What Are Your Options When You Think That Your Arbitrator Has Gone Out Of Control?

You don't have many options when you think that the arbitrator who you agreed to hear your case has delivered a plainly wrong arbitration award.  In fact, you probably have none at all.

The Defendants in the NC Business Court's recent decision in Trilogy Capital Partners,, LLC v. Killian, 2015 NCBC 103 were left stuck with a $4 million plus Award against them, despite their argument that the Arbitrator had exceeded his authority in making that Award.

The North Carolina Revised Uniform Arbitration Act

These parties had been arbitrating pursuant to the North Carolina Revised Uniform Arbitration Act, which provides only narrow grounds for vacating an arbitration Award.  The reasons include that the arbitrator ""exceeded the arbitrator's powers." The entire list is contained in Section 1-569.23 of the General Statutes.

It's Not Enough That The Arbitrator Just "Got It Wrong"

The Defendants argued that the Arbitrator awarded greater damages than those permitted under the North Carolina Limited Liability Company Act.

Judge McGuire disagreed that this was a basis for vacating the Award and held that:

even if the Arbitrator awarded damages outside of those available under the statute, such an award amounts to no more than an error of law insufficient to vacate the Award.

Op. ¶34.

Arbitrators Do Not Have To Follow The Law

But even if North Carolina law had limited the Arbitrator in the amount he was permitted to award, that made no difference.

Judge McGuire held that arbitrators:

'are not bound to decide according to law when acting within the scope of their authority, being the chosen judges of the parties and a law unto themselves, but may award according to their notion of justice and without assigning any reason.'

Op. ¶33 (quoting Bryson v. Higdon, 222 N.C. 17, 19-20 (1942)).

This Deference To The Decisions Of Arbitrators Is Not A Recent Development

This hands-off approach to the decisions of arbitrators -- even if they don't follow the law and are completely wrong -- is nothing new.

In 1895 (that's right. 120 years ago!), the NC Supreme Court held that:

[i]f an arbitrator makes a mistake, either as to law or fact, it is the misfortune of the party, and there is no help for it.  There is no right of appeal, and the Court has no power to revise the decisions of judges who are of the parties own choosing.

Patton v. Garrett, 116 N.C. 497, 504 (1895)(quoted in Op. ¶34)(emphasis added).

The Federal Arbitration Act

Do you have a greater chance of averting the effect of a wrongly decided arbitration Award under the Federal Arbitration Act?

Probably not.  The grounds for vacating an Award per the FAA are contained in 9 U.S.C. §10.  They are pretty congruent with the grounds enumerated in the state statute.

Federal courts used to recognize "manifest disregard of the law" as an additional common law basis for vacatur, but that ground for challenging an Award was cast into doubt by the United States Supreme Court in Hall Street Associates, LLC v. Mattel, Inc., 552 U.S. 576 (2008) in which the Court said that the grounds set forth in the statute are exclusive.

There is an additional basis in the federal statute for "modification or correction of an award."  Section 11 of the FAA says that a Court may do so if "there was an evident material miscalculation of figures."  10 U.S.C. §11(a).

The Plaintiff in the case before Judge McGuire might have taken a run at a "material miscalculation of figures" argument if the FAA were applicable.  But that argument would likely not have succeeded, given that the argument was more that the award of damages wasn't warranted under the law as opposed to a "miscalculation."


NC Business Court Turns 100

The Business Court turned out its one hundredth published (numbered) opinion of 2015 at the end of last week.  It came in the form of a tax case, in Home Depot U.S.A., Inc. v. North Carolina Dept. of Revenue, 2015 NCBC 100.

How much of a milestone ruling is this?  It marks the first time that the Business Court has delivered one hundred opinions in a year.  That's way more than the opinions issued by the Court in its early years (like in 1996, the Court's second year: 2 opinions, 1997: 5 opinions, 1998: 4 opinions).  Its most productive year before this year was 2014: 73 opinions.

You might be wondering how those 100 opinions compare to the production of the Delaware Court of Chancery.  That Court has already rendered more than twice the number of opinions of the Business Court, 237.  Well, there are five Judges (Chancellors) on that Court and only three active Judges on the Business Court.

And don''t forget that the Court of Chancery is way older (founded in 1792) than the Business Court (founded in 1995).

The Case Was About A Sales Tax Refund Based On The "Bad Debt Deduction"

Home Depot was seeking a refund of some of the sales tax which it had paid to the Department of Revenue (DOR). It said that it was entitled to a bad debt deduction against its gross sales, the amount on which sales tax is calculated.  The requested bad debt deduction for 2004-07 was nearly $2 million.  Op. ¶7.

The applicable statute says that a retailer can deduct from its gross sales "[a]ccounts of purchasers, representing taxable sales, on which the tax imposed by this Article has been paid, that are found to be worthless and actually charged off for income tax purposes."  N.C. Gen. Stat. §105-164.13(15).

Private Label Credit Cards

The bad debts which Home Depot was seeking to deduct were unpaid amounts on Home Depot's Private Label Credit Cards (PLLCs)(credit cards branded with Home Depot's colors and logo, usable only at Home Depot).

