Contract Limiting Exposure of Fiduciary Partially Enforced
In Thomas John, etc. v. George Varughese, etc., 2017-04162, 2017-05352, 2021 NY Slip Op 03026, Supreme Court Of The State Of New York Appellate Division, Second Judicial Department (May 12, 2021) the plaintiff appealed a judgment upon the decision made after a nonjury trial, in favor of the defendant and against the plaintiff dismissing the complaint.
In April 2015, the plaintiff on behalf of Dutchess Gardens Realty, LLC (hereinafter the company), commenced a shareholders’ derivative action against the defendant, George Varughese, the then managing member of the company. The defendant had begun serving in that capacity in late 2009. The plaintiff alleged that the defendant engaged in certain improper conduct to the detriment of the company. After a nonjury trial, the Supreme Court, dismissed the complaint.
The elements of a cause of action to recover damages for breach of fiduciary duty are (1) the existence of a fiduciary relationship, (2) misconduct by the defendant, and (3) damages directly caused by the defendant’s misconduct.
The company’s operating agreement contained a provision exculpating a managing member from liability for breach of fiduciary duty, except as to actions or omissions that were “in bad faith or involved intentional misconduct or a knowing violation of law or that he personally gained in fact a financial profit or other advantage to which he was not legally entitled.” The defendant may be held liable only for an intentional or bad faith breach of fiduciary duty, or an act from which he personally gained a financial profit or other advantage to which he was not legally entitled.
The trial evidence showed that the defendant intentionally breached a fiduciary duty to the company by transferring the sum of $50,000 from the company’s funds to another entity in which he had an interest, without authority and without any benefit to the company. The defendant’s use of those funds for his own attorney’s fees was not authorized by the company’s operating agreement.
However, the remaining alleged actions of the defendant did not rise to the level of an intentional or willful breach of fiduciary duty, nor an intentional waste of the company’s assets. The plaintiff failed to establish that the defendant overpaid himself for professional services or overpaid a property manager, or that he otherwise breached a fiduciary duty to the company.
In addition, the plaintiff failed to establish any acts of actionable misrepresentation. To prevail on a cause of action for fraudulent misrepresentation, a plaintiff must allege a misrepresentation or a material omission of fact which was false and known to be false by defendant, made for the purpose of inducing the other party to rely upon it, justifiable reliance of the other party on the misrepresentation or material omission, and injury. Liability for negligent misrepresentation has been imposed only on those persons who possess unique or specialized expertise, or who are in a special position of confidence and trust with the injured party such that reliance on the negligent misrepresentation is justified.
In light of the operative exculpatory clause in the company’s operating agreement, the defendant may be held liable only for an intentional act of misrepresentation or concealment. The plaintiff alleged that the defendant failed to disclose certain information regarding the lack of insurance coverage after a 2011 fire, and failed to timely disclose an action to foreclose a mortgage on real property owned by the company. The plaintiff also alleged that the defendant failed to timely disclose certain financial information about the company. Because the plaintiff did not prove that any such actions induced reasonable reliance or resulted in damage to the company, Plaintiff failed to establish the elements of these causes of action.
Lastly, the cause of action alleging gross negligence, insofar as based on a 2011 fire and the lapse in insurance coverage at that time, was untimely asserted. Contrary to the plaintiff’s contention, the defendant properly raises the statute of limitations as an alternative ground for affirmance.
The plaintiff failed to establish that any other alleged acts of the defendant constituted gross negligence, as the evidence did not show that the defendant engaged in intentional wrongdoing, or conduct that evinced a reckless indifference to the rights of others.
The judgment was modified, on the law and the facts, by deleting the provision thereof dismissing the second cause of action, which alleged breach of fiduciary duty, and substituting therefor a provision awarding judgment in favor of the plaintiff as to that cause of action in the principal sum of $50,000; as so modified, the judgment was affirmed insofar as appealed from.
Failure to obtain insurance by a fiduciary of a property owning LLC could be actionable except where there is no damage to the LLC. The defendant was lucky that his failure to provide insurance coverage protecting the property resulted in no harm to the LLC. However, using the LLC’s money to pay his personal attorney, was a clear breach of the fiduciary duty and the appellate division reversed that part of the judgment and ordered the defendant to pay what he misappropriated.
© 2021 – Barry Zalma
Barry Zalma, Esq., CFE, now limits his practice to service as an insurance consultant specializing in insurance coverage, insurance claims handling, insurance bad faith and insurance fraud almost equally for insurers and policyholders. He also serves as an arbitrator or mediator for insurance related disputes. He practiced law in California for more than 44 years as an insurance coverage and claims handling lawyer and more than 52 years in the insurance business. He is available at http://www.zalma.com and email@example.com.
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