A Happy Dance For Plaintiffs Who Moot A Motion To Dismiss By Moving To Amend Their Complaint

Maybe you've been in this situation before.  You've moved to dismiss a complaint, have fully briefed your motion, and the defendant dances in on the day of the hearing on your motion and amends his complaint.  And the defendant doesn't even bother to make a motion to amend his complaint!

What effect does that have on your well-drafted, sure to be granted, motion to dismiss?

Judge Bledsoe addressed almost exactly that situation today in Krawiec v. Manly, 2015 NCBC 82.  The only difference was that the Plaintiff made a Motion to Amend its Complaint.

The Plaintiffs had hired the Defendants to teach at their Forsyth County dance studio, "Happy Dance."  The Defendants quit their jobs and began working at another dance studio, in Charlotte.  The Plaintiffs' lawsuit followed, alleging everything from breach of contract to misappropriation of trade secrets.

The Defendants all moved to dismiss the Complaint in May 2015.  None of them filed an Answer to the Complaint.  The Court held a hearing on the Motion to Dismiss in July 2015.

About one month after the hearing, the Plaintiffs filed a Motion to Amend their Complaint.  That litigation maneuver leads to several questions:

Did Plaintiffs need to move to amend their Complaint?  No, the motion was unnecessary because Rule 15(a) of the North Carolina Rules of Civil Procedure says that "a party may amend his pleading once as a matter of course at any time before a responsive pleading is served. . . ."  N.C.R.Civ. P. 15(a)(emphasis added).

Weren't the Motions to Dismiss a "responsive pleading"?  No, because "[f]or the purposes of [Rule 15(a)], a Rule 12(b)(6) motion to dismiss is not a responsive pleading and thus does not itself terminate plaintiff's unconditional right to amend a complaint under Rule 15(a)."  Op. ¶10 (quoting Hardin v. York Mem'l Park, 221 N.C. App. 317, 320, 730 S.E.2d 768, 773 (2012)).

What happened to the Motion to Dismiss filed before the amendment?  It was rendered moot by the Amended Complaint, which was deemed filed by the Court as of the date of the entry of its Order.  Op. ¶14(b).

So, the outcome for the Defendants in the Krawiec opinion was that Judge Bledsoe allowed the amendment to the Complaint and denied the Motion to Dismiss as moot.

One way you can avoid the disappointing result for the Defendants in this case is to file your Answer at the same time you file your Motion to Dismiss.  But really, who wants to do that?

Special note: This post is the first one in years that i have published the same day as the decision being handed down.  I would be doing a happy dance myself about that if I could dance.  Unfortunately, I have self-diagnosed myself as being "beat deaf" and I have given up any hope of dancing.  But that promptness is largely a function of Judge Bledsoe's opinion only being five pages long anyway.

 

 

Business Court Awards Rule 11 Sanctions For Baseless Fiduciary Duty Claim

It is probably a good idea for a corporation to avoid making fiduciary duty claims against its employees  (unless they are also officers and directors).  Clients (or their lawyers) who insist on making such claims are liable to be assessed with the attorneys' fees of the persons they sue, at least based on the circumstances in Judge Gale's Order last week in Southeast Air Charter, Inc. v. Stroud, 2015 NCBC 79.

Southeast Air Charter had brought suit against three of its former employees, none of whom were officers or directors of the Plaintiff, alleging that they had breached their fiduciary duties to it.  It's not hard to be aware that fiduciary duty claims against "rank and file" employees are rarely going to get past a Motion to Dismiss.  The North Carolina Supreme Court pretty much eliminated the possibility of making a fiduciary duty claim against a non-officer or director employee almost fifteen years ago, in Dalton v. Camp, 353 N.C. 647, 548 S.E.2d 704 (2001).

Judge Gale wrote in his Southeast Air Charter ruling that:

[a]bsent extraordinary circumstances of special relationships of trust and confidence leading to dominion and control, employees who are not also officers and directors should not be put to the burden of defending fiduciary duty claims.

Order ¶26.

The Court had previously ordered that Rule 11 sanctions were appropriate for the Plaintiff "having filed the claims for which Plaintiff had no reasonable basis to believe were factually supported."  By the time the Court ordered sanctions, the Plaintiff had voluntarily dismissed all of its claims.  The ruling granting the Defendants' Motion for Sanctions was entered in a June 30, 2015 unpublished Order.

