Even Where CPLR 3211(a)(4) Does Not Require Dismissal, Cases Can be Consolidated

On July 10, 2014, Justice Schweitzer of the New York County Commercial Division issued a decision in 11 E. 68th St. LLC v. Madison 68 Realty LLC, 2014 NY Slip Op. 31872(U), analyzing the rules for dismissal or consolidation when there are two pending actions regarding similar subject matter.

In 11 E. 68th St. LLC, the defendant filed an action relating to a real estate deal done bad. The next day, the plaintiff filed a similar action. The defendant moved to dismiss the second-filed action pursuant to CPLR 3211(a)(4). The court ultimately decided to consolidate the actions, rather than dismiss the second-filed on, but in doing so, it explained a number of issues relevant to a motion to dismiss in favor of a prior pending proceeding:

Under the first-filed rule, the action that is commenced first is the action in which a complaint was first filed. A case in which a complaint is filed only a day before the filing of a complaint in another action is generally immune from dismissal based on CPLR 3211(a)(4) under the first-filed rule.

Pursuant to CPLR 3211(a)(4), a court has broad discretion as to the disposition of an action when another action is pending and may dismiss one of the actions where there is a substantial identity of the parties and causes of action. The critical element is that both suits arise out of the same subject matter or series of alleged wrongs. Courts must ultimately determine whether the relief sought is the same or substantially the same. If the court finds such symmetry in the parties’ claims, then it has wide discretion to decide whether to dismiss. stay, or consolidate the current suit. The critical issue in determining this motion is whether [the plaintiff's] claims in this action arise out of the same subject matter or alleged wrongs as [the defendant's] claims in the first-filed complaint. The fact that two lawsuits emanate from a common transaction or occurrence is not necessarily sufficient to warrant dismissal based upon CPLR 3211(a)(4). . . .

The assertion of claims in both actions by a party is not required for a finding of identity of issues under CPLR 3211(a)(4). The fact that [the defendant's] claim concerning the units in the first-filed action is for declaratory relief does not attenuate the court’s belief that a dismissal, stay, or consolidation may be warranted. The action for a declaratory judgment having been first commenced, this court is not ousted of its jurisdiction by the proceeding later brought and that the situation is an appropriate one for a declaratory judgment. If the court were to determine that dismissal of this action would be premature, then a stay of the instant case pending the outcome of the first-filed action might be appropriate  pursuant to the court’s powers under CPLR 3211(a)(4).

After reflecting on the options at its disposal, however, the court concludes that consolidating the instant action into the first action is the most equitable and rational outcome, and will avoid the waste of judicial resources and the risk of inconsistent verdicts. Under CPLR 602(a), a court . . . may order the actions consolidated, assuming both involve a common question of law or fact and are both pending before a court. The action that was commenced first is the action that should retain priority. The first-filed rule also typically applies to consolidation orders under CPLR 602(a). Even if the complaint in the first action was filed only a few days before a subsequent action, the first filed rule demands that consolidation be into the first-filed action.

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

BCL § 1112 is Controlling for Determining Venue In an Action Seeking Judicial Dissolution

On July 21, 2014, Justice Demarest of the Kings County Commercial Division issued a decision in Sicignano v. Hymowitz, 2014 NY Slip Op. 51100(U), refusing to change venue in an action seeking judicial dissolution.

In Sicignano, the defendants in an action seeking “judicial dissolution . . . pursuant to Business Corporation Law § 1104-a” and asserting claims for negligence and breach of fiduciary moved for a change of venue. The court denied the motion, explaining:

Venue may be changed as of right on the ground that the county designated is not a proper county (CPLR § 510[1]) or on the discretionary ground that the convenience of material witnesses and ends of justice will be promoted by the change (CPLR § 510[3]). Here, the defendants are not entitled to a change of venue as of right because Kings County is a proper venue, pursuant to Business Corporation Law § 1112. Further, the defendants are not entitled to a discretionary change of venue because they have not met the burden of demonstrating that the convenience of material witnesses and the ends of justice would be promoted by the change.

