Judge Murphy set some new ground rules for cases brought under the North Carolina Securities Act (the NCSA) last week in Associated Packaging, Inc. v. Jackson Paper Manufacturing Co., 2012 NCBC 13. The Jackson Paper case is an important read for any lawyer bringing or defending an NCSA claim in the Business Court. Sorry for the length of this post, but the case has got a lot of stuff in it.
Choice of Law for NC Securities Act Claims
Most cases in the Business Court touch multiple states, and there is often a spat about which state’s law ought to apply. Some of the plaintiffs in Jackson Paper were Georgia investors in a failed Delaware LLC, Stonewall, whose operating agreement said that "[a]ll issues and questions concerning the construction, validity, enforcement and interpretation of this Agreement [shall] . . . be governed by, and construed in accordance with, the laws of the State of Delaware." The defendants said in their Motion to Dismiss that Delaware law applied and required dismissal of the securities claims.
So did Delaware law govern the claims by the Plaintiffs that the prospects of Stonewall had been misrepresented to them by the defendants in order to procure their investments? No, because those were tort claims, not claims regarding the enforcement of the LLC Agreement, Judge Murphy said, relying on Mosteller Mansion, LLC v. Mactec Eng’g & Consulting of Georgia, Inc., No. COA07-664, 2008 N.C. App. LEXIS 1011 at *7–8 (N.C. Ct. App. May 20, 2008).
Judge Murphy then waded into a thicket of law on which state’s law ought to apply to the NCSA claims. He said that NC’s appellate courts had never before ruled on whether NCSA claims were based in tort. If they were based in tort, then the appropriate choice of law test was lex loci delicti (if your Latin dictionary isn’t close by, that means the law of the situs of the claim). The alternative choice was the "most significant relationship test." He relied on cases determining the choice of law test for unfair and deceptive trade practices, like the NC Supreme Court’s decision in Boudreau v. Baughman, 322 N.C. 331, 368 S.E.2d 849(1988), in ruling that the lex loci test should apply to NCSA claims.
Under the lex loci rule, "the law of the state where the plaintiff was injured controls the outcome of the claim." Op. ¶28. Injury happens in the state "where the last act occurred giving rise to [the] injury." Id. The inquiry is different for negligence based claims (the plaintiffs had made some) and the NCSA claims.
The location of the state of injury for a corporate plaintiff is "more difficult" than determining the location of an individual victim of an assault and battery. Judge Murphy said "it might be presumed that the last act occurred where Plaintiffs made their investments in Stonewall." Op. ¶32. But the Court provided a different answer for the negligence claims, because Judge Murphy said that Plaintiffs had no loss at that time, and therefore no injury, and therefore no claim to make at the time of investment. Their loss (and injury) occurred when the receiver handling the demise of Stonewall completed the sale of Stonewall’s assets. That happened in Sylva, North Carolina, where Stonewall’s plant was located and where the receiver’s sale took place.
The question is a little easier to answer on the NCSA claims, because the statute specifies liability for an offer to sell securities, or the actual sale, made "by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made . . . not misleading." N.C. Gen. Stat. §78A-56(a)(2). So a claim for a violation of the NCSA "is complete upon the "[o]ffer[ing] or s[ale] of a security" by means of an untrue statement or omission of a material fact." Op. ¶31.Judge Murphy said that the offers to sell an interest in Stonewall were made by employees or agents of Jackson Paper, a North Carolina company with its principal place of business in North Carolina. He determined that North Carolina law, the NCSA, therefore applied.
Whether Scienter Is Required To Prove An NCSA Claim
Whether scienter (fraud or reckless disregard for the truth) is required to prove an NCSA claim is another question on which the North Carolina appellate courts have not ruled. But you might recall that the U.S. Supreme Court said that scienter was required under the federal Rule 10b-5, in Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976). So since the NC Court of Appeals has said (in State v. Davidson, 131 N.C. App. 276, 282-83, 506 S.E.2d 743, 748 (1998)) that 10b-5 cases are "instructive" when construing Section 78A-8 of the NCSA because it "closely parallels" 10b-5, shouldn’t Hochfelder be the end of the analysis?
