The Business Court tentatively waded back into its well-settled case law that tends to scold litigants who try to convert internal company disputes into unfair trade practice claims in Constr. Managers, Inc. v. Amory, 2019 NCBC 31, 2019 WL 2167311 (N.C. Super. Ct. May 17, 2019). In doing so, the Court denied much of the defendant’s motion to dismiss the Amended Complaint. See Order and Opinion.

Takeaways:

  • The Business Court still thinks that a Chapter 75 claim is not the right vehicle for addressing shareholder disputes, disagreements among company members and other issues of internal management or strife.
  • The Court is likely to continue its vigilance policing Chapter 75 counts so that cases are not unnecessarily burdened by illusory claims that threaten great damages.
  • Only limited factual allegations that allege events beyond the confines of a single market participant may be needed to meet the “in or affecting commerce” standard.

The defendant provided accounting and bookkeeping functions for an integrated set of plaintiffs that were in the business of building, leasing, and managing clinics for the U.S. Department of Veterans Affairs. Id. at ¶¶ 2-3, 13. Before leaving to join a construction consulting firm, the Amended Complaint alleges Amory downloaded a raft of confidential and trade secret information and emailed some to one of plaintiffs’ former employees. Id. at ¶¶ 15, 17-18.

Plaintiffs’ claim under N.C. Gen. Stat. § 75-1.1 led the court to confront an issue it has addressed repeatedly in the last several years: is the conduct alleged “in or affecting commerce,” as required by the statute, or is it an “intra-company feud about internal operations” for which there is other, more appropriate legal recourse. Brewster v. Powell Bail Bonding, Inc., 2018 NCBC 74, 2018 WL 3603023, at *6 (N.C. Super. Ct. July 26, 2018) (Judge Conrad). See Order and Opinion. Construction Managers, Brewster and a host of other Business Court opinions have examined the issue within the North Carolina Supreme Court’s guidance in White v. Thompson, 691 S.E.2d 676, 679-680 (N.C. 2010) that § 75-1.1 regulates “a business’s regular interactions with other market participants” and not the “internal conduct of individuals within a single market participant.”

Plaintiffs complained that Amory was using their trade secrets to compete against them, but failed to describe how he was competing, and failed to assert that Amory had disclosed trade secrets to his new employer. Construction Managers, at ¶ 80. Moreover, plaintiffs essentially conceded that their fears about improper competition were prospective. Amory, plaintiffs claimed, “could begin to unfairly compete” with them, and was “preparing to cause” them significant damages by using the illegally obtained information. Id. at ¶ 81. The Court even found that plaintiffs’ general allegations of competition didn’t allege specific facts that were sufficient, under White, to remove it from fact patterns “contained solely within a single business.” Id. at ¶ 82.

Yet, the Court “reluctantly conclude[d]” that as a matter of notice pleading, the Chapter 75 claim survived a motion to dismiss because it was “barely sufficient to provide Amory with sufficient notice of the nature of the claim to withstand Amory’s motion to dismiss.” Id. at ¶ 83. Thus, the Court held that it was sufficient under Chapter 75 for the plaintiffs to claim – generally – that Amory was unfairly competing against them, without alleging facts regarding any of “the events or transactions which produced the claim to enable the adverse party to understand the nature of it and the basis for it[.]” Spoor v. Barth, 811 S.E.2d 609, 612 (N.C. Ct. App. 2018).

Construction Managers is a tenuous fit in the Business Court’s “in or affecting commerce” jurisprudence. The Court has regularly dismissed Chapter 75 claims that purport to center on shareholder disputes, disagreements among company members and other issues of internal management or strife. Conflating these events into unfair trade practice claims is, the Court has held, “a regrettable trend in North Carolina business litigation.” Brewster, 2018 WL 3603023 at *6. Indeed, the Court has gone out of its way to intentionally put a fine a point on the point:

By now, the message should be clear: section 75-1.1 plays no role in resolving these internal corporate disputes. Yet time and time again, section 75-1.1 appears where it does not belong, with consequences that are significant and unhealthy. The routine addition of section 75-1.1 claims in these cases invites avoidable motion practice – driving up the cost of litigation, taxing the resources of the Court, and exposing the plaintiff to a potential award of attorney fees under section 75-16.1. It also impedes settlement discussions by introducing remedies (including treble damages) that would otherwise be unavailable, thereby distorting the parties’ incentives and their perceived risks.

Id. at *7. Construction Managers cites the letter of the Court’s Chapter 75 doctrine on the types of claims it feels are within the statute, but slightly disclaims its spirit. Here, the barest pleading nudge by the plaintiffs – unsupported by facts regarding defendant Amory’s purported competition against them – was enough to survive characterization as an “internal business matter” that would doom an unfair trade practice claim. It’s by no means a Chapter 75 doctrinal sea change for the Court, but it foretells a decision or two down the line that address attempts to salvage wounded claims with the “notice pleading” life raft extended in Construction Managers.

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 Two Contract Claims on Summary Judgment for Lack of Mutuality


In separate cases, the North Carolina Business Court answers the question: When exactly is a contract formed?  The Court reminds business leaders that parties do not form an enforceable agreement until their minds meet on all the material terms.

In Denver Property Partners, LLC v. Sisson, 2019 NCBC 22 (N.C. Super. Ct. Apr. 1, 2019), Judge Robinson granted the Defendants’ motion for partial summary judgment on the Plaintiffs’ breach of contract claim.  See Order and Opinion.

In Hocutt v. Hocutt, 2019 NCBC 24 (N.C. Super. Ct. Apr. 4, 2019), Judge McGuire denied a Defendant’s motion to enforce a settlement agreement allegedly formed prior to the action’s filing.  See Order and Opinion.

Denver Property Partners, LLC v. Sisson

In Denver Property Partners, the Plaintiffs claimed the Defendants breached an agreement to purchase an indoor shooting range and firearms retail store. The Defendants argued the parties never formed an accord. The Court agreed.

The facts in the light most favorable to the Plaintiffs showed the following:  The Plaintiffs and Defendant Mr. Sisson entered into an agreement whereby Mr. Sisson would manage the range and store and would undertake due diligence to determine whether to purchase them.  Thereafter, the  parties began negotiations for the purchase:

  • Mr. Sisson emailed the Plaintiffs’ agent, attaching a signed purchase agreement that he called a “draft.”  He invited the Plaintiffs to sign it.
  • The Plaintiffs’ agent responded, telling Mr. Sisson to add the effective date of the agreement and to add two related parties as sellers.
  • Mr. Sisson replied, telling the Plaintiffs’ agent to modify the purchase agreement as needed.

The parties engaged in no further negotiations.

Two months later, Mr. Sisson informed the Plaintiffs he wanted out. He would neither purchase the businesses, nor manage them. Litigation ensued.

