North Carolina Business Litigation Lawyer & Attorney : Mack Sperling : Brooks Pierce Law Firm : Greensboro, Raleigh, Winston-Salem, Charlotte

Today, the Business Court entered an Order granting summary judgment against members of a limited liability company who contended that an investor who was the principal source of funding to the LLC had a fiduciary duty to the LLC and its members.

The case, Kaplan v. O.K. Technologies, arose following the dissolution of a company formed to commercialize a process for filtering hog waste.  Kaplan, a minority member of the LLC, was its only source of funds and controlled the LLC's checkbook.  Over time, he lent the LLC nearly $2 million, which the company used to pay salaries and legal expenses, among other things.

When the company's prospects faded, Kaplan stopped funding the company and asked for repayment of his loans.  The other members responded by voting to dissolve the LLC, which was placed in receivership.  Kaplan sued to collect his substantial debt.

The other members of the LLC claimed that because Kaplan had "complete control over all expenditures," and because he knew that the LLC was completely reliant on his contributions, he had an "enhanced fiduciary duty" to the LLC and the other members.

Judge Tennille held:

Being an investor in a company does not create a fiduciary relationship. . . . Kaplan, as a minority shareholder, had no fiduciary duty to the other shareholders even though he was the sole financial contributor to O.K.  Like an investor in a corporation, Kaplan's position as the holder of the purse strings did not create a fiduciary duty.  At all pertinent times, Kaplan was a minority shareholder without dominance or control over either O.K. or any of the other shareholders and therefore without a fiduciary duty.

Op. at 5-6. Judge Tennille stated that, in any event, it was "unclear what Defendants believe Kaplan's fiduciary duty required him to do."  (Op. at 9).  The Court held that Kaplan was not required to provide "limitless funding" and he was entitled to seek to collect the debt owed to him.

The LLC members also contended that Kaplan had not followed the procedures set forth in the LLC's Operating Agreement in making his loans.  The Court ruled, however, that these claims were barred by ratification and estoppel.  It held "Defendants are estopped from objecting to the loans by their continued acceptance of reimbursement and salary made possible by the loans, as well as their inaction when O.K. creditors were paid with the loaned money."  (Op. at 8).

Two other claims made by the Defendants, for negligent misrepresentation and unfair and deceptive practices, are worth mentioning.

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The case of  Land v. Land is a minority shareholder dispute among shareholders of a family business. 

The Business Court sees these kinds of disputes regularly, and there's not much novel in the Court's Order today denying summary judgment in a fight over a masonry business involving two brothers and their father.

The part of the Order that warrants a mention, however, has to do with the Plaintiff's claim of a breach of fiduciary duty by his brother Eddie, the majority shareholder of the business.  Eddie had an unusual defense to this claim by his brother, Alan.

The defense was that Eddie had an affair with Alan's wife, that Alan had discovered the affair, and that Alan therefore could not have had any expectation of a fiduciary duty being owed to him by Eddie.  According to Eddie, Alan therefore could not have relied on the allegedly false statements made to him by Eddie regarding the affairs of the Company.

The Court rejected the argument, holding:

Eddie claims that Alan could not have reasonably relied upon any actions of Eddie’s because Alan caught Eddie in a compromising position with Alan’s then wife in the mid-1980s. (Def. Br. Summ. J. Alan 11.) Eddie asks the Court to hold that that circumstance alone defeats any claim to reasonable reliance or a fiduciary relationship between the two. Alan claims that his knowledge of the situation (which he kept secret until discovery in this case) gave him more leverage and reason to trust Eddie in business. (Alan Br. Opp’n 19; Def. Mot. Summ. J. Alan 4.) While the Court may have its own personal view of the wisdom of one brother trusting another under these circumstances, the Court believes that the overall question of whether there was a fiduciary relationship between Eddie and Alan is one for the jury after it sorts out all the sordid facts.

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Does North Carolina recognize a claim for aiding and abetting breach of fiduciary duty?  The North Carolina Court of Appeals shed a little bit of light on the question this week., but it wasn't very illuminating.

The linchpin for this frequently made claim has been the twenty year old case of Blow v. Shaughnessy, 88 N.C. App. 484, 364 S.E.2d 444 (1988), in which the Court of Appeals recognized the tort.  It held simply that "a cause of action on this theory has been recognized by federal courts in securities fraud cases based on violations of section 10(b) of the Securities Exchange Act of 1934."

But six years after Blow was decided, in Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164 (1994), the United States Supreme Court held that there was no liability for aiding and abetting under the securities laws, thus eviscerating the underpinning of the Blow case. 

