Author Archives: George Sanderson

When Does a Business Dispute That Involves a Third Party Remain “Internal” for Purposes of an Unfair and Deceptive Trade Practice Claim?

The North Carolina Business Court has issued several opinions this year that examine the contours of the “internal business affairs” doctrine. As we have explained in prior posts, North Carolina courts have recognized that internal business disputes are exempt from N.C. Gen. Stat. § 75-1.1 because they are not “in or affecting commerce.”

In the latest Business Court opinion, JS Real Estate Investments, LLC v. Gee Real Estate, LLC, Judge Adam Conrad had to pick between two lines of North Carolina Supreme Court precedent to determine whether the doctrine applied.

This post examines why the Court in JS Real Estate decided that the dispute was an internal business matter, even though the defendant diverted funds to a third party.

The Parting of the Ways

The JS Real Estate case arose from the aftermath of a messy business divorce between two investors, James Shaw and Raymond Gee.

Shaw and Gee were members in multiple entities that owned and managed commercial real estate. Shaw and Gee were also members in companies that supervised the day-to-day management of those entities.

After several years, Shaw and Gee decided to end their business relationship.  Shaw and Gee executed a formal Separation Agreement in order to divide their interests.  The Separation Agreement explicitly provided that proceeds from their prior business affairs would be shared equally, but that Gee and his wholly owned company would manage the assets.

After the execution of the Separation Agreement, Gee replaced the firms that provided supervisory services with a company that Gee solely owned, GVest Capital.  GVest imposed a new management fee that it collected before any distributions were paid to Shaw and Gee.

Shaw, through his real estate company, claimed that Gee’s installation of GVest violated the terms of the Separation Agreement. Shaw alleged that the management fees GVest collected should have instead been distributed equally to Shaw and Gee.

Shaw’s real estate company sued Gee and Gee’s real estate company for breach of the Separation Agreement, breach of fiduciary duty, constructive fraud, and for committing an unfair or deceptive trade practice in violation of section 75-1.1. Shaw designated the case to the Business Court upon filing.

After discovery closed, Shaw moved for partial summary judgment as to the breach-of-contract claim. At the same time, Gee moved for partial summary judgment on the claims for breach of fiduciary duty, constructive fraud, and violation of section 75-1.1.

The Business Court issued an opinion on the cross motions for summary judgment. The only claim that the Court disposed of was the section 75-1.1 claim. The Court dismissed the section 75-1.1 claim because it viewed the matter as an internal business dispute.

The Fundamental Character of the Dispute Was Internal

In briefing summary judgment, Shaw argued that the matter was not solely an internal business matter because Gee’s conduct involved “commercial interactions” with an outside market participant, i.e. the company to which funds were allegedly diverted, GVest.  

Shaw argued that the North Carolina Supreme Court case of Sara Lee Corp. v. Carter was controlling precedent. In Sara Lee, the Supreme Court held that an employee violated section 75-1.1 by engaging in self-dealing when he sold computer parts and services to his employer from companies that the employee owned.

Gee countered that all of the alleged conduct was “encompassed within the rubric of the management and ownership” of the entities that Shaw and Gee jointly owned.

Gee argued that a different North Carolina Supreme Court case, White v. Thompson, controlled. In White, the Supreme Court held that a partner’s alleged misconduct in diverting work to a new business away from the partnership was not “in or affecting commerce” because the partner only breached his duty “as a partner in this single market participant.”

Weighing the two lines of precedent, the Court characterized the dispute between Shaw and Gee as a dispute between members over the internal management of, and right to receive distributions from, the companies of which they were members. Ultimately, the court decided that the facts at hand were more analogous to those presented in White than in Sara Lee.

The Court decided that third-party GVest’s collection of the new management fees did not change the “fundamental character” of the dispute as an internal business matter. In the Court’s estimation, GVest’s alleged involvement was more accurately classified as a “misappropriation of corporate funds within a single entity rather than commercial transactions between separate market participants.”

The Court further noted that White itself involved a partner diverting work towards his own business and away from the partnership.

How Involved are Third Parties?

The Business Court’s decision in JS Real Estate suggests that the determination of whether the internal business doctrine applies is often intensely fact-specific. Practitioners should note well, however, that the Court looked at the fundamental character of the dispute and still determined that the doctrine applied, notwithstanding the “tangential involvement” of third parties. Plaintiffs and defendants alike should assess what conduct lies at the core of the dispute when analyzing whether a section 75-1.1 claim is truly in or affecting commerce.

Author: George Sanderson

The North Carolina Business Court Explores the Boundaries of “Substantial Aggravating Circumstances”

Courts have long recognized limitations on claims brought under N.C. Gen. Stat. § 75-1.1 in conjunction with alleged breaches of contract. Although the North Carolina Supreme Court has never formally recognized a restriction, state and federal courts alike have determined that a breach of contract does not give rise to an unfair or deceptive trade practice claim unless “substantial aggravating circumstances” accompany the breach.

