“The Unfair and Deceptive Conduct is Coming from Inside the House!” An Overlooked Limit to Section 75-1.1 Liability

North Carolina litigants commonly assert claims under the Unfair and Deceptive Trade Practices Act. But the tantalizing prospect of being awarded treble damages and attorneys’ fees can blind attorneys to the statute’s threshold requirements. This article explores a common pitfall that practitioners stumble into: the Act does not regulate conduct occurring within a single business. And North Carolina courts have grown especially impatient with attorneys who force intracorporate conduct into the Section 75-1.1 mold.

Section 75-1.1: The Key is “Commerce”

Section 75-1.1(a) of the Unfair and Deceptive Trade Practices Act declares that “[u]nfair methods of competition in or affecting commerce, and unfair or deceptive acts or practices in or affecting commerce, are [ ] unlawful.” But what does it mean to be “in or affecting commerce”?

Although Section 75-1.1(b) broadly defines “commerce” as “all business activities,” the Supreme Court of North Carolina has construed the term more narrowly, limiting it to “the manner in which businesses conduct their regular, day-to-day activities, or affairs, such as the purchase or 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, 403 S.E.2d 483, 493 (1991). The Supreme Court has more recently explained that Section 75-1.1 regulates “a business's regular interactions with other market participants.” White v. Thompson, 364 N.C. 47, 51, 691 S.E.2d 676, 679 (2010).

One necessary side effect of this definition of “commerce” is that the “Act is not focused on the internal conduct of individuals within a single market participant, that is, within a single business.” Id. at 53, 691 S.E.2d at 680. But patrolling the boundary between the internal conduct of a single company and “commerce” can be less intuitive than it appears at first glance.

Insider Misappropriation Is Not “in or Affecting Commerce”

Sometimes disloyal owners or officers will create a separate corporate entity to facilitate their plot to divert company funds and opportunities to themselves. Even though these schemes involve dealings between multiple, separate companies, North Carolina courts uniformly hold that such “misappropriation of corporate resources and usurpation of corporate opportunities are internal matters that are not in or affecting commerce. . . .” JT Russell & Sons, Inc. v. Russell, No. 23 CVS 363, 2024 WL 836261, at *2 (N.C. Super. Ct. Feb. 28, 2024)

In more obvious cases, the separate entity is just a tool to route company funds into the pocket of the disloyal owner or officer. Take the case of JS Real Est. Invs. LLC v. Gee Real Est., LLC, No. 15 CVS 22232, 2017 WL 5197488 (N.C. Super. Ct. Nov. 9, 2017). There, an owner of a real estate company sued his co-owner under Section 75-1.1 for using a separately owned property management company to scalp fees off of distributions that should have been paid out of the co-owned real estate company. Id. at *6–7. The Business Court granted summary judgment in favor of the defendants because this was really a “dispute between members of the [co-owned real estate companies] over the companies' internal management and the member’s right to receive distributions—that is, whether defendants deprived [plaintiff] of an appropriate share of the proceeds received by (or that should have been received by) the [co-owned real estate company].” Id. at *7.

In such cases, the “tangential involvement” of third parties does not mean that the defendant’s acts were in or affecting commerce. Id. (quoting Polyquest, Inc. v. Vestar Corp., LLC, No. 7:13-CV-23-F, 2014 WL 496494, at *12, 2014 U.S. Dist. LEXIS 14905, at *35 (E.D.N.C. Feb. 6, 2014)). “ ‘The Supreme Court's refusal in White [v. Thompson] to allow indirect involvement of other market participants to trigger liability under Section 75–1.1 forecloses’ that argument.” Id. (quoting Powell v. Dunn, 2014 WL 340254, at *4, 2014 NCBC LEXIS 3, at *10, 11 (N.C. Super. Ct. Jan. 28, 2014)).

But even instances where the disloyal owner or officer intentionally benefits a third party through his misappropriation do not necessarily violate Section 75-1.1.

Transfers Outside the Company Are Not Actionable Under Section 75-1.1 When they Result from Unfairness Inside the Company

Consider an LLC with two 50% members. One of the members begins diverting company funds and opportunities to himself—and also to outside companies that his family members own. It is apparent that the member’s self-dealing takes place entirely within a single company and is therefore exempt from a Section 75-1.1 claim, but what about that member’s transfers to his family members’ companies?

The North Carolina Business Court addressed precisely these facts in Potts v. KEL, LLC, No. 16 CVS 2877, 2018 WL 1597644 (N.C. Super. Ct. Mar. 27, 2018). Defendant Rives was a member of a company called Steel Tube. After becoming an officer and director of Steel Tube, he diverted $120,000 and several pieces of manufacturing equipment from Steel Tube to a company that Rives’ family owned. Rives also had Steel Tube enter a transportation and trucking contract with a different company owned by his brothers.

Outraged at this misconduct, the co-owner of Steel Tube sued not only Rives, but also the outside companies, alleging they committed unfair and deceptive trade practices. Even though the outside companies directly benefitted from Rives’ intentional transfers, the court granted a motion to dismiss and held that these transfers did not implicate Section 75-1.1. The Business Court reasoned that the complaint alleged “a management disagreement within Steel Tube, in which the unfairness occurred in the interaction between the company’s owners and directors. The involvement of [the family-owned companies] was merely incidental to what is, at bottom, an intra-company dispute.” Id. at *6.

