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.

First Department dismisses 626(c) claim in split decision.

In Goldstein v Bass, 2016 NY Slip Op 03060 (First Dept., April 21, 2016), in a split decision, the First Department  affirmed the lower court’s decision and dismissed the Plaintiff’s derivative action.  The Plaintiff failed to make a demand on the Board pursuant to BCL § 626(c), arguing in the complaint that doing so would be futile. However, on appeal, Plaintiff argued that the demand requirement had been fulfilled.

The case involved the sale of cooperative units being sold at below market rates.   In 1995, the co-op obtained more than 300 units after a failed conversion.  The board approved the sale of 71 units at below market rates and in addition, agreed to pay above market rates to a managing agent for a period of ten years.

The lower court dismissed the complaint on the grounds that the Plaintiff failed to comply with BCL 626(c) and failed to plead demand futility.  Under BCL 626(c), “the complaint shall set forth with particularity the efforts of the plaintiff to secure the initiation of such action by the board or the reasons for not making such effort”.  The Court citing Marx v Akers, 88 NY2d 189, 66 N.E.2d 103, 644 N.Y.S.2d 121, stated the Plaintiff must plead with “particularity that (1) a majority of the directors are interested in the transaction, or (2) the directors failed to inform themselves to a degree reasonably necessary about the transaction, or (3) the directors failed to exercise their business judgement in approving the transaction” (internal citations omitted).

Here,  the Plaintiff failed to establish any of the elements that would satisfy demand futility.  The complaint failed to specify that any of the directors were interested in the direction; that the directors failed to apply any due diligence and failed to inform themselves about the transaction or that the directors were acting in bad faith or self-dealing with respect and therefore violating the business judgment rule.

The dissent had some interesting points.  First it agreed with the majority that the the Plaintiff failed to make a demand on the board and the various communication indicating that such demand had been made was not sufficient.  Secondly, while the lower court did not consider the other causes of action, the dissent also agreed that the cause of action for aiding and abetting breach of fiduciary duty and the cause of action and unjust enrichment would have been dismissed against the Leifer defendant.  The Plaintiff had failed to plead with particularity that Lefier had actual knowledge as opposed to constructive knowledge for any breaches of fiduciary duty.

However, the dissent disagreed with the majority in that making a demand would have been futile (agreeing wth the Plaintiff’s original position in the complaint).  Contrary to the majority’s position, the dissent was persuaded that it would have been futile because; (1) board approved the sale of 43 units at lower market rates to defendants, Leifer; 27 units were sold to Monarch that also happened to be a principal of a managing agency thereby perpetuating a potential conflict of interest; and finally, the board also approved a sale of one unit to a board member, which makes at least one member an interested member.  In addition, the board paid an above market rate of $288,000 a year in a ten year non-cancellable contract to a managing agent which would make a justified cause of action for corporate waste as well.  Considering the totality of the circumstances, the dissent agreed that it would have been futile to make a demand on the board.

Royal Bank of Canada prevails against Balanced Return Fund.

In Balanced Return Fund Ltd. v Royal Bank of Can., 2016 N.Y. Slip Op. 02928 (First Dept., April 19th, 2016), the First Appellate Division affirmed the lower court’s order granting summary judgment to Royal Bank of Canada (“RBC”), thereby dismissing Balanced Fund’s claims for breach of fiduciary duty, fraud, aiding and abetting breach of fiduciary duty and aiding and abetting fraud.

The Court held that there was no fiduciary relationship between the parties.  The relationship was more of a debtor-creditor relationship as RBC was merely a depository bank for investors in the transaction.  The Court emphasized that the fiduciary relationship must exist at the onset of the transaction and “not as a result of it”.

The fraud clam was also dismissed as RBC lacked a duty to disclose the “overvaluation and illiquidity of investment assets”.  In any case, RBC was not directly transacting with the plaintiff and again, had no fiduciary relationship with the plaintiff.

