A Pig in a Poke: The Rollercoaster Kadosh Settlement Litigation

March 15, 2019

Years ago, we wrote about the perils of “impromptu” settlements in business divorce cases – settlements eked out at the courthouse, on the fly, under pressure, during conferences, hearings, or trials. The resulting agreements tend to be memorialized in on-the-record, transcribed settlements made verbally between lawyers, clients, and the judge.

In-court settlements are both common and vital to litigation, the ultimate goal of which, of course, is to resolve disputes. But sometimes the parties’ eagerness to resolve a lengthy, difficult litigation can cause them to overlook or ignore subtle (or not-so-subtle) aspects of the deal vital to the overall transaction.

In a recent decision, fissures in the façade of an impromptu settlement began to appear almost from the moment the parties put their agreement on the record. What followed was a series of painful, two-and-a-half year, post-settlement proceedings – a veritable parade of horribles that reached its climax in a decision last month by a Manhattan appeals court in Kadosh v Kadosh, 169 AD3d 439 [1st Dept Feb. 7, 2019].

The Dispute

In Kadosh, Michel sued his brother, David, for alleged wrongful conduct in the operation of an LLC of which the brothers were 50/50 member/managers that owned and operated a mixed-use building in Manhattan. According to Michel’s latest complaint, he contributed far more capital to the enterprise than David, both in cash and construction / maintenance costs, and was entitled to recoup his disproportionate contributions. Eventually, David forced Michel out and Michel sued for damages.

The Dissolution and Appointment of a Receiver

In a related lawsuit, later joined with Kadosh, David sued for dissolution. The Hon. Shirley Werner Kornreich granted dissolution and appointed an attorney as liquidating trustee to sell the LLC’s building. In Kadosh, Justice Kornreich issued an order appointing the same attorney as temporary receiver. The liquidating trustee/receiver sold the building owned by the LLC for $8.7 million, holding the net proceeds in escrow. The Court scheduled a trial on various issues, including the proper distribution from the receiver of the sale proceeds.

The On-the-Record Settlement

On the 23rd day of trial, the parties read into the record what they described as a “partial settlement.” The parties agreed to split the proceeds of the sale of the building between themselves 50/50, with the exception of $700,000 to remain in escrow to satisfy the allegedly disproportionate expenditures for the building by the two LLC members. At the time, the parties stated their belief that the receiver had “about” $7.9 million in his account.

As to the remaining $700,000, the parties agreed to await a decision by the Court as to its distribution, i.e., to Michel, to David, or to both. The parties agreed that “the Court’s decision does not need to be a reasoned decision or written decision,” and that “when the Court renders its decision as to how to allocate the funds,” the decision will be “final” and “the parties are waiving all rights to appeal.” After reciting these terms, the parties were sworn in and gave lengthy allocutions that they understood the settlement, agreed with its terms, and were satisfied with their legal representation.

Cracks in the Façade

The Kadosh settlement was imperiled from its infancy. Just days after the parties settled, they sent a volley of letters to the Court indicating that the receiver had $7 million in his account, not $7.9 million. Counsel for David insisted there remained an enforceable settlement, but counsel for Michel asserted that the discrepancy rendered the settlement unenforceable for lack of “meeting of minds” and “mistake.” You can read the letters here, here, and here. As seen below, the parties’ roles later reversed, with David challenging, and Michel defending, the settlement.

The Settlement Modification

A few days later, the parties agreed on the record to modify their settlement to increase the amount being held in escrow from $700,000 to $1.6 million, and to split the remaining $5.4 million 50/50. The parties were re-allocuted and confirmed the settlement, including their waiver of right to appeal. The same day, Justice Kornreich issued an order confirming the settlement. In the order, the Court wrote that David’s share could be released only upon a written letter from his own legal counsel, to whom David was indebted, instructing the receiver how to release the funds.

The Escrow Decision

About a year later, Justice Kornreich issued her decision on the final piece of the litigation – distribution of the remaining $1.6 million in escrow. The Court noted that the parties agreed its decision “would not be a reasoned one – one containing findings of fact.” It then awarded the entirety of the funds being held in escrow to Michel. Despite agreeing twice that the decision would be final and nonappealable, David – now represented by new counsel – appealed the decision.

