On October 12, 2022, the Commercial Division for New York County issued a decision in a consolidated series of motion sequences in CDx Diagnostics, Inc. v. Rutenberg, 2022 BL 479595 (N.Y. Sup. Ct. Oct. 12, 2022). The decision clarified a range of legal issues involving motions to compel arbitration, the scope of the Noerr-Pennington doctrine, and tortious interference with contractual rights. In this post, we will discuss some of the salient features of the court’s opinion.
Background
Dr. Mark Rutenberg founded CDx Diagnostics Inc. (“CDx” or “the company”) and served as the company’s CEO until 2018. CDx is a healthcare company that develops advanced diagnostic cancer tests. In 2015, the company fell into difficult financial conditions and negotiated a rescue from Galen, a private equity firm based in Stamford, Connecticut. In February 2017, Galen agreed to invest $40 million in CDx in exchange for a controlling stake in the company. Galen and CDx entered into a stock and asset purchase agreement in June 2017. Id. at *3. Rutenberg and certain other legacy shareholders with interest in the company agreed to spin out their interests to a new entity called Red Mountain Medical Holdings Inc. Id. At the time of closing, Rutenberg entered into an Executive Employment Agreement (“EEA”) and an IP Agreement with CDx. Id. at **3-4.
Under the IP Agreement, Rutenberg assigned all proprietary rights to his inventions developed during the course of his employment to CDx. Id. at *5. The EEA contained an arbitration clause that provided, in relevant part, that, “any dispute between the parties arising out of or relating to the negotiation, execution, performance or termination of this Agreement or Executive’s employment, including, but not limited to, any claim arising out of this Agreement … shall be settled by binding arbitration in accordance with the National Rules for the Resolution of Employment Disputes of the American Arbitration Association.” Id. at *4.
The crux of the dispute at issue is that Rutenberg filed a patent application between 2018-19 for a technology that detected pancreatic cancer, and assigned that patent to a Delaware LLC called Adenocyte. Id. at *5. CDx claimed that Rutenberg developed the technology relating to this patent application during the course of his employment at CDx and demanded that Rutenberg assign his proprietary rights in the pancreatic detection technology to the company in accordance with the terms of the IP Agreement. Id. Rutenberg refused, claiming that he had developed this invention outside the scope of his employment at CDx and that he had not used the resources at CDx to develop the technology. Id.
In September 2020, CDx terminated Rutenberg’s employment for cause. Id. at *6. Shortly thereafter, CDx commenced an action against Rutenberg, Red Mountain, Adenocyte, and other individuals and entities seeking, among other things, (1) a declaration that the IP Agreement was enforceable; (2) an order invalidating Rutenberg’s assignment of the pancreatic detection technology to Adenocyte; (3) a declaration that CDx was the rightful owner of the patent on the pancreatic detection technology; and (4) an order compelling Rutenberg to assign the intellectual property to CDx. In response, Rutenberg raised a host of affirmative defenses and counter-claims, including claims of improper employment termination. Id. at *6.
Compelling Arbitration
Justice Reed granted CDx’s motion to compel Rutenberg to arbitrate the dispute of improper termination. Justice Reed began with the proposition that agreements to arbitrate disputes are both favored as a matter of policy and binding as a matter of law, as per the terms of the Federal Arbitration Act. Id. at *7. Under New York state court precedents, Justice Reed emphasized that the court’s role in deciding motions to arbitrate is narrow. The court must determine only whether there is a reasonable relationship between the subject-matter of the dispute and the general subject-matter of the underlying contract. Id. Once such a reasonable relationship is established, the court must grant the motion. Id. at *8. Any ambiguity in the scope of the arbitration clause must be resolved in favor of arbitration. Id. at *9. Justice Reed held that the scope of the arbitration clause in the EEA was sufficiently broad to capture within its ambit most of Rutenberg’s counter-claims against CDx, including the claim of improper employment termination. Id.
Justice Reed also rejected two arguments raised by Rutenberg. First, Rutenberg argued that the arbitration clause in the EEA terminated when Rutenberg’s role in CDx changed from CEO to Chief Scientific Officer a year before his termination from the company. As a result, Rutenberg argued, the EEA’s arbitration clause did not extend to his claims of improper employment termination. Id. Justice Reed held that the question of whether an arbitration clause survived the change in the Rutenberg’s employment at CDx was a matter for the arbitrator to decide. Id. at *10.
Second, Rutenberg argued that the arbitration clause did not apply to the dispute over the intellectual property between Rutenberg and CDx, which was the crux of the litigation between the parties. Rutenberg claimed that allowing the motion to arbitrate would lead to multiple and overlapping claims before multiple fora. Id. at *11. Justice Reed ruled, following the decision of the New York Supreme Court in PNE Media, LLC v Cistrone(294 A.D.2d 143 [1st Dep’t 2002]), that “arbitration clauses are binding contracts which must be strictly enforced, even if enforcement will lead to bifurcated and overlapping litigation.” Id. at *11. Even if the employment dispute had to be arbitrated before an arbitrator and the intellectual property claim had to be litigated before a court, Justice Reed held that the possibility of bifurcated litigation was not sufficient grounds to deny CDx’s motion to compel arbitration. Id.
The Noerr-Pennington doctrine
Rutenberg and other defendants raised a host of counter-claims for abuse of process, conversion, civil conspiracy, and misappropriation of commercial advantage. Specifically, Rutenberg and other defendants claimed that by filing a “fraudulent lawsuit,” CDx had “usurped” and “misappropriate[d] economic opportunity” from the defendants.
