“If it looks like a duck, swims like a duck, and quacks like a duck, then it probably is a duck.” This saying best describes the duplication of claims doctrine that this Blog often writes about – that is, the doctrine whereby a fraud claim will duplicate a contract claim when “the only fraud alleged is that the defendant was not sincere when it promised to perform under the contract.” Mañas v. VMS Assoc., LLC , 53 A.D.3d 451, 453 (1st Dept. 2008) (quoting First Bank of Ams. v. Motor Car Funding , 257 A.D.2d 287, 291 (1st Dept. 1999)). As we have noted before ( here ), courts do not hesitate to dismiss fraud claims when they are merely contract claims “dressed in the garb of a fraud count.” Songbird Jet Ltd., Inc. v. Amax Inc. , 581 F. Supp. 912, 924 (S.D.N.Y. 1984).   A fraud-based cause of action may lie, however, where the plaintiff pleads a breach of a duty separate from a breach of the contract. Mañas , 53 A.D.3d at 453. “Thus, where the plaintiff pleads that it was induced to enter into a contract based on the defendant’s promise to perform and that the defendant, at the time it made the promise, had a ‘preconceived and undisclosed intention of not performing’ the contract, such a promise constitutes a representation of present fact collateral to the terms of the contract and is actionable in fraud.” Id. (quoting Deerfield Communications Corp. v. Chesebrough-Ponds, Inc. , 68 N.Y.2d 954, 956 (1986)). The Appellate Division, First Department recently addressed these issues in International Dev. Inst., Inc. v. Westchester Plaza, LLC , 2021 N.Y. Slip Op. 02746 (1st Dept. May 4, 2021). International Development arose from a lease between the parties, whereby plaintiff leased the second floor of defendant’s building for the purpose of running a school. Plaintiff asserted a number of causes of action for, inter alia , breach of the lease, fraud, negligent misrepresentation, and unjust enrichment. With regard to the fraud claim, plaintiff contended that defendant misrepresented that it would cooperate in obtaining the certificate of occupancy (“CO”), including by curing existing first-floor violations and carrying out the supporting work that defendant undertook to do ( e.g. , roof repair and electrical work). The First Department found that the claim duplicated the lease claims because it was simply a contention that “defendant never intended to perform its obligations under the lease.” Slip Op. at *1. Therefore, held the Court, the fraudulent misrepresentation claim should have been dismissed. Id. For the same reason ( e.g. , plaintiff failed to allege the breach of any duty separate and apart from the contractual obligations under the lease), the Court held that the negligent misrepresentation claim should have been dismissed. Id. (citing Greenman-Pedersen, Inc. v. Levine , 37 A.D.3d 250 (1st Dept. 2007)). [Ed. Note: Where “a legal duty independent of the contract itself has been violated<,> ” or where the misrepresentation is “collateral or extraneous to the terms of the parties’ agreement,” a fraudulent inducement claim can stand side-by-side with “a simple breach of contract” claim.  Dormitory Auth. v. Samson Constr. Co. , 30 N.Y.3d 704 (2018) (citation omitted).] The Court also found that plaintiff’s fraudulent concealment claim should have been dismissed. Under that claim, plaintiff contended that defendant should have, but did not, disclose numerous existing first-floor violations, which made it impossible to use the premises as a school, as stated in the lease, or to obtain a CO. The Court found that “Plaintiff’s own submissions demonstrate that the first-floor violations were numerous, long-standing (many dating back to the 1990s), and matters of public record.” Id.   As “a sophisticated party to an arm’s-length contract” in which “defendant expressly eschewed any warranties and presented the property for lease ‘as-is’”, “ t was incumbent on plaintiff to exercise full due diligence to ascertain all factors having a bearing on obtaining a CO,” said the Court. Id. Since “Plaintiff did not do so,” concluded the Court, it could not “assert any claim for fraudulent concealment.” Id. (citing Jana L. v. West 129th St. Realty Corp. , 22 A.D.3d 274, 278 (1st Dept. 2005)). see, e.g. , hsh nordbank ag v. ubs ag , 95 a.d.3d 185, 194-95 (1st dept. 2012).> see, e.g. , hsh nordbank ag v. ubs ag , 95 a.d.3d 185, 194-95 (1st dept. 2012).> The Court further held that plaintiff’s unjust enrichment claim, which was based upon its fraud allegations, should have been dismissed as duplicative of the lease claims. Id. at *1-*2. The Court explained that, in addition to the absence of an independent duty, the damages sought by the unjust enrichment claim were not “distinct from the contract claim.” Id. at *2.  “In each case,” observed the Court, “plaintiff principally to recoup the value of the improvements.” Id. here),=">here)," even="even" where="where" a="a" plaintiff="plaintiff" alleges="alleges" duty="duty" independent="independent" the="the" contract,="contract," courts="courts" will="will" dismiss="dismiss" fraud="fraud" claim="claim" because="because" damages="damages" sought="sought" are="are" same="same" as="as" those="those" by="by" contract="contract" claim.="claim." explained,="explained," reason="reason" has="has" to="to" do="do" with="with" purpose="purpose" sought.="sought." MBIA="MBIA" Ins.="Ins." Corp.="Corp." v.="v." Credit="Credit" Suisse="Suisse" Sec.="Sec." (USA)="(USA)" LLC ,="LLC," A.D.3d="A.D.3d" 108,="108," (1st="(1st" Dept.="Dept." 2018);="2018);" Mañas ,="Mañas," at="at" 454.="454." meant="meant" redress="redress" different="different" harm="harm" than="than" for="for" breach="breach" contract.="contract." latter="latter" restore="restore" nonbreaching="nonbreaching" party="party" good="good" position="position" it="it" would="would" have="have" been="been" had="had" performed;="performed;" former="former" indemnify="indemnify" losses="losses" suffered="suffered" result="result" fraud.="fraud." MBIA ,="MBIA," 114;="114;" Thus,="Thus," all="all" remedied="remedied" through="through" claim,="claim," is="is" duplicative="duplicative" and="and" must="must" be="be" dismissed.="dismissed." 114.="114." This="This" so="so" sufficiently="sufficiently" an="an" owed="owed" them="them" separate="separate" apart="apart" from="from" Id. ="Id."> . Accordingly, concluded the Court, the unjust enrichment claims should have been dismissed as duplicative of the contract claims. Slip Op. at *2 (citation omitted). Takeaway The title of this article aptly describes the Court’s reasoning in International Development . As discussed, the Court was asked to examine fraud claims that were essentially indistinguishable from plaintiff’s contract claims. Under the duplication of claims doctrine, the fraud claims could not stand side-by-side with the lease (contract) claims.  As discussed above, plaintiff did not allege any representation that was collateral to the lease. Instead, plaintiff merely alleged that defendant was not sincere when it promised to perform under the lease. To the First Department, under those facts, the fraud-based claims duplicated the contract claims.

