The North Carolina Court Of Appeals Rejects Wal-Mart's Request For A $30 Million Tax Refund

The Court of Appeals today affirmed a trial court’s ruling that Wal-Mart had been properly assessed more than $30 million in taxes, penalties and interest.  The case is Wal-Mart Stores East, Inc. v. Hinton.

The tax strategy of Wal-Mart rejected by the Court involved the discounter transferring the ownership of its stores to a Delaware Real Estate Investment Trust headquartered in Arkansas.

Wal-Mart paid rent for its North Carolina stores to the REIT, and deducted those payments on its North Carolina tax returns. When the REIT paid out that income to its shareholders – which were other Wal-Mart entities – the REIT didn’t have to pay income tax. That’s because REITs don’t pay income tax so long as they distribute 90% of their income to their shareholders.

The $30 million assessment resulted from the Secretary of Revenue’s disregard of Wal-Mart’s restructuring, and his combination of the earnings of the various Wal-Mart entities involved. That power comes from G.S. §105-130.6, which authorizes him to “require the corporation to file a consolidated return of the entire operations of the parent corporation and its subsidiaries and affiliates,” upon a finding “that a report by a corporation does not disclose the true earnings of the corporation on its business carried on in this State.”

I’ll leave it to those of you who want the details to parse through the opinion, which discusses the construction of the statutory term “true earnings,” the constitutionality of the statute, and the validity of the substantial penalties assessed against Wal-Mart.  But footnote 14 of the opinion is worth a mention if you, like me, don't rank tax law as one of your favorite subjects.  It's a quote from Judge Learned Hand:

The words of . . . the Income Tax [Act] . . . merely dance before my eyes in a meaningless procession: cross-reference to cross-reference, exception upon exception couched in abstract terms that offer no handle to seize hold of leave in my mind only a confused sense of some vitally important but successfully concealed, purport.

The Wall Street Journal estimated that Wal-Mart's tax strategy had saved it $230 million in taxes in dozens of states.
 

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Motions To Dismiss, Little Green Men, And The United States Supreme Court

If you are working on a motion to dismiss in a federal case, you should stop right now and read the U.S. Supreme Court's decision today in Ashcroft v. Iqbal.  The decision sharpens and refines the heightened standard for a Rule 12(b)(6) motion articulated by the Court  in Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007).

The decision today makes it clear that Twombly applies to all civil cases, not just antitrust cases, as the Plaintiff in Ashcroft had argued.  It also has an important point on the requirement for pleading intent in discrimination cases.

In Ashcroft, Iqbal, a Muslim, had been arrested and imprisoned following September 11th.  He claimed this was a result of discrimination against him based on his race, religion, and national origin. The Second Circuit had affirmed the denial of the Defendants' motion to dismiss, but the Supreme Court reversed and dismissed the case.

Here's the key quote from the opinion, which will undoubtedly be repeated often in Rule 12(b)(6) briefs:

Two working principles underlie our decision in Twombly. First, the tenet that a court must accept as true all of the allegations contained in a complaint is inappli­cable to legal conclusions. Threadbare recitals of the elements of a cause of action, supported by mere conclusory statements, do not suffice. (Although for the purposes of a motion to dismiss we must take all of the factual allegations in the complaint as true, we 'are not bound to accept as true a legal conclusion couched as a factual allegation'). Rule 8 marks a notable and generous departure from the hyper-technical, code-pleading regime of a prior era, but it does not unlock the doors of discovery for a plaintiff armed with nothing more than conclusions. Second, only a complaint that states a plausible claim for relief survives a motion to dismiss. Determining whether a complaint states a plausible claim for relief will, as the Court of Appeals observed, be a context-specific task that requires the reviewing court to draw on its judicial experience and common sense. But where the well-pleaded facts do not permit the court to infer more than the mere possibility of misconduct, the complaint has alleged -- but it has not 'show[n]' -- that the pleader is entitled to relief.'

