Court Opinion

ID: 2677908
Source: CourtListenerOpinion
Date Created: 2014-06-10 23:48:36.738881+00
Date Added: 2024-06-11T13:08:57.771624
License: Public Domain

IN THE SUPREME COURT OF NORTH CAROLINA

                                    No. 384PA12

                             FILED 28 AUGUST 2013
HCW RETIREMENT AND FINANCIAL SERVICES, LLC, a North Carolina limited
liability company; HCWRFS, LLC, formerly Hill, Chesson & Woody Retirement &
Financial Services, LLC, a North Carolina limited liability company; and WILTON
R. DRAKE, III
             v.
HCW EMPLOYEE BENEFIT SERVICES, LLC, a North Carolina limited liability
company; HILL, CHESSON & WOODY, INC., a North Carolina corporation;
PRESTWICK SIX, LLC, a North Carolina limited liability company; FRANK S.
WOODY, III; and TODD T. YATES

      On discretionary review pursuant to N.C.G.S. ' 7A-31 of a unanimous

decision of the Court of Appeals, ___ N.C. App. ___, 731 S.E.2d 181 (2012), affirming

an order denying a motion to compel arbitration entered on 9 September 2011 by

Judge Charles C. Lamm, Jr. in Superior Court, Orange County.            Heard in the

Supreme Court on 8 May 2013 by special session in the Old Chowan County

Courthouse (1767) in the Town of Edenton pursuant to N.C.G.S. § 7A-10(a).

      Northen Blue, LLP, by J. William Blue, Jr., for plaintiff-appellees.

      Coats & Bennett, PLLC, by Anthony J. Biller and Emily M. Haas; and Morris,
      Manning & Martin, LLP, by Keith D. Burns, for defendant-appellants Frank
      S. Woody, III and Todd T. Yates.

      HUDSON, Justice.

      Here we address whether the individual defendants waived their contractual

right to demand arbitration through actions inconsistent with arbitration rights
                                   HCW V. HCW

                                  Opinion of the Court

and prejudicial to plaintiffs. We conclude that plaintiffs have failed to prove such

prejudicial actions. Therefore, we reverse the decision of the Court of Appeals and

remand for further proceedings.

      Frank Woody and Todd Yates (defendants), along with plaintiff Wilton

Drake, are financial planners and advisers who each own and operate financial

services businesses. On 12 August 2003, defendants and plaintiff Drake formed a

limited liability company, Prescott Office Management. Defendants and plaintiff

Drake each owned a one-third interest in Prescott, and the Operating Agreement

provided that “[a]ll decisions and commitments regarding LLC matters shall be

carried out by the Managers subsequent to the approval of 100% of the Members in

order to be binding on the Company.”            Notwithstanding that provision, the

Operating Agreement also specified certain actions that could be taken without

approval of 100% of the Members, including amending the Operating Agreement

itself, which could be accomplished “by Members holding 51% of the aggregate

Company Ownership Interests.”        The Operating Agreement also contained an

arbitration provision, which read in pertinent part:

                   14.10 Arbitration. Any dispute, controversy or
             claim arising out of or in connection with, or relating to,
             this Operating Agreement or any breach or alleged breach
             hereof shall, upon the request of any party involved, be
             submitted to, and settled by, arbitration in the State of
             North Carolina, pursuant to the commercial arbitration
             rules then in effect of the American Arbitration
             Association (or at any time or at any other place or under
             any other form of arbitration mutually acceptable to the

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                                  Opinion of the Court

             parties so involved). Any award rendered shall be final
             and conclusive upon the parties and a judgment theron
             [sic] may be entered in the highest court of the forum,
             state or federal, having jurisdiction.

      Around the same time the parties formed Prescott Office Management, LLC,

Prescott itself entered into an Operating Agreement with two other entities to form

Prestwick Six, LLC.    Prescott owned a 50% interest in Prestwick. As a result,

Prestwick could not make most business decisions without the approval of Prescott,

which at the time could not make most business decisions without the approval of

all three Members (plaintiff Drake and defendants). On or about 1 September 2004,

Prestwick purchased an office condominium. Subsequently, Prestwick leased space

in its office condominium to plaintiff Drake’s company, HCW Retirement &

Financial Services, LLC (“RFS”), and to defendants’ company, HCW Employee

Benefit Services, LLC (“EBS”).

      No material changes in the corporate or office-sharing arrangements occurred

from 2004 until 2010. But in September 2010 defendants Yates and Woody, in their

capacities as Members of Prescott, held a meeting without informing Drake and

amended the Prescott Operating Agreement. The amendments to the Operating

Agreement allowed business decisions to be made with approval of 66% of the

Members, rather than the previously required 100%. These amendments effectively

cut plaintiff Drake out of the decision-making process for Prescott.

