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Not every case can be brought in the federal court system.  Supreme Court Justice Antonin Scalia, in explaining the limited nature of federal court jurisdiction, stated that “ hey possess only that power authorized by the Constitution and statute, which is not to be expanded by judicial decree.” ( Kokkonen v. Guardian Life Insurance Company of America , 114 S.Ct. 1673, 1675 (1994) (citations omitted).)   Stressing his point, Justice Scalia continued by pointing out that, “ t is to be presumed that a cause lies outside this limited jurisdiction and the burden of establishing the contrary rests upon the party asserting jurisdiction.”  ( Kokkonen, 114 S.Ct. at 1675 (citations omitted).) The plaintiff in Hussian v. U.S. Bank National Assoc. (E.D.N.Y. June 7, 2018), brought an action in federal court seeking an emergency temporary restraining  order to stop the defendants from selling his home at a foreclosure sale after a judgment of foreclosure and sale was issued in a state court foreclosure action.  Hussian, the plaintiff, appeared in the federal action, pro se --  meaning that he represented himself without the assistance of legal counsel.  It seems that Mr. Hussian’s pro se status led the court to write an easy to understand opinion addressing the basics of federal court jurisdiction. Hussian attempted to invoke the Court’s federal question jurisdiction pursuant to 28 U.S.C. §1331 and diversity jurisdiction pursuant to 28 U.S.C. §1332 .  Section 1331 provides that federal district courts “…shall have original jurisdiction of all civil actions arising under the Constitution, laws, or treaties of the United States”.  Section 1332 provides that federal district courts “shall have original jurisdiction of all civil actions where the matter in controversy exceeds the sum or value of $75,000…” and involves: (1) “citizens of different States;” (2) citizens of a State and citizens of a foreign state; (3) “citizens of different States and in which citizens or subjects of a foreign state are parties; and, a foreign state, as plaintiff, citizens of a State or different States.”  Jurisdiction under 28 U.S.C. 1332(1) (citizens of different States) generally requires “complete diversity between all plaintiffs and all defendants,” meaning that none of the plaintiffs can be from the same state as any of the defendants.  ( Lincoln Property Co. v. Roche , 126 S.Ct. 606, 613 (2005) (Ginsburg, J.) (citations omitted).)  State (as defined with a capital “S”) includes the fifty states, the District of Columbia, Puerto Rico and the Territories of the Unites States. In determining that diversity jurisdiction does not exist, the Hussian court found that while Hussian “alleges diversity jurisdiction … complete diversity does not exist between the parties as Hussian and RAS are residents of New York, and thus appear to be citizens of the same state.” The Hussian court also found that there was no federal question jurisdiction under 28 U.S.C. 1331.  Hussian urged that 42 U.S.C. 1983, a civil rights statute, provided the requisite “federal question” to be in federal court. The court disagreed, stating that “Section 1983 requires that the conduct complained of must have been committed by a person acting under the color of state law and the conduct complained of must have deprived a person of rights, privileges or immunities secured by the Constitution or laws of the United States.”  (Internal quotation marks omitted.)  Acts of private individuals are not covered by Section 1983 and Hussian’s complaint did not allege that any of the defendants are “state actors.” Subject matter jurisdiction is so important, that “ ack of subject matter jurisdiction cannot be waived and may be raised at any time by a party or by the court sua sponte .” (Citation omitted.)  An action brought in federal court in the absence of subject matter jurisdiction “must” be dismissed.  The Hussian court did , however, grant plaintiff leave to serve an amended complaint, recognizing that “courts should allow plaintiffs to amend complaints to drop dispensable nondiverse defendants whose presence would defeat diversity of citizenship.” (Citation and internal quotation marks omitted.) The Hussian court also determined that plaintiff’s claim for injunctive relief challenging the state court foreclosure proceedings should be dismissed under the Younger abstention doctrine. Younger prohibits federal courts from hearing cases that “would disrupt state proceedings that: (1) are pending; (2) implicate important state interests; and (3) provide the plaintiffs an adequate opportunity to litigate federal claims.” (Citations and internal quotation marks omitted.)  The scope of the Younger abstention doctrine has been limited to three types of state court proceedings including “civil proceedings that implicate a State’s interest in enforcing the orders and judgments of its courts.”  (Citations and internal quotation marks omitted.)  “The Younger requirements are more than adequately satisfied when mortgage foreclosure proceedings, which concern the disposition of real property and hence implicate important state interests, are pending in state court, and there is no reason to doubt that the state proceedings provide the would-be federal plaintiff with an adequate forum to make the arguments he seeks to raise in federal court.”  (Citations omitted.) Similarly, the Hussian court recognized that it was without jurisdiction to intervene in plaintiff’s dispute concerning the judgment of foreclosure and sale because “judgments of foreclosure are fundamentally matters of state law.  (Citations omitted.)

This Blog has previously written about the difficulties plaintiffs often have distinguishing between direct and derivative claims. ( Here and here .) In today’s post, this Blog looks at Khan v. Garg , 2018 N.Y. Slip Op. 31061(U) (Sup. Ct. N.Y. County, May 30, 2018) ( here ). In Khan , the court dismissed a fraud claim because the plaintiff failed to demonstrate whether the claim belonged to the plaintiff or his company. A Brief Primer on the Applicable Rules Where the wrong is directed against a corporation, the claim belongs to the entity. The shareholder does not have an individual claim, even if the shareholder loses the value of his/her shares or incurs personal liability in an attempt to keep the corporation solvent. Abrams v. Donati , 66 N.Y.2d 951, 953 (1985); Serino v.  Lipper , 123 A.D.3d 34, 40 (1st Dept. 2014). “The distinction between derivative and direct claims is grounded upon the principle that a stockholder does not have an individual cause of action that derives from harm done to the corporation but may bring a direct claim when the wrongdoer has breached a duty owed directly to the shareholder which is independent of any duty owing to the corporation.” Accredited Aides Plus, Inc. v. Program Risk Mgmt., Inc. , 147 A.D.3d 122, 132 (3d Dept. (2017) (citation and internal quotation marks omitted). In determining whether a claim is direct or derivative, “a court must look to the nature or the wrong and to whom the relief should go.” Tooley v. Donaldson Lufkin & Jenrette, Inc. , 845 A.D.2d 1031, 1038 (Del. 2004). Specifically, the court should consider “(1) who suffered the alleged harm (the corporation or the suing stockholders, individually); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders, individually).” Yudell v. Gilbert , 99 A.D.3d 108, 114 (1st Dept. 2012) (internal quotation marks and citations omitted); Maldonado v. DiBre , 140 A.D.3d 1501, 1503-1504 (3d Dept. 2016). “The pertinent inquiry is whether the thrust of the plaintiff’s action is to vindicate his personal rights as an individual and not as a stockholder on behalf of the corporation.” Maldonado , 140 A.D.3d at 1504 (internal quotation marks and citation omitted). The plaintiff must show that the duty allegedly breached was owed to the shareholder, and that he/she can prevail without showing an injury to the corporation. Yudell , 99 A.D.3d at 114. If the individual claim of harm is “confused with or embedded” within the harm to the corporation, then it must be dismissed. Serino , 123 A.D.3d at 40; Patterson v. Calogero , 150 A.D.3d 1131, 1133 (2d Dept. 2017) (even where individual harm is claimed, if it is confused with or embedded in the harm to corporation, it cannot stand separately). Khan v. Garg In Khan , the Plaintiff, Raza Khan (“Plaintiff” or “Khan”), alleged that his business partner, Vishal Garg (“Defendant” or “Garg”), misappropriated funds from their business, Education Investment Finance Corporation (“EIFC”).  