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The Public Company Accounting Oversight Board (“PCAOB” or the “Board”) is a nonprofit corporation established by Congress to oversee the audits of public companies. The Board was created as part of the Sarbanes-Oxley Act of 2002 in response to the accounting scandals at Enron Corp. and WorldCom Inc. – scandals that cost investors billions of dollars. Prior to the creation of the Board, the profession was self-regulated. The PCAOB protects investors by promoting informative, accurate, and independent audit reports. It does so by, among other things, inspecting the audits of public companies conducted by registered public accounting firms. Through these inspections, the PCAOB assesses the audit firms’ compliance with the statutes, regulations, and professional standards governing the accounting profession. The PCAOB selects the audit engagements it will inspect based on confidential internal analysis and thereafter notifies the firms of the audits it will inspect. The PCAOB typically issues inspection reports, only parts of which are made public, after all the inspections for a firm are complete. To ensure the integrity of the inspection process, the PCAOB closely guards the confidentiality of both its inspection targets prior to firm notification and its methodology for selecting those targets. All PCAOB employees must certify that they are complying with PCAOB Ethics Rules, which prohibit employees from using confidential PCAOB information for private gain (or even merely creating the appearance that they are) and that bar them from making unauthorized disclosures of confidential information obtained during their employment. These prohibitions apply even after employment with the Board has ended. The Securities and Exchange Commission (“SEC” or the “Commission”) has oversight authority over the PCAOB, including the approval of the Board’s rules, standards, and budget. (For more information about the PCAOB, click here .) Recently, a group of former senior partners at one of the Big Four accounting firms was charged with obtaining confidential information on planned audit inspections and used it to avoid negative assessments of the firm’s work. On January 22, 2018, the SEC announced ( here ) that it brought charges against six certified public accountants – including former staffers at the PCAOB and former senior officials at KPMG LLP – arising from their participation in a scheme to misappropriate and use confidential information relating to the PCAOB’s planned inspections of the accounting firm. In two separate orders, the SEC’s Division of Enforcement and Office of the Chief Accountant (“OCA”) alleged that the former PCAOB officials made unauthorized disclosures of PCAOB plans for inspections of KPMG audits, enabling the former KPMG partners to analyze and revise audit workpapers in an effort to avoid negative findings by the Board. Two of the former PCAOB officials had left the Board to work at KPMG. The SEC alleged that the third official leaked PCAOB data at the time he was seeking employment with KPMG. According to the SEC, the misconduct began in 2015 and continued until February 2017. Soon after the conduct was discovered, the six accountants were terminated, resigned or placed on leave before separating from KPMG and the PCAOB, respectively. “As alleged, these accountants engaged in shocking misconduct – literally stealing the exam – in an effort to interfere with the PCAOB’s ability to detect audit deficiencies at KPMG,” said Steven Peikin, Co-Director of the SEC’s Enforcement Division. “The PCAOB inspections program is meant to assess whether firms are cutting corners, compromising their independence, or otherwise falling short in their responsibilities. The SEC cannot tolerate any scheme to subvert that important process.” In a parallel action, the U.S. Attorney’s Office for the Southern District of New York announced the commencement of criminal charges against the six accountants. ( Here .) As set forth in the orders instituting public administrative and cease-and-desist proceedings ( here and here ), the Enforcement Division and OCA alleged that while preparing to leave his supervisory position at the PCAOB for a job at KPMG, Brian Sweet (“Sweet”) downloaded confidential and sensitive inspection-related materials that he believed might help him at KPMG. KPMG had recruited him to join the firm at a time when it had a high rate of audit deficiencies. According to the SEC, nearly half of the KPMG audits that the PCAOB inspected in 2013 were found deficient. After leaving the PCAOB, Sweet allegedly continued to gain access to confidential PCAOB materials through Cynthia Holder (“Holder”), a PCAOB inspector. After Holder joined Sweet at KPMG, a third PCAOB employee, Jeffrey Wada (“Wada”), allegedly leaked confidential information about planned PCAOB inspections of KPMG to Holder. According to the SEC, Wada leaked this information while he was seeking employment at KPMG. The SEC alleged that upon his arrival at KPMG, Sweet told his supervisors that he had taken confidential materials from the PCAOB and revealed, for example, the KPMG audit clients that the PCAOB intended to inspect that year. According to the SEC, Sweet’s supervisors – David Middendorf, KPMG’s then-national managing partner for audit quality and professional practice and Thomas Whittle, KPMG’s then-national partner-in-charge for inspections and another high-level partner at the firm, David Britt, KPMG’s banking and capital markets group co-leader – encouraged him to divulge the stolen information to them and others at the firm. The Enforcement Division and OCA alleged that Middendorf, Whittle, Sweet, Holder, and Britt worked together to review the audit workpapers for at least seven banks they were told the PCAOB would inspect in an effort to minimize the risk that the PCAOB would find deficiencies in those audits. Middendorf and Whittle allegedly instructed that no one disclose that they had confidential PCAOB information. Sweet agreed to settle to a Commission Order requiring that he cease-and-desist from violating PCAOB Ethics Rules and barring him from appearing or practicing before the Commission as an accountant based on findings that he, among other things, violated PCAOB Ethics Rules regarding confidentiality and lacks integrity. In a statement, the PCAOB said it cooperated with investigators and when it learned of the alleged misconduct it reviewed and reinforced the safeguards against improper disclosure of confidential information. “The new PCAOB Board will conduct an ongoing review of the organization’s information technology and security controls, as well as its compliance and ethics protocols, to assess their effectiveness,” PCAOB Chairman William Duhnke said in a statement. A KPMG spokesman said that the firm has been cooperating with the government investigation. “KPMG took swift and decisive action, including the engagement of outside legal counsel to conduct a detailed investigation and the separation of involved individuals from the Firm.” Takeaway: Audited financial statements are at the heart of the SEC’s disclosure-based regulatory regime: a company’s financial statements provide investors with a wealth of information, and independent audits give investors confidence that those statements can be trusted. Conduct that undermines this regime is inimical to the efficiency and effectiveness of the capital markets. It is important therefore for the Board to enhance its controls and compliance protocols to restore the public trust in the audits of the financial statements of public companies.

The Financial Industry Regulatory Inc. ("FINRA") recently proposed establishing a roster of arbitrators specifically qualified to adjudicate expungement cases, a concept that was initially recommended by FINRA’s regulatory task force in December 2015. What is an expungement? The expungement process allows a customer complaint regarding a broker to be removed from FINRA’s online database known as BrokerCheck. By relying on arbitrators with the necessary background and training to oversee expungement cases, FINRA hopes to address concerns that the process grants expungement requests without considering the merits of a case. Critics contend that this alters a broker’s online profile and hides disciplinary problems. In particular, the Public Investors Arbitration Bar Association contends the FINRA arbitration system has granted expungement requests far too often. On the other hand, proponents of expungement say that it clears the record of a broker who has been accused of wrongdoing unfairly. FINRA’s New Expungement Panels Under the proposal, a three-person panel would be selected from the list of arbitrators to handle expungements of settled cases. The panel would also hear cases requested by a broker, provided the request for a hearing is made within one year of the close of an underlying case. Brokers would be required to appear at a hearing, and the panel must vote unanimously to grant the expungement. It is worth noting that in FINRA arbitration cases in which an award is granted, the panel that presided over the dispute would also hear the expungement case. Arbitrators from the special roster would hear matters that are settled by other means. "The proposals help address concerns related to arbitration panels granting expungement requests without hearing the full merits of the underlying case," Richard Berry, FINRA executive vice president and director of its Office of Dispute Resolution, said in a statement. Finra also believes the proposed changed will make it easier for customers to participate in expungement hearings and that information about underlying cases will be more readily available to the arbitration panels. The Takeaway Ultimately, the proposal is designed to provide more structure to the expungement process, regularize it, and make it more predictable. Previous FINRA guidance to arbitrators advises that  expungements should be granted only in “extraordinary circumstances.” Whether the proposed changes to the expungement process will provide enhanced safeguards to investors remains to be seen.  The proposal is open for public comment until Feb. 5. 2018.

