New York’s highest court on Thursday backed a legal standard that makes it difficult for plaintiffs to hold individuals liable for alleged corporate abuses, nixing a personal injury plaintiff’s bid to recover damages from two property owners in a ruling experts say should protect businesses statewide.
The unanimous New York State Court of Appeals agreed with a lower appellate court, the First Department of the Supreme Court of New York’s Appellate Division, which in 2011 turned aside plaintiff Atara James’ effort to pierce the corporate veil of Loran Realty V Corp.
James appealed after losing on her veil-piercing claim in a 2009 Bronx County Supreme Court bench trial. She sued in 2002 on behalf of her infant daughter Kayla, seeking to win damages for lead-paint injuries from real estate investor Frank Palazzolo, as well as from former Loran Realty V owner Carmine Donadio.
Thursday’s decision beat back James’ challenge to a widely cited 1993 precedent, Morris v. New York State Department of Taxation and Finance, which holds that a plaintiff must show an individual “abused the privilege of doing business … to perpetrate a wrong or injustice.”
Like the First Department, the Court of Appeals said James bore that burden of proof and didn’t clear the hurdle of showing specific intent.
“Plaintiffs … failed to produce evidence that the individual defendants took steps to render the corporate defendant insolvent in order to avoid plaintiffs’ claim for damages or otherwise defraud plaintiffs,” the Court of Appeals wrote.
The appeal was a “tough road,” according to Scarsdale, N.Y.-based attorney Lawrence Gottlieb of Hass & Gottlieb, who represents Palazzolo.
“What they tried to do in the Court of Appeals was to overturn a long-standing precedent, which holds that in order to pierce the corporate veil you need to show that a person not only denuded a corporation of its assets but also did so to prevent a plaintiff from collecting,” Gottlieb said.
The decision should come as a relief to businesses across the Empire State, according to Melville, N.Y.-based commercial litigation defense attorney Leo K. Barnes Jr. of Barnes & Barnes PC.
“Thankfully, from the defense perspective, the courts rarely go as far as to pierce,” Barnes said. “Business owners are advised to incorporate for this purpose.”
Under the Morris precedent not only must a plaintiff show that an individual defendant dominated a corporate transaction — such as a move to strip a company of its assets — they must also show that such domination was used to commit a fraud, according to Barnes.
In any closely held business the shareholders will almost always “dominate and control” transactions, Barnes pointed out, making that part of the standard easy to clear.
But it’s far more difficult to show that the shareholders of the corporate defendant intentionally depleted corporate assets to render the corporate defendant judgment proof, Barnes said.
“The fraud or injustice element of the claim is often the turning point,” Barnes said.
The attorney who sought to overturn the Morris precedent, Brian J. Shoot of Sullivan Papain Block McGrath & Cannavo PC, had a different take, saying that “sham corporations” currently enjoy protection under the law that is too strong for legitimate plaintiffs to overcome.
It was not difficult to show that Loran Realty V had no assets, Shoot said, but it was a virtual impossibility to prove that the two individual defendants stripped it of assets it solely to dodge the plaintiffs’ claims.
With courts having refused to relax the standard, New York’s legislature should consider taking action to protect plaintiffs injured by corporations in similar ways, Shoot said, noting that the lower appellate court conceded Loran Realty V was a “judgment-proof shell.”
“The substantial corporations of this world — the IBMs, the Verizons — they don’t have a dog in the fight, so to speak,” Shoot said. “They’re not undercapitalized. It’s another class of defendant we’re talking about.”
While the James case dealt with lead paint injury, Shoot said many similar cases involve New York’s taxi cab companies, which are formed with such protections in mind.
“Cab companies have no idea who a cab might run over,” he said. “The corporations are set up to stop anyone who might want to pursue a claim beyond the corporate veil.”
The James plaintiffs also have a lead paint liability claim pending against the defendants but, without the ability to recover from either Palazzolo or Donadio directly it was unclear what the prospects of that part of the case would be. The liability claim was bifurcated from the corporate veil claim for purposes of trial. No trial has been set related to the other claim, still pending in Bronx County Supreme Court.
The plaintiffs are represented before the trial court by Gregory J. Cannata of Gregory J. Cannata & Associates. They are represented before the appellate court by Sullivan Papain Block McGrath & Cannavo PC.
Palazzolo is represented by Hass & Gottlieb.
Donadio is represented by attorney Daniel G. Heyman.
By Leo K. Barnes Jr.*
*Mr. Barnes, a member of Barnes & Barnes, P.C., can be reached at firstname.lastname@example.org
Last month we addressed the transformation of a criminal court plea or guilty verdict into civil court liability, relying upon collateral estoppel. This month we take a step back. Assume that the civil case is in the midst of discovery, the corresponding criminal case is also still pending prior to plea or verdict, and that the adverse party’s deposition yields a slew of Fifth Amendment invocations. There is opportunity, once again, to turn the lemons into lemonade by convincing the Court that the Fifth Amendment invocation warrants a negative inference which may advance the likelihood of achieving judgment on liability.
The Fifth Amendment at a Deposition
Of course, a witness in civil litigation may invoke the privilege against self-incrimination if she has reasonable cause to apprehend danger from a direct answer. However, the privilege does not relieve the party of the usual evidentiary burden attendant upon a civil proceeding; nor does it afford any protection against the consequences of failing to submit competent evidence.
It is settled that invoking the privilege against self-incrimination is generally an insufficient basis for precluding discovery in a civil matter. As the Court of Appeals stated in Steinbrecher v. Wapnick:
When a defendant fails to present evidence on his own behalf in a civil case * * * but chooses instead to assert his constitutional privilege, he places himself at an obvious disadvantage. Moreover * * * the courts need not permit a defendant to avoid this difficulty by staying the civil action until a pending criminal prosecution has been terminated (see Langemyr v. Campbell, 21 N.Y.2d 796 [288 N.Y.S.2d 629, 235 N.E.2d 770]; cf. Oleshko v. New York State Liq. Auth., 21 N.Y.2d 778 [288 N.Y.S.2d 474, 235 N.E.2d 447]). The fact that a defendant in a civil suit assumes a substantial risk when he chooses to assert his privilege does not, however, mean that the plaintiff is relieved of his obligation to prove a case before he becomes entitled to a judgment.”
The fact that a litigant might be forced to elect “between complete silence and presenting a defense has never been thought an invasion of the privilege against compelled self-incrimination.”
Common Sense Must Prevail
In a perfect world, each crime would be documented like a CSI episode. The Appellate Division, mindful that a typical defendant will not verify the details of her criminal wrongdoing, mandates that a trial Court take a common sense view of the evidence and avoid a Pollyanna perspective on the nature of criminal matters generally, especially in light of the Fifth Amendment obstacle.
In the context of this type of claim, where fraud or illegality is likely to be involved, transactions such as those outlined above “must be judged not with clinical detachment but with a common sense view to the realities of normal life” ( Wilson v. Attaway, 757 F.2d 1227, 1235 [11th Cir.1985], rhg denied 764 F.2d 1411; see also, United States v. $5,644,540.00 in U.S. Currency, 799 F.2d 1357, 1363 [9th Cir.1986] [where drug trafficking was alleged, court considered aggregate of facts in light of “ ‘common experience considerations' ” in finding that civil forfeiture was warranted] ), and “[p]articularly in cases involving bank accounts, money or other fungible assets, the only proof demonstrating probable cause is likely to be circumstantial, revealing unexplained wealth in conjunction with evidence of [illegality]” ( United States v. All Right Title and Interest, 983 F.2d 396, 405 [2d Cir.1993], cert denied sub nom Beckford v. U.S., 508 U.S. 913, 113 S.Ct. 2349, 124 L.Ed.2d 258) [emphasis added].
In this regard, at the summary judgment stage of civil proceedings, the Court is required to bear in mind that that a litigant’s Fifth Amendment invocation is a two-fold strategy: first it hopes to avoid criminal consequences and second, it is a simultaneous barrier to the production of testimony which is fatal to her civil defense.
Accordingly, it is proper to infer that defendant withheld evidence regarding the source of the funds deposited in the bank accounts not only because it would have incriminated her, but also would have been unfavorable to her in this action [emphasis added].
