This Blog previously wrote about a case involving a whistleblower’s claim, under the “alternate remedy” provision of Section 3730(c)(5) of the False Claims Act (“FCA”), to settlement proceeds obtained in a later-filed action brought by the government even though the whistleblower had voluntarily dismissed his earlier qui tam action. Earlier this month, Judge William H. Pauley, III had the opportunity to address the issue in United States ex rel. Kolchinsky v. Moody’s Corp ., 12-cv-1399 (S.D.N.Y. Mar. 2, 2017), a qui tam action brought by a former Moody’s Corp. (“Moody’s”) managing director who claimed that Moody’s sold subscriptions for its ratings delivery service to the government, which contained false ratings. Kolchinsky filed the action in February 2012, asserting numerous violations of the FCA. The common thread among the claims was that, prior to 2009, Moody’s issued credit ratings that a) were improperly inflated or deflated; b) entered the financial markets through various channels; and affected certain governmental entities relying on the quality of those ratings. After two years of investigation, the government declined to intervene. Following protracted settlement discussions, Kolchinsky amended his complaint in May 2015. The amended complaint largely tracked the original complaint. The Court granted Moody’s motion to dismiss, finding that all but one of the claims alleged in the amended complaint failed to establish that Moody’s sought payment from the government, as opposed to payment from private entities. As to the surviving claim ( i.e. , the ratings delivery service claim), the Court gave Kolchinsky leave to replead it. Thereafter, Kolchinsky filed a second amended complaint, which was essentially the same as his prior complaints. Judge Pauley once again dismissed the complaint. In doing so, the court found that the government was on notice of the facts Kolchinsky relied upon to support the fraud alleged in his second amended complaint. And, as that complaint established, the government nonetheless continued to pay Moody’s for its credit-ratings products. “Such allegations plead Kolchinsky out of court, because,” as the Supreme Court explained in Universal Health Servs., Inc. v. United States , 136 S. Ct. 1989, 1996 (2016) (discussed here ), “when the ‘Government pays a particular claim in full despite its actual knowledge that certain requirements were violated, that is very strong evidence that those requirements are not material.’” (quoting Escobar , 136 S. Ct. at 2003–40). Judge Pauley found that Kolchinsky failed to allege any facts giving rise to an inference that any listed agency could have been unaware of the alleged fraud during the proscribed time period. Having disposed of the second amended complaint, Judge Pauley addressed Kolchinsky’s claimed entitlement to a portion of a $864 million settlement among Moody’s, the Department of Justice, several states, and the District of Columbia relating to violations of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (“FIRREA”) and parallel state laws. Noting the harshness of the result, Judge Pauley found that the absence of a viable complaint at the time of the “related” action negated any entitlement to alternate-source relief: No alternate remedy is available here, however, because the Second Amended Complaint fails to state a valid FCA claim as a matter of law. Nor is the alleged “overlap” between Kolchinsky’s allegations and those described in the settlement agreement a basis for recovery by Kolchinsky. Even if a timely variant of Kolchinsky’s Ratings Delivery Service theory could have formed a basis for the settlement, that theory did not appear in his initial pleading, which was the basis on which the Government declined to intervene. Indeed, at least two of the “state cases” that formed the basis for the Government’s settlement occurred in the years before Kolchinsky’s first complaint was filed under seal. Kolchinsky is not entitled to the proceeds of a settled action he did not initiate. This Court acknowledges that this a harsh result. The role of a whistleblower is never an easy one. Kolchinsky provided enormously helpful information to various congressional committees and government investigators. This Court is particularly sympathetic to Kolchinsky’s position in light of the serious and far-reaching effects that Moody’s conduct had on the American economy. This observation does not, however, cure the deficiencies in Kolchinsky’s pleadings or enable him to collect a share of the FIRREA settlement. Internal citations omitted.

Medicare and Medicaid fraud costs taxpayers billions of dollars each year.  In 2016, the Government Accountability Office (“GAO”) estimated that in fiscal year 2015, taxpayers lost almost $90 billion to improper payments from Medicare and Medicaid providers.  The GAO defines an improper payment to be any payment that should not have been made or that was made in an incorrect amount (including overpayments and underpayments) under statutory, contractual, administrative, or other legally applicable requirements. It is estimated that fraud and abuse account for approximately 10% of all Medicare and Medicaid expenditures annually. Unfortunately, the government’s resources dedicated to anti-fraud enforcement are limited. However, whistleblowers – those willing to risk career, financial security, reputation and sometimes personal safety to report fraud on the government – can increase the power and impact of those resources significantly. Earlier this month, the Department of Justice (“DOJ”) announced the filing of criminal and civil actions relating to a 12-year scheme to defraud Medicaid, Medicare, and private health insurance companies out of more than $50 million. The DOJ civil action joins (through intervention) a pending qui tam action that was previously filed under seal. According to the DOJ, Dr. Asim Hameedi (“Hameedi”), a New York cardiologist, and Dr. Emad Soliman (“Soliman”), a New York neurologist, were arrested and charged in the scheme to defraud. Also charged were four employees or associates of City Medical Associates, P.C. (“CMA”), a clinic operated by Hameedi. All defendants are facing criminal charges for their roles in submitting false insurance claims to defraud Medicaid, Medicare and private health insurance companies. According to the DOJ, between 2003 and 2015, the defendants perpetrated their fraud by, among other things: (1) making false representations to insurance providers, including providers paid through Medicaid and Medicare, about the medical condition of patients in order to obtain pre-authorization for medical tests and procedures; (2) submitting false claims to insurance providers for tests and procedures that were not performed and/or medically unnecessary, as well as for drug items not used or provided; (3) paying kickbacks to local primary care medical offices in exchange for referrals from these offices; and (4) accessing, without authorization, electronic health records of patients at a hospital based on Long Island, New York (“Hospital-1”), in violation of the Health Insurance Portability and Accountability Act of 1996, in order to identify patients to be recruited to CMA. In furtherance of the scheme, and to hide from the insurance companies the huge volume of claims, including fraudulent claims, being submitted by CMA, Hameedi, and others submitted claims to the insurance companies falsely representing that medical tests had been ordered or performed by doctors who did not work at CMA and who had not ordered or performed the tests.  These doctors included Soliman, who knowingly participated in the scheme to allow CMA to submit false claims to the insurance companies in his name, as well as two other doctors who did not know that their identities were being used to further the fraud. In addition, Hameedi and others used various unlawful means to obtain and maintain a high volume of patients for use in the fraudulent scheme, including, among other things, paying kickbacks to local primary care offices and practitioners in exchange for referrals of patients by those offices and practitioners to CMA.  Moreover, Hameedi and employees of CMA repeatedly, and without authorization, accessed information in electronic health records of patients of Hospital-1 to identify and recruit them to CMA and Hameedi’s practice. “Public health insurance programs, like Medicare and Medicaid, are not a personal pocketbook for criminals seeking to exploit a program designed to help those who need these programs the most,” FBI official William F. Sweeney Jr. said in a statement. HHS-OIG Special Agent-in-Charge Scott J. Lampert added: “Health care fraud schemes like the one alleged here loot government health programs, compromise patient well-being, and undermine the public’s trust in the health profession.  You can bet our agents will continue to thoroughly investigate such allegations and hold fraudsters accountable for their crimes.” In the fraud action filed against CMA and Hameedi, among others, the government is seeking treble damages and civil penalties under the False Claims Act for the fraudulent claims submitted to Medicare and Medicaid for reimbursement by CMA. The criminal case is U.S. v. Asim Hameedi et al. , No. 17-cr-00137 (S.D.N.Y.). The civil case is U.S. ex rel. Dr. Patricia A. Kelley et al. v. City Medical Associates et al. , No. 1:15-cv-07261 (S.D.N.Y.).

