It is hard to base your case on a breach of fiduciary duty when there is a contract in place between the parties.  Contracting parties owe no special duties to each other beyond the terms of the contract.  Branch Banking & Tr. Co. v. Thompson, 107 N.C. App. 53, 61, 418 S.E.2d 694, 699 (1992).

But the NC Business Court twice in January allowed fiduciary duty claims to survive when the relationship between the parties was based on a contract.  The cases are Austin v. Regal Investment Advisors, 2018 NCBC 3 and Can-Dev, ULC v. SSTI Centennial, LLC, 2018 NCBC 9.

Breach Of Fiduciary Duty Claim Against Investment Advisor Gets Past Motion To Dismiss

The Plaintiffs in the Austin case, who had invested funds with the Defendants acting as their investment advisors, sued when the individual Defendant (Barnes) persuaded them to invest in a sketchy venture.  A key claim against the investment advisors was for breach of fiduciary duty.

You probably think that an investment advisor stands in a fiduciary relationship to his client as a matter of law (a de jure relationship), but no NC appellate decision has so held.  Judge Robinson didn’t see any need to take that step, and instead ruled that the facts alleged in the Complaint were sufficient at the Motion to Dismiss stage to support a de facto fiduciary relationship.  Op. 43.  He said:

that the Complaint’s allegations regarding the relationship between the parties, the amount of discretion given to Mr. Barnes and Regal to manage Plaintiffs’ investments, and the circumstances of the Triton investment, together with the allegations that Plaintiffs, who were not sophisticated investors, relied on Mr. Barnes and Regal for their financial expertise to manage their investment accounts, are sufficient at the Rule 12(b)(6) stage to plead the existence of a de facto fiduciary relationship.

Op. 43.

Breach Of Fiduciary Duty Claim Survived Motion For Summary Judgment When Contracting Party "Held All The Cards"

So does it get tougher to get beyond the summary judgment stage when you are claiming a de facto fiduciary relationship?  It didn’t for the Plaintiff in the Can-Dev decision. That Plaintiff had entered into a joint venture deal with the Defendants to develop self-storage facilities in Canada.  The contractual relationship was carefully detailed, and Judge Robinson noted the well accepted principle that 

parties to a contract do not thereby become each others’ fiduciaries; they generally owe no special duty to one another beyond the terms of the contract[.]

Op. 40 (quoting Branch Banking & Tr. Co. v. Thompson, 107 N.C. App. 53, 61, 41, 8 S.E.2d 694, 699 (1992)).

He then observed that:

the existence of a contract does not foreclose the possibility that a contracting party may repose trust and confidence in the other party, beyond the terms of the contract, such that the other party, in equity and good conscience, becomes bound to act in good faith and with due regard to the interests of the one reposing confidence.

Op. 40.

The standard for proving a de facto fiduciary relationship "is a demanding one."  Op. 37.  The NC Court of Appeals has said that "[o]nly when one party figuratively holds all the cards — all the financial power or technical information, for example — have North Carolina courts found that the special circumstance of a fiduciary relationship has arisen.” Lockerman v. S. River Elec. Membership Corp., 794 S.E.2d 346, 352 (2016).

Plaintiff Can-Dev got over that hurdle  (and at the summary judgment stage, which is all the more impressive).  The Defendants had taken over control of the development projects which were the subject of the contracts, and had failed to provide financial information regarding the projects to the Plaintiff.  Plaintiffs argued, successfully quoting the Court of Appeals’ decision in Lockerman, that this "resulted in Defendants “literally ‘[holding] all the cards — all the financial power [and] technical information[.]’”

                                                                          * * *

This isn’t the end of the road for the Plaintiffs in either of these cases.  They still have to prove their claims at trial, because whether a de facto fiduciary relationship exists it is "is generally a question of fact for the jury.”  Can-Dev at 40.

I should note that the Plaintiffs in the Austin case (the investment advisor case) are represented by Brooks Pierce lawyers Clint Morse and Jessica Thaller-Moran.

 

 

A lot of North Carolina court decisions have questioned whether a claim for "aiding and abetting a breach of fiduciary duty" can be made in North Carolina  (many of them are cited in ¶16 of the Islet Sciences Opinion referenced below). Most of those decisions have cast doubt on whether that claim is recognized at all in North Carolina, including several in the Business Court.  But no Business Court Judge has been willing to dismiss an aiding and abetting breach of fiduciary duty claim on the basis that it is not a valid claim in North Carolina

So parties keep asserting that questionable claim.  I wish they’d quit.  It’s a dead end.