According to Khan, Garg did so on two occasions. First, in early 2012, Garg allegedly falsified EIFC’s records to reflect that EIFC owed Garg approximately $1.6 million for capital contributions that Garg had not made. Khan asserted that Garg then misappropriated EIFC funds and transferred those funds into Garg’s personal bank account. Second, in early May 2013, Garg allegedly withdrew $1,067,000 from EIFC accounts to satisfy his “pro-rata share of excess capital.” Khan alleged that Garg’s “pro-rata share of excess capital” was an illusion created by Garg’s manipulation of EIFC records to reflect the absence of capital contributions to EIFC by Khan. Khan brought suit “individually, in his official capacity as 50% owner of, and on behalf of ” against Garg. Khan alleged: (1) deadlock as to EIFC; (2) breach of fiduciary duty as to Garg; (3) conversion of EIFC assets by Garg; (4) fraud “by Garg” for falsifying EIFC’s financial records/tax returns to benefit Garg and entities owned/controlled by Garg; (5) tortious interference by Garg and Capital; (6) Garg’s failure to execute corporate documents on behalf of a non-party EIFC subsidiary; (7) conversion of EIFC funds by Garg to a MRU Lending (“MRU”), a company owned solely by Garg; (8) unjust enrichment against Garg as a result of EIFC payments to MRU; and (9) accounting. Garg moved, pursuant to CPLR 3211 (a) (7), to dismiss the fraud cause of action, arguing that Khan failed to plead the elements of intent, reliance, and injury. The Court granted the motion. As an initial matter, the Court observed that Khan failed to “specify whether the fraud claim is direct or derivative,” though the allegations in the complaint “indicate that intended to be direct.” In analyzing the allegations in the complaint, the Court found that Khan failed to “allege that he sustained any harm separate from that sustained by EIFC.” Here, the allegations supporting Khan’s fraud claim confuse Khan’s direct and derivative rights; therefore, the claim must be dismissed. Khan alleges that Garg intentionally induced Khan to rely on the EIFC financial records falsified by Garg, and those records made it appear that EIFC owed Garg $1.6 million. Thus, though Khan seeks to plead a direct claim for fraud, there is no individual harm alleged in the amended complaint: Khan does not allege that he sustained any harm separate from that sustained by EIFC. Derivatively, the Court found that Khan failed to satisfy the elements of a fraud claim: Construed as a purely derivative fraud claim, dismissal is still required. Khan does not adequately allege that Garg made a misrepresentation of fact (falsified EIFC’s records) with the intent of inducing EIFC’s reliance; instead, the allegations pertaining to Garg’s intent to induce reliance, and the resulting reliance on Garg’s misrepresentations, are assertions pertaining to Khan in his individual capacity. The amended complaint does not adequately plead a derivative fraud claim; indeed, Khan alleges that EIFC was the vehicle by which Garg defrauded Khan, individually, not EIFC in general. As a result, the Court dismissed the fraud claim. Takeaway The difference between a direct and derivative claim is not always easy to discern. For many practitioners, even those who devote most of their practice litigating derivative claims, the distinction between the two types of claims can be elusive. Nuance and subtlety often rule the day, leading to confusion and uncertainty. As Khan learned, the consequences of such confusion can (and often will) result in dismissal of one’s claims.

On May 8, 2018, the U.S. Government Accountability Office (GAO) issued recommendations for the purpose of increasing the effectiveness of paying whistleblowers to report illegal wildlife trafficking. Wildlife trafficking, one of the top-ranked illegal trades in the world, accounts for approximately $23 billion a year, with the United States as one of the greatest contributors. Animal Trafficking and the Push for Accountability According to the GAO report ( here ), trafficking has “pushed several endangered species to the brink of extinction,” devastating “wild populations of elephants, rhinoceroses, tigers, pangolins, turtles, exotic birds, and many other species.” The report was prepared at the request of Oregon Senator, Ron Wyden. It details the GAO’s findings of an audit of the U.S. Fish and Wildlife Service (FWS) and National Oceanic and Atmospheric Administration (NOAA) regarding their use of rewards for whistleblowers of wildlife crime, during the years 2007-2017. Both agencies have concurred with the GAO’s guidance and recommendations in letters of response. Senator Wyden believes that the agencies that have been tasked with protecting and combating the trafficking of endangered wildlife are not doing enough. He requested that the GAO look into the underuse of financial incentives as a method for encouraging whistleblowers to report such illegal conduct. In the House of Representatives, Rep. Madeleine Bordallo (D-GU) and Rep. Don Young (R-AK) recently introduced the Wildlife Conservation and Anti-Trafficking Act of 2018 (WCATA). ( Here .) The purpose of the legislation is to enhance the ability of informants worldwide to use qui tam laws to report wildlife crimes. The WCATA is a legislative fix that builds on the GAO’s findings by obligating FWS, NOAA, and many other federal agencies to augment and improve their use of financial rewards to pay wildlife trafficking whistleblowers. In her floor speech introducing the legislation, Rep. Bordallo said: “this bipartisan bill confronts the global black-market trade in illegal wildlife and seafood products driving iconic wildlife to extinction and responsible for countless human rights abuses.” If passed, the WCATA will mandate that the Department of Interior, the agency that oversees FWS, and the Department of Commerce, the agency that oversees NOAA, to create and implement wildlife whistleblower reward programs. It also mandates the establishment of Whistleblower Offices in several other agencies, and the creation of confidential and anonymous programs to report wildlife crimes. Under the WCATA, whistleblowers would receive at least 15%, and as much as 50%, of the funds recovered from successful prosecution. Anonymous Whistleblower Files Complaint Against Facebook According to a recently filed complaint by an anonymous whistleblower to the Securities and Exchange Commission regarding Facebook, the social media giant has been accused of being one of the world’s largest sources for endangered wildlife trafficking. Attorneys for the anonymous whistleblower released a statement: The amount of wildlife being traded on closed and secret groups on Facebook is horrifying. We saw multiple products: rhino horn, bear claws, tiger skins, reptiles, and tons and tons of ivory. At a time when the world is losing 30,000 elephants a year to poachers, the amount of ivory sold on Facebook is particularly shocking. Over months of working undercover, the attorneys traveled abroad to confirm that the products listed on Facebook were in fact real. Chat apps, including WhatsApp, have been used to communicate things like pricing of the illegal items. Is Facebook Compliant with Trafficking? For Stephen Kohn, the pro-bono executive director for the National Whistleblower Center, the lack of follow-through is appalling. “I’ve done whistleblowing for 33 years. Seen pretty much everything. And for criminal activity to be this open and for the United States government not to be cracking down on it aggressively, is absolutely shocking. You can go on Facbook today and you’ll see every single endangered species for sale. Some live, some dead. It’s pretty shocking. What we saw immediately was the Facebook was most likely the number one source of trafficking worldwide.” Kohn claims that Facebook had been made aware of the illegal activities occurring on its site despite Mark Zuckerberg’s denial of knowledge. He argues that Facebook is guilty of more than just housing illegal activity or failing to properly monitor itself, but that it is “aiding and abetting” the crimes. They are no longer a neutral party. They are no longer an innocent bystander. You can look at the page where the trafficker puts the item and right next to it, there are advertisements. They are profiting from that trafficking. Our belief is the moment they ran those ads on trafficker pages, they’re actually outside the immunities. The Global Wildlife Whistleblower Program continues to fight against the illegal wildlife trafficking industry. Takeaway It should prove interesting to see whether Facebook can be held liable for profiting off of the illegal activity. On the legislative front, the WCATA appears to be a step in the right direction. It would empower federal agencies responsible for the enforcement of wildlife trafficking to use whistleblowers in the fight against illegal wildlife trafficking. As this Blog has noted in prior posts, whistleblowers can be an effective tool in the fight against wrongdoing.

