Recently in Contract/Corporate Category

Finding No Consideration Court Refuses to Enforce Non-Compete Agreement

December 29, 2015

NBTY, Inc. is a manufacturer and seller of vitamins and nutritional products. Piping Rock Health Products, LLC is a competitor run by NBTY's former CEO. Between the end of 2014 and the middle of 2015, a number of high-level NBTY employees resigned and went to work at Piping Rock. In 2011, while already employed, these individuals signed stock-option/trade secret agreements with Alphabet Holding Company, Inc., NBTY's parent. Under these agreements, the individuals were (i) able to purchase a number of shares of the common stock of Alphabet, vesting over a period of time, and (ii) learn NBTY's trade secrets. These agreements also contained restrictive covenants prohibiting the individuals from competing with NBTY for a one-year period following the end of their employment with NBTY and from revealing any of NBTY's business secrets. After they resigned and went to Piping Rock, NBTY sued to enforce these individuals' non-compete agreements.

Judge Emerson, sitting in the Commercial Division of Suffolk County, refused to enforce the non-compete provision. The court considered Delaware law (as provided for in the parties' agreements but noted that it largely tracked New York law), and found that the non-compete restrictions were not supported by valid consideration. This meant that these individuals received no additional benefit for agreeing not to compete and the agreements were therefore not enforceable against them. NBTY argued that the options and access to NBTY's trade secret were sufficient consideration. The court disagreed and stated that there was no evidence that these individuals did not have access to these secrets before they signed, and the options expired, unexercised, 90 days after they left NBTY. Thus, the court held that because the individuals had a choice between their continued employment with NBTY and exercising their benefits, or foregoing those benefits and competing, which they did, resulted in the individuals receiving no benefit in exchange for the non-compete agreements. The court noted further that while Delaware law allows consideration to be in the form of continued employment, the language of the agreements with NBTY specifically provided that NBTY made no promise of continued employment.

Finally, the court also invalidated the non-compete agreements, finding that they were overbroad in restraining competition in North America, Europe and China.

While the court decision does not detail whether these individuals could have left NBTY and exercised their options-it seems like they could have-it also seems that these departing NBTY employees specifically did not act on their options so that they could argue the lack of consideration for the non-compete allowing them to move to Piping Rock. They were clearly thinking ahead.

NBTY, Inc. v. O'Connell, et al.

Buyer Not Obligated to Close on Property for Which He Does Not Have Exclusive Use

August 25, 2015

A buyer entered into to a contract to purchase a penthouse co-op apartment for $27.5 million. Part of the unit being purchased included a terrace, which was to be for the buyer's exclusive use. Between contract and closing, this exclusive use was questioned as the board intended to convert the roof to a common area and provide access to the roof through the penthouse terrace. Obviously, the buyer would not agree to that invasion of privacy necessary for roof access. The board provided conflicting authorizations and plan drawings, and had to be compelled to provide the co-op plans. The buyer informed the seller that it was canceling the contract and demanded the return of its down payment. The board then withdrew its demand for terrace access but refused to provide an unqualified statement that the roof was not common area, that no access would be provided for the terrace or that the board would not in the future raise this issue. Nonetheless, the seller refused to return the downpayment, claiming that the buyer was getting the co-op as described in the contract. The buyer disagreed and refused to close. Litigation followed over the $2.7 million downpayment. The trial court decided that the buyer's failure to appear at the closing and see what plan was delivered was a breach, and refused to direct the return of the downpayment.

The appellate court disagreed, and found that the seller's inability to provide an unqualified promise by the board not to convert the roof to a common area and allow the buyer private and exclusive use of the terrace supported a finding that the seller was unable to deliver the apartment as promised. The Court seemed unimpressed by the board's qualified promise not to interfere, given the board's prior conduct, and the buyer's need to interact with the board on some regular basis. The appellate court was concerned that a fight would erupt in the future and the Buyer should not be compelled to buy a "problem" property. All of this, supported the buyer's right to rescind the purchase contract.