If a Home Depot customer does not pay his or her PLLC bill, doesn't Home Depot suffer a bad debt which it should be allowed to deduct from its gross sales?

You would think the answer should be "yes," but first you need to get into the business of PLLCs.  Home Depot doesn't actually extend the credit which its customers enjoy on their cards.  Home Depot, like many other companies that issue PLLCs, farms out the administration of its PLLC program to third party lenders.  In Home Depot's case, the lenders were General Electric Capital Financial, Inc., and Monogram Credit Card Bank of Georgia,  Op. ¶20(5).

The third party banks owned the PLLC accounts.  The banks settled up with Home Depot at the end of each day, paying Home Depot the amount charged by the customer less a service fee.  Op. ¶20(16-17).  The bank, not Home Depot, bore the risk of non-payment.

This case represents one of a number of cases where Home Depot has sought a state sales tax refund based on a bad debt deduction.  Home Depot has apparently not won a single one of these cases. The states where Home Depot has made the same arguments as in North Carolina and lost include: Alabama (Magee v.. Home Depot U.S.A., Inc., 230 So.3d 781 (Ala. App. 2011); Arizona (Home Depot U.S.A., Inc. v. Arizona Dept. of Revenue); Indiana (Home Depot U.S.A., Inc. v. Indiana Dept. of State Revenue, 891 N.E.2d 187 (Ind. Tax 2008);  New Jersey (Home Depot, U.S.A., Inc. v. Director, Division of Taxation); New York (In re Home Depot USA, Inc. v. Tax Appeals Tribunal);Ohio (Home Depot U.S.A., Inc. v. Levin, 905 N.E.2d 630 (Ohio 2009); Oklahoma (In re Sales Tax Claim for Refund of Home Depot, 198 P.3d 902 (Okla. App. 2008); and Washington (Home Depot, U.S.A., Inc. v. State Dept. of Revenue); 

Home Depot can now add North Carolina to its list of losses.  This was an appeal to the Business Court, from a final Agency Decision of the DOR, which had affirmed a grant of summary judgment against Home Depot by an Administrative Law Judge.  Home Depot didn't get traction in the Business Court with any of its arguments.


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You CAN Get A Ruling From A Superior Court Judge After Your Case Is Designated To The Business Court

I wrote yesterday about the arbitration aspects of Gaylor, Inc. v. Vizor, LLC, 2015 NCBC 98.

But there is a significant aspect of Business Court procedure addressed in that case which deserved its own post.

It concerns the authority of a non-Business Court Judge (i.e. a regular Superior Court Judge) to make a ruling in a case after the case is designated to the Business Court.

Business Court Rule 15.1 seems to preclude that kind of ruling. It says that:

[a]fter a case has been assigned or designated to the Business Court . . . parties shall seek rulings on all motions in the case from this Court, and not from Superior Court Judges or Clerks in the counties where cases originate."

I''ve written before about getting a ruling from a Superior Court Judge after designation to the Business Court, but that post was based on emails from two of the Business Court Judges' law clerks and the Business Court TCA (for the many otolaryngologists* who read this blog and who may not know what a TCA is, it is a "Trial Court Administrator," who is charged with managing civil cases as they move through the judicial system).  I cautioned then against relying too heavily on the statements of persons who were not Judges.

But now you've got the Business Court's interpretation of its Rules straight from a Judge.  Here's what Judge Bledsoe said In the Vizor decision:

[w]here, as here, a Notice of Designation requesting designation of a matter as a complex business  case has been filed after a motion has been calendared for hearing before the presiding Superior Court Judge of the county in which the action is pending, the policy of the Business Court has been that the judge before whom the matter was calendared may, in his or her discretion, elect to rule on the motion or defer resolution of the motion to the Business Court judge assigned to the case.

Op. ¶12 & n.4 (emphasis added).

If this practice now bears Business Court approval, it still won't be an easy trick to pull off.  Even if you can get a motion calendared for hearing in Superior Court before the designation of the case to the Business Court, my guess is that most Superior Court Judges probably will decide not to rule in a case that is headed to the Business Court.


*Well, there really is at least one.  And if you don't know what an otolaryngologist is, it is an ear, nose, and throat doctor.



NC Business Court On Arbitrability: Clear And Unmistakable

You may have pondered over the question whether a Judge or an Arbitrator decides if a particular dispute is subject to an agreement to arbitrate.

If you have wondered who makes that sort of decision, it's actually not an open question.  The U.S. Supreme Court held twenty years ago that:

[u]nless the parties clearly and unmistakably provide otherwise, the question of whether the parties agreed to arbitrate is to be decided by the court, not the arbitrator.

AT&T Techs. v. Commun. Workers of America, 476 U.S. 643, 649 (1986)(emphasis added).

The Business Court addressed what can be "clear and unmistakable" at the end of last week in Gaylor, Inc. v. Vizor, LLC, 2015 NCBC 98.  Plaintiff, a subcontractor on a construction project, was suing the general contractor on the project, Vizor.

