NC Supreme Court Reaffirms that Raising Funds from Outside Investors, Even Fraudulently, is not a “Business Activity” Subject to Unfair and Deceptive Trade Practice Scrutiny
The North Carolina Supreme Court ruled recently that a company’s allegedly fraudulent efforts to raise capital from outside investors can avoid sanction as an unfair or deceptive trade practice because the conduct is not undertaken “in or affecting commerce.” In Nobel v. Foxmoor Group, LLC, 2022-NCSC-10, the Court rejoined a debate in the state’s courts about when alleged wrongdoing is “confined within a single business” and thus does not impact “commerce” as required to make out a Chapter 75 claim.
These distinctions impact the already difficult-to-satisfy gateways to recovery under Chapter 75: (i) that a defendant committed an unfair or deceptive act or practice; (ii) where the conduct was “in or affecting commerce;” and (iii) is proximately linked to plaintiff’s injury. Dalton v. Camp, 353 N.C. 647, 656 (2001). Nobel found the defendants’ actions insufficient to meet this test on the premise that a “business entity’s acquisition of capital” is not a “business activity” that is “in or affecting commerce” because it focuses on conduct that is inside a corporate entity. Id. ¶¶ 14-15.
In Nobel, a retired friend of defendants Mark Griffis and Dave Robertson – who was not affiliated with Foxmoor – alleged she invested in the company relying on false representations, was warned that bankruptcy would ensue if she didn’t cease efforts to determine the fate of her investments, and later learned her capital had been diverted for personal uses such as cruise tickets, cosmetic surgery and a luxury hotel stay. Id. ¶¶ 19-20.
Given that some estimates peg start-up capital raised in 2021 in North America at $329 billion (up 92% from 2020), the Court’s holding that transactions “to provide and maintain adequate capital for [the] enterprise” are beyond the scope of Chapter 75 functionally walls off a large segment of the economy from scrutiny under unfair and deceptive conduct principles. Id. ¶ 13. Plus, in a business climate where around 90 percent of startups fail – approximately 50 percent of them in the first two years – much of the actual activity of those companies is centered around raising the money that would allow them to do something other than raising money.
It’s worth a look to figure out how we got here. As the Business Court has noted in recent cases we wrote about here and here, the animating principle behind this limitation on Chapter 75’s scope is to reinforce that “the Act is not focused on the internal conduct of the individuals within a single market participant, that is, within a single business.” Id. ¶ 15 (quoting White v. Thompson, 364 N.C. 47, 52 (2010)). In Nobel, the Supreme Court further paved a promising avenue for defendants’ efforts to avoid Chapter 75 claims by widening what conduct can be considered “internal” to the entity. The Court acknowledged that the defendants’ conduct “in securing the loans from [Nobel] may be morally suspect,” but that investments from a corporate outsider “concern[ed] the internal operations of Foxmoor.” Id. ¶¶ 14, 16. Even when, as the Court observed, some of the funds are diverted to outside, personal uses by corporate officers.
The narrow construct of Nobel necessarily relies on a constrained view of what comprises the “business activity” of a company. “Commerce,” under Chapter 75, “includes all business activities, however denominated[.]” N.C.G.S. § 75-1.1(b). But in an earlier case, the Supreme Court noted that “business activities” means “the manner in which businesses conduct their regular, day-to-day activities, or affairs, such as the purchase and sale of goods, or whatever other activities the business regularly engages in and for which it is organized.” HAJMM Co. v. House of Raeford Farms, Inc., 328 N.C. 578, 594 (1991). In HAJMM, “the issuance of corporate securities to raise capital was not a business activity deemed to be ‘in or affecting commerce,'” but instead an inside-baseball type corporate transaction. NCSC-10, ¶ 12. Relying on HAJMM, the Court in Nobel reasoned that soliciting investment capital from unsophisticated, individual investors should be treated similarly.
Nobel reaches the awkward result that startups which regularly engage in the life-or-death struggle for capital act outside the purview of Chapter 75 because using “financial mechanisms for capitalization merely enable an entity to organize or continue ongoing business activities in which it is regularly engaged.” Id. In a fulsome dissent, Justice Earls issue spotted the tension generated by holding harmless corporate actors who may often raise money for no other purpose than raising money:
[T]here is no evidence Foxmoor had any ‘business purpose’ or ‘day-to-day activities’ other than the ‘acquisition of capital’ from people like Nobel. To the extent Foxmoor did sell a product or service to the public, it appears to have been the (ultimately illusory) opportunity to own an income-generating asset.
Id. ¶ 27. In a tip of the cap across the judicial aisle, the dissent notes former Chief Justice Mark Martin asked a similar question when he filed a “vigorous dissent” in HAJMM (¶ 25):
“How can raising funds to operate a business not be a business activity?”
- The practical endgame of Nobel is that making widgets is a “business activity” but raising funds from those outside the company is unregulated by Chapter 75 because it merely affords a company the opportunity to make widgets.
Brad Risinger is a partner in the Raleigh office of Fox Rothschild LLP.