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.

Judge Robinson recently issued an order containing what may be the first interpretation of the “Special Meeting” provisions of the North Carolina Business Corporation Act (the “Act”),  N.C. Gen. Stat. §§ 55-7-02 and -03, in In re Matter of Special Shareholders’ Meeting of Phytonix Corporation.  The statute provides  shareholders with a mechanism to demand a prompt meeting on an issue of interest.  In particular, the Act requires a non-public corporation to hold such a meeting

within 30 days after the holders of at least ten percent (10%) of all the votes entitled to be cast on any issue proposed to be considered at the proposed special meeting sign, date, and deliver to the corporation’s secretary one or more written demands for the meeting describing the purpose or purposes for which it is to be held.

N.C. Gen. Stat. § 55-7-02.

If the corporation does not timely hold the Special Meeting within those 30 days, “[t]he superior court of the county where a corporation’s principal office (or, if none in this State, its registered office) is located may, after notice is given to the corporation, summarily order a meeting to be held … on application of a shareholder who signs a demand for a special meeting valid under G.S. 55-7-02[.]” N.C. Gen. Stat. § 55-7-03.

In the Phytonix case, the shareholder delivered a valid demand for a special shareholders’ meeting pursuant to § 55-7-02 on December 4, 2019.  Twenty-three days later, on December 27, 2019, the shareholder filed an Application pursuant to § 55-7-03, asking the superior court to summarily order the meeting.

Astute readers might notice that the Act gives the corporation 30 days to hold the Special Meeting, but the shareholder only waited 23 days before filing an action. Phytonix noticed the same discrepancy, and moved to dismiss the Application as premature—arguing that it still had a week to hold a Special Meeting when the shareholder asked for court intervention.

Judge Robinson disagreed.  Looking deeper into the Act, Judge Robinson cited both the notice provisions of  § 55-7-05(a) which require at least 10 days’ notice of the meeting and the Phytonix Bylaws which require 15 days’ notice.  Finding that the larger notice period in the Bylaws controlled, the Court reasoned that Phytonix would have had to send appropriate notice of the Special Meeting at least 15 days before the end of the 30-day period required by the Act.   In other words, Phytonix only had 15 days from the shareholder’s demand to properly notice the meeting, even though it had the full 30 days to hold the meeting.  When December 19, 2019 came and went with no meeting noticed, it was a foregone conclusion that a proper meeting would not be timely held.

Phytonix had an alternative argument for dismissal that also failed.  Phytonix had moved to dismiss the Application as moot because shortly after the shareholder filed the Application, the Phytonix Board passed a resolution to hold a Special Meeting on January 31, 2020.  Once again, Judge Robinson disagreed, concluding that once the Court has the authority to summarily order the Special Meeting pursuant to the Act, it has “significant discretion” in setting the meeting terms.  The Court listed several examples of such terms from § 55-7-05(b), including the meeting time and place, the shareholders entitled to participate, the quorum required for specific matters, and the discretion to award reasonable expenses including attorneys’ fees.  In this instance, the meeting described in the Board Resolution differed from the meeting demanded by the shareholder, and therefore there was still a live controversy for the Court to determine.  The Court then set out meeting terms that substantially varied from the Board resolution.

Takeaways:

  1. Shareholder demands often require expeditious action, and a Special Meeting demand is no different.  Because the Act requires at least 10 days’ notice of a Special Meeting, the 30-day deadline to hold a meeting becomes a 20-day deadline in practice—or even sooner, depending on the bylaws.
  2. A corporation that fails to timely hold a Special Meeting cannot necessarily get a “do over” by later voluntarily offering to hold a meeting, particularly if the conciliatory meeting differs from the shareholder’s demand.

 

Business Court examines personal jurisdiction over restoration company CEO

Hurricane Florence made landfall near Wrightsville Beach, North Carolina on September 14, 2018, and its slow-moving chaos brought more than 30 inches of rain to some localities along with fierce winds. It left in its wake an estimated $24 billion in damages, and a multi-state footprint of clean-up and reconstruction work that stretched contractors thin and brought official warnings about those who prey upon storm victims.

JCG & Associates, LLC, et al. v. Disaster America USA, LLC, 2019 NCBC 78, 2019 WL 7018939 (N.C. Super. Ct. Dec. 19, 2019) focused on a challenge to personal jurisdiction against the backdrop of allegations of fraud and uncompleted repair work. It is representative of the litigations over construction disasters that often follow the natural ones.  See Order and Opinion.