The Adverse Inference
Accordingly, once the Fifth Amendment invocation has been documented, adverse counsel can request that the trial court draw an adverse inference from the defendant’s refusal to answer relevant questions pursuant to New York Pattern Jury Instruction 1:76, which provides:
From the assertion of the privilege you may infer, if you deem it proper to do so, that had the answers been given they would not have contradicted the opposing evidence on the issue of [identify issue] or would not have supported (the defendant’s, plaintiff’s) position on that issue and you may, although you are not required to, draw the strongest inference against the (plaintiff, defendant) on that question that the opposing evidence permits [emphasis added].
It has been observed that “[a] court may draw an adverse inference against a party who asserts his Fifth Amendment privilege in a civil matter, because the invocation of the privilege results in a disadvantage to opposing parties by keeping them from obtaining information they could otherwise get” and that an adverse inference may “be given significant weight because silence when one would be expected to speak is a powerful persuader.”
The Summary Judgment Motion
But the heavy lifting is not complete upon the Fifth Amendment invocation because the adverse inference may not be the sole basis for liability. At that point, the movant still bears the burden of laying bear the proof warranting summary judgment sufficient to convince the court that the same, in light of the application of the negative inference, is appropriate. Movant’s counsel must bear in mind that the typical admissions gathered at a party deposition will not exist in light of the Fifth Amendment obstacle. However, movant’s presentation of all other indicia of wrongdoing, even if purely circumstantial, may nonetheless be characterized by the Court as compelling, and sufficient to warrant summary judgment.
Counsel will be faced with obstacles in the vast majority of highly contested litigations; tenacious attorneys will nonetheless achieve success by identifying a viable strategy no matter the legal dilemma. The interaction between civil and criminal proceedings may reveal challenging circumstances, but with the proper legal strategy designed to address those unique challenges, success in the civil arena can be achieved.
By Leo K. Barnes Jr.*
*Mr. Barnes, a member of Barnes & Barnes, P.C., can be reached at email@example.com
For civil counsel engaged to right criminal wrongs committed by a Corporation’s former officer or employee, the frustration of the delays incident to a parallel criminal proceeding can nonetheless ultimately bear fruit in the civil arena. While the civil proceedings stand in the proverbial second place behind a criminal case (as civil discovery may be obstructed by stay applications and Fifth Amendment invocations) there is opportunity nonetheless. Inasmuch as criminal proceedings are generally completed on a faster track than the civil counterparts, when that criminal matter results in a guilty plea or verdict, it is capable of easy transformation to corresponding civil liability.
The doctrine of issue preclusion bars re-litigation in a second proceeding, even one involving a different cause of action, of issues that have been actually and necessarily determined in a prior adjudication. To invoke issue preclusion two requirements must be met: “first the identical issue necessarily must have been decided in the prior action and be decisive of the present action, and second, the party to be precluded from re-litigating the issue must have had a full and fair opportunity to contest the prior determination.”
In Pav-Co Asphalt, Inc. v. County of Suffolk, the Second Department observed:
Where a criminal conviction is based on facts identical to those in a related civil action, the plaintiff in the civil action can successfully invoke the doctrine of collateral estoppel to bar the convicted defendant from relitigating the issue of liability . “The doctrine applies whether the conviction results from a plea or a trial”  “The party seeking the benefit of collateral estoppel bears the burden of proving that the identical issue was necessarily decided in the prior proceeding, and is decisive of the present action” [internal citations omitted].
In William Floyd Union Free School Dist. v. Wright, James Wright was the former treasurer of the plaintiff William Floyd Union Free School District. In January 2006, Wright pleaded guilty to one count of grand larceny in the second degree and seven counts of offering a false instrument in the fifth degree. His plea included his acknowledgment that he stole money while employed by plaintiff.
The plaintiff filed a complaint to recover the stolen funds and all compensation it paid the defendant following his breach of fiduciary duty. The Supreme Court determined that the defendant was collaterally estopped from litigating liability with respect to the plaintiff’s breach of fiduciary duty cause of action, and granted summary judgment to the plaintiff. The Second Department affirmed:
In connection with his plea of guilty, Cifonelli testified under oath that he remained in the plaintiff’s employ until 2004 following his sham retirement in August 1998. “Collateral estoppel effect will be given to issues necessarily decided in prior criminal actions, including those which terminate in judgments based on pleas of guilty” (Colby v. Crocitto, 207 A.D.2d 764, 765, 616 N.Y.S.2d 399). The issue of Cifonelli’s employment status was material to and decided in the prior criminal action, and is critical to the instant action. Moreover, there is no evidence that Cifonelli was denied a full and fair opportunity to contest this point. Accordingly, Cifonelli is collaterally estopped from disputing his employment status between 1998 and 2004 (see S.T. Grand, Inc. v. City of New York, 32 N.Y.2d 300, 304, 344 N.Y.S.2d 938, 298 N.E.2d 105; Colby v. Crocitto, 207 A.D.2d at 765, 616 N.Y.S.2d 399).
The Second Department ruled that a grand larceny plea bears collateral estoppel effect incident to a corresponding breach of fiduciary duty civil claim. The opinion continued:
Moreover, the Supreme Court properly determined that the defendants’ pleas of guilty to grand larceny in the second degree and other crimes established the plaintiff’s entitlement to judgment as a matter of law on its breach of fiduciary duty cause of action (see American Map Corp. v. Stone, 264 A.D.2d 492, 492-493, 694 N.Y.S.2d 704; Luskin v. Seoane, 226 A.D.2d 1144, 641 N.Y.S.2d 478).
These same issues came to light in the criminal and civil proceedings surrounding Tyco International’s former Chief Executive Officer Dennis Kozlowski in the Southern District matter entitled Tyco International Ltd v. Dennis Kozlowski. According to the decision by Judge Griesa, Kozlowski rose through the ranks after being hired in 1975 as the Director of Internal Audit, ascending to Chief Executive Officer and Chairman of the Board as of 1997. In June 2002, Kozlowski was discharged from Tyco because pending an imminent indictment for sales tax evasion; the ensuing investigation revealed that Kozlowski had conspired with other corporate officers to pilfer Tyco’s treasury of tens of millions of dollars. Kozlowski was charged with 23 criminal counts, including 12 counts of grand larceny, one count of conspiracy to commit larceny, nine counts of falsifying business records, and one count under New York’s Martin Act. Kozlowski was convicted on 22 of the 23 counts of the indictment during the 2005 trial and was sentenced to prison; the convictions were affirmed on appeal.
When he was discharged from Tyco in 2002, Kozlowski demanded payment pursuant to certain deferred compensation agreements. Tyco refused and instead filed an action asserting claims against Kozlowski. Kozlowski answered with counterclaims, seeking payment under the deferred compensation agreements and indemnification for other civil suits naming him as a defendant. Tyco responded that the compensation agreements were void because they were fraudulently induced and also represented compensation that Kozlowski must forfeit under New York’s “faithless service doctrine.” Judge Griesa invoked collateral estoppel to found summary judgment in favor of Tyco:
Earlier in this decision, the court summarized the grand larceny and falsification of business records counts on which Kozlowski was convicted in his criminal case. The convictions necessarily constituted jury findings not only that Kozlowski wrongfully took or misappropriated the funds and property of Tyco, and falsified Tyco’s business records, but that he did so with the intent to do the wrong, and, in connection with the false entry, that he did so with intent to deceive. These convictions establish the elements of the following causes of action in the civil case beyond any doubt.
The theft of millions of dollars from Tyco was, to say the least, a breach of fiduciary duty (first cause of action). The same can be said of the elements of the second and third causes of action, alleging, respectively, inducing breach of fiduciary duty and conspiring to breach fiduciary duty. There is no question that any civil litigation on the issue of liability on the fiduciary duty causes of action would involve identical issues as those litigated in Kozlowski’s criminal case.
Thereafter, Judge Griesa likewise rejected Kozlowski’s counterclaims for deferred compensation because the same was procured during periods of disloyalty:
Even if these contracts were validly entered into, Kozlowski cannot recover on them. The “faithless servant doctrine,” used as a sword in Tyco’s claims, may also be used as a shield to Kozlowski’s counterclaims. As a result of Kozlowski’s many breaches of fiduciary duty, Tyco has no duty to honor compensation agreements made during Kozlowski’s period of disloyalty.
