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By: Jeffrey M. Haber To allege a cause of action based on fraud, plaintiffs must assert “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. 1 To withstand a motion to dismiss, plaintiffs must satisfy each element of the claim. One of the most difficult elements of the fraud claim to plead and prove is the scienter element. First, a defendant is not likely to declare to the world that he or she intended to commit a fraud. Second, knowledge of the falsity of the representation at issue is “likely to be within the sole knowledge of the defendant and least amenable to direct proof.” 2 For these reasons, plaintiffs “need only allege specific facts from which it is possible to infer defendant’s knowledge of the falsity of its statements.” 3 A defendant’s knowledge of a corporate fraud or its concealment may be deduced by his or her position and responsibilities within the organization. 4 And, while fraudulent intent may “be divined from surrounding circumstances,” 5 it is generally a question that cannot be resolved on a motion to dismiss. 6 here,=">here," >here=">here" and="and" >here.=">here."> The damages element of a fraud claim can also be difficult to satisfy. Generally, plaintiffs are allowed to recover only their out-of-pocket damages – that is, the actual pecuniary loss sustained as the direct result of the wrong. Under the out-of-pocket damages rule, plaintiffs may recover what they lost because of the fraud, not what they might have gained had there been no fraud. 7 In other words, plaintiffs cannot recover the profits which would have been realized in the absence of the fraud. For that reason, plaintiffs cannot recover damages for fraud based on the loss of a contractual bargain, “the extent, and, indeed the very existence of which is completely undeterminable and speculative.” 8 To determine whether the plaintiff sustained out-of-pocket losses, courts employ a two-part test. 9 First, the plaintiff must show the actual value of the consideration it received. 10 Second, the plaintiff must prove that the defendant’s fraudulent inducement directly caused the plaintiff to agree to deliver consideration that was greater than the value of the received consideration. 11 The difference between the value of the received consideration and the delivered consideration constitutes the plaintiff’s out-of-pocket damages. 12 here=">here" and="and" >here.=">here."> With these principles in mind, we look at Community Association of the East Harlem Triangle, Inc. v. Butts , 2021 N.Y. Slip Op. 07503 (1st Dept. Dec. 28, 2021) ( here ). The Motion Court Proceedings here).=">here)."> In March 1994, defendant, Abyssinian Development Corporation (“ADC”), and plaintiff, the Community Association of East Harlem Triangle, Inc. (“CAEHT”), formed a joint venture for the purpose of developing property in New York City as a Pathmark supermarket (“Property”). The parties formed East Harlem Abyssinian Triangle Corp. (“EHAT Corp.”) to conduct the business of the joint venture and East Harlem Abyssinian Triangle Limited Partnership (“EHAT LP”) to own and develop the Property. EHAT Corp. was the general managing partner of EHAT LP, and CAEHT and ADC each held 50% of EHAT Corp.’s stock. EHAT Corp. holds a 51% interest in EHAT LP and the New York City Economic Development Corporation holds a 49% interest in EHAT LP.  At a meeting of the EHAT Corp. board of directors (the “Board”), held in March 2013, defendant James Howard, Senior VP of ADC and a director of EHAT Corp., initiated the first of several discussions with the Board regarding the sale of the Property. Thereafter, defendants Howard and Butts (Chairman of ADC) took a lead role in managing the sale of the Property on behalf of EHAT Corp. According to plaintiff, defendant Victor Sozio of Ariel Property Advisors LLC (“Ariel”), a commercial real estate broker, and defendant Charles Simpson, a partner in the WM law firm, assisted with the sale. Beginning in October 2013, Derek Johnson of Integrated Urban Holdings, LLC (“Integrated”) started working with R. Donahue Peebles, Chairman and CEO of Peebles Corp, (“Peebles Corp.”), to submit an offer to acquire the Property. Peebles Corp. had a real estate portfolio worth approximately $5 billion. At a Board meeting held on or about November 25, 2013, Howard informed the Board that he had identified seven potential buyers of the Property, including Peebles Corp. and Extell Development Company (“Extell”). On January 15, 2014, Integrated and Peebles Corp. (together “Peebles/Integrated”) jointly submitted a written offer to purchase the Property for $40 million to Butts, and mailed copies of the offer to Sozio and Simpson. Thereafter, Sozio allegedly told Johnson that EHAT Corp. would accept an offer of $42 million, and Johnson allegedly responded that Peebles/Integrated would increase its offer to that amount. On February 12, 2014, Sozio sent Johnson a term sheet containing the terms that EHAT Corp. would agree to accept the $42 million offer. After Johnson communicated his assent, Sozio told him that the offer had been forwarded to Simpson, who would follow up with Johnson to memorialize the offer in a formal contract. However, Johnson allegedly never heard from Simpson. On March 24, 2014, the Board held a meeting to consider an offer from Extell to purchase the Property for $39 million. Simpson, Howard and Sozio attended the meeting. During the meeting, a CAEHT representative asked Howard whether there were any other offers to purchase the Property aside from that of Extell. Before Howard could answer, however, Simpson allegedly stated that Extell was the only party to show an interest in purchasing the Property. According to plaintiff, despite knowing this statement was untrue, neither Sozio nor Howard corrected Simpson at or after the meeting, or otherwise disclosed the higher Peebles/Integrated offer. Plaintiffs alleged that the Peebles/Integrated offer was deliberately concealed from them because Simpson, WM, ADC, Butts, Howard, Sozio and Ariel had previously agreed to steer the Property to Extell. In this connection, at the March 24, 2014 meeting, the Board also discovered that ADC had already received an advance payment from Extell in the amount of $2.5 million at an unspecified date prior to the meeting, which Simpson, Howard, Sozio and Butts had allegedly failed to disclose. Additionally, at that meeting, plaintiffs learned that ADC had never informed Extell of plaintiffs’ interest in the Property. In view of this new information, the meeting ended without a vote on the sale of the Property. The Board met again on April 3, 2014, to discuss the sale, at which time Howard allegedly denied that there were any other offers besides Extell’s. The Board deadlocked on the vote to approve the sale, with the four ADC-appointed directors voting in favor and the four directors appointed by CAEHT voting against the offer. However, a majority of the Board voted in favor of the sale at an April 10, 2014, meeting, including Butts, who did not attend the meeting but voted by proxy. Plaintiffs alleged that, as a direct and proximate consequence of the fraudulent concealment of the Peebles/Integrated offer, EHAT Corp. was damaged in the amount of $3 million, or the difference between the amount paid by Extell to purchase the Property and the market value of the Property. Plaintiffs asserted 58 causes of action in various permutations against different combinations of the defendants, sounding in fraud, breach of fiduciary duty, and aiding and abetting, together with a claim pursuant to Business Corporations Law (BCL) § 720 and a demand for punitive damages. Defendants moved to the dismiss the claims against them. The Motion Court’s Decision All defendants challenged the fraud claims on the ground that plaintiffs failed to allege any damages under a recognized tort theory. Specifically, defendants argued that recovery of any loss resulting from the alleged concealment of the Peebles/Integrated $42 million offer was barred by the “out-of-pocket” rule. Defendants claimed that, at most, plaintiffs asserted a claim for lost opportunity or lost profit damages ( i.e. , damages incurred by the sale of the Property at a deflated price). Under the out-of-pocket rule, defendants argued, such losses were inherently speculative and nonrecoverable as a matter of law. Relying on Bernstein v. Kelso & Co. , 231 AD2d 314 (1st Dept. 1997), the motion court rejected defendants’ contention. In Bernstein , the plaintiff alleged that the management employees of a company schemed with a potential buyer to sell the company at the lowest price that the principal and other shareholders would accept, furnishing confidential information to aid the buyer in obtaining the most favorable offer for itself. The Court found it irrelevant that the plaintiff ultimately made an overall “profit” from the transaction, noting that the plaintiff was not seeking the undeterminable future profits that might generated by the company after the sale. Rather, the plaintiff “sought to recover the difference between the price he received in the sale of the company and the price he would have received had his employees and not deceived him.” The motion court held that plaintiffs could submit nonspeculative proof demonstrating that they were induced “to deliver consideration that was greater than the value of the received consideration <$39 million> ” by proffering evidence of the market value of the Property at the time of the sale. 13 The ADC defendants argued that plaintiffs failed to allege that defendants possessed the requisite intent to defraud. In particular, they contended that there were no allegations indicating their motive for steering the sale to Extell or suggesting how they benefitted in any way from doing so. They also pointed out that the broker defendants would be working against their own interest in a commission by procuring a sale at a lower price. The motion court rejected the ADC defendants’ contention. The motion court noted that plaintiffs alleged that both Butts and Howard were aware of the Peebles/Integrated offer through their interactions with each other, their counsel and the brokers, and either falsely denied or concealed its existence. At this stage of the proceeding, noted the motion court, such allegations were sufficient to demonstrate their knowledge for the purpose of the fraud claim.  Regarding the argument that the individuals did not personally profit from the alleged fraud, the motion court observed, quoting Polonetsky v Better Homes Depot , 97 N.Y.2d 46, 55 (2001), that “corporate officers and directors may be held individually liable if they participated in or had knowledge of the fraud, even if they did not stand to gain personally.”  