Not so, said Judge Murphy, who deemed it appropriate to plumb the intent of the North Carolina Legislature in enacting the NCSA. He concluded that there was no requirement of scienter, holding that "the legislature intended for the civil remedy provided under Section 78A-56 of the NCSA to include claims based on negligence and negligent misrepresentations." Op. ¶48.
Particularity Is Not Required To Plead A Negligence Based NCSA Claim
The defendants moved to dismiss the NCSA claim on the grounds that NCRCP 9(b) required it to be plead with particularity and that the Complaint did not specify which financial information supplied by them was false. The plaintiffs said that the state securities act allowed negligence based claims and that their notice pleading was sufficient.
The Court observed that "it is generally known and widely accepted among practitioners that when pleading claims under Section 78A-56 it ‘is important to remember that a claim under the antifraud provisions cannot be ple[d] under the normal notice pleading standards because an averment of fraud must be ple[d] with particularity.’" But Judge Murphy ruled that:
Notwithstanding the general practice of applying Rule 9(b)’s particularity standard to claims brought under the NCSA, unlike claims based in fraud, the rationale for requiring
particularized pleading here is not well adapted to claims based in negligence. Accordingly, this Court finds that when claims brought under Section 78A-56(a)(2)
are based in negligence rather than fraud, plaintiff need only meet the general
notice pleading standard of Rule 8(c).
Disgruntled Investors Could Make A Claim For Negligence And Adequately Pleaded Reasonable Reliance
Plaintiffs faced another hurdle in the general rule 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.” Barger v. McCoy Hillard & Parks, 346 N.C. 650, 488 S.E.2d 215 (1997). Those types of claims belong to the corporation, and must be brought on a derivative basis.
Judge Murphy apparently assumed that the plaintiffs’ claims, being for their lost investment in Stonewall, fell within the Barger rule, and he went on to consider whether the claims met the "special duty" exception to the rule. Barger says that "the [special] duty must be one that the alleged wrongdoer owed directly to the shareholder as an individual." Op. ¶57.
He concluded that a "special duty" arose because the challenged actions induced the investors to buy an interest in Stonewall.
Another issue the opinion dealt with was whether the plaintiffs had pleaded reasonable reliance on the financial information provided in connection with their investment in Stonewall. Judge Murphy found the reasonable reliance requirement satisfied by the Complaint’s allegation that the plaintiffs "had an accountant review the financial information provided by Defendants. (Compl. ¶ 109.)." He said that "[t]he accountant’s inability to detect any irregularities supports Plaintiffs’ contention that they could not have discovered the truth." Op. ¶61. The same rationale saved the negligent misrepresentation claim.
This decision definitely breaks some new ground. You don’t have to show scienter for a state securities claim? You don’t have tp plead your claim with particularity? Those are real relaxations of requirements for plaintiffs. It is not clear that these rulings are the law of North Carolina, but they are the law in Judge Murphy’s courtroom. Whether they’ll stick on appeal is an open question. The Court of Appeals seems to love to reverse the Business Court. They did it today in Hill v. Stubhub, Inc., reversing a determination by Judge Tennille that the Communications Decency Act didn’t insulate StubHub from a claim that its ticket selling practices violated North Carolina’s anti-scalping laws. I wrote about that case back in 2008.
So if you are a plaintiff with a securities claim, don’t wait to see what the Court of Appeals might do. Bring it now, in Mecklenburg County or elsewhere in the Western part of North Carolina, and put it in the Business Court. It’s most likely that it will be assigned to Judge Murphy. That seems like a good place to be.
But don’t think that the Jackson Paper plaintiffs are about ready to collect a jackpot. If you read the opinion, you’ll see that there are a lot of warts on their case.