Should An Arbitrator Or A Judge Be The One To Decide Whether An Arbitration Is Barred By Res Judicata

There are all sorts of questions when court proceedings run alongside an arbitration dispute.  Who decides issues that cut across both?  Judge?  Arbitrator?

Assume that you represented the Claimant in an arbitration In which the opposing party (the Respondent) made a number of counterclaims on which it was awarded a substantial amount.  You're still smarting from the loss, and the Respondent starts a second arbitration.  The claims in the second arbitration are essentially a rehashing of the original counterclaims.

You've got a pretty good res judicata defense.  But who decides whether the Respondent now turned Claimant is barred from pursuing its new claims?  Can the Arbitrator assigned to the second Arbitration deal with that issue?

A Plaintiff in the Business Court found itself in precisely this situation.  Allscripts, a "healthcare-related software provider"  had initiated an arbitration against Etransmedia Technology, Inc., which "delivers similar software programs to medical practices and health systems."

The arbitration panel socked Allscripts with an Award of nearly $10 million on Etransmedia's counterclaims which was confirmed by an NC Court..

Almost two years after that Award, Etransmedia filed its own arbitration action against Alllscripts.

Allscripts, seeing these "new" claims as barred by the resolution of the first arbitration, filed a Complaint seeking an injunction that the claims were barred by res judicata.  Etransmedia opposed the request for an injunction, arguing that the question of res judicata should be decided by the Arbitrator in the second  case. The case (Allscripts Healthcare, LLC v. Etransmedia Technology, Inc.) was designated to the Business Court, and Judge McGuire issued an (unpublished) Order right before Christmas, denying the request for an injunction and ruling that the Arbitrator was the proper decisionmaker on this issue.

The NC COA Had Previously Ruled That A Judge (Not An Arbitrator) Decided Issues Of Res Judicata

Allscripts presented two Court of Appeals decisions seeming to dictate a ruling in its favor and giving the Business Court the right to rule on the injunction.  In the first, C & O Dev. Co. v. American Arbitration Ass'n,  48 N.C. App. 548 (1980), the Court held that "it is our opinion that the extent of a judgment's binding effect is a matter for judicial determination." In the second case, Rodgers Builders, Inc. v. McQueen, 76 N.C. App. 16 (1985), the Court held that:

[t]he scope of an arbitration award and its res judicata effect are matters for judicial determination; therefore, whether plaintiff's claims are barred was for the superior court to determine.

Id. at 23.

The NC Legislature Changed Those Rulings With The Enactment Of The Revised Uniform Arbitration Act

Why would Judge McGuire rule otherwise, given the clarity of those COA decisions?  Because those cases were decided before North Carolina adopted the Revised Uniform Arbitration Act (the "RUAA") in 2003,  Order 21.  Judge McGuire observed that:

[s]ection 6(c) of the RUAA provides that '[a]n arbitrator shall decide whether a condition precedent to arbitrability has been fulfilled and whether a contract containing a valid agreement to arbitrate is enforceable.

Order 21 (quoting N.C. Gen. Stat. §1-569.6(c)).

If you are not seeing how that statutory language covers a res judicata argument, it's clearer in the Official Comment to Section 6(c)  It says that the provision is meant to:

incorporate the holdings of the vast majority of state courts and the law that has developed under the [Federal Arbitration Act] that . . . issues of procedural arbitrability, i.e. whether  prerequisites such as time limits, notice, laches, estoppel and other conditions precedent to an obligation to arbitrate have been met, are for the arbitrators to decide.

Order 27.

Given that the RUAA was meant to bring the state arbitration act in line with the Federal Arbitration Act, the NC COA's opinion in WMS, Inc. v. Alltel Corp., 185 N.C. App. 86 (2007) was determinative.  There, the appellate court held that "in the context of the FAA, the issues of res judicata and collateral estoppel must be decided initially by the arbitrator and not the trial court."  Id. at 92.

