212 Inv. Corp. v Kaplan

[*1] 212 Inv. Corp. v Kaplan 2005 NY Slip Op 50265(U) Decided on February 9, 2005 Supreme Court, New York County Cahn, J. Published by New York State Law Reporting Bureau pursuant to Judiciary Law § 431. This opinion is uncorrected and will not be published in the printed Official Reports.

Decided on February 9, 2005
Supreme Court, New York County

212 INVESTMENT CORPORATION, ALICE DODGE WALLACE, BAGAN 1992 FAMILY TRUST, BERNARD GREENBERG FAMILY TRUST, BURTON S. BENOVITZ, M.D., CAROLYN G. NELSON, CLB TRUST, CYNTHIA S. RASKIN, DODGE ASSOCIATES, DORISS LAKIN ZAFRANI IRREVOCABLE TRUST 1987, DRAKE LIMITED PARTNERSHIP, GRANT BAGAN, HARVEY S. KLEIN, HAND G. NELSON FOUNDATION, HOMER L. DODGE, JEMP D. FOUNDATION, JOYCE BAGAN, JUDITH & HARVEY KLEIN FAMILY LIMITED PARTNERSHIP, JULIUS P. FOUTS PENSION PLAN, MARGO LAKIN 1987 IRREVOCABLE TRUST, MARGO J. LAKIN 1991 INVESTMENT TRUST, MILIDA INVESTORS, NATHAN SHAPELL TRUST, ROBERT H. SCHOCK, ROBERT D. STEIN, SEYMOUR BAGAN, SHAPELL INDUSTRIES, INC., VERA S. GUERIN TRUST, DERIVATIVELY ON BEHALF OF KAPLAN, NATHAN & CO., Plaintiffs,

against

MYRON KAPLAN, KAPLAN, NATHAN & CO. LLC, BARBARA KAPLAN and ALAN STARK, Defendants,



603029/04

Herman Cahn, J.

Plaintiffs, limited partners Nominal Defendant Kaplan, Nathan & Co., (the Partnership), commenced this derivative action on behalf of the partnership, alleging causes of action for [*2]breach of fiduciary duty and fraud, among others.

Defendant Myron Kaplan moves to dismiss the complaint on the ground that all causes of action are time-barred, CPLR 3211(a)(5), and in the alternative, to stay the action and compel arbitration. Defendant Kaplan, Nathan & Co. LLC cross-moves for the same relief.

FACTUAL ALLEGATIONS

Plaintiffs allege the following in the complaint.

Kaplan, Nathan & Co. is a limited partnership formed in 1969 to engage in a broad range of investment activities, including all types of securities arbitrage. The partnership is a hedge fund. Prior to 1997, it had two general partners: Myron Kaplan and James Nathan. As limited partners, plaintiffs have ownership interests in the partnership equal to the proportionate value of their capital accounts. They represent approximately ninety percent of the partnership's dollar value, excluding the interests of the general partners and their families.

Myron Kaplan's sister, defendant Barbara Kaplan, is a stock broker. Since 1969, the partnership has placed trades through her. At some point after the partnership was formed, Myron Kaplan began buying and selling the same securities as the partnership for his personal accounts, with his sister also acting as broker. On numerous occasions, Barbara Kaplan traded securities for her brother's personal accounts at the same time as or close to when she traded in the partnership's accounts.

It is alleged that at various times, Barbara Kaplan would execute a trade, and fail to specify the account for which it was executed, i.e. for the partnership's account or for Myron Kaplan's personal account. The securities that were purchased or sold were later allocated to a particular account, ("post-execution allocations).

Transactions were also conducted in Myron Kaplan's accounts ahead of transactions in the same securities for the partnership's accounts, in order to benefit Kaplan's personal accounts.

The partnership's accounts were charged higher commissions than Kaplan's personal accounts.

On January 20, 1997, Myron Kaplan sent a letter to the limited partners announcing that Nathan and he were no longer the general partners of the partnership, and that a newly-formed limited liability company, defendant Kaplan, Nathan & Co. LLC, was the new general partner. Kaplan and Nathan are the sole members of this limited liability company. However, Kaplan and Nathan still hold themselves out as general partners of the partnership.