In granting Mr. Sisson’s motion for partial summary judgment, Judge Robinson cited Normile v. Miller, 313 N.C. 98, 103 (1985), for the general rule that new terms added by acceptance operate as a counteroffer and a rejection of the original offer.  He determined that the first Sisson email was an offer.  The agent’s response was a counteroffer (and a rejection).  Sisson’s reply was an invitation to the Plaintiffs to make an additional offer.

Neither party ever accepted the other’s terms. There was no contract.

Hocutt v. Hocutt

In Hocutt v. Hocutt, Judge McGuire denied a Defendant’s motion to enforce a settlement agreement allegedly formed prior to the action’s filing. He treated the motion as one for summary judgment.

This case arose from “a long-simmering dispute” over control of three closely-held corporations among Plaintiff Joey Hocutt; his father, Defendant Mike Hocutt; and his brother, Defendant Jay Hocutt.  In an attempt to resolve their conflict, the family engaged counsel, who met without their clients to discuss a framework for settlement. Counsel circulated unsigned draft agreements to their respective clients to work toward resolution. Defendants Mike and Jay accepted the terms of a final draft, but Joey did not. Joey offered additional terms, which the Defendants rejected. Joey filed this action.

Defendant Mike filed a motion to enforce the settlement agreement. He argued that an agreement existed because Joey’s attorney circulated it, and each Defendant signed it. Yet, he provided no evidence that the final draft was a formal offer. To the contrary, Defendant Mike admitted that Joey refused to sign the final draft and that Joey’s attorney communicated Joey’s rejection of it.

Judge McGuire denied the motion to enforce.  He cited Chappell v. Roth, 353 N.C. 690, 692 (2001), for the rule that a valid contract requires a meeting of the minds as to all material terms.  “If any portion of the proposed terms is not settled, or no mode agreed on by which they may be settled, there is no agreement.” Chappell, 353 N.C. at 692.

Going even further, the Court cautioned the motion was “close to frivolous, and that undisputed facts arguably would entitle Plaintiff to judgment as a matter of law” rather than Defendant Mike.

In a series of recent opinions in Justice v. Mission Hospital, Inc., the Business Court dismissed claims that MedPay benefits were improperly routed to a treating hospital, dismissed the appeal of the dismissal, and dismissed the appeal of the dismissal of the appeal. First, the Court dismissed a purported class action on behalf of the Plaintiffs who complained that the medical payments coverage (“MedPay”) under their automobile insurance policy was improperly directed to the hospital where they were treated, rather than to them. See 2019 NCBC 21 (N.C. Super. Ct. Mar. 27, 2019). Second ,after the Plaintiffs directed their Notice of Appeal to the Court of Appeals instead of the North Carolina Supreme Court (as required by statute), the Court reluctantly reaffirmed its 2018 ruling in a similarly postured case that a trial court does not have authority to address such a jurisdictional defect. The Plaintiffs’ misdirected appeal was dismissed, with their only recourse to seek discretionary review from the Supreme Court. See 2019 NCBC 36 (N.C. Super. Ct. Jun. 5, 2019).  Third, Plaintiffs timely appealed the Court’s dismissal of its first appeal, and the Business Court dismissed it, too, finding that the Court of Appeals was not vested with jurisdiction in such circumstance.  See 19 NCBC 52 (N.C. Super. Ct. Aug. 21, 2019).

Takeaways:

  • The Business Court holds that MedPay benefits may appropriately be considered “health insurance” and can be assigned to a treating entity.
  • The Business Court reaffirmed that clients and counsel need to be vigilant about directing appeals to the North Carolina Supreme Court in cases filed after October 1, 2014.

Plaintiffs were involved in an automobile accident, and were brought to defendant Mission Hospital for treatment. 19 NCBC 21 at ¶7. As part of a Consent to Treatment/Financial Agreement executed contemporaneously with treatment, the Plaintiffs assigned all “liability and health insurance benefits” to the provider. Id. at ¶10. The carrier paid out three checks to the provider constituting the limits of the subject MedPay. Id. at ¶14. The Plaintiffs objected that these payments were made without them being consulted. Even if their obligations to the provider exceeded the MedPay, Plaintiffs felt the money was theirs to control and pay out, if they chose, at their discretion. Id. at ¶30.

The Court ruled that the MedPay benefits were “unambiguously” assigned under the agreement executed by the Plaintiffs. Id. at ¶35. The Court was unable to conclude that MedPay could be considered “liability insurance” under the Agreement, but it had no trouble deciding that it was “clearly and unambiguously” considered “health insurance.” Id. at ¶41. As the Court noted, “MedPay coverage is first-party coverage where one seeks to provide coverage for injury irrespective of fault and liability.” Id.

Plaintiffs also contended they could not assign their MedPay payments because of an anti-assignment clause in their policy with the insurance carrier. The Court noted this was an issue of first impression in North Carolina as it related to MedPay. Id. at ¶49. The Court dismissed the challenge because such clauses are interpreted to benefit the carrier, and do not prevent assignments after a loss has occurred. Id.

The Court did not tread new ground in dismissing Plaintiffs’ misdirected appeal. Indeed, it took “no pleasure in doing so.” 19 NCBC 36 at ¶19. But, N.C. Gen. Stat. § 7A-27(a)(2) requires appeals from final judgments in cases designated as a mandatory complex business case to be directed to the North Carolina Supreme Court, not the Court of Appeals. Judge Gale did the analytical work on the issue the previous year in Zloop, Inc. v. Parker Poe Adams & Bernstein. See 2018 NCBC 39 (N.C. Super. Ct. Apr. 30, 2018). Citing his opinion in Zloop, Inc., Judge Gale put it frankly: “The Court here again concludes it must dismiss the appeal, even though the jurisdictional defect was clearly inadvertent and the record would allow for no finding that Defendant was surprised as to the matter being appealed from or otherwise suffered prejudice.” 19 NCBC 36 at ¶2.

This issue has attracted attention and discussion in the state’s appellate Bar. Our colleagues at the North Carolina Appellate Practice Blog have discussed the application of Rule 3 of the North Carolina Rules of Appellate Procedure, if it should be amended, and whether the Notice of Appeal rule interpreted and applied in these cases is truly jurisdictional. See Zloops! Another Rule 3 Dismissal (June 6, 2019); When Is a Deadline or Other Requirement for Filing a Notice of Appeal Jurisdictional? (State Edition) (May 3, 2018).

