New York Court of Appeals extends personal jurisdiction over party under “furtherance of agreement”.

In a case involving personal jurisdiction between two parties located outside of New York state, the Court of Appeals recently reversed the decision of the Appellate Division in D & R Global Selections v. Bodega Olegario Falcon Pineiro and held that long arm personal jurisdiction over the party exists where the furtherance of the agreement occurred in New York state.

The defendant, Bodega, is a winery located in Ponteveda, Spain and the plaintiff D&R, also located in the same town entered into an oral agreement to locate a distributor for the defendant’s wines in the United States. Pursuant to the agreement, the defendant also agreed to pay commissions to the plaintiff based on a specified rate. As the Court noted, neither party were a domiciliary of New York nor did they have any permanent presence in the state.

The parties jointly visited New York multiple times to locate a distributor. In one such event in May 2005, the defendant was introduced to Kobrand Corp. by the plaintiff. In November 2005, the defendant commenced selling wine to Kobrand. In January 2006, both plaintiff and defendant attended Kobrand’s promotional events which included the promotion of defendant’s wine. The defendant paid commissions to the plaintiff until November 2006 and in January 2007, the defendant ceased paying commissions to the plaintiff, citing that the oral agreement was for one year.

In November 2007, the plaintiff commenced cause of action against the defendant for breach of contract, quantum meruit, unjust enrichment, and an accounting. The plaintiff alleged that agreement did not terminate after one year, but would continue during the period for which Kobrand promoted the defendant’s wine. In June 2008, the plaintiff obtained default judgment on the grounds of defendant’s failure to answer the complaint. The defendant appealed the judgement. The Appellate Division vacated the judgment on grounds as to a question of fact if the court had personal jurisdiction over the defendant under CPLR 302(a)(1).

The Court began its analysis with the textual interpretation of CPLR 302(a)(1). To be subject to personal jurisdiction under CPLR 302(a)(1), either (1) the defendant needs to transact business or (2) contracts to supply goods and services in the state. In either case, there is a further two-fold query: (i) the defendant must be purposefully availing itself in cases (1) or (2) and (ii) the claim against the defendant must arise from said business transaction.

In order for the defendant to purposefully avail itself, a non-domiciliary defendant transacts business in New York when “on his or her own initiative, the non-domiciliary projects himself or herself into this state to engage in a sustained and substantial transaction of business” citing Paterno v. Laser Spine Inst., 24 NY3d 370 (2014). Furthermore, the quality of contacts is to be considered especially focusing if the non-domiciliary “seeks out and initiates contact with New York, solicits business in New York, and establishes a continuing relationship”.           Thus, the Court agreed with the Appellate Division’s determination that the Defendant did conduct business in New York. First, the agreement between the parties emphasised locating a distributor in the United States; secondly, the parties visited New York multiple times to attend wine industry events and did locate a distributor and thirdly, the defendant entered into an agreement with Kobrand for the distribution and promotion of its wine. Therefore, the Court concluded that the defendant purposefully availed itself of “the privilege of conducting activities within New York, thus invoking the benefits and protections of its laws”.

The Court reiterated that simply transacting business in New York was not sufficient for long arm jurisdiction under CPLR 302(a)(1), but in addition, there must have an “articulable nexus” or “substantial relationship” with the defendant’s transaction of business and the plaintiff’s claim. It should be noted that an articulable nexus or substantial relationship exists “where at least one element arises from the New York contacts” rather than “every element of the cause of action pleaded”. Here, the Court deviated from the Appellate Division’s reasoning and concluded that such a nexus exists since the agreement was not performed entirely in Spain. Most importantly, under the Court’s analysis, the parties engaged in activities in New York in furtherance of their agreement. The parties travelled to New York multiple times to locate a distributor; the defendant was introduced to Kobrand; the meeting led to attending Kobrand’s promotional events where the defendant’s wine was purchased; and finally, the non-payment of the commissions based on the purchases was the basis of plaintiff’s claim. Therefore, the Court concluded that the plaintiff’s claim arose from the defendant’s transaction in New York.

Finally, the Court also considered whether long arm personal jurisdiction would comport with federal due process. In order to comport with the constitutional requirement, the defendant must have (1) minimum contacts with New York and should “reasonably anticipate being hauled into court” and (2) defending such suit comports with “traditional notions of fair play and substantial justice”. The first element had been established since the defendant visited New York to locate a distributor and also signed an agreement with a distributor to promote its wine. Thus, the Court concluded that the defendant could reasonably be anticipated to defend a suit in New York. With respect to the second element, the burden falls on the defendant to “present a compelling case that the presence of some other considerations would render jurisdiction unreasonable”. Here, the Court noted that defendant did not present any reason and thus long arm jurisdiction could be exercised over the defendant without violating due process.

