author: Bellacosa, J.

text:
    [674 NE2d 313, 651 NYS2d 383]
    In the Matter of the Liquidation of Union Indemnity Insurance Company of New York. Michigan National Bank-Oakland, Appellant, v American Centennial Insurance Company et al., Respondents, et al., Defendants. Edward J. Muhl, Superintendent of Insurance, as Liquidator of Union Indemnity Insurance Company of New York, Third-Party Plaintiff-Intervenor-Appellant, v American Centennial Insurance Company et al., Third-Party Defendants-Respondents, et al., Third-Party Defendants.
    Argued October 15, 1996;
    decided November 14, 1996

      POINTS OF COUNSEL

      Winthrop, Stimson, Putnam & Roberts, New York City (Leo T. Crowley and Takemi Ueno of counsel), for appellant.

      Anderson Kill & Click, P. C, New York City (R. Mark Keenan, Pablo Quinones and M. Christina Ricarte of counsel), Joseph Termini and Costigan Hargraves & McConnell (Daniel Hargraves of counsel), for third-party plaintiff-intervenorappellant.

      Rosenman & Colin, L. L. P., New York City (Lawrence I. Brandes, Nancy K. Eisner and William M. Popalisky of counsel), for Atlas Assurance Company of America and others, respondents and third-party defendants-respondents.

      Ohrenstein & Brown, LLP, New York City (Peter J. Biging and Christopher B. Hitchcock of counsel), for Philan Insurance Ltd. and another, respondents and third-party defendants-respondents.

      Whitman Breed Abbott & Morgan, New York City (Harry E. Peden, III, of counsel), and Hutchins Wheeler & Dittmar (Joseph C. Tanski, of the Massachusetts Bar, admitted pro hac vice, of counsel), for Connecticut Insurance Guaranty Association and others, amici curiae.

      Debra J. Hall and Anthony J. Mormino, of the District of Columbia Bar, admitted pro hac vice, for Reinsurance Association of America and another, amici curiae.

   OPINION OF THE COURT

Bellacosa, J.

Intervenor Superintendent of Insurance, as Liquidator, and plaintiff Michigan National Bank-Oakland respectively appeal pursuant to leave granted by this Court. The order of the Appellate Division affirmed a judgment of Supreme Court, granting the motions of defendants reinsurers for summary judgment. Their affirmative defense of fraud was upheld and rescission of their reinsurance treaties with the insolvent insurer was allowed.

These appeals, in the context of a procedurally complex reinsurance series of disputes, raise core issues whether (1) statements made by a State Liquidator’s outside counsel in a sworn affidavit in a related action, incorporating supporting documentation and evidence, constitute informal judicial admissions; (2) failure of an insolvent insurer to disclose its insolvency to a reinsurer may constitute fraud in the inducement; and (3) such an omission may constitute a valid defense to claims for enforcement of the reinsurance contracts brought by the Liquidator and the beneficiary of a surety bond, thus, justifying rescission of the reinsurance contracts.

L

On July 16, 1985, Union Indemnity Insurance Company of New York, Inc. (Union), a subsidiary of Frank B. Hall & Co., Inc. (Hall), was placed into liquidation by Supreme Court, based in part upon the finding that it was insolvent. Under Insurance Law § 7419, the court prohibited any action against the insolvent estate, represented by the Liquidator.

On September 20, 1985, Michigan National Bank-Oakland (Michigan) the beneficiary of a $2 million surety bond issued to Ginso Investment Corp. by Union, brought an action on the bond against the reinsurers (defendants-respondents American Centennial Insurance Co. et al.). The Liquidator intervened in that action, contending that the reinsurance proceeds were assets of insolvent Union and should be paid to the Liquidator directly for the benefit ultimately of all policyholders. The re-insurers counterclaimed that the reinsurance agreements had been procured by fraud in that (1) Hall operated Union for improper purposes, and (2) Union failed to disclose its insolvency.

Thereafter, the Liquidator brought a separate action, Corcoran v Hall & Co. (the Hall action), against Union’s parent company, its affiliates, Hall and Union’s officers and directors, and Hall’s outside auditors. This action asserted mismanagement, failure to disclose Union’s insolvency, breach of fiduciary duties, violations of the Insurance Law and malpractice. Various creditors of the insolvent insurer’s estate, including the reinsurer American Centennial, also filed similar complaints against the named defendants in the Hall action, which were ultimately consolidated.

The defendants in the Hall action moved to dismiss for failure of the Liquidator to plead fraud with specificity and for lack of standing, and the Liquidator cross-moved to shift the burden of proof to the defendants. Most pertinently for this appeal, defendants’ dismissal motions in the Hall action were met by the Liquidator’s affidavits of two of its outside counsel, accompanied by supporting documentation, including affidavits drafted by Union officers and directors. These filed opposition papers recorded that the Liquidator’s complaint rested on Hall’s active participation in a scheme to defraud and the allegations were based in part on findings of the Liquidator’s investigation of Union’s business practices. These motions were denied and the Appellate Division affirmed (149 AD2d 165). In June 1989, the Liquidator and all of the defendants in the Hall action agreed to settle that dispute, subject to court approval, that is still open and pending. That matter is not before us on this appeal.

In the meantime, the reinsurers in the action now appealed from moved for summary judgment, seeking rescission of their reinsurance agreements with Union. They submitted the affidavits of the Liquidator’s outside counsel in the Hall action, asserting that these proofs constituted informal judicial admissions by the Liquidator regarding Union’s fraud and failure to disclose material facts.

The Liquidator opposed this motion by submitting additional and different affidavits from those that had been submitted in the Hall action. At this juncture, the Liquidator took the position through Union’s former president and its former board chairman that Union was operated as an independent insurance company separate from Hall, and through Union’s former auditor that the transactions between Hall and Union passed muster under acceptable insurance industry standards. The Liquidator argued that because these affidavits contradicted those made by outside counsel in the Hall action, the latter should not be given conclusive effect. Additionally, the Liquidator asserted that neither set of the affidavits was based upon firsthand knowledge.

Justice Gammerman, who has presided over all phases of this complex matter for over 10 years, ruled on this motion in 1989 that the affidavits in the Hall action constituted informal judicial admissions. Thus, he granted the reinsurers’ motion for summary judgment and rescinded the reinsurance agreements. In concluding that the reinsurance treaties were void, the court stated that "[w]hat is evident from these admissions is that material omissions as well as misrepresentations occurred, that Union officers and directors were aware of the operations and financial condition of the company and that a conscious plan was in operation to utilize Union for Hall’s purposes and not run the corporation as an independent entity.” The court emphasized and relied upon the fact that it had been "conceded that had a reinsurer been aware of insolvency it certainly would not have underwritten the sum encompassed by reinsuring the bankrupt company.” The decision was amended to add another reinsurer to those entitled to this relief.

Upon motions for renewal and reargument, the court, in 1992, essentially adhered to its grant of summary judgment based on the informal judicial admissions doctrine and documentation and the fraud finding as to Union; however, it modified to the extent of technically precluding the reinsurers’ counterclaim for rescission in the form of affirmative relief, as barred by the injunction contained in the order of liquidation. Nonetheless, the court functionally rescinded and deemed the reinsurance treaties unenforceable as a result of its finding that the affirmative defense of fraud was established, thus rendering them void.

The central holding was reiterated in the 1992 decision that a " 'reinsured is obliged to disclose to potential reinsurers all material facts concerning the original risk, and failure to do so generally entitles the reinsurer to rescission of its contract’ ” (quoting Sumitomo Mar. & Fire Ins. Co. v Cologne Reins. Co., 75 NY2d 295, 303). The court further noted that "[s]olvency of the reinsured becomes an integral part of the risk undertaken and is a material fact that should be disclosed” (citations omitted). Agreeing with the reinsurers that liquidation principles do not deprive them of a defense of fraud against the Liquidator, the court, quoting Matter of Midland Ins. Co. (79 NY2d 253, 264-265), stated that " 'liquidation cannot place the liquidator in a better position than the insolvent company he takes over, authorizing him to demand that which the company would not have been entitled to prior to liquidation’ ” (citation omitted).

The Appellate Division unanimously affirmed (200 AD2d 99). After this Court dismissed leave to appeal on nonfinality grounds (84 NY2d 1026), Supreme Court severed the Liquidator’s claim for return of reinsurance premiums and dismissed the Liquidator’s claim for recovery of reinsurance proceeds. The Appellate Division affirmed and we granted leave to appeal.

The Liquidator argues that (1) the doctrine of informal judicial admissions was improperly invoked to support the admissibility of the reinsurers’ submissions, and (2) even if the reinsurers’ common-law fraud defense was proven at trial, New York’s statutory insurance liquidation scheme is exclusive and precludes the remedy of rescission "or its equivalent,” contending that the lower courts’ reliance on Midland is erroneous. Michigan, for its part, argues that (1) the judicial admissions in the Hall action were improperly admitted against it, and (2) even if Union induced the reinsurers to enter into the reinsurance treaties by fraud, that would not constitute a defense by the reinsurers to Michigan’s surety bond claims.

We are not persuaded by these contentions and affirm the order of the Appellate Division. We are satisfied that the courts below properly allowed the doctrine of informal judicial admissions to support the reinsurers’ submissions, at least as against the Liquidator. Additionally, we conclude that an insurance company’s insolvency is a material fact that must be disclosed to a potential reinsurer and that the reinsured’s failure to do so supports the voiding of the reinsurance treaties as against both the Liquidator, who assumes the role of the insolvent insurance company, and the beneficiary, which holds a bond issued by the insolvent insurer.

