Rule 11 Sanctions (Again!) From The NC Business Court

This month, for the second time in the last two months, Judge McGuire of the NC Business Court entered Rule 11 sanctions against a party whose attorney relied on inaccurate information from the client in making claims against the opposing party.

This month's decision was in NC Bioremediation, LLC v. Sea Winds, LLC, 2015 NCBC 94. The issue relevant to the Motion for Sanctions was whether the person representing himself to Plaintiff's counsel that he was a manager and member of NC Bioremediation in fact had the authority to file the lawsuit.  Or, more bluntly, was he even a member or a manager at all?

Counsel's Investigation Before Filing The Complaint Was Not A Reasonable One Under The Circumstances, And Violated Rule 11

It turned out, of course, that he wasn't.  But could the attorney for the Plaintiff, who had filed his lawsuit in the name of the LLC have known this and not filed the Complaint?  As Judge McGuire put it, "the question for the Court is what inquiry into the facts did Plaintiff's counsel conduct prior to filing the Complaint and was that inquiry a reasonable one under the circumstances?"  Op. ¶16.

It was not, said Judge McGuire.  It consisted mostly of hearsay support from Mauney's former office assistant who said that he had an ownership interest in NC Bioremediation and financial documents that implied that Mauney was a member of the LLC along with another person (Overton).

But public filings --- annual reports filed by NC Bioremediation with the NC Secretary of State -- showed only Overton as a member/manager of the LLC.

Overton delivered an Affidavit to Plaintiff's counsel in which he said that Mauney had never had an ownership interest or member status with the LLC.  Given that it was the Plaintiff which filed that Affidavit with the Court, Judge McGuire questioned why Overton had not been contacted earlier.  He said:

the Court can only conclude that contacting Overton to get his position on Mauney's contended ownership . . . could have been accomplished relatively quickly and with little additional effort.  Counsel has offered no explanation as to why the information in the Overton Affidavit could not have been discovered before the Complaint was filed.

Op. ¶20.

The Court concluded that the factual investigation done by Plaintiff's counsel fell short of Rule 11's requirement that such an inquiry be reasonable under the circumstances."  Op. ¶20.

The Sanction Entered By The Court Was The Dismissal Of The Action (Without Prejudice)

In an earlier decision in Southeast Air Charter, Inc. v. Stroud, 2015 NCBC 79, Judge McGuire sanctioned a Plaintiff whose lawyer relied inappropriately on its client's representation that some of the Defendants had positions with the Plaintiff corporation that warranted them being sued for breach of fiduciary duty.  (You can read about that decision here) .  The sanction imposed there was the payment of $35,887.01 in attorneys' fees.

What was the sanction in NC Bioremediation?  A dismissal without prejudice, with no attorneys' fees awarded.

Was that sanction harsh enough?  Maybe not, given that Overton stated in his Affidavit that he wishes the action to continue. The dismissal without prejudice leave the door open for Overton to recommence the action. 

It's hard to say who would be a worse representative to sue on behalf of the LLC.  Mauney, a North Carolina lawyer, was disbarred by the North Carolina State Bar In July 2013 for, among other professional violations, "mak[ing] demonstrably false statements under oath."  Op. ¶6 & n.9.  And Overton has "been accused of embezzling approximately $500,000 from" Defendant Sea Winds (which Overton denies in his Affidavit at ¶10).  Op. ¶11 & n.28

 

 

 

 

Unusual Area Of Law For The NC Business Court: Life Estate In A Beach House

When Governor McCrory appointed Judge Gregory McGuire to the Business Court, I doubt that he had any concern whether Judge McGuire had any expertise in the area of trusts and estates.  After all, that area of law is not enumerated in the types of case that warrant designation to the Business Court, contained in G.S. §75A-45.4.

But yesterday's decision in Davis v. Davis, 2015 NCBC 95 required exactly that type of expertise.  In particular, expertise on the validity of restrictions on the alienation of a life estate.

But why would such a case be in the Business Court in the first place?  It was designated to the Business Court on the basis that it concerned the operation of an LLC, and the Court previously issued an (unpublished) Opinion in the case which concerned the standing of the Plaintiffs, members of an out-of-state (Virginia) LLC, to bring a derivative action in North Carolina.

Having resolved that issue in favor of the Plaintiffs in November 2014, all that remained to decide was the interpretation of a restriction on a life estate.

If you are thinking of clicking away, don't. Keep reading. This gets interesting, I promise.

Family Battle Over An Outer Banks Beach House

The Plaintiffs, Melvin and J. Rex Davis, were suing their own mother, Dorothy Davis, over an Outer Banks beach house which the children owned through an LLC (MKR)  in which Melvin, J. Rex, and their sister, Kaye, were the sole members.