The Court’s opinion is interesting in that “in furtherance of an agreement” could be considered a factor as to whether long arm jurisdiction can be extended to a defendant. The oral agreement appeared to have been manifested in Spain rather than New York. It didn’t appear to be the party’s intention from the onset that New York would be the sole location for locating a distributor.


US Supreme Court extends interpretation of statute of limitations to SEC injunctions.

In a case that perhaps is not directly related in a commercial litigation context, but nevertheless has implications on the United States Supreme Court’s statutory interpretation of the distinction between civil penalties, the Court has held in Kokesh v. SEC that disgorgement would be considered a penalty and thus, subject to the five year statute of limitations under 28 USC § 2462. The opinion extends Cebelli v. SEC, 568 U.S. 442 (2013) which considered the statutory limitations in a monetary penalty context.

The defendant, Charles Kokesh, misappropriated funds between 1995 and 2009 for approximately $34.9 million dollars and inter alia filed misleading statements with the SEC. In 2009, the District Court found him guilty for the misappropriation for all events prior to 2004. The defendant was order to pay a civil penalty of $2,354,593 and initially for the conduct outside the five year period, $29.9 million dollars since in the District Court’s opinion, this was not a penalty, but disgorgement. The Tenth Circuit upheld the District Court’s judgment that the $29.9 million disgorgement was not a penalty and thus, not subject to the statute of limitations.

A unanimous Supreme Court has reversed the Tenth Circuit’s decision. The Court began with the definition of a “penalty” which under Huntington is a “punishment, whether corporal or pecuniary, imposed and enforced by the state”. The Court made a distinction between a sanction, which is a penalty to an individual or public and pecuniary sanction which is acts as a punishment or deference. Under Brady v. Daly (1899), compensation for a private wrong is not a penalty. Furthermore, in Mecker v. Lehigh, a “penalty is imposed for something punitive for an infraction of a public law”.

Thus, applying the above principles, the Supreme Court held that disgorgement would be a penalty under § 2462. The Court delineated between three purposes of a penalty: (1) public interest, where the remedy sought is committed against the United States and where the victim’s views are not of paramount consideration; (2) punitive, where the emphasis is to prevent future violations, and (3) compensatory, where the damages paid are to the District Court directly. In the third purpose, the District Court determines the payout to the victims and the U.S. Treasury, if applicable.

The SEC argues that the penalty is strictly remedial. However, the Supreme Court had a skeptical view if the penalty is truly remedial since in many cases the defendants are not simply being returned to the original position had the violation not occurred, but in some cases asked to pay much more than the profit gained.

Interestingly, the Court took an example of insider trading where the tippee’s gains has been attributed to the tipper. Even in instances where the tipper has not personally profited from the tippee’s gains, nevertheless, tippee’s actions are imputable to the tipper and have to disgorge the tippee’s profits. Thus, the Court had observed that the SEC sanctions were beyond compensatory and had a retributive aspect to the sanctions.

First Appellate Division rules ambiguity exists in patent royalties breach of contract case.

In a divided court opinion, the First Appellate Division reversed a lower court ruling in New York Univ. Pfizer, Inc., 2017 NY Slip Op 03464 (May 2nd, 2017) to find that a relevant provision that addressed royalties payments was ambiguous and reinstated the complaint.

Plaintiffs ,NYU, sued defendants, Pfizer, Inc. for breach of contract, specifically, royalties on the sale of a cancer drug, Xalkori®, which NYY alleged was developed in part by the NYU research project with Sugen, company purchased by Pfizer in a later stage.

In 1991, Sugen and NYU entered a license agreement whereby Sugen provided sponsorship for NYU’s research into tyrosine kinase inhibitors (TKR).  As part of the bargain, Sugen would receive an exclusive license to use the NYU’s “research technology”  for development of any drug that resulted from the research.  Furthermore, Sugen agreed to pay any royalties on any sales with respect to the drugs.

In 1996, Sugen was acquired by a third party and thus, a new agreement, Second Amended Research and License Agreement was executed between the parties.  As part of the amended, agreement, NYU agreed to reduce its royalty rates for “the right to royalties in on certain later developed products” and specifically added Section 9 which stated:

“[3] SUGEN Products that are developed based on Receptor targets which were not adopted into drug discovery at the time of the effective date of such acquisition, merger, or joint venture shall be subject to a). a royalty of 2.5% on Net Sales of SUGEN, and/or Corporation Entity, which may be offset by 50% of the royalties paid by SUGEN to third parties (other than MPG), provided that the royalties due to NYU shall not be less than 1.5%of Net Sales of SUGEN and/or Corporation Entity and b). 10% of License Revenues with respect to any SUGEN Product, provided that with respect to such SUGEN Product there exists a Patentable Invention with respect to such target and/or its utility which is derived from or based on the Research Technology, and provided further that such SUGEN Product shall include a product irrespective of whether an IND application is filed with respect thereto within 4 years from the end of the Research Period, or not.”

