Dead Partner And Disqualification

The Business Court on Wednesday disqualified  a law firm from representing its longtime corporate client in a lawsuit against the corporation's former CEO and Chairman of its Board of Directors.

The basis for the ruling in Kingsdown Inc. v. Hinshaw, 2015 NCBC 27 was that a partner in the law firm (now deceased) had represented the former CEO/Chairman of the corporate plaintiff (Hinshaw) on a personal basis in some of the transactions that were at issue in the lawsuit.

Hinshaw moved to disqualify the law firm over its protestations that its representation was permitted by Rule 1.10 of the Revised Rules of Professional Conduct.  If that Rule isn't uppermost in your mind, it says that:

When a lawyer has terminated an association with a firm, the firm is not prohibited from thereafter representing a person with interests materially adverse to those of a client represented by the formerly associated lawyer and not currently represented by the firm, unless:

(1) the matter is the same or substantially related to that in which the formerly associated lawyer represented the client; and

(2) any lawyer remaining in the firm has information protected by Rules 1.6 and 1.9(c) that is material to the matter. 

So, to succeed on his disqualification motion, Hinshaw had to show that he had an attorney-client relationship with a former lawyer at the firm, and that the matters on which he had been represented were the "same or substantially related to" the matters involved in the lawsuit  before the Business Court, and the law firm had the burden to show that it did not have access to material confidential information protected by Rules 1.6 and 1.9(c).

Attorney-Client Relationship?

Kingsdown contended that the law firm had never opened a client matter for Hinshaw, had never sent him an engagement letter, and had never been paid any money by Hinshaw.  Hinshaw, from his side, presented affidavit testimony that the law firm's senior partner, since deceased, had often advised him personally. 

Some of the advice concerned his compensation from Kingdown and a transaction regarding a beach house owned by Hinshaw which he traded to Kingsdown for an undeveloped beach property owned by Kingsdown which Hinshaw then leased back to Kingsdown. 

Both of those matters -- Hinshaw's compensation from Kingsdown and the curious beach house deal -- were at the front and center of Kingsdown's lawsuit against Hinshaw for breach of his fiduciary duty.

Judge Bledsoe didn't waste much of his opinion in finding "ample evidence" that Hinshaw could have "reasonably inferred" that he had an attorney-client relationship with the deceased partner, and therefore the law firm. Op. par. 30.

Confidential Information?

The law firm fought hard to show that none of its current attorneys had any of Hinshaw's confidential information.  That was the lawyers' burden to carry, per Ferguson v. DDP Pharmacy, 174 N.C. App. 532, 539, 621 S.E.2d 323. 328 (2005)(“The burden rests upon the law firm to prove the former attorney did not share any information about the former client with the remaining attorneys in the firm.”).  Op. ¶37.

The argument of the lawyers rested partly on an affidavit from a lawyer representing Kingsdown as to his review of his firm's billing records.  The affiant stated that the records showed that none of the lawyers still at the firm had represented Hinshaw on the matters at issue in the lawsuit.  Other lawyers at the firm who had worked on Kingsdown matters presented affidavits stating that they were "not aware" of any of Hinshaw's confidential information.

Judge Bledsoe found that insufficient.  He noted that the situation before the Court was not the usual paradigm presented by Rule 1.10 of an attorney leaving a law firm and taking a client's files and records containing confidential information with her.  Here, the attorney who had personally represented Hinshaw had passed away and the law firm had continued in existence.  The Court held that:

the client’s files and confidential documents presumably remain at the Firm and are available to the other attorneys in the firm. As such, the Court concludes that the failure of the Firm to provide competent and persuasive evidence of the existence and whereabouts of these files, and the clients’ confidential documents and information that may be contained therein, is a significant factor in determining whether Kingsdown and the Firm have met their burden under Rule [1.]10(b).

Op. ¶46.

What could the law firm have done to persuade Judge Bledsoe that its lawyers did not have access to or knowledge of Hinshaw's confidential information?  He didn't say specifically, but wrote that Kingsdown had:

not brought forward competent evidence that the Firm has conducted a sufficient investigation of the Firm’s attorneys and files to ascertain whether the Firm has knowledge of [Hinshaw's] material confidential information, or if such an investigation has been conducted, provided evidence of what the investigation involved, who and what was consulted, and what the investigation found.

Op. ¶44.

So, if you ever find yourself in the unenviable position of representing a corporate client against a former officer/director on transactions where a deceased partner was personally advising that individual, you now have somewhat of a road map to avoiding disqualification.

Appearance of Impropriety

The "overarching consideration" in considering a motion to disqualify is to "prevent even the appearance of impropriety and thus resolve any and all doubts in favor of disqualification."  Op.  ¶48.

