The Compass

The Compass

Charting Business and Technology Litigation in North Carolina and the Fourth Circuit

The New Rule 37(e) Pushes Forward

Posted in Data Security, Discovery, Federal Rules of Civil Procedure

The proposed revision of Rule 37(e), which recently cleared another hurdle in the rulemaking process, could dramatically limit the exposure companies face from spoliation claims. It may also go too far.

The current version of Federal Rule of Civil Procedure 37(e) provides that parties who do not appropriately preserve documents related to litigation may face sanctions. While it does contain a “safe harbor” for loss of electronically stored information (ESI) due to “routine, good-faith operation of an electronic information system,” the Committee Note to Rule 37 provides that the prospect of litigation could require alteration of “routine operation[s]” and mentions that a “litigation hold” may be required. Generally, Rule 37 can lead lawyers and clients, respectively, to rush litigation holds and preservation efforts in an effort to avoid the specter of discovery sanctions.

In June 2013, noting that “the amount and variety of digital information has expanded enormously in the last decade, and the costs and burdens of litigation holds have escalated as well,” the Judicial Conference Advisory Committee on Civil Rules approved for public comment a new version of Rule 37(e). The new rule is designed to ameliorate pressure that parties feel to preserve a wide scope of information in order to avoid sanctions.  As revised, the rule would require that in order to recover sanctions for loss of information parties must show all three of the following:

1. that there was substantial prejudice in the litigation;
2. that the other party’s actions were willful or in bad faith; and
3. that the loss of information irreparably deprived a party of any meaningful opportunity to present or defend against the claims in the litigation.

In addition, the new Rule 37(e) provides that courts should consider “all relevant factors” in determining whether a party’s efforts to preserve were appropriate and whether the failure was willful or in bad faith. The new rule lists five of these factors: reasonableness of the party’s preservation efforts, whether the party received a clear and reasonable request to preserve, the “proportionality” of the preservation efforts to the litigation, and whether the party timely sought the court’s guidance on preservation issues.

The proposed changes are discussed in depth beginning on page 270 of The Advisory Committee Report.

While aimed at easing the litigation burden on parties, by excusing a party from sanctions absent willful/bad faith spoliation, the new rule may incentivize poor preservation habits.  Judge Schira Schiendlin, who presided over the influential Zubulake v. US Warburg cases in the Southern District of New York that set guidelines for the scope of electronic discovery, recognized this potential pitfall of the new rule.  In Sekisui American Corp. v. Hart, she noted that “[u]nder the proposed rule, parties who destroy evidence cannot be sanctioned . . . even if they were negligent, grossly negligent, or reckless in doing so” and “would require the innocent party to prove that it has been substantially prejudiced by the loss of relevant information, even where the spoliating party destroyed information willfully or in bad faith.”  The new Rule 37 will also undoubtedly create more litigation in connection with parties’ preservation efforts as courts are asked to interpret the criteria for such efforts and whether they were sufficient.

The public comment period for the new rule ended on February 18, 2014, and the Advisory Committee is now considering the public comments that it received.  The rule, including any changes approved by the Advisory Committee, will next go to the Standing Committee, and then on for Judicial Conference approval, Supreme Court approval, and finally Congressional approval. Thus, it will likely take many months before the new rule takes effect. As you will see in an upcoming post on The Compass, in the interim, the burden remains squarely on the preserving party, the “reasonable and appropriate” standard remains in place, and sanctions for failing to appropriately preserve ESI and other documents can be catastrophic.


Removal to Federal Court Based on Diversity Jurisdiction: How Long Do You Have?

Posted in Uncategorized

Complaints filed in state court routinely allege only damages “in excess of $10,000.” If you’re a defendant considering removal to federal court based on diversity, such an allegation doesn’t meet the $75,000 amount in controversy threshold.  But if you have information outside of the complaint – for example, based on settlement conversations or demands – that the plaintiff is in fact seeking more than $75,000 damages, when does the 30 day period for removal start?

According to a decision by the Western District of North Carolina, the plaintiff’s response to the defendant’s written statement of monetary relief sought starts the thirty-day clock. The defendant’s subjective knowledge of potential damages or the parties’ pre-litigation settlement discussions do not start the clock for removal.

