Commercial Division Blog

Current Developments in the Commercial Divisions of the
New York State Courts by Schlam Stone & Dolan LLP
Posted: January 12, 2014

Derivative Claim Dismissed for Failure to Allege Demand Futility with Particularity

On January 6, 2014, Justice Bransten of the New York County Commercial Division issued a decision in Zacharius v. Kensington Publishing Corp., 2014 NY Slip Op. 50011(U), addressing a number of business divorce issues, including the standard for pleading demand futility.

Zacharius involved a dispute between shareholders in a closely held corporation. The court’s decision in Zacharius addressed several issues, including whether the plaintiff’s derivative claim for breach of fiduciary duty should be dismissed for failure adequately to plead demand futility. The court held that it should, explaining:

New York law requires that shareholder derivative actions “set forth with particularity the efforts of the plaintiff to secure the initiation of such action by the board or the reasons for not making such effort.” See NY Bus. Corp. Law § 626(c) (McKinney 2013). The Court of Appeals clarified this statutory stricture in Marx v. Akers, 88 NY2d 189, 200 (1996), holding that demand is excused because of futility when a complaint alleges with particularity that a majority of the board of directors is interested in the challenged transactions or is controlled by a self-interested director.

Control or lack of independence of directors must be alleged with particularity. Director interest may be either self-interest in a transaction, or a lack of independence owing to complete domination and control by a self-interested director. The allegation that a shareholder has appointed directors to the board does not place their independence in doubt.

The Complaint fails to name any directors besides Steven and Judith Zacharius, or even how many directors sit on the board. The sole averment in the Complaint relating to directors is that they were appointed by Steven Zacharius. New York law requires a description of self-interest or control with greater particularity than simply stating that the board was “hand-picked.”
. . .
The Complaint does not show the requisite domination and control by Steven or Judith Zacharius, such that the board could not have exercised its business judgment and put the interests of Kensington before that of Steven and Judith. Without any particularized allegations showing that Steven or Judith Zacharius dominated and controlled the board such that any demand would be futile, the Complaint fails to meet the burden imposed by BCL section 626(c).

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

Zacharius stands a reminder that the requirement to make a demand–or show demand futility–is a real requirement under New York law and that boilerplate recitation of demand futility may not survive judicial scrutiny if challenged.

Posted: January 11, 2014

No At Issue Waiver of Privilege When Party Chooses Not to Use Privileged Documents in Litigation

On December 30, 2013, Justice Kornreich of the New York County Commercial Division issued a decision in Old Republic Insurance Co. v. United National Insurance Co., 2013 NY Slip Op. 33423(U), discussing the “at issue” waiver doctrine.

In Old Republic, the defendant moved for “the production of attorney communications” relevant to the oral contract that the plaintiff had alleged existed between it and the defendant. According to the defendant, by alleging the contract, the plaintiff had put all communications regarding it at issue, waiving the attorney-client privilege. The court denied the motion, holding:

“At issue” waiver of privilege occurs where a party affirmatively places the subject matter of its own privileged communication at issue in litigation, so that invasion of the privilege is required to determine the validity of a claim or defense of the party asserting the privilege, and application of the privilege would deprive the adversary of vital information. However, that a privileged communication contains information relevant to issues the parties are litigating does not, without more, place the contents of the privileged communication itself “at issue” in the lawsuit; if that were the case, a privilege would have little effect. Generally, no “at issue” waiver is found where the party asserting the privilege does not need the privileged documents to sustain its cause of action. Where reliance is an element of plaintiff’s claim (i.e., claims based on estoppel or fraud), the mere assertion of such a claim does not automatically place privileged communications at issue, regardless of their relevance. . . . .

(Internal quotations and citations omitted). The court went on to discuss the practical implications of the rule:

[The defendant] is not entitled to the privileged communications unless [the plaintiff] seeks to use them, which it does not. [The plaintiff’s] decision not to utilize the subject communications, however, somewhat imperils its case, which rests entirely on its contention . . . that the parties–highly sophisticated insurance companies–orally agreed as to the parameters of the funding to settle an extremely contentious litigation. [T]he plaintiff[] has the burden of proving its prima facie case establishing the material terms of the parties’ oral agreement (for breach of contract) and its position both before and after [the defendant’s] promise (for its estoppel claim). If [the plaintiff] does not, for instance, produce attorney communications prior to [the defendant’s] promise (all the relevant communications involved attorneys), it may not be able to prove what its original position was. Ergo, it cannot prove a change in position. If [the defendant] makes the strategic decision not to produce this evidence, such decision might doom its case. Yet, that is for [the [plaintiff] to decide, not [the defendant].