The Department of Justice ("DOJ") recently announced that CA Technologies ("CA") has agreed to pay $45 million to resolve allegations under the False Claims Act related to a General Services Administration ("GSA") contract awarded to the company for software licenses and maintenance services. CA is an international information technology management software and services company with headquarters on Long Island, New York.  The government alleged that CA made false statements and claims in connection with the negotiation and administration of the GSA contract. Under Multiple Award Schedule contracts, like the one at issue, prices and contract terms for subsequent orders by federal agencies are pre-negotiated. In order to negotiate a fair price, the GSA required CA to fully and accurately disclose how it conducted business in the commercial marketplace. In addition, the contract included a price reduction provision that required CA to reduce the prices charged to the government if prices charged to commercial customers fell. The settlement resolves allegations that CA did not fully and accurately disclose its discounting practices to GSA contracting officers. In particular, the agreement resolves claims that CA provided false information about discounts given to commercial customers when the contract was first negotiated in 2002, as well as when it was subsequently extended in 2007 and 2009. Additionally, the settlement resolves claims that CA violated the price reduction clause in the contract by not providing government customers with additional discounts when commercial discounts improved. The allegations initially surfaced in a whistleblower lawsuit brought by a former employee of CA Software Israel. “Today’s settlement demonstrates our continuing vigilance to ensure that contractors deal forthrightly with federal agencies when seeking taxpayer funds,” said Acting Assistant Attorney General Chad A. Readler of the Justice Department’s Civil Division.  “We will take action against contractors who withhold information and cause the government to pay more than it should for commercially available items.” What is the False Claims Act? The False Claims Act ("FCA") is a federal law that prohibits businesses or individuals from knowingly submitting false or fraudulent claims to the federal government for payment. The FCA also rewards whistleblowers, referred to as "relators," who successfully recover funds on behalf of the government. In this case, the CA whistleblower is set to receive about $10.2 million under the settlement. In addition, the FCA includes an anti-retaliation provision that protects whistleblowers from workplace retaliation, including acts such as termination, suspension, demotion, and discrimination. If you are aware of a violation under the False Claims Act, an experienced attorney can help you understand and explore your options in blowing the whistle on fraud.

The Financial Industry Regulatory Authority, Inc. ("FINRA") has proposed a rule change that will allow broker-dealers to project the performance of investment strategies or asset allocations, but not specific stocks, in communications with clients. If approved, the new rule would put brokers on an equal footing with registered investment advisers that are currently allowed to use these projections in their communications. The self-regulatory organization ("SRO") is currently accepting comments on the proposed rule. The objective of the rule is to allow firms that are not dually registered, or those that do not employ dually-registered persons, to compete more effectively by providing this service to clients. "FINRA anticipates that these benefits would largely accrue to clients that do not have investment advisory accounts and, as a result, are not already receiving projections-related communications," the SRO wrote in its proposal. Under the proposed rule change, brokers would need a "reasonable basis" for all assumptions, conclusions and recommendations made in investment planning illustrations that are designed for clients. Moreover, the illustration must clearly and prominently disclose that the projection is hypothetical and that there is no guarantee that a projected performance or event will occur. All material assumptions and applicable limitations would also have to be disclosed. There are a number of ways to establish a reasonable basis, such as referring to the historical performance and volatility of asset classes, the duration of fixed income investments, anticipated contribution and withdrawal rates by clients, and the impact of a variety of other factors. Nonetheless, "hypothetical back-tested performance" or reliance on a particular asset manager's performance would not be permitted. Lastly, the projections would need to be approved by a principal of the firm or supported by a reliable software package. The proposed rule change stems from a recent self-assessment of current disclosure rules, and it has the support of brokers and industry groups. Ultimately, industry observers believe the rule change will harmonize FINRA's oversight of brokers with the standards that govern investment advisers. FINRA has requested comment about the proposed rule change, particularly concerning its potential impact on member firms, and whether there are alternative approaches that should be considered. Whether the amendment will be approved remains to be seen, but any member firm that needs advice and counsel on FINRA rules or that may be involved in a dispute should speak with a FINRA arbitration attorney.

Last November, this Blog discussed the faithless servant doctrine under New York law. ( Here .) As explained, the courts have applied the doctrine to a wide variety of misconduct, including, but not limited to, conflicts of interest, stealing money or goods, and secretly starting a competing business. Any act that can give rise to a claim for breach of fiduciary duty will trigger the doctrine. The penalty for violating the doctrine is harsh: the employee must forfeit all compensation earned since the first date of employment, even though the employee’s services may have otherwise benefitted the employer or the employer suffered no damages. Indeed, any value provided by the employee through loyal service is irrelevant. Thus, if an employee, even an otherwise valuable employee, is found to have been disloyal, then the employee will be required to disgorge all compensation even if the harm caused by the misconduct was minimal and the employee otherwise provided valuable service during the period of employment. Recently, Justice Ramos of the Supreme Court, New York County, Commercial Division, had the opportunity to rule on a summary judgment motion involving the doctrine. On February 27, 2017, Justice Ramos issued a decision in  Schulhof v. Jacobs , 2017 NY Slip Op. 50264(U), where he found the defendant, an art dealer, liable for fraud and breach of fiduciary duty and held that she not only had to account for the fraud, but also had to forfeit her commission on a sale of art work under the faithless servant doctrine. Background The action arose from a written agreement dated October 25, 2011 between the plaintiff, Michael P. Schulhof (“Schulhof”), and the defendant, Lisa Jacobs (“Jacobs”) (a private curator and art consultant) (“October Agreement”), pursuant to which Jacobs was to locate a buyer for a painting in the Schulhof Collection (the “Work”) for a minimum purchase price of $6 million in exchange for a $50,000 fee. The October Agreement required Jacobs to contact Schulhof prior to approaching any prospective purchaser, and prohibited her from presenting or seeking offers below $6 million without written confirmation of the lower price. Additionally, Jacobs could not “accept any fee from the purchaser, in cash or in kind". On November 1, 2011, Jacobs met with Amy Wolf (“Wolf”), an art dealer, to discuss the sale of the Work. Jacobs informed Wolf that the asking price for the Work was $6.5 million. By November 2, 2011, Jacobs and Wolf reached an agreement for the sale of the Work at the asking price. Shortly thereafter, on November 4, 2011, Wolf invited Jacobs to send her an invoice for the Work. The next day, on November 5, 2011, Jacobs informed Schulhof that she had a potential purchaser for the Work. On November 7, 2011, Jacobs informed Schulhof by email that she “was able to get the up to 5.5 million. We have a firm deal.” Schulhof accepted the deal. Jacobs suggested that the transaction be structured as a two-step process, stating that the buyer wanted to remain anonymous. Honoring the request, Schulhof sold the Work to Jacobs for $5,450,000, and Jacobs immediately resold it to Wolf for $5.5 million. On November 11, 2011, Jacobs executed a contract with Wolf for the sale of the Work for $6,500,000 (“November Agreement”). After receiving the $6.5 million from Wolf, Jacobs wired $5,450,000 to Schulhof on November 16, 2011. Jacobs never informed Schulhof that she received a $1 million profit in connection with the sale of the Work or that the buyer had accepted the $6.5 million offer. Approximately one year later, Schulhof discovered that the purchase price for the Work was actually $6.5 million and that Jacobs kept not only her agreed $50,000, but also an additional $1 million from the sale of the Work. The Complaint On August 26, 2013, Schulhof filed a complaint against Jacobs asserting causes of action for breach of fiduciary duty, fraud, breach of contract, restitution, and unjust enrichment. The complaint sought compensatory damages in excess of $1 million, as well as punitive damages. Following the completion of fact discovery, each party filed a motion for summary judgment. The Court’s Decision The court granted Schulhof’s motion for summary judgment, finding that Jacobs had “misrepresented” the terms of the sale of the Work knowing “that the buyer was actually willing and ready to pay” more than was represented by Jacobs ( e.g. , $6.5 million). In addition, the court found that the fraud occurred in the context of a fiduciary relationship, which obligated Jacobs “to disclose the $6.5 million offer prior to entering into the November Agreement.”  Given Jacobs “disloyalty” and breach of fiduciary duty, the court considered Jacobs to be a faithless servant, requiring her to account “for the $1 million of secret profits earned for the sale of the Work,” and “forfeit the $50,000 in compensation” she had earned under the October Agreement. Takeaway The faithless servant doctrine is a potent weapon for employers faced with an employee who acts with disloyalty during his/her employment. Although this Blog queried whether the doctrine was too draconian last year, it is hard to disagree with its application in Schulhof .  After all, the defendant was found to have secretly profited from the sale of goods, at the expense of the plaintiff, in breach of her fiduciary duties.

