Wake Forest Law Review
14Apr

LLC: Least Likely to Care?

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By Kyle Brantley

The time-tested principle of having “skin in the game” rings true in many aspects of life.  When individuals have something on the line to lose, they are more likely to be invested in the ultimate success of the venture at hand.  For example, a company may want to utilize an Employee Stock Ownership Plan (“ESOP”) so that employees can gain a piece of company profits and therefore potentially be more incentivized to work harder in the interest of their own personal wealth.[1]  The same basic concept of having “skin in the game” can be utilized to highlight a potential flaw of today’s most popular form of business organization: Limited Liability Companies (“LLCs”).[2]

Up until the end of the eighteenth century, almost all business entities were formed as either sole proprietorships or general partnerships.[3]  As corporations became more prevalent in the next two centuries, founders had to be extra deliberate in weighing the pros and cons of opening themselves up to the personal liability of general partnerships versus footing the bill for the “double taxation” feature of corporations.[4]  The Wyoming state legislature cracked open the door to a new option with the first domestic LLC in 1977.[5]  This brand-new form of business organization combined the best of both worlds and was predominately motivated by a desire for a lower total tax burden; notably, members of LLCs enjoy limited personal liability for both debts of the organization and tort liability of other members.[6]  In the next decade, Florida was the only other state to follow in Wyoming’s footsteps in 1982.[7]

The mid 1990s saw an elevated level of adoption, however, as eighteen states implemented LLC legislation in 1993 alone.[8]  By 1996, all fifty states had adopted LLCs as a form of entity creation.[9]  Astonishingly, 600,000 LLCs were in operation in the United States by 1999.[10]  By 2007, LLCs were indisputably “king-of-the-hill among business entities” as twice as many LLCs were organized when compared to business corporations.[11]  The quick nationwide ascension of LLC legislation at the state level was driven by innovation and competition among the states.[12]

Since LLCs essentially cut the potential tax payment of traditional corporations in half, experts have pontificated that the boon in LLCs has created “big holes in the federal corporate tax base” that will ultimately lead to sizeable revenue losses for the government.[13]  While much of the conversation around the proliferation of LLCs has focused on the diminished tax revenue, not enough attention has been given to the hundreds of thousands of businesses that have newfound limited liability protections.

Sole proprietorships and general partnerships create unlimited personal liability for the partners.[14]  The misconduct of one partner can financially ruin another partner who is not at fault for horrid behavior, potentially leading to significant tort liability.  In a business deal, however, creditors and vendors can rest assured, knowing that not only will the business assets be available in the event of nonpayment, but the personal assets of the partners will be available to repay their losses as well.  This availability of additional funds for repayment can bring more confidence to business dealings.  This full personal debt and tort liability exposure can also lead to safer behavior and less risk taking on the part of the business owners.  Since LLCs take away this personal liability, their members may be more inclined to make less prudent decisions since there is a cap on their financial exposure.  The lack of personal liability repercussions can also lead to more lackadaisical membership inclusion since the misfeasance of one member will not open up other members to personal liability.

Unfortunately, many underprivileged or underinformed communities do not have access to attorneys to help with the logistics of organizing an LLC and therefore are far more susceptible to personal liability via sole proprietorships and general partnerships.[15]  Most general partnerships in existence today are frequently businesses that are formed without legal advice.[16]  This dearth of liability protection can lead to ruined businesses, personal tragedy, and an inability to transfer wealth to the next generation.  Attorney access at the business formation stage should not be the make-or-break moment for businesses in our country. 

This blog post does not attempt to prove that more creditors have been shortchanged or that more risky deals have been undertaken because of the proliferation of LLCs.  Instead, the fact that LLCs are now the norm simply begs the question of what, if anything, the general populace and the government have gained from this relatively new business entity and whether it is equitable to have two vastly different outcomes for business owners based solely on their access to attorneys in the early stage of business formation.

[1] See Mary Josephs, Six Reasons Why Now Is a Good Time to Consider an ESOP, Forbes (May 28, 2020, 4:13 PM),  https://www.forbes.com/sites/maryjosephs/2020/05/28/six-reasons-why-now-is-a-good-time-to-consider-an-esop/?sh=41090015ef11.

[2] See generally David Gindis & Martin Petrin, Economic Analysis of Corporate Law (Apr. 10, 2020), in Encyclopedia of Law and Economics 11 (Alain Marciano & Giovanni Ramello eds.).

[3] See Susan Pace Hamill, The Story of LLCs: Combining the Best Features of a Flawed Business Structure, in Business Tax Stories 295, 304 (Foundation Press 2005).

[4] See Howard Friedman, The Silent LLC Revolution –  The Social Cost of Academic Neglect, 38 Creighton L. Rev. 35, 40 (2004).

[5] See The Complete History of the LLC, Wyoming LLC, https://www.wyomingllcs.com/history-of-the-llc/ (last visited Apr. 13, 2022).

[6] See Friedman, supra note 4, at 42.

[7] See Hamill, supra note 3, at 296.

[8] Id. at 297.

[9] Id.

[10] Id.

[11] See Rodney Chrisman, LLCs Are the New King of the Hill, 15 Fordham J. Corp. & Fin. L. 459, 460 (2010).

[12] See Hamill, supra note 3, at 303.

[13] See Hamill, supra note 3, at 309.

[14] See Friedman, supra note 4, at 40.

[15] See Andre M. Perry et al., Black-Owned Businesses in U.S. Cities: The Challenges, Solutions, and Opportunities for Prosperity, Brookings (Feb. 14, 2022), https://www.brookings.edu/research/black-owned-businesses-in-u-s-cities-the-challenges-solutions-and-opportunities-for-prosperity/.

[16] See Friedman, supra note 4, at 49.

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23Sep

Business Interruption Coverage in North Carolina: Victory Dinner for North State Deli?

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By Taylor N. Jones

As North Carolina courts resume in-person oral arguments,[1] small businesses wait to see when the significant case, North State Deli, LLC v. Cincinnati Ins. Co.,[2] will be scheduled for oral argument.  Described as a “groundbreaking and powerful win for policyholders during this era of economic devastation for small businesses,”[3] North State Deli was one of the first COVID-19-related insurance cases nationwide in which a court granted summary judgment in favor of policyholders on a business interruption claim.[4]  Sixteen restaurants (collectively “Plaintiffs”), located in the Raleigh-Durham area, filed suit against their property insurer, Cincinnati Insurance Company (“Cincinnati”).[5]  The case was heard in the Durham County Superior Court,[6] and Cincinnati has since appealed.[7]

At issue before the Superior Court were two key provisions in Plaintiffs’ “all risk” property insurance contracts: the “Business Income” and “Extra Expense” provisions.[8]  These provisions provide:

 

(1) Business Income

We will pay for the actual loss of “Business Income” . . . you sustain due to the necessary “suspension” of your “operations” during the “period of restoration.”  The “suspension” must be caused by direct “loss” to property . . . .

(2) Extra Expense

We will pay Extra Expense you sustain during the “period of restoration” . . . .[9]

 

Under the policies, “loss” is defined as “accidental physical loss or accidental physical damage.”[10]  Notably, the policies do not define “physical loss” or “physical damage.”[11]

Plaintiffs filed a motion for partial summary judgment, seeking a declaratory judgement that governmental orders and travel restrictions issued during the pandemic and the resulting restaurant closures constitute a “direct loss” under the policies.[12]  Opposing the motion, Cincinnati argued that coverage under the policies does not apply in the absence of direct physical loss of or structural alteration of the insured property.[13]  Moreover, in April 2020, Cincinnati wrote in its 10-Q filing that “no coverage exists” for COVID-19-related claims because a virus “does not produce direct physical damage or loss to property.”[14]

In ruling on Plaintiffs’ motion, the judge rejected Cincinnati’s argument that both “physical loss” and “physical damage” require alteration of the insured property.[15]  Because the policy lacked definitions for several key terms, he resorted to dictionary definitions to shed light on the terms used in the policies.[16]  The judge found “direct physical loss” could describe a “scenario where businessowners and their employees . . . lose the full range of rights . . . of using or accessing their business property.”[17]  Ultimately, because he found the language to be ambiguous,[18] and the policies do not contain a virus exclusion,[19] the judge granted Plaintiffs’ motion for partial summary judgment, requiring Cincinnati to pay business interruption coverage for losses suffered while the restaurants were closed.[20]

A combination of factors may lead the Court of Appeals to reverse the trial court’s ruling.  First, the judge failed to cite any North Carolina case law interpreting phrases similar to “accident physical loss or accident physical damage.”[21]  Notably, the judge failed to cite Harry’s Cadillac-Pontiac-GMC Truck Co., Inc. v. Motors Ins. Co.[22]  In Harry’s Cadillac, the North Carolina Court of Appeals held that a business interruption provision providing coverage in the event of “direct physical loss of or damage to property” during the “period of restoration” only applied to losses requiring building repair or replacement.[23]  Harry’s Cadillac is clearly relevant to this case, as it sheds light on the interpretation of both the Business Income and Extra Expense provisions.

Second, though the judge quoted a North Carolina case to the effect that “[t]he various terms of the policy are to be harmoniously construed, and if possible, every word and every provision is to be given effect,”[24] his interpretation does not account for the “period of restoration” language found in both the Business Income and Extra Expense provisions.  As discussed in Summit Hospitality Group, Ltd. v. Cincinnati Ins. Co.,[25] the “restoration period” terminating at the time when the property should be repaired or replaced supports Cincinnati’s argument that coverage under either the “physical loss” or the “physical damage” language requires alteration to the insured property.[26]  In the absence of physical alteration of the property, there would be nothing to restore during the “period of restoration.”[27]

Third, the ruling deviates from the vast majority of COVID-19-related business interruption rulings.[28]  Though COVID-19-related litigation throughout the country necessarily turns on the specific language of the disputed policies and the applicable state insurance laws, at the time of the judge’s order, roughly 75% of claims in the country had been dismissed by the summary judgement stage in favor of the insurer.[29]  Early cases, such as Sandy Point Dental, PC v. Cincinnati Ins. Co.,[30] held that “direct physical loss” “unambiguously requires some form of actual, physical damage to the insured premises to trigger coverage.”[31]  Cases that deviated from this line of reasoning, such as Studio 417 v. Cincinnati Ins. Co.,[32] merely allowed the insured to survive the insurance company’s Rule 12(b)(6) motion to dismiss.[33]  These cases did not make the substantial leap of granting summary judgment in favor of the insureds.[34]

Fourth, and finally, most subsequent cases have rejected the decision in North State Deli.[35]  Notably, three such cases which dismissed the ruling as a minority view involved similar policies issued by Cincinnati.[36]  Pulling no punches, in Kevin Barry Fine Art Associates v. Sentinel Ins. Co.,[37] the United States District Court for the Northern District of California rejected North State Deli as “not persuasive,” “[d]ue to its lack of analysis and the vast majority of courts contradicting this finding.”[38]  The overwhelming lack of support for the case and such harsh criticism may prove decisive as the North Carolina Court of Appeals hears the case on appeal.