Plaintiffs’ second appeal challenged whether the Court had the authority “to dismiss a second appeal that seeks appellate review of its earlier order dismissing a first appeal.” 19 NCBC 52 at ¶4. In an exchange worthy of a fancy flow chart:

  • Plaintiffs argued that App. Rule 25 only applies to instances of untimely appeal filings; and
  • The Business Court held that Court of Appeals cases deciding issues of untimely filings under App. Rule 25 compelled a finding that no appellate jurisdiction vests from a notice of appeal of an order dismissing an appeal.

Id. at ¶¶5-8. As in last year’s Zloop decision, the Court found that “where a record on appeal has not been filed, the trial court has power to dismiss a timely notice of appeal that is jurisdictionally defective.” Id. at ¶10.

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 All Counterclaims in a Dispute Stemming from a Failed Romance.


In Rabinowitz v. Suvillaga, 2019 NCBC 7 (N.C. Super. Jan. 28, 2019), Judge Robinson granted the Plaintiff’s motion to dismiss the Defendant’s counterclaims in an action involving an alleged agreement “predicated on the Defendant’s expectation” that the couple “would live together and remain in a relationship indefinitely.” Op. ⁋ 2. While the Court refused to dismiss the responsive pleading in its entirety, it did dismiss all of the counterclaims asserted therein, providing the Plaintiff with a significant win.  This unlikely Business Court case provides a trove of valuable nuggets for court watchers. See Order and Opinion.

Takeaways: 

  • A party may seek Business Court designation based on an opposing party’s amended pleading even when the amendment is filed in violation of a court order and even though the designating party seeks to strike it.
  • Neither Rule 12(b)(1), nor Rule 12(f), nor Rule 15(a) permits the Court to strike or dismiss an untimely amended pleading.
  • Rule 41(b) permits a court to dismiss counterclaims in a pleading for failure to comply with the Rules of Civil Procedure or a court order. This authority derives from the inherent power of the Court to manage its proceedings.
  • A trial court has discretion pursuant to Rule 41(b) to dismiss counterclaims with prejudice, but this action is imposed only when the Court determines less drastic sanctions are insufficient.
  • Contracts between parties in a romantic relationship can be enforced so long as illicit services do not provide consideration for that contract.
  • An indispensable element of the formation of a partnership is co-ownership of a business venture.
  • The Business Court requires negligent misrepresentation to be pled with particularity pursuant to Rule 9(b).
  • Equitable estoppel is a proper defense, but not a proper claim.

Allegations

Mr. Rabinowitz (Plaintiff) and Ms. Suvillaga (Defendant) carried on a romantic relationship for about ten years. They began a dating in Spring Valley, New York in 2006.  When Ms. Suvillaga got a job about two hours away, Mr. Rabinowitz purchased an apartment for Ms. Suvillaga to use.  Ms. Suvillaga paid for rent and utilities.

On weekends, Ms. Suvillaga would return to Spring Valley.  While there, she performed what she called “relationship duties”—cooking; cleaning; doing laundry; helping with Mr. Rabinowitz’s doctors’ appointments, medical problems, and hygienic needs; and engaging in a sexual relationship with Mr. Rabinowitz.

In 2015, Mr. Rabinowitz wanted to move to North Carolina. After the couple ventured to Wilmington to tour homes, Mr. Rabinowitz purchased one.  He allegedly told Ms. Suvillaga that after the move, she would not have to work again, she could live with him forever, and he would leave her money and the Wilmington property in his will. Ms. Suvillaga quit her job, and the couple moved south.  Ms. Suvillaga alleged that the parties “expressly formed a contract that obligated [them] to act as if they were married,” but, after the move, Mr. Rabinowitz ended the relationship abruptly.

Procedure

Mr. Rabinowitz filed the lawsuit in January 2017 for Ms. Suvillaga’s alleged failure to pay for her portion of the Wilmington house. He alleged breach of contract and various tort claims.

Ms. Suvillaga answered. Six months later, she moved to amend her response. In the amendment, she would reassert her answer and affirmative defenses and would add counterclaims including breach of contract, breach of a partnership agreement, negligent misrepresentation, and equitable estoppel. But, the motion was never calendared.

Later, Mr. Rabinowitz noticed his own motions for a hearing as well as Ms. Suvillaga’s motion to amend.  The Court granted Ms. Suvillaga’s motion to amend.  It ordered her to file the amended pleading within five days. She filed it over a month later.

Ten days after Ms. Suvillaga’s late filing, Mr. Rabinowitz filed a Notice of Designation to the Business Court based on the breach of partnership claim asserted in the untimely pleading. Once the Business Court had jurisdiction, Mr. Rabinowitz moved to dismiss the entire amended pleading pursuant to Rule 15(a) and all the counterclaims therein pursuant to Rule 12(b)(6).

Analysis

Rule 15(a)

Mr. Rabinowitz urged the Court to dismiss Ms. Suvillaga’s amendment because she violated Rule 15(a). Rule 15(a) requires that after a responsive pleading is served, a party may amend a pleading only with leave of court. Since Ms. Suvillaga filed her amendment outside the time allotted, Mr. Rabinowitz argued that she lacked the Court’s leave.

Ms. Suvillaga countered that Mr. Rabinowitz wholly relied on the amendment for its designation notice, thereby waiving his right to object it.

The Court found no merit in Ms. Suvillaga’s waiver argument. It held that Mr. Rabinowitz has “a statutory right to have [the] matter designated to the Business Court” without waiving “any right to dispute the validity of [the] counterclaims.” Op. ¶ 28 (citing N.C. Gen. Stat. 7A-45.4).

Then the Court considered Mr. Rabinowitz’s Rule 15(a) argument.  It determined the rule provides no authority to dismiss an untimely amendment. At Mr. Rabinowitz’s urging, the Court considered whether it could  dismiss for lack of subject matter jurisdiction under Rule 12(b)(1), or whether it could strike the pleading as “redundant, irrelevant, immaterial, impertinent, or scandalous” under Rule 12(f).  The court determined that Rule 12(b)(1) did not apply and Rule 12(f) did not permit the Court to strike Ms. Suvillaga’s amended pleading.

But … , what about Rule 41(b)?

Rule 41(b)

Rule 41(b) permits a court to dismiss counterclaims in a pleading for failure to comply with the N.C. Rules of Civil Procedure or any court order. Since Ms. Suvillaga violated Rule 15(a) (and the prior order) by filing the amendment late, the counterclaims were subject to dismissal under Rule 41(b). Judge Robinson noted that Mr. Rabinowitz did not move to dismiss pursuant to Rule 41(b), but the Court still had the power to do so. See, e.g., Plasman ex rel. Bolier & Co. v. Decca Furniture (USA), Inc., 811 S.E.2d 616 (N.C. Ct. App. 2018) (affirming dismissal under Rule 41(b) for a Rule 8(a) violation when the plaintiffs were on notice that defendants were seeking dismissal). The Court used its authority under Rule 41(b) to dismiss Ms. Suvillaga’s untimely amendment.

