March 2009

Whether the departure of three partners from a law firm LLC was a withdrawal or a dissolution of the LLC was the issue in Mitchell, Brewer, Richardson, Adams, Burge & Boughman, PLLC v. Brewer, 2009 NCBC 10 (N.C. Super. Ct. March 26, 2009), decided today by the North Carolina Business Court.

The characterization of the nature of the Plaintiffs’ departure determined whether they were entitled to proceeds from contingent fee cases generated after their departure.

If a dissolution had occurred, Plaintiffs’ rights were governed by N.C. Gen. Stat. §§57C-6-04(b) and 57C-6-05(3), which said that the law firm would continue in existence and that its managers would be obligated to obtain "as promptly as reasonably possible. . . the fair market value for the [LLC’s] assets" and to distribute the recovery to the members of the LLC.  That interpretation might have yielded a significant distribution from the in-process contingent fee cases.

But if the actions of the Plaintiffs constituted a "withdrawal," the Plaintiffs’ rights would be governed by N.C. Gen. Stat. §57C-05-07, and their final distributions would be limited to the fair value of their interest in the firm as of the date of withdrawal.  The value of the contingent fee cases was potentially nothing under this analysis.

Plaintiffs Had No Right To Voluntarily Withdraw

The law firm had no written operating agreement,  and the articles of organization were silent on the subject of withdrawal.  Plaintiffs argued that dissolution was the only remedy;but  the Defendants argued that this interpretation made it impossible for a member to withdraw. 

The Court held in what it described as a case of first impression that the LLC Act does not allow a voluntary withdrawal by a member unless the articles of organization or a written operating agreement provide for a withdrawal.  It rejected Defendants’ arguments to cobble together an operating agreement from various documents, though it did hold that "it may well be in a given case, multiple documents viewed collectively could constitute a written operating agreement as contemplated by the Act."

Plaintiffs Were Estopped From Disputing Their Withdrawal

The Court nevertheless ruled that Plaintiffs were estopped from disputing that they had withdrawn from the LLC.  Judge Jolly held that estoppel is "kaleidoscopic," that it could arise "by conduct, deed, or misrepresentation," and that estoppel "is viewed as ‘flexible’ in its application." 

The factors he considered in concluding that estoppel applied were (a) the Plaintiff’s oral and written representations that they intended to withdraw, including one Plaintiff’s statement "I am out of here," (b) the treatment by all parties of Plaintiffs’ departure as a withdrawal, (c) the Plaintiffs’ formation of their own firm, (d) Defendants’ detrimental reliance on Plaintiffs’ representations of withdrawal, and (e) Plaintiffs’ silence "on the pivotal issue [of whether there had been a dissolution or a withdrawal] for approximately one year."

The Court rejected Plaintiffs’ arguments that they could not have withdrawn because they "did not appreciate the distinction between withdrawal and dissolution" at the time they left the firm.  Judge Jolly said that "when they unilaterally chose to leave the Firm, and characterized their leaving as a ‘withdrawal,’ the Plaintiffs were charged with knowledge of the consequences of their actions; and Defendants were entitled to rely and act upon those actions."

Judge Jolly held that "[t]he fact that the unilateral decision by Plaintiffs to leave the Firm subsequently turned out potentially to be to their economic disadvantage is regrettable, but not relevant to whether they are deemed to have withdrawn."

Brief in Support of Motion for Summary Judgment

Brief in Opposition to Motion for Summary Judgment

Reply Brief in Support of Motion for Summary Judgment 

A losing plaintiff would be liable for the defendant’s attorneys’ fees if a bill introduced this month in the North Carolina Senate becomes law. 

Other pending bills of interest to litigators include one which would change the way in which the Rules of Civil Procedure and the Rules of Evidence can be amended, legislation which would affect the use of computer forensics consultants, and a change to Rule 4 on who is authorized to serve process.

Attorneys’ Fees.  Senate Bill 942 would change the American Rule in North Carolina.  It would require a Court  "to award reasonable attorneys’ fees, resulting from the successful defense of any civil action arising under this Chapter or any other statute, against the plaintiff."  As presently drafted, the term "successful defense" is defined as "the defendant prevailed after trial with respect to all claims presented by plaintiff, or the action was dismissed pursuant to Chapter 1A‑1, Rule 12(b)."

