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Current Developments in the Commercial Divisions of the
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Posted: October 21, 2014

Standard of “Ordinary and Reasonable Skill and Knowledge” In Legal Malpractice Action Measured As Of the Time of the Representation

On September 18, 2014, the First Department issued a decision in Lichtenstein v. Willkie Farr & Gallagher LLP, 2014 NY Slip Op. 06242, affirming New York County Commercial Division Justice Melvin Schweitzer’s dismissal of a legal malpractice claim for failure to state a cause of action.

In Lichtenstein, the plaintiff, Lichtenstein, hired Willkie Farr to advise him in connection with the restructuring of an entity he owned, Extended Stay, Inc., which faced a liquidity crisis. The law firm advised Lichtenstein that, as an officer and director of ESI, he “had a fiduciary obligation to put ESI into bankruptcy for the benefit of the [company’s] lenders.” This had the effect of exposing Lichtenstein, and his company Lightstone Holdings, LLC, to $100 million in personal guarantees they had given in connection with mortgage loans to ESI. However, “Willkie Farr warned that Lichtenstein otherwise faced the prospect of unequivocal and uncapped personal liability in any subsequent action by the lenders absent a bankruptcy filing by ESI.” Relying on this advice, Lichtenstein caused ESI to file a bankruptcy petition, and the lenders subsequently brought actions to enforce the guarantees, which resulted in the entry of a $100 million judgment against Lichtenstein and Lightstone Holdings.

Lichtenstein brought a malpractice action against Willkie Farr, arguing that the law firm’s advice as to the viability of a breach of fiduciary duty claim by ESI’s creditors was erroneous because ESI’s “constituent entities” were LLCs, and recent Delaware Supreme Court authority holds that lenders of an LLC (as opposed to a corporation) lack standing to bring derivative claims for breach of fiduciary duty against the LLC’s management. The First Department rejected this argument because the issue of lender standing in the LLC context had not been established at the time the advice was rendered:

On this appeal, plaintiffs argue that Willkie Farr’s advice did not meet the requisite standard of professional skill because a derivative suit by the lenders against Lichtenstein for breach of fiduciary duty would not have been successful. In making the argument, plaintiffs recognize that under Delaware law, the exposure Lichtenstein faced by reason of ESI’s insolvency differed from the exposure that would be faced by the officers and directors of a traditional stock-issuing corporation. For example, when a corporation is solvent its directors’ fiduciary duties may be enforced by its shareholders, who have standing to bring derivative actions on behalf of the corporation because they are the ultimate beneficiaries of the corporation’s growth and increased value (North Am. Catholic Educ. Programming Found., Inc. v Gheewalla, 930 A2d 92, 101 [Del 2007]). On the other hand, when a corporation is insolvent, “its creditors take the place of the shareholders as the residual beneficiaries of any increase in value. Consequently, the creditors of an insolvent corporation have standing to maintain derivative claims against directors on behalf of the corporation for breaches of fiduciary duties” (id.).

Citing CML V, LLC v Bax (28 A3d 1037 [Del 2011], plaintiffs argue that the landscape is different with respect to Lichtenstein’s fiduciary duty because the constituent entities that made up ESI were Delaware limited liability companies (LLCs) as opposed to corporations. In CML, the Supreme Court of Delaware held that under the Delaware Limited Liability Company Act (6 Del Code Ann tit 6, ch 18) § 18-1002, derivative standing is limited to “member[s]” or “assignee[s]” and unavailable to creditors of LLCs (id. at 1046). Plaintiffs’ argument is not persuasive because the Supreme Court of Delaware’s opinion in CML as well as the Delaware Chancery Court’s opinion, which it affirmed (6 A3d 238 [Del Ch 2010]), were decided after Willkie Farr gave the advice described in the complaint. In fact, the Chancery Court observed that “virtually no one has construed the derivative standing provisions [of § 18-1002] as barring creditors of an insolvent LLC from filing suit” (id. at 242). The Chancery Court further noted that “[m]any commentators . . . have assumed that creditors of an insolvent LLC can sue derivatively” (id. at 243 [citations omitted]).

