Highland Capital Management L.P. v. Schneider

05-4729
Highland Capital v. Schneider
UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT
August Term, 2005
(Argued: June 15, 2006 Decided: May 14, 2007)
Docket Nos. 05-4729-cv(L), 05-4869-cv(XAP)
HIGHLAND CAPITAL MANAGEMENT L.P.,
Plaintiff-Appellant-Cross-Appellee,
—v.—
LEONARD SCHNEIDER, LESLIE SCHNEIDER,
SCOTT SCHNEIDER, and SUSAN SCHNEIDER,
Defendants-Third-Party-Plaintiffs-
Counter-Defendants-Appellees-
Cross-Appellants,
JENKENS & GILCHRIST PARKER CHAPIN L.L.P.,
Defendant-Appellee.
Before:
WINTER and RAGGI, Circuit Judges, CROTTY, District Judge.1
Appeal from an order of the United States District Court for the Southern District of New
York (Peter J. Leisure, Judge), entered on August 2, 2005, granting summary judgment in favor
1
The Honorable Paul A. Crotty, United States District Judge for the Southern District of New
York, sitting by designation.
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of Defendants-Third-Party-Plaintiffs-Counter-Defendants-Appellees.
VACATED and REMANDED.
PAUL B. LACKEY (Jamie R. Welton, on the brief), Lackey Hershman, L.P.P.,
Dallas, Texas, for Plaintiff-Appellant-Cross-Appellee.
ALVIN M. STEIN (Katherine C. Ash, Tyler D. Lenane, of counsel), Troutman
Sanders L.L.P., New York, New York, for Defendants-Third-Party-
Plaintiffs-Counter-Defendants-Appellees-Cross-Appellants,
ROBERT B. GILBREATH, Jenkens & Gilchrist Parker Chapin L.P., Dallas, Texas
for Jenkens & Gilchrist Parker Chapin L.P.
CROTTY, District Judge:
I. Background
The facts on this appeal are set forth in the Court’s prior opinion, Highland Capital
Mgmt. L.P. v. Schneider, 460 F.3d 308 (2d Cir. 2006), and more extensively in the District
Court’s opinion, Highland Capital Mgmt. L.P. v. Schneider, 2005 U.S. Dist. LEXIS 14912, at
*2-28 (S.D.N.Y. July 26, 2005), familiarity with which is assumed. In our opinion, we certified
the following question to the New York Court of Appeals:
Based on this record, do the eight promissory notes issued by McNaughton
Apparel Group Inc., to the Schneiders fall within the definition of a “security” as
contemplated by Section 8-102(15) of the New York Uniform Commercial Code?
Highland Capital Mgmt., 460 F.3d at 321.
2
On April 3, 2007, the New York Court of Appeals answered the question in the
affirmative. See Highland Capital Mgmt. L.P. v. Schneider, 2007 N.Y. LEXIS 613 (Apr. 3,
2007). Specifically, it found that the eight notes issued to the Schneiders met the transferability,
divisibility and functionality tests of N.Y. U.C.C. § 8-102(a)(15).2 See id. at *10-11.
While the notes were not in bearer form, they were in a form which “contemplated the
possibility of future transfer.” Id. at *15. Since McNaughton would have to register a transfer
upon appropriate demand by the note holders, the Court of Appeals concluded “that the notes
satisfy the transferability test in N.Y. U.C.C. § 8-102(12)(I): they were obligations represented by
a security certificate in registered form.” Id.Since the eight notes are divided into two groups of four notes each, they were clearly a
class of obligations which are divisible. Id. at *16.
Finally, the Court of Appeals recognized that the functionality test had to be liberally
construed to address and “create a framework for commercial activity that reflects and fosters
developing custom and usage.” Id. at *17. Since McNaughton had treated the notes as
securities, as did the securities trading entities, they were securities within the meaning of U.C.C.
§ 8-102(a)(15).
We have previously disposed of Counts Three, Four, Five, and Six of the Third Amended
Complaint (“Complaint”) by summary order.3 See Highland Capital Mgmt. L.P. v. Schneider,
2
The question of whether a note is a “security” within the meaning of N.Y. U.C.C. § 8-
102(a)(15) does not depend on whether it represents an investment in the issuing
company. The financing arrangement does not have to be analogous to a stock transaction
in order to be a security, nor does it have to meet any criteria (e.g., financing and
investment, or representing title) other than those set forth in § 8-102(a)(15).
