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.

Court of Appeals Arguments of Interest for the Week of October 20, 2014

Arguments the week of October 20, 2014, in the Court of Appeals that may be of interest to commercial litigators.

  • No. 197Kimso Apartments, LLC v. Gandhi (To be argued Tuesday, October 21, 2014) (considering whether Supreme Court improvidently exercised its discretion in permitting the defendant to “conform the pleadings to the proof” by amending his answer to assert an “intrinsic,” but formally unasserted, counterclaim). The Second Department decision is available here.
  • No. 216: Sierra v. 4401 Sunset Park, LLC (To be argued Wednesday, October 22, 2014) (considering whether insurance company complied with disclaimer requirements of Section 3420(d)(2) of the Insurance Law by providing notice of disclaimer of insurance to insured’s primary insurer, but not directly to the insured). The Second Department decision is available here.
  • No. 203: Strauss Painting, Inc. v. Mt. Hawley Insurance Company (To be argued Wednesday, October 22, 2014) (considering whether an insured satisfied the policy’s notice requirement by notifying its broker of the claim with the expectation that the broker would notify the carrier). The First Department decision is available here.

Client Q & A: Why Do I Have To Give Evidence To My Opponent?

We have been blogging on recent developments in the Commercial Division for over a year now–over 430 posts. Our posts normally focus on the legal aspects of court decisions in commercial litigation. This post marks the beginning of a different kind of post here: one directed to clients rather than other commercial litigators.

We are calling these new posts Client Q & A’s, because they are written in the form of answers to questions we get from non-lawyer clients. Our introductory post is entitled Why Do I Have To Give Evidence To My Opponent?

Client Q & A: Why Do I Have To Give Evidence To My Opponent? By John M. Lundin.

One of the things often overlooked about civil litigation in the United States is that, if you are in a lawsuit, you likely will have to give evidence to your opponent, including evidence that it can use against you at trial. In big lawsuits, this exchange of evidence—usually called discovery—can be the most expensive part of the lawsuit. Here are some key things to know about a litigant’s obligations to give discovery before trial.

Document Demands: Normally, each party in a lawsuit gets to demand that the other parties turn over documents relating to the lawsuit. These requests, usually called document demands or document requests, can be very broad. The standard for what must be turned over varies from state to state and between the states and the federal courts, but usually an opponent can ask for anything relevant to the case, or sometimes even anything that could lead to the discovery of relevant evidence, even if the documents themselves are not relevant. And, the documents you will have to produce are not just paper stored in a filing cabinet, but also include evidence stored in electronic form, such as word processing files, databases and e-mails. You might also be called upon to produce documents held by others if you have the right to obtain and produce them, such as bank records, documents exchanged with your accountant, or documents you previously provided to a lawyer.

Finding and producing all these documents can, in a large case, be very expensive and time consuming. But it has to be done. Courts do not look kindly at litigants who fail or refuse to provide discovery, and no matter how bad you think the evidence is for you, it almost certainly is not as bad as what will happen if the court finds out that you had it and did not produce it.

Of course, this does not mean that you have to give up anything your opponent asks for no matter the cost. Courts are willing to limit discovery if the importance of the evidence is outweighed by the cost of finding and producing it. There also are procedures for protecting the confidentiality of sensitive evidence, such as trade secrets or business plans. And some categories of documents, such as your communications with your lawyers, generally are protected by privilege and do not have to be produced at all.

Interrogatories: In addition to producing documents, you might have to give written responses to questions called interrogatories. Very generally, interrogatories have to be questions to which there is a relatively short answer, although you might also have to provide relevant data, such as sales data. As with document productions, courts are willing to limit the scope of interrogatories if they are inappropriate or too burdensome. Some courts also limit the number and type of allowed interrogatories in their local rules.