Rules of Civil Procedure and EvidenceSenate Bill 862 would give the North Carolina Supreme Court the authority to "adopt and amend" the North Carolina Rules of Civil Procedure and Rules of Evidence. The General Assembly would retain the ability to amend or veto any rulemaking by the Supreme Court.  Under the current wording of the statute, the Supreme Court can "prescribe rules of practice and procedure for the superior and district courts supplementary to, and not inconsistent with, acts of the General Assembly."

Licensing Requirement For Digital Forensics ConsultantsComputer forensic consultants working in North Carolina will need to be licensed as "digital forensics examiners" under House Bill 570. Those persons requiring a license would include "[a]ny person who, on a contractual basis, engages in the practice of conducting examinations of digitally stored data to recover, image, analyze, or examine the data by using specialized software to determine responsibility or reconstruct usage of the data." There are a number of states that require licensing for these types of consultants.  I wrote about this subject several months ago.

Private Process ServersSenate Bill 1090 would amend Rule 4 of the North Carolina Rules of Civil Procedure to provide that the persons authorized to serve a Summons and Complaint include "a private investigator duly licensed under Chapter 74C of  the General Statutes." 

The North Carolina Business Court delivered a significant opinion on discovery sanctions today in Azalea Garden Board & Care, Inc. v. Vanhoy, 2009 NCBC 9 (N.C. Super. Ct. March 26, 2009). If you are litigating in the Business Court, you’d better read this one, which emphasizes the duty of lawyers to cooperate with one another in discovery.

The Defendant’s Motion for Sanctions concerned an interrogatory response by Plaintiff identifying two attorneys as potential expert witnesses, its subsequent refusal based on attorney-client privilege to supply information that it had provided to the experts, and its withdrawal of those persons as experts after the Court granted a Motion to Compel.

That earlier ruling on the Motion to Compel was very short, and wasn’t published, but if you were reading this blog you would have seen it in this May 2008 post.

The Defendant, having prevailed on the Motion to Compel, sought sanctions. The basis for the Sanctions was Rule 26(g) of the North Carolina Rules of Civil Procedure, which provides that an attorney’s signature on a discovery response is a certification that it is "consistent with the rules," and "not interposed for any improper purpose," and "not unreasonable or unduly burdensome or expensive."

In a first impression aspect of his ruling, Judge Tennille said that sanctions under Rule 26(g) are mandatory in the event of a violation.  He also said that Rule 11 cases don’t have much relevance in a Rule 26(g) sanctions motion.

Judge Tennille emphasized the duty of attorneys to cooperate in discovery in complex cases, quoting extensively from Mancia v. Mayflower Textile Serv. Co., 253 F.R.D. 354 (D.Md. 2008), an opinion by Magistrate Judge Paul Grimm.  Judge Tennille described Judge Grimm as "one of the leading commentators on discovery issues in the federal court,"  and said that "his entire opinion should be read by all trial lawyers."  Op. ¶18. (The link is in the case name).

Forthright discovery is particularly important, said Judge Tennille, when expert discovery is involved.  He held that "[o]ur rules are designed to flush out what opinions are going to be expressed at trial so that challenges to those opinions can be heard pretrial without wasting the jurors’ time. Responses to discovery that comply with the rules save the parties and the courts substantial time and money." Op. ¶13.

Here’s how Judge Tennille summed it up:

Judges and lawyers should resurrect the original intention of the discovery rules, which was to make discovery a more cooperative and less adversarial system designed to reduce, not increase, the cost of litigation. North Carolina’s Rule 26(g) was designed to do that and mandates sanctions when violations of the rule occur. Our system of civil justice cannot function effectively and economically unless lawyers and judges return to the original intention of the discovery rules and make cooperation, communication, and transparency the cornerstones of the discovery process.

Op. ¶19.

On the facts before him, Judge Tennille entered sanctions.  He determined that Rule 26(g) had been violated because Plaintiff’s counsel had (1) designated one person (Wagner) as an expert "without an intention of having  Wagner prepare any expert report containing his opinions and the basis therefore, (2) failing to make inquiry into Wagner’s qualifications to give any expert opinions, and (3) designating [another witness, Tarr] as an expert without even having communicated with Tarr." Op. ¶28.

