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Conrad v. KOR Electronics, Inc.

California Court of Appeals, Fourth District, Third Division
Dec 30, 2011
G044457, G044682 (Cal. Ct. App. Dec. 30, 2011)

Opinion

NOT TO BE PUBLISHED

Appeal from orders of the Superior Court of Orange County No. 06CC07881, Gary L. Taylor, Temporary Judge. (Pursuant to Cal. Const., art. VI, § 21.)

The Rosen Law Firm, Laurence M. Rosen; Catanzarite Law Corporation and Kenneth J. Catanzarite for Plaintiff and Appellant.

Foley & Lardner, Sonia Salinas; Roger A. Lane, Courtney Worcester; DLA Piper, David F. Gross and Francesca Cicero for Defendants and Respondents.


OPINION

RYLAARSDAM, ACTING P. J.

Minority shareholder plaintiff David Conrad asserted derivative causes of action on behalf of KOR Electronics, Inc. (KOR) against defendants New Enterprise Associates IV, L.P. (NEA IV), Spectra Enterprise Associates, L.P. (Spectra), and KOR’s directors James Cole, Kevin Carnino, Albert Jicha, Eugene Havanec, Gregory George and Robert Kohler (KOR directors). The trial court entered judgment against plaintiff on all claims and granted defendants’ motions for attorney fees.

Plaintiff appeals from both the order awarding attorney fees and the denial of his motion to vacate that order. We consolidated the appeals. (Plaintiff and the other plaintiffs asserting direct causes of action separately appeal the underlying judgment in consolidated case Nos. G043715 and G044362.)

Plaintiff contends there was no legal basis to award attorney fees because his derivative claims asserted torts and were not “on a contract” within the meaning of Civil Code section 1717 (all further statutory references are to this code unless otherwise stated), he was not a party to any contract containing a fee provision, and the case the trial court relied on was wrongly decided. We reject these claims but agree with plaintiff the court erred in awarding fees to Cole and KOR and, as a result, improperly apportioned fees to the KOR directors. We reduce the fees awarded to the KOR directors to $249,004 and affirm the order in all other respects. By not addressing the arguments contained in his motion to vacate the award of fees to defendants, plaintiff has forfeited those issues. (Paulus v. Bob Lynch Ford (2006) 139 Cal.App.4th 659, 685.)

FACTS

After a series of events, irrelevant to this appeal but set forth in greater detail in our opinion in Alexandros, et al. v. Cole, et al. (Dec. 30, 2011, G043715, consol. with G044362) [nonpub. opn.]), dealing with the appeal from the underlying judgment, KOR entered a share repurchase transaction (transaction), in which it issued and sold new preferred stock and used the proceeds to purchase outstanding preferred stock from former preferred stockholders. The purchase agreement and the investor rights agreement of the transaction provide, “If any action at law or in equity is necessary to enforce or interpret the terms of this Agreement, the prevailing party shall be entitled to reasonable attorney[] fees, costs and necessary disbursements in addition to any other relief to which such party may be entitled.”

KOR issued promissory notes to the holders of the repurchased stock, including NEA IV, Spectra, and Carnino, as part of the consideration. The notes contain the following provision: “The Company (KOR) shall pay all costs and expenses, including reasonable attorney[] fees and expenses [NEA IV, Spectra, and Carnino] expend[] or incur[] in connection with the enforcement of this Note... or the protection or preservation of any rights....”

Carnino signed all of the above documents as President and CEO of KOR. Plaintiff was not a signatory on any of them.

Plaintiff and the minority shareholders sued defendants, alleging the transaction “unfairly and disproportionately transferred all the equity value of [p]laintiffs’ securities to the equity securities of the controlling shareholders and their affiliated entities in breach of their fiduciary duties owed to [p]laintiffs and other minority shareholders.” Although both direct and derivative causes of action were alleged, only the latter are relevant to this appeal.

