Many an article or blog post concerns minority shareholder rights, shareholder oppression or shareholder “freeze out”. As business and litigation lawyers, we are always mindful of the rights between and among business owners, what can and cannot be done in furtherance of those rights and the legal mechanisms applicable to the exercise of those rights. We frequently write on the strategies available to a minority shareholder such as examination of books and records, claims of breach of fiduciary duty and the potential for appointment of a corporate receiver or custodian.
This is not that article.
The fact is, being a minority shareholder means that, by definition, there are often things you simply cannot control. A shareholder or member in a business entity who possesses less than a controlling stake must have reasonable expectations as to the rights attendant to such ownership and understand the limits of such rights so as to make informed decisions concerning the investment of time, energy and money in pursuit of the collective enterprise.
Let’s start with who owns the remaining shares in the company. In the absence of an agreement to the contrary, the majority shareholder is free to transfer the majority (said another way; controlling) interest in the company without the consent of the minority. A transaction can result in a change in control such that the minority shareholder suddenly works for someone entirely new. While a minority shareholder can enjoy “dissenter’s rights”, such rights are applicable in very narrow situations specified by statute. In fact, in the absence of a prohibition, the stock in a business entity is readily transferrable, just like on an exchange, if a buyer and/or seller can be identified.
Internally, a minority shareholder can find it difficult to impact the direction of the business. Depending on the by-laws of the entity and, frankly, the will of the majority, a minority shareholder may or may not have a voice on the board of directors and thus may not possess a vote on material decisions such as the persons who will fulfill critical roles in the executive branch of the business such as the officers of the corporation. More importantly, a minority shareholder may not have input on the financial operations of the company including distributions, financing arrangements, major purchases of inventory, equipment or talent. All of which can dramatically affect the annual bottom line.
Even employment is not guaranteed to a minority in interest. In the absence of an agreement to the contrary, the employment of a minority shareholder may simply be at will in the same way as the sales force, the administrative assistants or the custodian. Certainly, terminating a minority’s employment could be one of the factors argued in a freeze out, but in the absence of other factors, termination of employment alone may not give rise to a cause of action. Certain courts have suggested continued employment may be implicit in a “founder” but those situations are few and far between and a plaintiff/minority shareholder must be prepared with more to argue than the end of employment if freeze out is alleged.
In business, like politics, being in the minority means sometimes you are powerless to immediately change the course of the company. Sometimes, a group of shareholders can band together to pool their collective influence for their mutual benefit. Other times, the best strategy is to become the majority even when the acquisition of additional shares comes at an unnecessary or unanticipated cost. Under any circumstances, rights afforded to the majority are not constrained solely because a minority shareholder does not agree with a particular course of action.
As a litigator, I am often contacted by minority shareholders who are frustrated by their lack of control or influence. While the law offers certain protection for holders of such minority interests, those remedies are factually limited and are often unsatisfactory even if granted in full after significant expense in litigation. Certainly an appropriate agreement outlining the respective rights and obligations can change the analysis. Business owners should consider, and plan for, what rights their stake in the company provides.
As commercial litigators, we frequently field calls from counsel in other states seeking to enforce judgments entered in a state other than Pennsylvania against assets of the judgment debtor which may be identified within the Commonwealth. Under Pennsylvania Law, a judgement creditor may effectively transfer a judgment in two ways; the traditional approach of a civil action to enforce judgment at common law or pursuant to the terms of the Uniform Enforcement of Judgments Act. The Uniform Act prescribes the mechanism for transfer of the judgment and the procedures which follow thereafter.
The effectiveness of a foreign judgment is based upon the full faith and credit clause of the United States Constitution and grounded in principles of comity among the several states. Pennsylvania, like many other states, has adopted the Uniform Enforcement of Judgment Act in an effort to streamline the process of transferring a judgment from a “foreign” – meaning a different state – court. The Act merely requires that a certified copy of the judgment and relevant docket entries be filed with the Prothonotary together with an affidavit of last known address of the judgment debtor. That transferred judgment then becomes a lien against the debtor’s real property within the county. Of course, not all arguments are resolved by the simple process outlined by the Act; frequently, the transfer signifies the beginning of a new litigation cycle.
