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< editor's note: this article has been edited. > editor's note: this article has been edited.> As discussed in previous Blog posts ( here and here ), business owners and entrepreneurs wishing to insulate themselves from personal liability for the acts taken in the name of their business can generally do so by forming a corporation ( e.g. , C-Corp. or an S-Corp.) or limited liability company (“LLC”). Such protection, however, is not absolute; there are exceptions to the rule. For instance, a creditor or other third party can “pierce the corporate veil” – i.e. , go behind the corporate form – to hold an officer, director, or shareholder liable when he/she fails to follow corporate formalities, comingles corporate funds with personal funds, or perpetrates a fraud or other wrongdoing on a third party. TNS Holdings v. MKI Sec. Corp. , 92 N.Y.2d 335, 340 (1998) (the corporate veil may be pierced to impose liability for corporate wrongs upon persons who have “misused the corporate form for personal ends.”); Matter of Morris v. New York State Dept. of Taxation & Fin. , 82 N.Y.2d 135, 142 (1993) (the corporate veil may be pierced where the owners have “abused the privilege of doing business in the corporate form” by “perpetrat a wrong or injustice . . . such that a court in equity will intervene.”). Additionally, an officer, director, member or shareholder can be sued individually when the corporation is accused of committing a tort in which the individual personally participated. Hamlet at Willow Cr. Dev. Co., LLC v. Northeast Land Dev. Corp. , 64 A.D.3d 85, 116 (2d Dept. 2009) (“A corporate officer may be liable for torts committed by or for the benefit of the corporation if the officer participated in their commission.”). Notably, tort liability applies regardless of whether the third party can pierce the corporate veil. A tort is generally defined as an act or omission that gives rise to injury ( i.e. , the invasion of any legal right) or harm ( i.e. , a loss that an individual suffers) to another for which the courts will impose liability. There are three general categories of torts: intentional; negligent; and strict liability. Intentional torts are wrongs that the defendant knew or should have known would result through his/her actions or omissions (such as fraud). Negligent torts occur when the defendant’s actions were taken without reasonable care. Strict liability torts focus on whether a particular result or harm manifested from the actions taken by the defendant. In the business context, there are numerous types of torts, including, but not limited to, fraudulent misrepresentation, misappropriation, conversion, interference with contractual or business relations, breach of fiduciary duty, negligence, and defamation. In Starr Indemnity & Liability Co. v. Global Warranty Group, LLC , 2018 NY Slip Op. 07346 (2d Dept. Oct. 31, 2018) ( here ), the Appellate Division, Second Department, recently addressed the foregoing principles, in affirming the denial of a motion to dismiss a conversion claim against corporate officers who participated in the alleged conversion of assets. Starr involved an alleged diversion of funds belonging to the plaintiff, Starr Indemnity & Liability Company and two related corporations (collectively, “Starr” or “Plaintiff”), by the defendants (five related corporate entities and four individuals who were officers of those corporate entities). As set forth in the decision appealed from, Starr and Global Warranty Group, LLC and related entities (“GWG”) entered into an administrative services agreement (“ASA”) in June 2012, pursuant to which GWG agreed to be the service provider for Starr’s cellular-telephone service plans. Among other things, GWG served as third-party administrators of extended-service contracts and insurance policies covering mechanical breakdown, accidental damage, loss and theft of various appliances and portable electronics (principally cell phones) insured by Starr. Under the ASA, Starr bore the sole financial risk and reward of the plans. GWG’s role was limited to interfacing with the dealers who sold the service contracts and insurance plans, collecting the premiums, depositing them into an account maintained for Starr’s benefit, remitting them to Starr, and processing and paying the claims. The ASA required GWG to account for and be liable to Starr for all premiums owed to Starr and to act as a fiduciary for Starr. The ASA provided that all premiums collected by GWG were Starr’s exclusive property and were to be deposited into a premium account maintained by GWG as a fiduciary for Starr’s sole benefit. The ASA also provided that all funds intended for claim disbursement were Starr’s exclusive property and were to be deposited in a claims-disbursement account maintained by GWG as a fiduciary for the sole purpose of paying claims. At the end of May 2014, GWG allegedly owed Starr premiums in the amount of approximately $841,000, but belatedly paid Starr only $356,000. GMG allegedly failed to make the premium payment that was due at the end of June 2014 (approximately $650,000), purportedly explaining that it was due to late payments by GWG’s dealers. In July 2014, GWG allegedly revealed that it was facing financial difficulties. On July 25, 2014, there was an alleged shortfall of more than $1.6 million in the claims-disbursement account. A subsequent audit by Starr revealed that the shortfall exceeded $7 million as of August 1, 2014. Starr commenced the action shortly thereafter, alleging 20 causes of action, 16 of which were asserted against the individual defendants. The claims fell into four basic categories: conversion, fraud, breach of fiduciary duty and tortious interference. Defendants moved to dismiss, which the motion court granted in part and denied in part. Two fo the individual defendants appealed, arguing, among other things, and relevant to this post, that they could not be held personally liable for the alleged conversion. The Second Department affirmed, finding that Starr stated a claim of conversion against the individual defendants. In doing so, the Court reiterated the legal principle discussed above, namely: “A corporate officer, although acting for the benefit of a corporation, may be held liable for conversion, if he or she participated in the commission of the tort.” Takeaway Although Starr is pithy in its discussion of personal liability of a corporate officer, it nevertheless illustrates the importance of understanding the various bases upon which a plaintiff may seek to hold a corporate officer personally liable for an alleged wrong. In Starr , the alleged wrong was the tort of conversion. But, as noted in the legal analysis preceding the discussion of Starr , there are numerous torts that can be asserted against a corporate officer, director, member or shareholder. Thus, Starr confirms the legal principle that insulation from liability using the corporate form is not absolute.

Practitioners and their clients involved in bond offerings or other credit instruments are no strangers to trust indentures. These agreements typically contain a no-action clause, the primary purpose of which is to deter minority securityholders from filing duplicative, economically inefficient, or otherwise meritless lawsuits against the issuer, servicer, or other third party at the expense of the majority’s interest. No-action clauses generally achieve these purposes by funneling securityholder actions through a trustee, who is given the sole authority to initiate and prosecute lawsuits to enforce the rights of securityholders, but only when a specified number of holders agree that such action is appropriate. The trustee’s power to act for bondholders is typically triggered by a majority vote and situations in which all bondholders will benefit from such action. Delaware courts have generally construed no-action clauses broadly.  E.g. , Feldbaum v. McCrory Corp. , 1992 WL 119095 (Del. Ch. June 1, 1992); Lange v. Citibank, N.A. , 2002 WL 2005728, *1 (Del. Ch. Aug. 13, 2002). In Feldbaum and Lange , the Court of Chancery construed the no-action clauses, which barred securityholders from pursuing remedies under “this Indenture or the Securities,” to cover both contractual claims related to the indenture agreements and any claims that individuals might possess as securityholders. In Quadrant Structured Products v. Vertin , 23 N.Y.3d 549 (2014), the New York Court of Appeals, answering a certified question from the Delaware Supreme Court, held that a no-action clause that bars claims brought “upon or under or with respect to” an indenture will not bar all claims by investors against other parties to the indenture. In Quadrant , a minority holder of notes asserted various claims, directly and derivatively, against the issuer of the notes, the issuer’s officers and directors, the issuer’s parent corporation, and an affiliated entity for, inter alia , alleged breaches of fiduciary duty and fraudulent transfers. The claims arose from, among other things, the issuer’s exposure to credit default swap obligations incurred during the 2008 financial crisis. The defendants moved to dismiss the complaint, arguing that the plaintiff’s claims were barred by a no-action clause in the governing indenture, which “permitted only Trustee-initiated suits upon request of a majority of securityholders, and prohibited individual securityholder actions.” 