Opinion
006110/09.
Decided on March 12, 2010.
This motion, by defendants Andover Associates Management Corp., Joel Danziger, and Harris Markhoff, to dismiss the amended complaint for lack of capacity and failure to state a cause of action is denied ; and a motion, by defendant Citrin Cooperman, to dismiss the amended complaint for lack of capacity and failure to state a cause of action is denied ; and a motion, by defendant Ivy Asset Management, to dismiss the amended complaint for lack of capacity and failure to state a cause of action is granted in part and denied in part; and a motion, by defendant Andover Associates LLC I, to transfer the action to Westchester County is denied .
This derivative action against the officers of an investment company, its investment consultant, and the company's auditor arises from the collapse of Bernard L. Madoff Investment Securities. Andover Associates, L.P. was a New York limited partnership formed for the purpose of trading, "either for its own account or through other . . . entities, in securities and financial instruments of every kind and description." The firm was formed around 1992, and it is governed by a limited partnership agreement which was amended and restated on April 1, 2004.
Andover Associates' amended and restated limited partnership agreement provides that the general partner is defendant Andover Associates Management Corp. ("Andover Management"). Defendant Joel Danziger was the president of Andover Management, and defendant Harris Markhoff was the vice president, secretary, and treasurer of the corporation. The office of Andover Associates and Andover Management was located at 123 Main Street, Suite 900, White Plains, New York.
The limited partnership agreement provided that the general partner had the "full and exclusive right" to manage the partnership. The general partner was permitted to delegate any of its duties, provided that it remained "primarily responsible" for their performance. As compensation for managing the business, the general partner was to receive a monthly "general partner fee" of .125 % of the "net capital" of the partnership.
The limited partnership agreement provided that the general partner was authorized to retain an "investment consultant," who would perform services as provided in a separate agreement between the general partner and the investment consultant. The initial consulting agreement has not been submitted to the court. However, on August 9, 2004 Andover Associates issued a "confidential offering memorandum," offering prospective investors the opportunity to invest in the limited partnership. The confidential offering memorandum disclosed that the investment consultant would provide advice with respect to selection of "independent investment managers," the allocation of the partnership assets among managers and investment pools, and "certain administrative and accounting services to the general partner." The limited partnership agreement provided that the investment consultant was to receive a "monthly management fee," or "investment consultant fee," which was to be paid by the general partner from the general partner fee and "no part thereof shall be charged to any series [of limited partnership interest]."
In October 1992, Andover Management had retained defendant Ivy Asset Management Corp. as its investment consultant. Around that time, Ivy recommended that Andover Management utilize Madoff's firm as its investment manager. Plaintiff alleges that Madoff's overall fees were much lower than what investment managers typically charge and Andover Management initially invested 100% of Andover Associates' money with Madoff. For a number of years, Madoff's firm paid generous returns to Andover Associates. However, in December, 2008, it became known that Madoff had been running a "Ponzi scheme," whereby no profits were actually being earned but rather earlier investors were paid "profits" from the capital of newer investors. Plaintiff alleges that at the time Madoff's fraud was discovered, approximately 25 % of Andover Associates' assets were invested with Madoff.
As noted, in August, 2004, before Madoff's fraud was uncovered, Andover Associates had issued a "confidential offering memorandum," offering prospective investors the opportunity to invest in the limited partnership. Although the offering memorandum referred to the interests it was offering as "securities," it stated that the offering was not a "public offering." The offering memorandum stated that the "investment objective" of the partnership was to provide "average rates of return while attempting to minimize risk." However, the offering memorandum stated that the investment was not suitable for someone who could not "afford a loss of principal" or had "need for liquidity." It further stated that the "minimum initial purchase" was $150,000.
On January 1, 2006, Andover Management entered into a "consulting agreement" with Ivy Asset Management Corp. The consulting agreement references an earlier agreement dated October 1, 1992 and recites that Ivy had previously recommended Madoff's firm to Andover Management. The consulting agreement further recites that Andover Management continued to "utilize the strategies implemented by Madoff" and that it understood "the risks" associated with those strategies. The consulting agreement provided that Ivy would recommend other investment managers to Andover Management and advise the corporation as to the "allocation of partnership funds" among investment managers, including "timing of retaining and terminating" investment managers other than Madoff." Although Ivy agreed to use reasonable care in providing these services, it was not to "be responsible or held accountable for any act or failure to act by investment managers regardless of whether it recommends such manager or by Madoff." As compensation for performing these services, Ivy was to receive 40% of the general partner fees received by Andover Management from January 1 through December 31, 2006. Commencing January 1, 2007, Ivy was to receive 37.5 % of the general partner fees received by Andover Management. Additionally, Ivy agreed to indemnify Andover Management for all claims arising from Ivy's gross negligence or wilful misconduct, and Andover Management agreed to indemnify Ivy for claims arising from similar conduct on the part of Andover Management.
