In a March 12, 2010 order (here) in a Madoff-related derivative suit, the New York (Nassau County) Supreme Court, applying New York law, substantially denied defendants’ motion to dismiss, holding among other things that demand was excused. As far as I am aware, this is the first Madoff-related derivative suit to survive a motion to dismiss. It is also the first Madoff-related lawsuit dismissal motion denial by a New York court of which I am aware.


The derivative suit was filed on April 1, 2009 by non-managing member of Andover LLC, on behalf of Andover LLC, as nominal defendant. Among the defendants are Andover’s investment manager (Andover Management), general partner, and investment consultant (Ivy Asset Management) and Andover’s auditor. The complaint, which can be found here, alleged that Andover should recover damages for the defendants’ negligence, gross negligence, breach of fiduciary duty, and for aiding and abetting breach of fiduciary duty.


The complaint alleges that the defendants committed these wrongs by permitting Andover to invest "approximately a quarter of its assets under the personal control of [Bernard Madoff] through his investment firm." The complaint alleges that as of December 31, 2007, Andover had assets of $57.7 million. The complaint further alleges that Andover’s auditors were negligent in conducting annual audits by failing to plan and perform appropriate audits and appropriate tests that would have identified Madoff’s fraud.


The plaintiff alleged that serving a demand on Andover’s management to prosecute these claims would have been futile because Andover and its principles were involved in wrongdoing constituting the basis of the claims. The plaintiff also asserted that it would have been futile to demand that Andover pursue claims against Ivy because Ivy’s agreement with Andover required Andover to indemnify Ivy. The plaintiff alleged it would have been futile to demand that Andover suit the auditor because Andover’s misconduct was "inextricably interconnected" with that of management.


The defendants moved to dismiss, arguing the plaintiff’s lack of capacity to sue; that the plaintiff’s claims are barred by New York’s Martin Act; that his derivative claims were barred by failure to make a demand on the managing member of the limited liability company and by the business judgment rule, and numerous other grounds. The auditor moved on lack of capacity and lack of proximate causation since the investment has been made before the current auditor was retained and the loss therefore could not have been avoided.


In its March 12, 2010 order, the court substantially denied the defendants’ motions in all material respects.


First, the court ruled that the plaintiff’s failure to make a demand was excused. The court reasoned that Andover Management and general partner had an interest in not being sued and an interest in protecting its principals, Ivy and its auditor from being sued, as claims against those persons "would tend to establish that Andover Management negligently breached its own fiduciary duty."


Second, the court ruled that the plaintiff’s claims were not barred by the Martin Act because the plaintiff’s claims do "not arise from alleged securities fraud and is not simply a securities fraud claim."


Third, the court also denied the defendants’ motion to dismiss plaintiffs’ gross negligence claim against Andover Management because "it may be inferred" that Andover Management "failed to exercise even slight care in failing to detect" Madoff’s fraud. It may also" be inferred" that Andover Management "showed complete disregard for Andover associates’ right and the safety of its investment."


In addition to its several other holdings, the court also denied the auditor’s motion to dismiss as well, observing that "the court must assume that an audit … conducted pursuant to generally accepted accounting procedure would have uncovered Madoff’s fraud" and that "a proper audit would have provided Andover with an opportunity to liquidate its investment."


The Andover case is not the first Madoff lawsuit to survive a motion to dismiss (see, for example, my recent post here about a dismissal motion denial in a Madoff-related case). However, it is as far as I am aware, the first dismissal motion denial in a Madoff-related derivative case and it is as far as I am aware the first dismissal motion denial in a court in New York, many of the Madoff-related cases are pending.


If the March 12 order is in any way indicative of the likely course of Madoff investors’ claims against feeder funds and investment gatekeepers, the investors’ litigation outlook appears favorable, at least at the dismissal motion stage. Indeed, the March 12 order fairly bristles with incredulity that the various defendants failed to take steps that, the court assumes, would have detected Madoff’s fraud.


But while a similar judicial predisposition might allow other claimants, like the plaintiff in this case, to survive a dismissal motion, it remains to be seen whether the claimants ultimately will be able to recover their losses or any substantial part thereof.


Of course, to even have any hope of any recovery, the aggrieved investors’ claims must first survive a motion to dismiss. The March 12 order in this case should be of keen interest to other Madoff claimants.


Special thanks to Daniel Tepper, one of the plaintiff’s counsel in the Andover case, for providing a copy of the March 12 order.