When you think of sanctions, your mind probably goes to Rule 11 of the Rules of Civil Procedure.  But what about Rule 37(b)(2)?  It says that: 

if a party . . . fails to obey an order to provide or permit discovery, . . . a judge of the court in which the action is pending may make such orders in regard to the failure as are just . . . . In lieu of any [such order] or in addition thereto, the court shall require the party failing to obey the order to pay the reasonable expenses, including attorney’s fees, caused by the failure . . . .

Judge Murphy applied the teeth in Rule 37 to sanction two of the parties — Allison and Stathopoulos — in an Order this week in BOGNC v. Cornelius Self-Storage LLC to the tune of almost $10,000 for failing to comply with an earlier discovery order in the case.

 He had entered that Order in December 2011, ruling that the attorney-client privilege did not apply to communications between Allison (an attorney) and Stathopoulus, both of whom were LLC members.  He directed those two parties to produce the documents they had withheld on the basis of privilege within thirty days, and to produce a privilege log for documents they continued to maintain as privileged within the same time frame.  If disputes continued, Allison and Stathopoulus were to deliver the documents in camera for the Court’s review.

The deadlines passed without compliance.  Although the Order did not state a deadline for production of the documents for an in camera review, they were not provided until eight months after the entry of the Order.  Judge Murphy said that the production was "riddled with deficiencies" and  the parties had acted in "blatant disregard" of his Order.   Order 18.

The sanctions were equivalent to the reasonable expenses incurred by the Plaintiff as a result of the parties’ failure to comply with the Court’s 2011 Order, which were ruled to be $9,614.00.

It is worth mentioning that these sanctions didn’t run against the lawyers for Allison and Stathopoulus.  They ran directly against the parties.

 

 

Maybe you’ve wondered whether a claim for legal malpractice can be assigned. Maybe you haven’t. But yesterday, the North Carolina Court of Appeals answered that question.  In Revolutionary Concepts, Inc. v. Clements Walker PLLC, the Court held that "malpractice claims are not assignable in North Carolina."  Op. at 10.

Why not?  A cascade of horribles might result if they were assignable.  The concerns noted by the COA were:

the potential for a conflict of interest, the compromise of confidentiality, and the negative effect assignment would have on the integrity of the legal profession and the administration of justice.

Op. at 9.

Malpractice claims now fit in a broad category of personal injury claims which are not assignable, like "claims for defamation, abuse of process, malicious prosecution or conspiracy to injure another’s business, unfair and deceptive trade practices and conspiracy to commit fraud."  Op. at 8.

If the name of the case sounds familiar, that’s because it was a Business Court case which you’ve read about before on this blog.

And don’t think that this result represents a win for the law firm involved.  The COA reversed a 2010 Order from the Business Court holding that the firm’s individual client had assigned away his malpractice claim to a corporate Plaintiff and that he therefore had no standing to bring the malpractice claim.

You’ve undoubtedly prevailed in a federal case — either at summary judgment or after a trial — and you have probably struggled with what you are entitled to recover as costs under 28 U.S.C. §1920.  And recently, your client, being the victor, most likely has asked about the recovery of its costs associated with the production of electronically stored information.

The Fourth Circuit’s decision on Monday of this week in The Country Vintner v. E & J Gallo Winery, Inc. gives answers to those questions, but your prevailing party client won’t like them.

Gallo ran up bills from e-discovery vendors of more than $100,000 in its production to the Plaintiff of its ESI, and it sought to have the District Court award that as an element of costs.  The bulk of that amount was for "flattening" and "indexing" the ESI. The Court defined that as the "initial processing" of the data, which:

involved decompressing container files (e.g., ZIP files or Microsoft PST files); making the data searchable by extracting text and creating Optical Character Recognition for text that could not be extracted; indexing the data; removing system files that were known not to contain any user-generated content; and removing duplicate files. 

Op. at 5.

That part of the application for costs was denied by the District Court, which was affirmed by the Fourth Circuit.

