Mind Your Business http://randyhermanlaw.com Legal News and Information for Small Businesses Fri, 07 Mar 2014 14:36:18 +0000 en-US hourly 1 http://wordpress.org/?v=3.8.1 Impossible and Illegal Contracts http://randyhermanlaw.com/?p=204 http://randyhermanlaw.com/?p=204#comments Fri, 07 Mar 2014 14:36:18 +0000 http://randyhermanlaw.com/?p=204 Today’s case also comes from the Court of Appeals. In Botts v. Tibbens, the court considered the circumstances under which an otherwise valid contract can be unenforceable because it is either impossible or illegal.

Background

Since it occurs to me that I have never really done a contracts case where I went back to basics, I am going to begin here at the beginning. In the most general terms, a contract is an exchange of promises between two parties. It can be written, oral, or implied by conduct.

The whole point of a contract is that if the other party does not do the thing he promised to do, you can get a court to enforce the contract. Even though in most cases it will not come to that, the mere fact that you could get it enforced if you wanted to is important to making contracts work. Therefore, when we talk about contracts we talk a lot about enforceability. Certain kinds of contracts have to be in writing in order to be enforceable, but most of the time an oral contract is enforceable.

When you sue someone over a breach of contract, the first step is to prove that a contract existed. This is a lot easier if the contract is in writing. Next you have to prove that the contract has been breached, meaning that the other person failed to do the thing he promised to do. That can be to perform some task, to pay you some amount of money, etc. Once you have proven the existence of a contract and a breach of that contract, it is up to the defendant to prove that he has some defense that makes the contract unenforceable.

The defenses at issue in today’s case are illegality and impossibility. You cannot enforce a contract to do something illegal. For instance, if you make an agreement with your drug dealer to sell you cocaine and he decides not to sell you the cocaine, you cannot sue him for breach of contract. Your agreement, while a valid contract, is unenforceable.

Impossibility usually means literal impossibility. If you contract to pay someone to build you a time machine, you probably cannot sue them when they fail to invent time travel. More prosaically, if you contract to build a cathedral in two days, it may be unenforceable due to impossibility. I say it may be unenforceable because, in that case, it was probably foreseeable when the contract was made that it was impossible. If you, in making the promise, know that it is impossible or assume the risk that it is, you will probably still be held to have breached the contract when you cannot do the thing you agreed to.

There is some overlap between the two defenses. If a new law gets in the way of performing your promise, it could be said to be either illegal or impossible. For instance, if you contract to build a house on a piece of land but then the government confiscates that land so it can build a highway there, building the house is now both illegal and impossible.

The Case

Tibbens owned a parcel of land in Orange County. In January 2088 he sold 15 acres of it to Botts, who wanted to build a house there. As part of the purchase, the parties signed a written contract for installation of a septic system. Tibbens agreed to install the system, with Botts paying the first $10,000 of the cost and Tibbens paying any amount over $10,000.

At some point, Tibbens apparently figured out that the septic system was going to cost a lot more than $10,000. In February 2010, he wrote Botts a letter, telling her that the contract was unenforceable. He argued that since he was not a licensed contractor, it would be both illegal and impossible for him to install her septic system. Under state law, only a certified contractor can install a septic system. Botts hired a contractor to install the system, then sued Tibbens for breach of contract. He once again asserted that the contract was both illegal and impossible.

The court first determined, looking at the language of the contract, that it did not require Tibbens to personally install the septic system himself. It only required that he make sure the system was installed. Therefore he could easily have performed the contract by paying a contractor to install the system. The court also noted that it was two years from the time when the contract was made and the time when Tibbens decided that he was not going to install the septic system. As the court noted, even if the contract had required Tibbens to personally install the system, two years was plenty of time for him to become certified.

Similarly, the performance was not impossible just because Tibbens did not know how to install a septic system. Again, he could have hired someone or sought out the knowledge himself. As the court noted, someone who contracts to do something is expected to make reasonable efforts to gain the required skills and can only plead impossibility if he is still unable to perform.

The Bottom Line

Don’t contract to do something until 1) you are fairly sure how much it will cost you and 2) you actually know how to do it. The fact that you agreed to do something you didn’t know how to do is not going to save you from a breach of contract claim.

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Another Noncompete Case, With a Twist http://randyhermanlaw.com/?p=201 http://randyhermanlaw.com/?p=201#comments Thu, 06 Mar 2014 20:45:23 +0000 http://randyhermanlaw.com/?p=201 Today’s post is about another noncompete agreement case, Horner International Co. v. McKoy. In many ways it is similar to last week’s case which I blogged about here so this post will be brief. See the earlier post for background on noncompete agreements generally.

