N.C. Business Court Considers When a  Private Company Can Be Deemed a State “Agency” for Purposes of the Public Records Act

 

In Southern Environmental Law Center v. Saylor et al., 2019 NCBC 59 (N.C. Super. Ct. Sept. 11, 2019), the Business Court considered whether the defendant North Carolina Railroad Company (the “Railroad”) was a State “agency” for purposes of the Public Records Act, N.C. G.S. § 132-1 et seq. If so, then the Railroad was required to comply with the plaintiff Southern Environmental Law Center’s (“SELC”) request for its “public records.” The Railroad asserted that as a private corporation, it was not subject to the Act, and moved for judgment on the pleadings. The SELC countered that the Railroad was a State “agency”—and therefore was subject to the Act—because, among other reasons, it was wholly owned by the State of North Carolina. Judge Robinson held that the matter was “incapable of resolution on the pleadings,” and denied the Railroad’s motion in favor of a more developed factual record.

Take-Aways:

  • A private corporation may be required to produce its “public records” where it is deemed to be an “agency” of the State.
  • Whether a private corporation is an “agency” of the State depends largely on the degree of control exercised by the State over the corporation.
  • The determination whether a private corporation is an “agency” of the State is fact-intensive and not easily resolved based on the pleadings alone.

Many in North Carolina are familiar with the Durham-Orange Light Rail Transit Project, which would have connected Chapel Hill and Durham via a 17.7 mile light rail line. Id. ¶ 6. The SELC was “significantly involved” in advocating for that project, which was discontinued in the spring of 2019. Id.

In May 2019, the SELC requested records from the Railroad relating to the Light Rail Project. Id. ¶ 16. The Railroad, which owned tracks near the contemplated rail line and apparently was not a supporter of the project, declined the SELC’s request for records on the basis that it was not subject to the Public Records Act. Id. ¶¶ 8, 16.

The SELC thereafter brought suit against the Railroad, seeking an order “compelling the Railroad and its agents to permit inspection of certain documents pursuant to the [Public Records] Act.” Id. ¶ 3. In particular, the SELC brought its claim under N.C.G.S. §§ 132-1 – 132-10, which provides, among other things, that “[e]very custodian of public records shall permit any record in the custodian’s custody to be inspected and examined at reasonable times and under reasonable supervision[.]” Id. ¶ 22 (quoting N.C.G.S. § 132-6) (emphasis added).

The matter was designated to the Business Court, where it was “given priority” pursuant to N.C.G.S. § 132-9(a) (providing expedited proceedings with respect to “[a]ny person who is denied access to public records”). Id. ¶¶ 4, 25-26.

Once in the Business Court, the Railroad sought to stop the SELC’s claim in its tracks. The Railroad attached “numerous documents” to its answer (more on this later) and moved for judgment on the pleadings. The Railroad contended that as a private corporation, it was not subject to the Public Records Act as a matter of law. The SELC opposed the motion on the grounds that the Railroad was, in fact, subject to the Public Records Act as an “agency” of the State of North Carolina. See N.C.G.S. § 132-1(a) (defining “public records” to include “all documents . . . made or received . . . by any agency of North Carolina government or its subdivisions) (emphasis added).  The SELC pointed out that the Railroad was wholly-owned by the State, had eminent domain powers, and was comprised of board members who were appointed by government officials.

The Business Court framed the central, “intriguing question” as follows: “may ‘private’ corporations, otherwise generally exempt from the disclosure requirements of the [Public Records Act], nonetheless be subject to the Act’s requirements where those corporations are wholly-owned by the State of North Carolina?” Id. ¶ 2.

Spoiler alert: the answer is “yes,” but only if the private corporation is deemed a State “agency” for purposes of the Public Records Act.

In addressing this question, the Business Court looked to the North Carolina Court of Appeals’ decision in News & Observer Publishing Co. v. Wake County Hospital System, Inc., 55 N.C. App. 1, 284 S.E.2d 542 (1981). There, the appellate court concluded that the Wake County Hospital System was an “agency” of the State based on the degree of control that Wake County exercised over the hospital. Id. ¶ 31. In reaching its decision, the News & Observer court noted the following:

  • Upon dissolution, the hospital’s assets were to be transferred to Wake County;
  • All vacancies on the board of directors were subject to approval by county commissions;
  • The hospital occupied premises owned by the county virtually rent-free;
  • County commissioners reviewed and approved the hospital’s annual budget;
  • The county audited the hospital’s books and records;
  • The hospital reported its charges and rates to the county;
  • The hospital was financed by county bond orders;
  • Revenue collected pursuant to the bond orders was to be considered revenue of the county;
  • The hospital would not change its corporate existence or amend its articles of incorporation without the county’s written consent; and
  • The hospital was performing an important “public and governmental” function.

Id. ¶ 32 (citing News & Observer, 55 N.C. App. at 11, 284 S.E.2d at 548-49).

Noting that the above “factors” were “not intended to be an exclusive list,” id. ¶ 33, the Business Court observed that the “ultimate question” in its analysis was “the degree of ‘supervisory responsibilities and control’” exercised by the State over the corporate entity. Id. ¶ 34 (quoting Chatfield v. Wilmington Hous. Fin. & Dev., Inc., 166 N.C. App. 703, 708-09, 603 S.E.2d 837, 840 (2004)).

In other words, where the State’s exercise of control over the private company is such that the company is, in essence, acting as an arm or “agency” of the State, the company will be treated as a “public” company for purposes of the Public Records Act.

The Business Court proceeded to determine that the following allegations were “potentially supportive” of a finding that the Railroad was an “agency” of the State:

  • The Railroad’s assets upon dissolution will be transferred to the State;
  • The Governor of North Carolina and General Assembly appoint all members of the Railroad’s Board of Directors;
  • The Railroad is required to provide annual reports to the legislature which go above and beyond what is required for other corporate entities;
  • The Railroad has eminent domain power; and
  • According to the Railroad’s stated mission, the Railroad performed the important “public and governmental” function of managing a railroad corridor for the benefit of North Carolina citizens.

