Commercial Division Blog

Current Developments in the Commercial Divisions of the
New York State Courts by Schlam Stone & Dolan LLP
Posted: May 16, 2014

Derivative Plaintiff Entitled to Advancement of Attorneys’ Fees to Defend Counterclaims Brought by Corporation

On May 14, 2014, Justice DeStefano of the Nassau County Commercial Division issued a decision in Schlossberg v. Schwartz, 2014 NY Slip Op. 50760(U), ruling that a corporation’s by-laws and New York’s Business Corporations Law (“BCL”) entitled the plaintiff in a shareholder derivative action to advancement of attorneys’ fees and costs incurred in defending counterclaims asserted against him.  Schlossberg provides a careful reading of the relevant provisions of the BCL concerning indemnification and advancement of attorneys’ fees for corporate officers and directors.

In Schlossberg, the plaintiff, a shareholder, director and former officer of the defendant corporation, filed derivative claims on behalf of the company. In the answer, the company asserted counterclaims against the plaintiff, seeking damages for misappropriation of confidential information, unfair competition, unjust enrichment, conversion, breach of fiduciary duty, breach of the duty of loyalty, violation of BCL § 720 and corporate waste. Claiming that he was entitled to mandatory indemnification under the company’s by-laws, the plaintiff filed a motion, pursuant to the BCL and the company’s by-laws, seeking permissive advancement of his defense fees and expenses, during the pendency of the lawsuit.

Where a corporation is obligated to indemnify an officer or director but not to advance his litigation expenses, the BCL, although not New York’s LLC law, generally permits a court to exercise its discretion and order advancement of “reasonable expenses, including attorneys’ fees . . . necessary in connection with [the] defense,” BCL § 724(c), subject to the caveat that the officer or director may not retain the advanced funds if a judgment or other final adjudication establishes that his acts were committed in bad faith or were the result of deliberate dishonesty. BCL § 725. In Schlossberg, the company raised two defenses to the motion for advancement: (1) that the indemnification provisions of the by-laws apply but only to third-party claims; and (2) that the indemnification provision did not apply to the counterclaims because they were unrelated to the plaintiff’s “mere status as director or officer.” Justice DeStefano rejected these arguments and directed the Company to advance $54,477.72 for fees and expenses incurred to date, referring disputes concerning future advancement requests to a special referee.

Sections 722(a) and (c) of the BCL permit a corporation to agree to indemnify directors and officers:

A corporation may indemnify any person made . . . a party to an action or proceeding (other than one by or in the right of the corporation to procure a judgment in its favor), whether civil or criminal, including an action by or in the right of any other corporation of any type or kind . . . . by reason of the fact that he was a director or officer of the corporation.

BCL § 722(a) (emphasis added).

A corporation may indemnify any person made . . . a party to an action by or in the right of the corporation to procure a judgment in its favor by reason of the fact that he, his testator or intestate, is or was a director or officer of the corporation
. . . .

BCL § 722(c) (emphasis added).

Section 8.1 of the company’s by-laws provides:

The Corporation shall indemnify any person made, or threatened to be made, a party to any action, suit or proceeding by reason of the fact that he . . . is or was a director or officer of the Corporation, . . . against all judgments, fines, amounts paid in settlement and reasonable expenses, including attorneys’ fees, actually and necessarily incurred by him in connection with the defense of such action, . . . to the fullest extent and in the manner set.

The company argued that Section 8.1 of the by-laws only provided indemnification for third-party claims—not claims asserted by the company itself. It compared the language of the by-laws to BCL § 722(c), noting that, unlike the statute, the by-laws did not refer to claims “by or in the right of the corporation.” It therefore asked the court to infer that the provision was enacted pursuant to BCL § 722(a), which is limited to third-party claims (i.e., an action “other than one by or in the right of the corporation”). Justice DeStefano disagreed, concluding that the by-law’s provision mirrors the language of BCL § 722(a), but omits the parenthetical phrase “other than one by or in the right of the corporation”), leading to the conclusion that it covers both third-party claims and claims by the corporation.