Mrs. Davis and her late husband had acquired the beach house in the 1980's, and gifted the beach house to MKR in 2009.  In connection with their grant of the property, the parents retained a life estate in the property with a restriction.  It said that:

said life estate [was] to be personal to the use of the Grantors . . . and may not be utilized by any other person, nor may it be reduced to a cash value for the benefit of the Grantors, or the survivor thereof, but must remain always during the lifetime of said Grantors, or the survivor thereof, available for their individual and personal use without interference from either the remainderrmen or any other person.

Op. ¶13

The children were offended that their mother had been renting out the house after the death of her husband.  The attorney who had drafted the deed testified that he had included that language with the intention that Mr. and Mrs. Davis would not be able to rent the house during their life tenancy. Op. ¶15.  And when I read that provision, I interpret it to mean that the parents could not rent the house.

So you think that would be the end to this unhappy family squabble.  Mom has to stop renting, right? (We all know that renters destroy vacation homes.)

Life Estates And Restrictions On Them

But if you are thinking that Mrs,. Davis was  barred from renting the beach house in which she had a life estate, you are wrong.  Judge McGuire started by running through a short dissertation on life estates and restrictions on their alienation (conveyance).  He observed:

  • '[A] life estate is an estate in land, vesting the holder with the right to use and possess the property during his lifetime.''  Op. ¶27.
  • "An unlimited restraint on alienation of a life estate is against public policy, and therefore, void." Op. ¶28
  • "This principle favoring alienability . . .l conflicts with another common law tenet -- that one who has an interest in property should be able to convey that interest subject to whatever condition he or she desires to impose on the conveyance.  Op. ¶29.
  • "Faced with this conflict, the law has developed so that 'some direct restraints on alienation are permissible where the goal justifies the limit on the freedom to alienate or where the interference with alienation is so negligible that the major policies furthered by freedom of alienation are not materially hampered.'"  Op. ¶29 (quoting 4 Restatement of the Law of Property, Introductory Note to Part II at 2380).

All of that led to the conclusion that "North Carolina has recognized some limited restraints on alienation of life estates as being permissible."  Op. ¶29.

So what about the restriction on Mrs. Davis' life estate?  Permissible or impermissible?

The Plaintiffs took a run at a creative argument: "since Mra. Davis is both the grantor and the life tenant and imposed the restrictions upon her own use of the life estate, the restriction in the Deed does not implicate the public policy reasons underlying the prohibition on alienation.."  Op. ¶30.

Judge McGuire didn't buy that argument.  He concluded that the deed provisions "create a disabling restraint on the alienation of Mrs. Davis' life estate, which is against public policy; thus, such provisions found in the Deed are void."  Opp. ¶34.

Maybe you are worried for Mrs. Davis that the invalidation of the restriction voids the entire life estate.  Judge McGuire said it did not.  Op. ¶34 & n.39.

 

 

Two Cases From NC Business Court: Class Action Fees Doubled And Expedited Discovery Denied

Last week (well, two weeks ago, I'm kind of behind) seemed like class action week at the Business Court.  Judge Gale issued three rulings in class action cases.

Two of the rulings were in consolidated class actions that had been settled.  Those were in In re Pike S'holders Litig., 2015 NCBC 89 and  90.  The third decision was in a case just at its commencement: Raul v. Burke, 2015 NCBC 91, about whether the plaintiff challenging a merger transaction was entitled to expedited discovery on her claims. 

In The Pike Order, The Court Awarded Twice The Amount Of Fees Which The Defendants Had Agreed To Pay

There''s not much worthy of note in the first Pike "decision."  It is merely an Order approving the settlement cut in the four separate class action lawsuits attacking Pike's merger.

The decision in the second Pike case, In re Pike S'holders Litig., 2015 NCBC 90, concerned an award of attorneys'' fees to the lawyers for the class.  The case is notable since the class' lawyers were awarded double the amount of fees ($550,000) than the amount which the Defendants' lawyers had agreed not to oppose ($275,000).

How did the Plaintiffs' lawyers pull that off?  They had to first get past the Defendants' argument that the Court did not have the authority to award fees in excess of the amount that they had agreed not to contest.  That argument was pretty much foreclosed by the language of the Memorandum of Understanding which led to the settlement.  It said:

[i]f the parties are unable to reach agreement with respect to the amount of such attorneys' fees, costs, and expenses to which Plaintiffs' counsel are entitled, then Plaintiffs reserve the right to submit an application for an award of attorneys' fees, costs, and expenses to be paid to Plaintiffs' counsel (the "Contested Fee Application"). . . . In the event of a Contested Fee Application, Defendants agree to pay whatever award of attorneys' fees, costs, and expenses that the Court awards.

