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From Health Law Daily, June 26, 2014

Former medical residents’ fraud action against hospital will proceed

By Michelle L. Oxman, JD, LLM

New York and Presbyterian Hospital (NYPH) must defend against the claims of former medical residents for fraud, constructive fraud, negligent misrepresentation, unjust enrichment, and breach of fiduciary duty arising out of the hospital’s settlement of a dispute with the Internal Revenue Service (IRS). Although neither the employer-employee relationship nor the university-student relationship ordinarily gives rise to a fiduciary duty, the hospital had both a fiduciary duty and a duty to disclose material information to the residents when it bargained away both its own and the residents’ right to claim refunds of FICA taxes in its settlement of an unrelated dispute with the IRS. Therefore, the hospital’s motion to dismiss was denied as to all claims other than breach of contract (Childers v The New York and Presbyterian Hospital, June 23, 2014, Schofield, L).

The FICA tax issue. Between the mid-1990s and 2010, there was a dispute between the IRS and medical schools as to whether medical residents were subject to FICA taxes on the income they earned from medical school. The medical schools contended that a statutory exemption for students applied. In order to protect their potential claims for refunds, many hospitals with graduate medical education (GME) programs, including New York and Presbyterian, filed protective claims on behalf of themselves and their residents and fellows.

In 1998, in State of Minn. v. Apfel, 151 F.3d 742, the Eighth Circuit held that the residents were entitled to the exemption, but the IRS disagreed. IRS regulations published in 2005 provided that students who worked more than 40 hours per week were not eligible for the exemption. Between 2007 and 2009, three more circuits ruled that the medical residents were not automatically ineligible for the exemption (see, e.g.U.S. v Mt. Sinai Medical Center of Florida, Inc., 486 F.3d 1248 (11th Cir. 2007)). Eventually, in 2010, the IRS announced that no FICA taxes were required for medical residencies before 2005. The IRS paid refunds to the medical schools that had filed protective claims.

The hospital’s actions. NYPH had GME programs affiliated with the medical schools at both Cornell University (Cornell) and Columbia University (Columbia). Plaintiffs were medical residents in Cornell’s program at NYPH between 1995 and 2001. NYPH had withheld FICA taxes from the paychecks of residents in both programs. It filed protective claims for refunds on behalf of the Columbia residents and fellows for 1995 and 1997 through June 30, 2005. However, it did not file claims on behalf of the Cornell residents and fellows until 2001 because it had waived the rights to refunds for the period ending June 30, 2001 to settle an unrelated tax dispute.

When the former Cornell residents learned of the IRS decision, they contacted NYPH and were told that claims would be filed on their behalf. NYPH did not disclose that it had waived the residents’ claims in the settlement. In 2013, when they learned that residents from other schools were receiving refunds of FICA taxes withheld, the former Cornell residents contacted NYPH again. NYPH then told them that no protective claim had been filed. By the time the former residents learned of the settlement, the statute of limitations for filing the refund claims had expired.

The consolidated complaints. Two groups of plaintiffs (the Simon group and the Childers group) filed claims alleging unjust enrichment and breach of fiduciary duty. The Childers group also alleged fraud, constructive fraud, negligent misrepresentation, and breach of contract. Both complaints sought damages arising out of NYPH’s having bargained away the plaintiffs’ claims for refunds without the residents’ knowledge or consent and withholding the information until the statute of limitations had expired.

Jurisdictional defense. NYPH first argued that the complaints were claims for tax refunds and were barred by 26 USC sec. 7422, which provides that actions for refunds may be brought only against the government. The residents argued that they did not seek refunds of taxes paid, but damages for the hospital’s tortious conduct. The court agreed, reasoning that the purpose of section 7422 was to protect employers from claims by employees for taxes allegedly withheld in error when the employer might still be liable to the government for the taxes. This situation was distinguishable in that NYPH had not merely withheld taxes, but waived the former residents’ rights to claim the refund without their knowledge or permission.

Unjust enrichment. The court first ruled that the residents stated a claim for unjust enrichment by alleging that the hospital: (1) was aware of the legal issue concerning exemption from FICA taxes and knew that the residents were not aware of it; (2) bargained away the residents’ rights without their knowledge; and (3) retained the benefit for itself. Using the residents’ claims to settle its own dispute was equivalent to keeping the withheld funds for itself.

Breach of duty. In addition, the court ruled that NYPH incurred a fiduciary duty toward the residents when it acted on their behalf with respect to their potential claims for refunds. Under 26 CFR sec. 31.6402(a)-2, an employer who seeks a refund of FICA taxes must certify that it has paid the employees the share withheld from them or make the claim on behalf of and with the consent of the employees. The regulation and related statute impose a fiduciary duty and, for purposes of fraud, a duty to disclose material facts. The same conduct constituted intentional fraud, constructive fraud, breach of fiduciary duty, and negligent misrepresentation.

The court denied the hospital’s motion to dismiss based on the statute of limitations because the residents adequately alleged that they were unaware of the claim until they learned of the settlement in 2013.Whether they reasonably should have been expected to learn of it earlier was a fact question to be resolved later.

The breach of contract claims. The court dismissed the Childers group’s claims for breach of contract on the ground that there were no factual allegations that supported the formation of either an express or an implied agreement by NYPH with respect to the FICA taxes withheld.

The case numbers are: 13 Civ. 5414 (LGS) and 13 Civ. 5899 (LGS).

Attorneys: Steven Karl Barentzen (The Law Office of Steven Barentzen) for Dr. Henry Erle Childers, IV. Maura Barry Grinalds (Skadden Arps Slate Meagher & Flom LLP) for The New York and Presbyterian Hospital.

Companies: The New York and Presbyterian Hospital

MainStory: TopStory EmploymentNews GMENews NewYorkNews

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