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Commercial Division Blog

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

No-Action Clause Must Be Strictly Construed

On June 10, 2014, the Court of Appeals issued a decision in Quadrant Structured Products Co., Ltd. v. Vertin, 2014 NY Slip Op. 04114, construing the scope of a no-action clause in a securities litigation.

The underlying action in Quadrant Structured Products is taking place in the Delaware Chancery Court. The plaintiff, a noteholder, sued the issuer for breach of fiduciary duty, fraudulent transfer, and other claims. The issuer argued that the action was barred by a no-action clause in an indenture signed by the noteholders providing:

No holder of any Security shall have any right by virtue or by availing of any provision of this Indenture to institute any action . . . upon or under or with respect to this Indenture . . . unless such holder previously shall have given to the Trustee written notice of default in respect of the series of Securities held by such Security holder . . . and unless also the holders of not less than 50% of the aggregate principal amount of the relevant series of Securities at the time outstanding shall have made written requests upon the Trustee to institute such action . . . .

The plaintiff argued that, by its language, the no-action clause applied only to actions on the indenture, and not to actions brought on the securities themselves. After a number of conflicting decisions in the Delaware courts, and because the indenture was governed by New York law, the Supreme Court of Delaware certified the question to the Court of Appeals.

The Court of Appeals agreed with the plaintiff. Distinguishing this indenture from others where the no-action clause “specifically mentioned claims arising under both the indenture and ‘the Securities,’” (emphasis in the original) the Court found that the no-action clause “only extended to actions or proceedings where a securityholder claims a right by virtue or by availing of any provision of the indenture.”

The Court of Appeals based this holding upon the fundamental rules of contract interpretation:

As the case law further establishes, we read a no-action clause to give effect to the precise words and language used, for the clause must be ‘strictly construed’ . . . . Even where there is ambiguity, if parties to a contract omit terms—particularly, terms that are readily found in other, similar contracts—the inescapable conclusion is that the parties intended the omission . . . . where [a] sophisticated drafter omits a term, expressio unius precludes the court from implying it from the general language of the agreement.”

The court further rejected the defendant’s argument that such an interpretation would defeat the purpose of the no-action clause and the intent of the parties—which was allegedly to prohibit individual suits by securityholders without the consent of the majority—by pointing out that the no-action clause only permitted the Trustee to take action with respect to “default in respect to the series of Securities,” and no default had yet occurred. “Logically then, the no-action clause applies when the Trustee is authorized to decide whether to act; it cannot serve as an outright prohibition on a suit filed by a securityholder in the case where the Trustee is without authorization to act.” (The Court also noted that the language was unambiguous, and that the intention of the parties could be determined from the four corners of the agreement.)

It appears therefore that this case turned on two drafting omissions in the no-action clause: (1) failing to restrict actions on the indenture and the securities; and (2) failing to explicitly bar all suits in the absence of a default.  From the perspective of a commercial litigator in a dispute where “form language” is commonly used, the case also shows that courts can be persuaded to give substantial weight to any particular deviations from that “standard form.”

Posted: June 16, 2014

First Department Addresses Disclosure of Documents That Are Privileged as to Only Some Parties

On June 10, 2014, the First Department issued a decision in Arkin Kaplan Rice LLP v. Kaplan, 2014 NY Slip Op. 04154, addressing the disclosure of documents that were privileged as to some plaintiffs but not others.

