Hefty Judgments Against LLC Member Didn't Make Him "Insolvent" So As Disqualify Him From Membership Rights, Including Standing To Sue LLC

My favorite multi-volume treatise is Words and Phrases.  If you don't know it, it is a super-legal dictionary that collects cases from every jurisdiction defining ... well, frequently used words and phrases.  Since business litigation often turns on the definition of a word or a term that the drafters left undefined, I have a thoroughly excellent time finding a definition in the cases that supports my interpretation.

Last week, in Nelson v. Alliance Hospitality Management, LLC, 2011 NCBC 42, Judge Gale tangled with a word undefined in an LLC's Operating Agreement: "insolvency".  The word was tucked away  in what is probably familiar rote language to you, setting out the conditions under which an LLC member would lose his or her rights as a member.  It said "[a] member shall cease to have any power as a Member or Manager, any voting rights or rights of approval hereunder upon death, bankruptcy, insolvency, dissolution, assignment for the benefit of creditors, or legal incapacity. . . ."

The Defendant, Alliance, said that Nelson didn't have standing to sue it because he was insolvent, and he therefore had lost all rights of a member.  Alliance presented evidence to Judge Gale that Nelson had several judgments and other court activity which had not gone at all in his favor.  The net amount against him totaled almost $8 million. Op.¶28.

Judge Gale was unwilling to rule on a Motion to Dismiss that Nelson was insolvent even in light of the $8 million that he owed.  He said that there was no evidence before the Court establishing the asset side of Nelson's balance sheet, and nothing to demonstrate "his conclusive inability to pay his debts as they come due."  Op. ¶29. 

You don't want to leave this post without knowing what Words and Phrases says about "insolvent," do you?  It collects four North Carolina cases defining the term.  Three of them approve a balance sheet test, which appears to be what Judge Gale used, asking whether the obligor can meet liabilities by converting all of the property owned by that person into money  (e.g. Silver Valley Mining Co. v. North Carolina Smelting Co., 119 N.C. 417 (1896)).

It's nice to have a Court assume that you might have a net worth of more than $8 million and that you therefore wouldn't be rendered insolvent by scrambling to pay off multi-million dollar judgments.  I only know a couple of people who really warrant that generous a presumption, but I'm not one of them

 

 

Expensive Lesson From The Business Court For Derivative Action Plaintiff Whose Case Was Dismissed

 

It’s hard to call a client and have to tell her that the case you filed for her was dismissed. But it must be even harder to tell a client that she now has to pay the defendant for his legal fees in winning the dismissal. And think how much worse that would be if the defendant were her ex-husband.  And it's even worse if it's Thanksgiving!

That hasn’t happened to me (at least not yet), and I hope it hasn’t happened to you, but it is the phone call that the lawyers representing Jane Sutton in Sutton v. Sutton, 2011 NCBC 43 probably had to make after Judge Jolly’s ruling in her case on the Tuesday before Thanksgiving.

Jane Sutton became a shareholder in her husband’s business, Sutton’s Tree Service, Inc. during their marriage. She filed a derivative action against her ex-husband on behalf of the corporation for conversion, breach of fiduciary duty and the “improper filing of income tax returns.” Op. ¶1.

There were two fatal flaws in this turkey of a lawsuit which led to its dismissal. The first was that there had been no demand on the corporation to take the action against Mr. Sutton. Section 55-7-42 makes a demand a precondition to the filing of a derivative action. It says:

No shareholder may commence a derivative proceeding until:

(1)        A written demand has been made upon the corporation to take suitable action; and
2)        90 days have expired from the date the demand was made unless, prior to the expiration of the 90 days, the shareholder was notified that the corporation rejected the demand, or unless irreparable injury to the corporation would result by waiting for the expiration of the 90‑day period.

There’s also a statutory requirement that the person filing the derivative action must have been “a shareholder of the corporation at the time of the act or omission complained of….” N.C. Gen Stat. §55-7-41(1). He or she must also be able to “[f]airly and adequately represent[] the interests of the corporation in enforcing the right of the corporation.” Id. At 55-7-41(2).