Takeaways:

  • A corporate officer’s “minimum contacts” with North Carolina can be an aggregation of his official, and individual capacity, acts. 
  • The Court accepts that “minimum contacts” may well require a claim-by-claim analysis to determine specific jurisdiction, but a defendant seeking to avoid personal jurisdiction on that ground should argue specifically for it on brief.

Plaintiffs James and Patricia Bonica and MIP 1, LLC owned properties on Bald Head Island that suffered significant wind and water damage. They were approached by defendant Jason Husk, and executed contracts for repair work with Disaster Services under which it would perform repair work approved by the insurance carriers. Jason Husk’s father, defendant Donald Husk, signed the contracts. Id. ¶¶ 5, 7-8.

The Bonicas and MIP 1 gave notice to terminate within six months, and each had similar laments: Disaster Services (i) had no general contractor’s license at execution and fraudulently indicated it did via plaintiff JCG, and (ii) hadn’t done any restoration work.  Id. ¶ 9. Donald Husk responded to the purported terminations by sending an unpaid invoice to MIP 1’s counsel and threatening a lien on its property for non-payment, and informing the Bonicas’ counsel that their personal property would be retained pending full payment.  Id. ¶ 10.

Plaintiffs filed suit, characterizing Donald Husk’s responses to the plaintiffs as unfair debt collection practices, and also alleging fraud, constructive fraud, Chapter 75 violations, racketeering, and negligence.  JCG, which alleged Disaster America had falsely represented it in the contracts as a general contractor on the work, lodged similar claims. Id. ¶ 11.

Donald Husk moved to dismiss for lack of personal jurisdiction. While he signed the contracts and hired a company to pack and store the homeowners’ personal property, in an affidavit he denied drafting the contracts, making any representations to the Bonicas or MIP 1, or traveling to North Carolina for any purpose related to the contracts. Id. ¶ 8.

The Court’s consideration of Husk’s motion to dismiss focused on the traditional due process analysis of whether he had sufficient “minimum contacts” with North Carolina to pass a “specific” jurisdiction test.  Husk’s primary argument was that as Disaster America’s CEO he only had contacts with North Carolina in his official capacity that were insufficient to hail him into a North Carolina court in his individual capacity. Id. ¶ 14.

The Court agreed that Husk’s corporate officer role was not enough, alone, to subject him to suit in a North Carolina court. Nor, though, did the Court believe that “insulate[d]” him from suit as an individual.  Id. ¶ 15. Rather, the Court said that a defendant’s aggregated official and individual capacity contacts, together, formed the appropriate jurisdictional standard:

Put simply, ‘a corporate officer’s contacts with North Carolina – whether established in his individual capacity or in his capacity as an officer or agent of his company – count for purposes of determining whether that particular individual has sufficient minimum contacts with North Carolina.’”

Id. (citing Insight Health Corp. v. Marquis Diagnostic Imaging of N.C., LLC, 2015 WL 263515, at * 7 (N.C. Super. Ct. Jan. 21, 2015).

Husk’s terse volleys back at the plaintiffs’ purported contract terminations were his undoing for jurisdictional purposes. The Court found that these acts “directed to North Carolina” were sufficient contacts at least for the unfair debt collection claims because Husk knew when he sent them that the contracts he signed were invalid because Disaster America did not have a general contractor’s license. 2019 NCBC 78, ¶ 16. The Court issue-spotted that Husk might well have asserted that specific jurisdiction should be decided on a claim-by-claim basis, thus broaching the possibility that plaintiffs’ remaining claims might fail a “minimum contacts” analysis. However, because Husk did not advocate for that more nuanced jurisdictional analysis as to the remaining claims, the Court said that it “need not and does not” reach the issue. Id. ¶ 18. The Court exercised its discretion to keep Husk around for a determination of whether Disaster America’s recovery work was a storm all to itself.

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

Arbitration is supposed to be a less formal, more efficient way of resolving a dispute. More and more, though, we see certain threshold issues—like whether a dispute is ‘arbitrable’ in the first place—undermine the benefits of this supposedly streamlined process. Any clarity from the courts when it comes to issues of arbitrability, therefore, is a good thing to practitioners (and their clients) in this increasingly litigated area.

In Rickenbaugh v. Power Home Solar, LLC, 2019 NCBC 79 (N.C. Super. Ct. Dec. 20, 2019), the Business Court brought some clarity to this area, rolling out several (nearly) bright-line rules with respect to arbitrability. See Order and Opinion.