On February 21, 2017, the Supreme Court vacated the judgment in  Bishop v. Wells Fargo & Co . and remanded the case to the Second Circuit “for further consideration in light of Universal Health Servs. v. United States ex rel. Escobar ,” in which the Court recognized the implied certification theory as “a basis for liability” in False Claims Act (“FCA”) lawsuits. In Bishop , the relators, Robert Kraus and Paul Bishop (together, the “relators”), brought a qui tam action under the FCA against Wells Fargo & Company and Wells Fargo Bank, N.A. (together, “Wells Fargo”), alleging that Wells Fargo defrauded the government by falsely certifying that it was in compliance with various banking laws and regulations when it borrowed money at favorable rates from the discount window operated by the Federal Reserve (the “Fed”). The relators contended that the Fed would not have permitted the banks to borrow at those favorable rates had it known that they were undercapitalized (itself a violation of Fed rules) as a result of the fraud. The relators alleged that each time the bank borrowed money from the Fed’s Term Auction Facility, it was falsely certifying to the Fed that they were in sound financial condition. The government declined to intervene in the relators’ suit. Wells Fargo filed a motion to dismiss, which the district court granted, holding that the banks’ certifications of compliance were too general to constitute legally false claims under the FCA and that the relators had otherwise failed to allege their fraud claims with particularity. The relators appealed. The Second Circuit affirmed the district court ruling. Relying heavily on Mikes v. Strauss , 274 F.3d 687 (2d Cir. 2001), the court held that even if the allegations concerning fraudulent accounting practices were true, the relators could not connect the fraud to any implied false claim submitted to the government for payment. Bishop v. Wells Fargo & Co ., 823 F.3d 35, 48-49 (2d Cir. 2016). Because the Federal Reserve Act did not expressly condition Fed loans on compliance, it was irrelevant whether knowing the true capitalization of the banks would have caused the Fed to change its lending terms. Id . at 44 (stating that the FCA “does not encompass those instances of regulatory noncompliance that are irrelevant to the government’s disbursement decisions.”). After Bishop was decided, the Supreme Court issued its decision in Escobar . 136 S. Ct. 1989 (2016). In Escobar , the Court held that implied certification liability under the FCA may exist where the following two conditions are satisfied: (1) the defendant does not merely request payment, but also makes specific representations about the goods or services provided; and (2) the defendant’s failure to disclose noncompliance with material statutory, regulatory, or contractual requirements makes those representations misleading. (This Blog discussed Escobar here .) In response to Escobar , the relators in Bishop filed a writ of certiorari, asking the Supreme Court to revive their lawsuit. The relators argued that the Court’s confirmation of the implied certification theory of liability in Escobar abrogated the Second Circuit’s longstanding rejection of the theory. Takeaway The Court’s summary disposition in Bishop serves as a reminder to the circuit courts, especially those that did not previously recognize the implied certification theory, that the theory is viable and should be considered when properly alleged. The Supreme Court’s summary disposition in Bishop can be found here .

The New York Department of Financial Services' ("DFS") cybersecurity regulations became effective March 1, 2017, but the rules are slated to be phased in on a rolling basis 180 days after the effective date. The rules apply to financial institutions, financial services companies, insurance firms and other entities regulated by the DFS ("Covered Entities").  The rules require Covered Entities to establish and maintain cybersecurity programs in order to identify internal and external cyber risks and detect Cybersecurity Events, defined as “any act or attempt, successful or unsuccessful, to gain unauthorized access to, disrupt, or misuse an information system or information stored on such a system...that has a reasonable likelihood of materially harming any material part of the normal operations." What are the responsibilities of Covered Entities? Under the rules, Covered Entities must develop defensive infrastructure to protect their information systems and prevent the unauthorized access or use of nonpublic information stored on these systems. In addition, Covered Entities must implement policies and procedures and employee training to achieve these objectives. Covered Entities also must have a system in place to respond to cybersecurity events, mitigate adverse effects and recover from these events. There is also a strict reporting requirement that requires the DFS to be notified of an event within 72 hours of the occurrence. Beyond developing defensive capabilities, Covered Entities must be proactive and conduct periodic penetration testing and vulnerability assessments. They are also required to maintain records of internal audits, which must be available for inspection by the DFS. The DFS cybersecurity rules have additional requirements, including: Encryption of nonpublic information Establishing a third-party service provider's security policy Data retention and monitoring procedures Establishment of an incident response plan Finally, the rules mandate the identification of a Chief Information Security Officer ("CISO") to oversee and implement the cybersecurity program. The CISCO is required to report to the board of directors about the program. Thereafter, Covered Entities must submit a certification to the DFS that the board or a senior official reviewed the report and that the cybersecurity program complies with the rules. In the end, while there is a 180 day grace period and the rule is being phased in on a rolling basis, the transition periods are short, therefore it is crucial to take measures now to ensure compliance with the DFS cybersecurity rules.

