Breaking Up Is Hard To Do: Withdrawal of LLC Members And Dissolution When The Operating Agreement Is Silent

In general, when a member wants to withdraw from a New York limited liability company or when members wish to dissolve it, the terms of the operating agreement will control.  Problems often arise, however, when the operating agreement is silent on these points.  To begin with, absent a provision in the operating agreement to the contrary, LLC members may not withdraw prior to the dissolution or winding up of the company.  Limited Liability Company Law § 606(a).  Similarly, when the operating agreement is silent, the Limited Liability Company Law only provides for dissolution under a narrow set of circumstances: approval by a majority of members, the LLC finding itself without members, or judicial dissolution.  Limited Liability Company Law § 701(a)(3)-(5).

Taking these provisions together, if a non-majority member wants to exit an LLC, their sole remedy is to seek judicial dissolution of the LLC. Kassab v. Kasab, 27 N.Y.S.3d 680 (2d Dept. 2016).  If the requirements are met, the court can then order an equitable buyout of one member by the others.

A.     Requirements for Judicial Dissolution

As Section 702 of the Limited Liability Company Law provides, judicial dissolution is appropriate where it is no longer reasonably practicable for the LLC to continue operating.  While the statute unhelpfully does not specify a definition of “reasonably practicable,” the courts have adopted a two-factor test to determine whether judicial dissolution is appropriate: a person seeking dissolution must show either (a) that that the entity is no longer able to achieve its stated purpose, or (b) continuing the entity is financially infeasible.  In re the Dissolution of 1545 Ocean Avenue, LLC, 72 A.D.3d 121, 127 (2d Dept. 2010).  These tests are independent of each other, so an entity that is financially viable but no longer able to serve its intended purpose is subject to dissolution. In re Natanel v. Cohen, 2013 NY Slip Op 52107(U) (Sup. Ct., Kings Cty. 2014)

Turning to the first of these tests, courts will look to the operating agreement to determine what the LLC’ stated purpose is, and then determine whether it is still achievable.  If there is no operating agreement or if it is silent on that point, courts will then determine the purpose of the LLC from context. In re Dissolution of 47th Rd. LLC, 54 Misc 3d 1217[A] (Sup. Ct., Queens Cty. 2017); Sieni v. JAMSFAB, LLC, 2013 N.Y. Slip Op. 31473(U) (Sup. Ct., Suffolk Cty. 2013).  While considerable deference is given to the words of the operating agreement, at least one appellate court has found that language in an operating agreement stating that its purpose was to conduct “any lawful business” was too broad to be accepted and construed it as not stating a purpose at all, turning instead to the LLC’s prior business operations to divine its purchase.  Mace v. Tunick, 60 N.Y.S.3d 314 (2d Dept. 2017).

Notably, the courts have held that deadlock between or among members of an LLC is not an independent ground for dissolution, and can only support dissolution where it prevents an LLC from reaching its stated purpose.  1545 Ocean Avenue, 72 A.D.3d at 129.  For example, deadlock between members was found not to be sufficient in situations where the operating agreement contained provisions allowing the LLC to operate despite the deadlock.  See, e.g., Id. (each of the managing members was authorized to operate autonomously); Belardi-Ostroy, Ltd. v. Am. List Counsel, Inc., 2016 N.Y. Slip Op. 30727(U) (Sup. Ct., N.Y. Cty. 2016) (operating agreement allowed for tie-breaking fifth board member); Goldstein v. Pikus , 2015 N.Y. Slip Op. 31483(U) (Sup. Ct., N.Y. Cty. 2015) (operations conducted by independent managing agent).  However, judicial dissolution can be granted when the deadlock truly prevents the LLC from operating or calls its financial feasibility into question. See, e.g., Advanced 23, LLC v. Chambers House Partners, LLC, 2017 N.Y. Slip Op. 32662(U) (Sup. Ct., N.Y. Cty. 2017) (operating agreement required unanimous agreement of members); Fakiris v. Gusmar Enters., LLC, 2016 NY Slip Op 51665[U] (Sup. Ct., Queens Cty. 2016) (50/50 split between members with independent tie-breaker disqualified); In re Dissolution of 47th Rd. LLC, 2017 NY Slip Op 50196[U] (Sup. Ct., Queens Cty. 2017)(disagreement between members drove primary asset of LLC into foreclosure).

Similarly, oppressive conduct by a majority member of an LLC does not justify judicial dissolution so long as the company is still fulfilling its purpose and financially feasible.  For example, several courts have denied petitions for dissolution based upon the systematic exclusion of a minority member. Doyle v. Icon, LLC, 959 N.Y.S.2d 200 (1st Dept. 2013); Huggins v. Scott, 2019 N.Y. Slip Op. 33506(U) (Sup. Ct., N.Y. Cty. 2019); Kassab v. Kasab, 60 Misc. 3d 1204 (Sup. Ct., Queens Cty. 2018); Mangan v. Second to None, LLC, 2016 N.Y. Slip Op. 32378(U) (Sup. Ct., Richmond Cty. 2016).  Waste and self-dealing are also not, in and of themselves, sufficient to support judicial dissolution. 1545 Ocean Avenue, 72 A.D.3d at 132; Norvell v. Guchi's Idea LLC, 2016 N.Y. Slip Op. 32307(U) (Sup. Ct., Kings Cty. 2016).  Even amendments to operating agreement allegedly designed to squeeze out a minority member were deemed insufficient. Yu v. Guard Hill Estates, LLC, 2018 N.Y. Slip Op. 32008(U) (Sup. Ct., N.Y. Cty. 2018).
As for the financial feasibility test, there is not much case law construing what is or is not financially feasible.  From the limited information available, it appears that the amount of the LLC’s debts and whether the debts are being paid as they come due are important factors in this analysis.   47th Rd. LLC, 2017 NY Slip Op 50196(U); Koch v. HC Hospitality Partners, LLC, 2015 N.Y. Slip Op. 30828(U) (Sup. Ct., N.Y. Cty. 2015).  On the other hand, disagreements about business strategy are not, in and of themselves, sufficient to have the LLC declared financially infeasible.  Belardi-Ostroy, 2016 N.Y. Slip Op. 30727(U).

