"Holding All The Cards" And Fiduciary Duty Claims

It is hard to base your case on a breach of fiduciary duty when there is a contract in place between the parties.  Contracting parties owe no special duties to each other beyond the terms of the contract.  Branch Banking & Tr. Co. v. Thompson, 107 N.C. App. 53, 61, 418 S.E.2d 694, 699 (1992).

But the NC Business Court twice in January allowed fiduciary duty claims to survive when the relationship between the parties was based on a contract.  The cases are Austin v. Regal Investment Advisors, 2018 NCBC 3 and Can-Dev, ULC v. SSTI Centennial, LLC, 2018 NCBC 9.

Breach Of Fiduciary Duty Claim Against Investment Advisor Gets Past Motion To Dismiss

The Plaintiffs in the Austin case, who had invested funds with the Defendants acting as their investment advisors, sued when the individual Defendant (Barnes) persuaded them to invest in a sketchy venture.  A key claim against the investment advisors was for breach of fiduciary duty.

You probably think that an investment advisor stands in a fiduciary relationship to his client as a matter of law (a de jure relationship), but no NC appellate decision has so held.  Judge Robinson didn't see any need to take that step, and instead ruled that the facts alleged in the Complaint were sufficient at the Motion to Dismiss stage to support a de facto fiduciary relationship.  Op. 43.  He said:

that the Complaint’s allegations regarding the relationship between the parties, the amount of discretion given to Mr. Barnes and Regal to manage Plaintiffs’ investments, and the circumstances of the Triton investment, together with the allegations that Plaintiffs, who were not sophisticated investors, relied on Mr. Barnes and Regal for their financial expertise to manage their investment accounts, are sufficient at the Rule 12(b)(6) stage to plead the existence of a de facto fiduciary relationship.

Op. 43.

Breach Of Fiduciary Duty Claim Survived Motion For Summary Judgment When Contracting Party "Held All The Cards"

So does it get tougher to get beyond the summary judgment stage when you are claiming a de facto fiduciary relationship?  It didn't for the Plaintiff in the Can-Dev decision. That Plaintiff had entered into a joint venture deal with the Defendants to develop self-storage facilities in Canada.  The contractual relationship was carefully detailed, and Judge Robinson noted the well accepted principle that 

parties to a contract do not thereby become each others’ fiduciaries; they generally owe no special duty to one another beyond the terms of the contract[.]

Op. 40 (quoting Branch Banking & Tr. Co. v. Thompson, 107 N.C. App. 53, 61, 41, 8 S.E.2d 694, 699 (1992)).

He then observed that:

the existence of a contract does not foreclose the possibility that a contracting party may repose trust and confidence in the other party, beyond the terms of the contract, such that the other party, in equity and good conscience, becomes bound to act in good faith and with due regard to the interests of the one reposing confidence.

Op. 40.

The standard for proving a de facto fiduciary relationship "is a demanding one."  Op. 37.  The NC Court of Appeals has said that "[o]nly when one party figuratively holds all the cards — all the financial power or technical information, for example — have North Carolina courts found that the special circumstance of a fiduciary relationship has arisen.” Lockerman v. S. River Elec. Membership Corp., 794 S.E.2d 346, 352 (2016).

Plaintiff Can-Dev got over that hurdle  (and at the summary judgment stage, which is all the more impressive).  The Defendants had taken over control of the development projects which were the subject of the contracts, and had failed to provide financial information regarding the projects to the Plaintiff.  Plaintiffs argued, successfully quoting the Court of Appeals' decision in Lockerman, that this "resulted in Defendants “literally ‘[holding] all the cards — all the financial power [and] technical information[.]’”

                                                                          * * *

This isn't the end of the road for the Plaintiffs in either of these cases.  They still have to prove their claims at trial, because whether a de facto fiduciary relationship exists it is "is generally a question of fact for the jury.”  Can-Dev at 40.

I should note that the Plaintiffs in the Austin case (the investment advisor case) are represented by Brooks Pierce lawyers Clint Morse and Jessica Thaller-Moran.



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.

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.



NC Business Court Says That Bank Didn't Owe A Fiduciary Duty To Its Customer, But Recognizes New Cause Of Action: Breach Of A Duty To Negotiate In Good Faith

Were you thinking that the Business Court might, one day, find that a bank owed a fiduciary duty to its customer?  That seemed like it might happen eventually, as the NC Supreme Court seemed to hold out that possibility last year, in Dallaire v. Bank of America, N.A., 367 N.C. 363, 368 (2014), in which it said that:

it is possible, at least theoretically, for a particular bank-customer transaction to give rise to a fiduciary relationship under the proper circumstances.

But on Monday of this week, in RREF BB Acquisitions, LLC v. MAS Properties, LLC, 2015 NCBC 58, Judge McGuire stuck to the long-standing case law in North Carolina that a lender does not owe any fiduciary duties to its customer.  At the same time, however, he also recognized a new cause of action which might have ramifications for claims against any type of entity (not just a lender) which decides to break off negotiations with an opposing party.

The Plaintiff RREF had purchased from BB&T two loans totaling $5.275 million which BB&T had made to the Defendants back in 2005.  It had purchased the loans from BB&T while they were in default, and shortly after BB&T stopped negotiating a forbearance agreement with the Defendants.

No Fiduciary Duty

The Defendants' lead argument against RREF's lawsuit to collect on the loans was that BB&T had violated a fiduciary duty it owed to them.  They said that BB&T had breached its duty by failing to disclose its attempts to sell their loans while it was in the midst of negotiating a forbearance agreement with them.

The Defendants claimed that if they had known that BB&T was selling their loans, they would have tried to buy them themselves or had a third party buy the loans on their behalf.

The basis argued by the Defendants for BB&T's alleged fiduciary duty was that they had a thirty year relationship with a local office, and that they had worked closely with the Bank in developing various residential communities and in selling homes in those communities.  Op. ¶41.  BB&T responded that it owed no fiduciary duties to the Defendants and that it was simply pursuing the options available to it as the holder of loans that were in default.

As Judge McGuire noted, "[t]here is no reported North Carolina appellate case in which a fiduciary relationship has been found in a borrower-lender transaction."  Op. ¶38.  Given that one of the hallmarks of a fiduciary relationship is "a duty of the fiduciary to act in the best interests of the other party," Judge McGuire held that "it would seem nearly antithetical to require a commercial lender to put a borrower's interest ahead of its own in a business transaction."  Op. ¶41.

Another reason the Court refused to find a fiduciary relationship lay in the restructuring negotiations themselves.  Both the Defendants and the Bank were at this point represented by attorneys and were "negotiating to protect their respective best interests."  (Op. ¶43).  If there ever had been a fiduciary relationship between them, "such relationship ceased once BB&T declared Defendants in default of the Loans and the positions of the parties became adverse."  Op. ¶43.

The New Cause Of Action: Breach Of A Duty To Negotiate In Good Faith

Although it did grant summary judgment on the fiduciary duty claim, the Court nevertheless allowed the Defendants to go forward on a new claim hitherto not formally recognized in North Carolina: breach of a duty to negotiate in good faith.


Continue Reading...

Receiver Appointed To Oversee Sell-Off Of Corporation's Intellectual Property

When I wrote last week about Americana Development, Inc. v. Ebius Trading & Distributing Co., the Business Court had entered a TRO against the Defendants prohibiting them from disposing of the intellectual property of Defendant Ebius Trading and using the proceeds to pay off debts which had been personally guaranteed by its officers and principals.

This week,  the court followed up with an Order granting a Preliminary Injunction prohibiting the same conduct, and it has also appointed a Receiver to handle the disposition of the assets of the Defendants.

If you are not familiar with the concept of receivership, North Carolina allows for the appointment of a receiver "when a corporation becomes insolvent or suspends its ordinary business for want of funds, or is in imminent danger of insolvency. . . ."  N.C. Gen. Stat. §1-507.1.  It is often referred to as the state law equivalent of bankruptcy.

You might be wondering why injunctive relief wasn't sufficient in this case.  Judge Jolly expressed concern about the willingness of the individuals associated with the corporations to promptly liquidate the intellectual property of the entities.  He said that:

the value of the intellectual property has a finite shelf life.  Federal courts have long recognized that the appointment of a receiver (or interim trustee in bankruptcy) may be necessary to promptly liquidate assets when the assets are 'liable to deteriorate in price and value.'

Op. 28 (quoting Collier on Bankruptcy 2002.02[2]).

He granted the Receiver broad powers, literally running from a to z in the Court's Order.

The only one that I blinked at was its ruling that the person appointed as the Receiver (a lawyer in a law firm) would be entitled to the "customary hourly rates" for him and other members of his firm.  Order at 17. That may be excessive unless the Receiver or members of his firm end up performing services "beyond the ordinary routine of a receivership," as the receivership 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. The court is authorized and empowered to allow counsel fees to an attorney serving as a receiver (in addition to the commissions allowed him as receiver as herein provided) where such attorney in behalf of the receivership renders professional services, as an attorney, which are beyond the ordinary routine of a receivership and of a type which would reasonably justify the retention of legal counsel by any such receiver not himself licensed to practice law.

G.S. §1-507.9.

If you are thinking that this receivership remedy sounds attractive and is easy to obtain, you are wrong.  Judge Jolly stated at the outset of his opinion that "receivership is a 'harsh' remedy and 'should be utilized only with "attendant caution and circumspection."'  He also said that "a receivership is appropriate 'only where there is no other safe or expedient remedy.'"  Op. 24.

In the circumstances of this case, where the principals of the corporations were "engaged in fraud and gross misconduct in the management" of those corporations (Order 26), the appointment of  a Receiver was deemed appropriate. 

Don't forget that this outstanding result was obtained by my Brooks Pierce colleague Clint Morse.


Pro Se Defendant Wins Trial On Breach Of Fiduciary Duty Claims In Business Court

When I was a young pup preparing to go to court against the uncommon adversary who was proceeding without a lawyer, I would joke that "I hope I don't lose."  Luckily, I never did.

But the Plaintiff in Seraph Garrison, LLC v. Garrison, 2014 NCBC 28, didn't have the same good luck.  It lost a case, following trial by Judge Murphy, to a Defendant who had no lawyer and didn't even bother to appear for trial.

Defendant Garrison was the CEO and a member of the Board of Directors of Garrison Enterprises, Inc.  He was sued derivatively for breaching his fiduciary duty to the corporation.  The alleged breaches included:

  • failing to pay payroll taxes due from the corporation.
  • failing to make 401(k) contributions.
  • executing a significant contract with an outside vendor without obtaining Board approval.

All of these things were uncontested at trial, but the defalcating Defendant escaped without any liability without even appearing at trial.  How so?

Judge Murphy said that:

Plaintiff has failed to present evidence that Defendant’s decision not to pay payroll taxes and 401(k) contributions was not in good faith, beneath the standard of care an ordinarily prudent person in a like position would exercise under similar circumstances, or not in a manner Defendant reasonably believed to be in the best interests [of[ the corporation.

Op. ¶38.

The evidence was that the corporation was in a cash crunch, and the Defendant had chosen to pay employees rather than the IRS obligations in order to keep the business running.

And as to the unapproved contract,  the Judge said that there was"insufficient evidence before the Court to support a finding that Defendant was obligated to seek approval before entering into contracts on behalf of" the corporation.  Op. ¶41.

But the Court found that the Defendant had breached his fiduciary duty by misleading the Board on the contents of the contract.  He had presented the Board with a previous unexecuted draft of the contract which was more favorable than the one he ended up actually signing.  No damages were awarded for this breach, because the Court ruled that the Board had not relied on the misrepresentation.

In any event, this unrepresented Defendant escaped scot-free.  There was no showing of the Board relying on his misrepresentation to its detriment.

Just a caution:  If you are thinking that you can proceed without a lawyer in the Business Court because of this case, you are wrong.  Don't do it.  But to be fair to this Plaintiff, who lost against a pro se rival, it was more than good luck for the Defendant.  He was represented by counsel until his lawyer withdrew, shortly before trial.


Real Estate Agents Need To Be Careful About Disclosing Dual Agency

Dual agency is a big deal to real estate agents.  It lets them represent both a buyer and a seller in a transaction.  Dual agency was the focal point of the Business Court's opinion last week in BDM Investments v. Lenhil, Inc., 2014 NCBC 6.  The Opinion shows the dangers of failing to disclose that you are acting as a dual agent.

If a real estate agent is acting as a dual agent she owes a fiduciary duty to both the buyer and the seller, "and must make a full and truthful disclosure . . . of all material facts [concerning] the [p]roperty."  Op. ¶43.

