What exactly is the “securities transaction” exception to a UDTP claim?  As highlighted by the Business Court’s recent decision in Aym Technologies, LLC v. Scopia Capital Management, LPC et al., 2021 NCBC 20B (N.C. Super. Ct. Mar. 31, 2021), it can be a potent defense against the UDTP claims we see litigated—perhaps too frequently—in the Business Court and elsewhere across the state.

 A.    What is the “Securities Transaction” Exception?

For those unfamiliar with it, the securities transaction exception operates essentially as a defense to a UDTP claim.  Where applicable, it effectively removes the subject transaction from the purview of G.S. § 75-1.1, the statute that creates and governs UDTP claims, by defeating the “in or affecting commerce” element of a UDTP claim.

But why?  The rationale for the securities exception is simple enough: securities transactions are heavily regulated, both federally (under the Securities Acts of 1933 and 1934) and at the state level (under the North Carolina Securities Act).  Given this “pervasive and intricate regulation,” our courts have reasoned that private enforcement under § 75-1.1 (in the form of a UDTP claim) is unnecessary or superfluous.  Skinner v. E.F. Hutton & Co., Inc., 314 N.C. 267, 275 (1985).

Courts also have applied the exception in a second instance—where the transaction in question is an “extraordinary” business event, such as a company’s issuance or redemption of its stock.  HAJMM Co. v. House of Raeford Farms, Inc., 328 N.C. 578, 594 (1991).  The idea is that a UDTP claim requires a transaction “in or affecting commerce,” i.e., “regular, day-to-day business activities,” and extraordinary events are not regular business activities.  See id.  (One might also argue that at least some stock issuance and redemption transactions involve intra-company disputes, which typically fall outside the UDTP sphere because they are not “in or affecting commerce.”  See, e.g., Potts v. KEL, LLC, 2018 NCBC 24 ¶ 33 (N.C. Super. Ct. Mar. 27, 2018) (collecting cases holding that intra-company disputes do not support a UDTP claim)).

Applying these concepts, North Carolina courts consistently have held that transactions involving securities are outside the scope of G.S. § 75-1.1, and consequently cannot form the basis of a UDTP claim.  See, e.g., Skinner, 314 N.C. 267 (conceiving securities exception based on “pervasive” regulation rationale articulated with respect to commodities transactions in Bache Halsey Stuart, Inc. v. Hunsucker, 38 N.C. App. 414 (1978), cert. denied, 296 N.C. 583 (1979)); HAJMM Co., Inc., 328 N.C. 578; Oberlin Capital, L.P. v. Slavin, 147 N.C. App. 52 (2001); White v. Consolidated Planning, Inc., 166 N.C. App. 283 (2004); Latigo Investments II, LLC v. Waddell & Reed Financial, Inc., 2007 NCBC 17 (N.C. Super. Ct. May 22, 2007).

A straightforward test has emerged: “the question is whether the transactions at issue involve securities or other financial instruments involved in raised capital.”  White, 166 N.C. App. at 304.  If so, the securities transaction exception applies.  Id.

B.   The Business Court Applies the Securities Transaction Exception in Aym Technologies.

Chief Judge Bledsoe applied the securities transaction exception in Aym Technologies.  (We have previously written on this litigation here.)  The plaintiff there moved to dismiss the defendants’ UDTP counterclaim, which alleged that the plaintiff had “misrepresented and failed to disclose material information” during negotiations that were “for the purpose of raising investment capital.”  Aym Technologies, 2021 NCBC 20B ¶ 58.  The Court made quick work of the UDTP claim, holding that because the alleged misrepresentations had been made as part of the capital-raising process, “the security exception applies.”  Id.

Although seemingly straightforward, the Court’s analysis of the securities transaction exception highlights an important point:  the exception may defeat a UDTP claim if either of the two “rationales” for the exception are present.  The Court indicated as much in addressing the defendants’ argument that the exception should not apply because raising capital was part of their day-to-day business activities (i.e., it was not an “extraordinary” event).  The defendants argued, essentially, that because their capital raising was a regular business activity—and therefore “commerce” within the meaning of G.S. §  1-75.1—the “in or affecting commerce” requirement was met.  The Court disagreed.  It explained that even if capital raising were a regular business activity of the defendants, it did not change the fact that their “investment solicitation of [the plaintiff] and any purchase and sale of investment securities that might have followed [were] likewise subject to extensive state and federal securities regulation.”  2021 NCBC 20B ¶ 59.

Stated differently, and framed in terms of the two “rationales” for the securities transaction exception described above, the Court’s analysis in Aym indicates that the exception will apply to foreclose a UDTP claim if either:  (1) a separate enforcement regime exists (e.g., the NC or federal securities acts) to regulate the subject transaction; or (2) the transaction constitutes an extraordinary event, i.e., is not a regular business activity.  And because the first rationale was present in Aym, the analysis ended there and it was of no consequence whether the second rationale also existed.

