April 2009

This case from the North Carolina Business Court involves the world’s 29th richest man, the City of Detroit, and a $55 million default judgment.  Oh, and airplanes too.  Big ones.

All this and more was discussed in the Business Court’s decision today in Deutsche Bank Trust Company Americas v. Tradewinds Airlines, Inc.2009 NCBC 12 (N.C. Super. Ct. April 29, 2009). 

The $55 Million Default

The saga began when TradeWinds, an air freight carrier, obtained an entry of default against C-S Aviation in August 2004.  C-S was once the world’s largest lessor of A300 aircraft, and had leased planes to TradeWinds. 

The entry of default was obtained jointly by TradeWinds, its sole shareholder, TradeWinds Holdings, and another company, Coreolis Holdings.  The three parties did not pursue a default judgment.

Four years passed.  TradeWinds by then had been sold.  Its new owners included the General Retirement System of the City of Detroit and the Police and Fire Retirement System of the City of Detroit. 

TradeWinds learned that the plaintiff in a New York lawsuit had pierced the corporate veil of C-S Aviation.  That was a worthwhile endeavor.  The shareholders of C-S Aviation are George Soros, who Forbes Magazine says is the 29th richest man in the world (the "S"); and Purnendu Chatterjee, also a "wealthy individual," according to the Court (who is the "C.")

TradeWinds decided to pursue a big payday.  It moved in April 2008, without TradeWinds Holdings or Coreolis, to secure the missing default judgment.  It obtained that on June 27, 2008.  The judgment was a whopper: $54,867,872.49.  The very next day, TradeWinds filed suit in the Southern District of New York against Soros and Chatterjee to recover the $55 million.  A month later, TradeWinds filed for bankruptcy protection in Florida in what the Court described as an apparent effort to "shield" the default judgment.  Op. ¶73.

The Motion To Set Aside

Coreolis and TradeWinds Holdings didn’t appreciate being left out of this potential multi-million dollar recovery.  They filed a motion in the Business Court to be added as beneficiaries of the judgment.  By then, C-S had moved to set aside both the entry of the default and the default judgment in the Business Court based on service of process, personal jurisdiction, and "extraordinary circumstances."

Judge Tennille deferred ruling on the Motion, noting the multi-state litigation pending concerning his default judgment, including a Bankruptcy Court stay.  He said "like aircraft lined up for departure, the litigation involving TradeWinds is stacked up on the taxiway awaiting clearance for takeoff."  Op. ¶2.  The Court didn’t make any definitive ruling in the case because of the Bankruptcy Court stay, but stated what it was likely to do once the stay was lifted.

Service of Process

C-S, a Delaware corporation, claimed that the service of the Third Party Complaint was invalid because Delaware law (8 Del. Code §321) requires in-person delivery of service on a Delaware corporation.  TradeWinds had served C-S by certified mail addressed to C-S’ registered agent, CT Corporation, which C-S contended was inadequate.  That was perfectly valid service under Rule 4 of the North Carolina Rules of Civil Procedure.

Judge Tennille ruled that the argument of C-S was "unpersuasive," and that "the local law of the forum determines the method of serving process and of giving notice of the proceeding to the defendant."  Op. ¶36.  North Carolina law therefore controlled the question of service of process.

The Judge further held that he could look to Delaware substantive law "to decide whether the party is properly qualified as an ‘agent’ to receive service of process," but that he was "not bound by Delaware’s restrictions on the manner in which service on a duly qualified agent must be conducted."  Op. ¶36, 39.

C-S further quibbled that the Affidavit of Service filed electronically with the Business Court didn’t show a signature reflecting receipt.  The return receipt in the paper file at the Guilford County Superior Court did have the missing signature, however, and Judge Tennille held that the statute permitted him to consider not only "the attached registry receipt" but also "other evidence satisfactory to the court of delivery to the addressee."  Op. ¶51; N.C. Gen. Stat. §1-75.10(a)(4)b.

Personal Jurisdiction

The jurisdictional question turned on N.C. Gen. Stat. Sec. §1-75.4 which permits jurisdiction if there has been "solicitation or services activities . . . carried on within this State by or on behalf of the defendant."  C-S said it hadn’t solicited TradeWinds in North Carolina, and that it was actually TradeWinds that had initially approached it. 

