Wilmington North Carolina Business Law and Litigation Attorney Blog

North Carolina Shareholder Actions, Bankruptcy, and the Statute of Limitations

In North Carolina, shareholders can sue on behalf of corporations, but only under certain conditions. In particular, there are a number of specific statements which must appear in the complaint; without them, the case will be dismissed.  

 In Coderre v. Futrell, No. COA 12-517, the North Carolina Court of Appeals, by affirming the dismissal of a breach of contract claim, reminds the legal and business community of the importance of basic procedural concepts, particularly standing and the statute of limitations. In this case a North Carolina corporation called NALA bought for 200 acres of land, mostly financed by a note secured by a deed of trust. When NALA failed to make payments its president tried to make a payment on its behalf. The seller rejected this payment, opting to foreclose.

The parties then made a new agreement in which the seller would assign its successful bid back to NALA upon payment. But on August 12, 2008, one day before the expiration of that agreement, NALA filed for bankruptcy. On February 11, 2011, while NALA's bankruptcy case was still pending, Coderre, one of NALA's shareholders, filed an action against the seller for breach of contract. The seller moved to dismiss for lack of standing. In response, Coderre filed an amended complaint adding NALA as a plaintiff. The seller then moved for dismissal, arguing that the statute of limitations had run on the claim.

The Court of Appeals affirmed that Coderre, as a shareholder, did not have standing to file a complaint against the seller in his individual capacity. His name was nowhere on the original purchase agreement and he did not state in his complaint that he was filing on behalf of NALA. Coderre attempted to fix this mistake by filing an amended complaint adding NALA as a plaintiff the day that defendants filed their first motion to dismiss, June 13, 2011. Coderre argued that the amended complaint relates back to the date of the initial complaint. The Court rejected this argument, stating that the initial complaint was nullified because Coderre did not have standing to bring the lawsuit, therefore there was no valid complaint to which the amended complaint could relate back to. Thus, the initial complaint could not be used to defeat defendants' statute of limitations defense to the amended complaint.

Second, the Court affirmed that the bankruptcy proceedings did not toll the statute of limitations and that the amended complaint was filed outside of the limitations period to bring a breach of contract action. NALA argued that 11 U.S.C. § 108(c), which tolls the statute of limitations by the amount of time the debtor is in bankruptcy, should apply. However, the Court noted that this section applies only to a claim against the debtor, not to a claim brought by the debtor against third parties. Instead, 11 U.S.C. § 108(a) applies, which states that “a trustee may commence a nonbankruptcy action before the later of either the expiration of the statute of limitations for such action or two years after the entry of the order for relief.” Here, the alleged breach of contract occurred on April 1, 2008, so the three-year statute of limitations would have run on April 1, 2011. The order for relief in NALA's bankruptcy action was entered on August 12, 2008, so two years after this would have been August 12, 2010. Since the later of these two dates is April 1, 2011, the complaint for breach of contract should have been filed on or before that date. NALA filed its amended complaint on June 13, 2011 and was, therefore, past the statute of limitations.

North Carolina Law Emphasizes the Critical Importance of Well Drafted, Negotiated, LLC Operating Agreements

North Carolina LLC members need to make absolutely certain that their operating agreements have been carefully negotiated, planned, and drafted. When North Carolina General Statutes § 57C-10-03 was enacted in 2010, the legislature made that much abundantly clear. That section provides that the terms of an operating agreement, once signed by the members of the LLC, are the beginning and end of each member's rights. Quite simply, if it isn't in the operating agreement, it does not exist. That section provides: “Except as otherwise provided in this Chapter, it is the policy of [the North Carolina Limited Liability Company Act] to give the maximum effect to the principle of freedom of contract and to the enforceability of operating agreements. ”

 This mirrors similar language in the Delaware LLC Act, which provides: “It is the policy of this chapter to give the maximum effect to the principle of freedom of contract and to the enforceability of limited liability company agreements. ” Del. Code §18-1101(b).

 Delaware, for those who may not already know, is a “thought leader” among the nation's court systems and legislatures with regard to its approach to corporate and LLC law. Delaware is home to a great number of large US corporations who take advantage of its favorable corporate and tax laws. Many states, including North Carolina, have patterned their corporate and LLC laws after Delaware's laws. It is no surprise then that North Carolina would ultimately adopt the same principle, which guides the courts of Delaware when it comes to interpreting LLC operating agreements and determining the rights and responsibilities of LLC members.

