NC Business Court: Choice Of Law Dooms Trade Secrets Claim

What choice of law rule applies to trade secrets claims?  No North Carolina appellate court has answered that question, but Judge Robinson of the NC Business Court stepped into that breach in his Opinion in SciGrip v. Osae, 2018 NCBC 10.

The Plaintiff certainly didn't like the answer, as it resulted in the dismissal of its claim for the misappropriation of its trade secrets.

Defendant Osae had worked for the Plaintiff SciGrip for years developing its adhesive products.  He then left to join a competitor, Scott Bader, Inc. (SBI).  SciGrip sued both Osae and SBI in 2008 (in another lawsuit) for Osae's violation of confidentiality restrictions which he had signed while working for SciGrip.  That first lawsuit was settled via a Consent Order, which specified that Osae could not disclose SciGrip's confidential information, and that SBI could not use it.

SciGrip sued Osae again in 2013, after he had joined another company, EBS, which is also in the adhesives industry.  This is the case in the Business Court.  EBS had filed a provisional patent application regarding its adhesives in Europe.  SciGrip alleged that the patent application contained its trade secret information and that Osae was in violation of the Consent Order.

SciGrip also sued Osae for misappropriation of trade secrets.  It sued SBI as well.  SBI, based in the UK, moved for summary judgment on the basis that all of  the alleged misappropriation of trade secrets had occurred outside of the State of North Carolina, and that NC's Trade Secrets Protection Act does not apply to misappropriation that occurred outside of the State.  Osae had done all of his work for SBBI and EBS outside of the State of North Carolina.

The case turned on whether North Carolina's  law ought to apply to the trade secrets claim.  Plaintiff argued for the "most significant relationship" test, saying the North Carolina had the most significant relationship to the events leading to the misappropriation.

Judge Robinson went with SBI's argument, that the proper test was lex loci delicti.  "Under this test, the situs of the claim is the state where the injury or harm was sustained or suffered — the state 'where the last act occurred giving rise to [the] injury.'  Op. Par. 34.

So what was the last act causing harm to the Plaintiff?  Judge Robinson said that "[m]isappropriation occurs when defendant acquires, discloses, or uses another’s trade secret without the owner’s consent or authority."  Op. Par. 35.

Osae had worked for the Plaintiff in North Carolina when he acquired its trade secrets, so that would seem to be the end of the choice of law inquiry.  But Judge Robinson looked to a North Carolina federal court ruling, and decisions from other federal jurisdictions holding

that the lex loci delicti 'is  not the place where the information was learned, but where the tortious act of misappropriation and use of the trade secret occurred.'  Domtar AI Inc. v. J.D. Irving, Ltd., 43 F. Supp. 3d 635, 641 (E.D.N.C. 2014)(concluding that plaintiffs could not bring a claim under North Carolina’s TSPA because defendants’ alleged misappropriation occurred in Canada); 3A Composites USA, Inc. v. United Indus., Inc., No. 5:14-CV-5147, 2015 U.S. Dist. LEXIS 122745, at *10 (W.D. Ark. Sept. 15, 2015) (applying North Carolina conflict of laws rules and following the approach taken in Domtar); Chattery Int’l, Inc. v. JoLida, Inc., No. WDQ-10-2236, 2012 U.S. Dist. LEXIS 57512, at *12−13 (D. Md. Apr. 24, 2012) (applying the lex loci delicti rule and stating that “[m]isappropriation occurs where the misappropriated information is received and used, not necessarily where it was taken or where the economic harm is felt”). 

Op. Par. 35.

Under this standard, Osae's alleged misappropriation occurred either in the United Kingdom, where he had worked at SBI's facilities, or in Florida, where Osae had worked for EBS.

Judge Robinson ruled that Plaintiff could not bring a claim under North Carolina's Trade Secrets Protection Act, and granted summary judgment for the Defendants.

This means that claims for violations of NC's TSPA cannot be pursued (at least in the NC Business Court) for misappropriation occurring outside of the State.  I'm already hearing gloom and doom about this decision, but Plaintiff almost immediately noticed an appeal, so we will be hearing from the NC Supreme Court on this choice of law issue.  Probably next year.

And if you are outraged at Judge Robinson's blunting of the reach of the NC TSPA, remember that "state laws may not generally operate extraterritorially."  Carolina Trucks & Equip., Inc. v. Volvo Trucks of N.A., Inc., 492 F.3d 484, 489-90 (4th Cir. 2007).  So there is nothing unusual about Judge Robinson's unwillingness to extend the TSPA's reach to conduct taking place not only outside of North Carolina, but outside of this country.



