CBD Industry Dispute Examines when Conduct Outside an Entity can be Considered an Internal Dispute that Avoids Gateway to Unfair Trade Practice Damages

The CBD product market, by some estimates, could skyrocket to $19.5 billion by 2025. With farmers, manufacturers and distributors scrambling for a seat at this lucrative table, it’s not surprising to see the Business Court joining the fray to referee the exchange of sharp elbows among industry hopefuls. In Botanisol Holdings II, LLC v. Propheter, 2021 NCBC 68, the ownership of a CBD processing business left childhood friends at odds and money flowing in ways at least one of them didn’t intend.

David Talenfeld and Scott Propheter, along with Propheter’s father-in-law, David Mayer, shared roughly equal control of an Arizona LLC that was set to enter a joint venture with Thar Process Technologies.  Thar would provide equipment for a CBD processing plant, and Criticality, LLC (an Arizona company) would supply the hemp and run the facility. Id. ¶¶ 4, 7, 9. The lurking plot twist is that Propheter also privately formed a North Carolina entity, Criticality, LLC, without apparent notice to Talenfeld. Id. ¶ 14,

Corporate hijinks ensued. Talenfeld would later learn that the joint venture was not owned 50/50 between Thar and Criticality Arizona. Propheter had another entity he controlled own a portion of the venture. And Criticality North Carolina allegedly sold 40% of its interest for $10,000,000 to one buyer, and 60% of its equity to a second for an undisclosed price. Id. ¶¶ 17, 20, 23. A lengthy litigation lies ahead, likely centered around the fraudulent misrepresentation and fraud claims that Judge Earp forwarded past Rule 12 practice.

Unfair and Deceptive Trade Practices

But, as the action proceeds, the story of the two Criticality entities, and whether the North Carolina iteration was used in the place of its Arizona relative to improperly advantage Propheter at the expense of the joint venture parties, will not include the risk of treble damages under Chapter 75. The Court dismissed the unfair and deceptive trade practices claim against the defendants as not meeting the “in or affecting commerce” test of Chapter 75 because the Act does not cover “[m]atters of internal corporate management.” Id. ¶¶ 62-63. See Wilson v. Blue Ridge Elec. Membership Corp., 578 S.E.2d 692, 694 (N.C. App. 2003). The Court reasoned that the North Carolina iteration of Criticality was alleged as being “an instrument” used by Propheter “to facilitate harm within” the Arizona entity, and therefore “the dispute is intracorporate” and not covered by Chapter 75. 2021 NCBC 68, ¶ 64.

As recently as 2019, the Business Court reiterated its stance that Chapter 75 claims which purport to center on shareholder disputes, disagreements among company members, and other issues of internal management or strife are misplaced. We wrote about it here, noting the Court’s waning patience with over-used Chapter 75 allegations. “By now,” the Court noted in Constr. Managers, Inc. v. Amory, 2019 NCBC 31, “the message should be clear: section 75-1.1 plays no role in resolving these internal corporate disputes.” Botanisol Holdings revisits a tangent of the settled rule: that external conduct can be properly viewed as an intracorporate affair when directed to cause harm in the entity.

The Court relies on the North Carolina Supreme Court’s ruling in White v. Thompson, 691 S.E.2d 676, 680 (N.C. 2010) that

“the Act was designed to achieve fairness in dealings between individual market participants” . . . [and] “is not focused on the internal conduct of individuals within a single market participant, that is, within a single business.”

In White, the Supreme Court explained that a partner which diverted business opportunities to another entity he controlled and misinformed his partners about the subterfuge “unfairly and deceptively interacted only with his partners, [and] his conduct occurred completely within the [ ] partnership and entirely outside the purview of the Act.” Id.

Interestingly, White itself relies on Sara Lee Corp. v. Carter, 519 S.E.2d 308 (1999), where Chapter 75 was found to apply when a corporate employee arranged for his company to buy parts from a firm in which he had a financial interest. The Supreme Court found those actions occurred outside the employee’s relationship with the employer and were more properly viewed as interactions between the employer and the employee-related entity. Id. at 312.

Botanisol Holdings fairly relies on White to conclude that Propheter acted “completely within [Criticality Arizona],” 691 S.E.2d at 680, when he allegedly used and concealed two entities outside that company to construct a labyrinth of business relationships that may have enriched himself and other entities at the expense of the Arizona entity and his childhood pal, Talenfeld. Perhaps, though, the North Carolina Supreme Court will have occasion to find a middle ground between cases that conflate evidently internal disputes into treble-damage claims, and actions like Botanisol Holdings that consider elaborate external schemes as matters of “internal corporate management.”

Takeaways

  • Current North Carolina law provides defendants an effective tool to recharacterize conduct occurring outside a corporate entity to nonetheless be considered a dispute involving “internal corporate management” that avoids potential Chapter 75 liability.
  • If you made it this far, perhaps take a final step and review the inspiration for the headline – “The Trouble with Tribbles,” episode 15 of Star Trek season 2 from December 1967.