On the same date as the consulting agreement, Ivy entered into an "administrative services" agreement with Andover Associates. The agreement recited that Ivy had been performing certain administrative services for Andover Management and agreed to provide services of the "same nature" for Andover Associates. The services included maintaining the capital accounts of the "partners," reconciling all Bernard L. Madoff statements against "trade tickets," and maintaining "original books of entry for all Madoff activity," including "purchase and sales activity." As compensation for these services, Ivy was to be paid $35,000 per year. However, on January 1, 2008, the administrative services agreement was amended to provide that Ivy would be paid an annual fee of .1 % of the net capital of the partnership.
On January 31, 2006, plaintiff Charles Hecht signed the "subscription documents," necessary to acquire an interest in Andover Associates. Among the documents was an "accredited investor certification," representing that Hecht had net worth in excess of $ 1 million. In the "subscriber qualifications" section of the "application and agreement," Hecht stated that he could afford an interest in a "speculative venture" and could "sustain a loss of this entire investment." Hecht further represented that he was an "experienced investor, . . . capable of evaluating the merits and risks of this investment, and ha[d] obtained . . . sufficient information to evaluate the merits and risks of this investment."
In the "series election" information section, plaintiff elected to participate in "series 1 interests," meaning that he would participate in profits and losses from "all transactions," including "futures transactions." In the "amount of subscription" section, plaintiff indicated that the consideration for his interest would be the transfer of his interest in another investment pool, Beacon Associates, LLC II. On June 2, 2008, Andover Associates was converted to a limited liability company. Andover Management is the managing member of Andover Associates LLC I, the nominal defendant on behalf of whom the derivative action is maintained.
In December, 2008, Madoff's fraud was disclosed. Madoff subsequently declared bankruptcy and was convicted of fraud, perjury, and other crimes in connection with his criminal enterprise.
This action was commenced on March 31, 2009. Plaintiff purports to sue derivatively on behalf of Andover Associates. In addition to Danziger, Markhoff, and Andover Management, plaintiff names as defendants Ivy and Citrin Cooperman Co., LLP, who is the auditor for Andover Associates. In the first cause of action, plaintiff asserts a claim against Ivy for breach of the administrative services agreement by failing to reconcile Madoff's monthly statements. Plaintiff alleges that had Ivy attempted to reconcile Madoff's monthly statements against the trade tickets, it would have discovered that there were no trade tickets because no trades were ever executed. Thus, plaintiff alleges that, but for Ivy's failure to reconcile the statements, Madoff's fraud would have been discovered earlier and Andover Associates would have been able to withdraw its investment. Plaintiff claims that, as a result of Ivy's breach of the administrative services agreement, Andover sustained damages in the amount of approximately $14 million, allegedly the value of its Madoff investment.
In the second cause of action, plaintiff asserts a claim against Andover Management for breach of the partnership agreement. Plaintiff construes the provision in the limited partnership agreement that the investment consultant's fee was not to be "charged to any series" to mean that the fee was not to be paid by the limited partnership. Plaintiff alleges that Andover Management violated this provision by agreeing in the administrative services agreement that Andover Associates would pay Ivy an annual fee and subsequently arranging for the fee to be paid by Andover Associates. Plaintiff alleges that Andover Associates sustained damages in the amount of the administrative services fees paid in violation of the limited partnership agreement, i.e. approximately $100,000.
In the third cause of action, plaintiff asserts a claim against Ivy for negligence. In essence, plaintiff alleges that Ivy was negligent in recommending Madoff's firm without conducting a sufficient "due diligence" investigation of his operation.
In the fourth cause of action, plaintiff asserts a claim against Andover Management for gross negligence in investing with Madoff without conducting its own due diligence investigation. In particular, plaintiff alleges that Madoff's confirmation slips and statements reported purchases and sales of securities at prices outside the range at which the securities traded on the days in question. Plaintiff alleges that had Andover Management conducted a proper investigation it would have learned that Madoff's confirmation slips and statements were false because no trades were actually being conducted. Plaintiff alleges that, but for Andover Management's negligence in failing to react to the suspicious confirmation slips and other "red flags," Andover Associates would have learned of Madoff's fraud and been able to liquidate its investment.
In the fifth cause of action, plaintiff alleges that Andover Management breached its fiduciary duty of loyalty by entering into the consulting and administrative services agreements and through acts of gross negligence described above. In the sixth cause of action, plaintiff alleges that defendants Joel Danziger and Harris Markhoff aided and abetted Andover Management's breach of fiduciary duty. Plaintiff alleges that Danziger and Markhoff provided substantial assistance to Andover Management by causing it to invest a substantial portion of Andover Associates' assets with Madoff and entering into the consulting and administrative services.
In the seventh cause of action, plaintiff asserts a claim against Ivy for aiding and abetting Andover Management in the breach of its fiduciary duty. In the eighth cause of action, plaintiff asserts a claim for accountant's negligence against Citrin Cooperman.
Plaintiff purports to assert these claims derivatively on behalf of Andover Associates. Plaintiff alleges that serving a demand upon Andover Management to prosecute these claims would have been futile because Andover Management and its principals were involved in the wrongdoing constituting the basis of the claims. Plaintiff notes that the consulting agreement contains a provision requiring Andover Management to indemnify Ivy for any claims arising from Andover Management's gross negligence or wilful misconduct. Plaintiff argues that it would have been futile to demand that Andover Management pursue a claim against Ivy because the indemnity provision would have been triggered. Finally, plaintiff asserts that a demand upon Andover Management to pursue a claim against Citrin Cooperman would have been futile because the misconduct of Andover Management was "inextricably interconnected" with the liability of the auditor.
