Commercial Division Blog

Current Developments in the Commercial Divisions of the
New York State Courts by Schlam Stone & Dolan LLP
Posted: August 25, 2014

New York Choice of Law Clause Not Sufficient To Invoke New York Rule Against Punitive Damages Awards In Arbitration

On August 14, 2014, the First Department issued a decision in In re Flintlock Construction Services, LLC v. Weiss, NY Slip Op 05818, ruling (by a 3-2 vote) that a choice of law provision providing that the parties’ agreement was to be “construed and enforced” in accordance with the law of New York was not sufficient to invoke New York’s public policy against the imposition of punitive damages in a private arbitration, and therefore, the issue of punitive damages could be submitted to the arbitrators.

In In re Flintlock, investors in a real estate project commenced an arbitration against real estate development companies and their principals, alleging fraud and breach of contract, and seeking punitive damages. The transactions at issue were governed by two LLC operating agreements, which contained identical choice of law clauses, providing that the agreements “shall be construed and enforced in accordance with the laws of the State of New York.” The defendants moved before the arbitration panel to dismiss the punitive damages claim on the ground that such a claim was not arbitrable under New York law. Specifically, the Court of Appeals held, in Garrity v. Lyle Stuart, Inc., 40 N.Y.2d 354, 356 (1976), that under New York law, arbitrators “ha[ve] no power to award punitive damages, even if agreed upon by the parties.” By contrast, under the Federal Arbitration Act (which applies to any claim concerning a “transaction involving interstate commerce”), punitive damages are available if the parties’ agreement so provides. See Mastrobuono v. Shearson Lehman Hutton, 514 U.S. 52, 58 (1995) (where parties “agree to include claims for punitive damages within the issues to be arbitrated, the FAA ensures that their agreement will be enforced according to its terms even if a rule of state law would otherwise exclude such claims from arbitration”). The panel denied the motion to dismiss “without prejudice to renewal at the hearing, based on a more complete record as to whether the claim affected interstate commerce, and thus, mandated application of the [FAA].” The defendants then commenced a special proceeding in New York Supreme Court to permanently enjoin the arbitration, under CPLR 7503(b), on the grounds that the arbitrators had exceeded their authority, and lacked the power to award punitive damages. The motion court denied the motion, holding that the movants had “charted their own course” by “actively litigat[ing]” before the arbitration panel, and waived any argument as the arbitrability of punitive damages claims.

The First Department, in a decision by Justice Manzanet-Daniels (and joined by Justices Acosta and Saxe), affirmed. The majority rejected the argument that the New York choice of law provision in the contracts mandated application of the Garrity rule barring punitive damages claims in arbitration:

Merely stating, without further elaboration, that an agreement is to be construed and enforced in accordance with the law of New York does not suffice to invoke the Garrity rule. The Supreme Court has made clear that in order to remove the issue of punitive damages from the arbitrators, the agreement must “unequivocal[ly] exclu[de]” the claim (id. at 60). The agreement in this case, which provided only that it was to be “construed and enforced” in accordance with the law of New York, did not unequivocally exclude claims for punitive damages from the consideration of the arbitrators. . . . A New York choice-of-law provision does not constitute a manifestation of unequivocal intent sufficient to invoke the Garrity rule.

(Citations omitted) (emphasis added).

The majority went on to hold that the defendants had waived their right to seeks a stay of the arbitration by their active participation in the arbitration:

Petitioners’ motion to stay the arbitration should be denied for the further reason that they have participated in the arbitration, precluding late resort to CPLR 7503(b). CPLR 7503(b) authorizes motions to stay arbitration by parties “who ha[ve] not participated in the arbitration.” Petitioners participated in the arbitration process for nearly eight months — selecting arbitrators, participating in preliminary proceedings — before registering an objection to the arbitrability of respondent’s claim for punitive damages. Even then, petitioners chose not to move to stay the arbitration, but to make a motion to dismiss the claim, squarely placing the issue of the arbitrability and availability of punitive damages before the arbitrators. Having “charted their own course,” in the words of the motion court, they cannot now avail themselves of the mechanisms set forth in CPLR 7503(b).

