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In litigation, the prevailing party is frequently entitled to the reimbursement of statutory costs.  See, e.g., CPLR § 8101 .  What happens if a defendant is awarded costs, but the plaintiff refuses to pay?  Certainly, if the defendant is within the jurisdiction, the plaintiff can decide if it is cost effective to pursue the defendant to collect the costs.  If, however, the plaintiff is in a different jurisdiction, efforts to collect awarded costs could be more difficult.  The New York Legislature recognized this problem and enacted the “Security for Costs” provisions of the CPLR (Article 85) to ensure that New York residents sued in New York by out of state plaintiffs should not be forced to pursue out of state plaintiffs in other jurisdictions to collect awarded costs. The court in Clement v. Durban , 147 A.D.3d 39 (2nd Dep’t 2016), affirmed , ___ N.Y.3d ____ (November 14, 2018), recognized that the requirement that out of state plaintiffs post security for costs has long been a part of New York’s laws because “ ecurity for costs is a device ordinarily used against a nonresident plaintiff to make sure that if he loses the case he will not return home and leave defendant with a costs judgment that can be enforced only in plaintiff's home state” and because by “directing a nonresident to post a bond, the defendant is protected from frivolous suits and is assured that, if successful, he will be able to recover costs from the plaintiff.”  Clemente , 147 A.D.3d at 42 (citations and some quotation marks omitted). Article 85 of the CPLR governs security for costs.  CPLR § 8501(a) , which permits a defendant to be awarded security for costs as of right, provides that “ xcept where the plaintiff has been granted permission to proceed as a poor person or is the petitioner in a habeas corpus proceeding, upon motion by the defendant without notice, the court or a judge thereof shall order security for costs to be given by the plaintiffs where none of them is a domestic corporation, a foreign corporation licensed to do business in the state or a resident of the state when the motion is made.”  CPLR § 8501(b) gives the court the discretion to award a defendant security for costs in certain situations, such as where the defendant is a trustee or a receiver. Pursuant to CPLR § 8502 , if security for costs are awarded to the defendant, all proceedings are stayed (other than those that seek to review the award of security for costs) until the security is posted, and, if the security is not posted within thirty days of the order, the defendant can move to dismiss the action. Finally, pursuant to CPLR § 8503 , “ ecurity for costs shall be given by an undertaking in an amount of five hundred dollars in counties within the city of New York, and two hundred fifty dollars in all other counties, or such greater amount as shall be fixed by the court that the plaintiff shall pay all legal costs awarded to the defendant.”  While the amounts set forth in CPLR § 8503 may seem insignificant and, accordingly, moving for security for costs might not be worthwhile, courts can, and have, directed plaintiffs to post security for costs in significantly greater amounts. Thus, in Small v. Stern , 65 A.D.2d 1326, 1327 (2009), the Second Department affirmed the lower court and directed plaintiffs to post security for costs in the amount of $10,000.00 because the plaintiffs did not reside in New York and a significant bond was necessary in the “complex medical malpractice action in which defendants would incur significant expense.”   The Second Department, in Manente v. Sorecon Corp. , 22 A.D.2d 954 (1964), after finding the trial court’s order limiting security for costs to $250.00 was an “abuse of discretion,” modified the order by directing that plaintiff “file[] and serv an undertaking in the sum of $4,500.00.”  The Manente Appellate Court’s determination was based on the fact that: the “ isbursements in t action, to the present, amount to $4,062.48 for the printing of records and briefs in two prior appeals to this court from judgments in plaintiff’s favor<;> ” “ n each appeal th court reversed the judgment and granted a new trial, with costs to abide the event<;> and, “ f successful on a third trial or appeal, defendant’s statutory costs may amount to about $375.” Manente , 22 A.D.2d at 954 (citation omitted). The constitutionality of the CPLR’s security for costs provisions was challenged in Clement .  The Plaintiff in Clement , who was a New York resident when she was involved in an automobile accident with a New York City Police Department vehicle, commenced a personal injury action in Kings Supreme Court.  During the pendency of the action, Clement moved to Georgia prompting the defendant to move for security for costs in the amount of $500.00.  In opposition to the motion, Clement argued that the security for cost provisions of the CPLR violated the Privileges and Immunities Clause of the United States Constitution.  The motion court granted defendant’s motion and plaintiff appealed. The Second Department, in Clement, recognized that the appeal “raises a constitutional issue of first impression in the appellate courts.”  In unanimously affirming the motion court, the Second Department held that “the statutes, insofar as they are challenged, do not deprive nonresident plaintiffs of reasonable and adequate access to New York courts, and thus, do not violate the Privileges and Immunities Clause.  The Second Department granted permission for plaintiff to appeal to the Court of Appeals. On November 14, 2018, the Court of Appeals in Clement affirmed the Second Department and upheld the constitutionality of Article 85 of the CPLR.  In so doing the Court recognized that “ he Privileges and Immunities Clause is the preeminent constitutional directive "to constitute the citizens of the United States one people” and that “ n keeping with that goal, the Supreme Court has interpreted the clause to require the State to treat all citizens, resident and nonresident, equally and applies to only those privileges and immunities bearing upon the vitality of the Nation as a single entity." (Citations, internal quotation marks and brackets omitted.) “ ccess to the courts of the State” is one of the fundamental privileges protected by the Privileges and Immunities Clause.  While neither the United States Supreme Court nor the New York Court of Appeals “have insisted on equal treatment for nonresidents to a drily logical extreme,” the Supreme Court has explained that “the Privileges and Immunities Clause prevents a state from imposing only unreasonable burdens on nonresidents, including with respect to access to the courts of the state.”  Clement , __ N.Y.3d at __ (citations and internal quotation marks omitted).  The Court of Appeals noted that in the specific context of access to courts “the Supreme Court has held that the Privileges and Immunities Clause does not require States to erase any distinction between citizens and non-citizens that might conceivably give state citizens some detectable litigation advantage."  (Citations, internal quotation marks and brackets omitted.) The Court of Appeals set forth the two-step analysis that “governs Privileges and Immunities Clause challenges to statutes providing for disparate treatment on the basis of residency.”  First, the Court stated that it “must decide whether the burdens one of those privileges and immunities protected by the Clause" and “ hen the provision implicates access to the courts, the court must assess whether nonresidents are given access on reasonable and adequate terms for the enforcing of any rights they may have."  (Citations, internal quotation marks, brackets and ellipses omitted.)   Thus, even where nonresidents do not get exactly the same access to courts, constitutional requirements are satisfied where their access is reasonable and adequate. As to the second prong, “should the court determine that the plaintiff's exercise of a fundamental right has been impinged, the burden shifts to the defendants, who have the opportunity to prove that the challenged restriction should be upheld even though it deprives nonresidents of a protected privilege."  (Citation and internal quotation omitted.)   Restrictions should be invalidated only if it “is not closely related to the advancement of a substantial state interest.”  (Citations, internal quotation marks and brackets omitted.)  "A state may defend its position by demonstrating that (i) there is a substantial reason for the difference in treatment; and (ii) the discrimination practiced against nonresidents bears a substantial relationship to the State's objective." (Citations, internal quotation marks and brackets omitted.) In applying the constitutional analysis to the Security for Costs provisions of the CPLR, the Court of Appeals first pointed out that the posting of security for costs for nonresident access to courts is “a fixture in states across the country.”  (Citations omitted.) Specifically, the Court of Appeals found that Article 85 of the CPLR does not violate the Privileges and Immunities Clause “because nonresidents are provided reasonable and adequate access to the New York courts.”  In so holding the Court stated: For these reasons, we conclude that sections 8501 (a) and 8503 do not unduly burden nonresidents' fundamental right to access the courts because they impose marginal, recoverable security for costs on only those nonresident plaintiffs who do not qualify for poor persons' status pursuant to CPLR 1101, or fit any other statutory exemption. Where these nonresident plaintiffs do not prevail in their litigation, they must pay the same costs required of non-prevailing residents, but are simply required to post the security applied to those costs at an earlier date. Conversely, should nonresident plaintiffs prevail, their security is refunded, with any accrued interest. Even if, as plaintiff contends, this provides resident litigants with some detectable litigation advantage, imposing a relatively minor hardship on a limited class of nonresident plaintiffs is not enough to constitute an impermissible burden, such that nonresident plaintiffs do not have reasonable and adequate access to the courts. (Citations and internal quotation marks omitted.)  Finally, because the plaintiff failed to meet her burden on the initial prong of the analysis the Court of Appeals did not address the second prong. TAKEAWAY The Security for Cost provisions of the CPLR can oftentimes be used by a defendant to not only ensure the recovery of awarded costs, but to test the bona fides of a plaintiff’s claim.  The Court of Appeals has made clear that these provisions are valid and Constitutional.