B.     Equitable Buyouts and Other Remedies

If the stringent requirements for judicial dissolution are met, the court can then order an equitable buyout of the member seeking withdrawal.  Mizrahi v. Cohen, 104 A.D.3d 917 (2d Dept. 2013).  Indeed, there is some authority to suggest that it is reversible error not to do so if the LLC is financially viable.  Id.  As a purely equitable remedy, the court has considerable discretion to set the process, and proposed remedies have generally been upheld where the process allowed the withdrawing member to recover their investment and a reasonable rate of return.  Id., In re Superior Vending, 71 A.D.3d 1153 (2d Dept. 2010).  Notably, there is no statutorily fixed date for valuing the company to establish a buyout, but the court has discretion to set a date “in consideration of the equities.” See PFT Tech., LLC v. Wieser, 2020 N.Y. Slip Op. 1942 (2d Dept. 2020)(setting date on day prior to commencement of action); Superior Vending, 71 A.D.3d at 1153 (setting date on day of member’s declaration of withdrawal).  Whatever date is chosen for valuation, New York’s 9% pre-judgment interest rate applies from that date forward. Man Choi Chiu v. Chiu, 125 A.D.3d 824 (2d Dept. 2015).

Alternatively, if the court orders dissolution instead of an equitable buyout, Section 704 of the Limited Liability Company law governs the distribution of assets, with payment first made to creditors, then to satisfy liabilities for unpaid distributions to members, then to repay members’ capital contributions and, finally, pro rata according to the proportion of membership interests.  Other than creditor payments, the remainder of these provisions can be changed if contrary terms are set forth in the operating agreement.

Notably, regardless of whether the company is to be dissolved or the member is to be equitably bought out, the courts have a wide array of tools to preserve the company’s assets.  For example, courts can also order a permanent or temporary receiver to oversee the assets of the company. Limited Liability Company Law § 703; Fakiris, 2016 NY Slip Op 51665[U].  Courts can also grant injunctive relief to prevent transfers of company assets. Scomello v. Pascarella, 2011 N.Y. Slip Op. 51965 (Suffolk Cty. 2011).

C.     Conclusion

If a minority member of an LLC wants to exit, and there are no relevant provisions in the operating agreement, then the only remaining avenue available to them is to submit a petition seeking the judicial dissolution of the LLC.  If, and only if, the requirements for judicial dissolution are met, the court can then enter an order compelling the buyout of the want-away member’s interest on equitable terms.

IS PRIVITY REQUIRED FOR A BREACH OF EXPRESS WARRANTY CLAIM? AN EMERGING CONSENSUS SAYS “NO”

A pair of recent decisions from the S.D.N.Y. reaffirms the growing consensus among district courts within the Second Circuit that establishing privity is not a requirement for breach of
express warranty claims seeking recovery for purely economic loss.[1]

In general, “To prevail on a claim of breach of express warranty, a plaintiff must show 'an affirmation of fact or promise by the seller, the natural tendency of which was to induce the buyer to purchase and that the warranty was relied upon.” Factory Assocs. & Exporters, Inc. v. Lehigh Safety Shoes Co., LLC, 382 F. App'x 110 (2d Cir.  2010).  For contracts for the sale of
goods, the UCC further provides that “any affirmation of fact or promise made by the seller to the buyer which relates to the goods and becomes part of the basis of the bargain creates an express warranty that the goods shall conform to the affirmation or promise." N.Y. U.C.C. § 2-313(1)(a). Moreover, "[a]ny description of the goods which is made part of the basis of the bargain creates an express warranty that the goods shall conform to the description." Id. § 2-313(1)(b).  It should also be noted that federal jurisdiction exists over many warranty claims due to the Magnusson-Moss Warranty Act, 15 U.S.C. § 2301 et seq., though that act expressly does not restrict state law rights and remedies.  15 U.S.C. § 2311(b)(1).

Turning to the specific issue of privity, the New York Court of Appeals in Randy Knitwear, Inc. v. Amer. Cyanamid Co., 11 N.Y.2d 5 (1962), modified the previous common-law rule requiring privity for breach of express warranty claims, recognizing that “the significant warranty, the one which effectively induces the purchase, is frequently that given by the manufacturer through mass advertising and labeling to ultimate business users or to consumers with whom he has no direct contractual relationship.” Id. at 12.

However, Randy Knitwear predated New York’s 1975 adoption of the U.C.C., § 2-318, which provides that express (and implied) warranties extend to any natural person if it is reasonable to expect that such a person might use the goods and suffers a personal injury.  However, this section is silent on the question of purely economic loss, an exclusion that is especially notable considering that the drafters of the UCC provided three alternative versions of this section for states to consider enacting, one of which states that warranties extend to any injury suffered by anyone who might be expected to use the goods, not just personal injuries. Compare U.C.C. § 2-318 Alternative B (adopted by N.Y.) with Alternative C.  Accordingly, a series of district court decisions held that New York’s enactment of the U.C.C. abrogated Randy Knitwear and restored the privity defense for express warranty claims.  See, e.g., Koenig v. Boulder Brands, Inc., 995 F. Supp. 2d 274 (S.D.N.Y. 2014); Ebin v. Kangadis Food, Inc., No. 13 Civ. 2311(JSR), 2013 WL 6504547 (S.D.N.Y. Dec. 11, 2013); Dibartolo v. Abbott Laboratories, 914 F. Supp. 2d 601 (S.D.N.Y. 2012).  Similar conclusions were reached by several state appellate courts.  See, e.g., Mfrs. & Traders Trust Co. v. Stone Conveyor, Inc., 91 A.D.2d 849 (4th Dept. 1982); Hole v. General Motors Corp., 83 A.D.2d 715, 716 (3d Dept. 1981).

Additionally, a series of decisions described Randy Knitwear as a narrow exception to the general rule, holding that the requirement of privity was waived only for express warranties contained in public advertising or sales literature.; Silva v. Smucker Natural Foods, Inc., Case No. 14-CV-6154 (JG)(RML), 2015 WL 5360022 (E.D.N.Y. Sep. 14, 2015); Weisblum v. Prophase Labs, Inc., 88 F. Supp. 3d 283 (S.D.N.Y. 2015); Arthur Glick Leasing, Inc. v. William J. Petzold, Inc., 51 A.D.3d 1114 (3d Dept. 2008); Murrin v. Ford Motor Co., 303 A.D.2d 475 (2d Dept. 2003); Carcone v. Gordon Heating & Air Conditioning Co., Inc., 212 A.D.2d 1017 (4th Dept. 1995).

