Internal Affairs Doctrine Leads To Dismissal Of An Aiding And Abetting A Breach Of Fiduciary Duty Claim By NC Business Court

A lot of North Carolina court decisions have questioned whether a claim for "aiding and abetting a breach of fiduciary duty" can be made in North Carolina  (many of them are cited in ¶16 of the Islet Sciences Opinion referenced below). Most of those decisions have cast doubt on whether that claim is recognized at all in North Carolina, including several in the Business Court.  But no Business Court Judge has been willing to dismiss an aiding and abetting breach of fiduciary duty claim on the basis that it is not a valid claim in North Carolina

So parties keep asserting that questionable claim.  I wish they'd quit.  It's a dead end.

Business Court Judge McGuire dismissed such a claim earlier this month in an Opinion in Islet Sciences, Inc. v. Brighthaven Ventures, LLC, 2017 NCBC 5.  The individual Defendants, Green and Wilkinson, had been officers and directors of the Plaintiff and therefore owed it a fiduciary duty.  They were also the owners of the Defendant Brighthaven, whose merger discussions with the Plaintiff had fallen through.  The Plaintiff alleged in support of its claim that Brighthaven had provided "substantial assistance to Green and Wilkinson in breaching [their] fiduciary duties" and had therefore aided and abetted those breaches. Op. ¶15.

The Internal Affairs Doctrine

The Plaintiff, a Nevada corporation, argued that the law of Nevada -- which recognizes an aiding and abetting breach of fiduciary duty claim -- should control and that Defendant Brighthaven's Motion to Dismiss should be denied.  The argument for the application of Nevada law was premised on the internal affairs doctrine.

Maybe you don't remember the internal affairs doctrine.  The NC Court of Appeals has defined it as:

a conflict of laws principle which recognizes that only one State should have the authority to regulate a corporation's internal affairs — matters peculiar to the relationships among or between the corporation and its current officers, directors, and shareholders — because otherwise a corporation could be faced with conflicting demands.

Op. ¶18 (quoting Bluebird Corp. v. Aubin, 188 N.C. App. 671, 680, 657 S.E.2d 55, 63).

It wasn't difficult for Judge McGuire to shoot down the internal affairs argument, given that the corporate Defendant was an outsider to the Plaintiff, not one of its officers or directors.  He held that:

While a standard of fiduciary responsibility expected of officers and directors of a corporation generally should be the subject of uniform regulation by the state of incorporation, the same concerns do not necessarily apply to the conduct of third-party corporate outsiders that may lead to tort liability for aiding and abetting.  Such third party conduct does not implicate the standard to which a director or officer should be held; that standard is best left to determination by the state of incorporation.

Op.. ¶22 (emphasis added).

The Pleading Standard For A Non-Existent Claim

After determining that North Carolina law controlled the question of the validity of the aiding and abetting claim, Judge McGuire held the Plaintiff to a heightened pleading standard.  He said that pleading such a claim (even if it doesn't exist) requires "facts supporting an allegation of “substantial assistance by the aider and abettor in the achievement of the primary violation.'”  Conclusory facts like those alleged by the Plaintiff -- that the abettor “was aware of [the fiduciary's] . . . acts and rendered substantial assistance” -- didn't suffice.  Op. ¶27.  The claim was therefore dismissed.

The need for factual specificity in an aiding and abetting claim comes from an NC Court of Appeals decision cited by Judge McGuire (Op. ¶27): Bottom v. Bailey, 238 N.C. App. 202, 767 S.E.2d 883 (2014).  The Bottom case, which relies on another appellate decision, says that:

the tort of aiding and abetting a breach of fiduciary duty, according to Blow [v. Shaughnessy, 88 N.C. App. 484, 364 S.E.2d 444 (1988)], requires “(1) the existence of a securities law violation by the primary party; (2) knowledge of the violation on the part of the aider and abettor; and (3) substantial assistance by the aider and abettor in the achievement of the primary violation.”

Despite its articulation of that standard, the Bottom decision was unsparing in its assessment that an aiding and abetting breach of fiduciary duty claim cannot be made in North Carolina.  It said:

The court finds that no such cause of action exists in North Carolina. It is undisputed that the Supreme Court of North Carolina has never recognized such a cause of action. The only North Carolina Court of Appeals decision recognizing such a claim, Blow v. Shaughnessy, 88 N.C. App. 484, 489, 364 S.E.2d 444, 447–48 (1988), involved allegations of securities fraud, and its underlying rationale was eliminated by the United States Supreme Court in Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164, 114 S.Ct. 1439, 128 L.Ed.2d 119 (1994).

