The June 8th opinion from Business Court Judge Judge Gale in Best Cartage, Inc. v. Stonewall Packaging, LLC, 2011 NCBC 15, dismissed the Plaintiff’s complaint, finding its allegations that an alleged partner should be liable for the partnership debts, or otherwise liable on a veil piercing basis, were insufficient to state a valid claim.  There’s also a choice of law issue.

The Plaintiff Best, which had contracted with the Defendant Stonewall to provide transportation services, sued another defendant, Jackson, arguing that Jackson and Stonewall were partners or joint  venturers or alternatively that Stonewall was Jackson’s alter ego, and therefore liable for Stonewall’s debt to the Plaintiff.

The facts that seemed to the Court  to be most detrimental to Plaintiff’s claims of partnership were Best’s own allegations that it had known of the claimed partnership before it entered into its contract only with the Defendant Stonewall LLC instead of with the partnership itself, and also that the contract made no mention at all of a relationship between Stonewall and Jackson but instead disclaimed the existence of any third party beneficiary to the contract.

The Court faulted Plaintiff for its pleading of the basis for partnership liability, stating:

A party seeking to impose partnership liability on a fellow partner when neither the partnership nor that partner is a party to the contract faces a particularized pleading burden to show that the contract was for partnership purposes.

Op. ¶19.  Judge Gale said that the Plaintiff "hadn’t alleged the minimal elements to show that the [contract] was entered into for partnership purposes," including a lack of an allegation that the alleged partners had shared profits and losses, an "essential element of a partnership."  Op. ¶22

 The lack of specificity in Plaintiff’s complaint  also did in its claim that the Court should pierce Stonewall’s corporate veil and find Jackson behind the veil.  The Court said the veil piercing allegations were "broad and conclusory" and were missing the "critical element" that Jackson had misused the corporate form to "achieve a wrongful or inequitable result."  Op. ¶30  Judge Gale concluded by saying that:

Disregarding the protection of the limited liability company under these circumstance reaches beyond the intended purpose of the doctrine and improperly seeks to use a “drastic remedy” which should be utilized sparingly. See Dorton v. Dorton, 77 N.C. App. 667, 672, 336 S.E.2d 415, 419 (1985).

On the choice of law issue, Plaintiff had argued that the Court couldn’t decide the corporate veil issue without evidence as to Stonewall”s state of formation, which the contract recited was Delaware.  Judge Gale agreed that the appellate courts of this State had not ruled on which state’s law should apply to a veil piercing claim.

He nevertheless concluded that the claim couldn’t survive under either North Carolina law or Delaware law, based on an opinion from Judge Beaty of the Middle District in Richmond v. Indalex, Inc., 308 F.Supp.2d 648 (M.D.N.C. 2004) in which Judge Beaty dismissed a veil piercing claim based on insufficient allegations to support a veil piercing claim under the law of the same two states.  Judge Beaty’s opinion contains an extensive discussion of what Delaware law requires to pierce a corporate veil.  He said in the Richmond case that that the entity alleged to be liable must exercise “complete domination and control” over the alter ego and have "used such control to commit a fraud or injustice."

 

 

On Tuesday, the Court of Appeals affirmed the Business Court’s award of summary judgment against a shareholder of three private corporations in High Point Bank & Trust Co. v. Sapona Manufacturing, Inc.  We wrote about the Business Court’s ruling last year, but here’s the quick recap:  The estate of a woman who was the daughter and granddaughter of the founders of three family-originated corporations in Randolph County sued those businesses seeking the redemption of over $3.6 million worth of stock. 

The estate asserted a Meiselman claim, seeking dissolution on the grounds that the decedent had a reasonable expectation that her shares would be repurchased by the corporations upon her death and that the corporations had frustrated that expectation by refusing to redeem the shares.  Judge Tennille dismissed her claim on the grounds that the expectation, even if subjectively held by the decedent, was not held by all of the other shareholders and that her expectation was therefore unreasonable.

