Opinion
NOT TO BE PUBLISHED
APPEAL from an order of the Superior Court of San Diego County No. 37-2008-00051379- CU-FR-NC, Jacqueline M. Stern, Judge. Affirmed; motion for sanctions denied.
McINTYRE, J.
Defendants Morgan Stanley & Co., Inc. and Morgan Stanley Trust, N.A. (together Morgan Stanley) appeal an order denying their petition to compel arbitration of the claims made by Dorothy M. Mannell, by and through her court-appointed conservator, Beverly McKenzie. Morgan Stanley asserts the trial court erred when it declined to enforce an arbitration provision between Morgan Stanley and Dorothy on the ground she lacked the mental capacity to enter into the contracts containing the provision. We disagree and affirm the order, but deny McKenzie's request that we impose sanctions for a frivolous appeal.
FACTUAL AND PROCEDURAL BACKGROUND
As a preliminary matter, we note that the facts of this dispute are hotly contested. We set forth only those facts necessary to resolve the narrow issues presented on appeal.
Dorothy married Harry Mannell in 1932 and they lived together for many years in a home located in Solana Beach, California. The couple had no children, and their closest living relatives were one nephew and four nieces, including McKenzie. In 1995, the Mannells executed a last will and testament and a family trust. The family trust designated the Mannells as cotrustees with Morgan Stanley. These instruments provided for the distribution of the Mannells' estate to their nieces and nephew. The couple also executed durable powers of attorney for health care designating each other as conservators with power to make medical decisions, and McKenzie as the alternate conservator. Defendant Gregory Grajek (together with Morgan Stanley, Defendants), a Morgan Stanley senior vice-president, was the Mannells' financial advisor at the time. He referred the Mannells to Attorney James Donart, who handled the estate planning paperwork for them.
Harry died on January 21, 2001, and Dorothy was hospitalized on February 2 at age 88. Dorothy's physician, Dr. Robert Yuhas, diagnosed her as suffering from a stroke and her MRI studies revealed brain changes indicating she had dementia. On February 6, the hospital discharged Dorothy to a skilled nursing facility where she currently resides. That same day, Dorothy executed a first amendment to the family trust adding a provision that upon her death, the Solana Beach home would be gifted to Grajek free of all encumbrances. On February 21, Dorothy executed a second amendment to the trust providing that if her home were sold to Grajek, that upon her death the trustee, Morgan Stanley, would cancel all indebtedness from Grajek. On February 22, Dorothy designated Grajek as her agent to make health care decisions. On March 6, Dorothy executed a grant deed conveying her home to Grajek and his wife.
In 2007, after McKenzie learned of the transaction, she filed a petition to be appointed the conservator for Dorothy's person and estate (together, the Estate). The court granted the petition. McKenzie then filed the instant action on behalf of the Estate alleging financial elder abuse and other claims. Morgan Stanley petitioned the trial court to compel arbitration and stay the action, citing an arbitration clause contained in documents signed by Dorothy in February or March 2001 and June 2005.
The Estate opposed the petition on the ground the arbitration provision was unenforceable on two grounds: (1) it violated public policy and was unconscionable and (2) Dorothy lacked the mental capacity to agree to the contracts containing the arbitration provision. The trial court, after ruling on various evidentiary objections, concluded that Dorothy lacked the mental capacity to enter into the contracts containing the arbitration provision. It also rejected Morgan Stanley's argument that McKenzie should be judicially estopped from arguing lack of mental capacity. Morgan Stanley timely appealed.
DISCUSSION
I. The Appropriate Decision Maker
Morgan Stanley relies on Prima Paint Corp. v. Flood & Conklin Mfg. Co. (1967) 388 U.S. 395 (Prima Paint) to argue that the validity of a contract containing an arbitration provision should be decided by the arbitrator in the first instance. (Id. at p. 400.) Specifically, Morgan Stanley asserts the trial court erred in finding that Dorothy lacked the mental capacity to consent to the arbitration clause because the question was one for the arbitrators to decide. (See Primerica Life Ins. Co. v. Brown (5th Cir. 2002) 304 F.3d 469, 471-472 [applying Prima Paint to conclude that a party can be compelled to arbitrate a lack of capacity claim]; compare, Spahr v. Secco (10th Cir. 2003) 330 F.3d 1266, 1273 [court must decide lack of capacity claim before compelling arbitration].) We disagree.
