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Re: Breach of Fiduciary Duty Claims Against the Directors of a Corporation, the Plaintiffs Failed to Rebut the Presumptions of Loyalty, Prudence and Good Faith Under the Business Judgment Rule

In finding that the breach of fiduciary duty claims against the directors of a corporation were properly dismissed, the First Department explained the relevant analysis:

The court, after citing and applying the correct standard of review …, properly dismissed the breach of fiduciary duty claims against [defendant-directors of the corporation] …, due to plaintiffs’ failure to rebut the presumptions of loyalty, prudence and good faith under the business judgment rule … . In particular, plaintiffs failed to allege facts that support a finding of interest or lack of independence by a majority of the board members … . Giuliano v Gawrylewski, 2014 NY Slip Op 07941, 1st Dept 11-18-14

 

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Relationship Between the “Open Repudiation [of Fiduciary Obligations] Rule” and the Laches Defense Explained/Allegations that Investments Made by the Fiduciary Underperformed Does Not State a Cause of Action for Breach of the Fiduciary Duty

In reversing Surrogate’s Court’s dismissal of objections to the fiduciary’s final accounting based on the laches defense, the Fourth Department explained the “open repudiation rule” and its relationship to laches.  To take advantage of the laches defense, the fiduciary must have openly repudiated his or her obligation or there must have been a judicial settlement of the fiduciary’s account, niether of which took place here.  The Fourth Department reached the same result as did Surrogate’s Court by concluding, pursuant to CPLR 3211(a)(7), that the numerous specific objections failed to state any cause of action against the fiduciary.  With respect to the “open repudiation rule” and the “underperforming investments” allegations, the court wrote:

… [T]he open repudiation rule applies to the defense of laches … . As the Court of Appeals stated in Barabash, “[a] fiduciary is not entitled to rely upon the laches of his beneficiary as a defense, unless he repudiates the relation to the knowledge of the beneficiary” … . Moreover, the open repudiation rule “requires proof of a repudiation by the fiduciary which is clear and made known to the beneficiaries” … . * * * Inasmuch as petitioner’s repudiation of its role of fiduciary was a prerequisite to its assertion of the defense of laches, and because no such repudiation occurred, we conclude that the Surrogate erred in permitting petitioner to assert that defense and in dismissing the objections on the ground that the objections were barred thereby. * * *

The elements of a cause of action for breach of fiduciary duty are ” the existence of a fiduciary duty, misconduct by the [fiduciary] and damages that were directly caused by the [fiduciary’s] misconduct’ ” … . * * *

We reject objectants’ contention that they stated a cause of action for breach of fiduciary duty by filing an objection to petitioner’s refusal to consider investment in nonproprietary funds. Objectants correctly concede that the Prudent Investor Act permits petitioner to invest trust assets in proprietary funds (see EPTL 11-2.3 [d]). The Prudent Investor Act also requires a trustee such as petitioner with “special investment skills” to “exercise such diligence in investing and managing assets as would customarily be exercised by prudent investors of discretion and intelligence having special investment skills” (EPTL 11-2.3 [b] [6]). Even under this standard, however, ” it is not sufficient that hindsight might suggest that another course would have been more beneficial; nor does a mere error of investment judgment mandate a surcharge’ ” … . Thus, it is well settled that ” a fiduciary’s conduct is not judged strictly by the success or failure of the investment . . . In short, the test is prudence, not performance, and therefore evidence of losses following the investment decision does not, by itself, establish imprudence’ ” … . Here, objectants merely alleged that the proprietary funds were underperforming, which is insufficient to state a cause of action for breach of fiduciary duty … . Matter of JPMorgan Chase Bank NA, 2014 NY Slip Op 07799, 4th Dept 11-14-14

 

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Shareholders’ Requests for Documents for Investigation of Possible Wrongdoing by Corporation Were Facially Legitimate Under the Business Corporation Law (BCL) and Common Law–No Need for Shareholders to Bring a Shareholders’ Derivative Action to Procure the Documents