Defendants argued that Plaintiffs’ choice of venue was improper because CPLR § 503(a) is controlling and no parties resided in Kings County when this action was commenced. However, this argument is unavailing because, in an action seeking judicial dissolution, Business Corporation Law § 1112 is controlling for determining venue. Business Corporation Law § 1112 prescribes that an action or a special proceeding under this article shall be brought in the supreme court in the judicial district in which the office of the corporation is located at the time of the service on the corporation of a summons in such action or of the presentation to the court of the petition in such special proceeding. Office of a corporation means the office the location of which is stated in the certificate of incorporation of a domestic corporation. Here, the plaintiffs clearly seek judicial dissolution of the Corporation, pursuant to Business Corporation Law § 1104-a, and the Certificate of Incorporation states Kings County as the location of the office of the Corporation. Since the office of the corporation was located in Kings County at the time Defendants commenced this dissolution proceeding, Kings County is a proper venue. Plaintiffs assert that the Corporation has offices [in Manhattan]. However, the sole residence of a domestic corporation for venue purposes is the county designated in its certificate of incorporation, despite its maintenance of an office or facility in another county. The principal office of the corporation as stated in its certificate is conclusive evidence of its residence. Hence, Kings County is a proper venue for this action and the defendants are not entitled to a change of venue as of right.

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

This decision illustrates some of the many procedural rules governing dissolution proceedings with which counsel should be familiar.

Commercial Division Applies Delaware Demand Futility Pleading Rules

On July 3, 2014, Justice Schweitzer of the New York County Commercial Division issued a decision in David Shaev Profit Sharing Account v. Riggio, 2014 NY Slip Op. 31776(U), dismissing a derivative action for failure adequately to plead demand futility.

In David Shaev Profit Sharing Account, the plaintiff filed a derivative action against the individual directors of Barnes & Noble, accusing them of failing properly to oversee the company’s affairs. As evidence of this, the plaintiff pointed to errors in Barnes & Noble’s earnings reports and an SEC investigation arising from subsequent corrections. The defendants moved to dismiss on the grounds that the plaintiff had failed to plead demand futility with the necessary particularity.

Because Barnes & Noble is a Delaware corporation, the court applied Delaware law, specifically Delaware Chancery Court Rule 23.1, to the pleading question. Rule 23.1, like similar rules in New York and elsewhere, requires derivative plaintiffs claiming that pre-suit demand would have been futile to plead particularized facts, in a ‘director-by-director’ fashion, that would be sufficient to contradict the presumption that the directors were disinterested and independent when performing their duties.

Sorting through the many Delaware tests and precedents on the issue of demand futility, the court first determined that the Rales test applied to actions alleging a general failure of oversight rather than challenging specific business decisions. Under Rales,

A plaintiff must adequately plead that a majority of the company’s board of directors were incapable of objectively responding to a demand because they either (1) face a substantial threat of personal liability and are thus themselves interested, or (2) are compromised in their ability to act independently of the interested directors . . . . interestedness under Rales solely focuses on whether a director confronts a substantial likelihood of liability for Plaintiff’s proffered claims.

(Internal citations and quotations omitted.)

And because Barnes & Noble exculpates its directors from liability for breaches of the duty of care, the plaintiff was further restricted, having to show that the majority of the directors faced a substantial likelihood of personal liability for breach of their duty of good faith or loyalty to the corporation.

Claims that directors breached their duty of loyalty by failing to exercise oversight are known as Caremark claims, “which are recognized by Delaware courts as possibly the most difficult theory in corporate law upon which a plaintiff might hope to win judgment.” In essence, to prevail under a Caremark analysis, the plaintiff would have to show that the Barnes & Noble directors “consciously failed to put forth any control systems, or knowingly refused to monitor those systems already in existence.”

The court held that the plaintiff did not satisfy this demanding standard of pleading. Barnes & Noble’s audit committee met regularly, and the existence of errors in audit statements or an SEC investigation are insufficient to show a breach of the duty of loyalty. Plaintiff alleged that a whistleblower had identified many control issues, but could not allege that any individual board member had known of the problems and intentionally ignored them. And because none of the directors could be shown to be interested, allegations that the directors were unable to act independently of one another were also unavailing. The court also noted that, for demand futility purposes, Delaware does not apply SEC or NYSE rules to determine whether directors are independent of one another, placing a higher burden on plaintiffs.