Mike Causey, North Carolina’s Insurance Commissioner, cautioned businesses in April 2020 that, “Standard business interruption policies are not designed to provide coverage for viruses, diseases, or pandemic-related losses because of the magnitude of the potential losses.”[39]  In his letter to the business community, he wrote, “We can’t legally force insurers to cover a risk which they didn’t intend to cover . . . .”[40]  Though the North State Deli case has not yet been placed on the Court of Appeals’ publicly available calendar,[41] it will be an important case with implications for both small business owners and the insurance industry.  As one federal magistrate judge cogently summarized the competing values, “The Court is sympathetic to the difficult and unprecedented circumstances facing Plaintiffs and similar businesses.  But at face value, COVID-19 harms people and not property.”[42]

[1] Press Release, North Carolina Judicial Branch, Court of Appeals to Resume In-Person Oral Arguments in August (July 27, 2021), https://www.nccourts.gov/news/tag/press-release/court-of-appeals-to-resume-in-person-oral-arguments-in-august. 

[2] No. 20-CVS-02569, 2020 N.C. Super. LEXIS 38 (Oct. 7, 2020), appeal docketed, No. 21-293 (N.C. Ct. App. June 09, 2021).

[3] Paynter Law Secures Landmark Victory: NC Court Finds Cincinnati Insurance Must Pay Business Interruption Coverage to 16 Area Restaurants for COVID-related Government Shutdown Orders, Paynter Law, https://www.paynterlaw.com/covid-19-business-insurance-litigation/ (last visited Sept. 23, 2021).

[4] See id. (describing the North State Deli case as “the first case in the country requiring an insurance company to pay” business interruption losses and referencing key documents in the case including the order granting partial summary judgment).

[5] Id.

[6] See N. State Deli, 2020 N.C. Super. LEXIS 38.

[7] See Kimberly Marston, Appeal Information Statement: Case: N. State Deli, LLC v. The Cincinnati Ins. Co. (21-293) Civil, N.C. Supreme Ct. & Ct. Appeals Elec. Filing Site & Document Libr., https://www.ncappellatecourts.org/ais-view.php?sDocketNumber=21-293 (last visited Sept. 23, 2021).  Plaintiffs sought immediate review by the Supreme Court of North Carolina through a petition for discretionary review before determination by the Court of Appeals under N.C. Gen. Stat. § 7A-31(b), but this motion was dismissed by the Supreme Court of North Carolina in an unpublished opinion. N. State Deli, LLC v. Cincinnati Ins. Co., No. 225P21-1, 2021 N.C. LEXIS 783 (Aug. 10, 2021).

[8] N. State Deli, 2020 N.C. Super LEXIS 38, at *3.

[9] Id.

[10] Id. 

[11] Id. at *3–4.

[12] See Memorandum in Support of Plaintiffs’ Motion for Partial Summary Judgment at 28, N. State Deli, LLC v. Cincinnati Ins. Co., No. 20-CVS-02569, 2020 N.C. Super. LEXIS 38 (Oct. 7, 2020), https://www.paynterlaw.com/content/uploads/2020/10/2020-08-17-Memo-ISO-Plaintiffs-Motion-for-Partial-Summary-Judgment.pdf.

[13] See Defendant The Cincinnati Insurance Company’s Memorandum of Law in Opposition to Plaintiffs’ Motion for Partial Summary Judgment at 39, N. State Deli, LLC v. Cincinnati Ins. Co., No. 20-CVS-02569, 2020 N.C. Super. LEXIS 38 (Oct. 7, 2020), https://www.paynterlaw.com/content/uploads/2020/10/2020-09-17-Defs-Opp-to-Mot-for-Partial-Summary-Judgment.pdf.  

[14] The Cincinnati Ins. Co., Quarterly Report (Form 10-Q) (Apr. 27, 2020), https://cincinnatifinancialcorporation.gcs-web.com/static-files/787fd5db-ee48-474b-98b1-4d7186fa8fb5.  

[15] N. State Deli, 2020 N.C. Super LEXIS 38, at *8.

[16] Id. at *5–7.

[17] Id. at *7.

[18] Id. at *8.  Finding the language to be ambiguous, the judge gave the terms “the reasonable definition which favors coverage.” See Accardi v. Hartford Underwriters Ins. Co., 373 N.C. 292, 295 (2020).

[19] N. State Deli, 2020 N.C. Super LEXIS 38, at *9.

[20] Id. at *10.

[21] Paul Ferland, North Carolina Court Finds Coverage for Restaurants’ COVID-19 Business Income Losses, JD Supra (Oct. 26, 2020), https://www.jdsupra.com/legalnews/north-carolina-court-finds-coverage-for-68500/.

[22] 126 N.C. App. 698 (1997).

[23] Id. at 700, 701–02.

[24] N. State Deli, 2020 N.C. Super LEXIS 38, at *8 (citing C. D. Spangler Constr. Co. v. Indus. Crankshaft & Eng’g Co., 326 N.C. 133, 152 (1990)).

[25] No. 5:20-CV-254-BO, 2021 U.S. Dist. LEXIS 40613 (E.D.N.C. Mar. 4, 2021).

[26] Id. at *9.

[27] See Oral Surgeons, P.C. v. Cincinnati Ins. Co., No. 20-3211, 2021 U.S. App. LEXIS 19775, at *5–6 (8th Cir. July 2, 2021).

[28] Rachel E. Keen & Jonathan Reid Reich, COVID-19 Shutdowns, Related Litigation Put Pressure on Business Interruption Insurers, The Nat’l L. Rev. (Oct. 26, 2020), https://www.natlawreview.com/article/covid-19-shutdowns-related-litigation-put-pressure-business-interruption-insurers.

[29] Id.

[30] 488 F. Supp. 3d 690 (N.D. Ill. 2020).

[31] See, e.g., id. at 693.

[32] 478 F. Supp. 3d 794 (W.D. Mo. 2020).

[33] See, e.g., id. at 805.

[34] Id. (denying Cincinnati’s motion to dismiss but stating that Cincinnati could reassert its argument at the summary judgment stage).

[35] See Chelsea Ventures, LLC v. Cincinnati Ins. Co., No. 20-13002, 2021 U.S. Dist. LEXIS 114907 (E.D. Mich. June 21, 2021); Dino Drop, Inc. v. Cincinnati Ins. Co., No. 20-12549, 2021 U.S. Dist. LEXIS 114891 (E.D. Mich. June 21, 2021); Akridge Fam. Dental v. Cincinnati Ins. Co., No. 1:20-00427-JB-B, 2021 U.S. Dist. LEXIS 99312 (S.D. Ala. May 06, 2021); Hamilton Jewelry, LLC v. Twin City Fire Ins. Co., No.: 8:20-cv-02248-PWG, 2021 U.S. Dist. LEXIS 176430 (D. Md. Sept. 16, 2021); Infinity Real Est., LLC v. Travelers Excess & Surplus Lines Co., No. 20-6398, 2021 U.S. Dist. LEXIS 173912 (E.D. Pa. Sept. 12, 2021); Goodwood Brewing, LLC v. United Fire Grp., No. 3:20-CV-306-RGJ, 2021 U.S. Dist. LEXIS 131094 (W.D. Ky. July 13, 2021); Deer Mountain Inn LLC v. Union Ins. Co., No. 1:20-cv-0984-BKS-DJS, 2021 U.S. Dist. LEXIS 97602 (N.D.N.Y. May 24, 2021); Hair Studio 1208, LLC v. Hartford Underwriters Ins. Co., No. 20-2171, 2021 U.S. Dist. LEXIS 91960 (E.D. Pa. May 14, 2021); Tria WS LLC v. Am. Auto. Ins. Co., No. 20-4159, 2021 U.S. Dist. 60500 (E.D. Pa. Mar. 30, 2021); Kevin Barry Fine Art Assocs. v. Sentinel Ins. Co., 513 F. Supp. 3d 1163 (N.D. Cal. Jan. 13, 2021).  But see Henderson Rd. Rest. Sys. v. Zurich Am. Ins. Co., 513 F. Supp. 3d 808 (N.D. Ohio Jan. 19, 2021); Atwells Realty Corp. v. Scottsdale Ins. Co., No. PC-2020-04607, 2021 R.I. Super. LEXIS 49 (June 4, 2021).

[36] Chelsea Ventures, 2021 U.S. Dist. LEXIS 114907; Dino Drop, 2021 U.S. Dist. LEXIS 114891; Akridge Fam. Dental, 2021 U.S. Dist. LEXIS 99312.

[37] 513 F. Supp. 3d 1163.

[38] Id. at 1170 n.1.

[39] Letter from Mike Causey, N.C. Ins. Comm’r, N.C. Dep’t of Ins., to Business Owner (Apr. 17, 2020), https://www.ncdoi.gov/media/1360/open.

[40] Id.

[41] See Court of Appeals – Oral Arguments Calendar, North Carolina Judicial Branch, https://appellate.nccourts.org/calendar.php?court=2 (last visited Sept. 23, 2021).

[42] Memorandum and Recommendation at 13, FS Food Grp., LLC v. Cincinnati Ins. Co., No. 3:20-CV-00588-RJC-DSC (W.D.N.C. Mar. 18, 2021).

