When the Pleading Makes It Difficult to Determine the Causes of Action Being Pled

• Posted on: Sep 30 2019

The title of this post comes from the observation Justice Saliann Scarpulla made in Jobar Holding Corp. v. Halio, 2019 N.Y. Slip Op. 32813(U) (Sup. Ct., N.Y. County Sept. 23, 2019) (here), wherein she was asked to decide a motion to dismiss a complaint that asserted both direct and derivative claims.  As discussed below, because, among other things, the complaint “mingled” the direct and derivative claims and otherwise failed to differentiate between the causes of action, the Court dismissed the complaint with leave to replead.

The Law: Direct vs. Derivative Claims

It is well-settled that a plaintiff asserting a derivative claim seeks to recover for injury to the business entity. A plaintiff asserting a direct claim seeks redress for injury to himself/herself individually. Sometimes, the distinction between the two types of actions is not readily apparent. Yudell v. Gilbert, 99 A.D.3d 108, 113 (1st Dept. 2012).

In considering whether a claim is direct or derivative, courts look to the nature of the wrong and the person or entity to whom the relief should go. Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A2d 1031, 1039 (Del. 2004). See also Yudell, 99 A.D.3d at 114; Higgins v. New York Stock Exch., Inc., 10 Misc. 3d 257, 264 (Sup. Ct. N.Y. County 2005) (citation omitted). Thus, for a shareholder’s injury to be direct it must be independent of any alleged injury to the corporation. The shareholder must demonstrate that the duty breached was owed to the stockholder and that he/she can prevail without showing an injury to the corporation. Tooley, 845 A2d at 1039.

“The pertinent inquiry is whether the thrust of the plaintiff’s action is to vindicate his [or her] personal rights as an individual and not as a stockholder on behalf of the corporation.” Maldonado v. DiBre, 140 A.D.3d 1501, 1504 (3d Dept. 2016). Therefore, the plaintiff must show that the duty allegedly breached was owed to the shareholder, and that he/she can prevail without showing an injury to the corporation. Yudell, 99 A.D.3d at 114. If the individual claim of harm is “confused with or embedded” within the harm to the corporation, then it must be dismissed. Serino v. Lipper, 123 A.D.3d 34, 40 (1st Dept. 2014); Patterson v. Calogero, 150 A.D.3d 1131, 1133 (2d Dept. 2017) (even where individual harm is claimed, if it is confused with or embedded in the harm to corporation, it cannot stand separately).

Jobar Holding Corp. v. Halio

Background

[Ed. Note: the background facts are based upon the Court’s decision, prior decisions of the Court, the amended complaint, and the parties’ papers on the motion to dismiss.]

Plaintiff, Jobar Holding Corp. (“Jobar” or the “Company”), is a small family-run corporation organized in 1958 under the laws of the State of New York. Jobar was owned and managed by Otto and Kitty Buck, the parents of Defendant, Barbara Halio (“Halio”) and Joan Buck. Until the 1980s, the Buck family operated Cake Masters, a bakery located on the property. After the bakery closed, Jobar continued to operate the property. Upon Kitty Buck’s death in 2001, Halio and Joan Buck served as co-presidents of Jobar until Joan Buck’s death in 2005, when Halio became the Company’s sole president.

In May 2006, Jobar sold the property for $22,000,000, and began winding down its operations under Halio’s supervision. At the time of the sale, Plaintiff, Robert Buck (“Buck”), in his personal and executory capacities, owned 38 shares of Jobar common stock, equal to a 38% ownership interest in the Company. Buck alleged that, following the sale, Halio embezzled $1,500,000 from Jobar’s bank accounts, by misappropriating funds in a variety of ways, including disguising the embezzlement as “bogus management fees, officer compensation, or as fake loans which were never intended to be repaid.” Halio maintained that the withdrawals were used for proper purposes, including the recoupment of loans made to Jobar by Halio from her husband’s pension and a home equity loan, payment of fees for the loans, executory and management fees, deferred salary, and payment of other post-closing fees.

According to Buck, in March 2007, Halio and Yeskoo Hogan & Tamblyn (“Yeskoo”) arranged for the $1,500,000 sale proceeds to be held in a “reserve”, which Halio then used for her personal use. Buck alleged that, as holders of 38% of Jobar’s interest, he and Joan Buck’s estate were owed $570,000 from the reserve.

On July 26, 2016, Buck filed a petition pursuant to Business Corporation Law (“BCL”) § 624 to inspect the Company’s books and records. According to Plaintiffs, although the records were incomplete, they revealed that Halio fraudulently transferred at least $1.5 million of the Company’s funds to herself. Plaintiffs maintained that by the time her fraud was discovered in mid-2017, Halio had stolen all of Jobar’s funds that had remained after the property was sold in 2006.

Plaintiffs commenced the action in 2017 against Halio, her accountants, Turman & Eimer LLP (“Turman”), and her attorneys. Against Halio, plaintiffs alleged causes of action for fraudulent conveyance, conversion, unjust enrichment, breach of fiduciary duty and accounting. Plaintiffs alleged aiding and abetting claims against her accountants.

Turman moved to dismiss the complaint, arguing that the claims asserted against it were time barred and otherwise failed to state a claim for which relief could be granted. According to Turman, Halio’s theft purportedly began in 2006 with the sale of the property. As such, because the action was commenced in 2017, the statute of limitations barred all the claims asserted against it. In opposition, Plaintiffs argued that the statute of limitations did not bar their causes of action because they only discovered Halio’s alleged wrongdoing and Turman’s claimed involvement when the Company’s books and records were obtained in 2017. Plaintiffs also claimed that the statute of limitations did not begin to run until the last unlawful act under the continuous wrong doctrine.

In addition to the statute of limitations, Turman contended that Plaintiffs failed to plead any individual injury apart from the alleged injury to Jobar. Turman also claimed that the derivative allegations in the complaint were improperly interspersed with the non-derivative allegations. Thus, because Plaintiffs’ individual claims were “confused with or embedded” within the harm to the Company, the entire complaint should be dismissed as against it. Plaintiffs maintained that the derivative claims alleged in the complaint were only asserted against Halio and that “Buck, as an individual, [was] not seeking to pursue any derivative claims” against Turman.

The Court granted the motion without prejudice.

The Court’s Decision

As an initial matter, the Court observed that the complaint lacked clarity about whether the claims asserted against Turman were direct or derivative:

Although the complaint is rife with allegations that a serious wrong was committed, the drafting of the pleading makes it difficult to determine the precise causes of action that are being pled. Plaintiffs state in their opposition papers that derivative claims are only being asserted against Halio, however, some of the allegations stated in the causes of action asserted against Turman support derivative causes of action as well. In addition, while the causes of action asserted against Turman are stated as being on behalf of Buck individually, some of those causes of action would be inappropriate or unsustainable as causes of action on behalf of an individual.

Slip Op. at *5.

With regard to Turman’s statute of limitations arguments, the Court held that “the complaint [did] not clearly state when the claims accrued” and that “[f]urther information [wa]s needed to determine whether the statute of limitations [barred the] causes of action against Turman.” Id. at *7 n.3. For example, explained the Court, the BCL § 624 proceeding on which Buck relied did not provide the clarity needed to make a determination:  “It appears that Buck did not obtain certain documents until 2016 pursuant to the BCL § 624 proceeding, while others were allegedly obtained before then.” Id.  Additional information was also needed to determine whether there was privity or a fiduciary duty sufficient to toll the statute of limitations. Id.

Turning to the claims asserted against Turman, Justice Scarpulla held that they were “an unclear mix of Buck’s personal claims, derivative claims on behalf of Jobar, and other claims that [were] not sustainable to any of the plaintiffs.” Id. at *7.

Although the complaint explicitly sets forth a cause of action based on BCL § 626 (shareholders’ derivative action) against Halio and does not do the same against Turman, it is not clear from the complaint that derivative allegations are not also being asserted against Turman. For example, the aiding and abetting breach of fiduciary duty cause of action is based on the allegation that Turman aided and abetted Halio’s wrongs against Jobar, not against Buck individually.

Regarding plaintiffs’ allegations that Turman caused Buck individual harm, the complaint states that Turman consistently delayed delivery of K-1s to Buck and many times intentionally interfered with Buck’s attempts to obtain financial information for Jobar. The complaint alleges that Buck relied on the allegedly falsified tax forms prepared by Turman to prepare his own and his mother’s estate’s taxes. These are not derivative claims, as Buck, not Jobar, suffered the alleged harm and would receive the benefit of any recovery. However, plaintiffs do not allege a clear injury to Buck or damages sustained by him resulting from this alleged misconduct.

Id. at **6-7.

Finally, the Court found that because the direct and derivative claims were “based on the same operative facts[, they could not] be interspersed in the same action.” Id. at *7 (citing Abrams v. Donati, 66 N.Y.2d 951 (1985); Barbour v. Knecht, 296 A.D.2d 218, 228 (1st Dept 2002)). Consequently, the Court dismissed the complaint as against Turman with leave to replead. Id. (“Because of the mixing of derivative and individual claims, and the unclear nature of the allegations being asserted against Turman, the complaint is dismissed insofar as asserted against Turman without prejudice to bring properly pled causes of action against this defendant.”).

Takeaway

The theme that runs throughout Jobar is the importance of filing a well pled complaint. As indicated by the Court, allegations of serious wrongdoing may get lost in a pleading that does not identify the precise claims being asserted: “Although the complaint is rife with allegations that a serious wrong was committed, the drafting of the pleading makes it difficult to determine the precise causes of action that are being pled.”

In Jobar, the absence of such clarity affected the Court’s consideration of the claims asserted against Turman – that is, whether the claims asserted were direct or derivative. To be sure, the difference between a direct and derivative claim is not always easy to discern. In fact, the distinction between the two types of claims can be elusive. Nuance and subtlety often rule the day, leading to confusion and uncertainty. For this reason, as Plaintiffs learned in Jobar, it is important to present direct and derivative causes of action in a clear way to avoid the dismissal of the claims (even if the dismissal is without prejudice, as in Jobar).

Tagged with: Books and Records, Business Divorce, Business Litigation, Derivative Litigation, Statute of Limitations