The decision also contains a gem for lawyers defending claims of discrimination.  Iqbal's lawyers had argued, relying on FRCP 9, that that they were entitled to plead "generally" the Defendants' discriminatory intent.  The Supreme Court majority disagreed:

It is true that Rule 9(b) requires particularity when pleading 'fraud or mistake,' while allowing '[m]alice, intent, knowledge, and other conditions of a person's mind [to] be alleged generally.'  But 'generally' is a relative term.  In the context of Rule 9, it is to be compared to the particularity requirement applicable to fraud or mistake.  Rule 9 merely excuses a party from pleading discriminatory intent under an elevated pleading standard.  It does not give him license to evade the less rigid -- though still operative -- strictures of Rule 8.

The Court held that Iqbal's rote allegation that he had been discriminated against "on account of [his] religion, race, and/or national origin and for no legitimate . . . interest" was insufficient to state a claim.

The Ashcroft decision provoked a vigorous dissent.  Justice Souter (joined by Justices Stevens, Ginsburg, and Breyer) said that a trial judge is bound to accept the allegations of a complaint as true, no matter how skeptical he or she may be.  He went on to say "[t]he sole exception to this rule lies with allegations that are sufficiently fantastic to defy reality as we know it: claims about little green men, or the plaintiff's recent trip to Pluto, or experiences in time travel.  That is not what we have here."

Oh, if you're in North Carolina state court, and want to argue the Twombly standard, you are out of luck, at least for now.  The Court of Appeals said late last year in Holleman v. Aiken that it didn't have the power to adopt Twombly absent a ruling by the North Carolina Supreme Court.

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Default Entered Against LLC Even Though Its Derivative Action Had Been Dismissed

Can you have a default entered against you if you aren't a proper party to the lawsuit?  The answer is yes, at least on the unique facts before the Business Court in its opinion Friday in the derivative action Regional Property Development Corp. v. Carpenter.

Regional Property, a member of Lancaster Industrial Park, LLC, had filed a derivative action on behalf of the LLC against three other members of Lancaster, and also the lender to the LLC, Regions Bank. 

In a March 25th Order, the Business Court dismissed the derivative claims, ruling that Regional Property wasn't entitled to sue on behalf of Lancaster because of it hadn't made a demand on the managers of the LLC to file the suit.  The Court allowed Regional Property leave to amend to assert demand futility.

But right before that ruling, Regions Bank had counterclaimed against Lancaster, asserting that Lancaster was in default on its loan obligations to the Bank.  Lancaster, whose derivative claim had been dismissed by the time the answer deadline had run, didn't answer.  (Or rather, Regional Property, which had brought the lawsuit, didn't answer on behalf of the LLC).  Regions Bank then moved for entry of default.

The other defendants, the members who had moved to dismiss the derivative action, objected to the Motion for Entry of Default and said that default was not proper because the LLC wasn't a party to the litigation.  They said in their Opposition that "Lancaster cannot be in default in this matter for the simple reason that it is not a party."  They also argued that Regions Bank should be estopped from arguing that Lancaster was a party, because it also had taken the position there was no authority for Regional Property to file the lawsuit on behalf of Lancaster.

Judge Diaz entered default over that objection.  He said that once the counterclaims were filed, Lancaster "was bound to respond to the counterclaims or risk default, regardless of whether it should have appeared in the action to begin with."  Also, given that Regional Property had moved after the dismissal of its derivative action to amend the Complaint to excuse its lack of demand, the Court held:

where a party seeks to pursue a claim derivatively on behalf of a limited liability company, the LLC is a necessary party and is normally joined as a defendant. See generally Russell M. Robinson, II, Robinson on North Carolina Corporation Law § 17.05[2] (7th ed. 2008) (citing relevant cases with respect to derivative actions filed on behalf of a corporation). Thus, even if Lancaster now disavows any role in this case as a party-plaintiff, because Regional Property’s Second Amended Complaint asserts derivative claims on Lancaster’s behalf, Lancaster remains a party.