"Holding All The Cards" And Fiduciary Duty Claims

It is hard to base your case on a breach of fiduciary duty when there is a contract in place between the parties.  Contracting parties owe no special duties to each other beyond the terms of the contract.  Branch Banking & Tr. Co. v. Thompson, 107 N.C. App. 53, 61, 418 S.E.2d 694, 699 (1992).

But the NC Business Court twice in January allowed fiduciary duty claims to survive when the relationship between the parties was based on a contract.  The cases are Austin v. Regal Investment Advisors, 2018 NCBC 3 and Can-Dev, ULC v. SSTI Centennial, LLC, 2018 NCBC 9.

Breach Of Fiduciary Duty Claim Against Investment Advisor Gets Past Motion To Dismiss

The Plaintiffs in the Austin case, who had invested funds with the Defendants acting as their investment advisors, sued when the individual Defendant (Barnes) persuaded them to invest in a sketchy venture.  A key claim against the investment advisors was for breach of fiduciary duty.

You probably think that an investment advisor stands in a fiduciary relationship to his client as a matter of law (a de jure relationship), but no NC appellate decision has so held.  Judge Robinson didn't see any need to take that step, and instead ruled that the facts alleged in the Complaint were sufficient at the Motion to Dismiss stage to support a de facto fiduciary relationship.  Op. 43.  He said:

that the Complaint’s allegations regarding the relationship between the parties, the amount of discretion given to Mr. Barnes and Regal to manage Plaintiffs’ investments, and the circumstances of the Triton investment, together with the allegations that Plaintiffs, who were not sophisticated investors, relied on Mr. Barnes and Regal for their financial expertise to manage their investment accounts, are sufficient at the Rule 12(b)(6) stage to plead the existence of a de facto fiduciary relationship.

Op. 43.

Breach Of Fiduciary Duty Claim Survived Motion For Summary Judgment When Contracting Party "Held All The Cards"

So does it get tougher to get beyond the summary judgment stage when you are claiming a de facto fiduciary relationship?  It didn't for the Plaintiff in the Can-Dev decision. That Plaintiff had entered into a joint venture deal with the Defendants to develop self-storage facilities in Canada.  The contractual relationship was carefully detailed, and Judge Robinson noted the well accepted principle that 

parties to a contract do not thereby become each others’ fiduciaries; they generally owe no special duty to one another beyond the terms of the contract[.]

Op. 40 (quoting Branch Banking & Tr. Co. v. Thompson, 107 N.C. App. 53, 61, 41, 8 S.E.2d 694, 699 (1992)).

He then observed that:

the existence of a contract does not foreclose the possibility that a contracting party may repose trust and confidence in the other party, beyond the terms of the contract, such that the other party, in equity and good conscience, becomes bound to act in good faith and with due regard to the interests of the one reposing confidence.

Op. 40.

The standard for proving a de facto fiduciary relationship "is a demanding one."  Op. 37.  The NC Court of Appeals has said that "[o]nly when one party figuratively holds all the cards — all the financial power or technical information, for example — have North Carolina courts found that the special circumstance of a fiduciary relationship has arisen.” Lockerman v. S. River Elec. Membership Corp., 794 S.E.2d 346, 352 (2016).

Plaintiff Can-Dev got over that hurdle  (and at the summary judgment stage, which is all the more impressive).  The Defendants had taken over control of the development projects which were the subject of the contracts, and had failed to provide financial information regarding the projects to the Plaintiff.  Plaintiffs argued, successfully quoting the Court of Appeals' decision in Lockerman, that this "resulted in Defendants “literally ‘[holding] all the cards — all the financial power [and] technical information[.]’”

                                                                          * * *

This isn't the end of the road for the Plaintiffs in either of these cases.  They still have to prove their claims at trial, because whether a de facto fiduciary relationship exists it is "is generally a question of fact for the jury.”  Can-Dev at 40.

I should note that the Plaintiffs in the Austin case (the investment advisor case) are represented by Brooks Pierce lawyers Clint Morse and Jessica Thaller-Moran.



A Case Doesn't Have To Be "Complex" To Be Designated To The NC Business Court

The North Carolina Business Court sent a message to all lawyers practicing in the Business Court last week in Barclift v. Martin, 2018 NCBC 5.  Judge Gale said in the ruling that:

The  Court is publishing this Order & Opinion to provide guidance to the practicing bar on the statutory process for designating a case as a mandatory complex business case and to clarify apparent misconceptions regarding the requirements for designation.

Op. Par. 1 (emphasis added).

Barclift, contesting the Defendants' designation of his case as a "complex business case," argued that there was nothing complex about his case, and that it could be handled by a regular (non-Business Court) Superior Court Judge.

The "apparent misconception" referenced by Judge Gale?  That a case has to be complex in order to be designated to the Business Court.  The source of the supposed need for complexity stems from Rule 2.1 of the General Rules of Practice, which says that "the complexity of the evidentiary matters and legal issues involved" should be considered in the process of getting a case into the Business Court.