While the full faith and credit clause as implicated by the Act is a very powerful vehicle available to a judgment creditor, the application is not unlimited. Review by a Pennsylvania trial court is for the most part limited to issues of jurisdiction and due process in the issuing court; if the issuing court did not have jurisdiction, or if due process has not been served therein, then Pennsylvania may decline to enforce the foreign judgment. The judgment debtor bears the burden to establish the absence of jurisdiction and due process. A judgment debtor should be expected to file a Motion to Strike the transferred judgment arguing the inapplicability of the full faith and credit clause.
Significantly, the application of the full faith and credit clause extends to the determination of jurisdiction and due process. In other words, if the parties “fully litigated” the issue of jurisdiction in issuing court and the issuing court, even incorrectly, concludes jurisdictional requirements are satisfied, that decision in and of itself is subject to full faith and credit regardless of whether that decision was correct by application of fact and law. A judgment debtor that has not appeared in the foreign action certainly retains the right to challenge jurisdiction and due process if the creditor subsequently transfers the judgment to Pennsylvania, but certainly runs the risk of the entry of judgment by default in the foreign court. Conversely, a judgment debtor that appears in a foreign court where jurisdiction and due process are in any way addressed by such court runs a substantial risk of deference to that court upon transfer to Pennsylvania.
Thousands of businesses across the United States fall within the definition of what is commonly referred to as “small business”. Many of these small business are formed by two “friends” with compatible skill sets and both possessing knowledge of a particular industry. Business owners commonly refer to their co-owners as “partners”. As the business and its’ complexity grows, deficiencies in performance or capacity on the part of one partner may be exposed. Alternatively, the absence of immediate success can cause a less patient partner to seek other opportunities and abandon the work that is necessary for the collective good. What starts as a promising partnership can quickly turn sour. Here are a few tips on moving forward:
1. Agree on material issues ahead of time. It goes without saying that a written agreement which contemplates and addresses material issues benefits everyone. Terms frequently addressed in such agreements include the relative duties of the parties, corporate officers, duties of directors and financial matters. If shareholders/partners/members are required to devote substantially all of their time to the venture, the agreement must so state. Similarly, if shareholders/partners/members can be required to contribute capital to the business, the prevailing agreement must so state. Agreed upon rights and remedies upon abandonment of functions within the business by a shareholder/partner/member can provide the road map for resolution and expedite transition.
2. Change terms of employment. An option which may be available to a shareholder/partner/member is the exercise of corporate power to change terms of employment with respect to the non-performing shareholder/partner/member. While a founding shareholder/partner/member may arguably have certain rights to continued employment, such guarantees are limited and may not preclude a change in terms when faced with non-performance or abandonment. Exercise of corporate power does not come without risk and any change in employment terms is almost always alleged as part of a minority shareholder oppression claim.
3. Offer a buy-out. Certainly the cleanest and most efficient means to end an unproductive arrangement quickly is to acquire the non-performing shareholder/partner/member’s interest in the business by the payment of money. Of course, such an agreement is not always financially available. Moreover, a voluntary transfer necessarily implicates that that non-performing shareholder/partner/member agree. Issues of valuation, income streams, indemnification and restrictions against competition can complicate any potential buy-out.
4. Sell the business. Often the solution to a disagreement on partner performance is a sale of the business with a corresponding post sale employment agreement for the performing shareholder/partner/member. Money is a powerful motivator. A sale generates money in a lump sum which can induce a shareholder/partner/member to forego the ongoing income stream that results from future operations. Certainly, control over the sale process, including the legal right to effectuate a sale by virtue of agreement or corporate control, are essential factors for evaluation.
5. Dissolve and start something new. As a matter of last resort, dissolution of the entity may be the only way to gain freedom from a non-performing shareholder/partner/member. The Business Corporations Law provides a mechanism for dissolution. Provided the requirements can be met, a shareholders/partners/member may seek judicial dissolution of the entity essentially forcing a judicial sale. An important aspect of dissolution is relief from fiduciary duties owed to the business and minority owners. Dissolution can be a complicated and expensive proposition and very disruptive to ongoing business operations but remains a viable strategy when business owners can no longer work together but also cannot agree on separation.
People often ask, “What kind of lawyer are you?” After my stock (and feeble) comedic response of “a good one”, I often say I am a “commercial litigator”. I explain that our practice includes litigation of disputes which arise between businesses and business owners. Commercial litigation includes a wide range of potential issues ranging from business torts to breach of contract, both internal to a business entity, and between two or more separate entities. While there are a wide range of potential issues which must be considered, there are certain basic tenets which I always discuss with our clients before recommending litigation or taking on their representation.
