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Current Developments in the Commercial Divisions of the
New York State Courts by Schlam Stone & Dolan LLP
Posted: November 20, 2018

Court Finds Pooling and Servicing Agreement to be Ambiguous, Orders Discovery

On November 9, 2018, Justice Bransten of the New York County Commercial Division issued a decision in Matter of U.S. Bank N.A., 2018 NY Slip Op. 32875(U), holding that a pooling and servicing agreement was ambiguous and ordering discovery, explaining:

Under New York law, written agreements are construed in accordance with the parties’ intent and the best evidence of what parties to a written agreement intend is what they say in their writing. Thus, a written agreement that is complete, clear and unambiguous on its face must be enforced according to the plain meaning of its terms. Extrinsic evidence may be used to interpret a contract only where it is ambiguous, and the determination as to ambiguity is a question of law to be answered by the court. A contract is ambiguous if on its face it is reasonably susceptible of more than one interpretation. There must be no reasonable basis for a difference of opinion, but ambiguity does not exist simply because one of the parties attaches a different, subjective meaning to one of its terms. Furthermore, the existence of ambiguity is determined by examining the entire contract and considering the relation of the parties and the circumstances under which it was executed — with the wording viewed in the light of the obligation as a whole and the intention of the parties as manifested thereby.

The petition is denied and the parties are directed proceed with discovery. As a preliminary matter, it is of some significance that the alleged error in allocation was not discovered by the Objectors for three years, and that US Bank then found the new interpretation to be sufficiently reasonable that it employed it for two years. Indeed, the bank was so persuaded that the new procedure was correct that it did not seek judicial instructions at that time. And even after reversing its conclusion, US Bank has asserted only that the original allocation procedure was the best reading. Assuming that that is so, it still does not mean that it is the only reasonable reading. The case thus presents something more than merely one of the parties attaching a subjective meaning to the language of a contract; rather, it is a case of a third party, disinterested sophisticated financial institution attaching conflicting meanings to the same language on three different occasions. The court finds this confusion to be understandable and holds that the PSA is ambiguous regarding the proper allocation of the lost interest.

Read in context with sections 6.5, 6.6(a) and the later passages of 6.6(f), the PSA can reasonably be construed as either permitting, or prohibiting, application of the interest losses to the Certificate Balances. The parties have attempted to support their positions by applying competing axioms of contractual construction to selected passages of the PSA. However, those tools are too blunt to be applied to such a complex financial transaction and do not meaningfully resolve the conflict And even if the language were sufficiently clear to permit the court to commit to one interpretation or the other, the parties’ submissions have failed to provide an easily comprehensible explanation (if one is possible) of how the payments are calculated and distributed to the various classes of Certificates, The mechanism is apparently something to be pieced together from the 300-
page PSA’s Preliminary Statement, the Definition section and the schedules contained therein, and the various paragraphs of section 6.

In this connection, the court notes that the status of the Class A-JFX Certificates is unclear, counsel having stipulated at oral argument as to the seniority of the Class A-J Certificates hut indicated that Class A-JFK was a different story. Those Certificates are mentioned in footnote (c) of the schedule of REMIC III Class designations, which indicates that they represent the Class JFX Percentage Interests of the Class JFL Regular Interests. Later in that footnote, it is stated that following the Second Restatement Date the Aggregate Certificate Balances of the Class JFX Certificates and three other classes will be subject to further re-designations as between such Classes pursuant to Section 3, 10. Expert affidavits or testimony may thus be required to clarify this and other issues, especially because apart from appeals to common sense and contractual construction, some of parties’ arguments center around the financial purposes, tax policies and other considerations underlying the complicated structure of the Trust Their resolution may implicate business judgments rather than legal considerations.

Finally, the court concurs that the ProSupp may have some evidentiary value, in that it provides a clear sequence to the allocation of Realized Losses among the items in 6.6(f)(A), (B) and (C). But that also raises the question of why the clarifying language was not incorporated into the PSA itself resort to the intent of the drafters, and witnesses with expertise in REMIC structured trusts will be needed. Similarly, their assistance would be helpful in explaining the relevance and import of the guidance provided the Commercial Real Estate Finance Council with respect to the reporting of a modification resulting in a permanent rate reduction.

