Default judgments are merely rubber-stamped when defendant fails to appear and/or answer, right?  Wrong, as the New York County Commercial Division’s recent decision in Gutterman v. Stark (Hon. Shirley Werner Kornreich, J.) reminds us. In Gutterman, a case arising from plaintiff’s failed investment in a would-be ambulatory care surgical facility, the plaintiff purportedly served by personal service the individual (“Stark”) and corporate defendant (“FinPrime”) in question with a summons with notice and subsequently served its complaint on both by overnight express mail. FinPrime never appeared and Stark, after appearing, failed to file an answer. Naturally, plaintiff moved for a default judgment under CPLR § 3215 against Stark and FinPrime. Notwithstanding the FinPrime and Stark’s failures to appear and answer, respectively, the Commercial Division denied the plaintiff’s motion. So, what gives?

The plaintiff failed to satisfy the two fundamental requirements: effectuating proper service and pleading viable claims.  First, the court held that FinPrime was not properly served. Plaintiff’s affidavit of service for FinPrime indicated only that the recipient of service was “a person of suitable age and discretion” who was employed at the location of FinPrime’s principal place of business. The court explained that suitable age and discretion service under CLPR § 308(2) is proper as against a corporation only if the person served is authorized to receive service on the corporation’s behalf. Plaintiff’s AOS did not indicate whether the person served was employed by FinPrim, let alone authorized to accept service on its behalf.  Second, the court held that the plaintiff failed to meet its very minimal pleading burden with respect to each of its claims against Stark. While noting that the standard of proof “is not stringent, amounting only to some firsthand confirmation of the facts,” the Commercial Division explained that notwithstanding, “a default judgment does not ‘give rise to a mandatory ministerial duty to enter a default judgment” but rather it is the plaintiff’s burden to demonstrate that it “at least [has] a viable cause of action.”(quoting the Second Department’s decision in Resnick v. Lebovitz).  With respect to the plaintiff’s claims against Stark, the Court explained that:

  • Its claim for malpractice could not be maintained as a matter of law because financial advisors such as Stark are not “professionals” in the context of professional malpractice;
  • the negligent misrepresentation claim failed to allege specific facts indicating the requisite special relationship between plaintiff and Stark;
  • the negligence claim failed to identify from where Stark’s alleged duty of care originated or how his alleged breaches caused plaintiff’s alleged damages; and
  • that its claims for breach of the implied covenant of good faith and fair dealing were not viable because Stark was not a party to the underlying agreement.

The court did, however, show  plaintiff some leniency by sua sponte granting it leave to amend its Complaint. The lesson to be learned here is that a defendant’s default does not automatically entitle the plaintiff, as a matter of right, to a default judgment. As always, the plaintiff must properly effectuate service and must establish through its complaint that it has viable claims.

Diamonds are nothing more than chunks of coal that stuck to their jobs,” said Malcom Forbes.  An industry that generates over $13 billion annually, diamonds are considered one of the world’s major natural resources.  Critical to the integrity of the market are reports or certificates that grade the quality of the stones based upon the “four C’s”:  color, cut, clarity and carat.  These reports are issued by one of several grading entities.  One of them, the Gemological Institutes of America, Inc. (“GIA”), is considered to be one of the most well-respected and renowned.

Diamond purchasers and resellers, such as L.Y.E. Diamonds Ltd. (“LYE”) and E.G.S.D. Diamonds Ltd. (“EGSD”), contract with GIA in order for the formers’ diamonds to be analyzed and graded.  On May 15, 2015, GIA published an Alert, advising the diamond industry that it reasonably suspected that nearly 500 diamonds submitted to GIA’s laboratory in Israel might have been subjected to a “temporary treatment” that masks the inherent color of the stone, leading to an improper higher grading level.  In the Alert, which was published on its websites and mass email, LYE and EGSD, were identified.

As a result of the published Alerts, LYE and EGSD claim they were defamed and suffered significant losses.  They sued, filing a complaint for $180 million in compensatory and punitive damages, alleging defamation and trade libel.  At issue on the defendants’ motion to dismiss was whether GIA was entitled to qualified immunity, negating any presumption of implied malice.  Qualified immunity may exist when a statement is made by a person in the discharge of a duty — either private or public — in which another person relies as both have a common interest.

