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

You probably know that there is a fight afoot between the North Carolina State Bar and the do-it-yourself vendor of legal documents, LegalZoom. The simmering dispute has been covered in the Wall Street Journal, the ABA Journal, and the case is now in the Business Court over Legalzooom's vitriolic objections.  The issue is whether LegalZoom's offerings constitute the unauthorized practice of law.

LegalZoom bills itself as “transform[ing] the way people think about and fulfill common legal needs.” It says that it has made its mission “to simplify the process and to set new standards for convenience and service in an industry not typically known for great customer care.” The company basically sells legal forms to non-lawyers (and helps its customers to fill them out by computer) which enable them to form their own corporations, write their own wills, and get their own divorces, while at the same time avoiding what LegalZoom condemns as the high cost of attorneys’ fees.

It’s said pretty often that “you get what you pay for,” so it’s not surprising that LegalZoom has taken some heat (like from Consumer Reports) for the quality of its services, even though it advertises that 94% of its customers "recommend LegalZoom to friends and family." The lawyers who provide the same services as those offered by LegalZoom, such as estate planning lawyers, and lawyers filing trademark applications, aren’t keen on the service. 

Not much has happened in the Business Court so far, except for LegalZoom’s strident efforts to stay out of the Business Court. Those began with the filing of the case by LegalZoom against the State Bar. LegalZoom immediately asked the Chief Justice of the NC Supreme Court for an exceptional case designation to Superior Court Judge Paul Gessner. That was granted back in October, apparently without notice to the NC Bar.  The Bar then designated the case to the Business Court as a mandatory complex business case, which LegalZoom opposed, saying its case was not a " complex business case" within the mandatory jurisdiction of the Business Court.

LegalZoom has lost Round 1.  Judge Jolly (who decides all designation motions as the Chief Judge of the Business Court) ruled that the claims made by LegalZoom in its Complaint are squarely within the jurisdiction of the Business Court. Count 1 of the Complaint is for a violation of the Monopoly Clause of the North Carolina Constitution, saying that the State Bar has interfered with LegalZoom’s constitutional right to freely do business in North Carolina. Count 2 says that the State Bar has also violated the state Constitution by excluding LegalZoom from “register[ing] its legally compliant prepaid legal services plan.” (That's a whole different LegalZoom service).  The third count is for “commercial disparagement,” alleging that the State Bar has made false statements to the public which caused the public “to regard [LegalZoom’s] product as legally unauthorized, and imputing illegal conduct to [LegalZoom].”

 In opposing the Bar’s designation as a mandatory business case, LegalZoom argued that its case was “exceptional,” but not a “complex business case.”  Judge Jolly didn’t spill much ink in denying the Opposition in an Order on January 9th. He said:

Plaintiff's Complaint specifically alleges that "this case includes claims that involve a material issue relating to . . . [a] anti-monopoly, anti-competition, and antitrust law claims that are not based solely on N.C. Gen. Stat. § 75-1.1; [b] unfair competition law claims that are not based solely on N.C. Gen. Stat. § 75-1.1; and [c] the Internet and electronic commerce." These allegations are substantially identical with three separate statutory grounds for designation of a civil action as a mandatory complex business case under the Removal Statute.

Order ¶3.  So that's that.  The case has been assigned to Judge Gale and will be resolved in the Business Court.

Where was the vitriol?

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A broadly worded defense in a case challenging the sale of a company resulted in a waiver of the attorney-client and work product privileges last week, in Richardson v. Frontier Spinning Mills, Inc.

Richardson claimed that the company had improperly structured its sale so that non-employee shareholders like him were paid less for their stock than the shareholders who were employed by Frontier and that the company had failed to disclose material facts regarding the transaction.  The company defended by asserting that it had relied on the advice of its corporate counsel in how the sale was structured.

It is not unusual for counsel defending corporate directors to raise an "advice of counsel" defense because G.S. §55-8-30 says that directors may rely upon information provided by "[l]egal counsel, public accountants, or other persons as to matters the director reasonably believes are within their professional or expert competence" in discharging their duties as directors.

