December 2011

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

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

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

It is almost impossible in North Carolina for a shareholder to sue an officer or director for the loss in value of stock.  The Fourth Circuit said that in North Carolina and in South Carolina as well, "[t]he well-established general rule is that shareholders cannot pursue individual causes of action against third parties for wrongs or injuries to the corporation that result in the diminution or destruction of the value of their stock."

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

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

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

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

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

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

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

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

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

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

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

The Business Court decision last week in Shamoon v. Turkow, 2011 NCBC 46  has a little bit of everything: a plaintiff who is a claimed huckster (maybe even a fraudster), parties who are members of a fundamentalist church, plus a Fortune 50 company.  When you mix patents for a high-tech device called the "Ubiquitous Connectivity & Control System for Remote Locations," into that cast of characters, you’ve got something like a holiday delicacy that is itself ubiquitous.

Shamoon is the inventor of the Ubiquitous device.  He sold a 1/2 percent interest of some type in it to the Turkows.  Whether ownership was conveyed was a principal issue in the case.  The assignment document said:

We, Charles and Deborah Shamoon, hereby grant Allen & Lucy Turkow one-half percent ownership in the Ubiquitous Connectivity & Control System for Remote Locations for the sum of $60000.00.

This grant of ownership entitles Allen & Lucy Turkow to one half percent of all the proceeds from the sale of the Ubiquitous Connectivity & Control System for Remote

The Turkows made their investment based on Shamoon’ s representations that he was about to license the invention to General Electric and that he was expecting money from GE in "sixty, ninety, worst case scenario, one hundred and twenty days."  He said he was "at the finish line" of the deal. 

The Turkows learned of Shamoon through their church, of which Shamoon was also a member.   He had sold an interest in the invention to a number of other members of the Living Word Family Church in Raleigh.  No doubt there was great expectation of a quick profit on the investment in the patents.  Parishioners at the church subscribe to a theology:

that believers who have strong faith and employ wise and moral business practices will be rewarded with spiritual abundance and financial prosperity.

Brf in support of Turkows’ Motion for Summary Judgment at 3.  So it looked like a sure thing, with a quick return, but you can guess already that the transaction with GE failed to materialize, and the fallout was a  lawsuit.

Ownership of the Patents

Shamoon sued the Turkows because the Turkows were threatening to "assign or grant licenses[s] under the Patents to others" without sharing the proceeds with him. Complaint  Par. 11.  Shamoon said that he had not sold an ownership interest in the Patents to the Turkows and that the Turkows should be enjoined from their activity.

Could the Turkows have done what Shamoon feared with their teeny half a percent, if they had obtained an assignment of ownership?  Yes, because 35 U.S.C. §262 says that a joint owner of a patent  "may make, use, offer to sell, or sell the patented invention within the United States, or import the patented invention into the United States, without the consent of and without accounting to the other owners." 

Judge Jolly found the agreement to be ambiguous as to the nature of the interest acquired by the Turkows, and denied Shamoon’s motion for summary judgment.  Shamoon was seeking a declaratory judgment that the Turkows were not owners of the Patents, but he now faces a trial if he wants that kind of relief.


The Turkows made counterclaims against Shamoon based on the statements he had made regarding the imminent closing of his deal with GE.  Those were styled as claims for fraud and negligent misrepresentation.  Summary judgment was denied as to both of those claims, in part because Judge Jolly found a question of fact whether the Turkows could prove reasonable reliance based on the alleged statements about the finality of a deal with GE.  The Turkows had argued that their reliance on Turkow was reasonable because they were members of the same church.

Judge Jolly also found a question of fact about whether Shamoon’s statements could be the basis for an unfair and deceptive practices claim.  As he put it, the issue was "whether Charles Shamoon’s solicitation of Defendants’ investment was primarily a "capital raising device" or a transaction to produce personal income for Charles Shamoon."  Op. ¶57.  "Capital raising" can’t be an unfair and deceptive practice, but "personal income raising" can be.  So Shamoon is facing a trial on that issue too.

No fruitcakes were eaten during the preparation of this post. 


Everybody loves a penguin, or at least I think that is so.  But Penguin Toilets, the Defendant in Roth v. Penguin Toilets, LLC, 2011 NCBC 45, can’t be loving the result it got on its Motion to Dismiss, which was denied in the Business Court by Judge Murphy on Wednesday.

The Motion to Dismiss was based on Penguin’s argument that litigation against it had to be brought in Michigan and that North Carolina was therefore an improper venue.  This was premised on a forum selection clause in the LLC’s operating agreement which said that:

Any dispute or other legal action concerning this Agreement, including any arbitration or litigation proceedings shall be conducted in Wayne County, Michigan.

I don’t know why even a penguin would choose to litigate in Wayne County, which boasts of being the home of the City of Detroit, over the North Carolina Business Court, but Wayne County is where Penguin has its headquarters, so that provides some explanation.

Roth was the former President of Penguin.  He had sued Penguin after his termination, claiming violations of the terms of his Employment Agreement.  He was also a member of the LLC.  Penguin said that venue was improper in North Carolina because of the forum selection clause in the Operating Agreement, although there was no forum selection language in the Employment Agreement.  Judge Murphy held that the terms of the Operating Agreement had not been incorporated by reference into the Employment Agreement and that the lawsuit was about the obligations owed to Roth under his Employment Agreement, not his rights as an LLC member.

Judge Murphy ruled that the clause would not be enforceable even if had been properly incorporated into the Employment Agreement.  North Carolina will only dismiss a case based on a forum selection clause if the clause is mandatory as to where the case must be filed.  That has been the ruling of the NC Court of Appeals before, in Mark Group Int’l, Inc. v. Still, 151 N.C. App. 565, 566 S.E.2d 160 (2002).  Although the Penguin clause specified that "any arbitration or litigation proceedings shall be conducted in Wayne County, Michigan," that language wasn’t "mandatory" enough. 

You might think that the word "shall" is equivalent to "must," and therefore mandatory, but the word "shall" is falling into disfavor as a command.  The Committee drafting the Restyled Rules of Federal Evidence, which became effective yesterday, dropped the use of that word in a number of the Restyled Rules. The Committee on Rules of Practice and Procedure said:

‘shall’ is no longer generally used in spoken or clearly written English. The restyled rules replace "shall" with ‘must,’ ‘may,’ or ‘should,’ depending on which one the context and established interpretation make correct in each rule.

See here. at 29.  Words like "exclusive," "sole," or "only" are the magic words that will carry the ball across the line for an enforceable forum selection clause, as the NC Court of Appeals noted in the Mark Group case.

So what’s this Penguin to do?  Leave some of that Michigan winter gear at home and resign itself to litigating in North Carolina.  Keep selling the Penguin toilets with overflow protection it offers from its headquarters in Michigan.  And work on revising that forum selection clause so it will stick the next time.  There’s pretty clear guidance now about the words that it takes. 

Oh, and don’t forget about N.C. Gen. Stat. §22B-3,  which makes a forum selection clause unenforceable if it requires litigation outside of North Carolina and it’s "in a contract entered into in North Carolina."  That type of forum selection clause is against North Carolina’s public policy, per the statute.  Roth presumably didn’t enter into the Employment Agreement in North Carolina so that statute wasn’t an issue in the case.