¡L

Informal judicial admissions are recognized as "facts incidentally admitted during the trial or in some other judicial proceeding, as in statements made by a party as a witness, or contained in a deposition, a bill of particulars, or an affidavit” (Prince, Richardson on Evidence § 8-219, at 529 [Farrell 11th ed] [citations omitted]). "A formal judicial admission in one action may become an admission in the evidentiary sense in another action, and would be classified as an informal judicial admission in the later action” (Richardson, op. cit, at 530). To be sure, they are not conclusive, though they are "evidence” of the fact or facts admitted (Richardson, op. cit., at 530). Furthermore, "[a]n admission in a pleading in one action is admissible against the pleader in another suit, provided it is shown 'by the signature of the party, or otherwise, that the facts were inserted with his knowledge, or under his direction, and with his sanction’ ” (Richardson, op. cit., at 530, quoting Cook v Barr, 44 NY 156, 158). Additionally, as Justice Gammerman correctly noted, it is irrelevant that the admissions were made in part by counsel on behalf of the Liquidator and that they were contained in affidavits or briefs (see, Matter of Home of Histadruth Ivrith v State of New York Facilities Dev. Corp., 114 AD2d 200; Yannon v RCA Corp., 100 AD2d 966; Bellino v Bellino Constr. Co., 75 AD2d 630).

The admissions made by counsel for the Liquidator and filed with supportive documentation in the Hall action documented that Union’s officers and directors made material omissions and misrepresentations regarding the operations and financial condition of the company and that a plan to utilize Union for Hall’s purposes was in operation — contrasted to running the corporation as an independent entity, as required by Insurance Law §§ 1507 and 1505. These facts are admissible against the Liquidator as informal judicial admissions.

It would be unseemly, to say the least, to permit the Liquidator to renege on its court-submitted evidence and, in effect, to use quasi-official assertions as both a sword and a shield by simultaneously documenting Union’s fraud and failure to disclose its insolvency and yet later trying to deny the relevance and applicability of the same admissions and data in an action involving the reinsurers. Moreover, the Liquidator was given full and fair opportunity to rebut the nonconclusive material, attempted to do so, and failed on the record before the nisi prius court and now the appellate courts, within our respective review powers.

Michigan, in its distinct posture, attempts to remove itself from the effect of these nonconclusive judicial admissions. It argues that the statements made by the Liquidator’s counsel constitute hearsay as applied to Michigan, and that the hearsay exception for admissions is inapplicable because hearsay statements, in any event, constitute admissions against only the person chargeable with the admission. Michigan further contends that it played no role in the underlying Hall action and, more specifically, never had an opportunity to cross-examine the declarants whose evidentiary submissions are being used as facts against it. Although Michigan finds itself caught in a procedural cross fire, its contentions inevitably fail under the circumstances presented here for a distinct reason. As a technical matter, the Liquidator’s statements in the Hall action were not admitted against Michigan, but as a practical matter, once the reinsurers established their fraud defense, effecting a void ab initio consequence on the reinsurance treaties, the reinsurance treaties and any obligation for proceeds of them legally disappeared under the interrelated circumstances of this case. Accordingly, the reinsurers were entitled to summary judgment against both parties making claims to reinsurance proceeds, including Michigan.

¡¡L

We must now turn, to the question of whether the failure of the ceding insurance company to disclose its insolvency to the potential reinsurer constitutes fraud in the inducement. Connected to this is whether such fraud will qualify as a valid defense by the reinsurers to claims for enforcement of those treaties brought by the Liquidator and the surety bond beneficiary. The bottom line is whether rescission or its functional equivalent as part of a fraud finding is a proper remedy in such a situation.

The premise of the Liquidator’s argument is that Union’s financial status during the negotiation of the reinsurance agreements is irrelevant and, therefore, proof of Union’s failure to disclose its insolvency does not support rescission. The Liquidator contends that a ceding insurance company’s insolvency, being a neutral factor, does not adversely affect re-insurers because it does not relate to the risk they undertake and underwrite; regardless of Union’s insolvency, the Liquidator asserts, the reinsurers remain liable to pay all losses reinsured. Additionally, the Liquidator argues that the duty of utmost good faith (uberrimae fidei) only mandates the disclosure of information, material to the reinsured risk, and since insolvency does not relate to the risk, disclosure is not required.

The underlying counterpoint from the reinsurers is that their reinsurance agreements are rescindable for Union’s failure to disclose its insolvency. They emphasize that Union was acquired by Hall as a loss leader for Hall’s brokerage business, hiding the fact that Hall caused Union to write bond business not acceptable to underwriting standards. The reinsurers argue that insolvency is material and its disclosure crucial, because one way to conceal insolvency is for an insurer to simply keep writing additional premiums on bad risk situations. The reinsurers further argue that the writing of substandard and underpriced risks, which were then subsumed within the reinsurance, constitutes a material fact subject to disclosure because the reinsurers’ true risks would not be generating sufficient premiums to justify such unknown exposures. The reinsurers also contend that the reinsurer has no duty to investigate such activity because the absolute duty to fully disclose the risk insured is on the primary insurer. A violation of that duty, they argue, vitiates the reinsurance. Additionally, the re-insurers assert that had they been aware of Union’s insolvency, they would not have underwritten reinsurance for it — a circumstance relied upon by the courts below and conceded by the appellants throughout — "particularly in light of the greater responsibility imposed on reinsurers by Insurance Law § 1308 in the event the ceding insurer is liquidated, whereby the reinsurer must pay the Liquidator on reinsured claims even if the Liquidator has not yet paid the policyholder” (200 AD2d, at 105).

IV.

It is useful in this part of the analysis to reference the underlying fundamental structure of the specialty law of reinsurance. Reinsurance is " 'the insurance of one insurer (the "reinsured”) by another insurer (the "reinsurer”) by means of which the reinsured is indemnified for loss under insurance policies issued by the reinsured to the public’ ” (Kramer, The Nature of Reinsurance, reprinted in Reinsurance, at 5 [Strain ed 1980]). Essentially, it is a vehicle through which insurers distribute their insurance liabilities or risks (Kramer, op. cit., at 6). There are two main forms of reinsurance: "facultative” and "treaty.” Facultative reinsurance is "a transaction between reinsurer and reinsured ceding company involving one specific policy,” whereby "the primary insurer voluntarily offers a portion of its risk” to the reinsurer, to which "the reinsurer is under no obligation to accept” (Clark, Facultative Reinsurance: Reinsuring Individual Policies, reprinted in Reinsurance, at 117 [Strain ed 1980]). In a treaty reinsurance relationship, there is "1) no individual risk scrutiny by the reinsurer, 2) obligatory acceptance by the reinsurer of covered business, and 3) a long-term relationship in which the reinsurer’s profitability is expected, but measured and adjusted over an extended period of time” (Clark, op. cit., at 121). The reinsurance agreement in the present case is the treaty type, for which the duty of disclosure is broader due to the nature of the risk involved (see, Kramer, The Nature of Reinsurance, reprinted in Reinsurance, at 10 [Strain ed 1980]).

The phrase uberrimae fidei and its translation, "of the utmost good faith,” has long been used to characterize the core duty accompanying reinsurance contracts (see, Kramer, op. cit., at 9; Reinsurance, at 665 [Strain ed 1980]; Sun Mut. Ins. Co. v Ocean Ins. Co., 107 US 485, 510; Christiania Gen. Ins. Corp. v Great Am. Ins. Co., 979 F2d 268, 278). Encompassed within this duty is a basic obligation of a reinsured to disclose to potential reinsurers all "material facts” regarding the original risk of loss, and failure to do so renders a reinsurance agreement voidable or rescindable (Sumitomo Mar. & Fire Ins. Co. v Cologne Reins. Co., 75 NY2d 295, 303, supra, citing Royal Indem. Co. v Preferred Acc. Ins. Co., 243 App Div 297, 301, affd 268 NY 566; see, Sun Mut. Ins. Co. v Ocean Ins. Co., supra, 107 US, at 510; Christiania Gen. Ins. Corp. v Great Am. Ins. Co., supra, 979 F2d, at 278; see also, Kramer, The Nature of Reinsurance, reprinted in Reinsurance, at 9 [Strain ed 1980]; Ostrager and Newman, Insurance Coverage Disputes § 16.03 [a], at 710 [8th ed 1995]). Material facts are those likely to influence the decisions of underwriters; facts which, had they been revealed by the reinsured, would have either prevented a reinsurer from issuing a policy or prompted a reinsurer to issue it at a higher premium (Christiania Gen. Ins. Corp. v Great Am. Ins. Co., supra, 979 F2d, at 278, citing Merchants & Shippers Ins. Co. v St. Paul Fire & Mar. Ins. Co., 219 App Div 636, 639; see, Sun Mut. Ins. Co. v Ocean Ins. Co., supra, 107 US, at 510). A reinsured need not possess a specific intent to conceal information from a reinsurer to make a contract voidable, rather "an innocent failure to disclose a material fact is sufficient” (Ostrager and Newman, Insurance Coverage Disputes § 16.03 [a], at 710 [8th ed 1995], citing Sun Mut. Ins. Co. v Ocean Ins. Co., supra, 107 US, at 510). Additionally, " '[t]here is no principle of imputed knowledge of facts material to the risk that the reinsurer is asked to assume’ ” (Ostrager and Newman, Insurance Coverage Disputes § 16.03 [a], at 711 [8th ed 1995], quoting A/S Ivarans Rederei v Puerto Rico Ports Auth., 617 F2d 903, 905 [1st Cir 1980]). Rather, when a ceding insurer has knowledge of circumstances that would influence a reinsurer’s underwriting decision, in compliance with and in preservation of principles of utmost good faith, a ceding insurer is required to disclose all such circumstances (Ostrager and Newman, op. cit., § 16.03 [a], at 711).

