On August 6, 2017, Justice Andrew Borrok of the Supreme Court, New York County, Commercial Division, decided In re Everquote, Inc. Securities Litigation , 2019 N.Y. Slip Op. 29242 (Sup. Ct., N.Y. County Aug. 6, 2019) ( here ), in which he held that the automatic stay of discovery required by the Private Securities Litigation Reform Act of 1995 (the “Reform Act” or “PSLRA”), 15 U.S.C. § 77z-1(b)(1), applies in state court as well as in federal court. In doing so, Justice Borrok split with Justice Saliann Scarpulla of the Commercial Division who twice held to the contrary. See In re PPDAI Group Securities Litigation , 2019 WL 2751278 (Sup. Ct., N.Y. County, July 1, 2019), and In re Dentsply Sirona, Inc. Shareholders Litigation , 2019 N.Y. Slip Op. 32297(U), 2019 WL 3526142 (Sup. Ct., N.Y. County, Aug. 2, 2019) ( here ). In PPDAI , Justice Scarpulla held that “ pplication of the federal PSLRA automatic discovery stay would undermine Cyan’s holding that ‘33 Act cases may be heard in state courts.”   PPDAI , 2019 WL 2751278, at *7, citing Cyan, Inc. v. Beaver County Empl. Retirement Fund , 138 S.Ct. 1061, 1078 (2018). “Accordingly,” said Justice Scarpulla, “I am persuaded that the PSLRA automatic stay is not applicable to an action brought in New York State court.” Id . This Blog wrote about PPDAI here . ppdai filed a notice of appeal of justice scarpulla’s decision.> ppdai filed a notice of appeal of justice scarpulla’s decision.> In Dentsply Sirona , Justice Scarpulla denied a motion to stay a parallel litigation under the Securities Act of 1933 (“Securities Act” or “1933 Act”), holding that the PSLRA did not apply to state court actions. Slip Op. at *14 (“As I recently held (on a motion to stay based on the PSLRA), to hold that the PSLRA automatic stay applies to state court actions would undermine Cyan’s holding that ‘33 Act cases can proceed in state courts. Thus, the PSLRA’s automatic discovery stay is not applicable to state court actions.”) (footnote and citation omitted). Background EverQuote arose in connection with the company’s June 28, 2018 initial public offering (“IPO”) of its common stock. On February 15, 2019 and February 26, 2019, plaintiffs filed lawsuits in Supreme Court, New York County, under the Securities Act, claiming that defendants made false and misleading statements in the registration statement and prospectus filed in connection with the IPO. Following the consolidation of the actions in May 2019, and the filing of an amended complaint in June 2019, plaintiffs commenced discovery proceedings. Defendants objected to the demands, arguing that discovery was stayed pursuant to the PSLRA. By order to show cause, defendants moved, pursuant to the PSLRA’s automatic stay of discovery provision, to stay discovery pending adjudication of their motion to dismiss. The Court’s Decision After discussing the origin and outcome of Cyan , Justice Borrok concluded that “ he heart of the issue before this court not center around 15 USC § 77v (a) and 15 USC § 77p (b) or otherwise involve the jurisdictional question addressed” by the United States Supreme Court. Slip Op. at *5. “ Cyan therefore does not control the outcome of the issue presented by the instant motion.” Id . Cyan,="Cyan," in="in" which="which" it="it" unanimously="unanimously" held="held" that="that" Securities="Securities" Litigation="Litigation" Uniform="Uniform" Standards="Standards" Act="Act" of="of" (“SLUSA”)="(“SLUSA”)" does="does" not="not" strip="strip" state="state" courts="courts" subject-matter="subject-matter" jurisdiction="jurisdiction" over="over" class="class" actions="actions" involving="involving" claims="claims" exclusively="exclusively" brought="brought" under="under" Act,="Act," and="and" allow="allow" for="for" removal="removal" those="those" cases="cases" to="to" federal="federal" court.="court." This="This" Blog="Blog" wrote="wrote" about="about" Cyan ="Cyan" decision="decision" here.=">here."> Cyan was, nevertheless, helpful, explained the Court, “in that it further underscore the most basic and fundamental rule in statutory interpretation—the court must start with the express language of the statute and presume that it means what it says.” Id . at **5-6. Looking at the automatic stay provision of the PSLRA, the Court held that “ he simple, plain, and unambiguous language expressly provides that discovery is stayed during a pending motion to dismiss ‘ n any private action arising under this subchapter.’” Slip Op. at *6 (orig’l emphasis). The Court noted that “ owhere in 15 USC § 77z-1 (b) (1) does the statute indicate that it applies only to actions brought in federal court.” Id . at **6-7.  To underscore the point, the Court explained that “ he statute simply does not say that the automatic stay is limited to claims brought pursuant to the 1933 Act in federal court. Put another way, as the Cyan Court held, ‘ he statute says what it says—or perhaps better put here, does not say what it does not say.’” Id . at *7, quoting Cyan , 138 S.Ct. at 1069. The Court rejected plaintiffs’ argument that 15 U.S.C § 77z-1 (b) (1) and 15 U.S.C § 77z-1 (b) (2), when read together, indicate that the stay applies only to federal court actions because it incorporates the Federal Rules of Civil Procedure, which do not apply in state court: 15 USC § 77z-1(a)(1) provides that “ he provisions of this subsection shall apply to each private action arising under this subchapter that is brought as a plaintiff class action pursuant to the Federal Rules of Civil Procedure” — i.e. , in federal court. By contrast, as discussed above, 15 USC § 77z-1 (b) does not provide that this subchapter applies only to private actions brought as a plaintiff class action pursuant to the FRCP. 15 USC § 77z-1 (b) (2) as written creates a uniform approach to document preservation. Any party with notice of the allegations must treat documents “as if” they were the subject of a continuing document request for production under the FRCP— i.e. , without regard to each individual and potentially different jurisdiction’s rules regarding document preservation and spoliation. The “as if” highlights how Congress made clear that Federal Rule principles apply both to state and federal proceedings where document perseveration was concerned during the pendency of the discovery stay. Slip Op. at *7. In addition, the Court rejected plaintiffs’ argument that because 15 USC § 77z-1 (c), titled Sanction For Abusive Litigation, requires the court to determine at the conclusion of the litigation if sanctions are warranted under Rule 11 of the Federal Rules of Civil Procedure, 15 USC § 77z-1 (c) necessarily means that the automatic discovery stay provision of the PSLRA applies only in federal court. Id . Most significantly, however, although Congress did provide for sanctions for violations of the Reform Act’s automatic discovery stay and corresponding requirement for the preservation of evidence, 15 USC § 77z-1 (c) is not the applicable statutory provision, subsection (3) of 15 USC § 77z-1(b) ( i.e. , 15 USC § 77z-1 <3> ) is. And, as set forth above, 15 USC § 77z-1 (b) (3) Sanction for Willful Violation provides that “ party aggrieved by the willful failure of an opposing party to comply with paragraph (2) may apply to the court for an order awarding appropriate sanctions (emphasis added).” Significantly, the language of the relevant sanctions provision, 15 USC § 77z-1 (b) (3), on its face does not refer to FRCP 37 (e) or sanctions generally under the FRCP. Rather, providing that an aggrieved party of a violation of the Reform Act’s discovery stay and corresponding preservation of evidence requirement may apply for “appropriate sanctions” without reference to the FRCP, further underscores that Congress made clear that 15 USC § 77z-1 (b) applies both to state and federal proceedings. Id . at **7-8. Moreover, the Court rejected plaintiffs’ argument that the PSLRA interferes with a state court’s docket management. This argument, said the Court, “is wholly without merit.” Id . at *8. First, the Court noted that the automatic stay applies only during the pendency of a motion to dismiss, “not in advance of one.” Id .  Second, observed the Court, “state court proceedings are often stayed for a host of other reasons.” Id . Third, said the Court, “the critical issue is not how a stay of discovery squares in the abstract with either Commercial Division Rule 11 or CPLR 3214 or case assignment. Rather, the controlling issue is how this court implements the congressional mandate regarding how it is to manage 1933 Act claims that find their way into state courts.” Id .  “That mandate,” held the Court, “requires a stay, and is not, in any event, inconsistent with rules relating only to a ‘presumption’ as to discovery generally with respect to dispositive motions of all kinds.” Id . at **8-9. Finally, the Court held that its ruling advanced the policy underlying the PLSRA. Id . at *9. In this regard, the Court noted that not only is application of the automatic stay in state court supported “by the text of the statute,” but a contrary finding “would … run afoul of the well-recognized purpose of the Reform Act and SLUSA” – to provide defrauded investors a mechanism “to recover their losses,” while at the same time curtailing perceived abuses in litigating securities class actions, including the filing of lawsuits and making discovery requests in otherwise meritless lawsuits in the hope of securing a settlement. Id . In conclusion, Justice Borrok cautioned that a contrary ruling would “create the undesirable … and absurd incentive for lawsuits brought under the 1933 Act to be brought in state court as opposed to federal court to avoid the very protection supporting the enactment of the and necessarily confounding Congress’ acknowledged intention that the lion’s share of securities litigation would occur in the federal courts.” Id. , citing Cyan , 138 S.Ct. at 1073 (“SLUSA ensured that federal courts would play the principal role in adjudicating securities class actions.”). Takeaway EverQuote is one of several recent putative class actions filed in New York state court alleging violations of the Securities Act. As noted in a prior post, following the U.S. Supreme Court’s decision in Cyan , plaintiffs have been filing Securities Act cases in state court with more frequency. And, defendants, who are also the subject of parallel litigation in federal court have been filing motions to stay with similar frequency. EverQuote is notable because of its focus on the PSLRA’s automatic stay of discovery provision, rather than on CPLR § 2201, and its rejection of the contextual interpretation of the statute. While Cyan explained that Securities Act claims can be brought in state court, it did not decide whether the automatic stay of discovery under the PSLRA applies in a state court action. The absence of such a ruling has left a vacuum for the lower courts to fill. A number of courts outside of New York have reached the same conclusion as Justice Scarpulla (albeit many prior to Cyan ) and found that the automatic stay does not apply in state court. These courts have concluded that the PSLRA discovery stay does not apply in state court because the text, structure, and reference to the Federal Rules of Civil Procedure demonstrate that Congress intended the statute to apply in federal court only. But see City of Livonia Retiree Health & Disability Benefits Plan v. Pitney Bowes Inc. , 2019 WL 2293924 (Conn. Super. Ct. May 15, 2019) (applying the stay pursuant to the plain mean of the statutory text). Cyan supports this view, say plaintiffs, when it held that the PSLRA’s “substantive” provisions “appl even when a 1933 Act suit s brought in state court,” unlike the PSLRA’s procedural provisions, which do not. 138 S.Ct. at 1066-67. EverQuote joins the Livonia court in applying the “plain meaning rule” of statutory interpretation. As discussed, under this rule, the court is to presume that the statute means what it says. Since PPDAI is on appeal, it remains to be seen whether this approach will prevail over the one applied by Justice Scarpulla.

Forum non conveniens is a common law doctrine in which a court may dismiss an action where another forum would be better suited to adjudicate the matter. In New York, the doctrine is codified in CPLR §327(a). Under this section, a court may stay or dismiss an action if it finds “that in the interest of substantial justice the action should be heard in another forum.” CPLR § 327(a). The party seeking dismissal bears a heavy burden of establishing that New York is not the proper forum for the action. In considering a forum non conveniens motion, New York courts consider a number of factors, including the burden on New York courts, the potential hardship to the defendant, the unavailability of an alternative forum, whether both parties are nonresidents, whether the transaction out of which the cause of action arose occurred primarily in a foreign jurisdiction, the location of potential witnesses and documents, and the potential applicability of foreign law. No one factor is controlling. In New York, the seminal case discussing the doctrine is Islamic Republic of Iran v. Pahlavi , 62 N.Y.2d 474 (1984), cert. denied , 469 U.S. 1108 (1985). In Pahlavi , the plaintiffs alleged that the Shah of Iran and his wife misappropriated, embezzled or converted $35 billion dollars in Iranian funds. Id . at 477. The plaintiff alleged that New York was the proper forum for the action because the funds were deposited into New York banks and there was no alternate forum to litigate the claims. The defendants moved to dismiss the complaint alleging that it raised nonjusticiable political questions, that the court lacked personal jurisdiction due to defective service of process on them and that the complaint should be dismissed on forum non conveniens grounds. Special Term granted defendants’ motion based on forum non conveniens , concluding that the parties had no connection with New York other than a claim that the Shah had deposited funds in New York banks, a claim which it found insufficient under the circumstances to justify the court in retaining jurisdiction. A divided Appellate Division, First Department, affirmed. In dissent, Justice Fein argued that jurisdiction should be assumed because no other forum was available to plaintiff. The Court of Appeals affirmed the dismissal, holding that the plaintiff failed to establish “a substantial nexus between this State and plaintiff's cause of the action.” Id . at 483. In so holding, the Court set forth a non-exhaustive list of factors (discussed above) that the lower courts could consider when confronted with a motion to dismiss on forum non conveniens . Id . at 479. In applying the factors, the Court said that the ruling should rest on justice, fairness and convenience. Id .  