C.   What Does This Mean for UDTP Claims?

UDTP claims are frequently litigated in North Carolina, to say the least. As the Aym plaintiff pointed out, courts have taken note of the sometimes detrimental impact of such claims on litigation and even settlement prospects.  See Brewster v. Powell Bail Bonding, Inc., 2018 WL 74 ¶ 36 (N.C. Super. Ct. July 26, 2018) (observing that the “routine addition” of UDTP claims “driv[es] up the cost of litigation, tax[es] the resources of the Court, and expos[es] the plaintiff to a potential award of attorney fees” while “imped[ing] settlement discussions by introducing remedies (including treble damages) that would otherwise be unavailable, thereby distorting the parties’ incentives and their perceived risks”).

Given this reality, any arrow in the defense quiver is valuable not just to the defense but also to the courts in weeding out “add-on” UDTP claims and to the parties in working toward a resolution of their disputes.  The Business Court has reminded us that the securities transaction exception is one such arrow, representing a potent defense against UDTP claims, and at least in this instance that arrow hit its target.

 

Matt Krueger-Andes is a litigation associate in Fox Rothschild’s Charlotte office.

Digging hole

Discovery in a complex commercial case can feature its fair share of mayhem, particularly where it includes a large document production.  Yet, where parties plan and execute information exchanges with reasonable diligence, the Business Court typically affords considerable latitude.  That’s consistent with the ethic of the Court’s discovery rules – “designed for the parties to set expectations, with reasonable specificity, about what information each party seeks and about how that information will be retrieved and produced.”  BCR 10.3.

Where a discovery dispute extends beyond the pre-filing dispute resolution mechanism in the Court’s rules (see BCR 10.9), a primary objective in Business Court dockets often is to present a narrative of reasonable, if ill-fated disputes.  In Lunsford v. JBL Communications, LLC, 2021 NCBC 14, the Court called out an easy way to lose control of your own story: telling opposing parties and the Court what you think they want to hear, as opposed to the facts and discovery realities they need to appreciate.  As Judge Conrad put it,

When the Court asks for counsel’s guidance, it expects probity, not propitiation.

¶ 33.

In Lunsford, the Court noted that plaintiffs had “assured partial or complete production” on eight different dates over a four-month period, but conceded in later sanctions proceedings “they had no reasoned basis for assuring compliance by any of these dates.”  At a hearing, plaintiffs’ counsel indicated they were “pie in the sky” dates that relied on “blind optimism.”  Id. ¶ 33.  The Court offered a more stark characterization, calling it an “unjustified lack of diligence” and “a lack of candor.”  Id. ¶¶ 32-33.

It didn’t have to be that way.  Parties that find themselves in deep discovery holes will sometimes find after abandoning the shovel that a ladder lies just beyond a substantial cloud of dirt.  In Lunsford, the parties participated in the BCR 10.9 discovery dispute mechanism that includes submission of position summaries to the Court and a discretionary phone hearing.  In considering responses “outstanding for at least five months and as many as nine months,” the Court pointed out the ladder and afforded instructions for climbing: serve the overdue responses, provide a date by which documents would be produced, and provide guidance about what documents plaintiff would produce, could not produce, or refused to produce.  ¶ 8.

Continued digging ensued.  A first sanctions motion resulted in the Court’s conclusion that plaintiffs “had not even begun to search for and retrieve information” from electronic sources that likely held responsive material, nor made determinations about how to preserve, identify and produce such information.  Id. ¶¶ 10-11.  The Court awarded a modest sanction of payment of expenses caused by plaintiffs’ noncompliance, and a new production deadline of 30 days to which plaintiffs did not object based on their retention of a vendor to assist with producing electronically stored information.  Id. ¶ 12.

The aftermath brought four motions to extend the new deadline, but no production.  Ten weeks distant from the sanctions order, plaintiffs’ counsel conceded “he had spent little time on document review and could not guarantee production by any date.”  A week later, counsel indicated at a status conference his only step toward retention of a vendor to assist with the production “was to fill out an online contact form.”  Id. ¶¶ 18-19.  The Court later extended the case calendar by seven months to accommodate renewed production efforts, but at a hearing on a second sanctions motion plaintiffs indicated a 12-week review by its vendor had not yet commenced.  Id. ¶¶ 22-23.

A “habitual failure to live up to their own estimates of the time needed to meet their discovery obligations” led to an evidence preclusion sanction that barred plaintiffs “from introducing evidence” to support their own claims and defenses, as well as to oppose defendant’s defenses and counterclaims.  Id. ¶¶ 32, 34-35.  The Court allowed reasonable expenses, including attorney’s fees, as a monetary sanction but declined requests to declare certain facts as established or to dismiss plaintiffs’ claims.  The Business Court offered a host of evidence preclusion citations, but practitioners may wish to note in particular a Court of Appeals decision that affirmed evidence preclusion in response to evasive discovery conduct and failure to obey orders compelling discovery.  See GE Betz, Inc. v. Conrad, 752 S.E.2d 634 (N.C. App. 2013).