The purpose of this week's Order was to determine the appropriate amount of the sanction.  The Court had to determine how to allocate the attorneys' fees incurred by these Defendants, all of whom were represented by the same law firm.  The law firm requested a total of $35,887.01.  It broke that down as $19,322 for one of the Defendants (Steiner-Crowley) against whom all of Plaintiff's claims were deemed to be in violation of Rule 11, and an amount representing one-third of the total fees incurred by the two other Defendants (Robinson and Viall) who were subjected to not only the fiduciary duty claims deemed to have been made in violation of Rule 11 but also a variety of other claims that were not subject to Rule 11 sanctions.

Judge Gale didn't agree with those proposed allocations.  As to Defendant Steiner-Crowley, even though all the claims against her were subject to Rule 11 sanctions, he did not award her all of her fees.  Given that Steiner-Crowley had said that there was never any basis for the claims brought against her, the Court said that she "should bear some responsibility for not attacking those claims on the pleadings before incurring significant other expense."  Order ¶16.  In its discretion, the Court discounted her fees by fifty percent.

For Defendants Robinson and Viall, the determination of fees was more difficult.  Those Defendants had faced multiple claims, only two of which were subject to Rule 11 sanctions.  Their counsel suggested that they each receive a third of the fees they had paid.  Should they, like Steiner-Crowley have mounted an early attack on the claims forming the basis for sanctions?

Judge Gale recognized the "strategic considerations"  dictating that an early Motion to Dismiss not be filed.  He said:

[e]ven if counsel believed the motion was strong regarding the claims now subject to sanctions, the strong possibility that other claims would have survived an early dispositive motion justified allowing even the weak claims to survive. 

Order ¶20.

The Court then looked at the total fees billed for the entire representation, and found them to be reasonable.  But it determined that awarding one-third of the total fees would be excessive, as:

it cannot determine that this amount was incurred solely because [the pleadings] included the breach of fiduciary duty . . . claims.

Order ¶22.The Court found that an appropriate sanction would be ten percent of the fees charged.

Even after the cutting of the amount of fees sought, this was not an insignificant sanction.  The total fees awarded were $14,680.70.  Order ¶23.  And after some discussion about whether it was reasonable for Plaintiff's counsel to rely on his client's representations to make the fiduciary duty claims, Judge Gale ordered that the Plaintiff should bear the entire burden of the sanction as opposed to it being shared jointly with its lawyer.

If you are thinking that the award of nearly $15,000 in fees was not enough to give the Defendants a full recovery, Judge Gale dealt with that point as well.  he said:

the purpose of imposing Rule 11 sanctions is not to assure a full recovery on claims arising from a common factual nucleus.  Rather, the purpose is to sanction conduct and the statutory direction is to sanction only that portion of efforts that would not have been required but for the improper claims.

Order ¶22 & n.1.

 

 

Minority Shareholder Owed No Fiduciary Duty To Other Shareholders In Merger Transaction

Judge Gale's decision earlier this month in Corwin v. British American Tobacco PLC, 2015 NCBC  74 dismissed all of the claims of the Plaintiff class.  If the name Corwin is ringing a bell with you, his case is the shareholder class action over the now completed transaction among Reynolds American, Inc. (RAI), Lorillard, Inc., British American Tobacco (BAT), and Imperial Tobacco Group.  RAI (which you probably still think of as RJ Reynolds Tobacco Company) is the second largest tobacco company in the United States.  Defendant BAT  is RAI's largest shareholder, holding 42% of its stock.  RAI acquired Lorillard (then the third largest tobacco company in the U.S.) in the transaction.

BAT helped fund RAI's purchase of Lorillard (for $27.4 billion) by buying approximately $4.7 billion in RAI stock in order to maintain its 42% ownership of RAI.  RAI funded the remainder by selling of several of its popular cigarette brands to Imperial Tobacco Company, a tobacco holding company headquartered in Bristol, England.

Corwin's action asserted that BAT and RAI's  board of directors had breached their fiduciary duty of candor to him and other BAT shareholders by making inadequate disclosures regarding the transaction.  The claim that the disclosures were inadequate were resolved by a settlement in January 2015.  You can read that settlement agreement here.