Rule 2.1 isn't totally obsolete as a method for getting a case to the Business Court, but most cases (like the Barclift case) are designated there by way of G.S. sec. 75A-45.4.  A Rule 2.1 designation involves persuading a Superior Court Judge in the County in which the case was filed that it should be a "complex business case."  The factors included in making that persuasion include its complexity.  The "local" Judge, upon being persuaded that the case should be handled by a "Superior Court Judge for Complex Business Cases", (i.e. a "Business Court Judge") then makes a recommendation to the Chief Justice of the NC Supreme Court that he or she so designate the case. Those recommendations are usually rubber stamped and the case lands in the Business Court.

The practice under Section 7A-45.4 is much more streamlined and far more automatic.  The statute lists six categories of cases that can be designated to the Business Court so long as they raise a "material issue."  "Complexity" is not necessary for these cases.

Is this ruling about the lack of a need for complexity in a 7A-45.4 designation something new from the Business Court?  Not at all.  Judge Tennille said in a ruling, over ten years ago, pretty much the same thing.  He held in Johnson v. Johnson, an unpublished Order from 2007, that:

complexity or the lack thereof is not an issue under section 7A-45.4. Section 7A-45.4 simply requires that the action involves a material issue related to at least one of six subjects, including “[t]he law governing corporations” and “issues concerning governance” and “breach of duty of directors.” N.C. Gen. Stat. § 7A-45.4(a)(1).

Order at 1 (emphasis added).



You Don't Want Your Confidentiality Agreement Evaluated Like A Non-Compete Agreement

You probably think that you can avoid having a confidentiality agreement struck down by an NC court because it doesn't have to meet the stricter standard applied to non-compete agreements.

The NC Business Court's Opinion this month in Duo-Fast Carolinas,, Inc. v. Scott's Hill Hardware & Supply Co., 2018 NCBC 2 may get you thinking differently.

The validity of a non-compete often turns in part on whether the restriction is "reasonable as to time and territory, and designed to protect a legitimate business interest of the employer."  See, e.g., A.E.P. Indus., Inc. v. McClure, 308 N.C. 393, 402–03, 302 S.E.2d 754, 760 (1983).

But a confidentiality agreement is enforceable "even though the agreement is unlimited as to time and area, upon a showing that it protects a legitimate business interest of the promisee.” Chemimetals Processing, Inc. v. McEneny, 124 N.C. App. 194, 197, 476 S.E.2d 374, 376 (1996).

In Duo-Fast, Judge McGuire found a confidentiality agreement to be invalid because it was not reasonable as to time and territory, in Duo-Fast Carolinas,, Inc. v. Scott's Hill Hardware & Supply Co., 2018 NCBC 2.  Wait, what about Chemimetals, which says that confidentiality agreements don't need to be limited as to time and territory.?

The individual Defendant in Duo-Fast, Modero,had been an outside sales representative for the Plaintiff.  He had signed an Employment Agreement saying that he would "not make known to any person. . . the contents of any customer lists."  There was no time limit on this restriction. 

Modero kept Plaintiff's customer information in his personal Yahoo email account.  Op. ¶¶5, 9.  After he left Plaintiff and began working as a sales representative for the Defendant, a direct competitor, Modero contacted some of his former customers using his Yahoo information.

Plaintiff made a number of claims against Modero and his new employer, including a claim for breach of the confidentiality provision of the Employment Agreement.  Judge McGuire ruled that provision to be unenforceable.  He found that "the non-disclosure provisions do not serve Plaintiff’s legitimate business interests, but rather seek to prevent Medero from soliciting Plaintiff’s customers in restraint of trade."  Op. 46.

Analyzing the "confidentiality provision" as a restrictive covenant, the Business Court concluded that:

prohibiting Medero’s use or disclosure of Plaintiff’s customer identities is overbroad. The non-disclosure provisions are not limited as to time, but rather are perpetual.  Such a restraint would prevent Medero from ever using the names  and contact information of Plaintiff’s customers.  Insofar as the non-disclosure provisions seek to prevent Medero from soliciting Plaintiff’s customers, they constitute an unenforceable restrictive covenant.

Op. 47.

What probably harmed Plaintiff's case was that the identities of its customers weren't confidential at all.   They were "readily ascertainable" by visiting construction sites and speaking to contractors.  Op. ¶45.

Plaintiff did not come out well in its lawsuit.  Judge McGuire found a separate non-compete provision to be unenforceable and dismissed all of Plaintiff''s claims.



NC Business Court Approves Another Disclosure Only Class Action Settlement

Judge Gale's approval last week of a class action settlement, in In re Krispy Kreme Doughnuts, Inc. Shareholder Litigation, 2018 NCBC 1 gives me another opportunity to rail against disclosure only settlements.  You know that I don't like them.  If you don’t know that, I’ve written on this subject several times. Like here, here, and here.