Finally, yet another line of authority has held that Randy Knitwear continues to waive the requirement of privity for all express warranty claims, based upon Comment 2 of the Official Comments UCC § 2-313, which states that, “[a]lthough this section is limited in its scope and direct purpose to warranties made by the seller to the buyer as part of a contract for sale, the warranty sections of [Article 2] are not designed in any way to disturb those lines of case law growth which have recognized that warranties need not be confined either to sales contracts or to the direct parties to such a contract.”  See Sitt v. Nature's Bounty, Inc., 15-CV-4199 (MKB), 2016 WL 5372794 (E.D.N.Y. Sep. 26, 2016); Mahoney v. Endo Health Sols., Inc., 15-cv-9841(DLC), 2016 WL 3951185 (S.D.N.Y. July 20, 2016). 

The most recent decisions on this issue have generally agreed with the most expansive line of authority.  For example, the court in Brady v. Anker Innovations Ltd., No. 18-cv-11396 (NSR), 2020 WL 158760 (S.D.N.Y. Jan. 13, 2020) conducted an extensive review of the case law on this issue, before explicitly following Mahoney and Sitt, while rejecting Koenig and Ebin.  A similar result was reached in Wedra v. Cree, Inc., 19 CV 3162 (VB) (S.D.N.Y. Mar. 20, 2020), where the court found that privity was not required though it dismissed the claim on other grounds.  Accordingly, until the Second Circuit provides definitive guidance in this area, it appears that the current trend is to waive the requirement of privity for breach of express warranty claims.

[1] Notably, this analysis does not extend to claims for breach of implied warranties of merchantability and fitness for a particular purpose where the only loss claimed is economic.  In such cases, it is well-established that privity is a requirement.  See Wedra v. Cree, Inc., 19 CV 3162 (VB) (S.D.N.Y. Mar. 20, 2020); Catalano v. BMW of North America, LLC, 167 F. Supp. 3d 540 (S.D.N.Y. 2016)

Contracts and the Coronavirus: Force Majeure Clauses as an Excuse for Non-Performance

While my previous two posts on  Coronavirus-related issues have focused on non-contractual remedies, all of those remedies are generally superseded when the parties have entered into a contract containing an applicable force majeure clause excusing or otherwise modifying the performance due under the applicable circumstances.

1.      The Thing Speaks for Itself: The Specific Language of the Clause Controls

In construing force majeure clauses under New York law, courts will defer to whatever the contract at issue provides in terms of the scope of such a clause, how it is applied, and what its effect will be. Constellation Energy Servs. of N.Y., Inc. v. New Water St. Corp., 146 A.D.3d 557, 558 (1st Dept. 2017).  For example, if a force majeure clause contains a provision requiring notice, it must be followed precisely before the non-performing party can invoke force majeure, and a party failing to do so cannot avail itself of the defense. Vitol S.A., Inc. v. Koch Petroleum Grp., LP, No. 01-CV-2184, 2005 WL 2105592, at *11 (S.D.N.Y. Aug. 31, 2005); Gould Enter. Corp. v. Bodo, 107 F.R.D. 308, 313 (S.D.N.Y. 1985).  Similarly, as discussed below, while courts are generally reluctant to allow parties to use changes in their financial conditions or foreseeable events as predicates to trigger a force majeure clause, such actions are permissible if specifically allowed in the contract. See Four Points Shipping, Inc. v. Poloron Israel, L.P., 846 F. Supp. 1184, 1188 (S.D.N.Y. 1994); In re Old Carco LLC (f/K/A Chrysler LLC), 452 B.R. 100, 119 (Bankr. S.D.N.Y. 2011).  Conversely, while numerous courts have upheld force majeure clauses where government action makes performance impossible, a clause explicitly stating that such actions do not constitute force majeure will be upheld. See Chase Manhattan Bank v. Traffic Stream (BVI) Infrastructure Ltd., 86 F. Supp. 2d 244, 257 (S.D.N.Y. 2000) rev’d on other grounds 251 F.3d 334, 337 (2d Cir. 2001).

2.      But What the Heck Does it Say: Interpreting Force Majeure Clauses

When determining whether a force majeure clause has been invoked, New York courts interpret such clauses narrowly and will only excuse non-performance if the predicate event is specifically identified.  Kel Kim Corp. v. Central Markets, Inc., 70 N.Y.2d 900, 902 (N.Y. 1987); Duane Reade v. Stoneybrook Realty, LLC, 2009 N.Y. Slip Op. 4348 (1st Dept. 2009).  Accordingly, in determining whether a force majeure clause applies, a court must first determine whether one of the triggering events in such a clause has occurred.   While this may be a relatively straightforward endeavor if a force majeure clause specifically references epidemics or governmental action, problems can arise where the clause contains catch-all language in addition to a list of specific events.  In considering whether such catch-all language applies, courts lean heavily on the concept of ejusdem generis, a canon of construction providing that words of excuse are only held to apply to events of the same general kind or class as those listed.  Team Marketing USA Corp. v. Power Pact, LLC, 41 A.D.3d 939, 942 (3d Dept. 2007). 

In assessing whether a force majeure clause applies, the party seeking to be excused has the burden of showing that a predicate event occurred and that it attempted to overcome the event if possible to do so. Phillips Puerto Rico Core, Inc., v. Tradax Petroleum, Ltd, 782 F.2d 314, 318 (2d Cir. 1985); Beardslee v. Inflection Energy, LLC, 904 F. Supp. 2d 213, 220 (N.D.N.Y. 2012).  These issues are questions of fact that, if subject to bona fide dispute, may only be resolvable at trial. Goldstein v. Orensanz Events LLC, 44 N.Y.S.3d 437, 438 (1st Dept. 2017); Phibro Energy, Inc. v. Empresa De Polimeros De Sines Sarl, 720 F. Supp. 312, 319 (S.D.N.Y. 1989).