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

Counsel in North Carolina Derivative Actions can Represent Company, and Targeted Directors who do not Face “Serious Charges of Wrongdoing”

Amidst a “bitter family dispute” over future control of a closely held oil company, can the same law firm represent the directors paving the way for their son to take the reins and the company that minority shareholders seek to protect from the heir’s perceived shortcomings? In Mauck v. Cherry Oil Co., Inc, 2021 NCBC 59, the Business Court took a first impression look and adopted a subjective standard that would disapprove of such dual representations only when allegations of “serious wrongdoing” are made against the directors sued in a derivative action.

Defendants Jay and Ann Cherry own and control about 66% of Cherry Oil, a propane and refined fuel distribution business. Jay’s sister, Louise, controls about 34% of the company along with her husband. The dispute centers around Jay’s plans to retire, and the apparent interest he and his wife have in passing to their son, Jason, a controlling interest in the company. ¶¶ 4-5, 7-8. Aunt Louise and Uncle Armistead, the plaintiffs, sued over the unease they have with their nephew taking charge, alleging he lacks “commit[ment] to developing the skills or doing the work necessary to succeed on individual merit, rather than nepotism.”  Id. ¶ 6.

Womble Bond Dickinson (US) was counsel for defendants Jay and Ann Cherry, and over the repeated objections of the plaintiffs, the firm subsequently was retained to represent Cherry Oil. As Judge Davis aptly noted, the plaintiffs drew little comfort from Womble Bond purporting to protect the interests of the majority shareholders and the company (id.¶¶ 13, 25):

In essence, the Plaintiffs’ argument is that an attorney cannot represent one client at the same time that it is investigating that client for potential wrongdoing against another client.

The Business Court surveyed differing approaches from other jurisdictions, but ultimately settled on a rule that would allow the same law firm to represent both company and directors in a derivative action unless there are “serious charges of wrongdoing” against the directors. Judge Davis was influenced by comments to Rule 1.13 of the North Carolina Rules of Professional Conduct that suggest a conflict could exist if there were such “serious charges” alleged against “those in control of the organization.” Id. ¶ 35. Cf. In re Conduct of Kinsey, 660 P.2d 660, 669 (Or. 1983) (separate counsel needed unless claim “patently sham or patently frivolous”); Rowen v. LeMars Mut. Ins. Co. of Iowa, 230 N.W.2d 905, 914 (Iowa 1975) (potential conflict of interest “well established” when counsel seeks to represent company and “corporate insiders accused of wrongdoing”).

The Court’s application of the newly adopted standard shows that following the judicial course may be more complicated than charting it.  There are, Mauck concludes, instances when a law firm should not represent both company and targeted directors in a derivative action but discerning them depends on a subjective determination of when alleged director misconduct amounts to “fraud, theft, self-dealing, or usurpation of corporate opportunities.” 2021 NCBC 59, ¶ 36. The analysis of whether Jay and Ann Cherry’s mixing of personal estate and corporate succession planning amounted to “self-dealing” may show the appeal of a bright-line standard for these dual representations.

The minority shareholders allege that Jay and Ann Cherry took a concerted series of steps “for the benefit of themselves and what they call their ‘next generation’ to the exclusion and at the expense of Armistead and Louise and Cherry Oil.” Id. ¶ 8. Further, they alleged that the effort was advanced by attempts to remove each of the plaintiffs from the company’s board, and that an allegedly reconfigured board sought to implement a “call” of plaintiff’s shares. Id. ¶ 13.

Yet, the Court noted the defendant directors were alleged to have engaged in self-dealing “to consolidate their power,” but not “in its traditional sense” as, for example, transactions motivated by personal benefit, being allied with a competing business, or undertaking unauthorized transactions. Instead, the Court held, alleged efforts by the defendant directors to consolidate their power and lessen the influence of the minority shareholders was a debate about “current mismanagement and future direction,” not the sort of “theft, fraud, or gross financial conflicts of interest that courts have found sufficient to constitute serious charges of wrongdoing.” Id. ¶¶ 38, 39.

Takeaways

  • A fact-specific, subjective standard for when a law firm can represent both company and alleged wrongdoer directors in derivative actions forecasts frequent disputes over counsel which purport to investigate director conduct – and defend it.

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

Hog Supplier Allowed Discovery to Prove Smithfield Foods Impermissibly Favored Other Vendors Despite Contract Clause

The paths that lead to the North Carolina Business Court are often paved with the broken hearts of business partners whose interests, and fortunes, have diverged. Often as not, the Court’s opinions survey the wreckage, identify factors that may have caused the chaos, but lack a record of context to paint the landscape of the corporate collision. Not so in Maxwell Foods, LLC v. Smithfield Foods, Inc., 2021 NCBC 50, where one of the country’s largest suppliers of swine sued a mammoth pork producer claiming sharp business practices fueled Smithfield’s ascent, and Maxwell’s approaching demise.  As Judge Conrad summarized plaintiff’s lament (¶ 10):

“Smithfield’s success is Maxwell’s sorrow.”