The Court said that this made no difference, holding that "C-S Aviation negotiated a contract for the leasing of aircraft, made assurances about the aircraft engine performance, induced TradeWinds to enter into the contract, maintained an ongoing relationship with TradeWinds, renegotiated the agreement that resulted in better leasing terms for TradeWinds, and delivered the aircraft to TradeWinds in North Carolina. . . . C-S Aviation directed its efforts toward TradeWinds, who, while operating out of a North Carolina airport, was a North Carolina resident."  Op. ¶68.

Jurisdiction was therefore proper in North Carolina.

Default Judgment

It doesn’t appear that the default judgment will stand.

Judge Tennille observed that he had the power under Rule 60(b)(6) to set aside a default judgment if "(1) extraordinary circumstances exist, (2) justice demands the setting aside of the judgment, and (3) the defendant has a meritorious defense." 

Although the Court didn’t set aside the default judgment, it said that it was likely to do so once the bankruptcy court stay was lifted, based on the following:

  • The sheer size of the award itself was "an extraordinary circumstance in favor of setting aside a default judgment."
  • There were "significant procedural irregularities with respect to the Entry of Default and the Default Judgment." 
  • Although the entry of default was entered on behalf of three parties, only TradeWinds sought and obtained the default judgment.

Op. ¶¶71-72.  The Court concluded that "[a] full hearing on damages with all affected parties represented and participating would provide a more just resolution than the procedural gamesmanship now being employed."  Op. ¶73.  

The Court further expressed concerns about what it described as a "lack of transparency on the part of TradeWinds, particularly its failure to disclose the divergence of interests between TradeWinds and the other parties to the Entry of Default."  Op. ¶73.

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.

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.

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.

Until today, there wasn’t any law in North Carolina on the proper choice of law analysis to decide what state’s law to apply in an accounting malpractice case.  That changed with the North Carolina Business Court’s decision today in Harco Nat’l Ins. Co. v. Grant Thornton LLP, 2009 NCBC 11 (N.C. Super. Ct. April 20, 2009)

Harco sued Grant Thornton, alleging that it relied on the accounting firm’s audit of Capital Bonding Corporation, a Pennsylvania company, in deciding to participate in a bonding program.  Capital failed and Harco paid millions of dollars in claims for bonds issued by Capital.

The claim touched at least three states: Illinois, where both Harco and Grant Thornton are headquartered; Pennsylvania, where Capital was based and where Grant Thornton did its auditing of Capital; and North Carolina, where Harco directed its operations with regard to the bonding program, Harco’s key officers were located, and where Harco paid its first and some of its most significant losses on the bonding program.

The three states have very different approaches to the duty of care owed by an auditor to a third party claiming reliance on an audit opinion.  Grant Thornton moved for summary judgment relying on Illinois law, which requires near privity, a standard very favorable to accountants when they are sued by third parties claiming to have relied upon an audit.  In fact, Judge Tennille said that Grant Thornton would have been entitled to summary judgment under Illinois law.

Harco argued for the application of North Carolina law, which is less favorable to accountants.  North Carolina follows the test  of the Restatement (Second) of Torts §552, which is not as stringent a standard as privity but which requires more than reasonable forseeability. 

Judge Tennille, however, ruled that Pennsylvania law should apply, under what he referred to as the "Audit State Test."  He held that "[t]he law of the state where an audit is performed, delivered, and disseminated (the ‘Audit State’) should control the scope of liability to third parties not in privity with an accountant."  Op. ¶30. 

The justifications for this choice of law standard, according to Judge Tennille, are that "the Audit State has the most significant public policy interest in the liability of auditors performing audits within the state for local companies," and that it "provides clarity, certainty, and consistency for the auditing profession and those relying on the auditor’s work."  This will promote "clear risk analysis" for both the auditor and those relying on the auditor’s work. Op. ¶¶31-32.

The clarity will be only short-lived, because Pennsylvania has not clearly staked out a position on the issue of the liability of auditors to third parties. 

