A Million Dollars In Fees For Class Counsel in Wachovia/Wells Fargo Merger Lawsuit

When I first looked at Judge Murphy's (unpublished) Order in Ehrenhaus v. Baker earlier this month awarding attorneys' fees to the class action attorneys who sued Wachovia and Wells Fargo over their merger in 2008,  I was disappointed, though the Judge was following a mandate from the Court of Appeals.

He awarded $1 million in fees and expenses ($1,056,067.57 to be exact) to the NY lawyers representing the class.  That ruling came following a decision from the NC Court of Appeals reversing a previous award of fees in that case (by Judge Diaz) and remanding the fee determination to the Business Court.

Judge Murphy had assessed that his "sole directive" on remand was "to determine whether Plaintiff's attorney's fee award request of $1.5 million is reasonable in light of Rule 1.5 of the RPPC."  (the Revised Rules of Professional Conduct).  Order ¶14.

The Lawyers Got Much Less Than They Had Requested

My disappointment stems from my perspective that the Ehrenhaus lawsuit achieved absolutely nothing of value for Wachovia's shareholders, except for obtaining a more detailed proxy statement containing additional (and to me, pointless) disclosures about the merger transaction.  So why did the lawyers deserve anything at all, let alone a million dollars? 

But after shedding a few tears for the widows and orphans who were holding Wachovia stock and their undoubtable anger at a million dollars for lawyers who obtained nothing of value for them , I came to the conclusion that this was a pretty good shellacking of the lawyers for the class.   After all, they had asked for almost twice that amount ($1,975,000) to start with and had to wait for years to get paid (though there's no telling whether they will have to wait longer as there might be another appeal of this fee award).

And in this most recent round, they had asked for $1.5 million, requesting that a "contingency multiplier" be applied to the fee generated by the hours (over 3,000 hours) they spent on the case at their hourly rate.  Judge Murphy rejected that request because there was no contingent fee agreement signed by the class representative.  RRPC 1.5(c) says that "[a] contingent fee agreement shall be in a writing signed by the client."  Given the mandatory nature of the Rule, Judge Murphy saw this as "a prerequisite in order to create an effective contingent fee agreement."  Order ¶29.  He ruled that "in the absence of a valid contingent fee agreement between Plaintiff and his attorneys, as required by Rule 1.5(c), any award using a contingency multiplier is unreasonable."  Order ¶30.

If you are wondering about the hourly rates proposed to the Business Court by class counsel, they had previously asked Judge Diaz  for a $750/hour rate, which he had said in 2010 was "far in excess of those normally charged by attorneys in North Carolina."  In their new application for fees, class counsel backed down to a maximum hourly rate of $450, which Judge Murphy ruled "was not excessive when compared with the hourly rates of attorneys engaged in complex business litigation in Charlotte, Mecklenburg County, North Carolina."  Order ¶22.

Oh, and there was very bad news in this Order for Mr. Ehrenhaus' local counsel.  The Court awarded not a dollar to him even though there was a valid fee sharing agreement between him and Ehrenhaus' out of state counsel.  The agreement specified that local counsel would receive five percent of the total fee, but local counsel offered no evidence of the time expended or his hourly rate so the Court could not determine whether the five percent (which would have been more than $50,000) was reasonable.

If you are despondent over the lack of recovery by the North Carolina counsel, Judge Murphy seemed willing to consider the submission of further evidence on the services rendered by him. Order ¶38.

"Disclosure Only" Settlements Should Be Closely Examined For Their Value

Turning back to the reasonableness of the Ehrenhaus fee, there has been quite a bit of judicial discussion recently  about the fees appropriate in "disclosure only" settlements.  In the case of Kazman v. Frontier Airlines, 398 S.W.2d 377 (Texas App. 2013), the Texas Court of Appeals refused to award any attorneys' fees where the only relief for the plaintiff was additional disclosures in SEC filings.

Delaware courts have ruled that they should scrutinize these types of settlements.  The Judges there have taken to asking the attorneys requesting fees in disclosure only settlements to identify which of the disclosures obtained are the most material and thereby evaluating their value.  (See In re PAETEC Holding Corp. Shareholders Litigation (letter opinion).

What would Ehrenhaus' lawyers say about the value of the additional disclosures that they obtained?  What could they have said?  If you want to make that evaluation yourself, you can find the "enhanced" disclosures here.