If you are going to fire off a derivative action, you need to be prepared to defend against whatever might get shot back in the way of a counterclaim. 

[Update: The Court set aside this entry of default in an Order dated September 23, 2009, permitting the members of the LLC to adopt after the fact a response to the counterclaims filed by the Plaintiff when it did not have authority to act for the LLC in filing the lawsuit].

The Fourth Circuit Slams The Door On Animal House (And Overly Long Briefs Too)

The Fourth Circuit this week considered the antics of the Sigma Chi fraternity at George Mason University, and it didn't like what it saw.  In Iota Xi Chapter of Sigma Chi Fraternity v. Patterson, the Court affirmed the District Court's dismissal of the fraternity's lawsuit asserting that its ten year ban from campus had violated its procedural due process and free speech rights.

This post isn't about the vile and obnoxious conduct of the brothers of Sigma Chi, or why it hadn't suffered an injury to its reputation by the University saying in its student newspaper that the fraternity had "faciliated sexual assaults." or even why the frat had no standing to pursue its free speech claim.

Instead, I'm writing about the opinion because of how the Fourth Circuit handled the issue of the fraternity's motion to strike the Defendants' summary judgment brief in the District Court because it was two pages too long. The University's brief rambled for 32 pages instead of the 30 allowed by Local Rule.

The District Court had refused to strike the brief.  Instead, it struck only the last two pages.  The fraternity argued that the District Court had no authority to do anything other than strike the entire brief, because the applicable Local Rule said that briefs shall not exceed 30 pages.  It also argued that the trial court couldn't strike the last two pages because then there would be no signature page on the brief and it then wouldn't be in compliance with Rule 11.

The Fourth Circuit ruled that the District Court had "acted well within its discretion," and that it "is for courts, not litigants, to decide what rules are desirable and how rigorously to enforce them." Striking the last two pages therefore was an appropriate sanction.

I think a better sanction would be striking the first two pages.  That's where I put all the good stuff.

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Business Court Grants Motion For Disqualification Of Counsel

The Business Court today granted a motion to disqualify counsel for Plaintiffs, finding their prior representation of the Defendants involved a matter "substantially related" to the matters at issue in the lawsuit. 

The law firm representing the Plaintiffs in The Cottages of Stonehenge Condominium Homeowners Association, Inc. v. Dominion Mid-Atlantic Properties II, LLC had been longstanding counsel for the Plaintiff homeowners association.  They had first been retained when Defendant Dominion, the former owner of the property, converted it to a condominium and incorporated the HOA.

The Board of the HOA at that time consisted of representatives appointed by Dominion.  In 2006, the Dominion-controlled Board sought the law firm's advice about maintenance issues.  The advice was sought on behalf of both the HOA and Dominion.  The lawyers delivered a written opinion letter on "the maintenance responsibilities between the Unit Owners and the Association."

Over a year later, an owner-controlled Board of the HOA was elected.  Issues arose regarding the adequacy of maintenance reserves.  The law firm filed a lawsuit for the HOA against Dominion and the former board members for breaching their fiduciary duty by failing to set adequate reserves for common area and maintenance expenses.

After sifting through the positions of the parties, the Court held:

[h]ere, Defendants find themselves in a position in which the very lawyer who advised one or more of them with respect to duties and obligations relating to budgeting for and maintaining Stonehenge common areas now seeks damages against them for breaching their duty to adequately set aside fiscal reserves for the repair and maintenance of those same common areas.  The court is forced to conclude that the two are inextricably and substantially related.

Judge Jolly granted the Motion to Disqualify, stating that the prior representation presented the "substantial risks contemplated under Rule 1.9" of the North Carolina Rules of Professional Conduct, and that "it is the court's duty to resolve any and all such risks in favor of disqualification."

The Dairy Queen sign is from tboard's photostream on Flickr.