McKoy worked in the flavor materials manufacturing business. He ran a factory in Durham which produced flavorings for food and tobacco by processing natural products such as cocoa, coffee and ginseng. He subsequently switched to another company which did similar work but was located in New Jersey.

This switch was in violation with McKoy’s signed noncompete agreement, which forbid him from working for or being “an advisor, consultant, or salesperson for, or becoming financially interested, directly or indirectly, in any person,proprietorship, partnership, firm, or corporation engaged in, or about to become engaged in, the business of selling flavor materials.” This restriction had no geographical limitation.

Like in last week’s case, the court struck this agreement down as being too broad. The court said it was overly restrictive both in the type of activity which it attempted to bar and also in the worldwide geographical scope.

The reason I am writing about this case so soon after the previous similar case is the very interesting concurrance written by Judge Steelman (if you follow the link to the case it starts on page 23). A concurrance is what a judge writes when he does not disagree with the main opinion but has some separate point that he wants to make.

The concurrance in this case says first that everything in the main opinion is correct under existing North Carolina law. Judge Steelman goes on to say, however, that the existing rules for noncompete agreements date from a time when essentially all businesses were local and therefore only had a legitimate interest in restricting former employees from competing with them locally. An example of this is last week’s case, where the former employer and the new employer each operated in a small number of counties in eastern North Carolina.

However, Judge Steelman argues that today’s case illustrates a much more modern global business model. The former employer and the new employer each market specialized products, food flavorings, all over the country, and maybe the world. Thus even though one factory is physically located in North Carolina and the other in New Jersey, they are in actual competition with each other.

The Court of Appeals cannot make changes to the law. However, Judge Steelman urges the North Carolina Supreme Court to look again at the law on noncompetes and allow them be enforced over a broad geographical range, at least where the former employer competes with the new employer over that whole range.

It will be interesting to see if the Supreme Court takes him up on his call.

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Can the Bank Take Away Your Right to Vote? http://randyhermanlaw.com/?p=192 http://randyhermanlaw.com/?p=192#comments Thu, 06 Mar 2014 14:18:45 +0000 http://randyhermanlaw.com/?p=192 Membership in an LLC gives you two basic rights: the right to receive a portion of the company’s profits and the right to vote on issues regarding the management of the company. Today’s case, called First Bank v. S&R Grandview, LLC, deals with the right of a bank to take over some control of the LLC as payment for the debts of the LLC member. In other words, if the bank can take over your right to profits, does that allow it to take over your right to vote as well?

Background

Like corporations, LLCs exist only because the state legislature passed a law allowing them to exist. That means that the rules for how LLCs function are included in state statutes.

One of the functions of an LLC is, as implied by the name, that it limits liability. Usually this means that the investors, who are called members, are not responsible for the debts of the LLC. The most they can lose is their investment. But limited liability also works the other way: the LLC is not responsible for paying the personal debts of its members.

So if a member in a profitable LLC owes you money, is there no way to get at those profits? There is, by a device called a charging order. Basically the creditor can get a court order, requiring the LLC to turn over the debtor’s share of profits directly to the creditor as they are paid out. It is equivalent to the process of garnishing someone’s wages.

The question, previously unresolved, is whether by charging an LLC member’s share of profits, the creditor also gains control of the member’s ability to vote on LLC matters.

There is some logic on either side. On the one hand, if the creditor is hoping to get repaid from the profits of a company, it makes some sense that the creditor gets to have a say in whether the company is run in a profitable manner. The member whose ownership has been charged has some incentive to run the company into the ground in order to spite his creditors.

On the other hand, just because a state agency gets to garnish the wages of a store manager doesn’t mean that the agency should come in and run the store. The right to be repaid is not the same as the right to run the debtor’s life in every detail.

The Case

Donald Rhine owed a significant amount of money to the plaintiff, First Bank. After First Bank got a judgment against Rhine, it tried to collect on the judgment by charging Rhine’s membership in the defendant S&R Grandview, LLC. In addition to collecting the money it had loaned by taking Rhine’s share of S&R’s profits, First Bank also sought to prevent Rhine from participating in the management of S&R until the debt was repaid. It requested that his membership rights “lie fallow” while the debt was outstanding.

The key statutory provision that First Bank relied on stated that a creditor which has charged a membership interest in an LLC “has the rights of” an assignee. A separate section of the statutes stated that a member who has made an assignment of all his rights loses the ability to participate in management of the LLC. (Note that all of these rules are part of the old LLC statute. Major revisions to the LLC rules, which I blogged about here, have changed much of this language, although not the underlying rule.)