Less than three weeks ago, this Blog wrote about an enforcement action brought by the Securities and Exchange Commission (“SEC” or the “Commission) against Zachary Horwitz, a.k.a. Zach Avery, a Los Angeles-based actor known for low budget features such as “Trespassers” and “The White Crow”, and his company 1inMM (one in a million) Capital, LLC, for allegedly running a Ponzi scheme that raised over $690 million (here). As discussed in the article, the scheme had two components: the misappropriation of investor funds and the use of new investor money to pay the “returns” of older investors – the hallmark of a Ponzi scheme. This combination – a Ponzi scheme and the misappropriation of investor funds – was at the heart of the SEC’s emergency enforcement action against Jonathan P. Maroney (“Maroney”) and several entities he controls. The SEC announced (here) the action on April 26, 2021. According to the SEC’s complaint (here), from at least May 2015 through the present, Maroney and his entities raised in excess of $17.1 million from more than 100 investors nationwide through a series of unregistered fraudulent securities offerings. The securities sold were in the form of either promissory notes or agreements issued by an affiliated entity that Maroney controlled. Investors were told that their money would accrue interest from between 2% to 5% per month for 12 to 36 months. Additionally, investors in those instruments were allegedly promised a full return of their investment principal upon maturity. The SEC alleged that beginning in late 2018, Maroney and five special purpose entities he controlled sold “high yield, secured bonds” with interest rates varying from 1% to 1.5% per month. The bonds were offered in 1-, 2-, 3- or 5-year terms, with a guaranteed return of investment principal at maturity. Defendants allegedly represented to investors that the proceeds from the offerings would be used to provide “bridge funding” for one of the entity’s business of generating online customer lead campaigns for other businesses. According to the offering documents, the leads generated from the campaigns were to be sold at a substantial profit to the entity’s “pipeline” of business clients within the “$200 Billion internet advertising sector.” From the resulting profits, investors were supposed to receive monthly interest payments followed by the return of their principal when their notes or bonds matured. According to the SEC, Defendants solicited and raised money from investors primarily through the company’s website and a series of on-line marketing videos featuring Maroney posted both on the company’s website and on YouTube. In the videos, Maroney allegedly represented the bonds to be as “safe as a CD” and equated the offering to “going down to your local bank and purchasing a certificate of deposit.” Besides the company’s website and marketing videos, the SEC said that Defendants marketed their high-yield bonds through pop-up advertisements on social media platforms like Facebook. According to one investor, these ads guaranteed annual returns of up to 18%. According to the SEC, once investor money was received, their funds were transferred into entity-controlled accounts and commingled along with funds from the other offerings. Maroney was the sole signatory on all related company bank accounts. The SEC alleged that Defendants’ representations concerning the use of proceeds raised from the offerings were materially false and misleading. According to the SEC, Defendants were not engaged in a significant lead generation business and only used a small portion of the money raised from investors to fund their business. Instead, said the SEC, from January 2017 to February 2021, Defendants generated no significant revenues from their customer lead generation businesses or from any other venture. Significantly, alleged the SEC, of the $17.1 million in investor funds deposited into related bank accounts, at most only about $449,000 may have gone to business expenses. Instead, claimed the SEC, Maroney used investor money to enrich himself and his family, and to perpetuate the Ponzi scheme by making payments of fictitious returns to existing investors using other investor funds. Specifically, explained the SEC, of the $17.1 million raised from investors, Maroney misappropriated more than $4.88 million for his own personal use, including the purchase and maintenance of his waterfront home and a Mercedes Benz, and to pay for his extensive credit card bills and renovation-related expenses on the house. In addition, said the SEC, Maroney allegedly misused approximately $1.4 million of investor money by making payments to other entities unrelated to the supposed purpose of the offerings, including money sent to a company involved in the container, storage and shipping industry. Thus, explained the SEC, about $6 million of investors’ money was allegedly misappropriated and misused by Maroney. Regarding the Ponzi scheme, the SEC alleged that since 2017, Maroney used at least $6.5 million of investor funds to make monthly interest payments and other payouts to investors. “As alleged in our complaint, Maroney lured investors with promises of double-digit returns and false claims, while pocketing millions of investor dollars for himself,” said Eric I. Bustillo, Director of the SEC’s Miami Regional Office. “Investors should be skeptical of any investment that promises extraordinarily high rates of return.” The SEC filed its complaint on April 20, 2021, in the United States District Court for the Middle District of Florida. The Commission charged Defendants with violating the antifraud and registration provisions of the federal securities laws. In addition to the emergency relief the SEC obtained from the Court (i.e., a temporary restraining order and asset freeze), the complaint seeks preliminary and permanent injunctions, disgorgement, prejudgment interest, and a civil penalty from each Defendant. The complaint also named Tonya Maroney, Maroney’s wife, and Celtic Enterprises LLC, another Maroney-controlled entity, as relief defendants for receiving proceeds from the alleged fraud. The Court set a hearing for April 29, 2021, to determine if a preliminary injunction should be entered and whether the asset freeze should remain in force for the duration of the litigation.

Judiciary Law 470 , which, in its present form, was passed in 1909, but has its origins to the time when President Lincoln was in office, provides: A person, regularly admitted to practice as an attorney and counsellor, in the courts of record of this state, whose office for the transaction of law business is within the state, may practice as such attorney or counsellor, although he resides in an adjoining state. This Blog has addresses Judiciary Law 470 < HERE =">HERE"> , < HERE =">HERE"> and < HERE =">HERE"> .  Our July 3, 2018, Blog post, “ Out Of State Attorneys Admitted In New York, Cannot Rely On New York Virtual Offices If They Intend To Practice In New York ,” addressed the need for an attorney admitted to practice law in New York, but who resides outside of the State, to maintain a physical office within the State in order to practice law in the State.  The Blog highlighted case-law holding that the in-state office requirement is not satisfied by maintaining a “virtual” office in New York.   In our follow-up Blog posted on January 2, 2019, we reported that one of the cases discussed in the July 3 Blog, Arrowhead Capital Finance v. Cheyne Specialty Finance Fund , 154 A.D.3d 523 (1st Dep’t 2017), was scheduled for oral argument before the New York Court of Appeals.  The First Department in Arrowhead , affirmed the dismissal, without prejudice, of the action because it was commenced by a non-resident attorney without an office in New York and “ laintiff’s subsequent retention of co-counsel with an in-state office did not cure the violation since the commencement of the action in violation of Judiciary Law § 470 was a nullity.”  The Court of Appeals rendered a decision on February 14, 2019, in which it reversed the harsh rule established by the First Department and held that a “violation of Judiciary Law § 470 does not render the actions taken by the attorney involved a nullity nstead, the party may cure the section 470 violation with the appearance of compliant counsel or an application for admission pro hac vice by appropriate counsel” (citation omitted).   Earlier this year, bills were introduced in the New York State Assembly ( A. 5895 ) and Senate ( S. 700 ) to repeal Judiciary Law 470.  On April 27, 2021, the New York State Bar Association issued a press release in which it reported that “ he State Senate Judiciary Committee voted this afternoon to advance NYSBA-backed legislation that would repeal the controversial Judiciary Law Section 470….”  Regarding the potential repeal of Judiciary Law Section 470, NYSBA President Scott M. Karson said: In our rapidly modernizing legal world, the profession has adapted with electronic filing of documents in the courts, virtual conferences and court proceedings, along with already established standards for perfecting service. Our laws must continue to adapt with the times too. Judiciary Law Section 470 places an onerous burden on rural and underserved communities and limits the availability of legal services simply because of where an attorney chooses to call home….  The association will continue to advocate for its repeal and thanks the legislature for moving the bill one step closer to enactment. Similarly, the NYSBA’s Memorandum in Support , which refers to the statute as “outdated,” argues that: The repeal of this requirement first enacted when the horse and buggy was a primary mode of transportation is similarly unsuited to the needs of New Yorkers in rural communities. Rural communities have an imminent crisis as only 4% of New York licensed attorneys serve rural communities with nearly 75% of those practitioners expected to retire in the next 10-30 years. By eliminating this onerous requirement, these New Yorkers will be able to make use of a population of attorneys that would otherwise be available to them but for this antiquated and unnecessary law.  Lastly, it is important for the State to be prepared for the changes to the practice of law because of the COVID-19 pandemic.  Attorneys who had no issue with maintaining a physical office location are now experiencing disruptions to their practices. The office space they use may no longer available, they have restructured to a remote work environment, or they have relocated out of the State for a variety of professional or personal reasons to meet our rapidly evolving world. Repealing this antiquated law will allow New York licensed attorneys to continue representing New Yorkers without disruption to their practices. This Blog will continue to follow, and report on, the pending legislation as it progresses through the New York State Legislature. TAKEAWAY Advances in technology have made it easier for lawyers to practice law outside of the traditional “brick and mortar” office scenario that has predominated the profession for centuries.  The virtues of remote and/or virtual workspaces has only been highlighted by the dramatic changes to almostt all work environments occasioned by the need for rapid adaptation to the impact of the COVID-19 pandemic.