Business Court Judge McGuire dismissed such a claim earlier this month in an Opinion in Islet Sciences, Inc. v. Brighthaven Ventures, LLC, 2017 NCBC 5.  The individual Defendants, Green and Wilkinson, had been officers and directors of the Plaintiff and therefore owed it a fiduciary duty.  They were also the owners of the Defendant Brighthaven, whose merger discussions with the Plaintiff had fallen through.  The Plaintiff alleged in support of its claim that Brighthaven had provided "substantial assistance to Green and Wilkinson in breaching [their] fiduciary duties" and had therefore aided and abetted those breaches. Op. ¶15.

The Internal Affairs Doctrine

The Plaintiff, a Nevada corporation, argued that the law of Nevada — which recognizes an aiding and abetting breach of fiduciary duty claim — should control and that Defendant Brighthaven’s Motion to Dismiss should be denied.  The argument for the application of Nevada law was premised on the internal affairs doctrine.

Maybe you don’t remember the internal affairs doctrine.  The NC Court of Appeals has defined it as:

a conflict of laws principle which recognizes that only one State should have the authority to regulate a corporation’s internal affairs — matters peculiar to the relationships among or between the corporation and its current officers, directors, and shareholders — because otherwise a corporation could be faced with conflicting demands.

Op. ¶18 (quoting Bluebird Corp. v. Aubin, 188 N.C. App. 671, 680, 657 S.E.2d 55, 63).

It wasn’t difficult for Judge McGuire to shoot down the internal affairs argument, given that the corporate Defendant was an outsider to the Plaintiff, not one of its officers or directors.  He held that:

While a standard of fiduciary responsibility expected of officers and directors of a corporation generally should be the subject of uniform regulation by the state of incorporation, the same concerns do not necessarily apply to the conduct of third-party corporate outsiders that may lead to tort liability for aiding and abetting.  Such third party conduct does not implicate the standard to which a director or officer should be held; that standard is best left to determination by the state of incorporation.

Op.. ¶22 (emphasis added).

The Pleading Standard For A Non-Existent Claim

After determining that North Carolina law controlled the question of the validity of the aiding and abetting claim, Judge McGuire held the Plaintiff to a heightened pleading standard.  He said that pleading such a claim (even if it doesn’t exist) requires "facts supporting an allegation of “substantial assistance by the aider and abettor in the achievement of the primary violation.’”  Conclusory facts like those alleged by the Plaintiff — that the abettor “was aware of [the fiduciary’s] . . . acts and rendered substantial assistance” — didn’t suffice.  Op. ¶27.  The claim was therefore dismissed.

The need for factual specificity in an aiding and abetting claim comes from an NC Court of Appeals decision cited by Judge McGuire (Op. ¶27): Bottom v. Bailey, 238 N.C. App. 202, 767 S.E.2d 883 (2014).  The Bottom case, which relies on another appellate decision, says that:

the tort of aiding and abetting a breach of fiduciary duty, according to Blow [v. Shaughnessy, 88 N.C. App. 484, 364 S.E.2d 444 (1988)], requires “(1) the existence of a securities law violation by the primary party; (2) knowledge of the violation on the part of the aider and abettor; and (3) substantial assistance by the aider and abettor in the achievement of the primary violation.”

Despite its articulation of that standard, the Bottom decision was unsparing in its assessment that an aiding and abetting breach of fiduciary duty claim cannot be made in North Carolina.  It said:

The court finds that no such cause of action exists in North Carolina. It is undisputed that the Supreme Court of North Carolina has never recognized such a cause of action. The only North Carolina Court of Appeals decision recognizing such a claim, Blow v. Shaughnessy, 88 N.C. App. 484, 489, 364 S.E.2d 444, 447–48 (1988), involved allegations of securities fraud, and its underlying rationale was eliminated by the United States Supreme Court in Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164, 114 S.Ct. 1439, 128 L.Ed.2d 119 (1994).

238 N.C. App. 202, 211.

The Business Court has often dismissed fiduciary duty/aiding and abetting claims.  Like in Tong v. Dunn, 2012 NCBC 16,  Regions Bank v. Regional Property Development Corp., 2008 NCBC 8, Battleground Veterinary Hospital, P.C. v. McGeough, 2007 NCBC 33; and Sompo Japan Insurance Inc. v. Deloitte & Touche, LLP, 2005 NCBC 2.