(Internal quotations and citations omitted).

Under New York law, the starting point of contract interpretation is the words of the contract. As this decision shows, sometimes those words, without context, may be insufficient to establish what the parties intended–if anything. Contact Schlam Stone & Dolan partner John Lundin at jlundin@schlamstone.com if you or a client face a situation where you are unsure how to enforce rights you believe you have under a contract.

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Posted: November 19, 2018

Allegations of Duress Insufficient to Overcome Voluntary Payment Doctrine

On November 15, 2018, the First Department issued a decision in Beltway 7 & Props., Ltd. v. Blackrock Realty Advisers, Inc., 2018 NY Slip Op. 07844, holding that allegations of duress were insufficient to overcome the voluntary payment doctrine, explaining:

In seeking to avoid application of the voluntary payment doctrine, plaintiff first contends on appeal that it made clear to Blackrock that its payment was not voluntary at all. The doctrine bars recovery of payments voluntarily made with full knowledge of the facts, in the absence of fraud or mistake of material fact or law. The onus is on a party that receives what it perceives as an improper demand for money to take its position at the time of the demand, and litigate the issue before, rather than after, payment is made.

. . .

Plaintiff asserts that, even if it did not lodge a proper protest at the time of the payment, it can still recover the payment if it can establish that it was made under economic duress or as the result of a mistake. . . . .

The relative sophistication of the parties is not a factor to be considered in assessing a claim of economic duress. Economic duress exists where a party is compelled to agree to terms set by another party because of a wrongful threat by the other party that prevents it from exercising its free will. Accordingly, our analysis consists of two prongs: first, whether Blackrock’s decision to demand the late charge and extra interest payment was lawful, that is, based on rights enumerated in the agreement; and second, if it was not, whether the demand placed plaintiff in a position such that it had no other choice but to accede. With respect to the first prong, Blackrock relies on M.W. Realty in arguing that, because the mezzanine loan agreement is part of the record, we can decide, even at this procedural posture, that, as a matter of law, the charges were not wrongful. In that case, plaintiff, a developer, claimed duress when the defendant, from which the plaintiff had contracted to purchase air rights so it could build a 31-story building, sought to extract more favorable terms from the plaintiff after the plaintiff had begun construction. The Court rejected the duress claim because after reviewing the contract, which was annexed to the complaint, it concluded that the defendant’s obligation to transfer the air rights had not yet been triggered when it sought the modification. The Court affirmed dismissal of the complaint because a party cannot be guilty of economic duress for refusing to do that which it is not legally required to do. Defendant argues that, here too, the agreement plainly establishes that it had the right to make the demand it did. Plaintiff, in contrast, asserts that the late charge provision is, at the very least, ambiguous with respect to how Blackrock was to calculate the charge, and that, even if the calculation was correct, it constitutes an unenforceable penalty.

We agree that the relevant contractual provisions are ambiguous, as they are each susceptible to more than one reasonable interpretation. As plaintiff notes, the 5% rate is expressly stated to apply to the unpaid sum. However, whether the Maximum Legal Rate is to be applied to the unpaid sum or something else is unclear. Plaintiff suggests that it was intended to apply to the length of time that payment was outstanding, which was seven days. Blackrock counters by, inter alia, characterizing the Maximum Legal Rate as a standard savings provision designed to ensure that it not be deprived of any recourse at all if payment is tardy. Each of these arguments has merit, and neither is susceptible of resolution at the pleading stage.

There is similar uncertainty concerning whether Blackrock was justified in charging interest for the November to December period. . . . Similarly, we are unwilling at this stage to declare that the amount charged by Blackrock was not an unenforceable penalty. . . . .