Id. ¶ 35. In addition, the Railroad was exempt from paying Federal and State income taxes and its charter provided that it shall “have a corporate existence as a body politic in perpetuity.” Id. ¶¶ 9, 15.

The Railroad, for its part, put forth a number of reasons why it should not be deemed a State “agency” under the Public Records Act. For example, the Railroad offered a report published by the General Assembly in 2012 explicitly stating that the Railroad was “not part of state government” and that certain state laws, including the State’s public records law, “do not apply” to the Railroad. Id. ¶¶ 14, 42. With respect to the State’s status as the Railroad’s sole shareholder, the Railroad cited a more-than-century-old case holding that “the State of North Carolina ‘laid down her sovereignty’ when the State became a shareholder of a private corporation” and, further, that “the state’s sovereignty did not extend to a corporation which it controlled . . . .” Id. ¶ 39 (quoting Southern Railway Co. v. North Carolina Railroad Co., 81 F. 595, 599-600 (N.C. 1897)). The Railroad also argued that the “body politic” language in its charter was essentially meaningless because all corporations created at that time (in the 1840s) were created by an act of the legislature. Id. ¶ 45.

Potentially detrimental to the Railroad’s motion, however, was the Court’s decision not to consider the “numerous documents” attached to the Railroad’s answer. Id. ¶ 21 n.1. Although, as the Court noted, it was free to consider documents attached to an answer “that are the subject of a plaintiff’s complaint and to which the complaint specifically refers,” it can only do so where the plaintiff has made admissions with respect to those documents. Id. And because the SELC had made no admissions with respect to the documents attached to the Railroad’s answer, those documents could not properly be considered by the Court in ruling on the Railroad’s Rule 12(c) motion. (The Court did, however, consider a report prepared by the General Assembly that was attached to Railroad’s answer—which “pronounced therein that the [Railroad] is not part of state government”—because the SELC had cited that document in its complaint. Id. ¶ 42.)

In the end, the Business Court concluded that the State “agency” determination required a “fact-intensive” inquiry that was “ill-suited for resolution on the pleadings pursuant to Rule 12(c).” Id. ¶ 35. Based on the pleadings alone, questions remained. And under the Rule 12(c) standard, the SELC’s complaint was not “so fatally deficient in substance as to present no material issue of fact . . . .” Id. ¶ 20 (quoting George Shinn Sports, Inc. v. Bahakel Sports, Inc., 99 N.C. App. 481, 486, 393 S.E.2d 580, 583 (1990)); id. ¶ 46 (concluding that “SELC’s position taken in the Complaint is not factually deficient and that this matter is incapable of resolution on the pleadings”).

Accordingly, the Business Court denied the Railroad’s motion for judgment on the pleadings, allowing the case to proceed in favor of a more developed factual record.

 

Following up on my post from earlier this week, the Mecklenburg County Business Court CLE concluded on Friday with the panel of Judges, Chief Judge Bledsoe, Judge McGuire, and Judge Conrad, sharing some practice pointers and personal preferences.  What follows is my summary and interpretation of what they said.  As with my recitation of the statistics provided, I have worked hard to be an accurate reporter, but this is not a verbatim recitation (hence why you should attend this CLE-this summary is not a substitute from hearing from the Judges in person!).

Judge McGuire had some advice for those on the Plaintiff’s side of the “v” with respect to drafting complaints: less is more.  “Shotgun” complaints with 12-14 claims that are sure to have a significant number dismissed on 12(b) motions weakens a party’s overall case and could potentially undermine your standing with the court.  Focus on your three to four genuinely good claims.

Judge McGuire also warned lawyers to be conscious of their movements and facial expressions while their opponents are arguing during a hearing.  Grimacing and gesticulating in reaction to the other side’s arguments makes it appear that you are getting beaten and that you know it.  And people are watching you.

When it comes to trade secret cases, Judge McGuire suggested that Plaintiffs can, and should, describe a trade secret in a Complaint with much more specificity than they usually do.  He referenced the recent summary judgment opinion in DSM Dyneema, LLC v. Thagard, 2019 NCBC 43, as instructive with respect to how trade secrets can be defined.

Judge Conrad advocated for more communication between parties.  He said that the Judges want parties to talk to each other and resolve as much as possible before bringing disputes to the Court.  And this doesn’t just relate to discovery disputes, it can mean discussion about viability of actual claims.  To that end, he would like to see more consultation on motions to dismiss.  Rather than a request for amendment at the time of the hearing on the motion, he suggested that parties can discuss these issues in advance and the Plaintiff can amend or narrow claims in some way so as to alleviate the need for motion practice.  Defendants might consider allowing the Plaintiff to amend, and then file a targeted motion to dismiss, resulting in a more efficient process for the parties and the Court.  Moreover, talking means actually talking.  Don’t just communicate by email, pick up the phone.  And perhaps even get together in person with counsel for the other side, something that was commonplace in the past, but has all but disappeared in modern day practice.

Judge Conrad also recommended that practitioners be aware of the ongoing e-courts initiatives,  the effort spearheaded by former Chief Justice Martin to bring the North Carolina State Court System into the Electronic Age, as that will have an effect on the Business Court.

You likely have heard this before and perhaps even had it contained in a Case Management Order with Judge Conrad, but know that he and his chambers find tables of authorities to be incredibly helpful.

Chief Judge Bledsoe wants lawyers to remember to pay attention to choice of law issues.  He noted that many times counsel reflexively assume that North Carolina law applies, but that is often not the case.  Think through the different tests and brief the correct law.  Briefing where the parties argue under the wrong jurisdiction’s law is not helpful to the Court, yet it happens when the issue is not at the forefront of the lawyers’ minds.

Speaking of being helpful to the Court, Chief Judge Bledsoe had some advice for younger lawyers (which applies equally to experienced lawyers): when you engage the Court and ask for something, put yourself in the Court’s shoes and think about what the Court would need to know in order to decide the issue.  (Author’s note: this advice dovetails nicely with the new NCBC Rule 6.5, which affirmatively encourages participation of junior attorneys at oral argument.)

Similarly, Chief Judge Bledsoe commented that in many instances when injunctive relief is sought, the party seeking the relief is hyper-focused on satisfying the standard for an injunction and doesn’t think through what it wants the Court to actually do.  Help the Court by suggesting what the injunction should actually look like.