3.      What’s Been Said Before: Trends in Enforcement

Turning to some general principles, with the caveat that the specific language of the contract controls, some trends in the enforcement of these clauses can be discerned.  For example, courts are generally unwilling to allow force majeure clauses to be invoked when the predicate event was within the control of the party seeking to be excused.  Goldstein, 44 N.Y.S.3d at 438; Macalloy Corp. v. Metallurg, Inc., 284 A.D.2d 227 (1st Dept. 2001); Constellation Energy Servs. of N.Y., Inc. v. New Water St. Corp., 2016 N.Y. Slip Op. 30470(U) (Sup. Ct., N.Y. Cty. 2016). In the case of Coronavirus claims, while the epidemic itself and the governmental reaction to it are likely outside of a party’s control, it should be noted that voluntary shutdowns due to financial conditions have been deemed insufficient to invoke force majeure unless the clause at issue explicitly includes changes in financial conditions as a predicate event.  Macalloy, 228 A.D.2d at 227; U.S. v. Panhandle Eastern Corp., 693 F. Supp. 88, 95-96 (D. Del. 1988)(applying N.Y. law).  However, acceding to informal means of governmental suasion rather than insisting on the formal invocation of the Defense Production Act or other regulations is not considered to be a voluntary act, and is likely sufficient to trigger a force majeure clause. See NFL Enterprises LLC v. Echostar Satellite L.L.C., 2008 N.Y. Slip Op. 31389(U) (Sup. Ct., N.Y. Cty. 2008) see also Eastern Air Lines, Inc. v. McDonnell Douglas Corp., 532 F.2d 957 (5th Cir. 1976). 

Similarly, barring specific language to the contrary, the predicate event triggering a force majeure clause must not be foreseeable at the time of contract.  Macalloy, 284 A.D.2d at 227; Phibro Energy, 720 F. Supp. at 317.  In the case of Coronavirus-related issues, it may be more difficult to successfully invoke force majeure clauses in contracts signed once the depths of the crisis became apparent. In addition, if the force majeure event is not the Coronavirus itself but the associated economic downturn, it is again less likely that that will be upheld as a predicate event, since economic downturns are generally considered to be foreseeable events. Urban Archaeology Ltd. v. 207 E. 57th St. LLC, 34 Misc. 3d 1222 (Sup. Ct., N.Y. Cty. 2009).

4.      Conclusion

In assessing whether a force majeure clause applies, the main issue is the specific language of that clause, as the courts will give full force and effect to its provisions. To the extent that the language of the clause is ambiguous, the courts will interpret it narrowly with a focus on whether the predicate event is set forth within the clause.  That said, a party is more likely to successfully invoke a force majeure clause when the predicate event was not within its control and was unforeseeable.

The Coronavirus Ate My Homework: Impossibility And Frustration Of Purpose As Excuses For Non-Performance

In my previous post, I discussed the extent of situations where the Coronavirus crisis might excuse non-performance of contracts for the sale of goods under U.C.C. § 2-615. However, even in situations where U.C.C. § 2-615 does not apply, a party faced with contractual obligations dramatically affected by the Coronavirus crisis might still be able to have its performance excused under the doctrines of impossibility or frustration of purpose.[1]

1.      Impossibility

The doctrine of impossibility is limited in its scope, excusing performance only when a supervening event makes fulfilling the contract objectively impossible. Kel Kim Corp. v. Central Markets, Inc., 70 N.Y.2d 900, 902 (1987).  The doctrine is narrowly construed, as financial hardship alone is insufficient to invoke this defense, even if performing the contract would drive the affected party into insolvency or bankruptcy. 407 E. 61st Garage v. Savoy Corp., Inc., 23 N.Y.2d 275, 281 (1968); Urban Archaeology Ltd. v. 207 E. 57th Street LLC, 891 N.Y.S.2d 63 (1st Dept. 2009); General Elec. Co. v. Metals Resources Group, Ltd., 293 A.D.2d 417 (1st Dept. 2002).

Moreover, the predicate event triggering the impossibility defense must be one that the parties were unable to foresee when entering into the contract.  Kel Kim, 70 N.Y.2d at 902. When determining whether a predicate event was foreseeable, courts will take the sophistication of the parties into consideration.  See, e.g., Four Asteria Realty, LLC v. BCP Bank of North America, 71 A.D.3d 822 (2d Dept. 2010); Pleasant Hill Developers, Inc. v. Foxwood Enter., LLC, 65 A.D.3d 1203 (2d Dept. 2009).  Accordingly, courts considering impossibility claims will likely need to assess the circumstances surrounding the contract, especially its timing relative to the Coronavirus crisis, as well as whether the contract contained cancellation or similar clauses that arguably anticipated that events disrupting performance may occur, with sophisticated, global businesses getting less of the benefit of the doubt than unsophisticated, locally-focused ones.

The specific nature of the predicate event also matters. Government action, such as orders shutting down “non-essential” businesses, can serve as a predicate for an impossibility defense.  Kolodin v. Valenti, 979 N.Y.S.2d 587, 590 (1st Dept. 2014); A&S Transp. Co. v. Cty. of Nassau, 154 A.D.2d 456, 459 (2d Dept. 1989); Metpath v. Birmingham Ins. Co., 86 A.D.2d 407, 413 (1st Dept. 1982); Moyer v. City of Little Falls, 134 Misc. 2d 299, 302 (Sup. Ct., Herkimer Cty. 1986).[2]  On the other hand, courts have generally been reluctant to find that economic downturns are unforeseeable.  See, e.g., Urban Archaeology, 891 N.Y.S.2d at 63.  Accordingly, a contract rendered impossible as a direct result of governmental actions is more likely to be excused under this defense than one rendered impossible because of the economic disruptions resulting from the Coronavirus.