But the Business Court has never dismissed that type of claim on the basis that it is not recognized in North Carolina.  It is inevitable that that is going to happen, but until then, the Court will find another way to dismiss those claims.  Don’t waste your time making that claim.

It is probably a good idea for a corporation to avoid making fiduciary duty claims against its employees  (unless they are also officers and directors).  Clients (or their lawyers) who insist on making such claims are liable to be assessed with the attorneys’ fees of the persons they sue, at least based on the circumstances in Judge Gale’s Order last week in Southeast Air Charter, Inc. v. Stroud, 2015 NCBC 79.

Southeast Air Charter had brought suit against three of its former employees, none of whom were officers or directors of the Plaintiff, alleging that they had breached their fiduciary duties to it.  It’s not hard to be aware that fiduciary duty claims against "rank and file" employees are rarely going to get past a Motion to Dismiss.  The North Carolina Supreme Court pretty much eliminated the possibility of making a fiduciary duty claim against a non-officer or director employee almost fifteen years ago, in Dalton v. Camp, 353 N.C. 647, 548 S.E.2d 704 (2001).

Judge Gale wrote in his Southeast Air Charter ruling that:

[a]bsent extraordinary circumstances of special relationships of trust and confidence leading to dominion and control, employees who are not also officers and directors should not be put to the burden of defending fiduciary duty claims.

Order ¶26.

The Court had previously ordered that Rule 11 sanctions were appropriate for the Plaintiff "having filed the claims for which Plaintiff had no reasonable basis to believe were factually supported."  By the time the Court ordered sanctions, the Plaintiff had voluntarily dismissed all of its claims.  The ruling granting the Defendants’ Motion for Sanctions was entered in a June 30, 2015 unpublished Order.

The purpose of this week’s Order was to determine the appropriate amount of the sanction.  The Court had to determine how to allocate the attorneys’ fees incurred by these Defendants, all of whom were represented by the same law firm.  The law firm requested a total of $35,887.01.  It broke that down as $19,322 for one of the Defendants (Steiner-Crowley) against whom all of Plaintiff’s claims were deemed to be in violation of Rule 11, and an amount representing one-third of the total fees incurred by the two other Defendants (Robinson and Viall) who were subjected to not only the fiduciary duty claims deemed to have been made in violation of Rule 11 but also a variety of other claims that were not subject to Rule 11 sanctions.

Judge Gale didn’t agree with those proposed allocations.  As to Defendant Steiner-Crowley, even though all the claims against her were subject to Rule 11 sanctions, he did not award her all of her fees.  Given that Steiner-Crowley had said that there was never any basis for the claims brought against her, the Court said that she "should bear some responsibility for not attacking those claims on the pleadings before incurring significant other expense."  Order ¶16.  In its discretion, the Court discounted her fees by fifty percent.

For Defendants Robinson and Viall, the determination of fees was more difficult.  Those Defendants had faced multiple claims, only two of which were subject to Rule 11 sanctions.  Their counsel suggested that they each receive a third of the fees they had paid.  Should they, like Steiner-Crowley have mounted an early attack on the claims forming the basis for sanctions?

Judge Gale recognized the "strategic considerations"  dictating that an early Motion to Dismiss not be filed.  He said:

[e]ven if counsel believed the motion was strong regarding the claims now subject to sanctions, the strong possibility that other claims would have survived an early dispositive motion justified allowing even the weak claims to survive. 

Order ¶20.

The Court then looked at the total fees billed for the entire representation, and found them to be reasonable.  But it determined that awarding one-third of the total fees would be excessive, as:

it cannot determine that this amount was incurred solely because [the pleadings] included the breach of fiduciary duty . . . claims.

Order ¶22.The Court found that an appropriate sanction would be ten percent of the fees charged.

Even after the cutting of the amount of fees sought, this was not an insignificant sanction.  The total fees awarded were $14,680.70.  Order ¶23.  And after some discussion about whether it was reasonable for Plaintiff’s counsel to rely on his client’s representations to make the fiduciary duty claims, Judge Gale ordered that the Plaintiff should bear the entire burden of the sanction as opposed to it being shared jointly with its lawyer.

If you are thinking that the award of nearly $15,000 in fees was not enough to give the Defendants a full recovery, Judge Gale dealt with that point as well.  he said:

the purpose of imposing Rule 11 sanctions is not to assure a full recovery on claims arising from a common factual nucleus.  Rather, the purpose is to sanction conduct and the statutory direction is to sanction only that portion of efforts that would not have been required but for the improper claims.