The fact of the dual agency is a material fact and must be disclosed.  Op. ¶44. 

Hollingsworth, one of the Defendants, did have a real estate license at the time of the transaction, but there's an issue of material fact whether he was acting as an agent for either the buyer or seller in the transaction.  Plaintiffs said that they would not have purchased ten residential lots for $850,000 if Hollingsworth had disclosed his relationship with the seller and the fact that he would earn a commission on the sale. 

The Plaintiffs wanted to rescind the transaction and get their $850,000 back, but there was nothing wrong with the property purchased, and there had been no misrepresentations about it by the purported agent.  As Judge Murphy observed, there are no:

case[s] under North Carolina law considering whether an undisclosed dual agency,
without any other misrepresentation or omission, permits a party to rescind a real
estate transaction if a jury finds the failure to disclose led to the purchase.

Op. ¶52.

He relied on two non-North Carolina opinions in ruling that if the jury at trial were to conclude that the failure to disclose a dual agency led to the decision to buy the property, that the Plaintiffs would be entitled to the remedy of rescission and also to pursue damages against Hollingsworth for "injuries not fully remedied by recovery of its purchase price."  Op. ¶53.

There would also be the danger of Hollingsworth having his real estate license revoked.  The General Statutes provide that a broker's license can be revoked for representing "more than one party in a transaction without the knowledge of all parties for whom he or she acts."  N.C. Gen. Stat. §93A-6(a)(4).  Hollingsworth died after the lawsuit was filed, so he doesn't face that danger. 

There are many more claims discussed in the BDM decision, but I have focused only on the dual agency aspect of the case because I am engaged to a real estate agent and I am of course now fascinated by real estate issues.  I felt it was necessary to make that disclosure.


The NC Supreme Court Speaks On Fiduciary Duty And Piercing The Corporate Veil

The best lines in Green v. Freeman, decided last week by the NC Supreme Court, are that "[t]he doctrine of piercing the corporate veil is not a theory of liability.  Rather, it provides an avenue to pursue legal claims against corporate officers or directors who would otherwise be shielded by the corporate form."  Op. 17-18 (emphasis added).

That means it's not enough to show merely that the shareholder has so "dominated the corporation" that its "corporate separatedness" should be disregarded.  As Justice Martin put it, "sufficient evidence of domination and control establishes only the first element for liabilityThere must also be an underlying legal claim to which liability may attach."  Op. 17.

The Supreme Court reversed the jury's verdict that one of the defendant corporation's directors had breached a fiduciary duty to the Plaintiffs and that she was accordingly personally liable due to her domination and control of the corporation.  It also found that no fiduciary duty was owed to the Plaintiff by the defendant director.  It remanded the case to the Court of Appeals to consider another theory of liability.

Is there anything else of interest in the Green case?  It's got some good language to cite in future cases for the well-accepted principle that directors of a North Carolina corporation don't owe a fiduciary duty directly to shareholders:  "The General Assembly has expressly indicated its intent “to avoid an interpretation [of N.C.G.S. §55-8-30]. . .that would give shareholders a direct right of action on claims that should be asserted derivatively” and to avoid giving creditors a generalized fiduciary claim."  Op. 9.  Of course, there are numerous Business Court cases stating the same principle, but it's always nice to have a Supreme Court case to rely on.

My basic comment about this case is that it represents the application of long established rules in the context of litigation against corporate officers and directors, and that it breaks no new ground.

It's worth noting that piercing the corporate veil claims are mostly unsuccessful.  Five years ago, Justice Timmons-Goodson of the NC Supreme Court said  that "proceeding beyond the corporate form is a strong step: 'Like lightning, it is rare [and] severe[.]'"  That's the last time the State's high Court spoke to the subject.

And don't forget that piercing the corporate veil allegations are not a basis for mandatory jurisdiction in the Business Court.

What Withdrawing Partners Can Expect

If you are a partner in a limited liability partnership, or if you have clients who are, you'll want to read Judge Gale's opinion in Chesson v. Rives, 2013 NCBC 49, decided last week.  It provides guidance on the rights of partners withdrawing from LLPs.

Chesson, one of the Plaintiffs, was a partner in an accounting firm, Rives & Associates, an LLP.  Chesson and two other partners withdrew from the firm, and then sued two of their former partners on a variety of claims, including breach of fiduciary duty, constructive fraud, and "constructive expulsion."

The case is a good reminder that most of the relationship between partners is governed by the Uniform Partnership Act (Chapter 59 of the General Statutes), but can often be modified by a written Partnership Agreement.

Can a partner make claims against his partners after he has withdrawn from the partnership?  Judge Gale said that "[a]lthough Plaintiffs withdrew from the partnership, they retained personal rights for the value of their partnership interest at the time of their withdrawal."  Op. ¶22.  In other words, the withdrawing partners had standing to make their claims.

Didn't the former partners' withdrawal result in a dissolution of the partnership? Ordinarily it would have, because dissolution "occurs automatically by operation of law upon any partner's unequivocal expression of an intent and desire to dissolve the partnership."  Op. ¶29 (quoting Sturm v. Goss, 90 N.C. App. 326, 332, 368 S.E.2d 399, 402-03 (1988)),  In this case, the partnership agreement provided that the non-withdrawing partners could continue the partnership.

Does a partner have to make a demand on the partnership, and have that demand refused,  before suing for an accounting?  Judge Gale said that a demand was not necessary.

Can Partners eliminate the fiduciary duties they owe to one another via a partnership agreement? No, "a partnership agreement cannot eliminate those enumerated fiduciary duties partners owe to one another as a matter of law."  Op. ¶26.  Those "duties include providing full information to the partnership, accounting for the use of partnership property, disclosing self-dealing transactions, and remitting profits obtained through transactions affiliated with the partnership’s business." Id.

Thus, the partners who had withdrawn had not lost claims that the remaining partners had diverted partnership assets to themselves personally and had used partnership assets to form a separate entity.

What is the measure of damages for partners who have withdrawn?  "Absent agreement to the contrary, upon dissolution which was not caused by contravention of the partnership, a partner's right is his pro rata share of the net value of the partnership assets at the time of dissolution."  Op. ¶30.

What about a claim for "constructive expulsion," that the remaining partners had made working conditions so intolerable that they forced a resignation?  North Carolina "does not recognize a claim for wrongful expulsion from a partnership," held Judge Gale.  Op. ¶36.

At least accountants don't commonly have contingent fee engagements.  Those can cause real headaches in valuation, as the Court's opinion last year in Mitchell v. Brewer, 2013 NCBC 14, illustrates.  I wrote about that case last year.

Don't Sue A North Carolina Board Of Directors Over A Merger Without Reading This Case

Last week's Order in Gusinsky v. Flanders Corp., 2013 NCBC 46, should be required reading for lawyers thinking of suing the directors of a corporation in North Carolina over a merger transaction.  It provides guidance on the duties of directors in those transactions, whether the claims are derivative or direct, and lays down some heightened pleading requirements for some of those types of claims. 

You probably wouldn't be surprised to have never heard of Flanders Corporation.  Flanders, based in Washington, NC, says it is the largest United States manufacturer of air filters.  It was publicly traded until its shareholders approved a sale of the company via a merger in May 2012.

That approval by the shareholders came nearly a year and a half ago, but it was only last week that the NC Business Court dismissed a shareholder class action challenging the merger.  In its Order, the Court dismissed the  claims by the Plaintiff (a trust) for breach of fiduciary duty and for aiding and abetting breach of fiduciary duty.

One claim of breach of fiduciary duty was an alleged failure to "maximize shareholder value" in the sale of the company, which Plaintiff claimed was a duty owed by the directors of Flanders to all shareholders.  The other was an alleged failure to disclose information material to the deal.

There Is Rarely A Fiduciary Duty Owed Directly From A Corporation's Directors To Its Shareholders

In dismissing the claim, the Business Court underscored the principle that directors virtually never owe a fiduciary duty directly to shareholders.  The duty is owed to the corporation, not shareholders. Those claims therefore must be made derivatively, unless the circumstances of the "Barger rule" are met. (I've written about the Barger rule before).

It seems so obvious that this type of claim is derivative that you might be wondering how this class action plaintiff even argued its position.  All it made was a couple of pretty anemic arguments which Judge Jolly shot down.

One was that the General Statutes contemplate fiduciary duties owed directly to shareholders.  Plaintiff said that G.S. Section 55-8-30, which delineates the duties of directors, contains only one reference to a duty to the corporation and that the other duties prescribed therefore must be owed directly to shareholders.

That's so wrong.  The North Carolina Court of Appeals held last year that:

The drafters [of the Business Corporation Act] recognized that directors have a duty to act for the benefit of all shareholders of the corporation, but they intended to avoid stating a duty owed directly by the directors to the shareholders that might be construed to give shareholders a direct right of action on claims that should be asserted derivatively.

Estate of Browne v. Thompson. __ N.C. App. __, 727 S.E.2d 573, 576 (2012)(quoting Russell M. Robinson, II, Robinson on North Carolina Corporation Law § 14.01[2] (7th ed.) (citing Official Commentary, N.C. Gen. Stat. § 55-8-30 (1989)).

The Plaintiff also failed in its argument that it met the requirements of the "Barger rule." Plaintiff struck out on that score because the Flanders directors owed no duty to the class Plaintiff that was personal to the Plaintiff.  The cases that the Plaintiff relied on were cases involving closely held corporations controlled by a majority shareholder.  Judge Jolly found them not to be apposite.

Judge Jolly also ruled that a claim alleging inadequate consideration in a merger transaction was a harm to the corporation itsself, not to shareholders individually.  He said that:

[t]his is so because a claim for inadequate consideration is, functionally, a claim for the diminution of the value of shares held by all Flanders shareholdrs.  Without more, the 'lost value' of all shares of Flanders' stock does not describe an injury peculiar and personal to Plaintiffs.

Op. Par. 32.

You can probably guess the rest of this story.  If you can't, remember that derivative claims require the prospective Plaintiff to make a demand on the corporation to pursue the claim before being allowed to file a complaint.  This Plaintiff made no demand.  As the Court observed, "A plaintiff's failure to fulfill the statuory requirements for bringing a shareholder derivative action [is an] . . insurmountable bar [to recovery]." (quoting Allen v. Ferrera, 141 N.C. App. 284, 287, 546 S.E.2d 761, 764 (2000)).

So the first claim for breach of fiduciary duty for "failure to maxinize shareholder value" was dismissed.



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50% Shareholder Didn't Owe Fiduciary Duty To His 50% Co-Shareholder

This week's decision from the Business Court in Maurer v. Maurer, 2013 NCBC 44 is a continuation of the litigation between Jill Maurer and the company owned by her and her husband, which was the subject of three Business Court opinions in 2005 and 2006, in 2005 NCBC 1, 2005 NCBC 4, and 2006 NCBC 1.  And that case even went to trial, yielding a $1.6 million verdict for Mrs. Maurer against Slickedit's then CEO.  A portion of that verdict was set aside by Judge Tennille in  2006 NCBC 1.

After all that previous litigation, what could be left to fight about?  Well, the Maurers had gotten divorced during the earlier litigation, and each departed the marriage with a 50% ownership interest in Slickedit.  Business lawyers know that a 50/50 split is a recipe for disagreement and disaster, and the situation in which the ex-spouses found themselves was no exception. 

Mrs. Maurer sued her ex-husband in March 2013, who had by then become the company's CEO and only director.  She alleged that he had excluded her from any knowledge of or participation in corporate affairs, notwithstanding her 50% ownership.  There was a "consistent deadlock" between the Maurers, and Mrs. Maurer said that her ex-husband's conduct was in violation of his fiduciary duty owed to her individually and that she therefore had a direct claim against him.

Mrs. Maurer needed to show a fiduciary duty owed to her because in the absence of such a "special" duty the general rule is that "shareholders lack standing to bring individual causes of action to enforce actions accruing to the corporation."  Op. 21.  Those types of claims must be pursued on a derivative basis, on behalf of the corporation.

Judge Gale dismissed the fiduciary duty claim, ruling that there is no fiduciary duty "in favor of one fifty percent owner against the other fifty percent owner who has effective control."  Op. 24.  In the absence of a direct claim against her ex, all Mrs. Maurer had was a derivative claim, on behalf of the corporation, against Mr. Maurer.