238 N.C. App. 202, 211.

The Business Court has often dismissed fiduciary duty/aiding and abetting claims.  Like in Tong v. Dunn, 2012 NCBC 16,  Regions Bank v. Regional Property Development Corp., 2008 NCBC 8, Battleground Veterinary Hospital, P.C. v. McGeough, 2007 NCBC 33; and Sompo Japan Insurance Inc. v. Deloitte & Touche, LLP, 2005 NCBC 2.

But the Business Court has never dismissed that type of claim on the basis that it is not recognized in North Carolina.  It is inevitable that that is going to happen, but until then, the Court will find another way to dismiss those claims.  Don't waste your time making that claim.

Five Things You Should Know About Discovery Under The New Business Court Rules

There are new Rules for the NC Business Court In effect, as of January 1, 2017.  If you have a case in the Business Court, or are expecting to designate a case there, you should look them over.  They are applicable to all actions currently pending in the Business Court.

If you are not willing to take the time to read the new Rules (which is not recommended), here are five things which affect discovery in the Business Court under the new Rules:

Be Courteous And Cooperative

New Rules 10.1 through 10.8 govern discovery.  The new Rules dictate cooperation in discovery.  Rule 10.1 (titled "general principles") says that:

The parties should cooperate to ensure that discovery is conducted efficiently. Courtesy and cooperation among counsel advances, rather than hinders, zealous representation.

If you think that this is a new and unfairly burdensome obligation, you are in the wrong profession.  The North Carolina Revised Rules of Professional Conduct say that "[l]awyers are encouraged to treat opposing counsel with courtesy and to cooperate with opposing counsel when it will not prevent or unduly hinder the pursuit of the objective of the representation."  Comment 1 to RRPC 1.2

Proportionality

The Rules make a specific reference to the concept of "proportionality," which was incorporated into the Federal Rules of Civil Procedure with the 2015 amendments to those Rules.  New Rule 10.3(a) says that in the Case Management Conference:

Counsel should discuss the scope of discovery, taking into account the needs of the case,the amount in controversy, limitations on the parties’ resources, the burden and expense of the expected discovery compared with its likely benefit, the importance of the issues at stake in the litigation, and the importance of the discovery for the adjudication of the merits of the case.

If you find this to be a startling limitation on the scope of discovery, it isn't.  NCRCP 26(b)(1a), effective in 2015 and captioned "limitations on frequency and extent," references much the same concepts.  If you have an interest in mastering the challenge of proportionality, the drafters of the new Business Court Rules recommend studying A Practical Guide in Achieving Proportionality under New Federal Rule of Civil Procedure 26, 9 The Fed. Cts. L. Rev. 20 (2015).

Electronically Stored Information (ESI)

The new Rules speak more specifically to electronically stored information (ESI), more so than did Old Rule 17.1(t), which mentioned only "metadata.".  New Rule 10.3(c) says that counsel for the parties should prepare an ESI protocol —an agreement between the parties for the identification, preservation, collection, and production of ESI."  The Rule goes on to suggest the items that should be covered, like "the specific sources, location, and estimated volume of ESI" and how the search should be conducted.  When should this happen?  Per new Rule 9.1(d), at the Case Management Meeting.  That meeting is required to happen no more than sixty days after the designation of the case to the Business Court.  (new Rule 9.1(b)).

Interrogatories, Requests For Admission, And Depositions

Interrogatories and requests for admission are limited to no more than twenty-five (new Rule 10.4(b)).  That's half the number permitted by the past set of Rules, which allowed for fifty of each (old Rule 18.2).  The number of depositions allowed remains unchanged-- to no more than twelve by each party.  (new Rule 10.4(c); old Rule 18.2),  Though under the old Rules, Rule 18.2 excluded "testifying experts" from the limitation of twelve.  The new Rules make no such exclusion, so this represents somewhat of a limitation.