In a legal malpractice action, what constitutes ordinary and reasonable skill and knowledge should be measured at the time of representation. In this case, the time of Willkie Farr’s representation preceded the Chancery Court’s decision in CML by approximately two years. Accordingly, the complaint fails to allege that Willkie Farr’s advice was wanting by reason of its failure to advise Lichtenstein that the creditors of the ESI constituent entities lacked standing to bring derivative actions.

Whenever an attorney advises a client on an area of the law that is unsettled, as was the case in Lichtenstein, the advice may, with the benefit of 20/20 hindsight, prove to be incorrect. However, as this decision illustrates, the standard of “ordinary and reasonable skill and knowledge” does not require clairvoyance on the attorney’s part. A malpractice claim will not lie because an attorney failed to predict future developments in the case law.

Posted: October 20, 2014

Court of Appeals Arguments of Interest for the Week of October 20, 2014

Arguments the week of October 20, 2014, in the Court of Appeals that may be of interest to commercial litigators.

  • No. 197Kimso Apartments, LLC v. Gandhi (To be argued Tuesday, October 21, 2014) (considering whether Supreme Court improvidently exercised its discretion in permitting the defendant to “conform the pleadings to the proof” by amending his answer to assert an “intrinsic,” but formally unasserted, counterclaim). The Second Department decision is available here.
  • No. 216: Sierra v. 4401 Sunset Park, LLC (To be argued Wednesday, October 22, 2014) (considering whether insurance company complied with disclaimer requirements of Section 3420(d)(2) of the Insurance Law by providing notice of disclaimer of insurance to insured’s primary insurer, but not directly to the insured). The Second Department decision is available here.
  • No. 203: Strauss Painting, Inc. v. Mt. Hawley Insurance Company (To be argued Wednesday, October 22, 2014) (considering whether an insured satisfied the policy’s notice requirement by notifying its broker of the claim with the expectation that the broker would notify the carrier). The First Department decision is available here.
Posted: October 19, 2014

A Cautionary Tale Regarding Procedural Pitfalls: Part 2

In yesterday’s post on the October 1, 2014, decisions by Justice Oing of the New York County Commercial Division in Loreley Financial (Jersey) No. 3, Ltd. v. Morgan Stanley & Co. Inc., 2014 NY Slip Op. 32622(U) and 2014 NY Slip Op 32624(U), we discussed the decision in 2014 NY Slip Op 32624(U), in which the court held that despite having been given leave to file an amended complaint, the court had no jurisdiction to hear the amended complaint the plaintiffs filed after judgment dismissing the action had been entered. This post looks at the decision in 2014 NY Slip Op. 32622(U), in which the court addressed the defendants’ motion to dismiss the plaintiffs’ newly-filed action on statute of limitations ground.

The plaintiffs’ new action was not filed within the limitations period for their claims.  The plaintiffs argued that the newly-filed “action relates back to the prior action because they filed it within six months of withdrawing the appeal of the prior action.”  The court disagreed, explaining:

CPLR 205[a] provides that where an action is terminated, the plaintiff may commence a new action upon the same transaction or occurrence or series of transactions or occurrences within six months after the termination. Termination, for purposes of CPLR 205[a], occurs when appeals as of right are exhausted. In other words, the six month period runs from the date of entry of the order determining [the] appeal. The question, which appears to be one of first impression, is when does the six month period begin to run where there is a voluntary withdrawal of a timely appeal–at the time of the voluntary withdrawal, which would necessarily require a finding that such act should be deemed an appellate determination, or at the time the appealed order herein was entered, namely July 1, 2013. In resolving this issue, this Court is mindful of the following observation: “it is not the purpose of the statute to permit a party to extend the time to commence a new action by merely taking appellate action.”

Keeping that underlying principle in mind, this Court holds that plaintiffs’ voluntary withdrawal is not an appellate determination. Indeed, plaintiffs never perfected the appeal prior to withdrawing it. By doing so, for the purposes of CPLR 205[a], plaintiffs did not take an appeal. Procedurally, had they perfected their appeal, an order would have been required to have the appeal dismissed. In that circumstance, the six month statute of limitations would have run from that dismissal order. Given that plaintiffs chose to withdraw their unperfected appeal, the termination date is July 1, 2013, the date in which this Court’s order dismissing the prior action was entered. As such, this action is untimely.

(Internal quotations and citations omitted) (emphasis added).