Pastor v. DeGaetano, First Dept. 2015

Real Estate Broker Entitled to Recover the Value of Its Services

March 2, 2015

Goli Realty Corp., commenced an action for the recovery of brokerage commissions. Goli sued Halperin claiming to have brought a buyer that was ready, willing and able to purchase certain real property that Halperin and his entity, SPJ LLC, were looking to sell. Goli prepared marketing packages for Hess Oil, Walgreens, and others, detailing the property's attributes. Hess and Walgreens responded with interest, and Goli showed the property to Hess. Hess had Goli send Halperin a proposal which provided for the minimum rent required by Halperin. Goli sent its commission agreement to Haleprin with Hess's proposal. Thereafter, Halperin contacted Hess directly. Shortly thereafter, Halperin informed Goli that he was not interested in a gas station as a tenant and claimed that Goli had promised to provide an agreement with Walgreens. A few days later, Goli presented Halperin with a proposal from Walgreens, also with the minimum rent. Goli claimed that Halperin agreed to proceed with negotiations with both prospective tenants and to consider how to buy an adjacent property. Despite what Goli had been told, it learned that Halperin had signed a lease with Hess. Goli sued for its brokerage commissions.

Reviewing how the Court discussed the facts and party testimony makes clear that it found Haleprin's testimony to not be credible. At one point, the Court states that outright. Among other things, the Court seemed troubled by Halperin's inability to explain why SPJ did not agree to a lease with Walgreens, as brokered by Goli, if Halperin would not accept a gas station tenant, especially as it ultimately signed with Hess.

At the end, the Court was able to find that an enforceable brokerage agreement existed despite the absence of a formal writing. There was no question that Goji was asked to find a tenant and did so, securing two acceptable tenants. Thus, Goji was entitled to the value of its services, which were the same as the commission that he demanded in his proposed brokerage agreement (even though the Court noted that those commission may have been a bit higher than market rates). The Court did not allow that amount to be awarded against the individual Halperin defendants, however, because Goji had done the work for SPJ, LLC.

This point is critical in any lawsuit as it highlights the importance of obtaining some security when dealing with entities. While Goli obtained an award of $293,962, that award was against SPJ, LLC only. If for some reason SPJ cannot pay that amount and has no assets, Goli collects little or nothing. Had Goli had some agreement with the individual defendants, collecting would be far less of a concern. At a minimum, the judgment could have been obtained against an individual and not just a potentially worthless entity.

This case does two things: It highlights the general rule that a broker is entitled to commissions if it is asked to find a tenant and does so, even if that agreement is not in writing. It also illustrates the pitfalls of entering into an agreement with an entity without any security or guaranty from the individuals behind that entity. The broker might be entitled to a fee but without the ability to collect from a defunct entity.

Transfer of Looted Company Held Valid

February 10, 2015

Steve Hong is the sole shareholder of Koryeo International Corp. Hong sued his mother, Kyung Ja Hong for looting Koryeo before she transferred the corporation to him.

Hong worked for the corporation after law school. His parents promised to transfer the corporation to him in exchange for his agreement to work for a minimal salary. After the death of Hong's father, Mrs. Hong assumed sole ownership and control of corporation. In 2012, Mrs. Hong transferred ownership and control of the corporation to Hong. Upon that transfer, Hong learned that the corporation's bank account held some $50,000, despite revenue in the millions of dollars. Hong and the Corporation sued his mother, claiming that she looted the corporation prior to its transfer, leaving him with a virtually worthless entity. Mrs. Hong sought dismissal of the claims.

Initially, the court found that because Mrs. Hong was the sole shareholder when she allegedly looted the corporation, the corporation could not be a plaintiff against her. The Court would not find anything wrongful in the corporation's actions, or claims of a wrong, when those actions were sanctioned by its sole shareholder. The Court then held that the vague promise to Hong, made 20 years before the transfer, was too indefinite to create a true contract. Moreover, found the court, Hong received exactly what he was promised--the corporation--and even if looted, that was all he was promised.

Keep in mind: There are few exceptions to the rule that any business agreement--even with one's mother--should be set out in a detailed writing. Oral or indefinite agreements are fertile grounds for long-term legal battles.