The Court of Appeals affirmed Judge Tennille’s opinion in all material respects.  The insufficient evidence of a shared understanding and expectation of a right of redemption consisted of the repurchase of one shareholder’s stock after his death in 1997, two corporations issuing a tender offer in 1997, and one corporation issuing another tender offer in 2000.  Rather than establishing an expectation of repurchase, this evidence "establish[es] a precedent that the corporation will ‘from time to time’ offer to purchase shares up to a certain amount and at a specified price."

In a footnote, the Court noted Judge Tennille’s analysis that there is a theoretical limit on the size of a corporation that can still be liable under Meiselman.  (In contrast to certain lending houses that were "too big to fail," these corporations would be "too big for plaintiffs to succeed").  Although the Court of Appeals did not really take a position on this part of the Business Court’s analysis, the size and breadth of the ownership base is relevant to several factors:  the likelihood of antagonistic relationships with and dominance by a single majority shareholder; the number of other shareholders whose own expectations would need to mirror the plaintiff’s in order for her to prevail; and the equity of dissolution toward shareholders who don’t play a role in the oppressive conduct.  These factors become nearly impossible for shareholder plaintiffs to satisfy once ownership is spread beyond more than a handful of people.

Full Opinion

We all sometimes say things that we are sorry to have said.  Even judges. Those types of statements by a District Court Judge in South Carolina, which the Fourth Circuit called "neither wise nor temperate" were the subject of a recusal motion ruled on last week by the Fourth Circuit, in Belue v. Aegon USA, Inc.   The Court also discussed the circumstances under which a pro hac vice admission can be withdrawn, taking issue with the trial judge’s revocation of that status.

The comments by Judge Anderson of the District of South Carolina were made in connection with a hearing in a  class action matter.  He criticized a related settlement in another jurisdiction as possibly being one "of those buddy settlements  we have to watch out for."  He was also critical of the defendants’ approach in another case and suggested that the settlement in that case had been "improper."

This prompted the defendants’ lawyers to file a motion to recuse Judge Anderson pursuant to 28 U.S.C. sec. 455 (b)(1), which requires recusal when a judge "has a personal bias or prejudice concerning a party, or personal knowledge of disputed evidentiary facts concerning the proceeding."

The Judge’s reaction to the motion to recuse was fiery.  He said it was the defense counsel’s reaction to negative rulings, saying "you lose the case and attack the judge."  He called the request for recusal "the most inappropriate motion in the world."

Judge Wilkinson, writing for the Fourth Circuit, said that recusals based on in-trial conduct generally involved "singular and startling facts."  He noted that the Supreme Court has said that the bias should stem from a source outside of the judicial proceeding, usually requiring an "extrajudicial source." 

The Fourth Circuit called the recusal motion "decidedly ill founded."  Judge Wilkinson said that "strong views" expressed by a judge about a case were not grounds for recusal, stating that:

Litigation is often a contentious business, and tempers often flare. But to argue that judges must desist from forming strong views about a case is to blink the reality that judicial decisions inescapably require judgment. Dissatisfaction with  a judge’s views on the merits of a case may present ample grounds for appeal, but it rarely — if ever — presents a basis for recusal.

Op. p.15. 

The opinion expresses a general disfavor of recusal motions, saying that they should not "become a form of brushback pitch for litigants to hurl at judges who do not rule in their favor," and that "no appellate court can afford to leave trial judges prey to a slew of groundless calls for recusal from litigants whose major objection to those judges appears to be a perceived disagreement with them."

Continue Reading The Fourth Circuit On Recusals And Pro Hac Vice Admissions

The Business Court yesterday sifted through cross motions for summary judgment brought by the seller and buyer of a business selling "power protection devices used primarily to control power surges and to provide power filtration in high volume office equipment." Op. ¶12.  The case turned on the application of New York law, which the APA had specified as the governing law, and the Order left a number of claims for trial.