Take-Aways:

  • The FAA applies to any contract involving interstate commerce—no matter what the parties say in their choice-of-law provision.
  • Where a contract incorporates the AAA Rules, questions of substantive arbitrability are for the arbitrator, not the court.
  • Where the parties have agreed for the arbitrator to determine the scope of the arbitration, the question of class arbitrability is one for the arbitrator, not the court.

Background:

The Rickenbaugh plaintiffs purchased a “solar energy system” from the defendant Power Home Solar. According to the Rickenbaughs, they did so based on Power Home’s representation that the system “was guaranteed to save [them] at least 97% on their energy bills.” Rickenbaugh, 2019 NCBC at ¶ 5. The parties’ contract included an arbitration provision, which provided that any dispute between them would be arbitrated “as provided by North Carolina & South Carolina law.” Id. ¶ 6 (caps removed).

The Rickenbaughs had the system installed, but their actual energy savings, they contend, was only a “fraction” of the 97% energy savings promised by Power Home. Id. ¶ 7. The Rickenbaughs complained to Power Home, who allegedly “refused to provide the promised energy savings or otherwise afford them a remedy.” Id. ¶ 7. The Rickenbaughs thereafter filed a class action complaint against Power Home, on behalf of themselves and potentially “more than 10,000 people” allegedly defrauded by Power Home “throughout the United States.” Id. ¶ 8.

The case was designated to the Business Court, where Power Home moved to dismiss or, in the alternative, compel bilateral arbitration (despite the “class action” complaint) based on the arbitration provision in the parties’ contract.

In addressing the motion, the Court considered several arbitrability-related questions:

  • Which law applied to the parties’ arbitration agreement—federal or state law?
  • Who decided whether the dispute was arbitrable—the arbitrator or the court?
  • Who decided whether class arbitration was available—the arbitrator or the court?

Analysis:

  1. Which Law Applies?

As noted, the parties’ contract provided that any dispute between them would be arbitrated “as provided by North Carolina & South Carolina law.” So, state law applied, right? Not so fast.

The Court observed that any contract “involving interstate commerce” is governed by the Federal Arbitration Act (FAA). Id. ¶ 13. And this was true regardless of any choice-of-law provision in the parties’ contract. Id. ¶ 15.

The question, then, was whether the parties’ contract “involved interstate commerce.”

The Court said yes – the contract involved interstate commerce because:

  • Diversity of citizenship existed between the parties: Plaintiffs were residents of North Carolina, while Power Home was a Delaware LLC;
  • Plaintiffs’ claims were based on Power Home’s sale and installation of its energy efficiency system to customers both inside and outside North Carolina and its allegedly fraudulent scheme to deceive customers in at least five states; and
  • Although Power Home denied Plaintiffs’ claims, it did not deny that its conduct at issue occurred both inside and outside North Carolina.

Id. ¶¶ 13-14. Accordingly, the FAA applied.

  1. Who Decides Arbitrability?

Next, knowing that the FAA applied, the question became: Who gets to apply it – the arbitrator or the court?

Presumptively, questions of substantive arbitrability—like whether a particular dispute falls within an arbitration provision—are for the court, not the arbitrator, to decide. This presumption can be overcome, though, where there is “clear and unmistakable” evidence that the parties agreed to have the arbitrator decide arbitrability. Id. ¶¶ 17-18.

Under the FAA, one way for the parties to “clearly and unmistakably” delegate arbitrability to the arbitrator is by incorporating the American Arbitration Association (AAA) Rules into their agreement. Id. ¶ 19. This is because, under the AAA Rules, arbitrability is specifically delegated to the arbitrator. In particular, the AAA Construction Rules provide that “[t]he arbitrator shall have the power to rule on his or her own jurisdiction, including any objections with respect to the existence, scope or validity of the arbitration agreement.” Id. ¶ 20 (quoting AAA Construction Rule 9(a)).

Here, the parties had agreed that “any dispute” relating to their agreement would be settled through arbitration “in accordance with the Construction Industry Rules of the American Arbitration Association.” Id. ¶ 20. The Court also noted that “nearly identical” language had been held sufficient to delegate issues of substantive arbitrability to the arbitrator. Id. ¶ 21 (citing Epic Games, Inc. v. Murphy-Johnson, 247 N.C. App. 54, 785 S.E.2d 137 (2016)). Accordingly, “deem[ing] itself bound by [Epic Games],” the Court concluded that by incorporating the AAA Rules into their contract, the parties had “clearly and unmistakably” agreed to arbitrate issues of substantive arbitrability. Id. ¶ 21.

