Opinion
A145544
05-01-2018
LEFTY, LLC, Plaintiff and Appellant, v. DANIEL MACCHIARINI et al., Defendants and Respondents.
ORDER MODIFYING OPINION AND DENYING REHEARING
[NO CHANGE IN JUDGMENT] BY THE COURT: It is ordered that the opinion filed herein on May 1, 2018, be modified as follows:
1. On page 6, last paragraph, after the words, "California Civil Code section 1671", add the words "(section 1671)" so that the sentence reads:
California Civil Code section 1671 (section 1671), subdivision (b) governs whether liquidated damage clauses are enforceable, stating that "a provision in a contract liquidating the damages for the breach of the contract is valid unless the party seeking to invalidate the provision establishes that the provision was unreasonable under the circumstances existing at the time the contract was made.
2. On page 8, in the second full paragraph, before the sentence beginning "Lefty 'd[id] not dispute", insert the words: "In its briefing in the trial court," so that the sentence reads:
In its briefing in the trial court, Lefty "d[id] not dispute that [respondents] may have anticipated various costs and liabilities that could result if Lefty failed to prepare the tax returns and pay back taxes . . . includ[ing] . . . unpaid taxes, as well as fines, penalties and fees ($15,000-30,000), hiring accountants to prepare and file the tax returns ($5,000-15,000) and defending audits by tax authorities ($25,000-40,000)."
3. Also on page 8, at the end of the second full paragraph, add footnote 2 at the end of the sentence reading "and defending audits by tax authorities ($25,000-40,000).' " Footnote 2 shall read:
2 In a petition for rehearing, Lefty argues that the quoted language did not amount to a concession or judicial admission by him because it was contained in a brief filed in the trial court rather than in his trial testimony. (See Haynes v. Hunt (1962) 208 Cal.App.2d 331, 335.) We disagree that counsel on appeal may take a factual position diametrically opposed to that asserted by the same counsel in briefing in the trial court. For instance, in Fassberg Construction Co. v. Housing Authority of City of Los Angeles (2007) 152 Cal.App.4th 720, 752, counsel's statement in open court on a disputed factual issue was deemed a judicial admission where it was an "unambiguous concession of a matter then at issue and was not made improvidently or unguardedly." Indeed, because the statement here was one of fact, not simply a legal argument, we treat it as a judicial admission. (See Fibreboard Paper Products Corp. v. East Bay Union of Machinists (1964) 227 Cal.App.2d 675, 709 [to be considered a binding judicial admission "the declaration or utterance must be one of fact and not a conclusion of law, opinion, legal contention, or argument"].) Significantly, Lefty's counsel did not disavow the statement in his trial court briefing at any time before our opinion issued, and only raised a claim of inadvertent error for the first time on petition for rehearing. But even assuming for purposes of argument that we should have ignored the quoted admission, it would not have changed our holding that the liquidated damages clause is enforceable. (See fn. 3, post.)
4. On page 8, in the middle of the last full paragraph, after the words, "Here, $85,000 in anticipated damages", add footnote 3, which shall read:
3 On rehearing, building on the incorrect premise that we should not have relied on a statement made by trial counsel in a brief
There is no change in the judgment. Lefty's petition for rehearing is denied. (Streeter, Acting P.J., Reardon, J., and Schulman, J. participated in the decision.) Dated: __________(see fn. 2, ante), Lefty argues that, without this concession, it was improper to include the cost of defending audits by tax authorities ($25,000-40,000) as an anticipated source of damages due to breach of the Note. Rather, Lefty suggests, we should have considered those damages to have been anticipated based only on Coyle's misconduct that predated the Note, and, with that reduction, the undisputed anticipated damages were somewhere in the vicinity of $45,000 rather than $85,000. But even if we used Lefty's proposed calculation, we would still find the liquidated damages clause enforceable. There is no bright line mathematical formula to determine whether a liquidated damages clause is in fact a penalty. The ratio here is roughly twice the undisputed anticipated damages, not nearly approaching the more than three times ratio found to be a penalty in Greentree, supra, 163 Cal.App.4th at page 500. The arguments advanced by Lefty in his petition for rehearing do not change our conclusion that the liquidated damages did not so far exceed the reasonably anticipated damages as to render the clause a penalty.
