The pages of this blog are filled with cases pitting a minority owner of a closely-held business—most often a corporation or an LLC—against the majority.  Books and records proceedings, derivative actions brought on behalf of the company, bids for dissolution, and cases seeking to enforce the terms of the owners’ agreement, are all different litigation strategies in the minority owner’s playbook.

As these and other posts make clear, the law in the area of minority owners’ rights is incrementally evolving with each new case and decision.  Every so often, however, we must take a step back and consider the body of minority owners’ rights more generally.  Otherwise, we risk losing sight of the forest among all those trees.

This post and a webinar in which I recently spoke (available here) seek to provide a broader-than-usual overview of the rights of minority owners in New York corporations and LLCs.  A potential investor, a nascent company choosing its structure, or a minority owner crafting her litigation strategy would be wise to peruse this refresher.

Depending on the nature of the closely-held company—most often, a corporation or an LLC—and subject to the terms and rights set forth in the owners’ agreement, the rights of a minority owner are established both by New York’s statutory regime (for corporations, the Business Corporation Law; for LLCs, the LLC Law) and the common law.  Significant minority rights include:

The Right to Vote on Company Action / Participate in Management

Minority shareholders’ rights to participate in the management of a corporation are limited.  They can vote to elect the Board of Directors (BCL 614), vote on a merger or consolidation of the corporation (BCL 903), vote on an amendment to the Certificate of Incorporation (BCL 803), and vote on items requiring shareholder approval in the shareholders’ agreement.  Beyond those voting rights, however, minority shareholders do not have a right to be involved in the day-to-day operations of the business.

A minority member in an LLC may have more substantial management rights, depending on the nature of the LLC.  In a member-managed LLC (the default under New York law [LLC Law 401]), the members are vested with the right and ability to run the company.  Thus, a minority member in a member-managed LLC may have the independent authority to hire and fire employees, manage accounts, make payments and enter into contracts on behalf of the company.  A manager-managed LLC is more like a corporation; the members simply elect the managers, and the managers have day-to-day authority over the company.

The Right to Inspect Books and Records

Minority shareholders are entitled to inspect the books and records of corporation under both BCL 624 and the common law right of inspection.  BCL 624 allows a minority shareholder to inspect (i) annual balance sheets and income statements and, (ii) upon a proper showing, a record of shareholders and minutes of shareholder meetings.  The common law right of inspection is generally broader than the inspection rights under BCL 624—including things like company tax returns, account books, and records of subsidiaries—but it also requires a greater showing: shareholders seeking to access records under their common law rights must demonstrate that they seek them for a “proper purpose” (see this recent post discussing the proper purpose requirement).

LLC members may access an LLC’s books and records under LLC Law 1102—which allows for the inspection of member information, articles of organization, tax returns—and their common law right of inspection, which is analogous to the common law governing shareholders’ inspection rights.

The Right to Purchase Shares to Avoid Dilution

What rights does a minority owner have when a potential new investment in the company threatens to dilute the minority owner’s interest?  In pre-1997 companies, BCL 622 provides that a minority shareholder shall have the right to purchase additional shares to avoid dilution of his interest when the corporation intends to issue new shares that would adversely affect either the dividend rights or the voting rights of that shareholder.  In post-1997 companies, the BCL expressly states that a shareholder does not have preemptive rights unless they are provided for in the corporation’s certificate of incorporation.

New York’s LLC Law does not contain an analogue for BCL 622, so minority LLC owners do not have preemptive rights unless their operating agreement provides for them.

The Right to Prosecute Derivative Actions

A hallmark right of the minority owner is the right to prosecute legal actions on behalf of the company when those in control of the corporation refuse to do so.  For corporations, BCL 626 authorizes minority shareholders to commence an action on behalf of the corporation for injury to the corporation.  While the LLC law does not have an analogue to BCL 626, the New York Court of Appeals in 2008 held that an LLC member has a common-law right to sue derivative for injury to the LLC in Tzolis v. Wolff, 884 N.E.2d 1005 (2008).

A minority owner suing the majority must clearly state whether she is bringing her claims directly in her capacity as an owner or derivatively on behalf of the company; a suit that mixes or confuses direct and derivative claims is likely to be dismissed.  Whether a claim should be pled derivatively or directly depends on (1) who suffered the alleged harm (the corporation or the stockholders); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders individually.  Derivative claims include claims against management for waste, misuse of company funds, claims against management for self-dealing, breach of fiduciary duty, and claims that the company wrongly advanced legal fees.

While an indispensable tool for minority owners, the derivative action is subject to some notable limitations.  Those include the requirement of a particularized pre-suit demand, ownership of an interest throughout the litigation, and certain standing requirements.  Additionally, any recovery in a derivative suit goes to the company, not directly to the minority shareholder.  This means that many times, the economics of a derivative suit weigh sharply against minority owners.  Derivative claims are also subject to superior claims against others held by the company, and a derivative plaintiff has no right to a jury trial on her claims.

The Right to Petition for Involuntary Dissolution

A minority shareholder seeking to have the corporation dissolved has a few potential options under the BCL.  First, BCL 1104 allows a 50% owner or owners to petition for dissolution on the grounds of director deadlock precluding board action, shareholder deadlock precluding an election of directors, or because “there is internal dissension and two or more factions of shareholders are so divided that dissolution would be beneficial to the shareholders.”  Second, BCL 1104-a allows the holders of shares representing at least 20% of all voting shares to petition for dissolution when, inter alia: (i) the directors or those in control of the corporation have been guilty of illegal, fraudulent or oppressive actions toward the complaining shareholders; or (ii) the property or assets of the corporation are being looted, wasted, or diverted for non-corporate purposes by its directors, officers or those in control of the corporation.  A minority shareholder holding less than 20% of the shares entitled to vote seeking to petition for dissolution must rely on the common law.  Common law dissolution requires showing that the corporation exists solely to enrich the majority at the expense of the minority, as discussed here.