What was the reasoning behind this ruling?  Fifty percent shareholders have options that may not be available to shareholders with a smaller interest.  The Court said that a less than fifty percent shareholder might face

insurmountable hurdles because of the procedural requirements for derivative actions which can be manipulated by a controlling majority. A fifty percent owner, with the ability to impose an impasse, is not in the same precarious position. An equal owner, unlike a minority owner, can automatically create a deadlock on any matter requiring a shareholder vote, and the existence of such a deadlock may afford greater access to judicial dissolution and a limit on the control of the other shareholder. See N.C. Gen. Stat. § 55-14-30.

Op. 26.

Judge Gale recognized that the allegations of the derivative claim were "admittedly thin," but let the "liberal standards of Rule 12(b)(6)" dictate the outcome. Op. 37.  He said that "[d]erivative litigation should not be the forum for claims that are, in essence, really domestic disputes."  Op. 37.

Congratulations to my colleagues Walt Tippett, Jennifer Van Zant and Eric David, who represented the Defendant.

Usurpation Of Corporate Opportunity Yields Preliminary Injunction

A breach of fiduciary duty by the Defendants resulted in a sweeping preliminary injunction in an Order entered by the Business Court last Friday, in Esposito v. Esposito.

The parties were co-shareholders of Anthem Leather, Inc., a Delaware corporation, which was in the business of buying leather from tanneries and selling it to its customers for various uses.  The Defendants also served as officers and directors of the company.

According to the Plaintiffs, the Defendants embarked on a related venture focusing on the distribution of contract leather, which is leather used in institutional furniture in offices, hotels, and hospitals. Anthem had never been in this business, but said that it was a natural area of growth for it.

When the Plaintiffs learned that the Defendants had formed a new entity, Crest Leather, LLC, to engage in the contract leather business, using Anthem's resources, they filed their Complaint alleging breaches of fiduciary duty.  The Defendants, caught with their hand in the cookie jar, responded by attempting to assign their interest in Crest to the Plaintiffs.

The grant of the injunction turned on Delaware law per the internal affairs doctrine.  In Delaware, it is a breach of fiduciary duty for an officer or director to usurp an opportunity belonging to the corporation.  The elements of that claim are:

(1) the corporation is financially able to exploit the opportunity; (2) the opportunity is within the corporation's line of business; (3) the corporation has an interest or expectancy in the opportunity; and (4) by taking the opportunity for his own, the corporate fiduciary will thereby be placed in a position inimicable to his duties to the corporation.

The Defendants argued that their assignment to Plaintiffs of their interest in the usurped opportunity made it impossible for the Plaintiffs to show that they had been irreparably harmed.  Judge Jolly was not buying any of that.  He said:

Defendants contend that by voluntarily assigning their Crest interests to Anthem they mooted any showing of irreparable harm to Plaintiffs. The court does not agree.  A preliminary injunction is a measure taken by a court to preserve the status quo of the parties during litigation. Triangle Leasing Co. v. McMahon, 327 N.C.224, 227 (1990). An "injunction is generally framed so as to restrain the defendant from permitting his previous act to operate, or to restore conditions that existed before the wrong complained of was committed." Anderson v. Waynesville, 203 N.C. 37, 46 (1932); see also Rauch Indus., Inc. v. Radko, No. 3:07-cv-197-C, 2007 U.S. Dist. LEXIS 79311, *19 (W.D.N.C. Oct. 25, 2007) (characterizing the status quo between the parties as "the time that the allegedly unlawful acts complained of reasonably may be believed to have occurred"). Defendants' voluntary assignment of their Crest interests to Anthem does not cure the possibility that Plaintiffs still can be irreparably harmed by Defendants' breach of fiduciary duty. On this requirement, the court concludes that Plaintiffs have shown they are likely to sustain irreparable harm in the absence of an injunction.

Op. Pars. 15-16.

The injunction barred the Defendants from, among things, entering Anthem's facilities, accessing its computer systems, or contacting or selling leather to Anthem's customers.

You can't put the cookie back in the cookie jar after you've taken it.

Congratulations to my colleagues Bob King and Elizabeth Taylor, who represented the Plaintiffs.

O Lord Don't Buy The Nanny A Mercedes-Benz

The Order Wednesday of last week in Patriot Performance Materials, Inc. v. Powell, 2013 NCBC 10 was appropriately timed for the day before Valentine's Day.

Powell, the Defendant, had a 50% interest in several businesses with Henderson, one of the Plaintiffs.  He alleged in a third party complaint that Henderson, who shared the other 50% interest, had diverted $30,000 (and more) from their corporations.

The purpose of the $30,000?  For Henderson to shower goodies on the nanny for his children.  The third party complaint against the nanny said that the funds were lavished upon her to buy her a "Mercedes-Benz automobile and a high-end Mac computer."  Op. 5.  

Perhaps the nanny's child-care services were exceptional and warranted the computer and the Mercedes.  Or perhaps the allegations of the Third Party Complaint against the nanny, which were that she was Henderson's mistress, were true.

And she wasn't the only woman who was the target of Henderson's largesse, though the $30,000 spent on her was small potatoes.  The Third Party Complaint alleges that Henderson took $800,000 in company funds "to spend primarily on extravagant European and Middle Eastern vacations with both his wife . . . and his mistress."  Third Party Complaint at 37.

Powell argued that the diversion of $30,000 for the Mercedes and the computer was an inappropriate use of corporate funds. He sued the nanny, Amber Clancy, for unjust enrichment.  

That didn't fly, for a couple of reasons.  Unjust enrichment does not include claims for gifts, which were what Powell alleged the Mercedes and the Macintosh  were.  Also, Judge Gale ruled that Powell was not the proper party to bring the claim.  He said that "it was the corporation, not Powell individually, who conferred a benefit . . . upon Clancy and it is the corporation that would be the proper party to bring such an action."  Op. ¶10.

Our nannies always drove Porsches.

Be Ready To Prove Your Damages If You Want To Get To Trial

The lesson in the Business Court's first opinion of the year, Allen Smith Investment Properties, LLC v. Barbarry Properties, LLC, 2013 NCBC 1 is to be ready to present your calculation of damages at the summary judgment stage or to be prepared to have your claim dismissed.

The Plaintiffs in Allen Smith were suing their business partner for breach of fiduciary duty. They said that the Defendant's decision to defer maintenance on an apartment complex that the parties co-owned had caused them damages in the form of lost profits.

The problem for Judge Murphy was the lack of any reasonably certain calculation of the claimed lost profits.  The damages witness had said in his deposition that he was "still trying to figure out how to quantify losses" and that he didn't think he could calculate the lost profits until "[t]he day before the trial."  Op. ¶23.

Judge Murphy ruled that:

Although the parties conducted discovery for over a year, Plaintiffs could not provide sufficient evidence for the Court to determine the causation or amount of damages with reasonable certainty. Therefore, the Court concludes that [the Defendant] has met its burden of demonstrating Plaintiffs’ failure to provide adequate proof of damages to support their breach of fiduciary duty claim.

Op. ¶55.

He also rejected the efforts of the Plaintiffs to present a new calculation of damages after the discovery period had ended.  They tried this by way of an affidavit presented two months after discovery had closed.  The Judge said that the Plaintiffs had presented no reason why the late-breaking damages calculation could not have been provided during the discovery period, and said that "[s]uch conduct goes directly against the purpose of Rule 26(e) in preventing 'untimely, evasive, and incomplete responses.'"  Op. ¶74.

It's easy to lose sight of damages during discovery when you are focused on proving liability. Don't let that happen to you or you may have your case dismissed.


It's A First: Fiduciary Duty Claim Sticks Against A Bank

For the first time that I am aware of, the Business Court has found a Complaint to sufficiently allege a breach of fiduciary duty claim against a bank, in today's opinion in WNC Holdings, LLC v. Alliance Bank & Trust Co., 2012 NCBC 50.

The case has a familiar ring to it on the facts.  Real estate loan based on an appraisal alleged to have overvalued the property.  Bank loaned $1 million plus which the borrower says it wouldn't have borrowed but for the appraisal.  Property never developed due to financial downturn.

The borrower alleged the Bank had done more than just lend money, saying that it had served as a financial and development advisor for the project.  It said that the Bank had:

  • “review[ed] property development agreements and [made] suggested changes”
  • “[performed] inspections of the property and development," and
  • “complet[ed] financial feasibility pro [forma]” statements that are traditionally completed by the debtor.

Op. 62.

Those alleged facts were enough to Judge Murphy to state a claim for breach of fiduciary duty, and he denied the bank's motion to dismiss.

If you are a lawyer representing banks, there's still not much to worry about on the fiduciary duty front.  The Business Court said in an earlier case that  an ordinary debtor-creditor relationship generally does not give rise to the "special confidence" needed for a fiduciary relationship. Peak Coastal Ventures, LLC v. SunTrust Bank, 2011 NCBC 13 (N.C. Super. Ct. May 5, 2011).  It dismissed a fiduciary duty claim in Allran v. Branch Banking and Trust Corp., 2011 NCBC 21 (N.C. Super. Ct. July 6, 2011). And the Court of Appeals affirmed the dismissal of a fiduciary duty claim against a bank in Branch Banking & Trust Co. v. Thompson, 107 N.C. App. 53, 61, 418 S.E.2d 694, 699 (1992).

Judge Murphy mentioned all those cases, but he left out Wells Fargo Bank, N.A. v. Vandorn, 2012 NCBC 6 (N.C. Super Ct. January 17, 2012), in which Judge Gale said in dismissing a fiduciary duty claim against a bank that “in an ordinary lender-borrower relationship, the lender does not owe any duty to its borrower beyond the terms of the loan agreement."  Op. 17.

Bank Not Liable For Embezzlement, Says NC Business Court

Do you have a client who says his associate embezzled a lot of his money?  Does he want to sue the Bank that held the funds, claiming that the Bank should have known that misdoings were afoot and blown the whistle?  You'd better tell him to think twice before bringing that claim to the Business Court, based on last week's decision in Global Promotions Group, Inc. v. Danas Inc.

The Plaintiffs in Global had given one of the Defendants signature authority over their accounts at BB&T.  That Defendant later made unauthorized wire transfers from the accounts and deposited forged and unauthorized checks drawn on those accounts into their own accounts.  The total amount embezzled was more than $300,000.

The Plaintiffs said that BB&T should have discovered and prevented these transactions, but it was a claim looking for a cause of action that just couldn't be found.

Judge Jolly first considered the North Carolina Uniform Fiduciaries Act, which states that a Bank can be liable for checks drawn by a depositor's fiduciary only if "the bank pays the check with actual knowledge that the fiduciary is committing a breach of his obligation as fiduciary in drawing such check, or with knowledge of such facts that its action in paying the check amounts to bad faith."  N.C. Gen. Stat. §32-9.

Even if the Defendants were fiduciaries of the Plaintiffs (about which there was little discussion) Judge Jolly found nothing in the Complaint to support an allegation of bad faith, He said that "suspicious circumstances," with a "failure to make inquiry," were not "bad faith."  Op. ¶24.  A failure to make inquiry amounts to bad faith only if if it is "due to the deliberate desire to evade knowledge because of a belief or fear that inquiry would disclose a vice or defect in the transaction, – that is to say, where there is an intentional closing of the eyes or stopping of the ears.'"  (quoting Edwards v. Northwestern Bank, 39 N.C.App. 261 (1979)).

He held that the Plaintiffs had not alleged facts giving rise to a reasonable inference of either actual knowledge or the turning of a blind eye to the misconduct.  He went on to hold also that the Plaintiffs did not have a claim under what he termed the "more stringent" common law standards of care for banks.

On that "more stringent" standard, in trying to impose a fiduciary duty on BB&T, the Plaintiffs argued that the Bank and its employee had "exercised actual control over" the accounts and that they had placed a "special confidence" in the employee as a result.  They argued that the Bank's employee therefore had a "responsibility to oversee their accounts."  Op. ¶32.

Not so, said Judge Jolly, who wrote that "all banks exercise some degree of custodial control over their
customers' accounts; nonetheless, banks ordinarily do not owe fiduciary duties to their customers."  Op. ¶33. The Plaintiffs' allegations did nothing more than merely establish the existence of an ordinary relationship between a bank and its customers, as all banks have a responsibility to safeguard their customers' accounts."  Id.  Judge Jolly observed that "an ordinary relationship between a bank and its customers does not, without more, impose upon the Bank any special duties to its customers."  Op. ¶30.

After that, the other claims asserted by the Plaintiffs against BB&T fell like dominoes.