Order ¶22 & n.1.

 

 

Judge Gale’s decision earlier this month in Corwin v. British American Tobacco PLC, 2015 NCBC  74 dismissed all of the claims of the Plaintiff class.  If the name Corwin is ringing a bell with you, his case is the shareholder class action over the now completed transaction among Reynolds American, Inc. (RAI), Lorillard, Inc., British American Tobacco (BAT), and Imperial Tobacco Group.  RAI (which you probably still think of as RJ Reynolds Tobacco Company) is the second largest tobacco company in the United States.  Defendant BAT  is RAI’s largest shareholder, holding 42% of its stock.  RAI acquired Lorillard (then the third largest tobacco company in the U.S.) in the transaction.

BAT helped fund RAI’s purchase of Lorillard (for $27.4 billion) by buying approximately $4.7 billion in RAI stock in order to maintain its 42% ownership of RAI.  RAI funded the remainder by selling of several of its popular cigarette brands to Imperial Tobacco Company, a tobacco holding company headquartered in Bristol, England.

Corwin’s action asserted that BAT and RAI’s  board of directors had breached their fiduciary duty of candor to him and other BAT shareholders by making inadequate disclosures regarding the transaction.  The claim that the disclosures were inadequate were resolved by a settlement in January 2015.  You can read that settlement agreement here.

Did BAT, RAI’s 42% Shareholder, Owe A Fiduciary Duty To RAI’s Minority Shareholders?

The issue before Judge Gale was whether BAT, which held only 42% of RAI’s shares and was therefore not a majority shareholder of RAI’s stock, owed any fiduciary duty at all to Corwin and the class of minority shareholders which he was seeking to represent.

North Carolina Law

If you are thinking that in North Carolina only majority shareholders owe a fiduciary duty to minority shareholders, and are skilled enough at math to know that 42% is not a majority, then you are dead on target.  Judge Gale wrote that "North Carolina courts have never squarely addressed whether a minority shareholder can exercise control adequate to impose such a fiduciary duty."  Op. ¶46.

Corwin argued that a fiduciary duty should be imposed because North Carolina precedent turned on whether the shareholder exercised "dominance and control, which can exist without majority ownership or voting control."  Op. ¶46.

To be fair to Mr. Corwin, loose language (you might say dicta) in North Carolina appellate decisions can be read to support the position that a minority shareholder’s control (absent majority ownership) of a corporation can result in that shareholder owing a fiduciary duty to its fellow shareholders.  Judge Gale cited the following cases for that proposition:

See, e.g., Hill v. Erwin Mills, 239 N.C. 437, 444, 80 S.E.2d at 358, 363 (1954)("It is the general rule that when the fairness of transactions between a corporation and one dominating its policies is challenged, the burden is upon those who would maintain such transactions to show their inherent fairness to all parties concerned."); T-WOL Acquisition Co. v. ECDG S, LLC, 220 N.C. App. 189, 208 n.8, 725 S.E.2d 607, 617 n.8 (2012) ("[C]ontrolling or majority shareholders owe a fiduciary duty to minority shareholders in a closely held corporation." (emphasis added)); Freese v. Smith, 110 N.C. App. 28, 37, 428 S.E.2d 841, 847 (1993) ("In North Carolina, it is well established that a controlling shareholder owes a fiduciary duty to minority shareholders."); . . . .  Fulton v. Talbert, 255 N.C. 183, 185, 120 S.E.2d 410, 412 (1961) ("[W]here the corporation is so dominated and controlled by a wrongdoer as to be powerless to act, minority stockholders may bring the action, making the corporation a party.").

Op. ¶53.  Judge Gale, upon reviewing those cases, concluded that none of these North Carolina cases held that a "controlling shareholder must be a majority owner" but that in each case imposing a fiduciary duty, "the shareholder subject to that duty either owned or had control over a majority interest."  Op. ¶51.  He said that North Carolina precedent:

leaves open the specific question of whether a minority shareholder can exercise the degree of control . . . adequate to impose a fiduciary duty on that shareholder.

Op. ¶53.

The argument that North Carolina would impose a fiduciary duty on a non-majority shareholder therefore failed, Judge Gale then turned to Plaintiff’s argument that Delaware law placed a fiduciary duty on a "controlling" — even if minority — shareholder.