  1. Who Decides Class Arbitrability?

The Court next addressed an issue of first impression in North Carolina: Who decides whether class arbitration is available?

The Court observed that, unlike bilateral arbitration, class arbitration “raises serious due process concerns by adjudicating the rights of absent members of the plaintiff class . . . with only limited judicial review.” Id. ¶ 23 (quoting Lamps Plus, Inc. v. Varela, 139 S. Ct. 1407, 1416 (2019)). Because of these concerns, “a party may not be compelled under the FAA to submit to class arbitration unless there is a contractual basis for concluding that the party agreed to do so.” Id. ¶ 24 (quoting Stolt-Nielsen S.A. v. AnimalFeeds Int’l Corp., 559 U.S. 662, 684 (2010)).

Power Home argued that, under this standard, the parties’ “incorporation of the AAA Construction Rules in [their contract], without more, cannot constitute clear and unmistakable evidence that the parties agreed for an arbitrator to decide the availability of class arbitration.” Id. ¶ 25. The Court disagreed.

The Court noted that the AAA Construction Rules, incorporated by the parties into their contract, provided that “the arbitrator shall have the power to rule on his or her own jurisdiction, including any objections with respect to the . . . scope . . . of the arbitration agreement.” Id. ¶ 30. And based on the plain meaning of the word “scope,” the Court reasoned, the question of whether arbitration could proceed on behalf of a class concerned the scope of the arbitration. Id. ¶¶ 33-34.

The Court found further support for its decision not only in cases from other jurisdictions, but also in the AAA’s “Supplementary Rules.” In fact, the Supplementary Rules explicitly provided that the arbitrator “shall determine as a threshold matter . . . whether the applicable arbitration clause permits the arbitration to proceed on behalf of or against a class.” Id. ¶ 31.

Accordingly, based on the AAA Rules and Supplementary Rules, the plain meaning of the word “scope,” and supporting cases from other jurisdictions, the Court concluded that the parties had “clearly and unmistakably” delegated the question of class arbitrability to the arbitrator.

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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. 

 

Considering whether to add a Chapter 75 claim to your breach of contract dispute? If you don’t have substantial aggravating circumstances, resist the urge and don’t assert the Chapter 75 claim. In a recent order, Judge McGuire made clear that asserting an unjustified Chapter 75 claim may get you sanctioned.

More snow leopard than unicorn, attorney fee sanctions in North Carolina are rarely seen. Everyone knows that UDTPA claims under Chapter 75 come with enhanced remedies (treble damages and attorney’s fees). It’s easy to miss, however, that attorney’s fees are available to both a prevailing plaintiff and a defendant forced to deal with a “frivolous” and “malicious” Chapter 75 claim. Likewise, there is an even broader fee shifting provision in G.S. § 6-21.5, which allows a Court to award fees incurred in defending pleadings that raise “nonjusticiable” issues.

The defendants in W&W Partners, Inc. v. Ferrell Land Co., LLC spotted these fee-shifting provisions.  After successfully moving to dismiss the Chapter 75 claim and fending off a motion to amend (to reassert the dismissed Chapter 75 claim), the defendants moved for fees.  Judge McGuire granted the motion.

W&W Partners involved a disagreement over the parties’ obligations under a land development contract. In simple terms, if the defendants purchased certain land, the plaintiffs would develop it in exchange for a fee. The more land the defendants bought, the more development fees the plaintiffs could earn.  A dispute arose, however, when the defendants refused to purchase a particular parcel. The plaintiffs claimed that defendants were required to purchase it (so plaintiffs could develop it and earn their fee), and the defendants claimed that land purchases under the contract were discretionary.

The dispute, therefore, appeared to be purely contractual: Did the contract require the defendants to purchase the parcel or not?

The plaintiffs’ multiple complaints (initial, first amended, and second amended) each included breach of contract claims. Each time, the plaintiffs also tacked on a UDTPA claim under Chapter 75—despite the defendants’ warnings not to assert a Chapter 75 claim since the dispute was purely contractual.

The defendants moved to dismiss the Chapter 75 claim, arguing that the dispute was contractual and the Chapter 75 claim was duplicative. Judge McGuire agreed: “The Parties’ competing interpretations of the [contract], which underlies Plaintiffs’ claim for breach of contract, is also the basis of the UDTPA claim.” And since “a mere breach of contract, even if intentional, is not an unfair and deceptive act under Chapter 75,” Judge McGuire dismissed the UDPTA claim with prejudice. [Order 5/22/2018] The plaintiffs did not seek reconsideration.

