E.J.Brooks Company d/b/a TydenBrooks (“TydenBrooks” or “Plaintiff”) manufactures plastic security seals (“Seals”). When TydenBrooks acquired Stoffel Seals Corp. (“Stoffel”) it came to own Stoffel’s fully automated, and confidential, process for manufacturing Seals.  Some TydenBrooks employees “defected to a rival manufacturer, Cambridge Security Seals (“CSS”), and brought with them TydenBrooks’ confidential Seal manufacturing process. TydenBrooks then commenced an action in the United States District Court for the Southern District of New York and asserted causes of action sounding in common law misappropriation of trade secrets, unfair competition , and unjust enrichment.  On the issue of damages: TydenBrooks sought to measure its injury by the costs CSS avoided as a result of its unlawful activity.  Under this “avoided costs” theory, TydenBrooks sought monetary relief in an amount equal to the difference between the costs CSS actually incurred in developing and using the TydenBrooks’ manufacturing process and the costs that CSS would have incurred had it not misappropriated TydenBrooks’ process. TydenBrooks presented CSS’ avoided costs as a measure of CSS’ benefit from the misappropriation, “which TydenBrooks asserted was its per se measure of damages.”  TydenBrooks failed to present evidence or argue that “CSS’ avoided costs could be a proxy for its own losses.”  Consistent with this position, TydenBrooks repeatedly urged that “its own financial losses were irrelevant to its “avoided costs” theory of damages.”  The Federal District Court’s jury charge was based on TydenBrooks’ theory of damages and the Court: Reminded the jury that it “may award compensatory damages only for injuries that TydenBrooks proved were proximately caused by defendants’ allegedly wrongful conduct” and “only for those injuries that TydenBrooks has actually suffered or which it is reasonably likely to suffer in the near future.” However, the court did not explain how the jury cold make the inference that CSS’ avoided costs approximated the losses that TydenBrooks “actually suffered” or was reasonably likely to suffer in the near future (emphasis in original). The jury returned a verdict in favor of TydenBrooks.  Among the post-judgment activity of the parties was a motion by CSS for various forms of relief based on “avoided cost” being an improper measure of damages.  In denying CSS’ motion, the court held that “the amount of damages recoverable in an action for misappropriation of trade secrets may be measured either by the plaintiff’s losses…or by profits unjustly received by the defendant” and that avoided costs “could either measure the defendant’s gain or, alternatively, the plaintiff’s losses.” On CSS’ appeal from the District Court’s denial of its post-judgment motion, the Second Circuit Court of Appeals , certified, among another, the following question to the New York Court of Appeals: “Whether under New York law, a plaintiff asserting claims of misappropriation of trade secret, unfair competition, and unjust enrichment can recover damages that are measured by the costs the defendant avoided due to its unlawful activity.”  In so certifying its question, the Court recognized that “neither the Second Circuit nor the New York courts appear to have approved the specific type of award in this case.” (Internal brackets omitted.) On May 3, 2018,  the Court of Appeals, in  E. J. Brooks Company v. Cambridge Security Seals , issued an opinion answering in the negative, the certified question of whether “avoided cost” analysis is the appropriate measure of damages in misappropriation of trade secret cases.  In reaching its conclusion, the Court of Appeals recognized that the “fundamental purpose of compensatory damages is to have the wrongdoer make the victim whole.”  (Citations and internal quotation marks omitted.) As to Unfair Competition The essence of TydenBrooks’ case was a misappropriation theory of unfair competition, which makes a party liable if they “exploit the skill, expenditures and labors of a competitor” (citations and internal quotation marks omitted), and was described by the Court as follows: The essence of the misappropriation theory is not just that the defendant has reaped where he has not sown, but that it has done so in an unethical way and thereby unfairly neutralized a commercial advantage that the plaintiff achieved through honest labor (citations, brackets and internal quotation marks omitted). The Court noted that the damages must be measured by plaintiff’s loss of commercial advantage, which “may not correspond to what the defendant has wrongfully gained.”  Thus, the Court recognized that while “courts may award a defendant’s unjust gains as a proxy for compensatory damages in an unfair competition case,” “the accounting for profits in such cases is not in lieu of damages but is the method of computing damages.” (Emphasis in original, citations and internal quotation marks omitted.)  Such calculations may be appropriate where plaintiff’s actual losses cannot be accurately traced, but there still must be some correlation between the defendant’s gains and the opportunities lost by the plaintiff. As to Trade Secret The Court then analyzed whether “avoided costs” may be awarded in trade secret cases, in which a plaintiff must prove that it “possessed a trade secret” and that the defendant “is using the trade secret in breach of an agreement, confidence, or duty, or as a result of discovery by improper means.” (Citations omitted.)  The Court too, concluded that “damages in trade secret actions must be measured by the losses incurred by the plaintiff, and that damages may not be based on the infringer’s avoided development costs” and that calculations tied to defendant’s gains, as opposed to plaintiff’s losses, are not “permissible measure of damages. This Blog recently addressed pleading requirements in trade secret cases < here =">here"> . As to Unjust Enrichment Nor can “avoided costs” be a measure of compensatory damages in a claim for unjust enrichment, in which a plaintiff must show that: 1. the defendant was enriched; 2. at plaintiff’s expense; and, 3. that equity and good conscience should not permit the defendant to keep that which the plaintiff seeks to recover. The Court held that “where a defendant saves, through its unlawful activities, costs and expenses that otherwise would have been payable to third parties, those avoided third-party payments do not constitute funds held by the defendant ‘at the expense of’ the plaintiff” and, accordingly, “a plaintiff bringing an unjust enrichment action may not recover as compensatory damages the costs that the defendant avoided due to its unlawful activity in lieu of the plaintiff’s own losses.” It should be noted that a lengthy dissent, in which two justices concurred, is rather critical of the majority decision, in which three justices concurred.

It is well settled that arbitration is a favored means of resolving disputes. See , e.g. , CPLR § 7501 (“A written agreement to submit any controversy . . . to arbitration is enforceable without regard to the justiciable character of the controversy and confers jurisdiction on the courts of the state to enforce it and to enter judgment on an award.”); Harris v. Shearson Hayden Stone, Inc. , 82 A.D. 2d 87, 91-93 (1st Dep’t), aff’d , 56 N.Y.2d 627 (1981) (“ his State favors and encourages arbitration as a means of conserving the time and resources of the courts and the contracting parties. . . .”). Consequently, courts will interfere as little as possible with the agreement of consenting parties to submit their disputes to arbitration. Matter of Smith Barney Shearson v. Sacharow , 91 N.Y.2d 39, 49-50 (1997) (citations and quotation marks omitted). Nonetheless, “ ike contract rights generally, a right to arbitration may be modified, waived or abandoned.” Sherrill v. Grayco Bldrs. , 64 N.Y.2d 261, 272 (1985). Accordingly, a litigant may not compel arbitration when his/her use of the courts is “clearly inconsistent with later claim that the parties were obligated to settle their differences by arbitration.” Flores v. Lower E. Side Serv. Ctr., Inc. , 4 N.Y.3d 363, 372 (2005) (citations and internal quotation marks omitted). “Generally, when addressing waiver, courts … consider the amount of litigation that has occurred, the length of time between the start of the litigation and the arbitration request, and whether prejudice has been established.” Cusimano v. Schnurr , 26 N.Y.3d 391, 400-01 (2015). There is no bright-line rule or rigid formula “for identifying when a party has waived its right to arbitration;” rather, the courts apply the foregoing factors to the facts of the case before it.   Louisiana Stadium & Exposition Dist. v Merrill Lynch, Pierce, Fenner & Smith Inc. , 626 F3d 156, 159 (2d Cir 2010). “That said,” however, “‘ he key to a waiver analysis is prejudice.’” Id. And, when examining whether there is prejudice, the courts look to see if the opposing party is procedurally and substantively harmed by arbitration and whether the opposing party will incur excessive costs and delay by going to arbitration. Id . See also Cusimano , 26 N.Y.3d at 401. On April 17, 2018, the Appellate Division, First Department issued a decision in Black Rhino Investments LLC v. Wilson , 2018 N.Y. Slip Op. 02582 (1st Dept. Apr. 17, 2018) ( here ), in which it held that the plaintiffs had waived their right to arbitrate their claims after the defendant moved to dismiss the complaint. Black Rhino Investments LLC v. Wilson Background Black Rhino arose from a business venture to sell wearable air purifying equipment in China. In April 2015, Plaintiff, Howard R. Levitt (“Levitt”), entered into discussions with John Wilson (“Wilson”) and non-party, Darui Jiang (“Jiang”), about launching the venture. The venture was to be known as Black Rhino (“Black Rhino,” the “Business” or the “Company”). During the early stages of their discussions, Levitt, Wilson, and Jiang agreed that Levitt would provide certain services to the Business, including assisting in raising investment funds, acting as an advisor, and acting as a Board Member of the Company, in exchange for a 2% equity stake in the Business and other identified remuneration (the “Agreement”). The Agreement contained an arbitration clause, which provided, in pertinent part, that “ ny controversy or claim arising out of or relating to this contract … shall be settled by arbitration administered by the American Arbitration Association in accordance with its Commercial Arbitration Rules.” In July 2015, Levitt introduced Wilson and Jiang to Plaintiff, Jonathan Bloostein (“Bloostein”). Following the introduction, Levitt, Bloostein, and Jiang began working to get the Business operational, while Bloostein also provided the funding necessary to do so. On September 16, 2015, the parties incorporated the Company in Delaware. Thereafter, in October 2015, the parties met to discuss ownership of the Business. By the conclusion of the meeting, the parties agreed to supplement and revise