Notably, however, the availability of an alternative forum, though a pertinent factor, is not a precondition to dismissal. Id . at 481. On August 6, 2019, the Appellate Division, First Department, issued two decisions involving the forum non conveniens doctrine: Primus Pac. Partners 1, L.P. v. Goldman Sachs Grp., Inc ., 2019 N.Y. Slip Op. 06052 (1st Dept. Aug. 6, 2019) ( here ); and Kainer v. UBS AG. , 2019 N.Y. Slip Op. 06053 (1st Dept. Aug. 6, 2019) ( here ). In both cases, the Court unanimously affirmed the dismissal of the actions. Primus Pacific Partners 1, L.P. v. Goldman Sachs Group., Inc. Background In Primus Pacific , the plaintiff, Primus Pacific Partners 1, LP (“Primus”), a private equity firm organized under the laws of the Cayman Islands and based in Hong Kong, sued the defendants, Goldman Sachs Group, Inc. (“GS Group”), a global investment banking, securities and investment management firm incorporated in Delaware and headquartered in New York, Goldman Sachs (Singapore) PTE (“GSS”), a wholly owned subsidiary of GS Group, organized under the laws of Singapore with its principal place of business in Singapore, and Tim Leissner (“Leissner”), co-President and Managing Director of GSS, for fraud and breach of fiduciary duty in connection with financial advice that GSS gave to a Malaysian company of which Primus was a shareholder. In December 2009, Hong Leong Bank (“HLB”), a Malaysian bank, made an unsolicited bid to acquire EON Capital (“EON”), which owned EON Bank Berhard (“EON Bank”), another large Malaysian bank. Primus was the largest shareholder of EON, controlling approximately 20 percent of the shares, and had a designee on EON’s Board of Directors (“Board”). In January 2010, GSS was retained, together with non-party Ethos & Company (“Ethos”), as a financial advisor to EON, to, among other things, evaluate and negotiate HLB’s offer. Thereafter, HLB made a second, slightly improved offer for EON. In April 2010, based on the advice of GSS, the Board accepted the revised offer. EON’s shareholders approved HLB’s second offer in September 2010, and the cash proceeds of the sale subsequently were distributed to the shareholders. In June 2010, Primus brought a petition in the High Court of Malaysia challenging and seeking to set aside the sale of EON’s assets to HLB. The petition alleged that the submission of the offer to shareholders for approval was rushed at the behest of certain shareholders seeking to divest their shares, and the actions of certain shareholders and Board members were illegal or in breach of their fiduciary duties. The petition was dismissed by the High Court and affirmed in 2011. Plaintiff commenced the action in July 2016, prompted by press reports in March 2016 that Leissner and GSS were being investigated for misconduct in connection with their dealings with the Malaysian Prime Minister and the Malaysian state investment fund, 1 Malaysia Development Bhd. (“1 MBD”), established by the Malaysian Prime Minister. Plaintiff alleged that GSS, at the time it was retained by EON, was an adviser to l MBD and had a close relationship with the Malaysian Prime Minister, who had close family and business ties to 1 MBD and an interest in the success of HLB’s hid to acquire EON. Plaintiff claimed that GSS, by concealing its relationship and dealings with the Prime Minister, fraudulently induced EON to retain it. Plaintiff also claimed that GSS’s advice to EON was influenced by its relationship with the Malaysian Prime Minister; that GSS used confidential information obtained from the EON Board to advantage HLB in its takeover bid; and that GSS sought to “curry favor” with the Malaysian Prime Minister by recommending that EON accept HLB’s second offer, knowing it was not a fair offer. Plaintiff further contended that EON would not have retained GSS if it had been aware of GSS’s conflicts of interest, and that it would not have accepted HLB’s revised offer if GSS had not recommended that EON accept it. Plaintiff sought compensatory damages of $170 million and at least $340 million in punitive damages. Defendants moved to dismiss the complaint pursuant to CPLR § 3211(a) and CPLR § 327(a), based on lack of personal jurisdiction and forum non conveniens . Among other things, the motion court held that New York was not a convenient forum for the action. The motion court found that “most, if not all, of the events giving rise to the alleged misconduct occurred in Malaysia.” The court explained that “ one of the events that allegedly gave rise to plaintiff’s fraud and breach of fiduciary claims occurred in New York, and plaintiff not allege that it, or EON, had any dealings with GS Group or its employees in New York in connection with the HLB transaction.” The court rejected plaintiff’s argument that New York was a convenient forum because the DOJ and the GS Group were investigating GSS’s dealings with the Malaysian Prime Minister and 1 MBD and the advice given by GSS in connection with EON’s acceptance of the HLB offer: “Plaintiff presents no evidence that any of the activities surrounding the EON sale occurred in New York, and its claims that subsequent investigations occurred in New York do not demonstrate a substantial nexus.” The motion court also found that “the majority of witnesses reside outside of New York,” e.g. , Hong Kong and Singapore, and that Malaysia had “a greater interest than New York in transactions involving the sale of its banks and in regulating its banking system.” Significantly, the court noted that plaintiff had already filed a case in Malaysia in which it challenged the sale of EON to HLB. Finally, the court found that “the law of Malaysia, or possibly Singapore, likely apply,” a finding that was not contested by the parties. The First Department’s Decision The Court unanimously affirmed the dismissal “given … the balance of the forum non conveniens considerations.” Slip Op. at *1. The Court found that there was no nexus between New York and plaintiff’s causes of action for fraud and breach of fiduciary; plaintiff was not resident in New York, it was a Cayman Islands partnership; and Malaysia had “a greater interest than New York in whether one Malaysian bank (nonparty Hong Leong Bank) corruptly took over another Malaysian bank (EON).” Id . (citations omitted). In addition, the Court rejected plaintiff’s contention that there was no alternative forum to hear the dispute. Id . (“Contrary to plaintiff’s contention, New York law does not require an alternative forum to be available”) (citations omitted). Kainer v. UBS AG Background Kainer involved a dispute among purported heirs to Margaret Kainer’s estate over ownership rights to a Degas painting, “Danseuses,” which the Nazis illegally confiscated from Kainer, who died without a will or children in 1968, and which, many years later, was sold in New York at a Christie’s auction. Plaintiffs consist of Kainer’s estate and 11 heirs to the estate, according to French certificates of inheritance identifying them as such. Defendants UBS AG, UBS Global Asset Management (Americas), Inc. (together, “UBS”), Norbert Stiftung f/k/a Norbert Levy Stiftung (the “Foundation”) and Edgar Kircher moved to dismiss the complaint against them on various grounds, including on forum non conveniens grounds. The motion court dismissed the complaint. The First Department affirmed the dismissal. The First Department’s Decision As an initial matter, the Court observed that none of the parties were New York residents. The Foundation, another purported heir to Kainer's estate and thus to the painting, was founded under Swiss law and is domiciled in Switzerland. UBS AG is a Swiss bank that maintains offices in New York. Its subsidiary, UBS Global Asset Management, is a Delaware corporation. UBS managed the assets of the Kainer family and allegedly created the Foundation. Edgar Kircher, a Swiss citizen and resident and UBS employee, served on the board of trustees of the Foundation, and allegedly directed all acts of the Foundation. Christie’s, a New York auction house, was incorporated in New York and has a principal place of business in New York City. Slip Op. at *1. In examining the factors identified in Pahlavi , the First Department held that defendants “clearly demonstrate that New York an inconvenient forum.” First, the Court found that since “Plaintiffs’ rights as heirs to the painting arose in Germany and France,” the burden on New York courts weighed in favor of dismissal. Id . In fact, said the Court, that burden was “significant”. Id . (“The burden on the New York court in applying Swiss and French estate law to determine the underlying issue of the lawful heirs to Kainer’s estate is significant”). Indeed, observed the First Department, “the parties ‘not only dispute the applicable foreign law, but discuss the substance of the law . . . in a manner that is, at best, opaque.’” Id . (quoting the motion court). Thus, the “applicability of foreign law,” which the Court said was “an important consideration in determining a forum non conveniens motion . . . weigh in favor of dismissal.’” Id . (citations omitted). Second, the Court found that the hardship of litigating the case in New York outweighed any alternative forum. The potential hardships to the defendants of litigating in New York are clear. Kircher lives in Switzerland, the Foundation was created and is domiciled in Switzerland, UBS AG is incorporated and headquartered there, and UBS Global Asset Management has consented to jurisdiction there. Although UBS has a New York office and resources to litigate the case here, many relevant nonparty witnesses and documents are located in Switzerland and Germany, and UBS would be powerless to compel their attendance in New York. Id . at *2 Third, the Court held that in addition to France and Germany, “Switzerland appear to be an available alternative forum” for adjudication of the action. Id .  The Court based its holding on the fact that plaintiffs had asked a Swiss court to determine the heirs of the Kainer estate, “declare the Swiss certificates of inheritance null and void, and order that all assets — not just the painting at issue — originating from Kainer’s estate be returned to plaintiffs.” Id . at **2-3. The Court reasoned that the underlying merits of the action could not “be determined without reference to the underlying issue of ownership — the very issue that is already being litigated abroad.” Id . at *3, quoting Citigroup Global Mkts., Inc. v. Metals Holding Corp. , 45 A.D.3d 361, 362 (1st Dept. 2007). The availability of an alternative forum and the risk of conflicting rulings, concluded the Court, favored dismissal. Id . at *3. Finally, the Court rejected plaintiffs’ argument that Switzerland was not an alternative forum because the lawsuit could be dismissed. Id . In doing so, the Court explained “while the existence of a suitable alternative forum is an important factor, its absence does not require a New York court to retain jurisdiction.” Id ., citing Pahlavi , 62 N.Y.2d at 481. Takeaway The forum non conveniens doctrine, codified in CPLR § 327, permits a court to dismiss an action when, “in the interest of substantial justice the action should be heard in another forum.” CPLR § 327(a). It is based upon “justice, fairness and convenience” ( Pahlavi , 62 N.Y.2d at 479), in which the party challenging the forum bears the burden of demonstrating that the action would be best adjudicated elsewhere. It is a flexible doctrine that a court should apply in its sound discretion based upon the facts and circumstances of the case. Only “when it plainly appears that New York is an inconvenient forum and that another is available which will best serve the ends of justice and the convenience of the parties” should a case be dismissed on forum non conveniens grounds. Silver v. Great Am. Ins. Co. , 29 N.Y.2d 356, 361 (1972). As shown in Primus Pacific and Kainer , the defendants were able to satisfy the burden reflected in the foregoing principles.

There is almost nothing more frustrating, or potentially costlier, to a business than a dispute over the meaning of a contract. Such disputes can take many forms. It may be that the language used is ambiguous; or the language is reasonably clear but is susceptible to different meanings; or although the language is clear, taken literally, it might not reflect the parties’ intent; or, as is often the case, an event has occurred that was not contemplated by the parties at the time of drafting, so the contract does not specifically provide for it. When parties enter into a contract, each assumes that the language in their agreement accurately memorializes their understandings and intentions. For this reason, when a dispute arises, the courts in New York look to the intent of the parties as expressed by the language they chose to put into their writing. Ashwood Capital, Inc. v. OTG Mgt., Inc. , 99 A.D.3d 1 (1st Dept. 2012). A clear, complete document will be enforced according to its terms. Id . at 7. When the parties have a dispute over the meaning of their contract, the court first asks if the contract contains any ambiguity. Id .  Since New York is a textual jurisdiction (where the courts look to the agreement itself to determine the meaning of the agreement), whether there is ambiguity “is determined by looking within the four corners of the document, not to outside sources.” Kass v. Kass , 91 N.Y.2d 554, 566 (1998). Thus, courts will examine the parties’ intentions as set forth in the agreement and give the language an interpretation that is sensible, practical, fair, and reasonable. Riverside S. Planning Corp. v. CRP/Extell Riverside, L.P. , 13 N.Y.3d 398, 404 (2009); Abiele Contr. v. New York City School Constr. Auth. , 91 N.Y.2d 1, 9-10 (1997); Brown Bros. Elec. Contr. v. Beam Constr. Corp. , 41 N.Y.2d 397, 400 (1977). A contract is not ambiguous if, on its face, it is definite and precise and reasonably susceptible to only one meaning. White v. Continental Cas. Co. , 9 N.Y.3d 264, 267 (2007). The “parties cannot create ambiguity from whole cloth where none exists, because provisions are not ambiguous merely because the parties interpret them differently.” Universal Am. Corp. v. Nat’l Union Fire Ins. Co. of Pittsburgh, Pa. , 25 N.Y.3d 675, 680 (2015) (citation and internal quotation marks omitted). “Whether or not a writing is ambiguous is a question of law to be resolved by the courts.” WWW Assocs., Inc. v Giancontieri , 77 N.Y.2d 157, 162 (1990). “ xtrinsic and parol evidence is not admissible to create an ambiguity in a written agreement which is complete and clear and unambiguous upon its face.” Id . at 163. This rule is especially applicable where the parties are commercially sophisticated, and their contract contains a merger clause. Schron v. Troutman Sanders LLP , 20 N.Y.3d 430, 436 (2013) (“where a contract contains a merger clause, a court is obliged to require full application of the parol evidence rule in order to bar the introduction of extrinsic evidence to vary or contradict the terms of the writing.”) (citation and quotation marks omitted). Finally, since a “contractual provision that is clear on its face must be enforced according to the plain meaning of its terms,” Bank of N.Y. Mellon v. WMC Mortg., LLC , 136 A.D.3d 1, 6 (1st Dept. 2015) (citation omitted), courts may not “add or excise terms, nor distort the meaning of those used and thereby make a new contract for the parties under the guise of interpreting the writing.” Id . (citations omitted). This is especially so “in commercial contracts negotiated at arm’s length by sophisticated, counseled business people.” Id . Sometimes, a contract dispute gives rise to other claims, such as fraud and breach of fiduciary duty. In each instance, the plaintiff must allege “a legal duty independent of the contract” or a misrepresentation or breach that is “collateral or extraneous to the terms of the parties’ agreement” to withstand a dismissal motion for being duplicative of the contract claim. Dormitory Auth. v. Samson Constr. Co. , 30 N.Y.3d 704 (2018) (citation omitted). Recently, Justice Saliann Scarpulla of the Supreme Court, New York County, Commercial Division, addressed the foregoing issues in Barnett v. Seth Berkowitz Serve U Brands Inc. , 2019 N.Y. Slip Op. 32257(U) (Sup. Ct., N.Y. County July 29, 2019) ( here ). Barnett v. Seth Berkowitz Serve U Brands Inc. Background Barnett arose from the sale of an equity interest in a cookie business that would soon become a successful enterprise and the subject of an acquisition by Krispy Kreme. In 2003, Plaintiff, Jared Barnett (“Barnett”), and Defendant, Seth Berkowitz (“Berkowitz”), co-founded Insomnia Cookies, LLC (“Insomnia”), a company engaged in the business of baking and delivering cookies, especially late at night. By March 2006, Barnett and Berkowitz owned 29.332% and 44.000%, respectively, in the company. In 2006, Barnett and Berkowitz agreed that Barnett would sell his equity interest in Insomnia to Berkowitz. Barnett alleged that Berkowitz confirmed the terms of the sale in an attachment to a May 4, 2006 email (the “May 2006 Email”). Among other things, the email provided that Barnett would receive “all economic benefits of a 5% member in Insomnia Cookies, LLC.” About one month later, on June 8, 2006, Barnett and Berkowitz signed a buy-out agreement (the “Buy-Out Agreement”), pursuant to which: (a) Barnett resigned as Insomnia’s manager; and (b) Berkowitz acquired Barnett’s equity interest in Insomnia in exchange for (1) payments to Barnett aggregating $90,000, and (2) Barnett retaining a seller benefit (the “Retained Seller Benefit”) of 6.8% non-voting interest in the proceeds received by Berkowitz as a result of any Insomnia “Liquidation Event.” The Buy-Out Agreement defined a Liquidation Event to mean, inter alia , any transaction that resulted in the transfer of Berkowitz’s equity interests in Insomnia to a third-party, and a restructuring, financing, recapitalization or other structuring transaction that diluted Berkowitz’s interest in Insomnia. On September 17, 2018, Krispy Kreme acquired Insomnia (the “Krispy Kreme Transaction”). According to Barnett, Berkowitz received more than $29 million in connection with the Krispy Kreme Transaction. Barnett alleged that the transaction constituted a Liquidation Event under the Buy-Out Agreement pursuant to which he was entitled to receive money. Barnett claimed that he did not receive any money from the transaction. In his Amended Complaint, Barnett pleaded nine causes of action for: (i) breach of contract; (ii) breach of the implied covenant of good faith and fair dealing; (iii) interference with contractual relations; (iv) contractual indemnification; (v) declaratory