The length of the Corornavirus-related disruption is also a key factor in assessing the defense.  Where the predicate event creates a temporary impossibility of brief duration, the impossibility may be viewed as only excusing performance until it is possible to perform rather than excusing it all together. Bank of Boston Intern. v. Arguello Tefel, 644 F. Supp. 1423, 1427 (E.D.N.Y. 1986); Bush v. Protravel Int’l, Inc., 746 N.Y.S.2d 790 (Civ. Ct., Richmond Cty. 2002).  However, when the predicate event makes performance impossible for a long or uncertain period, then performance may be excused entirely.  Leisure Time Travel, Inc. v. Villa Roma Resort & Conference Ctr., Inc., 52 N.Y.S.3d 621, 623 (Sup. Ct., Queens Cty. 2017).  While it is likely that Coronavirus-related shutdowns will be of limited duration, assessing whether the Coronavirus will lead to a contract being considered temporarily or permanently impossible will probably turn on an assessment of the nature and purpose of the contract.

Finally, it should be noted that successfully invoking the defense of impossibility will likely not result in a windfall for the avoiding party, as it will need to return any benefit received under the doctrine of restitution.  University of Minn. v. Agbo, 176 Misc. 2d 95, 26 (2d Dept. 1998); Metpath, 86 A.D. 2d at 413.

2.     Frustration of Purpose

Even if impossibility is not an available defense to a contracting party because it may still be able to physically perform its obligations under the contract, it may still be able to avoid performing in situations where the Coronavirus crisis has destroyed the rationale for entering into the contract in the first place.  In such situations, pointless performance may be excused on the grounds of frustration of purpose.

In order to invoke frustration of purpose, “the frustrated purpose must be so completely the basis of the contract that, as both parties understood, without it, the transaction would have made little sense.” PPF Safeguard, LLC v. BCR Safeguard Holding, LLC, 85 A.D.3d 506, 508 (1st Dept. 2011).  This doctrine is narrowly construed and can only be applied in situations where the purposes of the contract have been substantially frustrated, to the point that the transaction is unintelligible without the frustrated purpose.  See, e.g., Ahrons v. Charpentier, 36 A.D.3d 636 (2d Dept. 2007); Crown IT Services, Inc. v. Koval-Olsen, 11 A.D.3d 263, 264 (1st Dept. 2004). As the name implies, the key inquiry in determining whether frustration of purpose applies is what the actual purpose of the contract was.  In general, courts will examine the language and structure of the contract, using traditional principles of contract interpretation, in order to determine its purpose. In re Fontana D’Oro Foods, Inc., 65 N.Y.2d 886 (1985).  To the extent that the specific purpose of the contract cannot be readily ascertained, the doctrine cannot be applied.  E-Pass Techs. v. Moses & Singer, LLP, No. C-09-5967 EMC (N.D. Cal. Apr. 13, 2012) (applying N.Y. law).  For Coronavirus-related claims, contracts entered into for a specific purpose that no longer makes sense, such as providing services for a now-cancelled event, are likely subject to this doctrine, while more general contracts are less likely to be covered.

Frustration of purpose is subject to some of the same constraints as the impossibility doctrine.  For example, frustration of purpose does not apply in situations where changed circumstances merely makes performance less profitable or even if the avoiding party would suffer a loss by performing.  Rockland Dev. Associates v. Richlou Auto Body, Inc., 173 A.D.2d 690, 691 (2d Dept. 1991).   Frustration of purpose also cannot be invoked in situations where the frustrating event was foreseeable. U.S. v. General Douglas MacArthur Senior Village, Inc., 508 F.2d 377, 381 (2d Cir. 1974); Gander Mountain Co. v. Islip U-Slip LLC, 923 F. Supp. 2d 351, 360 (N.D.N.Y. 2013); Warner v. Kaplan, 71 A.D.3d 1,6 (1st Dept. 2009).    As with impossibility, the sophistication of the parties is taken into account in evaluating whether the event was foreseeable.  Gander Mountain, 923 F. Supp. 2d.  A party invoking frustration of purpose is also subject to the obligation to make restitution for the benefits it has already received. D & A Structural Contrs. Inc. v. Unger, 2009 N.Y. Slip Op. 52026(U) (Sup. Ct., Nassau Cty. 2009).

3.      Conclusion

For contracts that can no longer be performed at all, the doctrine of impossibility may excuse performance, while contracts that can technically be performed but the reasons for doing so no longer exist may be excused due to frustration of purpose.  For either defense to apply, however, the party seeking to be excused performance must show more than mere financial hardship and lack of foreseeability of the events leading to non-performance.

[1] Notably, this discussion presumes that the contract at issue either does not contain a force majeure clause or the clause does not apply.  Legal issues regarding force majeure clauses will be addressed in a subsequent post.

[2] However, as with any predicate event, the government action in question must be unforeseeable at the time of making the contract in order to invoke an impossibility defense. RW Holdings, LLC v. Mayer, 17 N.Y.S.3d 171, 173 (2d Dept. 2015); Inter-Power of N.Y. v. Niagara Mohawk Power, 208 A.D.2d 1073 (3d Dept. 1994); A & S Transp., 154 A.D.2d 459.  **

Coronavirus and Commercial Impracticability:An Analysis of U.C.C. § 2-615

As the Coronavirus crisis of 2020 has led to the voluntary or mandatory shutdown of innumerable businesses, it is likely that many companies have orders for the sale of goods that they either can no longer fulfill or that can only be fulfilled at exorbitant cost.[1] In such cases, rather than face liability for breaching its contracts, the seller’s performance may be excused in situations that meet the requirements of Section 2-615 of New York’s Uniform Commercial Code (the “U.C.C.”).

1.      U.C.C. § 2-615(a): Is The Seller Off The Hook?

For contracts for the sale of goods governed by the U.C.C., Section 2-615 will excuse a seller from performance of its contractual obligations when such performance has been rendered impracticable by either (a) unforeseen and uncontracted-for contingencies or (b) supervening foreign or domestic governmental regulations.  U.C.C. § 2-615(a).  In either event, the test is whether the delivery of goods has become impracticable because of unforeseen supervening circumstances that were not within the contemplation of the parties when the contract was formed.  U.C.C. § 2-615, cmt. 1. 