In happier times, under a mid-90s output contract, Smithfield bought all of Maxwell’s hog output from its Virginia and Carolinas farms up to a monthly cap of 155,000. These purchases, the Court noted, joined those from hundreds of Smithfield-owned farms and other independent suppliers like Maxwell. It formed a giant supply pipeline that leads Smithfield, in just three East Coast plants among a larger footprint, to process more than 55,000 hogs per day. (Id. ¶ 4-5).

The Maxwell-Smithfield part of this massive industry appears to have collapsed in dispute over decreased purchases by Smithfield and the failure of key pricing mechanisms: the metric picked by the parties to set per-pound purchase prices, and a “most-favored nation” clause addressing how Smithfield’s relationship to other hog suppliers compared to its business deal with Maxwell. Smithfield’s motion to dismiss did not target the claim that it breached the output provision by halving its purchases from Maxwell in April 2020. That claim will proceed against Maxwell’s allegation that Smithfield favored its own affiliated suppliers at the expense of Maxwell’s interests. (Id. ¶ 12).

Most-Favored-Nation Clause

The Court reported the MFN clause as affording to Maxwell “the same economic incentives” provided to all “other major swine suppliers” and offering “the benefit of future changes in economic benefits given said major swine suppliers during the term of this contract.” Smithfield argued the provision was unenforceable as vague and indefinite, and focused on the purportedly boundless nature of the term “economic benefits.” (Id. ¶¶ 18, 23). Judge Conrad showed little interest, particularly at a pre-discovery phase, in limiting Maxwell’s access to discovery to support its view of the MFN clause. Noting that “[p]arties presumably intend that their agreements will be effective,” the Court explained it “must take language as it is and people as they are. All agreements have some degree of indefiniteness and some degree of uncertainty.” (Id. ¶ 21) (quoting Carolina Helicopter Corp. v. Cutter Realty Co., 263 N.C. 139, 146 (1964)). The Court found no basis to short-circuit litigation about application of the MFN clause based on a failure to discern what the parties were after when they drafted the provision (id. ¶ 22):

“The most-favored-nation clause is hardly so vague as to defy understanding.

The undeniable intent was to ensure that Smithfield would treat Maxwell just as well as similarly situated suppliers. Clauses like this one are both common and commonly enforced.”

Setting Prices for an Output Contract

While the Court found the parties’ MFN was “a fixed and final obligation,” it was just as exacting in analyzing Maxwell’s claims that Smithfield had a duty to negotiate in good faith revised terms after the pricing mechanism selected by the parties was no longer viable. (Id. ¶ 28). The Court found that the contract required the parties to “designate” a new basis for determining market value of purchases, but “[m]issing is any promise to negotiate the new basis in good faith.” (Id. ¶ 32). Instead, the Court offered Maxwell what the contract provided regarding pricing disputes: an opportunity “to arbitrate their disagreements, not to negotiate them.”  As Judge Conrad noted, the Court “must construe [the agreement] as written, leaving out ‘imagined terms’ that the parties could have included but did not.” (Id. ¶ 33) (quoting Morrell v. Hardin Creek, Inc., 371 N.C. 672, 686 (2018)).

Chapter 75 Claims Based on Antitrust Allegations

Maxwell’s Chapter 75 claim followed Smithfield’s failed attempt to remove the action to federal court. The claim centered around allegations that Smithfield “abused its monopoly buyer power . . . to target Maxwell unfairly and to force Maxwell out of the hog business.” (Id. ¶ 13). While it successfully broached the specter of treble damages, it also brought Maxwell something it unsuccessfully opposed: designation to the Business Court. The Court retained jurisdiction because a material issue of antitrust law needed to be resolved for Maxwell’s claim to proceed. (Id.). See N.C.G.S. § 7A-45.4(a)(3).

Maxwell alleged that Smithfield’s accumulated market power – through vertical integration and industry consolidation – led to control of the buyer’s market that was used to pressure Maxwell out of business by favoring itself and other vendors. The Court found there was “no serious question that these are allegations of antitrust misconduct” that must meet the pleading requirements for a monopoly on a market’s buyer’s side – a monopsony. (Id. ¶ 39). As the Court noted, it is well settled that “the failure of the antitrust claim also defeats liability under section 75-1.1” (Id. ¶ 42). The Court dismissed the Chapter 75 claim based on Maxwell’s failure to adequately plead required monopsony elements, including Smithfield’s monopoly power in the relevant market and “willful acquisition or maintenance” of it.  (Id. ¶ 40).

Takeaways

  • Finding a contract void for vagueness at a pleading stage is a rare outcome, even where challenged terms are broad, as the Business Court warns that “it would be a mistake to equate breadth with ambiguity, much less indefiniteness.” (Id. ¶ 24).
  • Where an unfair and deceptive trade practices claim is based on antitrust misconduct, a failure to adequately plead that underlying violation also fells the Chapter 75 claim.

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

Discord within a faith community comes with all the challenges of a secular dispute, but carries with it the special responsibility that members of a congregation share in a collective spiritual undertaking. Yet, there are limits that test even the bounds of The Bible’s guidance that, “Blessed are the peacemakers.” Matthew, 5:9.