S&P Is Forced to Provide Broad Access of its Books to Shareholders

November 3, 2014

One of the repercussions of the mortgage meltdown was the subsequent scrutiny of the bond rating agencies, including S&P. Claims were made that the rating agencies ignored bond risks and overstated the quality of certain bonds so that the agencies would earn more fees from the increased volume of bonds they reviewed and rated. Because those companies issuing bonds would not patronize the agencies that did not endorse the bonds issued, the agencies did not properly police the quality and reliability of the bonds. In the ensuing collapse, numerous federal and state agencies pointed fingers at the rating agencies and launched investigations into the agencies' business practices. This setting provides the basis for this action.

Under State statute, in certain circumstances, a shareholder of a corporation is allowed to review the corporation's books and records. Forcing compliance requires a lawsuit, but it is more streamlined than a typical lawsuit and the issues before the court are narrow. The documents to be provided under statute are limited, but a judge has the authority under common law, meaning laws developed over time by the courts, to provide more information than what the statutes allow.

In the S&P case, the shareholders, an individual and a retirement fund, sought access to S&P's books and records. The shareholders claimed that they were entitled to review a host of S&P's internal business records to determine how S&P conducted its business and whether management acted improperly (one wonders if the damage to S&P's stock price had something to do with these demands). S&P disagreed that the shareholders were permitted access to the extensive list of documents demanded, and agreed to provide only the limited information allowed under the statutes.

The Appellate Division, First Department, sided with the shareholders. The court held that so long as the shareholders' purpose behind their demands were legitimate and reasonable, S&P could not refuse their requests. Thus, S&P was forced to provide access to the broader list of documents and information allowed under common law and could not hide behind the narrow provisions of the statutes.

Retirement Plan of Gen. Empls. of City of N. Miami Beach v. The McGraw-Hill Companies, Inc.

Violating Confidentiality Agreements

October 23, 2014

Confidentiality provisions are common in many different settings, including settlements, business transactions and intellectual property agreements. The cost of violating a confidentiality provision often leads to litigation and damages, and significant aggravation. While a few months old, a recent article I read highlighted some real-life examples. Have a look here and here.

Before signing a confidentiality provision, non-compete, or any agreement, know what is being bound---many times the one agreeing is unaware of some of the sweeping terms of the agreement made. The wake-up can be painful.

Protective Order Renders Commercial Contract Impossible to Perform

September 15, 2014

Plaintiff Kolodin is a singer who lived with her agent, defendant Valenti. Despite the deterioration of their relationship the parties maintained a professional arrangement and Kolodin continued to sign with Valenti and his company, Jayarvee.

At some point, their relationship turned worse and Kolodin obtained an order of protection against Valenti, which prevented him from contacting her. This protective order was extended on consent a number of times. Kolodin then sued seeking recision of the last contract she signed with Jayarvee arguing that fulfilling the terms of that contract was impossible due to the order of protection signed by Kolodin and Valenti. The parties resolved the issues underlying the order of protection by signing a stipulation by which they agreed to have no further contact with each other. The draft of that stipulation had language allowing contact with employees of Jayarvee, but that language was dropped from the final version. Once this stipulation was in place, the court agreed that the parties' contract could not be fulfilled and should be terminated due to its impossibility of performance.

In affirming that decision, the First Department first discussed the narrow grounds for recision of a contract based upon of impossibility of its performance. Those grounds are where the "'the subject matter of the contract or the means of performance makes performance objectively impossible. Moreover, the impossibility must be produced by an unanticipated event that could not have been foreseen or guarded against n the contract.'" Because the parties' stipulation "destroyed the means of performance by precluding all contact" between the parties, the First Department found that the parties' stipulation "rendered objectively impossible by law" the terms of the parties' contract. As such, the Appellate Division agreed that the contract could be rescinded and cancelled. The court went further and noted that this contract, by its nature, would not allow any relationship, finding that because Valenti had a "central role" in the performance of the Jayarvee contract, his input was material and necessary for the execution of the parties' responsibilities under the contract.

