Though challenges to Business Court designations, i.e. subject matter jurisdiction, are relatively common (see, e.g., Business Court Retains Case Even After ‘Jurisdictional Hook’ Claim is Dismissed), challenges to personal jurisdiction are less frequent.  So we noted with interest the North Carolina Supreme Court’s recent opinion on personal jurisdiction in Beem USA Limited-Liability Ltd. P’ship v. Grax Consulting, LLC, — N.C. — , 838 S.E.2d 158 (2020), a rare reversal of a Business Court ruling. We also noted the results in a trio of Business Court rulings on personal jurisdiction that followed.

The two-step, “minimum contacts” analysis hasn’t changed much for more than a decade. Personal jurisdiction must comport with: (1) North Carolina’s long-arm-statute and (2) due process. Relying on cases we read about in law school, these new opinions don’t really change the analysis, they explain which contacts are relevant and why. For example, seemingly tangential contacts with the forum itself are also important (e.g., submissions to the Secretary of State). And contracting with a foreign defendant may not be enough, especially if that contract requires performance outside North Carolina.

In a series of PJ posts, we’ll dig into these new opinions, and we’ll highlight what they add to the “minimum contacts” analysis. We begin today with the Supreme Court’s decision in Beem.

Cutting ties with NC post-breach doesn’t matter. For breach claims – contacts throughout performance are relevant (not just contacts during the breach).

Beem USA Limited-Liability Ltd. P’ship v. Grax Consulting, LLC, — N.C. — , 838 S.E.2d 158 (2020) reversed a Business Court ruling on personal jurisdiction, broadening the proper view of relevant contacts. When breach of duties are alleged, a court should consider contacts throughout performance, not simply contacts during the period of alleged malfeasance. This ruling gives important, practical meaning to contacts that “arise out of” or “relate to” claims. Here’s a brief discussion of the case.

The partnership.

The plaintiff, Beem USA, was a Nevada limited partnership with two partners: Stephen Stark (from Chapel Hill, a co-plaintiff) and Grax Consulting (from Rock Hill, SC, the defendant). Grax was Beem USA’s general partner, and Stark was the limited partner. Grax had regular contacts with Stark (in North Carolina) on partnership business, including frequent emails, calls, texts, and regular mail. Grax also set up a bank account at a North Carolina branch into which it made deposits and initiated wire transfers.

The partners got sideways.

After less than two years of operations, Grax was removed as general partner, and Stark tried to take over; but Grax refused to give up control. Beem USA and Stark filed suit against Grax alleging breach of the partnership agreement and fiduciary duties, demanding that Grax cede control.

Business Court: No PJ, because there were no NC contacts during period of malfeasance.

Grax failed to appear and was defaulted. Before final judgment was entered, the Business Court assessed the threshold question of whether it had personal jurisdiction over Grax – a South Carolina entity. After taking evidence from the plaintiff, the Business Court ruled that it lacked personal jurisdiction because Grax’s questionable conduct (refusing to give up control, etc.) necessarily occurred after Grax was removed as general partner, and plaintiff provided no evidence that Grax had any contacts with North Carolina after it was removed. The Business Court reasoned that Grax’s alleged malfeasance, therefore, did not involve conduct that was directed to North Carolina. Beem USA and Stark appealed to the North Carolina Supreme Court.

Supreme Court: Yes PJ, because there were ample contacts throughout period of performance.

The Supreme Court reversed.   It explained that the Business Court’s focus on contacts only during the period of alleged malfeasance, i.e. after Grax was removed as general partner, was too narrow. Instead, the court should have considered Grax’s contacts with North Carolina throughout the period of performance. Grax’s regular emails and calls, the bank account, etc.  were contacts with North Carolina made in Grax’s capacity as a partner in Beem USA, and the claims in the lawsuit all concerned Grax’s alleged breach of duties as a partner. “As a result, plaintiffs’ claims alleging breach of the partnership agreement and breach of fiduciary duty ‘arise out of’ or, at the very least, ‘relate to’ Grax’s contacts with North Carolina.” Beem, 838 S.E.2d at 164 (quoting Helicopteros).

Takeaway: Contacts throughout the period of performance are relevant – not just those during the breach.

This ruling gives practical meaning to contacts that “arise out of” or “relate to” claims in a lawsuit. In particular, it addresses when contacts with North Carolina are relevant.  If claims involve breach of duties, relevant contacts include those occurring throughout performance, not just those occurring during breach.

Within two weeks of Beem, Business Court Judges issued three more rulings (two opinions and an order of significance) deciding motions to dismiss for lack of personal jurisdiction. Those additional PJ rulings will be discussed in future posts.

Business Court Retains Case Even After ‘Jurisdictional Hook’ Claim Is Dismissed.

We know that only certain types of claims can trigger Business Court jurisdiction. See N.C.G.S. 7A-45.4. But what happens when the claim that establishes jurisdiction—the ‘jurisdictional hook,’ if you will—is dismissed? Can the case still proceed in the Business Court? That question was answered in Gallaher v. Ciszek, 2020 NCBC Order 7 (N.C. Super. Ct. Feb. 17, 2020). See Order.

Take-Away:

Once jurisdiction is established in the Business Court, the Court will retain jurisdiction even if the claim that formed the basis for jurisdiction is dismissed.

