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Can Forcing a Company into Bankruptcy be an Unfair or Deceptive Trade Practice?

Ellis Winters

Ellis & Winters

Can a bankruptcy trustee prove a violation of N.C. Gen. Stat. § 75-1.1 based on business strategies that forced a debtor into bankruptcy?

The U.S. Bankruptcy Court for the Eastern District of North Carolina recently addressed this question in In re American Ambulette & Ambulette Service, Inc. 

The Debtors’ Corporate Parents Allegedly Force the Debtors to Liquidate

The debtors in American Ambulette were in the medical-transport business. Each of them filed for liquidation under chapter 7 of the bankruptcy code. The bankruptcy court consolidated the cases and appointed a single bankruptcy trustee to administer the debtors’ assets.

The trustee then filed an adversary proceeding against the debtors’ parent and sibling corporations, as well as their officers and directors.

The trustee alleged that the debtors’ corporate parents developed a business plan to expand their operations. As part of the expansion plans, the parent entities established two new subsidiaries. The new subsidiaries allegedly competed with the debtors. According to the trustee, the corporate parents and the officers and directors caused the debtors to incur substantial expenses to further the expansion plans.

The trustee accused the defendants of (1) diverting the fruits of their business-development activities to the competing subsidiaries, (2) transferring assets from the debtors to those subsidiaries, and (3) forcing the debtors into liquidation. Those activities, the trustee argued, eliminated the debtors as competition for the new subsidiaries.

These allegations fueled a 79-page complaint from the trustee. The complaint included a claim against the parent companies and their officers and directors for violations of section 75-1.1.

The Defendants Won the Battle, but Did They Win the War?

The defendants moved to dismiss. The motion largely relied on a recent federal district court decision. The defendants argued that, under the recent decision, a business can pursue a 75-1.1 claim only when the business has acted as a consumer or has engaged in commercial dealings with the defendant.

The defendants conceded that the trustee’s complaint described commercial dealings. They argued, however, that the allegations about those dealings did not state a violation of section 75-1.1. They stressed that the defendants on the 75-1.1 claim did not include the competing subsidiaries themselves.

The bankruptcy court granted the motion to dismiss. The court identified three categories of cases in which a business plaintiff may assert a 75-1.1 claim:

  • The plaintiff has acted as a consumer or has otherwise engaged in commercial dealings with the defendant.
  • The plaintiff and the defendant have competed with each other.
  • The conduct that gives rise to the claim has had a negative effect on the consuming public.

In American Ambulette, the trustee did not allege that the debtors engaged in commercial dealings with—or were competitors of—the defendants themselves. The complaint also lacked any allegations on how the defendants’ conduct affected consumers.

These points led the bankruptcy court to dismiss the complaint, albeit with leave to amend.

Shortly after this order, the trustee filed an amended complaint. The amended complaint adds the competing subsidiaries as parties to the 75-1.1 claim. It also asserts that the defendants’ actions benefited the competing subsidiaries. Finally, it includes detailed allegations on how those actions affected the marketplace and the consuming public.

The Takeaway

American Ambulette suggests that if corporate parents merely run a company into the ground and force it to liquidate, that activity alone would not support a 75-1.1 claim. In the case itself, however, the 75-1.1 claim survived because the parents formed competing entities and then diverted corporate opportunities and assets to those new entities.

The defendants’ time to respond to the amended complaint has not run. We’ll be interested to see:

  • whether the 75-1.1 exemption for activities within a single business comes up,
  • whether the alleged diversions are considered commercial dealings, and
  • whether the trustee has alleged enough on whether those alleged activities affected competitors or consumers.

As American Ambulette illustrates, bankruptcy cases often generate different styles of 75-1.1 claims from the styles that one sees in other trial courts.

Author: George Sanderson

October 25, 2016
Posted in  Creditors Rights, Lender Liability, and Bankruptcy