An important part of any litigation is documentary discovery. As any litigant can attest, especially in complex matters, documents form the foundation of discovery plans and strategies, and, more significantly, proof at trial. Consequently, litigants must collect and preserve their documents, particularly electronically stored information (“ESI”), from the moment they are aware of their involvement in a lawsuit, or when there is a reasonable anticipation that a lawsuit may be filed. Given the importance of documents to a litigation, attorneys will typically send “litigation hold” letters to all custodians ( e.g. , their clients, opposing parties, or third parties) of documents and information, including ESI, to ensure that all steps are taken to preserve them for the litigation. These letters generally (a) identify the subject matter of the litigation and the documents and business records covered by it, (b) reinforce the duty to preserve, and (c) reinforce the ongoing duty to preserve until the lawsuit is resolved. Essentially, parties and non-parties are instructed that nothing should be deleted, removed, hidden, modified, or discarded by anyone while the litigation is pending. When a person or company withholds, alters, hides, or destroys evidence relevant to the litigation, either intentionally or negligently, it is considered “spoliation” of evidence and can lead to sanctions against the party that is guilty of spoliation including, but not limited to, dismissal of the action, striking a pleading, assessing monetary penalties, or permitting the jury to take a negative inference against the spoliating party.  The negative inference at trial can be very damaging to a party because it permits the jury to infer that there was something to hide ( e.g. , the party had a “guilty conscience”) and the missing evidence is unavailable because it negatively impacted that party’s affirmative case or defense. The Law In New York  A party that seeks sanctions for spoliation of evidence must show that the party having control over the evidence possessed an obligation to preserve it at the time of its destruction, that the evidence was destroyed with a “culpable state of mind,” and “that the destroyed evidence was relevant to the party’s claim or defense such that the trier of fact could find that the evidence would support that claim or defense.” Voom HD Holdings LLC v. Echostar Satellite L.L.C. , 93 A.D.3d 33, 45 (1st Dept. 2012) (quoting Zubulake v. UBS Warburg LLC , 220 F.R.D. 212, 220 (S.D.N.Y. 2003); Pegasus Aviation I, Inc. v. Varig Logistica S.A. , 26 N.Y.3d 543, 547-48 (2015). Where the evidence is determined to have been intentionally or wilfully destroyed, the relevancy of the destroyed documents is presumed ( see Zubulake , 220 F.R.D. at 220). On the other hand, if the evidence is determined to have been negligently destroyed, the party seeking spoliation sanctions must establish that the destroyed documents were relevant to the party’s claim or defense. The party requesting sanctions for spoliation has the burden of demonstrating that a litigant intentionally or negligently disposed of critical evidence, and fatally compromised the movant’s ability to prove a claim or defense. Utica Mut. Ins. Co. v. Berkoski Oil Co. , 58 A.D.3d 717, 718 (2d Dept. 2009) (citation and quotation marks omitted); Mendez v. La Guacatala, Inc. , 95 A.D.3d 1084, 1085 (2d Dept. 2012). Under certain circumstances, the failure of a party to institute a litigation hold or to implement any uniform or centralized plan to preserve data or even the various devices used by the key players in the transaction might demonstrate gross negligence, which would gave rise to a rebuttable presumption that the spoliated documents were relevant. E.g. , VOOM HD Holdings , 93 A.D.3d at 45; AJ Holdings Group, LLC v. IP Holdings, LLC , 129 A.D.3d 504, 505 (1st Dept. 2015).  Sanctions for discarding items in good faith and pursuant to a company’s normal business practices are inappropriate in the absence of pending litigation or notice of a specific claim. See , e.g. , Conderman v Rochester Gas & Elec. Corp. , 262 AD2d 1068 (4th Dept. 1999); Gogos v. Modell’s Sporting Goods, Inc. , 87 A.D.3d 248 (1st Dept. 2011)). However, where the party failing to preserve evidence is placed on notice of litigation within or before the time period when the requested evidence is subject to automatic destruction, a sanction will be appropriate. See Strong v. City of N.Y. , 112 A.D.3d 15 (1st Dept. 2013). Ferrara Bros. Bldg. Materials Corp. & Best Concrete Mix Corp. v. FMC Constr. LLC In Ferrara Bros. Bldg. Materials Corp. & Best Concrete Mix Corp. v. FMC Constr. LLC , 2016 N.Y. Slip Op. 26362 (Sup. Ct. Queens Co. 2016), the Court assessed a discovery sanction against the defendant for the improper destruction of ESI during the pendency of the litigation. Background Ferrara Bros . involved a claim by the plaintiff, Ferrara Bros. Bldg. Materials Corp. & Best Concrete Mix Corp. (“Ferrara”), that the defendant, Casa Redimix Concrete Corp. (“Casa”), interfered with its contract with the defendant FMC Construction LLC (“Construction”) to provide cement for a construction project, thereby causing it to lose prospective profits from the job. Casa claimed that it did not know of the existence of the contract between Ferrara and Construction. Ferrara alleged that Casa purposely backdated its contract with Construction to give the impression that it was entered into prior to Ferrara’s contract rather than after Casa’s principals became aware of Ferrara’s contract. Ferrara claimed that electronic data, such as metadata, would reveal the true generation dates and revision histories of the documents. Ferrara sought ESI from the defendants, specifically metadata that would reveal the dates on which the defendants prepared, modified, and executed their contract.  In response to the request, Casa provided an affidavit from an information technology specialist, who claimed that two years after the case was commenced, the computers on which the native information was stored had been replaced and discarded to update Casa’s computer system. Significantly, the update was not done through an automatic process. Ferrara moved for sanctions against Casa for the spoliation of evidence. Because there was no issue that the computer system was destroyed during the pendency of the lawsuit, the only issues before the Court were “whether Casa knew or should have known that the computers would have evidence relevant to the case, whether the plaintiff’s delay waived its right to demand the subject electronically stored information, and what sanction, if any, an appropriate exercise of the Court’s jurisdiction.” The Court’s Ruling As an initial matter, the Court rejected Casa’s argument that Ferrara waived its right to request the ESI ( i.e. , the metadata) due to the passage of time, noting that there was no case authority “that stands for the proposition that a party may discard relevant evidence during the pendency of a litigation if opposing counsel waited until years later in the lawsuit to request it.” Having disposed of the waiver argument, the Court addressed whether the requested ESI was relevant to Ferrara’s claim and whether Casa wrongfully destroyed it. As to the former inquiry, the Court determined that the requested ESI ( i.e. , the metadata showing “the date and time of creation” of the contract) were “relevant to the case at bar” and that Casa failed to rebut the presumption of relevance. In fact, Casa failed to rebut the presumption that it “was negligent, even grossly negligent, in failing to suspend its destruction of the computer system on which the contract in question was generated.” Thus, as to the latter, the Court found that, considering the parties were in litigation at the time of the request, Casa “knew or should have known, even absent a specific demand by the plaintiff, that the creation and modification of the contract, via the defendant’s computer system, would bear upon the parties’ dispute.” Given such knowledge, Casa had an obligation to preserve the ESI and its failure to do so subjected it to sanctions. Noting that the “the lynchpin for spoliation sanctions under New York law, is prejudice” (citation omitted), the Court found that, although Ferrara was prejudiced by the destruction of the system and the consequent inability “to include a forensic analysis of the metadata, to demonstrate … that the … contract was created at a time when had notice of contract with” Construction, it could still present testimonial evidence. As a result, the Court sanctioned Casa by assessing “a negative inference at trial, … to strike balance between the need to ameliorate any prejudice related from the destruction of the computer system, and the absence of demonstrable wilfulness on the defendants’ part.” Takeaway The importance of preserving evidence at the outset of litigation, or in anticipation of litigation, cannot be underscored enough.  While Casa may have needed the computer system upgrade, a litigation hold and periodic reminders of the requirement to preserve evidence would have put it on notice that such an upgrade would expose it to discovery sanction. As Ferrara shows, courts will impose a duty on litigants to have litigation holds in place to ensure that all relevant evidence is preserved, and that the failure to do so can result in sanctions.