23 N.Y.3d at 557. The Delaware Court of Chancery dismissed the complaint. Following a number of appeals concerning the application of New York law, which governed under the indenture, the Delaware Supreme Court certified the following question to the New York Court of Appeals: A trust indenture no-action clause expressly precludes a security holder who fails to comply with that clause’s preconditions, from initiating any action or proceeding upon or under or with respect to “this Indenture” but makes no reference to actions or proceedings pertaining to “the Securities.” The question is whether, under New York law, the absence of any reference in the no-action clause to “the Securities” precludes enforcement only of contractual claims arising under the Indenture, or whether the clause also precludes enforcement of all common law and statutory claims that security holders as a group may have. In answering the question, the Court of Appeals held that under New York law, a no-action clause that covers any action alleging claims “upon or under or with respect to” the indenture will bar contract claims based on the indenture only but will not bar investors’ other common law or statutory claims. As these cases illustrate, a no-action clause, like the Athilon clause, that refers only to actions under the indenture, is limited by its language to indenture-based contract claims. However, a no-action clause similar to the clauses in Feldbaum and Lange , that refers specifically to claims and remedies arising under the indenture and the securities, applies to all claims, except those excluded from coverage as a matter of law. Here, the Athilon no-action clause when strictly construed and afforded its plain meaning, makes no reference to the securities, and therefore does not apply to claims arising outside the scope of the indenture. Accordingly, we agree with the Delaware Chancery Court’s Report on Remand that Feldbaum and Lange are distinguishable, and the Athilon no-action clause applies only to contract claims under the indenture, not to Quadrant's common-law and statutory claims. Quadrant , 23 N.Y.3d at 564. In reaching its decision, the Court found that the indenture was clear and unambiguous and interpreted the indenture in accordance with its plain meaning. Id . at 564 (“As we have discussed, the no-action clause is clear on its face and applies to indenture contract claims only.”). It further observed that a no-action clause must be “construed strictly” and “read narrowly.” Id . at 560 (“we read a no-action clause to give effect to the precise words and language used, for the clause must be ‘strictly construed’” and “ pplying these well<-> established principles of contract interpretation, and with the understanding that no-action clauses are to be construed strictly and thus read narrowly….”). With these principles of contract interpretation in mind, the Court found that the specific reference in the no-action clause to the indenture and the omission of an express reference to the securities barred the initiation of indenture-related contract claims only, not common law and statutory claims relating to the underlying securities. Last month, the Appellate Division, First Department, addressed the question whether the plaintiffs’ claimed failure to comply with a no-action clause in an indenture precluded them from asserting their breach of contract claims. In Blackrock Balanced Capital Portfolio (FI) v. U.S. Bank N.A. , 2018 N.Y. Slip Op. 06990 (1st Dept. Oct. 18, 2018) ( here ), the Court, applying Quadrant , held that the plaintiffs’ failure to comply with the no-action clauses was excused because it would have been futile to demand the trustee commence an action against itself for breaches of the governing Pooling and Service Agreements (“PSA”). Blackrock involved breach of contract allegations by holders of certificates issued by residential mortgage-backed securities trusts of which U.S. Bank is the trustee. The complaint alleged that the trustee breached its obligations under the PSAs by failing to provide notices to cure to servicers once it gained knowledge of certain servicing breaches and by failing to make prudent decisions concerning the events of default. The Court rejected the defendant’s argument that all of the plaintiffs’ breach of contract claims had to be dismissed because the plaintiffs failed to allege compliance with the requirements of the no-action clauses in each of the PSAs. The Court found that “ ompliance with the clauses was excused because it would be futile to demand that the trustee commence an action against itself for breaches of the PSA.” Quadrant , 23 N.Y.3d at 566; see also Cruden v. Bank of New York , 957 F.2d 961, 968 (2d Cir. 1992) (no-action clause will not bar security holder suit against Trustee because “it would be absurd to require the debenture holders to ask the Trustee to sue itself”). “Once performance of the demand requirement in the no-action clause is excused,” noted the Court, “performance of the entire provision is excused, including the requirement that demand be made by 25% of the certificate holders. Thus, under well-established rules for contract interpretation ( Quadrant , 23 N.Y.3d at 560), the Court concluded that there was “no basis for requiring that the suit be supported by 25% of certificate holders.” BlackRock Core Bond Portfolio v. US Bank Natl. Assn. , 165 F. Supp. 3d 80, 97-99 (S.D.N.Y. 2016). Takeaway A no-action clause typically channels the right to initiate lawsuits to the indenture trustee and conditions the commencement of any litigation upon the demand of the majority or some other threshold of securityholders. In New York, such clauses are “construed strictly” and applied “narrowly.” For this reason, the language used in a no-action clause to define the scope of the limitation is critical. In Quadrant , the language used made the difference between allowing or barring securityholders the right to commence their own lawsuit. As the Quadrant court noted, trust indentures and no-action clauses contained therein, like all contracts, will be interpreted using the traditional rules of contract interpretation. Thus, a no-action clause that refers specifically to claims and remedies arising under the indenture and the securities issued pursuant thereto, applies to all claims and bars the securityholders from initiating their own litigation. However, where the no-action clause makes no reference to the securities being issued, it does not bar claims that arise outside the scope of the indenture. As Quadrant makes clear, the importance of contract interpretation in the no-action clause/trust indenture context cannot be emphasized enough. Quadrant , 23 N.Y.3d at 560, 564 (courts interpreting no-action clauses should “give effect to the precise words and language used”). Indeed, it was the underpinning of the Blackrock court’s decision. Under the no-action provision of the PSAs, the trustee was the demand party for claims against the issuer or third parties. Compliance with the demand requirement was, therefore, excused because the securityholders were asking the trustee to sue itself, not the issuer or other third parties.

Arbitration is an alternative form of dispute resolution where the parties voluntarily agree that a neutral, private person will resolve any legal disputes between them, instead of a judge or jury in a court of law. In recent years, arbitration has increased in popularity and is part of most business and commercial contracts and employment agreements. This increase in popularity reflects the state (and federal) policy that arbitration is a favored means of resolving disputes. See , e.g. , CPLR § 7501 (“A written agreement to submit any controversy . . . to arbitration is enforceable without regard to the justiciable character of the controversy and confers jurisdiction on the courts of the state to enforce it and to enter judgment on an award.”); Harris v. Shearson Hayden Stone, Inc. , 82 A.D. 2d 87, 91-93 (1st Dep’t), aff’d , 56 N.Y.2d 627 (1981) (“ his State favors and encourages arbitration as a means of conserving the time and resources of the courts and the contracting parties. . . .”). Although favored, this method of dispute resolution is not always preferred.  