The Court was constrained by the terms of 28 U.S.C. sec 1920(4), which says that a "judge or clerk of any court of the United States may tax as costs . . . fees for exemplification and the cost of making copies of any materials where the copies are necessarily obtained for use in the case."

The heart of the holding was in the narrow definition of "making copies."  The Court relied on the Third Circuit’s decision in Race Tires America, Inc. v. Hoosier Racing Tire Corp., 674 F.3d 158 (3d Cir. 2012), which held that "only the scanning of hard copy documents, the conversion of native files to TIFF, and the transfer of VHS tapes to DVD involved ‘copying’" within the meaning of §1920(4).  Id. at 171.

Judge Davis of the Fourth Circuit ruled that "subsection (4) limits taxable costs to . . . converting electronic files to non-editable formats, and burning the files onto discs."  Op. at 21.  Thus, Gallo recovered only about $600 of the more than $100,000 it had asked for.
 
Why so little?  Well, as the Supreme Court has said,
Taxable costs are a fraction of the nontaxable expenses borne by litigants for attorneys, experts, consultants, and investigators. It comes as little surprise, therefore, that costs almost always amount to less than the successful litigant’s total expenses in connection with a lawsuit.
Taniguchi v. Kan P. Saipan, Ltd., 132 S. Ct. 1997, 2006 (2012).
 
If you don’t like this result, your only option may be to move to England, where "loser pays" is the general rule.

 

 

 

If you were thinking that an arbitration agreement needs to be signed in order to get an order compelling arbitration, your world may have been turned on its ear by the Order from the Business Court last week in Morton v. Ivey, McClellan, Gatton & Talcott, LLP, 2013 NCBC 23..

 There’s certainly a fair amount of North Carolina authority that an arbitration agreement can’t be enforced if it was never signed (noted in 20 of the Order), but Judge Gale held that the Revised Uniform Arbitration Act relaxes this requirement.

The RUAA became effective in 2004, and provides that "[a]n agreement contained in a record to submit to arbitration . . . is valid, enforceable, and irrevocable except upon a ground that exists at law or in equity for revoking a contract."  N.C. Gen. Stat. §1-569.6(a).  

A "record" is defined by the Act as "information that is inscribed on a tangible medium."  N.C. Gen. Stat. §1-569.1(6).  The predecessor statute — the Uniform Arbitration Act — carried a more stringent standard.  It said that "parties may agree in writing to submit to arbitration . . . or they may include in a written contract a provision for the settlement of arbitration of any controversy. . . . "

Even though the Plaintiffs had never signed the partnership agreement containing the arbitration provision, they had known of the agreement and taken a significant role in drafting it.  Judge Gale found that:

the draft Partnership Agreement circulated by [one of the Plaintiffs] and assented to by [the Defendants], is a sufficient ‘record’ to satisfy the requirement of § 569.6(a) of the RUAA.

Order 23.

Congratulations to my partners Jeff Oleynik and John Ormand for pulling off this magic trick and getting the Order compelling arbitration.  (And no, that’s not Jeff or John in the picture.  Or their rabbit.)

 

 

The Court of Appeals in February 2011 ordered Judge Jolly to dissolve Mitchell, Brewer, Richardson, Adams, Burge & Boughman, a law firm organized as a member-managed professional limited liability company.  The dissolution was ordered per N.C. Gen. Stat. §57C-6-02, which authorizes judicial dissolution when the managers of the LLC are deadlocked "in the management of the affairs of the limited liability company."

The deadlock, which had existed since June of 2005, concerned how  the profits from contingent fee engagements, concluded after several partners withdrew from the PLLC, should be divided among the partners.  Carrying out the directive of the Court of Appeals, Judge Jolly  last week in Mitchell v. Brewer, 2013 NCBC 14 resolved the issue of how those profits should be shared.

These former partners have been at war for seven years over the division of these fees.  I’ve written several times about the case, including in May 2007, April 2008, and March 2009.