In ruling on the motion to dismiss in L.Y.E. Diamonds Ltd. v. Gemological Inst. of Am., Inc., at the outset, Justice Barry Ostrager rejected plaintiffs’ procedural argument that “qualified immunity” is an affirmative defense that could not be raised in a pre-answer motion.  Rather, the court relied on a series of First Department cases holding that a question of privilege could be determined at the pleading stage.  Turning to the merits of the application of the privilege, the court recognized that the Alerts served a “public function by warning interested parties of potentially treated diamonds, pursuant to GIA’s agreement with plaintiffs.”  Applying the privilege, the burden then shifted to plaintiffs to demonstrate that malice existed which would negate the privilege.   The court granted dismissal of the complaint, finding that the plaintiffs did not allege more than conclusory allegations of malice, with little or no detail that would support an inference that the statements were made out of spite or ill will.

Where allegations of actual malice are required to support a defamation claim, the courts appear to consistently uphold a heightened pleading standard, see, e.g., Themed Rests., Inc. v. Zagat Survey, LLC.  Remember, CPLR 3016(a) requires specificity when it comes to pleading defamation claims.  Thus, it behooves the drafter to allege facts surrounding the time, place, manner of publication, and the context of the statements made.

 

 

This week, we examine the answer to a simple question: may an out-of-state lawyer serve as counsel in a New York state court proceeding absent making a motion for admission pro hac vice? To answer this slightly ambiguously worded question, we need more information.  Specifically, the answer depends on the meaning of “out-of-state” in a particular situation.  The determinative factor is not whether the attorney resides in New York, but whether she maintains a law office in the state. Under Judiciary Law § 470 — the constitutionality of which was recently upheld (see Schoenefeld v. New York, 748 F.3d 464 [2d Cir 2014] [certifying question of statute’s constitutionality to New York Court of Appeals], Schoenefeld v. State, 25 NY3d 22 [2015] [answering certified question]) — an attorney who resides “in an adjoining state” may practice in New York only if she is admitted to practice and maintains a physical law office in New York.

A recent decision from the Appellate Division, First Department makes clear that the in-state office requirement is not to be taken lightly, especially by would-be plaintiff’s counsel. In Arrowhead Capital Fin., Ltd. v. Cheyne Speciality Fin. Fund L.P., the First Department affirmed a decision of the New York County Commercial Division (Hon. Shirley Werner Kornreich, J.), dismissing the complaint solely on the basis that at the time the action was commenced, plaintiff’s counsel failed to maintain an in-state office.

Further, the First Department found that the plaintiff’s ex post facto retention of New York based co-counsel was moot, holding that the “commencement of the action in violation of Judiciary Law § 470 was a nullity.” Additionally, the First Department affirmed the Commercial Division’s decision permitting the defendants’ dispositive motion based on Judiciary Law § 470, even though it was their second such motion, because at time the defendants made their first motion, they had no reason to suspect that plaintiff’s counsel had violated the statute.

For those curious readers, the standard for what qualifies as maintaining a physical office in New York for purposes of the statute has been examined on multiple occasions. Not surprisingly, maintaining a small, barely accessible room in the basement of a restaurant/bar in New York is insufficient (see Lichtenstein v. Emerson, 251 AD2d 64 [1st Dept 1998]), while establishing proof of an “of counsel” relationship with a New York attorney who has a New York office is sufficient (see Tatko v McCarthy, 267 AD2d 583 [3d Dept 1999]).

In one of our very first posts on this blog – entitled “First Things First:  Check the Rules!” – we reported on some updates in March of this year to Manhattan Commercial Division Justice Eileen Bransten’s individual practice rules.  We took the opportunity then to remind Commercial Division practitioners, in light of the frequency with which Commercial Division judges update their individual rules, to make a point of regularly checking the rules of those judges to whom their cases have been assigned.

Justice Bransten rules

Case in point:  Justice Bransten recently updated her practice rules for the second time this year.

