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Adversarial negotiation does not erase duty

Repudiation of fiduciary duties to LLC required to avoid breach

It is well-established that a separating spouse’s fiduciary duties to the other party evaporate the moment one of them hires an attorney and the relationship becomes adversarial.

It was only established recently — in a June 20 North Carolina Business Court decision in RCJJ, LLC v. RCWIL Enters., LLC, to be specific — that the same does not necessarily apply to officers of an LLC negotiating the separation of their interests.

“This is an issue of first impression in North Carolina, and one on which very little guidance exists from other jurisdictions,” wrote Special Superior Court Judge Gregory McGuire, noting that cases holding that fiduciary duties can be “extinguished in an adversarial setting” do not hold that the fiduciary was relieved of duties “merely because the parties had retained attorneys or were negotiating over a separation of interests.”

“Rather, those cases make clear that the facts surrounding the adversarial negotiation must establish that there has been a change in the trusted and confidential nature of the relationship and that the fiduciary has repudiated his fiduciary duties,” he wrote.

From Good to bad  

In 2010, defendant Ryan Crecelius formed Do Good Real Estate, a Wilmington-area brokerage firm that donated a portion of its commissions to charity. Crecelius was a sole proprietor until 2012, when he sold 50 percent of the business’s equity to a longtime friend, Johnathon Jackson.

They formed RCJJ, LLC, which was the sole member of Do Good, and Do Good Real Estate became the sole member of Do Good Real Estate Wilmington, LLC.

The partners entered into an operating agreement containing noncompete and nonsolicitation covenants prohibiting either of them from competing with RCJJ and employing any RCJJ workers while they were members of RCJJ and for six months thereafter.

With Jackson serving as Do Good’s chief financial officer and Crecelius serving as its chief executive officer and broker-in-charge, the company grew to include 13 agents — independent contractors — by August 2014. The agents also signed restrictive agreements.

But by summer 2014, Crecelius’ and Jackson’s relationship had soured. Jackson, the defendants allege, treated Do Good’s agents poorly and was distracted from his Do Good duties by other business ventures.

In late July, according to the court’s opinion, the pair began talking about parting ways and separating their interests in the company. Crecelius told agents that Jackson would likely be leaving Do Good.

After several days of discussing buyouts and dissolutions, Jackson and Crecelius each hired counsel to continue talks on their behalves. On Aug. 20, 2014, they agreed that Crecelius would sell his interest for $25,000 and receive, among other things, a release from the restrictive covenants and any other contractual obligations.

Per the separation agreement, signed five days later, Crecelius withdrew as a member and officer of Do Good and was required to return all keys and company property to Jackson, including “online systems and accounts” such as Highrise and other databases. The agreement did not expressly address whether Crecelius had the right to retain copies of the databases and associated information.

According to the Business Court opinion, Crecelius began planning for life after Do Good while still negotiating his exit from Do Good, contacting a principal in Nest Realty in Virginia about opening an affiliated branch in Wilmington.

Crecelius formed RCWIL, LLC on Aug. 22, 2014, and began doing business as Nest Realty on Aug. 29.

All except one of Do Good’s agents left their jobs to work at Nest.

The plaintiff’s attorney, W. Cory Reiss of Shipman & Wright in Wilmington, said that while still owing a duty to Do Good, Crecelius was planning “his own rival business,” making off with trade secrets and advising agents to keep their plans for leaving secret from Jackson so that the deal would not fall through.

McGuire agreed.

“While there is no evidence that Crecelius solicited agents to leave Do Good, it is undisputed that he encouraged them not to reveal Crecelius’ plans, to avoid contact with Jackson at certain times, and to not say or do anything to make Jackson suspicious,” McGuire wrote.

The issue, Reiss said, was whether a business partner or LLC can “declare an intention to sell his interest in the business and then kneecap the business on his way out the door.”
“[O]ur contention was, no, you owe a fiduciary obligation to the LLC or to the corporation until you are no longer a member of the corporation,” he said.

Jackson claimed that he expected to lose only a couple of agents, and that had he known he would lose them all, he would not have entered into the separation agreement. Records show that Crecelius texted Jackson on Aug. 8 that “several” agents were threatening to leave Do Good.

Jackson replied that he had “an idea” of who would leave. “I’m willing to take the risk,” Jackson texted back.

Downloaded files, filed complaints

Do Good maintained databases and other information it considered trade secrets or confidential information. The Highrise database allowed the company to catalog current customer information and potential customer leads. Dropbox contained files on individual Do Good clients, raw data used to build Highrise, and “strategic company documents.”

According to the court, it’s undisputed that Crecelius downloaded these databases, without disclosing the downloads to Jackson, just before signing the separation agreement. Crecelius also downloaded his Do Good email account and contended that he regularly copied these files “to comply with the record preservation and retention requirements” of the state’s Real Estate Commission.