In the present case, Kozlowski’s multiple breaches of his fiduciary duty over several years clearly demonstrate his faithless service. Kozlowski must therefore forfeit all compensation and benefits, deferred or otherwise, earned during his period of disloyalty, which began at its latest in September 1995. Because all of the benefits at issue in these contracts were earned during Kozlowski’s period of disloyalty, Tyco is relieved from any obligation to honor them.
Although the burden of establishing liability may be resolved by virtue of the criminal plea or verdict, civil counsel nonetheless bears the burden of establishing damages at an inquest. To the extent that there may be some down time during the civil action while a stay or Fifth Amendment invocation obstructs discovery proceedings, civil counsel is wise to actively monitor the developments in criminal court, document Plaintiff’s damages, and be ready to pounce upon opportunities provided by the parallel criminal litigation.
By Leo K. Barnes Jr.*
*Mr. Barnes, a member of Barnes & Barnes, P.C., can be reached at firstname.lastname@example.org
The adage “money isn’t everything” has particular significance for injunction applications. A January 2011 decision by Eastern District Judge Nicholas Garaufis reminds counsel that no matter how solid a liability and damages analysis appears, and no matter how egregious the wrongdoing by a defendant, Courts will not grant an injunction application if damages can be quantified, thereby undermining the irreparable harm element of the injunction application.
In Liberty Power Corp., LLC v. Katz and Foundation Energy Services, LLC, 2011 WL 256216 (E.D.N.Y. 2011), Plaintiff LPC moved for a preliminary injunction seeking to preclude Defendants from continued use of Plaintiff’s alleged proprietary information for the purpose of continued solicitation of Plaintiff’s customers. According to the decision, LPC is a supplier of electricity to businesses, maintained an in-house staff to solicit large businesses, yet relied upon brokers (“sales channels”) to solicit small and medium sized businesses. Defendants, former sales channels for the Plaintiff LPC, sought to identify customers interested in obtaining electricity from LPC, which prospective customers would enter into an electricity supply agreement with Plaintiff LPC. The Defendants would receive a commission premised upon the electricity usage by the customers it referred to Plaintiff, and Defendants were responsible for renewing the customer’s contracts with LPC.
Judge Garaufis found that there was “considerable evidence that Defendants obtained LPC’s trade secrets in breach of an agreement, confidential relation or duty, or as a result of discovery by improper means.” More specifically, a former employee of Plaintiff LPC, Keith Hernandez, was the inside sales channel support representative for Defendants, and was responsible for maintaining LPC’s relationship with Defendants. Mr. Hernandez stated that while he was employed by LPC, Defendants offered to pay Hernandez if he would provide LPC’s proprietary information to Defendants; Hernandez ultimately agreed to the proposal and, beginning in the fall of 2008, did, in fact, provide LPC’s customer information to Defendants. Defendants, in turn, utilized that information to obtain renewals from existing LPC customers whose contracts were initially achieved by other sales channels. Defendants paid Hernandez a percentage of the commissions which Defendants earned from LPC for these renewals. When Hernandez was terminated by LPC in the summer of 2009, the theft continued.
[Hernandez] allegedly conspired with [Defendants] to continue to obtain LPC’s customer-specific information from an LPC sales channel support representative, Yamil Moya (“Moya”) . When Keith Hernandez went to work for [Defendants] in January 2010, Moya gave Keith Hernandez his password to LPC’s systems so that Keith Hernandez could access LPC’s customer-specific information. Keith Hernandez used this access to continue providing customer-specific information to [Defendants]. … [Defendants] do not dispute that [they] received LPC customer-specific information from Keith Hernandez. … Katz does not specifically deny in his Affidavit that Katz paid Keith Hernandez a total of $40,000 for LPC’s customer-specific information.
Injunction Analysis in Federal Court
Judge Garaufis cited the Second Circuit’s 2009 decision in Faiveley Transport Malmo AB v. Wabtec Corp., 559 F.3d 110, at 116 (2nd Cir. 2009) which reiterates that, in this Circuit, a movant “seeking a preliminary injunction must demonstrate: (1) either (a) a likelihood of success on the merits or (b) sufficiently serious questions going to the merits to make them a fair ground for litigation and a balance of hardships tipping decidedly in the movant’s favor, and (2) irreparable harm in the absence of the injunction.” After the District Court observed that LPC’s injunctive relief claim was premised on “the risk that Defendants will further misappropriate its trade secrets”, Judge Garaufis surmised that:
Accordingly, LPC is not entitled to preliminary relief prohibiting the misappropriation of trade secrets unless it demonstrates that Defendants likely misappropriated a trade secret. Faiveley, 559 F.3d at 116-17. “To succeed on a claim for the misappropriation of trade secrets under New York law, a party must demonstrate: (1) that it possessed a trade secret, and (2) that the defendants used that trade secret in breach of an agreement, confidential relationship or duty, or as a result of discovery by improper means.” N. Atl. Instruments, Inc. v. Haber, 188 F.3d 38, 43-44 (2d Cir. 1999).
1. Likelihood of Success on the Merits
Trade Secret Analysis
As the New York Court of Appeals observed in Ashland Management Inc. v. Janien, 82 N.Y.2d 395, 604 N.Y.S.2d 912 (1993), six factors recognized in the Restatement are utilized to determine whether the compilation of information constitutes a protected trade secret.
There is no generally accepted definition of a trade secret but that found in section 757 of Restatement of Torts, comment b has been cited with approval by this and other courts . It defines a trade secret as “any formula, pattern, device or compilation of information which is used in one’s business, and which gives him an opportunity to obtain an advantage over competitors who do not know or use it.” The Restatement suggests that in deciding a trade secret claim several factors should be considered:
“(1) the extent to which the information is known outside of [the] business; (2) the extent to which it is known by employees and others involved in [the] business; (3) the extent of measures taken by [the business] to guard the secrecy of the information; (4) the value of the information to [the business] and [its] competitors; (5) the amount of effort or money expended by [the business] in developing the information; (6) the ease or difficulty with which the information could be properly acquired or duplicated by others” (Restatement of Torts § 757, comment b).
In Liberty Power, the Court agreed with Plaintiff’s contention that LPC’s established customer specific information was entitled to trade secret protection. The Court’s conclusion was premised upon several factors, including the fact that the information: was gathered over a long period of time and “through a specific investment of resources”; was specific to LPC’s existing and former customers; was not easily ascertainable; and would permit “competitors to easily undercut” LPC’s prices. Further underscoring the need for trade secret protection, the Court observed that LPC maintained internal “security protocols” to control access to the information and likewise provided confidential protection of that information when contracting with its sales channels.
Trade Secret Achieved by Improper Means
The Court also agreed with Plaintiff’s second contention, that the trade secrets were achieved improperly by the Defendants.
Despite the conflicting evidence, the court finds that Plaintiff has established that Defendants likely paid at least one LPC employee kickbacks in order to obtain customer-specific data that are likely trade secrets. “If a trade secret is acquired through conduct that is itself a tortious or criminal invasion of the trade secret owner’s rights, the acquisition ordinarily will be regarded as improper.” Restatement (Third) of Unfair Competition § 43 cmt. c (1995); see also Restatement (First) of Torts § 759 cmt. c (1939) (“Among the means which are improper are theft, trespass, bribing or otherwise inducing employees or others to reveal the information in breach of duty….”). Plaintiff has established that Defendants would not have been given access to the customer data had they not bribed an LPC employee to obtain it. Therefore, Plaintiff has established that Defendants discovered its trade secrets through “improper means.” Faiveley, 559 F.3d at 117
The Court went so far as to observe, in a footnote, that Defendants’ actions apparently transcended the civil arena and likely constituted criminal conduct, noting that New York Penal Law § 180.03 prohibits commercial bribing in the first degree.
2. Irreparable Harm
As the title foreshadows, Plaintiff’s injunction application failed upon the Court’s analysis of the purported irreparable harm. Plaintiff argued that absent an injunction, Defendants would continue to use LPC’s customer information to solicit LPC’s customers and deliver them to other electricity suppliers. In fact, the Court noted that Defendants’ opposition papers essentially acknowledged the diversion plan. Nonetheless, irreparable harm analysis must proceed:
In this analysis “the court must actually consider the injury the plaintiff will suffer if he or she loses on the preliminary injunction but ultimately prevails on the merits, paying particular attention to whether the ‘remedies available at law, such as monetary damages, are inadequate to compensate for that injury.’ “ Salinger v. Colting, 607 F.3d 68, 80 (2d Cir.2010) (quoting eBay, Inc. v. MercExchange, LLC, 547 U.S. 388, 391, 126 S.Ct. 1837, 164 L.Ed.2d 641 (2006).