In two recent blog posts entitled: “ Appellate Division, Second Department Tells Foreclosing Residential Lender to ‘SHOW ME THE EVIDENCE ’” and “ The Second Department Denies Summary Judgment to Another Foreclosing Mortgagee Due to the Insufficiency of Evidence Presented on the Motion ,” foreclosing mortgagees were cautioned that evidence in admissible form must be submitted to the court to demonstrate compliance with the many statutory provisions that must be followed to ensure a successful foreclosure action.  In Bank of New York Mellon v. Zavolunov (2 nd Dep’t January 17, 2018) , the Court once again reiterates the importance of the need for sufficient evidence when it comes to satisfying the burdens of a summary judgment movant in mortgage foreclosure actions.  While Zavolunov was a residential mortgage foreclosure action, the decision is instructive in all cases where proof of mailing is a necessary requisite to a parties’ prima facie case. As previously discussed on this Blog, RPAPL 1304(1) and (2) requires, inter alia , that at least ninety days prior to commencing a foreclosure action against a borrower with respect to a “home loan” (as defined in the relevant statutes (a “Home Loan”)), a lender must send written notice to the borrower by certified and regular mail that the loan is in default.  Such notice must: be sent to the borrower’s last known address and to the residence that is the subject of the foreclosure; provide a list of approved housing agencies that provide free or low-cost counseling; and, advise that legal action may be commenced after ninety days if no action is taken to resolve the matter. The lender in Zavolunov (the “Lender”) commenced an action to foreclose a mortgage on a Home Loan and alleged in its complaint that it served the required RPAPL 1304 notices.  The Zavolunov supreme court granted Lender’s motion for summary judgment and the borrower appealed. In reversing the supreme court on this issue, the Zavolunov Court recognized that “ roper service of RPAPL 1304 notice on the borrower or borrowers is a condition precedent to the commencement of a foreclosure action, and the plaintiff has the burden of establishing satisfaction of this condition.”  (Citations and internal quotation marks omitted.)  The Zavolunov Court also cautioned that a lender moving for summary judgment “must prove its allegations by tendering sufficient evidence demonstrating the absence of material issues as to its strict compliance with RPAPL 1304.” (Citations and internal quotation marks omitted.) In support of its motion for summary judgment, the Zavolunov plaintiff provided an affidavit from a representative of Lender’s loan servicer asserting that more than ninety days prior to the commencement of the foreclosure action “notice was sent to Defendant by certified mail and first class mail to the last known address of the Defendant and, if different, to the residence that is the subject of the mortgage.”  Annexed to the affidavit were copies of the 90-day notices “all of which contained a bar code with a 20-digit number below it”.  However, the Court noted that the notices contained no language “indicating that a mailing was done by first -class or certified mail, or even that a mailing was done by the U.S. Postal Service”.  Moreover, the Zavolunov Court also found that the Lender’s representative failed to make the “requisite showing that he was familiar with the plaintiff’s mailing practices and procedures, and therefore did not establish proof of a standard office practice and procedure designed to ensure that items are properly addressed and mailed.”  (Citations and internal quotation marks omitted.) Because the Zavolunov Court found that the Lender failed to establish that complied with the requirements of RPAPL 1304, it held that the supreme court should have denied the Lender’s summary judgment motion. TAKEAWAY Whether specifically related to RPAPL 1304 or otherwise, proof of compliance with statutory and/or contractual notice requirements is important.  It is also important that all evidence of required statutory and/or contractual compliance is submitted to the Court.  For example, a contemporaneous affidavit of mailing from the individual that actually mailed the notice indicating that he/she actually deposited the notice in a mailbox or delivered the notice to the post office, might have satisfied the Second Department.  It might also help to have had photocopies of the addressed envelopes with proper postage and, where applicable, the certified mail card affixed to the envelope.  The Second Department also suggests that it was looking for an indication on each of the respective notices as to how it was mailed (i.e., regular mail or certified mail).  If the evidence suggested here was presented, perhaps the Second Department would have found compliance with RPAPL 1304. Many times, it is difficult for a bank employee to undertake to actually place notices in a mail box or to personally deliver a notice to the post office.  In such situations, as suggested by the Second Department, proof of compliance with notice requirements can be satisfied by the submission of an affidavit by someone with knowledge, of the company’s standard office procedures regarding the mailing of notices and other documents explaining the nature of such procedures and attesting to the fact that all such procedures were followed in the given case.

Last month, the Second Circuit reinstated a securities class action against Alibaba Group Holding Ltd. (“Alibaba” or the “Company”) and four of its senior executives for making materially false and misleading statements and omissions in connection with the Company’s September 2014 initial public offering (“IPO”). In June 2016, Chief Judge Colleen McMahon of the U.S. District Court for the Southern District of New York dismissed the complaint because the plaintiffs failed to state a claim for which relief could be granted under the Securities Exchange Act of 1934 (the “Exchange Act”) ( Here .). In a summary order issued on December 5, 2017, the Second Circuit vacated the judgment and remanded the case for further proceedings ( here ), concluding, among other things, that Judge McMahon misapplied Rule 12(b)(6) in dismissing the plaintiffs’ claims. The Plaintiffs alleged that the Chinese e-commerce giant and several of its officers and directors knowingly or recklessly concealed that the Company was the subject of an “administrative proceeding” by a Chinese regulatory agency. According to the plaintiffs, the State Administration for Industry and Commerce (“SAIC”) warned the Company that it lacked appropriate internal controls, was operating in contravention of Chinese laws and regulations, and could be subject to substantial financial fines. The plaintiffs maintained that the defendants’ failure to disclose the pendency of the “administrative proceeding” rendered the Company’s registration statement, filed in connection with the IPO, materially false and misleading, despite its cautionary disclosures. According to the complaint, Chinese regulators summoned Alibaba executives to a secret meeting two months before the IPO in which they threatened to levy daily fines if the Company continued to host a marketplace for third parties to sell counterfeit goods. This information was not revealed until four months after the IPO, when the SAIC published on its website a white paper about the “guidance” it had provided to Alibaba.  Within two days of the publication of this information, the price of Alibaba’s stock dropped 13 percent, wiping out $33 billion in market capitalization. Notably, the white paper was later withdrawn. The plaintiffs alleged that the facts underlying the white paper were material to investors and that they should have been disclosed in Alibaba’s registration statement. The district court disagreed: Then there is the problem of the White Paper itself. Considering that the White Paper was posted on the SAIC’s website only briefly before being quickly withdrawn, Plaintiffs reliance on its contents is tenuous at best. Plaintiffs argue that the quick withdrawal of the White Paper suggests Alibaba’s sway over Chinese regulators; it also supports the equally, if not more, compelling inference that the posting was unauthorized and, hence, not to be trusted. That competing inference is lent further credence by the fact that the SAIC never subsequently initiated any formal enforcement action against Alibaba, and that the SEC, which investigated Alibaba’s compliance with US securities laws after the White Paper’s posting, never moved forward with a formal investigation or leveled any charges. Further, a principal basis alleged in the Consolidated Complaint for giving credit to the White Paper was that Alibaba “confirmed the authenticity of the White Paper and the harsh position taken by the SAIC.” In fact, that allegation is contradicted by the document to which the Consolidated Complaint refers — the press release issued by Alibaba immediately after the White Paper was posted. In that press release, the only thing Alibaba confirmed was the date of the Meeting. It not only denied the rest, but it announced that it had filed a complaint with the SAIC protesting the posting of the White Paper. But even assuming the White Paper were to be believed, nothing in it suggest that the July 16 Meeting constituted some sort of formal enforcement proceeding. It says that the meeting met SAIC’s “pre-set goal ” by making Alibaba “clearly aware of e-commerce regulatory agencies’ severe concern and censure as to the long existing misconduct on the platforms in Alibaba family,” cautioning it against self-congratulation, and prompting it “to pay great attention to the severity of the problems and to promptly take measures to redress the problem.” Making Alibaba aware of concerns and prompting it to pay attention to problems it had plainly disclosed is not tantamount to the institution of a formal regulatory proceeding. Citation omitted. The Second Circuit found that revelation of the information likely would have had a negative effect on Alibaba’s IPO. The Court criticized the district court for improperly discrediting “significant allegations” upon which the plaintiffs’ claims relied, such as the facts underlying the white paper. For example, the Court noted that the district court gave too much weight to Alibaba’s contention that the white paper was “unauthorized” and untrustworthy because the SAIC quickly withdrew the paper. Under Rule 12(b)(6), said the Court, the district court should have credited the plaintiffs’ “proffered reasonable inference that the withdrawal resulted from Alibaba’s influence over Chinese regulators.” Thus, “ ccepting Plaintiffs’ allegations as true,” the Court concluded that Alibaba “had a duty to disclose these facts, in a manner that accurately conveyed the seriousness of the problems Alibaba faced, so as not to render Defendants public disclosures ‘inaccurate, incomplete, or misleading.’” The Second Circuit also concluded that the plaintiffs alleged “strong circumstantial evidence” of scienter – that is, Alibaba acted with the requisite state of mind in withholding information about its secret meeting with the SAIC. The Court reasoned: “Considering the high-level nature of the meeting, the seniority of the attendees, its conduct in secret, and the huge potential impact of the SAIC’s threat made at the meeting on Alibaba and its imminent IPO, it is virtually inconceivable that this threat was not communicated to the senior level of Alibaba’s management, the individual Defendants.” Consequently, “Defendants’ subsequent failure to disclose the meeting concealed the true facts about the threat to the company that had been communicated by the” Chinese government, thus “powerfully support a strong inference that the Defendants acted with scienter.” The Court also found that the plaintiffs adequately alleged corporate scienter against Alibaba because they adequately alleged scienter against the individual defendants.