The Loreley Financial decisions show how procedural pitfalls can trap counsel. One can understand how the plaintiffs in Loreley Financial thought that their claims were preserved–they had permission to replead, a stipulation staying the time to move and a timely-filed original action. But the court found otherwise. We look forward to seeing what the First Department does with these decisions.

Posted: October 18, 2014

A Cautionary Tale Regarding Procedural Pitfalls: Part 1

On October 1, 2014, Justice Oing of the New York County Commercial Division issued two decisions in Loreley Financial (Jersey) No. 3, Ltd. v. Morgan Stanley & Co. Inc., 2014 NY Slip Op. 32622(U) and 2014 NY Slip Op 32624(U), illustrating the importance of keeping an eye on the rules of practice.

This post focuses on the decision in 2014 NY Slip Op 32624(U), in which the court held that despite having been given leave to file an amended complaint, the court had no jurisdiction to hear the amended complaint the plaintiffs filed after judgment dismissing the action had been entered.

In Loreley Financial, the plaintiffs asserted claims of rescission, fraud, fraudulent conveyance, and unjust enrichment. On June 20, 2013, the trial court issued a decision dismissing their complaint but granting leave to replead under the same index number. The plaintiffs filed a notice of appeal and

the parties entered into a stipulation staying plaintiffs’ time to move to renew and reargue, and defendants’ time to respond to any amended complaint until a party or the Court lifted the stay. The stipulation also provided that the parties reserved all rights, and defendants did not consent to an amended complaint by signing the stipulation.

The stipulation did not prevent the defendants from seeking entry of a judgment of dismissal, and they did so. Plaintiffs did not move to vacate the judgment when it was entered.

Over seven months after the judgment dismissing the action was entered, the plaintiffs filed an amended complaint and, later, withdrew their appeal, which they had not perfected. Plaintiffs also filed “a new, identical action under” a new index number. The defendants moved to dismiss the amended complaint in the original action, arguing that the court lacked subject-matter jurisdiction to hear the amended complaint because the Clerk had entered judgment dismissing the action. The court agreed, explaining:

Nothing in this Court’s prior ruling as set forth on the record precluded defendants from exercising their rights, including having a judgment entered dismissing the action. Thus, defendants correctly point out that post dismissal filings, such as plaintiffs’ April 3, 2014 amended complaint, are nullities because there is no longer an active case. Indeed, nothing in this Court’s decision to grant plaintiffs leave to file an amended complaint can be deemed to countermand the provisions of the CPLR regarding terminated actions and subsequent filings, or defendants’ right to seek entry of a judgment of dismissal.

(Internal quotations and citations omitted) (emphasis added).

The court went on to discuss why the plaintiffs could not “take refuge in the safe harbor provisions of CPLR 5019 and 5015.” As to CPLR 5019(a), which relates to errors in judgments that are “mistake[s], defect[s] or irregularit[ies] not affecting a substantial right of a party,” the court held that it did not apply because the relief the plaintiffs sought was substantive. As to the court’s prior order granting leave to replead, the court explained that while it “noted that plaintiffs have a right to file an amended complaint, this Court did not state that such right would be absolute, and that it would not have to yield to other provisions of the CPLR.”

According to the court, once the judgment was entered, the plaintiffs’ “options were to appeal, or move to vacate the judgment pursuant to CPLR 5015. Here, plaintiffs took an appeal, but withdrew it prior to perfecting it. Given that plaintiffs filed an amended complaint, rather than pursue their appeal, the issue then is whether CPLR 5015 provides a basis to vacate the judgment so as to permit the amended complaint to go forward.” As the court explained, CPLR 5015 also provided no basis for the relief the plaintiffs sought:

CPLR 5015(a) provides that a court may relieve a party from a judgment on the grounds of excusable default, newly-discovered evidence after trial, fraud, misrepresentation, or other misconduct, lack of jurisdiction to render the initial judgment, or reversal, modification, or vacatur of the initial judgment. This list is not exhaustive, an a court retains the inherent power to vacate its own judgment for sufficient reason and in the interests of substantial justice. This authority, however, is not plenary, and should only be used in cases of fraud, mistake, inadvertence, surprise or excusable neglect. Indeed, a motion to vacate an order pursuant to CPLR 5015 cannot serve as a substitute for an appeal, or remedy an error of law that could have been addressed on a prior appeal.