Illustration by Jessica Karsner

In McKnight v. Wakefield Missionary Baptist Church, Inc., 2021 NCBC 35, the Business Court considered the splintering of an unincorporated religious association so rancorous that one surviving entity claimed the other “no longer exists.”

After a more than 150-year history, internal financial disputes within the congregation of Wakefield Missionary Baptist Church (WMBC) escalated to such a degree that a group of its trustees fired the senior pastor, locked the doors to the church, “and purported to reorganize the church as a nonprofit corporation” – Wakefield Missionary Baptist Church, Inc. (WMBC, Inc.). They also subsequently transferred the real property of the church to WMBC, Inc. Id. ¶ 6-7.

What arose, then, was a very Business Court-looking dispute in which WMBC’s trustees raised fiduciary duty, constructive fraud and unjust enrichment claims centered on transfers of church property. And WBMC Inc.’s trustees countered with claims for trade name infringement, conversion, and civil conspiracy.

The Court’s subject matter jurisdiction in such settings is narrow, as the First Amendment’s ecclesiastical entanglement doctrine “severely circumscribes the role that civil courts may play in resolving church property disputes.” Id. ¶ 21 (quoting Harris v. Matthews, 361 N.C. 265, 271 (2007).  As the Court explained:

“Simply put, secular courts may not adjudicate ‘controversies over religious doctrine and practice.'”

Id. Harris limits a court’s ability to resolve factional disputes within a church to those:

“that can be resolved on the basis of neutral principles of law such as (1) who constitutes the governing body of this particular church, and (2) who has that governing body determined to be entitled to use the properties.”

361 N.C. at 272. The Business Court held that its secular authority could be employed in just that way – to determine the appropriate governing body at key junctures and whether its actions met the terms of the church’s constitution and bylaws. 2021 NCBC, ¶¶ 23, 25.

The Court concluded that a fiduciary duty claim could lie against the trustees who formed WMBC, Inc. because they were trustees of WMBC when they did it. Id. ¶ 30. See N.C.G.S. § 61-2. But the Court made a more interesting call when it allowed constructive fraud claims against the defendant trustees to proceed by finding that plaintiffs had adequately pled those trustees had benefitted themselves by moving the church’s property to an entity they controlled – WMBC, Inc. The Court observed that, “[r]ead liberally,” those allegations suggested a personal benefit to the trustees because they controlled the new entity. 2021 NCBC, ¶ 31.

Standing

The Court resolved a couple of standing issues worthy of note. First, defendants claimed plaintiffs were not trustees of WMBC and therefore had no standing to sue under N.C.G.S. § 61-2. Judge Conrad held defendants made no showing plaintiffs weren’t trustees, and absent that it was good enough that they said they were. 2021 NCBC, ¶ 16. See N.C. R. Civ. P. 9(a) (plaintiffs required to “make an affirmative averment showing [ ] capacity and authority to sue”).

The Court also rejected the argument by the defendant trustees that because they had converted WMBC to WMBC, Inc., plaintiffs were attempting to sue on behalf of an entity “that has ceased to exist.” 2021 NCBC, ¶ 18. The Court noted that because the propriety of WMBC Inc.’s incorporation “is one of the key issues underlying this case,” it was not required to resolve that merits issue in response to a standing challenge. Id. ¶ 19. See Cline v. Teich, 374 S.E.2d 462, 465-66 (N.C. App. 1988).

Takeaway

  • A secular court can use neutral principles of law to resolve a dispute among church factions about who constitutes its governing body and what that means for control of its property.

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

Evidence a Party Controls, but Fails to Marshal at Trial, Falls Short of High Bar to Undo a Final Judgment Based on an Adversary’s Fraud

When a motion for reconsideration hearing features a plaintiff’s accusation that the court made arguments for the other side, the effort to flip a prior ruling – already a tough get – has gone a bit off the rails.  In Bayport Holdings, Inc. v. Sisson, 2021 NCBC 39, the Business Court considered a Rule 60(b)(3) effort to undo a final judgment based on alleged fraud by the prevailing party. It ended with the Court’s concern about the “troubling” course plaintiff’s arguments had traveled.

Plaintiff claimed that defendant Brian Sisson had committed fraud and attempted to prove it up with boxes of documents he had left behind at the shooting range and firearms retail store he previously managed for them, as well as through emails found in the account of one of its shareholders. Id. ¶¶ 2, 15. The Rule 60(b)(3) bar is high, requiring a showing of a “meritorious defense” that a party was unable to put on because of its adversary’s fraud. See Milton M. Croom Charitable Remainder Unitrust v. Hedrick, 654 S.E.2d 716, 721 (2008). Tough work, for sure, but previously unknown documents are a good starting point for the plot.

The drama is considerably lessened when it turns out plaintiff had the documents all along. Plaintiff obtained the boxes during discovery but didn’t review them for over a year – despite its “unilateral access . . . without interference by Sisson” – on the assumption they were business records that predated the current dispute. NCBC 39, ¶¶ 16, 19-21. The shareholder’s emails were not reviewed or produced during the case because he “could not remember the password to his Gmail account,” only to recall it earlier this year with the help of family and a business colleague. Id. ¶¶ 23-25.