Under Section 702 of New York’s Limited Liability Company Law (“LLCL”), a court sitting in the judicial district in which the office of the company is located may dissolve the company “whenever it is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement.” LLCL § 702. (This Blog addressed Section 702 here and here .) To successfully petition for the dissolution of a limited liability company under LLCL § 702, the petitioning member must demonstrate the following: 1) the management of the company is unable or unwilling to reasonably permit or promote the stated purpose of the company to be realized or achieved; or 2) continuing the company is financially unfeasible. Matter of 1545 Ocean Avenue, LLC v. Crown Royal Ventures, LLC , 72 A.D.3d 121 (2d Dept. 2010); Doyle v. Icon, LLC , 103 A.D.3d 440 (1st Dept. 2013). Therefore, where the purposes for which the LLC was formed are being achieved and its finances remain feasible, dissolution pursuant to LLCL § 702 will be denied. Matter of Eight of Swords, LLC , 96 A.D. 3d 839, 840 (2d Dept. 2012). Disputes between members, by themselves, are generally insufficient to dissolve an LLC that operates in a manner within the contemplation of its purposes and objectives as defined in its articles of organization and/or operating agreement. See e.g. , Matter of Natanel v. Cohen , 43 Misc.3d 1217(A) (Sup. Ct. Kings Co. 2014). It is only where discord and disputes by and among the members are shown to be inimical to achieving the purpose of the LLC will dissolution be considered an available remedy to the petitioner. Matter of 1545 Ocean , 72 A.D.3d at 130-132. (Last year, this Blog wrote about Matter of 47th Rd. LLC , 54 Misc. 3d 1217 , 2017 NY Slip Op. 50196(U) (Sup. Ct. Queens County Feb. 16, 2017), in which the discord between the partners was so severe, it became violent, thereby persuading the court that dissolution was appropriate < here =">here"> ). Today, this Blog revisits judicial dissolution under LLCL § 702 by discussing a decision coming out of the Supreme Court, New York County, wherein the Court held that questions of fact precluded the dismissal of an application to dissolve an LLC. Advanced 23, LLC v. Chambers House Partners, LLC , 2017 NY Slip Op. 32663(U) (Dec. 15, 2017) ( here ). Advanced 23, LLC v. Chambers House Partners, LLC Background Respondent Herbert Margrill (“Herbert”) and Respondent Anita Margrill (“Anita”) (collectively, “Respondents”) and Ephraim Resnick and Hisako Resnick (collectively, the “Resnicks”) purchased land and a building in lower Manhattan in mid-January 1982 (the “Building”). The Building contained four residential units and one commercial unit. On the same day, the Respondents and the Resnicks conveyed the Building to Chambers House Partners, a general partnership. The Respondents each held a 25% membership share in the Building and the Resnicks collectively held 50% of the membership shares. In early November 2007, Chambers House Partners conveyed the Building to Chambers House Partners, LLC (“CHP”); the Respondents and the Resnicks each maintained their membership shares in the Building. About three months later, co-Petitioner Advanced 23, LLC (“Advanced”) purchased the Resnicks’ 50% membership share in CHP. Shortly thereafter, co-Petitioner David Shusterman (“Shusterman”) and Herbert began to manage CHP as Co-Managers pursuant to an Amended and Restated Operating Agreement (“Operating Agreement”). As Co-Managers, Herbert and Shusterman were responsible for making CHP’s business decisions, most of which required members’ unanimous consent. Although management under the Operating Agreement was to occur “on an equal basis” Shusterman largely ran the LLC. In accordance with the Operating Agreement, CHP established a bank account at Capital One Bank, N.A. (“Capital One Account”). Rent checks from the Building’s tenants were to be deposited into this account, and payments of expenses were to be withdrawn from it. In July 2015, Anita allegedly began to harass Shusterman and his companion, and, on at least one occasion, entered Shusterman’s apartment without his permission. There was also an alleged physical altercation between Shusterman and Anita. Because of the unresolved tensions, Herbert appointed an attorney on September 17, 2015 to negotiate with Shusterman on his behalf regarding Shusterman’s obligations under the Operating Agreement. In mid-November 2015, the Respondents created a separate bank account as trustees for CHP at TD Bank (“TD Bank Account”) and deposited the November rent checks from CHP, in violation of the Operating Agreement. Thereafter, Herbert wrote Shusterman, informing him that the account had been created “in order to ensure the timely and full payment of all obligations” because Shusterman’s “conduct has seriously interfered with the operation of .” On December 3, 2015, the Respondents transferred money from the Capital One Account into the TD Bank Account without Shusterman’s authorization. The Petitioners maintained that the Respondents either forged Shusterman’s name on the check, or they used one of the blank checks that Herbert had Shusterman sign, which was supposed to be used to pay CHP’s expenses. Based upon these and other actions, the Petitioners filed an action seeking: (1) a judicial decree dissolving CHP pursuant to LLCL § 702, directing that its real property be sold, and that CHP be liquidated; (2) an accounting of all transactions from the TD Bank Account and any other transactions the Respondents unilaterally entered into with CHP funds without Shusterman’s authorization or consent; and (3) injunctive relief to maintain the status quo and to prevent irreparable harm to CHP’s business during the pendency of the proceeding. The Respondents opposed the petition, arguing that if it was no longer reasonably practicable to carry on CHP’s business it was due to Shusterman’s conduct. They also argued that since Shusterman became Co-Manager, he failed to fulfill his managerial duties, and that Herbert had been the only one actively managing the Building. They contended that Shusterman’s sole role as Co-Manager was limited to negotiating a lease, proposing house rules, and co-signing checks. As such, they maintained that the creation of the TD Bank Account was not a breach of the Operating Agreement and their actions were necessary and justified because Shusterman improperly interfered with CHP’s operations. The Court’s Ruling The Court found that the “Petitioners have made a prima facie showing that it is no longer reasonably practicable for CHP to continue functioning in accordance with its Operating Agreement to achieve its stated business purpose.” In so ruling, the Court explained: The Operating Agreement provides that virtually any material business decision requires the unanimous consent or the majority vote of either its Members or Co-Managers, however the relationship between the parties has degraded to such an extent that they are no longer on speaking terms (Respondents retained an attorney to deal with Shusterman directly) and they have been unable to cooperate to make business decisions regarding a tenant's inability to pay rent or refinancing their mortgage. The Court next addressed whether CHP could continue to operate notwithstanding the disagreements of the Co-Managers: Here, there is evidence showing that CHP cannot continue to function because of the disagreements and inability of the parties to cooperate. Even though Operating Agreement ¶ 13.11 authorizes and requires that any dispute arising out of the Operating Agreement and exceeding $25,000 to be resolved through arbitration, neither party has availed themselves of this provision to resolve any of their disputes. Further, the Operating Agreement does not provide any means to resolve disputes that do not meet the amount in controversy requirement of the arbitration clause. Notwithstanding the finding that CHP could not operate because of the disagreement, the Court nevertheless found issues of fact precluding dissolution of CHP: However, Respondents have raised issues of fact to preclude a summary determination on the issue of judicial dissolution. Respondents allege that any ineffectiveness in CHP’s management and operation is due to the intentional acts of Shusterman in his attempt to force dissolution and gain control of the Building. Respondents argue that Shusterman breached his material obligation to manage CHP and that he was significantly interfering with CHP’s operation by either refusing or causing a significant delay signing the checks to pay for CHP’s expenses and operating costs and routinely ignoring Herbert's requests for managerial meetings. The Respondents’ allegations regarding Shusterman's conduct raise triable issues of fact, and if the trier of fact credits Respondents’ allegations, judicial dissolution may not be warranted. Based on the parties’ submissions, I find that a material issue of fact exists as to whether Shusterman breached his duties and obligations under the Operating Agreement to force dissolution. Citation omitted. Accordingly, the Court ordered an evidentiary hearing to resolve the issue of fact. In a companion decision ( here ), the Court denied the Respondent’s motion to dismiss the petition, rejecting without discussion the Respondent’s argument that judicial dissolution under LLC Law § 702 was unavailable based on a provision in the Operating Agreement stating that the LLC would “be dissolved only upon the unanimous determination of the Members to dissolve.” Takeaway While deadlock between managers is not an independent basis for judicial dissolution under LLCL§702, it may be sufficient if the discord contravenes the terms of the operating agreement and impairs the continued ability of the company to function in that context. In re 1545 Ocean Ave., LLC , 72 A.D.3d at 129. In Advanced 23 , though finding that there was discord between the Co-Managers, the Court could not make such a finding.

