Board Member's Vote for Disputed Conduct Not Deemed Bias for Demand in Derivative Action

August 25, 2014

Often, litigation involving a corporation will be framed as a derivative action meaning, that the shareholder that is suing is doing so on behalf of the corporation but not individually. A prerequisite for a derivative action is the suing shareholder's demand on the board to act on behalf of the corporation. However, one way to avoid this demand, is to demonstrate to a judge that because the entity's board members are biased against the demand, any demand would be futile. Upon such a showing, the demand will be waived.

In a case involving Life Medical Technologies, Inc., Suffolk County commercial division judge, Elizabeth Emerson, held that a board member's vote for the conduct in question did not equate to bias so that a demand may not have been futile. That meant that just because the board member agreed to take the action that is now the subject of the lawsuit did not mean that a demand on that board member to sue would be useless. The court held that the board member, when faced with a demand, could change his or her mind.

I suppose.

The brief facts here involve the company's failure to take steps to recover certain stock grants to a consultant and company officer (both of whom sat on the company's board). There was no dispute that the other board members voted in favor of the grants and failed to take action to recover them.

When the shareholder commenced a derivative action against the company and board members, he alleged that any demand to the board to act on behalf of the company would have been futile and he was thus relieved from making the demand. The Court disagreed, finding that while the two that received the shares would be deemed interested and biased, the other board members, notwithstanding their votes in favor, would not be automatically biased against a demand to recover the grants. Therefore, the allegation that a demand would have been futile was denied, and the case was dismissed.

This decision highlights the fine line often present in derivative litigation, and whether or not to make a demand must be carefully considered. Do not act alone in making that decision, as the dismissal of an otherwise meritorious lawsuit may result.

Court Finds the Word "Control" to Be Ambiguous and Affirms $17.2 Million Malpractice Award

August 18, 2014

In interpreting deal documents, an issue arose as to the definition of the word "control" when used in an attempt to obtain "control" over a board of directors. For that reason, and others, the law firm that drafted those documents was found liable to its client to the tune of $17.2 million. The details are a bit complex, but worth a read. Have a look here. Read the comments too.

Bottom line: Write what you mean. As simply as possible.

Important--Required--Reading for Employers and Employees

August 12, 2014

We have written and counseled on an employer's right to access an employee's personal email account from a work computer. Here is an article that goes beyond email, to an employer's ability to access an employee's social media account, for a host of reasons, even if accessed from a personal computer.

Its a bit technical, so please let us know if you have any questions.

New York State High Court Refuses to Force Parties to Negotiate Forever

July 14, 2014

Tyco and IDT entered into a joint venture agreement. Numerous litigations commenced, which were settled by a 2000 settlement agreement. That settlement agreement provided for IDT to use Tyco's yet unbuilt infrastructure, upon the parties' mutual agreement. As time went on, negotiations failed to produce mutually agreeable terms and conditions for IDT's use, and litigation followed.

The Court of Appeals agreed with IDT that the settlement agreement was enforceable, but refused to enforce Tyco's obligation to negotiate in good faith to mean that the parties were compelled to negotiate without end. The court stated that an "obligation [to negotiate] can come to an end without a breach by either party. There is such a thing as a good faith impasse; not every good faith negotiation bears fruit." The court extended that position to a case where market conditions made the proposed deal untenable or even uninteresting and one party walked away. As a result, the court dismissed IDT's case, finding that IDT stated no cause of action upon which relief could be granted.

The dissent would not have dismissed IDT's complaint because IDT's allegations did raise questions of Tyco's negotiation tactics. While the dissent addressed dismissal, it clearly disagreed with the majority's finding as to Tyco's conduct and questioned whether Tyco acted in good faith.

Often, preliminary agreements, which are often enforceable--to the surprise of a party--contain language similar to that which was under consideration here. Writing that protects the parties but also binds them, is critical to an enforceable agreement.

Court Enforces Plain Language of Insurance Policy

June 23, 2014

Plaintiff, Castle Oil Corp., operated a fuel oil terminal in the Bronx, receiving and supplying fuel. The terminal was insured by defendant ACE American Insurance Co. for "direct physical loss or damage" during the policy period. The policy included provisions for flood damage, including from storm surges, which carried a $2.5 million annual limit. The policy had a deductible provision specifically for flood damage that was equal to "2% of the total insurable values at risk," with a minimum of $250,000. During Superstorm Sandy, Castle's terminal suffered flood damage of $2.2 million. When Castle submitted an insurance claim, ACE declined to pay claiming that applying the 2% deducible against the entire insurable value of the $124,701,000 policy resulted in a deducible amount of $2,494,202, which was more than the loss.

