PRCM Advisers LLC v. Two Harbors Investment Corp.

Background

PRCM Advisers LLC managed Two Harbors Investment Corp. under a management agreement from 2009 until 2020. PRCM alleged that Two Harbors breached that agreement when it terminated PRCM as its external manager, allegedly fabricated reasons for doing so, hired PRCM employees, and misappropriated PRCM intellectual property. Two Harbors denied wrongdoing and asserted counterclaims against PRCM and Pine River Capital Management, L.P.

Two Harbors’s counterclaims alleged that the management agreement was invalid under the Investment Advisers Act of 1940, that the agreement’s indemnification and termination-fee provisions violated that law, and that a later amendment improperly transferred ownership of certain intellectual property. Two Harbors also alleged that PRCM and Pine River breached fiduciary duties and committed other wrongdoing, including gross negligence, fraud, negligent misrepresentation, unjust enrichment, aiding and abetting a breach of fiduciary duty, and breach of the implied covenant of good faith and fair dealing.

Motion and legal standards

The plaintiffs moved for judgment on the pleadings under Federal Rule of Civil Procedure 12(c). The court applied the same standard used for a motion to dismiss for failure to state a claim: it accepted well-pleaded factual allegations as true, but not legal conclusions, and considered whether the allegations plausibly supported relief. The court also explained that affirmative defenses can be challenged through a pretrial motion for judgment on the pleadings.

Investment Advisers Act claims

The court held that Section 215 of the Investment Advisers Act permits a contract to be declared void when the contract was illegally formed or when its required performance would violate the Act. It does not make a contract void merely because an investment adviser later engaged in disloyal or fraudulent conduct while carrying out an otherwise lawful agreement. The court therefore dismissed Two Harbors’s claims for rescission, setoff, and declaratory relief, as well as its voidness defense, to the extent they were based on alleged misconduct unrelated to illegal contract formation or required illegal performance.

The court separately ruled that Two Harbors’s challenges to the management agreement’s indemnification and termination-fee provisions and to the later amendment were time-barred. The two provisions were included when the agreement was executed in 2009, and the amendment was executed in 2014. The court rejected Two Harbors’s arguments for extending the filing period, including its argument that the plaintiffs’ executives’ management roles justified equitable tolling. Because the claims were time-barred, the court did not decide whether the provisions themselves violated the Investment Advisers Act.

Common-law and tort counterclaims

The court rejected the plaintiffs’ argument that Two Harbors’s common-law and tort counterclaims duplicated its breach-of-contract claim. At the pleading stage, the court accepted Two Harbors’s allegations that PRCM acted as its investment adviser and manager, exercised substantial discretion over its business, managed investments, ran day-to-day operations, and supplied personnel. Those allegations plausibly supported a relationship of trust and confidence that could create duties independent of the management agreement.

The court also held that Two Harbors plausibly alleged a claim under New York’s faithless-servant doctrine, which can deny compensation to an agent or employee whose disloyal conduct substantially permeated the performance of their services. The court applied the same reasoning to the claims for breach of fiduciary duty, gross negligence, fraud, negligent misrepresentation, breach of the implied covenant of good faith and fair dealing, and unjust enrichment, except for the portion of the unjust-enrichment claim based on the alleged invalidity of the management agreement.

Disposition

Judge Lewis A. Kaplan granted in part and denied in part the plaintiffs’ motion for judgment on the pleadings. The motion was granted as to Two Harbors’s Investment Advisers Act-based counterclaims and its second affirmative defense asserting that the agreement was void. It was denied as to the common-law and tort counterclaims, except that the unjust-enrichment counterclaim was dismissed to the extent it relied on the agreement’s alleged invalidity. The court denied Two Harbors’s request for leave to amend the Investment Advisers Act counterclaims and denied the request as moot as to the other counterclaims.