The Court found that these actions had caused delay and undue expense for Defendant and his counsel, necessitating a Motion to Compel, and furthermore that "[t]he conduct was unreasonable under the circumstances. It was more than mere negligence."  Op. ¶28.  The Court also said that the refusal to provide information based on attorney client privilege was "totally unfounded in the law." Op. ¶29.

Another factor leading to sanctions was Plaintiff’s counsel refusal to discuss matters with Defendant’s counsel.  Judge Tennille said that "[l]awyers have a responsibility and a duty to their clients, the Court, and opposing counsel to communicate openly and civilly with each other. A failure to do so is a breach of their professional duties and results in unnecessary delay and expense to the parties and the Court." Op. ¶32.

Brief in Support of Motion for Sanctions

Brief in Opposition to Motion for Sanctions

If the filings of the parties and the rulings of the Business Court weren’t available electronically on the Business Court’s website, I wouldn’t be able to write this blog.  That’s one reason I found so interesting the short Order by Judge Diaz today in the case of Clemenzi v. Freer. 

The Order addressed Plaintiffs’ Motion to place their Complaint under seal.  The concern they raised was the electronic availability of their filing on the Business Court’s website.  In their Brief, Plaintiffs said that they had "only recently discovered that the Business Court allows for public access to individual court records in ongoing actions via an unsecured internet link on its website."  

The specific concern of the Plaintiffs was that "the case documents might be indexed by Google" which they said would create "an extremely troubling degree of public access."  They stated that although they had "done several experiments with Google, and have determined that Google does not index the documents which are held within a Zip file, as is the case on the Business Court’s website," they remained concerned that there was a "threat of indexing . . . unless the court has arrangements to the contrary with Google and the other web indexing services."

Judge Diaz denied the Motion.  He held that Court filings are "public records" which fall under N.C. Gen. Stat. §7A-109(a).  That statute specifically grants the public the right to inspect court records in criminal and civil proceedings. A Court therefore can limit the public’s right of access only “when there is a compelling countervailing public interest and closure of the court proceedings or sealing of documents is required to protect such countervailing public interest.” (citing Virmani v. Presbyterian Health Servs., 350 N.C. 449, 476, 515 S.E.2d 675, 693 (1999).

On the point that a public record should be treated differently if it is available online at the Business Court’s website as opposed to simply being in the paper file at the courthouse, Judge Diaz held: "because all court filings are ‘public records,’ the fact that the Complaint in the Court’s paper file is also accessible on the Court’s website is a distinction without meaning." 

The Court granted a Motion opposing the designation of the case, which involved the allegedly fraudulent transfer of assets by a corporate defendant and its sole shareholder, as a mandatory complex business case.  The Court ruled that the allegations did not present a material issue related to the law governing corporations.  The Court found that the principal issue in the case involved the Uniform Fraudulent Transfer Act, and furthermore that Defendant’s potential individual liability based on veil piercing allegations did not by itself create grounds for mandatory jurisdiction. 

Full Opinion

Brief in Opposition to Notice Of Designation

Brief in Support of Notice of Designation

Notice of Designation and Complaint

The Court denied an Opposition to Designation of Action as a Mandatory Complex Business case, which was based partly on the argument that the case had been pending for a year before the Notice of Designation was filed.

The Complaint had been amended, however, to state a new claim for constructive fraud.  The Court observed that the new claim was "substantively different from the original claims."

The Court’s denial was based on Business Court Rule 3.1,  which states that “[i]n the event that a party amends a pleading under N.C. R. Civ. P. 15 . . . if the amendment raises a new material issue listed in subsections (a)(1) through (a)(6) of N.C. Gen. Stat. § 7A-45.4, then a Notice of Designation (with respect to the entire action) may be filed with respect to such new material issue. . . .” BCR 3.1(b) (2006).

The new cause of action fell under the Business Court’s mandatory jurisdiction, because it alleged "(1) liability for actions taken by the Individual Defendants as corporate officers and directors, (2) ‘preferential payment to various creditors,’ and (3) liability for actions taken during a ‘winding up’ or ‘dissolution’ of" a corporate entity.  The Court found that "these allegations support mandatory jurisdiction under N.C. Gen. Stat. 7A-45.4."