The First Department determined shareholders’ (petitioners’) requests for documents from the respondent corporation were facially legitimate pursuant to the Business Corporation Law (BCL) and common law and disputes about the propriety of the requests should be resolved in a hearing.  Supreme Court’s ruling that the petitioners were required to institute a shareholders’ derivative action was reversed.  The shareholders were investigating whether respondent’s board of directors failed to oversee wrongdoing by S & P, a credit rating agency wholly owned by respondent:

Under New York law, shareholders have both statutory and common-law rights to inspect a corporation’s books and records so long as the shareholders seek the inspection in good faith and for a valid purpose … . The statutory right supplemented, but did not replace, the common-law right … .

Here, petitioners sufficiently showed that they were acting in good faith and for a proper purpose in seeking to enforce their common-law right to inspect respondent’s books and records. Specifically, the petition alleges that petitioners seek to investigate alleged mismanagement and breaches of fiduciary duty by respondent’s board of directors in failing to oversee purported wrongdoing by S & P; this alleged wrongdoing, petitioners assert, exposed respondent to substantial potential liability in multiple civil actions and investigations. These allegations form a proper basis for petitioners’ request … .

Contrary to respondent’s contentions, investigating alleged misconduct by management and obtaining information that may aid legitimate litigation are, in fact, proper purposes for a BCL § 624 request, even if the inspection ultimately establishes that the board had engaged in no wrongdoing … . Indeed, petitioners identified several reasons for making their demand, including assessment of policies that the board had implemented when issuing credit ratings and investigation of possible wrongdoing by the respondent’s board of directors. Each of these purposes adequately justifies petitioners’ access to certain board documents. Moreover, because the common-law right of inspection is broader than the statutory right, petitioners are entitled to inspect books and records beyond the specific materials delineated in BCL § 624(b) and (e) … . Retirement Plan for Gen Empls of City of N Miami Beach vs McGraw-Hill Cos Inc, 2014 NY Slip Op 06154, 1st Dept 9-11-14

 

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In this Shareholder Derivative Lawsuit, Causes of Action Not Subject to the “Internal Affairs” Doctrine Should Not Have Been Dismissed

The First Department determined many of the causes of action in this shareholder derivative suit were not governed by Bermuda law under the “internal affairs” doctrine and, therefore, should not have been dismissed:

Plaintiffs — minority shareholders of Culligan Ltd. — bring this derivative action on behalf of that entity, a Bermuda company that does business in New York. Supreme Court granted the motion to dismiss upon finding that Bermuda law applied to the case pursuant to the “internal affairs” doctrine. That doctrine “recognizes that only one State should have the authority to regulate a corporation’s internal affairs — matters peculiar to the relationships among or between the corporation and its current officers, directors, and shareholders”  Since the internal affairs doctrine does not apply to those defendants who are not current officers, directors, and shareholders of Culligan Ltd. … Bermuda law does not apply to claims asserted against them.

Nor does the internal affairs doctrine apply to claims based on sections of the Business Corporation Law (BCL) enumerated in BCL §§ 1317 and 1319. BCL § 1319(a)(1) expressly provides that BCL § 626 (shareholders’ derivative action) shall apply to a foreign corporation doing business in New York. Thus, the issue of plaintiffs’ standing to bring a shareholder derivative action is governed by New York law, not Bermuda law … . …

Pursuant to German-American Coffee Co. v Diehl (216 NY 57, 62-64 [1915]) and BCL §§ 1319(a)(1), 719(a)(1), and 510, New York law applies to the second cause of action, which alleges that the directors of Culligan Ltd. declared illegal dividends.