Crecelius also advised some agents to download information he claimed they were required to retain under the commission’s rules.

The plaintiffs filed their complaint on Sept. 23, 2014, but amended it to dismiss claims against the agents who joined Nest. A week later, Crecelius sent plaintiffs’ counsel a flash drive containing the Highrise database. An accompanying letter from his attorney said that Crecelius had not reviewed, shared or copied the database and had it “expunged” from his computers. Crecelius made clear, however, that he possessed “Time Machine” — a document recovery system that would allow him to recover any deleted files unless he disabled the program or destroyed his hard drive — and would not disable it because he believed it was necessary to ensure compliance with commission rules.

On Sept. 4, 2015, the plaintiffs filed their second amended complaint, alleging, among other things, tortious interference with contractual relations, misappropriation of trade secrets, fraud and breach of fiduciary duties.

The defendants moved for summary judgment on all 13 claims against them, with mixed results.

Crecelius’ attorney, Michael Murchison of Murchison, Taylor & Gibson in Wilmington, declined to discuss the case, citing pending litigation regarding several claims.

‘Til the end

Among other arguments, Crecelius contended that any fiduciary duties he might have had “were extinguished by the initiation of adversarial discussion” between him and Jackson regarding separation.

The court noted that North Carolina’s courts have held that duties arising from certain fiduciary relationships can be extinguished when parties become adversarial and are represented by attorneys.

It cited several state Court of Appeals examples.

In Piedmont Inst. of Pain Mgmt. v. Staton, the court found that the trustee’s fiduciary duty ended when both parties, represented by counsel, were negotiating for the termination of legal rights.

In Lancaster v. Lancaster, the court held that the confidential relationship between a husband and wife is “usually over” when one party hires an attorney to begin divorce proceedings.

And in Harton v. Harton, it determined that a husband’s fiduciary duty to his wife ended when the parties separated and became adversarial while negotiating the terms of their separation.

So, McGuire noted, the question for the court became whether as a matter of law Crecelius was relieved of his duties of care and loyalty by the adversarial negotiation with Jackson.

With little case law to go on, the court looked to a similar scenario in the 1985 New York case Fender v. Prescott and an unpublished North Carolina case that applied Florida law, Spanish Moss, LLC v. Wachovia.

In Fender, the defendant remained as an officer and shareholder of the company after executing a separation agreement. Since the buyout never happened, the court held, “he was subject to the same fiduciary duty as existed previously and from which he would be relieved only upon his withdrawal from the corporation.”

In Spanish Moss, the Court of Appeals noted that under Florida law, defendants owe a fiduciary duty to the LLC and its members but that the duty to disclose material facts based on a fiduciary duty ended when the parties became adversaries. In North Carolina, a manager does not have a fiduciary duty to the individual members of the company.

McGuire found the reasoning in Fender “more closely aligned” with the fiduciary duty at issue in this case and that to allow a departing manager of an LLC to be relieved of his fiduciary duties solely because of adverse negotiations and the involvement of attorneys would be inconsistent with those duties.

Citing the Court of Appeals 2003 ruling in Piedmont Inst. of Pain Mgmt. v. Staton Foundation, McGuire found that “there must be a change in the nature of the relationship between the parties that establishes that the parties are no longer in a relationship of confidence and trust, and that fiduciary duties have been repudiated,” McGuire wrote.

According to the North Carolina Limited Liability Company Act, an individual ceases to be a manager of an LLC only if he resigns, transfers his “entire economic interest” in the LLC or ceases to be a member of the LLC.

Plaintiffs’ attorney Reiss believes that this decision will influence business breakups for the foreseeable future, especially in Business Court.

“Judge McGuire’s ruling tells attorneys and judges that a manager of an LLC owes that company fiduciary duties even while he negotiates the sale of his interest and the terms of his exit,” Reiss said. “Being adversarial with partners does not mean you can be adversarial to the corporation.”

Charles Johnson of Robinson, Bradshaw & Hinson in Charlotte said that while he doesn’t recall seeing a case on point with RCJJ, he agrees with the ruling that it should go to a jury.

“It is reasonable that the defendant manager’s hiring away the employees and concealing his plan to hire them could constitute breach of fiduciary duty and constructive fraud,” Johnson said. “The court suggests that the defendant manager would not have breached a duty if he had disclosed his plans to the plaintiff, which seems correct and fair under these circumstances.”

The 40-page decision is RCJJ,LLC v. RCWIL Enterprises, LLC (Lawyers Weekly No. 020-042016). The full text of the opinion is available online at nclawyersweekly.com.

Follow Heath Hamacher on Twitter @NCLWHamacher

 


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