Arkin Kaplan Rice, one of the plaintiffs moved “for, among other things, disclosure of a legal file maintained by a nonparty law firm . . . in connection with a prior joint representation of the individual defendants and” that plaintiff. The First Department affirmed, with modification, the trial court’s grant of that motion in a decision that addresses the sometimes complicated issue of documents that are privileged to some opposing parties but not others:

The parties agree that, to the extent the attorney-client privilege has not been waived, the documents in the joint-representation file are privileged with respect to persons other than [the moving plaintiff] and the individual defendants. . . . Accordingly, the IAS court erred in implicitly finding that defendants’ disclosure of the email waived the privilege with respect to any documents in the file pertaining to the specific subject matter addressed in the email. However, the email dated March 29, 2012, which revealed part of [the moving plaintiff’s] understanding of a call with the mediator and the information he relayed, was a privileged communication. Therefore, the IAS court correctly held (albeit implicitly) that defendants’ disclosure of that email waived the privilege with respect to any documents in the file pertaining to the subject matter of the email. Accordingly, [the moving plaintiff’s] coplaintiffs are entitled to only those documents in the file pertaining to the subject matter of the March 29, 2012 email.

This Court has already noted that the documents in the joint-representation file are not privileged as to [the moving plaintiff], and that she may use them in her litigation against the individual defendants. However, this Court also noted that the documents in the file are privileged as against [her] coplaintiffs, who were not jointly represented by the [the nonparty law] firm, and that she cannot unilaterally waive the privilege so as to benefit her coplaintiffs. Therefore, we remand to the IAS court to set forth guidelines and procedures for [the moving plaintiff’s] use in this litigation of the privileged documents in the file (i.e., those documents that do not pertain to the subject matter of the March 29, 2012 email) so as to protect the privilege.

Posted: June 15, 2014

Court Refuses to Enforce Alleged Parol Forum Selection Clause

On June 12, 2014, Justice Demarest of the Kings County Commercial Division issued a decision in Zucker v Ron Waldmann, Basel, LLC, 2014 NY Slip Op. 50914(U), rejecting an argument that a parol forum selection clause applied to an action on a written contract without a forum selection clause.

In Zucker, the defendant moved to dismiss on several grounds, including lack of personal jurisdiction. The trial court held that it lacked personal jurisdiction over the defendants, rejecting the plaintiff’s argument that the parties had agreed in a telephone call that any dispute would be litigated in New York. The court explained:

Plaintiff, in his affidavit, attests that [the defendants] specifically agreed with him that any and all disputes concerning his investment could be taken care of in a court action here in New York. He claims that this agreement as to New York jurisdiction was reached during a telephone call made to him in Brooklyn before he signed the Investment Agreement. He states that he accepted [the individual defendant’s] word on this, without insisting that he put it in writing. While conceding that the Investment Agreement does not mention this aspect of their agreement, plaintiff points to the fact that the Investment Agreement does not specifically state that it constitutes the entire agreement between him and [defendants]. He further states that he relied upon this representation . . . executing the Investment Agreement, and claims that since [the individual defendant] was also a New York City resident at that time, he thought that it made sense that they would have access to New York courts in the event of a dispute. He argues that there is an issue of fact as to whether [the parties] agreed that all disputes among them could be litigated in New York. . . . Here, there is no forum selection clause contained in the Investment Agreement. When parties set down their agreement in a clear, complete document, their writing should as a rule be enforced according to its terms, and 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, since the written Investment Agreement between the plaintiff and Basel was unambiguous, parol evidence to add terms to this agreement is inadmissible.

(Internal quotations and citations omitted).

Posted: June 14, 2014

Personal Guaranty Unenforceable Because Loan was Usurious

On June 3, 2014, Justice Demarest of the Kings County Commercial Division issued a decision in Sasidharan v. Piverger, 2014 NY Slip Op. 50890(U), refusing to enforce a personal guaranty because the loan it guaranteed was usurious.

In Sasidharan, the plaintiffs sued a guarantor for payment on a guaranty. The trial court granted the guarantor’s motion to dismiss, explaining:

Under New York law, usurious contracts are unenforceable. A usurious contract is void and relieves the obligor thereunder of the obligation to repay principal and interest thereon.