According to the Business Court, there is "ample authority" that the raising of such a defense results in a waiver of the attorney-client privilege.  Given that the scope of waiver is often a "thorny issue" (Op. Par. 9), a defense relying on Section 55-8-30 should be carefully worded.  The defense before Judge Jolly in the Richardson case stated that

if it is determined there was illegal disparate treatment of the "Outside Shareholder[s]" and the "Inside Shareholders" or insufficient material disclosure in the Stock Purchase Agreement and otherwise, which the Defendants specifically deny, then Defendants assert that in the discharge of any legal responsibilities with respect to these allegations, they relied on the advice of counsel.

In his ruling, the Judge said that the word "otherwise" was "so broad as to be elusive of clear and reasonable definition." Op. at Par. 8. He said also that "[s]uch broad language makes it extremely difficult for the court to define fairly and reasonably where any resulting waiver of the attorney-client privilege begins and ends." Op. ¶10.

He held that the waiver covered any communications between the defendants and their counsel that took place before the closing of the sale and which reasonably related to a broad range of matters involving the sale.

The waiver extended to the work-product of counsel, because the statutory defense applies only if the director reasonably relies on the legal advice.  Judge Jolly relied on cases outside of North Carolina for the proposition that:

fairness dictates the necessity for an examination of the underlying good faith and reasonableness of the advice itself, including the circumstances surrounding issuance of the legal opinion, and that relevant work product therefore loses its privilege protections.

That exposed the lawyers to having to produce all documents reflecting communications between the law firm's primary counsel to the company and other lawyers at the law firm.

Judge Jolly said that "it would not have been difficult" to limit the scope of the waiver by limiting the wording of the defense. Op. ¶10.  That might be easier said than done.  Waiver is a slippery slope once you start heading down it.  There's no telling where you might end up.

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in an Order yesterday in International Forest Products Corp. v. Jackson Paper Mfg. Co., the Business Court denied a motion to disqualify defense counsel from representing Jackson Paper.  The lawyers who were challenged were from the Atlanta firm of McKenna Long & Aldridge. 

The basis for disqualification was that McKenna had previously represented a Jackson Paper subsidiary, Stonewall, in matters substantially related to the Business Court case and in matters on which the lawyers'  testimony would be required. The Plaintiff  International had acquired the claims it was pursuing against Jackson Paper by assignment from Stonewall in a receivership proceeding.

If it were Stonewall suing Jackson, it seems likely that McKenna Long could not have been jackson's counsel due to McKenna's previous representation of stonewall.  That's because Rule 1.9 of the Revised Rules of Professional Conduct says that

a lawyer who has formerly represented a client in a matter shall not thereafter represent another person in the same or a substantially related matter in which that person's interests are materially adverse to the interests of the former client.

But International Forest didn't acquire the attorney-client relationship between McKenna Long and Stonewall.  It only acquired the claims that Stonewall had against Jackson.  Judge Murphy said that this made all the difference and that the Rule did not apply:

Rule 1.9 and its commentary. . .make clear that a duty of loyalty attaches to a client, and not to a claim or transaction. The lawyer-client relationship is a personal one and cannot be assigned. In the present matter, a lawyer-client relationship existed between McKennaLong and [Stonewall]. Thus, McKenna Long’s duty of loyalty and confidentiality are owed to Stonewall, not to Stonewall’s claims or interests. This personal duty, therefore, did not transfer to Plaintiff International Forest Products Corporation (“International Forest”) when it acquired certain of Stonewall’s claims. As an assignee, International Forest cannot claim protection under the duty of loyalty because it is not a former client of McKenna Long itself. Therefore, Rule[] 1.9 [is] inapplicable.

Another ground for disqualification was International's stated intention to call McKenna Long lawyers (other than Jackson's litigation counsel) as witnesses.  RPC 3.7(a) says that a lawyer cannot be an advocate at a trial in which the lawyer is likely to be a necessary witness.  But RPC 3.7(b) says that other lawyers in a lawyer-witness’s firm may continue to act as advocate unless the lawyer-witness’s testimony would be adverse to the client’s interests.  The Defendants didn't claim that the lawyer testimony would be adverse, so Judge Murphy denied that aspect of the disqualification motion as well.

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What's the difference between a patent holder who suffers harm from third-party infringement and a patent holder who suffers harm from his own attorney's malpractice?  The latter can pursue his claim in state court, according to a March 9 Business Court decision.