Between 1999 and 2003, Sugen was acquired by Pharmacia, which was subsequently acquired by Pfizer.  Pfizer further developed PHA-66572 which then led to the development of crizotinib.  Subsequently in 2005, Pfizer filed an IND application…..

In 2007, Japanese scientists discovered EML4-ALK,  a mutated form of “ALK” TKR as a cause for lung cancer.   Pfizer determined that crizotnib acted as a inhibitor to the EML4-ALK receptor and thus amended its IND application to include clinical testing of criztonib.  Eventually, a drug Xalkori® was approved by the FDA and subsequently NYU demanded royalties on all sales.

The Court determined that NYU’s claim to royalties was based on Section 9(3) of the amended agreement and specifically, the language that applied to products not being developed at the time of of the effective date of Sugar’s ownership and also the existence of a “Patentable Invention with respect to such target or and/or its utility which is derived from or based on the Research Technology”.

The majority’s interpreted this provision that the “nexus between the invention and the target need not be direct.”  One interpretation (and expansive, at that) of Section 9(3) was that “any “Sugen Product” containing a “Patentable Invention” “derived” in part through NYU’s “Research Technology” may be the source of royalty payments”.  Thus, the Court took a view that since Xalkori® was developed on a patentable invention, criztonib, there was the requisite nexus between the the receptor and its target

With respect to “non-adopted” targets, the majority held that that agreement was silent as to the application of Section 9(3).  It pointed that only Section 11 of the prior 1996 agreement restricted the targets as those that “identified directly by NYU in the course of the NYU Research Project”.  This provision did not appear to be included in the subsequent license agreement and thus, the majority concluded that if restrictions on targets would have been addressed in the current agreement.

On the other hand, the dissent adopted the contrarian view and concluded that Section 9(3) was unambiguous.  The dissent initially agreed with the majority that Section 8 of the agreement did not apply as Pfizer filed for the IND more than four years after the Research Period ended.  Thus, any relief for NYU stems from the interpretation of Section 9.

Under the dissent’s view, Section 9(3) is unambiguous because the target must have been identified from the onset of the project and since EML4-ALK was not identified, NYU was not entitled to any royalties.  Further, the dissent noted the the EML$-ALK was discovered by the Japanese scientists without the involvement of NYU’s Research Technology.  Most importantly, Pfizer did not rely on NYU’s Research Technology to discover that crizotnib inhibited EML4-ALK.

The dissent also reiterated the lower court’s observation that “Patentable Invention” must be related to the target or its utility and did not include the drug that would inhibit the target.  if the provision was to include any drugs, (1) it would have been included in the agreement, and (2) the provision would be meaningless if the interpretation included drugs.

Finally, the dissent noted that target was not identified prior to the change in ownership of Sugen; not only should the target be identified, it should also be a Patentable Invention and exist at the time of the ownership change; lastly, the dissent noted that it would be commercially unreasonable under NYU’s interpretation of Section 9 since every target subsequently discovered indirectly would be subject to royalty payments.


Court declines to extend collateral estoppel defense in artwork ownership litigation.

In Reif v. Nagy, 2017 NY Slip Op 02920 (April 18, 2017), the First Department affirmed a lower court’s ruling dismissing a complaint brought by heirs claiming ownership to Nazi looted art.  The Court held that collateral estoppel did not apply since a lawsuit involving an earlier art piece did not extend to the other two art pieces.

The two artworks in consideration in the present suit were painted by Egon Shiele and include: (1) “Woman in a Black Pinafore” and (2) “Woman Hiding Her Face” .

The plaintiffs are heirs to cabaret artist, Fritz Grunbaum, who was the owner of the artwork before they were looted by the Nazis prior to his execution during the Holocaust.  The defendant, Nagy, an art dealer, procured the artwork around 2013.

The defendants argued that the principle of collateral estoppel should apply since a third piece, “Seated Woman with a Bent Left Leg (Toro)” was previously the basis of a federal lawsuit in which the Court held against the plaintiffs when establishing ownership of that piece.

However, the Court rejected this argument and declined to extend the principle of collateral estoppel to the current suit since “requires the issue to be identical to that determined in the prior proceeding, and requires that the litigant had a full and fair opportunity to litigate the issue”.

Here, the Court observed that the requirements were not fulfilled since “the purchaser, the pieces, and the time over which the pieces were held differ significantly”.  Thus, the Court declined to impute the status of one piece to another since in its opinion, the artworks were not part of the same collection.

Nevertheless, Nagy prevailed in having the§ General Business Law § 349 cause of action dismissed since the facts did not indicate any consumer type harm envisioned by the statute.

First Department reiterates factors to be considered in determining art ownership in divorce proceedings.