judgment; (vi) injunctive relief; (vii) breach of fiduciary duty; (viii) fraud and misrepresentation; and (ix) accounting. Defendants moved to dismiss the Amended Complaint, arguing that Barnett failed to state a claim and that documentary evidence disproved his claims as a matter of law. The Court granted in part and denied in part the motion. The Court’s Decision Breach of Contract Causes of Action Defendants argued that Barnett’s breach of contract claims, which were based on Berkowitz’s alleged failure to give Barnett a 5% economic benefit in the Krispy Kreme Transaction, must be dismissed because the language in the Buy-Out Agreement explicitly contradicted Barnett’s allegations. In response, Barnett maintained that the operative and enforceable agreement between the parties included both the Buy-Out Agreement and the May 2006 Email and that only by reference to the May 2006 Email could the full agreement of the parties and their intentions be determined. Barnett further maintained that both documents were part of an integrated transaction and should therefore be interpreted together. Justice Scarpulla found that “the Buy-Out Agreement a complete, unambiguous agreement, … which clearly set[] out the terms agreed upon by both Barnett and Berkowitz.” Slip Op. at *4. Having determined the foregoing, the Court held that, at the pre-answer stage of the proceeding, Barnett stated a claim for breach of contract. The Court explained: Barnett alleges that, after execution of the Buy-Out Agreement, Berkowitz owned 73.332% of the equity interest in Insomnia, and Barnett owned a 6.8% non-voting interest in the proceeds received by Berkowitz as a result of any Insomnia “Liquidation Event.” Barnett further alleges that a Liquidation Event occurred when Holdings acquired Insomnia, and Berkowitz has failed to pay Barnett for his interest in the proceeds of that Liquidation Event. At this pre-answer motion to dismiss stage, Barnett has sufficiently pled that there is an underlying contract (the Buy-Out Agreement), which entitles Barnett to 6.8% interest in Berkowitz's equity interest and that Barnett was not paid any such benefit after a Liquidation Event (including the Krispy Kreme Transaction). Id . at **4-5 (footnote omitted). Breach of Fiduciary Duty Causes of Action To plead a breach of fiduciary duty, a plaintiff must plead “the existence of a fiduciary relationship, misconduct by the other party, and damages directly caused by that party’s misconduct.” Pokoik v. Pokoik , 115 A.D.3d 428, 429 (1st Dept. 2014) (citation omitted). “A fiduciary relationship exists between two persons when one of them is under a duty to act for or to give advice for the benefit of another upon matters within the scope of the relation” but generally does not arise “between those involved in arm’s length business transactions.” EBC I, Inc. v. Goldman, Sachs & Co. , 5 N.Y.3d 11, 19 (2005) (citations and quotation marks omitted). “If the parties ... do not create their own relationship of higher trust, courts should not ordinarily transport them to the higher realm of relationship and fashion the stricter duty for them.” Id . at 20. Defendants argued that the Buy-Out Agreement was an arm’s-length business transaction in which no fiduciary duty attached. Defendants maintained that Barnett held no interest in Insomnia after the Buy-Out Agreement and any dilution of Berkowitz’s equity interest, even if undertaken by Berkowitz directly, would not have constituted a breach of fiduciary duty. In response, Barnett argued that the Buy-Out Agreement made it clear that a relationship of trust was created thereunder. According to Barnett, he was the beneficiary of the But-Out Agreement; Berkowitz was the trustee; and the 6.8% of Berkowitz’s interest in Insomnia along with distributions or interests that Barnett would thereafter acquire on account of his equity interest in Insomnia was trust property and upon closing of the transaction under the Buy-Out Agreement, there was actual delivery or legal assignment of trust property to Berkowitz. The Court agreed with Defendants, holding that Barnett failed to plead the existence of a fiduciary relationship. The Court explained that “ part from Berkowitz’s contractual obligation to pay Barnett in the event of a Liquidation Event, Barnett did not retain any other right or benefit under the Buy-Out Agreement and the Buy-Out Agreement did not put Berkowitz under a duty to act for the benefit of Barnett.” Slip Op. at *11. “Because the essential element of a breach of fiduciary duty cause of action – the existence of a fiduciary duty – has not been adequately pled,” the Court dismissed “this cause of action.” Id . Fraud Cause of Action To plead a cause of action for fraud, the plaintiff must allege “a misrepresentation or a material omission of fact which was false and known to be false by defendant, made for the purpose of inducing the other party to rely upon it, justifiable reliance of the other party on the misrepresentation or material omission, and injury.” Genger v. Genger , 152 A.D.3d 444, 445 (1st Dept. 2017) (citation and quotation marks omitted). The allegations must be stated with particularity to satisfy CPLR 3016(b). Id . Thus, the plaintiff must provide sufficient facts to support a “reasonable inference” that the allegations of fraud are true. Id . at 559-60. Conclusory allegations will not suffice. Id . Neither will allegations based on information and belief. See Facebook, Inc. v. DLA Piper LLP (US) , 134 A.D.3d 610, 615 (1st Dept. 2015) (“Statements made in pleadings upon information and belief are not sufficient to establish the necessary quantum of proof to sustain allegations of fraud.”). Although, CPLR 3016 (b) provides that “the circumstances constituting the shall be stated in detail,” the New York Court of Appeals has “cautioned that section 3016 (b) should not be so strictly interpreted as to prevent an otherwise valid cause of action in situations where it may be impossible to state in detail the circumstances constituting a fraud.” Pludeman v. Northern Leasing, Sys., Inc. , 10 N.Y.3d 486, 491 (2008) (internal quotation marks and citations omitted). Thus, where the facts “are peculiarly within the knowledge of the party charged with the fraud,” and “it would work a potentially unnecessary injustice to dismiss a case at an early stage where any pleading deficiency might be cured later in the proceedings,” dismissal should be denied. Id . at 491-92 (internal quotation marks and citations omitted). See also CPC Intl. v. McKesson Corp. , 70 N.Y.2d 268, 285-286 (1987). Defendants argued that Barnett’s fraud claim should be dismissed because it was time barred due to the fact that all alleged misrepresentations occurred in 2006 and otherwise insufficiently particular to withstand a motion under CPLR § 3016(b). “ fraud-based action must be commenced within six years of the fraud or within two years from the time the plaintiff discovered the fraud or could with reasonable diligence have discovered it.” Sargiss v. Magarelli , 12 N.Y.3d 527, 532 (2009) (citations and quotation marks omitted). “Where a plaintiff relies upon the two-year discovery exception to the six-year limitations period, the burden of establishing that the fraud could not have been discovered prior to the two-year period before the commencement of the action rests on the plaintiff who seeks the benefit of the exception.” Cannariato v. Cannariato , 136 A.D.3d 627, 627 (2d Dept. 2016) (citations and quotation marks omitted); accord Endervelt v. Slade , 214 A.D.2d 456, 457 (1st Dept. 1995). The cause of action accrues when “every element of the claim, including injury, can truthfully be alleged” ( Carbon Capital Mgmt., LLC v. Am. Express Co. , 88 A.D.3d 933, 939 (2d Dept. 2011)  (citation and alterations omitted)), “even though the injured party may be ignorant of the existence of the wrong or injury.” Schmidt v. Merchants Despatch Transp. Co. , 270 N.Y. 287, 300 (1936). In response, Barnett argued that Berkowitz’s fraudulent conduct first came to his attention in August 2018, when the Court ordered Berkowitz to provide information about Berkowitz’s equity interest, and information respecting Insomnia and its business. Therefore, contended Barnett, the statute of limitations on his fraud cause of action began to run after August 2018. The Court rejected Barnett’s argument, holding that the fraud claim was time-barred: Under the plain terms of the Buy-Out Agreement, Berkowitz was under no obligation to disclose to Barnett any information regarding the sale of Berkowitz’s equity interests in Insomnia. And Barnett made no effort to get any information about his Retained Seller Benefit from Berkowitz between execution of the Buyout Agreement in 2006 and the commencement of this action in 2018. As Barnett has not alleged facts to show that he sought to obtain information about his Retained Seller Benefit for more than ten years before commencing this action, Barnett has not met his burden of showing that Berkowitz’s alleged fraud could not have been discovered, even with the benefit of the discovery rule, prior to expiration of the statute of limitations Slip Op. at *13 (citation omitted). Takeaway Contracts are often at the heart of business and commercial disputes. Not all contract disputes result in litigation. A well-drafted contract can often prevent or resolve a dispute before the parties run to court. But, as Barnett shows, when the parties cannot resolve their differences, and resort to litigation, it is important to understand the rules governing the breach of contract claim. Barnett also shows the importance of demonstrating the existence of a duty separate from the contractual one. Conduct amounting to breach of a contractual obligation may also constitute the breach of a duty arising out of the relationship created by contract which is independent of that contract. In Barnett , Justice Scarpulla found that there was no relationship independent of the contractual one. Finally, Barnett reminds litigants to pursue the prosecution of their claims as soon as they are known. Although determining when accrual occurs, and when the claim should have been discovered, is not easy and often contested, New York law is clear that “where the circumstances are such as to suggest to a person of ordinary intelligence the probability that he has been defrauded, a duty of inquiry arises, and if he omits that inquiry when it would have developed the truth, and shuts his eyes to the facts which call for investigation, knowledge of the fraud will be imputed to him.” Gutkin v. Siegal , 85 A.D.3d 687, 688 (1st Dept. 2011) (citation and internal quotation marks omitted). In Barnett , as noted, the Court found that Plaintiff did not undertake such an inquiry.

Insurance policies typically provide that the insurer will “defend” its insured in the event of a lawsuit and “indemnify” its insured against liability resulting therefrom.  The insurer’s duty to defend, however, is broader than its duty to indemnify.  Seaboard Surety Co. v. Gillette Co. , 64 N.Y.2d 304 (1984).  Simply stated, an insurer may be obligated to provide a defense to a lawsuit even though it may be relieved of the obligation to indemnify its insured from any judgment rendered in that lawsuit. In Seaboard , the insurer brought an action against its insured seeking a declaratory judgment that it had no duty to defend or indemnify with respect to an action brought against the insured.  In describing the distinction between the duty to defend and the duty to indemnify, the Seaboard Court stated that: Where an insurance policy includes the insurer's promise to defend the insured against specified claims as well as to indemnify for actual liability, the insurer's duty to furnish a defense is broader than its obligation to indemnify. The duty to defend arises whenever the allegations in a complaint against the insured fall within the scope of the risks undertaken by the insurer, regardless of how false or groundless those allegations might be. The duty is not contingent on the insurer's ultimate duty to indemnify should the insured be found liable, nor is it material that the complaint against the insured asserts additional claims which fall outside the policy's general coverage or within its exclusory provisions. Rather, the duty of the insurer to defend the insured rests solely on whether the complaint alleges any facts or grounds which bring the action within the protection purchased.  Though policy coverage is often denominated as “liability insurance", where the insurer has made promises to defend it is clear that the coverage is, in fact, litigation insurance as well.  As such, so long as the claims asserted against the insured may rationally be said to fall within policy coverage, whatever may later prove to be the limits of the insurer's responsibility to pay, there is no doubt that it is obligated to defend. Seaboard , 64 N.Y.2d 310 -11 (citations, some quotation marks and brackets omitted).  The Seaboard Court found that summary judgment in favor of the insurer relieving it of its duty to defend was not established because “ declaration that there is no obligation to defend could now properly be made only if it could be concluded as a matter of law that there is no possible factual or legal basis on which the insurer might eventually be held to be obligated to indemnify the insured under any provision of the insurance policy.”  Seaboard , 64 N.Y.2d 312 (citations, quotation marks and some brackets omitted). On July 31, 2019, the Appellate Division, Fourth Department, addressed these issues in Pixley Dev. Corp. v. Erie Ins. Co.  The plaintiff in Pixley, a landlord that was named as an additional insured on a tenant’s insurance policy, brought an action in which it sought a declaratory judgment that Erie was obligated to defend and indemnify it in a personal injury suit commenced by a delivery person that slipped on ice on a “delivery driveway” while delivering supplies to Pixley’s tenant.  Pixley moved for summary judgment and the insurer cross-moved for summary judgment dismissing Pixley’s complaint.  Supreme court denied Pixley’s motion and granted the insurer’s cross-motion.  The Fourth Department modified by “denying the cross-motion in part and reinstating the complaint against ” and declaring that the insurer “is obligated to defend plaintiff in the underlying personal injury action.” Under the operative lease, tenant’s premises “was defined as ‘a ground floor store … together with … the right to use the driveway designated for delivery purposes in common with other tenants.’”  Tenant was also required to pay common area maintenance charges and was “obligated to provide ‘for the benefit of Pixley, a comprehensive liability policy of insurance protecting Pixley against any liability whatsoever, occasioned by accident, on or about the Premises, or any appurtenances thereto.’”  (Emphasis in original, brackets omitted.) Tenant obtained the required policy.  The additional insured endorsement, however, only named Pixley as an additional insured “only with respect to liability arising out of the ownership, maintenance or use of that part of the premises leased to and shown in the Schedule.’" On supplemental declarations, the policy “identified the leased premises only by its address.” The Court found that Pixley established that “the use of the delivery driveway was included in the scope of the demised premises, and there are triable issues of fact whether assumed some responsibility for maintenance of that area, including snow removal.”  (Citations, internal quotation marks and brackets omitted.)  The delivery driveway was necessary for ingress and egress and, therefore, was part of the license provided by the lease.  Finally, the Court thought it relevant to its determination that the “claims arguably arise out of that part of the premises leased to are that the lease required to procure insurance against any liabilities on or about the demised premises or any appurtenances thereto and required to pay its proportional share of the common area costs' incurred in operating and maintaining the subject property.”  (Emphasis in original, citations and internal quotation marks omitted.) Because the Fourth Department found that “the allegations of the personal injury complaint and the terms of the policy create a reasonable possibility that the tort plaintiff’s claims are covered under the terms of the policy,” it was established that the insurer had a duty to defend Pixley in the personal injury lawsuit. The Court, however, found that Pixley failed to establish as a matter of law that that it would “ultimately be entitled to indemnification from .”  Therefore, supreme court properly denied such relief to Pixley.

