FINANCIAL REGULATION--The Ancient Doctrine of Champerty and a First for the New York Court of Appeals.

• Author: Kelly, Sean
• Position: Case note

FINANCIAL REGULATION--The Ancient Doctrine of Champerty and a First for the New York Court of Appeals--Justinian Capital SPC ex rel. Blue Heron Segregated Portfolio v. WestLB AG, 65 N.E.3d 1253 (N.Y. 2016).

The requirements of standing have safeguarded the court system from being subjected to unwarranted claims and unworthy parties, yet exceptions to standing have created the need to further expand these protections; while the doctrine of maintenance and champerty pre-dates the standing requirements, it was adopted to prevent the courtroom from becoming a trading floor for claims and frivolous litigation by disinterested third parties. (1) New York codified their stance on champerty, which asserts that parties cannot purchase financial instruments or claims "with the intent and for the purpose of bringing an action or proceeding thereon." (2) In Justinian Capital SPC ex rel. Blue Heron Segregated Portfolio v. WestLB AG, (3) the New York Court of Appeals addressed whether the appellant's purchase of notes from a third party and subsequent suit against the respondent constituted champerty, and if the transaction fell under the "safe harbor provision" established in the statute. (4) The Court ruled that the proper interpretation of the New York statute finds this transaction champertous, and that the appellant was not protected under the "safe harbor provision." (5)

In 2003, Deutsche Pfandbriefbank AG (DPAG) devoted nearly EUR180 million to notes offered through two portfolios that were managed and sponsored by WestLB AG (WestLB). (6) During the global financial crisis of 2007-2008, both DPAG and WestLB experienced massive losses, and the notes became virtually worthless. (7) The losses DPAG suffered with regards to the notes was attributed to investments made in mortgage-backed securities through the portfolios WestLB managed, even though the securities fell short of their investment guidelines. (8) This provided DPAG with an opportunity to recoup damages during a time of substantial recession, but DPAG feared that their supportive funding from the German government would be jeopardized if they pursued a claim against WestLB; as a result of the global recession, the German government now predominantly owned WestLB. (9) DPAG's political concerns stopped them from bringing a claim against WestLB directly, but in order to alleviate their financial damages, DPAG opted to have a third party bring the claim. (10) In April 2010, a deal was reached between DPAG and Justinian Capital SPC (Justinian) that stipulated DPAG would assign the notes to Justinian in exchange for capital and specific proceeds related to subsequent litigation; days later Justinian brought the claim against WestLB. (11)

The Sales and Purchase Agreement (the Agreement) assigned the notes to Justinian along with "all the Seller's legal, beneficial and equitable rights and claims ..." for an aggregate purchase price of USD1 million. (12) The first motion to dismiss resulted in the court ordering the parties to conduct further discovery based on the champerty defense raised by WestLB, mainly because Justinian had not revealed the Agreement in its entirety. (13) Subsequently, discovery exposed that DPAG still retained ownership rights of the notes and merely subcontracted its right to litigation to Justinian. (14) Although the Agreement provided that Justinian was to pay USD1 million, they had not yet transferred any money to DPAG prior to commencing litigation. (15) Even more troubling was that Justinian had agreed to remit 80-85% of the proceeds from successful litigation back to DPAG in exchange for the remaining 20-25% of the judgment. (16) The Supreme Court of New York had little trouble finding this Agreement champertous, focusing much of their attention to precedent and the interpretation of the champerty statute. (17) As did the Supreme Court Appellate Division, who reiterated much of what the lower court had already established. (18) It was not until the case reached the New York Court of Appeals before that it seemed Justinian would have an opportunity to successfully argue their case, although the lower courts had recognized New York as the "financial capital of the world," the Court of Appeals was sensitive to an issue that could disrupt major complex commercial transactions. (19) Nevertheless, the Court of Appeals affirmed the decisions of the lower courts; Justinian initiated appeal with the intention of resolving whether WestLB's malfeasance would be recouped and dismissing the concerns of champerty. (20)