But … , would the dismissal be with or without prejudice?

Judge Robinson had discretion to dismiss with prejudice under Rule 41(b), but he noted the Court should do so only when less drastic sanctions are insufficient. Here, despite the “flagrant” rule violation, Judge Robinson determined that dismissal with prejudice was not warranted because counsel had neither engaged in repeated rule violations, nor did anything further to aggravate the Rule 15(a) violation. Op. ¶ 39.

Having found dismissal without prejudice appropriate on procedural grounds, Judge Robinson then considered the merits of Ms. Suvillaga’s individual claims.

Substantive Allegations

Pursuant to Rule 12(b)(6), Judge Robinson dismissed seven of Ms. Suvillaga’s eight counterclaims with prejudice and one without prejudice.

Breach of Contract

Ms. Suvillaga alleged that the parties contracted to act as if they were married, and they exchanged various promises related to that agreement. Mr. Rabinowitz argued the alleged contract is not recognized by North Carolina law. Ms. Suvillaga countered that the contract is enforceable because it is not based solely upon illicit services.

The Court stated that contracts between two people in a romantic relationship can be enforced “so long as illicit services do not provide consideration for that contract.” The Court distinguished cases where the parties had contracts related to activities independent from their relationship. Here, though, the alleged contract went to the very essence of the parties’ personal relationship. Accordingly, North Carolina law will not enforce it. Judge Robinson dismissed the claim with prejudice.

Breach of Partnership

Ms. Suvillaga alleged that the parties “formed an equal partnership both assuming equally responsible roles which included maintaining the household.”

An indispensable element to the formation of a partnership is co-ownership of a business venture. The amendment contained no allegations that the parties “participated in any business venture, let alone operated as co-owners of that business.” Op. ¶ 58. Thus, the claim could not satisfy “the elements minimally necessary to assert a valid breach of partnership counterclaim.” Op. ¶ 59. Judge Robinson apparently did not think much of the claim.  He dismissed it with prejudice.

Misrepresentation

Ms. Suvillaga alleged that Mr. Rabinowitz misrepresented that he would take care of her and help her pay off her debt. She did not specify whether Mr. Rabinowitz’s misrepresentation was fraudulent or negligent.

The Court did not quibble about the oversight.  It held that Ms. Suvillaga failed to properly allege either claim with the required particularity.  Op. ⁋ 61.  Rule 9(b) requires a claimant to plead “averments of fraud, duress, and mistake” with particularity.  But, the rule is silent as to negligent misrepresentation.  The Court cited another Business Court case, Deluca v. River Bluff Holdings II, LLC, 2015 NCBC LEXIS 12, at *20 (N.C. Super. Ct. Jan. 28, 2015) (Judge Gale), for the rule that negligent misrepresentation must meet the same pleading standard as fraud.  Deluca, in turn, cited an earlier Business Court case, BDM Invs. v. Lenhil, Inc., 2012 NCBC LEXIS 7, at *56 (N.C. Super. Ct. Jan. 18, 2012) (Judge Gale), and a case from the Middle District, Breedon v. Richmond Cmty. Coll., 171 F.R.D. 189, 199 (M.D.N.C. 1997) (holding the particularity requirements of Rule 9(b) of the Federal Rules of Civil Procedure apply to negligent misrepresentation to “more accurately comport[] with the basis behind the rule and its original rationale”).

In order to plead fraudulent or negligent misrepresentation with particularity, “one must allege (1) the time, place and content of the misrepresentation, (2) the identity of the person making the representation and (3) what was obtained as a result of the fraudulent acts or representations.”  Op. ⁋ 61.  “Additionally, the representation must be definite and specific, more than ‘mere puffing, guesses, or assertions of opinions’ but actual representations of material facts.” Id. (quoting Rowan County Bd. of Educ. v. U.S. Gypsum Co., 332 N.C. 1, 17, 418 S.E.2d 648, 659 (1992)).  Ms. Suvillaga failed to meet these requirements.  Thus, the Court dismissed the misrepresentation claim without prejudice.

Equitable Estoppel

Ms. Suvillaga pled equitable estoppel as a claim. The doctrine cannot be used as a sword, but only as a shield.  The Court dismissed the claim, but allowed Ms. Suvillaga’s corresponding defense to stand.

Ms. Suvillaga never filed a second amended complaint. The parties settled the matter shortly before a bench trial was to begin.

Thanks to Ashley Oldfield, Fox Rothschild summer associate, for her work on this post.

N.C. Business Court Declines to Impose Fiduciary Duties among Sibling Managers of an LLC and Declines to Extend Any “Control Group” Exception to LLCs, but allows Dissolution Claim to Survive, which Creates a Possible Ruling on Meiselman’s application to LLCs.


In Bennett v. Bennett, 2019 NCBC 18 (N.C. Super. Ct. Mar. 15, 2019), Judge Conrad considered a dispute between two groups of six siblings who are current or former members of family-owned real estate company. The case pits Plaintiffs Bert and Terry Bennett against four of their siblings, Defendants Graham, Ann, Jim, and Louise Bennett, for their alleged improper actions concerning Bennett Linville Farm, LLC (“Bennett Farm”), which the parties formed with their parents to facilitate the latter’s estate planning. The Court granted the controlling group’s motions to dismiss certain breach of fiduciary duty claims and constructive fraud claims, but denied the group’s motions to dismiss a claim for judicial dissolution.  See Order and Opinion.

Takeaways:

  • Infringement of an LLC member’s voting rights (including the right to elect managers and the residual right to vote in the absence of proper managers) is a distinct harm and supports a direct claim against fellow members.
  • Dilution of an LLC member’s relative ownership interest is a distinct harm to the member which can confer standing.
  • Judge Conrad held that a group of minority LLC members alleged to exercise control of the company did not owe fiduciary duties to minority members, and he is reluctant to grant such rights when minority members fail to include them in the operating agreement.
  • Judge Conrad did not dismiss an LLC member’s assertion of Meiselman claims in the LLC context because it would be “prudent” (at this juncture) to address the issue after discovery.

Allegations

Plaintiffs allege that  Defendants Graham, Ann, and Jim gained control of the company to the exclusion of the other sibling members and nearly all actions they took were unauthorized.  Plaintiffs assert direct claims against Defendants Graham, Ann, and Jim, alleging they conspired to control the company; that they fraudulently amended the operating agreement to consolidate their control; and that they engaged in unauthorized activity. Defendants Graham, Ann, and Jim moved to dismiss, challenging Plaintiffs’ standing and the merits of their claims. Plaintiffs dismissed their monetary demands against Louise, but kept her in the case as a necessary party.