In Revolutionary Concepts, Inc. v. Clements Walker PLLC, the inventor of an "automated audio video messaging and answering system" and the current holder of the patent sued a patent agent, three patent attorneys, and a law firm for malpractice in failing to take certain actions before the United States Patent & Trademark Office ("USPTO").  Specifically, Plaintiffs alleged that Defendants failed to file certain paperwork that cost Plaintiffs their ability to patent their invention in foreign jurisdictions, including Japan and the European Union.  Defendants moved to dismiss for lack of subject matter jurisdiction, arguing that the claims lay within the exclusive jurisdiction of the federal courts. 

Further complicating matters, shortly after filing the Business Court lawsuit, Plaintiffs filed a separate lawsuit in the Western District of North Carolina, Carter v. Ozoeneh (W.D.N.C. No. 3:09-CV-614), to determine the ownership of the patent at issue.  The defendant in the federal lawsuit is an individual who was listed as a co-inventor on a prior patent application for the technology at issue.  Plaintiffs sought to amend the federal complaint to add one of the attorney defendants from the Business Court lawsuit along with Lawyers Mutual for claims of racketeering, maintenance, unfair competition, and tortious interference.  On September 16, 2009, Magistrate Judge David Cayer denied the motion to amend and recommended that the District Judge dismiss other claims against John Doe defendants, but the ownership claims remain in the federal lawsuit.

As for the jurisdictional issue in the Business Court lawsuit, Judge Tennille held that Plaintiffs' malpractice claim was not within the exclusive jurisdiction of the federal courts.  The Court examined cases from several jurisdictions, some of which permitted malpractice claims to proceed in state court and others of which held them to be exclusively federal claims.  The distinction depended on whether federal patent law was an essential element of the Plaintiffs' claims.  In Revolutionary Concepts, it was not:

In this Court’s view, the case sub judice is different.  The Complaint in this case does not raise an issue which requires the determination of the validity, scope or infringement of a United States patent.  Furthermore, the Complaint does not raise an issue requiring determination of what the USPTO would do under certain circumstances, nor does it involve regulation of the conduct of counsel appearing before the patent office.  The Complaint clearly raises issues of what the validity and scope of potential foreign patents would have been and perhaps issues of infringement of potential foreign patents that were allegedly lost.

The loss of the foreign patent rights is based upon a breach of the standard of care, quintessentially a state law claim.  Every malpractice action will require determination of a standard of care.  It is unlikely that any standard of care can be assessed without some reference to compliance with the proper procedures in the USPTO.  This Court does not read the Federal Circuit decisions to hold that any case by a patent owner against its patent counsel will fall within the exclusive jurisdiction of the federal courts.  Where federal jurisdiction will promote uniformity of claim construction, consistency in validity, scope and infringement of U.S. patents, or promote uniform regulation of patent counsel conduct before the USPTO, federal jurisdiction is mandated.  Where the issues involve foreign patent rights and issues of whether a lawyer complied with a standard of care, federal jurisdiction is not mandated.

The Court also noted that Plaintiffs voluntarily dismissed a claim for breach of contract in the prosecution of the patent before the USPTO.  In contrast to the foreign registrability issues of the malpractice claim, the breach of contract claim would have implicated federal law enough to confer exclusive federal jurisdiction over the lawsuit.  After the dismissal of that claim, however, whatever exclusivity may have existed previously no longer did.

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The Business Court granted a Motion to Disqualify counsel today in Ferguson Fibers, Inc. v. Foster, and sent a cautionary word to lawyers who represent the employees of their corporate clients in what they might believe to be unrelated matters.

The issue was whether the attorney for Plaintiff Ferguson Fibers should be disqualified because he had previously represented Foster in a child support matter and in a lawsuit involving the sale of the business of Foster's wife. The new lawsuit appeared to be completely unrelated to those past representations. It involved claims by Ferguson Fibers that Foster had engaged in inappropriate conduct while employed by Ferguson Fibers.

Rule 1.9 of the North Carolina Rules of Professional Conduct provides that "a lawyer who has formerly represented a client in a matter shall not thereafter represent another person in the same or a substantially related mater in which that person's interests are materially adverse to the interests of the former client unless the former client gives informed consent, confirmed in writing."

The test for whether matters are "substantially related" is "if they involve the same transaction or legal dispute or if there otherwise is a substantial risk that information as would normally have been obtained in the prior representation would materially advance the client's position in the subsequent matter."

Foster asserted that he had discussed with his former lawyer during the past representations his employment and business dealings with Ferguson Fibers, his role in helping his employer move part of its business to Mexico, and his "strained relationship" with his boss. He said that disqualification was warranted because this information might be relevant to the lawyer in his representation of his former employer.

