Trademark registration is essential for small business owners who are looking to build and protect the brand within their community. But when a competitor opens up down the street with the same or similar name, trademark registration may only be half the battle:  customer confusion is the other half. Justice Elizabeth Hazlitt Emerson’s ruling in the recent case out of Suffolk County, JJFM Corp v Mannino’s Bagel Bakery, emphasizes the importance of establishing consumer confusion when it comes to trademark disputes.

In JJFM Corp, the court denied plaintiff’s motion for summary judgment and granted defendants cross-motion for summary judgment, finding that two families operating food establishments in the same town under the Mannino’s name did not constitute trademark infringement, unfair competition, or a unfair business practices in violation of New York General Business Law (“GBL”) §§ 349 and 360-k.

Plaintiff operates three family-owned Italian restaurants in Suffolk County: Mannino’s Pizzeria Restaurant (Smithtown), Mannino’s Restaurant & Lounge (Oakdale), and Mannino’s Italian Kitchen & Lounge (Commack). If visiting one of the plaintiff’s restaurants, one can expect high-quality Italian food in an elegant setting. Needless to say, the plaintiff wasn’t thrilled when defendants opened Mannino’s Bagel Bakery only a few miles away from plaintiff’s Smithtown location, selling deli items like bagels and sandwiches.[1] Alleging defendants were capitalizing on the Mannino brand and good will, plaintiff brought suit for a permanent injunction and to recover damages.

While you may expect trademark infringement and unfair competition claims to be brought in Federal Court under the Lanham Act, rather than in State Court under the GBL, the elements required to prevail on trademark-infringement and unfair competition claims in New York mirror those required under the Lanham Act.  The choice to use one or the other likely comes down to strategy, rather than a substantive legal difference. Under both the Lanham Act and GBL 360-k, a plaintiff must prove the defendant’s mark is likely to cause confusion, mistake or deception. To make this determination, the court employed a two-prong test: (1) whether plaintiff’s mark is entitled to protection; and (2) whether the defendant’s use of the mark is likely to cause consumers confusion as to the origin or sponsorship of the defendant’s goods.[2]

Plaintiff easily satisfied the first prong because the logos for all three of its restaurants had been registered as service marks in New York since 2016, and two of the three were registered with the U.S. Patent and Trademark. Thus, the only issue for the court to determine was the likelihood of confusion. For this, the court employed an eight-factor test: (1) the strength of the plaintiff’s mark, (2) the similarity of the plaintiff’s and the defendant’s marks, (3) the proximity of the products, (4) the likelihood that the plaintiff will “bridge the gap,” (5) actual confusion between products, (6) the defendant’s good or bad faith in adopting the mark, (7) the quality of the defendant’s product, and (8) the sophistication of the buyers.[3]

The court instructed that just because two marks appear similar is not dispositive. Rather they need to be compared against each other as a whole to determine whether such similarity is more likely than not to cause consumer confusion. Here, the court found that beyond using the common word “Maninno’s,” the plaintiff’s mark and the defendants’ bakery sign had no similarity; plaintiff’s mark showed the Mannino’s restaurant name in stylized lettering with shaded shapes, whereas defendants’ sign did not use the stylized lettering, shaded shapes, or words like “Italian,” “Kitchen,” “Pizzeria,” “Restaurant,” or “Lounge.” While the court determined the marks were not similar, it continued its analysis because “the use of the word ‘Maninno’s’ may still have some effect.”

Although registered trademarks are typically afforded the utmost protection, the court in this case determined the strength of plaintiff’s mark to be weak. Noting that “Mannino” is a relativity common Sicilian name and the name itself did not necessarily identify the product (such as “Bacardi” for rum, “Ford” for automobiles, or “Smucker’s” for jam), the court determined that plaintiff’s existence in Suffolk County since 1996 and brand notoriety was insufficient to give the Mannino’s mark a high strength rating.

The court found that despite the fact that the parties were both in restaurant business, their businesses were vastly different; one serving high end food with the other selling deli items. There was no evidence that plaintiff had any intention of entering the bagel or the delicatessen business, and thus had no intention of “bridging the gap.” Although there had been one instance where a check meant for the defendants was mistakenly sent to the plaintiff, and defendants were occasionally asked by customers if they were affiliated with the plaintiff, these facts were insufficient to evidence actual confusion between the two. The court found no evidence of bad faith, especially because when the defendants were asked if they was affiliated with the plaintiff, they responded “no.” Plaintiff alleged the defendants were taking advantage of its reputation for high-quality Italian cuisine, however the court found that other than a few items, defendants did not even sell Italian food. Thus the relative quality of the products was not a significant factor and it was unlikely that even an unsophisticated buyer would be confused as to the source of the products.

In the end, the court held these facts factored the defendants, and thus dismissed plaintiff’s claims for trademark infringement and unfair competition. Unable to find evidence in the record suggesting risk of harm to the public, the court further dismissed plaintiff’s claim for unfair business practices.

Upshot: To be successful on trademark infringement and unfair competition claims, a plaintiff needs to show a defendant has more than a similar name and operating in the same general industry. Rather, a plaintiff needs to be ready to withstand the scrutiny of an eight-factored test to establish defendant’s use of the mark is likely to cause consumer confusion.

 

[1] Defendants are two corporations, RAGF Food Corp. (“RAGF”) who operate Mannino’s Bagel Bakery in Freeport, New York, and ARF Food Corp. (“ARF”) who operate Mannino’s Bagel Bakery in Smithtown, New York.

[2] The law of trademark infringement is part of the law of unfair competition and the same test is applied in determining each claim.

[3] These factors originate from Polaroid Corp v Polarad Elecs Corp.

Proximate cause is a necessary element in tort law, but also applies to claims of breach of commercial contract.  In a recent decision by Justice Barry R. Ostrager in MUFG Union Bank, N.A. v. Axos Bank et al., No. 652474/2019, 2020 N.Y. Slip Op. 51101(U) (Sup. Ct., New York County Sept. 25, 2020), the Commercial Division of the Supreme Court, New York County addressed, among other things, the issue of whether a defendant’s breach was a proximate cause of plaintiff’s damages in denying one defendant’s motion for summary judgment seeking to dismiss plaintiff’s breach of contract claim.

The parties to the action are MUFG Union Bank, N.A. (“Union”), Epiq Systems, Inc. (“Epiq”), and Axos Bank, Axos Fiduciary Services, Axos Nevada, LLC, and Seller Sub, LLC (collectively, “Axos”).