The Court soberly observed that plaintiffs’ own, persistent digging “built a record of disobedience, disregard for the judicial process, and prejudice to their adversary.”  Id. ¶ 38.  For failure to acknowledge and avail themselves of a ladder to escape their discovery excavations, the Business Court decided that plaintiffs would sit in the hole for the duration of the case.

Takeaways:

  • The Business Court is likely to honor its ethic of reasonable and efficient discovery exchanges, even as problems arise, but when pushed will sanction parties that fail to right their ways – particularly after judicial invitation to do so.
  • BCR 10.9 provides an avenue for efficient resolution of discovery disputes that can save time and a client’s money, but beware the Court’s recently expressed concern that overuse of this mechanism might lead to appointment of discovery referees for more complex disputes.

Brad Risinger is a partner in the Raleigh office of Fox Rothschild LLP.

At the NCBA’s annual Antitrust and Complex Business Disputes Section CLE last week, there was a panel segment of the North Carolina Business Court Judges.  Fox Rothschild was there, and here is our recap of what we heard and learned.  As always, we strive to be accurate reporters, but this is not a verbatim recitation of what was said.  If you want that, however, my understanding is that the CLE will be available on-demand in the coming months.

As always, the Judges were extremely helpful and gracious with their time and insight. They began by reporting on the necessary modifications that the pandemic has forced on their court operations.  Not surprisingly, they have all been fully remote for some time now.  The Judges indicated that virtual hearings have been going well, and the lawyers have stepped up to the technology.  There were no reports of any lawyers appearing in court as a kitten (if you haven’t seen this, check it out).  While there has been a complete pause in jury trials, cases are otherwise generally progressing.

As some may be aware, Judge McGuire has accelerated bench trials.  The Judges indicated that as jury trial backlogs grow, parties interested in exploring bench trials should pursue that, even with judges other than Judge McGuire.  Because jury trials in Business Court cases have to occur in the county where the case was filed, when NCBC jury trials will ultimately resume will depend on a case-by-case and county-by-county basis.

There was discussion of NCBC Rule 10.9 related to discovery motions.  There appeared to be indication that parties in some instances may be over-utilizing the telephonic conference element of that rule, and that in cases where that is occurring the Court may suggest or assign a discovery referee.  The underlying message seemed to be that while this rule is supposed to streamline discovery disputes and conserve judicial resources, in recent practice it has at times had the opposite effect.  The Judges are sometimes finding themselves involved in repeated discovery disputes in cases, with those discovery disputes often submitted for resolution with hundreds of pages of accompanying materials.  It should come as no surprise that the Judges would prefer that counsel for parties make legitimate good faith efforts to resolve discovery disputes and involve the Court through Rule 10.9 judiciously and only when truly necessary.

Motions to dismiss were once again a topic of discussion.  Back in 2019 at a similar Business Court Judge’s panel, Judge Conrad discussed his preference for parties seeking to consult and perhaps narrow claims outside of the motion to dismiss process, or as a part of the process that resulted in amended complaints being filed without the Court’s involvement.  Motions to dismiss are still posing significant burdens on the Court, especially when they are not likely to resolve the case due to factual issues.  So while the Judges did not specifically state this, a takeaway could be that defendants considering filing a motion to dismiss should undertake an analysis of whether the motion will actually change the scope of the case in any significant way.  If a partial grant of a motion to dismiss or a grant of a partial motion to dismiss will not impact the ultimate liability the defendant is facing and/or change the nature of discovery that will be necessary, then is that motion really worth filing?

Other motions were also discussed, such as motions for extension of time.  The Judges noted that for agreements between parties to extend the time for discovery responses, those do not need to be filed with the Court.  However, any motions to extend actual Court deadlines, such as briefing deadlines, require Court approval.  Judge Robinson also noted that there is no such thing as a “motion to substitute counsel.”  New counsel should file a notice of appearance, and then the withdrawing counsel must file a motion to withdraw (following all the requirements for such a motion).

Chief Judge Bledsoe reminded everyone of the change that eliminated the three day mailing rule, which we previously blogged on here.

The Judges offered some “best practices” tips for remote hearings:

  • They emphasized the importance of making eye contact; attorneys should not have the camera pointing at the side of their face.
  • If using PowerPoint, don’t just repeat your brief, and don’t make hyper-busy slides; distill your arguments to their essence, or put up key documents with key language highlighted.
  • After you put up a PowerPoint slide, take it back down as soon as possible to get your face back up on the screen.
  • Don’t be rigid and scripted and tied to doing your PowerPoint in order; be prepared to move around your slide deck to answer specific questions from the judge.
  • Submit and exchange any demonstratives ahead of the time of the hearing.

Not surprisingly, all of the Judges commended and expressed appreciation for Senior Business Court Judge Gale, who is nearing his planned retirement.  Judge Gale’s NCBC caseload has been reduced significantly as he transitions towards leaving the bench.

Finally, all of the Judges said they considered the opportunity to serve as Business Court judges as the highest honors of their careers, and they did not take that for granted.  They expressed appreciation for the opportunity to come speak (albeit virtually) to the bar.  As practitioners before the North Carolina Business Court, we should be equally appreciative that we have Judges so committed to their roles and willing to regularly share these insights with us.  I know I am.

