| UBS Sec. LLC v Highland Capital Mgt., L.P. |
| 2011 NY Slip Op 05979 [86 AD3d 469] |
| July 21, 2011 |
| Appellate Division, First Department |
| UBS Securities LLC et al.,Respondents-Appellants, v Highland Capital Management, L.P., Appellant-Respondent,et al., Defendants. UBS Securities LLC et al., Respondents-Appellants, v Highland CapitalManagement, L.P., Appellant-Respondent. |
—[*1] Cadwalader, Wickersham & Taft LLP, New York (Gregory A. Markel of counsel), forrespondents-appellants.
Order, Supreme Court, New York County (Bernard J. Fried, J.), entered August 9, 2010,which, insofar as appealed from, in this consolidated action arising out of investment lossesincurred by plaintiffs, denied defendant Highland Capital Management, L.P.'s motion to dismissthe complaint in the second action as to the first, third and fourth causes of action for fraudulentinducement, breach of the covenant of good faith and fair dealing and fraudulent conveyance,respectively, and granted the motion as to the fifth cause of action for tortious interference withcontractual relations, unanimously modified, on the law, to grant the motion as to the first causeof action and as to those portions of the third and fourth causes of action that rely on conductpredating the commencement of the prior action, and otherwise affirmed, without costs. Appealfrom order, same court and Justice, entered June 21, 2010, which granted in part and denied inpart plaintiffs' motion for leave to file an amended complaint, unanimously dismissed, withoutcosts, as moot.[*2]
In April 2007, plaintiff UBS[FN*]agreed to finance and act as placement agent in connection with the issuance of certain collateraldebt obligations by defendant Highland Capital Management, L.P. (Highland). Highland, aTexas-based hedge fund, did not complete the issuance, and the agreement expired. At that pointHighland owed UBS as much as $86 million under the arrangement, based on the depreciation ofassets that UBS had been required to hold, or "warehouse." However, because Highland stilldesired to issue the collateral debt obligations with UBS's assistance, UBS agreed to restructurethe transaction. The new arrangement, formed in March 2008, consisted of two agreementsbetween UBS, on the one hand, and Highland, and certain funds affiliated with Highland, on theother. A third agreement, referred to by the parties as an engagement letter, was entered into byUBS and Highland. The engagement letter provided, inter alia, that UBS would bear no risk inconnection with losses in the securities to be held by UBS. It further provided that Highlandwould hold UBS harmless from any claims against UBS arising out of the breach of theagreements by Highland or its affiliated funds.
The agreements gave UBS the right to make margin calls on the Highland affiliated funds ifthe market value of the securities it was holding on behalf of those funds declined. During thefall of 2008, UBS made three such margin calls. The affiliated funds provided additionalcollateral in response to the first two margin calls, but not in response to the third call, made inNovember 2008. In December 2008, UBS terminated the restructured transaction beforeHighland could issue the collateral debt obligations, and demanded payment for almost $700million in losses claimed as a result of the depreciation of the assets it was holding. Highlandrefused to pay.
In early 2009, UBS commenced an action against Highland and the affiliated funds assertingthree causes of action. The first two causes of action alleged breach of contract against theaffiliated funds only. The third claim was asserted against Highland, and was based on theindemnification language contained in the engagement letter. Highland asserted counterclaimsfor breach of contract and unjust enrichment against UBS arising out of the restructuredtransaction.
Highland moved to dismiss the complaint as against it, on the basis that the indemnificationprovision did not apply to the particular losses claimed by UBS. The court denied the motion,finding that UBS's interpretation of the clause was not unreasonable, and that there was at least aquestion of fact whether it applied. However, on February 18, 2010, this Court unanimouslyreversed, holding that "[d]ismissal of plaintiffs' indemnification claim against Highland iswarranted, since the agreements between the parties contain no promise on the part of Highlandto undertake liability with respect to the investment losses suffered by plaintiffs, or to ensure orguarantee the performance of defendant off-shore funds' obligations to bear the risk ofinvestment losses. Absent facts alleging that Highland otherwise breached the engagement letter,the indemnification provision contained in said letter was not triggered" (70 AD3d 526). [*3]The Clerk was directed to enter judgment in favor of Highlanddismissing the complaint.