The First Department recently held in Anonymous v. Anonymous, 2017 NY Slip Op 02613, (April 4th, 2017) that invoices paid by one party does not in itself constitute as  ownership for the purposes of single ownership with respect to marital property.  The Court reiterated the the factors stated in  Susan W. v Martin W. (89 Misc 2d 681 [Sup Ct, Kings County 1977]) are to be considered in determining art ownership: (1) parties’ interest in art; (2) joint involvement in the purchase of art and (3) source of payment e.g joint or single accounts.

The parties were married on May 5th, 1992 and under the prenuptial agreement signed on April 21st, 1992,  specific disposition of any art collection acquired was not explicitly addressed.  However, a key provision of the prenuptial agreement stated that with respect to property in general: “hereafter . . . acquired” by one party remains that party’s separate property.  It provides that “[n]o contribution of either party to the care, maintenance, improvement, custody or repair of . . . [the other’s party] . . . shall in any way alter or convert any of such property . . . to marital property.” (internal citations omitted).  Furthermore, in another key provision: “No property hereafter acquired by the parties or by either of them . . . shall constitute marital property . . . unless (a) pursuant to a subscribed and acknowledged written agreement, the parties expressly designate said property as marital property . . . or (b) title to said property is jointly held in the names of both parties.”  (Internal citations omitted).

Throughout the course of their marriage, the parties obtained art through various channels, and the wife’s contention was the such pieces obtained were jointly held whereas the husband argued that the such pieces where part of his personal collection and thus, outside of marital property.

The husband substantiated his position that he has sole title to the works because the invoices attached to the sale were solely on his name.  The Court disagreed with this argument and held that “that invoices, standing alone, may not be regarded as evidence of title or ownership of the art.”

Court’s reasoning was based on two premises: (1) the plain meaning definition of an invoice and (2) also its reliance in the Supreme Court case, Sturm v Boker, 150 US 312 (1893) which held that “”An invoice . . . is not a bill of sale, nor is it evidence of a sale. It is a mere detailed statement of the nature, quantity, or cost of the goods, or price of the things invoiced, and it is as appropriate to a bailment as a sale. Hence, standing alone, it is never regarded as evidence of title.”  (Internal citations omitted).

In its reasoning, the Court expressed its concerns over potential unreliability of invoices since prices may be distorted and the possibility of inaccurate description of the goods purchased.  As applicable to the parties here, the Court noted that the invoices presented already contained multiple discrepancies including issues with names presented to the auction house and where applicable, actual purchases in private sales, as well as painting explicitly purchased jointly, but the invoice indicating only the husband’s name.

The Court had disregarded the husband’s reliance on Tajan v Pavia & Harcourt (257 AD2d 299 [1st Dept 1999], lv dismissed in part, denied in part 94 NY2d 837 [1999]).  In Tajan, the Court noted that despite reference to a bill of sale produced during an auction “warranted the painting’s good title”, nevertheless, the Tajan Court considered the admissions and other releases of claims by the parties in determining the ownership of the art work.

In considering the wife’s arguments, the Court appeared to rely more on the cases cited, in particular Lindt v Henshel (25 NY2d 357 [1969]) and Susan W. v Martin W. (89 Misc 2d 681 [Sup Ct, Kings County 1977]).  The Lindt, the Court of Appeals held that a wife was entitled to a sculpture since she purchased it without the involvement of her husband and further, attended the auction by herself.  The Court noted that the bid card was signed by her and furthermore, the price of the painting was charged to her account along with the invoice being in her name.  In Susan W., the Court considered factors such as (1) parties’ interest in art; (2) joint involvement in the purchase of art and (3) source of payment e.g joint or single accounts.

Overall, the Court appears to be dismiss invoices as the sole determination of ownership of art between the parties.  The totality of the circumstances of the purchases needs to be considered as stated in the suggested factors in Susan W. and Lindt decisions.

First Appellate Division declines to extend mutual mistake doctrine to commercial art transaction.

In an interesting application of mutual mistake in an art deal transaction, the First Appellate Division, in a split opinion, affirmed in Jerome M. Eisenberg, Inc. v. Hall, 2017 NY Slip Op 01437 (February 23rd, 2017) that the Plaintiff was not entitled to summary judgment for the breach of contract pursuant to the doctrine of mutual mistake.

The Plaintiff, Jerome Eisenberg, purports to be an expert in classical antiquities and is a buyer and seller of various antiquities.  The Plaintiff is also a Qualified Appraiser of the Appraisers Association of America and also has PhD in Roman, Egyptian and Near Eastern Art.

Defendant, Maurice E. Hall, Jr. is an art dealer who transacts primarily in 16th to 19th century European art, and in particular, Renaissance art. He self-proclaims to be only an amateur collector with regards to ancient antiquities. The subject matter between the parties were two pieces: (1) marble head or bust of Faustina II (“Faustina”) and (2) a bronze warrior statue purported to be either from the Etruscan or Roman Era (“Etruscan”). it should be noted that both these pieces are considered to be ancient.