All depositions are subject to a time limit of seven hours.  New Rule 10.7(a).  You might remember that when Rule 30 of the Federal Rules of Civil Procedure were amended in 2000  to provide for the same time limit, that there initially was debate about whether the time taken for breaks -- like coffee, lunch, or a trip to the bathroom -- was included in the time limit.  It wasn't really much of a debate, since the federal advisory committee notes actually resolved that question. The notes say “[t]]his limitation contemplates that there will be reasonable breaks during the day for lunch and other reasons, and that the only time to be counted is the time occupied by the actual deposition.”

The new Business Court Rule 10.7(a) resolves that practical issue on its face, it says that the seven hours is measured by "on--the-record time."

The new Rule contains some clarification for 30(b)(6) depositions.  A party providing a 30(b)(6) witness may often present multiple witnesses, each addressing a separate 30(b)(6) topic.  Rule 10.4(c) says that "for depositions conducted pursuant to Rule 30(b)(6), each period of seven hours of testimony will count as a single deposition, regardless of the number of designees presented during that seven-hour period."

Streamlined Procedure For Resolving Discovery Disputes

In a new approach for resolving discovery disputes, new Rule 10.9(b)(1) requires the moving party to "initiate a telephone conference among counsel and the presiding Business Court judge about the dispute."  in order to initiate this telephone conference, the moving party a party first must e-mail a summary of the dispute [of less than 700 words] "to the judicial assistant and law clerk for the presiding Business Court judge and to opposing counsel."  The opposing party has seven calendar days to respond with an equally pithy (700 word) response.  After receiving the response, the Judge can either require the filing of a formal motion and a brief, or rule based on the summaries.

It will be interesting to see how this approach works.  Maybe the Business Court Judges will be innundated with telephone conferences.  Or maybe, after the lawyers exchange the summaries, they will be infected with the spirit of courtesy and cooperation dictated by new Business Court Rule 10.1.

Credit Where Credit Is Due

I was guided in preparing this post by a document prepared by the principal drafters of the new Rules, including my partner Jennifer Van Zant, who seems to get mentioned on this blog more than any other Brooks Pierce lawyer.  The document was prepared quite a while ago (in May 2016), so the Rule changes actually implemented may vary from what are described in it.  It is titled Key Features of Proposed Changes to the North Carolina Business Court Rules.

I am working on adding the Revised Rules to the Sidebar of this blog.  They have been hyperlinked by my assistant Nancy Preslan, who is undoubtedly the best legal assistant in the world.  "Hyperlinked," in this case, means that you can clink on any Rule in the table of contents and hop to that Rule, and then click on the Rule itself to return to the Table of Contents.  That saves a lot of paging back and forth.  For now, they are here.

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NC Business Court Starts Off 2017 By Denying A Motion For Sanctions And Adding A New Judge

In the NC Business Court's first Opinion of the new year, Judge Bledsoe denied Defendants' Motion for Rule 11 Sanctions in Kure Corp. v. Peterson, 2017 NCBC 1.  The decision holds a few lessons about the operation of Rule 11 of the NC Rules of Civil Procedure.

You Can't Avoid A Rule 11 Sanction in North Carolina By Withdrawing Your Complaint

Maybe you got carried away and filed a Complaint that you discovered later wasn't "well grounded in fact" or "warranted by existing law" and was therefore in violation of Rule 11.  That  conduct exposed you (and your client) to a sanction of having to pay "the reasonable expenses incurred because of the filing of the pleading . . . including a reasonable attorney's fee."  NCRCP 11(a).

Can you avoid the whole problem by dismissing or amending the Complaint?  If you are in federal court, the answer would be "yes."  There is a "safe harbor" under FRCP 11.  Judge Bledsoe observed that under the Federal Rules, "once a party serves a Rule 11 motion on the opposing party, the motion 'must not be filed or be presented to the court if the challenged paper, claim, defense, contention, or denial is withdrawn or appropriately corrected within 21 days after service or within another time the court sets.'  Fed. R. Civ. P. 11(c))."  Op. 7 & n.2.

The Federal Rules were amended in 1993 to add that "safe harbor" language.  The North Carolina Rule was last amended in 1986 and was nearly identical to the federal rule in effect at that time.  It therefore doesn't provide for any "safe harbor."

So even though the Plaintiff in the Kure case had amended its Complaint, and even though the counsel filing the Complaint had had new counsel substituted for them, the lawyers filing the original Complaint were still subject to Rule 11 sanctions.