In Gallaher, the Plaintiffs asserted several claims against Defendants, none of which supported jurisdiction in the Business Court. The Defendants’ counterclaims, however, included a trade secrets misappropriation claim under N.C.G.S. § 66-152.

Ever attuned to Business Court jurisdiction, the Plaintiffs used the trade secrets claim to designate the case as a Business Court case pursuant to N.C.G.S. § 7A-45.4(a)(8) (providing for Business Court jurisdiction over “[d]isputes involving trade secrets”). The case was thereafter designated as a mandatory complex business case by the Chief Justice of the North Carolina Supreme Court and assigned to Judge Bledsoe, the Business Court’s Chief Judge.

Defendants then had second thoughts about their trade secrets claim—or perhaps about litigating the case in the Business Court. Defendants voluntarily dismissed their trade secrets claim and, the same day, filed an opposition to Business Court designation on the grounds that no remaining claim supported Business Court jurisdiction.

In a succinct, 3-page order, Chief Judge Bledsoe held that the case would stay in the Business Court—notwithstanding the dismissal of the trade secrets claim. Judge Bledsoe explained that the case had been properly designated based on the trade secrets claim, and that once “a case is ‘properly designated and assigned to a special superior court judge for complex business cases based on the [pleading] and the [notice of designation], [a party may] not render the designation and assignment improper by subsequent[] filing[s.]’” Gallaher, 2020 NCBC Order 7 ¶ 6 (citation omitted).

The lesson here: be mindful of whether your claims (or your opponent’s) provide a basis for Business Court jurisdiction. Even if a case is not brought in the Business Court, your counterclaims (or your opponent’s) could provide a ticket (or hook, depending on how you look at it) into the Business Court. And as the saying (now) goes, “once a Business Court case, always a Business Court case.”

Matt Krueger-Andes is a litigation associate in Fox Rothschild’s Charlotte office.  He regularly represents clients in the Business Court and advises on Business Court and other business litigation-related matters.  He is also a former law clerk to the Honorable Louis A. Bledsoe, III, Chief Judge of the North Carolina Business Court. 

 

 

Business Court Confirms a Right
To Invest in a “Second” Project
Extends No Further

At Fifth and Church streets in uptown Charlotte, a group of investors opened the aptly named restaurant, 5Church. Other locations and restaurant brands followed, the fifth of which – Sophia’s Lounge – landed next door to the original location in an adjacent hotel building. A falling out among the investment group led the Business Court, in Maurice Panzino v. 5 Church, Inc., et al., 2020 NCBC 13 (N. C. Super. Ct. Feb. 12, 2020), to resolve a breach of contract claim going strictly by the numbers. See Order and Opinion.

Plaintiff had been an original investor in 5Church, and by operating agreement had rights under a “first refusal” provision with regard to investment in the entity’s restaurant expansions.  Id. ¶ 6. Panzino claimed breach of this provision because he was not offered a chance to invest in the nearby Sophia’s, but the Court determined that the investment option did not extend beyond the group’s second outing, the now-departed South End restaurant Nan & Byron’s. It was all in the numbers, as the operating agreement limited Panzino’s option to invest only “[i]n the event of a second business to be operated after the commencement of [5Church].”  Id.

There was no dispute that Panzino was not offered a chance to invest in Sophia’s and the defendants contended this was appropriate because Sophia’s “was the fifth business opened, not the second.” Plaintiff was offered, and declined, an opportunity to invest in the group’s second restaurant, Nan & Byron’s. He argued that the “first refusal” provision should be read to provide investment options in all of the restaurant group’s future ventures.  Id. ¶¶ 7, 25.

The Court readily concluded that “second” didn’t mean fifth, or anything else besides what follows first. It followed the logic of a Western District of North Carolina case that found the provision “plain and unambiguous” in a related dispute involving 5Church investors:

“The ordinary meaning of `second’ is ‘coming next after the first in order, place, rank, time, or quality.’”

Kamel v. 5Church, Inc., 2019 WL 4024252, *8 (W.D.N.C. Aug. 23, 2019). The Business Court also rejected a request to examine extrinsic evidence to shed light on what the parties intended, noting that’s intended only “to clarify ambiguities not to create them.”  2020 NCBC 13, ¶ 28.

Takeaways:

  • The Court opted for a narrow, literal interpretation of a clause defining right of first refusal investment options.
  • The Court continues a trend of carefully parsing parties’ claims about what agreements say, and calling out litigants for expansive liberties taken in describing them.

Fiduciary Duty

Plaintiff also alleged breach of fiduciary duty and constructive fraud claims arising from defendant Patrick Whalen’s failure to disclose that the group intended to open a 5Church restaurant in Charleston, South Carolina. Each of the claims required a finding that Whalen owed a fiduciary duty to Panzino – an inquiry complicated by 5Church’s status as an incorporated entity that behaved and ran itself more like a limited liability company. The Court noted that while 5Church was a North Carolina corporation, it “has been governed much like a limited liability company.” That included a contract “styled as an operating agreement,” a manager instead of a board of directors, and references to members instead of shareholders. Id. ¶ 5. The Business Court found the formation “unusual,” but applied the operating agreement because “no one challenges [its] validity.” Id.