Barbara Kaplan was employed by CIBC World Markets, Inc. (CIBC) from November 18, 1998 through April 16, 1999. On April 16, 1999, CIBC sent a Uniform Notice of Termination (Form U-5) indicating that she had been permitted to resign, to the New York Stock Exchange (NYSE). The U-5 stated that she had been under investigation for facilitating the execution of transactions at a more favorable price for a relative's individual account, than the account of an investment partnership that was controlled by the relative, but in which other investors were participating. Following CIBC's letter, the NYSE commenced an investigation of Barbara Kaplan for engaging in improper post-execution allocations of the trades.

The complaint accuses defendants of attempting to cover up their misconduct. In particular, on June 22, 1999, Barbara Kaplan, Myron Kaplan, and defendant Alan Stark, an attorney representing both the partnership and Myron Kaplan, unbeknownst to the partnership, [*3]drafted a letter to CIBC in order to persuade it to retract its statement in the U-5. This letter allegedly contained false allegations that the partnership had conducted an investigation of the trades and had not been harmed. In addition, plaintiffs allege that both Barbara Kaplan and Myron Kaplan refused to cooperate with the NYSE investigation.

On June 12, 2003, the NYSE found that Barbara Kaplan effected improper post-execution allocations on approximately 375 occasions between November 1998 and April 1999 for trades which she knew, or should have known, would result in more favorable prices being allocated to her relative's account to the detriment of an account with public investors. The NYSE censured Barbara Kaplan, suspended her from the securities industry for one year, and fined her $100,000.

Defendants are alleged to have deliberately concealed and failed to disclose this information to the limited partners and the partnership. During this period, the limited partners relied upon performance statements and other communications from Myron Kaplan regarding the partnership's investments and value. After defendants' misconduct was discovered, Myron Kaplan ceased to play a day-to-day role in the management of the partnership, effectively leaving it unmanaged.

Plaintiffs also allege that for many years, Myron Kaplan has improperly failed to reimburse the partnership for his use of use of partnership resources, including office space, employees, computers, and research for inappropriate and/or personal expenses.

The limited partners purportedly first learned of the wrongdoing in a July 6, 2004 letter from James Nathan. In the same year, the limited partners learned that Stark admitted that inappropriate trading occurred before Barbara Kaplan's employment at CIBC, including when she was employed by Bear Stearns from 1984 through 1998. Plaintiffs also learned that Barbara Kaplan's conduct dates back to the partnership's formation in 1969. After this conduct was discovered, Myron Kaplan has refused to provide trading records to the limited partners, and has refused to pursue legal claims on behalf of the partnership.

The complaint contains eleven causes of action: (1) breach of fiduciary duty, pleaded against all defendants; (2) aiding and abetting a breach of fiduciary duty, pleaded against all defendants; (3) gross negligence, pleaded against all defendants; (4) waste, pleaded against all defendants; (5) diversion of opportunity, pleaded against all defendants; (6) forfeiture of compensation, pleaded against all defendants; (7) fraud, pleaded against all defendants; (8) aiding and abetting fraud, pleaded against all defendants; (9) conversion, pleaded against Myron Kaplan; (10) unjust enrichment, pleaded against all defendants; and (11) attorney malpractice, pleaded against Alan Stark.

DISCUSSIONMyron Kaplan and Kaplan, Nathan & Co. LLC contend that all of the causes of action are time-barred, and seek to compel arbitration of the claims, arguing that they arise under the broad arbitration clause contained in the limited partnership agreement.[FN1] [*4]