The atmospherics of plaintiff’s claims were not improved by its concession at hearing that defendant Sisson didn’t prevent it from presenting documents at trial that plaintiff, itself, controlled during the discovery period. Judge Robinson noted that plaintiff’s delay in reviewing the boxes, or in securing access to its own shareholder’s emails, could hardly be laid at a defendant’s doorstep:

“The Court finds it troubling that Plaintiff clearly failed to review relevant documents in its possession, both before and during the pendency of this litigation, which review would have alerted counsel to their existence, and now blames [a defendant] for withholding this information from the Court.”

Id. ¶ 54.

Without a North Carolina guidepost, the Court relied on interpretations of Fed. R. Civ. P. 60(b)(3) for the requirement that a moving party show the other side’s fraud by “clear and convincing” evidence. See Turner v. Duke Univ., 381 S.E.2d 706, 713 (N.C. 1989) (“Decisions under the federal rules are thus pertinent for guidance and enlightenment in developing the philosophy of the North Carolina rules.”). Judge Robinson dismissed each of plaintiff’s four contentions of fraud in turn, concluding that the newly surfaced materials did not meet the exacting burden for Rule 60 relief. NCBC 39, ¶¶ 36, 42, 46, 53. The Court hastened to add that, “even if a lesser burden of proof may apply” – whatever it might be – the plaintiff’s arguments and late-produced materials could not meet the mark for Rule 60(b)(3) relief. Id. ¶ 54.

The Business Court also cautioned against overloading a Rule 60 motion with claims appropriately brought through “timely appeal.” (Plaintiff’s motion was filed just within the one-year deadline for seeking Rule 60(b)(3) relief.)  ¶¶ 13, 52.  Where plaintiff’s motion sought to challenge an earlier court ruling subject to normal appeal deadlines, the Court reminded that later-arriving Rule 60 motions cannot remedy expired appeal windows:

“Erroneous judgments may be corrected only by appeal, and a motion under [Rule 60(b)(3)] cannot be used as a substitute for appellate review.”

Id. ¶ 52 (quoting Chicopee, Inc. v. Sims Metal Works, Inc., 391 S.E.2d 211, 216 (1990)).

Takeaways

  • The standard to show an adversary’s fraud prevented a party from presenting evidence is an exacting one, whether it’s “clear and convincing” or something with a less stern sound to it.

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

Major Expansion at an Exclusive Country Club Leads to a Fight over Access to Records, Plans and Financials

At one of Charlotte’s finest golf courses, Myers Park Country Club, the summer weather isn’t all that’s leaving some members hot under the collar.  As the club embarks on a $27 million renovation plan tied to its 100th anniversary, member Mark Erwin has sued the club under state corporate inspection laws for a better look at records relating to the approvals, plans and financials related to the project. In Erwin v. Myers Park Country Club, Inc., 2021 NCBC 45, the Business Court surveys the “absolute” and “qualified” rights of inspection available to a member like Erwin, and in the process sheds some light on the typically private affairs of exclusive clubs.

Club renovations are common, but a $27 million price tag to “be partially funded through a combination of assessments, monthly fees, and member fees” is likely to draw a curious glance. Id. ¶ 11. Here, Erwin sought to gather information on the “Connecting the Centuries” project to examine the propriety of related transactions, potential mismanagement, and financial feasibility to share with other club members and shareholders. Id. ¶¶ 14, 49.

Takeaways

  • Court fights over shareholder inspections may, on balance, lead to public disclosure of more sensitive information than would an initial, agreed production.
  • Corporations in North Carolina can’t use the Business Judgment Rule to shield records from a shareholder’s exercise of statutory inspection rights.

The North Carolina Business Corporation Act provides a “qualified shareholder” – at least six months as a member or holder of 5% of any share class – the opportunity to inspect certain corporate records in two, distinct areas generally considered as “absolute” and “qualified” inspection rights under N.C. Gen. Stat. § 55-16-02(a), (b), (g).

Judge Robinson affirmed Erwin’s access to several information categories to which he had “absolute” access under the statute, including shareholder minutes and records of final project-related actions taken by the shareholders (without any meeting), as well as any revenue shortfalls experienced by the club from 2019 through March 2021.  2021 NCBC ¶¶ 33, 35-36.  The Court noted, interestingly, that the club’s Rule 30(b)(6) deponent testified there were no minutes created of meetings, though there may have been at least one held during the time period.  Id. ¶ 33.

The Court also upheld Erwin’s right to “written communications” to shareholders related to the renovation project, and any revenue shortfalls or plans to address them. As is typical, the really interesting stuff was not access to the discovery loaf itself but how the parties proposed to slice it. Erwin sought project “renderings, narratives, presentations, and brochures” shared by the club at a shareholder meeting.  The club argued such materials weren’t written communications, but the Court disagreed and ordered production. Id. ¶ 39-40.