Would you rather have a Judge or an Arbitrator decide a question of res judicata? Don't forget that arbitrators aren't obligated to follow the law.  Judge McGuire observed a month ago that arbitrators:

'are not bound to decide according to law when acting within the scope of their authority, being the chosen judges of the parties and a law unto themselves, but may award according to their notion of justice and without assigning any reason.'

Trilogy Capital Partners,, LLC v. Killian, 2015 NCBC 103, ¶33 (quoting Bryson v. Higdon, 222 N.C. 17, 19-20 (1942)).

If you are wondering whether an arbitration Award is even entitled to res judicata effect, that bridge was crossed years ago.  See  Lancaster v. Harold K. Jordan and Co., 2014 NCBC 22, 48 ("It is clear that a confirmed Arbitration Award constitutes a final judgment on the merits for purposes of collateral estoppel.").

 

 

 

Sometimes It Might Not Be Worth It To Appeal The Denial Of A Preliminary Injunction

I don't think that it was worth it for TSG to appeal Judge Murphy's Order denying its Motion for a Preliminary Injunction on a covenant not to compete.  That's true even though an injunction (though not on the covenant) was ultimately granted by Judge Bledsoe in an unpublished Order on December 14th. 

From Business Court To Court Of Appeals To NC Supreme Court And Back

Here''s a quick procedural history of the case:  In January of last year TSG filed in the Business Court a Motion for Preliminary Injunction enforcing a covenant not to compete..  Judge Murphy denied the Motion via an unpublished Order in February 2014.  TSG appealed and obtained a decision from the NC Court of Appeals reversing Judge Murphy in December 2014., 566 S.E.2d 561 (2014). The COA remanded the case to the Business Court and directed it to enter the previously denied Preliminary Injunction.  But then, the Defendant filed a Petition for Discretionary Review with the NC Supreme Court.  The Supreme Court denied that Petition (like it does with almost all of them) eight months later, in August 2015.

The Term Of The Covenant Not To Compete Ran Down During The Appeals

All throughout this appeal, the clock on TSG's two year -compete was winding down,  Its former employee, Defendant Bollinger, had quit his job at TSG on November 21, 2013 and began employment with a competitor, Defendant American Custom Finishing, LLC, four days later.  The non-compete agreement which he had signed was in place for two years.  (It said as to its term thatthe employee could be enjoined "[d]uring the period of two (2) years following the date of Employee's termination of employment with TSG. . . ."  Murphy Order 9).

By the time of Judge Bledsoe's Order last week, the two-year period of the non-compete had expired, and Judge Bledsoe ruled that the covenant not to compete could not be enforced.  Op. 23.

The Court Couldn't Extend The Term Of The Covenant Not To Compete

Covenant not to compete experts will think of those NC cases that extend the term of the non-compete for the period that it was being violated.  But those cases involve covenants that contain an explicit provision regarding their extension, like: "[t]he periods of protection shall not be reduced by any period of time during which [the employee is] not in compliance therewith." Phillips Elecs. N. Am. v. Hope, 631 F.Supp.2d 705, 718 (M.D.N.C. 2009)

The NC COA enforced such language in QSP, Inc. v. Hair,  152 N.C.App. 174, 177-78, 566 S.E.2d 851, 853 (2002), where the non-compete said that:

[Employee] agree[s] in light of the special nature of QSP's fund-raising business that if [employee] violate[s] this Agreement, appropriate relief by a court requires that the terms of paragraphs 1(a-f) and 3(b) will be extended for a period of twelve (12) months commencing on the date of [employee's] last violation of this Agreement....

But in this case, the covenant contained no provision regarding an extension, so Judge Bledsoe could not extend it beyond its two year term.

