New York top court upholds dismissal of ‘champerty’ suit

November 1, 2016

George F. Meierhofer

George F. Meierhofer

New York state’s highest court has declined to revive a lawsuit brought by a company that purchased investment notes allegedly for the sole purpose of pursuing litigation against the notes’ sponsor and manager.

The New York Court of Appeals ruled 5-2 that the sale of the notes from the original noteholder to Justinian Capital violated the state’s law against champerty suits. The law prohibits buying or acquiring rights to a legal cause of action for the sole purpose of pursuing litigation.

Justinian had bought the securities from Deutsche Pfandbriefbank AG and within days brought claims of breach of contract, fraud, breach of fiduciary duty, negligence, negligent misrepresentation, and breach of the covenants of good faith and fair dealing against WestLB AG.

The notes and sale agreement

According to the complaint, nonparty Deutsche Pfandbriefbank AG bought the notes for 180 million euros, or about $200 million, in 2003 from special purpose companies Blue Heron VI Ltd. and Blue Heron VII Ltd.

The Blue Heron companies invested in mortgage-backed securities, and WestLB AG managed their assets, the suit said.

WestLB acted as sponsor and manager for the Blue Heron entities, setting up the companies and entering into agreements with them to monitor the underlying assets and make prudent investment decisions, Justinian alleged.

During the 2008 financial crisis the underlying mortgage loans performed poorly, the suit said.

WestLB allegedly could no longer buy assets that met the guidelines of its agreements with the Blue Heron entities, so it began buying “junk-grade assets” that it dressed up as higher-quality securities, the complaint said.

The notes ultimately became worthless.

Deutsche Pfandbriefbank decided against pursuing its own action against WestLB, another German bank. At the time, the German government was supporting both banks, making Deutsche Pfandbriefbank worry that it would lose the government’s support if it sued WestLB, the Court of Appeals opinion said.

Instead, Deutsche Pfandbriefbank agreed to sell its Blue Heron notes to Justinian Capital in April 2010 for a base price of $1 million and a share of any proceeds from litigation against WestLB, the opinion said.

Nonpayment of the $1 million within a specified timeframe did not constitute a breach, the opinion said; it only reduced proceeds from litigation as interest to Deutsche Pfandbriefbank.

Within days of executing the agreement, Justinian Capital sued WestLB in the New York County Supreme Court.

Champerty prohibition

Justice Shirley Kornreich granted WestLB’s motion for summary judgment, finding the doctrine of champerty prohibited the suit. Justinian Capital SPC v. WestLB, 981 N.Y.S.2d 302 (N.Y. Sup. Ct., N.Y. Cty. 2014).

The Supreme Court Appellate Division, 1st Department, affirmed. Justinian Capital SPC v. WestLB, 128 A.D.3d 553 (N.Y. App. Div., 1st Dep’t 2015).

Justinian then appealed to the state high court, which concluded that the company’s purchase of the notes was champertous and prohibited.

“Justinian’s business plan … was acquiring investments that suffered major losses in order to sue on them, and it did so here within days after it was assigned the notes,” Chief Judge Janet DiFiore wrote for the court.

The majority noted that champerty is allowed if the transaction is over $500,000 but that threshold did not apply here because the $1 million was contingent on a litigation result.

“The record establishes, and we conclude as a matter of law, that the $1 million base purchase price listed in the agreement was not a binding and bona fide obligation to pay the purchase price other than from the proceeds of the lawsuit,” the opinion said.

The dissenters, Judges Leslie Stein and Eugene F. Pigott, said the majority should not have affirmed the grant of summary judgment when triable material issues of fact exist.

“To be sure, the majority points to evidence in the record that would support a finding that plaintiff was a champertor, merely acting as a proxy to bring suit for [Deutsche Pfandbriefbank],” the dissent said. “However, the record also contains evidence supporting plaintiff’s argument that it procured the notes with an intent to enforce its rights in them in whatever way possible, not necessarily by way of litigation.”

Because the limitations period was about to run on allegations tied to the notes, the dissent said Justinian had no choice but to file suit to protect its legal claims.

“The action was commenced by a summons with notice and there is evidence that plaintiff unsuccessfully attempted to contact defendants, prior to filing the complaint, to discuss options other than protracted litigation,” the dissent said.

Expert reaction

Attorney George Meierhofer of Kaufman Dolowich & Voluck, who is not involved in the lawsuit, said the decision imposes a “radical” restriction on the debt markets.

“As the dissent noted, this is the first time in history that that court found an agreement was champertous as a matter of law,” he said.

He added that the dissent’s reasoning may limit the effect of the majority’s holding.

“I think the cogency of the dissent may make this decision of little precedential value in the future, but going forward, parties to assignment agreements may need to add language to make clear that the purpose in acquiring the assignment is not solely to file litigation against a third party and to make sure that the purchase price is a binding obligation, as I expect the champerty defense to be raised much more often than before,” Meierhofer said.

Justinian Capital SPC et al. v. WestLB AG et al., No. 155, 2016 WL 6270071 (N.Y. Oct. 27, 2016).