THE TEST FOR A DIRECT OR DERIVATIVE CLAIM ESTABLISHED IN FRYDMAN LLC DECISION FIVE YEARS LATER

This is the five year anniversary of the decision obtained by Frydman LLC in Yudell v. Gilbert, 99 A.D.3d 108, 949 N.Y.S.2d 380 (1st Dep’t 2012), where we successfully defended a joint venture partner and property manager of a shopping center on Long Island.  The plaintiff, a minority joint venturer, asserted breach of fiduciary duty and other claims based upon alleged improper management of the shopping center.  A core issue was whether the claims were direct (held by the partner) or derivative (where the partner was seeking to enforce a claim held by the joint venture and affecting all of the joint venturers).  If it was a derivative claim, the plaintiff would have to explain why he failed to simply demand that the joint venture bring the claim.  Derivative claims are a potent weapon for shareholders to redress mismanagement and self-dealing in corporations – from IBM to family owned companies.

Frydman LLC moved to dismiss the complaint on the basis, among others, that the claims were derivative, or owned by the joint venture, and plaintiff failed to properly plead that it would have been futile for plaintiff to demand that the joint venture bring the claims.  The trial court agreed, granted our motion and dismissed the case.  The appellate court affirmed.

While there were some other novel issues, in adopting our arguments the appellate court noted that “New York does not have a clearly articulated test” for determining whether a shareholder claim is direct or derivative (despite the prevalence and importance of such claims in corporate litigation).  The appellate court made a precedent setting holding by adopting the test used by Delaware courts set forth in Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031 (Del. 2004) to determine whether a claim is direct or derivative:  (1) who suffered the harm? (e.g. the company or the shareholders) and (2) who would receive the benefit of recovery? (e.g. would the recovery go to the company or the shareholders).  The appellate court upheld the trial court’s holding that plaintiffs’ claims were derivative because (1) the joint venture suffered the alleged harm caused by the mismanagement and (2) any potential recovery would go to the joint venture because “It is only through loss to [the joint venture] that plaintiffs suffer a loss at all … all members suffer losses from the failure to collect rents and other obligations owed the joint venture.”

It is gratifying to see that the Yudell holding has provided much needed clarity in the area of derivative litigation in New York, home to very significant corporate litigation, and has been cited some 100 times by state and federal courts, taught in corporate law classes and discussed in many legal publications.

If you have questions about the direct/derivative claim distinction or the ability to bring suit concerning a business dispute, please do not hesitate to contact us.

   10/11/17

Tags: Business LitigaitonCorporate LitigationDerivative ClaimsDirect Claims

THE IMPORTANCE OF IMPLEMENTING A LITIGATION HOLD

With the proliferation of email communication and other electronically stored information (“ESI”), litigation over the handling of ESI has also grown in scope, complexity and expense.  In this post, we discuss the issue of the destruction of ESI, making relevant documents unavailable for exchange in pre-trial discovery.  Clearly, a party found to have intentionally deleted incriminating email is subject to serious sanction by the courts.  Inadvertent destruction of ESI, such as failing to shut off an auto-delete function in Outlook or on a backup drive, can also land a party in hot water.

The general rule is that a party should implement a “litigation hold” when it reasonably anticipates litigation.  The litigation hold should be crafted with counsel and delivered to all potential document custodians or persons that might have relevant ESI or other documents.  Oftentimes, counsel will need to consult with IT staff to understand a client’s network architecture and develop protocols to ensure overwrite, delete or other functions are disabled and to collect and preserve potentially relevant ESI for review by counsel or other qualified persons.

In the seminal 2003 decision in Zubulake v. UBS Warburg LLC, 220 F.R.D. 212 (S.D.N.Y.), the Federal District Court in Manhattan held that “[o]nce a party reasonably anticipates litigation, it must suspend its routine document retention/destruction policy and put in place a ‘litigation hold’ to ensure the preservation of relevant documents.”  The Zubulake decision has been followed by the courts in New York and across the country.