First Bank argued that because it “had the rights of” an assignee, that meant an assignment had actually taken place. Therefore, Rhine had lost his ability to participate in management of the LLC in any way.

The court disagreed. Its basic decision was that there is a difference between having the rights of an assignee and actually being an assignee, which is pretty closely splitting the hairs. More importantly, the court looked at the public policy aspect of the question. It held that economic rights to receive a payout from the LLC are quite different from management rights. Especially since many LLCs are small businesses between individuals who know each other personally, injecting an outside third party into running that business would be unreasonable.

The Bottom Line

If you are in debt to a bank or any other creditor, and you are a member of an LLC, the bank can take away your right to get money from the LLC. But it can’t take away your right to manage the company, by voting or in any other way. Debtors are not slaves and still retain their rights, including economic rights.

If you are in debt and a member of an LLC, or if you are considering forming an LLC with another person who might be over his head in debt, you should consult an attorney to protect your rights. If you do not have an attorney, feel free to contact me.

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Knowing What Your Company’s Name Is http://randyhermanlaw.com/?p=190 http://randyhermanlaw.com/?p=190#comments Tue, 04 Mar 2014 14:54:52 +0000 http://randyhermanlaw.com/?p=190 The Court of Appeals just published a whole set of business law opinions today so I probably will be posting a lot this week. The first case is a little bit outside what I normally cover because it is more of a caution to other lawyers than to business owners. But nevertheless it is a business law case so it is here.

Background

Judges always like to talk about how the courts are overburdened with cases. Because there are too many cases and not enough judges and other court staff to manage them, judicial efficiency becomes a justification in itself as a reason to limit certain kinds of cases.

Judicial efficiency is one of the main justifications for a limit on lawsuits which is called “standing.” There are also Constitutional limits on standing which are not involved in this case. Standing means that in order for a case to be decided by a court, the plaintiff must have something to gain from winning the case. Otherwise the courts would just be deciding abstract questions with no point.

In a business law case, the plaintiff does not necessarily have to be, for instance, the same business entity that signed the contract. It just has to be able to show a connection between the entities so that the company bringing the lawsuit would benefit from winning the suit.

There is also another, lesser issue in this case. A company which does business under a name other than its official name must register this “fictitious name” in every county in which it does business. This is a consumer protection law, allowing consumers to figure out what the real name of the business is in order to investigate it and if necessary sue it.

When a company sues using its fictitious name, it must include in the lawsuit the location of a county in which the fictitious name is registered.

The Case

Today’s case is known as American Oil Company, Inc. v. Aan Real Estate, LLC. The name itself is a big part of the issue.

Anyway, a company called American Oil Group leased a property in Charlotte for use as a car wash and auto repair shop. After the property was allegedly not developed as called for in the lease, the plaintiff American Oil Company sued the defendant for breach of the lease.

There are two problems with this lawsuit. First and kind of incidentally, the court noted that there is no corporation registered in North Carolina under the name American Oil Company, Inc. Therefore, American Oil Company must be a fictitious name for some other kind of business entity and was required to tell the court in its suit where the fictitious name was registered. These problems, however, could have been solved fairly easily.

The main problem with the plaintiff’s suit is that the name under which it sued, American Oil Company, was different than the company that signed the lease, American Oil Group. The plaintiff had not alleged in its suit that the companies were the same or were connected in any way. The court could not assume merely because the names were similar that the companies are related. Just look up the number of companies that start with the word “American” and you will see why.

In the absence of any connection between the companies, the plaintiff had no standing to sue for breach of the lease. Therefore the case was dismissed.

The Bottom Line

Of course realistically, the two companies are almost certainly related. American Oil will just file another suit under the correct name. So why am I writing about this case? Because in order to take the case this far, the plaintiff has probably already spent tens of thousands of dollars in attorney fees. For that they got nothing except the opportunity to start over again. So my advice to my fellow attorneys is make sure you are suing in the correct name. And to any businessmen reading this, it never hurts to look over your attorney’s shoulder.

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Is Your Rival’s Janitor in Competition With You? http://randyhermanlaw.com/?p=183 http://randyhermanlaw.com/?p=183#comments Fri, 07 Feb 2014 14:14:23 +0000 http://randyhermanlaw.com/?p=183 North Carolina is an “at will” employment state. This means, in general, that the state looks unfavorably on contracts that restrict the right of either employers or employees to terminate the employment. Employees are free to leave at any time and employers are free to let them go. Generally, the obligations of the parties end when the employment ends. Today’s case, Copypro, Inc. v. Musgrove, comes from the Court of Appeals and deals with one limited case where the employee has an obligation to the employer even after leaving. This is a covenant not to compete and as we will see it is pretty limited.