Your client is engaged in negotiations to sell his company’s widgets in a purchase and sale transaction. After months of negotiations, the parties verbally agree to the salient terms of the transaction – that is, they agree to price, quantity, and specifications. You summarize these terms in an email on the same day. Your email also confirms that a formal contract will follow. The following day, you send the contract to the buyer and its counsel. The agreement contains the agreed upon material terms, but also includes terms and conditions not discussed over the phone, such as a forum selection/choice of law provision, a waiver of warranty provision, a notice of claim provision, and a merger clause. In your email communication to which the agreement and the accompanying terms and conditions are attached, you inform the buyer and its counsel that they have 48 hours to comment on, or object to, any provision in the contract, including the additional terms and conditions. The deadline passes without objection. Subsequently, a dispute arises over your client’s delivery of widgets in accordance with the specifications in the contract. Rather than send your client notice of the dispute as required by the contract, the buyer sues your client for breach of contract. The foregoing scenario forms the basic fact pattern in Lion Copolymer, LLC v Kolmar Ams., Inc. , 2017 N.Y. Slip Op. 01307 (1 st Dept. Feb. 21, 2017).  As discussed below, Lion Copolymer stands for the proposition that the subsequent confirmation of a verbal agreement by a formal contract containing additional terms and conditions does not negate or modify the original agreement. Background On July 19, 2011, the defendant Kolmar Americas, Inc. (“Kolmar”) and the plaintiff Lion Copolymer, LLC (“Lion”) entered into an agreement whereby Kolmar agreed to sell and Lion agreed to buy 3,000 to 3,500 metric tons of butadiene (a raw material required to manufacture synthetic rubber) (“Butadiene” or the “Product”) for $2.12 per pound. The Butadiene was to be shipped within Exxon Import Specifications to “CFR Baton Rouge, LA (ACT Terminal) via ‘Arctic Gas.’” The parties negotiated the Butadiene purchase by phone. Upon reaching agreement on quantity, price, and shipping specifications ( i.e. , “the major details of the agreed-upon deal”), Kolmar e-mailed Lion on July 19, 2011, to summarize those contractual terms and confirm that a “formal contract follow.” The following day, Kolmar sent Lion the formal contract, which embodied the parties’ full agreement and set forth Kolmar’s Transaction Confirmation (the “Confirmation”) and General Terms and Conditions (“GT&Cs”) (the Confirmation and GT&Cs together are referred to as the “Contract”). The Contract included provisions that were not discussed over the phone. These terms included, among others, that: (1) Kolmar would deliver Butadiene, at loading, that met certain defined specifications, including quality and quantity; (2) title and risk of loss passed to Lion upon loading of the Butadiene aboard the ocean vessel; (3) in the event of any challenge to the quality of the Butadiene that was loaded onto the ocean vessel, Lion was required to provide written notice to Kolmar no later than five (5) calendar days after loading of the Butadiene onto the vessel commenced; and (4) any claims regarding  the quality of the Product were to be submitted to Kolmar in writing with supporting documentation within 90 days of the Product having been loaded aboard the vessel or the claims would be forever “waived and barred.” In addition, the Confirmation contained a forum selection/choice of law provision, a waiver of warranty provision, and a limited liability for damages provision. The Confirmation also contained a merger clause, which specifically provided that it, and the GT&Cs, “constitute the Parties’ full and entire understanding of the sales transaction and may not be contradicted by evidence of any prior agreement or of a contemporaneous oral agreement.” The Confirmation further provided that the “terms of the sales transaction as expressed in this Confirmation will be deemed irrevocably accepted” by Lion unless Lion provided written notice to Kolmar of any errors or omissions to the sales terms within 48 hours of the Confirmation being sent. During discovery, a Lion senior officer testified that the company (i) received the Confirmation and GT&Cs, (ii) understood that the Confirmation and GT&Cs would become part of the Contract if Lion did not object within 48 hours, and (iii) did not object to any of the terms and conditions in the Confirmation and GT&Cs. Between July 27, 2011 and August 5, 2011, Kolmar arranged for several quantities of Butadiene to be loaded aboard the ARCTIC GAS near Flushing, Netherlands. An inspection of the Butadiene revealed, however, that the Butadiene did not meet the specifications set forth in the Contract. On August 22, 2011, the ARCTIC GAS arrived at ACT Terminal Baton Rouge to discharge the Butadiene. On August 30, 2011, Exxon purchased the Butadiene from Lion for $8,879,260.53. In October 2011, Lion submitted a claim against its cargo insurer for $7,955,239.92, representing the difference between the Exxon purchase price and the amount that Lion paid to Kolmar under the Contract. Although the Butadiene did not meet the specification’s in the Contract, Lion did not: (1) send notice in writing, or in any other form, rejecting the Butadiene loaded aboard the ARCTIC GAS, (2) provide Kolmar with any notice that the Butadiene failed to conform to the Contract, and (3) provide Kolmar with written notice of a claim, or any documentation supporting such a claim, at any time before the lawsuit was filed in June 2012. In its complaint, Lion asserted causes of action for breach of contract, negligence and breach of implied warranties related to its purchase of the Butadiene. On October 9, 2015, Kolmar moved for summary judgment on Lion’s causes of action. On April 21, 2016, the motion court granted Kolmar’s motion with respect to Lion’s causes of action for negligence and breach of implied warranties, and denied Kolmar’s motion with respect to Lion’s cause of action for breach of contract. The parties appealed. The First Department’s Ruling The First Department unanimously modified the motion court’s ruling with regard the breach of contract claim to grant Kolmar’s motion. The Court otherwise affirmed the motion court’s decision. The Court found that the “Confirmation and terms and conditions provided by defendant Kolmar Americas, Inc. (Kolmar) formed the parties’ contract.” The fact that the “forum selection, waiver of warranty and notice of claim provisions” came after the salient terms were agreed to over the phone “did not constitute a material alteration such as would require Lion’s consent for enforcement.” Consequently, the notice provision in the Contract controlled. Having determined that the terms and conditions in the Contract controlled the parties’ actions, the Court found that Lion’s failure to comply with it constituted a breach of contract: Kolmar established Lion’s failure to comply with the notice of claim provision. Lion’s assertion that it complied with the two year requirement does not negate its obligation to provide an initial notice of claim within 90 days of discharge. In the absence of a timely notice of claim, Lion is barred from bringing its breach of contract claim, regardless of the questions raised regarding whether the butadiene was nonconforming when it was loaded onto a ship in the Netherlands and whether the butadiene testing in the Netherlands contained manifest errors. As result, the Court reversed the motion court’s denial of Kolmar’s summary judgment motion as to Lion’s breach of contract claim. Takeaway Lion Copolymer is notable for its treatment of contract formation and whether the parties had a meeting of the minds when they agreed to the transaction. As discussed above, where the parties agree on the major terms of a transaction and later confirm those terms in writing, the fact that additional terms and conditions are added to the writing does not negate or modify enforcement of those terms. In fact, the new provisions in the subsequent writing will constitute a part of the parties’ original agreement when no party objects to them.

Over the past few weeks, this Blog has explored the advantages and disadvantages of forming a limited liability company (“LLC”), as well as the fiduciary obligations of non-managing members in manager-managed LLC to each other and the LLC itself ( here and here ). In today’s installment, this Blog will explore the circumstances under which a member in a multi-member LLC can obtain a judicial dissolution of the company. The Law Governing the Dissolution of an LLC   An LLC is a hybrid business entity that provides the limited liability features of a standard corporation and the tax efficiencies and operational flexibility of a sole proprietorship or partnership. The “owners” of an LLC are referred to as “members.” An LLC can consist of a single individual, two or more individuals, corporations or other LLCs. In New York, LLCs are governed by the Limited Liability Company Law (“LLCL”). There are two fundamental principles underlying the LLCL: (1) members can structure and operate the company as they see fit through the LLC’s articles of incorporation and operating agreement; and (2) unless the operating agreement provides otherwise, members wishing to dissolve the company can avail themselves of the LLCL’s dissolution procedures. Article 7 of the LLCL governs dissolution of an LLC. Under Section 701(a), an LLC will be dissolved and its affairs wound up upon the first to occur of the following: a) the latest date provided in the articles of organization or the operating agreement; if no date is specified, then the existence of the LLC is perpetual; b) the happening of events specified in the operating agreement; c) the vote or written consent of at least a majority in interest of the members (subject to the provisions in the operating agreement); d) at any time there are no members in the LLC, unless a legal representative of the last remaining member agrees in writing within 180 days to continue the LLC and to the admission of the legal representative as a member; and e) the entry of a decree of judicial dissolution pursuant to LLCL §702.  Section 702 applies only when the articles of incorporation and/or the operating agreement do not provide the circumstances under which the LLC will be dissolved. Section 702 of the LLCL empowers a court to dissolve an LLC “whenever it is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement.” The LLCL does not define the term “not reasonably practicable.” Judicial dissolution under Section 702 is a drastic remedy. E.g. , In The Matter of Dissolution of 1545 Ocean Ave., LLC , 72 A.D.3d 121, 131 (2d Dept. 2010). For this reason, New York courts strictly apply the standard set by Section 702. Matter of Horning v. Horning Constr., LLC , 12 Misc. 3d 402, 413 (Sup. Ct. Monroe Co., 2006).  