The NC Business Court Rules On Recovering Attorneys' Fees In A Derivative Action Against An LLC

In this week's opinion in Ekren v. K&E Real Estate Investments, 2014 NCBC 56, Judge Bledsoe outlined how a derivative action plaintiff can recover attorneys' fees.

What Constitutes A 'Substantial Benefit"?

Fees are specifically allowed by §57D-8-05(1) for a plaintiff in a derivative action against an LLC  if the action results in a "substantial benefit to the LLC."

North Carolina's appellate courts have not construed that term in the LLC context but the Court of Appeals has ruled in a case involving similar language under North Carolina's Business Corporation Act that:

the plaintiff need not necessarily be the prevailing party, nor must the derivative claim have proceeded to a final judgment or order.

Op. ¶13 (quoting Aubin v. Susi, 149 N.C. App. 320, 326, 560 S.E.2d 875, 880 (2002).

The Business Court found further light shed on the term "substantial benefit" by looking to the Model Business Corporation Act, which references in a comment the United States Supreme Court's interpretation of similar language in MBCA §7.46(1).  The Supreme Court said in the case of Mills v. Electric Auto-Lite Co., 396 U.S. 375 (1970) that:

[A] substantial benefit must be something more than technical in its consequence and be one that accomplishes a result which corrects or prevents an abuse which would be prejudicial to the rights and interests of the corporation or affect the enjoyment or protection of an essential right to the stockholder’s interest.

Id. at  396.

The Plaintiff in the Ekren Case Obtained A "Substantial Benefit" For The LLC Even Though The Defendant Granted Her All The Relief Demanded In Her Complaint Before Judgment

The Defendant in the Business Court case argued that the Plaintiff had not obtained a substantial benefit because the Defendant had voluntarily returned to the LLC title to the four properties which he had originally transferred to himself from the LLC, and he had also returned $20,000 he had removed from the LLC account.  The Defendant further argued that he was justified in these actions because he merely meant to "safeguard" the LLC's assets from the Plaintiff, who Defendant said was engaging in "irrational and pathological behavior which appeared to be the product of a degenerative disease." Op. ¶17. 

Because the properties had been returned and the $20,000 had been returned, and those items were the only relief sought by the Plaintiff, the Business Court had dismissed all the claims as moot in March 2014. 

Even so, Judge Bledsoe was buying none of the Defendant's arguments that his good intentions as opposed to the lawsuit, had prompted the result.  He said:

all of the evidence brought forward by the parties shows that the catalyst for the return of the LLC’s assets was the filing and prosecution of Plaintiff’s lawsuit. Although [the Defendant] contends he was going to return the LLC’s assets, he did not do so after Plaintiff’s pre-suit demand, and he did not take any action prior to Plaintiff’s suit to have a receiver or trustee appointed to receive the LLC’s assets he claimed he held in trust. Even if he planned to return the assets to the LLC, the fact that he returned them when he did – and thus the timing of relief to the LLC – was because of the litigation.

Op. ¶18.

So the Court found that the Plaintiff had obtained a "substantial benefit" for the LLC by obtaining the return of the properties and the funds.  It awarded $33,704.50 in attorneys' fees after reducing the amount sought and finding some of the fees sought to be "excessive, redundant or otherwise unnecessary." Op. ¶34.

Recovering For Rule 11 Type Violations In A Derivative Action

The LLC statute allows for the recovery of attorneys' fees if the court finds that any filing:

was not well grounded in fact or was not warranted by existing law or a good-faith argument for the extension, modification, or reversal of existing law and that it was interposed for an improper purpose, such as to harass or to cause unnecessary delay or needless increase in the cost of litigation.

N.C. Gen. Stat. §57D-8-05(3).

If that language sounds familiar, it may be because it "sets out a standard similar to the standard for sanctions under Rule 11 of the North Carolina Rules of Civil Procedure."  Op. ¶20.

