Judge Robinson boldly went where no North Carolina Judge writing published Opinions had gone before last month in the case of Wheeler v. Wheeler, 2018NCBC117.  The subject was a corporate officer’s right to the advancement of legal fees incurred in defending against a lawsuit.

Judge Robinson noted that there was only “one case in which our appellate courts have dealt with the issue of advancement.”  Op. ¶1 & n.1.  That case was inapplicable to the Wheeler decision.

Advancement (the right for an officer, director, agent or employee of a corporation to be reimbursed for expenses incurred in litigation) is governed by G.S. §55-8-53.  The right to be indemnified for a liability resulting from such litigation is governed by G.S. §55-8-51.

The corporation of which Plaintiff (Gray Wheeler) was an officer, director, and shareholder had provided for advancement and indemnification rights in its Bylaws.  It was the Gray Wheeler who was seeking advancement.  The corporation refused to advance his legal fees and expenses, and Wheeler moved for a preliminary injunction forcing the Defendant corporation to pay his fees and expenses.

Why Was A Plaintiff Seeking Advancement?

Plaintiff Wheeler initiated the lawsuit before the Business Court, alleging a breach of fiduciary duty by one of his co-directors and shareholders, and also seeking dissolution of the corporation.  There was no advancement due for those claims.

Instead, Plaintiff sought advancement for counterclaims brought against him as well as a separate arbitration filed against him.

The corporation took the position that counterclaims are not “an action, suit or proceeding” for which advancement is allowed.

Judge Robinson didn’t waste much time in rejecting that argument, holding that the language in the Bylaws “contained no language excluding counterclaims . . . .”  Op. ¶80.

The Relationship Between Advancement And Indemnification

The General Statutes prohibit indemnification:

(1) In connection with a proceeding by or in the right of the corporation in which the director was adjudged liable to the corporation; or

(2) In connection with any other proceeding charging improper personal benefit to him, whether or not involving action in his official capacity, in which he was adjudged liable on the basis that personal benefit was improperly received by him.

N.C. Gen. Stat. §55-8-51(d).  Also, a corporation may not provide indemnification to a person for “activities which were at the time taken known or believed by him to be clearly in conflict with the bests interests of the corporation.”  N.C. Gen. Stat. §58-8-57(a).

The Defendant corporation argued that it was not obligated to advance Wheeler’s litigation expenses and fees.  It said it would not be permitted to indemnify him because Wheeler had to have known that the conduct at issue was in conflict with the best interests of the corporation.  In other words, its position was that the right to advancement is dependent on the right to indemnification.

Not so, said Judge Robinson, looking to the more well-developed Delaware law on this subject.  He held:

The Delaware Supreme Court has held that “[a]lthough the right[s] to indemnification and advancement are correlative, they are separate and distinct legal actions.” Generally, “[t]he right to advancement is not dependent on the right to indemnification.

Op. ¶58 (citations omitted).

 

Can A Corporate Officer Or Director Ever Obtain An Injunction To Force Advancement?

So after finding that Plaintiff Wheeler had shown a clear likelihood that he was likely to succeed on the merits on his claim for advancement, why didn’t Judge Robinson enter an injunction requiring the corporation to advance his legal fees?

The short answer is that Gray Wheeler hadn’t shown that he would be irreparably harmed if he did not receive an injunction.  On this point, there was no guidance from the Delaware courts because advancement claims in that State “are decided in separate, stand-alone proceedings and/or on summary judgment, not by means of a preliminary injunction” Op. ¶87.  That is a function of the Delaware statute governing advancement.  Del. Code Ann. tit. 8, § 145(k).

Wheeler’s pursuit of an injunction to assure his advancement rights was an issue of first impression in North Carolina.  Op. ¶86.

The injunction sought by the Plaintiff was a mandatory injunction as opposed to the more common prohibitory injunction.  If you missed learning about that distinction (maybe it was in first year Civil Procedure), here is the difference:

‘A prohibitory injunction seeks to preserve the status quo, until the rights of the parties can be determined, by restraining the party enjoined from doing particular acts.’. . .  In contrast, ‘[a] mandatory injunction is intended to restore a status quo and to that end requires a party to perform a positive act.’