Months later, the plaintiffs, citing “new evidence,” sought leave to file a third amended complaint. Plaintiffs again sought to include the previously dismissed Chapter 75 claim. Since the prior dismissal of the Chapter 75 claim was with prejudice (and reconsideration was never sought), Judge McGuire denied the motion for leave to amend under res judicata principles. [Order 4/23/2019]

Thereafter, the defendants moved for attorney’s fees incurred in (i) defending the Chapter 75 claim and (ii) responding to plaintiffs’ motion for leave to amend to reassert it. In a pointed order, Judge McGuire granted the defendants’ motion for fees on both grounds.

As to the Chapter 75 claim, Judge McGuire concluded that the plaintiffs knew or should have known that the original Chapter 75 claim was frivolous and asserted the claim maliciously. As Judge McGuire explained, the Chapter 75 and the breach claims were both grounded in the same facts and the same conduct. Plaintiffs had not alleged fraudulent inducement, and the only supposedly deceptive conduct was the defendants’ differing interpretation of the contract. Judge McGuire also noted that the plaintiffs ignored defendants’ repeated pre-litigation warnings that the dispute was purely contractual.  With this backdrop, Judge McGuire awarded the defendants’ attorney’s fees for having to defend against the Chapter 75 claim.

As to the motion to amend, Judge McGuire concluded that the motion failed to raise a justiciable issue, which, as Judge McGuire noted, was the bare minimum standard for all pleadings. Attempting to assert the previously dismissed Chapter 75 claim (from which the plaintiffs had not sought reconsideration) was, according to Judge McGuire, “almost the very definition of asserting a nonjusticiable claim.”

W&W Partners thus serves as a cautionary tale to litigants who may think that adding a Chapter 75 claim makes their case stronger.  If all you have is a contract claim, tacking on a duplicative Chapter 75 claim could get you sanctioned.

Here at the blog, we love a well-crafted set of local rules as much as the next lawyer. (Yes, we hear you laughing; we’re the folks who recap decisions about business law instead of episodes of Watchmen  or The Marvelous Mrs. Maisel. We enjoy them a lot more than the next, more normal, lawyer.) Sometimes, though, it’s the informal guideposts to commercial litigation practice that serve you the best. One of the classics is the Mark Twain maxim of notice pleading:  “Get your facts first, and then you can distort them as much as you please.”

That second part is not in the Business Court’s rules, of course, but in Aym Technologies, LLC v. Gene Rodgers, et al.¸ 2019 NCBC 63, 2019 WL 5257950 (N.C. Super. Ct. October 16, 2019), the Court made clear the first part is pleading Job One. See Order and Opinion.   Aym contended that Rodgers had assisted the corporate defendants in beating Aym to acquisition targets it coveted, and did so in part by sharing a confidential plan (the Plan) designed to further a purchase and vertical integration strategy in North Carolina’s competitive Medicaid intellectual and development disability (IDD) industry. Id. ¶¶ 4, 8. Aym advanced a trade secret misappropriation claim centered on the Plan, and inched that claim past a motion to dismiss based on complaint allegations about the unattached Plan’s proprietary and confidential contents. Id. ¶ 32. But at summary judgment, with the Plan in the record, Judge Bledsoe applied the “Twain test” with resolute clarity:

The written Plan has now been made part of the record at summary judgment, and it cannot be disputed that the Plan does not comport with Aym’s characterization of that document in its Complaint.

Id. ¶ 33.

Takeaways:

  • The Business Court reacts about as you would expect when a complaint is later shown to have taken liberties with a document that the plaintiff declined to attach to the pleading. 
  • “Reasonable efforts” to protect an alleged trade secret do not include its frequent dissemination without accompanying confidentiality restrictions. 
  • They especially don’t include its unfettered transmission by a plaintiff to a defendant accused of misappropriation.

Aym’s characterization was, at a minimum, a bit cavalier.  The complaint averred that the Plan identified specific acquisition targets and outlined Aym’s confidential vertical integration strategy for the IDD industry. Id. ¶¶ 8, 32. Aym alleged that Rodgers, its non-exclusive contractor, was enlisted to help it acquire North Carolina IDD providers and had its strategic plan as part of that work. The relationship went off the rails when defendants Scopia Capital Management LP and Community Based Care, LLC (CBC) acquired three IDD targets that Aym had pursued without success. Aym believed that this was only possible because Rodgers had disclosed its confidential plan to Scopia.  Id. ¶¶ 12-13.