–Patrick Kane

On January 5, 2021, the North Carolina Business Court published on its website guidance for attorneys seeking admission to the Court pro hac vice.  You can find a link to the resource here along with additional information and procedures for appearing before the Business Court.  The resource is also available from the website’s landing page on the right side, where there is a link to “Pro Hac Vice Motions Practice.”

The pro hac vice process is tedious and particular, and this guidance aims to ensure more consistent compliance.  In addition to reminding counsel to adhere to the requirements of N.C. Gen. Stat. § 84-4.1, North Carolina’s pro hac vice statute, the Business Court’s guidance provides a practical “how to” for those seeking admission pro hac vice under the Business Court Rules and the Business Court’s e-filing system.  Here are some helpful takeaways:

  • The attorney seeking admission pro hac vice must associate with an in-state attorney. The in-state attorney must create an account with the Business Court and first electronically file a notice of appearance in the action.
  • Then, the in-state attorney must electronically file a motion for pro hac vice admission of the out-of-state attorney.
  • The motion should fully comply with BCR 7 (the Business Court Rule that governs motions practice). However, the motion need not be accompanied by a brief (unless the Court directs otherwise).
  • Because the motion must comply with BCR 7, it must state that the in-state attorney has consulted with all other counsel and unrepresented parties to the action and must set forth the position of each party concerning the motion, whether any party intends to file a response to the motion, and whether any party wishes to be heard concerning the motion. See BCR 7.3.  This is a requirement above and beyond section 84-4.1.  Failure to comply with BCR 7.3 could result in the motion being summarily denied.

The Business Court also clearly reiterates the information that must be included with, or attached to, the pro hac vice motion pursuant to section 84-4.1:

  • The name, mailing address, state(s) of licensure, and bar membership number(s) of the out-of-state attorney seeking admission to appear pro hac vice in the action.
  • The out-of-state attorney’s history of pro hac vice admission in the State of North Carolina.
  • A client statement with certain declarations.
  • A statement signed by the out-of-state attorney seeking admission with certain representations.
  • A statement from the in-state attorney with certain representations, including a statement that they have forwarded or will forward the required $225.00 check to the Clerk of Superior Court in the county of venue.

Please refer to the Pro Hac Vice Motions Practice document for further details.  Attorneys seeking admission pro hac vice in the Business Court should carefully review this document in addition to the Business Court Rules, which—as noted above—set forth detailed requirements for motions practice in the Business Court.  The most up-to-date version of the Business Court Rules is available on the Business Court’s website here.

Contract with “substantial connection” with NC leads to PJ over a California Defendant who never visited NC.    

In Toshiba Global Commerce Solutions, Inc. v. Smart & Final Stores LLC, 2020 NCBC 95, Judge Conrad held that a California-based company that reached into NC to contract with a NC business was subject to personal jurisdiction.  What makes this decision interesting for PJ purposes is that the California company never travelled to NC or met or dealt directly with anyone in NC.  Instead, it dealt with the NC company’s employees located outside NC.  Nevertheless, the California company was subject to PJ in NC because it twice initiated contact with the NC-based company, and it knew (or should have known) it was dealing with a NC-based company and that work would occur in NC.  As a result, the California company reasonably should have anticipated the possibility of being haled into a NC Court.

Key Takeaways:  Things like who made first contact and whether the contract has a “substantial connection” with NC are key considerations.   As a practical matter, if you reach into NC to contract with a NC entity – especially for work in NC – your contract probably has a “substantial connection” with NC, and you are probably subjecting yourself to PJ of NC Courts.

The parties.  The Plaintiff, Toshiba Global Commerce Solutions, provides point of sale solutions (think bar code scanners at check out) for retail operations, including maintenance and repair services.  Toshiba’s headquarters and certain key operations are in Durham, NC.  The defendant, Smart & Final, is a California company that operates a chain of warehouse-style grocery stories in the western United States – none in NC.

First (and Second) Contact.  In 2017, Smart & Final was looking for a new maintenance company for its point of sale equipment.  One of the vendors it contacted was Toshiba.  The parties signed a non-disclosure agreement – notable, as Judge Conrad put it, because it lists Toshiba’s NC address at the top.  Over the next few months, Toshiba sent Smart & Final pitch materials and a formal proposal.  Those materials also indicated that Toshiba’s HQ was in North Carolina and that aspects of Toshiba’s work would be performed in NC.  Ultimately, Smart & Final hired another company; but that didn’t work out, and Smart & Final soon reached out to Toshiba a second time.

Negotiations lead to a deal.  Negotiations ensued between Smart & Final representatives in California and Toshiba representatives located in California and Texas.  Eventually, a deal was struck.  Of the array of maintenance options that Toshiba offered, Smart & Final chose a plan that involved Smart & Final’s pre-purchase (via Toshiba) of an assortment of repair and replacement parts that Toshiba would warehouse in NC and then dispense to Toshiba field technicians as needed.  As new parts were sent out, old parts were sent back to Toshiba’s facility in NC for repair.  Importantly, other service plans – that Smart & Final did not select – did not involve Toshiba’s pre-purchase, warehousing, and repair of part stock.  Over the course of performance, more than 4,000 parts were shipped from Toshiba’s NC warehouse and more than 2,000 old parts were sent back to Toshiba in NC for repair.