Judge of the Superior Court of California, City and County of San Francisco, assigned by the Chief Justice pursuant to article VI, section 6 of the California Constitution.
/s/_________, P.J.
NOT TO BE PUBLISHED IN OFFICIAL REPORTS
California Rules of Court, rule 8.1115(a), prohibits courts and parties from citing or relying on opinions not certified for publication or ordered published, except as specified by rule 8.1115(b). This opinion has not been certified for publication or ordered published for purposes of rule 8.1115. (San Francisco County Super. Ct. No. CGC-14-539762)
Appellant Lefty, LLC (Lefty) appeals from an adverse judgment against it following a bench trial, asserting the trial court erred in enforcing what it contends is an invalid liquidated damages clause. Lefty advances two arguments on appeal: (1) the trial court improperly evaluated the reasonableness of the liquidated damages amount by looking in hindsight to the actual damages suffered, not to the anticipated damages at the time the clause was agreed to, and (2) even if the trial court correctly looked to anticipated damages, it improperly evaluated the reasonableness of liquidated damages by including certain costs that were not eligible for inclusion in its calculation of anticipated damages. We see no merit to either argument and therefore affirm.
I. BACKGROUND
The dispute in this case arises out of a series of transfers of ownership interest in a commercial unit that is part of a mixed-use property (the Property) in San Francisco. Located at 1540-1544 Grant Avenue, the Property is owned under a Tenants in Common Agreement (TIC). On the ground floor of the Property is the above noted commercial unit; below that, there is a basement; and above the commercial unit are four residential units on the second floor. The commercial unit is owned by a limited liability company known as The Cellar, LLC (The Cellar), which respondent Daniel Macchiarini operates as a jewelry store.
Approximately half the interest in The Cellar was owned by W.B. Coyle, an individual not directly party to this action, who in 2009 transferred that interest to his mother, Louisa Trifiletti. In 2012, Trifiletti transferred her interest in The Cellar to another limited liability company, Lefty, the appellant in this action, an entity which she owned and controlled, and for which Coyle served as acting manager. The remaining half interest in The Cellar was owned by Macchiarini and Joan Mankin.
Originally, Coyle was also the manager for the TIC. His duties included collecting and managing monthly fees for the mortgage, taxes, insurance, and maintenance. Part of his duties included making reports to the other tenants in common that described his actions as manager, payment of property taxes, and so forth. In addition, he was in charge of managing the finances of The Cellar, where his responsibilities included doing the books, paying and collecting necessary fees and costs, and paying taxes.
In 2011, one of the TIC owners discovered there were four years' worth of past property taxes due on the Property amounting to tens of thousands of dollars, which Coyle had failed to pay despite his representation to the contrary to the TIC owners and despite his collecting money for that purpose from the tenants over those four years. Distressed by this discovery, the TIC owners terminated Coyle as the manager.
Afraid of the ramifications of continuing to be involved with Coyle, Macchiarini negotiated an agreement under which he and Mankin would buy out Trifiletti's, and later Lefty's, interest in The Cellar. The agreed-upon, and still undisputed, price for the transfer of interest was $293,519, which was paid as follows: (1) $100,000 in cash; (2) Macchiarini assumed $110,000 of Lefty's debt; and (3) the remaining $83,519 was secured by a promissory note that included an interest rate of 7.9 percent per year. Notably, the promissory note was subject to a condition, set forth in its Paragraph Four, under which Lefty was to prepare the tax returns for 2008 through 2011 on behalf of The Cellar, and also pay the taxes due for those years, by February 25, 2013. If Lefty failed to do so, Paragraph Four provided that the promissory note would become null and void.
Beginning from the transaction date of January 25, 2013, the promissory note called for monthly interest-only payments of $549.83, and the maturity date would be no later than December 31, 2013.