Subscribers to CourtAlert, a New York case-tracking service, may recall receiving an email alert in early November, notifying practitioners that Justice Bransten had updated her practice rules as of October 27, 2017, and recommending that practitioners working on cases assigned to Part 3 download her newly-updated rules and forward them on to all other attorneys working on such cases.  A handy comparison with Justice Bransten’s prior rules highlights the following updates:

  • Status Conference Order Form:  In addition to providing Part 3 order forms for Preliminary and Compliance Conferences, Justice Bransten’s practice rules provide a New Model Status Conference Stipulation and Order form – which, as far as we can tell, is a first-of-its-kind in the Commercial Division.  The stated purpose of the form is “to assess the progress the parties have made and to determine what items are outstanding and what needs to be done to ensure that discovery is completed and the Note of Issue is filed in a timely fashion.”

The 33-page, comprehensive order form covers the waterfront, including but not limited to prior conferences and appearances; an updated description of the surviving claims and amounts demanded; general progress reports on document discovery and depositions, including any proposed new dates for completion; specific reports on electronic discovery and privilege logs; anticipated expert discovery, if any; and a status report on any progress toward settlement, including through the use of ADR.

Apropos to a number of recent posts on this blog, Justice Bransten’s new Status Conference order form makes specific reference to, and offers detailed descriptions of, virtually all the newer Commercial Division Rules that have been rolled out in recent years.

  •  Discovery Dispute Procedure:  In accordance with Commercial Division Rules 14 and 24, Justice Bransten prefers to resolve discovery disputes “through a court conference – not through motion practice.”  Her updated rules now provide for a dispute-resolution process that, in addition to requiring the moving party to submit a pre-conference position letter, permits “[t]he non-moving party to submit a rebuttal letter no later than 3 business days after the moving letter is filed.”  In addition to being e-filed on the NYSCEF system, all pre-conference letters must be submitted in hard copy before the Court will conduct the conference.
  • Motion Exhibits:  With respect to all motion submissions, Justice Bransten’s updated rules now specify that “Plaintiff shall use lettered exhibits [and] Defendant is to use numbered exhibits.”
  • Pre-Trial Submissions:  Finally, with respect to the parties’ pre-trial submissions, particularly the identification of witnesses, Justice Bransten’s updated rules make a point of clarifying that “[t]he Court need only be advised of witnesses each party will call as part of their case-in-chief [and] reserves the right to permit rebuttal witnesses upon application from the parties.”

**Nota Bene** – Once again, we would be remiss not to mention an upcoming Commercial Division-related event, particularly one concerning rule changes, sponsored by the Commercial & Federal Litigation Section of the New York State Bar Association.  On Thursday, January 18, 2018, the NYSBA will be sponsoring a webcast CLE entitled “Amendments to the Commercial Division Rules 2018:  A Renaissance in Commercial Litigation Practice.”  The CLE will cover recent rule changes concerning, among other areas, expert disclosure, limitations on depositions, non-party electronic discovery, and privilege logs.

Disclosure of Electronically Stored Information (“ESI”) has become a staple in commercial cases.  Of course, with the vast number of documents and ESI being reviewed and the increased complexity in the review process, the risk of inadvertent production of privileged information is at its highest.  The inadvertent production of privileged material often leads to lengthy, costly litigation, the consequences of which can be disastrous to litigants.

While the most efficacious approach for addressing privilege waiver as a result of inadvertent disclosure would be an amendment to the CPLR, there’s no telling whether the Legislature will pass such an amendment, or when.  Accordingly, the subcommittee of the Commercial Division Advisory Council (the “Subcommittee”) has proposed an “interim measure” to address these concerns.  Specifically, the Subcommittee proposed a new amendment to Commercial Division Rule 11-g (which addresses confidentiality orders in the Commercial Division) to incorporate specific “privilege claw-back” language into the confidentiality order.  Parties employing the language would agree to:

  • Implement and adhere to reasonable procedures to prevent the disclosure of privileged information;
  • Take reasonable steps to correct errors when protected information is inadvertently produced;
  • Return or destroy copies of inadvertently produced protected information upon request of the producing party;
  • Neither challenge the producing party’s document review procedure or its efforts to rectify the production error, nor claim that the return of the protected information has caused the receiving party to suffer prejudice.

This language is consistent with existing New York case law regarding inadvertent privilege waiver, which provides that the inadvertent production of documents does not constitute a waiver if: (i) the producing party had no intention of producing the document; (ii) the producing party took reasonable steps to ensure that the document was not disclosed; (iii) the producing party took prompt action to rectify the inadvertent production; and (iv) the party receiving the inadvertently produced document would not suffer prejudice by having to return the document.  See, e.g., AFA Protective Sys., Inc., v City of New York, 13 AD3d 564, 565 [2d Dept 2004].