Justice Reed held that commencing a legal action in court was a protected activity under the First Amendment, and that the Noerr-Pennington doctrine barred the counter-claims. Under the Noerr-Pennington doctrine, “parties may not be subjected to liability for petitioning the government.” Caesars Entertm’nt Operating Co. v Appaloosa Inv. Ltd. P’ship I, 48 Misc 3d 1212[A], 2015 NY Slip Op 51095, * 4 [Sup. Ct., NY Cty. 2015]. Justice Reed held that the act of filing a complaint and summons in court fell within the scope of “petitioning activity” under the Noerr-Pennington doctrine. Justice Reed concluded that, “the Noerr-Pennington doctrine precludes precisely what [defendants] attempt to do here: interfere with the act of filing a lawsuit, which is protected First Amendment activity, by bringing civil claims against the plaintiff, CDx, based on that act.” Id. at *13.
Rutenberg claimed that CDx was not immunized from civil liability because the company’s complaint fell within the “sham lawsuit” exception to the Noerr-Pennington doctrine. Justice Reed rejected Rutenberg’s claim holding that the “sham lawsuit” exception was a narrow one and that the burden of proving the exception fell on the party invoking it. Id. at *14. In order to successfully invoke the “sham lawsuit” exception, Rutenberg and the other defendants had to show that “no reasonable litigant could realistically expect success on the merits of CDx’s declaratory judgment claim.” Id. (cleaned up). Justice Reed concluded that the defendants had failed to allege sufficient facts to establish that the “sham lawsuit” exception applied to CDx’s complaint. Id. So long as CDx had “probable cause” to bring the lawsuit, which Justice Reed found existed in this case, the company was protected under the Noerr-Pennington doctrine. Accordingly, the court dismissed most of the defendants’ counter-claims.
Rutenberg’s other counter-claims
Rutenberg raised several other counter-claims that we discuss here briefly. First, Rutenberg asserted a claim for breach of implied covenant of good faith and fair dealing against CDx Holdings, one of CDx’s affiliated entities. He claimed that “CDx Holdings materially breached the agreements by . . . concocting a pretext to unfairly and in bad faith fire Dr. Rutenberg ‘for cause’” thereby depriving him of compensation that was due to him.” Id. at *18 (cleaned up). Second, Rutenberg claimed that the private equity firm, Galen, committed tortious interference with his contract with CDx by “caus[ing] the CDx entities … to materially breach their contractual obligations to Dr. Rutenberg.” Id. at *19 (cleaned up). Justice Reed dismissed these counter-claims for both procedural impropriety and for the failure to state a claim.
Justice Reed noted that CPLR 1007 authorizes defendants to proceed against a person who may be liable “for all or part of the plaintiff’s claim against that defendant.” CPLR § 1007. Justice Reed held that the plain language of CPLR § 1007 required that the third-party claims must “arise from or be conditioned upon the liability asserted against the third-party plaintiff in the main action.” Id. at *16. (quoting Lucci v Lucci, 150 A.D.2d 649, 650 (2d Dep’t 1989)(cleaned up). CDx had sought a declaratory judgment and asserted a claim for unjust enrichment against the defendants. Justice Reed held that Rutenberg’s counter-claims for the breach of implied covenant or tortious interference did not “arise out of” CDx’s claims for unjust enrichment or declaratory judgment. Id. at *17. The counter-claims “have nothing to do with ultimate liability for [CDx’s] claims.” Id. Although Rutenberg argued that the claims and the counter-claims share common questions of law or fact, Justice Reed held that a common set of facts was insufficient to permit the defendants to raise the third-party claims against CDx and Galen.
Justice Reed also held that the defendants had failed to state a cause of action for both counter-claims. Although only Rutenberg and CDx were parties to the EEA, Rutenberg sued another CDx entity, CDx Holdings, for breach of implied covenants. Justice Reed held that a claim for breach of implied covenant was not a distinct cause of action, but rather a different mode of asserting a claim for breach of contract. Id. at *18. The court found that since CDx Holdings was not party to the relevant agreement, CDx Holdings was not a proper defendant to the counter-claim. Accordingly, the court dismissed this counter-claim.
Justice Reed also dismissed the claim for tortious interference with Rutenberg’s contract. A party asserting tortious interference must a plead the following facts: “(1) that a valid contract exists; (2) that a third party had knowledge of the contract; (3) that the third party intentionally and improperly procured the breach of the contract; and (4) that the breach resulted in damage to the plaintiff.” Id at *20 (quoting Lama Holding Co. v. Smith Barney Inc., 88 N.Y.2d 413, 424 [1996]). However, the third party is not liable for tortious interference if such conduct was justified under the economic interest doctrine. Under the economic interest doctrine, a third party is immune from liability for interfering with someone else’s contract, when such third party is “acting to protect its own legal or financial stake in the breaching party’s business.” Id. (quoting White Plains Coat & Apron Co. v Cintas Corp., 8 N.Y.3d 422, 426 [2007]). The court noted that “a corporation that acquires another corporation and then causes one of the acquired corporation’s contracts to be terminated, is not liable for interference with that contract, because it had an economic justification for its actions.” Id. (quoting American Water Enters. Inc. v. Tectura Corp., 2014 NY Slip Op 32182[U], * 4 [Sup. Ct., NY Cty. 2014]). The court held that Galen pleaded sufficient facts to establish the economic justification defense. Once the economic interest defense is established, the party asserting tortious interference must plead that the contractual interference was effected “through illegal or fraudulent means, or were otherwise motivated by malice.” Id. at *21. Since the court found that Rutenberg’s allegations of illegality and malice against Galen was merely conclusory in nature, the court dismissed Rutenberg’s counter-claim for tortious interference.
Conclusion
The case raises several issues that are common in complex commercial litigation. It is a lesson to corporate lawyers drafting arbitration clauses. And the decision also contains important lessons to litigators regarding the creative pleadings as well as procedural and substantive barriers to commonly asserted tort claims.
