Opinion
No. 58458-8-I.
May 21, 2007.
Appeal from a judgment of the Superior Court for King County, No. 05-2-29419-1, Douglas D. McBroom, J., entered June 1 and 12, 2006.
Reversed and remanded by unpublished opinion per Coleman, J., concurred in by Schindler, A.C.J., and Cox, J.
This case concerns a guaranty agreement signed by Michael Devine after his company, Video Internet Broadcasting (VIB), defaulted on promissory notes it issued, along with stock purchase warrants, in exchange for $273,000. The first issue is whether the original securities agreement (the exchange of promissory notes and stock purchase warrants for $273,000) was still executory at the time Devine signed the guaranty agreement. The next two issues are whether there are genuine issues of material fact as to whether any misrepresentations in the guaranty were "in connection with the offer, sale or purchase of" securities because of its association with a later merger and settlement agreement. We also must consider if there is a genuine issue of material fact as to whether Devine made material misrepresentations in the guaranty. The final issue is whether, under Washington conflicts law, Arizona community property law applies to the question of whether an Arizona husband may bind his marital community by signing a guaranty agreement without his wife's signature, consent, or knowledge, where the guaranty states that it shall be governed by Washington law.
We agree with the trial court's ruling that the securities agreement was fully executed at the time Devine signed the guaranty and that Arizona community property law applied to the issue of whether the respondent bound his marital community by signing the guaranty. We reverse and remand, however, on the issues of whether the guaranty agreement contained material misrepresentations made in connection with the offer, sale, or purchase of securities in a later merger and settlement agreement.
FACTS
VIB was a struggling Internet start-up in need of more money. The appellants in this case, investors Stonebridge Securities, LLC; Eastside Pinnacle, LLC; Martin S. Rood, Joseph S. Carr, Lance E. Farr, George D. Holland, and Kevin Kaldestad ("the noteholders"), loaned VIB a total of $273,000 in exchange for promissory notes convertible to stock in the corporation, as well as preferred stock purchase warrants. The notes required VIB to promptly notify the noteholders of any board actions. The notes also gave the noteholders the right to be paid if VIB merged with another company. The stock purchase warrants gave the noteholders the option to exchange the outstanding balance on the notes for stock equal to two times the outstanding balance, divided by the lowest price for which the stock would be sold in an offering.
VIB continued to struggle, and by August 2004, it was in default on all of the notes. It negotiated to sell to and merge with Faraday Financial, Inc., and scheduled a shareholders meeting to consider the deal. The noteholders threatened to seek an injunction of the shareholders meeting.
In response to the threat, VIB's principals, respondents Devine and Kelly Ryan, entered into negotiations with the noteholders, hoping to keep the scheduled merger on track. The noteholders offered to refrain from seeking an injunction if Devine and Ryan guaranteed the notes. A guaranty agreement was executed on August 20, 2004, three days before the scheduled VIB shareholders meeting.
The guaranty agreement was an unconditional promise to guaranty both payment and performance of the notes. In the recitals, it included:
WHEREAS, as part of and conditioned upon an acceptable resolution of the claims of the Note Holders ("Note Holder Settlement"), VIB has agreed to issue to Stonebridge Securities (which shall be identical to the securities issued to the Note Holders as part of the Note Holder Settlement) having a value (determined on the same basis as the securities to be issued to the Note Holders) equal to not less [than] one hundred thousand dollars ($100,000) for
services rendered (the "Fee") together with related, documented expenses. The guaranty agreement stated, "This Guaranty Agreement and the legal relations between the parties hereto shall be governed by and in accordance with the laws of the State of Washington."
Devine and Ryan each signed the guaranty agreement above printed lines stating their names and the phrase, "individually and on behalf of his marital community." In the first paragraph of the guaranty agreement, Devine and Ryan were named as "Guarantors," "whose address is 135 Basin Street Southwest, Ephrata, Washington." The notice address listed for the guarantors was in Tucson, Arizona. Devine and his wife, Sabra Devine, lived in Arizona when the guaranty agreement was executed. According to her declaration, Sabra did not know about the guaranty agreement at the time her husband signed it and would not have agreed to it had she known about it.