In 2009, the Plaintiff purchased the Faustina from the Defendant’s townhouse and later sold the piece to Mougins Museum of Classical Art in France. In September 2011, the Plaintiff was informed by the Museum that the Faustina was a fake and substantiated their position by submitting two expert valuations.

In April 2011, the Plaintiff purchased the Etruscan and a bronze helmet. At a later stage ,the Plaintiff submitted photographs and the statute to various experts who concluded that based on the style and metallurgical analysis, the Etruscan was produced in the 19th or 20th century which would not qualify it as ancient.

Plaintiff moved for summary judgment and argued that the contract should be voidable under the doctrine of mutual mistake.

The Majority cited the standard set In Matter of Gould v Board of Educ. of Sewanhaka Cent. High School Dist., 81 NY2d 446, 453 [1993] and P.K. Dev. Elvem Dev. Corp., 226 AD.2d 200 (First Dept., 1996) as to whether the plaintiff bore any risk of the mistake due to its “conscious ignorance” of the items’ authenticity. Furthermore, the Court reiterated that where the doctrine of mutual mistake applies, the contract is subject to rescission because it does not represent the meeting of the minds of the parties. In addition, the said mistake must exist at the time of the formation of the contract and must be substantial (internal citations omitted).

The Majority reasoned that while both parties mistakenly assumed that the item in question was ancient, nevertheless there were “ancient, issues of facts exist as to whether plaintiff bore the risk of that mistake due it its “conscious ignorance” of the items’ authenticity”.

The Majority re-iterated that a contract would be voidable if it is entered under a mutual mistake since it does “not represent the meeting of the minds’ of the parties”.   Furthermore, such mutual mistake shall exist at the time of entering the contract and must be substantial (internal citation omitted).

Regardless, there are exceptions where such a mutual mistake may not apply, such as a party’s own negligence. Where a party should “in the exercise of ordinary care, should have known or could have easily ascertained the relevant fact, then the party is deemed to have been “consciously ignorant” and barred from seeking rescission or other damages.  The Majority emphasized that the relevant party “must go beyond its own efforts in order to ascertain relevant facts”.

Thus, under the Majority’s reasoning, the Plaintiffs simply failed to conduct sufficient due diligence despite having the ability and the access to the relevant expertise. It was noted that during previous transactions, the Defendants had produced items with questionable authenticity and thus Plaintiff should have had notice as to the authenticity of the current item.

The Dissent’s fairly expansive reasoning disagreed with one aspect of the Majority’s decision and that is if the Plaintiff was consciously ignorant of the items’ authenticity.

The Dissent supported the Plaintiff’s position that that he genuinely did not believe the artwork in question was inauthentic. However, the disagreement with the Majority’s position was that the Dissent believed that “there is no evidence that the plaintiff consciously ignored its uncertainty as to a crucial fact”. Despite having notice that the Defendants sold inauthentic pieces in the past, with respect to the pieces at hand, there is no indication that the Plaintiff was “uncertain to a crucial fact”. The record did not indicate the circumstances of the details of the previosu transactions, and nevertheless the Plaintiff was refunded for all monies paid and thus suffered no financial loss.

However, the critical distinction between the Majority and the Dissent is that pursuant to Richard L. Feigen & Co. v. Weil, 1992 NY Misc LEXIS 711, aff’d 191 AD.2d 278 (First Dept. , 1993), the Dissent relied on the assertion that “there is no authority for the proposition…that in a contract between an expert and non-expert, rescission based on mutual mistake is unavailable to the expert” (internal citations omitted). The Dissent also cited Uptown Gallery, Inc. v. Doninger (1993 NY Misc LEXIS 661 [Sup. Ct. , New York County 1993]) where the conscious ignorance claim was also set aside on grounds that there was no uncertainty involved in the underlying painting, but the parties simply assumed that the painting was an authentic piece painted by a certain artist.

Ultimately, the majority decided that the Plaintiff bore the risk of the transaction and in essence, could have conducted further due diligence on the pieces whereas the Dissent focused on that such due diligence was unnecessary since there was no apparent uncertainty on the onset of the formation of the contract.

First Department reverses Supreme Court decision on”holdback”provision in stock purchase agreement.

In a rare reversal, the Court in Golden Tech. Mgt., LLC v. NextGen Acquisition, Inc., 138 AD3d 625 (2016) granted defendant’s motion for summary judgment dismissing a breach of contract cause of action.

As part of the terms of a stock purchase agreement, the defendants were to make an initial cash deposit at the time of closing.  In addition, they were also to deposit a “holdback” amount in an escrow account of non-party NextGen Fuels, Inc.   The deposit would then be returned to the plaintiffs after one year.

Plaintiffs filed a cause of action for breach of contract approximately seven years after the closing date, but within six years of the time that the deposit should be disbursed to the plaintiffs.