The proposed amendment seeks to protect litigants from the inadvertent disclosure of protected information and reduce the number of disputes arising from inadvertent productions.  And, by incorporating language consistent with New York case law, the proposed amendment ensures that the parties take steps necessary under New York law to avoid an inadvertent waiver and take prompt action to rectify the inadvertent production if it occurs.

There’s a little over a month left to chime in on this important proposed amendment.  Persons wishing to comment on the proposal should e-mail their submissions to rulecomments@nycourts.gov or write to: John W. McConnell, Esq., Counsel, Office of Court Administration, 25 Beaver Street, 11th Floor, New York, New York 10004.  Comments must be received no later than January 16, 2018.

Notwithstanding general public opinion of attorney ethics, most people (including attorneys) believe that an attorney cannot dump a client in the middle of litigation to represent the other side. However, attorneys in the First Department may be surprised to learn that, in certain circumstances, a representation adverse to their former clients, even in litigation arising from substantially similar facts and issues, is sometimes allowed. Justice Shirley W. Kornreich of the New York County Supreme Court recently discussed these circumstances in two related decisions (found here and here) over the past year (Omnivere, LLC v. Friedman, No. 154544/2016).

First, some brief factual background. In 2013, Marcie Balint sold her legal staffing company, B3, to various individuals and companies referred to in subsequent litigation as “the Friedman Parties,” who then sold B3 to Omnivere, LLC. In 2014, Balint, represented by attorney Robert Bernstein of Eaton & Van Winkle, sued Omnivere, LLC and the Friedman Parties to enforce a consulting agreement. In response, the Friedman Parties asserted a third-party claim against the former CEO of B3, Gadi Rosenfeld, for allegedly approving a version of Balint’s consulting agreement that was different from the version that had been authorized.

On October 20, 2014, Rosenfeld met with Bernstein and provided documents and information to assist Balint in her actions against Omnivere, LLC and the Friedman Parties. In exchange, Bernstein agreed to represent Rosenfeld at a reduced hourly rate in the Friedman Parties action only (in May 2015, Rosenfeld, represented by separate counsel, commenced an action against Omnivere, represented at the time by Perkins Coie, alleging nonpayment of consulting fees).

At some point during the following year (when, exactly, was the subject of debate between the parties), Bernstein claimed to have become aware that Rosenfeld assisted the Friedman Parties in lying to Omnivere about the financial condition of B3 and other companies that Omnivere purchased from the Friedman Parties. In September of 2015, Balint settled with Omnivere, and together they joined forces with Bernstein as counsel in the remaining litigations with the Friedman Parties and Rosenfeld. Consequently, in November of 2015 Bernstein withdrew as counsel to Rosenfeld and replaced Perkins Coie as counsel of record to Omnivere.

On May 27, 2016, Omnivere commenced a new action against the Friedman Parties asserting causes of action for fraud, breaches of the asset purchase agreement governing the sale of B3, and conversion. Although Rosenfeld was not a named defendant, Omnivere’s complaint alleged Rosenfeld’s participation in the fraudulent scheme. If Omnivere prevails, Rosenfeld will lose shares of Omnivere equity.

Based on Bernstein’s prior representation of Rosenfeld, the Friedman Parties and Rosenfeld moved to disqualify Bernstein. Justice Kornreich denied the motion.

The Friedman Parties’ motion was denied because they had never been former clients of Bernstein and therefore lacked standing. The court held that it lacked authority to grant disqualification motions to non-clients, especially where such motions were intended as a litigation tactic, because the power to sanction attorneys for ethical violations is “principally vested in the Appellate Divisions.”