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                                   HCW V. HCW

                                  Opinion of the Court

      Plaintiff Drake alleges, and defendants admit, that defendants used their

control over Prescott—which therefore gave them 50% control over Prestwick—to

decline to renew the lease between Prestwick and plaintiff Drake’s company, RFS,

when the lease terminated on 31 December 2010. Drake, along with his LLCs, filed

suit against defendants EBS, Prestwick, Yates and Woody individually, and another

corporation run in part by Yates and Woody. Although the suit contains numerous

claims against the various defendants; this appeal addresses only the twelfth and

thirteenth claims for relief, which relate to plaintiff Drake and defendants Yates

and Woody individually.

      Relevant here are plaintiff Drake’s claims alleging breach of good faith by

defendants as Members of Prescott and defendants’ breach of fiduciary duty to a

minority Member. In response, defendants filed a motion to compel arbitration on

those two issues under section 14.10 of the Operating Agreement.          During the

pendency of the motion to compel arbitration but before it was heard, plaintiffs

sought discovery from defendants on those and other issues but defendants objected

on the basis that the claims were subject to arbitration. Also during that period,

defendants deposed plaintiff Drake. During the course of the ten-to-eleven-hour

deposition, plaintiff Drake was asked some questions regarding the twelfth and

thirteenth claims for relief, despite defendants’ refusal to respond to plaintiffs’

discovery requests on those issues pending a ruling on the motion to compel

arbitration. In their briefs the parties appear to agree that the questions related to

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                                 Opinion of the Court

the arbitrable claims consumed approximately one hour of the ten-to-eleven-hour

deposition and occupied exactly forty-eight pages of the lengthy transcript of the

deposition.

      The trial court denied the motion to compel arbitration on 8 September 2011.

In its order the court found that the two claims in question “do not arise out of the

Operating Agreement or any alleged breach or violation of the Operating

Agreement.” The court concluded that the claims “fall outside the substantive scope

of the arbitration provisions of the Prescott Operating Agreement” and thus “the

dispute is not subject to arbitration.” In the alternative, the court also found that

defendants, by deposing plaintiff Drake about the arbitrable claims after refusing to

respond to Drake’s discovery requests on the same issues, had utilized discovery

procedures that were available in litigation under the Rules of Civil Procedure but

“could occur in arbitration only with permission of the arbitrator.”      The court

concluded that plaintiffs were prejudiced by these actions and that “by their acts

and conduct with regard to discovery, Defendants Yates and Woody have impliedly

waived any right that they might have to arbitration.”

      Defendants appealed. The Court of Appeals unanimously held that the trial

court had erred in concluding that the claims were not arbitrable, but affirmed on

the basis of waiver. HCW Ret. & Fin. Servs., LLC v. HCW Emp. Benefit Servs.,

LLC, ___ N.C. App. ___, ___, 731 S.E.2d 181, 193 (2012). In its opinion the Court of

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                                  Opinion of the Court

Appeals panel cited to the rule that a party opposing a motion to compel arbitration

based on waiver has the burden of proving prejudice and to this Court’s prior

holdings explaining what may constitute prejudice. Id. at ___, 731 S.E.2d at 189.

The court concluded “that the trial court’s determination that Defendants waived

their right to have the relevant claims submitted to arbitration by engaging in

discovery that would not have been available as a matter of right during the

arbitration process” was supported by the record and therefore affirmed the trial

court’s order. Id. at ___, 731 S.E.2d at 190. Defendants sought discretionary review

on the waiver issue, which this Court allowed. Because we conclude that plaintiff

has failed to establish prejudicial actions, inconsistent with arbitration, we now

reverse.

      In Cyclone Roofing Co. v. David M. LaFave Co. this Court discussed waiver of

contractual arbitration rights. 312 N.C. 224, 229-30, 321 S.E.2d 872, 876-77 (1984).

After noting the strong public policy in favor of arbitration, this Court held that “a

party has impliedly waived its contractual right to arbitration if by its delay or by

actions it takes which are inconsistent with arbitration, another party to the

contract is prejudiced by the order compelling arbitration.” Id. at 229, 321 S.E.2d at

876 (footnote and citations omitted). The Court then described some examples of

what would constitute such prejudice. Id. at 229-30, 321 S.E.2d at 876-77. Two

years later this Court restated those examples concisely in Servomation Corp. v.

Hickory Construction Co.:

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                                    HCW V. HCW

                                  Opinion of the Court

                    A party may be prejudiced by his adversary’s delay
             in seeking arbitration if (1) it is forced to bear the expense
             of a long trial, (2) it loses helpful evidence, (3) it takes
             steps in litigation to its detriment or expends significant
             amounts of money on the litigation, or (4) its opponent
             makes use of judicial discovery procedures not available
             in arbitration.

316 N.C. 543, 544, 342 S.E.2d 853, 854 (1986).           In Cyclone Roofing this Court

determined that the filing of pleadings and a month’s delay before moving to compel

arbitration did not constitute waiver when no discovery was conducted during the

delay and no evidence was lost.       312 N.C. at 233, 321 S.E.2d at 878-79.       In

Servomation this Court decided that a party did not waive arbitration despite

serving its opponent with “numerous interrogatories” that, as argued by opposing

counsel, necessitated lengthy responses before moving to compel arbitration. 316

N.C. at 545, 342 S.E.2d at 854-55. The Court noted that no evidence presented by

the party opposing arbitration showed that there had been a long trial, that any

helpful evidence was lost, or that any steps in litigation were taken to the detriment

of that party. Id. at 545, 342 S.E.2d at 854. Most importantly for the purposes of

the current appeal, the Court in Servomation emphasized that “plaintiff has failed

to demonstrate that the judicial discovery procedures used by defendant, or their

equivalent, would be unavailable in arbitration.” Id. (emphasis added).