Defendants argue that the partnership agreement's arbitration clause is governed by the Federal Arbitration Act (FAA). The FAA states that a written provision to arbitrate any controversy arising out of a "contract evidencing a transaction involving commerce" is valid and enforceable. 9 USC § 2 (2004). In enacting the FAA, Congress established a strong federal policy favoring arbitration agreements, which requires courts to "'rigorously enforce agreements to arbitrate'" (Shearson/American Express, Inc. v McMahon, 482 US 220, 226 [1987], citing Dean Witter Reynolds Inc. v Byrd, 470 US 213, 221 [1985]), including the parties' choice of governing law (Volt Info. Sciences v Board of Trustees of Leland Stanford Jr. Univ., 489 US 468, 475 [1988]). Furthermore, courts must resolve any ambiguities as to the scope of arbitration clauses in favor of arbitration. Volt Info. Sciences, 489 US at 476; Moses H. Cone Mem. Hosp. v Mercury Constr. Corp., 460 US 1, 24-25 (1983).

Claims stemming from securities transactions on national exchanges have been viewed as "involving interstate commerce." Smith Barney, Harris Upham & Co., Inc. v Luckie, 85 NY2d 193 (1995), rearg denied 85 NY2d 1033, cert denied sub nom. Manhard v Merrill Lynch, Pierce, Fenner & Smith, Inc., 516 US 811 (1995); Matter of Prudential Securities Inc. (Purello), 206 AD2d 713, 715 (3d Dept 1994). Moreover, the term "involving interstate commerce" should be broadly read as "the functional equivalent of affecting." Allied-Bruce Terminix Cos., Inc. v Dobson, 513 US 265, 274 (1995). The arbitration clause in the limited partnership agreement is governed by the FAA because the purpose of the partnership is to engage in a wide range of investment activities, which clearly occur in interstate commerce.

Under New York law, a court may address three threshold questions on a motion to compel or stay arbitration: (1) whether the parties made a valid agreement to arbitrate; (2) if so, whether the agreement has been complied with; and (3) whether the claim sought to be arbitrated would be time-barred if it were asserted in State court. Matter of County of Rockland (Primiano Constr. Co., Inc.), 51 NY2d 1, 6-7 (1980); Travelers Indem. Co. v Levy, 195 AD2d 35, 40 (1st Dept 1993); CPLR 7502(b), 7503.

In contrast, federal law prohibits courts from addressing a statute of limitations defense before sending the matter to arbitration. Howsam v Dean Witter Reynolds, Inc., 537 US 79, 85 (2002); Conticommodity Servs. Inc. v Philipp & Lion, 613 F2d 1222, 1224-25 (2d Cir 1980). In fact, under federal law, a court may only consider whether the parties agreed to arbitrate and whether the disputes fall within the scope of the arbitration clause. Hartford Acc. and Indem. Co. v Swiss Reins. Am. Corp., 246 F3d 219, 226 (2d Cir 2001); Norcom Elecs. Corp. v CIM USA Inc., 104 F Supp 2d 198, 202 (SD NY 2000).

Plaintiffs argue that the motions to compel should be denied because the limited partnership is not a party to the agreement. This court disagrees. While the partnership is not a signatory to the agreement, the partnership must act through the general and limited partners. [*5]The limited partners do not dispute that they are parties to the partnership agreement which itself contains an arbitration clause. Furthermore, plaintiffs' claims against Myron Kaplan clearly fall under the agreement's provision that the parties submit to arbitration "any controversy or claim arising out of or concerning this Agreement or the performance thereof or arising out of or concerning the management of the business of the Partnership."

Plaintiffs also contend that Partnership Law § 115-a requires a judicial adjudication of their derivative claims, and that the American Arbitration Association (AAA) does not provide sufficient procedural protections for these claims. Neither of these arguments requires denial of defendants' motion to compel arbitration.

First, Partnership Law § 115-a merely provides that limited partners may bring derivative actions to address harm to limited partnerships. Partnership Law § 115-a(1); see also CCG Assocs. I v Riverside Assocs., 157 AD2d 435, 442 (1st Dept 1990). More importantly, plaintiffs fail to point to any authority indicating that Congress intended that derivative claims, brought by limited partners pursuant to state partnership law, were not arbitrable. See generally Fletcher v Kidder, Peabody & Co., Inc., 81 NY2d 623, 638, cert denied 510 US 993 (1993), citing 9 USC § 1; Miller v Schweickart, 405 F Supp 366, 368 (SD NY 1975). Indeed, any doubts as to arbitrability of plaintiffs' claims must be resolved in favor of arbitration. See Moses H. Cone Mem. Hosp., 460 US at 24-25.

