Opinion
No. C 03-5023 CW, (Related Case) C 03-3657.
November 5, 2004
ORDER GRANTING IN PART AND DENYING IN PART DEFENDANTS' MOTION TO DISMISS SECOND AMENDED COMPLAINT
Defendants move to dismiss certain claims alleged in Plaintiff Bradley Sharp's second amended complaint. Defendants William A. Hall, H. William Jesse, Jr., and Richard S.F. Lehrberg move to dismiss Plaintiff's eighth claim for relief (negligent misrepresentation) pursuant to Federal Rule of Civil Procedure 12(b)(6). Plaintiff offers a statement of no opposition to this motion. Defendant William M. Hawkins III moves to dismiss Plaintiff's fourth (reformation on grounds of actual fraud), fifth (reformation on grounds of constructive fraud), seventh (deceit and actual misrepresentation) and eighth (negligent misrepresentation) claims for relief pursuant to Federal Rules of Civil Procedure 9(b) and 12(b)(6). Plaintiff opposes this motion. This matter was heard on October 1, 2004. Having considered all of the papers filed by the parties and oral argument on this motion, the Court GRANTS Defendants Hall, Jesse and Lehrberg's motion to dismiss and DENIES Defendant Hawkins' motion to dismiss.
BACKGROUND
Plaintiff's second amended complaint alleges as follows. Bradley Sharp is the trustee of the bankruptcy estate of The 3DO Company (3DO Cal). 3DO Cal, whose parent holding company and sole shareholder is also named The 3DO Company (3DO Del), developed, manufactured and sold video games prior to its filing for Chapter 11 bankruptcy on May 28, 2003 (the case was converted to Chapter 7 on November 7, 2003). From 1991 to August, 2003, Defendant Hawkins was chairman of the board of directors and chief executive officer of both 3DO Cal and 3DO Del, and owned over thirty-five percent of voting common stock in 3DO Del. From 1997 to late June, 2003, Defendants Hall and Jesse were directors of 3DO Del and of 3DO Cal. From November, 2001 to August, 2003, Defendant Lehrberg was a director of 3DO Del and of 3DO Cal (Hall, Jesse and Lehrberg will hereinafter be referred to as the "Directors").
In March, 2002, 3DO Cal became insolvent under the definition of federal and State law, meaning generally that its debts exceeded its assets and it could no longer afford to maintain operations absent large infusions of capital. In June, 2002, GE Capital Commercial Services agreed to extend a revolving line of credit to 3DO Cal of up to $15 million secured by 3DO Cal's receivables and inventory (but not by its intellectual property, its most valuable asset). As part of the deal, GE Capital agreed to provide further credit to 3DO Cal in exchange for $4.6 million in subordinated debt or equity that Hawkins agreed to provide himself.
Three months later, Hawkins refused to provide the $4.6 million, and instead insisted on personally loaning 3DO Cal $3 million to be secured by a lien on 3DO Cal's intellectual property. The Directors approved this transaction. On November 6, 2002, GE Capital informed 3DO Cal that, because it had failed to raise the additional equity as promised and lacked sufficient net worth, no further line of credit would be extended. Facing an increasingly bleak financial picture and without the prospect of further credit from GE Capital, the Directors accepted an additional $9 million loan from Hawkins that was also secured by a lien on 3DO Cal's intellectual property. Hawkins had effectively replaced GE Capital as 3DO Cal's senior secured lender and obtained a lien on 3DO Cal's most valuable asset. It was not in 3DO Cal's best interests to encumber its most valuable asset when it did not have to, and the company did not receive reasonably equivalent consideration from Hawkins in exchange for the lien on its intellectual property. Furthermore, given 3DO Cal's deteriorated financial situation, Hawkins and the Directors knew or should have known that further infusions of debt were not in 3DO Cal's best interests.
Thereafter, Hawkins agreed with 3DO Cal that the first $3 million of his loan would be converted to equity investment. Hawkins then made representations to creditors and public statements disclosing the conversion, and caused and permitted the company to file at least one report with the United States Securities and Exchange Committee detailing the reduction of 3DO Cal's purported debt to Hawkins from $12 million to $9 million. However, Hawkins later filed a proof of secured claim in the 3DO Cal bankruptcy case in which he disputed that the conversion ever took place, and he now claims that his secured debt is in fact the full $12 million.