As the Horning court observed: “Where the evidence does not demonstrate that it is not reasonably practicable to carry on the business in the circumstances (Limited Liability Company Law § 702), the court’s discretion, conferred by statute only, is not invoked and the petition must be dismissed.” Id . at 411 (footnote omitted). In considering dissolution, LLCL § 702 requires the court to first examine the company’s operating agreement to determine whether it is not “reasonably practicable” for the company to continue to carry on its business in conformity with the operating agreement. 1545 Ocean Ave., LLC , 72 A.D.3d at 128. Where the operating agreement does not address the issue of member withdrawal or dissolution, the petitioning member is bound by the requirements set forth in the LLCL § 702. 1545 Ocean Ave., LLC , 72 A.D.3d at 128. To satisfy the “not reasonably practicable” standard of Section 702, New York courts have required the member seeking dissolution to establish that: (1) the management of the entity is unable or unwilling to reasonably permit or promote the stated purpose of the entity to be realized or achieved, or (2) continuing the entity is financially unfeasible. E.g. , 1545 Ocean Ave., LLC , 72 A.D.3d at 131. Common Reasons for Seeking Judicial Dissolution The reasons advanced by petitioners wanting to dissolve an LLC are limitless. Some reasons fit comfortably in the standard set by Section 702 of the LLCL, while others do not. Regardless of the reason advanced, as noted, the petitioner must satisfy the “not reasonably practicable” standard. Below are some of the more common reasons advanced by petitioners to dissolve an LLC. Frustrated Purpose . A member may petition for dissolution because the stated purpose of the LLC can no longer be fulfilled. For example, the stated purpose of an LLC may be frustrated if the company was formed to market and sell light fixtures to a particular company and it loses its operative asset – the sales and marketing agreement with that entity. Similarly, the stated purpose of an LLC may be frustrated if the company was formed to develop and market technology that has become obsolete. Member Breach . A member may petition for dissolution because of a breach of the operating agreement by another member, or because the other member has failed to perform as expected and has not lived up to the benefit of the bargain made by the members. Discord and Dissention . Internal discord and dissention is generally the most common reason for LLC members to seek judicial dissolution.  For example, a member may petition for dissolution because the members cannot agree on the LLC’s strategy and current operations, or on the terms and conditions for raising and using operating capital. Importantly, discord and dissention between and among members is not by itself sufficient to warrant the exercise of judicial discretion to dissolve an LLC that operates in a manner within the contemplation of its purposes and objectives as defined in the articles of organization and/or operating agreement. See , e.g. , Matter of Natanel v Cohen , 43 Misc 3d 1217(A), 2013 N.Y. Misc. LEXIS 2900 *12-13 (Sup. Ct. Kings Co. 2014). As discussed below, it is only where discord and dissention are shown to be inimical to achieving the purpose of the LLC will dissolution under the “not reasonably practicable” standard be considered by the court to be an available remedy to the petitioner. Abandoned Business . A member may petition for dissolution of the LLC because the other members abandoned the business or the company has stopped conducting the business stated in the operating agreement. Deadlock . A member may petition for dissolution of the LLC because the members are deadlocked in the management of the company’s affairs. In this regard, the deadlock is such that they are unable to break the impasse, and irreparable harm to the company is threatened or being suffered, e.g. , the business and affairs of the company can no longer be conducted, or be conducted to the advantage of the company’s members because of the deadlock. Member Misconduct . A member may petition for dissolution of the LLC because another member engaged in serious misconduct, mismanagement, illegality or fraud, or because a member owning a majority share of the company abused or exceeded his/her authority granted under the operating agreement. A Case Study in Judicial Dissolution: Severe Discord Found To Satisfy The Standard of  LLCL § 702 On February 16, 2017, Justice Timothy J. Dufficy of the Supreme Court, Queens County, Commercial Division issued a decision concerning an application to dissolve an LLC under Section 702 of the LLCL. In In the Matter of The Dissolution of 47th Road LLC, a New York Limited Liability Company , 2017 NY Slip Op 50196(U), Justice Dufficy granted the application because the discord between the members was so severe, the LLC could not achieve its operating purpose. Background The case involved the application to dissolve 47th Road LLC, a New York limited liability company owned by two brothers, Vincent Cortazar and James Cortazar. Each brother had a 50% ownership interest in the company. The sole asset of 47th Road, LLC was a residential, four story walk-up apartment building with eight separate units occupied by tenants, having a fair market rental value of approximately $160,000 per year. The apartment building is located in Long Island City, New York. In February 2011, the brothers borrowed $1,200,000 from Hudson Valley Bank (now Santander Bank) to purchase approximately one hundred acres in Rio Del, California. The loan was secured by a $1,200,000 mortgage on the Long Island City property. Unbeknown to Vincent, the California property was titled in his brother’s name only. When Vincent found out about the ownership of the property, he and his brother had “a physically violent confrontation.” In addition to cutting Vincent out of the ownership of the California property, James locked his brother out of the company’s day-to-day operations, claiming that Vincent mismanaged the Long Island City property. With his brother out of the way, James collected the rents from the apartments, but did not pay down any of the indebtedness of the mortgage. On March 1, 2016, the Santander mortgage loan matured. As a result, all amounts due under the note became due and payable. However, James refused to pay the mortgage. Consequently, the property went into foreclosure. In addition to the foreclosure proceeding, there were numerous violations against the Long Island City property, amounting to over $33,000, as well as unpaid taxes, all of which jeopardized the economic feasibility of continuing the corporate existence of 47 th Road, LLC. Finally, during the past few years, the brothers have asserted claims against each other in New York courts, as well as courts outside the state, seeking various forms of relief, including an application by Vincent to dissolve the company. Court’s Ruling The court granted the application to dissolve the company and appointed a receiver to wind down its business and operations. As an initial matter, the court looked to the company’s operating agreement to see if there was any provision governing dissolution. Noting that the operating agreement only stated that the company’s business purpose was to operate an eight-unit residential apartment building in Queens County, N.Y., the court found that there was insufficient guidance on whether it was reasonably practicable for the company to continue to carry on its business operations. Given the broadly defined business purpose of the company, the court looked to the law under Section 702 of the LLCL. As noted above, to successfully petition for the dissolution of an LLC under LLCL § 702, the petitioning member must demonstrate, the following: 1) the management of the entity is unable or unwilling to reasonably permit or promote the stated purpose of the entity to be realized or achieved; or 2) continuing the entity is financially unfeasible. E.g. , 1545 Ocean Ave., LLC , 72 A.D.3d at 131. The court found that Vincent satisfied this standard: Disputes between members are alone not sufficient to warrant the exercise of judicial discretion to dissolve an LLC that is operates in a manner within the contemplation of it purposes and objectives as defined in its articles of organization and/or operating agreement. It is only where discord and disputes by and among the members are shown to be inimical to achieving the purpose of the LLC will dissolution under the “not reasonably practicable” standard imposed by LLCL § 702 be considered by the court to be an available remedy to the petitioner. In the case at bar, the dissension among the parties has driven the company’s only asset into foreclosure. There are numerous outstanding violations on the property, and the respondent has collected the rents without making repairs, paying the violations, or the mortgage. There are other lawsuits in this and other states between the protagonists. Due to the violent relationship between the two managers, the company will be unable to achieve its purpose of operating an apartment building. The parties seem willing to permit the building to be foreclosed rather than cooperate with each other in the decision-making process. In short, the Court finds that it is not reasonably practicable to carry on the business. Citations omitted. Conclusion Obtaining a judicial decree dissolving an LLC is not easy. 47th Road LLC shows how dysfunctional the relationship between members must be before the court will dissolve the company. Remember, in 47th Road LLC , the discord was so extreme, the brothers came to physical blows and allowed the company’s only asset to go into foreclosure. But, until that point, to the outside world, 47th Road LLC was a viable company –  a prior court declined to dissolve the company because of the inability to demonstrate financial unfeasibility. Aside from highlighting the difficulties in obtaining a judicial dissolution under the LLCL, 47th Road LLC is instructive because it underscores the importance of negotiating and drafting an operating agreement that includes a provision governing how members can exit the LLC. While not every situation demands consideration of exit provisions at the outset of the company, the parties to the operating agreement should understand the consequences of that decision and the risk that they may not be able to agree on dissloution terms at a later date. As the preceding discussions show, reliance on the judicial dissolution provision in the LLCL may not be warranted considering the difficulties satisfying the standard required to obtain such relief.