Brief in Support of Motion to Disqualify

Brief in Opposition to Motion to Disqualify

Hiring Of Employee In Violation Of Covenant Not To Compete Subjected New Employer To Personal Jurisdiction

The Business Court held today in Armacell v. Bostic that it had personal jurisdiction over an Italian company, L'Isolante, which hired a scientist, Bostic, away from a competitor.

The Plaintiff claimed that the hiring violated Bostic's non-compete agreement, and that Bostic had also stolen "thousands of data files containing sensitive proprietary information and trade secrets."

The Business Court rejected the argument of L'Isolante that it was not subject to personal jurisdiction, finding that the Italian company had (1) pursued and offered employment to Bostic in North Carolina, (2) had obtained a legal opinion from its North Carolina counsel about the enforceability of Bostic's non-compete agreement, (3) tasked Bostic with supporting, from North Carolina, L'Isolante's research and development efforts, (4) worked directly with Bostic in North Carolina after he was hired, and (5) shipped samples of product to North Carolina.

The Court found these contacts to be "direct and strong," and that L'Isolante "had fair warning that these activities might subject it to the jurisdiction of North Carolina."  Judge Tennille also held that "North Carolina's interest in exercising jurisdiction over L'Isolante is substantial.  This case involves the alleged theft of a large amount of trade secrets from a North Carolina company, with injury felt in North Carolina."

At his deposition, Bostic pled the Fifth Amendment about his alleged theft.  In an earlier opinion, the Business Court drew an adverse inference from Bostic's refusal to testify, and entered a preliminary injunction.

Brief in Support of Motion to Dismiss

Reply Brief in Support of Motion to Dismiss

Fourth Circuit Reinstates Securities Fraud Lawsuit Against Mutual Fund Investment Advisor

The Fourth Circuit Court of Appeals delivered an opus today on whether a mutual fund investment advisor could be primarily liable under the federal securities laws for allegedly misleading statements in prospectuses issued by the mutual funds.

The case, First Derivative Traders v. Janus Capital Group, involves alleged misrepresentations by the Janus family of mutual funds about their position on allowing market timing in the funds. The principal focus was whether the statements in the prospectuses were "sufficiently publicly attributable" to the advisor to make out reliance under a fraud-on-the-market theory of liability.

The Circuit courts have gone off in different directions on this issue, with some (the 2nd and 11th) requiring "direct attribution of the allegedly misleading statement to the defendant," another (the 9th) saying that "substantial participation or intricate involvement in preparing the misleading statement is sufficient," and another (the 10th) with yet another standard.

The Fourth Circuit went its own way today, reversing the District Court's grant of a motion to dismiss and holding:

for the public attribution element of the reliance inquiry, we hold that a plaintiff seeking to rely on the fraud-on-the-market presumption must ultimately prove that interested investors (and therefore the market at large) would attribute the allegedly misleading statement to the defendant.  At the complaint stage a plaintiff can plead fraud-on-the-market reliance by alleging facts from which a court could plausibly infer that interested investors would have known that the defendant was responsible for the statement at the time it was made, even if the statement on its face is not directly attributed to the defendant.

The conclusion of the Court was that "given the publicly disclosed responsibilities of [the advisor], interested investors would infer that [the advisor] played a role in preparing or approving the content of the Janus fund prospectuses, particularly the content pertaining to the funds' policies affecting the purchase or sale of shares."

The opinion also discusses loss causation and control person liability.

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Nondisparagement Provision Wasn't Violated By "Barroom Gossip"

When law firms break up, litigation often follows.  The case of Merritt, Flebotte, Wilson, Webb & Caruso, PLLC v. Hemmings, decided Tuesday by the North Carolina Court of Appeals, involved claims between lawyers of defamation and violation of a nondisparagement provision in a settlement agreement.

The Defendants had left the Plaintiff's firm to start their own practice. The Plaintiff sued them over sharing of fees and reimbursement of costs. The fighting lawyers settled the first lawsuit. A nondisparagement provision was included in their settlement agreement.

