Acquisition of Notes Champertous; Purchaser Lacks Standing to Assert Claims

On October 27, 2016, the Court of Appeals issued a decision in Justinian Capital SPC v. WestLB AG, 2016 NY Slip Op. 07047, holding that a sale of notes was champertous, and thus the purchaser of the notes did not have standing to bring an action relating to them.

In Justinian Capital, the plaintiff purchased notes from non-party Deutsche Pfandbriefbank AG (DPAG). Under the purchase agreement, DPAG assigned the notes to Justinian and Justinian agreed "to pay DPAG a base purchase price of $1,000,000." However, the assignment "was not contingent on Justinian's payment of the $1,000,000. Nor did Justinian's failure to pay the $1,000,000 constitute an Event of Default under section 9 of the Agreement." Rather, "the only consequences of Justinian's failure to pay by the selected due date appear to be that interest would accrue on the $1,000,000 and that Justinian's share of any proceeds recovered from the lawsuit would be reduced from 20% to 15%." Justinian did not pay the $1 million.

Justinian brought an action for "breach of contract, fraud, breach of fiduciary duty, negligence, negligent misrepresentation, and breach of the covenants of good faith and fair dealing" in connection with the notes. After allowing discovery on the issue, the trial court granted the defendant's motion to dismiss for lack of standing, finding that the assignment of the notes to Justinian was champertous, and thus void. The First Department affirmed. The Court of Appeals affirmed the decisions below, explaining:

Judiciary Law § 489 is New York's champerty statute. Section 489 (1) restricts individuals and companies from purchasing or taking an assignment of notes or other securities with the intent and for the purpose of bringing an action or proceeding thereon.

. . . Here, the impetus for the assignment of the Notes to Justinian was DPAG's desire to sue WestLB for causing the Notes' decline in value and not be named as the plaintiff in the lawsuit. Justinian's business plan, in turn, was acquiring investments that suffered major losses in order to sue on them, and it did so here within days after it was assigned the Notes. Contrary to the suggestion by the dissent, there was no evidence, even following completion of champerty-related discovery, that Justinian's acquisition of the Notes was for any purpose other than the lawsuit it commenced almost immediately after acquiring the Notes. . . .

Conduct that is champertous under Judiciary Law § 489 (1) is nonetheless permissible if it falls within the safe harbor provision of Judiciary Law § 489 (2). Section 489 (2) exempts the purchase or assignment of notes or other securities from the restrictions of section 489 (1) when the notes or other securities have an aggregate purchase price of at least five hundred thousand dollars. Here, although the price listed in the Agreement, $1,000,000, satisfies the threshold dollar amount for the safe harbor, Justinian has not actually paid any portion of that price. Justinian argues that a binding obligation to pay is sufficient to receive the protection of the safe harbor. WestLB argues that in order to come within the safe harbor an actual payment of at least $500,000 must have been made. The courts below endorsed WestLB's position. We do not agree. Actual payment of the purchase price need not have occurred to receive the protection of the safe harbor. Nonetheless, for the reasons set forth below, under the circumstances presented here, Justinian is not entitled to the protection of the safe harbor.

The parties disagree about whether the phrase "purchase price" in section 489 (2) is ambiguous. Justinian argues that it is unambiguous and means whatever amount is denominated the "purchase price" in a purchase agreement. WestLB argues that reading "purchase price" with "'absolute literalness'" would violate the safe harbor's "'purpose and intent'". We agree with that statement.

Although the phrase "purchase price" may be unambiguous in some contexts, here it is not, and we must look to the legislative history to discern its meaning. A review of draft versions of the safe harbor legislation introduced during the legislative session reveals that at least one version of the bill contemplated that the safe harbor would protect a purchaser of notes or securities if either the aggregate face amount of the notes or securities sued upon totaled at least $1,000,000 or the purchaser had paid, in the aggregate, at least $500,000 to acquire them. The statute as enacted contained different language, requiring instead that the notes or securities have "an aggregate purchase price" of at least $500,000. The "purchase price" language effectively falls between the two earlier proposed safe harbor formulations — strong indication that the Legislature did not intend either that actual payment necessarily had to have been made or that face value alone would suffice to obtain the protection of the safe harbor.

The legislative explanation of the safe harbor's purpose further supports our reading. New York has long been a leading commercial center, and our statutes and jurisprudence have, over many years, greatly enhanced New York's leadership as the center of commercial litigation. The safe harbor was enacted to exempt large-scale commercial transactions in New York's debt-trading markets from the champerty statute in order to facilitate the fluidity of transactions in these markets. The participants in commercial transactions and the debt markets are sophisticated investors who structure complex transactions. Requiring that an actual payment of at least $500,000 have been made for these transactions to fall within the safe harbor would be overly restrictive and hinder the legislative goal of market fluidity. The phrase "purchase price" in section 489 (2) is better understood as requiring a binding and bona fide obligation to pay $500,000 or more for notes or other securities, which is satisfied by actual payment of at least $500,000 or the transfer of financial value worth at least $500,000 in exchange for the notes or other securities. Such understanding conforms with the realities of these markets in which payment obligations may be structured in various forms, whether by exchange of funds, forgiveness of a debt, a promissory note, or transfer of other collateral. We emphasize that we find no problem with parties structuring their agreements to meet the safe harbor's requirements, so long as the $500,000 threshold is met, as set forth above.

However, as the dissent concedes, unquestionably, if the obligation to pay at least $500,000 is entirely contingent on a successful outcome in the litigation, it does not constitute a binding and bona fide debt. The legislative history reveals that a purchase price of at least $500,000 was selected because the Legislature took comfort that buyers of claims would not invest large sums of money to pursue litigation unless the buyers believed in the value of their investments. This comfort is lost when a purchaser of notes or other securities structures an agreement to make payment of the purchase price contingent on a successful recovery in the lawsuit; such an arrangement permits purchasers to receive the protection of the safe harbor without bearing any risk or having any skin in the game, as the Legislature intended. The Legislature intended that those who benefit from the protections of the safe harbor have a binding and bona fide obligation to pay a purchase price of at least $500,000, irrespective of the outcome of the lawsuit.

That is precisely what is lacking here. The record establishes, and we conclude as a matter of law, that the $1,000,000 base purchase price listed in the Agreement was not a binding and bona fide obligation to pay the purchase price other than from the proceeds of the lawsuit. The Agreement was structured so that Justinian did not have to pay the purchase price unless the lawsuit was successful, in litigation or in settlement. The due date listed for the purchase price was artificial because failure to pay the purchase price by this date did not constitute a default or a breach of the Agreement. The Agreement permitted Justinian to exercise the option to let the due date pass without consequence and simply deduct the $1,000,000 (plus interest) from its share of any proceeds from the lawsuit.

In sum, we hold that because the Notes were acquired for the sole purpose of bringing litigation, the acquisition was champertous. Further, because Justinian did not pay the purchase price or have a binding and bona fide obligation to pay the purchase price of the Notes independent of the successful outcome of the lawsuit, Justinian is not entitled to the protection of the safe harbor. In essence, the Agreement at issue here was a sham transaction between the owner of a claim which did not want to bring it (DPAG) and an undercapitalized assignee which did not want to assume the $500,000 risk required to qualify for the safe harbor protection of section 489 (2) (Justinian).

(Internal quotations and citations omitted).