The Deal Goes South.  Less than a year into the initial three-year term, problems arose.  Toshiba claims the repair frequency was higher than predicted, leading to overage fees, which Smart & Final refused to pay.  Ultimately, Smart & Final terminated the contract early. Toshiba then sued in NC, and Smart & Final challenged PJ.

PJ Analysis:

No need to recite long arm statute.  First, Smart & Final argued that Toshiba failed to expressly plead PJ under NC’s long-arm statute, which is not mentioned in Toshiba’s complaint.  Judge Conrad quickly dispatched this argument, explaining that the failure to include a formulaic recitation of the statute is not required.  As long as the underlying facts were in the complaint, the long-arm statute is satisfied.  Here, the complaint included allegations of solicitation of and contract for services to be performed in NC, which satisfied the long-arm statute.

PJ is foreseeable if the contract has “substantial connection” to NC.  “Foreseeability,” Judge Conrad explained, is the “crucial factor.”  The foreseeability test is met when a suit is based on a contract that has a “substantial connection” with the State.   Citing to the NC Supreme Court’s 2020 PJ decision in Beem USA LLLP v. Grax Consulting, which we discuss here, Judge Conrad explained that “substantial connection” is based on several factors including, prior negotiations, future consequences, contract terms, and the parties’ course of dealing.

Assessing dueling affidavits – and reconciling any factual inconsistencies therein – Judge Conrad sided with Toshiba.  To start, Judge Conrad noted that Smart & Final twice contacted Toshiba to solicit services, noting that this was a “critical factor.”  Reaching into NC and soliciting business from a forum resident “tends to show purposeful availment.”

Smart & Final countered that none of the employees involved in the solicitation and contract negotiations was located in NC.  Analogizing the U.S. Supreme Court’s decision we all read in law school –  Burger King v. Rudzewicz, 471 US 462, 475 n.18 (1985) (where the Michigan defendant contacted a Florida company via it’s Michigan district office) – Judge Conrad concluded that it made “little difference” that the Toshiba employees that Smart & Final contacted were located outside NC.  Smart & Final was “well aware” that it was soliciting business from a NC-based entity.  The non-disclosure agreement that preceded negotiations noted Toshiba’s NC headquarters, there are repeated references to NC in the pitch materials and proposal, and the contract itself required formal contract notices be sent to Toshiba’s Durham, NC headquarters.  Finally, as to the parties’ course of dealing (i.e., performance): Judge Conrad explained that Smart & Final selected a maintenance plan that required Toshiba to coordinate all service calls and establish and maintain a part stock, which was work that would take place at Toshiba’s NC headquarters.  As a result, Judge Conrad concluded that the contract had a “substantial connection” with NC and that Smart & Final’s connections with North Carolina related to the contract were sufficient “minimum contacts” to establish personal jurisdiction.

Conclusion: Reaching into NC to contract with a NC-based company for work that will occur in NC will subject a foreign defendant to PJ in NC – even if the defendant never actually comes to the State; so, KYC (know your contractor).

 

 

 

Be careful what you wish for, lest it come true.

– drawn from The Old Man and Death, Aesop

In Brewer v. Grue, 2020 NCBC 59, Judge Conrad offers a helpful update to convert that traditional morality tale to the rough and tumble world of commercial litigation. With apologies to Aesop, and the Court, it goes something like this:

Be careful what you ask for in litigation, because you will get that (if you’re lucky), and only that.

Versions of that maxim govern how most of us are trained in a commercial litigation practice. Draft a discovery request to leave as little wriggle room as possible for the responder; and respond to a request as fairly, and narrowly, as is possible. In Brewer, the Business Court showed little interest in policing a lack of diligence on the requesting end or in faulting precise responses to indifferent inquiries.

Three equal shareholders in Whispering Pines Sportswear, Inc. had a “history of mistrust” based on plaintiff Craig Brewer’s claims that defendants John Grue and Don Corey had used company resources to pay personal legal fees and to route payroll to nonemployees. ¶ 2. A 2003 settlement of those disputes did not bring eternal peace to Whispering Pines.

Brewer filed suit in 2018, as Judge Conrad put it, for “a mix of self-dealing and phony accounting” claims. The claims included new laments, like altering company records to adjust the shareholders’ interests; and old chestnuts, such as defendants Grue and Corey having the company pay their personal legal bills. ¶ 3. The dispute ultimately resolved by a settlement agreement in which Brewer would purchase Grue’s and Corey’s interests in Whispering Pines, as well as their interests in a second company, upon that entity’s closure of a pending real estate deal. ¶ 5.

The Business Court ultimately entertained a motion by Grue and Corey to enforce the settlement agreement after Brewer declined to follow through with either of its purchase components. Judge Conrad’s decision to enforce the settlement agreement hinged on what plaintiff Brewer knew because of discovery and settlement negotiations, and what he could have known.