Generally, notice of removal of a civil action must be filed within thirty days of the defendant’s receipt of the initial pleadings.  When, however, it is not clear from the pleadings that the case is removable, a defendant has thirty days from receipt of “an amended pleading, motion, order, or other paper from which it may first be ascertained” that the case is removable.

In Hall v. Hillen, the plaintiff sought damages “in excess of $10,000” for injury, pain and suffering, and lost wages arising from a motor vehicle accident.  During the early months of litigation, the defendant answered the complaint, served and responded to discovery, and communicated an offer of judgment.  Four months after the complaint was filed, the defendant received a written response to its request for a statement of monetary relief sought, which indicated that the plaintiff sought damages in excess of $75,000.  Nine days later, the defendant filed a notice of removal.

The Court found removal to be timely.  In so holding, the Court noted several other potential events which did not start the clock on the thirty-day removal period.  Neither the plaintiff’s subjective knowledge of the damages at issue nor a pre-litigation insurance demand were sufficient to render the amount-in-controversy “ascertainable” for purposes of the removal deadline.  The Court also held that the defendant had not waived his right to remove the action by answering the complaint, making an offer of judgment, or engaging in discovery, as those “expected procedural steps” did not indicate a “clear and unequivocal intent to remain in state court.” The Court also indicated that if the defendant had filed a counterclaim, he would likely have waived his right to remove later.

The Hall decision indicates a narrow interpretation of what “other paper” may be considered to give notice of removability.  The Court was unwilling to delve into what the defendant actually knew, and when he knew it, and instead limited its inquiry to the documents formally exchanged during the course of the lawsuit. Here the window for removal did not close until months after service of the complaint – in part because of the care taken by defendant to stake out plaintiff’s damages early in the case, and engaging in minimal discovery.



Can You Keep a Secret? Confidentiality Clauses in Settlement Agreements Are For Real

Posted in Contracts, Settlements

If a party to a confidential settlement agreement blabs about the settlement, could the party lose some of the benefits of the settlement?  A recent Florida appellate decision is a good reminder to think carefully about the confidentiality clauses in your settlement agreements both before—and after—you settle your case. (Look for some best practices at the end of the post.)  In Gulliver Schools v. Snay, a former headmaster of a Florida prep school filed suit against the school, alleging age discrimination and retaliation, when the school did not renew his contract.  Snay settled his case for $10,000 in backpay, an additional $80,000 payment, and $60,000 in attorney’s fees.   The settlement agreement included the following “detailed” confidentiality provision: 

 13.  Confidentiality. . . . [T]he plaintiff shall not either directly or indirectly, disclose, discuss or communicate to any entity or person, except his attorneys or other professional advisors or spouse any information whatsoever regarding the existence or terms of his Agreement. . . . A breach . . . will result in disgorgement of the Plaintiff’s portion of the settlement Payments.

Snay and his wife decided they needed to tell their daughter something–so they told her only that the case was settled and that they were happy with the result.  Snay’s daughter added a little embellishment to the announcement and posted it on Facebook, saying “Mama and Papa Snay won the case against Gulliver.  Guliver is now officially paying for my vacation to Europe this summer.  SUCK IT.”  The post went out to 1200 of the daughter’s closest “friends,” many of whom were current or past Gulliver students.

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Field Set for NC Supreme Court Races

Posted in North Carolina Supreme Court, Uncategorized

In November, North Carolina voters will select the individuals who will hold of the majority of the seats on the Supreme Court of North Carolina until 2022.  Four of the seven seats on the Supreme Court are up for grabs and observers expect that the races will be hotly contested despite their relatively low profile.  The outcome of this election could have a major impact on the law of North Carolina and how it is applied to the citizens and businesses of the state.

The races are non-partisan – although the major political parties always have their favorites in each race.  If more than two individuals are running for a seat, there will be a primary election for each seat with the top two vote getters moving on to the general election.

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N.C. Business Court Weighs In On Enforcement of Restrictive Covenants Following Aquisition of a Company

Posted in Contracts, Trade Secrets

Your company acquires another company through merger or stock purchase.  You require the key employees of the acquired company to sign new employment agreements which provide for similar pay, benefits and job duties  – but the new agreement also imposes new non-compete obligations.  A recent decision by the North Carolina Business Court reminds companies that after a stock or equity purchase such clauses may not be enforceable because they lack consideration.  If you make an acquisition through merger or a stock purchase, there must be additional consideration to support any restrictive covenants entered into concurrently with the acquisition.