It is important to recognize this outcome because the contract was between Kolodin and Jayarvee, not between Kolodin and Valenti. The court disregarded this normally critical distinction because it recognized the underlying involvement of Valenti and essentially extended the Kolodin-Jayarvee contract to Valenti. And this outcome was not just a by-product of the core decision. The court specifically rejected Valenti's argument that because only he was party to the stipulation, but not Jayarvee, there was no reason why Kolodin could not perform for Jayarvee. The Court determined that "[p]ractically speaking [ ] Jayarvee's employees answer to Valenti, and the company's decisions are ultimately made by Valenti. It would be impossible for Jayarvee, without Valenti's input, to engage in communication with Kolodin. It is of no moment that Jayarvee could hypothetically perform the contract[ ] absent Valenti's involvement; to do so would require a sort of firewall, the very establishment of which would necessitate (direct or indirect) communication between Valenti and plaintiff. Valenti's own admissions as to his role managing Jayarvee compel the conclusion that the contracts could not be performed without his involvement and, thus, without violating the stipulation."

Finally, the appeals court noted that even if the breakdown of the relationship could have been a foreseeable act at the time the parties entered into the contract, so that impossibility could not be established, it was the parties signing the stipulation that was the trigger for creating impossibility of performance of the parties' contract. Thus, what was foreseeable at the time the contract was signed was not relevant.

Kolodin v. Valenti (1st Dept. 2004)

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.

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

Corporation Permitted to Sell its Sole Real Estate Holding as Being in the Regular Course of Business

October 10, 2013

The stated purpose of the corporation, owned by two shareholders in a 55%-45% split, was to lease residential and commercial space. The corporation owned one building and the majority holder wanted to sell it as part of a ยง1031 Exchange. The expected return was expected to be 300% over a three year period. The minority shareholder refused, and claimed that a super-majority vote was required to allow the sale.

The court noted that under the Business Corporation Law a super-majority was not required if the corporation was making the sale in the ordinary course of its business as "actually conducted by the corporation in furtherance of the objectives of its existence." Because both parties agreed that the corporation's business was to lease property, the court had to determine how the proposed sale fit into the corporation's ordinary business.

The court held that the corporation was proposing a sale, not an exchange. The minority shareholder argued that the sale of the sole asset was not in the regular business of the corporation. The court disagreed. Because the purpose of the sale was not to liquidate the corporation but to reinvest the sale proceeds in a different property, and to then engage in the corporation's ordinary business with that new property, no super-majority consent was required.

Shareholder dispute's often arise over a large corporate transaction. While the corporate statutes are the baseline authority, where there is no shareholders' agreement among the shareholders, that agreement is really where this type of issue should be addressed. Shareholders can avoid substantial cost and aggravation by a executing a comprehensive shareholders' agreement.

Theatre District Realty Corp. v. Appleby (New York County)

Interest Rate on $1.13 Million Secured Loan Deemed Usurious and Unenforceable

July 1, 2013

A few months ago, the First Department appellate court invalidated a $1.13 million loan because it found its charges and interest to violate New York's criminal usury laws. The interesting facts of this case are worthy of discussion.

In 2009, ASI, a corporation, needed an immediate cash infusion. Blue Wolf, an investment firm, agreed to lend ASI a sum of money while it conducted due diligence and decided whether it would make an equity investment in ASI. The loan documents, executed in January 2010, provided for Blue Wolf to loan ASI $1,130,000 with interest to accrue at 12% per annum. The loan was secured by ASI's assets. Although not completely clear from the decision, it seems that Blue Wolf could call the loan upon demand. At closing, ASI received only $805,000 because Blue Wolf kept $325,000 as fees and deposits. Those were broken down as a $50,000 commitment fee, a $75,000 deposit against Blue Wolf's costs and expenses incurred in connection with the loan, and $200,000 was retained by Blue Wolf as a "'deposit against future commitment fees'" in the event that ASI rolled over the loan into future financing. Even with this fee charged, Blue Wolf was not obligated to advance future funds or even roll over the loaned funds into a new note. Remarkably, the loan terms provided that if new financing was not arranged by March 31, 2010, Blue Wolf was permitted to keep all or part of the $200,000 as "'compensation for [Blue Wolf's] time and expenses, as determined by [Blue Wolf] in its sole discretion.'"