Here, the record clearly does not reflect the existence of any of the enumerated bases to warrant vacatur of the instant judgment pursuant to CPLR 5015[a]. Indeed, there was no fraud, and the Clerk did not enter judgment of dismissal inadvertently or by mistake. Nor can plaintiffs claim surprise or neglect, as they filed an opposition to entry of judgment before the Clerk entered the judgment. Indeed, although permitted to do so, plaintiffs did not submit a proposed counter-judgment that could have included language preserving their right to file an amended complaint. As such, any purported error in not including such language is not chargeable to the Clerk. There has been no default, no reversal of this Court’s prior decision and order, no challenge to this Court’s jurisdiction to render its prior decision and order, and no misconduct by defendants. Lastly, plaintiffs do not assert that the judgment should be vacated due to newly-discovered evidence. Under these circumstances, vacatur of the judgment is not warranted.

(Internal quotations and citations omitted).

But what of the new action the plaintiffs had filed? Weren’t their claims saved by filing a new action? That is the subject of tomorrow’s post.

Posted: October 17, 2014

Claim by Nonresident Dismissed Based on Statute of Limitations of State Where Claim Accrued

On October 9, 2014, Justice Friedman of the New York County Commercial Division issued a decision in Cambridge Capital Real Estate Investments, LLC v. Archstone Enterprises LP, 2014 NY Slip Op. 32625(U), dismissing an action based on the statute of limitations of the state where the action accrued.

In Cambridge Capital, the plaintiff, a “minority limited partner of a fund, which invested in a real estate investment trust,” sued “the general partner of the fund and other entities, based on the general partner’s alleged conflict in the sale of the fund’s assets.” Among the issues the court addressed in deciding the defendants’ motion to dismiss was whether the plaintiff’s breach of contract claim, which accrued in Colorado, was barred by the statute of limitations. The court ruled that it was, explaining:

It is well settled that when a nonresident sues on a cause of action accruing outside New York, CPLR 202 requires the cause of action to be timely under the limitation periods of both New York and the jurisdiction where the cause of action accrued. The purpose of the statute is to prevent nonresidents from shopping in New York for a favorable Statute of Limitations. Furthermore, when an alleged injury is purely economic, the place of injury usually is where the plaintiff resides and sustains the economic impact of the loss.

While plaintiffs contract claim based on the amendments to the LPA is timely under New York’s six year statute of limitations, Colorado’s limitation period for such a claim is three years. Under Colorado law, a breach of contract claim accrues on the date the breach is discovered or should have been discovered by the exercise of reasonable diligence.

Contrary to plaintiffs contention, the determination as to when a claim accrues may be made at the pleading stage where, as here, it is clear from the undisputed facts when the breach was or should have been discovered. The Amended LPA, dated March 31, 2009, contains the amendments that plaintiff challenges. Plaintiff admits that it received the Amended LPA on August 12, 2009. As a sophisticated business entity, plaintiff could have discovered the relevant amendments by reading the document to determine the changes it made and its effect on plaintiffs interests. When it received the Amended LPA, it was aware or should have been aware that the amendments had been made without its consent.

(Internal quotations and citations omitted) (emphasis added).

Posted: October 16, 2014

Second Department Affirms Decision Finding Fee Splitting Agreements Unlawful

On October 15, 2014, the Second Department issued a decision in South Shore Neurologic Associates, P.C. v. Mobile Health Management Services, Inc., 2014 NY Slip Op. 06963, declaring contracts void as unlawful fee-splitting arrangements in connection with medical services.

In South Shore Neurologic Associates, the Second Department affirmed a trial court’s confirmation of a referee report

recommending that the court award summary judgment declaring that the subject commercial relationship among certain parties constituted an unlawful fee-splitting arrangement, and properly denied the appellants’ motion to reject the report. South Shore established its prima facie entitlement to judgment as a matter of law declaring that the commercial relationship constituted an unlawful fee-splitting arrangement in violation of Education Law § 6530(19) and 8 NYCRR 29.1(b)(4) by submitting documents and deposition testimony showing that certain contracts were a pretext to justify the appellants’ receipt of one third of the profits of South Shore’s MRI practice . . . .