Finally, the aiding and abetting claim was dismissed as the plaintiff failed to establish the elements of the cause of action, namely, substantial assistance and actual knowledge.  Here, the plaintiff failed to establish that RBC “knew it was structuring the transaction to plaintiff’s detriment in order to benefit the non-party primary wrongdoer”.  Furthermore, the Court noted that inaction was not sufficient to establish such a claim as it would not be considered as actual knowledge.

First Appellate Division grants Akon reprieve in breach of contract case.

In Belgium v. Mateo Prods., 2016 NY Slip Op 02730, (April 12th, 2016, First Department), the Plaintiff, Lofraco Belgium (Front Row Entertainment) entered a contract with Defendant, Kon Live Touring (KLT), who was also Akon’s management company.  Akon was scheduled to perform at a concert in Belgium.  However, on the day of the concert, Akon claimed he was too sick to perform.  The plaintiff filed a breach of contract claim against Akon for the $125,000 advance given.  Subsequently, both parties filed motions for summary judgment.  In a split decision, the Court held that there was a triable issue of fact as to the ther there was a breach of contract and denied both motions.

On August 7th, 2009, the parties entered into an agreement whereby Akon was to perform on October 16th, 2009 at a concert.  The plaintiff paid $125,000 to Akon’s management team.  The concert was re-scheduled to December 9th, 2009, but on the day of the concert, Akon stated he wasn’t going to appear due to illness.  Akon claimed he was still suffering symptoms from his surgery that took place on November 16th, 2009 and thus could not perform.

The agreement signed between the parties had a force majeure clause whereby it stated that “If ARTIST is unable to perform in the event of sickness or accident then this will be considered Force Majure’ [sic] by ARTIST and ARTIST shall not be subject to any liability…Monies will be returned for any nonperformance that is not covered under the scope of force Force Majure’ [sic].”

A force majeure clause is enforceable where the “expectation of the parties and the performance of the contract have been frustrated by circumstances beyond the control of the parties” quoting United Equities Co. v First Natl. City Bank, 52 AD2d 154, 157 [1st Dept 1976], affd 41 NY2d 1032 [1977].  The burden remains on the defendant to prevail on a force majeure defense .

KLT moved for summary judgment and submitted two key pieces of evidence: (1) records from Akon’s surgery and (2) testimony from Akon’s surgeon that claimed the symptoms suffered by Akon were “consistent with tearing of scar tissue following the surgery he had undergone a few weeks before the concert date.”   The lower court denied the motion for summary judgment as KLT failed to meet the burden on numerous grounds.  Firstly, despite testimony from the surgeon, KLT failed to submit any evidence that Akon was ill on that particular day.  Furthermore, the Court held that the lack of an explanation as to  why such medical records were not submitted, despite being in KLT’s control, was a factor in denying the summary judgment motion.

The majority also reversed the lower court’s ruling granting summary judgment to the plaintiff.  In order to prevail on the summary judgment motion, the Court stated that two elements needed to be satisfied: (1) Akon was able to perform and (2) Akon was not sick and thus was in a position to perform.  Here, the plaintiff only argued that the lack of medical records provided by Akon was enough to show that Akon was not sick.  However, the majority disagreed and stated a trial was needed.

The dissent agreed in part with the majority in that KLT should have been denied summary judgment, but dissented on the grounds that the plaintiff should have been granted summary judgment.

The dissent disagreed with majority and put forth many persuasive arguments as to why the plaintiff should have prevailed on the summary judgment motion.  First, the elective procedure was on November 16th, 2009 even though Akon knew he was going to perform in Belgium a few weeks later; Akon admitted in his affidavits that he was recovering from surgery quite well; he travelled to Puerto Rick for a promotional event only a few days before the Belgium concert; admittedly, Akon was ill for a period of time in Puerto Rico, but continued to appear at the promotional event and in any case such illness did not require any medical treatment; despite his defense that he seemed medical care upon return to the US, he has failed to produce any medical records to substantiate his claim.  Finally, the only treatment Akon received was a massage therapy and did not see his surgeon until December 22nd 2009.