Did BAT, RAI's 42% Shareholder, Owe A Fiduciary Duty To RAI's Minority Shareholders?

The issue before Judge Gale was whether BAT, which held only 42% of RAI's shares and was therefore not a majority shareholder of RAI's stock, owed any fiduciary duty at all to Corwin and the class of minority shareholders which he was seeking to represent.

North Carolina Law

If you are thinking that in North Carolina only majority shareholders owe a fiduciary duty to minority shareholders, and are skilled enough at math to know that 42% is not a majority, then you are dead on target.  Judge Gale wrote that "North Carolina courts have never squarely addressed whether a minority shareholder can exercise control adequate to impose such a fiduciary duty."  Op. ¶46.

Corwin argued that a fiduciary duty should be imposed because North Carolina precedent turned on whether the shareholder exercised "dominance and control, which can exist without majority ownership or voting control."  Op. ¶46.

To be fair to Mr. Corwin, loose language (you might say dicta) in North Carolina appellate decisions can be read to support the position that a minority shareholder's control (absent majority ownership) of a corporation can result in that shareholder owing a fiduciary duty to its fellow shareholders.  Judge Gale cited the following cases for that proposition:

See, e.g., Hill v. Erwin Mills, 239 N.C. 437, 444, 80 S.E.2d at 358, 363 (1954)("It is the general rule that when the fairness of transactions between a corporation and one dominating its policies is challenged, the burden is upon those who would maintain such transactions to show their inherent fairness to all parties concerned."); T-WOL Acquisition Co. v. ECDG S, LLC, 220 N.C. App. 189, 208 n.8, 725 S.E.2d 607, 617 n.8 (2012) ("[C]ontrolling or majority shareholders owe a fiduciary duty to minority shareholders in a closely held corporation." (emphasis added)); Freese v. Smith, 110 N.C. App. 28, 37, 428 S.E.2d 841, 847 (1993) ("In North Carolina, it is well established that a controlling shareholder owes a fiduciary duty to minority shareholders."); . . . .  Fulton v. Talbert, 255 N.C. 183, 185, 120 S.E.2d 410, 412 (1961) ("[W]here the corporation is so dominated and controlled by a wrongdoer as to be powerless to act, minority stockholders may bring the action, making the corporation a party.").

Op. ¶53.  Judge Gale, upon reviewing those cases, concluded that none of these North Carolina cases held that a "controlling shareholder must be a majority owner" but that in each case imposing a fiduciary duty, "the shareholder subject to that duty either owned or had control over a majority interest."  Op. ¶51.  He said that North Carolina precedent:

leaves open the specific question of whether a minority shareholder can exercise the degree of control . . . adequate to impose a fiduciary duty on that shareholder.

Op. ¶53.

The argument that North Carolina would impose a fiduciary duty on a non-majority shareholder therefore failed, Judge Gale then turned to Plaintiff's argument that Delaware law placed a fiduciary duty on a "controlling" -- even if minority -- shareholder.

Delaware Law Says That A Minority Shareholder Can Owe A Fiduciary Duty Under Certain Circumstances

The Delaware cases on which Corwin relied in support of his fiduciary duty argument were distinguished by Judge Gale as requiring "actual, rather than theoretical control" before imposing that duty.  Op. ¶56.

There is a presumption in Delaware "that a shareholder who owns less than fifty percent of the outstanding stock of a corporation is not a controlling shareholder.  Op. ¶56.

Getting past that presumption requires detailed allegations of actual control.  Judge Gale said that:

Delaware courts impose a significant pleading burden to allow a fiduciary claim against a minority shareholder and will dismiss such a claim under Delaware's Rule 12(b)(6) in the absence of sufficient allegations.

Op. ¶56.

Corwin's Complaint contained "significant detail," (Op. ¶62), which Corwin said demonstrated BAT's control over RAI (summarized in ¶62 of the Opinion), including a "Governance Agreement," between RAI and BAT which gave BAT veto power over whether certain intellectual property of RAI could be sold to complete the deal and a variety of other factors.

Judge Gale said, after reviewing Corwin's argument, that BAT had influence over the transaction but that "[i]nfluence does not equate to control and the potential imposition of a fiduciary duty turns on evidence of actual control."  Op. ¶63.

