Being A Minority Shareholder Can Be Like Being In A Bad Marriage

Litigation between shareholders can be as unpleasant and messy as a divorce. That was the situation today in Koopman v. Koopman Dairies, Inc., a case which the North Carolina Business Court called a "corporate domestic dispute."

That analogy to family law led the Court to award attorneys' fees for the defendants' contempt of court orders. Ordinarily, fees aren't allowable in a contempt proceeding. Getting that type of award is as rare as, say, a 75th wedding anniversary.

In Koopman, two brothers and their wives each owned 50% of a family dairy farm. They squared off in a lawsuit seeking dissolution. During the course of the lawsuit, the defendants made a habit of taking funds out of the corporate account without the consent of the plaintiffs. The Business Court responded by ordering that neither party could remove funds except in the ordinary course of business.

The defendants violated that order, other directives of the Court, and a settlement agreement regarding the permissible use of corporate funds. You can read the opinion if you want the detail, but Judge Tennille summarized that the defendants "have routinely and repeatedly resorted to self-help when it suited their purposes and deliberately and without justification violated clear and direct orders of this Court. In doing so they also breached the settlement agreement they had reached. Their conduct has been willful and intended to harm [the plaintiff's] business."

The Court held the defendants in contempt. The plaintiffs requested the attorneys' fees they incurred in obtaining that ruling. Judge Tennille observed the "general rule" that "its inherent authority to issue sanctions for failure to obey its orders does not include an award of attorney fees." Op. ¶14.

Nevertheless, the Court awarded fees, relying on Hartsell v. Hartsell, 99 N.C. App. 380, 393 S.E.2d 570 (1990), a domestic case in which the Court of Appeals awarded fees for a party's failure to comply with an equitable distribution award. 

Judge Tennille held "[t]his is a corporate domestic dispute in which the parties had agreed to an equitable distribution of the assets of the company. The rationale for awarding attorney fees under both circumstances is the same. If the parties can choose to ignore court orders and treat the assets at issue in any manner they choose, the system does not work. Parties could simply choose to comply with a court order on distribution in any way they saw fit, leaving the court and their adversary with no remedy." Op. ¶15.

 

Secured Creditor's Sale Of Collateral The Day After Christmas Wasn't Commercially Reasonable

If you are a secured creditor trying to sell off the collateral securing your loan in a "commercially reasonable manner" under North Carolina's Uniform Commercial Code, it's not a good idea to advertise the sale right before Christmas and have the sale right after Christmas.

That's at least part of the lesson from the North Carolina Court of Appeals last week in Commercial Credit Group, Inc. v. Barber, where the Court ruled that the secured creditor's Christmas-time sale had not been commercially reasonable, and denied its request for a substantial deficiency judgment.

The Facts

Barber had given his lender a security interest in a Peterson Pacific 5400 heavy duty waste recycler, a specialized piece of commercial equipment which grinds logs into wood chips.

The recycler broke down almost immediately after Barber bought it. The dealer wasn't able to repair it, and Barber defaulted on his loan to Commercial Credit because he couldn't generate any revenue from the recycler. The creditor took possession of the broken down recycler and gave Barber written notice that it would sell it at public auction on December 27, 2007.

Commercial Credit complied literally with the terms of its security agreement with Barber, which said that a public sale "will be deemed commercially reasonable" if (1) the Debtor had ten days notice of the sale, (2) the sale was advertised twice in at least one newspaper in the area of the sale, and (3) the terms of sale were 25% down plus the balance within 24 hours.

Commercial Credit gave ten days notice. It advertised the sale twice (on December 23rd and 26th) in general publication newspapers. It stated in the ads that 25% down would be required, but with a slight variation that turned out to be a problem, and said that the sale would be "as is," which also turned out to be a problem.

Only one bidder other than Commercial Credit showed up at the December 27th sale. Commercial Credit made the only bid of $100,000. Commercial Credit sold the recycler a few months later at a private sale for $90,000 more than its bid, but still sued to recover the full $128,000 difference between its auction bid and the outstanding balance on the loan.

The trial court ruled that the sale hadn't been conducted in a commercially reasonable manner and rejected Commercial Credit's claim for a deficiency judgment. The Court of Appeals affirmed, taking issue with the content of Commercial Credit's advertising of the sale, and the timing of the advertisements about the sale.