The first of these tests excuses a seller from performance where it can show the existence of (1) a contingency (2) the impracticability of performance as a consequence of the occurrence of that contingency, and (3) that the nonoccurrence of the contingency was a basic assumption of the contract. See Dell's Maraschino Cherries Co. v. Shoreline Fruit Growers, Inc., 887 F. Supp. 2d 459 (E.D.N.Y. 2012). The official comments to Section 2-615 list as examples of possible contingencies: “a severe shortage of raw materials or of supplies due to a contingency such as war, embargo, local crop failure, unforeseen shutdown of major sources of supply or the like, which either causes a marked increase in cost or altogether prevents the seller from
securing supplies necessary to his performance.”  U.C.C. § 2-615.  Performance under this doctrine will only be excused when it can only be done at extreme and unreasonable cost. See Asphalt Intern., Inc. v. Enterprise Shipping Corp., 667 F.2d 261, 266 (2d Cir. 1981) (applying maritime law but incorporating UCC §2-615 by analogy); Transatlantic Fin. Corp. v. U.S., 363 F.2d 312 (D.C. Cir. 1966).  However, mere financial hardship is not sufficient to excuse performance. See Rochester Gas Electric Corporation v. Delta Star, Case No. 06-CV-6155-CJS-MWP, 2009 WL 368508 (W.D.N.Y. Feb. 13, 2009); Maple Farms v. City Sch. Dist., 76 Misc. 2d 1080, 1083 (Sup. Ct., Chemung Cty. 1974) see also U.C.C. § 2-615, cmt. 4.

In addition, if the hardship was foreseen by the parties, the doctrine of impracticablilty will not apply.  See, e.g., Kel Kim Corp. v. Central Markets, Inc., 70 N.Y.2d 900, 902 (1987); U.S. v. Brooks-Callaway Co., 318 U.S. 120, 122-23 (1943); Ahlstrom Machinery, Inc. v. Associated Airfreight, Inc., 251 A.D.2d 852, 853 (3d Dept. 1998).  For example, if the contract between the parties include a force majeure clause specifically or impliedly covering epidemics, the terms of that contractual provision would control instead of the U.C.C.  Similarly, companies that continued accepting orders as it became foreseeable that the Coronavirus would create considerable economic disruption may not be able to invoke the protections of Section 2-615. See Cliffstar Corp. v. Riverbend Prods., 750 F. Supp. 81, 84 (W.D.N.Y. 1990) citing Roth Steel Prods. v. Sharon Steel Corp., 705 F.2d 134, 149-50 (6th Cir. 1983).

Turning to the second prong of the UCC 2-615(a) test, the imposition of governmental regulations is an excuse to performance if it both renders performance genuinely impractical and was unforeseen at the time of contracting.  See, e.g., Matter of A S Transp. Co. v. Cty. of Nassau, 154 A.D.2d 456, 459 (2d Dept. 1989); Moyer v. City of Little Falls, 134 Misc. 2d 299, 301 (Sup. Ct., Herkimer Cty. 1986) see also Barton Windpower, LLC v. N. Ind. Pub. Serv. Co., 13-cv-5329 (N.D. Ill. June 18, 2018) (applying N.Y. law). 

For example, regulations that would render performance illegal would excuse the seller, assuming they were not foreseen at the time the contract was entered into.  See, e.g., Matter of Kramer Uchitelle, Inc., 288 N.Y. 467, 471 (1942); Boer v. Garcia, 240 N.Y. 9, 16 (1925).  Similarly, regulations that supersede existing contracts and require goods to be sold at the government’s direction would also constitute an excuse if unforeseen. Nitro P. Co. v. Agency of C.C. and F. Co., 233 N.Y. 294 (1922); Mawhinney v. Millbrook Woolen Mills, 231 N.Y. 290 (1921). 

Accordingly, it is likely that a court addressing recent regulations such as N.Y. Executive Order 202.6, which required the closure of various “non-essential” businesses, would conclude that the affected businesses had a valid excuse for non-performance.[2]

Similarly, non-performance of contracts for the sale of goods that were superseded by the invocation of the Defense Production Act, 50 U.S.C. §§4501 et seq. or other legal provisions, is also likely excusable.  There are, however, two possible caveats to that analysis.  First, if a seller was found to have caused or colluded in the government action preventing performance, then this excuse would not apply, which may present problems for companies that affirmatively request that the Defense Production Act apply to them in order to supersede existing contractual obligations. MG Refining & Marketing, Inc. v. Knight Enterprises, Inc., 25 F. Supp. 2d 175 (S.D.N.Y. 1998); Cliffstar Corp. v. Riverbend Products, 750 F. Supp. 81, 84 (W.D.N.Y. 1990) citing Roth Steel Products v. Sharon Steel Corp., 705 F.2d 134, 149-50 (6th Cir. 1983). Second, performance is not excused if the supervening regulation was foreseeable, which may create some ambiguity regarding contracts entered into after the start of the Coronavirus crisis.

2.      U.C.C. § 2-615(b): How Should Goods Already Produced Be Allocated?

If, despite commercial impracticability, a seller is able to produce some, but not all, of the contracted-for goods, Section 2-615(b) requires that the seller allocate production and delivery between existing customers, regular customers not then under contract, and their own manufacturing requirements in a fair and reasonable manner.  U.C.C. § 2-615(b).  As the official comments to Section 2-615 explain, this section is intended to provide “reasonable business leeway” to sellers in order to determine a fair and reasonable method of allocation.

Courts in New York have not had much opportunity to address whether allocations under Section 2-615(b) are fair and reasonable, and the courts which have looked at this issue have generally found that whether an allocation is reasonable is a question of fact for the jury. See, e.g., Cliffstar Corp., 750 F.Supp. at 87.  In general, courts in other jurisdictions have upheld allocation schemes where goods were distributed according to objective, consistently applied criteria, such as prior sales volume.  See, e.g., Cecil Corley Motor Co., Inc. v. General Motors Corp., 380 F. Supp. 819 (M.D. Tenn. 1974); Intermar, Inc. v. Atlantic Richfield Company, 364 F. Supp. 82, 99 (E.D. Pa. 1973). It can be permissible to include subsidiaries and affiliates in an allocation scheme assuming that they already either had contracts to receive goods and
were regular customers and were not given favorable treatment over other customers under the allocation criteria the seller determined.  See Intermar, 364 F.Supp. at 99.