While the general proposition that all material facts to a contract for reinsurance must be disclosed is well settled, the specific question whether insolvency constitutes a material fact in the reinsurance context is more nuanced and open. Our precedents in this more indefinite aspect of highly regulated law are sparse. Yet, this Court has applied the general principles of good faith and disclosure devolved from reinsurance jurisprudence and has resolved a related and relevant issue in Sumitomo Mar. & Fire Ins. Co. v Cologne Reins. Co. (75 NY2d 295, supra). In Sumitomo, the defendants reinsurers argued that their agreement to reinsure the plaintiff ceding insurance company, a "facultative” reinsurance agreement, was voidable at the outset based upon plaintiff’s failure to disclose to the reinsurers its extension of coverage to incidental nuclear damage. This Court stated that "[a] reinsured is obliged to disclose to potential reinsurers all 'material facts’ concerning the original risk, and failure to do so generally entitles the reinsurer to rescission of its contract” (Sumitomo Mar. & Fire Ins. Co. v Cologne Reins. Co., supra, 75 NY2d, at 303 [citations omitted]). Furthermore, we held that disclosure is required "[w]here the reinsured has offered extended coverage or an unusual term * * * that is a material fact which, if not disclosed, would render a reinsurance agreement voidable” (id., at 303). The Court’s expression there regarding the reinsured’s duty to disclose material facts finds apt application and transference here. Insolvency, not unlike extended coverage or an unusual term, has a potent potential impact on the reinsurers’ risk sufficient to trigger the uberrimae fidei obligation for disclosure.

V.

We do not accept the Liquidator’s contention that New York’s insurance liquidation scheme precludes the reinsurers’ defense of fraud and entitlement to the rescission remedy. Over 40 years ago, in Bohlinger v Zanger (306 NY 228), this Court concluded that "[liquidation does not change the situation and the liquidator should not and may not be placed in a better position than the company he takes over and demand that which it is not owed” (id., at 234). More recently, in Matter of Midland Ins. Co. (79 NY2d 253, supra), pointedly relied upon by the Appellate Division in resolving this very case now on appeal, this Court held that a reinsurer could offset the proceeds it owed an insolvent ceding insurer under a reinsurance contract against amounts the insolvent insurer owed the reinsurer for premiums under a separate and distinct contract. The Court rejected the defendant’s argument that the liquidation order created a special category of obligation regarding the reinsurance proceeds, which ran directly to the Liquidator and not to the insolvent insurer. The Court reasoned that "liquidation cannot place the liquidator in a better position than the insolvent company he takes over, authorizing him to demand that which the company would not have been entitled to prior to liquidation” (Matter of Midland, supra, 79 NY2d, at 264-265, citing Bohlinger v Zanger, 306 NY 228, 234 [citations omitted]).

The Liquidator argues, nevertheless, that the lower courts overextended this Court’s holding in Midland because the liquidation scheme’s statutory right of offset is fundamentally different from "the non-statutory remedy of rescission” or its functional equivalent. We are satisfied the Appellate Division correctly reasoned that "[w]hile Midland involved an interpretation of the statutory defense of setoff (Insurance Law § 7427), as opposed to the common-law defense of fraud, that decision should be extended to apply to the situation at bar in light of the policy of preserving preliquidation rights inasmuch as the defense of fraud in the inducement and the equitable rescission of a contract due to fraud are declarations that the contract was void ab initio” (200 AD2d, supra, at 107, citing Stephens v American Home Assur. Co., 811 F Supp 937, 946-948 [SD NY 1993], vacated and remanded on other grounds 70 F3d 10 [2d Cir 1995], citing Christiania Gen. Ins. Corp. v Great Am. Ins. Co., 979 F2d 268, 278, supra; Eastern Dist. Piece Dye Works v Travelers Ins. Co., 234 NY 441).

Notably, the District Court in Stephens v American Home Assur. Co. (811 F Supp 937 [SD NY 1993], supra, vacated and remanded on other grounds 70 F3d 10 [2d Cir 1995]), recently addressed the issue of whether the insolvency of an insurance company renders the remedy of rescission or the defense of fraud or both unavailable as a matter of New York law (811 F Supp, at 947). It relied on Sumitomo, Midland and the instant case as decided up to the point at the Appellate Division stage to conclude that fraud and rescission were not foreclosed. The court stated that "[t]he general rule is that a liquidator of an insurance company 'stands in the shoes’ of the insolvent, gaining no greater rights than the insolvent had” (Stephens, supra, 811 F Supp, at 947, citing Bohlinger v Zanger, 306 NY 228, supra). The court reasoned that "absent specific law to the contrary, 'the reinsurers are free to assert any affirmative defenses, such as fraud, that they may have had against the [insolvent company]” (Stephens, supra, 811 F Supp, at 947, quoting Matter of Union Indem. Ins. Co., Sup Ct, NY County, Oct. 28, 1992, Gammerman, J., index No. 41292-85). Analyzing Midland, the court stated that "[w]hile Midland was an interpretation of a statutory defense of setoff, see, N. Y. Ins. Law § 7427, as opposed to the common law defense of fraud or remedy of rescission, the analysis of the Court of Appeals is distinctly relevant” (Stephens, supra, 811 F Supp, at 947). Finally, the District Court concluded that the "New York courts have been strongly supportive of preserving rights which existed prior to liquidation proceedings [and] [a]s illustrated by Union Indemnity, the defense of fraud and the remedy of rescission for fraudulent inducement are included in this protection,” regardless of insolvency proceedings (Stephens, supra, 811 F Supp, at 948).

Additionally, the reinsurers’ defense of fraud was properly asserted against Michigan. Although Insurance Law § 4118 (a) (1) (A) requires the reinsurance agreement between the insurers to provide Michigan with a direct right of action against the reinsurers, nonetheless, as the Appellate Division correctly concluded, applying general principles of contract law, "inasmuch as the reinsurance treaties relied upon have been found to be void ah initio as the result of Union Indemnity’s fraud, Michigan, as an insured stands in no better position than its now defunct insurer Union Indemnity” (200 AD2d 99, 108, supra).

In sum, the reinsurers’ defense of fraud in the inducement is properly upheld along with the voiding of the reinsurance treaties in this case. Insolvency is a material fact, of which disclosure for reinsurance is required under governing precedents and principles, including uberrimae fidei.

Accordingly, the order of the Appellate Division should be affirmed, with costs.

Chief Judge Kaye and Judges Simons, Titone, Smith and Ciparick concur; Judge Levine taking no part.

Order affirmed, with costs.


source: Caselaw Access Project

author: Bbllacosa, J. Simons, J.

license: Public Domain

text:
    [674 NE2d 322, 651 NYS2d 392]
    The People of the State of New York, Respondent, v Stephanie Wernick, Appellant.
    Argued October 17, 1996;
    decided November 21, 1996

      POINTS OF COUNSEL

      Stephen P. Scaring, P. C., Garden City (Stephen P. Scaring and Susan C. Carman of counsel), for appellant.

      Denis Dillon, District Attorney of Nassau County, Mineóla (Margaret E. Mainusch and Peter A. Weinstein of counsel), for respondent.
   OPINION OF THE COURT

Bbllacosa, J.

Defendant appeals from an order of the Appellate Division, which affirmed a judgment of County Court, Nassau County, convicting her, after a jury trial, of criminally negligent homicide of her newborn infant. The dissenting Justice at the Appellate Division granted permission to appeal, and we now affirm.

The primary issue, as it has evolved, is whether CPL 60.55 (T) automatically obviates the need for a Frye hearing in this case. We must determine whether the trial court erred as a matter of law when it precluded, without a reliability assessment, reference by expert opinion witnesses to publications of others concerning profiles of a novel neonaticide "syndrome,” proposed in support of the defendant’s affirmative defense of insanity. Appellant also argues that the trial court deprived her of a fair trial by admitting a photograph of the deceased infant.

Upon giving unattended birth to a baby boy in the bathroom of a college dormitory, defendant asphyxiated the infant and secured a friend’s unwitting assistance in disposing of the body. Defendant was charged with first and second degree manslaughter.

Before the trial commenced, the People requested that the trial court conduct a Frye hearing to determine the admissibility of the defense experts’ expected testimony on neonaticide, a term used to describe a mother killing her newborn within 24 hours of birth. The People argued that defendant was required to establish the scientific reliability of neonaticide as a psychological syndrome if such evidence were to be accepted. Defense counsel specifically objected to a Frye hearing, stating that he had no intention of presenting neonaticide as a syndrome. County Court denied the People’s request for a Frye hearing, stating that it would make specific evidentiary rulings regarding the expert’s testimony as the trial progressed. The court cautioned, however, that it would be unable to rule on syndrome evidence without a hearing.

On her affirmative defense of insanity, defendant presented expert testimony which tended to establish that (1) she completely denied the existence of her pregnancy, (2) such denial occurs in almost all cases in which women kill their newborn infants immediately after birth, ánd (3) in a large number of those cases the women believed that they were not pregnant. Defense experts also testified that, upon giving birth, defendant suffered from a brief reactive psychosis because she was no longer able to deny her pregnancy. The trial court permitted all this testimony but precluded defendant’s expert witnesses only from additionally describing a profile of the symptoms of women who have killed their children under similar circumstances. Defendant objected to the limitation, arguing that CPL 60.55 (1) permits a psychiatric expert to testify as to the basis of an opinion in connection with an insanity claim and restricts courts from discretely evaluating the appropriateness of the basis of an expert’s opinion.

The Appellate Division, with one Justice dissenting, affirmed defendant’s conviction of criminally negligent homicide (215 AD2d 50). The Court reasoned that "[bjefore an expert may testify about the existence of a mental disease or syndrome, the party seeking the introduction of such testimony must establish that the disease or syndrome is generally accepted in the field of psychiatry or psychology and that it would assist the jury in rendering a verdict” (id., at 52, citing People v Taylor, 75 NY2d 277, 287-292; People v Weinstein, 156 Misc 2d 34, 42-43; Frye v United States, 293 F 1013). The Court further held that the trial court’s ruling did not violate CPL 60.55 (1) because the court did not preclude defendant’s experts from referring to relevant literature or their own relevant experiences with other patients regarding neonaticide, but rather prohibited defendant’s experts only from additionally setting up a specific psychiatric profile of women who kill their newborns (215 AD2d, at 53-54). Finally, it found no error with respect to the admission of the photograph. The dissenting Justice voted to reverse the defendant’s conviction and to remit the matter for a Frye hearing and a new trial (id., at 54).