As the manager of 5Church, the Court found Whalen functioned akin to a corporate director who had duties to the corporation but not any one, or all, of the shareholders.  See N.C. Gen. Stat. § 55-8-30. The Court did not decide whether 5Church had the authority to contract for a non-statutory fiduciary duty (as an LLC would), but curtly rejected Plaintiff’s argument that the parties had intended to do so in an operating agreement provision regarding Whalen’s authority as manager.

The Court found that Panzino had taken considerable liberties in that argument, and flagged it:

“In his opposition brief, Panzino crops the first sentence in its entirety, omits the introduction to the second sentence, and then reads the last clause in isolation to impose new fiduciary duties by implication. That is not a reasonable interpretation.”

2020 NCBC 13, ¶ 18. (For another look at the Court’s scrutiny of parties’ claims about controlling documents, see our recent post, here.) The Court noted that MAP Management of Charlotte, LLC, a majority shareholder in 5Church, might have had a duty to protect the interests of Panzino as a minority shareholder. But, Plaintiff did not sue MAP, and Whalen’s participation in MAP did not impute duties MAP might have had to him, personally. Id. ¶ 20. Panzino attempted to remedy the problem by suing MAP for constructive fraud and breach of fiduciary duty in a separate action that was just recently designated to the Business Court.

Surviving Breach Claims

The Court allowed two breach claims to proceed to trial. Panzino argued that defendants had failed to make distributions required under the operating agreement during a period before he sold his remaining interests. Defendants argued that, without any proof of damages, summary judgment was appropriate. The Court declined, noting that proof of damages is not a breach of contract claim element. Id. ¶ 31. Plaintiff’s undisputed claim that 5Church did not provide specified monthly financial statements also advanced. The Court rejected application of the traditional rule that a shareholder can’t bring an action for damage to his or her shares because of a wrong to the entity. Here, Panzino’s claim survived because the agreement required the entity to provide information to him, and Plaintiff “seeks to enforce his own rights, and not those of 5Church.” Id. ¶ 34.

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

This afternoon North Carolina Business Court Chief Judge Bledsoe issued an Order confirming that the Order issued by Chief Justice Beasley last Thursday applies to cases in the North Carolina Business Court.   Judge Bledsoe’s Order contains comprehensive explanation as to what this means for current North Carolina Business Court cases and effectively suspends any and all deadlines in pending matters until at least April 17, 2020.  It also extends the deadline for hard copy filing of materials listed in Rule 5(d) of the North Carolina Business Court Rules in the clerk’s office of the county of venue until April 24, 2020.

The Order does not necessarily mean that all activity in the Business Court will come to a halt, however.  The parties in a specific case, with the consent of the assigned Business Court judge, may agree to deadlines prior to April 17, 2020.  Moreover, while no in person hearings or conferences may take place in NCBC cases prior to April 17, 2020, the assigned Business Court Judge to a case may convene telephonic or videoconference hearings or conferences with the consent of the parties.

A full copy of the Order can be found here.

–Patrick Kane

In the current coronavirus pandemic environment, many businesses and their insurance carriers are (or soon will be) looking at the issue of claims for “business interruption.”  While there is not a large body of caselaw in North Carolina or the Fourth Circuit devoted to such claims, below are summaries of a few cases that address this type of coverage.

In Prudential LMI Commercial v. Colleton Enterprises, Inc., 976 F.2d 727 (4th Cir. 1992), the Fourth Circuit gave a concise summary of what business interruption insurance is:

Generally, business interruption insurance “is designed to do for the insured in the event of business interruption caused by [an insured peril], just what the business itself would have done if no interruption had occurred-no more….”

The Court also summarized how an insured must prove a claim for lost profits under business interruption coverage, citing cases from around the country:

In order to establish coverage for lost profits or lost earnings under business interruption coverage provisions, the insured must establish that: (1) the peril insured against occurred, (2) the peril caused damage to the business facility insured, (3) the damage resulted in a partial or complete interruption of business,; and (4) the business suffered a loss of earnings or profits as a direct result of the business interruption.

Colleton also addressed an interesting issue of causation.  The case involved a Charleston, SC motel that was shut down for a period of time after it sustained damage in 1989’s Hurricane Hugo.  The business sought lost profits that it contended it would have received from housing the influx of repair persons and construction workers that traveled into the area after the devastating storm.  The Court focused on the fact that the same event caused both the business interruption and the increase in visitors that the hotel missed out on housing, and for which they were claiming lost profits.  The Court emphasized that the purpose of business interruption insurance is to keep a business in the same position as it would have been if there had been no interruption.  In this case, the panel majority said that there existed “an intuitively-sensed logical flaw,” and that to have allowed the hotel’s lost profit claim based on the increase in visitors to the area would have resulted in a windfall for the insured.  Thus, since the purpose of business interruption insurance is to keep the insured in the same position as it would have been if the interruption not occurred, the Court held that the insurer was not liable for the claimed lost profits of the hotel: “the business interruption provision here in issue did not cover the specific claim for loss of net-profit from the peril-generated source relied upon.”

