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Current Developments in the Commercial Divisions of the
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Posted: November 15, 2013

Condition Precedent Strictly Interpreted

On November 1, 2013, Justice Kornreich of the New York County Commercial Division issued a decision in Kay Investments Series A, LLC v. Nordica Investments, LLC, 2013 NY Slip Op. 32834(U), reiterating the rule that when there is a doubt about the effect of contractual language, there is a presumption in New York against conditions precedent.

In Kay Investments, Justice Kornreich denied a motion for a preliminary injunction by several members of an LLC moving to, inter alia, remove the managing member for alleged breaches of fiduciary duty. Justice Kornreich held that the underlying action was barred by a settlement agreement by the same parties. The plaintiffs argued that a condition precedent for the settlement, the closing of a certain loan, had not occurred. In rejecting this argument, Justice Kornreich held:

In determining whether a particular agreement makes an event a condition courts will interpret doubtful language as embodying a promise or constructive condition rather than an express condition. This interpretive preference is especially strong when a finding of express condition would increase the risk of forfeiture by the obligee . . . .

The express language of the Settlement Agreement does not condition its enforcement on the closing of the Madison Loan. Had the parties, who were all represented by counsel, wished to agree to such a condition precedent, they could have explicitly provided for one in the Settlement Agreement. Instead, the relevance of the Madison Loan in the Settlement Agreement is limited to the timing of the payments to the Preferred Members and the stock transfer to the Sponsor Member. The representation contained in Section IV.1 addresses the Sponsor Member’s right to access the funds, a right not challenged by the Preferred Members. The court cannot change the terms of the parties’ negotiated agreement, nor can the court give weight to the parties’ supposed contemporaneous side agreements, which are disclaimed by the integration clause.

(Internal quotations and citations omitted).

This case presents a cautionary tale for commercial litigators who draft settlement agreements. As Justice Kornreich noted, “a settlement agreement is a contract between the parties, it must be construed according to ordinary contract law.”

Posted: November 14, 2013

Lease Clause Requiring Commercially Reasonable Efforts Strictly Construed Against Plaintiffs

On November 14, 2013, the Court of Appeals issued a decision in JFK Holding Company LLC v. City of New York, Docket No. 196, declining to apply a broad interpretation to a commercially reasonable efforts clause.

In JFK Holding, plaintiff building owners sued the Salvation Army, “which operated” a building leased from plaintiffs “as a homeless shelter under an agreement with the City of New York,” for breach of contract, claiming that when the Salvation Army terminated the lease, it returned the building “in bad condition.” The complication for plaintiffs was that the lease limited the Salvation Army’s obligations in several ways, including that it would “only be liable” for payments due under the lease “to the extent of the amounts paid to” it by the City. However, the lease also required the Salvation Army to “use commercially reasonable efforts to enforce its rights against the” City.  (Emphasis added.)

In 2005, the City terminated its agreement with the Salvation Army and “the Salvation Army in turn terminated the lease,” paying “the $10 million termination fee payment called for by the Lease.” Plaintiffs accepted the return of the building, but then brought an “action to collect damages for the alleged injury to their building,” originally against the City and, after the City was dismissed, against the Salvation Army.  The Salvation Army moved to dismiss, arguing that because the City was not obligated to pay it for damage to the premises, it was in turn not obligated to pay plaintiffs for the damage. The trial court granted the motion, but was reversed by the Appellate Division.

The Court of Appeals held that while the Salvation Army could not rely solely on the City’s refusal to pay for the damage, the Salvation Army could not have been reasonably expected to do more than exercise its rights under its agreement with the City, based on its reasonable expectations at the time the lease was in force.  Because it had no contractual right to make the City pay for the damage to the building, the complaint should have been dismissed.

The lesson from JFK Holding (besides, perhaps, that the Salvation Army is a very sympathetic defendant) is that a commercially reasonable efforts clause means just that, and a court should not accept an invitation to rewrite the clause to replace the term “reasonable” with “possible.”

