It is somewhat rare for a business dispute to be litigated all the way through trial. Protracted litigation is costly, time-consuming, and unpredictable. When that does happen, however, the results can be illuminating—especially when the trial court’s decision is upheld on appeal.
That is what happened in the recent decision of the Appellate Division, First Department, in Mohinani v. Charney, 208 A.D.3d 404 (1st Dep’t 2022). After a decade of litigation and a trial, the appellate court upheld the trial court’s dismissal of the plaintiffs’ breach of fiduciary duty claim. The appellate court also addressed aspects of fiduciary-duty claims that have particular importance for businesspeople, especially real-estate investors: (1) the duties that promoters of real-estate ventures owe their passive investors; (2) the necessary elements of a successful breach of fiduciary duty claim, including pleading damages properly; and (3) when a derivative claim on behalf of an entity, rather than an individual claim on behalf of one of the entity’s shareholders or members, is the appropriate vehicle to seek redress.
The Mohinanis Become Passive Investors in Charney’s Project
This dispute arose from a failed real-estate venture. Leon Charney, a New York-based real-estate tycoon, reached out to a representative of the Hong Kong-based plaintiffs, the Mohinani brothers, about a potential investment in the redevelopment of two adjacent Midtown Manhattan properties. Specifically, Charney sought to make improvements to a commercial building, and to demolish an adjacent building to make way for a boutique hotel.
The Mohinanis signed on to Charney’s project, investing $4.5 million and becoming minority members of an entity called LHC Club LLC (“LHC”). LHC, in turn, was a minority member of each of the LLCs that owned and managed the office property and hotel property, respectively (together, the “Sub-LLCs”). Following the market crash in 2007, however, the office property defaulted on its mortgage, and the property wound up in the hands of a receiver. And hotel property defaulted on its mortgage in 2009. In 2010, Charney’s health declined and he went into a coma. Finally, in 2011, the hotel property was sold at a loss. All in all, not an optimal conclusion to a once-promising real-estate venture.
The Mohinanis File Suit in Their Own Names Rather than Derivatively
The Mohinanis filed suit against Charney’s estate in 2012. Among other claims, the Mohinanis alleged breach of fiduciary duty. Significantly, the Mohinanis sued in their own names rather than derivatively—that is, on behalf of LHC.
As discussed, the Mohinanis were minority members of LHC, which in turn had a minority interest in each of the two Sub-LLCs. The Mohinanis alleged that Charney breached his fiduciary duties in two distinct ways: (1) by allegedly taking for himself “special distributions” of $1.5 million from the Sub-LLCs, and also by taking a $1 million “acquisition fee,” all of which they claimed belonged to LHC; and (2) by allegedly causing the Sub-LLCs to pay Charney’s management companies $850,000, payments the Mohinanis alleged were improper.
Eight years after the Mohinanis filed suit, the case finally went to trial in 2020. The trial court issued a decision in November 2020 dismissing the Mohinani’s fiduciary-duty claim. The appellate court affirmed.
The Appellate Court Rejects the Mohinanis’ Fiduciary-Duty Claim
First, there was no question that Charney owed the Mohinanis fiduciary duties in his capacity as the promoter of a real-estate venture in which the Mohinanis were merely passive investors. As an earlier appeal in the litigation determined, there was “a fiduciary relationship between Charney, as the promoter of a real estate investment opportunity, and plaintiffs, as passive investors in the project.” Mohinani v. Charney, 156 A.D.3d 443, 444 (1st Dep’t 2017). This is an important concept that can ensnare real-estate promoters in fiduciary-duty liability.
However, the Mohinanis failed to establish a crucial, basic element of their fiduciary-duty claim: damages.
First, the Mohinanis claimed that Charney wrongfully diverted from LHC the $1.5 million in “special distributions” and the $1 million “acquisition fee.” But these purported damages would have been sustained by LHC, not by the Mohinanis individually.
Second, the Mohinanis claimed that Charney’s management company improperly received $850,000 from the Sub-LLCs. Again, however, these damages would have been sustained not by the Mohinanis, but by the Sub-LLCs.
Accordingly, the Mohinanis could not assert a claim to recover any of these sums in their own names, as they had done. Rather, the Mohinanis should have sued derivatively on behalf of LHC to recover the “special distributions” and “acquisition fee.” And they should have brought a so-called double-derivative action—or an action in their capacity as minority members of LHC but on behalf of the Sub-LLCs—to recover the $850,000 in management fees that Charney purportedly diverted from the Sub-LLCs.
Conclusion: A Double Loss for the Passive Investors
In the end, not only was Charney’s redevelopment project a failure, but the Mohinanis’ years-long court battle also failed to yield them a favorable result. This case is useful for a number of reasons. First, it shows just how lengthy (and expensive) litigation can be when parties decide to go to trial—a process that has absolutely no guarantee of a positive outcome. Second, it shows how important it is to plead and establish the most basic elements of a cause of action. Here, after a decade of litigation, the appellate court rejected the Mohinanis’ fiduciary-duty claim because they failed to establish that they suffered damages individually. Had they pleaded their case differently by bringing derivative claims on behalf of the relevant entities rather than bringing suit in their own names, the Mohinanis probably would have had a higher chance of succeeding in court. Finally, this case shows how real-estate promoters in Charney’s position who solicit passive investments may expose themselves to liability. Although the court ultimately rejected the Mohinanis’ claim, Charney still faced exposure for potentially breaching his fiduciary duties to his passive investors.