This is not to say that a garden variety dispute over the meaning of contractual terms will serve as the basis of a viable duress claim. It is necessary that the second prong of the duress analysis, which involves the deprivation of meaningful choice on the duress victim’s part, also be present. Thus, the possibility, or even the fear, of litigation is insufficient to establish duress. In Oleet, the defendant lender represented to the plaintiff borrowers, who were seeking a three-year loan, that it could only issue notes for 90 days at a time, but that it would continually extend such notes for the desired three years. However, when the first note became due, the lender told the plaintiffs that it would only extend the note if the plaintiffs, inter alia, paid certain charges to it. This Court rejected the plaintiffs’ duress claim, stating:

At the time the extension agreement was executed, the bank had no interest in or control over plaintiffs’ business or property. All the bank had was a claim for repayment of a loan, represented by ninety-day notes. Despite their financial distress, the borrowers could have refused to honor the fraudulently induced notes, thereby compelling the bank to institute suit, in which event the defense of fraud and, perhaps, equitable estoppel would have been available to them. Fear of financial embarrassment not created by the bank or the stress that might follow from a lawsuit brought to enforce the notes, is not sufficient to constitute such duress as will excuse or invalidate an agreement made to avoid such consequences. An impending suit, without more, does not create the cognizable impulsion of duress.

Here, plaintiff’s duress claim derives not from a fear it had that, should it demur from Blackrock’s insistence that it pay the late charges and extra interest, thus foregoing its ability to refinance, Blackrock would merely sue to recover the mezzanine loan. Rather, plaintiff claims that it feared that Blackrock would foreclose on plaintiff’s very valuable portfolio of properties. For this reason, it asserts, it was placed in a position where, even though it doubted Blackrock’s entitlement to the charges, it had no choice but to comply with Blackrock’s demand. Indeed, economic duress is established when the facts show that breach of a contractual obligation will result in an irreparable injury or harm. Furthermore, as this Court observed in Oleet, a demand can be characterized as improper when it is based on a claim insignificant when contrasted with the demands. Here, plaintiff contends that there is a gross disproportionality between the claim (a payment that was one week late) and the demand (nearly $850,000).

That plaintiff may have established a question whether Blackrock may have had a right to extract the late charge from it does not compel a decision upholding the complaint, for while there is a question whether Blackrock acted reasonably in imposing the penalty, we must also consider the consequence of plaintiff’s failure to seek recovery of the payment after the threat of foreclosure had passed. One who would recover moneys allegedly paid under duress must act promptly to make his claim known. That is because a contract procured by duress is not void, but merely voidable, such that the duress victim’s failure to act can be viewed as a ratification of the contract. Plaintiff dismisses this principle as inapplicable here because Blackrock did not procure a contract by duress, but rather a payment concomitant with an already existing contract. This appears to be a distinction without a difference. Plaintiff does not explain why a payment like the one at issue is void (not simply voidable), nor does it offer any authority to support that contention. Indeed, in Austin Instrument, a party was held to have procured price increases on an already existing contract through economic duress, and the Court still weighed whether the victim of that duress had ratified the price increase by waiting too long to seek recovery.

Plaintiff further asserts that the proper analysis where a party fails to promptly seek recovery of a payment made under duress is whether it is guilty of laches. It argues that because a showing of laches requires prejudice on the part of the party asserting the defense, it must prevail here, because Blackrock was not prejudiced. We disagree. Plaintiff has not cited any authority to support its theory that prejudice enters the analysis. Indeed, decisions by this Court declaring that a party has waived a duress claim have not even suggested that prejudice is a relevant factor. This is not to say that a lengthy wait to recover funds paid under duress bars the claim absolutely. In Austin Instrument, for example, the victim of the duress faced an imminent threat of wrongful compulsion long after it was placed in a position of duress, excusing its delay. Here, however, plaintiff fails to allege any set of facts justifying its decision to wait nearly two years to invoke duress, and then only after defendant invoked the voluntary payment doctrine. For that reason, its complaint was properly dismissed.

(Internal quotations and citations omitted).

As this decisions discusses, a claim of duress can relate to economic duress, and not just the paradigm case of someone being forced to sign a contract with a gun to their head. But, as this decision also shows, the standards for pleading duress are demanding. Contact Schlam Stone & Dolan partner John Lundin at jlundin@schlamstone.com if you or a client have questions regarding a contract entered into under duress.