Only two days before this Court issued its ruling, UBS had written a letter to the motioncourt, as required by the rules of the Commercial Part. It sought permission to move to amend itscomplaint to assert against Highland, and others, "a variety of new allegations that furthersupport the indemnification and breach of contract claims that UBS already has alleged in theoriginal Complaint." UBS also stated in the letter that "the new causes of action arise out of thesame or related circumstances and events as UBS's pending claims."
Knowing that this Court had dismissed the complaint against Highland, the court granted therequest, and UBS made its motion.
In support of the motion, UBS submitted an attorney's affirmation that summarizeddocuments produced by Highland the month before. UBS claimed that the documents, primarilyminutes of meetings of Highland's board of directors, formed the basis of the proposed newclaims. Those documents, it was explained, revealed that Highland disregarded corporateformalities vis-à-vis the affiliated funds, that it knew that its methodology for pricing theassets held by UBS was unreasonable and inaccurate, and that it caused improper asset transfersand payments to the affiliated funds' creditors in the fall of 2008 and in 2009, when those fundswere insolvent or nearly insolvent.
UBS also submitted the affidavit of Timothy Leroux, a former employee who was involvedin the Highland transaction. According to Leroux, in November 2008, after UBS made the thirdmargin call and Highland's affiliated funds were unable to immediately comply, Highlandpermitted UBS representatives to make several due diligence trips to its offices to evaluate theaffiliated funds' finances, assets and business practices. Leroux attested:
"Among other things, the information that Highland Capital provided to UBS inNovember 2008 revealed the following:
"(a) The Fund Counterparties[ ] did not satisfy their Initial Restructuring Collateralobligation by the Agreements using their own assets;
"(b) CDO Fund had pledged and encumbered a substantial portion of its assets prior toentering the Agreements, and additional assets immediately thereafter;
"(c) While Highland Capital was negotiating the Restructured Transaction, it did not tellUBS that it was planning to encumber more of the Fund Counterparties' assets, includingimmediately after March 14, 2008;
"(d) Highland Capital assigned unreasonable valuations to the Fund Counterparties' assets;
"(e) Highland Capital was willing to ignore corporate formalities and commingle assetsbetween and among various entities related to Highland Capital and the Fund Counterparties tosatisfy debts and liquidity needs; and[*4]
"(f) Highland Capital was willing to manage the FundCounterparties without regard for the corporate form to achieve its goals" (emphasis added).
The proposed amended complaint included the following claims against Highland: (1)fraudulent inducement arising out of, inter alia, the misrepresentation of information andomissions to UBS concerning defendants' financial ability and commingling of assets; (2) breachof the covenant of good faith and fair dealing implied in the agreements underlying therestructured transaction; (3) fraudulent conveyance arising out of the transfer of cash and assetsfrom the affiliated funds, impairing the funds' ability to satisfy their obligations to UBS,including transfers of assets made in March 2009 (after commencement of the original action);and (4) tortious interference with contract based on the allegation that Highland caused theaffiliated funds to breach the agreements by fraudulently transferring assets and money.
In opposition, Highland asserted that UBS's complaint against it had been dismissed andcould not be amended. Highland further argued that res judicata barred the proposed claimsbecause they arose out of the same transaction or series of transactions as the original action.Highland maintained that the preclusive effect of this Court's decision dismissing the originalaction as against Highland was not diminished by the fact that UBS' claims against the affiliatedfunds and Highland's counterclaims were still pending. Highland also challenged the sufficiencyof the claims and asserted that it could not have tortiously interfered with a contract to which itwas a party.
The motion court denied that portion of UBS's motion that sought leave to add new claimsagainst Highland, agreeing with Highland's position that a party cannot amend a pleading that hasalready been dismissed. However, the court expressly rejected Highland's res judicata argument,stating that "the evidence that UBS needs to prove the new claims is entirely different from theevidence that it needed to prove the contract claim that was dismissed." The court also found thatit would be unfair to bar relief on res judicata grounds because, pursuant to the CommercialPart's rules, UBS sought permission to make the motion and, before permission was granted, thisCourt issued its decision dismissing the original complaint as against Highland. The Court alsofound it would be unfair to apply res judicata here because the dismissal of the original complainttook place in the context of the same action, to which Highland remained a party, having assertedcounterclaims.