Recent Appellate Division decisions outside the context of director and officer liability, have construed indemnification provisions in commercial contracts narrowly to exclude the award of fees arising from disputes between the parties to the contract, as opposed to third-party claims. See, e.g., Gotham Partners, L.P. v. High River Ltd., 76 A.D.3d 203, 206 (1st Dep’t 2010) (“for an indemnification clause to cover claims between the contracting parties rather than third party claims, its language must unequivocally reflect that intent”). Although the decision does not expressly address that line of cases, Justice DeStefano effectively distinguished such precedent through his reading of the BCL.

With respect to the company’s argument that indemnification was not permitted because the counterclaims did not arise “by reason of the fact” that the plaintiff was a director of the company, the Court noted that there was little case law on the meaning of that phrase, but the Delaware Courts had adopted “a broad interpretation . . ., which would include a wide array of claims that might be asserted against a director or officer.” Under this interpretation, “if there is a nexus or causal connection between any of the underlying proceedings . . . and one’s official corporate capacity, those proceedings are ‘by reason of the fact’ that one was an officer or director.” In a leading case (in which Schlam Stone & Dolan represented certain parties), Ficus Invs., Inc. v. Private Capital Mgt., 61 A.D.3d 1 (1st Dep’t 2009), the First Department, applying Delaware law, noted the public policy advanced by such a broad interpretation—i.e., “to help attract capable individuals into corporate service by easing the burden of litigation related expenses.” In light of those principles, Justice DeStefano concluded that “as pleaded,” the counterclaims against [the plaintiff] appear to be indemnifiable, and he was therefore entitled to indemnification during the pendency of the action. It is also notable that Justice DeStefano permitted advances here even though they came up in the context of defending a counterclaim as opposed to an action brought by the corporation against the officer or director in the first instance. This is also consistent with Delaware case law.

This decision reflects a continuing trend of the New York Courts following the approach of the Delaware courts in construing the BCL and corporate by-laws broadly to provide officers and directors with indemnification and advancements of defense costs, even though New York law generally construes indemnification provisions narrowly in other commercial contexts.

Posted: May 16, 2014

Transcripts and Videos of Arguments in the Court of Appeals for the Week of May 5, 2014, Now Available

On May 1, 2014, we noted four cases of interest from the oral arguments for the week of May 5, 2014:

  • Docket No. 121: Norex Petroleum Limited v. Blavatnik (addressing whether “CPLR 202, New York’s borrowing statute, which requires a nonresident plaintiff to satisfy the statute of limitations of New York and of the foreign jurisdiction where the claims accrued” trumps 28 USC § 1367(d) and CPLR 205(a), which toll the statute of limitations to allow plaintiffs to re-file dismissed federal suits in state court, in situations where the foreign jurisdiction has no analogous tolling statute). See the transcript and the video.
  • Docket No. 109: Morpheus Capital Advisors LLC v. UBS AG (considering the effect of an exclusive agency agreement where the buyer was procured by the seller, not a third-party). See the transcript and the video.
  • Docket No. 112: Quadrant Structured Products Co., Ltd. v. Vertin (addressing the following question certified from the Delaware Supreme Court: 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). See the transcript and the video.
  • Docket No. 110: KeySpan Gas East Corporation v. Munich Reinsurance America, Inc. (considering whether insurers have a common law duty to make a coverage determination as soon as reasonably possible or forfeit their right to deny coverage). The transcript and video  are not available due to technical difficulties.
Posted: May 14, 2014

Airbnb Subpoena Quashed as Overbroad

On May 13, 2014, Justice Connolly of the Albany County Supreme Court issued a decision in Airbnb, Inc. v. Schneiderman, Index No. 5393-13, quashing a much-publicized subpoena by the State Attorney General’s Office on Airbnb, Inc. seeking information on its clients that rent apartments in New York state.

Justice Connolly rejected most of the arguments advanced by Airbnb, including that the subpoena was an “unfounded fishing expedition,” that the subpoena was being used to enforce “unconstitutionally vague” laws, that the subpoena was “burdensome,” and that the subpoena impermissibly sought “confidential, private information from” Airbnb’s users.  Further, to the extent the subpoena related to Airbnb clients that rented apartments in New York City, the court found the subpoena appropriate.  However, because, the subpoena was not limited to Airbnb hosts whose activities would be covered by the Multiple Dwelling Law or the New York City Hotel Occupancy Tax (potential violations of which the Attorney General was investigating), it was quashed as overbroad.