In the derivative claims for breach of fiduciary duty, gross mismanagement, waste of corporate assets, and unjust enrichment, plaintiff, who replaced the original derivative plaintiff Vincent Battaglia, alleged defendants “intentional[ly] breach[ed] and/or reckless[ly] disregard[ed]... their fiduciary duties to [KOR]” as a result of the transaction, causing KOR substantial monetary damages. In his prayer, plaintiff requested, among other things, the “[c]ancel[ation of] the... [t]ransaction and restoring all parties... to the position each occupied prior to such transaction, including cancelling the... preferred shares and the $9[] million Note from [KOR].”

Following a trial, the court entered judgment against plaintiff and defendants moved for attorney fees. The KOR directors’ motion was based on section 1717. NEA IV and Spectra sought fees under that section and also on the basis plaintiff had “stepped directly into the shoes of KOR.”

At the hearing on the motions, defense counsel clarified they only sought attorney fees against plaintiff, and not the other plaintiffs, because the corporation would recover damages in a derivative action and the substantial benefit doctrine applied. The court agreed and awarded fees against plaintiff only on the derivative claims. It concluded the action, which “sought to reverse, rescind, or modify the... [t]ransaction, ” was “‘on a contract’” within section 1717’s broad meaning and that had plaintiff prevailed, he “would [have been] entitled to recover attorney fees under the “substantial benefit” theory and awarded fees to all defendants except Jicha, Hovanec, George, and Kohler because they were not parties to a contract.

As a separate basis, the court found plaintiff liable for fees based on the promissory notes, stating, “[plaintiff] did not sue on the notes, but his claim caused [NEA IV and Spectra] to defend the lawsuit in order to protect and preserve their notes. Thus, [NEA IV and Spectra] would be entitled to fees from KOR. Having ‘stepped into the shoes’ of KOR by bringing this derivative action, ... [plaintiff] is liable for attorney fees incurred by [NEA IV and Spectra].” The court awarded attorney fees in the amount of $747,012 to the KOR directors and $919,224 to NEA IV and Spectra.

DISCUSSION

1. Introduction

“‘On review of an award of attorney fees after trial, the normal standard of review is abuse of discretion. However, de novo review of such a trial court order is warranted where the determination of whether the criteria for an award of attorney fees... have been satisfied amounts to statutory construction and a question of law.’” (Connerly v. State Personnel Bd. (2006) 37 Cal.4th 1169, 1175.)

Attorney fees are not recoverable as costs unless authorized by statute or contract. (Code Civ. Pro., § 1021; Santisas v. Goodin (1998) 17 Cal.4th 599, 607, fn. 4.) A successful defendant may collect attorney fees from a plaintiff-shareholder under section 1717 if the derivative claims were on a contract containing an attorney fee clause. (Brusso v. Running Springs Country Club, Inc. (1991) 228 Cal.App.3d 92, 107-108 (Brusso).) Here, the trial court awarded fees under section 1717 based on its determination plaintiff’s action was “on a contract, ” i.e., the transaction. Because we agree, we need not address defendants’ alternative theory they were entitled to fees pursuant to the promissory notes signed by KOR, in whose shoes plaintiff had stepped.

2. Section 1717

Plaintiff asserts the court erred in awarding attorney fees under section 1717 because (1) his derivative causes of action for breach of fiduciary duty and unjust enrichment were tort-based and not “on a contract” within the meaning of section 1717, (2) he was not a party to any contract containing a fee provision, and (3) Brusso was wrongly decided. We disagree.

a. “On a Contract”

“‘It is difficult to draw definitively from case law any general rule regarding what actions and causes of action will be deemed to be ‘on a contract’ for purposes of... [section] 1717.’ [Citation.] Among the relevant factors are ‘the pleaded theories of recovery, the theories asserted and the evidence produced at trial, if any, and also any additional evidence submitted on the motion in order to identify the legal basis of the prevailing party’s recovery. [Citations.]’ [Citation.]” (Hyduke’s Valley Motors v. Lobel Financial Corp. (2010) 189 Cal.App.4th 430, 435.)