The issue before Judge Bledsoe was whether the arbitration should include the resolution of Plaintiff's unfair and deceptive practices claim.  In other words, the question was the "arbitrability" of that claim --whether it should be decided in the Business Court or by the arbitrator.

The subcontract said nothing specifically about the scope of the arbitrator's authority.  It provided that all claims rising out of, or relating to this Agreement or the breach thereof. . . shall be subject to arbitration."  But it also said that "[s]uch arbitration shall be conducted in accordance with the Construction Industry Arbitration Rules of the American Arbitration Association then in effect." Op. ¶19.

Rule 9(a) of the Construction Industry Arbitration Rules seems to decide the question.  It says that "[t]he arbitrator shall have the power to rule on his or her own jurisdiction, including any objections with respect to the existence, scope, or validity of the arbitration agreement."

This case was decided under the Federal Arbitration Act.  The Fourth Circuit, however, has never ruled on whether the incorporation of the AAA's Construction Industry Rules meets the "clear and unmistakable" standard laid down by the Supreme Court.

Judge Bledsoe neverthelesss boldly went ahead and ruled that the incorporation of the AAA Rules met the "clear and unmistakable" standard.  Actually, it's not so bold of a ruling, because seven federal Circuit Courts had already reached the same conclusion.  See United States ex rel. Beauchamp v. Academi Training Ctr., 2013  U.S.. Dist. LEXIS 46433, at *15-16 (E.D. Va. 2013).

You might be thinking that you don't care much about this decision because you don't handle  construction arbitrations.  But you would be wrong.  The AAA's Commercial Arbitration Rules contain a very similar provision.  It's Rule 7, which says that:

The arbitrator shall have the power to rule on his or her own jurisdiction, including any objections with respect to the existence, scope, or validity of the arbitration agreement or to the arbitrability of any claim or counterclaim.

So if you have a question of the arbitrability of a claim. and the arbitration agreement incorporates the AAA Rules, arbitrability is likely to be resolved by the arbitrator.



Rule 11 Sanctions (Again!) From The NC Business Court

This month, for the second time in the last two months, Judge McGuire of the NC Business Court entered Rule 11 sanctions against a party whose attorney relied on inaccurate information from the client in making claims against the opposing party.

This month's decision was in NC Bioremediation, LLC v. Sea Winds, LLC, 2015 NCBC 94. The issue relevant to the Motion for Sanctions was whether the person representing himself to Plaintiff's counsel that he was a manager and member of NC Bioremediation in fact had the authority to file the lawsuit.  Or, more bluntly, was he even a member or a manager at all?

Counsel's Investigation Before Filing The Complaint Was Not A Reasonable One Under The Circumstances, And Violated Rule 11

It turned out, of course, that he wasn't.  But could the attorney for the Plaintiff, who had filed his lawsuit in the name of the LLC have known this and not filed the Complaint?  As Judge McGuire put it, "the question for the Court is what inquiry into the facts did Plaintiff's counsel conduct prior to filing the Complaint and was that inquiry a reasonable one under the circumstances?"  Op. ¶16.

It was not, said Judge McGuire.  It consisted mostly of hearsay support from Mauney's former office assistant who said that he had an ownership interest in NC Bioremediation and financial documents that implied that Mauney was a member of the LLC along with another person (Overton).

But public filings --- annual reports filed by NC Bioremediation with the NC Secretary of State -- showed only Overton as a member/manager of the LLC.

Overton delivered an Affidavit to Plaintiff's counsel in which he said that Mauney had never had an ownership interest or member status with the LLC.  Given that it was the Plaintiff which filed that Affidavit with the Court, Judge McGuire questioned why Overton had not been contacted earlier.  He said:

the Court can only conclude that contacting Overton to get his position on Mauney's contended ownership . . . could have been accomplished relatively quickly and with little additional effort.  Counsel has offered no explanation as to why the information in the Overton Affidavit could not have been discovered before the Complaint was filed.

Op. ¶20.

The Court concluded that the factual investigation done by Plaintiff's counsel fell short of Rule 11's requirement that such an inquiry be reasonable under the circumstances."  Op. ¶20.

The Sanction Entered By The Court Was The Dismissal Of The Action (Without Prejudice)

In an earlier decision in Southeast Air Charter, Inc. v. Stroud, 2015 NCBC 79, Judge McGuire sanctioned a Plaintiff whose lawyer relied inappropriately on its client's representation that some of the Defendants had positions with the Plaintiff corporation that warranted them being sued for breach of fiduciary duty.  (You can read about that decision here) .  The sanction imposed there was the payment of $35,887.01 in attorneys' fees.

What was the sanction in NC Bioremediation?  A dismissal without prejudice, with no attorneys' fees awarded.

Was that sanction harsh enough?  Maybe not, given that Overton stated in his Affidavit that he wishes the action to continue. The dismissal without prejudice leave the door open for Overton to recommence the action. 

