You probably thought that you would never again have to argue that a demand on a corporation’s board of directors before filing a derivative action should be excused because it would have been futile. 

That’s because the North Carolina Legislature amended NC corporate law in 1995 to make clear that a demand on the corporation to take action is an essential prerequisite to the filing of a derivative action.  Section §55-7-42 of the General Statutes, as amended twelve years ago, says that a shareholder "may not commence a derivative proceeding" without having made a written demand "upon the corporation to take suitable action."  In other words, there is no excuse for not making a pre-filing demand.

But demand futility was alive and directly before the Business Court last week in Finley v. Brown, 2017 NCBC 78.

It’s easy to forget that there is an entire set of statutes that apply to non-profit corporations (Chapter 55A of the North Carolina General Statutes) than to "business corporations" (Chapter 55 of the North Carolina General Statutes).  The lawsuit in Finley involved a non-profit corporation: the Finley Foundation.

Before the Legislature amended the demand requirement in Chapter 55 in 1995, the parallel provision regarding demand applicable to non-profit corporations (N.C. Gen. Stat. §55A-7-40) was virtually identical to its "business corporation" partner.  That unamended statute applicable to non-profit corporations says that:

(b) The complaint shall allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors or comparable authority and the reasons for the plaintiff’s failure to obtain the action or for not making the effort.

The North Carolina appellate courts had made it pretty clear, before the amendment, that a demand on a business corporation before filing a derivative action could be excused if it would have been futile.  Op. 26-27 (citing Norman v. Nash Johnson & Sons’ Farms, Inc., 140 N.C. App. 390, 409, 537 S.E.2d 248, 261 (2000); Roney v. Joyner, 86 N.C. App. 81, 84, 356 S.E.2d 401, 403 (1987); Seaboard Air Line R.R. v. Atl.Coast Line R.R., 240 N.C. 495, 515, 82 S.E.2d 771, 785 (1954)).

So, looking at the "old" law applicable to for-profit corporations, Business Court Judge Bledsoe ruled that the Plaintiff had established that a pre-lawsuit demand would have been futile.

This Plaintiff, a board member of the Finley Foundation did a pretty good job of showing why it would have been futile to make a demand on the four Foundation directors he was suing.

He was attacking them for violating their fiduciary duties, saying that they had "grossly mismanaged the Foundation, and unjustly enriched themselves . . . , by, among other things, failing to prudently manage the assets of the Foundation, incurring unnecessary expenses, paying themselves excessive compensation, and dishonoring Mr. Finley’s intent as the donor of charitable gifts to the Foundation."  Op. ¶12.

Given that the Defendants were direct participants in the conduct that Plaintiff Finley was complaining of, especially in controlling their allegedly "excessive compensation," Judge Bledsoe agreed that the Plaintiff had pled enough to establish that a demand on them to take action would have been futile.

You might remember the derivative action filed against the board of directors of Duke Energy Corporation stemming from its 2012 merger with Progress Energy.  It received a lot of publicity.  The merger was concluded long ago, but there’s finally been a ruling from the Business Court dismissing the derivative action.  It’s Krieger v. Johnson, 2014 NCBC 13.

The lawsuit challenged the severance payment due to Progress’ former CEO, Bill Johnson, following the merger.  Johnson was set to be the CEO of the combined entity following the merger, but he was removed as CEO a few hours after the merger became final.  This entitled Johnson to as much as $44.4 million in payments under his new (and very short-lived) employment agreement with Duke Energy.

Krieger made claims for unjust enrichment and for the directors’ breach of fiduciary duty with regard to what he condemned as a grossly excessive payment for "scant hours of service." Op. ¶16.

Unjust Enrichment Claim Was Dismissed

Judge Jolly dismissed the unjust enrichment claim given Johnson’s written employment agreement with Duke Energy.  He wrote that:

[e]ven assuming the payments to Johnson might be considered excessive as Plaintiff alleges, the existence of a contract between the parties concerning the subject matter of the unjust enrichment claim is dispositive.