The Court concluded that Plaintiff failed to carry its burden of establishing that the anticipated harm was actually irreparable. After casting doubt on Plaintiff’s suggestion that a presumption of irreparable harm exists in trade secrets cases, and holding Plaintiff to its burden of establishing truly irreparable harm absent the injunction, the Court found to the contrary and concluded that Plaintiff’s harm was, in fact, quantifiable.
According to Plaintiff, Defendants stole trade secret information only with respect to a finite – albeit large – number of customers [Plaintiff claimed that Defendants acquired trade secret information concerning 4,630 former and current customers]. … The harm Plaintiff has alleged in this case is the possibility that Defendants will use its trade secrets to undercut its contracts with a defined subset of its current and former customers and move them to competing electricity suppliers. Even if the court finds that Plaintiff has shown that there is an actual and imminent risk that Defendants will use Plaintiff’s trade secrets to do this, the harm that would result is measureable and compensable through an award of damages after trial. Indeed, Plaintiff has calculated the potential renewal value of the contracts between it and the customers about whom Defendants obtained Plaintiff’s proprietary information. At trial, Plaintiff would be able to offer evidence establishing how many customers it lost due to Defendants’ misappropriation of its trade secrets, and could recover damages to compensate it for this harm [emphasis added].
The Court rejected the injunction application, despite concluding that: (1) Plaintiff’s misappropriated customer information was entitled to trade secret protection; and (2) that Defendants’ effort to gain that data likely constituted criminal misconduct. Despite these egregious circumstances, wherein a defendant bribed his competitor’s employee to obtain confidential trade secret information, the Court refused to award an injunction. When presenting an injunction application, movant’s counsel must carefully maneuver a tightrope between competing concerns — at all times balancing the need to demonstrate the severe consequences which a given Defendant’s egregious misconduct has imposed upon the movant’s business, while simultaneously developing the irreparable injury aspect of the claim. Unfortunately for LPC, the two concerns were irreconcilable.
By: Leo K. Barnes Jr.
In a recent column, we addressed recent Appellate Division authority concerning the ultimate sanction for failure to disclose, a CPLR 3126 Order striking a pleading. In December, the Court of Appeals issued Gibbs v. St. Barnabas Hospital, 2010 N.Y. Slip. Op. 09198 (2010) reversing a Supreme Court decision which refused to strike a pleading upon violation of the terms of a conditional order of preclusion. As per the authority cited in the January column, the result in Gibbs is hardly an anomaly; yet, Gibbs is significant for the Court’s recognition of the frustration that all members of the bar, litigants and the public encounter in response to “chronic” non-compliance. It provides additional guidance (and fodder) to counter non-cooperation, and the Court’s frustration is palpable:
The failure to comply with deadlines not only impairs the efficient functioning of the courts and the adjudication of claims, but it places jurists unnecessarily in the position of having to order enforcement remedies to respond to the delinquent conduct of members of the bar, often to the detriment of the litigants they represent. Chronic noncompliance with deadlines breeds disrespect for the dictates of the Civil Practice Law and Rules and a culture in which cases can linger for years without resolution. Furthermore, those lawyers who engage their best efforts to comply with practice rules are also effectively penalized because they must somehow explain to their clients why they cannot secure timely responses from recalcitrant adversaries, which leads to the erosion of their attorney-client relationships as well. For these reasons, it is important to adhere to the position we declared a decade ago that “[i]f the credibility of court orders and the integrity of our judicial system are to be maintained, a litigant cannot ignore court orders with impunity” .
The factual background is straight forward. In June 2005, Gibbs commenced a medical malpractice action against the Hospital and, inter alia, Dr. Vinces. In August 2005, Dr. Vinces served an answer and discovery demands. When no response followed, defense counsel for Dr. Vinces sent plaintiff’s counsel a letter requesting compliance within 10 days, and another letter requesting compliance with some other outstanding discovery. Plaintiff failed to reply to either letter. Two additional letters demanding compliance followed on March 21st and May 26th. Significantly, the Gibbs Court observed that Plaintiff did not respond to any letter and did not request an extension of time to respond to the demands. Dr. Vinces moved to compel in June 2006 and, upon service of the bill of particulars in August 2006, withdrew the pending motion. The November 2006 Preliminary Conference Order directed Plaintiff to serve a supplemental bill of particulars within 30 days; upon Plaintiff’s failure to do so, in January 2007, Dr Vinces moved to strike pursuant to CPLR 3126. Supreme Court conditionally granted the motion on February 21, 2007, stating Plaintiff would be barred from introducing evidence of the Defendant’s negligence if Plaintiff did not serve the supplemental Bill of Particulars within 45 days. Plaintiff failed to do so, and did not seek an extension of time or otherwise seek relief. In May 2007, Dr. Vinces moved to enforce the conditional order of preclusion and for summary judgment. Plaintiff served the supplemental bill of particulars in June 2007, approximately 75 days after the preclusion order deadline, and likewise served opposition to the motion, arguing that the Plaintiff did not incur any prejudice in light of the fact that the supplement bill of particulars had been served as of the return date of the motion, and likewise asserting that a reasonable excuse for the delay (law office failure) had been demonstrated; as for the meritorious defense, Plaintiff asserted the motion to strike did “not suggest that plaintiff does not have a meritorious claim.”
Supreme Court granted the motion, but only to the extent of imposing a $500 sanction for the delay. The Appellate Division affirmed, concluding that the Supreme Court did not abuse its discretion in declining to enforce the conditional order of preclusion. Dr. Vinces appealed to the Court of Appeals.
The Court of Appeals observed that in order to obtain relief from a conditional order of preclusion, a party must show a reasonable excuse and meritorious defense, and noted that the Appellate Division “overlooked the two-part test in determining that Supreme Court’s decision not to enforce the preclusion order was not an abuse of discretion warranting reversal. We certainly understand the Appellate Division’s concern that courts be permitted to exercise discretion in their pre-trial management of their caseloads ….”
But there is also a compelling need for courts to require compliance with enforcement orders if the authority of the courts is to be respected by the bar, litigants and the public. … [D]espite Dr. Vinces’ written requests for compliance, plaintiff apparently ignored the applicable statutory time periods, without taking the simple step of contacting the opposing party to ask for an extension or seeking the assistance of Supreme Court to clarify or modify the requests. … Again, no attempt was made to request an extension or seek some form of relief from the court prior to the expiration of time period set forth in the order.
The three Justice dissent observed that the majority opinion effectively imposed a CPLR 3126 sanction despite the fact that the Supreme Court concluded that Plaintiff’s conduct was “dilatory, but not intentioned and [did] not warrant the extreme measure of precluding.” The Appellate Division likewise noted that absence of evidence to indicate that Plaintiff’s inaction was “willful, contumacious or the result of bad faith”. The dissent concluded: “Thus, although the CPLR makes willfulness a prerequisite for preclusion, the majority here is imposing the sanction where there is an affirmed finding that Gibbs’ behavior was not willful.”
The Gibbs’ progeny will reveal whether the dissent characterization that the Gibbs’ majority goes so far as to effectively constitute a willfulness substitute is an accurate prediction. Nonetheless, Gibbsprovides fodder to counsel seeking to level the playing field. Notwithstanding the fact that the Supreme Court found that the delay was not willful, the Court of Appeals nonetheless dismissed the claim. The Opinion highlighted the fact that the Plaintiff failed to respond to multiple letters requesting compliance with outstanding demands. The GibbsCourt recognized, and remedied, the universal frustration that Judges, counsel and litigants encounter when cases stagnate due to unreasonable discovery delays. Gibbslevels the playing field by providing a basis for striking a pleading short of a willful noncompliance finding.
By: Leo K. Barnes Jr.
At first blush, two principles regarding the loyalty due to a current employer from an employee seem irreconcilable: on the one hand, an employee owes his employer complete loyalty; on the other, an employee may incorporate a competitive business prior to departure from employment as long as he does not use his employer’s time, facilities or proprietary secrets in the process.i Despite the apparent inconsistency between these two modes of conduct, they can peacefully co-exist. However, when they collide – i.e., when an employee fails to honor his duty of loyalty by using his employer’s time and facilities to get a “head start” on a soon-to-be competitive business — litigation often follows.