It's hard to say who would be a worse representative to sue on behalf of the LLC.  Mauney, a North Carolina lawyer, was disbarred by the North Carolina State Bar In July 2013 for, among other professional violations, "mak[ing] demonstrably false statements under oath."  Op. ¶6 & n.9.  And Overton has "been accused of embezzling approximately $500,000 from" Defendant Sea Winds (which Overton denies in his Affidavit at ¶10).  Op. ¶11 & n.28





Unusual Area Of Law For The NC Business Court: Life Estate In A Beach House

When Governor McCrory appointed Judge Gregory McGuire to the Business Court, I doubt that he had any concern whether Judge McGuire had any expertise in the area of trusts and estates.  After all, that area of law is not enumerated in the types of case that warrant designation to the Business Court, contained in G.S. §75A-45.4.

But yesterday's decision in Davis v. Davis, 2015 NCBC 95 required exactly that type of expertise.  In particular, expertise on the validity of restrictions on the alienation of a life estate.

But why would such a case be in the Business Court in the first place?  It was designated to the Business Court on the basis that it concerned the operation of an LLC, and the Court previously issued an (unpublished) Opinion in the case which concerned the standing of the Plaintiffs, members of an out-of-state (Virginia) LLC, to bring a derivative action in North Carolina.

Having resolved that issue in favor of the Plaintiffs in November 2014, all that remained to decide was the interpretation of a restriction on a life estate.

If you are thinking of clicking away, don't. Keep reading. This gets interesting, I promise.

Family Battle Over An Outer Banks Beach House

The Plaintiffs, Melvin and J. Rex Davis, were suing their own mother, Dorothy Davis, over an Outer Banks beach house which the children owned through an LLC (MKR)  in which Melvin, J. Rex, and their sister, Kaye, were the sole members.

Mrs. Davis and her late husband had acquired the beach house in the 1980's, and gifted the beach house to MKR in 2009.  In connection with their grant of the property, the parents retained a life estate in the property with a restriction.  It said that:

said life estate [was] to be personal to the use of the Grantors . . . and may not be utilized by any other person, nor may it be reduced to a cash value for the benefit of the Grantors, or the survivor thereof, but must remain always during the lifetime of said Grantors, or the survivor thereof, available for their individual and personal use without interference from either the remainderrmen or any other person.

Op. ¶13

The children were offended that their mother had been renting out the house after the death of her husband.  The attorney who had drafted the deed testified that he had included that language with the intention that Mr. and Mrs. Davis would not be able to rent the house during their life tenancy. Op. ¶15.  And when I read that provision, I interpret it to mean that the parents could not rent the house.

So you think that would be the end to this unhappy family squabble.  Mom has to stop renting, right? (We all know that renters destroy vacation homes.)

Life Estates And Restrictions On Them

But if you are thinking that Mrs,. Davis was  barred from renting the beach house in which she had a life estate, you are wrong.  Judge McGuire started by running through a short dissertation on life estates and restrictions on their alienation (conveyance).  He observed:

  • '[A] life estate is an estate in land, vesting the holder with the right to use and possess the property during his lifetime.''  Op. ¶27.
  • "An unlimited restraint on alienation of a life estate is against public policy, and therefore, void." Op. ¶28
  • "This principle favoring alienability . . .l conflicts with another common law tenet -- that one who has an interest in property should be able to convey that interest subject to whatever condition he or she desires to impose on the conveyance.  Op. ¶29.
  • "Faced with this conflict, the law has developed so that 'some direct restraints on alienation are permissible where the goal justifies the limit on the freedom to alienate or where the interference with alienation is so negligible that the major policies furthered by freedom of alienation are not materially hampered.'"  Op. ¶29 (quoting 4 Restatement of the Law of Property, Introductory Note to Part II at 2380).

All of that led to the conclusion that "North Carolina has recognized some limited restraints on alienation of life estates as being permissible."  Op. ¶29.

So what about the restriction on Mrs. Davis' life estate?  Permissible or impermissible?

The Plaintiffs took a run at a creative argument: "since Mra. Davis is both the grantor and the life tenant and imposed the restrictions upon her own use of the life estate, the restriction in the Deed does not implicate the public policy reasons underlying the prohibition on alienation.."  Op. ¶30.

Judge McGuire didn't buy that argument.  He concluded that the deed provisions "create a disabling restraint on the alienation of Mrs. Davis' life estate, which is against public policy; thus, such provisions found in the Deed are void."  Opp. ¶34.

Maybe you are worried for Mrs. Davis that the invalidation of the restriction voids the entire life estate.  Judge McGuire said it did not.  Op. ¶34 & n.39.



Two Cases From NC Business Court: Class Action Fees Doubled And Expedited Discovery Denied

Last week (well, two weeks ago, I'm kind of behind) seemed like class action week at the Business Court.  Judge Gale issued three rulings in class action cases.

Two of the rulings were in consolidated class actions that had been settled.  Those were in In re Pike S'holders Litig., 2015 NCBC 89 and  90.  The third decision was in a case just at its commencement: Raul v. Burke, 2015 NCBC 91, about whether the plaintiff challenging a merger transaction was entitled to expedited discovery on her claims. 

In The Pike Order, The Court Awarded Twice The Amount Of Fees Which The Defendants Had Agreed To Pay

There''s not much worthy of note in the first Pike "decision."  It is merely an Order approving the settlement cut in the four separate class action lawsuits attacking Pike's merger.