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One More Nail in the Coffin for Claims For Aiding and Abetting Breach of Fiduciary Duty

I've written before about the unsettled nature of North Carolina law on whether it's valid to assert a claim for aiding and abetting a breach of fiduciary duty.  It doesn't seem that there is much legal enthusiasm for allowing such a claim, but no Court, including the Business Court and the Court of Appeals, seems willing to come out and say that the claim is not recognized.

Judge Gale dismissed an aiding and abetting fiduciary duty claim last month in Tong v. Dunn, 2012 NCBC 16, but he skinned the cat in a different way than declaring the cause of action invalid.

Tong was suing his co-directors for their actions involving the sale of Engenious Software, Inc., the company on whose board they served.  He was claiming that Engenious -- the corporation -- had aided and abetted the directors in their breaches of fiduciary duty in accepting an offer he deemed too low for the company.

A corporation generally "cannot be said to conspire with its own directors," (Op. ¶ 28), so Tong argued that a director who was also an officer had aided the other directors in breaching their duties, and that her acts were imputed to the corporation.

Judge Gale wasn't biting on the distinction between directors and officers.  He held:

[a[s a general rule, the conduct of a corporate officer, within the scope of
employment, cannot expose the corporation itself to aider and abettor liability
because of the intra-corporate immunity doctrine, which recognizes that 'a
corporation cannot successfully conspire with its own officers, employees or agents.'

Op. ¶29 (quoting Tate v. Sallie Mae, Inc., 2011 WL 3651813, at *3 (W.D.N.C. Aug. 19, 2011).

The claim might have survived in Delaware, which Judge Gale observed recognizes a "limited exception to the intra-corporate immunity doctrine."  Op. ¶29  But in North Carolina, if Tong sticks in the Court of Appeals, there's not much chance of a plaintiff succeeding on a claim that a corporation aided and abetted its own officers or directors in breaching their fiduciary duties.

If you've noticed the lack of posting on this blog for the last couple of weeks, that's because of the visit of my son, who I had to spend a lot of time chauffeuring around town so he could visit his many buds, and my moving into a new house and all the distraction of that.  Oh, and there was also the season premiere on Sunday night of Game of Thrones and episode 2 of this season's Mad Men  to take into account.  But I am more focused now.  At least until next Sunday night.

A Trustee Can't Tell The Trust He Serves To "Take This Job And Shove It"

It's not easy to walk away from your fiduciary duties as a trustee, even if you try to resign.  That's the subject of Judge Murphy's opinion this week in Wortman v. Hutaff, 2012 NCBC 9.

Two of the Defendants, Moyer and Hutaff, were trustees of a trust established by Dan L. Moser.  They resigned as trustees by filing a written "Notice of Resignation" with the Union County Superior Court on December 3, 2007.  The Moser Trust hadn't funded when they "resigned."  It was a "pour over" trust from Moser's estate, which had not yet been settled.

The Plaintiffs, potential beneficiaries of the Moser Trust when it was funded, claimed that the trustees had breached their fiduciary duties after their resignation.  The nature of the alleged breach isn't that relevant, but it involved allowing an LLC interest in a golf course, an asset of the Estate, to be sold at foreclosure at substantially less than its fair market value, eliminating an equitable interest in the LLC which should have poured into the Moser Trust.

The trustees said they had no fiduciary duty after their resignation.  The resignation to the clerk of court, however, wasn't a resignation in compliance with G.S. §36C-7-705.  Judge Murphy said that the terms of the statute were "exclusive" as to the procedure for resignation.  The statute says that a trustee can resign “(1) [u]pon at least 30 days’ notice in writing to the qualified beneficiaries, the settler, if living, and all co-trustees; or (2) [w]ith the approval of the court.”  Moyer and Hutaff had followed neither path to resign.

In addition, G.S. §36C-7-707(a)  says that a trustee's duties don't pass "until the trust property is delivered to a successor trustee."  The successor trustee wasn't appointed for nearly three years.  It was during that gap of trusteeship that the claimed breach of fiduciary duty occurred.

Judge Murphy refused to carve out an exception from the strictures of the statute regarding trustee resignation.  He also didn't buy the argument that resignation procedures ought to be different because the Trust hadn't yet been funded.  So the defendant trustees of the Moser Trust who thought they had terminated their responsibilities are still on the hook for what may be a substantial claim.

Judge Benjamin Cardozo said in a famous (at least from law school) quote in Meinhard v. Salmon that "[a] trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior. . . ."  And you know what Johnny Paycheck said.  I guess that Judge Murphy is more of a Cardozo fan.

Do Bankers Ever Have Fiduciary Duties To Their Customers?

If a bartender serves a visibly intoxicated customer with even more alcohol and the customer then causes an accident while driving drunk, the bartender can be liable under North Carolina's Dram Shop Act, N.C. Gen. Stat §18B-120, et seq.  But if a banker showers cash on a borrower to fund a  deal which goes bad, does the borrower have any claim against the banker for not cutting him off?

 The short answer is that bartenders are held to a higher standard than bankers.  A claim against a lending bank for anything other than a violation of the terms of the loan documents -- say such as a claim for breach of fiduciary duty -- is almost always doomed to dismissal  Judge Gale of the Business Court last week did exactly that to the borrower's claim in Wells Fargo Bank, N.A. v. Vandorn, 2012 NCBC 6, saying that “[I]n an ordinary lender-borrower relationship, the lender does not owe any duty to its borrower beyond the terms of the loan agreement[,]” Op. ¶__. (quoting Branch Banking & Trust Co. v. Thompson, 107 N.C. App. 53, 418 S.E.2d 694, 699 (1992)).

Wells Fargo had sued Vandorn, Cook and an LLC formed by the two individuals to collect on a defaulted loan made for the LLC  to buy a lot in a high-end resort development called Laurelmor.  Laurelmor was billed as a 6,000 acre golf resort, with the course designed by PGA great Tom Kite, to be developed in the North Carolina mountains.  The Winston-Salem Journal says that Laurelmor "collapsed under the bad economy and a massive loan."

The three defendants counterclaimed, seeking to avoid liability on their loan.  They alleged that Wells Fargo (then Wachovia) had breached its fiduciary duty to them because it failed to obtain an accurate appraisal on the lot and it also failed to determine that the LLC borrowing the funds was insufficiently capitalized to repay the loan.

The Vandorn Defendants said that Wells Fargo owed them a fiduciary duty to vet the deal because one of the Defendants, Cook, was a client in the Bank's Wealth Management Division.  That's the part of the Bank which handles its wealthiest clients, offering them a "holistic approach" and the advice of a "team of highly experienced specialists." Cook said he relied on the Division  for most of "his banking, investment, and insurance needs, and . . . for advice and counseling regarding a broad spectrum of financial matters." p. Par. 9.  Cook said he had relied upon the Bank to obtain a valid and reliable appraisal on the Laurelmor property and that the Defendants would not have purchased the lot if the Bank had appropriately protected them.

Judge Gale said that the "conclusory allegations" of the Counterclaim didn't have enough heft to establish a fiduciary relationship and he granted Wells Fargo's Motion to Dismiss. He summed up what was lacking this way:

Defendants do not allege Plaintiff or its employees located, identified, or recommended the lot, or that the lot purchase was part of a broader financial plan that Plaintiff had developed for [] Cook or the Defendants. Defendants do not allege that B. Cook or any other Defendant sought investment advice regarding the lot transaction. To the contrary, Defendants’ allegations indicate that Plaintiff became involved in the lot transaction only after Defendants had located the lot, formed the intent to purchase the lot, formed [the LLC] to facilitate the purchase, and approached Plaintiff about financing the transaction.

Op. ¶17

So if the Wealth Management Division had recommended the development to the Defendants, might that have established a fiduciary relationship?  Maybe, but the Vandorn decision is the latest in a series of Business Court decisions where investors in resort  development projects sought unsuccessfully to transfer the burden of their loss to their lenders, See Allran v. Branch Banking & Trust Corp., 2011 NCBC 21 (N.C. Super. Ct. Jul.6, 2011), and  Beadnell v. Coastal Communities,  (N.C. Super. Ct. June 3, 2011).

On a totally different subject, yesterday I checked out http://www.supremecourthaiku.com/, which summarizes US Supreme Court decisions in haiku.  The video explaining it is absolutely hilarious.  If I could write in three line haikus, my blog posts would be much shorter.  But I'm probably better at limericks, but not by much.

A Lump Of Coal From The Fourth Circuit for A Wachovia Shareholder

The Fourth Circuit delivered a lump of coal right before Christmas to a Wachovia shareholder whose 100,000 shares of the Bank's stock, once worth about $5.6 million, sank into near worthlessness when Wachovia failed.  The case, decided December 23rd, is Rivers v. Wachovia Corp., and it affirms the dismissal of all of Rivers' claims.

Rivers sued Wachovia and its top officers and directors for misrepresenting the Bank's  financial condition in the months leading up to its failure in 2008.  He said that he would have sold his shares but for the positive statements made by  the Bank about its soundness and stability, which he said amounted to fraud.

Judge Wilkinson said that although Rivers sought to cast his claims as belonging personally to him (i.e. "individual"), they were in fact derivative claims (which belonged to the corporation). 

It is almost impossible in North Carolina for a shareholder to sue an officer or director for the loss in value of stock.  The Fourth Circuit said that in North Carolina and in South Carolina as well, "[t]he well-established general rule is 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."

The reasons that such individual actions are precluded include that they prevent "self selected
advocate[s] pursuing individual gain rather than the interests of the corporation or the shareholders as a group,[from] bringing costly and potentially meritless strike suits."  All Wachovia shareholders were equally injured by the misrepresentations of which Rivers complained.

So, " [a] derivative lawsuit is . . . the vehicle for a shareholder to litigate injuries that result in the diminution in value of the corporation’s stock." The North Carolina Supreme Court has recognized two exceptions to its solidly established rule: "(1) where there is a special duty, such as a contractual duty, between the wrongdoer and the shareholder, and (2) where the shareholder suffered an injury separate and distinct from that suffered by other shareholders."

No Fiduciary Duty Was Owed By Wachovia's Officers To Rivers As A Shareholder

Rivers argued that the defendants owed him a "special duty," which Rivers said was met by the fiduciary duty owed to him by the officers and directors of Wachovia.

Judge Wilkinson quashed that argument, stating  that "[u]nder North Carolina law, officers and directors of a corporation owe a fiduciary duty to the corporation which does not create an individual cause of action."  In other words, the fiduciary duty of an officer/director is owed to the corporate entity, not to the shareholders individually.  Note that the answer can be different with a closely held corporation. 

There Is No Valid Claim For A "Lost Profit Opportunity"

Rivers' argument that he had a "special injury" met with the same result.  He argued that he "meant to sell his shares in Wachovia before the decline in share price but forwent the opportunity to sell based on the false statements of defendants."  Rivers characterized this as a "lost profit opportunity," but the Court said this argument was "indistinguishable" from the argument that every Wachovia shareholder might make.  Judge Wilkinson said the "effort to disguise a classic derivative claim for the decline in stock value as a 'lost profit opportunity' " was "too clever by half."

Judge Wlkinson also pointed out what he termed a "troublesome paradox" in Rivers' claim.  Rivers was saying that the fraudulent scheme caused his injury, but the same scheme had inflated the value of the stock in the first place.  He said that "[t]he failure to sufficiently capitalize on the effects of an alleged fraudulent scheme is not an injury we are prepared to credit." 

There is also a hypothetical aspect to a shareholder saying he would have sold his shares.  When? How many shares?  At what price?  Judge Wilkinson said that "[u]nlike a typical securities claim involving a precise date, number of shares, price, and profit or loss," such claims "involve only a hypothetical transaction."

So that's Rivers' lump of coal.  And if the Rivers case seems like "deja vu all over again," it is.  The North Carolina Business Court dismissed identical claims (brought by the same Plaintiff's counsel) early in 2011 in Harris v. Wachovia Corp., 2011 NCBC 3. In fact, that last quote from the Rivers case is straight  from Judge Jolly's opinion in Harris. But be aware that Mr. Harris suffered more pain than Mr. Rivers.  He owned 900,000 shares of Wachovia stock.  And he didn't even get a lump of coal for Christmas. 

And for the rest of us, we did better than a lump of coal because it's not all that often that the Fourth Circuit decides a derivative action case.  There's now a clearly articulated opinion on the issues decided in Rivers.  It's a must cite if you are moving in federal court to dismiss a derivative claim masquerading as an individual claim.