Maybe I'm being too harsh on the minimal value of this lawsuit for Wachovia's shareholders.  The class did obtain the invalidation of the 18 month "tail" in the merger agreement between Wachovia and Wells Fargo.  That gave Wells Fargo the right to keep its 40% voting interest in Wachovia's stock for 18 months if the shareholders voted against the merger.

But really, what other entity was likely to be deterred from making a better bid for Wachovia as a result of the tail?  Remember that Wachovia was literally hours away from a receivership when Wells Fargo made its offer.  And Judge Diaz ruled in his 2008 opinion that "the sobering reality is that there are few (if any) entities in a position to make a credible bid for Wachovia that would be superior to the Merger Agreement."  2008 NCBC 20 at ¶151.

So was a $1 million fee warranted?  I don't know, but In the old days of the Business Court, Judge Tennille might have condemned these fees as "stinky fees."

Don't get me wrong on my feelings about fees paid to class action counsel.  Sometimes they are well-earned.  For example, just  the other day, Amazon.com notified me that I was getting $13.00 or so in the settlement of the price-fixing class action against it over the pricing of e-books.  (though my Dad pointed out that he only got $3.00)  But what was the award for fees and expenses for the lawyers for the class in that case?  More than $11 million.  I have no problem with that.  They can buy a lot of books.  And they deserve them.

As for the prospects of an appeal of this fee award, that is unlikely to be warmly welcomed by the Court of Appeals.  The Fourth Circuit said yesterday, in a completely unrelated case, that:

[A]ppeals from awards of attorneys fees, after the merits of a case have been concluded,. . .must be one of the least socially productive types of litigation imaginable.

Best Medical Int'l, Inc.  v. Eckert & Ziegler Nuclitec GMBH at 10 (quoting Daly v. Hill, 790 F.2d 1071, 1079 n.10 (4th Cir. 1986).
 

 

Business Court Makes North Carolina Safe For Construction Lawyers

Construction lawyers in North Carolina can breathe a sigh of relief.  On Friday of last week, the Business Court ruled that the service of on-line service provider Lienguard in preparing claims of lien constitutes the unauthorized practice of law. 

You most likely have never heard of Lienguard.  It says on its website that it files throughout the country: "commercial mechanics liens, notices, public and federal bond claims as well as municipal liens." It does this on a fixed price basis.  It charges $495 for the preparation and filing of a mechanics lien.

A committee of the North Carolina State Bar sent Lienguard a cease and desist letter in 2010 informing Lienguard that it had concluded that Lienguard's conduct constituted the unauthorized practice of law.  Lienguard, notwithstanding the letter, continued offering its services in North Carolina.

The Order in North Carolina State Bar v. Lienguard, Inc., 2014 NCBC 11, followed in the State Bar's lawsuit.  Lienguard raised a litany of defenses against what it termed the State Bar's "monopolistic crusade" against the UPL.

Lienguard's Services Are The Unauthorized Practice Of Law

The Business Court didn't agree with any of Lienguard's defenses.  Lienguard argued, for example, that a claim of lien wasn't a "legal document" and its assistance in preparing those documents was therefore not within the statutory definition of the "practice of law."  Section 84-2.1 of the General Statutes bars non-lawyers from "preparing or aiding in the preparation of "deeds, mortgages, wills, trust instruments, inventories, accounts or reports of guardians, trustees, administrators or executors. . . ." 

Given the absence of "claims of liens" from the language of the statute,  Lienguard said it was not engaged in the practice of law.  Judge Gale looked to G.S. §84-4, which prohibits non-lawyers from preparing "any other legal document."  It took him just twenty words to conclude that a claim of lien is a "legal document":

Clearly, a claim of lien is prepared to enforce the claimant’s statutory lien rights.  It is,
therefore, a “legal document.”

Op. 55.

The Court also ruled that Lienguard's statements about its expertise in the construction industry, its commitment to compliance with the law,  and its qualifications to prepare claims of lien constituted Lienguard "holding out" that it was licensed to practice law.  There are  administrative regulations in North Carolina that direct that a lawyer who is not admitted to practice in this jurisdiction "shall not. . .  hold out to the public or otherwise represent that the lawyer is admitted to practice law in this jurisdiction.” 27 N.C. Admin. Code 02, Rule 5.5(b).