The First Department’s 1984 decision in Maritime Fish Products Inc. v. World-Wide Fish Products, Inc.ii is one of the leading decisions on the ramifications of employee disloyalty. In Maritime Fish, plaintiff sold dried fish purchased from Canadian packers to wholesale distributors and retail chains throughout the United States. Maritime’s President, Mr. Hertzwig, hired his cousin, Roy Christensen, as a salesperson for the New York market. From the time of his hiring in 1970, Christensen rose quickly through the ranks, was named Vice President in July 1976, and became the sole signatory of Maritime’s checking account. Christensen was not bound by a restrictive covenant during his tenure with Maritime.
In 1974, without informing Maritime, and following the lead of a Maritime customer, Christensen found a buyer in the Dominican Republic known as Frutos. Christensen later confirmed that he never advised Maritime of this opportunity but decided to take the opportunity for himself. Having a customer in place, Christensen contacted Maritime’s resident buyer of dried fish in Canada, Graham Garrison. Soon thereafter, Garrison located a source of supply. Defendant World-Wide’s first sale to Frutos was made in January 1976, within weeks of World-Wide’s incorporation. By June 1976, World-Wide had completed four other transactions with Frutos. Maritime was kept completely in the dark about these transactions.
Christensen resigned from Maritime in February 1977 and began to work for World-Wide. Unbeknownst to Maritime, Christensen had secretly incorporated World-Wide 14 months earlier, hiring his wife as secretary/treasurer and his father-in-law as vice president.
The court ruled that World-Wide competed directly with Maritime. In reversing that portion of the trial court order which dismissed Plaintiff’s employee disloyalty claim, the First Department found:
On this record, it is apparent that Christensen abandoned all pretense to the loyalty expected of a trusted employee. He surreptitiously organized a competing organization, corrupted a fellow employee, and secretly pursued and profited from one or more opportunities properly belonging to his employer. … Christensen was not just preparing to go into his own business; he was in business for himself, while drawing a salary from a trusting employer.iii
The remedy awarded to Plaintiff was significant: the court held that Plaintiff was entitled to, inter alia, an accounting to ascertain the damages resulting from Christensen’s diversion of business from the date of World-Wide’s incorporation until Christensen’s resignation from Maritime.
Two Means of Establishing Loss
Citing the Court of Appeals decision in Duane Jones Co. v. Burke,iv the First Department ruled in Maritime Fish that a plaintiff is “entitled to damages for the wrongful diversion of its business measured by the opportunities for profit on the accounts diverted from it through defendant’s conduct.”v Eighteen years later, in Gomez v. Bicknell,vi the Second Department issued its first opinion addressing the law of damages for an employee’s “breach of a duty of loyalty in converting to himself a corporate opportunity.” In Gomez, the Second Department instructed that an employer may select one of two avenues to establish its damages incident to an employee’s disloyalty.
[T]he remedy for breach of fiduciary duty is not only to compensate for the wrongs but to prevent them. The remedy, not unlike applying a constructive trust, is disgorgement for breach of the loyalty an employee owes to the employer. This is not to say that other methods of calculating an employer’s damages are unavailable. As an alternative to an accounting of the disloyal employee’s claim, calculation of what the employer would have made of the diverted corporate opportunity is an available measure of damages. The choice of remedy belongs to the employer [internal citations omitted].vii
The Second Department’s Gomez decision essentially permits the employer to shift the burden in establishing damages sustained as a result of employee disloyalty. Of course, consistent with the Maritime Fish decision, an employer may elect to affirmatively assume the burden of establishing its lost opportunities for profit.viii Or, relying upon the Gomez alternative, the employer may simply put the onus on the disloyal employee:
For disgorgement of Gomez’s profits stemming from disloyalty, all BAS needed to show was the gross fee Gomez received. We conclude that BAS met this prima facie burden of showing damages by simply proving the $353,000 gross fee that Gomez was paid. The burden then shifted to Gomez to demonstrate the amount of his direct costs in generating this gross income because he is in exclusive possession of that information. BAS would then have the opportunity to question the reasonableness of any deduction.ix
Recovering Both Economic Losses & Compensation Paid
As set forth in Maritime Fish and Gomez, recovery in an employee disloyalty case may be premised upon the economic loss sustained by the former employer. Moreover, the employer’s economic loss may be assessed on two distinct bases. Thus, in Carco Group, Inc. v. Maconachy, Magistrate Judge Lindsay of the Eastern District of New York issued a decision awarding the plaintiff economic loss damages premised upon breach of an Asset Purchase Agreement and Employment Agreement, and also simultaneously awarded damages based upon the defendant’s disloyalty. The result was that the Court awarded one set of damages for breach of the relevant contracts, and another set of damages arising from breach of the employee’s duty of loyalty.
According to the Court, in Carco Group, Inc. v. Maconachy,x Drew Maconachy (“Maconachy”), had co-founded Murphy & Maconachy, Inc. (“MMI”), a security consulting firm that offered investigation and litigation support services. Carco’s majority owner had focused on MMI for its targeted expansion because the principals of both companies were former FBI agents and because MMI could provide Carco a foothold in the investigative services field. MMI had been in business for fifteen years prior to its acquisition by Carco, which provided research and background check services and was seeking to expand its operations to include investigative services. Carco acquired the assets of MMI on January 7, 2000 via an Asset Purchase Agreement (“APA”) and employment agreements (“EA”)xi for Murphy and Maconachy. The EAs were a condition precedent to the APA and were explicitly described to be an integral part of the APA, primarily because a report prepared by Merrill Lynch regarding MMI’s value concluded that MMI’s revenue generation was heavily dependent upon Maconachy and Murphy, and that MMI’s business was derived principally through professional relationships and word of mouth.
Subsequent to the closing of Carco’s purchase of MMI, MMI began to sustain significant losses. Over the course of several years, Carco insisted that Maconachy follow a certain sales and expense reduction plan in an attempt to remedy the declining revenue. After a four-week bench trial, the Court made findings of fact, which included a painstakingly-detailed account of Maconachy’s consistent refusal to follow Carco’s plans and directives. That ongoing refusal ultimately resulted in the award to plaintiff of damages premised upon breach of the APA and EA.
Part and parcel with Maconachy’s breach of his duty to perform was Maconachy’s repeated and consistent failure to comply with the tasks assigned to him by [Carco]. The record is rife with examples …xii
At every turn, Maconachy failed to comply with the reasonable duties and directions given to him by his superiors. Accordingly, due to the acts described above that show a wanton disregard of reasonable instructions from supervisors, the court finds that Maconachy breached the [APA and EA].xiii
The Court concluded that the failure to perform as directed, in breach of the APA and EA, entitled the plaintiff to damages in an amount equal to the economic loss that it suffered for the period November 2000 through December 2002.xiv
The Court’s findings of fact also revealed that Maconachy had intentionally attempted to conceal his hiring of family members by falsifying time records which were submitted for review by Carco’s hierarchy, and found that Carco was entitled to damages based upon the falsification of the time records.
Maconachy’s contractual obligations under the Performance Clause were the duties of reasonable performance and to follow directions. In contrast, Maconachy’s fiduciary duty was to act on Carco’s behalf and to avoid self-dealing. The court thus finds that Maconachy’s involvement in falsifying business records is a quintessential breach-of-fiduciary claim and therefore separate from Carco’s breach of contract claim. The falsification of records represents not only a failure to perform adequately and the failure to follow directions, but also self-dealing and acts against Carco’s interests. While the conduct may overlap both claims, the obligation to act on Carco’s behalf is distinct from Maconachy’s separate contractual obligations. The court thus finds that Maconachy’s involvement in altering documents gives rise to a separate claim of breach of fiduciary duty that is distinct from Carco’s breach of contract claims.xv
Further, forfeiture of this amount does not constitute double recovery of Carco’s breach of contract claims because those damages derive from a separate period of time from November 2000 to December 2002. The court is unaware of any authority under New York law limiting recovery under both a theory of breach of contract and breach of fiduciary duty, except where the two claims are duplicative as described above. Therefore, Carco is entitled to an award of $889,711, which constitutes the compensation paid to Maconachy during his period of disloyalty from September 26, 2003 [the date of the first falsification] to December 28, 2005 [the date of termination].xvi
In sum, the Court concluded that “despite the many directives he received, Maconachy never implemented the sales plan”xvii and MMI’s “business was failing from a lack of management and the absence of any good faith effort to follow corporate directives [regarding sales and expense reduction].”xviii The Carco Court essentially concluded that Maconachy’s disloyalty was all-encompassing; the corresponding array of damages was devastating to the defendant.