Sometimes, a party to an arbitration agreement will resist resolving his/her disputes outside of the courthouse. When that happens, the non-resisting party can seek to compel arbitration. The question, though, is at what point should the motion to compel arbitration be made? In New York, CPLR § 7503(a) provides the framework from which the courts attempt to answer the question. Under CPLR § 7503(a), a motion to compel may be made by “ party aggrieved by the failure of another to arbitrate ....” The same is true under the Federal Arbitration Act (“FAA”). See 9 U.S.C. § 4 (“a party aggrieved by the alleged failure, neglect, or refusal of another to arbitrate under a written agreement for arbitration may petition ... for an order” compelling arbitration). Under both New York law and the FAA, a party is aggrieved when the non-aggrieved party (a) commences litigation in lieu of arbitration, or (b) refuses to comply with an order of a relevant arbitral authority to arbitrate the dispute. See Jacobs v. USA Track & Field , 374 F.3d 85, 89 (2d Cir. 2004) (holding that the petitioner was not an aggrieved party where the respondents had neither commenced litigation nor failed to comply with an order to arbitrate by the arbitral authority). See also Koob v. IDS Fin’l Servs., Inc. , 213 A.D.2d 26, 30-31 (1st Dept. 1995) (holding that “a party to an arbitration agreement is not aggrieved until litigation of an issue within the operation of the arbitration provision is attempted”); SH Tankers Ltd. v. Koch Shipping Inc. , 2012 WL 2357314, at *3 (S.D.N.Y. 2012) (noting that “unless the respondent has resisted arbitration, the petitioner has not been ‘aggrieved’ by anything, and there is nothing for the court to compel”)  (internal quotations and citations omitted); LAIF X SPRL v. Axtel, SA. de CV , 390 F.3d 194, 198 (2d Cir. 2004) (stating that a party is aggrieved if the other party “commences litigation or is ordered to arbitrate the dispute by the relevant arbitral authority and fails to do so”) (internal quotations omitted). Last month, Justice Barry R. Ostrager of the Supreme Court, New York County, Commercial Division, applied the foregoing principles in KPMG LLP v. Kirschner , 2018 N.Y. Slip Op. 32661(U) (Oct. 16, 2018) ( here ), in which he found that KPMG lacked standing compel arbitration because it was not an aggrieved party within the meaning of CPLR § 7503(a). KPMG arose from an attempt by KPMG to arbitrate its dispute with the trustee of two bankrupt entities, Millennium Lab Holdings, Inc. and Millennium Lab Holdings II, LLC (together, “Millennium”), privately held laboratory services companies based in California. KPMG provided audit services to Millennium in connection with government investigations into the companies’ sales and marketing practices and related litigation. The engagement letter between KPMG and Millennium contained an arbitration provision. In 2015, Millennium filed for bankruptcy. The bankruptcy court confirmed a reorganization plan that, inter alia , created two separate litigation trusts to handle pre-bankruptcy claims of Millennium itself and pre-bankruptcy claims of certain lenders. Respondent, Marc Kirschner (the “Kirschner” or “Trustee”), was appointed trustee of the two trusts. The Trustee sought discovery from KPMG regarding Millennium’s pre-bankruptcy claims against KPMG. The parties started negotiating a potential settlement and allegedly entered into statute of limitations tolling agreements so that the parties could achieve pre-litigation resolution of the dispute. On August 3, 2018, KPMG commenced a special proceeding pursuant to CPLR § 7503(a) to compel Kirschner to submit to arbitration all claims arising out of KPMG’s provision of auditing services to Millennium. Three days later, on August 6, 2018, the Trustee filed an action against KPMG in California Superior Court (the “California Action”). The Trustee moved to dismiss the petition for lack of subject matter jurisdiction, lack of standing, and failure to state a cause of action. The Trustee argued that KPMG lacked standing at the time it filed the petition because KPMG was not “aggrieved” as required by the CPLR and the FAA. The Trustee further argued that because the California Action was subsequently commenced after the filing of the New York special proceeding, KPMG’s only recourse to compel arbitration was to make such a motion in the California Action. In opposition, KPMG argued that litigation is not a necessary precondition to a party being “aggrieved” by a failure or refusal to arbitrate under New York law and the FAA. Further, KPMG argued that even if it was not an aggrieved party when it filed the petition, it became an aggrieved party once the California Action was initiated in violation of the agreement to arbitrate. The Court’s Decision Noting that the “relatively narrow issue before this Court” was “whether KPMG had standing to commence special proceeding pursuant to CPLR § 7503(a),” the Court held that KPMG did not possess such standing. After discussing the meaning of “aggrieved” under CPLR § 7503(a), the Court found that “(1) the Trustee had not commenced litigation at the time KPMG’s petition was filed, and (2) no order had been issued by an arbitral authority.” Thus, KPMG was not aggrieved within the meaning of the CPLR or the FAA. The Court also held that the pendency of the California Action did not make KPMG an aggrieved party. In that regard, the Court held that the dispositive point in time to consider whether KPMG was “aggrieved” under the CPLR and FAA was the date on which the New York special proceeding was commenced. KPMG filed this petition before the Trustee commenced the California Action, and thus, the Court does not have jurisdiction to adjudicate such a petition from a non-aggrieved party even though the California Action has since been commenced. See Grupo Dataflux v. Atlas Global Group, L.P. , 541 U.S. 567, 570 (2004) (“It has long been the case that the jurisdiction of the court depends upon the state of things at the time of the action brought.”). Further, courts “have adhered to the time-of-filing rule regardless of the costs it imposes.” Id . at 571. Thus, the petition in this special proceeding must be dismissed for lack of subject matter jurisdiction and lack of standing. Finally, the Court addressed the question whether the petition should be dismissed with prejudice on the grounds that CPLR § 7503(a) required the motion to compel be made in the California Action. The Court determined that CPLR § 7503(a) did “not dictate such a result.” In addition to the language quoted above, CPLR § 7503(a) provides, in pertinent part, that: “If an issue claimed to be arbitrable is involved in an action pending in a court having jurisdiction to hear a motion to compel arbitration, the application shall be made by motion in that action.” The Court explained that the while “judicial efficiency would be achieved by KPMG filing its motion to compel in the California Action,” courts in New York have “enjoined litigation in other states pending New York actions under CPLR 7503.” Indeed, noted the Court, “ or over half a century, New York courts have enjoined parties from litigating a foreign action in contravention of an agreement to arbitrate in New York.” Thus, “an aggrieved party may seek to compel arbitration and enjoin pending proceedings in other states under CPLR § 7503(a).”  For this reason, the Court granted “the Trustee’s motion to dismiss” but did so “without prejudice to KPMG renewing its petition with proper standing.” Takeaway It has become commonplace for corporations and small businesses to incorporate arbitration provisions into their agreements with customers and employees. While these clauses often seem to be merely procedural, they are not.  They prevent consumers and employees from having their day in court before a judge or a jury. Over the past few decades, the courts have endorsed the use of arbitration as an alternative to litigation, reduced the ability of individuals to avoid arbitrating their disputes, and narrowed the possibility of obtaining judicial review. They have adopted pro-arbitration doctrines such that arbitration agreements are almost always upheld when challenged, even when individuals can show that an arbitration clause was buried in fine print or incorporated by reference to an obscure and inaccessible source. KPMG shows that even with the weight of authority firmly behind arbitration, a party cannot compel arbitration simply because there is an agreement to arbitrate. The party seeking arbitration must be “aggrieved” – that is, the other party (a) commenced litigation in lieu of arbitration, or (b) refused to comply with an order of a relevant arbitral authority to arbitrate the dispute. Absent these circumstances, a motion to compel arbitration cannot succeed. KPMG is also notable for its refusal to stay the New York proceedings in favor of the California Action. While the language of CPLR § 7503(a) seems to require adjudication of a motion to compel arbitration in the jurisdiction in which an action involving the dispute is pending – i.e. , that if there is an arbitrable issue “involved in an action pending in a court having jurisdiction to hear a motion to compel arbitration a motion to compel,” the motion “shall be made … in that action” – the courts in New York have declined to read the CPLR in that manner. As the KPMG court observed, “the CPLR does not dictate such a result.”