First, do you have an agreement which might apply to the situation and, if so, what does that agreement say about your position? Agreements can come is various shapes and sizes, such as corporate by-laws, a formal shareholder agreement, a proposal combined with an acceptance or performance, or even a simple exchange of emails. Documentary evidence is key, as a litigator is challenged to explain why the written word should not be impactful.
Second, what is your goal? The kiss of death as to our representation is a client who says “it’s not about the money, it’s the principle”. When I was a young lawyer I had a mentor who gave sage advice when he communicated the firm’s policy that litigation was only appropriate when money was involved. He would politely say, “we don’t litigate over principle”. In many ways and in most situations that adage applies. However, in the corporate setting, sometimes the connection to money is not readily evident or direct such as with regard to disputes over corporate control or enforcing a covenant not to compete. In many situations, I caution stakeholders to take the long view and weigh the probable outcomes from a purely practical standpoint, taking care never to lose sight of their long range business goals.
Third, what is your capacity for litigation and business distraction? Litigation not only costs money in terms of attorney fees, accountant fees, experts and costs, but participation also requires commitment of a leader’s most valuable commodity; time. Business people are first and foremost concerned with business (daily operations, management and the bottom line). Litigation invariably requires substantial client involvement in developing strategy, reviewing pleadings, searching for documents, reviewing documents produced by other parties and preparation for testimony. I advise potential parties to litigation to think long and hard about the cost/benefit to the business of such an undertaking.
Fourth, what can you hope to recover or save; and what will it cost to do so? While a corollary to litigation about money, it is not the same question. The evaluation of potential cost is complex and issue dependent. In a recent case, settlement discussions in a commercial litigation setting were driven by the anticipated six figure cost to translate thousands of pages of information from Chinese characters to English. Costs of experts on any issue involving an opinion on issues ranging from the standard of care applicable to a corporate officer, to whether a machine functioned in the way represented, can rapidly accumulate. Unless there is a provision in an agreement which provides for the recovery of attorney fees or such recovery is otherwise permitted under law, those fees and costs are not recoverable.
The above is not to discourage litigation of bona fide disputes; of which we handle many. It is simply imperative that the lawyer and the client be on the same page as to expectations, risks and litigation management. These questions can assist in forming the framework of a solid attorney client relationship in a commercial litigation setting, which goes a long way toward developing realistic expectations, reducing the stress inherent in the process, and optimizing the chances of a successful outcome.
In my many years of practice as a commercial litigator dealing with conflicts between shareholders, it has become clear time and again that one of the best things business owners can do when in business with multiple shareholders or partners is to have a well-defined agreement which governs the operations of the business. Not only can that agreement memorialize the respective rights and obligations of the parties, it can also provide dispute resolution mechanisms which may serve the parties well in the event of material disagreement. Utilizing the powers granted by the Business Corporations Law and granted by the terms of an agreement governing business owners can be complex and risky but can often force an acceptable resolution when the status quo is no longer tenable.
In the case of a corporation, a shareholders agreement or by-laws will often identify the corporate office which holds supreme executive authority subject only to removal of that corporate officer by a vote of the directors. If the officer controls sufficient votes from the board, removal by a disgruntled shareholder may be impossible. The acts of the executive are subject to the business judgment rule and granted a certain amount of deference at law.
A majority shareholder who holds the top executive office is free to wield that power, consistent with the business judgment rule, in many ways - including business dealings with outside parties and, generally, with respect to employment decisions. If the disgruntled shareholder is an employee of the company, which is often the case in small business, that shareholder’s continued employment may be at the discretion of the majority. Termination of employment, if justified, is a use of corporate power which often impacts on the relative negotiating positions.
Of course, a majority shareholder who exercises corporate authority can be faced with claims that the minority has been “frozen” or “squeezed” out of the business. In such cases, it is important that the majority have “clean hands” and has avoided self-dealing, corporate waste or fraud as such allegations, if proven, could result in the appointment of a custodian or receiver and a loss of control. Certainly the majority cannot transfer the assets of the business to a new entity controlled solely by the majority. However, the existing entity can be managed in a way that maximizes benefit to the majority consistent with the exercise of business judgment. The existence of a dispute between shareholders does not in and of itself negate the discretion afforded by the business judgment rule.