Posted: November 14, 2013

First Department Addresses Scope of the Judicial Proceedings Privilege

On November 12, 2013, the First Department issued a decision in Hadar v. Pierce, 2013 NY Slip Op. 07414, dismissing claims based on, among things, the judicial proceedings privilege.

The First Department noted that “[t]he judicial proceedings privilege applies to causes of action other than defamation. However, it does not apply to” allegations of “malpractice, because the gravamen of the malpractice claim is that defendants failed to exercise the skill, prudence, diligence, and care expected of members of the legal profession.” (Internal quotations and citations omitted). Similarly, “[t]he judicial proceedings privilege does not apply to” allegations of “malicious prosecution, because that cause of action, by definition, involves a prior proceeding.” (Internal quotations and citations omitted).

Litigators are well advised to be aware of both the scope and the limitations of the judicial proceedings privilege so that they can avoid the unhappy occasion of becoming litigants rather than advocates.

Posted: November 13, 2013

New York Shareholder Derivative Plaintiffs Must Plead With Particularity Why Board’s Failure to Comply With Pre-Suit Demand Was Improper

On November 8, 2013, Justice Bransten of the New York County Commercial Division issued a decision in Kenney v. Immelt, 2013 NY Slip Op. 51831(U), dismissing with leave to replead a shareholder derivative claim filed by shareholders of General Electric Company against GE’s officers and directors alleging that they breached their fiduciary duties by, among other things, cutting the quarterly dividend paid to GE’s shareholders from 31 cents/share to ten cents/share.

Section 626(c) of New York’s Business Corporation Law (“BCL”) provides that a complaint in a shareholder derivative action “shall set forth with particularity the efforts of the plaintiff to secure the initiation of such action by the board or the reasons for not making such effort.” (Emphasis added). In contrast, Delaware Chancery Court Rule 23.1 (which is substantially similar to FRCP 23.1) provides that a derivative complaint “shall also allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors or comparable authority and the reasons for the plaintiff’s failure to obtain the action or for not making the effort.”

Here, the plaintiffs did not allege that it would have been futile to demand that GE’s Board sue its officers and directors but instead alleged that they made such a demand and that it was wrongfully refused by GE’s Board. The issue before Justice Bransten was, therefore, whether plaintiffs were required to plead with particularity not only how they made their demand on the Board but also why the Board wrongfully rejected their demand. As Justice Bransten noted, “while the language of [Del. Ch. R. 23.1] is similar to that of BCL 626(c), the New York rule notably omits an explicit requirement that the complaint allege with particularity the reasons why the sought after action was not obtained.” After exhaustively canvassing relevant New York and Delaware case law, Justice Bransten concluded that “the particularized pleading requirement of BCL 626(c) should include not only allegations that demands were made on the [Board] . . . to initiate legal action, but also who made the demands, when they were made, which Board members they were made to, the content of the demands [and] why the Board refused to take action.” (Internal quotation marks omitted)(emphasis added). Justice Bransten also observed that these heightened pleading requirements were consistent with the heightened pleading requirements imposed by the New York Court of Appeals for pleading demand futility. Applying this heightened standard, Justice Bransten then concluded that plaintiffs had not pled with sufficient particularity that GE’s Board had wrongfully refused plaintiffs’ pre-suit demand.

Finally, Justice Bransten rejected plaintiffs’ request (made in their opposition to defendants’ motion to dismiss and not in a separate motion or cross-motion) for limited discovery into the facts relating to the investigation and refusal of their pre-suit demands before the Court addressed whether the Board’s refusal of plaintiffs’ demands were wrongful, although she did grant plaintiffs leave to replead their complaint with the particularity that she found was lacking, even though plaintiffs had not requested leave to do so in opposing defendants’ motion to dismiss.