If a minority shareholder seeks dissolution under BCL 1104-a, the majority has the right, pursuant to BCL 1118 to purchase all of the petitioning shareholder’s shares for fair value.

New York’s LLC law, by contrast, does not provide for dissolution in the event of deadlock or minority owner oppression.  Rather, a minority member seeking to have an LLC dissolved must show that “it is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement.” (LLC Law 702; Matter of 1545 Ocean Avenue, LLC, 72 AD3d 121 [2d Dept Jan. 26, 2010] [its influence on dissolution of LLCs discussed here]).  So as long as the company is (i) operating–i.e., generating revenue–and (ii) acting in accordance with its stated purpose, dissolution of an LLC is difficult to obtain.  Notably, many LLCs state in their governing documents that the LLC “is formed for any valid business purpose.”  In those cases, as discussed here, a revenue-generating LLC is exceedingly difficult to involuntarily dissolve.

Additional Limitations of Minority Owners’ Rights

A minority owner’s interest is subject to several other critical limitations, including the majority’s power to dilute ownership interests, make capital calls, expel minority owners in certain circumstances, and cash out the minority’s interest in a freeze-out merger.  We’ll unpack those and other limitations on a minority owner’s interest in a subsequent post.  For those that can’t wait, we cover all these limitations and their import in this webinar.

When a party to a contract repudiates, the non-repudiating party is faced with two options: (1) treat the repudiation as an anticipatory breach, terminate the contract and seek damages; or (2) continue to treat the contract as valid and await the time for performance before bringing suit. In a recent decision from the Suffolk County Commercial Division, Justice Elizabeth H. Emerson reminds us that a non-repudiating party must choose one or the other—a plaintiff cannot assert simultaneously a cause of action for breach of contract and anticipatory breach.

In Contract Pharmacal Corp. v Air Industries Group, Plaintiff Contract Pharmacal Corp., as sublessor, and Defendant Air Industries Group, as sublessee, entered into a sublease on May 21, 2018, for approximately 81,000 square feet of space in a large warehouse building (“Sublease Agreement”). About a month later, Defendant informed Plaintiff that it was unable to immediately deliver the entire 81,000 square foot warehouse and instead offered to deliver 31,500 square feet of “back space” with the promise of delivering the remainder of the space by the “4th quarter” of 2018. Defendant assured Plaintiff the “back space” would be available by August 3, 2018, and offered to construct a wall for the purpose of separating the “back space” from the rest of the warehouse.

Plaintiff alleges in its Complaint that based on the Sublease Agreement, it proceeded with purchasing substantial equipment and merchandise, and although Plaintiff objected to any changes to the Sublease Agreement, it needed the “back space” to store its newly purchased equipment. On August 3, 2018, Plaintiff advised Defendant that it was in breach of the Sublease Agreement and expressly reserved its rights and remedies under the Sublease Agreement, but also accepted Defendant’s offer to construct a wall to separate the “back space” under the condition that the wall was constructed at Defendant’s sole cost and expense. Plaintiff built the wall, and Defendant moved in.

Shortly after, on September 10, 2018, Defendant informed Plaintiff that “the deal has now changed” and requested the Plaintiff enter a new sublease agreement for the “back space” only, replacing the original Sublease Agreement. Frustrated by Defendant’s failure to deliver the agreed upon space, Plaintiff went elsewhere and entered into a lease in another warehouse building for approximately 50,000 square feet of space.

Plaintiff then commenced an action in the Suffolk County Commercial Division against Defendant alleging causes of action for breach of contract, specific performance, and promissory estoppel. Plaintiff subsequently sought to amend its Complaint to add a cause of action for anticipatory breach of contract, which the Court denied. Plaintiff then sought reargument.

Upon reargument, Justice Emerson adhered to her prior determination that

“a plaintiff who brings a claim for breach of contract cannot simultaneously pursue a claim for anticipatory breach.”

The Court instructed that when confronted with an anticipatory repudiation, the non-repudiating party has two options: (1) treat the repudiation as an anticipatory breach and seek damages for breach of contract, thereby terminating the contractual relation between the parties; or (2) continue to treat the contract as valid and await the designated time for performance before bringing suit. The non-repudiating party must, however, affirmatively choose between these two exclusive options; it cannot “treat the contract as broken and subsisting at the same time.” The operative factor is whether the non-breaching party has taken an action (or failed to take an action) as to indicate to the breaching party that it has made an election between his options.

In Contract Pharmacal, the Court determined that Defendant repudiated the Sublease Agreement when it advised Plaintiff it could not immediately deliver the entire premise. At that point, Plaintiff could have terminated the parties’ contractual relationship and sought damages for breach of contract. Plaintiff, however, did not take that course of action. Instead, Plaintiff accepted Defendant’s offer to build a wall and moved into the “back space.” By doing so, Plaintiff indicated to the Defendant that it was electing to treat the Sublease Agreement as valid and to await the Defendant’s performance under it. The Court held that once Plaintiff made this choice, its decision was binding with respect to that breach, could not be changed, and thus Plaintiff’s claim for anticipatory breach was barred as a matter of law.

Upshot:

A complaint which asserts both a cause of action for breach of contract and anticipatory breach will likely not survive the pleading stage. A non-repudiating party’s decision to either terminate a contract upon repudiation and assert a cause of action for anticipatory breach or wait until the time of performance before bringing a cause of action for breach of contract is both exclusive and binding.

What can you do when the parties you are suing are effectively judgment-proof? Oftentimes, plaintiffs will try to go after a defendant’s family member or related entity. However, as we see in a recent case from the courtroom of Manhattan Commercial Division Justice Robert R. Reed, New York courts require more than just a family connection to hold such attenuated actors liable.

