Occasionally, we come across post-trial decisions with such scathing rebuke of one side that it’s difficult to imagine why the loser ever chose to take the case to trial. O’Mahony v Whiston is a perfect example.
Years into a protracted derivative lawsuit by a 20% founding shareholder against his co-founder 60% shareholders over their misappropriation of “Smithfield,” an Irish sports bar in Manhattan, New York County Commercial Division Justice Jennifer G. Schechter colorfully warned the litigants of the trial risks when she denied summary judgment:
[T]he court would be remiss if it did not take this opportunity to encourage a sober reckoning on each side, as the parties (or at least their attorneys) have an unjustifiably rosy view of their respective positions such that each side believes sanctions are warranted against the other due their contentions being frivolous. Not so. An impartial view of the record makes clear that while the parties’ actions certainly suffered from shortcomings, each side has a certain amount of justification for what they did. Before trial, perhaps cooler heads will prevail. For this reason, the pre-trial process will be delayed for 30 days, during which the parties shall personally meet for good faith settlement discussions.
Instead of settling, both sides appealed. In the resulting decision, the Appellate Division ruled: “Summary judgment was properly denied” because the record raised numerous issues of fact, including, according to the appeals court:
- “whether a bar opened by defendants qualified as a corporate opportunity of the bar and corporation owned by plaintiffs and defendants together”;
- “whether assets of the corporation, including its goodwill, were given to the new bar for no consideration”;
- “whether the individual defendants looted, committed waste, or paid themselves unfair bonuses”;
- “whether a loan issued by plaintiffs to the corporation was repaid;” and
- “whether the individual defendants’ treatment of plaintiffs amounted to shareholder oppression.”
Issues of fact framed succinctly, the parties proceeded to a bench trial before Justice Schechter in January 2022. What resulted was an absolutely devastating finding of liability and damages against the defendant majority shareholders for misappropriation of corporate opportunity, including a rare imposition of punitive damages and an accounting surcharge. Justice Schechter’s post-trial decision is a tour de force, well worth a read. But first, the basic facts.
Origins of the Dispute
Foley, Whiston, McCarthy, and Slattery formed Dubcork, Inc. (“Dubcork”) as co-equal, 25% shareholders to own and operate Smithfield bar. There was no shareholders’ agreement. Foley assigned or transferred his stock in Dubcork to his romantic partner, O’Mahony. The four shareholders later sold 20% of Dubcork’s stock to a handful of minority investors, leaving Foley / O’Mahony with 20%, Whiston, McCarthy, and Slattery with the remaining 60%.
According to the Third Amended Complaint, Smithfield “was a huge success from day one and quickly became one of the most popular sports bars in New York City.” Just one month after Smithfield’s opening, though, the landlord informed Dubcork’s owners it desired to buy out Dubcork’s lease to sell the land for a redevelopment project. Foley’s co-shareholders quickly excluded him from the lease buyout discussions. Litigation ensued between Dubcork and the landlord, eventually resulting in a whopping $1.9 million payment from the landlord to buy out Dubcork’s lease and close Smithfield. According to Foley and O’Mahony, they did not learn of the settlement until after they commenced the derivative lawsuit.
Unbeknownst to O’Mahony and Foley, Whiston, McCarthy, and Slattery secretly formed a new corporation, Moxy Restaurant Associates, Inc. (“Moxy”), declined to offer O’Mahony and Foley the opportunity to join as shareholders, then used the landlord’s $1.9 million settlement payment to acquire a lease elsewhere, perform the physical build-out, and open a new Smithfield bar – named “Smithfield Hall” – just a few blocks away from the original bar.
Outraged, O’Mahony and Foley sued on behalf of Dubcork for misappropriation of corporate opportunity, accounting, minority shareholder oppression (but not dissolution) under Section 1104-a of the Business Corporation Law (the “BCL”), misappropriation of Dubcork’s fixed assets, and breach of contract for failure to repay a $90,000 loan Foley made to Dubcork.
Liability for Misappropriation of Corporate Opportunity
After trial and post-trial briefing (read here and here), Justice Schechter excoriated Whiston, McCarthy, and Slattery, ruling that there was “abundant evidence” they “intended” to make their new bar resemble as closely as possible the original: they used the same website, the same sign, the same tables, chairs, and furnishings, and the same name. The Court found that the new bar was “essentially the same bar” as the original.
“The majority owners of the old bar,” held the Court, “using Dubcork assets opened the new bar under a new corporation (Moxy), thereby misappropriating a corporate opportunity of the corporation that owned the old bar (Dubcork), effectively cutting out plaintiffs, its minority owners.” The Court found particularly important that the “settlement proceeds from the landlord” from the lease buyout “were sufficient to open the new bar so Dubcork could have availed itself of the opportunity to own the new bar.”