Another Preliminary Injunction For Breach Of Fiduciary Duty

For the second time in a space of two weeks,  the Business Court granted a motion for a preliminary injunction against  an LLC member/manager as a result of breaches of fiduciary duty.  The first case was GoRhinoGo, LLC v. Lewis,  which I blogged about last week, and the second case, decided last Thursday, was Lake House Academy for Girls LLC v. Jennings, 2011 NCBC 40.

Lake House provides a residential therapeutic program to "troubled" girls aged 10 to 14.  It is one of only two programs in the United States directed at that target age group.  Lake House's boarding school is in Flat Rock, NC.  The other program is located in Bend, Oregon.  Op. ¶.5.  (Where do the mothers of 10-14 year old girls go for therapy?  My wife was fond of saying that she wanted to check into Charter Hills, a private psychiatric hospital in Greensboro, when our daughters were in that age bracket.  As things turned out, I should have listened and dropped her off there.)

Ms. Jennings was a member manager of the Lake House LLC.  Her breaches of fiduciary duty arose from her activities to set up a competing school in the same area as Lake House, to be called Glen Willow Academy. Judge Gale included in his opinion a laundry list of fiduciary duty violating conduct by Ms. Jennings.  Op. ¶¶39a-j.  This included soliciting Lake House employees to join the competitive entity, disparaging Lake House to the parents of daughters boarding there, leasing the space for Glen Willow's operations, and deleting documents from a Lake House computer.

Ms. Jennings defended the case on the basis that once she resigned as a manager of the LLC, she had no fiduciary duty to the LLC.  And, as she frequently pointed out in her brief, she had not signed a non-compete.  On that defense, she was part right.  Members do not owe fiduciary duties to each other or to the entity.  Op. ¶34.  But managers do, and much of Ms. Jennings actions took place before she resigned as a manager.  There was also an issue about whether her resignation as a manager was effective, because the Lake House Operating Agreement said that each member was a manager.  Ms. Jennings had sought to retain her status as a member when she resigned. 

The evidence at the preliminary injunction stage was enough to show a likelihood of success that Jennings had subverted Lake House's operations while she was a manager of the facility.  She was pretty candid and threatening about her plans.  According to a Lake House employee, Jennings said that she was "going to start up another school and that [she and others]  would make sure that no one would ever enroll another student at Lake House Academy and that she would make sure the school shut down and that [its employees] would all lose [their] jobs Op.  ¶14.

She also said “there would not be an educational consultant in the country who would make a referral to [Lake House]; I will make sure of that.” Op. ¶ 13

Irreparable injury was established by the impact of the opening of Glen Willow on a pending sale of Lake House.  Judge Gale said "[i]f Glen Willow Academy were to open its doors and compete with Lake House under these circumstances, such actions would unquestionably cause irreparable injury" to Lake House. Op. ¶46.  Ms. Jennings testified that the opening of the new school would affect the amount the buyer was willing to pay for Lake House.

On balancing the harms to the parties, the Court also ruled that Mrs. Jennings and Glen Willow Academy will suffer materially less damage or injury than Lake House if Jennings were permitted to open Glen Willow and compete with Lake House during the pendency of the litigation.  Judge Gale ordered Lake House to post a $100,000 bond as a condition of the injunction.

It was a big week in the courts last week for  breaches of fiduciary duty.  The Delaware Chancery Court entered judgment for $1.2 billion against corporate directors for their role in an acquisition of another company.  You can read about that case on the Delaware Corporate and Commercial Litigation Blog.

Court of Appeals Affirms Business Court Dismissal of Meiselman Claim by Shareholder's Estate

On Tuesday, the Court of Appeals affirmed the Business Court's award of summary judgment against a shareholder of three private corporations in High Point Bank & Trust Co. v. Sapona Manufacturing, Inc.  We wrote about the Business Court's ruling last year, but here's the quick recap:  The estate of a woman who was the daughter and granddaughter of the founders of three family-originated corporations in Randolph County sued those businesses seeking the redemption of over $3.6 million worth of stock. 

The estate asserted a Meiselman claim, seeking dissolution on the grounds that the decedent had a reasonable expectation that her shares would be repurchased by the corporations upon her death and that the corporations had frustrated that expectation by refusing to redeem the shares.  Judge Tennille dismissed her claim on the grounds that the expectation, even if subjectively held by the decedent, was not held by all of the other shareholders and that her expectation was therefore unreasonable.

The Court of Appeals affirmed Judge Tennille's opinion in all material respects.  The insufficient evidence of a shared understanding and expectation of a right of redemption consisted of the repurchase of one shareholder's stock after his death in 1997, two corporations issuing a tender offer in 1997, and one corporation issuing another tender offer in 2000.  Rather than establishing an expectation of repurchase, this evidence "establish[es] a precedent that the corporation will 'from time to time' offer to purchase shares up to a certain amount and at a specified price."

In a footnote, the Court noted Judge Tennille's analysis that there is a theoretical limit on the size of a corporation that can still be liable under Meiselman.  (In contrast to certain lending houses that were "too big to fail," these corporations would be "too big for plaintiffs to succeed").  Although the Court of Appeals did not really take a position on this part of the Business Court's analysis, the size and breadth of the ownership base is relevant to several factors:  the likelihood of antagonistic relationships with and dominance by a single majority shareholder; the number of other shareholders whose own expectations would need to mirror the plaintiff's in order for her to prevail; and the equity of dissolution toward shareholders who don't play a role in the oppressive conduct.  These factors become nearly impossible for shareholder plaintiffs to satisfy once ownership is spread beyond more than a handful of people.

Full Opinion

You'd Better Have A Real Expert If You Are Making A Malpractice Claim In The Business Court

The Business Court dismissed a legal malpractice claim right before Thanksgiving last week in Inland American Winston Hotels, Inc. v. Winston, 2010  NCBC 19Judge Tennille found Plaintiff's expert, a  Duke Law School professor, to be incompetent to testify to the Defendant lawyer's alleged breach of his duty of care.

The claimed malpractice concerned the lawyer's work on a commercial real estate transaction by which the Plaintiff acquired an entity from the Defendant and by which an entity controlled by the Plaintiff was substituted as the purchaser under an option.  The alleged breach of fiduciary duty (a form of professional malpractice) was the lawyer's role in a change of the identity of the purchaser under the option.

Expert testimony is necessary in almost all cases to prove professional negligence, and Judge Tennille found the professor to lack the "requisite experience" to supply the required expert testimony, observing that he came up short on a number of grounds:

  • He hadn't been licensed to practice law for more than 25 years;
  • He had never been licensed to practice law in North Carolina; and
  • He had never conducted any real estate transaction "as a lawyer or represented any individual, partnership, joint venture, LLC, or corporation in any real estate transaction. "

Op. ¶37.  Another factor contributing to the dismissal of the claims against the lawyer was the expert shooting himself in his own foot at his deposition, when he gave up any assertion that he was an expert in the sphere of real estate transactions:

  • He testified he did  not "consider himself to be an expert in the practice of real estate development or the practice of law related to real estate developments."
  • He admitted that he did "not know everything that a real estate lawyer does in representing a developer, putting together deals, and seeing them through to closing," and he conceded that he did "not know for sure . . .what the standard of care is for written engagement letters for an attorney handling the type of transaction at issue in this case."

The professor was undoubtedly an expert in the field of legal ethics, which he teaches at Duke.  He formed his opinion that the Defendant lawyer had been negligent based on what he saw as violations of the North Carolina Rules of Professional Responsibility, but the Court observed that "North Carolina appellate courts repeatedly have rejected the use of the Rules of Professional Conduct to establish attorney liability."  Op. ¶39.

The takeaways from this opinion are: if you are pursuing a malpractice claim in the Business Court against a lawyer, you need an expert witness who has been practicing in the field of the alleged malpractice in North Carolina, not a law school professor without that background.  And have your expert be sure about the applicable standard of care.

This is the second significant opinion to come out of the Inland American lawsuits.  The first concerned the enforceability of agreements to agree, which I wrote about in March 2009.

A Tale of Reluctant Reconsideration in the Business Court

In what Judge Tennille described as a "close case," the Business Court reconsidered and reversed the prior dismissal of a breach of fiduciary duty claim, but the principles it outlined should not give litigants high hopes for reconsideration motions in general.

Charlotte-Mecklenburg Hospital Authority v. Wachovia Bank, N.A. involved an investor suing its advisors over investments gone bad.  The Hospital Authority asserted a number of claims against Wachovia, including a breach of fiduciary duty claim that the Court dismissed last October on a Rule 12(b)(6) motion.

Discovery ensued, and at the end of discovery Plaintiff moved to reconsider the dismissal of the fiduciary duty claim under Rule 54(b).  Several points from the order are worth noting.

First, the Court adopted the federal Rule 54(b) standard, which allows for reconsideration of interlocutory orders at any time before final judgment, but which has judicially-created, policy-based limitations to situations:  "(1) where there has been an intervening change in controlling law; (2) where there is additional evidence that was not previously available; or (3) where the prior decision was based on clear error or would work manifest injustice.”

Second, the plaintiff did not argue an intervening change in controlling law, but instead asserted a new legal theory -- that as a federally registered investment adviser, one of the Wachovia defendants was a fiduciary as a matter of law.  Rather than new law, this argument was based on a 1963 U.S. Supreme Court case and a 2003 decision from the Eastern District of Virginia.  The Court was troubled by the assertion of a new theory on a motion to reconsider:

Motions for reconsideration do not serve as an avenue for a party to “present a better and more compelling argument that the party could have presented in the original briefs.”   Madison River Mgmt. Co. v. Bus. Mgmt. Software Corp., 402 F. Supp. 2d 617, 619 (M.D.N.C. 2005).  Generally, when a party “fails to present his strongest case in the first instance,” he loses the “right to raise new theories or arguments in a motion to reconsider.”  Duke Energy Corp., 218 F.R.D. at 474.  Nonetheless, had Plaintiff presented this newly raised argument initially, it would have affected the Court’s decision.  Metropolitan’s status as a federally registered investment advisor provides the strongest case for asserting clear error of law in the Court’s October 9, 2010 Order.  However, the fact that a party did not make its strongest and best case on prior submissions will not, standing alone, justify reconsideration.

Third, Plaintiff also asserted that newly discovered facts justified reconsideration.  The Court did not believe Plaintiff's argument that the defendant's status as a federally registered investment advisor was a fact not available until discovery.  On the other hand, Plaintiff provided facts adduced during discovery that demonstrated the existence of a special relationship of trust and confidence.

The Court was troubled by the fact that discovery occurred on a dismissed claim, but determined that justice required reconsideration and reversal of the dismissal:

This Court is not inclined to encourage parties to conduct discovery on claims that have already been eliminated in hopes of finding grounds for reconsideration.  Litigation is complex and expensive enough as it is without conducting discovery on claims that have already been dismissed.  Furthermore, viewing Plaintiff’s position charitably, many of the “new” facts adduced could have related to Plaintiff’s breach of contract claim as well as its breach of fiduciary duty claim.

However, the newly discovered facts, if true, would have impacted the Court’s earlier decision.  These new facts contradict the facts on which the Court previously relied.  The Court, therefore, will set aside the concerns expressed herein and hold fast to its ultimate responsibility—reaching “the correct judgment under law.”

In reconsidering the dismissal, however, the Court noted the inequity of allowing Plaintiff to take discovery on the dismissed claim while Defendants relied on the dismissal by not seeking discovery relevant to that claim.  To remedy the situation, the Court ordered discovery by Plaintiff to be closed, but allowed Defendants a 90-day period to conduct discovery on the revived fiduciary duty claim.

Full Order

[Ed. note:  The Business Court has been busy this week issuing orders at a rate faster than your humble author has been able to comment upon them.  Stay tuned for more posts in the coming days on some other recent orders of interest.]

Bostic Update: Bankruptcy Court Allows Business Court Claims to Proceed

The insolvency of prominent contractor Bostic Construction, Inc. has been a fertile source of Business Court litigation over the last couple of years in three cases against the company's officers and directors.  A recent Bankruptcy Court decision from the Middle District permits the Business Court cases to proceed, holding that they are not barred by a settlement between the bankruptcy trustee and those officers and directors.

The procedural history is complicated (as you would expect with three cases in Business Court and one in Bankruptcy Court) but the underlying facts are not.  Bostic Construction was formed by one of the "Hogs," former Redskins guard Jeff Bostic, and his brother, former St. Louis Cardinals guard Joe Bostic, both Greensboro natives.  In its heyday, Bostic was the nation's second-largest apartment builder, with over $200 million in revenue.  Bostic Construction's operating model focused on construction management, delegating most or all of the labor, materials, and equipment to subcontractors.