Defendant argues for reversible error and a new trial because of the trial court’s refusal to allow her psychiatric experts to explain their reliance upon out-of-court scientific evidence. Specifically, she contends that defense experts had no intention of testifying that she was suffering from neonaticide syndrome, as such and in that precise terminology. Such testimony, she concedes, would be inadmissible because the neonaticide syndrome has not been classified as an illness. To the contrary, defendant’s lawyer argues, the defense experts sought to utilize the clinical experience of various doctors to support their expert opinions that defendant suffered from a brief reactive psychosis; that their proffered testimony was introduced to explain a diagnosis and not to establish a fact. Defendant asserts that she merely attempted to show that clinical studies have established patterns of conduct of young women, reflecting certain similar characteristics, who have suffered from a genuine pathological denial of their pregnancies and subsequently killed their newborns immediately after birth.

Defendant’s contentions are not persuasive in the factual and procedural construct of this case. Regardless of whether defense counsel classified its proffered evidence as an attempt to establish a "pattern,” "profile,” "theory” or "syndrome,” and regardless of whether defendant used the term "neonaticide syndrome,” the essential defense theory was an attempt to portray a pattern of behavior not generally recognized in the relevant medical context and community. No threshold evidentiary foundation whatsoever was offered that acknowledged the validity or existence of defense counsel’s postulate to warrant these experts using this kind of extrapolated material to bolster their expert opinions. Yet, defendant’s theory — at best, a novel hypothesis and the product of a refined strategy — was presented for the jury’s consideration by way of the experts’ opinions. The only point of contention is the exclusion of additional improper bolstering based on outside influences and references that we agree should be subject to a reliability hearing under such circumstances as are proffered in this case. The strategic avoidance by the defense of this very procedural safeguard is not without its own significance in this regard.

This Court has often endorsed and applied the well-recognized rule of Frye v United States (293 F 1013, supra; but see, Daubert v Merrell Dow Pharms., 509 US 579; Fed Rules Evid, rule 702). That protocol requires that expert testimony be based on a scientific principle or procedure which has been " 'sufficiently established to have gained general acceptance in the particular field in which it belongs’ ” (People v Wesley, 83 NY2d 417, 423, quoting Frye v United States, supra, at 1014). Specifically, in People v Wesley, we noted that novel scientific evidence, such as DNA evidence, requires a determination as to its reliability (People v Wesley, supra, at 422). In People v Taylor (75 NY2d 277, supra), we concluded "that the relevant scientific community has generally accepted that rape is a highly traumatic event that will in many women trigger the onset of certain identifiable symptoms” (id., at 286). We, thus, held expert testimony describing rape trauma syndrome admissible when "offered to explain behavior that might appear unusual to a lay juror not ordinarily familiar with the patterns of response exhibited by rape victims” (id., at 293 [emphasis added]).

The Legislature has, to be sure, expressed a threshold of admissibility for when defendants assert the affirmative defense of insanity. CPL 60.55 (1) provides that a psychiatrist or licensed psychologist, testifying to a defendant’s mental condition at the time of an offense charged, "must be permitted to make any explanation reasonably serving to clarify his [or her] diagnosis and opinion.” This section was enacted to modify the common-law rule — otherwise known as the Keough rule (People v Keough, 276 NY 141, 145) — that limited the expression of expert foundation testimony to facts in evidence and personal observation and examination of the defendant (Preiser, Practice Commentaries, McKinney’s Cons Laws of NY, Book 11 A, CPL 60.55 [1], at 147).

This Court has analyzed the effects of CPL 60.55 on this common-law restriction, specifically discussing the legislative purposes behind its enactment, which our ruling in no way undermines as the dissent contends. In People v Stone (35 NY2d 69), we considered the issue of whether a psychiatric expert may testify as to reliance on out-of-court evidence— extrajudicial statements — despite the traditional common-law limitation (id., at 74, citing People v Keough, 276 NY 141, supra). The Court stated that CPL 60.55 "represents an effort by the Legislature to strike a balance between the potentially conflicting factors [of] * * * the medical soundness and legal admissibility of a psychiatrist’s expert opinion” (People v Stone, supra, at 75). Although in Stone the Court permitted the expert testimony, importantly "the court ha[d] reasonably assured itself of a legally competent basis for the psychiatrist’s opinion” (id., at 75).

Thereafter, in People v Sugden (35 NY2d 453), .this Court confronted the issue of whether an expert opinion may be based on an out-of-court written statement of a witness who testified at trial (id., at 456). The Court stated that Stone "reflect[s] to some degree a policy which would allow an expert to base his opinion on material not in evidence, provided the data relied upon is of the kind ordinarily accepted by experts in the field” (id., at 459 [emphasis added]). The Court concluded that a psychiatrist may refer to out-of-court evidence under two circumstances: when the evidence "is of a kind accepted in the profession as reliable in forming a professional opinion,” and when it "comes from a witness subject to full cross-examination on the trial” (id., at 460-461). A per se admissibility authorization would eliminate these important threshold safeguards built into the rule by our precedents.

Recently, in People v Angelo (89 NY2d 217), this Court considered whether a psychiatric expert may testify to reliance on a polygraph examination of the defendant. While CPL 60.55 was inapplicable because the defendant had not asserted an insanity defense, we observed that the exceptions to the common-law rule discussed in People v Sugden permitting an expert to base an opinion on out-of-court evidence under certain conditions, "specifically incorporate the customary admissibility test for expert scientific evidence — which looks to general acceptance of the procedures and methodology as reliable within the scientific community” {People v Angelo, supra, at 222-223 [emphasis added] [citations omitted]). That is the apt reliance which we give to our recent unanimous utterance.

Our principal controlling precedents regarding the application of CPL 60.55 (1) highlight this Court’s consistent policy that evidence offered by a psychiatric expert be of a kind established as generally accepted in the profession as reliable (People v Sugden, 35 NY2d 453, supra; People v Stone, 35 NY2d 69, supra). CPL 60.55 (1) does not overrule the reliability need for a Frye or Frye-like hearing in all instances when a party seeks to present novel scientific or psychiatric or medical evidence. The Legislature neither expressly nor impliedly enacted such a comprehensive change. Its intent to retain some reliability requirement in CPL 60.55 (1) is reflected in our controlling precedents and is further evidenced by the statute’s reasonableness component — requiring that a psychiatric expert "be permitted to make any explanation reasonably serving to clarify his [or her] diagnosis and opinion” (emphasis added).

In sum, the trial court did not err in narrowly precluding only the ultimate, bottom-line expert testimony of neonaticide syndrome — even if the precise words were going to be deftly and strategically avoided. The experts should not have been allowed to parade before the jury nontestifying experts’ publications about a theoretical profile, without a reliability foundation being satisfied at the threshold. We are satisfied that trial courts under a proper application of CPL 60.55 (1) should retain some measure of authority to examine such potentially unreliable and prejudicial evidence before automatically allowing its admission before the jury for its weight assessment.

Finally, based on our precedents, we agree with the Appellate Division that the trial court did not deprive defendant of a fair trial by admitting the photograph of the deceased infant into evidence; moreover, the argument as to the sentence is beyond our review.

Accordingly, the order of the Appellate Division should be affirmed.

Simons, J.

(dissenting). CPL 60.55 provides a narrow exception for the introduction of hearsay evidence when the defendant asserts an affirmative defense based upon mental disease or defect. In such cases any psychiatrist or psychologist who has examined the defendant and offers an opinion on defendant’s mental capacity at the time of the crime "must be permitted to make any explanation reasonably serving to clarify his diagnosis and opinion” (CPL 60.55 [1] [emphasis added]). The exception applies whether the expert testifies for the People or the defendant. The statute was enacted to provide a broad rule of admissibility for expert testimony in the narrow circumstances it addresses (see, Preiser, Practice Commentaries, McKinney’s Cons Laws of NY, Book 11 A, CPL 60.55, at 147), one that is far less stringent than the common-law reliability test.

The majority would undermine the legislative purpose by holding that before an expert can refer to various psychiatric conditions discussed in the scientific literature used to inform his or her opinion, those conditions must be generally accepted by the scientific community to a degree satisfying the test for admissibility set forth in Frye v United States (293 F 1013). However, admissibility must be determined by the context and purpose of the expert testimony, not the substance of the evidence. If the evidence is offered by an expert testifying in support of the affirmative defense, and if it reasonably serves to clarify the expert’s opinion or diagnosis, it should be admitted even if the substance of it has not attained general acceptance in the relevant scientific community. It is then for the jury to determine the weight to be accorded the expert’s opinion after hearing the basis for it. Because I believe the neonaticide evidence reasonably served to clarify the experts’ opinions in this case, I dissent.

I agree with the majority that our law generally requires application of the Frye standard to determine the admissibility of an expert’s testimony regarding a novel scientific principle or procedure (see, majority opn, at 115). The Frye test, however, is a test of admissibility. It ensures that the evidence presented to the jury to establish relevant scientific facts is reliable. For example, in People v Wesley (83 NY2d 417) the People used a novel scientific test — DNA profiling — to identify the DNA in bodily fluids obtained from various items of evidence and those facts were used to establish defendant’s identity as the perpetrator. The Frye test was applied to ensure that the DNA tests were reliable means of identifying characteristics of bodily fluids. Similarly, in People v Taylor (75 NY2d 277) an expert, who had not examined the witness and was not testifying about her behavior as such, testified that there exists a rape trauma syndrome and described what it is. Those facts were then used by the People as affirmative evidence to establish the reasonableness of the rape victim’s conduct which, to the lay jury, might seem inconsistent with the behavior one might expect of a rape victim. The evidence in Taylor was offered to negate the inference that the victim had consented, and the Frye test was applied to determine whether the rape trauma syndrome evidence was reliable.

