N.C. Business Court Holds that (Federal) Dividends Received Deduction Must Offset (State) Net Economic Loss Tax Deduction


In N.C. Dep’t of Revenue v. Graybar Elec. Co., Inc., 2019 NCBC 2 (N.C. Super. Ct. Jan. 9, 2019), the Business Court addressed the interplay between the federal dividends received deduction and the (now repealed) North Carolina net economic loss deduction. The issue, in particular, was whether the respondent corporation was required to reduce its North Carolina net economic loss deduction by the amount of the dividends received deduction it had claimed on its federal taxes. Chief Judge Bledsoe concluded that because the State had not taxed the dividend income, the dividends were “income not taxable” and applied to reduce the respondent’s net economic loss deduction accordingly.

The court further concluded that the State’s treatment of the dividend income was constitutional (under both the North Carolina and U.S. Constitution), but left open the question of whether that treatment had imposed a “double tax” on the same income.

Take-Aways:

  • Any income that is not taxed by the State of North Carolina, including dividend income deducted under the dividends received deduction, constitutes “income not taxable” for purposes of reducing a corporation’s North Carolina net economic loss deduction.
  • Subjecting corporate income to a “double tax” is both well-accepted and constitutional.
  • Regardless of constitutionality, a question is raised whether the State’s treatment of the dividend income resulted in double (or perhaps triple) taxation.

In Graybar Electric, the respondent corporation (“Graybar”) received from its subsidiaries two large dividends for which it claimed a dividends received deduction (“DRD”) on its federal income tax return. Graybar did not apply this DRD to “offset” the net economic loss (“NEL”) deduction that it claimed on its North Carolina state tax return, which would have reduced the NEL deduction to zero.

The North Carolina Department of Revenue (the “Department”) disallowed the NEL deduction, asserting that the dividends were “income not taxable” and therefore applied to reduce the NEL deduction (to zero, in this instance) under G.S. § 105-130.8(a)(3) (providing that NEL deductions may be claimed only to the extent that they exceed any “income not taxable” received for the year). Graybar Elec. Co., Inc., 2019 NCBC 2 ¶¶ 11-13.

Graybar thereafter filed a contested case with the Office of Administrative Hearings (“OAH”), which agreed with Graybar that the dividends were not “income not taxable” and therefore should not have been applied by the Department to reduce Graybar’s NEL deduction. The OAH further noted that, while not necessary to its decision, it agreed with the premise that “the Department’s position created a[n unconstitutional] double taxation on the same income.” Id. ¶ 15.

The Department exercised its right to appeal the OAH’s decision to the North Carolina Business Court. (Yes, the Business Court hears tax cases, too.) See G.S. § 7A-454(b)(1) (providing that “[a]n action involving a material issue relating to tax law that has been the subject of a contested tax case for which judicial review is requested under G.S. 105-241.16…shall be designated as a mandatory complex business case”).

On appeal, the Business Court addressed two issues: (1) whether the dividend income was “income not taxable” such that it applied to reduce Graybar’s NEL deduction; and (2) whether such a reduction, if allowed, amounted to a constitutional violation.

The court also touched on—but did not decide—whether the Department’s treatment of the DRD resulted in a “double tax” on the same income.

  1. “Income Not Taxable”

The Business Court first considered whether the dividends received by Graybar (for which it had claimed a DRD) constituted “income not taxable.”

Chief Judge Bledsoe consulted the text of G.S. § 105-130.8(a)(5) (repealed 2014), which identified two categories of “income not taxable” as follows:

For purposes of this section, [1] any income item deductible in determining State net income under the provisions of G.S. 105-130.5 and [2] any nonapportionable income not allocable to this State under the provisions of G.S. 105-130.4 shall be considered as income not taxable….

There was no dispute that the dividend income fell outside the two categories identified in the statute – the dividends were not deductible under G.S. § 105-130.5 (which specifies certain adjustments to arrive at net income) and were not allocable to other states. The dispute, instead, was whether the two categories represented an exhaustive list of the types of income that could qualify as “income not taxable” (as Graybar contended), or whether there were other types of income—such as deducted dividends—that could also qualify as “income not taxable” (as the Department contended).

Applying principles of statutory construction, the court concluded that G.S. § 105-130.8(a)(5) was intended to be “exemplary—not exclusive or exhaustive,” as “the statute’s plain words do not purport to provide a complete list or otherwise limit ‘income not taxable’ to only the types of income referenced there.” Graybar Elec. Co., Inc., 2019 NCBC 2 ¶ 28.

The court then proceeded to address the next logical question in the analysis: If the two categories identified in the statute were not exhaustive, then what other types of income might also qualify as “income not taxable?”

The answer, as it turned out, was that pretty much any income could be considered “income not taxable,” if the State did not tax it.

The court observed that the North Carolina Supreme Court had previously defined “income not taxable” as any “income on which the State does not levy a tax.” Id. ¶ 30-32 (citing Dayco Corp. v. Clayton, 269 N.C. 490, 498, 153 S.E.2d 28, 33 (1967), for the proposition that “‘taxable income’ clearly means income on which the State of North Carolina, by the Revenue Act, levies a tax” and that “[a]ll other income is ‘income not taxable.’”).

Applying this (broad) definition, the court concluded that the dividends in question qualified as “income not taxable” under Dayco because Graybar had deducted the dividends (via the DRD) in determining its federal taxable income—the starting point for calculating its North Carolina state net income—and the dividends were not “added back in” to Graybar’s state net income via any of the adjustments under G.S. § 105-130.5. The dividends were therefore not included in Graybar’s North Carolina state net income and, consequently, “were not income upon which the State levied a tax.” Id. ¶¶ 24, 31.