In this latest round in their war, the former partners (the Plaintiffs) and the remaining Partners (the Defendants, who did all the work after the dissolution to resolve the outstanding contingent fee matters) had different approaches as to how the fees should be allocated among them.

Plaintiffs said they were entitled to their share in the profits from the engagements regardless when and by whom they were realized.  There is some support for this view in the LLC Act, which 

provides that upon dissolution, unless otherwise agreed, an LLC such as [the Company] continues in existence while its managers, or others charged with winding up the affairs of the LLC, have a statutory duty to (a) obtain ‘[a]s promptly as reasonably possible . . . the fair market value for the [LLC’s] assets,’ and (b) distribute the net balance of those assets to the LLC’s Members, and others.
G.S. 57C-6-04(b), 05(3).

Op. 7.  Plaintiffs said that the statute placed a duty on the managers of the LLC "to carry on the firm’s unfinished business in order to realize fair market value for its assets."  Op.  8.

The Defendants, who had done the work to pursue the contingent fee engagements to resolution, had a different point of view.  They said that the only interest that the former partners had in the contingent fee engagements was the value that they had before dissolution.  Since the value that actually materialized thereafter was due solely to the Defendants’ efforts after the dissolution, they said that

they should be required to remit to the Company only the value of net profits ultimately derived from the Contingent Fee Engagements less those profits that are attributable exclusively to Defendants’ post-dissolution efforts.

Op. 12.

Judge Jolly, as the decider, disagreed with both positions.  He observed that contingent-fee engagements "cannot be ‘liquidated’ in the conventional sense of the term.  The only way to realize a tangible value in a contingent fee case is "by ultimately reaching a favorable settlement or verdict in the matter."  Op. 19.

Therefore, he said, "dissolution should end the right of members to share in the future profits of their fellow members’ personal-service engagements."  Op. 22.  So profits attributable to "post-dissolution personal services by individual former members should not accrue to the LLC."  Op. 22.

The valuation protocol which Judge Jolly dictated was to look to the "percentage of pre-dissolution Time expended relative to the net profit ultimately realized on that matter."  Op. 25.  He gave this example:

if a total of 100 attorney hours were expended on a particular Contingent Fee Engagement and 50 of those hours were performed prior to dissolution, the net fee ultimately received by Defendants should be shared 50/50 with Plaintiffs.

Id.

It seems doubtful that the contingent fee engagements will fall that neatly into boxes.  That may be the reason that the Judge appointed an accountant as a Special Master to conduct an accounting of the contingent fee engagements. 

 

 

If you are in NC state court and want to take the deposition of an out-of-state non-party, the Order last week in Out of the Box Developers, LLC v. Logicbit Corp. carries a few lessons.

Serving A Subpoena.  You can’t serve a subpoena on a non-party through their counsel unless they are authorized to accept service.  That’s true even if counsel has appeared in the case.  Only parties can be served through their counsel of record, per Rule 5(b) of the Rules of Civil Procedure. 

The subpoena at issue in Out of the Box was directed to LexisNexis, which is based in Massachusetts. LexisNexis had appeared in the case to move to quash an earlier subpoena, so the party serving the new subpoena apparently thought it was valid to serve its North Carolina counsel.

Place Of Deposition.  The subpoena called for LexisNexis to present its witness in North Carolina. Judge Gale ruled that LexisNexis could not be required to send its witness to North Carolina.  He relied on a Business Court ruling of six years ago that:

the existence of personal jurisdiction over a non-party foreign corporation, standing alone, is insufficient to extend the Court’s subpoena power to that corporation for purposes of a deposition or the production of documents.

AARP v. American Family Prepaid Legal Corp., 2007 NCBC 4 (February 23, 2007).

