Court of Appeals Holds That, Absent Express Language, “Affiliate” only Includes Existing Affiliates

On October 23, 2014, the Court of Appeals issued a decision in Ellington v. EMI Music, Inc., 2014 NY Slip Op. 07197, affirming a decision of the First Department affirming a Supreme Court dismissal of an action for breach of contract brought by a grandson of music legend Duke Ellington.

Ellington, presented a type of dispute apparently common in the entertainment industry—a creative artist suing a copyright holder/distributor for engaging in some form of self-dealing in order to reduce the amount of royalties to be paid.

Here, the plaintiff was a grandson of Duke Ellington, who, along with his heirs, was the First Party to a 1961 copyright renewal agreement. The agreement provided that the Second Parties—various music publishers, including EMI’s predecessor in interest as well as “any other affiliate of [the predecessor],” would pay the First Party royalties from the publication of Ellington’s works, including 50% “of the net revenue actually received by the Second Party from . . . foreign publication.” Plaintiff sued EMI for breach of contract, alleging that EMI had at some point begun distributing Ellington’s works through affiliated foreign subpublishers rather than independent foreign subpublishers (as was industry practice when the agreement was signed), thereby effectively increasing EMI’s share of the net revenues at plaintiff’s expense.

However, the foreign subpublishers were retaining the same 50% share of the overall royalties from foreign sales as the previous, unaffiliated subpublishers had. So, it appears that (although not stated explicitly in the opinion) at the time of the contract, the foreign subpublishers would retain 50% of the foreign royalties, with 25% going to EMI and 25% to Ellington. Under the new arrangement, Ellington is getting the same 25%, but EMI and its affiliates collectively get the entire remaining 75%.

In an opinion written by Judge Abdus-Salaam, the majority affirmed the lower courts’ dismissal.

The majority first held that “net revenue actually received” was clear and unambiguous, and that that term did not preclude the use of affiliated foreign subpublishers. The majority also found that the affiliated foreign subpublishers were not included in the term “any other affiliate” because they were not in existence at the time the contract was signed:

Absent explicit language demonstrating the parties’ intent to bind future affiliates of the contracting parties, the term “affiliate” includes only those affiliates in existence at the time the contract was executed. Furthermore, the parties did not include any forward-looking language. If the parties intended to bind future affiliates they would have included language expressing that intent. Absent such language, the named entities and other affiliated companies of EMI’s predecessor which existed at the time are bound by the provision, not entities that affiliated with EMI after execution of the agreement.

(Internal citations omitted.)

The majority dismissed the dissent’s criticism, stating that “the parties merely did not account for the possibility that the publisher would eventually affiliate with foreign subpublishers.”

Concurring, Judge Smith rejected the majority’s reasoning: “As a general proposition, it seems wrong to me that, when a contract is written to bind ‘any affiliate’ of a party, its effects should be limited to affiliates in existence at the time of contracting. That invites parties to create new affiliates, and to have them do what the old affiliates are prohibited by the contract from doing.” He also stated that, if the facts had been different and the foreign affiliates had been keeping a greater overall share of the total revenues, the majority would probably have interpreted the term “affiliate” differently.

Judge Smith concurred in the judgment based upon the plaintiff and his predecessors’ apparent acquiescence with the current scheme since 1994.

In dissent, Judge Rivera, joined by Chief Judge Lippman, thought that the term “affiliate” was not clear and unambiguous, and that EMI’s argument that foreign affiliates were not included “merely begs the question of what is an affiliate.” For the dissent, the majority holding excluding subsequently-created affiliates from the term was inconsistent with the purpose of the agreement and with then-prevailing industry practice, and that the plaintiff’s proposed interpretation of the term was “reasonable, or at least as reasonable as the one proposed by EMI.”

The dissent also shared Judge Smith’s policy concerns, stating that the majority interpretation was “troubling” and “sets the stage for the type of abuse alleged here, namely corporate reconfigurations that avoid the understanding of the parties.”

The most interesting question about this decision is whether Judge Smith is right—if under the new arrangement, if the heirs had been getting less than their previous 25%, would the final outcome have been different? On its face, it also appears to be a victory for the kind of prosy contract drafting that long since went out of favor in law schools and legal writing manuals: if the key provision had only included some phrase like “that now exist or ever have existed since the beginning of the world or ever will exist until the end of the world,” plaintiff would have prevailed.