The Court delineated the contract provision to include two obligations: (1) a deposit to be made into an escrow account and (2) the payment obligation whereby the plaintiffs would receive the amount deposited after one year.

Here, the plaintiff intended to enforce the payment obligation and the Court noted that while it was not time-barred under CPLR  213(2), nevertheless the defendants were “not responsible for the breach” and the correct party was non-party NextGen Fuels, Inc.


Court dismisses cross-complaint based on defective UCC-1 filing.

In 1380 Hous. Dev. Fund v. Carlin, 138 A.D3d 613 (2016), the First Department dismissed defendant’s cross-complaint based on a defective UCC-1 fixture filing.

In order to perfect a lien against real property, the UCC-1 financing statement needs to be filed with the local property records pursuant to UCC 9-334.  Here, the defendant filed  UCC-1 with the Secretary of State in 2005.  The second fixture filing filed in 2010 fails to satisfy the criteria set forth in UCC 9-502(b).  There was no description of the collateral, specifically the fixtures it needed to cover; there was no explicit intention to cover fixtures on the property; the filing lacked the description of the property including block and lot numbers.

The defendant also failed to meet the requirement under UCC 9-108 in that the description was not sufficient to identify the collateral subject to the lien.  While there was a stipulation and pledge agreement, it only referred to the borrower’s 50% share certificates and not the real property itself.  The UCC-1 financing statement referred to the stipulation agreement, but did not reasonably identify the assets.  Thus, in the Court’s view, the defendant failed to perfect a lien established by a security agreement under UCC 9-102.



NY Court of Appeals applies additional scrutiny to opt-out of clauses in mergers.

The Court of Appeals recently held in Jiannaris v. Alfant, 2016 Slip Op 03548 (May 5th, 2016) that a settlement that would deprive out-of-state class members of a cognizable property interest to opt-out should be rejected.

On August 4th, 2009, Google and On2 entered into a merger agreement.  A class action was commenced by plaintiff alleging that the On2’s board of directors had breached its fiduciary duty to its shareholders.  Another group of shareholders commenced similar actions in the Delaware Court of Chancery.

A settlement was reached between plaintiffs in both actions with the directors of On2.  The stipulation of settlement was filed in Supreme Court that provided for, inter alia, “the dismissal of the New York and Delaware actions in their entirety with prejudice” and a “release of of any and all merger related claims.” However, the settlement failed to state any opt-out rights.  The Supreme Court certified the proposed class pursuant to CPLR Article 9 subject to a fairness hearing.

The Supreme Court found the settlement to be fair ,but rejected it ultimately as there was no opt-out clause for out of state class members.  The Appellate Divison upheld the Supreme Court’s judgment, see 124 A.D.3d 582 (2nd Dep., 2015).  Leave of appeal was granted by the Court of Appeals.

The Court began its analysis with a review of the Philips Petroleum Co. v. Shutts, 472 US 797 (1985), which held that due process requires opt-out rights in actions “wholly or predominately for monetary damages.”  The Court of Appeals affirmed this decision in Matter of Colt Indus. Shareholder Litig., 77 N.Y.2d 185 (1991).  In Matter of Colt, a Missouri corporation wanted to opt-out of a New York class action that seeked equitable relief.  The Court held that “there was no due process right to opt out of a class that seeks…equitable relief.”   Nevertheless, the settlement still violated due process since it precluded class members to pursue an action for damages in another jurisdiction (internal citations omitted).  

Similarly, the settlement proposed between Google and On2 also contained a provision whereby out-of-state class members could not pursue non-equitable claims.  The defendants distinguished Colt by stating that the scope of the release was different in that Colt also related to claims prior to the buyout in addition to the merger-related claims.  However, the Court emphasized that the holding based on the damage claims that could not be pursued because of the merger.  Thus, for the purpose of the opt-out analysis, the case was not distinguishable.

In addition, the defendants sought to distinguish the different types of damages claims such as incidental damages and individualized damage claims.  To this effect, the defendants cited Wal-Mart Stores, Inc. v. Dukes, 131 S.Ct.  2541 (2014) where the Supreme Court held that legal damage claims incidental to equitable relief may be bound on out-of-class members.

The Court distinguished Wal-mart by indicating that it applies to federal class actions whereas the current case is a New York class action suit.   Under FRCP 23(b)(2), there is no right to opt out of class actions where equitbale relief is sought.

Since the current class action was brought under CPLR 9, the Court stated that Wal-Mart did not apply here.  Furthermore, pursuant to Colt, a judge has discretion “to permit a class member to opt out of a class”, particularly where a settlement may violate due process rights.

The takeaway from this case is the differentiation of right of out-of-state class members in New York state class actions versus federal ones.  The lack of opt-out clauses for out-of-state class members are likely to be scrutinized further in New York state class actions.