The conclusion of the Court was that even if North Carolina were to follow the Delaware standard, that the Complaint's allegations did not:

adequately allege that BAT's control over the Transaction was considerable enough to be the voting and managerial equivalent of a majority shareholder's control, or so potent that the independent Other Directors were unable to exercise their judgment freely with[out] fearing BAT's retribution.

Op. ¶65 (citation omitted).

The Court went on to dismiss fiduciary claims against the RAI directors.  That dismissal involved a discussion of whether a shareholder has standing to bring a direct claim against a member of a board of directors. That sort of claim is generally brought on a derivative basis.  Judge Gale sidestepped the standing issue, ruling that the attempted claim against the RAI directors failed on the merits..Op. ¶74..

What's Next

Given Corwin's marked lack of success on his claims regarding the RAI Transaction,  I'm wondering how much Corwin's counsel will dare to ask for in fees for getting the "disclosure only" settlement which they obtained in January of this year.  My views on the value of such settlements are that they often bring little value to the members of the shareholder class obtaining them and that the fees awarded should take that into account.

Judge Gale directed Corwin's counsel to file a motion for approval of their settlement before the end of August.  We will soon see if this settlement will spin off a sizeable fee.


 

 

Did It Need To Be In Writing?

Surratt v. Brown, 2015 NCBC 72, decided last week by the Business Court, involved an oral partnership to open and operate tattoo parlors throughout North Carolina.

Plaintiff and Defendant entered into an partnership (without any written agreement) to open a tattoo parlor in Winston-Salem.  Defendant Brown was to finance the business for a 30% share of the profits; Plaintiff Surratt was to open and operate the business for a 70% share.

The parties later orally agreed to expand their tattooing business by opening additional retail locations in which they would each have a 50% interest.  The new shops, according to Plaintiff, were to carry the "name. concept, design, and intellectual property developed" by Plaintiff in connection with the first store.  Op. ¶28.

Over the next few years, Defendant Brown opened several new new North Carolina tattoo shops: in Greensboro, Greenville, Jacksonville, and Fayetteville.  Surratt sued Brown over the new stores, alleging that he was entitled to an ownership interest in them.

Did The Agreement Need To Be In Writing?

Even if you are fascinated by tattoos, there is not much of interest in the Surratt decision.  It's mostly about whether Plaintiff's claims were barred by the statute of limitations, but there are a couple of interesting tidbits about Section 75-4 of the General Statutes, which requires that certain types of contract be in writing, and also one about conversion.  That statute says that:

No contract or agreement hereafter made, limiting the rights of any person to do business anywhere in the State of North Carolina shall be enforceable unless such agreement is in writing duly signed by the party who agrees not to enter into any such business within such territory.

N.C. Gen. Stat. §75-4 (emphasis added).

The Defendant said that the claimed unwritten promise that he would not open other tattoo shops in North Carolina was unenforceable per Section 75-4 because it limited his right to be in the tattoo business in North Carolina.

Judge Gale, relying on a Fourth Circuit decision, said that:

where an oral agreement merely concerns the use of intellectual property, section 75-4 may not apply so long as other terms do not 'substantially' limit the party's right to do business.

Op. ¶31 (citing Ashley Furniture Indus. v. Sangiacomo, N.A., 187 F.3d 363, 378 (4th Cir. 1999)).

Judge Gale observed that "Plaintiff's narrowed description of the agreement does not prohibit [the Defendant] from operating in the tattoo and piercing industry without [the Plaintiff] so long as [the Defendant] does not utilize the name, concept, or related intellectual property created pursuant and subject to the agreements between the parties."  Op. ¶32.

Given the early stage of the case (this was a Motion to Dismiss), Judge Gale ruled that it was "premature to determine whether the agreement under which Plaintiff seeks to recover must be in writing in order to be enforceable."  Op.  ¶32.

You Cannot Convert A Partnership Interest

On Plaintiff's conversion claim, which asserted that the Defendant had converted the profits of the Partnership as well as Plaintiff's Partnership interest and his management rights, Judge Gale wrote that:

[a[lthough the law is unclear as to the dividing line between tangible and intangible property in some instances, it is clear that only goods and personal property are subject to a conversion claim: intangible interests, such as business opportunities or expectancy interests are not subject to conversion.