Second, plaintiffs' argument that the AAA rules fail to provide sufficient procedural protections for derivative claims is without merit. Plaintiffs have submitted the AAA arbitration rules for class actions, which are similar to derivative claims brought by shareholders or limited partners with regard to complexity. Moreover, streamlined procedures are consistent with the purposes of arbitration. As noted by the AAA rules, "[a]rbitration has proven to be an effective way to resolve [disputes involving business transactions] privately, promptly, and economically." Berman Aff., Exh. E, at 3. See also Folkways Music Publishers, Inc. v Weiss, 989 F2d 108, 111 (2d Cir 1993).

However, that does not end the inquiry in this case. The partnership agreement at issue contains a choice-of-law clause, providing that the "terms and provisions hereof shall be construed under the laws of the State of New York." In light of this provision, the court must determine the effect of the choice-of-law clause on whether the court or the arbitrator should decide the timeliness of plaintiffs' claims.

In Smith Barney, Harris Upham & Co., Inc. v Luckie (85 NY2d 193 [1995]), the Court of Appeals held that the timeliness of claims sought to be arbitrated is properly resolved by a court, even though the agreement is otherwise governed by the FAA, where it contains a choice-of-law clause providing that the "agreement and its enforcement" are governed by New York law. Id. at 202 (emphasis in original). Two years later, the Court of Appeals distinguished Luckie in Smith Barney Shearson Inc. v Sacharow (91 NY2d 39 [1997]), stating that Luckie was "narrowly tailored to the specific framework presented by that case and was not projected as a preclusion against freely contracting parties to submit every part of their disputes to arbitration" and that the Luckie Court was interpreting the specific language of the subject choice-of-law provision, which applied to the "agreement and its enforcement." Id. at 48; Smith Barney, Inc. v Hause, 238 AD2d 104, 108 (1st Dept), affd sub nom. Smith Barney Shearson Inc. v Sacharow, 91 NY2d 39 (1997). [*6]

Thus, where an agreement is governed by the FAA, and provides that the agreement "and its enforcement" are subject to New York law, a court may resolve a defendant's statute of limitations defense prior to sending the matter to arbitration. Smith Barney, supra; cf. Diamond Waterproofing Co., Inc. v 55 Liberty Owners Corp., 6 AD3d 101, 105 (1st Dept), lv granted 2 NY3d 822 (2004) (since the subject contract's choice-of-law provision did not explicitly provide that the agreement and "its enforcement" would be governed by New York law, the question of timeliness was for the arbitrator, not the court); Smith Barney Inc. v Heiman, 235 AD2d 344 (1st Dept 1997) (same); Hamerschlag, Kempner & Co., L.P. v Oestrich, 234 AD2d 172, 173 (1st Dept 1996) (same).

A choice-of-law clause choosing New York law to govern the arbitration may also require a court to consider statute of limitations defenses. In Hackett v Milbank, Tweed, Hadley & McCloy (86 NY2d 146 [1995]), the agreement was subject to the FAA, and the parties expressly stated that New York law would govern the arbitration. The Court of Appeals held that such an explicit and unambiguous choice of law must be given effect, provided that doing so will not conflict with the terms of or policies underlying the FAA. Id. at 154; cf. Salvano v Merrill Lynch, Pierce, Fenner & Smith, Inc., 85 NY2d 173, 180 (1995). In Luckie, the Court found that a court's consideration of statute of limitations issues did not conflict with the policies underlying the FAA, because CPLR Article 75 furthered the objectives of the FAA. Luckie, 85 NY2d at 206.

Here, since the choice-of-law clause in the partnership agreement does not provide that the agreement and "its enforcement" are governed by New York law, (see § 9.09, Partnership Agreement), or that the arbitration is to be governed by New York law, federal law controls. Accordingly, the issue of whether plaintiffs' claims are barred by the statutes of limitations, is one for the arbitrator.