Lienguard's services also constitute impermissible "legal advice" in violation of Chapter 84.  It provides definitions of lien law terms, gives warnings regarding time requirements, and reminders about sending out preliminary notices.  Those things are "legal advice," when combined with the preparation of legal documents.  Op. 72.

You might remember the "scrivener's exception" to charges of UPL, which recognizes that merely typing or “scrivening” a petition or legal document does not constitute the practice of law, so long as the non-attorney does not create the document, or advise on how the document should be prepared." Op. 59.  Lienguard wasn't entitled to this exception because "it performs services beyond that of a scrivener."  Op. 65.

Lienguard's Constitutional Claims Were Rejected

Lienguard also argued that Chapter 84 is so vague due to its lack of definitions that it cannot be constitutionally applied to it.  The Court rejected that argument, ruling that "there is no vagueness involved in concluding that a claim of lien is a legal document."  Op. 82.  Besides, the NC Supreme Court held almost a century ago that G.S. §84-4 is constitutional and valid. Seawell v. Carolina Motor Club, Inc., 209 N.C. 624, 632, 631 S.E.2d 540, 544 (1936).  And Lienguard hadn't taken the necessary procedural steps to attack the constitutionality of a statute anyway.  G.S. §1-260 requires service on the Attorney General if the constitutionality of a statute is in question, and he has an opportunity to be heard.

If you are not exhausted from reading this by now, you might be wondering how the Court resolved Lienguard's argument that the State Bar was in violation of the monopoly clause of the North Carolina Constitution.  That clause says that: "monopolies are contrary to the genius of a free state and shall not be allowed."  N.C. Const. §34.  The State Bar, which is a state agency, has the power to exclude persons from practicing in the legal profession "to protect the public against incompetents and imposters."  Op. 86.  (There was no finding that Lienguard was "incompetent.").  Judge Gale rejected the monopoly claim.

There's More To Come

The Court's ruling is not the final round for Lienguard.  The State Bar was directed to prepare a proposed form of permanent injunction for the Court to enter.  It was given twenty days to present it to Lienguard for "comments as to form."  You all know that this type of instruction from a Court can lead to endless back and forth between counsel for the parties.

A couple more things:

The Supreme Court of Ohio, bin 2010,also found Lienguard to be engaged in UPL. 

Also, I was surprised to discover that there are multiple companies in the business of providing DIY lien preparation services in North Carolina.  Companies named zlien, CRM Lien Services, and the Lien Professor all do that.  If the State Bar is truly concerned about stamping out UPL in this area, it has a lot more work to do. 

 

Real Estate Agents Need To Be Careful About Disclosing Dual Agency

Dual agency is a big deal to real estate agents.  It lets them represent both a buyer and a seller in a transaction.  Dual agency was the focal point of the Business Court's opinion last week in BDM Investments v. Lenhil, Inc., 2014 NCBC 6.  The Opinion shows the dangers of failing to disclose that you are acting as a dual agent.

If a real estate agent is acting as a dual agent she owes a fiduciary duty to both the buyer and the seller, "and must make a full and truthful disclosure . . . of all material facts [concerning] the [p]roperty."  Op. ¶43.

The fact of the dual agency is a material fact and must be disclosed.  Op. ¶44. 

Hollingsworth, one of the Defendants, did have a real estate license at the time of the transaction, but there's an issue of material fact whether he was acting as an agent for either the buyer or seller in the transaction.  Plaintiffs said that they would not have purchased ten residential lots for $850,000 if Hollingsworth had disclosed his relationship with the seller and the fact that he would earn a commission on the sale. 

The Plaintiffs wanted to rescind the transaction and get their $850,000 back, but there was nothing wrong with the property purchased, and there had been no misrepresentations about it by the purported agent.  As Judge Murphy observed, there are no:

case[s] under North Carolina law considering whether an undisclosed dual agency,
without any other misrepresentation or omission, permits a party to rescind a real
estate transaction if a jury finds the failure to disclose led to the purchase.

Op. ¶52.

He relied on two non-North Carolina opinions in ruling that if the jury at trial were to conclude that the failure to disclose a dual agency led to the decision to buy the property, that the Plaintiffs would be entitled to the remedy of rescission and also to pursue damages against Hollingsworth for "injuries not fully remedied by recovery of its purchase price."  Op. ¶53.