Finally, the motion court declined to rule on defendants’ argument that the business judgment rule protected them from liability for the alleged breaches of fiduciary duty. The motion court said that it was premature to rule on the applicability of the business judgment rule, especially given its ruling on plaintiffs’ allegation concerning the ADC defendants’ state of mind at the time of the sale. It is premature to rule on the applicability of the business judgment rule as to the ADC defendants’ conduct. Although the rule would ordinarily shield them from liability in such a routine decision concerning the sale of a corporate asset, defendants are entitled “adduce evidence of self-dealing, fraud, or other acts constituting a breach of fiduciary duty sufficient to overcome the business judgment rule” Accordingly, resolution of the issue is not appropriate at the pleading stage, as questions of fact exist “involving the condition or state of the defendants’ minds, which can be proved or judged only through evidence.” [Ed. Note: “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.” 14 The rule does not, however, protect directors who “passively rubber-stamp[] the acts of active corporate managers." 15 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.” 16 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.” 17 ]  On appeal, the Appellate Division, First Department affirmed. The First Department’s Decision The Court held that plaintiffs “adequately pleaded nonspeculative damages,” such that their claims were “not barred by the out-of-pocket rule.” 18 The Court found that “Plaintiffs allege that a specific alternative offer for the property for $3 million more was made at around the same time as the Extell offer, that the higher offer was concealed from them, and that they had unknowingly passed on that offer in approving the $39 million sale.” 19 The Court explained that the “alternative Integrated/Peebles offer of $42 million and the term sheet conditions had been agreed to, and thus did not amount to mere speculative damages.” 20 “The agreement was never memorialized in a contract,” observed the Court, “because defendant Charles Simpson, EHAT Corp.’s lawyer, allegedly colluded with the other defendants to steer the sale to Extell, and never drafted and delivered a contract to Peebles's principal.” 21 The Court also held that the motion court “correctly concluded that the amended complaint sufficiently pleaded intent to defraud by the ADC defendants.” The Court noted that the “amended complaint allege that Butts and Howard, as officers and board members of EHAT Corp. and ADC, worked together on the sale of the property; that Howard personally heard Simpson mispresent at the March 24, 2014 board meeting that there were no offers other than Extell’s; that Butts was sent the Integrated/Peebles offer; and that they communicated with one another concerning the Integrated/Peebles offer.” 22 The Court rejected the ADC defendants’ argument that any fraudulent intent on their part was “nonsensical because they too stood to gain from the sale of the property”. 23 The Court stated that “at this juncture in the absence of any explanation as to why they would accept the lower offer without disclosing the Integrated/Peebles offer to the board,” the complaint stated a claim. 24 Finally, the Court held that “the motion court correctly concluded that dismissal based on the business judgment rule would be premature.” Takeaway The Court of Appeals has explained that under the out-of-pocket damages rule, damages should compensate the plaintiff “for what lost because of the fraud,” not “what might have gained.” 25 Consequently, “there can be no recovery of profits which would have been realized in the absence of fraud.” 26 The Court underscored this point by noting that it had “consistent refus to allow damages for fraud based on the loss of a contractual bargain, the extent, and, indeed, … the very existence of which is completely undeterminable and speculative.” 27 In Community Association , the Court made it clear that a plaintiff alleging fraud can recover lost opportunity damages, where such damages are not speculative and can be quantified. As discussed, the alleged damages were quantifiable at $3 million.  Aside from the damages issue, Community Association is notable for its analysis of the scienter element of a fraud claim. There, the Court found that plaintiffs alleged sufficient facts from which state of mind could be inferred – namely, that “Butts and Howard, as officers and board members of EHAT Corp. and ADC, worked together on the sale of the property; that Howard personally heard Simpson mispresent at the March 24, 2014 board meeting that there were no offers other than Extell’s; that Butts was sent the Integrated/Peebles offer; and that they communicated with one another concerning the Integrated/Peebles offer.” 28 While these defendants raised an interesting argument about the absence of motive to deceive, the Court held that such arguments are left for later proceedings. Contact our business lawyer to get started on your claim. Footnotes Lama Holding Co. v. Smith Barney , 88 N.Y.2d 413, 421 (1996) (citations omitted). Houbigant, Inc. v. Deloitte & Touche , 303 A.D.2d 92, 98 (1st Dept. 2003). Id. at 99. Pludeman v. N. Leasing Sys., Inc. , 10 N.Y.3d 486, 493 (2008). Oster v. Kirschner , 77 A.D.3d 51, 56 (1st Dept. 2010). ACA Fin. Guar. Corp. v. Goldman, Sachs & Co. , 131 A.D.3d 427, 428 (1st Dept. 2015). Connaughton v. Chipotle Mexican Grill, Inc. , 29 N.Y.3d 137, 142-43 (2017) (quoting, Lama, supra ) (internal quotations omitted)). Id. Kumiva Grp., LLC v. Garda USA Inc. , 146 A.D.3d 504, 506 (1st Dept. 2017). Id. Id. Id. Citing Kumiva , 146 A.D.3d at 506. 40 W. 67th St. Corp. v. Pullman , 100 N.Y.2d 147, 153 (2003) (citation omitted). Matter of Comverse Tech, Inc. Deriv. Litig. , 56 A.D.3d 49, 56 (1st Dept. 2008) (citation omitted). Goldstein v. Bass , 138 A.D.3d 556, 557 (1st Dept. 2016). Matter of Levandusky v. One Fifth Ave. Apt. Corp. , 75 N.Y.2d 530, 538 (1990) (internal quotation marks and citation omitted). Slip Op. at *1 (citation omitted). Id. Id. Id. Id. at *1-*2. Id. Id. (citations omitted). Connaughton , 29 N.Y.3d at 142. Id. (citations omitted). Id. at 142-143 (quoting, Dress Shirt Sales v. Hotel Martinique Assoc. , 12 N.Y.2d 339, 344 (1963)). Slip Op. at *1-*2.

By Jonathan H. Freiberger Generally speaking, usury statutes prevent excessive interest from being charged on a loan. The New York Court of Appeals has noted that “ tatutes prohibiting usurious loans were enacted in the 15 th century England, became part of New York’s colonial history, and have remained since” and that “ heir purpose is to protect desperately poor people from the consequences of their own desperation.” Seidel v. 18 East 17 th Street Owners, Inc. , 79 N.Y.2d 735, 740 (1992) (citations and internal quotation marks omitted). As noted in this Blog’s December 22, 2021, article entitled: “ Agreements That Are Not Loans Are Not Subject to New York’s Usury Statutes ,” “the rudimentary element of usury is the existence of a loan or forbearance of money” and, accordingly, “where there is no loan, there can be no usury….”  (Citations, footnotes and internal quotation marks omitted.)  That article also discussed when a transaction is considered a loan for the purpose of applying New York’s usury statutes.   Pursuant to General Obligations Law §5-501(1) , interest on a loan or forbearance “shall be six per centum per annum unless a different rate is prescribed in section fourteen-a of the banking law.”  GOL §5-501(2) prevents individuals or entities from charging interest rates exceeding those permitted pursuant to GOL §5-501(1).  Banking Law §14-a(1) provides that the “maximum rate of interest provided for in section 5-501 of the general obligations law shall be sixteen per centum per annum.”  GOL §5-511 provides that usurious contracts are void.  When calculating interest rates on loans for less than one year, the interest will be annualized if not so stated in the note.  Thus, in Bakhash v. Winston , 134 A.D.3d 468 (1 st Dep’t 2015), the Court found a loan criminally usurious where a four-month note provided for 12% interest without indicating that such rate was annual.  The Bakhash Court said that “ here, as here, the loan is for less than a year, the interest rate is annualized, and thus, the annual rate on the note is 36%, well above the criminal usury rate of 25%.”  Bakhash , 134 A.D.3d at 469 (citation omitted). Failure to abide by usury laws could have significant repercussions.  “The consequences to the lender of a usurious transaction can be harsh: the borrower is relieved of all further payment—not only interest but also outstanding principal, and any mortgages securing payment are cancelled. In effect, the borrower can simply keep the borrowed funds and walk away from the agreement.”  Seidel , 79 N.Y.2d at 740.  Further, GOL § 5-513 permits the borrower to “recover any interest paid above the amounts permitted by law. Because the penalties are harsh, usury must be proven by “clear and convincing evidence.”  Roopchard , 154 A.D.3d at 988 (citation omitted). Because Corporations are “generally the antithesis of … desperately poor people”, they are “ordinarily barred from asserting a usury defense.”  Seidel , 79 N.Y.2d at 740 (citations, footnote and internal quotation marks omitted).  See also GOL  § 5-521(1) .  However, a corporation can assert usury as a defense to the extent that the usury is criminal under Section 190.40 of New York’s Penal law , which makes interest on a loan or forbearance that exceeds twenty-five per cent per annum a felony.  GOL § 5-521(3) .  See also Roopchand v. Mahammed , 154 A.D.3d 986, 988 (2 nd Dep’t 2017) (citation omitted). Some of the preceding principles were applied by the Second Department in Adler v. Marzario , a case decided on December 15, 2021.  The defendants in Adler , delivered to plaintiff a note evidencing a promise to repay $75,000 with interest at the rate of 20% per annum.  The note was secured by a mortgage on real property owned by one of the defendants.  Upon defendants’ default, plaintiff commenced a mortgage foreclosure action, which was defended on the ground of usury.  Plaintiff moved for summary judgment and defendants cross-moved for summary judgment dismissing the complaint “as asserted against them and deeming the mortgage void on the ground that the loan was usurious.”  Supreme court granted the cross-motion and plaintiff appealed. The Second Department found the loan usurious on its face and, therefore, “void … as a matter of law.”  Accordingly, the borrowers were relieved “of the obligation to repay principal and interest thereon.”  The Court also rejected plaintiff’s efforts to avoid the usury laws by attempting to characterize the underlying transaction as a “business or investment loan.”   The Court also stated that “contrary to the plaintiff’s further contention, a clause in the subject promissory note purporting to reduce the rate of interest to a non-usurious rate if the rate originally imposed was found to be usurious could not save the note from being usurious (Fred Schutzman Co. v Park Slope Advanced Med., PLLC, 128 AD3d 1007, 1008; see also Bakhash v Winston, 134 AD3d 468, 469; Simsbury Fund v New St. Louis Assoc., 204 AD2d 182).” Jonathan H. Freiberger is a partner and co-founder of Freiberger Haber LLP. This article is for informational purposes and is not intended to be and should not be taken as legal advice.