In very general terms, fraudulent conveyance statutes are designed to protect creditors from situations where a debtor transfers its assets to a creditor’s detriment.  Sometimes such transfers are made with actual intent to defraud.  Other times, transfers may be deemed to be constructively fraudulent regardless of the actual intent of the debtor/transferor. Presently, Article 10 of New York’s Debtor and Creditor Law (the “DCL”) governs fraudulent transfers.   For example, section 273 (Conveyances by insolvent) provides that conveyances that render a debtor insolvent that are made without fair consideration, are fraudulent as to creditors regardless of intent;  section 273-a (Conveyances by defendants) provides that a conveyance made without fair consideration by a defendant in an action for money damages is fraudulent as to the plaintiff in that action, regardless of intent, if the defendant fails to satisfy a resulting judgment in the action; and, section 276 (Conveyance made with intent to defraud) provides that conveyances made with actual intent (as opposed to presumed intent) to “hinder, delay, or defraud either present or future creditors, is fraudulent as to both present and future creditors.” The Court, in Capital One Equipment Finance Corp. v. Patton R. Corrigan, et. al. (Sup. Ct. New York Co. December 14, 2017) (the “Action”), recently decided two motions to dismiss plaintiff’s fraudulent conveyance complaint.  The facts in Capital One are interesting.  Transit Funding Associates, LLC (“TFA”) was in the business of lending money to Chicago taxi owners and drivers to purchase taxi medallions.  Levine and Corrigan were principals of TFA.  In 2009, Capital One provided TFA with a $35 million revolving credit line to finance its business.  The credit line, which was guarantied by Levine and Corrigan, was increased to $80 million in 2012.  In 2014, due to its decision to stop lending in the Chicago medallion market, Capital One began denying TFA’s requests for funding.  As a result of Capital One’s decision, TFA was unable to extend new medallion loans or obtain replacement financing.  TFA’s business “was destroyed” and, when its loan obligations to Capital One matured in late 2014, it defaulted. Thereafter, in a related action, TFA sued Capital One for, inter alia , breach of contract and fraud related to the decision to stop lending.  In another related action, Capital One moved for summary judgment in lieu of complaint against Corrigan and Levine on their respective guaranties.  Supreme Court denied the motion, but the Appellate Division reversed and Capital One entered a $57 million judgment against Corrigan and Levine. Capital One commenced the Action in 2016 alleging, constructive and actual fraudulent conveyances under sections 273 , 274 , 275 , 276 , 276-a and 278 of the DCL.  To support its complaint, Capital One alleged numerous transfers by Levine and Corrigan during time periods when they should have known that they might have liability to Capital One under their guaranties.  Thus, Capital One alleged that over a two-year period, the value of Levine’s assets declined from $155 million to $29 million, with $45 million in assets being transferred to his wife for no consideration.  It was also alleged that, in a similar period of time, Corrigan’s assets decreased from $163 million to $12 million – with a total reduction in cash and marketable securities from $45 million to $1 million.  Finally, Capital One alleged that, while “entities controlled by Corrigan and Levine” sold medallions valued at between $150 and $175 million, only $11 million of the proceeds was used to pay down TFA’s loan, but at least $76 million was distributed to family members and related entities (the “$76 Million Family Distribution”). In dismissing the twenty-first and twenty-second causes of action in the complaint related to the $76 Million Family Distribution, the Court recognized that “Capital One fail to specifically allege that Corrigan and Levine had an ownership or beneficial interest in the transferred property, such that Corrigan and Levine would have benefitted in any way from the transfers… they just allege that they ‘controlled’ the entities that sold the medallions and distributed the money.” The twenty-third and twenty-fourth causes of action in the complaint were also dismissed.  Those causes of action allege that Corrigan and Levine transferred tens of millions of dollars: without consideration and were rendered insolvent; and, with the actual intent to hinder, delay or defraud Capital One.  In recognizing the insufficiency of the factual allegations supporting these causes of action, the Court recognized that “Capital One merely alleges a decline of Levine and Corrigan’s assets because of a transfer of cash and assets, however, fails to allege how specific assets or money were fraudulently transferred or conveyed, and fails to allege specific recipients of any such fraudulent conveyance during a specific time frame.” The Court did, however, sustain the other twenty causes of action in the Complaint.  For example, causes of action pursuant to DCL 273, 274 and 275 were sustained. These causes of action are based on constructive fraud and, therefore, do not require the particularized pleading required with causes of action based on actual fraud (as with claims made pursuant to DCL 276 (see CPLR 3016(b) and Swartz v. Swartz , 145 A.D.2d 818 (2 nd Dep’t 2016)).  In this regard, the Court found that: Capital One alleges conveyances of millions of dollars’ worth of assets and property from Levine to his wife for no consideration during the time that Uber was gaining control in the market and beginning to threaten the taxi medallion industry.  Capital One alleges that the conveyances rendered Levine insolvent or left with small capital such that he would be unable, if required, to pay his debt pursuant to the guaranty.  The allegations can support an inference that when making the conveyances, Levine believed that he would incur debts beyond his ability to pay.  Further discovery will yield more information as to these allegations, but the pleadings are sufficient to survive Levine’s motion to dismiss this claim. The Court also sustained causes of action for conveyances made with actual intent fraud to defraud under DCL 276 and 276-a.  Because actual intent to hinder, delay or defraud creditors is difficult to prove, the Court recognized that “a pleader is allowed to rely on ‘badges of fraud’ to support its case, such as: a close relationship between the parties to the alleged fraudulent transaction; a questionable transfer not in the usual course of business; inadequacy of the consideration; the transferor’s knowledge of the creditor’s claim and the inability to pay it; and retention of control of the property by the transferor after the conveyance.”  The Court found that Capital One’s allegations that “conveyances were made from Levine to his wife, with no consideration, not in the ordinary course of business, and with knowledge that he could be liable under the guaranty” were sufficient to sustain the applicable allegations for transfers made with actual intent to defraud. TAKEAWAY When pleading under the DCL, it is important to appreciate the applicable pleading standards based on the varying burdens and to satisfy the requisite burden with sufficient facts.  Ironically, the Capital One Court dismissed the causes of action with the more liberal pleading standard because insufficient facts were alleged by Capital One. The New York Legislature is presently considering repealing the existing fraudulent conveyance laws and adopting the “Uniform Voidable Transaction Act” in its place.  Developments in this area will be reported herein.