There would also be the danger of Hollingsworth having his real estate license revoked.  The General Statutes provide that a broker's license can be revoked for representing "more than one party in a transaction without the knowledge of all parties for whom he or she acts."  N.C. Gen. Stat. §93A-6(a)(4).  Hollingsworth died after the lawsuit was filed, so he doesn't face that danger. 

There are many more claims discussed in the BDM decision, but I have focused only on the dual agency aspect of the case because I am engaged to a real estate agent and I am of course now fascinated by real estate issues.  I felt it was necessary to make that disclosure.

 

NC Business Court Stays Arbitration Pending Ruling On Piercing The Veil Claim

The Order in Cold Springs Ventures, LLC v. Gilead Sciences, Inc., 2014 NCBC 10 is a procedural conundrum wrapped up in arbitration issues.  The Plaintiffs in the Business Court are the respondents in a separate arbitration proceeding brought by the Defendant.  But none of the Plaintiffs -- all of whom were shareholders or directors of a corporation which had signed off on the arbitration agreement forming the basis for the arbitration -- had personally signed the arbitration agreement.

There's nothing novel about holding persons who haven't signed arbitration agreements to be bound by them.  The NC Court of Appeals held years ago that "well-established common law principles dictate that in an appropriate case a nonsignatory can enforce, or be bound by, an arbitration provision within a contract executed by other parties.” Ellen v. A.C. Schultes of Md., Inc.,172 N.C. App. 317, 320, 615 S.E.2d 729, 732(2005) (quoting Wash. Square Sec., Inc. v. Aune, 385 F.3d 432, 435 (4th Cir. 2004)).

The non-signatories in Cold Springs were not willing to go to arbitration.  They moved for a preliminary  injunction to enjoin the Defendant from proceeding with the arbitration against them.  The Defendants' response was that they were entitled to "pierce the veil" against the corporate signer of the arbitration agreement and thereby get to the shareholders.

But is a Court entitled to determine a piercing the veil theory up front, in advance of an arbitration that is based on that very issue, or does that improperly delve into the merits?

Start with the concept of "arbitrability," which is "undeniably an issue for judicial determination."  AT&T Techs. v. CWA, 475 U.S. 643, 649 (1986).  Going along with that, however, is the concept that the court "is not to rule on the potential merits of the underlying claims."  Id.

So what's a court to do when arbitrability is wrapped up with the merits of the case?  Especially when the Defendants' demand for arbitration provides no specifics as to why the veil should be pierced, and makes only rote allegations as to why it should obtain that result.

Judge Jolly had little hesitation about getting at least somewhat into the merits.  He held:

An important distinction must be drawn between [impermissible] consideration of the merits of an arbitrable claim and the threshold arbitrability inquiry that necessarily involves the same issues that underly the merits of a claim. The mere fact that certain issues could later be litigated substantively cannot on its own foreclose courts from assessing arbitrability. In such a situation, the overriding spirit of the Supreme Court's jurisprudence demands that courts nonetheless address those issues for the narrow and limited purpose of determining whether a claimant seeking to compel arbitration can sufficiently allege a basis for going forward against a responding party.

Op. ¶16.

Remember that this was a Motion for a Preliminary Injunction, to enjoin the Defendants from proceeding with the arbitration against the Plaintiff shareholders.  So what else did Plaintiff have to show to halt the arbitration?  Irreparable harm and a likelihood of success on the merits.

Irreparable harm was present, because "forcing a party to arbitrate an issue absent an agreement to do so constitutes 'per se irreparable' harm."  Op. ¶17.

On likelihood of success on the merits, Judge Jolly looked to G.S. § 1-569.7(b), which says that"[o]n motion of a person alleging that an arbitration proceeding has been initiated or threatened but that there is no agreement to arbitrate, the court shall proceed summarily to decide the issue."

He ruled that the parties should plan limited discovery on whether the shareholder Plaintiffs could be compelled to arbitrate, to be concluded in about the next six weeks.  The Judge also stayed the arbitration pending a ruling on the piercing the veil basis for the arbitration.

Oh, and if you are wondering which party has the burden of proof going forward, it is the Defendant, because "under both state and federal law, the party seeking to compel arbitration bears the "burden of establishing an agreement to arbitrate."  Op. 27  (citing  Routh v. Snap-On Tools Corp., 108 N.C. App. 268, 274 (1992).