Courts have provided little guidance on what counts as a substantial aggravating circumstance, though some cases suggest there needs to be a showing of deceptive conduct. Courts usually focus on whether the specific fact pattern at hand discloses “egregious” or “substantially aggravating” conduct.

In a recent decision, however, North Carolina Business Court Judge Adam M. Conrad surveys several 75-1.1 cases that involve an alleged breach of contract. In examining the cases, Judge Conrad makes some helpful observations about what type of conduct courts do and do not recognize to be substantially aggravating.

The depth of analysis in Judge Conrad’s opinion appears to be unique among decisions that examine the intersection of 75-1.1 and breach-of-contract claims. As such, the opinion is a critical read for all North Carolina business litigators.

Questions About the Buyer’s Post-Closing Accounting

Post v. Avita Drugs, LLC involves the sale of MedExpress. MedExpress was a successful pharmacy based in Salisbury, North Carolina. MedExpress’s shareholders sold the business to Avita Drugs.

A stock purchase agreement governed the terms of the sale. Avita paid $6 million for MedExpress at closing. The stock purchase agreement also provided for a deferred payment of up to $5.5 million.  The actual amount of the deferred payment was to be determined under a formula in the stock purchase agreement. The formula was tied to the financial performance of MedExpress during the one-year period after the sale.

After the sale of MedExpress closed, the shareholders and Avita were unable to agree on the deferred payment amount. One of the shareholders ultimately sued Avita.

In his complaint, the shareholder alleged that Avita took a series of wrongful actions after the sale closed, including: (1) improperly adjusting the earnings calculation for MedExpress; (2) making retroactive adjustments to MedExpress’s books and records; and (3) failing to operate MedExpress as a separate company in the manner that the stock purchase required. The shareholder alleged that these actions improperly depressed the earnings calculation used to set the deferred payment amount.

The shareholder brought breach-of-contract claims under the stock purchase agreement and a 75-1.1 claim.

Avita’s Alleged Post-Closing Conduct was not Substantially Aggravating

Avita moved to dismiss the 75-1.1 claim. The Court granted the motion on the basis that the shareholder failed to allege sufficient substantial aggravating circumstances. Judge Conrad’s opinion went into great detail about the policies driving the substantial aggravating circumstances doctrine.

Judge Conrad first noted the high frequency of 75-1.1 claims in North Carolina business litigation. Citing Matt Sawchak’s article in the University of North Carolina Law Review about direct-unfairness claims, Judge Conrad hypothesized that the reason for the proliferation of 75-1.1 claims is chiefly economic. He observed that a successful 75-1.1 claimant is entitled to treble damages and, in certain instance, reasonable attorneys’ fees.

Judge Conrad contrasted the “potent and credible” threat of a treble-damages recovery with the purpose of damages recoveries generally for breaches of contract. Ordinarily, punitive damages are not recoverable for a contract breach under North Carolina law. By extension, Judge Conrad proffered that 75-1.1 claims that “piggyback” on breach-of-contract claims are disfavored by North Carolina state and federal courts.

Judge Conrad theorized that the prospect of damage recoveries that are disproportionate to the amounts involved in the underlying contract may cause uncertainty for contracting parties. That uncertainty could possibly increase transaction costs incurred in contractual negotiations.

Judge Conrad examined several cases in which a 75-1.1 claim involved a contract. He  concluded that most substantial aggravating circumstances (1) are attendant to the formation of the contract, and (2) are some variety of a fraud-in-the-inducement claim. He also noted that it appears “far more difficult to allege and prove egregious circumstances after the formation of the contract.”  

Judge Conrad also cited a line of cases that indicate that a 75-1.1 violation “is unlikely to occur during the course of contractual performance.”  Based on the case law, Judge Conrad opined that “efforts to encourage” continued contractual performance while “planning to breach” do not rise to the level of aggravating circumstances.

Judge Conrad’s case review did disclose a narrow band of post-formation conduct sufficient to trigger 75-1.1 liability. He cited instances of “clear deception” such as “forging and destroying documents” and “concealment of a breach” combined with “acts to deter further investigation” as actionable conduct.

Regarding the facts at hand, Judge Conrad did not find Avita’s alleged conduct to be sufficiently egregious or aggravating for the plaintiff to maintain a 75-1.1 claim. All of Avita’s alleged wrongful conduct occurred post-closing.

The judge also emphasized that each of Avita’s wrongful acts alleged was subject to an express provision of the stock purchase agreement. As such, he determined that the stock purchase agreement, and not section 75-1.1, defined the parties’ rights and obligations.

A Guide for Future Breach of Contract Cases?

One of the main purposes of the establishment of the North Carolina Business Court was to encourage the development and definition of business law in North Carolina. In keeping with that mandate, Judge Conrad’s opinion is a commendable attempt to provide definition to the concept of substantial aggravating circumstances not previously undertaken. It will be interesting to see how other courts use this framework in subsequent 75-1.1 decisions that involve a breach of contract.