The Court found Aym’s trade secret misappropriation claim flawed in many respects under the North Carolina Trade Secret Protection Act, but particularly so because Aym over-promised and under-delivered on whether its Plan contained information that would merit protection under the Act. Upon inspection of the Plan, the Court found that it not only failed to identify any of the acquisition targets lost to Scopia, but “does not otherwise contain a list of proposed acquisition targets, or a formula for identifying them.” As well, the Court found that Aym’s Plan amounted to little more than an industry survey that recognized the value of roll up and integration strategies “not unique” to Aym. Id. ¶ 33-34. As confirmation, the Court noted discovery revealed that Aym’s CEO had even referred to the Plan as a “white paper” that was “high level rough.” Id. ¶ 33.

The Court also rejected Aym’s contention that its Plan deserved trade secret protection as a “compilation or manipulation” of public information that has a “particular value.” As the Court noted, “Aym admits that a strategy of rolling up IDD companies – the core concept of Aym’s Plan – is well known and not a trade secret.” Id. ¶¶ 35-36. Despite earlier allowing the misappropriation claim to survive Rule 12(b)(6) based on the Plan’s alleged contents, the Court also addressed a new argument—raised by Aym in its summary judgment briefing—that the Plan, when combined with Aym’s industry experience and enhanced analytical position, formed a greater whole that deserved trade secret protection. The Court wryly noted that Aym’s attempt to “salvage” its trade secret claim also fell well short of the statutory bar:

Even as reinvented, however, Aym’s claim must still be dismissed because Aym has failed to describe this newly conceived trade secret with the specificity our Supreme Court requires.

Id. ¶ 42.

Reasonable Efforts to Maintain Secrecy

While unnecessary to the outcome, the Court also reviewed Aym’s required efforts “that are reasonable under the circumstances to maintain [the plan’s] secrecy.”  N.C. Gen. Stat. § 66-152(3). Even had the Court determined the Plan presented a protectable trade secret, the facts showed that the Plan had been passed around like a cold at a preschool. An Aym principal provided the report to an investment banker assisting its acquisition strategy, but did so without any nondisclosure protections. That banker then actually provided the Plan to an entity Aym twice tried and failed to acquire, and discussed Aym’s strategies with another of Aym’s unsuccessful acquisition targets. Id. ¶¶ 12, 48.

Aym, itself, treated the Plan as something well shy of a document whose confidentiality was a priority. Aym’s litigation position was that Scopia and CBC were only able to acquire targets that Aym wanted for itself because defendant Rodgers had disclosed the plan to Scopia. Id. ¶ 13. Yet, Aym’s CEO emailed the plan to a Scopia partner with no confidentiality protections when trying to sell his company to Scopia, and observed in the covering note that he didn’t think the plan contained “anything of a proprietary nature that isn’t already common knowledge.” Id. ¶¶ 14, 49.

Misappropriation

The Court made clear there was no trade secret to misappropriate, and that Aym did nearly the opposite of protecting that alleged secret. But, it nonetheless paused to also note Aym failed to show that Rodgers disclosed the Plan, that the other defendants got it from him, or that Rodgers disclosed Aym’s interest in particular acquisition targets or its vertical integration strategy. Id. ¶ 53. At root, the Court held the claim relied on little more than an “inferential leap” of misappropriation given this undisputed evidence, and discounted Aym’s theory as one of “inevitable disclosure” regularly rejected under North Carolina law. Id. ¶¶ 56-57.

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

N.C. Business Court Digs into Pleading Requirements in Tossing Three Misrepresentation-Based Claims

A “failed deal” or contract often gives rise to claims for breach of contract, fraud, and/or negligent misrepresentation. Each claim presents its own path to relief. And that path is replete with obstacles, beginning with pleading requirements unique to each claim. Even a “simple” breach claim can become complex, particularly when tangled with other misrepresentation-based claims. For instance—if a party promises not to make false statements in a contract, but then does, is that a breach of contract, fraud, or both? What if the misrepresentations are made during negotiations versus in the contract itself? And what role, if any, does the parol evidence rule play in this analysis? The Business Court grappled with these questions, among others, in Value Health Sols. Inc. v. Pharm. Research Assocs., Inc., 2019 NCBC 68 (N.C. Super. Ct. Sept. 6, 2019). See Order and Opinion.[1]

Take-Aways:

  • Whether fraud in the contract has occurred requires looking no further than the contract itself, at least where the contract is “clear and unambiguous.”
  • When pleading fraud, “reliance” should be pled like any other element—with particularity, which in this context means showing why the reliance was reasonable under the circumstances.
  • A duty of care arises where one party controls the information in question, but only where the other party has made diligent efforts to obtain it.

