Posted in Arbitration Class Actions

Judge Pauley Decides its Equitable to Compel Arbitration

Compelling a class action plaintiff to arbitrate in a private forum instead of litigating in federal can be a huge victory for a defendant.  And with the prevalence of form documents containing arbitration clauses, fights over arbitrability are common.  In Cooper v. Ruane Cunniff, an opinion that was noted as a Decision of Interest on the Southern District web site, Judge Pauley came down strongly in favor arbitration—he enforced an arbitration provision in an employment agreement even though the party seeking to compel arbitration was not a party to the agreement.

Plaintiff Cooper brought a putative class action against his employer’s profit sharing plan, naming the employer, DST, and the plan’s manager, Ruane, as defendants.  He claimed that the plan was mismanaged and that Ruane engaged in self-dealing, resulting in losses exceeding $100 million.  Cooper, a long-time employee and participant in the plan, signed an Acknowledgment and Agreement Form at the time he started working at DST which contained an arbitration provision covering “all legal claims arising out of or relating to employment….”  The Form allowed him to opt-out from the arbitration provision within 30 days, which he did not.

Seeking to maximize his chances of staying in federal court, Cooper dismissed his claims against DST, leaving Ruane, the plan’s manager, as the only defendant.  Ruane was not a party to Cooper’s arbitration agreement with DST, and Cooper claimed he therefore could sue Ruane in court.  After finding that Cooper’s claims were subject to arbitration, Judge Pauley turned to the question of “whether Ruane, a non-signatory to the Arbitration Agreement, may compel Cooper to arbitrate his claims under the doctrine of equitable estoppel.”

According to Judge Pauley, a non-signatory can compel arbitration where there is a close relationship between the parties and controversies involved, and the signatory’s claims are “founded and intertwined” with the underlying agreement containing an arbitration clause.  A close relationship includes an agency, or one where the non-signatory must be associated with the signatory in some significant way.  Here, Judge Pauley found that the DST and Ruane “occupied co-extensive positions” as plan fiduciaries, and Cooper was aware of their roles.  Thus, the primary issue involving Ruane was the same as with DST: whether their actions breached their fiduciary duty to the plan.  Given that overlap, Judge Pauley found that Cooper “may not evade [his] obligation to arbitrate by naming [Ruane] as the sole party in this action.”

Notably, Cooper also argued that arbitration should be denied because under federal law employees cannot be compelled to enter into an arbitration agreement as a condition of employment.  Judge Pauley not only questioned that argument on its merits, but found that, in any event, because Cooper “understood that he could opt-out of the arbitration program and voluntarily chose not to,” the arbitration was not a “condition of employment.”

So Cooper’s court claims against a party that did not sign an arbitration agreement were shunted to arbitration, no doubt a distressing result for class action counsel, especially in light of recent criticism the ever-broader use of arbitration provisions to squelch collective action by plaintiffs.

Posted in Pleading Securities

Judge Engelmayer Sees Conspiracies

Judge Engelmayer’s opinion in In Re Interest Rate Swaps Antitrust Litigation dissects one of the most interesting questions in anti-trust law—when does an anti-trust complaint fail because a plaintiff only alleges parallel conduct by companies acting in their own self-interest, as opposed to a conspiracy or agreement between them to act in concert. “The crucial question…is therefore whether the challenged conduct stems from independent decision, or from an agreement, tacit or express.” This crucial question, of course, is broader than anti-trust, as allegations of conspiracy are made frequently in civil litigation, but not so easily proven.

As explained by Judge Engelmayer, the Plaintiffs primarily are buyers and sellers of interest rate swaps. Historically, swap customers communicated almost exclusively with Dealers by phone, which created a “one-way” information flow to the Dealers that the Dealers used to their trading advantage. The Dealers were largely household name investment banks who were swaps market makers. The development of technologically advanced anonymous “all to all” electronic swaps exchanges, however, threatened to “disintermediate” the Dealers by allowing buyers “to access a broader market of sellers with transparent pricing.” The Plaintiffs claimed the Dealers conspired in violation of the anti-trust laws to prevent the creation of independent swap exchanges that offered lower transaction costs than they offered, and then, once the exchanges were established, sought to squelch them. The lawsuit spans the period 2007-2016, during with electronic swap exchanges blossomed as a technology, in part as a result of new regulatory requirements imposed by the 2010 Dodd-Frank Act.