While  Hinshaw obviously had angst at being sued by the same law firm that he said had given him the advice that he claimed to have followed, the Court pointed out another significant concern that might create the "appearance of impropriety."

The law firm's attorneys were likely to be witnesses in the lawsuit.  Judge Bledsoe pointed out that:

those attorney-witnesses may potentially face divided loyalties between their allegiance to the Firm and the defense of the Firm’s advice, on the one hand, and their duty of loyalty to, and zealous advocacy for, their clients, on the other, as that advice, and the parties’ actions in alleged reliance on that advice, comes under intense scrutiny.

Op. ¶52.

This Opinion was issued at the same time as another published opinion in the case, Kingsdown Inc. v. Hinshaw, 2015 NCBC 28  That decision -- which I may write about tomorrow -- concerns a motion to dismiss one of the Defendant's counterclaims and third party claims.

 

If You Are Proceeding Pro Se In The Business Court It Is Best Not To Be Defiant

It's probably never a good idea to proceed without a lawyer in any Court, but if you are a non-lawyer and insist on proceeding pro se in the Business Court, don't be defiant and obnoxious.  You will not like the result.

Two of the Defendants (JW Ray and Digi-Plus LLC) in a case called London Leasing LLC v. Arcus  terminated the counsel representing them and decided to proceed on their own.

They did that in a high-handed and arrogant way. When Plaintiff's counsel called Ray to try to arrange a mediation, Defendant Ray told him that:

(1) neither Ray nor DigiPlus would attend any mediation in person, and would only attend by teleconference 'so that the mediator could explain to Plaintiff how absurd or ridiculous Plaintiff’s claims are in this lawsuit;'

(2) neither Ray nor DigiPlus would offer any payment towards a settlement;

(3) neither Ray nor DigiPlus would hire replacement counsel;

(4) neither Ray nor DigiPlus would respond to any discovery requests;

(5) neither Ray nor DigiPlus would pay any judgment levied against them in the lawsuit; and

(6) neither Ray nor DigiPlus would participate in the lawsuit unless they were “arrested for criminal conduct.”

Order ¶6.

As you can imagine, the (unpublished) Order entered by Judge McGuire was not complimentary of this discourtesy.  He stated that these two Defendants had "openly flouted this Court's [case management] order and the applicable North Carolina rules."  ¶14.

The relief granted by the Court in light of this rude behavior -- after ruling that lesser sanctions would be inadequate given the "seriousness of the misconduct" (Order ¶15)  -- was to strike the Answer of these Defendants and to enter default against them.

The only punishment not delivered by Judge McGuire was not noting that Ray was engaging in the unauthorized practice of law if he was also speaking on behalf of DigiPlus LLC.

 

There Is A Difference Between "Inducing" Something and "Causing" Something

If you asked me to list my favorite torts, tortious interference with prospective economic advantage would be near the bottom of the list.

But that tort was front and center in Judge McGuire's Opinion in KRG New Hill Place, LLC v. Springs Investors, LLC, 2015 NCBC, 2015 NCBC 19, which addressed the proof required for an essential element of the tort.

To prove tortious interference with prospective economic advantage, "a plaintiff must show that the defendant, without justification, induced  a third party to refrain from entering into a contract with the plaintiff, which would have been made absent the defendant's interference."  Op. ¶4.

The Defendant Springs Investors -- which was asserting a tortious interference counterclaim -- said that the Plaintiff KRG's breach of an agreement to develop a 123 parcel of real estate caused a third party (Kaplan) to back out of a Joint Venture to develop a residential apartment complex on adjoining property owned by Springs.

Defendant said that the Plaintiff's breach had met the requirement that its actions induced Kaplan's decision to refrain from entering into the Joint Venture, because the breach had caused Kaplan's decision to decide to refuse to go ahead with the Joint Venture.

That was insufficient to make out a claim for the prospective interference tort, said Judge McGuire.  He relied on a Court of Appeals decision affirming a Business Court ruling.  In that case, the COA held, in interpreting the word "induce" in a contract, that:

The relevant definition of 'induce' is (1) 'to move by persuasion or influence[;]'
(2) “to call forth or bring about by influence or stimulation[;]' and (3) “to cause the formation of[.]' Similarly, Black’s Law Dictionary defines inducement as '[t]he act or process of enticing or persuading another person to take a certain course of action.'  We note that all of the above-cited definitions of . . . 'induce' are similar in that they involve active persuasion, request, or petition.