Court Applies Pro Rata “Time on the Risk” Method to Allocate Loss From Environmental Damage Among Liability Insurance Policies

On October 14, 2014, Justice Scarpulla of the New York County Commercial Division issued a decision in Keyspan Gas East Corp. v. Munich Reinsurance America, Inc., 2014 NY Slip Op. 24306, applying a pro rata “time on the risk” allocation to determine damages in an insurance coverage matter arising from an environmental clean-up at two former manufactured gas plant sites located in Hempstead and Rockaway Park New York.

Where environmental damages occur over a period of years, triggering coverage under multiple insurance policies, allocating the losses has proved “a nettlesome problem.” As Justice Scarpulla explained, courts faced with this dilemma have allocated the loss among the carriers and the insured on a pro rata basis based on their respective “time on the risk”:

A pro rata “time on the risk” allocation requires costs to be allocated according to the number of years that the insurer was on the risk by multiplying the total loss by a fraction that has as its denominator the entire number of years of the claimant’s injury, and as its numerator the number of years within that period when the policy was in effect. Proration of liability among the insurers acknowledges the fact that there is uncertainty as to what actually transpired during any particular policy period.

For years where an insured has no insurance coverage, the insured generally bears its own pro rata share of the loss. Proration to the insured is appropriate for the years where the insured elected not to purchase insurance or purchased insufficient insurance. For those years, the insured is treated as self-insured and bears responsibility for its pro rata share of damages.  Proration to the insured is inappropriate, however, for those years where insurance was unavailable in the marketplace.

(Citations omitted).

In Keyspan, the court found issues of fact precluding summary judgment as to (1) the time period over which the damage occurred, and (2) when insurance coverage was available. The Court did find that Keyspan should be required to bear losses incurred during the period 1971 to 1982 when New York law precluded insurance coverage for “liability arising out of pollution.” The policy reason underlying the rule was “to prohibit commercial or industrial enterprises from buying insurance to protect themselves against liabilities arising out of their pollution of the environment.” Justice Scarpulla concluded: “Given the Legislature’s clear intent that companies such as Keyspan bear the full burden of their own actions affecting the environment, I decline to exclude the period between 1971 and 1982 from the allocation period when pollution insurance was prohibited.”

Appellant’s Arguments Rejected Based on Judicial Estoppel

On October 21, 2014, the First Department issued a decision in Bank Hapoalim B.M. v. Westlb AG, 2014 NY Slip Op. 07092, rejecting arguments made on appeal when the appellants had taken contrary positions at trial.

In Bank Hapoalim, the plaintiffs were “investors in a structured investment vehicle” who sued the defendant financial institutions regarding the investment. In reviewing the trial court’s decision the First Department noted as an initial matter that:

[O]n this appeal, plaintiffs are judicially estopped from asserting their position on choice of law, as they consistently argued to the motion court that New York law governed the case and that their arguments relied on New York law. A party may not adopt a position on appeal at odds with its arguments to the trial court, and plaintiffs cite no law to the contrary.

Similarly, plaintiffs are judicially estopped from arguing that the Income Notes should be treated as debt, since they argued repeatedly to the motion court that the Income Notes should be treated as equity. Indeed, plaintiffs concede that they previously argued in favor of the proposition that the notes were equity, but now assert that they may argue that the Income Notes are equity for some purposes and debt for others.

(Internal citations omitted).

No Claim for Breach of Covenant of Good Faith and Fair Dealing When Claim Has Same Basis as Breach of Contract Claim

On October 21, 2014, Justice Whelan of the Suffolk County Commercial Division issued a decision in J. Kokolakis Contracting Corp. v. Evolution Piping Corp., 2014 NY Slip Op. 24321, dismissing a claim for breach of the covenant of good faith and fair dealing.

In J. Kokolakis Contracting Corp., the plaintiff building contractor sued a subcontractor in connection with work the defendant did on a job site, as well as its insurer. The defendant insurer moved to dismiss the plaintiff’s causes of action against it for breach of the covenant of good faith and fair dealing and for attorney’s fees. In granting the motion, the court explained:

Distinguishable [from tort claims] are claims premised upon a breach of the covenant of good faith and fair dealing which the law of this state imposes upon all contracting parties. This covenant mandates that none of such parties shall do anything which will have the effect of destroying or injuring the right of the other party to receive the fruits of the contract. The covenant is breached when a party to a contract acts in a manner that, although not expressly forbidden by any contractual provision, would deprive the other party of the right to receive the benefits under their agreement.

