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.


“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.



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 madeAs 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.


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.

At this point, after nearly three months of practicing law virtually from home, I think it’s fair to say that what was once novel and experimental has become a kind of new norm for the future.

Sure, state courts in New York, including the Commercial Division, have been returning slowly-but-surely to in-person operations over the last couple weeks, particularly upstate where Syracuse, Binghamton, Rochester, Buffalo, and the surrounding counties officially have entered Phase II of Governor Cuomo’s reopening protocols.

But make no mistake, as long as health and safety remain the priorities — and as well they should — physical interaction in the courthouse will continue to be minimized while virtual interaction is maximized.  As Chief Judge Janet DiFiore remarked earlier this week:

As we progress toward fuller in-person court operations across the State, our foremost priority remains protecting the health and safety of all those who work in and visit our court facilities.

As it stands, only essential family matters will be conducted in-person.  Criminal, juvenile-delinquency, and mental-hygiene proceedings, as well as all other “non-essential” matters, will continue to be held virtually.  Mediation and all other ADR proceedings also will continue to be conducted virtually.

No strangers to technological innovation, Commercial Division judges around the state have been embracing the new virtual norm with optimism, if not enthusiasm.  A few weeks ago, on May 11, NYSBA’s Commercial and Federal Litigation Section sponsored a “Virtual Town Hall” discussion via Zoom during which Commercial Division Justices Saliann Scarpulla (NY County), Timothy Driscoll (Nassau County), and Deborah Karalunas (Onondaga County) reported on the status of litigating in the Commercial Division during COVID-19 and the methods being employed to move their cases forward.  Here are some highlights on a just a few topics from the program:

  • The Transition to Virtual Proceedings Generally.  The move to virtual courtroom practice, along with all the associated technology (primarily Skype for Business), will require much patience on the part of the bench and bar alike.  Expect some bumps in the road and be prepared to deal with them cooperatively.  Judges are welcoming and even encouraging lawyer input.  Everyone needs to be sensitive to the reality of a general unwillingness to get back to the courthouse on the part of judges and other court staff.
  • Virtual Evidentiary Hearings.  Judges for the most part are encouraging virtual evidentiary hearings and, for those that have conducted them, are finding that they proceed fairly seamlessly.  Managing exhibits remains a challenge, however, especially for document-intensive cases involving lengthy contracts, etc.  Again, patience and cooperation is required.
  • Settlement and ADR.  Judges across the board actively (and successfully) are encouraging parties to settle their cases through court settlement conferences and/or the court’s mediation/ADR programs.  Specifically, Justice Scarpulla has been encouraging settlement by reminding lawyers that their clients should not expect to receive a trial date any time soon.  Justice Driscoll personally has been conducting three-room Skype settlement conferences.  And Justice Karalunas has been emailing lawyers directly, encouraging them to resolve their cases by settlement conference or mediation.

Next week, on June 8, the Business & Commercial Law Committee of the Westchester County Bar Association will be presenting a similar program entitled “Litigating in the Westchester Commercial Division During COVID-19:  A Virtual Town Hall Discussion.”  Westchester Commercial Division Justices Linda Jamieson and Gretchen Walsh will be on hand to address questions concerning, among other topics, the virtual practices and procedures being implemented in their courtrooms, upticks in ADR and settlement, and the recently-instituted gradual reopening of the courthouse on Martin Luther King Boulevard in White Plains.  Register for the program here and join us for the discussion!

Disputes over the scope of insurance coverage are common fixtures in the Commercial Division Courts.  Earlier this month, the First Department partially affirmed Justice Sherwood’s decision in Westchester Fire Ins. Co. v. Schorsch et al.  Considering a matter of first impression in the New York Commercial Division Courts, the decision holds that a D&O policy’s “insured versus insured” exclusion does not preclude coverage for claims against corporate officers by a creditor trust.

