Conflict of Laws and Home Affairs Doctrine | Farrell Fritz, PC

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The legal concept of “conflict of laws” is difficult to say the least, confusing lawyers and even seasoned judges, with voluminous treatises and entire classes of law schools devoted to the subject.

Broadly, the art term “conflicts of laws” refers to the question of how to determine which state laws provide the decision rules for resolving a particular issue, controversy, or dispute.

For example, when a business divorce litigant files a lawsuit, they may allege a mixture of substantive claims, such as breach of contract, breach of fiduciary duty, and accounting (among a number of other colorful claims in the business divorce litigant’s palette). Conflict of law issues arise when the entity is incorporated in a state (e.g. Delaware), but the entity has operated, the applicable contract has been entered into, or the alleged tortious activity has occurred. in another state (for example, New York).

To determine whether the plaintiff has sufficiently alleged or proven the essential elements of a legal cause of action, the court must first determine the state laws that govern the claim. Sometimes a claim will be sufficient under the laws of one state but insufficient under another, so the conflict of laws analysis can determine whether the plaintiff can pursue or recover a particular claim.

Things can get even trickier when the laws of one state refer the court to the laws of the other state, and vice versa. This circularity problem is called dismissal. Transactional lawyers avoid dismissal problem by including choice of law provisions in their contracts containing language that disputes arising out of the contract shall be governed by the laws of a particular state “without regard to principles of conflict of laws”, or words to that effect. Things can get even more complicated when a lawsuit is filed Federal Court Based on Diversity Jurisdictionand the court must, under the “Erie doctrine”, apply “substantive” state law, but federal “procedural” law.

The marital dispute turned into business and divorce

Recently, Manhattan Matrimonial Division Judge Douglas E. Hoffman issued an interesting decision dealing with complex choice-of-law issues in a business divorce dispute between an Italian billionaire Silvio Scaglia (“Scaglia”) and its business partner/spouse, Julia Haart (“Haart”), regarding Haart’s alleged embezzlement of $850,000 in cash from a Delaware entity, Freedom Holding, Inc. (“Freedom”), one day after being informed of his imminent departure as CEO of the wholly-owned subsidiary of Freedom, a top model agency Global Elite Group, Inc.. (“EWG”).

In the resulting decision, Freedom Holding, Inc. v. Haart (2022 NY Slip Op 22225 [Sup Ct, NY County July 20, 2022]), Judge Hoffman rejected Haart’s contention that Delaware law applied in all respects to Freedom and Scaglia’s claims simply because of the entity’s incorporation in Delaware.

Before we get to the facts: how Freedom end up in the marital division? Freedom is yet another example of many we have written about (read here and here) where a marital dispute has spawned a parallel business divorce dispute. In Freedomthe parties fought over whether the case should go to the Business Division or the Matrimonial Division, with Haart winning in that particular battle.

Scaglia and Haart’s matrimonial-turned-business-divorce dispute also spawned separate litigation in the Delaware Chancery Court, with Haart suffering a significant loss earlier this year (read here) when Vice Chancellor Morgan T. Zurn issued a comprehensive post-trial decision rejecting Haart’s claim that she owned the preferred shares of Freedom.

Amended Complaint and Motion to Dismiss

According to amended complaint in Freedom, Scaglia and Haart became equal shareholders of 50% of the common stock of Freedom after Scaglia offered Haart his shares in anticipation of their impending (ultimately short-lived) marriage. Freedom, in turn, was the sole member of the EWG. EWG was one of the plaintiffs in Freedom, although it voluntarily withdrew his claims.

Based on Haart’s alleged misappropriation of $850,000 from Freedom, Freedom and Scaglia alleged five causes of action: conversion, breach of fiduciary duty, breach of contract, unjust enrichment, and constructive trust. Haart decided to dismiss all claims but breach of fiduciary duty. You can read the summary here, hereand here.

Haart argued for Delaware law under the “home affairs doctrineexcept for the breach of contract claim, which she admitted was governed by New York law because her alleged verbal promise — not to withdraw money from Freedom beyond $250,000 – had been made in New York.

Freedom and Scaglia argued for New York law except with respect to breach of fiduciary duty, which they argued was governed by Delaware law under the internal affairs doctrine.