The pertinent allegations in Lanaras v. Premium Ocean LLC, et al (as taken from the Complaint) are as follows: Sometime in 2013, the principal Defendant is alleged to have convinced her longtime friend (the Plaintiff) into “loaning” substantial sums to assist her and her business associates in establishing and operating a shrimp import business. Between 2013 and 2017, Plaintiff loaned a total of $3.4 million to the venture, and Defendant expanded the business into wholesale fish and retail sectors (creating two new entities, respectively).

Due, in part, to the longstanding friendship between Plaintiff and Defendant and certain oral assurances made, the parties never put the terms of the “loan” in writing.

In a twist that will surprise none of the readers of this blog, the businesses are now struggling and Plaintiff has not received repayment of any portion of the principal or interest on her loan to date. Equally unsurprisingly, Plaintiff sued her former friend, the business associates, and the corporations for various breaches of contract, fiduciary duties, unjust enrichment, and fraud-based claims.

The motion to dismiss before Justice Reed, however, concerns Defendant’s Husband, who is the principal of several successful businesses unrelated to the claims in the action. Plaintiff alleged that Defendant issued regular distributions of company assets into joint accounts shared with her Husband, and therefore, the Husband was a beneficiary of his wife’s alleged fraudulent conveyances by virtue of their joint property holdings and joint bank accounts. Plaintiff thus named Husband for unjust enrichment, fraudulent conveyances under NY DCL §273, and constructive trust.

Justice Reed granted dismissal of all three claims against the Husband.

On the unjust enrichment claim, the Court first noted the Departmental split on whether a three-year statute of limitations (Second Department) or six-year statute of limitations (First Department) should apply. The Court opted to follow the rule in the First Department and applied a six-year statute of limitations, rendering the claim timely.

But timeliness was not enough to salvage it. The Court held that while the allegations need not establish privity between Plaintiff and the Husband, they must at least “assert a connection between the parties that [is] not too attenuated” (quoting Georgia Malone & Co.). In other words, the fact that the Husband is married to Plaintiff’s longtime friend (i.e. the Defendant), alone, is not enough to establish the requisite relationship between Plaintiff and the Husband sufficient to cause reliance or inducement, warranting dismissal of the unjust enrichment claim.

The Court likewise dismissed the constructive trust claim on similar grounds. The claim requires “a confidential or fiduciary relationship, a promise, a transfer in reliance thereon, and unjust enrichment.” Again, being a “family friend”, alone, is not enough to satisfy the elements of the claim.

As for the constructive fraudulent conveyance claim under NY DCL §273, Plaintiff argued that Defendant issued regular distributions of company assets that rendered the companies insolvent (as the companies were apparently floating along on Plaintiff’s cash infusions), and transferred these distributions into joint accounts shared with her Husband. The Court found this argument unpersuasive. Even if the Husband was a beneficiary of the conveyances (assuming the alleged facts as true for the purposes of the motion), Plaintiff still failed to demonstrate that the conveyances were fraudulent. The Husband is not an officer nor holds any role in the businesses, so the conveyances cannot be viewed as “presumptively fraudulent”. Nor was it alleged that the conveyances were made for no consideration, as the Plaintiff herself acknowledged that the Husband previously made loans to the businesses.

Accordingly, the Court dismissed all claims against the Husband.

Key Takeaway

It can be tempting for a plaintiff to go after the “deep pocket”, especially when the “deep pocket” is a family member of the true targets who are effectively judgment-proof. However, courts in the Commercial Division will not allow such a claim to skate through unless there is some relationship between the “deep pocket” and the plaintiff, as well as an articulable nexus between the “deep pocket” and the alleged fraud, regardless of the legal theory under which it is framed.

Much ink has been spilled over the last couple of years, including here at New York Commercial Division Practice, on the topic of practicing law remotely in the COVID (and likely post-COVID) era.  As we all brace for the coming wave of Omicron, which may well be the fastest spreading virus in human history, let’s take a quick look at the newest ComDiv rule on the topic — Rule 37 Remote Depositions — which went into effect on December 15, 2021.

We’ve reported on the recent trend of remote depositions on at least three occasions over the last year or so, including the ComDiv Advisory Council’s September 2020 proposal for, and request for public comment on, the new rule.  As noted in the memo supporting the recommendation, in light of COVID, whereas “remote depositions were previously the exception, they are now the rule.”

But more than that, “[t]here is good reason . . . to encourage their continued use . . . after the pandemic is brought under control.”  Why?  Because, as we all have learned from experience over the last couple years, “remote depositions can be quicker, easier, less costly, and more efficient than in-person depositions.”

New ComDiv Rule 37 — which generally permits courts, “upon the consent of the parties or upon a motion showing good cause, [to] order oral depositions by remote electronic means — is accompanied at new Appendix G by a fulsome template stipulation setting forth a remote depo protocol that addresses common practical concerns regarding technology, security, private communications, and the use of exhibits.  Some key excerpts:

  • Administration of Remote Depo Services.  “An employee . . . of the [court reporting] service provider shall . . . be available at each remote deposition to record the deposition, troubleshoot any technological issues that may arise, and administer the virtual breakout rooms.”
  • Audio and Video Clarity.  “Each person attending a deposition shall be clearly visible to all other participants, their statements shall be audible to all participants, and they should each use best efforts to ensure their environment is free from noise and distractions.”
  • Communications During Questioning.  “Deponents shall shut off electronic devices . . . and shall refrain from all private communication during questioning on the record.”
  • Use of Virtual Breakout Rooms.  “Parties may use a breakout-room feature, which simulates a live breakout room through videoconference[, but c]onversations in the breakout rooms shall not be recorded . . . [and] shall be established by . . . and controlled by the [court reporting] service provider.”
  • Collaboration and Advance Troubleshooting.  “The parties agree to work collaboratively and in good faith with the court reporting [service provider] to assess each deponent’s technological abilities and to troubleshoot any issues at least 48 hours in advance of the deposition . . . [and] also agree to work collaboratively to address and troubleshoot technological issues  that arise during a deposition.”
  • Sufficient Technology.  “Counsel shall use best efforts to ensure that they have sufficient technology to participate in a [remote] deposition . . . [and] shall likewise use best efforts to ensure that the deponent has such sufficient technology.”