The affirmance ensures that Westchester Fire will remain among Justice Sherwood’s extensive list of widely-cited insurance coverage decisions (See, e.g., Freedom Specialty Ins. Co. v. Platinum Mgt. (NY), LLC, 2018 NY Slip Op 32233 [denying a D&O insurers’ motion for summary judgment based on a prior and pending litigation exclusion]; Zurich Am. Ins. Co. v Don Buchwald & Assoc., Inc., 2018 NY Slip Op 33325(U) [holding that an intentional tort could be a covered occurrence, triggering a CGL insurer’s duty to defend]; Alexander v. Starr Surplus Lines Ins. Co., 2020 NY Slip Op 30297(U) [granting a preliminary injunction directing a D&O insurer to advance defense costs to a former corporate officer for an investor lawsuit alleging fraudulent inducement]).

RCAP, Bankruptcy and the Creditor Trust

RCS Capital Corp. (“RCAP”) is a wholesale broker-dealer and investment banking advisor.  Backed by billionaire entrepreneur and investor Nick Schorsch, RCAP’s initial success took a major turn in October 2014, when a related company, American Realty Capital Properties, Inc. announced that a $23 million accounting error over the first half of 2014 was left intentionally uncorrected.  The fallout from that accounting scandal included the resignation of executives, investigations into the misconduct, and a plummeting share price of RCAP.

In March 2016, RCAP announced its intention to file for bankruptcy.  With bankruptcy in its near-future, RCAP’s management made a pitch to creditors in order to maintain control over the company: in exchange for the creditors’ supporting RCAP’s proposed plan of reorganization, RCAP would create, upon its emergence from bankruptcy, a trust for the benefit of RCAP’s creditors (the “Creditor Trust”), and it would assign to the Creditor Trust certain causes of action RCAP had against certain of its former directors and officers, including Schorsch and those allegedly responsible for the accounting scandal.

On May 19, 2016, the bankruptcy court confirmed the bankruptcy plan, which included the provisions creating the Creditor Trust.  Under the plan, the Creditor Trust was assigned all of RCAP’s claims against its former directors and officers and was empowered to “enforce, sue on, settle, or compromise . . . all Claims, rights, Causes of Action, suits, and proceedings . . . against any Person without the approval of the Bankruptcy Court [and] the Reorganized Debtors[].”

The Creditor Trust Sues RCAP’s Directors and Officers, Westchester Fire Denies Coverage under the Policy’s “Insured vs. Insured” Provision

After assignment of RCAP’s claims, the Creditor Trust brought suit in the Delaware Chancery Court against certain former directors and officers for, inter alia, their breach of fiduciary duty to RCAP.  The Complaint ties many of its allegations of “disloyal self-dealing” to Schorsch: “In 30 months nearly $1 billion in public stakeholder investments [in RCAP] was destroyed.  Every penny of loss was the result of wrongdoing by Schorsch and his colleagues.”

Schorsch and the additional individual defendants (the “Individual Insureds”) in the Delaware action sought coverage and indemnification under RCAP’s D&O liability insurance policy.  The policy consisted of a primary policy and several layers of excess; Westchester Fire had the seventh layer of excess coverage.  Westchester Fire’s excess policy followed the form of the primary policy, but unlike the primary and the first through sixth excess layers, Westchester Fire denied coverage and refused to advance defense costs.

Westchester Fire based its denial on various grounds, including that D&O coverage of the Individual Insureds in the action by the Creditor Trust as assignee of claims held by RCAP was barred under the policy’s insured vs. insured exclusion.  Specifically, the policy’s insured vs. insured provision excluded coverage for “any Claim made against an Insured Person . . . : by, on behalf of, or at the direction of the Company or Insured Person.”