The Appeal Presented No Basis For An Extension

How about that failed Petition for Discretionary Review?   Was that a basis for extending the covenant's duration?  The passage of time caused by that unsuccessful Petition by the Defendants had caused the non-compete to expire.  The competitive restriction was governed by Pennsylvania law, which allows for an extension of a covenant's restriction if "fraud or unnecessary delay caused by the [enjoined party] . . . unjustly permitted the . . . time restraint to expire."  Op. 22 (quoting Hayes v. Altman, 266 A.2d 269, 272 (Pa. 1970)).

Judge Bledsoe said that there was no evidence:

to suggest that Bollinger has engaged in fraud or unnecessary delay to cause the restrictive period to expire.  To the contrary, Judge Murphy declined to enter a preliminary injunction in February 2014, and Plaintiff elected to appeal.  When the Court of Appeals overturned Judge Murphy's decision, Bollinger timely exercised his legal right to file a petition for discretionary review with the North Carolina Supreme Court.  Upon learning of the Supreme Court's denial of Bollinger's petition for discretionary review and the certification of that decision to [the Clerk of Superior Court for the County in which the case had been filed], this Court has acted promptly to issue this Preliminary Injunction Order as directed by the Court of Appeals.  Accordingly, the timing of this Order is the result of the normal processes of the North Carolina court system and not due to any 'fraud or unnecessary delay' by Bollinger.  Thus, an extension of the restrictive period . . . is not available. . . .

Op. 26 (emphasis).  Read "normal processes of the North Carolina court system" to read that the judicial system is not built for speed.  (I'm not picking on the North Carolina courts, that's true of all court systems).  If you are chasing after an injunction on a non-compete in the appellate courts after it was denied in the trial court, your non-compete is likely to expire during the appeals. So, pursuing the "normal processes" of an appeal may be a waste of time (and your client's money).

Can You Really Appeal An Order Denying (Or Granting) An Injunction Or Is It Interlocutory And Not Appealable?

The opinion from the NC COA in the TSG case gives a brief discussion of the appealability of an Order granting or denying an injunction.

The Court said that:

North Carolina appellate courts have routinely reviewed interlocutory court orders both granting and denying preliminary injunctions, holding that substantial rights have been affected. See, e.g., A.E.P. Industries, Inc. v. McClure, 308 N.C. 393, 302 S.E.2d 754 (1983); Iredell Digestive Disease Clinic, P.A. v. Petrozza, 92 N.C.App. 21, 373 S.E.2d 449 (1988) aff'd, 324 N.C. 327, 377 S.E.2d 750 (1989); Cox v. Dine-A-Mate, Inc., 129 N.C.App. 773, 501 S.E.2d 353 (1998); Masterclean of North Carolina, Inc. v. Guy, 82 N.C.App. 45, 345 S.E.2d 692 (1986).

566 S.E.2d at 853.

An Argument Based On The Inevitable Disclosure Doctrine Didn't Work

Plaintiff took a run at enjoining Bollinger from working in its industry of textile finishing based on the inevitable disclosure doctrine.  That seemed like a good idea given that Pennsylvania recognizes the doctrine.  Op. 28.  But Judge Bledsoe said that NC law, not Pennsylvania law, governed Plaintiff's claim for misappropriation of trade secrets.  Order 28.  He cited three previous Business Court opinions in which the Business Court said that it was "uncertain" and "unclear" whether North Carolina's appellate courts had recognized the doctrine.  Op. 28.

But the Plaintiff got an injunction enjoining Bollinger from misappropriating its trade secrets or any "confidential or other proprietary information as opposed to an injunction based on the non-compete, which would have prevented Bollinger from working for his neww employer.  The bond required was quite small -- only $250 -- since "the potential risk for damages" to Bollinger was deemed to be minimal.  Order 31.

All Is Not Lost: Plaintiff Can Still Get Damages

It's worth noting that the expiration of the non-compete doesn't preclude the Plaintiff from recovering  damages "that arose as a result of Bollinger's alleged violation of the Non--Compete Provision during the restrictive period."  Op. 27 & n.8.