Full Opinion

The Business Court provided a thorough discussion today on whether a subsidiary and its parent can conspire with one another, in BHB Enterprises, Inc. v. Waste Management of Carolinas, Inc.

Judge Diaz rejected Defendants’ argument that a parent can never be liable for the actions of its subsidiary under a conspiracy theory.  But he dismissed the claim anyway, in the absence of any assertion that the subsidiary had been rendered unable to pay its debts by the action of the parent. 

The Court also rejected Plaintiff’s attempt to bring an unfair and deceptive practices claim based on what was essentially a breach of contract, notwithstanding what the Court called "artful pleading."

Plaintiff runs a restaurant in Charlotte called Vinnie’s Sardine and Raw Bar. It had contracted with Waste Management of Carolinas, Inc. ("WMC"), a subsidiary of Waste Management, Inc., for waste collection and disposal services.

WMC had unilaterally increased its monthly charges to Vinnie’s, relying on contract provisions that permitted such increases under certain circumstances.  Vinnie’s contested WMC’s right to raise the charges and sought to represent a class of WMC customers.  Among other claims, Plaintiff asserted one for civil conspiracy, alleging that WMC and its parent were in cahoots on the unauthorized price increases. 

WMC responded that that it was not possible for a parent to conspire with a wholly owned subsidiary. Judge Diaz disagreed.  He stated that "the Court’s research discloses only six (6) cases addressing the doctrine of intracorporate immunity in the context of a claim for civil conspiracy under North Carolina law,"  and summarized all six of them.  He observed that none of these cases dealt with the point "whether a parent and its wholly owned subsidiary are capable of committing a civil conspiracy under the doctrine."

Judge Diaz looked to Delaware law.  Relying on Allied Capital Corp. v. GC-Sun Holdings, LP, 910 A.2d 1020 (Del. Ch. 2006), he concluded that such a claim could be made, although he reiterated the concern raised by the Allied case in permitting such claims:

"if plaintiffs were allowed to sue parent entities whenever the decision to cause a subsidiary to act in a certain manner originated with the parent, it ‘would increase litigation costs and deter the use of subsidiaries, even when there is a legitimate purpose for doing so and there is no wrong to others in being forced to look only to the subsidiary for relief.’"

The Court dismissed the claim made by Vinnie’s, stating that there was no allegation that WMC would be unable to satisfy a judgment if Plaintiff were to prevail, concluding that the civil conspiracy claim was barred by the intracorporate immunity doctrine.

Continue Reading Business Court Rejects Bright Line Rule That A Subsidiary Cannot Conspire With Its Parent

The Fourth Circuit held today that the manner in which manufacturers of pest control products sold their products to consumers did not constitute illegal resale price maintenance.  The decision in Valupest.com of Charlotte, Inc. v. Bayer Corprejected Plaintiffs’ argument that an antitrust stalwart, United States v. General Electric Co., 272 U.S. 476 (1926) had been overruled by a recent decision of the Supreme Court, Leegin Creative Leather Products, Inc. v. PSKS, Inc., 127 S.Ct. 2705 (2007).

Both Defendant Bayer Corporation, which sells a termite killer called Premise, and Defendant BASF, with a competing product called Termidor, sold their products through distributors.  The distributors sold Premise and Termidor at prices set by the manufacturers to the "pest management professionals ("PMPs"), who provide pest control services to homeowners and other individual customers."  The Plaintiffs making the antitrust claim were three of the PMPs.

For those who need a refresher on this aspect of antitrust law, which included me, the General Electric case held that a manufacturer selling its product directly to consumers through agents is not liable for vertical price fixing.  The rationale of the decision was that when a manufacturer sells through a genuine agent, there is no "contract, combination" or "conspiracy" to violate Section 1 of the Sherman Act.

In Leegin, the Court overruled Dr. Miles Medical Co. v. John D. Park & Sons Co., 220 U.S. 373 (1911), which had held that resale price maintenance agreements were per se unlawful.  In other words, during the long era during which Dr. Miles held sway, such agreements did not require proof that they unreasonably restrained trade.  They were presumed to do so.  The Leegin decision abolished the per se rule and held that such restraints were subject to the rule of reason, because of "a growing consensus in economic theory that vertical pricing agreements, while sometimes anti-competitive, can often have procompetitive effects."