The second fatal flaw was that in addition to not making a demand, Mrs. Sutton hadn’t been a shareholder of the corporation since her divorce from Mr. Sutton, which was undoubtedly before the alleged misconduct had taken place. There had been a Consent Judgment by which Mrs. Sutton had “surrendered to Defendant any and all interest she had in the Corporation.” Op. ¶11.

Judge Jolly said that her lack of ownership was established as a matter of res judicata and collateral estoppel, since the “Consent Judgment constitutes a valid, final judgment determining the respective rights of Plaintiff and Defendant regarding ownership of the Corporation.” She therefore had no standing to maintain the suit, and Judge Jolly ordered that it be dismissed,

So what about the fees, you are wondering. The statute on fees in derivative actions says that “On termination of the derivative proceeding, the court may:. . .  Order the plaintiff to pay any defendant's reasonable expenses, including attorneys' fees, incurred in defending the proceeding if it finds that the proceeding was commenced or maintained without reasonable cause or for an improper purpose.” N.C. Gen. Stat. 55-7-46(2).

           

 

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Business Court Strikes "Impertinent" Reply To Counterclaim

 

Have you ever filed a reply to a counterclaim where your reply was 89 pages long and to which you attached more than 200 pages of exhibits? I think you probably haven’t, but the Plaintiff in the Business Court case Fountain v. Fountain Powerboats, Inc. did. When the Defendant made a Motion to Strike the Reply, Judge Gale granted it in an Order filed last Friday,  saying that dissecting all the irrelevant allegations of the Reply "would burden this opinion with a tediousness serving no useful purpose.”” Op. ¶21.

            The legal issue decided in the opinion was whether a responsive pleading like a reply to a counterclaim or an answer to a complaint gives the responding party the latitude to provide the Court with “notice of the transactions, occurrences, or series of transactions or occurrences, intended to be proved,” which is what the Plaintiff said his rambling Reply had provided. The problem with that argument was that the quoted language, from Rule 8(a) of the North Carolina Rules of Civil Procedure, applies only to complaints. The part of Rule 8 that governs answers to complaints and replies to counterclaims doesn’t contain that language and doesn’t permit “a new cause of action or other matter beyond the scope of the new matter raised in the answer.”

 In other words, complaints and counterclaims, which set forth causes of action, allow for a “richness of detail” which isn’t warranted in a response to those allegations.

 
The court ruled that the expansive reply included statements that were “immaterial, impertinent, and redundant,” which included allegations which were

  • “self-promotional,”
  • Self-serving and irrelevant metaphors and analogies,”
  • “Statements that appear to serve no purpose but to frustrate Fountain Powerboats current operations and promote RF Powerboats,” and
  • Unnecessary name calling”

Those types of things are frowned upon, although necessary name calling is often tempting.

And as for the hundreds of pages of exhibits, Judge Gale said that “none of these exhibits are germane to any legitimate defenses that can be asserted by Reggie Fountain.”Op. ¶22.   In fact, he said that the only reason for the exhibits to be attached to the Reply was “so as to become part of a centralized public record Reggie Fountain can use to further his personal ends, easily accessible via the Business Court’s website.”Op. ¶22.

The Judge let the Plaintiff dictate what would be stricken from the Defendant's Reply, ordering that the Plaintiff's version of the Reply would be the version considered as the case went forward.  Plaintiff submitted with its Motion filed on September 9, 2011 as Exhibit A a redlined copy of the Reply proposed by the Defendant.  It's not very often (like never) that an opposing party gets to control what the other side's pleading will say.

 

The New And Improved Federal Rules Of Evidence

If you are trying a case in in federal court after December 1, 2011, you’d better bring a new copy of the Federal Rules of Evidence. Don’t lose any sleep, because the substance of the Rules hasn’t changed, they’ve only been “restyled.” This reworking of the FRE was aimed at making the Rules more consistent in their use of terminology, to stick to “plain language” and to make the language more “user-friendly.”