 

Problems To Avoid When Making A Meiselman Claim And/Or Filing A Derivative Action

The Business Court's Opinion last week in Coleman v. Coleman, 2015 NCBC 110, provides useful guidance on how to properly plead a Meiselman claim, and proper procedure to follow before making a derivative claim.

Plaintiff in the Coleman case made both a Meiselman claim and a derivative claim.  As you will guess from the case name, this was a family dispute in which all of the parties were  "related, either through blood or through marriage."  Op. 3.  Plaintiff was a shareholder and President of two family-owned corporations, one of which owns Asheville Mall.  He had been removed from  his position by his co-shareholder family members despite what he said was a shared expectation that he would remain the President as long as he was "capable and willing to serve."  Op. 11.

Plaintiff couched his first claim as one for "Breach of Fiduciary Duty -- Meiselman Action.  If you aren't familiar with a "Meiselman action," the North Carolina doctrine -- decided iby the NC Supreme Court in the case of Meiselman v. Meiselman in 1983 -- protects a shareholder in a closely held corporation from "the frustration of his reasonable expectations as a shareholder" (Op. 19).  That can include things like like continued employment with the corporation or actions affecting share ownership.  The shareholder must show that his  "reasonable expectations" were known to or assumed by the other persons involved with the corporation.  

Don't Expect Conclusory Allegations To Get You Past A Motion To Dismiss

The Plaintiff before the Court hadn't pleaded his Meiselman claim adequately.  Judge Bledsoe said that:

Plaintiff has not pleaded sufficient facts to show his expectations were reasonable or concurred in by Defendants.  Plaintiff has advanced only conclusory allegations that Defendants knew of and frustrated his substantial and reasonable expectation of continuing to serve as President of the Corporations.

Op. 22.

Plaintiff also hadn''t pled his claim with enough detail to get past the presumption afforded the corporation by the business judgment rule.  The business judgment rule creates a "a strong substantive presumption that [a] director's judgment will not be judicially second-guessed unless it cannot be attributed to a rational business purpose."  Op. 31.

Plaintiff said he had been replaced as President by a person who did "not have the requisite expertise or experience to properly manage the Corporations."  Op. 32  The Judge said that "[t]his conclusory statement, standing alone, is insufficient to demonstrate that the board's actions were outside the realm of the business judgment rule." Op. 32. 

Don''t Ask For Relief Which The Court Doesn't Have The Power To Grant

Another reason that the Meiselman claim was dismissed was because the relief that the Plaintiff sought (his reinstatement as President) could not be granted by the Court.

Judge Bledsoe observed that here was a significant change "between the statutory framework in which North Carolina courts  analyzed Meiselman and the framework in existence today."  Op. 24.  Years ago, a trial judge had the power per the now repealed G.S. §55-125.1 to cancel, alter, or enjoin "any resolution or other act of the corporation or to direct or prohibit "any act of the corporation or of shareholders, directors, officers or other persons party to the action."

As the law stands now, "courts are limited in the exercise of their 'discretionary equitable jurisdiction to order involuntary dissolution, or, alternatively, a mandatory buyout for the protection of the minority shareholders in closely held corporations.'"  Op. 24.  Reinstatement?  Not available.

The Dismissal Of The Meiselman Claim Was Without Prejudice

The Court allowed the Plaintiff to amend his Meiselman claim "in a manner consistent with Rule 8's requirements and prevailing case law.

A Demand on The Corporation Is Essential Before Filing A Derivative Action

A demand on the corporation to take action is an essential prerequisite to the filing of a derivative action.  G.S. §55-7-42 says that a shareholder "may not commence a derivative proceeding" without having made a written demand "upon the corporation to take suitable action."

A Plaintiff must wait ninety days after the demand before starting a derivative action.  The 90 day period is waived only if the corporation rejects the demand before the 90 days have run, or if irreparable injury would result to the corporation if the potential plaintiff is forced to wait.  N.C. Gen. Stat. §55-7-42.

This Plaintiff didn't wait the 90 days, contending that the corporations had rejected his demand via a voicemail.