Macchiarini testified at trial that he specifically negotiated for Paragraph Four, explaining his thinking as follows. First, having learned about the years of fraud Coyle had committed as manager of the TIC, and subsequently having learned about ten other similar fraud actions initiated by owners of other San Francisco TICs against Coyle, Macchiarini did not trust him to prepare and pay the taxes on good faith alone. Second, Macchiarini knew if he bought out Lefty's interest in The Cellar and Lefty failed to pay the taxes, the responsibility for paying those taxes would fall to him. This was particularly troubling considering Coyle had been managing The Cellar for the past four years, keeping Macchiarini effectively in the dark as to what was owed, how those taxes had been calculated, and what Coyle had reported to the California Franchise Tax Board and Internal Revenue Service (IRS), among other things. Needless to say, Macchiarini was also concerned that he would be left with the burden of paying any resulting tax liabilities himself.
To make matters even more difficult for Macchiarini, as these events were taking place, the TIC won the San Francisco condominium lottery in 2012, allowing the Property to be converted into condominiums. The lottery win was welcome news for the TIC because it brought with it an expected sharp upward increase in its property value, but added further concerns for Macchiarini, as well as the other TIC owners, because for the condominium conversion to be approved, title on the Property was required to be free and clear of any liens. And should the Franchise Tax Board or IRS put a lien on the Property as a result of The Cellar's unpaid taxes, or if Lefty put a lien on it itself, the conversion process could be terminated. On top of that, Macchiarini was personally concerned that if the condominium conversion fell through on account of a lien being put on the Property, he would likely be sued by the other TIC owners.
With these fears in mind, prior to the negotiations, Macchiarini made a list of the costs he believed he was likely to have to pay if Lefty did not pay The Cellar's back taxes. He came up with the following items.
The first cost item was the taxes themselves. Not only that, there were sure to be penalties from the Franchise Tax Board and IRS for failing to pay the taxes for such a long period of time. At the time, Macchiarini believed the total cost to him, including all fees and penalties, would be $15,000 to $30,000.
The second cost item, the expected professional fees of an accountant, arose from the first. In order to pay the anticipated fees and penalties, the amounts of tax owing would have to be calculated, and returns prepared, by an accountant, which Macchiarini believed would cost within the range of $5,000 to $15,000.
Next, Macchiarini was worried about risk that state and federal tax authorities would conduct audits concerning The Cellar's failure to pay taxes from 2008 until 2011. Macchiarini believed the cost to him of such audits, in the form of attorneys' fees, accountant fees, and tax preparer fees, would amount to $25,000 to $45,000.
Macchiarini was also concerned about the possibility of litigation with Lefty. He thought it likely, if Lefty failed to pay the taxes, he would have to sue to compel performance or recover damages. He was also aware of the strong possibility, considering Coyle's long history of similar litigation, that Lefty would sue him on the promissory note. Thus, anticipating a threat of litigation with Lefty, Macchiarini expected potential legal fees in the amount of $50,000 to $100,000 as a cost of litigating any matters that arose from any failure to perform.
Finally, Macchiarini anticipated either the state or federal government, or Lefty, would put a lien on the Property, which would halt the condominium conversion process, creating additional potential expense. He would have to hire an attorney and possibly an accountant to clear the lien, which he believed would cost in the range of $25,000 to $50,000. In addition, he would likely face suit from the other TIC owners if the condominium conversion process was terminated, opening him up to what he believed would be anywhere between $300,000 and $500,000 in potential liability.
Ultimately, Lefty did not provide Macchiarini with The Cellar's tax returns by February 25, 2013, nor did it pay the taxes as agreed. Indeed, Lefty never performed at all. Thus, on March 1, 2013, Macchiarini sent Lefty a letter informing it the February deadline had passed, Lefty had failed to perform, and the promissory note was therefore null and void as provided by Paragraph Four. Lefty never responded to the letter, remaining silent for 11 months, after which the litigation Macchiarini foresaw became a reality.
Lefty filed suit against Macchiarini, Mankin and The Cellar (collectively, respondents) to enforce the promissory note, which it claimed The Cellar had breached by failing to tender payments as agreed, and recorded a lis pendens on the Property. Coincidentally, Lefty recorded the lis pendens just as the condominium conversion was about to be finalized, which stalled the process. For his part, Macchiarini filed a cross-complaint. Prior to trial, the parties were able to negotiate the removal of the lis pendens quickly enough to complete the condominium conversion and settle most of the causes of action in the complaint and cross-complaint. The only claim that saw trial alleged respondents breached the promissory note.