The shareholders approved the merger of VIB and Faraday. As a result of the merger, Faraday became HomeNet Corporation and its new subsidiary, HomeNet Communications, Inc., merged in September 2004 with VIB. In February 2005, the two HomeNet corporations entered into a settlement agreement with the noteholders. The settlement agreement included HomeNet Communication's promise to repay the notes by a specified deadline in cash or, at each noteholder's election, in HomeNet Corporation stock. The settlement agreement made one reference to the guaranty agreement, stating that when the settlement agreement was fulfilled and the notes satisfied, the guaranty agreement would be "deemed null, void and of no further force or effect."
HomeNet Corporation did not pay the notes by the specified deadline of June 16, 2005. In August 2005, the noteholders demanded payment from Devine, but he did not pay. The noteholders then filed suit against Michael Devine, Jane Doe Devine, and their marital community; and Kelly Ryan, Jane Doe Ryan, and their marital community. The noteholders claimed breach of the guaranty agreement and sought the total principle amount of their investment, $273,000, plus interest, reasonable attorney fees, and costs. They later filed an amended complaint alleging securities fraud against Devine and his marital community.
The investors moved for summary judgment on the issues of whether Devine and his marital community were liable for (1) breaching the guaranty agreement and (2) violating the Washington State Securities Act (WSSA). Devine cross moved for summary judgment, claiming that his marital community was not liable on the guaranty agreement, the guaranty agreement was not a security, and that the guaranty agreement did not contain material misrepresentations made in connection with the offer, sale, or purchase of securities.
Devine never disputed his individual liability on the guaranty agreement, and the trial court entered judgment against him accordingly.
At the summary judgment hearing, the trial court found that the promissory notes were securities and assumed, but did not decide, that the guaranty agreement contained a material misrepresentation. The court asked for additional briefing on whether the misrepresentations in the guaranty were made "in connection with the offer, sale or purchase of any security." RCW 21.20.011. The court was concerned with the application of Helenius v. Chelius, 131 Wn. App. 421, 120 P.3d 954 (2005), review denied, 152 P.3d 347 (2007). The parties submitted supplemental briefs. The court then denied the noteholders' motion for summary judgment and granted Devine's cross motion in its entirety. The noteholders moved for reconsideration, and the trial court denied that motion. The noteholders appeal.
ANALYSIS
The noteholders first contend that the misrepresentations in the guaranty agreement were made "in connection with the offer, sale or purchase of any security" because the guaranty agreement secured the value of the convertible promissory notes that investors held, but had not received consideration for, at the time they entered the guaranty agreement. RCW 21.20.010. The parties agree that the notes were securities, but disagree as to whether the original securities agreement was executory or executed at the time Devine signed the guaranty agreement. We conclude that the guaranty agreement was not "in connection with the offer, sale or purchase of any security" because the original securities agreement (the exchange of $273,000 for promissory notes and stock purchase warrants) was executed by the time Devine signed the guaranty.
The parties dispute the application of Helenius to this issue. Helenius concerned a stock purchase agreement in which the defendants agreed to pay certain liabilities of the plaintiffs in exchange for stock. The plaintiffs put the stock in escrow until the defendants paid the liabilities. The defendants, however, conspired to avoid paying the liabilities. The court held that it could consider both the pre-and post-agreement representations made by the defendants in determining whether they had violated the WSSA. In resolving the case, the court stated:
[W]here a party engages in fraudulent misrepresentations or conduct in connection with an agreement to buy or sell securities, the agreement is executory, and continuing fraudulent conduct affects the unperformed part of the agreement, a court may consider both the pre-and post-agreement representations and conduct to determine whether there is a violation of the RCW 21.20.010. Helenius, 131 Wn. App. at 452-53 (emphasis added). Thus, under Helenius, the stock purchase agreement must be executory in order for post-agreement representations to be "in connection with the offer, sale or purchase" of the security. RCW 21.20.010.
Devine is correct that the original securities agreement was already executed by the time he signed the guaranty. As the trial court stated in the letter accompanying its order denying the noteholders' motion for reconsideration, "In this case, the agreement was completed when VIB provided its promissory note to the [noteholders] in January, 2004."