Accordingly, the court had to determine the applicable law for three claims: conversion, unjust enrichment and constructive trust.

A disproportionate part of the briefing focused on the conversion request. In Haart’s view, “Delaware law provides that a cause of action for conversion is improper where, as here, a demand for payment of money is involved.” In the resulting ruling, Justice Hoffman provided a nuanced treatment of the choice of law issue, analyzing each claim independently.

The choice of law framework

In choosing the law of New York, Judge Hoffman wrote, “the initial question is whether there is a difference between the laws of Delaware or New York for claims, and whether there is there is no conflict between the laws of the relevant jurisdictions, there is no reason to engage in a choice of law analysis” (citation omitted).

If there is an actual conflict between the laws of the two states, the next question is which state, New York or Delaware, has “the greater interest” in the application of its laws to the particular dispute, usually determined by which state has “the most interest”. meaningful contacts” about the controversy.

Home Affairs Doctrine

According to Haart, Delaware had the greater interest in the dispute under the Home Affairs Doctrine due to Freedom’s incorporation into Delaware.

Justice Hoffman took a much narrower view of the doctrine, writing that “the internal affairs doctrine of conflict of laws could apply (and result in the application of Delaware’s choice of law) only whether the claims relate to the internal affairs of a Delaware entity and its officers, directors, or shareholders As such.

Justice Hoffman wrote that the internal affairs doctrine “governs only the choice of law determinations involving questions particular to companies, i.e. activities concerning relations among oneself of the company, its directors, officers and shareholders”, not to all claims automatically simply because they relate to a business entity (citations omitted).

The Court ruled, “Haart is not alleged to be an officer or director” of Freedom, and “[a]Although she owns 50% of the common (but not preferred) shares of Freedom, she is not deemed to be its majority shareholder for purposes of fiduciary duty. Therefore, the court held, the complaint “does not allege sufficient facts. . . to require the application of Delaware law to these three claims” (citations omitted).

Presumably to protect itself on appeal, the Court noted that it would nevertheless consider Delaware law “if applicable” “on the side of caution.”

Disposition of claims

The Court applied the laws of New York and Delaware to the conversion claim, finding that the claim was insufficient under either state’s laws. The Court held that “the tort of conversion (whether in Delaware or New York) has its roots in common law, and New York would take a similar view of the alleged conversion of unspecific money: Money conversion requests are only permitted if the funds in question were separate, distinct, separately identifiable and not commingled with other funds. The Court ruled that under the laws of either state, the money Haart allegedly embezzled was not “separately identifiable” and dismissed the claim “as presently alleged, without prejudice to the claims claimant’s remaining claims or, if advised, appropriate amended claims if they were sufficient to claim a conversion claim.

Haart challenged the unjust enrichment claim as “duplicating” others, particularly the breach of contract claim. The Court applied New York law to the unjust enrichment claim, but also wrote, “There does not appear to be any substantial difference, however, between the laws of New York and Delaware on the question of whether whether potentially redundant requests can be allowed at this point. stage of the procedure. Under each, pleading in the alternative at this stage may be permitted. In other words, the court declined to dismiss the claim for unjust enrichment as redundant on the basis that a plaintiff is entitled to plead alternative or inconsistent legal theories, but signaled that it might consider do so later at the appropriate time.

In a final paragraph, Judge Hoffman disposed of Scaglia’s alleged constructive trust claim solely for lack of standing, leaving the claim to survive as alleged by Freedom, and the applicable law being that of New York.

Results

If there are takeaways from Freedomis that business divorce litigants and their attorneys should pay particular attention to conflict-of-laws analysis when litigating claims in New York involving foreign-incorporated entities. Wood’s reliance on the internal affairs doctrine can be short-sighted when claims relate to a transaction or discrete conduct not directly related to or dependent on the parties’ unique roles as directors, officers, shareholders, managers or members.

That said, I have seen other thoughtful judges disagreeing with the Court’s internal affairs doctrine for the simple reason that it is difficult to see on what basis, other than as a trustee of Freedom, Haart allegedly embezzled money from the company. Perhaps we will eventually get some clarification on this difficult question from the Court of Appeals.

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