But there's a difference between this section and Rule 11,  A Rule 11 analysis has "three prongs."  A violation of any of the three prongs -- which are "(1) factual sufficiency, (2) legal sufficiency, and (3) improper purpose" -- makes out a Rule 11 violation.  Op. ¶23.

The LLC statute, by contrast, requires showing an “improper purpose” in addition to finding that same document 'was not well grounded in fact or was not warranted by existing law. '" Op. ¶23.

The Defendant escaped from being tagged with attorneys' fees despite filing an Answer containing defenses that the Court said were "not well-grounded in law."  Judge Bledsoe found that the Defendant's actions were not motivated by an improper purpose based on the "totality of the objective circumstances."  Op. ¶28.

But don't think that this case gives you the license to raise unfounded defenses.  Judge Bledsoe "caution[ed] . . . that [his] ruling [was] based on the specific circumstances of this case and [was] not in any way intended to suggest a general rule that a party may assert claims or defenses that are not well-grounded in law without consequences under N.C.G.S. § 57D-8-05(3)."  Op. ¶28.

Avoid "Block Billing" Because It Can Result In A Reduction Of Fees

A good point for those seeking to recover attorneys' fees is to avoid "block billing."  That is the pretty common practice for aggregating all of your time entries for a client on a given day without providing the hours expended for each separate task.  Judge Bledsoe cited a couple of cases for the propositions that:

  • “[B]lock billing is not objectionable ‘per se,’ though it may increase the risk that the trial court, in reasonable exercise of its discretion, will discount a fee request, and that
  • block billing precludes the court from determining that all of the amounts claimed . . . are both compensable and reasonable.

Op. ¶33 (quoting Jaramillo v. Cnty. of Orange, 200 Cal. App.4th 811, 830 (Cal. Ct. App. 2011) and Dixon v. Astrue, 2008 U.S. Dist. LEXIS 9903, *11 (E.D.N.C. Feb. 8, 2008))

Based on his review of the Plaintiff's counsel's blocked billed time entries, Judge Bledsoe excluded nearly 80 hours of billing recorded by Plaintiff's attorney on  the basis that those hours  were "excessive, redundant, or otherwise unnecessary."  Op. ¶35.

Notwithstanding that reduction in fees, Judge Bledsoe said that Plaintiff's counsel was "a highly experienced and able litigator and practitioner," and that his hourly rate of $275 was reasonable. Op. ¶¶39-40.

 

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Eighty Five Thousand Reasons Not To Represent An LLC Without The Approval Of A Majority Of The Members (and one Other Thing)

Be sure that an LLC member has the authority to hire you before accepting the representation of the LLC in a suit by or against another LLC member.  That authorization generally requires a majority of the interest of the members, at least under the default provisions of the LLC Act, which apply in the absence of an Operating Agreement providing to the contrary.

But what if a 50% owner goes ahead and retains counsel to represent the LLC against her 50% co-owner, who does not consent to the representation?  That can only turn out badly, even if there is a written fee agreement signed by the 50% owner.

In Judge Bledsoe's decision last week in Battles v. Bywater, LLC, 2014 NCBC 52, the Court found that one of the 50% owners of two LLCs which were defendants did not have the power to hire counsel for the LLCs, either under the default provisions of the LLC Act or the terms of the Operating Agreement of one of the LLCs.

There is nothing new in holding that one 50% member does not have the power to retain counsel for the LLC in a lawsuit against the other 50% member.   The Court of Appeals held seven years ago, in Crouse v. Mineo, 189 N.C. App. 232, 658 S.E.2d 33 (2007) that:

a fifty percent LLC member 'lacked authority to cause [the LLC] to institute [an]  . . . action on its own behalf' against the other fifty percent LLC member).

Id. at 239, 658 S.E.2d 37-38.

The Business Court rejected the Plaintiff's argument that he, as a 50% owner of the LLCs, had the authority under the new LLC Act to hire counsel without the consent of his adversarial member. 

Judge Bledsoe struck all of the filings made in the case by the lawyers for the LLC, though "without prejudice to Defendants' right to refile these or other legally supportable and permissible documents after retention of new counsel." Op. ¶52.