During the 1990s, Bostic Construction performed most of its work for unrelated third parties, but at the turn of the millenium, the company transitioned to projects for LLCs owned or controlled by company insiders.  Those insiders also formed other LLCs to provide labor and materials to Bostic Construction at a profit for the LLCs.  Bostic Construction's financial condition deteriorated in 2003 and 2004, and the company's creditors allege that the insiders began acting to ensure the profitability of the LLCs rather than Bostic Construction itself.

Bostic Construction's creditors filed an involuntary Chapter 7 petition in January 2005.  The trustee settled the company's claims against the insiders in 2007.  Three cases then were filed in Superior Court against the insiders:  the Phillips & Jordan case in January 2008, and the American Mechanical and Yates Construction cases in October 2009. 

The insiders moved for Judge Diaz to dismiss the American and Yates cases and moved the Bankruptcy Court for an interpretation that its order approving the 2007 settlement barred the creditors' claims against the insiders.  (By that time, Judge Diaz had already ruled that the plaintiffs in the Phillips & Jordan case had direct claims against the insiders which were not impacted by the trustee's settlement).  Judge Diaz stayed the American and Yates cases pending the Bankruptcy Court's ruling.

The Bankruptcy Court held that the settlement did not bar the Business Court claims.  The key question was whether the creditors' claims were personal, direct claims against the insiders or whether they were derivative claims that could be asserted only by the trustee.  That question is determined by state law. 

Judge Waldrep cited North Carolina cases for a familiar series of propositions:  

Although the general rule is that directors of North Carolina corporations do not owe a fiduciary duty to the creditors of the corporation, an exception exists when there are circumstances amounting to a winding up or dissolution of the corporation. . . .  If the directors and officers continue to operate an insolvent corporation only to recover the amounts owed to them, to the detriment of the corporation’s other creditors, North Carolina courts equate that to a winding up or dissolution and find that the directors and officers owe a fiduciary duty to creditors. . . . However, no duty is owed to creditors, even if the corporation is balance sheet insolvent, when the directors and officers are acting in good faith in running the business.

The claims of constructive fraud, aiding and abetting constructive fraud, and violations of the NC RICO statutes were personal to the creditors, not derivative.  The circumstances of Bostic Construction amounted to a winding up or dissolution of the business, creating a fiduciary duty from the directors to each creditor to support the constructive fraud and aiding and abetting claims.  (The Court noted the ongoing doubt over whether any aiding and abetting claims exist under North Carolina law anymore, but ruled that if they existed at all, they were direct claims).  Similarly, the Court examined the text of Chapter 75D, which includes the element that RICO defendants personally benefit from the illegal conduct.  Based on that element, the Court concluded that the RICO claims were direct, not derivative, and were not barred by the settlement.

Bankruptcy Court Opinion


No Meiselman Claim for the Not-So-Closely-Held Business

For almost 30 years, minority shareholders in North Carolina have sought relief from corporate oppression via so-called Meiselman actions.  An important Business Court opinion released Tuesday discusses the limits of Meiselman claims, which will be less appropriate the larger the number of shareholders and the greater the corporate governance in operation.

In the Meiselman case itself, the Supreme Court permitted minority shareholders in closely-held corporations to seek judicial relief to enforce those shareholders' reasonable expectations, such as employment or participation in management.  Meiselman characterized closely-held corporations as "little more than 'incorporated partnerships,'" often formed due to family or friend relationships, in which the minority shareholders are not practically able to bargain for protection (or to recognize the need for protection) when the corporation is formed.  Meiselman involved seven such corporations -- all part of a family business formed by the father of the two brothers who found themselves on opposite sides of the lawsuit.

The Business Court decision confronted a different situation, and those differences determined a different outcome.  In High Point Bank & Trust Co. v. Sapona Mfg. Co., at issue were the plaintiff's rights as minority shareholder of three corporations.  Although the corporations originated as family businesses -- the youngest of which was over 75 years old -- the shareholder and employee base had expanded significantly over time.  Acme-McCrary, a hosiery manufacturer, now has 81 shareholders and 892 employees; Sapona, a yarn processor, now has 51 shareholders and 200 employees; Randolph Oil, a petroleum wholesaler and convenience store owner, now has 25 shareholders and 49 employees.  The shares of these corporations were unmarketable and functionally locked the shareholders into ownership absent some company action.  Two of the three corporations had issued tender offers to their shareholders on one or two occasions in the last 20 years.

Following the death of the individual plaintiff, the daughter and granddaughter of the companies' founders, her executor asked the three companies to redeem her shares at a market value established by an appraisal that the executor commissioned.  Each company's board of directors met and considered the request, but declined.  The executor sued under a Meiselman theory, arguing that the companies' refusal to repurchase the shares was coercive and oppressive conduct leaving a minority shareholder without rights.  The question for the Court was whether the right to have stock repurchased was an enforceable right or interest under Meiselman.  If so, the corporations' refusal to repurchase rendered that right in need of protection.

Judge Tennille began his analysis by discussing the broad Meiselman remedies and the limitations on those remedies from more recent statutory amendments.  Under the old N.C.G.S. § 55-125, a court had equitable discretion to fashion a number of remedies besides dissolution of the corporation -- remedies such as repurchase at fair value, altering corporate bylaws provisions, or prohibiting certain corporate actions.  Section 55-14-30, the modern replacement, eliminates those alternative remedies.  With liquidation as the only remedy, judicial dissolution required a "strong showing" because such a remedy conflicted with the business judgment rule and other traditional judicial deference to corporate governance. 

The Court viewed this case as significantly different from Meiselman and the Court's own 1999 decision in Royals v. Piedmont Elec. Repair Co. (which found a right of redemption for a minority shareholder) for several reasons.  First, there was no loss of ownership benefits here.  Plaintiff was not denied an opportunity to work; the trust now holding her shares continued to receive the same benefits that she enjoyed while living; no assets were diverted; no excessive salaries were paid, but regular dividends were paid to all shareholders.  The Court held that there was no mandatory right of redemption of stock in closely-held corporations.  Such a right "would place the other shareholders in close corporations at financial risk upon the death of any shareholder."

Second, there was no personal or familial antagonism of the sort experienced in Meiselman.  The plaintiff was never an employee or involved in management, and thus was not being deprived of such opportunities.  The majority of shares in the three companies were owned by non-employees.

Third, there was no controlling shareholder and the shares were diffused to a much greater extent than in Meiselman.  Each corporation observed corporate formalities.  The majority of the companies' officers were not related to the founders.  In short, these corporations were not the same as a corporation with three shareholders being run like a partnership.

The Court was not willing to create a bright-line number of shareholders that would remove a corporation from Meiselman analysis.  Nevertheless, the more diffuse the ownership of a company, the more important "the number, composition, and rights and interests of the non-complaining shareholders" become.  "Where, as here, there is no impediment to the majority of shareholders exercising their voting rights, the courts should not intervene on behalf of a minority shareholder."

Judge Tennille also held that the plaintiff had no reasonable expectation of a right of redemption.  There was no written agreement establishing such a right.  The limited activities of the corporations with a one-time tender offer and a one-time repurchase of the shares of a deceased shareholder were not sufficient to create a future right of redemption.  Most importantly, there was no evidence that any shareholder other than the plaintiff or any officer or director had any notice of or expected that plaintiff would have such a right of redemption.

The expectation also was unrealistic on two grounds:  first, that the redemption of plaintiff's minority interest would be at fair market value with no minority discount, and second, that the redemption would be personal to plaintiff.  The latter, in particular, would have created "stiff fiduciary challenges" from the other shareholders.  Although the plaintiff had some minimal evidence of oppression, "oppression is not the standard for determining rights and interests.  It is applicable only when determining the need for protection."

Meiselman likewise requires consideration of the impact of the plaintiff's claim on other shareholders.  Here, dissolution would impose stock value and tax losses on all of the other shareholders and displace hundreds of employees.

After High Point Bank & Trust, it would be an overstatement to declare Meiselman dead for corporations with more than a handful of shareholders.  Nevertheless, the larger the shareholder base and the more significant the formal corporate governance, the less likely it is that a corporation will have created unwritten "expectations" for shareholders or that the corporation will face dissolution in the name of shareholder protection.

Full Order & Opinion


Business Court Awards Nominal Damages After Noncompete Bench Trial

An award of damages for breach of a noncompete agreement, like any other damages award, requires evidentiary support.  In a judgment issued yesterday after a bench trial, the Business Court awarded the plaintiffs nominal damages absent such evidence.

In HILB Rogal & Hobbs Co. v. Sellars, the Court faced a common factual scenario:  a former vice president of the plaintiffs resigned and went to work for a direct competitor.  The businesses in question were insurance companies targeting building materials suppliers.  The plaintiff and defendant executed an employment agreement that contained standard restrictions on post-employment competition and on the use of confidential business information.

Two days after interviewing for the competitor's job, the defendant

copied the entire hard drive of his work computer, which contained, among other things, confidential and proprietary information about [plaintiffs'] Lumber Program accounts and business strategies, including account files and lists, policy expiration dates, policy terms, conditions and rates, internal and external pricing and profit margins, information relating to accounts’ risk characteristics, and carrier information.

He resigned two weeks later and went to work for the competitor, taking the confidential information with him.  (The Court ordered him to return the confidential information in 2008).

Plaintiffs asserted claims for breach of fiduciary duty, breach of contract, and unfair & deceptive trade practices, and defendant counterclaimed for breach of contract for unpaid salary.  Judge Diaz applied New York law to the claims.

During the lawsuit, the defendant took two Rule 30(b)(6) depositions of the plaintiffs concerning their claimed damages.  At those depositions, the witness, another vice president of plaintiffs, disclaimed lost profits, as did counsel for the plaintiffs.  The witness did not know of the origin or calculation of two summary exhibits that plaintiffs attempted to use at the bench trial -- those exhibits were prepared by other employees, none of whom testified at trial.  Judge Diaz noted at least eleven unexplained discrepancies between the two exhibits.  Moreover, the Rule 30(b)(6) witness "could not rule out the possibility that the damages exhibits contained amounts for lost revenues for business that Plaintiffs could not underwrite, irrespective of [defendant's] alleged breach of the Employment Agreement."

The damages witness suddenly became unavailable for trial due to the pre-trial but post-discovery termination of his employment -- he declined to appear voluntarily, and he was outside the Court's subpoena power.  The plaintiffs attempted to notice a de bene esse deposition less than one month before trial.  The Court quashed the notice of deposition based on a month-long delay between plaintiffs' awareness of the witness's unavailability and the issuance of the notice, as well as the fact that the Court already had continued the trial once to allow de bene esse depositions to occur.  Thus, plaintiffs had to rely upon his deposition testimony.

Although the plaintiffs proved that the defendant breached his fiduciary duty and breached the employment agreement by copying the contents of his hard drive before resigning, the Court held that there was insufficient evidence of damages.  Under New York law, breach of fiduciary duty damages "are limited to profits lost from the actual diversion of customers," a damages theory that the plaintiffs waived. The Court awarded $1 in damages for the breach of contract claim.

Although the plaintiffs attempted to rely on a liquidated damages formula in the employment agreement, the Court similarly held that they had not provided sufficient evidence of the components of that formula.  Specifically, the Court rejected the argument that the summary exhibits were admissible business records under Rule 803(6) because the Rule 30(b)(6) witness did not lay any foundation for admissibility or for the reliability of the figures contained in the exhibits.  The Court awarded $1 in damages for the breach of contract claim.

The Court rejected the unfair and deceptive trade practices claim, holding that North Carolina's Chapter 75 was inapplicable under the "most significant relationship test" and that, even if it applied, the lack of actual damages was fatal to a UDTP claim.  Likewise, the Court found no basis to award punitive damages or attorneys' fees.

As for the counterclaim, the employee asserted that he was entitled to over $94,000 in unpaid salary.  The plaintiffs responded that an interim $50,000 payment constituted an accord and satisfaction.  The Court rejected plaintiffs' defense on the grounds that they failed to prove that the $50,000 was intended to settle all compensation claims or that the defendant was informed of that intention before he accepted the check.  Instead, the Court offset the $50,000 payment from the employee's salary claim and awarded him the balance.

Although the claims on both sides arose under New York law, there is no apparent reason why the result would be different under North Carolina law.  In either event, enforcement of a noncompete provision can prove to be an expensive proposition (here, two and a half years of litigation), particularly where the former employee has counterclaims.