The court next found that the claims of fraudulent inducement (as to misrepresentationsabout the funds' ownership of assets and creditworthiness, but not as to the failure to disclose),fraudulent conveyance and breach of covenant of good faith and fair dealing had been adequatelypleaded. However, the court found that UBS had not asserted a claim for tortious interferencewith contract, because economic justification was a defense and "Highland Capital's alleged actswere evidently taken in its own economic interests."
UBS commenced a new action against Highland, in which it asserted the causes of action ithad unsuccessfully proposed to add to the original complaint. That action was consolidated withthe original action. Highland moved to dismiss the action, based on the substantive arguments ithad made in opposition to the motion to amend. The court granted the motion to the extent ofdismissing one of the fraudulent conveyance claims and the tortious interference claim. However,based on the reasoning in its previous order, the court denied the motion with respect [*5]to UBS's other claim for fraudulent conveyance, its claim forfraudulent inducement, and its claim for breach of the implied covenant of good faith and feardealing.
The parties appealed, presenting us with the question whether and to what extent the doctrineof res judicata applies to these circumstances. The doctrine dictates that, "as to the parties in alitigation and those in privity with them, a judgment on the merits by a court of competentjurisdiction is conclusive of the issues of fact and questions of law necessarily decided therein inany subsequent action" (Gramatan Home Invs. Corp. v Lopez, 46 NY2d 481, 485[1979]). It used to be the rule that, even if the two actions arose out of an identical course ofdealing, the second was not barred by res judicata if "[t]he requisite elements of proof and hencethe evidence necessary to sustain recovery var[ied] materially" (Smith v Kirkpatrick, 305NY 66, 72 [1953]). However, the Court of Appeals expressly rejected that method of analysis inO'Brien v City of Syracuse (54 NY2d 353 [1981]). There it held that "once a claim isbrought to a final conclusion, all other claims arising out of the same transaction or series oftransactions are barred, even if based upon different theories or if seeking a different remedy" (54NY2d at 357). The Court further stated: "[w]hen alternative theories are available to recoverwhat is essentially the same relief for harm arising out of the same or related facts such as wouldconstitute a single 'factual grouping' (Restatement, Judgments 2d, § 61 [Tent Draft No. 5]),the circumstance that the theories involve materially different elements of proof will not justifypresenting the claim by two different actions" (id. at 357-358). Notably, regarding thispoint, the Court stated in a footnote that, insofar as Smith v Kirkpatrick (305 NY 66)"may be to the contrary, it is overruled" (id. at 358 n 1). Whether facts are deemed toconstitute a single factual grouping for res judicata purposes "depends on how the facts arerelated in time, space, origin, or motivation, whether they form a convenient trial unit, andwhether . . . their treatment as a unit conforms to the parties' expectations orbusiness understanding or usage" (Smith v Russell Sage Coll., 54 NY2d 185, 192-193[1981] [internal quotation marks and citations omitted]).
Here, to the extent the claims against Highland in the new complaint implicate events allegedto have taken place before the filing of the original complaint, res judicata applies. That isbecause UBS's claims against Highland in the original action and in this action all arise out of therestructured warehousing transaction. While the claim against Highland in the original action wasbased on Highland's alleged obligation to indemnify UBS for actions taken by the affiliatedfunds, and the claims against Highland in the second action arose out of Highland's allegedmanipulation of those funds, they form a single factual grouping. Both are related to the samebusiness deal and to the diminution in the value of the securities placed with UBS as a result ofthat deal. Thus, the claims form a convenient trial unit. Moreover, it can hardly be said that theclaims in the two actions are so unrelated that reasonable business people, not to mention theparties themselves, would have expected them to be tried separately (see Smith v RussellSage Coll., 54 NY2d at 192-193). Also, we note that, when seeking permission to amend thecomplaint, UBS itself asserted that "the new causes of action arise out of the same or relatedcircumstances and events as UBS's pending claims."