A transaction is usurious under civil law when it imposes an interest rate exceeding 16% per annum, and it is criminally usurious when it imposes an interest rate exceeding 25% per annum. While the defense of civil usury is unavailable to a corporation or an individual guarantor of a corporate obligation, a corporation or a guarantor of a corporation’s debt may assert a defense of criminal usury. Thus, Piverger, as a guarantor of ACI’s obligation, who was not involved in the drafting of the note, and did not obtain any direct benefit from the loan transaction, may raise the defense of criminal usury.

Here, since the note was extended to January 18, 2012, it was a one-year loan of $150,000 with interest of $32,000 (plus the $7,500 extension fee) resulting in interest of $39,500 for one year, which is in excess of 25% annual interest (which would be $37,500), rendering it criminally usurious. In addition, the sums retained by a lender are included as interest. Thus, since ACI never received the amount of $63,000 of the $150,000 loaned which was held in escrow and later released to plaintiffs, this effectively resulted in an annual interest of $39,500 on disbursed funds of $87,000, rendering it further in excess of the rate of 25% established for criminal usury.

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

This decision illustrates that in analyzing whether a loan is usurious–and thus unenforceable–courts look to the substance of the transaction, including all fees, and not simply whether a loan recites an interest rate above the legal maximum. It also shows the draconian penalty for making an usurious loan–not reformation to the maximum rate, but unenforceability. Given the stakes, counsel should take particular care not to cross the usury threshold.

Posted: June 13, 2014

Liability Insurer did not Waive Defense of Late Notice by Failing to Disclaim Coverage on this Ground “As Soon as Reasonably Possible”

On June 10, 2014, the Court of Appeals issued a decision in KeySpan Gas Electric Corp. v. Munich Reinsurance America, Inc., 2014 NY Slip Op. 04113, holding that the “mere passage of time” does not effect a waiver of a liability insurer’s right to disclaim coverage for untimely notice by the insured; rather the insurer’s delay must be assessed under the common law doctrines of waiver and estoppel.

In KeySpan, the plaintiff brought a declaratory judgment action seeking coverage for losses relating to environmental contamination at sites formerly owned by LILCO. The insurer asserted an affirmative defense based on LILCO’s failure to give timely notice of the claim, which was a condition precedent to coverage under the policy. On summary judgment, the Supreme Court rejected LILCO’s argument that the insurer waived the untimely notice by failing to disclaim coverage on that basis prior to the lawsuit. The Appellate Division reversed, finding that “issues of fact remain as to whether defendants waived their right to disclaim coverage based on late notice” by “failing to timely issue a disclaimer.” The Appellate Division held that, on remand, a jury should consider whether the insurance company “possessed sufficient knowledge to require that they meet the obligation to issue a written notice of disclaimer on the ground of late notice as soon as reasonably possible after first learning of the accident or of grounds for disclaimer of liability.”

The Court of Appeals held that the Appellate Division applied the wrong standard in evaluating the waiver argument. The Appellate Division’s “as soon as reasonably possible” standard derives from a provision of the New York Insurance Law (Section 3420(d)(2) that by its terms is limited to coverage for “death or bodily injury”:

If under a liability policy issued or delivered in this state, an insurer shall disclaim liability or deny coverage for death or bodily injury arising out of a motor vehicle accident or any other type of accident occurring within this state, it shall give written notice as soon as is reasonably possible of such disclaimer of liability or denial of coverage to the insured and the injured person or any other claimant.

The Court of Appeals held that this standard did not apply in this case, where the coverage at issue concerned environmental harm rather than death or bodily injury:

The Legislature enacted section 3420(d)(2) to “aid injured parties” by encouraging the expeditious resolution of liability claims. To effect this goal, the statute establishes an absolute rule that unduly delayed disclaimer of liability or denial of coverage violates the rights of the insured or the injured party. Compared to traditional common-law waiver and estoppel defenses, section 3420 (d) (2) creates a heightened standard for disclaimer that “depends merely on the passage of time rather than on the insurer’s manifested intention to release a right as in waiver, or on prejudice to the insured as in estoppel.