There are numerous situations in which the value of real estate becomes an issue in litigation – condemnation proceedings, tax certiorari proceedings and calculating deficiency judgments in foreclosure proceedings – to name a few.  Sometimes, when the value of a particular property is at issue, a recent “arm’s length” sale of that same property provides the best assessment of its value.  “Although value and price are not necessarily synonymous, the rule has evolved that the purchase price set in the course of an arm’s length transaction of recent vintage, if not explained away as abnormal in any fashion, is evidence of the ‘highest rank’ to determine the true value of the property at the time.”  ( Plaza Hotel Associates v. Wellington Associates, Inc. , 37 N.Y.2d 273 (1975).) Frequently, however, there is not a recent sale of the very property that requires valuation.  Sometimes there is a recent sale of the subject property, but the sale price is not truly reflective of market value.  This circumstance can arise where, for example, the property was sold: at a judicial sale; by a seller under pressure to sell; to a buyer with a special need for that exact piece of property. In such circumstances, courts can determine the value of real property by the reports and/or testimony of expert real estate appraisers.  “New York case law is clear that expert appraisal evidence is the method for proving the value of real property in litigation.” NexBank, SSB v. Soffer (Sup. Ct. May 18, 2018) (“ NexBank 2018 ”).  NexBank 2018 makes plain the importance of appraisal evidence in litigation involving real estate valuation, as well as the importance of timely making expert disclosure. The underlying facts and circumstances related to NexBank 2018 are long and tortured; involving litigation and appeals in numerous related actions in New York and Nevada.  Some necessary facts are set forth in the NexBank court’s Decision and Order dated October 18, 2017 (“NexBank 2017”) Simply, Turnberry/Centra Sub, LLC (“Turnberry”) borrowed $475 million to purchase a shopping center in Las Vegas.  Jeffrey and Jacquelyn Soffer are principals of Turnberry.  To secure the loan, in part, Jeffrey and Jacquelyn delivered personal guaranties to the lender (the “Guaranties”).  When the underlying loan was not repaid at maturity, the lender “began the process of foreclosing on the deed of trust, and taking title to the property.”  ( See NexBank 2017.) The property was sold for $276.5 million at a non-judicial foreclosure sale to TSLV LLC, an entity affiliated with several entities that purchased a controlling share of the underlying debt on the secondary market.  ( See NexBank 2017.) Just prior to the sale, however, Jeffrey and Turnberry commenced an action in Nevada “to enforce what he alleged to be a binding commitment by the Lenders to restructure the oan <(the “restructure action”)> .”  (See NexBank 2017)  In the context of the Restructure Action, Jeffrey recorded a lis pendens and otherwise sought specific performance remedies that affected title to the property.  ( See NexBank 2017.) In 2013, NexBank, SSB v. Soffer , was commenced in the Supreme Court, New York County, to collect on the Guaranties.  The amount of damages due under the Guaranties increased if the Guarantors voluntarily encumbered the property, and the lis pendens filed in, and some of the relief sought by, the Nevada Action were determined to have done just that (the “Encumbrances”). Accordingly, one element of damages due to the lender under the Guaranties is the difference between the $527 million unencumbered value of the property at the relevant date and the value on that date as encumbered by the Encumbrances.  The lender argued that the encumbered value of the property was the $276.5 million paid by TSLV LLC at the foreclosure sale. ( See NexBank 2017.)  The court, however, rejected the lender’s analysis and, in so doing, expressed numerous concerns about that sale being an “arm’s length” transaction.  ( See NexBank 2017.) The court set a July 20, 2016 deadline for filing expert reports and the lender filed its Note of Issue on November 11, 2016.  Prior to both of those dates, the lender failed to serve an expert report.  Instead, it made the decision to rely on the foreclosure sale price as its measure of market value on the relevant date.  However, on December 8, 2017, the lender moved by Order to Show Cause for “leave to supplement its expert disclosure.”  By NexBank 2018 , the court denied the motion. The court recognized: that it has broad powers to supervise disclosure and control its dockets; and, the importance of enforcing fact and expert discovery deadlines.  The court also noted that “Commercial Division Rule 13 requires a plaintiff who intends to call an expert at trial to submit a report after the close of fact discovery, but before the filing of a Note of Issue. See 22 NYCRR §202.70.  ‘Expert disclosure provided after without good cause will be precluded from use at trial.’ Id .”  ( See NexBank 2018 (emphasis in original).) In exercising its discretion to deny the lender’s application to file new expert reports “more than a year after the deadline”, the court noted that “this court and others in the Commercial Division have precluded expert reports served well after the court ordered deadline”; a practice approved by the Appellate Division. ( See NexBank 2018.) In finding that “good cause” was not proffered “to justify service of late expert reports,” the court stated: The facts, record evidence, and the parties’ legal theories were clearly established prior to the filing of the Note of Issue.  Plaintiff made the calculated decision to attempt to prove damages exclusively through its credit bid and the unencumbered value of the property….  “In fact, instead has argued extensively in this action that expert testimony would be unreliable and inappropriate.  instead has argued that its lay witness testimony and documentary evidence is sufficient to prove its damages and in fact is a better, more reliable method of proof than expert testimony. ( See NexBank 2018 (citations and footnote omitted).) After noting that case law and NexBank 2017 made plain that “expert testimony was required to prove the Property’s encumbered value”, the court stated: It is simply implausible to believe that plaintiff and its counsel, who are extremely sophisticated, were unaware of this rule.  Instead, for strategic reasons, they chose not to rely on expert testimony.  Now that the court has squarely rejected that approach, plaintiff seeks a second bite at the apple and proffers new expert reports.  Plaintiff cites no commercial case in which such a tactic was approved or found to constitute good cause.  This court sees no reason to permit parties to preview the court’s view of their trial strategy at summary judgment, and then abandon that strategy if the court signals that it is unlikely to prevail.  To hold otherwise would severely prejudice defendants.  Summary judgment is an exercise in issue spotting for trial.  It is not, for the unsuccessful movant, an opportunity to reformulate its case. Plaintiff’s stark pivot in its proposed proof is simply too great to permit at this late stage….To force the defendants to now counter these new expert opinions, which require further rebuttal reports and depositions, is extremely prejudicial on the eve of trial.  Under these circumstances, it is simply too late for plaintiff to deviate from the course it has charted. ( See NexBank 2018 (citations and footnote omitted).) TAKEAWAY Early on in litigation, consideration should be given to whether there is a need for expert disclosure.  Further, litigants should not assume that disclosure deadlines will routinely be extended.

Is an entity providing pre-construction management services in anticipation of a construction project entitled to file a mechanic’s lien if not paid?  While recognizing that there is a dearth of caselaw on this question, the court in Matter of Old Post Road Associates, LLC (Sup. Ct. Westchester Co. May 9, 2018), held that the answer is dependent on the specific nature of the pre-construction services provided. Old Post Road Associates, LLC (“Old Post” or “Petitioner”) owned a piece of property it intended to develop (the “Project”). LRC Construction, LLC (“LRC” or “Respondent”) was “engaged” to perform pre-construction management services in conjunction with the Project including “updating the conceptual budget for the roject and attending meetings with etitioner’s consultants to discuss construction phasing in connection with the site plan approval application.”  According to the opinion, LRC performed its pre-construction services for free with the hope that it would be retained as the construction manager for the Project.  However, LRC was terminated from the Project without being hired in its desired role.  It appears that the parties believed that LRC should have been compensated for its pre-termination work, but an agreement on the amount could not be reached. Thereafter, LRC filed a mechanic’s lien in the amount of $250,000.00 and claimed the amount due was for “pre-construction management services”.  To discharge the lien, Old Post brought a special proceeding pursuant to New York’s Lien Law § 19 , which provides numerous bases for the discharge of a mechanic’s lien.  The provision relied upon by Old Post (§ 19(6)) permits the discharge of a lien “ here it appears from the face of the notice of lien that the claimant has no valid lien by reason of the character of the labor or materials furnished and for which a lien is claimed….”  Old Post argued that, as a firm rule, “pre-construction management services” cannot support a mechanic’s lien. In denying the petition to summarily discharge Old Post’s mechanic’s lien, the Old Post court analyzed the relevant provisions of the Lien Law and the scant caselaw (which was from a “handful of trial-level court rulings” and “has not been addressed by appellate authority” since Goldberger-Raabin, Inc. v. 74 Second Ave. Corp. , 252 N.Y. 336 (1929), was decided almost 90 years ago) on the subject of whether certain work is or is not an “improvement” under the Lien Law. The statutory authorities relied upon by the Old Post court were §§ 3 and 2(4) of New York’s Lien Law.   Section 3 provides that a “contractor…who performs labor or furnishes materials for the improvement of real property with the consent or at the request of the owner…shall have a lien for the principal and interest, of the value, or the agreed price, of such labor….” (Emphasis supplied.) “Improvement” is defined at Lien Law §2(4) to include “demolition, erection, alteration or repair of any structure upon, connected with, or beneath the surface of, any real property and any work done upon such property or materials furnished for its permanent improvement…and shall also include the drawing by any architect or engineer or surveyor, of any plans or specifications or survey, which are prepared for or used in connection with such improvement….” The Old Post court also relied on caselaw.   Goldberger-Raabin involved tearing down an old building and replacing it with a newly constructed building. The lienor in Goldberger-Raabin was the project engineer responsible for “aiding or assisting in procuring subcontracts and subcontractors” and “superintending the construction of the new building and tearing down of the old building”.  The former was held not to be part of the work that “improved” the property and, thus, was not lienable.  