Background

 It is an inevitable part of having employees that employers must give them access to valuable information. Restaurants have to tell the cooks how to make their recipes. Manufacturers need to tell their employees the process for making their products. And sales firms need to give their salesmen a list of customers. When employees are free to leave their employment at any time, there is always a risk that the employees will take this valuable information with them to a competitor.

The solution to this problem is the covenant not to compete or noncompete agreement. This is an agreement, signed either when the employee is hired or later, under which the employee agrees not to compete with his former employer after leaving his job.

Noncompetes are generally disfavored by courts. Generally, we want people to be able to work. And we want them to be able to work in the job for which they are best trained and most suited. Noncompetes force the employee to choose between staying at a job in which they are no longer happy, moving into a different industry which doesn’t compete with their current job, or quitting and not working at all. Also, if employees are practically unable to leave their jobs, employers can unilaterally cut employee wages or benefits without the risk that the employees will leave.

Noncompetes are given particularly unfavorable treatment in North Carolina. The state’s promise of “at will” employment is meaningless if there are restrictions preventing employees from actually leaving.

Noncompetes are not generally enforceable. They will only be upheld in court if they are in writing and given in exchange for something (like a raise). They also need to be reasonably restricted in three ways: time, place, and description of the work. That is to say, the noncompete will not be upheld if it prevents an employee from competing for too long a period. Generally courts are ok with a year and not much more. Also it will be upheld if it restricts competition only in the geographical area where the employee worked in the job he is leaving. A nationwide restriction would not be acceptable. Finally, the noncompete can only restrict the employee from working in positions that would actually bring him into competition with his former employer. It is this last element that is at issue here.

The Case

Copypro sells and leases office equipment in eastern North Carolina. Musgrove was employed by Copypro as a salesperson in Pender and Onslow Counties. He resigned his position in 2012 and immediately went to work for a competitor, Coastal Document Systems. Coastal operates only in Brunswick, Columbus and New Hanover Counties. After leaving Copypro, Musgrove made no attempt to contact his former customers and indeed Coastal informed him that he would be terminated if he did so.

Copypro sued Musgrove, alleging he had violated a noncompete agreement that he signed when he began working there. The agreement forbid Musgrove from “directly or indirectly, owning, managing, operating, joining, controlling, being employed or participating in the ownership, management, operation or control of, or being connected in any manner with” a business that competes with Copypro. The restriction was for three years and applied to basically the whole of eastern North Carolina.

Although the Court expressed some concern with the time restriction and the geographical restriction, saying that they probably were both too broad, its primary issue was with the broad definition of what behavior was restricted. Remember, a noncompete is only valid if it protects the employer’s legitimate business interests. However, the noncompete as written would prohibit Musgrove from being involved in a competing business even in the most indirect way, such as buying one share of stock for investment purposes. Also, as the court repeatedly pointed out, it would prohibit Musgrove from working for Coastal as a janitor. Since Copypro had no legitimate business interest in stopping Musgrove from being a janitor, the restriction was too broad and could not be enforced.

Importantly, the court did not make any attempt to limit  the agreement in a way that would make it enforceable. Instead it just threw out the whole agreement. Copypro, in attempting to restrict too much competing activity, ended up being unable to restrict anything at all.

The Bottom Line

Noncompetes can be a valuable tool to prevent your employees from taking valuable skills to your competitors. But they must be carefully written in order to be any use. If you are an employer trying to draft a noncompete, or an employee looking to get out of one, you need to consult an attorney. If you don’t have an attorney, feel free to contact me.

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When a Temporary Injury is a “Disability” http://randyhermanlaw.com/?p=176 http://randyhermanlaw.com/?p=176#comments Fri, 24 Jan 2014 08:00:09 +0000 http://randyhermanlaw.com/?p=176 I don’t often post on cases from the federal Fourth Circuit Court of Appeals (the federal appellate court that includes North Carolina). But when I see a case that is a big deal, I like to highlight it. Today’s case, Summers v. Altarum Institute, is one such big deal. The Fourth Circuit held, at least under the circumstances presented, that a person with a temporary injury is “disabled” under the Americans With Disabilities Act (ADA) and therefore cannot be fired on the basis of the injury.

Background

The reasoning in this case requires a bit of understanding of the history of the ADA. However, I will do my best not to get too far into the weeds.

The ADA is designed to prevent discrimination against the disabled and to require reasonable accommodations to allow the disabled to participate in normal life. It requires handicapped parking spaces and wheelchair ramps. It also prohibits employers from wrongfully firing an employee on the basis of a disability.