      In reviewing Cyclone Roofing and Servomation, we have identified several

important points. First, this Court has held that a party implicitly waives its right

to compel arbitration when it takes actions inconsistent with arbitration that result

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                                     Opinion of the Court

in prejudice to the opposing side. Second, the party opposing arbitration bears the

burden of proving prejudice. Third, the use of judicial discovery procedures per se

does not constitute prejudicial action; rather, the judicial discovery procedures

employed must be unavailable in arbitration. Cyclone Roofing, 312 N.C. at 230, 321

S.E.2d at 877 (noting potential prejudice when “a party’s opponent takes advantage

of judicial discovery procedures not available in arbitration”); see also Servomation,

316 N.C. at 545, 342 S.E.2d at 854 (requiring for a finding of prejudice that “judicial

discovery procedures used by defendant, or their equivalent, would be unavailable

in arbitration”).

       Here, none of the first three examples of prejudicial action described in

Cyclone Roofing and Servomation are at issue. There has been no lengthy trial, no

allegation of helpful evidence lost, and no allegation of detrimental steps taken in

litigation or significant expense incurred.1        Plaintiffs rely solely on the alleged

prejudicial effect of defendants’ use of judicial discovery procedures in a manner

inconsistent with arbitration rights.

       Plaintiffs attempt to broaden the inquiry by arguing that the totality of the

circumstances here—in which defendants refused to respond to plaintiffs’ discovery

requests, then took plaintiff Drake’s deposition, then sought to terminate discovery

       1 Like the Court of Appeals, we recognize that plaintiffs must have incurred some
expense in having counsel present for the single hour of deposition questions at issue in this
appeal. We do not believe, and plaintiffs do not appear to argue, that this constitutes the
type of significant expense contemplated by the Court in Cyclone Roofing and Servomation.

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                                  Opinion of the Court

by calendaring the motion to compel arbitration—constitute prejudicial actions. We

are not persuaded. Plaintiffs must show prejudice from actions “inconsistent with

arbitration.” Cyclone Roofing, 312 N.C. at 229, 321 S.E.2d at 876. Defendants’

refusal to respond to discovery while the motion to compel was pending is an action

consistent with arbitration. Only their taking of plaintiff Drake’s deposition was

possibly inconsistent with arbitration rights, and plaintiffs must show prejudice

therefrom.

          Here plaintiff Drake argues that by spending an hour on the arbitrable

claims during his deposition, defendants “engag[ed] in discovery that could occur in

arbitration only at the discretion of the arbitrator.”   The trial court found that

“Defendants have utilized and benefited from discovery . . . that would be available

in arbitration only if permitted by the arbitrator.” The Court of Appeals affirmed

the conclusion that “Defendants waived their right to have the relevant claims

submitted to arbitration by engaging in discovery that would not have been

available as a matter of right.” HCW Ret. & Fin. Servs., ___ N.C. App. at ___, 731

S.E.2d at 190. Each of the passages quoted above contains a subtle but important

shift from the original Cyclone Roofing standard that the discovery employed be

“unavailable in arbitration” to a standard requiring that the discovery employed be

“available only at the discretion of the arbitrator” or “unavailable as a matter of

right.”     This varies from the standard this Court has previously endorsed for

prejudice under these circumstances: prior case law requires that the discovery

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                                  Opinion of the Court

procedures employed be unavailable in arbitration, not just unavailable as a matter

of right. If the arbitrator has discretion over the discovery procedures at issue, then

they are not per se unavailable. Moreover, the opinion in Servomation suggests

that discovery need not be exactly reciprocal. See 316 N.C. at 545, 342 S.E.2d at

854 (requiring for a finding of prejudice that “judicial discovery procedures used by

defendant, or their equivalent, would be unavailable in arbitration” (emphasis

added)).   Plaintiffs here presented no evidence that the opportunity to question

defendants about the twelfth and thirteenth claims for relief, whether in a formal

deposition or some equivalent interview or examination, would be unavailable at

arbitration.

      Plaintiffs here have attempted to prove prejudice specifically because of

defendants’ use of discovery procedures not available in arbitration, but have

offered no evidence that something equivalent to the one hour of deposition

questions would not be available at arbitration. We conclude that plaintiffs have

failed to prove prejudicial actions and therefore, that the trial court and Court of

Appeals erred in finding waiver of contractual arbitration rights. The remaining

issues addressed by the COA are not before this Court and its decision as to those

issues remains undisturbed.      We reverse the decision of the Court of Appeals

affirming the trial court’s order finding waiver and remand this case to that court

for further remand to the trial court for proceedings not inconsistent with this

opinion.

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                  Opinion of the Court

REVERSED AND REMANDED.

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