As to the latter, the Goldberger-Raabin Court, found that superintending the new construction was lienable as was superintending the demolition of the old building – provided that “the old building was torn down as part of the work necessary for construction and for the improvement of the real property”.  Such a determination, however, was a factual question to be determined “upon a new trial”. The Old Post court also cited Chas. H. Sells, Inc. v. Chance Hills Joint Venture , 163 Misc.2d 814 (Sup. Ct. Westchester Co. 1995) and Henry & John Assoc. v. Demilo Constr. Corp. , 137 Misc.2d 354 (Sup. Ct. Queens Co. 1987) for the proposition that “the procurement of bids or application for building permits and approvals” are not lienable.  The Chas. H. Sells court did hold that architects and engineers that rendered services in conjunction with obtaining permits for a project that was never commenced and, therefore, where “no actual physical permanent improvement has taken place” were entitled to liens for unpaid work, reasoning that because “a landowner fails to take a project to completion, for whatever reason, the claims for work done to improve the property are no less entitled to the benefits of the statute.” Based on the foregoing, the Old Post court found that the mere fact that a lienor may have rendered services on a pre-construction basis does not, in and of itself, resolve the issue of whether an otherwise validly filed lien must be discharged.  Instead, the actual services provided must be analyzed, and a determination must be made, as to whether the services resulted in a permanent improvement to real property.  In Old Post, the court determined that some of the services provided were subject to liens (i.e. “preparing site logistics and access plans for the property and performing a constructability review for the project at the property) and some were not (i.e. procuring permits or bids).  Accordingly, the Old Post court held that “ n the absence of clear case law precluding mechanic’s liens for all the types of work respondent now describes, and construing the Lien Law liberally Lien=">Lien" Law="Law" §23="§23"> , this Court concludes that respondent’s lien is not entirely invalid on its face, and therefore denies the petition for summary discharge.” TAKEAWAY Before performing “pre-construction” services or work on a project to permanently improve real property, consideration should be given to whether such services or work may support the filing of a mechanic’s lien.  This is particularly so if there are any concerns as to the owner’s ability or willingness to pay for such services. As an aside, the Old Post court described the decision in 8 th Ave. Recoveries Corp. v. 111 Stellar 8 Owner, LLC , 42 Misc.3d 1212(A) (NOR) (Sup. Ct. Kings Co. 2104), as “inapposite” and less persuasive than the other authorities cited by it.  In so doing, the Old Post court summarized the 8th Avenue decision as “ invalid a mechanic’s lien for purported supervisory work that occurred after construction work had ceased” (emphasis in original) quoting the 8 th Avenue court’s reasoning that “supervision of construction work may be the basis of a lien, where the property is not being improved, there is nothing to supervise and thus no basis for a lien.” The relevant issue in 8 th Avenue , however, was whether the subject lien was timely filed, which issue necessarily turned on whether the lienor performed supervisory work on the project within the eight-month period preceding the filing of the lien.  (See Lien Law §10(1) .)  The 8 th Avenue court determined that it did not and vacated the lien as having been untimely filed.  It is suggested that had the 8 th Avenue court been called on to answer the identical question posed in Old Post , it would likely have come to the same conclusion as the Old Post court.

Margin abuse occurs when investment professionals take advantage of investors that do not entirely appreciate the risk associated with margin-based investments. In fact, these professionals have a duty to ensure that the investor understands the danger of such an account before entering into an investment agreement. Failure to meet this duty could result in legal liability.  What Does Buying on Margin Mean? When you “buy on margin,” you are purchasing securities with (at least partly) borrowed money. Borrowed money can come from virtually any source, but when you use an investment firm, you must create a “margin account” with that firm. By engaging in this type of investing, you increase your overall purchasing power, which can, in turn, increase your return on your investment. These accounts have minimal risk for the investment firm, and they generate income as well. The advice that you might get from an investment firm or advisory firm is to buy on margin—because they often have commissions or other financial incentives to push you in that direction. Nonetheless, margin investing comes with several risks attached for you, even though it is relatively safe for the investment firm. What is a Margin Call? When you buy on margin, you generally purchase part of the securities with your own money and finance the rest. When you make this type of arrangement, the securities you bought are the collateral for the remaining portion of the investment. If the collateral value dips below a certain amount, the investment firm can take steps to increase their position. This process is generally referred to as a “margin call.” The investment firm will require you to add more money to the margin account. If you do not do this within a specified timeframe, then they can start liquidating your securities to increase the value of the account. There are no extensions for margin calls, making them very risky and potentially very costly. Other Risks Associated with Buying on Margin Investing on margin is not for the faint of heart. It is possible that the entire security could have little to no value, which would require that the investor input more money for an asset that is virtually worthless. While you really take that risk with any investment, buying on margin makes the potential losses a multiple of what you actually invested. You are also charged interest and/or fees for having the margin loan. This means that you could end up paying for the margin loan before you make any money on the securities. Forced sales due to a margin call could also mean that you sell the securities long before you would in a typical investing situation, significantly decreasing your overall return. Margin call abuse does happen. If you have been forced into fronting more money or your securities have been sold because of a margin call, you may have legal options. Investors should consult an attorney to understand whether they have been the victim of margin abuse .

San Francisco-based Credit Karma, Inc. ("Credit Karma" or the "Company"), the rapidly growing financial services tech company, has been penalized by the Securities and Exchange Commission ("SEC") for regulatory violations related to its Employee Stock Ownership Plan ("ESOP"). The SEC alleged that the Company unlawfully offered securities to its employees and failed to provide them with timely financial statements and risk disclosures.  A copy of the press release announcing the settlement can be found here . The Credit Karma Penalty In the tech sector, stock options are used as a perk to attract and retain highly-skilled workers. Between October 1, 2014, and September 30, 2015, the company issued about $13.8 million in employee stock options, above the regulatory threshold of $5 million.  In the SEC’s Order instituting cease-and-desist proceedings ( here ), the SEC found that Credit Karma did not register its offer of stock options.  Instead, the Company sought to rely on Securities Act Rule 701, which allows privately-held companies to compensate their employees with securities without incurring the obligations of public registration and reporting as long as, once the company issues $5 million worth of securities, it provides essential information about the investment to employees. The SEC found that even though financial statements and risk disclosures were available and confidentially provided to potential institutional investors, Credit Karma failed to provide this information to its own employees. “Registration requirements exist to ensure that all investors have access to important information before deciding to invest,” Jina Choi, director of the SEC’s office in San Francisco, said in a prepared statement. “This is equally true for employees who are investors in the companies where they work.” The alleged wrongdoing occurred while Credit Karma was rapidly growing and hiring employees at a dramatic pace. “Between 2014 and 2016, Credit Karma headcount increased by a factor of five to support an additional 20 million new members,” Credit Karma stated in comments emailed to news organizations.  In early 2014, for example, the Company had about 100 employees. By the end of 2016, the number spiked to about 500. Credit Karma presently employs about 750 people, most of whom are located in San Francisco. The SEC also found that Credit Karma executives were aware of the disclosure requirements regarding the stock options as early as April 2015.  Notwithstanding, “ or the next eleven months after August 2015, Credit Karma continued to grant employees stock options and allowed them to exercise their vested stock options granted in the unregistered offering.” The SEC concluded that “ lthough Credit Karma periodically provided certain limited financial information to its employees, it failed to deliver to the employees the complete financial information and disclosures required by Rule 701.”  Credit Karma also allowed employees to exercise vested stock options, but failed to deliver complete financial information and other required disclosures to employees.  After the Company received an inquiry from the SEC regarding its Rule 701 disclosures in July 2016, Credit Karma began providing disclosure packets to its employees.  According to Credit Karma, the violations have ceased. “We have been in full compliance since mid-2016,” the company stated. The SEC concluded that Credit Karma violated the registration requirements of the Securities Act of 1933 because it offered to sell and sold its securities to employees without a valid Rule 701 exemption. As a result, without admitting or denying the allegations in the Order, Credit Karma consented to the civil penalty and the SEC ordered Credit Karma to cease and desist from any further registration violations. The Takeaway The Credit Karma action is the first enforcement proceeding to arise out of the SEC's investigation into Rule 701 option-granting practices.  The settlement reinforces the SEC’s concern that private companies are not providing to employees the disclosures mandated under Rule 701. The Credit Karma action teaches the importance of Rule 701 compliance. Private companies should, therefore, examine their procedures and controls for ensuring that Rule 701 disclosures are made in a reasonable amount of time before options are exercised if the $5 million threshold is met, or if the company anticipates that the threshold will be met. The Credit Karma action also teaches that companies should carefully consider the methods by which Rule 701 disclosures are made to ensure that they permit effective and ongoing access to the disclosure information. Finally, private companies should keep in mind that until the SEC states otherwise, Rule 701 disclosures must be made prior to the grant of the stock options.