Unlike some anti-discrimination laws, where it is fairly clear whether the person suffering discrimination is a member of the protected group or not, one of the first steps in ADA analysis is determining who counts as “disabled.” Under the ADA, a person is disabled if he has “a physical or mental impairment that substantially limits one or more major life activities” such as walking, talking or eating.

Although the ADA has been in place since 1990, a Supreme Court decision in 2002 significantly impacted its scope. The Court ruled, overturning earlier cases in lower courts, that a temporary condition cannot be a disability. In other words, a person could only be disabled, and therefore protected from discrimination, if their condition was permanent.

Congress responded in 2008. It passed amendments to the ADA, requiring courts to broadly interpret what people are disabled, and specifically overturning the 2002 case. Congress expressed its intention that protection under the ADA should be as broad as possible.

There were, until today, no federal appellate court cases interpreting the effect that this 2008 amendment had on the scope of the ADA.

The Case

Summers performed statistical research for the Altarum Institute, a government contractor. His work required him to travel frequently to a Department of Defense facility that studies traumatic brain injury. While traveling between these workplaces, Summers fell and injured both legs as he exited a commuter train. He broke his left leg and right ankle and injured the tendons in both knees. This injury left him unable to walk for at least 7 months.

Although Altarum initially told Summers that he could return to work on a part-time basis as he recovered from his injury, it later terminated his employment. Summers sued, alleging that he was terminated because of his injury in violation of the ADA.

The trial court threw out the case. It ruled that because Summers’ injury was only temporary, he could not be disabled. The court relied entirely on cases from before the 2008 amendment and did not consider how that amendment affected the situation.

On appeal, the Fourth Circuit said this approach was totally incorrect. Rather than creating a per se rule that a temporary injury cannot be a disability, the Fourth Circuit said that the trial court should have looked at the circumstances of the injury. In particular, it should have considered how much the injury impacted Summers’ “major life activities,” in this case walking, and how long the injury was expected to last. Using these factors, the court should have determined whether the injury was severe and long-lasting enough to be considered a disability.

Although the court did not attempt to set out any absolute standards for when an injury crosses the line to disability, it did note an example used by the EEOC. In that example, a person is injured with a back impairment that keeps him from lifting heavy objects for several months. The EEOC, acting under the direction of Congress, declared that this was an example of a disability. The court said if that was a disability, than certainly the much more severe and long-lasting injury that Summers suffered would also count.

Of course, there are other factors not considered in this case that affect whether a disabled person can sue for discrimination after having been fired. In particular, the ADA only requires employers to make reasonable accommodations for disabled people, not to completely restructure their business. This sort of rule may serve as some limitation.

The Bottom Line

At least for now and at least in states under the jurisdiction of the Fourth Circuit, a person who has a temporary injury can potentially sue an employer who replaces that injured employee. If you are an employer, or an injured employee, you should consult an attorney to see how this case may affect your rights and responsibilities going forward. Of course, if you do not have an attorney, you are welcome to contact me.

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Paying Your Attorney http://randyhermanlaw.com/?p=170 http://randyhermanlaw.com/?p=170#comments Thu, 23 Jan 2014 18:36:14 +0000 http://randyhermanlaw.com/?p=170 As an attorney, there is something that I need to take into consideration with any client, which is: who is going to pay my fee? Today’s case deals primarily with the issue of attorney’s fees. I realize that this is not a topic of much interest to anyone other than attorneys. However, the case also deals with some interesting issues related to derivative suits so it is worth covering for that as well. The case is McMillan v. Ryan Jackson Properties, LLC.

Background

Corporations, as much as some people dislike the idea, are considered legal “persons.” This means that, even though they are really just groups of people, they are allowed to sue and be sued in their own names without any real person (what the law calls a “natural person”) being named in the suit. It also means, controversially, that corporations have legal and civil rights, such as the right to freedom of speech under the First Amendment. This is the reasoning behind the famous (or infamous) Citizens United decision, which held that it is a violation of the First Amendment to limit the amount of money that corporations can donate to political candidates and organizations. But I digress.

In the law, the corporation is considered to make its own decisions about who to sue and when. In reality, of course, this decision is made by real people. For a business corporation this is usually the board of directors. But the members of the board are not the only people who are affected by a decision to sue or not. The amount of the dividends that individual shareholders get on their investment is based on the value and profits of the corporation. If the corporation gets cheated by a bad deal and loses money, the shareholders may lose money.

Because of this, there are provisions that allow individual shareholders to also bring lawsuits on behalf of the corporation. This is called a derivative suit because the claim of the individual derives from the harm that has been done to the corporation as a whole.