It is a good idea for homeowners to make sure that hired home improvement contractors are licensed.  Licensure, however, is just as important from the perspective of the home improvement contractors because their rights and remedies could be impacted if they are not.  New York case law and statutory law address this issue. In Millington v. Rapoport , 98 A.D.2d 765 (2 nd Dep’t 1983), in reversing the court below and dismissing plaintiff’s complaint which sought to foreclose a mechanic’s lien, the Court stated: Since the purpose of is to protect the homeowner against abuses and fraudulent practices by persons engaged in the home improvement business, it is well established that the lack of a license bars recovery in either contract or quantum meruit . Since strict compliance with the licensing statute is required, recovery is barred regardless of whether the work was performed satisfactorily or whether the failure to obtain a license was willful. The fact that the homeowner was aware of the absence of a license or even that the homeowner planned to take advantage of its absence creates no exception to the statutory requirement . The potentially harsh results for an unlicensed contractor is highlighted by the Millington dissent in which it was urged that an estoppel should apply in this case because one of the defendants “is an attorney, knew at all times that plaintiffs were unlicensed, delayed compensating them in the course of their work and waited until the job was completed before raising the claim that the lack of a license should operate to defeat payment. Thus, defendants are not the innocent, unsuspecting parties that the licensing requirement was designed to protect.” Similarly, the Court of Appeals, in Richards Conditioning Corp. v. Oleet , 21 N.Y.2d 895 (1968), in reversing the Second Department’s unanimous affirmance of the trial court’s judgment in favor of the foreclosing mechanic’s lienor, dismissed the complaint and stated: The finding of substantial performance is supported by the record. However, plaintiff cannot recover on the agreement since the installation was not licensed and since it employed unlicensed personnel to install the air conditioning system. The air conditioning system is a "refrigerating system" … and, therefore, may not be installed by unlicensed persons. Since the purpose of the regulatory scheme is to protect the public health and safety, lack of an installer's license bars recovery on the agreement ”. Further, a “home improvement contractor who fails to possess and plead possession of a valid license as required by relevant laws may not commence an action to foreclose a mechanic's lien.”  Nicotra v. Manger , 64 A.D.3d 547 (2 nd Dep’t 2009) (citations omitted). Consistent with the case law, CPLR § 3015(e) requires that if a “plaintiff’s cause of action against a consumer arises from the plaintiff’s conduct of a business which is required by state or local law to be licensed by , the complaint shall allege, as part of the cause of action, that plaintiff was duly licensed at the time of services rendered and shall contain the name and number, if any, of such license and the governmental agency which issued such license the failure of the plaintiff to comply with this subdivision will permit the defendant to move for dismissal pursuant to paragraph seven of subdivision (a) of rule thirty-two hundred eleven of this chapter.” These issues were recently discussed in two decisions of the Appellate Division, Second Department issued1 on October 31, 2018.  In the first case, Kristeel, Inc. v. Seaview Development Corp. , plaintiff, a steel subcontractor not licensed to perform home improvements in East Hampton, sought to foreclose a mechanic’s lien.  The defendants were the general contractor constructing two new homes and the business entities developing the homes “on speculation”.  The plaintiff subcontractor commenced the action after the defendant general contractor defaulted in its payment obligations.  Supreme court, according to the decision and order appealed from, in denying defendants’ motion to dismiss, held that: (1) CPLR § 3015(e) did not apply because “no Suffolk County license is required for the construction of a new home (emphasis in original);” and, (2) East Hampton Town Code, which defined “home improvement” to include new construction, did not apply because the homes were being “speculatively built” and the “plaintiff has not entered into a home improvement contract with an “owner” of the home and instead entered into a contract with a development corporation (not a “person”) who in turn entered into a contract with the limited liability companies that are the owners of the residences.” In reversing supreme court “on the law,” the Kristeel Court held that: (1) a complaint seeking recovery of contract damages or for quantum meruit for the breach of a home improvement contract is subject to dismissal if licensing compliance is not alleged; and, (2) “a home improvement contractor who fails to possess and plead possession of a valid license as required by relevant laws may not commence an action to foreclose a mechanic’s lien.”  The Court further held that, while plaintiff was required to have a license for the construction of new homes in East Hampton, it was not so licensed and even though they were business entities, the defendant owners were entitled to the protections of CPLR § 3015(e) and the local licensing laws. The second case, Crippen v. M. Adamao , was decided (as relevant here) under General Business Law § 772 (“GBL 772”), which provides, in pertinent part, that: Any owner who is induced to contract for a home improvement, in reliance on false or fraudulent written representations or false written statements, may sue and recover from such contractor a penalty of five hundred dollars plus reasonable attorney's fees, in addition to any damages sustained by the owner by reason of such statements or representations. In addition, if the court finds that the suit by the owner was without arguable legal merit, it may award reasonable attorney's fees to the contractor. The Crippen Court penalized the contractor for falsely and/or fraudulently representing in the construction contract that the contractor was licensed to perform the work when its license “was suspended when the contract was executed.”  This is yet another basis to penalize an unlicensed contractor. The Crippen plaintiff commenced the action alleging that, among other things, defendants violated GBL 772 by “fraudulently inducing the plaintiff to enter into the home improvement contract premised on the false representation in the contract that the defendants held a valid home improvement license.” After trial, plaintiff was awarded, inter alia , restitution damages, a statutory penalty in the amount of $500.00 and legal fees pursuant to GBL 772. On appeal, the Second Department held that the award of the statutory penalty of $500.00 was proper as was an award of attorney’s fees.  As to attorney’s fees, however, the Court set aside the trial court’s award of $56,141.58 and remitted same to supreme court “for a new determination of statutory counsel fees.”  The Court also held that the award of restitution damages was improper because “restitution damages are not provided for under .”

Recently, this Blog wrote about the success of the Commodity Futures Trading Commission’s (“CFTC”) Whistleblower Program ( here ).  As noted in that post, over the course of a few weeks, the CFTC had paid whistleblowers more than $45 million in awards. (The CFTC press release announcing the award can be found here .) Despite the positive direction in which the CFTC Whistleblower Program has been moving, many believe the whistleblower programs run by the CFTC and the Securities and Exchange Commission (“SEC”) could be improved. Indeed, whistleblowers who have provided information that resulted in a successful enforcement action have walked away with the feeling that the award-determination process could be better; they believe the process was cumbersome, exhausting, and, as noted in a recent Forbes article, “far too slow.” ( here ) Statistics appear to back up those sentiments. According to the SEC, as of September 2018, over $326 million has been awarded to 59 individuals since it issued its first award in 2012.  During that time, more than $1.7 billion in monetary sanctions have been ordered against wrongdoers based on actionable information received by whistleblowers. By contrast, the CFTC awarded only $85.6 million to whistleblowers since the CFTC whistleblower program was established in 2011. SEC Overwhelmed with Whistleblower Submissions A recent story in The Wall Street Journal ( here ) took a look at the SEC Whistleblower Program and concluded that the award-determination process can take even longer than the average time it takes to investigate and close an enforcement proceeding. Some have attributed this delay to the overwhelming number of claims the agency receives each year – nearly 4,500 tips were received in fiscal year 2017 alone). SEC Proposes Changes to Improve the Process Because of the time delay, officials of the Whistleblower Programs have urged changes that would accelerate the length of time needed to resolve a claim and issue an award. The SEC has proposed changes to the award-determination process, which would make the Whistleblower Program run more efficiently and effectively. Some of the proposed changes include barring individuals from submitting tips if they had previously submitted three meritless/frivolous claims and disposing of tips where it is likely an award will not be issued, such as when an individual fails to come forward with original information required under program rules. A False Claims Act Case Approach Another approach being considered is to follow the process used by the U.S. Department of Justice in cases under the False Claims Act in which there are multiple whistleblowers who file claims against the same entity or involve similar illegal conduct. In many of those cases, the whistleblowers reach agreement among themselves as to how to share any award issued in the case. Although the SEC and the CFTC are restricted from disclosing the identities of a whistleblower, they can share the names of the attorneys representing the whistleblowers involved in the matter, if requested to do so by the whistleblowers. Armed with such information, counsel could negotiate the allocation of any award issued in the case, thereby eliminating much of the delay created by individual requests for reconsideration and consequent appeals. Takeaway While the recent CFTC awards underscore the economic benefit to individuals who come forward to report fraud and other illegal conduct, an efficient, less time-consuming award-determination process will go a long way to reinforce the incentives to participate in the SEC and CFTC Whistleblower Programs. As officials at both agencies have noted, the Whistleblower Programs are integral components of their enforcement activities. Given their commitment to protect and reward whistleblowers, it is important for these agencies to improve their programs so that whistleblowers will remain encouraged to report fraud and other violations of the securities and commodities laws.