“‘Whether an action is based on contract or tort depends upon the nature of the right sued upon, not the form of the pleading or relief demanded. If based on breach of promise it is contractual; if based on breach of a noncontractual duty it is tortious. [Citation.] If unclear the action will be considered based on contract rather than tort. [Citation.] [¶] In the final analysis we look to the pleading to determine the nature of plaintiff’s claim.’ [Citation.]” (Kangarlou v. Progressive Title Co., Inc. (2005) 128 Cal.App.4th 1174, 1178-1179 [because breach of fiduciary duty arose out of escrow agreement, section 1717 entitled prevailing plaintiff to attorney fees].)

The pleadings demonstrate plaintiff’s derivative action was “on a contract, ” specifically the purchase and investor rights agreements of the transaction. The mere fact the operative complaint labeled the derivative causes of action as torts is not dispositive. As the trial court found, the gravamen of plaintiff’s action was to “reverse, rescind, or modify the... [t]ransaction.” Plaintiff has not shown this was error. He alleged defendants had breached their fiduciary duties to KOR by entering into the transaction and wasted corporate assets due to “improper policies established and executed, including the... [t]ransaction.” Among other things, he sought the “cancel[ation of] the... [t]ransaction and restoring all parties... to the position each occupied prior to such transaction, including cancelling the... preferred shares and the $9[] million Note from... [KOR].”

Although plaintiff is correct that a tort claim is not “on a contract, ” an action to “rescind [an] agreement between the parties... [is] not upon a cause of action in tort....” (Star Pacific Investments, Inc. v. Oro Hills Ranch, Inc. (1981) 121 Cal.App.3d 447, 461; see also Super 7 Motel Associates v. Wang (1993) 16 Cal.App.4th 541, 549 [although fraud action seeking damages sounds in tort and is not “on a contract” under section 1717 even if underlying transaction involved a contract containing an attorney fee provision, “where the plaintiff’s claim instead seeks rescission based on fraud, the courts have concluded such claim does sound in contract and permits the award of fees”].) The cases he cites, Santisas v. Goodin, supra, 17 Cal.4th 599, Reynolds Metals Co. v. Alperson (1979) 25 Cal.3d 124 (Reynolds), Stout v. Turney (1978) 22 Cal.3d 718, Loube v. Loube (1998) 64 Cal.App.4th 421, and McKenzie v. Aetna (1976) 55 Cal.App.3d 84, do not involve a party seeking to rescind a contract and are thus inapposite.

b. Nonparty to Contracts

Plaintiff maintains the court erred in awarding fees against him because he was not a party to any contract containing a fee provision. Brusso rejected the same contention, stating: “The remaining plaintiffs did not sign the contracts.... Nonetheless, they can still be held liable as nonsignatory plaintiffs for the payment of fees to signing defendants. [Citations.]... Defendants here were sued on contracts containing attorney[] fees provisions and were forced to defend the contract causes of action. It would be ‘extraordinarily inequitable’ to deny them attorney[] fees because plaintiffs who are not signatories chose to sue on the contracts in an action on behalf of the corporation when the corporation would not bring suit itself. [Citation.]” (Brusso, supra, 228 Cal.App.3d at pp. 109-110, fn. omitted.)

Brusso further observed “the nonsignatory plaintiffs would have had a right to receive fees under the substantial benefit doctrine had they prevailed. [Citation.]” (Brusso, supra, 228 Cal.App.3d at p. 111.) That doctrine “‘permits the shareholders to recover attorney[] fees in a successful derivative suit... as long as [the suit] provided a substantial benefit to the corporation.’ [Citations.]” (Ibid., fn. 7.) In other words, “had defendants lost, they would have been liable to plaintiffs for damages and fees under the contract, thereby creating a benefit to the corporation in the form of a common fund from which all plaintiffs could have recovered their fees. Therefore, ... the trial court correctly awarded fees to the signatory defendants from the nonsignatory plaintiffs under the mutuality theory of... section 1717, doing so on the grounds that, had plaintiffs prevailed, they would have been entitled to attorney[] fees pursuant to the substantial benefit doctrine. [Citations.]” (Id at p. 111.) The same analysis pertains to this case.