Many derivative suits are actually brought on behalf of the corporation against the directors or officers of the corporation. This is basically a claim by the shareholder that the director or officer has mismanaged the corporation, causing the corporation (and therefore the shareholder) to lose money. A derivative suit is often needed in this situation because of course the directors, who decide on the initiation of lawsuits, are not going to authorize the corporation to sue them. However, derivative suits can also be brought against third parties where the directors for whatever reason decide not to sue.

All of the above deals with business or for-profit corporations. However, corporations may also be formed for other non-profit purposes. This may be for philanthropy, to provide social services, or to manage property that is not expected to turn a profit. Non-profit corporations are subject to a different set of laws than for-profit corporations, although they are usually parallel.  As it relates to today’s case, there are also provisions allowing for derivative suits on behalf of non-profit corporations. Today’s case arises because those provisions are invoked more rarely and therefore the rules for non-profit corporations tend not to come into court for interpretation very much.

The Case

The plaintiffs Thomas McMillan and Shawn Hendrix live in a condo building located at 220 West Market St in Greensboro. The building is owned by Ryan Jackson Properties and managed by the 220 West Market Street Condominium Association, Inc., a non-profit corporation. The plaintiffs, as condo owners, are members (shareholders) of the corporation.

The building at 220 West Market was originally an office building which became abandoned. As part of a general revitalization of downtown Greensboro, it was renovated in 2006-2007 and turned into condominiums. The work was performed by C&G, a general contractor. As far as this case is concerned, the only work done by C&G was renovation of the building interior.

In the summer of 2007, the basement of the building flooded. The plaintiffs both owned condo units in the basement of the building which were damaged by the flood. The cause of the flood is unknown, although the plaintiffs put forward several theories involving the terrain surrounding the building.

The plaintiffs brought suit on two different theories: against Ryan Jackson on their own behalf and against C&G as a derivative suit on behalf of the Condo Association. Ryan Jackson did not show up at trial and a default judgment was entered against it. This left the case only between the plaintiffs and C&G. C&G claimed that the only work it performed was to the interior of the building. Since all of the plaintiffs’ theories about the cause of the flood were related to the surrounding terrain, C&G argued that it could not be responsible for the flood. The judge agreed and dismissed the case.

The specific issue that the Court of Appeals dealt with was who should pay the plaintiffs’ attorney fees. As a general rule, each party to a lawsuit has to pay their own lawyer, regardless of who wins. However, in some specific cases, the winning party can request that their fees be paid by the losing party. This generally is where the suit was brought frivolously and is to discourage suits that are completely baseless. This “shifting” of the fee also has to be specifically authorized by statute.

The problem in this case was that although the non-profit corporation statute does have a provision allowing a prevailing party in a derivative suit to request the payment of attorney’s fees, there were no recorded cases interpreting the language of the statute. Therefore it was unclear what the language allowing the recovery of attorney fees when a suit was brought “without reasonable cause” actually meant.

The plaintiffs argued that because they had won against Ryan Jackson, albeit only because the company defaulted, there must have been reasonable cause for their lawsuit. The court said that was irrelevant. Since the action against Ryan Jackson was not a derivative suit but a totally different claim that just happened to be brought at the same time, it had no effect on the “reasonable cause” issue.

Next, the court looked at the for-profit corporation statutes. Although they have since been amended, at one point the language of the statute on derivative suits for for-profit corporations was identical to the statute for non-profit corporations. By looking at cases interpreting that for-profit corporation statute, the court decided that an action is brought “without reasonable cause” when the plaintiff could not have had a reasonable belief that there was some chance of winning.

Here, the court looked at the work actually done by C&G. Since that work consisted only of internal renovations to the building and the plaintiffs alleged that the flood of their condos was caused by terrain features outside the building, the court found that it was entirely impossible that C&G could have been responsible for the flood. Given that fact, there was no way that plaintiffs could have reasonably believed they would win. Therefore the suit was brought without reasonable cause and the plaintiffs were ordered to pay the defendant’s attorney fees.

The Bottom Line

If you are a shareholder of a for-profit corporation or a member of a non-profit corporation, and your corporation suffers some kind of loss, you may be able to sue on behalf of the corporation if the corporation decides it doesn’t want to sue on its own. However, there must be at least some reasonable chance that you will win your suit. By win, I mean actually win on the merits and not just pressure the defendant to settle out of court. If not, you may end up not only losing your case but being required to pay the defendant’s attorney fee.

If you are a shareholder considering a derivative suit, or a defendant facing one, you should always consult an attorney before making your first move. If you don’t have an attorney, feel free to contact me.