Chief Judge Bledsoe also shared some personal preferences, one being paper copies.  If your filing for Judge Bledsoe is in excess of 100 pages or has more than 10 attachments, supply his chambers with a hard copy of that submission.  Also, when you have a question that you think a law clerk might be able to answer, don’t call on the phone.  Rather, send an email copying all counsel of record.  This avoids the clerk being put in a position of trying to determine if the communication is improperly ex parte.

And finally, although Judge Robinson  unfortunately was unable to make it down to Charlotte for the panel, his brethren on the bench noted that if he were there, his advice would be, “Read the Rules.  Then Re-read the Rules.”

Thanks to the Mecklenburg County Bar for putting on such a great CLE.  Hope to see you all there next year!

–Patrick Kane

Before you judge a man, walk a mile in his shoes. After that who cares? He’s a mile away and you’ve got his shoes!

-Billy Connolly, Scottish comedian, shoe sage.

The N.C. Business Court might not be your first stop for tips on picking quality footwear, but in the spiritual homestead of Air Jordans, solid shoe advice lurks where you least expect it. So it was in Epic Chophouse, LLC v. Morasso, 2019 NCBC 54, 2019 WL 4166626 (N.C. Super. Ct. Sept. 3, 2019), where Judge Conrad laced up his judicial kicks to note there’s no harm in a member strolling in her LLC’s shoes if they’re just gathering dust in the closet.  See Order and Opinion.

Takeaways:

  • The Business Court will scrutinize individual claims by LLC members to ensure they do not actually accrue to the entity.
  • Derivative claims where an LLC member walks in the entity’s shoes likely only survive in the Business Court when the company cannot, or will not, wear them itself.

Epic Chophouse, LLC (“Epic”), which operates a restaurant, and two of its members sued a third member, Defendant Morasso, for booting his job as Epic’s general manager to favor other food enterprises he owned or managed. The complaint alleged that Morasso used Epic as leverage to help Defendants Webb Custom Kitchen, LLC and Chillfire Grill, LLC secure volume discounts on food supplies and better terms with financial vendors. Id. at ¶¶ 1, 6. Epic’s frustrations with Morasso’s alleged inattention to his job mushroomed to the point that it ultimately hired another person to do his job and ejected him as an LLC member. Id. at ¶¶ 7-8.

The Court found sufficient evidence for somebody to have potential claims arising from Morasso’s alleged conduct, but could not shake a solid suspicion that Epic, and two of its members – individually and derivatively – were all trying to walk a good mile in the same pair of sneakers. “In short,” the Court observed, “this is a direct action by the company, an individual member action, and a derivative action all in one. Something is amiss.” Id. at ¶ 16.

Epic could pursue claims in its own stead; and aggrieved, remaining LLC members could pursue claims “peculiar to them,” even if Epic “also has a cause of action arising from the same wrong.” (citing Barger v. McCoy Hillard & Parks, 346 N.C. 650, 659, 488 S.E.2d 215, 219 (1997)). 2019 NCBC 54, at ¶¶ 12, 15. Yet, the Court found, the plaintiff members added a poorly matching belt and suspenders to the sartorial story by, essentially, raising the same claims as the company in their individual capacities, “[a]nd for good measure,” purporting to raise them again in a derivative action on behalf of Epic. Id. at ¶ 16.

This duplication of claims, the Court found, ran afoul of two well-settled concepts that help delineate who can bring what, on behalf of whom. An individual member cannot typically allege claims in her own name that accrue to the company unless equity dictates she must do so because the entity won’t. And, such “derivative actions are typically appropriate only when a corporation is unwilling or unable to litigate its claims for itself.” (citing Anderson v. Seascape at Holden Plantation, LLC, 241 N.C. App. 191, 204, 773 S.E.2d 78, 87 (2015)). 2019 NCBC 54, at ¶¶ 13, 17.

The plaintiff members’ claims were not helped by their election to file no brief in opposition to a Rule 12(c) motion. However, Judge Conrad’s treatment of the motion as “uncontested” under Business Court rules hurt much less than the conclusion that “[t]here is no question that the asserted [derivative] claims are claims accruing to Epic,” and that Epic was “willingly litigating all asserted claims for itself.” Id. at ¶¶ 17-18. The bulk of the plaintiffs’ individual capacity claims suffered the same fate, and were dismissed as the “types of harms [that] are plainly injuries to the company shared by all members proportionately.” Id. at ¶ 19.

The Court’s end-game message to LLCs, LLC members, and their counsel when seeking to match plaintiffs and claims?

In simple terms, the member is allowed to step into the shoes of the LLC but only if the LLC isn’t already wearing them.

Id. at ¶ 17, n.3.

Brad Risinger is a partner in the Raleigh office of Fox Rothschild LLP. He maintains a commercial litigation practice that frequently involves business disputes before the North Carolina Business Court, and the state’s federal and state trial courts.

This past Friday, the Mecklenburg County Bar held its 7th Annual North Carolina Business Court CLE.   If you regularly practice in the Business Court, this is a “must attend.”  There were a number of helpful, relevant, and informative presentations, but the highlight of the CLE was the day’s last session, when attendees heard directly from the Business Court Bench itself, with Chief Judge Bledsoe, Judge McGuire, and Judge Conrad sharing insights and practice pointers.  The session began with Chief Judge Bledsoe providing a compilation of statistics about the Business Court and its cases.  For those of you not in attendance, but nevertheless interested, here’s what I jotted down:

Disclaimer–Any errors in these stats are likely my transcription errors.