By its plain terms, section 3420(d)(2) applies only in a particular context: insurance cases involving death and bodily injury claims arising out of a New York accident and brought under a New York liability policy. Where, as here, the underlying claim does not arise out of an accident involving bodily injury or death, the notice of disclaimer provisions set forth in Insurance Law § 3420 (d) are inapplicable. In such cases, the insurer will not be barred from disclaiming coverage simply as a result of the passage of time, and its delay in giving notice of disclaimer should be considered under common-law waiver and/or estoppel principles.

Here, the Appellate Division erred when it held that defendants had a duty to disclaim coverage “as soon as reasonably possible” after they learned that LILCO’s notice was untimely under the policies. The environmental contamination claims at issue in this case do not fall within the scope of Insurance Law § 3420 (d) (2), which the Legislature chose to limit to accidental death and bodily injury claims, and it is not for the courts to extend the statute’s prompt disclaimer requirement beyond its intended bounds. Indeed, Keyspan has never relied on section 3420 (d) (2) and instead asserts a common-law waiver defense. The Appellate Division must determine whether the evidence supporting this defense is sufficient to defeat defendants’ motion for summary judgment based on LILCO’s failure, as a matter of law, to give timely notice under the policies. Specifically, the Appellate Division must consider if, under common-law principles, triable issues of fact exist whether defendants clearly manifested an intent to abandon their late-notice defense. We therefore remit this matter to the Appellate Division to make these determinations.

(Citations omitted) (emphasis added).

The common law waiver standard is much more difficult to satisfy. One imagines it will be difficult to show that the insurer’s delay in disclaiming coverage for late notice “clearly manifested an intent to abandon” the defense where, as here, the insurance company expressly reserved the right to disclaim coverage on that ground.

Posted: June 12, 2014

Claim Dismissed Based on In Pari Delicto Doctrine

On June 4, 2014, the Second Department issued a decision in Burgers Bar Five Towns, LLC v. Burger Holdings Corp., 2014 NY Slip Op. 03970, affirming the dismissal of a Franchise Sales Act claim based on the doctrine of in pari delicto.

In Burgers Bar, the plaintiff sued the defendant “inter alia, to recover damages for violation of the Franchise Sales Act (General Business Law § 680 et seq.) and breach of contract.” The trial court found the defendant liable for breach of contract but dismissed the plaintiff’s Franchise Sales Act claim “based on the doctrine of in pari delicto.” The defendant appealed and the plaintiff cross-appealed. The Second Department affirmed the dismissal of the Franchise Sales Act claim, explaining:

Contrary to the plaintiff’s contention on its cross appeal, the Supreme Court correctly dismissed the cause of action alleging violation of the Franchise Sales Act, based on the doctrine of in pari delicto. The doctrine of in pari delicto mandates that the courts will not intercede to resolve a dispute between two wrongdoers. The doctrine survives because it serves important public policy purposes. First, denying judicial relief to an admitted wrongdoer deters illegality. Second, in pari delicto avoids entangling courts in disputes between wrongdoers. The evidence established that the plaintiff knew that the defendants were offering to sell what amounted to a franchise as defined by General Business Law § 681(3), to multiple persons at the same time that the plaintiff and the defendants entered into their agreement, and that the plaintiff was both aware of and complicit in the defendants’ violation of the Franchise Sales Act. Under the circumstances, the court properly applied the doctrine of in pari delicto, not to favor the defendant, but as a matter of public policy.

(Internal quotations and citations omitted).

Posted: June 11, 2014

Brokerage Agreement Held to Create an Exclusive Agency, not an Exclusive Right to Sell

On June 10, 2014, the Court of Appeals issued a decision in Morpheus Capital Advisors LLC v UBS AG, 2014 NY Slip Op. 04112, interpreting a contract as creating “a standard exclusive agency, not an exclusive right to sell.”

