Source: http://businesslaw.ncbar.org/newsletters/nbijune2011/businesslawdevelopments
Timestamp: 2013-05-26 03:57:12
Document Index: 587310404

Matched Legal Cases: ['§ 57', '§ 57', '§ 57', '§ 57', '§ 57', '§ 57', '§ 57', '§ 57', '§ 57', '§ 57', '§ 57', '§ 57', '§ 57', '§ 55', '§ 55']

Business Law Section Website › Newsletters › Notes Bearing Interest, June 2011 › Business Law Developments
The North Carolina Business Court considered the enforceability of an option to purchase real property for a price equal to the "fair market value" of the property on the date of exercise. NRC Golf Course, LLC v. JMR Golf, LLC, 2010 NCBC 20 (December 29, 2010). The court concluded that the option was unenforceable because "fair market value" is not a sufficiently definite price term and the option did not include an adequate procedure for determining the fair market value of the property.
In 2006, NRC Golf Course, LLC and JMR Golf, LLC entered into a lease under which NRC leased a golf course from JMR. As part of the lease, JMR granted NRC an option to purchase the golf course for $2.5 million at any time during the lease term. The parties amended the option in March 2007, changing the purchase price to the property's "fair market value at [the] exercise date validated by an independent third-party appraisal." In October 2009, NRC attempted to exercise the amended option for $750,000, the fair market value of the golf course determined by an appraiser presumably engaged by NRC. After JMR refused to sell the golf course for $750,000, NRC sought specific performance. In response, JMR asserted that the amended option was invalid because it lacked essential terms such as price, sale conditions, and a closing date and because NRC did not give sufficient consideration for the amended option.
Citing opinions of the North Carolina Court of Appeals in Connor v. Harless, 176 N.C. App. 402, 626 S.E.2d 755 (2006), and Phoenix Ltd. Partnership of Raleigh v. Simpson, __ N.C. App. __, 688 S.E.2d 717 (2009), the Business Court concluded that the amended option was invalid because it "not only lack[ed] a sufficiently definite price term, but also lack[ed] a sufficient method by which to determine the price term." The court stated that "[if an] agreement does not provide a definite purchase price, it must reflect clear and unambiguous direction on how to arrive at a purchase price, so that the parties do not have to reach further agreement before a final price may be determined." In reaching its decision, the court observed that the amended option neither addressed how an appraiser would be selected or nor stated explicitly that one of the parties had the unilateral right to select an appraiser.
The court also rejected NRC's argument that, because JMR had received consideration for the amended option in the form of rent payments under the lease, JMR was estopped from denying that the amended option was enforceable. The court determined that the rent payments under the lease did not constitute consideration for the amended option because the lease and the amended option did not represent "an integrated single contract or agreement." In reaching this conclusion, the court cited the fact that the amended option was entered into eight months after the lease.
In light of the Business Court's opinion in NRC Golf Course, when drafting a contract that includes a price or payment based on "fair market value," practitioners should be sure that the contract provides a clear procedure for determining fair market value. The opinion also highlights the importance of having independent consideration when parties amend existing contracts.
A Hole to Be Plugged
The North Carolina Court of Appeals considered, in a case of first impression, whether a member of a North Carolina limited liability company can withdraw voluntarily in the absence of a provision in its articles of organization or a written operating agreement allowing voluntary withdrawal. Mitchell, Brewer, Richardson, Adams, Burge & Boughman, PLLC v. Brewer, __ N.C. App. __, 705 S.E.2d 757, disc. review denied, __ N.C. __, 707 S.E.2d 243 (2011). The court held that a member may withdraw only to the extent provided in the LLC's articles or a written operating agreement.
The plaintiffs and the defendants were members of Mitchell, Brewer, Richardson, Adams, Burge & Boughman, PLLC, a law firm organized as a North Carolina professional limited liability company (the "Firm"). In June 2005, under less than amicable circumstances, the plaintiffs stopped practicing law with the Firm and decided to form a new law firm. After the parties were unable to agree as to whether the plaintiffs would share in fees received in the future from the Firm's existing contingent fee engagements, the plaintiffs filed individual and derivative claims against the defendants and sought judicial dissolution of the Firm. The defendants counterclaimed for, among other things, a declaratory judgment that the plaintiffs had withdrawn from the Firm.
