Case Dismissed for Champerty

On February 24, 2014, Justice Kornreich of the New York County Commercial Division issued a decision in Justinian Capital SPC v. WestLB AG, 2014 NY Slip Op. 24046, granting a motion for summary judgment and dismissal on the grounds of champerty.

Justinian Capital arose from an investment portfolio that contained mortgage-backed securities that did not meet the portfolio’s investment guidelines. The defendant, WestLB, was the portfolio’s investment manager. The original holder of the notes, non-party DPAG, is a non-party German bank that relies on the German government for funding. Because WestLB is partially owned by the German government, DPAG was unwilling to sue it. Instead, DPAG agreed with the plaintiff, Justinian, that Justinian would sue WestLB and would remit the litigation recovery to DPAG minus a 15% cut.

When the Court learned of the arrangement, it directed the parties to conduct limited discovery on the issue of champerty. Although champerty has been abolished as a defense almost everywhere in the United States, it still exists in New York under Judiciary Law § 489:

No person shall solicit, by or take an assignment of, or be in any manner interested in buying or taking an assignment of a bond, promissory note, bill of exchange, book debt, or other thing in action, or any claim or demand, with the intent and for the purpose of bringing an action or proceeding thereon.

In 2004, the Legislature added a safe harbor, § 489(2), which precludes a champerty defense when the securities being sold have an aggregate purchase price of at least $500,000.

In this case, the principal question to be decided by the Court was "whether such money must actually be paid," because although the plaintiff's agreement with DPAG recited a sale price of $1 million, the plaintiff did not pay the sale price, did not have the means to do so, and its failure to pay was not considered an event of default under the agreement between it and DPAG.

The Court held that the safe harbor required actual payment, and dismissed the action with prejudice:

If an investor buys worthless mortgage backed securities, it can sue the issuer for fraud and, if it wins, it can keep the money. Such a sale, according to the Court of Appeals, is not prohibited by § 489. Nonetheless, that is not the situation in the instant case because [the plaintiff], a shell formed exclusively for the purposes of litigating the instant action, did not buy the subject notes.

. . .

[The Plaintiff] paid nothing for the notes; 85% of any verdict or settlement goes back to DPAG; and DPAG still effectively controls the notes . . .

. . .

No reasonable finder of fact could conclude that Justinian was making a bona fide purchase of securities . . . . it is not champerty to sue on behalf of debt that you buy for yourself, but it is champerty to sue, on behalf of another and for a fee, for a debt that is not really your own.

The lesson here for practitioners is that although a champerty defense, which once prohibited buying a cause of action, can now be asserted only in rare circumstances, it still exists and counsel should ensure that the purchase of a claim or cause of action does not run afoul of it.