Plaintiffs claiming that they have been the victims of fraud must satisfy heightened pleading standards to enter the courthouse.  Under the New York Civil Practice Law and Rules, CPLR 3016(b), and the Federal Rules of Civil Procedure, Rule 9(b), the circumstances constituting the alleged fraud must be stated in detail. here).=">here).">   Proving fraud in New York becomes even more difficult for plaintiffs – they must prove fraud by “clear and convincing evidence,” a higher standard than the preponderance of the evidence standard.  Gaidon v. Guardian Life Ins. Co. of Am. , 94 N.Y.2d 330 (1999). Where the plaintiff is “sophisticated,” the task of pleading and proving fraud becomes even more challenging. Last month, a sophisticated businessman learned this lesson in Unique Goals International, Ltd. v. Finskiy , 2018 NY Slip Op. 32788(U) (Sup. Ct., N.Y. County Oct. 29, 2018) ( here ), when his companies’ fraud claim was dismissed for failure to satisfy the justifiable reliance element. The Law in New York The elements of a fraud claim are well known to readers of this Blog: 1) a misrepresentation or an omission of material fact, 2) that was known to be false by the defendant, 3) made for the purpose of inducing the other party to rely upon it, 4) justifiable reliance of the other party on the misrepresentation or omission, and 5) injury. Mandarin Trading Ltd. v. Wildenstein , 16 N.Y.3d 173, 178 (2011); Pasternack v. Laboratory Corp. of Am. Holdings , 27 N.Y.3d 817, 827 (2016). To prevail on a claim of fraud, the plaintiff must plead and prove each element. But, as plaintiffs, especially sophisticated ones, often find that is not so easy. In Ambac Assurance Corp. v. Countrywide Home Loans, Inc. , 31 N.Y.3d 569 (2018), the New York Court of Appeals underscored the difficulty sophisticated plaintiffs encounter in trying to satisfy the justifiable reliance element of their fraud claim. In doing so, the Court reasoned that pleading and proving justifiable reliance discourages specious claims by sophisticated parties who claim that they had “been taken in”: “Public policy reasons support the justifiable reliance requirement. Where a sophisticated business person or entity . . . claims to have been taken in, the justifiable reliance rule ‘serves to rid the court of cases in which the claim of reliance is likely to be hypocritical.” Id . at 580. (Citation and internal quotation marks omitted.)  Thus, “ xcusing a sophisticated party … from demonstrating justifiable reliance,” concluded the Court, “would not further the policy underlying this ‘venerable rule.’” Id . What constitutes justifiable reliance, however, is “always nettlesome” because it is so fact-intensive. DDJ Mgt., LLC v. Rhone Group L.L.C. , 15 NY3d 147, 155 (2010) (internal quotation marks omitted). Sophisticated parties must show that they used due diligence and took affirmative steps to protect themselves from misrepresentations by employing what means of verification were available at the time. See , e.g. , HSH Nordbank AG v. UBS AG , 95 A.D.3d 185, 194-95 (1st Dept. 2012). Accord , Ashland Inc. v. Morgan Stanley & Co. , 652 F.3d 333, 337-38 (2d Cir. 2011) (“An investor may not justifiably rely on a misrepresentation if, through minimal diligence, the investor should have discovered the truth.”) (internal quotation marks and citation omitted). In her dissenting opinion in ACA Financial Guaranty Corp. v. Goldman, Sachs & Co. , 25 N.Y.3d 1043, 1051 (2015), which was endorsed by the majority in Ambac Assurance , Judge Read explained the rationale behind requiring sophisticated parties to affirmatively take steps to protect themselves: Savvy commercial and financial players and inventive lawyers abound in New York. Our venerable rule requiring that the reliance necessary to establish fraud must be justifiable is designed to make sure that the courts “reject[] the claims of plaintiffs who have been so lax in protecting themselves that they cannot fairly ask for the law’s protection” and “may truly be said to have willingly assumed the business risk that the facts may not be as represented.” This Blog discussed Ambac Assurance here . Unique Goals International, Ltd. v. Finskiy Background Unique Goals concerned a series of investments made by Plaintiffs in a publicly-traded Canadian gold mining company, White Tiger Gold, Ltd. (“White Tiger”), now known as plaintiff Mangazeya Mining Ltd. (“Mangazeya”, also sometimes referred to as “White Tiger”). In 2009, Defendant Maxim Finskiy (“Finskiy”) invested millions of dollars in White Tiger and its subsidiary, Century Mining Corporation (“Century”). By the end of 2010, Finskiy had taken control of both companies and, beginning in 2011, arranged for a series of intra-company and third-party financing. Among the financial transactions executed was a $33,000,000 Deutsche Bank Gold Forwarding Facility pursuant to which Century agreed to deliver 61,183 ounces of gold to Deutsche Bank over five years in exchange for a $33,000,000 loan, secured by virtually all of Century’s mining assets (the “Deutsche Bank Loan Agreement”). The Deutsche Bank Loan Agreement was amended twice over the course of 2011 as Century amended its estimates of resources available and its mines produced significantly less output than anticipated. Notwithstanding these amendments, Century defaulted on its obligations under the agreement in late 2011 and again in March of 2012. In May of 2012, White Tiger announced that Deutsche Bank would be taking control of Century’s mines in Peru and Quebec due to Century’s continuous default. The mines were seized by a receiver on behalf of Deutsche Bank and shut down. Following this seizure, White Tiger was left with only one operational mine in Russia: the Savkino mine. In 2011, Finskiy arranged for White Tiger and/or its subsidiaries to make and receive several loans from various entities, including those owned by his friends and business associates. Plaintiffs alleged that to secure the loans, Finskiy misrepresented the future prospects of the company knowing that White Tiger was in financial distress. In July 2011, White Tiger obtained a commitment for a loan of up to $150 million from VTB Capital PLC (“VTB”) to fund exploration, development, and production activities in Russia (the “VTB Facility”). However, pursuant to VTB’s conditions on the loan, White Tiger had to obtain feasibility studies on its Savkino and Nasedkino mines before receiving any funding. Plaintiffs alleged that Finskiy knew obtaining such studies would be problematic because a November 2010 technical report indicated that, as of September 2010, the Savkino mine had 113 thousand ounces of proved and probable gold reserves, which was insufficient to secure the VTB loan (the “Micon Report). As a result, Finskiy retained a different entity, J.S.C TOMS International (“TOMS”), a local Russian geological consulting company, to prepare an updated mineral resource and reserve study on the Savkino mine. TOMS was given little more than three weeks to prepare its entire study, which Plaintiffs claimed was an insufficient amount of time to conduct an independent investigation of a mine’s feasibility. As a result, TOMS was allegedly forced to rely on data provided by White Tiger and other third-party sources to reach its conclusions. The TOMS report (the “TOMS Report”) found that the amount of reserves was 380% higher than what was reported in the Micon Report and estimated the Savkino mine gold reserves as 438.9 thousand ounces. Plaintiffs claimed the TOMS Report was falsely presented as a technical report based on a thorough investigation and independent analysis when, in fact, it was a “Preliminary Economic Assessment” or “Scoping Study,” which is generally much less accurate. On February 2, 2012, White Tiger entered into the VTB Facility. The facility was divided into three tranches: $40 million to fund exploration, $40 million for development, and $70 million for production activities. Plaintiffs alleged, however, that Defendants never intended to use the funds as required by the terms of that loan. Rather, the money was used to prop up other entities and repay loans on behalf of Finskiy-affiliated companies, including loans that were not yet due and had lower interest rates. About $25 million of that money ended up being returned to Defendant Kirkland Intertrade Group (“Kirkland”). The second tranche of the Deutsche Bank loan was drawn down in October of 2012 and, according to Plaintiffs, used to “make payments to sham corporations and pay improper bonuses to White Tiger executives.” Simultaneously, in 2012, Finskiy started selling his White Tiger shares and Kirkland began turning its loan to White Tiger into equity, allowing it to divest. Plaintiffs claimed that Finskiy began to target Sergey Yanchukov (“Yanchukov), a Russian citizen and businessman, and friend of Finskiy, to take White Tiger off of his hands. In September of 2010, Plaintiff, Faith Union Industries, Ltd. (“Faith Union”), entered into the first of three subscription agreements to purchase shares of Century for a total of Cdn $5 million. Between November of 2010 and November of 2011, Faith Union spent an additional $3.8 million on Century shares. In April of 2011, after Finskiy allegedly talked up Century’s prospects, Faith Union purchased an additional 10.3 million shares of Century stock. Thereafter, throughout 2012, Finskiy allegedly caused Yanchukov to provide additional financial support for Century and White Tiger by, among other things, making a number of allegedly false and misleading statements about Century’s prospects and “short term liquidity cris s.” In January 2013, White Tiger announced it had not produced enough gold to satisfy the gold sales covenant of the VTB Facility. Nonetheless, Finskiy reassured Yanchukov that White Tiger had sufficient gold reserves, and the still-functioning mine would provide enough gold to fulfill the company’s obligations and provide a return on investment. That same month, Unique Goals commissioned SRK Consulting (“SRK”) to prepare a report on the mines, including the open mine, Savkino. Based on the limited data provided by Defendants, SRK reached a preliminary conclusion that it was possible to turn the economic situation at White Tiger around. This conclusion, however, was allegedly based on the false and/or inflated data provided by Defendants and the true state of the mines was, therefore, not revealed to Plaintiffs by SRK’s report. After Plaintiffs purchased Defendants’ interest in White Tiger in April 2013, they commissioned a financial audit of the company as well as a new geological study of the company’s mines. The audit revealed that $30 million was misappropriated from the company rather than being used for drilling work and that the company’s management team had received “unreasonable and unwarranted bonuses” despite the dire economic situation facing White Tiger. In August of 2013, White Tiger, now known as Mangazeya, attempted to renegotiate the terms of the VTB Facility, but was unable to do so in a way that would allow it to become profitable and was forced to buy out the VTB debt at market value ( i.e. , for $59 million). White Tiger also performed an inventory of the Savkino mine, which revealed that the ore on the site was only half of what the company had previously reported, and the mine itself would only produce for four more years, not enough to satisfy the VTB Facility and not enough for Plaintiffs to make a profit. At this point, Plaintiffs attempted to revise the terms of their purchase of Defendants’ interest in White Tiger, but Defendants refused to negotiate. Mangazeya lacked the funds to repay the loans previously extended to it by Faith Union and Unique Goals. Faith Union and Unique Goals settled their debt by purchasing shares in Mangazeya at a premium to its then current stock price in order to enhance the company’s liquidity and improve its prospects for raising additional capital. Plaintiffs filed a complaint against Defendants, alleging four causes of action: fraud, conspiracy to commit fraud, unjust enrichment and breach of fiduciary duty. Defendants moved to dismiss the complaint. The Court’s Decision As to the fraud claim, the Court granted the motion, holding that Plaintiffs failed to plead justifiable reliance. As an initial matter, the Court determined that Yanchukov, Plaintiffs’ controlling shareholder, was “a sophisticated businessperson with access to plentiful resources to protect himself and his investments.” The Court rejected the notion that because he lacked experience in the mining industry, he was not a sophisticated businessman. Although the complaint here attempts to cast Yanchukov as a newcomer to the mining business who relied on his close, personal friend Finskiy to guide him, Yanchukov, plainly, is a sophisticated businessperson with access to plentiful resources to protect himself and his investments, to obtain the requisite inspections and perform the necessary due diligence. While he may have lacked experience in the mining industry, he clearly had the resources necessary to obtain expert advice or, indeed, do an investigation. The Court held that because Yanchukov was a sophisticated businessman, he should have taken affirmative steps to protect himself from Defendants’ misrepresentations “by employing what means of verification were available at the time.” The Court found that he did not. His failure to conduct any due diligence was, therefore, fatal to Plaintiffs’ fraud claim. MAFG Art Fund, LLC v. Gagosian , 123 A.D.3d 458, 459 (1st Dept. 2014) (where a sophisticated plaintiff conducts no due diligence, he cannot demonstrate reasonable reliance as a matter of law). Takeaway In Ambac the Court of Appeals sent a strong message to sophisticated parties claiming fraud: if the person or entity has the means of knowing, by the exercise of ordinary intelligence, the truth of the subject of the alleged false representation, that person or entity must make use of those means, or he/she/it will not be heard to complain that he/she/it was the victim of fraud. Thus, where a person or entity, especially a sophisticated one, does not verify and investigate the truthfulness of assurances and representations, or is lax in doing so, the claim should be dismissed for failing to satisfy the justifiable reliance element. In Unique Goals , the Court heeded this message. Contact our business litigation lawyers in NYC about your claim.