Op. ¶26 (quoting Inland Am. Winston Hotels, Inc. v. Crockett, 212 N.C. App. 349, 354, 712 S.E.2d 366, 369 (2011) (citing Merriam-Webster’s Collegiate Dictionary 637 (11th ed. 2005) and Black’s Law Dictionary 845 (8th ed. 2009)).

So, "inducing" something has to mean more than just causing something.  As Judge McGuire put it:

To equate 'induced' with 'caused' would mean that any type of conduct by a party that caused a third party to refrain from entering into a contract with a claimant would be grounds for asserting the claim. This would have broad implications for contractual relations in this State as it would make every contracting party potentially liable for the types of damages available for intentional torts, including compensatory and punitive damages, whenever the failure to fulfill a contract for any reason caused the other party to the contract to lose a prospective business opportunity.
 

 Op. ¶28.

Judge McGuire granted Plaintiff's Motion to Dismiss the tortious interference counterclaim because the Defendant had not made any allegations of purposeful conduct by the Plaintiff directed towards Kaplan.

Stop Asking The Business Court To Overrule An Order Of Another Business Court Judge

I don't know why lawyers keep trying to get Business Court Judges to overrule decisions by one of their predecessors.  It is just not going to happen, as illustrated (yet again) by Judge Bledsoe's decision in County of Catawba v. Frye Regional Medical Center, Inc., 2015 NCBC 17.

Judge Murphy, in October 2014, had granted summary judgment in favor of the Defendant on  Plaintiff's claims of fraud and unfair and deceptive practices.  Plaintiff, disagreeing with the ruling, first filed a Motion for Reconsideration (which it withdrew), and followed it with a "Motion for Revision."  It filed both motions after Judge Murphy's retirement.

Judge Bledsoe observed that both motions "seek the same relief -- reversal of Judge Murphy's [summary judgment order" ].  Op. ¶8.

If you read this blog, you know that the Business Court has already rejected the argument that Judge Murphy's retirement, and the resulting change in the Business Court Judge handling the case, is not a "substantial change in circumstances" giving the new Judge the authority to modify, overrule, or change Judge Murphy's Order.

But the Plaintiff in the Catawba County case made a new argument as to why Judge Bledsoe had the authority to overrule Judge Murphy.  It relied on Rule 63 of the North Carolina Rules of Civil Procedure, entitled "disability of a Judge," which says that:

If by reason of death, sickness or other disability, resignation, retirement, expiration of term, removal from office, or other reason, a judge before whom an action has been tried or a hearing has been held is unable to perform the duties to be performed by the court under these rules after a verdict is returned or a trial or hearing is otherwise concluded, then those duties, including entry of judgment, may be performed:

(1) In actions in the superior court by the judge senior in point of continuous service on the superior court regularly holding the courts of the district.

NCRCP 63.

Judge Bledsoe disagreed that Rule 63 granted him the authority to overrule Judge Murphy, stating:

Plaintiff essentially contends that [Rule 63] treats Judge Murphy’s retirement at the expiration of his term of office as an invitation to this Court to decide Defendants’ SJ Motion anew. The Court disagrees. Not only would such a reading ignore the North Carolina rule that one Superior Court judge generally cannot overrule another, but read in context, the Court concludes that Rule 63 is intended for situations where, for example, a Superior Court judge leaves the bench prior to entering a written order on a matter that has been heard, or before a matter is remanded from the appellate courts with instructions for further action. The Court does not read Rule 63 to address the situation here, where Judge Murphy received the parties’ briefs, held a hearing, issued a written order ruling on the parties’ arguments and dismissing claims, and then left the bench.

Op. ¶16.

Those of you who are civil procedure aficionados are no doubt thinking about NCRCP 54(b), which says that in the absence of a final judgment, "any order . . . is subject to revision at any time before the entry of judgment adjudicating all the claims and rights and liabilities of all the parties."

Judge Bledsoe recognized that his Opinion means that a party loses its "right to seek revision of a summary judgment ruling by the trial court under Rule 54(b) when the issuing Superior Court Judge retires or otherwise leaves the bench prior to the entry of a final judgment."  Op. ¶16.

Judge Bledsoe also observed that allowing him to overrule Judge Murphy's decision would invite a "potential sea of motions. . . from disappointed litigants seeking to overturn decisions issued in the last weeks of [a] departing judge's service on the bench."  Op. ¶17 & n.2.

So what's the remedy for the unhappy Plaintiff in this case?  As Judge Bledsoe put it, "the party's redress is with the North Carolina appellate courts and not with another Superior Court judge."  Op. ¶17.

 

A Valuable Point From The NC Business Court On Subpoenas Without Depositions

Can you send a subpoena duces tecum -- which translated from Latin is "a writ commanding a person to produce in court certain designated documents or evidence " --  without coupling it with a deposition?

