Business Litigation in the Southern District of New York

Judge Kaplan Finds Claim of Fraud Trumps Attorney-Client Privilege

Tony Coles — Sun, 05 May 2013 14:54:02 -0600

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.

In 2011, an Ecuadorian court entered an $18.2 billion judgment against Chevron in an environmental action brought by 47 individuals (the “Lago Agrio Plaintiffs” or “LAPs”). The Patton Boggs firm acted as co-counsel for the LAPs in the Ecuadorian case and has taken the lead role in subsequent American proceedings to enforce the judgment. In the case at hand, one of a cascade of motions and litigations arising out of the judgment, Chevron asserted RICO and common law fraud claims against the LAPs and one of their attorneys, alleging that the Ecuadorian judgment was fraudulently obtained. Patton Boggs is a named RICO co-conspirator but not a defendant. Accordingly, Chevron subpoenaed Patton Boggs for documents relating to services the law firm provided to plaintiffs in the Ecuadorian litigation. Patton Boggs resisted compliance on attorney-client privilege and work product grounds.

To resolve the dispute, Judge Kaplan engaged in what he called a “painstaking, step-by-step process”:

First, the court found “probable cause” in the existing factual record to believe there was fraud or other criminal activity in the procurement of the Ecuadorian judgment. For example, Chevron adduced evidence that the LAPs’ representatives threatened the judge with a judicial misconduct complaint in order to coerce him into appointing a hand-picked expert. That expert, who was charged with undertaking an “independent” assessment of alleged environmental conditions, submitted a report attributing $27.3 billion in damages to Chevron.

Second, Judge Kaplan limited the subpoena’s scope to the subjects as to which Chevron had established probable cause to suspect fraud or criminal activity. There is no legitimate claim of privilege as to those documents because they “relate to the crime or fraud and [therefore] were in furtherance of the crime or fraud.”

Third, the court found that Chevron had established substantial need for the documents it sought and that it could not obtain their equivalent elsewhere. Patton Boggs “has had a hand in almost every major development” and was a “unique source of evidence of the alleged fraud that is available nowhere else.” A finding of substantial need destroys any remaining ordinary work product claim, whether the documents furthered a crime or fraud or not.

According to Judge Kaplan: If probable cause exists as to the commission of a fraud or crime, it is not necessary to show also that a lawyer from whom otherwise privileged or protected documents may be sought was a culpable or knowing participant in the fraud or crime. On that basis, the court ordered Patton Boggs to produce all documents responsive to the now-narrowed subpoena. Patton Boggs was also ordered to submit a privilege log of all documents that it claims did not relate to fraud and are otherwise subject to attorney-client privilege.

(My colleague, Jason Gerstein ably crafted this entry.)

Judge Sullivan Teaches Apple a Lesson

Tony Coles — Sun, 10 Mar 2013 17:57:17 -0600

Activist investor David Einhorn’s hedge fund, Greenlight Capital, withdrew the highly publicized case it brought against Apple alleging that the tech giant tried to ram through a proposal in its annual proxy by “bundling” it with other less controversial proposals. But not before Judge Sullivan gave Greenlight a nice win, and left some important precedents on proxy voting for the rest of us.

The issue in Greenlight Capital v. Apple, Inc. was whether, for purposes of a shareholder vote, Apple could bundle its proposal to revoke its Board’s power to unilaterally issue preferred stock, commonly known as “blank check” authority, with several unrelated proposals with shareholder appeal. According to Judge Sullivan, the authority to unilaterally issue preferred shares “has been derided by shareholder rights advocates given its potential use as an anti-takeover tactic…” Nevertheless, Greenlight – owner of 1.3 million shares – wanted Apple’s Board to exercise that “derided” power and issue perpetual preferred shares with a 4% dividend to existing shareholders because Apple’s stock price has stagnated.

Greenlight’s and Apple’s difference of opinion might never have reached the courthouse if Apple had not “bundled” the proposal with three other proposals. In addition to the elimination of “blank check” authority, Apple sought to (1) conform previously adopted majority voting provisions to California state law; (2) establish a par value for Apple’s common stock; and (3) address other ministerial changes. Presumably, Apple figured the bundled proposal was sure to pass. Greenlight argued that by combining these four issues into a single proposal for a shareholder vote, Apple violated an SEC rule requiring a company’s proxy statement to “identify clearly and impartially each separate matter intended to be acted upon.”