The decision in the second Pike case, In re Pike S'holders Litig., 2015 NCBC 90, concerned an award of attorneys'' fees to the lawyers for the class.  The case is notable since the class' lawyers were awarded double the amount of fees ($550,000) than the amount which the Defendants' lawyers had agreed not to oppose ($275,000).

How did the Plaintiffs' lawyers pull that off?  They had to first get past the Defendants' argument that the Court did not have the authority to award fees in excess of the amount that they had agreed not to contest.  That argument was pretty much foreclosed by the language of the Memorandum of Understanding which led to the settlement.  It said:

[i]f the parties are unable to reach agreement with respect to the amount of such attorneys' fees, costs, and expenses to which Plaintiffs' counsel are entitled, then Plaintiffs reserve the right to submit an application for an award of attorneys' fees, costs, and expenses to be paid to Plaintiffs' counsel (the "Contested Fee Application"). . . . In the event of a Contested Fee Application, Defendants agree to pay whatever award of attorneys' fees, costs, and expenses that the Court awards.

Op. ¶17.

Judge Gale, relying on the COA's recent decision in Ehrenhaus v. Baker, held that:

when the parties agree to fee shifting but do not agree on the amount of fees to be awarded, the Court may award the amount that it determines to be fair and reasonable.

Op. ¶29.

The Court assessed the reasonableness of the half million dollar plus fee by breaking the fee down to an hourly rate (for the 1394.60 hours of time) of $550 per hour for lead counsel, $375 per hour for partner hours of non-lead counsel, and $250 per hour for associate time. Op. ¶37.  Judge Gale said that those rates were "within, but at the higher end of, the range that this Court has found to be reasonable for complex business litigation in North Carolina."  Id.

The Court Awarded Fees Based On "North Carolina Rates"

Out of state lawyers looking to take on class action cases in the Business Court might want to take caution from this part of Judge Gale's ruling:

the affidavit of Lead Counsel [who was from Pennsylvania] reflects billing rates that exceed those typically charged in North Carolina.  The Court believes that there are North Carolina lawyers who are fully capable of pursuing similar litigation and, thus, that it would be unnecessary and inappropriate to apply billing rates higher than those typically charged by skilled counsel in North Carolina.

Op. ¶36 (relying on GE Betz, Inc. v. Conrad, ____ N.C. App. __, 752 S.E.2d 634, 657 (2013).

This Was A "Disclosure-Only" Settlement

Also significant was that this doubling of attorneys' fees came in a disclosure only settlement.  Judge Gale expressed this view regarding this type of settlement :

[t]he Cpurt is mindful of substantial commentary that disclosure settlements might often reflect more of a tax cost of a merger transaction rather than a meaningful substantive benefit to the settlement class, particularly when the accompanying release is the broadest possible.  Those considerations perhaps underlie the Delaware Court of Chancery's recent caution that fee requests in disclosure-only settlements may now face more searching scrutiny, particularly when accompanied by the broadest possible releases.  See In re Riverbed Tech., Inc. S'holders Litig., C.A. No, 10484-VCG, 2015 Del. Ch. LEXIS 241, at *21-22 (Del. Ch. Sept. 17, 2015).

Op. ¶39.

The Court found that the supplemental disclosures obtained by the class plaintiffs could not "be fairly characterized as 'routine'" and that they "were clearly required to correct prior material disclosures that erroneously described circumstances related to negotiations between the corporation, its CEO, and its suitor."  Op. ¶41.

Expedited Discovery Denied In Class Action Attacking Ecolab's Acquisition Of Swisher Hygiene

It is common in litigation involving merger transactions for the plaintiff to ask for expedited discovery.  Often, there is a rapidly approaching date for a shareholder vote to approve or disapprove of the transaction, and the class representative seeks to develop evidence which will warrant an injunction preventing the vote.

In Raul v. Burke, 2015 NCBC 91, the Plaintiff was attacking the sale of Swisher's assets to Ecolab for $40 million in cash.  With a shareholder vote only a week away (set for October 15th), The Business Court denied a Motion for Expedited Discovery (on October 8th).

Plaintiff''s argument was that the disclosure of the transaction did not disclose how much of the $40 million sale price would be distributed to Swisher shareholders. The proxy statement stated repeatedly that the management and directors of Swisher could not reliably estimate any shareholder distribution.  Op. ¶12. In fact, it said that "[w]e can provide no assurance as to if or when such distribution will be made." Op. ¶11.

Where is all of that $40 million going?  Well, Swisher is in financial trouble, facing "continuing recurrent losses."  Op. ¶13.  Its accountants have issued an opinion with a "going concern" qualification.  Op. Par. 13.  Moreover, there is a criminal proceeding ongoing in the Western District of North Carolina regarding accounting irregularities.  Op. ¶9.