Last month, former Dewey & LeBoeuf, LLP (“Dewey”) executives agreed to a settlement with the U.S. Securities and Exchange Commission (“SEC” or the “Commission”) to pay civil penalties in connection with their roles in a $150 million fraudulent bond offering by the now defunct international law firm. The SEC claimed that the executives used accounting tricks when the firm needed money to weather the economic recession and steep costs resulting from the merger between the predecessor firms that made up Dewey.  Fearful that declining revenue might cause its bank lenders to cut off access to the firm’s credit lines, Dewey’s executives combed through the firm’s financial statements and devised ways to artificially inflate income and distort financial performance.  Dewey then resorted to the bond markets to raise significant amounts of cash through a private offering that seized upon the phony financial statements. Former Dewey & LeBoeuf Leaders Face Civil Penalties In September, the SEC announced ( here ) that a federal district court entered judgments on consent against Francis Canellas (“Canellas”), Thomas Mullikin (“Mullikin”), and Steven H. Davis (“Davis”), former executives of the firm, in connection with their roles in the fraudulent bond offering by the now defunct law firm. In its complaint ( here ), filed in the Southern District of New York on March 6, 2014, the SEC alleged that Dewey’s 2010 bond offering fraudulently relied on the firm’s materially misstated financial results for 2008 and 2009, which were incorporated into the private placement memorandum for the offering and provided to investors. ( See also the SEC press release discussing the charges, here .) The SEC alleged that Canellas, Dewey’s then-director of finance, along with Dewey’s former chief financial officer, orchestrated a scheme to falsify Dewey’s financial statements and provide the false financial statements to investors. The Commission also alleged that they instructed Mullikin, Dewey’s then-controller, and others in the firm’s finance department, to carry out the scheme. Davis, the firm’s then-chairman, who was aware of the fraudulent adjustments, made key decisions concerning the offering, including approving the offering and signing off on the private placement memorandum. Canellas consented to the entry of a judgment permanently enjoining him from violating the antifraud provisions of the Securities Act of 1933 (“Securities Act”) and the Securities Exchange Act of 1934 (“Exchange Act”) and requiring him to pay $43,178.82 in disgorgement and prejudgment interest. Mullikin consented to the entry of a judgment permanently enjoining him from violating the antifraud provisions of the Securities Act and the Exchange Act and requiring him to pay $8,635.78 in disgorgement and prejudgment interest. Davis consented to the entry of a judgment permanently enjoining him from violating the antifraud provisions of the Securities Act and the Exchange Act, prohibiting him from acting as an officer or director of a public company, and requiring him to pay $130,000 in a civil penalty. The settlements resolve completely the cases against Canellas, Mullikin, and Davis. Jury Deadlocked on Charges of Fraud and Larceny In October 2015, a Manhattan jury found itself deadlocked on charges of fraud and larceny brought against Davis, Stephen DiCarmine (“DiCarmine”) and Joel Sanders (“Sanders”), the latter two being executive directors of the firm. The three were accused of conspiring to manipulate Dewey’s financial statements in an attempt to defraud the firm’s lenders and insurance companies during the financial crisis. Both Canellas and Mullikin had plea agreements in effect in exchange for their cooperation with the government. Government Drops Charges in Exchange for Suspension and Ban In 2016, Davis reached a deferred prosecution agreement, which included not practicing law in New York State for a period of five years as well as a lifetime ban on practicing before the Commission. In exchange for successfully completing that agreement, the government agreed to drop the charges. Retrial of DiCarmine and Sanders Leads Sanders to Appeal In 2017, DiCarmine and Sanders were retried together. Though a Manhattan jury acquitted DiCarmine, it found Sanders guilty of securities fraud, a scheme to defraud, and conspiracy. He was sentenced to 750 hours of community service and ordered to pay a fine of $1 million. According to news reports, Sanders was appealing the verdict. On April 18, 2018, a federal court entered judgments against DiCarmine and Sanders in an SEC enforcement action arising from their roles in the fraudulent bond offering discussed above. ( See SEC press release, here .) DiCarmine consented to the entry of a final judgment permanently enjoining him from violating the Securities Act and requiring him to pay a civil monetary penalty of $35,000. Sanders consented to the entry of a judgment permanently enjoining him from violating the Securities Act and the Securities Exchange Act, prohibiting him from acting as an officer or director of a public company, and requiring him pay money in disgorgement, plus prejudgment interest, and a civil penalty to be determined by the court at a later date.

In the prior Blog article GET RID OF A STALE MORTGAGE BY BRINGING AN ACTION UNDER RPAPL 1501(4) , we discussed provisions of New York’s Real Property Actions and Proceedings Law that permit a mortgagor to remove, of record, the lien of a stale mortgage on real property. New York’s Real Property Law contain a similar provision that permits the court to cancel certain recorded instruments that are clouds on title but were not recordable or were not required to be recorded.  Thus, RPL §329 provides: An owner of real property or of any undivided part thereof or interest therein or an owner of rent to accrue from a tenancy or subtenancy thereof, may maintain an action to have any recorded instrument in writing relating to such real property or interest therein, other than those required by law to be recorded, or any recorded assignment of rent to accrue from a tenancy or subtenancy of such property or interest therein declared void or invalid, or to have the same canceled of record as to said real property, or his undivided part thereof or interest therein, or as to the rent to accrue therefrom belonging to him. It is not uncommon for a County Clerk to accept for recording, an instrument that should not be recorded because “the Clerk has a statutory duty that is ministerial in nature to record a written conveyance if it is duly acknowledged and accompanied by the proper fee ccordingly, the Clerk does not have the authority to refuse to record a conveyance which satisfies the narrowly-drawn prerequisites set forth in the recording statute.”  Merscorp, Inc. v. Romaine , 24 A.D.3d 673 (2 nd Dep’t 2005) (citations omitted), affirmed , 8 N.Y.3d 90 (2006). For example, in Newpar Estates, Inc. v. Barilla , 4 A.D.2d 186 (1 st Dep’t 1957), the Court found that plaintiff’s complaint stated a cause of action under RPL §329.  The complaint in Newpar alleged that a contract containing a “right of first refusal” on the sale of real property, which, by agreement was not supposed to be recorded and was not in “recordable” form because it was not properly acknowledged, was nonetheless recorded  The Newpar defendant “procured the inclusion of the contract in the record by attaching it to an assignment and reassignment of the third mortgage and recording the assignment and reassignment.”  Newpar , 4 A.D.2d at 190.  The Newpar Court found that, by recording the contract, defendant “converted his ‘personal right’ against the plaintiff into an equity which he may assert against any subsequent purchaser.”  “Since the defendant would be entitled to specific performance of his right of first refusal as against the plaintiff, a purchaser with notice of the defendant’s rights would likewise be subject to the same equity (citations omitted).” On October 24, 2018, the Supreme Court of the State of New York, Appellate Division, Second Department, decided Silverberg v. Bank of New York Mellon , an action brought under RPL §329.  The plaintiff in Silverberg was the defendant in a mortgage foreclosure action commenced in 2008 by Bank of New York (the “Foreclosure Action”).  In 2011, the Second Department in the Foreclosure Action , held that Bank of New York did not have standing to bring the Foreclosure Action “because its purported assignor…MERS…, the nominee and mortgagee of record for the underlying mortgage instruments, was not a lawful holder or assignee of the note and, therefore, did not have the authority to assign the underlying note to the Bank of New York.” After the decision in the Foreclosure Action, the Silverbergs commenced the subject action “to cancel of record, inter alia, two 2008 assignments of mortgage from MERS to the Bank of New York and to declare them void and invalid.”  Supreme court granted defendants’ motion to dismiss the complaint pursuant to CPLR § 3211(a)(1) “determining, inter alia, that the lacked standing to challenge the validity of the assignments of mortgage because they were neither parties to the mortgage assignments nor third-party beneficiaries of the assignments.” In reversing supreme court, the Silverberg Appellate Division found that, as owners of the property subject to the assignments, the Silverbergs “have standing under Real Property Law § 329 to challenge the recorded assignments and seek to have them removed as a cloud on their title (citations omitted)”.  The Second Department found that supreme court erred in relying on principals of contract law to resolve the issue of standing when as “an owner of real property,” the Silverbergs were expressly conferred standing by RPL §329. Because the assignments in question were found to be invalid and otherwise were a cloud on the Silverbergs’ title to their property, RPL §329 permitted the assignments to be removed of record.