Depositions: Normally, the parties to a civil lawsuit have the right to depose each other. In a deposition, a witness is asked questions under oath by their opponent’s attorney. The testimony normally is recorded by a person called a court reporter, who prepares a written transcript of the testimony. In general, if you are deposed, you will have to answer any question put to you unless it asks for confidential communications between you and your attorney, but there are some other minor exceptions. In federal court, the default rule is that each person can be deposed for no more than one day of seven hours, but courts will for good reason allow longer depositions. State court rules vary; some allow multiple days of depositions. However, the amount of time a deposition can go will be limited by the court to what it considers reasonable given the circumstances.

Non-Party Discovery: Not only can the parties to a lawsuit gather evidence from each other, their lawyers normally also can serve subpoenas on people and businesses that are not parties to the lawsuit to get relevant documents and to get deposition testimony.

Conclusion: Discovery can add significantly to the time and expense of litigation, which can be frustrating, but it also means that, by the time you get to trial, the material facts of a case normally will all be on the table. This is one of the reasons most civil cases do not go to trial. Once all the evidence is out, it usually is possible to anticipate the odds of success at trial, leading to settlement or, if the relevant facts all point in favor of one opponent or the other, to a decision by the court without a trial.

A big part of our job as business litigators is managing the discovery process to make sure that it is no more burdensome on you (or expensive) than necessary and at the same time making sure that we get the evidence you need from your adversary and others to prove your claim or defense. We do this through application not just of our knowledge of the law of discovery, but also through our experience with project management and our technical skills in managing both the process of collecting electronic records from your files (documents on your computers or central servers and e-mail) and using the sophisticated electronic databases that manage and analyze large collections of evidence.

A Cautionary Tale Regarding Procedural Pitfalls: Part 2

In yesterday’s post on the October 1, 2014, decisions by Justice Oing of the New York County Commercial Division in Loreley Financial (Jersey) No. 3, Ltd. v. Morgan Stanley & Co. Inc., 2014 NY Slip Op. 32622(U) and 2014 NY Slip Op 32624(U), we discussed the decision in 2014 NY Slip Op 32624(U), in which the court held that despite having been given leave to file an amended complaint, the court had no jurisdiction to hear the amended complaint the plaintiffs filed after judgment dismissing the action had been entered. This post looks at the decision in 2014 NY Slip Op. 32622(U), in which the court addressed the defendants’ motion to dismiss the plaintiffs’ newly-filed action on statute of limitations ground.

The plaintiffs’ new action was not filed within the limitations period for their claims.  The plaintiffs argued that the newly-filed “action relates back to the prior action because they filed it within six months of withdrawing the appeal of the prior action.”  The court disagreed, explaining:

CPLR 205[a] provides that where an action is terminated, the plaintiff may commence a new action upon the same transaction or occurrence or series of transactions or occurrences within six months after the termination. Termination, for purposes of CPLR 205[a], occurs when appeals as of right are exhausted. In other words, the six month period runs from the date of entry of the order determining [the] appeal. The question, which appears to be one of first impression, is when does the six month period begin to run where there is a voluntary withdrawal of a timely appeal–at the time of the voluntary withdrawal, which would necessarily require a finding that such act should be deemed an appellate determination, or at the time the appealed order herein was entered, namely July 1, 2013. In resolving this issue, this Court is mindful of the following observation: “it is not the purpose of the statute to permit a party to extend the time to commence a new action by merely taking appellate action.”

Keeping that underlying principle in mind, this Court holds that plaintiffs’ voluntary withdrawal is not an appellate determination. Indeed, plaintiffs never perfected the appeal prior to withdrawing it. By doing so, for the purposes of CPLR 205[a], plaintiffs did not take an appeal. Procedurally, had they perfected their appeal, an order would have been required to have the appeal dismissed. In that circumstance, the six month statute of limitations would have run from that dismissal order. Given that plaintiffs chose to withdraw their unperfected appeal, the termination date is July 1, 2013, the date in which this Court’s order dismissing the prior action was entered. As such, this action is untimely.