Maybe that question has never puzzled you, but in an Order of the Business Court on February 12, 2015 in Harriott v. Central Carolina Surgical Eye Associates, P.A. Judge Bledsoe answered whether a subpoena duces tecum can be served without noticing a deposition in conjunction with the subpoena.

Plaintiff had served a subpoena duces tecum on several entities which were not party to the case. Those entities objected contending that a "subpoena duces tecum must be issued in conjunction with a proceeding in which testimony is to be received."

Judge Bledsoe disagreed, ruling "a subpoena duces tecum . . . can . . . be used to compel a non-party to produce documents without a concurrent request to testify."  Order at 1-2.

The governing Rule of Civil Procedure (NCRCP 45) is less than clear on this point. It says that a "command to produce records, books, papers, electronically stored information, or tangible things may be joined with a command to appear at trial or hearing or at a deposition, or any subpoena may be issued separately." NCRCP 45(a)(2).

The federal rule, by contrast,  is explicit on being able to serve a subpoena for documents without a contemporaneous deposition.  It says that:

Combining or Separating a Command to Produce or to Permit Inspection . . . . A command to produce documents, electronically stored information, or tangible things or to permit the inspection of premises may be included in a subpoena commanding attendance at a deposition, hearing, or trial, or may be set out in a separate subpoena.

FRCP45(a)(1)(C).

So, if there was any doubt about this practical nuts and bolts issue, state law practice is now consistent with the federal rule.  Subpoena away.  At least in the Business Court.

The Business Court Rules Again On Claims Under The North Carolina Securities Act

Last week's decision in Atkinson v. Lackey, 2015 NCBC 13 doesn't tell you everything you wanted to know about the North Carolina Securities Act (the "NCSA"), but it comes pretty close.

The lawsuit was brought by three individuals who had made investments in the Pacific Fund, a defendant LLC.  The individual Defendants -- Lackey, Saldarini, and Mehler -- were the members of Pacific Capital, which was in turn the sole manager of the Pacific Fund.

The Plaintiffs alleged that their investments in the Pacific Fund had been fraudulently induced by Lackey, Saldarini, and Mehler.  The alleged misrepresentations were that the Pacific Fund owned various properties in high-end residential communities on the South Carolina coast.

The Atkinson case is the latest in a small handful of cases brought under the NCSA that have resulted in rulings from the Business Court.  The others are: NNN Durham Office Portfolio 1, LLC v. Highwoods Realty Limited Partnership, 2013 NCBC 12, Associated Packaging, Inc. v. Jackson Paper Manufacturing Co., 2012 NCBC 13, and Skoog v. Harbert Private Equity Fund, II, LLC, 2013 NCBC 17.  I wrote about NNN Durham and Associated Packaging on this blog, but missed Skoog.

Standing: Were The Fiduciary Duty Claims Direct Or Derivative?

The first issue up for consideration by Judge Bledsoe in Atkinson was whether the Plaintiffs had standing to bring their claims for a breach of fiduciary duty. That issue turned on whether the claims were direct or derivative.  An LLC member or corporate shareholder generally cannot pursue a direct cause of action against a third party for the loss of the value of his investment.  Barger v. McCoy Hilliard & Parks, 346 N.C. 650, 660, 488 S.E.2d 215, 220-21 (1997).

The exceptions to the "Barger Rule" -- rarely met -- are that direct claims may be brought by an LLC member or shareholder when "the wrongdoer owed him a special duty, or (2) that the injury suffered by the guarantor is personal to him and distinct from the injury sustained by the corporation itself."  Id. at 659, 488 S.E.2d at 221.

Judge Bledsoe did not have to plow any new ground to find that the Plaintiffs before him were owed a "special duty."  The NC Court of Appeals held more than thirty years ago that a special duty exists "when the wrongful actions of a party induced an individual to become a shareholder."  Howell v. Fisher, 49 N.C. App. 488, 498, 272 S.E.2d 19, 26 (1980).  Since the Plaintiffs alleged that the Defendants had made misrepresentations in order to obtain their investment, the Plaintiffs had standing to pursue their claims.

Securities Fraud Claims: Primary and Secondary Liability

Standing was not an issue for the state securities fraud claims.  G.S. §78A-56(a)(2) provides an individual cause of action for "any person purchasing a security."

