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.

 

Reading Before Signing Is Advisable

It's pretty basic that your clients should read the agreements that they sign before they sign them.  Or you should at least explain to your client the key provisions in what they are going to sign, if they are not going to read it.

In McMillan v. Unique  Places, LLC, 2015 NCBC 4, decided this week by the NC Business Court, the fact that the Plaintiff had not read the agreement requiring him to arbitrate his claims provided no defense against him being compelled to arbitrate.

McMillan, one of the Plaintiffs, had entered into a business arrangement with the Defendants based upon a three page "Memorandum of Understanding."  The MOU contemplated the subsequent formation of an LLC called Enigma.  A few weeks later one of the Defendants presented McMillan with an Operating Agreement for the LLC.

The thirty plus-page Operating Agreement contained a provision obligating the LLC members to arbitrate any disputes arising out of the agreement.

When disagreements arose among the members of Enigma about the control of the LLC, McMillan ignored the arbitration provision and filed suit in Catawba County.  He then designated the case to the Business Court.

The Defendants made a Motion to compel arbitration.  McMillan, seeking to escape the arbitration obligation, said that he had not read the Agreement.  He said that he was fraudulently induced to sign the Agtreement and that he was unaware of the arbitration provision at the time that he signed it.

Those of you who went to law school know that this type of argument is not going to fare well.  Judge Bledsoe found these contentions unpersuasive, holding:

under well-established North Carolina law, a signatory to 'a written instrument is under a duty to read it for his own protection[; ] . . . [is] ordinarily . . . charged with knowledge of its contents[;] . . . [and] may [not] predicate an action for fraud on his ignorance of the legal effect of its terms.'

Opinion ¶15 (quoting Raper v. Oliver House, LLC, 180 N.C. App. 414, 420, 637 S.E.2d 551, 555 (2006) (quoting Biesecker v.Biesecker, 62 N.C. App. 282, 285, 302 S.E.2d 826, 828-29 (1983)).

But McMillan's wife, another Plaintiff, was also trying to get out from under the unwanted burden of having to arbitrate her claims.  She had not signed the Operating Agreement, but her arguments met with about the same success as those of her non-reading husband.

Judge Bledsoe found her to be bound by the arbitration provision, even though she hadn't signed the Agreement containing it, because she was an intended third party beneficiary of the Operating Agreement, and some of the claims made by her in the Complaint before the Business Court were based on the Agreement.

These Plaintiffs, apparently appalled by the prospect of arbitration, have already filed a Notice of Appeal of Judge Bledsoe's decision.

My partner Clint Morse represents one of the Defendants (Josh Hawn) in this case.

 

Do You Have To Be The Owner Of A Trade Secret To Sue For Misappropriation?

Can an exclusive licensee of a trade secret sue for its misappropriation?  Maybe, even though North Carolina's version of the Uniform Trade Secrets Protection Act reserves the right to sue to an "owner."  N.C. Gen. Stat. §66-153.

The Uniform Act, by contrast, allows a "complainant" to bring an action for misappropriation.  The Fourth Circuit, applying Maryland's version of the Uniform Act, has held that it is not necessary to be an "owner" to sue under that state's law.  DTM Research, LLC v. AT&T Corp., 245 F.3d 327, 332 (4th Cir. 2001).

Judge Gale addressed the question whether a licensee has standing to sue for misappropriation of its trade secret under the North Carolina Trade Secrets Protection Act just before the new year began, in SCR-Tech LLC v. Evonik Energy Services LLC, 2014 NCBC 71.  Well, he kinda sorta addressed the question, because he refused to reconsider an earlier ruling in the case and never really delved into the issue.

Judge Tennille had been presented with the exact same issue in the SCR-Tech case back in 2010.  (This case has the dubious distinction of being one of the longest running cases in the Business Court, having been filed in 2008).  He denied a motion for summary judgment in which the Defendants argued that Plaintiff lacked standing to pursue its trade secrets claim because it was not the owner of the trade secrets at issue.  That Motion was summarily denied without any discussion.

So, did  that 2010 ruling settle the issue of whether non-owners of trade secrets can sue for misappropriation?  In other words, was Judge Gale entitled to reconsider the issue?

Judge Gale refused to reconsider the issue, stating that he did not see any new argument that had not been raised before Judge Tennille, and that he was "mindful of the import of allowing or requiring one Business Court Judge to revisit the earlier order of another Business Court Judge without any material change in record, policy, or authorities."  Order ¶15.

I would not read this Order as opening the door to trade secrets lawsuits by licensees, given the lack of discussion of the issue by Judge Tennille, and Judge Gale's reluctance to tread on the prior ruling.

Can the Defendants appeal to the NC Supreme Court based upon the recent changes to the cases that may be appealed from the Business Court?  Perhaps.

Let me observe that there were a lot of Business Court decisions in the final month of 2014 which I did not write about.  I've been kind of distracted and will get back on top of things early this new year.