At trial, the determination of whether respondents were in breach of the promissory note hinged on whether Paragraph Four was a valid liquidated damages clause or an invalid penalty. Ultimately, the trial court found for respondents on that linchpin issue, upholding Paragraph Four as a valid liquidated damages clause and excusing them from paying on the note. Lefty timely appealed.
II. DISCUSSION
Lefty contends the trial court committed two errors in awarding judgment for respondents. First, it argues the trial court improperly found there was a reasonable relationship between respondents' anticipated damages and the amount of liquidated damages. Second, it argues, alternatively, that the trial court improperly calculated respondents' anticipated damages. Of the five categories of damages found at trial—(1) The Cellar's unpaid back taxes, fines, penalties, and fees; (2) the accounting cost of preparing and filing tax returns; (3) the cost of defending audits by tax authorities; (4) attorney's fees and costs; and (5) the cost of litigation related to the TIC conversion—Lefty claims only the first two items could have been reasonably anticipated.
Determining whether a liquidated damages clause is enforceable is a factual question that turns on whether the parties reasonably estimated foreseeable damages under the prevailing circumstances. (Krechuniak v. Noorzoy (2017) 11 Cal.App.5th 713 (Krechuniak).) The determination "becomes a question of law when the facts are undisputed and susceptible of only one reasonable interpretation." (Id. at p. 723, citing Better Food Mkts. v. Amer. Dist. Teleg. Co. (1953) 40 Cal.2d. 179, 184-186.) Effectively, "the ultimate question of a provision's invalidity as a penalty is a question of law subject to de novo review, but the factual foundation for appellate review consists of (1) the facts that are not in dispute and (2) the facts that are established by viewing the conflicting evidence in the light most favorable to the trial court's judgment." (Grand Prospect Partners, L.P. v. Ross Dress for Less, Inc. (2015) 232 Cal.App.4th 1332, 1355.) If there is a conflict in the evidence, we must "review the trial court's ruling for substantial evidence supporting it." (El Centro Mall, LLC v. Payless ShoeSource, Inc. (2009) 174 Cal.App.4th 58, 62.)
California Civil Code section 1671, subdivision (b) governs whether liquidated damage clauses are enforceable, stating that "a provision in a contract liquidating the damages for the breach of the contract is valid unless the party seeking to invalidate the provision establishes that the provision was unreasonable under the circumstances existing at the time the contract was made." Explaining section 1671, subdivision (b), our Supreme Court has stated that "California law has . . . long recognized that a provision for liquidation of damages for contractual breach . . . can under some circumstances be designed as, and operate as, a contractual forfeiture. To prevent such operation, our laws place limits on liquidated damages clauses. . . . As amended in 1977, the code continues to apply [a] strict standard to liquidated damages clauses in certain contracts (consumer goods and services, and leases of residential property (§ 1671, subds. (c), (d)), but somewhat liberalizes the rule as to other contracts." (Ridgley v. Topa Thrift & Loan Assn. (1998) 17 Cal.4th 970, 976-977 (Ridgley).)
The genesis of the current version of section 1671 was a proposal from the California Law Revision Commission (the Law Revision Commission or the Commission). (Hong v. Somerset Associates (1984) 161 Cal.Ap.3d 111, 114.) The Law Revision Commission's proposal, enacted by the Legislature without change, was followed post-enactment by a set of comments from the Commission explaining the relevant changes to the statute. (Krechuniak, supra, 11 Cal.App.5th at p. 721.) When construing statutes proposed by the Law Revision Commission that were adopted by the Legislature without substantial change, the Commission's comments are entitled to great weight. (Pacific Trust Co. TTEE v. Fidelity Fed. Sav. & Loan Assn. (1986) 184 Cal.App.3d 817, 823.)
Notably, the Commission explained in its comments that section 1671, subdivision (b) outlined "a new general rule favoring the enforcement of liquidated damages provisions except against a consumer in a consumer case. . . . [¶] . . . [¶] The subdivision limits the circumstances that may be taken into account in the determination of reasonableness to those in existence 'at the time the contract was made.' The validity of the liquidated damages provision depends upon its reasonableness at the time the contract was made and not as it appears in retrospect. Accordingly, the amount of damages actually suffered has no bearing on the validity of the liquidated damages provision. . . . [¶] Unlike subdivision (d), subdivision (b) gives the parties considerable leeway in determining the damages for breach. All the circumstances existing at the time of the making of the contract are considered, including the relationship that the damages provided in the contract bear to the range of harm that reasonably could be anticipated at the time of the making of the contract." (Recommendation Relating to Liquidated Damages (Dec. 1976) 13 Cal. Law Revision Com. Rep. (1976) pp. 1750-1751).)