Number of Cases Filed in the NCBC by Year:

2013 — 134

2014 — 119

2015 — 141

2016 — 148

2017 — 203 (136 when Charlotte School of Law cases are removed)

2018 — 173 (145 when Charlotte School of Law cases are removed)

2019 (so far) — 91 (on pace for 112 for the year)

 

2019 NCBC filings by County:

Mecklenburg – 24

Wake – 16

Guilford – 8

No other county has had more than four NCBC cases filed in 2019

 

NCGS sec. 7A-45.4(a) Basis for Notice of Designation in 2019 NCBC Filings:

Law of Corporations (7A-45.4(a)(1)) — 55

Trade Secrets (7A-45.4(a)(8)) —19

Securities (7A-45.4(a)(2)) — 11

Breach of Contract where amount in controversy is greater than $1,000,000 (7A-45.4(a)(9)) — 10

Intellectual Property (7A-45.4(a)(5)) — 8

Trademarks (7A-45.4(a)(4)) — 6

Antitrust (7A-45.4(a)(3)) — 3

*These add up to 102, presumably meaning that some of the 91 cases filed thus far in 2019 had numerous statutory bases for designation to the NCBC.

 

Opinions Published by the NCBC by Year:

2013 — 73

2015 — 112

2016 —106

2017 —113

2018 —137

2019 (so far) — 70 (on pace for 85)

*It was noted that while the number of opinions published this year appears to be in decline from prior years, those opinions that have been published in 2019 have been extremely comprehensive, with many of these opinions over 100 pages in length and a substantial number between 50-100 pages in length.

 

Historic Results of Appellate Review of NCBC Cases (from 1/1/14 to Present):

Affirmed — 55

Modified/Affirmed —1

Dismissed — 8

Affirmed/Reversed — 6

Reversed — 2

 

Stay tuned later in the week when I will post a recap of the “practice pointers” and “personal preferences” that Judges Bledsoe, McGuire, and Conrad shared with the group…

–Patrick Kane

The Business Court sorted through the drama of an affiliated outsider who wanted to buy a company, settled for half and became an insider, and then allegedly used that perch to benefit himself and his family in W. Avalon Potts v. KEL, LLC, et al, 2019 NCBC 29, 2019 WL 2058599 (N.C. Super. Ct. May 9, 2019). See Order and Opinion. The story has a common backdrop: a nearly 30-year old company (founded by two partners) that wrestles with ownership changes and their impact on the entity’s fortunes. The twist: an original owner goes to the mat to reclaim control and alleges claims that allow the Court to revisit several legal principles that animate disputes over frayed business relationships.

Takeaways:

  • The Business Court, like the North Carolina Supreme Court, declines to hold that a minority shareholder exercising “actual control” could have a fiduciary duty to other shareholders.
  • The Court confirms that the business judgment rule, designed to curb “judicial second guessing,” does not apply “when the officer or director has an interest in the disputed transaction.”
  • Adopting a Third Circuit holding, the Court finds that when “independent third parties are alleged to have joined,” a conspiracy can exist in face of claims that an agent and principal cannot conspire as a matter of law.

Steel Tube, Inc. is a manufacturer of carbon steel and galvanized steel tubing. Plaintiff Potts and Walter Lazenby founded it, divided the stock evenly, and, over time, used the services of Leon Rives, an accountant. Rives offered to buy the company in 2014. Potts resisted the transaction, but Rives bought Lazenby’s shares – in which Lazenby retained a security interest. ¶¶ 5, 6.

With no notice to Potts, Lazenby and Rives promptly executed a management agreement under which Rives and one of his entities would manage Steel Tube. ¶ 7. That shaky start was predictive of what would follow: a series of disputes over Rives’ role in the company that included numerous allegations of self-dealing to benefit Rives and his family. Potts filed a lawsuit seeking dissolution, but recast it a year later in an amended complaint that alleged fiduciary duty breaches, fraud and other individual and derivative counts. Potts changed course after acquiring Lazenby’s security interest in the stock on which Rives ultimately defaulted, and he regained control of Steel Tube. ¶¶ 13-14.

Fiduciary Duty

At summary judgment, the Court considered the fiduciary duty claims within the lens of its general rule that shareholders “do not owe a fiduciary duty to one another.” Id. at ¶ 24. It rejected one exception to that rule – that majority shareholders have a duty to protect minority interests – because Rives and Potts had equal ownership shares. Id. Judge Conrad took a cautious course with regard to a second purported exception: that a minority shareholder exercising “actual control” could have a fiduciary duty to other shareholders. That doctrine had been adopted by the Court of Appeals at the time of the summary judgment hearing, but by the time of the Potts decision the Supreme Court had reversed and found it unnecessary to decide the ultimate issue because the particular plaintiffs had not sufficiently alleged “actual control.” Corwin v. British Am. Tobacco PLC, 251 N.C. App. 45, 51, 796 S.E.2d 324, 330 (2016), rev’d 371 N.C. 605, 821 S.E.2d 729 (2018); see also Blog Post Smoke ’em if You Got ’em (June 2, 2019). So, too, Judge Conrad found it unnecessary to decide what the Supreme Court would not, as the record reflected insufficient evidence of Rives’ “actual control.” The Court added:

Potts points to evidence that Rives was able to misappropriate Steel Tube’s resources without his knowledge, but that is not evidence of control. Rather, if true, it shows the opposite, confirming the Rives was forced to circumvent the board to accomplish his goals.

2019 NCBC 29, at ¶ 26.

Derivative Claims

The Court allowed a variety of derivative claims regarding Rives’ duties to Steel Tube to survive to trial. These included allegations of (i) improper payments to Lazenby, (ii) monthly and lump sum cash withdrawals by Rives, (iii) transferring $120,000 to a company Rives helped form in which his wife was a member, and (iv) entering a services deal with defendant KEL, owned by Rives’ brothers. ¶¶ 8-10. The Court rejected the contention that payments to Rives were contracts fixing compensation for officers allowed under Fulton v. Talbert, 255 N.C. 183, 184, 120 S.E.2d 410, 411 (1961). It found factual disputes about the payments, and that the payments could be challenged under the Court’s recent holding that “`[c]onflict-of-interest transactions between a corporation and its officers or directors have long been subject to special rules,’ including that the transaction must be fair to the corporation.” (citing Ehmann v. Medflow, Inc., 2017 NCBC 86, 2017 WL 4321107 (N.C. Super Ct. Sept. 26, 2017).

Business Judgment Rule

Rives seemed to contend that his transfer of $120,000 to Elite Tube, the company he helped found, was shielded by the business judgment rule. The Court rejected applying the rule, which limits “judicial second guessing,” by noting that those “protections do not apply when the officer or director has an interest in the disputed transaction.” The Court noted sufficient allegations of self-dealing and efforts to conceal the transaction to preclude use of the rule. 2019 NCBC 29, at ¶ 37.