Insured vs. Insured or “IvI” exclusions are common in D&O policies.  Generally, they prevent a company from expanding its D&O policy into general business insurance by invoking its D&O insurance policy in all cases where the company now disagrees with the actions of certain directors or officers.  In other words, they prevent the company from “push[ing] the costs of mismanagement onto an insurance company just by suing (and perhaps collusively settling with) past officers who made bad business decisions,” Indian Harbor Ins. Co. v. Zucker (6th Cir. 2017).  Like most D&O policies, the IvI exclusion here contained an exception restoring coverage for claims asserted by specified persons who have replaced RCAP’s management and assumed control over RCAP during the pendency of a bankruptcy proceeding.  This “Bankruptcy Trustee Exception” to the IvI exclusion applies to claims “brought by the Bankruptcy Trustee or Examiner of the Company, or any assignee of such Trustee or Examiner, any Receiver, Conservator, Rehabilitator, or Liquidator or comparable authority of the Company.” (emphasis added).

Westchester Fire reasoned that because the IvI exclusion applies to claims asserted by RCAP, and because the Creditor Trust, as assignee of RCAP’s claims, stands in RCAP’s shoes, the IvI exclusion likewise bars coverage in suits brought by the Creditor Trust.  The Bankruptcy Trustee Exception to the IvI exclusion did not apply, Westchester Fire argued, because the limited carve out did not specifically include a voluntary assignee of RCAP’s claims and the Creditor Trust was not a “comparable authority of the Company,” as that phrase is used in the carve out.

Justice Sherwood’s Decision and Partial Affirmance

Justice Sherwood’s April 2019 decision assumed that the Delaware action by the Creditor Trust  triggered the IvI exclusion, but held that the Bankruptcy Trustee Exception restored coverage.  Although the Creditor Trust is not among the specific persons listed in the Bankruptcy Trustee Exception, the trial court held that the catchall phrase in the Bankruptcy Trustee Exception for claims brought by a “comparable authority” of the Company was ambiguous, and that ambiguity must be construed in favor of coverage.  The court accordingly held that the Creditor Trust Action fell within the Bankruptcy Trustee Exception, rendering the IvI Exclusion inapplicable to claims brought by the Creditor Trust.

On appeal, Westchester Fire argued that the Bankruptcy Trustee Exception’s use of the phrase “comparable authority,” was not ambiguous; it referred to authority comparable to a receiver, conservator, or liquidator, and the Creditor Trust was “in no way ‘comparable’” to any of those persons.  Receivers, conservators, and liquidators have control over a company; the Creditor Trust did not have control over RCAP.  Receivers, conservators, and liquidators have fiduciary duties to a company; the Creditor Trust did not have fiduciary duties to RCAP.  And most importantly, receivers, conservators, and liquidators are disinterested—such that they can fulfill simultaneous duties to the debtor and its creditors; the Creditor Trust is not disinterested and works solely for the creditors.  Because the Creditor Trust was more like RCAP itself than a receiver, conservator, or liquidator, Westchester Fire argued, the IvI exclusion applied.

The Individual Insureds argued the contrary: the Creditor Trust was an authority comparable to a receiver, conservator, or liquidator, and accordingly, its claims were subject to the Bankruptcy Trustee Exception to the IvI exclusion.  In fact, the Individual Insureds argued, the Creditor Trust expressly had all the “rights and powers provided in the Bankruptcy Code in addition to any rights and powers granted in the Plan Documents[.]”  So the Creditor Trust’s authority was co-extensive with the powers of any of the other entities listed in the Bankruptcy Trustee Exception.

The First Department, noting that this case raised a matter of first impression, held that the phrase “comparable authority” as used in the Bankruptcy Trustee Exception to the IvI exclusion included the Creditor Trust, and accordingly, the IvI exclusion did not apply to claims brought by the Creditor Trust.  The Court reasoned that because the bankruptcy court approved the reorganization plan, the Creditor Trust was, contrary to Westchester Fire’s argument, more than a naked asignee of the Company’s claims:

Turning to the question of whether the exception for bankruptcy trustees and comparable authorities applies here to restore coverage removed by the insured vs. insured exclusion, we find that the pertinent clauses of the insured vs. insured exclusion and the bankruptcy exception, when read together, are unambiguous.  Their plain language indicates no intent to bar coverage for D & O claims brought by the Creditor Trust, as a post-confirmation litigation trust. . . . [W]hat makes a Creditor Trust “comparable” to a bankruptcy-related entity, seeking to recover funds for the creditors, is that the Trust is not merely a creditor.  Rather, it is an entity and authority created as part and parcel of the bankruptcy reorganization proceeding, empowered by the bankruptcy court’s order of confirmation to file D&O claims.