Delaware Law Says That A Minority Shareholder Can Owe A Fiduciary Duty Under Certain Circumstances

The Delaware cases on which Corwin relied in support of his fiduciary duty argument were distinguished by Judge Gale as requiring "actual, rather than theoretical control" before imposing that duty.  Op. ¶56.

There is a presumption in Delaware "that a shareholder who owns less than fifty percent of the outstanding stock of a corporation is not a controlling shareholder.  Op. ¶56.

Getting past that presumption requires detailed allegations of actual control.  Judge Gale said that:

Delaware courts impose a significant pleading burden to allow a fiduciary claim against a minority shareholder and will dismiss such a claim under Delaware’s Rule 12(b)(6) in the absence of sufficient allegations.

Op. ¶56.

Corwin’s Complaint contained "significant detail," (Op. ¶62), which Corwin said demonstrated BAT’s control over RAI (summarized in ¶62 of the Opinion), including a "Governance Agreement," between RAI and BAT which gave BAT veto power over whether certain intellectual property of RAI could be sold to complete the deal and a variety of other factors.

Judge Gale said, after reviewing Corwin’s argument, that BAT had influence over the transaction but that "[i]nfluence does not equate to control and the potential imposition of a fiduciary duty turns on evidence of actual control."  Op. ¶63.

The conclusion of the Court was that even if North Carolina were to follow the Delaware standard, that the Complaint’s allegations did not:

adequately allege that BAT’s control over the Transaction was considerable enough to be the voting and managerial equivalent of a majority shareholder’s control, or so potent that the independent Other Directors were unable to exercise their judgment freely with[out] fearing BAT’s retribution.

Op. ¶65 (citation omitted).

The Court went on to dismiss fiduciary claims against the RAI directors.  That dismissal involved a discussion of whether a shareholder has standing to bring a direct claim against a member of a board of directors. That sort of claim is generally brought on a derivative basis.  Judge Gale sidestepped the standing issue, ruling that the attempted claim against the RAI directors failed on the merits..Op. ¶74..

What’s Next

Given Corwin’s marked lack of success on his claims regarding the RAI Transaction,  I’m wondering how much Corwin’s counsel will dare to ask for in fees for getting the "disclosure only" settlement which they obtained in January of this year.  My views on the value of such settlements are that they often bring little value to the members of the shareholder class obtaining them and that the fees awarded should take that into account.

Judge Gale directed Corwin’s counsel to file a motion for approval of their settlement before the end of August.  We will soon see if this settlement will spin off a sizeable fee.

 

 

Were you thinking that the Business Court might, one day, find that a bank owed a fiduciary duty to its customer?  That seemed like it might happen eventually, as the NC Supreme Court seemed to hold out that possibility last year, in Dallaire v. Bank of America, N.A., 367 N.C. 363, 368 (2014), in which it said that:

it is possible, at least theoretically, for a particular bank-customer transaction to give rise to a fiduciary relationship under the proper circumstances.

But on Monday of this week, in RREF BB Acquisitions, LLC v. MAS Properties, LLC, 2015 NCBC 58, Judge McGuire stuck to the long-standing case law in North Carolina that a lender does not owe any fiduciary duties to its customer.  At the same time, however, he also recognized a new cause of action which might have ramifications for claims against any type of entity (not just a lender) which decides to break off negotiations with an opposing party.

The Plaintiff RREF had purchased from BB&T two loans totaling $5.275 million which BB&T had made to the Defendants back in 2005.  It had purchased the loans from BB&T while they were in default, and shortly after BB&T stopped negotiating a forbearance agreement with the Defendants.

No Fiduciary Duty

The Defendants’ lead argument against RREF’s lawsuit to collect on the loans was that BB&T had violated a fiduciary duty it owed to them.  They said that BB&T had breached its duty by failing to disclose its attempts to sell their loans while it was in the midst of negotiating a forbearance agreement with them.

The Defendants claimed that if they had known that BB&T was selling their loans, they would have tried to buy them themselves or had a third party buy the loans on their behalf.

The basis argued by the Defendants for BB&T’s alleged fiduciary duty was that they had a thirty year relationship with a local office, and that they had worked closely with the Bank in developing various residential communities and in selling homes in those communities.  Op. ¶41.  BB&T responded that it owed no fiduciary duties to the Defendants and that it was simply pursuing the options available to it as the holder of loans that were in default.