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

The Loreley Financial decisions show how procedural pitfalls can trap counsel. One can understand how the plaintiffs in Loreley Financial thought that their claims were preserved–they had permission to replead, a stipulation staying the time to move and a timely-filed original action. But the court found otherwise. We look forward to seeing what the First Department does with these decisions.

A Cautionary Tale Regarding Procedural Pitfalls: Part 1

On October 1, 2014, Justice Oing of the New York County Commercial Division issued two decisions in Loreley Financial (Jersey) No. 3, Ltd. v. Morgan Stanley & Co. Inc., 2014 NY Slip Op. 32622(U) and 2014 NY Slip Op 32624(U), illustrating the importance of keeping an eye on the rules of practice.

This post focuses on the decision in 2014 NY Slip Op 32624(U), in which the court held that despite having been given leave to file an amended complaint, the court had no jurisdiction to hear the amended complaint the plaintiffs filed after judgment dismissing the action had been entered.

In Loreley Financial, the plaintiffs asserted claims of rescission, fraud, fraudulent conveyance, and unjust enrichment. On June 20, 2013, the trial court issued a decision dismissing their complaint but granting leave to replead under the same index number. The plaintiffs filed a notice of appeal and

the parties entered into a stipulation staying plaintiffs’ time to move to renew and reargue, and defendants’ time to respond to any amended complaint until a party or the Court lifted the stay. The stipulation also provided that the parties reserved all rights, and defendants did not consent to an amended complaint by signing the stipulation.

The stipulation did not prevent the defendants from seeking entry of a judgment of dismissal, and they did so. Plaintiffs did not move to vacate the judgment when it was entered.

Over seven months after the judgment dismissing the action was entered, the plaintiffs filed an amended complaint and, later, withdrew their appeal, which they had not perfected. Plaintiffs also filed “a new, identical action under” a new index number. The defendants moved to dismiss the amended complaint in the original action, arguing that the court lacked subject-matter jurisdiction to hear the amended complaint because the Clerk had entered judgment dismissing the action. The court agreed, explaining:

Nothing in this Court’s prior ruling as set forth on the record precluded defendants from exercising their rights, including having a judgment entered dismissing the action. Thus, defendants correctly point out that post dismissal filings, such as plaintiffs’ April 3, 2014 amended complaint, are nullities because there is no longer an active case. Indeed, nothing in this Court’s decision to grant plaintiffs leave to file an amended complaint can be deemed to countermand the provisions of the CPLR regarding terminated actions and subsequent filings, or defendants’ right to seek entry of a judgment of dismissal.

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

The court went on to discuss why the plaintiffs could not “take refuge in the safe harbor provisions of CPLR 5019 and 5015.” As to CPLR 5019(a), which relates to errors in judgments that are “mistake[s], defect[s] or irregularit[ies] not affecting a substantial right of a party,” the court held that it did not apply because the relief the plaintiffs sought was substantive. As to the court’s prior order granting leave to replead, the court explained that while it “noted that plaintiffs have a right to file an amended complaint, this Court did not state that such right would be absolute, and that it would not have to yield to other provisions of the CPLR.”

According to the court, once the judgment was entered, the plaintiffs’ “options were to appeal, or move to vacate the judgment pursuant to CPLR 5015. Here, plaintiffs took an appeal, but withdrew it prior to perfecting it. Given that plaintiffs filed an amended complaint, rather than pursue their appeal, the issue then is whether CPLR 5015 provides a basis to vacate the judgment so as to permit the amended complaint to go forward.” As the court explained, CPLR 5015 also provided no basis for the relief the plaintiffs sought:

CPLR 5015(a) provides that a court may relieve a party from a judgment on the grounds of excusable default, newly-discovered evidence after trial, fraud, misrepresentation, or other misconduct, lack of jurisdiction to render the initial judgment, or reversal, modification, or vacatur of the initial judgment. This list is not exhaustive, an a court retains the inherent power to vacate its own judgment for sufficient reason and in the interests of substantial justice. This authority, however, is not plenary, and should only be used in cases of fraud, mistake, inadvertence, surprise or excusable neglect. Indeed, a motion to vacate an order pursuant to CPLR 5015 cannot serve as a substitute for an appeal, or remedy an error of law that could have been addressed on a prior appeal.