The Krispy Kreme shareholder class litigation followed what has become the inevitable path for almost every merger deal.  The transaction was announced on May 9, 2016.  Seven shareholder lawsuits alleging that the Krispy Kreme board members had breached their fiduciary duties in agreeing to the transaction (five in NC state courts and later consolidated in the NC Business Court) followed in the next month.

The plaintiff shareholders filed a motion for a preliminary injunction blocking any shareholder vote on the transaction until supplemental disclosures in Krispy Kreme's proxy statement were made.  The very next day, in connection with a settlement agreement, Krispy Kreme filed a Form 8-K to supplement its proxy statement.  The shareholder vote went ahead on July 27th, with 95% of those voting approving the deal.

The value of those additional disclosures was assessed by Judge Gale in determining whether to approve the settlement.  As the Opinion didn't consider the amount of attorneys' fees to be awarded to Plaintiffs' class counsel (there has not yet been an application for fees), Judge Gale assessed the "give and the get" of the "give" of the release by the class against the materiality of the additional disclosures (the "get").

North Carolina assesses materiality based on the U.S. Supreme Court's definition of that term in TSC Industries, Inc. v. Northway, 4266 U.S. 48 (1976).  The holding in TSC Industries was:

[a]n omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote. . . .It does not require proof of a substantial likelihood that disclosure of the omitted fact would have caused the reasonable investor to change his vote. What the standard does contemplate is a showing of a substantial likelihood that, under all the circumstances, the omitted fact would have assumed actual significance in the deliberations of the reasonable shareholder. Put another way, there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the “total mix” of information made available.

 Id. at 449.

 Okay.  Let's assume that I am a reasonable investor looking at the Krispy Kreme supplemented proxy.  Would the supplemental disclosures obtained through the blood and sweat of Plaintiffs' counsel have "significantly altered the 'total mix of information made available" to me in the original proxy? 

I don't think so.

First, "[t]he Supplemental Disclosures included the specific projected unlevered, after-tax free cash flows of Krispy Kreme for the remainder of 2017 and for the fiscal years 2018 through 2023,as derived from the financial projections provided to Wells Fargo by Krispy Kreme management."  This disclosure was designed to deal with the lack of disclosure of Krispy Kreme’s specific projected unlevered after-tax free cash flows Wells Fargo used in its DCF analysis."  Op.  

That would not change the mix of information before me because it is actually meaningless to me,  Unlevered?  Come on.  What?  I don't have a clue what that supplemental disclosure means.  Maybe a hedge fund manager or an MBA student focusing on finance would.  But they would be too knowledgeable to be considered "reasonable investors". 

Class counsel argued that the differences between the discounted cash flow analyses, while "slight in any particular year" that "the differences over time have greater significance."  Op. ¶58.  Judge Gale accepted that as "a reasoned argument that some shareholders might have found" that the Supplemental Disclosure regarding the DCF analysis was material."  Op. ¶58. 

The next supplemental disclosure has a little more meaning to me.  It was in response to Plaintiffs complaining that the original Proxy did not disclose whether the Krispy Kreme board "had discussed post-Merger employment opportunities at the inception of merger negotiations."  Op. ¶52.


 In a less than stunning supplemental disclosure, the Defendants added this nugget of questionable value:


that Krispy Kreme board members, in preliminary discussions about a potential merger . . . discussed [the buyer's] 'history or managing its portfolio companies for long-term growth and relying on company management to run the business.'

Op. ¶52.

So board members also employed by Krispy Kreme might have been influenced to vote in favor of the transaction because they might keep their jobs?  That speculation makes no difference to me.  And how many board members served in company management?  Did they have excessively rich employment contracts being drafted with the buyer of Krispy Kreme's assets?  Were their votes essential to the approval of the deal? 

Another supplemental disclosure concerned the previous relationship of Wells Fargo -- the investment banker on the deal --- to Krispy Kreme and its acquiror. 

The supplemental disclosures revealed that in the two years before the deal was struck, Krispy Kreme had paid Wells Fargo $300,000 for "investment banking services" and that an affiliate of the buyer had paid Wells Fargo $1 million "in connection with corporate loans."  Op. 52.

Would that have caused reasonable investor me to discount Wells Fargo's analysis of the transaction because they were tainted by their previous receipt of fees?  No.  $1.3 million doesn't carry the influence that it used to.

There's at least one other Krispy Kreme ruling imminent from the Business Court.  That will be the ruling on the fee application from the Plaintiff class' lawyers.  I will be watching for that.

I should probably disclose that I prefer Dunkin’ Donuts over Krispy Kreme.