As these decisions demonstrate, the Frye test is generally applied to determine the admissibility of a novel scientific principle or procedure when the scientific evidence derived from the novel procedure or principle is itself offered as proof (see, People v Middleton, 54 NY2d 42, 49-50 [scientific evidence from bite marks on victim’s body]; People v Allweiss, 48 NY2d 40, 50 [hair found at crime scene]; People v Henson, 33 NY2d 63, 73-74 [battered child syndrome; used to establish that injuries were not accidental and were sustained at the hands of parents]; cf., People v Angelo, 89 NY2d 217 [polygraph evidence not admissible to negate the necessary mens rea element of offenses charged]; People v Leone, 25 NY2d 511 [polygraph]; People v Williams, 6 NY2d 18, cert denied 361 US 920 [theory that heroin addicts were generally not credible could not be used to challenge witness’s credibility]).

The evidence authorized by CPL 60.55 (1) is offered for a very different reason: to explain the basis for the expert’s diagnosis and opinion. The section was enacted to relax the common-law rules of admissibility when: (1) an expert who has examined the defendant; (2) offers an opinion of the defendant’s mental condition at the time of the crime; (3) in support of the affirmative defense of mental disease or defect. This narrow statutory exception was thought necessary to permit the psychiatric expert to refer to and explain sources of relevant background information commonly used and necessary in forming a medical judgment. The statute was designed to permit a psychiatrist to give the basis for his or her opinion because preventing the expert from doing so vastly limits the value of psychiatric evidence (see, Matter of Lee v County Ct., 27 NY2d 432, 441; see also, Preiser, Practice Commentaries, McKinney’s Cons Laws of NY, Book 11A, CPL 60.55, at 147; Comment to Model Penal Code § 4.07 [4]). It was enacted to overcome the constricting common-law rule set forth in People v Keough (276 NY 141) and to permit experts to tell the jury that the opinion it is asked to evaluate is based on matters that experts in the field usually rely upon, even though some of the items considered are not in evidence. The statute accommodates two potentially conflicting concerns — the medical soundness of the expert’s testimony and legal admissibility of expert opinion— and strikes a balance between them (People v Stone, 35 NY2d 69, 75). It permits otherwise inadmissible evidence to be received but explicitly provides that the expert may be cross-examined as to "any matter bearing on his competency or credibility or the validity of his diagnosis or opinion” (CPL 60.55 [1]).

The purpose of expert opinion evidence is to inform the jury on scientific matters about which they have no knowledge. In the specific context of the affirmative defense, the experts are trying to explain to lay jurors how they could determine retrospectively what defendant’s mental state or condition was at the time of the crime when they did not observe her condition then. Mental disease is a highly complex area in which diagnosis depends heavily on subjective judgments. The Legislature has recognized that when a defendant asserts an affirmative defense based on mental disease it is important for the jury to be fully informed about the basis for the psychiatrist’s opinion so that it may evaluate it. If the expert’s diagnosis and opinion are based on theories that are of questionable validity (and therefore inadmissible under the Frye standard), the opposing party may challenge the medical soundness of the theory informing the expert’s opinion, and "[t]he jury may then take the opinion for what they think it is worth” (People v Stone, supra, 35 NY2d, at 76).

Thus, in People v Stone (supra) and People v Sugden (35 NY2d 453) — our only controlling precedents in this context— psychiatrists who had examined defendants were permitted to refer to extrajudicial hearsay statements that would ordinarily have been inadmissible because of their inherent unreliability. The evidence was admissible under the circumstances because it was information upon which the experts relied and was presented solely to explain the basis for their opinions that the defendants were legally sane when they committed their crimes. Similarly, in this case defendant’s experts were not trying to establish that, the scientific community generally recognizes a neonaticide syndrome. They were attempting to testify that some women suffered from similar symptoms and that they had used that information when making a diagnosis, along with the patient’s history, their examination findings and interviews with those who could shed light on defendant’s condition. That this neonaticide information may háve been unreliable or the doctors foolish to rely upon it was a matter of weight not admissibility.

To be sure, the court may, in its discretion, foreclose the use of such testimony because the witness’ reliance is unreasonable under the circumstances. It cannot, however, bar the testimony as a matter of law because it does not meet the reliability standard of Frye. The statutory provision speaks of "reasonableness”, nothing more, and manifestly, it is reasonable for a psychiatrist to consider scientific theories which have yet to attain general acceptance.

After examining defendant, the experts diagnosed her as having suffered a reactive psychosis at the time of the homicide, and they offered their opinions that at that time she was unable to appreciate the consequences and wrongful nature of her actions. The experts established the necessary foundation for their opinions by detailing their personal examinations of defendant and their investigation of her conduct and emotionality over a period of time (see, People v Stone, supra, 35 NY2d, at 73, 76). They should also have been permitted to explain how that evidence assisted them in concluding that defendant suffered a psychotic break at the time of the homicide by reference to articles they had studied in the medical literature which discussed other psychiatrists’ experience with women whose circumstances and conduct were similar. The experts testified that it is common in their field to draw on colleagues’ experiences, and the materials on which they relied were facially reasonable because they were written by legitimate practitioners and published in recognized medical journals. The evidence was thus "data * * * of the kind ordinarily accepted by experts in the field” (People v Sugden, supra, 35 NY2d, at 459) and under provisions of the statute the psychiatrists "must be permitted” to present it in reasonable explanation of their opinion. The Court’s failure to allow them to do so here violated CPL 60.55 (1). Defendant’s experts were precluded from fully explaining the basis for their opinions and the jury was precluded from fully evaluating the opinions. Accordingly, defendant’s presentation of her affirmative defense was compromised and reversal is required.

Chief Judge Kaye and Judges Titone, Smith, Levine and Ciparick concur with Judge Bellacosa; Judge Simons dissents and votes to reverse in a separate opinion.

Order affirmed.

       The majority’s reliance on People v Angelo (88 NY2d 217, supra) is not in point. Defendant in that case did not assert an affirmative defense of insanity and therefore was not entitled to the liberal rule of admissibility CPL 60.55 (1) permits.


author: Chief Judge Kaye.

text:
    [674 NE2d 663, 651 NYS2d 954]
    Tekni-Plex, Inc., Respondent, v Meyner and Landis, a New Jersey Partnership, Appellant. Tekni-Plex, Inc., Respondent, v Tom Y. C. Tang, Appellant.
    Argued September 4, 1996;
    decided October 22, 1996

      POINTS OF COUNSEL

      Geoffrey C. Hazard, Jr., of the Pennsylvania Bar, admitted pro hac vice, for appellant in the first and second above-entitled actions; Meyner and Landis (Cynthia Brooks, of the New Jersey Bar, admitted pro hac vice, of counsel), appellant pro se in the first above-entitled action; and Curtis, Mallet-Prevost, Colt & Mosle, New York City (Turner P. Smith of counsel), for appellant in the second above entitled action.

      Richards Spears Kibbe & Orbe, New York City (Linda Imes and Adam D. Mitzner of counsel), and Bruce A. Green for respondent in the first and second above-entitled actions.
   OPINION OF THE COURT

Chief Judge Kaye.

Central to this appeal, involving a dispute over a corporate acquisition, are two questions. First, can long-time counsel for the seller company and its sole shareholder continue to represent the shareholder in the dispute with the buyer? And second, who controls the attorney-client privilege as to premerger communications? We conclude that counsel should step aside, and that the buyer controls the privilege as to some, but not all, of the pre-merger communications.

A. Facts

Tekni-Plex, Inc., incorporated under the laws of Delaware in 1967, manufactured and packaged products for the pharmaceutical and other industries. For nearly 20 years, from 1967 to 1986, Tekni-Plex had 18 shareholders and was managed by a five-member Board of Directors. Appellant Tom Y. C. Tang was both a director and a shareholder of the company.

In 1986, Tang became the sole shareholder of Tekni-Plex. From that time until the corporation’s sale in 1994, Tang was also the president, chief executive officer and sole director of Tekni-Plex.

Appellant Meyner and Landis (M&L), a New Jersey law firm, was first retained as Tekni-Plex counsel in 1971. During the ensuing 23 years, M&L represented Tekni-PIex on various legal matters, including environmental compliance. As the record indicates, M&L in the mid-1980’s assisted Tekni-PIex in securing an environmental permit for the operation of a laminator machine at its Somerville, New Jersey, plant. Similarly, the law firm apparently assisted the company in an investigation by the New Jersey Department of Environmental Protection into Tekni-Plex’s compliance with environmental laws. Additionally, during this period M&L represented Tang individually on several personal matters.

In March 1994, Tang and Tekni-PIex entered into an Agreement and Plan of Merger (the Merger Agreement) with TP Acquisition Company (Acquisition), whereby Tang sold the company to Acquisition for $43 million. M&L represented both Tekni-PIex and Tang personally. The two instant lawsuits grow out of that transaction.

Acquisition was a shell corporation created by the purchasers solely for the acquisition of Tekni-PIex. Under the Merger Agreement, Tekni-PIex merged into Acquisition, with Acquisition the surviving corporation, and Tekni-PIex ceased its separate existence. Tekni-PIex conveyed to Acquisition all of its tangible and intangible assets, rights and liabilities. Acquisition in return paid Tang the purchase price "in complete liquidation of Tekni-PIex,” and all of Tang’s shares in Tekni-PIex — the only shares outstanding — were canceled.

The Merger Agreement contained representations and warranties by Tang concerning environmental matters, including that Tekni-PIex was in full compliance with all applicable environmental laws and possessed all requisite environmental permits. It further provided for indemnification of Acquisition by Tang for any losses incurred by Acquisition as the result of misrepresentation or breach of warranty by either Tang or Tekni-PIex. Acquisition, in turn, agreed to indemnify Tang and Tekni-PIex for any similar losses suffered by them.

Following the transaction, Acquisition changed its name to "Tekni-PIex, Inc.” (new Tekni-PIex). In June 1994, new Tekni-PIex commenced an arbitration against Tang, alleging breach of representations and warranties contained in the Merger Agreement regarding the former Tekni-Plex’s (old Tekni-PIex) compliance with environmental laws.