Castle disputed that computation, claiming that the deductible was not be setoff against the value of the entire property and operation, but only against the property that was "at risk" from flood loss. Because the limit for flood loss "at risk" was $2.5 million, the 2% deductible was $250,000. Castle also pointed out that the $124 million amount was for "premium purposes only," meaning, to determine the policy cost, but not for deductible calculation.

The Court first recited the law applicable to interpreting insurance policies--according to their plain terms and definitions. The Court's role was to look at the policy as a whole and attempt to enforce the policy as intended, so that all provisions of the policy are defined and implemented. In this case, the court noted that "at risk" was not defined in the policy. If the policy was interpreted as ACE argued, the term "at risk" would be redundant and the provision "premium purposes only" would be irrelevant. Finally, the court pointed out that following ACE's logic, the $2.5 million limit on flood damage would also be meaningless, as the deductible amount would always be more than the flood loss limit. Given that the approach proposed by ACE left provisions of the policy without any import or meaning, the Court rejected that position and found for Castle.

Two important lessons can be gleaned here: First, words matter and second, insurance companies try hard to avoid paying on policies.

Applicable Florida Law Held "Truly Obnoxious" and Not to Be Enforced in New York

May 21, 2014

After Johnson was terminated by her employer, a subsidiary of a Florida company, Johnson went to work for a competitor. Claiming that working at Johnson's new job violated a non-compete agreement that she had signed, her prior employer sued Johnson and her new employer. The agreement sued upon contained a provision dictating that Florida law governed the parties' relationship. The Court determined that because the parties contracted to apply Florida law, Florida Law controlled. Notwithstanding that holding, the court refused to apply Florida law.

The court discussed the general rule that while parties to a contract are free to agree to be governed by a particular state's law, that was true so long as that governing state had some relationship to the parties or their transaction, and the law was not "truly obnoxious" to New York's public policy. In this case, the court found that one of the related parties to Johnson's former employer was based in Florida so that Florida law could apply. However, because Florida law on the enforcement of non-compete agreements was "truly obnoxious" to New York's public policy, the court refused to apply that law.

The court explained that New York disfavors restricting an employee from competing with a past employer once employment has been terminated so that an individual is not prevented from earning a livelihood. Even when non-compete agreements are enforced, they are done so only to the extent that they are not unduly harsh or burdensome. Florida law, however, specifically excludes any consideration of the hardship suffered by the employee when enforcing such an agreement. Florida law further provides that a Florida court must consider the reasonable protection of the legitimate business interest established by the employer, and should not construe the non-compete provision narrowly against the employee. This "anti-employee bias" contained in Florida law, which is almost the mirror image of New York law, was found to be obnoxious and unenforceable in New York. The New York court was not persuaded by the employer's argument that while Florida law was written as such, undue hardship was in fact considered by Florida courts' in their practical application of the statute.

The court also refused to enforce the non-solicitation agreement, finding that it was overbroad in that it precluded Johnson's solicitation of her prior employer's customers even if those customers never had any relationship with Johnson. The court would not modify the agreement to reduce its scope and threw out that claim.

Non-competes in New York are not favored and to have them enforced they must raised, applied and enforced in specific ways. Simply having an employee sign a document often results in an unenforceable agreement and serves no end.

Measuring Damages in Broken Real Estate Transactions

May 1, 2014

An issue that client's grapple with concerns how to measure damages where a contract to buy real property is breached by the purchaser. In 2013, the Court of Appeals (New York State's highest court) addressed this in a comprehensive decision.

Parties to a real estate contract often assume that where a buyer fails to close, and the seller is forced to sell that property to another, the seller is entitled to damages from the first buyer that is equal to the difference between the first contract price and the second contract price (assuming the contract does not limit damages, which is often the case). This assumption is drawn from general legal principles and common-sense intuition. That assumption, however, is wrong.

