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FRIDAY, OCTOBEr 19, 2012

COMMERcIAL DIVISION UPDATE

Expert Analysis

The Narrow Application Of the Champerty Doctrine

doctrine with ancient and medieval roots,1 champerty makes illegal an agreement to divide litigation proceeds between the owner of the litigated claim and a party unrelated to the lawsuit who supports or helps enforce the claim.2 The practice is outlawed in New York by Judiciary Law 489, pursuant to which any corporation or association found in violation of the law can be liable for a fine of up to $5,000, and any person, copartnership, corporation, or association found violating the section may be found guilty of a misdemeanor.3 New York Court of Appeals precedent places a high burden of proof on the party asserting champerty, requiring a showing that the purpose of the assignment was the collection of a claim that would not have been prosecuted otherwise.4 A number of recent Commercial Division cases have addressed the assertion of a champerty defense. While most have been cautiously avoiding finding claims champertous, one Commercial Division court recently held that champerty existed where a company and a law firm formed a partnership, the primary purpose of which was to acquire debt instruments and profit from the related litigation.

By George Bundy Smith

And Thomas J. Hall

Recent Precedent
Two recent New York Court of Appeals decisions have informed the Commercial Divisions rulings regarding champerty. In Bluebird Partners v. First Fid. Bank, Bluebird Capital purchased second series certificates from Continental Airlines, later suing the second series trustee, alleging breach of fiduciary duty.5 One defendant asserted the defense of champerty. The New York Court of Appeals surveyed champertys history, noting that it is a venerable doctrine developed hundreds of years ago to prevent or curtail the commercialization of or trading in litigation, and that the New York Legislature extended this prohibition to apply to nonlawyers and corporations in 1907.6 The opinion also noted that the New York Court of Appeals has

been hesitant to find that an action is champertous as a matter of lawconsistent with the limited scope of the champerty doctrine as it originally appeared and developed in the Anglo-American legal system.7 The Bluebird Partners court concluded that in order to constitute champertous conduct in the acquisitions of rights, the foundational intent to sue on that claim must at least have been the primary purpose for, if not the sole motivation behind, entering into the transaction.8 The court found that the record did not support a finding of champerty as a matter of law, because it could not be determined that profiting from litigation was the primary motivation behind Bluebird Capitals

The court explained that the critical issue in assessing champerty is the purpose behind the acquisition of rights that allowed the plaintiff to file the lawsuit. The court also explained the particular concerns surrounding the acquisition of debt instruments, stating: [I]f a party acquires a debt instrument for the purpose of enforcing it, that is not champerty simply because the party intends to do so by litigation.10 Because in Merrill Lynch Mortg., the plaintiff would directly suffer the damages of any default on the loan in question, the court held the plaintiff had a preexisting proprietary interest in the loan. If the plaintiffs purpose in taking an assignment of another partys rights was to enforce its proprietary interest in the loan, this did not violate New Yorks law against champerty.

Claims Not Champertous

The Commercial Division courts have followed the lead of the New York Court of Appeals in their restrictive view of champerty. In Seomi v. Sothebys, Justice Bernard Fried of the New York County Commercial Division looked to Merrill Lynch Mortg. to determine that the claim at issue was not champertous.11 The plaintiff, Gallery Seomi, had successfully bid to purchase a painting from Sothebys, then sold the painting to a third party, Moon-Deuk Park, and later fell into arrears with Sothebys. Sothebys at all times had maintained possession of the painting and sold it to a third party before Park ever took possession. Seomi then sued Sothebys for replevin, conversion, negligence and breach of contract. Sothebys claimed the replevin and conversion claims, on assignment from Park, were champertous. Fried held that the complaint should be dismissed regardless of whether the claims were champertous, but nonetheless addressed the issue in a footnote. He noted that in light of the holding in Merrill Lynch Mortg. that New Yorks champerty law does not apply where the purpose of an assignment is the collection of a legitimate claim, the suit did not appear champertous. Fried noted that according to the New York Court of Appeals, the champerty statute prohibits only the purchase of claims with the intent and for the purpose of bringing an action thatmay involve parties in costs and annoyance, where such claims would not be prosecuted if not stirred up in [an] effort to secure costs.12 Apparently