In reaching this conclusion, the court rejected Graybar’s attempt to distinguish Dayco on the grounds that Dayco had involved income that was not apportionable to North Carolina and thus was outside the State’s authority to tax. Dayco, according to Graybar, stood only for the proposition that income was “income not taxable” where the State lacked the authority to tax; and since there was no dispute that the State here did have the authority to tax the dividend income, Dayco was not controlling. The court declined to adopt this distinction, however, opting instead for a bright line rule that any income not taxed by the State was “income not taxable” and that, accordingly, “[b]ecause the Dividends [were] income on which the State did not levy a tax, the Dividends were ‘income not taxable’….” Id. ¶ 35.

The dispositive question, therefore, was not whether the State had the authority to tax the dividends, but whether the State had actually taxed them.  And because the State had not actually taxed this income, it was “income not taxable” and applied to reduce Graybar’s NEL deduction accordingly.

  1. Constitutional Issues

The court next addressed Graybar’s contention that the Department’s treatment of the dividend income—and specifically, its use of the DRD to offset Graybar’s NEL deduction—resulted in an unconstitutional “double tax” on the same income.

Chief Judge Bledsoe concluded that no constitutional violation had occurred, even if the income had been subjected to a double tax, because “nothing in either the United States Constitution or the North Carolina Constitution prevents the State from imposing double taxation, provided the tax is imposed without arbitrary distinction,” and “Graybar has failed to show that its tax burden resulting from the State’s determination—i.e., the reduction of Graybar’s NEL deductions by the apportioned amount of the Dividends received—is the product of discriminatory or arbitrary taxation….” Id. ¶¶ 49-50.

The court thus acknowledged the parties’ dispute over “whether the Department’s treatment has resulted in a double tax,” but concluded that it “need not resolve this dispute to determine Graybar’s constitutional challenges.” Id. ¶ 50, n. 8.

This question left open by the court—i.e., whether the Department’s treatment resulted in a double tax—is an intriguing one, even if “academic” in light of the court’s ruling, because it cuts right to the heart of the DRD and its underlying purpose. It is therefore considered in some detail below.

  1. Double (or Triple?) Taxation

A hallmark of corporate taxation is the “double tax” that applies to income generated by the corporate entity – the income is taxed first when earned by the corporation, and second when it is distributed to the company’s shareholders. Hence, the same income is taxed twice; and this concept is well understood and accepted in the corporate tax world.

What the tax law has long disfavored, however, is the idea that income earned by a corporation (or any entity, for that matter) could be taxed more than twice.

This concern of triple taxation (or more) creeps up in the case of affiliated entities – where, for example, a subsidiary corporation earns income that it later distributes to its parent company. In that situation, the potential for more than double taxation arises because:

  1. The subsidiary is taxed on the earned income (first level of tax);
  2. The same income is distributed to the parent in the form of a taxable dividend (second level of tax); and
  3. The parent eventually distributes the same income to its shareholders in the form of a taxable dividend (third level of tax).

In the case of longer chains of parent and subsidiary corporations, these multiple layers of tax on the same income can be extended well beyond the feared triple taxation.

To protect against this, Congress enacted the DRD, which provides a parent company receiving a dividend from its subsidiary with a deduction in the amount of the dividend received. The result is that the income is taxed twice – but only twice: once when earned by the subsidiary, and once when distributed by the parent company to its shareholders.

Applying these concepts to Graybar, there is no question that the dividend income was subject to two layers of tax – first when earned by Graybar’s subsidiaries, and second when Graybar distributed the income to its shareholders (whenever it chose or chooses to do so). The question, really, was whether a third layer of tax was introduced when the Department applied the DRD to offset the NEL deduction. And since the DRD, to that point, had effectively shielded Graybar from tax on the dividends it received from its subsidiaries, it is not difficult to see how “negating” that DRD—by using it to offset the NEL deduction—might arguably have resulted in a triple tax.

To be clear, there is nothing in and of itself unconstitutional about imposing two (or even three) layers of tax on the same income. The point is that these additional layers of tax are disfavored, and the DRD represents an attempt to alleviate the impact of an already relatively burdensome corporate tax regime. But as the Business Court aptly noted in its ruling, all deductions—whether in the form of a DRD or the NEL deduction—“are privileges, not rights,” Graybar Electric, 2019 NCBC 2 ¶ 51; and the General Assembly “permit[ted] a net economic loss or losses deduction . . . purely as a matter of grace.” Id. ¶ 48 n.7.

In sum, Graybar Electric answers an interesting (and difficult) question of corporate taxation, holding that the federal dividends received deduction must yield to a North Carolina statute that effectively negates that deduction. Given that Graybar has now appealed this decision to the North Carolina Supreme Court, it will be interesting to see whether the state’s highest court addresses the question left unanswered by the Business Court – that is, whether the Department’s treatment of the dividend income resulted in a double (or the much feared triple) tax.

N.C. Business Court Dismisses Inadequately Pled Retaliation and Wrongful Discharge Claims.


In Michael J. Kelley v. Charlotte Radiology, P.A., 2019 NCBC 14 (N.C. Super Feb. 27, 2019), Judge Conrad granted a motion to dismiss claims alleging wrongful discharge and a violation of the Retaliatory Employment Discrimination Act (REDA). The case involved a dispute between a radiologist and a Charlotte-based physician practice in which he had been a shareholder. The wind-down of their relationship, which commenced in an amicable matter, ultimately occasioned a lawsuit advancing breaches of contract and fiduciary duty, as well as violations of the North Carolina Securities Act. The Court’s ruling solely concerned two later-added claims that arose from the parties’ continuing efforts to negotiate the terms of their waning professional relationship.