c. Brusso’s Validity

Plaintiff argues Brusso was wrongly decided because “[s]ection 1717 only provides for the corporation on whose behalf the derivative plaintiff sues to be liable for the attorney[] fees of the prevailing defendants -- because the corporation, not the derivative plaintiff, is the party to the contract with the defendants.” But his failure to provide reasoned argument or supporting authority forfeits the issue. (Badie v. Bank of America (1998) 67 Cal.App.4th 779, 784-785.)

Plaintiff also maintains Brusso’s award of fees was improper under Code of Civil Procedure section1021 because it was based on the substantial benefit rule, not section 1717, and thus was not rooted in a statute or contract. On the contrary, Brusso utilized both in reaching its result. After concluding its analysis under section 1717, Brusso went on to determine the nonsignatory plaintiffs would have been entitled to attorney fees had they prevailed in the suit based on the substantial benefit rule.

Plaintiff further asserts that rather than the substantial benefit rule, Brusso actuallyimplemented what he calls “‘the substantial detriment rule’” “by transferring the corporation’s detriment to the derivative plaintiffs (by making the derivative plaintiffs pay the defendants’ attorney[] fees that the corporation was liable to pay under [s]ection 1717).” That may have been the end result of Brusso’s analysis, but it does not alter the fact it relied on the substantial benefit rule to determine the nonsignatory plaintiffs would have been entitled to fees, thereby allowing fees to be awarded against them under the reciprocity provision of section 1717. We thus reject plaintiff’s contention Brusso legally erred because “[t]here is no statutory or judicial precedent for [its] creation and application of such a substantial detriment rule....”

3. Award of Attorney Fees to Cole and KOR and Apportionment

Plaintiff maintains that even if his claims were on a contract, the court erred in awarding Cole and KOR attorney fees and, as a result, improperly apportioned fees to the KOR directors. He is correct.

a. Cole

Plaintiff contends Cole was not entitled to attorney fees because he was not a party to any pertinent contract containing a fee provision. Defendants argue he did not have to be a party to a contract in order to recover fees. We are not persuaded.

Defendants analogize Cole’s status to the nonsignatory intervenors in Montgomery v. Bio-Med Specialties, Inc. (1986) 183 Cal.App.3d 1292 (Montgomery). There, two shareholders intervened on the corporation’s behalf in an action on a promissory note containing a fee clause and were awarded attorney fees under section 1717 as the prevailing parties, having been found to have “step[ped] into the shoes of defendant Bio-Med....” (Id. at p. 1295.) Montgomery rejected the plaintiffs’ argument the shareholders were not entitled to fees because they were nonsignatories to the note. It relied on Reynolds, supra, 25 Cal.3d at p. 128, which “interpreted... section 1717 to ‘provide a reciprocal remedy for a nonsignatory defendant, sued on a contract as if he were a party to it, when a plaintiff would clearly be entitled to attorney[] fees should he prevail in enforcing the contractual obligation against the defendant.’ [Citation.]” (Montgomery, supra, 183 Cal.App.3d at p. 1295, fn. omitted.)

The plaintiffs in Montgomery sought to distinguish Reynolds on basis the intervenors were not alleged to be the alter egos of the corporation, as in Reynolds. Montgomery held that failure was not fatal to section 1717’s application: “In order to protect the interests of the defendant corporation directly and their own interests as principal shareholders indirectly, [intervenors] were forced to intervene on behalf of Bio-Med, which included defending against a claim to attorney[] fees pursuant to the note.” (Montgomery, supra, 183 Cal.App.3d at p. 1295.) Here, in contrast to Reynolds and Montgomery, Cole was not acting on KOR’s behalf in defending himself. These cases thus do not aid him.