For the pre-Dodd Frank period of 2007-2012, the Dealers allegedly alleged conspired to inhibit modern trading platforms from coming into existence; post 2012, the Dealers allegedly conspired to quash the newly established “all to all” platforms. The opinion is a terrific guide to what’s needed to plead an agreement between defendants, above and beyond independent parallel conduct.

For the pre-Dodd Frank period, Judge Engelmayer found that “shards” of parallel conduct could not give rise to an inference of an agreement amongst the Dealers to block development of new trading platforms. Each Dealer independently had good reason “to preserve the status quo,” and independent self-interest is an “obvious alternative explanation for defendants’ common behavior.” Further, because the computing infrastructure for the development of the new platform was not yet in place, there was “no urgency” for collective action, making the inference of an actual agreement remote.

Judge Engelmayer also rejected the claim that the Dealers joint purchase of an existing platform with the capacity to develop anonymous trading, and their business decision not to develop that platform demonstrated actual collaboration by the Dealers. A decision to “alter the direction of a single financial technology company” is not on its face illegal, and the acquired company was not “an unattractive investment opportunity, such that only one with conspiratorial aims would have invested in it.”

But financial technology moves on, and post-2012, Dodd-Frank encouraged the development of “all to all” trading platforms with their own clearing capacity. The Plaintiff swaps buyers, together with three new “all to all” swap trading platforms, claimed that the Dealers successfully “conspired to starve” the new platforms to maintain the Dealers’ market position. Judge Engelmayer rejected the Dealers’ claim that a collective refusal to do business, like in the pre-2012 period, had a “natural explanation.” Problematic to the Dealers defenses was the fact that four of the Dealers made virtually identical statements to one of the exchanges on the day it opened for trading–that they would not do business until they had audited the exchange’s rule book (even though it had been approved the regulator)—and never sought to complete their audits. The “contemporaneous and similar calls” on the same day “suggest coordination,” especially as the new technology now was a direct competitive threat, not a concern about what may happen in the future.

The defendants also submitted voluminous material that the “market reality” was that the new swaps exchanges had many start-up problems that caused them to lose traction, irrespective of any boycott, and that they were unattractive to investors. But this “alternative narrative,” although plausible, did not make plaintiffs’ claim of a group boycott implausible. And it was not up to the court on a motion to dismiss to make a choice “between two plausible inference”– that’s the purpose of a trial.

There’s much more in Judge Engelmayer’s lengthy opinion, but little as important as his careful parsing of when parallel conduct is of such a nature that it can support an inference of an agreement or conspiracy, as opposed to similar but independent decision-making “with a natural explanation.”


Posted in Contract

Judge Rakoff Gives the City an Unpleasant Surprise

It’s very common in commercial contracts for one party to agree to obtain insurance coverage for its counter-party. But according to Judge Rakoff, the scope of that coverage may be less than meets the eye.

In The City of New York v. Crothall Healthcare, the City hired Crothall to provide janitorial services to the city’s hospitals. Their contract required Crothall to procure insurance covering Crothall the City for any claims arising from Crothall’s services. The contract provided that Crothall could self-insure for the first $1,000,000 of insurance coverage, so long as it provided to the City “the same defense…as an insurer would be obligated to provide.”

Sure enough, a personal injury claim was filed against the City, and three months later the City tendered the case to Crothall to handle under Crothall’s $1,000,000 self-insured retention.  Crothall declined the tender, claiming that the parties’ contract required the tender to be made within 15 days of notice, not three months.

The City argued that the 15 day notice provision should be excused because under New York insurance law a late tender to an insurance company is not fatal unless the insurance company can show it was prejudiced by the delay—which Crothall was not. According to the City, Crothall committed to provide the “same defense” as an insurance company, and late notice should be excused just as it would be under an insurance policy.

Judge Rakoff did not see it the City’s way. He found that the parties’ contract was not an insurance policy, but an agreement to procure insurance. Therefore, it had to be interpreted according to traditional contract principles, not the regulatory scheme that governs insurance policies. “Crothall’s duty to ‘provide the same defense…as an insurer would be obligated to provide’ does not, by implication, import a raft of New York insurance regulations into the Contract.” Therefore, the 15 day contractual notice provision was strictly enforceable against the City, and the City could not require Crothall to pay for its defense.

The City argued it “never would have permitted Crothall to self-insure a portion of the coverage owned to the City if the City had known that the coverage was illusory.” Judge Rakoff had the answer to that as well: the City should not have dawdled three months to give notice. “The fact that the Contract is not subject to [New York insurance law] does not mean the City is not covered … if there is a gap in coverage, it is simply because the City failed” to give notice within the 15 day contractual notice period.

Lesson to be learned from Judge Rakoff: Even though a contracting party agrees to provide the same defense as an insurance company, if that obligation is contained in a contract to procure insurance, as opposed to an actual contract of insurance, it may not offer all the protection that it seems to offer on its face.

Posted in Class Actions Pleading Securities

Judge Koeltl on How to Swat Away a Securities Fraud Claim

In Schwab v. E*TRADE, Judge Koeltl sent packing a proposed class action plaintiff who was sure E*TRADE misrepresented how they processed his stock trades, but failed to give the detail necessary to make his point.

Brokers like E*TRADE are paid commissions by their customers, and also are paid rebates by the market makers and exchanges that execute their customers’ securities trades. These rebates, known as payments for order flow, are perfectly legal although heavily regulated. Brokers also owe a duty of best execution to their customers, which means they must try to get their customers the best price for each stock sale or purchase available under prevailing market conditions. Needless to say, there is a lurking conflict of interest between a broker’s duty of best execution to his customer, and the amount of the rebate a broker can collect from the market maker he directs to execute his customer’s trade.

Mr. Schwab alleged that E*TRADE directed his stock transactions to market makers that paid E*TRADE the biggest rebate, not those that offered the best price. E*TRADE countered that it discloses to its customers that it takes rebates into account in choosing where it directs its customers’ trades, along with cost to the customer, speed and level of service. But Schwab claimed that E*TRADE misrepresented its practices because it actually directed trades to maximize the rebates it received, and that the customer-friendly reasons were merely window dressing. Schwab alleged that E*TRADE generated hundreds of millions of dollars at its customers’ expense by prioritizing its rebates and business relationships over its duty of best execution.

To plead a securities fraud claim, Schwab had to show that he relied on E*TRADE’s false statement that it fulfilled its duty of best execution. But Schwab merely claimed that he “would” have used another broker if he had known that E*TRADE was prioritizing rebates over best execution. That’s not specific enough, according to Judge Koeltl. Schwab didn’t even claim that he read E*TRADE’s best execution disclosures, or that he “was aware with any sort of particularity– whether by reading, hearing or otherwise– of any of the challenged misstatements when he traded with E*TRADE.”

Schwab also failed to show that E*TRADE’s misstatements were made with scienter, that is, an intent to deceive—a necessary element of a securities fraud claim. Schwab had to show that E*TRADE’s executives had a motive to deceive their customers, such as by selling their own shares at a profit, or that they recklessly ignored information about E*TRADE’s conduct.

Schwab alleged only that based on E*TRADE’s own internal reviews of its best execution practices, third-party industry studies, and an older regulatory fine E*TRADE’s senior executives “must have known” that E*TRADE was prioritizing its rebates over its duty of best execution. Not enough, according to Judge Koeltl: Schwab made “no allegation about [the CEO’s] role in monitoring any of these items (let alone that he acted recklessly in fulfilling any such duty) beyond the allegation that he was CEO.” And since obtaining rebates from market makers and exchanges is legal, the pursuit of rebates alone “is the type of generic profit motive that is insufficient to establish scienter.”

Judge Koeltl dismissed the complaint without prejudice to renewal, and the opinion is a careful lesson on how (or how not) to plead securities fraud.

Hat tip to Bethany Clarke for her assist on this post.

Posted in Contract Pleading

Judge Pauley’s Special Relationships

When sophisticated investors carefully document their relationship, it’s unusual to see a claim for negligent misrepresentation. After all, sophisticated parties typically are only held to those commitments they agree to in writing. But as Judge Pauley’s opinion in Kortright v Investcorp teaches, unusual is not the same as never.

Investcorp, a well-known investment adviser, agreed to provide seed capital to an up-and-coming fund, Kortright, by investing $50 million of its own capital and $40 million of its clients’ capital. But soon thereafter, a competing financial bigfoot, The Man Group, tempted Kortright with a $300 million investment in exchange for absorbing Kortright’s funds. When Investcorp learned of Man’s interest it insisted on withdrawing its own proprietary investment, but agreed to leave its clients’ capital with Kortright. Man then negotiated its acquisition of Kortright, including a condition that Kortright maintain a minimum level of investment from Investcorp.

To assure that condition was met, Kortright persuaded Investcorp to sign a consent authorizing the transfer of its clients’ funds, and Kortright announced that Investcorp would remain an investor in Kortright after its absorption by Man—a plum selling point. But clouds soon appeared.

Investcorp determined that it could not transfer its clients’ funds on its own. Because Investcorp’s clients declined to consent, the client capital was not available for the Man transaction. Man walked away from its acquisition of Kortright, leaving Kortright holding the proverbial bag. Kortright sued Investcorp, asserting a boatload of breach of contract and tort claims. The only claim to hold water was the tort of negligent misrepresentation.

According to Judge Pauley, proof of negligent misrepresentation requires a material false statement on which a party reasonably relies to its detriment, and the existence of a duty “as a result of a special relationship” to give correct information. Absent a special relationship, there is no claim for negligent misrepresentation.

A special relationship is “less rigorous” than a fiduciary duty, but “a duty to speak with care exists when the relationship of the parties … is such that in morals and good conscience the one has the right to rely on the other for information ….” Although the duty can be related to a contract, it “must spring from circumstances extraneous to the contract….”

Investcorp moved to dismiss, arguing that it only had a contractual relationship with Kortright, and that under its contracts it had no obligation to maintain an investment in Kortright for any specific time-period. Therefore, the case should be thrown out.

Judge Pauley said it’s not that cut and dried.

He found that Investcorp also held itself out as a “strategic partner” of Kortright, had access to Kortright’s confidential information, helped to market Kortright’s funds, and had the right to veto certain Kortright transactions─all indicia of a special relationship. And nothing in the parties’ contracts specifically “disclaimed” a trust relationship. Thus, Kortright made out a claim of negligent misrepresentation, and its lawsuit was allowed to proceed on that ground.

According to Judge Pauley: Even in carefully documented transactions, parties may have obligations that go beyond those that they specifically agree to assume by contract.

Hat tip again to Bethany Clarke for assisting with this post.



Posted in Arbitration Class Actions Contract

Judge Netburn Shrinks an Arbitration Clause

Here’s a pop a quiz, drawn from Judge Netburn’s Report and Recommendation in Borecki v. Raymours Furniture Co., Inc. Is the following arbitration provision in a contract between a store and its customer a broad or narrow arbitration requirement: “[A]ny claim, dispute, or controversy between you and us that in any way arises from or relates to the goods and/or services you have purchased or are purchasing from us (the “Purchases”), now or in the past, including . . . any information we seek from you . . . .”?

Many lawyers, accustomed to courts’ deference to arbitration provisions, would answer “broad, arbitration will apply to any dispute.” But they’d fail the test.

Scott Borecki purchased a bedroom set from Raymours, and left his cell-phone number for the furniture company to contact him when the set was ready for pick up. The sale and pick up went smoothly. But three years later, Raymours texted Borecki four times promoting its local Raymour and Flanigan store. Borecki was not interested in the local promotion; instead, he brought a putative class action asserting that Raymours violated the Telephone Consumer Protection Act, a federal law which restricts unauthorized telemarketing.

Raymours moved to compel arbitration, arguing that Borecki’s claim “arises from or relates to” the purchase of his bedroom set. After all, but for Borecki’s purchase Raymours wouldn’t have his cell number. Therefore, Raymours assumed, the claim “relates to” the purchase.

But Judge Netburn drew a finer line. The question she posed was whether Raymour’s text messages were related to Borecki’s purchase of the bedroom set—not whether the means by which Raymours obtained Borecki’s contact information related to the purchase. Even though the arbitration agreement defined “claim” to require the “broadest reasonable meaning,” Judge Netburn concluded that the text messages were sale promotions unrelated to the purchase of the bedroom set, and that Borecki’s claim was not subject to arbitration. Judge Netburn distinguished Borecki’s claim from claims that she said would be arbitrable, such as false advertising, a product defect, or even text messages asking Borecki to rate its furniture favorably.

Rubbing salt in to Raymours’ wound, Judge Netburn also found that a class action waiver included as part of the arbitration provision could not be enforced: “Because the Agreement’s class action waiver is applicable only to arbitrable claims, and because I recommend finding that the Arbitration Agreement does not require Borecki to arbitrate his TCPA claim, Borecki’s TCPA claim may be asserted as a class action.”

Under court rules, Judge Netburn’s Report and Recommendation now goes to Judge Kaplan for his review (since she sits as a Magistrate-Judge). Regardless of the case’s ultimate outcome, Borecki is a cautionary tale for companies that expect that customer-related litigation will take place in the privacy of an arbitration forum, not in the glare of a class action courtroom.

Hat tip again to Christine Choi for helping with this post.

Posted in Injunctions Trials

Judge Forrest Helps UPS Quit Cigarettes

In The State of New York v. United Parcel Service, Inc., the State claimed that UPS illegally transported untaxed cigarettes from Native American reservations to New Yorkers. In ruling for the State, Judge Forrest walked a fine line in sanctioning UPS; she awarded damages, but denied the State’s request for injunctive relief, and a court monitor.

Judge Forrest awarded $166 million to New York State and $81 million to New York City. Given UPS’s “high level of culpability” and the public health issues related to cigarettes, Judge Forrest found that the financial penalties imposed were not unfair. “[O]nly a hefty fine will impact such a large entity sufficiently to capture the attention of the highest executives in the company.”

However, Judge Forrest also found that UPS “dramatically improve[d] its compliance efforts” in response to the lawsuit. Steps taken after the case started included  screening against non-compliant shipper lists, adding personnel to the compliance team, hiring an outside counsel to investigate active shippers, and boosting its audit procedures. As the Judge  put it, UPS “transformed itself from a willfully blind actor to one actively doing far more.” Of note, Judge Forrest recognized that “this lawsuit, including the resulting reputational and financial costs, provides standalone economic motivation for UPS to proceed more carefully in the future.”

The claims against UPS asserted that the company had violated the terms of an Assurance of Discontinuance (AOD) it negotiated with New York in 2005 as a resolution to a state investigation into whether the company was in compliance with the applicable laws on cigarette shipments. Plaintiffs argued, and Judge Forrest ruled, that UPS had violated the 2005 agreement by continuing to ship millions of dollars’ worth of untaxed cigarettes between Native American reservations and other locations throughout New York state. But despite violating the AOD, in the end UPS − at some financial cost − maintained control over its own business operations and avoided a third-party monitor.

Bottom line: UPS dodged a bullet, but did not escape uninjured.

Hat tip to Bethany Clarke for assisting with this post.

Posted in Contract

Judge Pauley Pierces the Veil

Judge Pauley’s opinion in LiquidX v. Brooklawn Capital, LLC is a good example of a company paying a steep price for trying to outwit its creditors.

The Receivables Exchange (TRE), a financial startup that created an exchange for the purchase and sale of accounts receivable, was on the verge of a desperately needed round of financing. But on the eve of closing, TRE lost an important arbitration to a creditor, opening the door to similar creditor claims. The new money evaporated.

Undeterred, one of the potential new financiers and two TRE board members hatched a plan to salvage TRE’s business by acquiring its assets and transferring them to a new corporation, LiquidX—and leaving TRE’s creditors holding the bag while continuing TRE’s business, albeit under a new name. The linchpin of the plan, named after Caerus, the Greek God of opportunity, involved LiquidX buying TRE’s bank loan, and then privately foreclosing on TRE’s assets.

Critically, TRE had to independently appraise its assets at less than its bank loan to cut-off other creditor claims.

Sure enough, with the chief operations officer telling the appraiser that TRE was in the dumps, the appraisal came in low. The private foreclosure went ahead, and TRE’s business immediately re-emerged intact under the name LiquidX, providing a “seamless” transition to its customers. When TRE’s creditors complained, LiquidX (over) confidently sought a court ruling that it was not TRE’s alter-ego, and therefore was free and clear of TRE’s creditors.

That’s when Judge Pauley stepped in. He rejected the argument that the plan was a good-faith effort to save TRE and its employees jobs. He noted that its masterminds, including the two members of the TRE board, hid their interest in LiquidX from the entire TRE board when negotiating the loan purchase. As such, the transaction between the two companies was tainted. “The most significant factor in this case, however, is that the corporations did not deal with one another at arm’s length.” Indeed, the low appraisal of TRE’s assets flew in the face of LiquidX’s own optimism about its future.

Judge Pauley also rejected LiquidX’s argument that it had no alter-ego relationship with TRE because the ownership of the two companies did not overlap. “Ownership…is a proxy for control. It is certainly possible to exercise control over corporate functions without owning the corporation itself….” After finding that LiquidX controlled TRE’s decision making even in the absence of ownership, Judge Pauley had little trouble finding that LiquidX used its control to perpetrate a wrong—leaving TRE’s creditors in the lurch. Therefore, TRE’s creditors could pursue LiquidX as TRE’s alter-ego.

Project Caerus may have seemed quite creative when it was hatched, but Judge Pauley was not impressed. The Greek Gods can be tricky.

Hat tip to Christine Choi for assisting on this post.


Posted in Contract ERISA Preemption Promissory Estoppel

Judge Oetken Teaches Doctors a Hard Lesson about Promissory Estoppel

A promise made is a promise kept—unless it is made over the phone under an ERISA plan.  So ruled Judge Oetken last week, in a dismissal of a doctor’s lawsuit to collect payment allegedly promised by a healthcare benefit plan administrator.  McCulloch Orthopedic Surgical Servs., PLLC, a/k/a Dr. Kenneth E. McCulloch v. United Healthcare Ins. Co. of New York, a/k/a Oxford, No. 14–CV–6989 (JPO) (S.D.N.Y. June 8, 2015).

Dr. McCulloch, an orthopedic surgeon, performed arthroscopic knee surgery on a patient.  Prior to performing the surgery, his staff contacted United Healthcare Insurance Company of New York (aka “Oxford”), and allegedly was assured that the patient was covered by Oxford’s plan, that the plan provided for payment to out-of-network physicians such as Dr. McCulloch, that the plan covered the surgical procedures that Dr. McCulloch would provide for the patient, and that Oxford would reimburse Dr. McCulloch at 70% of UCR (the usual, customary, and reasonable rates for such procedures).

The doctor proceeded with the surgery on the basis of his understanding.  Afterwards, he billed Oxford $15,479.80 for the surgery (i.e., the alleged UCR of $34,024, minus certain deductions and offsets).  Oxford paid $641.66, and also apparently sent McCulloch a reply letter denying coverage.  Continue Reading

Posted in Privilege Issues

Judge Kaplan Finds Claim of Fraud Trumps Attorney-Client Privilege

Without waiver, discovery of bona fide privileged documents is usually a dead end. That principle would seem to be especially rock-solid when those documents are the subject of a subpoena addressed to adversary counsel in related litigation (in this case, to enforce a foreign judgment). But in Chevron v. Donziger, et al., a judgment enforcement action that has been anything but ordinary (here and here), Judge Kaplan ruled that where there is probable cause that the foreign judgment was procured by fraud, and the documents sought relate to that fraud, neither work product protection nor attorney-client privilege applies.   Continue Reading