A claim for breach of the implied covenant of good faith and fair dealing is generally actionable only where wrongs independent of the express terms of the contract are asserted and demands for the recovery of separate damages not intertwined the damages resulting from a breach of a contractual are advanced. Where a contractual party is merely seeking to reap the benefits of its contractual bargain, the implied covenant breach claim will not lie, as it is considered duplicative of the breach of breach of contract claim.

Federal appellate authorities have long held that a breach of the implied duty of good faith is a breach of the underlying contract. There is however, recognition of authority to the contrary.

. . .

Here, the court finds merit in the moving defendant’s contention that the plaintiff’s claims for recovery of consequential damages arising from any breach of the implied covenant of good faith and fair dealing and its claims for recovery of litigation costs, including attorneys fees due to the moving defendant’s alleged bad faith denial of coverage are not actionable and are thus subject to dismissal pursuant to CPLR 3211(a)(7). Review of the allegations set forth in complaint reveal that the facts which underlie these claims are the same as those which underlie the plaintiff’s breach of contract claim. There are no allegations of independent breaches of tort duties such as fiduciary duties owing to the plaintiff from the moving defendant which would support a breach of fiduciary duties claim or other tort claim.

(Internal quotations and citations omitted) (emphasis added).

Court Uses Doctrine of Falsus in Uno, Falsus in Omnibus to Find Whole of Witness’s Testimony Not Credible

On October 2, 2014, Justice Emerson of the Suffolk County Commercial Division issued a decision in Motherway v. Retail Unlimited Maintenance or Remodel, Inc., 2014 NY Slip Op. 32673(U), applying the principle of falsus in uno, falsus in omnibus to disregard the entirety of a witness’s testimony.

In Motherway, the plaintiff sought damages for the defendants’ alleged use of proprietary information. This post focuses on that part of the court’s decision after a bench trial that addressed its credibility findings. The court wrote:

In reaching its decision, the court has considered the record in its entirety. In addition, the court has assessed the credibility of each of the witnesses. In particular, the court has considered the testimony of both Mr. Motherway and Mr. Cartisano. The courts finds Mr. Motherway to be a credible witness and his version of key events to be believable. The court credits Mr. Motherway’s testimony and significant portions of the testimony of his employee witness. On the other hand, the court finds that Mr. Cartisano’s testimony conflicts in significant ways with the credible evidence produced by Mr. Motherway and that it is both unreliable and improbable. Applying the doctrine of falsus in uno, falsus in omnibus, which permits the fact finder to disregard in its entirety the testimony of a witness who has willfully given false testimony on a material matter (NY PJI 1:22), the court does not credit any of Mr. Cartisano’s testimony.

(Emphasis added). Ouch! If ever you have trouble getting your client simply to testify to the facts as they happened, show them this post.

Court Finds No Oral Modification of Written Contract

On September 25, 2014, Justice Whelan of the Suffolk County Commercial Division issued a decision in Air & Power Transmission, Inc. v. Weingast, 2014 NY Slip Op. 32670(U), rejecting a claim based on an alleged oral modification of a written contract.

In Air & Power Transmission, the plaintiffs’ claims were based upon, among other things, the breach of “purported oral promises to indemnify the plaintiffs.” The court dismissed that claim, explaining:

The . . . alleged oral assurances are flatly contradicted by the terms of existing writings between the parties governing the same subject matter . . . .  To be enforceable, a separate, subsequent, additional agreement must address a scenario that was not anticipated and not covered by the terms of the existing written agreements between the parties. There are no allegations that the alleged oral assurances constituted separate, subsequent, additional agreements that addressed a scenario not anticipated or covered by the terms of the existing written agreements. Moreover, the particulars of the oral promises allegedly made by Mass Mutual agents are not alleged with the sufficient particularity to give rise to claims for breach of the alleged oral agreement was a separate, additional agreement.

(Internal quotations and citations omitted) (emphasis added).

Breach of a Contractual Representation or Warranty Occurs at the Time of Signing, Not the Effective Date of the Agreement

On October 21, 2014, the First Department issued a decision in U.S. Bank N.A. v DLJ Mortgage Capital, Inc., 2014 NY Slip Op. 07093, addressing the question of when a claim for breach of a representation or warranty occurs.