The modern common law doctrine of maintenance and champerty finds its origins in medieval times and was structured to protect ethics in the legal profession. (21) From as early as ancient Greece through 19th Century England, judiciaries were very cautious about parties other than the litigants having a stake in the claim at bar. (22) Issues of champerty even arose when agreements similar to contingency fees for the successful outcome of a claim were arranged between attorney and client, although these instances have since been taken care of by legal ethics codes. (23) While the historical foundations of maintenance and champerty still provide a clear context of what the offense entails, the development of the modern world has convoluted when an offense of this nature may occur. (24) Through various case law and statutes, it is clear that jurisdictions have developed their own understanding of when a champertous act has taken place and how the offense should be handled. (25)

Important as it is to recognize the foundations for this doctrine, it is the world around it that has reduced it to an ancient legal theory that survives in few jurisdictions. (26) There are some jurisdictions that follow the precedent that has developed their acceptance of champerty, while few have codified the concept in statute. (27) New York, a jurisdiction that has a specific champerty statute, has tried to keep the offense relevant with the current affairs. (28) It is important to note New York City is the capital of the world financial market that regularly practices debt-trading techniques that legal minds could interpret as champertous. (29) So while some may argue that champerty, as the 19th Century English courts developed it, is dead, others realize that it has evolved similar to the markets it looks to regulate. (30)

The New York codification of champerty was recently rewritten to adapt to the climate of the 21st Century. (31) The first subsection of the statute provides that it cannot be the primary purpose of an entity to obtain financial instruments in order to bring a claim upon them. (32) This was illustrated in Moses v. McDivitt, (33) which established a "primary purpose test" that has been in force since its inception, focusing on the language of the statute--which has been retained in the newly revised statute-- the Moses court looked at whether a transaction was made "with the intent and for the purpose" of commencing litigation and not just incidental to the transaction. (34) The second subsection is a "safe harbor provision" which exempts transactions from being considered champertous under the first subsection if the transactions exceed USD500,000; that is intended to prevent champerty claims from intervening in complicated Wall Street transactions and deter financiers from practicing in New York. (35) Subsection one retains much of the language from New York's previous champerty statute; while subsection two is a recent development that allows for some dealings to fall within the "safe harbor provision" which exempts otherwise champertous transactions from being unenforceable. (36)

In Justinian Capital SPC ex rel. Blue Heron Segregated Portfolio v. WestLB AG, (37) the Court of Appeals of New York held that the agreement between Justinian and DPAG was in fact a champertous act and not protected by the "safe harbor provision" of the statute. (38) The Court found that it was clear Justinian had acquired the notes "with the intent and for the purpose of bringing an action or proceeding thereon." (39) Justinian's principal made an effort to show that litigation was one of many possible sources of recovery, but the court did not entertain this idea, notably dismissing other avenues of recovery on the notes as speculation. (40) Next, the Court looked to the "safe harbor provision" to determine if the act was nevertheless permitted even if found champertous. (41) The Court grappled this issue over whether actual payment was necessary when the provision required a "purchase price" of at least USD500,000. (42) Ultimately, the Court determined that actual payment was necessary to qualify for the "safe harbor provision" "purchase price" standard, and the majority affirmed WestLB's summary judgment based on their motion to dismiss the claim on the affirmative defense of champerty due to the interpretation of the "safe harbor provision" which the Court ultimately concluded required that the purchasing party in the transaction actually make payment to qualify for this exemption. (43)

Justice Leslie E. Stein's dissenting opinion addressed both the issue of champerty and the qualifications for the "safe harbor provision." (44) When addressing the champerty issue, the dissenters argued that summary judgment was inappropriate because the "primary purpose" must be a question of fact left to the jury. (45) The deposition of Justinian's principal was the crux for determining whether there was the possibility that Justinian could recoup damages by other means than litigation was, in the majority opinion, it was decisively resolved but, as the dissenters viewed, a question that should have been left to the jury. (46) Further, the dissenters argued that the "safe harbor provision" was wrongly applied to this case. (47) The dissent made no reference to whether it required actual payment but instead focused on the majority's premature decision to deem...