The principal breach of warranty claimed by the buyer in KLATMW, Inc. v. Electronic Systems Protection, Inc., 2011 NCBC12, concerned the stability of the seller’s customer base.  Section 3.18 contained the following language:

none of the customers . . . required to be listed on Schedule 3.18 has cancelled, terminated or otherwise materially altered (including any material reduction in the rate or amount of sales or purchases or material increase in the prices charged or paid, as the case may be) or notified the Business of any intention to do any of the foregoing.

The seller had a significant customer, Global, that was in the process of being acquired by Xerox at the time the APA was signed.  There was some evidence that the seller should have expected a decline in the sales to Global as a result of Xerox’s historical lack of interest in the seller’s product, and Global was in fact listed on Schedule 3.18 as a customer whose sales volume "appears to be diminishing" as a result of Xerox’ acquisition of Global.  As things developed, the Global business declined by more than $2 million in the year following the purchase. Op.¶46.

The buyer made claims following the closing for breach of warranty and for fraud.  Its claims included breaches of warranty other than of section 3.18.  The claims were to be resolved per New York law, as the Court ruled in a 2010 Order.  As Judge Gale explained in yesterday’s opinion, New York law made a difference in the resolution of the case, both as to the buyer’s obligation to prove reliance on the warranty, and the circumstances under which the buyer might be found to have waived the warranty.

In New York, reliance is an element of a breach of contract claim, but reliance is established "so long as a buyer demonstrates that the warranty is a part of the basis of the parties’ bargain." Op. ¶ 5.  And waiver is proved only based on information provided by the seller to the point of knowledge on the part of the buyer of a breach of the warranty at the time of the closing.  Knowledge obtained from sources other than the seller, such as information commonly known, is irrelevant to waiver. 

Judge Gale did an admirable summary of ten years of  New York law on the questions of breach of warranty, reliance, and waiver. Op. ¶¶59-64  After this analysis, he found that there were questions of fact as to the buyer’s level of knowledge regarding the impending decline of the Global business.

Judge Gale dismissed the tort claims on the ground that the buyer could not show reasonable reliance on the misrepresentations it claimed with respect to Global’s status as a customer.  That finding stemmed in part from the buyer’s independent and extensive due diligence through a business broker which directly  contacted Global representatives about Xerox’s intentions.  He also dismissed a Chapter 75 claim because "the contract claims are adequate to provide the remedies [the buyer] seeks if those claims can be proven."  Op. ¶90

There’s a whole lot more to the facts of this case and to the claims made by the parties than are mentioned in this post.  Those especially interested in New York law should read the opinion.

And if you are just exhausted by now from reading this drudgy post you might want to look at the best blog in the Sperling family.  It’s written by my younger daughter, Maddie,  who is on a semester abroad in Argentina.  She is having a good time and she is often hilarious.  Great pictures too.  Check it out.

 

 

 

 

 

The Fourth Circuit on Thursday sided with a franchisor in its efforts to recover prospective damages under North Carolina law, including lost profits, from a franchisee which it had terminated.  Franchisors seeking such damages should find joy in Meineke Car Care Centers, Inc. v. RLB Holdings, LLC,  in which the Court said it was not necessary for the franchise agreement to speak to the possibility of the recovery of prospective damages.

The opinion also resolves what appears to be a burning issue for franchisors: whether they can recover lost profits if it is the franchisor which takes the step of terminating the franchisee as a result of the franchisee’s breach of the franchise agreement.  The Fourth Circuit discussed a variety of approaches to the recovery of damages in such circumstances, but found the answer in this case "in the relevant North Carolina law concerning damages recoverable following a breach of contract."

RLB claimed that its shops weren’t "commercially feasible" to operate, but the Court said that Meineke didn’t need to show that the shops could have been profitable, but only that they would have generated revenues upon which royalty payments would have been based. 

The Fourth Circuit also found acceptable Meineke’s method of calculation of its lost profits, which the franchisor based on the average weekly sales of the shops multiplied by the number of weeks in the three year period for which it sought relief times the average historical royalty rate paid to Meineke.  The district court had said this formula was speculative, but the appellate court disagreed.  It said that "using past profits as a basis for calculating future lost profits is a widely accepted methodology."