Defendants Andover Management, Danziger, and Markhoff move to dismiss the amended complaint for lack of capacity and failure to state a cause of action pursuant to CPLR 3211 (a)(3) and (7). Defendants argue that plaintiff's claims against Andover Management for breach of fiduciary duty and gross negligence, and his claims against Danziger and Markhoff for aiding and abetting breach of fiduciary duty are preempted by the Martin Act, General Business Law §§ 352, 353. Defendants argue that plaintiff's claims for breach of fiduciary duty are duplicative of his claims for breach of the partnership agreement; and that plaintiff's derivative claims should be dismissed for failure to make a demand on the managing member of the limited liability company. Defendants assert that plaintiff's claims for breach of the partnership agreement, breach of fiduciary duty, aiding and abetting breach of fiduciary duty, and gross negligence are all barred by the business judgment rule; and that plaintiff's claims for breach of fiduciary duty, aiding and abetting, and breach of the partnership agreement are barred by the limitation of liability provision in a subsequent offering memorandum issued on June 2, 2008. That provision limits the liability of the managing member, and the liability of its officers and shareholders, for good faith acts believed to be in the best interests of the company, except in cases of gross negligence, fraud, or wilful misconduct. Defendants contend that plaintiff's claim for gross negligence is insufficient because their conduct did not constitute reckless disregard for the rights of others; and that plaintiff's claim for breach of the partnership agreement is insufficient because the administrative services fee was not covered by the provision requiring the investment consultant's fee to be paid from the general partner fee.
Alternatively, defendants move that the action be transferred to Westchester County. Defendants note that there is a provision in the subscription agreement that any action or proceeding arising from the subscription agreement shall be resolved within the County of Westchester. In the agreement, the subscriber consents to the jurisdiction of the federal and state courts located within the County of Westchester. Defendants argue that in view of this forum selection clause, Nassau is not a proper county in which to maintain the action.
Defendant Ivy moves to dismiss the complaint for lack of standing and failure to state a cause of action. Ivy argues that plaintiff cannot maintain his claims against it for negligence and aiding and abetting breach of fiduciary duty because those claims are based on conduct which occurred prior to his investment. Defendant contends that plaintiff has failed to establish that it would have been futile to demand that the company bring suit; and that plaintiff's breach of contract claim is legally insufficient because the administrative services agreement did not require Ivy to perform any investment consulting or due diligence with respect to Madoff. Defendant asserts that plaintiff's negligence claim is insufficient because any duty of care with respect to investment advice runs in favor of Andover Management rather than Andover Associates; and that plaintiff's claim for negligence is time-barred to the extent that it is based upon conduct occurring prior to April 1, 2006. Defendant further argues that plaintiff's negligence claim is essentially one for breach of an oral contract to provide consulting services and is unenforceable under the statute of frauds; and that plaintiff's claims for negligence and aiding and abetting Andover Management's breach of fiduciary duty are preempted by the Martin Act. Finally, defendant further contends that plaintiff has not established that Ivy knew that Andover Management breached a fiduciary duty or that Ivy provided substantial assistance to Andover Management.
Defendant Citrin Cooperman moves to dismiss the complaint for lack of capacity and failure to state a cause of action; that plaintiff has failed to establish that a demand would have been futile or that a failure to sue could not have been the product of sound business judgment; and that plaintiff has failed to establish proximate causation because Andover Associates last invested funds with Madoff in 2002 and Citrin Cooperman was not retained to audit Andover Associates until February 2006. Additionally, defendant contends that once Andover Associates' funds were misappropriated by Madoff, the funds could not have been returned to Andover even if the auditor had uncovered the fraud. Finally, defendant avers that Andover Associates' damages are not the $14 million fictitious balance reported by Madoff but rather $3.288 million, the amount of Andover's un-recouped investment.
A member of a limited liability company may bring a derivative suit on behalf of the company, even though there is no provision authorizing such a suit in the Limited Liability Company Law ( Tzolis v Wolff , 10 NY3d 100 , 2008). Where a minority shareholder brings a derivative suit on behalf of a corporation, the complaint must set forth with particularity plaintiff's demand upon the board of directors to bring the action, or the reasons that a demand would have been futile (Business Corporation Law § 626[c]; Bansbach v Zinn , 1 NY3d 1 , 8, 2003). Shareholder derivative suits are not favored because they ask courts to
second-guess the business judgment of the individuals charged with managing the company (Id). On the other hand, derivative actions protect minority shareholders against officers and directors who place other interests ahead of the corporation (Id). Thus, a demand is futile when the complaint alleges with particularity that 1) a majority of the board of directors is interested in the challenged transaction, 2) the board members did not fully inform themselves about the challenged transaction to the extent reasonably appropriate in the circumstances, or 3) the transaction was so egregious on its face that it could not have been the product of sound business judgment ( Bansbach, 1 NY3d at 9). Director interest may be either self-interest in the transaction at issue or a loss of independence because a director with no direct interest in the transaction is controlled by a self-interested director (Id).