As Judge McGuire noted, "[t]here is no reported North Carolina appellate case in which a fiduciary relationship has been found in a borrower-lender transaction."  Op. ¶38.  Given that one of the hallmarks of a fiduciary relationship is "a duty of the fiduciary to act in the best interests of the other party," Judge McGuire held that "it would seem nearly antithetical to require a commercial lender to put a borrower’s interest ahead of its own in a business transaction."  Op. ¶41.

Another reason the Court refused to find a fiduciary relationship lay in the restructuring negotiations themselves.  Both the Defendants and the Bank were at this point represented by attorneys and were "negotiating to protect their respective best interests."  (Op. ¶43).  If there ever had been a fiduciary relationship between them, "such relationship ceased once BB&T declared Defendants in default of the Loans and the positions of the parties became adverse."  Op. ¶43.

The New Cause Of Action: Breach Of A Duty To Negotiate In Good Faith

Although it did grant summary judgment on the fiduciary duty claim, the Court nevertheless allowed the Defendants to go forward on a new claim hitherto not formally recognized in North Carolina: breach of a duty to negotiate in good faith.

 

Continue Reading NC Business Court Says That Bank Didn’t Owe A Fiduciary Duty To Its Customer, But Recognizes New Cause Of Action: Breach Of A Duty To Negotiate In Good Faith

When I wrote last week about Americana Development, Inc. v. Ebius Trading & Distributing Co., the Business Court had entered a TRO against the Defendants prohibiting them from disposing of the intellectual property of Defendant Ebius Trading and using the proceeds to pay off debts which had been personally guaranteed by its officers and principals.

This week,  the court followed up with an Order granting a Preliminary Injunction prohibiting the same conduct, and it has also appointed a Receiver to handle the disposition of the assets of the Defendants.

If you are not familiar with the concept of receivership, North Carolina allows for the appointment of a receiver "when a corporation becomes insolvent or suspends its ordinary business for want of funds, or is in imminent danger of insolvency. . . ."  N.C. Gen. Stat. §1-507.1.  It is often referred to as the state law equivalent of bankruptcy.

You might be wondering why injunctive relief wasn’t sufficient in this case.  Judge Jolly expressed concern about the willingness of the individuals associated with the corporations to promptly liquidate the intellectual property of the entities.  He said that:

the value of the intellectual property has a finite shelf life.  Federal courts have long recognized that the appointment of a receiver (or interim trustee in bankruptcy) may be necessary to promptly liquidate assets when the assets are ‘liable to deteriorate in price and value.’

Op. 28 (quoting Collier on Bankruptcy 2002.02[2]).

He granted the Receiver broad powers, literally running from a to z in the Court’s Order.

The only one that I blinked at was its ruling that the person appointed as the Receiver (a lawyer in a law firm) would be entitled to the "customary hourly rates" for him and other members of his firm.  Order at 17. That may be excessive unless the Receiver or members of his firm end up performing services "beyond the ordinary routine of a receivership," as the receivership statute says that:

the court shall allow a reasonable compensation to the receiver for his services, not to exceed five percent upon receipts and disbursements, and the costs and expenses of administration of his trust and of the proceedings in said court, to be first paid out of said assets. The court is authorized and empowered to allow counsel fees to an attorney serving as a receiver (in addition to the commissions allowed him as receiver as herein provided) where such attorney in behalf of the receivership renders professional services, as an attorney, which are beyond the ordinary routine of a receivership and of a type which would reasonably justify the retention of legal counsel by any such receiver not himself licensed to practice law.

G.S. §1-507.9.

If you are thinking that this receivership remedy sounds attractive and is easy to obtain, you are wrong.  Judge Jolly stated at the outset of his opinion that "receivership is a ‘harsh’ remedy and ‘should be utilized only with "attendant caution and circumspection."’  He also said that "a receivership is appropriate ‘only where there is no other safe or expedient remedy.’"  Op. 24.

In the circumstances of this case, where the principals of the corporations were "engaged in fraud and gross misconduct in the management" of those corporations (Order 26), the appointment of  a Receiver was deemed appropriate. 

Don’t forget that this outstanding result was obtained by my Brooks Pierce colleague Clint Morse.

 

When I was a young pup preparing to go to court against the uncommon adversary who was proceeding without a lawyer, I would joke that "I hope I don’t lose."  Luckily, I never did.

But the Plaintiff in Seraph Garrison, LLC v. Garrison, 2014 NCBC 28, didn’t have the same good luck.  It lost a case, following trial by Judge Murphy, to a Defendant who had no lawyer and didn’t even bother to appear for trial.