Op. ¶16.  He also said that "[a]n assertion that the express terms of a contract were ultimately unfavorable to one of the contracting parties, without more, does not state a claim for unjust enrichment."  Op. ¶16 & n.13.

Derivative Claims Were Dismissed Due To Plaintiff’s Failure To Make A Demand

Krieger’s derivative claims were also dismissed, due to his failure to make a demand on the Duke board of directors to pursue the claims.  That took some analysis by Judge Jolly, first on the point whether the law of North Carolina or Delaware (Duke’s state of incorporation) should control.  Delaware law won out, because this was a matter of the internal affairs of the corporation, and only the state of incorporation can exercise the authority over "matters peculiar to the relationships among or between the corporation and its current officers, directors, and shareholders."  Op. ¶21.

That was only a minor win for Krieger, who was arguing that a demand on the board of directors was excused because it would have been futile, due to the board’s alleged inability to make an independent and disinterested decision on the subject of the lawsuit.  Delaware recognizes the futility exception to the demand requirement, but North Carolina does not.

Plaintiff Couldn’t Show That A Demand Would Have Been Futile

But Krieger couldn’t meet the Delaware standard for showing futility, which requires a showing that there is a "reasonable doubt as to (a) director disinterest or independence or (b) whether the directors exercised proper business judgment in approving the challenged transactions."  Op. ¶23.

He argued that the board would be exposed to personal liability for agreeing to such excessive compensation, but Judge Jolly held that:

Mere allegations that directors participated in or approved of the alleged wrongs as a showing of directorial interest have been consistently rejected by Delaware courts.

Op. ¶27.

 Krieger argued that the grant of severance benefits to Johnson violated the corporation’s publicly disclosed compensation mandates.  Those mandates said that compensation was designed to attract and retain talented executive officers, was to be performance based and was meant to reward individual performance.

But that got the Plaintiff nowhere.  The Court found those statements to be "aspirational," and said that they "should not be contorted into affirmative mandates or representations that could give rise to a substantial likelihood of liability. . . . "  Op. ¶31.

The only other attempt by Krieger at proving demand futility lay in his effort to raise a reasonable doubt that the challenged transaction was the product of  a valid exercise of business judgment.  Krieger argued that the payment to Johnson constituted waste, and asserted that what Duke had received in exchange for the millions of dollars of severance payments was "so inadequate that no person of ordinary, sound business judgment would deem it worth" what Duke had paid.  Op. ¶35.

Judge Jolly observed that "Delaware courts have developed an exacting standard by which to evaluate claims of corporate waste."  Op. Par. 36.  Krieger had to "plead specific facts from which it can be inferred that ‘the decision [by the board] is so beyond the bounds of reasonable judgment that it seems essentially inexplicable on any other grounds."  Krieger’s argument that $44.4 million for less than a day’s work didn’t meet that standard.

So, since Krieger had not made any demand on the Duke board to pursue this litigation, all of his claims were dismissed.

If you are affronted by the payment of $44.4 million to Johnson for "a few hours work,"  here are some things that you should know: (1) the Amended Complaint referred to only about $10 million in payments (Op. Par. 11 & n.8), (2) Johnson would have been due substantial severance benefits under the Progress Management Change-In-Control Plan even if his  Employment Agreement with Duke had never been formalized, and (3) Duke received agreements from Johnson in consideration of the severance payments, like (a) a release of claims against Duke; (b) an agreement to cooperate with Duke in respect to transition matters and (c) non-competition, non-solicitation, non-disparagement and confidentiality covenants.  Op. ¶37.

 

 

If you are a derivative action plaintiff, and you make a demand on an LLC to take action which is then considered and rejected, may you still pursue your claims?  Judge Murphy answered that question, and others relating to derivative actions under Delaware law in this week’s opinion in  Scott v. Lackey, 2012 NCBC 58.

By the way, the reason that I am writing today about Delaware law, instead of North Carolina law, is that the entities involved in the Scott case were formed in Delaware, so Judge Murphy ruled that Delaware law controlled.

