October 2010

If you are bringing or defending a derivative action in North Carolina, you may have to look to the law of another state to determine whether a pre-filing demand on the board of directors to pursue the claim is a prerequisite and whether there are any exceptions to the need for a demand.  The law depends on the corporation’s state of incorporation.  In a case decided by the North Carolina Business Court on Friday, Smith v. Raymond, 2010 NCBC 18, the application of Delaware law resulted in the dismissal of  a derivative action against the directors of a Delaware corporation because of the Plaintiff’s failure to establish that the demand should have been excused because a demand would have been futile.

Delaware and North Carolina disagree on the futility exception to the demand requirement.  North Carolina does not recognize a futility exception.  In a 1998 decision in Greene v. Shoemaker, Judge Tennille observed "it is absolutely clear that the [North Carolina] legislature intended to adopt the universal demand requirement and eliminated the futility exception when it passed the 1995 North Carolina Business Corporation Act."  Delaware. with a different point of view, recognizes futility as an excuse to the demand requirement.

So do North Carolina’s lawyers need to know about demand futility when it has been rejected as an exception to demand in North Carolina?  Sure, because when a Delaware corporation is the defendant in a derivative action, the application of Delaware law to resolve issues is required by North Carolina statute.  The General Statutes provide that "in any derivative proceeding in the right of  foreign corporation, the matters . . . shall be governed by the laws of the jurisdiction of incorporation of the foreign corporation."  N.C. Gen Stat Sec. 55-7-47 (2009). The failure to make a demand before filing  a lawsuit against a Delaware corporation resulted in the dismissal  on Friday in Smith v. Raymond.

The defendants in the Smith case were outside directors of Horizon Lines, Inc.  Other directors had previously pled guilty to price-fixing charges, and the Complaint in the North Carolina case asserted that the outside directors had "knowingly conspired" in the illegal price-fixing plan and that a demand upon them would therefore have been futile.

Judge Diaz held that the allegations of the Complaint "fell far short of what is required under Delaware law to excuse demand."  He described those allegations as "blanket allegations that the directors participated in or approved the alleged misconduct."  A 1993 Delaware Supreme Court decision, Rales v. Blasband, 634 A.2d 927 (Del. 1993) requires "particularized factual allegations" as to why a demand would have been futile.

Demand can also be excused under a standard set forth in Aronson v. Lewis, 473 A.2d 805 (Del. 1984), which applies when a particular transaction is being challenged.  In such a case, the questions are:

i) whether a reasonable doubt is created that the directors are disinterested and independent; and (ii) whether the pleading creates a reasonable doubt that the challenged transaction was anything other than the product of a valid exercise of business judgment.

The Aronson standard didn’t apply, according to Judge Diaz,  because the Complaint did not allege a decision by the Horizon board of directors which would implicate the business judgment rule.

The best place to keep up Delaware law regarding corporations  is Francis Pileggi’s Delaware Cororate and Commercial Litigation Blog.

Brief in Support of Motion to Dismiss

Brief Opposing Motion to Dismiss

Reply Brief in Support of Motion to Dismiss



Yesterday, the Business Court entered a preliminary injunction against a distributor which the Court determined had engaged in deceptive conduct by "passing off" a Chinese product as coming from the American manufacturer of a  superior product, in Pittsburgh Corning Corp. v. McCormick Insulation Supply, Inc.

Plaintiff Pittsburgh Corning Corp. is the only American manufacturer of cellular glass insulation, which it sells under the trademark FOAMGLAS.  McCormick had been a licensed distributor of FOAMGLAS until May 2008.  After that, McCormick began delivering the Chinese insulation to its customers even as it continued to represent on its website that it was still a distributor for the Plaintiff, and it accepted orders from customers specifying Plaintiff’s trademarked product.

Testing of the product after it was installed revealed that it contained carcinogenic levels of crystalline silica about which the buyers had not been informed.

The Order outlines the circumstances under which McCormick sold 220,000 pounds of the Chinese insulation to 53 customers who believed they were receiving PCC’s product.  Judge Tennille called McCormick’s actions deceptive (Op. ¶¶39, 50-51).

The injunction entered was sweeping, ordering McCormick among other things to notify all 53 customers which had received the Chinese product of its opinion, and the Court drafting a letter for McCormick to send  to those customers informing them of the inadequacy of the Chinese product and its carcinogenic nature. 



In a case decided Tuesday by the Business Court, the parties were at loggerheads over how the assets of a partnership were to be valued upon the dissolution of the partnership or the withdrawal of a partner.  Judge Jolly granted the motion for summary judgment by EHP Land Company, the withdrawing partner of HPB Enterprises, which was the developer of a resort community on 750 acres of land in Perquimans County.  EHP Land Co., Inc. v. Bosher.

The partnership agreement said that EHP was entitled to the book value of its interest, to be adjusted based on the fair market value of  "any inventory owned by the partnership."  The critical word for construction by Judge Jolly was "inventory," which was undefined in the agreement and as to which there was a huge difference of opinion between the parties regarding the meaning of the word.  To  the plaintiff corporate partner it included all the developed and undeveloped real property owned by the Partnership, "as well as development amenities such as the golf course, pro shop, clubhouse, restaurant and marina."   Op. ¶21. 

The defendant partners had a much more limited view, arguing that the term was ambiguous and therefore void.  In the alternative, they contended that "inventory"  was limited to assets developed and held for sale, which would not have included much of the property owned by the partnership.

Given the lack of any evidence regarding the intention of the parties as to the construction of the undefined word, Judge Jolly determined that it had  a "natural and ordinary meaning."  Op. ¶52.  Looking to dictionary definitions, he concluded that undeveloped lots to be developed in the future were within the scope of the "inventory" of the partnership.

The Court recognized testimony that the partnership had not discussed the term at the time the partners entered into the agreement and that there was no draftsman who could testify as to the meaning of the undefined word. The lawyer who had drafted the agreement testified that the partnership agreement was the "standard, ‘cookie-cutter’ Partnership Agreement that [he] used for partnerships at that time."  Judge Jolly said:

It is not uncommon for contracts to be form-based and not created from "scratch."  Indeed, one reason the use of form contracts is beneficial is because terms may acquire meaning from continual use over time.  The very fact that the term“inventory” appears in the Partnership Agreement weighs in favor of according it specific meaning; that is, the term was chosen not haphazardly without thinking, but was chosen for inclusion in a form contract precisely because it carries meaning. 

Op. ¶50.

I can’t end without saying that my partner John Buford deserves a public thank you for running this blog very well during the many months (since February) I have not been working or writing on this blog due to a stroke.  He did a great job and only gave the blog back somewhat unwillingly when I asked for it a few days ago.  I hope to be back to work in a few months but will start keeping up the blog now.  I’ll leave it to you whether you preferred John over me.  Please don’t hurt my tender feelings.  I appreciate all of you who wrote to me while I was in the hospital.  Thank you for reading and for noticing that I was missing.