Read This Case. Slap Your Head. Not Too Hard.
September 25, 2017
Having read thousands of court opinions during my 30+ years as a litigator, I’ve learned to assume that there are things going on beyond what can be gleaned from the court’s written decision, and that these hidden factors may explain positions and outcomes that otherwise seem untenable.
I’m nonetheless having difficulty giving the benefit of the doubt to most of what happened in Verkhoglyad v Benimovich, 2017 NY Slip Op 51133(U) [Sup Ct Kings County Sept. 12, 2017], a case recently decided by the Brooklyn Supreme Court in which it denied enforcement of a mandatory forum selection clause, disregarded the operating agreement’s New Jersey choice-of-law provision by applying New York law to various claims, refused to enforce the agreement’s pre-suit mediation clause, and let proceed a claim for judicial dissolution of a New Jersey limited liability company despite governing appellate law stripping New York courts of jurisdiction over the dissolution of foreign business entities.
Verkhoglyad involves a short-lived, ill-fated enterprise between two individuals who were boyhood friends. In 2014, the plaintiff Verkhoglyad became a 50% co-managing member of defendant Benimovich’s existing HVAC business organized as a New Jersey LLC. They entered into a written operating agreement designating the LLC’s principal office in New Jersey and dictating application of New Jersey law to the operating agreement and its interpretation. It also includes the following provision captioned “Settlement of Disputes and Jurisdiction”:
Members agree that, should a dispute under this agreement arise, Members shall first seek a mediation of their dispute before filing a lawsuit. All Members should attend at least one mediation session prior to seeking a remedy in a Court of Law. Any legal action or proceeding with respect to this Agreement shall be brought in the courts of the state of New Jersey, or a Federal Court having jurisdiction, and, by execution and delivery of this Agreement, the parties hereby accept, generally and unconditionally the exclusive jurisdiction of the aforesaid court(s) and appellate courts from any thereof.
Verkhoglyad’s complaint (read here) alleges that things went downhill quickly. He accuses Benimovich of using LLC funds for his personal expenses; mismanaging the business; failing to report Verkhoglyad as a member on the LLC’s 2014 tax return; and, after being confronted by Verkhoglyad, forming a separate, new HVAC company to which he diverted LLC funds and clients.
In March 2017, Verkhoglyad filed his complaint in Brooklyn Supreme Court against Benimovich and his new company. The complaint asserts direct claims for breach of fiduciary and other business torts, along with a claim for judicial dissolution under § 42:2C-48 of New Jersey’s Revised Uniform LLC Act.
Benimovich moved to dismiss the complaint in its entirety, first, for lack of personal jurisdiction based on the operating agreement’s New Jersey forum selection provision, and second, based on Verkhoglyad’s alleged failure to submit the dispute to pre-suit mediation as required by the same provision. Benimovich alternatively moved for dismissal of Verkhoglyad’s assorted claims either as duplicative or for failure to state a viable cause of action.
The court:
- denied dismissal based on the forum selection clause, holding that the defendants waived any objection to personal jurisdiction in a written stipulation signed by their counsel extending their time to answer the complaint;
- denied dismissal based on plaintiff’s failure to submit the dispute to pre-suit mediation, based on evidence that the parties and their counsel held a “mediation session” in May 2016 (albeit without a mediator) resulting in a letter-agreement signed by the two lawyers; and
- applying only New York law, granted dismissal of four of Verkhoglyad’s six causes of action, leaving intact only his claims for fiduciary breach and judicial dissolution.
Question #1: Why didn’t the court enforce the forum selection clause?
Before we get to that question, ask yourself, why did the plaintiff, himself a New Jersey resident suing for dissolution of a New Jersey entity, decide to bring suit in New York? I can think of two possible reasons: the convenience of his Brooklyn-based New York lawyer, and naming as a co-defendant Benimovich’s new company, a New York corporation likely not subject to personal jurisdiction in New Jersey.
Assuming those were good enough reasons for Verkhoglyad to sue in New York (except for the dissolution claim, discussed below), did the court correctly find that Benimovich waived exclusive jurisdiction in the courts of New Jersey under the operating agreement’s forum selection clause, by signing a stipulation extending defendants’ time to answer in which defendants waived “any and all jurisdictional defenses”?
Viewed solely as a waiver of personal jurisdiction — which is how the defendants presented it, how the plaintiff responded to it, and how the court analyzed it — it’s difficult to agree with the outcome. There was never a legitimate question of the New York court’s personal jurisdiction of Benimovich and his company, both of whom are New York residents. A stipulated waiver of any objection to personal jurisdiction in the New York action should not negate, as a matter of contract enforcement, a forum selection clause conferring on the courts of a different state the exclusive authority to hear and decide the parties’ dispute arising under the agreement. It also makes little sense that Benimovich would have moved to dismiss based on the forum selection clause if he or his counsel had intended the stipulation to waive its enforcement.
Question #2: Why didn’t the court enforce the pre-suit mediation clause?
I suspect that most lawyers (and judges) would define mediation as an alternative dispute resolution process in which an independent person (the mediator) aids the disputing parties in reaching a settlement. In Verkhoglyad, the plaintiff convinced the court that a settlement meeting between the parties and their counsel, without the assistance of a mediator, satisfied the operating agreement’s pre-suit mediation requirement.
Was he right? Does the answer depend on whether one defines mediation as requiring the participation of a mediator? In Verkhoglyad, the settlement meeting with counsel resulted in a signed letter-agreement seemingly limited to the work to be performed for a single client of the company, without any reference to other issues raised in the later complaint or any statement that the agreement resolved all issues between them.
Mandatory pre-suit mediation provisions in shareholder and operating agreements have gained in popularity. To remove any doubt whether discussions between the parties constitute mediation, drafters should consider spelling out the mediation process in greater detail than the bare-bones provision in Verkhoglyad, by naming the proposed mediator or mediation forum and by requiring written demand to initiate mediation.
Question #3: Why didn’t the court dismiss the claim for dissolution of a foreign entity?
That’s an easy one: the defendants never mentioned in their motion papers the governing appellate law holding that New York courts lack subject matter jurisdiction to hear and decide claims for judicial dissolution of foreign entities. Apparently the judge assigned to the case, who is not a member of the Commercial Division and therefore does not normally decide dissolution matters, also was unfamiliar with case law developments concerning dissolution of foreign entities.
The good news for defendants, since parties can’t confer subject matter jurisdiction on the court, is that it’s a non-waivable defense that can be raised at any time — even after a judgment on the merits. But why would anyone wait for that?
Question #4: Why did the court apply New York law to plaintiff’s other claims?
Another easy one: both sides exclusively cited New York case law in addressing the sufficiency of the fiduciary breach and other assorted claims. Neither the parties nor the judge acknowledged the internal affairs doctrine applicable to disputes among co-owners of corporations, LLCs, and partnerships, whereby courts apply the law of the state of formation. Would application of New Jersey law have made a difference? Who knows, but that’s not the point in a case that likely should have been brought in New Jersey in the first place.
One of my very first posts on this blog almost 10 years ago was entitled Get Thee to the Commercial Division in which I extolled the advantages of litigating dissolution cases, and other disputes among co-owners of closely held business entities, before the judges of New York’s Commercial Division who have the background, experience, and specialized knowledge so critical to the resolution of complex business disputes. The parties in this case did not apply to have it assigned to the Brooklyn Commercial Division. Had they done so, it might have made a difference.