NC Business Court On Conversion Of Electronic Data

The Defendant in SQL Sentry, LLC v. ApexSQL, LLC, 2017 NCBC 105 was alleged to have copied the Plaintiff's software program which was designed to make "resource intensive T-SQL queries. . . in the Microsoft enterprise database platform, SQL Server."  Op. Par. 5.  (Ask your IT person).

Adding insult to injury, the Defendant marketed the program it had copied under the same trademark used by the Plaintiff  to sell its competing program ("Plan Explorer"). 

So, when representatives of this Plaintiff walk into your office, what claims do you fire off in your Complaint against that thieving Defendant?  Trademark infringement, obviously.  How about a claim for conversion?

Maybe.  Electronic data is personal property, so it falls into the category of property which is subject to a claim for conversion.  Op. ¶14.

But the Plaintiff ran into a problem with its conversion claim.  It still had full access to its software, and that killed its conversion claim.

The NC Business Court has repeatedly "held that making a copy of electronically-stored information which does not deprive the plaintiff of possession or use of information, does not support a claim for conversion.” Op. ¶15 (citing RCJJ, LLC v. RCWIL Enters., LLC, 2016 NCBC 44, ¶67; accord New Friendship Used Clothing Collection, LLC v. Katz, 2017 NCBC 71, ¶77; Strategic Mgmt. Decisions, LLC v. Sales Performance Int'l, LLC, 2017 NCBC 68, ¶18; Addison Whitney, LLC v. Cashion, 2017 NCBC 50, ¶39.

Trying to fit a 21st century development like ESI into a tort like conversion, which has been around since the 1500's, is like trying  to fit a round peg into a square hole.

If you are insistent on including a conversion claim in your lawsuit over improper copying of electronic data, you might do better suing in federal court.  The United States District Court for the Western District of North Carolina has recognized such a claimBridgetree, Inc. v. Red F Marketing, LLC, 3:10CV228-FDW, 2013 WL 443698 (W.D.N.C. Feb. 5, 2013).

But avoid the NC Business Court.


Nc Business Court Stretches NCRCP 14 to Allow New Third Party Defendants To Be Added Years After The Commencement Of Litigation

The North Carolina Rules of Civil Procedure are fairly identical to the Federal Rules of Civil Procedure.  In fact, I am hard pressed to think of any substantial differences.

But the lack of one word contained in FRCP 14 -- "original" -- but omitted from the parallel NC Rule made all the difference in the NC Business Court's Opinion in AP Atlantic, Inc. v. Crescent University City Ventures, LLC, 2017 NCBC 91.

The case had to do with Plaintiff AP filing a third party complaint against multiple Defendants after Defendant Crescent University amended its Answer and counterclaim.  Big deal, you are probably thinking.  Rule 14 says that you can add as a third party Defendant anyone who "is or may be liable" to that party.  It is designed to "promote judicial efficiency and the convenience of parties by eliminating circuity of action . . . by consolidating [all] suits into one action."  Op. ¶26 (quoting Heath v. Board of Comm’rs, 292 N.C. 369, 376, 233 S.E.2d 889, 893 (1977)(quoting Charles Alan Wright et al., Federal Practice and Procedure § 1442 (1971)).

What made the AP Atlantic case unusual was that the counterclaim against AP which entitled it to add third party defendants who "were or might be liable to it" was first made in January 2016.  It wasn't until a year and a half later (in July 2017), when Crescent amended its counterclaim, that AP made its third party complaint against thirteen new third party defendant subcontractors.

AP Did Not Need The Permission Of The Court To File Its Third Party Complaint

Defendant Crescent said that AP needed to leave of court to make its third party complaint.  Crescent, relying on NCRCP 14, disputed that it had needed leave of court.  North Carolina's Rule 14 says:

At any time after commencement of the action a defendant, as a third-party plaintiff, may cause a summons and complaint to be served upon a person not a party to the action who is or may be liable to him for all or part of the plaintiff's claim against him. Leave to make the service need not be obtained if the third-party complaint is filed not later than 45 days after the answer to the complaint is served.

N.C. R. Civ. Pro. 14(a)(emphasis added).

The third party complaint adding the thirteen new parties was filed 21 days after the Answer amending the counterclaim against AP.  Timely?  Not under federal Rule 14, which says that:

the third-party plaintiff must, by motion, obtain the court's leave if it files the third-party complaint more than 14 days after serving its original answer.

FRCP 14(a)(1)(emphasis added).

The absence of the word "original," or any reference to amended pleadings in NCRCP 14, led Judge Bledsoe to rule that the words "answer to the complaint" in NCRCP 14 were ambiguous.  Op. ¶18.  He then embarked on an effort to determine the intention of the North Carolina Legislature in adopting a rule that did not parrot the "original answer" language of FRCP 14.

