Can Forcing a Company into Bankruptcy be an Unfair or Deceptive Trade Practice?

Can a bankruptcy trustee prove a violation of N.C. Gen. Stat. § 75-1.1 based on business strategies that forced a debtor into bankruptcy?

The U.S. Bankruptcy Court for the Eastern District of North Carolina recently addressed this question in In re American Ambulette & Ambulette Service, Inc. 

The Debtors’ Corporate Parents Allegedly Force the Debtors to Liquidate

The debtors in American Ambulette were in the medical-transport business. Each of them filed for liquidation under chapter 7 of the bankruptcy code. The bankruptcy court consolidated the cases and appointed a single bankruptcy trustee to administer the debtors’ assets.

The trustee then filed an adversary proceeding against the debtors’ parent and sibling corporations, as well as their officers and directors.

The trustee alleged that the debtors’ corporate parents developed a business plan to expand their operations. As part of the expansion plans, the parent entities established two new subsidiaries. The new subsidiaries allegedly competed with the debtors. According to the trustee, the corporate parents and the officers and directors caused the debtors to incur substantial expenses to further the expansion plans.

The trustee accused the defendants of (1) diverting the fruits of their business-development activities to the competing subsidiaries, (2) transferring assets from the debtors to those subsidiaries, and (3) forcing the debtors into liquidation. Those activities, the trustee argued, eliminated the debtors as competition for the new subsidiaries.

These allegations fueled a 79-page complaint from the trustee. The complaint included a claim against the parent companies and their officers and directors for violations of section 75-1.1.

The Defendants Won the Battle, but Did They Win the War?

The defendants moved to dismiss. The motion largely relied on a recent federal district court decision. The defendants argued that, under the recent decision, a business can pursue a 75-1.1 claim only when the business has acted as a consumer or has engaged in commercial dealings with the defendant.

The defendants conceded that the trustee’s complaint described commercial dealings. They argued, however, that the allegations about those dealings did not state a violation of section 75-1.1. They stressed that the defendants on the 75-1.1 claim did not include the competing subsidiaries themselves.

The bankruptcy court granted the motion to dismiss. The court identified three categories of cases in which a business plaintiff may assert a 75-1.1 claim:

  • The plaintiff has acted as a consumer or has otherwise engaged in commercial dealings with the defendant.
  • The plaintiff and the defendant have competed with each other.
  • The conduct that gives rise to the claim has had a negative effect on the consuming public.

In American Ambulette, the trustee did not allege that the debtors engaged in commercial dealings with—or were competitors of—the defendants themselves. The complaint also lacked any allegations on how the defendants’ conduct affected consumers. 

These points led the bankruptcy court to dismiss the complaint, albeit with leave to amend.

Shortly after this order, the trustee filed an amended complaint. The amended complaint adds the competing subsidiaries as parties to the 75-1.1 claim. It also asserts that the defendants’ actions benefited the competing subsidiaries. Finally, it includes detailed allegations on how those actions affected the marketplace and the consuming public.

The Takeaway

American Ambulette suggests that if corporate parents merely run a company into the ground and force it to liquidate, that activity alone would not support a 75-1.1 claim. In the case itself, however, the 75-1.1 claim survived because the parents formed competing entities and then diverted corporate opportunities and assets to those new entities.

The defendants’ time to respond to the amended complaint has not run. We’ll be interested to see:

  • whether the 75-1.1 exemption for activities within a single business comes up,
  • whether the alleged diversions are considered commercial dealings, and
  • whether the trustee has alleged enough on whether those alleged activities affected competitors or consumers.

As American Ambulette illustrates, bankruptcy cases often generate different styles of 75-1.1 claims from the styles that one sees in other trial courts.

Author: George Sanderson

Practical Guidance for Framing an Unfair-Trade-Practices Claim

A recent decision from a North Carolina federal court underscores the importance of how a plaintiff frames an alleged violation of N.C. Gen. Stat. § 75-1.1.

In Hongda Chemical USA, LLC v. Shangyu Sunfit Chemical Co., Judge N. Carlton Tilley Jr. of the U.S. District Court for the Middle District of North Carolina considered a motion to dismiss a section 75-1.1 claim. The claim involved a contract. As we have seen, when a 75-1.1 claim involves a contract, the claim usually faces substantial hurdles, even at the pleadings stage.

In Hongda, however, the court denied the motion to dismiss. Why?

The court seems to have interpreted the claim as one partially based on a misrepresentation and partially based on direct unfairness. This characterization matters, especially because unfairness is potentially the broadest category of section 75-1.1 claims.