The attorney disputed that he had ever discussed such matters with his former client, but Judge Tennille held that this made no difference. He observed that a court should "prevent even the appearance of impropriety and thus resolve any and all doubts in favor of disqualification." He said "[t]he Court need not resolve this factual dispute. Its existence is sufficient to require disqualification," and that "Foster's perception of events, as the client, is of 'paramount importance' in preventing the appearance of impropriety."

The Court also provided a quick word of advice to lawyers who represent organizations as well as their employees: "Attorneys who represent various constituents of an organization, be they investors, employees, suppliers, or customers, are in a better position than lay persons to protect against potential conflicts of interest. Where counsel represents both a company and its employees, it is the duty of the lawyer to inform the client about the implications of the dual relationship."

Other decisions by the Business Court involving Motions to Disqualify are The Cottages of Stonehenge Condominium Homeowners Association, Inc. v. Dominion Mid-Atlantic Properties II, LLC, Chemcraft Holdings Corp. v. Shayban, and Flick Mortgage Investors, Inc. v. The Epiphany Mortgage, Inc.

Brief in Support of Motion to Disqualify

Brief in Opposition to Motion to Disqualify

Reply Brief in Support of Motion to Disqualify

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I had an out of state lawyer call me, concerned, a few weeks ago. He was defending a client in his home state in a case in which the plaintiff's counsel had obtained commissions to take depositions in North Carolina. The depositions were scheduled to begin in just a few days, and he was concerned that he needed to admitted pro hac vice, in a hurry.

My reaction was that this was unnecessary. It was an out of state case. Rule 5.5(c)(2)(B) of North Carolina's Revised Rules of Professional Practice says that it's not the unauthorized practice of law to take a deposition in North Carolina if the "matter . . .  arises out of or is otherwise reasonably related to the lawyer's representation of a client in a jurisdiction in which the lawyer is admitted to practice." Moreover, it was the other side that had gotten the necessary commission and subpoena to take the deposition. The lawyer who called just planned on attending and possibly asking some questions after the other lawyer finished with his questions.

But after I looked at the situation a little bit I wasn't so sure. One of the North Carolina depositions was to be taken in Wake County, where there is a specific Local Rule on point. Wake County Local Rule 13.1 says that "out-of-state attorneys seeking to take depositions of Wake County residents to be used in actions pending in other jurisdictions must be admitted pro hac vice unless local counsel has been associated."

That's pretty broad. It might even cover an out of state lawyer taking the deposition of someone who agreed to appear voluntarily, without a subpoena. And are you "seeking to take depositions" if you are not the lawyer who compels the appearance of the witness, but you simply show up and ask some questions? And what about "unless local counsel has been associated?" Does that mean that NC counsel has to take the deposition or at least attend it, or is it enough if NC counsel simply obtains the issuance of the commission?

Given all these questions, we went ahead and got the lawyer admitted out of an abundance of caution.

I did a quick spot check of Local Rules for similar provisions. The only other county I'm aware of with an applicable rule is Mecklenburg County. The local rule there, 18.2(f),says "[i]f the out-of-state attorney intends to make an appearance in North Carolina in connection with this matter (such as attending the deposition)," the lawyer must be admitted pro hac.

There are occasional quirky local requirements of a different nature regarding pro hac admissions, like including a statement in the motion confirming payment of the $225 admission fee, which Guilford County Local Rule 5.12 requires. (All of the local rules for North Carolina's counties are available here, it's worth checking the pertinent rules if you are seeking or considering a pro hac admission).

Don't forget that when a lawyer is admitted pro hac here, the NC attorney responsible for the admission has to obtain a completed Pro Hac Vice Registration Statement, and file that with the state bar within thirty days of the admission. Failure to do so is grounds for administrative suspension of the NC attorney from the practice of law.  27 NCAC Subchapter H, Section .0101(b).

The North Carolina Bar has has an FAQ page on pro hac admissions which has a lot of useful information. The statute governing pro hac admissions is N.C. Gen. Stat. §84-4.1.

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The North Carolina State Bar has proposed an Ethics Opinion on whether a lawyer can look for and use metadata contained in a electronic communication from another party or that party's lawyer. Proposed 2009 Formal Ethics Opinion 1, if approved, would place affirmative obligations on not only the recipient of the data, but also its sender.