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Posted: November 18, 2018

General Release Bars Claim Relating to Settled Claims

On November 7, 2018, Justice Ostrager of the New York County Commercial Division issued a decision in Lam Pearl St. Hotel LLC v. Golden Pearl Constr. LLC, 2018 NY Slip Op. 32852(U), holding that a general release barred a claim regarding settled claims, explaining:

GPC argues that the implied covenant of good faith and fair dealing cannot be used to circumvent the clear and unambiguous terms of the Termination Agreement to require GPC to pay the alleged refund to Lam. The Termination Agreement does not explicitly mention anything regarding insurance premiums, however, it does contain a broad, general release of GPC”s liabilities as to Lam. The Termination Agreement states:

Lam Pearl releases GPC and its officers, directors, members, agents, affiliates and subsidiaries from and against any and all liabilities, damages, promises, covenants, agreements, causes of action, judgments, claims, or determinations, in law or in equity, or any costs or expenses, inclusive of legal fees, whether known or unknown arising out of or related to work performed under the Trade Contracts, responsibility for ongoing operations including conditions at the Project site, and any warranties or guarantees of GPC under the Contract.

(emphasis added).

Lam argues in opposition that it is not re-writing the Termination Agreement, but rather seeking the benefits to which it is entitled because GPC failed to disclose that it did not procure the legally required project-specific insurance.

When parties set down their agreement in a clear, complete document. their writing should as a rule be enforced according to its terms. The meaning and coverage of a general release depends on the controversy being settled and upon the purpose for which the release was actually given.

Here, Lam entered into the Termination Agreement and Settlement Agreement terminating the Pearl Street Contract and providing for a settlement payment to GPC-allegedly under the false belief that GPC had procured project-specific insurance in accordance with the Pearl Street Contract and applicable City of New York rules. Lam asserts that it pre-paid GPC for the purpose of purchasing project-specific insurance which would purportedly run with the life of the Project regardless of the general contractor working on the Project. There is evidence in the record indicating that Lam could have learned that GPC had used the pre-paid funds to cover GPC’s practice policy instead of a project-specific insurance premium, but Lam contends it took no notice of the single sheet of paper indicating the type of insurance GPC purchased. After the parties terminated their relationship, GPC allegedly received a premium refund of over $900,000. Lam, meanwhile, did not receive the project-specific insurance covering the life of the Project it claims it was led to believe GPC had procured before the parties entered into the Termination Agreement and Settlement Agreement. While these agreements do not explicitly address the insurance premium-and thus there is no breach of contract claim asserted-the agreements both contain broad releases of all claims, whether known or unknown. arising out of work performed for the Project. If the parties had intended to limit the scope of the release, particularly as to insurance related claims, the Termination Agreement would have stated such in explicit terms. Ultimately, however, the parties terminated their relationship and exchanged broad releases covering all claims related to the Project. For this reason, Plaintiff’s breach of the implied covenant claim is precluded by the release in the parties’ Termination Agreement and must therefore be dismissed.

(Internal quotations and citations omitted).

Settlement agreements are treated just like any other contract in New York, and as this decision shows, if you release all claims against a party, the court will enforce that promise. Contact Schlam Stone & Dolan partner John Lundin at jlundin@schlamstone.com if you or a client have questions regarding a settlement agreement.

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Posted: November 17, 2018

Valuation Prepared as Part of Joint Venture’s Break Up Not Privileged

On November 9, 2018, Justice Schecter of the New York County Commercial Division issued a decision in Noven Pharms., Inc. v. Novartis Pharms. Corp., 2018 NY Slip Op. 32851(U), holding that a valuation prepared as part of a joint venture’s break up was not privileged, explaining:

Novartis has the burden of establishing that the valuation report is privileged and, therefore, exempt from the disclosure. It failed to meet its burden here.

The exemption for attorney work product (CPLR 3101[c]) does not apply because the valuation was not prepared by counsel acting as such and does not otherwise uniquely reflect a lawyer’s learning and professional skills. Nor has Novartis sufficiently shown that the valuation is exempt from disclosure as material prepared in anticipation of litigation (CPLR 3101[d][2]) because it did not demonstrate that the report was created solely and exclusively in anticipation of litigation. Under the circumstances, a mixed purpose cannot be ruled out.

It is undisputed that a valuation by Deloitte was contemplated for business purposes before Novartis claims that it appreciated that litigation potentially lay ahead. The record establishes that Novartis first contacted Deloitte about performing a valuation in response to the HL valuation with which Novartis disagreed. Novartis explained to Noven that it would be procuring the valuation, which would then inform their discussions.