Under New York law, a party’s performance may be excused, even if the contract contains no express provision for the event that made performance impossible. See , e.g. , City of New York v. Local 333, Mar. Div., Intl. Longshoremen’s Assn. , 79 A.D.2d 410 (1st Dept. 1981). To determine whether performance may be excused, the court takes a wholistic approach, considering the facts and circumstances surrounding the non-performance and the roles, if any, the parties played in said non-performance. In Local 333, Mar. Div., Intl. Longshoremen’s Assn. , the First Department explained the analysis as follows: “ ather than mechanically apply any fixed rule or law, where the parties themselves have not allocated responsibility, justice is better served by appraising all of the circumstances, the part the various parties played, and thereon determining liability.” 79 A.D.2d 410, 412-13. Additionally, performance may be excused where it is impossible to do so. “Impossibility excuses a party’s performance only when the destruction of the subject matter of the contract or the means of performance makes performance objectively impossible.” Warner v. Kaplan , 71 A.D.3d 1 (1st Dept. 2009). The “impossibility must be produced by an unanticipated event that could not have been foreseen or guarded against in the contract.” The doctrines of frustration and impossibility of performance were recently examined by the court in 1877 Webster Ave. Inc. v. Tremont Ctr., LLC , 2021 N.Y. Slip Op. 21113 (Sup. Ct., Bronx County Mar. 29, 2021). 1877 Webster Avenue involved a written commercial lease, with a 10-year term, which the parties executed on or about November 15, 2019. In the lease, the parties agreed that the premises would be “used and occupied solely as a first class NIGHT CLUB and for no other purpose.” Plaintiff commenced the action seeking a declaration that the purpose of the lease had been frustrated by the COVID-19 pandemic and that it was released from its obligations because the lease was voided and/or terminated as of March 17, 2020. Plaintiff also sought rescission of the lease based upon impossibility of performance; failure of consideration; constructive eviction; and a declaration that the personal guaranty given by Michael Franklin on behalf of Plaintiff was void. Defendant moved to dismiss under CPLR §§ 3211(a)(1) and (a)(7). Defendant argued that Plaintiff’s frustration of purpose and impossibility of performance claims should be dismissed because there was no force majeure provision in the lease. force majeure clause excuses non-performance only where the reasonable expectations of the parties have been frustrated due to circumstances beyond the control of the parties. see macalloy corp. v. metallurg, inc. , 284 a.d.2d 227 (1st dept. 2001).> force majeure clause excuses non-performance only where the reasonable expectations of the parties have been frustrated due to circumstances beyond the control of the parties. see macalloy corp. v. metallurg, inc. , 284 a.d.2d 227 (1st dept. 2001).> Defendant maintained that an economic downturn caused by a global pandemic could have been foreseen or guarded against in their lease. Therefore, Defendant argued, the parties should be bound to the allocation of risks they agreed to in the lease. Defendant also claimed that the global pandemic was foreseeable and, therefore, Plaintiff’s claims of frustration and impossibility should fail. Defendant argued that the parties could have allocated the risk of a global pandemic in their lease. Defendant furthered argued that the lease only entitled Plaintiff to a rent abatement even if it was determined that Plaintiff’s performance was excused by the Covid pandemic and the Governor’s executive orders. Defendant maintained that Plaintiff was simply trying to get out of its obligations under the lease since Plaintiff temporarily closed its business. Defendant noted that, by Plaintiff’s admission, the business was ready to reopen. Finally, Defendant claimed that the lease specifically allocated the risks of closure to each party and Plaintiff acknowledged that the closing of the business was not due to any failure of the landlord. In response, Plaintiff argued that the global pandemic and the Governor’s executive orders were unforeseeable and that, in any event, there were material issues of fact as to foreseeability of the Covid-19 pandemic. Plaintiff also argued that its claims for frustration and impossibility were not waived because their lease did not contain a force majeure clause. The Court denied the CPLR § 3211(a)(7) motion. The Court held that Plaintiff adequately pleaded frustration and impossibility of performance due to the Covid-19 pandemic and the Governor’s executive orders. The Court found that Plaintiff sufficiently alleged that the Covid-19 pandemic and the Governor’s executive orders prevented it from exclusively operating the subject premises as a night club as required by the lease. As such, the existence of the Covid pandemic and the executive orders “completely frustrated the purpose of the parties’ lease as both parties understood, and that without the ability to operate the nightclub, the lease and the guarantee make ‘little sense’”. Slip Op. at *4 (quoting Warner , 71 A.D.3d 1). The Court also held that there were issues of fact surrounding the foreseeability of the impact of the Covid pandemic on the business. Slip Op. at *3. The Court found that the parties’ conflicting positions on foreseeability warranted denial of the motion. The Court further held that Plaintiff sufficiently alleged impossibility of performance. As noted, Plaintiff claimed that due to the Covid-19 pandemic and the Governor’s executive orders, it was impossible perform under the lease. Since a night club was not an essential business under the Governor’s executive orders, Plaintiff claimed that it could not conduct its business as contemplated by the lease. As with the frustration defense, the Court held that there were genuine issues of material fact concerning the impact of the Covid-19 pandemic and the Governor’s executive orders on Plaintiff’s performance under the lease: “The parties’ conflicting arguments regarding their abilities to anticipate or guard against the Covid pandemic that resulted in the Governor’s executive orders shutting down Plaintiff’s business also create a genuine issue of fact.” Id. Such issues of fact, concluded the Court, warranted the denial of the motion. Takeaway The global pandemic has impacted businesses across the country. Many states imposed emergency measures to address the health crisis – measures that had the effect of reducing business operations or shutting down the business. New York was no different. Emergency measures and their impact on the legal rights of parties, as in 1877 Webster Avenue , will be litigated in the courts for years to come.

In today’s installment of Enforcement News, this Blog examines, among other things, the fiduciary duties of investment advisers, in particular, the duty of loyalty. An investment adviser is a fiduciary, and as such is held to the highest standard of conduct and must act in the best interest of his/her client. SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 194 (1963). This means, among other things, that an investment adviser has an affirmative duty of utmost good faith and full and fair disclosure of all material facts. Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11, 17 (1979). In broad terms, an investment adviser owes his/her client the duty of care, loyalty and candor. The duty of care includes, among other things, the duty to provide advice that is suitable and in the best interest of the client. To meet this duty, investment advisers must (a) make a reasonable inquiry into a client’s financial situation, level of financial sophistication, investment experience, and investment objectives and (b) provide personalized advice that is suitable for and in the best interest of the client based on the client’s investment profile. The duty of loyalty requires an investment adviser to put his/her client’s interests first. An investment adviser must not favor his/her own interests over those of a client or unfairly favor one client over another. In seeking to meet this duty, an adviser must make full and fair disclosure to his/her clients of all material facts relating to the relationship. Additionally, an investment adviser must seek to avoid conflicts of interest with his/her clients, and, at a minimum, make full and fair disclosure of all material conflicts of interest that could affect the advisory relationship. The disclosure must be clear and detailed enough for a client to make a reasonably informed decision to consent to such practices, strategies or conflicts or reject them. An adviser disclosing that he/she “may” have a conflict is not adequate disclosure when the conflict actually exists. On April 23, 2021, the Securities and Exchange Commission (“SEC”) announced (here) that it charged Andrew T. Franzone (“Franzone”), the former owner of a race car team, and investment adviser FF Fund Management, LLC (“FFM”) with fraudulently raising and misappropriating tens of millions of dollars from the sale of limited partnership interests in a private fund, FF Fund I LP (the “Fund”). In the SEC’s complaint (here), the Commission alleged that Franzone, the sole owner and principal of FFM, defrauded investors by making misrepresentations regarding the Fund’s strategy and investments, failing to eliminate or disclose conflicts of interest, misappropriating fund assets, and falsely representing the Fund would be audited annually. According to the SEC, from August 2014 through September 24, 2019, Franzone told potential and existing investors that his investment strategy for the Fund was to maintain a highly liquid portfolio primarily focused on options and preferred stock trading. Franzone allegedly raised more than $38 million for the Fund from approximately 90 investors through these representations. In reality, alleged the SEC, Franzone diverted substantial Fund assets to an entity he owned and invested the Fund’s remaining assets mainly in highly illiquid private companies and real estate ventures. The SEC also alleged that Franzone’s management of the Fund was subject to numerous conflicts that he did not eliminate or disclose, and that he misused Fund assets. For example, Franzone took personal loans from the founders of at least two companies in which the Fund invested, pledged Fund assets to secure other loans for his own personal benefit, and misappropriated Fund assets for personal uses, including the purchase of a garage to store his private race car collection. Finally, the SEC alleged that Franzone and FFM removed a critical safeguard for investors by failing to have the Fund audited on an annual basis despite representations they would do so. The Fund filed for bankruptcy under Chapter 11 in the Southern District of Florida on September 24, 2019. “Investment advisers must provide honest representations to investors, disclose or eliminate conflicts of interest with clients, and not abuse client assets,” said Adam S. Aderton, Co-Chief of the Enforcement Division’s Asset Management Unit. “We allege that Franzone and FFM violated federal securities laws by breaching these fundamental obligation.” The SEC’s complaint, filed in United States District Court for the Southern District of New York, charges Franzone and FFM with violating the antifraud provisions of the federal securities laws and seeks disgorgement of ill-gotten gains, civil penalties, and permanent and conduct-based injunctive relief. In a parallel action, the U.S. Attorney’s Office for the Southern District of New York announced (here) that it filed criminal charges against Franzone. According to the press release, Franzone was charged with securities fraud and wire fraud for bilking more than 100 investors out of approximately $40 million. Commenting on the indictment, U.S. Attorney Audrey Strauss said: “Andrew Franzone allegedly promised his clients access to his successful liquid trading strategy and consistent, positive trading returns. As alleged, those promises were lies. Franzone lied about his fund’s investments and performance, and he lied in promising clients that they had could readily access their invested capital. While his investors lost money, Franzone enriched himself. We will continue to work with our law enforcement partners to protect investors from these types of deceptive practices.” USPIS Inspector-in-Charge Philip R. Bartlett said: “Mr. Franzone allegedly misled investors to believe his fund was liquid and he could cover their redemption requests, in a scheme to lure them in to investing in his hedge fund. This should be a reminder that greed has no boundaries and does not care about a favorable portfolio. Postal Inspectors remind all investors to thoroughly check offers, and if they sound too good to be true, keep your money in the bank.”