[Note: On October 22, 2009, the State Bar Ethics Committee voted to withdraw this opinion and to send it to a subcommittee for further study.]

Metadata is "data contained within electronic materials that is not ordinarily visible to those viewing the information."  Metadata might show information that a lawyer chose to delete, or a private comment that the lawyer didn't mean the reader to see.

Obligations On Sending Lawyers

Those sending an email or electronic version of a document to an opposing counsel or party will be obligated to "use reasonable care to prevent the disclosure of confidential client information." That means being careful about using word processing software that tracks changes, allows the insertion of comments, or permits the saving of multiple versions of a document. The Opinion says that lawyers should use scrubbing applications that delete metadata, or avoid metadata altogether by sending fax transmissions or hard copies of documents.

Obligations On Receiving Lawyers

On the recipient side, the Proposed Opinion would prohibit a lawyer receiving electronic communications from searching for or using confidential information contained in the metadata in the document. And not only that, if the recipient unintentionally views hidden data, he or she must notify the sender of that fact.

The Proposed Opinion doesn't apply, of course, to documents produced in response to a subpoena or a discovery request.

Other States

The issue of metadata has been confounding state bar ethicists for years. The Proposed Opinion references a number of other state bars which have issued ethics opinions on the subject, including Alabama, Arizona, Colorado, the District of Columbia, Florida, Maine, Maryland, New York, and Pennsylvania.

North Carolina, if it adopts the Proposed Opinion, will be lining up with Alabama, Arizona, Florida, Maine, and New York. Each of those states takes the position that a lawyer should not search metadata for confidential information belonging to an opposing party. There are a few with a contrary view or which don't take a position on the subject, including the American Bar Association, Colorado, Maryland, and Pennsylvania.

The ABA has a good one page summary of the rules on metadata in these various jurisdictions, including a few additional jurisdictions not referenced by the NC State Bar in the Proposed Opinion.

If you have thoughts on this subject, you can address comments on the Proposed Opinion by September 30, 2009, to the NC State Bar Ethics Committee at P.O. Box 25908, Raleigh, North Carolina 27611.

The full text of the Proposed Opinion is below.

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The Business Court today granted a motion to disqualify counsel for Plaintiffs, finding their prior representation of the Defendants involved a matter "substantially related" to the matters at issue in the lawsuit. 

The law firm representing the Plaintiffs in The Cottages of Stonehenge Condominium Homeowners Association, Inc. v. Dominion Mid-Atlantic Properties II, LLC had been longstanding counsel for the Plaintiff homeowners association.  They had first been retained when Defendant Dominion, the former owner of the property, converted it to a condominium and incorporated the HOA.

The Board of the HOA at that time consisted of representatives appointed by Dominion.  In 2006, the Dominion-controlled Board sought the law firm's advice about maintenance issues.  The advice was sought on behalf of both the HOA and Dominion.  The lawyers delivered a written opinion letter on "the maintenance responsibilities between the Unit Owners and the Association."

Over a year later, an owner-controlled Board of the HOA was elected.  Issues arose regarding the adequacy of maintenance reserves.  The law firm filed a lawsuit for the HOA against Dominion and the former board members for breaching their fiduciary duty by failing to set adequate reserves for common area and maintenance expenses.

After sifting through the positions of the parties, the Court held:

[h]ere, Defendants find themselves in a position in which the very lawyer who advised one or more of them with respect to duties and obligations relating to budgeting for and maintaining Stonehenge common areas now seeks damages against them for breaching their duty to adequately set aside fiscal reserves for the repair and maintenance of those same common areas.  The court is forced to conclude that the two are inextricably and substantially related.

Judge Jolly granted the Motion to Disqualify, stating that the prior representation presented the "substantial risks contemplated under Rule 1.9" of the North Carolina Rules of Professional Conduct, and that "it is the court's duty to resolve any and all such risks in favor of disqualification."

The Dairy Queen sign is from tboard's photostream on Flickr.

Brief in Support of Motion to Disqualify

Brief in Opposition to Motion to Disqualify

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When the attorney closing a residential real estate transaction steals the closing proceeds, does the buyer or the seller bear the loss? 

The holding of the 2-1 majority today in the North Carolina Court of Appeals decision in Johnson v. Schultz is that in the typical transaction the loss will fall on the party whose lawyer absconded with the funds, at least in the absence of fault.