Though Novartis has shown that shortly thereafter it contemplated possible litigation, it has not established that the nature, character or scope of the valuation that had already been discussed with Deloitte changed in any way whatsoever or that Novartis was exclusively in litigation mode and not still desirous of arriving at a mutually agreeable business solution with Noven. Indeed, there is no evidence between September 2015–when Novartis maintains that it first contemplated potential litigation–and the commencement of this action, that Novartis ever explicitly committed to Noven that, contrary to its earlier position, it was not going forward with nor would it exchange or discuss the valuation that it had earlier committed to. Novartis has not shown any proof (in camera or otherwise) that after its business people chose Deloitte to prepare the valuation for business purposes, the actual scope or nature of the retention changed in any material way. In fact, even after the valuation was prepared, the parties were still on course for and engaged in business discussions to resolve the disputes between them.

It is clear, moreover, that both parties fully appreciated that litigation was a possibility before they officially commissioned their respective valuations. That does not alter the analysis nor does the involvement of attorneys or the parties’ own privilege designations (which were likely designed to afford the parties with maximum flexibility depending on the outcome of the valuation).

In the end, while Novartis’ lawyers formally retained the valuator selected by its business people, and one of the purposes of procuring the valuation may have been to prepare for litigation, Novartis has not convinced the court that litigation was the sole reason and that it had entirely abandoned its earlier commitment. On this record, where the parties continued in the same course of negotiations for which the Deloitte valuation had been contemplated, it is hard to believe that Novartis decided, in September 2015, that potential litigation justified an uncommunicated change in course with respect to the valuation and that, despite verily believing that a valuation was irrelevant, it continued to pursue the very same valuation that it had anticipated earlier, yet it was for a completely different purpose (and that Novartis did so, at this stage and with urgency, solely for litigation that had not even been commenced and not for use in its ongoing business negotiations). Because Novartis has not negated that the valuation, at the very least, had a dual purpose–that it still served the function originally contemplated–it is subject to disclosure and must be produced.

(Internal quotations and citations omitted).

An issue that arises in almost all complex commercial litigation is identifying evidence that should be withheld from production in evidence because it is subject to the attorney-client or other privilege. Contact Schlam Stone & Dolan partner John Lundin at jlundin@schlamstone.com if you or a client have questions regarding the attorney-client, common interest, work product or other privileges or exemptions from production of evidence.

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Posted: November 16, 2018

City Department of Finance Not Entitled to Two Percent Payment Fee On Abandoned Funds Transferred to Comptroller

On October 25, 2018, Justice Ramos of the New York County Commercial Division issued a decision in Swezey v. Lynch, 2018 NY Slip Op. 32810(U), holding that the City Department of Finance was not entitled to a two percent fee on abandoned funds transferred to the City Comptroller, explaining:

The DOF is the custodian of court-deposited funds in New York City under Article 26 of the CPLR. When the DOF takes custody of court-deposited funds, it is entitled to two statutory fees, set forth in CPLR 8010: one fee for investing, and one fee for making payment. Specifically, sub-section (1) of CPLR 8010 entitles the DOF to receive two percent upon a sum of money paid of out court by him. Sub-section (2) entitles the DOF to one half of one percent upon a sum of money invested by him.

The term “paid out of court,” as used in CPLR 8010(1), has not been judicially construed. The Court of Appeals has stated that when the language of a statute is clear and unambiguous, the statute should be construed so as to give effect to the plain meaning of the words.

The plain meaning of the term “paid out of court,” which triggers the DOF’s entitlement to a two percent fee for its custodial services, is the payment of the money out of court, either an award of the court or other order of the court directing payment.

Considering the construction of CPLR 8010 with the Abandoned Property Law does not alter this Court’s conclusion. Abandoned Property Law §§ 600 and 602 directs the DOF to transfer dormant court-deposited funds to the comptroller without a court order, after five years. The substance of this transfer is a ministerial act triggered by the passage of time, which runs from the date the DOF takes custody of the money. The ministerial act of transferring abandoned funds to the comptroller does not entitle the DOF to a two percent fee under CPLR 8010 (1) because it is not money paid out of court to the party entitled to the money or other order directing payment.