To be sure, given the ominosity of Omicron, the new ComDiv rule concerning remote depositions comes to us at an appropriate time.  But given the efficiencies associated with the practice that we all have discovered along the way, and with essential safeguards now in place at Appendix G, one can expect frequent and ongoing invocation of Rule 37 long after the infection curve has flattened.

 

It’s not often that a lawsuit in the Commercial Division between sophisticated parties to an arm’s-length business transaction warrants a blistering rebuke of the parties by the Court.  But on December 3, 2021, New York County Commercial Division Justice Andrew Borrok issued a scathing decision in a case entitled Extended CHAA Acquisition, LLC v Mahoney, in which the Court granted the plaintiff-buyer (“Buyer”) summary judgment and specific performance directing the defendants to proceed with the sale of their interests in defendant Extended Nursing Personnel CHHA, LLC (“Seller”) to Buyer for tens of millions of dollars and censured Seller’s principals (“Sellers”), who, “motivated by dissatisfaction with the business deal that the Seller . . .  cut and fueled by unabashed insidious antisemitism, actively prevented the Buyer from closing and breached the Purchase Agreement.”

Judge Borrok prefaced the facts of the case and his legal analysis of the merits of the parties’ motions by citing numerous excerpts from communications among Sellers and Seller’s agent-representative who

“actively took glee in frustrating the Buyer’s ability to close and in being gratuitously abusive and disrespectful of the Buyer’s principals and their religious observance. The degree to which [Sellers] taunted the Buyer’s principals to their face and mocked them behind their back because they are Jewish is horrifying and cannot be overstated. Their bigotry is disgusting and shameful, representing the worst and most depraved behavior that has no place in civilized society.”

[Oral argument on the motions held four days earlier is just as compelling of a read.]

In September 2019, Buyer and Seller entered into a membership interest purchase agreement (“the Purchase Agreement”) whereby Sellers agreed to sell and convey all of their membership interests in Seller to Buyer in exchange for Buyer’s payment of an “Estimated Purchase Price” of $49,000,000 plus estimated cash on hand and minus indebtedness, transaction expenses, and certain liabilities. As part of the closing deliverables, Seller was required to provide the server and IT infrastructure necessary to operate Seller’s business before the closing date of the transaction.

Under the Purchase Agreement, the parties also expressly agreed that specific performance was an appropriate remedy because no adequate remedy of law would compensate Buyer in the event of a Seller breach, and that such provision survived termination of the Purchase Agreement.

For over a year and a half, the parties worked to consummate the sale, and on March 25, 2021, the parties executed a Third Amendment to the Purchase Agreement and agreed to extend the closing date to March 29, 2021. Over the course of the next four days, Seller’s principals actively worked in bad faith to prevent the closing by intentionally ignoring Buyer’s repeated attempts to consummate the sale, trying to run out the clock on the closing deadline set by the Third Amendment, after which time Sellers believed they would no longer be obligated to comply with the Purchase Agreement so that the company could be sold to a third-party at a higher price.

Specifically, the record reflected, among other things, the following bad-faith conduct/ breaches by Seller:

  • On March 26, 2021, three days prior to the closing, Buyer called to ask to close on Tuesday, March 30, rather than March 29, due to the Passover holiday. Sellers refused to extend the closing date by just one day for no apparent reason other than religious intolerance.
  • Also on March 26, Sellers provided a proposed Fourth Amendment to the Purchase Agreement — which Buyer had no obligation to agree to — and demanded that Buyer return the signed Fourth Amendment by 5:00 pm that day.  Although Buyer returned comments on March 27 (the very next day and two days prior to the closing) in an effort to bring this transaction to a close, Sellers refused to negotiate with Buyer as to Seller’s demanded Fourth Amendment.
  • Seller failed to fulfill certain pre-closing obligations including delivering the Seller’s computer server and IT infrastructure necessary to operate the business which was scheduled to occur on March 28, 2021.
  • On the March 29 closing date, Sellers tried to shake down Buyer, expressly representing that they would not close unless Buyer paid $58 million (an $18 million increase in the agreed-upon purchase price), and without the server. Absent the $18 million premium, Sellers were not interested in engaging in any further discussions, negotiations, or extensions regarding the transaction.

In the December 3 Decision, the Court denied Sellers’ motion pursuant to CPLR 3211 to dismiss Counts I through III of Plaintiff’s Complaint sounding in specific performance, injunctive relief, and breach of the implied covenant of good faith and fair dealing as “frivolous” and granted Buyer leave to bring an order to show cause seeking appropriate sanctions for having to defend the motion.

Stating that Buyer’s entitlement to summary judgment and specific performance was “not a close call,” the Court granted Buyer’s motion directing that the transaction close by December 10, 2021, and granted Buyer leave to move by order to show cause for summary judgment that Seller breached the covenant of good faith and fair dealing since the record reflected “evidence of the insidious antisemitism fueling the breach by the Sellers.”

The Court expressly held that there were “no material issues of fact that the Purchase Agreement was a valid contract which the Seller breached, that the Buyer was ready, willing, and able to perform under the Purchase Agreement, and that the balance of the equities weighs in the Buyer’s favor.”  Although Seller argued that Buyer anticipatorily repudiated the Purchase Agreement on March 26, the Court found that argument to be entirely “disingenuous” as it was undisputed that Seller voluntarily agreed to extend the closing date until March 29 and that “the Seller actively avoided the Buyer in an effort to frustrate the Buyer’s ability to close and celebrated when the Buyer could not wire because of the Seller’s multiple breaches by 5 pm on March 29, 2021 and then treated the contract as having expired at that point.”

