There is little case law under the North Carolina Securities Act.  But last week, in NNN Durham Office Portfolio 1, LLC v. Highwoods Realty Limited Partnership, 2013 NCBC 12, Judge Gale took several steps into that uncharted territory.

TIC Interests Are Securities

The first issue addressed in NNN was whether the "TIC interests" purchased by Plaintiffs fell within the definition of a "security."  If you’ve never heard of a TIC interest, it is "an undivided share in real property ‘with each person having an equal right to possess the whole property. . . .’" Op. ¶42.

There’s been a good bit of litigation about whether a TIC interest can  be considered a security.  It’s not a security if it simply involves the sale of fractional real estate shares, but it can be if it is coupled with a management contract.

That was the situation before the Court in NNN.  Plaintiffs had purchased TIC interests in several office buildings in Durham.  Two of the primary tenants of the buildings were affiliates of the Duke University Health System.  The properties were to be managed by Triple Net Properties, LLC, which is a defendant in a separate lawsuit also before the Business Court.

Plaintiffs alleged that Triple Net and Highwoods, the former owner of the properties, obtained their investment by making material misstatements which misled them into making their purchases. The alleged misstatements concerned Duke’s intention to remain as a tenant.  After the purchases of the TIC interests, Duke decided not to renew its leases.  The properties which it had occupied then went to foreclosure. 

The State Scheme For Civil Liability Under The Securities Act

Section 78A-56(a) imposes "primary liability" on the seller or offeror of a security.  There are two "pathways" to primary liability.  One lies in fraud, generally comparable to federal 10b-5 claims. That’s in N.C. Gen. Stat. §78A-8, (Section 78A-56(a) creates civil liability for a violation of section 78A-8.)  The other pathway is through making false or misleading statements, comparable to federal claims under 12(a)(2) of the Securities Act of 1933.  That’s in N.C. Gen. Stat. §78A-56(a)(2).

Note that the remedies under the NCSA are less generous than those under the corresponding federal claims.  The recovery under NC law is generally limited to the consideration paid for the security.  N.C. Gen. Stat. §78A-56(a).

Pleading, Scienter, and Justifiable Reliance Under Sections 56(a)(1) and 56(a)(2)

Judge Gale ruled that a Plaintiff must prove scienter and justifiable reliance to make out a primary violation under Section 56(a)(1) of the NCSA.  Recall that Judge Murphy ruled last year that scienter is not necessarily a required element of a claim under Section 56(a)(2), which can be grounded on negligence.  

So, Judge Gale ruled, a claim under Section 56(a)(1) must be pled with particularity, in compliance with Rule 9(b) of the NC Rules of Civil Procedure.  Op. ¶¶62-63.

Section 56(a)(2) is different.  It provides for a claim against an offeror or a seller of a security "who (1) makes any untrue statement of a material fact, or (2) fails to state a material fact necessary for a statment which was made to not be misleading."  Op. ¶64.  There’s a built-in defense in the statute.  A seller or offeror can avoid liability for such a statement or omission if he can prove that "he did not know, and in the exercise of reasonable care could not have known of the truth or omission."  N.C. Gen. Stat. §78A-56(a)(2).

On pleading requirements as to Section 56(a)(2),  Judge Gale ruled that "the heightened pleading standards of Rule 9(b) do not apply [to a claim under that Section] where the action is grounded on negligence, but rather Rule of Civil Procedure 8(c) controls."  Op. ¶67.  The plaintiff also doesn’t need to prove justifiable reliance under this Section.  Id.

Secondary Liability Under Section 56(a)(2)

North Carolina extends secondary liability under Section 56(a)(2) to "every other person who materially aids in the transaction."  But the "other person" must be shown to "actually [know] of the factual predicate of the primary liability."  Op. ¶69.

What does "materially aid" mean?  Judge Gale devoted several paragraphs of his decision to that issue (¶¶71-80), and concluded that:

for purposes of the present Rule 12(b)(6) motion the court will require allegations of conduct which rises to the level of having contributed substantial assistance to the act or conduct leading to primary liability under the NCSA, and, when later assessing plaintiff’s proof, will apply the concept of ‘substantial assistance’ restrictively.

Op. ¶79.

The Liability Of One Of The Defendants

The last part of the opinion deals with the liability of the Defendant Highwoods.  Highwoods conveyed the fractional interests in the properties directly to the Plaintiffs, but hadn’t been involved in the peddling of the management contract.  That wasn’t enough to make it liable as a seller of the security and make it primarily liable, so there was no claim for liability under Section 78A-56(a)(1).

Highwoods did not fare as well on Plaintiffs’ claims that it was secondarily liable under Section 78A-56(a)(2).  Judge Gale ruled that "[w]hether a person’s participation in the sale of a security constitutes ‘material aid’ and whether that person ‘actually knew of the existence of the facts by reason of which the liability is alleged to exist’ are necessarily fact-intensive inquiries. " Op. ¶91.

The facts about Highwoods’ knowledge that Duke planned to vacate the sold properties are to be the subject of "further proceedings."  Op. ¶90.

Being a Tar Heel fan, I have to say It’s a shame that no one can figure out a way to sue Duke.