Op. ¶35.

The burden for obtaining a mandatory injunction is greater than that for a prohibitory injunction.  Op. ¶101.  Thus, Wheeler was required to” show that the injury was “immediate, pressing, irreparable, and clearly established.”  Op. ¶84.

Wheeler ran into the well-established principle that “where an injury may be compensated by the payment of monetary damages, the injury is not irreparable, and an injunction should not issue.”  Op. ¶92.

Judge Robinson did not rule out the possibility that a person denied advancement might suffer irreparable harm warranting an injunction.
But the Plaintiff’s contention that he lacked the funds to “continue effectively defending himself” were not enough.  Wheeler said that his lawyers had already billed him more than half a million dollars for his defense.

Judge Robinson observed that Wheeler had “submitted no evidence showing that he has been unable to pay these fees as they became and become due.”  Op. ¶96.  Wheeler’s only effort in establishing his inability to pay his lawyers was to say that his net worth was “concentrated in illiquid assets.  That “illiquidity” was said to be tied up in an apartment he owned in New York City, a house in Asheville, NC, and his and his wife’s 401(k) accounts.

Judge Robinson was unimpressed by this claimed illiquidity, and said that  he was “unable to obtain loans or borrow against any of his illiquid assets to pay his legal fees as they become due.”

The Judge also brushed aside the argument that Wheeler’s litigation strategy had been affected because he could not afford to “take a more aggressive approach with expert witnesses.”  Op. ¶100.  Assuming that “more aggressive” meant “more expensive,” Wheeler hadn’t identified
who the “more costly expert witnesses” are, the claims on which they would testify, and how this testimony might improve Gray’s chances of ultimate success in defense of the . . . claims against him. Op. ¶100.

 

Wheeler Was Not Entitled To Advancement For Some Of The Claims Made Against Him.

The corporate Bylaws provided that Wheeler was entitled to indemnification for claims brought “by reason of the fact” that he was acting as an officer or a director.  The “by reason of the fact” language is contained in the Delaware indemnification statute (Del. Code. Ann. tit. 8, §145(a)-(b)), so Judge Robinson looked to Delaware law for interpretation of this phrase.

He held:

“[I]n order for one to be deemed a party to a proceeding ‘by
reason of the fact’ of one’s corporate position, there must be a ‘causal connection or nexus’ between the underlying proceedings and ‘the corporate function or “official [corporate] capacity. . . .  ‘The requisite connection is established ‘if the corporate powers were used or necessary for the commission of the alleged misconduct.’

Op. ¶72 (citations omitted).

The claim in question involved Wheeler’s breach of his obligation to tender his shares of the corporation per a Buy-Sell Agreement.  It therefore lacked any causal relationship to his status as a corporate officer or director.

The NC Business Court delivered a full Opinion last week on attorney-client privilege in Technetics Group Daytona, Inc. v. N2 Biomedical, LLC, 2018 NCBC 115.  It’s on the subject of the scope of attorney-client privilege accorded to corporate clients.

That a corporation is entitled to the protection of the attorney-client privilege is “generally accepted.”  Op. ¶13.  But how far down the corporate employee ladder does the privilege extend?  As Judge Conrad observed, “it is often a challenging task to decide who speaks for a corporation and whether that person’s communications with corporate counsel are subject to the privilege.”  Op. ¶13.

The law on this point is “particularly unsettled” in North Carolina.  Op. ¶14.  The issue in the Technetics case was whether the privilege could encompass communications between the Defendant’s lawyer and an independent contractor (Storey) working for it.

Mr. Storey had been included in communications between the Defendant and its patent counsel regarding a patent application which is at issue in the lawsuit.  The Defendant refused to produce those communications based upon the attorney-client privilege.