Civil Conspiracy

Rives also contended a civil conspiracy claim that relied on the relationship between himself and one of his companies, Rives & Associates, was barred under the doctrine of intracorporate immunity, because an agent and principal cannot conspire as a matter of law. Id. at ¶ 42. But, showing that family ties take as they give, the Court ruled that inclusion of KEL (owned by Rives’ brothers) preserved a conspiracy claim where “independent third parties are alleged to have joined the conspiracy.” Id. (citing Robison v. Canterbury Vill., Inc., 848 F.2d 424, 431 (3d Cir. 1988)).

Brad Risinger is a partner in the Raleigh office of Fox Rothschild LLP. He maintains a commercial litigation practice that frequently involves business disputes before the North Carolina Business Court, and the state’s federal and state trial courts.

N.C. Business Court Addresses the Scope of a Judicial Appraisal Proceeding

In Reynolds American Inc. v. Third Motion Equities Master Fund Ltd. et al., 2019 NCBC 35 (N.C. Super. Ct. June 4, 2019), the Business Court considered the scope of a judicial appraisal proceeding under G.S. § 55-13-30. The defendants, who owned stock in the plaintiff company, dissented from a merger involving the plaintiff and sought to have their interest bought out at fair value. Navigating an issue of first impression, Chief Judge Bledsoe held that whether the defendants had perfected their appraisal rights was a question beyond the scope of the proceeding and, accordingly, would not be considered at trial.

Take-Aways:

  • A judicial appraisal proceeding is limited in scope under G.S. § 55-13-30.
  • The question whether dissenting shareholders have perfected their appraisal rights is outside the scope of the proceeding, and will not be addressed by the Court, at least not where the issue is first raised after summary judgment.    
  • A corporation seeking to contest perfection should specifically request in their complaint a declaratory judgment that certain dissenting shareholders have not properly perfected their appraisal rights.

It all started when British American Tobacco p.l.c. (“BAT”) sought to increase its (already 42% indirect) ownership interest in Reynolds American, Inc. (“RAI”) by acquiring the balance of RAI’s outstanding common stock. Compl. ¶ 26.

Following extensive negotiations, the RAI shareholders voted overwhelmingly in favor of the acquisition, whereby the RAI shareholders would receive, in exchange for their RAI shares, “Merger Consideration” consisting of a mix of BAT shares and cash. Compl. ¶¶ 31, 36.

Not all RAI shareholders were on board with the acquisition, though. Instead of carrying forth their investment in RAI through an equity interest in BAT, a number of “dissenting” shareholders decided it was time to cash out.

The dissenting RAI shareholders thus exercised their appraisal rights pursuant to G.S. § 55-13-21, initiating a detailed process aimed to compensate the dissenters for the “fair value” of their shares.

The question then became, of course: What is the fair value of the RAI shares?

RAI estimated the fair value of the shares at $59.64, and sought to pay each dissenting shareholder accordingly. Reynolds American Inc., 2019 NCBC 35 ¶¶ 5-6. The dissenting shareholders (not surprisingly) disagreed with RAI’s valuation, and instead offered their own valuations ranging from $81.21 to $94.33 per share. Id. ¶ 7.

This disagreement prompted RAI to institute a proceeding under G.S. § 55-13-30, essentially asking the Court to resolve the parties’ dispute over the fair value of the dissenters’ RAI shares. Id. ¶ 8.

Once in the Business Court, the parties staked out their competing positions as to what they deemed “fair value” of the RAI stock. The difference in their valuations stemmed largely from disagreement over the “controlling date” for the valuation: Was it the date that the merger was announced that should be used to value the shares (as RAI argued), or was it the closing date of the merger that should control (as the dissenters argued)? Id. ¶ 8; CMO, ECF No. 33, p. 3-6.

As the case approached trial, RAI shifted focus to a different issue. RAI argued (in its pre-trial submissions) that certain dissenting shareholders had never perfected their appraisal rights, and therefore were not proper parties to the proceeding. These dissenters should be dismissed from the case, according to RAI, unless they could prove at trial that they had, in fact, perfected their appraisal rights (i.e., the burden was on the dissenters to make this showing). Id. ¶ 11.

The dissenters disagreed. They countered that “through filings or conduct in this litigation, [RAI] had admitted or waived its right to contest [the dissenters’] entitlement to appraisal.” Id. ¶ 14. Basically, RAI had conceded perfection when it instituted the appraisal proceeding, the scope of which was limited to determining the fair value of the dissenters’ shares. (The dissenters also disagreed that it was their burden to prove perfection.)

Addressing the issue on its own motion, and noting the late stage at which the “perfection” issue had been raised (after summary judgment and just prior to trial), the Court did not analyze the issue as one of “waiver.” Instead, the Court simply asked: Is the issue of perfection within the scope of a judicial appraisal proceeding? Put differently, was the dissenters’ perfection of (or failure to perfect) their appraisal rights a “relevant” issue for trial? Id. ¶ 16.

The answer, the Court concluded, was “no.”

The Court reasoned that perfection was not relevant to a judicial appraisal proceeding brought under G.S. § 55-13-30 because, first, the plain language of the statute did not allow the Court to consider it. Id. ¶¶ 26–28 (“There is no language in this subsection allowing or requiring a review of a dissenting shareholder’s entitlement to appraisal. The lack of such a provision is consistent throughout the statute.”).

But “[m]ost importantly,” according to the Court, the statute contemplates only two possible outcomes – and both involve the dissenting shareholders recovering a judgment. Id. ¶ 29.  The dissenters are “entitled” to a judgment, and the question is simply the “form” of the judgment, which “depends upon whether the dissenter is (i) a shareholder that has already received a payment consistent with the corporation’s estimate fair value or (ii) a shareholder ‘for which the corporation elected to withhold payment under G.S 55-13-27.’” Id. (quoting G.S. § 55-13-30(e)). In short, there is “no third option” under the statute “whereby the corporation may obtain a judgment declaring certain shareholders are not entitled to appraisal after failing to perfect their appraisal rights.” Id.