Distinguishing between direct and derivative claims is not easy. Sometimes, the difficulty arises because of the entity involved. For example, in the LLC context, there are fiduciary relationships ( e.g. , managing member and non-managing member) that will support a direct action in circumstances that might otherwise require a derivative action. E.g. , Pokoik v. Pokoik , 115 A.D.3d 428 (1st Dept. 2014); Salm v. Feldstein , 20 A.D.3d 469, 470 (2d Dept. 2005). Other times, the difficulty rests with the wrong sought to be redressed and the harm incurred ( e.g. , the diversion of assets by officers or directors of a company for their own benefit and the resulting diminution in the value of the shareholder’s stock).    Being able to tell the difference between the two types of claims is both procedurally and substantively important. For example, as this Blog has noted in previous posts ( e.g. , here ), in a derivative action, the plaintiff must satisfy the demand requirement, or demonstrate with particularity why demand should be excused, before being permitted to proceed with litigation. There is no comparable pleading requirement in a direct action.  In today’s post, this Blog looks at Huldisch v. Mermelstein , 2019 N.Y. Slip Op. 32216(U) (Sup. Ct., N.Y. County, July 24, 2019) ( here ). In Huldisch , the Court dismissed a breach of fiduciary duty counterclaim because the defendants failed to demonstrate that the claim belonged to them and not the company. A Brief Primer on The Applicable Rules Where the wrong is directed against a corporation, the claim belongs to the entity. The shareholder does not have an individual claim, even if the shareholder loses the value of his/her shares or incurs personal liability in an attempt to keep the corporation solvent. Abrams v. Donati , 66 N.Y.2d 951, 953 (1985); Serino v.  Lipper , 123 A.D.3d 34, 40 (1st Dept. 2014). “The distinction between derivative and direct claims is grounded upon the principle that a stockholder does not have an individual cause of action that derives from harm done to the corporation but may bring a direct claim when the wrongdoer has breached a duty owed directly to the shareholder which is independent of any duty owing to the corporation.” Accredited Aides Plus, Inc. v. Program Risk Mgmt., Inc. , 147 A.D.3d 122, 132 (3d Dept. 2017) (citation and internal quotation marks omitted). In determining whether a claim is direct or derivative, “a court must look to the nature of the wrong and to whom the relief should go.” Tooley v. Donaldson Lufkin & Jenrette, Inc. , 845 A.D.2d 1031, 1038 (Del. 2004). Specifically, the court should consider “(1) who suffered the alleged harm (the corporation or the suing stockholders, individually); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders, individually).” Yudell v. Gilbert , 99 A.D.3d 108, 114 (1st Dept. 2012) (internal quotation marks and citations omitted); Maldonado v. DiBre , 140 A.D.3d 1501, 1503-1504 (3d Dept. 2016). “The pertinent inquiry is whether the thrust of the plaintiff’s action is to vindicate his personal rights as an individual and not as a stockholder on behalf of the corporation.” Maldonado , 140 A.D.3d at 1504 (internal quotation marks and citation omitted). The plaintiff must show that the duty allegedly breached was owed to the shareholder, and that he/she can prevail without showing an injury to the corporation. Yudell , 99 A.D.3d at 114. If the individual claim of harm is “confused with or embedded” within the harm to the corporation, then it must be dismissed. Serino , 123 A.D.3d at 40; Patterson v. Calogero , 150 A.D.3d 1131, 1133 (2d Dept. 2017) (even where individual harm is claimed, if it is confused with or embedded in the harm to corporation, it cannot stand separately). Huldisch v. Mermelstein Background Huldisch arose from a dispute over the investment in, and management of, the Jeffrey Stein Salon NYC East 78 Inc. (the “Salon”). Plaintiffs’ Claims Plaintiffs invested money in the Salon in 2016. At the time, the Salon was financially struggling, owing tens of thousands of dollars in rent arrears. Defendants purportedly needed Plaintiffs’ investment to pay the back rent. Plaintiffs alleged that to induce them to make the investment, Defendants made numerous misrepresentations and omissions concerning the financial condition of the Salon, actions that Defendants allegedly had taken regarding the renewal of the Salon’s lease, which was set to expire on April 30, 2018, and their commitment to servicing clients at the Salon in the future. Plaintiffs claimed that Defendants concealed material information about the Salon which Plaintiffs had expressly requested as part of their due diligence prior to making their investment including, among other things, that Defendants were taking cash from the company without reporting it on its books and records, purchasing product through the Salon that was used in other Stein salons (“Other Stein Salons”), and improperly running personal expenses through the Salon. After Plaintiffs made their initial investment in the Salon, Defendants allegedly mismanaged the Salon and wasted its assets. Among other things, Defendants purportedly diverted clients from the Salon to the Other Stein Salons by, inter alia , falsely telling them (and employees) that the Salon was closing. In May 2018, the Salon closed its doors. Defendants’ Counterclaims According to Defendants, Plaintiffs promised that they had the skill, experience and contacts to support the Salon and that they had additional staffing who had significant new clientele that would be brought into the business. Based upon these promises, among others, Defendants sold their shares in the Salon to Plaintiffs rather than to a third party that had made a higher offer for the shares. Defendants maintained that Plaintiffs knew that those promises were false, and that Defendants were being misled by Plaintiffs. Defendants claimed that despite the promises, and their reliance on those promises, Plaintiffs never hired any stylists with clients. Moreover, Plaintiffs allegedly failed and refused to pay the full amount of the purchase price for the shares of stock in the business. Plaintiffs were supposed to pay an additional $70,000, which was needed for renovations and upgrades. Defendants alleged that Plaintiffs failed to pay the $70,000 balance due. Finally, Defendants argued that Plaintiffs mismanaged the business for Plaintiffs’ benefit. On September 7, 2018, Plaintiffs filed their complaint. On April 18, 2019, Defendants filed an answer and counterclaims. In their answer, Defendants sought relief for: (l) breach of contract (first counterclaim), (2) indemnification (second counterclaim),  (3) contribution (third counterclaim), (4) breach of contract (fourth counterclaim), (5) breach of fiduciary duty (fifth counterclaim), fraud (sixth counterclaim), and an accounting and judicial dissolution (seventh counterclaim). Plaintiffs moved to dismiss all but the seventh counterclaim. The Court granted Plaintiff’s motion. The Court’s Decision In dismissing the breach of fiduciary duty counterclaim, the Court held that the counterclaim asserted derivative, not direct, claims. Defendants alleged that Plaintiffs mismanaged the Salon by, among other things, changing bank accounts, failing to pay Salon staff, failing to pay contractors, refusing to communicate with Defendants, causing checks to bounce, and hiring relatives that were incompetent. Without reaching the issue whether Plaintiffs breached their fiduciary duties, the Court held that the counterclaim should be dismissed because Defendants did not assert the claims derivatively. Slip Op. at *6. In dismissing the fraud counterclaim, the Court held that Defendants failed to plead fraud with particularity under CPLR § 3016(b) and a misrepresentation of present fact that did not relate to future performance. Defendants alleged that Plaintiffs made two misrepresentations: that Plaintiffs had the “skill, experience, and contacts to support the Salon”; and that Plaintiffs would bring in new staff with clients in the future. To plead a cause of action for fraud, the plaintiff must allege that (1) the defendant made a material false representation, (2) which the defendant knew was false (3) the defendant intended to defraud the plaintiff thereby, (4) the plaintiff reasonably relied upon the representation, and (5) the plaintiff suffered damage as a result of such reliance. See Lama Holding Co. v. Smith Barney Inc. , 88 N.Y.2d 413, 421 (1996). A fraud claim cannot be based on statements that are promissory in nature and that relate to future performance. Elghanian v. Harvey , 249 A.D.2d 206, 206-07 (1st Dept. 1998). To be actionable, a fraud claim based upon a statement of future intention must allege facts that show the defendant, at the time the promise was made, never intended to honor or act on his/her statement. Lanzi v. Brooks , 54 A.D.2d 1057, 1058 (3d Dept. 1976). If the plaintiff can show that the promise was actually made with a preconceived and undisclosed intention of not performing it, the promise constitutes a misrepresentation of a material existing fact upon which an action for rescission may be predicated. White v. Davidson , 150 A.D.3d 610, 611 (1st Dept. 2017); see also Sabo v. Delman , 3 N.Y.2d 155, 160 (1957); Laduzinski v. Alvarez & Marsal Tax and LLC , 132 A.D.3d 164, 168-169 (1st Dept. 2015). Such misrepresentations are collateral to the agreement and can form the basis of a fraudulent inducement claim. White , 150 A.D.3d at 612; Laduzinski , 132 A.D.3d at 169. With these principles in mind, the Court held that “Defendants fail to identify any statements made by the Plaintiffs that would constitute a material misrepresentation.” Slip Op. at * 7. In particular, the Court found the representation that Plaintiff had the “skill, experience, and contacts to support the Salon” to be insufficiently vague “to meet the heightened pleading standard for fraud.” Id .  The Court also found the representation that Plaintiffs would bring new staff and clientele to the Salon to be promissory in nature and, therefore, an insufficient basis for alleging fraud. Id . citing Tribune Print Co. v. 263 Ninth Ave. Realty, Inc. , 88 A.D.2d 877, 879 (1st Dept. 1982). Takeaway Mismanagement or diversion of corporate assets is a wrong to the corporation. Abrams , 66 N.Y.2d at 952. As such, a lawsuit seeking to redress such harm must be brought derivatively. This is so even if the plaintiff has a direct claim that is embedded in the derivative claim. Yudell , 99 A.D.3d at 115. In Huldisch , the Court found that the wrongs complained of – mismanagement and diversion of assets – impacted the Salon, not Defendants in their individual capacities. Consequently, the Court dismissed the fiduciary duty counterclaim because it should have been asserted derivatively, not directly. Huldisch also serves as a reminder that fraud must be pleaded with particularity and that a promise alleged to be false must be shown to have been made with a preconceived and undisclosed intention of not performing it. In the absence of such a showing, the promise will be deemed to be an inactionable promise of future performance, instead of a misrepresentation of a material existing fact upon which an action for fraud may be predicated.

Last week was a rough one for Facebook, Inc. (FB-NASDAQ). On July 24, 2019, the social network giant, agreed to pay a $100 million fine to the Securities and Exchange Commission (“SEC”) ( here ) to settle claims related to the Cambridge Analytica scandal and a $5 billion penalty to the Federal Trade Commission (“FTC”) to settle claims concerning misleading disclosures related to the company’s privacy practices ( here ). The settlements are the culmination of investigations by the SEC, FTC and other federal agencies that started about a year ago (July 2018) following Facebook’s disclosures in March 2018 that Cambridge Analytica, the British political data-analysis firm that has been connected to the 2016 presidential campaign, improperly accessed the personal information of approximately 87 million Facebook users. ( Here .) The SEC fine – $100 million – represents the “highest penalty the SEC has ever assessed for this kind of disclosure failure,” said Stephanie Avakian (“Avakian”), the SEC’s deputy director of enforcement. The FTC penalty – $5 billion – is “the largest ever imposed on any company for violating consumers’ privacy and almost 20 times greater than the largest privacy or data security penalty ever imposed worldwide,” said the FTC in its announcement. “It is one of the largest penalties ever assessed by the U.S. government for any violation.” SEC v. Facebook, Inc. The SEC brought charges against Facebook for making misleading disclosures about the risk that user data could be misused ( here ).  According to the SEC, for more than two years, Facebook’s public disclosures presented the risk of misuse of user data as merely hypothetical when, in fact, Facebook knew that a third-party developer ( i.e. , Cambridge Analytica) had misused the social network giant’s user data.  According to the SEC’s complaint ( here ), in 2014 and 2015, Cambridge Analytica, the now-defunct British advertising and data analytics company, paid an academic researcher, through a company he controlled, to collect and transfer data from Facebook to create personality scores for approximately 30 million Americans.  In addition to the personality scores, the researcher, in violation of Facebook’s policies, also transferred to Cambridge Analytica the underlying Facebook user data, including names, genders, locations, birthdays, and “page likes.”  Cambridge Analytica used this information in connection with its political advertising activities. In the complaint, the SEC alleged that Facebook discovered the misuse of its users’ information in 2015 but did not correct its existing disclosure for more than two years.  Instead, Facebook continued to tell investors that “our users’ data may be improperly accessed, used or disclosed.” According to the SEC, Facebook reinforced this false impression when it told news reporters who were investigating Cambridge Analytica’s use of Facebook user data that it had discovered no evidence of wrongdoing.  Facebook did not disclose that a researcher had improperly transferred data for millions of Facebook users to Cambridge Analytica until March 16, 2018, when the company publicly acknowledged on its website that it had learned of the violation of its policy in 2015. The complaint further alleged that during the referenced two-year period, Facebook had no specific policies or procedures in place to assess the results of its investigation for the purpose of making accurate disclosures in the company’s public filings. “Public companies must accurately describe the material risks to their business,” said Avakian.  “As alleged in our complaint, Facebook presented the risk of misuse of user data as hypothetical when they knew user data had in fact been misused.  Public companies must have procedures in place to make accurate disclosures about material business risks.” “We allege that Facebook exacerbated its disclosure failures when it misled reporters who asked the company about its investigation into Cambridge Analytica,” said Erin E. Schneider, Director of the SEC’s San Francisco Regional Office. “This gave further weight to Facebook’s misleading statements in its public filings.” Without admitting or denying the SEC’s allegations, Facebook agreed to the entry of a final judgment ordering a $100 million penalty and an injunction that permanently enjoins it from violating Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933 and Section 13(a) of the Securities Exchange Act of 1934, and Rules 12b-20, 13a-1, 13a-13, and 13a-15(a) thereunder. United States of America v. Facebook, Inc. The FTC brought charges against Facebook ( here ), alleging that the company violated a 2012 FTC order (the “2012 FTC Order”) by deceiving users about their ability to control the privacy of their personal information. To settle the claims, Facebook agreed to pay a $5 billion penalty and submit to new restrictions and a modified corporate structure that is intended to hold the company accountable for the decisions it makes about its users’ privacy. (The FTC’s announcement can be found here and the settlement fact sheet can be found here .) According to the FTC, Facebook repeatedly used deceptive disclosures and settings to undermine users’ privacy preferences in violation of the 2012 FTC Order. Under the order, Facebook was prohibited from making misrepresentations about the privacy or security of consumers’ personal information, and the extent to which it shared personal information, such as names and dates of birth, with third parties. It also required Facebook to maintain a reasonable privacy program that safeguarded the privacy and confidentiality of user information. The FTC alleged that Facebook violated the 2012 order by deceiving its users when the company shared the data of users’ Facebook friends with third-party app developers, even when those friends had set more restrictive privacy settings. According to the agency, Facebook allowed users’ personal information to be shared with third-party apps that were downloaded by the user’s Facebook “friends.” The FTC claimed that many users were unaware that Facebook was sharing such information, and therefore did not take the steps needed to opt-out of sharing. “Despite repeated promises to its billions of users worldwide that they could control how their personal information is shared, Facebook undermined consumers’ choices,” said FTC Chairman Joe Simons. “The magnitude of the $5 billion penalty and sweeping conduct relief are unprecedented in the history of the FTC. The relief is designed not only to punish future violations but, more importantly, to change Facebook’s entire privacy culture to decrease the likelihood of continued violations. The Commission takes consumer privacy seriously, and will enforce FTC orders to the fullest extent of the law.” “The Department of Justice is committed to protecting consumer data privacy and ensuring that social media companies like Facebook do not mislead individuals about the use of their personal information,” said Assistant Attorney General Jody Hunt for the Department of Justice’s Civil Division. “This settlement’s historic penalty and compliance terms will benefit American consumers, and the Department expects Facebook to treat its privacy obligations with the utmost seriousness.” The Terms of the New Settlement In addition to the record-breaking $5 billion penalty levied by the FTC, the settlement also imposes new restrictions on Facebook’s business operations and creates multiple levels of governance and compliance. The order requires Facebook to restructure its approach to privacy from the corporate board-level down and establishes new mechanisms to ensure that Facebook executives are accountable for the decisions they make about privacy, and that those decisions are subject to meaningful oversight. Under the settlement order, the board of directors is required to establish an independent privacy committee, which is designed to remove control over user privacy by Facebook’s Chief Executive Officer (“CEO”), Mark Zuckerberg. Members of the privacy committee must be independent and will be appointed by an independent nominating committee. Members can be fired only by a supermajority of the board of directors. The settlement also requires Facebook to designate compliance officers who will be responsible for Facebook’s privacy program. These compliance officers will be subject to the approval of the new privacy committee and can be removed only by that committee, not by Facebook’s CEO or Facebook employees. Importantly, Mark Zuckerberg and designated compliance officers must independently submit to the FTC quarterly certifications that the company is in compliance with the privacy program mandated by the order, as well as an annual certification that the company is in overall compliance with the order. Any false certification will subject them to individual civil and criminal penalties. Moreover, the settlement is intended to strengthen external oversight by requiring an independent third-party to assess the effectiveness of Facebook’s privacy program and identify any gaps. The assessor’s biennial evaluations of Facebook’s privacy program must be based on the assessor’s independent fact-gathering, sampling, and testing, and must not rely primarily on assertions or attestations by Facebook management. The order prohibits the company from making any misrepresentations to the assessor, who can be approved or removed by the FTC. Importantly, the assessor is required to report directly to the new privacy board committee on a quarterly basis. The order also authorizes the FTC to use the discovery tools provided by the Federal Rules of Civil Procedure to monitor Facebook’s compliance with the order. The settlement not only applies to Facebook and its other social media offerings, WhatsApp and Instagram, but also to every new or modified product, service, or practice before it is implemented, and document its decisions about user privacy. The designated compliance officers must generate a quarterly privacy review report, which they must share with the CEO and the independent assessor, as well as with the FTC upon request by the agency. The order also requires Facebook to document incidents when data of 500 or more users has been compromised and its efforts to address such an incident and deliver this documentation to the FTC and the assessor within 30 days of the company’s discovery of the incident. Additionally, the order imposes significant new privacy requirements, such as greater oversight over third-party apps; prohibiting the use of telephone numbers to enable a security feature ( e.g. , two-factor authentication) for advertising; providing clear and conspicuous notice of its use of facial recognition technology, and obtaining affirmative express user consent prior to any use that materially exceeds its prior disclosures to users; encrypting user passwords and regularly scanning such encryptions to detect whether any passwords are stored in plaintext; and prohibiting the request for email passwords to other services when consumers sign up for Facebook services. The FTC Commissioners The FTC voted 3-2 to refer the complaint and stipulated final order to the Department of Justice. “The Order imposes a privacy regime that includes a new corporate governance structure, with corporate and individual accountability and more rigorous compliance monitoring,” said the three Commissioners voting for the settlement in a statement ( here ). “This approach dramatically increases the likelihood that Facebook will be compliant with the Order; if there are any deviations, they likely will be detected and remedied quickly.” The dissenting Commissioners said the $5 billion penalty, though substantial, was insufficient and the privacy governance changes insufficient to change Facebook’s practices with regard to gathering and leveraging users’ data. “The settlement imposes no meaningful changes to the company’s structure or financial incentives, which led to these violations,” Commissioner Rohit Chopra said in a statement ( here ). “Nor does it include any restrictions on the company’s mass surveillance or advertising tactics.” “The settlement imposes no meaningful changes to the company’s structure or financial incentives,” Chopra continued, “nor does it include any restrictions on the company’s mass surveillance or advertising tactics. Instead, the order allows Facebook to decide for itself how much information it can harvest from users and what it can do with that information, as long as it creates a paper trail.” “Even though this settlement is historic, in order to support it I would have to be confident that its combined terms would effectively deter Facebook from engaging in future law violations and send the message that order violations are not worth the risk,” Commissioner Rebecca Kelly Slaughter said in a statement ( here ). “When executives at large companies exercise control over decisions, including decisions to break the law,” Slaughter continued, “they should be held accountable the same way executives at smaller companies are.” The company issued a statement in a Facebook blog post ( here ), explaining that the settlement “will mark a sharper turn toward privacy, on a different scale than anything we’ve done in the past.” Mark Zuckerberg also issued a statement about the settlement ( here ), stating “We have a responsibility to protect people’s privacy. We already work hard to live up to this responsibility, but now we’re going to set a completely new standard for our industry.”