Op. ¶17.

Judge Gale, relying on the COA's recent decision in Ehrenhaus v. Baker, held that:

when the parties agree to fee shifting but do not agree on the amount of fees to be awarded, the Court may award the amount that it determines to be fair and reasonable.

Op. ¶29.

The Court assessed the reasonableness of the half million dollar plus fee by breaking the fee down to an hourly rate (for the 1394.60 hours of time) of $550 per hour for lead counsel, $375 per hour for partner hours of non-lead counsel, and $250 per hour for associate time. Op. ¶37.  Judge Gale said that those rates were "within, but at the higher end of, the range that this Court has found to be reasonable for complex business litigation in North Carolina."  Id.

The Court Awarded Fees Based On "North Carolina Rates"

Out of state lawyers looking to take on class action cases in the Business Court might want to take caution from this part of Judge Gale's ruling:

the affidavit of Lead Counsel [who was from Pennsylvania] reflects billing rates that exceed those typically charged in North Carolina.  The Court believes that there are North Carolina lawyers who are fully capable of pursuing similar litigation and, thus, that it would be unnecessary and inappropriate to apply billing rates higher than those typically charged by skilled counsel in North Carolina.

Op. ¶36 (relying on GE Betz, Inc. v. Conrad, ____ N.C. App. __, 752 S.E.2d 634, 657 (2013).

This Was A "Disclosure-Only" Settlement

Also significant was that this doubling of attorneys' fees came in a disclosure only settlement.  Judge Gale expressed this view regarding this type of settlement :

[t]he Cpurt is mindful of substantial commentary that disclosure settlements might often reflect more of a tax cost of a merger transaction rather than a meaningful substantive benefit to the settlement class, particularly when the accompanying release is the broadest possible.  Those considerations perhaps underlie the Delaware Court of Chancery's recent caution that fee requests in disclosure-only settlements may now face more searching scrutiny, particularly when accompanied by the broadest possible releases.  See In re Riverbed Tech., Inc. S'holders Litig., C.A. No, 10484-VCG, 2015 Del. Ch. LEXIS 241, at *21-22 (Del. Ch. Sept. 17, 2015).

Op. ¶39.

The Court found that the supplemental disclosures obtained by the class plaintiffs could not "be fairly characterized as 'routine'" and that they "were clearly required to correct prior material disclosures that erroneously described circumstances related to negotiations between the corporation, its CEO, and its suitor."  Op. ¶41.

Expedited Discovery Denied In Class Action Attacking Ecolab's Acquisition Of Swisher Hygiene

It is common in litigation involving merger transactions for the plaintiff to ask for expedited discovery.  Often, there is a rapidly approaching date for a shareholder vote to approve or disapprove of the transaction, and the class representative seeks to develop evidence which will warrant an injunction preventing the vote.

In Raul v. Burke, 2015 NCBC 91, the Plaintiff was attacking the sale of Swisher's assets to Ecolab for $40 million in cash.  With a shareholder vote only a week away (set for October 15th), The Business Court denied a Motion for Expedited Discovery (on October 8th).

Plaintiff''s argument was that the disclosure of the transaction did not disclose how much of the $40 million sale price would be distributed to Swisher shareholders. The proxy statement stated repeatedly that the management and directors of Swisher could not reliably estimate any shareholder distribution.  Op. ¶12. In fact, it said that "[w]e can provide no assurance as to if or when such distribution will be made." Op. ¶11.

Where is all of that $40 million going?  Well, Swisher is in financial trouble, facing "continuing recurrent losses."  Op. ¶13.  Its accountants have issued an opinion with a "going concern" qualification.  Op. Par. 13.  Moreover, there is a criminal proceeding ongoing in the Western District of North Carolina regarding accounting irregularities.  Op. ¶9.

The Proxy Statement says that:

[t]he balance of the proceeds will be retained to pay ongoing corporate and administrative costs and expenses associated with winding down the Company, liabilities and potential liabilities relating to or arising out of our outstanding litigation matters, any fines or penalties and other costs and expenses relating to or arising out of the USAO/SEC inquiries, and potential liabilities relating to our indemnification obligations, if any, to Ecolab or to current and former officers and directors.

Op. ¶11.

The Court said that it had to balance the substantiality of the Plaintiff's claim against the harm or burden that might be imposed on the Defendant if it had to go through the expense and "potential business delay" that would result from expedited discovery.  Op. ¶7.


