To Catch a Leprechaun: Our Continuing Quest for Certainty on the Application of the Economic-Loss Rule to Unfair and Deceptive Trade Practices Claims
For St. Patrick’s Day, my kids always make elaborate leprechaun traps to try and catch the leprechaun. If they catch him, they get to keep his pot of gold from the end of the rainbow.
As luck would have it, March also brought a decision from Chief Judge Richard E. Myers II in the Eastern District of North Carolina that considered the application of the economic-loss rule to section 75-1.1 claims. We have previously explored this subject in detail (here, here, here, here, and here).
This post explores Judge Myers’s discussion of the interplay between the economic-loss rule and section 75-1.1 in JTH Tax LLC v. CMB Tax Service, LLC. Much like I warn the kids every year that they might not catch the leprechaun, Judge Myers explained to the litigants that North Carolina has failed to provide clear guidance on applying the economic-loss rule to section 75-1.1 claims. Without precedent on that issue, Judge Myers instead considered whether the allegations plausibly stated a section 75-1.1 claim. In so doing, Judge Myers also provided helpful direction on how a breach of contract can be repackaged with substantial aggravating factors to constitute a section 75-1.1 claim.
From Lucky Charms to Getting Pinched
Apropos as we near April 15, JTH Tax involved a dispute between a tax company and its franchisee.
Plaintiff Liberty is in the tax preparation business. Liberty franchises to area representatives, allowing the area representatives to use Liberty’s name and system for tax preparation services.
From 2015-2017, Defendant’s area representatives signed several franchise agreements with Liberty for the rights to conduct the tax preparation business in ten territories.
Defendants were successful. Their operation became one of Liberty’s most successful franchisees.
Meanwhile, the DOJ began investigating Liberty for fraud (though not in the Defendants’ locations). In 2017, the Liberty founder and CEO was fired, apparently as a result of that investigation.
In January 2021, Defendants were hacked, and the hackers modified the tax returns of Defendants’ customers. Defendants sought help from Liberty, but Liberty blamed Defendants for the attack.
In February 2021, Liberty notified Defendants that it had received anonymous complaints about Defendants’ practices. Liberty ultimately terminated the franchise agreements based on alleged misconduct by Defendants. Liberty canceled the agreements and locked Defendants out of the franchises.
Defendants denied the allegations. Defendants believed that Liberty trumped the allegations as a pretext to take over Defendants’ successful operations.
Liberty sued Defendants for breaches of franchise agreements and restrictive covenant obligations. Defendants counterclaimed and included a section 75-1.1 claim. Liberty moved to dismiss the counterclaims.
Still Looking for the Four-Leaf Clover
Defendants premised their section 75-1.1 counterclaim on Liberty’s alleged misappropriation of their franchises, seizure of their property, and defamatory statements by Liberty.
Liberty moved to dismiss because the parties had a valid contract, and the counterclaim sought recovery for purely economic loss. Liberty argued that the economic-loss rule should bar the section 75.1.1 counterclaim.
In its motion, Liberty relied on, an interesting opinion in the history of North Carolina’s consideration of this issue. In Bradley Woodcroft, the North Carolina Court of Appeals reversed the dismissal of a section 75-1.1 claim because the claim was “factually interwoven” with allegations of fraud, and “while claims for negligence are barred by the economic-loss rule where a valid contract exists between the litigants, claims for fraud are not so barred.”
When we examined the North Carolina Court of Appeals’ decision in Bradley Woodcroft, we noted that the case could be read to support the idea that breaches of promises in an oral contract could support a fraud claim (and thereby open the door to a section 75-1.1 claim). But Judge Myers read Bradley Woodcroft more narrowly, finding that it held only that fraud claims are not barred by the economic-loss rule and did not address the application to section 75-1.1 claims.
Judge Myers also reviewed the history of the economic-loss rule more generally, including the Fourth Circuit’s decision in Legacy Data Access, Inc. v. Cadrillion, LLC. You may recall that in 2018, Judge Whitney relied on Legacy Data in applying the economic-loss rule to bar a section 75-1.1 claim (creating a little more certainty in the Western District of North Carolina).
But Judge Myers did not follow Judge Whitney. Instead, Judge Myers noted the lack of any precedent from North Carolina state courts on whether the rule applies to a section 75-1.1 claim.
In the absence of guidance on that issue, Judge Myers considered whether the section 75-1.1 claim had been adequately pleaded. Defendants alleged the same conduct to support both the contract and the section 75-1.1 counterclaims, so Judge Myers considered whether Defendants sufficiently alleged substantially aggravating circumstances to allow the section 75-1.1 claim to proceed.
Defendants alleged that Liberty did not seriously investigate the anonymous allegations against Defendants. Instead, Liberty conducted a sham review in order to seize the Defendants’ business and cover up Liberty’s own misconduct that led to the ouster of its CEO.
Judge Myers found those allegations to be sufficiently aggravating to allow the section 75-1.1 claim to proceed.
The End of Rainbow
We have been waiting for direction on the economic-loss rule for a long time.
Many contract disputes also include a tagalong section 75-1.1 claim. Business Court decisions are appealed directly to the North Carolina Supreme Court.
Under these circumstances, we should receive some guidance on this issue at some point in the near future.
But I recognize that my certainty sounds just like my kids: surely, this year we will catch the leprechaun!
Author: Jeremy Falcone