Investors must arbitrate claims over startup

By PAUL THARP, Staff Writer

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Shareholders must arbitrate their claims over a startup Charlotte advertising company in which they invested hundreds of thousands of dollars, even though they brought suit against its CEO as an individual, the appeals court has ruled.

The plaintiffs – Scott, James and Paul Ellison – sued C. Rudy Alexander, the chief executive officer of The Elevator Channel, Inc., after reading a 2006 newspaper article that called Alexander’s credentials into question.

They sued Alexander in his individual capacity to avoid a mandatory arbitration clause in their shareholder agreements. After a superior court judge denied Alexander’s motion to stay the state court action pending binding arbitration, he appealed.

In an Oct. 19 opinion authored by Judge Sam Ervin IV, the Court of Appeals reversed the trial court’s ruling and remanded the case “to the trial court for the entry of an order staying all further proceedings and requiring the parties to proceed to arbitration in accordance with the relevant provision of the [shareholder agreements].”

The case is Ellison v. Alexander (Lawyers Weekly No. 10-07-1005, 22 pp.).

“This case affirms what our position has been all along,” said Charlotte attorney Ross R. Fulton of Rayburn Cooper & Durham. Fulton represented Alexander in the case. “You cannot sue an individual officer of a company to get around an arbitration agreement with the company.”

Charlotte attorney Ian M. Byrne of Caudle & Spears, who was not involved in the case, said that “if you consider the inverse of this holding from the standpoint of the administration of justice, any time plaintiffs or investors wanted to pierce the corporate veil or avoid arbitration, they could just allege that the corporate agent who signed the agreement was signing personally and not on behalf of the corporation.”

The creation of a question of fact in that context would result in cases “getting halfway through trial” before resolution of the issue of whether the corporate agent signed the agreement on behalf of the company or in his or her individual capacity, Byrne said. That would defeat the purpose of creating corporate entities in the first place.

Fulton said practitioners should look to the language of the arbitration clause in Brown v. Centex Homes (Lawyers Weekly No. 05-07-0871, 9 pp.) when drafting such clauses. Brown “sets forth the proper language for the broadest possible arbitration clause,” Fulton said.

“Once that agreement is in place, these decisions [including Brown and Ellison] make clear than an officer or director of a company who is sued individually can enforce the clause if the plaintiffs’ claims relate to the agreement with the company,” he said.

The intent of the shareholder agreements at issue in the Ellison case, Fulton said, was “to cover any disputes that arose out of the investments as against the company officers or directors.”

Fulton said the plaintiffs were accredited investors as defined under the Securities Act of 1933. “These were sophisticated investors investing large sums money,” he said. The Elevator Channel, he added, was a startup, “not a Fortune 500 company putting the heel of its boot down on the little guy.”

The plaintiff-investors, in other words, had quite a bit of bargaining power and were sophisticated enough to understand the terms of the shareholder agreements.

Byrne wasn’t sure the plaintiffs could have bargained for better terms, citing the risk/reward tradeoff of investing. “From a practical perspective, I don’t see that the plaintiffs would have been able to bargain for a clause that was narrow enough for the court to find that the subject matter of the complaint was not covered by the clause,” he said.

According to the Ellisons’ complaint, James Ellison invested a total of $250,000 in The Elevator Channel. A $25,000 loan he made to the company was converted into 26,354 shares of stock. Scott Ellison invested a total $195,000 and made a $110,000 loan to the company, while Paul Ellison invested $10,000 and made a $5,000 loan which was later converted into 5,271 shares.

At the time of the investments, “the Elevator Channel was a network operator for a digital advertising network,” according to the company’s answer to the complaint. At the time of the answer, the company was serving as “a software technology provider for in-store media applications.”

Fulton said the nature of The Elevator Channel’s business had changed slightly. “It was a media-hosting company, and it still does some of that.”

The company hosted advertisements and informational spots on video screens in uptown Charlotte elevators. It then expanded out of elevator cabs and into the lobbies of restaurants, banks and other institutions, where it projects advertising and informational spots to waiting customers.

In the suit the Ellisons sought repayment of the loans and stock they bought. “They still hold the stock,” Fulton said. If the company is successful, they could still profit off their investments.

Opinion Brief

Type of action: Ellison v. Alexander

Court: N.C. Court of Appeals

Judges: Judge Sam Ervin IV; Judges Linda M. McGee and Martha Geer, concurring

Date: Oct. 19, 2010

Plaintiff-appellee’s attorneys: Hoyt G. Tessener and Walter McBrayer Wood, both of Martin & Jones (Raleigh)

Defendant-appellant’s attorneys: Ross R. Fulton and Daniel J. Finegan, both of Rayburn Cooper & Durham (Charlotte)

Issue: Could plaintiff-shareholders avoid a mandatory arbitration clause in a shareholder subscription agreement where the corporate officer allegedly signed the agreement in his individual capacity?

Holding: No, the plaintiffs’ claims are inextricably entwined with the provisions of the their shareholder agreements. The plaintiffs’ claims arose in connection with the shareholder agreements and the defendant was acting in his capacity as a representative of the company that issued the shares when he allegedly made the misrepresentations upon which the plaintiffs’ claims rest. The defendant is entitled to enforce the arbitration clause in the shareholder agreements, therefore the trial court’s order denying the defendant’s motion to compel arbitration is reversed and the matter is remanded to the trial court for the entry of an order staying all further proceedings and requiring the parties to proceed to arbitration.

Noteworthy: Court of Appeals compels arbitration in published decision; ignores two-week old unpublished opinion.

Opinion digest: Click here.