Judge Sullivan agreed with Greenlight, and preliminarily enjoined Apple from offering the bundled proposal to its shareholders. Of particular interest, the court found that Greenlight would be irreparably harmed by having to vote on the proposal, and that the balance of equities -- between affecting Greenlight’s shareholder rights, on the one hand, and forcing Apple to pay an estimated $3 million to prepare an amended proxy as well as validating a claimed “unprecedented interference [into] the exercise of corporate suffrage by one of the most respected companies in America,” on the other hand -- weighed in Greenlight’s favor.

The immediate impact of the opinion is that Apple’s CEO Tim Cook withdrew the bundled proposal and expressed a willingness to take seriously Einhorn’s and other investors’ suggestions on how to unlock more of Apple’s cash pile, one of the largest in technology. And the Apple Board's blank check authority, disliked by shareholder rights groups, can be reset for a vote next year on its own merits. Not a bad outcome all around. The high profile decision and fast paced nature of the case -- Greenlight filed its complaint on February 7 and Judge Sullivan issued his opinion on February 22 – also likely will appeal to plaintiffs seeking to force corporate action in the future.

(Hat tip again to Neal Kronley for his help on this post.)

Judge Rakoff on the Edge Act and "Local Prejudices of State Courts"

Tony Coles — Thu, 28 Feb 2013 14:13:07 -0600

Investors who lost money in the housing crisis may prefer to have their case heard by a hometown jury in state court, instead of as a federal securities fraud claim. But if their investment included properties outside of the United States, the Edge Act – created after WWI "in order to protect federally chartered banks engaged in international banking from variations in state law and the local prejudices of state and insular courts" – will force their claims into federal court.

As Judge Rakoff found in Dexia SA/NV v. Bear Stearns, the Edge Act even mandates federal jurisdiction where the international banking is an incidental aspect of the case. In Dexia, investors sued in state court claiming that a number of federally chartered banks misrepresented the quality of 250,000 mortgage loans that supposedly collateralized various securities offered by the banks. Of the 250,000 loans, eighteen were located on properties in the Virgin Islands. The plaintiffs argued that the Edge Act did not apply at all because the core of their case was based on the fraudulent marketing of the securities in the United States, not on the underlying mortgages. But Judge Rakoff found that claim was undermined by the investors’ own complaint, which alleged that the value of the securities offered by the banks depended on the quality of the underlying mortgages, including the lonely eighteen mortgages in the Virgin Islands. Nor was the court impressed by the argument that the Edge Act did not apply because the mortgages were sponsored by a subsidiary, not by the federally chartered bank itself. As long as the federal bank has “potential liability,” the Edge Act applies, and here both the bank itself and its subsidiary were sued.

So the investors lost out on trying to benefit from any perceived “local prejudices of state and insular courts.” But keep in mind that the scope of the Act is not fully settled in the SDNY. In Allstate Ins. Co. v. CitiMortgage, Inc., Judge Sullivan did not apply the Edge Act and remanded a case to state court on a similar set of facts. He found that remand statutes are to be construed narrowly, and that the federally chartered bank was not a itself a party to the Offering that contained the international mortgages, even though it was a party to the overall lawsuit.

Judge Rakoff Issues First Verdict Ever For Insurer and Against Bank for Bad Mortgages

Tony Coles — Sat, 23 Feb 2013 16:18:53 -0600

Judge Rakoff issued an opinion with significant implications for parties litigating cases involving mortgage backed securities. In Assured Guaranty v. Flagstar Bank, Assured sought to recover some $89 million in insurance claims it paid to bondholders who invested in Flagstar bonds secured by what turned out to be lousy mortgages. When the mortgage market collapsed, the bonds secured by the mortgages also failed, leaving Assured on the hook. Assured claimed that Flagstar breached its contract with Assured by overstating the quality of the mortgages when it asked Assurance to insure the bonds -- about 15,000 separate mortgage loans. After a bench trial, Judge Rakoff agreed with Assured and found that Flagstar was liable for the $89 million in insurance claims paid by Assured to bondholders. Judge Rakoff's opinion is the first ever after trial holding a bank liable for breach of its representations and warranties to its monoline insurer about the quality of the morgages it originated.