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16Sep

SPAC ATTACK: The Boom (and Bust?) of the Capital Vehicle Du Jour

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By Michael J. Riedl

 

Shaquille O’Neal.  Patrick Mahomes.  Serena Williams.  Alex Rodriguez.  No, this is not a reading of the guest list at the 2021 ESPY Awards,[1] but rather a list of athletes on the management or advisory boards of various Special Purpose Acquisition Companies (“SPACs”).[2]  SPACs, far from a novel financial vehicle,[3] grew to prominence over the past few years as record numbers of SPACs listed on exchanges across the globe.[4]  The capital flooding into SPACs reached a high watermark when investor William Ackman raised $4 billion for his fund, Pershing Square Tontine Holdings (“PSTH”), in July 2020.[5]  However, issuance[6] dramatically slowed towards the end of 2020,[7] and the valuation of SPACs both pre- and post-business combination fell precipitously.[8]

In a nutshell, SPACs are capital vehicles for purchasing equity ownership in a private company and then bringing that company public through a business combination.[9]  SPACs raise money through a fairly traditional Initial Public Offering (“IPO”), with a few key differences.[10]  Unlike a traditional IPO, in which the company uses the proceeds from the issuance for further growth or expansion, SPAC IPO proceeds are held in a trust account until a merger with a private company occurs.[11]  Additionally, most SPACs issue warrants (the right to purchase shares of the SPAC at a certain price)[12] at the time of the IPO to investors and SPAC sponsors.[13]  Lastly, because SPAC IPOs are not taking an existing company public at the time of IPO, reporting and regulatory requirements are significantly lessened.[14]

In the early stages of the SPAC resurgence, both issuance and post-business combination valuation remained healthy.[15]  For example, after combining with VectoIQ Acquisition Corp.,[16] the hydrogen vehicle start-up Nikola soared to a market capitalization of $34 billion—on almost no revenue.[17]  However, investors soon learned that Nikola’s groundbreaking hydrogen truck was rolling downhill in a demonstration and not moving on its own power.[18]  Nikola’s CEO at the time, Trevor Milton, was subsequently indicted for securities and wire fraud.[19]  In addition, the “SPAC King,” Chamath Palihapitiya, who has led ten SPAC IPOs,[20] ran into significant investor pushback after the Securities and Exchange Commission (“SEC”) launched an investigation into one of his SPAC combinations.[21]

Outside of the concern about the quality of the companies that SPACs are bringing public,[22] the decline in SPAC activity may result from a change in guidance from the SEC,[23] recent investor behavior,[24] and an uptick in shareholder litigation.[25] On April 12, 2021, the SEC issued guidance that the warrants issued by a vast majority of SPACs should be classified as liabilities on financial statements, not as equity instruments.[26]  This guidance was based on the consideration that, when sponsor warrants are transferred by sponsors to non-sponsors, their settlement price changes in ways not indexed to the SPAC’s underlying price.[27]  This change in guidance led to a rush of SPACs to file Form 8-Ks to update their previous filings.[28]

More recently, SPACs have been hit by a wave of redemptions prior to business combination.[29]  SPACs are required to offer shareholders the ability to redeem their shares before the official merger between the entities for a pro-rata share of the money in the trust account.[30]  This requirement has been said to make SPACs a relatively low-risk investment, at least before business combination.[31]  For example, a shareholder who purchased ten shares of a SPAC IPO priced at ten dollars per share can redeem their shares for one hundred dollars pre-combination.  However, in recent months, redemption rates have skyrocketed, with some SPACs seeing redemption rates over 50 percent, and Sandbridge Acquisition Corp. (“SBG”) having a redemption rate of 86 percent.[32]  Curiously, these redemptions are happening after shareholders—many of whom will later redeem—approve the business combination.[33]  One can only assume that investors want to get their money out of the SPAC as quickly, and at as high of a price, as possible.

Besides the apparent effects on investor sentiment, one consequence of the high redemption rate is that the amount of money held in trust by some SPACs have fallen below the minimum capital requirement set by the SPAC.[34]  Because investors can redeem their shares for the cash held in trust prior to business combination, a minimum capital requirement is typically structured into SPAC mergers to allow the target company an “out” when the capital they were expecting to get no longer exists.[35] For example, SBG, with its 86 percent redemption rate,[36] was $125 million short of its minimum capital requirement.[37]  However, the company they merged with, Owlet Baby Care, Inc., waived the capital requirement  in order to consummate the deal.[38]  For investors that did not redeem, this meant they were left owning equity in a company with significantly less capital to grow their business.[39]  Should the high redemption trend continue, it might further be a headwind on new SPAC issuance, since investors may lack confidence in SPACs and private companies may see SPAC mergers as increasingly risky.

Lastly, and perhaps most importantly, shareholders are beginning to bring derivative suits against SPACs.[40]  Most actions have been brought regarding falling share prices, where investors allege that the company mislead investors.[41]  However, after Mr. Ackman’s fund, PSTH, failed to acquire an equity stake in Universal Music Group due to the likelihood of violating SEC regulations,[42] an investor brought suit alleging the fund was an “Investment Company.”[43]  Such a lawsuit, according to Mr. Ackman, will “have a chilling effect on the ability of other SPACs to consummate merger transactions or to engage in IPOs until the litigation is resolved.”[44]

At the heart of the suit is whether Mr. Ackman’s fund, and SPACs writ large, is an Investment Company as classified by the Investment Company Act of 1940, 15 U.S.C. §§ 80a-1 to 64.[45]  The plaintiff’s lawyers allege that PSTH invested in short-term U.S. Treasuries which qualifies them as an Investment Company.[46]  If so, the sponsor warrants and other compensation structures that are ubiquitous in the SPAC industry could be found to violate the Investment Company Act.[47]  In a rebuke to this assertion, fifty-eight of the largest law firms in the world signed a joint statement stating that they “view the assertion that SPACs are investment companies as without factual or legal basis.”[48]  It is the view of the collective firms that SPACs are “engaged primarily in identifying and consummating a business transaction,” not a company that is “primarily, in the business of investing, reinvesting or trading in securities.”[49]

Regardless of how the merits of the lawsuit turn out, it has already affected Mr. Ackman’s SPAC, as he plans to return the $4 billion that he raised.[50]  However, Mr. Ackman is already looking to create another capital vehicle called a Special Purpose Acquisition Rights Company (“SPARC”).[51]  Unlike a SPAC, which requires investors to purchase shares at an IPO, a SPARC does not require such an investment.[52]  A SPARC issues warrants which grant rights, but not obligations, for warrant holders to purchase shares in a proposed future business combination.[53]  This has the benefit of allowing investors to put their capital to work in other investments while the SPARC seeks a merger target.[54]  Whether or not this new capital vehicle gets approved is ultimately up to the SEC and the New York Stock Exchange.[55]  However, one thing is clear, even if the SPAC boom has officially faded, sophisticated investors will continue to financially engineer capital vehicles to pursue business combinations.

[1]See Press Release, Isabelle Lopez, ESPN, Nominees Announced for The 2021 ESPYS Presented by Capital One as Fan Voting Begins, (June 16, 2021) https://espnpressroom.com/us/press-releases/2021/06/nominees-announced-for-the-2021-espys-presented-by-capital-one-as-fan-voting-begins/.

[2] Amrith Ramkumar, The Celebrities From Serena Williams to A-Rod Fueling the SPAC Boom, Wall St. J. (Mar. 17, 2021, 5:32 AM), https://www.wsj.com/articles/the-celebrities-from-serena-williams-to-a-rod-fueling-the-spac-boom-11615973578.

[3] See Devin Sullivan, A Look at SPACs: From the 90s to Covid-19, IR Magazine (Aug. 11, 2020), https://www.irmagazine.com/small-cap/look-spacs-90s-covid-19.

[4] Id.

[5] Tomi Kilgore, Billionaire Bill Ackman Has a $4 Billion ‘Blank Check’ to Buy a Company, but He Hasn’t Said Which One, MarketWatch (July 23, 2020, 7:40 AM), https://www.marketwatch.com/story/billionaire-bill-ackman-has-a-4-billion-blank-check-to-buy-a-company-but-he-hasnt-said-which-one-2020-07-22.

[6] Adam Hayes, Issue, Investopedia, https://www.investopedia.com/terms/i/issue.asp (Aug. 30, 2021).

[7] See Ben Scent, Wall Street’s $100 Billion SPAC Boom Upends the League Tables, Bloomberg, https://www.bloomberg.com/news/articles/2021-04-01/wall-street-s-100-billion-spac-boom-is-resetting-the-rankings (Apr. 1, 2021, 4:10 PM).

[8] Yun Li, SPACs are becoming less of a sure thing as the deals get stranger, shares roll over, CNBC, https://www.cnbc.com/2021/03/04/spacs-are-becoming-less-of-a-sure-thing-as-the-deals-get-stranger-shares-roll-over.html (Mar. 4, 2021).

[9] Ramey Layne & Brenda Lenahan, Special Purpose Acquisition Companies: An Introduction, Harv. L. Sch. Forum on Corp. Governance (July 6, 2018), https://corpgov.law.harvard.edu/2018/07/06/special-purpose-acquisition-companies-an-introduction/.

[10] Id.

[11] Id.

[12] James Chen, Warrant, Investopedia, https://www.investopedia.com/terms/w/warrant.asp (Aug. 8, 2021).

[13] Joel L. Rubenstein et al., Clarity Emerges in the Aftermath of the SEC Statement on SPAC Warrant Accounting: A Roadmap for the Changes to Permit Equity Classification, White & Case LLP (June 1, 2021), https://www.whitecase.com/publications/alert/clarity-emerges-aftermath-sec-statement-spac-warrant-accounting-roadmap-changes.

[14] Layne & Lenahan, supra note 9.

[15] See Nicholas Jasinski, Why Nikola Decided to Merge With a SPAC. And Why More Such Deals Are Coming., Barron’s (Aug. 2, 2020, 8:00 AM), https://www.barrons.com/articles/after-the-sept-11-attacks-how-barrons-helped-investors-navigate-a-changed-world-51630604795.

[16] Press Release, Nikola Corporation, Nikola and VectoIQ Acquisition Corp. Announce Closing of Business Combination (June 2, 2020), https://nikolamotor.com/press_releases/nikola-and-vectoiq-acquisition-corp-announce-closing-of-business-combination-77.

[17] Edward Ludlow & Craig Trudell, Nikola May Not Be Next Tesla, But Its Valuation Is More Extreme, Bloomberg, https://www.bloomberg.com/news/articles/2020-06-09/meet-nikola-a-26-billion-electric-truck-maker-with-no-revenue (June 10, 2020, 11:15 PM).

[18] Timothy B. Lee, Nikola Admits Prototype Was Rolling Downhill in Promotional Video, Ars Technica (Sept. 14, 2020, 1:58 PM), https://arstechnica.com/cars/2020/09/nikola-admits-prototype-was-rolling-downhill-in-promotional-video/; see also Nikola: How to Parlay An Ocean of Lies Into a Partnership with the Largest Auto OEM in America, Hindenburg Rsch. (Sep. 10, 2020), https://hindenburgresearch.com/nikola/.

[19] Michael Wayland, Grand Jury Indicts Trevor Milton, Founder of Electric Carmaker Nikola, on Three Counts of Fraud, CNBC, https://www.cnbc.com/2021/07/29/us-prosecutors-charge-trevor-milton-founder-of-electric-carmaker-nikola-with-three-counts-of-fraud.html (July 29, 2021, 4:16 PM).

[20] David Pogemiller, Chamath and Social Capital’s 4 New SPACs IPO Today, TheStreet, https://www.thestreet.com/boardroomalpha/spac/chamath-spac-king-dnaa-dnab-dnac-dnad-ipo (June 30, 2021) (NASDAQ: DNAA, DNAB, DNAC, DNAD; NYSE: IPOA, IPOB, IPOC, IPOE, IPOD, IPOF).

[21] See Zeke Faux, The SPAC King Is Doing Just Fine Even as the Bubble Starts to Burst, Bloomberg Businessweek (Mar. 13, 2021, 5:00AM), https://www.bloomberg.com/news/features/2021-05-13/spac-king-chamath-palihapitiya-hopes-his-hype-will-keep-mesmerizing-you.

