Business Litigation, pt. 2 Victory

We won our trial, and now I can describe more details about it. My client, a real estate developer, had been sued for issues arising from a former partnership. My client and three other men had formed a partnership to develop a tract of land. One of the partners, who happened to work for my client, was bought out years ago. However, in 2006, when the partnership sold its last lots in 2006, the former partner sued, saying he was still a partner and entitled to partnership proceeds. The Plaintiff lost and received nothing. My client received satisfaction and bragging rights--but at what cost? Here is what I believe my client learned from this lawsuit:


1. Get everything in writing and keep good records.

My client had evidence that he'd gotten, in writing, something showing the Plaintiff had given up his interest, but that the file mysteriously disappeared when the Plaintiff quit working for my client. What could my Plaintiff have done differently? He could've had his lawyer at the time draw up the document, make it legally clear, and keep triplicate originals--one for the client, one for the man who gave up his interest, and one for the lawyer (just to be safe). Also, my client could have kept his employee files locked (the testimony was that the files weren't locked).


2. Understand the sheer randomness of a jury.

I always tell clients that you never know what a jury is going to do in a trial, and I really couldn't tell, until they returned a verdict in our favor, what the jurors were thinking. I try to pick up on body cues (do they appear bored when I talk? Are there arms crossed? Are they attentive), but this is not an exact science, and worse yet, an attorney (or his client) can drive himself crazy trying to put meaning into every action of a juror. At one point, the jury sent a question to the judge, and when it was read, my client thought we had lost. Instead, we won; jurors create an emotional rollercoaster for the parties involved, and I think my client knows this now.



3. Place a value on your opportunity costs and your time. This case, in the grand scheme of things, did not involve a lot of money. In fact, early on it became clear that--if carried to its finish--my fees would eclipse the value of the case. However, this case involved (to my client) principle, and, honestly, a bit of a grudge between two individuals. My client was fully prepared to to pay my costs to the end. However, I believe if he were to be asked now, he'd rethink settling earlier, not for the fees he's having to be me, but for the amount of money he probably lost having to sit at trial for a week. My client is an entrepeneur, a commercial real estate developer, who travels the country. During the time he spent in trial, my client missed an important meeting with his largest customer in South Carolina (who, in fact, was going to present him with an achievement award), and also had to forego trips to other parts of the country to oversee and/or initiate start-up projects. The greatest loss, for a client like this, is not the court costs, but the missed opportunity costs.

Things aren't all bad, however. I obtained this client because he was on the opposite side of a lawsuit about five years ago and, though I'd handled many cases for him in the interim, they'd all either gotten dismissed or settled. This was the first opportunity I'd had to show my client how I reacted in the stressful setting of a courtroom in a week-long jury trial. Many corporate lawyers sit behind their desks advising clients, but I hope that my client has now seen my advice put to action.

The Business of Business Litigation

In cities larger than the one in which I practice, most attorneys either fall into the category of litigators (i.e., trial lawyers) or office attorneys who never see the inside of a courtroom.

I've volunteered to be part of a working group of the Bar Association's Business Section, that is comparing the corporate laws of North Carolina versus the analogous laws of Delaware. I'm going to have to miss the group's first face-to-face meeting next week because it appears that I'm going to be in court trying out a partnership case.

The benefit I believe I bring to the table for prospective business clients is that, when I'm advising them or drafting something for them, my experience comes not just from a knowledge of the law or from what someone has taught me, but quite often from my experience in litigating similar issues.

When I reach a trial, I already feel in a sense as if I've failed, because I have been unable to reach a resolution of the case (whether through obtaining a court dismissal or a settlement) for my client. At trial, you see, there comes a point at which the result will be out of the hands of myself and my client: that is, the jury will take over.

In my experience, juries really do try to do the right thing, and also in my experience, I've found they most times have done the right thing. We've all heard the stories of runaway jury verdicts that appear to rape justice, but at least where I practice, the jurors have good common sense and try to do the right thing.

Still, a business tries to control uncertainty as much as possible. Sure there's risk--without which, we wouldn't have entrepeneurism--but most businesses I represent don't want uncertainty (which is different than risk). A jury trial is the ultimate uncertainty. I can do my best for a client in court, but on any given day, something can happen--a bad judge, a runaway jury, whatever--and the unbelievable happens.