What’s More . . .

On December 3, Sellers filed a Notice of Appeal of the Court’s decision and additionally filed in the Appellate Division, First Department, an Emergency Motion for a Stay Pending Appeal in light of the Court’s Order to proceed with a closing of the transaction at issue by December 8 (transfer of server and “closing deliverables”) and December 10 (final closing, including payment of purchase price).

On December 7, the First Department granted Sellers’ application for interim relief and set forth a briefing schedule for the expedited motion with a decision date of December 24, 2021.

Stay tuned . . .

A few weeks ago, I blogged about the Arco Acquisitions, LLC, v Tiffany Plaza LLC et al. decision, in which Suffolk County Commercial Division Justice Elizabeth Hazlitt Emerson held that the plaintiff’s fraud claims were barred by the specific disclaimer provisions contained in the parties’ agreement to purchase commercial real property.

A recent decision from the First Department appears to follow suit, as it recently affirmed New York County Justice Andrew Borrok’s decision in Silver Point Capital Fund, L.P. v Riviera Resources, Inc., in which he also dismissed plaintiffs’ fraud claims because they were barred by the express language of the agreement between the parties.

In Silver Point, plaintiffs, highly sophisticated former minority shareholders (“Plaintiffs” or “Sellers”) of defendant Riviera Resources, Inc. (“Defendant” or “Buyer”) entered into a Stock Repurchase Agreement (“Repurchase Agreement”) with Buyer under which they agreed to sell their shares to Buyer at a discount. In connection with the Repurchase Agreement, the parties entered into a “big boy” letter (the “Letter Agreement”), which contained a number of disclaimer provisions.

For example, the Letter Agreement contained the following language:

1. The Seller hereby acknowledges that it is aware that the Buyer may have access to certain material, nonpublic information regarding the Buyer, its financial condition, results of operations, businesses, properties, assets, liabilities, management, projections, appraisals, plans and prospects (the “Information”). Any such Information may be indicative of a value of the Common Stock that is substantially different than the purchase price reflected in the Purchase.

3. The Seller acknowledges that the Buyer is relying upon this letter in engaging in the Purchase and would not engage in the Purchase in the absence of this letter.

4. Notwithstanding the Buyer’s possession of the Information and the absence of disclosure thereof to the Seller, the Seller wishes to enter into the proposed transaction. The Seller, to the extent that it is acting as an agent and not as a principal, has fully advised its principal of the foregoing and the risks involved in participating in the proposed transaction.

The Letter Agreement also contained the following disclaimer provision  “[n]otwithstanding anything that may be expressed or implied in this letter, the Seller covenants, agrees and acknowledges that it shall have no recourse hereunder or under any documents or instruments delivered in connection herewith . . .”

In addition, the Seller waived

all warranties, express or implied, arising by law, equity or otherwise, with respect to its sale of the Common Stock, and hereby forever releases, discharges and dismisses any and all claims, rights, causes of action, suits, obligations, debts, demands, liabilities, controversies, costs, expenses, fees, or damages of any kind . . . against the Buyer or any of its affiliates . . . which are based upon or arise from the existence or substance of the Information and the fact that the Information has not been disclosed to the Seller.

Finally, and most pertinently, the Letter Agreement also contained the following disclaimer provision:

8. Each of the Seller and the Buyer acknowledges and represents and warrants that (a) neither such party, nor any party acting on its behalf, has made any representation or warranty, whether express or implied, of any kind or character, regarding the sale and purchase of the Common Stock, except as expressly set forth in this letter; and (b) the assignment and transfer of the Common Stock by the Seller to the Buyer is irrevocable.

In the case before Justice Borrok, Sellers alleged that Buyer fraudulently induced them to sell all of their shares in the corporation three weeks before it announced “an asset sale of its most valuable properties, after which share prices soared and defendant made a substantial distribution to shareholders.” Sellers further alleged that it would not have entered into the Repurchase Agreement or signed the Letter Agreement had it known that Buyer was negotiating the sale of the property, which resulted in the $295 million transaction and the resulting $260 million shareholder distribution at issue in the case.

In its defense, Buyer relied on the express release language contained in the Letter Agreement in which Sellers acknowledged that Buyer may have material nonpublic information regarding its properties and that such information “may be indicative of a value of the Common Stock that is substantially different than the purchase price reflected in the Purchase.”

Justice Borrok rejected Sellers’ argument, concluding that, Sellers’ claims were barred by the express terms of the Letter Agreement in which Seller acknowledged that the Buyer may have material nonpublic information concerning the properties, which included the subject property.

The court also rejected Buyers’ contention that the underlying real-estate transaction was not contemplated within the definition “Information” because “Information,” as defined in the Letter Agreement, expressly included “certain material, nonpublic information regarding the Buyer, its financial condition, results of operations, businesses, properties, assets, liabilities, management, projections, appraisals, plans and prospects.”  The court therefore determined that the definition of “Information” clearly encompassed the underlying transaction, and that nothing in the Letter Agreement served to carve out any sales of Defendant’s properties.

The court also reasoned that if the parties intended to include a carve-out exception for major sales of properties, they would have negotiated that exclusion. Justice Borrok ultimately held that Plaintiffs cannot now, ask the court after the fact to rewrite the parties’ agreement.

The First Department agreed and held that the Letter Agreement clearly, and in sufficient detail, set forth the type of information that may not have be disclosed in the course of the share repurchase to enable the parties to make an informed decision as to whether or not to execute the Repurchase Agreement.