Full Order and Judgment

[UPDATE:  In an Order dated July 6, 2010, Judge Diaz denied the company's motion to reconsider the ruling on the employee's counterclaim].

Supreme Court Rejects Chapter 75 Claim Between Partners

In modern business litigation in North Carolina, it is increasingly rare to see a complaint that does not contain a claim under G.S. § 75-1.1 for unfair or deceptive trade practices.  Courts that have prevented the statute from having almost unlimited application have done so by determining that particular activities are not "in or affecting commerce."  The Supreme Court continued that pattern last week, holding that a dispute between partners did not trigger Chapter 75 liability.

In White v. Thompson, partners in a Bladen County fabrication and welding business enjoyed initial success, but "eventually fell victim to disagreements and infighting among the partners."  Two partners filed suit alleging that the third partner started a competing business that diverted the business of the original partnership.  The plaintiffs asserted that their partner's conduct constituted breach of fiduciary duty and unfair and deceptive trade practices.  The jury found in plaintiffs' favor and awarded judgment in the amount of $138,195 against the former partner.  The trial court ruled that the acts were unfair and deceptive and trebled the judgment amount pursuant to G.S. § 75-16.

Both defendants appealed, and a divided panel of the Court of Appeals reversed as to the former partner.  (Mack Sperling reported the Court of Appeals' decision to you last May).  Plaintiff appealed to the Supreme Court as of right based on the dissent in the Court of Appeals.

Justice Newby examined several prior Chapter 75 cases, including HAJMM Co. v. House of Raeford Farms, Inc., 328 N.C. 578, 403 S.E.2d 483 (1991).  HAJMM established that securities transactions and other "capital-raising activities" are not "in or affecting commerce" so as to trigger Chapter 75 liability.  The Court also cited Bhatti v. Buckland, 328 N.C. 240, 400 S.E.2d 440 (1991), for the proposition that the General Assembly intended to regulate conduct between market participants in two categories:  "(1) interactions between businesses, and (2) interactions between businesses and consumers."  (The Business Court has relied on the HAJMM line of cases to reject internally-generated Chapter 75 claims on several occasions,  including J Freeman Floor Co., LLC v. Freeman (May 14, 2009) (unpublished) (usurpation of LLC opportunities, dismissed on basis of Court of Appeals' opinion in White); Reid Pointe, LLC v. Stevens, 2008 NCBC 15, 2008 WL 3846174 (Aug. 18, 2008) (discharging LLC manager and demanding capital call); Kaplan v. O.K. Technologies, LLC (June 27, 2008) (unpublished) (dispute among LLC members), and Maurer v. Slickedit, Inc., 2005 NCBC 1, 2005 WL 1412496 (May 16, 2005) (dismissal as CEO, denial of board participation, and failure to take action to sell company)).

As the Supreme Court stated, Section 75-1.1 "is not focused on the internal conduct of individuals within a single market participant, that is, within a single business. . . .  As a result, any unfair or deceptive conduct contained solely within a single business is not covered by the Act."  Because the dispute was between partners, the Court affirmed the decision of the Court of Appeals reversing the trial court judgment.

Justice Hudson, joined by Justice Timmons-Goodson, dissented.  She criticized the majority's holding for relying on an outdated statement of purpose contained in a disco-era version of the statute.  She also distinguished HAJMM  on the grounds that the capital-raising activities in that case were not the core function of the company, whereas the disputes in White involved two partnerships competing for the business of a particular customer.

The bottom line is that, although White doesn't exactly break new ground given that HAJMM has been the law of North Carolina for nearly 20 years, the Supreme Court declined the opportunity to retreat from HAJMM and expand the scope of the unfair and deceptive trade practices statute.  The upside for North Carolina businesses is that treble damages should continue to be unavailable in internal corporate disputes.

Supreme Court Opinion

Court of Appeals Opinion

Business Court Blockbuster: If You Only Read One Corporate Governance Case This Year, Make It This One

I'm not sure we've ever had the opportunity to describe a Business Court opinion as "epic" before, but here we are.  On Friday, in State v. Custard, the Court delivered a 70-page, 4-appendix opinion that's the corporate governance equivalent of The Ten Commandments or Ben-HurIn addition to a thorough discussion of directors' duties under North Carolina and Delaware law, the opinion answers four previously unanswered questions posed in the Robinson on North Carolina Corporation Law treatise that occupies a prominent shelf in every North Carolina business lawyer's library.

Custard was a breach of fiduciary duty case brought by the Commissioner of Insurance as the liquidator of Commercial Casualty Insurance Company of North Carolina ("CCIC") against three directors of CCIC.  To make a long story short, CCIC focused on "artisan" liability insurance policies for small contractors and tradesmen in California.  For a period of time, it also offered non-standard auto policies in North Carolina and redomesticated itself from Georgia to North Carolina in 2001, thus becoming subject to NCDOI regulation.  In hindsight, CCIC set its premiums too low and wrote too many policies.  As the Court tactfully phrased it, "CCIC’s growth outperformed the Company’s ability to generate policyholder surplus."  It became insolvent in 2004.

Key points from Judge Tennille's opinion include:


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Forced Out Minority Shareholder Gets Past Motion to Dismiss

A minority shareholder who said he was forced to resign as an officer and director of the company got past a Motion to Dismiss challenging his claims for breach of fiduciary duty, breach of the duty of good faith and fair dealing, conspiracy, and punitive damages in the Business Court's opinion last Friday in Oakeson v. TBM Consulting Group, Inc.

Plaintiff had been TBM's Vice President of Global Consulting, a board member, and owned a 13.5% interest in the company. He was party to both a Shareholders Agreement and an Employment Agreement. The latter agreement had a five year term, running through 2009, and specified that Plaintiff could only be terminated for defined "cause."

The Plaintiff alleged that Sharma, the majority shareholder of TBM, began demanding, insistently, that Plaintiff resign. Plaintiff refused to do so. Sharma told Plaintiff that he and the other defendants had the votes to remove Plaintiff as an officer and director of the company, and that they were "resolute in [their] decision to remove [him]." He told Plaintiff that he shouldn't bother to attend the board meeting at which the vote would be taken.

Plaintiff gave in and resigned as a director, but not as an officer and employee. Sharma then continued his pressure on Plaintiff to obtain a full resignation, to which Plaintiff finally agreed. Plaintiff then filed suit against the company raising a variety of claims resulting from his ouster.

Breach of Fiduciary Duty: Judge Jolly, denying the motion as to the claim for breach of fiduciary duty, said that "our courts long have recognized that a controlling shareholder owes a fiduciary duty to minority shareholders not to misuse his management power to promote his personal interests." Op. ¶44. The opinion has a brief history of appellate cases recognizing the duty of the majority to the minority, beginning with White v. Kincaid, 149 N.C. 415 (1908), and continuing through Gaines v. Long Manufacturing Co., 234 N.C. 331 (1951) and Freese v. Smith, 110 N.C. App. 28 (1993).

Breach of Covenant Of Good Faith and Fair Dealing: Defendants argued that a tort action which arises from a breach of contract couldn't be maintained. Judge Jolly disagreed, and said "the allegations go beyond a pure and simple contract claim. Rather, they raise implications of the respective fiduciary duties, if any, between shareholders in a closely-held corporate setting, and of possible civil conspiracy." Op. ¶40.

Civil Conspiracy: In response to the motion to dismiss the conspiracy claim, the Court recognized that "North Carolina does not recognize an independent cause of action for civil conspiracy," Op. ¶48, but Judge Jolly went on to say that "where there exists a separate but underlying claim for unlawful conduct, a plaintiff also may state a claim for civil conspiracy by alleging that two or more persons came together in agreement to carry out the unlawful conduct complained of in the separate cause of action, and that injury to the plaintiff proximately resulted from the agreement." Op. ¶48. The Complaint, said the Court, "alleges that the Defendant shareholders agreed upon a combined course of various actions designed to force Plaintiff out of TBM in all his corporate capacities, one of those actions resulting in beach of Plaintiff's Employment Agreement." Op. ¶49.

Punitive Damages: The claim for punitive damages also survived the Motion to Dismiss. Judge Jolly ruled that "when a breach of contract claim reflects potential fraud or deceit, or other aggravated or malicious behavior, a claim for punitive damages may lie." Op. ¶52. He said also that "the North Carolina courts will recognize a claim for punitive damages arising from a breach of fiduciary duty when it is coupled with the requisite aggravating factors." Op. ¶53.

The opinion is premised on the liberal pleading standard of the U.S. Supreme Court's decision in Conley v. Gibson. The Conley standard has been rejected by the Supreme Court, but remains the law of North Carolina based on a recent North Carolina Court of Appeals opinion.

Brief in Support of Motion to Dismiss

Brief in Opposition to Motion to Dismiss

Directors Of Corporation Facing "Deepening Insolvency" Owed Fiduciary Duties To Creditor

Directors of corporations verging on insolvency can owe fiduciary duties to creditors under certain circumstances.  Whether those duties were owed -- and whether the claim for their breach had been released as a part of the corporation's bankruptcy proceeding -- were the main issues yesterday in Phillips and Jordan, Inc. v. Bostic, 2009 NCBC 13 (N.C. Super. Ct. June 2, 2009).

The Plaintiff claimed that the Defendant directors had diverted money through "a web of sham entities" for their own personal benefit during a time when the corporation faced "deepening insolvency" and that they were liable to it under a theory of constructive fraud.

Here's how Judge Diaz described North Carolina law on the duties of directors of a corporation in financial difficulty:

In certain circumstances. . . corporate directors may owe a fiduciary duty to creditors of the corporation. The circumstances under which a director’s fiduciary obligations extend to creditors have been limited to those situations 'amounting to a "winding up" or dissolution of the corporation.'

'Once the fiduciary duty arises, a director must treat all creditors of the same class equally by making any payments to such creditors on a pro rata basis.'

Where a creditor can show constructive fraud by a director at a time when the corporation 'is in declining circumstances and verging on insolvency,' or 'where such facts establish circumstances that amount "practically to a dissolution,"' the claim is one that 'belongs to the creditor and not the corporation.'

Op. ¶¶42-45.

The Court denied the Defendants' motion to dismiss the Plaintiff's claim for constructive fraud.  It also rejected arguments that the claim had been settled as a part of the corporation's bankruptcy proceeding, ruling that "where . . . the claim arises from a purported breach of a fiduciary duty owed by a corporate director to a creditor, and where the claim, therefore, properly belongs to the creditor and not the corporation, 'it is not a part of the bankruptcy estate, and the trustee in bankruptcy does not have authority to bring [or settle the] claim.'"  

In another part of the Opinion, the Court granted a motion to dismiss a fraud claim because it failed to comply with Rule 9(b).  The Complaint, which asserted the fraud claim against a group of individuals, did not identify the specific person who made the alleged misrepresentations.  The Court allowed leave to amend.

Judicial Serendipity: North Carolina And Delaware On Fiduciary Duties Of LLC Members And Managers

The fiduciary duties owed by members and managers of limited liability companies are very different under North Carolina and Delaware law.  In a bit of judicial serendipity, the North Carolina Court of Appeals and the Delaware Court of Chancery each issued opinions on those issues last week, just a day apart. 

The North Carolina case is Kaplan v. O.K. Technologies, LLC (April 21).  the Delaware Court of Chancery case is Bay Center Apartments Owner, LLC v. Emery Bay PKI, LLC (April 20).  The two cases highlight the differences in the nature and scope of fiduciary duties in the LLC context.

The Delaware View

The Delaware view, crisply stated in the Emery Bay decision, was summed up by the Delaware Corporate and Commercial Litigation Blog (which you should absolutely be reading) as follows:

On the point of the fiduciary duty of a manager to the members: 'in the absence of a contrary provision in the LLC Agreement, the manager of an LLC owes the traditional fiduciary duties of loyalty and care to the members of the LLC.'

On the point of the fiduciary duty of a member to other members: 'the LLC cases have generally, in the absence of provisions in the LLC Agreement explicitly disclaiming the applicability of default principles of fiduciary duty, treated LLC members as owing each other the traditional duties that directors owe a corporation.'

North Carolina on Fiduciary Duties of LLC Members

North Carolina goes off in a different direction entirely on the fiduciary duty of an LLC member to another member.  There is none, though there can be exceptions.  But the general rule, stated in the Kaplan case, is that:

The North Carolina Limited Liability Company Act, N.C. Gen. Stat. § 57C-1-01 et seq., does not create fiduciary duties among members. Members of a limited liability company are like shareholders in a corporation in that members do not owe a fiduciary duty to each other or to the company.