Posted: January 10, 2014

UCC Statute of Frauds Does Not Apply to a Contract to Create Artwork

On January 2, 2014, Justice Kornreich of the New York County Commercial Division issued a decision in Brand X Editions, Ltd. v. Wool, 2014 NY Slip Op. 50005(U), addressing the applicability of the UCC Statute of Frauds (§ 2-201) to a contract to produce artworks.

In Brand X Editions, the plaintiff printer and the defendant artist entered into an agreement to produce original artworks in which the printer would cover all production costs in exchange for title in 1/3 of the artworks created. After the parties’ relationship broke down and the printer sued for breach of contract, the defendant moved to dismiss on the grounds that no signed writing existed sufficient to satisfy the UCC statute of frauds.

The court rejected this argument for two reasons. The principal reason was that the arrangement between the parties was not a sale of goods covered by the UCC:

In this case, the parties’ agreement was to collaborate on the creation of artwork. Wool, the artist, provided artistic vision, while Brand X, the artisan printer, leveraged its unique methods to bring Wool’s vision to life. Their combined efforts led to the creation of artwork. The parties agreed that, of the completed works to which each contributed, Wool would keep two-thirds and Brand X would keep one-third. This agreement is not a sale. Rather, it is an agreement to divide the fruits of the parties’ joint venture. . . . Consequently, this is not a case in which goods are provided in consideration for services. . . . In contrast, in this case, title to the works did not exist at the time the parties entered into their agreement since the works did not yet exist. The very point of the parties’ agreement was to decide who gets title to the works once they were jointly created. Hence, there is no sale, since title to the works never transferred between the parties.

In the alternative, the court held that even if the UCC applied, an email sent by Brand X to Wool setting forth the “parameters of the parties’ agreement,” which Wool never objected to, was sufficient to satisfy the statute of frauds.

As in other situations where the Statute of Frauds comes into play, the lesson is that if the subject matter of the agreement was substantial enough to sue about when there were problems, it was substantial enough that the parties should have memorialized it in writing.

Posted: January 9, 2014

Court of Appeals Arguments of Interest for the Week of January 6, 2014

Arguments this week in the Court of Appeals that may be of interest to Commercial Division practitioners include:

  • Docket No. 2: Executive Plaza, LLC v. Peerless Insurance Company (Argued on Monday, January 6, 2014) (addressing, on a certified question from the Second Circuit, whether a lawsuit under a fire insurance policy is barred by a policy provision that requires any lawsuit be brought within two years of the damage, when a contractual condition precedent to suit could not reasonably be accomplished within two years). See the Second Circuit decision here.
  • Docket No. 8: Biotronik A.G. v. Conor Medsystems Ireland, Ltd. (Argued on Tuesday, January 7, 2014) (examining whether the relief sought in an exclusive distributor’s breach of contract claim against a manufacturer for lost profits from sales to third parties constitutes “consequential damages,” and therefore barred under the terms of the distribution agreement, or instead “general damages” given that the distributor’s resale to third parties “was the very purpose of the Agreement”). See the First Department decision here.
  • Docket No. 11: Voss v. The Netherlands Insurance Company (To be argued Thursday, January 9, 2014) (considering whether the doctrine that an insurance policyholder is “charged with conclusive presumption of knowledge of the terms and limits” of the policy can be invoked to defeat a claim against an insurance broker for negligence in advising the insured as to the adequate amount of insurance). See the Fourth Department decision here.
Posted: January 8, 2014

Claim for Misappropriation of Ideas Dismissed on Summary Judgment Because Idea Not Novel

On December 23, 2013, Justice Kapnick of the New York County Commercial Division issued a decision in PSKW, LLC v. McKesson Specialty Arizona Inc., 2013 NY Slip Op. 33257(U), granting defendant summary judgment to the extent the plaintiff claimed misappropriation of ideas.