In March of this year, this Blog wrote about the voluntary payment doctrine ( here ) and how it is alive and well in New York. On November 15, 2018, the Appellate Division, First Department, addressed the doctrine and the defense of economic duress in affirming the dismissal of a complaint under the doctrine. Beltway 7 & Props., Ltd. v. Blackrock Realty Advisers, Inc. , 2018 NY Slip Op. 07844 (1st Dept. Nov. 15, 2018) ( here ). The “voluntary payment doctrine … bars recovery of payments voluntarily made with full knowledge of the facts, in the absence of fraud or mistake of material fact or law.” Dillon v. U–A Columbia Cablevision of Westchester , 100 N.Y.2d 525, 525 (2003). Under the doctrine, “ he onus is on a party that receives what it perceives as an improper demand for money to “‘take its position at the time of the demand, and litigate the issue before, rather than after, payment is made.’” DRMAK Realty LLC v. Progressive Credit Union , 133 A.D.3d 401, 403 (1st Dept. 2015) (citation omitted). To protest the payment to overcome the voluntary payment doctrine, the aggrieved party must do so “in writing and … at the time of payment.” Neuner v. Newburgh City Sch. Dist. , 92 A.D.2d 888 (2d Dept. 1983). The written protest must also indicate that the plaintiff was reserving his/her rights when the payment was made ( DRMAK Realty , 133 A.D.3d at 405) and must communicate as much to the party receiving the payment. C.f. Walton v New York State Dept. of Correctional Servs. , 13 N.Y.3d 475, 489 (2009) (noting that “the protest requirement would have been fulfilled by a letter to MCI,” the entity levying the charge, “and DOCS,” the entity receiving commission for that charge “at the time the bills were paid”). “ he voluntary payment doctrine does not apply when a party makes payments under economic duress or compulsion, e.g. , when a party must make payment or face the loss of possession of its property.” Rocky Knoll Estates MHC, LLC v. C W Capital Asset Mgmt., LLC , 2015 WL 1632637, at *2 (W.D.N.Y. Apr. 13, 2015); see also U.S. Bank Nat. Ass’n v. PHL Variable Ins. Co. , 2014 WL 2199428, at *10 (S.D.N.Y. May 23, 2014) (voluntary payment doctrine does not apply “where payments were necessary in order to preserve property or protect his business interests”). The rationale behind the duress defense was explained by the New York Court of Appeals in 805 Third Ave. Co. v. M.W. Realty Assoc. , 58 N.Y.2d 447, 451 (1983) as follows: The theory on which plaintiff seeks recovery permits a complaining party to void a contract and recover damages when it establishes that it was compelled to agree to the contract terms because of a wrongful threat by the other party which precluded the exercise of its free will. The existence of economic duress is demonstrated by proof that one party to a contract has threatened to breach the agreement by withholding performance unless the other party agrees to some further demand. Citations omitted. Notably, “ owever, a mere threat by one party to breach the contract by not delivering the required items, though wrongful, does not in itself constitute economic duress. It must also appear that the threatened party could not obtain the goods from another source of supply and that the ordinary remedy of an action for breach of contract would not be adequate.” Austin Instr. v. Loral Corp. , 29 N.Y.2d 124, 130 (1971). See also Oleet v. Pennsylvania Exch. Bank , 285 A.D. 411, 414-15 (1st Dept. 1955). In Beltway 7 , the First Department applied a two-prong test to determine whether the plaintiff was under economic duress when it made payments to the defendant. First, the Court looked at whether the decision to demand the payment was lawful ( e.g. , if an agreement existed, was the demand based on rights enumerated in the agreement?). Interpharm, Inc. v. Wells Fargo Bank, Nat’l Ass’n , 655 F.3d 136, 142 (2d Cir. 2011) (“The law demands threatening conduct that is ‘wrongful,’ i.e. , outside a party’s legal rights.”). Second, if the demand was not lawful, the Court looked to whether the demand placed the plaintiff in a position such that it had no other choice but to accede. This prong is necessary, said the Court, to distinguish between “a viable” claim of economic duress and “a garden variety dispute over the meaning of contractual terms.” Beltway 7 , Slip op. at 5. Thus, to satisfy the second prong, the plaintiff must establish facts showing that breach of an obligation “will result in an irreparable injury or harm.” Sosnoff v. Carter , 165 A.D.2d 486, 491 (1st Dept. 1991). The possibility, or even the fear, of litigation is insufficient to establish economic duress. Oleet , 285 A.D. at 414. Moreover, merely facing “financial pressures” and “lack equal bargaining power” is not sufficient to survive dismissal. Bethlehem Steel Corp. v. Solow , 63 A.D.2d 611, 611 (1st Dept. 1978); Stewart M. Muller Constr. Co. v. New York Tel. Co. , 50 A.D.2d 580, 581 (2d Dept. 1975) (being “financially constrained … does not constitute economic duress”). A contract procured by duress is not void, but merely voidable. Thus, if a party wants to disaffirm a contract made under duress, he/she must act promptly to repudiate it or be deemed to have ratified or affirmed it. Bethlehem Steel , 63 A.D.2d at 612. However, where, during the period of acquiescence or at the time of the alleged ratification, the disaffirming party remains under the same continuing duress, he/she has no obligation to repudiate the contract until the duress has ceased. Austin Instr. , 29 N.Y. 2d at 133). In fact, such continuing economic duress would even have the effect of tolling any period of limitations if the disaffirming party had commenced the action. Baratta v. Kozlowski , 94 A.D.2d 454, 458-459 (2d Dept. 1983). As discussed below, in Beltway 7 , the Court found issues of fact surrounding the first prong of the test. It did not squarely address the second prong of the test because the plaintiff failed to act promptly to repudiate the duress: “while there is a question whether Blackrock acted reasonably in imposing the penalty, we must also consider the consequence of plaintiff’s failure to seek recovery of the payment after the threat of foreclosure < i.e. , the economic duress> i.e., the economic duress> had passed.” Beltway 7 & Properties, Ltd. v. Blackrock Realty Advisers, Inc . Background Beltway 7 involved payments due under a $25 million mezzanine loan originally made by non-party JP Morgan to Plaintiff, Beltway 7 & Properties, Ltd. The loan was secured by Plaintiff’s interest in an affiliated entity called L Reit Ltd., which in turn owned real property in Texas. Defendants (collectively, “Blackrock”) were the assignees of the loan. Around the time that JP Morgan extended the loan to Plaintiff, it made a $26 million mortgage loan to L Reit. Pursuant to the agreement that governed the loan, Plaintiff was required to make payments on the “Payment Date,” defined as “the ninth (9th) day of each calendar month during the term of the Loan,” or the nearest previous business day if the ninth day was not a business day. The portion of those monthly payments attributable to interest was to be calculated based on interest accruing between the fifteenth day of the prior calendar month and the fourteenth day of the calendar month during which a “Payment Date” fell. The agreement provided that the maturity date for the loan would be November 9, 2014, at which time Plaintiff would be required to pay off the principal balance, including all accrued and unpaid interest. November 9, 2014 was a Sunday, so the actual maturity date pursuant to the agreement was November 7. The agreement also provided for a late payment penalty, which entitled the lender to demand, upon Plaintiff’s failure to make any required payment, “the lesser of five percent (5%) of such unpaid sum or the Maximum Legal Rate” (defined in the agreement as the maximum nonusurious interest rate under applicable law). As the maturity date approached, Plaintiff negotiated to refinance the loan and the mortgage loan with JP Morgan, and scheduled a closing for November 7, 2014, the maturity date for both loans. However, shortly before that date, Plaintiff discovered that an umbrella insurance policy it was required to maintain for the properties securing the mortgage loan had lapsed. Keybank, which JP Morgan had appointed to service the mortgage loan, was responsible for paying the insurance premiums out of Plaintiff’s monthly loan payments. However, it failed to make the $8,600 payment necessary to renew the umbrella