Category: Fiduciary Duty
First Department Holds That “Sole and Absolute Discretion” Clause Does Not Preclude Breach of Fiduciary Duty Claim
In Shatz v. Chertok, the First Department affirmed in part and reversed in part a decision by Justice Jennifer G. Schechter of the Commercial Division. The key issue on appeal was whether a New York limited liability company’s operating agreement that provided the managing member “sole and absolute discretion” over investment decisions barred a derivative claim for breach of fiduciary duty. The First Department held that this contractual language did not bar a breach of fiduciary duty claim against the company’s manager.
The issues related to the bringing of claims involving a cancelled LLC were addressed in the Commercial Division’s recent decision in Hopkins v. Ackerman. In November 2019, Justice Saliann Scarpulla dismissed most of Hopkins’s and his co-plaintiffs’ claims as derivative, and therefore unable to be brought on behalf of a cancelled LLC. We covered that decision here. Following that decision, Hopkins sought leave to bring additional direct claims, but Justice Scarpulla’s recent decision rejected all but one of the proposed claims—a breach of fiduciary duty claim based on allegations that Hopkins was frozen out of decision-making and membership rights. The other claims were rejected as derivative because they concerned the alleged failure to distribute the LLCs’ assets, a harm felt equally by all members. Justice Scarpulla also reaffirmed her earlier ruling that a challenge to an LLC’s cancellation status (which could re-open the door to derivative claims) must be brought in Delaware, where the entities were established and cancelled.
The Commercial Division recently ruled, in a case captioned as Hopkins v. Ackerman, that derivative claims on behalf of an LLC need to be brought before the LLC ceases to exist. In Hopkins, Justice Saliann Scarpulla granted a motion to dismiss several derivative claims involving now-cancelled Delaware LLCs because, under Delaware law, a cancelled LLC does not have the ability to bring legal claims. The Court also rejected the plaintiffs’ efforts to cast most of the claims as direct claims on behalf of a specific member in the LLCs.
There has been a new development in the Xerox and Fujifilm (“Fuji”) litigation: Justice Ostrager of the New York Commercial Division declined to (i) certify the putative class, (ii) approve the proposed class settlement, and (iii) award the class attorney’s fees pursuant to a memorandum of understanding that was reached by defendant Xerox and putative class plaintiffs. The material terms of this agreement—changes to the Xerox Board of Directors—already took effect prior to the Justice Ostrager ruling.
Commercial Division Dismisses Shareholder Derivative Suit Because General News Reports and Articles Were Insufficient to Plead Demand Futility with Particularity
Before filing a shareholder derivative suit, the plaintiff must typically serve a pre-litigation demand upon the company’s Board of Directors, except in narrow circumstances where the demand may be futile. In Gammel v. Immelt, Justice Andrea Masley of the New York Commercial Division dismissed the shareholder derivative suit because the plaintiff did not meet the pre-litigation demand requirement and failed to plead with particularity the circumstances establishing the futility exception.
Last month, the First Department in Madison Sullivan Partners LLC v. PMG Sullivan St., LLC, 2019 N.Y. Slip Op. 04460 (June 6, 2019), affirmed the decision of former Commercial Division Justice Shirley Werner Kornreich that the Plaintiff in a LLC dispute failed to sufficiently allege a breach of fiduciary duty claim. The case concerned the parties’ relationship in a joint venture to develop Manhattan real estate as a mixed use project that was formed using several LLCs. In a detailed amended complaint, the Plaintiff alleged that Defendants collected monthly sums for work on a construction project for the venture, when Defendants were not actually working on the construction project but instead pursuing their own ventures.
On Wednesday June 5, 2019, all eight of the New York County Commercial Division justices participated on a panel for the New York State Bar Association’s Commercial and Federal Litigation Section on “Motion Practice Before the Commercial Division.” Motion practice is one of the most frequently used aspects of practice in the Commercial Division. The format was an informal question and answer session on motion practice, moderated by the Section’s Past Chair, Robert Holtzman.
