A decision out of the North Carolina Business Court could serve as a teachable moment for those looking to set up a closely held corporation about the importance of corporate bylaws.
Commercial litigators said the lesson of Gwaltney v. Gwaltney is that whatever a company’s bylaws say goes—even if it leads to impractical results.
The bylaws at issue in Gwaltney required the three owners of Little Creek Electronics Inc. in Guilford County to reach 100 percent agreement before any shareholder decisions could be made.
The question before Business Court Judge Gregory McGuire was whether the 100 percent clauses of the bylaws meant the attorney hired by two of the partners to handle a derivative action should be disqualified from the case because the third partner hadn’t agreed to the hire.
McGuire ultimately ruled that the clear language of the bylaws meant the attorney had to go. What that meant for the derivative claims brought by the two partners, McGuire didn’t say.
But Lee Whitman of Wyrick Robbins Yates & Ponton in Raleigh said the two partners may have trouble pursuing the derivative claims in light of the 100 percent mandate included in the company’s bylaws.
“North Carolina law is pretty clear on this point. In the world of corporate law, the bylaws are the Bible,” Whitman said. “They can be different from company to company, but once they’re in place, that’s how the company is governed.”
In early 2016, Little Creek co-owner Douglas Gwaltney filed suit against his partners James Gwaltney and Michael Green after he allegedly discovered they had made a number of decisions on behalf of the company without his approval.
The three men found the industrial electronics company in 1999. The Gwaltneys and Green each received a one-third stake in the company.
Under its original bylaws, decisions made on behalf of Little Creek required majority approval of the company’s officers. But in 2009, the bylaws were amended to require unanimous approval of all corporate decisions.
The arrangement appears to have worked well until Jan. 26, 2016, when James Gwaltney and Green allegedly fired the company’s chief executive officer, Mark Kesslick, without gaining the approval of Douglas Gwaltney.
When Douglas Gwalteny complained about the decision, James and Gwaltney and Green allegedly told him that they had the power to remove him from the company’s board of directors and to terminate his employment.
As the dispute ramped up, Douglas Gwaltney hired Robert Boydoh of Boydoh & Hale in Greensboro to handle the lawsuit, which Gwaltney filed individually and derivatively on behalf of the company.
The complaint alleged claims of breach of amended bylaws and breach of fiduciary duty and sought to remove James Galtney and Michael Green from Little Creek’s board for alleged fraud or dishonest conduct and abuse of authority. Douglas Gwaltney’s complaint also alleged derivative claims on behalf of Little Creek.
In response, James Gwaltney and Green tapped Harry Gordon, a Greensboro-based solo practitioner, to handle their defense.
Gordon soon filed an answer that included derivative counterclaims on Little Creek, which included claims of abuse of process, breach of contract, breach of fiduciary duty, conversion and fraud.
Boydoh and Gordon also exchanged communications in an attempt to resolve the dispute but court records say those efforts went nowhere.
On Sept. 1, 2016, Boydoh sent Gordon an email informing Gordon that he could not be hired to handle a derivative action on Little Creek’s behalf without the unanimous approval of the company’s board. Two months later, Douglas Gwaltney filed a motion to disqualify Gordon from the case.
Douglas Gwaltney’s motion rested on two key arguments. First, he said James Gwaltney and Green lacked the authority to retain Gordon because the amended bylaws required unanimous approval of the three Little Creek directors. Additionally, Douglas Gwaltney said Little Creek lacked standing to defend itself against the derivative claims raised by him.
To support his case, Douglas Gwaltney cited the Business Court’s 2014 decision in Battles v. Bywater, L.L.C., which resulted in Asheville Law Group being disqualified from representing an L.L.C.s because the company’s operating agreement required majority consent of the members to retain counsel for the corporation. The Business Court also struck all filings submitted by the law group on behalf of both corporate defendants.
James Gwaltney and Green tried to argue that the 100 percent requirement in Little Creek’s bylaws was not intended to apply to any board action other than attempt by two of the directors to “oust” the third from the company.
James Gwaltney and Green also argued the three directors orally agreed to amend Little Creek’s bylaws to allow for majority votes on company decisions.
However, neither of those arguments swayed McGuire, who ultimately granted the motion to disqualify Gordon.
“The court concludes that pursuant to the Amended bylaws, in order for Little Creek to retain an attorney to represent the corporation in this lawsuit, the unanimous consent of all three directors is required,” McGuire said. “James and Green, acting alone as two members of the board, did not have the authority to retain Gordon on behalf of Little Creek.”
Gordon declined to comment on the decision.
Boydoh was not immediately available for comment.
It’s unclear where McGuire’s decision leaves the derivative claims that James Gwaltney and Geen filed on Little Creek’s behalf.
The two men could pursue those claims pro se. But without James Gwaltney’s consent, they will be unable to hire an attorney to handle them.
Wyrick Robbins’ Whitman said that’s one of the problems with bylaws that require unanimous approval of company decisions.
“McGuire’s opinion was well in line with North Carolina law, and the judge seems to be saying it’s not the court’s job to alleviate all of the practical problems the bylaws have presented to the defendants,” Whitman said.
He added that the Gwaltney case should serve as a lesson for closely held companies.
“Everyone starts out as friends when the company is founded. But it’s very important to think through how disputes will be resolved if they arise in the future,” he said. “You really want to try to avoid getting to this point because it’s exceedingly unclear where they go from here.”
The 18-page opinion is Gwaltney v. Gwaltney (Lawyers Weekly No. 020-023-17). An opinion digest is available at nclawyersweekly.com.
Follow Jeff Jeffrey on Twitter @NCLWJeffrey