Ultimately, although the First Department affirmed Justice Sherwood’s conclusion with respect to the applicability of the IvI exclusion, it held that summary judgment on the coverage obligations was inappropriate in light of material factual disputes regarding whether the insureds engaged in wrongdoing to benefit a separate entity.

Practical Considerations

Going forward, the applicability of an IvI exclusion in a D&O insurance policy will still depend on the language of the exclusion and any bankruptcy trustee exception.  That said, companies headed toward bankruptcy reorganization and their creditors would be wise to give strong consideration to Westchester Fire and the potential bargaining chip it provides.  If  creditors can form a trust and pursue a valuable D&O policy by suing former directors and officers for mismanagement, those creditors might be more willing to support a reorganization plan that includes the assignment of such claims to a Creditor Trust.



UPDATE – August 20, 2020:

In an opinion dated August 20, 2020, the First Department Recalled and Vacated its May 14, 2020 Decision.  Read that decision Here.  The revised decision does not materially deviate from the reasoning and holdings discussed above.

Many of us have previously heard the expression that there is a fine line between fact and fiction.  In securities law that holds especially true where companies that risk walking the “fine line” in their registration statements and prospectuses could find themselves liable to their stockholders.

In a recent decision, Justice Barry R. Ostrager granted defendants’ motion to dismiss a class action complaint in the Matter of Sundial Growers Inc. Securities Litigation, which was brought by stockholders against Sundial Growers Inc. (“Sundial”), a Canada-based producer of cannabis products, its individual officers and directors, and underwriters.

The class action complaint alleged violations of Sections 11 and 12(a)(2) of the Securities Act of 1933 (“Securities Act”), among other violations, related to misrepresentations made in Sundial’s Prospectus and Registration Statement regarding the “high-quality” of its cannabis in light of the fact that Sundial had previously experienced quality problems which resulted in production of contaminated cannabis that had been rejected by one of its major customers due to its materially deficient quality.

Under Section 11 of the Securities Act, a plaintiff who acquires security may bring suit to hold insurers, directors, or underwriters liable based on allegations that a registration statement “contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading…” (15 U.S. Code § 77k).  Similarly, under Section 12(a)(2) of the Securities Act, a plaintiff may also bring suit against “a person who offers or sells a security…by means of a prospectus or oral communications” under similar conditions (15 U.S. Code § 771[a][2]).

However, as the Court explained, not all statements are actionable. Both the First Department and Second Circuit have previously held that expressions of mere puffery or corporate optimism are not actionable under the securities laws (see Northern Group Inc. v Merrill Lynch, Pierce, Fenner & Smith Inc., 135 AD3d 414 [1st Dept 2016]; see Nadoff v Duane Reade, Inc., 107 Fed Appx 250, 252 [2d Cir 2004]).

“Puffery” includes statements that are “too general to cause a reasonable investor to rely upon them, and thus cannot have misled a reasonable investor” or “lack the sort of definite positive projections that might require later correction” (In re Vivendi, S.A. Sec. Litig., 838 F3d 223 [2d Cir 2016]).