Blue Wolf admitted that by January 2010, it had decided that it would not purchase any portion of ASI and would not provide further financing. Blue Wolf called the loan in March 2010, claiming a loss of confidence in ASI, and informed ASI that it would keep half of the $200,000 it retained. ASI did not repay the loan, and in May 2010, Blue Wolf again demanded repayment, and informed ASI that it would now keep the entire $200,000. When ASI did not pay, Blue Wolf began the foreclosure process against ASI's assets, as a secured lender. Because of a defect in the March notice, Blue Wolf notified ASI in July 2010 that it would accept ASI's assets in lieu of repayment of the loan. In July and August 2010, ASI paid Blue Wolf $54,000. Blue Wolf rejected those payments claiming that it had foreclosed on ASI's assets, which ASI was then holding for Blue Wolf's benefit. Blue Wolf offered to sell those assets back to ASI for $1.3 million and apply the $54,000 toward that purchase price.

When ASI refused to accede to Blue Wolf's demands, Blue Wolf filed a lawsuit. ASI responded by asking the judge to find the loan usurious and void, which request the judge granted. The court held that when the $325,000 Blue Wolf retained from the loan proceeds was added to the interest rate and applied against the amount ASI received, the effective interest rate was 57.14%, violating the 25% criminal usury cap. As a result, the loan was void and unenforceable.

Arguing among other things, that the $325,000 should not be deemed an interest payment, Blue Wolf appealed. Alternatively, Blue Wolf claimed that even if usurious, the interest rate should be modified to be brought within the legal limit, and then enforced. Not surprisingly, Blue Wolf found the appeals court remarkably unsympathetic.

Addressing just the $200,000 deposit against future commitment fees, the appeals court stated that courts are "not to look to its form [of the transaction] but to its substance or real character." Because this "fee" was for payment of a contingency beyond the borrower's control, the appellate court found that fee to be a masked interest charge, bringing the actual rate to 36.9%. With this, the appellate court affirmed the court's decision and voided the entire transaction.

This issue was common in the early days of the mortgage/foreclosure mess, even in commercial foreclosures. Lenders stacked many fees and charges onto the loan proceeds which when challenged, were deemed additional interest and void. While the outcomes of those cases were not as dramatic as found here, principally because the amounts charged were far lower, this case is instructive as to the pitfalls of carelessly and greedily adding loan fees on top of interest charges. This practice is often found where high rate loans are made to desperate borrowers. While not encouraging default and cautioning that these facts were extreme, one must be aware that despite a lender's aggressive approach upon nonpayment, a borrower has remedies of which it can avail itself. Feel free to contact us if you find yourself in this kind of unfortunate situation.

The Bridesmaids Had No Dresses-but Were the Damages Sought Speculative?

February 20, 2013

Defendant failed to complete eight bridesmaids dresses until two hours after the ceremony was scheduled to begin, when they were delivered by the groom. As a result of this delay, plaintiff incurred a host of delays for which she incurred expenses, including a delay in the bride's appearance from the rented limousine, so as not to break the tradition of not being seen by the groom or guests before the ceremony. For these expenses, the court awarded plaintiff damages. However, for the wedding parties' inability to have pictures taken in the scenes scheduled and for the bridesmaids wearing different clothing in different pictures, no award would be made as no amount could be reasonably fixed as damages for these items. The court also rejected damages for emotional distress, finding that plaintiff "failed to meet the high threshold required in proving" this claim because defendant's failure to deliver the dresses was "not so outrageous in character and extreme in degree that it exceeds all bounds tolerated by a decent society which is of a nature calculated to cause, and does cause, serious mental distress."

Property Inspection Part II-from a Haunted House to the Bat Cave

December 26, 2012

After writing about the "haunted house" case recently, I came across another case that addressed the same concepts, and also in an unusual setting. The haunted house court had decided that because the buyer could not have anticipated that the house under contract was haunted, and was therefore not expected to inspect the property for ghosts, and because the sellers had knowledge of the haunting, the buyer could cancel the purchase contract.