policy. JP Morgan refused to refinance the two loans until the insurance issue was resolved, which was on November 14, when the new loans closed. Plaintiff missed the maturity date payment by one week causing Blackrock to exercise its right under the mezzanine loan agreement to impose a late charge. It calculated the charge as 5% of the unpaid indebtedness, a sum of approximately $1.2 million. Further, it sought an additional interest payment to cover the interest period running from November 15 to December 14. In contrast to Blackrock, JP Morgan did not penalize Plaintiff for settling the mortgage loan one week late. It did persuade Blackrock, however, to reduce the late charge to $500,000. Nevertheless, needing to satisfy the mezzanine loan before it could close on the refinance, and facing the imminent loss of its properties to foreclosure, Plaintiff paid the amount demanded by Blackrock – approximately $844,000. The Proceedings Before the Motion Court Approximately 1½ years later, Plaintiff commenced the action. Plaintiff asserted three causes of action: breach of contract, asserting that Blackrock misconstrued the loan agreement in charging interest; a declaratory judgment that the late charge and additional interest were unenforceable as penalties that were disproportionate to the harm suffered by Blackrock; and restitution to recover the amounts that Plaintiff claimed it was unlawfully forced to pay to Blackrock. Blackrock moved to dismiss, pursuant to CPLR sections 3211(a)(1) and (7). It argued that it properly applied all relevant contractual provisions, and that, in any event, Plaintiff’s claims were barred by the voluntary payment doctrine. In response, Plaintiff submitted an amended complaint, which added a cause of action seeking a declaratory judgment that Plaintiff made the payment under economic duress and under protest, and upon a mistake of law and fact, such that the voluntary payment doctrine did not apply. Plaintiff also submitted the affidavit of its president, Mohammad Nasr, in which he reiterated the allegations in the amended complaint, including that Plaintiff protested the charges after Blackrock announced its intention to impose them, but determined that it had no choice but to pay. Blackrock agreed to treat its motion as if directed to the amended complaint. It argued that there was no allegation of a written protest, as required, that Plaintiff’s allegations of duress were substantively insufficient and, in any event, waived by the passage of time, and that there was no cognizable mistake of law or fact. Blackrock also argued that the charges were all proper under the mezzanine loan agreement. The motion court granted the motion in its entirety and dismissed the amended complaint. It rejected Plaintiff’s allegation that it made the payment under protest, since it had stated no facts concerning the manner in which such protest was lodged. The court also rejected Plaintiff’s argument that it made the payment under a mistake of fact or law since Blackrock had explained the basis for the charges. Moreover, the court held that Plaintiff failed to allege that it made a reasonable effort to learn what its actual legal obligations to Blackrock were. Finally, the court rejected Plaintiff’s economic duress argument. Though acknowledging that a threatened loss of property could form the basis of a claim of economic duress, and intimating that Plaintiff had sufficiently alleged duress, the court found that Plaintiff sat on its rights, having waited 1½ years to commence the action. The First Department affirmed. The First Department’s Decision As noted, in affirming the motion court’s decision, the First Department applied a two-prong test to determine whether Plaintiff suffered economic duress sufficient to avoid the application of the voluntary payment doctrine. As to the first prong – “whether Blackrock’s decision to demand the late charge and extra interest payment was lawful, that is, based on rights enumerated in the agreement” – the Court found that “relevant contractual provisions ambiguous,” and “susceptible to more than one reasonable interpretation.” Slip op. at 4. The Court explained: As plaintiff notes, the 5% rate is expressly stated to apply to the “unpaid sum.” However, whether the “Maximum Legal Rate” is to be applied to the unpaid sum or something else is unclear. Plaintiff suggests that it was intended to apply to the length of time that payment was outstanding, which was seven days. Blackrock counters by, inter alia, characterizing the “Maximum Legal Rate” as a standard savings provision designed to ensure that it not be deprived of any recourse at all if payment is tardy. Each of these arguments has merit, and neither is susceptible of resolution at the pleading stage. The Court also found “uncertainty concerning whether Blackrock was justified in charging interest for the November to December period.” Finding sufficient ambiguity in the parties’ interpretation of the term “Payment Date” and Plaintiff’s obligations under the agreement, the Court declined to “determine how the provision should be properly interpreted.” Id . at 4. Similarly, the Court was “unwilling … to declare that the amount charged by Blackrock was not an unenforceable penalty.” Id . The late charge was, according to the agreement, designed “to defray the expense incurred by Lender in handling and processing such delinquent payment and to compensate Lender for the loss of the use of such delinquent payment.” However, we are unable to determine on the limited record before us whether such damages were incapable of calculation at the time the mezzanine loan agreement was executed, or whether there is a proportional relationship between the consequences to Blackrock of receiving late payment, and the sum plaintiff was required to pay. As to the second prong – whether Plaintiff was deprived “of meaningful choice” – the Court did not explicitly make a ruling, though it indicated that Plaintiff had sufficiently alleged, for pleading purposes, irreparable injury had it not paid “the late charges and extra interest” because it would lose the ability to refinance the mortgage loan and Blackrock would foreclose on “Plaintiff’s very valuable portfolio of properties.” Id . The Court explained that it could not ignore “the consequence of plaintiff’s failure to seek recovery of the payment after the threat of foreclosure had passed.” Id . The Court rejected Plaintiff’s argument that there was no contract ratification “because Blackrock did not procure a contract by duress, but rather a payment concomitant with an already existing contract.” Id .  In doing so, the Court said that Plaintiff’s argument was based upon “a distinction without a difference.” Id . The Court also rejected Plaintiff’s argument that the proper way to analyze ratification is through the prism of laches. Noting that there was no case authority supporting Plaintiff’s argument and that prejudice was not an element of the analysis, the Court found that the passage of time without explanation could not support a claim of duress: Plaintiff further asserts that the proper analysis where a party fails to promptly seek recovery of a payment made under duress is whether it is guilty of laches. It argues that because a showing of laches requires prejudice on the part of the party asserting the defense, it must prevail here, because Blackrock was not prejudiced. We disagree. Plaintiff has not cited any authority to support its theory that prejudice enters the analysis. Indeed, decisions by this Court declaring that a party has waived a duress claim have not even suggested that prejudice is a relevant factor. This is not to say that a lengthy wait to recover funds paid under duress bars the claim absolutely.… Here, however, plaintiff fails to allege any set of facts justifying its decision to wait nearly two years to invoke duress, and then only after defendant invoked the voluntary payment doctrine. Takeaway In the takeaway of this Blog’s prior post about the doctrine, we said the following: “A lesson to be learned from these cases is that payors should not ‘pay now and ask questions (or litigate) later,’ lest they run the risk that a court will not permit the recovery of such payments from the payee.  Known rights should be asserted promptly.” (Internal quotation marks altered.) This lessen was highlighted in Beltway 7 , wherein the First Department found that waiting 1 ½  years to invoke the economic duress defense negated any bar to the application of the voluntary payment doctrine.