(Emphasis added). Some background not in the opinion: Education Law § 6530(19) prohibits fee splitting among medical professionals. Its prohibitions include:

any arrangement or agreement whereby the amount received in payment for furnishing space, facilities, equipment or personnel services used by a licensee constitutes a percentage of, or is otherwise dependent upon, the income or receipts of the licensee from such practice, except as otherwise provided by law with respect to a facility licensed pursuant to article twenty-eight of the public health law or article thirteen of the mental hygiene law . . . .

Posted: October 15, 2014

Action for Corporate Waste Cannot be Brought Against the Former Sole Owner of a Company

On October 14, 2014, Justice Demarest of the Kings County Commercial Division issued a decision in Koryeo Intl. Corp. v. Kyung Ja Hong, 2014 NY Slip Op. 51495(U), dismissing an action for corporate waste and breach of contract.

The plaintiff, Steve Hong, who brought the action on his own behalf, and directly on behalf of Koryeo as its sole shareholder and officer, is the company’s founder’s son. He alleged that his father and the defendant induced him to abandon his legal career and work for Koryeo for a “minimal salary” by promising him that control and ownership would eventually be transferred to him. In 1995 his father died, and his mother became the sole shareholder, director and officer. In December 2012, the defendant finally transferred the company to him, and he became sole shareholder, officer, and director. But the plaintiff soon discovered that only $54,000 had been deposited in the company’s bank account in 2012, despite income of millions of dollars being disclosed on the company’s tax returns and invoices. He accordingly sued his stepmother, alleging that she had looted the company before handing it over to him.

Justice Demarest denied all claims.

First, the court held that Koryeo’s standing to bring claims was defeated by the “contemporaneous ownership rule” set forth in BCL § 626 (b):

[P]laintiffs’ allegations that all of the alleged wrongs at issue occurred while Kyun Ja Hong was Koryeo’s sole officer, director, and shareholder, and before she transferred her interest in Koryeo to Steve Hong, compel a finding that Koryeo does not have standing to bring this action. As stated by the Court of Appeals, ‘the rule is that, when stockholders are individually estopped from questioning wrongs done to their corporation, they cannot redress those same wrongs through a suit brought directly by the corporation or derivatively, by themselves, for the corporation.’ Two grounds support such an estoppel here. The first is that Steve Hong received his shares from Kyung Ja Hong, a shareholder who must be deemed to have unanimously ratified her own acts of waste and misappropriation. Any wrongdoing by Kyung Ja Hong is therefore imputed to Koryeo, which is equitably estopped from obtaining redress for its own actions. Furthermore, Steve Hong, Koryeo’s current sole shareholder and the sole prospective beneficiary of Koryeo’s recovery, acquired all of his shares after the alleged wrongful acts, and as such, he is barred from bringing a derivative action under section 626 (b). With respect to both of these grounds for estoppel, a court will pierce the corporate veil and bar a direct action by the corporation when it would only benefit a shareholder who would otherwise be barred from raising the claims in a derivative action.

(Internal citations omitted) (emphasis added).

And second, the court dismissed Steve Hong’s personal breach of contract and tort claims:

According to Steve Hong, sometime prior to his father’s death in 1995, Kyung Ja Hong promised to transfer ownership and control of Koryeo to him at some future time following his graduation from law school, which must have occurred prior to his admission to the Bar in 1992. Without providing for a specific time frame, and in light of plaintiff’s failure to seek enforcement of the alleged contract for over twenty years, the alleged promise to turn over ownership and control of Koryeo is too indefinite to establish a legally enforceable contract. In any event, Steve Hong received exactly what was promised when Kyung Ja Hong transferred the entirely of her shares to him in December 2012. While Steve Hong asserts that he received virtually worthless shares in an indebted corporation, he has made no allegation that Kyung Ja Hong promised to transfer a company with a certain amount of assets.

(Internal citations omitted.) Steve Hong’s tort claims were dismissed as derivative of his contract claim.

It may seem obvious that relying on vague promises grounded primarily in family feeling often ends in disaster, but it still happens. And in circumstances where the bad actor is the sole owner of a company, often nothing can be done.