In Morpheus Capital Advisors, the plaintiff contracted with defendant UBSRE to serve as “financial advisor and investment banker in the proposed sale” of student loan assets owned by UBSRE. The plaintiff ultimately sued UBSRE and its parent for failing to pay it a commission when UBSRE sold “assets to a fund created by the Swiss National Bank as part of a 2008 bailout.” The trial court granted the defendants’ motion to dismiss “on the ground that the 2008 financial crisis and the bailout by the SNB constituted an unforeseeable event which undermined the basic assumption and purpose of the agreement, i.e., the introduction of UBSRE by Morpheus to a third party buyer.” The First Department reversed, holding that while “UBSRE had not established its frustration of purpose defense,” the agreement only “confer[ed] an exclusive agency to plaintiff insofar as it does not expressly prohibit UBSRE from finding a buyer for its toxic assets and thereafter engaging in a self-brokered sales transaction.” However, the First Department also held that the plaintiff had adequately pleaded a cause of action even under that interpretation. The Court of Appeals granted leave to appeal and reversed the First Department, explaining:

The distinction between an exclusive agency and an exclusive right to sell is well established in a body of Appellate Division case law. As stated nearly a century ago,

The general rule is that where an exclusive right of sale is given a broker, the principal cannot make a sale herself without becoming liable for the commissions. But where the contract is merely to make the broker the sole agent, the principal may make a sale herself without the broker’s aid, if such sale is made in good faith and to some purchaser not procured by the broker.

Put differently, a broker is entitled to a commission upon the sale of the property by the owner only where the broker has been given the exclusive right to sell; an exclusive agency merely precludes the owner from retaining another broker in the making of the sale. We have endorsed this dichotomy implicitly in the past, and now do so explicitly.

Furthermore, we agree with the case law of the lower courts holding that a contract giving rise to an exclusive right of sale must clearly and expressly provide that a commission is due upon sale by the owner or exclude the owner from independently negotiating a sale. Requiring an affirmative and unequivocal statement to establish a broker’s exclusive right to sell is consistent with the general principle that an owner’s freedom to dispose of her own property should not be infringed upon by mere implication.

(Internal quotations and citations omitted) (emphasis added). The Court of Appeals went on to hold that the agreement was an exclusive agency agreement and under that agreement, USBRE was not obligated to give the plaintiff “a chance to seek a buyer before UBSRE consummated an independent sale,” and thus the plaintiff failed to state a claim.

This decision highlights the importance of using clear and unequivocal language in defining a broker’s rights with respect to the subject of the brokerage agreement.

Posted: June 10, 2014

Boilerplate Affirmative Defenses are Subject to Dismissal

On June 4, 2014, Justice Demarest of the Kings County Commercial Division issued a decision in Amazon Properties US, LLC v. Park Avenue Bank, 2014 NY Slip Op. 50862(U), dismissing boilerplate affirmative defenses.

In Amazon Properties, the plaintiff sued for “breach of contract, breach of the implied covenant of good faith and fair dealing, interference with a contractual relationship, and conversion” and subsequently moved for partial summary judgment and to dismiss the defendant’s affirmative defenses. The decision in Amazon Properties addresses several topics; this post looks at only one: the court’s decision to strike most of the defendant’s affirmative defenses. The court explained:

Defendants have listed fourteen boilerplate affirmative defenses, the majority of which are conclusory and fail to plead any supporting facts. Conclusory affirmative defenses that merely plead conclusions of law without any supporting facts are properly dismissed.

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

Because of the importance of preserving them in the answer, it is common practice to recite any affirmative defenses in an answer that are colorable. It is less common to plead the facts supporting those defenses. As this decision shows, affirmative defenses without a factual predicate are subject to dismissal.