The exception is when the member has majority control.  Then, "a controlling shareholder owes a fiduciary duty to minority shareholders," and an LLC member with control would owe a fiduciary duty to the minority members.

North Carolina on Fiduciary Duty of LLC Managers

A manager of a North Carolina  LLC does owe a fiduciary duty, as does a manager of a Delaware LLC.  But in North Carolina, the fiduciary duty is not owed directly to other members, as it is in Delaware.  It is instead owed to the LLC:

Managers of limited liability companies are similar to directors of a corporation in that '[u]nder North Carolina law, directors of a corporation generally owe a fiduciary duty to the corporation, and where it is alleged that directors have breached this duty, the action is properly maintained by the corporation rather than any individual creditor or stockholder.' Thus, like directors, managers of a limited liability company also owe a fiduciary duty to the company, and not to individual members.

The principles described above are default rules, applied by the North Carolina and Delaware courts in the absence of provisions in the LLC Operating Agreement as to the duties of members and managers.  The members are free to provide for the imposition of fiduciary duties (which the Court found they had in the Emery Bay case); or to provide for no or limited fiduciary duties (as they did in the Kaplan case).

It's pretty common for North Carolina attorneys to be advising clients regarding Delaware LLC issues, because so many corporate attorneys opt for formation under Delaware law.  There were 111,820 LLCs formed in Delaware in 2007, and 81,923 in 2008.  The North Carolina numbers show significantly fewer LLC formations here: there were 33,212 LLCs formed in NC in 2007 and 29,384 formed in 2008.  These numbers were provided by the Division of Corporations at the Delaware Secretary of State and by the Director of Corporations at the North Carolina Secretary of State.

I originally wrote about the Kaplan case when it was decided by the Business Court in June 2008.  You can find that post here.

Threats And Secret Promises: Bank Of America's Merger With Merrill Lynch

Ken Lewis, Bank of America’s CEO, has testified under oath to threats by former Secretary of the Treasury Hank Paulson to remove the Bank’s Board of Directors and its management if the Bank didn't close its deal to acquire Merrill Lynch, and secret promises to support the Bank with federal funds if it did close the transaction. 

Those statements are contained in Lewis’ deposition, portions of which were released yesterday by New York's Attorney General. 

Lewis testified that the financial deterioration of Merrill in the fourth quarter of 2008 was "staggering,"  Dep. 13, and the acquisition  was turning out to be "a $15 billion hole" for the Bank. Dep. 60.  Lewis told Paulson that the Bank "was strongly considering" invoking the Material Adverse Change provision (the "MAC") in the Merger Agreement with Merrill.  Dep. 34, 58. The action of "calling a MAC" would have permitted Bank of America to terminate the Merrill transaction or at least to negotiate a better deal.  Paulson didn't like that idea, and asked Lewis to temporarily "stand down."  Dep. 42.

The Threat And The "Undisclosable" Promise Of Federal Funds

Lewis followed with a personal call to Paulson (who was out riding his bike at the time) and told Paulson, again, that the Bank was considering the invocation of the MAC.  According to Lewis' testimony, Paulson responded that the government "does not feel it's in your best interest for you to call a MAC" and that if the Bank did so or maybe even intended to do so, that the Treasury Department "would remove the board and management" of Bank of America.  Dep. 52. 

Paulson, testified Lewis, promised government support for the growing burden of the acquisition, but was unwilling to put that promise in writing.  He said to Lewis that a written commitment for federal funds "would be a disclosable event and we [the Treasury] do not want a disclosable event."  Dep. 80.

Lewis Reports To The BofA Board On The Threat And The Promise

Lewis reported to the Bank's board, shown in the minutes of the December 22, 2008 meeting, that if the Bank were "to invoke the material adverse change clause in the merger agreement with Merrill Lynch and fail to close the transaction, the Treasury and Fed would remove the Board and management of the" Bank.   He also reported on the verbal assurances provided by Paulson and also by Fed Chair Ben Bernanke.

In a bit of corporate minutekeeping that will undoubtedly become pivotal in the flood of shareholder suits already filed over this merger and those yet to come, the December 22 minutes say that "the Board concurred it would reach a decision that it deemed in the best interest of the Corporation and its shareholders without regard to this representation by the federal regulators."  In other words, the Board minutes says the Board wasn't influenced at all by Paulson's threat.  (How, well, fiduciary-like of them.)

Lewis Still Wants To "Call A MAC," But Reports To The Board On "Detailed" -- But Secret -- Assurances From Federal Regulators

Merrill's condition worsened over the eight days before the next Bank board meeting.  The minutes of that December 30th meeting show that Lewis reported he had told federal regulators "were it not for the serious concerns regarding the status of the United States financial services system and the adverse consequences of that situation to the Corporation articulated by the federal regulators, the Corporation would, in light of the deterioration of the operating results and capital position of Merrill Lynch, assert the material adverse change clause in its merger agreement with Merrill Lynch and would seek to renegotiate the transaction."

Lews reported at that meeting that he had "obtained detailed oral assurances from the federal regulators with regard to their commitment and has documented those assurances with e-mails and detailed notes of management's conversations with the federal regulators."  Those e-mails and notes haven’t yet been made publicly available, but they will certainly provide interesting reading when they are.

The Treasury Comes Through, Post-Closing, With Billions Of Dollars Of Funds

The Merrill transaction closed two days after the December 30th board meeting, on January 1, 2009.  The oral promises made by Paulson and the "federal regulators" weren't disclosed in connection with the transaction. 

But about two weeks after the closing, the Treasury showered Bank of America with an additional $20 billion in TARP funds and a $118 billion "backstop" on the assets acquired from Merrill.  That's more than enough to fill a "$15 million hole,"  as long as you aren't still digging. 

There's already a shareholder derivative action pending in the North Carolina Business Court over the Bank of America/Merrill Lynch merger, Cunniff v. Lewis.

The photo is from Rainforest Action Network's photostream.

A Business Court Hat Trick Today In The North Carolina Court Of Appeals

Three decisions from the North Carolina Business Court were affirmed today by the North Carolina Court of Appeals.  They involve fiduciary duties of members of LLCs, the right of limited partners to sue directly for injury to a partnership, and the obligation of the personal representative of an estate to give notice to creditors.   They are:

Kaplan v. O.K. Technologies, LLC, in which the Court of Appeals ruled that a member of an LLC without majority control does not have a fiduciary duty to the other members of the LLC or to the LLC itself.  Nor does a manager have a fiduciary duty to the other members, as that duty is owed directly to the LLC.  The Court also affirmed the Business Court's ruling that the Plaintiff's control over the funding of the LLC did not create a fiduciary duty. The Business Court ruling was by Judge Tennille, Judge Stephens wrote the appellate opinion.

Gaskin v. Proctor, ruling that a limited partner was not entitled to bring suit in his personal capacity for claimed injury to the partnership in the absence of "a special duty or a separate and distinct injury."  The Court rejected the argument that the limited partner was entitled to maintain his suit due to "the closely held nature of the company, and the domination of the company by the defendants and resulting powerlessness of the plaintiffs." The Business Court ruling was by Judge Diaz, Judge Stroud wrote the appellate opinion.

Azalea Garden Board & Care, Inc. v. Vanhoy, holding that the personal representative of an estate was not obligated under N.C. Gen. Stat. Sec. 28A-14-1(b) to give personal notice to a creditor because the creditor's claims were not "actually known" or "reasonably ascertain[able]" by her.  The claims of the Plaintiff were barred because it failed to assert its claim by the date specified in the notice of the estate administration published in the newspaper.  The Court said that the initial burden should be with the claimant "to produce a forecast of evidence demonstrating that a material issue of fact exists as to whether its identity and its claim were reasonably ascertainable" a standard which the Plaintiff was unable to meet.  The Business Court ruling was by Judge Tennille, Judge Robert C. Hunter wrote the appellate opinion.

Court of Appeals Rulings Today (September 2, 2008)

The North Carolina Court of Appeals ruled today on cases involving the statute of repose applicable to legal malpractice actions, fiduciary duties of trustees, and the waiver of the right to arbitration.

On the fiduciary duty issue, the Court affirmed the decision of the Business Court in Heinitsh v. Wachovia Bank on an obscure point of trust law for which it observed there was "surprisingly little guidance." The trustee in Heinitsh was caught between the income beneficiaries and the remaindermen of a substantial trust over a dispute whether millions of dollars from the sale of property should be categorized as income or principal. During the dispute, the trustee took the disputed funds and invested them in a money market account. The plaintiff, an income beneficiary, argued that the trustee's duties required it to maximize income in her favor, and that the trustee had breached its fiduciary duties by placing the funds in a low-yielding money market account. The Court of Appeals held that "holding the retained funds during the pending litigation was reasonable in light of the circumstances and defendant did not breach its fiduciary duty to plaintiff." The Court suggested, however, that "the better practice may be to interplead the funds. . . ."

The legal malpractice case is Goodman v. Holmes & McLaurin Attorneys at Law. The plaintiff had sued outside the four year statute of statute of repose contained in N.C. Gen. Stat. §1-15(c), but contended that the law firm was equitably estopped from asserting the statute given a lawyer's active conduct in trying to hide the fact of his malpractice.  The Court of Appeals found that conduct of concealment to be "particularly egregious," but held that "this Court has consistently refused to apply equitable doctrines to estop a defendant from asserting a statute of repose defense in the legal malpractice context. . . ."  It found plaintiff's claims therefore to be barred by the statute of repose.

In Gemini Drilling and Foundation, LLC v. National Fire Insurance Co. of Hartford, the Court found that the defendant had waived its right to arbitration. The defendant had filed a motion to compel arbitration, and lost. Instead of taking an immediate interlocutory appeal, which it had the right to do, it participated in discovery and then a bench trial of the claim. The Court held that the purpose of arbitration "would be defeated if a party could reserve its right to appeal an interlocutory order denying arbitration, allow the substantive lawsuit to run its course (which could take years), and then, if dissatisfied with the result, seek to enforce the right to arbitration on appeal from the final judgment."

There's another case from today's opinions, Odell v. Legal Bucks, LLC, which I'll deal with separately. You can find all of the Court of Appeals opinions today here.

The photo of the Court of Appeals building is from Juliet Sperling.


Does The Manager Of An LLC Have A Fiduciary Duty To The Members Of The LLC?

The United States District Court for the Middle District of North Carolina dismissed an LLC member's fiduciary duty claims against a manager based on grounds of standing in Morris v. Hennon & Brown Properties, LLC.

The Defendant LLC was an investor and member of three limited liability companies.  It alleged in a counterclaim that the Plaintiff, the manager of three of the LLCs, owed it a direct fiduciary duty, and that Plaintiff had violated that duty by comingling funds of the LLCs and using them for his personal benefit. 

Plaintiff pitched its Motion to Dismiss on the argument that a co-manager of the LLC does not have a fiduciary duty to its members under N.C. Gen. Stat. Sec. 57C-3-22, which sets out the duties of LLC managers.  The Court declined to decide the case on this basis, noting that there was no North Carolina state court authority on the point and stating that it had an obligation to approach an issue of first impression cautiously, and to avoid it if possible. 

The Court instead framed the issue as follows: "the more important question in this case is to whom is that duty owed-to the LLCs or to the member individually."  The Court found that the breaches of duty alleged by the Defendant would have affected all of the members of the LLC, not just the Defendant, and that the Defendant therefore was not entitled to assert a direct claim for breach of fiduciary duty.

The Court concluded as follows in granting the Motion:

In the instant case, Defendant fails to make any allegations of a special duty owed only to it and not the other members of the LLCs, nor has it shown that it suffered a special loss, separate and distinct from the harm to the LLCs and other members of the LLCs. Consequently, Defendant has no standing to bring a direct or individual action against a member-manager of the LLCs. For this reason, Defendant's claims alleging breach of fiduciary duty should be dismissed.

This case was decided about a month ago, I picked it up from this week's North Carolina Lawyers Weekly.

LLC Investor Did Not Owe A Fiduciary Duty To The LLC Or Its Members

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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Sex and Fiduciary Duty

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.



Aiding And Abetting Breach Of Fiduciary Duty: Alive Or Dead?

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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Claim That LLC Made Unlawful Distributions Was Derivative, Not Direct

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

Fiduciary Duty Claims Can Proceed Against Director And Employee Who Allegedly Sank $100 Million IPO

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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