Posted: October 15, 2014

Economic Loss Rule Precludes Tort Claims For Purely Economic Losses Arising From Defective Product

On October 1, 2014, the Second Department issued a decision in 126 Newton St., LLC v. Allbrand Commercial Windows & Doors, Inc., 2014 NY Slip Op 06563, applying the “economic loss rule” to bar the plaintiff (a “downstream purchaser” of a product) from recovering tort damages for economic losses resulting from a defect in the product.

In 126 Newton Street, the plaintiff purchased defective glass doors and windows that permitted water intrusion and brought contract and tort claims against the defendant who had fabricated and installed the defective product. Queens County Supreme Court Justice Orin Kitzes denied the defendant’s motion for summary judgment, and the Second Department reversed in part, ruling that the plaintiff’s claims for negligence and strict products liability were barred by the economic loss rule to they extent they sought damages for economic losses resulting from damage to the product itself, or consequential damages resulting from the defect. The Second Department explained the often-misunderstood economic loss rule as follows:

The economic loss rule provides that tort recovery in strict products liability and negligence against a manufacturer is not available to a downstream purchaser where the claimed losses flow from damage to the property that is the subject of the contract and personal injury is not alleged or at issue.

The rule is applicable to economic losses to the product itself as well as consequential damages resulting from the defect. Therefore, when a plaintiff seeks to recover damages for purely economic loss related to the failure or malfunction of a product, such as the cost of replacing or retrofitting the product, or for damage to the product itself, the plaintiff may not seek recovery in tort against the manufacturer or the distributor of the product, but is limited to a recovery sounding in breach of contract or breach of warranty.

The Court then proceeded to apply the rule to the Plaintiff’s claim, finding that tort claims for damages to the product itself were precluded, but the Plaintiff could recover damages in tort for injury to other structural elements of the building that were not subject to the parties’ contract:

Here, the plaintiff alleges, inter alia, that it sustained economic losses generated by the repair and replacement of the glass doors and windows of a building due to the failure of such doors and windows to properly prevent water intrusion. The fabrication and/or installation of those doors and windows were the subject of its agreement with the appellant. To the extent that the plaintiff seeks to recover losses generated by the repair and replacement of these doors and windows pursuant to causes of action sounding in negligence or strict products liability, such causes of action are prohibited by the economic loss rule. Thus, the Supreme Court should have granted those branches of the appellant’s motion which were for summary judgment dismissing so much of the causes of action sounding in negligence or strict products liability as sought to recover losses arising from the repair and replacement of the doors and windows.

However, the plaintiff also claims that the intrusion of water caused by the defective windows and doors resulted in injury to other structural elements of the building, such as flooring and walls. These losses constitute damage to “other property” that was not the subject of the parties’ agreement and, accordingly, support a valid tort cause of action. We note that while other structural elements of the building may have been damaged as a consequence of the infiltration of water through allegedly defective windows and doors, such losses do not constitute “consequential damages,” also known as “special damages,” as that term is used in contract law. Consequential or special damages usually refer to loss of expected profits or economic opportunity caused by a breach of contract.

Notably, the Defendant had not made the argument concerning the economic loss rule to the motion court. Nevertheless, the Second Department exercised its discretion to consider the issue for the first time on appeal because it was a “purely legal argument that appears on the face of the record and could not have been avoided had it been brought to the attention of the Supreme Court.” Although it would be ill-advised to withhold a winning argument with the expectation of raising it on appeal. One lesson here is that counsel handling an appeal should give new thought to legal arguments that might be raised, even if they were not made in the motion court.

Posted: October 14, 2014

Non-Signatory May Be Bound by a Contract’s Forum Selection Clause

On October 3, 2014, Justice Kornreich of the New York County Commercial Division issued a decision in Taberna Preferred Funding II, Ltd. v. Advance Realty Group LLC, 2014 NY Slip Op. 51461(U), analyzing the question of whether the court had personal jurisdiction over defendants.