Takeaways:

  • The Business Court will not strain to identify an allegedly protected employment activity when a party’s own pleadings undercut its position. 
  • The Court declined to create new law that an “anticipated, but never consummated, renewal of a term contract gives rise to an at-will employment relationship.” ¶ 33.

The decision arose from a fairly simple factual template. Dr. Kelley had decided to retire at the end of 2016, but ultimately changed his mind and entered with the practice a Retiree Employment Agreement that governed his work for the first six months of 2017. The practice informed Dr. Kelley he would no longer be a shareholder, and redeemed his shares without apparent dispute. ¶¶ 5-6. However, when Dr. Kelley later learned that the practice was considering a “refinance transaction” that would benefit shareholders, he claimed a continuing interest in such benefits. ¶ 7.

Dr. Kelley filed his complaint, alleging that Charlotte Radiology wrongfully redeemed his shares knowing of the impending, profitable transaction, at the same time he was attempting to negotiate an extension of his Retiree Employment Agreement. The practice withdrew a pending offer regarding a renewed agreement after the suit was filed. ¶¶ 9-10.

The Court first considered whether Charlotte Radiology violated REDA when it decided not to extend or renew the Retiree Agreement with Dr. Kelley. While the practice appears to have conceded that “the failure to renew an employment contract constitutes an adverse employment action for purposes of REDA,” Johnson v. Trs. Of Durham Tech. Cmty. Coll., 139 N.C. App. 676, 682, 535 S.E.2d 357, 362 (2000), it contended that any retaliation that might be present was not actionable because Dr. Kelley did not exercise a statutorily protected right. Dr. Kelley’s alleged protected activity was that his original complaint exercised his rights under the Wage and Hour Act. ¶¶ 19-20.

However, the Court demurred, noting that none of his original claims were made under the Act, nor was the Act even mentioned in the original complaint. “It would be odd,” the Court held, “to hold that an employee, having chosen not to bring a Wage and Hour Act claim, nevertheless engaged in protected activity by instead filing claims based on other statutory or common-law rights not protected by REDA.” ¶ 21. Moreover, the Court held that the original complaint could not have given Charlotte Radiology fair notice that Dr. Kelley was exercising a statutorily protected right, given its drafting flaws and its statement that he sought to “vindicate [his] rights as a shareholder.” ¶ 23.

The Court dispatched Dr. Kelley’s wrongful termination claim in a brief analysis. While noting that the Retiree Agreement raised interesting questions about whether Dr. Kelley was an at-will employee under the Agreement, the Court did not reach the issue because Dr. Kelley was not terminated, and had stayed on through the term of the Agreement. The Court relied on what it termed consistent holdings that “the tort of wrongful discharge in violation of public policy does not contemplate failures to rehire or reappoint.” Randleman v. Johnson, 162 F. Supp. 3d 482, 488 (M.D.N.C. 2016).

 

Brad Risinger is a partner in the Raleigh office of Fox Rothschild LLP. He maintains a commercial litigation practice that frequently involves business disputes before the North Carolina Business Court, and the state’s federal and state trial courts.

N.C. Business Court Dismisses a Motion to Enforce Mediated Settlement Agreement After a Protracted Struggle Among Owners


In Local Social, Inc. v. Stallings, 2019 NCBC 8 (N.C. Super. Ct. Jan. 30, 2019), Judge Robinson granted the Plaintiffs’ Motion to Dismiss the Defendant’s Motion to Enforce the Mediated Settlement Agreement for lack of subject matter jurisdiction based on the doctrine of mootness.

The current conflict grew out of several prior disputes between 50/50 owners of Plaintiff Local Social, Inc. Beginning in 2009, Ms. Eaddy, the Plaintiff owner of Local Social, and Mr. Stallings, the Defendant, were engaged in a romantic relationship. In 2014, Ms. Eaddy sold half of her interest in the company to Mr. Stallings. After the transaction, the co-owners had a falling out. Arbitration ensued. Later, Ms. Eaddy and the company alleged that Mr. Stallings “engaged in an array of misconduct,” including personal use of the company’s credit card for personal expenses totaling $146,736 (the “Disputed Expenses”). Mr. Stallings was removed as an officer and his employment terminated. Litigation followed. Mr. Stallings asserted various counterclaims.

The parties mediated their dispute and executed a Memorandum of Settlement in December 2017. The Plaintiffs agreed to make several cash payments to Mr. Stallings over time, to be secured by a confession of judgment.

With regard to the Disputed Expenses, the Memorandum stated in Paragraph 3(f) that Plaintiffs

agree to work in good faith with Local Social Inc.’s accounting firm to recharacterize [sic] the item marked “loan to [Stallings]” on the 2016 Local Social, Inc. balance sheet: (i) as an uncollectible debt on the 2017 taxes, (ii) as a business expense for the year 2016, requiring an amendment of the 2016 tax returns of Local Social, Inc., or (iii) some combination of the above, in increments recommended by Local Social, Inc.’s accountant.

Op.  ⁋ 8.

Thereafter, Local Social’s accountant determined that the Disputed Expenses should be reclassified as neither an uncollectable debt on the 2017 return nor a business expense for 2016. That decision prompted Mr. Stallings to file the motion to enforce the settlement agreement.