Operating Agreement

For years, the siblings owned an equal share of Bennett Farm. The Plaintiffs alleged that the limited liability company was designed to be member managed. The original Operating Agreement, however, required management by certain managers listed on its Schedule II, or by others elected by the membership. Plaintiffs allege the Operating Agreement included no Schedule II when executed, and no managers were ever elected. They further allege that Defendants Graham and Ann were later listed on a document labeled as Schedule II, but without membership approval.

Amended Operating Agreement

Plaintiffs allege that in 2010, Defendants Graham, Ann, and Jim amended the Operating Agreement without the knowledge of the other members, and made significant changes. The Amended Operating Agreement:

  • designated Jim as a third manager,
  • authorized the managers to make capital calls without member consent, and
  • permitted Bennett Farm to redeem any member’s interest upon the consent of members owning at least 75% of the company.

While Plaintiffs acknowledged that they executed the signature page for the Amended Operating Agreement, they allege they did so without seeing the document and as a result of brother Graham’s trickery.

Transition

In 2012, the Bennett parents’ ownership interest in Bennett Farms passed to their children, leaving the six siblings in sole ownership. Thereafter, a seventh Bennett sibling (John) granted Bennett Farm a right of first refusal to his 35-acre tract at the request of Defendants Graham, Ann, and Jim. When he requested termination of the right, conflict erupted.

The Conflict

Plaintiffs Bert and Terry (together with Nominal Defendant Louise) claimed they knew nothing of Bennett Farm’s purported acquisition of brother John’s property right, but they would have granted it. Defendants Graham, Ann, and Jim disagreed and, “claiming managerial authority, decided to exercise and enforce the right of first refusal even in the absence of majority approval of the members.” Op. ⁋ 10.

Plaintiffs allege that Defendants Graham, Ann, and Jim used the controversy to force sister Plaintiff Terry out.  Graham allegedly informed Terry that she would have to make a capital contribution of over $100,000, or she could sell her interest to the other siblings. Terry alleges she could afford a capital contribution only with access to a trust fund, for which Defendant Ann served as trustee. Ann allegedly refused to assure Terry that she could dip into the fund for the contribution. Thereafter, Terry sold her interest to the five sibling owners remaining.

Nominal Defendant Louise (allegedly weary from the conflict) sold her ownership interest to the remaining sibling owners in 2018, giving Defendants Graham, Ann, and Jim a combined 80% of the company, and leaving Plaintiff Bert with the remaining 20%.

Analysis

Fiduciary Duty

Plaintiffs Bert and Terry alleged that Defendants Graham, Ann, and Jim breached their fiduciary duties to them as fellow LLC members. Defendants argue Plaintiffs lack standing and the claim lacks merit.

Plaintiffs Alleged Sufficient Distinct Harm to Confer Standing.

The Court held that Plaintiffs Bert and Terry alleged distinct injuries so as to confer standing.

Barger v. McCoy Hillard & Parks, 36 N.C. 650, 658 (1997), provides the rules for shareholder standing for corporations. These rules apply “equally to LLCs.” Op. ⁋ 24. While normally, “shareholders cannot pursue individual causes of action against third parties for wrongs or injuries to the corporation that result in the diminution … of the value of their stock,” Barger’s exceptions allow direct claims when members are owed a special duty, or if the injury is separate and distinct from the harm to other shareholders or to the corporation. Op. ⁋ 24 (citing Barger, 36 N.C. at 659).

Plaintiffs alleged that Defendants deprived them of their voting rights, which include the right to elect managers and the residual right to vote in the absence of proper managers. The Court held that infringement of the voting right is a distinct harm and the subject of a direct claim.

Plaintiffs alleged additional harm to support standing. Plaintiff Terry properly alleged distinct harm caused by Defendant Graham’s alleged wrongful inducement that she sell her ownership interest. Plaintiff Bert properly alleged distinct harm caused by the alleged improper sale of Nominal Defendant Louise’s membership interest, which diluted Bert’s relative share. Op. ⁋ 27 (citing Corwin v. British Am. Tobacco PLC, 821 S.E.2d 729, 735-36 (N.C. 2018) (corporations case)). (See Blog Post Smoke ’em if You Got ’em, dated June 2, 2019).

Plaintiff Alleged Insufficient Facts to Impose a Fiduciary Duty.

While Plaintiffs had standing, their claims based on Defendants’ corporate actions failed on the merits.

Fiduciary Duties Excluded By Operating Agreement

Generally, LLC members do not owe fiduciary duties to each other or to the company. Perhaps because of that rule (and because the original Operating Agreement disclaimed fiduciary duties concerning its members), Plaintiffs based their claim on other factors: the sibling relationship and their disparate business acumen.

The Court had no trouble dispensing with the claim. The Court questioned whether a fiduciary duty could attach in light of the original Operating Agreement’s express language precluding it. But, the Court did not have to decide that issue because the allegations failed to show the requisite control needed. Under North Carolina law, a fiduciary duty can arise only when one party “holds all the cards.” Op. ⁋ 32. As no individual sibling was alleged to wield all the power in the company, no fiduciary duty could attach. Id.

No Control Group Exception for LLCs

You may wonder: could the collective interest of the Defendant siblings form a control group that owes a fiduciary duty to a minority member? When Terry liquidated her membership interest, Defendants Graham, Ann, and Jim together owned more than 50% of the company.  They could use their collective interest against Plaintiff Bert, a minority owner.

The Business Court has recognized the possibility that multiple minority shareholders in a corporation who act in concert to control the corporation may owe a duty to a minority shareholder. See, e.g., Brewster v. Powell Bail Bonding, Inc., 2018 NCBC 74, *19-32 (N.C. Super. Ct. Jul. 26, 2018) (Judge Conrad).

(In Brewster, Judge Conrad cited the Court of Appeals decision in Corwin v. British Am. Tobacco PLC, in which the Court determined that a minority shareholder of a corporation exercising actual control may owe a fiduciary duty to other shareholders. See 796 S.E.2d 324 (N.C. Ct. App. 2016). When the North Carolina Supreme Court considered the issue in the Corwin appeal, it left the matter undecided. (See Blog Post Smoke ’em if You Got ’em, dated June 2, 2019).)

Judge Conrad noted that some recent Business Court cases “have stated that a holder of a majority interest who exercises control over the LLC owes a fiduciary duty to minority interest members.” Op. ⁋ 35 (citing Fiske v. Kieffer, 2016 NCBC 22, ⁋ 35) (N.C. Super. Ct. Mar. 9, 2016) (emphasis added) (Judge McGuire)). But, he also noted that the “scope of the [control group] exception … remains unsettled” and that “[t]his Court has cautioned against a broad application because of the fundamental differences between LLCs and corporations.” Id. Minority members of LLCs have “much greater” ability to negotiate for protections in the operating agreement. Id. Thus, “this Court has routinely refused to extend the control group exception to LLCs.” Id.

