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North Carolina Court of Appeals extends Section 75-1.1’s Securities Exemption beyond Securities

Ellis Winters

Ellis & Winters

We have recently examined several cases that explore the contours of two related exemptions to liability under N.C. Gen. Stat. § 75-1.1—the internal business disputes doctrine and the securities exemption.

Courts generally exempt both the internal business affairs of a company and their securities transactions from 75-1.1 liability. The underlying rationale for both exemptions, at least in part, is that the internal operations of a company are ordinarily not conduct “in or affecting commerce,” which is an express requirement of section 75-1.1.

In Bickley v. Fordin, the North Carolina Court of Appeals affirmed the dismissal of a section 75-1.1 claim related to the purchase and resale of an interest in a limited liability company. The Court upheld the trial court’s directed verdict based on both the internal business disputes doctrine and the securities exemption. In an apparent case of first impression, the Court indicated that the LLC interest could be subject to the securities exemption, even if it didn’t meet the actual definition of a “security.”

This post examines the Court’s reasoning to dismiss the plaintiff’s section 75-1.1 claim under both exemptions.

The Plaintiff Is Forced to Resell His Interest

Adam Bickley purchased for $50,000 a 10% interest in a software company named M3.  Shortly thereafter, Bickley was sentenced to two years in prison for drug offenses.

Two years later, M3’s founder, Fred Fordin, approached Bickley and expressed concern that Bickley’s continued involvement in M3 would harm the company. Fordin offered to repurchase Bickley’s interest in M3 in exchange for a $50,000  promissory note. Fordin told Bickley that if Bickley didn’t accept the offer, Fordin would bankrupt M3. Bickley accepted the offer and resold his interest to M3.

Fordin subsequently assigned the software that M3 was developing to another company. Fordin and the other shareholders of M3 (but not Bickley, because he had sold his shares back to M3) received minority stakes in the new company. Several years later, Fordin sold the new company for $14 million, presumably producing a substantial gain for him and the other shareholders.

After the sale, Bickley sued Fordin, M3, and the new company in Wake County Superior Court for breaching the terms of the $50,000 promissory note, as well as for fraud, constructive fraud, breach of fiduciary duty, and for violation of section 75-1.1.

The Jury Awards Damages, But the Judge Dismisses the 75-1.1 Claim

At trial, the jury awarded Bickley $505,000 for his fraud, constructive fraud, and breach of fiduciary duty claims. The judge also determined that Bickley was entitled to recover $50,000 on the promissory note as a matter of law. Nonetheless, the trial judge granted the defendants a directed verdict on the 75-1.1 claim.

The parties cross-appealed.  In a published opinion, the North Carolina Court of Appeals upheld both the jury’s award and the judge’s dismissal of the 75-1.1 claim.

The Court of Appeals refused the plaintiff’s request to reverse the trial court’s dismissal of the 75-1.1 claim on two grounds.  First, the Court determined that the claim did not fail within the scope of section 75-1.1 because it related only to M3’s internal business operations. Second, the Court determined that the securities exemption applied, even though the Court did not expressly determine that the transaction involved securities.

The Internal Business Disputes Exemption

With respect to the internal business disputes exception, the Court relied on prior North Carolina Supreme Court precedent that reasoned that the General Assembly’s enactment of section 75-1.1 was intended to target unfair and deceptive conduct between market participants. Based on that reasoning, the Supreme Court limited 75-1.1’s applications to prevent “intru[sion] into the internal operations of a single market participant.”

The Court of Appeals reasoned that the conduct in Bickley was limited to the internal dealings of two owners of a single business. Because the transaction did not involve any other market participant, the Court determined that that conduct fell outside of section 75-1.1’s scope.

The Securities Exemption

As an alternate basis for its decision, the Court opined that Bickley’s resale of his interest was “analogous” to a securities transaction and was therefore exempt from 75-1.1 liability.

Even though the Court did not expressly determine whether Bickley’s ownership interest in M3 (a limited liability company) was a “security,” the Court determined that the reasoning behind the securities exemption was equally relevant.

The Court indicated that the Supreme Court exempted securities from 75-1.1 liability because the issuance, redemption, and transfer of securities “merely work a change in ownership of the security itself” and are therefore not a “business activity.” In turn, because securities transaction are not business activities, they are not activities “in or affecting commerce,” which is an express requirement of section 75-1.1.

The Court of Appeals did not discuss the other main rational advanced by the Supreme Court for the securities exemption—that securities are subject to extensive statutory provisions and administrative regulation.

The Court went on to uphold the remainder of the plaintiff’s claims and the jury’s verdict.

Beyond Securities

In upholding the dismissal of the plaintiff’s 75-1.1. claim, the Court appears to have read the exceptions for internal business conduct expansively to cover conduct involving ownership issues of a company, even if the conduct may not involve the issuance of instruments that meet the technical definition of  securities. It will be interesting to see how broadly other courts apply the “internal” exemptions in other cases involving ownership matters in light of Bickley.

Author: George Sanderson

February 27, 2018
Posted in  75-1.1 Exemptions