Derivative Action After Rejected Demand

In North Carolina, the answer is in G.S. §57C-8-01. If the Court appoints a committee of "two or more disinterested managers, directors, or other disinterested persons, acceptable to the limited liability company, to determine whether it is in the best interest of the limited liability company to pursue a particular legal right or remedy."  Then, if the committee determines that it would not be in the best interests of the LLC to pursue the claim, the Court can dismiss it.

In Delaware, the answer is a bit more complicated, as borne out by the Business Court’s decision  in the Scott case. 

Delaware law in this niche implicates the business judgment rule.  Three issues arise:

‘(1) whether the [managers] acted independently and not self interestedly; (2) whether the [managers] reasonably investigated the basis for the proposed litigation; and (3) whether the [managers] refused to act in good faith.  Seaford Funding Ltd. P’ship v. M & M Assocs. II, 672 A.2d 66, 70 (Del. Ch. 1995) (citing Spiegel, 571 A.2d at 777).

Op. ¶52.

in Delaware, by making a demand, the derivative plaintiff "tacitly concedes the independence of a majority of the board to respond."  Op. ¶52.  But Delaware law does not imply a concession that the managers of an LLC will act in a disinterested way in considering a demand.  Op. ¶53.

Judge Murphy found a "reasonable doubt" as to whether two of the managers had acted in good faith in responding to the demand.  He noted that they had refused to meet with the Plaintiff to discuss his concerns.  He also observed that they stood to benefit directly from the challenged transactions, and he denied the Motion to Dismiss the derivative claims.

Adequacy Of Derivative Plaintiff

A Delaware derivative Plaintiff "must be qualified to serve in a fiduciary capacity as a representative of a class, whose interest is dependent upon the representative’s adequate and fair prosecution."  Op. ¶93.

The Defendants in the Scott case said that Scott was an inadequate Plaintiff because he had a personal interest in gaining control of the LLC.

Judge Murphy disagreed, holding that "selfish motives alone will not mandate Plaintiff’s disqualification as an inadequate representative."  Op. ¶96.  He added that "it is hardly unusual for derivative plaintiffs to have their own interests in mind when bringing a derivative action."  Id.

The Defendants pointed to a defamation claim lodged against them by the Plaintiff as evidence of Plaintiff’s vindictiveness towards them.  Judge Murphy shot down that argument as well, again looking to Delaware law:

absent some concrete fact revealing a conflict between Plaintiff and BHCM, ‘amorphous hostile feelings against defendants [are] not in [themselves] relevant.’ Emerald Partners, 564 A.2d at 677 (quoting Vanderbilt v. Geo-Energy Ltd., 590 F. Supp. 999, 1001 (E.D. Pa. 1984)).

Op. ¶99.

Defendants also argued that the Plaintiff’s derivative action did not have the support of other members of the LLC.  That too was an insufficient argument  Judge Murphy observed that "[a] derivative claim may be maintained . . . without the support of a majority or ownership or even the support of the entire minority."  Op. ¶100.

 

Breach of Fiduciary Duty

Judge Murphy found that the Defendants owed a fiduciary duty to the Plaintiff, stating that "unless otherwise stated in the LLC agreement, ‘the member-managers of a Delaware limited liability compan[y] owe traditional fiduciary duties to the LLC and its members."  Op. ¶69.

For a long time, that appeared to be the law of Delaware, but recent developments show that it is not.  In Gatz Properties LLC v. Auriga Capital Corp., No. 148, 2012 (Del. Supr. Nov. 7, 2012), the Delaware Supreme Court said that the issue of a "default fiduciary duty" remained an "open question," 

It chastised the Chancey Court Judge for saying otherwise, stating 

We feel compelled to address this dictum ‘because it could be misinterpreted in future cases as a correct rule of law,’ when in fact the question remains open. Gotham Partners, L.P. v. Hallwood Realty Partners, L.P., 817 A.2d 160, 167 (Del. 2002).

Gatz, supra, at n.62 (emphasis added).