In Amerigas Propane, LP v. Coffey, 2014 N.C.B.C. 4, the Plaintiffs sought a preliminary injunction to enforce the confidentiality and non-compete provisions in an employment agreement signed by Ermon Coffey, a Defendant.

Coffey signed the employment agreement in conjunction with the Plaintiffs’ acquisition of Heritage Operating, LP, which had employed Coffey for eleven years.  Before the sale, Coffey had not been subject to any non-competition or non-solicitation agreements with Heritage.  The new employment agreement stated that consideration for the new restrictions included “initial employment . . . continued employment . . . promotion . . . incentive compensation payment; and/or . . . increase in compensation.”  Just over a year after the acquisition, Plaintiff fired Coffey, who then went to work for a competitor.

The Court denied the Plaintiffs’ motion for a preliminary injunction, finding there was insufficient consideration to support the employment agreement Coffey signed at the time of the purchase.  As the Court stated,

“Signing a contract in exchange for continuing an employment relationship, without more, will not suffice as consideration. . . .As sch, an employment contract signed at the time of a business acquisition may only use employment with the acquiring company as consideration if the old employment relationship is deemed terminated as a result of the transaction.”

Here, because the acquisition occurred through purchase of equity (akin to a stock purchase), no “new” employment had been provided as consideration.

In contrast, the Court noted that an acquisition structured as an asset purchase will act to terminate existing employment relationships. In that scenario existing employees of the acquired company don’t necessarily become employees of the acquiring company.  Thus, if this had been an asset purchase, and if Coffey had then signed an employment agreement, it appears there would have been adequate consideration.

Knowing this, Plaintiffs contended that Coffey was eligible for new benefits and raises under his employment agreement.  The Court was unpersuaded, and instead found that Coffey’s benefits were not materially different from those to which he had been entitled under his previous employment with Heritage.

Ten Years Later: NC Catches Up With Rule 702, Adopts Daubert and Bids Adieu to Howerton

Posted in Appellate, Discovery, North Carolina Court of Appeals

In January, the North Carolina Court of Appeals decided State v. McGrady, in which it finally addressed the impact of the 2011 amendments to Rule 702.  McGrady confirmed what many practitioners have believed for two and a half years — that North Carolina State Courts must now adhere to and apply Daubert standards to expert witnesses and opinion testimony. 

McGrady was convicted of shooting and killing his cousin.  On appeal he argued that his expert’s testimony regarding the doctrine of “use of force” was wrongfully excluded.  The expert testified and opined that McGrady’s cousin exhibited a number of physiological and circumstantial “pre-attack cues” that were “consistent with exhibition by an individual that an attack was likely imminent,” prompting McGrady to shoot him.  He also testified that the rounds were fired in “somewhere around 1.8 seconds.”   The scientific basis for his opinions came from published articles on use of force and the training he received “by some of those authors and studies that I have myself been involved in.”    He claimed that this information is regularly relied on by people in the field of use of force, but he did not know its “potential rate of error.”  He also had no medical degree or medical education.

The trial court found that: (1) the expert’s opinions were based on medical knowledge that he was not qualified to discuss; (2) his testimony was not helpful to the jury; (3)  he was not competent to testify about reaction times; (4) his testimony was not based on sufficient facts or data; (5) his testimony was not the product of reliable principles or methods; (6) his methods had not been subject to peer review; and (7) his opinions were based on speculation.  The Court of Appeals affirmed the exclusion of the expert testimony, and discussed the October 2011 changes to NC Rule of Evidence 702(a).  Noting that the rule was amended to include additional criteria for the admission of expert testimony (“the testimony is based upon sufficient facts or data[;] the testimony is the product of reliable principles and methods[; and] the witness has applied the principles and methods reliably to the facts of the case”), the Court confirmed that the amendment replaces the expert witness standard from Howerton v. Arai Helmet with the U.S. Supreme Court’s decision in Daubert.  The Court further noted that the trial judge should serve as a gatekeeper and determine whether expert testimony is based on the scientific method, whether the techniques or methods have been subjected to peer review and publication, the known or potential rate of error, the existence and maintenance of standards controlling the technique’s operation, and whether the theory or technique is generally accepted as reliable in the relevant scientific community. The Court concluded that the trial court employed the appropriate standard in evaluating the expert’s testimony, and did not abuse its discretion by excluding it.

