There isn’t much out there in the way of a road map from North Carolina’s state courts on how lawyers should fulfill their obligations to produce electronically stored information. So you might want to take notice of a little bit of direction in today’s Order from the Business Court in Hill v. StubHub, Inc.

By a little bit of direction, I mean exactly that.  It’s only this tidbit from the last paragraph of the Order, where Judge Tennille said:

Attached hereto is an opinion from Magistrate Judge Andrew Peak in William A. Gross Construction Association, Inc. v. American Manufacturers Mutual Insurance Company.  It contains a message for counsel. 

What’s the message of American Manufacturers?  Well, that case involved a dispute between parties about how a keyword search of an email database in the hands of a non-party ought to be done.  The parties disagreed on what words ought to be searched for.  One wanted narrow terms, the other broad terms, and no one had bothered to talk to the party that held the emails about what would make sense.

Instead of making any deliberate effort to resolve the issue, the parties dropped the problem in Judge Peck’s lap.  He wasn’t happy about being the decider, noting that he was "no keyword expert."  He said:

This case is just the latest example of lawyers designing keyword searches in the dark, by the seat of the pants, without adequate (indeed, here, apparently without any) discussion with those who wrote the emails.  Prior decisions . . . have warned counsel of this problem, but the message has not gotten through to the Bar in this District.

Judge Peck said he was delivering a "wake-up call to the Bar."  He said that "[i]t is time that the Bar — even those lawyers who did not come of age in the computer era — understand" what it takes to craft an appropriate keyword search.  He stressed the "need for careful thought, quality control, testing, and cooperation with opposing counsel in designing search terms . . . to be used to produce emails or other electronically stored information."

So, that’s the "message" conveyed today by Hill v. StubHub. Judge Tennille told the parties that they had twenty days "to meet and confer and agree upon a word search that is carefully crafted with the appropriate keywords determined after consultation with StubHub’s ESI custodians."  He also ordered the parties to "address quality control and testing in their discussions and, if the volume of documents is excessive, use of appropriate sampling methodologies."

Eighteen new cases were designated to the Business Court during the month of May 2009.  Most are the usual disputes between members, partners, or shareholders of business organizations, but there are a few securities claims and a couple of trade secrets cases as well.

[Update: It’s actually nineteen new cases, I added the Napco case, which I had overlooked, after this post was first published.]

American Acquisition, LLC v. Goldman (Mecklenburg)(Diaz): claims involving dissolution of general partnership, and general partner’s refusal to distribute proceeds from sale of partnership asset based on his position that funds may be necessary to defend against potential claims.

Boone v. American Benefit Concepts, Inc. (Guilford)(Tennille): Claim by investors that defendant brokers violated the North Carolina Securities Act by inducing them to invest in a company later placed into SEC receivership (Diversified Lending Group, Inc.).

Bradley v. Bradley Farms, Inc. (Halifax)(Tennille): shareholder dispute alleging misappropriation of funds, claims for breach of fiduciary duty and dissolution.

Cartridge Limited v. JRiDevelopment Group, LLC (Alamance)(Tennille): defendants, formerly associated with plaintiff, are alleged to have stolen Plaintiff’s technology for use and sale by a competing entity.

Fitte v. Rutter (Guilford)(Tennille):dispute between members of an LLC, plaintiff alleges that he has been improperly excluded from participating in the management of the LLC.

Henderson v. Manuel (Guilford)(Tennille): Claims for breach of fiduciary duty and self-dealing against member and partner in multiple business entities.

Howard Perry & Walston Realty, Inc. v. Campbell (Wake)(Jolly): Allegations of theft of trade secrets and violation of non-compete agreements against former employees of real estate brokerage firm.

InSource Business Strategies, Inc. v. Bell (Iredell)(Diaz): claims that member/manager allegedly failed to provide truthful and accurate information about the financial condition of the Plaintiffs, and improperly obtained investment in the corporation without proper board approval and usurped corporate opportunities.  Also issues of validity of board approval of asset purchase agreement due to deficiencies in notice and lack of quorum.

Mast v. Edward D. Jones & Co. (Johnston)(Jolly) claim against securities broker involving unanticipated tax consequences from rollover of insurance policies.

