The North Carolina Business Court Explores the Boundaries of “Substantial Aggravating Circumstances”
Ellis & Winters
Courts have long recognized limitations on claims brought under N.C. Gen. Stat. § 75-1.1 in conjunction with alleged breaches of contract. Although the North Carolina Supreme Court has never formally recognized a restriction, state and federal courts alike have determined that a breach of contract does not give rise to an unfair or deceptive trade practice claim unless “substantial aggravating circumstances” accompany the breach.
Courts have provided little guidance on what counts as a substantial aggravating circumstance, though some cases suggest there needs to be a showing of deceptive conduct. Courts usually focus on whether the specific fact pattern at hand discloses “egregious” or “substantially aggravating” conduct.
In a recent decision, however, North Carolina Business Court Judge Adam M. Conrad surveys several 75-1.1 cases that involve an alleged breach of contract. In examining the cases, Judge Conrad makes some helpful observations about what type of conduct courts do and do not recognize to be substantially aggravating.
The depth of analysis in Judge Conrad’s opinion appears to be unique among decisions that examine the intersection of 75-1.1 and breach-of-contract claims. As such, the opinion is a critical read for all North Carolina business litigators.
Questions About the Buyer’s Post-Closing Accounting
Post v. Avita Drugs, LLC involves the sale of MedExpress. MedExpress was a successful pharmacy based in Salisbury, North Carolina. MedExpress’s shareholders sold the business to Avita Drugs.
A stock purchase agreement governed the terms of the sale. Avita paid $6 million for MedExpress at closing. The stock purchase agreement also provided for a deferred payment of up to $5.5 million. The actual amount of the deferred payment was to be determined under a formula in the stock purchase agreement. The formula was tied to the financial performance of MedExpress during the one-year period after the sale.
After the sale of MedExpress closed, the shareholders and Avita were unable to agree on the deferred payment amount. One of the shareholders ultimately sued Avita.
In his complaint, the shareholder alleged that Avita took a series of wrongful actions after the sale closed, including: (1) improperly adjusting the earnings calculation for MedExpress; (2) making retroactive adjustments to MedExpress’s books and records; and (3) failing to operate MedExpress as a separate company in the manner that the stock purchase required. The shareholder alleged that these actions improperly depressed the earnings calculation used to set the deferred payment amount.
The shareholder brought breach-of-contract claims under the stock purchase agreement and a 75-1.1 claim.
Avita’s Alleged Post-Closing Conduct was not Substantially Aggravating
Avita moved to dismiss the 75-1.1 claim. The Court granted the motion on the basis that the shareholder failed to allege sufficient substantial aggravating circumstances. Judge Conrad’s opinion went into great detail about the policies driving the substantial aggravating circumstances doctrine.
Judge Conrad first noted the high frequency of 75-1.1 claims in North Carolina business litigation. Citing Matt Sawchak’s article in the University of North Carolina Law Review about direct-unfairness claims, Judge Conrad hypothesized that the reason for the proliferation of 75-1.1 claims is chiefly economic. He observed that a successful 75-1.1 claimant is entitled to treble damages and, in certain instance, reasonable attorneys’ fees.
Judge Conrad contrasted the “potent and credible” threat of a treble-damages recovery with the purpose of damages recoveries generally for breaches of contract. Ordinarily, punitive damages are not recoverable for a contract breach under North Carolina law. By extension, Judge Conrad proffered that 75-1.1 claims that “piggyback” on breach-of-contract claims are disfavored by North Carolina state and federal courts.
Judge Conrad theorized that the prospect of damage recoveries that are disproportionate to the amounts involved in the underlying contract may cause uncertainty for contracting parties. That uncertainty could possibly increase transaction costs incurred in contractual negotiations.
Judge Conrad examined several cases in which a 75-1.1 claim involved a contract. He concluded that most substantial aggravating circumstances (1) are attendant to the formation of the contract, and (2) are some variety of a fraud-in-the-inducement claim. He also noted that it appears “far more difficult to allege and prove egregious circumstances after the formation of the contract.”
Judge Conrad also cited a line of cases that indicate that a 75-1.1 violation “is unlikely to occur during the course of contractual performance.” Based on the case law, Judge Conrad opined that “efforts to encourage” continued contractual performance while “planning to breach” do not rise to the level of aggravating circumstances.
Judge Conrad’s case review did disclose a narrow band of post-formation conduct sufficient to trigger 75-1.1 liability. He cited instances of “clear deception” such as “forging and destroying documents” and “concealment of a breach” combined with “acts to deter further investigation” as actionable conduct.
Regarding the facts at hand, Judge Conrad did not find Avita’s alleged conduct to be sufficiently egregious or aggravating for the plaintiff to maintain a 75-1.1 claim. All of Avita’s alleged wrongful conduct occurred post-closing.
The judge also emphasized that each of Avita’s wrongful acts alleged was subject to an express provision of the stock purchase agreement. As such, he determined that the stock purchase agreement, and not section 75-1.1, defined the parties’ rights and obligations.
A Guide for Future Breach of Contract Cases?
One of the main purposes of the establishment of the North Carolina Business Court was to encourage the development and definition of business law in North Carolina. In keeping with that mandate, Judge Conrad’s opinion is a commendable attempt to provide definition to the concept of substantial aggravating circumstances not previously undertaken. It will be interesting to see how other courts use this framework in subsequent 75-1.1 decisions that involve a breach of contract.
Author: George Sanderson