Ponzi schemes remain a familiar and unfortunate risk for investors. Because Ponzi schemes purport to offer high returns with little or no risk, and rely on inflated credentials of a financial professional, investors are attracted to the investment products these scammers offer. Often, Ponzi schemes are perpetrated on specific groups of people sharing common interests, such as a church or charitable group. (Fraudulent sales practices that target specific organizations or groups is referred to as Affinity Fraud.) The most notorious Ponzi scheme in recent years was perpetrated by Bernie Madoff. In 2016, there were 59 Ponzi schemes uncovered in the United States, with losses totaling $2.4 billion, according to the website Ponzitracker ( here ). ( See Financial Times, “ Investors beware: the Ponzi scheme is thriving ,” March 30, 2017. Here .) On December 21, 2017, the Securities and Exchange Commission (“SEC”) announced ( here ) that it brought charges, and sought an asset freeze, against Robert H. Shapiro  (“Shapiro”), a luxury real estate developer, and a group of unregistered investment companies called the Woodbridge Group of Companies LLC (“Woodbridge”), for bilking thousands of retail investors, many of them seniors, in a $1.2 billion Ponzi scheme. The SEC action followed proceedings in September and November of 2017, in which it obtained court orders forcing Woodbridge to produce the corporate records of several company executives and employees, including Woodbridge’s President and CEO, to SEC investigators. ( Here and here ). “We allege that through aggressive tactics, Woodbridge and Shapiro swindled seniors into a business model built on lies, which the SEC’s Miami Regional Office staff moved to halt,” said Stephanie Avakian, Co-Director of the SEC’s Enforcement Division. According to the SEC’s complaint ( here ), from July 2012 through December 4, 2017, Shapiro and Woodbridge defrauded more than 8,400 investors in unregistered Woodbridge funds. At least 2,600 of these investors unknowingly placed their retirement savings into Shapiro’s Ponzi scheme. “Our complaint further alleges that Shapiro used a web of layered companies to conceal his ownership interest in the purported third-party borrowers,” said Eric I. Bustillo, Director of the SEC’s Miami Regional Office.  “Shapiro used the scheme to line his pockets with millions of investor dollars.” The SEC claims that Woodbridge advertised its primary business as issuing loans to third-party commercial property owners, who were paying Woodbridge 11-15 percent annual interest for “hard money,” short-term financing.  In return, Woodbridge promised to pay investors 5-10 percent interest annually.  While Woodbridge claimed it made high-interest loans to third parties, the SEC alleges that the vast majority of the borrowers were Shapiro-owned companies that had no income and never made interest payments on the loans. The SEC also noted that investors had difficulty cashing out their investment. In that regard, Woodbridge and Shapiro used their marketing materials to convince investors to keep their money with Woodbridge by boasting that “clients keep coming back to because time and experience have proven results.  Over 90% national renewal rate!” “Our complaint alleges that Woodbridge’s business model was a sham,” said Steven Peikin, Co-Director of the SEC’s Enforcement Division. “The only way Woodbridge was able to pay investors their dividends and interest payments was through the constant infusion of new investor money.” The SEC alleged that Shapiro and Woodbridge used investors’ money to pay other investors, and paid $64.5 million in commissions to sales agents who pitched the investments as “low risk” and “conservative.”  Shapiro is alleged to have diverted at least $21 million for his own benefit, including to charter planes, pay country club fees, and buy luxury vehicles and jewelry.  According to the complaint, the scheme collapsed in early December 2017 as Woodbridge stopped paying investors and filed for Chapter 11 bankruptcy protection. Shapiro resigned as Woodbridge’s chief executive officer on December 1, days before Woodbridge filed for bankruptcy protection. Shapiro has “denie any allegation of wrongdoing,” said Ryan O’Quinn, a lawyer for Shapiro. According to O’Quinn, “Mr. Shapiro is cooperating with the bankruptcy to protect the assets held for the benefit of Woodbridge’s stakeholders.” The court granted the SEC’s request for a temporary asset freeze against Shapiro and Woodbridge, and ordered them to provide an accounting of all money received from investors. The SEC is seeking return of the ill-gotten gains with interest and financial penalties. Takeaway As noted in a prior Blog post ( here ), the SEC has warned investors to be vigilant in protecting themselves before they invest money. ( Here .) This means asking questions, many of which are based upon the common features of a Ponzi scheme, e.g. , high investment returns with little or no risk, overly consistent returns, unregistered investments, unlicensed sellers, secretive and/or complex strategies, issues with paperwork, and difficulty receiving payments. If these questions are not answered, investors should not be afraid to request more information. Any push-back or doublespeak should raise red flags. After all, as the proverb says: “if it sounds too good to be true, then it probably is.

What word that comes to mind when you hear the term “professional malpractice”? Medical? Legal? To be sure, doctors and lawyers are the more common professionals subject to malpractice claims. But, there are other professionals who can commit malpractice. These include accountants, architects, and engineers. Yet, not all professionals are subject to malpractice claims. In Gutterman v. Stark , 2017 NY Slip Op. 32618(U) (Sup.Ct. N.Y. County, Dec. 18, 2017) ( here ), a financial advisor learned, to his benefit, that he was not a professional for purposes of a malpractice claim. To put Gutterman in perspective, a brief summary of the law follows. Who is a Professional? Malpractice is the negligence of a professional toward a person for whom a service is rendered. Historically, a “professional” is a person engaged in an occupation generally associated with long-term educational requirements leading to an advanced degree, licensure evidencing qualifications met prior to engaging in the occupation, and control of the occupation by adherence to standards of conduct, ethics and malpractice liability. Santiago v. 1370 Broadway Assocs., LP , 264 A.D.2d 624, 625(1st Dept. 1999); see also Leather v. United States Trust Company of New York , 279 A.D.2d 311, 312 (1st Dept. Jan. 11, 2001); Matter of Rosenbloom v. State Tax Commn. , 44 A.D.2d 69, 71 (3d Dept. 1974). As noted, the occupations that traditionally fall within the definition of “profession” have been limited to such “learned professions” as the law, accountancy, architecture, and engineering. Gutterman v. Stark Background Gutterman arose out of an investment in an ambulatory care surgical facility. In early 2015, defendant Ilya Kogan (“Kogan”), a part-time employee of an asset management company (“Asset Manager”), referred plaintiffs Aharon Gutterman, MD and Aharon Gutterman MD PLLC (together, “Gutterman”) to an advisor (“Advisor”) at the Asset Manager about investing in surgical centers. In connection with the referral, Gutterman and the Advisor met at a Manhattan restaurant to discuss Gutterman’s interest in investing in an ambulatory surgery center (“ASC”). During their meeting, Gutterman claims that the Advisor falsely touted his experience and expertise in ASCs, and told Gutterman that he could “get it done” for him. Months later, the Advosor informed Gutterman of an investment opportunity to convert the offices of Luis A. Vinas (“Vinas”), a Florida plastic surgeon, into a surgical center where Vinas and other surgeons could operate. The Advosor, Kogan and Nicholas Monroy (“Monroy” and, together with the Advisor, Kogan, and the Asset Manager, the “Asset Management Defendants”) introduced Gutterman to Vinas for the purpose of forming a partnership to establish the ASC. In December 2015, Gutterman, Vinas, and the Asset Manager entered a Memorandum of Terms, which set forth the terms of their “efforts to expedite creation of new surgical facility in West Palm Beach.…” The proposed facility faced numerous regulatory hurdles, among which was Kogan and the Advisor's alleged lack of experience with ASC facilities. Gutterman claimed that if the Asset Management Defendants had the claimed experience or performed due diligence, circumstances upon which they relied, they would have known of the regulatory requirements that rendered the project unfeasible. Gutterman commenced the action on October 13, 2016 by summons with notice and filed a complaint on November 22, 2016, asserting eight causes of action, one of which (the third claim) was against the Advisor for malpractice. Service was made by overnight delivery and first-class mail, which the Court ruled failed to comply with the CPLR. The Asset Manager never appeared, and neither the Asset Manager nor the Advisor filed an answer. Gutterman moved for a default judgment, which the Court denied for failure to specify the cause of action forming the basis for the requested default. Thereafter, Gutterman refiled the motion, seeking a default judgment against the Advisor and the Asset Manager on Plaintiffs’ third, fourth, fifth, sixth, and seventh causes of action. The Court’s Ruling The Court denied the motion. Regarding the malpractice cause of action, the Court dismissed the claim because the Advisor, against whom the claim was brought, was not a “professional” for purposes of the claim: As to , the motion is denied as to the third cause of action for malpractice. The Complaint alleges that became the financial and investment advisor for Gutterman, but failed to use reasonable and proper skill in providing financial and investment advice and to properly manage account. Malpractice is professional misfeasance. Professional malpractice requires that a professional failed to perform services with due care and in accordance with the recognized and accepted practices of the profession. Professionals, in the context of professional malpractice, refers to the learned professions such as, architects, engineers, lawyers, and accountants. Financial advisors are not professionals. Citations and internal quotation marks and insertions omitted. Although the Court dismissed the malpractice claim, it found that Gutterman alleged