Here, the record clearly does not reflect the existence of any of the enumerated bases to warrant vacatur of the instant judgment pursuant to CPLR 5015[a]. Indeed, there was no fraud, and the Clerk did not enter judgment of dismissal inadvertently or by mistake. Nor can plaintiffs claim surprise or neglect, as they filed an opposition to entry of judgment before the Clerk entered the judgment. Indeed, although permitted to do so, plaintiffs did not submit a proposed counter-judgment that could have included language preserving their right to file an amended complaint. As such, any purported error in not including such language is not chargeable to the Clerk. There has been no default, no reversal of this Court’s prior decision and order, no challenge to this Court’s jurisdiction to render its prior decision and order, and no misconduct by defendants. Lastly, plaintiffs do not assert that the judgment should be vacated due to newly-discovered evidence. Under these circumstances, vacatur of the judgment is not warranted.

(Internal quotations and citations omitted).

But what of the new action the plaintiffs had filed? Weren’t their claims saved by filing a new action? That is the subject of tomorrow’s post.

Claim by Nonresident Dismissed Based on Statute of Limitations of State Where Claim Accrued

On October 9, 2014, Justice Friedman of the New York County Commercial Division issued a decision in Cambridge Capital Real Estate Investments, LLC v. Archstone Enterprises LP, 2014 NY Slip Op. 32625(U), dismissing an action based on the statute of limitations of the state where the action accrued.

In Cambridge Capital, the plaintiff, a “minority limited partner of a fund, which invested in a real estate investment trust,” sued “the general partner of the fund and other entities, based on the general partner’s alleged conflict in the sale of the fund’s assets.” Among the issues the court addressed in deciding the defendants’ motion to dismiss was whether the plaintiff’s breach of contract claim, which accrued in Colorado, was barred by the statute of limitations. The court ruled that it was, explaining:

It is well settled that when a nonresident sues on a cause of action accruing outside New York, CPLR 202 requires the cause of action to be timely under the limitation periods of both New York and the jurisdiction where the cause of action accrued. The purpose of the statute is to prevent nonresidents from shopping in New York for a favorable Statute of Limitations. Furthermore, when an alleged injury is purely economic, the place of injury usually is where the plaintiff resides and sustains the economic impact of the loss.

While plaintiffs contract claim based on the amendments to the LPA is timely under New York’s six year statute of limitations, Colorado’s limitation period for such a claim is three years. Under Colorado law, a breach of contract claim accrues on the date the breach is discovered or should have been discovered by the exercise of reasonable diligence.

Contrary to plaintiffs contention, the determination as to when a claim accrues may be made at the pleading stage where, as here, it is clear from the undisputed facts when the breach was or should have been discovered. The Amended LPA, dated March 31, 2009, contains the amendments that plaintiff challenges. Plaintiff admits that it received the Amended LPA on August 12, 2009. As a sophisticated business entity, plaintiff could have discovered the relevant amendments by reading the document to determine the changes it made and its effect on plaintiffs interests. When it received the Amended LPA, it was aware or should have been aware that the amendments had been made without its consent.

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

Second Department Affirms Decision Finding Fee Splitting Agreements Unlawful

On October 15, 2014, the Second Department issued a decision in South Shore Neurologic Associates, P.C. v. Mobile Health Management Services, Inc., 2014 NY Slip Op. 06963, declaring contracts void as unlawful fee-splitting arrangements in connection with medical services.

In South Shore Neurologic Associates, the Second Department affirmed a trial court’s confirmation of a referee report

recommending that the court award summary judgment declaring that the subject commercial relationship among certain parties constituted an unlawful fee-splitting arrangement, and properly denied the appellants’ motion to reject the report. South Shore established its prima facie entitlement to judgment as a matter of law declaring that the commercial relationship constituted an unlawful fee-splitting arrangement in violation of Education Law § 6530(19) and 8 NYCRR 29.1(b)(4) by submitting documents and deposition testimony showing that certain contracts were a pretext to justify the appellants’ receipt of one third of the profits of South Shore’s MRI practice . . . .