On or about September 27, 2012, Union and Epiq entered into a Joint Services Agreement (“JSA”), effective October 1, 2012, as amended. Pursuant to the JSA, Union and Epiq agreed, among other things, “to jointly promote their products and services to bankruptcy and insolvency professionals and also fiduciary types as may be agreed upon by the parties on a case-by-case basis,” which professional and fiduciary types were deemed “Joint Clients”. Specifically, Union provided deposit services to bankruptcy trustee customers and Epiq provided software services to bankruptcy trustee customers. The JSA expressly restricted Union and Epiq’s ability to assign the JSA or transfer Joint Client relationships or accounts without the other’s prior written consent. Notwithstanding this restriction, Epiq, without consent of Union, decided to sell its software business to Axos. In order to circumvent the anti-assignment provision in the JSA, Epiq established Seller Sub, LLC (“Seller Sub”), identified as “a special purpose entity wholly owned by Epiq and allegedly created for the sole purpose of effectuating the transfer of the JSA to Axos without Union’s consent.” Epiq formed Seller Sub one day before entering into a fifh amendment of the JSA with Union. Epiq then transferred the JSA to Seller Sub. Axos then acquired Seller Sub with the JSA. But Epiq directly transferred its software business to Axos. Thereafter, Axos terminated the JSA with Union and the action ensued. Continue Reading Proximate Cause In Breach Of Contract Actions: Is Loss A Foreseeable Consequence Of Circumstances Created By The Breaching Party?

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To be sure, much has been reported on here at New York Commercial Division Practice concerning Commercial Division innovation — including in the areas of courtroom technology and, more recently, in adapting to the “new norm” of virtual practice in the wake of the COVID-19 pandemic.  As we observed a few months back, the virtual practice of law in the Commercial Division is becoming more real than virtual.  A recent amendment to the Commercial Division Rules over the summer, particularly to Commercial Division Rule 1 (“Appearance by Counsel with Knowledge and Authority”), has arguably furthered the cause by expressly allowing lawyers to request permission from the court to appear remotely by videoconference.

ComDiv Rule 1 is your basic “Be Prepared!” reminder when practicing in the Commercial Division.  It specifically requires lawyers appearing before ComDiv judges to be “fully familiar” with their cases; “fully authorized” to enter into agreements; “sufficiently versed” in e-discovery matters; and promptly “on time” for scheduled appearances.  As of July 15, 2020, Rule 1 now also provides at subsection (d) that:

Counsel may request the court’s permission to participate in court conferences and oral arguments of motions from remote locations through use of videoconferencing or other technologies. Such requests will be granted in the court’s discretion for good cause shown; however, nothing contained in this subsection (d) is intended to limit any rights which counsel may otherwise have to participate in court proceedings by appearing in person.

The language of Rule 1’s new subsection is both permissive and discretionary.  As the Commercial Division Advisory Council noted in its memorandum setting forth the reasons for the amendment, “Rule 1 enables any lawyer to decline to participate from remote locations … [and is not] intended to limit any rights which counsel may otherwise have … by appearing in court.”  As noted by the Council, “many lawyers feel that to serve their clients effectively, they must be able to make their presentations in person and see the judge in order to gauge his or her reactions to the arguments presented.”  The use of the permissive “may” in the new provision addresses that concern, among others.

The use of the phrase “in the court’s discretion” likewise addresses common concerns from the bench, including but not limited to the ability to “control overbearing or other inappropriate behavior by counsel more readily and more effectively by visual cues or otherwise.”  That said, the Advisory Council’s memo made specific reference to a videoconferencing survey circulated some years back among federal appeals judges in which the majority of the judges “indicated no difference in their understanding of the legal issues in arguments that were video-conferenced versus those that were not.”  After all, as the Council observed, “videoconferencing can replicate the experience of talking to a real person across the table, will all the nuances and body language that in-person conversations would convey.”

Notably, the amendment is limited to “court conferences and oral argument of motions and … not intended to address the more complex subject of testimony by witnesses at trials or other evidentiary hearings.”

Having been sent out for public comment over a year ago, there understandably is no mention of COVID-19 in the Advisory Council’s rationale for the amendment, which instead focused on efficiency and “obviat[ing] huge amounts of wasted time and money devoted to unnecessary travel by lawyers.”  Here’s the money quote (literally) from the Council on the topic:

A lawyer who travels from White Plains to Albany County to participate in a status conference will require a minimum of four hours of travel time and will incur out-of-pocket disbursements for travel by train or automobile. If that lawyer bills $600 per hour, the cost of the travel to the lawyer’s client would be $2,400 in attorney’s fees plus another $100 in disbursements.

In other words, a Westchester-based client may soon be pleasantly surprised to find a “.5” rather than a “5.5” next to a billing entry that says, “Travel to/from Albany County Supreme for status conference before Platkin, J.”

In short, there is much in the way of practical wisdom behind the new amendment to ComDiv Rule 1, even without consideration of the novel circumstances we’ve all been navigating over the last six months.  Add a pandemic to the mix, and the amendment couldn’t have come to us at a more perfect time.

In 2015, our colleagues in the white-collar criminal defense bar braced for the impact of a memorandum penned by then Deputy Attorney General Sally Yates.  The Yates Memo encouraged both federal prosecutors and civil enforcement attorneys to make increased efforts to hold culpable individuals accountable for corporate misconduct.

The Yates Memo embodied the precept that justice is better served when the responsible individuals are held accountable for corporate misconduct.  That precept plays a prominent role in a case recently decided by Justice Ostrager of the New York County Commercial Division.  In Kilgour Williams Group, Inc. v. Ben-Artzi, Justice Ostrager awarded the plaintiffs—accounting and financial experts Colin Kilgour and Daniel Williams—summary judgment on their breach of contract claims stemming from their assistance in securing an $8.25 million whistleblower award.

The case highlights the difficulty of avoiding an agreement based on unconsionability, finding no issues of fact concerning the enforceability of an eleventh-hour “letter agreement” that quadrupled plaintiffs’ consulting fee after their engagement was completed.  It also adds a chapter to the fascinating story of the Deutsche Bank executive who blew the whistle on accounting misconduct, then turned down a multi-million dollar award.

The Misconduct, the Experts, and the Agreements

Between 2010 and 2011, Eric Ben-Artzi was a risk officer at Deutsche Bank.  In that role, he discovered that during the financial crisis, Deutsche Bank concealed from its shareholders potentially massive credit-derivatives losses.  He reported that misconduct first internally, and then to the SEC.

In November 2011, Ben-Artzi and his attorneys commenced a proceeding for a whistleblower award before the SEC.  At the suggestion of his attorneys, Ben-Artzi retained Kilgour Williams Group (“KWG”)—the Plaintiffs in this action—to render expert consulting services in support of his whistleblower claim.  The relationship between KWG and Ben-Artzi evolved as his whistleblower proceeding unfolded, and KWG’s compensation was memorialized in several agreements:

First, in April 2013, Ben-Artzi’s company, Model Risk LLC, entered into an agreement with KWG where KWG agreed to provide expert consulting services in exchange for 3% of the gross value of any whistleblower award rendered by the SEC.