That's a heavy burden here, because the NC Supreme Court said in State ex rel. Cooper v. Ridgeway Brands Mfg., LLC that "proceeding beyond the corporate form is a strong step: 'Like lightning, it is rare [and] severe[.]'"


 

Maybe We Are Getting Closer To A Decision in North Carolina On Whether LegalZoom Is Engaged In The Unauthorized Practice Of Law

Legalzoom may be a step closer to overcoming the NC State Bar's assertion that its online legal document service constitutes the unauthorized practice of law (UPL), following yesterday's ruling in LegalZoom, Inc. v. North Carolina State Bar, 2014 NCBC 9.  Or it may be only a few questions away from a ruling that would impact its ability to conduct business in North Carolina, depending on how you read the decision.

If you need some background on LegalZoom, you probably don't own a television or you haven't read my two previous posts on this long simmering dispute, from January 2012 and August 2012.  The company is constantly advertising its legal document generation service which it says on its website "strive(s) to be the best legal document service on the web."  It prepares incorporation papers, wills, trademark applications, and divorce documents and other things for its customers, who want a "do it yourself" approach to law.   LegalZoom has been battling with the NC State Bar in the Business Court since 2010 over whether its service constitutes the UPL.

Yesterday, Judge Gale denied the State Bar's motion for judgment on the pleadings, ruling that he needed a "more developed record" to make a decision, in 2014 NCBC 9.  Op. 50.

Exceptions To The Unauthorized Practice Of Law and Judge Gale's Questions

The definition of the "practice of law" is contained in G.S. §84-2.1.  LegalZoom argues that it falls within recognized exceptions to states' prohibitions on the UPL.  One is known as the “self-help” or the “self-representation” exception, which means "that one can legally undertake activities in his own interests that would be UPL if undertaken for another, or to “practice law” to represent oneself." Op. 58.

The NC Supreme Court weighed in on the "self-help" exception fifty years ago, in State v. Pledger, 257 N.C. 634, 127 S.E.2d 337 (1962), in which it held that a non-lawyer employee of a company in the business of constructing and selling of homes did not engage in the UPL by preparing deeds of trust for homes that his employer sold.  The Court said that:

[a] person, firm or corporation having a primary interest, not merely an incidental interest, in a transaction, may prepare legal documents necessary to the furtherance and completion of the transaction without violating [the law].” Id. at 637, 127 S.E.2d at 339.

Op. ¶61.  Since LegalZoom doesn't have a "primary interest" in its customers' business, it wasn't able to successfully avail itself of the "self-help" exception.

The second exception, relied on more heavily by LegalZoom has been referred to as a “scrivener’s exception,” which essentially means "that unlicensed individuals may record information that another provides without engaging in UPL as long as they do not also provide advice or express legal judgments." Id.

Judge Gale had a number of questions whether the operation of LegalZoom's online software fit within the scrivener's exception.  Those questions could not be answered on the existing record.  He posed the following:

if a customer makes one choice presented to him by the [LegalZoom] software, are there portions of the template that are then never shown to the customer? If so, what is the reasoning behind and the legal significance of the software’s determination not to present that portion of the form?  [Does the premise of the Pledger decision] require that only the unlicensed individual make choices in drafting a legal document, and that the choice or risk of an incorrect choice about which portions of a form to include must belong exclusively to the individual? Is there then a legally significant difference between how one engaging in self-representation uses a form book versus LegalZoom’s interactive . . . software? A form book presents the customer with the entire form, often accompanied by opinions or directions on how to use the form, but any choice and its implications are solely the customer’s. Does the LegalZoom software effectively make choices for its customer? Do responses depend in any part on the effects of statements embodied in the software, either those that promote the program or those that disclaim legal advice being given?

Op. ¶66.  Although the Judge was careful to say that these were not the "controlling or only relevant questions,"  Op.¶67, they certainly provide a road map for future resolution of the case via a motion for summary judgment.  

LegalZoom's Prepaid Legal Services Plan

There's another aspect to the case, which involves Legaloom's prepaid legal services plans. The State Bar, which is responsible for registering such plans, refused to register LegalZoom's plans.  The online vendor said this refusal violated the equal protection clauses of the U.S. and North Carolina Constitutions.

Judge Gale dismissed that claim, because LegalZoom had not exhausted its remedies by failing to request a hearing before the State Bar.  The Administrative Procedure Act, to which the State Bar is subject, requires a final agency decision before judicial review is allowed. 