sufficient facts that could give rise to a claim for breach of fiduciary duty. Consequently, the Court sua sponte granted leave to replead the claim accordingly: If, as alleged, Gutterman reposed confidence in and reasonably relied on superior expertise or knowledge, owed Gutterman fiduciary duties as his financial and investment advisor and as manager, through , of Gutterman’s invested funds. Allegations of self-dealing, conflict of interest, and failure to prudently advise Gutterman may give rise to a breach of fiduciary duty. Citations and internal quotation marks omitted. Takeaway Whether a person is a professional under the law matters. Among other reasons, it is relevant for statute of limitations purposes. Under CPLR 214(6), a claim for professional malpractice (other than medical malpractice) must be brought within three years of the wrongdoing. In making the limitations period three years, the New York Legislature sought to correct attempts to circumvent the statute by “allowing actions that were technically malpractice actions to proceed under a six-year contract statute of limitations.” Matter of Arbitration Between Kliment & McKinsey & Co. , 3 N.Y.3d 538, 541 (2004). Prior to the Legislature’s action, the courts “determined the appropriate statute of limitations in nonmedical malpractice actions based upon the proposed remedy instead of the theory of liability.” Id . (citations omitted). The courts reasoned that “liability would not have existed between the parties without the contractual relationship and that there was an implied agreement to perform professional services using due care.” Id . (citations omitted). With the amendment to the CPLR, the analysis changed. Thus, as the Court of Appeals observed, “ he pertinent inquiry is … whether the claim is essentially a malpractice claim.” Although the statute of limitations was not at issue in Gutterman , the decision nevertheless highlights the importance of understanding whether a person is a professional. For Gutterman, it meant dismissal of the claim – though, with leave to replead the claim as one for breach of fiduciary duty.

On December 12, 2017, the New York Court of Appeals resolved an ambiguity in Rule 908 of the Civil Practice Law and Rules, concerning whether the parties to a putative class action must give notice of a dismissal, discontinuance, or compromise to members of the class before the lower court certifies the action as a class action. In Desrosiers v. Perry Ellis Menswear, LLC , 2017 NY Slip Op 08620 ( here ), a divided court held that, where a complaint containing class allegations is dismissed, discontinued, or settled before the action has been certified by the court as a class action, notice of the impending dispositon must be provided to potential class members, even though the disposition is not binding on them. Desrosiers involved two unrelated actions under CPLR 908.  In the first action, Desrosiers v. Perry Ellis Menswear, LLC , the plaintiff, Geoffrey Desrosiers, brought a class action to recover wages from the defendant, Perry Ellis Menswear, LLC, that Desrosiers claimed should have been paid to him and those similarly situated. Desrosiers worked as an unpaid intern for Perry Ellis. In March 2015, Perry Ellis sent an offer of compromise to Desrosiers, which he accepted. On May 18, 2015, Perry Ellis moved to dismiss the complaint. By that date, the time within which Desrosiers was required to move for class certification pursuant to CPLR 902 had expired. Desrosiers did not oppose dismissal of the complaint, but filed a cross motion seeking leave to provide notice of the proposed dismissal to putative class members pursuant to CPLR 908. Perry Ellis opposed the cross motion, arguing that notice to putative class members was not required because Desrosiers had not moved for class certification within the required time. The Supreme Court dismissed the complaint but denied the cross motion to provide notice to putative class members. In the second action, Vasquez v. National Sec. Corp. , the plaintiff, Christopher Vasquez, brought a class action against the defendant, National Securities Corporation, for alleged minimum wage and overtime violations. Vasquez worked as a financial products salesperson at National Securities and filed a class action on behalf of himself and “all similarly-situated individuals.” The parties agreed to postpone a motion for class certification in order to complete pre-certification discovery. In February 2015, before Vasquez had moved for class certification, NSC made a settlement offer, which Vasquez accepted the following month. NSC thereafter moved to dismiss the complaint. Vasquez cross-moved to provide notice of the proposed dismissal to putative class members pursuant to CPLR 908. NSC opposed the cross motion, asserting that CPLR 908 applies only to certified class actions. The Supreme Court granted the cross motion to provide notice to putative class members and granted NSC’s motion to dismiss the complaint, but directed that the action would not be marked disposed until after notice had been issued. On appeal, in both cases, the Appellate Division, First Department held that the notice requirement of CPLR 908 applied despite the absence of a certified class.  In  Desrosiers , the court held that the notice requirement in CPLR 908 “is not rendered inoperable simply because the time for the individual plaintiff to move for class certification has expired,” and notice to putative class members of the compromise is “particularly important … where the limitations period could run on the putative class members’ cases following discontinuance of the individual plaintiff’s action.”  In  Vasquez , the First Department followed its ruling in  Avena v. Ford Motor Co. , 85 A.D.2d 149 (1st Dept. 1982).   Avena involved the settlement of a putative class action that did not release the claims of absent class members. 85 A.D.2d 149 (1st Dept. 1982). The settling parties contended that because absent class members were preserving all their claims, there was no need to send class members notice or review the compromise and dismissal for fairness. The First Department disagreed, holding that the necessity of notice and review followed from the existence of the class representatives’ fiduciary duties. Though the individual plaintiffs’ recovery, and lawyers’ fee was “in absolute terms … a modest amount” the settlement assured the fiduciaries of these results. Id . at 154. Meanwhile, “the other members of the class, left to struggle for themselves.” Id . Thus, the First Department held that notice was required even in the case of “a without prejudice (to the class) settlement and discontinuance of a purported class action before certification or denial of certification.” Id. at 152. The court emphasized the role of CPLR 908 in preventing abuse of the class action device: Clearly some control of settlement or discontinuance of a purported class action is necessary. The abuses which have developed incident to the beneficent widened availability of class actions and the potential for abuse in a private settlement even before certification are widely recognized. The requirement of notice to the class makes settlement more difficult, perhaps even impossible in some cases. But of course Rule 908 intends to make settlement of class actions somewhat more difficult as part of the price of preventing abuse. And by the very act of asking for court approval, which would otherwise not be necessary, the parties recognize that such settlements are subject to greater control and thus more difficult than the settlement of a purely individual lawsuit. Id. at 153. The First Department further noted the role that objectors would play in any hearing on the settlement’s fairness and the importance of notice in bringing contrary points of view to the court considering a settlement: In our adversary system of justice the court must rely on adversary attorneys to produce the necessary facts. But here, without some notice to the outside world and to possible other members of the class and their representatives (or at least the appointment of a special guardian), who is to find and present to the court considerations that may cast doubt upon the agreement of the attorneys for defendant and for the named plaintiffs for a settlement without notice? Id. at 155. In each case, the First Department granted the defendant leave to appeal to the Court of Appeals, certifying the question whether its order was properly made. The Court of Appeals affirmed the ruling in both cases. The Court of Appeals Ruling The Court found the language in CPLR 908 to be ambiguous, noting that the phrase “class action” had multiple meanings and no clear legislative intent on which to rely: The text of CPLR 908 is ambiguous with respect to this issue. Defendants argue that the statute’s reference to a “class action” means a “certified class action,” but the legislature did not use those words, or a phrase such as “maintained as a class action,” which appears in CPLR 905 and 909. Plaintiffs assert that an action is a “class action” within the meaning of the statute from the moment the complaint containing class allegations is filed, but the statutory text does not make that clear. Similarly, the statute’s instruction that notice of a proposed dismissal, discontinuance, or compromise must be provided to “all members of the class” is inconclusive. Defendants contend that there are no “members of the class” until class certification is granted pursuant to CPLR 902 and the class is defined pursuant to CPLR 903. Yet the legislature did not state that notice should be provided to “all members of the certified class,” or “all members of the class who would be bound” by the proposed termination, or some other phrase that would have made the legislature’s intent clear. “ urning to other principles of statutory interpretation and sources beyond the statutory text itself to discern the intent of the legislature,” such as the former version of Rule 23 of the Federal Rules of Civil Procedure, on which CPLR Article 9 was modeled, and which “was virtually indistinguishable from the current text of CPLR 908,” the Court determined that these sources supported the requirement of a pre-certification class notice of settlement, dismissal or discontinuance. The majority also drew a distinction between CPLR 908 and the current version of Rule 23(e). Rule 23 was amended to provide that a district court is required to approve settlements only in cases where there is a “certified class” and