Then came round two. Plaintiff sued the Defendants again, saying they hadn't complied with the settlement. The Defendants responded that they were excused from their obligations for several reasons, including a breach of the nondisparagement provision. They counterclaimed for defamation.

The defamation claim involved statements made by Plaintiff's office manager. He had been out one night at a bar in Raleigh called "White Collar Crime." He allegedly said to a friend of one of the Defendants that the Defendant was "untrustworthy" and "suggested" that the Defendant "had done something wrong or committed some kind of crime when he left the firm."

The Defendants said that the office manager had been acting on behalf of the Plaintiff law firm when he made these statements and that the nondisparagement provision had been breached. The Plaintiff disputed that the office manager was authorized to speak for the firm, and said that the after hours statements at the bar hadn't been made within the course and scope of his employment anyway.

The Court of Appeals affirmed the trial court's summary judgment for the Plaintiff, and said that the Defendants could "articulate no legal connection between these facts and the legal relationship of principal and agent. Defendants offered no evidence that the scope of [the office manager's] employment included barroom gossip about members of the firm, and cite no appellate opinions suggesting that an employee is considered an 'agent' of his employer even when he acts far outside the scope of his employment."

Court Of Appeals Rules That Partner's Self-Dealing Isn't "In Or Affecting Commerce" And Isn't An Unfair And Deceptive Practice

The Court of Appeals split today 2-1 on whether two partners with claims against a third partner for self-dealing and breach of opportunity could make an unfair and deceptive practices claim.  The case is White v. Thompson.  Judge Wynn wrote the majority opinion, and Judge Ervin dissented. 

The partnership was Ace Fabrication and Welding, the partners were White, Ellis, and Thompson.  Ace did several jobs for a large customer, but Thompson then secured a number of jobs from that customer on his own, without performing them with the partnership.

The other partners obtained a jury verdict on a breach of fiduciary duty claim, and were awarded damages of $138,195.  The trial court trebled the damages, but the Court of Appeals majority reversed. 

Its reasoning was that the claim was for a breach of partnership duties involving matters of internal management of the partnership, so the claim did not make out the "in or affecting commerce" requirement of a Section 75-1.1 claim.  It said that the Defendant's activities had indeed harmed the partnership, "but had no impact in the broader marketplace."

Judge Ervin saw things completely differently.  He said:

"Impairing the ability of others to compete for work in this fashion is tantamount to unfair competition, a type of conduct which is clearly actionable" as an unfair and deceptive practice.

"The effect of such conduct was to deprive the partnership of the ability to actually perform certain specialty fabrication jobs . . . a fact which clearly implicates the 'activities the business regularly engages in and for which it [was] organized.'"

"Depriving the partnership of the opportunity to perform these . . .  jobs inevitably affected its financial viability, producing an inevitable impact on competitive conditions in the market for the performance of . . . jobs in the area served by the partnership."

The North Carolina Business Court has faced the issue of what is "in or affecting commerce" on a number of occasions.

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Plaintiff's Claims Barred By One Satisfaction Rule

A Plaintiff who obtained an Arbitration Award against two members of an LLC lost the right to recover under the Award from the LLC when it settled up with the two LLC members.  The case, decided today by the Business Court, is Essa Commercial Real Estate, Inc. v. Five Trees, LLC.

The facts are complicated, but they boil down to this: Plaintiff got an arbitration award of $325,000 against two members of an LLC (Five Trees).  Plaintiff then sued the LLC and its other members to collect on the Award.  In the meantime, Plaintiff settled its claims against the two members against whom it had obtained the Award.

Under the settlement, the Plaintiff agreed to give up its claims against the two members in exchange for $150,000 and an assignment of the two members' interest in the LLC.  The Plaintiff attempted to preserve its right to pursue the LLC and the other members for the balance by including language in the settlement which said "nothing in this Agreement shall act to release, dispose of, compromise, or otherwise impair the right or ability of [Essa] to seek recovery from Five Trees, its members or members of its members under any theory of law or for recovery of the Arbitration Award."