By:  Jeffrey M. Haber “A transaction ... is usurious under criminal law when it imposes an annual interest rate exceeding 25%.” 1 General Obligations Law § 5–521 bars a corporation from asserting usury in any action, except in the case of criminal usury as defined in Penal Law § 190.40, and then only as a defense to an action to recover repayment of a loan, and not as the basis for a cause of action asserted by the corporation for affirmative relief. 2 As the Appellate Division, First Department explained three decades ago: 3 While the statute expressly prohibits only the interposition of usury as a defense, this court has employed the principle that a party may not accomplish by indirection what is directly forbidden to it and has accorded the rule a broader scope. Thus, it is well established that the statute generally proscribes a corporation from using the usury laws either as a defense to payment of an obligation or, affirmatively, to set aside an agreement and recover the usurious premium. The statutory exception for interest exceeding 25 percent per annum is strictly an affirmative defense to an action seeking repayment of a loan and may not, as attempted here, be employed as a means to effect recovery by the corporate borrower.  As noted, the “rudimentary element of usury is the existence of a loan or forbearance of money.” 4 Thus, “where there is no loan, there can be no usury, however unconscionable the contract may be.” 5 To determine whether a transaction constitutes a usurious loan, it “must be ‘considered in its totality and judged by its real character, rather than by the name, color, or form which the parties have seen fit to give it.’” 6 The court must examine whether the plaintiff “is absolutely entitled to repayment under all circumstances.” 7 “Unless a principal sum advanced is repayable absolutely, the transaction is not a loan.” 8 When considering whether repayment is absolute or contingent, courts typically weigh three factors: 9 (1) Whether there is a reconciliation provision in the agreement . The reconciliation provisions of a contract allow the merchant to seek an adjustment of the amounts being taken out of its account based on its cash flow (or lack thereof). If a merchant is doing poorly, the merchant will pay less, and will receive a refund of anything taken by the company exceeding the specified percentage (which often can also be adjusted downward). If the merchant is doing well, it will pay more than the daily amount to reach the specified percentage. If there is no reconciliation provision, the agreement may be considered a loan. 10 (2) Whether the agreement has a finite term . If the term of the agreement is indefinite, then it is consistent with the contingent nature of each and every collection of future sales proceeds under the contract. This is because the defendant’s collection of sales proceeds is contingent upon the plaintiff actually generating sales and those sales resulting in the collection of revenue. 11 (3) Whether there is any recourse should the merchant declare bankruptcy .  In 110% Effort, 1000% of the Time LLC v. High Roller Rentals LLC , 2021 N.Y. Slip Op. 32678(U) (Sup. Ct., Kings County Dec. 13, 2021) ( here ), the Court examined the foregoing principles in denying a motion to dismiss, finding that the agreement between the parties was was not a loan and therefore did not require the payment of criminally usurious interest. On January 30, 2020, the parties entered into a contract whereby defendant, High Roller Rentals LLC, sold $129,000.00 worth of High Roller’s future receivables to plaintiff for $100,000.00 (the “Purchase Agreement”). Defendant William Casey Penn personally guaranteed High Roller’s obligations under the Purchase Agreement. The Purchase Agreement obligated High Roller to deposit all of its receipts into a designated bank account and authorized plaintiff permission to debit and retain 12% of all future receipts until the sum of $129,000.00 was paid back to plaintiff. Plaintiff alleged that High Roller breached the Purchase Agreement by changing the designated bank account without its authorization. Defendant moved to dismiss the complaint claiming that the Purchase Agreement was in actuality a criminally usurious loan and was, therefore, unenforceable under General Obligations Law § 5-521. Applying the three factors discussed above, the Court concluded that the Purchase Agreement was not a loan.  With respect to the first factor ( i.e. , whether there is a reconciliation provision in the agreement), the Court held that the “fact that High Roller ha no right of adjustment/reconciliation … under the Purchase Agreement militate in favor of deeming the transaction a loan.” “However,” said the Court, “this is just one of the three factors that must be weighed in determining the true nature of the transaction at issue.” With respect to the second factor ( i.e. , whether the agreement has a finite term), the Court held that plaintiff’s entitlement to repayment was not absolute and was contingent upon several factors, such as the cessation of defendant’s business due to “adverse business conditions” beyond defendant’s control, the loss of the premises where defendant operated its business, defendant’s bankruptcy, and/or natural disasters or similar occurrences beyond defendant’s control. With respect to the third factor ( i.e. , whether there is any recourse should the merchant declare bankruptcy), the Court held that High Roller’s obligations under the Purchase Agreement terminated if High Roller was declared bankrupt. In other words, said the Court, “bankruptcy not a default under the Purchase Agreement, entitling plaintiff to an immediate judgment against High Roller. Based upon the foregoing three-factor analysis, and a review of the Purchase Agreement, the Court concluded that the agreement between the parties was not a loan. As such, the Purchase Agreement was “not subject … to New York’s usury statutes.” Takeaway In New York, there is a presumption that a transaction is not usurious. As a result, claims of usury must be proved by clear and convincing evidence. 12 In determining whether a transaction is a loan or not, the court must examine whether the defendant is absolutely entitled to repayment under all circumstances. Weighing the factors discussed above, the Court in 110% Effort concluded that defendants were not absolutely entitled to repayment under all circumstances. As such, the Purchase Agreement was not a loan. Jeffrey M. Haber is a partner and co-founder of Freiberger Haber LLP. This article is for informational purposes and is not intended to be and should not be taken as legal advice. Footnotes Abir v. Malky, Inc. , 59 A.D.3d 646, 649 (2d Dept. 2009); see also Penal Law § 190.40. Paycation Travel, Inc. v. Glob. Merch. Cash, Inc. , 192 A.D.3d 1040, 141 (2d Dept. 2021); LG Funding, LLC v. United Senior Props. of Olathe, LLC , 181 A.D.3d 664, 666 (2d Dept. 2020).  Intima-Eighteen, Inc. v. Schreiber Co. , 172 A.D.2d 456, 457-458 (1st Dept. 1991) (internal quotation marks and citations omitted). LG Funding , 181 A.D.3d at 665. Id. (citations omitted). Abir , 59 A.D.3d at 649 (quoting Ujueta v. Euro–Quest Corp. , 29 A.D.3d 895, 895 (2d Dept. 2006) (internal quotation marks omitted). K9 Bytes, Inc. v. Arch Capital Funding, LLC , 56 Misc. 3d 807, 816 (Sup. Ct. Westchester County 2017). LG Funding , 181 A.D.3d at 666. K9 Bytes , 56 Misc. 3d at 816–819. Id. Id. Giventer v. Arnow , 37 N.Y.2d 305, 309 (1975).

By: Jeffrey M. Haber Broker-dealers are required to file suspicious activity reports (“SARs”) for transactions suspected to involve fraud or a lack of an apparent lawful business purpose. In that regard, under Section 17(a) of the Securities Exchange Act and Rule 17a-8 promulgated thereunder, a registered broker-dealer is required to file a SAR when it knows, suspects, or has reason to suspect that certain transactions (1) involve funds derived from illegal activity, (2) involve the use of the broker-dealer to facilitate criminal activity, (3) are designed to evade any requirement of the Bank Secrecy Act, or (4) have no business or apparent lawful purpose. The U.S. Treasury Department’s Financial Crimes Enforcement Network (“FinCEN”) instructs SAR filers to “provide a clear, complete, and concise description of the activity, including what was unusual or irregular that caused suspicion” in the narrative and to “include any other information necessary to explain the nature and circumstances of the suspicious activity.”  See  FinCEN, FinCEN Suspicious Activity Report (FinCEN SAR) Electronic Filing Instructions (October 2012) ( here ). To be effective, the SAR should describe “the five essential elements of information – who? what? when? where? and why? – of the suspicious activity being reported.”  See ,  e.g. , FinCEN, Guidance on Preparing a Complete & Sufficient Suspicious Activity Report Narrative (Nov. 2003), at 3 ( here ). When a SAR “lack basic information regarding the Five Essential Elements … SAR s deficient as a matter of law.”  See SEC v. Alpine Sec. Corp. , 308 F. Supp. 3d 775, 800 (S.D.N.Y. 2018) < here =">here"> ,  aff’d , 982 F.3d 68 (2d Cir. 2020).  here=">here" and="and" >here.=">here."> In The Matter of Wedbush Securities Inc. On December 15, 2021, the Securities and Exchange Commission (“SEC”) announced ( here ) that Wedbush Securities Inc., a California-based broker-dealer, agreed to pay more than $1.2 million to settle charges arising from the unlawful unregistered distribution of nearly 100 million shares of more than 50 different low-priced microcap companies, and from Wedbush’s failure to file SARs pertaining to those transactions. According to the SEC’s order ( here ), from January 2017 through September 2018, Wedbush engaged in unregistered offers and sales of large blocks of low-priced securities that were part of the unlawful, unregistered distribution of securities by Silverton SA (a/k/a Wintercap SA), a former offshore customer. The SEC found that Wedbush failed to conduct a reasonable inquiry into the facts surrounding the sales, and therefore Wedbush’s offers and sales did not qualify for the usual exemption from registration that applies to brokers’ transactions. The SEC also found that, despite the presence of numerous red flags that Wedbush had identified in its written guidance to employees, Wedbush failed to file SARs for certain suspicious transactions that it executed on behalf of Silverton while the account was active, as broker-dealers are required to do when transactions are suspected to involve fraudulent activity. Commenting on the settlement, Gurbir S. Grewal, Director of the SEC’s Division of Enforcement, stated: “Broker-dealers have a critical obligation to inquire into the origin of any microcap security they sell, as well as an obligation to report suspicious activity relating to transactions in the markets. It is our expectation that they will fully perform these important gatekeeping obligations, and when they fail to do so we will hold them accountable.” In the the SEC’s order, the SEC found that Wedbush violated the registration provisions of Sections 5(a) and 5(c) of the Securities Act of 1933, and the recordkeeping requirements of Section 17(a) of the Securities Exchange Act of 1934 and Rule 17a-8 thereunder.  Without admitting or denying the SEC’s findings, Wedbush agreed to cease and desist from committing or causing violations of these provisions; to be censured; to pay disgorgement and prejudgment interest of over $207,000, and a civil penalty of $1 million. The SEC also directed Wedbush to engage an independent compliance consultant, who will undertake a broad review of Wedbush’s supervisory, compliance, and other policies and procedures reasonably designed to prevent violations of the federal securities laws by the firm and its employees. Jeffrey M. Haber is a partner and co-founder of Freiberger Haber LLP. This article is for informational purposes and is not intended to be and should not be taken as legal advice.

By Jonathan H. Freiberger Followers of this Blog know that we frequently address issues involving residential mortgage foreclosure.  Actions involving the pre-foreclosure requirements of RPAPL 1304 are frequently decided by the Appellate Courts in New York and, accordingly, are analyzed in our articles.  See, e.g., < here =">here"> , < here =">here"> , < here =">here"> , < here =">here"> , < here =">here"> and < here =">here"> .  As previously noted in our Blog: RPAPL 1304 requires that at least ninety days prior to commencing legal action against a borrower with respect to certain loans, a lender must: send written notice to the borrower by certified and regular mail that the loan is in default; provide a list of approved housing agencies that provide free or low-cost counseling; and, advise that legal action may be commenced after ninety days if no action is taken to resolve the matter.  The failure of a lender to comply with RPAPL 1304 will result in the dismissal of a foreclosure complaint ( see, e.g., U.S. Bank N.A. v. Beymer , 161 A.D.3d 543 (1 st Dep’t 2018)) when the issue is raised as an affirmative defense by the borrower ( see, e.g., One West Bank, FSB v. Rosenberg , 189 A.D.3d 1600, 1602-3 (2 nd Dep’t 2020) (citation omitted)).  Indeed, “proper service of the notice containing the statutorily mandated content is a condition precedent to the commencement of a foreclosure action.”  U.S. Bank N.A. v. Taormina , 187 A.D.3d 1095, 1096 (2 nd Dep’t 2020) (citations omitted).  When failure to comply with RPAPL 1304 is raised as an affirmative defense, the foreclosing lender must demonstrate its compliance with the statute as part of its prima facie case.  Bank of America, N.A. v. Wheatly , 158 A.D.3d 736 (2 nd Dep’t 2018) (citations omitted). In our October 1, 2021, blog we discussed Wells Fargo Bank, N.A. v. Yapkowitz , a case in which the Appellate Division, Second Department, dismissed lender’s complaint and held that a joint notice in one envelope addressed to two borrowers residing at the same address did not satisfy the requirements of RPAPL 1304. On December 15, 2021, the Appellate Division, Second Department, decided Bank of America, N.A. v. Kessler .  As in Yapkowitz , the Court in Kessler , strictly interpreted RPAPL 1304 and dismissed a Complaint because lender included additional notices in the envelope with the required 1304 notices.  Significantly, RPAPL 1304(2) provides that “ he notices required by this section shall be sent by the lender, assignee or mortgage loan servicer in a separate envelope from any other mailing or notice .”  (Emphasis added.)  Thus, the Kessler Court held “that inclusion of any material in the separate envelope sent to the borrower under RPAPL 1304 that is not expressly delineated in these provisions constitutes a violation of the separate envelope requirement of RPAPL 1304(2). The Kessler Court relied heavily of the Court of Appeals decision in Freedom Mortgage Corp. v. Engel , and citing to, and quoting from Engel , stated that this “strict approach precluding any additional material in the same envelope as the requisite RPAPL 1304 notices not only comports with the statutory language, it also provides clarity as a bright-line rule to plaintiff lenders and ‘promotes stability and predictability’ in foreclosure proceedings.”  [Eds. Note, this Blog has discussed Engel < here =">here"> and < here =">here"> .]   The Court noted that the language of 1304 is clear and that “ n matters of statutory interpretation, the primary consideration is to discern and give effect to the Legislature's intention” and that "the text of a provision is the clearest indicator of legislative intent and courts should construe unambiguous language to give effect to its plain meaning.”  (Citations, internal quotation marks and brackets omitted.)  The Court, after analyzing the legislative history of 1304, noted that same was consistent with its “strict interpretation” of the “‘separate envelope’” requirement. Policy considerations, as articulated in Engel , also supported the Kessler Court’s “exacting” “‘separate envelope’” requirement because clear rules “‘will be easily understood by the parties and can be consistently applied by the courts.’”  In establishing its “bright-line” rule, the Court also expressly rejected certain suggested “flexible standards” and/or prior analyses of trial courts, including: (1) evaluation of the additional materials contained in the envelope to determine if same prejudices or assists the borrower; (2) analysis of the whether the additional information “is included as a separately paginated sheet of paper or some other physical demarcation of the information exists, or whether the additional information is on the same page as the requisite notice”; and, (3) whether the inclusion of additional notices in the envelope along with the requisite RPAPL 1304 notice is a de minimis deviation from the requirements of the statute and, thus, does not constitute a failure to comply with the separate envelope requirement.”  (Citations omitted.)  The Court concluded that such approaches could: (1) “vitiate” the unequivocal requirements of RPAPL 1304; (2) “place the burden on a defendant to show a lack of prejudice or show that the information is not relevant to the notice mandated under RPAPL  1304, rather than on the plaintiff to show compliance”; and/or (3) cause courts to engage in the “judicial scrutiny” rejected by the Engel Court by having them “interpret” what the “Legislature intended, rather than what it said.” Finally, the Court noted that: Nor will our determination as to strict compliance with the dictates of RPAPL 1304(2) undermine the legislative goal of providing information about additional protections and foreclosure prevention opportunities to homeowners at risk of losing their homes ( see Senate Introducer's Mem in Support, Bill Jacket, L 2008, ch 472 at 7), as nothing in RPAPL 1304 prohibits a lender from mailing, in other envelopes, notices to a borrower—whether such notices be federally mandated or consist of any other notice or information that may assist a homeowner to avoid foreclosure. RPAPL 1304(2) simply requires that the notices required by its provisions be mailed in a separate envelope from those other notices. Jonathan H. Freiberger is a partner and co-founder of Freiberger Haber LLP. This article is for informational purposes and is not intended to be and should not be taken as legal advice.

