The North Carolina Court of Appeals recently issued an opinion regarding governmental immunity in Flomeh-Mawutor v. City of Winston-Salem. While the decision may not chart new territory, it offers a number of insights into local government immunity, including the nature of economic development activities, the pleading requirements for waiver of immunity, and the applicability of contract law principles.

Factual Background

The plaintiffs in Flomeh-Mawutor, three individuals conducting business as a local company, applied for a loan of $100,000 through the City of Winston-Salem’s (“City”) small business loan program. The City’s federally funded program is designed to “address the problem of urban decline within the City by focusing on revitalization, development, and/or redevelopment” of certain areas, as defined by the U.S. Department of Housing and Urban Development (“HUD”). One of the plaintiffs purportedly received verbal confirmation from a City employee that their loan application had been approved and that a letter of approval was forthcoming. According to the plaintiffs, this City employee was “in routine communication” with the plaintiffs, providing repeated assurances that the loan would close. Several months later, the City sent the plaintiffs a letter conditionally approving the loan and establishing preliminary loan terms. The plaintiffs eventually signed the loan agreement with the City nearly one year after they originally applied for the loan, and the City disbursed the funds to the plaintiffs the next month.

Claiming to have lost “significant business opportunities and goodwill as a result of the delay in their receipt of the [loan] funds,” the plaintiffs filed suit against the City. The lawsuit alleged breach of contract, negligent misrepresentation, and negligent hiring and retention. The City raised the defense of governmental immunity in its answer and moved for summary judgment. The trial court granted the City’s motion and dismissed the plaintiffs’ claims. The plaintiffs then appealed.

Governmental v. Proprietary Function Analysis

The Court of Appeals first considered whether the City was entitled to governmental immunity from claims of negligence in its operation of the small business loan program. Under the doctrine of governmental immunity, a local government unit is immune from suit for the negligence of its employees in the exercise of a governmental function, absent some waiver of immunity. Such immunity does not apply, however, if the claim against a local government arises from the performance of a “proprietary” function. The North Carolina Supreme Court has described a governmental function as an activity that is “discretionary, political, legislative, or public in nature and performed for the public good [on] behalf of the State rather than for itself, while a proprietary function is one that is commercial or chiefly for the private advantage of the compact community.” Providence Volunteer Fire Dep’t, Inc. v. Town of Weddington, 382 N.C. 199, 212 (2022) (cleaned up).

In Flomeh-Mawutor, the Court of Appeals engaged in the three-part inquiry established in Estate of Williams v. Pasquotank Cnty. Parks & Recreation Dep’t, 366 N.C. 195 (2012), to determine whether the City’s small business loan to the plaintiffs was governmental or proprietary in nature. That framework, in short, is as follows:

• Whether, and to what degree, the legislature has designated the specific activity that led to the plaintiff’s injury as a governmental or proprietary function.
• Whether the undertaking is one that only a governmental agency could perform.
• If necessary, consideration of additional factors:
  • Whether the service is one traditionally provided by a governmental entity;
  • Whether a substantial fee is charged for the service provided; and
  • Whether the fee does more than simply cover the operating costs of the service provider.

In this case, on step one, “whether, and to what degree, the legislature has addressed the issue,” the Court reasoned that the legislature’s grant of authority to local governments “to engage in, to accept federal and State grants and loans for, and to appropriate and expend funds for community development programs and activities” was “clearly relevant.” However, the Court concluded the legislature’s designation was not determinative because “the legislature has not deemed all urban redevelopment and downtown revitalization projects governmental functions that are immune from suit.” Slip op. at 10-11.

As for the second prong—whether the activity is one in which only a governmental agency could engage—the Court again reserved judgment. First, the Court explained that “whether the loan at issue constituted governmental or proprietary activity depends on how narrowly the activity is defined.” Second, the Court observed that it is increasingly difficult to identify services that can solely be rendered by the government, where “many services once thought to be the sole purview of the public sector have been privatized in full or in part.” The City argued that its loaning of funds through its federally funded small business program was “necessarily governmental” because only governmental entities are eligible for this type of HUD block grant. The plaintiffs, on the other hand, contended that while the receipt of federal funds may constitute governmental activity, the act of loaning those funds is proprietary in nature. Slip op. at 11-12.