Justice Renwick wrote a dissenting opinion, which was joined by Justice Andrias. The dissenters argued that the Supreme Court’s decision in Mastrobuono, on which the majority relied, was distinguishable because the choice of law provision at issue in that case provided only that the agreement would be “governed” by New York law, which the Court interpreted as requiring the application of the “substantive principles that New York courts would apply, but not . . . special rules limiting the authority of the arbitrators” (i.e., the rule precluding the award of punitive damages). The choice of law provision in In re Flintlock, calling for the agreement to be “construed and enforced” in accordance with New York law, had been construed by the New York Court of Appeals, in Matter of Diamond Waterproofing Sys., Inc. v. 55 Liberty Corp., 4 N.Y.3d 247, 252 (2005), to mandate application of New York’s law requiring statute of limitations issues to be resolved by the Court, not the arbitrators. The dissent held that, under Diamond, the choice of law clause at issue in In re Flintlock required application of the Garrity rule precluding arbitrators from awarding punitive damages:

Diamond and its progeny make clear that, even if the FAA applies to an agreement, the parties may still limit the arbitrator’s power by invoking New York law. To do so, however, the parties must not only make the agreement subject to New York law, but must also make its “enforcement” subject to New York law. By using such language, the parties “unequivocally” invoke the limitations on arbitration under New York State law.

The majority, however, finds it significant that the language at issue here, that “an agreement is to be construed and enforced’ in accordance with New York law, has [never] been held to displace Mastrobuono.” The majority finds that Diamond is not controlling here because it “involved application of the statute of limitations and does not speak to the issue sub judice.” The majority’s refusal to acknowledge that Diamond is controlling here appears to be based upon a fundamental difference in its approach to distinguishing between substantive and procedural law. The procedural law establishes whether the arbitrators have the power to address punitive damages claims, while the substantive law establishes whether certain circumstances are proper for granting such remedy.

For example, in an international commercial arbitration case with the situs of New York and with a general choice-of-law clause providing for New York law, New York law would be the substantive law for the dispute, and the FAA would be the procedural law governing the arbitration. New York’s procedural rule would not be the proper procedural law for the aforementioned scenario, absent the critical language limiting the power of the arbitrator. Thus, the Garrity rule prohibiting arbitrators from awarding punitive damages would not be part of the procedural rule governing this international arbitration. In this hypothetical, the arbitrator would have the power to award punitive damages. As New York law is the substantive law for the case, however, New York law would be applied by the arbitrator to determine whether punitive damages are warranted.

The dissent also rejected the argument that the defendants had waived the right to seek a stay by participating in the arbitration:

[T]he majority finds that the motion to stay arbitration of punitive damages should be denied because petitioners “have participated in the arbitration, precluding late resort to CPLR 7503(b).” I disagree. The grant of a permanent stay of respondent’s claim for punitive damages would not interfere with the ongoing arbitration proceeding. Moreover, a waiver is akin to an implicit agreement. Indeed, there can be no implicit agreement to submit punitive damages to an arbitrator where the parties’ “unequivocal choice-of-law provision” is intended to incorporate the Garrity rule.

In re Flintlock is the second significant decision from the First Department this month on arbitrability and waiver issues in the arbitration context. We previously blogged about the Court’s August 7 decision in Cusiamo v. Schnurr, which reaffirmed the broad application of the FAA even to intrastate activities that “affect” interstate commerce. Both decisions demonstrate the New York Court’s implementation of the strong pro-arbitration policy of the FAA, even when that policy conflicts with New York law. The contrasting standards in the two decisions for waiver of the right to arbitrate vs. waiver of the right to move for stay of arbitration illustrate the point: In Cusiamo, the First Department held that the plaintiff had not waived the right to arbitrate, despite filing a lawsuit in New York state court, and only commencing the arbitration when the complaint was dismissed with leave to replead; in In re Flintlock, by contrast, the Court found that participation in preliminary proceedings in the arbitration effected a waiver of the right to move for a stay of the arbitration.