An "executory contract" is one that "remains wholly unperformed or for which there remains something still to be done on both sides[.]" Black's Law Dictionary 344 (8th ed. 2004). Another definition provides, "Executory contracts are those in which some act remains to be done[.]" Bouvier's Law Dictionary 660 (rev. 8th ed. 1914). In Helenius, the securities purchase agreement was executory because when the defendants made misrepresentations, the stock was still in escrow and the defendants had not yet paid the plaintiffs' liabilities.
A contract is "executed" when the parties need to do nothing more to complete their agreement as an enforceable commitment. See Felt v. McCarthy, 130 Wn.2d 203, 212, 922 P.2d 90 (1996) (Sanders, J. concurring) (explaining that an agreement was executed when the sellers delivered their deed and the purchasers tendered cash and a promissory note for the balance). In Felt, the defendant gave the plaintiffs a promissory note and other consideration in exchange for land. The defendant had planned to develop the land but was not able to because of changes in zoning laws. The defendant failed to pay the note and the plaintiffs sued. The defendant argued that frustration of purpose on the land sale agreement excused him from paying the note. The court disagreed, holding that the defendant "assumed all risks that his planned use of the property would become frustrated due to any future occurrence[.]" Felt, 130 Wn.2d at 209 (Sanders, J. concurring). Justice Sanders concurred because "[c]ommercial frustration is not a defense for [the defendant] because he had already completed his obligations arising from the original transaction by the time he defaulted on the note." Felt, 130 Wn.2d at 211 (Sanders, J. concurring). Justice Sanders reasoned that the agreement was executed once the parties exchanged the land for the promissory note and the other consideration, even though the note was unpaid. Justice Sanders' concurrence in Felt followed and quoted Edwards v. Petrone, 465 N.W.2d 847 (Wis. 1990), which concluded that an agreement involving promissory notes was executed by using the following analysis:
"The promissory note from Petrone to Edwards is an executed contract. Edwards delivered $50,000 to Petrone and Petrone, in exchange, gave his written promise, the promissory note, to repay the money. Promises were exchanged and nothing more had to be done to complete the contract. The requirement that Petrone make payments does not make the promissory note an executory contract. All of the acts necessary to give rise to Petrone's obligation — a delivery of money and a promise to repay — have been performed."
Felt, 130 Wn.2d at 212 (Sanders, J. concurring) (quoting Edwards, 465 N.W.2d at848). Similarly, the securities agreement in this case was executed because the noteholders delivered money to VIB and it, in exchange, gave the noteholders written promises to repay the money (the promissory notes) and stock purchase warrants. The promissory notes' requirement that Devine make payments does not make the securities agreement executory. And the stock purchase warrants were not executory simply because the noteholders had not exercised the rights given by the warrants. The noteholders argue that Felt is irrelevant because it is not about the WSSA and relies on out-of-state authority. In analyzing this case under Helenius, however, we must determine whether the securities agreement was executory. The Felt concurrence and the out-of-state authority it relies on are helpful in determining that issue because they address the meaning of "executory" and "executed" in an agreement involving promissory notes.
The noteholders also argue that the securities agreement was executory because they had not yet received the promised consideration at the time Devine signed the guaranty agreement. Obligations within a contract, separate from what is exchanged among the parties and gives rise to the contract, are not the consideration for the contract. "To constitute consideration, a performance or a return promise must be bargained for" and "[a] performance or return promise is bargained for if it is sought by the promisor in exchange for that promise." Restatement (Second) of Contracts, §§ 71 (1981). Here, the noteholders received consideration for their loans: VIB's promise to repay and, in the alternative, the noteholders' option to convert the notes to stock and the stock purchase warrants. The trial court correctly decided that the original securities agreement was executed when Devine signed the guaranty agreement.
Our conclusion on this issue is supported by the WSSA's reliance rule. "To establish liability under the WSSA, the purchaser of a security must prove that the seller and/or others made material misrepresentations or omissions about the security, and the purchaser relied on those misrepresentations or omissions." Stewart v. Estate of Steiner, 122 Wn. App. 258, 264, 93 P.3d 919 (2004) (emphasis added), review denied, 153 Wn.2d 1022 (2005). Reliance was possible in Helenius because the securities agreement was not completed when the defendants made misrepresentations: the plaintiff's stock was still in escrow and the defendants had not paid the plaintiffs' liabilities. If the plaintiffs in Helenius had known the defendants were making misrepresentations, they could have rescinded the securities agreement. Here, it was not possible that the noteholders relied on the guaranty agreement during the "offer, sale or purchase" of the securities (the promissory notes) because they had already loaned VIB money and received the promissory notes by the time Devine signed the guaranty. RCW 21.20.010. Even if the noteholders had known the guaranty agreement contained misrepresentations, they could not have rescinded the original securities agreement.