Colleton was not a unanimous opinion, however.  The dissent argued that coverage should not be affected by the fact that the cause of the interruption was the same as the cause of the uptick in profits that were not realized.  In the dissent’s view, only the loss to the insured should be considered, and the impact of the cause of that loss on the surrounding area was of no relevance to whether coverage existed:

The majority acknowledges that proof of an imminent general economic up-turn, or of a lost profit opportunity thwarted by the loss causing event, can justify recovery under a lost-earnings provision. I assume, then, that had the motel been destroyed by an isolated fire the day before Hugo hit, the majority would rule that lost profits would have been recoverable because the cause of the property loss (the fire) was not the same as the cause of the profit opportunity (the storm). Similarly, if gold were discovered the day after Hugo and the entire region filled with gold seekers (as well as relief workers), I assume that lost profits would be covered. Colleton had a lost profit opportunity (the dimensions of which the parties stipulated). Although Hugo caused both the property loss and created the profit opportunity, it does not strike me as an “intuitively-sensed logical flaw” to permit recovery under these circumstances.

The North Carolina Court of Appeals addressed a declaratory judgment action on a business interruption claim in Great American Ins. Co. v. Mesh Cafe, Inc., 158 N.C.App. 312 (2003).  That case also involved a hurricane, 1999’s Hurricane Floyd.  A restaurant that lost power and water for 24 hours as a result of the storm sought to recover income lost during that time under an insurance policy that covered  “loss of Business Income or Extra Expense, caused by the interruption of service to the described premises.”  At issue in the case was language in the policy that said “the interruption must result from direct physical loss or damage by a Covered Cause of Loss to the property described below,” followed by a list that included “Water Supply Services” and “Power Supply Services.”  The insurer argued that the damage to the business was caused by flooding, and that did not qualify as “direct physical loss or damage.”  For its part, the insured argued that its loss of power and water was a “direct physical loss,” and therefore coverage existed; it argued that under the policy’s wording, the “Covered Cause of Loss” list did not apply to “direct physical loss.”

The trial court held that coverage existed, and the Court of Appeals affirmed.  The Court of Appeals determined that whether coverage existed under the plain language of the policy was susceptible to different reasonable interpretations:

Whereas a reasonable person could understand the language “by a Covered Cause of Loss” to be a prepositional phrase modifying “direct physical loss or damage,” another reasonable person could understand “direct physical loss” to be an alternative to “damage by a Covered Cause of Loss” because of the conjunction “or.”

Therefore, because the policy language was ambiguous and the policy had been drafted by the insurer, whether there was coverage was to be construed in favor of the insured.

Mesh Café was not the Court of Appeals’ first foray into the world of business interruption insurance claim disputes.  In Harry’s Cadillac-Pontiac-GMC Truck Co, Inc. v. Motors Insurance Corporation, 126 N.C. App. 698 (1997), the Court analyzed whether a snowstorm that caused the insured’s dealership to be inaccessible for a week fell within the coverage provision for its business interruption insurance.  Importantly for that case, the snowstorm caused damage to the dealership’s roof that required repairs but the roof damage and the repairs did not cause an interruption in plaintiff’s business.   The interruption in business was caused solely by the business owner’s inaccessibility of the dealership due to the snowstorm.

The business income coverage provision in Harry’s Cadillac was as follows:

We will pay for the actual loss of Business Income you sustain due to the necessary suspension of your ‘operations’ during the ‘period of restoration.’  The suspension must be caused by direct physical loss of or damage to property at the premises described in the Declarations, including personal property in the open (or in a vehicle) within 100 feet, caused by or resulting from any Covered Cause of Loss.

The policy defined “A Covered Cause of Loss” as “risks of direct physical loss.”

The insured argued that its inability to access the dealership to conduct business because of the snowstorm caused it to lose profits in the same way it would have had the building been leveled by the storm.  In contrast, the insurer argued that, aside from the roof damage that did not cause business interruption, there was no “direct physical loss or damage” that resulted in a loss of business income.

The Court found that the business interruption clause in the policy “[did] not cover all business interruption losses, but only those losses requiring repair, rebuilding, or replacement.”  Based on that reasoning, the Court held that there was no coverage for the insured’s losses because the alleged lost business income was not due to damage to or the destruction of the property – it was caused by the business owner’s inability to access the dealership due to the snowstorm.  The Court stated:

Under the language of the business interruption clause of the policy, coverage is provided only when loss results from suspension of operations due to damage to, or destruction of, the business property by reason of a peril insured against.

Similar to business interruption insurance is event cancellation insurance.  Event cancellation insurance, generally speaking, provides coverage to protect single event revenue and expenses that are lost due to circumstances beyond the control of the insured.  With the multitude of event cancellations occurring due to Covid-19, this is sure to be at the forefront of the minds of event organizers and insurers everywhere.  For a North Carolina Court of Appeals case dealing with event cancellation insurance, see Defeat The Beat, Inc. v. Underwriters At Lloyd’s London, 194 N.C. App. 108 (2008).  That case highlights a potential difference between business interruption and event cancellation insurance, particularly when it comes to reimbursement for lost profits.

Keep checking back regularly with It’s Just Business, as we hope to continue to provide more information over the coming days and weeks on areas of law that are going to be impacting businesses and business litigators as we together navigate these unique and trying times.  Stay safe, stay healthy, and wash your hands.

–Patrick Kane and Olivia Fajen

Supreme Court of North Carolina Chief Justice Cheri Beasley issued an Order today under N.C.G.S. § 7A-39(b) that provides litigants and their attorneys some relief from deadlines for filings and other acts in light of the need to minimize travel to and entry into the state’s courthouses due to the coronavirus pandemic.

The full text of the Order can be found HERE.