There are "two different pathways" to liability under the NCSA.  The first "pathway" is for "primary liability" under G.S. § 78A-56(a)(2):

which imposes primary civil liability upon “an offeror or seller of a security who (1) makes any untrue statement of a material fact, or (2) fails to state a material fact necessary for a statement which was made to not be misleading.” NNN Durham Office Portfolio 1, LLC, 2013 NCBC 12 at ¶64. To avoid primary liability, an offeror or seller must prove “he did not know, and in the exercise of reasonable care could not have known[] of the truth or omission.” Id.; Latta v. Rainey, 202 N.C. App. 587, 598, 689 S.E.2d 898, 908 (2010). Section 78A-56(a)(2). 

Op. ¶34.

The second "pathway" lies in "secondary liability":

If Plaintiffs can prove that an offeror or seller has primary liability under N.C.G.S. § 78A-56(a)(2), secondary liability will lie for “[e]very person who directly or indirectly controls [that person], every partner, officer, or director of the person, every person occupying a similar status or performing similar functions, and every dealer or salesman who materially aids in the sale,” unless that person proves that he “did not know, and in the exercise of reasonable care could not have known, of the existence of the facts by reason of which the liability is alleged to exist.” N.C.G.S. § 78A-56(c)(1) (2014).

Op. ¶35.

 

 

Continue Reading...

An Answer To A Million Dollar Question About Designating Cases To The NC Business Court

This past Friday, I went to a seminar put on by the Antitrust and Complex Business Disputes Law Section of the North Carolina Bar Association in an almost successful effort to finish getting my required CLE hours for 2014.  This seminar included presentations from Business Court Chief Judge Gale as well as Business Court Judges Bledsoe, McGuire, and Jolly (Judge Jolly was presented with the Section's Distinguished Service Award). 

Sometimes there is real value in a seminar.  One tip from Chief Judge Gale was worth the price of admission to this alone.  The tip concerned an open question under the Business Court Modernization Act, which became effective on October 1, 2014.

The Modernization Act created a new class of cases which can be designated to the Business Court: Contract disputes where a corporation, partnership, or LLC is a party and where the amount in controversy is more than $1 million.  It is the only type of case which requires the consent of all parties before it can be properly designated to the Business Court.  G.S. §7A-45.4(a)(9)(d).

That consent requirement is hard to reconcile with the requirement that a Notice of Designation must be filed "contemporaneously with the filing of the complaint." G.S. §7A-45.4(d)(1).

How can you get the consent of the opposing party before the complaint is filed?  What if you have no idea what lawyer is going to represent the defendant?  And even after the filing, it may take weeks before counsel appears for the opposing party.  If you wait for counsel to appear and consider your request that the case be designated, you may run afoul of the "contemporaneous" requirement.

So what's the best course of action?  Here's where the tip from Judge Gale came in handy.  He said that it is best not to wait, but to file the Notice of Designation immediately and request that it be held in abeyance pending a response from all other parties whether they will consent.

You would think that having all the Judges in one place last Friday would mean that no opinions would be issued by the Court that day, giving me a day off.  But that was not the case.  Judge Bledsoe delivered an opinion late Friday evening in Atkinson v. Lackey, 2015 NCBC 13, an interesting case involving the North Carolina Securities Act.  Considering that the Judge probably didn't get back to Charlotte from Cary until 6:30 p.m. at the earliest, it makes me wonder how late his clerks work.  But I will write about that case tomorrow.

Supreme Court Justices Box The Fourth Circuit's Ears

Two Justices of the U.S. Supreme Court took the Fourth Circuit to task for not publishing a significant opinion.  The ear-boxing came last month in the form of a denial of a Petition for Certiorari from which Justice Thomas and Justice Scalia dissented, taking the position that the Supreme Court should accept the case for review.

Let's set the stage: The Fourth Circuit's unpublished opinion, forty pages long, came in the case of Austin v. Plumley.  The case is as far as can be from the usual business law case that I usually write about on this blog.  It concerns the sentencing of criminal defendants.  The Fourth Circuit opinion construes a presumption that the Supreme Court set down nearly fifty years ago in North Carolina v. Pearce, 395 U.S. 711, 725-26 (1969): that when a trial judge imposes a harsher sentence on a defendant who was previously sentenced by that judge for the same crime, "judicial vindictiveness" should be presumed..

There is a split among the Circuit courts about under what circumstances judicial vindictiveness should be presumed.  The Fifth and Ninth Circuits construe the presumption narrowly, holding that it applies only when there is a "triggering event" like a reversal by a higher court that "prods the sentencing court into a posture of self-vindication."  Kindred v. Spears, 894 F.2d 1477, 1480 (5th Cir. 1990); accord Fenner v. United States Parole Comm'n, 251 F.3d 782, 788 (9th Cir. 2001).