the Agreement. Sometime later, Wilson allegedly reneged on the deal with the other members of the Company. Motion Court Proceedings Plaintiffs commenced the action on July 17, 2016. Two months later, Wilson moved to dismiss the complaint. On October 26, 2016, following the filing of the motion, and pursuant to the arbitration provision in the Agreement, Plaintiffs filed a Demand for Arbitration and Statement of Claim (the “Arbitration Demand”) with the AAA. Although Plaintiffs Bloostein and Black Rhino were not parties to the Agreement, Bloostein and Black Rhino each executed and submitted a form along with the Arbitration Demand submitting to AAA arbitration. Following a conference with the motion court, Plaintiffs moved to compel arbitration pursuant to CPLR § 7503(a). The motion court granted Plaintiffs’ motion. The Court rejected the argument that Plaintiffs waived their right to arbitration by filing the Arbitration Demand after Defendant filed the motion to dismiss, stating that such activity “is not sufficient” and “has never been held to be sufficient prejudice.” Instead, the motion court explained that the activity needed to constitute a waiver was greater than filing a complaint and a motion to dismiss: “Extensive discovery, extensive motion practice, hearings, trials, that is” required. Defendant appealed. The First Department’s Decision The First Department “unanimously reversed” the motion court’s order. In a terse decision, the Court found that by moving to compel arbitration after the filing of the motion to dismiss, Plaintiffs waived their right to arbitration notwithstanding the arbitration clause in the Agreement: Plaintiffs commenced this action upon an alleged oral agreement entered into in October 2015 involving the ownership of plaintiff Black Rhino and the licensing of defendant’s intellectual property. Upon defendant’s motion to dismiss the complaint, plaintiffs claimed for the first time that the controversy had to be arbitrated, pursuant to a separate agreement entered into in April 2015 involving services to be performed for Black Rhino by plaintiff Levitt. We find that plaintiffs waived their right, if any, to arbitration ( see Cusimano v Schnurr , 26 NY3d 391, 400-401 <2015> ; Louisiana Stadium & Exposition Dist. v Merrill Lynch, Pierce, Fenner & Smith Inc. , 626 F3d 156, 159 <2d cir 2010> ). Although the First Department did not elaborate further, its citation to Cusimano is notable. In Cusimano , the plaintiff sought to compel arbitration after filing a complaint in Supreme Court, New York County, and after the defendant had filed a motion to dismiss under CPLR § 3211. The Court of Appeals held that such activity demonstrated a waiver of arbitration. In so holding, the Court found that the defendant had been prejudiced by the attempt to arbitrate in terms of the imposition of excessive costs and time delay, and the forum shopping engaged in by the plaintiff, which the Court viewed as an attempt to avoid a court ruling on claims that the motion court found to be “vexatious and largely time-barred.” 26 N.Y.3d at 401 (relying on Louisiana Stadium , supra ). Takeaway Prior to Cusimano , New York courts placed a lot on emphasis on the degree of participation by the parties in the action to determine whether their actions were consistent with the assertion of the right to arbitrate: The crucial question, of course, is what degree of participation by the defendant in the action will create a waiver of a right to stay the action. In the absence of unreasonable delay, so long as the defendant’s actions are consistent with an assertion of the right to arbitrate, there is no waiver. However, where the defendant’s participation in the lawsuit manifests an affirmative acceptance of the judicial forum, with whatever advantages it may offer in the particular case, his actions are then inconsistent with a later claim that only the arbitral forum is satisfactory. De Sapio v. Kohlmeyer , 35 N.Y.2d 402, 405 (1974). In Cusimano , the Court of Appeals placed the inquiry more squarely on the prejudice felt by the party opposing arbitration. As the Court noted, “waiver cannot be established in the absence of prejudice.” Consistent with Cusimano , Black Rhino underscores the importance of examining the substantive and financial prejudice incurred by the party opposing arbitration. Although the procedural posture of the case remains important, Cusimano and its progeny, like Black Rhino , make it clear that it is the prejudice incurred that should drive the analysis.

On April 24, 2018, the Securities Exchange Commission (“SEC” or “Commission”) announced that Altaba, Inc. (“Altaba”), the successor in interest to Yahoo! Inc. (“Yahoo”), agreed to pay $35 million to settle charges that it misled investors by failing to disclose that hundreds of millions of user accounts had been hacked, resulting in the theft of sensitive user personal data. ( Here .) The settlement follows the issuance of the SEC’s cybersecurity disclosure guidance for reporting companies. (The SEC’s release of the guidance can be found here .) Issued in February 2018, the guidance provides information to public companies to assist in the disclosure of cybersecurity risks and incidents ( here ).  Among other things, the guidelines identify the factors companies should consider in deciding whether and when cyber-incidents must be disclosed to investors. The guidelines emphasize the importance of maintaining adequate internal controls to ensure that company management is aware of cyber-incidents when they occur, as well as the importance for managers to maintain procedures to help guide disclosure decisions. In late 2014, Yahoo had learned of a massive breach of its user database that resulted in the theft, unauthorized access, or acquisition of hundreds of millions of its users’ personal data. As noted in the SEC’s cease-and-desist-order (the “Order”) ( here ), at that time, Yahoo’s internal information security team became aware that the company’s information technology networks and systems had suffered a severe and widespread intrusion by hackers associated with the Russian Federation. By December 2014, Yahoo’s information security team, including its Chief Information Security Officer (“CISO”), had determined that the hackers had stolen the personal data of at least 108 million users, and likely even Yahoo’s entire user database of billions of users. The personal data in the stolen files included highly sensitive information that Yahoo’s information security team referred to as Yahoo’s “crown jewels”: “Yahoo usernames, email addresses, telephone numbers, dates of birth, hashed passwords, and security questions and answers.” Yahoo’s information security team, including the CISO, also concluded that “the hackers had successfully gained access to a separate source of data: the email accounts of 26 Yahoo users specifically targeted by the hackers because of their connections to Russia.” Despite its knowledge of the 2014 data breach, Yahoo did not disclose the data breach in its public filings for nearly two years. In September 2016, Yahoo issued a press release in which it disclosed the data breach to investors; the release was attached to a Form 8-K filed in connection with the proposed sale of Yahoo’s operating business to Verizon Communications, Inc. (“Verizon”).  The day after Yahoo publicly disclosed the data breach, the price of Yahoo’s stock declined by 3%, causing the company’s market capitalization to fall by nearly $1.3 billion. As a consequence, Verizon renegotiated the stock purchase agreement to reduce the price paid for Yahoo’s operating business by $350 million, representing a 7.25% reduction in price. “We do not second-guess good faith exercises of judgment about cyber-incident disclosure.  But we have also cautioned that a company’s response to such an event could be so lacking that an enforcement action would be warranted.  This is clearly such a case,” said Steven Peikin, Co-Director of the SEC Enforcement Division. In the Order, the SEC found that Yahoo filed several quarterly and annual reports during the two-year period following the breach but failed to disclose the breach or its potential business impact and legal implications.  Instead, the company’s SEC filings stated that it faced only the risk of, and negative effects that might flow from, data breaches.  In addition, the SEC found that Yahoo did not share information regarding the breach with its auditors or outside counsel in order to assess the company’s disclosure obligations in its public filings.  Finally, the SEC found that Yahoo failed to maintain disclosure controls and procedures designed to ensure that reports from Yahoo’s information security team concerning cyber-breaches, or the risk of such breaches, were properly and timely assessed for potential disclosure. “Yahoo’s failure to have controls and procedures in place to assess its cyber-disclosure obligations ended up leaving its investors totally in the dark about a massive data breach,” added Jina Choi, Director of the SEC’s San Francisco Regional Office. “Public companies should have controls and procedures in place to properly evaluate cyber incidents and disclose material information to investors.” The facts and circumstances relating to the Yahoo data breach were also the subject of a securities class action lawsuit that investors brought in 2017. In March 2018, the class action lawsuit settled for $80 million. Last year, the U.S. Department of Justice announced charges against four men, including two officers in Russia’s Federal Security Service, for their roles in the theft of 500 million Yahoo accounts. ( Here .) In agreeing to the settlement, Altaba neither admitted nor denied any wrongdoing. The SEC’s investigation into the matter remains ongoing. Takeaway The Altaba settlement represents the first time the SEC has investigated and determined to commence an enforcement proceeding against a company for failing to disclose a cybersecurity breach. Combined with the recent guidance on the disclosure of cybersecurity risks and incidents, the settlement indicates that cybersecurity disclosure and internal control procedures are a priority for the Commission. Steven Peikin, co-director of the SEC’s enforcement division, confirmed this view, noting that cybersecurity disclosure and controls were a priority for the agency and that the Commission hoped companies facing issues similar to those experienced by Altaba would take note: “The message in this case and the package of remedies here I think is a pretty strong one and I hope will be viewed as a significant penalty by other issuers.” Considering the Commission’s stated priority, it seems certain that other companies with similar issues as Yahoo will be the subject of an SEC investigation and possible enforcement action. Add to this likely consequence the commencement of securities class action lawsuits over disclosure deficiencies, and it is certain that management and their companies will face liability exposure for years to come.