Also of interest, both Assured and Flagstar relied on expert testimony to explain why - or why not - the loans suffered from material defects. But how do you actually try a case that involves the minute details of 15,000 different mortgage loans? Notably, the court focused on a statistical sample of 800 loans rather than the total universe of 15,000 loans used for collateral. Assured’s expert found a compendium of unreliable loan documentation in the sampled loan files, representing an overview of much that went wrong in the housing market: loans made to borrowers who failed to disclose significant debt obligations, loans made to borrowers who inflated their incomes, loans made to borrowers who misrepresented their occupancy, and loans made with incomplete documentation. Assured found that a whopping 76% of the sampled loan applications were bogus.

In determining that Flagstar breached its contract with Assured, Judge Rakoff extrapolated these findings to all 15,00 of the insured loans. The use of a statistical sample to extrapolate the volume of defective loans in the total loan population is significant. While this is not the first time that the method has been used – in fact, Judge Rakoff cites to two other cases in New York courts where it has been done before – it is reportedly the first instance to do so in a housing crisis trial. According to Judge Rakoff:

“Although Flagstar argues that the fact determination of material breach in any given instance requires consideration of an entire loan file renders the loans ill-suited to proof by statistical sampling, this argument is unpersuasive. The very purpose of creating a representative sample of sufficient size is so that, despite the unique characteristics of the individual members populating the underlying pool, the sample is nonetheless reflective of the proportion of the individual members in the entire pool exhibiting any given characteristic.”

Finally, the central question in the case – whether underwriting standards were materially defective – of course is also at the heart of cases involving MBS proceeding in courthouses across the country. Here in the Southern District, for example, cases before Judge Cote alone brought by the Federal Housing Financing Agency on behalf of Fannie Mae and Freddie Mac seek up to $200 billion in combined damages from a who’s who of banks, including Bank of America, Citigroup, Inc., and Morgan Stanley. Undoubtedly, the Assured opinion – and appeal - will be followed closely.

(Thank you to my colleague Neal Kronley who helped prepare this entry.)

Judge Stein on Saddam, Oil for Food and RICO

Tony Coles — Sat, 09 Feb 2013 15:37:39 -0600

In Republic of Iraq v ABB AG, Judge Stein dismisses claims by the current Iraqi government, the Republic of Iraq, against BNP Paribas under RICO for facilitating the corruption of the United Nation’s Oil for Food Program by the Saddam Hussein Regime. The Oil for Food Program was intended to allay the suffering of the Iraqi people caused by worldwide trade sanctions against Iraq after its 1990 invasion of Kuwait. The Program allowed Iraq to sell oil to third parties so long as the proceeds were used to purchase food and medical supplies for the Iraqi population. Under the Program, the proceeds of approved sales were deposited in a UN escrow account at the New York Branch of BNP Paribas. According to the complaint, the Hussein Regime, with the active assistance of the Bank and other defendants, exploited the Program to siphon off millions of dollars in kickbacks for itself and its political allies.

In a fascinating decision, Judge Stein finds the Republic has standing to sue for wrongful depletion of the UN escrow account because the account was held for Iraq’s “proprietary benefit,” and further finds that the Republic’s claims are not barred by either the act of state or political question doctrines. But, after dangling those hopeful signs before the Republic, he then dismisses its case against BNP with prejudice.

First, Judge Stein finds that the RICO scheme concerning the Oil for Food Program “is primarily foreign…” Accordingly, there is no basis for adjudication of the claim in the SDNY. “The RICO statutes do not apply extraterritorially… [and] the peripheral contacts with the United States - up to an including the use of a New York bank account - do not bring an otherwise foreign scheme within the reach of the RICO statutes.”