When a complaint is served and filed, a defendant can respond to the pleading in many ways. For example, he/she can answer the complaint or file a motion to dismiss. If the defendant files an answer or the court denies the motion, discovery ensues. Sometimes, a party may conclude that the facts and law necessitate the filing of a motion for summary judgment, even before the close of discovery. Regardless of the timing, the moving party must establish their prima facie entitlement to judgment as a matter of law. The failure to do so, as the defendants learned in UB Distributors, LLC v. S.K.I. Wholesale Beer Corp. , 2018 N.Y. Slip Op. 03559 (2d Dept. May 16, 2018) ( here ), will result in denial of the motion. Background The plaintiff, UB Distributors, LLC (“UB”), commenced the action against the defendants, asserting causes of action sounding in fraud, negligent misrepresentation, conversion, and unjust enrichment, among other things. UB alleged that the defendants fraudulently obtained payments from it under the Returnable Container Act by redeeming empty beverage containers that had already been redeemed by a deposit initiator. In particular, UB alleged that sudden and drastic shifts in the defendants’ empty container redemption volume indicated fraudulent activity and corresponded in time with a double-redemption scheme uncovered on Long Island in the summer of 2009. The defendants denied the allegations and asserted counterclaims against UB. The defendants moved for summary judgment dismissing the complaint, arguing, among other things, that UB lacked any direct evidence of their participation in the scheme. UB opposed the motion and cross-moved for summary judgment dismissing the defendants’ counterclaims. The motion court denied the motion and cross motion. The defendants appealed the denial of their motion. The Appellate Division, Second Department, affirmed. The Standard on Summary Judgment A defendant seeking summary judgment bears the initial burden of demonstrating its entitlement to judgment as a matter of law by submitting evidentiary proof in admissible form, even though the ultimate burden of proof at trial falls upon the plaintiff. See Zuckerman v. City of New York , 49 N.Y.2d 557, 562 (1980). For this reason, the ultimate burden of proof after trial plays no part in the assessment of whether there are relevant factual issues presented on a motion for summary judgment. See generally Jacobsen v. New York City Health & Hosps. Corp. , 22 N.Y.3d 824 (2014). On a motion for summary judgment, a moving defendant must affirmatively demonstrate the merit of its claim or defense. The movant cannot satisfy this burden by merely pointing to gaps in the plaintiff’s case. See Marielisa R. v. Wolman Rink Operations, LLC , 94 A.D.3d 963 (2d Dept. 2012). See also Winegrad v. New York Univ. Med. Ctr. , 64 N.Y.2d 851 (1985). The court’s function on a motion for summary judgment is “to determine whether material factual issues exist, not to resolve such issues.” Lopez v. Beltre , 59 A.D.3d 683, 685 (2d Dept. 2009). A motion for summary judgment, therefore, “ ‘should not be granted where the facts are in dispute, where conflicting inferences may be drawn from the evidence, or where there are issues of credibility’ ” Ruiz v. Griffin , 71 A.D.3d 1112, 1115 (2d Dept. 2010), quoting Scott v. Long Is. Power Auth. , 294 A.D.2d 348, 348 (2d Dept. 2002). See also Bykov v. Brody , 150 AD 3d 808, 809 (2d Dept. May 10, 2017) (“Resolving questions of credibility, determining the accuracy of witnesses, and reconciling the testimony of witnesses are for the trier of fact.”) (citation and internal quotation marks omitted). The Court’s Ruling The Court found that denial of summary judgment was appropriate in light of the credibility issues of the witnesses and the conflicting inferences that could be drawn from the evidence submitted. The Court explained: Here, the defendants failed to establish their prima facie entitlement to judgment as a matter of law. While the defendants submitted the deposition transcripts of their two principals and warehouse manager in which those witnesses denied that the defendants engaged in a double-redemption scheme, those witnesses also testified that the defendants kept no records of their container redemption transactions or records of a “cashbox” they used to pay some of their redemption expenses. Those witnesses offered vague and conflicting testimony as to why the defendants’ redemption volume fell so drastically around the time prosecutors acted on the double-redemption scheme on Long Island. Where, as here, conflicting inferences can be drawn from the evidence and issues of credibility exist, summary judgment is inappropriate. “In light of the defendants’ failure to meet their prima facie burden,” the Court “agree with the Supreme Court’s determination to deny their motion for summary judgment, regardless of the sufficiency of the plaintiff’s opposition papers.” Takeaway UB Distributors is a good example of the shifting burdens associated with a summary judgment motion. As a general matter, the courts view the evidence submitted in a light most favorable to the party opposing the motion and give the non-movant the benefit of every favorable inference. Cortale v. Educ. Testing Serv. , 251 AD 2d 528, 531 (2d Dept. 1998).  Notwithstanding, the burden remains on the proponent of the motion to establish entitlement to summary judgment as a matter of law.  Failure by the movant to make the prima facie showing will result in the denial of the motion, regardless of the sufficiency of the opposing paper. See Alvarez v. Prospect Hosp. , 68 N.Y.2d 320, 324 (1986); Winegrad v. New York Univ. Med. Ctr. , 64 N.Y.2d 851, 853 (1985).  However, if the movant makes the requisite showing, the burden shifts to the party opposing the motion for summary judgment to produce evidentiary proof in admissible form sufficient to establish the existence of material issues of fact that require a trial of the action. Zuckerman , 49 N.Y.2d at 562. In UB Distributors , since the defendants could not meet their burden, the burden never shifted to UB to establish the existence of material issues of fact necessary to defeat the motion.