As for Rosenfeld’s motion, the court found that there was insufficient proof that Rosenfeld had actually provided information to Bernstein during the prior representation that would be prejudicial to Rosenfeld. Citing the First Department’s decision in Mayers v Stone Castle Partners, LLC, 126 AD3d 1, 6 (1st Dept 2015), the court held that rather than simply resolving all doubts in favor of disqualification to avoid the appearance of impropriety, as was required under the old rules, disqualification should be denied if “the conveyed information did not have the potential to be significantly harmful to the former client in the matter from which he seeks to disqualify counsel.” This standard required an evidentiary hearing to determine what information was actually conveyed from Rosenfeld to Bernstein and whether it had the potential to be significantly harmful to Rosenfeld. The Special Referree conducted a two-day hearing and issued a report finding that no “confidences that were harmful to Rosenfeld” had been disclosed to Bernstein.

Justice Kornreich appeared to have had misgivings about the proper application of the First Department’s decision in Mayers, noting that other Appellate Division Departments (as well as the First Department, occasionally) still apply the rule that doubts must be resolved in favor of disqualification. Justice Kornreich therefore explicitly appealed to the First Department for additional “guidance” on the continued applicability of this rule, as well as whether the requirement that the conveyed information have the potential to be “significantly harmful” is consistent with the Court of Appeal’s apparent holding to the contrary in Tekni-Plex, Inc. v Meyner & Landis, 89 NY2d 123, 131 (1996) (“By mandating disqualification irrespective of any actual detriment—that is, ‘even when there may not, in fact, be any conflict of interest’—the rule also avoids any suggestion of impropriety on the part of the attorney.”). Indeed, other recent decisions by the First Department involving legal professionals “switching sides” indicates continued adherence to the rule that “whether there is a conflict of interest must be resolved in favor of disqualification.” See USA Recycling, Inc. v Baldwin Endico Realty Assocs., Inc., 147 AD3d 697 (1st Dept 2017).

Until further clarification is received from the First Department, attorneys for now may evaluate representations adverse to former clients based on whether there would be actual prejudice to the former client, without regard to the appearance of impropriety or unfairness to other (non-client) parties.

So you were just retained on what could become a high-profile case.  The stakes are high, and it’s unclear how this will play in the media.  The issue may arise based on the parties to the case, the nature of the claims, or both.  Either way, as part of your litigation strategy, you decide that the assistance and guidance of a public relations or media crisis management firm is wise and necessary to render effective counsel.  You prepare your standard Kovel letter, and retain the PR consultant to assist.  As part of that engagement, you advise both consultant and client that it is essential that  you — as counsel — be copied on all communications so as to ensure the protection of privileged communications.  Is this enough protection to guard against the PR consultant from being compelled to disclose communications?  Maybe not.

In Gottwald v. Sebert, a case involving singer-songwriter and recording artist Kesha, Justice Shirley Kornreich ordered non-party Sunshine Sachs (the PR consultant) to produce certain documents identified on its privilege log.  The court held that the communications with the PR agency were not necessary for the rendering of legal advice.  Simply copying an attorney on the communication is not enough to invoke the attorney client privilege.  In footnote 7, the court raised an issue with respect to draft complaints logged and whether they were protected by the work product doctrine, which the court noted “is less likely to result in a waiver than with the attorney-client privilege.”  Following the court’s decision, counsel for defendant submitted a letter addressing the work product issue and why it prevented disclosure of certain materials.  The parties have been ordered to address this issue at an upcoming court conference in December.

Hiring a PR consultant to assist counsel navigate the media minefield, although wise, can be risky.  The court in Gottwald  analyzed the growing body of case law in this area, particularly in the federal courts within the Second Circuit, which seem to lean toward not finding “necessity” for the PR consultant’s involvement, but they are more apt consider application of the attorney work product doctrine.  Of course, unlike privilege, work product may, under certain circumstances be invaded, see Fed. R. Civ. P. 26(b)(3)(A).

There are several key decisions from the federal courts on this issue, namely, In re Chevron (SDNY; Kaplan, J.), Calvin Klein Trademark Trust v. Wachner (SDNY; Rakoff, J.), and Bloomingburg Jewish Educ. Ctr. v. Vill. of Bloomingburg (SDNY; Forrest, J.), that are a “must read” before engaging a PR consultant.  In New York, there is a scarcity of decisions, but the First Department in 2014 ruled in Pecile v. Titan Cap. Group, LLC that communications with a PR consultant do not per se waive the privilege.   The common thread in all of these authorities is to determine whether the particular communications with the PR consultant are necessary in order for counsel to render informed legal advice to the client.