The California Supreme Court examined the Prima Paint decision in addressing the procedures by which petitions to compel arbitration (Code Civ. Proc., § 1281.2) are to be determined in the superior courts. (Rosenthal v. Great Western Fin. Securities Corp. (1996) 14 Cal.4th 394, 402 (Rosenthal).) The Rosenthal court examined the ruling on a petition to compel arbitration and the claims of several plaintiffs that the arbitration provisions they had agreed to were void for fraud in their execution. (Id. at pp. 402, 404.) It rejected the defendants' argument that Prima Paint mandated the arbitration of any fraud claim, even one going to the execution of the contract. (Id. at pp. 415-416.) The court concluded that "claims of fraud in the execution of the entire agreement are not arbitrable under either state or federal law. If the entire contract is void ab initio because of fraud, the parties have not agreed to arbitrate any controversy; under that circumstance, Prima Paint does not require a court to order arbitration." (Id. at p. 416.)
The Rosenthal court explained that "[i]n the absence of a contrary agreement, parties to a predispute arbitration agreement are presumed to have intended arbitration of controversies, including allegations of fraud in the inducement of the contract generally, that may allow rescission or reformation of the contract or part of it. They cannot, however, have intended arbitration under a contract wholly void for fraud in its execution. We therefore conclude Prima Paint does not preclude the court from deciding claims of fraud in the execution of the entire contract." (Rosenthal, supra, 14 Cal.4th at p. 417; Saint Agnes Medical Center v. PacifiCare of California (2003) 31 Cal.4th 1187, 1200 ["If a party can show that it did not know it was signing a contract, or that it did not enter into a contract at all, both the contract and its arbitration clause are void for lack of mutual assent"].)
Thereafter, the Rosenthal court examined the plaintiffs' declarations to determine whether they had shown facts that would void the entire contract. (Rosenthal, supra, 14 Cal.4th at p. 423.) In particular, the daughter and guardian ad litem of one plaintiff submitted a declaration stating that the plaintiff suffered from "'severe memory loss, diminished understanding and [was] incapable of understanding complicated monetary transactions.'" (Id. at p. 430.) The Rosenthal court concluded that the "declaration, if believed, raise[d] a factual issue as to [the plaintiff's] capacity to contract; if extreme enough, her mental deficiency could render void any contract to which she apparently assented, including client agreements containing the arbitration clause. [Citation.]" (Id. at pp. 430-431.) Thus, it remanded the matter to the trial court to find the facts and decide whether the plaintiff's alleged incapacity rendered the contract void. (Id. at p. 431.)
Accordingly, pursuant to Rosenthal, the trial court properly decided the issue whether Dorothy lacked the mental capacity to agree to the 2001 and 2005 contracts containing the arbitration provision. Although Morgan Stanley correctly notes that the defenses to arbitration at issue in Rosenthal were fraud in the execution and fraud permeating the entire agreement, this is a distinction without a difference. (Rosenthal, supra, 14 Cal.4th at p. 403.) A necessary element of fraud in the execution of an agreement is reasonable reliance and a finding of fraud in the execution renders the agreement void. (Id. at pp. 416, 419-420.) Similarly, a contract is void if created by a person entirely without understanding of the nature and purpose of the contractual transaction. (Civ. Code, § 38; see infra, part II.A.)
We reject Morgan Stanley's argument that in ruling on the petition to compel arbitration, the trial court improperly addressed the merits of the underlying dispute. Our review of the complaint reveals that the Estate alleged that Defendants should have known that Dorothy lacked the mental capacity to make decisions about her financial and estate assets; thus, they should be liable for taking advantage of her under several legal theories. The Estate did not claim that Dorothy lacked the mental capacity to enter into the 2001 and 2005 agreements with Morgan Stanley. Rather, this was the Estate's response to Morgan Stanley's petition to compel arbitration. As noted by the Rosenthal court, "[i]n deciding an application to compel [arbitration]... the superior court does not decide whether the plaintiff's causes of action have merit, although some factual questions considered in deciding the application may overlap those raised by the plaintiff's claims for relief. The only question implicated by the petition to compel arbitration is whether the arbitration [clause] should be specifically enforced." (Rosenthal, supra, 14 Cal.4th at p. 412.) Here, while Dorothy's mental capacity is a factual dispute at issue in the complaint and the petition to compel arbitration, the ruling on the petition to compel arbitration does not impact the merits of the Estate's claims.