(Emphasis added). Some background not in the opinion: Education Law § 6530(19) prohibits fee splitting among medical professionals. Its prohibitions include:

any arrangement or agreement whereby the amount received in payment for furnishing space, facilities, equipment or personnel services used by a licensee constitutes a percentage of, or is otherwise dependent upon, the income or receipts of the licensee from such practice, except as otherwise provided by law with respect to a facility licensed pursuant to article twenty-eight of the public health law or article thirteen of the mental hygiene law . . . .

Action for Corporate Waste Cannot be Brought Against the Former Sole Owner of a Company

On October 14, 2014, Justice Demarest of the Kings County Commercial Division issued a decision in Koryeo Intl. Corp. v. Kyung Ja Hong, 2014 NY Slip Op. 51495(U), dismissing an action for corporate waste and breach of contract.

The plaintiff, Steve Hong, who brought the action on his own behalf, and directly on behalf of Koryeo as its sole shareholder and officer, is the company’s founder’s son. He alleged that his father and the defendant—apparently his stepmother—induced him to abandon his legal career and work for Koryeo for a “minimal salary” by promising him that control and ownership would eventually be transferred to him. In 1995 his father died, and his stepmother became the sole shareholder, director and officer. In December 2012, the defendant finally transferred the company to him, and he became sole shareholder, officer, and director. But the plaintiff soon discovered that only $54,000 had been deposited in the company’s bank account in 2012, despite income of millions of dollars being disclosed on the company’s tax returns and invoices. He accordingly sued his stepmother, alleging that she had looted the company before handing it over to him.

Justice Demarest denied all claims.

First, the court held that Koryeo’s standing to bring claims was defeated by the “contemporaneous ownership rule” set forth in BCL § 626 (b):

[P]laintiffs’ allegations that all of the alleged wrongs at issue occurred while Kyun Ja Hong was Koryeo’s sole officer, director, and shareholder, and before she transferred her interest in Koryeo to Steve Hong, compel a finding that Koryeo does not have standing to bring this action. As stated by the Court of Appeals, ‘the rule is that, when stockholders are individually estopped from questioning wrongs done to their corporation, they cannot redress those same wrongs through a suit brought directly by the corporation or derivatively, by themselves, for the corporation.’ Two grounds support such an estoppel here. The first is that Steve Hong received his shares from Kyung Ja Hong, a shareholder who must be deemed to have unanimously ratified her own acts of waste and misappropriation. Any wrongdoing by Kyung Ja Hong is therefore imputed to Koryeo, which is equitably estopped from obtaining redress for its own actions. Furthermore, Steve Hong, Koryeo’s current sole shareholder and the sole prospective beneficiary of Koryeo’s recovery, acquired all of his shares after the alleged wrongful acts, and as such, he is barred from bringing a derivative action under section 626 (b). With respect to both of these grounds for estoppel, a court will pierce the corporate veil and bar a direct action by the corporation when it would only benefit a shareholder who would otherwise be barred from raising the claims in a derivative action.

(Internal citations omitted) (emphasis added).

And second, the court dismissed Steve Hong’s personal breach of contract and tort claims:

According to Steve Hong, sometime prior to his father’s death in 1995, Kyung Ja Hong promised to transfer ownership and control of Koryeo to him at some future time following his graduation from law school, which must have occurred prior to his admission to the Bar in 1992. Without providing for a specific time frame, and in light of plaintiff’s failure to seek enforcement of the alleged contract for over twenty years, the alleged promise to turn over ownership and control of Koryeo is too indefinite to establish a legally enforceable contract. In any event, Steve Hong received exactly what was promised when Kyung Ja Hong transferred the entirely of her shares to him in December 2012. While Steve Hong asserts that he received virtually worthless shares in an indebted corporation, he has made no allegation that Kyung Ja Hong promised to transfer a company with a certain amount of assets.