NC Business Court Says That The Consultant Was Not The “Functional Equivalent” Of An Employee Who Could Be Covered By The Privilege

Some courts extend the protection of the privilege to non-employees, “as long as they perform roles that are functionally equivalent to employees.”  Op. Par. 16.  Judge Conrad was unwilling to follow those cases, but held that even if North Carolina were to adopt that test, the Defendant hadn’t carrying the burden of showing that Mr. Storey was the functional equivalent of an employee.

Mr. Storey was retained “on a project-by-project basis and paid by the hour.”  Op. ¶15.  He didn’t have an office and didn’t spend much time working for the Defendant.  As Judge Conrad summed it up, “Storey’s role was ‘akin to that of an ordinary third-party specialist, disclosure to whom destroys the attorney-client privilege.’”  Op. ¶19.

NC Business Court Considers The “Kovel Doctrine” And Finds That It Doesn’t Apply

Another argument in favor of the privilege offered by the Defendant was also rejected by the Business Court.  This was a federal court approach known as “the Kovel doctrine.”  This doctrine “holds that the attorney-client privilege is not destroyed by the presence of a third party if the third party “is necessary, or at least highly useful, for the effective consultation between the client and the lawyer which the privilege is designed to permit.” Op. ¶21 (quoting United States v. Kovel, 296 F.2d 918, 922 (2d Cir. 1961)).

Judge Conrad said that although the Kovel doctrine was “widely embraced,” it had also been “carefully limited.”  Op. ¶22.  It is not enough that the participant’s consultation be “useful or convenient.”  It must instead be “nearly indispensible or serve some specialized purpose in facilitating the attorney-client communications.”  Op. ¶23 (quoting Cavallero v. United States, 284 F.3d 236, 249 (1st Cir. 2002).

In other words “the third party must function more or less as a “translator or interpreter” between the client and the lawyer.”  Op. 23.  Mr. Storey’s involvement in the claimed privileged communication did not rise to this level.

The Common Interest Doctrine Was Not Applicable

In a final run at claiming the privilege as to Mr. Storey, the Defendant argued that “the common-interest doctrine, which “extends the protection of the attorney-client privilege . . . to communications between parties sharing a common interest about a legal matter.”  Op. ¶27.

The Defendant lost out on this argument as well.  As Judge Conrad observed, an essential element of a common interest is that “the parties must ‘agree to exchange information for the purpose of facilitating legal representation of the parties.'”  Op. ¶28 (quoting Friday Invs., LLC v. Bally Total Fitness of the Mid-Atl., Inc., 247 N.C. App. 641, 648, 788 S.E.2d 170, 177 (2016).  Since Mr. Storey wasn’t represented by counsel, he wasn’t included in the Defendant’s privilege.

And if you’re thinking that the common interest doctrine really doesn’t fit here because Mr. Storey wasn’t involved in any litigation, you are right.  Judge Conrad said that “our appellate courts have not ‘extended the common interest doctrine to relationships formed primarily for purposes other than indemnification or coordination in anticipated litigation.’”  Op. ¶30 (quoting Friday Invs., supra, 247 N.C. App. at 6, 51, 788 S.E.2d at 178.

Issues Of Waiver Of Privilege

There’s more worth writing about from the Technetics Opinion.  It concerns whether the Defendant had waived the privilege by its production of a document prepared by its attorney regarding the negotiation of a “Confidential Development Agreement.”  Technetics argued that by disclosing this legal advice, the Defendant had made a subject matter waiver of all the negotiations regarding that Agreement.

You are probably familiar with the issue of the scope of a waiver coming up when there has been an inadvertent production of a privileged document.  I’ve written about that issue before.

But what if the waiver is intentional?  Then different considerations are in play.  Judge Conrad said:

It is patently unfair for a party to use the privilege as a sword and a shield in litigation, making selective disclosures for tactical gain.

Op. ¶36.  The document which Technetics was claiming had resulted in a subject matter waiver had been provided by the Defendant before the litigation began, in the course of negotiating the agreement.  While in the past this might have resulted in a subject matter waiver, there is a “modern trend” on the approach to this issue  Op. ¶37. And that trend is “to employ fairness considerations to decide the scope of waivers.”  Id.