The case involved an appeal from the North Carolina Business Court's decision in Mitchell, Brewer, Richardson, Adams, Burge & Boughman, PLLC v. Brewer, 2009 NCBC 10 (March 31, 2009), which was discussed in the June 2009 edition of this column. In its opinion, the Business Court explained the significance of the characterization of the plaintiffs' ceasing to practice with the Firm. Dissolution of the Firm under N.C. Gen. Stat. § 57C-6-02 meant that the plaintiffs would share in distributions related to the contingent fee cases retained by the Firm through the winding-up process. Voluntary withdrawal, on the other hand, meant that the plaintiffs would be entitled under N.C. Gen. Stat. § 57C-5-07 to receive the fair value of their interests in the Firm as of the date of the withdrawal, which fair value the defendants contended did not include any value related to the contingent fee cases because the cases were impossible to value in light of the uncertainty of their outcomes.
Before delving into the substantive claims at issue on appeal, the Court of Appeals addressed whether the plaintiffs had standing to file the lawsuit. Consistent with its holding in Crouse v. Mineo, 189 N.C. App. 232, 658 S.E.2d 33 (2008), the court determined that, because the plaintiffs represented a minority of the members of the Firm, they did not have the authority to cause the Firm to bring a lawsuit against the defendants. The court further determined that the plaintiffs did not have standing to bring their individual claims, including a claim for an accounting to the plaintiffs, because the claims were "based on duties that ar[o]se as part of the [LLC]."
As to derivative standing, the court reached a different conclusion. To bring a lawsuit in right of an LLC, under N.C. Gen. Stat. § 57C-8-01(a)(2)(i), a plaintiff must be a member of the LLC at the time he or she files the suit. The defendants argued that the plaintiffs had withdrawn from the Firm before they filed suit and therefore did not meet the requirements for derivative standing. The court rejected this argument, determining that the plaintiffs had not withdrawn.
N.C. Gen. Stat. § 57C-5-06 allows for voluntary withdrawal "only at the time or upon the happening of the events specified in the articles of organization or a written operating agreement." None of the parties argued that the articles of organization addressed withdrawal, and the Firm never had a formal written operating agreement. The defendants asserted, however, that a combination of writings and e-mails relating to the plaintiffs' departure from the Firm constituted a binding written operating agreement that addressed voluntary withdrawal and that, under the terms of that operating agreement, the plaintiffs had withdrawn. The court disagreed, finding that the writings and e-mails "f[e]ll significantly short of establishing a 'written operating agreement' allowing for withdrawal" and that, in any event, the plaintiffs had not expressly assented to all of the terms of the writings and e-mails as would have been required under N.C. Gen. Stat. § 57C-3-05. The court, therefore, concluded that the plaintiffs' ceasing to practice law with the Firm could not be a withdrawal under N.C. Gen. Stat. § 57C-5-06 because the Firm had no operating agreement. According to the court, then, the plaintiffs had derivative standing because they remained members of the Firm when they brought the lawsuit.
When the Business Court considered the defendants' counterclaim for a declaratory judgment that the plaintiffs had withdrawn, it likewise concluded that no withdrawal had occurred. The Business Court, however, then determined that, because of numerous statements the plaintiffs had made indicating that they were withdrawing and because the parties acted as though the plaintiffs had withdrawn, the plaintiffs were estopped from denying that they had withdrawn. The Court of Appeals disagreed and reversed. In doing so, it stated that equitable remedies are not appropriate when a party has a remedy at law. The court determined that the defendants had a legal remedy through judicial dissolution under N.C. Gen. Stat. § 57C-6-02. The court rejected the defendants' argument that judicial dissolution did not offer them a legal remedy because the Business Court had discretion not to order judicial dissolution and elected not to order dissolution. The Court of Appeals determined instead that the Business Court erred when it resolved the case based on equitable estoppel and that the Business Court abused its discretion by failing to order judicial dissolution when it was appropriate and "represented the only legal remedy to resolve [an LLC's] disputes."
In a single paragraph – without any detailed discussion of the facts of the case – the Court of Appeals found three different bases on which the Business Court could have ordered judicial dissolution under N.C. Gen. Stat. § 57C-6-02(2). First, the Court of Appeals indicated that the members of the Firm were deadlocked because they disagreed about how to share fees from existing contingent fee arrangements. Second, the court without explanation stated that, because of the disagreement, liquidation was "reasonably necessary to protect the rights and interests of [a] complaining member." Finally, the court suggested that "there was potential that the [Firm's] assets [were] being misapplied." The Court of Appeals accordingly remanded the case to the Business Court to grant summary judgment to the plaintiffs on their claim for judicial dissolution.