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New Rules for LLCs http://randyhermanlaw.com/?p=166 http://randyhermanlaw.com/?p=166#comments Tue, 14 Jan 2014 16:14:36 +0000 http://randyhermanlaw.com/?p=166 A new set of rules for North Carolina LLCs took effect on January 1. Since most small businesses, and many large ones, use an LLC structure to run their business, I thought it would be helpful to quickly run through some of the changes.

Changes

First I want to note that existing LLCs are not required to change anything about the way they run. The new laws have automatic provisions so that companies formed under the old laws are still valid. Nobody is legally requred to do anything. That having been said, as you will see many North Carolina companies will probably want to run their existing documents by a lawyer to see what effect the new rules will have on them.

The big change is that the new rules allow much greater flexibility to how LLCs will be structed and run. Under the old rules, you basically had two choices: your LLC could be member-managed or manager-managed. In a member-managed LLC, all the members, meaning all the owners, have authority to make decisions for the company and bind the company to contracts. With a manager-managed LLC, only the designated manager(s) has that authority. The manager could be a member or not a member.

This disctinction is now totally gone. The LLC can be run by whoever the members choose. The operating agreement will determine how the managers are chosen. You can have members that have no say over the company and only have an ownership interest. Members can sell not only their right to receive a share of the profits but also their right to vote on managers and company decisions. If you want your LLC to have a board of directors and a CEO, you can do that. Basically however you want the company to work is ok.

The other big change is that the operating agreement, the document that sets the rules for how the company is run, no longer has to be a document. It can by written, oral, or implied by conduct. You can have an oral agreement to amend a written operating agreement. You can amend the operating agreement by how you act. In other words, the courts will generally assume that however you actually run your LLC is the way you want it to be run. It is still possible to require that all amendments to the operating agreement need to be in writing, but that requirement itself needs to be in writing.

A final smaller change is that the operating agreement can now contain penalties for members who fail to uphold their obligations to the company. This can be financial penalties, loss of a vote, loss of an ownership interest, etc.

Examples

So let’s take a look at some scenarios for how all of this might work together.

Scenario 1

Let’s say you have an existing LLC with two members, you and your brother. The operating agreement says that it is a member-managed LLC and that all major decisions require the support of both members. However, you live in Asheville and your brother lives in Raleigh, which is where your store is. Therefore, you let your brother make most of the day to day decisions. You just want to have a vote to stop your brother from doing anything stupid and losing your investment.

If you go a long time, say a year, without actually voting on any decisions, a court might decide that you and your brother have made an amendment to the operating agreement, implied by your conduct, to allow your brother to be the sole manager of the company. Now you no longer have the right to vote on anything.

Scenario 2

Let’s say you have an LLC with three members: you, your brother, and your brother’s wife. The two of them do the actual running of the business but you put down most of the capital to help them get started. In exchange for this investment, they gave you a 1/3 vote. Your operating agreement states that day to day decisions can be made by majority vote but major decisions require unanimous consent. Your brother and his wife meet a sketchy investor with a bad reputation who wants to buy the business with a promissory note. You know this investor is bad news and the note will not be honored so you will all lose your money.

Your brother and his wife call a member meeting to vote on the buyout. You already know that you are going to vote no so you tell them you disagree with the buyout and don’t bother going to the meeting. At the meeting, your brother and his wife use their 2/3 voting power to amend the operating agreement. Now it says that any member that refuses to participate in the running of the company by refusing to attend member meetings will be penalized by losing their right to vote. Then they vote to sell the company.

Of course, you still have a 1/3 interest in the company so you get 1/3 of the sale price. But if the company is sold for a worthless note, you have 1/3 of nothing.

The Bottom Line

If you are a member of an existing LLC, you should have your operating agreement and other documents reviewed by an attorney to determine how these new rules could affect you. Contact your business attorney, or of course I am always available for a reasonable fee.

 

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The Arbitration Case, Decided http://randyhermanlaw.com/?p=164 http://randyhermanlaw.com/?p=164#comments Fri, 10 Jan 2014 19:45:59 +0000 http://randyhermanlaw.com/?p=164 A couple of months ago, I blogged about an upcoming Court of Appeals case regarding the intersection of arbitration and class actions. That case was decided right at the end of December and I am just getting around to reading it. The case is Elliott v. KB Home North Carolina.

Since there is some possibility I might actually end up working on this case in the future, I won’t get into too much detail. Background on the case can be found in my previous post.

Suffice it to say, my predictions were wrong on every count. First, the court held that there was no need to decide whether federal or state arbitration rules applied in this case. Since the case was brought in state court, the part of federal arbitration law dealing with when arbitration rights have been waived did not apply. The court held that that provision could only be applied in federal court. I have some concerns about this from the standpoint of the rules of federalism, but whatever.