[22] Li, supra note 8.

[23] Yun Li, SPAC Transactions Come to a Halt Amid SEC Crackdown, Cooling Retail Investor Interest, CNBC, https://www.cnbc.com/2021/04/21/spac-transactions-come-to-a-halt-amid-sec-crackdown-cooling-retail-investor-interest.html (Apr. 22, 2021, 9:35 AM).

[24] See infra note 29 and accompanying text.

[25] See infra note 40 and accompanying text.

[26] John Coates & Paul Munter, Staff Statement on Accounting and Reporting Considerations for Warrants Issued by Special Purpose Acquisition Companies (“SPACs”), SEC (Apr. 12, 2021), https://www.sec.gov/news/public-statement/accounting-reporting-warrants-issued-spacs.

[27] Rubenstein et al., supra note 13.

[28] See Coates & Munter, supra note 26.

[29] David Pogemiller, A SPAC Risk Exposed?, TheStreet (July 16, 2021), https://www.thestreet.com/boardroomalpha/spac/spac-risk-exposed-redemptions-sponsor-promote.

[30] Layne & Lenahan, supra note 9.

[31] See Pogemiller, supra note 29.

[32] Id.

[33] David Drapkin, Spring Valley / AeroFarms Need More Capital, TheStreet (Aug. 30, 2021), https://www.thestreet.com/boardroomalpha/spac/spacs-sv-snooze-september.

[34] Pogemiller, supra note 29.

[35] See Pamela Marcogliese et al., 20 Key Considerations for Private Companies Evaluating Whether to Be Acquired by a SPAC, Freshfields Bruckhaus Deringer LLP (July 27, 2020), https://blog.freshfields.us/post/102gcbg/20-key-considerations-for-private-companies-evaluating-whether-to-be-acquired-by.

[36] See Pogemiller, supra note 29.

[37] See Sandbridge Acquisition Corp., Current Report (Form 10-K, Item 8.01) (July 14, 2021) (At a special meeting of stockholders, 19,758,773 shares of common stock were presented for redemption, which left $15 million of “Available Sandbridge Cash.” The agreement with Owlet Baby Care, Inc., provided Owlet the option to leave the deal if, after redemption, Sandbridge did not have $140 million in cash.).

[38] See Sandbridge Acquisition Corp., Current Report (Form 10-K, Exhibit 99.1) (July 14, 2021), https://sec.report/Document/0001140361-21-024354/brhc10026886_ex99-1.htm.

[39] See Pogemiller, supra note 29.

[40] Jean Eaglesham, SPACs Are Having Their Day—in Court, Wall St. J. (Aug. 25, 2021, 7:00 AM), https://www.wsj.com/articles/spacs-are-having-their-dayin-court-11629889200.

[41] Id.

[42] Thomas Seal & Nishant Kumar, Ackman Abandons Universal Music SPAC Deal After SEC Backlash, Bloomberg, https://www.bloomberg.com/news/articles/2021-07-19/pershing-square-decides-not-to-proceed-with-universal-music-deal (July 19, 2021, 8:49 AM).

[43] Complaint at 6, Assad v. Pershing Square Tontine Holdings, Ltd., No. 1:21-cv-06907 (S.D.N.Y.  Aug. 17, 2019), ECF No. 1.

[44] Press Release, William A. Ackman, CEO, Pershing Square Tontine Holdings, Ltd., Pershing Square Tontine Holdings, Ltd. Releases Letter to Shareholders (Aug. 19, 2021), https://pstontine.com/wp-content/uploads/2021/08/8.19.2021-Press-Release-PSTH-Letter-to-Shareholders.pdf.

[45] Assad, supra note 31, at 6.

[46] Id. at 10–11.

[47] Id. at 43, 47.

[48] Press Release, Sidley Austin LLP, Over 55 of the Nation’s Leading Law Firms Respond to Investment Company Act Lawsuits Targeting the SPAC Industry (Aug. 30, 2021), https://www.sidley.com/-/media/update-pdfs/2021/08/joint-statement.pdf?la=en.

[49] Id.

[50]Ackman, supra note 44, at 2.

[51] Andrew Ross Sorkin et al., Bill Ackman’s SPAC Deal Gets Messier, N.Y. Times, https://www.nytimes.com/2021/08/20/business/dealbook/bill-ackman-spac-sparc.html (Aug. 20, 2021).

[52] Id.

[53] See, e.g., Press Release, Pershing Square Tontine Holdings, Ltd., Pershing Square Tontine Holdings, Ltd. (“PSTH”) to Acquire 10% of the Ordinary Shares of Universal Music Group (“UMG”) from Vivendi S.E. for Approximately $4 Billion, Representing an Enterprise Value of €35 Billion (June 20, 2021), https://pstontine.com/wp-content/uploads/2021/06/Final-Announcement-Press-Release-6.20.2021.pdf.

[54] Id. at 5.

[55] Sorkin et al., supra note 51.

Post image by Ken Teegardin on Flickr

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8Apr

COVID-19: N.C. Governor’s Order Enables Remote Shareholder Meetings During Pandemic

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By Matthew Hooker

           For the duration of the COVID-19 emergency, North Carolina corporations may conduct shareholders’ meetings completely via remote communication technology, pursuant to an executive order by Governor Roy Cooper.[1] This order temporarily resolves an ambiguity in the North Carolina Business Corporation Act pertaining to remote participation in shareholders’ meetings, allowing North Carolina corporations to address pressing business matters without raising concerns about the validity of actions taken at wholly virtual shareholders’ meetings.[2]

            The global crisis stemming from the COVID-19 pandemic[3] has brought the global, national, and local economies to a collective screeching halt.[4] For those businesses that have sought to continue operations, those operations now look vastly different. In the United States, currently at least forty-two states, the District of Columbia, and Puerto Rico (together representing around 316 million people) are under various forms of “stay-at-home” orders.[5] Now that avoiding even small groups and staying at home have become the new normal, virtual conferencing platforms using video and screen sharing technology have quickly emerged as vitally necessary to businesses’ continued operations.[6]

            Corporations in North Carolina have been forced to deal with the question of whether shareholders’ meetings may be conducted completely remotely and still be valid under North Carolina law. As drafted, the North Carolina Business Corporation Act is not entirely clear on this issue; it can be interpreted as providing that a valid shareholders’ meeting may only be held at a physical location. To illustrate, the Act refers to holding both annual and special meetings “in or out of this State at the place stated in or fixed in accordance with the bylaws”[7] and requires that a valid notice of a meeting include the “place” of the meeting.[8] Under certain circumstances, the Act allows shareholders to participate and vote in those meetings “by means of remote communication.”[9] But the Act is silent as to whether the entire meeting may be held virtually with no physical place of meeting.[10]

            To bring clarity to this issue in light of the COVID-19 pandemic and the need for business to be conducted remotely as much as possible, North Carolina Governor Roy Cooper issued an executive order on April 1, 2020 authorizing and encouraging remote shareholders’ meetings.[11] This order appears to apply equally to annual meetings and special meetings. Under the order, a corporation’s board of directors may determine that all or part of a shareholders’ meeting may be held solely via remote communication.[12] This type of remote shareholders’ meeting is permissible under two conditions: (1) shareholders must be allowed to participate and vote under the existing remote participation and voting statute,[13] and (2) all shareholders must have the right to participate in the meeting via remote communication.[14] Governor Cooper’s executive order resolves the ambiguity of the North Carolina Business Corporation Act by providing that a “place” of a meeting within the meaning of the Act can include a meeting where all shareholders participate through remote communication (i.e., there is no physical “place” of the meeting).[15]

            But the order goes even further. It also permits a corporation’s board of directors to limit the number of attendees physically present at a shareholders’ meeting in order to ensure conformity to other state gathering restrictions.[16] In other words, it appears that not only may a board of directors call for a completely remote shareholders’ meeting, but the board could also hold a meeting at a physical place but then prohibit shareholders from physically attending and force shareholders to attend remotely.

            This executive order provides North Carolina corporations with clarity during the COVID-19 crisis. It enables them to conduct meetings and business that involve shareholders without fear that actions taken at a remotely held shareholders’ meeting will be deemed void.[17] In the midst of a global crisis such as COVID-19, it is important that corporations can continue to operate as best as they can without compromising the health and safety of shareholders, among others.

            However, not only does Governor Cooper’s order resolve this important issue for corporations as long as the COVID-19 emergency lasts, but it also reveals that the North Carolina Business Corporation Act needs updating. The current version of the North Carolina Business Corporation Act was enacted in 1989 and thus does not comprehend many of the vast technological shifts and developments of the 21st century.[18] Although the Act was amended in 2013 to allow shareholders to remotely participate in shareholders’ meetings,[19] the addition of that provision only explicitly allows remote participation; the Act overall still seems to contemplate some sort of physical location where the meeting is actually held. If anything, that 2013 amendment creates ambiguity rather than resolving confusion. Interestingly enough, Governor Cooper’s executive order actually concludes by advising that the order should not be construed or interpreted as suggesting that a shareholders’ meeting held wholly via remote communication would not otherwise be valid if not for the executive order.[20] Thus, even Governor Cooper’s order seems to subtly acknowledge the lack of clarity within the North Carolina Business Corporation Act on this matter.

            The world has changed greatly since 1989—and even since 2014. With key provisions of the North Carolina Business Corporation Act now over three decades old, it may be time for the North Carolina legislature to revisit the Act. Modern technology has opened up a world of possibilities for corporations, and the Act should reflect that. Remote communication options are just one example. These technologies are becoming increasingly prevalent and dependable—even when no global health crisis exists—and the law should not inhibit progress in the corporate context. In fact, Delaware has long permitted shareholders’ meetings to be held solely via remote communication.[21] Amending the North Carolina Business Corporation Act will align North Carolina with other leading states in corporate law. Ultimately, this will enhance North Carolina’s viability as a modern, attractable location for entity incorporation as well as facilitate existing domestic corporation’s continued leverage of the digital world.

[1] See N.C. Exec. Order No. 125 (Roy Cooper, Governor) (Apr. 1, 2020), https://files.nc.gov/governor/documents/files/EO125-Authorizing-Encouraging-Remote-Shareholder-Meetings.pdf.

[2] See id. § 1(A).

[3] See WHO Director-General’s opening remarks at the media briefing on COVID-19 – 11 March 2020, World Health Org. (Mar. 11, 2020), https://www.who.int/dg/speeches/detail/who-director-general-s-opening-remarks-at-the-media-briefing-on-covid-19—11-march-2020.