The Court proceeded to the final step of the Williams inquiry—a list of additional, non-exhaustive factors. The Court was persuaded by the City’s argument at this stage: (1) the federally funded program is one only a governmental entity could administer; (2) the loan program only serves businesses that cannot secure loans from traditional, private lenders; and (3) the program was designed to operate at a loss.

The Court’s Holding

The Court concluded that the City’s provision of the small business loan in this case constituted governmental activity, such that the City was entitled to governmental immunity. The Court then held that the City had not waived its immunity as to the tort claims because the plaintiffs failed to allege waiver of immunity in their complaint and the City’s risk manager swore under oath that the City had not purchased liability insurance to cover the claims alleged. As for the remaining breach of contract claim, the Court determined that the City’s letter of conditional approval of the loan did not constitute a valid contract, so the City had not waived its governmental immunity from suit on this claim either. Ultimately, the Court affirmed the trial court’s order granting summary judgment to the City.

Immunity Insights

Provision of a small business loan classified as governmental, rather than proprietary, function? Based on the outcome of the case, one might conclude that the operation of a federally funded small business loan program specifically and economic development generally constitute governmental activities for purposes of governmental immunity. Yet, the Court was careful to narrowly construe its holding on this point. The Court distinguished the economic development activity at issue in this case—provision of a small business loan—from the economic redevelopment activity classified as governmental in a North Carolina Supreme Court case, Meinck v. City of Gastonia, 371 N.C. 497 (2018)—the purchase and lease of an historic building. In doing so, the Court of Appeals heeded Meinck’s warning that “the legislature has not deemed all urban redevelopment and downtown revitalization projects governmental functions that are immune from suit.” It also followed guidance from the Supreme Court that “even when the legislature has designated a general activity, the question remains whether the specific activity at issue, in this case and under these circumstances, is a governmental function.” Nevertheless, this Court’s classification of the provision of a small business loan as a governmental activity, read in conjunction with Meinck’s treatment of the purchase and lease of an historic building for redevelopment purposes as a governmental activity, may provide persuasive authority for governmental immunity in other economic (re)development contexts.

Pleading requirements for waiver of immunity. By statute, a city may waive its immunity through, among other things, the purchase of liability insurance. In this case, the City’s risk manager attested that the City had “neither purchased nor had in effect any liability insurance to cover such claims as alleged.” Further, the plaintiffs failed to allege waiver of governmental immunity in their complaint. The general rule is that, to overcome a defense of governmental immunity to a claim based in tort, a complaint must specifically allege a waiver of governmental immunity. Wray v. City of Greensboro, 370 N.C. 41, 47 (2017). Otherwise, the complaint fails to state a cause of action. Id. Yet, this strict pleading requirement does not apply to contract claims. Instead, an allegation of a valid contract alone is sufficient to allege waiver of governmental immunity because the waiver is “implied, and effectively alleged, when the plaintiff pleads a contract claim.” Slip op. at 14. Here, the Court determined that there was no valid contract, so the City had not waived its governmental immunity with respect to the breach of contract claim. As always, parties to litigation alleging governmental liability should pay careful attention to allegations of waiver in the pleadings. Former School of Government faculty, (now) Justice Trey Allen, wrote more about pleading waiver of governmental immunity here.

Basic contract law principles apply. Contract claims raise “unique issues” in the context of governmental immunity. Slip op. at 6. Whenever a local government, through its authorized officers and agencies, enters into a valid contract, the unit “implicitly consents to be sued for damages on the contract in the event it breaches the contract.” Slip op. at 14. Still, the plaintiffs failed to clear the lower hurdle in this case—alleging and establishing a valid contract. Though the plaintiffs did not identify or describe the purported contract in their complaint, the Court ascertained from discovery and testimony that the conditional approval letter was the “contract” they alleged had been breached. The Court held that the letter did not constitute a valid contract because the City’s small business development specialist did not possess the actual authority to bind the City to a contract. Those dealing with local governments are charged with notice of “the extent of the power and any restrictions imposed” because the “scope of such authority is a matter of public record.” Slip. op. at 15. Under basic principles of contract law, it is also unlikely that a court would view a letter of conditional approval with preliminary loan terms as a valid contract, particularly where the parties later execute a loan agreement.