We can expect further litigation in In re Flintlock, since the appellants have an appeal as of right to the Court of Appeals, given the 2-justice dissent in the Appellate Division.

Posted: August 24, 2014

Court Refuses to Vacate Default Judgment Where Defendant Provides no Reasonable Excuse for his Failure to Answer

On August 5, 2014, Justice Whelan of the Suffolk County Commercial Division issued a decision in Wells Fargo Bank, N.A. v. Pasciuta, 2014 NY Slip Op. 32113(U), granting a default judgment.

In Wells Fargo Bank, the plaintiff moved for default judgment against the defendant and the defendant cross-moved to vacate the default and answer. Notwithstanding the liberality shown by courts to defaulting defendants, the court granted the motion for default judgment, explaining:

A defendant who has failed to appear or answer the complaint must generally provide a reasonable excuse for the default and demonstrate a potentially meritorious defense to the action to avoid the entering of a default judgment or to extend the time to answer. Absent a valid jurisdictional or abandonment defense, a party in default may not appear in the action and contest the plaintiffs right to relief unless the defaulter can establish grounds for the vacatur of his or her default.

The cross motion of defendant Pasciuta rests principally on the grounds to vacate defaults and extend times which appellate case authorities have engrafted in CPLR 317, 3012(d), 2004 and 2005. A defendant moving under CPLR 317 must establish that he or she did not personally receive noticeof the summons in time to defend and that he or she possesses a meritorious defense to the claim of the plaintiff. No demonstration of a reasonable excuse is necessary under CPLR 317, since the statute itself provides for same, namely, non-receipt of personal notice of the summons in time to defend. However, an affidavit of merit by the moving defendant or a proposed answer, verified by such defendant containing the assertion of facts which potentially constitute at least one bona fide defense must be attached to motion papers, in which, relief under this statutes is demanded.

Here, there has been no showing that defendant Pasciuta failed to receive notice of the action in time to defend as the record is replete with evidence otherwise. In any event, the absence of any denial of receipt of the mailings of the summons and complaint to the correct address as attested to in the affidavit of the plaintiffs process server are fatal to the defendant’s claim for relief under CPLR 317. His conclusory claims that he only learned of this action in January of 2013 when he first spoke with his current counsel and that he was never personally served with [the plaintiff’s] foreclosure complaint are insufficient to establish that he did not receive notice of the summons and complaint in time to defend. Such claims are also insufficient to raise a successful jurisdictional defense of the type contemplated by CPLR 3211(a)(8). . . .

Motions for relief pursuant to CPLR 3012(d) are governed by a different standard than those made under CPLR 317, although the requirement of a showing of a meritorious defense remains. A defendant who has failed to timely appear or answer the complaint must provide a reasonable excuse for the default and demonstrate a meritorious defense to the action when moving to extend the time to answer or to compel the acceptance of an untimely answer. The determination of that which constitutes a reasonable excuse lies within the discretion of the Supreme Court. Where the delay in moving to vacate is lengthy, the moving party must offer a reasonable explanation for such delay as well as one for the initial default.

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

The court went on to hold, based on the facts presented by the defendant, that there was not a reasonable explanation for the delay. Moreover, the court in addition found that the defendant “failed to demonstrate his possession of a bona fide defense to the plaintiffs claims for foreclosure and sale.”

Posted: August 23, 2014

Statute of Limitations Applicable to Fraud and Breach of Fiduciary Duty Claims Can Vary Based on Nature of Claim and Relief Sought

On August 4, 2014, Justice Sherwood of the New York County Commercial Division issued a decision in Blumenstyk v. Singer, 2014 NY Slip Op. 32124(U), illustrating the analysis used to determine the statute of limitations applicable to claims of breach of fiduciary duty and fraud.