30(b)(6) Deposition Topics.  The last lesson of Out of the Box is that when Rule of Civil Procedure 30(b)(6) says that the topics on which a corporation is to designate a witness must be stated with "reasonable particularity," it really means it. The Defendant framed its topics in an expansively broad way, like the name of the software product at issue "in the broadest sense and including any and all conceivable topics."  Judge Gale found the subjects identified to be too broad, and recast them in his own terms.

 

 

When I last wrote about SCI North Carolina Funeral Services, LLC v. McEwen Ellington Funeral Services, Inc., Judge Murphy had entered a TRO against the Defendants for trademark infringement over their use of the McEwen name in their funeral home business.  The case seemed cut and dried then, and it looked like that the Defendants had no defense to the infringement claim.

Last week, Judge Murphy entered a preliminary injunction in the same case in 2013 NCBC 11, this time over the Defendants’ vigorous defense.  The second time around was a much closer call. 

The case involves the McEwen name, which is the middle name of Defendant Carl Ellington. When the Defendants sold the funeral homes that they had operated under the McEwen name to the Plaintiffs, they included in the sale the rights to all "trademarks, tradenames (including all trade names under which [they] did business."  McEwen was the last name of Carl J. McEwen, the founder of McEwen Funeral Services, Inc.

Several years after their sale, the Defendants opened a new, competing funeral home under the McEwen name and this trademark infringement lawsuit ensued.

 

Continue Reading Developments In NC State Trademark Law

There is little case law under the North Carolina Securities Act.  But last week, in NNN Durham Office Portfolio 1, LLC v. Highwoods Realty Limited Partnership, 2013 NCBC 12, Judge Gale took several steps into that uncharted territory.

TIC Interests Are Securities

The first issue addressed in NNN was whether the "TIC interests" purchased by Plaintiffs fell within the definition of a "security."  If you’ve never heard of a TIC interest, it is "an undivided share in real property ‘with each person having an equal right to possess the whole property. . . .’" Op. ¶42.

There’s been a good bit of litigation about whether a TIC interest can  be considered a security.  It’s not a security if it simply involves the sale of fractional real estate shares, but it can be if it is coupled with a management contract.

That was the situation before the Court in NNN.  Plaintiffs had purchased TIC interests in several office buildings in Durham.  Two of the primary tenants of the buildings were affiliates of the Duke University Health System.  The properties were to be managed by Triple Net Properties, LLC, which is a defendant in a separate lawsuit also before the Business Court.

Plaintiffs alleged that Triple Net and Highwoods, the former owner of the properties, obtained their investment by making material misstatements which misled them into making their purchases. The alleged misstatements concerned Duke’s intention to remain as a tenant.  After the purchases of the TIC interests, Duke decided not to renew its leases.  The properties which it had occupied then went to foreclosure. 

The State Scheme For Civil Liability Under The Securities Act

Section 78A-56(a) imposes "primary liability" on the seller or offeror of a security.  There are two "pathways" to primary liability.  One lies in fraud, generally comparable to federal 10b-5 claims. That’s in N.C. Gen. Stat. §78A-8, (Section 78A-56(a) creates civil liability for a violation of section 78A-8.)  The other pathway is through making false or misleading statements, comparable to federal claims under 12(a)(2) of the Securities Act of 1933.  That’s in N.C. Gen. Stat. §78A-56(a)(2).

Note that the remedies under the NCSA are less generous than those under the corresponding federal claims.  The recovery under NC law is generally limited to the consideration paid for the security.  N.C. Gen. Stat. §78A-56(a).

Pleading, Scienter, and Justifiable Reliance Under Sections 56(a)(1) and 56(a)(2)

Judge Gale ruled that a Plaintiff must prove scienter and justifiable reliance to make out a primary violation under Section 56(a)(1) of the NCSA.  Recall that Judge Murphy ruled last year that scienter is not necessarily a required element of a claim under Section 56(a)(2), which can be grounded on negligence.  

So, Judge Gale ruled, a claim under Section 56(a)(1) must be pled with particularity, in compliance with Rule 9(b) of the NC Rules of Civil Procedure.  Op. ¶¶62-63.