The substance of the order is as follows:

I order that all pleadings, motions, notices, and other documents and papers
that were or are due to be filed in any county of this state on or after 16 March 2020
and before the close of business on 17 April 2020 in civil actions, criminal actions,
estates, and special proceedings shall be deemed to be timely filed if they are filed
before the close of business on 17 April 2020.

I further order that all other acts that were or are due to be done in any county
of this state on or after 16 March 2020 and before the close of business on
17 April 2020 in civil actions, criminal actions, estates, and special proceedings shall
be deemed to be timely done if they are done before the close of business on
17 April 2020.

While one might initially assume that this Order would toll deadlines in North Carolina Business Court cases, a close look at the plain language of the Order renders such an assumption questionable and potentially dangerous.  The extension applies to things “due to be filed in any county” and “due to be done in any county.”  Although many business court filings must be filed not only in the NCBC, but also in the clerk’s office where the case originated, and therefore would be covered by this Order, what about filings in business court cases that wouldn’t also be filed in the home county, like a brief that is due next week in response to a motion that is pending?  The submission of that response brief is not a filing nor an act that must be done in any county; the brief simply must be submitted through the NCBC electronic filing system.   So is the deadline for that submission tolled by Chief Justice Beasley’s Order? I don’t think I can confidently say that it is, and as one of my colleagues here just noted, filing deadlines are one area in which it is not “better to ask for forgiveness than permission.”  In all of my currently pending NCBC cases, the Court already communicated by email to all counsel in the case after Chief Justice Beasley’s March 13 Order (which continued many matters for 30 days), and encouraged the lawyers to reach out with any questions in light of these unique and trying circumstances.  If I were facing the issue above, I would probably take the Court up on that offer and seek confirmation of deadlines.  Meanwhile, if you have any clarity on this issue, please share in the comments below, and if we gather any further insight on this topic, we will update the blog accordingly.

And while there might be uncertainty as to the scope of this Order in the North Carolina Business Court, there is less uncertainty as to its application to the state’s appellate courts.  The Order specifically states

This order does not apply to documents and papers due to be filed or acts due
to be done in the appellate courts.

For what that exclusion means for the filing of notices of appeal, arguably the most important filing in an appeal, see Beth Scherer’s post with appellate court updates here.  (As NOAs are filed in the trial court, the Order presumably does apply to them.)

–Patrick Kane

It’s not often that the rote listing of involved attorneys at the outset of a Business Court opinion gives much of a clue of what issues lie ahead. A curious exception is when the same party is listed as represented by counsel on both sides of the case. In Turner v. Hunt Hill Apartments, LLC, 2020 NCBC 12 (N. C. Super. Ct. Feb. 11, 2020), it set the stage for review of ethical conflicts and reticent litigants. See Order and Opinion.

Hunt Hill, the defendant, hired Sweetwater Construction, LLC to build apartments in Asheville. The complex was built, Hunt Hill allegedly didn’t pay for the work, and Sweetwater’s president, John Turner, launched a derivative action on the entity’s behalf when it declined to do so. Id. ¶¶ 3, 13. But, as Judge Conrad observed, “it’s never that easy. Id. ¶ 4.

The North Carolina derivative action brought by Turner is part of a larger dispute that the Business Court termed a “fight for control of Sweetwater.” In a parallel South Carolina action Turner seeks a declaration that he is Sweetwater’s sole member, or at least one with a significant share. The South Carolina defendants contend Turner has no interest in the LLC at all, and one of them sought to intervene in the North Carolina action to make the same point: Turner had no authority to file the action against Hunt Hill. Id. Naturally, the North Carolina defendant – Hunt Hill – took the same position on Turner’s standing to bring the action. Id. ¶¶ 4-5.

So, the Court had to decide whether Turner had the authority to act for Sweetwater when the LLC elected otherwise. Plus, it had to figure out whether Turner’s counsel in the North Carolina action could purport to work on behalf of Sweetwater in North Carolina but also work on Turner’s behalf in South Carolina to get himself declared the sole member of Sweetwater over its objections.

Essentially, Hunt Hill’s position boiled down to this: Turner’s counsel was derivatively for Sweetwater in North Carolina; it was adverse to Sweetwater in South Carolina trying to get control of the entity for Turner; and in an effort to salvage the North Carolina litigation, an amended complaint proposed that the firm would purportedly work directly for Sweetwater. Id. ¶ 7.

Takeaways:

  • South Carolina law requires a derivative action be brought by a member who was around for the underlying events, and when the suit is filed.
  • Because of a lawyer’s “equal duty” to each of its clients, the Business Court was cool to the argument that a concurrent conflict could be cured by finding new counsel for one of the clients.

Standing for Derivative Actions in South Carolina

Turner’s ability to sue on Sweetwater’s behalf was a straightforward application of South Carolina corporate law, the Court found. Among the requirements, Turner had to be a member of Sweetwater “when the action is commenced” as well as a member “at the time of the transaction” which underlies the proposed derivative action (or have its interest devolved from a member who was).  See S.C. Code Ann. § 33-44-1102. The Court found that the complaint didn’t allege Turner was a member of Sweetwater, but instead that he was its president with an undefined “ownership interest.” 2020 NCBC 12, ¶¶ 12-13. It declined subject matter jurisdiction, and noted that even if Turner had an ownership interest of some sort in Sweetwater that wouldn’t confer authority to sue under South Carolina law. Id. ¶ 14.