In Shakespeare’s Romeo and Juliet , Juliet utters the oft quoted phrase, “parting is such sweet sorrow,” when saying goodnight to Romeo.  While Juliet may have been upset that Romeo was leaving for the evening, the thought that she would see him again, and that she would be able to imagine their next meeting, made the parting “sweet”. The Decision and Order issued by the New York Supreme Court (Kornreich, J.) in Young Adult Institute, Inc., et al. v. The Corporate Source, Inc. (April 11, 2018), illustrates why, to an employer, the parting of a group of employees may not be so sweet. Very briefly stated, plaintiff Young Adult Institute, Inc. (“YAI”) is a not-for-profit organization that, through a network of agencies, provides a variety of services to developmentally and intellectually challenged individuals.  Defendant The Corporate Source, Inc. (“TCS”), one such network agency, provided management services to YAI pursuant to a five-year management agreement that, inter alia , did not contain non-compete or non-solicitation covenants.  The individual defendants are employees and independent contractors of TCS, many of whom previously worked for YAI. During the term of the management agreement, TCS sought to change some of the terms of the agreement and YAI agreed to negotiate with TCS regarding same.  “Unbeknownst to YAI…TCS—through its senior management…--had been working covertly for months with YAI employees to terminate its relationship with YAI and transfer the business to a newly formed operation.”  To that end, while still employed, and getting paid, by YAI, some of the individual defendants recruited other YAI employees, negotiated deals for TCS with YAI’s vendors, established TCS’s back-office operations, among other things.  The e-mails of many of the individual defendants make plain that they knew that what they were doing was wrong and evince an effort to hide the true nature of their actions. Ultimately, many of the individuals left YAI’s employ to work for TCS and some went so far as to lie about their future employment so as to hide the fact that they were leaving to work for TCS.  Upon leaving, one employee deleted e-mails and files on YAI’s computer system to “cover[] her tracks” and to make “it more difficult for YAI to uncover her and the other disloyal YAI employees’ wrongdoing.”  Other individual defendants copied computer files belonging to YAI and brought the files to TCS.  Many of the stolen computer files contained personal confidential information for many of YAI’s clients, which information was protected by federal and state law.  Accordingly, YAI spent significant sums of money complying with federal and state remediation and notification laws. Plaintiff filed an amended complaint, which defendants moved to dismiss.  While the court addressed several legal issues in deciding the motion, a few stuck out as particularly interesting. Plaintiff’s fifth cause of action sounded in conversion and was based on Plaintiff’s allegation that its former employee deleted numerous of YAI’s electronic files.  The court stated that conversion “takes place when someone, intentionally and without authority, assumes or exercises control over personal property belonging to someone else, interfering with that person’s right of possession.” (Citation omitted.)  The elements of a conversion claim, as set forth by the court are: 1. “plaintiff’s possessory right or interest in the property” and 2. “defendant’s dominion over the property or interference with it, in derogation of plaintiff’s rights.”  (Citations omitted.) While normally, one thinks of conversion in conjunction with tangible property, the court noted that deleting electronic files can give rise to a conversion claim. In Young Adult , however, the court found that the complaint failed to state a claim for conversion because plaintiff failed to plead that it was deprived of access to the deleted materials.  In this regard, the court stated that “just because one ‘deletes’ electronic files does not mean they cease to exist, therefore, “the employer should have to unequivocally allege in the complaint that, as a result of the deletion, it actually lost access to the files.  If such access was not lost, the employer has suffered no deprivation and, therefore, cannot maintain a claim for conversion.”  The court noted, for example, that the recipient of the e-mails should have electronic copies of the e-mails. Thus, the conversion claims was dismissed without prejudice and with leave to replead. The court sustained Plaintiff’s first cause of action, sounding in breach of fiduciary duty of loyalty based on the faithless servant doctrine.  The court stated the “well settled” law that “employees owe a fiduciary duty of loyalty to their employer during the course of their employment.” (Citations omitted.)  “Fundamental to relationship is the proposition that an employee is to be loyal to his employer and is prohibited from acting in any manner inconsistent with his agency or trust and is at all times bound to exercise the utmost good faith and loyalty in the performance of his duties.”  (Citations and internal quotation marks omitted.) An employee that breaches this duty is deemed a “faithless servant” that “forfeits the right to any compensation earned during the period of disloyalty.” (Citation omitted.)  A claim under the faithless servant doctrine is stated by an employer alleging that “a former employee, during the period of her employment and using company resources, secretly planned and organized a competing business.”  (Citations omitted.)  This Blog previously wrote about the faithless servant doctrine ( here ) and ( here ). Plaintiff’s cause of action against TCS for aiding and abetting the fiduciary duty breaches by YAI’s former employees was also sustained.  To allege such a claim, the complaint must state: “(1) a breach by a fiduciary of obligations to another, (2) that the defendant knowingly induced or participated in the breach, and (3) the plaintiff suffered damage as a result of the breach.” (Citations and internal quotation marks omitted.)  The court rejected TCS’s argument that the second element was not present in Young Adult.  The Young Adult complaint alleges that TCS’s senior management knew that some of the individual defendants were YAI employees, who “clearly knew that those employees were acting in TCS’s interests, and against YAI’s, in secret.”  Among other things, the complaint alleges that: TCS’s management did not typically communicate using e-mail so their plan would not be uncovered; the plan could have only originated with TCS; TCS provided substantial assistance to the breach by collaborating with YAI’s former employees by teleconference and otherwise; and, TCS secretly shared its separation plans with some of the individual defendants while they were still employed by YAI.  Based on the allegations in the complaint, the court found it “implausible to believe that the Former YAI Employees acted on their own and not at the direction of TCS.”  Therefore, plaintiff met its pleading burden under CPLR 3016(b) by alleging “facts that permit a reasonable inference of the TCS Defendants’ substantial assistance  to the Former YAI Employees’ breach.”   (Citations and internal quotation marks omitted.) Also interesting is the court’s discussion surrounding the dismissal of plaintiff’s claim for misappropriation of confidential information.  The court held that such a cause of action can only be sustained where the allegedly confidential information qualifies for trade secret protection.  This Blog previously discussed related issues ( here ) and will not be reiterated. TAKEAWAY There are appropriate ways to depart from your former employment and move to a competitor (particularly where, as here, no restrictive covenants exist).  The manner in which the defendants proceeded does not seem appropriate and was not favored by the court.