The franchise agreements didn’t mention the possibility of the recovery of lost profits, but the Fourth Circuit did not find that to be necessary.  It ruled that lost profit damages were "reasonably supposed to have been within the contemplation of the parties," and that an express written agreement was therefore not required.  The district court had entered summary judgment for the franchisee on this point, but the Fourth Circuit remanded the case for further proceedings.

The Court ended its opinion by discussing Meineke’s obligation to mitigate its damages.  The trial judge had held that Meineke’s failure to mitigate barred it from any recovery.  The Fourth Circuit held that if there had been a failure to mitigate it only served as a limitation of the damages that might be recovered, not a complete bar.  The Court accepted Meineke’s argument that its decision to limit its recovery to a three year period of lost profits rather than the longer remaining term of each of the franchise agreements could serve as the needed mitigation by Meineke.

The upshot of the Court’s decision is that it found issues of fact that should have prevented the trial court’s entry of summary judgment in favor of the franchisee.  Meineke still has to prove its damages.

 

 So much of discovery depends on agreement: for example, where and when will the officers of an out of state corporate defendant appear for their depositions.  And what about an out of country defendant?  Can you make their representatives appear in the United States for a deposition if you can’t persuade opposing counsel to do so?  There was no North Carolina state court authority on this point until yesterday, when Judge Jolly ordered in Cheatham v. Ribonomics, Inc., that the president and CEO of a Japanese company (MBL) which had invested in a North Carolina entity (Ribonomics) would be required to appear for a deposition in one of the 48 continental United States, the state to be  agreed upon by all counsel.

Before making that ruling, the Court denied Plaintiff’s request for a video deposition   He based that denial on "notions of international comity and foreign sovereignty" as protected by the Hague Convention.  Since the witness would have been on Japanese soil for a video deposition, Judge Jolly observed that Japan’s territorial sovereignty would be implicated.    The defendants said that Japanese law prohibits the taking of video depositions.

The same concerns for comity and sovereignty are not present when a foreign national’s deposition is taken in the U.S.  From there, it becomes a question whether the Court has jurisdiction over the defendant corporation.  Because of MBL’s controlling interest in Ribonomics, the Court found that MBL was subject to personal jurisdiction, and that it therefore could be "compelled under Rule 30(b)(6) to produce its officers, directors or managing agents in the United States to give deposition testimony."

Judge Jolly concluded his Order by directing counsel to agree on the "time, place, date and mechanics" of an in-person  deposition to take place "in any one of the States of the United States, other than Hawaii and Alaska."

In one of his final actions as a Business Court Judge, Judge Tennille threw down the gauntlet for lawyers representing class action plaintiffs who are seeking approval of settlements.  Last week in Ward v. Lance, Inc., Judge Tennille condemned what he called "stinky fees," which he said "just smell bad and have no economic justification."

Stinky fees, from Judge Tennille’s observation, are paid because "[w]e have come to the point in this country that whenever a merger is announced, some lawyer with a client holding a small number of shares rushes to file a lawsuit containing class action allegations."

But it wasn’t just the plaintiffs’ lawyers who got a lashing from Judge Tennille.  He included the lawyers defending these cases, the investment bankers who arrange the deals, and also the companies engaging in the transactions.  Here’s what he said:

For their part, defense lawyers, investment bankers, and the companies are willing to pay these fees to get the deal done, regardless of the merits. Defense lawyers get paid to handle them. The fees are not significant in light of the amounts involved in the deal. Defendants are, in effect, complicit in the economically valueless charade. Our overburdened courts do not have the time or adequate information to review the settlements. If we continue to impose these unnecessary financial burdens of our legal system on financial transactions, these transactions will eventually move to London, Hong Kong, or Munich, or some other venue outside the United States. . . .The Court suspects that investment bankers bake that fee into the anticipated costs of the transaction.