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It Can Be A Tough Road For Trade Secrets Plaintiffs In The NC Business Court

If you are a regular reader of this blog, you know that litigating a trade secrets case in the Business Court can be tough.  Last year, the Court barred a plaintiff from engaging in any discovery at all until it identified its allegedly misappropriated trade secrets with sufficient particularity.  And the Court has frequently dismissed trade secrets claims altogether because they weren't pled with the necessary degree of particularity.

Judge Bledsoe made it even tougher for trade secrets plaintiffs earlier this month, in SciGrip, Inc. v. Osae, 2015 NCBC 86.  SciGrip develops and produces "acrylic-based structural adhesives that are used in the marine and other industries to bond fiberglass and other material together."  Op. ¶2.

SciGrip sued its former employee, Osae, for allegedly disclosing its trade secrets to his new employer, Engineered Bonding Solutions, LLC ("EBS"), a direct competitor of SciGrip.  Osae obtained a 25% membership interest in the EBS LLC as a part of his employment. 

SciGrip sought to obtain information regarding EBS' manufacturing processes from Osae.  Osae had that information, which he said involved EBS' trade secrets, on his computer.  Osae said that the computer was owned by EBS and that he couldn't be forced to disclose EBS' trade secret information.

You are probably thinking that since Osae had possession of the documents (on the computer he was using), that he has the "possession, custody, or control" of the material which was the subject of the discovery requests and that he should be forced to provide it.  Those are the "magic words" of Rule 34 of the NC Rules of Civil Procedure, after all.

Plaintiff Couldn't Force Production Of A Non-Party's Trade Secret Information From Its Employee

But Judge Bledsoe said that this discovery request "present[ed] a highly unique scenario.," and held that:

[h]ere, Plaintiffs seek to discover trade secret and proprietary information of their direct competitor solely through one of its employees.  Typically, when a company alleges trade secret violations by an employee who has departed and begun employment with a competitor, the competitor is either joined as a party in the lawsuit or, if the competitor is a non-party, the company seeks discovery of the competitor's documents from the competitor itself through a third-party subpoena under Rule 45.

Op. ¶17.  The Judge observed that "obtaining trade secret information from a non-party competitor is preferable under Rule 45 because Rule 45 affords greater protections to non-parties.  Op. ¶19.  It is certainly true that Rule 45 provides some protection to a person responding to a subpoena.  Among other things, the Court can compensate the person unduly burdened by the subpoena for lost earnings and for reasonable attorney's fees.  Rule 45(c)(1).

The ultimate holding of the Court was that:

the Court declines to compel production of trade secret and proprietary information of a non-party competitor where the plaintiff seeks such information through an employee's possession of a company laptop and the non-party competitor has refused to submit to North Carolina jurisdiction.

Op. ¶20.

Why wasn't Osae's possession of the trade secret information enough to force him to produce it?  Judge Bledsoe said the following:

[i]]n a workforce where employees have access to a multitude of company documents through any number of portable electronic devices, the traditional line between possession and access has been blurred.

Op. ¶18.

But don't forget that the party claiming to have trade secrets must make "efforts that are reasonable under the circumstances to maintain its secrecy."  N.C. Gen. Stat. sec. 66-152(3)(b).  So don't advise your clients that they can maintain trade secret protection if they make thumb drives or laptops containing their trade secrets indiscriminately available to their workforce.

Plaintiff's Arguments That It Could Compel Production Of The Trade Secret Information Due To Osae's Status As An Agent And As An LLC Member Also Failed

Plaintiff made what seemed like a very good argument that Osae was the agent of EBS and that he therefore had the authority to turn over EBS' trade secret information.  Judge Bledsoe disagreed, saying that "this Court has found no authority compelling an agent to turn over his principal's confidential trade secret information."  Op. ¶23.

And what about Osae's membership interest in EBS?  Wasn't that status sufficient to give him the authority to produce EBS' information?  Judge Bledsoe said no, citing again the lack of authority empowering him to do so:

Plaintiffs have not pointed to any North Carolina or persuasive authority finding that a person's status as an agent, employee, minority shareholder, or part owner of  a company equates to 'possession, custody, or control' of the company's confidential or proprietary documents for purposes of discovery.

Op. ¶27.

SciGrip had not made EBS a co-defendant with Osae because EBS disputed that it was subject to jurisdiction in North Carolina.  SciGrip has gone ahead and sued EBS in EBS' home state of Florida, however, and has already served EBS with a subpoena there.

In the event that "all reasonable efforts to obtain the documents from EBS fail[]," the Court said that SciGrip could renew its motion.

How Concerned Should You Be About This Decision?

I don't read this decision to impede discovery from employees of a plaintiff's competitor.  It is literally limited to trade secret material on a laptop owned by an out-of-state entity which is not subject to jurisdiction in North Carolina.  I don't think that you will face that situation very often.