Most simply stated, champerty is the prohibited practice of purchasing claims for the purpose of commencing litigation and has been described as “a venerable doctrine developed hundreds of years ago to prevent or curtail the commercialization of or trading in litigation.”  Bluebird Partners, L.P. v. First Fidelity Bank, N.A. , 94 N.Y.2d 726, 729 (2000) (describing the historical antecedents to New York’s present champerty rules).  While an ages old doctrine dating back to medieval times, most present-day lawyers view champerty more as an annoying topic covered in bar review course rather than a legal theory that might actually be litigated these days.  Champerty, however, does rear its head from time to time. New York’s prohibition against champertous transactions is codified in section 489 of the Judiciary Law , which provides in relevant part, and with some exceptions, that “ o person or co-partnership, engaged directly or indirectly in the business of collection and adjustment of claims, and no corporation or association, directly or indirectly, itself or by or through its officers, agents or employees, shall solicit, buy or take an assignment of, or be in any manner interested in buying or taking an assignment of a bond, promissory note, bill of exchange, book debt, or other thing in action, or any claim or demand, with the intent and for the purpose of bringing an action or proceeding thereon….” As the Court in Bluebird explained, “‘ hamperty,’ as a term of art, grew out of this practice to describe the medieval situation where someone bought an interest in a claim under litigation, agreeing to bear the expenses but also to share the benefits if the suit succeeded.”  Bluebird , 94 N.Y.2d at 734.  The Court explained that because, during medieval times, important litigation involved land, the purchase of lawsuits could result in a “partial interest in landed estates.”  Acquiring real property in this manner was “taint ” because “the purchase price was usually far below the value of the potential land acquisition” and, accordingly, such a transaction was “suffused with speculation related to the ‘sin’ of usury and its concomitant legal prohibitions evaded the strict prohibitive laws involving usury.”  Id. “ arly New York cases indicate that the prohibition of champerty was limited in scope and largely directed toward preventing attorneys from filing suit merely as a vehicle for obtaining costs, which, at the time, included attorneys' fees.”  Jurisprudence from the Court of Appeals: demonstrates that while this Court has been willing to find that an action is not champertous as a matter of law ( see, Fairchild Hiller Corp. v McDonnell Douglas Corp., 28 NY2d 325 ; see also, Avalon, L. L. C. v Coronet Props. Co., 248 AD2d 311 ), it has been hesitant to find that an action is champertous as a matter of law ( see, Sprung v Jaffe, 3 NY2d 539 <1957> ; see also, Moses v McDivitt, 88 NY 62 <1882> ). This prudent approach is consistent with the limited scope of the champerty doctrine as it originally appeared and developed in the Anglo-American legal system. The Bluebird Court noted that in Fairchild Hiller Corp. v McDonnell Douglas Corp. , 28 N.Y.2d 325 (1971), the Court of Appeals “first examined the actions of a nonattorney, under the champerty statute….”  Bluebird , 94 N.Y.2d at 735 - 36.  Fairchild involved claims related to the design and manufacture of the Phantom F-4 fighter-bomber (the “Bomber”).  Republic Aviation was to manufacture for McDonnell Douglas certain components of the Bomber using tools and drawings supplied by McDonnell.  Republic asserted claims against McDonnell based on defects in the supplied tools and drawings that resulted in increased production costs for Republic.  Subsequently, Fairchild Hiller Corp. acquired all of Republic’s operating assets, including Republic’s claim against McDonnell, while Farmingdale Co. acquired Republic’s non-operating assets – mostly land.  “As to , Fairchild and Farmingdale entered into a separate agreement which provided that in the event of recovery by Fairchild against McDonnell, Fairchild would turn over to Farmingdale 75% of the net proceeds received by Fairchild.”   After settlement negotiations proved unsuccessful, Fairchild commenced suit against McDonnell.  In turn, McDonnell moved for summary judgment dismissing, inter alia , the champerty claim arguing “that the assignment of the claim by Republic to Fairchild is champertous and, therefore, in violation of section 489 of the Judiciary Law.”  Supreme court dismissed the champerty claim but the Appellate Division reinstated the claim due to the existence of fact questions that required trial.  The Fairchild Court of Appeals reversed and dismissed the champerty claim and, in so doing, stated: We have consistently held that in order to fall within the statutory prohibition, the assignment must be made for the very purpose of bringing suit and this implies an exclusion of any other purpose. ( Moses v. McDivitt , 88 N.Y. 62, 65 .) More recently, in Sprung v. Jaffe (3 N Y 2d 539, 544), we stated: "the statute is violated only if the primary purpose of the purchase or taking by assignment of the thing in action is to enable the attorney to commence a suit thereon. The statute does not embrace a case where some other purpose induced the purchase, and the intent to sue was merely incidental and contingent."   Fairchild , 28 N.Y.2d at 330.  Recognizing that the “intent and purpose of the purchaser or assignee of a claim” is typically to be determined by the trier of fact, the “undisputed facts…as developed by extensive pretrial discovery, established that Fairchild did not receive the assignment …for the sole and primary purpose of bringing an action….”  Id .  Indeed: Fairchild's primary purpose, as the record indicates, was to acquire Republic's operating assets. The acquisition of the claim was simply an incidental part of a substantial commercial transaction, taken in order to induce Farmingdale to take part in the acquisition by purchasing Republic's nonoperating assets. Under such circumstances, it can by no means be said to be champertous. Consequently, we conclude that the assignment was not within the reach of section 489 of the Judiciary Law. Id. In concluding that the transactions at issue in Bluebird were not champertous, the Court of Appeals stated: We conclude that in order to constitute champertous conduct in the acquisition of rights that would then be nullified and to resolve the question at issue, the foundational intent to sue on that claim must at least have been the primary purpose for, if not the sole motivation behind, entering into the transaction. The words, "sole" and "primary," are not synonymous generally or in law. A purpose that is the sole purpose is, by necessity, the primary purpose. However, a purpose that is primary is not necessarily the sole purpose ( see, People v Lopez, 73 NY2d 214, 219 ["two primary purposes"]). Yet, the distinction is one without a legal difference when the "primary" element is present. The bottom line is that Judiciary Law § 489 requires that the acquisition be made with the intent and for the purpose (as contrasted to a purpose) of bringing an action or proceeding ( compare, Moses v McDivitt, supra ; Sprung v Jaffe, supra ). Thus, we are satisfied that the record here does not support a finding of champerty as a matter of law for summary resolution. It cannot be determined on this record and in this procedural posture that champerty was the primary motivation, no less the sole basis, for all this strategic jockeying and financial positioning. Bluebird , 94 N.Y.2d at 736 (emphasis in original). On April 22, 2021, the Appellate Division, First Department, decided Leasing Control Inc., as Assignee of Firequench, Inc. v. 500 Fifth Avenue, Inc.   The facts of Leasing Control are simple and were obtained from the underlying record available on the e-court’s website.  Firequench, Inc. is a company that provided, inter alia , fire alarm installation and repair services to buildings in Manhattan, including a building (the “Building”) owned by defendant (“Owner”).  Firequench claimed that Owner owed it a significant sum of money for services allegedly rendered for which payment was never made.  Plaintiff was formed on November 30, 2012 and is owned by the sister of Firequench’s owner.  On March 5, 2013, Firequench delivered to plaintiff, a blanket assignment of all of Firequench’s claims against Owner.  On March 7, 2013, two days later, plaintiff commenced its collection action as the assignee of Firequench’s claims against Owner.  In seeing through the sham transaction between Firequench and Leasing Control and finding plaintiff’s claims against Owner champertous, the First Department stated: As plaintiff’s president admitted during her deposition, the primary purpose of Firequench’s assignment of its claims against defendants to plaintiff was for plaintiff to pursue litigation against defendants on the claims in exchange for a portion of the proceeds from the litigation ( Justinian Capital SPC < v westlb ag, n.y. branch > v westlb ag, n.y. branch>, 28 NY3d <160> at 164-165 <2016> ). Plaintiff and Firequench had no pre-existing relationship and plaintiff had no pre-existing interest in the claim before the assignment ( compare Trust for Certificate Holders of Merrill Lynch Mtge. Invs., Inc. Pass-Through Certificates, Series 1999-C1 v Love Funding Corp. , 13 NY3d 190, 200-201 <2009> ). Instead, plaintiff was a shell company with no real assets, corporate structure, or operations, and it commenced litigation two days after the assignment (see Justinian Capital SPC, 28 NY3d at 165).

