Wilmington North Carolina Business Law and Litigation Attorney Blog

Foreign Corporations and the Certificate of Authority in North Carolina

If you are a foreign / out-of-state corporation and need to file suit in North Carolina, you will first need to file a Certificate of Authority with the Secretary of State, and as of the date of this post, that will cost you $250.00.   

This is a prerequisite; if you do not have a Certificate of Authority on file in North Carolina prior to filing suit, your case will be thrown out of court.  You can click the following link to get a Certificate of Authority form.  You will have to scroll down to Form B-09.  Instructions are included on page three of that form. 

Piercing the "Corporate" Veil of LLCs in North Carolina - Part 4

In the previous post, I promised a discussion of motions for sanctions pursuant to Rule 11 of the North Carolina Rules of Civil Procedure, in cases where LLC members are named as individual defendants in contract, fraud and Chapter 75 cases.

In North Carolina, the rule is straightforward:  an individual LLC member cannot be sued, except "by reason of his own acts or conduct."  See N.C.G.S. s 57C-3-30(a).  This section does not, however, establish an alter ego or veil piercing creteria.  It is intended to allow plaintiffs to recover for torts committed by LLC members, not, as some might have it, to establish member liability in actions against the LLC.

Clarifying this purpose, subsection (b) provides:  "A member of a limited liability company is not a proper party to proceedings by or against a limited liability company, except where the object of the proceeding is to enforce a member's right against or liability to the limited liability company."

This subsection should clarify any doubt a litigant might have about what subsection (a) allows. 

In Page v. Roscoe LLC, 128 N.C. App. 678, 497 S.E.2d 422 (1998) the plaintiff learned this lesson the hard way.  Plaintiffs sought to enjoin the defendant LLC from constructing a gas storage facility they deemed a nuisance.  LLC member Dale Bone was also named as a defendant.  No actions by Bone were alleged that were not also alleged to have been undertaken by the LLC.   Accordingly, the court held that naming Bone was a violation of Rule 11, on the theory that the complaint, in naming him, was not well grounded in law.

In so holding, the Court of Appeals agreed with the trial court, that "no acts by Bone, individually, were properly alleged. Therefore, under the above statute [N.C.G.S. s57C-3-30(b)], it was improper to name an individual member of a limited liability company as a party defendant without any evidence to support it.  As such, the naming of Bone as an individual defendant was not well-grounded in law and therefore a violation of Rule 11." 

The decision provides little guidance to a plaintiff hoping to pierce the corporate veil of an LLC.  There is no explanation about what would need to be alleged to state a complaint If anything, it provides broad grounds to support Rule 11 motions whenever an individual LLC member is named in the same complaint as the LLC.

Piercing the LLC Veil in North Carolina - Part 3

As I touched on in previous posts, in North Carolina, the factors to consider in determining whether to pierce the corporate veil include: (1) inadequate capitalization; (2) non-compliance with corporate formalities; (3) complete domination and control of the corporation so that it has no independent identity; and (4) excessive fragmentation of a single enterprise into separate corporations. See Ridgway, 329 S.E.2d at 330-31 (citing generally, Robinson, North Carolina Corporation Law §§ 2-12, 9-7 to -10 (3d ed. 1983)).

Yesterday in Part 2 of this series, I looked at the second factor - non-compliance with formalities.  Today I will look at the first factor above, inadequate capitalization.

One common misconception surrounding this factor is the timing of its applicability.  Litigants frequently assume that when a bill is unpaid, that this fact, standing alone, establishes inadequate capitalization, regardless of how old the business entity may be.

But in fact, inadequate capitalization only applies to the initial capitalization of the corporation; a new corporation must have sufficient capital with which to pay for operating costs that it can reasonably expect to incur.  Over time, however, creditors have the opportunity to examine the creditworthiness of the corporation, and in extending credit, have the option of requiring a guarantor.  For these reasons, courts are not especially prone to give great weight to this factor in most contract cases, particularly when those contracts were formed well after the corporation has been in business for some length of time. 

Moreover, by itself, this factor is extremely unlikely to support a veil-piercing claim.  An additional showing of an intent to use the corporate entity to defraud creditors would almost certainly be required.

In the LLC context, it is quite tempting to seek to apply the same rationale. Although there do not appear to be any published North Carolina cases specifically addressing this issue under the LLC Act, there is no reason why the policy of protecting creditors from fraud would be any less important - or treated differently - in situations involving LLC creditors. 