Second, in August 2014, Ben-Artzi’s Model Risk entered into a “Tri-Party Agreement” among (i) Model Risk, (ii) KWG and (iii) its principals Daniel Williams and Colin Kilgour.  This agreement increased KWG’s fee to 5% of the gross value of any award, and it transferred to KWG the rights to the intellectual property that it had developed while working on Ben-Artzi’s claim.  As consideration for the transfer of intellectual property, KWG agreed that it would submit its own whistleblower claim, and that Ben-Artzi would be entitled to 60% of the payout on that claim.

Ben-Artzi Turns Down the Award

In 2015 after many meetings between Ben-Artzi and the SEC, including one where Plaintiffs gave a thorough powerpoint presentation regarding Deutsche Bank’s alleged misconduct, the SEC reached a settlement with Deutsche Bank.  The settlement imposed civil penalties on Deutsche Bank of $55 million for violations of the Securities and Exchange Act, but it did not punish any of the responsible executives.

Members of the SEC’s enforcement division subsequently attested to helpfulness of both Ben-Artzi and KWG in providing information necessary to bring their action.  Accordingly, Ben-Artzi’s whistleblower claim was accepted, and he was awarded 15% of the $55 million penalty imposed on Deutsche Bank, or $8.25 million.  Accordingly, under the Tri-Party Agreement, KWG was entitled to receive approximately $412,500.  The SEC denied KWG’s independent whistleblower claim.

About a month after receiving notice of the award (and while the ink was still wet on the Yates Memo) Ben-Artzi published an editorial in the Financial Times announcing his decision to turn down his share of the award because the SEC did not fine the executives responsible for the wrongdoing:

But Deutsche did not commit this wrongdoing. Deutsche was the victim. To be precise, the bank’s shareholders and its rank-and-file employees who are now losing their jobs in droves are the primary victims. . . . Although I need the money now more than ever, I will not join the looting of the very people I was hired to protect. I never intended to turn a job in risk management into a crusade, but after suffering at the hands of the Deutsche executives I will not join them simply because I cannot beat them.

Ben-Artzi attributed the SEC’s failure to personal relationships and the “revolving door” of high-level executives between Deutsche Bank and the SEC.

The Letter Agreement

According to Ben-Artzi, his decision to repudiate the award led both his counsel and KWG to turn on him.  Shortly after the Financial Times published his editorial, KWG presented Ben-Artzi with a curious letter.  The letter accused Ben-Artzi of somehow impacting KWG’s own whistleblower claim and requested that Ben-Artzi agree to transfer $2.5 million to them, in addition to the amounts payable under their agreements:

We understand that you regard your share of the award as dirty money and have decided not to personally accept any portion of the award. Therefore, we request that you direct the SEC to direct $2,500,000 to us. This payment is in addition to the contracted amount payable to Kilgour Williams Group. Please sign below to indicate your agreement . . .

For some reason—though it’s not at all clear why—Ben-Artzi signed this “Letter Agreement.”  In his affidavit opposing Plaintiffs’ motion for summary judgment, Ben Artzi argues that he “most certainly never intended to create an obligation in that amount,” but he does not explain what else he thought signing the Letter Agreement would do.

Ultimately, Ben-Artzi did not instruct the SEC to disburse the award in accordance with the Letter Agreement.  Rather, he instructed the SEC to pay a portion of the award to his ex-wife (as ordered by a court overseeing his divorce proceedings), a portion to his attorneys, and the balance to a trust for his children.  The SEC disbursed the award as requested.  Ben-Artzi did not contest that KWG was owed their 5% fee under their earlier agreements, but he disputed the notion that the Letter Agreement entitled them to an additional $2.5 million.

Ben-Artzi’s Unconscionability Claim

Plaintiffs sued to enforce the Letter Agreement.  Opposing their motion for summary judgment on their breach of contract claim, Ben-Artzi argued that the Letter Agreement was both procedurally and substantively unconscionable.  It was procedurally unconscionable, Ben-Artzi argued, because after KWG learned of Ben-Artzi’s intention to reject the award, “Kilgour and Williams became aggressive and threatening, exerting tremendous pressure upon him to give to them whatever portion of the award he would otherwise have realized (but for his repudiation).”  The Letter Agreement was substantively unconscionable, Ben-Artzi argued, because it changed Plaintiffs’ fee from 5% of the gross award ($412,500) to more than $2.5 million after the work was complete and without any corresponding benefit to Ben-Artzi.

Plaintiffs countered that the Letter Agreement was neither procedurally nor substantively unconscionable.  The Letter Agreement was negotiated between sophisticated parties—Ben Artzi has a Ph.D. in mathematics and worked at some of the world’s most powerful financial institutions—and emails preceeding the Letter agreement do not show any high-pressure or deceptive tactics.  Substantively, the Letter Agreement reflected a bargained-for exchange: in exchange for the increased payments, Plaintiffs were releasing Ben-Artzi for claims they might have had against him arising out of his rejecting the award or compromising KWG’s own whistleblower application.

Justice Ostrager’s Decision, Practical Considerations

Ruling from the bench, Justice Ostrager granted Plaintiffs’ motion for summary judgment for breach of the Letter Agreement.  Although his written findings of fact do not say much about his reasoning and the transcript of oral argument is not filed, Justice Ostrager holds Ben-Artzi to the terms of his Letter Agreement.  In so doing, he highlights just how difficult it is for sophisticated parties to avoid a contract based on unconscionability: KWG’s last minute, $2.5 million increase did not even raise an issue of fact concerning whether the Letter Agreement was unconscionable.  As the Commercial Division occasionally reminds us: absent circumstances that truly are extreme, sophisticated parties will be held to the deal they struck, however one-sided.

As New York courts reopen and the mandatory stay-at-home order is lifted, what remains unclear is how the numerous Executive Orders issued by Governor Andrew M. Cuomo during the COVID-19 pandemic will affect individuals and businesses who, based on the economic effects of the crisis, may no longer be able to abide by previously issued court orders.

In a recent decision, Justice Lawrence Knipel addressed one of likely many present-day contractual issues brought on by the coronavirus pandemic.

In 538 Morgan Avenue Properties et al., v. 538 Morgan Realty LLC et al., Plaintiffs entered into a business sales contract with Defendants in 2015 whereby Plaintiff NY Stone purchased Defendant SD’s business.  At the same time, the parties entered into a separate real estate sales contract whereby Plaintiff 538 Morgan Avenue Properties purchased from Defendant the real property where SD’s business was located.  While Plaintiffs continued to make payments to Defendants under the contracts for the business and real property, Defendants cancelled the real estate contract, asserting a material breach by Plaintiffs based on their failure to pay a certain amount by the contract’s “as of date.”  In turn, Plaintiffs brought this action for breach of contract, claiming that all payments were made within a reasonable time and Defendants were in breach when they cancelled the real estate contract.

