That was the interesting, infrequently-litigated question addressed in a recent decision by Manhattan Commercial Division Justice Melissa A. Crane.
Simon v FrancInvest, S.A. (2023 NY Slip Op 32422[U] [Sup Ct, NY County July 7, 2023]), was a summary judgment decision in a litigation still going strong after nearly ten years over a family-owned medical practice called the French-American Surgery Center (the “Surgery Center”) operating out of a valuable, family-owned condominium adjacent to Central Park in Manhattan (the “Premises”).
Pascal’s Claims Alleging a “Scheme to Defraud”
In the Third Amended Complaint, Jean-Pascal Simon (“Pascal”) sued his brother, Jean-Francois Simon (“Francois”) and others who allegedly aided and abetted Francois in a “scheme to defraud” Pascal and his sister “of the family’s crown jewels: the Surgery Center and the Premises.”
Pascal brought a mix of direct and derivative claims on behalf of two entities in whose names the family assets were held – nominal defendants FrancInvest, N.A. (“FrancInvest”) and JJS Group, Inc. (“JJS”).
Pascal alleged a series of transactions by which his brother illegitimately seized control of the family businesses then stripped them of their assets, including that Francois sold the Surgery Center “behind Pascal’s back for $2.3 million in a non-arms-length transaction” from which Francois allegedly collected all the proceeds, and separately “secretly caused JJS to refinance the mortgage on the Premises several times and cashed out millions of dollars for himself.”
In his eleventh cause of action for aiding and abetting fraud brought “double derivatively” on behalf of JJB, Pascal alleged that George Kessler (“Kessler”), an attorney for Francois, “provided substantial assistance” to Francois by drafting various legal documents instrumental to the plan.
Pascal and Francois eventually settled. As Justice Crane wrote in her opinion, “the case against Francois for fraud is over. All that remains for the court in this motion is the eleventh cause of action against Kessler for aiding and abetting fraud.”
Although the Court ruled that Pascal “established that Francois committed an underlying fraud,” the Court declined to summarily impose liability against Kessler for aiding and abetting, concluding that Pascal “failed to establish as a matter of law that Kessler had knowledge of the underlying fraud,” an essential element of the claim.
But this article is not about aiding and abetting fraud. In his Answer to the Third Amended Complaint, Kessler counterclaimed against Pascal in his individual capacity alleging five causes of action: (i) malicious prosecution; (ii) abuse of process; (iii) defamation; (iv) intentional infliction of emotional distress; and (v) a claim seeking to recover compensatory and punitive damages for a “hate crime or hate suit perpetrated against a senior citizen.”
Pascal’s Motion to Strike the Counterclaims
Branch “a” of Pascal’s Order to Show Cause for summary judgment requested an order “striking all of the . . . Counterclaims” in Kessler’s Answer. But, as Justice Crane wrote in her decision, Pascal made “no argument in support of dismissing Kessler’s counterclaims in the opening papers.”
Instead, for the first time on reply, Pascal wrote in just two paragraphs:
Finally, in an attempt to distract from his liability, Kessler has continually referenced his $15 million counterclaim against Plaintiff, his former client. Yet as a matter of settled law, ‘[S]tockholders suing derivatively are not subject to counterclaim against them as individuals.’ Binon v Boel, 66 N.Y.S.2d 425 (1st Dep’t 1946). . . .
The sole claim against Kessler is the eleventh cause of action, a derivative claim for aiding and abetting fraud, on behalf of JJS. All of Kessler’s counterclaims are asserted against Plaintiff, as an individual and no counterclaims are asserted against nominal defendants JJS or FrancInvest. Thus, as a matter of law, Kessler’s counterclaims must be dismissed.
Relying upon pre-CPLR case law from almost 80 years ago is generally a risky proposition. As it turns out though, the doctrine of Binon v Boel has far more recent support.
Recent Cases Barring Direct Claims Against Plaintiffs Suing in a Representative Capacity
In Michelman-Cancelliere Iron Works, Inc. v Kiska Constr. Corp.-USA (18 AD3d 722 [2d Dept 2005]), the Court wrote that a “claim and counterclaim must be by and against the same party in the same capacity” (quotations omitted).
Michelman held: “Since this action was brought by the Joint Venture to recover money due on a contract entered into by the Joint Venture, the defendants were not entitled to assert counterclaims against Michelman in its individual capacity, based on matters unrelated to the business of the Joint Venture.”
And in Choi v Cho (2014 NY Slip Op 33920(U) [Sup Ct, Nassau County July 28, 2014]), a shareholder derivative plaintiff moved to dismiss counterclaims against him arguing that “stockholders suing derivatively are not subject to counterclaims against them as individuals because they have no standing in the action apart from that which is derived as stockholders.”
In Choi, Nassau County Commercial Division Justice Timothy S. Driscoll granted the derivative plaintiff’s motion to dismiss, ruling: “The Court concludes that Cho’s counterclaim is not viable because Plaintiff has sued in his derivative capacity and, therefore, may not be sued in his individual capacity.”
The Simon Decision
Justice Crane resolved the direct-versus-derivative counterclaim question in three parts.
- First, the Court ruled that it “need not consider” Pascal’s argument because it was “raised for the first time on reply.”
- Second, the Court ruled, “[i]n any event, the third amended complaint to which Kessler counterclaimed contains both direct and derivative causes of action.”
- Third, the Court held:
[T]he court cannot determine as a matter of law that it was improper for Kessler to counterclaim against Pascal individually, particularly because JJS is a closely held corporation and its interests are tied closely with Pascal’s own interests (see Conant v Schnall, 33 AD2d 326, 328 [3d Dept 1970] [citing general rule that a ‘shareholder bringing a derivative action is not subject to counterclaims against him individually’ but then finding that the rule does not apply where the representative ‘is also the real party in interest’ as the ‘sole shareholder, officer and director of the corporation’]).
The Court’s Reliance Upon Conant
One might question the Court’s reliance upon Conant.
Conant analogized to the law of trusts and estates, “where an administrator, who is also the sole heir, brings an action in his representative capacity, he is subject to individual counterclaims. The theory of such a result is that his two capacities merged.” According to his own pleading, Pascal was not, as in Conant, the “sole” shareholder, officer, or director of JJS.
But it is hard to disagree with the Court’s ultimate conclusion. Where, as in Simon, a shareholder sues both directly and derivatively, it seems only fair that he voluntarily exposes himself to countersuit directly. In other words, if one sues directly at least in part, one should be prepared to defend a countersuit in a direct capacity.
The notion that shareholders suing derivatively are not subject to counterclaims against them individually may come as a surprise to business divorce practitioners. Many of us can think of examples in our practice where shareholder derivative plaintiffs have faced countersuit against direct claims. The somewhat arcane rule of law of Simon does not seem to match the modern reality of business divorce litigation.
Is there a pleading solution to the Simon problem?
Though I have never seen it done, I would suspect that a defendant in a shareholder derivative lawsuit might successfully file and serve a summons accompanying the answer and counterclaims amending the caption to name the plaintiff in his or her individual capacity as an “additional defendant on the counterclaims.”
Another option might be for the defendant to file a summons and third-party complaint naming the plaintiff as defendant in an individual capacity on third-party claims.
It certainly seems a waste of resources to force the defendant to file a separate lawsuit against the same individual who brought the original lawsuit just to allege some counterclaims. If forced to do so, the defendant could then move to join or consolidate. All of this, unfortunately, yields exactly what New York’s liberal joinder rules are designed to avoid: multiplicity of lawsuits and unnecessary expenditure of time, money, and court resources.