Further, the Court of Appeals' holding in Xiao Yang Chen v Fischer (6 NY3d 94 [2005]) [*6]does not support UBS's position. Nor does it represent a shift in resjudicata jurisprudence, as UBS argues. The circumstances of this case bear no resemblance tothose in Xiao Yang Chen, which involved a woman who, in a previously filed separateaction, was granted a divorce on the ground of cruel and inhuman treatment. In the divorceaction, the plaintiff supported her cruel and inhuman treatment claim with an allegation that herhusband had slapped her, causing injury. While the divorce action was pending, the plaintiffcommenced a separate personal injury action seeking damages for the intentional infliction ofemotional distress and injuries arising out of the alleged assault. In finding that res judicata didnot bar the personal injury action, the Court of Appeals noted that the two actions soughtdifferent types of relief and did not constitute a convenient trial unit. The Court of Appeals alsonoted other significant distinctions, such as the facts that divorce actions are typically decided bya judge and that attorneys in personal injury actions may be compensated by a contingency fee,and the policy consideration of expediting divorce proceedings. None of those considerationsapplies here, where the action seeks money damages arising only in connection with acommercial transaction.
While we have concluded that res judicata bars the claims in this action, we still mustaddress UBS's assertion that it would be fundamentally unfair to apply res judicata under thecircumstances of this case. UBS bases this argument primarily on the contention that it wouldhave moved to amend the complaint in the original action while that action was still in existence(i.e., before this Court dismissed it), but for the necessity that it comply with the CommercialPart rules requiring that it first seek permission in a letter. However, this argument fails because,even had they made such a motion, the ultimate result would have been the same. As evidencedby the affidavit of its former employee, UBS was aware of the facts that support the claims inthis action as long ago as November 2008. That was before UBS filed the original action.
Indeed, the evidence that the former employee admits had been gathered by UBS at that timesupports all the claims asserted against Highland in this action. That UBS received additionalevidence in the document production that Highland made shortly before UBS sought to amend itscomplaint is irrelevant. The proper inquiry for res judicata purposes is when UBS could haveraised a cause of action, not when it had enough evidence to prove the claim at trial(see Castellano v City of New York, 251 AD2d 194, 195 [1998], lv denied 92NY2d 817 [1998], cert denied 526 US 1131 [1999]). In this regard, we note that, basedon what it admits it knew in November 2008, UBS could have pleaded its fraud claim with therequisite particularity at that time, since the facts available would have permitted a "reasonableinference of the alleged conduct" (Pludeman v Northern Leasing Sys., Inc., 10 NY3d 486, 492[2008]). Because UBS could have asserted the instant claims in the original complaint or movedto amend well before that complaint was dismissed by this Court, we are not persuaded that theRules of the Commercial Part affected the eventual result. Nevertheless, to the extent that thethird and fourth causes of action, alleging breach of the covenant of good faith and fair dealingand fraudulent conveyance, respectively, rely on conduct alleged to have occurred after thecommencement of the prior action, such claims should be allowed.
Nor do we share the motion court's concern that it is unfair to apply res judicata whereHighland remains a party to the action by dint of its counterclaims. It would likewise be unjust tohold that a defendant that chooses to assert a counterclaim forfeits its right to assert the defenseof res judicata with respect to the main claims. Indeed, to so hold would deal a blow to judicialeconomy since counterclaims are not compulsory in New York (67-25 Dartmouth St. Corp. v Syllman,29 AD3d 888, 889 [2006]), and defendants would merely assert their own [*7]claims in separate actions to avoid the application of res judicata.
Finally, to the extent the fifth cause of action, alleging tortious interference with contractualrelations, is based on events that occurred after the original complaint was filed, it was properlydismissed, since Highland was a party to the contracts with which it is alleged to have interfered.While some courts have held that a party to a multilateral agreement can be found liable fortortious interference with the agreement (see e.g. Rosecliff, Inc. v C3, Inc., 1995 WL276156, *3, 1995 US Dist LEXIS 6281, *9 [SD NY 1995]), that has generally been where thealleged tortfeasor has rights and duties that are separate from those of the breaching party (seeAljassim v S.S. S. Star, 323 F Supp 918, 925 [SD NY 1971]). Here, the complaint isthoroughly suffused with allegations that Highland was essentially the alter ego of the parties itinduced to breach the agreements. Under such circumstances, Highland cannot be considered a"stranger" to the contractual relationship between UBS and the affiliated funds, and there can beno claim for tortious interference with contract (see Koret, Inc. v Christian Dior, S.A.,161 AD2d 156, 157 [1990], lv denied 76 NY2d 714 [1990]). Concur—Mazzarelli,J.P., Sweeny, Renwick, Richter and Manzanet-Daniels, JJ.
Footnote *: There are two affiliated UBScompanies named as plaintiffs that are referred to herein collectively as "UBS."