A similar result would have prevailed under North Carolina law because a member advancing a derivative action must have been a member at the time of the underlying events, or have at least some portion of its member interest devolved from a member who was. See N.C. Gen. Stat. § 57D-8-01.

A Hornbook Instance of Concurrent Conflict

Under North Carolina professional conduct rules,

“a lawyer shall not represent a client if the representation involves a concurrent conflict of interest.”

N.C. Rev. R. Prof’l Conduct 1.7(a). While the Court was clear to point out that the conflicted firm (Sellers, Ayers, Dortch & Lyons, P.A.) showed no bad faith or impure motives, and made no attempt to conceal the conflict, it easily concluded that “[t]he conflict here is clear.” 2020 NCBC 12, ¶¶ 19, 23. The Court found an actual, concurrent conflict, endorsing Hunt Hill’s argument that Sellers, Ayers “is explicitly seeking to represent as a client an LLC that it is actively suing on behalf of another client.” Id. ¶¶ 19-20. The Court granted a motion to disqualify the Sellers, Ayers firm as counsel for Turner and Sweetwater, and struck all filings made on their behalf not dismissed by its separate ruling on subject matter jurisdiction. Id. ¶ 24.

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

With Court “ordered” corporate record inspections, who pays for the fees? More often than not, shareholders have to pay their own attorneys’ fees.

In Bauk v. Piedmont Cheerwine Bottling Company, 18 CVS 358, Order and Opinion on Petitioners’ Requests for Costs and Fees and to Modify Protective Order, 2020 NCBC 6, Judge Conrad denied the shareholders’ request for attorneys’ fees incurred in forcing the corporation to adequately respond to their document inspection demands. The reason: a consent order – although sensible – does not trigger the right to attorneys’ fees under North Carolina’s Business Corporation Act (the “BCA”). Instead, inspection must be compelled by an adjudicative order (i.e., one with findings of fact and conclusions of law).

Quick Background on BCA: The BCA allows a shareholder, acting in good faith, to demand inspection of certain corporate books and records. N.C. Gen. Stat. 55-16-02.  Shareholder inspection demands are intrusive and potentially abusive. These demands often come after the corporation and the shareholder are already at odds, so corporations typically object or try to narrow them. Naturally, disagreements ensue.

The BCA contemplates corporate resistance. If a corporation fails to comply, the BCA allows a shareholder to petition for an order compelling inspection. N.C. Gen. Stat. 55-16-4. If the Court orders inspection, the BCA requires the Court to also award a shareholder’s costs (including reasonable attorneys’ fees) – unless the Corporation proves it had a reasonable basis for doubt about the right of the shareholder to inspect the records demanded. N.C. Gen. Stat. 55-16-4(c).

Bauk v. Piedmont Cheerwine Bottling Company: In this case, certain Cheerwine shareholders suspected management of self-dealing. Over the span of several years, the shareholders tried to investigate – making periodic requests for corporate records, which the shareholders say the corporation partly, but never fully satisfied. Fed up, the shareholders filed a petition under N.C. Gen. Stat. 55-16-04, seeking a court order compelling inspection.

The corporation resisted. It claimed to be the victim of years of shareholder harassment. By the corporation’s count, it had produced thousands of pages of information in response to at least thirty inspection requests, and it refused only those requests that were repetitive or that sought information to which the shareholders were not entitled.

After some apparent judicial encouragement by Judge Conrad, the parties reached a compromise that was memorialized in a consent order that Judge Conrad signed. Thereafter, the corporation produced agreed-upon documents.

Having obtained the requested documents via a court order, the shareholders then sought their attorneys’ fees under the BCA, which states:

[i]f the court orders inspection and copying of the records demanded, it shall also order the corporation to pay the shareholders costs (including reasonable attorneys’ fees) incurred to obtain the order unless the corporation proves that it refused inspection in good faith because it had a reasonable basis for doubt about the right of the shareholder to inspect the records demanded.

N.C. Gen. Stat. 55-16-04(c).

The shareholders argued that since there was an order compelling production (albeit a consent order), they were entitled to fees. In response, the corporation relied on the Court of Appeals decision in Carswell v. Hendersonville Country Club, Inc., 169 N.C. App. 227, 609 S.E.2d 460 (N.C. Ct. App. 2005). The corporation argued that under Carswell, a mere consent order is not enough; instead, an adjudicative order with findings of fact and law is required.

Following Carswell, Judge Conrad denies the shareholders’ motion for attorney’s fees. Carswell involved a similar situation. Mr. Carswell, a shareholder, asked to inspect the corporation’s books, and the corporation (a country club) resisted. Although the club was generally compliant (providing access to most of the documents), a dispute arose over whether Carswell was entitled to a complete membership list (with addresses). Carswell hired an attorney who petitioned for access under the BCA. The club responded with a motion to dismiss and suspension of Carswell’s club membership. In the end, cooler heads prevailed, and they were able to negotiate a settlement which included production of the records, membership reinstatement, and dismissal of the petition with prejudice. The settlement was memorialized in a consent order approved by a judge.

In their settlement, the parties cleverly carved out the issue of attorney fees. The consent order stated that the parties could submit by brief and affidavit their respective arguments on attorney fees. The trial court reviewed the materials and ruled that each side should bear its own costs and fees. Mr. Carswell appealed, arguing that an award of attorney fees was mandated under N.C. Gen. Stat. 55-16-04(c) (quoted above). The Court of Appeals disagreed.