Beginning in April 2019, the First Department has changed its practice to assign panels of four justices for oral argument, as opposed to five justices as has been the traditional practice of the court. This change is the result of three ongoing vacancies on the First Department that have remained unfilled by Governor Cuomo. The Presiding Justice of the First Department, Hon. Rolando Acosta, explained that the move to four justice panels is necessary because there are not enough judges to hear all the pending appeals. Aware that four justice panels could create a two-to-two split, Presiding Justice Acosta explained that a fifth judge can be brought in to issue a decision if needed. Parties can preserve their right to reargue or submit the case to a fifth justice by making a statement on the oral argument record. This change will likely remain in place until new judges are appointed to the court.
Commercial Division Issues Verdict for Plaintiffs Following Bench Trial in Family Feud Over the Palm Restaurant
On November 13, 2018, Justice Masley issued a decision following a bench trial in Ganzi v. Ganzi, which concerns a family feud over the Palm Restaurant empire. Ganzi provides a vivid illustration of the importance of observing corporate formalities, the need to be vigilant for self-dealing when shareholders hold ownership interests in multiple intertwined businesses, and, of course, the pitfalls of mixing family and business.
On October 16, 2018, the Appellate Division, First Department lifted several injunctions granted by the Commercial Division that had restrained a proposed merger deal between Xerox and Fujifilm (“Fuji”), and dismissed the Xerox shareholders’ actions against Fuji.
Commercial Division Holds That Fiduciary Duties Limit LLC Majority Members’ Ability to Adopt Amendments Aimed at Freezing Out Minority Members
Many LLC operating agreements expressly require the consent of all members to adopt or amend the operating agreement. However, some LLC operating agreements do not contain such provision, and instead simply require the consent of members holding a majority of the member interests. But such agreements do not simply allow majority members to make any amendments that they may see fit, as shown by the Commercial Division’s recent decision in Yu v. Guard Hill Estates, LLC. There, Justice Scarpulla explained that even amendments expressly authorized by an operating agreement can still give rise to breach of fiduciary duty claims if they are adopted for an illegitimate purpose.
Commercial Division Allows Stockholder Challenge to Merger to Proceed Due to Allegations that the Special Committee Had a Conflict of Interest
On May 9, 2018, Judge Barry R. Ostrager of the Commercial Division denied a motion to dismiss a shareholder complaint in the Matter of Handy & Harman Ltd. Stockholder Litig., No. 654747/2017, 2018 BL 172083 (Sup. Ct. May 9, 2018), concluding that a plaintiff shareholder had sufficiently alleged that the Board’s Special Committee was conflicted when it recommended a merger transaction.[i]
On April 27, 2018, Justice Barry Ostrager of the Commercial Division enjoined a no-cash transaction that would have granted Fujifilm (“Fuji”) a 50.1% controlling interest in Xerox. Just days after the Court’s decision an agreement was reached whereby the CEO of Xerox, Jeff Jacobson, and six other current Xerox board members would step down from their positions, ceding control of the company to representatives of investors Carl Icahn and Darwin Deason. Shortly thereafter, Xerox reversed course, indicating publically that Jacobson would stay on as CEO. However, ultimately Xerox entered into a settlement agreement with Icahn and Deason resulting in the resignation of Jacobson and the scuttling of the Fuji Deal.
What legal standard applies to assess a corporate board’s refusal to pursue litigation in response to a shareholder’s demand to take “all necessary actions” to correct alleged director misconduct? In Solak v. Fundaro,[i] Commercial Division Justice Charles Ramos applied the business judgment rule to such a situation, holding that a request to take “all necessary actions” constitutes as a shareholder demand under Rule 23.1 of the Delaware Chancery Court Rules and that a derivative plaintiff must plead particularized facts showing gross negligence or bad faith to proceed with a derivative claim following a board’s refusal to take the demanded action.
A unanimous panel of the Appellate Division, First Department recently affirmed a ruling by the Commercial Division dismissing causes of action against the ACE Group International LLC (“AGI”) brought by the estate of the deceased majority owner of AGI, Alexander Calderwood (the “Estate”). The decision in Estate of Alexander Calderwood v. ACE Group International LLC, No. 650150/15 (App. Div. 1st Dep’t Dec. 14, 2017), primarily rested on the principle of Delaware business law that parties are free to set the terms of a limited liability company’s operations through contract. As a result, the panel rejected the Estate’s arguments that provisions in Delaware’s Limited Liability Company Act (“LLC Act”) overrode contrary terms of AGI’s operating agreement (“LLC Agreement”), and affirmed the dismissal of the Estate’s claims.
