due diligence in selecting a properly bonded company as the qualified intermediary for the plaintiff’s exchange transaction?

Ruling: The defendants had failed their duty to perform due diligence. Plaintiff sufficiently pleaded the action for legal malpractice because the defendants failed to properly investigate the company prior to selecting it to act as a ‘qualified intermediary’ in the exchange transaction. Plaintiffs relied upon the defendants, who had carried themselves out to be experts in the field of section 1031 exchange transactions, and plaintiff relied on these representations before hiring them as counsel for a variety of matters. The court specifically found that the defendants’ failures were the proximate cause of plaintiff’s damages.

Lesson: For law firms, it is crucial to perform due diligence when choosing a company for an important purpose such as an exchange transaction. The defendants’ failure to find out that the company chosen was insufficiently bonded arose to the level of legal malpractice.

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Posted in: New York, Real Estate