So, for the many who believed that Howerton’s anti-“mechanistic” approach served as an unfortunate detour on the road of evidentiary jurisprudence, it would seem that a course correction has occurred.  Following the General Assembly’s lead, the Court of Appeals has officially adopted Daubert and embarked on a new direction that adds both a new phase to many cases and new gatekeeping obligations to Superior Court Judges.

Caller Beware: The Growing Risk of Hiring Telemarketers

Posted in Uncategorized

Outsourcing telemarketing to a third party may raise your risk profile. That appears to be the lesson from a recent discovery ruling in Mey v. Monitronics International, Inc., et al, highlighting the burgeoning legal exposure for companies that outsource telemarketing services.

Minitronics is a home security company that engaged a small army of independent contractors—styled “authorized dealers”—to sell its products and services through a nationwide telemarketing campaign. According to the half-dozen class-action lawsuits that sprang up in response, many of these contractors violated the Telephone Consumer Protection Act by, among other things, placing calls to numbers on the Do Not Call registry.

The cases have all been funneled to the Northern District of West Virginia by the multidistrict litigation panel. Mey is the oldest case of the lot.

In Mey, Minitronics argued that it could not be liable for its independent contractors’ alleged violations of the TCPA. But the court rejected that argument, looking to a recent FCC ruling that recognized, for the first time, that common law principles of agency can lead to vicarious liability for TCPA violations. The court allowed additional discovery from Minitronics to see whether it knew of, and ratified, its dealer’s wayward ways.

That’s when things got even more interesting. The plaintiff demanded discovery related to all of Minitronic’s authorized dealers, not just the one dealer (known as VMS) that supposedly harmed her and the putative class.  In particular, the plaintiff asked Minitronics to disclose consumer complaints made against any of its authorized dealers. Minitronics refused, arguing that actions of other authorized dealers were not relevant to its potential vicarious liability for the actions of VMS. Plaintiff moved to compel.

Magistrate Judge Kaull granted the motion to compel. The trove of information as to all dealer complaints was discoverable, he reasoned, not just because it may contain nuggets about VMS, but also because it might show that Minitronics “responded differently to other dealers accused of violating the TCPA than [it] did to VMS.”  The comparison was relevant to whether Minitronics ratified VMS’s conduct, the court suggested, because it might show that Minitronics took more aggressive steps to stop other dealers’ violations of the TCPA than it did for VMS.

Given the apparent scope of Minitronic’s nationwide telemarketing campaign, discovery of this magnitude is likely to be both onerous and expensive. Even if Minitronics can ultimately avoid vicarious liability, it’s now subject to being second guessed for how it dealt with each and every subcontractor.

Companies that outsource their telemarketing should take notice. The new prospect of vicarious liability not only increases the risk of drawing (and potentially losing) a TCPA lawsuit—it also seems to open the door for more costly and probing discovery practice.

NC COA: Tillman Substantive Unconscionability Test No Longer Valid

Posted in Arbitration, Class Action Waivers, North Carolina Court of Appeals

Jurisprudence controlling the enforceability of arbitration provisions has been at the forefront of legal attention for the past decade, and the unanimous decision of a North Carolina Court of Appeals’ (“COA”) panel Torrence v. Nationwide Budget Finances proves that it is still evolving.  Here, evolution breeds uncertainty.

In 2008, the North Carolina Supreme Court (“NCSC”) decided the then landmark case of Tillman v. Commercial Credit Corp.,  In Tillman, the NCSC held that an arbitration clause in a commercial contract is enforceable unless it is declared to be both procedurally and substantively unconscionable.  Under Tillman, an arbitration clause will be declared substantive unconscionability if the following factors exist: (1) the arbitration costs borrowers may face are “prohibitively high”; (2) “the arbitration clause is excessively one-sided and lacks mutuality”; and (3) the clause prohibits joinder of claims and class actions.