This post examines the section 75-1.1 claim in Hongda, the court’s decision, and the lessons that the case offers for litigants under section 75-1.1.

A Contract to Deceive

This heading might sound like the title of a bad James Bond movie, but it aptly describes the allegations in Hongda.

Hongda and Sunfit entered into a contract for the sale of NBPT, a chemical product. Under the contract, Hongda agreed to buy NBPT exclusively from Sunfit and to sell no other NBPT.

Hongda, however, had no intent to honor the agreement. Its managing members had conspired to create a competing venture that would manufacture and sell NBPT. The members planned to use the proceeds of Hongda’s sales of Sunfit NBPT to build the competing entity, instead of using those proceeds to pay Sunfit.

The members followed through on the plan. When Sunfit asked why it wasn’t getting paid, the Hongda conspirators lied: they told Sunfit that Hongda’s buyer hadn’t paid Hongda, so Hongda had no funds to pay to Sunfit.

Despite these facts, Hongda, rather than Sunfit, began the litigation by seeking a declaratory judgment. Sunfit responded with counterclaims, as well as third-party claims against Hondga’s members who had helped create the competing venture. The third-party claims included a claim under section 75-1.1.

When a Claim About a Contract Is Not a Contract-Based Claim

The Hongda members—the third-party defendants—moved to dismiss the section 75-1.1 claim.

In their briefing, the Hongda members framed the 75-1.1 claim as one alleging an intentional breach of contract. According to the members, the crux of the case was Hongda’s agreement to buy and sell NBPT exclusively from Sunfit. The members argued that even if Hongda didn’t fulfill its contract obligations, Sunfit should be limited to contract remedies against Hongda, not treble damages against Hongda’s members.

Sunfit, however, had potent counterpoints.

First, the Hongda members weren’t being sued over contract obligations, because they weren’t parties to the contract at issue. A section 75-1.1 claimant must show “substantial aggravating circumstances” only in a certain situation: when a claim is premised on a breach of contract. Although the Hongda members might have encouraged a breach of contract, they committed no breach themselves.

Second, the third-party complaint alleges that the members conducted their scheme in secret and, on top of that, lied to Sunfit. Thus, even if Sunfit were required to allege “substantial aggravating circumstances,” Sunfit alleged those circumstances: concealment and deception. As we have shown before, deception is usually a key ingredient in the recipe for substantial aggravating circumstances.

The court focused on both of these points.

It framed the section 75-1.1 claim not as an intentional-breach claim, but as a misrepresentation-based claim—with the misrepresentation being one by an individual Hongda member, not one by Hongda itself, the contracting party. The court specifically noted that Sunfit had alleged actual reliance, though the court’s order did not address whether that reliance was reasonable. Nor did the court address whether the claim was pleaded with particularity.

The court then described the conduct at issue as “unscrupulous” and “unethical.” Through this language, the court channeled Sunfit’s claim into the category of direct unfairness. This characterization had a big benefit for Sunfit: the claim satisfied the relatively open-textured standards that govern direct-unfairness claims.

Points for 75-1.1 Litigants

Hongda shows vividly why the framing of a 75-1.1 claim can make the difference between survival and dismissal. In particular:

  • Framing a 75-1.1 claim as a direct-unfairness claim increases the claim’s chances of surviving a motion to dismiss.
  • To maximize prospects under section 75-1.1, a plaintiff might consider focusing its claim on the bad conduct of third parties, not the conduct of contracting parties.
  • Even a misrepresentation-based claim—if it includes the required elements—might have better odds of surviving a motion to dismiss than a “substantial aggravating circumstances” claim would have.

Hongda shows that the survival of a 75-1.1 claim might turn on whether the claimant holds the claim at just the right angle.

Author: Stephen Feldman

Crash into Me? Not If You Want to Sue Me for Unfair Trade Practices

Does N.C. Gen. Stat. § 75-1.1 allow a lawsuit by a remote user of a product—a user who had no involvement in buying the product? A federal court in North Carolina recently answered no.

An unusual fact pattern for a 75-1.1 case

Early one morning, Danielle Washington was driving to work. She fell asleep at the wheel and crashed into a guardrail, suffering serious injuries. Ms. Washington later discovered that she hit an ET Plus® guardrail. Trinity Industries, the manufacturer of this guardrail system, describes it as “a federally accepted energy-absorbing guardrail end terminal system used on roadways.”

Ms. Washington sued Trinity, alleging that the guardrail was defective and dangerous. Indeed, she alleged that Trinity had changed the design of the guardrail in a way that made it more dangerous, while concealing the effects of these changes from federal regulators. Based on this alleged concealment, in 2014, a jury in the U.S. District Court for the Eastern District of Texas held Trinity liable under the federal False Claims Act.