By: Jeffrey M. Haber A forum selection clause is contractual provision that sets forth the location designated by the parties for dispute resolution. Such clauses can be found in virtually every type of contract, e.g. , employment agreements, commercial contracts, and purchase and sale agreements. Parties require forum selection clauses to reduce litigation expenses, avoid adverse laws, and mitigate the risks associated with unknown judges and/or juries. Under New York law, “a contractual forum selection clause is documentary evidence that may provide a proper basis for dismissal pursuant to CPLR 321l (a)(l).” 1 It is “prima facie valid and enforceable” unless the challenging party can show the forum selection clause “to be unreasonable, unjust, in contravention of public policy, invalid due to fraud or overreaching,” or “that a trial in the selected forum would be so gravely difficult that the challenging party would, for all practical purposes, be deprived of its day in court.” 2 Forum selection clauses can be mandatory or permissive. The former requires the dispute to be litigated only in the designated venue, while the latter permits litigation in a particular venue but does not prohibit it in another jurisdiction. 3 In interpreting forum selection clauses, courts apply the principles of contract construction. In Westaub II LLC v. Westermann , 2021 N.Y. Slip Op. 06976 (1st Dept. Dec. 14, 2021) ( here ), the Appellate Division, First Department affirmed the dismissal of an action on the grounds that the forum selection clause in the parties’ agreement governed the dispute.  westaub derives from the decision of the motion court ( i.e. , the transcript of the hearing on the motion), and the briefs on appeal.> westaub derives from the decision of the motion court ( i.e. , the transcript of the hearing on the motion), and the briefs on appeal.> Westaub involved a joint venture between two French citizens – Francis Staub, a well-known manufacturer of cookware, and Antoine Westermann, a three-star Michelin chef who developed a poultry restaurant in Paris called Le Coq Rico. Staub (through his wholly owned company, CSI Finances SAS (“CSI Finances”)) and Westermann (for himself and his wholly owned company Envol SARL) (“Envol”)) entered into an agreement in 2014 (the “2014 Agreement”), which they amended in 2015 (the “2015 Amendment”) (together, the “Amended Contract”), for the development of additional Le Coq Rico locations outside of France, including one in New York City. Pursuant to their agreement, the parties created two wholly owned U.S. subsidiaries: Westaub, Inc. and Westaub II LLC. The Amended Contract governed the financing, ownership, operational control and other rights of each party regarding, among other things, Westaub II LLC. Relevant to the appeal, the 2015 Amendment provided that it was governed by French law, and that all disputes in connection with its performance or interpretation that could not be resolved amicably were to be brought before a specific court in France: If an amicable agreement cannot be reached, any dispute between the undersigned parties in connection with the performance or interpretation of this Agreement shall be referred to the Colmar District Court (le Tribunal de Grande Instance de Colmar).  By 2018, the relationship between Staub and Westermann soured. In June 2019, Westermann notified Staub that unless their disputes were resolved amicably, he would take all steps necessary to recover his unpaid salary and unreimbursed expenses. In response, in September 2019, plaintiffs filed the action in New York. In October 2019, Westermann filed an action in Colmar, France to recover his unpaid compensation and reimbursements, and to enforce his rights in the entities created under the Amended Contract.  Westermann moved to dismiss the New York action based on the forum selection clause in the 2015 Amendment, and alternatively under the doctrines of prior action pending and forum non conveniens. Westermann argued, inter alia , that he and Westaub II LLC and CSI Finances were parties to the Amended Contract and/or were all so closely related to each other with regard to the joint venture that it was intended and foreseeable that they would be bound by the forum selection clause.  Staub opposed the motion, contending, inter alia , that neither Westermann nor Westaub II LLC was a signatory to the 2015 Amendment, which contained the forum selection clause. The motion court granted the motion, finding that the forum selection applied, thereby warranting dismissal of the complaint. The court also held that since the 2015 Amendment expressly amended the 2014 Agreement, the forum selection clause applied to Westermann. The court further found that all parties to the action were bound by the forum selection clause because its application was foreseeable as against each of them, whether as signatories or under the “close relationship” doctrine. 4 the relationship between the non-party and the signatory in such cases must be sufficiently close so that enforcement of the clause is foreseeable by virtue of the relationship between them. 5 > 4 the relationship between the non-party and the signatory in such cases must be sufficiently close so that enforcement of the clause is foreseeable by virtue of the relationship between them. 5 > On appeal, the First Department unanimously affirmed. The Court found that “ he motion court correctly read the 2014 Agreement and 2015 Amendment together to find that the forum selection clause in the 2015 Amendment applied to this dispute and required its dismissal.” 6 The Court noted that the 2015 Amendment was titled “amendment” and that the parties intended it to “amend the 2014 Agreement, which expressly referred to at least once in the Amendment and whose validity and ongoing force and effect, to the extent not contrary to the Amendment, was reiterated in … the Amendment.” 7 Moreover, explained the Court, “the complaint describe the 2015 Amendment as having been the decision of the parties to the 2014 Agreement — defendant and plaintiff CSI Finances SAS — who, the complaint allege , amended the original agreement to reflect an additional capital contribution by CSI and a revised equity allocation, and both agreements are described as having been part and parcel of the same overall transaction, namely, the establishment, operation, and management of the restaurant at issue.” The Court also held that “the motion court properly invoked the close relationship doctrine to render the 2015 Amendment’s forum selection clause binding on nonsignatories defendant and plaintiff Westaub II LLC.” 8 The Court explained that “Defendant’s enforcement of the forum selection clause was readily foreseeable, given that his close relationship to signatory Envol was well known to plaintiffs; defendant signed the 2014 Agreement on behalf of himself and Envol, and the 2015 Amendment itself indicate that defendant the manager and sole shareholder of Envol and provide that throughout the document Envol be referred to interchangeably as ‘Envol’ and ‘AW’ (defendant’s initials).” Finally, the Court said that it was “foreseeable that plaintiff Westaub II LLC, closely involved in the matters at issue in this dispute and closely intertwined with plaintiff CSI, would also be found to be within the reach of the forum selection clause.” 9 The Court noted that in the Westaub II LLC operating agreement, Westaub II LLC “designated Francis Staub as its sole manager, and the 2014 Agreement and 2015 Amendment identif Staub as the chairman of CSI.”  The Court found that the relationship between Westaub II LLC and CSI further evinced a close relationship sufficient to invoke the doctrine: “Both Westaub II LLC and CSI are involved in funding another entity, Westaub Inc., per the 2014 Agreement, with Westaub II LLC obtaining the funds to do so from another entity, Westaub France SARL, 75% of which, the complaint alleges, is owned by CSI. The documents further reflect that all shares of Westaub II LLC are owned by Westaub France SARL, which, again, is 75% owned by CSI.” 10 Takeaway Westaub reinforces the principles above; namely, a forum selection clause is prima facie valid and enforceable unless shown by the resisting party to be unreasonable or unjust ( i.e. , unconscionable). In Westaub , plaintiffs could not overcome their burden of demonstrating that the forum selection clause should be set aside. Westaub is also notable for its application of the “close relationship” doctrine. As noted, a signatory to a contract may enforce a forum selection clause against a non-signatory if the non-signatory is “closely related” to one of the signatories such that enforcement of the forum selection clause is foreseeable by virtue of the relationship between the signatory and the party sought to be bound. 11 If the non-signatory has an ownership interest or a direct or indirect controlling interest in the signing party (as in Westaub ) or, the entities or individuals consulted with each other regarding decisions and were intimately involved in the decision-making process (as in Westaub ), then application of a forum selection clause will be proper, as it achieves the purpose behind binding closely related entities to the forum selection clause: it “promote stable and dependable trade relations.” 12 Jeffrey M. Haber is a partner and co-founder of Freiberger Haber LLP. This article is for informational purposes and is not intended to be and should not be taken as legal advice. Footnotes Landmark Ventures, Inc. v. Birger , 147 A.D.3d 497, 497 (1st Dept. 2017); see also Lifetime Brands, Inc. v. Garden Ridge, L.P. , 105 A.D.3d 1011, 1012 (2d Dept. 2013). Molino v. Sagamore , 105 A.D.3d 922, 923 (2d Dept. 2013) (citation and internal quotation omitted). Phillips v. Audio Active Ltd. , 494 F.3d 378, 383, 386 (2d Cir. 2007). See ComJet Aviation Mgt. v. Aviation Investors Holdings Ltd. , 303 A.D.2d 272, 273 (1st Dept. 2003). Freeford Ltd. v. Pendleton , 53 A.D.3d 32, 38-39 (1st Dept. 2008). Slip Op. at *1. Id. Id. (citations omitted) Id. Id. at *2-*3. Tate & Lyle Ingredients Ams., Inc. v Whitefox Tech. USA, Inc. , 98 A.D.3d 401 (1st Dept. 2012). Id. (citation omitted).