In a non-binding request to judges hearing fee petitions in future cases, Judge Tennille said
Ihat they "should decline to approve any settlement that does not benefit shareholders in a material way." 

There’s no way to tell if that request will be followed, but there are multiple cases pending which challenge the Duke Energy-Progress Energy merger.  In the absence of a material benefit to shareholders of those companies from the cases, it might be a good time for the Business Court to take a stand against what Judge Tennille called "an economically valueless charade."

 

The Court of Appeals on Tuesday of last week, in Speedway Motorsports Int’l Ltd. v. Bronwen Energy Trading, Ltd., unwound a year old decision by the Business Court. In that decision, Judge Diaz had ruled that a Defendant bank which had issued a letter of credit was bound to litigate in Switzerland a crossclaim involving the letter of credit. The judge dismissed the claims against the Bank, relying on a choice of forum clause specifying that litigation would take place in Geneva.  The forum selection clause was contained in a secondary guarantee of amounts drawn on the letter of credit, a guarantee to which the Bank was not a party.

The Business Court had found the third party claims to be closely related to the letter of credit transactions that were at issue and therefore subject to the Swiss forum selection clause.  Judge Diaz based his decision partly on cases where a non-signatory to an arbitration agreement was held to be obligated to arbitrate.

The Court of Appeals went off in an entirely different direction, referencing its 1981 decision in Sunset Invs.,  Ltd. v. Sargent, 52 N.C. App. 284, 278 S.E.2d 558, disc rev. denied, 303 N.C. 550, 281 S.E.2d 401 (1981).  In Sunset, the Court said that the "one bright star" in letter of credit transactions was that "every letter of credit involves separate and distinct contracts."

This "basic principle" is known as the "independence principle" or the "autonomy principle."

The Court of Appeals said that it was "unwilling to risk undermining letter of credit transactions."  It said that given the need for certainty and speed of payment under letters of credit, "it is important that the law not carry into letter of credit transactions rules that properly apply only to secondary guarantees or to other forms of engagement."

The same principle led to another opinion in the same case issued the same day in which the Court of Appeals ruled that there was no personal jurisdiction over the letter of credit issuer in spite of its "incorporation by reference" of the document containing the forum selection clause.  So the Bank still prevailed on its jurisdiction-based motion to dismiss.  It didn’t have to defend the claim against it in North Carolina.

So, it seems clear that to draft a forum selection clause binding the issuer of a letter of credit, the drafter must make the clause part of the letter of credit itself.

The Business Court spanked the Department  of Revenue again last week, just after a ruling two weeks ago when it said in another case that the DOR’s position was "harsh, and potentially fatal. . . ."  This time, in Delhaize America, Inc. v. Lay, 2011 NCBC 2, Judge Tennille ruled that the attempted imposition of a $1 million tax penalty by the DOR not only violated the taxpayer’s due process rights, but also a provision of the state Constitution which requires the power of taxation to be exercised in "a just and equitable manner." 

Delhaize, the North Carolina operator of Food Lion grocery stores, was audited by the DOR after it restructured its operations by placing its trademarks, trade names, service marks, and other assets in an out of state subsidiary named Food Lion Florida (FLFL).  Delhaize paid royalties and fees to FLFL, and those were repaid to Delhaize in the form of non- taxable dividends. This resulted in "income distortions," Op. ¶23, and the payment of less tax by Delhaize

Given the North Carolina statute saying that a corporation "shall not file a consolidated return" (N.C. Gen. Stat §105-130.14), and the lack of clear guidelines to taxpayers about when a combined return might be accepted, the penalty was ruled to be unconstitutional.  Judge Tennille said on the due process issue that taxpayers were individuals with a property interest who "must receive notice and an opportunity to be heard before the government may deprive them of their property." Op. ¶73.  The guidelines for when a combined return would be allowed were, as the Court put it, "so elusive" that "ordinary taxpayers ‘exercising ordinary common sense’ [could not] sufficiently understand or predict when a penalty will be assessed." Op. ¶75.