The court in White v. Farrell addressed this issue. White entered into a contract to purchase a property from Farrell for $1.725 million. As in almost every transaction, the contract had certain contingencies. In an effort to close, the parties agreed to remove the contingencies in exchange for certain promises and a payment. Ultimately, unhappy with a particular issue, White terminated the contract.

White sued Farrell seeking the return of his down payment. White claimed that Farrell could not close under the terms of their agreement and the down payment should be returned. Farrell denied his inability to close, and counterclaimed for damages due to White's refusal to comply with the parties' agreement. During that litigation, Farrell sold the property for some $350,000 less than what White had agreed to pay. The issue that went all the way to the Court of Appeals addresses how much Farrell was entitled to collect as damages for White's breach, if anything.

Farrell demanded the difference between the amount in the White contract and the selling price. At the initial stage of the litigation, the trial judge held that because White breached the agreement he could not recover the down payment. However, the measure of damages that Farrell could potentially recover, was the difference between the price in White's contract and the value of the property on the date of breach, but not simply the difference between the two amounts. Because testimony established that the value of the property was the actual selling price, which was also the value on the date of White's breach, Farrell had no damages that he could recover.

Did The Sale of "Gray Goods" Mushrooms Infringe a Grower's Trademark?

February 14, 2014

Hokto USA is a subsidiary of Japan-based Hokuto Co. Ltd. Hokuto Co. grows non-organic mushrooms in Japan. Hokto USA produces the same mushroom varieties in the United States as Hokuto Co. does in Japan, but Hokto USA's products are certified organic. To earn organic certification, Hokto USA's plants are state of the art and employ robotic machines in temperature controlled environments, all of which are computer controlled. Unlike other growers, Hokto USA does not use manure in its fertilizers. It uses a "sterilized culture medium made of sawdust, corn cob pellets, vegetable protein and other nutrients."

For a time, Hokto USA imported mushrooms from Hokuto Co. These mushrooms were grown in Japan but in a controlled environment so as to meet the requirements for US organic produce. The packaging was in English and not Japanese. A small amount of goods, however, was not organic, but the packaging for those items was obviously different, and identified Hokto USA as a distributor of Hokuto Co.

After obtaining trademarks in Japan, Hokuto Co. sought US trademark registration for word and design marks.

For a number of years, Concord Farms imported Hokuto Co.'s non-organic mushrooms into the United States. Because the purchases were placed through intermediary companies, Hokuto Co. was unaware of Concord Farms. Hokto USA learned that Concord Farms was sometimes marketing the goods it imported from Hokuto Co. as organic and as "made in the USA" although it displayed a Japanese-language label displaying the name of Hokuto Co. Those mushrooms were neither organic nor made in the USA. Concord Farms refused to cease selling these mushrooms and Hokto USA filed suit. Among the arguments made by Concord Farms was that the mushrooms it sold were "gray goods" meaning, that the goods were manufactured by Hokuto Co., and the sale of those Hokuto Co. goods were the actual goods. Concord Farms also argued that because Hokto USA sold some non-organic goods, Concord Farms to do the same. Hokuto Co. prevailed before the trial court, and Concord Farms appealed.

The Ninth Circuit appellate court, in affirming, noted that these issues "implicate[] the set of trademark principles governing so-called 'gray-market goods': goods that are legitimately produced and sold abroad under a particular trademark, and then imported and sold in the United States in competition with the U.S. trademark holder's products." The court decided that Concord Farm's items were not true gray goods because they were not genuine goods. The court recited the general rule that "genuine goods" are excluded from trademark protection and may be sold by any party so long as they are genuine, meaning that they were properly obtained and sold without modification. The court found that the goods sold by Concord Farms were not "genuine goods" and were thus covered by the trademark laws. As such, Hokuto Co. was within its right to force Concord Farms to stop selling the infringing goods.

More broadly, "genuine goods" are defined as those goods bearing a trademark that do not differ in any material way from the goods sold by the trademark holder. These are often referred to as "gray goods." Gray goods can fall into this category because the goods sold in the US and the goods sold overseas are sometimes the same (but are many times not). If material differences are found, they cannot be deemed "genuine" and the sale of the gray goods may infringe on the trademark. This makes sense in the scheme of trademark law. The purpose of a trademark is to ensure that the public recognizes that a product or service meets a specific standard by associating the trademark with the product. The purchaser, recognizing the trademark, relies on the branded item to deliver the expected level of good or service. If the trademark is used by another, but delivers an inferior product or service, that trademark, improperly used, has been damaged as it no longer represents the standard expected by the consumer. The consumer may therefore no longer purchase the trademarked item.