Problems With The Timing Of The Advertisements

The Court of Appeals found fault with the timing of the ads run by Commercial Credit right before and after Christmas. Judge Robert N. Hunter said that a public sale was one where "the public has had a meaningful opportunity for competitive bidding," and that the advertisements by Commercial Credit were insufficient to generate that "meaningful opportunity":

The recycler at issue in this case has a narrow commercial use, and as a result, the pool of bidders potentially interested in this equipment was necessarily limited from the outset. This fact was then inexplicably exacerbated by Creditor’s decision to run advertisements for the auction in two general circulation newspapers just two days before and one day after the Christmas holiday. Obviously, scheduling a public auction for a highly specialized and expensive piece of inoperable machinery just two days after Christmas would almost certainly not enhance “competitive bidding” under N.C.G.S. § 25-9-610. Perhaps the best evidence of the result of Creditor’s decision was that only one other person in addition to Creditor attended the auction.

According to the Court, Commercial Credit "should have chosen a more appropriate date of sale, and tried considerably harder to market the recycler by targeting legitimate prospective buyers." It said "there is no excuse for putting forth clandestine advertisements that are misleading, obtuse, and targeted to no one during the busiest holiday season of the year."

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The Truth And Nothing But The Truth, But Not Necessarily In Settlement Negotiations, Says The North Carolina Court Of Appeals

Lawyers don't have any obligation to disclose information harmful to their client's position during settlement discussions, the North Carolina Court of Appeals ruled today in Hardin v. KCS International, Inc.

The parties in Hardin had settled an earlier lawsuit involving plaintiff's claims over problems with his new yacht. Plaintiff then was dissatisfied with the repairs to the yacht undertaken pursuant to the settlement, and filed a second lawsuit notwithstanding the settlement agreement's full release.

The plaintiff asserted that the release had been procured by fraud. He pointed to documents produced in the second lawsuit which showed that his yacht had been involved in a collision while being delivered to North Carolina. Plaintiff said he had never been told that his yacht had hit a tree while being transported down the road (really), and that he should have been informed of this fact during the settlement negotiations. He said he wouldn't have settled in the first place if he had known about the accident.

Judge Geer disagreed that the defendants had any obligation to disclose the fact of the collision, observing that plaintiff had been obligated to use reasonable diligence to find out about the damage and that he could have easily done so through discovery. She furthermore emphasized the arms length nature of the settlement negotiations, and said that "no negotiation could be more arms length" than negotiations during "the course of on-going litigation."

The Court held that Plaintiff:

cites no authority — and we have found none — requiring opposing parties in litigation to disclose information adverse to their positions when engaged in settlement negotiations. Such a requirement would be contrary to encouraging settlements. One of the reasons that a party may choose to settle before discovery has been completed is to avoid the opposing party's learning of information that might adversely affect settlement negotiations. The opposing party assumes the risk that he or she does not know all of the facts favorable to his or her position when choosing to enter into a settlement prior to discovery. On the other hand, the opposing party may also have information it would prefer not to disclose prior to settlement.

On a first impression point of appellate procedure, the Court held that a motion to enforce a settlement agreement should be reviewed under the same standard applicable to a motion for summary judgment.

Furniture Manufacturer Used "Commercially Reasonable Efforts" In Marketing Trademarked Products

Whether a furniture manufacturer's marketing of a line of trademarked furniture for its licensor had been "commercially reasonable" was decided by the Business Court yesterday in favor of the manufacturer, in Lexington Furniture Industries, Inc. v. Bob Timberlake Collection, Inc., 2009 NCBC 22 (September 9, 2009).

The parties had entered into a License Agreement giving Lexington the right to sell furniture collections under the Bob Timberlake trademarks. Sales had apparently gone quite well; Timberlake's COO testified that one of the collections was "the most successful furniture line in the history of the industry." Timberlake had made $25 million over the years in royalties from Lexington's sales.

In 2007, three years before the License Agreement was to expire, Timberlake asked to restructure the Agreement. Lexington declined. Timberlake offered to buy out the License Agreement, and Lexington refused that as well. Timberlake then notified Lexington that it would terminate it as a result of Lexington's alleged failure under the License Agreement "to use its commercially reasonable efforts in the manufacture, sale, promotion, advertisement, and marketing" of the Timberlake collections.

The Interpretation Of "Commercially Reasonable Efforts"

The case turned on the interpretation of the meaning of "its commercially reasonable efforts." Timberlake said that "the inclusion of the word 'its' prior to the term 'commercially reasonable efforts' makes the commercially reasonable standard personal to Lexington." Timberlake asserted that this subjective approach meant that Lexington had to market the furniture consistently with its past practice. As evidence of breach, Timberlake pointed to things that Lexington had done in the past to market the furniture lines that it was no longer doing.

Lexington said that "its" simply meant that Lexington was the party responsible for making the commercially reasonable marketing efforts. It presented the testimony of an industry expert detailing Lexington's marketing activities, who concluded that Lexington's efforts were "equal to that of the best companies in the furniture industry" and that they "exceeded industry practice."