The holdings in Arco Acquisitions and in Silver Point both bring home the recently emphasized rule that release language in contracts may bar certain claims.

In expensive lawsuits involving fraud claims, the temptation of a defendant to play hide and seek with its assets can be high. To prevent this result, CPLR § 6201 provides a mechanism (i.e., prejudgment attachment order) to preserve such assets. However, in a recent decision from the Suffolk County Commercial Division, Justice Elizabeth H. Emerson reminds us that a party seeking to obtain a prejudgment attachment order faces a heavy burden.

In Fritch v Bron, plaintiff Maureen Fitch (“Plaintiff”) and defendant Igor Bron (“Mr. Bron”) agreed to form an electrical construction contracting company, E. Electrical Contracting LLC (“EEC”). In or around 2004, Plaintiff and Mr. Bron signed an operating agreement for EEC, naming Plaintiff as the sole manager. As part of their duties, Plaintiff was responsible for contract administration and other administrative tasks at EEC, while Mr. Bron was responsible for EEC’s field operations. In or around 2016, Plaintiff and Mr. Bron signed an amended operating agreement (“Amended Operating Agreement”) for EEC, whereby the parties agreed that they would not perform any electrical contracting work outside of EEC, including for defendant Sajiun Electric, Inc. (“Sajiun Electric”). However, according to Plaintiff, since 2003, Mr. Bron, along with defendants Sajiun Electric, Richard Sajiun (“Mr. Sajiun”), and Rita Bron (“Mrs. Bron”), concocted an extensive scheme to divert EEC’s assets from Plaintiff, for the benefit of Sajiun Electric and other named defendants.

As a result, in March 2021, Plaintiff commenced an action to recover damages for fraud, aiding and abetting fraud, breach of fiduciary duty, aiding and abetting breach of fiduciary duty, constructive trust, and unjust enrichment. Thereafter, Plaintiff brought a motion for a prejudgment attachment order under CPLR §§ 6201 (1) and (3), arguing (a) Mr. Sajiun was a nondomiciliary who resided in Florida; (b) there was substantial evidence that Mr. Bron, Mrs. Bron, Mr. Sajiun, and Sajiun Electric were hiding assets for the purpose of defrauding creditors and frustrating the enforceability of a judgment; and (c) that she has shown a probability of success on the merits. Justice Emerson rejected each of Plaintiff’s arguments.

First, the Court addressed the applicable legal standard in determining whether to grant a prejudgment attachment order. Specifically, the Court stated that “[t]o obtain an order of attachment, the moving party must demonstrate through affidavit or other written evidence (1) the existence of a cause of action for a money judgment, (2) a probability of success on the merits, (3) the existence of one or more grounds enumerated in CPLR 6201 (e.g., the defendant is a nondomiciliary residing without the state, or the defendant with the intent to defraud his creditors or frustrate the enforcement of a judgment that might be rendered in plaintiff’s favor, disposes of secreted property), and (4) that the amount demanded from the defendant exceeds all counterclaims known to the plaintiff” (see CPLR 6212 (a); Ford Motor Credit Co. v Hickey Ford Sales, 62 NY2d 291, 301 [1984]). In addition, the Court noted that since attachment is a harsh remedy, CPLR § 6201 is strictly construed in favor of those against whom it may be employed (651 Bay St., LLC v Discenza, 189 AD3d 952, 953 [2d Dept 2020]).

Second, the Court rejected Plaintiff’s argument for a prejudgment attachment order against defendant Mr. Sajiun on the ground that he was a nondomiciliary residing in Florida because (a) Mr. Sajiun submitted an affidavit stating that he resided in Suffolk County and worked in New York City; and (b) the record reflected that Mr. Sajiun was served in Hampton Bays, New York. Moreover, the Court found that Plaintiff’s allegations that Mr. Sajiun sold his New York residence in June 2021 for the purpose of transferring the proceeds from New York to Florida, was not enough to support a prejudgment attachment order.

Third, the Court found that Plaintiff failed to establish her burden under CPLR § 6201 (3) that defendants Mr. Bron, Mrs. Bron, Mr. Sajiun and Sajiun Electric attempted to frustrate the enforcement of a judgment by disposing of secreted property. Indeed, the Court noted that the transfer of the Bron residence to a family trust was in 2017, long before the commencement of the action. In addition, the Court acknowledged that many of Plaintiff’s allegations involving fraudulent concealment of assets were based on “information and belief,” which is insufficient to support a prejudgment attachment order.

Fourth, the Court found that Plaintiff failed to establish a probability of success on the merits of her claims, which is a necessity to obtain a prejudgment attachment order. Accordingly, the Court denied Plaintiff’s motion for a prejudgment attachment order.

Upshot:

As pointed out by Justice Arlene P. Bluth in Erensel v Abitbol, the purpose of a prejudgment attachment order “is not merely to ensure a plaintiff can recover the amount sought if he or she prevails in a case. Otherwise, a plaintiff would be entitled to an attachment in nearly every case.”  Thus, this decision highlights that obtaining a prejudgment attachment order is an uphill battle and attorneys must educate their clients on the onerous burden needed to obtain such relief.

Nobody likes fraud claims asserted against them. Thankfully for defendants, fraud claims are notoriously difficult to prove, and defendants often try to have these claims dismissed at the pleading stage.

An express disclaimer in a contract is often a popular avenue for litigants facing a fraud claim to move for dismissal. A recent Commercial Division case, Arco Acquisitions, LLC, v Tiffany Plaza LLC et al. is a good example.

In Arco, plaintiff entered into an agreement to purchase commercial real property from defendants Tiffany Plaza LLC and 1075 Farmingville LLC (the “Defendants” or “Sellers”) (the “Agreement”). The Sellers of the property provided plaintiff with tenant-estoppel certificates and a certified rent roll detailing, inter alia, rents, taxes and arrears. The documents did not show that any  particular tenants were in arrears. After the parties’ closing, however, plaintiff discovered that two tenants were unable to pay their monthly rent. The lawsuit ensued.