[4] See, e.g., Harriet Torry & Anthony DeBarros, WSJ Survey: Coronavirus to Cause Deep U.S. Contraction, 13% Unemployment, Wall St. J. (Apr. 8, 2020, 10:00 AM), https://www.wsj.com/articles/wsj-survey-coronavirus-to-cause-deep-u-s-contraction-13-unemployment-11586354400.

[5] Sarah Mervosh et al., See Which States and Cities Have Told Residents to Stay at Home, N.Y. Times, https://www.nytimes.com/interactive/2020/us/coronavirus-stay-at-home-order.html (last updated Apr. 7, 2020).

[6] See, e.g., Akanksha Rana & Arriana McLymore, Teleconference Apps and New Tech Surge in Demand Amid Coronavirus Outbreak, Reuters (Mar. 13, 2020, 3:33 PM), https://www.reuters.com/article/us-health-coronavirus-teleconference/teleconference-apps-and-new-tech-surge-in-demand-amid-coronavirus-outbreak-idUSKBN21033K.

[7] N.C. Gen. Stat. §§ 55-7-01(b), 55-7-02(c) (2019).

[8] Id. § 55-7-05(a).

[9] Id. § 55-7-09(a).

[10] Cf. § 55-7-05(a) (requiring notice of the place of the shareholders’ meeting).

[11] See N.C. Exec. Order No. 125, supra note 1.

[12] Id. § 1(A).

[13] See N.C. Gen. Stat. § 55-7-09.

[14] N.C. Exec. Order No. 125, supra note 1, at § 1(A)(1)–(2).

[15] See id. § 1(B)(2).

[16] Id. § 1(B)(3).

[17] See id. § 1(C).

[18] See 1989 N.C. Adv. Legis. Serv. 265 (LexisNexis).

[19] See N.C. Gen. Stat. § 55-7-09 (2019); 2013 N.C. Adv. Legis. Serv. 153 (LexisNexis).

[20] See N.C. Exec. Order No. 125, supra note 1, at § 1(D).

[21] See Del. Code Ann. tit. 8, § 211(a) (2020).

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19Nov

The Golden Parachute – With Some Strings Attached: WeWork ex-CEO Faces Lawsuits After Shareholder Value Drops $30 Billion

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By Matt Digney

The “Golden Parachute” is a term that startup entrepreneurs and CEOs are familiar with and seemingly all pursue in one way or another.[1] A typical “Golden Parachute” scenario plays out when the executives of a company – typically a startup – are dismissed after their company is bought out, but receive massive departure packages that can measure well into the billions of dollars.[2] While a massive payday and a seat on the Board of Directors of the new entity may seem like a swift and easy transition into an early retirement, not all goes as planned all of the time, because this process can sometimes leave minority shareholders in a much worse position than they expected to be in. Just ask WeWork ex-CEO Adam Neumann.

In one of the most highly publicized IPO failures in recent memory, WeWork, a commercial real estate company which is a self-described community of shared co-working spaces,[3] saw its value plummet by over 66% after its IPO failed to get off the ground, leading to a bailout that some described as a “fire sale.”[4] In a timespan of less than 10 months, WeWork went from having a valuation of $47 billion to needing a bailout in the form of an $8 billion cash infusion from one of its largest investors, Softbank, to stay afloat.[5] Softbank is a multinational conglomerate group which, through its “vision fund,” had already been one of WeWork’s largest investors, funding billions of dollars to the business. The “fire sale” bailout in question occurred in the eleventh hour to stop WeWork from completely collapsing, and it resulted in Softbank essentially taking control over WeWork at an extremely discounted price. This bailout resulted in a valuation decrease of almost $40 billion, with shareholders and investors assuming $35 billion of that loss.[6]

Despite being the driving force behind one of the largest and most highly publicized IPO flops in recent history, former CEO Adam Neumann managed to make a quick and profitable escape from the sinking ship, with a $1.7 billion exit package, coupled with a $185 million consulting contract paid out by Softbank.[7] This exit did not proceed without some controversy, as many people were not on board with the modern, celebrity-like CEO long before the collapse of the IPO.[8]

Neumann had been no stranger to controversial leadership techniques, as he was known for shelling out top dollar for mandatory company retreats that featured celebrity performers, costing the company millions.[9] More controversial decisions included massive investments using company funds into an indoor wave pool business and a “superfood” business owned by one of his friends whom he met surfing.[10]

But the allegations of mismanagement do not end there.[11] Reports from Business Insider show some of Neumann’s “antics” including smoking marijuana on a private jet, serving tequila shots immediately following layoff discussions with employees, and attempted to trademark the word “We” for himself, before causing the company to purchase the trademark application for just under $6 million.[12] This “mismanagement” did not go unnoticed by many of the employees of WeWork and has started to surface after the IPO collapse.[13]

Neumann is no stranger to having allegations levied against him.[14] According to the New York Times, Neumann has faced at least two lawsuits over the past year – one gender discrimination suit and one pregnancy discrimination suit.[15] Now, after his escape from WeWork, Neumann faces a legal challenge that will be precedential in terms of shareholder litigation surrounding multi-billion dollar losses.

Former WeWork employee Natalie Sojka filed a class action lawsuit last week against ten defendants, including Adam Neumann and SoftBank Chairman Masayoshi Son, accusing the defendant-directors of breaching their fiduciary duties to similarly situated minority-shareholders, abusing control, and creating corporate waste, among other claims.[16] It is reported that the lawsuit filed by Sojka seeks to prevent Softbank from “rubber-stamping” future transactions with Neumann, as aggrieved shareholders accuse the directors of WeWork and Softbank alike of using their positions to enrich themselves at the expense of WeWork shareholders and the company itself.[17]

These new waves of lawsuits bring a feeling that directors and shareholders of WeWork have unfortunately become all too familiar with as of late – uncertainty.  The $30 billion shareholder loss is one of the largest IPO collapses that many financial reporters have ever witnessed.[18] Courts in most jurisdictions generally offer a remedy to minority shareholders, premised on the notion that controlling shareholders and directors owe the minority shareholders a fiduciary duty and must honor their reasonable expectations.[19] While the amount that the class action lawsuit is seeking is unspecified at this point, the complaint contains demands for punitive damages as well.[20]

An alternate explanation for this collapse, outside of the allegations of mismanagement, is that WeWork had a flawed and unsustainable business model in general, that resulted in the hemorrhaging of money through the constant purchase of expensive commercial real estate in top markets throughout the world. As Amol Sarva, founder and CEO of Knotel, a company who provides companies with “flexible workspace solutions,” explains in a short documentary from Bloomberg, WeWork may be a victim of their own immediate success, a classic “the first mouse to chase the cheese is the one that gets caught in the trap” type of scenario.[21]

Whether this is a case of gross mismanagement and self-dealing as Sojka’s complaint suggests, or the first showing of unsustainable growth in a company that is essentially a massive commercial landlord, will be played out in the courts in the coming months. Until then, investors will shift their focus to the next billion-dollar startup IPO, and corporate directors around the country will find comfort in the fact that they are not in Neumann’s shoes at the moment, while looking to the future to make sure their company does not become the next WeWork-sized failure.  

[1] See Kenneth C. Johnsen, Golden Parachutes and the Business Judgment Rule: Toward a Proper Standard of Review, 94 Yale L.J. 909, 909 (1985).

[2] See id.

[3] Our Mission, WeWork, https://www.wework.com/mission (last visited Nov. 19, 2019).

[4] Ellen Huet, The Spectacular Rise and Fall of WeWork, Bloomberg (Nov. 7, 2019, 9:06 AM), https://www.bloomberg.com/news/videos/2019-11-07/the-spectacular-rise-and-fall-of-wework-video.

[5]  Id.

[6]  Id.

[7] Rosabeth Moss Kanter, Opinion, WeWork’s Saga is a Cautionary Tale About Golden Parachutes and CEO Pay, CNN Business (Nov. 7, 2019, 5:38 PM), https://www.cnn.com/2019/11/05/perspectives/adam-neumann-golden-parachute-wework/index.html.

[8] Huet, supra note 4.

[9] Theron Mohamed, ‘It Seems Insane Now’: WeWork Employees Bought into Cofounder Adam Neumann’s Vision but Grew Worried as Red Flags Mounted, Business Insider (Nov. 8, 2019, 5:56 AM), https://www.businessinsider.com/wework-employees-startup-rise-fall-new-yorker-2019-11.

[10] Huet, supra note 4.

[11] Rebecca Aydin, The WeWork Fiasco 2019, Explained in 30 Seconds, Business Insider (Oct. 22, 2019, 11:12 AM),  https://www.businessinsider.com/wework-ipo-fiasco-adam-neumann-explained-events-timeline-2019-9#here-are-some-more-details-you-might-want-to-know-2.

[12] Id.

[13] Mohamed, supra note 9.

[14] Jonathan Stempel, WeWork, Ex-CEO Neumann, Softbank Sued over Botched IPO, Plummeting Value, Sharenet (Nov. 8, 2019), https://www.sharenet.co.za/views/views-article.php?views-article=146065.

[15] David Yaffe-Bellany, WeWork’s Ousted CEO Adam Neumann Is Accused of Pregnancy Discrimination, N.Y. Times (Oct. 31, 2019), https://www.nytimes.com/2019/10/31/business/wework-neumann-discrimination-complaint.html.

[16] See Stempel, supra note 14.

[17] See id.; Huet, supra note 4.

[18] Huet, supra note 4.

[19] Benjamin Means, A Contractual Approach to Shareholder Oppression Law, 79 Fordham L. Rev. 1161, 1163 (2011).

[20] Stempel, supra note 14.

[21] Huet, supra note 4.

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8Feb

Oil and Gas Lease Not Divisible into Separate Segments for Production and Storage, Fourth Circuit Says

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Oil Pumps

By Daniel Stratton

Today, the Fourth Circuit issued a published opinion in the civil case K & D Holdings, LLC v. Equitrans, L.P. In K & D Holdings, the court held that an oil and gas lease granted to defendants, Equitrans and EQT, by plaintiff, K & D Holdings, was not divisible into separate components. In reaching that conclusion, the court reversed and remanded the case to the district court with instructions to enter judgment in favor of Equitrans and EQT.

The Terms of the Original Lease

In December 1989, Henry Wallace and Sylvia Wallace signed a lease granting Equitrans the oil and gas rights to an area of land covering 180 acres in Tyler County, West Virginia. Currently, K & D is the successor in interest to the Wallaces. Additionally, Equitrans L.P., the successor-in-interest to Equitrans Corp., subleased the rights to produce and store gas on the land to EQT Corp. Essentially, the terms of the lease now govern a relationship between K & D and EQT.