In today’s business environment, it is not uncommon for departing employees to sign a separation or severance agreement that includes a bar from bringing “any and all” claims related to their employment. The enforceability of such pre-filing releases has frequently been the basis for motions to dismiss by defendant companies in actions arising under the False Claims Act (“FCA”). The FCA is silent on the issue. Last month, a district court judge sitting in the United States District Court for the Eastern District of Pennsylvania addressed the issue, holding that pre-filing releases are unenforceable, as a matter of public policy, where “the Government did not have sufficient knowledge of the Relators’ allegations prior to the signing of Relators’ releases.” United States ex rel. Susan Class et al., v. Bayada Home Health Care Inc. , No. 2:16-cv-00680 (E.D. Pa. Sept. 24, 2018). The Relators, former employees of Bayada Home Health Care Inc. (“Bayada”), a home healthcare service provider, alleged that Bayada falsely billed Medicare for home health services provided to patients that it knew were not “homebound” in violation of Medicare’s home healthcare reimbursement policy. The Relators filed their original complaint under seal on February 11, 2016. After numerous extensions, the Government declined to intervene. The Relators filed an amended complaint almost five (5) months later, claiming violations 31 U.S.C. § 3729(a)(1). Bayada moved to dismiss the action, claiming, among other things, that the Relators lacked standing to bring their FCA claims because they signed valid and enforceable separation agreements that prohibited them from bringing “any and all” claims related to their employment against Bayada (“Separation Agreements”). Bayada argued that because the Relators lacked standing to bring the claims, the Court lacked subject matter jurisdiction to consider the matter. The Relators opposed the motion, arguing that they had standing to bring their claims because: (1) the Separation Agreements did not contemplate FCA claims; and (2) public policy prohibited the enforcement of the Separation Agreements. The Court denied the motion, holding that although the Separation Agreements contemplated barring FCA claims, public policy did “not favor enforcement of the agreements.” The Court noted that “ lthough the Third Circuit has not opined on the enforceability of pre-filing releases that bar subsequent qui tam claims,” there was an “emerging agreement” among the courts in other circuits ( e.g. , the First, Fourth, Ninth, and Tenth Circuits), “that such releases bar FCA claims only if: “(1) the release can fairly be interpreted to encompass qui tam claims and (2) public policy does not otherwise outweigh enforcement of that release.” On the first prong, the Court concluded that the pre-filing release language was “expansive enough to include FCA claims.”  In reaching this conclusion, the Court noted that “the Third Circuit has found that explicit mention of a statute is not a prerequisite to enforceability of a release and that broad release language is adequate.” This authority was in-line with the courts in other circuits that had found release language similar to the Separation Agreements “to incorporate FCA claims.” On the second prong, the Court concluded that public policy outweighed enforcement of the pre-filing release. The Court explained that “the public policy recognized in FCA qui tam cases is to ‘set up incentives to supplement government enforcement’ of the Act by ‘encourag insiders privy to fraud on the government to blow the whistle on the crime.’” (Citation omitted.) However, “ f the release will be enforced, a party will have no right or reason to file a qui tam claim.”  (Citation and internal quotation marks omitted). Agreeing with the Fourth, Ninth, and Tenth Circuits, the Court concluded that “where the government has knowledge of the claims before the relator files the qui tam lawsuit, public policy weighs in favor of enforcing a pre-filing release of claims.” (Orig’l emphasis.) However, where the government lacks knowledge of the relator’s claims before he/she files suit, a pre-filing release is unenforceable. Applying the second prong to the facts of the case, the Court held that the pre-filing release included in the Separation Agreements was unenforceable because the government did not have knowledge of the claims prior to the filing of the lawsuit. The Court rejected Bayada’s argument that the government knew of the qui tam allegations because the initial complaint alleged that “ rior to filing this Complaint, Relators voluntarily disclosed to the Government the information upon which this action is based.” In doing so, the Court reasoned that “receiving a draft complaint ‘shortly before’ the filing of the Complaint is starkly different from the situations , where the Government conducted significant internal investigations or audits in advance of any litigation.” The Court went to say that because the government’s knowledge arose as a consequence “of the filing of the qui tam complaint,” the case was different from those where the government “conducted its investigation” in advance “of the filing of the qui tam complaint.” In fact, observed the Court, “the Government appears to have initiated and performed its investigation only while the case has been pending before me, evidenced by the multiple extension requests that have extended the seal for approximately one year.” The Court distinguished the case before it from other cases “because the Government did not learn of Relators’ fraud claims until after they signed their Separation Agreements and released their claims.” This fact noted the Court, “places this case in contrast” to the cases “where the relators notified the Government of alleged fraud before signing the releases.” Thus, “ nlike those cases, the Government here learned of the claims when it was provided with the draft complaint, which was after the releases had been signed.” Quoting a decision from the Eastern District of Michigan, the Court said: “ hile asserts that the government need only be made aware of the allegations prior to the filing of the qui tam complaint, it is clear that the policy interests . . . would not be served if the government’s knowledge did not precede the execution of the release.” (Quoting United States ex rel. McNulty v. Reddy Ice Holdings, Inc. , 835 F. Supp. 2d 341, 360 (E.D. Mich. 2011).) Thus, concluded the Court, “ here the Government does not have knowledge of the claims that form the basis for the qui tam complaint before the relators signed the release, enforcement of the release ‘interferes with and frustrates the FCA’s goals of incentivizing individuals to reveal fraudulent conduct to the government.’” Id . A copy of the court’s opinion can be found here . Takeaway The enforceability of employment agreements containing a pre-filing release of claims in qui tam litigation has been the subject of a growing number of judicial decisions. As the Bayada court noted, there is an “emerging agreement” among a number of circuits to dispense with the automatic rejection of qui tam claims where the government has declined to intervene and the former employee, who signed a pre-filing release, decides to continue litigating the case. In rejecting the reflexive dismissal, these courts, including the Bayada court, apply a balancing test to determine whether the government has sufficient knowledge of the qui tam allegations prior to the filing of the action. These courts reason that when the government does not know of the alleged qui tam claims, public policy encourages the use of whistleblower lawsuits to supplement federal enforcement. In that circumstance, public policy favors non-enforcement of the pre-filing release. However, where the government is aware of the claims prior to the filing of the qui tam action, such that it has been conducting its own investigation, there is little to no public interest in the lawsuit, and thus public policy supports the enforcement of employment agreements and settlements with a pre-filing release. As the Bayada court observed (quoting with approval the decision of the Ninth Circuit in United States ex rel. Green v. Northrop Corp. , 59 F.3d 953 (9th Cir. 1995)), enforcement of a pre-filing release when the government is without knowledge of the qui tam allegations “would dilute significantly the incentives that Congress attempted to augment in amending the .” Such a result would “impair significantly the operation of the FCA.…” Since Congress intended to incentivize individuals to come forward with information about a potential fraud on the government, enforcing a pre-filing release “when the government has neither been informed of, nor consented to, the release would undermine this incentive, and therefore, frustrate one of the central objectives of the .”

In March, this Blog wrote ( here ) about Hyuncheol Hwang v. Mirae Asset Sec. (USA) Inc. , 2018 N.Y. Slip Op. 30368(U) ( here ). Hwang involved an employment dispute in which Hyuncheol Hwang (“Hwang”) sought to stay the arbitration of his claims on the grounds that his employment agreement with Mirae Asset Securities (USA) Inc. (“Mirae”), a broker-dealer firm registered with FINRA, contained a forum selection clause directing the parties to litigate their disputes under the agreement in a New York court, notwithstanding his later signed Form U-4, which contained a mandatory arbitration provision. The trial court granted the motion to stay arbitration, finding that the evidence presented “demonstrate that the parties intended to be bound by the forum selection clause in the employment agreement.” The court noted that “Mirae present no evidence to show that the parties intended the arbitration clause in the U4 to supplant the forum selection clause in the employment agreement.” On October 2, 2018, the Appellate Division, First Department, “unanimously reversed” the trial court’s decision, holding that because the U-4 Form “encompasses the same employment-related disputes as were addressed in the employment agreement,” the “forum selection clause” in the employment agreement “was effectively extinguished” by the U-4 Form. A copy of the decision can be found here . In so holding, the Court noted that its decision was governed by state contract law principles, even though federal law and FINRA rules permeated the questions presented on appeal. Slip Op. at *1 (stating, “This dispute is governed by state contract law principles”) (citing Credit Suisse First Boston Corp. v. Pitofsky , 4 N.Y.3d 149, 158 n.2 (2005)). Under New York law, where a “subsequent contract regarding the same matter” exists, it “will supersede the prior contract.” Id . (citing Applied Energetics, Inc. v. NewOak Capital Mkts., LLC , 645 F.3d 522, 526 (2d Cir. 2011)). Though not discussed by the First Department, the courts in New York look to the parties’ intention to determine whether a subsequent agreement involving the same subject matter supersedes their earlier agreement: “where the parties have clearly expressed or manifested their intention that a subsequent agreement supersede or substitute for an old agreement, the subsequent agreement extinguishes the old one and the remedy for any breach thereof is to sue on the superseding agreement.” Northville Indus. Corp. v. Fort Neck Oil Terms. Corp. , 100 A.D.2d 865, 867 (2d Dept. 1984), aff’d , 64 N.Y.2d 930 (1985); see also Citigifts, Inc. v. Pechnik , 67 N.Y.2d 774, 775 (1986); Madey v. Carman , 51 A.D.3d 985, 986 (2d Dept. 2008). As the First Department noted, “ he determination whether a subsequent agreement is superseding is fact-driven.” Slip Op. at *1 (citing Blumenfeld Dev. Group, Ltd v. Forest City Ratner Cos., LLC , 50 Misc. 3d 1221 , 2016 N.Y. Slip Op. 50188 , *6 (Sup. Ct., Nassau County 2016). Thus, courts consider the following factors: (1) whether there is an integration and merger clause that explicitly indicates that the prior provision is superseded; (2) whether the two provisions have the same general purpose or address the same general rights; and (3) whether the two provisions can coexist or work in tandem. Long Side Ventures, LLC v. Adarna Energy Corp. , 2014 WL 4746026, at *6 (S.D.N.Y. 2014) (internal quotation marks and citation omitted). However, “the fact that a subsequent contract contains provisions which are of the same subject matter as those in an earlier agreement is not sufficient to supersede the entire contract; rather, a subsequent agreement supersedes only those terms of the earlier contract that are of the same subject matter.” CreditSights Inc. v. Ciasullo , 2007 WL 943352, at *6 (S.D.N.Y. 2007); see also Globe Food Servs. Corp. v. Consolidated Edison Co. of N.Y. , 184 A.D.2d 278, 279 (1st Dept. 1992). Takeaway In the original takeaway about Hwang , this Blog said: “ Hwang … highlights the point that courts use state-law principles of contract interpretation to decide whether a contractual obligation to arbitrate exists.”  The First Department’s decision reinforces this point.  The First Department’s ruling also highlights the point that where the parties’ intent is clear, courts will enforce it.