In U.S. Bank, the First Department affirmed a trial court’s denial of a motion to dismiss a claim for breach of a contractual warranty on statute of limitations grounds, explaining:

If a contractual representation or warranty is false when made, a claim for its breach accrues at the time of the execution of the contract. This is true even where the contract states that its effective date is earlier. The claim cannot accrue earlier, because until there is a binding contract, there can be no claim for breach of warranty. Additionally, in the residential mortgage-backed securities (RMBS) context, it should be noted that the claim cannot generally accrue before the contract, because the trust that is the recipient of the representations and warranties typically does not come into existence prior to the closing of the transaction. Furthermore, the representations and warranties were made as of the closing date, and the contract, which did not explicitly address the statute of limitations, does not indicate a clear intent to alter the accrual date relating to claims for a breach thereof. As such, the IAS court correctly held that the representation and warranty claims accrued on February 7, 2007, the date the pooling and service agreement, the agreement sued upon, was executed.

(Internal quotations and citations omitted) (emphasis added). It is not unusual for agreements to be executed on a date other than the effective date of the agreement. This decision provides a rule for determining the accrual date of a breach of representation and warranty claim in that situation.

Implied Covenant of Good Faith and Fair Dealing Requires Landlord to Consent to Renewal of Sidewalk Cafe Permit

On October 21, 2014, the First Department issued a decision in DMF Gramercy Enterprises, Inc. v. Lillian Troy 1999 Trust, 2014 NY Slip Op. 07110, illustrating the application of the implied covenant of good faith and fair dealing.

In DMF Gramercy Enterprises, the plaintiff sued the defendants over the defendant’s refusal to consent to the plaintiff’s continued operation of a sidewalk café in the space the plaintiff leased from defendants. The First Department affirmed the trial court’s finding that this refusal breached the terms of the lease and, at any rate, “that the implied covenant of good faith and fair dealing would otherwise restrict defendants’ ability to deny consent, and that they have failed to make a satisfactory showing of good faith in this case.” As to the implied covenant of good faith and fair dealing, the First Department explained:

We note initially defendants’ correct assertion that the sidewalk café is not part of the leased premises. . . . Nevertheless, the lease gives plaintiff the right to make use of the sidewalk space. . . .

Having determined that the lease allows plaintiff to use and occupy the sidewalk for the operation of a sidewalk café, it necessarily follows that defendants cannot withhold or revoke their consent to that use absent a good-faith basis. As the Court of Appeals has explained:

In New York, all contracts imply a covenant of good faith and fair dealing in the course of performance. This covenant embraces a pledge that neither party shall do anything which will have the effect of destroying or injuring the right of the other party to receive the fruits of the contract. While the duties of good faith and fair dealing do not imply obligations inconsistent with other terms of the contractual relationship, they do encompass any promises which a reasonable person in the position of the promisee would be justified in understanding were included.

Because the stipulated facts demonstrate that the sidewalk café existed at the time of the lease’s execution, plaintiff (through its assignor) was justified in understanding that the landlord promised to refrain from unreasonably withholding its consent to operate the sidewalk café. It is of no moment that paragraph 1(d) of the lease refers to the revocable nature of the right, if any, to maintain beyond the building lines, because that language does not go so far as to give defendants the right to revoke their consent for any reason whatsoever. Furthermore, paragraph 1(d) can be viewed alternatively as affirming that the landlord cannot guarantee the right because it is revocable by the City, the entity that owns the sidewalk and has the authority to grant sidewalk café licenses.

To permit defendants to withhold or revoke their consent at will would destroy plaintiff’s right to receive the fruits of the contract inasmuch as those fruits are gained by operating the sidewalk café. As discussed above, the lease permits plaintiff to use the sidewalk for the operation of a sidewalk café, provided, of course, that such use is lawful. Plaintiff’s sidewalk café can only be lawful if it obtains the consent of the landlord (a prerequisite to the grant of a license by the City). Accordingly, the landlord cannot obstruct plaintiff’s operation of the sidewalk café by refusing in bad faith to consent. As the trial court observed, defendants did not reserve the right to terminate consent in their sole discretion. Therefore, their right to deny consent must be bridled by the implied covenant of good faith and fair dealing.

(Internal quotations and citations omitted).

Standard of “Ordinary and Reasonable Skill and Knowledge” In Legal Malpractice Action Measured As Of the Time of the Representation

On September 18, 2014, the First Department issued a decision in Lichtenstein v. Willkie Farr & Gallagher LLP, 2014 NY Slip Op. 06242, affirming New York County Commercial Division Justice Melvin Schweitzer’s dismissal of a legal malpractice claim for failure to state a cause of action.