Furthermore, the dissent noted that Akon failed to produce such medical records when requested by the Plaintiff during the discovery process.  In addition, the surgeon who treated Akon claimed that he “did not treat him for post surgery symptoms”.  Akron’s credibility was also in question when the surgeon failed to corroborate that he advised Akon to go to the emergency room for the symptoms experienced in Puerto Rico.  Nevertheless, it was the surgeon’s position that such symptoms would not have prevented Akon from performing in Belgium.

Ultimately, the issue going forward for the plaintiff is that the medical records are solely in Akon’s possession and control.  For plaintiff to prevail, such records must be produced in order to prevail on the summary judgment otherwise it comes down to a trial.




Deutsche Bank prevails against Aozora in RMBS fraud suit.

In Aozora Bank, Ltd. v Deutsche Bank Sec. Inc., 2016 NY Slip Op 02511 (1st Dept., 2016), the First Appellate Division denied Aozora’s motion to file an amended complaint and affirmed the lower court’s opinion granting Deutsche Bank’s motion to dismiss the fraud claim.  The Court held that Aozora had sufficient inquiry notice and thus dismissed the fraud claim based on failure to file within the statutory limitations.

In 2006, Aozora invested $30 million in Blue Edge CDO, which was structured and sold jointly by Deutsche Bank and Deutsche Bank Securities, Inc.  Aozoara’s primary argument is that Deutsche Bank had negative views on the RMBS that were included in the CDO and yet continued to encourage investment in the CDO.  Aozora presented evidence that the global head of CDO’s stated in an internal email that the RMBS in Blue Star were “weak and horrible”.  Despite this negative view, Deutsche Bank approved selections for the CDO comprising of the subprime RMBS.

In 2005, Deutsche Bank took short positions with respect to the RMBS in Blue Edge and even sold credit default swaps to various entities and shifted the “long position to to CDOs such as Blue Edge.”  Deutsche Bank’s own negative view was not disseminated in any of the marketing materials with respect to Blue Edge.  Furthermore, while Deutsche Bank initially stated it held the collateral portfolio in its own books, it later decreased its exposure to the RMBS by approximately by 60%.  Aozora further alleged that the percentage of the portfolio comprising of sub-prime mortgage was 47.6% rather than the prime RMBS marketed value of 66.7%.

In 2013, Aozora filed a summons and notice and asserted causes of action for common law fraud, aiding and abetting fraud, breach of the implied covenant of good faith and fair dealing, negligent misrepresentation, and unjust enrichment.  Specifically with respect to the fraud claims, Aozora asserted that it relied upon Deutsche Bank’s misrepresentations with respect to the breakdown of the portfolio.  Despite conducting its own due diligence, Aozora further asserted that ” it did not know, and could not have known, that the marketing materials and offering documents contained material misrepresentations and omissions” and in particular, the quality of assets in the portfolio were much lower than represented in the marketing materials.

In its response, Deutsche Bank moved to dismiss the complaint under CPLR 3211(a)(5) and (7).  Primarily, Deutsche Bank argued that the claims were time barred since Aozora filed suit six years after it invested in Blue Edge and furthermore, failed to raise suit even after discovering the fraud within the extended two year period.  Deutsche Bank further argued that there was ample evidence to indicate there had been issues with mortgage backed securities and even submitted evidence such as Senate investigations and other press articles indicating that Aozora had sufficient opportunity to raise the issue.

In its opposition for dismissal, Aozora admitted that the suit was based on internal documents and records.  The primary purpose of Aozora’s US operations was to facilitate clients services and investing in structured finance products was not the primary task of the New York office.  Nevertheless, in 2012, upon realizing that other suits were filed with success, Aozora reviewed its structured products portfolio and examined the feasibility of raising claims against Deutsche Bank.

In March 2013, Aozora realized that there might be viable claims based on Senate reports and thus, commenced the action.  However, the lower,  court ruled that the fraud claim was untimely as the two year period to raise such a claim had passed.  The court also held that Aozora failed to conduct “reasonable due diligence” in investigating its fraud claim.