Among other things, new Tekni-PIex claimed that Tang falsely represented that a laminator machine at the Somerville facility did not emit volatile organic compounds (VOCs). New management, however, allegedly learned that the machine did indeed emit VOCs into the air. New Tekni-Plex further claimed that the permit for the laminator machine had been obtained on the false premise that it did not emit VOCs and that VOC emissions were therefore not authorized. New Tekni-Plex also contended that Tang and old Tekni-Plex had taken steps to conceal from Acquisition the emission of VOCs at the Somerville facility.

Tang retained M&L to represent him in the arbitration. New Tekni-Plex moved to disqualify the law firm from representing Tang, but the arbitrator concluded that he lacked authority to rule on the motion. New Tekni-Plex then moved by order to show cause in Supreme Court for an order disqualifying M&L. By separate order to show cause in Supreme Court, new Tekni-Plex moved for an order against M&L (1) enjoining the law firm from representing Tang in any action against new Tekni-Plex, (2) enjoining M&L from disclosing to Tang any information obtained from old Tekni-Plex, and (3) ordering M&L to return to new Tekni-Plex all of the files in the law firm’s possession concerning its prior legal representation of old Tekni-Plex. Tang and M&L each cross-moved for orders dismissing the complaints on the ground that there was another action pending in New Jersey.

Supreme Court concluded that New York was the proper forum for resolution of the disqualification issue and that the arbitrator’s conclusion that he did not have authority to decide the issue was proper. The court held that M&L should be disqualified from representing Tang in the arbitration. It further enjoined M&L from representing Tang in the arbitration, enjoined M&L from disclosing to Tang any information obtained from old Tekni-Plex, and directed M&L to return to new Tekni-Plex all of the files in M&L’s possession concerning its prior representation of old Tekni-Plex. Finally, the court denied both cross motions to dismiss. The Appellate Division affirmed.

We agree with the courts below that, in the circumstances presented, M&L should be disqualified from representing Tang in the arbitration. As for confidential communications between old Tekni-Plex and M&L generated during the law firm’s prior representation of the corporation on environmental compliance matters, authority to assert the attorney-client privilege passed to the corporation’s successor management. Moreover, because the record fails to establish that M&L also represented Tang individually on these matters, the exception to the privilege for co-clients who subsequently become adversaries in litigation is inapplicable. Thus, the Appellate Division correctly concluded that M&L should be enjoined from disclosing the substance of these communications to Tang and directed the law firm to return the files relating to this representation to new Tekni-Plex.

New Tekni-Plex, however, does not control the attorney-client privilege with regard to discrete communications made by either old Tekni-Plex or Tang individually to M&L concerning the acquisition — a time when old Tekni-Plex and Tang were joined in an adversarial relationship to Acquisition. Consequently, new Tekni-Plex cannot assert the privilege in order to prevent M&L from disclosing the contents of such communications to Tang. Nor is new Tekni-Plex entitled to the law firm’s confidential communications concerning its representation of old Tekni-Plex with regard to the acquisition.

B. The Applicable Ethics Principles

Attorneys owe fiduciary duties of both confidentiality and loyalty to their clients (see, Solow v Grace & Co., 83 NY2d 303, 306). The Code of Professional Responsibility thus imposes a continuing obligation on attorneys to protect their clients’ confidences and secrets. Even after representation has concluded, a lawyer may not reveal information confided by a former client, or use such information to the disadvantage of the former client or the advantage of a third party (Code of Professional Responsibility DR 4-101 [B] [22 NYCRR 1200.19 (b)]; see also, Code of Professional Responsibility DR 5-108 [A] [2] [22 NYCRR 1200.27 (a) (2)]). An attorney, moreover, "must avoid not only the fact, but even the appearance, of representing conflicting interests” (Cardinale v Golinello, 43 NY2d 288, 296; see also, Code of Professional Responsibility Canon 9).

In accordance with these duties, the Code precludes attorneys from representing interests adverse to a former client on matters substantially related to the prior representation. This ethical proscription is set forth in DR 5-108 as follows:

"A Except with the consent of a former client after full disclosure a lawyer who has represented the former client in a matter shall not:
"1. Thereafter represent another person in the same or a substantially related matter in which that person’s interests are materially adverse to the interests of the former client” (22 NYCRR 1200.27 [a] [1]).

Under DR 5-108 (A) (1), a party seeking disqualification of its adversary’s lawyer must prove: (1) the existence of a prior attorney-client relationship between the moving party and opposing counsel, (2) that the matters involved in both representations are substantially related, and (3) that the interests of the present client and former client are materially adverse (see, Solow v Grace & Co., 83 NY2d at 308). Satisfaction of these three criteria by the moving party gives rise to an irrebuttable presumption of disqualification (id., at 309).

This rule of disqualification fully protects a client’s secrets and confidences by preventing even the possibility that they will subsequently be used against the client in related litigation. This prophylactic measure thus frees clients from apprehension that information imparted in confidence might later be used to their detriment, which, in turn, "fosters the open dialogue between lawyer and client that is deemed essential to effective representation” (Spectrum Sys. Intl. Corp. v Chemical Bank, 78 NY2d 371, 377).

By mandating disqualification irrespective of any actual detriment — that is, "even when there may not, in fact, be any conflict of interest” — the rule also avoids any suggestion of impropriety on the part of the attorney (Solow v Grace & Co., 83 NY2d at 309; see also, Cardinale v Golinello, 43 NY2d at 296). This not only preserves the client’s expectation of loyalty but also promotes public confidence in the integrity of the Bar. Finally, the bright line rule provides a clear test that is easy to apply, thereby allowing self-enforcement among members of the Bar (Solow v Grace & Co., 83 NY2d at 309, supra).

Notwithstanding these important concerns, we have recognized significant competing interests inherent in attorney disqualification cases. Disqualification of counsel conflicts with the general policy favoring a party’s right to representation by counsel of choice, and it deprives current clients of an attorney familiar with the particular matter (see, id., at 309-310; S & S Hotel Ventures Ltd. Partnership v 777 S. H. Corp., 69 NY2d 437, 443). Disqualification motions, unfortunately, have also been used as a litigation tactic to gain strategic advantage over an adversary (see, S & S Hotel Ventures Ltd. Partnership v 777 S. H. Corp., 69 NY2d at 443, supra).

Thus, in assessing whether the moving party has met its burden of satisfying each of the three requirements for disqualification under DR 5-108, courts should avoid mechanical application of blanket rules. Rather, the three pivotal inquiries — whether there exists a prior attorney-client relationship, a substantial relationship between the representations and adversity of interests — require careful appraisal of the interests involved. Only where the movant satisfies all three inquiries does the irrebuttable presumption of disqualification arise (see, Solow v Grace & Co., 83 NY2d at 313).

C. Disqualification of Counsel

New Tekni-Plex, as the party seeking M&L’s disqualification, thus has the burden of satisfying the three-pronged test for disqualification by establishing that (1) it assumed the role of M&L’s "former client,” (2) the matters involved in both representations are substantially related, and (3) the interests of M&L’s present client Tang are materially adverse to the interests of the former client. We next consider each of these elements.

1. Is New Tekni-Plex a "Former Client” of M&L? It is undisputed that M&L represented old Tekni-Plex for over 20 years on a variety of legal matters. As counsel to the corporation, the law firm’s duties of confidentiality and loyalty ran to old Tekni-Plex on these matters (see, Wolfram, Modern Legal Ethics § 8.3.2, at 421; Code of Professional Responsibility EC 5-18). Concomitantly, the attorney-client privilege attached to any confidential communications that took place between M&L and Tekni-Plex corporate actors in the course of this representation (see, Commodity Futures Trading Commn. v Weintraub, 471 US 343, 348). The power to assert or waive the privilege, moreover, belonged to the management of old Tekni-Plex, to be exercised by its officers and directors (see, id., at 349; see also, Business Corporation Law § 701).

Appellants (Tang and M&L) argue that the purchase of old Tekni-Plex by Acquisition did not transfer the corporation’s attorney-client relationship to the newly formed entity. According to appellants, the transaction effected nothing more than a transfer of assets, with old Tekni-Plex expiring upon the merger, there being no "former client” still in existence. In support of this contention, appellants point out that, under the Merger Agreement, Acquisition was designated the surviving corporation, old Tekni-Plex explicitly ceased to exist and all of the outstanding shares of stock in old Tekni-Plex were liquidated. They further note that, for tax purposes, the transaction was deemed a sale of assets.

When ownership of a corporation changes hands, whether the attorney-client relationship transfers as well to the new owners turns on the practical consequences rather than the formalities of the particular transaction. In Commodity Futures Trading Commn. v Weintraub (471 US 343, supra), the Supreme Court held that power to exercise the attorney-client privilege of an insolvent corporation passed to the bankruptcy trustee, who assumed managerial responsibility for operating the debtor company’s business (see, id., at 352-353). In reaching this conclusion, the Court noted with regard to solvent corporations that

"when control of a corporation passes to new management, the authority to assert and waive the corporation’s attorney-client privilege passes as well. New managers installed as a result of a takeover, merger, loss of confidence by shareholders, or simply normal succession, may waive the attorney-client privilege with respect to communications made by former officers and directors” (id., at 349).

Weintraub establishes that, where efforts are made to run the pre-existing business entity and manage its affairs, successor management stands in the shoes of prior management and controls the attorney-client privilege with respect to matters concerning the company’s operations. It follows that, under such circumstances, the prior attorney-client relationship continues with the newly formed entity.