that notice must be given only to class members “who would be bound” by the settlement. In contrast, CPLR 908 has not been so amended, despite proposals by the New York City Bar Association and scholarly criticisms of the rule. The Court further considered the First Department’s decision in  Avena , “the only appellate-level decision to address this issue.” It put a lot of emphasis and weight on the fact that “no other department of the Appellate Division ha expressed a contrary view” of CPLR 908, the Court “never overruled Avena or addressed” the issue, and the legislature had not “amended CPLR 908 in the decades since Avena ha been decided.” The majority further found that the legislature’s refusal to amend CPLR 908 since  Avena  indicated that the First Department had correctly ascertained the legislature’s intent. Finally, the majority pointed to policy considerations, including ensuring that settlements are free from collusion and that absent class members are not prejudiced. The majority dismissed any concerns about practical difficulties that could arise from this decision, claiming that they were best addressed by the legislature, not the courts. Any practical difficulties and policy concerns that may arise from Avena’s interpretation of CPLR 908 are best addressed by the legislature, especially considering that there are also policy reasons in favor of applying CPLR 908 in the pre-certification context, such as ensuring that the settlement between the named plaintiff and the defendant is free from collusion and that absent putative class members will not be prejudiced. The balancing of these concerns is for the legislature, not this Court, to resolve. Citations omitted. The dissent took the majority to task for what it described as an unwarranted reading of the rule in light of the overall context of the class action provisions in Article 9 of the CPLR. In their view, the fact that the plaintiffs had never moved for, let alone received, a ruling certifying the action as a class action meant that the case was not a class action at all. “In each of the actions here,” they said, “plaintiffs did not comply with the requirements under article 9 of the CPLR that are necessary to transform the purported class action into an actual class action, with members of a class bound by the disposition of the litigation.” Responding in particular to the plaintiff’s contention that a case becomes a “class action” from the moment it is filed putatively as such, the dissent said: There is nothing talismanic about styling a complaint as a class action. Indeed, any plaintiff may merely allege that a claim is being brought “on behalf of all others similarly situated.” However, under article 9 of the CPLR, the court, not a would-be class representative, has the power to determine whether an action “brought as a class action” may be maintained as such, and may do so only upon a showing that the prerequisites set forth in CPLR 901 have been satisfied. Takeaway As the dissent observed, “ here is nothing talismanic about styling a complaint as a class action.” Notwithstanding, the filing of a class action complaint can impact the rights of the plaintiff and putative class members, especially before the filing of a certification motion. For example, absent class members may have statute of repose issues depending upon the claims asserted in the class action complaint. California Public Employees’ Retirement Sys. v. ANZ Sec., Inc. , 137 S. Ct. 2042 (2017) (“CalPERS”). In CalPERS , the Supreme Court held that the class action “tolling” principle set forth in American Pipe & Construction Co. v. Utah , 414 U.S. 538 (1974), does not apply to the three-year statute of repose under the Securities Act of 1933. This Blog discussed the CalPERS decision here . Although the Supreme Court specifically addressed the statute of repose set forth in the Securities Act, the Court’s reasoning indicates that tolling under American Pipe does not apply to a statutory repose period, unless the particular statute “itself contains an express exception.” Id . at 2050; see also id . at 2050 (“In light of the purpose of a statute of repose, the provision is in general not subject to tolling.”), 2051 (“statutes of repose are not subject to equitable tolling”), 2055 (“Because § 13’s 3-year time bar is a statute of repose, it displaces the traditional power of courts to modify statutory time limits in the name of equity.”). The majority’s ruling also ensures that, notwithstanding the costs of providing notice to absent class members, which may be an impediment to pre-certification dispositions, absent class members will be provided with an opportunity to present arguments as to the fairness and reasonableness of the settlement that might not be made by the parties. Whether the legislature takes up the issue remains to be seen. This Blog will update any developments on the legislative front, and post commentary about decisions of interest involving CPLR 908.

Should Your Business Contracts Contain Mandatory Arbitration Clauses? Mandatory arbitration clauses have increased in popularity in recent years and are now part of most business contracts. While arbitration clauses are not ideal for all situations, this method of dispute resolution can provide benefits to both businesses and customers alike.  What is an Arbitration Clause? 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. A mandatory arbitration clause is a contractual provision in which one party requires the other to arbitrate their disputes.  Such clauses are often found in a contract's "terms of agreement," including those used for employment, insurance, home-building, car loans and leases, credit cards, retirement accounts, investment accounts, and nursing facilities, among others. While the exact terms and conditions differ depending upon each business, most mandatory arbitration clauses limit the rights of a party to appeal an arbitral award and prevent claimants from pursuing their claims as a class action. Further, some mandatory arbitration clauses impose a cap on damages and require a non-disclosure agreement to be signed. Arbitration Clauses – The Upside and Downside There are advantages and disadvantages associated with the arbitration of disputes.  Below are some of the advantages: Since the parties agree to resolve their disputes by arbitration, the parties are indicating their confidence that the arbitrator, the rules governing the proceeding, and the forum in which the arbitration will take place are, and will be, impartial and fair. A dispute in arbitration typically gets resolved sooner than a litigation in court. Arbitration is usually less expensive than litigation in a court. Unlike a trial, arbitration is a private procedure.  Thus, if the parties want privacy, then the dispute and the resolution can be kept confidential. There are limited opportunities for either side to appeal an arbitral award. This gives finality to the resolution of the dispute that is not often present with a judgment after trial. There are, however, some disadvantages to arbitration, which are discussed in the next section. Incomplete Justice? A “one-size-fits-all” policy, mandating arbitration for all disputes, unnecessarily shoehorns disputes that would otherwise be more appropriate for the court system. Critics of mandatory arbitration clauses point to the incomplete justice that is sometimes administered in the name of efficiency and finality.  A few of the criticisms are discussed below. First, the agreement to arbitrate is not negotiated. Mandatory arbitration allows one party (typically the business or employer) to force the other party (usually the customer or employee) to use arbitration for dispute resolution. In most instances, the consumer or employee is unaware they have agreed to arbitrate their disputes and are, therefore, unaware of  the rights they have given up . Second, if arbitration is binding, both sides give up their right to an appeal. That means there is no opportunity to correct an erroneous decision. Third, if the matter is complex, but the amount in controversy is modest, then the fees and expenses imposed by the arbitrator and the arbitral forum may make arbitration uneconomical. Finally, the rules of evidence may prevent some evidence from being considered by a judge or a jury, but may nevertheless be considered by an arbitrator. Thus, an arbitrator's decision may be based on evidence that a judge or jury would not consider at trial. Limitation of Rights? In addition to losing the right to appeal any unfair judgments, mandatory arbitration clauses also limit other rights. Typically, the complaining party has a more limited access to evidence and witnesses.  Moreover, mandatory arbitration clauses can limit the public’s ability to expose corporate misbehavior -- that is, the deterrent effect that litigation can impose on other companies engaging in the same or similar misconduct.  Limiting Class Action Lawsuits? Mandatory arbitration clauses often include a provision that prohibits claimants from litigating their claims as a class action. In a class action, the claimant brings an action on behalf of a group of similarly situated people with damages that were caused by the alleged wrongdoer.  Class action lawsuits provide legal redress for people who, on their own, would likely not bring because their claim is too small to litigate on their own. Class action waiver clauses are used by businesses and employers to reduce the risk of collective or class action litigation.   Takeaway The use of mandatory arbitration clauses in business and consumer contracts has grown in recent years. In most cases, consumers are not aware of mandatory arbitration clauses, because they are located in the fine print within a user agreement.  Many critics of mandatory arbitration consider such clauses to be unfair. Despite the perceived unfairness of requiring a party to arbitrate a dispute as a condition of the transaction or employment, recent Supreme Court cases have upheld the right of companies to insert mandatory arbitration clauses in their agreements with other companies or consumers. Perhaps unsurprisingly, mandatory arbitration clauses have become the latest weapon in the political arena. Responding to the Obama administration's ban on the use of mandatory arbitration clauses in financial contracts, the Trump administration has now reversed the ban. With the legally-imposed cap on mandatory arbitration clauses lifted, this popular form of alternative dispute resolution is likely to grow.