In Torrence, the COA revisited the substantive unconscionability standard as articulated in Tillman and, in an unusual move that dramatically reshapes North Carolina law, declared that it is no longer good law.  In reaching this decision, the Torrence Court applied the United States Supreme Court’s opinions in AT&T Mobility LLC v. Concepcion and American Express Co. v. Italian Colors Restaurant which have limited the ability of state courts to find that arbitration clauses are unconscionable on state law grounds.

Since the substantive unconscionability factors announced in Tillman had been rejected by SCOTUS, the COA was left with no basis upon which to find the Torrence clause to be substantively unconscionable.  Thus, it reversed the trial court decision and implemented a sweeping change to contract and arbitration jurisprudence in North Carolina.

While the North Carolina Supreme Court does not accept many cases based upon Petitions for Discretionary Review, it is likely that Torrence will be closely considered because it eliminated the substantive unconscionability test announced in Tillman and will impact on consumer transactions across the state.

Fraud by Omission Claims: Pleading Isn’t Easy

Posted in Uncategorized

The Compass

In a recent decision by Judge Gale, the North Carolina Business Court has reminded plaintiffs seeking to advance the claim of fraud by omission that the particularity pleading threshold has teeth.

Island Beyond, LLC v. Prime Capital Group, LLC arose from a real estate development deal gone bad.  In 2005, the parties formed an LLC whose purpose was to own and operate a commercial development near Kernersville, NC.  The plaintiff erroneously assumed that the land for the development was being acquired on behalf of that LLC; in fact, the land was being acquired in the name of different corporate entities.  In 2011, six years after the project got underway, plaintiff learned that in fact the development entity owned only ten of the necessary 30 acres and had no income-producing property.

Plaintiff brought suit, asserting, among other things, that by failing to disclose the true ownership of the property at issue, defendants had committed fraud.  In granting the defendants’ 12(b)(6) motion as to the fraud claim, the court laid out the following pleadings requirements for an omission-based fraud claim. A plaintiff must allege (1) the relationship between plaintiff and defendant gives rise to a duty to speak; (2) the event that triggered the duty to speak or the general time period over which the relationship arose and the fraud occurred; (3) the general content of the information that was withheld and the reason for its materiality; (4) the identity of those under a duty who failed to make such disclosures; (5) what the defendant gained from withholding the information; (6) why the plaintiff’s reliance on the omission was reasonable and detrimental; and (7) the damages the fraud caused the plaintiff.

The court reemphasized an earlier business court holding that merely “parroting a legal conclusion” is insufficient, and noted that the court was “hard pressed” to see how the alleged silence of defendants regarding ownership of the property in question could give rise to a claim for fraud where those very facts were contained in public records contained at the Forsythe County Register of Deeds.

The lesson?  Litigants are often befuddled by what constitutes sufficient specificity in pleading fraud, and fraud by omission is even more oblique.  Here, the Business Court provides some clarity for the latter.  At a minimum, ensure the facts you allege should have been communicated weren’t publicly available.

Fourth Circuit Weighs in on Supreme Court’s Class Action Decision in Walmart v. Dukes–or Does It?

Posted in Class Actions, Federal Rules of Civil Procedure, Fourth Circuit

In the Fourth Circuit’s recent decision in Scott v. Family Dollar Stores, the concurrence and dissent sharply disagreed about the significance of the majority opinion.  Depending on which opinion you read, Family Dollar is either a sweeping reinterpretation of the Supreme Court’s class action decision in Wal-Mart v. Dukes or a narrow holding reiterating the rule in favor of liberal amendment of complaints.  Time will tell who is right.

In Family Dollar, a putative nationwide class of female store managers filed suit against Family Dollar under Title VII and the Equal Pay Act, claiming they were paid less than similarly situated male store managers.  Early in the case, the plaintiffs relied on the Ninth Circuit’s decision in Dukes v. Wal-Mart, arguing that the “Ninth Circuit has now affirmed certification of such a nationwide class having virtually identical claims of sex discrimination in pay to those brought in this case.”  Then, the Supreme Court overruled the Ninth Circuit. Continue Reading