New York Court of Appeals adopts Delaware Standard of Review in Private Mergers.

In a recent decision, Matter of Kenneth Cole Prods., Inc. Shareholder Liig., (2016 N.Y. Slip Op 354, May 5th, 2016), the New Court of Appeals adopted the standard of review decided in Kahn v. M&F Worldwide Corp., 88 A.3d. 635 (MFW) with respect to going private mergers.  The Court went on to affirm the application of the business judgment rule where shareholder-protective conditions are present.  In contrast, the Court further held that in the absence of such conditions, the entire fairness standard shall apply, drawing from MFW standard.

Kenneth Cole Productions, Inc. (KCP) had two classes of common stock: (1) Class A stock which was traded on the New York stock exchange and (2) Class B stock, which was held entirely by  the defendant Kenneth Cole himself.  There were 10,706,723 outstanding shares of Class A stock and each shareholder was entitled to one vote.  Kenneth Cole owned 46% of Class A stock.  With respect to Class B, there were 7,890,497 shares and each share was entitled ten votes.  The overall voting structure meant that Kenneth Cole had 89% of the voting power of KCP.

In February 2012, Cole had informed the Board that he wished to proceed with a going private merger and intended to submit an offer to purchase the remaining Class A shares.  The Board established a special committee consisting of Michael J. Blitzer, Philip R. Peller, Denis F. Kelly, and Robert Grayson to review the proposal and negotiate the merger.  Kenneth Cole was not present when the committee was formed.

On February 23rd, 2012, Kenneth Cole proposed to to buy the Class A shares at $15 per share.  Among the conditions of the offer, (1) the special committee had to approve the offer and (2) in addition, the majority of the minority shareholders need to approve the offer as well.  On a rather personal note, Kenneth Cole also stated that if the offer was not approved, “his relationship with KCP would not adversely be affected”.

After the announcement of Cole’s offer, various shareholders commenced class actions  against Cole and KCP.  During their review, the special committee asked Cole to increase his offer and Cole ultimately raised his offer to $15.50 and then $16.  However, Cole reduced his offer back to $15 stating the issues with the company and general economy.  Further negotiations ultimately settled for a price of $15.25 for each outstanding share of Class A stock.  A shareholder vote was held and 99.8% of minority shareholders voted in favor of the merger.

Plaintiffs in an amended complaint alleged: (1) Cole and the directors breached their fiduciary duty they owed to minority shareholders; (2) award of damages to the class; and (3) a judgment enjoining the merger.  The defendants filed a motion to dismiss the complaint on the grounds that it failed to state a cause of action.

The Supreme Court granted defendants’ motion to dismiss the complaint citing that complaint failed to “demonstrate a lack of independence on the part of any of the…individual defendants.”  The Supreme Court also pointed out that the directors engaged in negotiations with Cole over the period of months and the the price offered was a premium over the last selling price of the stock.  Furthermore, the plaintiffs had failed to show any specific unfair conduct by the committee and thus, there was no reason to second guess the committee’s business decisions.

Upon appeal, the Appellate Division affirmed the Supreme Court holding that the “the motion court was not required to apply the “entire fairness’ standard to the transaction”(internal citations omitted).  The Appellate Division distinguished this case from the seminal case, Alpert v. 28 Williams St. Corp., 63 N.Y.2d 557 (1984) in that the current merger required the “approval of the majority of the minority shareholders.”  Furthermore, the Appellate division pointed that Cole himself did not participate in the board’s vote on the merger and the plaintiffs failed to demonstrate any self-interest on the part of the remaining board members.

The Court of Appeals adopted a “middle ground” with respect to the standard that should be applied to a going private merger.  Plaintiff had argued that an entire fairness standard should be used which places a burden on the directors that they “engaged in a fair process and obtained a fair price.”  On the other hand, the defendants argued that the business judgment rule should apply.

The Court began to re-affirm the principle that “courts should…avoid interfering with the internal management of business corporations”.  Thus, in the application of the business judgment rule, as long as the directors and officers of a company exercise unbiased judgment in good faith, the courts will defer to those determinations.  40 W. 67th St. v. Pullman, 100 N.Y.2d 147, 153 (2003).  In expounding the business judgment rule, the Court also observed that courts are ill equipped to evaluate business judgments and there was no objective standard by which one could evaluate any corporate decisions.  Auerbach v. Bennett, 47 N.Y.2d 619 (1979).  The Court further emphasized that under the business judgment rule, “courts may inquire as to the disinterested independence of the members of that committee and as to the appropriateness and sufficiency of the investigative procedures chosen and pursued by the committee” citing Auerbach at 623-624.

The opinion also distinguished the different types of freeze-out mergers: (1) two-step mergers whereby an investor purchases the majority of the shares of the company and then uses said control to merge the target with a second company, compromising minority shareholders; (2)  parent-subsidiary mergers and (3) going-private mergers, whereby the majority shareholder of a public company buys the shares of the remaining investors.