On November 2, 2018, the U.S. Securities and Exchange Commission (the “SEC” or “Commission”), Division of Enforcement (the “Division”), released its annual report for the fiscal year ended September 30, 2018 (“FY 2018”) (the “Report”) ( here ). The Report highlights the Division’s enforcement-related actions and key initiatives for the fiscal year and reveals an agency focused on pursuing cases affecting retail investors, such as investment adviser fraud, as well as actions directed at the impact of emerging technological on the securities market, such as cryptocurrencies and cybersecurity. “As this report demonstrates, the Division’s approach to enforcement is multifaceted and outcomes-oriented with the interests of our Main Street investors front of mind,” said SEC Chairman Jay Clayton.  “The Enforcement Division has been and continues to be extremely successful in its efforts to deter bad conduct and effectively remedy harms to investors.” A copy of the November 2, 2018 press release announcing the issuance of the Report can be found here . Below are some of the Report’s highlights. FY 2018 Enforcement Proceedings .  In FY 2018, the Commission brought 821 enforcement actions, of which 490 were “stand alone” actions brought in federal court or as administrative proceedings, 210 were “follow-on” proceedings seeking bars based on the outcome of Commission actions or actions by criminal authorities or other regulators, and 121 were proceedings to deregister public companies – typically microcap issuers – that were delinquent in their Commission filings. A significant number of the stand-alone cases concerned securities offerings (approximately 25%), investment advisory issues (approximately 22%), and issuer reporting/accounting and auditing (approximately 16%). In addition to the foregoing, the Commission continued to bring actions involving broker-dealer misconduct (13%), insider trading (10%), and market manipulation (7%). From a year-over-year perspective, the number of Foreign Corrupt Practices Act (“FCPA”) cases brought by the Commission remained flat compared to FY 2017. In both years, the Commission brought 13 FCPA cases. The most significant year-over-year increases came from enforcement proceedings involving investment advisers/investment companies (108 in FY 2018 compared to 82 in FY 2017) and securities offerings (121 in FY 2018 compared to 94 in FY 2017). Focus on Retail Investors . The report shows that the SEC continues to focus its attention on the protection of retail investors. Of the 490 stand-alone enforcement proceedings, one half of the actions brought in FY 2018 involved allegations or findings of wrongdoing that harmed Main Street investors. Consistent with the Commission’s focus on Main Street, the SEC returned a substantial amount of money to these investors in FY 2018. In FY 2018, the Commission continued to obtain significant monetary relief in the form of disgorgement and civil penalties. In this regard, the Commission obtained $2.506 billion in the disgorgement of ill-gotten gains, a decrease over the prior year. The Commission imposed a total of $1.439 billion in civil penalties, an increase from the prior year. A significant amount of the money ordered in FY 2018, however, came from In the Matter of Petroleo Brasileiro S.A. – Petrobras , AP File No. 3-18843, Securities Exchange Act Release No. 34-84295 (Sept. 27, 2018) (disgorgement and prejudgment interest totaling $933,473,797 and a penalty of $853,200,000). Total monetary relief increased in FY 2018 by approximately 4% from the prior year. The Report noted that the Supreme Court’s 2017 decision in Kokesh v. SEC (discussed by this Blog here ), in which the Court held that Commission claims for disgorgement are subject to a five-year statute of limitations, continues to have a significant effect on the Commission’s efforts to obtain disgorgement. With respect to matters that have already been filed, the Division estimated that the Court’s ruling in Kokesh may cause the Commission “to forego up to approximately $900 million in disgorgement, of which a substantial amount likely could have been returned to retail investors.” Holding Individuals Accountable : According to the Commission, individual accountability was critical to its enforcement program and was one of the Division’s core principles during the fiscal year. In FY 2018, of the 490 stand-alone actions, 72% involved charges against one or more individuals, approximately the same percentage as in FY 2017 (73%). Many of the individuals charged in FY 2018 include senior officers at prominent companies and other public figures, including the CEOs of Tesla Inc. (“Tesla”) (discussed by this Blog here ) and Theranos Inc. (“Theranos”), the former CEO of SeaWorld Entertainment Inc., a U.S. Congressman, the former CEOs and CFOs of Walgreens Boots Alliance Inc. and Rio Tinto p.l.c., and a professional football player (discussed by this Blog here ). The Division also sought to penalize individuals and require them to pay back ill-gotten gains. In FY 2018, the Commission obtained judgments or orders for disgorgement and/or penalties from over 500 individuals, representing an increase of 9% over FY 2017. “In FY 2018, the Commission obtained favorable verdicts in three trials against four defendants and an unfavorable verdict in one trial against one defendant. As of the close of the fiscal year, the Commission was awaiting a verdict in one completed bench trial. The number of district court trials conducted in FY 2018 (5) is similar to the number of such trials in FY 2017 (4).” In FY 2017, there were various pending constitutional challenges to the Commission’s administrative proceedings and the appointment of its administrative law judges (“ALJ”). In June 2018, the Supreme Court held in Lucia v. SEC (discussed by this Blog here ) that the appointment of the SEC’s ALJs violated the U.S. Constitution’s Appointments Clause, requiring a new hearing in front of a different fact finder. After Lucia , the Commission stayed all pending administrative proceedings. The Commission lifted the stay on August 22, 2018, and approximately 200 administrative proceedings were reassigned at that time. The SEC noted that addressing these administrative proceedings would require the expenditure of substantial litigation resources during FY 2019. Cyber-Related Misconduct : According to the Report, cyber-related misconduct continues to be a key focus area for the Commission. In FY 2018, the Division commenced 20 stand-alone actions involving Initial Coin Offerings (“ICOs”) and digital assets. According to the Report, the Division’s Cyber Unit, which was formed at the end of FY 2017, and became fully operational in FY 2018, has been instrumental in identifying and bringing an array of cases from registration violations, to unregistered broker-dealer activity, to instances in which the purported use of blockchain-related technology was a thinly veiled cover for fraudulent misconduct. The Report also stated that the Division has 225 on-going cyber-related investigations. As such, the Commission expects FY 2019 to see even more significant developments in this area. Relief Obtained . In every enforcement action, the Division seeks “appropriately tailored remedies” that further its enforcement goals. In addition to disgorgement and penalties, there is a wide range of potential remedies available. Consequently, the agency seeks remedies that are appropriate and meaningful to the case and the alleged wrongdoing. In FY 2018, the Division employed undertakings ( e.g. , actions that require a defendant/respondent to take affirmative steps, either in conjunction with entry of the order or in the future) as a tool in its enforcement actions and settlement recommendations to the Commission. The Theranos and Tesla matters are examples of the Commission’s use of this remedial tool. Enforcement actions resulted in nearly 550 bars and suspensions of wrongdoers in FY 2018. According to the Report, one of the most important actions that the Commission can take to protect investors is to remove individuals from positions where they can engage in future wrongdoing. The Commission assesses bars and suspensions to prevent wrongdoers from serving as officers or directors of public companies, dealing in penny stocks, associating with registered entities such as broker-dealers and investment advisers, or appearing or practicing before the Commission as accountants or attorneys. As noted in the Report, “ nder the federal securities laws, the Commission may suspend trading in a stock for 10 days and generally prohibit a broker-dealer from soliciting investors to buy or sell the stock again until certain reporting requirements are met.” In FY 2018, the Commission suspended trading in the securities of 280 issuers in order to combat potential market manipulation and microcap fraud threats to investors. “In FY 2018, the Commission obtained 26 court-ordered asset freezes.” Court-ordered prejudgment relief in the form of asset freezes, said the Commission, is important to its ability to protect investors. As noted in the Report, asset freezes prevent alleged wrongdoers from dissipating assets that could otherwise be marshaled for distribution to investors harmed by the alleged misconduct. Impact of Resource Constraints : The Commission continues to be impacted by the constraints imposed by an agency-wide hiring freeze that has been in place since late 2016. The Report notes that the number of positions at the Division, including the number of contractors supporting the Division’s investigations, declined 10% from FY 2016 to FY 2018. As a result, the Division “paid careful attention to case selection” in FY 2018, “attempting to open and pursue investigations that likely to have the most meaningful impact for investors and the markets.” In discussing the financial constraints on the agency, the Report provides insight into the Division’s priorities going into the new fiscal year. In this regard, the Commission observed that “additional resources would support two key priorities of the Division: protecting retail investors and combating cyber-related threats.”  The Commission also said that “with more resources” it “could focus more on individual accountability,” especially since “individuals are more likely to litigate” and, therefore, exhaust the Division’s litigation resources. Takeaway The Report reflects an emphasis on protecting the Main Street investor. This emphasis is most likely the result of a change in philosophy within the Division away from the Wall-Street centric approach championed by Chairman Clayton’s predecessors.  The Division’s rollout in FY 2018 of the Retail Strategy Task Force and the Share Class Selection Disclosure Initiative (discussed by this Blog here ) further underscores the Commission’s shift to policing conduct that targets retail investors, including “disclosures concerning fees and expenses” and “misconduct that occurs in the interactions between investment professionals and retail investors.”  Likewise, FCPA-related enforcement actions – which received significant attention during the prior Chair’s tenure – is given little attention in the Report.  The numbers support this de-emphasis. FCPA-related enforcement actions declined nearly 40 percent from FY 2016, when enforcement actions reached an all-time high. Although Avakian and Peiken believe that the Division does not “face a binary choice between protecting Main Street and policing Wall Street,” the numbers cited in the Report tell a different story. The Report also reveals the Commission’s shift from deterrence through substantial monetary penalties to a “wide range” of “investor-oriented” individualized remedies “tailored” to “the underlying charged conduct.”  The Commission’s use of undertakings in its cases against Theranos and Tesla and their CEOs demonstrate this new approach. In both cases, the Commission required the CEOs of each company to relinquish control of the companies (temporarily and permanently) and the companies to implement internal controls to monitor the social media communications of their executives.  Consistent with the Division’s stated focus on protecting Main Street investors, the Report described these undertakings, along with the monetary penalties and governance reforms, as “remediat the harm visited on shareholders by the misconduct at issue and provid shareholders with greater protection in the future.” The Report further reveals an emphasis on combating cyber-related misconduct. In FY 2018, the Commission brought a dozen “cryptocurrency”-related cases. Four of those cases were brought by the SEC’s new Cyber Unit. At the time of the unit’s launch, Avakian identified cyber-related threats as “among the greatest risks facing investors and the securities industry.” In FY 2018, the Commission brought 20 stand-alone cases related to cyber fraud and had more than 225 ongoing cyber-related investigations. Although the numbers are not yet reflective of the Commission’s emphasis on all things cyber-related, the Report makes a point of discussing the need for additional funding to “combat[ ] cyber-related threats” – one of the “two key priorities of the Division” in the upcoming fiscal year. Finally, in the Commission’s FY 2017 report, the agency articulated five core principles that would guide the Division for the upcoming fiscal year: (1) focus on the Main Street investor; (2) focus on individual accountability; (3) keep pace with technological change; (4) impose remedies that most effectively further enforcement goals; and (5) constantly assess the allocation of our resources. Those principles are reiterated in the FY 2018 Report. The numbers and initiatives discussed in this year’s Report, concluded the Division, demonstrate “a faithful adherence to these principles.”