What Constitutes The Rejection Of A Demand

Plaintiff had made his demand in a letter which he  sent to the other directors and shareholders of the corporations.  The attorney who Plaintiff said was counsel for the "Majority Shareholders and Majority Directors" (Op. 27 & n.3) left Plaintiff the voicemail rejecting the demand.

That phone call was not sufficient to avoid the 90 day waiting period because there was no allegation that this attorney had the authority to bind the corporation.  Op. 29.  That ruling was consistent with a decision from the Business Court last year, in which Judge Gale held that:

any response adequate to constitute a corporate rejection that excuses the further running of the ninety day waiting period must be made by those with the authority to act on behalf of the corporation.

Petty v. Morris, 2014 NCBC 66 at 46

Make Sure To Verify Your Derivative Action Complaint

Rule 23(b) of the NC  Rules of Civil procedure says that all complaints initiating a derivative action must be verified under oath. 

This Plaintiff had not verified his complaint, so his lawsuit was dismissed without prejudice.

                  *          *          *          *          *

If you are thinking that this Plaintiff stands in pretty good shape even after the grant of the Defendants' Motion to Dismiss because he has the right to refile his claims, you are mostly right.  But given that the lawsuit was filed in August of last year, Mr. Coleman will be starting all over again, nearly a year and a half later, following the dismissal.

 

 

A Couple Of Points About Receiverships

There's a lot to wonder about receiverships.  Like, how is the Receiver's  compensation calculated?  And does it make a difference to compensation if a corporate shareholder says the receivership was unnecessary, and that it was obtained for improper purposes?

Judge Bledsoe answered those questions this week in Ekren v. K&E Real Estate Investments, LLC. 2015 NCBC 107,

Compensation Can Be Based On Gross, As Opposed To Net, Receipts

A Receiver, once appointed by the Court, is paid per the terms of G.S. §1-507.9.  The statute says that: the court shall allow a "reasonable compensation to the receiver for his services, not to exceed five percent upon receipts and disbursements, and the costs and expenses of administration of his trust and of the proceedings in said court, to be first paid out of said assets."

Let's say that a receiver sells a piece of property for $100,000 which is subject to a $90,000 mortgage.  Is the five percent allowed by the statute calculated on the $100,000 gross receipt, or the net receipt of $10,000 which is left following the payment of the mortgage?

 The receiver for K&E Real Estate Investments had submitted two previous requests for compensation based on net receipts, but in the request before the Court requested that it be based on the gross receipts.

Judge Bledsoe denied an objection to the request for compensation, stating:

N.C. Gen. Stat. sec. 1--507.9 . . . does not require that commission be paid on net receipts, and the Court does not find that the Receiver's decision to seek commission based on net receipts in his first two applications precludes his request to be paid on gross receipts in the current Motion.

Op. 5.

Compensation Of Receiver Appointed For "Spiteful Purposes"

The Court also rejected the Defendant's argument that the Receiver's fees should be reduced because the lawsuit which led to the appointment of the Receiver was "motivated strictly by [Plaintiff's] spite."  Order 8.  Judge Bledsoe said that '[t]he Receiver's compensation should not be dependent upon the wisdom of his appointment."  Op. 8.

 

Do The Same Rules Apply To Receivers For LLCs As For Corporations?

Eagle-eyed readers will have noticed that the receivership in this case was for an LLC, and that Section 1-507.9 only mentions the compensation of receivers for "insolvent corporations."

Judge Bledsoe noted that the Order appointing the Receiver for the LLC (entered by Judge Murphy in 2012) said that the Receiver would be paid per G.S. Section 1-507.9  Op. 3 & n.1.

The NC Limited Liability Company Act has multiple provisions providing for the appointment of a Receiver.  It has no specific provision regarding the compensation of a Receiver.  The closest it comes is Section 57D-6-04, which says that:

The court may order the LLC to compensate the receiver and reimburse the receiver's expenses, including the fees and expenses of attorneys and other professionals retained by the receiver.