Under  CPLR 213 (8), Aozora failed to file a claim within six years of when the cause of action accrued or two years from the time it discovered the fraud or conducted reasonable due diligence to discover such fraud.   Here, Aozora had inquiry notice of its fraud claims before June 18th, 2011.  For example, Blue Edge was downgraded to junk in 2008 and Aozora suffered severe losses as a result.  Furthermore, the press coverage, various investigations and lawsuits began much before 2011.  In addition, the Court also asserted that despite some due diligence conducted in 2012 and 2013, Aozora failed to conduct any similar diligence prior to 2011.

Therefore, since Aozora had sufficient inquiry notice, the Court affirmed the lower court’s decision to dismiss the complaint in its entirety.

Derivative Suit against JP Morgan directors dismissed.

In an RMBS case, the First Appellate Division affirmed the lower court’s decision in Asbestos Workers Phila. Pension Fund v Bell, 2016 NY Slip Op 02510 [U][1st Dept., 2016] that a pre-suit demand was required and the Plaintiff was not excused from raising such demand in its derivative suit.

The Plaintiff raised a derivative suit against the board members of JP Morgan without a pre-suit demand.  The complaint was in relation to securitization of and sale of subprime mortgages, whereby the Plaintiff alleged that JP Morgan board members were aware that these mortgages were troubled assets, and yet made them more “financially secure than they appeared.”  Furthermore, the Plaintiff alleged that the board improperly abdicated its duties by appointing a management committee to oversee the sale of the mortgages and failing to oversee the committee’s actives diligently.  Plaintiff also argues that no pre-suit demand was necessary as it asserted a demand futility claim.

The Court applied Delaware law as JP Morgan is incorporated in Delaware.  Under Delaware law, the condition precedent in filing a shareholder derivative action is that the plaintiff must raise pre-suit demand upon the board.  However, this pre-suit demand may be waived if it is deemed to be futile.  In determining the futility, the Court must apply the two pronged test stated in Aronson v Lewis, 473 A2d 805, 814 [Del 1984], overruled in part on other grounds Brehm v Eisner, 746 A2d 244 [Del 2000].   

The two pronged test must determine “whether, under the particularized facts alleged, a reasonable doubt is created that: (1) the directors are disinterested and independent [or] (2) the challenged transaction was otherwise the product of a valid exercise of business judgment” (Aronson v Lewis, 473 A2d at 814).  In order to prevail, if either prong is satisfied, the a pre-suit demand is deemed to excused.  Where the suit alleges board inaction, “demand futility can be established by particularized facts creating a reasonable doubt that at the time the complaint was filed, the board could not have properly exercised its independent and disinterested business judgment in responding to the demand”  quoting In re Goldman Sachs Group, Inc. Shareholder Litig., 2011 WL 4826104, 2011 Del Ch LEXIS 151 [Del Ch 2011] .

Here, the Plaintiff failed to satisfy the requirements of either prong.  There were no facts plead with any particularity as to how the board members were interested or lacked independence.  Here, the board members in question were outside directors and the Plaintiff failed to state if there was any personal financial gains received or if the directors stood on both sides of the transaction.  It should be noted that merely that a “director will be called upon to consider whether to sue himself or herself does not, in itself, warrant a conclusion that he or she lacks independence” is in itself not sufficient to prevail on a cause of action quoting Rales v Blasband, 634 A2d at 936.  In fact, Plaintiff’s argument was based on the “claim that the individual board members lack independence is based on plaintiffs’ argument that they will likely face individual liability for their acts.”   The Court rejected this contention and and reiterated the standard for liability of a director.

In Delaware, liability may be limited to a certain extent under Delaware Code Annotated, title 8, § 102(b)(7) which if incorporated into a company’s charter. Furthermore, such liability requires particularized allegations that the board’s actions were “made with  scienter, that is with actual knowledge that its conduct was legally improper.”  see also In re Goldman Sachs Group, Inc. Shareholder Litig., 2011 WL 4826104, 2011 Del Ch LEXIS 151 [Del Ch 2011] Supra.  Here, the Plaintiff failed meet the burden set forth as there was no particularity in the facts alleged.