A “recurring question” New York courts grapple with is whether the facts alleged in a complaint give rise to claims for both breach of contract and fraudulent inducement. Cronos Grp. v. XComIP, LLC , 156 A.D.3d 54, 56 (1st Dept. 2017). Readers of this Blog know that a fraud claim, which “ar from the same facts , s identical damages and d not allege a breach of any duty collateral to or independent of the parties’ agreements<,> is subject to dismissal as redundant of the contract claim.” Id. at 63 (quoting Havell Capital Enhanced Mun. Income Fund, L.P. v. Citibank, N.A. , 84 A.D.3d 588, 589 (1st Dept. 2011) (internal quotation marks omitted). See also HSH Nordbank AG v. UBS AG , 95 A.D.3d 185, 206 (1st Dept. 2012). As the First Department noted in Cronos Group , “ here is no shortage of recent decisions by this Court holding to similar effect.” 156 A.D.3d at 63 & n.8 (citing cases). Sometimes, a plaintiff alleges a duty independent of the contract but, nevertheless, has his/her complaint dismissed because the damages sought are the same as those sought by the contract claim. The reason has to do with the purpose of the damages sought. MBIA Ins. Corp. v. Credit Suisse Sec. (USA) LLC , 165 A.D.3d 108, 114 (1st Dept. 2018); Mañas v. VMS Assoc., LLC , 53 A.D.3d 451, 454 (1st Dept. 2008). Fraud damages are meant to redress a different harm than damages for breach of contract. The latter damages are meant to restore the nonbreaching party to as good a position as it would have been in had the contract been performed; the former damages are meant to indemnify losses suffered as a result of the fraud. MBIA , 165 A.D.3d at 114; Mañas , 53 A.D.3d at 454. Thus, where all the damages are remedied through the contract claim, the fraud claim is duplicative and must be dismissed. MBIA , 165 A.D.3d at 114. This is so even where the plaintiff sufficiently alleges breach of an independent duty owed them separate and apart from the contract. Id. ; see also Salamone v. EIP Global Fund LLC , 2021 N.Y. Slip Op. 02372 (1st Dept. Apr. 20, 2021) ( here ); Chowaiki & Co. Fine Art Ltd. v. Lacher , 115 A.D.3d 600, 600-601 (1st Dept. 2014) (dismissing fraud claim seeking duplicative damages even where the plaintiff sufficiently alleged a breach of duty independent of the contract). here=">here" and="and" >here.=">here."> In Salamone v. EIP Global Fund LLC , the Appellate Division, First Department recently affirmed the dismissal of a fraud claim because the damages alleged were the same of those sought by plaintiff’s breach of contract claim. Salamone concerned a loan by plaintiff Kenneth Salamone to defendants Sridhar Chityala (“Sridhar”) and EIP Global Fund, LLC (“EIP”) for $2,000,000. On October 10, 2019, Sridhar and EIP asked Salamone for an emergency loan of $5 million. Salamone offered a $2 million loan, if he got certain information and assurances. Salamone made the loan on October 11, 2019, pursuant to a thirty-day demand note (the “Demand Note”), which Sridhar signed personally and on behalf of EIP. The Demand Note provided for 10% interest, with the principal to be paid back either on November 10, 2019, or on demand. The Demand Note was not paid.  On November 11, 2019, Salamone made a written demand for repayment. Sridhar and EIP asked Salamone to forebear from taking further action, promising payment on November 21, 2019.  Over the next weeks, payment was not tendered but promises were made about the availability of funds. On November 27, 2019, Salamone, Sridhar, and EIP entered into a Forbearance and Security Agreement (the “Forbearance Agreement”) by which Sridhar and EIP agreed to pay Salamone $2,369,918.50, plus interest on or before December 17, 2019, in exchange for Salamone agreeing to forbear exercising his rights under the Demand Note. Sridhar signed the Forbearance Agreement individually and on behalf of EIP. Salamone also received a security interest in Sridhar’s interests in EIP, Vedas Group, LLC (“Vedas”), and CKL Partners, LLC (“CKL”) (the “Membership Interests”), entities that were owned and managed by Sridhar and defendant Shreyas Chityala (“Shreyas”), pursuant to a Pledge Agreement dated November 22, 2019 (the “Pledge Agreement”). Sridhar and EIP did not pay the money required by the Forbearance Agreement on December 17, 2019.  On December 18, 2019, Salamone notified Sridhar and EIP of the default and demanded payment and delivery of the Membership Interests. Neither was done. Plaintiff filed suit, asserting claims for, inter alia , breach of contract and fraudulent inducement. Pursuant to the former, plaintiff claimed that Sridhar and EIP breached the Demand Note and Forbearance Agreement by failing to repay the loan and the amount required by the Forbearance Agreement and by failing to deliver the Membership Interests, and pursuant to the latter, that Sridhar and Shreyas fraudulently induced Salamone to enter into the Demand Note and the Forbearance Agreement by making false statements about their need for the loan, the availability of funds to repay it, and their intent to do so. Defendants moved to dismiss ( here ). The motion court granted the motion with regard to the fraudulent inducement claim and the breach of contract claim only to the extent it sought damages for breach of the Forbearance Agreement. The Court denied the motion to dismiss the contract claim as it pertained to the Demand Note. With regard to the fraudulent inducement claim, the motion court found that it was “based on an undisclosed intent not to perform” and, therefore, was duplicative of plaintiff’s contract claim. On appeal, the First Department affirmed the motion court’s dismissal of the fraud claim, though for different reasons ( i.e. , modified on the law, but otherwise affirmed). Slip Op. at *1. The Court held that the fraudulent inducement claim was not based “merely on an undisclosed intention not to pay,” as the motion court found. Id. Instead, it was based “on false written statements by defendant as to the imminent receipt of funds by the corporate borrower that would allow repayment of the loan.” Id. Notwithstanding the presence of a duty collateral to, or independent of, the contracts, the Court held that “the only damages plaintiff claim beyond those under the contracts the opportunity costs of providing the funds to defendants for the loan.…” Id. Such damages, held the Court, “are not recoverable in fraud.” Id. (citing Lama Holding Co. v. Smith Barney , 88 N.Y.2d 413, 422 (1996) (noting that in fraud, “ he true measure of damage is indemnity for the actual pecuniary loss sustained as the direct result of the wrong” or what is known as the “out-of-pocket” rule”) (citation and internal quotation marks omitted)). Thus, the Court concluded, “the fraud claim, which otherwise arose from the same facts as those on which the contract claim is based, is duplicative of the contract claim.” Id. (citing Halliwell v. Gordon , 61 A.D.3d 932, 934 (2d Dept. 2009).