 

“The expert discovery rules are promulgated so no party will be ‘sandbagged’ or surprised by another expert’s opinion” – Manhattan Commercial Division Justice Eileen Bransten

Several weeks ago, we reviewed some of the newer Commercial Division Rules and reported on a couple of recent decisions from Justice Shirley Werner Korneich of the Manhattan Commercial Division applying one of those Rules, Rule 11-c, concerning nonparty electronic discovery.  We follow up this week as promised with a look at another recent new-rule application from the same court.

Earlier this year, Justice Eileen Bransten, whose similarly-insightful decisions also are regular fodder for this blog, addressed issues concerning expert disclosure under Commercial Division Rule 13(c) in Singh v PGA Tour, Inc.Sandbagger

In Singh, the plaintiff, a professional golfer and member of the defendant PGA Tour, sued the Tour alleging that he had been humiliated by an arbitrary administration of the Tour’s anti-doping program and that the Tour wrongfully withheld his prize monies.  Singh had used a product called “deer antler spray” between seasons to address knee and back problems.  Sports Illustrated later posted an article about the spray on its website, referencing Singh’s use and suggesting that he had used it in violation of the Tour’s drug policy.  Singh responded by providing the Tour with a bottle of the spray for testing.  The initial results were negative for steroids but positive for a separate prohibited substance called “IGF-1.”  The Tour suspended Singh and held his 2013 prize money in escrow.  Singh challenged the Tour’s determination in arbitration.

The World Anti-Doping Agency, from which the Tour adopted its list of prohibited substances, subsequently determined that deer-antler spray was not a prohibited substance.  As a result, the Tour dropped its disciplinary action against Singh, and the arbitration was discontinued on the eve of the hearing.  Singh then sued the Tour in the Manhattan Commercial Division.

In the course of expert discovery in the Supreme Court action, Singh submitted a second, expert “reply report,” which the Tour challenged under Commercial Division Rule 13(c) as “impermissibly including new opinions which were not included in the first report.”  Specifically, Singh’s expert reply contained certain newly-obtained “consumer data” leading Singh to conclude that the “Tour suspension reduced the favorable criteria that marketing executives would use in their decision-making process in evaluating Singh’s viability as a spokesperson/endorser/advocate.”

Rule 13(c) mandates that an expert report contain, among other things, “a complete statement of all opinions the witness will express and the basis and the reasons for them,” as well as “the data or other information considered by the witness in forming the opinion(s).”  Quoting from The Chief Judge’s Task Force on Commercial Litigation in the 21st Century, Justice Bransten noted in her decision that “this rule was promulgated in an effort to harmonize the disclosure rules of our state and federal courts,” and that the Commercial Division looks to the Federal Rules of Civil Procedure “for guidance on expert disclosure issues.”  Federal Rule 26(a)(2)(B) mandates that an expert report contain the same statement, data, and information cited above, and Federal Rule 37(c)(1) provides that if a party fails to do so, “the party is not allowed to use that information or witness to supply evidence on a motion, at a hearing, or at trial.”

Justice Bransten granted the Tour’s motion to strike Singh’s expert reply, finding that “the new analysis, information, opinion and data contained within Plaintiff’s Reply Expert Report violates Commercial Division Rule 13(c) and FRCP 26.”  Noting the “egregiousness of the belated disclosure,” Justice Bransten cautioned Commercial Division practitioners that Rule 13(c) does not provide for “an opportunity for a party to ‘correct’ the deficiencies and omissions made in an initial expert report — including addition of new data and opinions, particularly when that data was available to the expert at the time the initial report was issued” or for an expert “to say what he neglected to say in his opening report.”

The rules of golf prohibit a player from “sandbagging” or deceiving others about their knowledge, intentions, and abilities.  As Justice Bransten’s recent decision in Singh v PGA Tour, Inc. makes clear, the same goes for the Commercial Division Rules regarding expert disclosure.

**Nota Bene** – Readers interested in hearing from Commercial Division Justices directly on lessons to be drawn from the implementation of some of these new rules and rule-changes should register for the upcoming Bench & Bar Forum sponsored by the NYSBA Commercial & Federal Litigation Section.  The program, entitled “True Innovation and Efficiency: New York County Commercial Division Justices Discuss the Success of the New Commercial Division Rules,” is scheduled for the evening of November 27th at Foley & Lardner LLP.