It Was Fundamental To The Court's Decision That The NC Legislature Is Presumed To Know Everything

He started with the proposition that:

Because North Carolina’s rule was first enacted in 1967, and because the Court must presume the legislature acted with full knowledge of prior and existing law, the Court must presume that the legislature knew of the language in Federal Rule of Civil Procedure 14 and — and continues to make — a deliberate decision not to use it in North Carolina’s rule.

Op. ¶21.

The presumption that the NC Legislature was omniscient and well versed in the Federal Rules of Civil Procedure is not something that Judge Bledsoe created out of thin air.  The North Carolina Supreme Court has said many times that "[i]t is always presumed that the legislature acted with care and deliberation and with full knowledge of prior and existing law."  See, e.g., State v. Benton, 276 N.C. 641, 174 S.E.2d 793, 805 (1970).

Judge Bledsoe moved on to considering the meaning of the words "original answer" in the federal rule, concluding that it "would be the first or earliest answer filed in a lawsuit, as no answer would have been filed before it."  Op. ¶23. It follows from that proposition that North Carolina's version of Rule 14 doesn't make a distinction between original or amended pleadings.  Op. ¶23.

So, AP was allowed to amend its third party complaint -- without leave of Court -- to add more than a doen new parties to the case well more than a year after the case was first filed.

Judge Bledsoe obviously had some uneasiness about this ruling, saying that he made his decision "reluctantly."  Op. ¶23.



NC Business Court Rules On What Constitutes An "Arbitration"

You've probably never had to decide what it means to agree to arbitrate.  Usually, there is a written provision that references the AAA Rules and includes a consent to AAA's procedures as to the appointment of the arbitrator(s) and the conduct of the procedure. And most usually, the word "arbitration" is used in the provision.

Lately, however, the NC Business Court wrestled with two cases in which there was no provision referencing the AAA, no mention of the words "arbitrate" or "arbitration" but only a provision deferring resolution of some financial issues to an accountant.

The more recent one is Martin & Jones, PLLC v. Olson, 2017 NCBC 85.  The earlier case (unpublished) is Post v. Avita Drugs, LLC.  It is worth it to me to point out that I would not have known about the Post decision if it wasn't referenced in the Martin & Jones decision.  Back before the Business Court revamped its filing system, my software program would have caught the Post decision.  Now?  Not possible.  I hate that new filing system.  Maybe those of you filing cases in the Business Court like it.

Anyway, having vented and now feeling a little better, I can turn to the Post decision.  Post had sold his business to Defendant Avita.  The purchase price included an deferred earnout payment based on "six times (6x) the difference between (a) Adjusted EBITDA and (b) $925,000.

After the sale was completed, Post disputed Avita's calculation of Adjusted EBITDA.  He contended that Avita had depressed the amount of the Adjusted EBITDA by using improper accounting standards.

A Dispute Can Be "Arbitrated" By An Accountant If The Procedure Resembles "Classic Arbitration"

The Stock Purchase Agreement specified how a dispute over Adjusted EBITDA should be resolved. It said that:

the determination of Adjusted EBITDA shall be submitted promptly to [an] Independent Accountant for determination in accordance with this Agreement and the determination of the Independent Accountant shall be binding and conclusive for the purposes of this Agreement absent manifest error by the Independent Accountant” (the “Independent Accountant Process”).

After Post sued Avita, Avita moved to stay the case pending the resolution of the "Independent Accountant Process."  It made that Motion per G.S. §1-569.7, which is a motion to compel or stay arbitration.

As Judge Conrad concisely framed the issue, it was "whether [the] independent accountant process is an 'arbitration.'" Order ¶2.  You might think that the Federal Arbitration Act, which governed that issue, would contain a definition of "arbitration,"  but it doesn't.  Judge Conrad, looking to federal court decisions on whether an agreed dispute resolution procedure fit the definition of arbitration, held that:

courts routinely consider 'how closely the specified procedure resembles classic arbitration.' Fit Tech, Inc. v. Bally Total Fitness Holding Corp., 374 F.3d 1, 7 (1st Cir. 2004).  The question is whether the agreement exhibits the 'common incidents of arbitration': a final determination by 'an independent adjudicator,' 'substantive standards,' 'and an opportunity for each side to present its case.' Id. at 7.

Order ¶13 (emphasis added).

Judge Conrad found that the terms setting out the Independent Accountant Process met the standard of "classic arbitration."  The parties had agreed to a "binding and conclusive" determination.  The agreement required the application of "substantive standards" via a definition in the Stock Purchase Agreement of how Adjusted EBITDA should be calculated.  Furthermore each side was afforded the opportunity to present whatever written materials it deemed relevant.  Order ¶¶14-15.

