Suing on Behalf of People You’re Suing Can Sink a Derivative Lawsuit — Especially If You Have a Litigious Nature
May 01, 2017
The U.S. reportedly has the world’s highest number of lawyers per capita (1 for every 300 people) and the 5th highest number of lawsuits per capita (74.5 for every 1,000 people, topped only by Germany, Sweden, Israel, and Austria).
If, as it appears, litigation has become a national pastime in the U.S., then why, when we describe someone as having a “litigious nature,” does that label carry such opprobrium? Is there an unspoken assumption that anyone who brings a multitude of lawsuits must not have meritorious claims, or has ulterior motives to sue? Then again, we recently awarded the presidency to someone who, according to a USA Today analysis, has sued or been sued in 3,500 cases over the last 3 decades.
These observations are spurred by a recent court decision in Pokoik v Norsel Realties, 2017 NY Slip Op 50459(U) [Sup Ct NY County Apr. 12, 2017], in which Manhattan Commercial Division Justice Jeffrey K. Oing cited the plaintiff’s “litigious nature” among the factors supporting dismissal of his derivative lawsuit brought against the fellow members of a real estate partnership, some of whom are relatives of the plaintiff, Leon Pokoik. Granted, it was not cited as the primary factor, but it’s one of those atmospheric factors in a litigation whose impact is hard to measure.
I have no prior knowledge of Mr. Pokoik other than two blog posts I wrote about two other cases he brought against family members involved in his real estate ventures, in both of which he won significant victories. In 2016, he secured a first impression appellate ruling upholding shareholder rights to inspect books and records of a corporation’s wholly-owned subsidiary. In 2014, he won another first impression appellate decision rejecting an LLC manager’s reliance on the LLC Law’s safe-harbor provisions. That said, I have no idea of his rate of success or failure in whatever number of other lawsuits he’s brought against family and non-family business partners.
In the most recent case, Pokoik initially sued the two managing partners of a general partnership known as Norsel Realties that owns a Manhattan office building which it ground leases to an affiliate which in turn net leases to another affiliate. Pokoik and his immediate family members hold approximately 11% of the partnership interests in Norsel Realties and slightly different percentages in the affiliates.
Pokoik’s complaint asserted direct and derivative claims alleging that the defendants used depressed appraisals of the property in fixing the rent payable by the affiliated lessee for a 10-year renewal term commencing in 2015. The other 90% or so of the partnership interests consented to the management-approved ground rent of $7.2 million annually whereas Pokoik, based on an appraisal about four times greater than management’s, claimed the correct rental rate was over $20 million annually.
In 2015, Justice Oing dismissed the complaint based solely on the application of the business judgment rule. The following year, however, the Appellate Division, First Department, reinstated the complaint on the basis that it adequately pleaded that the individual defendants “were conflicted and stood to benefit personally, in a manner other than as shareholders of Norsel, so as to rebut the business judgment rule.”
Pokoik subsequently filed an amended complaint, the main difference being that it now named 39 additional defendants including all of the partners who approved the contested renewal rent plus a number of individuals who either were never partners or were no longer partners when the new ground rent was approved, alleging that each and every one of them breached fiduciary duty “by arranging and/or agreeing” to the ground rent.
The defendants moved to dismiss the amended complaint, primarily arguing that Pokoik lacked standing to bring direct claims because all his claims were derivative in nature, and that he also lacked standing to bring derivative claims because his “conflicts of interest” prevented him from “fairly and adequately” representing the partnership.
In his recent decision, Justice Oing readily agreed with defendants’ contention that Pokoik had no standing to sue directly since all of Pokoik’s claims allege injury to the partnership and thus “are strictly derivative in nature.”
Justice Oing then launched his analysis of Pokoik’s derivative standing by quoting case authorities for the proposition that,
because derivative actions bind absent interest holders they take on “the attributes of a class action” and a “plaintiff must therefore demonstrate that [he] will fairly and adequately represent the interests of the shareholders and the corporation, and that [he] is free of adverse personal interest or animus.” . . . If a plaintiff cannot demonstrate such representation, the derivative causes of action will be dismissed.
Pokoik, Justice Oing found, failed the test for a number of reasons, starting with the fact that his amended complaint named all interest holders as defendants. As Justice Oing further explained:
Having brought their claims against all other Norsel partners, plaintiffs cannot purport to simultaneously represent the interests of these adverse defendant partners. Unlike plaintiffs’ initial complaint, which named only [the two managing partners] as interest holders in Norsel and commenced on behalf of Norsel and all of its partners, by naming all other Norsel partners in the amended complaint there cannot even be a theoretical group of interest holders left on whose behalf plaintiffs purport to act. Indeed, in this amended complaint, plaintiffs Leon Pokoik and his family own or otherwise control approximately 10% of Norsel but assert derivative claims against the partners representing the other approximately 90% of the ownership interests. This presents a prototypical conflict of interest.
There’s more. Justice Oing found that Pokoik’s “inherent conflict of interest” also arose from his “attempting to double dip” by receiving the benefit of distributions from the ground lessee’s rental income “while suing [the property owning partnership] over the same ground rent.” The judge further cited Pokoik’s lack of “any genuine concern for Norsel or its related entities” as evidenced by his claims designed “to extract monetary damages from [his] partners” while failing to request any relief that would benefit Norsel, such as revising the ground lease rent or seeking court oversight of the appraisal process. “Indeed,” Justice Oing continued, “plaintiffs ignore the fact that their $20 million proposed annual rent, an almost 90% increase, would make business operations more difficult for [the operating affiliate] which, in turn, would jeopardize Norsel itself.”
Then, to top things off, there’s the matter of Pokoik’s “litigious nature.” Here’s what Justice Oing said on the subject:
Lastly, plaintiffs failed to demonstrate on this record that they are free from personal animus. Lead plaintiff Leon Pokoik has repeatedly sued his business partners and his own family [citing four cases]. The pleadings in each of Leon Pokoik’s actions are filled with allegations of mismanagement and improper conduct allegedly perpetrated by numerous individuals and closely-held entities, similar to the allegations made here. Given Leon Pokoik’s litigious nature, the totality of the circumstances constrains this Court to conclude that this action is “a weapon in the total arsenal” so as to gain leverage in the other disputes. Having named all of the Norsel partners with whom plaintiffs disagree as defendants in this action, and given Leon Pokoik’s demonstrated animus, plaintiffs’ self-interest is palpably obvious to the point that they are unable to show that they will adequately represent the interest of these defendants. Thus, the amended complaint must be dismissed. [Citations omitted.]
As I read the case, I don’t think it creates any hard-and-fast rule that would bar an interest holder’s standing to assert derivative claims whenever the complaint names as defendants all other interest holders. There are countless derivative suits that survive the pleading stage involving small, closely held business entities in which, for example, a non-controlling owner asserts claims for mismanagement and financial abuse against the remaining one or two controlling owners. Such cases hardly resemble the class-action model in which the court’s rulings can bind absent interest holders.
Rather, I think the case’s core lesson to potential derivative plaintiffs — whether or not of a litigious nature — is not to needlessly enlarge the defendant roster by including non-managing interest holders who aren’t alleged to have done anything more than vote their interests.