Our decision is also consistent with the two federal decisions discussed in Helenius: Ohashi v. Verit Indus., 536 F.2d 849 (9th Cir. 1976) and Davis v. Davis, 526 F.2d 1286 (5th Cir. 1976). In Ohashi, the court held that a stock exchange agreement was still executory where stock had been exchanged but the defendant continued to falsely assure the plaintiff that it would remove restrictions on the transferability of the stock. The Ohashi court decided that the stock exchange agreement was still executory because the defendant had not fulfilled its implied promise to lift restrictions on the transferability of the stock. And under California law, "every contract contains an implied covenant of good faith and fair dealing whereby no party will do anything to injure the right of any other to receive the benefits of the agreement[.]" Ohashi, 536 F.2d at 853. The Ohashi court warned, however, that "[n]ot every failure to perform a contractual covenant in a contract to sell or exchange securities can become a basis for a claim that a defaulting party has employed a `device, scheme, or artifice to defraud' within the meaning of Rule 10b-5[.]" Ohashi, 536 F.2d at 854 (quoting CFR §§ 240.10b-5). Unlike in Ohashi, the alleged misrepresentations in this case occurred after the parties had provided the promised consideration for the agreement, namely the promissory notes and the stock purchase warrants in exchange for $273,000. Though the notes turned out to be worthless, that is a risk with any security. In Davis, the defendants contracted to purchase the plaintiff's stock. They then refused to honor the contracts and tried to force the plaintiff to sell his stock for a "grossly inadequate consideration." Davis, 526 F.2d at 1289. The Davis court held: Even though the alleged scheme did not arise until after the contracts to sell had been entered, we agree with the District Court that it is still "in connection with the sale." Payment has not yet been made pursuant to the contracts and the purpose of the scheme is to reduce the amount of that payment. The alleged scheme sufficiently "touches" the contracts to sell plaintiff's securities to be "in connection with" a sale. Davis, 526 F.2d at 1290. Davis is distinguishable because it did not involve promissory notes. A contract involving a promissory note as consideration is unique in that it is executed once the note is delivered, even though the note remains unpaid. The securities agreement in this case was executed when the promissory notes and stock purchase warrants were exchanged for $273,000. Additionally, in Davis, the misrepresentations were sufficiently connected to the original transaction to be in connection with that sale. Here the alleged misrepresentations related only to the guaranty, which is a separate transaction. A guaranty agreement is a contractual obligation that exists separate and apart from the principal obligation it guarantees. Wilson Court Ltd. P'ship v. Tony Maroni's, 134 Wn.2d 692, 707, 952 P.2d 590 (1998).
The noteholders next argue that the guaranty agreement was "in connection with the offer sale or purchase of" securities because it was the condition precedent for the merger, which resulted in the creation of new securities. RCW 21.20.010. On this issue, we reverse the trial court's order granting the respondents' cross motion for summary judgment because, viewing the facts in a light most favorable to the noteholders and applying the WSSA liberally because of its purpose of protecting investors, there is a genuine issue of material fact as to whether the guaranty agreement was at least indirectly in connection with the offer, sale, or purchase of securities in the merger.
Summary judgment is appropriate only "`if there is no genuine issue of material fact and the moving party is entitled to judgment as a matter of law.'" Stewart, 122 Wn. App. at 264 (quoting Trimble v. Wash. State Univ., 140 Wn.2d 88, 93, 993 P.2d 259 (2000)). "The standard of review for a ruling on summary judgment is de novo." Stewart, 122 Wn. App. at 264. In ruling on summary judgment, the court views the evidence in the light most favorable to the nonmoving party. Stewart, 122 Wn. App. at 261. Courts construe the WSSA liberally because its primary purpose is to protect investors. Stewart, 122 Wn. App. at 264. Under the WSSA, it is "unlawful for any person" to make an untrue statement of material fact "in connection with the offer, sale or purchase of any security, directly or indirectly[.]" RCW 21.20.010.