Plaintiff asserts that a more relaxed standard of futility should apply to derivative suits on behalf of limited liability companies. However, in Tzolis, the Court of Appeals suggests that the demand requirement, and the required showing of futility, is the same for a derivative suit on behalf of a limited liability company as it is for a derivative suit on behalf of a corporation ( Tzolis v Wolff, supra, 10 NY3d at 108-09). In any event, because plaintiff has met the standard of futility applicable to a derivative suit on behalf of a corporation, the court need not decide whether a lower standard applies to derivative actions on behalf of limited liability companies.
Clearly, Andover Management has an interest in not being sued for breach of the limited partnership agreement, gross negligence, or breach of fiduciary duty. Similarly, Andover Management has an interest in protecting its principals, Danziger and Markhoff, from being sued for aiding and abetting a breach of fiduciary duty by Andover Management. The court determines that Andover Management also has an interest in protecting Ivy from being sued for breach of the administrative services agreement, negligence, or aiding and abetting a breach of fiduciary duty by Andover Management. The court further determines that Andover Management has an interest in protecting Citrin Cooperman from being sued for accountant's negligence. If it were established in such a suit that Ivy failed to exercise due diligence or that Citrin Cooperman failed to conduct a proper audit, these facts would tend to establish that Andover Management negligently breached its own fiduciary duty to Andover Associates. Accordingly, defendants' motions to dismiss the amended complaint for lack of capacity based upon plaintiff's failure to show that a demand was futile are denied.
On a motion to dismiss pursuant to CPLR 3211, the pleading is to be afforded a liberal construction. The court must accept the allegations of the complaint as true and provide plaintiff the benefit of every possible favorable inference ( AG Capital Funding Partners v. State Street Bank and Trust Co., 5 NY3d 582, 591, 2005). The business judgment rule bars judicial inquiry into actions of corporate directors taken in good faith and in the exercise of honest judgment in the lawful and legitimate furtherance of corporate purposes ( Consumers Union v New York, 5 NY3d 327, 360, 2005). Andover Management, Danziger, and Markhoff argue that the business judgment rule insulates their decisions to utilize Ivy as their investment consultant and Madoff as their investment manager. However, the issue is not whether defendants were in good faith in failing to detect Madoff's fraud but whether were defendants in bad faith in not bringing suit after the fraud was uncovered. Providing plaintiff the benefit of every possible favorable inference, the court must assume that Andover Management's decision not to proceed against Ivy or Citrin Cooperman was not in good faith.
The retaining of Ivy as the investment consultant, and the amount of compensation which Ivy was paid for investment consulting and administrative services, would ordinarily be within Andover Management's business judgment. However, administrative services included maintaining "original books of entry for all Madoff activity," presumably including his fictitious trades. Plaintiff alleges that there were no trade tickets, or any other documentation, to substantiate the trades. Giving plaintiff the benefit of every possible favorable inference, Ivy's preparing original books of entry, without the benefit of back up documentation, may have furthered Madoff's scheme or helped to avoid its detection. In any event, in view of the provision in the limited partnership agreement, prohibiting payment of the investment consultant's fee from partnership assets, the court cannot conclude that the arrangement concerning the administrative services fee was in good faith. Accordingly, defendants' motion to dismiss based upon the business judgment rule is denied. For similar reasons, the limitation of liability provision in the June 2, 2008 offering memorandum does not bar plaintiff's claims.
A trustee is under a duty to employ diligence and prudence in the management of the trust estate ( In re Marine Midland Bank, 127 AD2d 999, 4th Dept., 1987). Delegation of this duty to another is not an excuse for the failure to fulfill it by the trustee (Id). Nor does the trustee's good faith and honesty of purpose relieve him from a breach of his fiduciary obligation (Id). In essence, plaintiff's theory is that Andover Management breached the duty of diligence and prudence by delegating management of Andover Associates' investment to Madoff without conducting an adequate investigation into his operation. Since plaintiff's claim for breach of the limited partnership agreement is based on the provision prohibiting the investment consultant's fee from being paid from partnership assets, plaintiff's claim for breach of fiduciary duty is not duplicative of his breach of contract claim (See Perl v Smith Barney, Inc., 230 AD2d 664, 666, 1st Dept., 1996).
Although defendants acknowledge that they owed investors a duty of care and loyalty in the management of Andover Associates' assets, they argue that the Martin Act precludes plaintiff's breach of fiduciary duty, aiding and abetting, and gross negligence claims. "The Martin Act authorizes that Attorney General to investigate and enjoin fraudulent practices in the marketing of stocks, bonds and other securities within or from New York State" ( Kerusa Co. v Real Estate LP , 12 NY3d 236 , 243, 2009). The Act also makes it illegal to make or take part in a public offering of securities consisting of participation interests in real estate, including coops and condominiums, unless an offering statement is filed with the Attorney General (General Business Law § 352-e[a]). The disclosure provided by the offering statement is "designed to protect the public from fraudulent exploitation in the sale of real estate securities" ( Kerusa Co., 12 NY3d at 243). Because the Martin Act is designed to protect the public from fraudulent exploitation in the offering and sale of securities, a "private offering" of securities is exempt from the coverage of the Act ( People v Landes, 192 AD2d 1, 4, 3d Dept., 1993).