But, Judge Stein goes further and also finds that the corruption of the Program by the Hussein Regime is attributable to the Republic. Therefore, the Republic's RICO claims also are dismissed on the grounds of its own in pari delicto. “The ethicality, illegitimacy, or illegality of the acts [of the Hussein Regime] does not immunize the Republic of Iraq from responsibility. Instead, the Republic of Iraq bears responsibility for the Hussein Regime’s conduct alleged here because that conduct was governmental.” Judge Stein also finds that BNP’s servicing of the escrow account was too remote to be the proximate cause of Iraq’s RICO injuries.

The American court system can look pretty appealing to aliens, even foreign governments – you don’t have to pay the other side’s legal fees if you lose, and you get wide ranging discovery with the benefit of capacious statutes that allow for a cocktail of claims (RICO, 10b-5, aiding and abetting liability to name a few). And sometimes even the threat of treble damages. Why wouldn’t an alien plaintiff try to get his case heard here? Yet, like Judge Stein, our courts are more and more testing the notion that they should welcome claims arising outside our borders.

Judge Scheindlin Keeps Rating Agencies on the Hot Seat (Update on DOJ Filing)

Tony Coles — Sun, 03 Feb 2013 13:02:13 -0600

Judge Scheindlin continues to define the law for rating agencies, finding that they don’t have immunity from fraud claims on the ground that their ratings are merely their own opinions, not statements of fact. That’s pretty significant for lawsuits arising out of the subprime mortgage meltdown. Here’s how she nicely sums up the essence of a viable fraud claim against a rating agency in King's County v. IKB Deutsche Industriebank, which involved a rating for a structured investment vehicle made up of bad mortgages: “To sustain a fraud claim against each rating agency, then, plaintiffs must provide evidence that the rating agency issued a rating that it knew was unsupported by facts or analysis – that the rating agency did the equivalent of issuing a restaurant review despite never having dined at the restaurant.”

In denying motions by the rating agencies for summary judgment, Judge Scheindlin addresses each of the elements of a fraud claim against a rating agency. First, she finds that when "a rating agency issues a rating, it is not merely a statement of that agency’s unsupported belief, but rather a statement that the rating agency has … reached a fact based conclusion as to creditworthiness.” Next she finds that a jury can infer scienter, or intent to defraud investors, based on evidence that an agency issued a rating it knew was inaccurate, and that a plaintiff’s testimony is enough on its own to establish “reliance” on the rating. She also finds that reliance on the rating agencies can be reasonable where the agencies had access to information not available to investors, and the investments rated were “the most opaque structured credit vehicles and transactions on the market.”

King’s County makes much reference to Judge Scheindlin’s much publicized 2012 decision in Abu Dhabi Commercial Bank v.Morgan Stanley. Together, they show that conclusions that the rating agencies were going to be able to stroll away from the 2007/2008 subprime meltdown were premature. As well, of course, they are a marker for allocating responsibility in future meltdowns.

UPDATE: The Department of Justice announcded the filing of a civil fraud suit against Standard and Poor's on Feb. 4, venued in California. The case arises from ratings provided in connection with the subprime meltdown. Here's an early news report, and here's the DOJ Complaint.

Judge Crotty on Foreign Entanglements

Tony Coles — Fri, 28 Dec 2012 12:56:39 -0600

Yulia Tymoshenko is the former prime minister of the Ukraine, and was one its most successful businesswomen, reportedly making a fortune in the natural gas industry. Today, however, she is serving a seven year prison sentence in the Ukraine for abuse of power and for working against the Ukraine’s interests while in office by agreeing to buy natural gas from Russia at inflated prices. Her supporters claim the sentence resulted from an unfair trial, and Tymoshenko has challenged her conviction in the European Court of Human Rights. (Here is a brief news summary of Tymoshenko's political fights and present situation from Times Topics.)

But business moves on. In a case involving the scope of personal jurisdiction over foreign parties, Universal Trading v. Tymoshenko, Judge Crotty found that the New York courts did not have personal jurisdiction over Tymoshenko, and dismissed an action to enforce a $18.3 million judgment against her that stemmed from a mid-1990s commercial dispute in the Ukraine.