The court's decision to require the Business Court to order dissolution was, at best, premature and, at worst, incorrect. First, although the plaintiffs disagreed with the defendants as to the sharing of fees from existing contingent fee arrangements, the parties were not deadlocked as contemplated in N.C. Gen. Stat. § 57C-6-02(2)(i). N.C. Gen. Stat. § 57C-6-02(2)(i) addresses deadlock in the "management of the affairs" of an LLC, and under N.C. Gen. Stat. § 57C-3-20(b), management decisions are made by majority rule in the absence of contrary provisions in the articles of organization, a written operating agreement, or the North Carolina Limited Liability Company Act (the "LLC Act"). Therefore, as four of seven members of the LLC, the defendants alone could make management decisions. Second, the court offered no justification for its determination that dissolution was reasonably necessary to protect the rights and interests of the plaintiffs. The court should have given studied attention to the relevant facts under a framework similar to the one set out in Meiselman v. Meiselman, 309 N.C. 279, 307 S.E.2d 551 (1983), or should have remanded the case to the Business Court to do so. Finally, N.C. Gen. Stat. § 57C-6-02(2) does not permit judicial dissolution when there is a possibility of waste or misapplication of assets. There must be actual waste or misapplication. Again, the Court of Appeals might have remanded the case to the Business Court for a determination as to whether there was actual waste or misapplication.
Mitchell, Brewer highlights a deficiency in the LLC Act, and the North Carolina General Assembly should adopt an amendment to provide a default rule for voluntary withdrawal. Absent such an amendment, it is critical that parties address voluntary member withdrawal in an LLC's articles of organization or written operating agreement, and even if the LLC Act is amended, it still will be a good idea for parties to do so.
The North Carolina Business Court considered, as matters of first impression, whether a special duty to disclose nonpublic information arises as a result of personal relationships between shareholders and officers of a North Carolina corporation and whether "holder" claims are cognizable in North Carolina. Harris v. Wachovia Corp., 2011 NCBC 3 (Feb. 23, 2011); Browne v. Thompson, 2011 NCBC 4 (Feb. 23, 2011). The court concluded that personal relationships do not result in such a duty and that North Carolina has not recognized, and is unlikely to recognize, "holder" claims.
About nine months after Wells Fargo & Company acquired Wachovia Corporation, several disgruntled Wachovia shareholders filed lawsuits against Wells Fargo, Wachovia, and Wachovia directors and officers seeking damages the shareholders allegedly suffered because they did not sell their Wachovia common stock before its value plummeted in late 2008. The plaintiffs claimed that they did not sell their stock because Wachovia directors and officers deceived the plaintiffs about the Wachovia's financial condition.
The defendants responded by challenging the plaintiffs' standing, arguing that the plaintiffs' claims were for losses sustained by Wachovia itself and therefore were derivative in nature. The defendants also contended that "holder" claims – "actions for damages by shareholder plaintiffs who allege they decided not to sell their shares because of a misrepresentation or failure to disclose unfavorable information"– are not recognized in North Carolina.
In considering the plaintiffs' standing, the Business Court noted that individual shareholders generally cannot assert causes of action against third parties for corporate injuries that cause a decline in stock value. The court acknowledged, however, that there are two exceptions to the general rule. First, a shareholder can bring a direct action "if the shareholder can show that the wrongdoer owed him a special duty." Second, a direct shareholder action is permitted if "the injury suffered by the shareholder is separate and distinct" from the injury to the corporation or the other shareholders.
In both Harris and Browne, the Business Court determined that neither exception applied. The plaintiffs in Browne did not offer any reasoned justification for why the "special duty" exception applied to them. The plaintiffs in Harris, on the other hand, claimed a special duty because the plaintiffs had personal relationships with certain of the defendant directors and officers and those defendants made direct representations to, or withheld information from, the plaintiffs regarding Wachovia's financial condition. The court disagreed, noting that the defendants were making the same representations to, and withholding the same information from, all Wachovia shareholders and the public. Moreover, according to the court, if the plaintiffs had received more or different information and then traded, the plaintiffs very likely would have violated the insider trading prohibitions under the federal securities laws.
Like their claim that a special duty applied, the plaintiffs in Harris argued that their injuries were "separate and distinct" because of the personal relationships involved and the direct representations that "induced them to hold on to their shares." Again the court disagreed, concluding that any failure of the defendants to disclose correct information had a proportionate effect on all Wachovia shareholders. According to the court, the plaintiffs' claimed losses arose from alleged corporate mismanagement, not their personal relationships with defendant directors and officers. In Browne, the court added that the harm to the plaintiffs from any misrepresentations by the defendants was the same as the harm the corporation itself suffered.
