COA Limits Standing for Partners and Shareholders

Today in Gaskin v. J.S. Procter Co., LLC the NC Court of Appeals (COA) clarified and limited the standing of limited partners (and shareholders) to sue in their individual capacities. In holding that the plaintiffs, who are limited partners, have no standing to sue the general partners and a third party--and that their lawsuit must be dismissed as a consequence--the COA limited the reach of Norman v. Nash Johnson & Sons' Farms, Inc., 537 S.E.2d 248 (N.C. App. 2000), a case often associated with the protection of minority shareholder rights in closely held corporations.

The general rule, of course, is that a limited partner has no standing to sue his fellow partners or third parties in his own name--i.e., in his individual capacity. Such suits generally must be brought on behalf of the partnership. Likewise, generally a shareholder has no standing to sue in his individual capacity.

The Supreme Court, however, has recognized two exceptions to this rule: a partner or shareholder may sue (1) if he alleges "an injury separate and distinct to himself," or (2) his injuries "arise out of a special duty running from the alleged wrongdoer to the plaintiff.” Energy Investors Fund, L.P. v. Metric Constructors, Inc., 525 S.E.2d 441 (N.C. 2000) (limited partnerships); Barger v. McCoy Hillard & Parks, 488 S.E.2d 215 (N.C. 1997) (corporations). These are known as the special injury and special duty exceptions.

At issue in today's case was whether there's a third exception applicable for aggrieved owners of a closely held organization. The confusion was generated by the COA's 9-yr-old Norman decision. Norman purported to recognize an "additional exception to the general rule" for closely held companies, based on the defendants' domination of the company and the resulting powerlessness of the plaintiffs. In today's case, the plaintiffs relied on Norman and argued that their partnership is closely held and that they should be able to maintain the action in their own names and for their own benefit.

But the COA today rejected the notion of a sui generis exception for closely held organizations and in the process substantially narrowed the reach of Norman. The COA reasoned that "this Court could not have and did not create 'an additional exception' in light of the ... holding in Energy Investors, decided only eight months before Norman, that there are only two exceptions to the general rule of partner standing to bring an individual action." (Emphasis in original) The COA today said that Norman isn't reasonably read as having established a third exception since the judgment in Norman--finding that the plaintiff had standing--was actually based on one of the two established exceptions: the "special duty" exception. Thus, the COA held today, Norman doesn't establish a third exception. Instead, "Norman's extensive discussion of the closely held nature of the company and the powerlessness of the minority shareholders offers tools for a careful examination of the particular facts of a case to determine if a special duty or distinct injury exists . . . rather than 'an additional exception.'" The COA then held that the plaintiffs failed to meet either the special duty or the special injury exception.

As for special duty, although the limited partnership at issue in today's case is closely held in nature, the COA held that the facts of this case don't resemble Norman's. The plaintiffs didn't establish that they comprise a minority or are powerless to withdraw from the entity or to participate in any recovery from the lawsuit. The COA emphasized that the plaintiffs collectively own 90% of the partnership; that the complaint didn't establish that the defendants, as the general partners, control the equivalent of a "board of directors"; and that while the partnership agreement forbids the limited partners from withdrawing, it also gives them the right to convert their limited partnership interests into general partnership interests, enabling them to participate in management or to withdraw under certain conditions. The COA also noted that the plaintiffs and defendants aren't in a family business, which is a type of business where close relationships often break down. In short, the COA signaled that unless the plaintiffs in a closely held organization can establish that they're a powerless and captive minority who effectively won't be able to share in any recovery by the partnership, they can't use Norman to squeeze within the special duty exception.

The COA also held that plaintiffs failed to allege a special injury. On this issue, plaintiffs relied on this paragraph from Norman: "We also believe that plaintiffs have sufficiently alleged that they have suffered an injury 'separate and distinct' from the injury sustained by the other shareholders or the corporation itself. Plaintiffs have alleged in great detail acts of the individual defendants and the business entities they control to divert assets and business opportunities from the Company to the business defendants (and thereby to the individual defendants) and thus enrich themselves at the expense of the Company and the plaintiffs. The gist of plaintiffs' allegations is that they have suffered substantial financial losses as the result of the defendants' actions, while the defendantshave obviously profited from those same wrongful acts." Norman, 537 S.E.2d at 260-61. The COA today, however, held that "the above-quoted statement is non-binding dicta unnecessary to the disposition" of Norman. The key to special injury, the COA emphasized today, is whether the plaintiffs suffer a type of unique injury distinct from that sustained by all other limited partners and the partnership itself. The plaintiffs failed to meet that test.