As for the penalty running afoul of the the North Carolina Constitution’s requirement that it be "just and equitable," Judge Tennille held:

When a corporation is charged a significant penalty for complying with the law, the result of which is an automatic, non-negligence, punitive penalty assessed by the Department of Revenue, the state’s power of taxation is being exercised in a manner that is unjust and inequitable.

 Op. ¶87. It was constitutionally unjust to allow this penalty without published guidelines as to when the penalty was warranted. 

Judge Tennille also found distasteful the DOR’s program, operated before the amendment of the penalty statute, by which it offered amnesty to corporate taxpayers which had engaged in restructurings.  It agreed in those negotiations to waive the 25% penalty in exchange for the payment of the lost tax revenue.  This resulted in collection of an additional $300 million in tax.  Judge Tennille referred to the threat of a penalty in this program as "deft use" by the DOR of "a club." Op. ¶77.

I have been puzzling for the last three days on what to write about the Business Court’s first opinion of the year, in Technocomm Business Systems, Inc. v. North Carolina Department of Revenue, 2011 NCBC 1.  It involves an opinion about the sales and use tax and whether the taxpayer (Technocomm) was entitled to a refund.

You might be wondering: what is The Business Court doing writing about sales and use taxes?  The answer is that in 2008, the Business Court became the route of review for tax cases decided in the Office of Administrative Hearings by an Administrative Law Judge.  This was the first opinion from the Court acting in its judicial review capacity in a tax case. 

What standard of review applied?  Since it was a question of law, the standard of review was de novo.  That meant that Judge Tennille could "freely substitute [his] own judgment for the [ALJ’s] judgment." Op. ¶28.  And he did that.

Who won?  The Department of Revenue or the taxpayer? Judge Tennille  reversed the determination by an ALJ and remanded the case for the ALJ to determine the amount of a tax credit due Technocomm which the DOR had refused to allow.  Along the way, he condemned the Department’s position as "harsh at best and potentially fatal at worst." Op. ¶25 

What was the basis for the credit claim?  Technocomm said it was due a credit against use taxes as a result of sales taxes it had collected from its customers in error, and which it had remitted to the DOR. The sales taxes had been collected in connection with service agreements sold by Technocomm simultaneously with the sale of office equipment.  The agreements included parts and supplies estimated by Technocomm to be necessary for it to fulfill its maintenance obligations.

Technocomm had been told by the DOR in 1999 following an audit that it should not collect sales tax on its service agreements.  The Department said that Technocomm should pay a use tax based on the dollar value of the actual parts and supplies used to meet its service obligations.  But Technocomm disregarded that instruction, and continued to charge its customers the estimated sales tax in what it conceded to be "bad business practice." Op. ¶23.

The department and Technocomm were at war over which section of the state tax law applied: section 105-164.41 (titled Excess payments; refunds) or section 105-164.11 (titled excessive and erroneous collections).  After some statutory construction of how to deal with the conflict between a general and specific statute, and the obligatory Latin phrase generalia specialibus non derogant (general words do not derogate from special), the Court applied the more general provisions of 164.41 which says that when excess tax is paid "then the amount in excess shall be credited against any tax . . . then due from the taxpayer."

Now, wait a minute, you might say.  Isn’t Technocomm generating  this credit from money paid by its own customers?  Shouldn’t they, as opposed to Technocomm, get the credit since they provided the dollars that will result in the credit? Judge Tennille covered that point extensively, in Paragraphs 40 through 53 of the Opinion.  The bottom line, as I saw it, was that the service agreements allocated the risks and costs of repair in advance between Technocomm and its customers.  Technocomm carried the risk of having to provide more parts and supplies than it had anticipated and built into the cost of the service agreement.

Part of the cost of that repair risk flows from a human trait observed by Judge Tennille in my favorite part of the Opinion:

Continue Reading The Business Court’s First Opinion in 2011