The Committee leading this effort (and there was a herd of committees) tried to be clear that its changes were not substantive. The Committee Note to virtually every changed Rule says that “these changes are intended to be stylistic only. There is no intent to change any result in any ruling on evidence admissibility.” The Committee avoided making changes to what it called “sacred phrases” in the Rules, which it felt would have been substantive.  “Sacred phrases” are those phrases that had become “so familiar in practice that [their] alteration would be disruptive..” In other words,  that means "phrases that have become so familiar as to be fixed in cement."

Do you know any of those? The only one that has stuck in my mind like cement over the years has been an out of court statement “offered to prove the truth of the matter asserted.” That definition of hearsay was indeed deemed “sacred,” but there have been other rewritings of the hearsay rules that make them more digestible.

The new Rules aren’t on the level of as good a read as, let’s say, John Grisham’s new book, The Litigators. But they certainly are easier to read than they were before. There’s a side by side comparison of the original Rule against the restyled Rule available to look at if you have an affection for a particular Rule or Rules. Oh, and the new Rules won a Burton Award.  Those awards are "designed to reward major achievements in the law ranging from literary awards to the greatest reform in law." The restyled Rules won the Reform in Law Award.

These changes have been in the works since 2006, so freshly graduated lawyers ought to be familiar with them. The luminaries working on this five year restyling effort included Professor Ken Broun of UNC Law School, who was a consultant to the Advisory Committee. Another professor involved, Joseph Kimble of the Thomas Cooley Law School, was the “style consultant” for the project. He wrote a series of four articles explaining improvements in specific Rules. You can read those here, here, here,  and here.

Professor Broun, incidentally, is not taking a break from the Rules of Evidence after this multi-year effort.. He is leading a project to create a resource that” would describe the federal common law on evidentiary privileges.” A very detailed draft on attorney client privilege and the marital communications privilege as presented to the Advisory Committee on Evidence Rules is available (at Tab IV).

I wonder if we could get restyling going on the North Carolina Rules of Appellate Procedure. They are sludge.
 

A Covenant Not To Compete Cornucopia From The Business Court

On Friday,  the Business Court issued an opinion on a number of covenant not to compete issues, in Akzo Nobel Coatings Inc. v. Rogers, 2011 NCBC 41.  The Defendants were former employees of the Plaintiff, which had acquired the company for which they had worked.  The Defendants had executed non-competition and confidentiality agreements in connection with the acquisition.  The Defendant claimed a violation of the agreements and asserted a number of tort based claims, a 75-1.1 claim, breach of contract claims, and a trade secrets claim.

The Defendants moved for judgment on the pleadings.  There wasn't one overriding issue, but a host of issues decided by Judge Gale, which ended with a partilal grant of the motion and a denial of the motion as to some of the claims. Here's a summary:

Choice of Law Issue.  The covenants called for Delaware law to apply.  That was significant because Delaware law allows the Court to "blue pencil" an overly broad covenant, while North Carolina does not provide the Court with that power.  Defendants said that the Court should not enforce the choice of law provision because it would violate an entrenched public policy of North Carolina law (that "blue pencilling" is not allowed). The Court side-stepped this issue, ruling that the choice of law provision had been bargained for and was therefore valid.  That decision was no doubt prompted by Plaintiff's status as a Delaware corporation, and its payment of $9.5 million to Defendant Rogers for his stock in the acquired company.

Covenants Given In Connection with the Sale of a Business.  Judge Gale followed the general rule that "[N]on-compete covenants which accompany the sale of a business generally are afforded more latitude than covenants ancillary to employment contracts." Op.¶45.  He mentioned that point several times in his opinion while ruling on some aspects of the dismissal motion.  E.g. Op. ¶¶ 55, 60, & 67.

Standard for Non-Solicitation Agreements.  It has been an open question in my mind whether an agreement by an employee that she won't solicit employees of her old employer at a new employer is governed by the same requirements as a covenant not to compete.  There are distinctions to me between a non-solicitation agreement and a non-compete.  Judge Gale had no doubts about that, ruling "[t]he elements are the same for non-competition and non-solicitation clauses, but the latter are more easily enforced, as their restraints on employees are generally more tailored and less onerous on employees’ ability to earn a living." Op. ¶46.