The Court of Appeals explained that the parties’ agreement to allow access, reinstate membership, etc. was not the kind of inspection order discussed in 55-16-04(c). It was not an “adjudication of rights,” noting in particular that it had no findings of fact or conclusions of law. Instead, it was merely a court-approved contract without any judicial determinations. Thus, even though he got the corporate records, Mr. Carswell was not entitled to his fees under 55-16-04(c).

The Cheerwine shareholders, of course, tried to distinguish Carswell’s order as more akin to a general settlement and compromise. They argued that Carswell order did more than enforce document inspection rights – it reinstated club membership and allowed reciprocal document access. It also dismissed the petition for documents with prejudice. By contrast, the Cheerwine consent order was narrow, focused only on document production. The Cheerwine shareholders also argued policy: requiring an adjudicated order as a predicate to fee recovery invites abuse. It removes a key incentive for a corporation to comply with pre-litigation demands. Shareholders might give up rather than hire a lawyer to press their rights.

Judge Conrad considered these arguments but was not persuaded. Dutifully following Carswell, Judge Conrad sided with the corporation. He explained that although the Court approved it, the consent order was not an adjudicative order. Like the order in Carswell, it had no findings of fact or conclusions of law, and it adjudicated nothing. It simply memorialized the parties’ agreement.

As to the potential for abuse, Judge Conrad noted it was “[a] danger perhaps, but the severity is debatable.” Constrained by Carswell, and more broadly by North Carolina’s general rule that statutes authorizing attorney’s fees are to be strictly construed, Judge Conrad denied the shareholders’ request for fees.

Takeaway: The key takeaway is that a shareholder’s right to recover attorney fees under 55-16-04(c) seems broad but really is limited. A shareholder needs an adjudicative order (with findings of fact and conclusions of law), which the corporation can easily avoid even after a shareholder files a petition – by entering into a consent order or by simply producing the requested documents before an adjudicated order is entered (leaving nothing to adjudicate). So, if it is fees you’re looking for, keep looking. The fee shifting provision in the BCA has little practical value to a shareholder seeking corporate documents.

 

In the Business Court,
Consider it Pole Vaulting

A familiar Business Court journey – former employees and alleged trade secret misappropriation – took a detour in Lowder Construction, Inc. v. Ronald Phillips, et al., 2020 NCBC 1, 2019 WL 91867 (N.C. Super. Ct. Jan. 8, 2020). See Order and Opinion. A departed employee counter-claimed under Chapter 75 that the lawsuit against him was merely an effort to interfere with his new gig, and new employer. The Court considered whether the Noerr-Pennington doctrine – which affords immunity from antitrust liability for the filing of lawsuit’s like Lowder’s – could withstand a challenge that its complaint was merely a thinly veiled “sham” for anti-competitive aims.

Defendant Phillips’ departure from Lowder Construction prompted a wide-ranging lawsuit against him – and another ex-employee and their new employer – centered on trade secret misappropriation, conversion and tortious interference with prospective economic advantage. The allegations were keyed to Lowder’s allegedly proprietary model that generated three-dimensional structural project renderings, and related confidential customer and business information. Id. ¶ 4. The Phillips counterclaim spawned the Court’s Noerr-Pennington analysis because it alleged Lowder’s lawsuit was merely a vehicle designed to disrupt the ability of Phillips and his new employer to compete. Id. ¶¶ 5, 17.

Takeaways:

  • Noerr-Pennington immunity remains a stalwart protection in North Carolina courts, and finding a complaint “utterly baseless” is a very tough standard. 
  • A rare, successful challenge to Noerr-Pennington protection would need to establish that all of the claims of a plaintiff’s complaint are not “reasonably calculated to elicit a favorable outcome.”

The Business Court has a well-settled interpretation of Noerr-Pennington “that a party who seeks redress by filing a lawsuit is immune from claims that are based solely on the pursuit of that lawsuit.”  Id. ¶ 17 (citing Velocity Solutions, Inc. v. BSG Fin., 2016 WL 698506, at *6). (For a deeper dive on how North Carolina appellate courts have assessed the doctrine over the last 20 years, check out the Court of Appeals’ recent opinion in Cheryl Lloyd Humphrey Land Investment Company, LLC v. Resco Products, Inc., 831 S.E.2d 395 (2019)).  Lowder presented a fact-pattern rich with law school exam issue-spotting opportunities because it offered a template presentation of whether a plaintiff’s claims against a former employee retained Noerr-Pennington immunity when the integrity of the complaint’s claims, and motivations, got close scrutiny. The question for the Court was whether Lowder’s immunity to file its suit could be lost under the sham-litigation exception to the Noerr-Pennington doctrine:

“The institution of a lawsuit may be the basis for an unfair trade practice claim if the lawsuit is a mere sham to cover what is actually nothing more than an attempt to interfere directly with the business relationships of a competitor.”

Id. ¶ 18. The sham-litigation exception required the Court to determine whether Lowder’s complaint was “objectively meritless,” and if it was, whether its subjective motivation was direct interference in Phillips’ business activities. The initial objective component is an extremely high bar under North Carolina law, in that the suit must be “objectively baseless in the sense that no reasonable litigant could realistically expect success on the merits.”  Id. ¶ 21.