By:   Jeffrey M. Haber The “policy of to encourage arbitration.” 1 For this reason, “ ny doubts as to whether an issue is arbitrable will be resolved in favor of arbitration.” 2 This is especially so where the agreement to arbitrate incorporates rules that explicitly authorize the arbitrator to resolve all disputes, including those concerning “the formation, existence, validity, interpretation or scope of the agreement under which Arbitration is sought.” 3 In Schindler v. Cellco Partnership , “ he sole issue before Court whether the issue of arbitrability was properly delegated to the arbitrator.” 4 As discussed below, the Appellate Division, First Department held “that it was.” 5 Plaintiff commenced the action against Verizon Wireless and its employees after an altercation between Plaintiff, her husband and Venzon’s employees relating to a trade-in of Plaintiff’s iPhone. Defendant moved to compel arbitration, pursuant to CPLR § 7503(a) and the Federal Arbitration Act , 9 U.S.C. Sec. 1 et. seq., as required under the Verizon Wireless Agreement (the “agreement”) that Plaintiff signed. The motion court granted the motion. Defendant argued that Plaintiff’s claims fell within the broad arbitration provision in the Agreement, which provided in bold capitalized letters that the parties agreed “to resolve disputes only by arbitration or in small claims court” including “any dispute that in any way relates to or arises out of this agreement, or from any equipment, products and services … including any disputes you have with our employees or agents ….” For claims that exceeded $10,000, the Agreement provided that the American Arbitration Association’s Consumer Arbitration Rules would apply.  The court noted that “ ursuant to the Consumer Arbitration Rules, the arbitrator has the authority to rule on his or her own jurisdiction, including any objections to the existence, scope or validity of the arbitration agreement or the arbitrability of any claim.” Therefore, held the motion court, “ y specifically incorporating the AAA rules into the arbitration clause, the parties expressly agreed to submit the issue of arbitrability to the arbitrators.”  Accordingly, the motion court granted the motion to compel arbitration. On appeal, the Appellate Division, First Department affirmed. Schindler v. Cellco Partnership , 2021 N.Y. Slip Op. 06931 (1st Dept. Dec. 9, 2021) ( here ). The Court found that since Plaintiff “voluntarily accepted the terms of the Verizon Customer Agreement and the arbitration provision contained within it”, she and Verizon “clear and unmistakabl ” intended to incorporate the AAA rules into the Agreement. 6 As such, it was for the arbitrator to decide the issue of arbitrability. 7 Takeaway When parties to a contract, like the parties in Schlinder , delegate the question of arbitrability to an arbitrator, the courts will enforce the agreement as written. This “is true even if the court thinks that the argument that the arbitration agreement applies to a particular dispute is wholly groundless.” 8 Thus, “if a valid agreement exists, and if the agreement delegates the arbitrability issue to an arbitrator, a court not decide the arbitrability issue.” 9 Courts in New York follow the foregoing principles and will not take the issue of arbitrability away from the arbitrator when the parties clearly and unmistakably provide as such. 10 This approach reflects the “overarching principle of law ‘that arbitration is a matter of contract’” and that “courts must rigorously enforce arbitration agreements according to their terms.” 11 Thus, where, as in Schlinder , a contract contains a valid delegation to the arbitrator of the power to determine arbitrability, such a clause will be enforced absent a specific challenge to the delegation clause by the party resisting arbitration. 12 Jeffrey M. Haber is a partner and co-founder of Freiberger Haber LLP. This article is for informational purposes and is not intended to be and should not be taken as legal advice. Footnotes Smith Barney Shearson Inc. v. Sacharow , 91 N.Y.2d 39 (1997). State of New York v. Philip Morris Inc. , 30 A.D.3d 26, 31 (1st Dept. 2006), aff’d , 8 N.Y.3d 574 (2007). Offshore Expl. & Prod., LLC v. Morgan Stanley Private Bank, N.A. , 626 F. App’x 303, 305 (2d Cir. 2015). See also Smith Barney , 91 N.Y.2d at 46 (noting that while there is generally a presumption that the issue of arbitrability will be determined by the courts, the arbitrator decides the issue where the parties evince a “clear and unmistakable agreement to arbitrate arbitrability as part of their alternative dispute resolution choice.”). Slip Op. at *1. Id. Id. (citations omitted). Id. Henry Schein, Inc. v Archer & White Sales, Inc. , _____ U.S. at _____, 139 S.Ct. 524, 529 (2019). Id. at 530. Life Receivables Trust v. Goshawk Syndicate 102 at Lloyd’s , 66 A.D.3d 495, 495 (1st Dept. 2009). Monarch Consulting, Inc. v. National Union Fire Ins. Co. of Pittsburgh, PA , 26 N.Y.3d 659, 675 (2016) (citation omitted). Id. at 675-76

By Jonathan H. Freiberger There are two “components and constitutional predicates of personal jurisdiction.”  Keane v. Kamin , 94 N.Y.2d 263, 265 (1999).  “One component involves service of process, which implicates due process requirements of notice and opportunity to be heard.”  Id. (citations omitted).  Even though a defendant may be subject to the jurisdiction of the Court, dismissal may be sought “based on the claim that service was not properly effectuated.”  Id. (citations omitted).  “The other component of personal jurisdiction involves the power, or reach, of a court over a party, so as to enforce judicial decrees.”    Id. (citations omitted).   This requires a “constitutionally adequate connection between the defendant, the State and the action” ( Id. (citations omitted)) and is beyond the scope of this article.  In order for a court to exercise personal jurisdiction over a defendant in a litigation, among other things, defendant must be served with process (typically a summons).  In New York, service of process is usually performed by a process server and service is made pursuant to among others, CPLR Rules: 307 (State), 308 (natural person), 309 (infant, incompetent or conservatee), 310 (partnership), 310-a (limited partnership), 311 (corporation or governmental subdivision), 311-a (limited liability company) and 312 (court, board or commission), which govern how different individuals and entities may be served.  For example, under CPLR 308, personal service on an individual may be made by delivering the legal process: directly to the defendant (CPLR 308(1)); to someone of suitable age and discretion at the defendant’s “actual place of business, dwelling place or usual place of abode” and mailing a copy of the summons to the defendant’s last known residence or actual place of business (CPLR 308(2)); to an agent designated under CPLR 318 (CPLR 308(3)); and, where notwithstanding diligent, but unsuccessful, efforts to serve pursuant to CPLR 308(1) and (2), by affixing the process to the door at the defendant’s “actual place of business, dwelling place or usual place of abode within the state” and mailing a copy of the summons to the defendant at his/her/their actual place of business or last known residence (CPLR 308(4)).  The failure to serve process in “strict compliance” with the “statutory methods,” “leaves the court without personal jurisdiction over the defendant, and all subsequent proceedings are thereby rendered null and void.”  Nationstar Mortgage, LLC v. Gayle , 191 A.D.3d 1002 (2 nd Dep’t 2021) (citations omitted).  Accordingly, proof of proper service is of the utmost importance. Once service of process is made, the process server typically prepares an affidavit of service.  CPLR 306 sets forth the information that must be provided in an affidavit of service, which includes: the papers served, the person served and the date of service (CPLR 306(a)); and,  when service is made by delivering the summons to an individual, a description of the person to whom the papers were delivered including, among other things, sex, skin color, hair color, age, weight, height and any other identifying features.  In addition, if service is made pursuant to CPLR 308(4), the dates, addresses and times of attempted service must be specified.  This is so because in order to demonstrate diligence, the process server must attempt to make service on the defendant “at different times and on different days when the defendant could reasonably be expected to be home.”  Bank of America, N.A. v. Batson , 176 A.D.3d 771 (2 nd Dep’t 2019) (citations omitted).  A defendant can contest service of process on a motion to dismiss a complaint, inter alia , pursuant to CPLR  3211(a)(8) and/or CPLR 5015(a)(4).  On December 1, 2021, the Second Department decided three mortgage foreclosure actions addressing the sufficiency of service of process. Wells Fargo Bank, N.A. v. Enitan  In Wells Fargo Bank, N.A. v. Enitan , the borrower was purportedly served by “nail and mail” service pursuant to CPLR 308(4).  The court granted lender’s motion for a default judgment and for the appointment of a referee.  When the lender moved to confirm the referee’s report and for a judgment of foreclosure and sale, the borrower opposed the motion and cross-moved, inter alia , pursuant to CPLR 5015(a), to vacate the order granting a default judgment, and pursuant to CPLR 3211(a)(8), to dismiss the complaint for lack of personal jurisdiction over him.  The court granted lender’s motion and denied the cross-motion.  On appeal, the Second Department affirmed.  After discussing the relevant legal principals along the lines set forth supra , the Court stated: A process server's affidavit of service establishes a prima facie case as to the method of service and, therefore, gives rise to a presumption of proper service.  Although a defendant's sworn denial of receipt of service generally rebuts the presumption of proper service established by the process server's affidavit and necessitates an evidentiary hearing, no hearing is required where the defendant fails to swear to specific facts to rebut the statements in the process server's affidavits.   The sworn denial of receipt of service must be a detailed and specific contradiction of the allegations in the process server's affidavit. Here, the process server's affidavit of service, in which he attested that he attempted to serve the defendant on three prior occasions, constituted prima facie evidence of proper service pursuant to CPLR 308(4). In opposition and in support of his cross motion, the defendant's unsupported averment that he did not reside at the subject property at the time of service was insufficient to rebut the presumption of proper service created by the process server's affidavit. (Citations, internal quotation marks and brackets omitted.)  Bank of New York v. Dutan In Bank of New York v. Dutan , an order of reference was entered upon borrower’s loan default.  Borrower opposed lender’s motion to confirm the referee’s report and for a default judgment of foreclosure and sale and cross-moved, inter alia , “pursuant to CPLR 5015(a)(3) and (4) to vacate the order of reference, and thereupon pursuant to CPLR 3211(a) … (8) to dismiss the complaint insofar as asserted against him for lack of … personal jurisdiction.”  Supreme court granted lender’s motion and denied borrower’s cross-motion.  On appeal, the Second Department reversed. The Court noted that “ lthough a party moving to vacate a default must normally demonstrate a reasonable excuse and a meritorious defense, the movant is relieved of that obligation when lack of personal jurisdiction is asserted as the ground for vacatur."  (Citation omitted.)  Further, while the process server’s affidavit typically “constitutes a prima facie showing of proper service, … when a defendant submits a sworn denial of receipt of service containing specific facts to refute the statements in the affidavit of the process server, the prima facie showing is rebutted and the plaintiff must establish personal jurisdiction by a preponderance of the evidence at a hearing.”  (Citations omitted.)  Reversal was warranted because: the affidavit of service reflects that the defendant was served pursuant to CPLR 308(2)….  The affidavit of service sets forth a detailed description of the person of suitable age and discretion, and states that the person of suitable age and discretion represented to the process server that the mortgaged premises was the defendant's "dwelling house." The defendant rebutted the presumption of valid service by the submission of an affidavit in which he averred that the mortgaged premises was not his dwelling house or usual place of abode, and that his residence was located at a different specified address. He further averred that he had no knowledge of anyone being served on his behalf, and that he had not received a copy of the summons and complaint. Under these circumstances, a hearing on the issue of whether the defendant was properly served was warranted. (Citation omitted.)  Green Tree Servicing, LLC v. Frantzeskakis              In Green Tree Servicing, LLC v. Frantzeskakis , supreme court, after a traverse hearing (a hearing to determine whether service of process was properly made), granted borrower’s motion to dismiss the complaint pursuant to CPLR 3211(a)(8) for lack of personal jurisdiction.  On lender’s appeal, the Second Department reversed and held that: A minor discrepancy between the appearance of the person allegedly served and the description of the person served contained in the affidavit of service is generally insufficient to raise an issue of fact warranting a hearing. Further, the discrepancies must be substantiated by something more than a claim by the parties allegedly served that the descriptions of their appearances were incorrect. Here, notwithstanding alleged physical discrepancies, the process server averred that the person who answered the door, and on whom he served process, gave her name as Marina Frantzeskakis, and acknowledged she was the wife of the . The process server's affidavit of service constituted prima facie proof of proper service on the defendant via substituted service on his wife ( see CPLR 308<2> ). The affidavits submitted by the defendant failed to rebut the presumption of due service. The discrepancies alleged by the defendant between his wife's appearance and the description of the person served contained in the process server's affidavit were either too minor or insufficiently substantiated to warrant a hearing. Accordingly, a hearing to determine the validity of service of process was not warranted under the circumstances…. Jonathan H. Freiberger is a partner and co-founder of Freiberger Haber LLP. This article is for informational purposes and is not intended to be and should not be taken as legal advice.