Napco, Inc. v. PBM Graphics, Inc. (Alleghany)(Diaz): alleged misappropriation of trade secrets involving process for manufacture of sports memorabilia cards, breach of confidentiality agreement.

Pineway Partners, LLC v. Holt Asia, LLC (Alamance)(Tennille): claims for wrongful dissolution of an LLC and breach of fiduciary duty.

Port City Java, Inc. v. Reynolds and Sutton v. Reynolds (New Hanover)(Jolly): interpretation of shareholders’ agreement, counterclaims regarding breach of fiduciary duty and violation of the Stored Communications Act and the North Carolina Computer Crimes Act.

Queen City Television Services Co. v. Player (Mecklenburg)(Tennille): the Third Party Complaint seeks dissolution of a corporation based on alleged breaches of fiduciary duty.

St. George Technology, Inc. v. Watkins (New Hanover)(Jolly): alleged diversions of funds by former president of company, claims for breach of fiduciary duty, fraud, NC RICO, and unfair and deceptive practices.  Defendant claims he was released from such claims when Plaintiff purchased his stock in the company.

Tai Sports, Inc. v. Hall (Gaston)(Diaz):Claim by sports apparel company for injunctive relief to "freeze" corporate assets or appoint receivers, for accounting, for declaratory judgment concerning the ownership, use and possession of corporate assets, and for breach of cororate fiduciary duties.

Tedder v. Tedder (Dare)(Jolly): shareholder dispute (between brothers) alleging misconduct by shareholder and officer, including claims for conversion, "bogus expense reports," and excess compensation. 

Triad Group, Inc. v. Wachopvia Bank, N.A. (Yadkin)(Tennille): securities claims regarding bonds issued by plaintiff and sold by Wachovia and also claims involving an interest rate swap agreement.

Wefald v. Wake Heart and Vascular Associates, P.A. (Johnston)(Tennille):lawsuit by cardiologist forced out of medical practice, issues whether termination was "for cause" and right of corporation to redeem former employee’s shares.

The Court of Appeals today affirmed a trial court’s ruling that Wal-Mart had been properly assessed more than $30 million in taxes, penalties and interest.  The case is Wal-Mart Stores East, Inc. v. Hinton.

The tax strategy of Wal-Mart rejected by the Court involved the discounter transferring the ownership of its stores to a Delaware Real Estate Investment Trust headquartered in Arkansas.

Wal-Mart paid rent for its North Carolina stores to the REIT, and deducted those payments on its North Carolina tax returns. When the REIT paid out that income to its shareholders – which were other Wal-Mart entities – the REIT didn’t have to pay income tax. That’s because REITs don’t pay income tax so long as they distribute 90% of their income to their shareholders.

The $30 million assessment resulted from the Secretary of Revenue’s disregard of Wal-Mart’s restructuring, and his combination of the earnings of the various Wal-Mart entities involved. That power comes from G.S. §105-130.6, which authorizes him to “require the corporation to file a consolidated return of the entire operations of the parent corporation and its subsidiaries and affiliates,” upon a finding “that a report by a corporation does not disclose the true earnings of the corporation on its business carried on in this State.”

I’ll leave it to those of you who want the details to parse through the opinion, which discusses the construction of the statutory term “true earnings,” the constitutionality of the statute, and the validity of the substantial penalties assessed against Wal-Mart.  But footnote 14 of the opinion is worth a mention if you, like me, don’t rank tax law as one of your favorite subjects.  It’s a quote from Judge Learned Hand:

The words of . . . the Income Tax [Act] . . . merely dance before my eyes in a meaningless procession: cross-reference to cross-reference, exception upon exception couched in abstract terms that offer no handle to seize hold of leave in my mind only a confused sense of some vitally important but successfully concealed, purport.

The Wall Street Journal estimated that Wal-Mart’s tax strategy had saved it $230 million in taxes in dozens of states.
 

If you are working on a motion to dismiss in a federal case, you should stop right now and read the U.S. Supreme Court’s decision today in Ashcroft v. Iqbal.  The decision sharpens and refines the heightened standard for a Rule 12(b)(6) motion articulated by the Court  in Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007).

The decision today makes it clear that Twombly applies to all civil cases, not just antitrust cases, as the Plaintiff in Ashcroft had argued.  It also has an important point on the requirement for pleading intent in discrimination cases.