 Unfortunately, few North Carolina LLC owners bother to customize the forms they buy online or copy from books they buy at office supply stores. In an effort to save a few hundred dollars consulting a business law attorney during the formation process (because they listen to companies offering cheap business law paperwork and who scare them into thinking they'll have to pay “tens of thousands of dollars” to a bunch of “high priced lawyers”) they end up getting stuck with tens of thousands of dollars in liabilities and attorneys' fees when they find themselves in a dispute with their business partners.

 North Carolina law makes it perfectly clear that while you can use whatever sort of “agreement” you want to serve as your company's operating agreement, you will also be bound by those agreements to the very last letter if and when something goes wrong.    

Piercing the Corporate Veil in NC After the Judgment

Over at my North Carolina Judgment Enforcement blog, there is a post about a recent NC Court of Appeals decision regarding an attempt to pierce the corporate veil to levy on shareholder property after judgment against only the corporation.  The short answer is that it cannot be done.  The full post is here.

The Business Judgment Rule and North Carolina LLCs

In North Carolina, the business judgment rule applies to LLC managers. In Mooring Capital Fund, LLC v Comstock North Carolina, LLC (07 CVS 20852, Wake Co., Business Ct.), 2006 WL 46447078, 2009 NCBC 26, Judge Jolly was ruling on motions to stay, dismiss, and appoint a receiver.

In the course of issuing his ruling, the Judge opined, for what appears to be the first time in North Carolina, that, just as directors of a corporation are, the managers of an LLC are protected by the business judgment rule. “The managers of an LLC may also be entitled to the protections of the 'business judgment rule...'" Taking note of similar language found in the NC Business Corporation Act, § 55-8-30, the judge noted the corresponding portions of the North Carolina Limited Liability Company Act:

"See, e.g., G.S. 57C-3-22(d) (“A manager is not liable for any action taken as a manager, or any failure to take any action, if the manager performs the duty of his office in compliance with this section.”) and G.S. 57C-3-22(b) (“A manager shall discharge his duties as manager in good faith, with the care an ordinarily prudent person in a like position would exercise under similar circumstances, and in the manner the manager reasonably believes to be in the best interests of the limited liability company. . . .”). Such language suggests application of the business judgment rule, a matter of common law in North Carolina, to limited liability companies." (emphasis added).

He then went on to state:

"The rule applies in addition to the North Carolina Business Corporation Act (the “NCBCA”), G.S. 55-1-01 to -17-05, and creates an evidentiary presumption that directors acted reasonably and fairly in discharging their corporate duties. State ex rel. Long v. ILA Corp., 132 N.C. App. 587, 601 (1999). The Long court described the business judgment rule as follows:

[It] creates, first, an initial evidentiary presumption that in making a decision the directors acted with due care (i.e., on an informed basis) and in good faith in the honest belief that their action was in the best interest of the corporation, and second, absent rebuttal of the initial presumption, a powerful substantive presumption that a decision by a loyal and informed board will not be overturned by a court unless it cannot be attributed to any rational business purpose.

Id. at 602 (quoting Russell M. Robinson, II, Robinson on North Carolina Corporation Law § 14.6 at 281 (5th ed. 1995)). "

So while it may have seemed a fairly straightforward matter to put the two together and conclude that the Business Judgment Rule should also apply to LLC managers, we now have at least one written opinion stating as much -- though bear in mind that under the local rules of certain districts, you may not be able to cite to this opinion. Hopefully however, any case in which you would need to cite to this would be taking place in the Business Court.

Choosing Your North Carolina Business Entity: LLC or Corporation?

Then starting a new business in North Carolina, one of the most common questions people have is what form of business entity to use.  In this post I will compare corporations to LLCs (under North Carolina law only).  To put it mildly, when it comes to dealing with liability issues, there is little question that the LLC is the best choice.

A lot of clients initially prefer corporations.  This may be because they are more traditional, or more familiar.  But for most businesses, it makes much more sense to set up as an LLC.  For one, the LLC has stronger liability protection.  As has been discussed previously on this blog in older posts, North Carolina has a well developed "piercing the veil" doctrine -- a rule which allows courts to "look past" a corporation in order to find its shareholders liable in lawsuits.