This Blog has previously written about the bases upon which the losing party in an arbitration can challenge the award. ( Here .) Among the bases discussed include the arbitrator’s impartiality and his/her authority to hear the dispute and rule on the matter. What happens when a party to an arbitration is unhappy with the rulings and the proceeding before an award is issued? Can the unhappy party challenge the fairness of an ongoing proceeding, and, more particularly, the independence and fairness of the arbitrators and their rulings? In Habliston v. FINRA Regulation, Inc. , No. 15-2225 (D.D.C. Jan. 27, 2017), a federal judge in the District of Columbia held that challenges to an ongoing arbitral proceeding are premature and not ripe for judicial review. Background The case arose from an arbitration between the claimants Anna Morton Young Habliston and Seymour R. Young, Jr. (collectively, “Habliston”) and the respondent Wells Fargo Advisors, LLC concerning the claimants’ deceased parents’ brokerage accounts.  Dissatisfied with the rulings in the arbitration, Habliston brought the action against FINRA Regulation, Inc. (“FINRA Regulation” or “FINRA”), alleging that it failed to provide a fair arbitration forum “because the arbitrators are biased, and their procedural rulings to date have been unfair; that FINRA Regulation has failed to carry out its regulatory duties properly; and that the binding arbitration provisions contained in the brokerage contracts are void or unenforceable.” Slip op. at 2 (footnotes omitted). Habliston sought damages under 42 U.S.C. § 1983, and the appointment of new arbitrators to hear the pending arbitration. Defendant’s Motion FINRA moved to dismiss the complaint pursuant to Federal Rules of Civil Procedure 12(b)(1), 12(b)(6), 12(b)(7), and 12(h)(3), arguing, among other things, that: (a) the claims were premature since the arbitration was ongoing; (b) FINRA was immune from suit under the doctrines of arbitral and regulatory immunity; (c) FINRA was not a state actor for purposes of 42 U.S.C. § 1983; (d) the Securities and Exchange Act (the “Act”) does not create a private right of action for alleged violations of the rules enacted under the Act; and (e) the request for new arbitrators was moot because FINRA had already replaced the arbitrators. Id . at 2-3. The plaintiffs did not oppose many of FINRA’s arguments. Consequently, the court considered the motion to be “largely conceded.” However, as to the issues for which the plaintiffs put in an opposition ( e.g. , arbitral immunity, whether FINRA was a state actor for purposes of 42 U.S.C. § 1983, and whether the claim was premature), the court granted the motion, concluding that Habliston’s claims were “not ripe for review, and that defendant entitled to arbitral immunity.”   Id . at 3. The Court’s Ruling As an initial matter, the court addressed Habliston’s failure to address all the arguments raised by FINRA’s motion. The court held that “ hen a plaintiff fails to address arguments made in a defendant’s motion to dismiss, the Court may treat those arguments as conceded.” Id . at 7 (internal quotation marks and citations omitted). Because Habliston failed to address many of FINRA’s arguments, the court treated the motion on those grounds “as conceded” and dismissed the claims that corresponded to them. Id . at 8. Regarding Habliston’s claim that FINRA denied them their due process and equal protection rights (Habliston alleged that FINRA “violated its duty to act objectively and impartially” and acted with the “intent to prejudice” them by influencing “the objectivity and impartiality” of FINRA’s arbitrators), the court found that the claims were not ripe for review.  Noting that the ripeness doctrine is rooted in Article III standing and the “fitness of the issues for judicial decision and the hardship to the parties of withholding court consideration” (citation and internal quotation marks omitted), the court concluded that Habliston did not (and could not) demonstrate any actual injury since the arbitration was ongoing and could result in an award favorable to them: Since the arbitration is still ongoing, plaintiffs’ challenge to the proceeding is not ripe for review. For Article III purposes, plaintiffs cannot demonstrate that they have suffered an actual injury, or that any harm is “imminent or certainly impending.” And prudential considerations favor dismissal as well. While plaintiffs express fear that they will not receive an objective hearing, and they take issue with certain interlocutory procedural rulings such as the denial of the requested discovery and the postponement of hearing dates, the arbitration has not yet concluded, and the outcome - which could be in plaintiffs’ favor - is unknown. So any alleged bias on the part of FINRA Regulation’s arbitrators has not yet produced any adverse consequences, and the record upon which one would determine whether plaintiffs’ constitutional rights have been violated has not yet been developed. Id . at 10-11. (Citations omitted.) Because Habliston’s constitutional claims were deemed not ripe for review, the court declined to decide whether FINRA was a “state actor” for purposes of Section 1983. Nevertheless, in a lengthy footnote, the court concluded that the claim would fail because Habliston did not claim that FINRA acted under state law. In fact, Habliston alleged that FINRA acted “under federal laws” and in violation of “FINRA Rules.” Consequently, as other courts within the jurisdiction had held, FINRA, or its predecessors, were not “state actors” for purposes of a Section 1983 claim.  Id . at n.9. Regarding arbitral immunity for FINRA, the court found that such immunity was conferred on the organization.  Noting that the D.C. Circuit had not yet decided the issue, the court found that FINRA enjoyed such immunity: The doctrine of arbitral immunity “rests on the notion that arbitrators acting within their quasi-judicial duties are the functional equivalent of judges, and, as such, should be afforded similar protection.” As the Sixth Circuit noted in Corey , failing to extend immunity to the boards sponsoring the arbitrators would render the immunity “illusionary” because “ t would be of little value to the whole arbitral procedure to merely shift the liability to the sponsoring association.” Consistent with the purposes of arbitral immunity, the Court will extend the immunity to FINRA Regulation here. Id . at 13. (Citations omitted.) This finding, said the court, was consistent with the decisions in a majority of the circuits, which have “extended arbitral immunity to cover not only the individual arbitrator, but the arbitration forum as well.” Id . at 12. The court found the reasoning of the other circuits “persuasive.” Id . at 13. Takeaway The purposes underlying the ripeness doctrine underscore the correctness of the court’s decision: “to prevent the courts, through avoidance of premature adjudication, from entangling themselves in abstract disagreements over administrative policies, and also to protect the agencies from judicial interference until an administrative decision has been formalized and its effects felt in a concrete way by the challenging parties.” Id . at 9 (citation omitted). Parties to an arbitral proceeding undermine these purposes if they are permitted to challenge the proceeding merely because “they are extremely dissatisfied with how it is going so far.” Id . at 1. Moreover, the judicial endorsement of arbitration “as an effective and expeditious means of resolving disputes between willing parties desirous of avoiding the expense and delay frequently attendant to the judicial process” ( Westinghouse v. New York City Tr. Auth. , 82 N.Y.2d 47, 54 (1993)) would be rendered meaningless if arbitrators and arbitral forums were not given absolute immunity from civil liability in performing their quasi-judicial duties. As the court in Habliston noted, “ bsolute immunity is thus necessary to assure that judges, advocates, and witnesses can perform their respective functions without harassment or intimidation.”   Id . at 11 (citations omitted).