On the other hand, courts have generally been skeptical of allocation schemes that can be characterized as unfair self-dealing.  See, e.g, Chemetron Corp. v. McLouth Steel Corp., 381 F. Supp. 245 (N.D. Ill. 1974); Haley v. Van Lierop, 64 F. Supp. 114, 116 (W.D. Mich. 1945), Courts have rejected allocation schemes that include parties other than customers with existing contracts or regular customers, such as new customers or newly formed subsidiaries.  See, e.g., Roth, 705 F.2d at 151.  Allocation schemes that completely cut out certain disfavored buyers have also been found to be unreasonable. Cosden Oil & Chemical Co. v. Karl O. Helm Aktiengesellschaft, 736 F.2d 1064 (5th Cir. 1984). 

3.     U.C.C. § 2-615(c):  How Quickly Must Customers Be Told The Bad News?

Finally, Section 2-615 requires that sellers “seasonably” notify buyers that there will be delay or non-delivery and, in the event that there will be an allocation of goods under Section 2-615(b), the quota of goods available to the buyer. U.C.C. § 2-615(c).  “Seasonable” is defined in U.C.C. as an action undertaken within a reasonable time depending on the nature, purpose and circumstances of that action.  U.C.C. § 1-205.  The U.C.C. does not specify a form that this
notice must take, just that the seller take such steps as reasonably required to inform the buyer in the ordinary course of business.  U.C.C. § 1-202(d).

While I am not aware of any New York courts that have ruled upon what seasonable notice is in the context of Section 2-615, most courts that have considered similar requirements in other provisions of the U.C.C. have tended to treat the question of whether an action was done seasonably as a question of fact to be determined by the jury. See, e.g., Sherkate Sahami Khass Rapol v. Henry R. Jahn & Son, Inc., 701 F.2d 1049, 1051 (2d Cir. 1983).  However, courts will determine what constitutes a reasonable time before trial when the facts will admit of only one inference. Tabor v. Logan, 114 A.D.2d 894 (2d Dept. 1985).   Among the factors courts have considered in other contexts that may be relevant to disputes under Section 2-615(a) are whether the goods at issue were subject to rapid fluctuations in price and whether the aggrieved party was substantially prejudiced by the delay in notice.  See, e.g., Simply Natural Foods LLC v. Polk Mach. Co., Case No. 11-CV-3911(JS)(SIL), 2015 WL 5599152 (E.D.N.Y. Sep. 22, 2015); Levin v. Gallery 63 Antiques Corp., Case No. 04-CV-1504 (KMK), 2006 WL 2802008, (S.D.N.Y. Sep. 28, 2006).

4.     Conclusion

For companies faced with contracts for the sale of goods that they are unable to fulfill due to Coronavirus-related disruptions, they may be excused performance under U.C.C. § 2-615 if they can show that performing is either commercially impracticable or prohibited under
governmental mandates and that the disruption was not foreseeable.  In addition, for companies that can partially fulfill orders, they must allocate goods between customers in a fair and reasonable manner, ideally in accordance with objective and consistently
applied criteria.  Finally, companies wishing to invoke U.C.C. § 2-615 must notify customers within a reasonable time, with prompt notification especially necessary if the goods in question are subject to rapid fluctuations in price of if counterparties are likely to be substantially prejudiced by delay.

[1] This blog post only addresses contracts for the sale of goods.  Other contracts are governed by a somewhat different legal regime, which will be addressed in a subsequent post.

[2] With the possible exception of contracts entered into shortly before the issuance of Executive Order 202.6, when it arguably became foreseeable.

Ted Geiger Quoted In CNBC Article Regarding Consequences of Unfriending Coworkers

Can unfriending a colleague on Facebook give rise to liability?  It’s a question that CNBC asked me yesterday.  Last week, the Australian Fair Work Commission held that doing so could be considered an act of bullying pursuant to the Fair Work Act of 2009.  In Roberts v. VIEW Launceston Pty Ltd., [2015] FWC 6656, the FWC issued an order mandating that the bullying of an employee at a Tasmanian real estate office must cease.   The FWC’s decision was based upon allegations of 18 separate incidents of bullying between November 2013 and February 2015, including the unfriending of the plaintiff by her supervisor.

While most of the allegations were unremarkable, the FWC’s inclusion of the unfriending allegations made worldwide headlines, including on CNBC.  CNBC asked me to comment on what the implications of the decision could be for U.S. employers.  After noting that neither state nor federal law provides a general civility code for the workplace, I stated that "actions on social media, especially cyberbullying, could certainly be used to substantiate a claim for harassment based on a hostile work environment."  I also clarified that it was important to look at the unfriending issue in context: “This decision here is a onetime decision and while the unfriending is the headline, since the decision was based on number of actions over a two-year period…I don't think that unfriending will become the sole basis for liability anytime soon."

The full article can be read here.

A Guide To Enforcing Foreign Country Money Judgments In New York State

               Given its status as a global financial center and the continued popularity of Manhattan real estate among foreign investors, New York presents an attractive opportunity for those looking to enforce judgments obtained outside of the United States.[1]  Fortunately for judgment creditors, the Court of Appeals has stated, “New York has traditionally been a generous forum in which to enforce judgments for money damages rendered by foreign courts.”  CIBC Mellon Trust Co. v. Mora Hotel Corp., N.V., 100 N.Y.2d 215 (2003). 

                The recognition of foreign country money judgments is governed by Article 53 of the C.P.L.R., which is New York’s version of the Uniform Foreign Country Money Judgments Act.  Under this act, most foreign court judgments granting or denying the recovery of a sum of money can be enforced in New York.[2]  C.P.L.R. § 5301.  While this section sets forth a procedure that is somewhat more intricate than the process for recognizing a sister-state judgment, enforcing eligible foreign judgments is relatively straightforward.

    A.  Requirements and Procedure

                In general, unless one of the defenses discussed in the next section applies, a foreign country judgment can be enforced in New York if it is final, conclusive and enforceable in the country it was rendered in.  C.P.L.R. § 5302.  Such a decision can be enforced even if it is subject to appeal, though a  New York court can, in its discretion, stay enforcement proceedings until a foreign court appeal is resolved.  C.P.L.R. § 5306.

