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Current Developments in the Commercial Divisions of the
New York State Courts by Schlam Stone & Dolan LLP
Posted: July 7, 2018

Crime-Fraud Exception Does Not Apply to Challenged Privilege Claims

On June 21, 2018, Justice Masley of the New York County Commercial Division issued a decision in Kenyon & Kenyon LLP v. Sightsound Technologies, LLC, 2018 NY Slip Op. 31282(U), holding that the crime-fraud exception did not apply to challenged privilege claims, explaining:

According to the Firm, during a SightSound board meeting to ratify the Napster settlement agreement, defendants discussed, among other related items, the Firm’s security interest in the patents. The Firm alleges that a GE employee, claiming to be a DMT representative, attended the meeting and successfully directed the board to transfer the proceeds to GE. The Firm also alleges that Kenneth Glick’ — GE and DMT’s “designee” on the SightSound board of directors — voted that the Napster payment be transferred to GE instead of the Firm. In so doing, the Firm argues, Glick was “patently self interested” and effectively defrauded the Firm, as a known creditor, including breaching his fiduciary duty to SightSound’s shareholders.

The Firm’s principal allegation of fraud is that Glick was a self-interested board member and directed the transfer of the Napster Settlement Proceeds to his employer, GE, knowing that SightSound was insolvent. On this basis, the Firm contends that the record is replete with “badges of fraud.” In response, GE contends that the challenged documents bear no connection to the Napster Settlement Proceeds. GE also rejects the Firm’s theory of a supposed fraudulent scheme to keep the money away from Kenyon.

The crime-fraud exception to the attorney-client privilege lifts the veil of protection for communications made in furtherance of contemplated fraud or other wrongful conduct. Preserving the sanctity of privileged communications, advice in furtherance of a fraudulent or unlawful goal cannot be considered sound. Thus, the crime-fraud exception forces disclosure of communications involving fraudulent schemes, alleged breaches of fiduciary duty, or accusations of other wrongful conduct. A party seeking to compel disclosure based on the crime-fraud exception must establish a factual basis for a showing of probable cause to believe that a fraud or crime has been committed and that the communications in question were in furtherance of the fraud or crime. The Firm has established neither.

The facts alleged fail to establish probable cause that GE engaged in conversations to either commit or further a fraud on the Firm. The facts indicate that GE received the funds for distribution to DMT under the Asset Purchase Agreement (APA), which this court held gives DMT the sole discretion to decide whether the Firm’s lien would be a certain category of reimbursable expense under the APA. GE merely exercised its contractual discretion, as approved by the court. Even if, as the Firm argues, another agreement, the Novation Agreement, released DMT from certain obligations under the APA, that is hardly probable cause to believe fraud was committed or contemplated. The same is true as to Glick. The Firm alleges that Glick had a fiduciary duty to SightSound’s creditors given the company’s insolvency. The Firm argues that directors of an insolvent corporation are empowered, as fiduciaries, to protect the interests of the corporations’ creditors. On the premise that the corporation is insolvent, the Firm argues that Glick owes a fiduciary duty to the creditors of SightSound and that a breach of Glick’s fiduciary duty is an adequate basis for application of the crime-fraud exception. Contrary to the Firm’s insistence, however, SightSound’s solvency remains disputed, thus precluding application of the exception.

(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. This decision relates to a narrow exception to the attorney-client privilege rules: the crime/fraud exception. 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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