The Court denied the motion because it determined that Paragraph 3(f) is ambiguous. It can reasonably be interpreted to mean either that the Plaintiffs must make a good faith effort to re-characterize the Disputed Expenses in one of the three ways listed in Paragraph 3(f) (regardless of whether they succeed in doing so); or that the Plaintiff must re-characterize the Disputed Expenses and would work in good faith with their accountants to determine the method of re-characterization. The Court set the narrow matter for trial.

Before trial, Plaintiffs contacted a new CPA who, in accordance with option (i) of Paragraph 3(f), recommended re-characterizing the entirety of the Disputed Expenses as uncollectable debt. He wanted to list the debt on the company’s 2017 tax returns. After the Court continued the trial, the new CPA amended his recommendation. He advised splitting the Disputed Expenses: $51,043 would be written off as uncollectable debt for 2017, and the remainder would be deducted as a 2016 business expenses.

Plaintiffs filed the current motion to dismiss, arguing there was nothing left for the Court to resolve.

Mr. Stallings did not agree. The CPA’s recommendation to characterize the $51,043 as a non-deductible capital loss (rather than as a deduction) meant an increase in Mr. Stallings’ taxable income. He made a number of arguments that the existing dispute required Court adjudication.

One argument was based in equity. Mr. Stallings argued that the Plaintiffs must be barred from changing their position based on an equitable doctrine whose origin lies in corporal feats of strength.  The trusty “mend the hold” doctrine generally “precludes the assertion of inconsistent litigation positions, usually concerning the meaning of a contract, within the context of a single lawsuit.” Whitacre P’ship v. BioSignia, Inc., 358 N.C. 1, 24 (2004). The Court dispensed with this argument, however, based on the rule’s exception, i.e., when the change in position results from new facts.

Another argument was based in contract. Mr. Stallings argued that the parties previously agreed that the Disputed Expenses could not be deducted from Local Social’s taxes as an uncollectable debt, and that, regardless, Paragraph 3(f) did not authorize amending tax returns.  The Court considered Mr. Stallings’ request for a full deduction outside his motion to enforce and outside the proposed issues for trial.  The Court determined the issue of a full deduction was a question of breach, which Mr. Stallings could enforce only by separate action.

The Court agreed with Plaintiffs that the matter was moot. It cited In re Peoples, 296 N.C. 109 147 (1978), for the proposition that the Court should usually dismiss an action when the questions originally in controversy are no longer in issue.

As the claim for breach remains possible, this case could rear its head again.

Business Court Sanctions Party for Discovery Misconduct and Awards Forensic Examination


It started out like a typical Business Court case:  a company filed suit against its former employees (and their new company) and asserted claims for things like breach of contract and misappropriation of trade secrets.  The plaintiff also filed motions for a temporary restraining order and a preliminary injunction, and it sought expedited discovery to support the claims for injunctive relief.

But from there, the case of Red Valve, Inc. v. Titan Valve, Inc. took some interesting twists and turns.

For example, before the defendants even filed an answer, the court entered two different orders requiring the production of certain documents.  The court first entered a temporary restraining order ex parte, which required the defendants to return the plaintiff’s confidential and proprietary information.  Second, the court allowed some expedited discovery and required the defendants to produce all materials containing the plaintiff’s trade secrets, all marketing and/or promotional materials related to the new company’s products, all photographs or renderings of the new company’s products, and all documents describing efforts to create the new company.

The defendants produced some files in response to the orders but did not produce all responsive documents.  Months later, the plaintiff moved for sanctions for the non-compliance.  Chief Judge Bledsoe granted the motion in part and, in doing so, provided several important reminders:

1)            Remember that one judge is assigned to the case

Unlike the majority of civil cases assigned to superior court judges in North Carolina, a Business Court case is typically assigned to one judge for the entirety of the proceedings.  That unique facet of Business Court cases should demand an extra-special duty of care when it comes to judges’ orders.

In Red Valve, the court’s temporary restraining order required the production of documents describing the defendants’ efforts to “create” the new company.  The parties disputed what the term “create” meant—but it was Judge Bledsoe’s order that went back to him for interpretation.  Not surprisingly, he concluded that the defendants’ “restrictive interpretation” was “unreasonable and inconsistent” with his order.

2)            Prejudice and bad faith may be relevant to the sanctions analysis

Rule 37(b)(2) of the North Carolina Rules of Civil Procedure allows a court to impose sanctions when a party “fails to obey an order to provide or permit discovery.” As the court noted in Red Valve, neither the plain language of Rule 37 nor appellate court decisions require a showing of willfulness or bad faith before imposing such sanctions.  However, the Business Court has specifically said that willfulness, bad faith, and prejudice to another party are relevant in its analysis.  Attorneys should be prepared to argue those things whenever dealing with a motion for sanctions.

3)           Even when sanctions are appropriate, there is still a preference for resolving cases on their merits

In addition to other sanctions, the plaintiff sought to preclude the defendants from defending against the plaintiff’s claims.  The court rejected that request. Although that is a possible sanction under Rule 37, Judge Bledsoe explained that it “is a severe sanction which should only be imposed where the trial court has considered less severe sanctions and found them to be inappropriate.”  Here, the delay caused by the discovery misconduct could be ameliorated by an amended case management order.

But that is not to say that the defendants escaped unscathed . . .