The Business Court also concluded that North Carolina has not recognized, and is unlikely to recognize, "holder" claims because they "are both derivative and highly speculative." In reaching this conclusion, the court observed in Harris that "holder claims" are not actionable under federal securities laws and that most courts have rejected "holder" claims based on state common law. The court noted further that "holder" claims present an inherent damages paradox because, if the defendants had disclosed the information that presumably caused the decline in stock value, the market would have incorporated that information into the stock price and the plaintiffs then would have been unable to sell at the previously inflated price. The court asserted, moreover, that "holder" claims present challenges in calculating damages because they require a court to evaluate a transaction that never occurred, not one involving "a precise date, number of shares, price, and profit or loss." Accordingly, the Business Court commented, courts that have recognized "holder" claims have imposed strict pleading standards, ones which the plaintiffs' complaint could not meet.
In Browne, the court dismissed dicta in Gilbert v. Bagley, 492 F. Supp. 714 (M.D.N.C. 1980), suggesting that North Carolina recognizes "holder" claims. The court observed that Gilbert was premised on officers and directors owing a duty to shareholders, a concept that no longer exists in the North Carolina Business Corporation Act.
The Harris and Browne cases are important because they declare North Carolina's treatment of "holder" claims. By refusing to recognize such claims, the Business Court appropriately has sheltered corporations and their officers and directors from speculative claims rife with both theoretical and practical difficulties.
The North Carolina Business Court considered whether two members of a member-managed North Carolina limited liability company with three members had the authority to cause the LLC to file a lawsuit. PEAK Coastal Ventures, L.L.C. v. SunTrust Bank, 2011 NCBC 13 (May 5, 2011). The court concluded that the members did not have such authority because they owned only 50% of the LLC's membership interests and the operating agreement required the approval of members with a least 51% of the membership interests for the LLC to incur contractual liability.
Robert Richardson and Robert Pope each owned a 25% membership interest in PEAK Coastal Ventures, L.L.C., a North Carolina limited liability company. Jeffrey Stec owned the remaining 50% membership interest. PEAK Coastal was member-managed. Therefore, by virtue of being members, Richard, Pope and Stec all were managers.
The Law Firm of Hutchens, Senter & Britton, P.A. represented PEAK Coastal in connection with two loan transactions with SunTrust Bank. Stec signed the SunTrust loan documents on behalf of the LLC. Richardson and Pope disputed Stec's authority to do so and filed a complaint in the LLC's name against SunTrust and the law firm, asserting various claims related to Stec's alleged lack of authority. In response, the defendants challenged the standing of Richardson and Pope with respect to the various claims they asserted.
PEAK Coastal's operating agreement permitted a single manager to take actions on behalf of the LLC unless the operating agreement or the LLC Act "expressly" required approval by more than one manager. The operating agreement also provided that:
No individual Manager, nor any number of Managers that is less than 51% of the Managers in the Company (by virtue of their percentage of membership interest...) is/are authorized to bind the Company, contractually, on any matter in which the Company incurs any liability of any type without a majority approval of the Managers.
Hutchens, Senter accordingly argued that Richardson and Pope could not cause PEAK Coastal to file a lawsuit because they did not own at least 51% of the LLC's membership interests. While Richardson and Pope were willing to acknowledge that 51% ownership approval was required for contractual obligations, they asserted that no such approval was required to initiate a lawsuit. The Business Court disagreed. The court noted that Richardson and Pope represented a majority of the managers of the PEAK Coastal and that, under the default provisions of the LLC Act, management decisions require approval of a majority of the managers. The court concluded, however, that the provision in the operating agreement requiring 51% ownership approval for contracts overrode the statutory default as to filing a lawsuit. In reaching its conclusion, the court determined that the operating agreement allowed managers to take action individually only as to "normal business operations" and that, because filing a lawsuit is not a normal business operation, it required 51% ownership approval. The court observed further that the decision to file a lawsuit was specifically within the scope of the provision requiring 51% ownership approval for contracts because an LLC cannot represent itself and therefore must enter into a contract to engage counsel.
The Business Court also determined that Richardson and Pope did not have derivative standing to bring their claims in right of the PEAK Coastal. The court found that, although Richard and Pope met the requirements of N.C. Gen. Stat. § 57C-8-01(a) (i.e., they lacked authority to cause the LLC to bring the lawsuit and they were members at the relevant times), their complaint did not allege with particularity either that demand was made or that it would have been futile.