The terms of the lease grant EQT the right to use the land to explore and produce oil and gas, store gas, and protect stored gas. The lease’s initial term ran for five years and would continue on for as long as a portion of the land was used for “exploration or production of gas or oil, or as gas or oil is found in paying quantities thereon or stored thereunder, or as long as said land is used for the storage of gas or the protection of gas storage on lands in the general vicinity.” After taking control of the land, EQT never engaged in exploration, production, or gas storage, but has engaged in gas storage protection.  Equitrans owns the nearby Shirley Storage Field, a natural gas storage facility. The Federal Energy Regulatory Commission established a buffer zone of 2000 feet around the storage area for protection of the storage facility. The leased land falls within that buffer zone.

Due to EQT and Equitrans not using the leased land for gas or oil production, K & D sought to end the arrangement and enter into a more lucrative contract with another company. On September 20, 2013, K & D filed a lawsuit in state court against EQT, arguing that it was entitled to a rebuttable presumption under West Virginia state law that EQT had abandoned the land after not producing or selling gas or oil from the property for more than twenty-four months. EQT removed to the United States District Court for the Northern District of West Virginia. EQT and K & D filed cross motions for summary judgment.

On September 30, 2014, the court denied both cross motions. Acting sua sponte, the district court found as a matter of law that the lease was divisible. The court argued that because the lease had two primary purposes, (1) exploration and production and (2) storage and protection, the lease could be divided into two separate leases. The lease for exploration and production of oil and gas had expired in the district court’s view, because the initial five-year term had elapsed without EQT exploring for or producing oil or gas. The court held however, that the second lease, for storage and protection, was still in force because EQT had used the land for that purpose.

On January 21, 2015, the district court issued its final order, stating that K & D was entitled to drill exploration and production wells in areas that were not within the buffer zone of the Shirley Storage Field. EQT appealed.

West Virginia is for Lessors

Because this case was heard under diversity jurisdiction, West Virginia state law applies. Under West Virginia law, contract law principles apply equally to the interpretation of leases. The primary criterion for determining if a contract is severable is whether such an intention was reflected by the parties in the terms of the contract itself, the subject matter of the contract, and the circumstances giving rise the question.  A contract is not severable when it has material provisions and considerations that are interdependent and common to each other. Additionally, under West Virginia state law, there is a presumption against divisibility unless the contract explicitly states that it is divisible or the parties intent of divisibility is clearly manifested. As a general matter, West Virginia law regarding oil and gas leases are liberally construed in favor of the lessor, but only when there is ambiguity as to the lease terms.

A Lease Divisible Cannot Stand

On appeal, EQT made two arguments. First, it argued that the district court erred as a matter of law in holding the lease divisible. Second, EQT contended that the district court was wrong in determining that the exploration portion of the lease had terminated after its initial five-year term. Reviewing the district court’s findings of fact for clear error and its conclusions of law de novo, the Fourth Circuit agreed with both of EQT’s arguments.

Starting with its first argument, EQT pointed to the language of the lease itself. The lease’s use of the word “or” between each act required of EQT in order to continue the lease indicated that the acts were alternatives, and that only one would be required to keep the entire lease in effect. Applying West Virginia’s test for determining if a contract is severable, the Fourth Circuit concluded that the lease was intended to be entire and not divisible.  The Fourth Circuit applied the plain, ordinary meaning of the word “or,” holding that in this case it was a disjunctive and could not be considered to have the same meaning as the word “and.”

K & D argued that because EQT paid different rents depending on what activities it was engaging in, the lease was divisible. The court found this argument to not be persuasive, noting that the activities EQT could engage in under the lease were interrelated. Additionally, because the Fourth Circuit found no ambiguity in the lease, it did not need to liberally interpret in favor of the lessor.

Having decided that the lease was not divisible, the court then turned to the question of whether EQT had continuing rights under the lease. The terms of the lease dealing with renewal stated that the lease would continue beyond the initial five-year term if “(1) the lessee explores for or produces gas or oil; (2) ‘gas or oil is found in paying quantities thereon or stored thereunder’; or (3) the ‘land is used for the storage of gas or the protection of gas storage on lands in the general vicinity.” Again noting the use of the disjunctive “or,” the court found that because it was undisputed that part of the land was being used for protection, EQT continued to hold all rights under the original lease.

The Fourth Circuit Hold the Lease is Not Divisible and Valid; Reverses and Remands 

Having determined that the lease was not divisible and that EQT still held all rights under the original lease, the Fourth Circuit reversed and remanded the lower court’s decision, instructing that court to enter judgement in favor of EQT and Equitrans.

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3Feb

Fourth Circuit Affirms Summary Judgment in Case of Pesticide Application to Peanuts

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peanuts

By Malorie Letcavage

On December 2, 2015, the Fourth Circuit issued its published opinion in Severn Peanut Co., Inc. v. Industrial Fumigant Co. In this case, appellant Severn Peanut Co. (“Severn”) asked the Fourth Circuit to overturn the lower court’s grant of summary judgment for appellee, Industrial Fumigant Co. (“IFC”) on both the breach of contract and the negligence claim. The Fourth Circuit ultimately affirmed the grant of summary judgment because the consequential damages provision in the contract overcame the breach of contract claim and North Carolina law does not allow a plaintiff to pursue a tort claim under the guise of a contract claim.

Background

Severn entered into an agreement with IFC to apply a pesticide, phosphine, to its peanut storage dome. The parties signed a Pesticide Application Agreement (“PAA”) which detailed that Severn would pay IFC $8,604 for the pesticide services. The contract specified that the sum excluded IFC assuming any risk of “incidental or consequential damages” to Severn’s “property, product, equipment, downtime, or loss of business.” It also stipulated that the pesticide would be applied according to the instructions on its label.

The label on the phosphine requires the user to avoid the pesticide tablets from piling up because this could lead to fire or an explosion. Despite this warning, IFC dumped 49,000 tablets of the pesticide into the peanut dome through a single hatch. The pile up of the tablets caused a fire and an explosion. Severn’s insurer paid to cover Severn’s loss of peanuts, business income, and the damage to the peanut dome. Severn filed against IFC for breach of contract and negligence. The District Court granted partial summary judgment for IFC on the breach of contract claim because it found that the consequential damages clause in the PAA excluded a claim for breach of contract. It also found Severn to be contributorily negligent, and thus granted summary judgment in favor of IFC on the negligence claim.

Breach of Contract Claim

The Court examined the consequential damages limitations in North Carolina. It found that this doctrine allows parties the freedom to contract. It strongly stressed that it would not overhaul a valid enforceable contract that both parties agreed to and signed. It held that the consequential damages doctrine may only be limited if the clause is unconscionable. The Court found that overall the doctrine is a widely used tool for completing business.

In application to Severn’s case, the Court held that the language of the PAA established a valid consequential damages clause, and the items damaged fell within this language. It also found that the clause was not unconscionable. A clause is unconscionable when no reasonable person would view the contract’s result without feeling injustice. However, this clause was conscionable because it was between two experienced business parties who contracted specifically to include the provision; it was a fair result according to the contract.

The Court also rejected Severn’s argument that the clause was a violation of public policy. The Court refused to find consequential damage clauses against public policy without a clear indication from the North Carolina courts, of which there was none. It held that North Carolina law provides other criminal and civil penalties for the misapplication of the pesticide, so there was no reason to hold private liability as the only means of enforcement. Thus, the Court affirmed summary judgment on the breach of contract claim because the contract was an agreement between two sophisticated commercial entities who should be held to the terms of the contract they signed.

Negligence Claim and Economic Loss Doctrine

While the Court agreed with Severn’s argument that the ruling of contributory negligence ignored material facts, it still affirmed the grant of summary judgment for IFC because of the economic loss doctrine. The Court found that the negligence claims would not survive the assent to the consequential damages limitation. The economic loss doctrine “prohibits recovery for purely economic loss in tort when contract…. operates to allocate the risk.” The doctrine encourages parties to allocate the risk of loss themselves, as they are in the best position to do so.

In this case, Severn wanted to claim a remedy in tort for IFC’s breach of duty to apply the pesticide according to the label, which is the same source as their breach of contract claim. Yet since Severn bargained to limit consequential damages caused by breach of contract they cannot be allowed to try to undo that bargain using tort law. Additionally, the Court found that the storage dome and peanuts were not outside of the contract, and were not exempt from the economic loss doctrine.

Summary Judgment Affirmed

Thus, the Fourth Circuit affirmed the lower court’s grant of summary judgment for IFC on both the breach of contract and the negligence claim.

 

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21Jan

Fourth Circuit Upholds Refunds and Attorneys Fees Against Water Utility

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By Malorie Letcavage

On December 1, 2015, the Fourth Circuit issued its published opinion in the case of Tommy Davis Construction, Inc. v. Cape Fear Public Utility Authority. The defendant, Cape Fear Public Utility, appealed the district court’s findings and award of attorneys fees in favor of plaintiff, Tommy Davis Construction. Defendant raised four issues on appeal, but the Fourth Circuit affirmed the district court’s judgment in favor of plaintiff and the award of attorneys fees.

Davis Objects to Paying Invalid Impact Fees

Davis Construction (“Davis”) was developing a subdivision named Becker Woods, and arranged to have Aqua NC provide water and sewer services. Aqua NC was the only utility in that part of the county to offer those services, although Water and Sewer District (“WSD”), Cape Fear Public Utility’s predecessor, provided those services in other parts of the county. A County employee told Davis Construction it was necessary to pay WSD impact fees before it could get building permits from the County. WSD did not offer services where Becker Woods was located, and Davis had already paid Aqua NC those fees since it would be the utility providing the services. Despite objecting profusely, Davis paid in order to get the building permits.

About a year later WSD became Cape Fear Public Utility Authority (“Cape Fear”). Davis then applied for more permits for other lots in Becker Woods and was only required to pay the impact fees to Aqua NC for providing the services, and not to WSD.

Davis filed a suit in order to recover the fees it had paid to the county. The District Court found that Cape Fear’s collection of impact fees was “an ultra vires act beyond their statutory authority.” The district court rejected Cape Fear’s defenses of the claims being time-barred or the application of the doctrine of laches. The court awarded Davis a refund of the impact fees and attorney’s fees.

Statute of Limitations Bars the Federal Claims, but not the State Claims

The Court found that Davis’ federal due process claim was time barred by the statute of limitations. It held that the claim was really a §1983 claim, although this was not explicitly stated. The statute of limitations for §1983 claims are borrowed from the statute of limitations in a personal injury action in that state. In North Carolina, this is a three year period that began to run when Davis paid the impact fees. Since Davis then brought the claim five years later, the federal claim is time barred.

However, the Court found that the state law claims were timely filed. It compared the present case to Point South Properties, LLC v. Cape Fear Public Utility Authority (“Point South”). That case had extremely similar facts where impact fees were forced to be paid twice to a utility that was not providing the service. That court found that the applicable statute of limitations was ten years, derived from the catch all in NC. Gen. Stat. 1-56. The Court held this ten year period was also the appropriate statute of limitations, and the state claims were timely.