Under Delaware law, the decision to commence litigation on behalf of a corporation is, of course,  a fundamental exercise of business judgment, which decision rests with the Board of Directors.  A shareholder, therefore, cannot bring a derivative action without pleading that a demand on the corporation to do so had been made, or that such demand would have been “futile.”  The shareholder, therefore, has an initial decision to make:  make the demand, or plead futility. 

Recently, in Reese v. Andreotti, Justice O. Peter Sherwood dismissed a derivative action brought by a shareholder who made the demand, which was rejected by the Board.    Relying on Delaware law, the court noted that the mere making of a demand is a tacit acknowledgment by the shareholder that there is an absence of facts that would support a “futility” argument (citing Spiegel v. Buntrock).  Mere disagreement with the Board’s conclusion is simply not sufficient to raise doubts about the Board’s good faith and whether it acted on an informed basis.  Similarly, the court held that by making a demand, a shareholder is effectively conceding that his demand can be fairly assessed and thereby waives any later claim that the Board members were conflicted.

How about the availability of discovery to determine the reasonableness of the Board’s rejection of the demand?  “No” says the court, relying on both Delaware law and New York law, which come to the same conclusion:  plaintiffs are not entitled to discovery to assess the reasonableness of the Board’s rejection.

Making a demand or pleading futility becomes an important, strategic first step in any derivative action.  There are presumptions and ramifications that must be considered before the chosen course is charted and demand is made.

 

 

Under what circumstances do customer information and business operations constitute “trade secrets” that may be enjoined from use by a former employee ? A recent decision by Justice Elizabeth H. Emerson on this issue serves as a stark reminder that a preliminary injunction requires “clear and convincing” proof that the information is truly a secret.

In Devos, Ltd v. United Returns, Inc., recently-troubled pharmaceutical-return company Devos sought to enjoin its former employees from operating a competitor, United Returns, pursuant to business tort law and non-compete/solicitation provisions contained in the former employees’ employment contracts. In August 2015, Devos obtained a temporary restraining order and sought a preliminary injunction, which United Returns subsequently moved to vacate. 

The court denied the preliminary injunction and vacated the temporary restraints. After finding that the non-compete provisions included in the restrictive covenants were overly broad, the court found that the restrictive covenants were unnecessary, as well. As for Devos’ business tort claims involving misappropriation of trade secrets, the court found that “clear and convincing evidence” of a trade secret was lacking. In particular, the court rejected Devos’ contention that its customer information and business operations were “trade secrets” that United Returns had unfairly exploited to obtain competitive advantages. Crucially, there was no evidence that Devos had taken measures to protect its customer lists from disclosure; in fact, United Returns submitted evidence that the names of Devos’ customers were publicly available and well known within the industry.

Nor did the manner in which Devos conducted its business constitute a “trade secret.” United Returns introduced evidence that Devos’ systems and processes were used throughout the pharmaceutical-return industry, and “an employee’s recollection of information pertaining to the specific needs and business habits of particular customers is not confidential.” Thus, the court reaffirmed and applied the elements of “secrecy”: (1) substantial exclusivity of knowledge of the process or compilation of information and (2) the employment of precautionary measures to preserve such exclusive knowledge by limiting legitimate access by others.

Devos’ failure to meet its evidentiary burden demonstrates how important it is for employers to restrict access to important customer records. But even where efforts have been made to maintain the secrecy of customers’ information, a former employee still cannot be prevented from using that information if it could be easily obtained from publicly available sources.  For example, in Sasqua Group v. Courtney, the Eastern District of New York dismissed a misappropriation action because the  plaintiff’s allegedly “confidential” customer information database could have been duplicated through simple (though lengthy) internet searches. By contrast, in Freedom Calls Foundation v. Bukstel, the Eastern District of New York held that it would be very difficult to duplicate the plaintiff’s efforts in compiling its list of non-profit donors and clients because their personal contact information was not publicly known outside of the industry.  

Merely because a well-trained former employee has successfully competed does not prove that confidential information was misappropriated–all the more reason to take care when drafting non-compete provisions. Absent such an effective provision, Devos serves as a cautionary tale that institutional knowledge sometimes must jump a high hurdle before it can be protected as a trade secret.