Sir Walter Scott’s original line is infinitely better (“O, what a tangled web we weave when first we practise to deceive!”) than this Blog title, which, nonetheless helps to illustrate the instant topic – Courts will not assist litigants in enforcing illegal contracts. Stone v. Freeman , 298 N.Y. 268 (1948), is a case involving commissions for the sale of clothing.  The Stone plaintiff was a broker who sued for “his commissions earned in arranging a sale by defendant, who is a of clothing.”  The parties agreed that defendant vendor would pay plaintiff broker “commissions” based on broker’s agreement that those “commissions” would be divided with the purchaser’s buying agent.  Some, but not all, of the “commissions” were paid to broker, but broker failed to pay all the agreed upon sums to buying agent.  Vendor counterclaimed for the return of the portion of the commissions that, pursuant to the parties’ agreement, were to be, but were not, delivered to the purchaser’s buying agent.  The Stone trial and appellate courts both held that vendor’s counterclaims were valid, and that he was entitled to the return of that portion of broker’s commission that was to be paid to purchasing agent. The Court of Appeals in Stone reversed the two lower courts and dismissed vendor’s counterclaims, finding that the agreement between broker and vendor was a conspiracy to violate a section of the Penal Law that made it a crime to pay a “commission or bonus” to a purchasing agent.  In so doing, the Court held that “ t is the settled law of this State (and probably every other State) that a party to an illegal contract cannot ask a court of law to help him carry out his illegal object, nor can such a person plead or prove in any court a case in which he, as a basis for his claim, must show forth his illegal purpose.  For no court should be required to serve as paymaster of the wages of crime, or referee between thieves .” The plaintiff in Bonilla v. Rotter , 36 A.D.3d 534 (1 st Dep’t 2007), was a suspended lawyer and defendants were lawyers that assumed Bonilla’s cases during his suspension.  Bonilla claimed that he was owed money from defendants for his work as an “investigator,” in which role Bonilla was to receive a fee for cases referred to defendants.  The Bonilla Court found that the parties’ agreement to split fees was proscribed by Judiciary Law § 491 and, accordingly, the “agreement is illegal and plaintiff is foreclosed from seeking the assistance of the courts in enforcing it .” The Court in Valenza v. Emmelle Coutier, Inc., 288 A.D.2d 114 (1 st Dep’t 2001), dismissed plaintiff’s claim for intentional infliction of emotional distress against her former employer.  In so doing, the Court recognized that plaintiff failed to report her income to the IRS because she was being paid “off-the-books,” pursuant to an “illegal contract.”  Because plaintiff’s emotional distress claim “require proof of the illegal contract cannot be enforced.” In Parpal Restaurant, Inc. v. Robert Martin Co. , 258 A.D.2d 572 (2 nd Dep’t 1999), plaintiff, a subtenant sought a permanent injunction preventing the widening of streets abutting plaintiff’s premises.  After recognizing that “no right of action can spring out of an illegal contract,” the Second Department affirmed the dismissal of plaintiff’s complaint because the affidavit of plaintiff’s president demonstrated that “as a matter of law… sublease of the subject premises was created for the purpose of improper tax avoidance the contract was illegal, preclud any right of action arising from such an unlawful undertaking .” Consistent with the authorities discussed herein, in Linchitz Practice Management, Inc., v. Daat Medical Management, LLC (October 1 7, 2018), the Second Department affirmed the dismissal of plaintiff’s complaint and, in so doing, reaffirmed the principle that illegal contracts will not be enforced.   The plaintiff in Linchitz sold its assets and its interest in its lease to defendant.  Defendant delivered a promissory note to plaintiff for part of the purchase price. The Linchitz plaintiff commenced action to recover the balance due on the note and for costs and attorney’s fees pursuant to the terms of the note.  Supreme court denied plaintiff’s motion for summary judgment on its first and second causes of action and granted to plaintiff summary judgment dismissing defendant’s counterclaims.  However, upon “searching the record” supreme court awarded defendant summary judgment dismissing plaintiff’s first and second cause of action. The Second Department, in affirming supreme court, found, as did supreme court, that “the evidence submitted by the parties in connection with the motion for summary judgment established, prima facie, that the agreement and promissory note were a pretext for an unlawful fee-splitting arrangement in violation of the Education Law because they circumvented New York’s prohibition on physicians splitting fees with nonphysicians .” No, this is not a Shakespeare quote.

The distinction between common-law indemnification and contribution is important, though its application is often difficult to navigate. Glaser v. Fortunoff , 71 N.Y.2d 643, 646 (1988) (noting, “the distinction is … critical,” although “the proper characterization of third-party claims … often cause confusion.”). Generally speaking, indemnity and contribution sort out the degree of culpability of multiple defendants and their responsibility for the payment of damages to the plaintiff. In the “classic indemnification case,” the one seeking indemnification “had committed no wrong, but by virtue of some relationship with the tort-feasor or obligation imposed by law, was nevertheless held liable to the injured party.” D’Ambrosio v. City of New York , 55 N.Y.2d 454, 461 (1982). Thus, “where one is held liable solely on account of the negligence of another, indemnification, not contribution, principles apply to shift the entire liability to the one who was negligent.” Id . at 462. Indemnification “may be based upon an express contract,” though it is “more commonly” implied “based upon the law’s notion of what is fair and proper as between the parties.” Mas v. Two Bridges Assocs. , 75 N.Y.2d 680, 690 (1990) (internal citations omitted). “ he key element of a common-law cause of action for indemnification is not a duty running from the indemnitor to the injured party, but rather is a separate duty owed the indenmitee by the indemnitor. The duty that foms the basis for the liability arises from the principle that every one is responsible for the consequences of his own negligence, and if another person has been compelled to pay the damages which ought to have been paid by the wrongdoer, they may be recovered from him.” Raquet v. Braun , 90 N.Y.2d 177, 183 (1997) (internal quotation marks, citations, and ellipsis omitted.) “ here a party is held liable at least partially because of its own negligence, contribution against other culpable tort-feasors is the only available remedy.” Glaser , 71 N.Y.2d at 646.  “ n contribution, the tort-feasors responsible for plaintiffs loss share liability for it …. heir common liability to plaintiff is apportioned and each tort-feasor pays his ratable part of the loss.” Mas , 75 N.Y.2d at 689-690 (internal citation omitted). Under Article 14 of the Civil Practice Law and Rules (“CPLR”), “ he ‘critical requirement’ for apportionment by contribution ... is that the breach of duty by the contributing party must have had a part in causing or augmenting the injury for which contribution is sought.” Raquet , 90 N.Y.2d at 183 (citations omitted). Contribution can be sought in a separate action or by asserting a cross-claim, counterclaim or third-party claim in a pending action. Consequently, if a defendant is found liable, he/she may seek contribution from a third party who is not a named party to the original action. General Obligations Law (“GOL”) § 15-108 governs what happens when one of several tortfeasors obtains a release from liability. A settlement, or release, by one tortfeasor does not relieve the others from liability, but it does reduce the amount that can be recovered from them “by (1) the amount stipulated by the settlement, (2) the amount of consideration paid for it, or (3) the released tortfeasor’s equitable share of the damages, whichever is greatest.” Gonzales v. Armac Indus. , 81 N.Y.2d 1, 6 (1993) (citing GOL§ 15-108 (a)). “The settling tortfeasor is relieved from liability to any other person for contribution but, in exchange, is not entitled to obtain contribution from any other tortfeasor. Id . (citing GOL § 15-108 (b), (c)). “Thus, the statute establishes a quid pro quo arrangement: the settlor limits its liability but in exchange forfeits any right to contribution.” Id . Any payment or settlement prior to judgment is a voluntary payment; however, a tortfeasor who settles after judgment is not a volunteer. Id . In addition, the bar on contribution under GOL §15-108 can be waived as a part of the settlement. See Mitchell v. New York Hosp. , 61 NY 2d 208, 216-17 (1984) (holding contribution was not barred where settlement was subject to stipulation that settling defendant preserved