Background

The defendants in Value Health (“PRA”) conducted clinical trials “all over the world” and comprised “one of the world’s leading global contract research organizations (CRO).” Id. ¶ 2. As a CRO heavyweight, PRA needed software capable of managing their large-scale clinical trials. And they thought they had found the solution in plaintiffs’ product—which fittingly was called the “Solution.” Id. ¶ 3.

Plaintiffs made a number of representations to PRA regarding the capabilities of the Solution and various product “enhancements” needed to integrate the Solution with PRA’s existing software system. Id. ¶¶ 4-6, 9.  Based on these representations, PRA agreed to purchase the Solution from plaintiffs pursuant to an asset purchase agreement (“APA”). Id. ¶ 7. The APA included a provision, perhaps best described as a “No Fraud” clause, in which plaintiffs essentially agreed they had not misrepresented or omitted material facts in the APA. Id. ¶ 24.

After performance of the APA went south, each party asserted that the other had breached and made material misrepresentations in connection with the APA. Plaintiffs filed suit, and PRA asserted counterclaims, including for breach of contract, fraud, and negligent misrepresentation based on plaintiffs’ alleged pre-contract misrepresentations. Id. ¶¶ 10, 17.

Judge McGuire addressed plaintiffs’ motion to dismiss PRA’s counterclaims in the Business Court’s 68th opinion of 2019.

Analysis

  1. Breach of Contract – the “No Fraud” clause

First, what exactly did plaintiffs agree to do under the No Fraud clause? The No Fraud clause provided that:

No representation or warranty by [plaintiffs] in this Agreement and no statement contained in the Schedules to this Agreement or any certificate or other document furnished or to be furnished to [PRA] pursuant to this Agreement contains any untrue statement of a material fact or omits to state a material fact necessary to make the statements contained therein, in light of the circumstances in which they are made, not misleading.

Id. ¶ 24. Breaking down this painfully-worded provision, plaintiffs represented essentially two things in the No Fraud clause:

  • Plaintiffs did not make any false statements in the APA; and
  • Plaintiffs did not omit information from the APA that, as a result of the omission, made any statement in the APA misleading.

See id. ¶ 31. Put more simply, plaintiffs promised not to commit fraud in the APA. And this qualification—“in the APA”—made a difference in the Court’s analysis.

In particular, PRA alleged that plaintiffs breached the No Fraud clause by “failing to correct” certain pre-contract misrepresentations, including that (i) certain “milestones” relating to the Solution would be achieved within 18 months of closing the APA; and (ii) certain product enhancements to the Solution had already been implemented. Id. ¶ 25. PRA argued that plaintiffs’ failure to correct these misrepresentations were “omissions” that “made statements contained in the APA false.” Id. ¶ 25.

But plaintiffs did not make any promises in the APA to do these things. There was “no express language in the APA that any of the Product Enhancements were already implemented”; nor did the APA “contain any promise . . . that the Milestones would be achieved within eighteen months of the Closing.” As such, “Plaintiffs’ failure to correct any [such] representation . . . [was] not an omission of ‘a material fact necessary to make the statements contained [in the APA] . . . not misleading.’” Id. ¶¶ 32-33.

The parol evidence rule also factored into the analysis. The Court determined that the No Fraud clause was “clear and unambiguous,” meaning that (although not explicitly articulated by the Court) extrinsic evidence was not relevant in interpreting the No Fraud clause. Id. ¶¶ 30-31.  Elaborating further (and again, not explicitly articulated by the Court), this effectively meant that in considering whether the plaintiffs had breached the APA by “failing to correct” alleged pre-contract misrepresentations, there were no pre-contract misrepresentations to consider; the parties had a final written agreement (the APA), which, in turn, rendered any pre-contract negotiations, understandings, or agreements irrelevant. In short, PRA could not prove a breach of the APA by pointing to these (irrelevant) pre-contract representations.[2]

Accordingly, PRA’s contract claim failed to allege any breach of the APA, and was dismissed for failure to state a claim.

  1. Fraud

PRA’s fraud claim appeared more promising. Unlike with the contract claim, PRA could rely on plaintiffs’ pre-contract representations to support their fraud claim. (Recall that parol evidence can be used to prove fraud. Franco v. Liposcience, Inc., 197 N.C. App. 59, 71, 676 S.E.2d 500, 507, aff’d, 363 N.C. 741, 686 S.E.2d 152 (2009).)