In Blumenstyk, the plaintiffs brought twenty-four causes action against the defendants. Ultimately, most were dismissed. This post looks at the question of the statute of limitations applicable to the plaintiffs’ breach of fiduciary duty and fraud claims. The court reviewed the analysis used to determine the statute of limitations applicable to such claims:

New York applies different statutes of limitations for claims alleging breach of fiduciary duty, depending on the remedy sought. For equitable relief, the six-year limitations period in CPLR 213(1) applies. However, when the plaintiff seeks only money damages, courts interpret the claims as alleging injury to property and subject to the three year limitations period set forth in CPLR 214(4). Claims for breach of fiduciary duty accrue, and the statute of limitations begins to run, as of the date of the alleged breach, not when it was discovered. Generally, the three year statute of limitations to recover damages for injury to property (see CPLR 214[4]) accrues when the injury occurs, irrespective of when the damage was actually discovered.

The statute of limitations may be tolled while a relationship of trust and confidence exists between the parties. In such cases, the statutory period does not begin to run until the fiduciary relationship is repudiated or otherwise ended.

. . .

CPLR 213(8) provides that, as to claims of fraud, there is either a six year statute of limitations running from the time the cause of action accrued, or a two year period from the time the plaintiff discovered the fraud, or could with reasonable diligence have discovered it. However, courts will not apply the fraud Statute of Limitations if the fraud allegation is only incidental to the claim asserted; otherwise, fraud would be used as a means to litigate stale claims. Thus, where an allegation of fraud is not essential to the cause of action pleaded except as an answer to
an anticipated defense of Statute of Limitations, courts look for the reality, and the essence of the action and not its mere name.

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

Posted: August 22, 2014

Exchange of E-mails Did Not Create Binding Settlement Agreement

On August 6, 2014, Justice Schmidt of the Kings County Commercial Division issued a decision in Rubin v. Deckelbaum, 2014 NY Slip Op. 32150(U), declining to find that an exchange of e-mails had created a binding settlement agreement.

In Rubin, the defendant moved for judgment dismissing the complaint based on an out-of-court settlement agreement that the parties and their counsel had negotiated by e-mail but not reduced to a single writing. The court denied the motion, explaining:

CPLR 2104 provides, in relevant part, that an out-of-court agreement between parties or their attorneys relating to any matter in an action is not binding upon a party unless it is in a writing subscribed by him or his attorney. Three pertinent principles are deducible from the decisions applying CPLR 2104. First, for an enforceable agreement to exist, all material terms must be set forth and there must be a manifestation of mutual assent. Second, if the parties to an agreement do not intend it to be binding upon them until it is reduced to writing and signed by both of them, they are not bound and may not be held liable until it has been written out and signed. Third, the attendant circumstances, the situation of the parties, and the objectives they were striving to attain must be considered to determine whether the parties’ words and deeds establish their intent to enter into a binding agreement.

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

The court found that (1) the e-mails were ambiguous as to the nature of the agreement; (2) when negotiating the written settlement agreement, which the parties never signed, the parties reserved their rights to change the terms until it was finalized; and (3) after the parties exchanged drafts of the settlement agreement, they asked for the court’s help in finalizing it, representing that the agreement had not yet been finalized. Based on those findings, the court held that there was no binding settlement agreement.

The court concluded its analysis with this quote: “For the present, email should only be used with care, and not for stipulations on anything really important.”

Posted: August 21, 2014

Statute of Frauds Applies to All Aspects of Agreement Regarding Negotiating Business Opportunity

On July 30, 2014, Justice Kornreich of the New York County Commercial Division issued a decision in Penncolab LLC v. 118 E. 59th St. Realty LLC, 2014 NY Slip Op. 32027(U), holding that all aspects of an agreement “to pay compensation for services rendered in negotiating a business opportunity” were governed by the statute of frauds, even those collateral to the negotiation.

In Penncolab LLC, the plaintiff brought an action relating to the defendants’ alleged failure to honor an oral agreement. In granting the defendants’ motion to dismiss on statute of frauds grounds, the court explained:

GOL § 5-701(a)(l0) requires that every agreement to pay compensation for services rendered in negotiating a business opportunity be (1) in writing and (2) subscribed by the party to be charged therewith. § 5-701(a)(10) provides that negotiating includes procuring an introduction to a party to the transaction or assisting in the negotiation or consummation of the transaction. In JF Capital, the First Department addressed a case with virtually identical facts . . . .