The Court also rejected Cape Fear’s claim that even if the claims were timely, they were barred by the equitable doctrine of laches. The Court once again referenced Point South and came to the same conclusion as that case; laches did not apply because it is not available in an action at law. Laches also did not apply because Cape Fear did not establish that they were prejudiced by the delay in time.

Cape Fear’s Collection of Fees was Ultra Vires

The Court upheld the district court’s finding that the collection of fees was ultra vires. Cape Fear argued that since they intended to expand their services to that part of the county, the fees could have been considered in furtherance of “services to be furnished.” But the Court held that Cape Fear had only vague plans for forty years and had taken no concrete steps to expanding service to that area. The services to be furnished must take effect in a reasonable time after construction and even ten years after Davis received its permits, Cape Fear still had not taken steps to provide service. Cape Fear’s generalized goal to expand service was not sufficient, and the Court upheld the lower court’s finding of summary judgment in favor of Davis.

Court Upholds Award of Attorney’s Fees

Cape Fear alleged that attorney’s fees were inappropriate because they were not a city or a county as required under the relevant statute. However, the district court found that the County acted outside of its legal authority by requiring Davis to pay the impact fees in order to receive its permits, and that it collected those fees on behalf of WSD. Thus, the Court found that the lower court had the authority to award attorneys fees.

Judgment Affirmed

The Court affirmed the lower court’s grant of summary judgment for Davis and the award of attorneys fees.

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9Nov

Fourth Circuit Rules on Bank Director and Officer Liability with Business Judgment Rule

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By Amanda Whorton

On August 18, 2015, the Fourth Circuit issued a published opinion in the civil case FDIC v. Rippy. The court held that there were genuine issues of material fact as to Cooperative Bank’s officers’ liability for ordinary negligence and breach of fiduciary duty, but upheld summary judgment for the directors as to the ordinary negligence and breach of fiduciary duty claims. The court further upheld summary judgment on the gross negligence claim for both directors and officers.

The Annual Examinations of Cooperative Bank

Cooperative Bank (“Cooperative”) opened in Wilmington, North Carolina in 1898 and operated as a community bank and thrift until they converted to a state-charted savings bank regulated by the Federal Deposit Insurance Corporation (“FDIC”) in 1992. In 2002, Cooperative became a state commercial banking institution. Because of this status, the FDIC and North Carolina Commission of Banks (“NCCB”) gave Cooperative annual reviews as its regulators.

In 2006, the FDIC conducted an annual report of Cooperative. The majority of observations in the report were positive. However, the report identified problems with credit administration and underwriting, audit practices, risk management, and liquidity. Officials at Cooperative agreed to address these problems.

In 2007, the NCCB conducted their annual review. They found that Cooperative’s management was slow to address the problems found in the 2006 FDIC Report. Again, Cooperative’s management agreed to confront the issues.

Later that same year, Credit Risk Management (“CRM”) conducted an external loan review and gave Cooperative passing grades. However, they additionally suggested that Cooperative update their credit file documentation.

In 2008, CRM again conducted an external loan review. This year however, they gave Cooperative failing grades and reported that Cooperative had problems with loan documentation, loan monitoring, and using old financial information.

After this incident, the FDIC and NCCB conducted a joint review. They found that Cooperative’s management had ignored or failed to adequately address any of their previous concerns. It was then that FDIC issued a Cease and Desist Order. After Cooperative failed to comply, the NCCB closed Cooperative and named FDIC as the receiver.

Because of Cooperative’s failure, FDIC suffered losses and later brought this suit against the directors and officers of Cooperative, stating that the directors and officers were ordinarily negligent, grossly negligent, and breached their fiduciary duties in approving loans.

The District Court Granted Defendants’ Motion for Summary Judgment

At the district court, the defendants filed motions for summary judgment on all claims FDIC filed against them and FDIC filed a cross-motion for partial summary judgment on the defendants’ affirmative defenses of failure to mitigate and superseding or intervening cause.

The district court granted summary judgment for the defendants and denied FDIC’s cross-motion as moot. The district court held that FDIC failed to show evidence that the defendants engaged in “self-dealing or fraud” or acted in bad faith. Thus, the court argued, that their actions were protected by the business judgment rule from claims of ordinary negligence and breach of fiduciary duty. There was also no evidence that Cooperative’s officers and directors engaged in “wanton conduct” or “consciously disregarded” the corporation; the court held that the defendants were not grossly negligent either.

Directors’ Liability for Ordinary Negligence and Breach of Fiduciary Duty

Under North Carolina law, a director or officer can be liable for ordinary negligence. North Carolina law also allows corporations to shield directors from liability by including an exculpatory clause in their articles of incorporation. The business judgment rule further constrains liability for officers and directors for ordinary negligence.

Cooperative’s articles of incorporation included an exculpatory provision that shielded its directors. The provision protected directors from liability for ordinary negligence and breach of fiduciary duties.

Because FDIC only argued that defendants took harmful actions without obtaining adequate information, and did not produce sufficient evidence that the directors engaged in self-dealing, fraud, or acted in bad faith, the exculpatory provision in Cooperative’s articles protected the directors in this case.

The Fourth Circuit therefore affirmed the district court’s award of summary judgment to the directors on FDIC’s ordinary negligence and breach of fiduciary duty claims.

Officers’ Liability for Ordinary Negligence and Breach of Fiduciary Duty

Because Cooperative’s exculpatory provision only covered directors, the Fourth Circuit analyzed the officers’ liability under the business judgment rule. The business judgment rule creates a presumption that the officers acted with due care. This presumption can be rebutted with evidence that the officers (1) did not act on an informed basis, (2) acted in bad faith or with a conflict of interest, or (3) did not believe they were acting in the best interest of the bank.

The Fourth Circuit found that FDIC presented adequate evidence to survive summary judgment and rebut the presumption of the business judgment rule. They presented an expert who stated that the officers did not act in accordance with generally accepted banking practices, which shows that the officers may not have acted on an informed basis. Therefore, the Fourth Circuit vacated the district court’s grant of summary judgment in regards to the officers on the issues of ordinary negligence and breach of fiduciary duty.

Gross Negligence

To survive a motion for summary judgment, FDIC had to show that there was a genuine issue of material fact as to whether the defendants’ actions constituted “wanton conduct done with conscious or reckless disregard.” The Fourth Circuit found that FDIC did not present sufficient evidence and thus affirmed the district court’s award of summary judgment to the defendants on FDIC’s claim of gross negligence.

Fourth Circuit’s Holding

The Fourth Circuit vacated the district court’s award of summary judgment in regards to Cooperative’s officers on FDIC’s claims of ordinary negligence and breach of fiduciary duty and remanded those claims for further proceedings. The court also reversed and remanded the district court’s order denying as moot the FDIC’s cross-motion for summary judgment. On FDIC’s remaining claims, the Fourth Circuit affirmed the district court’s judgment.

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16Mar

Misleading Statements Sufficient for Trial in 10b-5 Suit

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By Dan Menken

Today in the published opinion of Zak v. Chelsea Therapeutics International, the Fourth Circuit vacated the district court’s dismissal of the plaintiffs’ claim that the defendants, Chelsea Therapeutics International, LTD (“Chelsea”) and several corporate officers, violated § 10(b) of the Securities Exchange Act of 1934 (“the Exchange Act”) and remanded the case for further proceedings.

Plaintiffs Claim Chelsea Therapeutics and its Officers Violated § 10(b) of the Exchange Act

The plaintiffs in this class-action suit claim that Chelsea and several of its corporate officers violated § 10(b) of the Exchange Act, 15 U.S.C. § 78j(b), by making materially misleading statements and omissions about the development and likelihood of regulatory approval for a new drug, Northera. The district court dismissed the complaint, holding that the plaintiff’s allegations were insufficient as a matter of law to establish that the defendants acted with the requisite state of mind.

On appeal, plaintiffs contend that the district court committed two errors: (1) the district court’s consideration of exhibits submitted with defendants’ motion to dismiss and (2) the court’s determination that the plaintiffs’ allegations of scienter were legally insufficient.

Misleading Statements Regarding Northera’s Chances for FDA Approval

Northera was designed to treat symptomatic neurogenic orthostatic hypotension, a condition which may cause a dramatic drop in blood pressure when a person stands. During clinical testing, Northera’s efficacy was brought into question—only one study achieved a positive outcome. Following a December 2010 meeting with the FDA where Chelsea was warned that a single positive study typically was not sufficient to support approval of a new drug, Chelsea announced to investors that the FDA had “agreed” that Chelsea’s application for Northera could be submitted based on data from the one successful trial.

During a conference call with Chelsea investors, Chelsea President and Chief Executive Officer along with Chelsea’s Vice President and Chief Medical Officer indicated that the meeting with the FDA represented a “successful outcome” and that Chelsea was “very pleased” with the FDA’s responses to Chelsea’s questions about its application and supporting data. Following these statements, Chelsea’s stock price rose about 28%.

After submitting the drug for approval, Chelsea announced to the public on February 13, 2012 that the FDA’s briefing document indicated questions regarding the drugs efficacy in clinical trials, but it did not disclose that the FDA recommended the drug not be approved. Following the press release, Chelsea’s stock price dropped 37.5%. When the briefing document became public eight days later, Chelsea’s stock price dropped an additional 21%. The FDA made its final decision not to approve Northera on March 28, 2012, and one week later the plaintiffs filed suit.

Defendant’s Motion to Dismiss

Defendants, in their motion to dismiss, attached three documents filed with the Securities and Exchange Commission (“SEC”). One document, a “Definitive Proxy Statement,” listed the amount of Chelsea stock shares held by the company’s officers at the end of February 2012, near the end of the class period. However, it did not reflect whether any of these stock holdings had been acquired or sold during the class period. Defendants represented that none of the Chelsea officers had sold any shares of Chelsea stock during the class period and this fact undermined any inference of scienter. The plaintiffs objected to the court’s consideration of the SEC documents because they did not show whether any individuals purchased or sold stock during the period in question. At the conclusion of the hearing, the district court took judicial notice of the SEC documents, and granted the defendants’ motion to dismiss.

Fourth Circuit Review

The Fourth Circuit reviewed the district court’s dismissal de novo. The court noted that Rule 10b-5 prohibited the making of “any untrue statement of a material fact” or the omitting of “a material fact necessary in order to make the statements made . . . not misleading.” Rule 10b-5(b). Plaintiffs asserting a claim under Rule 10b-5 must establish: “(1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation.” Yates v. Mun. Mortg. & Equity, LLC, 774 F.3d 874, 884 (4th Cir. 2014). To demonstrate scienter, a plaintiff must show that the defendant acted with “a mental state embracing intent to deceive, manipulate, or defraud.” Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 319 (2007). Allegations of reckless conduct can satisfy the level of scienter necessary to survive a motion to dismiss. However, the court noted, claims of securities fraud are subject to a heightened pleading standard under the Private Securities Litigation Reform Act. 15 U.S.C. § 78u-4(b)(2).