With respect to the second prong, the Plaintiff also failed to meet with the burden as there were no particularized facts pleaded either.  Delegating a management committee to sell the securities did not per se a violation of a valid exercise of business judgment.  In order for the Plaintiff to prevail, there must be allegations stated where a director failed to exercise good faith and failed to take a course of action in the best interests of the company.  See In re Walt Disney Co. Derivative Litig., 906 A2d 27, 52 [Del 2006].  Here, the Court indicated that the Plaintiff failed to satisfy the second prong.

As to the lack of oversight claim, the  Court stated that the burden is much higher for the Plaintiff to satisfy.  In order to prevail, “a plaintiff must set forth particularized facts that there was a “sustained or systematic failure” by the board to exercise oversight, demonstrating “the lack of good faith that is a necessary condition to liability” see In re Caremark Intl., Inc. Derivative Litig., 698 A2d 959, 967 [Del Ch 1996]). The Plaintiff’s claim amounted to a lack of monitoring of corporate operations which would not satisfy the standard above.



Breach of fiduciary duty complaint against Archstone dismissed.

In Cambridge Capital Real Estate Invs., LLC v Archstone Enter. LP, 2016 NY Slip Op 02017 (1st Dept., 2016), the First Department reversed the lower court and dismissed the complaint filed in its entirety.

The plaintiff invested $20 million in Archstone Multifamily  JV LP (the “Fund”) for 1% interest.  Archstone Multifamily GP, LLC is a general partner of the fund.  The Fund acquired Archstone Enterprise, LP which then controlled the assets of Archstone-Smith Real Estate Investment Trust, a $23.7 billion REIT.  As part of the deal, Lehman Brothers was a sponsor and provided financing for the acquisition in the amount of $3 billion in secured financing, which amounted to 47% of the total financing.  Bank of America provided 28% and Barclays provided the balance at 25%.

In 2009, the sponsors provided an additional $485 million in funding to Archstone and later in the year, the original limited partnership agreement was amended. The following year, sponsors exchanged $5.2 billion in debt for preferred shares in Archstone.  This resulted in a bifurcation of two share classes: (1) preferred interested held by the sponsors and (2) common interest held by the Fund itself.

In 2012, Lehman bought out the other sponsor’s shares in two separate transactions: $1.33 billion in January and the balance in June for $1.65 billion.  Lehman then sold its assets to  Equity Residential and AvalonBay Communities, Inc. via a asset purchase agreement for $2.7 billion in cash, $3.8 billion in stock, and the assumption of $9.5 billion in debt.  The transactions closed on February 27th, 2013.

In November 2012, plaintiff became aware of Lehman’s transaction.   On December 2012, Plaintiff filed a complaint alleging “breach of the limited partnership agreement, breach of the implied covenant of good faith and fair dealing, and breach of fiduciary duty as against the fund’s general partner; aiding and abetting breach of fiduciary duty as against the other defendants; and fraud and conversion as against all defendants.”

The lower court dismissed the breach of contract action as time barred.  Pursuant to Section 6.01 (e) and (g) of the amended limited partnership agreement, there is no requirement that there be a delivery of written notice to all limited partners.  The provision only requires that a “major decision” be approved by a “Requisite Interest of the Limited Partners”, which pursuant to the agreement, applies to limited partners holding more than 50% of the total percentage interest   Furthermore, consent was not required as the transaction had been approved by 99% of all the partnership interests and no partner responds within ten days.

The Court also reversed the lower court’s and dismissed the cause of action relating to breach of fiduciary duty against the general partner of the Fund.  IN applying Delaware law, the court examined the application of the heightened “entire fairness” standard, which focuses on two elements: (1) fair dealing and (2) fair price quoting In re Crimson Exploration Inc. Stockholder Litig. , 2014 WL 5449419, *9, 2014 Del Ch LEXIS 213, *30 [Del Ch 2014]).