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Counts Three and Four allege Tortious Interference with Contractual Relations and
Prospective Contractual Relations (respectively) against the Schneiders. Counts Five and
Six allege Tortious Interference with Contractual Relations and Prospective Contractual
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198 Fed. Appx. 41 (2d Cir. 2006). We affirmed the District Court’s decision with regard to
Counts Three and Four and vacated the decision with respect to Counts Five and Six for lack of
subject matter jurisdiction. We retained jurisdiction of Counts One, Two, and Seven of the
Complaint so that we could rule on the remainder of the appeal when we had the New York
Court of Appeals’ answer to the certified question.
Count One of the Complaint alleges a Breach of Contract against the Schneiders; Count
Two of the Complaint alleges a Breach of a Binding Preliminary Agreement against the
Schneiders (Breach of Good Faith and Fair Dealing); and Count Seven alleges Third Party
Beneficiary Breach of Contract against the Schneiders. In the analysis of each of these three
counts, the District Court found that since the notes were not securities, see Highland Capital
Mgmt., 2005 U.S. Dist. LEXIS 14912, at *44, there had to be a writing sufficient to satisfy the
Statute of Frauds. See id. at *55. That writing being absent, there was no contract, alleged oral
agreements to the contrary notwithstanding.
In considering the existence of the “purported oral agreement” in Counts One, Two, and
Seven, Judge Leisure found that there was a “genuine material issue of fact . . . as to whether the
Schneiders’ actions compelled RBC and Highland’s belief that GRS had the authority to bind the
Schneiders.” Id. at *35. Similarly, “a rational juror could find that the purported oral agreement
encompassed all material terms between the Schneiders/GRS and RBC.” Id. at *38. Since the
notes were not securities, however, the “purported oral agreement” fell within the Statute of
Frauds. The District Court went on to conclude, however, that there was no evidence of privity
of contract between Highland and the Schneiders, and dismissed Counts One and Two. As to
Relations (respectively) against JGPC.
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Count Seven (Third Party Beneficiary), the District Court found that “a material issue of fact
exists as to whether Highland was an intended third party beneficiary if the contract is found to
exist.” Id. at *68. Thus, the only claim not dismissed on the merits was Count Seven.
II. Discussion
In light of the New York Court of Appeals’ determination that the notes are securities
within the meaning of New York’s U.C.C., the District Court’s dismissal of Counts One and
Two based on the determination that there was insufficient support for a contract between
Highland and the Schneiders should be reconsidered. Upon finding that the notes were not
securities within the meaning of the N.Y. U.C.C., the District Court then analyzed the contract
claims purely under the common law. We remand for the District Court to reconsider these
claims under the framework of Article 8 of the N.Y. U.C.C.4
Finally, with respect to Count Seven, Third Party Beneficiary Breach of Contract against
the Schneiders, the District Court found that this count stated a valid claim, but dismissed for
want of the jurisdictional amount. It reasoned that, because the contract fell within the Statute of
Frauds, the damages were limited to $5,000, an amount that did not satisfy the statutory
4
Applying common law principles of agency, the District Court concluded that there was no
privity of contract between Highland and the Schneiders. By remanding for reconsideration, the
Court is not dictating a different outcome, as the District Court might conclude that,
notwithstanding Article 8 of the N.Y. U.C.C., the same common law principles yield the same
result. The N.Y. U.C.C. does not completely supplant the common law. See, e.g., N.Y. U.C.C. §
8-509 cmt. (“This Article is not a comprehensive statement of the law governing the relationship
between broker-dealers or other securities intermediaries and their customers. Most of the law
governing that relationship is the common law of contract and agency, supplemented or
supplanted by regulatory law. This Article deals only with the most basic commercial/property
law principles governing the relationship.”). The extent to which the analysis differs under the
N.Y. U.C.C. is for the District Court to determine in the first instance.
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requirement for diversity jurisdiction. See Highland Capital Mgmt., 2005 U.S. Dist. LEXIS
14912, at *76-77; 28 U.S.C. § 1332(a). In light of the New York Court of Appeals’
determination that the notes in question were in fact securities, the Statute of Frauds no longer so
limits the damages in question. Indeed, the value of the disputed promissory notes was $69
million, well over the $75,000 jurisdictional threshold. See Highland Capital Mgmt. L.P., 2005
U.S. Dist. LEXIS 14912, at *2. We therefore reverse the District Court’s jurisdictional
dismissal.
Since the District Court clearly has jurisdiction, it may exercise supplemental jurisdiction
over the third party complaints and counterclaims.
III. Conclusion
The judgement of the District Court with respect to Counts One, Two and Seven of the
Third Amended Complaint is hereby VACATED and REMANDED.
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