LegalZoom had taken the position that requesting a hearing was only optional, and that a hearing would have been futile.  Judge Gale observed that both arguments were foreclosed by NC appellate decisions.  Op.  46, 47.
 

LegalZoom's Claim that it has been Defamed by the NC State Bar was Dismissed

LegalZoom had made a claim against the State Bar that the Bar's statements that it was engaging in the UPL were "false and untrue" and that those statements disparaged its product.

Judge Gale found those statements to be barred by the doctrine of sovereign immunity.

 

 

NC Business Court Puts Teeth In Protective Order

I've never thought much about the consequences of the violation of a Protective Order.  In fact, before last week's Business Court ruling in Out of the Box Developers, LLC v. Logicbit Corp., 2014 NCBC 7, no North Carolina case had "squarely addressed whether Rule 37 permits sanctions for violations of Rule 26(c) protective orders." Op. 5.

But now we know that a North Carolina court can issue sanctions for a violation of a protective order because Judge Gale ruled so in the Out of the Box decision.  If you are surprised that this was uncharted territory for a North Carolina court, you probably should be.  Judge Gale cited nearly a dozen federal district court decisions, dating back more than ten years,  reaching the same conclusion.  Op. 5 & n.2.  Though he cited none from a North Carolina federal court.  Perhaps there weren't any.

So what had the Defendants done that warranted sanctions?  One of the Defendants had posted on the internet a document subject to the protective order that had been produced to it.  The document hadn't been designated as "confidential," but "it bore a Bates stamp and was clearly a document produced in discovery covered by the Protective Order's restriction that it not be used for business or competitive purpose or any other purpose unrelated to the litigation of [the] case."  Op. 19.

The sanctions imposed were the striking of the Defendants' counterclaims as well as their affirmative defenses.

The discovery process in the Out of the Box case has not been smooth.  The Defendants were previously sanctioned for $38,000 for failing to comply with production orders from the Court; and the Court also issued an interesting ruling last year about subpoenas directed to non-parties.

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NC Court Of Appeals: Foreclosures and Immutability

Can a law passed by a Legislature be called "immutable?"  (that means it's ageless, not ever subject to change).

The Court of Appeals used that word this week in Heaton-Sides v. State Employees Credit Union to describe a statute dealing with foreclosures. 

The case dealt with the rights of a person to her personal property after a foreclosure.  A homeowner has ten days following a foreclosure to retrieve personal property left in her home, based on a combined reading of G.S. §45-21.29(1) and §42-25.9(g).

The Court of Appeals rejected the Defendant's argument that Heaton-Sides had waived the ten day period by not taking it up on its invitation that she notify it of her intention to reclaim her property.

Chief Judge Martin ruled that the ten day period could not be waived, holding that:

In contract law there are generally two types of rules: default rules and immutable rules. Default rules are rules that “parties can contract around by prior agreement.” Ian Ayres & Robert Gertner, Filling Gaps in Incomplete Contracts: An Economic Theory of Default Rules, 99 Yale L.J. 87, 87 (1989).  Immutable rules, by comparison, are those rules that “parties cannot change by contractual agreement.”  Id. While these terms usually refer to the Uniform Commercial Code, they demonstrate the principle that some rules may be avoided by contract while others may not.

Op. 7.

When a law is subject to revocation or amendment by the Legislature, can it really be said to be immutable?  That's a pretty strong word.  That the sun rises in the east and sets in the west is immutable.  Nobody can change that.  Unless you live on Venus.

 

 

 

 

Collecting On Judgments Against A Member's LLC Interest

A lawyer has limited remedies to collect on a judgment from a defendant who is unwilling to pay.  If the defendant holds stock in a corporation, you can execute on the shares, take possession of them, and sell them. N.C. Gen. Stat. §1-324.3.  But if that ownership interest is in an LLC, a "charging order" is your only recourse (per G.S. §57D-5-03(d)).

If you don't know what a charging order is, it is a court order against an owner of an LLC interest which gives a creditor the right to receive any distributions that the owner of the interest would have received until the judgment is paid.

The Old LLC Act

Former Section 57C-5-03 of the General Statutes (which was repealed and replaced in January 2014 by the new North Carolina Limited Liability Act in Chapter 57D) said that:

On application to a court of competent jurisdiction by any judgment creditor of a member, the court may charge the membership interest of the member with payment of the unsatisfied amount of the judgment with interest.

