Current Developments and Firm News
Twice in the past month, the North Carolina Business Court entered preliminary injunctions against LLC members and managers for breaches of fiduciary duty. Both opinions are instructive on the standard necessary to obtain the drastic remedy of preliminary injunctive relief in cases involving alleged violations of fiduciary duties. In both cases, the Business Court found that the party seeking the preliminary injunction demonstrated a likelihood of success on the merits of the claim, and irreparable harm.
The first case was GoRhinoGo, LLC v. Lewis, 2011 NCBC 38, before the Hon. John R. Jolly, Jr. GoRhino operates a tavern in Raleigh. It brought suit against Paul Alexander Lewis, a former LLC member and manager, GoRhino’s landlord and others. GoRhino alleges that Mr. Lewis conspired with the landlord to terminate GoRhino’s lease so the space could be taken over by a new competing entity run owned or controlled by Mr. Lewis and others at the exclusion of GoRhino and its other members.
Judge Jolly granted the preliminary injunction in favor of the plaintiff. Judge Jolly noted that N.C. Gen. Stat. § 57C-3-22 requires “managers of limited liability companies to act ‘in the best interest of the limited liability company.’” Op. ¶ 33. Judge Jolly held that GoRhino was likely to prevail on the merits because the defendants’ acts “constituted a plan to violate the [Mr. Lewis’] fiduciary duties to [GoRhino]; and the plan was implemented using acts that themselves violated that fiduciary duty.” Op. ¶ 33.
GoRhino established irreparable harm because if the conspiring defendants evicted GoRhino to replace it with a competing tavern, “such action effectively would put [the plaintiff] out of business.” Op. ¶ 39. Judge Jolly, quoted a federal case from the Middle District of North Carolina: “In the ordinary case, proof that a going concern will be forced out of business during the pendency of litigation raises a presumption of irreparable harm.” United States v. Any and All Assets of Shane Co., 816 F. Supp. 389, 400 (M.D.N.C. 1991).
The second case was LakeHouse Academy for Girls LLC v. Jennings, 2011 NCBC 40, before Hon. James L. Gale. Lake House is the owner of a residential therapeutic program in Flat Rock for girls between ten and fourteen. The defendant, Ms. Jennings, is a member-manager and a minority interest holder in Lake House. Lake House alleges that Ms. Jennings breached her fiduciary duties to Lake House in the following ways: (1) by engaging in a plan to establish a competing program; (2) by soliciting Lake House’s employees; and (3) disparaging Lake House to its then-current clients and directing them to a website questioning the veracity and competency of Lake House’s staff; and (4) using Lake House’s confidential information, and deleting information from Lake House’s computers. Op. ¶ 39.
Judge Gale held an evidentiary hearing. Based upon Judge Gale’s findings, it appears that Ms. Jennings was conspicuous about her intention to start a competing program and to bring harm to Lake House if it did not meet certain demands. One employee of Lake House testified that Ms. Jennings threatened to “start up another school and that they would make sure that no one would ever enroll another student at Lake House Academy and that she would make sure the school shut down and that we would all lose our jobs.” Op. ¶ 14. Ms. Jennings attempted to recruit Lake House’s Clinical Director for her new venture, Glen Willow Academy. Op. ¶ 15. Lake House also presented evidence that Ms. Jennings sent Lake House’s business plan and other confidential documents to her husband, that she deleted electronically-stored information on her Lake House computer, and made arrangements to lease land for her new program and school. Op. ¶¶ 12, 19-22, 26.
Judge Gale rejected Ms. Jennings’ defense that she did not owe a fiduciary duty to Lake House since she resigned as a manager. Ms. Jennings sought to resign her position as a manger but retain her status a member of Lake House. This distinction was important because Judge Gale noted that “members of a limited liability company are treated like corporate shareholders and do not owe fiduciary duties to other members or the company, … however [managers], shall discharge his duties as manager in good faith, with the care an ordinary prudent person in a like position would exercise under similar circumstances, and in the manner the manager reasonably believes to be in the best interest of the limited liability company.” Citing Kaplan v. O.K. Techs, LLC, 196 N.C. App. 469, 473, 675 S.E.2d 133, 137 (2009); N.C. Gen. Stat. § 57C-3-22(b) (2011). Op. ¶ 35.
The Lake House operating agreement stated that each member was also a manager of Lake House. Op. ¶ 37. Thus, Lake House argued that Ms. Jennings’ attempted resignation of her manager status was ineffective, because she retained her status as a member, which under the LLC’s operating agreement, meant she was a manager. Judge Gale decided that he did not have to decide whether or not Ms. Jennings’ resignation as manager was effective since he concluded that Ms. Jennings’ misconduct occurred while she owed fiduciary duties to Lake House. Op. ¶ 38.Judge Gale found irreparable injury: “Clearly Lake House has been harmed. Mrs. Jennings actively solicited Lake House employees to terminate their employment and work for Glen Willow Academy, and she caused the release of confidential and proprietary parent contact information leading to parental unrest. Op. ¶ 45. He went on to reason that if Ms. Jennings was permitted to execute her plan to open a competing therapeutic program, “such actions would unquestionably cause irreparable injury" to Lake House. Op. ¶46.
North Carolina recently enacted several amendments to its civil procedure rules that address the issue of electronic discovery. The changes take effect on October 1, 2011. By and large, the amendments are consistent with similar changes made in 2006 to the Federal Rules of Civil Procedure. Parties to civil lawsuits in state courts will now have greater authority to obtain electronic evidence, as well as obligations to provide it. The new amendments, however, also provide parties with the ability to receive court-ordered protection against unduly burdensome productions of electronic materials.