On July 18, 2019, Justice Joel M. Cohen of the Supreme Court, New York County, Commercial Division, decided Shyer v. Shyer , 2019 N.Y. Slip Op. 32138(U) (Sup. Ct., N.Y. County July 18, 2019) ( here ), a third-party action involving allegations of fraudulent concealment relating to the failure to disclose material information about the deteriorating health of a company executive for the purpose of securing about $150,000 in annual benefits. The company, Zyloware Corp. (“Zyloware”), sued Catherine Shyer (“Catherine”), the wife of Robert Shyer (“Robert”), a company executive and director, for fraudulently inducing Zyloware to continue employing Robert when his claim for long term disability raised questions about his employability. Under an agreement with the company, Robert was to receive a lifetime salary and premium health benefits even if he was no longer employed by the company; however, if Robert were to cease his employment, Catherine would lose some or most of the benefits that she would receive – approximately $150,000 annually. This fact, claimed Zyloware, caused Catherine to conceal Robert’s dementia diagnosis so that he would continue his employment with the company. Catherine moved to dismiss the complaint, claiming, inter alia , that she had no duty to disclose Robert’s health condition to the company. As discussed below, the Court agreed with Catherine and dismissed the complaint.    Shyer v. Shyer Background Zyloware is a family-owned and operated optical frame supplier. It was founded by Joseph Shyer (“Joseph”). For several decades, it was run by Joseph’s sons, Robert and Henry Shyer (“Henry”). Eventually, Robert and Henry’s sons, Christopher Shyer (“Christopher”) and James Shyer (“James”), respectively, joined Zyloware and assumed significant executive responsibilities within the company. In March 2010, Robert, Henry, Christopher, and James entered into a Shareholders Agreement and a Master Executive Employment Agreement (the “Employment Agreement”) to formalize the succession of leadership in Zyloware. The Shareholders Agreement outlined the rights, responsibilities, and ownership interests between and among the four Shyers. Under the agreement, each would hold a 25% interest in the company. Christopher and James were designated co-chief executive officers of Zyloware, while Robert and Henry remained employed as executives and directors. The Shareholders Agreement also set forth procedures for Zyloware to buy back Robert and Henry’s company stock upon their deaths. The Employment Agreement included two features relevant to the action. First, the agreement provided that Robert (and Henry) “receive substantial annual salaries/benefits for life,” but “would lose certain of these benefits if no longer employed.” These benefits included Zyloware’s group health insurance coverage, and perks, such as the use of a corporate credit card and vehicle. Second, the Employment Agreement allowed Zyloware to terminate Robert’s employment if he suffered a “disability” within the meaning of the agreement. A “Disability” was defined as the “inability of an Executive to perform his functions as a shareholder, officer and/or director of the Corporation … , or the duties that he is required to perform ... because of a physical, mental or emotional condition which persists for an aggregate of 120 days (which need not be consecutive) during any period of 360 consecutive days, as determined by a medical doctor selected by the Board, to whom each Executive hereby consents to present himself promptly for examination upon the Board’s request.” On July 9, 2014, Robert signed a New York Short Form Power-of-Attorney in which he gave Catherine powers over his affairs and which became effective upon Catherine’s acceptance. That same day, Robert executed a Last Will and Testament, which, among other things, named Catherine as sole executor of Robert’s estate. Catherine accepted the power-of-attorney several months later, on November 6, 2014. Zyloware alleged that in 2015 Catherine persuaded Zyloware to continue employing Robert despite his declining health. At the time, Catherine had applied for a year’s worth of long-term disability for Robert. While Robert was assured a certain level of salary and benefits for life regardless of his employment status, his beneficiaries were not. If Robert were terminated under the disability provision of the Employment Agreement, Catherine and other beneficiaries would have lost the premium health benefits and would have lost other benefits, worth about $150,000 annually. Therefore, Zyloware alleged, “ o avoid losing her benefits, Catherine concealed from own son and other Zyloware shareholders the fact that Robert, who was in obvious physical decline, had been diagnosed with dementia or symptoms consistent with dementia.” Zyloware eventually retired Robert on November 30, 2017. Three weeks later, on December 19, 2017, Robert passed away. Thereafter, Catherine was named the preliminary executrix of his estate (the “Estate”). Procedural History In March 2018, Catherine, in her capacity as preliminary executrix of the Estate, sued Zyloware, Christopher, James, and Henry in part, because of the defendants’ purported violation of the Shareholders Agreement. In the complaint, Catherine alleged four causes of action: declaratory judgment, breach of contract, breach of fiduciary duty, and injunctive relief. The defendants moved to dismiss. In a Decision and Order dated July 19, 2018, the Court dismissed the breach of contract claim against the individual defendants, dismissed the injunctive relief claim against all defendants, and otherwise denied the motion. On November 14, 2018, Zyloware filed a third-party complaint against Catherine, individually (rather than in her capacity as the preliminary executrix of the Estate), alleging two causes of action: (1) wrongful interference with contract, on the basis that Catherine induced the Estate to breach the Shareholders Agreement; and (2) fraud, based on Catherine’s alleged failure to disclose to Zyloware the truth about Robert’s illness. Catherine moved to dismiss the third-party complaint under CPLR § 3211(a)(7) for failure to state a cause of action. The Court granted the motion. The Court’s Decision Zyloware alleged that Catherine defrauded it by concealing the truth about Robert’s health, i.e. , by failing to inform Zyloware that Robert had been diagnosed with dementia in order to preserve Robert’s employment status and Catherine’s access to certain benefits. The Court held that the claim failed because “Zyloware not allege facts establishing that Catherine had or breached a legal duty to disclose her husband’s medical information to the company.” Slip Op. at *15. To plead fraud concealment, a plaintiff must allege that the defendant made a material misrepresentation of fact, that the misrepresentation was made intentionally in order to defraud or mislead the plaintiff, that the plaintiff reasonably relied on the misrepresentation, and that the plaintiff suffered damage as a result of its reliance on the defendant’s misrepresentation. Mandarin Trading Ltd. v. Wildenstein , 16 N.Y.3d 173, 178 (2011). In addition to the foregoing elements, a plaintiff must allege that the defendant had a duty to disclose material information and that it failed to do so. P. T. Bank Cent. Asia v. ABN AMRO Bank N.V. , 301 A.D.2d 373, 376 (1st Dept. 2003); Mobil Oil Corp. v. Joshi , 202 A.D.2d 318 (1st Dept. 1994). And, with all complaints alleging fraud, the plaintiff must plead the claim with particularity. CPLR § 3016(b). No Affirmative Misrepresentation The Court found that Zyloware did not allege an affirmative misrepresentation. Slip Op. at *15 (“The closest Zyloware comes to alleging an affirmative misrepresentation is the allegation that, when Catherine learned that Henry had visited Robert in a rehabilitation facility and ‘observed that was in the dementia unit, told Henry that had been placed in the wrong unit’”). The Court rejected Zyloware’s assertion that “Catherine’s statement was ‘yet another lie.’” Id . More details were needed, said the Court. Id . The Court also noted that Zyloware failed to explain how this alleged misrepresentation could have “‘fraudulently induced Zyloware not to terminate ’s employment.’” Id . This was so given the fact that Zyloware had the right to order Robert to undergo a medical examination and to terminate Robert’s employment if the examination revealed that Robert was suffering a disability within the meaning of the Employment Agreement. “By the time Catherine made her alleged misstatement,” explained the Court, “Zyloware had already ‘sought to arrange for to be examined by a physician,’ knew that Robert ‘had suffered a stroke,’ knew that Robert ‘was admitted to a rehabilitation facility,’ and knew that Robert had ‘not reported to the office for about one year.’” Therefore, the Court concluded that Zyloware could not have been defrauded because it was on notice of the foregoing facts – facts that contradicted the alleged misrepresentation. Id . No Duty to Disclose Next, the Court turned its attention to whether Catherine had a duty to disclose information about the extent of Robert’s deteriorating health. This issue, said the Court, was “ he crux of Zyloware’s fraud claim” as its success “hinge ” on actionable “acts of omission.” Slip Op. at *16, citing Elghanian v. Harvey , 249 A.D.2d 206 (1st Dept. 1998). A duty to disclose arises when (1) the defendant speaks on the subject, in which case he/she must speak truthfully and completely about the matter ( see Bank of Am., N.A. v. Bear Stearns Asset Mgmt. , 969 F. Supp. 2d 339, 351 (S.D.N.Y. 2013)); (2) there is a fiduciary relationship between the plaintiff and defendant ( see Balanced Return Fund Ltd. v. Royal Bank of Canada , 138 A.D.3d 542, 542 (1st Dept. 2016)); or (3) the defendant possesses “special facts” about the matter not known by the plaintiff ( Pramer S.C.A. v. Abaplus Int’l Corp. , 76 A.D.3d 89, 99 (1st Dept. 2010). The Court found that none of the foregoing circumstances were present in the case. First, the Court found that Zyloware failed to identify “any relevant, specific instance of Catherine making a ‘misleading partial disclosure’ about her husband’s health.” Slip Op. at *17 n.5. Second, the Court found there was no existing fiduciary relationship between Catherine and the company. Such a relationship, observed the Court, “must exist prior to the transaction complained of and not as a result of it.” Balanced Return , 138 A.D.3d at 542; see also Elghanian , 249 A.D.2d at 206-207. The Court held that no such relationship existed. The Court rejected Zyloware’s argument that as a spouse, Catherine had a duty “on pain of a claim for fraud” “to affirmatively disclose otherwise confidential information about the specific nature of her husband’s medical condition.” Slip Op. at *17. The Court observed that the strength of the argument was undermined by the fact that Zyloware was “aware that a serious health issue present and the contractual right to conduct its own medical examination.” Id . The Court also rejected Zyloware’s argument that Catherine became a fiduciary of the company when she accepted the power of attorney. “ power of attorney … is … given with the intent that the attorney-in-fact will utilize that power for the benefit of the principal.” In re Estate of Ferrara , 7 N.Y.3d 244, 254 (2006). In other words, any fiduciary duty existed between Catherine and Robert, not between Catherine and the company. Slip Op. at *18. As the Court explained: “Zyloware cites no authority for the proposition that the attorney-in-fact undertakes an independent fiduciary duty to third parties, including her principal’s principals, exposing herself to individual liability to such parties.” Id . Third, the Court held that the “special facts doctrine” did not apply. Id . Under the doctrine, there is a duty to disclose information in the absence of a fiduciary relationship “when one party’s superior knowledge of essential facts renders a transaction without disclosure inherently unfair.” Pramer S.C.A. v. Abaplus Int’l Corp. , 76 A.D.3d 89, 99 (1st Dept. 2010). The doctrine does not apply, however, if the information could have been discovered through due diligence, i.e. , the “exercise of ordinary intelligence.” Jana L. v. W. 129th St. Realty Corp. , 22 A.D.3d 274, 278 (1st Dept. 2005) (quoting Schumaker v. Mather , 133 N.Y. 590, 596 (1892)). And “ f nothing else, the ‘exercise of ordinary intelligence’ imposes, “at the very least, a duty to inquire.” Jana L. , 22 A.D.3d at 278. In rejecting the application of the doctrine, the Court found that Zyloware “had both the means and the opportunity to discover the nature of Robert’s obvious health problems notwithstanding Catherine’s alleged silence on the matter.” Slip Op. at *19. The Court explained that under the Employment Agreement, Zyloware could have requested, at any time, Robert to present himself for a medical examination before a doctor selected by Zyloware who could determine “whether Robert suffered a ‘disability’ within the meaning of the Employment Agreement.” Id . Significantly, noted the Court, “Zyloware did not exercise this contractual right to inquire until June 2017, which “ y that point, Robert ‘had not reported to the office for about one year,’ was experiencing an ‘obvious physical decline,’ and ‘Zyloware had become concerned that ... it should retire him as an employee.’” Id . “Because Zyloware ‘could have, but chose not to, inquire about’ Robert’s health,” the Court concluded that, “‘ he special facts doctrine not applicable.’” Id. , quoting Johnson v. Levin , 165 A.D.3d 497 (1st Dept. 2018). Finally, in rejecting the application of the doctrine, the Court addressed Zyloware’s “protests” concerning the company’s lack of diligence in ascertaining the true nature of Robert’s health: Zyloware protests that it “was in the optical eyewear frame business, not in the business of making neurological medical diagnoses.” That is true, and presumably that is why Zyloware contracted for the right to order a medical examination. The company did not need to “mak neurological medical diagnoses,”' or any kind of diagnoses. Rather, Zyloware could have ordered Robert to undergo a medical examination at any time, and certainly once it suspected that he suffered a “physical, mental or emotional condition” that would interfere with his enumerated duties. For the same reason, Zyloware’s argument that “discerning a condition such as dementia surely involves more than the exercise of “ordinary intelligence” also misses the mark. The question here is not whether “ordinary intelligence” required Zyloware to discover the condition, but whether “ordinary intelligence” required Zyloware to at least inquire about it. Under the circumstances, Zyloware did have a duty to inquire. In those circumstances, Catherine had no duty to volunteer the truth about Robert’s health. Slip Op. at **19-20 (citations and footnote omitted). Takeaway Under New York law, to recover damages for fraud, a “plaintiff must prove a misrepresentation or a material omission of fact which was false and known to be false by defendant, made for the purpose of inducing the other party to rely upon it, justifiable reliance of the other party on the misrepresentation or material omission, and injury.” Lama Holding Co. v. Smith Barney , 88 N.Y.2d 413, 421 (1996). When the fraud involves an omission of material fact, it is actionable “only if the non-disclosing party has a duty to disclose.” Remington Rand Corp. v. Amsterdam-Rotterdam Bank, N.V. , 68 F.3d 1478, 1483 (2d Cir. 1995). As noted above, a duty to disclose arises if: (1) “one party makes a partial or ambiguous statement that requires additional disclosure to avoid misleading the other party,” id . (internal quotation marks omitted); (2) a special relationship exists between the plaintiff and defendant, such as a fiduciary relationship ( Mandarin Trading , 16 N.Y.3d at 178); or (3) the “special facts” doctrine applies ( P.T. Bank , 301 A.D.2d at 373). In Shyer , the Court found that none of the foregoing circumstances were present.

