Last week's decision in Atkinson v. Lackey, 2015 NCBC 13 doesn't tell you everything you wanted to know about the North Carolina Securities Act (the "NCSA"), but it comes pretty close.
The lawsuit was brought by three individuals who had made investments in the Pacific Fund, a defendant LLC. The individual Defendants -- Lackey, Saldarini, and Mehler -- were the members of Pacific Capital, which was in turn the sole manager of the Pacific Fund.
The Plaintiffs alleged that their investments in the Pacific Fund had been fraudulently induced by Lackey, Saldarini, and Mehler. The alleged misrepresentations were that the Pacific Fund owned various properties in high-end residential communities on the South Carolina coast.
The Atkinson case is the latest in a small handful of cases brought under the NCSA that have resulted in rulings from the Business Court. The others are: NNN Durham Office Portfolio 1, LLC v. Highwoods Realty Limited Partnership, 2013 NCBC 12, Associated Packaging, Inc. v. Jackson Paper Manufacturing Co., 2012 NCBC 13, and Skoog v. Harbert Private Equity Fund, II, LLC, 2013 NCBC 17. I wrote about NNN Durham and Associated Packaging on this blog, but missed Skoog.
Standing: Were The Fiduciary Duty Claims Direct Or Derivative?
The first issue up for consideration by Judge Bledsoe in Atkinson was whether the Plaintiffs had standing to bring their claims for a breach of fiduciary duty. That issue turned on whether the claims were direct or derivative. An LLC member or corporate shareholder generally cannot pursue a direct cause of action against a third party for the loss of the value of his investment. Barger v. McCoy Hilliard & Parks, 346 N.C. 650, 660, 488 S.E.2d 215, 220-21 (1997).
The exceptions to the "Barger Rule" -- rarely met -- are that direct claims may be brought by an LLC member or shareholder when "the wrongdoer owed him a special duty, or (2) that the injury suffered by the guarantor is personal to him and distinct from the injury sustained by the corporation itself." Id. at 659, 488 S.E.2d at 221.
Judge Bledsoe did not have to plow any new ground to find that the Plaintiffs before him were owed a "special duty." The NC Court of Appeals held more than thirty years ago that a special duty exists "when the wrongful actions of a party induced an individual to become a shareholder." Howell v. Fisher, 49 N.C. App. 488, 498, 272 S.E.2d 19, 26 (1980). Since the Plaintiffs alleged that the Defendants had made misrepresentations in order to obtain their investment, the Plaintiffs had standing to pursue their claims.
Securities Fraud Claims: Primary and Secondary Liability
Standing was not an issue for the state securities fraud claims. G.S. §78A-56(a)(2) provides an individual cause of action for "any person purchasing a security."
There are "two different pathways" to liability under the NCSA. The first "pathway" is for "primary liability" under G.S. § 78A-56(a)(2):
which imposes primary civil liability upon “an offeror or seller of a security who (1) makes any untrue statement of a material fact, or (2) fails to state a material fact necessary for a statement which was made to not be misleading.” NNN Durham Office Portfolio 1, LLC, 2013 NCBC 12 at ¶64. To avoid primary liability, an offeror or seller must prove “he did not know, and in the exercise of reasonable care could not have known of the truth or omission.” Id.; Latta v. Rainey, 202 N.C. App. 587, 598, 689 S.E.2d 898, 908 (2010). Section 78A-56(a)(2).
The second "pathway" lies in "secondary liability":
If Plaintiffs can prove that an offeror or seller has primary liability under N.C.G.S. § 78A-56(a)(2), secondary liability will lie for “[e]very person who directly or indirectly controls [that person], every partner, officer, or director of the person, every person occupying a similar status or performing similar functions, and every dealer or salesman who materially aids in the sale,” unless that person proves that he “did not know, and in the exercise of reasonable care could not have known, of the existence of the facts by reason of which the liability is alleged to exist.” N.C.G.S. § 78A-56(c)(1) (2014).
What Makes An "Offeror"
The Defendants didn't dispute that Defendants Mehler and the Pacific Fund were offerors or sellers of securities under the NCSA, but argued that Pacific Capital was not an offeror or seller and therefore not primarily liable to the Plaintiffs.
It didn't take much more than common law principles of agency law for Judge Bledsoe to reject that argument. He said:
It is undisputed that Mehler was authorized to manage and solicit investments on behalf of the Pacific Fund by virtue of his management role in Pacific Capital. It is also undisputed that Mehler was acting at all times within the scope of the authority provided to him by Pacific Capital and that Mehler directly solicited Plaintiffs’ investments in the Pacific Fund.