Therefore, though I'm happy to litigate for clients, I always advise them that they need to be in the business of THEIR business--not in the business of fighting in court. Because no matter how good your lawyer is, and no matter how good your case is, there are always two sides, and there's always uncertainty.

Minority Shareholders, Revisited

A friend of mine finally resolved a longstanding situation in which he was involved, and I thought I'd revisit a commonly queried subject of mine--buying shares of stock in startup companies.

During the Dot Com bubble, my friend, and many other intelligent, financially astute professionals, were talked into investing in a startup corporation. What it did or was supposed to do don't matter for the purposes of this discussion, but recently, the corporation was bought out by a larger company. My friend received five cents on the dollar for his investment, and by the time it had arrived, was happy that he even saw that much of his money back--he'd resigned himself to having lost it all.

The purpose of this blog is not to speak to that company's business plan, or why the business never really took off. However, in retrospect, my friend's experience demonstrates a cautionary tale for investors who are buying minority shares in a startup company.

1. Understand what you're buying into. Ok, in the strictest sense, this isn't legal advice, but it bears repeating. At the time this company was started, technology companies were the rage, and everyone wanted to be a part of a new tech startup that "took it public" (sounds like the recent "flipping" craze, doesn't it?). I listened to my friend and other investors describe the company's goals, but I never could understand it--and I don't consider myself too terribly slow. What I heard were lots of big academic words, such as "shifting of paradigms," but I never was satisfactorily told exactly WHAT the company would do. Looking back on it, I'm not sure my friends understood either. If you don't understand what it is the company is supposed to do, I'd submit that you shouldn't invest in it.

2. Understand what it means to be a minority shareholder. Being a minority shareholder means that, unless specific safeguards are put into place, you have very few rights. For example, you can't force the sale of a company, you can't get your money back upon demand, and you pretty much have to do what the majority dictates.

3. Understand the value of stock offered. Let's say this startup corporation issued 100,000 shares, each of which were valued at $1.00. Pretty simple right? You put in $25,000, and you own 25 percent of the company. Except you might not. Unless a shareholder's agreement is put into place, there's no restriction against the company issuing additional stock. Stock can be issued when needed to bring in additional money. For example, using the above example, if the corporation needed another $100,000, it could issue 100,000 more shares. But what if some of the shareholders were issued shares because they were the startup engineers (i.e., the "idea men")? What if, even though your stock was valued at $1.00 per share, the company issued 100,000 shares to monetary investors, and then 200,000 shares to the two guys who thought up the idea, yet put no money into the company. That simple math can show you that the company would take quite a bit of growth before the stock you had might really sell back at $1.00 per share. Worse yet, what if the two original startup guys decided to issue more stock--to themselves? They might be able to do it--they're the majority, after all.

When buying stock in a startup company, understand the real value of the stock--in other words, is its value initially diluted by investors who are holding stock but have contributed no money or assets? Can the stock value later be diluted by the issuance of additional stock without your consent? Think about these things. In the case of my friend, the only person who appears to have profited from the corporation was the "idea guy," who'd issued himself so much stock with having placed a minimal amount of money into it that, even being paid a nickel on the dollar, he has profited well.

4. Understand what it means to own stock that's not publicly traded. Lots of stocks on publicly traded exchanges gain and lose value every day, sometimes because of the poor acts of the officers or directors. However, when you buy publicly traded stock, you know that, at the very least, you're not captive--you can sell your stocks on the open market for whatever price it will bring. However, when stock is in a very small company and isn't publicly traded, you may simply be stuck--as my friend was. He knew for years that the company was doing poorly, and simply had to watch as the value of his stock went down the drain.

There's nothing wrong with investing in a private startup company--in fact, I've both invested and started such companies. However, at least understand your rights when you invest!

Arbitration, Part 3 -- Right of Appeal

Binding arbitration is designed to be a quick and final extrajudicial disolution to disputes. However, experience has shown that this forced expediency often sacrifices accuracy and correctness.