Commercial Reasonableness Needed To Be Assessed Against An Industry Standard

Judge Tennille rejected the notion that past practice was the guide. He said that

[t]o require Lexington to market the Timberlake Collections in 2008 in the same manner as it did when the furniture line was first introduced in 1991 would be unreasonable. The types of promotion and advertising that work effectively for a particular product do not remain static. As new collections gain brand name recognition, marketing strategies change to keep in step. Moreover, marketing means change daily.  The Internet has opened new avenues for advertising -- avenues not readily available eighteen years ago. New furniture shows, such as Las Vegas, now exist that were unheard of in 1991. Would Timberlake be satisfied if Lexington restricted its market shows to those which existed in 1991 or if Lexington only used print media that existed when the parties originally executed the contract? If the parties wished to bind Lexington to past practice, then their License Agreement should have expressly stated so.

The test for "commercial reasonableness," according to the Court, did not require consideration of "whether any specific activity should or should not have been used." The inquiry was "the marketing effort as a whole which must be judged against some industry standard." The only evidence of industry standard before the Court had been presented by Lexington.

The Court, granting summary judgment in favor of Lexington, held that "[t]he mere fact that Timberlake disagrees with the marketing decisions Lexington made is not enough to raise an issue of fact as to whether such decisions were commercially reasonable."

Mining For Metadata In Communications From Opposing Counsel Would Be Prohibited Under Proposed Ethics Opinion From North Carolina State Bar

The North Carolina State Bar has proposed an Ethics Opinion on whether a lawyer can look for and use metadata contained in a electronic communication from another party or that party's lawyer. Proposed 2009 Formal Ethics Opinion 1, if approved, would place affirmative obligations on not only the recipient of the data, but also its sender.

[Note: On October 22, 2009, the State Bar Ethics Committee voted to withdraw this opinion and to send it to a subcommittee for further study.]

Metadata is "data contained within electronic materials that is not ordinarily visible to those viewing the information."  Metadata might show information that a lawyer chose to delete, or a private comment that the lawyer didn't mean the reader to see.

Obligations On Sending Lawyers

Those sending an email or electronic version of a document to an opposing counsel or party will be obligated to "use reasonable care to prevent the disclosure of confidential client information." That means being careful about using word processing software that tracks changes, allows the insertion of comments, or permits the saving of multiple versions of a document. The Opinion says that lawyers should use scrubbing applications that delete metadata, or avoid metadata altogether by sending fax transmissions or hard copies of documents.

Obligations On Receiving Lawyers

On the recipient side, the Proposed Opinion would prohibit a lawyer receiving electronic communications from searching for or using confidential information contained in the metadata in the document. And not only that, if the recipient unintentionally views hidden data, he or she must notify the sender of that fact.

The Proposed Opinion doesn't apply, of course, to documents produced in response to a subpoena or a discovery request.

Other States

The issue of metadata has been confounding state bar ethicists for years. The Proposed Opinion references a number of other state bars which have issued ethics opinions on the subject, including Alabama, Arizona, Colorado, the District of Columbia, Florida, Maine, Maryland, New York, and Pennsylvania.

North Carolina, if it adopts the Proposed Opinion, will be lining up with Alabama, Arizona, Florida, Maine, and New York. Each of those states takes the position that a lawyer should not search metadata for confidential information belonging to an opposing party. There are a few with a contrary view or which don't take a position on the subject, including the American Bar Association, Colorado, Maryland, and Pennsylvania.

The ABA has a good one page summary of the rules on metadata in these various jurisdictions, including a few additional jurisdictions not referenced by the NC State Bar in the Proposed Opinion.

If you have thoughts on this subject, you can address comments on the Proposed Opinion by September 30, 2009, to the NC State Bar Ethics Committee at P.O. Box 25908, Raleigh, North Carolina 27611.

The full text of the Proposed Opinion is below.

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Franchisee's Fraud Claims Against Franchisor Dismissed By North Carolina Business Court

The written provisions of a franchise agreement -- and its merger clause -- resulted in summary judgment on a franchisee's fraud and other claims against a franchisor. The case, decided last Friday by the Business Court, is L'Heureux Enterprises, Inc. v. Port City Java, Inc.

Conflicting Representations

Plaintiffs claimed they had premised their purchase of a bakery on verbal representations from Port City Java, a franchisor of coffee shops, that it would only cost $50,000 to convert a small existing coffee kiosk in the bakery space into a full sit-down cafe.

Plaintiffs obtained an upfit estimate six days after closing in a range of $100,000 more than the $50,000 represented. Plaintiffs then sued the franchisor for fraud, negligent misrepresentation, unfair and deceptive practices, and breach of contract.