For attorneys defending LLCs in contract, fraud and/or Chapter 75 cases in North Carolina, it is important to be aware that plaintiffs will attempt to allege these factors in order to reach the assets of the individual members of the LLC, and that courts could well be persuaded to overlook the LLC's protection in cases where undercapitalization is alleged.  This is why a motion to dismiss should be filed, and the court made aware that there is no precedent for applying these factors to pierce an LLC.  Even if the motion is unsuccessful, the rationale behind it can be re-employed when your opponent is seeking to draft a jury instruction at trial.  The judge might not have granted your motion, but may be unwilling to instruct a jury on a doctrine whose applicabilty to an LLC has not been clearly established. 

Absent specific facts alleging fraud by a member, a motion to dismiss as to the LLC members should be filed, along with a motion for sanctions under Rule 11. 

In the next installment in this series, I will go into further detail about Rule 11 and how it applies to contract, fraud and Chapter 75 suits involving individual LLC members.

Piercing the LLC Veil in North Carolina - Part II

The North Carolina Limited Liability Company Act protects LLC members from liability for the actions of the LLC.  N.C.Gen.Stat. § 57C-3-30(a) provides:

A person who is a member or manager, or both, of a limited liability company is not liable for the obligations of a limited liability company solely by reason of being a member or manager or both, and does not become so by participating, in whatever capacity, in the management or control of the business.

However, it is still possible for a member to incur liability, as noted in the final sentence of subsection (a):  A member or manager may, however, become personally liable by reason of his own acts or conduct.

The act does not, however, go on to define what sort of "acts or conduct" would cause a member or manager to become personally liable.  Litigants have sought to apply the traditional veil-piercing factors for corporations as a guide to piercing the liability protections of the LLC; and in some cases, have sought to use them as precedent.

Of course, such an approach misses the obvious:  an LLC is not a corporation.  They are different types of business entity altogether.  Just because the courts can look past a corporation's liability protection under certain circumstances, it does not automatically follow that those exact same circumstances should cause an LLC member to lose liability protection.

For one, the traditional "adherence to formalities" factor is not nearly the issue for LLCs that it is for corporations.  This makes sense, as the legislature, in enacting the LLC act, sought to offer entrepreneurs and business owners a simpler, more manageable type of entity that, unlike a general partnership, could still afford liability protection.  If "failure to adhere to formalities" were to be adopted in any type of veil-piercing test by the courts, doing so might well run afoul of the legislative intent behind the Act.  Surely this factor would be hard to implement as any kind of general factor in an LLC veil-piercing analysis.  While some LLCs could have significant formalities built into their operating agreements, it is not clear how any such provisions could be invoked by an outside party suing the LLC. 

In the next part of this article, I will review some of the other traditional corporate veil-piercing factors, and examine their applicability to LLCs.

Piercing the LLC Veil in North Carolina - Part 1

In North Carolina, litigants frequently seek to "pierce the veil" of limited liability companies, in order to reach the assets of individual members.  In Part 1 of this series, I outline the traditional approach to veil piercing in the corporate context, and how North Carolina construes the doctrine.

Historically the corporate veil can be pierced, and liability imposed on shareholders, when courts find sufficient evidence of a combination of the following factors:  (1) inadequate capitalization; (2) non-compliance with corporate formalities; (3) complete domination and control of the corporation so that it has no independent identity; and (4) excessive fragmentation of a single enterprise into separate corporations. Glenn v. Wagner, 313 N.C. 450, 455, 329 S.E.2d 326, 330-31 (1985) (citing generally, Robinson, North Carolina Corporation Law §§ 2-12, 9-7 to -10 (3d ed. 1983)). 