The Court rejected RAI’s argument that perfection was a requirement “inherent” to (and therefore within the scope of) a judicial appraisal proceeding. The Court reasoned that although G.S. § 55-13-21(c) provides that a shareholder who votes in favor of a proposed corporate action “is not entitled to payment under this Article,” “only sections 55-13-30 and 55-13-31 deal directly with the subject matter of a judicial appraisal action, the trial court’s jurisdiction over that action, the required parties for such an action, and the relief the trail court may provide.” Id. ¶ 32. The more specific provision (section 55-13-30) and its clear instruction regarding the dissenters’ entitlement to a judgment in an appraisal proceeding therefore controlled. Id.

The Court also considered RAI’s (rather compelling) argument that:

“without a requirement that dissenting shareholders prove their entitlement to appraisal rights…, section 55-13-30 puts corporations in an impossible position of choosing to either comply with the procedures laid out by [the NC statutes] and bring a claim for judicial appraisal under section 55-13-30, thereby forfeiting the right to challenge a shareholders’ entitlement to appraisal, or to take a gamble by asserting that a shareholder is not entitled to appraisal, thereby risking any negative consequences that might follow should the corporation be incorrect, all without the benefit of discovery.” Id. ¶ 39.

The Court did not completely disagree with this line of reasoning, but observed that it was the function of the General Assembly, not the Court, “to make decisions based on such policy concerns.” Id. ¶ 40.   Likewise, the Court declined to adopt the two-step process utilized by the Delaware Chancery Court – whereby the court first determined perfection, and proceeded second to determine fair value only if perfection was met. Id. ¶ 40. While noting that there was “much to commend about the clarity and simplicity offered by Delaware’s statute,” the Court reiterated that it could not “ignore the lack of any such statutory provision in North Carolina’s Business Corporation Act, nor [could] it create one on its own.” Id.

Finally, the Court further rested its decision on the fact that RAI never requested a judicial determination as to the dissenter’s appraisal rights. RAI had simply filed a “Complaint for Judicial Appraisal” seeking a determination as to the fair value of the dissenters’ shares, and “did not seek a judicial determination or declaration that [the dissenters] failed to perfect their appraisal rights and did not forecast [the dissenters’] perfection of rights as an issue for judicial determination in the parties’ Case Management Order.” Id. ¶ 45. Nor had RAI amended its complaint, after the issue of perfection was raised, to include a request for declaratory judgment as to the dissenters’ appraisal rights. Id. ¶ 46. Thus, even assuming that the statute allowed the Court to address the issue of perfection, “RAI’s failure to bring a claim for declaratory judgment, request other relief, or even plead facts showing the existence of a controversy as to [the dissenters’] perfection of appraisal rights would still place a determination regarding the [dissenters’] right to participate in this proceeding beyond the scope of the present case.” Id. ¶ 47 (citing N.C. R. Civ. P. 57 and N.C. R. Civ. P. 8(a)(1)).

In sum, based on the statute, the pleadings, and the late stage at which “perfection” had been raised, the issue of whether the dissenters had perfected their appraisal rights was outside the limited scope of the judicial appraisal proceeding. As such, any evidence relating to perfection was “irrelevant” and inadmissible at trial.

Sometimes when seeking a trail of breadcrumbs to help unwind a twisty problem, one finds the whole loaf, instead. So it was for the N.C. Business Court in granting a preliminary injunction on a claim for misappropriation of trade secrets in Biesse America, Inc. v. Dominici, 2019 NCBC 50 (N.C. Super. Ct. Aug. 19, 2019). See Order and Opinion.

Takeaways:

  • Trade Secret Misappropriation cannot be remedied by return of confidential information. N.C. Gen. Stat. § 66-155 is violated when a defendant acquires information it knew (or should know) is a trade secret.
  • A geographically unbounded covenant not to compete is not dead on arrival, but showing its rational tie to the employer’s business and the employee’s job is a “tall order.” 2019 NCBC 50 at ¶43.

Shortly before leaving a job with Plaintiff, Defendant Dominici “began making unusual requests for documents” containing confidential information, including sensitive purchase order forms, price lists and negotiated discounts. Id. at ¶10. In entering a temporary restraining order, the Court ordered the return of that information; Dominici complied, and also produced thousands of other electronic files to his former employer. Id. at ¶15.

Contained in that bevy of confidential information was a conveniently labeled “Opportunities” spreadsheet created by Dominici that recorded dozens of Plaintiff’s perceived business opportunities in the Pacific Northwest, an area Dominici did not supervise for Biesse but where he was expected to work for his new employer, Defendant SCM Group North America, Inc. Id. at ¶17. While the Court concluded such information was unneeded for Dominici’s work with Plaintiff, “it “had self-evident value for his next job.” Id. at ¶28. A tart footnote sealed the analysis:

As best the Court can tell, Dominici’s position is that he never intended to contact these customers but instead identified them so that he would know which customers not to contact during his employment with SCM America. Nothing in the record lends credence to this alleged motive[.] (emphasis in original).

Id. at n.1. Placing special emphasis on the purloined “opportunity” information, as well as another self-created “Masterfile” spreadsheet that contained Plaintiff’s stock inventory and sales price information, the Court found “substantial evidence” that Dominici acquired and used Plaintiff’s trade secrets in violation of N.C. Gen. Stat. § 66-155, and entered a preliminary injunction. Id. at ¶¶16, 32.

Dominici and his new employer argued that any harm to Plaintiff had been “cured” by the return of Plaintiff’s information in conjunction with the TRO, but the Court demurred, stating that “[t]his is simply not the law.” Noting the long-term effects associated with misappropriations, the Court affirmed the necessity of a preliminary injunction given Dominici’s acquisition of the information with intent to compete. Id. at ¶34.

Judge Conrad’s resolute findings on misappropriation did not color the Court’s plain rejection of a non-compete clause in Dominici’s employment agreement with Plaintiff. The Court found the clause had no geographic restrictions, essentially making it a worldwide covenant. The opinion noted that neither the Plaintiff, nor the Court of its own inquiry, had identified “any case in which a North Carolina court has granted a preliminary injunction to enforce a worldwide covenant not to compete.” Id. at ¶¶42-43. The Court found that the non-compete clause’s short duration of six months did not sufficiently balance its “boundless territorial scope.” Id. at ¶45.