This Procedure Did Not Resemble "Classic Arbitration"

The result was different in the second Business Court decision, Martin & Jones, which was a dispute among former law firm partners regarding the amount to be paid to the Plaintiff for his retirement benefits per the law firm''s Operating Agreement.  That agreement, like the agreement in the Post case, called for the involvement of an accountant if there was disagreement.  It said that:

in the event of a dispute among the Members with respect to the determination of the net cash flow, net profit, net losses or capital account balances of the Law Firm, an independent certified public accountant shall be engaged by the Law Firm at the Law Firm’s expense whose computation of such items shall be binding upon all the Members.

Op. Par. 15.

The two flaws in the argument that this accountant-oriented provision should be treated as an arbitration as pointed out by Judge McGuire were that:

the Operating Agreement does not set forth any 'substantive standards' such as procedural guidance for selecting the independent CPA,or the method by which the independent CPA will make a determination. Furthermore, the Operating Agreement does not state whether, or how, each side will have the 'opportunity  . . .  to present its case.'

Op. Par. 19.

So if you want a CPA to be acting as the arbitrator of a dispute arising under a document that you drafted, set the appropriate rules of a "classic arbitration."


Demand Futility Isn't Dead For Derivative Actions Against Non-Profit Corporations

You probably thought that you would never again have to argue that a demand on a corporation's board of directors before filing a derivative action should be excused because it would have been futile. 

That's because the North Carolina Legislature amended NC corporate law in 1995 to make clear that a demand on the corporation to take action is an essential prerequisite to the filing of a derivative action.  Section §55-7-42 of the General Statutes, as amended twelve years ago, says that a shareholder "may not commence a derivative proceeding" without having made a written demand "upon the corporation to take suitable action."  In other words, there is no excuse for not making a pre-filing demand.

But demand futility was alive and directly before the Business Court last week in Finley v. Brown, 2017 NCBC 78.

It's easy to forget that there is an entire set of statutes that apply to non-profit corporations (Chapter 55A of the North Carolina General Statutes) than to "business corporations" (Chapter 55 of the North Carolina General Statutes).  The lawsuit in Finley involved a non-profit corporation: the Finley Foundation.

Before the Legislature amended the demand requirement in Chapter 55 in 1995, the parallel provision regarding demand applicable to non-profit corporations (N.C. Gen. Stat. §55A-7-40) was virtually identical to its "business corporation" partner.  That unamended statute applicable to non-profit corporations says that:

(b) The complaint shall allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors or comparable authority and the reasons for the plaintiff's failure to obtain the action or for not making the effort.

The North Carolina appellate courts had made it pretty clear, before the amendment, that a demand on a business corporation before filing a derivative action could be excused if it would have been futile.  Op. 26-27 (citing Norman v. Nash Johnson & Sons’ Farms, Inc., 140 N.C. App. 390, 409, 537 S.E.2d 248, 261 (2000); Roney v. Joyner, 86 N.C. App. 81, 84, 356 S.E.2d 401, 403 (1987); Seaboard Air Line R.R. v. Atl.Coast Line R.R., 240 N.C. 495, 515, 82 S.E.2d 771, 785 (1954)).

So, looking at the "old" law applicable to for-profit corporations, Business Court Judge Bledsoe ruled that the Plaintiff had established that a pre-lawsuit demand would have been futile.

This Plaintiff, a board member of the Finley Foundation did a pretty good job of showing why it would have been futile to make a demand on the four Foundation directors he was suing.

He was attacking them for violating their fiduciary duties, saying that they had "grossly mismanaged the Foundation, and unjustly enriched themselves . . . , by, among other things, failing to prudently manage the assets of the Foundation, incurring unnecessary expenses, paying themselves excessive compensation, and dishonoring Mr. Finley’s intent as the donor of charitable gifts to the Foundation."  Op. ¶12.

Given that the Defendants were direct participants in the conduct that Plaintiff Finley was complaining of, especially in controlling their allegedly "excessive compensation," Judge Bledsoe agreed that the Plaintiff had pled enough to establish that a demand on them to take action would have been futile.

NC Legislature Decides To Legislate Choice Of Law Provisions In "Business Contracts"

The North Carolina General Assembly has decided to legislate choice of law in commercial transactions.  The new statute, enacted in June, is called the "North Carolina Choice of Law and Forum in Business Contracts Act." It will be codified at N.C. Gen. Stat. §1G-1.

The Statute Applies Only To "Business Contracts"

The statute applies only to "business contracts."  That term is defined as: "[a] contract or undertaking, contingent or otherwise, entered into primarily for business or commercial purposes."  Specifically excluded from that definition are "consumer contract[s] or . . .. employment contract[s]."  N.C. Gen. Stat. §1G-2(1).  If you had any doubt about what constitutes a "consumer contract," that term is defined as well.  It is "[a] contract or undertaking, contingent or otherwise, entered into by an individual primarily for the individual's personal, family, or household purposes."  N.C. Gen. Stat. §1G-2(2).