AMM counsels clients through the minefield of corporate authority and with regard to available strategies to address disputes which arise between business owners.
Reprinted with permission from the Spring 2018 Issue of the Pennsylvania CPA Journal
My partners and I were retained for a recent case that highlighted the value of tax and accounting expertise in litigation. We represented shareholders in a precious metals business who were embroiled in a difficult intrafamily dispute. The work illustrated a successful marriage of lawyers and accounting experts in a very complicated commercial case.
A platinum recycling company owned by three brothers – I’ll call them O, S, and K – acquired an interest in a company in Gibraltar and another company in the United Arab Emirates (UAE). Their creditor was a South African platinum company.
Trouble started in 2008. The company fell behind in payments to its South African creditor, and the brothers fought over their company’s future and strategies to repay their creditor. Litigation ensued.
Suits erupted in four different jurisdictions: in the London Court of International Arbitration (LCIA) in the High Court of Justice, Chancery Division (Chancery case), venued in London, England; in Bucks County, Pa.; in Burlington County, N.J.; and in federal court in the Eastern District of Pennsylvania.
Brother S and the company sued Brother K in New Jersey for failure to pay funds due under a loan from the company. The loan was to permit Brother K to purchase the UAE and Gibraltar companies, and then to transfer half of his interest to Brother S.
In the Chancery case, Brother S sued Brother K for K’s conduct in the transactions to purchase the UAE and Gibraltar companies.
Brother O sued Brothers S and K and the company in Bucks County for failure to make distributions to him, for mismanagement, and for self-dealing. Brother K, as an owner of the UAE and Gibraltar businesses, filed on behalf of those entities against the brothers’ company for failure to return metal or pay funds due.
In London, the South African company sued the brothers’ company for $200 million in loans owed to it. It filed the same action in the Eastern District of Pennsylvania.
The brothers eventually settled the Bucks County, London, and New Jersey actions, as well as one of the federal court actions. However, the dispute with the South African company in the LCIA went to trial. The South African company won a judgment for slightly more than $200 million.
The South African company then filed a new action in federal court, alleging that the earlier settlements amounted to fraudulent conveyances made to avoid the $200 million claim while the brothers’ company was insolvent and without fair value exchanged.
The dispute required forensic accounting experts on both sides to present on several issues, including maintaining the entity’s status as an S corporation, evaluating the solvency of the entity, providing insight into whether certain transactions amounted to fraudulent conveyances, and assisting counsel with cross-examination.
The accounting experts evaluated whether settling the Bucks County case to preserve an S election was a viable defense under the fraudulent conveyance statute, and provided advice, reports, and testimony to explain the S election, the steps the company could properly have taken to preserve the election, and the consequences of losing the election.
The parties sought expert opinions regarding the company’s insolvency, and the date it became insolvent. With a $200 million judgment looming, the issue of insolvency was a matter of “when,” rather than “whether.” The lawyers and accountants worked together to determine the date on which insolvency occurred and how to present that to the jury.
The most daunting issue in the case was the lack of professional recordkeeping by the brothers’ company. This issue is too common in family businesses, even among those that have been successful. Experts were required to recreate financial information from the reports generated related to the insolvency and tax issues. The forensic accountants provided support in cross-examination aimed at challenging those recreated reports.
The jury was called upon to answer the following question: Did the settlements amount to fraudulent conveyances? The jury answered “yes” with regard to the Bucks County settlement, but “no” to the settlement of the dispute with the UAE and Gibraltar entities. The jury found that the shareholders did not engage in actual fraud. It returned a verdict of $16 million in favor of the South African company.
The creditor portion of this case required extensive use of forensic accounting experts who expressed opinions on both sides of the Subchapter S and insolvency issues. They assisted in devising strategies to present highly technical topics to the jury. Accounting experts on both sides recreated financial records, and wrote reports addressing the issues. They assisted in devising strategies for cross-examination, and they testified. Together the lawyers and accounting experts were able to present very complicated evidence in a way that kept the jury engaged.
Reprinted with permission from the August 19, 2016 issue of The Legal Intelligencer. (c) 2016 ALM Media Properties. Further duplication without permission is prohibited.
The rights of shareholders to dissent to corporate actions are set forth in PA C.S.A. §1571 et seq., the Pennsylvania Business Corporation Law. Dissenters who comply with the formalities of the statute have the right to demand payment for the fair value of their stock interest at the time of the corporate action giving rise to the right to dissent – provided the corporate goes through with that action. Since a shareholder in a publicly traded company can simply sell his shares if he disagrees with a proposed corporate action, dissenters’ rights do not apply to such corporations.