Regarding the plaintiffs’ assertion regarding the district court’s first error, the Fourth Circuit addressed the fact that, generally, when considering a Rule 12(b)(6) dismissal, courts are limited to considering the sufficiency of the allegations set forth in the complaint and documents attached to the complaint. Because the SEC documents were not explicitly referenced in the plaintiffs’ complaint, the Fourth Circuit believed that the district court should not have considered those documents in reviewing the sufficiency of the plaintiffs’ allegations. Even if the judge had the right to take judicial notice of the documents, he did not have the right to construe it in favor the defendants. The court concluded that the district court’s consideration of the challenged SEC documents was not harmless.

The plaintiffs further asserted that the district court erred in concluding that their allegations of scienter were insufficient as a matter of law. The plaintiffs pointed out that Chelsea was aware of the FDA’s adverse recommendation regarding the approval of Northera, but withheld that information, indicating a strong inference of wrongful intent. The Fourth Circuit pronounced that the defendants’ failure to reveal such information must be viewed in the context of the statements that they affirmatively elected to make. In light of Chelsea’s failure to reveal to investors the FDA’s expectation that Northera needed at least two successful clinical trials to be considered for approval, the Fourth Circuit believed that their affirmative assertions regarding their optimism following the FDA meeting could be construed as misleading. Therefore, the court concluded that the plaintiffs’ allegations were sufficient to support the required inference of scienter.

Vacated and Remanded

Thus, the Fourth Circuit held that the district court erred in taking judicial notice of the challenged documents filed with the SEC, because the documents did not relate to the complaint. This error was not harmless. The court also held that defendants’ failure to disclose critical information about the weaknesses of the new drug application were sufficient to support a strong inference of scienter. The Fourth Circuit thus vacated the district court’s judgment and remanded the case for further proceedings.

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4Mar

Fourth Circuit Doesn’t Buy Retail Tenant’s Argument, Affirms Decision Allowing Mall Redevelopment to Move Forward

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By Patrick Southern

Today, in a published opinion in the civil case of Lord & Taylor, LLC v. White Flint, L.P.,  the Fourth Circuit affirmed a ruling from the District of Maryland which refused to stop plans for redevelopment of a now-vacant shopping mall. It did so over the objections of the plaintiff, Lord & Taylor, which had argued the plans were barred by an existing Reciprocal Easement Agreement (“REA”) between the parties.

The Parties Had a Long-Standing Relationship

In 1975, White Flint began discussions with Lord & Taylor about developing a store at a new mall in Maryland. The parties ultimately agreed Lord & Taylor would serve as an anchor tenant in a building detached from the mall itself.

As part of their agreement, they entered into the REA, which bound White Flint to operating a three-story mall on the site. Any changes to the mall were to be approved by Lord & Taylor. The REA was to remain operative until at least 2042, and Lord & Taylor had an option to extend it until 2057 by exercising its final option to renew its lease.

The relationship was initially positive, but business at the mall steadily declined. By 2013, 75 percent of the mall’s tenants had left, and the mall was ultimately shuttered permanently early in 2015.

In October 2012, the local county government approved plans to tear down the mall and redevelop the site into a mixed-use development with apartments, parks, a hotel, and high-rise office buildings. The Lord & Taylor store was to remain in place.

Lord & Taylor Sought Declaratory Judgment and Injunctive Relief

Lord & Taylor filed an action to stop White Flint from going forward with the redevelopment plan, saying the REA promised Lord & Taylor’s store would have a “first class high fashion shopping center” adjacent to it for the duration of its lease. It said the new plans violated the terms of the REA and would negatively affect the store’s business.

Lord & Taylor sought declaratory judgment that the REA barred the plans and a permanent injunction that would prohibit White Flint from replacing the mall with the proposed “town center” development.

White Flint moved for partial summary judgment, arguing it would be infeasible for the courts to enforce an injunction requiring what was, by then, a mostly empty mall to resume operations and then to maintain status as a “first class high fashion shopping center” until 2057. White Flint further argued that halting the redevelopment project was against the public interest given the time and expense already devoted to the project.

The District Court granted White Flint’s motion, concluding an injunction would be unworkable in light of the advanced stage of the project.

Lord & Taylor Appealed On Two Grounds

On appeal to the Fourth Circuit, Lord & Taylor argued two separate issues: (1) that the district court erred by failing to apply the correct Maryland law to its request for injunctive relief, and (2) that the district court erred in judging the injunctive relief it sought would not be feasible.

The Fourth Circuit rejected both arguments, adopting similar reasoning to that of the District of Maryland in choosing to affirm the lower court’s decision.

The District Court Applied the Proper Legal Standards in Rendering Judgment

Lord & Taylor argued a proper application of Maryland law would necessarily mean an injunction should be granted. It indicated Maryland law strongly favors injunctive relief for breaches of restrictive covenants, to the point that other factors such as the public interest or the availability of monetary damages to compensate for a breach aren’t to be considered.

But the Fourth Circuit disagreed. It noted that even the cases cited by Lord & Taylor said that injunctive relief is subject to “sound judicial discretion.” Further, Maryland law makes clear that trial courts may take account of feasibility concerns, such as those cited by the District Court in this case, in considering injunctive relief for breach of a restrictive covenant.

The Fourth Circuit indicated Maryland courts have made clear that injunctions may be denied if they would cause courts to have to engage in “long-continued supervision” or “enforcement of the injunction would be ‘unreasonably difficult.'” Thus, it rejected Lord & Taylor’s argument.

The District Court Correctly Ruled Injunctive Relief Was Infeasible

Lord & Taylor further argued that the District Court incorrectly ruled that injunctive relief in this case would be infeasible. The Fourth Circuit reviewed that decision under an abuse of discretion standard and affirmed the lower court ruling. In making its decision, the Fourth Circuit noted that the practical realities of the situation didn’t weigh in favor of an injunction.

Much of the mall was vacant, so enforcing the REA would have necessitated an affirmative injunction ordering White Flint to transform the mall back into a “first class high fashion shopping center.” Such an order is difficult to draft with specificity, and also difficult to enforce. The court would be left to enforce detailed provisions involving parking and interior access roads, potentially for a protracted period of time, and such enforcement is beyond the level of judicial involvement that is practical.

While Lord & Taylor had indicated a “negative injunction” (which would merely bar the redevelopment plans from going forward) would be acceptable, the Fourth Circuit said that, too, was unrealistic. Such an injunction would freeze in place a vacant mall, and would essentially be a judicially-mandated blight on the area. The court was not prepared to take such a step, doing so would be against the public interest.

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28Jan

Fourth Circuit Not “Playing Games” in Retaliatory Firing Case 

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By Joshua P. Bussen

On Monday, January 26, in the civil case of Jones v. Southpeak Interactive Corporation, a published opinion, the Fourth Circuit established that in a claim for retaliatory firing under 18 U.S.C. § 1514A, part of the Sarbanes-Oxley Act of 2002 (“SOX”), evidence of an administrative complaint that was not answered within 180 days is sufficient to exhaust a plaintiff’s administrative remedies, that such claims under SOX are subject to a four-year statute of limitations, and finally, that under SOX emotional distress damages are available to plaintiffs.

Plaintiff Whistle-Blows on Video Game Developer

In 2009, Andrea Jones (“Jones”), the plaintiff in this case, was serving as the chief financial officer of Southpeak Interactive, the defendant. In February of that year, the company placed an order for over 50,000 video games from Nintendo. Southpeak, however, was in a predicament. It needed the games “as soon as possible” but did not have the funds to cover the cost up front. To avoid a potentially problematic delay, the chairman of Southpeak’s board, Terry Phillips, wired Nintendo $307,400 from his personal account. In May of that year Southpeak had not recorded the debt properly on its balance sheet or its quarterly financial report, which was filed with the Securities Exchange Commission (“SEC”).

When Jones became aware of the improper filing, she reported to Southpeak’s audit committee that she suspected the company was engaged in fraud. In response, Southpeak sought to rectify the improper filing with the SEC by submitting an amendment. In the proposed amendment, Southpeak denied any intentional fraud. Jones was asked to sign the report, and refused. On August 13, 2009, Jones sent a letter to Southpeak’s outside counsel stating that: “I do not know how a conclusion of no intentional wrongdoing or fraud can be reached.” The board of Southpeak convened a special meeting that very same day and fired Jones. This claim for retaliatory discharge under 18 U.S.C. § 1514A(a) ensued.  18 U.S.C. § 1514A(a) states that it is illegal for publicly traded companies to retaliate against employees who report potentially unlawful conduct.

OSHA Filing Was Sufficient to “Exhaust” Administrative Options

On October 5, 2009, Jones filed a complaint with the Occupational Safety and Health Administration (“OSHA”)—claiming her discharge was a retaliation to her reporting the company’s fraud. After 180 days of no action from OSHA, Jones informed the administration that she was electing to file a federal lawsuit pursuant to 18 U.S.C. § 1514A(b)(1)(B) of SOX and 29 C.F.R.§ 1980.114(b).  Her actions were satisfactory to the Fourth Circuit to fulfill her claim for administrative remedies, which were required to be exhausted under the statute.

Retaliatory Discharge Claims Fall Under SOX’s Four-Year Statute of Limitations

Southpeak also sought to have Jones’s claim dismissed for having lapsed the applicable statute of limitations. The Fourth Circuit easily dismissed this argument. Under 28 U.S.C. 1658(a), the section of the law that Jones brought her claim under, a plaintiff has a four-year window to file a claim for retaliatory discharge.

Emotional Distress Damages are Available to Plaintiffs Under SOX

Southpeak, additionally, attempted to have the award of emotional distress damages overturned.  The defendant claimed that this award was improper under SOX, however, the Fourth Circuit found 18 U.S.C. § 1514A(c)(1) instructive. Under that provision of SOX, in a successful claim for a retaliatory firing, a plaintiff may be entitled to “all relief necessary to make [her] whole.” The court read that provision broadly enough to mean that emotional distress damages were to be included.

Was the “Final” Verdict Really Final?

Southpeak, finally, attempted to have the verdict overturned because it claimed the jury was “confused” in its verdict. This argument held little merit to the circuit judges, as the jury was polled by a clerk at the conclusion of the trial—with each juror confirming the verdict—and the decision was not “clearly against the weight of the evidence.” Therefore, the court dismissed the argument.

District Court for the Eastern District of Virginia’s Decision Affirmed

Because the District Court for the Eastern District of Virginia found that the administrative remedy had been exhausted, the claim was not barred by any statute of limitations, that emotional damages were available to Ms. Jones, and that there was no evidence of jury “confusion,” the Fourth Circuit affirmed.

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