Justice Bransten’s opinion is a must-read for practitioners interested in the similarities and differences between New York and Delaware law with respect to the specificity with which a shareholder derivative plaintiff must plead the pre-suit steps the plaintiff took to demand that the corporation’s Board cause the corporation to bring the lawsuit demanded by the plaintiffs.

Posted: November 12, 2013

Delaware Supreme Court Certifies Questions to New York Court of Appeals on “No Action” Clauses in Trust Indentures

On November 7, 2013, the Delaware Supreme Court issued a decision in Quadrant Structured Products Co., Ltd. v. Vertin, in which it certified the following questions of law to the New York Court of Appeals:

(1) A trust indenture no-action clause expressly precludes a security holder who fails to comply with that clause’s preconditions, from initiating any action or proceeding upon or under or with respect to “this Indenture,” but makes no reference to actions or proceedings pertaining to “the Securities.”

The question is whether, under New York law, the absence of any reference in the no-action clause to “the Securities” precludes enforcement only of contractual claims arising under the Indenture, or whether the clause also precludes enforcement of all common law and statutory claims that security holders as a group may have.

(2) In its Report on Remand . . . , the Court of Chancery found that the . . . no-action clause [in this case], which refers only to “this Indenture,” precludes enforcement only of contractual claims arising under the Indenture. The question is whether that finding is a correct application of New York law to the . . . no-action clause [in this case].

The Delaware Supreme Court emphasized the importance of certifying these questions to the New York Court of Appeals given that “[i]n our national securities markets, the law governing many (if not most) publicly traded debt securities is a creature of New York law. Important rights and requirements pertaining to those securities are expressed in indentures that are, and for over a century have been, governed by New York law.” According to the Delaware Supreme Court, there is little, if any, New York case law discussing these issues.

Posted: November 12, 2013

Deponent not Required to Answer Questions About Legal Positions

Although our main focus is on Commercial Division opinions, many non-Commercial Division rulings will be of equal interest to Commercial Division practitioners. The recent opinion of Justice Dollinger of the Monroe County Supreme Court in White v. White, 2013 NY Slip Op. 23370, is a good example.

In White, a party was asked during his deposition whether he was conditioning withdrawing his request for child support on his wife’s withdrawing her request for child support. He refused to answer.

Justice Dollinger validated the decision not to answer using two different analyses. First, under Fourth Department precedent, despite the proverbial broad scope of discovery, a deponent need only answer questions regarding “facts or matters that relate to a witness’ bias or motive,” and not “questions of law or legal strategy or the witness’ opinion of legal strategy,” or even “questions asking [the witness] to draw inferences from the facts.” Alternatively, 22 N.Y.C.R.R. § 221.2(iii) permits a deponent to refuse to answer if a question is “plainly improper” and would cause “significant prejudice” if answered. Despite criticizing downstate cases that conflated both elements into one, Justice Dollinger held that the particular deponent would face “significant prejudice” if he was forced to answer questions about his legal strategy without first consulting with his attorney. (Presumably, the “plainly improper” element was established by his preceding explanation of the proper scope of deposition questioning.) The witness’s refusal to answer was therefore justified by both the common law and court rules.

Because party-deponents are often asked about their legal positions and goals, the question presented here is one of general interest, and practitioners ought to be aware that the scope of proper deposition questioning does not extend as far as may be commonly supposed.

Posted: November 11, 2013

Statute of Frauds Does Not Bar Multi-Year Oral Agreement That Could Be Performed in One Year

On November 8, 2013, the Fourth Department issued a decision in DeJohn v. Speech, Language & Communication Assoc., SLP, OT, PT, PLLC, 2013 NY Slip Op. 07331, showing the narrow scope of the Statute of Frauds.