Author: George Sanderson

Does the Fair Credit Reporting Act Preempt State-Law Claims for Unfair and Deceptive Trade Practices?

In cases that involve claims brought under North Carolina’s Unfair and Deceptive Trade Practices Act, an often overlooked issue is whether federal law preempts the 75-1.1 claim.

In a case of apparent first impression, a federal district court in North Carolina recently ruled that the federal Fair Credit Reporting Act (FCRA) can preempt a 75-1.1 claim, at least where there is no evidence that the defendant’s acts were willful or malicious.

Equifax doesn’t report the bankruptcy discharge of a consumer’s debt

Myrick v. Equifax Information Services, LLC involves a consumer whose obligations under a mortgage that had been discharged in bankruptcy. The consumer alleged that Equifax failed to properly report the status of the debt on the consumer’s credit report. Equifax was reporting that the consumer’s loan payments were past due, but did not note the discharge of the obligation.

The consumer disputed the report with Equifax through Equifax’s website. The consumer asserted that the credit report should reflect the discharge.

After Equifax received the dispute, Equifax contacted the bank that had extended the credit line and attempted to verify the status of the debt. The bank indicated that the consumer had an open account. The bank did not verify to Equifax that the account had been discharged. Equifax then informed the consumer that Equifax believed that the account reporting was correct.

Several months later, the consumer sent a dispute letter to Equifax. In the letter, the consumer reiterated that this debt had been discharged.  The consumer also attached a copy of the bankruptcy court’s order of discharge. As is typical, the discharge order did not specifically identify the bank’s debt.  The order further indicated that the bankruptcy had discharged at least some of the consumer’s debts, but may not have discharged all of them.

In response to the letter, Equifax requested that the consumer “be specific with [his] concerns by listing the names, numbers, and the nature of the dispute.”

The consumer sues Equifax for its reporting and dispute investigation procedures

The consumer did not provide the information requested. Instead, the consumer sued both the bank and Equifax in the United States District Court for the Eastern District of North Carolina. The lawsuit alleged that the companies violated both the FCRA and section 75-1.1.

The FCRA is a federal statutory scheme that governs the reporting of consumer debt. The FCRA imposes statutory duties on consumer reporting agencies about how they maintain and report consumer credit histories. The FCRA creates a private right of action, and provides for the recovery of actual damages, for the negligent or willful violation of any duty that the statute imposes. An aggrieved consumer can also recover punitive damages, but only if the consumer can prove that the reporting agency was willfully non-compliant.

After the consumer filed the lawsuit, the bank verified to Equifax that the debt had been discharged and settled with the consumer.  The consumer and Equifax proceeded to litigate the matter.  At the conclusion of discovery, Equifax moved for summary judgment.

Senior District Judge W. Earl Britt partially denied summary judgment as to the FCRA claims, but granted summary judgment to Equifax on the 75-1.1 claim.

The consumer alleged that Equifax violated the FCRA through both its procedures for preparing credit reports, and for conducting post-dispute investigations. As to its investigation, the consumer contended that Equifax had an independent duty to verify that the disputed debt had been discharged once Equifax received notice of the general bankruptcy discharge.

Judge Britt determined that the evidence was insufficient to make out a FCRA violation for Equifax’s original credit reporting, but denied summary judgment as to the FCRA claim premised on Equifax’s post-dispute investigation procedures. The judge did not believe that the consumer forecast sufficient evidence of willful non-compliance to take a punitive-damages claim to a jury.

The FCRA preempts the consumer’s 75-1.1 claim

Equifax also sought summary judgment on the 75-1.1 claim. Equifax argued that the 75-1.1 claim was preempted by the FCRA. The FCRA broadly limits consumers from bringing a suit against a reporting agency under state law “except as to false information furnished with malice or willful intent to injure such consumer.”

In a decision of apparent first impression, Judge Britt determined that the FCRA preempted the 75-1.1 claim in this particular case because Equifax’s conduct was, at most, negligent. In his decision, Judge Britt referenced Congress’s intent to allow state-law claims only in very narrow circumstances. Because the consumer failed to forecast any malice or willful intent to injure by Equifax, the consumer could not maintain his state-law claim for unfair and deceptive trade practices.

As Myrick shows, preemption can be a powerful way for a defendant to eliminate potential treble-damages liability under a state unfair and deceptive practices statute. The FCRA is one of a few federal statutes with an express preemption statute. Defendants have been successful, however, in arguing that other federal statutes so pervasively regulate conduct impliedly as to preempt state-law claims

Myrick is a reminder that plaintiffs and defendants alike should consider potential preemption arguments where federal statutes or regulations may also regulate conduct that allegedly violates section 75-1.1.

Author: George Sanderson