That's an expensive ruling for the lawyers who had been retained without proper authorization to represent the LLCs.  They had represented to the Court that they were owed $85,000 in legal fees by the LLCs that they were disqualified from representing.

Apart from guidance from the Bywater case of the necessary approval of the LLC members for an LLC representation, the case also makes clear that a management deadlock is a valid basis for dissolving an LLC per G.S. §57D-6-02(2).

Deadlock was formerly mentioned specifically in the dissolution statute (in the former G.S. §57C-6-02(2)), but the revised act deleted any reference to "deadlock" as a basis for dissolution in G.S. §57D-6-02.

Judge Bledsoe found that since the statute now allows dissolution where "it is not practicable to conduct the LLC's business," that this embraces deadlock.  He supported that conclusion with reference to the similar language of the Delaware LLC Act.  The Delaware Court of Chancery held in Fisk Ventures, LLC v. Segal, 2009 Del. Ch. LEXIS 7 (Del. Ch. 2009) that if:

a board deadlock prevents the limited liability company from operating or from furthering its stated business purpose, it is not reasonably practicable for the company to carry on its business.

Op. ¶19 (quoting Fisk Ventures at *12)

 

 

 

An Important Message From The Business Court On The Proper Filing Of A Notice Of Designation

Yesterday, the Business Court entered an important Order, titled "Order Regarding Notice of Designation and Assignment," in Southern Fastening Systems, Inc. v. Grabber Construction Products, Inc., 2014 NCBC 55.

The Order deals with the time limits for designating a case to the Business Court, and clears up the question of when and where a Notice of Designation needs to be filed.  This question was not raised by either of the parties to the case.  The Court said that it was the result of an inquiry "on its own motion whether the Notice of Designation was timely in accordance with recent statutory amendments regarding mandatory designation."  Order at 1.  

Section 7A-45.4(d) of the General Statutes says that a Notice of Designation "shall be filed . . . within 30 days of receipt of service of the pleading seeking relief from the defendant . . . ."

Grabber Construction Products, the Defendant, e-filed its Notice of Designation with the Business Court on November 3rd, which was within the thirty day period set by the statute.  The Defendant mailed the Notice of Designation that same day to the Superior Court for Buncombe County, where the case had originated.  The Notice of Designation then was filed in Buncombe County more than thirty days after service.

So, was the Designation timely?  No, said the Court, although it accepted the Designation, stating that it was "recognizing the possible uncertainty in how the statute should be read until clarified by [its] Order."

The Court concluded its very short (about two pages) Order by stating that this largesse would not be extended going forward and that the Order was being published to:

provide notice to the practicing bar that the Court will in the future expect a Notice of Designation to be filed with the appropriate Clerk of Superior Court within the time provided by N.C. Gen. Stat. § 7A-45.4, and that failure to do may result in the Notice of Designation being deemed untimely, defeating a right to mandatory designation.

Order at 2 (emphasis added).  This isn't the first time that the Business Court has dealt with the interplay between electronic filing and the need to file paper copies of filings in the Superior Court for the county in which the case originated.  You probably remember the several cases in which the Business Court dismissed an appeal because the notice of appeal, although timely filed with the Business Court, wasn't timely filed with the Clerk of Superior Court in the county where the case had originally been filed.

Two Things You Should Know If You Are Appealing A Preliminary Injunction On A Covenant Not To Compete

If you are representing a client who has been subjected to an injunction enjoining him from violating a covenant not to compete, and you want to appeal, there are two things you ought to know.  One is good for you, the other probably is not so good.  They were pointed out in Judge McGuire's unpublished Order last Friday in Union Corrugating Co. v. Viechnicki.

Viechnicki, former Director of Sales for the Plaintiff,  had been enjoined from competing with his former employer in some respects via a TRO (granted in Cumberland County Superior Court), which was continued into a Preliminary Injunction (by the Business Court, by Judge Jolly). 

He filed a Notice of Appeal, and a Motion that the Court recognize a stay of the proceedings pending the appeal.