In North Carolina, that's in most cases going to be the buyer, who typically selects the closing attorney.  The holding of Judge Robert C. Hunter, concurred in by Judge Martin, was as follows:

we conclude that where, as here: (1) one attorney is used to handle a residential real estate closing, (2) the attorney misappropriates the remaining balance of the purchase price owed to the seller, and (3) the risk of loss must be allocated to one or more parties, courts should first consider the existence of fault. However, if fault does not exist and the risk must be allocated between essentially “innocent” parties, courts should then consider which parties had an attorney-client relationship with the wrongdoing attorney and impose the risk of loss on those parties. Where multiple parties to the transaction have an attorney-client relationship with the offending attorney, the risk of loss should be shared among them.

The Court rejected the approach taken by the trial court, which had followed what is known as the "entitlement rule." Under that rule, the loss fell on the seller, who was the party entitled to the funds in the hands of the attorney.  The theory of the entitlement rule is that that the holder of an escrow is the agent for the party for whom the funds are being held.  An earlier Court of Appeals decision, GE Capital Mortgage Services v. Avent, 114 N.C. APP. 430, 442 S.E.2d 98 (1994), had followed the entitlement rule in a case involving an escrow held following a residential closing, but it was distinguished by today's decision.

Judge Wynn dissented, and took a completely different approach.  He would have placed the risk of loss on the seller, because the seller had opted to take its proceeds in the form of a check drawn on the closing attorney's trust account, as opposed to the cash payment specified in the standard 2005 NCBA contract form.  The majority reasoned that requiring sellers to walk away from the closing with cash "would significantly disrupt the way real estate transactions are traditionally closed in North Carolina."

The opinion contains a detailed discussion of how residential real estate transactions are closed in North Carolina.  Those generally involve the "settlement closing" method, but sometimes involve what's called an "escrow closing."  The case also defines what an "escrow" is, for the first time in a reported North Carolina appellate opinion, and discusses obscure types of escrows like a "set-aside escrow" and a "deed and money escrow."  (You'll have to read the opinion if you want to know more about these things).

In the Johnson case, the closing attorney, now disbarred, had made off with more than $250,000 in closing proceeds owed to the seller.  The case was apparently a big deal in the residential real estate closing world.  The North Carolina State Bar weighed in with an amicus brief on behalf of the seller, which was countered by an amicus brief by the North Carolina Land Title Association for the buyer.

It's now on to the Supreme Court.  And even then, the case may not be over.  That's because the buyer claimed that the attorney had been acting for the seller as well, and the Court of Appeals held that the case needed to be remanded for resolution of this issue.

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The Court of Appeals split yesterday on whether a Plaintiff and his lawyers who continued with a lawsuit after they should have determined that it was not well grounded in fact or law could be hit with non-monetary sanctions.  The majority reversed, saying that the trial court should not have considered events occurring after the filing of the Complaint in awarding sanctions.

The case decided by the Court of Appeals is Egelhof v. Szulik.  The case arose in the Business Court, and was a shareholder derivative action against the technology company Red Hat.  Judge Tennille dismissed the case in 2006 due to Plaintiff's failure to make a proper demand under Delaware law. 

After that, Defendants moved for sanctions and attorneys fees.  In the 2008 decision appealed from, Judge Tennille sanctioned Plaintiff and his lawyers by barring Plaintiff from serving as a representative plaintiff for five years and by barring the lawyers from being admitted pro hac in North Carolina for a like period.  Judge Tennille refused to award monetary sanctions.

Plaintiff appealed, arguing that there was no basis for Rule 11 sanctions because there had been no finding by the Business Court that their Complaint was "neither well grounded in fact nor warranted by existing law" at the time it was filed.  They were right, as the Business Court had expressly stated that the Complaint, standing alone, did not warrant Rule 11 sanctions.  Defendants appealed too, arguing that they were entitled to monetary sanctions.

The Business Court's sanctions ruling was based on post-filing events which it said should have led the Plaintiff to conclude that it should no longer pursue its action, including the dismissal of another case (Pozen) brought in the Business Court by the same lawyers, for the same reason that the Egelhof case was dismissed a few months later: failure to make a demand under Delaware law. 