Finally, the court ruled that a prior insufficient complaint and the plaintiff’s refusal to obtain pre-suit discovery of the corporate books and records under Delaware G.C.L. § 220—which the Delaware courts frequently emphasize as essential to a derivative action—warranted dismissal with prejudice.

This case is not interesting so much for the ultimate outcome—derivative actions are routinely dismissed for failure to plead demand futility—but for Justice Schweitzer’s comprehensive summary of Delaware’s demand futility precedents, which might be very useful to a practitioner unfamiliar with this area of the law.

Policy Exclusions Bar Coverage For Banks Sued By Investors Who Lost Funds In Madoff Ponzi Scheme

On June 24, 2014, the First Department issued a decision in Associated Community Bancorp, Inc. v. St. Paul Mercury Ins. Co., 2014 NY Slip Op. 04697, affirming the dismissal of insurance coverage claims by banks that were sued by customers who suffered losses as a result of investments in Bernard L. Madoff Investment Securities through custodial accounts managed by the banks.

In Associated Community Bancorp, the First Department found that several exclusions to the plaintiff banks’ “Bankers Professional Liability Insuring Agreements” barred coverage, including (1) an exclusion for claims arising from a loss of “money, securities, property or other items of value” in the possession of the bank, and (2) an exclusion for claims arising from the “insolvency” of any “investment company, investment bank or [] broker dealer”:

The Loss of Money Exclusion bars coverage for claims for “the actual loss of money, securities, property or other items of value in the custody or control of [the bank].” Contrary to plaintiffs’ contention, the investors’ allegation that the money in their accounts with Bernard L. Madoff Investment Securities (BLMIS) was stolen, unlawfully retained, or misappropriated is a claim for an actual loss of money (see Blenzak Black, LLC v Allied World Natl. Assur. Co., 2012 WL 1365973, *2-3 [NJ Super Ct App Div 2012]). Moreover, “[a]n insurance policy is not illusory if it provides coverage for some acts; it is not illusory simply because of a potentially wide exclusion’” (ACE Capital Ltd. v Morgan Waldon Ins. Mgt., LLC, 832 F. Supp. 2d 554, 572 [WD Pa 2011]). The subject policies provide a broad range of coverage for liability that may arise in connection with plaintiffs’ provision of ordinary banking services.

* * *

The Insolvency Exclusion bars coverage for loss “based upon, arising out of, or attributable to the insolvency . . . of . . . any . . . investment company, investment bank, or any broker or dealer in securities or commodities.” Insolvency exclusions have been held to apply despite the fact that the underlying claims are made against parties that are “independent of the insolvent entity” (Coregis Ins. Co. v American Health Found., Inc., 241 F3d 123, 130-131 [2d Cir 2001]). Further, the courts of Connecticut (whose law applies to this action) have interpreted broadly the term “arising out of” in insurance policies (see Board of Educ. of the City of Bridgeport v St. Paul Fire & Marine Ins. Co., 801 A2d 752, 758 [Conn 2002]). The investors’ claims certainly are “connected with,” “had [their] origins in,” “grew out of,” “flowed from” or “[were] incident to” Madoff’s Ponzi scheme and the insolvency of BLMIS (see id. [internal quotation marks omitted]). Thus, the Insolvency Exclusion bars coverage for those claims.

This decision illustrates that exclusions from coverage in an insurance policy that are not ambiguous will be enforced as written, even when they sharply limit the scope of coverage.

Court Examines Scope of Claim for Fraudulent Conveyance

On July 7, 2014, Justice Ramos of the New York County Commercial Division issued a decision in 135 E. 57th St., LLC v. 57th St. Day Spa, LLC, 2014 NY Slip Op. 31802(U), examining multiple alleged fraudulent conveyances.

In 135 E. 57th St., LLC, the plaintiff building owner and landlord brought an action to collect a judgment “for rent” obtained “against its former tenant, defendant 57th Street Day Spa, LLC (the Tenant),” “from the owners of the Tenant on theories of piercing the corporate veil, successor liability, civil conspiracy, and pursuant to Debtor and Creditor Law (DCL) § 270, et seq.” In deciding a motion for summary judgment brought by several defendants, the court analyzed the plaintiff’s fraudulent conveyance claims as follows:

Constructive fraud occurs when a conveyance is made without fair consideration by one who: 1) is insolvent or who is rendered insolvent by the conveyance; 2) is engaged or is about to engage in a business or transaction for which the property remaining after the conveyance is unreasonably small; or 3) intends or believes that it will incur debts beyond its ability to pay as they mature.