The Proxy Statement says that:

[t]he balance of the proceeds will be retained to pay ongoing corporate and administrative costs and expenses associated with winding down the Company, liabilities and potential liabilities relating to or arising out of our outstanding litigation matters, any fines or penalties and other costs and expenses relating to or arising out of the USAO/SEC inquiries, and potential liabilities relating to our indemnification obligations, if any, to Ecolab or to current and former officers and directors.

Op. ¶11.

The Court said that it had to balance the substantiality of the Plaintiff's claim against the harm or burden that might be imposed on the Defendant if it had to go through the expense and "potential business delay" that would result from expedited discovery.  Op. ¶7.

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It Can Be A Tough Road For Trade Secrets Plaintiffs In The NC Business Court

If you are a regular reader of this blog, you know that litigating a trade secrets case in the Business Court can be tough.  Last year, the Court barred a plaintiff from engaging in any discovery at all until it identified its allegedly misappropriated trade secrets with sufficient particularity.  And the Court has frequently dismissed trade secrets claims altogether because they weren't pled with the necessary degree of particularity.

Judge Bledsoe made it even tougher for trade secrets plaintiffs earlier this month, in SciGrip, Inc. v. Osae, 2015 NCBC 86.  SciGrip develops and produces "acrylic-based structural adhesives that are used in the marine and other industries to bond fiberglass and other material together."  Op. ¶2.

SciGrip sued its former employee, Osae, for allegedly disclosing its trade secrets to his new employer, Engineered Bonding Solutions, LLC ("EBS"), a direct competitor of SciGrip.  Osae obtained a 25% membership interest in the EBS LLC as a part of his employment. 

SciGrip sought to obtain information regarding EBS' manufacturing processes from Osae.  Osae had that information, which he said involved EBS' trade secrets, on his computer.  Osae said that the computer was owned by EBS and that he couldn't be forced to disclose EBS' trade secret information.

You are probably thinking that since Osae had possession of the documents (on the computer he was using), that he has the "possession, custody, or control" of the material which was the subject of the discovery requests and that he should be forced to provide it.  Those are the "magic words" of Rule 34 of the NC Rules of Civil Procedure, after all.

Plaintiff Couldn't Force Production Of A Non-Party's Trade Secret Information From Its Employee

But Judge Bledsoe said that this discovery request "present[ed] a highly unique scenario.," and held that:

[h]ere, Plaintiffs seek to discover trade secret and proprietary information of their direct competitor solely through one of its employees.  Typically, when a company alleges trade secret violations by an employee who has departed and begun employment with a competitor, the competitor is either joined as a party in the lawsuit or, if the competitor is a non-party, the company seeks discovery of the competitor's documents from the competitor itself through a third-party subpoena under Rule 45.

Op. ¶17.  The Judge observed that "obtaining trade secret information from a non-party competitor is preferable under Rule 45 because Rule 45 affords greater protections to non-parties.  Op. ¶19.  It is certainly true that Rule 45 provides some protection to a person responding to a subpoena.  Among other things, the Court can compensate the person unduly burdened by the subpoena for lost earnings and for reasonable attorney's fees.  Rule 45(c)(1).

The ultimate holding of the Court was that:

the Court declines to compel production of trade secret and proprietary information of a non-party competitor where the plaintiff seeks such information through an employee's possession of a company laptop and the non-party competitor has refused to submit to North Carolina jurisdiction.

Op. ¶20.

Why wasn't Osae's possession of the trade secret information enough to force him to produce it?  Judge Bledsoe said the following:

[i]]n a workforce where employees have access to a multitude of company documents through any number of portable electronic devices, the traditional line between possession and access has been blurred.

Op. ¶18.

But don't forget that the party claiming to have trade secrets must make "efforts that are reasonable under the circumstances to maintain its secrecy."  N.C. Gen. Stat. sec. 66-152(3)(b).  So don't advise your clients that they can maintain trade secret protection if they make thumb drives or laptops containing their trade secrets indiscriminately available to their workforce.

Plaintiff's Arguments That It Could Compel Production Of The Trade Secret Information Due To Osae's Status As An Agent And As An LLC Member Also Failed

Plaintiff made what seemed like a very good argument that Osae was the agent of EBS and that he therefore had the authority to turn over EBS' trade secret information.  Judge Bledsoe disagreed, saying that "this Court has found no authority compelling an agent to turn over his principal's confidential trade secret information."  Op. ¶23.

And what about Osae's membership interest in EBS?  Wasn't that status sufficient to give him the authority to produce EBS' information?  Judge Bledsoe said no, citing again the lack of authority empowering him to do so:

Plaintiffs have not pointed to any North Carolina or persuasive authority finding that a person's status as an agent, employee, minority shareholder, or part owner of  a company equates to 'possession, custody, or control' of the company's confidential or proprietary documents for purposes of discovery.

Op. ¶27.

SciGrip had not made EBS a co-defendant with Osae because EBS disputed that it was subject to jurisdiction in North Carolina.  SciGrip has gone ahead and sued EBS in EBS' home state of Florida, however, and has already served EBS with a subpoena there.

In the event that "all reasonable efforts to obtain the documents from EBS fail[]," the Court said that SciGrip could renew its motion.

How Concerned Should You Be About This Decision?