Judge Conrad was unwilling to grant such a right here. He determined that Defendants Graham, Ann, and Jim owed no fiduciary duty to Plaintiffs for their actions related to Bennett Farm.

Judicial Dissolution

Plaintiffs also seek judicial dissolution of Bennett Farm. They argue it is not practicable to conduct business in conformance with the operating agreement and governing statutes, and liquidation is necessary to protect their rights and interests. They seek dissolution based on the frustration of their reasonable expectations (rights enjoyed by shareholders of closely held corporations). See Meiselman v. Meiselman, 309 N.C. 279, 299 (1983).

The Court held that Plaintiff Terry lacks standing to seek the remedy because she is no longer a member of Bennett Farm.

But, Plaintiff Bert remains a member. If he develops evidentiary support for his claims, a jury might face “thorny questions” about the company’s ability to bring itself into compliance with its operating agreement after a decade of what would be unlawful management. The Court did not state whether Meiselman’s dissolution standards would apply to LLCs. It decided it would be “prudent” (at this juncture) to address the issue after discovery. Op. ⁋ 70 (citing Pure Body Studios Charlotte, LLC v. Crnalic, 2017 NCBC LEXIS 98 ⁋ 27-8 (N.C. Super. Ct. Oct. 18, 2017) (Judge Robinson)).

This leaves open the possibility that the Court could apply Meiselman in the LLC context.

N.C. Business Court Rejects Novel Fraudulent Conveyance Defense Which Offered Up Assets of Allegedly Drained Entity.


The N.C. Business Court has issued three rulings this summer on the pleadings in Willard v. Barger, 19 CvS 182 (Davie County). See 2019 NCBC 42; 2019 NCBC 33; 2019 NCBC 30. Most recently, the Court granted Plaintiffs’ Rule 12(c) motion on a cleverly worded affirmative defense that attempted to navigate around Plaintiffs’ claims for fraudulent conveyance. See 2019 NCBC 42 at ¶¶4-5.

Takeaways:

  • The Business Court did not hesitate to grant judgment on an affirmative defense cast as a narrative that failed to meet what the Court viewed as the substance of Plaintiffs’ claim.
  • The two proper methods to challenge the sufficiency of an affirmative defense are a motion for judgment on the pleadings under Rule 12(c) and a motion to strike under Rule 12(f).
  • The Court rejected a conversion claim brought by a party that did not own the asset allegedly held improperly by the opponent.

The Complaint alleged a business arrangement under which Charles Willard and Tracy Barnes formed and owned Tracy Barnes Blimp Works, LLC (“Barnes Blimp Works”), a venture in which Willard would ultimately assume 100 percent ownership after Barnes died. After a disagreement and failed attempt to buy out Willard, allegedly, Barnes and a colleague impermissibly transferred the assets of Barnes Blimp Works to a new entity, Blimp Works, Inc. (“BW”), to Willard’s detriment.

Defendants asserted as an affirmative defense that after Barnes’ death, the Defendants offered to deliver to Willard the assets of Barnes Blimp Works which Willard claims were fraudulently converted. Moreover, Barnes Blimp Works was “hopelessly insolvent.”

Plaintiffs sought judgment on the defense under Rules 12(c) and 12(b)(6). The Court determined that Rule 12(b)(6) did not apply. But, Rule 12(c) was proper to challenge an affirmative defense (as is Rule 12(f)).

In granting the Plaintiffs judgment as to the defense, the Court noted that Defendants’ position “misses the point” of Plaintiffs’ claim that Barnes and his partner impermissibly transferred the assets of Barnes Blimp Works to an entity in which Plaintiff Willard had no interest. Id. at ¶¶ 10-11. Defendants’ heads I win, tails you lose offer of Barnes Blimp Works’ existing assets failed to confront, the Court said, that “Plaintiffs seek to recover from Defendants any assets that [it] previously possessed but which were fraudulently conveyed … without adequate consideration.” Id. at ¶11 (emphasis added).

Earlier in the year, the Court denied Plaintiffs’ Motion for a More Definitive Statement of Defendants’ Second Counterclaim (2019 NCBC 30) and granted Plaintiffs’ Motion to Dismiss Defendants’ Conversion claim (2019 NCBC 33).

In a May 14, 2019 order, the Court allowed a six-paragraph counterclaim to survive, which alleged that the decedent defendant had advanced in excess of $300,000 in loans to one of the Plaintiffs. Plaintiffs’ lament that the claim failed to allege an immediate right of payment or written evidence of the loan was unavailing, the Court found, under the liberal pleading requirements of Rule 8. 19 NCBC 30 at ¶¶ 4, 11. The fact that the Plaintiff answered the counterclaim contemporaneously with its motion to further define it, showed it “was able to sufficiently comprehend” the counterclaim. Id. at ¶11.

In a May 29, 2019 ruling, the Court dismissed what amounted to Defendants’ misdirected counterclaim for recovery of a 2014 Subaru automobile (19 NCBC 33). The decedent Defendant’s Estate moved to recover the car, but conceded in a pleading that the car was actually owned by Defendant BW. Id. at ¶12. The Court found it unavailing that the estate controlled all of the shares of BW. That, the Court said, “may give the Estate the practical ability to control BW’s affairs, including the disposition of BW’s assets, but ownership in BW’s shares does not equate to direct ownership in BW’s assets.” Id. at ¶14. Thus, it may be love that makes a Subaru a Subaru, but it is still undisputed title that allows you to claim it.

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 Grants (Partial) Victory to Scrap Metal ‘Manufacturers’

In N.C. Dep’t of Revenue v. Tri-State Scrap Metal, Inc. et al., 2019 NCBC 41 (N.C. Super. Ct. July 8, 2019), the Business Court addressed whether the respondent “recyclers” qualified as “manufacturers” for purposes of the privilege tax under G.S. § 105-187.51 (now repealed). If so, the respondents were entitled to apply the lower (1%) privilege tax rate—as opposed to the generally applicable state and local tax rates—on certain business purchases. Judge Robinson concluded that yes, the respondents were manufacturers generally entitled to the privilege tax rate, but that remand was required to determine application of the privilege tax on a purchase-by-purchase basis.

Take-Aways:

  • To qualify for the privilege tax: (1) the taxpayer must be a “manufacturer”; and (2) the items in question must be used in the “production phase” of manufacturing.
  • The process of converting scrap metals into “new and different” products qualifies as “manufacturing” for privilege tax purposes.
  • Whether a manufacturer’s purchases are subject to the privilege tax must be determined on a purchase-by-purchase basis.