The COA also raised concerns that are present in many if not most direct actions brought by shareholders and partners: the risk of creditor prejudice and the possibility of multiple lawsuits. The COA was concerned that the partnership's creditors could be prejudiced if the suit went forward and plaintiffs recovered personally instead of the partnership recovering, and the COA essentially put the onus on the plaintiffs to overcome the presumption of creditor prejudice: "There is no evidence in the record," the COA said, "which tends to show that creditors of the partnership would not be prejudiced if the lawsuit went forward and resulted in recovery by plaintiffs rather than the partnership. To the contrary, the complaint alleges that the partnership is in 'dire financial condition' and in default on its obligations, implying that creditors of the partnership might go unpaid if plaintiffs received the benefit of any judgment against the general partners of the partnership." The COA also noted the "danger of multiple lawsuits" since "the partnership and two partners who hold ten percent (10%) of the limited partnership shares are not parties to the lawsuit."

COA Outlines Duties Members Of An LLC Owe To the LLC And Its Other Members

Today the COA held that members of an LLC, in general, only owe duties to the corporation and not its members. The case is Kaplan v. O.K. Technologies.

This case involved a corporate dissolution of a closely-held LLC, O.K. O.K. One of the disputes in dissolution was how the LLC should pay back loans made by one of the members (Kaplan). The primary issue was whether Kaplan violated his fiduciary duties to the other members by taking out the loans. The two other members argued that Kaplan's fiduciary duties to them arose from the following: (1) Kaplan's role as a member-manager of O.K.; (2) Kaplan's control over the company's finances and operations; and (3) Kaplan's role as a member in a closely-held LLC.

The COA first held that Kaplan only owed a fiduciary duty to the LLC and not to the individual members because managing members only owe a duty to the corporation. (O.K.'s operating agreement said all members were also managers.)

The COA also held that Kaplan's financing of the LLC did not rise to the level of dominion and control over the other members required to establish a fiduciary duty. The other members accepted Kaplan's loans and used them to discharge O.K.'s costs and obligations, including payment of their salaries and reimbursement of their expenses. Further, O.K.'s operating agreement provided that the vote of the majority controlled management decisions, and the other members exerted their power in this regard by voting on a repayment plan for the loans.

Finally, the COA held that Kaplan did not owe the other members a fiduciary duty based on the sole fact that O.K. was a closely-held LLC, rejecting the other members' argument that the relationship between members of a closely-held LLC is like the fiduciary relationship between partners in a partnership. The COA noted that O.K.'s operating agreement provided that no member would be liable to another for any damage stemming from breach of duty, negligence, or error judgment. The COA held that even if Kaplan had breached his duties under the operating agreement, his liability would extend only to the company, not to the other members.

Today's COA Decisions

The NC Court of Appeals released 16 published opinions today. Nine are criminal cases. There's only one dissent (in a criminal case). More on these cases later.

4th Circuit Holds That Investigatory And Remedial Expenses May Be Recovered As "Economic Damages" In CFAA Unauthorized Access Cases

Today the Fourth Circuit in A.V. v. iParadigms, LLC held that a claimant bringing a civil action under the federal Computer Fraud and Abuse Act (CFAA), 18 U.S.C. 1030(g), for unauthorized computer access may recover consequential damages such as investigatory and remedial expenses.

The CFAA, originally enacted as a criminal anti-hacking statute, proscribes various acts, one of which is "intentionally access[ing] a protected computer without authorization" where the unauthorized access causes damage. In order to establish a violation of that rule, however, the CFAA requires a certain type of harm. The access has to cause either a modification of medical records, physical injury to a person, a threat to public safety or health, or damage a government computer system. Failing that, the access has to cause "loss to 1 or more persons during any 1-year period . . . aggregating at least $5,000 in value." In a civil action for unauthorized access, moreover, the CFAA imposes this limit: when damages are sought only for a violation of the unauthorized access rule, damages "are limited to economic damages."