Plaintiffs also argue that Kaplan waived his right to arbitration by requesting that the court convert his motion to one for summary judgment pursuant to CPLR 3211(c). As the agreement is governed by the FAA, the issue of waiver must be determined by applying federal law. See Singer v Jefferies & Co., Inc., 78 NY2d 76, 84 (1991). A party may waive the right to compel arbitration, but the FAA's strong policy requires that any "doubts . . . be resolved in favor of arbitration." Bell v Cendant Corp., 293 F3d 563, 566 (2d Cir 2002), quoting Moses H. Cone Mem. Hosp., 460 US at 24-25. Waiver will not be inferred where there is no prejudice to the party seeking to avoid arbitration.[FN2] Rush v Oppenheimer & Co., 779 F2d 885, 887 (2d Cir 1985). Generally, litigation of substantial issues going to the merits may constitute a waiver of arbitration. Id.; Singer, 78 NY2d at 85. In this regard, a motion for summary judgment on substantive issues after extensive discovery indicates a preference to proceed other than by arbitration. National Found. for Cancer Research v A.G. Edwards & Sons, Inc., 821 F2d 772, 775-76 (DC Cir 1987). [*7]

Kaplan has not waived his right to arbitration. Kaplan's request to convert this motion into a summary judgment motion was made to allow the court to consider his documentary evidence in support of dismissal. Indeed, Kaplan has not sought to litigate the merits of the dispute, only to dismiss allegedly stale claims, and there has been no prejudice to plaintiffs, particularly since the court has declined to rule on the timeliness issue.

Although not all of plaintiffs' claims will proceed to arbitration, given that Barbara Kaplan and Alan Stark are not parties to the partnership agreement, the court is nonetheless required to compel arbitration. In Dean Witter Reynolds Inc. v Byrd, 470 US 213 (1985), the Supreme Court stated that the FAA mandates that a court "shall direct the parties to proceed to arbitration on issues as to which an arbitration agreement has been signed." Id. at 218 (emphasis in original).

Thus, the claims against Myron Kaplan and Kaplan Nathan & Co., LLC will proceed to arbitration, and the action will be stayed against them for a reasonable time to permit the arbitration to proceed. Neither Barbara Kaplan nor Alan Stark are covered by an arbitration agreement, so that the claims against them will be litigated in this action. To the extent that plaintiffs require discovery from Myron Kaplan or Kaplan Nathan & Co., LLC in order to prosecute the action against the other defendants, they may, of course, obtain it in the same way they would obtain discovery from any non-party.

Accordingly, it is

ORDERED that defendant Myron Kaplan's motion to dismiss and to compel arbitration and defendant Kaplan, Nathan & Co. LLC's cross-motion to dismiss and to compel arbitration are granted to the extent of staying further prosecution of and proceedings in this action as to said defendants except for an application to vacate or modify said stay, and the plaintiffs are directed to proceed to arbitration against said defendants.

The action may continue against the other defendants.

Dated: February 9, 2005

ENTER:

_______/S/_________

J.S.C. Footnotes

Footnote 1: Section 9.10 of the agreement provides: "[a]ny controversy or claim arising out of or concerning this Agreement or the performance thereof or arising out of or concerning the management of the business of the Partnership shall be settled by arbitration in accordance with the rules then pertaining of the American Arbitration Association, except that the Arbitrator(s) shall not have the power to reform this Agreement. Such arbitration shall be held in the Borough of Manhattan, City of New York. Judgement [sic] or any award rendered shall be binding on the parties hereto and may be entered in any court having jurisdiction thereof." Kaplan Aff., Exh. A, at 49-50.

Footnote 2: "Sufficient prejudice to infer waiver has been found where a party seeking to compel arbitration engages in discovery procedures not available in arbitration, makes motions going to the merits of an adversary's claims, or delays invoking arbitration rights while the adversary incurs unnecessary delay or expense." Cotton v Slone, 4 F3d 176, 179 (2d Cir 1993) (citations omitted).