Defendant Garrison was the CEO and a member of the Board of Directors of Garrison Enterprises, Inc.  He was sued derivatively for breaching his fiduciary duty to the corporation.  The alleged breaches included:

  • failing to pay payroll taxes due from the corporation.
  • failing to make 401(k) contributions.
  • executing a significant contract with an outside vendor without obtaining Board approval.

All of these things were uncontested at trial, but the defalcating Defendant escaped without any liability without even appearing at trial.  How so?

Judge Murphy said that:

Plaintiff has failed to present evidence that Defendant’s decision not to pay payroll taxes and 401(k) contributions was not in good faith, beneath the standard of care an ordinarily prudent person in a like position would exercise under similar circumstances, or not in a manner Defendant reasonably believed to be in the best interests [of[ the corporation.

Op. ¶38.

The evidence was that the corporation was in a cash crunch, and the Defendant had chosen to pay employees rather than the IRS obligations in order to keep the business running.

And as to the unapproved contract,  the Judge said that there was"insufficient evidence before the Court to support a finding that Defendant was obligated to seek approval before entering into contracts on behalf of" the corporation.  Op. ¶41.

But the Court found that the Defendant had breached his fiduciary duty by misleading the Board on the contents of the contract.  He had presented the Board with a previous unexecuted draft of the contract which was more favorable than the one he ended up actually signing.  No damages were awarded for this breach, because the Court ruled that the Board had not relied on the misrepresentation.

In any event, this unrepresented Defendant escaped scot-free.  There was no showing of the Board relying on his misrepresentation to its detriment.

Just a caution:  If you are thinking that you can proceed without a lawyer in the Business Court because of this case, you are wrong.  Don’t do it.  But to be fair to this Plaintiff, who lost against a pro se rival, it was more than good luck for the Defendant.  He was represented by counsel until his lawyer withdrew, shortly before trial.

 

Dual agency is a big deal to real estate agents.  It lets them represent both a buyer and a seller in a transaction.  Dual agency was the focal point of the Business Court’s opinion last week in BDM Investments v. Lenhil, Inc., 2014 NCBC 6.  The Opinion shows the dangers of failing to disclose that you are acting as a dual agent.

If a real estate agent is acting as a dual agent she owes a fiduciary duty to both the buyer and the seller, "and must make a full and truthful disclosure . . . of all material facts [concerning] the [p]roperty."  Op. ¶43.

The fact of the dual agency is a material fact and must be disclosed.  Op. ¶44. 

Hollingsworth, one of the Defendants, did have a real estate license at the time of the transaction, but there’s an issue of material fact whether he was acting as an agent for either the buyer or seller in the transaction.  Plaintiffs said that they would not have purchased ten residential lots for $850,000 if Hollingsworth had disclosed his relationship with the seller and the fact that he would earn a commission on the sale. 

The Plaintiffs wanted to rescind the transaction and get their $850,000 back, but there was nothing wrong with the property purchased, and there had been no misrepresentations about it by the purported agent.  As Judge Murphy observed, there are no:

case[s] under North Carolina law considering whether an undisclosed dual agency,
without any other misrepresentation or omission, permits a party to rescind a real
estate transaction if a jury finds the failure to disclose led to the purchase.

Op. ¶52.

He relied on two non-North Carolina opinions in ruling that if the jury at trial were to conclude that the failure to disclose a dual agency led to the decision to buy the property, that the Plaintiffs would be entitled to the remedy of rescission and also to pursue damages against Hollingsworth for "injuries not fully remedied by recovery of its purchase price."  Op. ¶53.

There would also be the danger of Hollingsworth having his real estate license revoked.  The General Statutes provide that a broker’s license can be revoked for representing "more than one party in a transaction without the knowledge of all parties for whom he or she acts."  N.C. Gen. Stat. §93A-6(a)(4).  Hollingsworth died after the lawsuit was filed, so he doesn’t face that danger. 

There are many more claims discussed in the BDM decision, but I have focused only on the dual agency aspect of the case because I am engaged to a real estate agent and I am of course now fascinated by real estate issues.  I felt it was necessary to make that disclosure.

 

The best lines in Green v. Freeman, decided last week by the NC Supreme Court, are that "[t]he doctrine of piercing the corporate veil is not a theory of liability.  Rather, it provides an avenue to pursue legal claims against corporate officers or directors who would otherwise be shielded by the corporate form."  Op. 17-18 (emphasis added).