Plaintiffs in Valupest.com argued that Leegin effectively overruled General Electric, and that Leegin dictated a rule of reason analysis even if there was a true principal-agent relationship between a manufacturer and its distributors.  The Fourth Circuit exterminated that argument, saying that Leegin had presented an entirely different question of the proper analysis to be applied after it had been established that there was in fact a retail price maintenance agreement.  It noted that Leegin had not mentioned the General Electric decision at all, and that the Supreme Court had said in another case that it "does not normally overturn . . . earlier authority sub silentio."

The Fourth Circuit then evaluated the validity of the principal-agent relationships in place between the pesticide manufacturers and their distributors, and found them to be well on the acceptable "General Electric side of the line."  The distributors bore the risk of loss, the agency sales method had been used for legitimate business reasons, and there was no evidence that the agency agreements were the product of coercion. 

The Court of Appeals for the Fourth Circuit invalidated a covenant not to compete today, in Lampman v. DeWolff Boberg & Associates, Inc. Along the way, the Court made allusions to Ford Motor Company and Zimbabwe to illustrate the overly broad scope of the agreement.

A couple of caveats first.  The opinion is unpublished, and it involves South Carolina law.  That said, the analysis is interesting, and potentially applicable to a North Carolina case given the similarity of South Carolina’s law on the subject of non-competes.

The restriction, contained in a Shareholders’ Agreement, said that the Plaintiff would "not, directly or indirectly, engage in Competition" with the Plaintiff.  The term "Competition" was defined as "serving in any capacity . . . for any Person that analyzes, designs, modifies and implements management systems to improve productivity, quality, service and capacity levels that generates quantifiable financial savings, and where such services are competitive with or similar to those that such Shareholder rendered during his or her employment with" the Defendant.

There was no geographic restriction in the covenant, which nevertheless had been upheld by the District Court.  It did so based on Defendant’s argument that its business occupied a "unique, narrow niche" with "a very limited set of direct competitors."

The Fourth Circuit reversed, observing that the effect of the non-compete was to prohibit the Plaintiff from working for many entities that didn’t compete at all with the Defendant.  It gave the example of Ford Motor Company, which it said was also engaged in "analyzing, designing, modifying and implementing management systems."  There was no valid reason to prevent the Plaintiff from working for Ford and providing those services, given that Ford and the Defendant weren’t competitors. 

Since South Carolina — like North Carolina — doesn’t blue pencil, that alone was enough of a basis to void this covenant.  But the Court pointed out another flaw in the covenant as well, that it would prevent the Plaintiff from providing competitive services anywhere in the world, even though the Defendant didn’t do business throughout the world.  It held that "the non-competition clause. . . would prohibit [Plaintiff] from working for a ‘competitor’ in Zimbabwe, even though [the Defendant] does not provide services in that country and has no legitimate interest in prohibiting [the Plaintiff] from working there."

The photograph is of Victoria Falls, from Dragonwoman’s photostream on Flickr.

 

The Court denied the entry of a mandatory injunction requiring the Defendant to deliver the title to a motor vehicle to a third party purchaser. 

The Court observed that “'[m]andatory injunctions are disfavored as an interlocutory remedy[]’ because, rather than maintaining the status quo (as is the case when a prohibitory injunction issues), a mandatory injunction effectively alters it."

The Court held that such an injunction is appropriate where a plaintiff provides proof of “serious irreparable injury to the [plaintiff] if the injunction is not granted, no substantial injury to the [defendant] if the injunction is granted, and predictably good chances of success on the [merits].”

The injunction requested by the Plaintiff was denied for several reasons, including because Plaintiff’s claimed injuries would be compensable by money damages and there was therefore no irreparable harm.

In a Uniform Commercial Code sidelight, the Court discussed the concepts of attachment, perfection, and priority, and held that Defendant might have a valid purchase money security interest under the UCC even though it had not perfected its claimed security interest.  The Court held "the Court has found no case (and Plaintiff cites none) holding that the failure to perfect a security interest deprives a secured creditor of its remedies against the debtor for default, including its right to demand possession of proceeds in the possession of the debtor following the unlawful sale of the creditor’s collateral."

Full Opinion

Brief in Support of Motion for Preliminary Injunction

Brief in Opposition to Motion for Preliminary Injunction

Reply Brief in Support of Motion for Preliminary Injunction