In the United States, support for legalizing marijuana has been growing. Thirty states and the District of Columbia have enacted legislation that legalize marijuana in some form. Eight states and the District of Columbia allow recreational use of marijuana. According to a 2017 Gallup Poll, 64% of Americans support legalizing marijuana for recreational use. With marijuana becoming more accepted, the cannabis industry has grown. Many of the companies fueling this growth are publicly traded and listed on the MJIC Marijuana Index ( here ) – the Index includes 17 companies, including four that are based in Canada but operate in the United States. As public companies, these entities are required to disclose material information about their business and operations. Legitimate companies do so when newsworthy information, both good and bad, necessitates such dissemination. Companies issuing multiple press releases during a compressed period of time, e.g. , daily or weekly, that only speak glowingly of the entity may be disseminating false information to shareholders and potential investors. Against this background, this Blog will examine the latest SEC enforcement actions against a penny stock cannabis company and its chief executive officer (“CEO”), among others.  The first action involves Bud Genius Inc. (“Bud Genius”), a medical marijuana firm run by Aaron “Angel” Stanz (“Stanz”), that issued false financial statements and claimed to have a licensing agreement with comedian Tommy Chong of Cheech and Chong fame. SEC v. Bud Genius, Inc. , Civil Action No. 18-cv-01005 (S.D. Cal. Filed May 21, 2018). (A copy of the complaint can be found here .) In the complaint, the SEC alleged that Bud Genius, a Wyoming corporation previously known as Rightsmile, Inc., and Stanz, the company’s sole director and CEO, issued false and misleading press releases about a purported licensing agreement with comedian Tommy Chong. In one press release, Stanz allegedly described Chong as a “partner,” and in a subsequent blog post, he described the purported licensing agreement with Chong as a “crowning achievement.” The agreement never materialized, and the defendants allegedly knew at the time that, in light of Bud Genius’s weak financial position, it was extremely unlikely that an agreement would ever be reached. The SEC charged that the defendants’ false and misleading claims about the agreement were picked up by multiple media outlets. The defendants also are alleged to have published fraudulent financial statements and to have facilitated an unregistered offering of Bud Genius securities. The unregistered offering is the subject of a second action filed by the SEC in the Northern District of Iowa against Taylor Moffitt, Carlos Febles, and U.S. CoProducts LLC. SEC v. Moffitt , Civil Action No. 18-cv-03034 (N.D. Iowa Filed May 22, 2018) (A copy of the complaint can be found here .) The SEC alleged that the defendants acquired, offered, and sold billions of shares of unregistered Bud Genius stock for a total profit of more than $540,000, approximately $140,000 of which was paid to Bud Genius and Stanz. Regarding the company’s financial condition, the SEC alleged that between 2012 and 2014, Bud Genius issued materially false and misleading financial reports to the investing public. In 2012, 2013, and the first three quarters of 2014, for example, the defendants allegedly inflated the company’s “total revenue” by adding revenue generated by the company and that of a charter jet business owned by Stanz. In 2012, and the third quarter of 2014, the defendants allegedly inflated the company’s “intangible assets” related to software developed overseas. Under GAAP, while some initial and preliminary development costs are expensed, costs incurred to develop website and computer software during the application development stage are capitalized using their historical ( i.e. , actual) cost. In the case of Bud Genius, the software development work was primarily performed by foreign subcontractors at a significant lower cost than if the work was performed in the U.S. The SEC claimed that Stanz knowingly assigned an inflated and unjustifiable value to the intangible assets by estimating what the cost would have been to perform the development work in the U.S., even though the actual cost was much less. Although the company’s accountant advised that the valuation violated GAAP, “Stanz insisted on going forward with the inflated valuation.” Finally, for 2013 through 2014, Bud Genius and Stanz allegedly reported loan payments owed to Bud Genius by a company owned by consultant Taylor Moffitt as “accounts receivable”. By mischaracterizing the loan as an “account receivable,” the SEC claimed that Bud Genius and Stanz created the false and misleading impression that the company was generating, or had previously generated, more business and operating revenue than was actually the case. Without admitting or denying the SEC’s allegations, Stanz agreed to a judgment enjoining him from violating Sections 5(a), 5(c), 17(a)(1) and 17(a)(3) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, imposing five-year officer-director and penny stock bars, and ordering disgorgement and prejudgment interest of $158,829. Without admitting or denying the SEC’s allegations, Bud Genius agreed to a judgment enjoining it from violating Sections 5(a), 5(c), 17(a)(1) and 17(a)(3) of the Securities Act, and Section 10(b) of the Exchange Act, and Rule 10b-5 thereunder. The settlements are subject to court approval. Without admitting or denying the SEC’s allegations, Moffitt, Febles, and U.S. CoProducts agreed to a judgment enjoining them from violating Sections 5(a) and 5(c) of the Securities Act and all three will be jointly and severally liable for $435,595 in disgorgement and prejudgment interest. In addition, Moffitt and Febles agreed to penny stock bars of three years and one year respectively, and to pay civil penalties of $35,000 and $20,000, respectively. These settlements also are subject to court approval. A copy of the SEC press release announcing the two enforcement actions can be found here .

Litigation of residential mortgage foreclosure actions in New York remains prevalent at the trial and appellate court levels.  Issues related to residential mortgage foreclosure are frequently treated in this Blog. ( Here , here , here , here and here .) It is not uncommon for an individual faced with the prospect of losing a home to foreclosure, to file a bankruptcy petition on the eve of a foreclosure sale in an effort to stop the sale.  Section 362 of the Bankruptcy Code , provides that the filing of a bankruptcy petition “operates as a stay, applicable to all entities, of…the commencement or continuation … of a judicial … or other action or proceeding against the debtor that was or could have been commenced before the commencement of the case under this title….”  (11 U.S.C. 362(a)(1).)  There is no doubt that the filing of a bankruptcy petition, in general, operates to stay mortgage foreclosure actions.  See Lubonty v. U.S. Bank National Association , 159 A.D.3d 962 (2d Dep’t 2018). The stay of a foreclosure sale frequently serves a legitimate purpose consistent with the objectives of the Bankruptcy Code.  Many times, however, the opposite is true and, in such cases, the Bankruptcy Code has some built in protections to prevent abuse.  One such provision of the Bankruptcy Code, known as “Three Strike Rule”, provides that: If a single or joint case is filed by or against a debtor who is an individual under this title, and if 2 or more single or joint cases of the debtor were pending within the previous year but were dismissed, other than a case refiled under a chapter other than Chapter 7 after dismissal under section 707(b), the stay under subsection (a) shall not go into effect upon the filing of the later case. 11 U.S.C. 362(c)(4)(A)(i). In USAA Federal Savings Bank v. Gotsch (Sup. Ct. Suffolk Co. May 10, 2018) ( here ), the Court relied on this provision to deny the mortgagor defendant’s request that the court invalidate the foreclosure sale of residential real property that he owned (the “Property”). The facts in Gotsch are simple. Gotsch borrowed $350,000 from plaintiff and secured the obligation to repay the resulting note with a mortgage on the Property.  When Gotsch defaulted in the repayment of the loan, USAA commenced a residential foreclosure action. Gotsch defaulted in answering the complaint and failed to appear at the scheduled foreclosure settlement conference.  Both of plaintiff’s subsequent motions, for an order of reference and then for a judgment of foreclosure and sale, were granted on default. On the day of the first foreclosure sale, Gotsch filed a petition under Chapter 13 of the Bankruptcy Code that stayed the sale (the “First Bankruptcy”).  The First Bankruptcy was dismissed a few months later.  A second foreclosure sale was scheduled and, on the day that it was to occur, Gotsch filed his second petition under Chapter 13 of the Bankruptcy Code (the “Second Bankruptcy”).  The Second Bankruptcy was dismissed two months later. A third foreclosure sale was scheduled and, on the day it was to occur, Gotsch filed a third petition under Chapter 13 of the Bankruptcy Code (the “Third Bankruptcy”). Despite Gotsch’s “bald” allegation that he notified the lender’s attorney, and that his realtor notified the foreclosure sale referee, of the filing of the Third Bankruptcy, the scheduled sale went forward, and the subject property was sold at public auction.  Within a few weeks of the foreclosure sale, Gotsch moved by Order to Show Cause (the “OSC”) to “invalidate the foreclosure sale” based on, inter alia , violations of the automatic stay provisions of the Bankruptcy Code.  The OSC contained a temporary restraining order prohibiting, inter alia , the transfer of the Property. The several arguments were made in opposition to the motion.  The lender argued that, by virtue of the Three Strike Rule, there was no automatic stay in place upon the filing of the Third Bankruptcy because there were “two or more bankruptcy cases … pending against within the previous year were dismissed….”  It was also argued that because there was ample evidence in the record that Gotsch did not reside at the Property, he would not be prejudiced or irreparably harmed if the sale was sustained. The Third Bankruptcy was dismissed within two months of the filing of the OSC. Relying on the Three Strike Rule and Second Department authority interpreting same, the Gotsch court held that there was no automatic stay in effect on the day of the third foreclosure sale.  The Court also held that there was no evidence to set aside the sale using its “broad equitable powers” that could be invoked in the face of “fraud, collusion, mistake, or misconduct cast doubt on the fairness of the sale.”  The Court further found that “the evidence suggests that three bankruptcy filings, each one initiated on the same day as a scheduled Foreclosure Sale, were brought simply to delay the sale of the subject property and may fairly be characterized as an abuse of the legal system.”  (Citations omitted.)