It seems like the General Assembly could have gone without bothering to define an "employment contract," but it didn't.  An "employment contract" is "A contract or undertaking, contingent or otherwise, between an individual and another party to provide labor or personal services by that individual to the other party, whether the relationship is in the nature of employer-employee or principal-independent contractor."  N.C. Gen. Stat. §1G-2(3).

So, what are the benefits extended to those who are party to a "business contract"?  The short answer is that they can choose North Carolina law to govern their contracts and they can select North Carolina as a forum to resolve their disputes.  You might be thinking: "big deal, couldn't they do that anyway"?

This Represents A Big Shift In NC Law On Choice Of Law Provisions

Before the new statute, you were always subject to the opposing party who had agreed to apply NC law being able to squirm out of its commitment.  The opposing party could do that by saying that North Carolina was improperly chosen as the State's law which should apply -- because the dispute does not bear a "reasonable relation" to this State, or could also argue that the application of North Carolina's law would violate a "fundamental policy" of the State whose law would apply in the absence of the choice of law provision (call that the "public policy exception") .

Those arguments have long been recognized by NC appellate courts. See below 

The new statute does away with those types of attacks on a choice of law provision. It says that parties to a business contract may agree that North Carolina law will govern their relationship:

whether or not any of the following statements are true:

(1) The parties, the business contract, or the transaction that is the subject of the business contract bear a reasonable relation to this State.

(2) A provision of the business contract is contrary to the fundamental policy of the jurisdiction whose law would apply in the absence of the parties' choice of North Carolina law.  

N.C. Gen. Stat. §1G-3(a)(emphasis added).

The approach of the new statute is directly contrary to what the widely accepted doctrine is on the validity of an agreement to apply the law of a particular State.  The North Carolina appellate courts have long followed the principles set out by the Restatement (Second) Conflict of Laws §187. See, e.g., Behr v. Behr, 46 N.C. App. 694, 266 S.E.2d 393 (1980); Cable Tel Services, Inc. v. Overland Contracting, Inc., 154 N.C.App. 639, 574 S.E.2d 31 (2002). The Restatement says that choice of law should be deemed invalid for the reasons that are permitted in the new statute.  It says that a choice of law provision should not be applied if:

(a) the chosen state has no substantial relationship to the parties or the transaction and there is no other reasonable basis for the parties' choice, or

(b) application of the law of the chosen state would be contrary to a fundamental policy of a state which has a materially greater interest than the chosen state in the determination of the particular issue and which, under the rule of [section] 188, would be the state of the applicable law in the absence of an effective choice of law by the parties.

Restatement (Second) Conflict of Laws §187.

Why Did We Need This Statute?

Did North Carolina need its Legislature to intrude in this area of the law?  According to the Business Law Section of the North Carolina Bar Association, there were "many sound reasons" for the legislation.  Those are detailed in a Report from the Legal Opinion Committee of the Business Law Section.

They seem to boil down to making North Carolina more "business friendly."  The report says:

The General Assembly’s enactment of statutes that give effect to choice of North Carolina law and forum provisions in business contracts will enhance the perception of North Carolina as a business friendly state. Businesses are attracted by such freedom and clarity, and the proposed legislation will provide certainty to businesses and the attorneys who counsel them as to the applicability of North Carolina law and the ability to have disputes resolved by North Carolina courts. Such legislation will, in effect, place North Carolina on an equal footing with states such as Delaware, New York, Illinois and California.

Report at 4.

Every one of the States mentioned in the Report have legislated that choice of law provisions are valid even if the matter has "no reasonable relation" to that State.  Delaware's statute is here, New York's is  here, Illinois' is here, and California's is here.

Will this statute be enough to make North Carolina the choice of lawyers as the State within which to incorporate, or whose law to choose, as opposed to Delaware?  Or New York, Illinois, and California? I doubt it, but it is probably at least a step in that direction.

But none of the four States mentioned in the Report have included in their statute a provision rejecting the public policy exception.

Effective Date And A Question

Drafters of business contracts don't need to do anything to revise previously drafted choice of law provisions.  The new statute says that it "is effective when it becomes law and applies to business contracts entered into before, on, or after that date."

I have at least one question about the force of this statute.  Although the title of the statute professes to "validate choice of North Carolina law and forum [selection] provisions in business contracts," the operative provision of the statute does not use the word "validate" or to make any suggestion that they must be enforced. It says simply that the parties to a business contract "may agree" that North Carolina law will control their relationship. 

You will note that I did not discuss the "choice of forum" aspect of this statute at all.  The choice of law part was much more interesting to me.