A creditor attempting to set aside a fraudulent conveyance is limited to setting aside the conveyance of the property which would have been available to satisfy the debt had there been no conveyance. The creditor can recover from the party who made the transfer or the party who received the transfer. A claim of fraudulent conveyance cannot be sustained against a nontransferee on the ground that it assisted in the transfer.

(Internal quotations and citations omitted) (emphasis added). The court went on to examine the five fraudulent conveyances alleged by the plaintiff.

The first conveyance failed to support a claim because the transfer was not made by its debtor.

The court denied summary judgment with respect to second and fourth conveyances, which involved payments that were due to the debtor being made to one of the defendants instead. Because “the monies belonged to and should have been paid to the Tenant, if the Tenant was bypassed and the monies paid directly to transferees, the transferees could have received a fraudulent conveyance.” Looking at the standard for whether a conveyance is fraudulent, the court explained:

In order for a conveyance not to be fraudulent, good faith is required of both the transferor and the transferee. A transfer without good faith is deemed to lack fair consideration. Transfers to controlling shareholders, officers, or directors of an insolvent corporation are deemed to be lacking in good faith and are presumptively fraudulent. Insolvency is presumed if fair consideration is lacking.

(Internal quotations and citations omitted) (emphasis added). The court found that there were questions of fact regarding whether the alleged transfer left the debtor insolvent.

The third conveyance failed to support a claim because the plaintiff failed to present evidence showing that the defendant did not receive fair consideration when it sold its 49% ownership interest in the Tenant.

The fifth conveyance

consists of the Tenant’s failure to insist on payment of the rent starting in January 2009, thereby benefitting the Lather companies and leaving the Tenant without any money. The Tenant did not demand the rent or sue the Lather entities, according to plaintiff. A waiver or release of an obligation can be a conveyance under DCL.

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

This decision illustrates several of the many applications of a claim of fraudulent conveyance, along with some of the limitations of such a claim.

Double Derivative Claim Dismissed For Failure to Show Control of Subsidiary

On July 9, 2014, Justice Schweitzer of the New York County Commercial Division issued a decision in USHA SOHA Terrace, LLC v. Robinson Brog Leinwand Greene Genovese & Gluck, P.C., 2014 NY Slip Op. 31813(U), dismissing derivative claims for lack of standing.

In USHA SOHA Terrace, the plaintiff “assert[ed] both direct and derivative claims against legal counsel for the owner and the developer with regard to a construction project in which plaintiff . . . was a minority investor in the developer.” The court granted the defendants’ motion to dismiss, holding that the plaintiff lacked standing to bring either direct or derivative claims. With respect to the plaintiff’s double derivative claim, the court explained:

Plaintiff also cannot maintain this as a double derivative action in the name of 2280 FOB. A double derivative action is one brought by a shareholder not only for wrongs inflicted directly on the corporation in which he holds stock, but for wrongs done to that corporation’s subsidiaries, which make indirect, but nonetheless real, impact upon the parent corporation and its stockholders. In order for a plaintiff to pursue a double derivative claim, it must allege that the company in which it owned shares controlled the subsidiary corporation that owned the claim. It cannot be maintained by the shareholder of a corporation which merely owns stock in the wronged corporation, or which is merely a creditor of the second corporation by virtue of preferred stock ownership. The key consideration is control at the time of the supposed harm.

(Internal quotations and citations omitted) (emphasis added). The court, after analyzing the 2280 FOB operating agreement, concluded that the defendant developer lacked the necessary control to support a double derivative claim.

Agreement Lacking Formula for Computing Compensation not Void for Indefiniteness

On July 9, 2014, Justice Scarpulla of the New York County Commercial Division issued a decision in Basu v. Alphabet Management LLC, 2014 NY Slip Op. 31807(U), holding that an alleged oral employment agreement was not unenforceably vague because it lacked a formula for calculating the plaintiff’s compensation.