In today's case the claimant didn't have economic damages (e.g., lost or misappropriated trade secrets; damaged hardware or software). Rather, the claimant had out of pocket losses (consequential damages) incurred in responding to the unauthorized access, namely investigatory and remedial costs. The district court concluded that consequential damages don't count as "economic damages," and therefore the court rejected the CFAA claim on summary judgment.

The Fourth Circuit reversed on the ground that the district court construed "economic damages" too narrowly. The Fourth Circuit held that "economic damages" encompasses expenses incurred as part of the response to a CFAA violation, to investigate the offense and to remediate the intrusion. These types of expenses may include fees charged or labor costs incurred by computer forensics and IT personnel.

4th Circuit Issues Pro-Creditor Ruling On Bankruptcy Code's Elusive "Hanging Paragraph"

Today in In re Price the Fourth Circuit issued a significant ruling on the "hanging paragraph" in Chapter 13 of the Bankruptcy Code (11 U.S.C. § 1325(a)). The Fourth Circuit decided how to apply the hanging paragraph to a secured claim when a portion of the claim relates to the financing of negative equity -- which, in a car transaction, refers to the difference between the value of the trade-in vehicle and the amount of the buyer’s preexisting debt on that trade-in.

The Fourth Circuit ruled for the creditor, Wells Fargo, holding that the hanging paragraph gives a creditor a purchase money security interest in the portion of a car loan that relates to negative equity on the trade-in vehicle. This was a significant issue on which other courts have split.

The Fourth Circuit relied on state law to interpret "purchase money security interest" in the hanging paragraph (i.e., UCC Article 9). And the Court was moved by, among other things, the fact that negative equity financing is integral to the debtor’s acquisition of a new car, as well as Congress’s intent to protect secured car lenders from having their claims bifurcated in Chapter 13.

COA: Venue Not Proper In County Where Government Official "Charged With Carrying Out Duties"

Today the COA held that where a public official is a party to an action, venue is proper where the cause of action arose and not where the official is "charged" with his or her duties. The case is Ford v. Paddock.

In this highly-publicized case, a four-year-old child was killed by his adoptive mother. The child's biological father filed a wrongful death suit in Johnston County against both adoptive parents, Wake County Human Services and some of its employees, and the Children's Home Society of North Carolina.

The COA affirmed the denial of defendants' motion to transfer venue to Wake County. The Court first noted that a denial of such a motion affects a substantial right, so review of the interlocutory appeal was proper. The Court reasoned that under N.C. Gen. Stat. § 1-77, an action against a public officer for acts performed in his or her official capacity “must be tried in the county where the cause, or some part thereof, arose," and that venue was proper in Johnston County because the events surrounding the adoption, mistreatment, and death of the child occurred there. Defendants argued that venue was only proper in Wake County because their decision-making authority was derived from that county and they were "charged" with their duties there. The Court held that the county where a public official's duties originate does not meet the definition of appropriate venue set out in N.C. Gen. Stat. § 1-77.

COA: Lack of Reasonable Reliance Defeats Actual Reliance Element Required for UDTP Claim

Today the COA held that lack of reasonable reliance on a misrepresentation defeated the element of actual reliance required for an unfair and deceptive trade practices (UDTP) claim based on the misrepresentation. The case is Sunset Beach Development v. Amec Inc.

Sunset Beach Development bought a parcel of land on which it planned to build a residential development. In order to build the development the parcel could only contain a certain percentage of wetlands. The parcel's seller, GGSH Associates (GGSH), had hired an engineer named Ball to conduct a wetlands assessment of the GGSH tract. Ball told GGSH that the tract contained twenty-five acres of wetlands. The contract of sale for the tract contained certain environmental warranties in which GGSH represented that "[t]here are no known violations of environmental laws on or which have occurred with respect to the [tract.]" The contract of sale also stated that Plaintiff's obligation to close on the sale was contingent on GGSH's providing Plaintiff with a wetlands delineation approved by the Army Corps of Engineers.

Plaintiff's engineering firm and one of its majority members expressed some uncertainty about Ball's wetlands delineations. Plaintiff obtained a master wetlands map from Ball and proceeded to drain the wetlands on the tract. Plaintiff later received a letter from the Army Corps of Engineers stating that it never received a verified wetlands delineation from Ball, and that if Plaintiff didn't produce one within 10 days the wetlands Plaintiff had drained on the parcel had to be restored to their prior condition. Plaintiff sued GGSH, Ball, and others for breach of contract, fraud, and unfair and deceptive trade practices (UDTP).

