New York Court of Appeals Clarifies Champerty Safe Harbor Provision
On October 27, 2016, Chief Judge Janet DiFiore delivered a much awaited opinion in Justinian Capital SPC v. WestLB. Judge Leslie Stein wrote a dissenting opinion, which was joined by Judge Eugene Pigott, Jr. Justinian involves the issue of champerty, which, as the Court describes, is “the purchase of notes, securities, or other instruments or claims with the intent and for the primary purpose of bringing a lawsuit.” Under New York law, champerty is prohibited. However, the New York champerty statute provides for a safe-harbor when the purchased asset has an “aggregate purchase price of at least five hundred thousand dollars.” Justinian clarifies that this safe harbor only applies when either the party pays “the purchase price or [has] a binding and bona fide obligation to pay the purchase price.” Put simply, at least $500,000 of the transaction must not be contingent on the litigation in order to fall within the safe harbor.
Background of the Litigation
Justinian centers around $209 million worth of notes issued by Blue Heron Portfolios and sponsored by WestLB. Non-party DPAG invested in the notes in 2003, which by 2008 had lost nearly all of their value. Because of the decline in value, DPAG’s board of directors approved the filing of a direct lawsuit against WestLB. Despite the approval, DPAG declined to sue WestLB because DPAG was receiving financial support from the German government and WestLB was partly owned by the government.
Instead of directly suing WestLB, DPAG took a different route. DPAG entered into an agreement with Justinian Capital SPC (“Justinian”) whereby Justinian would pay DPAG a base purchase price of $1,000,000 and Justinian would sue WestLB. Importantly, the agreement provided that failure to remit the purchase price did not constitute a breach of the agreement, but instead resulted in the accrual of interest. To date, DPAG has never demanded the purchase price from Justinian.
Within days of entering into the agreement, Justinian filed suit in the New York County Commercial Division. WestLB asserted the affirmative defense of champerty and the trial court ordered limited discovery on the champerty issue. Following that discovery, Justice Shirley Werner Kornreich ruled that the Agreement “was champertous because Justinian had not made a bona fide purchase of the Notes and was, therefore, suing on a debt it did not own.”  Justice Kornreich also determined that the safe harbor did not apply because Justinian had not actually paid the purchase price. The Appellate Division affirmed Justice Kornreich’s decision and the New York Court of Appeals granted leave to appeal.
The Court of Appeals’ Opinion
The Court of Appeals began the opinion by concluding that Justinian’s purchase of the notes from DPAG was champertous. In reaching this result, the Court explained that the test of whether conduct is champertous rests on whether the primary purpose of the transaction was to sue on a claim. After announcing that standard, the Court held that “Justinian’s sole purpose in acquiring the Notes was to bring this action and hence, its acquisition was champertous.”
Next, the Court turned to the question of whether Justinian’s conduct fell within the champerty safe harbor—that is whether the notes had an “aggregate purchase price of at least five hundred thousand dollars.” Justinian’s position was that since the price listed in the agreement, $1,000,000, represented a binding obligation, it was sufficient to receive protection of the safe harbor. WestLB argued that in order to come within the safe harbor protection, there must be an actual payment of $500,000. The Court of Appeals found that the term “purchase price” in the safe harbor statute was ambiguous.
Accordingly, the Court turned to the legislative history of the statute to ascertain the meaning of “purchase price.” From the legislative history, the Court determined that the purpose of the safe harbor provision was to “exempt large-scale commercial transactions in New York’s debt trading markets from the champerty statute.” Given that purpose, the Court reasoned that requiring actual payment would hinder the goal of market fluidity. Instead, the Court found that the meaning of “purchase price” in the safe harbor is “a binding and bona fide obligation to pay $500,000 or more for notes or other securities, which is satisfied by actual payment of at least $500,000 or the transfer of financial value worth at least $500,000 in exchange for the notes or other securities.”
After delineating this definition, the Court considered whether the agreement between DPAG and Justinian came within the safe harbor. In interpreting the agreement, the Court focused on the provision which permitted Justinian to withhold payment of the $1,000,000 base price without being in default or breach of the agreement. The Court found that the payment was not in fact a binding obligation, but instead was contingent on the success of the litigation. Accordingly, Justinian was not entitled to the protection of the safe harbor.
Judge Stein’s Dissent
Judge Stein dissented and was joined by Judge Pigott. On the issue of whether the agreement was champertous, Judge Stein suggested that while some evidence indicated that Justinian was merely acting as a proxy to bring suit for DPAG, other evidence suggested that Justinian may have had other purposes for the transaction. Against this record, Judge Stein felt that the issue needed to be resolved at trial.
Similarly, Judge Stein’s view was that some evidence in the record suggested that the agreement between Justinian and DPAG met the majority’s requirement for a “bona fide obligation” to pay. Judge Stein disagreed with the majority’s conclusion that because failure to timely pay the purchase price was not included as a default event, the agreement did not include a bona fide obligation to pay. Judge Stein would have reversed the Appellate Division and remanded for a trial.
Implications for Purchasers of Assets With Intent To Sue On Those Assets
Justinian provides important and clear guidance for individuals or entities that are considering purchasing assets with the intent to file a claim relating to those assets. In such instances, the safest way to ensure that a transaction is within the champerty safe harbor is to ensure that a purchase price of $500,000 is actually paid. That being said, following the Court of Appeals’ guidance, transactions that include a binding and bona fide obligation to pay at least $500,000, the payment of which cannot be contingent on the success of the litigation, will be protected under New York’s champerty safe harbor even if the purchase price is not immediately paid.
By Louis Russo and Muhammad U. Faridi