The Martin Act authorizes the Attorney General to seek restitution and damages for parties who have been injured by a violation of the Act (General Business Law § 353). However, the Attorney General need not allege or prove scienter, the intent to deceive element in a common law fraud action, to establish liability for fraudulent practices under the Martin Act" ( Caboara v Babylon Cove Dev. , 54 AD3d 79 , 81, 2d Dept., 2008).
Because "the attorney-general bears sole responsibility for implementing and enforcing the Martin Act, there is no private right of action under the statute" ( Kerusa Co. 12 NY3d at 244). Moreover, to avoid "a backdoor private cause of action to enforce the Martin Act," common law causes of action based upon conduct covered by the Act are precluded or "preempted" (Id at 245). However, plaintiff may participate in a business venture without acquiring a "security" in a "public offering," and promoters may defraud investors after the securities offering has taken place. Thus, whether plaintiff's particular claim is precluded by the Martin Act "varies from case to case" ( Owens v Gaffken Barriger Fund, 2009 U.S. Dist. LEXIS 90895, SDNY 2009).
According to the Howey test, discussed in All Seasons Resorts, a particular interest will be a "security," if "looking at the economic realities, the transaction involved an investment of money in a common enterprise with profits to come solely from the efforts of others" ( All Seasons Resorts v Abrams, 68 NY2d 81, 92, 1986). Clearly, plaintiff invested his money in a common enterprise, Andover Associates, with the expectation that profits would come solely from the efforts of Andover Management, or the manager to whom it delegated the operation of the fund. Indeed, the Andover Associates offering memorandum refers to the units of limited partnership interest which it was offering as "securities." The court concludes that the limited partnership interests offered by Andover Associates were securities within the meaning of the Martin Act.
Andover Associates' offering memorandum stated that it was not open to the general public. Taking the offering memorandum at face value, Andover's limited partnership interests were not marketed in a public offering, and the Martin Act would not preclude plaintiff's common law claims. Nevertheless, a statement in an offering memorandum that an offering is not a "public offering" may be self-serving with respect to the issue of whether the securities are subject to federal regulation or regulation under the Martin Act. In determining whether a particular offering constitutes a public offering under the Martin Act, the court may consider factors relevant under federal law, including the sophistication of the offerees and their need for the protection of the securities acts ( People v Landes, supra, 192 AD2d at 4). As under federal law, the court may also consider the number of offerees, the number of units offered, and the size and manner of the offering (Id).
While there is no evidence as to the number of people who were offered interests in Andover Associates, the offering memorandum indicates that the offer was made in at least two states other than New York. Despite his boilerplate disclaimers in the subscription agreement, it appears that plaintiff may have been in need of the protection of the Martin Act. Since Andover Associates' offering of limited partnership interests may have involved a public offering, the court must consider whether Andover Associates was involved in a "fraudulent practice" in the marketing of the limited partnership interests.
Since the Attorney General need not prove scienter to establish a Martin Act violation, claims sounding in fraud are "routinely dismissed," whether or not they require proof of fraudulent intent ( Owens v Gaffken Barrige Fund, supra, 2009 U.S. Dist. LEXIS 90895). Thus, a purchaser of a condominium unit will be precluded from bringing a fraud action against the sponsor based upon material omissions in the offering plan ( Kerusa Co. v Real Estate LP, supra, 12 NY3d at 245). Similarly, a purchaser of a coop will be precluded from asserting a claim for negligent misrepresentation or breach of the fiduciary duty of disclosure based upon misleading statements extrinsic to the offering plan ( Horn v 440 East 57th Street Co., 151 AD2d 112, 120, 1st Dept., 1989). In Horn, the court reasoned that the existence of a fiduciary relationship had been "substituted" for the element of intent to deceive in a fraud
action.
Where an investment advisor recommends a hedge fund without conducting sufficient due diligence, an investor's breach of fiduciary duty claim "arises in the securities context" ( Bayou Hedge Fund Litigation, 534 F. Supp.2d 405, 422, SDNY 2007, aff'd sub nom., South Cherry St. v Hennessee Group, 573 F.2d 98, 2d Cir., 2009). Such a claim will be precluded by the Martin Act, regardless of whether it involves an element of deception, because it is "related to a securities fraud claim" (Id at 421). Similarly, where a claim for breach of fiduciary duty is based upon a "significant component" of the representations that induced plaintiff to invest, the claim arises from the alleged securities fraud and is preempted by the Martin Act ( Heller v Goldin Capital, 590 F. Supp. 2d 603, 612, SDNY 2008). In Heller, a claim for breach of fiduciary duty based upon misrepresentations as to a fund's capitalization and diversification was preempted. Similarly, claims against a fund for unjust enrichment and conversion, based upon misrepresentations as to the investment's level of risk, are precluded as merely "recast securities fraud claims" ( Owens v Gaffken Barrige Fund, supra, 2009 U.S. Dist. LEXIS 90895).
