In a legal malpractice claim brought by Plaintiff, an Australian investment bank against Morrison & Foester, claiming that the law firm did not conduct due diligence in uncovering material misrepresentations pertaining to Plaintiff’s underwriting of a public stock offering of Puda Coal, Inc., Justice Scarpulla, in the New York County Supreme Court (Index No.: 650988/15) dismissed the suit. Notably, the Supreme Court held that the Plaintiff in Macquarie Capital (USA) Inc. v. Morrison & Foerster LLP was in possession of the information at issue as it had an investigative report, prepared by a private international investigation firm that gave Plaintiff notice of the material misrepresentations. The report produced by the private firm disclosed information regarding the public offering, which contradicted public representations and reports. Upon receipt of the report, Plaintiff forwarded the report to Defendant, neither of which picked up on the misrepresentations in the report that Puda did not own a 90% interest in Shanxi Coal. Instead, the law firm issued an opinion confirming its due diligence and advising Plaintiff that nothing came to its attention that would lead to the conclusion that the offering documents contain false or misleading information. However, the Supreme Court, nevertheless, held that Plaintiff could not claim that the law firm’s representations caused damage to Plaintiff.

However, the Appellate Division, First Department unanimously reversed Justice Scarpulla’s decision and determined that Plaintiff sufficiently demonstrated the “but for” causation element necessary for its legal malpractice claim in defeating Defendant’s pre-answer motion to dismiss. Specifically, the Court held that Plaintiff demonstrated that but for the law firm’s negligence, Plaintiff would have abstained from its involvement in the public offering, thus preventing Plaintiff from acquiring fees, expenses, and other damages.

Further, the Court concluded that the law firm’s argument that Plaintiff possessed the information in an investigative report is unavailing because the information contained in the report cannot be described as explicitly putting Plaintiff on notice and not requiring counsel’s interpretation of the information. Contrarily, in Ableco Fin. LLC v. Hilson, 109 A.D.3d 438 (1st Dep’t 2013), lv denied 22 N.Y.3d 864 (2014) this Court granted defendant’s motion for summary judgment dismissing the legal malpractice claim on the basis that plaintiff indisputably possessed certain information prior to the closing and was aware that it would not receive first priority lien on the inventory and, as such, counsel’s legal interpretation was not required.

 Takeaway: In Macquarie Capital (USA) Inc, the law firm was specifically hired to conduct due diligence and investigate the company’s offering. Ultimately, the Court held that the law firm should not be able to shift legal responsibility it was hired to perform to the client. A law firm cannot release itself from liability by arguing that because its client possessed certain information, that the law firm need not conduct the due diligence it was retained to do in the first instance.

In a thorough opinion last week by Justice Marcy Friedman in Bank of N.Y. Mellon v WMC Mtge., LLC, the New York County Supreme Court upheld the timeliness of “Failure to Notify” claims arising from subprime mortgage-backed securities formed into a trust in 2007. To put it mildly, the mortgages were problematic (go see The Big Short if you have not already done so). The primary issue the court examined was the accrual date of causes of action asserting that the securitizer (Morgan Stanley) had breached its contractual duty to notify the Trustee of any breaches of representations and warranties that it discovered after closing. (Separate causes of action directly asserting breaches of the representations and warranties were previously dismissed as time-barred.)

Did these “Failure to Notify” claims accrue upon the closing of the securitization? Or did the claims accrue when Morgan Stanley discovered the breaches?

The issue was complicated by the Court of Appeals’ landmark decision in ACE Securities Corp. v. DB Structured Products Inc., 25 N.Y.3d 581 (2015), which held that a plaintiff cannot avoid the statute of limitations on a claim for breach of representations and warranties by pleading a separate claim based on the defendant’s failure to repurchase materially breaching loans. The Court in ACE reasoned that the repurchase provision in the parties’ contract was more akin to a remedy for the breach of representations and warranties, rather than a separate and continuing obligation. In addition, the Court in ACE was concerned by the prospect of “accrual dates that cannot be ascertained with any degree of certainty,” especially cumbersome in mortgage-backed securities cases involving representations and warranties relating to thousands of loans per securitization.

Justice Friedman also gave pause to consider New York’s policy against applying the “discovery rule” to statutes of limitations in contract actions. For example, in Deutsche Bank National Trust Co. v. Flagstar Capital Markets Corp., 143 A.D.3d 15 (1st Dept 2016), the First Department held an accrual clause in the governing agreement unenforceable as against public policy, where the clause purported to delay the accrual of claims until three conditions were satisfied: (i) discovery of a breach, (ii) failure to cure or repurchase, and (iii) demand upon the defendant for compliance with the agreement. The First Department held that such a clause “creates an imprecisely ascertainable accrual date—possibly occurring decades in the future, since some of the loans extend for 30 years.”

The court found these policy arguments “compelling,” but ultimately held that it could not impose the same accrual date as the underlying breach of warranty claims, because in Nomura Home Equity Loan, Inc. v. Nomura Credit & Capital, Inc., 133 A.D.3d 96 (1st Dep’t 2015), Morgan Stanley Mortg. Loan Trust 2006-13ARX v. Morgan Stanley Mortg. Capital Holdings LLC, 143 A.D.3d 1 (1st Dep’t 2016), and Bank of NY Mellon v. WMC Mtge., LLC, 151 A.D.3d 72 (1st Dept 2017), the First Department held that a “duty to notify” accrued independent of the securitizers’ obligations with respect to representations and warranties and therefore gave rise to a separate cause of action for damages. Unlike in ACE, this duty to notify could not be characterized as a remedy for the breach, because it was entirely an obligation of the securitizer and did not depend on any prior action by the trustee.

The court limited its holding to only allow “Failure to Notify” claims involving breaches first discovered by Morgan Stanley within the six-year statute of limitations. In other words, Morgan Stanley had no “continuing obligation” to notify past the date of first discovery that would otherwise extend the statute of limitations indefinitely. Nonetheless, the possibility of revising otherwise time-barred claims makes it worthwhile for parties asserting claims based on breaches of representations and warranties in a securitization to carefully read the agreements to evaluate an independent duty to notify post closing.

That was the issue presented to the Appellate Division, First Department in Electron Trading, LLC v. Morgan Stanley & Co. LLC, which was an appeal from the grant of defendant’s motion to dismiss a contractual claim seeking damages above the amount allowable under the contract’s limitation of liability clause.   Justice Saliann Scarpulla granted defendant’s motion to dismiss that portion of the breach of contract claim, notwithstanding plaintiff’s allegations in the complaint that the defendant engaged in wrongdoing and, as such,  could not avail itself of the limitation of liability clause.  Her decision and order was affirmed by the First Department.

The case involved a developer of an alternative trading system (“ATS”), designed to be operated through a “dark pool”, that is, a “private exchange where investors can make trades anonymously.”  Plaintiff and defendant entered into an exclusive licensing agreement (“ELA”) and a consulting services agreement (“CSA”).  Although neither agreement refers to “dark pools,” plaintiff later claimed defendant breached the ELA based upon defendant’s insistence that it would perform only if plaintiff modified the agreement to allow defendant’s high-frequency traders to use it with other customers.  Although defendant conceded breach for purposes of the motion to dismiss, the ELA provided a limitation of liability clause, limiting total liability to amounts paid under the agreement.

Generally, “limitation of liability” clauses are routinely enforced, letting the parties to such a clause, “lie on the bed they made”, says the Court of Appeals in Metropolitan Life Ins. Co. v. Noble Lowndes Invtl.  There are circumstances, however, when a court will ignore the limitation clause when, for example, there is misconduct that “smacks of intentional wrongdoing”, or involves “gross negligence” displaying a reckless indifference. Id. 

Because the complaint here did not detail factual allegations as to the misconduct and “[a]t most . . . support[ed] a claim of intentional breach”, the Appellate Division unanimously affirmed.   The court reasoned that the allegations did not meet the heightened standard of pleading for fraud claims under CPLR 3016(b).  An interesting side note is that the case decided defendant’s motion to dismiss the complaint, but in effect decided the viability of a “limitation of liability” clause — something that is ordinarily pleaded as an affirmative defense.  The First Department noted, however, that the courts can consider whether documentary evidence (here the clause contained in the contract at issue) establishes an asserted defense.

When faced with a “limitation of liability” clause, consider whether the breaching party’s conduct amounts to “wrongful conduct” sufficient to vitiate the clause.  However, a heightened pleading standard applies.  The courts appear to abide by parties’ agreed upon limitation clause, unless the conduct rises to a significant level of misconduct.  Courts are unlikely to set aside such limitations lightly.  Remember, a mere “intentional breach” is not enough.

 

 

 

So your client wants you to file a declaratory judgment action, but you are unsure of whether the applicable statute of limitations has expired.  But what is the applicable statute of limitations in a declaratory judgment action?  Since there is no limitations period specifically addressed to the declaratory judgment action, it generally falls under the “catch-all” provision of CPLR 213[1] and gets six years as “an action for which no limitation is specifically prescribed by law.”  That being the case, you assume your declaratory judgment cause of action is timely so long as it is filed within six years of its accrual.  Think again.

Declaratory judgment actions are unique, in that the Court will actually examine the substantive nature of the claims and the relief sought to determine which limitations period applies.  If the Court determines that the underlying dispute could have been resolved through another proceeding for which a specific limitations period is statutorily provided, the Court will apply that limitations period – even if it is much shorter than six years.

The Appellate Division, Second Department recently addressed this point in Save the View Now v Brooklyn Bridge Park Corp., 156 AD3d 928 (2d Dept 2017).

Save the View Now involved a challenge to the development of a hotel, restaurant, and residential units upland of Pier 1 in Brooklyn Bridge Park (the “Park”).  The overall plan and structure for the Park were set forth in a general project plan (“GPP”) first adopted by Defendants Brooklyn Bridge Park Development Corporation (“BBPDC”) and the Empire State Development Corporation (“ESD”) in July 2005.  The general project plan, as modified (“MGPP”), stated that “[t]he residential and hotel uses would be located in two buildings, one of approximately 55 feet and one of approximately 100 feet in height.”

Construction began in July 2013 and, on September 10, 2014, the northern hotel building had already reached its maximum height.  By this time, members of the community began objecting that the height of the northern hotel building violated the MGPP and was obstructing the view of the roadbed of the Brooklyn Bridge from the Brooklyn Promenade.

In April 2015, Plaintiffs, a group comprised of local members of the community, commenced an action against BBPDC and others seeking, among other things, a declaration that the buildings were being constructed in excess of their height limitation in violation of the MGPP.  The Kings County Supreme Court (Knipel, J.) granted Defendants’ motion to dismiss on the ground that the action was untimely.

The Second Department affirmed.  The Court noted that while an action for a declaratory judgment is generally governed by a six-year statute of limitations (see CPLR 213[1]), the applicable statute of limitations in a declaratory judgment action is determined by the substantive nature of the claim.  Thus, “where a declaratory judgment action involves claims that could have been made in another proceeding for which a specific limitation period is provided, the action is subject to the shorter limitations period.”

Because Plaintiffs’ declaratory judgment action could have been brought as an Article 78 proceeding (and indeed should have, since it involved a challenge to governmental conduct), the four-month statute of limitations governing Article 78 proceedings – rather than the six-year statute of limitations under CPLR 213[1] – applied.

So what’s the takeaway?  The nature of the relief sought in a declaratory judgment action dictates the applicable limitations period.  Thus, prior to relying on the catch-all provision in CPLR 213[1], a careful lawyer should analyze the substance of a complaint to determine if a shorter limitations period may apply.  However, a lawyer may not use a declaratory judgment action as a vehicle to circumvent the statute of limitations that applies to the substance of a complaint.

 

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

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

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

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

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

 

 

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

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

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

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

Can a claim for equitable or common-law indemnification co-exist with a claim for express or contractual indemnification?

In Live Invest, Inc. v. Morgan Justice Emerson says “no”, when the claim seeks to recover for the defendant’s wrongdoing (e.g., breach of contract) as opposed to simply trying to hold a defendant liable based on vicarious liability.

In Live Invest, the court was faced with a motion to dismiss  a third-party action brought by Jericho Capital Corp. (“Jericho”) against Gamma Enterprises, LLC (“Gamma”).  The main action alleged claims seeking to pierce the corporate veil against an individual and several entities, including Jericho.  On motions to dismiss the main action, the court dismissed all but Jericho, see Order, and Order 2, Live Invest v. Morgan (Jan. 13, 2017).   Jericho then pursued the third-party action against Gamma, asserting three causes of action, all premised on variations of indemnification.   The first claim, for express or contractual, based liability on a clause in the Purchase Agreement between Jericho and Gamma, stating that Gamma, “agrees to indemnity and hold harmless [Jericho]. . . from. . . any and all manner of loss, suits, claims,or causes of action. . . arising out of. . . Delta.”  The latter two claims were based on equitable and common-law indemnification.

Noting that equitable or common-law indemnification generally applies when one is held responsible by operation of law due to the relationship of the parties, such as vicarious liability, the dismissed the two equitable claims since the contract itself is claimed to have been breached.  Therefore, the court reasoned, the claim is properly premised for the breach, not by reason of the relationship of the parties.

Interestingly, as to the express or contractual indemnification claim, Gamma raised the threshold issues of whether that claim was “premature” and if the claim for indemnification was incompatible with plaintiff’s veil-piercing claim, see Gamma’s Memorandum of Law.  The Court rejected both arguments.  Finding first that although public policy will render unenforceable contracts that purport to indemnify one for conduct that involves an “intent to harm”, the court here found that nothing precludes indemnification for damages flowing from a mere “volitional act” where no finding of intent to harm has been made.  As to the incompatibility argument, Justice Emerson found that the indemnification and veil-piercing actions could co-exist.  The court reasoned that a claim based on an alter-ego theory is a “procedural device”, not a substantive remedy.  It “merely furnishes a means for a complainant to reach a second corporation or individual”.

 

CPLR 3211(a)(1) allows a defendant to seek dismissal of a complaint when the defense is “founded upon documentary evidence.” “Documentary evidence”, however, is not defined by the CPLR – leaving many practitioners in the dark as to what qualifies as a sufficient “document” under this paragraph.  Indeed, in a recent blog, we highlighted a case involving whether a termination letter sent by the lawyer was sufficient.

By its plain meaning, “documentary evidence” seems to suggest that any type of evidence that has been reduced to writing could qualify. In reality, however, “documentary evidence” only encompasses certain types of documents, making CPLR 3211(a)(1) a narrow, and sometimes risky, ground upon which to seek dismissal.

That begs the question – what qualifies as documentary evidence under CPLR 3211(a)(1)? New York courts have held that judicial records and documents such as notes, mortgages, and deeds rise to the level of “documentary.” But what about contracts? In Hoeg Corp. v Peebles Corp., the Second Department recently affirmed that contracts can indeed attain the rank of “documentary evidence” under certain circumstances.

In Hoeg, plaintiff and defendant entered into a joint venture and memorialized the terms of their relationship in a written retainer agreement. Specifically, the retainer agreement provided, among other things, that plaintiff would act as a consultant in order to facilitate defendant’s acquisition and development of real property in New York City. The retainer agreement also set forth varying commission structures for work performed by plaintiff in facilitating the defendant’s acquisition of such properties. Notwithstanding the written retainer agreement, plaintiff alleged that it had entered into a prior oral agreement with defendant whereby the parties agreed that plaintiff would retain 25% of the equity in the joint venture.

The plaintiff ultimately commenced an action against the defendant for breach of the oral agreement, alleging that the defendant had failed to honor the terms of the oral agreement after the defendant had sold development rights to a parcel of property in a multimillion dollar deal. The Kings County Supreme Court denied the defendant’s motion to dismiss, but the Second Department reversed, finding that the written retainer agreement qualified as documentary evidence under CPLR 3211(a)(1).

In reaching its conclusion, the Court examined the parties’ written retainer agreement and found that the agreement was “comprehensive in its scope and coverage” that constituted a complete written instrument. Accordingly, the Court held that the parol evidence rule bars any evidence concerning the alleged prior oral agreement. For this reason, the Court ruled that the parties’ contract “conclusively disposed of the plaintiff’s claim alleging breach of the purported oral joint venture agreement.”

This does not necessarily mean that every contract will qualify as documentary evidence under CPLR 3211(a)(1). A document will be considered “documentary evidence” within the meaning of CPLR 3211(a)(1) if it “utterly refutes the plaintiff’s allegations, conclusively establishing a defense as a matter of law” (see, e.g., Eisner v Cusumano Corp.) .  In addition, the documentary evidence must be “unambiguous, authentic, and essentially undeniable” (id.).

The careful practitioner should be aware of the limited utility of CPLR 3211(a)(1) and be armed with the right evidence before relying solely on the “documentary evidence” ground. Otherwise, it might be wise for a practitioner to invoke CPLR 3211(a)(7) as a ground for dismissal as well.

 

In an action brought against a title company for losses in connection with a property sale, Justice Elizabeth H. Emerson, in JBGR LLC v. Chicago Title Ins. Co., denied the title insurer’s motion to amend its answer to add defenses, but also denied plaintiffs’ motion for a protective order concerning a withheld memorandum prepared by plaintiffs’ “expediter”.

This is the latest suit involving a 286-acre parcel of property for the development of homes surrounding a golf course on Long Island.  In an earlier suit, the court awarded $2.97 million in damages against the plaintiffs in the current action based upon a promissory note default.  In turn, plaintiffs sued Chicago Title, title insurer of the sale.  In short, plaintiffs allege they were unaware of a 1997 declaration that restricted development to 140 homes, of which the title insurer failed to advise.  Plaintiffs intended to build another 55 homes on the property, but couldn’t.

After years of discovery and motion practice, the case was certified trial ready, and note of issue filed in December 2016.  Post note of issue motions were then filed.  Defendant filed a motion to amend its answer to withdraw certain defenses, modify others and add six more.  Plaintiffs cross-moved for a protective order, seeking to prevent disclosure of a memorandum produced to defendant, based upon attorney client privilege and work product doctrines.

As to the proposed amendments, the court concluded that the delay, coupled with prejudice, warranted denial.  In considering the prejudice, the court applied the same elements used in the laches context, and noted that once certified as “trial ready”, the court’s discretion “should be discrete, circumspect, prudent, and cautious”.  In this case, the court focused particularly on how long defendant was aware of the facts, which had been since June 2015.

An even more significant ruling, however, was the denial of the motion for a protective order.  The memorandum in question was a memo generated by Joseph Dempsey, an attorney, summarizing a meeting held in 2010, at which the municipal applications for the development were discussed.  Defendant obtained the document through a third-party subpoena served upon one of the participants to the meeting, Victor Prusinowski.  Mr. Prusinowski described in his deposition that he was an expediter or “land-use consultant”.  The court held that the memo was not protected from disclosure on three grounds.  First, Prusinowski’s advice, as a non-lawyer service provider, while “important” to the legal advice given to the clients, was not “given to facilitate such legal advice”, and therefore the agency principle did not apply here and his presence waived any privilege.  Second, even if it were privileged, the court concluded that there was a waiver, since “plaintiffs’ took no concrete steps to obtain a ruling” or seek a claw-back for nearly two years.   Finally, the court concluded that the memo prepared by Dempsey was not considered “work product”, since he wasn’t acting as counsel when prepared.  The memo did not contain “language uniquely reflecting a lawyer’s learning an [sic] professional skills, including legal research, analysis, conclusions, legal theory or strategy”.

And all this means what?  As to amendments, consider amending or seeking leave soon after the new facts arise.  Although there may be strategy in waiting to amend, the courts will focus on how long you knew, and whether you had a reasonable excuse for the delay.  As to privilege, when working with non-lawyer service providers, courts will carefully scrutinize their retention, scope of services and their “necessity” for the rendering or facilitation of legal advice.  Consider whether counsel — and not the client — should retain the provider, and whether a Kovel agreement is needed.

 

The doctrine of equitable recoupment, which is codified in CPLR 203(d) permits a defendant to assert an otherwise untimely defense or counterclaim. The Appellate Division, First Department recently applied the doctrine in California Capital Equity, LLC v. IJKG, LLC, and highlighted a few caveats that a litigator should bear in mind when relying upon the doctrine.   Importantly, one must keep in mind that the doctrine of equitable recoupment is to be used as a shield, not a sword.

Plaintiff California Capital Equity, LLC (“CalCap”) commenced an action against defendants IJKG, LLC (“IJKG”) and Vivek Garipalli (“Garipalli”)¹ (collectively, “Defendants”) asserting claims of breach of contract, fraud, and breaches of fiduciary duty arising out of, among other things, Defendants’ failure to make interest payments to CalCap pursuant to a Note Agreement.   In response, IJKG asserted counterclaims for tortious interference with contract, breach of implied covenant of good faith and fair dealing, and unjust enrichment.

CalCap moved to dismiss IJKG’s counterclaims for tortious interference with contract and unjust enrichment on the ground that these counterclaims were barred by New York’s three-year statute of limitations.   Justice Ramos of the New York County Commercial Division denied CalCap’s motion, finding that the doctrine of equitable recoupment permitted IJKG to assert its otherwise time-barred counterclaims.

The First Department affirmed Justice Ramos’ ruling. The Court explained that the doctrine of equitable recoupment, which is codified in CPLR 203(d), permits a defendant to seek equitable recoupment in an otherwise untimely defense or counterclaim.   However, there are two main caveats with respect to the doctrine: (1) the defense or counterclaim must arise from the same transaction, occurrence, or series of transactions or occurrences as alleged in the complaint; and (2) the doctrine may only be asserted to offset any damage award or deficiency judgment that a plaintiff may obtain in its favor against a defendant.   In other words, the doctrine of equitable recoupment may only be used defensively as a shield for recoupment purposes, and not as a sword for a defendant to obtain affirmative relief on an otherwise stale counterclaim.

Applying these principles, the First Department concluded that IJKG’s tortious interference of with contract counterclaim, if proved, could be used defensively for recoupment purposes, but that IJKG could not obtain any relief from the counterclaims, such as disgorgement. Accordingly, the Court permitted IJKG to assert its counterclaim for tortious interference with contract solely to offset any damage award or deficiency that CalCap may obtain in its favor.

¹  Although Garipalli was named as a defendant in the lawsuit, all claims against him have been dismissed.