Here, the court noted the rigorous rules and standards under which Hokto USA grew its organic mushrooms. It also noted the absence of any of those rules for Concord Farms' goods. Concord Farm's goods were not organic and carried labels identifying the goods as produced in Japan. In short, the Concord Farms mushrooms were not produced to be organic, were not maintained using the rigorous rules in place at Hokto USA's plants, and the labels were misleading. Therefore, the court found that consumers could be confused by Concord Farms' products and could believe that Concord Farms was selling actual Hokuto Co. or Hokto USA's goods. A bad experience by one buying Concord Farm's goods would negatively impact the goodwill and brand reputation of the trademark holder.

Concord Farms attempted to argue that the trademark itself was defective, either because it was overbroad, to cover items not sold by Hokto USA, or because Hokuto Co. did not properly supervise Hokto USA, so it could not argue that the trademark brand would be damages by a lesser quality product. The court rejected all of these arguments.

They issue of gray goods is interesting because the line separating permissible and impermissible goods is often "gray." A review of the goods' manufacturing, marketing and sales is necessary, while considering elements of trademark law, to determine whether infringement is a viable claim.

Hokto Kinoko Company v. Concord Farms, Inc. (9th Circuit 2013)

Obama Care and the Sale of an Interest in a Privately Held Entity

January 24, 2014

I received some interesting information from EisnerAmper concerning this issue, which many people may be unaware of. Have a read here.

Meaningful Changes Come to NY's Non-Profit Laws

January 13, 2014

In late December 2013, new laws were put in place addressing non-profits. While we do not have a significant non-profit practice, we are often asked about issues relating to non-profits. To that end, here is a link to a more robust discussion of the Nonprofit Revitalization Act of 2013.

Another Reason Not to Accept Every LinkedIn Invite

January 10, 2014

LinkedIn sues to stop bots that are stealing its user profiles.

Failure to Verify Details of Disputed Credit Report Undermines Experian's Claims

January 8, 2014

Plaintiff Keisha James notified Experian that two items on her credit report were incorrect and were reported on her report as a result of identity theft. When Experian notified the companies that listed the debts of her dispute, those companies were only able to verify some of the information as being matching James's. Nonetheless, Experian refused to remove the disputed debts from her credit report. James sued Experian claiming that it failed to conduct a reasonable investigation into the disputed debts, as required by the Fair Credit Reporting Act. Experian responded by arguing that its investigation and verification complied with the Federal statute and asked that James's lawsuit be dismissed.

The court focused its decision on defining what would be deemed a"reasonable investigation" by Experian to satisfy its obligations under the law. Noting the absence of a clear definition, the court considered the totality of the circumstance. Observing that the companies reporting the debts to Experian were only able to verify some of the information, so that items like James's birth date, address and name were incorrect on those company reporting records, described by the court as "glaring discrepancies," coupled with Experian's failure to do anything more, compelled the court to deny dismissal of the complaint and allow James to proceed with her case.

Jones v. Experian Information Solutions, Inc.; Southern District of New York, Judge McMahon

Offering Plan for Condominium Building Deemed Contract with Unit Buyers

January 3, 2014

Plaintiff alleged that the sponsor of a condominium development breached the offering plan by converting the units to rentals from sales, and that the developer was therefore able to maintain control of the buildings board of directors.

Plaintiff, Bauer, alleged that she purchased multiple condominium units in a building newly constructed by defendant Beekman International Center, LLC. She alleged that Beekman's offering plan described its stated intent to sell the 65 units. Bauer claimed that such statement implied that the sales would be completed in a "reasonable time." Bauer further alleged that Beekeman's paperwork did not disclose that Beekman retained the option to rent any unit instead of selling it. Bauer claimed that Beekman's rentals breached the agreement in that it precluded the unit owners from taking over control over the building as owners. As a result, Bauer and other unit owners were unable to sell their units, the rentals caused the common charges to increase, and impeded the unit owners' ability from obtaining favorable refinancing rates from lenders. Bauer sought damages and the court's direction that the units be sold, in addition to forcing Beekman's principals from the board of directors. Beekman responded by stating that approximately half of the units had been sold and once the market was able to sustain the asking price, arrangements would be made to resume the unit sales. Beekman denied that the unit owners were having difficulty refinancing their respective units, but seemingly did not dispute all of Bauer's claims.