The COA held that summary judgment was properly granted with regard to the fraud and unfair and deceptive trade practices claims. Plaintiff's claim that GGSH and Ball committed fraud by misrepresenting the extent of wetlands on the tract failed because Plaintiff "chose to purchase the GGSH tract despite clear deficiencies in the wetlands delineations and the Master Wetlands Map," and because Plaintiff had ample opportunity to inspect the property before purchasing it. Thus, the COA concluded, Plaintiff 's reliance on any representations about the wetlands was not reasonable. The COA further held that an UDTP claim based on a misrepresentation requires actual reliance on the misrepresentation, and the lack of reasonable reliance also defeated the UDTP's actual reliance requirement.

COA Considers Factors Determining Timeliness of Motion for Relief From Judgment

Today the COA held that a Rule 60(b) motion for relief from judgment's timeliness is determined in part by "extraordinary circumstances" surrounding the judgment. The case is Sharyn's Jewelers v. Ipayment, Inc.

In this case, Sharyn's took telephone orders and charged them to the same credit card for about three months. Despite Sharyn's inquiries on the validity of a credit card, iPayment continued to make charges to that card and kept drawing processing fees for the transactions from Sharyn's account. Sharyn's was finally notified that the card had been reported stolen. As a result of the fraudulent transactions, Sharyn's credit card machine was "frozen" and it could no longer take credit card payments. Sharyn's sued Ipayment, Vericomm, and JPMorgan for fraud, unfair and deceptive trade practices, and negligent misrepresentation. Only JPMorgan entered a responsive pleading, and the trial court entered a default judgment against iPayment and Vericomm and awarded Sharyn attorneys' fees and punitive damages against both, jointly and severally.

The COA held that the unfair and deceptive trade practices claims against Vericomm had been awarded in excess of the relief supported by the allegations, because the Complaint only stated claims for relief from Vericomm on theories of breach of contract and negligent misrepresentation. The COA vacated the part of the default judgment imposing liability on Vericomm for punitive damages, attorneys' fees, and injunctive relief.

The COA further held that the timeliness for filing a motion for relief from a judgment is determined by the facts and circumstances surrounding each judgment. Even though Ipayment and Vericomm filed their motion seventeen months after entry of the default judgment, in this case the "extraordinary circumstances" of the excess judgment warranted the consideration of Vericomm's motion for relief from the default judgment. Judge Hunter wrote a separate concurrence to note that he believed the timeliness of such a motion should be determined from the time the defendant received notice of the judgment awarding excess relief.

COA Invalidates Non-Compete

Today the NC Court of Appeals (COA) held a non-compete agreement unenforceable because it wasn't reasonably tailored to protecting the employer's legitimate business interests. The case is Hejl v. Hood, Hargett & Assoc., Inc.

Hejl was an account rep for insurance services. Fourteen years after Hejl started working for HHA, HHA had him sign a 2-year non-compete agreement. For new consideration, HHA paid, and Hejl accepted, $500.00. Hejl persuaded the trial court that $500 was not adequate and valuable consideration for the obligation. The COA disagreed and held, "Our Courts have not evaluated the adequacy of the consideration. Rather, the parties to a contract are the judges of the adequacy of the consideration." The COA reiterated that the "slightest consideration is sufficient to support the most onerous obligation" absent fraud.

But the COA upheld the trial court's determination that the agreement was overbroad and not reasonably tailored to protecting HHA's legitimate business interests. First, the territory was too broad. The agreement defined the territory as Charlotte and any other place in North or South Carolina in which HHA "is engaged in rendering its services or selling its products." This two-state territory wasn't limited to locations where Hejl had customers at HHA; it included areas where he didn't have any personal knowledge of HHA's customers. Second, the agreement prevented Hejl from offering insurance services to "any person, firm or entity to whom [HHA] has sold any product or service, or quoted any product or service." (emphasis added). The restrictive covenant thus went beyond current and former customers of HHA and reached anyone to whom HHA had merely quoted a product or service. The COA held that HHA didn't have a legitimate business interest in extending the restriction to potential clients.