Posted: June 9, 2014

Court of Appeals Grants Leave To Appeal In Case of First Impression Regarding Interpretation of Computer System Fraud Insurance Policy

On June 5, 2014, the New York Court of Appeals granted the plaintiff’s motion for leave to appeal in Universal American Corp. v. National Union Fire Ins. Co. of Pittsburgh, Pa., Mo. No. 2014-411, a case of first impression regarding the interpretation of a computer systems fraud insurance policy. (NOTE: We represent the plaintiff, Universal American Corp.)

Universal American, a large issuer of health insurance policies, purchased a crime fraud policy that protected it from any “loss resulting directly from a fraudulent . . . entry of Electronic Data” into Universal American’s proprietary computer systems that causes “Property to be transferred, paid or delivered.” Universal American was the victim of a massive fraud perpetrated by Medicare-eligible doctors and clinics, who submitted phony invoices for services never rendered, totaling over $18 million. Although some of the fraudsters were criminally prosecuted, none of the money was ever recovered. The trial court and the First Department held that the policy language only covered losses from “wrongful acts in manipulation of the computer system, i.e., by a hacker, and did not provide coverage for fraudulent content consisting of claims by bona fide doctors” for services not rendered. In its motion for leave to appeal, Universal American argued that this reading was not supported by the text of the policy (which makes no reference to “hackers,” but instead provides broad coverage for any fraudulent entry of electronic data), and would render the policy useless as a practical matter. The briefs in support of, and opposition to, leave to appeal are here and here.

Given the prevalence of computer fraud in today’s economy, a definitive ruling by the Court of Appeals that these policies have wide application beyond the ‘hacker’ scenario to which the lower courts’ rulings restricted them will have a substantial impact on this area of insurance coverage. We expect that the appeal will be argued in the fall.

Posted: June 8, 2014

Guarantor Not Liable When Note is Paid, Even if Amount Paid is Less Than Amount Guaranteed

On June 5, 2014, the First Department issued a decision in PAF-PAR LLC v. Silberberg, 2014 NY Slip Op. 04049, holding that a guarantor is not liable to guarantee the full amount of a note when the parties to the note modified the note to provide for a lower amount and that amount was paid.

In PAF-PAR LLC, the defendants guaranteed a borrower’s obligations under a promissory note. The borrower and the plaintiff entered into a “Loan Modification and Extension Agreement” that decreased the amount due. The borrower paid the modified amount. Notwithstanding, the plaintiff sued the guarantors, claiming that they had guaranteed payment of the full amount. The trial court dismissed the plaintiff’s claim. The First Department affirmed, explaining:

It is well settled that since a guaranty is a contract of secondary liability a guarantor will be required to make payment only when the primary obligor has first defaulted. Here, there is no dispute that defendants guaranteed the payment of the borrower’s obligations under a promissory note, and that the borrower satisfied its obligations under the note, as modified by the Loan Modification and Extension Agreement signed by plaintiff. Nevertheless, plaintiff argues that despite the borrower’s full payment of the modified loan amount, the guaranty for the original loan amount is still enforceable because Article II of the guaranty states that it cannot be diminished, impaired, reduced or adversely affected by inter alia, modifications. However, as the Court below held, this language cannot operate to make the guarantor liable for more than what the primary obligor was obligated to pay and did pay.

Hence, plaintiff did not make out a prima facie case, since it did not show that the guarantors failed to make a payment called for by the terms of their guaranty (see Banner Indus. v Key B.H. Assoc., 170 AD2d 246 [1st Dept 1991]; see also SCP [Bermuda]; v Bermudatel Ltd., 224 AD2d 214, 216 [1st Dept 1996]).

While, as plaintiff points out, the guaranty waives many defenses, plaintiff’s failure to establish its prima facie case obviates the need for defendants to raise a triable issue of fact as to defenses.

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

This decision seems to be the triumph of common sense over clever lawyering. Still, one can imagine the possibility that the modification was made based on the assumption that the guarantor was going to pay the balance of the note. If so, this decision shows that such an agreement will not be inferred and should be plead and proved.