The Court further noted that opinions are not actionable.  For a statement of opinion to be actionable under securities law it must be false and not honestly believed when made (Waterford Township Police & Fire Retirement Sys. v Regional Mgt. Corp., 2016 WL 1261135 [S.D.NY 2016]).  As Justice Ostrager explained in one of his earlier decisions (Hoffman v AT & T Inc.), when analyzing the truthfulness of a statement made in a registration statement under Section 11, courts look at the facts represented as they existed when the registration statement became effective (In re Initial Pub. Offering Sec. Litig., 358 F Supp 2d 189 [S.D.NY 2004]).  Section 12(a)(2), however, does not specify a time to which materiality is related, thus, courts have held that time of purchase of the securities is the crucial moment for determining materiality of misrepresentations or omissions in a prospectus (In re Alliance Pharm. Corp. Sec. Litig., 279 F Supp 2d 171 [S.D.NY 2003])

In this case, the Court did not engage in the analysis of relating the alleged misrepresentations and omissions in the Registration Statement and Prospectus to the operative time frames.  Rather, the Court found that the alleged misrepresentations were not actionable.  Many of the statements, which began with opinion-based language such as “we believe” and “we intend,” were either “(1) corporate puffery, too vague to be actionable, (2) sincere statements of corporate optimism, or (3) sufficiently offset by robust risk disclosures.”  Thus, the Court held that Sundial made no guarantees regarding the quality of its cannabis.

The Court further explained that Sundial provided sufficient risk warnings in the disclosure section of their Prospectus, in which they outlined the inherent risks of the agricultural business, which could adversely impact their cannabis production, including manufacturers’ return of their products.

Takeaway: Courts view and analyze registration statements and prospectuses with a critical eye.  Thus, companies should take heed to disclose facts accurately and with sufficient detail.  Additionally, using proper diction and syntax in registration statements and prospectuses could differentiate a statement from being viewed by courts as actionable versus non-actionable under the Securities Act.


It’s back to business as usual for Commercial Division Justice Andrew Borrok, who recently issued a slew of decisions contributing to New York’s robust Commercial Division jurisprudence.   In one decision, Allergan Fin., LLC v Pfizer Inc. (2020 NY Slip Op 50422 [U] [Sup Ct, NY County Apr. 13, 2020]), Justice Borrok denied a motion to dismiss brought by Pfizer, Inc. (“Pfizer”), finding that the plaintiff’s claims are ripe for adjudication and Pfizer is contractually obligated to reimburse plaintiff for its defense costs in connection with the multi-district federal opioid litigation.

Allergan involved a claim for, among other things, contractual indemnification arising out of an Asset Purchase Agreement (the “APA”), dated December 17, 2008, between Actavis Elizabeth, LLC (“Actavis”) and King Pharmaceuticals LLC (“King”), pursuant to which Actavis acquired from King the prescription opioid Kadian®.

Under the APA, King agreed to indemnify Actavis and its successors for, among other things, third party claims based on the pre-2009 (i.e., pre-closing) marketing and sale of Kadian®.  King also agreed to reimburse Actavis, on a quarterly basis, for “the reasonable and verifiable” costs and expenses, including attorneys’ fees, incurred in connection with any such claim.

Plaintiff Allergan Finance, LLC (“Allergan”), the successor to Actavis’ rights and obligations under the APA, was later sued in a multi-district litigation in connection with its marketing of Kadian® (see In re: Natl. Prescription Opiate Litig., No. 1:17-MD-2804, ECF No. 1201, at *1 [ND OH Dec. 17, 2018]) (the “Opioid Actions”).  The primary basis for the allegations against Allergan was the allegedly improper marketing and sale of Kadian® in the months and years before Actavis acquired the prescription painkiller in December 2008 (i.e., pre-closing conduct for which Allergan claimed Pfizer, as successor to King, should be liable).

Allergan timely notified King/Pfizer (“Defendants”) of the claims in the Opioid Actions, and sought indemnification and reimbursement of its defense costs pursuant to the APA.  Defendants, however, disclaimed coverage and refused to reimburse Allergan for the defense costs.

Allergan ultimately filed an action against Defendants seeking reimbursement for its defense costs, contractual and equitable indemnification, and a declaratory judgment.  Defendants moved to dismiss the complaint, arguing each of Allergan’s claims were “unripe” and “premature,” since Allergan had not yet been found liable in the Opioid Actions, and therefore could not be considered an “Indemnified Party” entitled to reimbursement of its defense costs.