This decision–which is reported as an Airbnb victory in some press reports–stands more properly as an example of the large permissible breadth of Attorney General investigative subpoenas in the commercial context.  Ultimately, all the court asked of the Attorney General was to limit the subpoena to exclude information about hosts that could not possibly have been breaking the laws at issue.

Posted: May 13, 2014

Parties Can Modify UCC-Mandated Time for Customer to Notify Bank of Improperly Paid Item if the Modification is Not Manifestly Unreasonable

On May 8, 2014, the Court of Appeals issued a decision in Clemente Brothers Contracting Corp. v. Hafner-Milazzo, 2014 NY Slip Op. 03291, holding that “a bank and its customer may agree to shorten from one year to 14 days the statutory time period under UCC 4-406 (4) within which a customer must notify its bank of an improperly paid item in order to recover the payment thereon” “as long as the modification is not manifestly unreasonable.”

In Clemente Brothers Contracting Corp.,

Defendant Aprile Hafner—Milazzo worked as a secretary and bookkeeper for [the plainitff] until it was discovered that she had been forging Clemente’s signature on certain CapitalOne bank documents, including drawdown requests on the line of credit and checks paid from one of Clemente Brothers’s accounts. According to plaintiffs, Hafner—Milazzo embezzled approximately $386,000 over the course of approximately two years, from January 2008 through December 2009.

In February 2010, [the plaintiff] notified [defendant] CapitalOne of Hafner—Milazzo’s thefts. Thereafter, CapitalOne determined that an event had occurred that adversely affected [the plaintiff’s] ability to repay its debts and, pursuant to a clause in the two promissory notes, declared all amounts due and payable.

Plaintiffs subsequently commenced this action against Hafner—Milazzo and CapitalOne to recover damages resulting from Hafner—Milazzo’s forgeries and to prevent CapitalOne from forcing repayment on the loans. In its answer, CapitalOne interposed several counterclaims to recover amounts due under the loans and Clemente’s personal guaranty.

One issue raised by CapitalOne’s counterclaims was whether the plaintiff was bound by its account agreement with CapitalOne that shortened from ony year to fourteen days the time the plaintiff had to report forgeries to CapitalOne in order to avoid being liable for the forged check. The Court of Appeals agreed with the courts below that the plaintiff was bound by its agreement, explaining:

Turning to the application of UCC 4-406(4), the UCC permits parties to alter the provisions of article 4 by agreement (see UCC 4-103 [1]). The Official Comments go so far as to say that there exists a “blanket power to vary all provisions of the Article” (id. at Comment 2). But that power is not boundless:

No agreement can disclaim a bank’s responsibility for its own lack of good faith or failure to exercise ordinary care or can limit the measure of damages for such lack or failure; but the parties may by agreement determine the standards by which such responsibility is to be measured if such standards are not manifestly unreasonable (UCC 4-103 [1]).

The application of these limitations raises two issues: first, whether parties can vary the one-year period by agreement; we hold that they can; and second, whether shortening the one-year period to 14 days is manifestly unreasonable; we hold that it is not, at least under these facts.

The argument that modification is not allowed is that by shortening the period, the bank is “disclaiming” its obligation to act with care or that it is limiting the measure of damages for a failure to act with care in violation of UCC 4-403 (1). This argument finds some slender support in our decision in Regatos v North Fork Bank (5 NY3d 395 [2005]).

Regatos involved the funds transfers provisions of UCC article 4-A. Banks are liable under article 4-A for improper funds transfers, similar to how they are liable under article 4 for improperly paid items. As for funds transfers, UCC 4-A-204(2) provides that the obligation of a receiving bank to refund payment may not otherwise be varied by agreement.

UCC 4-A-505 contains a one-year notice period similar to that found in UCC 4-406(4). This Court held that parties could not shorten the one-year period in UCC 4-A-505 by agreement. The Court reasoned that shortening the one-year period effectively would vary the bank’s obligation to refund payment in violation of the plain language of UCC 4-A-204.

