The Plaintiff or Defendant Is Not from North Carolina. Does Section 75-1.1 Apply?

N.C. Gen. Stat. § 75-1.1 regulates conduct “in or affecting commerce.” The statute doesn’t expressly differentiate based on type of commerce—intrastate versus interstate.

When conduct involves parties both inside and outside North Carolina, however, the reach of section 75-1.1 can come into question. Only a few months ago, we reviewed a federal-court decision that described the different choice-of-law tests that courts have used when considering whether section 75-1.1 applies to multistate conduct.

The North Carolina Business Court recently issued another decision on the standards that govern whether a party from outside of North Carolina can raise a section 75-1.1 claim.

In Window World of Baton Rouge, LLC v. Window World, Inc., Judge Louis A. Bledsoe, III refused to dismiss a section 75-1.1 claim that the defendant argued was barred by choice-of-law principles. More specifically, the defendant argued that section 75-1.1 did not apply to the defendant’s conduct because no plaintiff had a home office in North Carolina.

How did Judge Bledsoe reach this conclusion? This post examines the decision.

A Window into a Franchise Dispute

The plaintiffs in Window World are franchisees of Window World, Inc. Window World is based in North Carolina.

The complaint accuses Window World—as franchisor—of committing a host of wrongs. Certain plaintiffs complained to Window World about these wrongs and appeared to reach a settlement with Window World, but Window World reneged.

This lawsuit followed. The complaint contains the usual assortment of contract claims, business torts, and an alleged violation of section 75-1.1.

The plaintiffs sued multiple defendants, including Tammy Whitworth, whose family once owned all outstanding shares of Window World’s stock, and against whom the plaintiffs seek to pierce the corporate veil.

Ms. Whitworth filed a motion to dismiss.  On the section 75-1.1 claim, Ms. Whitworth argued that the plaintiffs have not stated a cognizable claim because the plaintiffs have not alleged an in-state injury.

Mapping Out the Place of the Injury

Judge Bledsoe began his analysis of Ms. Whitworth’s argument by identifying the controlling choice-of-law rule.

Under decisions of the North Carolina Supreme Court, he explained, the law of the situs of the claim determines the applicable law for matters that affect the parties’ substantial rights. For tort claims, the situs of the claim is “the state where the injury occurred.”

How does a court determine where an injury occurs?

To answer that question, Judge Bledsoe drilled down on the specific choice-of-law rule that applies to alleged violations of section 75-1.1.

Just two months ago, in a decision called Soma Tech, Inc. v. Dalamagas, Judge Bledsoe concluded that the North Carolina Supreme Court would likely apply the lex loci rule to section 75-1.1 claims. The alternative rule would be the most-significant-relationship test, but, as Judge Bledsoe noted, the state Supreme Court has rejected the modern trend toward that test.

Under lex loci, the plaintiff is considered to have sustained his injury in the state where the last act occurred that gave rise to the injury.

This rule might sound straightforward, but the parties had competing arguments about how it applies:

  • Ms. Whitworth argued that because the plaintiffs are not located in North Carolina, they could not have been injured in North Carolina.
  • In response, the plaintiffs argued that they were injured in North Carolina. More specifically, they argued that the injury occurred when Window World—located in North Carolina—received kickbacks and other information that the law compelled them to disclose to the plaintiffs.

To evaluate these arguments, Judge Bledsoe turned to a 2010 decision of the North Carolina Court of Appeals called Harco National Insurance Company v. Grant Thornton LLP. In Harco, the Court of Appeals held that the location of a plaintiff’s business may be useful in determining whether a plaintiff suffered injury—but only if, “after a rigorous analysis, the place of injury is difficult or impossible to discern.”

In most cases, the Court of Appeals emphasized, “a plaintiff has clearly suffered its pecuniary loss in a particular state, irrespective of that plaintiff’s residence or principal place of business.” In those cases, lex loci applies, and the governing law is the law of the state where the plaintiff has actually suffered harm.

Judge Bledsoe then applied these teachings to the motion to dismiss.

In her motion, Ms. Whitworth made only a bare assertion that the plaintiffs “are not located in, and did not suffer injury in, North Carolina.” As Harco makes clear, the location of a plaintiff’s business does not exclusively determine where the plaintiff suffered injury. That determination depends on the facts of each case.

Here, the plaintiffs have alleged that they suffered an injury in North Carolina, based on Window World’s conduct and its acceptance of kickbacks. These allegations, viewed in the light most favorable to the plaintiffs, could not be interpreted to establish injury somewhere other than North Carolina, as Ms. Whitworth had argued.