The painting at the top is of Luca Pacioli, the "Father of Accounting."  According to the website of the American Institute of Incorporated Public Accountants, Pacioli said "do not go to bed at night until the debits equal the credits." 

Harco Amended Brief In Support Of Choice Of Law Determination

(Grant Thornton’s Brief was filed under seal).

One million nine hundred and seventy-five thousand dollars.  Those are the fees applied for by the lawyers representing the Plaintiff in the almost completely unsuccessful effort to get an injunction against the now completed merger between Wachovia and Wells Fargo. 

Plaintiff has presented a Stipulation and Agreement of Compromise, Settlement and Release to the Court, which includes a provision for the $1.975 million fee award.  Wells Fargo, the acquiror of Wachovia, is not opposing Plaintiff’s request.

What are Wachovia’s shareholders getting out of the proposed settlement in the Ehrenhaus v. Baker lawsuit?  Not money.  The merger closed, months ago, at the price offered by Wells Fargo and on Wells Fargo’s terms, after the Business Court denied Plaintiff’s Motion for Preliminary Injunction.

The only arguable "value" for the Wachovia shareholders obtained by the Plaintiff consists of two things.  The first is that Judge Diaz’ December 5, 2008 Order held invalid an 18-month "tail" on Wells Fargo’s right to vote its 40% interest in Wachovia if the merger wasn’t approved.  After that, Plaintiff filed a Proposed Amended Complaint asserting proxy violations.  Although that amendment has never been allowed by the Court, Wachovia made amendments to the Proxy Statement six days after the Proposed Amended Complaint was filed.

The information added by Wachovia to its Proxy Statement was (to me, anyway) completely inconsequential.  If you want to make the comparison yourself, the November 21, 2008 proxy statement is here, and the December 17, 2008 8-K filing containing the supplementation is here.

The Brief filed by Plaintiff in support of the settlement doesn’t contain any mention of a legal basis for an award of attorneys’ fees.  That might be because there isn’t any basis for such an award.  The North Carolina Court of Appeals has held that class counsel is not entitled to fees unless the relief obtained involves some pecuniary benefit to the class. 

That case, coincidentally, also involved Wachovia, and is In re Wachovia Shareholders Litigation, 168 N.C. App. 135, 607 S.E.2d 48 (2005).  That decision overturned an award of fees to class plaintiffs who got relief similar to the invalidation of the tail in the Ehrenhaus case.  So if Wachovia and Wells Fargo opposed a fee petition, it seems almost beyond doubt that they would win, because Plaintiff didn’t obtain any monetary benefit for the class.

If the Business Court is going to be willing to consider fees notwithstanding the roadblock of the In re Wachovia Shareholders case, there isn’t a bit of explanation in any of the papers filed this week about why counsel should be entitled to $1,975,000.  Nothing about hourly rates, nothing about the number of lawyers who worked on the case, nothing about the work they did, nothing about their out-of-pocket expenses, and no connection between the $1,975,000 and the value of the results achieved for Wachovia’s shareholders. (Though the Plaintiff’s lawyers did point out that they reviewed 9,500 pages of documents and they took four depositions.)

That’s a pretty glaring omission, because there’s no information for the Court to enable it to assess the reasonableness of the attorneys’ fees. That’s a requirement of the approval of a class action settlement, certainly under federal law. See, e.g., Piambino v. Bailey, 610 F.2d 1306, 1328 (5th Cir.) (holding that by summarily approving attorney’s fees in an unopposed settlement agreement the district court "abdicated its responsibility to assess the reasonableness of the attorneys’ fees proposed under the settlement of a class action, and its approval of the settlement must be reversed on this ground alone."), cert. denied, 449 U.S. 1011, 101 S.Ct. 568, 66 L.Ed.2d 469 (1980); Jordan v. Mark IV Hair Styles, Inc., 806 F.2d 695, 697 (6th Cir. 1986)("Even where there has been no objection to the size of the attorney’s fee requested, it is the responsibility of the court to see to it that the size of the award is reasonable.").

Wachovia shareholders who are members of the class will have the right, at a time set by the Court, to object to the terms of the proposed settlement.  By the way, this is proposed to be a non-opt out class of shareholders, which means that the settlement will cover every shareholder of Wachovia. Plaintiff says that’s appropriate because this was a "typical merger case" where the claims were "predominately equitable in nature." 