What triggers dissenters’ rights?
The corporate actions giving rise to dissenter’s rights are specified in the BCL and generally involve fundamental changes to the entity, such as a merger or a change in voting rights. When the corporation proposes to undertake such a change, a specific procedure must be followed by the dissenting shareholder.
Dissenters need not necessarily assert their dissenters’ rights to all of their shares. They must, however, assert those rights as to “all the shares of the same class or series beneficially owned by any one person.” Beneficial owners of shares should have the written consent of the record holder of the shares. 15 PA C.S.A. §1573.
Dissenters must file their dissent with the corporation prior to the vote on the proposed corporate action. The dissent must be in writing and must include a demand for payment of the “fair value for his shares” if the corporation adopts the proposed action. Merely abstaining or voting against the change is not sufficient to invoke dissenters’ rights. Once invoked, to preserve dissenters’ rights, the shareholder cannot change the beneficial ownership of the shares while the vote is pending, nor can he vote in favor of the proposed action.
By Thomas P. Donnelly, Esquire
Reprinted with permission from the November 23, 2015 issue of The Legal Intelligencer. (c) 2015 ALM Media Properties. Further duplication without permission is prohibited.
A high business “tide” does not necessarily float all boats. Often, when business is good and profits increasing, a business owner’s desire to avoid sharing those increasing profits with an underperforming partner can create an irreconcilable divide; particularly in the case of a partner not intimately involved in the day to day operations of the business. Similarly, more difficult economic times stress cash flow, and may motivate a performing partner to explore options to decrease or eliminate that portion of the business income flowing to those performing at a lower level. Of course, the lesser performing partner generally adopts a contrary perspective. In either case, the divergence between two or more partners can render the status quo unacceptable and threaten the business as a going concern.
In approaching disputes among shareholders several factors must be considered. First, does the attorney represent the company, the majority interest, or the minority interest? The practitioner’s potential strategies must be informed by the relative position of the parties. Second, what are the respective goals of the parties? Certainly, the long term goal of extracting the most gain in income or the value of the investment is the goal of all the parties, but short terms strategies can have a dramatic and sometimes unintended consequence. Third, what is the impact of the potential short term strategies, not only on the business, but also on the individuals? Financing arrangements and personal guarantees must be considered. Finally, the respective rights and obligations of the shareholders post dissolution must guide the process.
When approached by a client considering business divorce, the attorney must consider potential conflicts of interest. Often, the majority owner’s first call is to corporate counsel. However, Rules of Professional Conduct 1.7, 1.8 and 1.9 bear upon whether corporate counsel can represent the interests of only one shareholder/member. In summary, representation of the “company” in the same or substantially related matter, or receipt of confidential information which may bear upon the representation of the party not seeking to be represented by corporate counsel, would preclude corporate counsel from undertaking the representation of a single shareholder/member. In some circumstances, it may be appropriate for the company to have separate counsel, such as where the company is a potential defendant in litigation commenced by either a third party or a shareholder. However, such representation is complicated by divergence among board members and can present difficult issues in corporate governance and communication between counsel and the corporate client.
Representation of the majority interest provides for the implementation of whatever remedies may be available under the terms of written agreements among the shareholders or by means of corporate action as to a non-performer. Significantly, there is no statutory right or method for the involuntary removal of a shareholder (arguably, such a remedy may be available in a partnership or Limited Liability Company setting). Potential courses of action include severance of employment or reduction in employment benefits for the non-performer, voluntary dissolution if provided and appropriate pursuant to the agreements between the parties, and modification of corporate governance. Of course, such potential courses of action do not come without risk, and the potential for litigation alleging minority oppression should be anticipated. In such a case, documentation of non-performance and job duties is compelling.
Representation of the minority owner is more difficult. Many times, the minority owner is left with litigation alternatives such as actions for the appointment of a custodian or liquidating receiver pursuant to 15 Pa.C.S.A. Sections 1767 or 1985, respectively. While these litigation remedies can be compelling, it should not be expected that litigation would result in continuation of the status quo indefinitely. Litigation rarely restores a broken relationship. Further, as recently noted by the United States District Court in Spina v. Refrigeration Service and Engineering, Inc. 2014 WL 4632427, a shareholder seeking the appointment of a receiver or a custodian bears a heavy burden and such appointment is at the discretion of the Court.