4)            Forensic examinations of electronic devices are the exception, not the rule

The plaintiff also sought a forensic examination of the defendants’ electronic devices as a sanction for the discovery misconduct. Normally, a party is obligated to conduct a search of its own electronic devices and then produce documents that are in its possession, custody, or control. But sometimes a court can sanction a party with a more thorough examination conducted by forensic experts. This examination involves creating a mirror image of the device and therefore allows the experts (and perhaps the opposing party) to access all information on the device—including deleted information.

Given the breadth of this type of examination, courts do not impose such a sanction as a matter of course. Indeed, the Red Valve court reminded practitioners that “mere skepticism that an opposing party has not produced all relevant information is not sufficient to warrant drastic electronic discovery measures.”  Nevertheless, Judge Bledsoe granted the plaintiff’s request based on the specific circumstances before him—including a) the devices contained information related to the heart of the dispute, b) it appeared that the defendants had not produced all information from those devices, and c) the plaintiff offered evidence tending to show that the defendants had manipulated and/or destroyed evidence.

This is a burgeoning area of North Carolina law, as evidenced by the court’s reliance on federal district court decisions.  Currently there are no state appellate opinions addressing the propriety of such a sanction.

 

 

 

The Business Court considers a variety of claims arising out of a family campground business in Bohn v. Black, 2019 NCBC 34.


The Black Forest Family Camping Resort, Inc., a family business, was supposed to be a place where campers in Transylvania County could come to spend time with their families. It operated for over 20 years until one day the Black Family experienced a rift, causing the filing of this lawsuit in the North Carolina Business Court. Judge Conrad considered a variety of claims at summary judgment involving the break-up of a family business that operated with no formal contracts and communal family fund.

A takeaway: The Court was looking for more business formality to substantiate the plaintiffs’ claims rather than personal relationships.

In 1992, Judith Black and her late husband moved to Transylvania County to open a campground as a family business. The family members that operated the business were Judith, her three daughters – Jeanne, Nancy, and Laurie – and their spouses. Judith allegedly promised the other family members that they could be co-owners of the business with her. In reliance on this promise, the family members worked for the family campground without pay for a number of years. The family members also contributed financially to an account controlled solely by Judith and used for family and campground expenditures (“family general fund”).

The family campground operated as an unincorporated business from 1995 until 2004 when Judith incorporated the business. Judith is the corporation’s only officer and shareholder and the real property on which the campground sits is in Judith’s name only.

The plaintiffs, Laurie and her husband Matt Bohn, allege they were integral in the operation of the campground, including working nights and weekends without pay. They also lived on the campground property in a modular home, which according to the plaintiffs, was a promise that Judith made to induce them to live and work there. There is a question as to whether the funds from the family general fund were used to pay for the house.

In 2016, the plaintiffs had a falling out with Judith and the rest of the family when the family allegedly issued an ultimatum: either Matt would agree to turn over his expected Social Security benefits to the family general fund or the Bohns would be forced to lose their home and leave the campground. The plaintiffs refused.   In May 2017, Judith sent a letter demanding rent and stating that she intended to block the Bohns from accessing their home. Litigation resulted when Laurie and Matt Bohn, plaintiffs, sued Judith, other members of Laurie’s family, and the Black Forest Family Camping Resort, the defendants. The complaint alleged the following causes of action: breach of fiduciary duty, undue influence, unjust enrichment, equitable estoppel, breaches of contract, de facto partnership, and declaratory judgment. The plaintiffs sought ownership of the home, one-quarter of the campground business, and the real estate associated with both. The Court considered this case on cross motions for summary judgment.

De Facto Partnership: the plaintiffs argue that the campground business is a partnership based on Judith’s alleged promise that each of her daughters would be co-owners of the campground. In considering this issue, the Court held that even though no formal agreement is required for a partnership, co-ownership and the sharing of any actual profits are indispensable requisites for a partnership. The Court held that the indispensable requisite of co-ownership of the business is lacking – the campground business is a formally organized corporation and not a partnership, Judith is the sole shareholder of the business, no one filed a state or federal income tax return identifying the campground as a partnership, Laurie never reported income of any kind from the campground on her tax returns, Laurie never exercised independent judgment or control over the campground business, and Laurie never controlled the money of the campground business. Therefore, the Court granted summary judgment in favor of the defendants.

Breach of fiduciary duty: As the Court explained, “The relationship between Judith, her children, and the campground defies easy definition.” Therefore, a jury should decide whether a fiduciary relationship existed and whether it was breached. The Court also questioned whether the plaintiffs could provide any damages as a result of an alleged breach and whether the statute of limitations would bar this claim. Thus, the Court denied both motions for summary judgment.

Undue influence: the plaintiffs argue that Judith used her strong will and intimidation to coerce them into paying her large sums of money over the past two decades. The Court held that the key to proving undue influence is showing that the victim is in a physical or mental state that renders him or her subject to the coercive influence of another. Here, the Court did not find the plaintiffs, who were college graduates with multiple jobs outside of the campground, as physically or mentally weak. The Court again granted defendants’ motion for summary judgment.

Equitable estoppel: the Court held that North Carolina does not recognize equitable estoppel as an affirmative cause of action so summary judgment was granted in favor of defendants.

Unjust Enrichment: the plaintiffs base this claim on the fact that they worked at the campground without pay and contributed financially to the business. The key with an unjust enrichment claim is that the evidence must show that the property or benefits were conferred on a defendant under circumstances which give rise to a legal or equitable obligation on the part of the defendant to account for the benefits owed. The Court held that the allegation that Judith induced the plaintiffs to improve her land and business was sufficient to withstand summary judgment.