The Court did not reach the issue of whether the non-solicitation clause was unenforceable. While the case’s early record was replete with references to Dominici’s acquisition of Plaintiff’s information with the intent to compete against it, the Court denied a preliminary injunction because “there is no evidence that Dominici has solicited [Plaintiff’s] customers.” Id. at ¶38.

Brad Risinger is a partner in the Raleigh office of Fox Rothschild LLP. He maintains a commercial litigation practice that frequently involves business disputes before the North Carolina Business Court, and the state’s federal and state trial courts.

N.C. Business Court Refuses to Allow Member-Managers to Assert Contract Claims Belonging to their LLC.


In its second opinion in Bennett v. Bennett, 2019 NCBC 45 (N.C. Super. Ct. Aug. 6, 2019), the Business Court denied Plaintiff Bert Bennett’s motion to dismiss a breach of contract claim by an LLC, but granted his motion to dismiss the same claim by three of its member-managers for lack of standing – even though the individuals were parties to the contract at issue. See Order and Opinion.

A Takeaway:

  • A member of an LLC who is a party to an Operating Agreement lacks standing to sue for its breach when the legal injury asserted belongs solely to the LLC.

This case involves a dispute between sibling members of Bennett Linville Farm, LLC (“Bennett Farm”), a real estate company created to facilitate estate planning of the parties’ parents. Plaintiff Bert Bennett (along with Terry Bennett, who is no longer a party) alleged that Defendants Graham, Ann, and Jim Bennett gained control of the company to the exclusion of the other sibling members, and nearly all actions they took were unauthorized. A prior post describes the nature of Plaintiffs’ claims. See Don’t Fence Me In (Aug. 12, 2019).

Through counterclaims, Defendants Graham, Ann, and Jim Bennett allege the following: they are the managers of Bennett Farm; a majority of the managers may order capital contributions from the company’s members pursuant to its Operating Agreement; the managers authorized seven capital calls over a two-year period; Plaintiff Bert’s total share of the contribution was about $380,000; and Bert failed to pay it. These individual member-managers (and the LLC under their direction) seek an order directing Bert’s capital payment to Bennett Farm.

The Court questioned whether it had subject matter jurisdiction over the member-managers’ claim. The general rule is that members of an LLC cannot pursue individual causes of action against third parties for wrongs or injuries to the company. Op. ⁋ 4 (citing Energy Investors Fund, L.P. v. Metric Constructors, Inc., 351 N.C. 331, 335 (2000)).

Defendants Graham, Ann, and Jim argued they have standing to enforce the Operating Agreement because they are parties to it.

In response, the Court looked to the terms of the Operating Agreement alleged to be in force. It makes clear that members who fail to make required capital contributions are to be liable “to the Company.” Op. ⁋ 5.

While the Court noted that some operating agreements may be crafted to support actionable individual claims like these, Op. n.3, this Operating Agreement did not do so. It dismissed the member-managers’ individual claims.  The company’s breach of contract claim survived dismissal.

The Business Court tentatively waded back into its well-settled case law that tends to scold litigants who try to convert internal company disputes into unfair trade practice claims in Constr. Managers, Inc. v. Amory, 2019 NCBC 31, 2019 WL 2167311 (N.C. Super. Ct. May 17, 2019). In doing so, the Court denied much of the defendant’s motion to dismiss the Amended Complaint. See Order and Opinion.

Takeaways:

  • The Business Court still thinks that a Chapter 75 claim is not the right vehicle for addressing shareholder disputes, disagreements among company members and other issues of internal management or strife.
  • The Court is likely to continue its vigilance policing Chapter 75 counts so that cases are not unnecessarily burdened by illusory claims that threaten great damages.
  • Only limited factual allegations that allege events beyond the confines of a single market participant may be needed to meet the “in or affecting commerce” standard.

The defendant provided accounting and bookkeeping functions for an integrated set of plaintiffs that were in the business of building, leasing, and managing clinics for the U.S. Department of Veterans Affairs. Id. at ¶¶ 2-3, 13. Before leaving to join a construction consulting firm, the Amended Complaint alleges Amory downloaded a raft of confidential and trade secret information and emailed some to one of plaintiffs’ former employees. Id. at ¶¶ 15, 17-18.

Plaintiffs’ claim under N.C. Gen. Stat. § 75-1.1 led the court to confront an issue it has addressed repeatedly in the last several years: is the conduct alleged “in or affecting commerce,” as required by the statute, or is it an “intra-company feud about internal operations” for which there is other, more appropriate legal recourse. Brewster v. Powell Bail Bonding, Inc., 2018 NCBC 74, 2018 WL 3603023, at *6 (N.C. Super. Ct. July 26, 2018) (Judge Conrad). See Order and Opinion. Construction Managers, Brewster and a host of other Business Court opinions have examined the issue within the North Carolina Supreme Court’s guidance in White v. Thompson, 691 S.E.2d 676, 679-680 (N.C. 2010) that § 75-1.1 regulates “a business’s regular interactions with other market participants” and not the “internal conduct of individuals within a single market participant.”

Plaintiffs complained that Amory was using their trade secrets to compete against them, but failed to describe how he was competing, and failed to assert that Amory had disclosed trade secrets to his new employer. Construction Managers, at ¶ 80. Moreover, plaintiffs essentially conceded that their fears about improper competition were prospective. Amory, plaintiffs claimed, “could begin to unfairly compete” with them, and was “preparing to cause” them significant damages by using the illegally obtained information. Id. at ¶ 81. The Court even found that plaintiffs’ general allegations of competition didn’t allege specific facts that were sufficient, under White, to remove it from fact patterns “contained solely within a single business.” Id. at ¶ 82.