In Ashcroft, Iqbal, a Muslim, had been arrested and imprisoned following September 11th.  He claimed this was a result of discrimination against him based on his race, religion, and national origin. The Second Circuit had affirmed the denial of the Defendants’ motion to dismiss, but the Supreme Court reversed and dismissed the case.

Here’s the key quote from the opinion, which will undoubtedly be repeated often in Rule 12(b)(6) briefs:

Two working principles underlie our decision in Twombly. First, the tenet that a court must accept as true all of the allegations contained in a complaint is inappli­cable to legal conclusions. Threadbare recitals of the elements of a cause of action, supported by mere conclusory statements, do not suffice. (Although for the purposes of a motion to dismiss we must take all of the factual allegations in the complaint as true, we ‘are not bound to accept as true a legal conclusion couched as a factual allegation’). Rule 8 marks a notable and generous departure from the hyper-technical, code-pleading regime of a prior era, but it does not unlock the doors of discovery for a plaintiff armed with nothing more than conclusions. Second, only a complaint that states a plausible claim for relief survives a motion to dismiss. Determining whether a complaint states a plausible claim for relief will, as the Court of Appeals observed, be a context-specific task that requires the reviewing court to draw on its judicial experience and common sense. But where the well-pleaded facts do not permit the court to infer more than the mere possibility of misconduct, the complaint has alleged — but it has not ‘show[n]’ — that the pleader is entitled to relief.’

The decision also contains a gem for lawyers defending claims of discrimination.  Iqbal’s lawyers had argued, relying on FRCP 9, that that they were entitled to plead "generally" the Defendants’ discriminatory intent.  The Supreme Court majority disagreed:

It is true that Rule 9(b) requires particularity when pleading ‘fraud or mistake,’ while allowing ‘[m]alice, intent, knowledge, and other conditions of a person’s mind [to] be alleged generally.’  But ‘generally’ is a relative term.  In the context of Rule 9, it is to be compared to the particularity requirement applicable to fraud or mistake.  Rule 9 merely excuses a party from pleading discriminatory intent under an elevated pleading standard.  It does not give him license to evade the less rigid — though still operative — strictures of Rule 8.

The Court held that Iqbal’s rote allegation that he had been discriminated against "on account of [his] religion, race, and/or national origin and for no legitimate . . . interest" was insufficient to state a claim.

The Ashcroft decision provoked a vigorous dissent.  Justice Souter (joined by Justices Stevens, Ginsburg, and Breyer) said that a trial judge is bound to accept the allegations of a complaint as true, no matter how skeptical he or she may be.  He went on to say "[t]he sole exception to this rule lies with allegations that are sufficiently fantastic to defy reality as we know it: claims about little green men, or the plaintiff’s recent trip to Pluto, or experiences in time travel.  That is not what we have here."

Oh, if you’re in North Carolina state court, and want to argue the Twombly standard, you are out of luck, at least for now.  The Court of Appeals said late last year in Holleman v. Aiken that it didn’t have the power to adopt Twombly absent a ruling by the North Carolina Supreme Court.

Can you have a default entered against you if you aren’t a proper party to the lawsuit?  The answer is yes, at least on the unique facts before the Business Court in its opinion Friday in the derivative action Regional Property Development Corp. v. Carpenter.

Regional Property, a member of Lancaster Industrial Park, LLC, had filed a derivative action on behalf of the LLC against three other members of Lancaster, and also the lender to the LLC, Regions Bank. 

In a March 25th Order, the Business Court dismissed the derivative claims, ruling that Regional Property wasn’t entitled to sue on behalf of Lancaster because of it hadn’t made a demand on the managers of the LLC to file the suit.  The Court allowed Regional Property leave to amend to assert demand futility.

But right before that ruling, Regions Bank had counterclaimed against Lancaster, asserting that Lancaster was in default on its loan obligations to the Bank.  Lancaster, whose derivative claim had been dismissed by the time the answer deadline had run, didn’t answer.  (Or rather, Regional Property, which had brought the lawsuit, didn’t answer on behalf of the LLC).  Regions Bank then moved for entry of default.