Citing Supreme Court precedent that ‘[g]reat care and reserve should be exercised when extending our notions of personal jurisdiction into the international field,’ Judge Crotty found that Tymoshenko’s filing of an “unrelated” action as plaintiff in the SDNY, and hiring public relations and consulting firms in the U.S.” was insufficient to establish jurisdiction over her.* As to Tymoshenko’s hiring of U.S. advisers and consultants, Judge Crotty found that “there are no allegations [in the complaint] regarding the scope of the efforts taken on her behalf by these agents, nor, more importantly, does Universal Trading allege that any such efforts were made in New York.”

Judge Crotty also rejected the argument that Tymoshenko is subject to personal jurisdiction “because she did business in New York by directing numerous… transactions, passing [through] bank accounts in New York.” The Judge recognized that in very specific circumstances a bank that moves money through New York may be subject to jurisdiction here, but found no precedent “in which a foreign individual holding foreign accounts has been found subject to jurisdiction in New York because their bank moved money through New York via a correspondent account.”

The ruling is informative on the scope of jurisdiction over foreign parties, and reflects a wise concern about entangling our federal courts in foreign commercial disputes.

(* DLA Piper is counsel to one of the defendants in the unrelated action involving Tymoshenko referred to by Judge Crotty (11 cv 1794 (SDNY).)

Judge Scheindlin on Watching Sports

Tony Coles — Thu, 13 Dec 2012 17:50:39 -0600

Even an avid sports fan might reasonably believe that there's no shortage of sports programming on television. But according to Judge Scheindlin in Laumann v. National Hockey League, predatory practices by the National Hockey League and Major League Baseball, and television providers, may be restricting choice and pushing up the cost of watching our favorite teams.

TV subscribers sued their cable and satellite television providers, the NHL, the MLB, and regional sport networks (like YES, or MSG). They claim that those defendants agreed to divide the market for hockey and baseball broadcasts so that subscribers in one region usually can only watch their local team. The only way a subscriber can watch all the games of a favorite team that plays in another region is by buying an expensive "all league games" package. So, if you live in New York but root for the San Francisco Giants, you are blacked out from Giants games unless you buy a television or internet package that includes the games of every other team outside of New York. Without these agreements the regional network that produces the Giants, for example, might decide to compete against the local Yankee broadcasts, or vice-versa - which could be good for sports fans.

Judge Scheindlin allowed the case to go forward. She held that since all the defendants were claimed to be acting jointly, plaintiff could sue them all – even though they only made purchases directly from the cable and satellite companies. But she did limit the class of plaintiffs to those who actually subscribed to out of market sports packages, excluding those who simply purchased basic cable or satellite services and claimed that the illegal agreements increased the price of their package.

Judge Scheindlin found that the plaintiffs plausibly alleged that the agreements between the leagues, the television providers and the regional networks harmed competition. She also found that an “all or nothing package” was not a replacement for individual competition among the teams. “Making all games available as part of a package, while it may increase output overall, does not, as a matter of law, eliminate the harm to competition wrought by preventing the individual teams from competing to sell their games outside of their home territories in the first place.”

Although Judge Scheindlin found all defendants potentially on the hook for agreeing to divide the market (section 1 of the Sherman Act), she did dismiss the claim that the regional networks and cable and satellite providers illegally conspired to use monopoly power to prevent competition in the market for broadcasting of games (section 2 of the Sherman Act). That claim only survived against the baseball and hockey leagues, as only they have real monopoly control over baseball and hockey games, and allegedly "used their monopoly power to restrict the broadcast of television programming in a manner that harms competition."

Judge Scheindlin’s thorough opinion, by the way, is a great primer on anti-trust pleading. And for sports fans, particularly those who are not fans of their home teams, the case is very much worth watching.

Hat tip to my colleague, Paolo Morante, who assisted with this post.

Judge Engelmayer Shoots Down a Starr

Tony Coles — Wed, 05 Dec 2012 15:18:46 -0600

Starr International, a shareholder of AIG, is run by AIG's former leader, Hank Greenberg. In Starr Intern'l v. Federal Reserve Bank of New York, Judge Engelmayer takes on Starr’s charge that the FRBNY ran roughshod over AIG’s shareholders when it bailed out AIG during the 2008 financial crisis. Judge Engelmayer describes Starr’s complaint as painting "a portrait of government treachery worthy of an Oliver Stone movie." But like much of Oliver Stone’s work, the Judge found the complaint contains more imagination than fact.