Judge Bledsoe therefore denied the motion.

The Place of Injury and Section 75-1.1 Claims

Because section 75-1.1 claims are ubiquitous in North Carolina business litigation, one can easily overlook the question of whether section 75-1.1 applies when the plaintiff or defendant is not from North Carolina. This is an important question to answer.

The answer, moreover, can require careful analysis of the allegations and facts of each case.  As Window World clarifies, the location of the plaintiff’s business does not automatically supply the answer.

Window World also illustrates two other tactical considerations in section 75-1.1 litigation:

  • A challenge at the pleadings stage to the application of section 75-1.1 must take into account not only the relevant choice-of-law regime, but also the Rule 12(b)(6) standard; and
  • In anticipation of a Rule 12(b)(6) fight, a plaintiff with a section 75-1.1 claim would benefit from including allegations in the complaint that concern the location of the plaintiff’s injury.

In the end, choice-of-law issues can be thorny in any type of litigation. This can be especially true—as Window World reminds us—in section 75-1.1 litigation.

Author: Stephen Feldman

Defending Novel Theories in Data-Breach Litigation

The success of a data-breach lawsuit often turns on whether the plaintiff has standing to sue. Showing actual injury can be especially hard when the only alleged damage consists of a risk of future identity theft

Data-breach plaintiffs are therefore looking for new avenues into the courtroom. One of these avenues is an “overpayment” theory.  

This theory rests on the premise that the price of a product or service includes a payment for measures to protect the buyer’s personal information. When a data breach compromises that information, the buyer alleges that he or she has overpaid for the product or service because the seller failed to provide the agreed-upon measures. 

This theory has seen mixed success. 

Courts have rejected the theory in cases that involve the purchase of physical products, where privacy and data security factor only into the processing of the buyer’s payment, rather than the product itself. Examples include data-breach lawsuits against Chinese food restaurants, grocery stores, and brick-and-mortar bookstores for failing to protect credit- and debit-card information.  

Courts have accepted the theory, however, in cases involving the purchase of online services, such as paid subscriptions to social networks and digital magazines. The purchases of these online offerings—unlike the purchase of physical products—were governed by terms of service that included explicit privacy and data security commitments.

A federal court in Chicago recently issued a decision that straddles these two lines of cases. The case, In re VTech Data Breach Litigation, involved physical products whose features included connectivity to an online service.

A Toy Story

VTech Electronics North America sold learning toys for young children. These toys, which included tablet computers and other handheld electronics, connected to VTech’s online application store, from which customers could purchase and download games, books, music, and videos. Some toys could also connect to an online service that enabled children to exchange text, picture, and voice messages with their parents’ cellphones. 

To access these services, customers had to register for online accounts with VTech. Parents who registered provided personal information about themselves and their children to VTech. Parents also had to agree to terms and conditions that incorporated VTech’s privacy policy. In that policy, VTech promised to protect personal information through certain data-security measures.

In 2015, a hacker infiltrated VTech’s servers and downloaded the personal information of over ten million adults and children. The plaintiffs—purchasers of VTech’s toys who had also registered for the online services—sued VTech and alleged that the hack resulted from VTech’s failure to live up to its data security promises. Their complaint asserted various claims, including one for breach of contract. 

The plaintiffs alleged that their injuries consisted of an economic harm: receiving a product worth less than the one for which they paid. According to the plaintiffs, the “product” they paid for included the toys, the online service, and the promised data-security measures. 

You Only Get What You Pay For

VTech rejected that characterization of the transaction and moved to dismiss for lack of standing and for failure to state a claim. 

According to VTech, buyers participated in two transactions:

  1. a purchase transaction involving the plaintiffs’ payment for a standalone physical toy, and
  2. the plaintiffs’ registration for the online services, an optional but separate—and free—offering.

Because VTech had only made data-security promises in the second transaction, VTech argued that the plaintiffs could not establish any “overpayment” for the physical toys that would constitute an injury-in-fact for Article III purposes.

For the same reason, VTech argued, the plaintiffs could not establish a key element of their breach of contract claim, namely, that both parties understood and intended that a portion of the purchase price for the toys would be allocated to protecting personal information collected through the online service.

Overpayment for Data Security can be an Injury-in-Fact

The court denied VTech’s arguments as to standing. 

The court observed that economic injury can result “from being given a different, less valuable product than the one that was promised and paid for,” and that such an injury meets Article III’s injury-in-fact requirement. By alleging such an injury—one consisting of overpayment for VTech’s toys and the associated online services—the plaintiffs had satisfied Article III’s injury-in-fact requirement.