Op, ¶39. Since a principal is liable for the acts of its agent taken in furtherance of its business, even if it is unaware of those actions (Op. ¶39), Pacific Capital was exposed to primary liability from the actions of Mehler.
Saldarini and Lackey fared better on the question of whether they were "offerors." Judge Bledsoe observed that "North Carolina courts place great emphasis on the solicitation of the buyer as the ‘most critical stage of the selling transaction’ in determining who is an offeror or seller of securities," ¶48 (quoting Skoog v. Harbert Private Equity Fund II, LLC, 2013 NCBC 17 ¶22).
He then said that there was no evidence before him (this was a ruling on a motion for summary judgment so the factual record was well developed) that those two defendants had solicited the Plaintiffs;' investments and dismissed the primary liability claims made against them.
There is little precedent in North Carolina interpreting the "control person" standard of the NCSA. Judge Bledsoe therefore looked to the abundant federal authority under "analagous federal control person liability statutes" like 15 U.S.C. §77o, to determine whether Lackey and Saldarini could be secondarily liable under the NCSA. Op. ¶59.
Those cases (cited in ¶¶60-61 of the Opinion), look generally to whether the defendants had the power to direct or influence the management or policies of the primarily liable defendant.
The Court found that there were genuine issues of material fact whether Lackey and Saldarini "controlled" the Pacific Fund, and denied their motion for summary judgment on this ground. There were also facts precluding summary judgment on whether Lackey and Saldarini "knew or should have known" of the alleged misrepresentations. Thus, the defense allowed under G.S. Section 78A-56(c) that they could not be held liable because they were unaware of the misrepresentations would have to be resolved by a jury.
Disclaimers And A Merger Clause In The Offering Memorandum Were No Defense
The Defendants relied on the usual type of merger clause language contained in an Offering Memorandum as a defense to the securities fraud claim, but that argument was unsuccessful.
This language said in bold faced, all caps type, that "No person has been authorized in connection with this offering to make any representations other than as contained in this confidential private placement memorandum." It further said that all investors would be required to warrant that in making their investment they had "relied solely upon the information contained in this confidential private placement memorandum . . . and not on any additional or differing information. . . ."
That didn't work as a defense because the Plaintiffs were claiming fraud in the inducement in being persuaded to make their investment. Allowing the Defendants to escape their alleged misrepresentations based on the disclaiming language would “would leave swindlers free to extinguish their victims' remedies simply by sticking in a bit of boilerplate” Op. ¶41 (quoting Godfrey v. Res-Care, Inc., 165 N.C. App. 68, 77 n.1, 598 S.E.2d 396, 403 n.1 (2004)).
In this respect, a securities fraud claim is more powerful than a common law fraud claim. The common law fraud claim made against Lackey and Saldarini by the Plaintiffs was dismissed because of this disclaimer and statements in the PPM which contradicted the alleged misrepresentations.
Plaintiffs were done in on this claim on summary judgment because they could not show justifiable reliance. A claim under section 78A-56(a)(2), by contrast, "does not . . . require proof of scienter or justifiable reliance.” Op. ¶34 (quoting NNN Durham Office Portfolio 1, LLC, 2013 NCBC 12 at ¶ 66).
More On Fiduciary Duties In An LLC
The Opinion contains a good reminder on the place of fiduciary duties in the context of an LLC. You all know that:
[u]nder the North Carolina Limited Liability Company Act, N.C. Gen. Stat.
§ 57C-1-01 et seq., members of an LLC are treated like corporate shareholders and do not owe fiduciary duties to other members or the company. (citing Kaplan v. O.K. Techs., LLC, 196 N.C. App. 469, 473, 675 S.E.2d 133, 137 (2009)).
Op. Par. 69.
Thus, Lackey and Saldarini, as managers of Pacific Capital, owed no fiduciary duty to the Plaintiffs and the breach of fiduciary duty claims against them were dismissed. Op. ¶72.
And unlike Mehler, who had allegedly made misrepresentations to the plaintiffs to secure their investment in the Pacific Fund, Lackey and Saldarini owed no "special duty" to Plaintiffs. Op. ¶72.
And Even More
Believe it or not, there is even more to write about in the Atkinson decision. But I will end this post with this: the investment at issue in the case was in expensive real estate developments that failed. If you are thinking that those types of claims were remnants of the financial crisis of the last decade and that it seems awfully late for disputes of that type to still be percolating in the Courts, you are right.
A number of the Plaintiffs' claims were dismissed on the basis of the statute of limitations.