When a person releases another from claims or the threat of claims, he/she is giving up the right to sue the other in connection with the subject of the release. Centro Empresarial Cempresa S.A. v América Móvil, S.A.B. de C.V. , 17 N.Y.3d 269, 276 (2011) (“Generally, a valid release constitutes a complete bar to an action on a claim which is the subject of the release.”). A release effectively eliminates all claims against another that are possessed by the party giving the release. It does not matter whether the releasor knew of the claims at the time that he/she gave the release.  A release is generally ineffective as a bar against a claim that arises after the date the release is given. However, a plaintiff will not be barred from bringing a claim that falls within the scope of a release when he/she can demonstrate that the release was procured by fraud, duress or some other wrongdoing. Centro Empresarial Cempresa , 17 N.Y.3d at 276; Fleming v. Ponziani , 24 N.Y.2d 105, 111 (1969). Where a party “releases a fraud claim”, he/she “may later challenge that release as fraudulently induced only if can identify a separate fraud from the subject of the release.” Centro Empresarial Cempresa , 17 N.Y.3d at 276 (citing Bellefonte Re Ins. Co. v. Argonaut Ins. Co. , 757 F.2d 523 (2d Cir. 1985)).  The foregoing principles were highlighted in Sodhi v. IAC/Interactivecorp , 2021 N.Y. Slip Op. 31220(U) (Sup. Ct., N.Y. County Apr. 8, 2021). In Sodhi , plaintiffs, former employees of Hatch Labs, Inc. (“Hatch”), a subsidiary of defendant IAC/InterActiveCorp (“IAC” or “Defendant”), filed the action to recover money claimed to be improperly withheld from them by IAC.  Hatch was a startup incubator company that developed applications for mobile phones. Among other applications, Hatch launched Tinder, the popular mobile dating application, in 2012. At the time they were hired, plaintiffs were granted “phantom” equity units (the “Units”) in Hatch pursuant to an Equity Incentive Plan (the “Plan”), which was incorporated by reference into the letters outlining the plaintiffs’ terms of employment. The Plan provided for a one-time valuation (the “Appraisal Value”) and payout to plaintiffs, as participants in the Plan, for all vested Units on a date certain (the “Settlement Date”) in 2015. Dinesh Moorjani (“Moorjani”), a non-party to the action and the majority holder of the Units, was designated “Senior Participant” under the Plan and authorized to act as the representative of all Plan participants. In his capacity as Senior Participant, Moorjani was empowered to review the Appraisal Value provided by IAC, obtain an alternative appraisal of the value of the Units, communicate critical information to other Plan participants, and challenge IAC’s Appraisal Value before an arbitrator, if necessary. In his capacity as majority Unitholder, Moorjani also had the right to provide consent to amend, modify, change, suspend, or terminate the Plan on behalf of all participants. Conversely, all other Plan participants, including plaintiffs, were “deemed to have joined in the actions and agreements of the Senior Participant and waived any claim with respect thereto,” pursuant to the terms of the Plan. In March of 2014, Moorjani, in his capacity as Senior Participant and majority Unitholder, agreed with IAC to accelerate the Settlement Date. Pursuant to a written agreement submitted by defendant, Moorjani also agreed that the Appraisal Value for each Unit would be $166,566.42. Moorjani notified plaintiffs and other Plan participants of the acceleration on March 21, 2014. In accepting their payout, each of the plaintiffs signed a Settlement Letter agreeing to the Appraisal Value accepted by Moorjani, the number of vested Units to be settled, and the aggregate purchase price that IAC was to pay the participants as consideration for settling their vested Units. Each Settlement Letter further provided the plaintiffs a conditional right to an upward adjustment of the amount of their payout if, before October 15, 2014, a “Third Party Equity Financing” occurred in Tinder that implied a higher valuation of Tinder than the original Appraisal Value. Finally, each Settlement Letter included a broad, general release. Approximately six years after plaintiffs received their payouts for their Units, plaintiffs commenced the action against IAC, asserting causes of action to recover for breach of the Plan (first cause of action), breach of the implied covenant of good faith and fair dealing contained in the Plan (second cause of action), and fraud arising from IAC’s alleged misrepresentation of the value of the Units (third cause of action). Plaintiffs contended, inter alia , that IAC misled Moorjani as to the true value of Tinder, which was the principal asset underlying the value of the Units, withheld information from Moorjani with respect to Tinder’s value, and coerced Moorjani to accelerate the Settlement Date to March 2014. Defendant asserted that the complaint should be dismissed in its entirety in light of the contractual releases that plaintiffs signed. The Court agreed with Defendant. Plaintiffs alleged that the releases in the Settlement Letter did not cover the claims asserted in the action because the claims concerned their entitlement to a payout under the Plan, and not to their basic possessory interest in the Units. The Court rejected “ his narrow interpretation of the scope of the releases” as being “strained and unconvincing.” Slip Op. at 4. The Court found that the releases were broad and covered plaintiffs’ claim to the money alleged to be wrongfully withheld by IAC: he releases indicate[] the parties’ intention to bar “any and all” claims the plaintiffs “may now have, or hereinafter can, shall or may have” with respect to the plaintiffs’ interests in the Units. As the complaint makes clear, the plaintiffs’ interests in the Units are the basis for their participation in the Plan and the source of any claim they have to a payout at a certain time or in a certain amount.  Consequently, concluded the Court, “each of the plaintiffs’ claims in this action, including their fraud claims, derive from their interests in the Units and are covered by the expansive language of the subject releases they signed. Id. Moreover, explained the Court, the Settlement Letters “were meant to document the terms under which the plaintiffs would receive a payout as consideration for the Units.” Id. at *5. Thus, “the inclusion of releases covering only the plaintiffs’ ability to claim ownership of the Units would serve no purpose at that juncture, since the plaintiffs would no longer possess the Units after payment was made.” Id. Accordingly, the Court held that the releases in the Settlement Letter “cover all of the claims included in the complaint.” Id. Notwithstanding the foregoing, plaintiffs argued that the releases did not bar their claims because they were procured by fraud. In this regard, plaintiffs alleged that “‘IAC, either in conjunction with or utilizing Dinesh Moorjani, defrauded Plaintiffs by hiding the true value of Tinder (which was known to IAC at the time to be nearly $1 Billion) at the time of the settlement and accelerating that settlement to deprive Plaintiffs of settling their phantom equity one year later, as called for in the Plan, when Tinder’s value had swelled to approximately $3 Billion.’” Id. at 5 (quoting the record).  The Court found that plaintiffs failed to allege a fraud “separate from that which was the subject of the releases they signed, whether known or unknown to the plaintiffs at the time.” Id. at *7. In doing so, the Court rejected plaintiff’s argument that there was a lack of equal bargaining power and that they were “forced to accept the valuation and settlement date and were could not do anything about it.” Id. In any event, plaintiffs acknowledged that the Plan, which they were parties to, provided Moorjani in his capacity as Senior Participant with exclusive responsibility for negotiating with IAC and agreeing to the final Appraisal Value, and in his capacity as holder of the majority of Units the exclusive right to provide written consent to amend the Plan on behalf of all participants. The Court held that plaintiffs made “no factual, non-speculative allegations to suggest that Moorjani had any incentive to take a position adversarial to the plaintiffs in his representation of them in his dealings with IAC.” Id. “Rather,” said the Court, “all signs point to Moorjani’s interests being wholly aligned with the plaintiffs’ interests.” Id. For those reasons, the Court “decline to carve out an exception to the holding in Centro Empresarial in order to permit the plaintiffs to proceed on claims they duly released in 2014.” Id. Takeaway A “release is … a species of contract” that “is governed by the same principles of law applicable to other contracts.” Schuman v. Gallet, Dreyer & Berkey, L.L.P. , 180 Misc. 2d 485, 487 (N.Y. Co. 1999), aff’d , 280 A.D.2d 310 (1st Dept. 2001). Therefore, in the absence of duress, illegality, fraud, or mutual mistake, as in Sodhi , a release will not be set aside. Toledo v. W. Farms Neighborhood Hous. Dev. Fund Co., Inc. , 34 A.D.3d 228, 229 (1 st Dept. 2006). In Sodhi , plaintiffs broadly released all claims that they had against defendant. The release language was expansive and released “any and all claims” whether “known or unknown” against any of the released parties that plaintiffs may have had “against IAC and and their respective directors, officers and employees with respect to interest in the Units….” Such language was, as the Court noted, broad enough to cover their claims for non-payment.

It has been over 100 years since Charles Ponzi was indicted for the fraudulent scheme that bears his name. In a Ponzi scheme, the operator creates an investment program in which “profits” are paid to earlier investors with money taken from later investors. The “profits” are, therefore, fictitious instead of returns on investment. Ultimately, Ponzi schemes collapse under their own weight, taking investors, many of whom are the later ones in the scheme, down with them. Unfortunately, Ponzi schemes remain a familiar and unfortunate risk for investors. Because Ponzi schemes purport to offer high returns with little or no risk and rely on the celebrity of the individual or the credentials of a financial professional, investors are attracted to the investment products these scammers offer. Over the years, this Blog has written numerous articles about Ponzi schemes and the enforcement proceedings that resulted from them. See, e.g., here, here and here. Today, we examine an enforcement proceeding brought by the Securities and Exchange Commission (“SEC” or the “Commission) against Zachary Horwitz, a.k.a. Zach Avery, a Los Angeles-based actor known for low budget features such as “Trespassers” and “The White Crow”, and his company 1inMM (one in a million) Capital, LLC, for allegedly running a Ponzi scheme that raised over $690 million. In connection with the proceeding, the SEC obtained an asset freeze and other emergency relief. The SEC announced the proceeding on April 6, 2021 (here). According to the SEC’s complaint (here), Horwitz falsely claimed to have a track record of successfully selling movie rights to Netflix and HBO when, in fact, neither Horwitz nor 1inMM had ever sold any movie rights to, or done any business with, HBO or Netflix. Horwitz allegedly showed investors fabricated agreements and emails regarding the purported deals with HBO and Netflix. The SEC alleged that Horwitz and 1inMM promised investors returns in excess of 35%, and for many years paid supposed returns on earlier investments using funds from new investments. The complaint further alleged that Horwitz misappropriated investor funds for his personal use, including the purchase of his multi-million-dollar home, trips to Las Vegas, and to pay a celebrity interior designer. In late 2019, the scheme began to unravel, said the SEC, when Horwitz allegedly stopped making payments to investors with outstanding promissory notes and provided false explanations as to why the payments had stopped, such as that Netflix and HBO had failed to make promised payments. “We allege that Horwitz promised extremely high returns and made them seem plausible by invoking the names of two well-known entertainment companies and fabricating documents,” said Michele Wein Layne, Director of the SEC’s Los Angeles Regional Office. “We obtained an asset freeze on an emergency basis to secure for the benefit of investors what remains of the money raised by Horwitz.” The SEC charged Horwitz and 1inMM with violating the antifraud provisions of the federal securities laws. In addition to the asset freeze and other emergency relief granted by the Court, the SEC is seeking a permanent injunction, disgorgement, prejudgment interest, and civil penalties against Horwitz and 1inMM. The Court set a hearing for April 19, 2021, to determine if the asset freeze should remain in force for the duration of the litigation. On the same day that the SEC announced its enforcement proceeding, the Department of Justice (“DOJ”) announced (here) that it brought criminal charges against Horwitz. The DOJ alleges that Horwitz is “in default to investors on a total outstanding principal of approximately $227 million.” The criminal complaint that the DOJ filed against Horwitz charges him with wire fraud.