. . .

Unlike UCC 4-A-204, UCC 4-103(1) does not prohibit a bank from altering its obligation to refund payments made in good faith. And shortening the one-year period does not violate any of the prohibitions in UCC 4-103(1). CapitalOne did not disclaim its responsibility to act with care by requiring its customer to notify it of an improperly paid item within 14 days of receiving the account statement. While shortening the period certainly affected CapitalOne’s liability for improperly paid items, whether paid in good faith or not, it did not exclude all liability for negligence. Nor did the modification affect the measure of damages; it merely limited the time within which plaintiffs must provide notice of the improper charge.

. . .

To apply Regatos’s logic to this case would be to hold not only the 14-day period impermissible, but every other longer period used in the industry, be it 30 days or 9 months. We perceive no good reason for creating such an inconsistency in the banking laws of the various states. We therefore hold that parties may modify by agreement the one-year period in UCC 4-406 (4), as long as the modification is not manifestly unreasonable.

(Internal quotations and citations omitted). In a dissent, with which Judge Smith concurred, Judge Pigott argued:

In my view, because section 4-406(4) clearly imposes a one-year limitation on claims involving a bank’s “failure to exercise ordinary care,” the time period cannot be changed by agreement. To be sure, there may be a variation in standards by which a bank’s responsibility is to be measured (so long as such standards are not manifestly unreasonable), but the one-year limitation remains.

Posted: May 12, 2014

Court Recognizes Claim for Negligence/Insurer’s Errors and Omissions

On May 1, 2014, Justice Schweitzer of the New York County Commercial Division issued a decision in New Hampshire Insurance Co. v. Fresh Direct Holdings, Inc., 2014 NY Slip Op. 31192(U), allowing a policyholder to amend its complaint to add a claim for “Negligence/Insurer’s Errors and Omissions” against an insurer that allegedly failed to tell the policyholder about a regulatory decision that would cause its premium to go up before the policyholder renewed the policy.

In New Hampshire Insurance Co., the plaintiff insurer sued the defendant, its insured, to recover premiums due on workers’ compensation policies. The policies at issue

were issued upon a quoted estimated premium, with the final premium to be determined after the policy period, upon completion of an audit to determine if the assumptions upon which the estimated premium was based were borne out. Among the things that might vary from the assumptions on which the estimated premium was based, were the proper job codes assigned to [the defendant’s] workers. In 2002, the New York Compensation Insurance Rating Board (CIRB) assigned a particular job code to a certain class of [the defendant’s] employees.

The defendant gave this information to the plaintiff, which was told by the CIRB to change coverage accordingly–a change that would have increased the defendant’s premiums. The plaintiff did not change the coverage or inform the defendant of the increased premiums. Unaware of the CIRB-mandated coverage change, the defendant renewed its policies with the plaintiff. Only later did the plaintiff tell the defendant that it owed additional premiums because of the coverage change.

After discovery disclosed facts showing why the plaintiff failed to tell the defendant about the coverage change, the defendant moved to amend its counterclaims to add a claim for “Negligence/Insurer’s Errors and Omissions.” The trial court granted the motion over the plaintiff’s objection that the claim was duplicative of the defendant’s breach of contract counterclaim, explaining:

The Court of Appeals has explained the difference between tort and contractual obligations as follows:

A tort obligation is a duty imposed by law to avoid causing injury to others. It is apart from and independent of promises made and therefore apart from the manifested intention of the parties to a contract. Thus, defendant may be liable in tort when it has breached a duty of reasonable care distinct from its contractual obligations, or when it has engaged in tortious conduct separate and apart from its failure to fulfill its contractual obligations. The very nature of a contractual obligation, and the public interest in seeing it performed with reasonable care, may give rise to a duty of reasonable care in performance of the contract obligations, and the breach of that independent duty will give rise to a tort claim.

A legal duty independent of contractual obligations may be imposed by law as an incident to the parties’ relationship. Where a party is essentially seeking enforcement of the bargain, the action should proceed under a contract theory.