This Court originally ordered the DOF to take custody of the Arelma assets, and neither this Court, nor any other court with competent jurisdiction, has awarded the Arelma assets or otherwise directed payment thereof out of the DOF’s custody. Thus, the only fee to be retained by the DOF for its services as custodian of the Arelma assets is the retention of one half of one percent of the sum initially received by him for its placement of the funds in an interest bearing account. There is no statutory authority for the DOF’s retention of two percent for transferring funds as abandoned property to the comptroller’s custody, by passage of time.

(Internal quotations and citations omitted).

It happens from time-to-time that money related to a court case must be paid into court (or, as this decision explains, if the court is in New York City, into the New York City Department of Finance). Getting that money back from the Department of Finance is time consuming and, as this decision shows, potentially expensive. Contact Schlam Stone & Dolan partner John Lundin at jlundin@schlamstone.com if you or a client have a question regarding the payment of funds into court.

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Posted: November 15, 2018

Award of Lost Profits Upheld

On November 9, 2018, the Fourth Department issued a decision in Henderson Harbor Mariners’ Mar., Inc. v. Upstate Natl. Bank, 2018 NY Slip Op. 07555,, upholding an award of lost profits, explaining:

We reject defendant’s contention that the trial court erred in denying its motion to set aside the verdict and for judgment in its favor on the issue of, inter alia, the damages awarded for plaintiffs’ lost profits. Contrary to defendant’s contention, we conclude that plaintiffs’ lost profits were within the contemplation of both parties, at the time they made the contract, as the probable result of the breach of it. Although damages resulting from the loss of future profits are often an approximation, we further conclude that plaintiffs established their damages here with reasonable certainty and without undue speculation.

(Internal quotations and citations omitted).

A key element in commercial litigation is proving damages. As this decision shows, in some circumstances, those damages can include lost profits. Contact Schlam Stone & Dolan partner John Lundin at jlundin@schlamstone.com if you or a client have questions regarding proving damages.

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Posted: November 14, 2018

Because Court Allowed Plaintiff to Amend Complaint, Court Erred in Deciding Summary Judgment Motion Before Defendant Answered Amended Complaint

On November 7, 2018, the Second Department issued a decision in R&G Brenner Income Tax Consultants v. Gilmartin2018 NY Slip Op. 07470, holding that because the IAS court allowed the plaintiff to amend its complaint, the court erred in deciding the plaintiff’s summary judgment motion before the defendant had answered the amended complaint, explaining:

Here, contrary to the defendant’s contention, the Supreme Court providently exercised its discretion in allowing the plaintiff to amend its complaint. The defendant failed to show that he was prejudiced or surprised by the proposed amendments.

However, the Supreme Court should not have awarded the plaintiff summary judgment on the issue of liability on the first, third, and fourth causes of action in the amended complaint, while simultaneously allowing the plaintiff to serve the amended complaint. When an amended complaint has been served, it supersedes the original complaint and becomes the only complaint in the case. Since an amended complaint supplants the original complaint, it would unduly prejudice a defendant if it were bound by an original answer when the original complaint has no legal effect. As a result, an amended complaint should ordinarily be followed by an answer. Here, the court should not have awarded the plaintiff summary judgment on the issue of liability on the causes of action in the amended complaint before the defendant had answered the amended complaint.

(Internal quotations and citations omitted).

Cases in the Commercial Division of the New York courts usually involve a motion to dismiss at the outset and then a motion for summary judgment at the close of discovery, so such motions are a big part of our practice. Contact Schlam Stone & Dolan partner John Lundin at jlundin@schlamstone.com if you or a client have questions about seeking or opposing a motion for pre-trial dismissal of a commercial lawsuit.

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Posted: November 13, 2018

Fraud Claim Dismissed Because of Sophisticated Investor’s Lack of Due Diligence

On October 29, 2018, Justice Sherwood of the New York County Commercial Division issued a decision in Unique Goals Intl., Ltd. v. Finskiy, 2018 NY Slip Op. 32788(U), dismissing a fraud claim because of the sophisticated plaintiff’s lack of due diligence, explaining:

The first cause of action for fraud is asserted by Faith Union and Unique Goals against all defendants. This claim is based upon misrepresentations by Finskiy upon which plaintiffs relied in making their investments. Essentially, plaintiffs contend Finskiy’s various misrepresentations fraudulently induced them to purchase stock in White Tiger.