PEAK Coastal serves as a good reminder that provisions governing the decision-making authority of LLC members and managers must be drafted with precision. Doing otherwise leaves room for interpretation of provisions in a manner the parties may not have intended. A Continuing Search for Redemption
The North Carolina Court of Appeals considered whether the estate of a deceased shareholder of three North Carolina corporations, each with 25 or more shareholders and significant numbers of employees, was entitled to judicial dissolution when the corporations refused to redeem the shares of the deceased shareholder at fair market value following her death. High Point Bank & Trust Co. v. Sapona Mfg. Co., No. COA10-1369, 2011 WL 1854966 (N.C. Ct. App. May 17, 2011). Applying the framework in Meiselman v. Meiselman, 309 N.C. 279, 307 S.E.2d 551 (1983), the court determined that one previous repurchase of a deceased shareholder's shares and three previous offers to all shareholders to repurchase limited numbers of shares, without more, are not sufficient to create an enforceable right to redemption that would justify judicial dissolution under Meiselman.
Elizabeth Simmons was a minority shareholder of Sapona Manufacturing Company, Inc., Acme-McCrary Corporation, and Randolph Oil Company, all of which are North Carolina corporations in which Simmons' family had been involved for many years. Following Simmons's death, High Point Bank & Trust Co., the executor of her estate, requested that the corporations redeem her shares at fair market value. When the corporations did not agree to do so, the bank filed a lawsuit seeking judicial dissolution of the corporations under N.C. Gen Stat. § 55-14-30(2)(ii) or, alternatively, the purchase of Simmons' shares for their fair market value.
The case involved an appeal from the North Carolina Business Court's decision in High Point Bank & Trust Co. v. Sapona Manufacturing Co., 2010 NCBC 11 (June 22, 2010), which was discussed in the February 2011 edition of the column. The Business Court found that Simmons did not have a reasonable expectation that her shares would be redeemed at fair market value upon her death. Consequently, the Business Court determined that dissolution was not appropriate. The Court of Appeals agreed. N.C. Gen Stat. § 55-14-30(2)(ii) provides that a "superior court may dissolve a corporation . . . in a proceeding by a shareholder if it is established that . . . liquidation is reasonably necessary for the protection of the rights or interests of the complaining shareholder." Under Meiselman, whether liquidation is reasonably necessary to protect the rights and interests of a complaining shareholder depends on whether the reasonable expectations of the complaining shareholder have been frustrated. For a complaining shareholder's expectations to be reasonable, the other shareholders must have known or assumed them and must have agreed to them. High Point Bank & Trust cited several facts to support its claim that Simmons had a reasonable expectation that her shares would be redeemed by Sapona, Acme-McCrary, and Randolph Oil at fair market value upon her death. The bank pointed to Sapona's and Acme-McCrary's previous purchase of a shareholder's shares following his death. Additionally, the bank noted that Sapona and Acme-McCrary in 1997 had offered to repurchase shares from all of the corporations' other shareholders and that Sapona had made the same offer to its shareholders in 2000. Finally, High Point Bank & Trust asserted that Simmons wanted the proceeds of her shares to go to her son and had told the trust officer handling Simmons's estate planning that a sale of the shares "wouldn't be a problem."
The Court of Appeals concluded that the facts the bank identified might evidence a subjective expectation by Simmons that her shares would be redeemed upon her death, but they did not establish a reasonable expectation. First, Sapona and Acme-McCrary had repurchased the shares of a deceased shareholder only one time in the past, and in that instance, they did so voluntarily and because of unique circumstances surrounding his death, not based on any expectation. Second, the previous offers that Sapona and Acme-McCary had made to all shareholders did not mention the purchase of shares of deceased shareholders and merely "established a precedent" that the corporations "from time to time" would repurchase limited numbers of shares at specific prices. Finally, Simmons's statement to the trust officer did nothing more than indicate a "privately held expectation." Nothing indicated that Simmons had communicated to any officer, director, or shareholder of the corporations that she expected her shares to be redeemed upon her death, and no evidence indicated that any other shareholder knew, assumed, or agreed to Simmons's purported expectation. The Court of Appeals's opinion in High Point Bank & Trust highlights the importance of addressing (and, if appropriate, documenting) at the outset of a close business arrangement the circumstances under which any redemption rights should apply. Molony is assistant professor of law at Elon University School of Law.