Contract claims: the plaintiffs allege that they loaned Judith money for the campground, which she admitted she failed to repay in her deposition. The Court denied summary judgment for the plaintiffs because the loans were given without specifying a time for repayment. The plaintiffs also allege that Judith promised to provide two vehicles in exchange for labor and money to the campground. The Court denied defendants’ motion for summary judgment.

In addition to the rulings mentioned above, the Court denied summary judgment on the plaintiffs’ request for a declaratory judgment additional remedies, including a request for an accounting, receivership, a constructive trust, and a permanent injunction. The resolution of these requests in large part depends on the resolution of the unjust enrichment claim, so the Court denied the summary judgment motions.

N.C. Business Court Grants a Stay Pending Appeal, but Isn’t Convinced it Will Matter.


In Vizant Technologies, LLC v. YRC Worldwide Inc., 2019 NCBC 15 (N.C. Super Mar. 1, 2019), Judge Bledsoe granted a motion for stay pending appeal of an interlocutory order under N.C. Gen. Stat. § 1-294 after identifying an infrequently sighted legal bird: a substantial right that will be adversely affected.  See Order and Opinion.  A party’s first sign that the victory may be short-lived? The Business Court’s contemporaneously stated forecast that the “chance of success on appeal appears slim.” The case involved a long-running dispute about the payment of fees under a Professional Services Agreement, and the manner of establishing and proving a contracting party’s damages. At issue were discretionary stays under Appellate Rule 8 and appealing interlocutory orders under the substantial right doctrine.

Takeaways:

  • The Business Court values the efficiency of single proceedings that avoid having multiple juries hear “overlapping factual questions” common to multiple parts of a party’s claim.
     
  • The Court doesn’t shy away from telling a party it’s won a “technical” victory that it believes won’t ultimately carry the day.

In two earlier summary judgment orders, the Court laid the groundwork for the issues that would later animate the stay pending appeal dispute. Those orders decided closely related issues about the proof required for Vizant to show that it deserved a fee related to certain cost reduction strategies it suggested to YRC. In the first order, the Court excluded expert testimony that failed to demonstrate that cost reductions YRC experienced were related to Vizant’s advice. ¶12. In the second order, the Court took the next step and, under Kansas law, found that Vizant could not demonstrate damages that were appropriately linked to recommendations it had afforded to YRC. ¶18.

In considering whether to grant a discretionary stay under Appellate Rule 8, which requires first resort to the trial court, the Court relied on a previous determination that it should “focus on the potential prejudice to the appellant” in deciding such a stay request. See Rutherford Elec. Membership Corp. v. Time Warner Entm’t/Advance-Newhouse P’ship, 2014 NCBC LEXIS, at *9-10 (N.C. Super. Ct. July 25, 2014). The Court determined that the risk to Vizant of prejudice by denial of a discretionary stay was “slight,” based on Vizant’s key appellate contentions that the Court had rendered inconsistent summary judgment orders, and misunderstood the law regarding the causal connection required to prove Vizant’s damages. ¶¶ 22-23. Upon a re-examination of the evidence that underlied the summary judgment orders, the Court concluded that the North Carolina Supreme Court was unlikely to reject the Court’s analysis regarding the causal links found lacking in Vizant’s expert testimony and its damages presentation. ¶42.

The Court took a more nuanced approach to whether Vizant deserved a stay under the substantial right doctrine. While conceding that a party’s mere preference to have all claims or issues “determined during the course of a single proceeding” didn’t invoke a substantial right (see Hamilton v. Mortg. Info. Servs., 212 N.C. App. 73, 79, 711 S.E.2d 185, 190 (2011)), the Court balked at requiring Vizant to potentially litigate a claim ripe for trial and then potentially relitigate in a possible second trial – if its appeal succeeded – matters that would “substantially overlap” with evidence from the first trial. ¶50. The Court conceded Vizant found itself in a “novel position” where it could face two trials, “with substantially the same factual issues,” in the unlikely event that its appeal was successful. ¶55.

Thus, while the Court readily labeled the chances of success on appeal for Vizant as “slim,” and its risk of prejudice “slight” if a stay was denied, it nonetheless identified a conceivable scenario under which “unresolved and overlapping factual questions” could create inconsistent verdicts that merited a substantial right finding. ¶63.

 

Brad Risinger is a partner in the Raleigh office of Fox Rothschild LLP. He maintains a commercial litigation practice that frequently involves business disputes before the North Carolina Business Court, and the state’s federal and state trial courts.

When one business buys another business, the buyer might assume that it’s just stepping into the shoes of the purchased entity, especially as to employees that stay on. But a recent opinion from Judge Conrad reminds employers that this isn’t always the case. To play it safe, a successor business needs to have retained employees sign new employment agreements.

In Addison Whitney, LLC v. Cashion, the successor business didn’t play it safe. Employees had signed agreements making clear that trademarks, ideas, and work product that the employees created during their employment belonged to their employer. The employer was then purchased by a new business through an asset purchase, but the successor business didn’t have the retained employees sign new work-product agreements.

The consequences of that decision sat dormant for a decade. Then, a group of employees who had signed work-product agreements with the old entity departed to set up a competitor. The successor-employer then sued the departing employees, alleging that the employees were in breach of the work-product agreement because they took with them work product that they had created for the successor-employer.

The employees filed a motion to dismiss, arguing that they didn’t have any work-product agreement with the successor business. So what rights, if any, did the successor have in the old work-product agreements?