This Blog has previously examined the different aspects of a shareholder’s derivative action, such as the standing requirements and the distinction between direct and derivative claims. ( Here , here and here .) Today’s article revisits these issues. The Demand Futility Requirement Under Delaware law, to have standing to bring a derivative claim on behalf of a corporation, a plaintiff “must make a pre-suit demand that the board pursue the contemplated action.” Asbestos Workers Phila. Pension Fund Asbestos Workers v. Bell , 137 A.D.3d 680, 682 (1st Dept. 2016). “A pre-suit demand upon a board may be excused, however, if such a demand would have been ‘futile.’” Id .  Either allegation must be pled with particularity in order for a derivative claim to survive a motion to dismiss. See , e.g. , Brehm v. Eisner , 746 A.2d 244, 254 (Del. 2000). Where the “subject of the derivative suit is not a business decision of the board” but, instead, is a wrong committed against the company by a third party, or the board’s inaction, demand is only excused when the plaintiff alleges facts “rais a reasonable doubt that … the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand.” Rales v. Blasband , 634 A.2d 927, 934 (Del. 1993). “ o rebut the presumption of disinterestedness under the Rales test, the plaintiff must plead particularized facts that, if proved, would establish that a majority of the directors face a ‘substantial likelihood’ of personal liability for the wrongdoing alleged in the complaint.” Wandel v. Dimon , 135 A.D.3d 515, 517 (1st Dept. 2016). Demand futility is examined with respect to the board’s membership at the time the complaint is filed. Braddock v. Zimmerman , 906 A.2d 776, 785 (Del. 2006). The Distinction Between Direct and Derivative Claims Where the wrong is against a corporation, the shareholder does not have an individual claim, even if the shareholder loses the value of his/her shares or incurs personal liability in an attempt to keep the corporation solvent. Abrams v. Donati , 66 N.Y.2d 951, 953 (1985); Serino v.  Lipper , 123 A.D.3d 34, 40 (1st Dept. 2014). “The distinction between derivative and direct claims is grounded upon the principle that a stockholder does not have an individual cause of action that derives from harm done to the corporation but may bring a direct claim when the wrongdoer has breached a duty owed directly to the shareholder which is independent of any duty owing to the corporation.” Accredited Aides Plus, Inc. v. Program Risk Mgmt., Inc. , 147 A.D.3d 122, 132 (3d Dept. (2017) (citation and internal quotation marks omitted). In determining whether a claim is direct or derivative, “a court must look to the nature or the wrong and to whom the relief should go.” Tooley v. Donaldson Lufkin & Jenrette, Inc. , 845 A.D.2d 1031, 1038 (Del. 2004). Specifically, the court should consider “(1) who suffered the alleged harm (the corporation or the suing stockholders, individually); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders, individually).” Yudell v. Gilbert , 99 A.D.3d 108, 114 (1st Dept. 2012) (internal quotation marks and citations omitted); Maldonado v. DiBre , 140 A.D.3d 1501, 1503-1504 (3d Dept. 2016). “The pertinent inquiry is whether the thrust of the plaintiff’s action is to vindicate his personal rights as an individual and not as a stockholder on behalf of the corporation.” Maldonado , 140 A.D.3d at 1504 (internal quotation marks and citation omitted). The plaintiff must show that the duty allegedly breached was owed to the shareholder, and that he/she can prevail without showing an injury to the corporation. Yudell , 99 A.D.3d at 114. If the individual claim of harm is “confused with or embedded” within the harm to the corporation, then it must be dismissed. Serino , 123 A.D.3d at 40; Patterson v. Calogero , 150 A.D.3d 1131, 1133 (2d Dept. 2017) (even where individual harm is claimed, if it is confused with or embedded in the harm to corporation, it cannot stand separately). Glaubach v. PricewaterhouseCoopers, LLP In Glaubach v. PricewaterhouseCoopers, LLP , 2018 N.Y. Slip Op. 30875(U) (Sup. Ct., N.Y. County, May 9, 2018) ( here ), Justice O. Peter Sherwood of the Supreme Court, New York County, considered the foregoing principles in dismissing an action brought against, among others, PricewaterhouseCoopers, LLP (“PwC”) for accounting malpractice. Background In 2010, Plaintiff, Felix Glaubach (“Glaubach”), the founder, former president, and a minority shareholder of Personal Touch Holding Corp. (“Personal Touch”), a home health services company, took a medical leave of absence from Personal Touch. From 2010 through 2011, several Personal Touch executives, particularly chief executive officer David Slifkin (“Slifkin”), executive vice-president and general counsel Robert Marx (“Marx”), and vice-president Gertrude Balk (“Balk”), caused Personal Touch to pay themselves undeclared and undisclosed income that was improperly classified as reimbursement of education expenses that they never incurred. When Glaubach recovered from his illness and returned to Personal Touch, he blew the whistle on the fraud and improprieties. In 2013, the Internal Revenue Service (“IRS”) audited the company. Personal Touch hired counsel to represent it in the audit. The firm discovered the fraud and advised Glaubach of it. Glaubach personally paid $827,759 to the IRS and the New York State Treasury to address the wrongdoing perpretrated by the company’s executives. On July 2, 2013, Slifkin resigned from the board of directors. Notwithstanding Slifkin’s resignation, Glaubach claimed that the board, which added four new directors, was beholden to him. In July 2014, Glaubach demanded that the board take action with regard to the financial improprieties previously identified. That demand was followed up with a demand letter in October 2014 letter, and again in January 2015. In February 2015, the board appointed a committee consisting of newly appointed board members to investigate the allegations. During this time, PwC performed independent audits of Personal Touch’s consolidated financial statements and issued opinion letters with respect thereto. In March 2015, Glaubach commenced a derivative action in Supreme Court, Queens County, in which he asserted claims against all of the members of the board and company officers. Glaubach claimed that he incurred $5 million in legal expenses in that action. In 2016, Glaubach commenced the action in New York Supreme Court against PwC, asserting one derivative claim for accounting malpractice (first cause of action), and the remaining claims as direct claims arising from the fraudulent misconduct by the executives at the company (second through seventh causes of action). Glaubach asserted that for years he had a “direct relationship of trust” with PwC, and that each year PwC discussed the financial health of the company with Glaubach at Personal Touch’s offices. He also asserted that he discussed with PwC his role as a 27% shareholder, as a lender of $10 million, and the importance of the audits to his own financial decisions. PwC was told of the fraud and improper activities and reexamined and reevaluated the previous years’ financial statements to address those issues. Glaubach claimed that due to the fraudulent activities at the company and the alleged accounting malpractice, the value of the company had severely declined, and the value of his shares had plummeted. Glaubach stated that he loaned millions of dollars to the company, and that he had spent millions of dollars in legal fees to try to repair the damage to the company and to his reputation. PwC moved to dismiss, contending that Glaubach’s direct claims against it were derivative, and that it did not owe any duty to Glaubach independent of any duty it owed to Personal Touch. It also contended that the nature of the damages Glaubach sought demonstrated that the claims were derivative. As to the derivative claim, PwC contended that Glaubach failed to plead demand futility. The Court agreed and dismissed the complaint in its entirety. The Court’s Ruling The Court found that Glaubach failed to make a pre-suit demand on the board to pursue a  malpractice claim against PwC, or allege that such a demand would have been futile. The Court rejected Glaubach’s reliance on his letter demands because they were not directed at the claimed auditor malpractice: First, while Glaubach alleges “demands” that he made on the board of directors, his demands were for the Board to investigate alleged wrong doing of certain company executives, not to investigate and commence an action against PwC for auditing malpractice. Specifically, he demanded that the Board take “‘action against all parties who received monies fraudulently characterized as ‘educational expenses.’” This fails to satisfy Delaware’s presuit demand requirement for the derivative accounting malpractice claim. Moreover, the Court held that “the complaint fail to sufficiently allege demand futility.” The Court found that Glaubach failed to allege “particular facts establishing that a majority of the board at the time plaintiffs commenced this action was interested or lacked independence,” as required under Delaware law. The Court went on to note that “Plaintiffs fail to allege that any, much less a majority, of the directors faced a substantial likelihood of liability for PwC’s alleged malpractice.” The complaint failed to allege that “there were direct ties between PwC and Personal Touch’s board members, or any allegations that the board was dominated by a director or officer who condoned PwC’s alleged improper conduct.” (Citations omitted.) The Court further noted that the complaint did “not even detail the size of the board or its current composition, or that a majority of them were involved in, or even stood to gain by any alleged fraudulent conduct, or other improper conduct by PwC.” As such, Glaubach failed “to meet the heightened pleading standard set forth in Delaware Chancery Court Rule 23.1, as it failed to plead in a ‘director-by-director’ fashion, instead, asserting conclusory and speculative statements about the board.” (Citations omitted.) The Personal Touch executives Glaubach asserts were looting the company for their personal benefit, Slitkin, Balk, and Marx, were not a majority. In fact, Slifkin resigned from the Board in July 2013, and these executives were not alleged