That didn't work.  The Court held that Plaintiff's claim was barred by the "one satisfaction rule," which says that a party is only entitled to a single recovery for any judgment. Since the Plaintiff had resolved the Arbitration Award, it no longer had any right to seek recovery under the Award.

That was so even though the LLC and the other members weren't released by the settlement agreement. In this respect, the case is similar to a recent Court of Appeals decision, Santoni v. Sundown Cove, LLC, where the Court held that a plaintiff''s settlement with some defendants resulted in a settlement as to all plaintiff's claims, even against non-parties to the settlement.

In an earlier opinion in the Five Trees case, the Business Court ruled that the Arbitration Award had collateral estoppel effect. 

New Cases In The North Carolina Business Court: April 2009

This post is a listing and short summary of the fourteen new cases designated to the Business Court during the month of April 2009.  I may start doing a post like this on a monthly basis.

The Sunbelt v. Ahern case (which was settled almost immediately after it was filed) made me think of Yogi Berra.

1st Americard, Inc. v. Kitchens (Mecklenburg)(Diaz) and Grainger v. Kitchens (Union) (Diaz): Dispute between shareholders of a credit card processing company.

Ammons v. Fire & Wire, inc. (Guilford)(Tennille): Dispute between shareholders of a fire alarm and security company.  Plaintiff, a 1/3 shareholder of a Virginia corporation, alleges that his two co-shareholders set up a competing North Carolina company to engage in the same business.

Bason v. Euliss, Inc. (Alamance)(Tennille): enforceability of deed restrictions entered into by a dissolved corporation requiring the operation of an 18-hole golf course.

Browning Systems, Inc. v. Davis (Henderson)(Tennille): claim for breach of fiduciary duty and misappropriation of trade secrets against former officers and shareholder of Plaintiff for their actions in starting a competing business as issuing agents for Chicago Title Insurance Company.  Counterclaims for breach of fiduciary duty, tortious interference, and dissolution of the Plaintiff.

ChampBoat Series, LLC v. In2Focus Films, Inc. (Mecklenburg)(Diaz): copyright case alleging that the Defendant has infringed on Plaintiff's rights to audio and video of powerboat racing series.

Cunniff v. Lewis (Mecklenburg)(Diaz): shareholder derivative action against Bank of America regarding the Bank's acquisition of Merrill Lynch. 

LeCann v. Cobham, LeCann & Torres, P.A. (Wake)(Jolly): Dissolution of dental practice.

McKinnon v. CV Industries (Catawba)(Tennille): Interpretation of severance agreement and former shareholder's rights under a Shadow Equity Plan.

Pfeiffer v. Frontier Spinning Mills, Inc. (Lee)(Jolly): securities fraud claim in connection with squeeze out merger, breach of fiduciary duty, self-dealing, dissenters' rights.

Pharma Services, Network, Inc. v. Associated Medical Group (Mecklenburg)(Diaz): Dispute over agreements relating to clinical drug testing trials.  (Don't forget that the Business Court has mandatory jurisdiction over cases involving "biotechnology.")

Sunbelt Rentals, Inc. v. Ahern Rentals, Inc. (Mecklenburg)(Diaz): Claim by equipment leasing company against its competitor, charging that the defendant has "coordinated multi-state employee raids . . . to pirate away employees of Sunbelt through unlawful and unfair conduct."  If you think this is deja vu all over again, well, you are right.

USFalcon, Inc. v. Yorktown Systems Group, Inc. (Wake)(Jolly): Dispute whether Defendants have an ownership interest in an LLC.

Waste Industries, LLC v. Waste Hauling Services, LLC (New Hanover)(Jolly): Dispute between waste disposal and collection companies.  The Plaintiff claims that its competitor's alleged failure to comply with municipal regulations constitutes unfair competition because the non-compliance reduces its competitor's operational costs and results in an anti-competitive market.