Judge Conrad emphasized that the question turned on the nature of the change in corporate form. The business had changed through an asset purchase rather than some other change in corporate form (like a merger). The asset purchase implicated two employment principles:

  • The asset purchase terminated all existing employment relationships in existence at the time of the purchase.
  • Any employee that was retained entered into a new employment relationship with the purchasing business.

These principles meant that the work-product agreements themselves were terminated by the asset purchase. The successor business didn’t step into the shoes of the old business. Instead, the successor business only got whatever rights the old business had in the terminated work-product agreements.

In this case, that made all the difference for the employer’s claims. The work product at issue was all generated after the asset purchase. The old work-product agreements simply had nothing to say about work product generated by the employees for the successor business. As Judge Conrad put it, the successor business “obtained the right” to enforce the work-product agreements “as to work product created while” the employees were employed by the purchased business. But the successor business “did not obtain the right to enforce” the work-product agreements for issues related to the employees’ “distinct, subsequent employment” by the new employer.

Judge Conrad’s straightforward opinion doesn’t break new ground, but it does give businesses a good reminder. When you purchase a new business, check whether you need to re-up the employment agreements for employees that stay on board.

In a much-watched case, the Supreme Court affirmed the decision of the Business Court in Sykes v. Health Network Solutions. The case was being watched mostly for its analysis of pure, state-law antitrust claims, but the Court evenly divided on that issue, leaving the Business Court’s dismissal standing. In exchange for that disappointment, the Court offered a surprise: its first foray into the learned-profession exemption in section 75-1.1.

You can check out more analysis of Sykes  and the learned-profession exemption at my post on the North Carolina Appellate Practice Blog.  I’m a little biased, but both our blogs are worth the free subscription.

N.C. Supreme Court Amends N.C. Business Court Rules.


On June 11th, the Supreme Court of North Carolina issued an Order Amending the Rules of the N.C. Business Court pursuant to its supplemental rule-making authority under N.C.G.S. § 7A-34.  See Order Amending the North Carolina Business Court Rules.  The Business Court Rules govern all civil actions designated as mandatory complex business cases and those cases assigned to a Business Court Judge under Rule 2.1 of the General Rules of Practice. The revisions impact all 16 of the Business Court’s Rules and each appendix in the rules set. These rules become effective July 1, 2019.  Most of the rule changes are cosmetic, or serve to update citations to applicable statutes. Some of the changes will keep the Court better apprised of case status and parties’ intent. Two new rules are of particular note: an amicus curiae can brief matters with leave of court; and junior attorneys are encouraged to draw near and be heard.  The significant changes are described below.

Rule 2. Mandatory Business Court Designation

  • BCR 2.5. Designation under N.C.G.S. § 7A-45.4(a)(9).   Amended BCR 2.5 adds an administrative requirement and, wisely, provides an extension of time for a designating party to obtain consent to file a qualifying contract matter at the Business Court.

N.C.G.S. § 7A-45.4(a)(9) governs Business Court designation for contract disputes when a claimant asserts a breach of contract claim or seeks a declaration of rights under a contract; the amount in controversy is at least $1 million; at least one plaintiff and at least one defendant is a corporation, partnership, or limited liability company, including any entity authorized to transact business in North Carolina; and all parties consent to the designation.

    • Current BCR 2.5 gives a designating party time to seek the consent of all the parties in the case.  When there is lack of consent from all parties at the time the pleading supporting designation is filed, the designating party has to file a Conditional Notice of Designation and seek consent.
    • Amended BCR 2.5 retains the conditional notice requirement and further requires the Conditional Notice of Designation to be served by e-mail as if it were a standard Notice of Designation.
    • Current BCR 2.5 gives the designating party 30 days after service to file a supplement to the Conditional Notice of Designation reflecting the required consent by all parties.
    • Amended BCR 2.5 retains the 30-day deadline, but expressly allows the Court to extend the time period to file a supplement upon “a motion or its own initiative, and for good cause shown[.]”
  • BCR 2.6. Procedure upon remand from federal court.  BCR 2.6 is a new rule. It requires that the parties file a status report within 14 days upon a case’s remand from federal court.
  • BCR 2.7. Procedure following entry of stay.BCR 2.7 is a new rule. It requires that the parties file a status report within 14 days after a case is resolved through arbitration or bankruptcy.

Rule 3. Filing and Service

  • BCR 3.10. Procedure when the electronic-filing system appears to fail.  The Amended BCR 3.10 provides additional guidance for voluminous filings.
    • Current BCR 3.10 provides parties a means to file documents with the Court when technical glitches hamper the electronic filing effort.
    • Amended BCR 3.10 retains the same procedure, but adds an additional mechanism to assist with voluminous filings even before the parties experience difficulty.  If the parties anticipate or experience difficulties with large filings using the Court’s electronic filing system, the Court will work with the parties on an alternative method of filing, such as a cloud-based file-sharing system.  Parties should contact the presiding Judge’s judicial assistant when they anticipate a need for assistance.

Rule 4. Time 

  • BCR 4.1. Motions to extend time periods.  Rule 4.1(c) has always provided an automatic grace period following a motion for an extension of time.  The Amended Rule 4.1(c) makes clear that judicial grace has limits.
    •  Current BCR 4.1(c) states: “The filing of a motion to extend time automatically extends the time for filing or the performance of the act for which the extension is sought until the earlier of the expiration of the extension requested or a ruling by the Court.”
    • Amended BCR 4.1(c) makes clear that the grace period only applies to “timely” motions and does not apply to deadlines set by court order, including the deadline for completion of fact and expert discovery.