In addition, litigation alternatives necessarily incorporate business risk. Can the company survive the appointment of a custodian? By definition, a custodian is designed to continue the business as opposed to liquidation. The impact of a custodian on customer relationships, the entity’s capacity to contract and the willingness of business partners to engage in long term planning or projects may render liquidation inevitable. Certainly, the appointment of a custodian or receiver results in a loss of control on the part of the shareholders. All policy and management decisions fall within the purview of the court appointee. Such loss of control can be particularly problematic as it pertains to the case of tax reporting.
That same loss of control must be considered in a liquidation scenario. Liquidation contemplates an orderly winding down and distribution of assets which should be anticipated to include intellectual property and customer lists in addition to any fixed or hard assets possessed by the entity. As noted in Spina, liquidation is generally carried out by public auction so as to ensure fairness among shareholders. In the event of a liquidating receiver, a marketing campaign designed to enhance the value of the assets and maximize the selling price should be anticipated. In such circumstance, neither party may be in a position to acquire the liquidated assets or may be forced to over-pay, thereby rendering such acquisition economically unfeasible. Accordingly, while the goal at the outset of a liquidation proceeding may be to force a buy out of a shareholder, the end result may be that no party is in a position to acquire assets and engage in continued business operations.
The impact of a custodian or receivership on the individual business owners must also be considered. Business owners frequently guaranty corporate debt. The commencement of an action for the appointment of a custodian or receiver is almost always defined as an event of default with regard to the entity’s financing arrangements and could also trigger liability under the personal guaranty.
Finally, post liquidation obligations, or the lack thereof, should also be considered. It should be anticipated that former partners would compete post liquidation. The liquidation of the entity by definition precludes any claim for breach of fiduciary duty on the part of the company to the extent based on post liquidation acts or omissions and any right to enforce a post termination of employment restriction against competition. However, arguably, the sale of the entity’s assets, including confidential information such as customer lists, may implicate the Uniform Trade Secrets Act and preclude use of information known to the shareholders in competition with the buyer. While no case decided under Pennsylvania law addresses the application of the Act to such circumstance, the Act appears to be applicable where a shareholder retains possession of information which was subject to transfer in liquidation.
The complexities of business divorce through litigation mandate that the parties consider and pursue all avenues of amicable dissolution and consider all proposals for voluntary consolidation of ownership before pursuing litigation with uncertain results.
Tom Donnelly is a Partner with Antheil, Maslow & MacMinn. His practice focuses primarily on commercial litigation and transactions, employment disputes and personal injury.
Reprinted with permission from the September 28, 2015 issue of The Legal Intelligencer. (c) 2015 ALM Media Properties. Further duplication without permission is prohibited.
In a precedential opinion, the U.S. Court of Appeals for the Third Circuit affirmed an award of punitive damages awarded by a jury in a dispute between two businesses. Brand Marketing Group LLC v. Intertek Testing Services, No. 14-3010 (Sept. 10, 2015), addressed two issues of first or limited impression relating to punitive damages. First, the Third Circuit held that juries may award punitive damages in negligent misrepresentation claims. Second, the Third Circuit considered whether courts may consider harm to the public, rather than harm to the plaintiff only, in awarding punitive damages. As the dissent in Brand Marketing noted, the Third Circuit's decision creates some interesting risks and strategies for commercial disputes.
Brand Marketing Group LLC developed vent-free heaters known as Thermablasters. Brand contracted with a manufacturing company to manufacture the heaters, and a testing company, Intertek Testing Services N.A. Inc., to perform testing for the Thermablasters pursuant to American National Standards Institute (ANSI) standards. Brand entered into a contract with Ace Hardware Corp. to buy 3,980 Thermablasters for $467,000. Intertek then performed the testing on the heaters and found that they met the applicable ANSI standard. The heaters were delivered to Ace Hardware. Ace halted sales after discovering that the heaters, in fact, failed to meet the applicable ANSI standard. Ace sued Brand and obtained a judgment for $611,060. Brand then filed a claim against Intertek.
Brand prevailed on its negligent misrepresentation claim after a three-day trial. The jury awarded $725,000 in past compensatory damages, $320,000 in future compensatory damages, and $5 million in punitive damages. The jury found that Intertek negligently misrepresented it had the necessary expertise to test the heaters. Relevant to the issue of punitive damages, the jury found, after instruction by the court, that Intertek acted with reckless disregard for the safety of others.