For 3DO Cal's payroll period of May 17 through May 28, 2003, during which Hawkins and the Directors were discussing with legal counsel the possibility of filing for bankruptcy (and at a time when 3DO Cal had been insolvent for over one year), Defendants induced 3DO Cal employees to continue reporting to work by promising that they would be paid. When 3DO Cal filed for bankruptcy on May 28, it left over $535,000 in unpaid wages. Furthermore, during 3DO Cal's insolvency period, Defendants allowed employees to continue to accrue benefits such as paid time off and vacation pay that Defendants knew there was a substantial likelihood the company could never pay. During the fifteen months of 3DO Cal's insolvency prior to its declaration of bankruptcy, Defendants failed to take reasonable steps (e.g. layoffs and paying down benefits incrementally) to ensure 3DO Cal's ability to pay its substantial and increasing employee debt. Including unpaid wages, paid time off and vacation pay, 3DO Cal is indebted to its employees for over $1.7 million.
In response to (and in reliance upon) Defendants' misrepresentations and false promises, 3DO Cal, inter alia, encumbered the company's most valuable asset (its intellectual property), failed timely to seek advice regarding restructuring (and thereby protect its creditors), continued to incur operating expenses, and exposed itself to potential liability under federal and State employment and labor laws by failing to pay employee payroll and accrued benefits.
On August 6, 2003, the unsecured creditors' committee in 3DO Cal's Chapter 11 case filed a complaint in the bankruptcy court of this District both objecting to claims asserted by Hawkins against 3DO Cal's estate and asserting claims of its own against Hawkins. On October 23, 2003, the unsecured creditors' committee moved to withdraw the reference to the bankruptcy court. On November 7, 3DO Cal's Chapter 11 case was converted to Chapter 7 and Plaintiff was named trustee. Plaintiff filed an amended complaint on March 10, 2004 substituting himself as plaintiff, adding defendants (the Directors), and adding claims. On June 8, 2004, this Court granted Plaintiff's motion for withdrawal of reference but ruled that the bankruptcy court retained jurisdiction to resolve Hawkins' motion to dismiss Plaintiff's amended complaint. The bankruptcy court's memorandum decision, filed July 2, 2004, dismissed Plaintiff's fraud-based claims for relief (the fourth, fifth, seventh and eighth claims) but granted Plaintiff leave to amend those counts to include allegations regarding 3DO Cal's reliance on Hawkins' alleged misrepresentations. Plaintiff filed his second amended complaint on July 22, 2004. Both the Directors and Hawkins moved to dismiss the second amended complaint on August 9, 2004.
LEGAL STANDARD
A motion to dismiss for failure to state a claim will be denied unless it appears that the plaintiff can prove no set of facts which would entitle it to relief. Conley v. Gibson, 355 U.S. 41, 45-46 (1957); Fidelity Fin. Corp. v. Fed. Home Loan Bank of S.F., 792 F.2d 1432, 1435 (9th Cir. 1986). All material allegations in the complaint will be taken as true and construed in the light most favorable to the plaintiff. NL Indus., Inc. v. Kaplan, 792 F.2d 896, 898 (9th Cir. 1986).
A complaint must contain a "short and plain statement of the claim showing that the pleader is entitled to relief." Fed.R.Civ.P. 8(a). "Each averment of a pleading shall be simple, concise, and direct. No technical forms of pleading or motions are required." Fed.R.Civ.P. 8(e). These rules "do not require a claimant to set out in detail the facts upon which he bases his claim. To the contrary, all the Rules require is 'a short and plain statement of the claim' that will give the defendant fair notice of what the plaintiff's claim is and the grounds on which it rests." Conley, 355 U.S. at 47.
"In all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity." Fed.R.Civ.P. 9(b). The allegations must be "specific enough to give defendants notice of the particular misconduct which is alleged to constitute the fraud charged so that they can defend against the charge and not just deny that they have done anything wrong." Semegen v. Weidner, 780 F.2d 727, 731 (9th Cir. 1985). Statements of the time, place and nature of the alleged fraudulent activities are sufficient, Wool v. Tandem Computers, Inc., 818 F.2d 1433, 1439 (9th Cir. 1987), provided the plaintiff sets forth "what is false or misleading about a statement, and why it is false." In re GlenFed, Inc., Securities Litigation, 42 F.3d 1541, 1548 (9th Cir. 1994).
DISCUSSION
I. Directors' Motion to Dismiss
Defendant Directors move to dismiss the eighth claim for relief (negligent misrepresentation) in Plaintiff's second amended complaint. The Directors assert that, according to both California and Delaware law, a negligent misrepresentation claim requires as an essential element a showing of positive or affirmative representation. The Directors argue that the second amended complaint fails to allege any such representation on their part. At most, the Directors argue, the complaint alleges omissions or non-disclosures, for instance relating to 3DO Cal's inability to pay salaries and benefits, that standing alone are insufficient to sustain a claim for negligent misrepresentation.Byrum v. Brand, 219 Cal. App. 3d 926, 941-42 (1990); Brug v. Enstar Group, Inc., 755 F. Supp. 1247, 1259 (D. Del. 1991).