The Fourth Circuit, in its unpublished opinion, lined up with the Seventh Circuit (United States v. Paul, 783 F.2d 84, 88 (7th Cir. 1986) and took a more expansive view, ruling that the presumption applies when the trial court applies a more severe sentence after it grants a motion for a corrected sentence.

So, should the Fourth Circuit have published this opinion?  The Court's own Local Rules seem to call for that.  Local Rule 36(a) says that the Court's opinions will be published if they meet "one or more" of five criteria.  Justice Thomas felt that at least three were met because the opinion:

'establishe[d] . . . a rule of law within th[at] Circuit,' 'involve[d] a legal issue of continuing public interest,' and 'create[d] a conflict with a decision in another circuit.'

Denial at 7.

Does it make any difference that the opinion is unpublished?  The Fourth Circuit formerly "disfavored" the citation of its unpublished decisions, in the previous version of its Local Rule 36(c).  Now, there is a line of cleavage in the Fourth Circuit Rules -- citing unpublished decisions from before January 1, 2007 is still "disfavored," but unpublished decisions after that date are fair game for citation.  That is due to a change of that date in the Federal Rules of Civil Procedure, which states that:

[a] court may not prohibit or restrict the citation of federal judicial opinions, orders, judgments or other written dispositions that have been:

(i) designated as 'unpublished,' 'not for publication,' 'non-precedential,' 'not precedent,' or the like; and

(ii) issued on or after January 1, 2007.

FRAP 32.1.t

So, lawyers can cite all they want to the Austin v. Plumley decision. The real concern about the Fourth Circuit's unpublished ruling is that is not binding on the Court, as Justice Thomas pointed out, relying on Minor v. Bostwick Labs, Inc., 669 F.3d 428, 433 n.6 (4th Cir. 2012).  He said:

It is hard to imagine a reason that the Court of Appeals would not have published this opinion except to avoid creating binding law for the Circuit.

Denial at 7.

It will be interesting to see if Justice Thomas' and Scalia's beef with the Fourth Circuit results in any visible reaction from the lower appellate court.  It would probably be more likely if Chief Justice John Roberts had joined his two colleagues in the dissent to the denial of the Petition for Certiorari, as the Chief Justice is the Justice on the Supreme Court assigned to the Fourth Circuit.  Justice Scalia has the Fifth Circuit, and Justice Thomas the Eleventh.

Don't think that I scour the Supreme Court's denial of cert. petitions looking for something to write about.  I would not have known about this ruling but for my son, Dash Sperling, a freshman at UNC, reading about it in the New York Times and bringing it to my attention.  Oh, and the North Carolina Appellate Blog also wrote about Justice Thomas' complaining about the Fourth Circuit yesterday.

Is It Worth It For Plaintiffs' Counsel To Gamble On Merger Class Actions in North Carolina?

I hadn't written anything yet about the multiple shareholder actions challenging the merger of PokerTek -- a developer and distributor of electronic table (gambling) games -- with Multimedia Games -- another developer and distributor of gambling technology.

The transaction was valued at $12.6 million, making it one of the lowest value mergers ever attacked in the Business Court.  But the transaction generated five cases filed last year, shortly after the announcement of the transaction, by six shareholders named Simmer, Weber, Dabord, Lobo, Stephens, and Sandler (Weber and Dabord paired up as co-plaintiffs in their case).

Each case asserted various claimed violations of fiduciary duty by the PokerTek board, and alleged that PokerTek had made inadequate disclosures in its description of the transaction.  PokerTek and Multimedia were alleged to have aided and abetted the directors' claimed breaches of fiduciary duty.  The case was settled in July of 2014.  The settlement focused on the disclosure-based claims, and PokerTek made supplemental disclosures in a Form 8-K filing per the settlement.

PokerTek's shareholders voted overwhelmingly (96% to 4%)  to approve the merger ten days after the supplemental disclosures were filed.

The Plaintiffs Had No Viable Claims, Except Perhaps Their Disclosure Claims

The decision of counsel for the class (which was certified by Judge Bledsoe in the Order and Final Judgment, 2015 NCBC 8), to settle the case for the additional disclosures was deemed by the Court to be "prudent and reasonable."  Order ¶42.  That was kind, and the Judge was equally kind in not saying outright that the other claims brought by the shareholders were likely to be losers.

Even so, he expressed serious uncertainty whether they had any chance of succeeding.  He said that "there is nothing in the record to suggest that Plaintiffs' claims are strong enough to justify further litigation."  Order ¶38. 