Would it have made a difference to Judge Murphy’s opinion if Delaware law had been clear on the fiduciary duties of managers?  Probably not, as it seems inevitable that the Delaware Supreme Court will reach the conclusion that managers have a fiduciary duty to their LLC.  The North Carolina Court of Appeals  ruled three years ago that LLC managers owe such a fiduciary duty to the LLC, in  Kaplan v. O.K. Technologies, LLC.

I wrote about the differences between Delaware and North Carolina on the point of LLCs and fiduciary duty in April 2009.

*   *   *

If you are wondering what I want for Christmas, it would be a decision from the North Carolina Business Court on an open question of North Carolina’s corporate law to write about.  I’m tired of writing about Delaware law.  

 

 If you dip in to Judge Murphy’s Wednesday opinion in Blue Ridge Pediatric & Adolescent Medicine, Inc. v. First Colony Healthcare, LLC, 2012 NCBC 51, you’ll find a little bit of everything.  It’s a ruling on a Motion to Dismiss a Complaint that alleged everything under the sun.  Here are the high points:

Quick Facts

The Plaintiffs entered into a deal with the Defendants for them to develop office space for the Plaintiffs’ medical practice.  Plaintiffs were to share in the profits from the sale of the property, but none were ever paid.  There were also allegations of misrepresentations by the Defendants as to their financial stability and claims of unauthorized changes to the transaction documents.

The Complaint sets out 23 causes of action against multiple defendants.

Piercing the Corporate Veil

The lesson here is that rote pleading won’t get you there on a piercing the corporate veil claim.  Plaintiffs recited the bare bones of the "instrumentality rule" in their Complaint, but Judge Murphy said that "these bare legal conclusions are not entitled to the presumption of truth afforded factual allegations on a motion to dismiss."  Op. 37.  Plaintiffs needed to point to specific acts of control or domination to state a valid claim.

Fraud

Plaintiffs said they relied on Defendants’ representations of their financial stability.  The truth was that Defendants were teetering on the brink of insolvency.

Judge Murphy nevertheless dismissed the claims for fraud, fraud in the inducement, negligent misrepresentation and negligence.  He found that the Plaintiffs had failed to show reasonable reliance because they had failed "to allege facts in support of their own investigation and due diligence."  Op. 48.

Securities Fraud

After determining that the Plaintiffs had stated a claim for securities fraud under the North Carolina Securities Act, Judge Murphy ruled that the individual defendants, employees of the corporate defendants, could be personally liable for the securities fraud, notwithstanding their argument that they had acted as corporate agents.

He held:

Defendants misapprehend the well-settled rule that ‘one is personally liable for all torts committed by him, including negligence, notwithstanding that he may have
acted as agent for another or as an officer for a corporation.’ Strang v. Hollowell, 97 N.C. App. 316, 318, 387 S.E.2d 664, 666 (1990) (citing Palomino Mills, Inc. v.
Davidson Mills Corp
., 230 N.C. 286, 52 S.E.2d 915 (1949)).

Op. 64.

What about the lack of justifiable reliance which doomed the common law fraud claim, you may be thinking.  Judge Murphy disposed of that in a footnote, saying: "The Court is unaware of any case law asserting that the common law fraud requirement for alleging justifiable reliance extends to statutory claims for securities fraud. And, the Court declines to extend such a requirement to this claim at this stage."  Op. 63 & n.2.

Derivative Action

A member of an LLC who wants to file a derivative action is required by statute to allege "with particularity the efforts, if any, made by [him] to obtain the action [he] desires from the  managers, directors, or other applicable authority and the reasons for [his] failure to obtain the action, or for not making the effort."  N.C. Gen. Stat. §§ 57C-8-01(a)–(b) (2011). 

The efforts of these Plaintiffs to make the LLC aware of their claims were limited to sending a letter outlining their claims along with the contemporaneously filed Complaint.  Judge Murphy found that to be "insufficient" to meet the requirements of the statute and he therefore dismissed the derivative claims.

And More

There are many more claims discussed in this Opinion, including an unfair and deceptive practice claim, a civil conspiracy claim, and a constructive trust claim.  There is also discussion of equitable estoppel and a request for an accounting.

 

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.