Today's COA Decisions

Today the NC Court of Appeals released 38 published opinions. Ten are criminal cases. Five are domestic cases. There appears to be only one dissent--the first dissenting opinion of new appellate Judge Beasley (in a domestic case). There don't seem to be a lot of noteworthy cases in this mix. More on these cases later.

4th Circuit Overturns Rule 11 Sanctions Against FEMA Attorney

Yesterday in In re: Bees the Fourth Circuit held that a S.C. district judge abused her discretion in entering Rule 11 sanctions against a FEMA attorney. Even though the FEMA attorney submitted a misleading declaration, made a misleading statement in a brief, and made misleading comments at a motions hearing, the Fourth Circuit's per curiam opinion held that sanctions shouldn't have been entered. With respect to the attorney's statement at the hearing, the Fourth Circuit held that an attorney's oral statement can't be the basis for Rule 11 sanctions unless the the statement advocates a contention previously contained within a written submission. As for the misleading statements in the written submissions, it's unusual for an appellate court to find an abuse of discretion under these circumstances, but that's what what happened yesterday.

The sanctions in this case were pretty harsh. The district court (1) directed the clerk to withdraw the attorney's appearance in the case, (2) instructed the attorney to affix a copy of the sanction order to all future submissions she filed in the D.S.C., (3) stated that any future applications made by the attorney before that particular judge would be summarily denied, (4) ordered the attorney to complete CLE courses in ethics, and (5) directed the attorney to provide a copy of the sanctions order and a transcript of the underlying motions hearing to the disciplinary board for her state bar. The district court also instructed FEMA and the U.S. Attorney’s Office to circulate the sanctions order to all attorneys within their respective offices and to address the matter in CLE efforts.

The attorney must be relieved to have escaped these sanctions.

4th Circuit Lets First Amendment Case Go Forward Against Baltimore Police

Today, in Andrew v. Clark, the Fourth Circuit reversed the 12(b)(6) dismissal of a First Amendment suit brought by a Baltimore police officer claiming that officials with the Baltimore Police Department (BPD) retaliated against him for providing to the Baltimore Sun an internal memo he had written. The memo called for an investigation to determine if the use of deadly force by a tactical unit of the BPD against a barricaded suspect was justified and properly conducted.

But the most fascinating part of today's decision is the concurring opinion filed by Judge Wilkinson. Judge Wilkinson (former editorial page editor for the Norfolk Virginian-Pilot) used this as an opportunity to decry the fact that investigative journalism has been shortchanged as newspapers have struggled to survive in an age of online media outlets. Here's a bit from his dissent:

"It is well known that the advent of the Internet and the economic downturn have caused traditional news organizations throughout the country to lose circulation and advertising revenue to an unforeseen extent. As a result, the staffs and bureaus of newsgathering organizations—newspapers and television stations alike—have been shuttered or shrunk. Municipal and statehouse coverage in particular has too often been reduced to low-hanging fruit. The in-depth investigative report, so essential to exposure of public malfeasance, may seem a luxury even in the best of economic times, because such reports take time to develop and involve many dry (and commercially unproductive) runs. And in these most difficult of times, not only investigative coverage, but substantive reports on matters of critical public policy are increasingly shortchanged. So, for many reasons and on many fronts, intense scrutiny of the inner workings of massive public bureaucracies charged with major public responsibilities is in deep trouble.

"The verdict is still out on whether the Internet and the online ventures of traditional journalistic enterprises can help fill the void left by less comprehensive print and network coverage of public business. While the Internet has produced information in vast quantities, speedy access to breaking news, more interactive discussion of public affairs and a healthy surfeit of unabashed opinion, much of its content remains derivative and dependent on mainstream media reportage. It likewise remains to be seen whether the web—or other forms of modern media—can replicate the deep sourcing and accumulated insights of the seasoned beat reporter and whether niche publications and proliferating sites and outlets can provide the community focus on governmental shortcomings that professional and independent metropolitan dailies have historically brought to bear.

"There are pros and cons to the changing media landscape, and I do not pretend to know what assets and debits the future media mix will bring. But this I do know—that the First Amendment should never countenance the gamble that informed scrutiny of the workings of government will be left to wither on the vine. That scrutiny is impossible without some assistance from inside sources such as Michael Andrew. Indeed, it may be more important than ever that such sources carry the story to the reporter, because there are, sad to say, fewer shoeleather journalists to ferret the story out. "