Commercial Division Grants $1 Million Punitive-Damage Award for Diversion of Company’s IP in Breach of Fiduciary Duty
January 22, 2023
A recent decision from the Manhattan Commercial Division reminds us that although punitive damages are generally not recoverable in New York, certain circumstances require that they be awarded.
In Hall v Middleton, Manhattan Commercial Division Justice Jennifer G. Schecter granted a $1 million punitive-damages award against defendant Middleton due to the presence of such circumstances.
Veritaseum, Inc. (the “Company”) is a financial technology company that uses blockchain-based markets to permit transactions between individuals. During initial conversations between plaintiff Charles Hall (“Hall”) and the Company’s CEO, Reggie Middleton (“Middleton”), Middleton made representations to Hall concerning the Company’s pending patent applications for proprietary technology concerning the use of block-chain technology and cryptocurrencies for the execution of smart contracts, to entice Hall to invest in the Company. Middleton represented to investors that the Company had pending patent applications, causing them to believe that they would be investing in a company that would eventually own the patents.
Hall commenced the action derivatively on behalf of the Company against Middleton for breach of his fiduciary duties to the Company by misappropriating the Company’s assets, including its intellectual property.
After trial, the Court found that Middleton “breached his fiduciary duty of loyalty to the Company by diverting ownership of the patents to himself.” Justice Schecter further determined that the Company (and not Middleton) should have owned the patents and thus other entities’ use of the patents would entitle the Company (and not Middleton) to a licensing fee.
During trial, Middleton argued that, despite the fiduciary relationship between the parties, there need not be trust in cryptocurrency transactions because such transactions are inherently “unbreakable promises.” The Court disagreed, stating that there is a need for trust among fiduciaries. The Court further noted that when trust is flagrantly violated, “there must be real, meaningful consequences to ensure that it doesn’t happen again. Anything short of significant punitive damages would further, not thwart, duplicity.”
To be entitled to punitive damages, “a defendant’s conduct must be directed at the public generally” (see Sherry Assocs. v Sherry-Netherland, Inc., 273 A.D.2d 14, 15, 708 N.Y.S.2d 105 [1st Dept 2000]). Punitive damages are intended as punishment for gross misbehavior for the good of the public and to deter the defendant from repeating the wrongful act (see Le Mistral, Inc. v Columbia Broad. Sys., 61 AD2d 491, 494–95 [1st Dept 1978]).
In Hall, the Court determined that because Middleton clearly breached his fiduciary duty of loyalty to the Company, he may be held liable for punitive damages “regardless of whether his conduct was aimed at the public generally.” The Court noted that Middleton’s behavior impacted the public because he solicited investments from the public based on his misrepresentations concerning the Company’s ownership of the patents as well as conducted an illegal initial coin offering that resulted in the SEC issuing a consent order, thus destroying the value of the Company. Justice Schecter further determined that:
Punitive damages are warranted because Middleton’s diversion of assets in breach of his fiduciary duty to the Company was intentional and deliberate, the related securities-law violations constitute aggravating and outrageous circumstances and his attempted scheme to effectively steal the patents for himself was impelled by a fraudulent motive.
In ultimately deciding that the plaintiff was entitled to punitive damages, the Court considered that the SEC had ordered Middleton to pay more than $8 million in disgorgement and a $1 million penalty. Thus, the Court held that a $1 million punitive-damages award was “justified.”
Although punitive damages are rarely awarded in New York, practitioners should take note that the Commercial Division is not afraid to grant such remedies when circumstances, like those on display in Hall, require them to.