In 2017, the Court issued an order granting Plaintiffs’ motion for a preliminary injunction enjoining Defendants from interfering with their tenancy at the property under the condition that Plaintiffs pay a monthly use and occupancy fee in the amount of $22,986 along with a filing of an undertaking fee of $80,000.

Shortly before New York’s stay-at-home order was lifted in June 2020, Plaintiffs moved for an order modifying the preliminary injunction issued in the case concerning the use and occupancy payments due in light of the COVID-19 crisis.

In New York, although a landlord can recover use and occupancy costs for the reasonable value of the premises and use of those premises, the Court, ultimately, has broad discretion in awarding use and occupancy during the pendency of an action or proceeding (43rd St. Deli, Inc. v. Paramount Leasehold, L.P.).  When awarding use and occupancy, the Court takes into account the actual value of the property, whatever restrictions apply because of agreements between the parties, governmental decrees, and other factors (438 W. 19th St. Operating Corp. v. Metropolitan Oldsmobile, Inc.).

Here, to persuade the Court to modify the existing monthly use and occupancy payments due in light of the COVID-19 crisis, Plaintiff NY Stone argued that because it operates a stone fabrication store, which requires work to be done in person, the business was negatively affected by the government’s response to the COVID-19 pandemic through the Governor’s signing of numerous executive orders, including Executive Order 202.8, which forced Plaintiffs to first decrease their workforce and then completely forbid any of their employees from working on-site.  Accordingly, Plaintiffs asked the Court to waive any use and occupancy payments for the period from March 22, 2020 until such time as Plaintiffs are legally permitted to resume business operations.

Interestingly, Executive Order 202.8 (which Plaintiffs relied on in their motion) only prohibited “enforcement of either an eviction of any tenant residential or commercial, or a foreclosure of any residential or commercial property for a period of ninety days.”  The Executive Order, however, had no bearing on a commercial tenant’s obligations to pay rent nor did it mention forgiveness of a commercial tenant’s debt owed.

The Court recognized that because the Executive Order at issue was silent on use and occupancy fees, the Court had the power to modify use and occupancy upon a proper showing, leaving room for the possibility that a tenant’s use and occupancy could be modified or completely forgiven.

However, the Court, ultimately, denied Plaintiffs’ request for modification as Plaintiffs in this case failed to bring forth any competent evidence in the form of financial documentation or an accountant’s affidavit with supporting evidence to demonstrate that Plaintiffs could not actually pay for use and occupancy for the months during which they could not operate on-site.

Takeaway:  Courts have deference in issuing and modifying some court orders.  Even so, attorneys must make every effort to prove with the necessary evidence why a previously issued court order is entitled to and worthy of modification.

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Your client has just asked you to commence an action against a corporate entity in a New York state court.  But, the defendant is not incorporated in New York, and does not maintain a principal place of business in New York.  Further, the incident underlying your client’s claim did not occur in New York, nor is the claim connected to the defendant’s specific conduct in New York.  Obtaining specific personal jurisdiction over the foreign corporation is not an option.

The claims, then, may only be brought in New York if the court can exercise general personal jurisdiction over the foreign corporate entity.  But what is the standard for obtaining general personal jurisdiction in New York, and what must be shown?  The Appellate Division, Second Department recently answered these questions in Lowy v Chalkable, LLC (2020 NY Slip Op 04471 [2d Dept Aug. 12, 2020]).

The plaintiffs in Lowy had entered into a joint venture agreement with defendants to purchase and develop websites and web-based companies. Plaintiffs were to provide capital funding, and defendants were to develop and run the websites.  Plaintiffs allegedly provided the funding, but defendants did not perform their obligations under the contract, which included giving plaintiffs equity in the defendant Chalkable, LLC (the “LLC”), a Delaware web-based company allegedly controlled by defendants.

Sometime thereafter, defendant Chalkable, Inc. (the “Corporation”), purchased the LLC, and defendant PowerSchool Group, LLC (“PowerSchool”), purchased the Corporation. Both the Corporation and PowerSchool (the “PowerSchool Defendants”) were formed under the laws of Delaware and have their principal place of business in California.

Plaintiffs sued defendants, asserting claims for breach of contract, declaratory relief, and a constructive trust. The PowerSchool Defendants moved, among other things, pursuant to CPLR § 3211 (a)(8) to dismiss the complaint for lack of personal jurisdiction.  In October 2017, the Queens County Commercial Division (Grays, J.), granted the PowerSchool Defendants’ motion, and Plaintiffs appealed.

The Appellate Division, Second Department, affirmed Justice Grays’ decision, finding no basis to impose either general or specific personal jurisdiction over the PowerSchool Defendants.  With respect to the Court’s exercise of general personal jurisdiction, the Court reiterated the general rule that a corporation is subject to general jurisdiction only in the state of the company’s place of incorporation or principal place of business. Citing its prior decision in Aybar v Aybar, 169 AD3d 137 (2d Dept 2019), the Court noted that an exception exists in “an exceptional case” where the defendant’s contacts with New York are “so continuous and systematic, ‘judged against [its] national and global activities, that it is essentially at home’ in th[e] state.”  In the Court’s view, plaintiffs failed to make that showing.

Although the Second Department did not offer a lengthy analysis for its conclusion, its reasoning can be gleaned from the Court’s prior decision in Aybar, as well as the United States Supreme Court’s seminal decision in Daimler AG v Bauman (571 U.S. 117 [2014]).

Daimler

Prior to the Supreme Court’s decision in Daimler, a foreign corporation was amenable to suit in New York under CPLR § 301 only if it engaged in “such a continuous and systematic course of ‘doing business’ here that a finding of its ‘presence’ in this jurisdiction is warranted” (see e.g. Landoil Resources. Corp. v Alexander & Alexander Servs., 77 NY2d 28, 33 [1990], quoting Laufer v Ostrow, 55 NY2d 305, 309–310 [1982]).  Then, in Goodyear Dunlop Tires Operations, S.A. v Brown (564 US 915 [2011]), the Supreme Court addressed the distinction between general and specific jurisdiction, holding that a court is authorized to exercise general jurisdiction over a foreign corporation when the corporation’s affiliations with the state “are so ‘continuous and systematic’ as to render them essentially at home in the forum State” (id. at 919, quoting International Shoe Co. v Washington, 326 US 310, 317 [1945] [emphasis added]).