Counsel’s initial analysis of the potential damages in employee disloyalty claims serves as the keystone to the prosecution or defense of such claims. Any analysis must begin with a complete command of the events which occurred during the employee’s tenure of employment so that counsel can evaluate whether broad-based damages are viable.
i 30 FPS Production Inc. v. Livolsi, 68 A.D.3d 1101, 891 N.Y.S.2d 162 (2nd Dep’t 2009).
ii 100 A.D.2d 81, 474 N.Y.S.2d 281 (1st Dep’t 1984).
v 100 A.D.2d 81, at 91, 474 N.Y.S.2d 281, at 287 (1st Dep’t 1984).
vi 302 A.D.2d 107, 756 N.Y.S.2d 209 (2nd Dep’t 2002).
vii Id., at 113-14, at 214.
ix 302 A.D.2d 107, at 114-15, 756 N.Y.S.2d 209, at 215 (2nd Dep’t 2002).
x 644 F.Supp.2d 218 (E.D.N.Y. 2009).
xi According to the Court, Carco considered Murphy and Maconachy to be so essential to the purchase that it required each of them to sign “unusually long” employment agreements of eight years, a period of time which coincided with Carco’s repayment term of a bank loan obtained to acquire MMI.
xii 644 F.Supp.2d 218, 233 (E.D.N.Y. 2009).
xiv Although MMI West was profitable between 2003 through Maconachy’s termination in December 2005, the court found that such profitability was due to other measures not attributable to Maconachy’s actions.
xv 644 F.Supp.2d 218, 243 (E.D.N.Y. 2009).
By: Leo K. Barnes Jr.
In two opinions issued on the same day this spring, the First and Second Departments continued a trend of affirming trial court rulings striking pleadings pursuant to CPLR 3126 once a willful failure to disclose is documented. Although the result is severe, both the trial and appellate courts are universally refusing to perpetually provide “one more chance” to comply with unqualified obligations to disclose.
The CPLR 3126(3) motion to strike a pleading is premised upon establishing a willful failure to disclose; obviously, a movant’s regular and documented efforts to coax compliance must found the motion. Opposition to a CPLR 3126 motion is often premised upon a misunderstanding regarding disclosure obligations, arguing that violation of an order to disclose, or violation of a conditional order of preclusion, must serve as a predicate for a 3126 motion. To the contrary, the relevant and controlling authority explicitly confirms that striking a pleading is permissible even when no prior court order is violated. In Wolfson v. Nassau County Medical Center,i after an extensive failure to respond to defendant’s first set of interrogatories, defendant moved pursuant to CPLR 3126. Despite the fact that the plaintiff’s failure to respond did not violate any prior court order, the Second Department affirmed the CPLR 3126 dismissal and denied a subsequent motion by Plaintiff to reargue and vacate:
A court may dismiss an action if the plaintiff “willfully fails to disclose information which the court finds ought to have been disclosed” (CPLR 3126). The sanction of dismissal may be warranted even where, as in the present case, the plaintiff committed no violation of a prior court order (see, Goldner v. Lendor Structures, 29 A.D.2d 978, 289 N.Y.S.2d 687; Siegel, Practice Commentaries, McKinney’s Cons. Laws of N.Y. Book 7B, CPLR C3126:6, at 645-646).
In the present case, the extensive nature of the plaintiffs’ delay in responding to the defendant’s interrogatories permits an inference that the delay was willful. The plaintiffs’ current attorneys allege absolutely no excuse for this delay and state only that they were not substituted for the plaintiffs’ former attorneys until after, or shortly before, the defendant made the motion pursuant to CPLR 3126. This circumstance neither explains nor excuses the unconscionable delay in prosecuting this action. The default can therefore be considered willful and no error as a matter of law was committed when the Supreme Court imposed the sanction of dismissal.
Furthermore, we find that the refusal of the court to exercise its discretionary power to impose a lesser sanction (see, e.g., Applied Elec. Corp. v. City of New York [Museum of Natural History], 101 A.D.2d 795, 476 N.Y.S.2d 323) was neither abusive nor improvident [emphasis added].
In that same vein, Justice Kaye, writing for a unanimous majority in Kihl v. Pfeffeer,ii (which affirmed the dismissal of a complaint for failure to respond to interrogatories) confirmed as follows:
If the credibility of court orders and the integrity of our judicial system are to be maintained, a litigant cannot ignore court orders with impunity. Indeed, the Legislature, recognizing the need for courts to be able to command compliance with their disclosure directives, has specifically provided that a “court may make such orders * * * as are just,” including dismissal of an action (CPLR 3126). Finally, we underscore that compliance with a disclosure order requires both a timely response and one that evinces a good-faith effort to address the requests meaningfully [emphasis added].
Five years later, again writing for the majority, Justice Kaye ruled in Brill v. City of New Yorkiii that statutory deadlines, like Court orders, cannot be ignored without significant consequences.
The Spring 2010 Directives
The First Department’s decision in Fish & Richardson P.C. v. Schindleriv rejected the “one more chance” argument as a basis for an abuse of discretion reversal.
Defendant argues that it was an abuse of discretion for the court to strike the answer in the absence of a conditional order or a specific warning by the court that he faced imminent dismissal. Defendant points to no authority holding that a court must issue such a “last chance” warning or order in all cases before exercising its discretion to strike a pleading. CPLR 3126 permits the court to “make such orders … as are just,” and it may, in an appropriate case, determine that the pattern of noncompliance is so significant that a severe sanction is appropriate. Such a determination should not be set aside absent a clear abuse of discretion (see Arts4All, 54 A.D.3d at 286, 863 N.Y.S.2d 193) [emphasis added].
The Second Department’s opinion in Xiao Yang Chen v. Fischerv was also premised upon a CPLR 3126 motion after plaintiff’s spoliation of evidence violated several orders to disclose (ruling that the Supreme Court improvidently exercised its discretion in denying that branch of the defendant’s motion which was to dismiss certain other personal injury causes of action after the plaintiff willfully defied discovery orders by deleting from her computer’s hard drive materials that she had been directed to produce).
Compilation Should Start at Engagement
It is good practice to ready the client for disclosure obligations at the time that counsel is engaged by the party for representation. An overview of the anticipated discovery proceedings (documented in a follow up letter) will avoid unnecessary delays. Explain to the client that inasmuch as certain deadlines for production will be imposed by the Court, counsel must impose ancillary obligations upon the client so that production obligations are achieved on a timely and proactive basis. After the Supreme Court struck the Defendant’s answer in Fish & Richardson the client attempted to turn the table on his former counsel by blaming the former counsel for the disclosure failure. To his credit, former counsel successfully avoided criticism for failure to disclose because counsel documented his effort to encourage the client to comply with the disclosure obligations.
i 141 A.D.2d 815, 530 N.Y.S.2d 27 (2nd Dep’t 1988).
ii 94 N.Y.2d 118, 700 N.Y.S.2d 87 (1999).
iii 2 N.Y.3d 648, 781 N.Y.S.2d 261 (2004).
iv 75 A.D.3d 219, 901 N.Y.S.2d 598 (1st Dep’t 2010).
v 73 A.D.3d 219, 901 N.Y.S.2d 598 (2nd Dep’t 2010).
By: Leo K. Barnes Jr.
Several weeks before then-President George W. Bush defeated presidential candidate John Kerry, CBS News correspondent Dan Rather narrated a “60 Minutes” piece assailing President Bush’s service in the Texas Air National Guard. According to Mr. Rather, subsequent to Mr. Bush’s re-election in November 2004, CBS reduced his role and visibility at the network. After the loss of his highly prized seat as anchor of the nationally broadcast “Evening News” program, followed by an acrimonious severance from CBS, Mr. Rather filed suit, with claims sounding in breach of contract and related torts.
The Appellate Division, First Department’s complete dismissal of Mr. Rather’s claims against CBS confirmed an important point for counsel litigating tortious interference claims: claims of malice must be articulated with particularity because generic, bare allegations of malice will not suffice to circumvent an economic interest defense to a tortious interference claim.