In DeJohn, the parties allegedly entered into an oral agreement providing that “defendants would purchase plaintiff’s business for $480,000 and make an initial payment of $10,000, followed by 23 monthly payments of $20,000 and a final payment of $10,000.” Defendants moved to dismiss, arguing that an oral agreement envisioning performance over a period of more than a year was not enforceable under the Statute of Frauds. The Fourth Department affirmed the trial court’s denial of that motion, holding:

As long as an agreement may be fairly and reasonably interpreted such that it may be performed within a year, the statute of frauds will not act as a bar to enforcing it however unexpected, unlikely, or even improbable that such performance will occur during that time frame. Here, the absence of a term prohibiting payment in full within the first year makes possible full performance of the alleged oral agreement within that year, and thus defendants did not meet their burden of establishing that the statute of frauds renders the alleged oral agreement void and unenforceable.

(Internal quotations and citations omitted).

DeJohn shows the narrow scope of the Statute of Frauds. However, that plaintiff in DeJohn had to defend this motion at all shows why it is best to memorialize commercial contracts in writing.

Posted: November 10, 2013

Extrinsic Evidence of Meaning of Contract Term Not Considered

On October 30, 2013, the Second Department issued a decision in Outstanding Transport, Inc. v. Interagency Council of Mental Retardation and Developmental Disabilities, Inc., 2013 N.Y. Slip Op. 07020, illustrating the broad scope of New York’s parol evidence rule.

In Outstanding Transport, the Second Department affirmed the trial court’s refusal to consider extrinsic evidence of an oral agreement to clarify the interpretation of a word in a written contract, holding:

When parties set down their agreement in a clear, complete document, their writing should as a rule be enforced according to its terms. Evidence outside the four corners of the document as to what was really intended but unstated or misstated is generally inadmissible to add to or vary the writing. Thus, before looking to evidence of what was in the parties’ minds, a court must give due weight to what was in their contract. A contract should be read as a whole to ensure that undue emphasis is not placed upon particular words and phrases. . . . [C]ourts may not by construction add or excise terms, nor distort the meaning of those used and thereby make a new contract for the parties under the guise of interpreting the writing.

Here, the plaintiff failed to show any ambiguity in the subject contract that would permit consideration of the proferred extrinsic evidence of an alleged oral agreement to clarify the meaning of the term “preference” as used in the contract. Moreover, the interpretation advanced by the plaintiff would result in an unreasonable result, which should be avoided.

(Internal quotations and citations omitted).

Among the reasons that contracting parties choose to have their contracts interpreted under New York law is that New York courts generally enforce them as written. As Outstanding Transport shows, parties who attempt to modify the terms of a written contract orally may not have that oral modification enforced.

Posted: November 9, 2013

Foreign Derivative Claims Face Hurdles in NY Courts

On October 22, 2013, Justice Schweitzer of the New York County Commercial Division issued a decision in Gutstadt v. National Financial Partners Corp., 2013 NY Slip Op. 32733(U), illustrating the many hurdles that shareholders of foreign corporations face when they try to bring shareholder derivative suits against New York residents.

Gutstadt was brought by two minority shareholders on behalf of an Ontario corporation against the corporation’s majority shareholder and Board member, the corporation’s accountant, and a New York company and that company’s CFO. The derivative claims sounded in breach of fiduciary duty, fraud, conversion, and unjust enrichment and essentially alleged that the defendants had successfully conspired to fraudulently transfer the corporation’s assets and business to the New York company through a series of transactions, in violation of the Ontario Business Corporations Act (“OBCA”). One of those transactions was memorialized in a stock purchase agreement containing a New York choice-of-law clause and a forum selection clause requiring any disputes arising out of the agreement to be arbitrated in New York.