to have control over the board. Glaubach’s conclusory allegations that the board is populated by persons with “ties to” one of the alleged wrongdoers, falls far short of the requirement of particularized allegations that a majority of the board would face a substantial likelihood of personal liability. Accordingly, the Court dismissed the accounting malpractice claim against PwC. The Court also dismissed the remaining claims against PwC, holding that they were derivative, rather than direct, claims. As such, they “should have been pleaded as derivative claims, and were required to meet the demand requirements” discussed above. Here, Glaubach’s claim for damages based on the lost value of his shares is derivative. “The lost value of an investment in a corporation is quintessentially a derivative claim by a shareholder.” Because Glaubach’s alleged damage for lost share value is not any different from the losses suffered by any other shareholder, and his claim is supported by the identical proof, it is not viable as a direct claim, as a matter of law. All of the shareholders of Personal Touch are harmed by PwC’s alleged auditing failures and would recover pro rata in proportion with their ownership of the company’s stock because they are stockholders. In addition, his claim for damages in the amount of $2.2 million for the allegedly false continuing education reimbursements clearly alleges injuries suffered by the company, which would receive the benefit of any recovery, not the individual shareholders. The Court rejected Glaubach’s attempt to convert the action into a direct one by alleging that PwC made misrepresentations to him personally, or that PwC knew that he had a financial interest in the company. Such allegations, held the Court, were “unsubstantiated.” Similarly, the Court rejected Glaubach’s attempt to convert the action into a direct one because of the damage to his reputation “as a pioneer in the health services industry” and for lost earnings, “because they are inextricably intertwined within the derivative claim.” The Court noted that while Personal Touch did “not have any right to recover for damage to Glaubach’s reputation in the health services community, it is the financial difficulties that the company suffered as a result of the financial mismanagement and purported looting that could have negatively impacted his reputation.” The Court held that this claim was “indistinguishable from the embedded claims.” Finally, the Court rejected the argument that Glaubach had a relationship with PwC that converted the claim to a direct one. Contrary to Glaubach’s contentions, the amended complaint fails to allege and seek recovery for any personal damages for an individual, personal contractual relationship with PwC. Glaubach does not allege that he ever hired or paid PwC to perform any services for him individually. The annual engagement letters demonstrate that PwC was retained by Personal Touch, not Glaubach, and that it was for services for the company, not for him personally. Glaubach was not a party to a commercial contract with PwC that he was seeking to enforce in his own right. His allegations that he made personal financial decisions in reliance upon PwC’s audits of Personal Touch do not convert these derivative claims into direct claims. Takeaway Glaubach demonstrates that a board’s failure to act is “possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment.” Asbestos Workers , 137 A.D.3d at 684. One reason for such difficulty is the demand requirement. The cases show that the demand requirement is rigorous. Factual particularity is necessary. As Justice Sherwood found, Glaubach could not meet those requirements.

Contract provisions containing deadlines for giving notice of an event or occurrence, such as a claimed default, are key parts of commercial transactions. These provisions vary from contract to contract, often requiring different forms of notice and different timing requirements for notice to be given on different issues. Not surprisingly, notice provisions, and compliance with these provisions, are often a basis for disputes. Recently, the Delaware Court of Chancery underscored the importance of the foregoing. In PR Acquisitions, LLC v. Midland Funding LLC , C.A. No 2017-0465-TMR (Del. Ch. April 30, 2018) ( here ), the court barred a claim made for funds held in escrow because the subject agreements required notice to be sent to the seller, but instead notice was sent to the escrow agent. Although the buyer gave actual notice by phone to the seller prior to the deadline, the Court rejected such notice as violative of the agreements. Background PR Acquisitions involved the sale of consumer debt accounts by Plaintiff PR Acquisitions, LLC (“PRA”) to Defendant Midland Funding LLC (“Midland”) pursuant to a purchase and escrow agreement. The agreements required that claims for funds held in escrow based, for example, on alleged breaches of the parties’ representations and warranties, be sent to an address provided in the agreement. Midland drafted a letter identifying legal claims against the escrow in relation to the purchase agreement. Midland sent the letter by facsimile and FedEx to the escrow agent rather than PRA as required under the agreements. Midland never sent a copy of the letter or any other form of notice to PRA. A few days later, the escrow agent informed PRA of the letter containing Midland’s claims. Midland conceded that the sole reason for its failure to provide notice pursuant to the purchase agreement and escrow agreement was “ uman error” on its side. PRA asked Midland to release the escrow funds and disputed the claims set forth in the letter. Midland refused to release the escrow funds. PRA filed suit seeking the release of the escrow funds. Midland asserted counterclaims against PRA and third-party claims against Operating Partners Co., LLC, an affiliate of PRA that serviced the purchased accounts, alleging contractual breaches, fraud, aiding and abetting fraud, negligent misrepresentation, indemnification claims, and unjust enrichment arising from the sale of the accounts. A couple of months later, PRA moved for summary judgment on its request to release the escrow funds. Amendments to the counterclaims followed, along with motions to dismiss the counterclaims. On December 8, 2017, Midland moved for partial summary judgment, seeking declaratory judgment that the escrow funds should not be released until Midland’s counterclaims and third-party claims were adjudicated. The Court granted PRA’s motion and denied Midland’s motion. The Court’s Analysis Noting that “ he applicable provisions in the Purchase Agreement and Escrow Agreement express and clear,” the Court rejected Midland’s argument that notice by means other than those set forth in the agreement ( e.g. , by telephone) should suffice. To establish a timely claim, the Escrow Agreement requires that notice be sent either by a nationally recognized courier service or by certified mail to a specified PRA address, or by facsimile to a specified PRA location followed by a telephone call to confirm receipt thereof. If Midland fails to provide notice by these methods by the expiration date, then the terms of the transaction documents negotiated by the parties dictate that the escrow funds should be released. Midland acknowledges that it did not comply with these requirements. But Midland notes that the escrow agent made PRA aware of Midland’s escrow claims before the expiration date. Midland argues that because PRA received actual notice, case law allows the Court to ignore the terms of the notice requirements in the Escrow Agreement. Midland further argues that the actual text of the Purchase Agreement and Escrow Agreement do not require strict compliance with the notice provision. These arguments fail. Strict Compliance with The Terms of The Contract is Required The Court rejected Midland’s argument that actual notice to PRA by phone should suffice as substantial compliance with the agreements. It did so by distinguishing several cases that Midland relied on.  None of the cases, however, allowed for substantial compliance when the agreement specified a particular method of delivery to a specific party by a fixed deadline as a condition for claims to an escrow fund. PRA and Midland are sophisticated parties who negotiated the Purchase Agreement and Escrow Agreement at arm’s length. Further, in each case to which Midland points, the party actually transmitted notice to whom it was due. Here, Midland sent notice to a third party (the escrow agent) who then informed PRA of Midland’s escrow claims. Thus, I reject Midland’s argument that Midland substantially complied with the notice provision in the Escrow Agreement. The Court also rejected Midland’s argument that the agreements did not require “strict compliance” with the notice provision. The Court noted that the Escrow Agreement specified “what constitute notice and require the release of the escrow funds if such notice not provided by” the specified date. Midland failed to satisfy the provision and offered “no reason other than its own error for its failure to comply with the notice provision in the escrow agreement.” Consequently, the Court granted PRA’s motion for summary judgment and denied Midland’s motion for partial summary judgment. Takeaway While the result in PR Acquisition may seem a bit harsh, especially since Midland gave PRA actual notice, the analysis employed to get there reflects traditional contract interpretation. As the Court noted, “ he terms of the contract control when they establish the parties’ common meaning so that a reasonable person in the position of either party would have no expectations inconsistent with the contract language.” Slip op. at 16 (citations and internal quotation marks omitted). In PR Acquisition , “ he applicable provisions in the Purchase Agreement and Escrow Agreement express and clear.” Id . at 17.  As such, “the terms of the transaction documents negotiated by the parties dictate ” how and when notice was to be provided and the circumstances under which the escrow funds should be released. Therefore, as a matter of law, the failure to comply with the express terms of the notice provision compelled the result reached by the Court. Given the foregoing, PR Acquisition provides a cautionary tale about the importance of complying with contractual provisions.