That means it’s not enough to show merely that the shareholder has so "dominated the corporation" that its "corporate separatedness" should be disregarded.  As Justice Martin put it, "sufficient evidence of domination and control establishes only the first element for liabilityThere must also be an underlying legal claim to which liability may attach."  Op. 17.

The Supreme Court reversed the jury’s verdict that one of the defendant corporation’s directors had breached a fiduciary duty to the Plaintiffs and that she was accordingly personally liable due to her domination and control of the corporation.  It also found that no fiduciary duty was owed to the Plaintiff by the defendant director.  It remanded the case to the Court of Appeals to consider another theory of liability.

Is there anything else of interest in the Green case?  It’s got some good language to cite in future cases for the well-accepted principle that directors of a North Carolina corporation don’t owe a fiduciary duty directly to shareholders:  "The General Assembly has expressly indicated its intent “to avoid an interpretation [of N.C.G.S. §55-8-30]. . .that would give shareholders a direct right of action on claims that should be asserted derivatively” and to avoid giving creditors a generalized fiduciary claim."  Op. 9.  Of course, there are numerous Business Court cases stating the same principle, but it’s always nice to have a Supreme Court case to rely on.

My basic comment about this case is that it represents the application of long established rules in the context of litigation against corporate officers and directors, and that it breaks no new ground.

It’s worth noting that piercing the corporate veil claims are mostly unsuccessful.  Five years ago, Justice Timmons-Goodson of the NC Supreme Court said  that "proceeding beyond the corporate form is a strong step: ‘Like lightning, it is rare [and] severe[.]’"  That’s the last time the State’s high Court spoke to the subject.

And don’t forget that piercing the corporate veil allegations are not a basis for mandatory jurisdiction in the Business Court.

If you are a partner in a limited liability partnership, or if you have clients who are, you’ll want to read Judge Gale’s opinion in Chesson v. Rives, 2013 NCBC 49, decided last week.  It provides guidance on the rights of partners withdrawing from LLPs.

Chesson, one of the Plaintiffs, was a partner in an accounting firm, Rives & Associates, an LLP.  Chesson and two other partners withdrew from the firm, and then sued two of their former partners on a variety of claims, including breach of fiduciary duty, constructive fraud, and "constructive expulsion."

The case is a good reminder that most of the relationship between partners is governed by the Uniform Partnership Act (Chapter 59 of the General Statutes), but can often be modified by a written Partnership Agreement.

Can a partner make claims against his partners after he has withdrawn from the partnership?  Judge Gale said that "[a]lthough Plaintiffs withdrew from the partnership, they retained personal rights for the value of their partnership interest at the time of their withdrawal."  Op. ¶22.  In other words, the withdrawing partners had standing to make their claims.

Didn’t the former partners’ withdrawal result in a dissolution of the partnership? Ordinarily it would have, because dissolution "occurs automatically by operation of law upon any partner’s unequivocal expression of an intent and desire to dissolve the partnership."  Op. ¶29 (quoting Sturm v. Goss, 90 N.C. App. 326, 332, 368 S.E.2d 399, 402-03 (1988)),  In this case, the partnership agreement provided that the non-withdrawing partners could continue the partnership.

Does a partner have to make a demand on the partnership, and have that demand refused,  before suing for an accounting?  Judge Gale said that a demand was not necessary.

Can Partners eliminate the fiduciary duties they owe to one another via a partnership agreement? No, "a partnership agreement cannot eliminate those enumerated fiduciary duties partners owe to one another as a matter of law."  Op. ¶26.  Those "duties include providing full information to the partnership, accounting for the use of partnership property, disclosing self-dealing transactions, and remitting profits obtained through transactions affiliated with the partnership’s business." Id.

Thus, the partners who had withdrawn had not lost claims that the remaining partners had diverted partnership assets to themselves personally and had used partnership assets to form a separate entity.

What is the measure of damages for partners who have withdrawn?  "Absent agreement to the contrary, upon dissolution which was not caused by contravention of the partnership, a partner’s right is his pro rata share of the net value of the partnership assets at the time of dissolution."  Op. ¶30.

What about a claim for "constructive expulsion," that the remaining partners had made working conditions so intolerable that they forced a resignation?  North Carolina "does not recognize a claim for wrongful expulsion from a partnership," held Judge Gale.  Op. ¶36.

At least accountants don’t commonly have contingent fee engagements.  Those can cause real headaches in valuation, as the Court’s opinion last year in Mitchell v. Brewer, 2013 NCBC 14, illustrates.  I wrote about that case last year.