Fresh Direct argues that this is not simply an instance of negligent performance of a contract, but a course of negligence flowing from a total abdication by Chartis of compliance with its regulatory and statutory duties to Fresh Qirect and other insureds. Notably, Fresh Direct is not seeking the benefit of its contractual bargain, i.e.,insurance coverage for workers’
compensation claims. Rather, it is seeking to avoid having to pay an increased premium for such insurance due to the alleged negligence of Chartis in failing to comply with specific directives of the CIRB, and the CIRB Manual in general, to timely issue an endorsement to the policies to change the job code for Fresh Direct’s employees. That this was also an alleged breach of provisions of the policies does not necessarily render the claim nonactionable under a negligence theory. Accordingly, since the counterclaim is not palpably insufficient and there is no claim of prejudice or surprise to Chartis, the motion is granted.

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

This decision shows that hidden in a contract-based claim can be claims based on tort.

Posted: May 11, 2014

Contractually-Provided Damages Not Enforceable if They are Mere Penalties

On April 11, 2014, Justice Sherwood of the New York County Commercial Division issued a decision in Maina v. Rapid Funding NYC, 2014 NY Slip Op. 30952(U), refusing to award damages provided by contract on the ground that they were penalties.

In Maina, the court found that the plaintiff had breached its contract with the defendant-counterclaimant. The court refused to grant the defendant all of the elements of damages provided in the parties’ agreement, explaining:

Defendants have established a prima facie case for summary judgment, at least as to liability. . . . As to damages, [the defendant] does not adequately explain its entitlement to the purported origination fees that it claims are customary in the industry. These fees are not reflected in the loan agreements, although checks in amounts claimed as origination fees are endorsed on the back by plaintiff as approved. Further, [the defendant] has not shown that the pre-payment fees charged on loans it refinanced are anything other than a penalty. New York condemns the contractural imposition of a penalty. Summary judgement will be granted as to liability.

Regarding defendant[‘s] claim for an award of attorneys’ fees, the Note provides that [the defendant] is entitled to recover attorney fees and expenses in connection with enforcement of any of its remedies equal to 20% of the outstanding principal and interest then due. [The defendant] is entitled to recover attorney fees of 20% only if it demonstrates that the quality and quantity of the legal services rendered were such to warrant, on a quantum meruit basis, that full percentage. Because [the defendant] has offered no evidence to support the reasonableness of the attorneys’ fees it seeks, this aspect of the motion must be denied. Moreover, where contractural attorneys’ fees are in the nature of a penalty, they should be disallowed. In this case, [the defendant] has imposed multiple contractural penalties on plaintiff. They include large origination fees, late payment penalties, and pre-payment penalties on loans refinanced by [the defendant]. Arbitrary imposition of a 20% attorney fee charge without any need to show that such fees are reasonable, is yet another penalty.

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

It is understandable that transactional counsel want to provide a contractual mechanism for ensuring that all of the damages flowing from a breach of contract are recovered by the non-breaching party. However, if that mechanism crosses the line to becoming a penalty, it will not be enforced at all, making it important that contract terms stay on the right side of the line.

Posted: May 10, 2014

Transcripts and Videos of Arguments in the Court of Appeals for the Week of April 28, 2014, Now Available

Transcripts and audio/video recordings of arguments in the Court of Appeals for the week of April 28, 2014, are now available on the Court of Appeals website.

On April 28, 2014, we noted one case of interest from the oral arguments for the week of April 28, 2014:

  • Docket No. 96: IDT Corp. v. Tyco Group, S.A.R.L. (addressing the duration of a party’s obligation to negotiate final terms of an agreement when they have contractually obligated themselves to negotiate such terms). See the transcript and listen to the recording of oral the argument.
Posted: May 10, 2014

Former Counsel for Business Associates Disqualified from Representing One Former Client Against Another

On May 7, 2014, the Second Department issued a decision in Gordon v. Ifeanyichukwu Chuba Orakwue Obiakor, 2014 NY Slip Op. 03232, disqualifying trial counsel because of a conflict.