Here, as in JF Capital, the parties disagree on whether the statute of frauds applies to plaintiff’s claims. In JF Capital, the Court held that all of plaintiffs services rendered in connection with the real estate investment negotiations fall under the ambit of the statute of frauds. The Appellate Division found it irrelevant that plaintiff provided other services in addition to negotiating deals because plaintiff undertook those other services to assist defendants’ negotiations, largely by determining the value to defendants of pursuing the deal. In other words, all services rendered in connection with the facilitation of a real estate sale are subject to the statute of frauds. The Appellate Division has foreclosed the possibility of severing claims to recoup compensation for services relating to the “negotiation or consummation of[] investment opportunities from claims to recoup compensation for ancillary services related to those investment opportunities. Rather, such ancillary services clearly fall within § 5-701(a)(10).

Penncolab, like the plaintiff in JF Capital, provided a broad array of services to help defendants purchase the Property. Such services ran the gamut from conducting due diligence, valuing the property, procuring legal services, and interfacing with the seller. To wit, while some of the properties defendants were interested in were located by defendants, the Property actually purchased by 118 East was suggested to defendants by Penncolab. Penncolab’s breach of contract claim, therefore, is barred by the statute of frauds because its services were rendered in connection to defendants’ purchase of the Property and no signed, written agreement exists.

(Internal quotations and citations omitted).

Posted: August 20, 2014

JHO Vacates Own Report For Exceeding Her Mandate

On August 13, 2014, the Second Department issued a decision in GMS Batching, Inc. v. TADCO Construction Corp., 2014 NY Slip Op. 05773, largely affirming a 2012 judgment of Justice Kitzes of the Queens County Commercial Division.

The factual basis of the action was a run-of-the-mill contract dispute, but the procedural history is of some interest:

The action was initially referred to a judicial hearing officer . . . to hear and report. After taking testimony on July 30, 2010, the referee issued a decision [recommending that the action should be dismissed]. However, the JHO thereafter noted that the order of reference directed her to hear and report, and not to hear and determine, and that she had inadvertently issued a decision determining the merits of the plaintiff’s claims in the absence of the plaintiff’s consent to do so. Thus, on September 30, 2010, the referee issued a brief report vacating her prior decision, and summarizing the parties’ contentions, without making any findings of fact or recommendations.

The Supreme Court then directed a new trial due to the JHO’s failure to “make any findings or come to any conclusions,” and after a bench trial Justice Kitzes granted judgment to the plaintiff.

The Appellate Division affirmed (except on one individual-capacity claim), reasoning that the Supreme Court has the discretion to reject or accept a referee’s findings, with or without a new trial, and that in light of the limited JHO’s report, its decision to order a new trial was not an abuse of discretion. The Appellate Divisions also noted that, in a non-jury trial, “this Court’s power is as broad as the trial court’s power, and this Court may render the judgment it finds warranted by the facts, taking into account in a close case that the trial judge had the advantage of seeing the witnesses.”

So it appears that the procedural confusion surrounding “hear and report,” as opposed to “hear and determine,” essentially mooted the entire proceeding before the JHO, requiring a second trial before the Supreme Court and delaying resolution of the case—which was filed in 2006—for several years. Practitioners should be on their guard to clarify the scope of a JHO’s mandate before such expense or delay is incurred.

Posted: August 19, 2014

Judgment Creditor’s Attempt to Compel Turnover of Israeli Bank Account Denied due to Lack of Jurisdiction, ‘Separate Entity’ Rule

On August 4, 2014, Justice Schweitzer of the New York County Commercial Division issued a decision in Gliklad v. Bank Hapoalim B.M., 2014 NY Slip Op. 32117(U), dismissing a petition to compel an Israeli bank to answer a subpoena and turn over funds.