In Basu, the defendant moved to dismiss the plaintiff’s claim for breach of contract on multiple grounds, including that it was void for indefiniteness. The trial court denied the motion, explaining:

The defendants also argue that the oral contract, even if it existed, is void for indefiniteness because no formula was agreed upon on how to calculate the percentage of profits allegedly owed to [the plaintiff]. However, issues of fact remain as to the terms of the alleged oral contract, and those terms may have been sufficiently definite to be enforceable. A price term is not necessarily indefinite because it contains no computational formula. On the contrary, a price term may be considered sufficiently definite if it can be ascertained by reference to an extrinsic event, commercial practice, or trade usage. The calculation of profits, and [the plaintiff's] share of the profits, may be ascertainable by reference to the hedge fund’s own practice of calculating the profits owed to its traders, or by commercial practice in the industry. At his deposition, Adler testified that the profits and losses for all traders were calculated independently by the firm’s administrator, and that it was common for traders to receive a set percentage of the profits. Because the
calculation of profits may be obtainable by reference to an objective standard, the alleged contract may not be void for indefiniteness. Before rejecting an agreement as indefinite, a court must be satisfied that the agreement cannot be rendered reasonably certain by reference to an extrinsic standard that makes its meaning clear. The conclusion that a party’s promise should be ignored as meaningless is at best a last resort.

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

Absent Precise Language To the Contrary, Limitations Period In Insurance Policy Runs From Date Coverage Was Denied, Not Date of Underlying Loss

On June 30, 2014, Justice Schweitzer of the New York County Commercial Division issued a decision in Flat Ridge 2 Wind Energy LLC v. Those Underwriter at Lloyd’s, 2014 NY Slip Op. 31804(U), holding that unless an insurance policy contains precise language to the contrary, a limitations period provided for the in the policy runs from the date the insurance company denies coverage, rather than the date of the underlying injury.

In Flat Ridge 2, the plaintiff (a wind power generation company) brought an action against its insurer, seeking coverage for damages to a wind farm caused by a tornado. The insurer moved to dismiss the complaint as time barred under a provision of the policy requiring that any suit against the insurance company be “commenced within twelve (12) months next after the happening becomes known to the Insured.” The insurer argued that this 12-month limitations period ran from the date of the underlying loss and therefore the insured’s claim was time barred. The Court rejected this argument and found the claim timely because it was filed within 12 months of the insurance company’s denial of coverage:

New York law has consistently distinguished between generic policy language, like that used [in Flat Ridge 2’s policy], which is read to set the limitations period to run from the date the insured’s claim accrues, and more specific, precise language, which sets the period to run from the liability triggering event. In Steen v. Niagara Fire Ins. Co., 89 NY 315, 322-23 (1882), the first New York case to address the issue, the court held that the generic language, “next after the loss or damage shall occur” should be construed to mean that the limitations period does not begin to run until “the right to bring an action exists” rather than when the loss “in fact occurs.” The default rule in dealing with these contractual provisions then, is that, the time within which an action must be commenced shall be computed from the time the cause of action accrued, unless the parties agree that the date of loss or damage shall be looked to as the “happening” that starts the clock and they express this intention through clear and precise language. In Fabozzi [v. Lexington Ins. Co., 601 F3d 88 (2d Cir. 2010),] the Second Circuit concluded that only a limitations provision that uses the term of air “after the inception of the loss” or similarly precise language, “can tie a limitations period to the date of the accident or peril insured against.” Fabozzi, 601 F3d at 93. Although the exact language used in the provision in Flat Ridge 2′s policy was not construed by any of these New York courts, a leading insurance treatise quoted in Fabozzi addresses the phrase “after the happening of the loss,” stating that, “language such as ‘after the happening of the loss’ is considered to be ‘lacking in precision’ such that the limitations period
is computed not from the time of the occurrence of the physical loss . . . but from the time that liability accrues.” 601 F3d at 93 (quoting 71 NY Jur. 2d Insurance§ 2528 (2010)). Here, the provision at issue, stating only “after the happening becomes known [ ... ]” is similarly lacking in precision, as it does not employ any of the exacting language that would be sufficient to tie the limitations period to the occurrence of the loss or damage itself. For example, it does not make reference to “the physical damage out of which the claim arose,” a particular type of damage causing occurrence itself, or even to “the loss.” Since the language of the limitations provision here is vague and generic, it should be computed from the time that Flat Ridge 2′s claim against Underwriters accrued – the date upon which Underwriter denied coverage – not from the date of the windstorm.