The Commercial Division courts have followed the lead of the New York Court of Appeals in their restrictive view of champerty.
acquisition of the second series certificates. A 2009 New York Court of Appeals decision imparted additional requirements for parties seeking to prove claims were champertous. In Trust for the Certicate Holders of Merrill Lynch Mortg. Investors v. Love Funding (Merrill Lynch Mortg.), the Court of Appeals held, in response to certified questions from the U.S. Court of Appeals for the Second Circuit, that a corporation or association does not violate New Yorks champerty law where it takes an assignment of a claim for the purpose of collecting damages by means of a lawsuit, for losses on a debt instrument in which it holds a preexisting proprietary interest.9

GEOrgE BUnDY SMITH is an arbitrator and mediator with JAMS in New York City, and served as an associate judge on the New York Court of Appeals. THOMAs J. HALL is a litigation partner with Chadbourne & Parke. JILL KAHn, a litigation associate with the firm, assisted with the preparation of this article.

FRIDAY, OCTOBEr 19, 2012

believing that Park had a legitimate claim against Sothebys, the court did not find his assignment of the rights to Seomi champertous. In IRB-Brasil Resseguros v. Inepar Invs., Justice Shirley Werner Kornreich of the New York County Commercial Division held that an assignment of the rights of a noteholder was not champertous where the assignee had purchased $14 million worth of notes itself, and was a signatory to the Global Note.13 The court explained that [a] champertous assignment occurs where a person without interest in anothers litigation undertakes to carry on the litigation at his own expense, in whole or in part, in consideration of receiving, in the event of success, a part of the proceeds of the litigation.14 It also stated that the defense of champerty is to be construed narrowly, and is only applicable where the assignee attains the claim with the intent to initiate an action or proceeding, to the exclusion of any other purpose. The court found that under the circumstances at issue, the plaintiff [was] not a stranger to this transaction and had its own rights and interests in recovering its investment in the Note Program.15 The fact that the litigation concerned recovery of a debt obligation supported this conclusion because New York courts uniformly hold that the possibility that a purchaser of debt obligations will be required to resort to litigation to recover on the debt does not violate [Judiciary Law] 489.16 In Natl City Commercial Capital v. Becker Real Estate Servs., Justice Emily Pines of the Suffolk County Commercial Division also rejected the defense of champerty.17 The court held that the defendant failed to demonstrate that champerty was the primary motivation behind the plaintiffs acquisition of a financial lease. It held that, instead, the record reflected that the plaintiff purchased many leases from the assignor, that the defendant had made at least eight payments to the plaintiff prior to commencement of the action, and that the plaintiff had given the defendant more than one opportunity to cure the default prior to commencing the action. The court quoted the following passage from Bluebird Partners, which it found instructive: The bottom line is that Judiciary Law 489 requires that the acquisition be made with the intent and for the purpose (as contrasted to a purpose) of bringing an action or proceeding.18 Once again, the Commercial Division held that where bringing litigation was just one of several purposes for the acquisition of rights, the acquisition is not champertous.

violation of New Yorks law against champerty. The court explained that champerty should be applied with an abundance of caution. It noted that the ancient prohibition of champerty must be reconciled with modern financial transactions, explaining that Section 489(2) of the Judiciary Law lists a number of safe harbors offering protection from the rule.20 It noted that New York courts were warranted in their reluctance to find claims champertous because [t]he financial industry is critical to New Yorks economy, and its courts are rightly wary of fomenting uncertainty in its vibrant secondary debt markets by exposing the purchasers of debt instruments to charges of champerty.21 Werner Kornreich stated that this would be a particular problem in the market for high-risk distressed debt, because the nature of the instruments is that they are likely, or even destined, to be defaulted onthereby making litigation a near precondition to their enforcement.22 The court noted that to find such claims champertous would provide obligors on distressed instruments with perverse incentives to preemptively and publicly announce an intent to default, making any purchaser vulnerable to a charge of champerty. Despite its belief in the cautious application of champerty, the Justinian Capital court felt that the situation before it fell into the narrow category of transactions that may still be found

for conducting litigation by proxy in exchange for a fee.24 The court noted that while allegations of champerty in similar situations had been rejected, the case before it was unique in that it appeared possible that the plaintiff had partnered with a law firm to purchase debt instruments where the primary motivation for doing so was to make money from the litigation. The court directed the parties to conduct limited discovery on the question of the plaintiffs actual purpose and intent in purchasing the Class B notes, holding that if the primary intent was to profit from the litigation, the plaintiff should be found guilty of champerty.