I don't read this decision to impede discovery from employees of a plaintiff's competitor.  It is literally limited to trade secret material on a laptop owned by an out-of-state entity which is not subject to jurisdiction in North Carolina.  I don't think that you will face that situation very often.


Can An NC Superior Court Judge Modify Another Judge's Class Certification Order?

Is the certification of a class by an NC state court set in stone or can it be modified during the course of the litigation?

The federal rule vs. the state rule

There is a difference between the federal rule governing class actions (FRCP 23) and the North Carolina equivalent (NCRCP 23).  The length and precision of the federal rule is overwhelming when measured against the short and simple state rule.

The Federal rule contains a specific provision allowing the presiding judge to alter or amend a class certification order: It says that "[a]n order that grants or denies class certification may be altered or amended before final judgment."  FRCP 23(c)(1)(C).

The NC Rule, by contrast, is silent on this subject.

The Original Class Certification

The ability of a Business Court to alter or amend a previously entered class certification order was at issue last week in an unpublished Order in  Elliott v. KB Home North Carolina, Inc.  Judge Jolly had certified a class in the case three years ago, in 2012.  I wrote about that case at the time the class was certified.The class members had in common the issue whether Defendant KB Home should have installed a weather resistant barrier (a "WRB") behind the HardiePlank® siding on homes which they had purchased from KB Homes in two developments in Cary, North Carolina.  

Judge Jolly certified a class of "all persons who own a home that was constructed by Defendant KB Home without a weather restrictive barrier" behind the HardiePlank.  Class notice went out in March 2012.

Three and a half years later, the case is now before Judge McGuire after a couple of trips to the Court of Appeals and Judge Jolly's retirement.

Change In Ownership Of The Homes Owned By The Class Memberrs

Here was the issue for Judge McGuire: Even before the class notice was sent, 38 of the members of the potential class sold their homes ("Pre-Notice Sellers") to others.  And following the mailing of the class notice, 79 of the class members sold their homes ("Post-Notice Sellers") to others. Who are proper class members? Are all of the homeowners who owned the homes without a WRB on the date of class notice members of the class, even if they had sold their homes?  Or should membership in the class be confined to homeowners who originally bought their homes from KB Homes and continued to own them through the date of final judgment in the case (who knows how long it will be before that happens?).  

A request for modification to the class definition was made by the Plaintiff.

There are multiple issues regarding those potential class members who sold their homes after receiving the class notice.  They either did or did not disclose the existence of this litigation or the absence of a WRB to their buyer.  If they did not, there might have been no impact on the sales price and they therefore might have no damages.  And they certainly did not have a continuing interest in the installation of a WRB, no longer being owner of the house.

Did Judge McGuire have the power to modify Judge Jolly's order certifying the class?  If Judge McGuire were a federal judge, yes.  But as a state court judge, maybe not.  The NC Court of Appeals held ten years ago that:

Clearly, the federal rule contemplates continuing review of the class certification status of an action. See 3B Moore's Federal Practice ¶ 23.50 at 23-410. Rule 23 of the North Carolina Rules of Civil Procedure contains no such provision, Nobles v. First Carolina Communications, 108 N.C.App. 127, 423 S.E.2d 312 (1992), rev. denied 333 N.C. 463, 427 S.E.2d 623 (1993), and we will not judicially legislate one.

Dublin v. UCR, Inc., 115 N.C. App. 209, 444 S.E.2d 455, 461 (1994).

But given that a class certification order is an interlocutory order, Judge McGuire held that Judge Jolly's order was:

'subject to change at any time to meet the justice and equity of the case' and [was] 'modifiable for changed circumstances.'

Order ¶9 (quoting Dublin, supra, 115 N.C. App. at 220). 

He said, however,  that there would have to be "a change in circumstances since [the date of the certification order] that has altered the legal foundation upon which Judge Jolly based his decision to certify the class." Op. ¶10.

As to the homeowners who had purchased from the Pre-Notice Sellers, Judge McGuire ruled that Judge Jolly had "at least impliedly" considered the existence of persons buying the homes before the class was certified, and that he had not intended to limit the class to those who had purchased their homes directly from KB Homes.  The existence of the homeowners buying their homes from the Pre-Notice Sellers was therefore not a "changed circumstance warranting modification of the class definition. Op. ¶16.

The Home Owners Who Had Sold Their Homes After The Class Was Certified Became Members Of A Subclass

Judge McGuire rejected the argument that the potential that the Post-Notice Sellers might have different damages from other class members (in that they would not need the benefit of an WRB being installed or that they might not have suffered damage upon the sale of their home) was a "changed circumstance warranting modification of the class.  He said that:

such individual differences in damages, by themselves, are not sufficient to defeat class certification where they do not predominate over common questions of law or fact affecting an entire class.

Op. ¶22.

But the Post-Notice Sellers nevertheless did represent a "changed circumstance."  That was due to the reason that the Post-Notice Sellers would need to individually establish that they had suffered any injury at all.