Generally, matters that are not covered by an agreement to arbitrate do not have to be arbitrated. After all, arbitration is a creature of contract. And, because an agreement to arbitrate is governed by the rules of contract interpretation, the courts must “give effect to the contractual rights and expectations of the parties.” Volt Info. Scis., Inc. v. Board of Trustees of Leland Stanford Junior Univ. , 489 U.S. 468, 479 (1989). In other words, “as with any other contract, the parties’ intentions control.” Mitsubishi Motors Corp. v. Soler Chrysler-Plymouth, Inc. , 473 U.S. 614, 626 (1985).  Where there is a valid agreement to arbitrate, all matters that fall within the scope of that agreement are to be arbitrated. See Silverman v. Benmor Coats , 61 N.Y.2d 299, 309 (1984) (courts will not stay arbitration unless the “sole matter sought to be submitted to arbitration is clearly beyond the arbitrator’s power”). Matters that do not fall within the scope of the agreement will not be arbitrated, unless they are “inextricably interwoven” with the arbitrable ones, in which case “the proper course is to stay judicial proceedings pending completion of the arbitration, particularly where … the determination of issues in arbitration may well dispose of nonarbitrable matters.” Cohen v. Ark Asset Holdings , 268 A.D.2d 285, 286 (1st Dept. 2000); see also Lake Harbor Advisors, LLC v. Settlement Servs. Arbitration and Mediation, Inc. , 175 A.D.3d 479 (2d Dept. 2019); Monotube Pile Corp. v Pile Foundation Constr. Corp. , 269 A.D.2d 531 (2d Dept. 2000). The foregoing principles were recently applied by the Appellate Division, First Department in Protostorm, Inc. v. Foley & Lardner LLP , 2021 N.Y. Slip Op. 02227 (Apr. 8, 2021) ( here ), a legal malpractice action, in which the motion court stayed the action in favor of the arbitration of the law firm’s unpaid legal fees. As discussed, the Court reversed the stay of an arbitration on the grounds that the non-arbitrable matters were inextricably interwoven with the arbitrable ones. In Protostorm , plaintiff retained defendant to maintain a malpractice action against plaintiff’s prior counsel. Thereafter, plaintiff commenced a malpractice action against defendants and other attorneys in the United States District Court for the Eastern District of New York.  Defendants moved to dismiss the federal action based on the lack of subject matter jurisdiction. They also commenced an arbitration proceeding against plaintiff for unpaid legal fees based on the parties’ retainer agreement, which provided that “ ny dispute over fees and/or costs … be submitted to and settled exclusively by binding arbitration.”  The federal action was ultimately dismissed for lack of subject matter jurisdiction. As a result, the court did not rule on whether the arbitration should be stayed.  Plaintiff then commenced an action in New York Supreme Court, alleging the same claim of legal malpractice and moved to stay the arbitration pending resolution of the action. Defendants cross moved to stay the action and compel arbitration. The motion court granted plaintiff’s motion for a stay of arbitration and denied defendants’ cross motion to stay the action in favor of arbitration. The First Department unanimously reversed. The Court held that since there was a valid agreement between the parties to arbitrate any dispute regarding unpaid fees, it had to “compel arbitration of defendants’ claim for unpaid fees ….” Slip Op. at *1 (citing CPLR 7503(a)). And “because plaintiff’s nonarbitrable malpractice claim inextricably intertwined with the arbitrable claim for unpaid fees,” the Court held that “the proper course to stay the action pending completion of the arbitration.” Id. (citations omitted). Such a result, observed the Court, was consistent with decisional authority in the First and Second Departments, where the courts have held that “a nonarbitrable issue can be decided in an arbitration when it is inextricably intertwined with an arbitrable issue, particularly where … the determination of the arbitrable … claim may dispose of the nonarbitrable … claim.” Id. (citations omitted). In holding that the arbitrable and non-arbitrable matters should be arbitrated, the Court distinguished the facts in Protostorm with those in Laboratories Inc. v. Avon Prods. Inc. , 297 A.D.2d 505 (1st Dept. 2002), a case upon which plaintiff relied. There, the court stayed the arbitration pending resolution of the action because the parties’ agreements expressly provided that all disputes regarding the enforcement of the parties’ obligations would be decided in New York courts with the exception of one narrow category of disputes regarding royalties payable, which would be arbitrated. Id. (citing 297 A.D.2d at 506). Additionally, in Primavera , the court stayed the arbitration because numerous preliminary issues needed to be resolved in the action before the arbitration procedure could be invoked. Id. (citing id. ). Takeaway A court will not order a party to submit to arbitration absent evidence of that party’s unequivocal intent to arbitrate the dispute, and unless the dispute falls clearly within the class of claims the parties agreed to arbitrate. Since arbitration is a creature of contract, arbitration clauses must be enforced according to their terms, even if the result is bifurcated litigation. Notwithstanding, where arbitrable and non-arbitrable claims are inextricably interwoven, courts will stay the judicial proceeding pending completion of the arbitration, especially where the determination of issues in arbitration could dispose of non-arbitrable matters. That was the case in Protostorm , where the Court found that “the determination of the arbitrable unpaid fees claim dispose of the nonarbitrable malpractice claim.” Slip Op. at *2.  Thus, by arbitrating both the fee issue and the malpractice issue, the interests of judicial economy could be served and the risk of inconsistent results avoided.

