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