In April 2021, plaintiff commenced this litigation for fraud, aiding and abetting fraud, and piercing the corporate veil.  Plaintiff alleged that that the rent roll and estoppel certificates were fraudulent and that the Sellers misrepresented the rent roll and obtained false estoppel certificates “to inflate the rent roll and increase the value of the property.”

Sellers moved to dismiss, relying for the most part on the express “As Is, Where Is, and With All Faults” provision of the parties’ Agreement. Under this provision, the parties agreed that plaintiff was purchasing the property in its existing condition,  and that the Seller had no obligation to determine or correct any facts, circumstances, conditions or defects, or to compensate the purchaser for such facts and circumstances. In fact, the Sellers specifically negotiated for the “assumption by Purchaser of all responsibility to investigate the Property, Laws and Regulations, Rights, Facts, Condition, Leases, Open Permits and Violations and of all risk of adverse conditions existing on the date of this Agreement,” and structured the Agreement in consideration of these assumptions.

Under this provision, the parties also agreed that:

 “Purchaser has, as of the date hereof, undertaken all such investigations and review of the Property, Laws and Regulations, Rights, Facts, Condition, Leases, Open Permits, Violations or Tenancies, as Purchaser deems necessary or appropriate under the circumstances as to the status of the Property and based upon this Agreement, Purchaser is and will be relying strictly and solely upon such inspections and examinations and the advice and counsel of its own consultants, agents, legal counsel and officers, and . . . Purchaser assumes the full risk of any loss or damage occasioned by any fact, circumstance, condition or defect existing on the date of this Agreement and pertaining to this Property.”

The Arco Court cited clear precedent on this topic. When a “party specifically disclaims reliance upon a representation in a contract, that party cannot, in a subsequent action for fraud, assert it was fraudulently induced to enter into the contract by the very representation it has disclaimed” (Grumman Allied Industries, Inc. and Grumman Corporation, v Rohr Industries, Inc., 748 F2d 729 [2d Cir 1984]; citing Danann Realty Corp. v Harris, 5 NY2d 317, 323 [1959]). In Grumman Allied, the Second Circuit held that the specific disclaimed provision barred plaintiff’s misrepresentation claim.

In Arco, Suffolk County Commercial Division Justice Elizabeth Hazlitt Emerson opined that fraud claims are dismissed when disclaimer provisions are “sufficiently specific” to match the substance of the alleged misrepresentation. Justice Emerson noted, however, that the specificity requirement is more relaxed when the agreement is entered into by sophisticated business parties.

In determining that plaintiff’s reliance was not justified, the court considered both the sophistication of the parties involved in the transaction and the fact that plaintiff’s allegations tracked the specific language used in the disclaimer, which included “leases” and “tenancies.” The court concluded that “to hold otherwise would be to say that it is impossible for two businessmen dealing at arm’s length to agree that the buyer is not buying in reliance on any representations of the seller as to a particular fact.”

Takeaway:

Litigants: when entering into a contract, carefully review the disclaimers container therein because they may preclude you from asserting certain claims in the future.

Practitioners: courts consider a large array of factors, including the sophistication and expertise of the parties, the arm’s-length nature of the negotiations, and the plain language of the agreement in determining motions to dismiss fraud claims based on various disclaimer provisions, such as the ones present in the Arco case. You must therefore carefully review these disclaimer provisions, assess your client’s likelihood of success on the motion, and advise your client accordingly.

 

In recent years, the New York court system has endorsed alternative dispute resolution (“ADR”) as a way to increase efficiency in the court system, making ADR presumptive in most civil cases.  As a pioneer of efficiency, the Commercial Division has reinforced – through the adoption of multiple ADR-related rules and rule amendments – its “strong commitment to early case disposition” through ADR.

Consistent with this commitment, Commercial Division Rule 3(a) was recently amended to permit as an ADR mechanism the use of a “neutral evaluator” (as an alternative to a mediator), and to allow for the inclusion of “neutral evaluators” in rosters of court-approved neutrals.  The amendment, effective December 20, 2021, provides:

At any stage of the matter, the court may direct or counsel may seek the appointment of an uncompensated mediator or neutral evaluator for the purpose of helping to achieve a resolution of all or some of the issues presented in the litigation. Counsel are encouraged to work together to select a mediator or neutral evaluator that is mutually acceptable and may wish to consult any list of approved neutrals in the county where the case is pending . . . .

The amendment to Rule 3(a) will enable the Commercial Division to use the full range of ADR services contemplated by Part 146 of the Rules of the Chief Administrative Judge, which includes both mediators and neutral evaluators, and describes the qualification requirements for each.

Under Part 146.4, a lawyer or judge seeking qualification as a neutral evaluator must be admitted to practice for at least five years, and have at least five years of substantial experience in the specific subject area of the cases over which he or she will serve as a neutral.  In addition, the candidate must complete six hours of approved training in procedural and ethical matters related to neutral evaluation (as opposed to the 40-hour training requirement to become a mediator).  Once trained and certified, the neutral evaluator may be added to rosters of neutrals and selected by judges or parties to help facilitate the resolution of complex commercial matters, alongside the mediators already available.

The amendment to Rule 3(a) will help address the need for expanded ADR services as the New York court system continues to implement the presumptive ADR system, particularly in light of the many challenges posed by the COVID-19 pandemic.  As the Commercial Division Advisory Council (“CDAC”) explained in its proposal to amend Rule 3(a), given the recent initiatives to encourage ADR and the effects on litigation resulting from the COVID-19 pandemic, the rule change would permit attorneys and judges – some with just as much practical experience as current mediators – to become neutral evaluators without being required to undergo the more extensive training required of mediators.