In a case of first impression for the courts within the Second Circuit, Judge Richard J. Sullivan of the United States District Court for the Southern District of New York answered the foregoing question: no. United States v. L-3 Commc’ns Eotech, Inc. , No. 15-cv-9262 (RJS) (S.D.N.Y. Feb. 3, 2017). An Overview of the False Claims Act and the Whistleblower Reward The False Claims Act (“FCA” or the “Act”) prohibits businesses and individuals from defrauding the government by knowingly presenting, or causing to be presented, a false claim for payment or approval. Violations of the Act can result in a judgment equal to three times the losses sustained by the government, plus civil penalties for each false claim. The FCA requires the whistleblower (also known as a “relator”) to serve the government with his/her complaint and a “written disclosure of substantially all material evidence and information possesses.” 31 U.S.C. § 3730(b)(2). The complaint must be filed ex parte and remain under seal for at least 60 days, and within 60 days of receiving “both the complaint and the material evidence and information,” the government “may elect to intervene and proceed with the action.” Id . “Before the expiration of the 60-day period or any extensions” of that period for good cause, the government must choose between intervening and proceeding with the qui tam action itself, or declining to intervene, in which case the relator has the right to conduct the action. Id . § 3730(b)(4). “From its enactment, the FCA has encouraged private citizens to report fraud by promising a percentage of any eventual recovery.” Bishop v. Wells Fargo & Co. , 823 F.3d 35, 44 (2d Cir. 2016). A person who brings a successful “qui tam” action can receive between 15% and 30% of the government’s recovery depending upon whether the government intervenes in the action. If the government intervenes, the award generally falls between 15% and 25% of the government’s recovery. If the government declines to intervene and the whistleblower pursues the action alone, the award generally falls between 25% and 30% of the government’s recovery. In addition to the intervene-or-abstain options set forth above, the FCA permits the government to pursue other available remedies, while preserving the relator’s right to share in the proceeds of those remedies under certain circumstances. Specifically, the FCA provides that, “ otwithstanding <31 u.s.c. § 3730(b)> , the overnment may elect to pursue its claim through any alternate remedy available to the overnment, including any administrative proceeding to determine a civil money penalty.” Id . § 3730(c)(5). If the government pursues such an “alternate remedy,” the relator retains “the same rights in such proceeding as would have had if the action had continued under this section.” Id . L-3 Communications Eotech, Inc. Background The case arose from the motion by Milton DaSilva (“DaSilva”), a relator who voluntarily dismissed his qui tam complaint without prejudice before the government filed its action, for a declaration that he was entitled to a share of the government’s $25.6 million settlement with the defendants under Section 3730(c)(5) of the FCA. The Court denied DaSilva’s motion. Facts of the Action DaSilva worked as a quality control engineer at EOTech, Inc. (“EOTech”) from May 14, 2013 until June 25, 2013, when EOTech terminated his employment. On August 13, 2013, DaSilva made pre-filing disclosures to the government regarding EOTech’s production and sale of defective weapon sights in violation of the FCA. After discussions with the government regarding his allegations broke down, DaSilva filed a qui tam complaint under seal on April 25, 2014, asserting claims under the FCA and various state statutes on behalf of himself, the United States, the State of New York, the State of California, and the City of Los Angeles. On August 19, 2014, with the government’s consent, DaSilva voluntarily dismissed his qui tam action without prejudice. Approximately two weeks later, the court dismissed DaSilva’s qui tam action without prejudice and directed that the case remain under seal. On November 24, 2015, more than one year after DaSilva’s complaint was dismissed without prejudice, the government filed a complaint against EOTech, L-3 Communications (“L-3”), and Paul Mangano, for violations of the FCA and various state laws. One day later, the parties filed a stipulation of settlement and dismissal settling the government’s claims for $25.6 million. The Motion for Declaratory Relief On April 14, 2016, DaSilva filed a motion for declaratory relief, seeking a declaration that he was entitled to a share of the government’s settlement proceeds under Section 3730(c)(5) of the FCA because the settlement was an “alternate remedy” to pursuing the action initiated by DaSilva. The government opposed the motion arguing that because DaSilva voluntarily dismissed his qui tam action, the government’s own action was not an “alternate” to pursuing DaSilva’s action, and thus DaSilva had no right to share in the government’s recovery. The Court agreed with the government. The Court’s Decision Noting that the issue before the court had not been decided by the courts within the Second Circuit, Judge Sullivan explained that the framework of the FCA “unambiguously preclude recovery” sought by DaSilva: By beginning with the phrase “ otwithstanding subsection (b),” Section 3730(c)(5) makes clear that the “alternate remedy” described in that section is an “alternate” to the government’s options listed in Section 3730(b). Specifically, Section 3730(c)(5) governs the relator’s rights when the government “elect to pursue its claim through any alternate remedy,” 31 U.S.C. § 3730(c)(5) - that is, an “alternate” to the remedies set forth in Section 3730(b)(4), which are limited to (a) intervening and “proceed with the action” or (b) “declin to take over the action” and providing the relator with “the right to conduct the action,” 31 U.S.C. § 3730(b)(4). Slip op. at 7. Under this framework, said Judge Sullivan, it was “clear” that “when there is no  qui tam  action for the government to ‘take over,’ the government’s filing of its own action is not an ‘alternate’ to taking over (or not taking over) a  qui tam  action.” Id . Thus, “a dismissed qui tam suit does not present the government with the choice between acting under subsection (b)(4) or pursuing an ‘alternate remedy’ authorized by subsection (c)(5).” Id . Because DaSilva had dismissed his action, “the government’s commencement and settlement of this action was not an ‘alternate remedy.’” Id . The court found support for its statutory interpretation from Webster v. United States , 217 F.3d 843, 2000 WL 962249 (4th Cir. 2000), the only case it could find that was “precisely on point.” In that case, the plaintiff filed a qui tam action alleging, among other things, that a contractor had “fraudulently obtained money from the by submitting false invoices and vouchers requesting payment for work that had not been performed.” Id . at *1. The government “declined to intervene.” Thereafter, the plaintiff “voluntarily dismissed her qui tam action without prejudice” with the government’s consent. Id . At the time the plaintiff dismissed the case, “criminal charges and a civil forfeiture proceeding were pending against” one of the defendants. Id . The plaintiff believed, therefore, that “there would be nothing left to recover in her qui tam suit once those other actions concluded.” Id . Three months later, the government filed its own civil action against the contractor and several other defendants, “alleging false claims, conspiracy to defraud the government, and several additional common law causes of action.” Id . “The government did not inform of its intent to file the suit,” and the plaintiff sought to intervene once she learned of it. Id . The district court denied the intervention motion, and the Fourth Circuit affirmed, explaining that voluntary dismissal “wipes the slate clean, making any future lawsuit based on the same claim an entirely new lawsuit unrelated to the earlier (dismissed) action.” Id . at *2 (citation and quotation omitted). Thus, the plaintiff’s “assertion that her voluntarily dismissed complaint confer on her a continuing right to participate in the government’s subsequently filed FCA suit simply wrong.” Id . The court reasoned that the plaintiff could not “assert the rights of an original qui tam plaintiff . . . because she abandoned those rights when she voluntarily dismissed her suit.” Id . The court also observed that the plaintiff's reading of the “alternate remedy” provision would unacceptably “allow a private party to file a qui tam false claims suit with no intention of pursuing it, dismiss the suit without prejudice, and then, when the government chose to investigate and prosecute its own claim, clamber back on board.” Id . at *3. Judge Sullivan found the “parallels between Webster and case … obvious” and held that DaSilva had “no basis for claiming a share of the government’s settlement.” Slip op. at 9. “To hold otherwise would contradict the plain language of Section 3705(c)(5) and provide DaSilva with a windfall to which he s not entitled under the statute,” a result the court said it “ s unwilling to do.” Takeaway The alternate remedies provision protects the interests of both the relator and the government. In this regard, the provision expressly contemplates the possibility that the government may use a relator’s information and pending lawsuit to seek a remedy for fraud under other statutes.  31 U.S.C. § 3730(c)(5).  In those circumstances, the FCA permits the relator to share in a recovery under other statutes as if the government had recovered the money under the FCA. As the L-3 and Webster courts concluded, however, the protections provided by the FCA should not extend to non-pending qui tam actions. Relators should not be allowed to file a qui tam action with the intention of dismissing the complaint without prejudice, so that s/he can bear the fruits of the government’s decision to subsequently prosecute and settle its own claim against the same defendants. Not only does such conduct provide an unfair windfall to the relator, but it corrupts the purpose of the reward provisions of the FCA – to encourage individuals to report fraud and other misconduct on the government.