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Section 75-1.1 Liability for Self-Dealing

Today’s post examines two recent decisions from the North Carolina Business Court, Vanguard Pai Lung, LLC v. Moody and Langley v. Autocraft, Inc. These decisions implicate two related exemptions from section 75-1.1 liability for intra-enterprise operations and conduct occurring in the employer-employee relationship.

The intra-enterprise exemption, rooted in the statute’s “in or affecting commerce” clause and explained more fully in the North Carolina Supreme Court’s White v. Thompson decision, recognizes that section 75-1.1 regulates “a business’s regular interactions with other market participants,” but not conduct “solely related to the internal operations” of the business.

The employment exemption is also based in the “in or affecting commerce” clause. The North Carolina Supreme Court’s Dalton v. Camp opinion recognized that duties “commonly associated with any employee,” absent special circumstances, are not “in or affecting commerce.” Though Dalton did not definitively rule out section 75-1.1 liability for conduct occurring in an employer-employee relationship, it is difficult to pursue such a claim.

Both of the cases discussed below involve self-dealing. In each, an employee forced his current employer to conduct business with the employee outside the business or with a different entity that the employee owned. In each case the court concluded that the self-dealing fell within one or possibly both of these exemptions to section 75-1.1.

Vanguard: A Section 75-1.1 Verdict for a Lease Procured Through Self-Dealing

The Vanguard case involved a dispute between the majority and minority members of a business that makes and sells high-speed circular knitting machines. Vanguard and its majority member sued the company’s minority member and former president and CEO, William Moody, and several entities operated by Mr. Moody. Among other claims, plaintiffs brought a section 75-1.1 claim.

According to the plaintiffs, Mr. Moody carried out “a long-running scheme of self-dealing and other misconduct designed to benefit himself, his family, and his friends.”  The plaintiffs tried the case to a jury, presenting evidence that Mr. Moody caused Vanguard to hire and pay excessive salaries to his family and friends—at least one of whom “had no real job and performed no work for Vanguard.”  Evidence also showed that Mr. Moody charged personal expenses to Vanguard’s company credit card, used company money to pay for Carolina Panthers tickets, and kept company equipment for his own use after he was terminated.

Mr. Moody also caused Vanguard to enter into a lease with Nova Wingate, a company that Mr. Moody solely owned and controlled, to rent space to store knitting machines in a warehouse that Nova Wingate owned. Other than this lease, the Court observed, “Nova Wingate conducts no real business, has no separate identity, and does not exist apart from Mr. Moody in any meaningful sense.”

After a six-day trial, the jury sided with the plaintiffs. The jury awarded compensatory and punitive damages—including $50,000 for defendants’ breach of section 75-1.1. The section 75-1.1 claim and damages were premised on the self-dealing lease agreement between Vanguard and Nova Wingate.

After judgment on the verdict was entered, Mr. Moody and Nova Wingate moved for judgment notwithstanding the verdict; that is, they asked the Court to overturn part of the jury’s verdict. The defendants argued that the lease transaction between Vanguard and Nova Wingate was “solely related to the internal operations” of Vanguard and, therefore, exempt from section 75-1.1 under the intra-enterprise doctrine.

In response, the plaintiffs analogized the facts to a 1999 case called Sara Lee Corp. v. Carter. A short discussion of Sara Lee is helpful to understand this argument.

Side Bar: The Supreme Court’s Sara Lee Corp. v. Carter Decision

In Sara Lee, a company brought a section 75-1.1 claim against an employee who was the purchasing agent responsible for buying IT goods and services for the company. Unbeknownst to the company, Sara Lee, the employee purchased those goods and services at inflated prices from several businesses that he created after he started working for Sara Lee. The Sara Lee court held that the employee could be liable to his employer on claims for fraud, breach of fiduciary duty, and breach of section 75-1.1.

Sara Lee is best known not in its own right, but rather by how a later case, Dalton v. Camp, discussed and distinguished Sara Lee. Dalton announced the proposition that an employer-employee relationship ordinarily will not give rise to fiduciary duties or section 75-1.1 liability. In announcing these holdings, Dalton distinguished the facts in Sara Lee from those in an ordinary employer-employee relationship. Dalton explained that the employee in Sara Lee, as a purchasing agent, had special and unique duties that were breached when the employee purchased goods and services at inflated prices from businesses that the employee owned. This latter point, the Dalton court reasoned, made the conduct “in or affecting commerce” for section 75-1.1 purposes, as it involved a buyer-seller relationship between two separate market participants.

Now, Back to Vanguard: A Self-Dealing Lease Is Not “In or Affecting Commerce”

The Vanguard plaintiffs argued that Mr. Moody’s conduct was “in or affecting commerce” for the same reasons as the employee’s conduct in Sara Lee—Mr. Moody caused Vanguard to contract with another company in which he held an undisclosed interest.

The Court rejected the plaintiffs’ argument, granted Mr. Moody’s and Nova Wingate’s motion for JNOV, and set aside the jury’s verdict on the section 75-1.1 claim. The Court explained that Sara Lee creates an exception to the judicially recognized employment exemption—that conduct within the employer-employee relationship typically does fall within section 75-1.1’s scope. Sara Lee did not, according to the Court, create an exception to the intra-enterprise exemption.