In PSKW, LLC, the plaintiff alleged that the defendant had misappropriated its ideas for a pharmaceutical marketing product in violation of the parties’ NDA. Justice Kapnick noted that a claim for misappropriation of ideas could sound in contract or tort, but regardless of which, it depended on the idea being novel and not derivative of another concept. In applying this principle to the facts, she held:

Based on all the evidence submitted, this Court finds that defendant has met its burden of showing that the New Co-Pay Method was not novel (in absolute terms) as a matter of law, and although it may have been a clever, useful idea, it was derivative of the various products that came before it. Indeed, plaintiff does not dispute that its idea was meant to address the problems or shortcomings of the earlier generation debit card programs. Accordingly, the Court finds that the New Co-Pay Method was an expansion and adaptation of existing knowledge, rather than the innovation of a new idea. Therefore, the third cause of action for misappropriation of ideas is dismissed.

Justice Kapnick declined to dismiss the other claims which characterized as being for misappropriation of confidential factual information and not of ideas.

One lesson here is the importance of written non-disclosure agreements. The NDA claim survived here even when the misappropriation of ideas claim was dismissed.

Posted: January 7, 2014

Failure To Comply With Pre-Suit Notice Requirement Nullifies Action

On January 3, 2014, Justice Bransten of the New York County Commercial Division issued a decision in Home Equity Asset Trust 2006-5 (Heat 2006-5) v. DLJ Mortgage Capital, Inc., 2014 NY Slip Op. 50001(U), granting a motion to dismiss under the statute of limitations.

The court rejected the defendant’s first argument–that the summonses with notice were filed more than 6 years after the as-of dates of the contracts–because claims for breaches of representations and warranties do not accrue until the closing dates of the transactions.

However, defendants also claimed that plaintiffs’ failure to submit mandatory pre-suit cure notices 90 days before the summons with notices were filed rendered the summonses a nullity. The court agreed, holding that plaintiffs’ “failure to comply with a condition precedent to commencing suit rendered its summonses with notice a nullity.” (Emphasis added). And because the statute of limitations had since expired, the action was therefore barred by the statute of limitations.

Home Equity Asset Trust serves as yet another reminder to practitioners to read carefully the contracts under which they seek to bring an action and to ensure that all of the conditions precedent to the creation of a claim and bringing suit have been met.

Posted: January 6, 2014

Implied Commercial Contract Found to Exist, Preventing Termination Except by Terms of Original Contract

On December 20, 2013, Justice Walker of the 8th Judicial District Commercial Division issued a decision in Western N.Y. Immediate Med. Care, PLLC v. Healthnow N.Y., Inc., 2013 NY Slip Op. 52252(U), addressing a claim for breach of an implied contract.

In Western N.Y. Immediate Med. Care, plaintiff entered into a contract to be a participating provider with the defendant, a health insurer. The contract ended in 2011. The plaintiff continued to provide services and the defendant continued to pay for them. The “[d]efendant admits that . . . the parties agreed to retain the status quo pending negotiations of a new written agreement.” The defendant later sought to terminate its relationship with plaintiff. The plaintiff sought a preliminary injunction, preventing the defendant from terminating the relationship except pursuant to the notice provisions of the last written agreement between the parties–provisions that had not been met. The court granted the preliminary injunction, writing with respect to the plaintiff’s implied contract claim:

The parties agree that their original contract, the 2005 Agreement, expired . . . in August 2011. . . . When an agreement expires by its terms, if, without more, the parties continue to perform as theretofore, an implication arises that they have mutually assented to a new contract containing the same provisions as the old. Here, the . . . 2005 Agreement expired, but the parties continued to perform as before, with mutually agreed upon rates. Defendant relies heavily upon regulatory obligations that participating provider agreements be in writing. Nonetheless, it continues to categorize, and reimburse Plaintiff as a participating provider in the absence of a new writing.

It is rare to see a successful implied contract claim in commercial litigation. The (preliminary) success of plaintiff’s implied contract claim turns, no doubt, on the unique facts of this case. Still, it is worth noting that such claims can succeed.

Posted: January 5, 2014

Lack of Strict Compliance With Commercial Notice Provisions Can Be Excused Absent Prejudice

On December 23, 2013, Justice Kapnick of the New York County Commercial Division issued a decision in TLI Inv., LLC v. C-III Asset Mgt. LLC, 2013 NY Slip Op. 33328(U), addressing–among other things–the effect of a technical failure to comply with a commercial contract’s notice provisions.

In TLI Inv., the plaintiff shareholder claimed that it had properly replaced defendant as the servicer of a real estate investment trust. The defendant moved for summary judgment on the grounds that plaintiff, TLI Investments, had improperly sent termination notices in the name of TLI Investors, LLC, and that the notices were therefore ineffective. The court rejected this argument on the grounds that defendant knew full well that the notices had come from plaintiff and not from some other party, that defendant had suffered no prejudice from the typographical error, and that under settled law, “strict compliance with contract notice provisions is not required in commercial contracts when the contracting party receives actual notice and suffers no detriment or prejudice by the deviation.” (Emphasis added). The notices were therefore held not to have been defective.