the right to contribution against third-party defendants). Recently, some of these principles were considered by Justice Marcy Friedman of the Supreme Court, New York County, Commercial Division, in Foremost Contr. & Bldg., LLC v Go Cat Go, LLC , 2018 N.Y. Slip Op. 32381(U) ( here ). Foremost arose out of the construction of a condominium project (the “Project”) located in New York City (the “Property”). Foremost Contracting & Building, LLC (“Foremost”), a contractor and the plaintiff in the main action, brought suit against the defendants/third-party plaintiffs Go Cat Go, LLC (“Go Cat Go”), 87 Leonard Development LLC (“87 Leonard Development”), Anthony C. Marano, and Anthony M. Marano (collectively, the “Developer Defendants”) to recover its unpaid fees for the Project. Foremost claimed unjust enrichment, breach of trust and creditor fraud against the Developer Defendants, and breach of contract against Go Cat Go and 87 Leonard Development, based upon allegations that Go Cat Go failed to pay the amounts due and owing under the agreement between them, and that 87 Leonard Development was a third-party beneficiary of the contract as the record owner of the Property. In the third-party action, the Developer Defendants sought common law indemnification and common law contribution from the third-party defendant, German American Capital Corporation (“German American Capital”), a lender of funds for the Project. German American Capital moved to dismiss the amended third-party complaint in its entirety on the grounds that the Developer Defendants’ claims were barred by res judicata and, in the alternative, failed to state a cause of action. The Court granted the motion. First, the Court rejected the claim for common-law indemnification, noting that there was no authority supporting the argument advanced by the Developer Defendants – i.e. , that a lender is obligated by statute or common law to compensate a contractor for its work after a lender forecloses on a loan made to finance a construction project. Second, the Court found that the third-party defendants failed to allege a cognizable claim for contribution because Foremost did not allege “a viable tort” against the Developer Defendants. In opposing German American Capital’s motion, the developer defendants argued that Foremost pleaded tort causes of action against them for breach of trust, defrauding creditors, and breach of fiduciary duty, in connection with the sale of the Property. As the developer defendants acknowledged at the oral argument, Foremost’s pleading was predicated on the allegation that 87 Leonard Development was the owner of the premises at the time the Property was sold. This allegation was, however, based on a mistake of fact as to the ownership, as it was German American Capital that owned and sold the Property. Significantly also, the amended third-party complaint fails to plead a viable tort against German American Capital. As noted above, the decision of the prior action against German American Capital held that the foreclosure was not wrongful. Takeaway In contribution, the loss is allocated among tortfeasors by requiring them to pay a proportionate share of the loss to one who has discharged their joint liability, while in indemnity the party held legally liable shifts the entire loss to another. Foremost makes clear that to avail oneself of either cause of action, the facts must support the claim.  While this point seems obvious, it was enough to warrant dismissal of the third-party complaint by the Foremost court.

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).  “It is well settled that a cause of action for fraud does not arise, where the only fraud alleged relates to a contracting party’s alleged intent to breach a contractual obligation.”  ( Caniglia v. Chicago Tribune-New York News Syndicate Inc., 204 A.D.2d 233, 34 (1 st Dep’t 1994) (citation omitted).)  “ fraud claim that arises from the same facts as an accompanying contract claim, seeks identical damages and does 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.  Thus, where a fraud claim was supported by allegations that the defendants had misrepresented…their intentions with respect to the manner in which they would perform their contractual duties, we dismissed the fraud claim as duplicative of plaintiffs’ contract claim because the fraud claim was based on the same facts that underlie the contract cause of action, was not collateral to the contract, and did not seek damages that would not be recoverable under a contract measure of damages.”  ( Cronos Group Limited v. XCOMIP, LLC , 156 A.D.3d 54, 63 (1 st Dep’t 2017) (citations, internal quotation marks and internal brackets omitted).) Justice Sherwood (New York County—Commercial Division) addressed these issues in his September 21, 2018 decision in Bryan v. Slothower .  The individual defendant (Slothower) in Bryan was plaintiff’s investment advisor at Merrill Lynch.  Slothower left Merrill and started his own firm, corporate defendant Battery Private, Inc.  Slothower forged Bryan’s name on, among other documents, an account application with a brokerage firm and an investment advisory agreement with Battery.  Bryan sent money to Slothower to invest and, in turn, Slothower reassured Bryan that his investments were doing well.  To support these reassurances, Slothower would, from time-to-time, send Bryan “dividend” payments, some of which payments came from Slothower’s own funds. At some point, Slothower was instructed to sell Bryan’s stock position in Alibaba.  Slothower responded by advising that he never purchased Alibaba stock for Bryan and, instead, purchased options “which did not pan out” and that all of Bryan’s money was gone. To resolve their dispute, Bryan and Slothower entered into a “Settlement Agreement” pursuant to which Slothower was to pay Bryan $775,000 two months later.  Slothower defaulted under the Settlement Agreement by failing to make the payment.  As a result, Bryan sued Slothower and Battery and asserted, among other causes of action against them: (1) fraudulent inducement as to the Settlement Agreement (to the extent that Slothower never intended to make the required settlement payment); (2) fraud against Slothower and Battery for “untrue statements of material fact or omissions;” and, (3) breach of contract (to the extent that Slothower failed to make the required settlement payment). Bryan sought to void the Settlement Agreement because Slothower misrepresented his intention to make the settlement payment, that he forged Bryan’s signatures and that at the time the settlement was reached, Bryan was unaware of Slothower’s misrepresentations and omissions, including that he forged Bryan’s signature on several documents. In dismissing the fraudulent inducement claim, Justice Sherwood relied on a line of authorities holding that “ n a fraudulent inducement claim, the alleged misrepresentation should be one of then-present fact, which would be extraneous to the contract and involve a duty separate from or in addition to that imposed by the contract and not merely a misrepresented intent to perform”  (citations, internal quotation marks and ellipses omitted).  In order to sustain a fraud claim, “a mere misrepresentation of an intention to perform under the contract is insufficient” and “a present intent to deceive must be alleged” (citations, internal quotation marks and brackets omitted). Bryan relied on White v. Davidson, 150 A.D.3d 610 (1 st Dep’t 2017) , to support his claim that a “preconceived intent not to perform is sufficient to sustain the fraud in the inducement claim.” white v. davidson.> white v. davidson.>  In White , the First Department found that several of the misrepresentations that defendant promised or claimed in conjunction with the parties entering into an exclusive music recording agreement (i.e., that defendant:  (1) was highly successful and previously successfully represented famous recording artists; (2) would promote White’s music to radio broadcasting venues; (3) would organize marketing events to promote plaintiff’s single; (4) would organize a radio tour; and, (5) would promote the re-release of the single around Valentine’s Day 2015) were collateral to the underlying recording contract entered into by the parties.  White , 150 A.D.3d at 611.  As to item no. 1, the White Court found that the representations were neither opinion nor puffery, but were specific misrepresentations concerning defendants’ experience in promoting performing artists.  White , 150 A.D.3d at 611.  As to the remaining four items, the White Court found that “the complaint adequately alleges that defendants made specific representations concerning the actions that they would undertake to promote plaintiff's single in order to induce him to self-fund their promotional campaign while never intending to perform, and were, in effect, engaging in a Ponzi scheme.”  White , 150 A.D.3d at 611. In Bryan , Justice Sherwood found that, unlike the situation in White , the subject representation regarding the payment of settlement funds was not collateral to the Settlement Agreement but was an actual term of the Settlement Agreement.