In Daimler, the Supreme Court limited the scope of general jurisdiction to that definition, explicitly rejecting a standard that would permit the exercise of general jurisdiction in every state in which a corporation is engaged in a “substantial, continuous, and systematic course of business” (571 US at 137). The Court instructed that the two main bases for exercising general jurisdiction are (i) the place of incorporation, and (ii) the principal place of business (see id.), but left open the possibility of an “exceptional case” where a corporate defendant’s presence in another state is “so substantial and of such a nature as to render the corporation at home in that State” (id. at 139, n. 19 [emphasis added]).

Aybar

After Daimler, the Second Department in Aybar considered whether to exercise general personal jurisdiction over a foreign corporation registered to do business in New York,  which had appointed a local agent for service of process.  The plaintiffs in Aybar argued that the defendant, Ford Motor Company (“Ford”), should be subject to the Court’s general jurisdiction because Ford (i) had been authorized to do business in New York since 1920, (ii) operated numerous facilities in New York, (iii) owned property in New York and spent at least $150 million to maintain that property, (iv) employed significant numbers of New York residents, (v) contracted with hundreds of dealerships in New York to sell its products under the Ford brand name, and (vi) had frequently been a litigant in New York courts.  Seems sufficient for a court to exercise general personal jurisdiction, right?

It wasn’t.

Although the plaintiffs pointed to Ford’s factory in New York, employing approximately 600 people, and Ford’s contracts with “hundreds” of dealerships in New York, Ford presented evidence that it had 62 plants, employing about 187,000 people, and 11,980 franchise agreements with dealerships worldwide.  In the Second Department’s view, “appraising the magnitude of Ford’s activities in New York in the context of the entirety of Ford’s activities worldwide, it cannot be said that Ford is at home in New York.”

This brings us back to the Second Department’s decision in Lowy.  There, the Court noted that the Corporation “owns and operates software that facilitates communication in schools and provides educational data management in schools in 50 states, while the education technology platform owned and operated by PowerSchool Group serves millions of users in more than 70 countries.”  As in Aybar, the Second Department considered the entirety of the PowerSchool Defendants’ nationwide and worldwide activities, ultimately concluding that the PowerSchool Defendants’ activities in New York were not so “continuous and systematic” so as to render them “at home” in New York.

Takeaway: 

The fact that a foreign corporation conducts business in New York, standing alone, is insufficient to permit the exercise of general jurisdiction over claims unrelated to any activity occurring in New York.  To determine whether a foreign corporate defendant’s affiliations with the state are so “continuous and systematic” so as to render it essentially “at home” in New York, courts will not focus solely on the defendant’s in-state contacts, but will undertake an appraisal of the defendant’s activities in their entirety, both nationwide and worldwide.   As the United States Supreme Court noted in Daimler, “a corporation that operates in many places can scarcely be deemed at home in all of them.”

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The Manhattan Commercial Division lost a gem of a jurist last month when Governor Cuomo appointed Justice Saliann Scarpulla to a seat on the bench of the Appellate Division, First Department.  Good for her, to be sure.  But many of us ComDiv practitioners will be sorry to see her go.

Justice Scarpulla, after all, was a natural for the Manhattan Commercial Division.  She began her legal career in the late 1980s as a Court Attorney to former Manhattan Supreme Court Justice Alvin Klein.  In 1999, after more than a decade in private practice – and within just a few years of the inception of the Commercial Division itself – she became Principal Court Attorney to former Manhattan ComDiv Justice Eileen Bransten.  Fifteen years later, after serving more than a decade on the bench of the Manhattan Civil and Supreme Courts, Justice Scarpulla was elevated to replace former Manhattan ComDiv Justice Barbara Kapnick – who, like Justice Scarpulla, was tapped in 2014 to join the ranks of the First Department.

Justice Scarpulla has contributed much to the Commercial Division in her 5-plus years on the bench, including her push for a “paperless part” in Part 39 and her implementation of the Integrated Courtroom Technology (ICT) program in her courtroom over the last couple of years.  After launching the program for the Manhattan ComDiv in October 2018, and proclaiming the primacy of “hav[ing] the right technology to give the business community in New York the sense that we [can] compete with the best courts in the world,” Justice Scarpulla twice hosted demonstrative presentations by members of ComFed’s Committee on the Commercial Division – first in April and again in October of last year – of all the hi-tech equipment in her courtroom.  The standing-room only programs were attended by lawyers, judges, and court personnel alike – all of them eager to learn how to implement ICT into their own day-to-day routines.

Justice Scarpulla also made headlines late last year when she ordered the President in Matter of People v Trump to pay $2 million to settle claims brought by the New York Attorney General, finding that he breached his fiduciary duty as a director of the Donald J. Trump Foundation by “allowing his [political] campaign to orchestrate [a] fundraiser, allowing his campaign, instead of the Foundation, to direct distribution of the funds [raised], and using the fundraiser and distribution of the funds to further Mr. Trump’s political campaign.”

We here at New York Commercial Division Practice, as well as our colleagues over at New York Business Divorce, have spilled much ink reporting on Justice Scarpulla’s thoughtful and sometimes novel decisions over the years.  In fact, we separately highlighted two cases of first impression adjudicated by Justice Scarpulla in our annual NYLJ column earlier this year.

In Advanced 23, LLC v Chambers House Partners, LLC, Justice Scarpulla applied for the first time in the context of an LLC dissolution proceeding the 35-year old “bad-faith petitioner” defense — found in the Court of Appeals’ 1984 decision in Kemp & Beatley — when she affirmed a special referee’s finding that the petitioning LLC member had “breached the [the LLC’s] Operating Agreement to attempt a forced dissolution of [the LLC].”  And in Rosania v Gluck, she extended the now-uniform rule found in the First Department’s 2016 Matter of Raharney decision, which prohibits New York courts from dissolving foreign entities, to a Delaware LLC member’s attempt to assert quasi-dissolution claims for a compelled buyout or other liquidation of the LLC’s assets.  The equitable claims asserted by the plaintiff-member in Rosania, she ruled, was simply “an ill-disguised attempt to make an end-run around the rule” and “would be tantamount to ordering the dissolution of the LLC.”

With these and countless other decisions issued over her 5-plus years on the ComDiv bench, Justice Scarpulla no doubt has made a unique and important contribution to the Commercial Division jurisprudence from which we ComDiv practitioners regularly draw.  We thank you for your service.