But what exactly did the holder of the charging order receive under the Old LLC Act, and what did the LLC owner lose upon the issuance of a charging order?  Last week, the NC Court of Appeals wrestled with the question whether a charging order operates as an assignment of an LLC interest, in First Bank v. S&R Grandview, LLC.

First Bank had obtained a charging order against Donald Rhine, a member of S&R Grandview, an LLC.  The charging order said that the Plaintiff "shall hereafter have the rights of an assignee" of Mr. Rhine's interest of the LLC, and that Mr. Rhine then had no remaining membership interest in the LLC.  The charging order said that his membership right would "lie fallow" until the judgment against him was satisfied.

Mr. Rhine appealed, arguing that the charging order did not operate to assign his LLC interest.  First Bank rejoined that the effect of  the charging order under Section 57C-5-03 was that Mr. Rhine was no longer a member of the LLC to which the order applied.

There was some plausibility to First Bank's argument.  Section 57C-5-03 said that "[t]o the extent so charged, the judgment creditor has . . . the rights of an assignee of the membership interest." And Section 57C-5-02 said that "a member ceases to be a member upon assignment of all of his membership interest."

A Charging Order Does Not Work An Assignment Of An LLC Interest

The Court of Appeals disagreed with First Bank's position, holding that "[n]owhere in these provisions does the General Assembly mandate an assignment of membership interests from a debtor to a judgment creditor through a charging order." Op. 8.  It added that "[h]ad the General Assembly intended a charging order to assign all membership interests and terminate a debtor’s membership in an LLC, as plaintiff contends, it could have easily included language to that effect." Op. 8-9.

The changes in the LLC Act through Chapter 57D bolstered the Court's conclusion.  The new provision dealing with charging orders states that "this Chapter does not deprive any interest owner of a right."  N.C. Gen. Stat. §57D-5-03(c).  I'm not sure whether statutory interpretation lets a court look at the subsequent actions of a Legislature to determine what the Legislature meant the first time around.

But anyway, why did this Defendant care whether his LLC interest was assigned and whether he had lost his membership rights?  Remember that an LLC member has an ownership interest that includes both an economic interest and a right to participate in the management of the LLC.  N.C. Gen. Stat. §57D-1-03(25).

A charging order can affect only the economic interest.  The charging order in First Bank went too far.  It took away Mr. Rhine's management rights.

What happens if those with management rights in the LLC decide to defer distributions from the LLC because of a dislike for the judgment creditor?  That's undoubtedly a risk, and it will probably be the subject of a yet to be decided court decision.

Why Should You Care About The Old LLC Act?

The NC General Assembly repealed the Old LLC Act, in Chapter 57C and replaced it with the New LLC Act through Chapter 57D.  That change became effective three months ago, on January 1, 2014.

Do you need to worry about the repealed Act?

Maybe.  In the "Savings Provisions" in the New Act, the General Assembly said that "[a]ny proceeding commenced before January 1, 2014, may be completed in accordance with the law then in effect."  N.C. Gen. Stat.  §57D-11-03(d)

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The "Bright Star" Fades: The NC Business Court On Letters Of Credit

I've resolved this year to blog about every numbered decision of the Business Court, as opposed to past years, where my lack of enthusiasm about the more boring decisions has left me writing about less than 100% of the Court's decisions.

My resolve was tested with Judge Murphy's decision last week in Speedway Motorsports Int'l , Ltd. v. Bronwen Energy Trading, Ltd., 2014 NCBC 5, but I have bitten the bullet and I have laboriously produced this post.

What's the new Speedway decision about?  A complicated international dispute over oil contracts, letters of credit, a guarantee of letters of credit, and claims for fraud, conversion, negligent misrepresentation, and unfair and deceptive practices.

You might remember the Bronwen case.  It's been pending in the Business Court since 2008 and has been up and back from the Court of Appeals over that 5+ years.  I wrote about the Court of Appeals decision affirming  the Business Court in 2011 (and reversing it in another decision issued at the same time).  In the affirming decision, the COA held that the "one bright star" in letter of credit transactions was that "every letter of credit involves separate and distinct contracts."