Cases in the Potts v. KEL mold crop up with staggering regularity. In 2021, Judge Davis of the Business Court considered a Section 75-1.1 claim alleging that a fellow LLC member diverted assets to his wife and to his wholly owned company. Poluka v. Willette, No. 21 CVS 10099, 2021 WL 5711755 (N.C. Super. Ct. Dec. 2, 2021). Calling this case “simply another example of an internal dispute between members of a single company,” Judge Davis granted a motion to dismiss the Section 75-1.1 claim. Id. at *7.

Earlier this year, Judge Conrad of the Business Court dispatched a similar Section 75-1.1 claim alleging that a company officer funneled assets to himself and to his son’s business. JT Russell & Sons, Inc. at *1–2. Observing that “[t]his is a well-worn area of law,” Judge Conrad lamented that “[t]he docket brims with Section 75-1.1 claims alleging that a rogue owner or officer abused his official position to further personal interests.” Id. at *2. According to Judge Conrad, the “most powerful” rationale supporting this line of decisions “is that any unfairness arising from this kind of insider misconduct occurs within the company rather than in regular interactions with other market participants.” Id. (citing White, 364 N.C. at 54, 691 S.E.2d at 676).

A Vain Plea?

This article is unlikely to dissuade litigators from tacking on Section 75-1.1 claims to their pleadings, but it hopefully highlights how fragile a UDTPA claim can be.

In his JT Russell & Sons, Inc. opinion, Judge Conrad included a gargantuan footnote collecting nine decisions holding that misappropriation by an insider is an internal matter not in or affecting commerce. The footnote previews what a UDTPA claimant is up against when she tosses in a UDTPA claim alleging intracorporate conduct:

See also, e.g., Conservation Station, Inc. v. Bolesky, 2023 NCBC LEXIS 164, at *29, 2023 WL 8594479 (N.C. Super. Ct. Dec. 12, 2023) (“Bolesky's formation of CTS and usurpation of CSI's corporate opportunities was not in or affecting commerce for purposes of” section 75-1.1.); Langley v. Autocraft, Inc., 2023 NCBC LEXIS 95, at *22, 2023 WL 5018021 (N.C. Super. Ct. Aug. 7, 2023) (“[T]he fact that Langley formed LBM and used that entity to usurp some of Autocraft's opportunities does not transform the misconduct into an unfair or deceptive trade practice that affected commerce.”); Poluka v. Willette, 2021 NCBC LEXIS 105, at *17–21, 2021 WL 5711755 (N.C. Super. Ct. Dec. 2, 2021) (“The mere presence of BR Ventures as a potential beneficiary of Willette's alleged wrongful conduct does not alter the fundamental character of this internal dispute.”); Botanisol Holdings II, LLC v. Propheter, 2021 NCBC LEXIS 94, at *26–28, 2021 WL 4844528 (N.C. Super. Ct. Oct. 18, 2021) (“The fact that another entity or entities benefitted ... does not make the dispute one ‘in and affecting commerce.’ ”); Kane v. Moore, 2018 NCBC LEXIS 184, at *13–14, 2018 WL 6378428 (N.C. Super. Ct. Dec. 4, 2018) (“North Carolina courts have consistently held that allegations that a corporate manager breached fiduciary duties by diverting opportunities from a corporation to [himself], or to other third-party businesses the manager controlled, does not amount to unfair conduct ‘in or affecting commerce.’ ”); LLG-NRMH, LLC v. N. Riverfront Marina & Hotel, LLLP, 2018 NCBC LEXIS 105, at *11, 2018 WL 4902000 (N.C. Super. Ct. Oct. 9, 2018) (“That Schoninger advanced the interests of his own entities at the expense of the Harnett Entities does not change the fundamental character of the dispute.” (citation and quotation marks omitted)); Potts v. KEL, LLC, 2018 NCBC LEXIS 24, at *15, 2018 WL 1597644 (N.C. Super. Ct. Mar. 27, 2018) (“Rives may have carried out his ... misappropriation of Steel Tube's assets by channeling money and equipment to Elite Tube and diverting a corporate opportunity to KEL. But the unfairness of these actions, if any, inheres in the relationship between Potts and Rives as co-owners of Steel Tube.”); JS Real Est. Invs. LLC v. Gee Real Est., LLC, 2017 NCBC LEXIS 104, at *21, 2017 WL 5197488 (N.C. Super. Ct. Nov. 9, 2017) (“The fact that Defendants channeled management fees to Gvest Capital, an outside entity, does not change the fundamental character of the dispute.”); Bandy v. Gibson, 2017 NCBC LEXIS 66, at *21, 2017 WL 3207068 (N.C. Super. Ct. July 26, 2017) (“Any indirect dealings that Margaret or Perfect Fit had with other market participants was incidental to the alleged unfair conduct that took place solely within Perfect Fit.”).

Id. at *2 n.2. The message is clear. Attorneys should take care that their claim fits the Section 75-1.1 mold before asserting it.