A Trial Judge Has No Authority To Dismiss An Appeal As Interlocutory

First, if you are in this situation, can you even appeal?  Or is your appeal interlocutory and subject to dismissal by the trial court?  Mixed news here, mostly good.  Even if your appeal is interlocutory, a trial court does not have the power to dismiss an appeal as interlocutory.  Order 9.  That part of Judge McGuire's Order was based on a Court of Appeals decision -- Estrada v. Jaques, 70 N.C. App. 627, 321 S.E.2d 240 (1984) -- which held that a trial judge "acted beyond his authority in dismissing [an] appeal . . . as interlocutory."  Id. at 639-40, 321 S.E.2d at 248.

The only authority that a trial judge has to dismiss  an appeal of his or her order is contained in NC Appellate Rule 25.  That power is limited to dismissing an appeal for a failure to take action to perfect an appeal.  Order 9.

Thus, Judge McGuire denied the Plaintiff's Motion to Dismiss Viechnicki's appeal.

A Stay Of Proceedings In The Trial Court Is Only Appropriate If The Ruling Appealed From Affects A "Substantial Right"

But let's say that the case in which the injunction was entered is ongoing, as was Viechnicki's.  You are facing a load of annoying written discovery and then a deposition of your client, and your adversary is angling towards making a motion for summary judgment, as Viechnicki's former employer was.  Are you entitled to a stay of proceedings per G.S. §1-294 until the Court of Appeals hears your appeal? 

Section 1-294 says that:

When an appeal is perfected as provided by this Article it stays all further proceedings in the court below upon the judgment appealed from, or upon the matter embraced therein; but the court below may proceed upon any other matter included in the action and not affected by the judgment appealed from.

You might think that because the Court did not have the power to dismiss the appeal, and that the appeal would therefore be proceeding, that the action would be stayed.  But that's not right: the COA has said that the trial court "has the authority . . . to determine whether or not its order affects a substantial right of the parties or is otherwise immediately appealable."  RPR & Assocs. v. University of North Carolina, 153 N.C. App. 342, 348, 570 S.E.2d 510, 514 (2002). So whether a stay is in effect depends on whether the injunction affects a "substantial right."  While you might think that an injunction enforcing a covenant not to compete, which impairs your client's ability to be employed, must affect a substantial right, you could be wrong.

Appellate cases that have found an injunction enforcing a covenant not to compete affected a substantial right have involved injunctions that "effectively prohibit[ed] defendant from earning a living and practicing his livelihood" (Precision Walls v. Servie, 152 N.C. App. 630, 635, 568 S.E.2d 267, 271 (2002) or caused an "inability to do business" in a seasonal occupation (Milner Airco, Inc. v. Morris, 111 N.C. App. 866, 869, 433 N.C. App. 811, 813 (1993)).

The injunction being appealed by Viechnicki barred him from disclosing confidential information obtained from the Plaintiff, and from soliciting business from "any customer with whom [he] had contact while employed by Plaintiff."  Order 4.  Significantly, the Injunction did not bar Viechnicki  from working for the competitor as its new President or performing sales related duties that did not involve customers with whom he had had contact during his past employment with the Plaintiff.  And Viechnicki's protestations that the injunction prohibited from calling on over 9,000 customers didn't earn him any sway with Judge McGuire.

Judge McGuire ruled that the injunction affecting Viechnicki did not bar him from:

earning a living and practicing his livelihood, [or] deprive [him] of a reasonable opportunity to use his skill and talents, or otherwise give rise to an inability to do business.

Order 17 citations omitted).

Judge McGuire rejected the argument that "a preliminary injunction that enforces a non-compete restriction necessarily affects a substantial right."  Order 15.  Whether a substantial right is affected has to be examined on a case by case basis.  After this analysis, Judge McGuire held that the preliminary injunction enjoining some of Viechnicki's activities did not affect a "substantial right."

So Judge McGuire therefore denied the motion to stay proceedings by the Plaintiff, ordered that the case would proceed, and that Viechnicki should respond to outstanding discovery.