In April 2014, the plaintiff, Gliklad, got a $505 million judgment on a promissory note and served a subpoena and restraining notice on the New York branch of Bank Hapoalim, where the judgment creditor apparently had an account. The Bank refused to produce any documents or restrain any funds not located at the New York branch, but documents produced from the New York branch revealed that, in 2012, the judgment debtor wired funds from Cyprus, through the New York branch, to the Bank’s branch in Tel Aviv. The plaintiff applied to the court for an order requiring the Bank to produce all responsive documents, wherever located, and to turn over all of the judgment creditor’s funds at the Tel Aviv branch.

The plaintiff, relying on the general rule that “a New York court with personal jurisdiction over a defendant may order him to turn over out-of-state property regardless of whether the defendant is a judgment debtor or a garnishee,” argued that the court had both general and specific jurisdiction over the Bank as garnishee. Justice Schweitzer rejected both arguments.

First, the court held that there was no general jurisdiction over the Bank, which was both incorporated and headquartered in Israel, under U.S. Supreme Court precedent holding that “general jurisdiction is available only where the corporation is ‘fairly regarded as at home.'” The court rejected the plaintiff’s claim that general jurisdiction existed because the New York branch was the Bank’s “center of operations” in the United States, holding that the “center of operations” label was not meaningful, and that there was insufficient evidence of continuous and systematic activity in New York. The court also rejected the plaintiff’s claim that NY Banking Law § 200, appointing the Superintendent of Banks as the Bank’s agent for service of process and consenting to the jurisdiction of the New York courts, created general jurisdiction by consent, instead holding that NYBL § 200 only creates specific jurisdiction.

Next, the court held that specific jurisdiction could not be based upon the 2012 transfers through the New York branch:

Both of these transfers took place in late 2012, over a year and a half before judgment was handed down in the underlying controversy . . . . To find a bank subject to specific jurisdiction based solely on its permitting one of its customers to take advantage of a regularly available banking service would permit the extension of jurisdiction to a degree that would most certainly violate notions of ‘fair play and substantial justice.’ Without any suggestion that [the judgment debtor] initiated these transfers for the specific intent of depriving [the plaintiff of payment] on the promissory note, there is no basis for establishing specific jurisdiction over Bank Hapoalim. (Quoting International Shoe.)

Finally, Justice Schweitzer ruled that the plaintiff’s service of process was inadequate under the “separate entity” rule. “It has long been the rule of New York that each branch of a bank is to be regarded as a separate entity in no way concerned with accounts maintained by depositors in other branches or at the home office.” Rejecting the plaintiff’s argument that the “separate entity” rule had been abrogated, the court found that service on the New York branch was insufficient to reach the Tel Aviv branch.

This case reveals the still-significant obstacles faced by judgment creditors seeking to recover assets held in banks overseas.

Posted: August 18, 2014

Second Department Analyzes Rules Applying to the Admissibility of Out-of-State Affidavits

On August 13, 2014, the Second Department issued a decision in Midfirst Bank v. Agho, 2014 NY Slip Op. 05778, clarifying the law relating to the conformity of out-of-state affidavits as required by CPLR 2309(c).

In Midfirst Bank, the Second Department prefaced its decision with an explanation of the salience of the foreign affidavit issue:

Our Court is observing a significant upswing in the number of appeals where the parties are contesting the admissibility of affidavits executed outside of the state, without CPLR 2309(c) certificates of conformity. The issue has arisen in varied summary judgment and default motion contexts, including motions in residential mortgage foreclosure actions reliant upon affidavits of out-of-state bank employees, motions in medical malpractice actions reliant upon out-of-state physician experts, motions in slip-and-fall actions reliant upon out-of-state witnesses, motions in actions brought pursuant to Insurance Law § 3420(a), motions in motor vehicle negligence actions reliant upon out-of-state experts, and motions in contract actions reliant upon out-of-state expert contractors. We use the instant appeal as an occasion to clarify the law relating to the conformity of out-of-state affidavits as required by CPLR 2309(c).