In business divorce cases, it is often necessary for the parties’ experts to prepare valuation reports – that is, reports that value an owner’s interest in a business or venture. Sometimes, however, valuation reports are prepared by non-testifying consultants. When valuation reports are prepared by consultants, disputes often arise over whether those reports are discoverable. The answer depends on when they are prepared ( i.e. , in the ordinary course or in anticipation of litigation). In New York, CPLR 3101(c) governs whether documents or information are protected work product. CPLR 3101(c) provides that the “work product of an attorney shall not be obtainable.” The work product protection also “extends to experts retained as consultants to assist in analyzing or preparing the case, as an adjunct to the lawyer’s strategic thought processes ….” Hudson Ins. Co. v. Oppenheim , 72 A.D.3d 489, 490 (1st Dept. 2010) (citation and internal quotation omitted). See also 3A Weinstein-Korn-Miller, N.Y. Civ. Prac. ¶ 3101.52a, at 31-214 (“Accordingly, an expert who is retained as a consultant to assist in analyzing or preparing the case is beyond the scope of this provision; in fact, such experts are generally seen as an adjunct to the lawyer’s strategic thought processes, thus qualifying for complete exemption from disclosure under subdivision (c) and, now, the mental impressions …  exclusion of CPLR 3101 (d) (2) as well.”). By contrast, testifying experts do not necessarily enjoy such protection. CPLR 3101(d)(1) provides that “(i) pon request, each party shall identify each person whom the party expects to call as an expert witness at trial and shall disclose in reasonable detail the subject matter on which each expert is expected to testify, the substance of the facts and opinions on which each expert is expected to testify, the qualifications of each expert witness and a summary of the grounds for each expert’s opinion.” Breslauer v. Dan , 150 A.D.2d 324 (2d Dept. 1989). Clause (iii) permits a court to order further disclosure of a report prepared by an expert expected to testify upon a showing of special circumstances. E.g. , Beauchamp v Riverbay Corp. , 156 A.D.2d 172 (1st Dept. 1989). Over the years, courts have identified a number of consultants entitled to work-product protection, including, but not limited to, forensic accountants, engineering firms, appraisers, and, business valuation firms. See , e.g. , 915 2nd Pub Inc. v. QBE Ins. Corp. , 107 A.D.3d 601, 601 (1st Dept. 2013) (appraisal report); Hudson , 72 A.D.3d at 490 (forensic accounting analysis); Oakwood Realty Corp. v. HRH Constr. Corp. , 51 A.D.3d 747, 749 (2d Dept. 2008) (engineering report); Delta Fin. Corp. v. Morrison , 14 Misc. 3d 428, 432 (Sup. Ct., Nassau County 2006) (valuation of excess cash flow certificates). Even if a document or communication is not entitled to full protection, it may be entitled to qualified protection from discovery when it is prepared in anticipation of litigation. CPLR 3101(d)(2) restricts discovery of “materials prepared in contemplation of litigation even if by non-lawyers or lawyers acting in a non-legal capacity.” Kandel v. Tocher , 22 A.D.2d 513, 516-17 (1st Dept. 1965). This rule includes materials prepared by “a consultant to assist in analyzing or preparing the case.” Santariga v. McCann , 161 A.D.2d 320, 321 (1st Dept. 1990); see also Oakwood Realty , 51 A.D.3d at 749. On November 9, 2018, Justice Jennifer G. Schecter of the Supreme Court, New York County, Commercial Division, addressed the foregoing issues in Noven Pharms., Inc. v. Novartis Pharms. Corp. , 2018 N.Y. Slip Op. 32851(U) ( here ), and held that a valuation report prepared in connection with the break up of a joint venture was not protected work product under CPLR 3101(c) and 3101(d)(2). Noven Pharmaceuticals, Inc. v. Novartis Pharmaceuticals Corp. Background Noven concerned the break-up of the parties’ joint venture, which did business as Novogyne Pharmaceuticals (“Novogyne”) and sold different types of estrogen-patch products. The parties entered into a Termination Agreement on December 1, 2012, that provided for the disposition of Novogyne’s cash and non-cash assets including its products. Years after the joint venture ended, the parties disagreed on how the members’ capital contributions would be distributed. Plaintiff, Noven Pharmaceuticals, Inc. (“Noven”), maintained that, upon termination of the joint venture, a third-party expert valuation would determine the fair market value of the estrogen-patch products that were being allocated to the parties. Defendant, Novartis Pharmaceuticals Corp. (“Novartis”), maintained that a valuation report was not necessary or required, though it later believed that such a report would be internally useful. Consequently, Novartis requested a valuation report from Noven. Noven retained Houlihan Lokey (“HL”) to perform the valuation. On June 19, 2015, Noven sent HL’s draft valuation to Novartis and asked for feedback. On June 29, 2015, Novartis determined that it disagreed with HL’s valuation. Consequently, Novartis decided to procure its own valuation. On July 14, 2015, Novartis informed Noven that its team “thought it would be most prudent for Novartis to obtain its own 3rd party valuation” and committed to keeping Noven “updated on the status of completion of this valuation” with an eye toward meeting “sooner rather than later.” According to the Court, Novartis did not say that its initial decision to pursue a valuation was motivated in any way by anticipated litigation. On August 11, 2015, Noven asked Novartis for an update. Novartis responded the following day that it was still in the process of engaging a valuator and that it would provide an update in mid-September. By the end of August 2015, without the involvement of counsel, Novartis identified five potential valuation firms and ultimately selected Deloitte Transactions and Business Analytics (“Deloitte”) to perform a fair market value assessment of the Novogyne assets. Correspondence cited by the Court showed that Novartis intended to use and discuss Deloitte’s findings with Noven in the course of their business negotiations. On September 3, 2015, Novartis’ in-house counsel became involved in the matter for the first time. Based on his earlier participation in the winding down of the joint venture, counsel “recognized that Noven’s position was antithetical to the Termination Agreement” and “anticipated that the dispute could lead to litigation.” That day, Novartis engaged a law firm, White & Case, to represent it “in the dispute over the distribution of the Member’s Capital Contributions balance.” Novartis took steps to preserve documents for litigation and began contemplating basic litigation issues. On September 24, 2015, the parties held a conference call in which in-house counsel participated. Novartis informed Noven “that the joint venture did not need to account for the value of the distributed products . . . and that those products should not impact the joint venture’s distribution and that it was not necessary for either party to estimate the value of the distributed products.” According to the Court, there was no indication on the call (or at any time thereafter) that Novartis mentioned the valuation report it had commissioned. In October 2015, White & Case formally hired Deloitte to value the joint venture’s products even “though Novartis did not believe that the Termination Agreement required the parties” to do so. White & Case and Novartis purportedly took this step because they believed that “to assess the case, they should obtain their own estimates of products.” The engagement letter stated that Deloitte would be a “nontestifying consultant” and that because it was White & Case’s intention and position that the work for it would be covered by “the attorney work-product and other applicable privileges,” all working papers received or prepared by Deloitte would be maintained as confidential. On November 17, 2015, Deloitte provided White & Case with a first draft of its valuation. On February 25, 2016, Deloitte provided White & Case and Novartis with an updated draft, which was Deloitte’s last report. The valuation itself stated that it was “privileged and confidential” and that Deloitte “was pleased to assist White & Case ... in connection with its representation of Novartis ... with the provision of services for corporate planning purposes.” It also set forth that Deloitte was assisting “in connection with . . . litigation due diligence activities” and that its services were solely for internal “use to assist with ... litigation due diligence activities.” The report included a fair market valuation and basic facts related to Novogyne and its termination. According to the Court, the valuation did not reflect any legal assumptions or opinions (other than the fact that a valuation was performed at Novartis’ request, which had not been a secret in the case). Nor did it reveal “Novartis’ reaction to Noven’s position.” Ten days later, on March 5, 2016, White & Case sent Novartis’ counsel a legal memorandum that discussed the valuation. On March 14, 2016, Noven and Novartis met to discuss settlement of their dispute. Novartis relied on Deloitte’s valuation “in preparing for that meeting.” On September 7, 2016, Noven commenced the action, claiming that Novartis refused to disburse more than $16 million of the joint venture’s assets as required by the Termination Agreement. The Motion and the Court’s Decision On March 30, 2017, the Court heard argument on Novartis’ motion to dismiss. During the argument, the parties discussed Novartis’ valuation of the joint venture’s assets. Noven claimed the report was discoverable because, among other things, it evidenced the amount Novartis may owe Noven. Novartis opposed production, arguing that its valuation report was privileged. Believing that it was unlikely the report was privileged because it was prepared prior to litigation, the Court directed Novartis to produce the report. Notwithstanding, Novartis did not do so. The parties agreed that the bona fides of the privilege claim would be fleshed out in discovery and that motion practice would ultimately be required if Novartis refused to produce the report. The parties reached an impasse on whether the valuation report was privileged. Noven moved to compel Novartis to produce Deloitte’s valuation report. The Court granted Noven’s motion, finding that Novartis failed to meet its burden “of establishing that the valuation report privileged and, therefore, exempt from the disclosure.” (Citing 148 Magnolia, LLC v. Merrimack Mut. Fire Ins. Co. , 62 A.D.3d 486, 487 (1st Dept. 2009)). The Court concluded that Novartis could not demonstrate that “the report was created solely and exclusively in anticipation of litigation.” Thus, the Court could not rule out a mixed purpose for the report. The Court noted that “ t undisputed that a valuation by Deloitte was contemplated for business purposes before Novartis claim that it appreciated that litigation potentially lay ahead.” This fact was underscored by Novartis’ failure to demonstrate “that the nature, character or scope of the valuation” previously discussed with Deloitte had “changed in any way whatsoever or that Novartis was exclusively in litigation mode and not still desirous of arriving at a mutually agreeable business solution with Noven.” (Citing Plimpton v. Massachusetts Mut. Life Ins. Co. , 50 A.D.3d 532, 533 (1st Dept. 2008)). “Indeed,” said the Court, “there is no evidence between September 2015 – when Novartis maintain that it first contemplated potential litigation – and the commencement of this action, that Novartis ever explicitly committed to Noven that, contrary to its earlier position, it was not going forward with nor would it exchange or discuss the valuation that it had earlier committed to.” In short, concluded the Court, “Novartis has not shown any proof ( in camera or otherwise) that after its business people chose Deloitte to prepare the valuation for business purposes, the actual scope or nature of the retention changed in any material way.” The Court also rejected the notion that because “ both parties fully appreciated that litigation was a possibility before they officially commissioned their respective valuations” (orig’l emphasis), the Deloitte valuation was protected: “That does not alter the analysis nor does the involvement of attorneys or the parties’ own privilege designations (which were likely designed to afford the parties with maximum flexibility depending on the outcome of the valuation).” “In the end,” said the Court, “it is hard to believe that Novartis decided, in September 2015, that potential litigation justified an uncommunicated change in course with respect to the valuation and that, despite verily believing that a valuation was irrelevant, it continued to pursue the very same valuation that it had anticipated earlier, yet it was for a completely different purpose (and that Novartis did so, at this stage and with urgency, solely for litigation that had not even been commenced and not for use in its ongoing business negotiations).” This conclusion was reinforced by the record, which the Court observed, showed that “the parties continued in the same course of negotiations for which the Deloitte valuation had been contemplated.” Takeaway The burden of establishing the right to work-product protection is on the party asserting it. 148 Magnolia, LLC v Merrimack Mut. Fire Ins. Co. , 62 A.D.3d 486, 487 (1st Dept. 2009). Whether a particular document or communication deserves protection is a fact-specific determination. Rossi v. Blue Cross & Blue Shield , 73 N.Y.2d, 588, 592-93 (1989). Noven exemplifies these principles: under the facts and evidence before the Court, Novartis was unable to meet its burden of demonstrating that the Deloitte valuation report deserved work-product protection.