In the lead-up to settlement, Brewer had requested and received documents that included financial statements and payroll registers. Those records showed echoes of the parties’ first dispute, as they indicated a small salary and withholdings for Corey’s son. In response, Brewer secured an indemnification provision on that issue because he believed Brian Corey was not an employee and treating him as such might expose the company to liability. ¶ 4.

Brewer’s refusal to close on the agreement’s transactions stemmed from what he learned after it was executed in January 2020. While awaiting releases from involved banks to close on the Whispering Pines purchase, Brewer asked for and received information that the company paid more than $1,800 monthly in benefits for Brian Corey. He also obtained evidence that the company paid $30,000 in legal expenses to the defendants’ lawyers. ¶ 6.

The Court quickly, but thoroughly, dispatched Brewer’s claim that there was fraud in misrepresentation or concealment of this information.

Plaintiff asked for a payroll register, and got it.

That request revealed that Brian Corey had money withheld for a flex spending account, but a payroll register was not a document that could disclose the full range of benefits he received from the company. Against the backdrop of Brewer’s existing concern about phantom employees, the Court would not fault the defendants for not ensuring plaintiff got unrequested information that might satisfy all his concerns: “Defendants did not misrepresent how much the company paid for insurance by truthfully reporting how much Brian paid to fund his FSA Medical account.” ¶ 13.

Defendants had no duty to disclose unfavorable information in a settlement posture

Brewer argued that non-disclosure of the benefits was fraudulent, but the Business Court found the claim lacking because “the party accused of fraud must have had a duty to speak or have taken steps to actively conceal facts.” (citing Chesson v. Rives, 2016 NCBC 90). Judge Conrad noted that “[e]stablishing a duty to speak is a tall order when the negotiations related to ongoing litigation,” but that here, with filed litigation, the answer was clear:

[T]he filing of this lawsuit made the parties adversaries and extinguished any fiduciary relationship that might have existed, at least for purposes of settlement negotiations.

2020 NCBC 59, ¶¶ 15-16.

Seek it in discovery, and bring the receipts

The Court found that plaintiff “sign[ed] the agreement first and ask[ed] for a breakdown of insurance benefits later.” It was not the sort of diligence expected of a plaintiff who “had all the tools of modern discovery available to him,” plus the “presumptive access to company records” of being president of Whispering Pines. ¶¶ 17-18. Moreover, after long-standing disputes about alleged company payment of personal legal bills, Judge Conrad faulted plaintiff for offering no showing he had investigated the issue, or that defendants had refused to provide discovery or concealed the facts.

Takeaways:

  • It is a tall order to unseat a settlement agreement based on allegations of fraud. But, to scale such a height, the Business Court will require heightened diligence into seeking and pursuing allegedly withheld or misrepresented information.

Brad Risinger is a partner in the Raleigh office of Fox Rothschild LLP.

On December 15, 2020, the North Carolina Business Court updated its Quick-Reference Guide for the North Carolina Business Court’s Electronic Filing System, a hyper-linked reference guide accessible from the Business Court’s website.

Of significance, the Court updated Sections 2.3 and 4.1.  Section 2.3.3 reflects file size limits, reminding filers that the file size limit for an individual document is 110 MB, but also notes that there is no file size limit for the number of filings that may be placed in the filing queue.  This is of particular importance for filers attempting to submit documents in excess of 110 MB, such as trial transcripts, deposition transcripts, or a record on appeal.  In a situation where a document is larger than 110 MB, the filer will have to split the document into several smaller documents (with appropriate labels).  However, because there is no limit on the number of filings that may be placed in the queue, the filer can submit all of these smaller, separate documents together in a single submission.

It is also worth noting that Section 2.3.4 makes an important clarification between “parent” documents and attachments.  When a filer is attempting to submit a document with accompanying attachments (such as exhibits to a motion or pleading), Section 2.3.4 sets forth the procedure for appropriately attaching these “sub” documents to the “parent” document.  When done correctly, a parent filing will have its own electronic filing number (ECF No.) and a “sub” document or attachment will have a subset of the parent’s ECF No.  For example, the first attachment to a “parent” document with ECF No. 25 will be assigned ECF No. 25.1.  The Filer Quick Reference Guide provides step-by-step instructions for how to correctly file such documents.

Section 4.1 further explains the Court’s preferences for e-filing, including the acceptable filing formats (.pdf for general filings and attachments; .rtf and.docx for proposed orders).  Section 4.1.2 also notes that filers need to pay particular attention to the drop-down fields when submitting documents.  Where appropriate, a filer will be able to label documents by type and title.  The Filer Quick Reference Guide reflects the Court’s preference that submissions have detailed title descriptions.

The Filer Quick Reference Guide is an invaluable tool for litigants and attorneys appearing before the Business Court and provides most answers to common e-filing questions.  It is important to take advantage of these readily-available tools, but to also take heed of any specific Court orders, such as case management orders, that differ from the defaults reflected in the Filer Quick Reference Guide.

