The Business Court sorted through the drama of an affiliated outsider who wanted to buy a company, settled for half and became an insider, and then allegedly used that perch to benefit himself and his family in W. Avalon Potts v. KEL, LLC, et al, 2019 NCBC 29, 2019 WL 2058599 (N.C. Super. Ct. May 9, 2019). See Order and Opinion. The story has a common backdrop: a nearly 30-year old company (founded by two partners) that wrestles with ownership changes and their impact on the entity’s fortunes. The twist: an original owner goes to the mat to reclaim control and alleges claims that allow the Court to revisit several legal principles that animate disputes over frayed business relationships.
- The Business Court, like the North Carolina Supreme Court, declines to hold that a minority shareholder exercising “actual control” could have a fiduciary duty to other shareholders.
- The Court confirms that the business judgment rule, designed to curb “judicial second guessing,” does not apply “when the officer or director has an interest in the disputed transaction.”
- Adopting a Third Circuit holding, the Court finds that when “independent third parties are alleged to have joined,” a conspiracy can exist in face of claims that an agent and principal cannot conspire as a matter of law.
Steel Tube, Inc. is a manufacturer of carbon steel and galvanized steel tubing. Plaintiff Potts and Walter Lazenby founded it, divided the stock evenly, and, over time, used the services of Leon Rives, an accountant. Rives offered to buy the company in 2014. Potts resisted the transaction, but Rives bought Lazenby’s shares – in which Lazenby retained a security interest. ¶¶ 5, 6.
With no notice to Potts, Lazenby and Rives promptly executed a management agreement under which Rives and one of his entities would manage Steel Tube. ¶ 7. That shaky start was predictive of what would follow: a series of disputes over Rives’ role in the company that included numerous allegations of self-dealing to benefit Rives and his family. Potts filed a lawsuit seeking dissolution, but recast it a year later in an amended complaint that alleged fiduciary duty breaches, fraud and other individual and derivative counts. Potts changed course after acquiring Lazenby’s security interest in the stock on which Rives ultimately defaulted, and he regained control of Steel Tube. ¶¶ 13-14.
At summary judgment, the Court considered the fiduciary duty claims within the lens of its general rule that shareholders “do not owe a fiduciary duty to one another.” Id. at ¶ 24. It rejected one exception to that rule – that majority shareholders have a duty to protect minority interests – because Rives and Potts had equal ownership shares. Id. Judge Conrad took a cautious course with regard to a second purported exception: that a minority shareholder exercising “actual control” could have a fiduciary duty to other shareholders. That doctrine had been adopted by the Court of Appeals at the time of the summary judgment hearing, but by the time of the Potts decision the Supreme Court had reversed and found it unnecessary to decide the ultimate issue because the particular plaintiffs had not sufficiently alleged “actual control.” Corwin v. British Am. Tobacco PLC, 251 N.C. App. 45, 51, 796 S.E.2d 324, 330 (2016), rev’d 371 N.C. 605, 821 S.E.2d 729 (2018); see also Blog Post Smoke ’em if You Got ’em (June 2, 2019). So, too, Judge Conrad found it unnecessary to decide what the Supreme Court would not, as the record reflected insufficient evidence of Rives’ “actual control.” The Court added:
Potts points to evidence that Rives was able to misappropriate Steel Tube’s resources without his knowledge, but that is not evidence of control. Rather, if true, it shows the opposite, confirming the Rives was forced to circumvent the board to accomplish his goals.
2019 NCBC 29, at ¶ 26.
The Court allowed a variety of derivative claims regarding Rives’ duties to Steel Tube to survive to trial. These included allegations of (i) improper payments to Lazenby, (ii) monthly and lump sum cash withdrawals by Rives, (iii) transferring $120,000 to a company Rives helped form in which his wife was a member, and (iv) entering a services deal with defendant KEL, owned by Rives’ brothers. ¶¶ 8-10. The Court rejected the contention that payments to Rives were contracts fixing compensation for officers allowed under Fulton v. Talbert, 255 N.C. 183, 184, 120 S.E.2d 410, 411 (1961). It found factual disputes about the payments, and that the payments could be challenged under the Court’s recent holding that “`[c]onflict-of-interest transactions between a corporation and its officers or directors have long been subject to special rules,’ including that the transaction must be fair to the corporation.” (citing Ehmann v. Medflow, Inc., 2017 NCBC 86, 2017 WL 4321107 (N.C. Super Ct. Sept. 26, 2017).
Business Judgment Rule
Rives seemed to contend that his transfer of $120,000 to Elite Tube, the company he helped found, was shielded by the business judgment rule. The Court rejected applying the rule, which limits “judicial second guessing,” by noting that those “protections do not apply when the officer or director has an interest in the disputed transaction.” The Court noted sufficient allegations of self-dealing and efforts to conceal the transaction to preclude use of the rule. 2019 NCBC 29, at ¶ 37.
Rives also contended a civil conspiracy claim that relied on the relationship between himself and one of his companies, Rives & Associates, was barred under the doctrine of intracorporate immunity, because an agent and principal cannot conspire as a matter of law. Id. at ¶ 42. But, showing that family ties take as they give, the Court ruled that inclusion of KEL (owned by Rives’ brothers) preserved a conspiracy claim where “independent third parties are alleged to have joined the conspiracy.” Id. (citing Robison v. Canterbury Vill., Inc., 848 F.2d 424, 431 (3d Cir. 1988)).
Brad Risinger is a partner in the Raleigh office of Fox Rothschild LLP. He maintains a commercial litigation practice that frequently involves business disputes before the North Carolina Business Court, and the state’s federal and state trial courts.