Following the stock market crash in 1929, Congress enacted the Securities Act of 1933 (the “1933 Act”) and the Securities and Exchange Act of 1934 (the “1934 Act”). Cyan, Inc. v. Beaver Cty. Emps. Ret. Fund , 138 S. Ct. 1061, 1066 (2018). The 1933 Act has two primary objectives: (1) to provide transparency in financial statements so investors can make informed decisions about securities being offered for public sale; and (2) to address misstatements and omissions in the securities markets. To accomplish these goals, Congress required the disclosure of material information through the registration process. Thus, under the 1933 Act, companies that issue securities must file with the SEC a statement (known as a registration statement) that contains the following information: a description of the company’s business, the securities offered to the public, the company’s corporate management structure, and recent audited financial statements. In addition to the registration statement, registrants are required to file a prospectus. A prospectus is used to market securities to potential investors. The prospectus is included as part of the registration statement. Registration statements are subject to SEC examination for compliance with disclosure requirements. A registrant cannot make false statements in, or omit material facts from, a registration statement or prospectus. In fact, when a fact is disclosed, the registrant must disclose all information required to make that fact not misleading. Section 11 of the 1933 Act provides securities purchasers a private right of action if any part of a registration statement, when it became effective, “contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statement therein not misleading.” 15 U.S.C. § 77k(a). A plaintiff bringing an action under Section 11 must establish one of the following bases of liability: “(1) a material misrepresentation; (2) a material omission in contravention of an affirmative legal disclosure obligation; or (3) a material omission of information that is necessary to prevent existing disclosures from being misleading.” Hutchison v. Deutsche Bank Sec. Inc. , 647 F.3d 479, 484 (2d Cir. 2011). Section 11 “‘imposes strict liability on issuers and signatories, and negligence liability on underwriters,’ for material misstatements or omissions in a registration statement.” Fed. Hous. Fin. Agency for Fed. Nat’l Mortg. Ass’n v. Nomura Holding Am., Inc. , 873 F.3d 85, 99 (2d Cir. 2017) (quoting NECA-IBEW Health & Welfare Fund v. Goldman Sachs & Co. , 693 F.3d 145, 156 (2d Cir. 2012)). To be actionable under Section 11, any misrepresentation or omission must be material. Materiality is an “inherently fact-specific finding.” Basic Inc. v. Levinson , 485 U.S. 224, 236 (1988). A plaintiff demonstrates materiality when there is a “substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.” Ganino v. Citizens Utils. Co. , 228 F.3d 154, 162 (2d Cir. 2000) (quoting Basic , 485 U.S. at 231-32). Unlike a securities fraud, plaintiff proceeding under Section 10(b) of the 1934 Act, 15 U.S.C. § 78j(b), a Section 11 plaintiff need not demonstrate “scienter, reliance, or loss causation.” In re Morgan Stanley Info. Fund Sec. Litig. , 592 F.3d 347, 359 (2d Cir. 2010). Nevertheless, a defendant in a Section 11 action will not be liable if it can prove “negative loss causation” – that is, if it can demonstrate that the alleged misstatement or omission did not lead to a decline in the company’s stock price. See 15 U.S.C. § 77k(e) (“ f the defendant proves that any portion or all of such damages represents other than the depreciation in value of such security resulting from , such portion of or all such damages shall not be recoverable.”). To sustain this defense, a defendant must establish that “the risk that caused the losses was not within the zone of risk concealed by the misrepresentations and omissions,” or that “the subject of the misstatements and omissions was not the cause of the actual loss suffered.” Fed. Hous. Fin. Agency , 873 F.3d at 154 (alterations and internal quotation marks omitted). Because Section 11 “allocate the risk of uncertainty to the defendants,” courts have described rebutting loss causation as a “heavy burden.” Akerman v. Oryx Commc’ns, Inc. , 810 F.2d 336, 341 (2d Cir. 1987). “Section 12(a)(2) provides similar redress where the securities at issue were sold using prospectuses or oral communications that contain material misstatements or omissions.” Morgan Stanley , 592 F.3d at 359 (citing 15 U.S.C. § 77l(a)(2).) Claims under Section 12(a)(2) may be brought against a “statutory seller,” which includes those who successfully solicited the purchase of the security in service of their own financial interests. Id . “ he elements of a prima facie claim under section 12(a)(2) are: (1) the defendant is a ‘statutory seller’; (2) the sale was effectuated ‘by means of a prospectus or oral communication’; and (3) the prospectus or oral communication ‘include an untrue statement of a material fact or omit to state a material fact necessary in order to make the statements, in the light of the circumstances under which they were made, not misleading.’” Id . (quoting 15 U.S.C. § 77l(a)(2)). Courts have characterized Sections 11(a) and 12(a)(2) as “Securities Act siblings with roughly parallel elements....” Id . Section 11 imposes “‘virtually absolute’ liability” as to issuers, while other defendants under Sections 11 and 12(a)(2) “may be held liable for mere negligence.” Id . On July 11, 2019, Justice Andrew Borrok of the Supreme Court, County of New York, Commercial Division, dismissed a putative securities class action against a Brazilian sports and lifestyle online retailer in Latin America (the “Company” or “Netshoes”), certain of its executives and directors, and its underwriters in connection with the Company’s initial public offering (“IPO”).  In In re Netshoes Sec. Litig. , 2019 N.Y. Slip Op. 29219 (Sup. Ct., N.Y. County July 16, 2019) ( here ), plaintiffs brought claims under Sections 11, 12(a)(2), and 15 of the 1933 Act, alleging that, in connection with the IPO, defendants made materially false and misleading statements in the registration statement and prospectus they filed with the SEC.  The Court dismissed the claims without prejudice, holding that the challenged statements were inactionable opinions, protected under the bespeaks caution doctrine, and inactionable expressions of corporate optimism and/or puffery. Matter of Netshoes Securities Litigation Background Netshoes was brought in the Supreme Court, Commercial Division after the U.S. Supreme Court decided Cyan . In Cyan , the U.S. Supreme Court unanimously held that the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”) does not strip state courts of subject-matter jurisdiction over class actions involving claims exclusively brought under the 1933 Act, and does not allow for the removal of those cases to federal court. here.=">here."> Plaintiffs alleged that the Company’s registration statement and prospectus (collectively, the “Offering Documents”) issued in connection with its IPO, contained materially false and misleading information about the Company’s business. In particular, plaintiffs alleged that defendants overstated the Company’s competitive market position, misrepresented the performance of the Company’s business-to-business supplements and vitamins distribution business (“B2B Business”), misrepresented its future growth prospects, and inaccurately reported information in the Company’s financial statements. Plaintiffs alleged that although the Offering Documents touted Netshoes’ competitive position, “high margin” business strategy, and B2B Business, the Company’s core sports and lifestyle eCommerce business was under intense pressure to significantly increase its marketing spend and provide further and deeper discounts to customers, so as to preserve its market share at the expense of its supposedly “high margin” business model. In addition, plaintiffs alleged, the B2B Business was receiving substantial returns of product sales that had been improperly recognized as revenue in earlier periods. Indeed, maintained plaintiffs, information made public since the IPO indicated that Netshoes’ financial statements for the year ended December 2016 (the “2016 Financial Statements”), which were included in the Offering Documents, misstated revenues, assets, and losses and were not prepared in accordance with International Financial Reporting Standards, contrary to the representation contained in the Offering Documents. Plaintiffs alleged that as a result of the foregoing, Netshoes’ stock collapsed from its $18 per share IPO price on April 12, 2017, to $2.87 per share on May 15, 2018. Defendants moved to dismiss the complaint with prejudice, pursuant to CPLR § 3211(a)(1), (a)(5), and (a)(7) – i.e. , based on documentary evidence, statute of limitations, and failure to state a claim. Plaintiffs moved for alternative service as it relates to certain unserved defendants. The Court granted defendants’ motion. In doing so, the Court addressed several principles, that prior to Cyan , were most often seen in federal court decisions. We discuss these issues below. The Court’s Decision Statements of Opinion Plaintiffs alleged that unbeknown to investors, Netshoes faced competition from MercadoLibre, an eCommerce retailer active across all of Latin America, and from Amazon, which was active in Mexico, at the time of the IPO. Notwithstanding, plaintiffs alleged that defendants made a number of statements in the Offering Documents that falsely conveyed the impression that the Company was a leader in the industry without any competition – e.g. , “we do not believe we have a relevant direct competitor in eCommerce sports category in the region,” and “we believe we have become a clear contender for the market leader in Brazil.” The Court considered the challenged statements to be statements of opinion and, therefore, inactionable under Omnicare, Inc. v. Laborers Dist. Council Constr. Indus. Pension Fund , 135 S.Ct. 1318, 1326-27 (2015). Slip Op. at *4. In Omnicare , the U.S. Supreme Court held that a statement of opinion is not actionable under the securities laws, even if the opinion is ultimately wrong, if it was sincerely believed at the time it was made. 135 S.Ct. at 1327 (“ sincere statement of pure opinion is not an ‘untrue statement of material fact,’ regardless whether an investor can ultimately prove the belief wrong”). Thus, to be actionable, a statement of opinion must be (1) false, and (2) not honestly believed when made. Waterford Twp. Police & Fire Retirement Sys. v. Regional Mgt Corp. , 2016 WL 1261135, at *9 (S.D.N.Y. 2016). In addition, the Court found that certain risk disclosures in the Prospectus negated any falsity because they spoke to the competitive nature of the online retail industry. Slip Op. at **4-5. The Court also rejected plaintiffs’ argument that the Company’s financial statements were false at the time of the IPO because there were subsequent increases in allowances for “doubtful accounts” related to the B2B Business, finding that the adjustments involved subjective determinations that were honestly held at the time of the IPO. As explained by the Court: “‘ aluations and write-downs are subjective statements of opinion’ that are ‘actionable only if they are (1) subjectively disbelieved, i.e. , not “honestly held”; or (2) omit[] material facts about the issuer’s inquiry into or knowledge concerning statement if those facts conflict with what a reasonable investor would take from the statement itself.’” Slip Op. at *5, quoting In re Barclays Bank PLC Sec. Litig. , 2017 WL 4082305, *8 (S.D.N.Y. Sept. 13, 2017), aff’d , 2018 WL 6040846 (2d Cir 2018) (dismissing securities claims based on allegations defendant misvalued certain assets in its financial statements). The Bespeaks Caution Doctrine The Court found that alleged misstatements about the role of the B2B Business on the Company’s long-term growth, the projected growth of the Company’s customer base, the growth of the market, and the overall growth prospects of the Company were protected forward-looking statements under the bespeaks caution doctrine because they were accompanied by meaningful cautionary language that warned investors actual results could differ from the challenged statements. Under the bespeaks caution doctrine, “‘alleged misrepresentations in a stock offering are immaterial as a matter of law it cannot be said that any reasonable investor could consider them important in light of adequate cautionary language set out in the same offering.’” Id. , quoting Halperin v. eBanker USA.com, Inc. , 295 F.3d 352, 357 (2d Cir. 2002). See also Rombach v. Chang , 355 F.3d 164, 174 (2d Cir 2004). When such cautionary language is included, courts analyze “the allegedly fraudulent materials in their entirety to determine whether a reasonable investor would have been misled.” Id . at *7, quoting Halperin , 295 F.3d at 173. Notwithstanding, cautionary language about future risk does not insulate a defendant from liability under the doctrine when the defendant fails to disclose that the risk has already transpired. Halperin , 295 F.3d at 173.  As one court explained, the bespeaks caution “provides no protection to someone who warns his hiking companion to walk slowly because there might be a ditch ahead when he knows with near certainty that the Grand Canyon lies one foot away.” In re Prudential Sec. Inc. Partnerships Litig. , 930 F. Supp. 2d 68, 72 (S.D.N.Y. 1996). Corporate Optimism and Puffery The Court held that plaintiffs’ allegations concerning the Company’s position in an expanding market, the Company’s leadership in the Brazilian sports eCommerce market, the recognition of Netshoes’ Zattini website by its customers, and the Company’s customer loyalty and their “high” repeat purchasing were inactionable expressions of puffery and optimism. Slip Op. at *8, citing In re Duane Reade Inc. Sec. Litig. , 2003 WL 22801416, at *5 (S.D.N.Y. 2003). Item 303 Under Item 303 of SEC Regulation S-K, 17 C.F.R. § 229.303 (“Item 303”), the registrant is required to “ escribe any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations.” 17 C.F.R. § 229.303(a)(3)(ii). Disclosure under Item 303 is required where a trend or uncertainty is both presently known to management and reasonably likely to have material effects on the registrant’s financial conditions or results of operations. Litwin v. Blackstone Grp., L.P. , 634 F.3d 706, 716 (2d Cir. 2011). To be a required disclosure under Item 303, the information must be material, i.e. , “there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the total mix of information made available.” Litwin , 634 F.3d at 717 (internal quotation and citation omitted). Courts have “consistently rejected a formulaic approach to assessing the materiality of an alleged misrepresentation.” Id . Although bright-line numerical tests for materiality are inappropriate and have been rejected, courts do not entirely exclude analysis based on quantative considerations. Id. ; Ganino , 228 F.3d 154 (2d Cir. 2000). As the court in Litwin explained, a court must consider “both ‘quantitative’ and ‘qualitative’ factors in assessing an item’s materiality,” SAB No. 99, 64 Fed Reg at 45,151, and that consideration should be undertaken in an integrative manner. Id .; Ganino , 228 F3d at 163. Based upon the foregoing, the Court found that defendants did not violate Item 303. Here, the B2B business constituted 4.3% of Netshoes’ net sales. Just as importantly, the Offering Documents disclosed Netshoes’ actual financial metrics for years 2014 through 2016, including that, from 2015 to 2016, its gross margins had decreased and its annual net sales growth had halved; its customer “credit risk” from overdue B2B accounts receivable had nearly quadrupled; and that its allowance for doubtful accounts had more than tripled. Thus, under either a quantative or a qualitative analysis, Netshoes did not violate Item 303. Slip Op. at *9. Having determined that plaintiffs failed to allege any actionable misstatements of fact, the Court dismissed plaintiffs’ Section 11 and 12(a)(2) claims, though it did so without prejudice. And, because the Court dismissed plaintiffs’ claims under Section 11 and 12(a)(2) of the 1933 Act ( i.e. , the primary violations of the 1933 Act), the Court dismissed plaintiffs’ secondary liability claims under Section 15 of the 1933 Act against the individual officers and directors, also without prejudice.