Practitioners should contrast this ruling with Justice Kapnick’s second ruling, in which she refused to grant summary judgment excusing the plaintiff’s failure to comply with administrative prerequisites for replacing the servicer. The plaintiff claimed that the defendant’s obstruction relieved its obligation to obtain confirmations from rating agencies and opinion letters from counsel before replacing defendant, but the court found that factual questions remained to be answered and denied summary judgment to either party on that issue.

Posted: January 4, 2014

Appropriate Vehicle to Address Grievances In Two-Shareholder Corporations is Derivative Action

On December 20, 2013, Justice Demarest of the Kings County Commercial Division issued a decision in Machaneinu, Inc. v. Luria, 2013 NY Slip Op. 52197(U), concluding that a 50 percent shareholder of a not-for-profit corporation lacked authority to initiate a direct action on behalf of the corporation against the other 50 percent shareholder for breach of fiduciary duty, and instead, the lawsuit had to be maintained as a shareholder derivative action.

In Machaneinu, the court concluded that the 50 percent shareholder who initiated the direct action had authority as president of the corporation to cause the corporation to bring the lawsuit. However, a month after the lawsuit was filed, the corporation’s board of directors passed a valid resolution that the lawsuit should be withdrawn. The court, therefore, dismissed the action without prejudice to commencement of a shareholder’s derivative action. In its conclusion the court remarked:

[W]here, as in the instant case, a corporate entity is equally owned by two members or shareholders, and the suit is brought by one against the other claiming breaches of fiduciary duty and diversion of corporate assets, that the appropriate vehicle to address such grievances is not a direct action by the corporation against one of the 50% owners, but is a shareholder’s derivative action brought by one of the shareholders, and that a direct action by the corporation must be dismissed.

In the context of most closely-held corporations with two equal owners, the technical distinction between a direct claim by corporation and a shareholder derivative claim will be largely a formality, since demand futility should be a foregone conclusion where the two owners of the corporation are deadlocked. In the case of a not-for-profit or other entity with non-shareholder directors, however, the requirement to bring a derivative action may be dispositive.

Posted: January 3, 2014

Employee Promissory Notes to be Repaid from Earnings Not Amenable to Summary Judgment in Lieu of Complaint

On December 24, 2013, Justice Sherwood of the New York County Commercial Division issued a decision in Newmark & Co. Real Estate, Inc. v. Brennan, 2013 NY Slip Op. 33261(U), examining the standard for a motion for summary judgment in lieu of complaint pursuant to CPLR 3213.

In Newmark, the issues included that plaintiffs had made loans to defendant secured by promissory notes that defendant was to repay from commissions earned while working for plaintiffs. The notes provided that they became due if defendant left plaintiffs’ employ, which defendant did before the notes were paid off. Plaintiff sued for summary judgment in lieu of complaint on the notes. The court denied the motion, explaining:

CPLR 3213 provides for accelerated judgment where the instrument sued upon is for the payment of money only and where the right to payment can be ascertained from the face of the document without regard to extrinsic evidence, other than simple proof of nonpayment or a similar de minimis deviation from the face of the document. An action on a promissory note is an action for payment of money only. The usual standards for summary judgment apply to CPLR 3213 motions. The instrument and evidence of failure to make payments in accordance with its terms constitute a prima facie case for summary judgment.

The case of Tradition North America, Inc. v Sweeney (133 AD2d 53 [1st Dept 1987]) is controlling. In that case, an employee signed six promissory notes that held out the possibility of being repaid by bonuses. In order to determine the amount payable, the court was required to look beyond the notes to determine the employee’s entitlement to payments to offset the obligations evidenced by the notes. Even though the notes could have been satisfied by monetary payments, the employee did not make an unconditional promise to pay a sum certain at a given time or over stated period. Rather, he had the option of performing work for his employer to satisfy the debt. The court considered the notes alternatively as evidencing a loan obligation or an advance on bonus and indeed, nonbonus, compensation. The First Department concluded that when what purport to be notes have such a hybrid dimension they ought not to be considered instruments for the payment of money only.

(Internal quotation and citations omitted).

Newmark illustrates a (small) limitation to the use of promissory notes to secure obligations from employees of which counsel should be aware.