Defendants further argue the case is similar to Brusso, in that “it would be extraordinarily inequitable to deny... Colehis attorney[] fees -- because of [plaintiff’s] lawsuit, Cole had to incur significant attorney[] fees over five years to defend an action that KOR itself would not bring.” Equitable or not, “[a]ttorney fees may not be awarded absent statutory authorization or contractual agreement. [Citations.]” (Donner Management Company v. Schaffer (2006) 142 Cal.App.4th at p. 1303.) Because neither exists with respect to Cole, he is not entitled to fees.

b. KOR

As to KOR, plaintiff argues attorney fees were improperly awarded because he sued on its behalf and KOR was not a prevailing party as “[i]t is impossible for [KOR] to sue on behalf of [KOR], and yet against [KOR]. That would be akin to [KOR] suing [KOR].” He reasons “under Brusso’s application of the substantial benefit rule, a derivative plaintiff may be assigned to pay other defendants’ attorney[] fees where the corporation is liable to pay them under [s]ection 1717. Without a doubt, under [s]ection 1717, and consistent with basic logic, the corporation cannot be liable to pay itself its own attorney[] fees. It follows that the derivative plaintiff cannot be assigned a corporation’s liability to pay to itself the corporation’s own attorney[] fees.” The contention has merit.

Defendants respond that this overlooks the fact KOR had to indemnify the individual directors for their attorney fees under Corporations Code section 317 and the indemnification agreements between them. They claim Brusso addressed this issue by stating “[i]t would defeat these statutory aims [under Corporations Code section 317] to allow plaintiffs to avoid financial responsibility for the cost of defense by forcing defendants to seek reimbursement from the corporation....” (Brusso, supra, 228 Cal.App.3d at p. 104.) But KOR’s responsibility to indemnify its directors for their fees is a different issue from whether it is entitled to recover its own fees as a prevailing party on the derivative claims, which it was not. Brusso does not address this issue and defendants cite no other authority to support their assertion KOR’s indemnity obligations allow it to recover its own attorney fees incurred in a derivative action, forfeiting the issue. (Badie v. Bank of America, supra, 67 Cal.App.4th at pp. 784-785.)

c. Apportionment

Of the eight KOR directors, the trial court found only Cole, KOR and Carnino were entitled to recover attorney fees. Apportioning the amount of fees claimed, the court found “eligible fees are three-eighths (37.5%) of KOR’s $3,984,061 fee claim, or $1,494,023.” It further determined only 50 percent of that was recoverable ($747,012) because half of the fees requested related to the work performed in defending the direct claims. Plaintiff contends this apportionment was error because Cole and KOR were not entitled to fees and he is liable for only 50 percent of one-eighth of $3,984,061, or $249,004. He does not challenge the court’s method of apportioning fees.

Defendants agree that should we conclude Cole and KOR are not entitled to fees, we may reduce the $747,012 award by $249,004 for each defendant that we reverse. Because we reverse the fee awards to both Cole and KOR, the court’s award of fees to the KOR directors, of which only Carnino is entitled to recover, is reduced to $249,004.

DISPOSITION

The trial court’s order awarding attorney fees to respondents James Cole and KOR Electronics is reversed. Respondent Kevin M. Carnino is entitled to recover attorney fees in the amount of $249,004. In all other respects, the order awarding attorney fees, including $919,224 to NEA IV and Spectra, is affirmed. In the interests of justice, the parties shall bear their own costs on appeal.

WE CONCUR: BEDSWORTH, J., O’LEARY, J.


Summaries of

Conrad v. KOR Electronics, Inc.

California Court of Appeals, Fourth District, Third Division
Dec 30, 2011
G044457, G044682 (Cal. Ct. App. Dec. 30, 2011)
Case details for

Conrad v. KOR Electronics, Inc.

Case Details

Full title:DAVID CONRAD, Plaintiff and Appellant, v. KOR ELECTRONICS, INC., et al.…

Court:California Court of Appeals, Fourth District, Third Division

Date published: Dec 30, 2011

Citations

G044457, G044682 (Cal. Ct. App. Dec. 30, 2011)