Suing On Behalf Of An Incorrect Party Is Not Sanctionable Under Rule 11

The Plaintiff Kure Corp. was suing as a result of alleged misrepresentations made to it.  As the Defendant pointed out in its Rule 11 Motion, however, Kure had not been formed as a corporation until after the alleged misrepresentations were made.  The Defendant said that the Plaintiff's counsel were subject to Rule 11 sanctions because they had sued on behalf of the wrong party.

The Business Court, looking to the terms of NCRCP 17, which says in part that "[n]o action shall be dismissed on the ground that it is not prosecuted in the name of the real party in interest until a reasonable time has been allowed" for substitution of the proper party, denied that aspect of the Rule 11 Motion.

Judge Bledsoe's ruling was bolstered by an NC Court of Appeals decision holding that “[c]ourts should not impose sanctions under Rule 11 when relief is available under another provision which more specifically addresses the situation.”  Op. 21(quoting Overcash v. Blue Cross & Blue Shield, 94 N.C. App. 602, 618, 381 S.E.2d 330, 340 (1989)).

Wanting To Be The First To File Isn't An "Improper Purpose" Per Rule 11

The parties to the Kure case had met to discuss a resolution of their dispute before the lawsuit was filed.  Defendants alleged that at that meeting, Plaintiff's representative had demanded that the Defendants sign a settlement agreement or that "plaintiff would file its Complaint within the hour." Op. 27.

In addition to its requirement that a pleading be "well grounded in fact" or "warranted by existing law" Rule 11(a) also condemns filing for an "improper purpose."  It says that a signature on a Complaint is a certification that litigation it is not "interposed for any improper purpose, such as to harass or to cause unnecessary delay or needless increase in the cost of litigation."

An improper purpose is “any purpose other than one to vindicate rights . . . or to put claims of right to a proper test.” Op. 26 (quoting Mack v. Moore, 107 N.C. App. 87, 93, 418 S.E.2d 685, 689).  Judge Bledsoe ruled that the sort of conduct complained of by the Defendants was not sanctionable.  He said that:

Defendants. . . have not pointed to any authority demonstrating that a desire to gain a litigation advantage is beyond the scope of 'vindicating rights' or 'putting claims of right to a proper test.' Finding that Plaintiff acted with an improper purpose would expose to sanctions countless attorneys who make pre-filing settlement demands or seek to file before the opposing party does.

Op. 28.

A Couple More Things: New Judge(s?) for the Business Court And My Resolution

The Business Court also started off 2017 with at least one new Judge.  Adam M. Conrad was nominated a Special Superior Court Judge by outgoing Governor Pat McCrory in December 2016.  I don't know new Judge Conrad, but he has an outstanding background including a U.S. Supreme Court clerkship and formerly being a partner at King & Spalding.  Judge Conrad takes his Business Court judgeship by way of the General Assembly's enactment of N.C. Gen. Stat. sec. 7A-45.1(a9), which created  a new special superior court judgeship which the Governor, prior to submitting the nominee for confirmation and in consultation with the Chief Justice, shall determine has the requisite expertise and experience" to be designated as a business court judge."  His nomination was confirmed by the NC General Assembly last month.

Judge Conrad has assumed his position and will be residing in the Business Court in the Mecklenburg County courthouse.

Governor McCrory also nominated Andrew Heath as a Special Superior Court Judge.  Mr. Heath, confirmed by the General Assembly last month, is the former North Carolina Budget Director and former Chairman of the North Carolina Industrial Commission.  I'm pretty sure that I've read somewhere that Judge Heath is in line for an assignment to the Business Court, but don't count on me being correct on that. In any event, a seat on the Business Court may become available, possibly due to Judge Gale's resignation from the Court last October, which is referenced in the General Assembly's confirmation of Judge Heath (What!?  I spoke with Judge Gale about whether he had resigned, and he explained a complicated series of events, including his retirement, which led to him being named a "Senior Business Court Judge" (per a 2015 amendment to the General Statutes, codified in N.C. Gen. Stat. §7A-52(a1)).  That position allows him to be recalled from retirement to serve on the Business Court and to continue to hear cases beyond the mandatory retirement age of 72.  He continues to be the Chief Judge of the Business Court.

Finally, I made the ill-advised resolution in 2014 to write about every numbered Business Court decision.  I have failed miserably at that and please know that this year I have resolved that I definitely will NOT write about every numbered Business Court decision going forward.  That will be an easier resolution to keep.  I hope that this won't cause you to stop reading.