The Court of Appeals majority concluded that a Court cannot consider matters outside the face of the Complaint in determining whether the Complaint lacked factual or legal support so as to warrant Rule 11 sanctions.  It relied on Bryson v. Sullivan, 330 N.C. 644, 412 S.E.2d 327 (1992), in which the Supreme Court held that "in determining whether a pleading was warranted by existing law at the time it was signed the court must look at the face of the pleading and must not read it in conjunction with responsive pleadings."

Judge Calabria dissented, holding that "sanctions are not limited when later filings reveal the case has become meritless.  The trial court may look beyond the face of the pleading when considering whether litigation was continued for an improper purpose."  Judge Calabria found that sanctions were appropriate not only under Rule 11, but also under the inherent power of the Court.

And Judge Calabria took it one step further, holding that the trial court had erred by not giving proper consideration to an award of monetary sanctions under N.C. Gen. Stat. §6-21.5.  Relying on Sunamerica Financial Corp. v. Bonham, 328 N.C. 254, 400 S.E.2d 435 (1991), she held that a "trial court is required to evaluate whether the losing party persisted in litigating the case after a point where he should reasonably have become aware that the pleading he filed no longer contained a justiciable issue."

The Supreme Court will sort out this disagreement if the case goes forward, but there are two other Rule 11 tidbits in this opinion on which the majority and majority agreed:

The Court held that Rule 11 permits sanctions to be imposed against a party and his attorney attorney even though they didn't sign the Complaint.  (Here, out-of-state counsel had never signed the Complaint, but were sanctioned by the trial court.) 

The Court of Appeals also held that due process does not require that a party against whom sanctions are sought be put on notice of the specific type of sanctions which may be ordered, rejecting a due process challenge by the Plaintiff.  All that is required is notice of the bases of the sanctions and an opportunity to be heard.

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This post is about an Order Striking a Motion for Recusal by the North Carolina Business Court, in J. Freeman Floor Company, LLC v. Freeman.  The Motion was stricken because it was procedurally defective, but the factual allegations which the Plaintiff claimed warranted recusal were interesting, as was the way in which Judge Diaz handled those allegations.

The Plaintiff moved to recuse Judge Diaz from hearing the Defendant's Motion for Sanctions.  The argument for recusal ran like this: Plaintiff asserted that (1) Defendant's counsel (Winson) had  been counsel for Carnival Cruise Lines, (2) Carnival Cruise Lines had in the past been represented by Hunton & Williams, (3) Judge Diaz had formerly been an attorney with Hunton & Williams (even at the same time he was a Superior Court Judge, said the Plaintiff) , and (4) Judge Diaz had improperly reopened the case (which had been dismissed) in order to hear the Rule 11 Motion. 

The specific allegations made in the Motion for Recusal were that:

Mr. Winson has close and substantial ties with Hunton & Williams by virtue of his long and substantial relationship with Hunton & Williams' clients Carnival Corporation and Carnival Cruise Line.  Judge Diaz has close and substantial ties with Hunton & Williams due to his long and recent association with Hunton & Williams.  Mr. Winson's substantial ties to Hunton & Williams and Judge Diaz's substantial ties to Hunton & Williams creates a conflict of interest which Plaintiffs in good faith believe would prevent Judge Diaz from being fair and impartial to the Plaintiffs with regard to Mr. Winson's Rule 11 motion which was purposefully set before Judge Diaz in a closed case file which had to be re-opened in order to bring said motion before Judge Diaz, despite the fact that Mr. Winson could have filed the Rule 11 motion in the new case file which would not have been heard by Judge Diaz.  Thereafter, Mr. Winson removed the new case file to business court and purposefully requested that Judge Diaz be assigned to the case.  For these reasons, Plaintiffs in good faith do not believe that they will receive a fair and impartial decision with regard to Mr. Winson's Rule 11 motion.

The Motion to Recuse further alleged that Judge Diaz, who has been a Superior Court Judge since 2001, had been appearing in Court for Hunton & Williams clients as recently as 2006.  It referenced as support for this assertion several federal court opinions decided between 2003 and 2006 in which Judge Diaz was listed as counsel of record along with another Hunton & Williams attorney. (The Plaintiff was right about Judge Diaz being listed as counsel in those cases, but they all were filed before Judge Diaz took the bench).

The Plaintiff claimed that as a result of these facts there was an appearance of a "special relationship between Mr. Winson and Judge Diaz," and that this "would tend to give the appearance of impropriety." 