This case, Jablonski v Rapalje, involves sellers that may have hid from a buyer the fact that the house in question was bat infested. While some of the facts should have lead the buyer to pay more attention and realize that something was amiss (discussed below), the particulars of what the buyer should have questioned and investigated divided the court. The majority decided that the sellers may have concealed the bats from the buyer, so that the buyer was allowed to cancel the sales contract.

A fair reading of these cases highlight courts trying to find a way to grant recision. To do so, the courts had to first find the sellers' concealment. This case focused on whether the sellers actively concealed the bat infestation, while the haunted house court focused on whether the buyer had an obligation to search for ghosts once the seller publicized the haunting but did not inform the buyer. Each court then turned to a detailed explanation of why the buyers were not obligated to inspect for that concealed issue, so that the contracts could be rescinded.

The outcome in this case triggered a strong dissent, addressing the alleged concealment by the seller, and whether or not the buyer should have, with reasonable effort and investigation, discovered the bat problem that the majority found to have been concealed by the seller.

Although in the minority, the dissent's objections seem to make sense. The dissent argued that the buyer knew or should have known that something was amiss yet failed to investigate. The buyer had ample opportunity to inspect, was aware that the exterior of the property was stained, that the attic smelled strongly of urine and moth balls, and saw electric extension cords (presumably for lighting) running to the attic (which may have been used to force the bats to leave temporarily). The buyer even knew of the removal of "bird feces" (later determined to have been bat guano), all of which should have been sufficient to raise suspicions and cause the buyer to investigate further. Instead, the buyer took the word of the seller that nothing was amiss and left it at that. Given these facts, held the dissent, the buyer had no claim against the seller.

Ghosts and bats aside, don't be fooled. Claims that a seller hid some defect from a prospective buyer are often rejected by the courts. The concept of "buyer beware" is alive and well in New York State. Before one buys a property of any kind, a careful physical inspection and review of title cannot be ignored. Any defect or objection will not be sustained if that defect or objection was in any way known to the public or with reasonable diligence able to have been discovered by a prospective buyer.

Because the facts often dictate the outcome, investigating who knew what and when is critical. The Firm has been involved in concealment cases in New York City and can discuss any issues relevant to your situation.

Sophisticated Party Again Fails to Do its Own Investigation

December 11, 2012

The last time we wrote on this topic, a group of plaintiffs' had their $900 million claim thrown out by a judge, essentially because the plaintiffs had stuck their head in the sand and did not investigate red flags evident in a transaction. In Pappas v. Tzolis, it was a paltry claim of just a few million that was tossed, but the underlying facts and legal principals were the same. Interestingly, it was again the selling party, the one which many believe to have less risk than the buyer, that came up holding the very short end of the stick.

The facts here are as follows: Pappas and Tzolis (and one other) formed a LLC to lease property. Tzolis personally provided the lease deposit of almost $1.2 million and was permitted to sublet the property. The parties also agreed that they had other business and could compete with the LLC or other members without notice. Trouble surfaced when Tzolis subleased the property to a company he controlled for $20,000 above the LLC's monthly payment. Unhappy with that, Pappas claimed that Tzolis prevented the LLC from leasing it directly for a higher rent, and that Tzolis was generally frustrating the lease interest of the LLC. Shortly thereafter, Tzolis bought out the other members, including Pappas. At the closing, Pappas signed a document attesting to the facts that prior to his sale of his membership interest, he had done his own due diligence using his own lawyers, and was not relying on any representation made by Tzolis or upon their relationship as co-members of the LLC. After the transaction closed, Tzolis assigned the lease interest from his entity to a third-party for $17.5 million.

Pappas sued Tzolis claiming that Tzolis had lined up this sublease before the membership interest were transferred, in violation of his fiduciary obligations to him as a member of the LLC. Had he known, argued Pappas, he would not have agreed to sell for the price that he did. The lower court threw out the case, but parts of it, including the fiduciary claim, were reinstated by the Appellate Division. The Court of Appeals, reversed the Appellate Division and threw out the case.