To the extent plaintiffs allege violations of BCL § 720 (e.g. waste and unlawful conveyance), which is made applicable to foreign corporations doing business in New York by BCL § 1317(a)(2), those claims are also governed by New York law … . However, to the extent plaintiffs allege a violation of a section of the Business Corporation Law not enumerated in BCL § 1317 (e.g. § 717, which is part of plaintiffs’ breach of fiduciary duty claim), New York law does not apply … . Those claims are governed by Bermuda law …, and were thus correctly dismissed. Culligan Soft Water Co v Clayton Dubilier & Rice LLC, 2014 NY Slip Op 03955, 1st Dept 6-3-14

 

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Demand for Jury Trial Properly Struck/Rescission Was Core of Action and Counterclaim

In a detailed opinion by Justice Moskowitz, the First Department methodically went through the issues raised in a trial stemming from the breakdown of a partnership including breach of fiduciary duty, tortious interference with contract and unjust enrichment. In the course of the opinion, the court noted that inclusion of a cause of action and counterclaim for rescission constituted a waiver of a jury trial:

Defendants next assert that the trial court improperly struck their jury demand in Action 1. This argument has no merit. Because defendants’ demand for the equitable remedy of rescission in Action 2 was not “incidental” to that action, and their demand for rescission was not “incidental” to their counterclaims in Action 1, defendants effectively waived their right to a jury trial by joining those demands with claims for legal relief … . In addition, defendants argued that rescission of the partnership’s license agreements … was “the core” of their claims in both actions, and defendants all asserted, as part of their Action 1 counterclaims, that they had “no adequate remedy at law.” New Media Holding Co LLC v Kagalovsky, 2014 NY Slip Op 02888, 1st Dept 4-29-14

 

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Breach of Fiduciary Duty Cause of Action Stated Against Actuary

After sorting out professional malpractice claims (negligence—three-year S/L) from breach of contract claims (intentional—six year S/L), the Third Department explained the elements of a “breach of fiduciary duty” cause of action in the context of actuarial services (provided by SGRisk):

Actuaries are not considered professionals for the purpose of the shortened statute of limitations applicable to malpractice claims … . Despite not being deemed professionals in that context, actuaries can still develop relationships of trust and confidence sufficient to give rise to a fiduciary duty. Courts must conduct a fact specific inquiry to determine whether a fiduciary relationship exists based on confidence on one side and “resulting superiority and influence on the other” … . Plaintiff alleged that SGRisk “held itself out as being a skilled and competent actuarial” firm that “adhered to accepted professional standards,” that it rendered services for the trusts’ benefit, provided advice and created “a relationship of trust and confidence between” itself and the trusts. Plaintiff also alleged that SGRisk agreed to exercise “good faith and undivided loyalty” when determining appropriate valuation of the trusts’ future claims liability and the trusts reasonably relied on this, placing confidence in SGRisk that it would accurately produce truthful annual actuarial reports with correct estimates of future claims reserves. Additionally, plaintiff alleged that SGRisk breached the duty by knowingly and consistently underestimating the claims liabilities and necessary reserves and failing to identify dangerous underfunding … .  New York State Workers’ Compensation Board… v SGRisk LLC, 517387, 3rd Dept 4-3-14

 

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Question of Fact About Whether Managing Member Breached Fiduciary Duty Owed to Nonmanaging Member with Respect to Managing Member’s Alleged Reliance Upon an Outside Professional

The First Department determined the defendant (Gary) was not entitled to summary judgment.  Gary was the managing member of a Limited Liability Company (LLC) and was sued by a nonmanaging member. Gary argued that, under the Limited Liability Company Law (section 409), he was entitled to rely on the advice of an accountant, and that the cause of action based upon Gary’s acting in accordance with the accountant’s advice should be dismissed. The court described the fiduciary duty owed by Gary to the plaintiff and the criteria for the managing member’s reliance on an outside professional:

As the managing member of the LLCs, Gary owed plaintiff — a nonmanaging member — a fiduciary duty … . “[I]t is elemental that a fiduciary owes a duty of undivided and undiluted loyalty to those whose interests the fiduciary is to protect. This is a sensitive and inflexible rule of fidelity, barring not only blatant self-dealing, but also requiring avoidance of situations in which a fiduciary’s personal interest possibly conflicts with the interest of those owed a fiduciary duty” … .Reliance on outside professionals under Limited Liability Company Law § 409(b)(2) must be in good faith (see Limited Liability Company Law § 409[a]…).  As described here, Gary does not meet his initial burden of showing that he acted in good faith and undivided loyalty to plaintiff so as to rely on Limited Liability Company Law § 409 or the business judgment rule. Pokoik v Pokoik, 2014 NY Slip Op 01502,, 1st Dept 5-6-14