By: Jeffrey M. Haber As readers of this Blog know, one of the elements of a fraud claim is reliance. In the typical case, the defendant makes a false or misleading statement directly to the plaintiff, which the plaintiff claims to rely on. In the less frequent case, the misrepresentation of fact is made to a third party that relied on the alleged fraudulent statement. The question is whether, in that circumstance, a plaintiff can state a fraud cause of action, despite the absence of direct reliance by the plaintiff on the alleged misrepresentation?  In Pasternack v. Laboratory Corp. of Am. Holdings , 27 N.Y.3d 817 (2016), the New York Court of Appeals held that third-party reliance does not satisfy the reliance element of a fraud claim unless the third party “acted as a conduit to relay the false statement to plaintiff, who then relied on the misrepresentation to his detriment.” 1 In other words, the alleged misrepresentation or omission does not need to be made directly to the plaintiff so long as the statement was made with the intent that it be communicated to the plaintiff by a third party and the plaintiff relied on the representation or omission to his or her detriment. here.=">here."> When the plaintiff alleges fraud, he or she must show that the misrepresentation or omission was the direct and proximate cause of the claimed losses. 2 In other words, a plaintiff must show causation. “To establish causation, plaintiff must show both that defendant’s misrepresentation induced plaintiff to engage in the transaction in question (transaction causation) and that the misrepresentations directly caused the loss about which plaintiff complains (loss causation).” 3 Transaction causation is often the easier of the two prongs to satisfy, while loss causation is typically more difficult. As noted by the Appellate Division, First Department in Laub : “ egardless of whether plaintiff could establish that he was induced by the alleged misrepresentations to follow recommendations on purchases of equities, plaintiff’s claims must fail because he has not alleged or produced any evidence that those misrepresentations directly and proximately caused his investment losses.” 4 As noted above, the loss causation prong demands a showing that the misrepresentation or omission directly and proximately caused the plaintiff to take action or no action at all. 5 As the Court of Appeals noted in Pasternack , “the tort of fraud is intended to protect a party from being induced to act or refrain from acting based on false representations.” 6 here,=">here," and="and" >here.=">here."> Finally, the plaintiff must allege that the misrepresentation or omission was more than, a promise of future intent to perform some act. He or she must show that the misrepresentation or omission is one of existing fact made to induce action or inaction on his or her part. 7 here,=">here," and="and" >here.=">here."> The foregoing principles were addressed in Buff v. Nemeth , 2021 N.Y. Slip Op. 32532(U) (Sup. Ct., N.Y. County Dec. 1, 2021) ( here ). Buff involved a dispute over the estate of defendant’s husband, Alfred M. Buff (“decedent”). According to plaintiff, defendant allegedly used her will to induce her late husband “to execute his own estate planning documents in a manner favorable to ” and detrimental to plaintiff and her brother.  Background Plaintiff is the decedent’s daughter. The decedent was married to defendant at the time of his death on July 4, 2018. According to plaintiff, in January 2013, defendant and the decedent met with an estate planning attorney. At that time, the decedent intended to provide for defendant in the manner in which she was accustomed during their marriage, with the remainder of the estate to pass to plaintiff and her brother. In July 2013, defendant executed a will containing a provision that “she would segregate assets and create a special account upon death to which she would add all sums received from , and that upon her death those sums would revert to” plaintiff and her brother.  In May 2018, the decedent executed a will, which provided defendant with an annual income of $80,000 and lifetime occupancy of the decedent’s Manhattan apartment. In addition, the decedent left an investment account to defendant, which held approximately $1.5 million. The account was jointly held by the decedent and defendant, even though defendant never contributed to the account. Plaintiff maintained that as a result of the “representation” defendant made in her 2013 will about segregating assets, the decedent did not move the money into the trust he had established. Defendant closed the joint investment account in September 2019. Plaintiff alleged that defendant did not assure her the money had been segregated as provided in defendant’s will. After defendant’s husband died, and during settlement discussions concerning estate proceedings to probate his will, plaintiff requested that defendant sign a document to bind her to the terms of her 2013 will. Defendant declined to do so, allegedly stating that she could devise her own will as she saw fit and was not contractually obligated to dispose of her husband’s or her own estate in any particular manner.  Plaintiff brought suit, claiming that, among other things, defendant executed her will in 2013 solely to induce the decedent to execute his will in a way most favorable to her. Plaintiff further claimed that defendant had no intention of keeping the alleged promise(s) made to her late husband that she would either create a special account to segregate his estate and/or pass along his estate to plaintiff and her brother upon her passing. Defendant moved to dismiss the complaint. The Court granted the motion. The Court’s Decision First, the Court observed that the alleged false statement was not made to plaintiff but, rather, to her father, the decedent. The Court said that even assuming the statement was made to the decedent with the intent that it be passed along to plaintiff, the fraud claim nevertheless failed to state a claim. The reason, said the Court, was because plaintiff “failed to allege that she relied on the misrepresentation to her detriment.” 8 The Court explained that plaintiff failed to plead loss causation in that the complaint did not “contain allegations of plaintiff’s action or inaction, i.e., what she did or would have done but for the fraud.” 9 Second, the Court found that the alleged misrepresentations were, “at most, promises of future intent rather than misrepresentations of existing fact made to induce action or inaction on her part.” 10 “Indeed,” said the Court, “plaintiff, as a potential beneficiary under defendant’s 2013 Will, enjoys only ‘only expectancy interests and not vested legal rights.’” 11 Thus, the Court dismissed the fraud claims. Jeffrey M. Haber is a partner and co-founder of Freiberger Haber LLP. This article is for informational purposes and is not intended to be and should not be taken as legal advice. Footnotes Id. at 828. Friedman v. Anderson , 23 A.D.3d 163, 167 (1st Dept. 2005). Laub v. Faessel , 297 A.D.2d 28, 31 (1st Dept. 2002). Id. at 31. Vandashield Ltd v. Isaacson , 146 A.D.3d 552 (1st Dept. 2017). Pasternack , 27 N.Y.3d at 828.  Connaughton v. Chipotle Mexican Grill, Inc. , 135 A.D.3d 535, 537-38 (1st Dept. 2016), aff’d , 29 N.Y.3d 137 (2017) (holding that a fraud claim is not actionable where “the allegations at best suggest that” the “plaintiff might suffer injury” “depending on the future actions of ”). Slip Op. at *5. Id. Id. (citation and internal quotation marks omitted). Under New York law, “ o fulfill the element of misrepresentation of material fact , the party advancing the claim must allege a misrepresentation of present fact rather than of future intent.” Perella Weinberg Partners LLC v. Kramer , 153 A.D.3d 443, 449 (1st Dept. 2017) (citation omitted). “General allegations of lack of intent to perform are insufficient; rather, facts must be alleged establishing that the adverse party, at the time of making the promissory representation, never intended to honor the promise.” Id. (citation omitted).  Id. (citations omitted).

By Jonathan H. Freiberger A major concern raised by potential clients when deciding whether to commence litigation is whether they are entitled to recoup their legal fees if they prevail.  This issue was recently addressed in our BLOG article entitled: “ ’Can I Sue ‘Em For My Legal Fees?’ ,” in which we explained, inter alia , that: Clients are often dismayed to learn that attorney’s fees are not generally recoverable in litigation under the “American Rule,” because “ n the United States, the prevailing litigant is ordinarily not entitled to collect a reasonable attorney fee from the loser.”  Alyeska Pipeline Services Co. v. Wilderness Society , 421 U.S. 240, 247 (1975) (providing a historical perspective on the awarding of attorneys’ fees in Federal Court litigation); see also , Mighty Midgets, Inc. v. Centennial Ins. Co. , 47 N.Y.2d 12, 21-22 (1979).  The “American Rule” “reflects a fundamental legislative policy decision that, save for particular exceptions or when parties have entered into a special agreement, it is undesirable to discourage submission of grievances to judicial determination and that, in providing freer and more equal access to the courts, the present system promotes democratic and libertarian principles.”  Mighty Midgets , 47 N.Y.2d at 22 (citations omitted).   Thus, in general, legal fees and disbursements are deemed to be “incidents of litigation” and, therefore, unrecoverable in litigation.  A.G. Ship Maintenance Corp. v. Lezak , 69 N.Y.2d 1, 5 (1986) (citations omitted).  An exception, however, applies when “an award is authorized by agreement between the parties or by statute or court rule.”  Id. See also Hooper Assoc., Ltd. v. AGS Computers, Inc. , 74 N.Y.2d 487 (1989).  Accordingly, contracts frequently contain provisions permitting the collection of reasonable legal fees if, for example, a party defaults under the contract.  Such provisions are common in promissory notes and mortgages – an area of the law frequently covered by this BLOG.   Indeed, Courts routinely award lenders, “reasonable” legal fees and disbursements in cases where a promissory note or mortgage provides for same in the event of a default by a borrower.  See, e.g., Lupo v. Anna’s Lullaby Café, LLC , 189 A.D.3d 1205, 1208 (2 nd Dep’t 2020); Griffon V, LLC v. 11 East 36 th , LLC , 90 A.D.3d 705, 707 – 08 (2 nd Dep’t 2011); Cutter Bayview Cleaners, Inc. v. Spotless Shirts, Inc. , 57 A.D.3d 708, 710 (2 nd Dep’t 2008).  Legal fees in mortgage foreclosure actions are frequently requested and frequently awarded; often times, however, the amounts requested do not match the amounts awarded as legal fees as they are frequently reduced by Courts.   On December 1, 2021, the Appellate Division, Second Department, decided McCormick 110, LLC v. Gordon , a residential mortgage foreclosure action with a seemingly tortured history.    In 2006, defendants borrowed $400,000 from original lender and secured their repayment obligations with a mortgage on real property in Brooklyn.  Upon defendants’ default, original lender commenced a mortgage foreclosure action in 2013. During the pendency of the first action, the underlying note was assigned to plaintiff.  Plaintiff commenced its action in April of 2016, and the original action commenced by the original lender was discontinued by order of the court issued the following month granting the original lender’s motion for that relief. Plaintiff’s motion for summary judgment on the complaint and to strike defendants’ answer and for the appointment of a referee to compute was granted.  Plaintiff did not request that the referee calculate legal fees.  Plaintiff then moved for a judgment of foreclosure and sale in which it requested that the court, inter alia , award reasonable attorney’s fees pursuant to the terms of the mortgage.  In support of its attorney’s fees application, plaintiff submitted its invoices totaling $71,451.11.  While defendants opposed the motion for a judgement of foreclosure and sale, they “did not address the plaintiff's request for an award of attorney's fees.”  In its reply papers, plaintiff noted that "the Defendants' opposition papers fail to dispute in any manner the Plaintiff's request for an award of attorney's fees."  In the resulting order and judgment of foreclosure and sale, supreme court “confirmed the referee's report, directed the sale of the subject premises, and awarded the plaintiff $0 in attorney's fees.”   On the parties’ appeals, the Second Department held that plaintiff was entitled to its judgment.  However, the Court held that supreme court “improvidently exercised its discretion in denying the plaintiff’s unopposed request for an award of attorney’s fees and, in so holding, stated: A plaintiff in a foreclosure action may be entitled to attorneys' fees pursuant to the terms of the mortgage. However, an award of attorney's fees pursuant to such a contractual provision may only be enforced to the extent that the amount is reasonable and warranted for the services actually rendered. In determining reasonable compensation for an attorney, the court must consider such factors as the time, effort, and skill required; the difficulty of the questions presented; counsel's experience, ability, and reputation; the fee customarily charged in the locality; and the contingency or certainty of compensation. While a hearing is not required in all circumstances, the court must possess sufficient information upon which to make an informed assessment of the reasonable value of the legal services rendered.  Here, section 22 of the mortgage agreement at issue gave the plaintiff the right to collect "reasonable attorneys' fees" in any foreclosure action.  With its motion for a judgment of foreclosure and sale, the plaintiff submitted an affidavit from its attorney, stating that the plaintiff was entitled to $71,451 .11 in attorney's fees in this case.  In the affidavit, the attorney described his experience, and stated that his discounted billing rate of $175 per hour "is actually less than that of other attorneys prosecuting foreclosure actions in New York State."  The plaintiff further submitted its attorney's billing statements as evidence.  The defendants did not oppose the plaintiff's request for an award of attorney's fees.  Accordingly, the plaintiff should have been awarded attorney's fees in the sum of $71,451.11. Jonathan H. Freiberger is a partner and co-founder of Freiberger Haber LLP. This article is for informational purposes and is not intended to be and should not be taken as legal advice.