He then ticked through the relatively valueless claims.  He said that if the Plaintiffs' claims were deemed to be derivative, that the Plaintiffs "faced a significant standing hurdle in light of [their] failure to make statutory demand on PokerTek."  Order ¶39.  He also expressed doubt over whether the claims against PokerTek's directors "could overcome the evidentiary presumption afforded by the business judgment rule."  Order Par. 40.  And to the extent that the Plaintiffs took a run at holding the corporate defendants liable on an aiding and abetting breach of fiduciary duty theory, Judge Bledsoe said that those claims faced "substantial risk . . .  because it is unclear whether North Carolina recognizes this cause of action."  Order ¶41.  I've written at least a couple of times on this blog about the questionable viability of such a claim.  See here, and here.

When Are Disclosures "Material"?

So, the only claim with any value on which to base a settlement was the disclosure claims.  And all the preamble in this post leads up to whether Plaintiffs' counsel were entitled to any fees for obtaining this settlement.

Well, were the disclosures obtained by the Plaintiffs "material" to the transaction?  The standard for this is that "a disclosed fact is material if there is 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."  Order ¶43.

Judge Bledsoe, relying on precedent from the Delaware Court of Chancery, found the supplemental disclosures to fall into "the sort of information that the Delaware Chancery Court has recognized may be material."  Order ¶44.  This included:

  • information necessary for discounted cash flow analyses;
  • comparative financial information, including enterprise value/EBITDA and enterprise/revenue multiples for companies selected as comparable by PokerTek's financial advisor; and
  • information regarding PokerTek's engagement of a financial advisor and of the business relationship between PokerTek, Multimedia, and the financial advisor.

Order ¶44.

Would this type of information be significant to a "reasonable investor"?  Well, you might have read about the recent hoopla surrounding Jonathan Gruber's statements with regard to the Affordable Care Act, when he said that the ACA passed due to the "stupidity of the American voter."  I don't think that the mythical "reasonable investor" is stupid, but I doubt that he or she cares very much about the matters that Judge Bledsoe referenced.  Of course, there is the possibility that the "reasonable investor" is an institutional investor which might attach more importance to matters like a discounted cash flow analysis and enterprise/revenue multiples.  But even so, the supplemental disclosure about the relationship between PokerTek, Multimedia, and the financial advisor which was obtained as a price of the settlement was that the financial advisor had never previously performed services for either company.

The Award Of Attorneys' Fees

So, if you are with me on the lack of value of these disclosures, how much were Plaintiffs' counsel entitled to for their arduous efforts in obtaining them?  The Court awarded $140,000 in fees and expenses, the amount which the Defendants agreed to pay in the settlement agreement.

How did the parties arrive at that figure?  Plaintiffs' counsel collectively devoted about 500 hours to the case.  What did they do in that time?  They "retained an expert, reviewed and analyzed approximately 3,100 documents, prepared a motion for preliminary injunction with supporting briefs, and undertook confirmatory discovery after" entering into a Memorandum of Understanding regarding the settlement.  Order ¶57.

The hourly fee awarded counsel broke down to $226.83 per hour, which the Court found to be in line for rates for North Carolina counsel.  Judge Bledsoe noted that Plaintiffs' counsel, several of whom were from major metropolitan centers, usually charged substantially more for similar work and were taking a sizeable haircut off their usual attorney rate of $553.26 per hour.

That really wasn't a very rich recovery for the six law firms representing the Plaintiffs.  If the $140,000 is divided equally, that's only about $23,000 per firm.  It seems hardly worth the effort.  An agreement reflecting the division of the fees among the law firms is buried in the filing for the fee award (the percentages range from 45% to 5%).  That makes the work even less lucrative.

This award of $140,000 is in line with -- and actually a fair amount less than -- other fee awards by the Business Court in disclosure-only class action settlements. See, e.g. In re Progress Energy S'holder Litig., 2011 NCBC 45 ($550,000); In re PPDI Litigation, 2012 NCBC 33 ($450,000); In re Harris Teeter Merger Litig., 2014 NCBC 44 ($325,000).

The glaring outlier in the history of these fee awards in the Business Court is the $1 million plus awarded by the Court in the litigation over the Wachovia/Wells Fargo merger litigation, which is now before the NC Court of Appeals.  Perhaps the COA will undertake the analysis of the materiality of the disclosures obtained by the Plaintiff in that case.  I've previously written about my dismal opinion of the quality of those disclosures, and my disappointment at the Court's approval of a more than a million dollar fee.

I'm not the only one complaining about the fees obtained by the lawyers for the class plaintiffs in these merger related actions.  Judge Tennille, before he retired, wrote about what he condemned as "stinky fees."

Still, these types of lawsuits are certainly good for the legal economy and for the North Carolina lawyers called upon to defend them.