On April 9, 2018, Justice Shirley Werner Kornreich of the Supreme Court, New York County, Commercial Division granted a motion for summary judgment involving claims that the defendant owed the plaintiff nearly $3.5 million in connection with investment in more than 800 derivatives transactions over a four-year period. In granting the motion, Justice Kornreich had some harsh words about the strength of the defenses proffered in opposition to the motion. INTL FCStone Mkts., LLC v. Corrib Oil Co. Ltd., 2018 N.Y. Slip Op. 30646(U) (Sup. Ct., N.Y. County, Apr. 9, 2018) ( Here. ) Background Defendant Corrib Oil Co. Ltd. (“Corrob”) owed nearly $3.5 million to INTL FCStone Markets, LLC (“FCStone”). The debt arose from the investment in more than 800 derivatives transactions with FCStone, which Corrib made as a hedge on its exposure to oil price fluctuations. The trades were governed by an ISDA Master Agreement, Schedule, and Credit Support Annex, along with confirmations (“Confirmations”) governing each of the transactions. Until 2014, Corrib made money on the transactions because the price of oil increased. But in June 2014, the oil market crashed, and so too did Corrib’s positions on the trades. Margin calls followed. Corrib initially satisfied FCStone’s margin calls but, eventually, as Corrib’s positions went even more into the red, Corrib stopped making payments. Corrib first defaulted on a margin call in September 2015. It then defaulted on FCStone’s subsequent margin calls and payment demands. On December 11, 2015, FCStone declared an event of default under the Master Agreement and, on December 29, 2015, FCStone noticed an early termination. At that time, Corrib owed FCStone approximately $3.4 million on 59 trades. FCStone again demanded payment in May 2016, but Corrib did not pay. On June 24, 2016, FCStone commenced the action by filing a summons and motion for summary judgment in lieu of complaint. By order dated February 23, 2017, the Court denied the motion because FCStone failed to submit the Confirmations governing the trades. On March 15, 2017, Corrib filed an answer with counterclaims. At a preliminary conference conducted shortly thereafter, problems with the counterclaims were discussed. On April 17, 2017, Corrib filed an amended answer in which it asserted various counterclaims, including, but not limited to: breach of contract; breach of the implied covenant of good faith and fair dealing; fraud; and fraudulent inducement. At a compliance conference a few weeks later, the court stayed discovery because it became “apparent that Corrib’s defenses and counterclaims bordered on the frivolous.…” Corrib admitted that after production of the trade Confirmations, “it never objected to them,” it never had any written investment advisory agreement with FCStone, and, more importantly, Corrib had “no defense to nonpayment.” On August 7, 2017, FCStone filed a motion for summary judgment. The Court’s Decision As an initial matter, the Court observed that Corrib sought to avoid summary judgment (and, therefore, paying the money owed) on the strength of the “supposed merits of its counterclaims.” Those counterclaims, however, “have no merit,” said the Court. Consequently, the Court held that “ here is no question of fact regarding Corrib’s liability to FCStone.” There is no question of fact regarding Corrib’s liability to FCStone. Corrib does not dispute the occurrence of the subject transactions, that the Confirmations accurately reflect their terms, that FCStone’s margin calls were valid, that it failed to meet such margin calls, that FCStone was entitled to notice an early termination as a result, or that the amount due is $3,415,320.38 plus interest. Rather, Corrib seeks to avoid paying FCStone based on the supposed merits of its counterclaims. The counterclaims have no merit. Footnote omitted. Thereafter, the Court discussed the counterclaims/defenses to underscore the strength of its finding (i.e., that they “have no merit”). For example, with regard to Corrib’s claim that FCStone breached a duty to Corrib, the Court found that FCStone was neither a fiduciary nor an investment advisor for Corrib. Under the Schedule, the parties agreed that FCStone was “‘not acting as a fiduciary for or an advisor to ’” “and that Corrib was not relying on any advice from FCStone in deciding to enter into the Transitions.” In fact, said the Court, “the parties never executed any contract in which FCStone agreed to be Corrib’s financial adviser.” Consequently, Corrib could not claim that “FCStone breached duties arising from such an agreement, that FCStone negligently performed such duties, or that FCStone’s conduct amount to a breach of fiduciary duty.” Since the parties were not in a fiduciary relationship, the Court rejected Corrib’s argument that FCStone violated the Investment Advisers Act of 1940. In this regard, the Court noted that the transactions at issue were made at “arms’ length” and that FCStone did not receive any compensation for providing investment advice to Corrib. Instead, the Court found that FCStone “merely transacted with a counterparty on a securities trade.…” The Court rejected the fraud and fraudulent inducement defenses because Corrib could not show justifiable reliance on any purported misstatement. Noting that these defenses were based on alleged misrepresentations about the terms of the trades and FCStone’s promise not to serve as a counterparty, the Court found that the “terms of the trades set forth in the Confirmations, which clearly disclose that FCStone was the counterparty.” As such, Corrib could not claim any fraud or fraudulent inducement – Corrib could not claim “to have justifiably relied on a representation when that very representation negated by the terms of a contract.” Citations omitted. The Court also found that Corrib could not claim justifiable reliance on the alleged misrepresentations because it failed “to review and challenge terms of a Confirmation.” “Having failed to do so,” Corrib could not “claim it was justified in not noticing that terms in the Confirmations conflicted with oral assurances allegedly provided by FCStone.” Accordingly, the Court granted FCStone’s motion in its entirety. Takeaway INTL FCStone reinforces well-established legal principles about what it takes to plead, among other things, fraud and breach of fiduciary duty. On a practical level, however, the case is notable because it highlights the difficulties litigating a case in which the facts and the law are not favorable, and the Court informs the parties as such.

New York creditors often look to the Debtor and Creditor Law (the “DCL”), as well as the common law, to recover assets that have been (or may be) transferred by debtors to another party. Whether the debtor transfers assets with intent to defraud or without fair consideration, the DCL provides creditors with a number of remedies. The DCL in Brief Under Section 276 of the DCL, very conveyance made ... with actual intent ... to hinder, delay, or defraud either present or future creditors, is fraudulent.… In general, a party pleading a cause of action for fraudulent conveyance must allege specific facts, including, among other things, the identity of the specific transactions or conveyances that the plaintiff alleges were fraudulent. Syllman v. Calleo Dev. Corp., 290 A.D.2d 209, 210 (1st Dept. 2002); see CPLR 3016 (b). The burden of proving actual intent is on the party seeking to set aside the conveyance. Marine Midland Bank v. Murkoff , 120 A.D.2d 122, 126 (2d Dept. 1986); see also ACLI Gov’t Sec., Inc. Rhoades , 653 F. Supp. 1388, 1394 (S.D.N.Y. 1987). “Actual intent” to defraud must be proven by clear and convincing evidence. ACLI Gov’t Sec. , 653 F. Supp. at 1394. Since it is rarely susceptible to direct proof, actual intent is typically established through circumstantial evidence surrounding the allegedly fraudulent act. Consequently, courts allow creditors “to rely on badges of fraud to support his case, i.e. , circumstances so commonly associated with fraudulent transfers that their presence gives rise to an inference of intent.” Wall St. Assoc. v. Brodsky , 257 A.D.2d 526, 529 (1st Dept. 1999) (internal quotation marks and citations omitted). “Among such circumstances are: a close relationship between the parties to the alleged fraudulent transaction; a questionable transfer not in the usual course of business; inadequacy of the consideration; the transferor’s knowledge of the creditor’s claim and the inability to pay it; and retention of control of the property by the transferor after the conveyance.” Id. See also United Parcel Service v. Jay Norris Corp. , 102 Misc. 2d 231, 233 (Sup. Ct., Nassau Cty. 1979) (inference raised from the relationship of the parties to the transaction and the secrecy of the sale); Gafco, Inc. v. H.D.S. Mercantile Corp. , 47 Misc. 2d 661, 664 (Sup. Ct., N.Y. Cty. 1965) (“Inadequacy of consideration, secret or hurried transactions not in the usual mode of doing business, and the use of dummies or fictitious parties are common examples of ‘badges of fraud.’”). A conclusory allegation that the plaintiff has been defrauded is not sufficient. Syllman , 290 A.D.2d at 210. Under Section 273 of the DCL: very conveyance made … by a person who is or will be thereby rendered insolvent is fraudulent as to creditors without regard to actual intent if the conveyance is made … without a fair consideration. To establish a fraudulent conveyance under Section 273, the creditor must establish that: (1) the debtor made a conveyance; (2) the debtor was insolvent prior to the conveyance or rendered insolvent thereby; and (3) the conveyance was made without fair consideration. “A person is insolvent when the present fair salable value of his assets is less than the amount that will be required to pay his probable liability on his existing debts as they become absolute and matured.” DCL § 271(1). This is a “balance sheet test.” See In re Gordon Car & Truck Rental, Inc. , 59 B.R. 956, 961 (Bankr. N.D.N.Y. 1985). A debtor who transfers property without fair consideration is presumed to be insolvent. Fair consideration is deemed to have been given when: (1) the transferee conveys property in exchange for the transfer, or the transfer discharges an antecedent debt; (2) the property exchanged by the transferee is of “fair equivalent” value to the property transferred by the debtor; and (3) the transferee makes the exchange in “good faith.” See In re Sharp Intern. Corp. , 403 F.3d 43, 53–54 (2d Cir. 2005) (citing HBE Leasing v. Frank , 61 F.3d 1054, 1058–59 (2d Cir. 1995)) (“fair consideration” requires not only that the exchange be for equivalent value, but also that the conveyance be made in good faith). The burden of proving both insolvency and the lack of fair consideration is on the party challenging the conveyance and the determination of insolvency or what constitutes fair consideration is generally one of fact to be determined under the circumstances of the particular case. Matter of Am. Inv. Bank v. Marine Midland Bank , 191 A.D. 2d 690, 692 (2d. Dept. 1993) (citations omitted). (This Blog previously addressed the pleading standards here .) Carlyle, LLC v. Quik Park 1633 Garage LLC In Carlyle, LLC v. Quik Park 1633 Garage LLC , 2018 NY Slip Op. 02436 (1st Dept. Apr. 10, 2018) ( here ), the Appellate Division, First Department dismissed claims under DCL §§ 273 and 276 because the plaintiff failed to satisfy the burdens discussed above. Background Carlyle arose from Plaintiff’s attempt to recover approximately $2.5 million in damages allegedly suffered as a result of a fraudulent scheme to transfer and dispose of assets and monies for the purpose of thwarting Plaintiff’s ability to collect debts owed to it by Defendants, including a judgment in a related action. Plaintiff, Carlyle LLC, operates The Carlyle Hotel (the “Hotel”) pursuant to a commercial lease, under which it leases most of the building comprising the hotel and a parking garage adjoining the hotel (the “Garage”). Plaintiff subleased the Garage on December 7, 2001 (the “Sublease”) to non-party Beekman Garage LLC (“Beekman Garage”), an entity allegedly controlled by Defendant Rafael Llopiz (“Llopiz”), the principal and controlling member of Defendant Quik Park 1633 Garage LLC (“Quik Park 1633”). Pursuant to a written agreement, and with Plaintiff’s consent, Beekman Garage assigned its interest in the Sublease to non-party Quik Park Beekman LLC (“Quik Park Beekman”), an entity also allegedly controlled by Llopiz. On May 1, 2009, Plaintiff and Quik Park Beekman entered into a sublease modification and extension (“Sublease Extension”), which extended the term of the Sublease through April 30, 2016. On that same date, with Plaintiff’s consent, Quik Park Beekman assigned its interest under the Sublease to Quik Park Beekman II LLC (“Quik Park Beekman II”), another entity allegedly controlled by Llopiz. Under the Sublease Extension, Quik Park Beekman II was obligated to pay monthly rent to Plaintiff through April 30, 2016. Plaintiff alleged that it was never paid any rent. At the same time, the entities operating the Garage continued to collect revenues, in excess of $100,000 for each month the rent went unpaid. On July 24, 2013, Plaintiff terminated the Sublease, as well as any tenancy or occupancy of Quik Park 1633 in the Garage. Despite the termination, the various Quik Park-related entities and/or Defendant Quik Park 1633, continued to occupy the premises without paying any rent or compensation to Plaintiff until January 31, 2014, when they vacated the Garage. On August 7, 2013, Plaintiff commenced a related action, titled The Carlyle, LLC v. Beekman Garage LLC et al. , seeking unpaid rent, late fees on unpaid rent, and attorney’s fees. On October 14, 2015, the court entered a judgment against Beekman Garage, Quik Park Beekman and Quik Park Beekman II (the “Quik Park Entities”) for a little over $1.5 million. On September 3, 2013, Plaintiff commenced a holdover proceeding in New York Civil Court, titled The Carlyle LLC v. Quick Park Beekman II LLC et al. , seeking damages for post-lease-termination use and occupancy of the premises. The court granted summary judgment in Plaintiff’s favor on its possessory claims but did not determine a monetary award. Motion Court Proceedings In December 2015, Plaintiff filed suit in New York Supreme Court against Llopiz and Quik Park 1633 for, among other things, fraud, fraudulent conveyance, unjust enrichment and conversion. Plaintiff alleged that Defendants intentionally transferred all, or substantially all, of the funds out of the various Quik Park Entities and into certain shell entities and persons controlled by Llopiz, including Quik Park 1633. Plaintiff further alleged that those conveyances were made without fair or adequate consideration and rendered the Quik Park Entities insolvent, and thus incapable of paying the debts owed to Plaintiff. Defendants moved to dismiss the complaint arguing, inter alia , that Plaintiff failed to plead its fraudulent conveyance claims with the specificity required by CPLR 3016 (b). Among other things, Defendants contended that the complaint failed to identify any specific transfers or conveyances that were fraudulent or that were not supported by adequate consideration. The motion court sustained the fraudulent conveyance claims notwithstanding the fact that Plaintiff failed to identify the transactions alleged to be fraudulent. The court found that Plaintiff had alleged “enough facts to warrant further discovery as to whether, among other things, defendants wrongfully removed assets from any of the underlying judgment debtors.” The court cited to the following facts in support of its decision: “a close relationship between Llopiz and Quik Park 1633 on the one hand, and the various nonparty Quik Park Entities on the other,” payment to Plaintiff by Llopiz and/or Quik Park 1633, occupancy of the premises by Quik Park 1633, and the absence of sufficient assets by various Quik Park Entities to satisfy the judgments. In sustaining the fraudulent conveyance claims, the court also found dispositive facts drawn from information subpoenas that Plaintiff served on Defendants: First, the Responses indicate that the various Quik Park Entities had bank accounts into which, and from which, money from the operation of the garage was transferred. According to plaintiff, and not disputed by defendants, the Responses also indicate that the monies in such accounts were periodically transferred to a bank account in Quik Park 1633's name, controlled by Llopiz. The Responses further indicate that the Quik Park Entities closed their accounts at some point, and the companies are no longer operational. Further, the Responses state that Llopiz is a member of an unidentified entity which now owns the Quik Park Entities. Defendants appealed. here .=">here."> The First Department’s Decision The Court unanimously reversed the motion court’s decision to sustain the fraudulent conveyance claims. With regard to the claim under DCL § 276, the Court found that “plaintiff failed to allege fraudulent intent with the particularity required by CPLR 3016(b).” Citations omitted. The Court noted that “ he key allegations” in the complaint “were made ‘ pon information and belief,’ without identifying the source of the information.” Citation omitted. Additionally, “the timing of the allegedly fraudulent transfers — beginning two years before the judgment debtors incurred the subject debts — undermine the claim of fraudulent intent.” Citations omitted. Combined, these pleading failures sufficed to require dismissal of the fraudulent conveyance claims under DCL § 276. With regard to the claim under DCL § 273, the Court found that Plaintiff failed to meet its pleading burden, noting that the allegations concerning the absence of fair consideration, were also made on information and belief. Citation omitted. Accordingly, the Court reversed the denial of the motion with regard to the constructive fraudulent conveyance claims. Takeaway The purpose of the DCL is to protect creditors from fraudulent transactions entered into by debtors in attempt to shelter assets from the estate. To secure the protections under the DCL, creditors must comply with applicable pleading standards. The failure to meet these standards will result in the dismissal of the claim. Carlyle illustrates the importance of this point.

One of the first things students are taught in law school is that, to be valid, a contract must be supported by consideration.  In Reddy v. Mihos (April 17, 2017), the Appellate Division, First Department, analyzed the need for a guaranty to be supported by proper consideration. The plaintiff in Reddy was an experienced real estate investor. Defendant Mihos, an attorney, represented plaintiff in numerous real estate transactions over an extended period of time.  Plaintiff availed herself of an opportunity brought to her by Mihos, to make a $200,000.00 loan (the “Loan”) to a corporate borrower owned by another client of Mihos, defendant Hodzic.  The Loan was secured by a second mortgage on certain real property owned by borrower (the “Property”).  Borrower promptly defaulted in its payment obligations to plaintiff. After the default, Mihos alleges that plaintiff demanded that he repay the money loaned to the borrower and that borrower threatened to report him to the District Attorney. Plaintiff alleges that when confronted about borrower’s defaults, Mihos, on his own and without suggestion from plaintiff, prepared and delivered to plaintiff a written guaranty of the repayment of the Loan (the “Guaranty”).  The Guaranty provides: In the event plaintiff fails to receive the principal sum of $200,000.00 from , … Hodzic or otherwise, then in such event, I Evangelos Mihos…hereby guaranty to pay the principal sum of $200,000.00 to plaintiff on, or before, May 7, 2012. (Brackets in original omitted.) Ultimately, the Property was sold at a foreclosure sale and the proceeds were insufficient to pay down any portion of the Loan. When Mihos refused to make any payments to plaintiff under the Guaranty plaintiff commenced an action in Supreme Court against Mihos and Hodzic.  In her complaint, plaintiff asserted two malpractice causes of action against Mihos, a fraud claim against Mihos and Hodzic and a claim under the guaranty against Mihos.  In his answer, Mihos asserted among other affirmative defenses, that there was no consideration for the Guaranty. Plaintiff’s initial motion for summary judgment was denied. After Mihos’ deposition, plaintiff withdrew all causes of action except the claim seeking recovery under the Guaranty. On Plaintiff’s renewed motion for summary judgment, counsel urged that it could be inferred that the consideration for the Guaranty was plaintiff’s forbearance in reporting Mihos to the “Departmental Disciplinary Committee, as well as forbearing in bringing this lawsuit.”  Mihos cross-moved for summary dismissing the complaint for want of consideration for the Guaranty.  Supreme Court granted the motion and denied the cross-motion, holding that plaintiff implicitly agreed to forbear from, inter alia , pursuing legal action against Mihos during the term of the Guaranty. On Mihos’ appeal, the First Department reversed Supreme Court and dismissed plaintiff’s claim under the Guaranty, which it concluded was delivered without consideration. The First Department recognized that the Statute of Frauds requires that “a special promise to answer for the debt, default or miscarriage of another person” must be in writing and signed by the party to be charged.  ( GOL §5-701 (a)(2).)  In the instant case, the First Department found that “while the uaranty given by Mihos to plaintiff otherwise appears to satisfy the statute, it does not express, or even imply, any consideration for Mihos’s promise, whether by way of benefit to him or detriment to plaintiff.”  In dismissing the basis for Supreme Court’s ruling in favor of plaintiff, the First Department stated: It may be that, once the uaranty was given, plaintiff was unlikely to sue Mihos before it became due, but nothing stated in the uaranty bound her to refrain for the next two years from commencing an action against him on her common-law claims (which, as previously noted, she has now withdrawn).  Nor can any such commitment to forbear from suit be fairly inferred from the language of the guaranty….In the absence of such a binding promise by plaintiff, the uaranty is unenforceable for want of consideration. (Citations omitted.) The Court also noted that “an oral promise to guarantee the debt of another may be enforced notwithstanding General Obligations Law §5-701(a)(2), if the plaintiff proves the promise is supported by new consideration moving to the promisor and beneficial to him and that the promisor has become in the intention of the parties a principal debtor primarily liable.”  (Citation, internal quotation marks and brackets omitted.)  The First Department, however, found that plaintiff failed to offer any admissible evidence that she made any promise to forbear from suing Mihos prior to the due date of the guaranty. Absent any express or implied consideration given for the Guaranty, the Guaranty was unenforceable for want of consideration. Additionally, the Court discussed General Obligations Law §5-1105 , which provides: A promise in writing and signed by the promisor or by his agent shall not be denied effect as a valid contractual obligation on the ground that consideration for the promise is past or executed, if the consideration is expressed in the writing and is proved to have been given or performed and would be a valid consideration but for the time when it was given or performed. GOL § 5-1105 was held to be inapplicable because plaintiff never argued that the consideration for the Guaranty was the making of the Loan or any other of her prior actions and because the Guaranty does not expressly set forth, in writing, any prior consideration.