By: Jeffrey M. Haber On June 5, 2017, the U.S. Supreme Court held that claims for disgorgement imposed as a sanction for violation of the federal securities laws must be commenced within five years of the date the claim accrues. 1 In doing so, the Court concluded that disgorgement “in the securities enforcement context is a ‘penalty’ within the meaning of Section 2462” of the U.S. Code.  In concluding that disgorgement is a penalty, the Supreme Court looked at two factors. First, whether the payment had been imposed to redress a wrong to the public, or a wrong to an individual. The Court noted that a penalty is imposed to redress the former, not the latter. “This is because penal laws, strictly and properly, are those imposing punishment for an offense committed against the State.”  (Internal quotations omitted.) The Court also noted that disgorgement is more like a penalty because, as applied by the courts, it does not necessarily compensate the victims; disgorged profits are paid to the courts, and it is “within the court’s discretion to determine how and to whom the money will be distributed.” (Citation and internal quotation marks omitted.) Second, whether the payment was imposed to deter future wrongdoing by depriving violators of their ill-gotten gains. Apply those factors, the Supreme Court concluded that “ ecause disgorgement orders go beyond compensation, are intended to punish, and label defendants wrongdoers as a consequence of violating public laws, they represent a penalty .…” (Internal quotation marks and citation omitted.) Kokesh="Kokesh" here.=">here."> In J.P. Morgan Sec. Inc. v. Vigilant Ins. Co. , the New York Court of Appeals held that Kokesh did not apply to the dispute before it because the disgorgement was not punitive but compensatory and, therefore, was not a penalty. 2 J.P. Morgan involved a dispute between insured broker-dealers and certain excess insurers concerning the availability of coverage under a “wrongful act” liability policy for funds the insureds “disgorged’ as part of a settlement with the Securities and Exchange Commission (“SEC”). In concluding that the settlement payment in question was not excluded from insurance coverage as a “penalt imposed by law” under the policies at issue, the Court reversed the decision of the Appellate Division, First Department, which ruled to the contrary in reliance on Kokesh . 3 Factual Background As noted, the dispute concerned insurance which J.P. Morgan’s predecessor, The Bear Stearns Companies (the “Companies”), purchased from defendant Vigilant Insurance Company. The policy provided coverage for “wrongful acts” of the Companies and its subsidiaries. The Companies also purchased various excess insurance policies that followed the policy issued by Vigilant. The excess policies provided coverage for “loss” that the Companies became liable to pay in connection with any civil proceeding or governmental investigation into violations of laws or regulations. They defined “loss” as including various types of damages – including compensatory and punitive damages (“where insurable by law”) – but not “fines or penalties imposed by law.” In 2003, the SEC and other regulatory agencies began investigating Bear, Stearns & Co. Inc. and Bear, Stearns Securities Corporation – broker-dealers that processed and cleared trades for clients (collectively, “Bear Stearns”). The investigation concerned allegations that, between 1999 and 2003, Bear Stearns had facilitated “late trading” and deceptive “market timing” practices by its customers in connection with the purchase and sale of shares of mutual funds. 4 Bear Stearns notified its insurance carriers (the “Insurers”) of the pending investigation, but the Insurers effectively disclaimed coverage. Eventually, the SEC informed Bear Stearns that it intended to commence a civil action or administrative proceeding charging violations of the federal securities laws and that it would seek, among other things, $720 million in monetary sanctions. Although Bear Stearns disputed the proposed charges, in early 2006 it settled with the SEC. Pursuant to the settlement order, the SEC censured Bear Stearns and ordered it to cease and desist from any future securities law violations. Without admitting or denying the SEC’s findings, Bear Stearns agreed to disgorge $160 million and pay civil penalties of $90 million. Both payments were to be deposited into a Fair Fund 5 to compensate mutual fund investors allegedly harmed by the improper trading practices.  Further, “ o preserve the deterrent effect of the civil penalty,” the settlement order directed that the $90 million payment – but not the disgorgement payment – was ineligible to offset any sums owed by Bear Stearns to private litigants injured by the trading practices. Bear Stearns was also required to treat the $90 million payment as a penalty for tax purposes.  Following the settlement, Bear Stearns transferred the $160 million disgorgement and $90 million penalty payments to the SEC. Bear Stearns also eventually settled a series of class actions brought on behalf of injured private investors based on similar late trading and market timing allegations. Plaintiffs, Bear Stearns’ successor companies, subsequently commenced the action alleging that the Insurers breached the insurance contracts and seeking a declaration of coverage for the disgorgement payment, private settlement, and various other defense costs and expenses. The Insurers moved to dismiss the complaint arguing, among other things, that the disgorgement component of the SEC settlement was not insurable as a matter of public policy. The motion court denied the motions to dismiss, but the First Department reversed and granted the motions. 6 Bear Stearns appealed. The Court of Appeals reinstated the complaint, concluding that the Insurers were not entitled to dismissal because the disgorgement payment, allegedly “calculated in large measure on the profits of others,” was not clearly uninsurable as a matter of public policy. 7 Following additional motion practice, Bear Stearns moved for summary judgment, seeking dismissal of the Insurers’ various defenses to coverage and arguing that $140 million of the disgorgement payment represented disgorgement of its clients’ gains, as compared with Bear Stearns’ own revenue, and was an insurable “loss” under the policies. The Insurers opposed and cross-moved for summary judgment, arguing that the $140 million did not represent client gains and relying on various policy exclusions and public policy-based arguments against indemnification. The motion court denied the Insurers’ motions and granted summary judgment to Bear Stearns, concluding that the disgorgement of $140 million in client gains constituted an insurable loss. 8 The Insurers appealed. The First Department, among other things, reversed, denied Bear Stearns’ motion for summary judgment, and granted the Insurers’ motions for summary judgment, stating that Bear Stearns was not entitled to coverage for the SEC disgorgement payment. 9 Relying on Kokesh , the First Department determined that the relevant portion of the disgorgement payment was a “penalty” and, as such, was not an insurable loss under the language of the policies. 10 On remand, the motion court dismissed the complaint as to certain excess insurers and severed the remaining claims as to other insurers. The Court of Appeals granted leave to appeal as against four of the excess insurers. On appeal, Bear Stearns argued that the $140 million disgorgement for which it sought coverage was derived from estimates of client gain and investor harm and, therefore, the Insurers failed to meet their burden of establishing that the payment was not a covered loss because it was a “penalty imposed by law.” In a 6-1 decision written by Chief Judge DiFiore, the majority agreed, holding that the payment was not a penalty within the meaning of the policies. The Court’s Decision As an initial matter, the Court examined the insurance contracts as it would any other contract. 11 Thus, the Court looked to the specific language used in the policies, 12 and “interpreted according to common speech and consistent with the reasonable expectation of the average insured” at the time of contracting ( i.e. , in 2000), and construed any ambiguities against the Insurers and in favor of the insured. 13 Against the foregoing principles, the Court turned its attention to the policies at issue, noting that resolution of the dispute turned on the definition of “loss” thereunder. 14 The Court observed that under the policies, the Insurers agreed to pay the “loss” that Bear Stearns became legally obligated to pay as the result of any claim (defined as including any civil proceeding or governmental investigation) for any wrongful act, which encompassed any actual or alleged act, error, omission, misstatement, neglect, or breach of duty by Bear Stearns and its employees while providing services as a securities broker and dealer. 15 The Court noted that the policies defined “loss” to include compensatory damages, punitive damages where insurable by law, multiplied damages, judgments, settlements, costs, and expenses resulting from any claim.” 16 Further, said the Court, the term “loss” expressly encompassed “costs, charges and expenses or other damages incurred in connection with any investigation by any governmental body”, though “fines or penalties imposed by law” were excluded from the definition of “loss”. 17 The Court concluded that the Insurers had not met their burden of proving that in 2000, when the policies were purchased, the Companies understood the phrase “penalties imposed by law” to preclude coverage for the $140 million SEC disgorgement payment. 18 The Court examined the meaning of “penalty” and concluded that a “penalty” “is distinct from a compensatory remedy” – “a penalty is not measured by the losses caused by the wrongdoing.” 19 However, noted the Court, “where a sanction has both compensatory and punitive components, it should not be characterized as punitive in the context of interpreting insurance policies.” 20 Thus, said the Court, “a reasonable insured purchasing a wrongful act policy would expect an award or settlement payment that has compensatory purposes and is measured by an injured party’s losses and third-party gains to fall within its coverage grant and, concomitantly, not be deemed a penalty.” 21 The Court explained that “Bear Stearns demonstrated that the $140 million disgorgement payment was calculated based on wrongfully obtained profits as a measure of the harm or damages caused by the alleged wrongdoing that Bear Stearns was accused of facilitating.” 22 In contrast, noted the Court, the $90 million payment was denominated a “penalty” and “was not derived from any estimate of harm or gain flowing from the improper trading practices.” 23 This finding, reasoned the Court, was underscored by the SEC’s requirement that Bear Stearns treat the $90 million payment, but not the disgorgement, as a penalty for tax purposes. In addition, noted the Court, although the $90 million civil penalty funds were ineligible to be used to offset a private claim against Bear Stearns, the same was not true of the disgorgement payment. These factors, explained the Court, “must be taken together with the fact that the payment effectively constituted a measure of the investors’ losses.” 24 Notably, the Court held that Kokesh did not control the outcome in the case. The Court distinguished Kokesh on the ground that “the Supreme Court was not interpreting the term ‘penalty’ in an insurance contract (much less one governed by New York law).” 25 The Court noted that “the Supreme Court has since clarified that SEC-ordered disgorgement is not always properly characterized as a penalty insofar as the SEC may seek ‘disgorgement’ of a defendant’s net gain for compensatory purposes as ‘equitable relief’ in civil actions.” 26 “Moreover,” reasoned the Court, “ Kokesh – decided nearly two decades after the parties executed the relevant insurance contracts – could not have informed the parties’ understanding of the meaning of the term ‘penalty.’” 27 “Thus,” concluded the Court, “ Kokesh not mandate that the $140 million disgorgement payment be considered a ‘penalty imposed by law’ under the insurance policies at issue here.” 28 Accordingly, the Court held that the First Department erred in granting summary judgment to the Insurers. Judge Rivera dissented, arguing that “the majority’s conclusion that the disgorged funds recoverable from the insurers contrary to the insurance policy language and undermine both federal regulation of illegal conduct in the securities market and the SEC’s efforts to discourage future violations.” 29 Jeffrey M. Haber is a partner and co-founder of Freiberger Haber LLP. This article is for informational purposes and is not intended to be and should not be taken as legal advice. Footnotes Kokesh v. SEC , 581 US ___, 137 S.Ct. 1635 (2017). J.P. Morgan Sec. Inc. v. Vigilant Ins. Co. , 2021 N.Y. Slip Op. 06528 (Nov. 23, 2021) ( here ). J.P. Morgan Sec. Inc. v. Vigilant Ins. Co. , 166 A.D.3d 1 (1st Dept. 2018) ( here ). “Late trading is the practice of placing orders to buy, redeem or exchange mutual fund shares after the 4:00 p.m. close of trading, but receiving the price based on the net asset value set at the close of trading,” which practice “allows traders to obtain improper profits by using information obtained after the close of trading.” J.P. Morgan Sec. Inc. v. Vigilant Ins. Co. , 21 N.Y.3d 324, 330 n.1 (2013). Market timing is the “practice of frequent buying and selling of shares of the same mutual fund or the buying or selling of mutual fund shares to exploit inefficiencies in mutual fund pricing”; although this is “not per se improper, it can be deceptive if it induces a mutual fund to accept trades it otherwise would not accept under its own market timing policies.” Id. A Fair Fund is a fund established by the SEC to distribute disgorgements and penalties to defrauded investors. Congress created Fair Funds in the Sarbanes-Oxley Act of 2002. 91 A.D.3d 226 (1st Dept. 2011). 21 N.Y.3d 324, 336 (2013). 57 Misc. 3d 171, 179-183 (Sup. Ct., N.Y. County 2017). 166 A.D.3d 1 (1st Dept. 2018). Id. at 8. Slip Op. at *3 (“As we have often stated, insurance contracts are subject to the general rules of contract interpretation.”). Id. (citing Jin Ming Chen v. Insurance Co. of the State of Pa. , 36 N.Y.3d 133, 138 (2020); Roman Catholic Diocese of Brooklyn v. National Union Fire Ins. Co. of Pittsburgh, Pa. , 21 N.Y.3d 139, 148 (2013). Id. (citing ( Dean v. Tower Ins. Co. of N.Y. , 19 N.Y.3d 704, 708 (2012) (internal quotation marks and citation omitted). Id. Id. Id. at *3-*4. Id. at *4. Id. Id. Id. (citing Zurich Ins. Co. v. Shearson Lehman Hutton , 84 N.Y.2d 309, 312-313 (1994)). Id. at *4-*5. Id. at *6. Id. Id. Id. Id. at *7 (citing Liu v. SEC , ___ U.S. ___, 140 S. Ct. 1936, 1940 (2020) (footnote omitted). Id. Id. Id.