Op. ¶33 (emphasis added).

The Judge ruled that only the property interests of profits and distributions were subject to a conversion claim.  Thus, Plaintiff's conversion claim for "his right to partnership property, his business interest in the LLC/Partnership, and his right to participate in management of the LLC/Partnership" was intangible and not an appropriate conversion claim.  Op. ¶34.

 

 

 

Be Very Careful If You Are Instructing Your Clients Not To Answer Questions At A Deposition

In an (unpublished) Order last week in Griggs v. Bittersweet Farms, LLC, Judge McGuire ruled that Plaintiffs' counsel's instruction to his client not to answer certain deposition questions was improper.  He granted a Motion to Compel responses to the unanswered questions, denied a Motion for Protective Order to excuse the Plaintiffs from having to respond, and ordered the Plaintiffs to pay Defendants' attorneys' fees for the cost of Making the Motion to Compel.

Instructing a witness not to answer a deposition question is pretty much forbidden unless a privilege is at issue.  There are rules in almost all courts about this practice.

The Rules On Instructing A Witness Not To Answer

Rule 30 of the North Carolina Rules of Civil Procedure says that: "[s]ubject to any limitations imposed by orders entered pursuant to Rule 26(c) or 30(d), evidence objected to shall be taken subject to the objections."  NCRCP 30(c).  The italicized portion of the Rule has been interpreted to mean that counsel is prohibited "from instructing a witness not to answer where only an objection is proper."  Order ¶4

The federal rule is more specific.  It says that:

A person may instruct a deponent not to answer only when necessary to preserve a privilege, to enforce a limitation ordered by the court, or to present a motion under Rule 30(d)(3).

FRCP 30(c).  It also says that: "An objection must be stated concisely in a nonargumentative and nonsuggestive manner."

The Business Court has a Rule dealing specifically with when you may instruct a witness not to answer a question.  That is Business Court Rule 18.3:

Counsel shall not direct or request that a witness not answer a question, unless that counsel has objected to the question on the ground that the answer is protected by a privilege or a limitation on evidence directed by the Court.

Business Court Rule 18.3(a).  The Business Court Rule also deals with "speaking objections," saying that "[c]ounsel shall not make objections or statements which might suggest an answer to a witness." BCR 18.3(b).  Objections are to "be succinct, stating briefly the basis of the objection and nothing more."  Id.

The Griggs' Depositions

The questions which the witnesses in the Griggs case refused to answer fell into two categories.  The first was questions concerning the Plaintiffs' net worth, which the Defendants said were relevant to the Plaintiffs' ability to pay punitive damages if the Defendants succeeded on their counterclaims.  The basis for the refusal to answer those questions was that they were intended to "annoy, embarrass or oppress" the witnesses.  The second category of questions concerned a criminal proceeding pending against one of the Plaintiffs.

Judge McGuire said that he understood the Plaintiffs' desire to avoid disclosing their personal financial information in what he said was "an acrimonious family lawsuit,"  (Order ¶4), but he said that the protective order protecting that information should have been sought "prior to, or at the very latest during, the depositions."  Order ¶4.

The NC Rules of Civil Procedure expressly permit counsel to seek a protective order in the midst of a deposition (it's in Rule 30(d)), but I can't imagine a Judge being instantly available to resolve such a dispute.  As far as seeking a protective order "prior to" a deposition, how can a lawyer prophesize in advance of a deposition what opposing counsel might ask that she would want to prohibit?

The effort of Plaintiff's counsel to obtain a Protective Order was hurt by him waiting nearly seven months after the depositions to request it.  Given that the Motion to Compel involved depositions occurring on several different days, Plaintiff's counsel could have moved for a Protective Order after the first deposition.

Attorneys' Fees

In addition to granting the Motion to Compel, Judge McGuire ordered the Plaintiffs to pay more than $3,000 in attorneys' fees for their misconduct..  Rule 37(a)(4) says that the Court shall award attorneys' fees if it grants a Motion to Compel "unless the Court finds that the opposition to the motion was substantially justified or that other circumstances make an award of expenses unjust."

After finding that the opposition to the Motion to Compel was not "substantially justified, Judge McGuire awarded $3,312.50  in fees.  The individual Plaintiffs are responsible for half of the sanctioned amount, and their counsel is responsible for the other half.