The Court also refereed a dispute about the appropriate definition of a “revenue shortfall.” The club argued there were no such shortfalls, showing that in 2020 it “ended the year with a record high” of $2.87 million in cash – nearly double its year-end 2019 position.  Id. ¶ 41. But Judge Robinson sided with Erwin’s approach: that his request rightly sought information on shortfalls in actual club revenue as measured against its projected revenue. ¶ 42.

So-called “qualified” inspection rights differ from “absolute” ones in that they require a showing that demands are “made in good faith and for a proper purpose,” set forth with “reasonable particularity,” and are “directly connected” to the requester’s purpose.  N.C. Gen. Stat. § 55-16-02(c). In parsing several inspection requests under the “qualified” standard, the Court considered the club’s argument that Erwin’s exercise was not for a “proper purpose” because it sought “a re-assessment of the Board’s business judgment as to whether the Project should or should not be undertaken and what contractors should or should not be hired to complete the Project.” The Court found no controlling law to support the contention that the “business judgment rule” could be used to ward off a shareholder’s statutory inspection rights. 2021 NCBC ¶ 47-48.

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

State’s Authority over North Carolina Railroad Company Might be Significant, but Deemed Control of a “Shareholder,” not a “Sovereign”

In a case closely watched by public transit activists and “government in the sunshine” advocates, the North Carolina Supreme Court last week affirmed a 2020 Business Court decision that found the North Carolina Railroad Company (NCRR) beyond the reach of the North Carolina Public Records Act. The dispute arose when the Southern Environmental Law Center (SELC) sought records from NCRR regarding its refusal to cooperate in the construction of a light rail transit line once slated to connect Durham and Chapel Hill.  NCRR refused to provide any records, claiming the Act didn’t apply to it, and the Business Court agreed in a decision we discussed here.

In SELC v. N.C. Railroad Company, 2021 NCSC 84 (Aug. 13, 2021), the Supreme Court, in a 5-2 decision with Justices Earls and Hudson dissenting, held that NCRR was not an “agency of North Carolina government or its subdivisions” subject to the Act (N.C.G.S. § 132-1). The Court relied principally on NCRR’s status as a “separate corporate entity” that “makes decisions independently of any directives that it might receive from government officials, including the Governor.” ¶¶ 29, 39. Justice Ervin’s majority opinion was particularly focused on viewing the NCRR’s sole shareholder – the State of North Carolina – as a “single stockholder” having the role such solo owners can have, as opposed to the State acting as a sovereign in a way that would open up NCRR’s records to public review. Id. ¶ 40.

This “lens” was particularly important as the Court’s opinion notes the State: (i) picks all of NCRR’s directors; (ii) approves substantive amendments to its articles of incorporation; (iii) gets all of NCRR’s assets upon its dissolution; and (iv) can conduct thorough audits and receive detailed information in statutorily mandated reports. Id. ¶ 19. Indeed, the State’s control over NCRR is such that it once ordered payment of a $15 million dividend to the State, and “has the right to approve or disapprove certain fundamental corporate decisions.” Id. ¶¶ 10, 40.

While the Court allows that “the Railroad has enjoyed and continues to enjoy a number of benefits from its relationship with the State” (Id. ¶ 38), it cautioned that it would place “impermissible weight” on its analysis to effectively double-count “the fact that the State is the Railroad’s sole shareholder” and also that the State gets to take the actions and make the decisions that such a single shareholder can. Id. ¶ 40. Here’s how the majority set forth this newly announced “divisibility” doctrine of State actions that might trigger the Public Records Act:

“Simply put, most of the information upon which the SELC relies in seeking to persuade us that the Railroad should be deemed subject to the Public Records Act is the direct result of the State’s status as the Railroad’s sole shareholder rather than the exercise of the State’s sovereign authority.”

Id. Thus, the Court adopts a standard under which the State can be deeply intertwined into a private corporation’s activities, but nonetheless avoid public scrutiny of corporate actors like NCRR which frequently engage in matters that impact transit policies and projects across the state. In a gentle nod to the majority’s author, the dissent notes that legendary senator and Watergate interlocutor Sam J. Ervin, Jr. (Justice Ervin’s grandfather) might well have found the Court’s approach at odds with the ”uncontestable pre-condition of democratic government that the people have information about the operation of their government.” Id. ¶ 61.

Indeed, the “form versus substance” dialogue between the majority, dissent and the parties takes on a central role in the Court’s decision. The majority rejects SELC’s argument “that the nature of the State’s authority over the Railroad, rather than the source of that authority, should be deemed controlling.” Id. ¶ 41. Instead, it held that “authority derived from some other source” – here, as a solo shareholder – predominated over any purported exercise of “sovereign authority” by the State. Id. Justice Earls found that analysis to exalt form over the reality of how enmeshed the State is with NCRR:

“When the State owns the corporation, appoints its board, mandates its reporting, spends its revenue, and stands to receive the assets in the event of dissolution, we should recognize the obvious truth that the identity of the corporation, and its sole shareholder – the State – are meaningfully intertwined. NCRR’s argument – that the activities of this kind of corporation can be hidden from scrutiny by the people of North Carolina – is a self-interested attempt to cleave its public business from its public responsibilities. Today’s decision gives that attempt the force of law.”