Damages for Misappropriation of Corporate Opportunity
The Court focused most of its attention on damages. For the correct measure of damages, the Court held that “disgorgement of the value of Moxy, including its increased value,” was appropriate “since it should have been given the opportunity to own the new bar.”
Turning to the amount of damages for misappropriation of corporate opportunity, the Court lambasted defendants’ valuation expert:
An expert who testifies recklessly, whose testimony comes across as advocacy and not as reliable professional opinion, lacks credibility, particularly where, as here, his opinions are undermined by the credible evidence. The court finds that Johansen is not a reliable expert witness and does not credit his testimony.
Adopting the plaintiffs’ expert’s valuation with some modest adjustments, the Court imposed against Whiston, McCarthy, Slattery, and Moxy, jointly and severally, a mix of past and prospective future damages based upon income projections for Moxy’s business, specifically:
- $733,728 of Moxy’s reported net income through trial;
- an additional 15% of that amount ($110,059) to account for unreported cash;
- $476,630 in reported goodwill; and
- $1.5 million in projected future net income.
Clearly disturbed by what it described as an “egregious breach of fiduciary duty,” the Court wrote that it “also finds that punitive damages are warranted.” The Court continued: “The evidence established that defendants’ conduct was intentional, deliberate and fraudulent. They concealed material information and diverted assets despite their fiduciary status and lied about doing so.” As a result, the Court imposed against Whiston, McCarthy, Slattery a separate punitive damages award of $100,000 each.
You know you’re in trouble when a judge begins her analysis of your accounting with a remark like this: “The accounting is a mess.” The Court found defendants’ pre-trial accounting “untimely, incomplete, and unreliable,” particularly as to defendants’ failure to keep receipts:
By failing to maintain and produce clear records, defendants are essentially relying on their credibility by asking the court to trust them about the meaning and reliability of the records they managed to cobble together. That is difficult to do. The court did not find defendants to be particularly credible . . . . [D]efendants have only themselves to blame for their shoddy recordkeeping and destruction of documents.
Harsh words indeed. Finding that defendants failed to account for hundreds of thousands of dollars in unreported cash sales, the Court imposed against Whiston, McCarthy, Slattery a rare surcharge of $648,551 each.
“The whole point of an accounting,” wrote the Court, “is that plaintiffs and the court should not have to guess; the fiduciary is obligated to explain and justify the use of money. . . . Had defendants simply maintained clear corporate records, they would not have had any difficulty proving that they were really making payments for the bar. They have only themselves to blame for lacking credible proof.”
Misappropriation of Cash and Fixed Assets, the Foley Loan, and Attorneys’ Fees
The Court awarded damages for several additional items.
First, the Court held that Whiston, McCarthy, and Slattery improperly paid themselves “bonuses” of $55,000 each when they closed the old bar’s lease buyout transaction, ordering the money repaid to Dubcork.
Second, the Court held that Whiston, McCarthy, and Slattery misappropriated $70,500 of Dubcork’s inventory, writing that “simply walking away with the inventory” is not a viable option when winding down a business.
Third, the Court ruled that Dubcork failed to repay Foley’s $90,000 loan, ruling that “Whiston, McCarthy and Slattery are personally held liable on a veil-piercing theory since the credible evidence makes clear that they completely dominated Dubcork, abused its corporate formalities and stripped all of its value, transferred money to themselves and made it an empty shell that is unable to repay the loan.”
Fourth, the Court held that because O’Mahony and Foley prevailed on their derivative claims, they are entitled to “submit a fee application for reimbursement of their reasonable fees and expenses” under BCL § 626 (e).
Outcome of O’Mahony
O’Mahony was a crushing loss for the defendants, resulting in entry last month of a goliath money judgment against Moxy and its shareholders, with a potentially massive future attorneys’ fee award still to come. The one silver lining for the defendants: all but one component of the damages (the $90,000 Foley loan) the Court awarded derivatively on behalf of Dubcork. This means that 60% of the damages are payable to the pro rata share interest of Whiston, McCarthy, and Slattery. In other words, only 20% of the overall judgment is payable to O’Mahony / Foley.
What are some lessons from O’Mahony?
Don’t take a closely-held entity’s most valuable asset, such as a lease, sell it, and secretly use all of the proceeds to form a new entity operating a competing business.
If you are a fiduciary, expect that you will one day have to account, and always, always, keep the receipts.
Don’t try to get your expert witness to testify as if he were an advocate, or testify about matters that are beyond his ken. If you do, you run the risk of sullying his credibility entirely.
Finally, if you are a litigator, realistically assess whether taking a high-stakes case to trial is worth the risk to your clients. If it is not, say so. The alternative is a potentially embarrassing, painful, financially disastrous loss.