The Court’s Analysis

Justice Borrok rejected Defendants’ arguments and denied the motion, concluding Allergan’s claims were ripe, and that the APA expressly required Defendants to reimburse Allergan for its defense costs.

The Court carefully analyzed the relevant provisions in the APA, concluding that Defendants’ “limited reading of the APA” was “plainly at odds with [its] other provisions,” which expressly provide for both defense and indemnification in connection with any third party claims related to pre-closing conduct, and obligate Defendants to reimburse Allergan on a quarterly basis (i.e., “now”) for costs and expenses incurred in defending the Opioid Actions.

Significantly, the Court noted that the APA does not require an adverse determination as a precondition to the right to receive indemnification or defense costs, and explicitly provides Defendants the right to a refund “in the event” they are ultimately held to not be obligated to indemnify Allergan – a provision which “simply makes no sense if the Defendants are not obligated to provide defense costs until liability is adjudicated.”

The Court also rejected Defendants’ reliance on Dresser-Rand Co. v Ingersoll Rand Co. (2015 WL 4254033 [SD NY Jul. 14, 2015]) for the argument that Allergan’s declaratory judgment claim was premature.  The Court noted that Dresser-Rand, Southern District case, was decided in the context of the federal Declaratory Judgment Act, and had no applicability here.

As the Court explained, New York state courts do not follow the Second Circuit’s approach to ripeness for declaratory judgment claims, which requires careful analysis of several different factors, including (i) whether the judgment will serve a useful purpose in clarifying or settling the legal issues involved, (ii) whether it would resolve or finalize the controversy involved, and “(iii) whether the proposed remedy is being used merely for procedural fencing or a race to res judicata, (iv) whether the use of a declaratory judgment would increase friction between sovereign legal systems or improperly encroach on the domain of a state or foreign court, and (v) whether there is a better or more effective remedy” (Dresser-Rand, 2015 WL 4254033 at *6, citing Dow Jones & Co. v Harrods, Ltd., 346 F3d 359 [2d Cir 2003]).  Those concerns, which were present in Dresser-Rand, were simply not present in Allergan.

As explained by Justice Borrok, the rule in New York state is “that on a motion to dismiss the complaint for failure to state a cause of action, the only question is whether a proper case is presented for invoking the jurisdiction of the court to make a declaratory judgment, and not whether the plaintiff is entitled to a declaration favorable to him” (quoting Law Research Serv., Inc. v Honeywell, Inc., 31 AD2d 900 [1st Dept 1969]).  And so, “where a proper case for a declaration is set out, the merit of the claim is not a relevant factor and New York courts must permit the action to proceed to discovery, trial and judgment” (id.).

In upholding Allergan’s declaratory judgment claim, the Court concluded that Allergan

[I]s not required to wait until its liability is established in an underlying action before it can bring a declaratory action under New York law (see Hudson Ins. Co. v AK Const., LLC, 92 AD3d 521 [1st Dept 2012]). And, here a live and justiciable controversy exists as to whether the Defendants must provide Allergan with its defense costs in the Opioid Lawsuits.

Three main points may be taken from the Allergan decision:

First, where the right to indemnification or defense costs is based upon a written agreement, the specific language of the contract is paramount to the court’s decision.  New York courts will strictly construe an indemnification agreement as a whole and, whenever possible, interpret the agreement to give effect to its intended purpose.  Courts cannot, and will not, narrowly interpret an agreement so as to render any portion of it meaningless.

Second, although in some cases it may be premature to assert indemnification or declaratory judgment claims until there is a finding of liability,  certain indemnification-based claims may be ripe where the issue of indemnification is not contingent upon a finding of liability, and the parties’ respective obligation are clearly spelled out in the agreement.  In Allergan, the Defendants had a present obligation to reimburse and indemnify Allergan for defense costs incurred in the Opioid Actions (subject to a right of refund), which was not contingent upon a finding of liability.