Derivative actions are brought by current shareholders of a company to redress the harm (monetary or equitable) incurred by the company as the result of officer/director self-dealing, breaches of fiduciary duty, and/or other wrongdoing; to restore shareholder value caused by mismanagement and the waste of corporate assets; and to enhance and strengthen internal controls and the company’s governance policies and procedures. Very often, shareholder derivative actions are filed in the wake of an investigation initiated by a regulatory agency, such as the Securities and Exchange Commission (“SEC”), or the filing of a securities class action alleging violations of the federal securities laws by a company and/or its officers and directors. Gammel v. Immelt , 2019 N.Y. Slip Op. 32005(U) (Sup. Ct., N. Y. County June 28, 2019) ( here ), recently decided by Justice Andrea Masley of the New York Supreme Court, Commercial Division, is an example of the foregoing. There, shareholders of the General Electric Company (“GE” or the “Company”) commenced a derivative action against the officers and directors of the Company following the filing of a securities class action lawsuit pending in the United States District Court for the Southern District of New York, Hachem v. Immelt , 17-cv-08457, and the initiation of an investigation by the SEC, concerning the Company’s insurance reserves and accounting for long-term service agreements. This Blog takes a look at Gammel in today’s post. In particular, we take a look at the Court’s ruling concerning the “demand” requirement set forth in New York Business Corporation Law (“BCL”) § 626(c). A Brief Primer on Derivative Litigation It is well-settled that a plaintiff asserting a derivative claim seeks to recover for injury to the business entity. Marx v Akers , 88 N.Y.2d 189, 193 (1996). A plaintiff asserting a direct claim seeks redress for injury to himself/herself individually. Sometimes, the distinction between the two types of actions is not readily apparent. Yudell v. Gilbert , 99 A.D.3d 108, 113 (1st Dept. 2012). In considering whether a claim is direct or derivative, courts look to the nature of the wrong and the person or entity to whom the relief should go. Tooley v. Donaldson, Lufkin & Jenrette, Inc. , 845 A2d 1031, 1039 (Del. 2004). See also Yudell , 99 A.D.3d at 114; Higgins v. New York Stock Exch. , Inc., 10 Misc. 3d 257, 264 (Sup. Ct., N.Y. County 2005) (citation omitted). Thus, for a shareholder’s injury to be direct it must be independent of any alleged injury to the corporation. The shareholder must demonstrate that the duty breached was owed to the stockholder and that he/she can prevail without showing an injury to the corporation. Tooley , 845 A.2d at 1039. Derivative actions are often brought by shareholders of a corporation (or limited liability company) to vindicate the entity’s rights. Bansbach v. Zinn , 1 N.Y.3d 1, 8 (2003), rearg denied , 1 N.Y.3d 593 (2004); Marx , 88 N.Y.2d at 193. Although shareholders are given the right to bring such lawsuits, they are not, however, favored because “they ask courts to second-guess the business judgment of the individuals charged with managing the company.” Bansbach , 1 N.Y.3d at 8.  Notwithstanding, “derivative actions serve the important purpose of protecting corporations and minority shareholders against officers and directors who, in discharging their official responsibilities, place other interests ahead of those of the corporation.” Id . The tension between the foregoing interests is tempered by the requirement that a shareholder demand with particularity that the board of directors takes action to address the alleged wrongdoing or explain why such demand would have been futile. BCL § 626 (c) (providing that the derivative complaint “shall set forth with particularity the efforts of the plaintiff to secure the initiation of such action by the board or the reasons for not making such effort”). As explained by the Court of Appeals, “ he reason for the demand requirement rests on ‘basic principles of corporate control that the management of the corporation is entrusted to its board of directors, who have primary responsibility for acting in the name of the corporation and who are often in a position to correct alleged abuses without resort to the courts.’” Bansbach , 1 N.Y.3d at 9, quoting Barr v. Wackman , 36 N.Y.2d 371, 378 (1975) (citation omitted). “The demand requirement thus relieves courts of unduly intruding into matters of corporate governance by first allowing the directors themselves to address the alleged abuses. The requirement also provides boards with reasonable protection from harassment on matters clearly within their discretion, and it discourages ‘strike suits’ commenced by shareholders for personal rather than corporate benefit.” Id. , citing Marx , 88 N.Y.2d at 194. “Demand is futile, and excused, when the directors are incapable of making an impartial decision as to whether to bring suit.” Bansbach , 1 N.Y.3d at 9. In New York, the demand requirement is excused where a plaintiff pleads “with particularity that (1) a majority of the directors are interested in the transaction, or (2) the directors failed to inform themselves to a degree reasonably necessary about the transaction, or (3) the directors failed to exercise their business judgment in approving the transaction.” Marx , 88 N.Y.2d at 198. If any of these circumstances are met, the failure to file a pre-suit demand will be excused. Id . at 200-201. It is important to note that excusing a pre-suit demand is the exception and, therefore, “should not be permitted to swallow the rule” that a pre-litigation demand is required. Matter of Omnicom Grp. Inc. S’holder Deriv. Litig. , 43 A.D.3d 766, 768 (1st Dept. 2007), citing Marx , 88 N.Y.2d at 200. Thus, if a plaintiff fails to plead with particularity that service of a pre-litigation demand should be excused, the complaint must be dismissed. See Retirement Plan for Gen. Empls. of the City of N. Miami Beach v. McGraw , 158 A.D.3d 494, 495 (1st Dept. 2018). “ director may be interested under either of two scenarios: self-interest in a transaction or loss of independence due to the control of an interested director.” Matter of Comverse Tech., Inc. Deriv. Litig. , 56 A.D.3d 49, 54 (1st Dept. 2008). “The bare claim that the directors … should be viewed as interested because they are ‘substantially likely to be held liable’ for their actions is not enough” to find interestedness. Wandel v. Eisenberg , 60 A.D.3d 77, 80 (1st Dept. 2009). Indeed, simply naming each current or former director “in a lawsuit, without more, is insufficient to establish that they are conflicted and demand is futile.” Lerner v. Immelt , 523 Fed. Appx 824, 827 (2d Cir. 2013) (citations omitted); accord , Bildstein v. Atwater , 222 A.D.2d 545, 546 (2d Dept. 1995).  Likewise, the assertion that certain directors controlled the amount of compensation other directors would have received is inadequate, especially in the absence of an allegation that the compensation the directors received was excessive. Walsh v. Wwebnet, Inc. , 116 A.D.3d 845, 848 (2d Dept. 2014). Although a pre-suit demand can be excused because the directors failed to exercise their business judgment in approving the transaction, demonstrating such a failure can be difficult. Indeed, “it is the ‘rare case[ ] a transaction may be so egregious on its face that board approval cannot meet the test of business judgment.’” Stein v. Immelt , 472 Fed. Appx. 64, 66 (2d Cir. 2012), quoting Wandel , 60 A.D.3d at 82). “The business judgment rule is a common-law doctrine by which courts exercise restraint and defer to good faith decisions made by boards of directors in business settings.” 40 W. 67th St. Corp. v. Pullman , 100 N.Y.2d 147, 153 (2003) (citation omitted).  The rule does not, however, protect directors who “passively rubber-stamp[] the acts of active corporate managers.” Matter of Comverse Tech, Inc. Deriv. Litig. , 56 A.D.3d 49, 56 (1st Dept. 2008), citing Barr , 36 N.Y.2d at 381. The complaint must “allege facts, such as self-dealing, fraud or bad faith” to show that the subject transaction “could not have been the product of sound business judgment.” Goldstein v. Bass , 138 A.D.3d 556, 557 (1st Dept. 2016). Thus, “ o long as the corporation’s directors have not breached their fiduciary obligation to the corporation, the exercise of for the common and general interests of the corporation may not be questioned, although the results show that what they did was unwise or inexpedient.” Matter of Levandusky v. One Fifth Ave. Apt. Corp. , 75 N.Y.2d 530, 538 (1990) (internal quotation marks and citation omitted). Gammel v. Immelt Background Gammel arose out of the alleged acts and omissions of the current and former members of the GE Board of Directors (the “Board,” or “Director Defendants”) in connection with GE’s alleged lack of internal controls and the Director Defendants’ alleged failure to oversee the administration and management of the Company, including being uninformed about material aspects of several segments of the Company, including its Long Term Care (“LTC”) insurance business and the GE Power segment’s Long Term Services (“LTS”) Agreements (“LTSAs”). Plaintiffs brought the action derivatively on behalf of GE, the nominal defendant, against 19 GE officers and directors, alleging breaches of their fiduciary duty to the Company and its shareholders. GE is a global company engaged in a variety of different industries, such as insurance, through GE Capital, and energy, through GE Power. In 2004, GE spun off its LTC business into Genworth, Inc. (“Genworth”), although GE retained significant exposure as a reinsurer for Genworth’s LTC policies. According to plaintiffs, GE was required to maintain adequate cash reserves in order to pay claims on LTC insurance policies, but GE failed to increase their insurance reserves until late 2017. As alleged, Genworth was taking significant charges to reserves due to exposure to liabilities for LTCs. Given Genworth’s disclosures, as well as information that was publicly available, plaintiffs maintained that the Board should have addressed the reasons for such charges. Indeed, plaintiffs alleged that the entire LTC industry recorded massive charges to earnings and sought premium increases as high as 90%, all in connection with long-term care policies. Despite obvious red flags, plaintiffs contended that the Director Defendants failed to reassess GE’s LTC actuarial assumptions and make meaningful adjustments to the Company’s insurance reserves. A portion of GE Power’s business involved the service and maintenance of energy equipment for third parties pursuant to contracts known as Long Term Services Agreements. Plaintiffs alleged that flawed revenue projections from GE Power’s LTSAs negatively impacted the Company’s earnings. Despite negative trends in the power industry, plaintiffs maintained that GE Power improperly increased revenue estimates from the LTSAs until 2017, when GE Power announced an $850 million charge to earnings to account for project cost overruns. GE allegedly engaged in complex, aggressive accounting practices to conceal the extent of the problems with GE Power while simultaneously releasing false or misleading statements praising GE Power’s financial health. Plaintiffs alleged that the SEC had charged GE with accounting fraud previously in relation to these improper accounting practices, which GE had also used to increase its reported earnings. In addition to the foregoing, plaintiffs alleged that the Director Defendants wasted the Company’s assets by allowing Jeffrey Immelt to routinely use a “chase plane” when flying to foreign destinations – that is, a second aircraft that was completely empty to fly behind Immelt’s aircraft. Plaintiffs maintained that the use of such an aircraft was roundly criticized as wasteful and an improper use of corporate funds. Plaintiffs alleged that the truth was disclosed when GE announced: (1) in October 2017, a reduction in earnings guidance from $1.60-$1.70 per share to $1.05-$1.10 per share for 2017 due to “recently observed elevated claims experience” in the Company’s long-term care insurance business and “underperformance in its GE Power segment”; (2) in November 2017, a 50% reduction in GE’s dividend; and (3) in January 2018, a $6.2 billion after-tax charge and the setting aside of $15 billion over seven years to increase long-term care reserves and an investigation by the SEC concerning “the process that led to the insurance reserve increase and the fourth-quarter charge.” As noted, GE is the subject of a shareholders’ class action pending in Southern District of New York for violations of the federal securities laws, and the subject of an SEC investigation into GE’s LTC business and its revenue accounting practices related to GE Power. Plaintiffs commenced the action seeking damages for breach of fiduciary duty, unjust enrichment, waste of corporate assets, abuse of control, and gross mismanagement. Defendants moved to dismiss, contending that plaintiffs failed to plead demand futility with particularity. Plaintiffs opposed the motion, arguing that such a demand would have been futile. Plaintiffs argued that a majority of the Board was interested in the wrongs complained of and, therefore, incapable of arriving at an independent decision. They claimed that the Board ignored the “red flags” described in numerous published reports and articles, excerpts of which were contained in the complaint, warning of the downward trends in the LTC and energy industries, yet chose to rubber-stamp the decisions of GE’s executives whose actions they were charged with overseeing and monitoring. The Court’s Decision The Court granted the motion. The Court held that the complaint failed to plead any particularized facts that the Director Defendants were interested parties who received a personal financial benefit from the transactions alleged in the complaint. Slip Op. at *2, citing Marx , 88 N.Y.2d at 202; Walsh , 116 A.D.3d at 848. Likewise, the Court found that plaintiffs failed to allege any particularized facts demonstrating that any one of the Director Defendants controlled or dominated the other directors. Id. , citing Voluto Ventures, LLC v. Jenkins & Gilchrist Parker Chapin LLP , 46 A.D.3d 354, 356 (1st Dept. 2007). Moreover, the Court found that plaintiffs failed to allege any particularized facts showing that the Director Defendants were conflicted because, inter alia , they would have been held liable for their actions. Id . In this regard, the Court noted, citing Wandel , 60 A.D.3d at 80, that merely alleging that “the Director Defendants would have declined to initiate the litigation because they would have been subject to personal liability is insufficient.” Slip Op. at *7. Simply naming each current or former director as a defendant without more, said the Court, was “insufficient to establish that they are conflicted and demand is futile.” Id . at *9 (citations and internal quotation marks omitted). This was especially so since 17 of the Director Defendants were outside directors elected by the Company’s shareholders. Id . Finally, the Court rejected the allegation that because certain directors controlled the amount of compensation other directors would have received sufficed to show that those directors were beholden to the other directors. Id . at *8. Such allegations, held the Court, “especially in the absence of an allegation that the compensation the Director Defendants received was excessive,” were insufficient. Id. , citing Walsh , 116 A.D.3d at 848). Addressing the second prong of the Marx test, whether the Director Defendants were fully informed with regard to the transactions at issue, the Court held that plaintiffs failed to plead any particularized facts showing that they were not so informed. The Court noted that plaintiffs failed to refute the fact that “the Board, and its committees, met regularly” during the relevant time period. Id .   There were no allegations, said the Court, beyond merely “describe the duties of each committee” that “causally relat those duties to the purported acts, or omissions, at issue to each of the Director Defendants.” Id .  The Court also took issue with plaintiffs’ allegation that the Director Defendants knew, or were aware, of the purported red flags found in the publicly available documents cited in the complaint. Id . he complaint does not allege that the Board had been presented with red flags warning of the general health of the LTC and energy industries, or the specific health of GE Capital and GE Power, and that the Director Defendants consciously chose to overlook or ignore them. Plaintiffs do not allege that Genworth’s filings with the SEC had been presented to the Board, nor does it allege that it was GE’s policy to raise and discuss Genworth’s public disclosures at Board or committee meetings Notably, the complaint refers to three Genworth filings with the SEC on November 5, 2014, March 2, 2015 and November 8, 2016. These three filings hardly constitute a sustained pattern of red flags or warnings that should have caught the attention of the Director Defendants. In addition, there is no allegation that “any member of the Board actually read or learned the contents of” the published news articles, from 2017 and 2018, identified in the complaint. The complaint does not identify what actions the Director Defendants should have taken had they been aware of the red flags. Hence, merely identifying news articles discussing general, downward trends in the LTC and energy industries is “insufficient to alert corporate directors to internal wrongdoing.” Id . at **9-11 (citations and internal quotation marks omitted). The Court further held that plaintiffs failed to plead particularized facts showing that that use of the “chase plane” – the second corporate jet that trailed Immelt when he traveled for business, and which GE executive allegedly used for personal reasons – was so egregious on its face that it could not have been the product of sound business judgment of the directors. The Court found that the complaint was devoid of any facts showing “that the Director Defendants personally benefited from the practice” or identifying the specific, fraudulent conduct by the Director Defendants regarding their actions related to the chase plane, or their alleged failure to act. Id . at *14. This was especially notable since plaintiffs “admit that GE’s March 12, 2018 DEF 14A filing indicated that GE’s executives repaid the corporation for their personal use of corporate aircraft.” Id . In short, plaintiffs failed to allege any facts from which the Court could infer that the Director Defendants acted in bad faith or that “that they were acting for a purpose unaligned with the best interest of the corporation.” Id . at *15, citing Foley v. D’Agostino , 21 A.D.2d 60, 66 (1st Dept. 1964).     Having failed to satisfy the tests set forth in Marx , the Court dismissed the complaint for failure to plead demand futility with the requisite particularity.

McGuckin v. Privilege Underwriters Reciprocal Exch. was decided by the Appellate Division, Second Department, on July 17, 2019.  The facts of McGuckin , at least from the Second Department’s decision, seem rather straight forward.  The plaintiff, who was a passenger in a vehicle owned by Carol Giambrone and driven by Douglas Giambrone, was injured when the vehicle was in an accident.  The vehicle was insured by defendant Privilege under a policy that provided at the time of the accident, inter alia , personal injury coverage of up to $250,000 per person and $500,000 per occurrence. The Giambrones were sued by McGuckin for the personal injuries sustained in the accident.  A few months later the Giambrones entered into an agreement with Privilege to reform the insurance policy to reduce the bodily injury coverage from $250,000 to a single $80,000 limit (the “Reduction”) and McGuckin was so notified of the reduced coverage.  Ultimately, McGuckin obtained a $300,000 judgment against the Giambrones in the underlying personal injury action.  In this regard, a review of the court file in the underlying personal injury action reveals that McGuckin and the Giambrones entered into a stipulation and confession of judgment in which, inter alia : 1. McGuckin acknowledged the Reduction; 2. McGuckin asserted that he did not consent to the Reduction; 3. Giambrones assigned to McGuckin their right to challenge the reduction; and, 4. McGuckin waived his right to have the judgment satisfied out of the personal assets of the Giambrones and would limit its recovery to such sums as recovered in his contemplated declaratory judgment litigation against Privilege. McGuckin commenced a declaratory judgment action against Privilege in which he sought an order declaring, among other things, “that the purported reformation of the subject insurance policy was invalid and unenforceable that the defendant is bound by the full bodily injury coverage limits stated in the original policy….”  McGuckin moved for summary judgment and Privilege cross-moved for summary judgment.   In denying McGuckin’s motion and granting Privilege’s motion, supreme court held: Plaintiff offers no basis for his claim .  The Gambrones were legally permitted to reach an agreement with respect to their own rights to defense and indemnification by Privilege….  There is no allegation of collusion between the Giambrones and their insurer, and whatever deal they struck in 2012 with their insurer cannot be set aside in favor of a subsequent agreement in 2015 between the Giambrones and the Plaintiff here.  The settlement between the Giambrones and the Plaintiff expressly provides that the insurance policy had a reduced single limit of $80,000. In reversing supreme court, the Second Department held that an “insurer may not retroactively reform a policy to reduce the stated bodily injury coverage limits after a loss caused by its insured occurs, even if the reduced limits still meet or exceed the statutory minimum.”  (Citation omitted.)  According to the Second Department, McGuckin made his prime facie case by “demonstrating that the policy in effect at the time of the accident provided for a bodily injury coverage limit of $250,000 per person, and submitting the $300,000 judgment he obtained against insureds in the underlying personal injury action….”  The Court also held that McGuckin was entitled to a judgment “as a matter of law declaring that is obligated to satisfy the first $250,000 of the judgment he obtained against the Giambrones.