(Some internal citations and quotation marks omitted) (emphasis added). This decision illustrates that special limitations periods in insurance contracts are enforced. However, they must be written in precise language, and if ambiguous, they will be construed in a manner favorable to the insured.

Court Examines Elements of Claim for Misappropriation of Skills and Expenditures in Pinterest Lawsuit

On July 8, 2014, Justice Schweitzer of the New York County Commercial Division issued a decision in Schroeder v. Pinterest Inc., 2014 NY Slip Op. 31809(U), illustrating the elements of a claim for misappropriation of skills and expenditures.

In Schroeder, the plaintiffs claimed that the defendants used their ideas and work in creating the website Pinterest. The defendants moved to dismiss. This post looks at the court’s denial of the defendants’ motion with respect to the plaintiffs’ claim for misappropriation of skills and expenditures. The court explained:

To make a claim of misappropriation of skills and expenditures, plaintiffs must allege (1) investment of labor, skill or expenditure, (2) that the information was misappropriated in bad faith, (3) and used for defendant’s own benefit. Such claims are traditionally called unfair competition. Unfair competition claims can stand even when a misappropriation of trade secret claim fails. Finally, bad faith requires the existence of a confidential or fiduciary relationship and can consist of theft, deception, bribery, or coercion.

(Internal quotations and citations omitted). The court found all three elements adequately pleaded with respect to the individual defendant, Cohen, but not Pinterest, explaining:

Plaintiffs allege that the investment in skill, labor, and expenditures was misappropriated by Mr. Cohen when he took plaintiffs’ ideas to the Pinterest founders. Plaintiffs allege that Mr. Cohen acted in bad faith by stealing ideas when he promised he would not. Plaintiffs allege that Mr. Cohen, as chairman and CEO of both RDV and Skoopwire, while acting as an agent of NY A, knew that the proprietary information he acquired from plaintiffs should be kept confidential. Plaintiffs further allege that Mr. Cohen knew such information was to be kept confidential because Mr. Cohen signed the operating agreement, refused to sign a liquidation agreement, and wrote an email promising that he would not profit from plaintiffs’ ideas. . . .

Plaintiffs sufficiently allege that Mr. Cohen’s misappropriation of Mr. Schroeder’s labor, skill, and expenditures was for Mr. Cohen and NY A’s own benefit and gave defendants an unfair advantage. NY A is allegedly also responsible because Mr. Cohen was at all times acting in furtherance of NY A business and within the scope of his authority as an NYA officer. NYA exists “to provide capital to entrepreneur’s starting new businesses.” Mr. Cohen was affiliated with NY A and plaintiffs met with Mr. Cohen to look for capital. NY A’s success occurs through the investments made by its members. For example, NY A touted the success of Pinterest with a tombstone on its website. NY A is not just a clearinghouse (independent consortium of angel investors) and it does not matter that it is a not-for-profit entity.

This decision illustrates that even where a claim for theft of trade secrets might not exist, a plaintiff might still have a claim for the misappropriation of the fruits of her labor.

Court Lacks Power to Remove LLC Member

On July 9, 2014, Justice Schweitzer of the New York County Commercial Division issued a decision in Austin v. Gould, 2014 NY Slip Op. 31814(U), dismissing a cause of action seeking the removal of a member of a New York LLC.

In Austin, the plaintiff asserted a host of direct and derivative claims relating to a series of real estate investments. The defendants moved to dismiss. This post focuses on the plaintiff’s claim seeking to remove the individual defendant as a member of an LLC and to deny him indemnification, which the court dismissed. The court explained:

Unless there is a vote Of a majority in interest of the members (LLC Law § 414 ), this court is unaware of a legal basis for directing, ordering or adjudging that an LLC member be removed from a management position. Similarly, plaintiffs have not provided any authority, nor has the court found any, to support the existence of a cause of action seeking denial of indemnification without a contractual basis for doing so.

(Internal quotations and citations omitted).

This decision reinforces tha point that limited liability companies are governed by statute and member agreement. Whether it is the removal of a member or cutting off a member’s right to indemnification, courts are reluctant to supplant the law and the parties’ agreements.