In addition, North Carolina courts will "pierce the corporate veil" where an "individual exercises actual control over a corporation, operating it as a mere instrumentality[.]"  Becker v. Graber Builders, Inc., 149 N.C. App. 787, 790, 561 S.E.2d 905, 908 (2002) (citation omitted).  The North Carolina Supreme Court set forth the "instrumentality rule" as follows:
        "[When a] corporation is so operated that it is a mere instrumentality or alter ego of the sole or dominant shareholder and a shield for his activities in violation of the declared public policy or statute of the State, the corporate entity will be disregarded and the corporation and the shareholder treated as one and the same person, it being immaterial whether the sole or dominant shareholder is an individual or another corporation.  Henderson v. Finance Co., 273 N.C. 253, 260, 160 S.E.2d 39, 44 (1968).  Liability may be imposed on an individual controlling a corporation as an "instrumentality" when the individual had:
        (1)     Control, not mere majority or complete stock control, but complete domination, not only of finances, but of policy and business practice in respect to the transaction attacked so that the corporate entity as to this transaction had at the time no separate mind, will or existence of its own; and
        (2)     Such control must have been used by the defendant to commit fraud or wrong, to perpetrate the violation of a statutory or other positive legal duty, or a dishonest and unjust act in contravention of plaintiff's legal rights; and
        (3)     The aforesaid control and breach of duty must proximately cause the injury or unjust loss complained of.
Glenn, 313 N.C. at 455, 329 S.E.2d at 330.

NEXT:  The North Carolina LLC Act, and its provisions relating to individual liability of LLC members.

Tips For Businesses: Getting the Most From Your Attorney

New York City business attorney Dan Abrams has published an article in the New York Enterprise Report called Getting the Most From Your Attorney.  I have linked to it here because it contains lots of helpful suggestions for business owners about how -- and when -- to make the best use of an attorney.  In the third item on Dan's list is one I always emphasize:

Use lawyers to prevent problems, not just fix them. Many small businesses do not have attorneys until they think they need them. You need to make sure you are proactive in identifying legal issues before they become problems, and problems before they become lawsuits.

I would personally prefer to have my days be filled with short, simple, inexpensive legal work that solves problems and ends them, instead of having them filled with long, complicated, intractable and expensive problems.  The latter might ultimately be slightly more lucrative for the attorney, but my view is that both myself and my clients are best served when the problems are handled while they are still small, manageable, easy to handle, and cost little to solve. 

Five Inside Tips for Improving Your Collection Rate

A lot of clients have problems collecting from their customers.  Most of my work involves recovering that money.  Over time, I have developed a series of techniques that clients can use to help improve their collection rates, save money (by not having to pay me) and increase cash flow.  Here are a few:

1. Use a professionally drafted contract or promissory note.  For one thing, the mere fact that a note or contract appears to have been drafted by an attorney gives the customer the subtle impression that you have an attorney on your side.  This alone will cause them to take you more seriously, and therefore, more likely to pay accordingly.  You may spend a few hundred dollars - or for larger transactions - a few thousand - but if you do hundreds of thousands - or millions - of dollars in transactions every year using the same form contract, a small investment in a well-drafted contract easily and quickly pays for itself.
2. Make sure you provide that the customer in default is liable for the costs of collection and attorneys' fees.  In North Carolina, you are not automatically entitled to attorneys' fees just because you had to hire an attorney to collect a debt.  There are only two ways to get them: either by a specific statute that grants them to you, or by contract.  Since you control the terms of your contract, it makes sense to insert a brief clause - even a single sentence - providing that if the customer ever defaults, the customer must pay collection costs and attorneys' fees.  You might be surprised by how many contracts do not provide for collection of these costs.
3. Define default.  If you are going to implement #2 above, you should also have a "Definitions" section that defines exactly when the customer is in default.  Often on things like open accounts,for example, it can be difficult to tell if the customer is in default, or just running a high balance.  Rather than let a judge decide, make it clear in your contract:  all invoices are due within X days of mailing, or the customer is in default.  Or if you are running an open account, define default as any balance exceeding X dollars that is not brought below X dollars within Y days of first exceeding X dollars.
4. Know Your Customer.  It's not enough to get a representative to sign a contract.  You need to have a specific entity on the contract that will be liable for the debt.  A lot of times I will see a contract signed by "Sam Signer as agent for Gulf Bay Dreams".  Only there is no actual company called "Gulf Bay Dream"s.  That may be the name of a project under development, but the actual company might be called XYZ, Inc, dba Gulf Bay Dreams of Tallahassee.  If the contract only says "Gulf Bay Dreams" and you end up in court, you're going to have the extra task of having to prove that the "Gulf Bay Dreams" you are suing is in fact one in the same with the one who signed your contract. The problem gets worse when you go to the Florida Secretary of State website and find that there are 53 companies in Florida with variations on the name "Gulf Bay Dreams", engaged in everything from propane wholesaling to fencepost repair.   Get the right name on the contract the first time around and you cut your risk dramatically. 
5. Don't ever let them forget that you are on top of things.  You don't have to be nasty about it, and in fact you shouldn't be; but if you are shipping goods on a net-30 basis and day 31 rolls around and you have neither been paid nor contacted by the customer, make sure someone gets on the phone at 9:01 am on Day 31 to find out the status of the payment.  The techniques for handling this are highly variable, as some client relationships are more delicate than others, but you should have a calendaring system in place to notify you the minute any account or contract is in default, and have someone available with the time and tact to handle the situation.  With collections, the maxim "the squeaky wheel gets the oil" is absolutely correct.