Here, the Plaintiff failed to demonstrate that it did not “receive the substantial equivalent in value of what [it] had before”.  Furthermore, the facts indicate that the GP attained $16 billion in value, which was the current value of Archstone at the time of the transaction.  In addition, the Plaintiff conceded it “represented a premium of approximately 15% over the implied purchase price of Lehman’s combined acquisitions of the interests of the other [s]ponsor [b]anks’ interests earlier in 2012.”  Plaintiff merely asserted a conclusory statement that the transaction was “unfair” without any detail.

Since there was an express contract, the Court affirmed the dismissal for the cause of action relating to the breach of the implied covenant of good faith and fair dealing.

Thus, upon examining the transaction, the Court held that there was no breach of fiduciary duty and dismissed the Plaintiff’s complaint in its entirety.



Court limits waiver of liability in agreement governed by UCC Article 7.

In a rare UCC Article 7 issue, the First Appellate Division reversed the defendant’s motion to dismiss in XL Specialty Ins. Co. v Christie’s Fine Art Stor. Servs., Inc., 2016 NY Slip Op 01901 [U][1st Dept., 2016].

The plaintiff is the insurance company for Chowaiki Art Gallery and the defendant is Christie’s Fine Art Storage Services, Inc. which stored Chowaiki’s art pieces.  The parties entered into a one year agreement to provide secured storage for Chowaiki’s art works at Christie’s storage facility in Brooklyn.

Pursuant to the agreement, the Chowaiki had the option to either: “(a) have defendant “accept liability for physical loss of, or damage to, the Goods,” or to (b) “sign a loss/damage waiver,” under which Chowaiki accepted that defendant “shall not be liable for any physical loss of, or damage to, the Goods.  Furthermore, if Chowaiki elected to sign the waiver, it must provide an adequate insurance policy for all goods deposited.  The agreement also had a provision whereby Christie’s additional liability, if ever applicable, would be limited to the lower of either: (1) $100,000 or (2) the market value of the goods.

Chowaiki elected to sign the waiver.  The waiver also required Chowaiki to inform the plaintiff to “arrange for them to waive any rights of subrogation” against Christie’s.

In 2012, Hurricane Sandy struck New York.  Prior to the hurricane approaching, Christie’s informed Chowaiki that all property located on the first floor would be relocated to higher floors to prevent damage to the goods.  However, Christie’s failed to remove the goods and left them on the first floor resulting in extensive damage to Chowaiki’s goods.

The plaintiff reimbursed Chowaiki for the damages and commenced action against Christie’s for gross negligence, breach of bailment, negligence, breach of contract, negligent misrepresentation and fraudulent misrepresentation.  Christie’s responded by moving to dismiss pursuant to CPLR 3016(b), 3211(a)(1), (3), and (7).  Furthermore, in its response, Christie argued four points: (1) the waiver signed by Chowaiki also contained a provision whereby subrogation was waived and in addition liability was limited; (2) the liability was limited to $100,000; (3) there was no breach of bailment as the relationship between the parties was a lessor/lessee relationship and not a bailor/bailee relationship and (4) Hurricane Sandy was an act of god.

The Court affirmed the motion court’s position that the agreement was governed by UCC 7-204(a) and there was a bailor/bailee relationship created.  Thus, any waiver of liability was not enforceable as it was in contravention to the governing statute.  Under UCC 7-204,   a “warehouse is liable for damages for loss of or injury to the goods caused by its failure to exercise care with regard to the goods that a reasonably careful person would exercise under similar circumstances.”  There was a question of fact as to whether Christie’s exercised reasonable duty of care in its failure to move Chowaiki’s goods to another floor to prevent damage.

Furthermore, the Court disagreed with the motion court’s decision to to dismiss the action on the grounds that the waiver of subrogation bars any cause of action.  The Court’s decision was based on Kimberly-Clark Corp. v Lake Erie Warehouse, Div. of Lake Erie Rolling Mill, 49 AD2d 492 [4th Dept 1975], which held that such exculpatory clauses were invalid.  While it is acceptable for a bailor to limit its liability, it cannot completely exempt itself from liability pursuant to UCC Article 7.

