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.
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.