But there was one problem: PRA did not sufficiently plead the element of “reliance.”

In particular, a fraud claim requires showing not only reliance on the alleged misrepresentations, but also that the reliance was reasonable. And “[r]eliance is not reasonable where the plaintiff could have discovered the truth of the matter through reasonable diligence but failed to investigate. Value Health, 2019 NCBC at ¶ 51 (citation omitted).

In other words, reliance requires pleading facts to show that the “true facts” could not have been discovered through reasonable diligence. Id. And the facts pled should show the steps taken to discover the true facts and/or why the true facts were not discoverable through reasonable investigation. This effectively “heightened” pleading standard for the reliance element is consistent with the heightened pleading standard for fraud generally.

The Court concluded that PRA’s “reliance” allegations fell short. The allegations did not show that PRA had undertaken reasonable efforts to discover the true facts regarding plaintiffs’ alleged misrepresentations. Nor were facts pled to suggest that PRA could not have discovered the truth through reasonable investigation. Id. ¶¶ 49-52. Indeed, with respect to reliance, PRA alleged only that PRA had “relied upon [plaintiffs’] representations in entering into the APA” and that “[h]ad [plaintiffs] not made these representations and omissions, PRA would not have entered into the APA.” ECF No. 5 ¶¶ 53-54.

Because these allegations failed to adequately plead reliance, the fraud claim was dismissed for failure to state a claim.

  1. Negligent Misrepresentation

PRA’s negligent misrepresentation claim fared no better. While such a claim can be useful where fraudulent intent is difficult to prove (or lacking), intent was not the issue here. The issue, again, was that PRA failed to sufficiently allege reliance on the alleged misrepresentations, and, like fraud, negligence misrepresentation requires a showing of reliance. Value Health, 2019 NCBC at ¶ 51 (citations omitted).

But even aside from reliance, this claim failed for a separate reason: PRA failed to allege that plaintiffs owed them a duty of care.   Id. ¶ 46.

Like any negligence claim, negligent misrepresentation requires showing a duty of care owed to the claimant. Id. ¶ 37 (citation omitted). As relevant to PRA’s negligence claim, a duty of care arises in commercial transactions where the seller is “the only party who had or controlled the information at issue” during the parties’ negotiations, “and the buyer had no ability to perform any independent investigation.” Id. ¶ 47 (citation omitted).

Here, PRA did not allege that plaintiffs were the only party that “had or controlled” information relating to the Solution. Nor did PRA allege that they were unable to investigate and discover any information they needed relating to the Solution. Instead, PRA alleged that they were “a large, sophisticated CRO who negotiated the APA with Plaintiffs for a period of more than a year, frequently providing Plaintiffs with input as to the functionality required from the Solution and engaging in regular interactions with Plaintiff during the development of the software.” Id. ¶ 48. Essentially, PRA’s allegations showed that they were in a position to access, or at least attempt to access, the information needed to verify plaintiffs’ representations, but nonetheless failed to “undert[ake] any due diligence efforts related to the purchase of the Solution.” Id. ¶ 49.

Accordingly, because PRA did not adequately allege a duty of care, or reliance, this claim was also dismissed.

Conclusion

In the end, PRA’s misrepresentation-based claims were dismissed for several reasons—none of which was that no misrepresentations had been made. The “merits” were never reached because the pleadings, according to the Court, did not allow it. Value Health thus underscores the importance of adhering closely to the case law and what courts require when pleading these oft-asserted claims.

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[1] In addition to the three misrepresentation-based claims described here, the Court addressed (and allowed to proceed) two additional claims unrelated to the misrepresentations.

[2] Although the Court applied Delaware law to interpret the APA (pursuant to the parties’ choice of law provision), the result and application of the parol evidence rule would likely be the same under North Carolina law. Compare Carlson v. Hallinan, 925 A.2d 506, 522 (Del. Ch. 2006) (“The parol evidence rule bars the admission of ‘preliminary negotiations, conversations and verbal agreements’ when the parties’ written contract represents ‘the entire contract between the parties.’”) (citation omitted), with Jones v. Jones, ___ N.C. App. ___, ___, 824 S.E.2d 185, 199 (2019) (“Where the parties have put their agreement in writing, it is presumed that the writing embodies their entire agreement,” and “parol testimony of prior or contemporaneous negotiations or conversations inconsistent with the writing . . . is incompetent.”) (citations omitted).

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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.