By: Jeffrey M. Haber What is Expungement and When is It Granted? Expungement is the process by which a brokerage firm or registered representative seeks to remove an adverse disclosure event from the Central Registration Depository (CRD®) system. The CRD is the securities industry’s online registration and licensing database. Information in the CRD is obtained through forms that brokerage firms, associated persons and regulators complete as part of the securities industry registration and licensing process. 1 The CRD includes information about criminal matters, regulatory disciplinary actions, civil judicial actions, and information relating to customer disputes, such as customer complaints, arbitration claims, and arbitration awards.  The public can access information in the CRD through BrokerCheck® ( here ) – a free tool (powered by FINRA) that provides investors with information regarding a broker’s employment history, regulatory actions, investment-related licensing information, arbitrations and complaints. 2 FINRA and other regulators depend on the CRD system as a critical source of regulatory information to help inform examinations, investigations, and disciplinary actions to protect investors and safeguard markets. Expungement is an extraordinary remedy that is awarded only under limited circumstances: (a) the claim, allegation or information is factually impossible or clearly erroneous; (b) the registered person was not involved in the alleged investment-related sales practice violation, forgery, theft, misappropriation or conversion of funds; or (c) the claim, allegation or information is false. See FINRA Rule 2080 ( here ). If a party seeking expungement satisfies one of the foregoing grounds, then the record of the disclosure event will be expunged from the CRD – that is, it will be permanently deleted and will not be available to the investing public, regulators or prospective broker-dealer employers. Information about broker-customer disputes must be reported to the CRD regardless of whether the firm or the broker believes the allegations are false, irrelevant or malicious. There is no proof required before these disputes are reported. In addition, there is no regulatory review of the merits of a reported dispute before it is recorded in the CRD or disclosed through BrokerCheck. As noted by FINRA ( here ), the expungement framework seeks to balance the benefits of disclosing information about disclosure events to investors and regulators with the goal of protecting brokers from the publication of inaccurate allegations against them.  How To Get A Customer Disclosure Expunged Customer dispute information is expunged from the CRD system only after FINRA receives a court order to execute the expungement. In general, court orders compelling FINRA to expunge customer dispute information may result from one of two separate procedures: A firm or a broker may initiate a request for expungement in the arbitration forum administered by FINRA, often as part of adjudicating the dispute underlying the customer complaint. In this scenario, a panel of independent arbitrators decide whether to recommend expungement in the award. FINRA has no part in the decision. Even if the arbitration panel recommends expungement, the firm or broker must still obtain an order from a court of competent jurisdiction confirming the arbitration award, and then serve the confirmed award on FINRA.  A firm or a broker seeking expungement may initiate a proceeding directly in a court of competent jurisdiction, without first going through any arbitration proceeding. A court order confirming an arbitration award recommending expungement or compelling expungement is binding on FINRA. FINRA may oppose requests that a court confirm an arbitration award for expungement or requests for expungement initiated directly in court if it determines that such expungement is not meritorious, not consistent with its mission of investor protection, impairs the integrity of the CRD or adversely affects regulatory requirements.  FINRA Rule 2080 requires all directives to expunge customer dispute information from the CRD system to be confirmed by or ordered by a court of competent jurisdiction and requires the brokerage firm or associated person to name FINRA as a party in any judicial proceeding seeking confirmation of an arbitration award containing expungement relief. FINRA may, however, waive the requirement to name it as a party if it determines that the requested expungement relief is based on affirmative judicial or arbitral findings.  Expungement is Not Appropriate The Second Time Around When an arbitration panel or a court has issued an award or decision denying a broker’s expungement request, the broker may not request expungement in another arbitration case . Thus, if there has been a prior denial, the arbitration panel must deny the expungement request. Requests for Expungement Prior to the Conclusion of the Underlying Arbitration A broker may not file a request for expungement of customer dispute information arising from an underlying customer arbitration until the underlying customer arbitration has concluded. This means, for example, that if a firm requests expungement on behalf of an unnamed broker during an arbitration filed by a customer, the broker may not file a separate request to expunge the same customer dispute information in a new case while the underlying customer arbitration is ongoing. Additionally, the broker may not file an expungement request in a separate, expungement-only case while the underlying customer arbitration is ongoing, even if neither the broker nor the firm requests expungement of the customer dispute information in the underlying customer arbitration. Importance of Providing an Explanation for Recommending Expungement FINRA Rules 12805 ( here ) and 13805 ( here ) require arbitrators to provide a written explanation of the reasons for finding that one or more of the grounds for expungement apply to the facts of the case before them. FINRA instructs its arbitrators to provide an explanation that is complete, and supported by documentary or other evidence, and not a mere recitation of the Rule 2080 grounds or language provided in the expungement request.  Settlement Payments Relating to Expungement FINRA Rule 20813 ( here ) prohibits firms and registered representatives from conditioning settlement of a customer dispute on – or otherwise compensating a customer for – the customer’s agreement to consent to, or not to oppose, the firm’s or representative’s request to expunge such information from the CRD system.   Thus, arbitrators will consider whether the party seeking expungement: (a) contributed to the settlement; and (b) conditioned a settlement of the arbitration upon an agreement not to oppose the request for expungement. The latter scenario occurs in cases in which the customer does not participate in the expungement hearing, or the requesting party states that a customer has indicated that he or she will not oppose the expungement request. Martiak v. Financial Indus. Regulatory Authority, Inc. In Martiak , the foregoing rules were considered by the Court in confirming an arbitration award expunging a customer dispute from Petitioner’s record in the CRD system. Martiak v. Financial Indus. Regulatory Auth., Inc., (FINRA) , 2021 N.Y. Slip Op. 32297(U) (Sup. Ct., N.Y. County Oct. 26, 2021) ( here ). Petitioner commenced a special proceeding pursuant to Article 75 of the CPLR, seeking an order confirming the award issued in a FINRA arbitration, recommending the expungement of all references to the FINRA Arbitration contained in the CRD system for Petitioner.  CPLR § 7510 provides that “ he court shall confirm an award upon application of a party made within one year after its delivery to him, unless the award is vacated or modified upon a ground specified in section 7511.” The Appellate Division, First Department, in interpreting CPLR § 7510, gives “the word ‘shall’ its ordinary meaning” and directs the courts “to confirm an arbitration award if a timely application is made whenever the award is not vacated or modified under CPLR 7511.” 3 The Court found that Petitioner satisfied all the procedural requirements of CPLR § 7510. In that regard, the Court noted that Petitioner timely filed the application within one year of receipt of expungement the award. 4 Nominal Respondent, FINRA, had ample notice and made no motion to modify or vacate the expungement award and did not contest Petitioner’s efforts to have the award confirmed by the court. 5 In fact, FINRA granted Petitioner’s request for a waiver of the obligation to name and serve FINRA. 6 Accordingly, the Court granted the petition and ordered the expungement of the Occurrence from the CRD and BrokerCheck records. Takeaway Expungement is an “extraordinary remedy that arbitrators should recommend only under appropriate circumstances.” It involves a rigorous process in which claimants must present evidence that falls squarely within the boundaries of the three narrow grounds for expungement. Since the grounds upon which expungement may be granted are narrow, obtaining an expungement order is not easy. Indeed, statistics provided by FINRA show ( here ) that expungement is rarely granted: only 4% of the customer dispute disclosures in the CRD during the period 2015-2020 were expunged pursuant to a court order as of May 25, 2021. 7 Jeffrey M. Haber is a partner and co-founder of Freiberger Haber LLP. This article is for informational purposes and is not intended to be and should not be taken as legal advice. Footnotes In general, the information on the CRD is submitted by registered securities firms and regulatory authorities in response to questions on the Uniform Registration Forms, e.g. , Form U4 (the Uniform Application for Securities Industry Registration or Transfer) ( here ), Form U5 (the Uniform Termination Notice for Securities Industry Registration) ( here ), and Form U6. These forms are designed to elicit and collect administrative and disclosure information that is relevant to regulators in connection with their licensing and enforcement activities.  It is important to note that public investors cannot access the CRD system. However, most of the information submitted to CRD is made publicly available through BrokerCheck. Bernstein Family Ltd. P’ship v. Sovereign Partners, L.P. , 66 A.D.3d 1, 5 (1st Dept. 2009). Slip Op. at *2. Id. at *2-*3. As noted, FINRA Rule 2080(b) requires a party seeking expungement under Rule 2080(a) to name FINRA as an additional party and serve FINRA with all appropriate documents, unless FINRA waives this obligation upon request of the party.  During this same period, only 0.2% of registered persons industry-wide had a disclosure expunged ( here ).