Jeff MacHarg & Ashley Barton Chandler

In this order from Buckley LLP v. Series 1 of Oxford Ins. Co. NC LLC, Chief Judge Bledsoe dealt with dueling motions to compel.  Both sides claimed that their hybrid business-legal communications were privileged.  After an exhaustive review – Judge Bledsoe concluded that both sides were right, and wrong, and certain materials had to be produced.

Key takeaway: to protect intertwined business-legal communications, seeking (or providing) legal advice must be the “primary purpose.”  If the “primary purpose” isn’t legal—it probably isn’t privileged—even if lawyers are involved.

The Underlying Coverage Dispute

This is a coverage suit between a law firm, Buckley LLP, and its insurer, Oxford.  After misconduct was alleged against one of Buckley’s founding partners, Buckley’s Executive Committee followed the firm’s handbook and hired an outside law firm—Latham & Watkins LLP—to investigate.  While the investigation was underway, the partner accused of wrongdoing retired, taking his revenue with him.

Buckley filed a claim under a key-man policy with Oxford for loss of income caused by this attorney’s departure.  Oxford’s general counsel reviewed the claim, and ultimately denied it.  Coverage litigation followed.

As we previously reported, motions practice started early—with an Oxford motion to strike aspects of Buckley’s venomous complaint, which Judge Bledsoe denied.

Dueling Motions to Compel “Privileged” Communications

Both sides were suspicious of the other’s privilege decisions. This led to dueling motions to compel.

Buckley focused on the communications of Oxford’s general counsel who made the claim decision.  According to Buckley, the GC’s communications were not privileged because she was not providing legal advice when making the business decision to deny the claim.

Oxford, in turn, focused on the investigation conducted by Latham & Watkins.  Oxford argued that certain communications between Buckley and Latham were neither privileged nor work product because the investigation’s primary purpose was business-related.

Judge Bledsoe concluded that they were both partly right, and partly wrong.

Communications with general counsel were not automatically privileged.

Oxford’s GC explained that she never takes off her legal hat, that her claim decision was a legal one, and thus her materials and communications are privileged.  Not so, said Judge Bledsoe.

Judge Bledsoe noted that in house counsel, and general counsel in particular, wear many hats: claims reviewer, adjuster, supervisor, investigator, monitor, etc.—none of which are primarily legal.  Claims processing is a core business function of any insurer—involving factual investigation, policy review, and ultimately a decision.  This is far from a solely legal inquiry.  Thus, communications of and with Oxford’s GC are not automatically privileged.

In deciding which communications of Oxford’s GC, if any, were privileged, Judge Bledsoe reaffirmed and applied the “primary purpose” test.  Under this test, when it comes to hybrid, business-legal communications, if the primary purpose of the communication is business, then the communication is not privileged.

After an in camera review, Judge Bledsoe concluded most of the communications with Oxford’s GC were not privileged because they were made in her business role of reviewing the underlying claim.

Communications with law firm conducting an internal investigation are not automatically privileged.

Since Latham’s investigation was required by firm policy, Oxford argued that certain communications between Buckley and its investigator—Latham—were neither privileged nor work product because they involved business, not legal, issues.  Judge Bledsoe agreed.

Internal investigations are not automatically privileged—even if the investigations are handled by outside counsel.  The key questions are whether the investigation was related to rendition of legal services and whether the legal advice was a significant purpose of the investigation.

Judge Bledsoe concluded that since the investigation was required by the law firm’s policy, the investigation was primarily a business, not a legal, activity.  The fact that Buckley hired a law firm to investigate does not convert this business activity to a legal one.  The engagement letter—which broadly and vaguely stated the purpose of the investigation was to provide legal advice—could not create privilege protections for otherwise non-privileged communications.

After an in camera review, Judge Bledsoe ordered production of a swath of Latham-Buckley communications, including emails that were marked by the author as “Privileged and Confidential.”  Judge Bledsoe concluded that many of these emails, even those with privileged markings, were non-substantive (e.g., scheduling), primarily in furtherance of the investigation, and/or were unrelated to rendition of legal services.  Judge Bledsoe did note, however, that some of the Latham-Buckley communications were primarily for seeking or providing legal advice and thus were properly withheld.

Materials that are not prepared because of litigation are not work product.

Judge Bledsoe also ruled that several Buckley-Latham communications were not work product because they were not prepared because of the prospect of litigation.  Employee misconduct is routinely investigated.  Where the materials would be created irrespective of litigation, they are not work product.  Judge Bledsoe noted that none of the communications discussed the prospect of litigation, and none of the other Buckley witnesses testified that they believed the investigation would result in litigation.  The only evidence of anticipated litigation was the affidavit of the Latham attorney, but Judge Bledsoe was unconvinced.  Among other things, nobody explained how the investigation (or communications) would have differed had litigation not been anticipated.  In other words: litigation or no litigation, the investigation would have been the same.  Since the investigation was predominantly a business function and not done in anticipation of litigation, many of the communications with Latham were not protected as work product.