In the  Court’s analysis, the leading case in freeze-out mergers is Alpert v. 28 Williams St. Corp., 63 N.Y.2d. 557 (1984).  With respect to a two step merger, in the event of an “inherent conflict of interest and the potential for self-dealing, careful scrutiny of the transaction is required.” citing Alpert, 570.   The burden falls on the interested directors or shareholders to prove good faith and the entire fairness of the merger citing Chelrob, Inc. v. Barrett, 293 N.Y 442, 461 (1944).

Under Alpert, In order to determine fairness, two elements must be considered: (1) fair process and (2) fair price.  The fair process is comprised of factors such as “timing, structure, disclosure of information to independent directors and shareholders, how approvals were obtained” (internal citation omitted).   In contrast, the fair price can be determined whether “independent advisors rendered an opinion or other bids were considered in order to determine an arms-length negotiation.  These two elements are then considered as a whole to determine fairness to the minority shareholders.

Despite reiterating the standard used in Alpert, the Court nevertheless distinguished the case by stating that in Alpert there was no independent committee formed or a minority shareholder vote.  The question still remained whether the fiduciary standard set above would apply to mergers other than a two-step merger.

The Court considered the holding in the Delaware case of Kahn v. M&F Worldwide Corp., 88 A.3d. 635 (MFW) where a controlling shareholder proposed to purchase all outstanding shares of stock and thus, take the company private.   Similar to the current case, the shareholder also made the proposal contingent on: (1) approval from a special independent committee and (2) approval of the majority of the shareholders not associated with the controlling shareholder (internal citations omitted).  Furthermore, if the merger was not approved, the controlling shareholder would not bear an adverse relations with the corporation.

The Delaware court preferred the business judgement rule over the entire fairness standard because of the structure it created i.e. (1) an independent special committee and (2) uncoerced, informed vote of the majority of the minority shareholders.  The reasoning behind the adoption of the business judgment rule is that inter alia there are arms-length negotiations; the protection offered to minority shareholders in controller buyouts; there is a deference to the informed decisions of the independent directors and the incentive to protect minority shareholders.

The standard is defined as follows: (i) the controller conditions the procession of the transaction on the approval of both a Special Committee and a majority of the minority stockholders; (ii) the Special Committee is independent; (iii) the Special Committee is empowered to freely select its own advisors and to say no definitively; (iv) the Special Committee meets its duty of care in negotiating a fair price; (v) the vote of the minority is informed; and (vi) there is no coercion of the minority”.  (internal citation omitted).

The Court reasoned that the adoption of the Delaware standard “reinforces the business judgement rule.”  Furthermore, there remains a continued to deference to the disinterested board of directors consistent with Auerbach, and the interests of the minority shareholders are protected sufficiently.

In order to prevail in a complaint for breach of fiduciary duty, the plaintiff may proceed to discovery if it alleges “a reasonably conceivable set of facts” showing that one if the six elements does not exist.  Neither conclusory statements or speculation may support a cause of action for breach of fiduciary duty.  In the event that one of six elements does not exist, the business judgment rule no longer applies, and in its place, the entire fairness standard should be applied instead.

In applying the MFW standard, the Court affirmed the lower courts’ decision granting defendant’s motion to dismiss.  First, the plaintiffs did not allege with any sufficiency or specificity that any of the six elements were absent.  The first element had already been fulfilled as Kenneth Cole had established a special committee of independent directors and in addition, the majority of the minority shareholders.

Although the plaintiffs challenged the independence of some of the directors, the Court applied the MFW standard in that the ties must be “material in the sense that they could affect partiality.  MFW, 69.  Thus, the plaintiffs had failed to provide any evidence of fraud, conflict of interest or that the members lacked the capability of reaching an unbiased decision.

With respect to the third element, the plaintiffs only made speculative allegations that the directors acceded to Kenneth Cole’s demands.  The Court focused on the Cole’s conduct whereby he stated that his relationship with the company would not be adversely affected if the committee or the minority shareholders failed to vote for the transaction.

The plaintiffs also failed to fulfill the fourth condition.  The Court pointed out that mere cursory allegations that the committee failed to meet its duty of care in negotiating a fair price was not sufficient.  The plaintiffs failed to provide substantive instances where the committee engaged in any unfair conduct.  The Court noted that the final offer was higher than the original offer, which in itself was determined by a panel of independent analysts.

With respect to the fifth and sixth elements, the plaintiff failed to plead with any specificity that the minority shareholders were less than informed when they voted for the transaction or that they were coerced in any manner.

Essentially, the Court has held that unless the six conditions are met, the Court will continue to apply the business judgment rule.  The case stands as a re-affirmation to the deference to the board of directors with respect to corporate decisions to mergers.