If there is one thing people like less than attorneys, it is paying attorneys’ fees.  Accordingly, great effort is made in contracts to shift to another party, the obligation for the payment of attorneys’ fees in the event of dispute. “Under the general rule attorneys’ fees and disbursements are incidents of litigation and the prevailing party may not collect them from the loser unless an award is authorized by agreement between the parties or by statute or court rule.”  A.G. Ship Maintenance Corp. v. Lezak , 69 N.Y.2d 1, 5 (1986) (citations omitted); see also , Hooper Associates, Ltd. v. AGS Computers, Inc. , 74 N.Y.2d 487, 491 (1989).  According to the Court of Appeals, “ he rule is based upon the high priority accorded free access to the courts and a desire to avoid placing barriers in the way of those desiring judicial redress of wrongs. The preferred remedy for deterring malicious or vexatious litigation has been the use of separate, plenary actions after the challenged proceedings have concluded.”  A.G. Ship , 69 N.Y.2d at 5 (citations omitted). Notwithstanding the general rule, however, “ t is not uncommon…for parties to a contract to include a promise by one party to hold the other harmless for a particular loss or damage and counsel fees are but another form of damage which may be indemnified in this way.”  Hooper , 74 N.Y.2d at 491 (citations omitted).  “A promise assuming the obligation to pay the attorney’s fees of another should not be found unless it can be clearly implied from the language and purpose of the entire agreement and the surrounding facts and circumstances.”  214 Wall Street Associates, LLC v. Medical Arts-Huntington Realty , 99 A.D.3d 988 (2 nd Dep’t 2012) (citations and internal quotation marks omitted). The propriety of an attorneys’ fee shifting provision in a lease that provided for the reimbursement of “attorneys’ fees to a lessor even if the lessor is in default” was the subject of the First Department’s decision in Matter of Krodel v. Amalgamated Dwellings Inc. , decided on November 8, 2018.  The Krodel Court found such a provision to be “unconscionable and unenforceable as a penalty.” The tenant in Krodel owned shares in a cooperative apartment.  The operative proprietary lease contained the following attorneys’ fees provision: If the Lessor shall incur any cost, fee or expense . . . including reasonable legal fees . . . in connection with any action or proceeding brought by the Lessee against the Lessor . . . which is based on an alleged default of the Lessor hereunder or which is based on any other matter or thing relating to this lease, or to any alleged failure by the Lessor to perform any act which the Lessor is required to perform . . . or to the shares of the Lessor issued to the Lessee, or to the Lessor's Bylaws, . . . such cost or expense shall be paid by the Lessee to the Lessor, on demand, as additional rent. (the “Attorneys’ Fees Provision”) The petitioner in Krodel was the transferee of shares in her cooperative apartment.  Although she paid the transfer fees, the lessor/respondent refused to transfer the shares to her.  As a result, petitioner sued the respondent/lessor for default under the lease and for statutory violations.  The respondent counterclaimed for attorneys’ fees under the Attorneys’ Fees Provision. Thereafter, respondent moved for summary judgment on its counterclaim and petitioner cross-moved for summary judgment dismissing the counterclaim.  The motion court granted petitioner’s cross-motion and denied respondent’s motion. The First Department found that the motion court “properly declined to enforce because it is unconscionable and unenforceable as a penalty.”  In so doing, the Court recognized the accepted notion that “ arties to a lease may contract for attorneys’ fees provided they are reasonable and not in the nature of penalty or forfeiture.”  (Citation, internal quotation marks and brackets omitted.) The determination of whether a provision is “an unenforceable penalty is a question of law, giving due consideration to the nature of the contract and the circumstances” (quoting, 172 Van Duzer Realty Corp. v. Globe Alumni Student Assistance Assn., Inc. , 24 N.Y.3d 528, 536 (2014)).  The Court, relying on Gillman v. Chase Manhattan Bank , 73 N.Y.2d 1, 10 (1988), stated that “ finding of unconscionability requires some showing of an absence of meaningful choice on the part of one of the parties together with contract terms which are unreasonably favorable to the other party.”  (Internal quotation marks omitted.) After recognizing that the question decided was one of first impression in the First Department, the Court held that: In the present case, we find that an attorneys' fees provision which provides that the tenant must pay attorneys' fees if it commences an action against the landlord based upon the default of the landlord is unconscionable and unenforceable as a penalty. of the proprietary lease permits the landlord to recover attorneys' fees when the tenant brings an action against the landlord even when the landlord is in default. To enforce such a provision would produce an unjust result because it would dissuade aggrieved parties from pursuing litigation and preclude tenant-shareholders from making meaningful decisions about how to vindicate their rights in legitimate instances of landlord default. TAKEAWAY While contractual provisions for shifting attorneys’ fees are widely utilized, their import may be eviscerated by overreaching.

Dismissal of Securities Fraud Claim in Federal Court Has No Preclusive Effect on Common Law Fraud Claims Brought in State Court Securities fraud and common law fraud have much in common. The core elements required to prevail on both claims are similar. Yet, dismissal of a federal securities fraud claim is not necessarily the death knell of a common law fraud claim. Recently, Justice O. Peter Sherwood of the Supreme Court, New York County, Commercial Division, reached this conclusion in Brown v. Cerebus Capital Management, LP , 2018 N.Y. Slip Op. 32782 (Sup. Ct., N.Y. County Oct. 30, 2018) ( here ). Common Law Fraud vs. Securities Fraud Common Law Fraud The essential elements of a common law fraud cause of action include: a material misrepresentation or omission of fact, knowledge of its falsity, reasonable reliance upon such misrepresentation or omission, and resulting damages. See Eurycleia Partners, LP v. Seward & Kissel, LLP , 12 N.Y.3d 553, 559 (2009). Under CPLR 3016(b), each element must be pled with particularity. Id . CPLR 3016(b) is satisfied when the facts in the complaint “permit a reasonable inference of the alleged conduct.” Pludeman v. Northern Leasing Sys., Inc. , 10 N.Y.3d 486, 491 (2008). In Pludeman , the Court of Appeals explained that the purpose of CPLR 3016(b) is to inform a defendant of the complained-of conduct. For that reason, CPLR 3016(b) “should not be so strictly interpreted as to prevent an otherwise valid cause of action in situations where it may be impossible to state in detail the circumstances constituting a fraud.” 10 N.Y.3d at 491 (internal quotation marks and citation omitted). Therefore, at the pleading stage, a complaint need only “allege the basic facts to establish the elements of the cause of action.” Id . at 492. Thus, a plaintiff will satisfy CPLR 3016(b) when the facts permit a “reasonable inference” of the alleged misconduct. Id . Securities Fraud To bring a claim under Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”), and Rule 10b-5 promulgated thereunder, a plaintiff must allege sufficient facts to establish that a defendant: (1) made misstatements or omissions of material fact; (2) with scienter ( i.e. , intent to deceive); (3) in connection with the purchase or sale of securities; (4) upon which the plaintiff relied; and (5) that plaintiff’s reliance was the proximate cause of his/her injury. In re Puda Coal Sec. Inc., Litig. , 30 F. Supp. 3d 261, 265-66 (S.D.N.Y. 2014) (quoting In re IBM Corp. Sec. Litig. , 163 F.3d 102, 106 (2d Cir. 1998)). In addition, a plaintiff alleging securities fraud must also satisfy the heightened pleading requirements of the Private Securities Litigation Reform Act of 1995 (“PSLRA”), 15 USC § 78u-4, and Rule 9(b) of the Federal Rules of Civil Procedure by stating with particularity the circumstances constituting the alleged fraud. ECA & Local 134 IBEW Joint Pension Trust of Chi. v. JP Morgan Chase Co. , 553 F.3d 187, 196 (2d Cir. 2009). This pleading threshold is intended to give a defendant notice of the claim, like CPLR 3016(b), but also is designed to safeguard the defendant’s reputation from “improvident” charges in strike suits. ATSI Commc’ns, Inc. v. Shaar Fund, Ltd. , 493 F.3d 87, 99 (2d Cir. 2007). Given the particularity requirement, a securities fraud complaint based on false and misleading statements “must (1) specify the statements that the plaintiff contends were fraudulent, (2) identify the speaker, (3) state where and when the statements were made, and (4) explain why the statements were fraudulent.” ATSI , 493 F.3d at 99. The PSLRA “expanded on the Rule 9(b) standard, requiring that securities fraud complaints specify each misleading statement; that they set forth the facts on which belief that a statement is misleading was formed; and that they state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.” Anschutz Corp. v. Merrill Lynch & Co. , 690 F.3d 98, 108 (2d Cir. 2012) (emphasis added). Thus, plaintiffs must “do more than say that the statements ... were false and misleading; they must demonstrate with specificity why and how that is so.” Rombach v. Chang , 355 F.3d 164, 174 (2d Cir. 2004). In short, unlike CPLR 3016(b), which only requires a “reasonable inference” of fraud, the PSLRA and Rule 9(b) require a “strong inference” that the defendant acted with the requisite state of mind. Brown v. Cerebus Capital Management, LP Background Plaintiffs, former mid-level managers of Covis Pharmaceuticals, Inc. (“CPI”), filed suit in connection with the grant of employment compensation they claimed to be part of a fraudulent scheme to deprive them of their compensation benefits. Plaintiffs were each recruited to build the distribution network for the Covis Enterprise (a collection of various CPI related entities), a pharmaceutical start-up