In contrast, there is no such doctrine in North Carolina for LLCs.  For most practical purposes, this fact alone makes the LLC the clear-cut choice for most businesses.  But there's another aspect to LLCs that bears mentioning, where LLCs offer an even greater benefit:  if you end up having a judgment against you, individually, North Carolina law allows the other party to seize the shares of stock you hold in a North Carolina corporation, and liquidate them to satisfy the debt.  Whereas the law does not allow a judgment creditor to do the same with a person's membership interest in an LLC.  The most the creditor can do there is obtain a "charging order" to have the LLC pay over any distribution you might be owed - but not any salary.  Obviously then, if you own an LLC, and a court enters a judgment against you, you'll simply consult your accountant to figure out the best way to minimize "distributions" in such situations, in order to remain insulated from the effects of the judgment.  In theory, you could have any number of judgments against you and continue to receive salary from that LLC indefinitely, with creditors virtually powerless to reach that money, owing to the extraordinarily debtor-friendly nature of North Carolina law.  Accordingly, if someone recommends that you form a corporation or a partnership instead of an LLC, you should not hesitate to ask some pointed questions as to exactly why they would recommend such a choice.  The answer had better be quite compelling, because from a liability standpoint, forming any other type of entity besides an LLC is simply giving away a great deal of protection, often for little or no benefit. 

Port City Java Sues Founder

Wilmington-based coffee-house chain Port City Java has filed suit against its founder and former COO Don Reynolds.  The suit, filed in New Hanover County Superior Court, alleges that Reynolds, his wife, and an LLC held by Reynolds, diverted funds from the company for personal use, including the purchase of real estate in Highland, NC. 

According to the Star-News, the suit was filed on December 23, and in keeping with the Rules of Civil Procedure, does not specify the dollar amount sought, but instead recites the claim for damages as "in excess of $10,000."

Converting a North Carolina Corporation to An LLC

Many clients have sought to convert their closely held corporations to LLC's lately, and with good reason.  Very few small business owners actually do anything with their corporations that couldn't also be done under an LLC.  And let's face it:  very few closely held corporations do an adequate job of keeping up with corporate formalities.  In the event of a lawsuit, this can result in "veil piercing" which, as we have discussed here previously, is much harder to do to an LLC. 

So for this reason alone -- simpler management, fewer formalities, and less risk of a court overlooking the corporate entity to reach the assets of business owners -- many clients are choosing wisely to convert to an LLC.

While this seems like just a simple bit of paperwork (you can download Articles of Conversion from the secretary of state's website, after all) there can be a few catches.  There are also other methods for accomplishing the same result, without using the state conversion form.  A careful review of the tax implications involved should be undertaken prior to making a final decision on conversion.  For one, the conversion could trigger a taxable gain.  For another, there could be an effect on employment tax wage bases.  These effects could, of course, be quite sizable, and result in the need for additional planning, or foregoing conversion altogether. 

Forming a New Business in North Carolina: Additional Resources

In my last post, I listed some resources for starting a new business in Wilmington, North Carolina.  Each of those were local to the area.  The additional resources below can help you start a business statewide.

Business ServiCenter.  Sponsored by the North Carolina Department of Commerce.  The ServiCenter provides assistance with business plans, hiring, expansion, development, marketing, operations, and logistics for most types of businesses.  Additionally, the ServiCenter offers specific advice for companies involved in manufacturing, workforce training, exporting, and government contracts.

Contact:    North Carolina Department of Commerce
                    Business ServiCenter
                    4310 Mail Service Center
                    Raleigh, NC 27699-4310
                    919-715-2864
                    Toll-Free:  1-800-228-8443
                    Fax:  919-715-2855
                    http://www.nccommerce.com/servicenter

SBA - United States Small Business Administration

Contact:        SBA
                        North Carolina District Office
                        6302 Fairview Road
                        Charlotte, NC 28210-2227
                        704-344-6563

The SBA’s Small Business Guide for North Carolina can be found at:

http://www.reni.net/guides/pdf/english/northcarolina.pdf

Starting a Business in Wilmington, NC: Some Resources

If you are starting a business in North Carolina, particularly in the Wilmington area, here are some resources to help you get started.  Note that even if you are not around Wilmington, many of these services have offices in your area.  If you have any questions or would like a list of similar services in your area, please contact us. 

Small Business Technology Development Center.  Assists new businesses with planning, operation, human resources, marketing, government contracts, and other aspects of business.

Contact:    SBTDC
                5051 New Center Drive
                Wilmington, NC 28403-3297
                910-962-3744
                http://www.sbtdc.org

Wilmington SCORE.  Provides free business counseling and mentoring.  Holds seminars on topics such as accounting, business planning, and marketing.

Contact:  Wilmington SCORE
                    4010 Oleander Drive, Suite 6
                    Wilmington, NC 28403
                    910-452-5395
                    http://www.wilmingtonscore.org

Cape Fear Community College - Small Business Center.  Provides classes and counseling for small businesses.  Also offers a library of resources for new and small businesses, including books, pamphlets, videos and software.

Contact:        CFCC Small Business Center
                    419 North Third Street
                    Wilmington, NC 28401
                    E-mail:  [email protected]
                    910-362-7216

 

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.