Plaintiff Gets A Rare Win On A Motion For Reconsideration In The NC Business Court

It's pretty hard to succeed at getting a Business Court Judge to reconsider a prior ruling and reverse himself.  But the Plaintiff in RREF BB Acquisitions, LLC v. MAS Properties, LLC, 2015 NCBC 105, accomplished exactly that last week.

I wrote about this case when the earlier ruling in the case was made, about six months ago.  But I didn't mention the aspect of the ruling on which the Court has now reversed itself.

Why would have I overlooked something that was significant enough for Judge McGuire to reverse himself upon?  Well, it involved ECOA,  Writing about an ECOA issue is about as interesting to me as tackling something involving ERISA or RESPA. 

If you are lost in that alphabet soup of acronyms, ECOA is the Equal Credit Opportunity Act.  It was enacted by Congress in 1974, and it prohibits any creditor from discriminating against any applicant, with respect to any aspect of a credit transaction, on the basis of race, color, religion, national origin, sex, marital status, or age.

RESPA?  The Real Estate Settlement Procedures Act.  ERISA? The Employee Retirement Income Security Act.

The regulations controlling ECOA provide that a waiver of the protections of the Act cannot be waived in any transaction constituting an "extension of credit." The  Defendants in RREF had signed off on a waiver of their defenses to the collection of a promissory note.  They had signed that waiver in a loan modification agreement which said that they:

waive any objection thereto, affirm any and all obligations to [the lender] and certify that there are no defenses or offsets against said obligations or [the lender].

Op. ¶1 (emphasis added).

In its June ruling (2015 NCBC 58), the Business Court found this language to be ambiguous as to whether it was intended to cover the ECOA defense to collection of the promissory note raised by the wife of the borrower. 

So what changed in the intervening six months warranting a reconsideration of the June ruling?  It was one of those rare North Carolina Supreme Court rulings in a civil case delivered at a most opportune time, in Ussery v. Branch Banking and Trust Co. decided on September 25, 2015.

In Ussery, a factually similar case, the NC Supreme Court reversed the denial of a motion for summary judgment by the NCCOA.  The Supreme Court held that the plaintiff had waived all of its defenses to the validity of a loan by the Defendant.  The waiver language was contained in a loan modification agreement (like RREF's was) and was nearly identical to the waiver signed by Mrs. Saunders and procured by the same Bank involved in the RREF case (BB&T).  The Supreme Court called this language "clear and unambiguous."  Ussery at 21.

The Supreme Court did not specifically address the argument made by RREF in the Business Court: that the waiver was unenforceable as a matter of law because the loan modification agreement was an "extension of credit."

Judge McGuire, no longer hobbled by his previous ruling that the language of the waiver was ambiguous, went on to deal with that issue, and ruled that:

Sybil Saunders was not required to prospectively waive her rights under the ECOA when she entered into the original loan agreements, but did so in exchange for avoiding a soon due large payment and obtaining a modification of the terms o[f] the existing loan.  The Court cannot conclude that there is any basis . . . for permitting a borrower to waive their ECOA claims in a forbearance or settlement agreement but not in a loan modification or restructuring agreement.

Op. ¶11.

This decision is good news for banks working out troubled loans.  They can erect a strong defense to an ECOA claim when securing a waiver in a loan modification agreement.

Previous Motions for Reconsideration made in the Business Court have generally not met with success.  That''s been particularly true of Motions aimed at trying to get a new Business Court Judge to fix the claimed errors of a predecessor Judge.

The Business Court observed many years ago that "[t]he North Carolina Rules of Civil Procedure do not include a provision for ''reconsideration.'"    GR&S Atlantic Beach, LLC v. Hull, 2013 NCBC 39 n.1.

The Plaintiff in RREF was lucky to be handed an NC Supreme Court decision supporting its Motion for Reconsideration.  There''s probably not much chance of that happening.