Some Lessons:

  • In-house counsel beware: Even if you always wear your “lawyer hat,” your communications are not automatically privileged.
  • “Privilege” headers can help, but the best way to protect communications is to make clear that the writer is either seeking or providing legal advice.
    • So, if you are the client writing to a lawyer,  try to make your request for legal advice explicit: “I would like your legal advice on the following . . .”
    • And if you are a lawyer responding to a client, do the same: “Here is my response to your request for legal advice.”
    • If nothing else, this will help keep privilege front of mind.
  • Use the phone.  This allows for better, two-way communication and, with the exception of calendar invites, is less likely to lead to privilege and production disputes.
  • Draft your engagement letters carefully. A broadly drafted engagement letter does little to inform whether a particular engagement is a business or legal engagement.  Here, for example, perhaps the result would have been different if Latham’s engagement letter expressly noted anticipated litigation.
  • When it comes time for redactions and privilege logs: be reasonable. Not all communications between attorney and client are substantive or privileged.  Judge Bledsoe ordered the production a number of emails discussing meetings and scheduling issues—none of which remotely involved the provision of legal advice.

Final Note on Appeal-ability:

Because this opinion affected a substantial right, it is immediately appealable.  To account for the notice of appeal period, Judge Bledsoe gave the parties thirty-five (35) days to comply with the Court’s order.  In setting this compliance period, Judge Bledsoe also took note of another tool in litigants’ arsenal: a motion to reconsider.  Such a motion could provide swifter resolution than a full-blown appeal, but Judge Bledsoe reminded counsel that the permitted grounds for reconsideration are quite narrow.  Litigators, therefore, take note: a motion to reconsider may result in quicker action from a court, but it should be used only with careful consideration of the grounds.

A group of mostly powerless Class B members in a utility services firm suspected its only Class A member of self-dealing, but their suspicions did not mate with corporate authority to do much about it. However, blessed with wide-ranging inspection and audit rights under an operating agreement, they pushed forward with requests to determine the company’s financial health and investigate its management.  In Richardson v. Utili-Serve, LLC, 2020 NCBC 83, the Business Court considered the fate of this corporate inquiry when the managing member’s response to the requests was to attempt to take away the Class B members’ right to ask for the information in the first place.

Defendant C. Lee Dietrich, armed with “all voting rights on all matters,” found it “in the Company’s best interest” to amend the operating agreement to negate all audit rights and curtail the inspection rights it afforded. Id. ¶¶ 5, 9. Yet, to pull off the “Lucy with the football” maneuver you have to snatch it before Charlie Brown gets there to kick it.

Dietrich’s unilateral amendment spawned multi-layered concerns by Judge Conrad, but the cleanest issue spot was that, by its terms, the amendment to revise the Class B member inquiry rights was made effective ten days after they had already been exercised. Id. ¶ 18. The football already was sailing through a clear blue sky.

Examining the pre-amendment operating agreement in the context of Dietrich’s refusal to comply with plaintiffs’ exercise of their audit and inquiry rights, the Court allowed the plaintiffs’ breach, and good faith and fair dealing, claims to survive a motion to dismiss. Id. ¶¶ 19-20, 24. Moreover, plaintiffs’ breach of fiduciary duty claim survived the usual bar on LLC members having such a duty to one another based on the allegations of Dietrich’s control of the company. In aid of plaintiffs’ effort, Dietrich helpfully referred to his control as “plenary power” on brief. Id. ¶¶ 26-27.

While the purported amendment could not eradicate the Class B members’ inquiry rights because it was not retroactive, Judge Conrad noted it could well be an unenforceable contract because of the “unilateral rights” Dietrich reserved to later modify his performance obligations:

In other words, construing the operating agreement to give Dietrich the power to amend it unilaterally and with no duty to do so in good faith would threaten the validity of the disputed amendment.

Id. ¶ 22. The Court observed that the North Carolina Court of Appeals has cast a wary eye at the validity of such provisions  See e.g., Sears Roebuck & Co. v. Avery, 593 S.E.2d 424, 432 (N.C. Ct. App. 2004) (“the power to unilaterally amend contractual provisions without limitation gives rise to an illusory contract.”).

The Business Court found it well within its mandamus authority to enforce the inspection requests whether under the statutory grant of N.C. Gen. Stat. § 57D-3-04(a), or under expanded rights – as here – that an operating agreement may afford. N.C. Gen. Stat. § 57D-2-30(b)(4). 2020 NCBC 83, ¶ 32. However, it declined to enter a mandatory preliminary injunction to require an audit because Judge Conrad identified no irreparable harm – particularly where the Class B members were receiving a broad production of data about the condition and conduct of the company through their inspection request.

Takeaways:

  • Unbounded manager authority in an LLC poses risks of unenforceability where performance benchmarks can be altered unilaterally.
  • When Charles Schulz retired from drawing Peanuts, even he felt a little bad about the illusory football kick: “You know, that poor kid, he never even got to kick the football. What a dirty trick.”

Brad Risinger is a partner in the Raleigh office of Fox Rothschild LLP.