Typically, binding arbitration does not allow for a right of appeal--either through an appellate arbitration panel or through judicial appeal. This means that the entire dispute will be decided by one individual.

In Court, though the process is admittedly often too long, too expensive, and too arbitrary, one benefit is that the judicial procedure provides for sufficient checks and balances that will prevent many egregious judicial errors. If the judge inappropriately dismisses a case before trial, the courts of appeal will typically reverse the trial court's decision and remand (send) the case back to the trial level.

If the trial judge makes an error of law in his ruling, the appellate courts will likely catch this error and reverse it. Furthermore, most, if not all state courts (and the federal courts) provide for additional layers of appellate oversite such that there are appellate courts to which you can appeal the decisions of other appellate courts.

All of these layers of judicial oversite create a heavy cost to taxpayers and to the individual litigant. However, of all the criticisms of the judicial system, one that you rarely hear is that, at the end of the day, after all appeals are through, that the courts got it wrong.

In the Arbitration proceeding, however, if a party is unhappy with the Arbitrator's decisions, there is little recourse. The aggrieved party will not be able to seek further redress within the Arbitration procedure. Furthermore, the party will not have access to the courts either. Typically, the role of the courts is limited to (1) enforcing an arbitration award into an official enforceable judgment or (2) to set aside arbitration awards in only the most egregious circumstances (i.e., beyond just mere errors of law and erroneous rulings).

This means that your entire case is in the hands of one arbitrator, sometimes not even an individual trained in the law, who holds your interest in the palms of his hand, secure further in the knowledge that--whatever he does--he likely will not be overturned.

Therefore, before entering into an agreement for binding arbitration, decide whether accurate and correct rulings should be sacrificed to the potentially arbitrary and unappealable ruling of an arbitrator.

Arbitation, Part 2: Cost

One of the supposed benefits of Arbitration is the decreased costs in comparison to traditional litigation. The arbitration process is more compact and is briefer, and attempts to dispense with extended discovery (in fact, often opting for no discovery at all), thus reducing the costs of numerous lawyer's hours, court reporter's hours, deposition transcripts, etc. While in the case I just finished, it is true less money was spent on attorneys and depositions, the other costs that were incurred at the very least were equal if not greater than traditional litigation fees.

First, unlike in traditional litigation, the parties are required to pay the "judge" (i.e., the Arbitrator), whose fees per hour will rival or even exceed his attorney counterparts. While from a purely abstract libertarian perspective, I like the idea that the parties to a dispute pay the full costs of the legal proceedings rather than burdening the taxpayers through tax-funded courts and personnel, as a practical matter, this can sometimes end up being more costly for a client than simply going through the state- or federally-funded litigation process.

Second, in my specific case, the costs were trebled through legal maneuvering from the other party's attorneys. The case at issue involved an owner/contractor disagreement, involving three different properties the contract was constructing for my client. Instead of filing one lawsuit or one arbitration, the contractor filed three. In traditional litigation, a judge likely would have combined all three into one case for the sake of judicial efficiency. In this case, however, the arbitrator assigned to rule just on this motion (whom had to be paid separately) ruled against it. That meant my client was required to ante up money for three different arbitrators, assigned to three distinct cases, when one paid arbitrator could have decided it in about the time it would cost to hear one case. It was an interesting tactic, because I believe my client was more able to absorb the costs than his opponent.

We estimated that the case, if consolidated, would take about a week to try, but unfortunately, because each arbitrator would be hearing his particular case anew, each time we'd need to spend a few days simply laying out the facts. Instead of paying for one week's arbitration, we would now pay for approximately three. Do the math on arbitrators who charge about $300 per hour, assume eight hour days, times 21 days. It's not cheap. Now add in attorneys for each side who will also be litigating for three weeks.

Finally, even though trial litigation can be expensive, the reality is many cases never make it that far--not because of settlement (which of course happens often)--but because the case is disposed of earlier by motions. I've litigated numerous cases for this particular client, but more than half of them never made it to trial because I got them dismissed early on. Because the arbitration procedure does not typically rule on such dispositive motions, and simply lets it go to a hearing (and if you think about it, it's in the arbitrator's financial self-interest to keep the case going so he can be paid), my client would have spent far more if those cases had been arbitrated than it did by litigating them.