The overarching common question in the case remains whether KB Homes complied with the building code and the manufacturer's recommendations regarding the need for a WRB.  (Judge McGuire recently denied KB Home's motion for summary judgment on this issue in another unpublished Order).

borrowing from the U.S. Supreme Court''s recent Wal--Mart decision on class certification, Judge McGuire held that:

'[w]hat matters to class certification . . . is not the raising of common "questions" -- even in droves -- but, rather the capacity of a class-wide proceeding to generate common answers apt to drive the resolution of the litigation.  Here, the answer to the question of whether the failure to install a WRB violated the then-existing building code will ''drive the resolution' of Plaintiff's claims.

Op. ¶26 (quoting Wal-Mart Stores v. Dukes, 131 S.Ct. 2541, 2550-511 (2011)).

The "changed circumstances" allowed a modification of the class definition to create a sub-class of the Post-Notice Sellers.  Counsel for the class were directed to add a named Plaintiff who was a Post-Notice Seller to represent the interests of the class. Op. ¶29.

Are you confused about which homeowners are in this class and which are not?  Here's my take on that:

Time of Transaction In Or Out Of Class?
Sold before class notice Out (neither party sought their inclusion (Op. ¶14 & n.18)
Bought before class notice In
Sold after class notice In
Bought after class notice Out

II haven''t written about a class action issue for a while given the entry of the Robinson Bradshaw firm into the elite class of law firms with blogs.  Lawyers there write an excellent blog devoted entirely to the subject of class actions in North Carolina: the Carolinas Class Action blog.


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Court Of Appeals Affirms Business Court Award Of $1 Million In Fees To Class Counsel

It seems like forever ago that the then venerable North Carolina institution, Wachovia Bank, failed and was acquired by Wells Fargo.  (This was actually seven years ago).  But just last week came what might be the final closure in the battle by the lawyers representing the class which challenged that acquisition to be paid their "well-deserved fees."  If you don't detect the sarcasm in that last sentence, you can read what I've previously written about that fee application here and here.  I'm not a fan.

But putting aside my venom, last week the NC Court of Appeals, in Ehrenhaus v. Baker, affirmed Judge Murphy's March 2014 Order awarding class counsel slightly over $1 million in fees and expenses.  The COA didn't assess the reasonableness of that fat fee, it said that Judge Murphy had properly assessed it in his 2014 Order.

The value in the decision from the Court of Appeals is for lawyers representing class plaintiffs in future class action settlements.  North Carolina, in this ruling, has embraced the concept that class action settlements can include an agreement for the defendant to pay attorneys' fees.

Perhaps you are thinking that there is nothing unusual about a settling party agreeing to pay the opposing party's legal fees.  Defendants often agree to pay the plaintiff's attorneys' fees as a part of a settlement.  But in the class action context, the creation of a common fund was the only exception previously recognized in North Carolina to the "American Rule."  The American Rule provides that "a successful litigant may not recover attorneys' fees . . . unless such a recovery is expressly authorized by statute."  Op. at 17.

Some other jurisdictions recognize the "common benefit" doctrine as a second exception to the American Rule when a class action is involved.  North Carolina rejected that basis for fees -- which allows an award when the class plaintiff "confers a common monetary benefit on the class" -- in In re Wachovia Shareholders Litig., 168 N.C. App. 135, 139, 607 S.E.2d 48, 50-51, disc. rev. denied, 359 N.C. 411, 613 S.E.2d 25 (2005).

The COA approved the award of fees to the Ehrenhaus class'  lawyers by recognizing a third exception to the American Rule.  Judge Davis wrote:

we hold that the parties to a class action may agree to a fee-shifting provision in a negotiated settlement that is -- like all other aspects of the settlement -- subject to the trial court's approval in a fairness hearing.  During the fairness hearing, the trial court must carefully assess the award of attorneys' fees to ensure that it is fair and reasonable.

Op. at 22 (emphasis added).

This decision isn't big news to the Business Court.  The Court has been assessing the reasonableness of fees paid to class counsel via a negotiated settlement for a long time, at least since its decision in In re Harris-Teeter Merger Litig., 2014 NCBC 44, in which Chief Judge Gale thoroughly examined the Court's power to award fees as the result of a class action settlement (in ¶¶51-57).

I'm not sure if this is the final chapter in the effort by the class' attorneys to obtain the fees that they requested.  You might remember that Judge Murphy denied any award of fees to the North Carolina attorney co--lawyering with Mr. Ehrenhaus' New York counsel.  The Business Court awarded nothing to him even though there was a valid fee sharing agreement between him and Ehrenhaus' out of state counsel which specified that local counsel would receive five percent of the total fee.  Since local counsel offered no evidence of the time expended or his hourly rate the Court could not determine whether the five percent (which would have been more than $50,000) was reasonable.

Judge Davis dropped a footnote in the COA decision saying that "[w]hile we express no opinion on this issue, we note that Judge Murphy's Order does not contain language foreclosing the possibility of [NC counsel] ultimately being deemed entitled to receive some portion of the attorneys' fees at issue."  Op. at 26 & n.3.

Even so, it's probably a little bit late in the day for Mr. Ehrenhaus' local counsel to apply to the Business Court for fees.