Paramount to obtaining an often necessary preliminary injunction pursuant to Article 63 of New York’s Civil Practice Law and Rules (“CPLR”) is the movant’s obligation to establish a likelihood of success on the merits.  A related, and threshold question is, does the Court have jurisdiction over the defendant? In a recent decision, Justice Andrea Masley addressed this very issue of whether the court had jurisdiction over the defendant or not, and whether the absence of jurisdiction prevented the court from granting preliminary injunctive relief.In Setter Capital, Inc. (“Setter”) against Maria Chateauvert (“Chateauvert”), No. 651992/2020, 2020 NY Slip Op 20199 (N.Y. Sup. Ct., New York County July 15, 2020), Setter moved the court for a preliminary injunction “enjoining its former employee [Chateauvert] from directly or indirectly soliciting, inducing or recruiting or attempting to interfere with the relationship between [Setter] and any customer, client supplier, licensee or other business relation of [Setter’s] or otherwise disrupt, damage, impair or interfere in any manner with the business of [Setter] until February 3, 2022.” Id. at *1-2 (internal quotations omitted).

It is well settled that in order to obtain a preliminary injunction pursuant to CPLR 6301, a plaintiff has the burden to establish “(1) a likelihood of success on the merits of the action; (2) the danger of irreparable injury in the absence of preliminary injunctive relief; and (3) a balance of equities in favor of the moving party.” Id. at *2 citing Nobu Next Door, LLC v. Fine Arts Housing, Inc., 4 N.Y.3d 839 (N.Y. Ct. App. 2005).

At the outset, the court addressed the issue of whether the court had jurisdiction over Chateauvert, a Canadian resident. Id. at *2. In September 2013 and two years after graduation from college, Chateauvert signed a Confidentiality and Non-Compete Agreement (“Agreement”) related to Chateauvert’s employment with Setter. Id. The Agreement contains a choice of law and forum selection clause selecting New York law as governing law and New York courts as the exclusive venue and jurisdiction for disputes. Id. at *2.

In its analysis, the court addressed the question of the enforceability of the choice of law and forum selection clause of the Agreement (as an employment agreement) under Sections 5-1401 and 5-1402 of New York’s General Obligation Law (“GOL”). Id. at *2-3. “GOL § 5-1401 provides for the enforcement of choice of law provisions in contracts over $250,000 and GOL § 5-1402 provides for the enforcement of forum selection provisions in contracts over $1,000,000. Id. The court explained that that GOL § 5-1401 is inapplicable to contracts for “labor or personal services,” and although GOL § 5-1402 allows for actions based on contracts against non-residents to be maintained in New York “where: (1) the contract contains a choice of law clause pursuant to GOL § 5-1401,” that neither section was applicable in the case. Id. at 3 (citation omitted). Reading into the legislative intent behind these GOL provisions, the court also questioned whether Chateauvert, just two years out of college, was the “sophisticated business person the legislature envisioned in 1985 when GOL § 5-1401 and § 5-1402 were enacted.” Id. at *3.

The court determined that “if the court cannot exercise jurisdiction pursuant to the Agreement, then plaintiff must establish jurisdiction.” Setter, supra, at *3. The court found that the jurisdictional issue was “an issue of fact that undermines plaintiff’s likelihood of success.” Id.

Continue Reading Preliminary Injunctions: Jurisdictional Issue Undermines Likelihood of Success on the Merits

Attorneys do a lot for their clients. They offer counsel, provide legal advice, and work hard to advocate for their client. But one thing they shouldn’t do, is assist their client perpetrate millions of dollars of fraud and then assert a flawed statute of limitations defense in a desperate attempt to avoid liability. Unfortunately that’s exactly what is alleged against the defendant-attorney, Adam Chodos, in the recent New York Commercial Division matter, Sabourin v Chodos.

The facts of Sabourin involve a lawyer’s complicity in a complex fraudulent scheme with his client and non-party William Jack Frost (“Frost”), an investor in a fashion and lifestyle magazine known as Z!NK, on its founders, Isabelle Sabourin (“Sabourin”) and Sheriff Ishak (“Ishak”) (collectively the “Plaintiffs”). Though the underlying acts of fraud date back to 2008, the facts surrounding the Defendant’s involvement are alleged to have been unknown until evidence and testimony was adduced as part of Arbitration against Frost in 2013-2014 (the “2013-2014 Arbitration”). In this action, where the Plaintiff’s brought claims against Frost’s attorney, Justice Andrew Borrok denied the Defendant’s motion for summary judgment, finding issues of fact as to when exactly the Plaintiffs learned of the attorney’s fraudulent conduct for the purposes of the statute of limitations.

In 2007, Frost invested 8 million in Z!NK Magazine in exchange for 25% equity in a new joint venture called I.T. Global Media, LLC (“ITGM”). Frost defaulted on his initial funding obligations within the first 30 days—foreshadowing the tumultuous business relationship to come. After coming up with the funds to revive the deal, Frost, with the help of the Defendant, spent the next few years fraudulently wresting control of the Z!NK business and looting its assets.

Some of the duo’s fraudulent highlights include:

  • Misrepresenting that Frost would open an account for ITGM to deposit a $6 million check, never opening such an account, and instead producing forged account statements to Plaintiffs to show a false balance of $6 million;
  • Drafting a fraudulent resignation letter on behalf of Ishak, and as a result, taking over ITGM, terminating its employees and closing all of its bank accounts;
  • Forwarding the forged resignation letter to any bank where Ishak attempted to open a new bank account for Z!NK and demanding that those accounts be frozen;
  • Filing papers with the U.S. Patent and Trademark Office purporting to assign all the rights, title, and interest in the Z!NK trademark to a company solely owned by Frost;
  • Accusing Ishak of financial improprieties in order to dissuade Ishak from retaining an outside accountant (which would have likely exposed their fraudulent acts);
  • Drafting and notarizing several promissory notes and security agreements for the purpose of evidencing fictitious debts of approximately $4 million and causing ITGM’s accountants to file false tax returns acknowledging the fraudulent debts and a Schedule K-1 Form that one of Z!NK’s founding companies received $4 million in distributions; and
  • Making false statements to the FBI, the NY County District Attorney’s office, the IRS, and other authorities.

Plaintiffs claim that they were unaware of the Defendant’s involvement the above fraudulent acts because in 2008 Frost made multiple trips to Z!NK’s headquarters, where he pilfered all of Z!NK’s office documents which would expose the fraudulent scheme. Each time he packed files upon files of evidence into a large black suitcase, flew them to his home, and had his executive assistant scan them all into his personal computer. By taking everything out of the office, Frost effectively shuddered the company and prevented it from operating.

Z!NK filed a lawsuit against Frost in January of 2010. By September 2012, the matter was sent to arbitration. Through the evidence and testimony adduced at the 2013-2014 Arbitration, the Plaintiffs allege that they learned, for the first time, the true underlying facts of what had transpired and became aware of the Defendant’s involvement.