According to Starr, the FRBNY exploited its financial rescue of AIG to create “a backdoor bailout” of other banks. In particular, the FRBNY required AIG to satisfy its outstanding credit default swap contracts (insurance that AIG provided to banks for the banks’ disastrous subprime mortgage loans) on "terms needlessly detrimental to AIG.” The complaint also alleges that the FRBNY circumvented Delaware law anti-dilution provisions by grabbing 80 per cent of AIG's common stock. Because the FRBNY was alleged to have “de facto” control of AIG by reason of its rescue package, Starr alleged it “stood in a fiduciary relationship to AIG’s other shareholders…,” and had to act in the shareholders’ interests.

Judge Engelmayer determined that "against the settled standards of corporate control under Delaware law, Starr has not adequately pled that FRBNY controlled AIG at the time of the... challenged transactions," and that therefore "has not adequately pled that FRBNY was at those times a fiduciary to AIG and its shareholders." Judge Engelmayer found that AIG’s board was independent of the FRBNY, elected “through the ordinary mechanisms of corporate democracy.” According to the Judge, the decision to accept the federal rescue package describes “a moment of corporate desperation, in which AIG’s board grabbed the sole lifeline expended to the company. Merely because the AIG board felt it had ‘no choice’ but to accept bitter terms from its sole available rescuer does not mean that the rescuer actually controlled the company.”

But the Court went even further and determined that the FRBNY was a federal instrumentality, exempt from state fiduciary law. Otherwise, the FRBNY would be charged with “fundamentally incompatible missions.” On the one hand, it would be charged with the “unyielding duty” under Delaware law to further the interests of AIG shareholders, and, on the other hand, to act as “a custodian of the stability of the national banking system.” In these circumstances the federal mission, and federal law, take precedence. Judge Engelmayer found that the FRBNY’s judgment that the "stability of the U.S. economy required decisively terminating AIG’s exposure to counterparties; and that paying par value – as opposed to opening up a bazaar of uncertain any maybe protracted negotiations with counterparties- was the best means to attain such closure” shouldn't be second guessed.

The decision runs 89 pages, and includes an informative “good read” of the reasons for AIG’s meltdown, and the role of the Federal Reserve in our economy. In the end, Judge Engelmayer dismissed Starr’s entire suit with prejudice, finding no government treachery. "It is, however, one thing to make a sweeping and dramatic claim of government misconduct. It is quite another to plead plausibly... and based on concrete factual allegations... that FRBNY exercised control over AIG."

Judge Netburn on PLSRA and Prejudice

Tony Coles — Wed, 28 Nov 2012 06:42:36 -0600

The Private Litigation Securities Reform Act of 1995 was passed (over Bill Clinton's veto) in order to limit frivolous federal securities fraud lawsuits. The Act established strict pleading requirements, and, in order to reduce the costs of litigation, barred discovery during the pendency of a motion to dismiss, which is the routine first line of defense to securities lawsuits. A plaintiff can obtain discovery if a motion to dismiss is pending only if the discovery is necessary to preserve evidence or prevent "undue prejudice."

In In Re GMR Securities Litigation, Magistrate-Judge Netburn was faced with plaintiff's claim that he was the only "stakeholder" in the litigation without access to documents, and therefore was suffering undue prejudice. Judge Netburn noted that the Second Circuit has not yet addressed the meaning of "undue prejudice" under the PLSRA, but found that the fact that other individuals have access to the documents plaintiff wants is not "controlling." Rather, plaintiff would have to show that those other "stakeholders" were bringing ongoing litigation that competed with plaintiff's own PLSRA claims, thereby putting plaintiff at a disadvantage. Absent that specific showing, the Judge found no undue prejudice to plaintiff arising from the automatic stay, and denied discovery pending a decision on defendants' previously filed motion to dismiss.