Promissory notes and mortgages, like many other contracts, frequently contain provisions requiring a non-breaching party to provide the breaching party with notice of their default as a condition precedent to taking any action to enforce rights as a result of the breach.  Such action can include, but is not limited to, commencing legal action and/or accelerating the unpaid balance due under the note.  Similarly, default notice provisions may require that, in certain circumstances, the breaching party be afforded an opportunity to cure the default.  These provisions typically provide for the precise manner in which, and the address to which, the notices must be sent. Suffice it to say, notice provisions are material aspects of many contracts.  As a result, courts strictly enforce such notice provisions.  Accordingly, the failure to adhere to the provision’s requirements, and/or the failure to prove that you have adhered to the provision’s requirements, could have serious consequences. Such was the case in Deutsche Bank Nat. Trust Co. v. Bucicchia , a case decided by the Appellate Division, Second Department, on April 7, 2021.  The borrower wife in Bucicchia defaulted in her repayment obligations under a promissory note secured by a mortgage on real property owned by her and her husband.  Sections 22 and 15 of the mortgage “require service of a specified default notice as a condition precedent to the acceleration of the mortgage loan” (citation omitted) and “ ursuant to Section 15, the notice of default must be ‘mailed by first class mail or … actually delivered to notice address if sent by other means” (some brackets and ellipses in original).  As is typically the case, the mortgage in Bucicchia also provided “the notice address is the address of the mortgaged property unless the plaintiff is notified of another address by the borrower.” Lender commenced a mortgage foreclosure action.  Defendants, in their answer, asserted various affirmative defenses including, but not limited to, the failure to comply with the default notice provisions in the mortgage and failure to comply with the statutory notice provisions of RPAPL 1304.  This BLOG has written extensively on RPAPL 1304 < HERE =">HERE"> , < HERE =">HERE"> , < HERE =">HERE"> , < HERE =">HERE"> , < HERE =">HERE"> , < HERE =">HERE"> , and, accordingly, such issues will not be addressed in today’s article. Lender moved for summary judgment on the complaint and to dismiss defendants’ affirmative defenses and defendants cross-moved for summary dismissing the complaint.  Supreme court granted lender’s motion and dismissed defendants’ affirmative defenses except for the two defenses related to notice under the mortgage and under RPAPL 1304 and, as to those, the court scheduled a non-jury trial.  Defendants’ cross-motion was denied. After the trial, the court, inter alia , ruled in lender’s favor and struck defendants’ answer.  A referee was subsequently appointed to compute the amounts due to lender.  The referee’s report was confirmed and a judgment of foreclosure and sale was entered.   On defendants’ appeal, the Second Department, inter alia , reversed the judgment of foreclosure and sale, reinstated the affirmative defenses related to improper notice under the mortgage and RPAPL 1304, denied lender’s motion to the extent that it sought to confirm the referee’s report of sale and dismissed the complaint as against defendants.  The Court found that lender “failed to establish it complied with the notice requirements of the mortgage agreement.”  The Court explained: At the nonjury trial, the plaintiff relied upon the testimony of its sole witness, who testified as to the standard office mailing procedure of the plaintiffs prior and present loan servicer, but did not and could not attest to the practices and procedures of Walz Group, a third-party entity that was hired to undertake the requisite service of the notices on the defendants in accordance with the requirements of the mortgage agreement …. The plaintiffs witness expressly testified that she did not have familiarity with Walz Group's mailing practices "outside of their communications with" the loan servicer. In addition, the witness attested that she never mailed anything through Walz Group, was never employed by Walz Group, and was never trained by Walz Group in their procedures for mailing notices. Further, she testified that she could not say if Walz Group mailed the notices by first-class mail.  Thus, since the plaintiffs sole witness did not have "knowledge of the mailing practices of the entity which sent the notice[ s ]" (Deutsche Bank Natl. Trust Co. v Nelson, 183 AD3d 557, 558; see HSBC Bank USA, NA. v Sawh, 177 AD3d 959, 961), and the business records that were submitted in evidence failed to show that … the notices of default were actually made to the defendants or that the default notices were actually delivered to their "notice address," the plaintiff failed to establish … that the notices of default were sent in accordance with the terms of the mortgage agreement (see US Bank NA v Cope, 175 AD3d <527> at 530; LNV Corp. v Sofer, 171 AD3d <1033> at 1037).  Similarly, the Court in Deutsche Bank Nat. Trust Co. v. Crimi , 184 A.D.3d 707 (2 nd Dep’t 2020), addressing this issue, stated that “the attorney’s affirmation submitted by the plaintiff which stated that the purported 2010 notice was ‘in full compliance with the terms of the mortgage’ was unsubstantiated and conclusory either the attorney’s affirmation nor the copy of the purported 2010 notice established ‘that the required notice was mailed by first class mail or actually delivered to the notice address if sent by other means, as required by the mortgage agreement.’”  See also, U.S. Bank Nat. Assoc. v. Sabloff , 153 A.D.3d 879, 881 (2 nd Dep’t 2017). TAKEAWAY Care should be taken to follow the default notice provisions in promissory notes and mortgages (as well as other notice provisions).  Similarly, evidence of compliance should be maintained and presented to the court to demonstrate such compliance.

Under well-settled principles, summary judgment in lieu of complaint is available for an instrument for the payment of money only. In considering such a motion, the courts will look at the four corners of the instrument sued upon in determining whether the instrument qualifies as one for the payment of money only. here.=">here."> In Yang v. Dai , 2021 N.Y. Slip Op. 02125 (1st Dept. April 6, 2021) ( here ), the Appellate Division, First Department applied the foregoing principles in affirming the grant of summary judgment in lieu of a complaint on a note that was part of various business dealings between defendant and plaintiff’s spouse (a non-party). On December 28, 2018, plaintiff Jinmei Yang, as lender, and defendant Shang Dai, as borrower, executed an Amended and Restated Secured Promissory Note (the “Note”) in the sum of $1,150,000.00. The Note was guaranteed by defendant Da Wei Gongsun pursuant to a Continuing Guaranty (the “Guaranty”) executed on the same date as the Note.  Defendants defaulted on the payments, causing plaintiff to file the motion for summary judgment in lieu of a complaint. In support of the motion, plaintiff submitted an affidavit confirming that she wired $1,150,000.00 to defendant Dai, authenticating the loan documents on which she relied, confirming defendants’ default in payment on the Note, and providing the calculations supporting the amount due ($1,123,809.42). The motion court held that the affidavit and supporting documents sufficed to state a prima facie case. ( Here .) In opposition, defendant asserted that the Note was inextricably intertwined with various business dealings he had with plaintiff’s husband, nonparty Xiajie Huang, related to, among other things, a joint venture to invest in DaDong Restaurant (the “Restaurant”) via the formation of DaDong LLC. Defendant claimed that Huang offered to lend him the money represented by the Note to facilitate that investment.  The lender under the Note was plaintiff because Huang conducted business in the United States through his wife’s bank account. Defendant insisted that the terms of the original Note and all amendments were between him and Huang and that plaintiff was involved in name only. Defendant also claimed that he was fraudulently induced by Huang’s misrepresentations to borrow the money, believing the Restaurant would generate profits defendant could use to repay the loan. The venture ultimately failed, and defendant lost his entire investment. Defendant Da Wei Gongsun, the guarantor on the Note, also asserted that he was fraudulently induced to sign the Guaranty by Huang’s misrepresentations about the potential success of the Restaurant.  The motion court granted plaintiff’s motion. The motion court found that defendant “unconditionally promise ” to pay $1,150,000.00 to plaintiff pursuant to the terms of the Note. “Nowhere in the seven-page Note,” observed the motion court, was “there any reference to the Restaurant, to Huang, or to any business venture with Huang or anyone else.” “Nothing in the Note,” continued the motion court, “indicate that the Note inextricably intertwined with any related or unrelated business transaction.”  The motion court noted that, although the Note referenced an amended and restated pledge and security agreement, which the parties executed on the same day as the Note, it did “not change the fact that the Note an instrument for the payment of money only not dependent upon, or inextricably intertwined with, the success or failure of the Restaurant.” The referenced Amended and Restated Pledge and Security Agreement executed on the same date as the Note is between defendant Shang Dai as Pledgor, Dai’s company True Taste as Issuer, and plaintiff Jinmei Yang as the Secured Party. There, defendant pledged “100% of the membership interest of the Issuer , which was the managing member and the legal and beneficial owner of 10 Units or 10% of the issued and outstanding membership interests of Dadong Management LLC, a Delaware limited liability company (the “Company”), to the Secured Party ...” But the fact that defendant collateralized the Note with his or his company’s membership interest in the Restaurant’s operating company, or that he invested the loan money in the Restaurant company with the mistaken belief the Restaurant would succeed, does not change the fact that the Note is an instrument for the payment of money only not dependent upon, or inextricably intertwined with, the success or failure of the Restaurant.  The motion court also rejected defendant’s fraud in the inducement allegations, holding that they were “insufficient to negate the comprehensively detailed and carefully drafted multi-page Note for the payment of money only.” Accordingly, the motion court granted plaintiff’s motion and directed the entry of judgment in favor of plaintiff against defendants for the amount of the loan, plus interest, and attorney’s fees as provided in the Note. On appeal, the First Department affirmed. The Court held, like the motion court, that the Note was an unconditional promise to pay money, which defendant failed to pay: “The December 28, 2018 amended and restated note stated that defendant Shang Dai ‘unconditionally’ promised to pay plaintiff Jinmei Yang by the maturity date in exchange for the loan of $1,150,000 and it is undisputed that defendant Dai defaulted.” Slip Op. at *1. The Court also rejected defendant’s argument that the Note was intertwined with the joint venture, noting that “ t most, the promissory note ‘ part of an investment transaction between sophisticated, counseled parties dealing at arms-length and that the language of the notes [ ] obligated the defendant in his personal capacity.’” Id. (quoting Berlind v. Heinfling , 176 A.D.2d 452, 452 (1st Dept. 1991)). Further, the Court rejected defendant’s argument that because the Note was secured by defendant’s membership interest in a business that he owned, the Note was not an instrument for the payment of money only: That the note was secured by a membership interest in a business owned by defendant does not “alter its essential character as an instrument for the payment of money only and, accordingly, is immaterial to plaintiff’s right to relief pursuant to CPLR 3213.”  Id. (quoting Bhatara v. Futterman , 122 A.D.3d 509, 510 (1st Dept. 2014)). Finally, the Court noted that the profitability of the investment was no defense to a motion for summary judgment under CPLR § 3213: “the fact that the investment was not profitable did not constitute a defense to the note.…” Id. Takeaway As shown above, plaintiff sustained her initial burden of demonstrating entitlement to judgment as a matter of law by submitting proof of the existence of the underlying note and guaranty, the unconditional terms of repayment, and defendants’ failure to make payment. It was incumbent upon defendants to demonstrate by admissible evidence, the existence of a triable issue of fact with respect to a bona fide defense. The courts considering the facts and evidence found that they did not do so.