Section 56(a)(2) is different.  It provides for a claim against an offeror or a seller of a security "who (1) makes any untrue statement of a material fact, or (2) fails to state a material fact necessary for a statment which was made to not be misleading."  Op. ¶64.  There’s a built-in defense in the statute.  A seller or offeror can avoid liability for such a statement or omission if he can prove that "he did not know, and in the exercise of reasonable care could not have known of the truth or omission."  N.C. Gen. Stat. §78A-56(a)(2).

On pleading requirements as to Section 56(a)(2),  Judge Gale ruled that "the heightened pleading standards of Rule 9(b) do not apply [to a claim under that Section] where the action is grounded on negligence, but rather Rule of Civil Procedure 8(c) controls."  Op. ¶67.  The plaintiff also doesn’t need to prove justifiable reliance under this Section.  Id.

Secondary Liability Under Section 56(a)(2)

North Carolina extends secondary liability under Section 56(a)(2) to "every other person who materially aids in the transaction."  But the "other person" must be shown to "actually [know] of the factual predicate of the primary liability."  Op. ¶69.

What does "materially aid" mean?  Judge Gale devoted several paragraphs of his decision to that issue (¶¶71-80), and concluded that:

for purposes of the present Rule 12(b)(6) motion the court will require allegations of conduct which rises to the level of having contributed substantial assistance to the act or conduct leading to primary liability under the NCSA, and, when later assessing plaintiff’s proof, will apply the concept of ‘substantial assistance’ restrictively.

Op. ¶79.

The Liability Of One Of The Defendants

The last part of the opinion deals with the liability of the Defendant Highwoods.  Highwoods conveyed the fractional interests in the properties directly to the Plaintiffs, but hadn’t been involved in the peddling of the management contract.  That wasn’t enough to make it liable as a seller of the security and make it primarily liable, so there was no claim for liability under Section 78A-56(a)(1).

Highwoods did not fare as well on Plaintiffs’ claims that it was secondarily liable under Section 78A-56(a)(2).  Judge Gale ruled that "[w]hether a person’s participation in the sale of a security constitutes ‘material aid’ and whether that person ‘actually knew of the existence of the facts by reason of which the liability is alleged to exist’ are necessarily fact-intensive inquiries. " Op. ¶91.

The facts about Highwoods’ knowledge that Duke planned to vacate the sold properties are to be the subject of "further proceedings."  Op. ¶90.

Being a Tar Heel fan, I have to say It’s a shame that no one can figure out a way to sue Duke.

 

The Order Wednesday of last week in Patriot Performance Materials, Inc. v. Powell, 2013 NCBC 10 was appropriately timed for the day before Valentine’s Day.

Powell, the Defendant, had a 50% interest in several businesses with Henderson, one of the Plaintiffs.  He alleged in a third party complaint that Henderson, who shared the other 50% interest, had diverted $30,000 (and more) from their corporations.

The purpose of the $30,000?  For Henderson to shower goodies on the nanny for his children.  The third party complaint against the nanny said that the funds were lavished upon her to buy her a "Mercedes-Benz automobile and a high-end Mac computer."  Op. 5.  

Perhaps the nanny’s child-care services were exceptional and warranted the computer and the Mercedes.  Or perhaps the allegations of the Third Party Complaint against the nanny, which were that she was Henderson’s mistress, were true.

And she wasn’t the only woman who was the target of Henderson’s largesse, though the $30,000 spent on her was small potatoes.  The Third Party Complaint alleges that Henderson took $800,000 in company funds "to spend primarily on extravagant European and Middle Eastern vacations with both his wife . . . and his mistress."  Third Party Complaint at 37.

Powell argued that the diversion of $30,000 for the Mercedes and the computer was an inappropriate use of corporate funds. He sued the nanny, Amber Clancy, for unjust enrichment.  