Given that the Defendant had not produced this document to gain an unfair advantage, the waiver was limited to the communication which had been disclosed pre-litigation.

Note: The Defendant (N2) is represented by Brooks Pierce.

 

Having a client required to arbitrate a case — even though that client never signed off on an arbitration provision — is nothing new.  Judge Conrad dealt with that situation late last month in Charlotte Student Housing DST v. Choate Construction Co., 2018 NCBC 88, where he said:

Because arbitration is a matter of contract, the usual rule is that “a party cannot be required to submit to arbitration any dispute which he has not agreed so to submit.” United Steelworkers of Am. v. Warrior & Gulf Nav. Co., 363 U.S. 574, 582 (1960). In an appropriate case, though, “a nonsignatory can enforce, or be bound by, an arbitration provision within a contract executed by other parties.”  Int’l Paper Co. v. Schwabedissen Maschinen & Anlagen GmbH, 206 F.3d 411 , 415 (4th Cir. 2000).

Op. ¶14.

Plaintiffs, who had acquired a Charlotte apartment complex from its original owner, were suing the architect, general contractor and two subcontractors over design deficiencies in the construction.

Plaintiffs had not signed the Construction Contract containing the arbitration provision, but Judge Conrad ruled that they were required to arbitrate their claims.

He said that:

estoppel is dispositive here. In short, “[a] nonsignatory is estopped from refusing to comply with an arbitration clause when it receives a direct benefit from a contract containing an arbitration clause.” Int’l Paper, 206 F.3d at 418 (quotation marks omitted). It would be manifestly unfair to permit a party to take the benefit of the contract “despite [its] non-signatory status but then, during litigation, attempt to repudiate the arbitration clause in the contract.” Hellenic Inv. Fund, Inc. v. Det Norske Veritas, 464 F.3d 514, 517–18 (5th Cir. 2006); see also Int’l Paper, 206 F.3d at 418. That is what Plaintiffs seek to do here, and they are therefore estopped from refusing to arbitrate their claims against [the Defendants].

Op. Par. 23

Since the Plaintiffs were claiming that the Defendants had not performed their work in accord with the “Contract Documents,” they were bound by the terms of those documents, which contained the arbitration provision.

But what about that tricky question: who decides whether a matter should be arbitrated: Judge or Arbitrator?  Judge Conrad here seized the right to make that decision for the Business Court.  I’ve written about a Business Court decision on that point once before.  The short answer is that it has to be “clear and unmistakeable” that the parties intended for the arbitrator, not the Court, to decide the question of arbitrability.

It was certainly clear and unmistakeable that the parties signing the contract containing the arbitration provision had delegated authority to determine arbitrability to the arbitrator.  The arbitration clause invoked the AAA’s Construction Industry Rules, expressly delegate to the arbitrator “the power to rule on his or her own jurisdiction, including any objections with respect to the existence, scope, or validity of the arbitration agreement.”

But that wasn’t enough to bind the Plaintiffs, who were not signatories to the document referencing the Construction Industry Rules.

Those of you who aren’t at home hunkering down in fear of the impending hurricane are wondering why the Plaintiffs, who were found to beobligated to arbitrate, weren’t also obligated to have the arbitrator (as opposed to the Business Court Judge) decide whether they had to  arbitrate the case in the first place.

Well, even though bound by the arbitration provision, there was nothing to show that the Plaintiffs shared the intent of the signatories to have the arbitrator decide the issue of arbitrability.  As noted by Judge Conrad, “[c]ourts have generally found that agreements that do not mention or reference a particular non-signatory do not clearly or unmistakeably evidence an agreement by that non-signatory to have an arbitrator determine whether the agreement is arbitrable.” Op. ¶19 (quoting McKenna Long & Aldridge, LLP v. Ironshore Specialty Ins. Co., 2015 U.S. Dist. LEXIS 3347 at *14-15 (S.D.N.Y. Jan. 12, 2015).

It is one of the most frustrating things you can have happen after concluding a successful deposition.  The witness backtracks on all the substantive admissions she has made during her testimony.