The court, citing to the Centro Empresarial case discussed here earlier, reiterated the rule for raising a claim of fiduciary violations in this setting. Where sophisticated parties enter into negotiations already not trusting each other or embroiled in a dispute, so that each has good reason to know that they are each acting in their own best interest, and even signing a release or waiver, they cannot come back to complain about those transactions based on the purported trust the aggrieved party had in the other.

Here, the court held that Pappas's reliance on Tzolis was unreasonable and the documents he signed controlled. His claim of fraud, that Tzolis told them he had no lessee lined up, was not only waived when Pappas signed the release and waiver, but incredible given their relationship. Pappas's remaining claims were undermined, wrote the court, because Tzolis had a right to control the leasehold and should not have been trusted by Pappas given the history and relationship among the parties.

The Silber Law Firm, LLC has successfully litigated these types of cases, and the focus on the language of the documents, in the specific context and setting in which they are executed, cannot be overstated. There are ways to minimize the risk to the parties engaged in this kind of transaction, but a hefty dose of skepticism combined with realistic due diligence is required. Sometimes the services of a forensic accountant is also something to consider, as the entity's books often tell a story that is inconsistent with what one party is being told. If you are facing a situation described in these cases, feel free to give us a call.

Selling Shareholders' $900 Million Fraud Claim Dismissed for Failing to Investigate

June 18, 2012

A few months ago, the Court of Appeals highlighted the pitfall of a not uncommon scenario, that of experienced and sophisticated business people relying on the representations of others but which are later found to be less than truthful. In Centro Empresarial Cempresa S.A. v. America Movil, S.A.B. de C.V., the court dismissed the fraud claims of former shareholders of a Latin American mobile telephone company because those shareholders ignored obvious concerns that arose in the course of the sale of their shares that should have put them on notice of potential problems. Not only were those issues not addressed, but those shareholders released the company and remaining shareholders from liability in connection with the sale. The outcome of this case underlines the fact that experienced and sophisticated parties must do their own due diligence no matter what they are told.

The facts are somewhat complicated but can be summarized as follows: Plaintiffs held a majority interest in an Ecuadorian company which sought funding from a Mexican company, Telemex Mexico, controlled by billionaire Carlos Slim. The funding was provided and a new entity was formed which was owned by the plaintiffs and Telemex. The parties agreed that in the event that there were additional transfers to different entities, plaintiffs could swap their interest from the old entity to the new entity on terms to be agreed. Following a subsequent transfer, plaintiffs tried to negotiate the terms for the transfer of their ownership interest into the new entity. Encountering resistance from Telemex, plaintiffs opted to just sell their interest outright and did not receive any interest in the new entity.

Eight years later, plaintiffs sued claiming to have been defrauded. Plaintiffs claimed that they were given incomplete and bogus information of the new entity's value. Had they known the true state of affairs, they alleged, they would have forced a transfer or sold their interests at a far higher price. Under the agreement by which plaintiffs sold their interests, they agreed to release the other shareholders and the new entity from any claims in connection with the agreement. The remaining shareholders and their entities also provided plaintiff with no warranties related to the business' state of affairs.

In dismissing plaintiffs' claims, the Court of Appeals faulted the plaintiffs for agreeing to broad release language while not pursuing the information they acknowledged not receiving. The court refused to give any credence to the plaintiff' arguments that they were mislead and could not have known the true value of what they gave up. The court determined that plaintiffs were sophisticated entities engaged in complex businesses and transactions who made conscious decisions not to investigate the information they were provided. That plaintiffs were aware that they were given incomplete information from a partner they no longer trusted further highlighted the need for plaintiffs to undertake their own due diligence, which they did not do. Only if the release was itself procured by some fraud would plaintiffs be able to proceed, and that was something that the plaintiffs could not establish.

Not long ago, we successfully represented a company in defending against the claims of a shareholder who alleged similar claims. The issues are always complex and a thorough investigation of the underlying facts and arguments must be examined prior to deciding on a litigation process.