Breach of Contract, Business Divorce
As we have often noted on this blog, the importance of businesspeople setting all the terms of their agreements into a writing cannot be overstated. If a term is not in a written agreement – such as a requirement that all partners must actually work for a company rather than be a passive investor – with limited exceptions, the term might as well not exist. A recent decision in a “business divorce” case pending in the Commercial Division of the New York County Supreme Court is the latest reminder of the wisdom of a signed writing.
In Stavroulakis v. Pelakanos, et al., 2018 N.Y. Slip Op. 50180(U) (Sup. Ct. N.Y. Co. Feb. 13, 2018), plaintiff – a minority member of the company that owned and franchised the Bareburger restaurant brand – sued the other shareholders alleging they transferred all the assets of the company (including the rights to franchise royalties and the Bareburger Trademark) without consideration to a new entity formed by the other shareholders that did not include plaintiff. Plaintiff alleged, among other claims, that his partners breached their fiduciary duties to plaintiff and the company by self-dealing, usurping corporate opportunities and engaging in corporate waste. The defendant-shareholders claimed they were justified in effectively kicking plaintiff out of the business because plaintiff had not performed any work and owed his equity stake in the company solely to an initial cash investment. Notably, however, the company’s written agreement did not require any shareholder to work for the company. Nonetheless, defendants argued the “business judgment rule” – a doctrine prohibiting courts from inquiring into the internal business decisions of a company – protected their actions against plaintiff.
The Court disagreed with defendants and skewered their defense. The Court noted that the business judgment rule only protects acts taken in good faith and in legitimate furtherance of corporate purposes. The Court held that transferring the assets of the company to a new entity for no consideration solely to exclude plaintiff because he did not work for the company was not done in good faith or in the interest of the company. Further, defendant-shareholders all had a personal interest in the transaction – each shareholder’s interest in the business increased by eliminating plaintiff – barring application of the business judgment rule. Accordingly, defendants had the burden of proving the “entire fairness” of the transition to the company and plaintiff.
Defendants did not attempt to prove the fairness of the process of the transaction (done behind plaintiff’s back) or the price for the transaction (none). Defendants, rather, argued it was “fair” to cut out plaintiff because he had not worked for the company. The Court summarily dispensed with that defense because none of the company’s written agreements, nor the Business Corporation Law, obligated any shareholder to perform work for the company. To the contrary, the Court found that when the company was formed, the parties understood that only some of the shareholders would work for the company and would receive a salary unrelated to their economic interests as shareholders. The Court granted plaintiff partial summary judgment holding the transfer of assets for no consideration was not fair and breached defendants’ fiduciary duties. The Court noted the company’s agreements could have obligated shareholders to work or, alternatively, defendant-shareholders could have bought out plaintiff or engaged in a “freeze-out” merger (a strategic merger conducted to eliminate unwanted minority shareholders, the mechanics of which are beyond the scope of this post). The Court, relying on the precedent setting decision obtained by Frydman LLC in Yudell v. Gilbert, 99 A.D.3d 108 (1st Dep’t 2012), held plaintiff could recover damages against defendants derivatively on behalf of the company because the company suffered the harm of loss of its assets. The Court also determined plaintiff could recover money damages based on defendants’ oppression of plaintiff as a minority shareholder. The Court held off determining which type of recovery was appropriate until after trial.
If you have any questions about disputes among business partners, the best ways to avoid them or a partner’s rights in trying to resolve them, please do not hesitate to contact us.
Anticipatory Breach, Breach of Contract, Repudiation
When a party to a contract tells the other side that it has no intent of performing its contractual duties, the other party is typically entitled to either damages or a court order directing performance of the contract. This is referred to as an “anticipatory breach” or “anticipatory repudiation.” But what happens when a contract has been amended and a party only wants to disregard its obligations under the amendment and perform under the original contract? The Court of Appeals, New York’s top appellate court, recently offered some guidance on this previously unaddressed issue, but in so doing likely created more questions than it answered.
In Princes Point LLC v. Muss Dev. L.L.C., 30 N.Y.3d 127, 65 N.Y.S.3d 89 (2017), plaintiff contracted with defendants to purchase a waterfront commercial property in Staten Island for $36 million with $1.9 million down. Sellers were obligated within 18 months to provide certain government approvals necessary for purchaser to develop the property. Following Hurricane Katrina, the government required the sellers to rebuild a retaining wall at the property, making timely delivery of the permits impossible. The parties amended the contract several times to allow sellers time to rebuild the retaining wall, while increasing the purchase price and down payment, agreeing to share the cost of remediation and pushing out the approvals deadline and closing date.
One month before the new closing date, purchaser sued sellers seeking an order from the court rescinding, or cancelling, the amendments. Purchaser alleged sellers fraudulently induced purchaser to enter into the amendments. Purchaser wanted the amendments stricken and the parties to perform under the original. In short, purchaser wanted to pay the original, lower purchaser price and not contribute to the cost of rebuilding the wall. Sellers claimed that purchaser’s lawsuit was an anticipatory breach because purchaser was seeking to avoid performance of the amendments. The Appellate Division, First Department affirmed the trial court’s holding that the amendments were inseparable from the contract and purchaser’s commencement of the lawsuit evidenced its intent to disavow its contractual duty to perform. The Court of Appeals disagreed and reversed the First Department’s decision. The Court of Appeals held that purchaser sought only to rescind the amendments and perform under the original contract. Accordingly, the lawsuit did not constitute an unequivocal repudiation of purchaser’s obligations. The Court held that “the mere act of asking for judicial approval to avoid a performance obligation is not the same as establishing that one will not perform that obligation absent such approval.” In essence, the Court said that just because the purchaser asked a court to let it off the hook, it did not mean the purchaser would not perform if the court said “no.”
The Court of Appeals was careful to limit its holdings to the specific facts of this case and, as such, created more questions than it answered. Does a lawsuit seeking to rescind an unamended contract constitute an anticipatory breach? What if the lawsuit seeks to avoid performing only certain provisions of a contract? Every scenario requires independent analysis, which should be addressed prior to taking any action that could result in liability. If you have any questions concerning contract performance and enforceability, please do not hesitate to contact us.
Frydman LLC
Frydman LLC is pleased to announce that David Frydman has been selected to the 2020 America’s Top 100 Bet-The-Company Litigators list, an honor reserved for nation’s most exceptional trial lawyers for high stakes business litigation matters. Less than .5% of lawyers receive this honor. David’s selection recognizes his career long success representing clients in their high stakes business litigation. David’s selection is the result of third-party research or peer nominations by other elite attorneys and limited to the top 100 litigators in New York. Being named to the Bet-The-Company Litigators cements David’s position as a top New York business litigator.
Please do not hesitate to contact us to learn more about David’s practice and how Frydman LLC can help you in your business dispute.
Frydman LLC
Frydman LLC is pleased to announce that David Frydman has been selected to the 2020 New York Super Lawyers list, an honor reserved for no more than 5% of New York lawyers. David’s selection recognizes his tremendous work and success representing companies, individuals, funds, investors and real estate professionals in various forms of business litigation. David’s selection is the result of Super Lawyers’ independent research evaluation along with peer reviews by fellow attorneys against whom David litigates against on a daily basis. Being named to the Super Lawyers list cements David’s position as a top New York litigation counsel and advisor.
Please do not hesitate to contact us to learn more about David’s practice and how Frydman LLC can help you avoid a potential business conflict before it gets to litigation or resolve an already developed dispute.
Business Divorce, Corporate Litigation, Partnership Dispute
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 Litigaiton, Corporate Litigation, Derivative Claims, Direct 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.