Though North Carolina’s 1% “privilege tax” sounds like something that might apply to wealthy individuals or entities, it is actually something quite different. This sales and use tax of 1% is a “privilege” reserved for businesses qualifying as “manufacturers” under the governing statute; and it is a “privilege” because it applies in lieu of the generally applicable (and much higher) state sales tax rate. As such, this tax is actually one that taxpayers hope to qualify for.

Tri-State Scrap Metal involved three “secondary metal recyclers” (collectively, the “respondents”) in the business of purchasing and “processing” scrap metals into products for use by their customers in their own manufacturing businesses. Id. ¶ 2. The respondents’ operations essentially consisted of recycling scrap metals by buying, altering, and then selling them – a business model that one might expect to receive “favorable” tax treatment. (Recycling is a good thing, right?)

The respondents took the position that as “secondary metal recyclers,” they qualified as “manufacturers” entitled to the 1% privilege tax rate described under G.S. § 105-187.51 (the “privilege tax”) on their purchases of “certain machinery, parts, and accessories used in their operations at their respective facilities.” Id. The respondents thus made payments to the NC Department of Revenue (the “Department”) based on the privilege tax rate—instead of the generally applicable sales and use tax rate—with respect to these purchases. Id. ¶ 3.

Upon audit, the Department determined that the respondents’ operations—i.e., its purchasing and processing of scrap metals—did not qualify as “manufacturing” for purposes of the privilege tax. Id. ¶ 3. The Department therefore assessed tax deficiencies against the respondents representing essentially the difference between the generally applicable sales tax and the privilege tax that respondents had paid on their purchases, plus interest and penalties. Id.

The respondents appealed to the Office of Administrative Hearings (“OAH”), which disagreed with the Department and ruled that the respondents were, in fact, “manufacturers” entitled to the privilege tax rate on their business purchases. Id. ¶¶ 4, 13.

The Department thereafter appealed 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 respondents’ operations qualified as “manufacturing” under G.S. § 105-187.51; and (2) whether the OAH should have conducted a “purchase-by-purchase analysis” in determining whether the respondents’ purchases were subject to the privilege tax. Id. ¶ 5.

1. What is “Manufacturing?”

The Business Court first considered whether the nature of the respondents’ business operations entitled them to the 1% privilege tax rate.

As the Court observed, the privilege tax “is a partial exemption from State and local sales and use tax on tangible personal property.” Id. ¶ 19. The then-governing statute provided, in relevant part, as follows:

A privilege tax is imposed on the following persons: …. A manufacturing industry or plant that purchases mill machinery or mill machinery parts or accessories for storage, use, or consumption in this State. . . . The tax is one percent (1%) of the purchase price of the machinery, part, or accessory purchased.

G.S. § 105-187.51 (repealed effective July 1, 2018) (emphasis added). The threshold question, then, was whether the respondents’ business of purchasing and processing scrap metals qualified as “manufacturing” within the meaning of G.S. § 105-187.51.

Finding no statutory definition of “manufacturing” on point, the court turned to the case law, and specifically Duke Power v. Clayton, 274 N.C. 505, 164 S.E.2d 289 (1968). There, the North Carolina Supreme Court defined “manufacturing” as “the producing of a new article or use or ornament by application of skill and labor to raw materials.” Id. at 514, 164 S.E.2d at 295. An item is considered manufactured, in other words, where “the labor . . . result[s] in a new and different article with a distinctive name, character or use.” Id. at 513, 164 S.E.2d at 295.

The Business Court applied this “new and different” concept in analyzing the respondents’ “secondary metal recycling” operations. The court found that the respondents’ operations “transform[ed]” scrap metal that was “no longer usable into new products that have distinct names, characteristics, and uses.” Id. ¶ 22. For instance, the respondents took “post-consumer aluminum beverage cans”—which otherwise would be “discarded as trash”—and through their processes of drying, cleaning, flattening, and baling the used cans, converted them into a new product (“Baled Aluminum Used Beverage Can Scrap”) that could be used by the respondents’ customers. The respondents’ “transformation processes” thus converted otherwise useless items into products that had value for their customers and that their customers were willing to purchase. Id. ¶ 23. Indeed, as the court summed up (rather eloquently): “Respondents create new life and new purpose for products that have been discarded and have lost their intended value—[and] this is entirely consistent with the Duke Power definition of manufacturing.” Id. ¶ 23.

Accordingly, the respondents qualified as “manufacturers” for privilege tax purposes.

2. Which Items Get the Privilege Tax Rate?

The Business Court’s analysis did not end with its holding that the respondents were manufacturers, however. The question remained as to which items purchased by the respondents were subject to the lower privilege tax rate.

The OAH had concluded that all items purchased by the respondents were subject to the privilege tax. It did so, however, without assessing application of the privilege tax on a purchase-by-purchase basis. Instead, it had “assumed, without proof, that all claimed purchases were entitled to the lower Privilege Tax because the ALJ concluded as a matter of law that the Respondents were manufacturers.” Id. ¶ 35. This blanket assumption, according to the Business Court, was error (although, as the court was quick to point out, the OAH did not have before it the evidence needed to undertake a purchase-by-purchase analysis).

The Business Court reasoned that not all items purchased by a manufacturer necessarily qualified for the privilege tax because, under the plain language of the statute, the tax applied only to certain types of business purchases – namely, “mill machinery or mill machinery parts or accessories for storage, use, or consumption in this State.” G.S. § 105-187.51(a)(1). Further, the statute applied the tax to “the purchase price of the machinery, part, or accessory purchased.” G.S. § 105-187.51(b) (emphasis added). As this language suggests, and as the court concluded, “a purchase-by-purchase analysis must be done” to determine whether each item purchased qualifies for the lower privilege tax rate. Id. ¶ 31.

In short, “[w]hile being a manufacturer is a prerequisite to being eligible for the Privilege Tax, not all items purchased by a manufacturer are entitled to the lower rate of taxation.” Id. ¶ 31. And since the OAH had applied the privilege tax to all purchases without assessing whether each individual purchase was subject to the tax, remand was required.

As for which items actually qualify for the privilege tax, the Business Court did offer some guidance to the OAH on remand. In particular, the court instructed that “only those items used in the production phase of manufacturing are subject to the Privilege Tax.” Id. ¶¶ 33-36 (citing 17 N.C. Admin. Code 07D.0102(a)(1)) (emphasis added). The court cited “computer equipment and printer ink cartridges” as examples of items bought by the respondents that were “seemingly used for purposes other than manufacturing,” and therefore would not qualify for the privilege tax. Similarly, items used merely “for the movement of raw materials into inventory are not subject to the Privilege Tax.” Id. ¶¶ 34-35.

Accordingly, the ball now returns to the OAH, where the respondents must scrap together evidence sufficient to show that the privilege tax should apply to each (or as many as possible) of their purchases.