In Gordon, the plaintiff moved to disqualify the defendants’ counsel on the ground that counsel previously had represented her. The trial court denied the plaintiff’s motion. The Second Department reversed, explaining:

Where the Rules of Professional Conduct (22 NYCRR 1200.0) are invoked in litigation, courts are not constrained to read the rules literally or effectuate the intent of the drafters, but look to the rules as guidelines to be applied with due regard for the broad range of interests at stake. It is the Supreme Court’s responsibility to balance the competing interests, and the disqualification of an attorney is a matter that rests within the sound discretion of the Supreme Court.

Here, prior to the commencement of this action, the defendant’s attorney had provided legal advice to both the appellant, Barbara Gordon, and the defendant in their capacity as business partners and members of several limited liability companies. There was a substantial relationship between the involvement of the defendants’ attorney in the formation of those limited liability companies, and his involvement as general counsel to those limited liability companies in connection with the instant action for an accounting. In his capacity as general counsel, the defendant’s attorney was in a position to receive relevant confidences regarding several of those limited liability companies, in which the plaintiff’s interests are now adverse to the defendant’s interests. Thus, under the circumstances of this case, the Supreme Court improvidently exercised its discretion in denying the appellant’s motion to disqualify the defendants’ attorney.

(Internal quotations and citations omitted).

In a divorce, a couple’s friends sometimes feel as if they must choose between the members of the couple. In a business divorce, as this decision shows, former counsel for all the parties may be asked to make such a choice. This decision shows the result.

Posted: May 9, 2014

Commercial Division Rules Amended to Add Rules for Accelerated Adjudication

The Chief Administrative Judge has signed an order amending the rules of the Commercial Division by adding a new rule relating to accelerated adjudication. The new rule, Rule 9, which takes effect on June 2, 2014, provides:

Rule 9. Accelerated Adjudication Actions.

(a) This rule is applicable to all actions, except to class actions brought under Article 9 of the CPLR, in which the court by written consent of the parties is authorized to apply the accelerated adjudication procedures of the Commercial Division of the Supreme Court. One way for parties to express their consent to this accelerated adjudication process is by using specific language in a contract, such as: “Subject to the requirements for a case to be heard in the Commercial Division, the parties agree to submit to the exclusive jurisdiction of the Commercial Division, New York State Supreme Court, and to the application of the Court’s accelerated procedures, in connection with any dispute, claim or controversy arising out of or relating to this agreement, or the breach, termination, enforcement or validity thereof.”

(b) In any matter proceeding through the accelerated process, all pre-trial proceedings, including all discovery, pre-trial motions and mandatory mediation, shall be completed and the parties shall be ready for trial within nine (9) months from the date of filing of a Request of Judicial Intervention (RJI).
(c) In any accelerated action, the court shall deem the parties to have irrevocably waived:

(1) any objections based on lack of personal jurisdiction or the doctrine of forum non conveniens;

(2) the right to trial by jury;

(3) the right to recover punitive or exemplary damages;

(4) the right to any interlocutory appeal; and

(5) the right to discovery, except to such discovery as the parties might otherwise agree or as follows:

(i) There shall be no more than seven (7) interrogatories and five (5) requests to admit;

(ii) Absent a showing of good cause, there shall be no more than seven (7) discovery depositions per side with no deposition to exceed seven (7) hours in length. Such depositions can be done either in person at the location of the deponent, a party or their counsel or in real time by any electronic video device; and

(iii) Documents requested by the parties shall be limited to those relevant to a claim or defense in the action and shall be restricted in terms of time frame, subject matter and persons or entities to which the requests pertain.

(d) In any accelerated action, electronic discovery shall proceed as follows unless the parties agree otherwise:

(i) the production of electronic documents shall normally be made in a searchable format that is usable by the party receiving the e-documents;

(ii) the description of custodians from whom electronic documents may be collected shall be narrowly tailored to include only those individuals whose electronic documents may reasonably be expected to contain evidence that is material to the dispute; and

(iii) where the costs and burdens of e-discovery are disproportionate to the nature of the dispute or to the amount in controversy, or to the relevance of the materials requested, the court will either deny such requests or order disclosure on condition that the requesting party advance the reasonable cost of production to the other side, subject to the allocation of costs in the final judgment.

You can learn more about the background of the rule by reading the request for comment that the Office of Court Administration posted earlier this year on the proposed rule.