Justice Schweitzer dismissed the case on three independent grounds. First, Justice Schweitzer found that he lacked subject matter jurisdiction because New York’s internal affairs doctrine required him to apply the law of the jurisdiction where the corporation was incorporated to a shareholder derivative suit, and the OBCA required that a derivative plaintiff obtain leave from a Canadian court before bringing a derivative action, which plaintiffs admitted they had not obtained. Justice Schweitzer rejected plaintiffs’ argument that the choice-of-law provision in the stock purchase agreement trumped the internal affairs doctrine because that provision did not apply to plaintiffs’ tort claims “relating to the obligations of directors and controlling shareholders to minority shareholders” of the nominal defendant Ontario corporation.

Second, Justice Schweitzer found that all plaintiffs’ claims were time barred under Ontario’s two-year statute of limitations, which is shorter than New York’s, because CPLR 202 provides that an “action based upon a cause of action accruing without the state cannot be commenced after the expiration of the time limited by the laws of either the state or the place without the state where the cause of action accrued, except that where the cause of action accrued in favor of a resident of the state the time limited by the laws of the state shall apply.” Because the plaintiffs resided in Ontario and were suing derivatively on behalf of an Ontario corporation, Justice Schweitzer concluded that the plaintiffs’ tort claims accrued in Ontario where the alleged economic losses were sustained, and thus CPLR 202 required him to apply the shorter Ontario statute of limitations.

Third, Justice Schweitzer dismissed all the claims pursuant to CPLR 327(a) under the forum non conveniens doctrine after finding that most of the traditional factors he was required to apply under that doctrine favored the dismissal of the case in favor of an Ontario forum (plaintiffs were Canadian residents, nominal defendant was a Canadian corporation, the fraudulent transactions took place in Canada, most of the witnesses are in Canada and their court attendance on New York cannot be compelled, Canadian law applied, and Canada’s courts provided an available alternative forum, especially since plaintiffs had sued defendants in a prior pending action there for the same alleged misconduct).

In sum, before shareholders of foreign corporations decide to litigate their corporate governance disputes in New York, even where the relevant defendants reside in New York, they need to overcome the hurdles of the internal affairs doctrine, the potentially shorter statute of limitations that the CPLR often requires be applied, and the forum non conveniens doctrine.

For an illuminating discussion of three recent First Department cases dealing with demand futility in derivative lawsuits, see Peter Mahler’s New York Business Divorce Law blog post here

Posted: November 8, 2013

Default Judgment Should Be Entered Absent Specific Evidence of Lack of Service or Excuse for the Failure to Answer

On November 6, 2013, the Second Department issued a decision in Loaiza v. Guzman, 2013 NY Slip Op. 07159, illustrating that a failure to answer will not be excused without good reason.

The trial court in Loaiza refused to enter a default judgment against defendants who failed timely to answer and instead granted their motion to serve a late answer. The Second Department reversed, holding that the defendants had not justified the relief they had been granted:

The affidavits of the plaintiffs’ process server constituted prima facie evidence that the defendant Rene Guzman was validly served pursuant to CPLR 308(1) and that the defendant William Guzman was validly served pursuant to CPLR 308(2). The defendants did not deny receipt of process or swear to detailed and specific facts to rebut the statements in the process server’s affidavits. Therefore, the defendants were not entitled to relief pursuant to CPLR 5015(a)(4). Furthermore, to the extent that the defendants are arguing excusable default pursuant to CPLR 5015(a)(1), the defendants did not demonstrate a reasonable excuse for their failures to answer and oppose the plaintiffs’ initial motion for a default judgment, and for their delay of more than one year in appearing in this action. Accordingly, the plaintiffs’ motion for leave to enter a default judgment on the issue of liability against the defendants should have been granted and the defendants’ cross motion pursuant to CPLR 3012(d) for leave to serve a late answer and to compel the plaintiffs to accept service of that answer, should have been denied.

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

Loaiza presents a cautionary tale regarding the failure timely to answer a complaint. Courts are generally lenient in excusing a failure timely to answer, but as Loaiza shows, that leniency is not unlimited. The defendant must present the court with concrete and specific reasons for the default and any delay in dealing with it once the defendant became aware of the action.