Recently, this Blog wrote about the law governing the theft or misappropriation of trade secrets. ( Here .) As noted in that post, with the exception of New York and Massachusetts, the protection of trade secrets is generally governed by the Uniform Trade Secrets Act (“UTSA”). In those two states, however, the protection of trade secrets is governed by the common law. Generally, trade secret owners have recourse only against the misappropriation of a trade secret. Misappropriation is the use of a trade secret without permission “to gain an advantage over plaintiff.” CBS Corp. v. Dumsday , 268 A.D.2d 350, 353 (1st Dept. 2000). Under the UTSA, misappropriation occurs when a trade secret is acquired by “improper means” or from someone who has acquired it through “improper means.” Theft, bribery, and misrepresentation are among the acts considered to be “improper means.” In New York, there is no case law explicitly defining “improper means”.  Instead, New York courts have looked to the Restatement of Torts to define the elements of the claim. See Ashland Mgmt. Inc. v. Janien , 82 N.Y.2d 395, 407 (1993) (adopting the Restatement definition of a trade secret). Under New York law, a trade secret is misappropriated if it was obtained through corporate espionage or other improper manner. “Improper manner” usually means conduct that “fall below the generally accepted standards of commercial morality and reasonable conduct.” Restatement of Torts § 757 cmt. f (1939). New York courts consider improper manner to include, among other things, physical violence, fraud or misrepresentation, civil suits and criminal prosecutions, and some degree of economic pressure. Guard-Life Corp. v. Parker Hardware Mfg. Corp. , 50 N.Y.2d 183, 191 (1980). In addition, a person or company can be guilty of misappropriation if the information was obtained through a breach of trust, e.g. , an employee steals trade secrets from his employer, gives the information to another company, and that company uses the secrets even though it has obtained the information without permission. “Improper manner” was the subject of an April 3, 2018, decision issued by the Appellate Division, First Department in which the Court held that a theft of trade secrets claim should have been dismissed for failure to allege the use of improper means in obtaining the trade secrets. BGC Partners, Inc. v. Avison Young (Canada) Inc. , 2018 N.Y. Slip Op. 02290 (1st Dept. Apr. 3, 2018). BGC Partners, Inc. v. Avison Young (Canada) Inc. Background BGC Partners arose out of the acquisition by Plaintiffs, BGC Partners (“BGC”) and its indirect subsidiary, G&E Acquisition Company, LLC (“G&E Acquisition”), of certain assets and causes of action possessed by Grub & Ellis Company (“G&E”), one of the oldest and largest real estate brokerages in the United States. Plaintiffs alleged that Defendant, Avison Young (“AY”), one of Canada’s largest real estate brokerage firms, and its United States affiliates, embarked upon an aggressive expansion campaign in the U.S., by targeting and stealing G&E’s personnel, offices, trade secrets, and business opportunities. Defendants did so, according to Plaintiffs, through a variety of tortious and illegal means, including: (i) inducing dozens of G&E affiliates and brokers to breach their employment or independent contractor agreements; (ii) using improper means to misappropriate G&E’s trade secrets; and (iii) inducing and assisting larceny by these same brokers and affiliates by rewarding them—with full knowledge or recklessness to the consequences—for concealing and stealing trade secrets and business opportunities that belonged to G&E. In particular, Plaintiffs alleged that the improper means used by Defendants included: offering excessive incentives to G&E’s affiliates in Nevada and South Carolina to breach their Affiliate Agreements; offering excessive compensation packages to former G&E brokers – packages that were designed to incentivize brokers to conceal their in-progress deals from Plaintiffs; and providing brokers with up to 95% commission splits for transactions closed in the first few months after commencing employment with AY, as opposed to the industry standard split of about 60%. Plaintiffs alleged that Defendants induced at least 41 brokers to leave their employ with G&E. Motion Court Proceedings Defendants moved to dismiss the action in its entirety. The court granted the motion as to the claims for tortious interference, conspiracy, aiding and abetting breach of fiduciary duty and unjust enrichment, but denied it as to the claims for theft of trade secrets, aiding and abetting breach of the duty of fidelity, and injunctive relief. With regard to the claim for theft of trade secrets, the court found that Plaintiffs’ “customer list and other customer-specific data protectable as trade secrets.” The court noted that Plaintiffs acquired the customer information, which was not readily ascertainable, “through cultivation of long-standing relationships; that the customer information included not just names but specific customer data such as preferences about properties and locations; and that plaintiffs took reasonable steps to maintain its secrecy through the use of confidentiality agreements.” The court also found that Defendants used improper means to obtain the trade secrets.  They did so by inducing the affiliates and brokers to breach confidentiality agreements that protected customer lists and other information about customer preferences and histories and engaged in a scheme to deprive plaintiffs of commissions and business opportunities. “These allegations,” held the court, were “sufficient to plead improper means.” Citations omitted. In sustaining the claim, the court rejected Defendants’ argument that the type of conduct meant by improper manner is “limited to ‘industrial espionage.’” While “industrial espionage may undoubtedly support a claim for misappropriation of trade secrets <,> ” the court noted that “other tortious and wrongful acts, whether or not considered espionage, may constitute improper means.” As noted, the court found that Plaintiffs adequately pled “improper means by alleging that defendants paid the G&E brokers to induce them to violate their confidentiality agreements and to disclose plaintiffs’ trade secrets to defendants in order to divert plaintiffs’ business opportunities.” Plaintiffs appealed. The First Department’s Decision The First Department unanimously reversed the motion court’s order granting the motion to dismiss as to the theft of trade secrets, aiding and abetting breach of the duty of fidelity and injunctive relief causes of action, and otherwise affirmed the remainder of the decision. As to the claim for the misappropriation of trade secrets, the Court held that it should have been dismissed, finding that the means used to obtain the customer lists were not improper. In this regard, the Court noted that offering the brokers “competitive compensation” is not wrongful. Takeaway BGC Partners teaches that pleading an improper manner is not as easy as it seems. The plaintiff must show that the conduct used to misappropriate the trade secret was wrongful. Conduct that is considered customary or acceptable within the subject industry – such as offering lucrative compensation packages as an incentive to convince a broker to join another firm – is not wrongful or improper. More is needed.

It is not uncommon for drafters of contracts and statutes to use the word “notwithstanding” to establish precedence over other provisions in the document. Cisneros v. Alpine Ridge Group , 508 U.S. 10, 18 (1993) (The “use of . . . a ‘notwithstanding’ clause … signals the drafter’s intention that the provisions of the ‘notwithstanding’ section override conflicting provisions of any other section.”).  As such, the word “notwithstanding” is considered to be a trumping word that “controls over any contrary language.” Handlebar, Inc. v. Utica First Ins. Co. , 290 A.D.2d 633, 635 (3d Dept. 2002), lv. denied , 98 N.Y.2d 601 (2002); see also Bank of N.Y. v. First Millennium, Inc. , 607 F.3d 905, 917 (2d Cir 2010) (“This Court has recognized many times that under New York law, clauses similar to the phrase ‘(n)otwithstanding any other provision’ trump conflicting contract terms”); In re Gulf Oil/Cities Serv. Tender Offer Litig. , 725 F. Supp. 712, 729-30 (S.D.N.Y. 1989) (contract provision containing language “notwithstanding any other provision” explicitly overrides contrary provision). The effect of a “notwithstanding” clause will prevail “even if other provisions of the contract[ ] might seem to require . . . a result.” Cisneros , 508 U.S. at 18-19. On April 5, 2018, the Appellate Division, First Department, issued a decision in Veneto Hotel & Casino, S.A. v. German American Capital Corp. , 2018 NY Slip Op. 02414 ( here ), holding that a “notwithstanding” clause trumped a conflicting provision in the contract under review. Veneto Hotel & Casino, S.A. v. German American Capital Corp. Background The case arose from a 2007 loan and security agreement (the “Loan Agreement”) between the Plaintiff, Veneto Hotel & Casino, S.A. (“Veneto”), a Panamanian corporation that owns the Veneto Hotel & Casino in Panama City (the “Hotel”), and the Defendant, German American Capital Corp. (“GACC”), pursuant to which GACC loaned money to Veneto (the “Loan”). In June 2009, March 2010 and August 2012, the parties modified the Loan Agreement (the “First Amendment,” the “Second Amendment” and the “Third Amendment”) (collectively, the “Amendments”). Pursuant to the Loan Agreement and the Amendments, Veneto established an account into which the revenues from the Hotel’s operations were deposited each day (the “Holding Account”) by the account trustee, HSBC Bank (the “Account Trustee”). As long as no event of default had occurred or was continuing, the funds were to be distributed in a pre-determined order to certain other accounts. (Loan Agreement at § 3.1.7 - .) After the first four accounts were funded — i.e. , for any taxes, insurance, interest payments on the Loan, and franchise fees — funds sufficient to meet the Hotel’s operating expenses for the next month were to be deposited in Veneto’s account and any funds remaining were to go to Veneto. (Loan Agreement at § 3.1.7 - .) In the event of a default, additional accounts were to be funded before any remaining money would reach Veneto. ( Id . at 3.1.7 - .) In the Second Amendment, Section 3.1.7(a)(v) was modified such that Veneto’s operating expenses were to be included in the accounts funded from the Holding Account only after an event of default. By letter dated January 14, 2015, GACC notified Veneto that the latter had defaulted on its obligations (the “Default Notice”). Subsequently, by letter dated January 30, 2015, GACC notified Veneto that it had accelerated the Loan, and, as such, the full outstanding balance on the Loan was immediately due and payable (the “Acceleration Notice”). On January 30, 2015, GACC instructed the Account Trustee to stop providing Veneto with funds from the Holding Account. Veneto claimed