 

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Suit by Beneficiaries to Recoup Estate Property, Alleging Breach of Fiduciary Duty by Executor, Allowed to Go Forward

The Third Department determined the beneficiaries of an estate had stated a cause of action to recoup property for an estate (the role of the executor).  The complaint alleged misappropriation of decedent’s assets and included a cause of action against the executor (DiMaggio) for breach of fiduciary duty:

Initially, we note that, absent extraordinary circumstances, beneficiaries of an estate generally do not have a right to bring an action seeking to recoup property for the estate since that role belongs to the executor … . However, such extraordinary circumstances may be implicated where the executor is allegedly directly involved in purported egregious conduct and self-dealing that negatively impacts the potential assets of the estate … . When asserting conduct involving fraud or undue influence, the complaint must set forth in detail the circumstances constituting the wrong (see CPLR 3016 [b]…). .

Plaintiffs’ amended complaint sets forth a series of purported acts by defendants occurring during the last two years of decedent’s life when she was allegedly suffering from cancer and depression. Among other things, defendants allegedly induced decedent to give DiMaggio power of attorney by telling decedent that she would retain control over her accounts, but then used the power of attorney to withdraw funds, modify ownership interest, and change beneficiaries on accounts. Plaintiffs contend that defendants convinced decedent to cash about $360,000 in United States savings bonds by informing her it was illegal to continue to hold the bonds and that the government would take all her money. Most of that money was moved into a trust that defendants allegedly falsely informed decedent would benefit her descendants when proceeds of the trust actually went to defendants and their families. Plaintiffs further assert thatDiMaggio, who was substituted for decedent’s daughter as executor when decedent executed a new will in 2007, neglected to make an effort to recover funds inappropriately diverted from the estate. Lewis v DiMaggio…, 516811, 3rd Dept 3-6-14

 

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Medical Corporation Not Responsible for Unauthorized Disclosure of Medical Information by Employee Acting Outside the Scope of Employment

In a full-fledged opinion by Judge Pigott, over a dissent, the Court of Appeals answered a certified question from the Second Circuit in the negative.  The question was: “Whether, under New York law, the common law right of action for breach of the fiduciary duty of confidentiality for the unauthorized disclosure of medical information may run directly against medical corporations, even when the employee responsible for the breach is not a physician and acts outside the scope of her employment?”:

… [A] medical corporation's duty of safekeeping a patient's confidential medical information is limited to those risks that are reasonably foreseeable and to actions within the scope of employment.  Doe v Guthrie Clinic Ltd, 224, CtApp 1-9-14

 

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No Fiduciary Duty Re: Purchase of One Shareholder’s Stock by Another in a Close Corporation

In affirming Supreme Court’s dismissal of a cause of action for breach of fiduciary duty based on one shareholder’s purchase of another shareholder’s stock in a close corporation, the Second Department noted that the status of an officer, director or shareholder of a close corporation does not, without more, create a fiduciary relationship:

“The elements of a cause of action to recover damages for breach of fiduciary duty are (1) the existence of a fiduciary relationship, (2) misconduct by the defendant, and (3) damages directly caused by the defendant’s misconduct” … . “A fiduciary relationship exists between two persons when one of them is under a duty to act for . . . the benefit of another upon matters within the scope of the relation” …

Contrary to the plaintiff’s contention, [the purchaser’s] status as an officer, director, or shareholder of a close corporation “does not, by itself, create a fiduciary relationship as to his individual purchase of [another shareholder’s] stock” … .  Varveris v Zacharakos, 2013 NY Slip Op 07028, 2nd Dept 10-30-13

 

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