But before closing, the Plaintiffs had asked the franchisor's COO for a guarantee on the upfit costs. He wouldn't provide that, saying instead that he would not make any guarantee with regard to specific costs. He also provided a letter saying that the cost of renovations would be "entirely dependent on the extent and quality of same."

The Plaintiffs' claim was further weakened by the transaction documents. Those included a Uniform Franchise Offering Circular which provided an estimated range for typical costs associated with creating a cafe. And the Franchise Agreement signed by the Plaintiffs contained a merger clause which expressly excluded prior negotiations between the parties and stated that it represented the entire agreement of the parties.

Plaintiffs Could Not Establish Reasonable Reliance

Judge Jolly granted Port City's Motion for Summary Judgment, focusing on the issue of the reasonableness of Plaintiffs reliance on the alleged misrepresentations. He stated "[r]eliance is not reasonable where the plaintiff could have discovered the truth of the matter through reasonable diligence, but failed to investigate." Op. ¶37. He concluded that the Plaintiffs had not used reasonable diligence in relying on the claimed verbal statements "over clearly contrary language" in the written documents. Op. ¶39.

In dismissing the unfair and deceptive practices claim, Judge Jolly held:

While the disclosures and documents unfortunately appear not to have been adequately digested, investigated or understood by Plaintiffs, the forecast evidence does not establish any violation of duty on the part of Defendants to educate Plaintiffs on the plain meaning of the contractual documents involved in the Transaction.

Op. ¶47.

The clear written provisions of the UFOC and the Franchise Agreement also, according to the Court, warranted the grant of summary judgment on the breach of contract claim. 

NC Court Of Appeals To Duke University: What Part Of "All" Don't You Understand?

I write sometimes about litigation involving Duke University's sports teams. In fact, the most popular post ever on this blog was The Law And Duke Football: The Video, which has a video of Duke's own lawyer telling a judge how bad Duke football is. That video, according to youtube, has been watched over 17,000 times.

Posts on derivative actions and motions for sanctions don't get that kind of traffic.

Anyway, yesterday's decision (sorry, no video) from the North Carolina Court of Appeals in Pressler v. Duke University is worth a mention.  It involves Duke's unsuccessful effort to force its former men's lacrosse coach out of court and into arbitration on his defamation claims.

The defamation claim arose after Pressler and Duke had settled matters involving his resignation as coach. The Mutual Release and Settlement Agreement, entered into in 2007, contained a non-disparagement provision.  It also contained a provision stating that Pressler and Duke "wish to cancel all earlier agreements" between them. Those earlier agreements included an Employment Contract which incorporated by reference Duke's Dispute Resolution Policy. The Policy required arbitration of all disputes.

In 2008, Pressler sued Duke for allegedly defaming him in post-settlement statements. Duke moved to compel arbitration in reliance on its Policy, notwithstanding the language of the Release extinguishing all prior agreements. Duke argued that "when the mutual release referred to 'all earlier agreements,' this did not really mean all earlier agreements."

When all was said and done, the Court of Appeals disagreed.  The Court held "[t]he mutual release addresses 'all earlier agreements,' and whether the policy was a part of the 2005 Employment Contract or not, surely it was an 'earlier agreement' between the parties which would be encompassed by the term 'all.'"

Th-th-th-that's all folks. 

New Cases In The North Carolina Business Court: August 2009

Six new cases were designated to the Business Court in August 2009, including a case seeking class certification over charges for medical records (Toney), and a shareholder dispute pitting a father against his son (Shallcross).

Moltzon v. King (Wake)(Tennille): minority shareholder dispute in which plaintiff alleges the defendants breached their fiduciary duties by starting a competing business and forcing him out.

Oak-Bark Corp. v. French (New Hanover)(Tennille); Action by plaintiff against former employees for breach of restrictive covenants and misappropriation of trade secrets.

Shallcross v. Shallcross (Wake): Plaintiff, 89 years old and legally blind, sued his son to invalidate an irrevocable proxy allowing the son to vote his father's shares. The father contends that the son misrepresented the nature of the proxy as being revocable.

Thompson v. Manuel (Rowan)(Tennille): allegations regarding breach of partnership agreement, breach of fiduciary duty, alter ego, and accounting.

Toney v. IOD Inc. (Wake)(Jolly): Class action against a company which provides copies of medical records, for which Plaintiffs allege it overcharged in violation of North Carolina state law.

Williams v. McAlpine (Union)(Diaz): Securities claim by investor based on alleged misrepresentations as to defendant homebuilder's financial strength, contention that officers and members of LLC defendants are personally liable.