David’s Misappropriation from the Receiver

While the appeal was pending, the Court issued two remarkable decisions. Both emanated from David, in the Court’s words, “fraudulently inducing” the receiver to transfer directly to David the $2.7 million owed to him under the settlement agreement without the required instructions from his former counsel, to whom David owed nearly $400,000, as to how and where the money should be paid. The Court concluded that David had the money sent to him specifically to frustrate his lawyers’ lien on the settlement.

In the first decision, the Court found the receiver’s conduct in sending David the settlement proceeds “without first inquiring (e.g., with a quick email)” of the status of the fee dispute between David and his lawyers “amounts to gross negligence.” The Court ruled that the receiver “failed to faithfully discharge his duties,” and denied “without prejudice” the receiver’s motion to settle his accounts and be discharged. To be fair to the receiver, whom the Court praised earlier in the litigation as “without question,” the “best Receiver I have ever appointed,” the Court lambasted David as the “real wrongdoer” and signaled that he “may be held in contempt.”

Sure enough, in the second decision, the Hon. Jennifer G. Schechter granted motions by the receiver and David’s former law firm to hold David in contempt of court. The Court ruled that “David knew a court order barred him from touching the money” held by the receiver without his former firm’s permission, “yet asked an officer of the court to give it to him anyway.” “Allowing David to escape the consequence of his defiance,” the Court ruled, “would make a mockery of adherence to judicial mandates.” The Court held David in contempt, ordered him to purge his contempt “by paying the $2.7 million that he improperly obtained into court,” and threatened to issue an “arrest warrant to induce compliance.”

The Appellate Decision

Shortly after receiving these two scathing decisions, David perfected his appeal. Michel promptly moved to dismiss the appeal arguing that David knowingly waived his right to appeal. Despite the motion to dismiss, the parties fully briefed the appeal. In its decision, the Appellate Division granted, in effect, Michel’s motion and dismissed David’s appeal.

First, the Court held that the “stipulation between plaintiff and defendant, made in open court, setting forth the manner of resolving the parties’ claims and waiving their rights to appeal the trial court’s determination, is binding on defendant.”

Second, the Court held that the record “does not support defendant’s claim that he entered into the stipulation based on a unilateral mistake” about the amount of money held by the receiver.

Third, the Court held that Justice Kornreich’s decision awarding Michel all of the $1.6 million held in escrow for disproportionate expenditures was final and binding, that David “confirmed, on the record,” that he agreed to “waive his right to appeal,” and that he “understood that he would not have an opportunity to obtain a detailed, reasoned decision.” As a result, after two-plus years, the appeals court affirmed a settlement that should never have been appealed in the first place.

The Takeaway

There is a saying in insurance underwriting, “The perfume of the premium overcomes the stink of the risk.” This phrase aptly applies to impromptu in-court settlements where, in some cases, the powerful allure of resolving a longstanding dispute and finally getting paid can overpower the potential hazard to the entire arrangement of assumptions and unresolved details. In Kadosh, the lawyers and the Court were very careful to document the parties’ understanding of, and agreement to, the terms of the settlement, yet even then, the settlement faced a future appellate challenge.

What could have been done differently in Kadosh? Most of the problems in the rollercoaster Kadosh settlement litigation likely would have been eliminated by a negotiated, written settlement agreement, signed by the parties before a notary public, the Court, and the receiver. As is sometimes the case, though, it may be that the lawyers in Kadosh shunned negotiation and preparation of a formal, comprehensive, written agreement for fear the tentative settlement would crumble. The devil, as they say, is in the details.

But if a settlement is so delicate at its outset that the lawyers fear even trying to put the agreement in writing – all the more reason to document it. Faced with the choice of (i) no settlement at that particular moment, but possibly in the future, or (ii) a settlement at that moment, but held together with bubble gum and scotch tape, subject to years of potential future litigation over its terms and enforceability, the choice is clear. Trading one litigation for another is no settlement at all.