Commercial Division Analyzes Choice-of-Law on an Element-by-Element Basis in Upholding Claim for Aiding and Abetting Breach of Fiduciary Duty
In Wantickets RDM, LLC v. Eventbrite, Inc., No. 654277/2016, 2017 BL 261099 (Sup. Ct. Jul. 21, 2017), New York Commercial Division Justice Shirley Werner Kornreich denied defendant Eventbrite’s motion to dismiss plaintiff Wantickets’ claims for aiding and abetting breach of fiduciary duty, among other claims. In doing so, she applied Delaware law to assess plaintiff’s allegations of an underlying breach of fiduciary duty and New York law to the remaining elements.
In PMC Aviation 2012-1 LLC et al. v. Jet Midwest Group, LLC et al., No. 654047/2015, BL221447 (Sup. Ct. Jun. 21, 2017), Commercial Division Justice Shirley Kornreich denied a motion to dismiss a fraudulent inducement claim by an LLC member against its business partner. The court found that it could not find any “controlling, on-point authority” on the issue of reasonable reliance at issue in the case. The case relates to the scope of due-diligence obligations of LLC members when they rely upon the representations of business partners concerning the affairs of a jointly owned company.
Commercial Division Rejects Third-Party Claim as Derivative in Trusts’ Suit Concerning Upper West Side Beaux-Arts Building
Asserting a claim on behalf of a trust in the Commercial Division can be risky, as the party asserting the claim must establish that the claimed injury is independent of any injury to the trust, and that they are therefore not simply bringing a derivative claim. Recently, in 1993 Trust of Joan Cohen v. Baum, No. 150058/2015, 2017 NY Slip Op 30894(U), 2017 N.Y. Misc. LEXIS 1667 (May 2). Justice Shirley Werner Kornreich dismissed as derivative a third-party claim brought by a former trustee of two trusts against an individual who allegedly provided deficient tax advice to the trusts. The court ruled that the former trustee was owed no duty by the third-party defendant individually and could no longer prosecute claims that belonged to the trusts. Justice Kornreich also rejected the former trustee’s contribution claim against the tax adviser and another entity, explaining that those entities’ alleged wrongdoing was unrelated to the former trustee’s alleged wrongdoing, and thus did not make them subject to liability to the plaintiff for damages for the same injury.
Commercial Division Reaffirms Distinction Between Direct Versus Derivative Claims Under Delaware Law
When can a shareholder bring a direct claim in the Commercial Division against a corporate officer under Delaware law? On September 29, 2016, in Southern Advanced Materials LLC v. Abrams, No. 650773/2015, 2016 BL 331371 (Sup. Ct. N.Y. Cnty.), Justice Saliann Scarpulla of the Commercial Division ruled on a corporate officer’s motion to dismiss breach of contract and fraudulent inducement claims brought by a plaintiff shareholder. In her ruling, Justice Scarpulla articulated the distinction between direct and derivative claims under Delaware law, and applied that law to four contract and fraud claims brought by a shareholder against corporate officer. Justice Scarpulla’s opinion provides guidance to litigants addressing shareholder claims against corporate officers in the Commercial Division.
Fraud Pleading Standard: Specificity Not Required to Plead Scienter of Corporate Defendants in Alleged Corporate Fraud Conspiracy
What facts must a fraud plaintiff plead, pursuant to the heightened pleading standard under CPLR § 3016(b), to cognizably allege scienter among corporate entity defendants in the context of an alleged multi-corporation fraud conspiracy?
In Casey Capital, LLC v. Levy, the Commercial Division provides a cautionary tale for derivative shareholder plaintiffs alleging demand futility
Activist investors are an increasing presence on the stock ledgers and in the boardrooms of public companies. Since 2010, one in seven companies on the S&P 500 has faced an activist shareholder challenge. But activists can encounter pitfalls when they seek to challenge incumbents through derivative litigation, as illustrated by the recent Commercial Division decision in Casey Capital, LLC v. Levy, C.A. No. 652805/15, 2016 N.Y. Misc. LEXIS 3107 (N.Y. Sup. Ct. Aug. 19, 2016) (Scarpulla, J.).