Second, the court held that the defendant, KB Homes, had waived its right to arbitration with regard the the members of the class other than the named plaintiffs. This was so even though the class had not actually been certified until shortly before the request for arbitration was denied, meaning that those other class members had not really been part of the case prior to that point. The court held that since KB Homes had several times acknowledged that other class members might be added, it was basically acting like they were already included and therefore should have spoken up earlier regarding its intention to hold them to arbitration.

As I said, I might do some work on this case in the future so I will continue to keep the blog updated as things occur.

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Minimum Contacts for Teleworkers http://randyhermanlaw.com/?p=162 http://randyhermanlaw.com/?p=162#comments Wed, 08 Jan 2014 18:39:28 +0000 http://randyhermanlaw.com/?p=162 Even if you have done nothing wrong, having to appear in court can be an expensive proposition. You have to pay legal fees, produce documents and maybe give up some of your officers’ valuable time. If the court is somewhere other than your center of operations, the process becomes even more expensive and troublesome. Because of this, there are limits to the ability of a plaintiff to sue a defendant from another state. Today’s case explores how this works out with a plaintiff that is at least arguably a teleworker, suing his employer from another state.

Background

In order for a defendant to be required to show up in court, the court must have “personal jurisdiction” over that person. By person here, I am also including corporations, etc. The idea is that it is fundamentally unfair for a court in a state to require an appearance by someone who has no connection to that state.

Generally, the test for personal jurisdiction is called “minimum contacts.” That is, the defendant must have some minimum connection with the state such that it could reasonably expect to be sued there. Obviously for a person that lives in the state, this test is satisfied. But the courts have also held that pretty much any physical visit to the state, even a very brief one, is sufficient.

Also, for companies that sell things, if they intend their products to be sold in a particular state, they can generally be sued in that state for injuries caused by their products. This is true even if they have no stores or employees in that state.

The issue of teleworkers is fairly new so there is not a lot of case law on the subject. However, there is an argument to be made that an employer should not be subject to personal jurisdiction merely because its employee happens to live and work in a particular state, where the work is all done remotely by phone and/or internet.

This especially makes sense where the employee is the one suing the employer. If the location of the employee created personal jurisdiction, any employee could unilaterally subject its employer to suit wherever it wanted just by moving there. This would take away the fairness protection that is the reason for the personal jurisdiction rules in the first place.

The Case

The plaintiff Wheeler was the founder and president of Embark, which appears to have been basically a one-man event planning operation founded in 2007. The defendant, 1105 Media, hired Wheeler in 2011 to do event planning. Wheeler would continue to use the Embark name and would continue to be based in Mitchell County, North Carolina.

1105 Media is incorporated in Delaware, based in California, and there is no evidence that anyone from 1105 ever actually visited North Carolina. The employment contract was negotiated by phone and email. However, Wheeler’s work on behalf of 1105 was conducted mostly in North Carolina, his paycheck was direct deposited to a North Carolina bank, 1105 sent him a computer that it shipped to North Carolina, and 1105 paid for Wheeler’s office that he rented in North Carolina.

When there was a dispute over Wheeler’s employment contract, Wheeler sued 1105 Media in a North Carolina court. 1105 claimed that the court did not have personal jurisdiction over it or its officers. Its argument was largely based on the fact that nobody from 1105 had ever actually been to North Carolina. 1105 also argued that Wheeler was basically a teleworking employee, and cited several cases from other states holding that the location of a teleworking employee is not enough to create personal jurisdiction.

The court first held that Wheeler was not really a teleworker. Since he worked out of an office in North Carolina, on which 1105 paid the rent, what he had was really more like a branch office of 1105 in which Wheeler was the only employee. Therefore the concerns about teleworkers didn’t really apply. Wheeler could not simply relocate to another state, because 1105 would presumably have to approve his move and his new office.

The court next stated that, when considering personal jurisdiction, the important consideration was the connection between the plaintiff, the defendant, and the cause of action. In this case, the cause of action was the alleged breach of Wheeler’s employment contract.

As the court saw it, the contract was both to employ Wheeler and to make Embark a division of 1105. In other words, a big portion of the contract was an offer to create a North Carolina division of 1105 Media. It was therefore clear that the contract was closely connected to North Carolina. Because 1105 created a contract connected to North Carolina, it was fair to expect that it could be sued in North Carolina for breaching that contract.

The Bottom Line

Personal jurisdiction is really not much of a barrier to being sued. When everyone and everything is connected by phone, email and internet, the standard of minimum contacts becomes very easy to meet. So a company should expect that it can be sued anywhere it does any kind of business, however minimal its actual presence in that place.

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