By contrast, the mere transfer of assets with no attempt to continue the pre-existing operation generally does not transfer the attorney-client relationship. Thus, in Federal Deposit Ins. Corp. v Amundson (682 F Supp 981 [D Minn]), the court held that the FDIC, which had purchased the assets of a bank and was appointed receiver for the purpose of liquidation, did not assume the role of former client to the bank’s counsel. In denying the FDIC’s motion to disqualify the bank’s prior attorney from representing the bank’s former officers against the FDIC, the court explained that, unlike Weintraub, in the case before it "[t]here [wa]s no thought or effort to reconstitute the entity or to run it at all” (id., at 987; see also, Telectronics Proprietary v Medtronic, Inc., 836 F2d 1332 [Fed Cir] [assignment of patent does not transfer attorney-client relationship]; SMI Indus. Canada v Caelter Indus., 586 F Supp 808 [ND NY] [purchase of assets does not transfer attorney-client relationship]; Federal Deposit Ins. Corp. v McAtee, 124 FED 662 [D Kan] [same]).

Here, appellants emphasize that old Tekni-Plex merged into Acquisition and ceased to exist as a separate legal entity. That Acquisition, rather than old Tekni-Plex, was designated the surviving corporation, however, is not dispositive. Acquisition was a mere shell corporation, created solely for the purpose of acquiring old Tekni-Plex. Following the merger, the business of old Tekni-Plex remained unchanged, with the same products, clients, suppliers and non-managerial personnel. Indeed, under the Merger Agreement, new Tekni-Plex possessed all of the rights, privileges, liabilities and obligations of old Tekni-Plex, in addition to its assets. Certainly, new Tekni-Plex is entitled to access to any relevant pre-merger legal advice rendered to old Tekni-Plex that it might need to defend against these liabilities or pursue any of these rights.

As a practical matter, then, old Tekni-Plex did not die. To the contrary, the business operations of old Tekni-Plex continued under the new managers. Consequently, control of the attorney-client privilege with respect to any confidential communications between M&L and corporate actors of old Tekni-Plex concerning these operations passed to the management of new Tekni-Plex (see, Commodity Futures Trading Commn. v Weintraub, 471 US at 349, supra). An attorney-client relationship between M&L and new Tekni-Plex necessarily exists.

Thus, the first of the three prongs for disqualification is established: new Tekni-Plex is a "former client” of M&L.

2. Is There a Substantial Relationship Between the Current and Former Representations? M&L previously assisted old Tekni-Plex on at least two matters that are substantially related to its current representation of Tang in the arbitration. First, the record indicates that M&L represented old Tekni-Plex during negotiation of the Merger Agreement. That Agreement contains representations and warranties that are the subject of the arbitration.

Second, the record evidences that M&L counseled old Tekni-Plex concerning environmental compliance and assisted the company in obtaining the permit for the laminator machine at the Somerville facility. The alleged misrepresentations made by old Tekni-Plex and Tang relate to that permit and the corporation’s compliance with environmental laws.

There is thus a substantial relationship between the current and former representations.

3. Are the Interests of M&L’s Present Client Materially Adverse to the Interests of Its Former Client? The arbitration claims pit Acquisition’s interest as purchaser against Tang’s interest as the selling shareholder. Furthermore, the Merger Agreement provides that Tang is responsible for indemnifying Acquisition for any misrepresentation or breach of warranty made by either Tang or old Tekni-Plex. Plainly the parties contemplated a unity of interest between old Tekni-Plex and Tang should a.dispute arise between the buyer and seller regarding the representations and warranties. Thus, to the extent the arbitration relates to the merger negotiations — as opposed to corporate operations — Tang and old Tekni-Plex remain on the same side of the table. The interest of M&L’s former client old Tekni-Plex is aligned with the interest of the law firm’s present client Tang — both in opposition to the buyer.

International Elecs. Corp. v Flanzer (527 F2d 1288 [2d Cir]), relied on by appellants, supports this analysis. Like new Tekni-Plex, the plaintiffs in Flanzer acquired a corporation through a sale and merger transaction. They subsequently filed a complaint against the selling stockholders alleging that misrepresentations were made during the sale negotiations. Plaintiffs then moved to disqualify the selling stockholders’ law firm because counsel for the acquired corporation and the selling stockholders during the acquisition had worked for that firm. The Second Circuit denied the motion to disqualify, explaining that the law firm’s current client (the selling stockholders) was in a position adverse to the buyer, not the merged corporation:

"The law firm and the plaintiffs were on opposite sides of the negotiations which were conducted at arm’s length. The plaintiffs’ attack is now on the bona fides of the selling stockholders. These defendants — the selling stockholders — not the buyer, were the clients of the law firm. They have a right to defend themselves as adversaries. * * * The earlier relationship of the law firm to the merged corporation cannot be a source of disqualification in these circumstances, even though a former client is surely entitled to protection.” {Id., at 1292.)

The dispute here, however, unlike Flanzer, goes beyond the merger negotiations. It also involves issues relating to the law firm’s longstanding representation of the acquired corporation on matters arising out of the company’s business operations— namely, M&L’s separate representation of old Tekni-Plex prior to the merger on environmental compliance matters. Any environmental violations will negatively aifect not only the purchasers but also the business interests of the merged corporation. In this regard, the interests of M&L’s current client Tang are adverse to the interests that new Tekni-Plex assumed from old Tekni-Plex (see, e.g., Thomson U.S. v Gosnell, 151 Misc 2d 249, 256, affd 181 AD2d 558).

Indeed, M&L’s earlier representation of old Tekni-Plex provided the firm with access to confidential information conveyed by old Tekni-Plex concerning the very environmental compliance matters at issue in the arbitration. M&L’s duty of confidentiality with respect to these communications passed to new Tekni-Plex; yet its current representation of Tang creates the potential for the law firm to use these confidences against new Tekni-Plex in the arbitration.

Under the circumstances, the appearance of impropriety is manifest and the potential conflict of interest apparent. M&L should therefore be disqualified from representing Tang in the arbitration.

D. Confidential Communications

As a final matter, we must determine whether M&L was properly enjoined from revealing to Tang any confidential communications obtained from old Tekni-Plex and whether new Tekni-Plex owns the confidences created during the law firm’s prior representation of old Tekni-Plex. For analytical purposes, the attorney-client communications must be separated into two categories: general business communications and those relating to the merger negotiations.

1. General Business Communications. As explained above, the management of new Tekni-Plex continues the business operations of the pre-merger entity. Control of the attorney-client privilege with regard to confidential communications arising out of those operations — including any pre-merger communications between old Tekni-Plex and M&L relating to the company’s environmental compliance — thus passed to the management of new Tekni-Plex (see, Commodity Futures Trading Commn. v Weintraub, 471 US at 349, supra). As a result, new Tekni-Plex now has the authority to assert the attorney-client privilege to preclude M&L from disclosing the contents of these confidential communications to Tang. Likewise, ownership of the law firm’s files regarding its pre-merger representation of old Tekni-Plex on environmental compliance matters passed to the management of new Tekni-Plex. This conclusion comports with new Tekni-Plex’s right to invoke the pre-merger attorney-client relationship should it have to prosecute or defend against third-party suits involving the assets, rights or liabilities that it assumed from old Tekni-Plex.

Appellants urge that because Tang and old Tekni-Plex were co-clients of M&L, none of the communications made by corporate actors to the law firm are confidential from Tang. Generally, where the same lawyer jointly represents two clients with respect to the same matter, the clients have no expectation that their confidences concerning the joint matter will remain secret from each other, and those confidential communications are not within the privilege in subsequent adverse proceedings between the co-clients (see, Wolfram, Modern Legal Ethics § 6.4.8, at 274-275). While M&L jointly represented Tang and old Tekni-Plex during the acquisition, with respect to the environmental compliance matters the record before us establishes only M&L’s representation of the corporation.

We note that some courts have held that, in the case of a close corporation, corporate representation may be individual representation as well (see, e.g., Rosman v Shapiro, 653 F Supp 1441 [SD NY]; In re Brownstein, 288 Ore 83, 87, 602 P2d 655, 656-657; but see, Cohen v Acorn Intl., 921 F Supp 1062, 1064 [SD NY] ["(o)n several occasions this Court has held that a law firm does not represent the shareholder of a corporation, even a close corporation, simply by virtue of its representation of the corporation itself”]). Here, the record indicates that at least some of M&L’s representation of old Tekni-Plex on the environmental matters at issue took place before Tang became the corporation’s sole shareholder and manager. Whether corporate counsel also functioned as Tang’s individual attorney on the environmental matters involved factual questions not addressed by the trial court or Appellate Division. In this particular case there is an insufficient record from which we can conclude that M&L jointly represented the corporation and Tang individually on matters other than the. merger.

2. Communications Relating to the Merger Negotiations. As to the other category of attorney-client communications between old Tekni-Plex and M&L — those relating to the merger transaction — new Tekni-Plex did not succeed to old Tekni-Plex’s right to control the attorney-client privilege. New Tekni-Plex’s misrepresentation and breach of warranty claims do not derive from the rights it inherited from old Tekni-Plex but from the rights retained by the buyer, Acquisition, with respect to the transaction. Under the Merger Agreement, moreover, the rights of old Tekni-Plex with regard to disputes arising from the merger transaction remain independent from— and, indeed, adverse to — the rights of the buyer. During this dispute stemming from the merger transaction, then, new Tekni-Plex cannot both pursue the rights of the buyer (Acquisition) and simultaneously assume the attorney-client rights that the buyer’s adversary (old Tekni-Plex) retained regarding the transaction.

This conclusion is especially compelling here, where at the time of the acquisition the seller corporation was solely owned and managed by one individual, Tang. “As corporate stock ownership is concentrated into fewer and fewer hands, the distinction between corporate entity and shareholders begins to blur” and "[i]n the case of a sole-owner corporation, they may merge” (Wolfram, Modern Legal Ethics § 8.3.2, at 421). To allow new Tekni-Plex access to the confidences conveyed by the seller company to its counsel during the negotiations would, in the circumstances presented, be the equivalent of turning over to the buyer all of the privileged communications of the seller concerning the very transaction at issue. The parties here, moreover, recognized the community between the selling shareholder and his corporation and expressly provided that it be preserved in any subsequent dispute regarding the acquisition.