The changes to are significant. Parties and practitioners need to understand these amendments for active cases, as well as when they find themselves in midst of a dispute that has not yet blossomed into a formal suit. Below is an overview:
· Rule 26(b)(1) has been amended to expressly include electronically stored information (“ESI”) as material that is discoverable. A party is not obligated to produce ESI that is not “reasonably accessible” unless the requesting party can demonstrate a persuasive justification for why it should be collected and produced.
· ESI also includes reasonably accessible metadata that will allow the receiving party to discern “such information as the date sent, date received, author, and recipients.” A party, however, must demonstrate “good cause” to demand the production of other types of metadata from another party. This is a departure from the existing Federal Rules of Civil Procedure.
· A non-party that responds to a subpoena to produce documents under Rule 45 is now obligated to include ESI in its production.
· ESI can be very expensive to collect, review, and produce. Amended Rule 26(b)(3) allows courts the authority and flexibility to shift the costs of electronic discovery between parties depending on the circumstances, the expected relevance of the material sought, and costs involved.
· Amended Rule 26(b)(7) now mandates that parties must produce privilege logs setting out materials withheld on privilege grounds – even absent an express request to do so from another party. On a related note, the amended rule also protects parties from the inadvertent disclosure of privileged materials in that it will not waive the producing party’s privilege.
· Amended Rules 16 and 26(f) creates a new requirement for parties to “meet and confer” to work cooperatively in developing a proposed plan to govern the discovery process. If a party requests it, courts must now enter a discovery scheduling order to set the scope and limits of discovery.
These changes will have an effect on how discovery is conducted in North Carolina state court cases. Practitioners, companies, professionals, and other potential litigants need to understand these changes, and the obligations they may have from the onset of a dispute and in any future court case. If you are in North Carolina or conduct business in this state, it is now even more prudent to have in place clear and unambiguous polices and procedures regarding the storage and retention of all documents, including ESI. This includes policies to preserve potentially relevant ESI as soon as the obligation arises. Companies therefore need to understand their own retention policies, and when ESI may be overwritten, deleted or otherwise discarded in the normal course of business. It is important to consult with counsel to develop policies for when and how to enact a “litigation holds” – the suspension of normal retention/destruction procedures – to safeguard against the erasure of what may become relevant evidence.
Once litigation ensues, collaboration between client and counsel will go a long way towards ensuring compliance with the new rules, and to develop strategies for the smooth and cost-effective collection production of electronic evidence.
As lawyers and litigants may know, it has generally been extremely difficult in North Carolina to recover attorneys’ fees at the conclusion of the case, even if you win. However, thanks to a new law signed by Governor Purdue, reciprocal attorneys’ fees provisions in business contracts will now be enforceable in litigation.
North Carolina common law follows what is known
as the “American Rule,” which generally holds that each party to a lawsuit is
responsible for its own attorneys’ fees incurred during the course of a lawsuit
– irrespective of who wins and who loses.
This stands in contrast from other countries that allow for the
prevailing party to recover their attorneys’ fees from their opponent.
In North Carolina, the “American Rule” holds true unless there is an express statutory provision that provides an exception allowing for the recovery of fees. These exceptions historically have been few and far between. Prior to this new law, even where a parties’ contract provided that the prevailing party in a lawsuit was entitled to recover its attorneys’ fees, courts would refuse to enforce such a provision unless the case otherwise fit within one of the few narrow statutory exceptions.
North Carolina has now passed into law an additional exception that is likely to see wide use in future lawsuits between businesses. Session Law 2011-341 (codified as N.C. Gen. Stat. § 6-21.6) now makes enforceable any reciprocal provision for the recovery of attorneys’ fees in business contracts. The law defines “business contracts” to be agreements executed “primarily for business or commercial purposes.”
Because the new law creates an exception to prevailing North Carolina common law, its application will be construed narrowly. There are several important limitations to note. First, it covers any sort of contract between sophisticated business entities, but does not extend to consumer agreements of any kind, employment contracts, insurance agreements, or government contracts. A consumer agreement is defined as a “contract entered into by one or more individuals primarily for personal, family, or household purposes.”
Second, the new law only applies to contracts
entered into on or after October 1, 2011.
Third, the attorney’s fee clause must be reciprocal in favor of all
parties to the contract. Fourth,
the written contract containing the attorneys’ fee clause must be signed “by
hand.” Although courts have not
interpreted this last restriction, this would seem to exclude contracts
executed by electronic stamp or signature.
The new law does not provide a trigger mechanism for an attorneys’ fee clause, so it would seem that the parties to the contract are free to define when the clause will apply, and under what circumstances. The new law expressly disavows adherence to any contract term providing for a stated percentage of attorneys’ fees or gauging it to the amount of damages.
Courts will also still
maintain discretion in deciding whether or not to award attorneys’ fees in a
particular case, and importantly have discretion to determine a “reasonable”
fee award. In setting the
reasonableness of the award, the new law sets out thirteen different factors
for courts to consider, and include such things as the amount in controversy,
the existence, timing and amount of any settlement offers, the novelty of the
legal questions presented in the suit, the billing rates of counsel and time
billed, and the economic circumstances of the parties. Finally, the law makes clear that any
fee award cannot exceed the amount in controversy.
This huge change in North Carolina law has a very real potential to affect the strategy and behavior of business litigants in any suit involving a contract with an attorneys’ fees clause. With a statutory presumption of validity, it no doubt will increase the potential risk and exposure for all parties involved. Therefore, businesses and their counsel should have an eye out for a reciprocal attorneys’ fees clause in future proposed contracts under negotiation, and give careful consideration to the decision to include such a provision in their agreements moving forward.