                Enforcing foreign country money judgments is probably most typically done via a motion for summary judgment in lieu of complaint pursuant to Section 3213 of the C.P.L.R., due to the expedited procedures that section provides for, though initiating any procedurally proper action on the judgment will suffice.  Additionally, foreign country money judgments can also be recognized in a pending action by asserting a cross-claim, counterclaim or affirmative defense.  C.P.L.R. § 5303.

                As in any action, service on the defendant must be properly made pursuant to the C.P.L.R. and the Hague Convention (for defendants not present in the United States). See, e.g., Imax Corp. v. E-City Entertainment (I) Pvt. Ltd, 2014 N.Y. Slip. Op. 31710(U) (Sup. Ct., N.Y. Cty., July 2, 2014).  

Notably, however, it is not necessary for a New York court to have personal jurisdiction over the defendant.  See Abu Dhabi Comm. Bank PJSC v. Saad Trading, 986 N.Y.S.2d 454 (1st Dep’t 2014).  Additionally, it is also not necessary for the defendant to have assets in New York when a judgment enforcement proceeding is brought, as the creditor is perfectly within its rights to put a marker down in anticipation of a defendant bringing assets into New York at some later point. Id. 

                It should also be noted that, once recognized by the New York courts, a foreign money judgment is treated as if it were a New York judgment. Therefore, among other things, a judgment creditor with such a judgment can utilize New York’s post-judgment discovery and judgment enforcement procedures.  In addition, the newly domesticated judgment[3] begins to accrue interest at New York’s statutory 9% post-judgment interest rate from the date of domestication.  Id.

    B.  Defenses

               While New York is generally welcoming to foreign money judgments, there are some defenses available to the judgment debtor.

1.  Mandatory Defenses

                First, Section 5304(a) of the C.P.L.R. provides two grounds for finding a judgment to be not conclusive, and therefore per se unenforceable: (a) the judgment was the product of a system that did not provide for an impartial court or procedures compatible with due process or (b) the foreign court did not have personal jurisdiction over the defendant.  Id. 

               The "no impartial court” defense has been construed narrowly by the New York courts, which have only been willing to apply it in situations where the foreign country’s court system was seriously compromised and generally incapable of providing a fair trial.  See, e.g., Bridgeway Corp. v. Citibank, 45 F.Supp.2d 276 (S.D.N.Y. 1999) aff’d 201 F.3d 134 (2d Cir. 2000) (refusing to enforce judgment issued by Liberian Supreme Court when judiciary was barely functioning due to a civil war in that country); Chevron Corp. v. Donziger, 974 F. Supp.2d 362 (S.D.N.Y. 2014) (Ecuadorian judgment unenforceable when judgment creditor bribed and coerced judges and ghostwrote decision).  

                As for the defense of lack of personal jurisdiction, Section 5305 lists six bases for finding that the foreign court had personal jurisdiction: (a) the defendant was personally served in the foreign country; (b) the defendant voluntarily appeared in the proceedings (for purposes other than contesting jurisdiction or the seizure of property); (c) the defendant agreed to submit to the foreign court’s jurisdiction prior to the commencement of proceedings against him; (d) the defendant was domiciled or (if a corporation) incorporated in the foreign state; (e) the defendant had a business office in the foreign state and the proceeding arose out of business being done by the defendant out of that office; and (f) the defendant operated a motor vehicle or airplane in that country and the proceedings arose from that.  C.P.L.R. § 5305(a).  In addition, even if none of these bases for personal jurisdiction applied, the New York court could still find that personal jurisdiction existed if there were sufficient contacts between the defendant and the foreign country.  C.P.L.R. § 5305(b).

2.  Discretionary Defenses

                Second, a New York court has the discretion not to recognize a judgment if (a) the foreign court did not have subject matter jurisdiction, (b) the defendant did not have adequate notice of the foreign proceeding, (c) the judgement was the product of a fraud upon the foreign court, (d) the foreign judgment is repugnant to New York public policy, (e) the judgment conflicts with another final and conclusive judgment, (f) New York would be an inconvenient forum, if jurisdiction was based solely on personal service, and (g) the judgment is based on a defamation claim, unless the New York court first determines that the foreign court gave the defendant freedom of speech protections comparable to those available here.              

                Most of these defenses are fairly self-explanatory, but some have been the subject of controversy in recent years.  For example, in situations where a defendant was not properly served under the Hague Convention, questions of notice can arise. See, e.g. Baker & McKenzie Zurich v. Frisone, 2015 N.Y. Misc. Lexis 2037 (Sup. Ct., Nassau Cty., June 2, 2015) (summary judgment in lieu of complaint denied where service not properly made).  Similarly, as the Chevron/Donziger saga illustrates, questions whether the underlying judgment was procured by fraud can greatly delay enforcement if the defendant can make out a prima facie case, and can bar enforcement altogether if proved.  See generally Chevron, 974 F. Supp.2d at 557-564.  Finally, it should be noted that even in intellectual property cases that do not involve defamation, First Amendment concerns can act as a bar to enforcement since holding otherwise would be contrary to public policy.  See S.A.R.L. Louis Feraud Int’l v. Viewfinder, Inc., 489 F.3d 474 (2d Cir. 2007).

               The topic of enforcement of foreign (including out-of-state) judgments is vast.  This post can only scratch the surface.  If I can provide further assistance or information, please do not hesitate to contact me.

[1] Technically, judgments obtained in another state of the United States are also referred to as “foreign judgments;” however, we will call those judgments “out-of-state judgments” for purposes of this post. The enforcement of “out-of-state judgments” is a topic for another day.

[2] Article 53 does not apply to non-money judgments (such as those for injunctive relief), as well as matrimonial or child support obligations or to tax judgments, fines and penalties.

[3] An out-of-state or foreign judgment that is made enforceable in New York is referred to as a “domesticated judgment.”

Welcome to the Ted Geiger Law Blog

Hello and welcome to the TGL Blog!  In this space, I'll be providing my take on current legal issues, overviews of the legal framework underlying the areas I practice in, and anything else of interest.

If you have any comments or questions, please use the link below or email me at tgeiger@tedgeigerlaw.com.