Yet, the Court “reluctantly conclude[d]” that as a matter of notice pleading, the Chapter 75 claim survived a motion to dismiss because it was “barely sufficient to provide Amory with sufficient notice of the nature of the claim to withstand Amory’s motion to dismiss.” Id. at ¶ 83. Thus, the Court held that it was sufficient under Chapter 75 for the plaintiffs to claim – generally – that Amory was unfairly competing against them, without alleging facts regarding any of “the events or transactions which produced the claim to enable the adverse party to understand the nature of it and the basis for it[.]” Spoor v. Barth, 811 S.E.2d 609, 612 (N.C. Ct. App. 2018).

Construction Managers is a tenuous fit in the Business Court’s “in or affecting commerce” jurisprudence. The Court has regularly dismissed Chapter 75 claims that purport to center on shareholder disputes, disagreements among company members and other issues of internal management or strife. Conflating these events into unfair trade practice claims is, the Court has held, “a regrettable trend in North Carolina business litigation.” Brewster, 2018 WL 3603023 at *6. Indeed, the Court has gone out of its way to intentionally put a fine a point on the point:

By now, the message should be clear: section 75-1.1 plays no role in resolving these internal corporate disputes. Yet time and time again, section 75-1.1 appears where it does not belong, with consequences that are significant and unhealthy. The routine addition of section 75-1.1 claims in these cases invites avoidable motion practice – driving up the cost of litigation, taxing the resources of the Court, and exposing the plaintiff to a potential award of attorney fees under section 75-16.1. It also impedes settlement discussions by introducing remedies (including treble damages) that would otherwise be unavailable, thereby distorting the parties’ incentives and their perceived risks.

Id. at *7. Construction Managers cites the letter of the Court’s Chapter 75 doctrine on the types of claims it feels are within the statute, but slightly disclaims its spirit. Here, the barest pleading nudge by the plaintiffs – unsupported by facts regarding defendant Amory’s purported competition against them – was enough to survive characterization as an “internal business matter” that would doom an unfair trade practice claim. It’s by no means a Chapter 75 doctrinal sea change for the Court, but it foretells a decision or two down the line that address attempts to salvage wounded claims with the “notice pleading” life raft extended in Construction Managers.

Brad Risinger is a partner in the Raleigh office of Fox Rothschild LLP. He maintains a commercial litigation practice that frequently involves business disputes before the North Carolina Business Court, and the state’s federal and state trial courts.

N.C. Business Court Dismisses Two Contract Claims on Summary Judgment for Lack of Mutuality


In separate cases, the North Carolina Business Court answers the question: When exactly is a contract formed?  The Court reminds business leaders that parties do not form an enforceable agreement until their minds meet on all the material terms.

In Denver Property Partners, LLC v. Sisson, 2019 NCBC 22 (N.C. Super. Ct. Apr. 1, 2019), Judge Robinson granted the Defendants’ motion for partial summary judgment on the Plaintiffs’ breach of contract claim.  See Order and Opinion.

In Hocutt v. Hocutt, 2019 NCBC 24 (N.C. Super. Ct. Apr. 4, 2019), Judge McGuire denied a Defendant’s motion to enforce a settlement agreement allegedly formed prior to the action’s filing.  See Order and Opinion.

Denver Property Partners, LLC v. Sisson

In Denver Property Partners, the Plaintiffs claimed the Defendants breached an agreement to purchase an indoor shooting range and firearms retail store. The Defendants argued the parties never formed an accord. The Court agreed.

The facts in the light most favorable to the Plaintiffs showed the following:  The Plaintiffs and Defendant Mr. Sisson entered into an agreement whereby Mr. Sisson would manage the range and store and would undertake due diligence to determine whether to purchase them.  Thereafter, the  parties began negotiations for the purchase:

  • Mr. Sisson emailed the Plaintiffs’ agent, attaching a signed purchase agreement that he called a “draft.”  He invited the Plaintiffs to sign it.
  • The Plaintiffs’ agent responded, telling Mr. Sisson to add the effective date of the agreement and to add two related parties as sellers.
  • Mr. Sisson replied, telling the Plaintiffs’ agent to modify the purchase agreement as needed.

The parties engaged in no further negotiations.

Two months later, Mr. Sisson informed the Plaintiffs he wanted out. He would neither purchase the businesses, nor manage them. Litigation ensued.

In granting Mr. Sisson’s motion for partial summary judgment, Judge Robinson cited Normile v. Miller, 313 N.C. 98, 103 (1985), for the general rule that new terms added by acceptance operate as a counteroffer and a rejection of the original offer.  He determined that the first Sisson email was an offer.  The agent’s response was a counteroffer (and a rejection).  Sisson’s reply was an invitation to the Plaintiffs to make an additional offer.

Neither party ever accepted the other’s terms. There was no contract.

Hocutt v. Hocutt

In Hocutt v. Hocutt, Judge McGuire denied a Defendant’s motion to enforce a settlement agreement allegedly formed prior to the action’s filing. He treated the motion as one for summary judgment.

This case arose from “a long-simmering dispute” over control of three closely-held corporations among Plaintiff Joey Hocutt; his father, Defendant Mike Hocutt; and his brother, Defendant Jay Hocutt.  In an attempt to resolve their conflict, the family engaged counsel, who met without their clients to discuss a framework for settlement. Counsel circulated unsigned draft agreements to their respective clients to work toward resolution. Defendants Mike and Jay accepted the terms of a final draft, but Joey did not. Joey offered additional terms, which the Defendants rejected. Joey filed this action.

Defendant Mike filed a motion to enforce the settlement agreement. He argued that an agreement existed because Joey’s attorney circulated it, and each Defendant signed it. Yet, he provided no evidence that the final draft was a formal offer. To the contrary, Defendant Mike admitted that Joey refused to sign the final draft and that Joey’s attorney communicated Joey’s rejection of it.

Judge McGuire denied the motion to enforce.  He cited Chappell v. Roth, 353 N.C. 690, 692 (2001), for the rule that a valid contract requires a meeting of the minds as to all material terms.  “If any portion of the proposed terms is not settled, or no mode agreed on by which they may be settled, there is no agreement.” Chappell, 353 N.C. at 692.

Going even further, the Court cautioned the motion was “close to frivolous, and that undisputed facts arguably would entitle Plaintiff to judgment as a matter of law” rather than Defendant Mike.