In Lichtenstein, the plaintiff, Lichtenstein, hired Willkie Farr to advise him in connection with the restructuring of an entity he owned, Extended Stay, Inc., which faced a liquidity crisis. The law firm advised Lichtenstein that, as an officer and director of ESI, he “had a fiduciary obligation to put ESI into bankruptcy for the benefit of the [company's] lenders.” This had the effect of exposing Lichtenstein, and his company Lightstone Holdings, LLC, to $100 million in personal guarantees they had given in connection with mortgage loans to ESI. However, “Willkie Farr warned that Lichtenstein otherwise faced the prospect of unequivocal and uncapped personal liability in any subsequent action by the lenders absent a bankruptcy filing by ESI.” Relying on this advice, Lichtenstein caused ESI to file a bankruptcy petition, and the lenders subsequently brought actions to enforce the guarantees, which resulted in the entry of a $100 million judgment against Lichtenstein and Lightstone Holdings.

Lichtenstein brought a malpractice action against Willkie Farr, arguing that the law firm’s advice as to the viability of a breach of fiduciary duty claim by ESI’s creditors was erroneous because ESI’s “constituent entities” were LLCs, and recent Delaware Supreme Court authority holds that lenders of an LLC (as opposed to a corporation) lack standing to bring derivative claims for breach of fiduciary duty against the LLC’s management. The First Department rejected this argument because the issue of lender standing in the LLC context had not been established at the time the advice was rendered:

On this appeal, plaintiffs argue that Willkie Farr’s advice did not meet the requisite standard of professional skill because a derivative suit by the lenders against Lichtenstein for breach of fiduciary duty would not have been successful. In making the argument, plaintiffs recognize that under Delaware law, the exposure Lichtenstein faced by reason of ESI’s insolvency differed from the exposure that would be faced by the officers and directors of a traditional stock-issuing corporation. For example, when a corporation is solvent its directors’ fiduciary duties may be enforced by its shareholders, who have standing to bring derivative actions on behalf of the corporation because they are the ultimate beneficiaries of the corporation’s growth and increased value (North Am. Catholic Educ. Programming Found., Inc. v Gheewalla, 930 A2d 92, 101 [Del 2007]). On the other hand, when a corporation is insolvent, “its creditors take the place of the shareholders as the residual beneficiaries of any increase in value. Consequently, the creditors of an insolvent corporation have standing to maintain derivative claims against directors on behalf of the corporation for breaches of fiduciary duties” (id.).

Citing CML V, LLC v Bax (28 A3d 1037 [Del 2011], plaintiffs argue that the landscape is different with respect to Lichtenstein’s fiduciary duty because the constituent entities that made up ESI were Delaware limited liability companies (LLCs) as opposed to corporations. In CML, the Supreme Court of Delaware held that under the Delaware Limited Liability Company Act (6 Del Code Ann tit 6, ch 18) § 18-1002, derivative standing is limited to “member[s]” or “assignee[s]” and unavailable to creditors of LLCs (id. at 1046). Plaintiffs’ argument is not persuasive because the Supreme Court of Delaware’s opinion in CML as well as the Delaware Chancery Court’s opinion, which it affirmed (6 A3d 238 [Del Ch 2010]), were decided after Willkie Farr gave the advice described in the complaint. In fact, the Chancery Court observed that “virtually no one has construed the derivative standing provisions [of § 18-1002] as barring creditors of an insolvent LLC from filing suit” (id. at 242). The Chancery Court further noted that “[m]any commentators . . . have assumed that creditors of an insolvent LLC can sue derivatively” (id. at 243 [citations omitted]).

In a legal malpractice action, what constitutes ordinary and reasonable skill and knowledge should be measured at the time of representation. In this case, the time of Willkie Farr’s representation preceded the Chancery Court’s decision in CML by approximately two years. Accordingly, the complaint fails to allege that Willkie Farr’s advice was wanting by reason of its failure to advise Lichtenstein that the creditors of the ESI constituent entities lacked standing to bring derivative actions.

Whenever an attorney advises a client on an area of the law that is unsettled, as was the case in Lichtenstein, the advice may, with the benefit of 20/20 hindsight, prove to be incorrect. However, as this decision illustrates, the standard of “ordinary and reasonable skill and knowledge” does not require clairvoyance on the attorney’s part. A malpractice claim will not lie because an attorney failed to predict future developments in the case law.