As to the question at issue in the appeal–the admissibility of an affidavit signed outside of New York in support of a foreclosure action–the Second Department explained the application of CPLR 2309 (and particularly the distinction between a certificate of authentication and a certificate of conformity) as follows: (more…)

Posted: August 17, 2014

No Need for a Corporate Officer to Make Demand on Board Before Bringing BCL 706, 716 or 720 Actions

On August 6, 2014, Justice Demarest of the Kings County Commercial Division issued a decision in Kotlyar v. Khlebopros, 2014 NY Slip Op. 51185(U), holding that there is no need for a corporate officer to make a demand on the board of directors before bringing an action pursuant to BCL 706, 716 or 720.

In Kotlyar, the plaintiffs, “each an officer, director, and shareholder of Seagate Mini Mall, Inc., Seagate Banya Corp., and Za Zaborom, Inc. (the ‘Corporations’)” brought an action “seeking to remove defendant as a director and officer of the Corporations, pursuant to BCL 706(d) and 716(c), and for money damages, pursuant to BCL 720.” The defendant moved to dismiss arguing, among other things, that “the complaint fails to state a derivative cause of action under BCL 626(c)” because the “plaintiffs did not attempt to first secure the initiation of an action by the board as required under BCL 626(c) and that this failure deprives the plaintiffs of standing and a cause of action and deprives the court of subject matter jurisdiction.” The court rejected this argument, explaining:

Unlike BCL 626(c), which authorizes a shareholder to bring a derivative action on behalf of the corporation, BCL 720 does not require an officer or director to first demand that the board initiate an action. As stated by the Third Department in Conant v. Schnall, 33 AD2d 326, 328 [3d Dept 1970]:

An action under section 720 differs from an action under section 626 in many crucial respects. It is not derivative but original, being a statutory right of action rather than an equitable one. This being so, the director may sue in his own name and need not allege his representative capacity. While the cause of action and right of recovery actually belong to the corporation, and the director is suing as a representative, the corporation is only a proper party, neither necessary nor indispensable. Thus, as intended by the Legislature, none of the traditional rules (e.g., demand, stock ownership, judicial approval of settlements) surrounding a derivative action apply to an action under section 720.

Plaintiffs state in paragraph 20 of their Affirmation in Opposition that they have not brought this action as shareholders instituting a derivative action under BCL 626 but as an officer and director seeking compensation for defendant’s alleged breach of fiduciary duties and wasteful management under BCL 720(a)(1)(A). Plaintiffs are suing in their capacities as officers and directors on behalf of the Corporations to enforce a right of recovery belonging to the Corporations. Because the present suit is not a derivative action, but is a statutorily authorized direct action brought on the Corporations’ behalf, the motion to dismiss the action due to lack of subject matter jurisdiction, lack of standing, and failure to state a cause of action is denied.

(Internal quotations and citations omitted). The court went on to hold, however, that the dispute was subject to an agreement to arbitrate.

Posted: August 16, 2014

Lack of Due Diligence no Bar to Fraud Claim When no Amount of Diligence Would have Uncovered Fraud

On August 4, 2014, Justice Schweitzer of the New York County Commercial Division issued a decision in Higher Education Management Group, Inc. v. Aspen University Inc., 2014 NY Slip Op. 32106(U), declining to dismiss a fraud claim for lack of due diligence when no amount of diligence would have uncovered the fraud.

Counterclaim defendants contend that counterclaim plaintiffs are precluded from showing justifiable reliance because they were either aware of the allegedly false and undisclosed information, or such information was readily available to them. The law in New York is clear that if knowledge of the facts underlying the allegation of fraud are in the sole possession of counterclaim defendants, and due diligence would not have uncovered them, a counterclaim defendant cannot assert counterclaim plaintiffs’ lack of due diligence to defeat reliance. Here, it is alleged that Mr. Spada secretly pledged his stock to Aspen. No amount of due diligence is likely to have discovered this element of the alleged fraud. The court is satisfied that Aspen would not have been able to discover the alleged fraud at the time of the Merger. Aspen has plead the element of reasonable reliance with particularity, as the facts relating to the fraud were in the sole possession of Mr. Spada, and not discoverable through any investigation by Aspen.

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