Commercial Division Blog

Current Developments in the Commercial Divisions of the
New York State Courts by Schlam Stone & Dolan LLP
Posted: May 20, 2014

Fraudulent Inducement Claim Not Duplicative When Based on Misrepresentations of Present Facts Collateral to Contract

On May 13, 2014, the First Department issued a decision in Shugrue v. Stahl, 2014 NY Slip Op. 03460, holding that a fraudulent inducement claim was not duplicative of a breach of contract claim.

In Shugrue, the First Department reversed the trial court’s dismissal of a fraudulent inducement claim, explaining:

Plaintiffs’ fraudulent inducement claim was not duplicative of their claim for breach of contract, since it was based on misrepresentations of then present facts that were collateral to the contract, and involved a breach of duty distinct from, or in addition to, the breach of contract. Indeed, the complaint alleged that . . . the chief executive officer and sole shareholder of the corporate defendants, misrepresented to plaintiffs that defendants had obtained all of the required permits and approvals and had completed the construction plans for their home renovation project, which induced plaintiffs to enter into the construction contract with defendants in October 2012.

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

This decision gives a roadmap to pleading a fraudulent inducement claim that can be made in tandem with a breach of contract claim and survive a motion to dismiss.

Posted: May 19, 2014

Best Efforts Clause Enforceable if Criteria Can be Inferred From Circumstances

On May 13, 2014, Justice Demarest of the Kings County Commercial Division issued a decision in Board of Managers of the Chocolate Factory Condominium v. Chocolate Partners, LLC, 2014 NY Slip Op. 50754(U), refusing to dismiss a breach of contract claim because the best efforts clause upon which it relied did not contain guidelines for those efforts.

In Board of Managers of the Chocolate Factory Condominium, the plaintiff sued the defendants in connection with a condominium conversion. The defendants moved to dismiss. One ground for dismissal was that the “best efforts” clause in the offering plan was unenforceable. The court disagreed, explaining:

Defendants, in seeking dismissal of the Board’s first cause of action for Breach of Contract, point to the fact that the contractual provision in the Offering Plan upon which it is predicated requires that the Sponsor use its “best efforts” to obtain the J-51 benefits. They rely upon Strauss Paper Co. v RSA Exec. Search (260 AD2d 570, 571 [2d Dept 1999]), in which the Appellate Division, Second Department, held that where a clause in an agreement expressly provides that a party must use its best efforts, it is essential that the agreement also contain clear guidelines against which to measure such efforts in order for such clause to be enforced. Defendants argue that the Offering Plan does not contain any such guidelines against which to measure whether it used “best efforts” to obtain the J-51 tax benefits, and that this clause is, therefore, unenforceable.

Defendants’ argument, however, must be rejected. Initially, it is noted that, as recently observed in Cruz v FXDirectDealer, LLC (720 F3d 115, 124 [2d Cir 2013]), the New York Court of Appeals has not endorsed the requirement that the contract must contain clear guidelines before a best efforts clause can be enforced. Rather, numerous courts, including the New York Court of Appeals and the Second Department, have applied an express best efforts provision without articulated objective criteria. Noting that the cited cases appeared to conflict with the holding in Strauss Paper Co. (260 AD2d at 571) and other cases regarding the requirement for clear guidelines, Judge Battaglia observed that the cases can be reconciled by recognizing that there is no a priori rule precluding enforcement of a best efforts obligation even in the absence of articulated criteria, and that the obligation will be enforced where sufficient content may otherwise be read into it against which the promisor’s performance may be measured. This court concurs that the law does not require that best efforts criteria be defined by the contract. If external standards or circumstances impart a reasonable degree of certainty to the meaning of the phrase best efforts, the clause can be enforced.

While defendants rely upon language in the recent case of DirecTV Latin Am., LLC v RCTV Intl. Corp., 38 Misc 3d 1212[A] [Sup Ct, NY County 2013], affd 115 AD3d 539 [1st Dept 2014]) that for a promise to exert best efforts to be enforceable, there must be clear guidelines against which such efforts can be evaluated, such reliance is misplaced as the issue there was not best efforts, per se, but whether an enforceable agreement had been reached. Indeed, in affirming the dismissal of counterclaims in that case, the Appellate Division, First Department, found that the memorandum at issue lacked the definiteness as to material terms required in order to be a legally enforceable contract.