Indeed, to grant new Tekni-Plex control over the attorney-client privilege as to communications concerning the merger transaction would thwart, rather than promote, the purposes underlying the privilege. The attorney-client privilege encourages "full and frank communication between attorneys and their clients and thereby promoters] broader public interests in the observance of law and administration of justice” (Upjohn Co. v United States, 449 US 383, 389; see also, People v Mitchell, 58 NY2d 368, 373). Where the parties to a corporate acquisition agree that in any subsequent dispute arising out of the transaction the interests of the buyer will be pitted against the interests of the sold corporation, corporate actors should not have to worry that their privileged communications with counsel concerning the negotiations might be available to the buyer for use against the sold corporation in any ensuing litigation. Such concern would significantly chill attorney-client communication during the transaction.

Thus, while generally "parties who negotiate a corporate acquisition should expect that the privileges of the acquired corporation would be incidents of the sale” (Medcom Holding Co. v Baxter Travenol Labs., 689 F Supp 841, 842 [ND Ill]), the agreement between the parties here contemplated that, in any dispute arising from the merger transaction, the rights of the acquired corporation, old Tekni-Plex, relating to the transaction would remain independent from and adverse to the rights of new Tekni-Plex.

In light of the facts of this particular transaction and the structure of the underlying agreement, new Tekni-Plex is without authority to assert the attorney-client privilege to preclude M&L from revealing to Tang the contents of communications conveyed by old Tekni-Plex concerning the merger transaction. Similarly, new Tekni-Plex does not control M&L’s files relating to its prior representation of old Tekni-Plex during the acquisition. Of course, nothing in our decision today prevents new Tekni-Plex from obtaining through the normal course of discovery any non-confidential documents, or confidential documents for which the privilege has been waived, to which it is entitled.

Accordingly, the order of the Appellate Division, insofar as appealed from, should be modified, without costs, in accordance with the opinion herein, and, as so modified, affirmed.

Judges Simons, Titone, Bellacos a, Smith, Levine and Ciparick concur.

Order, insofar as appealed from, modified, etc.

      . Tang had commenced an action against new Tekni-Plex in New Jersey Superior Court seeking a declaration that (1) the arbitrator had authority to decide the disqualification issue, or (2) he had a right to be represented by M&L in the arbitration, and (3) as sole shareholder and director of old Tekni-Plex, he owned and controlled the attorney-client privilege attaching to communications between M&L and old Tekni-Plex. The New Jersey court indicated that it would not rule on this application until the motions pending in New York were resolved.

      . We underscore that we resolve only those attorney-client issues that are presented by the merger dispute before us. In any other matter Tang is of course not foreclosed from making the requisite showing of joint representation or alternative basis for access to attorney-client communications.


author: Simons, J.

text:
    [674 NE2d 672, 651 NYS2d 963]
    The People of the State of New York, Respondent, v Anthony Consalvo, Appellant.
    Argued October 15, 1996;
    decided November 26, 1996

      POINTS OF COUNSEL

      Judy A. Lang, New York City, for appellant.

      Dennis C. Vacco, Attorney-General, New York City (Bonnie H. Stein and Arthur G. Weinstein of counsel), for respondent.
   OPINION OF THE COURT

Simons, J.

Defendant is a podiatrist. On May 10, 1994, he entered a guilty plea to grand larceny, fourth degree, in full satisfaction of an indictment charging him with grand larceny and multiple counts of offering a false instrument for filing and falsifying business records. The charges were based on improper billings for Medicaid patients between 1986 and 1992. The plea was entered after extended negotiations and contained a provision requiring defendant to pay the State $500,000 as restitution prior to sentencing. When defendant subsequently appeared for sentencing, he was represented by new attorneys who moved to vacate the plea or, alternatively for a hearing on the amount of the restitution. The court denied both motions but before imposing sentence accepted from the prosecutor the affidavit of a statistician and incorporated it into the record. The affidavit purported to establish, by extrapolating from six fraudulent claims and the losses occasioned by them, that the damages to the State totaled no less than $571,552.37. Defendant was thereafter sentenced to a term of six months’ incarceration concurrent with five years’ probation and ordered to pay restitution of $500,000.

The question before the Court is whether the plea and the finding on restitution may stand. We conclude that the plea of guilty was knowing and voluntary but that the procedures followed by the court to establish the amount of restitution did not meet statutory standards. Accordingly, the matter must be remitted to Supreme Court for a hearing to determine the amount of restitution.

Section 60.27 of the Penal Law permits a sentencing court to order restitution to the victim of the crime in addition to any other dispositions authorized by statute. The amount, as the amendment to the statute in 1992 makes clear, may not include sums for pain and suffering or liquidated damages: restitution may be no greater than the sum necessary to compensate the victim for out-of-pocket losses (L 1992, ch 618; see, People v Fuller, 57 NY2d 152, 158, n 6).

Whether a defendant will be required to make restitution to a crime victim is a matter within the discretion of the court. If it determines that restitution is appropriate, the procedure for fixing the amount is set forth in section 60.27 (2). The statute provides that if the record contains the evidence necessary to support a finding of the victim’s loss, usually after a trial in which evidence of pecuniary loss has necessarily been proved, the court may fix the amount of restitution based on that evidence. If sufficient evidence does not appear in the record to support a finding of the victim’s loss, then the court must conduct a hearing to determine the amount. In either case, if the defendant requests a hearing, the court must conduct one.

Normally the court should determine the amount of restitution at the time of sentencing. This is evident from the directions in the statute that the District Attorney advise the court "at or before” the time of sentencing that the victim seeks restitution or reparation, and that a victim impact statement must be considered before fixing the amount (Penal Law § 60.27 [1], [2]). Inasmuch as a victim’s impact statement is usually prepared by the probation department after trial or a plea and before sentencing (see, CPL 390.30 [3] [b]), the necessary con sequence of that requirement is that restitution is to be determined at or near the time of sentencing, not at the time the plea is entered. Moreover, the statute provides that if a hearing is required it will be subject to the provisions of CPL 400.30, a section which contemplates a hearing on notice before sentencing.

In a case where guilt is established pursuant to a plea agreement rather than a trial, evidence to support the restitution amount generally can only be found in the agreement itself or the minutes of the plea allocution. Although a defendant may make a statement at the plea proceedings sufficient to support a determination of the victim’s out-of-pocket loss, thereby eliminating the procedures set forth in the Criminal Procedure Law, in most cases the court will be unable to determine the amount of restitution from the plea record. If restitution is appropriate but cannot be determined at the time of the plea, any sentence promise included within a plea bargain may properly be subject to a hearing on restitution at sentencing (see, Donnino, Practice Commentaries, McKinney’s Cons Laws of NY, Book 39, Penal Law § 60.27, at 192). The court may seek the assistance of the probation department in determining the amount of loss but the determination must be made by the court, not the department (see, People v Fuller, supra).

If a hearing is held, the procedure specified in CPL 400.30 must be followed. The court must notify the clerk of a hearing to be held in not less than 10 days (subd [1]). The clerk then notifies the parties and their attorneys (subd [2]). At the hearing, the court must permit the defendant to speak on the out-of-pocket loss and the court may accept that statement as proof of the loss. If it does not, it must proceed with the hearing (subd [3]). The People have the burden of proving the amount of loss by a fair preponderance of the evidence. Any relevant evidence is admissible unless privileged regardless of its admissibility under the rules of evidence (subd [4]).

The court did not follow these procedures in this case. The extended colloquy in the proceedings before sentencing reveals that the $500,000 figure was based largely on unrecorded statements made during plea negotiations in which defendant pressed to avoid a jail sentence. The People assert that there was sufficient evidence to support the restitution determination because (1) they documented six actual instances of defendant’s fraudulent billing practices through undercover work, (2) defendant confessed to illegal billings — although at an amount substantially less than $500,000 — and (3) the court had before it the statistician’s affidavit explaining her calculations of the loss. They contend that the court could deduce from this evidence that the government had sustained an out-of-pocket loss of at least $500,000. While the parties and the court may have been aware of some of this information, however, defendant was not given an opportunity to challenge the amount at a hearing.

Alternatively, the People contend that the defendant conceded the amount of the loss at the plea proceedings. CPL 400.30 (3) provides that if the defendant makes a statement at the restitution hearing, the court may base its finding thereon. Presumably, the same rule would apply to defendant’s statements made at the time a plea is entered. Defendant may concede the facts necessary to establish the amount of restitution as part of a plea allocution. Where there is no concession of facts, however, the guilty plea alone is not sufficient to support a determination of restitution contained in the court’s statements during the plea allocution (see, Preiser, Practice Commentaries, McKinney’s Cons Laws of NY, Book 11 A, CPL 400.30, at 318). If the court’s determination is based on the defendant’s statement, the amount of restitution must reflect more than just the court’s statement of a dollar figure or defendant’s conclusory admissions accompanying the plea. Defendant’s statements must contain facts from which the victim’s actual out-of-pocket loss from the offense can be inferred (Penal Law § 60.27 [2]).

When defendant retained new attorneys in this case, they strenuously urged before sentencing that the restitution amount was not adequately supported by the record and sought a hearing. Under these circumstances, the court was required to grant a hearing pursuant to Penal Law § 60.27 (2) irrespective of the level of evidence in the record and to provide defendant with a reasonable opportunity to contest the People’s evidence or supply evidence on his own behalf. Its failure to do so constituted a departure from the " 'essential nature’ of the right to be sentenced as provided by law” and requires remittal for a hearing on the amount of restitution (Fuller, 57 NY2d, at 156, supra).

We have considered defendant’s other claims and find them to be without merit.

Defendant has submitted a postargument request that the $500,000, now held by the People, be returned to him in the event that a new hearing is ordered. That application should be addressed to the trial court.

Accordingly, the order of the Appellate Division should be modified by remitting to Supreme Court for further proceedings in accordance with this opinion and, as so modified, affirmed.

Chief Judge Kaye and Judges Titone, Bellacosa, Smith, Levine and Ciparick concur.

Order modified, etc.