The other defendants, the members who had moved to dismiss the derivative action, objected to the Motion for Entry of Default and said that default was not proper because the LLC wasn’t a party to the litigation.  They said in their Opposition that "Lancaster cannot be in default in this matter for the simple reason that it is not a party."  They also argued that Regions Bank should be estopped from arguing that Lancaster was a party, because it also had taken the position there was no authority for Regional Property to file the lawsuit on behalf of Lancaster.

Judge Diaz entered default over that objection.  He said that once the counterclaims were filed, Lancaster "was bound to respond to the counterclaims or risk default, regardless of whether it should have appeared in the action to begin with."  Also, given that Regional Property had moved after the dismissal of its derivative action to amend the Complaint to excuse its lack of demand, the Court held:

where a party seeks to pursue a claim derivatively on behalf of a limited liability company, the LLC is a necessary party and is normally joined as a defendant. See generally Russell M. Robinson, II, Robinson on North Carolina Corporation Law § 17.05[2] (7th ed. 2008) (citing relevant cases with respect to derivative actions filed on behalf of a corporation). Thus, even if Lancaster now disavows any role in this case as a party-plaintiff, because Regional Property’s Second Amended Complaint asserts derivative claims on Lancaster’s behalf, Lancaster remains a party.

If you are going to fire off a derivative action, you need to be prepared to defend against whatever might get shot back in the way of a counterclaim. 

[Update: The Court set aside this entry of default in an Order dated September 23, 2009, permitting the members of the LLC to adopt after the fact a response to the counterclaims filed by the Plaintiff when it did not have authority to act for the LLC in filing the lawsuit].

The Fourth Circuit this week considered the antics of the Sigma Chi fraternity at George Mason University, and it didn’t like what it saw.  In Iota Xi Chapter of Sigma Chi Fraternity v. Patterson, the Court affirmed the District Court’s dismissal of the fraternity’s lawsuit asserting that its ten year ban from campus had violated its procedural due process and free speech rights.

This post isn’t about the vile and obnoxious conduct of the brothers of Sigma Chi, or why it hadn’t suffered an injury to its reputation by the University saying in its student newspaper that the fraternity had "faciliated sexual assaults." or even why the frat had no standing to pursue its free speech claim.

Instead, I’m writing about the opinion because of how the Fourth Circuit handled the issue of the fraternity’s motion to strike the Defendants’ summary judgment brief in the District Court because it was two pages too long. The University’s brief rambled for 32 pages instead of the 30 allowed by Local Rule.

The District Court had refused to strike the brief.  Instead, it struck only the last two pages.  The fraternity argued that the District Court had no authority to do anything other than strike the entire brief, because the applicable Local Rule said that briefs shall not exceed 30 pages.  It also argued that the trial court couldn’t strike the last two pages because then there would be no signature page on the brief and it then wouldn’t be in compliance with Rule 11.

The Fourth Circuit ruled that the District Court had "acted well within its discretion," and that it "is for courts, not litigants, to decide what rules are desirable and how rigorously to enforce them." Striking the last two pages therefore was an appropriate sanction.

I think a better sanction would be striking the first two pages.  That’s where I put all the good stuff.

The Business Court, relying on the Court of Appeals decision in White v. Thompson, dismissed an unfair and deceptive practices claim brought by an LLC member who claimed that another member and manager had usurped Company opportunities and converted Company assets.  It held that there was no assertion that the defendant’s "actions had any impact in the broader marketplace" and that dismissal was therefore appropriate.

Full Opinion

The Business Court today granted a motion to disqualify counsel for Plaintiffs, finding their prior representation of the Defendants involved a matter "substantially related" to the matters at issue in the lawsuit. 

The law firm representing the Plaintiffs in The Cottages of Stonehenge Condominium Homeowners Association, Inc. v. Dominion Mid-Atlantic Properties II, LLC had been longstanding counsel for the Plaintiff homeowners association.  They had first been retained when Defendant Dominion, the former owner of the property, converted it to a condominium and incorporated the HOA.

The Board of the HOA at that time consisted of representatives appointed by Dominion.  In 2006, the Dominion-controlled Board sought the law firm’s advice about maintenance issues.  The advice was sought on behalf of both the HOA and Dominion.  The lawyers delivered a written opinion letter on "the maintenance responsibilities between the Unit Owners and the Association."