Case law addressing the enforceability of liquidated damages clauses governed by section 1671, subdivision (b), accords with the Commission's explanatory comments. These clauses are considered valid " 'unless the party seeking to invalidate the provision establishes that the provision was unreasonable under the circumstances existing at the time the contract was made.' " (O'Connor v. Televideo System. Inc. (1990) 218 Cal.App.3d 709, 718.) "A liquidated damages clause will generally be considered unreasonable, and hence unenforceable under section 1671(b), if it bears no reasonable relationship to the range of actual damages that the parties could have anticipated would flow from a breach." (Ridgley, supra, 17 Cal.4th at p. 977.) While courts have not conclusively defined the exact percentage that defines an unreasonable relationship, liquidated damages that are three or more times the anticipated damages have been held to be unenforceable. (Greentree Financial Group, Inc. v. Execute Sports, Inc. (2008) 163 Cal.App.4th 495, 500 (Greentree).)
Lefty maintains the trial court improperly determined the enforceability of Paragraph Four, basing its ruling on the actual damages respondents suffered, not the anticipated damages. Having reviewed the record, we conclude this argument is unsustainable and reject it. The trial court's reasonable relationship determination in this case is amply supported by substantial record evidence.
As the above precedent makes clear, Lefty had the burden of showing Paragraph Four was unreasonable under the circumstances existing at the time the contract at issue was made. (Ridgley, supra, 17 Cal.4th at p. 977.) It failed to carry that burden, as can be seen most clearly in its acknowledgment at trial of the circumstances at the time the contract was made. Lefty "d[id] not dispute that [respondents] may have anticipated various costs and liabilities that could result if Lefty failed to prepare the tax returns and pay back taxes . . . includ[ing] . . . unpaid taxes, as well as fines, penalties and fees ($15,000-30,000), hiring accountants to prepare and file the tax returns ($5,000-15,000) and defending audits by tax authorities ($25,000-40,000)."
Given this concession, the trial court's only remaining task was to compare the amount of anticipated damages Lefty did not dispute, based on acknowledged circumstances at the time of contracting, to the amount of the liquidated damages, and then, having drawn this comparison, to determine whether the relationship between the two amounts was unreasonable. Here, $85,000 in anticipated damages is roughly commensurate with the $83,519 plus interest value of the promissory note. This does not come close to being in the prohibited range of three times the amount of the anticipated damages. (See Greentree, supra, 163 Cal.App.4th at p. 500.)
Lefty next insists the court erred by including the potential cost of defending against audits from federal or state tax authorities. This argument was never raised in the trial court. Lefty is barred from attacking the inclusion of audit costs in the anticipated damages calculation for the first time on appeal, since doing so would rest on a new theory that "contemplates a factual situation the consequences of which are open to controversy and were not put in issue or presented at the trial . . . ." (Panopulos v. Maderis (1956) 47 Cal.2d 337, 341 (Panopulos); see also Krechuniak, supra, 11 Cal.App.5th at pp. 751-752).)
To see why, one need only state the position Lefty takes. Lefty now wishes to argue against including the audits in the anticipated damages calculation on the ground that, if respondents ever have to defend against an audit, it will not be due to or even influenced by Lefty's failure to provide the tax returns or pay the taxes as promised. Whether this is a meritorious argument or not turns on a fact-dependent inquiry that could have been and should have been explored at trial. (Panopulos, supra, 47 Cal.2d at p. 341.) We deem it forfeited here on appeal. (Ibid.)
III. DISPOSITION
Affirmed. Respondents to recover their costs.
/s/_________
Streeter, Acting P.J. We concur: /s/_________
Reardon, J. /s/_________
Schulman, J.
Judge of the Superior Court of California, City and County of San Francisco, assigned by the Chief Justice pursuant to article VI, section 6 of the California Constitution.