Under New York law, a best efforts clause imposes an obligation to act with good faith in light of one’s own capabilities, and apply such efforts as are reasonable in the light of that party’s ability and the means at its disposal and of the other party’s justifiable expectations. Best efforts can only be defined contextually. Thus, the court finds that a best efforts provision may be enforced even in the absence of contractually articulated criteria where the contractual language and the circumstances permit an inference as to the applicable criteria for performance.

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

This decision illustrates the fine line transactional counsel must walk.  A too-well-defined best efforts clause defeats the purpose by limiting the scope of those efforts to specific items listed in the contract, eliminating flexibility; a too-broad definition will not be enforced.

Posted: May 18, 2014

Reports Can Be Basis for Fraud Claim Despite Disclaimers When Facts Peculiarly within Defendant’s Knowledge

On May 13, 2014, the First Department issued a decision in Forty Central Park South, Inc. v. Anza, 2014 NY Slip Op. 03453, holding that disclaimers in performance reports that induced the plaintiffs to make further investments did not immunize the defendant from a fraud claim.

In Forty Central Park South, the trial court granted the defendant’s motion to dismiss the fraud claim against it. The First Department reversed, explaining:

Plaintiffs allege that in the monthly reports, generated after the Operating Agreement was entered into, defendant misrepresented that the business venture had been profitable and that plaintiffs had been earning positive returns on their investment; that defendant in fact did not invest the funds as promised; and that they relied on the monthly reports in continuing their investment in the company. These allegations state a cause of action for fraud. The disclaimers set forth in each monthly report do not preclude a finding of justifiable reliance since the alleged misrepresentations in the reports concerned facts peculiarly within defendant’s knowledge.

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

Posted: May 17, 2014

Prevailing Plaintiff in Derivative Action Entitled to Fees, But From Corporation, Not Defendant

On April 2, 2014, Justice Emerson of the Suffolk County Commercial Division issued a decision in Motherway v. Cartisano, 2014 NY Slip Op. 31215(U), holding that a prevailing plaintiff in a derivative action is not entitled to indemnification from the losing party under BCL § 626(e).

In Motherway, the plaintiff prevailed on derivative claims against the defendants and sought “an award of attorney’s fees pursuant to § 626(e) of the Business Corporation Law in the amount of $250,000” to be paid by the defendants. The court refused, explaining:

The general rule regarding attorney’s fees under New York law is that the prevailing party may not collect them from the loser unless such an award is authorized by an agreement between the parties or by a statute or court rule.

Business Corporation Law § 626 (e) provides as follows:

If the action on behalf of the corporation was successful, in whole or in part, or if anything was received by the plaintiff or plaintiffs or a claimant or claimants as the result of a judgment, compromise or settlement of an action or claim, the court may award the plaintiff or plaintiffs, claimant or claimants, reasonable expenses, including reasonable attorney’s fees, and shall direct him or them to account to the corporation for the remainder of the proceeds so received by him or them. This paragraph shall not apply to any judgment rendered for the benefit of injured shareholders only and limited to a recovery of the loss or damage sustained by them.

Although Business Corporation Law § 626(e) provides that a successful plaintiff in a shareholder derivative action may recoup legal expenses and attorney’s fees from the proceeds of any judgment, compromise, or settlement in favor of the corporation, it does not authorize the imposition of such expenses on the losing party. The basis for an award of attorney’s fees in a shareholder derivative suit is to reimburse the plaintiff for expenses incurred on behalf of the corporation. Those costs should be paid by the corporation, which has benefitted from the plaintiff’s efforts and which would have borne the costs had it sued in its own right. Thus, an award of legal expenses and attorney’s fees to the innocent shareholder who brought the action is payable out of the award to the corporation.

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

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.