Plaintiffs Permitted to File Second Amended Complaint to Clarify Causes of Action Where Complaint Not Patently Devoid of Merit and Defendants Not Prejudiced

On July 25, 2022, in Ketterer v. Grayson, Index No. 653510/2021, Justice Borrok of the New York County Commercial Division granted plaintiffs leave to file a Second Amended Complaint. The original complaint asserted derivative claims and the amended complaint asserted claims for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, and unjust enrichment. In the Second Amended Complaint, plaintiffs sought to add additional factual allegations relating to already plead claims, remove certain causes of action, and clarify that the remaining causes of action are brought directly, and not derivatively. The Court explained:

Discovery is in its neonatal state. A preliminary conference had not even been held in the case when this motion was filed. There simply is no prejudice to the filing of the SAC and there has been no delay. It does not matter that previously the defendants may have filed motions to dismiss that this Court never heard. Nor are the defendants entitled to the Court ordering that this is the final amendment to the complaint that could be filed or for costs to be assessed. Should discovery (which has not taken place) disclose additional facts or information and the plaintiffs seek to further amend the complaint, this Court will review any such proposed amendment at that time. Nothing suggests that the plaintiffs’ conduct has been inappropriate in any manner much less willful and contumacious warranting any type of sanction.

Denial of the motion is also inappropriate based on the defendants’ argument that the SAC fails because these are derivative claims (which they cannot assert because they lack standing — i.e., having been bought out for $0 pursuant to an agreement that they never saw or signed to facilitate the defendants’ ruse, they are not owners so they cannot satisfy the dual requirements of contemporaneous and continuous ownership (Independent Inv. Protective League v Time, Inc., 50 NY2d 259, 263, 406 N.E.2d 486, 428 N.Y.S.2d 671 [1980]). Simply put, the defendants are wrong.

Under Delaware law, whether a claim is direct or derivative is determined under the Tooley test. The issues are (i) who suffered the alleged harm, the company or the shareholders, and (ii) who would receive the benefit of any recovery, the company or the shareholders (Tooley v Donaldson, Lufkin & Jenrette, Inc., 845 A2d 1031 [Del 2004]). The well pled SAC alleges prima facie evidence of breaches of both the duties of care and loyalty by Mr. Grayson and Mr. Sigg and aiding and abetting over those breaches by Berkshire, Beltone and New Frontier. No independent committee or valuation appears to have been done to determine if the transaction is fair and no independent approval was sought of the plaintiffs (shareholder approval of the Company which was controlled by Mr. Grayson and Mr. Sigg would have been without consequence). Given Mr. Grayson and Mr. Sigg’s interests disclosed in the documents, the recovery here would not flow to the Company or the Holding Company and in fact the injury was not to those entities. The injury as alleged was tactical and precise and occasioned by these plaintiffs and the recovery, if successful in this lawsuit, would necessarily flow to them. Thus, it cannot be said that the SAC is utterly devoid of merit.

The defendants’ reliance on Serino v Lipper, 123 AD3d 34, 994 N.Y.S.2d 64 (1st Dept 2014) is misplaced. In Serino, Mr. Lipper, the founder of a group of hedge funds, asserted counterclaims against PricewaterhouseCoopers, who had audited the funds and provided personal tax services to Mr. Lipper, alleging, among other things, that PricewaterhouseCoopers was aware that the funds were overvaluing their assets but failed to include that information in their audit. Mr. Lipper alleged that he could bring direct claims against PricewaterhouseCoopers because they had performed tax services for him and because he relied on the audit of the funds in making personal financial decisions. The Appellate Division applied the Tooley test and found that, where harm was caused to the individual, rather than the corporation, direct claims may proceed, but where individual harm is claimed but is confused with or embedded in the harm to the corporation, it cannot stand separately (id., at 40). The Appellate Division held that Mr. Lipper's claim for damages based on the lost value of his holdings was derivative and that his claim for lost earning capacity was inextricably embedded in that derivative claim (id., at 41). As discussed above, the claims in this case are not derivative in nature. The conduct alleged in this case was designed to strip these plaintiffs of their holdings without paying them. That is a direct claim under Tooley and Serino.

Finally, leave to amend cannot be denied because the Court cannot determine at this stage whether the statute of limitations limits or precludes these fraud based claims. As pled, the plaintiffs were unaware of the harm done to them (because they did not sign the Investment Agreement) until the conversion/buyout took place. Their claims may well be entitled to the benefit of equitable tolling or the discovery rule (Zumpano v Quinn, 6 NY3d 666, 674, 849 N.E.2d 926, 816 N.Y.S.2d 703 [2006]).

The attorneys at Schlam Stone & Dolan frequently litigate procedural issues such as filing amended complaints. Contact the Commercial Division Blog Committee at commercialdivisionblog@schlamstone.com if you or a client have questions concerning such issues.