The elements of a claim for fraud are an intentional misrepresentation of material fact, falsity, scienter, justifiable reliance and damages. In a fraudulent inducement claim, the alleged misrepresentation should be one of then-present fact, which would be extraneous to the contract and involve a duty separate from or in addition to that imposed by the contract and not merely a misrepresented intent to perform. In addition, claims of fraud must meet a heightened pleading standards requiring that the circumstances constituting the wrong be stated in detail.

Critically, reliance must be found to be justifiable under all the circumstances before a complaint can be found to state a cause of action in fraud. Sophisticated investors, like plaintiffs, must show they used due diligence and took affirmative steps to protect themselves from misrepresentations by employing what means of verification were available at the time. Although the complaint here attempts to cast Yanchukov as a newcomer to the mining business who relied on his close, personal friend Finskiy to guide him, Yanchukov, plainly, is a sophisticated businessperson with access to plentiful resources to protect himself and his investments, to obtain the requisite inspections and perform the necessary due diligence. While he may have lacked experience in the mining industry, he clearly had the resources necessary to obtain expert advice or, indeed, do an investigation. Moreover, to the extent that plaintiffs argue they were forced to rely on Finskiy’s representations about, e.g., the amount of gold reserves because an independent study would have been time and cost prohibitive, they could have required warranties that these facts are true be included in their purchase documents. Further, where a sophisticated plaintiff conducts no due diligence, he cannot demonstrate reasonable reliance as a matter of law. Such is the case here. Accordingly, the fraud claim is dismissed.

(Internal quotations and citations omitted).

Commercial litigation frequently involves fraud-based claims. Such claims have special pleading requirements or rules, including the rule that a sophisticated businessperson’s reliance on a false statement must be reasonable. Contact Schlam Stone & Dolan partner John Lundin at jlundin@schlamstone.com if you or a client think you have been defrauded, or if someone has accused you or a client of defrauding them.

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Posted: November 12, 2018

Dismissal With Prejudice of Federal Securities Law Claims Does Not Bar Common Law Fraud Claims

On October 30, 2018, Justice Sherwood of the New York County Commercial Division issued a decision in Brown v. Cerebus Capital Mgt., L.P., 2018 NY Slip Op. 32782(U), holding that the prior dismissal with prejudice of federal securities law claims does not bar new common law fraud claims, explaining:

In the first through eighth causes of action, plaintiffs bring claims for common law fraud and state blue-sky law claims. Specifically, plaintiffs allege that defendants fraudulently misrepresented that US Holdco and MIP II owned material, appreciable assets; and (2) that plaintiffs were entitled to 2.9% of the Covis Enterprise’s profits and a grossup (id. ~ 234). Plaintiffs also allege that defendants fraudulently set impossible and unreasonable performance targets in the 2012 and 2013 Award Agreements; fraudulently terminated plaintiffs in bad faith for pre-textual and false reasons when defendants anticipated a Winding Up Event; failed to disclose merger negotiations to Goeken; and fraudulently exercised MIP II’s call right.

Defendants argue that four of these claims (counts one, two, five and seven) are each barred by the doctrine of collateral estoppel because they all require scienter, and the federal court dismissed plaintiffs’ federal claims for lack of scienter. However, the federal dismissal of plaintiffs’ failed securities fraud claims for failure to allege a strong inference of scienter is not preclusive.

Collateral estoppel comes into play when four conditions are fulfilled: (1) the issues in both proceedings are identical, (2) the issue in the prior proceeding was actually litigated and decided, (3) there was a full and fair opportunity to litigate in the prior proceeding, and (4) the issue previously litigated was necessary to support a valid and final judgment on the merits. Collateral estoppel will bar claims over which a federal court declined to exercise supplemental jurisdiction if the federal court decided issues identical to those raised by the plaintiffs state claims.