Over a year later, an owner-controlled Board of the HOA was elected.  Issues arose regarding the adequacy of maintenance reserves.  The law firm filed a lawsuit for the HOA against Dominion and the former board members for breaching their fiduciary duty by failing to set adequate reserves for common area and maintenance expenses.

After sifting through the positions of the parties, the Court held:

[h]ere, Defendants find themselves in a position in which the very lawyer who advised one or more of them with respect to duties and obligations relating to budgeting for and maintaining Stonehenge common areas now seeks damages against them for breaching their duty to adequately set aside fiscal reserves for the repair and maintenance of those same common areas.  The court is forced to conclude that the two are inextricably and substantially related.

Judge Jolly granted the Motion to Disqualify, stating that the prior representation presented the "substantial risks contemplated under Rule 1.9" of the North Carolina Rules of Professional Conduct, and that "it is the court’s duty to resolve any and all such risks in favor of disqualification."

The Dairy Queen sign is from tboard’s photostream on Flickr.

Brief in Support of Motion to Disqualify

Brief in Opposition to Motion to Disqualify

The Business Court held today in Armacell v. Bostic that it had personal jurisdiction over an Italian company, L’Isolante, which hired a scientist, Bostic, away from a competitor.

The Plaintiff claimed that the hiring violated Bostic’s non-compete agreement, and that Bostic had also stolen "thousands of data files containing sensitive proprietary information and trade secrets."

The Business Court rejected the argument of L’Isolante that it was not subject to personal jurisdiction, finding that the Italian company had (1) pursued and offered employment to Bostic in North Carolina, (2) had obtained a legal opinion from its North Carolina counsel about the enforceability of Bostic’s non-compete agreement, (3) tasked Bostic with supporting, from North Carolina, L’Isolante’s research and development efforts, (4) worked directly with Bostic in North Carolina after he was hired, and (5) shipped samples of product to North Carolina.

The Court found these contacts to be "direct and strong," and that L’Isolante "had fair warning that these activities might subject it to the jurisdiction of North Carolina."  Judge Tennille also held that "North Carolina’s interest in exercising jurisdiction over L’Isolante is substantial.  This case involves the alleged theft of a large amount of trade secrets from a North Carolina company, with injury felt in North Carolina."

At his deposition, Bostic pled the Fifth Amendment about his alleged theft.  In an earlier opinion, the Business Court drew an adverse inference from Bostic’s refusal to testify, and entered a preliminary injunction.

Brief in Support of Motion to Dismiss

Reply Brief in Support of Motion to Dismiss

The Fourth Circuit Court of Appeals delivered an opus today on whether a mutual fund investment advisor could be primarily liable under the federal securities laws for allegedly misleading statements in prospectuses issued by the mutual funds.

The case, First Derivative Traders v. Janus Capital Group, involves alleged misrepresentations by the Janus family of mutual funds about their position on allowing market timing in the funds. The principal focus was whether the statements in the prospectuses were "sufficiently publicly attributable" to the advisor to make out reliance under a fraud-on-the-market theory of liability.

The Circuit courts have gone off in different directions on this issue, with some (the 2nd and 11th) requiring "direct attribution of the allegedly misleading statement to the defendant," another (the 9th) saying that "substantial participation or intricate involvement in preparing the misleading statement is sufficient," and another (the 10th) with yet another standard.

The Fourth Circuit went its own way today, reversing the District Court’s grant of a motion to dismiss and holding:

for the public attribution element of the reliance inquiry, we hold that a plaintiff seeking to rely on the fraud-on-the-market presumption must ultimately prove that interested investors (and therefore the market at large) would attribute the allegedly misleading statement to the defendant.  At the complaint stage a plaintiff can plead fraud-on-the-market reliance by alleging facts from which a court could plausibly infer that interested investors would have known that the defendant was responsible for the statement at the time it was made, even if the statement on its face is not directly attributed to the defendant.

The conclusion of the Court was that "given the publicly disclosed responsibilities of [the advisor], interested investors would infer that [the advisor] played a role in preparing or approving the content of the Janus fund prospectuses, particularly the content pertaining to the funds’ policies affecting the purchase or sale of shares."

The opinion also discusses loss causation and control person liability.