(Internal citations omitted.) Steve Hong’s tort claims were dismissed as derivative of his contract claim.

It may seem obvious that relying on vague promises grounded primarily in family feeling often ends in disaster, but it still happens. And in circumstances where the bad actor is the sole owner of a company, often nothing can be done.

Economic Loss Rule Precludes Tort Claims For Purely Economic Losses Arising From Defective Product

On October 1, 2014, the Second Department issued a decision in 126 Newton St., LLC v. Allbrand Commercial Windows & Doors, Inc., 2014 NY Slip Op 06563, applying the “economic loss rule” to bar the plaintiff (a “downstream purchaser” of a product) from recovering tort damages for economic losses resulting from a defect in the product.

In 126 Newton Street, the plaintiff purchased defective glass doors and windows that permitted water intrusion and brought contract and tort claims against the defendant who had fabricated and installed the defective product. Queens County Supreme Court Justice Orin Kitzes denied the defendant’s motion for summary judgment, and the Second Department reversed in part, ruling that the plaintiff’s claims for negligence and strict products liability were barred by the economic loss rule to they extent they sought damages for economic losses resulting from damage to the product itself, or consequential damages resulting from the defect. The Second Department explained the often-misunderstood economic loss rule as follows:

The economic loss rule provides that tort recovery in strict products liability and negligence against a manufacturer is not available to a downstream purchaser where the claimed losses flow from damage to the property that is the subject of the contract and personal injury is not alleged or at issue.

The rule is applicable to economic losses to the product itself as well as consequential damages resulting from the defect. Therefore, when a plaintiff seeks to recover damages for purely economic loss related to the failure or malfunction of a product, such as the cost of replacing or retrofitting the product, or for damage to the product itself, the plaintiff may not seek recovery in tort against the manufacturer or the distributor of the product, but is limited to a recovery sounding in breach of contract or breach of warranty.

The Court then proceeded to apply the rule to the Plaintiff’s claim, finding that tort claims for damages to the product itself were precluded, but the Plaintiff could recover damages in tort for injury to other structural elements of the building that were not subject to the parties’ contract:

Here, the plaintiff alleges, inter alia, that it sustained economic losses generated by the repair and replacement of the glass doors and windows of a building due to the failure of such doors and windows to properly prevent water intrusion. The fabrication and/or installation of those doors and windows were the subject of its agreement with the appellant. To the extent that the plaintiff seeks to recover losses generated by the repair and replacement of these doors and windows pursuant to causes of action sounding in negligence or strict products liability, such causes of action are prohibited by the economic loss rule. Thus, the Supreme Court should have granted those branches of the appellant’s motion which were for summary judgment dismissing so much of the causes of action sounding in negligence or strict products liability as sought to recover losses arising from the repair and replacement of the doors and windows.

However, the plaintiff also claims that the intrusion of water caused by the defective windows and doors resulted in injury to other structural elements of the building, such as flooring and walls. These losses constitute damage to “other property” that was not the subject of the parties’ agreement and, accordingly, support a valid tort cause of action. We note that while other structural elements of the building may have been damaged as a consequence of the infiltration of water through allegedly defective windows and doors, such losses do not constitute “consequential damages,” also known as “special damages,” as that term is used in contract law. Consequential or special damages usually refer to loss of expected profits or economic opportunity caused by a breach of contract.

Notably, the Defendant had not made the argument concerning the economic loss rule to the motion court. Nevertheless, the Second Department exercised its discretion to consider the issue for the first time on appeal because it was a “purely legal argument that appears on the face of the record and could not have been avoided had it been brought to the attention of the Supreme Court.” Although it would be ill-advised to withhold a winning argument with the expectation of raising it on appeal. One lesson here is that counsel handling an appeal should give new thought to legal arguments that might be raised, even if they were not made in the motion court.