Quizno's Franchisees Sue for Fraud and Unfair Business Practices

A group of Quizno's franchisees has filed suit against Quizno's alleging:  fraud, unfair competition, breach of contract, and racketeering, among other things.  The primary allegations are that Quizno's agreements with franchisees unlawfully prohibits them from seeking the best price on the goods they buy -- particularly food -- and instead requires them to buy only from certain suppliers.  These suppliers, the plaintiffs claim, over-charge because they know the franchisees have no other options. 

While the allegations are explosive, such suits are not new.  A few years ago, Quizno's franchisees sued the company, alleging similar kinds of unfair business practices, in its hometown of Denver.  Those cases were dismissed.  It will be interesting to see both (a) what these franchisees have learned from the mistakes of their predecessors, and (b) how well the company fares outside its own hometown. 

Borat Lawsuits: Valid?

The Borat movie has only been out a few days, and lawsuits are flying already.  Two frat boys from South Carolina have sued "Borat", comedian Sacha Baron Cohen, and the movie's makers and producers.  The suit alleges that they were tricked into believing that the film would not be shown in the United States, and that the young men only signed the Standard Consent Agreement after they had been drinking alcohol. 

The Complaint alleges several causes of action: fraud, false light, appropriation of likeness, and negligent infliction of emotional distress.  This despite the fact that Paragraph 4 of the Consent Agreement specifically waives their rights to file any such actions.

They key then is the plaintiffs' demand for recission of the Consent Agreement.  If they can succeed in having that waiver rescinded, then the claims the waiver would otherwise bar can move forward.

The plaintiffs allege that they were both lied to about the movie, and that they were intoxicated at the time they signed the waiver.  Either allegation, if sufficiently proven, could serve as a basis for rescission of the waiver, which would allow the other claims to go forward. 

Click Fraud: Are You Wasting Online Advertising Dollars?

BusinessWeek Online has this article on click fraud -- a practice whereby online advertisers generate phony clicks and charge clients for them.  The salient portions of this scam are summarized as follows:   

"The spreading scourge poses the single biggest threat to the Internet's advertising gold mine and is the most nettlesome question facing Google and Yahoo, whose digital empires depend on all that gold.  The growing ranks of businesspeople worried about click fraud typically have no complaint about versions of their ads that appear on actual Google or Yahoo Web pages, often next to search results. The trouble arises when the Internet giants boost their profits by recycling ads to millions of other sites, ranging from the familiar, such as cnn.com, to dummy Web addresses like insurance1472.com, which display lists of ads and little if anything else. When somebody clicks on these recycled ads, marketers such as MostChoice get billed, sometimes even if the clicks appear to come from Mongolia. Google or Yahoo then share the revenue with a daisy chain of Web site hosts and operators. A penny or so even trickles down to the lowly clickers. That means Google and Yahoo at times passively profit from click fraud and, in theory, have an incentive to tolerate it. So do smaller search engines and marketing networks that similarly recycle ads."

Under North Carolina law, defrauded advertisers could claim for Breach of Contract, Unfair and Deceptive Business Practices (N.C.G.S. ss 75-1.1 et seq.), Fraud, and possibly Civil Conspiracy.  Depending on the number of affiliated operators, there could even be a devastating Civil RICO claim, described by one appeals court as "the litigation equivalant of a thermonuclear device".  See Katzman v. Victoria's Secret Catalogue, 167 F.R.D. 649, 655 (S.D.N.Y. 1999).  Violators could be subject to triple damages or punitive damages under either N.C.G.S. Ch. 75 or under the Civil RICO law.

In recent years, companies such as Google and Yahoo have paid out multimillion dollar settlements to satisfy claims that their "pay per click" advertising campaigns were being conducted fraudulently.  Many more claims are pending.