The effect of that ruling was that the COA affirmed the dismissal of claims against Defendant BNP-Suisse, which had issued a demand guarantee to BNP-France on a letter of credit issued by France.  The Suisse guarantee was secured by $12 million which Plaintiff had on deposit with Suisse.  When Plaintiff sued over the draw on its letter of credit with Suisse, France argued that the case was governed by a choice of forum provision in the Suisse guarantee calling for resolution in Switzerland.

The COA held that Plaintiff, which was not a party to the guarantee given by Suisse in connection with the letter of credit transaction,  was barred by the "independence rule"  from availing itself of the choice of forum provision because the contracts surrounding a letter of credit transaction must be "separate and distinct."

So in last week's ruling, France sought to push the COA ruling in support of a new motion for judgment on the pleadings.  France argued that Plaintiff couldn't make any claims at all against it based on its draw on the guarantee because the guarantee was "separate and distinct" from the obligations between Suisse and the Plaintiff.

That seems to fit with the independence principle, doesn't it?  Not the way Judge Murphy saw it. France might have prevailed if the claims against it were based in contract.  But they were tort-based claims, for fraud, negligent misrepresentation, conversion, unfair and deceptive practices, and for an accounting.

Judge Murphy therefore denied the Rule 12(c) claim, holding that:

The Court of Appeals’ description of the “independence principle” was grounded in principles of contract. See Speedway I, 209 N.C. App. at 564, 706 S.E.2d at 263; see also Speedway II, 209 N.C. App. at 485, 707 S.E.2d at 392. Specifically, the Court of Appeals was concerned with maintaining the separateness of the multiple contracts that are characteristic of letter of credit transactions. See id. However, nothing in the Speedway opinions shields a defendant from purely tort-based claims like those alleged by Plaintiff. See id. Furthermore, France cites no authority that forecloses non-contract, purely tort-based claims by application of the independence principle. The import of the independence principle is that France is not bound by and cannot seek the benefits of the contracts that Plaintiff made with others.

Op. 28 (emphasis added).

 

What Happens To A Covenant Not To Compete Upon The Sale Of A Business?

Be careful with covenants not to compete when you buy or sell a business.  That's the lesson from Amerigas Propane, LP v. Coffey, 2014 NCBC 4, decided this week by Judge Jolly.

The Plaintiff had Defendant Coffey, an employee of the company which it was acquiring, sign a "Confidentiality and Post-Employment Agreement" after the acquisition.  The Agreement contained a non-solicitation provision and a section protecting the buyer's "confidential information." 

The Plaintiff fired Coffey a year later, and he went to work for a competing propane company.

Plaintiff moved for a preliminary injunction enforcing the restrictive covenants, which was denied by the Court.

You all know that there must be consideration for a covenant not to compete.  Those types of agreements ordinarily are entered into at the start of an employment relationship, and the new employment itself constitutes the consideration.  In North Carolina, continued employment can't satisfy the consideration requirement.

So did the acquisition work a termination of Coffey's employment with the selling company so that he had a new employment with the buyer?

Here's where it gets interesting.  The type of acquisition makes a difference. If it had been an asset purchase it might have been a new employment which could have served as consideration. Judge Jolly observed that:

an employment contract signed at the time of a business acquisition may only use employment with the acquiring company as consideration if the old employment relationship is deemed terminated as a result of the transaction. In this regard, North Carolina courts previously have stated that acquisition of another company by asset purchase will act as a termination of existing employment relationships, and existing employees of the acquired business do not necessarily become employees of the acquiring entity.

Op. 5 (relying on Calhoun v. WHA Med. Clinic, PLLC, 178 N.C. App. 585, 597 (2006) (citing
QSP v. Hair
, 152 N.C. App. 174 (2002)); and Better Bus. Forms & Prods., Inc. v. Craver, 2007 NCBC 34 (2007) ("[W]hen an employer sells its assets . . . the employment relationship has been terminated." Id. ¶38.).

But an acquisition via a stock purchase (or by purchasing membership interests, as happened in this case) doesn't have the same effect.  It does not automatically terminate existing employment relationships "and therefore ordinarily will not constitute new employment for purposes of consideration."  Op. 6.

So the Plaintiff was left to argue that there was other consideration for the restrictive covenants, like "new benefits" made available to Coffey, and a raise in salary shortly after the acquisition.  Judge Jolly didn't buy that.  He found the "new" benefits to be essentially the same as Coffey would have received with the selling employer.