Unsurprisingly, Ms. Washington sued Trinity in the Eastern District of Texas—the same federal court where Trinity had been held liable for false claims. That court, however, transferred the case to the Middle District of North Carolina, the location of Ms. Washington’s home and the site of the accident. The case was assigned to District Judge Loretta Biggs and Magistrate Judge Patrick Auld.

After the transfer, both sides saw potential benefits from applying North Carolina law, at least on points of their choosing. The defendants argued that North Carolina’s contributory-negligence rule barred Ms. Washington’s claims.

Ms. Washington, on the other hand, sought to amend her complaint to add a claim under section 75-1.1. Trinity opposed the motion to amend, arguing that the proposed amendment would be futile. In an opinion on that motion, Judge Auld held that the proposed 75-1.1 claim failed at the threshold.

Ms. Washington’s proposed 75-1.1 claim raises several interesting questions, including these:

  • Are violations of the federal False Claims Act per se violations of section 75-1.1?
  • Are false statements to government regulators—whether or not they support a deception claim—inherently unfair?
  • Is it ever possible for a remote “user” of a regulated product to rely on undisclosed statements to government regulators? If so, when?
  • Can a plaintiff recover personal-injury damages—times three—through a 75-1.1 claim?

On Ms. Washington’s motion to amend, some, but not all, of these questions arose. In the end, though, the court found other questions dispositive:

  • In a case like Washington (as opposed to a business-vs.-business case), must one be a “consumer” to sue a product manufacturer? The court answered yes.
  • If so, does a remote user of a product qualify as a consumer? The court answered no.

Consumers only, please

The court began its analysis by reviewing section 75-16, the main remedial statute for section 75-1.1. That statute allows a claim by “any person [who] shall be injured.” Reviewing earlier decisions, the Washington court stated that courts have generally interpreted “any person” to mean “consumers.” The court defined a consumer as someone who has “participate[d] in an exchange of value as a purchaser of some item.”

To try to broaden the set of eligible plaintiffs, Ms. Washington relied on two earlier decisions that arguably expanded the range of 75-1.1 plaintiffs beyond buyers and sellers. 

In Hyde v. Abbott Laboratories, Inc., the North Carolina Court of Appeals held that indirect purchasers of products—not just customers who deal directly with a defendant—might be able to recover damages under section 75-16. The Hyde court concluded that the legislature intended to extend recovery to “any person who suffers an injury,” whether or not “that person purchased directly from the wrongdoer.”

The Washington court distinguished Hyde because Ms. Washington never bought the guardrail at issue—directly or indirectly. Because she never “exchange[d] value” for the guardrail, she was a far more remote plaintiff than the Hyde plaintiffs were.

Ms. Washington also cited the North Carolina Supreme Court’s 2007 decision in Walker v. Fleetwood Homes of North Carolina, Inc. That case involved an allegedly defective mobile home. The plaintiff planned to live in the mobile home and make the monthly payments. Even so, it was the plaintiff’s father who made the initial down payment—the only money that had exchanged hands at the time of the complaint. 

The defendant in Walker argued that only the father had suffered an injury that allowed him to sue under section 75-1.1. The North Carolina Supreme Court, however, disagreed. According to the court, the daughter was injured by the defendant’s alleged misdeeds, because she was the intended owner of the home and she intended to make monthly payments on the home. 

In Washington, the court distinguished Walker as another case that involved a “purchase scenario.” Unlike the daughter in Walker, Ms. Washington did not “select, transact for, or plan to make payments” for the guardrail that allegedly harmed her.

By distinguishing these decisions, the Washington court underscored its conclusion that, to sue under section 75-1.1, a non-business plaintiff must be a consumer.

A downstream user is not a consumer

That conclusion doomed Ms. Washington’s proposed 75-1.1 claim.

Ms. Washington admitted that she did not buy the guardrail in question. Even so, she alleged that that she fell within the intended scope of recovery under section 75-1.1 because the defendants “anticipat[ed] and fore[saw]” that their products “would be impacted by members of the driving public.” Implicitly rejecting this theory, the court held that Ms. Washington “does not qualify as a ‘consumer.’”

Washington continues a trend of unsuccessful 75-1.1 claims by plaintiffs who are remote from a defendant’s alleged wrongdoing. We will watch to see whether any of the court’s reasoning migrates into business-vs.-business cases under section 75-1.1—a category that the court’s reasoning did not explicitly cover.

Author: Jeremy Falcone