Tuesday, April 21, 2009, 1:15 PM

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."

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