Since then, the North Carolina Business Court has expressed doubt about the continuing vitality of claims for aiding and abetting breach of fiduciary duty.  Judge Diaz noted the issue most recently in Regions Bank v. Regional Property Development Corp., 2008 NCBC 8 and in Battleground Veterinary Hospital, P.C. v. McGeough, 2007 NCBC 33; and Judge Tennille wrote on the subject in Sompo Japan Insurance Inc. v. Deloitte & Touche, LLP, 2005 NCBC 2.  In none of these cases, however, did the Business Court dismiss the claim on the basis that it is not recognized in North Carolina.

This week, the Court of Appeals decided the case of Hinson v. Jarvis, in which it made a passing reference to Blow which might be interpreted as giving some life to that case.  In a footnote, the Court stated:

In addition to the cases discussed in this section, plaintiffs also rely on Blow v. Shaughnessy, 88 N.C. App. 484, 364 S.E.2d 444 (1988). That case, however, involved the imposition of liability on a defendant that encouraged a third party to breach his fiduciary responsibility -- a securities law violation -- owed to the plaintiff. Id. at 489, 364 S.E.2d at 447. This case, however, does not involve any fiduciary relationship between Mr. Jarvis and plaintiffs. We therefore find Blow distinguishable from the instant case.  

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Regions Bank v. Regional Property Development Corp., 2008 NCBC 8 (N.C. Super. Ct. April 21, 2008) (Diaz)

The Business Court ruled today that a member of a North Carolina LLC could not sue the LLC's lender for aiding and abetting a breach of fiduciary duty, because that claim was derivative, not direct.

Here are the facts: The LLC had defaulted on its loan.  The Bank then sold the loan to the other members of the LLC.  The Defendant asserted in a counterclaim that the Bank had done so knowing that the other LLC members would use their ownership of the defaulted loan as leverage to obtain a substantial cash distribution to which they were not entitled.

The Court relied on “[t]he well-established general rule . . . that shareholders cannot pursue individual causes of action against third parties for wrongs or injuries to the corporation that result in the diminution or destruction of the value of their stock.”   That principle applies "equally to suits brought by members of a limited liability company."

The unlawful distribution claim was "just another way of saying that the Individual Members wrongfully diverted Company assets."  That was a derivative claim belonging to the Company, not to its members.  The Motion to Dismiss the Counterclaim was therefore granted.

The Court did not resolve a parallel ground for the Motion to Dismiss: whether North Carolina still recognizes a claim for aiding and abetting a breach of fiduciary duty in light of the United States Supreme Court's decision in Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164 (1994).  That question has come before the Business Court a number of times in recent years, but has not been resolved by North Carolina's appellate courts.

Brief In Support Of Motion To Dismiss

Brief In Opposition To Motion To Dismiss

Supplemental Brief In Support Of Motion To Dismiss

Supplemental Brief In Opposition To Motion To Dismiss

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Voyager Pharmaceutical Corp. v. Bowen, April 15, 2008 (Jolly)(unpublished)

Voyager, a company engaged in pharmaceutical research directed at slowing or halting Alzheimer's disease, was attempting a $100 million public offering in 2005.  It alleged in its Complaint that it was unable to complete the IPO due to the actions of one of its directors, Bowen, and one of its employees, Atwood.  It made a variety of claims, including claims for breach of fiduciary duty.

The allegations as to what Bowen had done are pretty interesting.  Here's how the Court characterized some of them:

While Voyager's management was in the 4:30 p.m. conference with Hambrecht, Bowen was in a hospitality suite in the Marriott Marquis Hotel that had been set up to accommodate Voyager's shareholders. (Compl. ¶ 66.)  There, Bowen told one or more shareholders that the IPO was not going to proceed because "God had told him so," and because Voyager had refused to add "the glorification of God" to its mission statement.  (Compl. ¶ 66.)  Bowen also told the shareholders present that day that any further attempts to complete the IPO would fail until his demands were met, including giving credit to God in Voyager's mission statement.  (Compl. ¶ 66.)  Bowen also asked one of the shareholders whether he would be willing to serve as a director of Voyager "when I regain control of the Company."  (Compl ¶ 66.)  Bowen also falsely told one or more shareholders that there was a problem with the Phase I data that had not been resolved and also falsely stated that when he raised this issue with management, management had locked him out of his office.  (Compl. ¶ 68.)

The Court first confronted the issue of choice of law on Voyager's claims for breach of fiduciary duty. The Court noted that there was little guidance in North Carolina as to the proper application of the internal affairs doctrine.  It determined that it would apply the law of Delaware, the state of Voyager's incorporation, to those claims.

It then rejected Bowen's argument that his actions were protected by the business judgment rule.  It held:

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