Readers of this Blog know that, as a general matter, New York courts will not permit a fraudulent inducement claim to survive a motion to dismiss when the claim arises from a breach of contract. Indeed, courts routinely dismiss a fraudulent inducement claim where “ he existence of a valid and enforceable written contract govern a particular subject matter” and the recovery sought arises out of the same facts and circumstances. Clark-Fitzpatrick v. Long Is. , 70 N.Y.2d 382 (1987). However, where “a legal duty independent of the contract itself has been violated<,> ” or where the misrepresentation is “collateral or extraneous to the terms of the parties’ agreement,” a fraudulent inducement claim can stand side-by-side with “a simple breach of contract” claim.  Dormitory Auth. v. Samson Constr. Co. , 30 N.Y.3d 704 (2018) (citation omitted). See also McKernin v. Fanny Farmer Candy Shops, Inc. , 176 A.D.2d 233, 234 (2d Dept. 1991). What constitutes “a legal duty independent of a contract” is not a question easily answered.  Cronos Group Ltd. v. XComIP, LLC , 156 A.D.3d 54, 56 (1st Dept. 2017) (referring to the question as a “recurring” one). In trying to answer the question, the courts make the distinction between a misrepresentation of intention and a misrepresentation of present fact. Id . at 63. See also Demetre v. HMS Holdings Corp. , 127 A.D.3d 493, 494 (1st Dept. 2015) (common law fraud is duplicative of breach of contract where the only misrepresentation alleged concerns an “intent to perform the contractual obligations at the time they were made.”). The former will result in dismissal, while the latter will not. Gosmile, Inc. v. Levine , 81 A.D.3d 77 (1st Dept. 2010). In Did-it.com, LLC v. Halo Group, Inc. , 2019 N.Y. Slip Op. 05644 (July 17, 2019) ( here ), the Appellate Division, Second Department, reversed the dismissal of a fraudulent inducement claim, holding that the claim contained “misrepresentations of present fact that were collateral to the” contract before it and, therefore, “was not duplicative of the breach of contract cause of action.” Slip Op. at *1 and *2.   Did-it.com arose from the sale of the Halo Group, Inc.’s (“Halo”) assets to Did-it.com, LLC (“Did-it”). In May 2017, Did-it and Halo entered into an asset purchase agreement (the, “APA”), pursuant to which plaintiff agreed to purchase all of Halo’s assets. The APA contained a number of representations and warranties, including that: 1) the 2016 financial statements provided by Halo to Did-it were accurate and complete; and 2) there were no adverse changes or events subsequent to the preparation of Halo’s 2016 financial statements that would result in, inter alia , a loss of customers or a reduction in revenues. Did-it claimed that these, and other representations, induced it to pay $1.5 million to purchase Halo’s assets. According to the complaint, following the closing of the transaction (“Closing”), Did-it learned that the assets (“Assets”) it had purchased from Halo were worth significantly less than what was represented, bargained for, and otherwise agreed upon. The client accounts purchased from Halo generated approximately $5,000 in revenues for Did-it during the first month after the Closing, although Halo’s 2016 financials reflected average monthly revenues in excess of $300,000. Did-it also learned after the Closing that all but one of Halo’s customers listed in defendants’ disclosures had ceased doing business with the company. Defendants also failed to turn over all of the Assets to Did-it as required under the APA. In June 2017, plaintiff commenced the action. In an amended complaint, plaintiff asserted six causes of action, including the first cause of action, alleging fraudulent inducement, and the third cause of action, alleging breach of contract. Prior to answering, defendants moved pursuant to CPLR 3211(a) to dismiss the amended complaint. The Supreme Court, inter alia , granted that branch of the motion which was to dismiss the first cause of action. Plaintiff appealed. In seeking dismissal, defendants argued, among other things, that Did-it failed to allege any facts to support its claim that defendants misrepresented the company’s finances, and failed to allege any facts that the financial statements were false and exaggerated or that a material adverse change occurred that Halo failed to disclose. Defendants maintained that Did-it merely made conclusory allegations that were contradicted by the actual facts and the express terms of the APA. Defendants also contended that Did-it’s fraud claim was duplicative of its breach of contract claim because it was based on representations in the APA; namely, that the 2016 financial statements were accurate and complete and there were no adverse changes or events subsequent to the preparation of the financial statements that would result in, inter alia , a loss of customers or a reduction of revenues. Thus, the false statements alleged in the amended complaint were not, and could not be, collateral or extraneous to the parties’ agreement. Plaintiff opposed the motion arguing, inter alia , that it stated a viable claim for fraudulent inducement by alleging that defendants made misrepresentations pursuant to the APA by providing 2016 financial statements that reflected a healthy business, providing a warranty that the financial statements were accurate and not misleading, and providing a warranty that no adverse changes had occurred since the financials were prepared. Plaintiff argued that these allegations constituted misrepresentations of present fact that were collateral to the APA. As noted, the Supreme Court dismissed the first cause of action, finding that the fraudulent inducement claim was duplicative of the breach of contract claim. The court held that the representations cited by plaintiff were “material terms of the APA” and, therefore, “duplicative of express representations made in the APA” that plaintiff claimed defendants had breached. On appeal, the Second Department reversed. In so holding, the Court found that plaintiff “allege misrepresentations of present fact that were collateral to the APA” and that those “misrepresentations induced the plaintiff to enter into the APA.” Slip Op. at *2. Consequently, said the Court, the Supreme Court “should have denied that branch of the defendants’ motion which was to dismiss the first cause of action.” Id . Takeaway Unfortunately, the Court did not provide an explanation for its holding. The absence of such an explanation leaves one trying to determine why the fraudulent inducement claim differed from the breach of the contract claim. In the fraud scenario, plaintiff must prove that the financial statements were not accurate. In the contract scenario, plaintiff must prove that the representation and warranty concerning the financial statements were breached – that is, that the financial statements were not accurate. Under either claim, therefore, the accuracy of the financial statements is at issue. Perhaps the foundational underpinning of the Court’s ruling is based on the principle that “ warranty is not a promise of performance, but a statement of present fact.” First Bank of Ams. v. Motor Car Funding , 257 A.D.2d 287, 292 (1st Dept. 1999). If so, then it stands to reason that defendants’ representation and warranty concerning the financial statements was collateral to the APA. Regardless of the reason for the decision, Did-it.com stands for the proposition that a fraudulent inducement claim and a breach of contract claim can stand side-by-side when the alleged false statement is collateral to the contract at issue and induces the plaintiff to enter into the agreement.

The disclosure of material information is the foundation of the Securities and Exchange Commission’s (“SEC”) mission. For this reason, the SEC considers itself to be “a disclosure agency.” See “The Importance of the SEC Disclosure Regime” by Daniel M. Gallagher, Commissioner, U.S. Securities and Exchange Commission (July 16, 2013) (here). One need only look at the SEC’s website to confirm this point: “he laws and rules that govern the securities industry in the United States derive from a simple and straightforward concept: all investors, whether large institutions or private individuals, should have access to certain basic facts about an investment prior to buying it, and so long as they hold it.” (Here.) To further underscore the point, Commissioner Gallagher said the following in his post: The federal corporate disclosure regime was established by Congress and serves as a cornerstone of the Commission’s tripartite mission to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. The underlying premise of the Commission’s disclosure regime is that if investors have the appropriate information, they can make rational and informed investment decisions. This is not to say that the disclosure regime was meant to guarantee that investors receive all information known to a public company, much less to eliminate all risk from investing in that company. Instead, the point has always been to ensure that they have access to material investment information. The foregoing themes were recently highlighted in a speech given by William H. Hinman, Director of the Division of Corporation Finance, at the 18th Annual Institute on Securities Regulation in Europe on March 15, 2019: As you know, our disclosure requirements are intended to provide investors with the material information they need about companies and their securities offerings to make informed investment and voting decisions. Robust disclosure decreases information asymmetries and is the foundation of reliable price discovery. When investors have confidence that they are receiving full and transparent disclosure, markets operate more efficiently and the cost of capital is reduced. With the foregoing in mind, this Blog looks at three enforcement proceedings brought by the SEC against individuals and entities that failed to disclose material information to their investors, customers, and/or shareholders. In the Matter of Fieldstone Financial Management Group, LLC et al. On July 1, 2019, the SEC announced (here) that it charged Fieldstone Financial Management Group LLC (“Fieldstone”) and its principal, Kristofor R. Behn (“Behn”), both of Foxboro, Massachusetts, with defrauding retail investment advisory clients by failing to disclose conflicts of interest related to their recommendations to invest in securities issued by affiliates of Oregon-based Aequitas Management LLC (“Aequitas”). The SEC also accused Behn of misusing an investor’s funds to pay personal expenses. According to the SEC (here), from 2014 to early 2016, approximately 40 retail clients of Behn and Fieldstone invested more than $7 million in Aequitas securities, which were the subject of a previous Commission enforcement action. The SEC found that Behn and Fieldstone failed to disclose to their clients that Aequitas had provided Fieldstone with a $1.5 million loan and access to a $2 million line of credit, both of which had terms that created a significant financial incentive for Behn and Fieldstone to recommend Aequitas securities to their clients. The SEC further found that Behn and Fieldstone made material misstatements and omissions in reports filed with the Commission, including false representations that the repayment terms of the loan from Aequitas were not contingent on Fieldstone clients investing in Aequitas. In addition, the SEC found that Behn and Fieldstone fraudulently induced a client to invest $1 million in Fieldstone. Within days of Fieldstone receiving the $1 million, Behn used approximately $500,000 to pay his personal taxes and make other payments to himself or for his personal benefit. “Behn flagrantly disregarded his most basic duties as an investment adviser by concealing the significant financial incentives he and his firm would receive by recommending investments in Aequitas,” said Erin E. Schneider, Director of the SEC’s San Francisco Regional Office. “The Commission is committed to rooting out breaches of fiduciary duty to retail investors.” i.e.,="(i.e.," candor,="candor," loyalty="loyalty" and="and" due="due" care)="care)" here.=">here."> Without admitting or denying the SEC’s findings, Fieldstone and Behn consented to the issuance of the order, which found that they violated the antifraud provisions of the federal securities laws, censured Fieldstone, ordered them to cease and desist from future violations, and ordered them to pay, on a joint-and-several basis, disgorgement and prejudgment interest of $1,047,971 and a penalty of $275,000, all of which is to be distributed to investors harmed by the alleged wrongdoing. Behn will also be permanently barred from association with any broker, dealer, investment adviser, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organization. In the Matter of Nomura Securities International, Inc. On July 15, 2019, the SEC announced that it had instituted two related enforcement actions against Nomura Securities International, Inc. (“Nomura”), which agreed to repay approximately $25 million to customers for its failure to adequately supervise traders in mortgage-backed securities. In its orders (here and here), the SEC found that Nomura bond traders made false and misleading statements to customers while negotiating sales of commercial and residential mortgage-backed securities (“CMBS” and “RMBS”). According to the SEC, several Nomura traders misled customers about the prices at which Nomura had bought securities, the amount of profit Nomura would receive on the customers’ potential trades, and who currently owned the securities, with traders often pretending that they were still negotiating with a third-party seller when Nomura had, in fact, already bought a security. The SEC further found that Nomura lacked compliance and surveillance procedures that were reasonably designed to prevent and detect this alleged misconduct, which inflated the firm’s profits on CMBS and RMBS transactions at its customers’ expense. The SEC previously filed charges against two CMBS and three RMBS traders at Nomura, whose misrepresentations were described in the SEC’s orders. “Firms acting as dealers in opaque markets like those for CMBS and RMBS must take steps to prevent misleading communications with their customers,” said Daniel Michael, Chief of the SEC Enforcement Division’s Complex Financial Instruments Unit. “These orders underscore that firms must have adequate supervisory procedures, particularly surrounding the sale of complex instruments,” said Sanjay Wadhwa, Senior Associate Director of the SEC’s New York Regional Office. “Weak procedures, such as those found here, may enable employee misconduct to go undetected.” To settle the charges that it failed to reasonably supervise its traders, Nomura agreed in the two orders to be censured and to reimburse customers the full amount of firm profits earned on any RMBS or CMBS trades in which a misrepresentation was identified, paying over $20.7 million to RMBS customers and over $4.2 million to CMBS customers. Nomura also agreed to pay a $1 million penalty in the RMBS-related case and a $500,000 penalty in the CMBS-related case. Both orders noted that the penalty amounts reflected substantial cooperation by Nomura during the SEC’s investigation, including remedial efforts by the firm to improve its surveillance procedures and other internal controls. SEC v. AR Capital, LLC On July 16, 2019, the SEC announced (here) that it had charged AR Capital LLC (“AR Capital”), its founder Nicholas S. Schorsch (“Schorsch”), and its former Chief Financial Officer, Brian Block (“Block”), with wrongfully obtaining millions of dollars in connection with two separate mergers between real estate investment trusts (“REITs”) that were sponsored and externally managed by AR Capital. The defendants agreed to settle the matter by, among other things, agreeing to over $60 million in disgorgement, prejudgment interest and civil penalties. According to the SEC’s complaint (here), between late 2012 and early 2014, AR Capital arranged for American Realty Capital Properties Inc. (“ARCP”), a publicly-traded REIT, to merge with two publicly-held, non-traded REITs. The SEC alleged that AR Capital, Schorsch, and Block, acting in breach of the relevant proxy disclosures, inflated an incentive fee in both mergers. As alleged, this improper calculation allowed them to obtain approximately 2.92 million additional ARCP operating partnership units as part of their incentive-based compensation. In addition, the SEC alleged that the defendants wrongfully obtained at least $7.27 million in unsupported charges from asset purchase and sale agreements entered into in connection with the mergers. “REIT managers and their professionals have an obligation to tell the truth when making disclosures to shareholders about their compensation,” said Marc P. Berger, Director of the SEC's New York Regional Office. “As we allege in our complaint, AR Capital and its partners Schorsch and Block failed to do so and benefitted themselves greatly at the expense of shareholders.” The SEC’s complaint, filed in the United States District Court for the Southern District of New York, charged AR Capital and Block with violating the antifraud provisions of Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5(b) promulgated thereunder, and falsifying books and records of ARCP. The complaint charged Schorsch with negligently violating the antifraud provisions of Sections 17(a)(2) and (3) of the Securities Act of 1933, as well as books and records violations. Without admitting or denying the allegations in the complaint, AR Capital, Schorsch, and Block consented to entry of a final judgment that imposed permanent injunctions from violations of the charged provisions; ordered combined disgorgement and prejudgment interest on a joint-and-several basis of over $39 million, which included cash and the return of the wrongfully obtained ARCP operating partnership units; and imposed civil penalties of $14 million against AR Capital, $7 million against Schorsch, and $750,000 against Block. The settlements are subject to court approval.