Economic Interest Rule
In Rather v. CBS Corporation,1 Mr. Rather alleged several causes of action including breach of contract, breach of fiduciary duty, breach of the implied covenant of good faith and fair dealing, and tortious interference with contract. The Supreme Court granted defendants’ motion to dismiss the claims for fraud, breach of the implied covenant of good faith and fair dealing and tortious interference with contract, but denied defendants’ motion with respect to the breach of contract and breach of fiduciary duty claims.
On appeal before the First Department, the Appellate Division held that the Supreme Court’s denial of the defendants’ motion to dismiss the breach of contract and breach of fiduciary duty claims was erroneous and, therefore, dismissed Mr. Rather’s complaint in its entirety.
In affirming that portion of the Supreme Court order which dismissed Mr. Rather’s tortious interference claim against CBS, the First Department cited the 2007 Court of Appeals decision in White Plains Coat and Apron Co., Inc. v. Cintas Corp.2 (holding that a generalized economic interest in soliciting business for profit does not constitute a defense to a claim of tortious interference with an existing contract for an alleged tortfeasor with no previous economic relationship with the breaching party), and ruled that the Supreme Court “correctly applied the economic interest doctrine to dismiss the claim against the corporate defendant [CBS].”
The White Plains Court explained the economic interest defense this way:
In response to such a [tortious interference] claim, a defendant may raise the economic interest defense—that it acted to protect its own legal or financial stake in the breaching party’s business. The defense has been applied, for example, where defendants were significant stockholders in the breaching party’s business; where defendant and the breaching party had a parent-subsidiary relationship; where defendant was the breaching party’s creditor; and where the defendant had a managerial contract with the breaching party at the time defendant induced the breach of contract with plaintiff [internal citations omitted].
Lack of Specificity
Mr. Rather attempted—unsuccessfully—to circumvent the economic interest defense by claiming that CBS was motivated by malice. The maxim that a sustained finding of malice serves as an exception to the economic interest defense has its genesis in decades-old precedent, e.g., Felsen v. Sol Cafe Mfg. Corp.3 In Foster v. Churchill,4 the Court of Appeals reiterated its rule of law, highlighted in Felsen, as follows:
The imposition of liability in spite of a defense of economic interest requires a showing of either malice on the one hand, or fraudulent or illegal means on the other [citing Felsen]. To defeat a claim of tortious interference under Felsen, respondents need to establish that their actions were taken to protect an economic interest. While the lower court found that respondents did not show good faith in their actions, and may have acted in bad faith, there was no evidence that independent torts were committed, nor were respondents’ actions advanced to serve some personal interest. Respondents were clearly acting in the economic interest of Microband, which was on the brink of insolvency. To the extent that respondents acted to preserve the financial health of an ailing Microband, their actions were economically justified.
Relying upon this rule, the First Department rejected Mr. Rather’s malice claim, emphasizing its lack of specificity: “Rather’s bare allegations of malice do not suffice to bring the claim under an exception to the economic interest rule.” Indeed, there is a long line of authority which confirms that sparsely detailed allegations of malice are insufficient to trigger the exception to the economic interest defense; the Rather court cited Ruha v. Guior5 for the proposition.
Practitioners in federal district court pursuing claims premised upon malice have two obstacles to overcome. There are many instances where federal district courts dismiss claims premised upon malice: see, e.g., U.S. District Judge Loretta Preska’s December 2009 order which cited the First Department’s decision in Rather in rejecting a tortious interference claim because it merely characterized the alleged offensive conduct as “malicious” and “without justification.” Without more, Judge Preska ruled that the claim must be dismissed.6
The claimant’s pleading burden in federal district court has been reinforced, generally, with the U.S. Supreme Court’s decision in Ashcroft v. Iqbal.7 That ruling confirmed that the pleading standard is now more challenging than ever:
To survive a motion to dismiss, a counterclaim “must contain sufficient factual matter, accepted as true, to ’state a claim to relief that is plausible on its face.’ “Ashcroft v. Iqbal,—U.S.—,—, 129 S.Ct. 1937, 1949, 173 L.Ed.2d 868 (2009) (quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007)). In making this determination here, this Court is mindful of two corollary rules. “First, the tenet that a court must accept as true all of the allegations contained in a complaint is inapplicable to legal conclusions.” Id. In other words, “[t]hreadbare recitals of the elements of a cause of action, supported by mere conclusory statements, do not suffice.” Id. (citing Twombly, 550 U.S. at 555). “Second, only a complaint that states a plausible claim for relief survives a motion to dismiss.” Id. at 1950 (citing Twombly, 550 U.S. at 556). The Supreme Court has noted that “[d]etermining whether a complaint states a plausible claim for relief will … be a context-specific task that requires the reviewing court to draw on its judicial experience and common sense.” Id. [citation omitted].8
In fact, in her recent order, Judge Preska additionally cited Iqbal in concluding that the tortious interference claim must be dismissed because the claimant’s “conclusory allegations do not meet the pleading standard set forth in Iqbal.”9 Thus, claims of malice are ripe for attack by the defense bar on two fronts: first, whether the claims meet common law standards constituting malice; second, whether the party claiming malice has likewise convinced the Court, at the pleading stage, that the claim is “plausible” in the corresponding “context-specific” environment.
Such a “context-specific” analysis served as a basis for dismissal of a tortious interference with prospective business advantage claim in Bayer Schera Pharma AG v. Sandoz, Inc.10 In Bayer, defendant Sandoz pursued a counterclaim against Bayer premised upon tortious interference; Sandoz alleged that it had “a continuing economic advantageous relationship with others for the supply of its generic products.” In response, Bayer urged that dismissal was appropriate because Sandoz had failed to identify a “particular, existing relationship” with which Bayer had interfered.
Southern District Judge Paul G. Gardephe, citing Iqbal, agreed with the defense.
Sandoz has not identified any specific business entities with which it had business relationships.11 “New York courts have dismissed complaints that failed to allege the specific business relationship that was interfered with.” Johnson & Johnson, 552 F.Supp.2d at 464-65 (collecting cases). Prior to Iqbal, New York district courts disagreed as to whether a plaintiff was required to identify specific business relationships in order to make out a claim for tortious interference with prospective economic advantage. See id. at 465 (collecting cases). After Iqbal, it is clear that a claim such as this-which merely “offers ‘labels and conclusions’ [and] ‘a formulaic recitation of the elements of a cause of action’ “-will not survive a motion to dismiss. See Iqbal, 129 S.Ct. at 1949. Although Sandoz has alleged that it has a “continuing economic advantageous relationship with others for the supply of its generic products,” and that Bayer has interfered with those relationships (Yasmin Cntrcl. ¶87; Yaz Cntrcl. ¶85), it is entirely unclear whether the “others” referenced are entities that purchase generic drugs from Sandoz, third-party business entities that market Sandoz’s products, business entities that supply the raw materials Sandoz uses to manufacture its products, or another type of business. Because Sandoz offers only “[t]hreadbare recitals of [an] element[ ] of a cause of action, supported by mere conclusory statements,” see Iqbal, 129 S.Ct. at 1949, its counterclaims for tortious interference with prospective economic advantage will be dismissed.
Returning to state court, in the First Department’s Advanced Global Technology, LLC v. Sirius Satellite Radio, Inc.,12 plaintiff had alleged that Sirius had warned an electronics manufacturer that it was running the risk of losing Sirius’ business if the electronics manufacturers did business with plaintiff. As a result, the electronics manufacturer broke off negotiations with the plaintiff, which, in turn, sued Sirius, alleging tortious interference. The First Department, in affirming the CPLR 3211(a)(7) dismissal, confirmed that:
[T]he allegations, on their face, show that Sirius’s interference was neither wrongful nor motivated solely by malice, as opposed to its normal economic interest (see Carvel Corp. v. Noonan, 3 N.Y.3d 182, 190, 785 N.Y.S.2d 359, 818 N.E.2d 1100 ), specifically, that a major facilitator of its business (KRI) not do any manner of business with a major facilitator (AGT) of its sole competitor’s (XM) business (see id. at 191-192, 785 N.Y.S.2d 359, 818 N.E.2d 1100 [so long as defendant is motivated by legitimate economic self-interest, it should not matter if the parties are, or are not, competitors in same marketplace]; cf. Sumitomo Bank of N.Y. Trust Co. v. DiBenedetto, 256 A.D.2d 89, 681 N.Y.S.2d 248 , lv. denied 93 N.Y.2d 804, 689 N.Y.S.2d 17, 711 N.E.2d 202  [threats by defendants town attorneys that if a prospective vendor did not withdraw its proposal to town, "its ability to do business thereafter with the Town…would be severely compromised," insufficient to sustain claim for tortious interference by plaintiff Trustee of noteholders where town's liability on notes depended on whether it was unable to procure contract for type of services provided by vendor] ).