One issue addressed by the court in Taberna Preferred Funding was whether the defendants should be bound by a forum selection clause in an indenture to which they were not parties, relying on Indosuez Int’l Fin., B.V. v Nat’l Reserve Bank, 304 AD2d 429, 431 (1st Dept 2003). The court explained:

In Indosuez, the Appellate Division held that “Plaintiff’s parent and subsidiary, although not parties to the agreement containing the choice of law and forum selection clauses, were sufficiently close in their relation to plaintiff to be included.” Indosuez cited federal cases in support of this holding, including Direct Mail Prod. Servs. Ltd. v MBNA Corp., 2000 WL 1277597 (SDNY 2000) (Stein, J.), which held that the relevant inquiry for discerning whether parties are closely related is whether the non-signatory is an intended beneficiary entitled to enforce the clause in question.. This is an accurate recitation of New York law. While defendants maintain this rule only applies to corporate subsidiaries and not individuals, they cite no law in support of this proposition. In fact, the rule has been applied to an individual in the arbitration context. Nonetheless, as this basis for jurisdiction turns on intent, a question of fact, the parties may pursue this issue in jurisdictional discovery and have leave to brief the issue more substantively on a subsequent motion to dismiss.

(Internal quotations and citations omitted).

Posted: October 13, 2014

Commercial Non-Compete Agreement Enforced as Written, Including the Injunctive Relief and No-Bond Provisions

On October 2, 2014, Justice Platkin of the Albany County Commercial Division issued a decision in Eric Woods, LLC v. Schrade, 2014 NY Slip Op. 51473(U), granting a preliminary injunction to enforce a commercial non-compete agreement.

In Eric Woods, LLC, the plaintiff purchased an Allstate insurance agency from the defendant, including customer files and goodwill. The agreement contained a non-compete agreement in which the defendant agreed (i) not to sell insurance within 25 miles of the former business (except within Saratoga County) for a period of five years, (ii) not to solicit or accept business from former customers for a period of five years, and (iii) that violation of the non-compete provisions would constitute irreparable injury, and consented to entry of injunctive relief without requiring a bond.

Once the plaintiff learned that the defendant had purchased a GEICO insurance agency in Albany County and that his Saratoga County insurance agency was accepting business from former customers, he filed the instant action and moved for a preliminary injunction.

In considering the application, the court first noted that the judicial disfavor of post-employment non-compete agreements does not apply to non-compete agreements incident to the sale of a business:

The sole limitation on the enforceability of such a restrictive covenant is that the restraint imposed be “reasonable,” that is, not more extensive, in terms of time and space, than is reasonably necessary to the buyer for the protection of his legitimate interest in the enjoyment of the asset he bought . . . . Accordingly, the Court must apply the more relaxed standard of reasonableness applicable to post-sale covenants, rather than the stricter post-employment standard emphasized by defendants. For this reason, plaintiff need not demonstrate a “legitimate interest” in enforcing the covenant beyond its protection of the confidential customer/policyholder information and goodwill that in purchased from [the defendant] for value.

(Internal citations omitted.)

The court then considered the traditional preliminary injunction factors, irreparable injury, likelihood of success on the merits, and the balance of the equities.

The court found that the non-compete provisions were likely reasonable, in that the 25-mile radius and the five-year term were both “well within prevailing notions of reasonableness.” (Indeed, the court noted that in similar cases, courts have enforced covenants of unlimited duration.) The court also found that the plaintiff had amply documented the defendant’s breaches of the agreement.

As to irreparable injury, the court found that, in general, “irreparable injury is presumed where the covenant not to compete was part of the consideration for the sale of an existing business with its goodwill,” and also that the defendant conceded irreparable injury in the agreement.

As to the balance of the equities, the defendant made the very common argument that injunctive relief “would cause him severe financial hardship.” The court was unimpressed, finding that because “these hardships largely are self-created,” and the violation was “flagrant”; “the burden imposed upon defendants by the injunction, while substantial, cannot be said to be inequitable.” The court also found that the defendant had not shown that any burden on third parties was severe enough to tip the balance against the plaintiff.

The court also enforced the no-bond provision of the agreement, granting the preliminary injunction without a bond.

This case is a good example of courts enforcing commercial non-compete agreements as written, including a no-bond provision. It may serve as useful precedent for attorneys seeking to enforce such agreements on the issue of balance of the equities: parties opposing preliminary injunctions enforcing non-compete agreements routinely argue some version of “granting the preliminary injunction will ruin my business, but he’s doing just fine under the status quo.” In this case, Justice Platkin rejected that argument in no uncertain terms.