The Court concluded that Mr. Moody’s use of Nova Wingate—effectively his alter ego—to contract with Vanguard was still an interaction among the principals of Vanguard. The misconduct, thus, was “more properly classified as a misappropriation of corporate funds within a single entity rather than commercial transactions between separate market participants ‘in or affecting commerce.’”  The Court’s holding was based on Alexander v. Alexander, an earlier case that held that a shareholder’s payment of “rent” from a corporation to himself (though not an entity that he controlled) to store trucks was not “in or affecting commerce” under section 75-1.1.

Presumably, Mr. Moody, as Vanguard’s president and CEO, had the authority to enter leases for the company, just as the employee in Sara Lee had the authority as a purchasing agent to procure products and services for his employer. There was also no dispute that Nova Wingate actually did store Vanguard’s knitting machines in its warehouse, similar to how the employee’s companies in Sara Lee provided products and services to his employer (albeit at inflated prices).

Unlike the employee in Sara Lee, Mr. Moody’s conduct fell outside of section 75-1.1’s reach. Perhaps the distinguishing feature is that Mr. Moody was a minority owner of his employer, Vanguard. More likely, though, is that the facts in Vanguard matched up very closely with Alexander, a case (albeit from the Court of Appeals) decided after Sara Lee.

Langley: A Similar Result—Self-Dealing Is Not “In or Affecting Commerce”

In our second case, Langley, a company called Autocraft hired Mr. Langley to manage its business. Mr. Langley oversaw employees and customer and supplier relationships. He also had access to confidential business information. Mr. Langley was not an Autocraft shareholder.

While still working for Autocraft, Mr. Langley established a competing business, LBM, and allegedly funneled work from Autocraft to LBM. Mr. Langley also allegedly undermined Autocraft’s relationships with its employees and encouraged them to leave the company to work for his new venture.

Autocraft asserted claims against Mr. Langley for breach of fiduciary duty, constructive fraud, and violation of section 75-1.1. The crux of Autocraft’s claims centered on Mr. Langley competing against Autocraft while it still employed him. (As an aside, there was no mention of Mr. Langley having a covenant not to compete with Autocraft or an agreement not to solicit its employees or customers.)

Mr. Langley, relying on Dalton v. Camp, argued that as a mere employee he did not owe Autocraft any fiduciary duties. Autocraft countered by pointing to Sara Lee. The Court noted that Sara Lee focused primarily on section 75-1.1, not fiduciary duties. The employee in Sara Lee was, through entities he owned, acting as a seller of parts and services to his employer, so his conduct was “in or affecting commerce.” Because Mr. Langley was not acting as a vendor to Autocraft, the Court reasoned that Sara Lee was inapplicable.

Most of the alleged conduct supporting Autocraft’s section 75-1.1 claim was internal to the company, such as Mr. Langley using Autocraft’s confidential information to compete with the company, sabotaging Autocraft’s relationships with its customers and employees, and the like. But Autocraft also alleged that Mr. Langley engaged in self-dealing (though it did not give further details on this).

Addressing the section 75-1.1 claim, the Court seized on the fact “that the wrongs Langley allegedly committed are alleged to have harmed Autocraft itself, not external market participants.”  Though a separate entity controlled by Mr. Langley, LBM, would benefit from the allegedly wrongful conduct, that did not remove the case from the intra-enterprise exception.

The Court cited another Business Court decision, Howard v. IOMAXIS, LLC, which stated that the distinction between “intracompany and intercompany disputes” came down to “the nature of the second entity’s involvement with the first.”  If the second entity or “the flow of commerce between the first and second entities” is harmed, then the conduct is “in or affecting commerce” under section 75-1.1. If, however, “the second entity is used merely as an instrument or ‘shell’ to facilitate harm within the first entity, the dispute is intracorporate” and falls outside of section 75-1.1’s reach.

How does Sara Lee fit within this rubric, though?  In that case, the harm was to the first entity, the employer, because the outside entities profited handsomely from the inflated prices that they charged. It’s also unclear how commerce between the employer and the employee-owned entities could have been harmed.

Just as it did with its fiduciary-duty claim, Autocraft rested on Sara Lee to support its section 75-1.1 claim. The Court, however, noted that the employee in that case did more than just harm his employer; he “was also a vendor who had engaged with the company in commercial transactions in the marketplace,” which the Court called an “unusual fact scenario.” Notably, the Court also discussed Dalton, which applied the employee-employer exemption, and cited another case, Buie v. Daniel International, which first recognized the exemption.

Ultimately, the Court concluded that the facts in Autocraft did not fit the Sara Lee mold, so it dismissed Autocraft’s section 75-1.1 claim.

So, When Can Self-Dealing Support a Section 75-1.1 Claim?

Sara Lee, which has not been overruled, arguably allows a company to sue one of its employees or officers (or entities they control) for engaging in self-dealing transactions involving the buying and selling of goods or services.

Unless it was entirely fraudulent, meaning that no goods or services were ever provided, a self-dealing transaction would seemingly always involve exchanging goods, services, or other benefits, and would therefore qualify as commerce. However, the modern trend—as illustrated by Vanguard and Langley—is for courts to find that most wrongdoing, including self-dealing, that employees, officers, or corporate fiduciaries inflict on their employers falls outside of section 75-1.1’s ambit.

September 27, 2023 Steven A. Scoggan Thomas H. Segars
Posted in  Other 75-1.1 Issues