In the famous Meinhard v. Lachs case, Judge Benjamin Cardozo wrote in high-pitched language that attorneys for abused business owners have since been fond of quoting that the duty of loyalty among close business owners is extraordinarily high:
“Not just honesty, but the punctuality of an honor is the most sensitive. . . the standard of behavior. “
Countless published decisions have since cited Meinhard. It is not surprising that the illicit act of breach of fiduciary duty expressed in Meinhard has become the workhorse of New York divorce proceedings.
Over the years, the cause of common law breach of fiduciary duty has grown into a remarkably versatile claim that encompasses a wide – almost unlimited – range of behaviors that can be characterized as embezzlement, personal responsibility, waste, or infidelity. A fiduciary breach in New York also exhibits a number of weird legal quirks that make it a powerful weapon in the petitioner / plaintiff’s arsenal when thoughtfully mortgaged.
As just one example, the claim has not one, not two, but three possible limitation periods. If the claim only demands monetary damages, the limitation period is three years. But plead for just relief and the statute of limitations jumps from three to six years. Make the claim as “fraudulent” and the statute of limitations will keep getting longer – six years from the date of the fraud or two years from the time the fraud could have been detected with reasonable care, whichever is longer is.
A recent ruling by a Rochester-based Court of Appeal, Howard v Pooler, ___ AD3d ___, 2020 NY Slip Op 03347 [4th Dept June 12, 2020]Emphasizes two other very useful aspects of the fiduciary breach tort: first, the availability of “disgorgation” of profits from someone who breaches a fiduciary duty, even if there is no actual harm as a result of the breach; and second, the potential for the non-infringing party to recover their legal fees by exercising fiduciary duty if the claim is derived on behalf of the company.
Howard and Pooler founded Archer Rd. Vista LLC (the “LLC”) developing 300 acres of housing estate in the city of Chili. They planned to convert the land into approved vacant lots to sell to builders who would then build houses on the land. The LLC had a written company agreement, according to which the two members had the same voting rights, although they owned disproportionate membership shares (Pooler owned 60%; Howard 40%). The company agreement referred to Pooler as a “manager,” a position Howard allegedly abused, leading to a breakdown in the relationship and Howard filing a 2013 complaint with the Monroe County Supreme Court in which thirteen complaints were raised against Pooler were made, including a breach of the works agreement (Number I), breach of fiduciary duty (Number VII) and accounting (Number VIII), all derived on behalf of the LLC.
The underlying orders
In 2016, former Commerce Department Judge Matthew A. Rosenbaum issued a ruling and order that gave Howard a partial summary assessment of the issue of liability for his derivative claims for breach of contract, breach of fiduciary duty, and accounting. The court ordered proceedings for compensation for these pleas and for liability for the remaining pleas. In 2017, the parties examined the case in a banking trial before Judge Rosenbaum for over a week, after which the court issued a decision and order in 2018 that ultimately led to Pooler’s appeal.
In his post-trial ruling, Justice Rosenbaum awarded Howard more than $ 1.2 million in damages for Pooler’s breach of the Company Agreement and Fiduciary Duties. In the first of two judgments that are the focus of this article, the court ruled that Pooler had violated his fiduciary duties by entering into undocumented proprietary dealings with a separate entity he commissioned, Pooler Enterprises. In addition to awarding Howard damages, the court awarded Howard a disgorgement of Pooler’s profits, writing:
Pooler granted Pooler Enterprises an unintended contract and the court has already held the defendant liable in connection therewith. . . Pooler eventually caused Archer Rd.Vista is paying Pooler Enterprises $ 692,080 for this unremembered contract, with at least $ 103,812 of that amount being overheads and profits. Taking into account the actual value of the work, the exaggeration in the invoices, and the actual amount of work done, Archer Rd. Vista is entitled to damages of $ 317,146 plus prejudice interest. Archer Rd. Vista is also eligible for a clawback of an additional $ 103,812, which is the overhead and profit calculated by Pooler Enterprises. See Excelsior 57th Corp. against Lerner, 160 AD2d 407, 408-09 (1st Dept. 1990) das [Company] has suffered no direct economic loss ”). Pooler is not entitled to any overhead costs or profits charged by Pooler Enterprises.