While the limited partnership interests in Andover Associates were securities, plaintiff's breach of fiduciary duty claim does not relate to fraud in connection with the sale of the limited partnership interests. Rather than Andover Management giving plaintiff any investment advice, plaintiff entrusted his money to Andover Associates so that it could make the investments. Plaintiff alleges that Andover Management breached its fiduciary duty by failing to exercise diligence and prudence, not with respect to investment recommendations, but in the management of Andover Associates' investments. Thus, plaintiff's breach of fiduciary duty claim does not arise from alleged securities fraud and is not simply a recast securities fraud claim. Defendants' motion to dismiss is denied to the extent that it argues that plaintiff's claim against Andover Management for breach of fiduciary duty and his claim against Danziger and Markhoff for aiding and abetting breach of fiduciary duty are preempted by the Martin Act.
Gross negligence is the failure to exercise even "slight care" or "slight diligence" ( Gentile v Garden City Alarm, 147 AD2d 124, 131, 2d Dept., 1989). It is conduct that is so careless as to show complete disregard for the rights and safety of others (Id). While Andover Management denies that it knew of Madoff's scheme, if may be inferred that Andover Management failed to exercise even slight care in failing to detect it. Similarly, it may inferred that in entrusting Andover Associates' funds to Madoff, Andover Management showed complete disregard for Andover Associates' rights and the safety of its investment. That public regulators also failed to uncover the fraud does not establish that Andover Management was diligent. Defendants' motion to dismiss plaintiff's gross negligence claim for failure to state a cause of action is denied.
Additionally, because defendants' gross negligence is not based upon a significant component of the representations that induced plaintiff to invest, it is not a recast securities fraud claim. Defendants' motion to dismiss plaintiff's gross negligence claim as preempted by the Martin Act is denied.
Plaintiff claims that Andover Management breached the provision in the limited partnership agreement, prohibiting the investment consultant's fee from being paid from partnership assets, by arranging for the partnership to pay Ivy an "administrative services fee," which, plaintiff alleges, was merely a disguised fee for the investment consultant. In moving to dismiss this claim, Andover Management argues that the administrative services agreement "had nothing to do" with investment consulting services. However, the offering memorandum suggests that the line between "administrative services" and investment consulting may have been hard to draw. Because Ivy was responsible for maintaining original records of Madoff's trades, the line may have been particularly vague with respect to the Madoff investment. In any event, the court cannot conclude that the administrative services fee was not a disguised fee for the investment consultant. Defendant Andover Management's motion to dismiss plaintiff's claim for breach of the limited partnership agreement for failure to state a cause of action is denied.
Business Corporation Law § 626(b) provides that plaintiff in a shareholder derivative action must be a holder at the time of bringing the action and have been a holder at the time of the transaction of which he complains or have received his shares by operation of law. Ownership at the time of the alleged wrong, the "contemporaneous ownership doctrine," is designed to "prevent litigious persons from buying stock for the purpose of bringing suit as to alleged past mismanagement" ( Independent Investor Protective League v Time, Inc., 50 NY2d 259, 263, 1980). The rule furthers the public policy of inhibiting speculation in litigation and must, as a general matter, be "rigorously enforced" (Id.) In Tzolis v Wolff, supra, the Court of Appeals suggested that the contemporaneous ownership requirement also applies to derivative actions on behalf of limited liability companies ( 10 NY3d at 109).
Ivy argues that plaintiff cannot maintain claims against Ivy for negligence or aiding and abetting breach of fiduciary duty because those claims are based on defendant's failure to investigate Madoff which occurred prior to plaintiff's investment.
Ivy asserts that, after January 1, 2006, its duty to perform due diligence was limited by the consulting agreement which provides that Ivy would research and evaluate investment managers other than Madoff.
In response, plaintiff asserts that Ivy's duty to perform due diligence with respect to Madoff arose pursuant to the confidential offering memorandum and the administrative services agreement. The confidential offering memorandum provided that the investment consultant, Ivy, would provide advice as to the selection of independent investment managers as well as certain administrative and accounting services for Andover Management. The administrative services agreement required Ivy to reconcile the Madoff statements against trade tickets and maintain the original books of Madoff's trades. Despite the limitation in the consulting agreement, it may be inferred that a reasonable administrative services provider would have insisted upon proper documentation and reported the absence of trade tickets to Andover Management. Thus, plaintiff's negligence and aiding and abetting breach of fiduciary duty claims are not barred by the contemporaneous ownership doctrine. Defendant Ivy's motion to dismiss plaintiff's negligence and aiding and abetting breach of fiduciary duty claims for lack of standing are denied. However, plaintiff's negligence claim is limited to Ivy's failure to perform due diligence within three years of the commencement of the action, that is failure to perform due diligence on or after April 1, 2006.