A recent blog post entitled: “ Appellate Division, Second Department Tells Foreclosing Residential Lender to ‘SHOW ME THE EVIDENCE ,’” cautioned foreclosing mortgagees that evidence in admissible form must be submitted to the court to demonstrate compliance with the many statutory provisions that must be followed to ensure a successful foreclosure action. The Second Department in U.S. Bank National Association v. Brody , decided on December 20, 2017, reiterates that foreclosing mortgagees must submit appropriate proof in admissible form in order to prevail on a summary judgment motion in a residential mortgage foreclosure action. In the Brody complaint, the plaintiff alleged that it was the current holder of the note secured by the mortgage being foreclosed. Brody, in his answer, alleged that the plaintiff did not have standing to bring the subject foreclosure action. The supreme court in Brody, inter alia , granted plaintiff’s motion for summary judgment, but the Second Department, “modified” the lower court’s decision by denying same. The Brody Court explained that a foreclosing mortgagee makes its prima facie case by the production of the note, the mortgage and evidence of default. The Court did note, however, that “when a defendant places standing in issue, the plaintiff must prove its standing in order to be entitled to relief.” (Citations omitted.) The Brody Court further recognized that standing is conferred on a plaintiff in a mortgage foreclosure action “when it is the holder or assignee of the underlying note at the time the action is commenced.” (Citations omitted.) A “holder,” according to the Brody Court, “is the person in possession of a negotiable instrument that is payable either to bearer or to an identified person that is the person in possession. (Citations and quotation marks omitted.) While the Court found that the Brody plaintiff produced the note, mortgage and proof of default, it also found that standing to bring the action was not sufficiently established. Because the note was “endorsed in blank”, standing must be established “by demonstrating that the original note was physically delivered to it prior to the commencement of the action.” (Citations omitted.) Initially, plaintiff attempted to establish standing through the affidavit of an officer of the plaintiff’s servicing agent, merely stating that the plaintiff was in possession of the note. A subsequent affidavit of another officer of the plaintiff’s servicing agent asserted that: the servicing agent was appointed in 2014; and, that based on her familiarity with the servicing agent’s business records, plaintiff had possession of the note in 2006. The Brody Court, however, found the servicing agents’ affidavits to be insufficient. First, the subsequent servicing agent’s affidavit “failed, among other things, to explain how a review of the business records of a servicing agent appointed in 2014 could prove that plaintiff had obtained physical possession of the note more than seven years earlier.” Thus, the Court concluded, neither affidavit provided “sufficient factual details to establish the physical delivery of the note to the plaintiff prior to the commencement of action, nor the foundational knowledge required to admit such factual details under the business records exception to the hearsay rule.” (Citations omitted.) Thus, the Brody Court held that the plaintiff’s motion for summary judgment and for the appointment of a referee should have been denied “regardless of the sufficiency of Brody’s opposition papers.” (Citations omitted.) TAKEAWAY Presumably, the submission of more detailed affidavits from individuals with first-hand knowledge of the facts and circumstances surrounding plaintiff’s acquisition of the note and its possession of the note at the time the action as commenced, would have been sufficient to establish standing, defeat Brody’s affirmative defense and support the grant of summary judgment in favor of the foreclosing mortgagee. As a result of the failure of plaintiff’s proof, the parties may have to go through discovery and trial; which could be costly. Courts continue to force parties to lay bare their proof if they expect to be granted summary judgment, notwithstanding the sufficiency of the opposition papers. In cases such as Brody , it is critical that the foreclosing mortgagee presents to the court in admissible form, all of the information necessary to justify the requested relief. Failure to do so can lead to otherwise costly and time-consuming litigation.

What facts must you plead to pursue a false claims case? In , the United States Court of Appeals for the Sixth Circuit (Sixth Circuit) reaffirmed the “stringent” pleading requirement for cases brought under the False Claims Act. The pleading standard comes from the Federal Rules of Civil Procedure 9(b) which requires the plaintiffs to plead their case with “particularity.” In , the Sixth Circuit held that the “particularity” standard for litigating complex schemes or fraud under the False Claims Act could be satisfied by providing proof of a single representative sample - from start to finish-  of the alleged fraud. The high bar set for plaintiffs seeking to bring a claim can reduce costly litigation and discovery periods for some plaintiffs with weak cases. However, critics of the heightened pleading standard point to a lack of available information and facts that could prevent The case in involves a lawsuit against a pharmaceutical company for allegedly encouraging medical professionals to prescribe the antipsychotic drug Abilify for off-label uses.  In short, the plaintiffs in the case allege that the pharmaceutical company’s promotion of Abilify for off-label uses caused pharmacies to submit “false claims” to the government when the government reimbursed the company for the price of the medication. Pleading a Complex Scheme With Particularity The plaintiff’s case rests upon what has become a popular legal approach to litigating False Claims cases - a “chain” or sequence of events that, taken as a whole, constitute a violation of the False Claims Act. In , the Plaintiff first alleges that the pharmaceutical company promoted Abilify for off-label uses. Then, physicians prescribed the drug for off-label uses. After that, the patients filled their Abilify prescriptions for these off-label uses. Finally, pharmacies received government reimbursement for the prescription cost. The Sixth Circuit responded by dismissing the case. According to the Sixth Circuit, in order to plead a complex scheme, the plaintiff must describe “each step with particularity.” This standard requires a plaintiff to “adequately allege the entire chain - from start to finish - to fairly show defendants caused false claims to be filed.” While the pleading standard is high, the Sixth Circuit notes the high burden would be satisfied if the Plaintiffs were to provide a single representative sample. Therefore in order to be successful, the Sixth Circuit required: proof that a specific prescription for Abilify that was prescribed for an off-label reason and then filled by a pharmacy that was later reimbursed by the government. Personal Knowledge Exception There is an exception for someone with “personal knowledge” that a false claim was submitted and later paid by the government. Because the Plaintiffs did not allege they had any personal knowledge of the fraud, the Sixth Circuit said the “personal knowledge” exception did not apply in this case The Sixth Circuit’s holding in Ibanez will almost certainly blunt future litigation under the False Claims Act for off-label prescriptions. Acknowledging the obvious effect of the high pleading standards, the Sixth Circuit described the False Claims Act as “an awkward vehicle” for litigating off-label drug prescriptions. If you are aware of a violation of the False Claims Act and would like competent advice on how to move forward, contact the experienced attorneys at Freiberger Haber LLP to ensure you obtain the rewards that you are entitled to.