The Third Circuit affirmed the trial court's denial of Intertek's post-trial motions, and thus the jury award of $5 million in punitive damages. In so doing, the Third Circuit predicted that the Pennsylvania Supreme Court would allow an award of punitive damages for negligent misrepresentation claims, noting there existed no precedent for treating negligent misrepresentation claims differently from general negligence claims for purposes of awarding punitive damages.
However, this holding is not the most interesting part of the case. The Third Circuit next examined whether courts could consider harm to the public in general in awarding punitive damages, or whether the court must limit its analysis to damage to the plaintiff. In this case, Brand experienced financial harm only (Intertek did assert, without success, that the economic loss doctrine barred Brand's claim). No consumer experienced an accident or injury as a result of the testing failure. Intertek argued that an award of punitive damages violated the due process clause under these facts because the jury should not consider potential harm to consumers, and must only consider harm to Brand, in awarding punitive damages. The court found that this issue was "not settled by precedent." The Third Circuit analyzed the case law to conclude that courts may only consider instances of misconduct by the defendant in evaluating a punitive damages award where the conduct is of the same sort as the conduct that injured the plaintiff. The court rejected Intertek's argument that applicable law prohibited consideration of potential public harm in reviewing an award of punitive damages, and found that, in this case, potential public harm was "directly tied" to the harm to the plaintiff. The Third Circuit likewise found that the fact that no one was physically injured by the Thermablasters did not matter, stating that Intertek "should not be rewarded" for the fact the risk did not come to fruition. Thus, Brand stands for the proposition that a court may consider potential harm to the public in reviewing an award of punitive damages as long as the potential harm is directly tied to the injury to the plaintiff.
In his dissent, Judge D. Michael Fisher opined that if an "admission of imperfection" or a "lack of absolute uniformity" allows for an award of punitive damages whenever something goes wrong, "Pennsylvania companies may be in for a rude awakening." Indeed, as Fisher notes, the Brand decision will create new strategies and areas of risk for businesses involved in commercial disputes. Brand represents, at its most basic level, a commercial dispute—a dispute between businesses regarding a failure of one party to do what that entity contractually agreed to do. Interestingly, Brand did not assert that it was entitled to punitive damages as a result of intentional and outrageous conduct of Intertek, but instead proved to the jury that Intertek's "reckless disregard" for a known risk to safety justified punitive damages. Of course, the jury heard evidence that it concluded met the standard, but the application of the standard to a business dispute is an interesting one. Presumably, this standard would have relevance in any business tort case where a failure occurs in, for example, manufacturing or testing products.
Procedurally, Brand allows for the issue of punitive damages to go to the jury, and, arguably, expands the factors a jury may consider in awarding punitive damages in the context of a business tort, but Brand does not mean that a plaintiff will prevail on the issue. It goes without saying that the threat alone may be enough. Brand's strategy in asserting a claim for negligent misrepresentation (and not, for example, breach of contract) created the opportunity to plead and prove punitive damages. Brand was also fortunate to have sufficient facts to overcome the application of the economic loss doctrine. The Third Circuit's opinion in this case supports that strategy by allowing punitive damages in a negligent misrepresentation case and by allowing the consideration of potential (related) harm to the public. In this way, the Third Circuit has created another tool in the commercial litigation arsenal. It will be interesting to see whether courts in the future limit the application of this case to its facts, or if it marks a dramatic change in the available remedies for business torts. •
By Thomas P. Donnelly, Esquire Reprinted with permission from the May 29, 2015 issue of The Legal Intelligencer. (c) 2015 ALM Media Properties. Further duplication without permission is prohibited.
Confidentiality agreements have become commonplace in commercial litigation. The purpose of a confidentiality agreement as the protection from disclosure of either private personal or sensitive business information which gives a party a competitive advantage is certainly a noble one and one which mandates an agreement against such disclosure in a wide variety of circumstances. Often, the parties seek the imprimatur of the court by requesting the court adopt the agreement of the parties as an order thereby incorporating the court’s power to impose sanctions in the event of breach. The entry of such an order, whether intentionally or as an unintended consequence, may change the nature of a third party, foreign to the dispute with respect to which the confidentiality order was entered, to obtain information produced in the prior litigation.