The Court had an objectivity measuring stick handy, as it had analyzed the substance of Lowder’s claims in a recent ruling on Phillips’ motion for judgment on the pleadings. 2019 NCBC 82, 2019 WL 7500408 (N.C. Super. Ct. Dec. 30, 2019). See Order and Opinion. In its earlier order, the Court determined Lowder had pled its trade secret misappropriation claim sufficiently to survive a pleadings challenge. While the Court conceded that Phillips retained challenges to whether Lowder’s model actually amounted to a trade secret, and if he had actually misappropriated it, surviving a thorough Rule 12(c) analysis was a valuable indicator that Lowder’s claim was “reasonably calculated to elicit a favorable outcome.”  2020 NCBC 1, ¶ 23.

Judge McGuire also concluded that Phillips’ counterclaim was, in the end, too narrow to meet the high standard for proving up the “sham litigation” exception. The counterclaim alleged that Lowder’s model was not a trade secret, and that its suit was therefore baseless. But, in order to prevail, Phillips had to show Lowder’s entire complaint was “utterly baseless.”  Id. ¶ 24. The Court held that Phillips’ counterclaim had not sufficiently alleged that Lowder’s additional misappropriation and tortious interference claims similarly lacked a proper basis. Thus, the complaint also was immunized under Noerr-Pennington because Phillips did not establish that all of the claims in Lowder’s suit were utterly baseless. Id. ¶¶ 24-25.

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

Business Court Turfs a
Long-Running Document
Production Dispute

In a dispute among the members of a dissolved soccer gear company, the Business Court flashed a “red card” on litigants who professed full compliance with discovery requests but missed that goal by at least several hundred documents. Kixsports, LLC v. Ryan Munn, et al., 2019 NCBC 61, 2019 WL 4766249 (N.C. Super. Ct. Sept. 30, 2019) considered the aftermath of a forensic inspection of electronic devices that unearthed a significant tranche of unproduced documents, and evidence that suggested intentional deletion of responsive materials. See Order and Opinion.

The Business Court inherited a Superior Court ruling (made before a joint Rule 2.1 and 2.2 designation) that had required a forensic analysis of devices based on that court’s finding it was “extremely difficult to believe” that two Kixsports principals, Casey Carr and Stephen Pye, had communicated as little as they professed about the subject matter of the lawsuit.  Id. ¶ 6. The court had established a fee allocation arrangement under which the forensic work’s costs would be borne by Kixsports, Carr and Pye if the inquiry uncovered relevant documents or evidence of intentional deletion of such materials.  Id.

 

Takeaways:

  • In evaluating the reasonableness of expert fees arising from a forensic investigation, the Court found that the results actually obtained from the analysis were a relevant factor.
  • The Court found that technical compliance with a discovery order did not shield litigants from the imposition of sanctions under Rule 37.

A forensic expert’s findings enabled the Business Court to make short work of a determination about which parties should bear the costs of the device inspections. As the Court put it:

“the inspection hit pay dirt.”

Id. ¶ 32.

The defendants moved for discovery sanctions and claimed the inspection unearthed 535 relevant documents, and attached more than 50 to their supporting papers.  Id. ¶ 16. In opposition, Carr and Pye contended that the retrieved documents were “a far cry from relevant,” though softened that pitch at hearing “and conceded that some of the documents were minimally relevant, though not significant or important.” Id. ¶ 17.

The Business Court did not weigh in on just how extensive the pool of relevant documents was, but concluded that “many of the communications recovered through the forensic examination are plainly relevant.”  Id. ¶ 18. That was enough, under the terms of the initial order, because cost shifting was required if the forensic work turned up communications simply “relevant to the subject matter of this proceeding.”  Id. ¶ 20. At a minimum, the Business Court found the identified documents were relevant to the defendants’ fraud and misrepresentation claims, and company valuation issues.  Id. ¶¶ 18-19.

The Court also considered the record of unearthed documents and the forensic expert’s findings and concluded that “[t]he evidence here is consistent with intentional deletion.”  Id. ¶ 26.  The Court noted that a spoliation finding was buttressed by evidence the mobile device backup files on some inspected devices had more likely than not been deleted, and because the targeted devices inexplicably did not contain any of nearly 300 text messages that one of the defendants showed he had exchanged with Carr and Pye. Id. ¶¶ 23-26.

Judge Conrad rejected an argument that forensic investigation fees of approximately $51,000 were excessive, concluding that they were “fair and reasonable” from at least two perspectives: (i) “when compared with the results achieved by [the] inspection,” and (ii) in consideration of the imaging, searching and records management undertaken related to retrieval of 100,000 documents. ¶¶ 32-35.

The Court declined to find Kixsports, Carr and Pye in contempt, noting no “willful noncompliance” with the court order mandating the forensic inspection.  Id. ¶ 36.  However, the Court found compliance with the discovery order did not shield the non-producing parties from sanctions under Rule 37.  In particular, the Court found that Carr and Pye had made false representations to the court in opposing the original motion to compel.  Id. ¶¶ 39-41. Moreover, Pye’s representation that he did not “send many emails or text messages,” balanced against the forensic retrieval of 30,000 texts from his devices, resonated with the Court. Id. The Court imposed sanctions of a spoliation jury instruction, additional discovery to redress lost evidence, and attorneys’ fees and costs connected with defendants’ motion.

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