Plaintiff has filed a statement of no opposition to this motion to dismiss. The Court grants Directors' motion to dismiss the eighth claim for relief (negligent misrepresentation) in Plaintiff's second amended complaint.
II. Hawkins' Motion to Dismiss
A. Federal Rule of Civil Procedure 9(b)
Hawkins moves to dismiss the fourth, fifth, seventh and eighth claims for relief in Plaintiff's second amended complaint. These four fraud-based claims find their factual basis in Plaintiff's allegations regarding three misrepresentations purportedly made by Hawkins: (1) Hawkins' promise to pay $4.6 million in subordinated debt or equity to satisfy a loan from GE Capital, (2) Hawkins' promise to convert $3 million from loan to equity investment, and (3) Hawkins' representations to 3DO Cal employees that they should continue coming to work because the company would continue to pay their salaries and benefits.
"In all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity." Fed.R.Civ.P. 9(b). In Hawkins' moving papers, he asserts that Plaintiff has not plead the fraud allegations with sufficient particularity as required by Rule 9(b). Specifically, he argues that Plaintiff has not plead facts explaining why the alleged misrepresentations were false at the time they were made. Hawkins argues that merely alleging that a promise was not kept is not evidence that the promise was false when made.
Plaintiff argues that the law of the case doctrine should preclude Hawkins from re-litigating this issue. In the bankruptcy court's July 2, 2004 decision, that court "disagree[d] with Hawkins' contentions that [Plaintiff] has failed to describe the alleged misrepresentations with sufficient detail (including how they are misleading)." Bankr. Ct. Mem. Dec. at 3. The court ruled that, other than the reliance issue, counts four, five, seven and eight were sufficiently plead.
Plaintiff also argues that he has plead sufficient facts to allege that Hawkins never had any intention of keeping the promises inhering in the three alleged misrepresentations. In the Ninth Circuit, entering into an agreement "with the secret reservation not to fully perform it" is cognizable fraud.Walling v. Beverly Enters., 476 F.2d 393, 396 (9th Cir. 1973). As to each of Hawkins' three alleged misrepresentations, Plaintiff alleges that Hawkins never intended to perform what he promised to do. For instance, Hawkins argues that the fact that "3DO Cal owed [paid time off] or vacation pay to its employees is not evidence that any earlier alleged promise to pay was false when made." Hawkins Mot. to Dismiss at 5. However, Plaintiff does allege that, due to 3DO Cal's increasing indebtedness through May, 2003, Hawkins "[a]t all relevant times . . . knew there was substantial likelihood the indebtedness could not be repaid when employees departed or were terminated." Sec. Am. Compl. ¶¶ 46-47. Plaintiff also alleges that the circumstances surrounding Hawkins' alleged promises to pay $4.6 million in subordinated debt or equity and to convert a $3 million loan into equity indicate that he had no intention of keeping those promises when he made them.
Plaintiff has plead facts sufficient to support an allegation that Hawkins had no intention of fulfilling the promises that form the basis for the fraud-based claims.
B. Federal Rule of Civil Procedure 12(b)(6)
Hawkins also contends that the fourth (reformation on grounds of actual fraud) and fifth (reformation on grounds of constructive fraud) claims should be dismissed because they do not allege the requisite elements of reformation. The fourth and fifth claims of the second amended complaint both relate to Hawkins' alleged unfulfilled promise to convert the $3 million loan into an equity investment. A claim for the reformation of a contract should allege what the real agreement was, what the written agreement as reduced to writing was, and where the writing fails to embody the real agreement. Johnson v. Sun Realty Co., 138 Cal. App. 296, 301 (1934). Hawkins argues that the second amended complaint refers neither to a contract nor to where any contract differs from the alleged agreement to convert the $3 million.
Plaintiff's fourth and fifth claims do sufficiently plead facts to establish a reformation claim. Plaintiff specifically alleges that Hawkins agreed to convert the $3 million loan into equity investment. Plaintiff alleges that contracts between Hawkins and 3DO Cal relating to the full $12 million advance do not reflect that conversion. Plaintiff argues that this fact is evidenced by Hawkins' filing of a proof of claim for $12 million in the 3DO Cal bankruptcy case. Plaintiff has sufficiently plead his fourth and fifth claims.
CONCLUSION
Defendants' motion to dismiss Plaintiff's second amended complaint is GRANTED in part and DENIED in part. The Court grants Defendant Directors' motion to dismiss the eighth (negligent misrepresentation) claim for relief. The Court denies Defendant Hawkins' motion to dismiss the fourth (reformation on grounds of actual fraud), fifth (reformation on grounds of constructive fraud), seventh (deceit and actual misrepresentation) and eighth (negligent misrepresentation) claims for relief.
IT IS SO ORDERED.