Id. ¶ 55.

The Court also notes it was influenced by several bypassed opportunities the General Assembly has had to show that it considered NCRR “to be a government agency or subdivision that was subject to the Public Records Act.” Id. ¶ 34. Among these data points was the legislature’s allowance of NCRR board members to get D&O insurance coverage through the State’s policy without designating the Railroad as a public body; and NCRR being granted the eminent domain authority of a private, rather than a public, condemnor. N.C.G.S. § 40A-3(a)(4). ¶ 35. Yet, the dissent laments that the majority’s search for legislative intent in parallel enactments is not paired with “any meaningful evaluation of the scope and purpose of the Public Records Act.” NCSC 84, ¶ 59.

The Court’s decision in SELC v. NCRR also is notable for its adoption of a modified standard for judging when the State is so involved in a private entity that it triggers the public’s oversight through the Public Records Act. Like the Business Court, below, the Supreme Court found that the existing standards that have guided this analysis were insufficient to meet the circumstances. Previously, the benchmarks were set by two Court of Appeals cases: News & Observer Pub. Co. v. Wake Cty. Hosp. Sys., Inc., 284 S.E.2d 542, 548 (1981) (9-factor analysis that probes “the nature of the relationship between the [entity] and the [government]”) and Chatfield v. Wilmington Hous. Fin. And Dev. Inc., 603 S.E.2d 837, 840 (2004) (cautioning that in such analyses “each new arrangement must be examined anew and in its own context.”).

The majority concluded it was “not prepared to conclude that the nine factors delineated in News & Observer should be treated as outcome determinative,” and instead “recognize[d]” that the Court of Appeals actually endorsed in the two cases a “totality of the circumstances approach” that relies on a whole record analysis of whether “the government exercised such substantial control over the operations of the relevant entity[.]” NCSC 84, ¶ 29. Justice Earls wryly observed the necessity of this new approach in dissent, noting that “if we were to apply the rule which has been the law in our state for the past forty years, NCRR falls firmly” within the meaning of an agency under the Public Records Act. Id. ¶ 62.

Takeaways

  • The decision is likely to lead to increased litigation over public oversight of public-private partnerships that conduct historically government-themed work in the public’s interest. As Justice Earls warned in dissent, the Court’s ruling could “create formalistic hideouts” for such enterprises “to escape scrutiny.”
  • Lack of public scrutiny into NCRR’s activities comes at an inopportune time for the State, as political and community tensions rise over the role of public transit in energy and climate debates.
  • The Supreme Court tends to affirm Business Court decisions per curiam without opinions. Perhaps that’s not the case here simply because there was a dissent, but it bears watching as litigants weigh the value of per curiam affirmances.

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

Large Settlement Led to a Big Plot Reveal: The Agreement was Never Executed

Rule 1.5(c) of the North Carolina Rules of Professional Conduct provides protection to clients with its requirement that “[a] contingent fee arrangement shall be in a writing signed by the client.”  In Rossabi Law PLLC v. Greater Greensboro Ent. Grp., LLC, 2021 NCBC 31, the Business Court considered what happens when a client turns the rule against its lawyer to block recovery of a fractional share of a settlement.

Plaintiff represented a defendant entity that operated the Cone Denim Entertainment Center (CDEC), a concert venue in downtown Greensboro. In summer 2017, the City of Greensboro advised that it had purchased property behind CDEC and intended to condemn the access easement and terminate the public parking arrangement that benefitted the property owned by defendant N Club, LLC on which CDEC operated. ¶ 12.  The key dispute before the Business Court arose from a latent dispute about the lawyer-client relationship formed to defend against the condemnation.

The City and N Club entered a review agreement under which the City would reimburse N Club as much as $45,000 for expenses associated the City’s condemnation plan, including potential attorneys’ fees. When the City took its proposed actions a few months later, its Council adopted a resolution that included payment of attorneys’ fees.  Id. ¶¶ 14, 16.  The lawyer-client dispute revolved around the nature of their relationship after the City’s condemnation action.

The Rossabi law firm believed after that point it represented defendants on a contingent basis in legal action against the City over the condemnation and parking termination. The Business Court’s opinion recites that a member of defendant Greater Greensboro Entertainment Group (GGEG) – Rocco Scarfone – asked for the contingent structure, told Plaintiff he would execute the Contingency Agreement that was delivered to him, later indicated he had signed it, and acknowledged the arrangement at a mediation. Id. ¶¶ 19, 22-24.

Scarfone and plaintiff’s managing partner, Amiel Rossabi, had agreed not to tell the City about the contingent arrangement over fears it would dampen their potential recovery at mediation. Thus, they negotiated for the City to pay $85,000 in attorneys’ fees as a term of settlement, with the parties to bear the costs of any other fees and expenses. Id. ¶¶ 25-27. Yet, after the parties reached a mediated settlement of approximately $1 million, the contingent arrangement was promptly more illusory than celebratory.