The Language "Directly or Indirectly".  Covenants not to compete typically prohibit the employee from competing with his employer "either directly or indirectly."  Judge Gale said that "North Carolina courts have refused to enforce non-competition clauses using" that term.  He held back on the enforceability of that term pending "a more fully developed record."  Op. ¶61.  And he threw out this nugget: that the covenant wasn't necessarily unenforceable under NC law because Rogers had the right under the agreement containing the covenant to "invest in competing firms under terms that are more narrowly drawn to protect Akzo Nobel’s interests." Op. 62.

Breadth of Covenants.  Judge Gale reserved ruling on the reasonableness of a four year covenant restricting Rogers from competing on an international basis with Akzo.  He noted Rogers' extensive job responsibilities with Akzo and his broad knowledge of Akzo's business practices.He struck down the restrictions on three other employees of the acquired entity.  One swept too broadly, purporting to prohibit an employee named Schoning from "working for a competitor [of Akzo's] in a position wholly outside the scope of his employment with Chemcraft and from indirect ownership of a competing firm." That provision went "farther than is necessary to protect a legitimate business interest."Op. ¶ 74.  The other two employees escaped enforcement of a five year restriction, which Judge Gale said was "incurable and unreasonable as a matter of law" due to the time length of the restriction. Op. ¶86.

Tort Claims.  Judge Gale dismissed almost all of the tort based claims (tortious interference with contract and tortious interference with prospective advantage) because the claims were based on breaches of contract.  There was no duty "separate and apart" from those contained in the contracts and therefore no basis for tort claims. Most of the unfair and deceptive practices claims were dismissed as well, along with the claim for punitive damages.  Judge Gale hesitated a bit on dismissing a UDPA claim that Rogers had misrepresented the nature of his involvement with an Akzo competitor, which he found to be the basis for an unfair practices claim,  but found the Complaint lacking any allegation of actual injury to Akzo as a proximate result of the misrepresentation.  Akzo's argument that it had refrained from taking legal action against Rogers due to his alleged untruths was "not sufficient to establish the actual injury requirement of Chapter 75." Op. ¶117

Trade Secrets Claims.  Akzo's trade secrets claims were severely winnowed down because they hadn't been described with sufficient particularity to enable the Defendants to identify what had been alleged to be misappropriated.  The description of trade secrets as the Plaintiff's "proprietary formulas, methodologies, customer and pricing data and other confidential information . . . deriv[ing] independent actual or potential commercial value from not being generally known or readily ascertainable" was too "broad and vague" to meet the standard of particularity. Op. ¶127

Whew.  This opinion is stuffed with law about non-compete claims against former employees.  It's a definite read if you've got that type of claim before Judge Gale.  He's way up to speed on this subject.  Don't lag behind.

 

 

 

North Carolina Court of Appeals Tosses Alienation of Affection Case

The North Carolina Court of Appeals sent a pretty clear message last Tuesday  to out of state citizens filing claims for alienation of affection in North Carolina courts.  The message was don't file your lawsuit here, even though North Carolina is one of the few states in the country that hasn't abolished that tort.

The case was Bell v. Mozley.  Mr. Bell, a resident of South Carolina, sued Mozley, another South Carolina resident, for alienating the affections of Bell's wife, and engaging in criminal conversation with her.  Mozley conceded having had sex with Mrs. Bell in a number of states, but denied having done so in North Carolina.  in fact, there was little evidence of any contact between them in North Carolina.

The trial judge denied the motion to dismiss for lack of jurisdiction, ruling that North Carolina had an "especially great" interest in providing a forum for a cause of action that had been abolished in South Carolina.  Judge McCullough, writing for the COA, took a distinctly different view.  He said, in reversing the trial judge and ordering dismissal of the case for lack of jurisdiction, that the decision of Bell to sue in North Carolina "smacks of forum-shopping."

i doubt there are many readers of this blog who concentrate their practice in alienation of affection cases  So beyond that small group, what's in this case for the you business litigators?    Not much, really.  But there's a good covenant not to compete case coming tomorrow, so stay tuned.