that, as a result, it has been unable to pay its operating expenses, including wages and taxes, which led to the suspension of its gambling license. Motion Court Proceedings Plaintiffs commenced the action on June 1, 2015, asserting claims for: (1) a declaratory judgment that GACC was obligated to fund the Hotel’s post-default operations; (2) breach of the Loan Agreement and the Amendments; (3) rescission of the Second and Third Amendments due to mutual mistake; (4) fraud as to Veneto; (5) breach of the covenant of good faith and fair dealing implied in the Loan Agreement and Amendments; (6) breach of GACC’s fiduciary duty to Veneto; (7) permanent equitable relief ordering GACC to withdraw the Default Notice and Acceleration Notice and to perform its obligations under the Loan Agreement; (8) breach of the subordination of management agreement between Veneto and co-plaintiff, SE Leisure Management LLC; and (9) breach of the covenant of good faith and fair dealing implied in the subordination of management agreement. GACC moved to dismiss the complaint. GACC contended that Section 3.1.11(a) of the Loan Agreement gave it the discretion to direct the Account Trustee not to transfer funds to Veneto. GACC also argued that the “notwithstanding” clause in Section 3.1.11(a) trumped the obligations in Section 3.1.7(a) – i.e. ,  because the Loan Agreement defined “Obligations” as “all indebtedness, obligations and liabilities” Veneto owed GACC under the Loan Agreement, Section 3.1.11 allowed it to, upon an event of default, override the standard flow of funds prescribed in Section 3.1.7(a) and instead retain these funds for itself. Veneto claimed that, under Section 3.1.7(a)(v) of the Loan Agreement, GACC was obligated, post-default, to fund the Hotel’s operating expenses. Veneto also argued that Section 3.1.11(a)’s “notwithstanding” language did not apply to Section 3.1.7(a)(v) because that provision was modified in the Second Amendment, and the “notwithstanding” language did not apply to modifications by subsequent Amendments. The motion court found “Veneto’s arguments unavailing.” ( Here .) The court noted that the Second Amendment specifically recognized that “‘ xcept as amended by this Second Amendment, the Loan Agreement and each of the other Loan Documents shall continue to remain in full force and effect.’” Since “the Loan Agreement contemplated that GACC could alter or ignore the pre-determined waterfall distribution post-default if there were unpaid obligations, the amendment of Section 3.1.7(a)(v) to move it from one category to another not change Section 3.1.11’s dominance.” Thus, found the court, “GACC’s refusal to fund Veneto’s operating expenses post-default was an appropriate exercise of its authority under the Loan Agreement.” Veneto appealed the dismissal of two claims: the breach of Loan Agreement and the Amendments, and breach of the covenant of good faith and fair dealing implied in the Loan Agreement and Amendments. The First Department’s Decision The First Department “unanimously affirmed” the dismissal. The Court found that the breach of contract claim, which was “based on defendant’s alleged breach of section 3.1.7(a)(v) of the parties’ loan agreement<,> was properly dismissed.” According to the Court, “ fair reading of the loan agreement and amendments reveal that was not obligated to apply its security to fund … Veneto’s expenses following an ‘Event of Default.’” The Court observed that Section 3.1.7 of the Loan Agreement only required the Account Trustee to follow the directions provided by GACC to it, “both when Veneto was in default and when it was not.” When read together with Section 3.1.11(a), said the Court, “it is clear that defendant had ‘sole and absolute’ discretion regarding whether it would pay for Veneto’s operating expenses from the Holding Account following an Event of Default.” The Court concluded that “Section 3.1.7(a)(v) does not supersede section 3.1.11(a), either expressly or impliedly, as it is clear that sections 3.1.7 and 3.1.11(a) work together and do not conflict.” As to the “notwithstanding” clause, the Court found that “even if section 3.1.7(v) could be interpreted to be inconsistent with section 3.1.11(a), section 3.1.11(a) would still prevail” because of the “trumping” language found within that section. Citing Warberg Opportunistic Trading Fund, L.P. v. GeoResources, Inc. , 112 A.D.3d 78, 83 (1st Dept. 2013). Section 3.1.11 provided “that it would apply ‘notwithstanding anything to the contrary’ in the Loan Agreement.” Thus, held the Court, “Defendant acted within the authority and discretion provided to it under section 3.1.11(a).” Takeaway The principles governing contract interpretation are familiar. When parties to a contract “set down their agreement in a clear, complete document,” their intention will be determined “from the four corners of the instrument and will be enforced according to its terms.” See Vermont Teddy Bear Co. v. 538 Madison Realty Co. , 1 N.Y.3d 470, 475 (2004); W.W.W. Assoc. v. Giancontieri , 77 N.Y.2d 157, 162 (1990). Importantly, when interpreting a contract, courts should not render any portion of the agreement meaningless. Beal Sav. Bank v. Sommer , 8 N.Y.3d 318, 324 (2007); God’s Battalion of Prayer Pentecostal Church, Inc. v. Miele Assoc., LLP , 6 N.Y.3d 371, 374 (2006); Excess Ins. Co. , 3 N.Y.3d at 582. For this reason, courts will read a contract “as a whole,” interpreting “every part … with reference to the whole.” Matter of Westmoreland Coal Co. v. Entech, Inc. , 100 N.Y.2d 352, 358 (2003). As such, courts will enforce a trumping clause according to its terms when it comports with the intention of the parties. See Bank of N.Y. Mellon Trust Co., N.A. v. Merrill Lynch Capital Servs. Inc. , 99 A.D.3d 626, 628 (1st Dept. 2012). Veneto teaches that these fundamental principles remain well entrenched in New York law. In Veneto , the contract language was clear. And, to the extent there was a dispute over the effect of the trumping language in Section 3.1.11(a), the Court left no doubt that such language should be enforced pursuant to its terms, even where the effect of the “notwithstanding” clause contradicts other provisions of the contract and would “require ... a result.” Cisneros , 508 U.S. at 18.

Sometimes in litigation, the facts get in the way of the desired results.  Such was the case for the defendant in Age Group, Ltd. v. Martha Stewart Living Omnimedia, Inc. (April 12, 2018), in which the First Department affirmed Supreme Court’s denial of defendant’s motion for summary judgment seeking to dismiss plaintiff’s causes of action sounding in breach of contract and breach of the implied covenant of good faith and fair dealing. The facts are set forth in Supreme Court’s Decision and Order (Kornreich, J).  Briefly stated, defendant, Martha Stewart Living Omnimedia, Inc. (“MSLO”), and plaintiff, Age Group, Ltd. (“AGE”), entered into a four-year licensing agreement (the “MSLO Agreement”) to market, manufacture and sell Martha Stewart branded pet products to pre-approved distributors.  In furtherance thereof, AGE entered into a four-year agreement with PetSmart (temporally coincident with the MSLO Agreement) (the “PetSmart Agreement”), pursuant to which PetSmart was to purchase MSLO Pet Products from AGE.  If the MSLO agreement was not renewed at the end of its term, AGE would not be permitted to sell pet products to PetSmart or other distributors.  The MSLO Agreement expired by its terms on December 31, 2013 and was not extended. AGE alleged that, as a result of MSLO’s realization that it “grossly undervalued the profit potential of its et roducts”, “MSLO interfered with ability to timely produce et roducts so that PetSmart would grow frustrated with and ultimately wish to contract directly MSLO” after the PetSmart Agreement ended.  MSLO’s plan, AGE argued, would frustrate the purpose of the MSLO Agreement, which was to “maximize[] revenue in the first four years and develop[] a long term profitable relationship.” In addition, it was alleged that MSLO not only refused to approve AGE’s designs, it improperly injected itself into the design and pricing of the pet products – duties that were within AGE’s province.  MSLO allegedly designed “overpriced” and “inferior” products and then blamed AGE.  According to AGE, MSLO’s actions were intended to frustrate AGE’s performance and to make it appear that AGE “lacked the capacity to deliver quality, low price et roducts, using this outcome to convince PetSmart that it should cut out of the process before the expiration of the MSLO Agreement.” (Some brackets in original.)  In this regard, AGE claims that MSLO unilaterally promised PetSmart designs that could not be manufactured at a price acceptable to PetSmart and vetted those designs with PetSmart without participation from AGE.  MSLO also sent PetSmart disparaging e-mails about AGE. Finally, as a result of some pressure from PetSmart, it is alleged that MSLO frustrated AGE’s ability to sell pet products to any other contractually approved retailer by, inter alia , indicating that it would reject any designs for pet products that AGE intended to sell to retailers other than PetSmart. Supreme Court, for the most part, denied MSLO’s summary judgment motion.  Regarding the covenant of good faith and fair dealing claim, Supreme Court held that there were factual issues precluding summary judgment, including “whether MSLO’s statement that, despite the MSLO Agreement permitting AGE to design and sell et roducts to certain retailers other than PetSmart, MSLO breached its implied covenant of good faith and fair dealing by declaring that it would not approve Pet Products for retailers other than PetSmart.” (Citation omitted.) The First Department unanimously affirmed Supreme Court.  As to MSLO good faith, the Court stated: The court correctly found that issues of fact exist as to whether defendant breached the agreement by saying that it would not approve any new designs.  While defendant was permitted to refuse any design on subjective grounds such as personal taste and sensibilities, it was nevertheless obligated to exercise its refusal in good faith, based on dissatisfaction genuinely and honestly arrived at.  The examination of such a state of mind is for a jury. (Citations omitted.) As to damages, the First Department agreed with Supreme Court that “plaintiff may recover lost profits, since plaintiff submitted evidence supporting its claim that such damages were caused by defendant’s alleged breach of the parties’ contract, are capable of proof with reasonable certainty, and were fairly within the contemplation of the parties at the time the contract was made.” (Citations omitted.) TAKEAWAY The factual allegations in the AGE case strongly suggest that MSLO sought to frustrate AGE’s ability to realize the benefit of its bargain.  Allegations of such bad faith tactics are sufficient to preclude summary judgment in favor of the allegedly breaching party. This BLOG has previously treated the covenant of good faith and fair dealing < here =">here"> and < here =">here"> .