 

N.C. Business Court Dismisses Counterclaims of an ALF Medical Provider for Lack of Standing.


In Doctors Making Housecalls-Internal Medicine, P.A. v. Onsite Care, PLLC, 2019 NCBC 5 (N.C. Super. Ct. Jan. 16, 2019), Judge McGuire granted the Plaintiff’s motion to dismiss the counterclaims of its competitor for lack of standing because the allegations were insufficient to show actual injury. See Order and Opinion.

Takeaways

  • In order to allege an injury in fact based on a state-law claim of attempted market monopolization, a claimant should allege that it lost a specific opportunity (or that it faces the imminent threat of losing one) as a result of the defendant’s conduct.
  • When a claim for unfair or deceptive acts or practices derives solely from an antitrust claim, the failure of the antitrust claim also defeats liability under N.C.G.S. § 75-1.1.
  • There is no abuse of process when the action complained of is confined to its regular and legitimate function in relation to the cause of action stated in the complaint.

Plaintiff Doctors Making Housecalls and Defendant Onsite Care compete to provide medical services to residents of assisted living facilities (“ALFs”) in North Carolina. While residents (or their guardians) must select their own healthcare providers, ALFs often identify and promote their “preferred providers” to their residents. This preferred status plays a significant role in residents’ selections. As a result, providers compete for the lucrative designation.

Previous Litigation

The current trouble began after the Defendant allegedly conferred with an ALF about replacing the Plaintiff as its preferred provider, and after three-quarters of its residents transferred their care to the Defendant. The Plaintiff quickly filed a lawsuit against Onsite Care and the ALF, alleging that the ALF’s residents lacked capacity to transfer their care and seeking injunctive relief. After a Temporary Restraining Order issued, the Plaintiff settled against the ALF and dismissed the case.

Current Litigation

Within weeks, the Plaintiff initiated this matter against Onsite Care, alleging a variety of tortious interferences and unfair and deceptive acts and practices.

Onsite Care counterclaimed, asserting claims for attempted monopolization (which conferred Business Court jurisdiction), unfair and deceptive acts and practices (based on the antitrust claim), and abuse of process (resulting from the previous litigation).

The Plaintiff filed a motion to dismiss pursuant to Rules 12(b)(1) and 12(b)(6) for lack of standing. The Court analyzed the issue under Rule 12(b)(6) because the Plaintiff did not rely on matters outside the pleadings.

Attempted Monopolization

Judge McGuire determined the Defendant’s allegations of injury resulting from the Plaintiff’s alleged anticompetitive conduct to be legally deficient and insufficient to confer standing. Standing is “among the justiciable doctrines developed by federal courts” (and adopted by North Carolina courts) to give meaning to the “case or controversy” requirement of the United States Constitution.  Op. ⁋ 27 (citing Neuse River Found. v. Smithfield Foods, Inc., 155 N.C. App. 110, 114 (2002)).  It refers to whether a claimant has a sufficient stake in a controversy as to properly seek its adjudication. Id. At a minimum, a claimant must allege a concrete and particularized injury that is fairly traceable to the challenged action and that likely will be remedied by a favorable decision. Id. The injury must be “actual” or “imminent,” not “hypothetical or conjectural.” While a claimant does not have to allege that the injury has already occurred, it must at least allege that the injury is “immediate” or “threatened.” Even though the claim of attempted monopolization is an inchoate offense (i.e., actionable when a defendant has not yet completed its effort to monopolize, but merely shows “a dangerous probability” of successful monopolization), the claim of resulting injury must be concrete.

To support its claim of attempted monopolization, the Defendant asserted:

  • The Plaintiff’s “conduct has the potential to chill competition in the relevant market, which harms [the Defendant] by foreclosing cooperative opportunities and harms consumers in the form of lower quality medical care and increased prices.” Op. ⁋ 15 (emphasis added).
  • The Plaintiff’s “threats of litigation may dissuade risk-adverse [ALFs] from working with alternative medical providers.” Op. ⁋ 30(a) (emphasis added).
  • The Plaintiff’s conduct “may dissuade [ALFs] from attempting to change service providers,” and ALFs “may hesitate to recommend other providers” out of fear of litigation. Op. ⁋ 30(c) (emphasis added).
  • The Plaintiff filed the lawsuits “for the purpose of interfering with competitors….” Op. ⁋ 30(b) (emphasis added).

The Court believed the injuries asserted were not distinct and palpable, but rather hypothetical and speculative. In order to properly allege an actual injury for attempted monopolization, the Defendant would have to allege a specific opportunity that it lost or one for which it faces the imminent threat of losing as a result of the Plaintiff’s alleged anticompetitive conduct. The Defendant’s typical catch-all allegation that the Plaintiff’s conduct proximately caused it injury in an amount to be proven at trial was too conclusory by itself to be accepted as true.

The Court did not address the allegation that the Plaintiff’s conduct allowed it to “raise prices in the relevant market” based on a special fee that it charged. It is likely that, while this type of harm may be actionable by some party, it would not support the Defendant’s claim of injury because it is too attenuated to cause it harm.

Unfair and Deceptive Act and Practices

The Court dismissed the Defendant’s unfair and deceptive practices claim because it was solely derivative of the attempted monopolization claim. It could not survive dismissal of the predicate claim.

Abuse of Process

The Court expressed skepticism about the merits of the Defendant’s abuse of process claim. To state a claim for abuse of process, a claimant must show: (1) an ulterior motive and (2) an act in the use of the legal process not proper in the regular prosecution of the proceeding. The motive requirement is satisfied when the claimant alleges that the defendant initiated a prior action to achieve a collateral purpose outside the normal scope. The act requirement is satisfied when the claimant alleges that after the prior proceeding began, the defendant committed an act using the existence of the proceeding to gain advantage in a collateral matter.

The Defendant alleged that the Plaintiff initiated the prior lawsuit against it and the ALF with the improper purpose of restricting competition and that it improperly sought to enforce a TRO against one of the Defendant’s employees to gain an advantage over the Defendant. However, the Court believed the Plaintiff sought and obtained the TRO for the proper purpose of determining the residents’ capacity. It stated that there is no abuse of process when the action complained of “is confined to its regular and legitimate function in relation to the cause of action stated in the complaint.” Op. ¶ 38.

The Court ultimately based its dismissal of the claim, however, on its standing analysis—the Defendant lacked sufficient allegations of injury in fact.

The Business Court may face these claims again. Judge McGuire dismissed the Defendant’s claims without prejudice, and, while the parties subsequently dismissed this action pursuant to a stipulation of dismissal, the dismissals were without prejudice.

Thanks to Sean Placey, Fox Rothschild summer associate, for his work on this post.

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.