Can she really do that?  Well, yes.  Rule 30(e) of the North Carolina Rules of Civil Procedure says that the deponent can review her testimony and:

If there are changes in form or substance, the deponent shall sign a statement reciting such changes and the reasons given by the deponent for making them.
But are there no limits on the changes which may be offered?  Apparently not, based on Judge Bledsoe’s Opinion this month in Window World of Baton Rouge, LLC v. Window World, Inc., 2018 NCBC 78.
Plaintiffs’ lawyers were attempting to prevent one of the Defendants (Tammy Whitworth) from making wholesale changes to her deposition testimony via the presentation of an errata sheet.  Those proposed changes included “thirty-eight substantive changes to her deposition testimony.”  Op. Par. 5.
The Opinion contains no detail on the nature of the changes offered by Defendant Whitworth, but it is safe to assume that they are in the nature of her saying “the light was green” at her deposition, and changing that testimony to “the light was red.”
Can a deponent make an absolute about face from her deposition testimony?  Yes, in North Carolina and in the majority of federal jurisdictions.  Although the Eastern District of North Carolina is in that minority. William L. Thorp Revocable Tr. v. Ameritas Inv. Corp., 57 F. Supp. 3d 508, 517 (E.D.N.C. 2014) (concluding that Federal Rule 30(e) “does not permit a party to make changes that substantively contradict or modify sworn deposition [testimony]”).
This Opinion did not leave the Plaintiffs with no value from the original deposition testimony.  Judge Bledsoe said that he would “impose[] two safeguards. . . in light of the extensive substantive changes Whitworth has made to her deposition transcript.”  Op. ¶16.
The first “safeguard”was that Whitworth’s original answers would remain in the record and could be used for impeachment purposes. “or for any other relevant or proper purpose.”  Op. ¶16.
The second protection granted by Judge Bledsoe was to allow Plaintiffs another deposition of Defendant Whitworth.  He limited that new deposition to one hour on the record, limiting questioning to “the reasons for those changes and to ask reasonable follow-up questions that flow from Whitworth’s answers to these permitted inquiries.”  Op. ¶17.  The new deposition will be at the Defendants’ expense.

This isn’t the first time that the Business Court has allowed a deposition errata sheet to be allowed over objections that the proposed changes were excessive.  Judge Diaz ruled on this issue in an unpublished Order in Bueche v. Noel, as did Judge Bledsoe in an unpublished Order in BB&T Boli Plan Tr. v. Mass Mutual Life Ins. Co.

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North Carolina’s Unfair And Deceptive Trade Practices Act (G.S. sec. 75-1.1) carries with it the heady possibility of triple damages and attorneys fees.  So nearly every Plaintiff’s lawyer routinely includes a Chapter 75 claim in his or her Complaint.

But last week, in Brewster v. Powell Bail Bonding, Inc, 2018 NCBC 74, Judge Conrad cautioned against that practice,  calling it “a regrettable trend in North Carolina business litigation.”  Op. ¶36.

The practice of trying to turn “every shareholder dispute or disagreement between members of a limited liability company into a section 75-1.1 claim” (Op. ¶36) continues despite a plethora of Business Court Opinions (more than ten of which were cited by Judge Conrad in Op. ¶36) rejecting such claims.

The dangers of this knee jerk inclusion of unviable Chapter 75 claims are that it:

invites avoidable motions practice–driving up the cost of litigation, taxing the resources of the Court, and exposing the plaintiff to a potential award of attorneys fees under section 75-16.1.

Op. Par. 37.

If you haven’t caught this message by now you have been asleep with your Complaint drafting.  Take this to heart:”  Judge Conrad says “[b]y now, the message should be clear: section 75-1.1 plays no role in resolving these internal corporate disputes.”  Op. ¶37.

Although there were no sanctions imposed on this Plaintiff,  a minority shareholder in Defendant Powell Bail Bonding, Inc. who had included a Chapter 75 claim in his lawsuit seeking dissolution of the corporation, I think that we will see those in the next Business Court Opinion dismissing a Section 75 claim.  So don’t give me that to write about.