II. Dorothy's Capacity to Contract
A. Legal Principles
In California, "[a]ll persons are capable of contracting, except minors, persons of unsound mind, and persons deprived of civil rights." (Civ. Code, § 1556.) The capacity of a person of unsound mind to contract is governed by specific provisions of the Civil Code. (Civ. Code, § 1557, subd. (b).) Contracts created by persons who are entirely without understanding of the nature and purpose of the contractual transaction are void (Civ. Code, § 38), whereas contracts created by persons of unsound mind, who are not entirely without understanding, are voidable (Civ. Code, § 39). (Smalley v. Baker (1968) 262 Cal.App.2d 824, 834-835, disapproved on other grounds in Weiner v. Fleischman (1991) 54 Cal.3d 476, 485-486.) The test in each instance is whether the persons understood the nature, purpose and effect of what they did. (Smalleyv. Baker, supra, at p. 832.) Additionally, a rebuttable presumption exists that a person is of unsound mind "if the person is substantially unable to manage his or her own financial resources or resist fraud or undue influence." (Civ. Code, § 39, subd. (b).)
In 1995, the Legislature enacted the Due Process in Competence Determinations Act (Prob. Code, § 810 et seq. (the Act), all undesignated statutory references are to the Probate Code; see Stats. 1995, ch. 842, § 12, p. 6413) encompassing the capacity to consent to medical treatment, to execute wills and trusts, and contract. The Act establishes a rebuttable presumption that all persons have the capacity to make decisions and to be responsible for their acts or decisions. (§ 810, subd. (a).) It makes clear that a person with a mental or physical disorder may still be capable of contracting. (§ 810, subd. (b).) Additionally, "[a] judicial determination that a person is totally without understanding... should be based on evidence of a deficit in one or more of the person's mental functions rather than on a diagnosis of a person's mental or physical disorder." (§ 810, subd. (c).)
Accordingly, a diagnosis of dementia alone is not sufficient to prove the incapacity to contract. Rather, a determination that a person lacks legal capacity to execute a contract must be supported by evidence of a deficit in at least one of several enumerated mental functions, including: (1) alertness and attention (level of arousal or consciousness; orientation to time, place, person, and situation; ability to attend and concentrate) and (2) information processing (short- and long-term memory; recognition of familiar objects or persons; ability to (a) understand or communicate, (b) understand and appreciate quantities, (c) reason using abstract concepts, (d) plan, organize, and carry out actions in one's own rational self-interest, or (e) reason logically). (§ 811, subd. (a)(1) & (2).)
A deficit in these mental functions "may be considered only if the deficit, by itself or in combination with one or more other mental function deficits, significantly impairs the person's ability to understand and appreciate the consequences of his or her actions with regard to the type of act or decision in question." (§ 811, subd. (b).) The "frequency, severity, and duration of periods of impairment" may be relevant to a judicial determination of legal capacity. (§ 811, subd. (c).)
B. Analysis
1. Applicable Standard
Morgan Stanley asserts the trial court erred because it did not articulate the standard it used when it determined that Dorothy lacked the mental capacity to agree to the contracts containing the arbitration provision. Morgan Stanley claims that had the court applied the standards articulated in the Civil Code, it would have found that Dorothy had the capacity to contract, even assuming the truth of the Estate's evidence. This argument fails on several grounds.
First, Morgan Stanley argued to the trial court that it should apply the Probate Code in deciding whether Dorothy lacked the mental capacity to contract. Accordingly, Morgan Stanley waived its argument that the trial court failed to consider Civil Code sections 38 and 39 in reaching a decision because it never mentioned these statutes below.
Second, as set forth above, the Civil Code and the Probate Code do not describe different standards for deciding the issue of mental capacity to contract. Rather, the Civil Code provides that a contract made by a person entirely without understanding is void, whereas a contract made by a person of unsound mind, but not entirely without understanding, is voidable. (Civ. Code, §§ 38, 39.) Any determination of capacity to contract under the Civil Code depends upon an analysis of the factors listed in section 811. The Probate Code similarly provides that a person should be deemed to lack the legal capacity to contract should a court determine that the person is totally without understanding based on an analysis of the factors in section 811. (§ 810, subd. (c).)