Ultimately, the Court’s decision reaffirms that waiver of liability cannot be enforced whereby a bailor/bailee relationship has been established.  Such waivers are in conflict with Article 7 and therefore unenforceable.





First Appellate Division reinstates complaint against major oil companies

In BMW Group v. Castle Oil Corp., 2016 NY Slip Op 01790, (First Dept., March 15, 2016), the First Department reinstated complaints stating that the plaintiffs sufficiently alleged facts to state a cause of action.

The core issue in the case was whether heating oil delivered to the plaintiffs was inferior and therefore did not meet the standard as set forth in the contracts signed between the parties.  The court held that the plaintiffs asserted sufficient cause of action under breach of contract as well as breach of UCC warranties.

There have been irregularities regarding the specific oil that was delivered to various customers.  There were both private and public investigations conducted as to the the fraud and misconduct perpetuated in the oil business.  After the government investigation concluded in 2013, with respect to defendant Castle Oil, the plaintiffs alleged “that during the four previous years they ordered from defendant Castle either No. 4 fuel oil or No. 6 fuel oil, and paid the retail price for that oil, but that the product Castle delivered was a mixture of those grades of fuel oil and waste oil or other types of inferior oil.”

With respect to co-defendant, Hess, the plaintiffs allege “that they contracted with Hess for the purchase of No. 4 and No. 6 fuel oil at various times between 2009 and 2013, but received a blend containing waste oil. Plaintiffs state that they were the victims of a scheme perpetrated by Hess’s independent transportation companies, which skimmed a percentage of the pure No. 4 and No. 6 fuel oil that they picked up from Hess, and replaced it with waste oil, which they then delivered to customers.”

Both respondents moved to dismiss the complaint under CPLR 3211(a)(7), and the lower court granted motions.  The underlying reasoning was that the plaintiffs did not allege any injury caused by the delivery of the inferior product.  Furthermore, the plaintiffs  could not claim “economic damages based on nonconforming goods is insufficient in the absence of any demonstrable ill effect or negative impact on the product’s performance or utility.”

The Court explored whether mere nonconformity with no great financial loss was sufficient to plead breach of contract and breach of warranty.   The Court simply held that if the delivered goods do not conform to the contracted goods, then a cause of action can be pleaded under the Uniform Commercial Code.

The Court further explored if the goods could even be considered non-conforming.  With respect to heating oil, the standard for delivery was based on the established industry standards and in addition, the regulatory standards.  Here, under Administrative Code of the City of New York, § 24-168.1, the Code refers to the American Society for Testing and Materials designation D 396-09a as the standard for New York City.  The standard details the specific formulae with respect to the different grades of oil.  Therefore, Plaintiffs did have a cause of action as to whether the oil delivered was consistent set forth in the ASTM standards.

With respect to the complaint against Castle Oil, the Court acknowledged that the poor quality of heating oil would cause a lower efficiency in heating systems and even may cause some environmental issues.  Castle, on the other hand, contends that the blend of fuel oil conforms with federal standards and further never promised to provide an express warranty for No. 4 and No.6 fuel oils.  The Court, however, rejected the position of Castle as the federal “does not necessarily or automatically justify its use for purposes of the parties’ contracts, and does not provide a basis for dismissal of these complaints.”

In the complaint against Hess, the plaintiffs asserted that the fuel provided was lower quality because it was mixed with “waste oil”, which as defined under Rules of the New York State Department of Environmental Conservation (6 NYCRR) § 225-2.2(b)(11) is essentially fuel oil not that has not been re-refined.    Thus any fuel blended oil would be of lower quality and therefore the value of the delivered oil.

Finally, the Court cited UCC 2-714(2) which defines the measure of damages for breach of warranty is the difference between the value of the goods delivered and the value of the goods warranted.  Here, there were sufficient inferences made to suggest that the quality and thus, the value of the oils delivered and therefore, a cause of action of breach of contract and warranty can be established.