Defendants alleged that Scarfone could not approve the contingency agreement without agreement of another member, Jeffrey Furr, and stated that neither of them had, in any event, signed it. The about-face was especially notable because Rossabi was also a member of GGEG and had been its legal counsel for more than 10 years. Id. ¶¶ 8, 11. Yet, financial warfare in the entertainment industry is hardly a new script.  As legendary television executive Don Ohlmeyer once observed:

“The answer to all your questions is: Money.”

The Court was thus faced with (i) defendants who allegedly suborned the belief of their counsel and fellow LLC member in a non-existent contingency agreement, and (ii) its own precedent that non-compliance with ethical Rule 1.5 likely dooms a contingent fee arrangement.  See Dunn v. Dart, 731 S.E.2d 274 (N.C. App. 2012) (affirming a Business Court decision that a fee agreement was unenforceable absent Rule 1.5 compliance).

Judge Robinson noted as “erroneous” the claim by defendants that it was undisputed there was no signed contingency agreement. ¶ 51.  The Court observed that whether Scarfone signed the agreement “is a genuine issue of material fact that the Court is unable to resolve without considering the credibility of Rossabi and Scarfone, which is inappropriate” at the summary judgment stage. While Judge Robinson confirmed that plaintiff would still need “to establish the execution and validity” of a contingency agreement, the Court allowed the breach of contract and perhaps more important quantum meruit claims to proceed.  ¶¶ 55-56.

Epilogue:  The Business Court has set a July 8, 2021 video hearing to consider defendants’ reconsideration motion that contends the Court committed “clear error” in interpreting GGEG’s Operating Agreement to grant Scarfone the authority to have executed, alone, a binding contingency agreement that may or may not ever be discovered. Popcorn is optional for that one.

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

As a still-young judicial panel, the Business Court frequently has an opportunity to define its boundaries in the face of challenges to its jurisdictional reach. In Inhold, LLC v. PureShield, Inc., 2021 NCBC 2, the Court considered a trade secret misappropriation fact pattern common to its docket: alleged informational theft and skullduggery among industry combatants. The jurisdictional test came when plaintiffs sought to amend their complaint to include a related dispute about the scope of rights defendant PureShield had obtained from multiple patent licenses.

Defendants claimed that the patent disputes arose under federal law and were thus beyond the Business Court’s jurisdiction. Instead, they preferred resolution of the patent issues in a Middle District of North Carolina action they filed shortly after plaintiffs sought leave to amend the state court action.

The issue before the Business Court was whether a contract dispute over patent enforcement rights nonetheless arose under federal law. The Court noted the United States Supreme Court’s guidance that only a “special and small category” of actions would meet the test for federal jurisdiction to lie over a state law claim, when a federal issue is:

“(1) necessarily raised, (2) actually disputed, (3) substantial, and (4) capable of resolution in federal court without disrupting the federal-state balance approved by Congress.”

Id. ¶ 12 (quoting Gunn v. Minton, 568 U.S. 251, 258 (2013)).

The Business Court acknowledged the defendants identified issues regarding the construction and assignability of the patents that were governed by federal law. ¶¶ 13-14. But the key factor for the Court was whether, aside from these identified issues of patent law, “[T]here are reasons completely unrelated to the provisions and purposes of the patent laws why the party may be entitled to the relief it seeks[.]” Id. ¶ 15. The Court readily identified grounds under state contract and corporate law under which plaintiffs’ claims could be resolved without reference to federal patent law. Thus,

“The upshot is that the Court could grant relief to Plaintiffs on these state-law theories `without ever reaching a patent law issue.’”

¶ 18.

Moreover, the Court held the case did not raise “substantial” issues of federal patent law where the effect of its outcome “would be limited to these patents and these parties.” Here, the contractual relationships of the parties predominated over the implicated provisions of patent law. Id. ¶ 22.

Takeaway

  • A well-pled state law claim arises under federal law “only when every legal theory supporting the claim requires resolution of a federal issue.”

Preemption/Noerr-Pennington Immunity

Plaintiffs’ proposed amendment also raised claims for tortious interference and defamation based on allegations that defendants improperly raised patent rights they did not possess in cease-and-desist letters and other communications to third parties. The Business Court adopted the analysis of several federal courts that such state law claims are not preempted when they rely on allegations of false or bad-faith claims to patents. Id. ¶ 26. Further, Judge Conrad also rejected defendants’ claim that their preemption argument based in federal patent law stripped the Court of jurisdiction over the interference and defamation claims. “Preemption,” the Court reminded, “is a defense and therefore does not create arising under jurisdiction.” Id. ¶ 27 (citing Christianson v. Colt Indus. Operating Corp., 486 U.S. 800, 809 (1988)).

First to File Rule

The Court wryly observed that defendants had not gone so far as to claim that the federal case they filed in the Middle District promptly after plaintiffs sought leave to amend in the Business Court was a first-filed action that should take precedence. A good thing, the Court said, because a defendant should not be able “to bring a declaratory suit involving overlapping issues in a different jurisdiction as a strategic means of obtaining a more preferable forum.” Id. ¶ 33 (quoting Coca-Cola Bottling Co. Consol. v. Durham Coca-Cola Bottling Co., 541 S.E.2d 157, 164 (2000)).

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