The rule change may also increase diversity of court-approved neutrals.  According to the CDAC, the challenges posed by a 40-hour mediation training requirement may have a disproportionate impact on women and minorities, who may feel that taking time away from client work and business development could put their career prospects at risk.

The pro-ADR initiative continues to be a priority for the New York Court system, especially in the Commercial Division. Indeed, several Commercial Division Rules address ADR.  Rule 3, as discussed above, permits courts in the Commercial Division to direct the appointment of a mediator – and now a neutral evaluator – to facilitate the resolution of a case, and expressly encourages counsel to “work together to select a mediator” or neutral evaluator mutually acceptable to the parties.  Rule 10 requires counsel to certify that he or she has discussed with the client the availability of ADR mechanisms in the Commercial Division.  And, Rule 11 requires that preliminary conference orders contain specific provisions for means of early disposition of the case through ADR.

In addition to these Rules, many of the Commercial Division justices encourage parties to explore ADR.  For example, in New York County, Justice Borrok’s individual rules explain that “the parties are encouraged to identify as early as possible any case where ADR would be appropriate” and “write a joint letter to the Court asking to be referred to ADR.”  Likewise, in New York County, Justice Cohen’s and Justice Reed’s individual part rules require the parties to report prior to the status conference whether they have attempted the ADR process offered by the Court.  In Suffolk County, Justice Emerson’s individual part rules address the procedure for seeking ADR and provide a link for more information on the Court’s ADR program.  And, in Queens County, Justice Grays’ individual rules expressly authorize the Court to refer matters to the Commercial Division ADR program without the parties’ request or consent.

Takeaway:

The recent amendment to Rule 3(a) will undoubtedly help facilitate access to the ADR programs already encouraged by the New York court system and Commercial Division justices.  By adding neutral evaluators to rosters of neutrals, the Commercial Division will enhance the options and solutions it provides to businesses that choose to bring their cases to New York courts, providing more diversity and experience in its neutrals and more types of ADR mechanisms.  This is especially true as litigants determine how to advance their cases in the aftermath of the COVID-19 pandemic.

Just like a bride and groom vow to join together for better or for worse, commercial parties joining together through a joint venture must make a similar promise to share in profits and losses. In a recent decision from the Suffolk County Commercial Division, Justice Elizabeth H. Emerson took a close look at the parties’ “vows” and determined that no joint venture agreement existed where one party did not truly agree to share in the venture’s losses.

In JRAP Enters., Inc. v Zuacro Constr., LLC, Plaintiffs JRAP Enterprises, Inc. and principal Joseph Rapaport alleged they entered into a joint venture agreement with Defendants Zucaro Construction, LLC and Zucaro House Lifters, Inc. to lift houses after Hurricane Sandy. Plaintiffs allege in their Complaint that Defendants engaged Plaintiffs to provide their expertise, time and skill to assist with preparing bids for contracts to lift homes under Long Island’s New York Rising and Recovery  and “Build it Back” programs.   

According to Plaintiffs, Defendants entered into several subcontracts with general contractors to perform work on lifted homes and agreed to pay Plaintiffs 10% of the gross payments received by Defendants for each subcontract. After not being compensated on more than 40 subcontracts, Plaintiffs commenced an action to recover damages for breach of contract, breach of fiduciary duty, an accounting, breach of the implied covenant of good faith and fair dealing, quantum meruit, and unjust enrichment. Defendants moved to dismiss the causes of action for breach of fiduciary duty, an accounting, and breach of the implied covenant of good faith and fair dealing. Plaintiffs opposed and cross moved to amend the Complaint.

The Court first addressed Plaintiffs’ second cause of action for breach of fiduciary duty which alleged that the Defendants’ failure to pay the agreed compensation to Plaintiffs was a breach of their fiduciary duty to Plaintiff. Recognizing that the cause of action was based on the alleged joint venture agreement, the Court looked to see if the essential elements of a joint venture had been properly alleged.

When seeking to establish a joint venture agreement, allegations of mere joint ownership, community of interest, joint interest in profitability, and acting in concert to achieve some stated economic objective are all insufficient. More than a simple contractual relationship is required. As the Court instructed,

“[a]n indispensable essential of a contract of joint venture is a mutual promise or undertaking of the parties to share in the profits of the business and submit to the burden of making good the losses.”

Here, the Court found Plaintiffs failed to allege a mutual promise to share in the “burden of the losses.” Plaintiffs alleged that the parties agreed “to accept the loss of being denied any compensation for the multitude of hours of uncompensated time and expenses incurred by them in performing the work . . . if the subcontracts, or any of them, were not awarded to Defendants or if Defendants were not paid for their work through no fault of their own.” In other words, Plaintiffs only agreed to risk losing their own expenses and the value of their own services, not the losses incurred by the venture, which was insufficient to establish a joint venture agreement.

What Plaintiffs actually alleged was a basic contractual relationship. Because it is well settled that parties engaged in an arms-length business transaction are not fiduciaries, and a breach of fiduciary duty cannot be based on the same facts and theories as a breach of contract claim, the Court dismissed the second cause of action for breach of fiduciary duty.

The Court went on to dismiss Plaintiffs’ third cause of action for an accounting because a cause of action for accounting cannot stand in the absence of a fiduciary relationship; the fourth cause of action for breach of the implied covenant of good faith and fair dealing as unopposed; and Plaintiffs’ cross-motion to amend the Complaint because Plaintiffs’ proposed amended complaint did not cure the pleading deficiencies of the original Complaint.

Upshot:

When alleging the existence of a joint venture agreement, it is crucial to allege a mutual promise or undertaking of the parties to share not only in the profits but also the losses of the joint venture. A party’s agreement to bear their own individual losses are insufficient.