Defendants cannot demonstrate that they have satisfied the elements of collateral estoppel because the federal court did not decide issues identical to those raised here. The federal securities claims brought in the federal action were subject to Rule 9(b) and the PSLRA, which require a plaintiff to allege facts giving rise to a strong inference that the defendant acted with the required state of mind. In contrast, the complaint’s fraud claims are subject to the CPLR and 3016(b) may be met when the facts are sufficient to permit a reasonable inference of the alleged conduct. New York courts have uniformly held that the federal strong inference standard is higher than New York’s reasonable inference standard.

Accordingly, because the federal court applied the strong inference standard to the federal action’s allegations of scienter, the federal dismissal is not preclusive of plaintiffs’ state law fraud claims. Indeed, a dismissal pursuant to the PSLRA cannot be preclusive because the district court rendered a decision on a claim rooted in federal statutory law, based on federal rules of pleading. Accordingly, defendants’ motion for dismissal of counts one, two, five and seven of the complaint is denied.

(Internal quotations and citations omitted).

Doctrines such as collateral estoppel and res judicata limit a plaintiff’s ability to litigate a dispute more than once. Contact Schlam Stone & Dolan partner John Lundin at jlundin@schlamstone.com if you or a client have questions regarding whether a claim is barred by an earlier action.

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Posted: November 11, 2018

Plaintiff Asserting Derivative Claims Must be Represented by Counsel

On November 1, 2018, Justice Schecter of the New York County Commercial Division issued a decision in Park v. Song, 2018 NY Slip Op. 28343, holding that a plaintiff asserting derivative claims must be represented by counsel, explaining:

Whether a derivative plaintiff can maintain claims without being represented by counsel is a question of first impression under New York law. The answer is well settled in Delaware and in the Second Circuit; shareholders are required to have counsel. The rationale underlying those courts’ determinations applies with equal force in New York State; therefore, plaintiffs must retain counsel to prosecute their derivative claims.

In New York, as in Delaware, it is black letter law that a stockholder has no individual cause of action against a person or entity that has injured the corporation. Rather, if demand requirements have been satisfied (unless futile), a stockholder can assert a derivative claim to recover for injury to the business entity. Because a derivative plaintiff is really seeking to vindicate the rights of the corporation, and not simply its own rights, derivative claims are considered to belong to the corporation itself.

Additionally, in New York, like in Delaware, corporations and LLCs cannot be represented by individual shareholders or members; they must be represented by counsel. When the party to an action is a fictional person—a legal entity with limited liability—the general rule is that it cannot represent itself but must be represented by a licensed practitioner answerable to the court and other parties for his or her conduct in the matter.

The Delaware Court of Chancery has held that because a derivative plaintiff seeks to ‘enforce a right of a corporation, and corporations appearing in this Court may only do so through counsel the derivative plaintiff who asserts the rights of the corporation must also be represented by counsel. The Second Circuit concurs. There is no reason for a different conclusion here.

The concern, of course, is that a derivative action implicates the rights of all shareholders and members who will ultimately be bound by the findings made and the outcome reached in the litigation. It is therefore essential that one pursuing derivative claims be capable of doing so on behalf of all who would be affected. A plaintiff who is unfamiliar with corporate law and unrepresented by counsel runs the risk of losing an otherwise meritorious case due to lack of familiarity with well settled, yet complex rules applicable to derivative litigation, imperiling the rights of others with ownership in the entity.

Any inconvenience to the plaintiffs here is heavily outweighed by the general policy concerns requiring that a business organization be represented by counsel. A successful derivative plaintiff, moreover, is entitled to an award of attorneys’ fees. Thus, if plaintiffs’ derivative claims have merit—and many have already survived a motion to dismiss—and there is a possibility of collecting damages, there should be no shortage of lawyers in New York City willing and capable of representing them.

(Internal quotations and citations omitted).

This decision illustrates another of the special requirements for derivative actions (an action where a shareholder brings an action on behalf of a corporation or other business entity). Even though an individual may be bringing the claims, the claims belong to the corporation, and so the derivative action plaintiff must be represented by a lawyer, just like the corporation would have been required to do had it brought the claims directly. Contact Schlam Stone & Dolan partner John Lundin at jlundin@schlamstone.com if you or a client have questions regarding bringing an action on behalf of a corporation or other business entity.

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