The court recited some of the legal history involving the relationship between sponsors and buyers. Citing case law and regulatory action, the court deemed a sponsor's offering plan to be an agreement which contained the implied promise to sell the units within a reasonable period of time. A sponsor's failure to do so supported a breach of contract claim. The court noted that the current regulatory scheme required a sponsor to specify the intended market for the units built. Those regulations further required a disclosure that once the sponsor sold the minimum 15% of the units necessary for the offering plan to become effective, its ability to rent rather then sell the units could result in the unit buyers never taking control of the condominium.

Beekman's claim that its offering plan stated that it held the right to rent and not sell the units was refused by the court, as it held that such rental was allowed only until a unit sale closed, implying that Beekman would in fact attempt to sell the units, and certainly fell short of the explicit statements required to maintain the units as rentals, indefinitely. Once Beekman stopped marketing the units for sale so that the offering plan lapsed, Beekman was in violation of the offering plan. However, the court held that because Bauer's claims of increased common costs and inability to obtain financing were usupported, and because Beekman held less than half of the units so that the unit owners could have formed a board to control the building, Bauer could not show the Beekman's conduct was damaging as alleged and the breach of contract claim was dismissed. The court held further that the claim of misuse of the common areas could not be maintained by the unit holders. Only the board could raise that claim.

Bauer v. Beekman Int'l Center, LLC; New York County, Judge Silver

Substituted Service of Process on Co-Defendant Ruled Insufficient

December 18, 2013

The plaintiff was a home health aide for Gilberto Rivas in Rivas's apartment, where she claims to have been injured by a defective window. The plaintiff sued the apartment's owner and Rivas. The plaintiff served the owner of the apartment by substituted service upon Rivas. Neither defendant responded and plaintiff obtained a default judgment. In seeking to vacate the default, the owner claimed that he was never served and that Rivas did not forward the litigation papers to him.

Putting aside the issue of whether the owner listed that apartment as his home address, the Court found it unreasonable and unreliable for the plaintiff to have served the owner by leaving the lawsuit papers with Rivas, who had interests that were adverse to the interest of the apartment's owner. In this setting, Rivas could not be relied upon to properly forward the papers to the owner. Therefore, the property owner was allowed to file his late answer and to defend the case.

Martinez v. McSweeny, Queens County - J. McDonald

Court Applies Pre-Suit Notice for Non-Foreclosure Action Based on Mortgage Note

December 10, 2013

A lender has two options in seeking repayment on a defaulted home loan. A lender has the option of commencing a foreclosure action, auctioning the property, and applying the sale proceeds against the loan amount due. Or, a lender can sue based on the promissory note underlying the loan and obtain a money judgment. A lender cannot do both. RPAPL § 1304 requires that a lender provide a 90-day notice before it commences a lawsuit based on a home loan, which is typically a foreclosure action. The question facing the court in this case was whether the 90-day notice is also required where the lender sues on the promissory note and foregoes seeking foreclosure.

Construing the statute broadly, the court found that RPAPL § 1304 is to be applied to any lawsuit commenced against a borrower that involves a home loan. The court seemed compelled to explain this outcome, because aside from finding this outcome to be consistent with the language of the statute, it grounded its decision on the fact that once a money judgment is obtained by the lender, the home owner will be "subject to levy upon his or her personal property, motor vehicle, savings account and/or other asset, such could result in the borrower being compelled to sell the property in order to protect these possessions." The court was also concerned that a money judgment "may complicate settlement negotiations" in the event the borrower also defaulted on a senior loan (this case involved a second loan). As a result, this borrower was entitled to the remedial provisions of this statute.

While the outcome here seems reasonable, it is clear that Judge Demarest felt the need to rationalize the outcome by making assumptions about what might occur in the future which could result in the sale of the property. Does that mean that for RPAPL § 1304 to apply in this setting there must be a possibility that the subject property will be at some point sold?

Cadelrock Joint Venture, LP v. Callender; Kings County, Judge Demarest