Looking northwest across Pierrepont Street and...

The Commercial Division and Appellate Division have issued interesting holdings on commercial disputes in recent weeks:

For example, On February 18, 2015, the Second Department issued a decision in Chiu v. Chiu, 2015 NY Slip Op. 01427, holding that funds paid by a member to an LLC should be treated as loans, rather than contributions to capital, in the absence of evidence that the parties intended them to be capital contributions.

In Chiu, two members of an LLC litigated their respective ownership shares and the value of those shares. Reversing a trial court decision after trial that one of the members had only a 10 percent ownership interest, the Second Department explained:

After a joint nonjury trial, the Supreme Court issued a decision finding that although Winston Chiu initially had a 25% membership interest in the LLC, subsequent capital contributions by Man Choi Chiu had the effect of reducing Winston Chiu’s membership interest to 10% and increasing Man Choi Chiu’s membership interest to 90%. . . . Here, the Supreme Court properly determined that the LLC’s records, which included the LLC’s tax returns for the years 1999 and 2000, established that Winston Chiu’s initial membership interest was 25%. Although Man Choi Chiu contends that the LLC’s records were incorrect, he cannot subsequently take a position contrary to that taken in the income tax returns which he admitted that he signed. However, the Supreme Court incorrectly determined that the subsequent contributions by Man Choi Chiu should be treated as capital contributions, and not as loans, as the record was bereft of any evidence of an agreement between the members to such treatment. Accordingly, on the date of his withdrawal, Winston Chiu’s membership interest remained at 25%.

(Internal quotations and citations omitted) (emphasis added).

NOTE: Schlam Stone & Dolan LLP was counsel for Winston Chiu at trial and on appeal.

And the Court of Appeals seems to have changed the law for attorney immunity vis-à-vis the litigation privilege.  On February 24, 2015, the Court of Appeals issued a decision in Front, Inc. v. Khalil, 2015 NY Slip Op. 01554, holding that statements made by attorneys prior to the commencement of litigation are protected by a qualified privilege if the statements are pertinent to a good-faith anticipated litigation.

In Front, Inc., counsel for plaintiff sent the defendant and, later, the defendant’s prospective employer, a letter accusing the defendant (its former employee) of attempting to steal the plaintiff’s “confidential and proprietary information,” conducting an “illegal competing side business,” misappropriating trade secrets, and other misconduct and threatening to sue. The defendant commended a third-party action for defamation against the plaintiff’s counsel.

The trial court determined that the letter was absolutely privileged, because the letter “clearly related to the litigation initiated by” the plaintiff and “the demands made in the letters . . . substantially reflect the causes of action and relief requested” in the main action. The First Department affirmed on substantially the same grounds. The Court of Appeals granted leave to appeal. It affirmed, resolving a split between the Appellate Divisions, explaining:

The rationale supporting the application of privileged status to communication made by attorneys during the course of litigation is also relevant to pre-litigation communication. When litigation is anticipated, attorneys and parties should be free to communicate in order to reduce or avoid the need to actually commence litigation. Attorneys often send cease and desist letters to avoid litigation. Applying privilege to such preliminary communication encourages potential defendants to negotiate with potential plaintiffs in order to prevent costly and time-consuming judicial intervention. Communication during this pre-litigation phase should be encouraged and not chilled by the possibility of being the basis for a defamation suit.

Nonetheless, as a matter of policy, the courts confine absolute privilege to a very few situations. We recognize that extending privileged status to communication made prior to anticipated litigation has the potential to be abused. Thus, applying an absolute privilege to statements made during a phase prior to litigation would be problematic and unnecessary to advance the goals of encouraging communication prior to the commencement of litigation. To ensure that such communications are afforded sufficient protection the privilege should be qualified. Rather than applying the general malice standard to this pre-litigation stage, the privilege should only be applied to statements pertinent to a good-faith anticipated litigation. This requirement ensures that privilege does not protect attorneys who are seeking to bully, harass, or intimidate their client’s adversaries by threatening baseless litigation or by asserting wholly unmeritorious claims, unsupported in law and fact, in violation of counsel’s ethical obligations. Therefore, we hold that statements made prior to the commencement of an anticipated litigation are privileged, and that the privilege is lost where a defendant proves that the statements were not pertinent to a good-faith anticipated litigation.

(Internal quotations and citations omitted) (emphasis added). The Court of Appeals went on to hold that the statements at issue met the standard for the qualified privilege.

Speaking of attorney immunity, clients should be careful paying counsel out of restrained funds.  On February 5, 2015, Justice Kitzes of the Queens County Commercial Division issued a ruling in Nissim Kassab v. Avraham Kassab et al. granting a motion for civil contempt.

Kassab, a hybrid special proceeding and action, concerns an LLC (“Mall”) and a corporation (“Corner”) which own adjoining properties and are both owned 25% by Nissim and 75% by his brother Avraham. Nissim sought judicial dissolution of both Mall and Corner, as well as other relief related to the two entities.

As is common in judicial dissolution cases, the court had entered a TRO prohibiting Avraham and his agents from “transferring, removing, hypothecating, secreting or in any way disposing of any and all income and property of [Mall and Corner] except in the ordinary course of business.” During the course of limited discovery pursuant to the TRO and the Business Corporation Law, it was revealed that Corner had paid $36,185.31 to Avraham’s attorneys after the TRO went into effect, and Nissim moved to have Avraham held in contempt. Avraham argued that he had allocated the fees incurred in the action between Corner, Mall, and himself, that he paid $80,799.60 and Corner paid $45,985.31, that he had personally loaned the money to Corner to pay the fees, and that the payments were made in the ordinary course of business. Justice Kitzes rejected these arguments, stating that the mere fact that Corner and Mall were named as parties was not sufficient reason for them to be incurring attorney’s fees:

Contrary to respondent’s assertions, it is well established that attorney fees incurred by a shareholder in defending a dissolution proceeding are not payable out of corporate funds. Thus, in the usual dissolution proceeding, where the corporation appears as a nominal party and the proceeding amounts to a dispute between the shareholders, corporate funds may not be used in payment of counsel fees for the individual shareholder. Here, Corner is a nominal party, as the claims alleged against Corner are solely for corporate dissolution and the appointment of a receiver.

(Internal citations omitted.)

Accordingly, any attorney fees paid by Corner—even assuming they were paid out of loans made by Avraham for that specific purpose, of which the judge noted no evidence was presented—were not made in the ordinary course of business. As a sanction, Avraham was ordered to pay the statutory fine of $250, Avraham and his attorneys were ordered to pay back all funds belonging to Corner, and Nissim was awarded his own reasonable attorney’s fees and costs in making the motion. In addition, Avraham was directed to produce and to continue to produce “all documents pertaining to the financial transactions of Corner” on a monthly basis until the dissolution proceeding is terminated.

This opinion illustrates the rule that corporate funds may not be used to pay a shareholder’s legal fees in dissolution proceedings.

NOTE: Schlam Stone & Dolan LLP represents the petitioner in this action.