The threshold question in any negligence action is whether defendant owes a legally recognized duty of care to plaintiff ( Hamilton v Beretta Corp., 96 NY2d 222, 232, 2001). The duty is defined "by balancing several factors, including the reasonable expectations of the parties and society generally, the proliferation of claims, the likelihood of unlimited or insurer-like liability, disproportionate risk and reparation allocation, and public policies affecting the expansion or limitation of new channels of liability" (Id). "Foreseeability, alone, does not define duty — it merely determines the scope of the duty once it is determined to exist. The injured party must show that a defendant owed not merely a general duty to society but a specific duty to him or her, for without a duty running directly to the injured person there can be no liability in damages, however careless the conduct or foreseeable the harm" (Id.).
Ivy argues that any duty of due diligence ran to Andover Management, the party with whom it contracted in the consulting agreement, not to Andover Associates. However, because Andover Management, the general partner, owed a duty of reasonable care to the partnership, the reasonable expectations of the contracting parties was that Ivy owed a duty of reasonable care to Andover Associates. Moreover, there is no danger of proliferation of claims in recognizing a duty of due diligence running in favor of the limited liability company or partnership. While a derivative action may potentially be brought by any member or limited partner, there can be only one recovery in favor of Andover Associates. Thus, the court concludes that Ivy owed Andover Associates a duty to investigate the investment manager with reasonable diligence.
"A contracting party may be charged with a separate tort liability arising from a breach of duty distinct from, or in addition to, the breach of contract. A tort may arise from the breach of a legal duty independent of the contract, but merely alleging that the breach of a contract duty arose from a lack of due care will not transform a simple breach of contract into a tort" ( Sommer v Fed. Signal Corp., 79 NY2d 540, 551, 1992). An investment consultant may owe a fiduciary duty of loyalty and care to an investment fund which is independent of the duty which is created by the consulting agreement ( Sergeants Benevolent Ass'n v Renck ,19 AD3d 107, 111, 1st Dept., 2005). In that circumstance, a negligence action by the fund is not duplicative of its breach of contract claim. In the present case, plaintiff's claim for breach of contract arises from the administrative services agreement, but his claims for negligence and breach of fiduciary duty are based upon an independent duty of due care arising from Ivy's role as the investment consultant.
Pursuant to the "economic loss rule," absent personal injury or property damage, plaintiff may not recover for economic injury, such as lost income, in an action for negligence ( 532 Madison Ave. v Finlandia, 96 NY2d 280, 288-92, 2001). In 532 Madison Ave, the court held that a business which did not suffer any property damage could not recover lost income caused by defendant's construction accident. The court reasoned that limiting the scope of defendant's duty to those who had suffered personal injury or property damage was a "principled basis" for apportioning liability (Id at 292).
In the present case, plaintiff is not seeking lost income but rather the value of the Madoff investment. Because the number of investors whom Ivy channeled to Madoff appears to be limited, there is no danger of insurer-like liability. Defendant Ivy's motion to dismiss plaintiff's negligence claim for failure to state a cause of action is denied.
"In disentangling tort and contract claims, [the court has] considered the nature of the injury, the manner in which the injury occurred and the resulting harm" ( Sommer v Fed. Signal Corp., supra, 79 NY2d at 552). "[W]here plaintiff is essentially seeking enforcement of the bargain, the action should proceed under a contract theory." While nonfeasance, or failure to perform a duty, was traditionally viewed as a breach of contract, and misfeasance, or defective performance, was viewed as sounding in tort, such labels are not controlling (Id).
In his claim for breach of the administrative services agreement, plaintiff seeks damages in the amount of the value of Andover's Madoff investment. Thus, plaintiff does not seek "the benefit of the contractual agreement" but rather tort damages in the form of the harm caused by defendant's conduct ( Camp Kennybrook, Inc. v Kuller, 214 AD2d 264, 267, 3d Dept., 1995). The court concludes that plaintiff's cause of action for breach of the administrative services agreement is duplicative of his claim for negligence. Defendant Ivy's motion to dismiss plaintiff's claim for breach of contract for failure to state a cause of action is granted.
A cause of action for aiding and abetting a breach of fiduciary duty requires a showing of a fiduciary duty owed to plaintiff by another, a breach of that duty, defendant's substantial assistance in effecting the breach, together with resulting damages ( Keystone Int'l v Suzuki, 57 AD3d 205, 208, 1st Dept., 2008). Ivy argues that it did not provide substantial assistance because it did not know that Andover Management breached its fiduciary duty to Andover Associates. Ivy may not have been aware of the provision in Andover Associates' limited partnership agreement prohibiting the investment consultant's fee from being paid from partnership assets. Furthermore, Ivy may have understood the consulting agreement as not requiring it to perform due diligence with respect to Madoff.
However, in view of Ivy's expertise in the securities industry, it may be inferred that it knew that Andover Management was under a fiduciary duty of diligence and prudence with respect to Andover Associates' investments. Moreover, because Ivy was the investment consultant, it may be inferred that Ivy knew that Andover Management was not performing due diligence with respect to Madoff. In the case on which Ivy relies, Design Strategies, Inc. v Davis, ( 384 F. Supp.2d 649, SDNY, 2005), the alleged aider and abettor did not know that a disloyal employee was not authorized to obtain a corporate opportunity for a competitor of his employer. Since it may be inferred that Ivy was aware of Andover Management's fiduciary duty to Andover Associates, Design Strategies is readily distinguishable. Defendant Ivy's motion to dismiss plaintiff's claim for aiding and abetting a breach of fiduciary duty for failure to state a cause of action is denied.