Finally, although the parties did not specifically argue for application of Civil Code sections 38 and 39 below, absent any indication to the contrary, a trial court is presumed to know the law, recognize the relevant facts, and apply the correct statutory and case law in the judicial decision making process. (See Evid. Code, § 644; People v. Coddington (2000) 23 Cal.4th 529, 644, overruled on other grounds in Price v. Superior Court (2001) 25 Cal.4th 1046, 1069, fn. 13.)
2. Expert Declarations
We reject Morgan Stanley's contention that the trial court improperly considered the declarations of Dorothy's treating physicians because the physicians based their opinions upon a review of Dorothy's medical records, which were not part of the court record. Generally, experts may base their opinions on any "matter" known to them, including otherwise inadmissible material, if that material may "reasonably... be relied upon" for that purpose. (Evid. Code, § 801, subd. (b).) Expert testimony may also be premised on material that is not admitted into evidence provided it is material of a type that is reasonably relied upon by experts in the particular field in forming their opinions. (People v. Gardeley (1996) 14 Cal.4th 605, 618.) Physicians frequently base their opinions on personal observations and medical and hospital records. Accordingly, the trial court did not err when it relied on the physicians' declarations.
3. Need for an Evidentiary Hearing
We reject Morgan Stanley's contention that the trial court erred by not conducting an evidentiary hearing. The role of the trial court was to sit as a trier of fact, weighing any affidavits, declarations, and other documentary evidence, together with oral testimony received at the court's discretion, to reach a determination on the issue of arbitrability. (Rosenthal, supra, 14 Cal.4th at pp. 413-414.) The Estate had the burden of proving, by a preponderance of the evidence, any fact necessary to its defenses to enforcement of the arbitration provision. (Id. at p. 413.)
In its reply brief below, Morgan Stanley argued in a footnote that the Estate had failed to meet its burden of proving Dorothy's incapacity because the Estate failed to request an evidentiary hearing on this defense. The Estate, however, offered to make its witnesses available and provide any further evidence the trial court might require. The trial court did not express a need for additional evidence and impliedly rejected Morgan Stanley's assertion that the Estate had failed to meet its burden of proof. As we discuss below, the Estate submitted sufficient documentary evidence to support its lack of capacity defense. (Infra, part II.B.4.) Moreover, Morgan Stanley never requested an evidentiary hearing to challenge the factual basis for the opinions of Dorothy's treating physicians. Under these facts, the trial court did not abuse its discretion by not conducting a full evidentiary hearing.
4. Sufficiency of the Evidence
The Estate presented declarations from Dorothy's treating physicians. Dr. Yuhas, Dorothy's physician in 2001, stated that she exhibited confusion with short term memory loss and lack of full orientation during her hospitalization. These problems remained after her discharge and continued through the last time he attended her in 2002. Dr. Michael A. Pietila treated Dorothy from 2002 to the present. He stated that Dorothy had moderate dementia in March 2002 and that she displayed almost all the deficits in mental function listed in subdivision (a)(1) and (2) of section 811. He opined that from 2001 to the present, Dorothy lacked the mental capacity to make decisions about her financial affairs, and did not understand and appreciate the rights, duties and responsibilities created by her decisions.
McKenzie stated that she visited Dorothy a few days after her release from the hospital. Dorothy initially did not seem to recognize her, later realized there was a connection, but remained confused and disoriented about her surroundings, and the date and the circumstances of her admission. Dorothy did not understand where she was or that her husband had died. From 2001 to the present, Dorothy's confusion and disorientation has remained essentially the same as it was shortly after her stroke.
Based on the severity and duration of Dorothy's mental deficits described by McKenzie and Dorothy's physicians, the trial court could reasonably conclude that her ability to understand and appreciate the consequences of her actions was significantly impaired (§ 811, subd. (b) & (c)) and that she was entirely without understanding to make a contract of any kind in 2001 and 2005. (Civ. Code, § 38.) Although Morgan Stanley presented the declaration of Attorney Donart, who expressed his belief regarding Dorothy's capacity to enter transactions with legal and tax ramifications, we must accept the trial court's resolution of the conflicting facts and related inferences. (Buehler v. Sbardellati (1995) 34 Cal.App.4th 1527, 1542.)
III. Judicial Estoppel
Morgan Stanley contends the Estate should be judicially estopped from claiming Dorothy continuously lacked the mental capacity to assent to the 2001 and 2005 contracts because this position is totally inconsistent with the position taken by McKenzie as the petitioner in Dorothy's 2007 conservatorship proceeding. Specifically, in the conservatorship proceedings Dorothy filed a voluntary petition to have McKenzie appointed as her conservator because she suffered from "transient lapses" of orientation to time, place and situation.
The doctrine of judicial estoppel applies when: (1) the same party has taken two positions; (2) the positions were taken in judicial or quasi-judicial administrative proceedings; (3) the party was successful in asserting the first position; (4) the positions are totally inconsistent; and (5) the initial position was not adopted as a result of ignorance, fraud or mistake. (Jogani v. Jogani (2006) 141 Cal.App.4th 158, 169.) Judicial estoppel "is an equitable doctrine,... its application, even where all necessary elements are present, is discretionary." (Id. at p. 170.) The trial court's findings of fact regarding application of the doctrine will be upheld if they are supported by substantial evidence. (Kelsey v. Waste Management of Alameda County (1999) 76 Cal.App.4th 590, 597.)
The trial court rejected Morgan Stanley's argument, stating that the positions were not inconsistent because "it does not necessarily follow that [Dorothy's] being competent enough to make the decision in 2007 to appoint a conservator means she was also competent enough to" manage her financial resources at any time relevant to petition to compel arbitration. Morgan Stanley contends the trial court erred as a matter of law when it failed to apply the doctrine because every element of judicial estoppel was met. We disagree.
There is no indication in the record that the court in the conservatorship proceedings made any finding as to the nature and extent of Dorothy's mental deficits; i.e., whether her lapses of orientation were transient or permanent. Rather, the court appointed McKenzie as Dorothy's conservator, impliedly finding by clear and convincing evidence that Dorothy was: (a) unable to provide for her personal needs; (b) substantially unable to manage her financial resources or resist fraud or undue influence; or (c) both. (§ 1801, subd. (a), (b) & (e).) Accordingly, it cannot be said that McKenzie was successful in asserting her first position. Moreover, Dorothy's consent to the filing of a voluntary conservatorship petition does not indicate she had the capacity to contract in 2001 or 2005; rather, it shows that she did not oppose the conservatorship petition. Finally, even assuming all necessary elements of judicial estoppel were present, the trial court had the discretion to decline to apply the doctrine and Morgan Stanley has not explained how the trial court abused its discretion. (Jogani v. Jogani, supra, 141 Cal.App.4th at p. 170.)
IV. Motion for Sanctions
McKenzie seeks as sanctions against Morgan Stanley the amount of attorney fees she incurred in this appeal, $64,000. She contends that any reasonable attorney would conclude that the appeal is totally and completely without merit.
"When it appears to the reviewing court that the appeal was frivolous or taken solely for delay, it may add to the costs on appeal such damages as may be just." (Code Civ. Proc., § 907.) An appeal may be deemed frivolous when (1) under a subjective standard, it is prosecuted for improper motives of harassment or delay, or (2) under an objective standard, it indisputably has no merit because any reasonable attorney would agree that the appeal is totally and completely without merit. (In re Marriage of Flaherty (1982) 31 Cal.3d 637, 649-650 (Flaherty); In re Marriage of Schnabel (1994) 30 Cal.App.4th 747, 754.) "The two standards are often used together, with one providing evidence of the other. Thus, the total lack of merit of an appeal is viewed as evidence that appellant must have intended it only for delay." (Flaherty, supra, at p. 649.) "Counsel and their clients have a right to present issues that are arguably correct, even if it is extremely unlikely that they will win on appeal. An appeal that is simply without merit is not by definition frivolous and should not incur sanctions." (Id. at p. 650.) Accordingly, we heed the caution that the power to sanction for frivolous appeals should not be used "in all but the clearest cases...." (Ibid., italics in original.)
While we agree with McKenzie that the appeal lacks merit, we do not believe the appeal was frivolous under the relevant standards. Morgan Stanley raised arguable issues as to the interpretation of Rosenthal and the applicable standard in deciding whether Dorothy lacked the mental capacity to contract. (Rosenthal, supra, 14 Cal.4th 394.) While certain aspects of the appeal could well be deemed frivolous, "we are unable to conclude that the appeal as a whole is so utterly devoid of potential merit as to justify sanctions." (Abdallah v. United Savings Bank (1996) 43 Cal.App.4th 1101, 1112.)
DISPOSITION
The order is affirmed. The motion for sanctions is denied. Respondent is entitled to her costs on appeal.
WE CONCUR: HUFFMAN, Acting P. J., IRION, J.