At the conclusion of the 2013-2014 Arbitration, the arbitrator found in favor of the plaintiff and in February of 2015, Plaintiffs entered judgment against Frost in the amount of $62,380,605.50. But by the time the judgment was entered, Frost had disappeared.

Based on the newly discovered information, Plaintiffs brought suit against the Defendant, asserting claims for fraud, aiding and abetting fraud, unjust enrichment, civil conspiracy to commit conversion, aiding and abetting breach of fiduciary duty, and tortious interference with economic advantage. The subject of Justice Borrok’s recent decision is a motion for summary judgment filed by the Defendant seeking to dismiss the complaint, arguing (i) the statute of limitations has run; (ii) he should not be liable for his client’s actions; and (iii) the damages were not ascertainable.

The Defendant argued that Ishak knew of the fraud since 2008 based on prior testimony (see Harty v Lenci). If this was so, it would preclude Plaintiff’s fraud claims, which must be commenced within six years of the fraud or within two years of the fraud being discovered (CPLR § 213 [8]; Saphir Intl SA v UBS PaineWebber Inc.). The Defendant was relying on the fact that Ishak had previously responded, “Yes, I believe so” and “Absolutely” when asked if at certain times in 2008 he came to the conclusion or believed that the Defendant was complicit in Frost’s fraud.

The Court was not persuaded that Ishak’s testimony established the Plaintiffs knew of the Defendants involvement in the fraudulent scheme. The Court found nothing in Ishak testimony established “the facts” known by Plaintiffs, or that they knew, or had reason to know of Defendant’s involvement prior to 2013-2014 Arbitration. The Court accepted Ishak’s argument that what he meant by his testimony was that “he now believes” the Defendant was involved in fraud as early as 2008. The Court found this explanation to be consistent with the fact that the Plaintiffs did not refer to the Defendant at all in their 2011 complaint against Frost. The Court further reasoned that Plaintiffs couldn’t have known of the Defendant’s involvement because they were cut-off from the records that may have revealed Defendant’s involvement.

Of course, the Court could not pass up the moment to comment on Rule 1.2 of the Rules of Professional Conduct, stating the Defendants conduct in preparing fraudulent instruments raises issues of his obligation as a lawyer to reveal fraud or resign from the matter and not continue to assist. The Defendant argued that he could not be liable for Frost’s fraud because he performed his services in a lawful manner. Once again, the Court disagreed, finding that Plaintiffs are suing Defendant for his individual fraudulent conduct and that the documentary evidence showed he played an instrumental role in the alleged fraud.

Ultimately, the court found the following issues of fact precluding summary judgment (i) the relationship of the Defendant and Frost; (ii) the likelihood that the Defendant knew, should have known, or maybe played a role in assisting Frost in forging the documents or stealing all the business records; (iii) the reasons for the delay in the 2013-2014 Arbitration and whether it really took Plaintiffs until the 2013-2014 Arbitration to have the facts to satisfy CPLR § 3016(b); and (iv) how Defendant’s alleged ethical breaches may have further altered Plaintiff’s ability to learn the facts. Accordingly, Defendant’s motion for summary judgment was denied.

Upshot: For the purposes of determining whether the statute of limitations applies, courts will not only look to previous testimony to determine when the plaintiff learned of the fraud, but the facts as a whole.

A familiar fact pattern: ParentCo is the owner and controlling shareholder of SubCo.  ParentCo completely controls SubCo.  The two companies have the same officers, issue consolidated financial returns, and the profits and losses of SubCo are passed through to ParentCo.  ParentCo deliberately keeps SubCo in a cash-starved and undercapitalized state, so SubCo is entirely dependent on advances and direct payments from ParentCo to meet its obligations.  ParentCo’s leash on SubCo is so tight that SubCo is destined for liquidity problems and, eventually, failure.  Meanwhile, ParentCo itself transfers most of the cash it receives from SubCo to another affiliate, RelatedCo.

When SubCo fails, creditors of SubCo obtain judgments against SubCo, then seek to unwind transfers made from ParentCo to RelatedCo that frustrated their ability to collect on their judgments.  The creditors reason that because ParentCo dominated and controlled SubCo, because the two were essentially the same entity, and because ParentCo deliberately kept SubCo undercapitalized, equity requires that Court pierce the corporate veil and unwind the fraudulent transfers made by ParentCo.  Otherwise, the creditors argue, ParentCo and RelatedCo will have gotten away with their shell game.

Justice Jennifer G. Schecter of the New York County Commercial Division recently considered this issue in South College Street, LLC v. Ares Capital Corp., No. 655045/2019 (N.Y. County June 15, 2020).  The case continues a recent trend toward greater scrutiny of veil-piercing allegations at the motion to dismiss stage and provides welcome guidance for all litigators facing veil-piercing claims.

Generally

“A basic tenet of American corporate law is that the corporation and its shareholders are distinct entities.”  Dole Food Co. v. Patrickson, 538 U.S. 468 (2003).  However, “[i]n the interests of justice, in an ‘appropriate case,’ a party wronged by actions taken by an owner shielded by the veil of a corporate shell may exercise its equitable right to pierce that screen and ‘skewer’ the corporate owner.”  David v. Mast, 1999 WL 135244 (Del. Ch. Mar. 2, 1999).

A plaintiff seeking to pierce defendant’s corporate veil must show: (1) the defendant exercised complete domination of the corporation in respect to the transaction attacked and (2) defendant used that domination to commit a fraud or wrong against the plaintiff which resulted in plaintiff’s injury.  Morris v. Dept. of Taxation and Finance, 623 N.E.2d 1157, 1160–61 (1993).

Although the standard is articulated with disarming ease, its application to a pre-answer motion to dismiss is, for several reasons, difficult and has at times been inconsistent.  First, Courts are understandably reluctant to wade into likely disputed issues of control, abuse of corporate formalities, and inadequate capitalization on a motion to dismiss.  See E. Hampton Union Free Sch. Dist. v. Sandpebble Builders, Inc., 884 N.Y.S.2d 94 (2d Dept 2009) (Dillon, J. concurring in part and dissenting in part); Cornwall Mgt. Ltd v. Kambolin, 2015 WL 2090371, at *7 (N.Y. Sup. Ct. Apr. 29, 2015) (“[A]s veil piercing claims are inherently fact driven, they are not typically susceptible to attack on a pre-answer motion to dismiss. . . . In fact, New York courts are even typically reluctant to dispose of veil piercing claims on summary judgment.”).  Second, veil-piercing allegations are subject only to the pleading requirements of CPLR § 3013, which is satisfied so long as the pleading provides notice to an adversary of the transactions or occurrences giving rise to a claim.  Third, in many veil-piercing cases, the equities weigh strongly in favor of resolution on the merits, irrespective of whether the complaint adequately alleges both the control and fraud elements of a veil-piercing theory.  Elements aside, Courts dislike shell games.