Viewing the evidence in the light most favorable to the noteholders, there is a genuine issue of material fact as to whether any misrepresentations in the guaranty agreement were directly or indirectly in connection with the offer, sale, or purchase of securities in the merger. It is clear from the record that the noteholders initially threatened to seek an injunction of the shareholders meeting but then offered to refrain if Devine and Ryan guaranteed the notes. Three days after the guaranty agreement was executed, the shareholders held a meeting and approved the merger. Under these facts, there is a genuine issue as to whether the guaranty agreement was at least "indirectly" "in connection with the offer, sale or purchase of" the securities issued as a result of the merger. RCW 21.20.010.
Devine argues that the guaranty agreement was not a condition precedent to the merger because the merger still had to be approved by shareholders. And even if the noteholders had sought an injunction, they may not have succeeded in obtaining it. Under the circumstances presented, however, it is a question of fact as to whether any misrepresentations in the guaranty agreement were "directly or indirectly" "in connection with" the securities issued as a result of the merger. RCW 21.20.010.
The noteholders next argue that there is a genuine issue of material fact as to whether any misrepresentations in the guaranty were "in connection with the offer, sale or purchase of" securities because of the guaranty's association with the noteholder settlement, in which VIB was to issue $100,000 worth of securities to at least one of the noteholders. Just like in the previous issue, we reverse the trial court's order granting the respondents' cross motion for summary judgment because there is a genuine issue of material fact.
The guaranty agreement, in its recitals, referenced the settlement agreement and the future issuance of securities to one of the noteholders (Stonebridge Securities, LLC).
WHEREAS, as part of and conditioned upon an acceptable resolution of the claims of the Note Holders ("Note Holder Settlement"), VIB has agreed to issue to Stonebridge Securities (which shall be identical to the securities issued to the Note Holders as part of the Note Holder Settlement) having a value (determined on the same basis as the securities to be issued to the Note Holders) equal to not less [than] one hundred thousand dollars ($100,000) for services rendered (the "Fee") together with related, documented expenses.
In his statement of the case, Devine concedes that this part of the guaranty agreement appears to be a promise to issue securities. See Brief of Respondent, at 9 ("The Guaranty included in the Recitals what read like a conditional promise of one not a party to the Guaranty, relating to a potential future agreement[.]"). The noteholders claim that this part of the guaranty agreement was a promise to issue new shares. The settlement agreement is also connected to the guaranty in that the settlement agreement stated that when it was fulfilled and the promissory notes satisfied, the guaranty would be "deemed null, void and of no further force or effect." The trial court erred in granting Devine's cross-motion for summary judgment dismissing the noteholders' WSSA claim in its entirety because, viewing the evidence in the light most favorable to the noteholders and with the WSSA's primary purpose in mind, a genuine issue of material fact exists as to whether any misrepresentations in the guaranty agreement were at least "indirectly" "in connection with the offer, sale or purchase of" securities in the settlement agreement. RCW 21.20.010.
Devine argues that he was not a party to the settlement agreement and therefore the guaranty agreement could not be in connection with the securities issued in the settlement agreement, despite the guaranty's reference to the settlement agreement. He also argues that the guaranty agreement was not connected to the securities issued in the settlement agreement because the noteholders entered into the settlement agreement at their own risk and without reliance upon the guaranty. Whether there is a sufficient connection between the guaranty agreement and the noteholder settlement is, however, a question of fact given the guaranty's reference to the settlement agreement in the recitals.
We next consider Devine's argument that he did not make misrepresentations in the guaranty agreement and that, even if he did, they were not material because the noteholders did not rely on them. The noteholders claim Devine misrepresented that he signed the guaranty on behalf of his marital community and that he resided in Washington. We conclude that there is a genuine issue of material fact as to whether Devine made material misrepresentations. Under the WSSA, it is unlawful for any person, in connection with the offer, sale or purchase of any security, directly or indirectly:. . . . (2) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they are made, not misleading[.]