Third, on a motion to dismiss a declaratory judgment claim on ripeness grounds, New York state courts will not analyze the multiple factors set forth by the Second Circuit in Dow Jones.  Rather, New York state courts will look to see whether “a proper case is presented for invoking the jurisdiction of the court to make a declaratory judgment” – that is, whether a live and justiciable controversy exists – not whether the plaintiff will ultimately be successful on such claim.

When filing a shareholder derivative suit, it‘s important to get the job done right the first time, as other shareholders may not get a second bite of the proverbial apple.

In Noor v. Mahmood, the Second Department upheld Justice Lawrence Knipel’s Order which granted defendants’ motion for summary judgment, dismissing a shareholder derivative action pursuant to the doctrine of res judicata where a previous derivative action commenced by a different shareholder against the same defendants and based on the same alleged wrongdoings had already been dismissed.

In the earlier action, commenced in 2015, a shareholder brought a derivative suit on behalf of the corporation based on defendants’ alleged breaches of fiduciary duty and diversion of corporate assets.  That action was dismissed pursuant to CPLR 3211 as a result of the shareholder’s failure to adequately allege demand futility.  There, the majority of the board consisting of disinterested directors had exercised their business judgment and refused to authorize the derivative suit (click here to read my blog on avoiding dismissal based on demand futility).

In 2017, plaintiff, a different shareholder, brought a separate derivative suit against the same defendants with identical allegations as those raised in the 2015 suit.  Interestingly, plaintiff in this action was one of the disinterested directors who had refused to authorize the derivative suit in the earlier action.

In an effort to save the second derivative suit from the same fate of the earlier action, plaintiff argued that because he had changed his mind and decided to file suit, there was no longer a disinterested majority that considered the action meritless.  Furthermore, plaintiff argued that the prior dismissal was not on the merits and cannot be the basis for res judicata.

The Second Department, however, reasoned that claims asserted in a shareholder’s derivative action belong to and are brought on behalf of the corporation, not the shareholders themselves.  Thus, a judgment in an action brought on behalf of the corporation by one shareholder precludes other actions brought by other shareholders where they are predicated on the same wrongdoing (Grika v. McGraw, 161 A.D.3d 450 [1st Dept. 2018]).

This case is in line with the public policy behind the doctrine of res judicata: to ensure finality, prevent vexatious litigation, and promote judicial economy (Xiao Yang Chen v. Fischer, 6 N.Y.3d 94, 100 [2005]).

The holding in Noor is also consistent with the precedent established in New York federal courts: that a determination on the merits in a shareholders’ derivative action is res judicata in subsequent actions as to the corporation and all of its shareholders, including those who were not parties to the prior derivative action, as long as the parties’ interest were adequately represented in the original action (Lee v. Marvel Enterprises, Inc., 765 F.Supp.2d 440 [S.D.N.Y. 2011]; see, e.g., Henrik v. LaBranche, 433 F.Supp.2d 372 [S.D.N.Y. 2006]).

The court in Henrik v. LaBranche noted that the general rule precluding other actions brought by subsequent shareholders where they are predicated on the same wrongdoing is not without exception.  There, the U.S. District Court for the Southern District of New York discussed the possibility for a different result where the plaintiff shareholder in the first action is alleged to have inadequately represented the interests of all of the shareholders and there is a showing that the “representative failed to prosecute or defend the action with due diligence and reasonable prudence, and the opposing party was on notice of facts making that failure apparent” (Henrik, citing Restatement (Second) of Judgments,§ 42).

Takeaway: Recognizing that shareholders may not get a second bite of the apple when filing a shareholder derivative action, it is important to analyze the merits of a derivative suit and determine if any claims may be brought by the shareholder individually.  Additionally, shareholders contemplating a subsequent derivative action should also consider whether their interests were adequately represented in the earlier action.