 

It’s hard to call a client and have to tell her that the case you filed for her was dismissed. But it must be even harder to tell a client that she now has to pay the defendant for his legal fees in winning the dismissal. And think how much worse that would be if the defendant were her ex-husband.  And it’s even worse if it’s Thanksgiving!

That hasn’t happened to me (at least not yet), and I hope it hasn’t happened to you, but it is the phone call that the lawyers representing Jane Sutton in Sutton v. Sutton, 2011 NCBC 43 probably had to make after Judge Jolly’s ruling in her case on the Tuesday before Thanksgiving.

Jane Sutton became a shareholder in her husband’s business, Sutton’s Tree Service, Inc. during their marriage. She filed a derivative action against her ex-husband on behalf of the corporation for conversion, breach of fiduciary duty and the “improper filing of income tax returns.” Op. ¶1.

There were two fatal flaws in this turkey of a lawsuit which led to its dismissal. The first was that there had been no demand on the corporation to take the action against Mr. Sutton. Section 55-7-42 makes a demand a precondition to the filing of a derivative action. It says:

No shareholder may commence a derivative proceeding until:

(1)        A written demand has been made upon the corporation to take suitable action; and

2)        90 days have expired from the date the demand was made unless, prior to the expiration of the 90 days, the shareholder was notified that the corporation rejected the demand, or unless irreparable injury to the corporation would result by waiting for the expiration of the 90‑day period.

There’s also a statutory requirement that the person filing the derivative action must have been “a shareholder of the corporation at the time of the act or omission complained of….” N.C. Gen Stat. §55-7-41(1). He or she must also be able to “[f]airly and adequately represent[] the interests of the corporation in enforcing the right of the corporation.” Id. At 55-7-41(2).

The second fatal flaw was that in addition to not making a demand, Mrs. Sutton hadn’t been a shareholder of the corporation since her divorce from Mr. Sutton, which was undoubtedly before the alleged misconduct had taken place. There had been a Consent Judgment by which Mrs. Sutton had “surrendered to Defendant any and all interest she had in the Corporation.” Op. ¶11.

Judge Jolly said that her lack of ownership was established as a matter of res judicata and collateral estoppel, since the “Consent Judgment constitutes a valid, final judgment determining the respective rights of Plaintiff and Defendant regarding ownership of the Corporation.” She therefore had no standing to maintain the suit, and Judge Jolly ordered that it be dismissed,

So what about the fees, you are wondering. The statute on fees in derivative actions says that “On termination of the derivative proceeding, the court may:. . .  Order the plaintiff to pay any defendant’s reasonable expenses, including attorneys’ fees, incurred in defending the proceeding if it finds that the proceeding was commenced or maintained without reasonable cause or for an improper purpose.” N.C. Gen. Stat. 55-7-46(2).

           

 

Continue Reading Expensive Lesson From The Business Court For Derivative Action Plaintiff Whose Case Was Dismissed

This week, Judge Jolly permitted a 50% shareholder to pursue derivative and individual claims against her co-shareholder. He found that the plaintiff had satisfied the demand requirement of G.S. sec. 55-7-42, and that she fit an exception to the general rule that a shareholder cannot pursue an individual cause of action for the diminution or destruction of the value of her stock.

The decision came in LeCann v. Cobham, a long running bitter dispute between dentists who operated a number of entities providing dental care.  LeCann said that Cobham had diverted funds from a practice in which they shared ownership to another dental practice operated solely by Cobham.

G.S. sec 55-7-42 says that a shareholder "may not commence a derivative proceeding" without having made a written demand "upon the corporation to take suitable action."  In discussing the adequacy of LeCann’s demand, Judge Jolly quoted Russell Robinson, who says that no specific form of demand is required by the statute:

except to require that it be in writing; but to serve its purpose it should set forth the facts of share ownership and  describe the redress demanded with enough particularity to allow the corporation either to correct the problem, if any, without a lawsuit or to bring its own direct action.

ROBINSON ON NORTH CAROLINA CORPORATION LAW, § 17.03[1] (7th ed. 2009).