The court’s second decision stated:
Howard is seeking reimbursement of legal fees related to the derivative claims. The Court agrees and related damages will be granted. Likewise, Howard is filing fees as a derivative plaintiff serving on Archer Road. Vista in the name. The Court agrees and fees are also granted. See e.g. B. Tzolis v. Wolff, 10 NY3d 100 (2008); Seinfeld v Robinson, 246 AD2d 291, 294 (1st Dept. 1998). . . .
To the extent that Howard charges fees in his individual capacity, no fees will be awarded.
In the resulting order, the court ruled: “Pooler is required to pay Howard damages in connection with attorney fees incurred by Howard as an inferred plaintiff. . . ”
Pooler appealed against Judge Rosenbaum’s decisions after the trial. You can read the parties’ key appeal files here, here and here. Pooler put away his arguments about the court’s alleged errors regarding disgorgation and legal fees as the last two items of his pleading. In its Memorandum and Order, the Appeals Department partially confirmed and partially reversed these two participations.
First, the Court ruled:
The defendant also alleges that the court erred in relation to the amount of damages granted in connection with the derived breach of fiduciary duty for which liability was previously imposed, since it has not been demonstrated that the LLC had been harmed by his misconduct. We reject this claim. The deterioration in profits is an appropriate remedy against a breach of fiduciary duty, even if the company was not directly damaged by the misconduct (see Diamond v Oreamuno, 24 NY2d 494, 498, 301 NYS2d 78, 248 NE2d 910) ;; Excelsior 57th Corp. Against Lerner, 160 AD2d 407, 408-409, 553 NYS2d 763 [1st Dept. 1990]).
Second, the Court ruled:
[W]We agree with the defendant that the court wrongly determined that the plaintiff, in his status as a derivative plaintiff acting on behalf of the LLC, is entitled to attorney fees and payouts and that it is granting those fees and payouts. . . The basis for awarding attorney fees in a derivative proceeding to shareholders is to reimburse the plaintiff for costs incurred on behalf of the company. . . These costs should be borne by the company that benefited from the plaintiff’s efforts and would have borne the costs if it had been sued itself “(Glenn v Hoteltron Sys., 74 NY2d 386, 393, 547 NYS2d 816, 547 NE2d) 71  [emphasis added]). The plaintiff’s success as an inferred plaintiff is therefore not an acceptable basis for awarding attorney’s fees and payments against the defendant in individual cases.
Disgorgement of poorly received profits
The principle that courts can award compensation or profit for breach of fiduciary duty is ancient. In most cases, disgorgation is seen in the context of the “faithless servant doctrine” according to which an agent who is not loyal to his employer must reasonably withhold all compensation from the date of the agent’s first disloyal act. As the Howard Court of Appeals found, the most succinct phrase of the doctrine comes from Excelsior, which stated that “when claims of proprietary trading and shared loyalty are asserted, a trustee may be required to preclude any improper gain, even if the plaintiff has suffered no direct economic loss. “In the divorce industry, where blame or infidelity and personal responsibility are the norm, the potential for disgorgement can indeed be a powerful weapon.
Attorney Fees for Deriving Derivative Trust Claims
Section 626 (e) of the Corporate Act, a law that has been followed in cases involving LLCs, empowers courts to award attorney fees to litigants who are “fully or partially successful” pursuing derivative claims. However, the law does not specify who pays the fees. One could make a solid argument that the perpetrator – whoever caused all the damage – should be responsible for paying the fees. In the Howard case, however, the Court stressed an important limitation on the ability to recover fees: the company – not the culprit – is responsible for the fees payable from the recovery.
So, as you are preparing to file a divorce lawsuit, it is a good idea to consider how you can maximize the potential of your fiduciary violation lawsuit. Fiduciary breach offers a wonderful array of remedies: remedies, fair remedies, a right to bookkeeping, monetary damages, disgorgement of self-generated profits, and finally, if inferred, the potential to reclaim legal fees.