That didn’t fly, for a couple of reasons.  Unjust enrichment does not include claims for gifts, which were what Powell alleged the Mercedes and the Macintosh  were.  Also, Judge Gale ruled that Powell was not the proper party to bring the claim.  He said that "it was the corporation, not Powell individually, who conferred a benefit . . . upon Clancy and it is the corporation that would be the proper party to bring such an action."  Op. ¶10.

Our nannies always drove Porsches.

The case of Blythe v. Bell is like the gift that keeps on giving.  It generated two significant opinions last year, and this week a third and a fourth.  The July 2012 opinion was a major e-discovery decision, and the December 2012 opinion addressed an important issue about the assignment of LLC interests.

Today’s post is about the Blythe v. Bell opinion numbered 2013 NCBC 8, on the subject of expert testimony.  In this third Blythe opinion, Defendants had moved to exclude the testimony of Plaintiffs’ expert witness, Barbee, on the grounds that he was not qualified to render his opinion and that his methodology was deficient.

Barbee, a CPA, had offered testimony that the Plaintiffs’ damages were lost profits consisting of more than ten million dollars, including  “historic lost profits” of about $3.3 million;  and “additional lost profits” of about $7.4 million.  Defendants’ Motion to Exclude at ¶7.

Remember that it is very tough to prove lost profit damages in North Carolina.  As Judge Gale held, 

[w]hile the courts do not demand mathematical certitude in calculating
lost profits, they do not countenance conjecture or speculation, and conjecture or
speculation does not become admissible simply because it is presented by an expert.

Op. ¶19.  He also said that while the amount of damages to be awarded is for the jury to determine, "the court determines as a matter of law whether the evidence would allow a jury to calculate lost profits with reasonable certainty."  Op. Par. 20.

Furthermore, the expert testimony must "pass the realm of conjecture, speculation, or opinion not founded on facts, and must consist of actual facts from which a reasonably accurate conclusion regarding the cause and the amount of the loss can be logically and rationally drawn." Op. ¶20 (quoting Overnite Transp. Co. v. Int’l Brotherhood of Teamsters, 257 N.C. 18, 30, 125 S.E.2d 277, 286 (1962). 

The Defendants attacked Barbee’s expertise, saying that he was not a qualified expert on the subject of marketing and that the method he had used to calculate lost profits was not reliable enough to pass muster.

Judge Gale gave a nod of approval to Barbee’s expertise, saying that he was well qualified in the field of damages calculations.  He had the qualifications many of us look for when hiring a financial expert, like certifications from the American Institute of Certified Public Accountants in the areas of business valuation and financial forensics.

The AICPA puts limitations on a CPA’s methods of calculating lost profits.  One of its publications counsels against speculation, saying that "damages for lost profits are recoverable only if the plaintiff can prove the damages related to lost profits are reasonable and that they have been calculated using reliable factors without undue speculation."  Op. ¶16 (quoting Richard A. Pollack, et al, AICPA, Calculating Lost Profits, Ch. 58 ¶¶ 52-53 (2006)).

Judge Gale ruled that Barbee’s calculation of lost profits crossed the line into "conjecture and speculation" and that it should be excluded from evidence.  Op. ¶5.  

So where did Barbee leave the terra firma of "reliable factors" and enter the world of "conjecture and speculation"?  His calculation assumed that one of the Plaintiffs would have increased its sale of the socks that were central to the lawsuit and thereby its profits.  He based that calculation upon an assumption that the Plaintiffs would have had more dollars available to spend on marketing to increase sales.  He didn’t specify how the dollars would have been spent or how they would have generated new sales.

But if you are cheering for the Blythe side of this case, all wasn’t lost.  Part of Barbee’s calculation of lost profits withstood Judge Gale’s scrutiny.  That portion (the "historic" lost profits of $3.3 million) didn’t involve a projection of sales which hadn’t happened, but instead was based on actual sales.  Even so, the Blythe side of the case had their damages reduced by 75%.