In VOOM HD Holdings LLC v. EchoStar Satellite L.L.C., 93 A.D.3d 33, 939 N.Y.S.2d 321 (1st Dep’t 2012), defendant started sending notices to plaintiff of alleged breaches and termination of the parties’ agreement for the distribution of television programming over a satellite network.  Defendant, however, did not issue a litigation hold letter to its employees until after the start of the lawsuit and did not suspend email auto-delete until four months after the lawsuit started. Defendant also allowed its employees to unilaterally determine which emails should be preserved, instead of collecting all potentially relevant documents.  Potentially relevant email were lost.  Defendant’s main defense was that it did not expect full blown litigation because it was in heavy settlement discussions with plaintiff.

The appellate court covering Manhattan and Bronx adopted Zubulake and held that a party “reasonably anticipates litigation” when it is on notice of a “credible probability” that it will be involved in a lawsuit, seriously contemplates commencing a lawsuit or takes specific actions to commence a lawsuit.  The court found the defendant reasonably anticipated litigation when it started sending termination and breach notices and itemized a laundry list of defendants’ failures in not putting in place a comprehensive litigation hold.  The court affirmed the lower court’s sanction of the defendant for its spoliation of ESI by granting that an adverse inference instruction against defendant would be issued at trial, i.e. an instruction to the trier of fact to assume the unpreserved document was adverse to the party.

It is critically important that a party facing any prospect of business litigation consult early on with an experienced litigation attorney about a proper litigation hold.  If you have any questions regarding litigation holds and the preservation of documents, please do not hesitate to contact us.

DO YOU KNOW THE DIFFERENCE BETWEEN A FINDER AND A BROKER? YOUR RIGHT TO BE PAID COULD DEPEND ON IT

You may have had a friend try to introduce you to a company looking for investors for a private offering or a PIPE transaction (private investment in public equity).  Maybe you were even the person doing the introducing.  If so, the issuer might have promised to pay you a commission.  What happens when your prospect invests and the company does not pay?  Based on the way New York courts have interpreted the law, the company could be entirely in the right, and you could be subject to a claim of violation of the securities laws.

A person acting as a “broker” must be with the Financial Industry Regulatory Authority (“FINRA”).  While somewhat underutilized defense, FLLC and other security litigators have successfully defended issuers against claims for commissions because the plaintiff acted as an unregistered “broker.”  A person acting as a “finder,” however, does not act as a “broker” and need not be registered.  While also infrequently litigated, FLLC and other lawyers have succeeded in getting clients paid because they fell under the “finder’s exemption.”

The Securities Exchange Act of 1934 (the “Exchange Act”) is part of an extensive series of legislation designed “to protect investors … through regulation of transactions upon securities exchanges and in over-the-counter markets.”  Section 15 of the Exchange Actspecifically prohibits an unregistered person from acting as a “broker,” while section 29(b) of the Exchange Act makes void any contract that violates the Exchange Act.  The question then is “who is a broker?”  The Exchange Act defines a “broker” as “any person engaged in the business of effecting transactions in securities for the accounts of others.”  Unhelpfully, the Exchange Act does not define either “effecting transactions” or “engaged in the business.”  Knowing whether you are engaged in the business of effecting transactions is incredibly important, because if you are instead acting as a “finder,” you may be entitled to payment.  Courts have held that distinguishing between a broker and finder “involves an evaluation of the quality and quantity of services rendered.”  A finder “is required to introduce and bring the parties together, without any obligation or power to negotiate the transaction, in order to earn the finder’s fee.”  A broker, on the other hand, will perform that same introduction, but “ordinarily also bring the parties to an agreement.”

Courts have generally agreed that “merely bringing together the parties to transactions, even those involving the purchase and sale of securities, is not enough” to find a person acted as a broker.  Rather, the person must have been involved at “key points in the chain of distribution,” such as participating in the negotiation, analyzing the issuer’s financial needs, discussing the details of the transaction and recommending an investment.  A finder generally has far less involvement in the ultimate transaction quantitatively and qualitatively than a broker.  Each case is different and courts in New York and elsewhere will take an in-depth look at the facts to determine whether a person was a broker or a finder.  Beyond the scope here, but further complicating matters, each state has its own “Blue Sky Law” regulating securities that could come into play.

Unfortunately, the Exchange Act’s vague definitions create fact issues and uncertainty for finders, brokers and issuers alike.  While the safest course is registration for a broker, the cost and administrative burden makes registration untenable for most.  If you have questions about the broker/finder distinction or the right to payment for broker/finder services, please do not hesitate to contact us.