founded in 2011 by former employees of GlaxoSmithKline PLC as a vehicle to obtain interests in the commercial rights of certain pharmaceutical products (the “Rights”), rebrand them, and sell them to other healthcare companies. With regard to compensation, Plaintiffs allegedly were told that they would be paid below-market salaries, but in exchange, would receive interests in the appreciation of the Rights, which would be worth more than tens of millions of dollars. Plaintiffs further alleged that, in reliance on this understanding, they built and managed CPI. Following their hire, Plaintiffs received an award of unvested profits interests (“Profit Interests”) through agreements with MIP I, which was created to provide profits incentives to Covis executives, directors, and managers (the “2012 Award Agreements”). The Profits Interests did not grant Plaintiffs any equity in the Covis Enterprise; instead, pursuant to contract, each received the potential to receive some of the profits of the Covis Enterprise, net of return of capital and repayment of debt. The 2012 Award Agreements allowed for 50% of the awarded Profits Interests to vest based upon continued employment over time, and the other 50% to vest if the company satisfied certain performance criteria. If and when fully vested, the Profits Interests afforded Plaintiffs a collective 1.25% stake in the Covis Enterprise’s profits. The 2012 Award Agreements made clear that continued employment was a condition of vesting, and that any unvested Profits Interests would be forfeit if employment was terminated, for any reason, whether voluntarily or involuntarily. In April 2013, the Covis Enterprise executed a corporate restructuring pursuant to a Master Restructuring Agreement. Pursuant to agreements with MIP II, which was also created to provide profits incentives to Covis executives, directors, and managers (the “2013 Award Agreements”), Plaintiffs surrendered their MIP I Profits Interests in exchange for equivalent Profits Interests in MIP II. The MIP I and MIP II Award Agreements and operating agreements are substantively identical. Plaintiffs signed the 2013 Award Agreements and received, as replacements for their interests under MIP I, Profits Interests under MIP II that granted equivalent interests in the profits of the Covis Enterprise. In the summer of 2014, two plaintiffs were terminated as employees due to a corporate restructuring, and one plaintiff voluntarily resigned. In December 2014, the employment of two plaintiffs ended as a result of CPI’s decision to eliminate its cardiovascular sales team. Pursuant to the 2013 Award Agreements, all of Plaintiffs’ unvested Profits Interests automatically forfeited back to MIP II as of their respective termination dates. At December 31, 2014, MIP II exercised its call right for Plaintiffs’ vested Profits Interests. Plaintiff’s Allegations Common to State and Federal Actions Plaintiffs alleged that the 2013 restructuring was a fraudulent scheme to wipe out their share of the Profits Interests and replace them with illusory interests in empty shell companies. Plaintiffs further alleged that Defendants made several extra-contractual false misrepresentations that they relied upon in executing the 2013 Award Agreements. In that regard, Plaintiffs alleged that Defendants falsely represented that Plaintiffs were entitled to 3.5% of the Covis Enterprise’s profits, and that any payments would be increased by 31% to account for taxes. Defendants also allegedly represented that the investment would be worth tens of millions of dollars – a representation Plaintiffs alleged was false. According to Plaintiffs, after they executed the 2013 Award Agreements, Defendants employed various schemes to “cancel” the Profits Interests, including setting impossible performance targets, and terminating Plaintiffs under false pretenses to prevent time-based vesting. Plaintiffs also claimed that Defendants failed to update certain disclosures to reveal merger negotiations that occurred in 2014, and the sale process in late 2013 that failed to receive any bids, which, if revealed, would have indicated to one Plaintiff that a sale of the Rights was imminent, and would have caused him not to resign. On March 9, 2015, the Covis Enterprise announced that it was selling substantially all of its assets to Concordia Healthcare Corporation (“Concordia”) for $1.2 billion. Plaintiffs filed suit, claiming they were entitled to greater payments based on the ultimate Concordia transaction. The Federal Litigation Plaintiffs filed their original action in the United States District Court for the Southern District of New York, asserting federal and state-law claims under the federal securities laws and the common law. Among other things, Plaintiffs alleged that: (1) Defendants violated Rule 10b-5(b) of the Exchange Act by telling Plaintiffs at the time of the 2013 restructuring that CPI’s managers were entitled to 3.5% of the Covis Enterprise’s profits, and promising that any payments would be increased by 31% to account for taxes; (2) Defendants violated Rules 10b-5(a) and (c) of the Exchange Act by terminating Plaintiffs’ employment and setting impossible performance targets, all to keep Plaintiffs’ Profits Interests from vesting; and (3) Defendants violated Rule 10b-5(b) of the Exchange Act by failing to inform one of the Plaintiffs about discussions to sell the Covis Enterprise’s assets, in order to dissuade him from resigning from his employment in August 2014. Defendants moved to dismiss the action, which Judge George B. Daniels granted with prejudice on December 12, 2016. In dismissing Plaintiffs’ federal claims, Judge Daniels declined to exercise supplemental jurisdiction over Plaintiffs’ state-law claims. In reaching that decision, Judge Daniels held that Plaintiffs failed to adequately plead scienter for their federal securities claims under the heightened pleading requirements of Rule 9(b) of the Federal Rules of Civil Procedure and the PSLRA. By summary order dated July 11, 2017, the United States Court of Appeals for the Second Circuit affirmed. The State Court Action and the Court’s Decision Thereafter, Plaintiffs filed suit in New York Supreme Court, asserting claims of common law fraud and violations of each Plaintiff’s state blue-sky laws, together with a variety of contract-based and quasi-contract claims. Defendants moved to dismiss. With regard to the fraud claims, Defendants argued that the claims were barred by the doctrine of collateral estoppel because they require scienter, and the federal court dismissed Plaintiffs’ federal claims for lack of scienter. The Motion Court rejected the argument. In denying the motion, the Motion Court observed that there was no preclusive effect resulting from the dismissal of Plaintiffs’ federal securities fraud claims because of the different standards for pleading scienter. After examining the elements of collateral estoppel – i.e. , (1) the issues in both proceedings are identical, (2) the issue in the prior proceeding was actually litigated and decided, (3) there was a full and fair opportunity to litigate in the prior proceeding, and (4) the issue previously litigated was necessary to support a valid and final judgment on the merits – the Motion Court concluded that “Defendants demonstrate that they satisfied the elements of collateral estoppel because the federal court did not decide issues identical to those raised here.” Defendants cannot demonstrate that they have satisfied the elements of collateral estoppel because the federal court did not decide issues identical to those raised here. The federal securities claims brought in the federal action were subject to Rule 9 (b) and the PSLRA, which require a plaintiff to allege “facts giving rise to a strong inference that the defendant acted with the required state of mind” (15 USC § 78u-4). In contrast, the complaint’s fraud claims are subject to the CPLR and “3016 (b) may be met when the facts are sufficient to permit a reasonable inference of the alleged conduct” ( Pludeman v North Leasing Sys., Inc. , 10 NY3d 486, 492 <2008> ). New York courts have uniformly held that the federal strong inference standard is higher than New York’s reasonable inference standard. Accordingly, because the federal court applied the strong inference standard to the federal action’s allegations of scienter, the federal dismissal is not preclusive of plaintiffs’ state law fraud claims. Citations omitted. Accordingly, the Court denied the motion to dismiss the fraud claims. Takeaway As discussed, federal securities claims are subject to the heightened pleading requirements of Rule 9(b) and the PSLRA. As such, a plaintiff must allege “facts giving rise to a strong inference that the defendant acted with the required state of mind.” 15 U.S.C. § 78u-4. By contrast, common law fraud claims brought in New York State courts are subject to CPLR 3016(b). To satisfy CPLR 3016(b), a plaintiff need only plead facts sufficient to permit “a reasonable inference of the alleged conduct.” Pludeman , 10 N.Y.3d at 491-92 (2008). Given the different pleading standards, New York State courts have routinely held that the federal standard is more exacting than New York’s standard. E.g. , Syncora Guar. Inc. v. Alinda Capital Partners, LLC , 2013 N.Y. Slip Op. 31489 , *18 (Sup. Ct., N.Y. County 2013) (CPLR 3016 (b) “is a more lenient test than the Second Circuit’s ‘strong inference of fraud’ test, in that it requires only that the complaint include ‘facts from which it is possible to infer defendant’s knowledge of the falsity of its statements.’”) (citation omitted); see also PMC Aviation 2012-1 LLC v Jet Midwest Grp., LLC , 2016 N.Y. Slip Op. 30972 , *14 (Sup. Ct., N.Y. County 2016) (“The particularity required by CPLR 3016 (b) is not as exacting as what is required under Rule 9 (b) in federal court”); NRAM PLC v. Societe Generale Corp. , 2014 N.Y. Slip Op. 32155 , *20 (Sup. Ct., N.Y. County 2014) (“The applicable New York standard requires only a ‘reasonable inference’ of scienter, while Rule 9(b) of the Federal Rules of Civil Procedure and its interpreting case law is far more demanding”). Brown adds its name to the list of cases that have recognized this difference.

< 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.