The court also noted, however, that whether an injury-in-fact had been sufficiently alleged was separate and distinct from whether the complaint plausibly stated a claim that would entitle the plaintiffs to recover damages. 

But the Plaintiffs Didn’t Pay for Data Security

Turning to that question, the court acknowledged the parties’ disagreement as to what the purchase contract included, but held that VTech had the better of that argument. To that end, it agreed with VTech that “there is a difference between selling a product that combines both a physical toy and a service, and selling a physical toy whose features may be supplemented by a separate service that VTech provided for free.” 

The court then concluded that VTech had done the latter. To support that conclusion, the court observed that the toys functioned without the online services. In addition, the online-services terms did not suggest that the plaintiffs “purchased” the online services, or that the parties intended to incorporate those terms into the purchase contract for the toys. 

The court thus held that the plaintiffs had failed to show that both parties understood a portion of the purchase price for the toys would be allocated to the protection of personal information submitted through the online services. 

The court concluded this failure was fatal to the plaintiffs’ breach of contract claim, and granted VTech’s motion to dismiss.

Implications for the Data Breach Litigants

VTech contains some important lessons for data breach litigants.

First, it suggests that overpayment theories can succeed where other injury theories have failed, provided that a plaintiff plausibly alleges some connection between a purchased product or service itself and a defendant’s data-security duties.

It also confirms, however, that claims premised on an overpayment theory of damages remain vulnerable to challenge under Rule 12(b)(6). That’s especially true if a defendant can show that terms of service that include data-security promises are not part of a purchase transaction, but rather a separate and distinct event for which it does not collect any payment at all.  

Author: Alex Pearce

Can Forcing a Company into Bankruptcy Be an Unfair or Deceptive Trade Practice? Part 2

In a recent post, we examined the bankruptcy case of In re American Ambulette & Ambulette Service, Inc.—a case in which a trustee raised a novel theory of liability under N.C. Gen. Stat. § 75-1.1. The bankruptcy trustee alleged that certain business strategies that forced the debtors into bankruptcy constituted unfair and deceptive trade practices.

The bankruptcy court dismissed the trustee’s original 75-1.1 claim for failing to plead how the defendants’ alleged conduct affected either competitors or consumers. But the court allowed the trustee to amend the complaint.

The trustee’s amended 75-1.1 claim survived dismissal. Today, we examine the court’s opinion about the amended complaint.

The Trustee’s Original Allegations

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 sister 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 their officers and directors caused the debtors to incur substantial expenses to further the expansion plans.

In the original complaint, 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.

The complaint included a claim against the parent companies and their officers and directors for violations of section 75-1.1.

The First Motion to Dismiss

The defendants moved to dismiss the original complaint. The motion largely relied on a recent federal district court decision since affirmed on appeal. 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 is engaged in commercial dealings with the defendant. The defendants also 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 were competitors.
  • The conduct that gives rise to the claim has had a negative effect on the consuming public.

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

After the court dismissed the original 75-1.1 claim, the trustee filed an amended complaint. The amended complaint added the competing subsidiaries as parties to the 75-1.1 claim. It also asserted that the defendants’ actions benefited the competing subsidiaries.

The amended complaint also contained detailed allegations about how the defendants affected the marketplace and the consuming public.  The trustee’s amended complaint specifically alleged that the defendants’ conduct did not merely cause the replacement of one competitor with another, but actually removed a competitor from the relevant market altogether.  The trustee further alleged that the removal forced the county in which the debtors previously operated to declare a state of emergency. The county was also allegedly forced to obtain an injunction to compel the debtors to continue to provide the 911 emergency services that the debtors contracted to provide to the county.

The Second Motion to Dismiss

The defendants moved to dismiss the amended complaint, but the court refused to dismiss the amended 75-1.1 claim. The court used the same analytical framework, and categories for when a business may assert a 75-1.1 claim, as in the prior opinion.  This time around, however, the trustee convinced the court that the debtor’s alleged removal from the relevant market, and the alleged interruption of emergency medical service to citizens that was a result, made a sufficient impact on the consuming public to violate section 75-1.1.

The factual scenario in which the possible 75-1.1 violation in American Ambulette arose is relatively unique.  But the caselaw concerning when a business may assert a 75-1.1 claim is developing quickly.  Going forward, we may see other “theft of corporate opportunity” claims—both in and out of bankruptcy.

Author: George Sanderson