Appeals Court Reinstates Derivative Claims Dismissed for Conflict of Interest Where Parties’ Relationship Not “Especially Acrimonious”

by Farrell Fritz, P.C.

Almost always there are elements of acrimony and intense emotion in litigation between co-owners of closely held business entities. The degree of toxicity can vary widely from case to case, although it tends to show up more conspicuously in litigation involving family-owned ventures.

Claims by non-controlling shareholders accusing controlling shareholders and directors of financial or other managerial abuses frequently are styled as derivative claims seeking recovery on the corporation’s behalf for harm to the corporation. In such suits, under the right circumstances the accused may challenge the accuser’s standing to pursue derivative claims based on conflict of interest.

Conflict of interest usually entails some tangible pecuniary interest held or asserted as a direct claim by the accuser that is adverse to the corporation or otherwise at odds with the claims asserted on behalf of the corporation. But a number of court decisions in New York also have cited as a factor in the analysis the accuser’s “animus” or “retaliatory” motive directed against the accused. The legal theory, akin to that applied in class actions, is that the accuser’s personal hostility and the resulting acrimony undermine the accuser’s ability to fairly and adequately represent the interests of the shareholders and the corporation.

Last year I posted about the decision in Pokoik v Norsel Realties in which a trial judge dismissed for lack of standing derivative claims brought by individuals holding an aggregate 11% interest in a realty-holding limited partnership. Among the reasons cited by the judge was that the plaintiffs “failed to demonstrate on this record that they are free from personal animus” as evidenced by the lead plaintiff’s “litigious nature” including several prior lawsuits against the defendants (including family members) alleging similar mismanagement claims, leading the court to conclude that the lawsuit was being wielded by the plaintiffs as “‘a weapon in the total arsenal’ so as to gain leverage in the other disputes.”

If, based on that decision, anyone thought freedom from personal animus is now part of the required showing by a derivative plaintiff, think again. Last week, the Manhattan-based Appellate Division, First Department, reversed the lower court’s decision and reinstated the derivative claims against some (but not all) of the named defendants.

The appellate panel’s unanimous decision reversing the lower court in Pokoik v Norsel Realties, 2018 NY Slip Op 01534 [1st Dept Mar. 8, 2018], unfortunately reaches its conclusion with only the briefest of analysis, consisting of a single, three-sentence paragraph. Here it is:

We perceive no conflict of interest that would prevent plaintiffs from fairly representing Norsel’s interests. In a separate derivative action by plaintiff Leon Pokoik against other Pokoik family members, who are also defendants in this action, we found that Pokoik’s relationship with defendants had not been shown to be “so acrimonious or emotional as to demonstrate that plaintiff cannot act as an adequate representative for the companies” (Pokoik v Pokoik, 146 AD3d 474, 475 [1st Dept 2017]). Nor is there in the present record any indication of an especially acrimonious relationship between the parties.

As you can tell from the above quote’s citation to the same appellate court’s decision in a prior derivative action brought by the same plaintiffs against some of the same defendants involving a different realty-holding company, last week’s ruling superficially can be described as déjà vu. I say superficially because the plaintiff’s supposed “litigious nature” and improper use of the lawsuit as leverage in other cases were not the only reasons for finding a conflict of interest cited by the lower court in the Norsel Realties case.

We can only surmise that in last week’s decision, the Appellate Division did not think enough of the other reasons to mention them, including the nature of the relief sought by the plaintiffs, the impact of the relief sought on the partnership, and naming all of the 30+ other partners as defendants because they voted to approve the challenged actions.

Personally I was disappointed the decision didn’t address the lower court’s reliance on the last-mentioned factor. As I said in my post last year on the Pokoik case, in the many derivative lawsuits brought by a minority owner involving small closely held business entities, the named defendants often comprise all the remaining owners. It would be odd if, under those circumstances, the plaintiff lost standing to sue on the entity’s behalf because all the other owners acted in concert adversely to the interests of the entity.

As I said up top, litigation between business partners is acrimonious by definition, and repeat litigation even more so. The lead plaintiff in the multiple Pokoik litigations met partial success at least in some of them. Should that weigh against a finding of an acrimonious relationship sufficient to create a conflict of interest?

Finally, if the relationship between the parties, in the court’s own words, was not “especially acrimonious,” is there some heightened level of animosity that would tip the scale in favor of negating the standing of a putative derivative plaintiff? The short answer is, we don’t know. In other cases I’ve looked at dismissing derivative suits for lack of standing, in which the derivative plaintiff’s hostile attitude or retaliatory motive was cited by the court, there were other, more tangible indicators of the plaintiff’s conflict of interest, usually involving antagonistic derivative and direct claims or inconsistent positions taken by the plaintiff in other litigation. In other words, acrimony or personal animus alone, however intense, may not be enough.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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