Although I am sure each arbitration varies on its merits, my experience thus far is that arbitration has not been less expensive than litigation, and in fact has been more so.

Arbitration and Arbitration Clauses in Contracts -- Overview

Many of my more sophisticated clients, for whom I draw contracts, commonly ask if we should put in a provision to require "Binding Arbitration" in the event of a legal dispute.

The idea, in theory, is a good one. Arbitration, it is said, will reduce the legal costs otherwise incurred in court; will produce fairer results less dependent on technicalities and based more on the merits and equities; and will resolve matters more quickly.

I'd sat on the sidelines for a long time and advised against them, primarily from cases I had watched and from my own personal convictions that I was able to use the mechanics of the legal system to obtain a more favorable result for most of my clients.

However, I finally got the benefit of putting Arbitration to the test, recently, when a client of mine got into a dispute with a large commercial contractor over several projects. Each project was governed by a separate contract, each of which provided for binding arbitration in the event of a dispute, and the contractor, pursuant to his rights, demanded binding arbitration. Because the contractor's attorney was a litigator who specialized in construction litigation, and because I did not want my first experience in arbitration to be against an experienced specialist when hundreds of thousands of dollars were on the line, I associated a colleage of mine who was also a construction litigation specialist.

Through the process, I got the opportunity to watch how binding arbitration worked, to see its advantages and disadvantages in action, and now feel more qualified than before to speak about arbitration.

First, my opinion: putting binding arbitration clauses in contracts is still, in my opinion, a bad idea. Arbitration, in my experience, does not adequately deliver on its promised benefits (costs and fairness), while subjecting its participants to a procedure and to rulings that are only loosely bound by a rule of law and, for the most part, are non-appealable.

Next, in the upcoming articles, I will discuss the structure of binding arbitration, its alleged benefits and its drawbacks, and allow the reader to draw his own conclusions. Stay tuned....

Reader's questions about minority shareholders

A reader recently wrote a very good question about minority shareholders, and I thought the situation would be worthy of posting. Here is the question, and answer, with permission.

"Hi,

I read your article about minority shareholders. I got an offer to become a shareholder of a small company without paying anything, just because I have been working for them for a period of time.

However, my plans are to go to grad school and then after a year or two look for a position in a large company. Can I then go to work for another company if now I've agreed to become a shareholder of the small company that is just starting? If not, can I, after a year or two, tell that small company that I don't want to be a shareholder anymore? I'm being told by the other shareholders that everything will need to be confidential, so I don't know if my husband and I can show the shareholder agreement to a lawyer."

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First, understand that I am only licensed to practice in North Carolina, and this does not constitute legal advice.

Second, at least in North Carolina, but usually in other states, it is a general industry practice that any agreements which would involve you personally but are labelled "confidential" can still be studied, shared, reviewed by legal counsel before you decide to sign it. Still, the best practice is to let the others know you'd like your personal attorney to review the documents.

Finally, there are two things which may prevent you from joining a big company while still a shareholder of the smaller one. The first is that (assuming their businesses are similar), if you're involved with the smaller company, you owe a duty of loyalty to that smaller venture. If you go to another company, you are not able to use your best efforts for the smaller company. In fact, your actions may go further and violate specific provisions of your shareholders' agreement.

The second issue is also a serious one: what if you just give up your stock rights and leave the company; will that solve everything? There still may be a problem if the remaining shareholders allege that you are using proprietary or confidential information you obtained while a shareholder in the small company. This may specifically violate terms of your shareholder's agreement (which may contain a non-disclosure provision) or it may violate your state's common law rules (i.e., civil rules created by caselaw) regarding what information from your former employer/partnership/venture/etc. that you can use once you leave.

The best thing you can do? Be upfront with the other shareholders, and negotiate a provision that, while protecting their interests, allows you the freedom one day to leave for bigger things: e.g., perhaps an agreement that allows you to leave and join a competing business, but provides that the remaining shareholders can buy out your interest at a fair price (the determination of which would be a subject in itself). If they won't agree to this, both sides are already on notice that there will be a potential conflict in the future--so why buy into it? Either walk away, or understand you may have a fight on your hands when you leave.