As a consequence, it is not at all rare to see relatively boilerplate allegations of domination and control survive a motion to dismiss.  This is true even where the allegations of the second element—that the domination or control was used to perpetrate a wrong against plaintiff—are thin.  See, e.g., 9 E. 38th St. Assocs., L.P. v. George Feher Assocs., Inc., 640 N.Y.S.2d 520, 521 (1st Dept 1996); Trans Int’l Corp. v. Clear View Techs., 278 A.D.2d 1, 1-2 (1st Dept 2000) (plaintiff adequately alleged alter ego liability by alleging “that the individual defendants are [the corporation]’s equitable owners, that [the corporation] was their alter ego, that they exercised complete dominion and control over [the corporation] and that equity requires that they be held liable for [the corporation]’s obligations to plaintiff”) Toledo v. Sabharwal, No. 653234/2017, 2019 WL 495801, at *1 (N.Y. Sup. Ct. Feb. 04, 2019).

First Department Encourages Closer Examination of Alter Ego Claims on Motion to Dismiss

Last year, as covered on this blog, the First Department reversed a trial court order denying defendants’ motion to dismiss an ill-pled veil piercing claim and, by so doing, encouraged courts to take a closer look at veil-piercing allegations at the motion to dismiss stage.

The facts of that case are recounted in our previous post.  Aspire Music Group signed the popular musician Drake to an exclusive recording artist agreement.  After Drake’s rise to stardom, Aspire furnished Drake’s services to a joint venture that included Cash Money Records, in exchange for one-third of the net profits from Drake’s albums.  When Cash Money Records failed to properly account to Aspire, Aspire sued not only Cash Money Records, but also its controller, Universal Music Group.

Aspire alleged that Universal took over control of Cash Money Records and paid itself higher distribution fees, which in turn left less for Aspire.  Aspire further alleged that Cash Money Records is a corporate instrument of Universal; Universal shares offices with Cash Money Records; Universal operates Cash Money Records’ website; and Cash Money Records remains undercapitalized and entirely dependent on advances and payments from Universal.

The First Department directed dismissal of Aspire’s claims against Universal, holding, “even assuming Universal was an “equitable owner” of Cash Money . . . the complaint fails to allege that Universal’s domination of Cash Money was used to commit a wrong against plaintiff.”  Aspire Music Grp., LLC v. Cash Money Records, Inc., 94 N.Y.S.3d 24 (1st Dept 2019) (emphasis added).  The Court held that Universal’s increasing its own fees, leaving less for Aspire, was “legitimate business conduct.”  Even assuming control, therefore, Aspire failed to plead abuse of that control to perpetrate a wrong against it.

South College Street, LLC v. Ares Capital Corp.

In accordance with the First Department’s ruling in Aspire, Justice Schecter closely scrutinized the veil-piercing allegations in South College Street. 

South College Street concerns a creditor’s attempt to unwind allegedly fraudulent transfers made by an alleged alter ego of the debtor.  Charlotte School of Law, LLC (“CSL”) was a for-profit law school in North Carolina.  CSL was a wholly-owned subsidiary of InfiLaw Corporation (“InfiLaw”), which itself was a wholly owned subsidiary of InifiLaw Holding, LLC (“HoldCo”).  InfiLaw was a guarantor on CSL’s lease.  When the CSL defaulted on the lease, the landlord—plaintiff here—obtained a $24.55mm judgment against CSL and InfiLaw.  But CSL and InfiLaw were insolvent.  As a result of a recapitalization and investment from Ares Corporation (“Ares”)—defendant here—InfiLaw and HoldCo had transferred more than $32 million to Ares over 14 months.

Generally, the New York Debtor and Creditor Law allows a creditor to commence an action against the transferee of a fraudulent conveyance made by the debtor.  Accordingly, Plaintiff sued Ares seeking to unwind the allegedly fraudulent transfers that InfiLaw (the debtor) made to Ares.

Plaintiff also sought to unwind transfers that HoldCo made to Ares.  But these claims were more difficult; HoldCo was not subject to Plaintiff’s $24mm judgment, and HoldCo had no obligations to Plaintiff.  In other words, Plaintiff was not a creditor of HoldCo with standing to unwind a transfer between HoldCo and Ares.

To overcome this hurdle, Plaintiff argued that Holdco and InfiLaw were alter egos.  They had consistently overlapping officers; they prepared consolidated financial returns; they had the same office; HoldCo engaged in no other business activities, and profits of InfiLaw were consistently passed through to HoldCo.  HoldCo’s control over InfiLaw was so complete, Plaintiff alleged, that it caused CSL’s failure and InfiLaw’s insolvency.  HoldCo’s practice of keeping InfiLaw in an undercapitalized state (with huge payments going through HoldCo to Ares) resulted in liquidity problems at CSL.  This caused CSL to lower its admission standards, which resulted in lower bar passage rates and employment placement.  Nonetheless, to continue meeting HoldCo’s obligations to Ares, CSL lowered its admissions standards even further, sending CSL into a death spiral.  Ultimately, the North Carolina Board of Governors terminated CSL’s license.  By kicking off this spiral, Plaintiff alleged, HoldCo caused InfiLaw to default on its obligations to Plaintiffs.

Ares moved to dismiss the claims, arguing, with respect to the transfers from Holdco, that Holdco was not a debtor and, consequently, Plaintiff could not state a DCL claim with respect to transfers from HoldCo to Ares.

Justice Schecter granted Ares’ motion to dismiss.  The Court held that although a veil-piercing theory would be sufficient to implicate the transfers between HoldCo and Ares, Plaintiff failed to sufficiently allege facts warranting veil piercing here.  Specifically, the Court found that the complaint—while not lacking in allegations of complete control—failed to allege that the purpose of the corporate distinction between InfiLaw and HoldCo was to defraud or injure Plaintiff.  The Court explained:

While plaintiff alleges that Holdco dominates and controls the Debtor, that is not enough.  Rather, plaintiff must plead, for instance, that the capital structure of Holdco and the Debtor was designed to ensure the Debtor’s creditors would be left seeking to collect from an empty shell. Nothing of the sort is alleged.

As to Plaintiff’s allegation that the transfers left CSL destined to fail, the Court found that those facts went to Plaintiff’s fraudulent transfer claim and, consequently, they could not also be used to pierce the corporate veil; something more was required.

Practical Considerations

Whether equity requires a Court to disregard corporate separateness and pierce the corporate veil remains a fact-intensive inquiry.  Nonetheless, litigants can expect that allegations in support of a veil-piercing theory will be closely scrutinized at the motion to dismiss stage.  And, as set forth in South College Street, complete control is not enough.