Judge Diaz didn't get to the merits of the Motion in his Order, but instead struck the Motion because it was filed without a brief, in violation of Business Court Rule 15.2.  He noted that the Rule violation would ordinarily result in a summary denial of the motion, but gave the Plaintiff ten days to refile its Motion (with a Brief).  The ten days have run out, and the Motion hasn't been refiled.

That's probably because notwithstanding the striking of the Motion, Judge Diaz gave the Plaintiff a direct response to its assertions showing that they didn't have any basis. The highlights are as follows:

• With regard to the allegations that he had been practicing law while a Judge, Judge Diaz said "[s]ince taking the oath of office as a superior court judge in November 2001, I have not practiced law, whether with my former firm Hunton & Williams, LLP or any other firm. Indeed, such activity would be patently inconsistent with my oath as a judge and would also violate the North Carolina Code of Judicial Conduct. See N.C. Code of Judicial Conduct, Canon 5(F) (“Practice of law. A judge should not practice law.”)."
• With regard to the allegations that Hunton & Williams had represented Carnival, Judge Diaz stated that was "news to me," and that "to the best of my knowledge and recollection, I never represented Carnival . . . during my tenure at H&W."
• On whether he had a relationship with Carnival's former General Counsel, Judge Diaz said that he "had never met Mr. Winson during my tenure at H&W" and that the first time he had encountered him was by telephone when Winson was in Court on another Business Court case.
• On the point of whether it was proper to reopen the case to hear the Rule 11 Motion, Judge Diaz observed that "the law is clear that a trial court retains jurisdiction to hear a motion filed pursuant to Rule 11 of the North Carolina Rules of Civil Procedure, even after the case is dismissed."  

The picture at the top is of one of Carnival's fleet of cruise ships, the Carnival Fantasy.

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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.

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Burgess v. Vitola, 2008 NCBC 7 (N.C. Super. Ct. March 26, 2006)(Diaz)

Bueche v. Noel, March 25, 2008 (Diaz)(unpublished)

The Business Court decided two cases this week involving what it found to be the unauthorized practice of law.  In the first, Bueche v. Noel, the Court held that a pro se defendant could not file an Answer on behalf of a corporation, because "a corporation must be represented by counsel and cannot appear pro se."  The Court struck the Answer filed by the defendant.

In the second case, Burgess v. Vitola, the issue was whether an out-of-state attorney who had apparently ghost written an Answer for a defendant had engaged in the unauthorized practice of law.

The defendant involved was Dr. Entezam, a California dentist sued by the plaintiff for allegedly trespassing on his computer through an unwanted advertisement.  (Whether those advertisements subjected the defendants to jurisdiction in North Carolina was the subject of an earlier post).  Dr. Entezam filed an Answer under her own pro se signature which had clearly been drafted by a lawyer.   

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Egelhof v. Szulik, 2008 NCBC 2 (N.C. Super. Ct. Feb. 4, 2008)(Tennille)

It’s hard to imagine a more inadequate plaintiff than Egelhof to undertake the fiduciary responsibility of being a plaintiff in a derivative action against Red Hat, a publicly traded company. Egelhof was only 24 years old, and held only a few hundred dollars of Red Hat's stock. He had become a plaintiff in response to a solicitation on the internet. As the Court described Egelhof, "[h]e had little investing experience, no experience in litigation, no prior connection with the [his] law firm, no personal knowledge of [the corporation] and its operations, and a minor criminal record."

The Court concluded that this plaintiff "lacked any credentials to act as a fiduciary for a company in multi-million dollar litigation." Noting Egelhof’s paltry stake in Red Hat, the Court held that "[w]hile the size of ownership is not determinative of standing, a potential plaintiff's lack of a real financial stake in the litigation is a warning sign that he or she may not be willing or able to devote the time necessary to fulfill the fiduciary obligations imposed by law on a shareholder derivative plaintiff."

These factors alone would probably not have warranted sanctions, but Egelhof was completely uninvolved in his case. He relocated, more than once, and never gave his lawyers a forwarding address. He sold his stock during the course of the lawsuit, creating a significant standing issue, but never mentioned this to his lawyers. He had never even met his lawyers until the night before his deposition and had spent a total of five hours on the case by the time he was deposed.

The Court's sanction to Egelhof was to prohibit him from being a plaintiff in a class action or derivative action in North Carolina for the next five years. The lawyers came in for an equally harsh sanction.

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