Conclusion
As financial transactions involving debt instruments become increasingly complex, New York Commercial Division courts have made clear that they are unlikely to find a lawsuit champertous unless the claim would not have been brought if not for the assignment in question. In Justinian Capital, Werner Kornreich identified a unique situation that would constitute champerty as a matter of lawwhere a company partners with a law firm to purchase debt instruments and the primary motivation for doing so is to make money from the litigation. The business transaction in question would not have come about without the potential to make money from litigation, and is therefore champertous pursuant to New York law.

As nancial transactions involving debt instruments become increasingly complex, New York Commercial Division courts have made clear that they are unlikely to nd a lawsuit champertous unless the claim would not have been brought if not for the assignment in question.
champertous today. The plaintiff was accused of engaging in a scheme whereby it would appear to purchase the Class B notes when, in fact, the true nature of its involvement was to bring the underlying claims as a proxy for the actual owners of the Class B notes. The defendants submitted as evidence a business presentation by the plaintiff which laid out its business model as follows: (1) purchase an investment that has suffered a major loss from a company so that the company does not need to report such loss on its balance sheet; (2) commence litigation to recover the loss on the investment; (3) remit the recovery from such litigation to the company, minus a cut taken by Justinian; and (4) partner with specific law firmsto conduct the litigation.23 The court explained that the relevant inquiry is whether the plaintiff bought the instruments as a bona-fide investment (which would properly include the ability to enforce rights through litigation) or if the purchase was merely pretext

A Finding of Champerty
In Justinian Capital v. Westlb, Werner Kornreich of the New York County Commercial Division provided an in-depth analysis of the instances in which a court might make a finding of champerty.19 That case arose when the plaintiff, as the current holder of two series of notes issued by collapsed special purpose vehicles (Class B notes), brought suit against the defendants alleging breach of contract and a number of related claims. The defendants argued that the plaintiff did not actually own the Class B notes but, if it did, it had purchased them solely to bring the litigation, a

1. Trust for the Certicate Holders of Merrill Lynch Mortg. Investors v. Love Funding, 13 N.Y.3d 190, 918 N.E.2d 889 (2009). 2. Blacks Law Dictionary (9th ed. 2009). 3. N.Y. Judiciary Law 489(1). 4. See Trust for the Certicate Holders of Merrill Lynch Mortg. Investors, 13 N.Y.3d 190, 918 N.E.2d 889. 5. Bluebird Partners v. First Fid. Bank, 94 N.Y.2d 726, 729, 731 N.E.2d 581, 583 (2000). 6. Id. at 729, 734, 731 N.E.2d 581, 582, 585. 7. Id. at 735, 731 N.E.2d 581, 586 (internal citations omitted). 8. Id. at 736, 731 N.E.2d 581, 587. 9. Trust for the Certicate Holders of Merrill Lynch Mortg. Investors, 13 N.Y.3d 190, 918 N.E.2d 889. 10. Id. at 200, 918 N.E.2d 889, 895. 11. Seomi v. Sothebys, 27 Misc.3d 1231(A), 910 N.Y.S.2d 765 (N.Y. Co. 2010) (Fried, J.). 12. Id. at *3 n.3 (quoting Trust for the Certicate Holders of Merrill Lynch Mortg. Investors, 13 N.Y.3d 190, 201, 918 N.E.2d 889, 895) (internal quotations omitted). 13. IRB-Brasil Resseguros v. Inepar Invs., No. 604448/06, 2009 WL 2421423, at *20 (N.Y. Co. July 31, 2009) (Werner Kornreich, J.). 14. Id. at *19 (internal citation and quotations omitted). 15. Id. at *20. 16. Id. at *19-20 (internal citations and quotations omitted). 17. Natl City Commercial Capital v. Becker Real Estate Servs., 24 Misc.3d912,918,885N.Y.S.2d173,178(SuffolkCo.2009)(Pines,J.). 18. Id. (quoting Bluebird Partners, 94 N.Y.2d 726, 736, 731 N.E.2d 581, 587). 19. Justinian Capital v. Westlb, No. 6000975/2010, 2012 WL 3536247, at *4-6 (N.Y. Co. Aug. 15, 2012) (Werner Kornreich, J.). 20. Id. at *4-5. 21. Id. at *5 (citing Bluebird Partners, 94 N.Y.2d 726, 739, 731 N.E.2d 581, 589). 22. Id. at *6. 23. Id. 24. Id.

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