After a case is designated to the Business Court, the Clerk of Court in the county in which the case is pending no longer has the authority to grant a motion for extension of time.  In this case, per Business Court Rule 9.2, the Court struck the Order entered by the Clerk granting an extension of time and directed the party to re-file a motion in compliance with the rules of the Court.


The Fourth Circuit today settled a nationwide debate, in this Circuit anyway, about an important issue involving automobile loans in Chapter 13 proceedings.  That’s whether a lender can have a purchase money security interest for the portion of its financing which includes "negative equity" or other items associated with the loan, like "gap insurance." 

The answer, according to the Fourth Circuit in the case of In re Price, is "yes."  The case drew amicus briefs from a group of bankruptcy law professors, the National Association of Consumer Bankruptcy Attorneys, and GMAC; and was argued for the creditors by noted bankruptcy lawyer and former Professor David Epstein.

This issue arises when a borrower who owes money on the car that he or she is trading in rolls the amount of the unpaid debt (the negative equity) into the loan for the new car.  An "upside down" borrower like this also has to take gap insurance for the loan.  That’s additional insurance covering the difference between the amount owed and the amount that would be paid if the car were totaled, because the lender is lending more than the car is worth.  According to the Fourth Circuit, this type of borrowing is involved in about 38% of new car loans. 

The financing of this additional debt becomes important in a Chapter 13 proceeding, because a Chapter 13 debtor has to repay in full a creditor’s "allowed secured claim."  That ordinarily is the present value of the collateral, and that is often less than the loan amount.  So in the non-car loan situation, this results in a bifurcation of a Chapter 13 creditor’s claim into two components — a secured claim for the value of the collateral, and an unsecured claim for the remainder.

But in 2005 Congress added something called the "hanging paragraph" to the Bankruptcy Code, which the Fourth Circuit said was designed "to protect secured car lenders." The hanging paragraph, at the end of 11 U.S.C. §1325(a), says that there won’t be bifurcation if the claimant has a purchase money security interest involving a motor vehicle. 

This statutory addition has resulted in a variety of different results in courts around the country:

  • Some courts have held that a lender is entitled to a purchase money security interest in the entire amount of the car loan, even if the lender financed negative equity and gap insurance.
  • Other courts hold that a lender can’t have a purchase money security interest in the portion of a car loan relating to negative equity or gap insurance. 
  • Then, some of these courts apply the "transformation rule," and treat the entire debt as non-purchase money if it includes any negative equity.
  • Other courts apply the "dual status rule," which grants the lender a purchase money security interest for the portion of the claim that doesn’t include negative equity and an unsecured claim for the remainder.

The Fourth Circuit took the side of the lenders on this one, looking to the Uniform Commercial Code definition of "purchase money security interest," and holding that "negative equity financing gives rise to a purchase money security interest under the UCC — and, thus, under the hanging paragraph as well." 

The Court held that the debtors "could not have traded in their old car unless they also extinguished their negative equity; car dealers are generally unwilling to accept a trade-in with an outstanding lien because the lien makes it difficult for the dealer to resell the car."  It rejected arguments of amici that this result would "make it more difficult for the chapter 13 debtor to retain his or her car" in the bankruptcy proceeding.

The result reached by the Fourth Circuit is consistent with an Eleventh Circuit decision, In re Graupner, 537 F.3d 1295 (11th Cir. 2008).

When a member leaves an LLC, whether his or her departure is a withdrawal or a dissolution can make a significant difference.  In this case, the characterization of the nature of the Plaintiffs’ departure from a law firm LLC 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.

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.  There was none in this case   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."

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."

Full Opinion

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

This case involves sanctions under 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."

The Court determined that sanctions under Rule 26(g) are mandatory in the event of a violation, and that Rule 11 cases don’t have much relevance in a Rule 26(g) sanctions motion.

Plaintiff was sanctioned because its 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.

Lawyers have a duty to cooperate in discovery in complex cases. 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.

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.

Full Opinion

Brief in Support of Motion for Sanctions

Brief in Opposition to Motion for Sanctions