And there will be one more merger class action fee decision coming down this year from the Business Court in which there will undoubtedly be a large application for a fee award.  That's the merger of R.J. Reynolds and Lorillard, in which a disclosure only settlement was recently announced.

If deal value is a factor in a fee award in a disclosure-only settlement, which it appears to be, then the Reynolds/Lorillard deal, valued at $25 billion, will spin off substantially larger fees than the PokerTek class actions (in which the deal was worth, by comparison, a paltry 12.5 million).

But should deal value be a factor?  Shouldn't it be the value of the disclosures?

A Couple Of Things To Know Before Bringing A Piercing The Corporate Veil Claim

You might remember the case of  Cold Springs Ventures, LLC v. Gilead Sciences, Inc..  Last year, Judge Jolly stayed an arbitration proceeding pending a ruling on a piercing the corporate veil claim.  If you are a reader of this blog, you will remember that I wrote about that decision last April.  Now, assuming that you've gone and reread that post, you are up to speed on the issue.

Judge McGuire, taking over the case and stepping into Judge Jolly's shoes, undertook the summary proceeding mandated by 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."

This month's ruling is in 2015 NCBC 1

The issue for the Court was whether the individual Plaintiffs, directors of NC Kyro, could be obligated to arbitrate based on a contract that their corporation had signed with Gilead.  The individuals had not signed the contract, but Gilead argued that it was entitled to pierce the corporate veil and thus make the individuals subject to arbitration.  Gilead is contending in the arbitration it commenced that the individuals are personally liable to it on that contract, again on a piercing the corporate veil theory.

Given that deciding the question of arbitrability involved the consideration of issues basic to Defendant's claim on the merits, Judge McGuire was exceedingly careful to abide by the U.S. Supreme Court's admonition that "in deciding whether the parties have agreed to submit a particular grievance to arbitration, a court is not to rule on the potential merits of the underlying claims."  AT&T Technologies, Inc. v. Communications Workers of America, 475 U.S. 643, 649 (1986).  He said that his "decision will not have collateral estoppel or res judicata consequences." Order ¶10.

But, even with that caution, Judge McGuire's Order should send a pretty clear signal to the Defendant's counsel that its piercing the veil claims aren't likely to succeed.  And for lawyers contemplating bringing such claims in the Business Court, it clarifies some of the standard "magic words" enunciated by courts when considering motions to pierce the corporate veil.

"Control and Domination"

A party seeking to pierce the corporate veil must show "control, not mere majority or complete stock control, but complete domination, not only of finances, but of policy and business practice . . . so that the corporate entity . . . had at the time no separate mind, will or existence of its own."  Green v. Freeman, 367 N.C. 136, 145, 749 S.E.2d 262, 270 (2013).

This element "is a critical, if not the most critical, element in a court's piercing analysis."  Order ¶28.

Gilead came up short on this critical element despite its showing of the individual Plaintiffs' direct involvement in key actions taken by NC Kyro, including its winding down and its dissolution.

Those actions were taken in their capacities as directors of NC Kyro, and Judge McGuire observed that:

directors of North Carolina business corporations are charged with exercising, or directing the exercise of, all corporate powers.  Gilead's argument regarding the control exercised by [the individuals] is based almost entirely on actions taken by those individuals pursuant to their statutory authority as directors.

Order ¶31.

"Inadequate Capitalization"

Another factor considered by the Courts in determining whether to pierce the corporate veil is "inadequate capitalization."  Green, supra, 367 N.C. at 1455, 749 S.E.2d at 270.  But there is a difference between "inadequate capitalization borne [sic] out of deception or fraud, and inadequate capitalization 'arising simply out of a lack of funds available for contribution to the enterprise.'"  Order Par. 39 (quoting R. Robinson, Robinson on North Carolina Corporation Law § 2.10[2].

Although NC Kyro did suffer from inadequate capitalization (one of the Plaintiffs had testified that it "was always insolvent" and "never a going concern"), it was a startup struggling to raise capital.

Judge McGuire held that "the mere fact that NC Kyro's capitalization efforts did not ultimately yield enough capital for the company to survive should not, without more, support the drastic remedy of disregarding the corporate form.  Order ¶40.

So, if you are making a piercing the corporate veil claim, be careful to distinguish actions taken pursuant to corporate authority from "domination and control," and watch out before you take a lack of funds to be the necessary "inadequate capitalization."

Before getting to the published Order, the Judge had to step through ruling on a Motion to Disqualify Gilead's counsel because it had previously represented the Plaintiffs.  He denied that Motion in an unpublished Order.  If you are interested in reading that Order, it is here.