The Securities and Exchange Commission (“SEC”) has been busy so far this spring. In the latest roundup, this Blog looks at enforcement actions taken by the SEC against investment advisors, a medical device company and a purported cryptocurrency company. SEC Charges Medical Device Company and Founder with Fraud for Failing to Make Disclosures and Misappropriating Investor Funds On April 5, 2018, the SEC announced (here) that it had charged convicted felon and former NHL team owner Peter H. Pocklington (“Pocklington”), his medical device company, and others with defrauding investors by hiding Pocklington’s recidivist history and by misappropriating investor funds. In its complaint (here), the SEC alleged that in 2010, Pocklington pleaded guilty to a federal felony perjury charge and was later ordered to pay over $5 million as part of a settlement for unrelated state securities fraud and registration charges. Thereafter, Pocklington founded The Eye Machine LLC (now known as Nova Oculus Partners LLC), a California-based medical device company that raised over $14 million between 2014 and 2017 from more than 260 investors in unregistered offerings. According to the SEC, Pocklington and his attorney, Lantson E. Eldred (“Eldred”), structured the ownership of The Eye Machine to conceal Pocklington’s role with the company and held Eldred out as the company’s “visual front.” In the offerings, Pocklington, Eldred, and The Eye Machine allegedly failed to disclose Pocklington’s criminal history and involvement in the company, and misrepresented how investor funds would be spent. Pocklington allegedly misappropriated over $600,000 of investor funds for personal use, including funding his gold mining companies and paying personal legal and credit card bills. The SEC also alleged that The Eye Machine paid millions of dollars in undisclosed and excessive sales commissions to defendants Yolanda C. Velazquez, Vanessa Puleo, and Robert A. Vanetten, who acted as unregistered brokers for the company. According to the complaint, Velazquez – whom the SEC previously barred from acting as a broker-dealer (here) – and Puleo used “boiler room” operations in Florida to “cold call” investors. “Investors should know when a recidivist plays a central role in a company’s operations and offerings,” said Michele W. Layne, Director of the SEC’s Los Angeles Regional Office. “Investors should research the background of anyone offering an investment, but they can only do this if the offering accurately and adequately discloses the individuals involved.” The SEC filed its complaint in federal court in California. In the complaint, the SEC charged: 1) The Eye Machine, Pocklington, and Eldred with violating the antifraud and securities registration provisions of the federal securities laws; 2) The Eye Machine’s majority shareholder, AMC Holdings, LLC, and Terrence J. Walton, The Eye Machine’s in-house accountant, with securities fraud violations; 3) Velazquez, Puleo, and Vanetten with broker-dealer registration and securities registration violations; and 4) Velazquez with violating a prior SEC order barring her from associating with a broker-dealer. The SEC seeks injunctive relief, disgorgement and interest, and penalties. SEC v. Pocklington, Case No. 5:18-cv-00701 (C.D. Cal. Apr. 5, 2018). Investment Advisers Settle Charges for Breaching Fiduciary Duties; Agree to Pay $12 Million to Injured Clients On April 6, 2018, the SEC announced that three investment advisers had settled charges for breaching their fiduciary duties to clients, which generated millions of dollars in improper fees. (Here.) In three separate orders (here, here and here), the SEC claimed that PNC Investments LLC (“PNCI”), Securities America Advisors Inc. (“SAA”), and Geneos Wealth Management Inc. (“Geneos”) failed to disclose conflicts of interest and violated their duty to seek best execution by investing advisory clients in higher-cost mutual fund shares when lower-cost shares of the same funds were available. The SEC also charged Geneos for failing to identify its revised mutual fund selection disclosures as a “material change” in its 2017 disclosure brochure. Collectively, the firms agreed to pay almost $15 million, with more than $12 million going to harmed clients. “These disclosure failures cause real harm to clients,” said C. Dabney O’Riordan, Co-Chief of the Asset Management Unit. “We strongly encourage eligible firms to participate in the recently announced Share Class Selection Disclosure Initiative as part of an effort to stop these violations and return money to harmed investors as quickly as possible.” The Share Class Selection Disclosure Initiative (discussed by this Blog here) gives eligible advisers until June 12, 2018, to self-report share selection misconduct and take advantage of the SEC’s willingness to recommend more favorable settlement terms, including no civil penalties against the adviser. (The SEC announcement of the SCSDI can be found here.) The SEC also found that PNCI and Geneos failed to disclose the conflict of interest associated with compensation they received from third parties for investing clients in particular mutual funds, and that PNCI improperly charged advisory fees to client accounts for periods when there was no assigned investment advisory representative. In the orders, the SEC concluded that PNCI, SAA, and Geneos each violated the Investment Advisers Act of 1940. Without admitting or denying the findings, the advisers each consented to a cease-and-desist order and a censure. The orders require PNCI to pay $6,407,770 in disgorgement and prejudgment interest along with a $900,000 penalty. SAA agreed to pay $5,053,448 in disgorgement and prejudgment interest along with a $775,000 penalty. Geneos agreed to pay $1,558,121 in disgorgement and prejudgment interest along with a $250,000 penalty.

Commercial litigation involving mortgage-backed securities (MBS) cases can be complex and labor-intensive. Attorneys handling MBS cases often must follow intricate and multiple transactions involving many players, including securities issuers, securities underwriters, loan originators, credit-rating agencies, due-diligence service providers, and insurers. Litigators must review the numerous factors and issues in each of the MBS disputes to determine liability and damages. Below are some of the common issues that we see arising in many of the MBS cases. What are Mortgage-Backed Securities? It helps to understand how mortgage-backed securities (MBS) are created and how they relate to real estate. MBS are bonds that are secured by real estate loans. RMBS (residential mortgage-backed securities) were a popular type of bond issued before the financial crisis in 2008. To create an MBS, a lender pools a number of loans together that have similar characteristics. That pool is then sold to a securities firm, a federal government agency, or a government-sponsored enterprise to be used as collateral for an MBS. Investors in an MBS benefit from the cash flow generated from the pooled mortgages. As mortgage holders pay their mortgage payments, investors receive payments, usually monthly payments, of interest and principal. Many industry experts viewed these securitizations as a factor in the financial crisis of 2008 as these securities failed to generate money when people stopped paying their mortgages. Therefore, this led to a sizeable number of lawsuits regarding various issues related to mortgage-backed securities. What Issues are Being Raised in MBS Cases? One of the common allegations in these cases is that the banks holding mortgages submitted documentation for an MBS that contained false or misleading information.  In some cases, it is alleged that the banks omitted key information from the documents about the mortgages within the pool. For instance, a bank would not include accurate information about its underwriting process, including how it valued property used as collateral for mortgages and determined if borrowers were actually qualified to borrow the sums being loaned to them. When a bank’s underwriting process is faulty, it can create a pool of mortgages that do not have the quality required to secure the MBS properly. These MBS cases often contain allegations of negligent misrepresentation, fraud, and unjust enrichment. Another issue in MBS cases is statute of limitations problems. Many defendants are arguing that the statute of limitations for bringing these actions have expired. Once a statute of limitations expires, the plaintiff is barred by law from pursuing the defendant for that cause of action. If the court rules in favor of defendants asserting statute of limitations problems, the plaintiffs who lost billions of dollars may not be able to hold credit-reporting agencies, banks, and mortgage lenders liable for misrepresenting the quality of pooled mortgages. Many of the MBS plaintiffs have been able to overcome this issue, but defense attorneys continue to argue statute of limitations as a defense in MBS cases. Another common allegation in MBS cases is that investment banks knew problems were developing in the MBS markets. However, the banks were more interested in the profits being generated by mortgage securities. Therefore, many banks began to ignore or failed to conduct due diligence. These banks failed to disclose these problems and risks to potential investors as they marketed MBS as investment opportunities. Instead, the banks profited on mortgages they knew were likely to fail. MBS Litigation Continues Many MBS lawsuits have settled without going to trial; however, MBS litigation continues as investors seek to recover money they lost by investing in mortgage-backed securities. Schedule a consult with the experienced commercial litigators at Freiberger Haber LLP today to discuss your legal options.