RCW 21.20.010(2). "A `material fact' is one `to which a reasonable [person] would attach importance in determining his [or her] choice of action in the transaction in question.'" Guarino v. Interactive Objects, Inc., 122 Wn. App. 95, 114, 86 P.3d 1175 (2004) (quoting Aspelund v. Olerich, 56 Wn. App. 477, 481-82, 784 P.2d 179 (1990)).
Applying these principles, it is clear that there is a genuine issue of material fact as to whether Devine made material misrepresentations in the guaranty agreement. Devine does not deny that he signed the guaranty on behalf of his marital community even though his wife did not know about the guaranty and would not have agreed to it had she known about it. And at least one of the noteholders claims that he relied on Devine's representation that he was binding his marital community. As to any material misrepresentations by Devine regarding his residency, Devine explains, "The language of the guaranty is very ambiguous, but it does not state that I lived in Washington." The guaranty, however, states that his address is in Ephrata, Washington. While it may not be credible to the finder of fact that the noteholders believed Devine lived in Washington, it is at least a genuine issue of material fact.
Finally, we consider the noteholders' argument that Devine bound his marital community in the guaranty agreement because he represented that he was executing the guaranty "on behalf of his marital community." The trial court held that Devine did not bind his marital community because under G.W. Equip. Leasing, Inc. v. Mt. McKinley Fence Co., 97 Wn. App. 191, 982 P.2d 114 (1999), an Arizona husband may not enter into a contract in Washington which obligates his community property when, under Arizona law, he could not bind his marital community without his wife also signing the contract as a party. We conclude that the trial court properly applied G.W. Equipment in deciding that under Washington conflicts law, Arizona community property law applied to this issue and that under Arizona law, Devine could not bind his marital community without his wife signing the guaranty as a party.
In G.W. Equipment, Washington corporations Mt. McKinley Fence Co. and G.W. Equipment entered into a leasing agreement that provided it would be governed by the laws of the State of Washington. Lindstrom, who lived with his wife in Arizona, personally guaranteed the lease while in Arizona. His wife signed the guaranty as a witness and the parties agreed that the marital community benefited from the leasing agreement. The court had to decide "whether an Arizona husband may enter into a contract in Washington which obligates his community property when, under Arizona law, he could not bind the community because his wife had not signed the contract as a party." G.W. Equip., 97 Wn. App. at 193.
The court held that Lindstrom had not bound his marital community because his wife did not sign the guaranty as a party, as required under Arizona community property law. The court applied Arizona community property law because "`it is undesirable that the rights, duties, disabilities, and immunities conferred or imposed by the family relationship should constantly change as members of the family cross state boundaries during temporary absences from their home.'" G.W. Equip, 97 Wn. App. at 197 (quoting Potlatch No. 1 Fed. Credit Union v. Kennedy, 76 Wn.2d 806, 813 n. 12, 459 P.2d 32 (1969)). The court further explained: Washington courts apply Washington law to determine the rights and authority of Washington spouses to enter into contracts affecting their community property. For Washington courts to conclude that residents of other community property states are bound by Washington community property law as well, rather than the law of their own state, would be illogical and unjust. The Arizona Legislature has enacted a statute which prohibits one spouse from entering into guaranty contracts without the other spouse's consent.
G.W. Equip., 97 Wn. App. at 197-98. Based upon this analysis, the court held that "Arizona law should govern the question of whether Lindstrom's marital community was bound by his execution of the guaranty agreement[.]" G.W. Equip., 97 Wn. App. at 199.
The trial court correctly applied G.W. Equipment. Devine and his wife Sabra are Arizona residents and therefore, under G.W. Equipment, Arizona community property law governs the question of whether their marital community was bound by the guaranty agreement. And under Arizona law, their marital community was not bound because Sabra did not sign the guaranty as a party.
The noteholders argue that the guaranty's Washington choice of law term is binding because Devine misrepresented on the guaranty that he lived in Washington and the noteholders relied on that misrepresentation. The trial court did apply Washington law, however, and under Washington law, Arizona community property law applies.
This opinion addresses only the effect of the guaranty's choice of law provision on Devine's marital community. We do not address the impact of a judgment for violation of the WSSA on the marital community because that issue is not before us.
Reversed and remanded for further proceedings consistent with this opinion.
WE CONCUR: