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.

“Read before you sign”, is what we counsel our clients, since we all know that courts will bind one contractually to a signed agreement even if not read. But, what if you never signed the agreement? Can you still be bound by it?  In earlier blogs — here and here — we addressed this very issue where the courts will, under certain circumstances, bind parties to an “unsigned agreement”.  Now, we examine the latest decision out of the Commercial Division considering whether a non-signatory to an arbitration agreement can be bound to arbitrate.

In a recent decision, Justice Barry R. Ostrager addressed important contract principles, including when a party will be bound by a contract’s arbitration provision where the party did not sign the contract.

In 2004 Parker Family LP v BDO USA LLP, a group of investors brought causes of action based on third-party breach of contract, negligence, and aiding and abetting breach of fiduciary duty against auditors who had been retained by the hedge funds that plaintiffs invested in to audit the hedge funds’ financial statements.  Plaintiffs’ claims stemmed from the Engagement Agreements (“Agreements”) entered into only between the hedge funds and defendants.  Plaintiffs alleged that defendants recklessly issued clean audit reports and ignored the hedge funds’ grossly inflated value of investments, failure to pay redemptions, and improper related-party transactions.  Defendants’ negligence, ultimately, allowed the hedge funds’ management to continue its scheme to defraud investors and led to the funds’ ultimate collapse.

In bringing their motion to compel arbitration, defendants also relied on the Agreements, which contained an arbitration provision requiring any dispute “between the parties” to be resolved in arbitration. Although plaintiffs weren’t parties to the Agreements, Defendants argued that because plaintiffs, as non-signatories to the Agreements, alleged third-party beneficiary status under the Agreements in plaintiffs’ third-party breach of contract claims, plaintiffs should also be bound by the arbitration provision in those Agreements.

As a threshold issue, a court, not the arbitrator, decides whether a party is bound by an arbitration provision in an agreement that the party did not execute (KPMG LLP v Kirschner).

The New York Court of Appeals previously noted in Matter of Belzberg v Verus Investment Holdings Inc. that as a general rule in New York, nonsignatories are not subject to arbitration agreements.  However, this rule is not without exception.

For example, a nonsignatory can be forced to arbitrate based on a contract’s arbitration provision where the party “knowingly exploits” the benefits of the contract and receives benefits flowing directly from the agreement (MAG Portfolio Consultant, GMBH v Merlin Biomed Group LLC).  This is referred to as the direct benefits theory of estoppel.  However, where the party merely exploits the contractual relation of the parties, but not the agreement itself, the benefit is considered “indirect” and the nonsignatory cannot be compelled to arbitrate based on the contract’s arbitration provision (Matter of Belzberg).

New York federal courts have also relied on the direct benefits theory of estoppel.  Specifically, the Second Circuit has held that where the agreement at issue is the direct source of the benefit, a direct benefit to the party exists and arbitration required by the agreement must be imposed on the nonsignatory (Deloitte Noraudit A/S v Deloitte Haskins & Sells, U.S.).

Here, the Court, ultimately, determined that where plaintiffs expressly relied on the Agreement in asserting their Third-Party Breach of Contract claims against defendants, thereby alleging that defendants are liable to plaintiffs as “third-party beneficiaries” of the Agreements based on plaintiffs’ reliance on the audit reports in making investment decisions, plaintiffs were bound by the Agreements’ arbitration clause under the direct benefits theory of estoppel.  Thus, the Court severed all claims against defendants and directed that they proceed to arbitration.

Takeaway:  The direct benefit theory of estoppel and this decision have wide application for corporate and commercial litigation.  Potential litigants should be aware that they may be bound by a contract’s arbitration provision and cannot avoid it by simply asserting their “nonsignatory” relationship to the contract.

 

 

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A few weeks ago, my colleague Sonia Russo blogged about how shareholders seeking to bring successive derivative actions should be wary, since dismissal of a derivative action for failure to allege pre-suit demand or  demand futility may have a preclusive effect on a subsequent derivative action based on the same issues.  But what if a shareholder plaintiff, whose first derivative suit was dismissed for failure to serve a pre-suit demand or allege demand futility, brings a subsequent derivative action based upon a different issue, such as a boards’ refusal to take action after a valid pre-suit demand has been made?

The Queens County Commercial Division in Feliciano v Seabrook, 2020 NY Slip Op 50753(U) (Sup Ct, Queens County Jun. 11, 2020) (Livote, J.) recently decided this issue, holding a subsequent derivative action will not be barred by the doctrine of res judicata if the board’s wrongful refusal of a litigation demand was not an issue that could have been litigated in the prior derivative action.

The plaintiffs in Feliciano, active and retired members of the Corrections Officers Benevolent Association, Inc. (“COBA”) and beneficiaries of the COBA Annuity Fund and COBA General Fund (“Plaintiffs”), commenced a derivative action in state court against Norman Seabrook (“Seabrook”), the former President of COBA, several members of COBA’s Executive Board (collectively “Executive Board Defendants”), and Koehler & Isaacs, LLP (“K&I”), a law firm that represented COBA, stemming from Seabrook’s participation in a Ponzi scheme (the “State Court Action”).

The complaint alleges Seabrook was indicted (and ultimately convicted) for investing money from COBA’s Annuity Fund and General Fund (the “COBA Funds”) with a “high-stakes” investment firm, which later turned out to be a Ponzi scheme, in exchange for bribes and personal kickbacks.  Plaintiffs allege the Executive Board Defendants, who were charged with overseeing the COBA Funds pursuant to COBA’s Constitution and Bylaws, had no safeguards in place to protect against Seabrook’s activities, and essentially authorized Seabrook’s investments. With respect to K&I, Plaintiffs allege K&I breached its fiduciary duties to COBA by failing to inform the Executive Board of Seabrook’s high-risk investments, or that the investments were being made without their approval.

The State Court Action was not the first lawsuit between Plaintiffs and Defendants.  Plaintiffs had previously filed a derivative action in the United States District Court for the Southern District of New York seeking to hold Seabrook, the COBA Executive Board and K&I responsible for the harm suffered by COBA (the “Federal Action”).  The Federal Action was ultimately dismissed for Plaintiffs’ failure to serve a pre-suit demand or allege demand futility with sufficient particularly

After the Federal Action was dismissed, Plaintiffs made a litigation demand on the Executive Board, requesting that it undertake an investigation, and take action to remedy the financial harm suffered by COBA.   Plaintiffs alleged in the State Court Action that the COBA Executive Board wrongfully refused Plaintiffs’ litigation demand, and declined to make any investigation or pursue any legal remedies against those responsible for causing harm to COBA.

K&I moved to dismiss the State Court Action on the ground that Plaintiffs’ claims were barred by the doctrine of res judicata, since the Federal Action “involved the same parties and alleged facts, and reached final resolution on the merits.”  According to K&I “dismissal of a derivative action for failure to plead demand futility is a final judgment on the merits for purposes of res judicata.”

The Court rejected K&I’s arguments, holding that dismissal based on demand futility does not have res judicata effect on a subsequent action based on the Executive Board’s failure or refusal to take appropriate action after the litigation demand was made.  As the Court explained, “[t]he Executive Board’s business judgment was not an issue litigated or one that could have been litigated in the Federal Action,” since, at the time of the Federal Action, the Executive Board had not yet decided whether or not to investigate and ultimately litigate Plaintiffs’ claims.

In the context of a corporate derivative action, dismissal for failure to plead demand futility is a final judgment on the merits for purposes of res judicata under New York law (see City of Providence v Dimon, 2015 WL 4594150, at * 6 [“[U]nder New York law, the dismissal of a derivative action for failure to plead demand futility is a final judgment on the merits for purposes of res judicata”]; Henik ex rel. LaBranche & Co., Inc. v LaBranche, 433 F Supp 2d 372, 379 [SD NY 2006] [precluding plaintiffs, on both res judicata and collateral estoppel grounds, from relitigating the issue of demand futility]; Wietschner v Dimon, 2015 WL 4915597, at *6 [Sup Ct, NY County, Aug. 14, 2015], aff’d 139 AD3d 461 [1st Dept 2016]).

But, this does not mean that dismissal of a demand futility action has a res judicata effect on a subsequent action based on a board of directors’ alleged refusal to initiate suit.  In Weitschner, for example, the later-filed case raised the same demand futility arguments as the action to which res judicata applied, effectively barring the subsequent action.  By contrast, in Seabrook, the State Court Action and Federal Action raised two different issues: demand futility (the Federal Action) and the Executive Board’s wrongful refusal to take action after a litigation demand had been made (the State Court Action).  While the Plaintiffs in Seabrook would not have been able to relitigate the issue of demand futility in the State Court Action, they were certainly permitted to litigate the issue of the Executive Board’s wrongful refusal – an issue that could not have possibly been litigated in the Federal Action, since that action was dismissed prior to the Executive Board’s alleged wrongful refusal.

Takeaway:

Under New York law, once the issue of demand futility is litigated and decided against a shareholder, the doctrine of res judicata bars all subsequent plaintiffs from relitigating the issue of demand futility.  However, where a subsequent derivative action involves different issues which could not have been raised in the prior action, res judicata will not apply.

Foreign cities, thieves, and millions of dollars’  worth of missing diamonds. This may sound like the trailer for this summer’s blockbuster action film, but this story of hustling and heisting comes straight from Swissgem S.A and Genevagem S.A. v M&B Limited, a New York case recently decided by Commercial Division Justice Peter O. Sherwood.

In Swissgem, Justice Sherwood granted a motion to dismiss brought by Defendant M&B Limited (“M&B”), on the grounds of forum non conveniens, finding Hong Kong, instead of New York, was a more convenient forum to litigate this international suit for ownership over a 20 carat diamond.

On September 28, 2018, in Geneva, Switzerland, a thief stole 24 round brilliant cut diamonds from Plaintiffs Swissgem S.A. and GenevaGem S.A.. The missing diamonds were valued at approximately $18 million. Amongst the two dozen stolen gems was one particularly spectacular 21.14 carat diamond (the “Diamond”). Plaintiff’s notified the police of the diamond heist, as well as the Gemological Institute of America, Inc. (“GIA”), advising GIA that the thieves may try to “re-cut” the diamonds into smaller diamonds, and resubmit them for grading.

Nearly 6,000 miles away in Hong Kong, M&B, a jewelry wholesaler and retailer, unknowingly purchased a 20.33 carat diamond and submitted the gem to GIA in New York for grading and certification. GIA’s analysis revealed that the submitted diamond was, in fact, the same diamond stolen from the Plaintiffs. Plaintiffs demanded return of the Diamond but M&B refused. M&B initiated a suit in Hong Kong asserting ownership over the Diamond and GIA secured the Diamond at its lab in New York, awaiting the resolution of the ownership dispute.

Plaintiffs later filed the subject action in New York Supreme Court, asserting claims of declaratory judgment, failure to purchase in good faith, and replevin. M&B responded by seeking to dismiss on the grounds of lack of personal jurisdiction, and forum non conveniens.

On the issue of personal jurisdiction, M&B argued that Plaintiffs’ reliance on New York’s long arm statute, CPLR § 302(a), was misplaced. Put simply, CPLR § 302(a) gives New York courts the power to exercise personal jurisdiction over non-New York residents who: (1) transact business within New York; (2) commit a tortious act within New York; (3) commit a tortious act outside of New York where the injured persons or property are located within New York; or (4) own, use, or possess real property in New York.

M&B argued that CPLR § 302(a)(1) is only applicable if M&B engaged in “purposeful business activities” within the state and if there was a “substantial relationship” between those activities and the Plaintiffs’ causes of action (see Talbot v. Johnson Newspaper Corp.; O’Brien v Hackensack Univ. Med. Ctr.; Golden Gulf Corp. v Jordache Enter. Inc.). In support of its motion to dismiss, M&B relied on the fact that (i) Plaintiffs’ claims arise from events taking place outside of the U.S., namely Switzerland and Hong Kong; (ii) M&B did not have “purposeful business activities” within New York; and (ii) merely sending the Diamond to GIA in New York for grading is too attenuated and insufficient to establish the necessary nexus.

Plaintiffs, on the other hand, urged the Court that “proof of just one transaction in New York is sufficient” provided the activities were purposeful and that a substantial relationship between the transaction and the claim existed (see Deutsche Bank Sec., Inc. v Montana Bd of Invs.; Kreutter v McFadden Oil Corp.). Plaintiffs relied on the fact that: (i) M&B transacts business by “regularly” sending diamonds to GIA in New York to be graded; (ii) M&B markets themselves as a “global presence,” acting as an admission that M&B is a participant in New York’s diamond market; (iii) the exercise of personal jurisdiction comports with due process because there is a substantial relationship between the lawsuit and M&B’s sending the Diamond to GIA, which allowed GIA to flag the diamond as stolen and notify the Plaintiffs; and (iv) M&B purposefully availed itself of the forum by sending the diamond from Hong Kong to New York. Plaintiffs thus argue that M&B should reasonably expect to defend its actions in New York.

While both parties’ arguments would make any law school civil procedure professor proud, the Court ultimately denied M&B’s motion to dismiss on the basis of lack of personal jurisdiction, finding Plaintiffs were successful in showing M&B “transacts business within New York, purposefully availing itself of the benefits and protections of transacting in the state.”

On the issue of forum non conveniens, however, the Plaintiffs were not so successful. M&B asserted in its moving papers that should the Court find personal jurisdiction, there were two other forums, Switzerland and Hong Kong, that were more appropriate. The supporting reasons included that the theft occurred in Switzerland, the Diamond was purchased in Hong Kong, documents and witnesses were located in Switzerland and Hong Kong (making production in New York burdensome for M&B), and New York had no interest in adjudicating the matter as neither the Plaintiffs nor M&B are residents of New York.

Plaintiffs argued the primary factor in proceeding in New York was the fact that the property in dispute, the Diamond, was currently located in New York. Further, there would be no undue hardship on M&B because it chose to direct business activity towards New York, and because GIA is in New York it would not be impossible to obtain GIA’s documents and witnesses. As for New York’s interest in the matter, Plaintiff’s argued that because New York has a reputation as a “world-renown center for art and culture,” New York has a vested interest in protecting its stream of commerce from stolen goods.

The Court explained that on a motion to dismiss on the basis of forum non conveniens, the challenging defendant bears the burden of “demonstrating relevant private or public interest factors which militate against accepting the litigation” (see Islamic Republic of Iran; Stravalle v Land Cargo Inc.). The Court also listed factors, with no one factor controlling, that should be considered: (a) the residency of the parties; (b) the potential hardship to proposed witnesses; (c) the availability of an alternative forum; (d) the sits of the underlying action; and (e) the burden which will be imposed upon New York Courts. The Court qualified this burden as a “heavy” one, but one that was ultimately met by M&B.

The Court dismissed the case on forum non conveniens grounds because Plaintiffs, a Swiss corporation, brought suit based on acts that occurred outside of New York, finding that a substantial nexus was not formed by simply sending the Diamond to GIA in New York. The Court found that documents and witnesses are primarily located in Switzerland and Hong Kong and that Hong Kong, a forum in which M&B has already begun an action for the same remedies, is a satisfactory alternative. However, the Court did condition dismissal upon the parties stipulating that the Diamond would remain in the possession of the GIA pending the court in Hong Kong giving directive that it had jurisdiction.

Upshot: The same set of circumstances may provide enough for a court to find personal jurisdiction, but may not be enough for a court to determine that the case was brought in the most appropriate forum.

Undoubtedly, unsuspecting foreign corporations may find themselves having business connections in New York and subject to the jurisdiction of New York courts.

This blog post focuses on a recent decision by Hon. Andrew Borrock of the Commercial Division of the New York State Supreme Court for New York County in Matter of Renren, Inc. Derivative Litig. v. XXX, 67 Misc. 3d 1219(A), 2020 N.Y. Slip Op. 50588(U) (Sup. Ct., New York County May 20, 2020), where the Court denied Renren, Inc.’s motion to dismiss.

In its decision, the Court addressed, among other things, the reach of New York’s long-arm statute—CPLR 302. Specifically, whether the Court has personal jurisdiction over Renren, Inc. (“Renren”), a Cayman Islands company with its principal place of business in China. Renren, meaning “everyone” in Mandarin Chinese, is a social media platform in China similar to Facebook (which the Chinese government banned in 2009). Renren is listed on the New York Stock Exchange (“NYSE”) as American Depository Shares (“ADS”). For purposes of this blog post, only a cursory examination of the facts is necessary.

On July 19, 2018, the plaintiffs, minority shareholders of Renren, commenced a shareholder derivative action on behalf of Renren (click here for a link to the Consolidated Stockholder Derivative Complaint (the “Amended Complaint”)). The action is premised on an alleged scheme perpetrated by Renren’s chief executive officer and certain directors and controlling shareholders to defraud Renren and its minority shareholders in amounts alleged to be in excess of $500 million for their investment (Renren, Inc., 67 Misc. 3d 1219[A], at *1). The purported scheme, as distilled by the Court, involves Renren’s chief executive officer seeking to raise substantial sums in an initial public offering (IPO) on the NYSE “to capitalize on Facebook being banned in China. According to the Court, the CEO promised not to make investments that would make his company qualify as an investment company under the Investment Company Act of 1940, broke the promise, and then when the investments appreciated, tried to go private by making an ‘offensive and ludicrous’ offer [which was rebuked] so as to ‘enrich’ himself and certain other controlling shareholders of Renren []” (id. at *1). Allegedly, instead of structuring a deal for the benefit of all shareholders, the chief executive officer and controlling interests “structured a transaction through New York where they could loot the company based on a cooked ‘true value and fairness’ opinion of [one of the other defendants] with so many caveats that no reasonable Board member should have relied on it . . .” (id.).

Specifically, per the Amended Complaint, in 2011, Renren filed with the SEC to list its shares on the NYSE as ADS (id. at *3). Renren raised in excess of $777 million in its IPO (id. at *4). Pursuant to various controlling agreements (e.g., an Underwriting Agreement and a Deposit Agreement), Renren agreed to be bound by New York law and consented to the jurisdiction of the federal and state courts of the State of New York located in New York City (Renren, Inc., 67 Misc. 3d 1219[A], at *3-4). According to the decision, “as Renren’s viability as social media company grew increasingly dubious, [the chief executive officer], armed with a stockpile of cash from the IPO, [with the assistance of others], began looking to make Renren more profitable by investing substantial amounts of the IPO funds in various other companies; most significantly, a 21.06% interest in SoFi (id. at *4-5). Since SoFi holds a New York mortgage banker license, the New York State Department of Financial Services must approve any transaction concerning a change of control (id. at *5). Ultimately, Renren effectuated a spin-off to a subsidiary company, OPI, to hold Renren’s minority stakes in privately held companies pursuant to a Separation and Distribution Agreement in 2018 (id. at *5). As a result of this transaction, Renren’s shares suffered significant price dilution (id. at *9).

Believing that they were defrauded, the plaintiffs commenced suit. The plaintiffs specifically allege that the “tainted transaction involved Renren (i) spinning off its wholly-owned subsidiary, OPI (the “Separation”) . . . and distributed the shares of the subsidiary to certain [e]ligible [s]hareholders through a private offering (the “Private Placement”) . . . and (ii) allegedly paid a substantially diminished cash dividend to non-participating shareholders (the “Cash Dividend”, and together with the Separation and the Private Placement, the “Transaction”) . . . in a transaction approved by an allegedly interested Special Committee and deliberately structured through New York pursuant to a Deposit Agreement” (Renren, Inc., 67 Misc. 3d 1219[A], at *2-3 [internal quotations added). Renren moved to dismiss, inter alia, pursuant to CPLR 3211(a)(8)—lack of personal jurisdiction (id. at *1).

This blog post only focuses on the Court’s determination of Renren’s motion to dismiss for lack of personal jurisdiction.

In New York, “[a] court may exercise general jurisdiction over a defendant pursuant to CPLR 301 on all causes of action where the defendant’s ties to New York ‘are so ‘continuous and systematic’ as to render them essentially at home in the forum state” (Renren, Inc., 67 Misc. 3d 1219[A], at *10 citing Goodyear Dunlop Tires Operations, S.A. v Brown, 564 US 915, 919 [2011], quoting International Shoe Co. v Washington, 326 US 310, 317 [1945]). For individuals, general jurisdiction is based on the individual’s domicile (id.). But for corporations, general jurisdiction is based on “the place of incorporation and its principal place of business;” except in an “exceptional case” (id. citing Daimler AG v Bauman, 571 US 117, 137 and 138, n.19 [2014]). In Renren, the Court found that since Renren is a Caymans Island company with its principal place of business in China, it was not subject to the general jurisdiction of the New York Courts pursuant to CPLR 301 (id.).

However, the outcome was not the same for specific jurisdiction. Unlike general jurisdiction, “a court in New York may exercise personal jurisdiction over a non-domiciliary defendant where (i) the court has long-arm jurisdiction over the defendant under CPLR 302, and (ii) the exercise of such jurisdiction comports with due process (Renren, Inc., 67 Misc. 3d 1219[A], at *10 citing Williams v Beemiller, Inc., 33 NY3d 523, 528 [2019] [“If either the statutory or constitutional prerequisite is lacking, the action may not proceed”]). Justice Borrock goes on to explain that “long-arm or specific jurisdiction ‘is confined to adjudication of issues deriving from, or connected with, the very controversy that establishes jurisdiction” (id. citing Goodyear, supra, 564 US at 919); that “the suit must arise out of or relate to the defendant’s conduct with the forum” (id. citing Bristol-Myers Squibb Co. v Superior Ct. of Cal., San Francisco County, 137 S Ct 1773, 1780 [2017] [emphasis, internal quotation marks and citation omitted]). Judge Borrock explains that New York’s long-arm statute—CPLR 302—is a “single act statute, meaning that proof of one transaction in New York [be it through a transaction in person or through an agent] is sufficient to invoke jurisdiction, even though the defendant never enters New York, so long as the defendant’s activities here were purposeful and there is a substantial relationship between the transaction and the claim asserted” (id. citing Kreutter v McFadden Oil Corp., 71 NY2d 460, 467 [1988] [quotations omitted]).

Furthermore, in order to exercise personal jurisdiction over a non-domiciliary defendant, the Court must ensure that constitutional due process requirements of the “minimum contacts test” are met. “Due process requires that a defendant must have sufficient minimum contacts with New York such that the defendant should reasonably expect to be haled into court [in New York] (Renren, Inc., 67 Misc. 3d 1219[A], at *10 citing LaMarca v Pak-Mor Mfg. Co., 95 NY2d 210, 216 [2000], quoting World-Wide Volkswagen Corp. v Woodson, 444 US 286, 297 [1980]), and that requiring the non-domiciliary to defend the action in New York comports with ‘traditional notions of fair play and substantial justice’” (id. citing LaMarca, 95 NY2d at 216, quoting International Shoe Co., 326 US at 316). Justice Borrock averred that the question is “whether the defendant has purposefully availed itself of the privilege of conducting activities within the forum State” (id.). In making this determination, courts consider “the burden on the defendant, the forum State’s interest in obtaining the most efficient resolution of controversies, and the shared interest of the several States in furthering fundamental substantive social policies (id. citing Burger King Corp. v Rudzewicz, 471 US 462, 477 [1985]). “When the defendant is a foreign corporation, the court must consider the international judicial system’s interest in obtaining efficient and effective relief and the shared interests of the nations in advancing substantive policies (id. citing Asahi Metal Indus. Co. Ltd. v Super Ct of Cal., Solano County, 480 US 102, 115 [1987]).

Using the foregoing principles, Justice Borrock determined that the plaintiffs made out a prima facie showing that the Court has personal jurisdiction over Renren pursuant to CPLR 302(a)(1).

Specifically, the Court found that the IPO in and of itself was insufficient to confer long-arm jurisdiction, but “taken together with the factual allegations concerning Renren’s New York contacts,” was sufficient for personal jurisdiction (id. at *12). Also, that the OPI Separation transaction “had an articulable nexus to New York and that the claim that Renren turned itself into a de facto venture capital fund using IPO proceeds and then siphoned off its investments to OPI, directly related to the Separation (id.).

Other factors that assisted the Court in its determination were the agreements relating to the IPO and the Transaction which required notices and payments to be sent into New York (e.g., the Separation Agreement required Renren to send an instruction letter to Citibank in New York, the Offering Circular required shareholders to send election forms to Renren’s counsel’s office in New York, the Deposit Agreement governing the Cash Dividend was governed by New York law, and the parties chose New York as the forum).

Importantly, the Court noted that the Court of Appeals has recognized that a party’s “intentional use of a bank account in New York in connection with a transaction supports personal jurisdiction pursuant to CPLR 302(a)(1) (id. at *13 citing Rushaid v Pictet & Cie, 28 NY3d 316, 325-328 [2016]).

Renren contended, inter alia, that neither CPLR 302 nor any other statute allows for jurisdiction over a foreign corporation in a shareholder derivative action (id. at *16). The Court aptly dismissed Renren’s contention as it ignored Business Corporation Law 626—which provides, in pertinent part: “An action may be brought in the right of a domestic or foreign corporation to procure a judgment in its favor, by a holder of shares or of voting trust certificates of the corporation or of a beneficial interest in such shares or certificates” (BCL 626[a]) (id.).

Moreover, the Court determined that since Renren’s IPO raised $777 million using New York’s capital markets, used such funds for investments and not Renren, and improperly divested such investments through the Separation under New York law, sufficient minimum contacts with New York existed to find that the exercise of personal jurisdiction over Renren comports with due process (id.).

With respect to the reasonableness of jurisdiction, the Court found that Renren failed to meet its burden (id. at *17). Specifically, the Court found that given Renren’s contacts with New York, Renren could foresee litigating an action in New York and the same would not be unduly burdensome (id.). The Court noted that Renren utilized New York counsel (Skadden, Arps, Slate, Meagher & Flom) for past New York related activities (id.), and further, a majority of the witnesses to the transactions at issue are citizens of the United States or are incorporated or have a principal place of business in New York (id.). Finally, the Court reiterated New York’s “strong interest” in adjudicating cases such as Renren, Inc. in New York’s Courts because New York has a “strong interest in maintaining and fostering its undisputed status as the preeminent commercial and financial nerve center of the Nation and the world” (id. citing Ehrlich-Bober & Co. v Univ. of Houston, 49 NY2d 574, 581 [1980] [internal quotations omitted]).

All of these contacts with New York allowed the Court to deny Renren’s motion to dismiss on jurisdictional grounds.

Bottom line:
A foreign entity planning to do business in New York, even for a “New York minute,” should be forewarned that it could unwittingly be subject to personal jurisdiction of New York Courts if it is not deliberate in preparing to undertake a transaction in New York, the commercial and financial nerve center of the United States and the world.