Rule 6. Hearings and Conduct

  • BCR 6.5. Participation of junior attorneys.  BCR 6.5 is a new rule. It encourages the participation of junior attorneys at oral argument.

  • BCR 6.6. Secure leave.  BCR 6.6 is a new rule. It requires attorneys to e-file designations of secure leave periods in each case in which the attorney is counsel of record.

 Rule 7. Motions

  • Rule 7.3. Consultation.  Amended BCR 7.3 adds a requirement for parties to inform the Court about whether the opposition will file a response to certain motions. If the Court knows not to anticipate a response, presumably, it can respond with greater efficiency.
    • Current BCR 7.3 requires consultation with the opposition for all motions except motions to dismiss and motions for default judgment, summary judgment, new trials, judgment amendments, relief from judgments, and injunctions. The motion must reflect the consultation with and the position of the opposition.
    • Amended BCR 7.3 requires the movant to state whether the opposing party intends to file a response.
  • Rule 7.5. Supporting materials and citations.  Parties are no longer required to file copies of the Business Court’s own published decisions.

    • Current BCR 7.5 requires parties to attach copies of the decisions cited in their briefs and motions that are published in sources other than the West Federal Reporter System, Lexis System, commonly used electronic databases such as Westlaw or LexisNexis, or the official North Carolina reporters.
    • Amended BCR 7.5 adds the decisions of the Business Court to the above list.
  • Rule 7.10. Motions that do not require briefs.  The Amended BCR 7.10 adds motions to seal confidential information to the list of motions that do not require a supporting brief.
  • Rule 7.14. Amicus Briefs.  BCR 7.14 is a new rule that allows an amicus curiae to file briefs.  An amicus curiae must file a motion requesting leave to file a brief, and must attach the proposed brief to the motion. The brief is limited to 3,750 words.  An amicus curiae cannot participate in oral argument without leave of Court.

 Rule 10. Discovery

  • Rule 10.9. Discovery Motions. The Amended BCR 10.9(b) stresses, again, that before a party files a discovery motion, the parties must confer.  They must engage in a “thorough, good-faith attempt to resolve or narrow the dispute.”

N.C. Business Court weighs in on a breach of contract action involving a wine bottle opener manufacturer and alleged counterfeiters.


How does one open a wine bottle clogged by an old half-crumbled cork? Plaintiff may have the solution, but since we’re in the business court, there is obviously a snag.

In Wining Taylors, LLC v. CE Precision, Inc. and Yuan Wang, 2019 NCBC 25 (N.C. Super. Ct. Apr. 5, 2019), Judge Conrad granted plaintiff’s summary judgment motion with respect to its conversion claim but denied it with respect to its claims for breach of contract, trademark infringement, and unfair and deceptive trade practices.

A takeaway: “Seesaw negotiations” through emails, rather than a formal purchase agreement, do not bode well for establishing at summary judgment that there was a meeting of the minds between the parties on the issues of whether the defendants produced goods that met quality standards or whether defendants agreed to not use patented and proprietary materials.

We all know the story too well in the business community. An American entrepreneur comes up with the latest and greatest idea and wants to sell it to the masses. The only problem? Manufacturing, and manufacturing for less. What is the only logical next step? To find component parts at a cheaper price. But as the plaintiff learned in this case, proceeding to China without a formal written agreement defining acceptable quality standards can lead to low quality products, and even worse, counterfeiting.

Wining Taylors, LLC, Plaintiff in this action, trademarked and sold a device called “the Durand,” which is used to extract stops or corks from wine bottles. The device specializes in removing compromised or fragile corks from older wine bottles. Plaintiff retained a Chinese company, Defendants, to manufacture component parts – a handle, a retainer, a twin blade, a stabilizer, and a corkscrew.

There was no formal purchase agreement between the parties; only a series of emails establishing the price per kit of component parts. It was undisputed that 20,000 kits were ordered for $4.31 per kit and that Plaintiff paid a deposit. It is less clear from the emails as to the other terms of the agreement, such as who would pay for the mold inserts or how the parties intended to allocate the costs of retooling. Notably absent was any discussion about the level of quality expected for the kits. Even though the UCC requires that goods be fit for a particular purpose, there was not enough evidence in the emails to establish whether baseline quality standards were met.

When Plaintiff received the samples, the parts had such poor die cast finishing that Plaintiff cancelled the agreement. By that point, defendant had already produced 2,000 kits. The cancellation of the order resulted in multiple months of negotiations between the parties. Plaintiff demanded a refund and a return of all of its property, including all faulty kits, molds, dies, and specifications. Defendants acknowledged that some refund was needed but it intended to keep some of the tooling because someone in China wanted to buy it. Plaintiff even submitted evidence that counterfeit versions of the Durand were being sold in China and on the internet and that Chinese authorities confiscated thousands of knock-off devices. Plaintiff alleged that Defendants were the source of the counterfeiting.

Plaintiff moved for summary judgment as to all claims but was only successful on its conversion claim. Plaintiff lost on the remaining claims because there was an issue of fact as to whether the parties’ negotiations resulted in a binding agreement, and if they did, what the terms of the agreement were. In essence, there was no meeting of the minds. Furthermore, plaintiff lacked evidence that Defendants were the perpetrators of the counterfeiting activities. All plaintiff could establish was that Defendants threatened to sell its proprietary materials to someone in China, but it could not prove that Defendants actually did.

The Court cautioned that it was essential to the formation of a contract that there was a mutual assent of the parties so as to establish a meeting of the minds, and the parties’ “seesaw negotiations” created a genuine issue of material fact as to whether a binding agreement existed.