There is no appellate North Carolina authority evaluating the sufficiency of a demand. The form of the LeCann written "demand" was several emails from LeCann to Cobham telling her to quit taking corporate funds for her own benefit  and to return what had been taken.  You can read one of the emails here. The Court said that these demands were "clear and particular enough to put Defendant Cobham reasonably on notice as to the substance of Plaintiff’s objections." 

Now, why did LeCann have the right to sue Cobham on an individual basis, especially in light of the NC Supreme Court’s opinion in Barger v. McCoy Hillard & Parks, 346 N.C. 650 (1997), where it held:

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.

Id. at 658.  Those types of claims affect all shareholders equally, and belong to the corporation.

LeCann said that she could pursue her claims on an individual because Cobham owed her a "special duty," a recognized exception to the Barger rule, as she was the only other shareholder in the companies.  Judge Jolly remarked that Cobham had asserted herself in her Answer that LeCann owed her a "duty of care, good faith, loyalty, fair dealing, full disclosure, [and] avoidance of self dealing."  He said given that each party claimed the other party owed her a fiduciary duty of care, that there was a genuine issue of material fact precluding a dismissal of LeCann’s claims.  He also equated the co-equal shareholders to partners, who certainly owe a fiduciary duty to one another.

 

 

 

 

In one of his final actions as a Business Court Judge, Judge Tennille threw down the gauntlet for lawyers representing class action plaintiffs who are seeking approval of settlements.  Last week in Ward v. Lance, Inc., Judge Tennille condemned what he called "stinky fees," which he said "just smell bad and have no economic justification."

Stinky fees, from Judge Tennille’s observation, are paid because "[w]e have come to the point in this country that whenever a merger is announced, some lawyer with a client holding a small number of shares rushes to file a lawsuit containing class action allegations."

But it wasn’t just the plaintiffs’ lawyers who got a lashing from Judge Tennille.  He included the lawyers defending these cases, the investment bankers who arrange the deals, and also the companies engaging in the transactions.  Here’s what he said:

For their part, defense lawyers, investment bankers, and the companies are willing to pay these fees to get the deal done, regardless of the merits. Defense lawyers get paid to handle them. The fees are not significant in light of the amounts involved in the deal. Defendants are, in effect, complicit in the economically valueless charade. Our overburdened courts do not have the time or adequate information to review the settlements. If we continue to impose these unnecessary financial burdens of our legal system on financial transactions, these transactions will eventually move to London, Hong Kong, or Munich, or some other venue outside the United States. . . .The Court suspects that investment bankers bake that fee into the anticipated costs of the transaction.

In a non-binding request to judges hearing fee petitions in future cases, Judge Tennille said
Ihat they "should decline to approve any settlement that does not benefit shareholders in a material way." 

There’s no way to tell if that request will be followed, but there are multiple cases pending which challenge the Duke Energy-Progress Energy merger.  In the absence of a material benefit to shareholders of those companies from the cases, it might be a good time for the Business Court to take a stand against what Judge Tennille called "an economically valueless charade."

 

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

 

 

The Court granted the motion to dismiss of a member of an LLC in which the Plaintiff sought dissolution, ruling that “'[i]t is not necessary to join members as parties to a proceeding to dissolve a limited liability company unless relief is sought against them individually, however the court shall order that appropriate notice of the dissolution proceeding be given to all members by the party initiating the proceeding.’” N.C. Gen. Stat. § 57C-6-02.1(b) (2007). The law is also clear that ‘[a] member of a limited liability company is not a proper party to proceedings by or against a limited liability company, except where the object of the proceeding is to enforce a member’s right against or liability to the limited liability company.” N.C. Gen. Stat. § 57C-3-30(b) (2007).’"

The Court further ruled that to the extent the complaint asserted claims against the Defendant regarding his management of the LLC, those claims were derivative in nature and Plaintiff was not entitled to pursue them individually.

Full Opinion

Brief in Support of Motion to Dismiss

Brief in Opposition to Motion to Dismiss

Reply Brief in Support of Motion to Dismiss