Accounting malpractice contemplates a failure to exercise due care and proof of a material deviation from recognized and accepted professional standards for accountants and auditors ( Friedman v Anderson , 23 AD3d 163 , 1st Dept., 2005). Plaintiff must establish that defendant departed from generally accepted accounting principles and the departure was the proximate cause of plaintiff's injury ( Kristina Denise Enterprises v Arnold , 41 AD3d 788 , 2d Dept., 2007). Giving plaintiff the benefit of every possible favorable inference, the court must assume that an audit of Andover Associates' investments conducted pursuant to generally accepted accounting procedures would have uncovered Madoff's fraud.
Although Citrin Cooperman was retained after plaintiff invested in Andover Associates, the court must assume that a proper audit would have provided Andover with the opportunity to liquidate its investment. Although the specific funds invested by Andover Associates could, of course, not be returned, because Madoff was in possession of other monies, the court must assume that Andover could have obtained the return of its investment. Thus, plaintiff has sufficiently alleged that Citrin Cooperman's departure from generally accepted auditing procedures was the proximate cause of the loss of Andover's investment. Defendant Citrin Cooperman's motion to dismiss the amended complaint for failure to state a cause of action is denied. Nevertheless, plaintiff may not recover the amount of profit which Madoff fraudulently claimed that Andover Associates earned, and Andover's damages are limited to the amount of its un-recouped investment.
Defendant Andover Associates LLC moves to transfer the action based on the provision in the subscription agreement that any action or proceeding arising from the subscription agreement shall be resolved within the County of Westchester. Defendants Andover Management, Danziger, Markhoff, and Citrin Cooperman join in the motion. On May 15, 2009, counsel for defendant Andover Associates LLC sent an email to counsel for plaintiff demanding that venue be changed to Westchester. On May 19, 2009, counsel for plaintiff sent a reply asserting that Nassau was a proper county because "one or more defendants" resided in Nassau. Ivy is in fact the only defendant who maintains an office in Nassau. Defendant's motion to transfer venue was made on October 22, 2009.
"A contractual forum selection clause is prima facie valid and enforceable unless it is shown by the challenging party to be unreasonable, unjust, in contravention of public policy, invalid due to fraud or overreaching, or it is shown that a trial in the selected forum would be so gravely difficult that the challenging party would, for all practical purposes, be deprived of its day in court" ( Trump v Deutsche Bank Trust Co. , 65 AD3d 1329 , 1331, 2d Dept., 2009). Defendants argue that plaintiff's claims arise from the subscription agreement, and Nassau is not a proper county because the forum selection clause requires the action to be brought in Westchester. Nevertheless, in moving for a change of venue on the basis of a forum selection clause, the moving party must comply with CPLR 511(b).
CPLR 511(a) provides that a demand for change of place of trial on the ground of improper county shall be served with the answer of before the answer is served. Since defendant Andover Associates LLC served its answer on June 19, 2009, its demand to change venue on the ground that Nassau was not a proper county was timely. CPLR 511(b) provides that defendant may move to change the place of trial within fifteen days after service of the demand, unless within five days after service plaintiff serves a written consent to change the place of trial to that specified by defendant. Since defendant Andover Associates LLC did not move to change the place of trial within fifteen days of May 15, 2009, its motion to change the place of trial was not timely. The parties' stipulations extending the time to "answer or otherwise move" with respect to the complaint did not have the effect of extending the time to move to change venue on the ground that Nassau was not a proper county.
Nevertheless, the court will consider defendant's motion as a motion to change the place of trial based on the convenience of material witnesses and the ends of justice pursuant to CPLR § 510(3). The party moving for a change of venue pursuant to CPLR § 510(3) has the burden of demonstrating that the convenience of material witnesses would be better served by the change ( Walsh v Mystic Tank Lines , 51 AD3d 908 , 2d Dept., 2008). The moving party must set forth 1) the names, addresses, and occupations of the prospective witnesses, 2) the facts as to which the witnesses will testify at trial, so that the court may judge whether the proposed evidence is necessary and material, 3) a statement that the witnesses are willing to testify, and 4) a statement that the witnesses would be greatly inconvenienced if the venue of the action is not changed (Id).
The only facts which defendant offers in support of its motion are that Anderson Associates and "all documents and witnesses relating to the Fund" are located in Westchester. Since defendant has not shown that the convenience of material witnesses would be better served by a change, defendant Andover Associates LLC's motion to change the place of trial to Westchester is denied.
This shall constitute the decision and order of the court.
A Preliminary Conference has been scheduled for April 27, 2010 at 9:30 a.m. in Chambers of the undersigned. Please be advised that counsel appearing for the Preliminary Conference shall be fully versed in the factual background and their client's schedule for the purpose of setting firm deposition dates.