Despite the historical deference afforded to claimants at the initial pleading stage, it is apparent that specificity rules the day when litigating tortious interference claims.
Leo K. Barnes Jr. is a member of Barnes & Barnes. He can be reached at email@example.com.
1. 68 A.D.3d 49, 886 N.Y.S.2d 121 (1st Dept. 2009).
2. 8 N.Y.3d 422 (2007).
3. 24 N.Y.2d 682 (1969).
4. 87 N.Y.2d 744 (1996).
5. 277 A.D.2d 116, 717 N.Y.S.2d 35 (1st Dept. 2000).
6. IMG Fragrance Brands, LLC v. Houbigant, Inc., 679 F.Supp.2d 395 (SDNY 2009)
7. 129 S.Ct. 1937 (2009).
8. Bayer Schera Pharma AG v. Sandoz, Inc., 2010 WL 1222012 (SDNY 2010).
9. 679 F.Supp.2d 395, at 406 (SDNY 2009)
10. 2010 WL 1222012 (SDNY 2010).
11. Judge Gardephe made an interesting observation in response to Sandoz’ explanation for failing to specifically identify business relationships which were harmed by Bayer. Sandoz claimed that the failure to identify specific business relationship was not inadvertent but was due to the “strict confidentiality ascribed to contracts for the supply of API [active pharmaceutical ingredients] in the pharmaceutical industry [internal citations omitted].” The Court rejected the viability of any such excuse: “Protection of trade secrets or other proprietary information can, of course, be accomplished through entry of a protective order and/or a sealing order. In any event, confidentiality concerns do not excuse a failure to plead the elements of a cause of action.”
12. 44 A.D.3d 317, 843 N.Y.S.2d 220 (1st Dept. 2007).
By: Leo K. Barnes Jr.*
With Plaintiffs seeking to maximize a source of recovery and Defendants seeking to minimize the same, discovery in commercial matters may focus upon the liability of an individual shareholder for a claim asserted against a corporation. Plaintiffs are quick to name shareholders as defendants in their individual capacities and defense counsel rapidly characterize the same as an improper ploy to expand the asset pool for a potential recovery. The Court of Appeals was perfectly clear in Murtha v. Yonkers Child Care Association, 45 N.Y.2d 913, 411 N.Y.S.2d 219 (1978):
A “director of a corporation is not personally liable to one who has contracted with the corporation on the theory of inducing a breach of contract, merely due to the fact that, while acting for the corporation, he has made decisions and taken steps that resulted in the corporation’s promise being broken” . “(A) corporate officer who is charged with inducing the breach of a contract between the corporation and a third party is immune from liability if it appears that he is acting in good faith as an officer * * * (and did not commit) independent torts or predatory acts directed at another”[internal citations omitted].
Nonetheless, one who dominates a corporation so to commit a fraud will not escape personal liability for acts performed as an officer or shareholder. Matter of Morris v. New York State Dept. of Taxation & Fin., 82 N.Y.2d 135, 141, 603 N.Y.S.2 807 (1993) confirms that a party seeking to pierce the corporate veil, based upon allegations of shareholder fraud, must establish that “(1) the owners exercised complete domination of the corporation in respect to the transaction attacked; and (2) that such domination was used to commit a fraud or wrong against the plaintiff which resulted in the plaintiff’s injury.”
Knowing that the Plaintiff, at the early stage of the litigation, may not have sufficient documented proof to substantiate a claim against an individual shareholder, defense counsel’s knee jerk reaction to a defendant named in his personal capacity may be to move to resolve the claim via CPLR 3211 or 3212. But in all but the most clear cut cases, Courts are not so accommodating because a Plaintiff’s theories of liability are premised upon factual allegations of the exercise of complete domination and control. “Veil-piercing is a fact-laden claim that is not well suited for resolution on a motion to dismiss.” First Bank of Americas v. Motor Car Funding, 257 A.D.2d 287, 690 N.Y.S.2d 17 (1st Dep’t 1999). Before dismissal can be granted, plaintiffs are entitled to obtain necessary discovery to ascertain whether grounds exist to pierce the corporate veil. Thus, a robust round of discovery is often necessary to determine whether a shareholder named as a defendant in his or her individual capacity so dominated the corporation so as to justify a piercing of the corporate veil.
Piercing may also occur absent fraud. “The corporate veil will be pierced to achieve equity, even absent fraud, when a corporation has been so dominated by an individual or another corporation and its separate entity so ignored that it primarily transacts the dominator’s business instead of its own and can be called the other’s alter ego.” John John LLC v. Exit 63 Dev. LLC, 35 A.D.3d 540, 826 N.Y.S. 2d 657 (2nd Dep’t 2006). In general, courts consider the following factors in determining whether a party’s domination and control of a corporation, and abuse of the privilege of doing business in the corporate form, warrants piercing the corporate veil:
(1) the absence of the formalities and paraphernalia that are part and parcel of the corporate existence, i.e., issuance of stock, election of directors, keeping of corporate records and the like, (2) inadequate capitalization, (3) whether funds are put in and taken out of the corporation for personal rather than corporate purposes, (4) overlap in ownership, officers, directors, and personnel, (5) common office space, address and telephone numbers of corporate entities, (6) the amount of business discretion displayed by the allegedly dominated corporation, (7) whether the related corporations deal with the dominated corporation at arms length, (8) whether the corporations are treated as independent profit centers, (9) the payment or guarantee of debts of the dominated corporation by other corporations in the group, and (10) whether the corporation in question had property that was used by other of the corporations as if it were its own.i
Mindful of the liberal scope of discovery,ii demands may be broad and, depending upon which side of the “v” you are on, intrusive. Of course, the demands must be tailored on a case- by-case basis, but a cursory review of the ten foregoing factors which may determine whether domination or alter ego liability exists directs counsel to a host of relevant discovery demands which may include personal and corporate banking information, corporate resolutions, meeting minutes, and the like.
The result of that investigation may yield significant leverage (or vulnerability). See, e.g., Fern Inc. v. Adjmi, 97 A.D.2d 444, 602 N.Y.S.2d 615, (1st Dep’t 1993)(Plaintiff established a cause of action for piercing the corporate veil so as to impose liability for the rent obligations of corporation upon the individual defendant where the corporation, as a mere alter ego of that defendant, had no assets, liabilities or income, no regularly elected officers or directors, and no bank accounts, and which had never transacted any business other than entering into the subject lease agreement) and Latham Sparrowbush Associates v. Shaker Estates, Inc., 153 A.D.2d 788, 545 N.Y.S.2d 219 (3rd Dep’t 1989)(corporation’s separate identity was properly disregarded to recover unpaid rent against an individual where the individual was the sole shareholder of the corporation, the corporation had existed for more than 20 years without holding a corporate meeting, and the individual repeatedly reported the profit or loss of the corporation as a sole proprietorship on his income tax return).
In light of the potential for personal exposure, shareholders must implement procedures for regular interaction with an accountant and counsel to confirm compliance with fundamental formalities; in addition to fostering peace of mind, the undertaking will go a long way toward limiting personal liability.
i Wm. Passalacqua Bldrs., Inc. v. Resnick Devs. S., Inc., 933 F.2d 131, 139 (2nd Cir. 1991).
ii CPLR 3101 mandates that there “shall be full disclosure of all matters material and necessary in the prosecution or defense of an action.” The Court of Appeals has explained that the words “material and necessary” are to be liberally construed “to require disclosure, upon request, of any facts bearing on the controversy which will assist preparation for trial by sharpening the issues and reducing delay and prolixity.” Allen v. Crowell-Collier Pub. Co., 21 N.Y.2d 403, 406-07, 288 N.Y.S.2d 449 (1968). Thus, the CPLR “requires the disclosure of all evidence relevant to the case and all information reasonably calculated to lead to relevant evidence.” See also Siegel, New York Practice § 344, at 525 (3rd Ed. 1999).