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Judge: Donald F. Gaffney, Case: "Signature Collection Properties, LLC v. Academy West Investments, LLC", Date: 2022-10-05 Tentative Ruling

TENTATIVE RULING:

Motion 1. Demurrer to FACC

Cross-Defendant Jason Hsu demurs to the FACC of Cross-Complainant Academy West Investments, LLC (“AWI”). For the following reasons, the demurrer is SUSTAINED with 15 days leave to amend.

A demurrer challenges the defects appearing on the face of the pleading or from other matters properly subject to judicial notice. (See Blank v. Kirwan (1985) 39 Cal.3d 311, 318.) The issue is the sufficiency of the pleading, not the truth of the facts alleged. (Cundiff v. GTE Cal., Inc. (2002) 101 Cal.App.4th 1395, 1404-05.) Questions of fact cannot be decided on demurrer. (Berryman v. Merit Prop. Mgmt., Inc. (2007) 152 Cal.App.4th 1544, 1556.) Because a demurrer tests only the sufficiency of the complaint, a court will not consider facts that have not been alleged in the complaint unless they may be reasonably inferred from the matters alleged or are proper subjects of judicial notice. (Hall v. Great W. Bank (1991) 231 Cal.App.3d 713, 718 n.7.)

The parties’ agreement includes a Delaware choice of law provision. (Agmt. at § 12.9.) It is undisputed that Delaware substantive law governs.

The FACC alleges four contract causes of action against Cross-Defendant Hsu based on the LLC Agreement between Cross-Complainant and Cross-Defendant Signature Collection Properties, Inc. (“SCP”). The FACC alleges that Hsu is the alter ego of SCP. (FACC ¶¶ 7-8.)

In order to state a claim for “piercing the corporate veil under the alter ego theory, [the plaintiff] must show (1) that the corporation and its shareholders operated as a single entity, and (2) that an overall element of injustice or unfairness is present.” (Trevino v. Merscorp, Inc. (D. Del. 2008) 583 F.Supp.2d 521, 528.) “Effectively, the corporation must be a sham and exist for no other purpose than as a vehicle for fraud.” (Wallace ex rel. Cencom Cable Income Partners II, Inc., L.P. v. Wood (Del. Ch. 1999) 752 A.2d 1175, 1184.)

Here, the FACC does not allege facts supporting alter ego liability. The FACC alleges in only conclusory terms that Hsu exercised complete dominion and control over SCP. (See FACC ¶¶ 7-8.) In addition, these allegations appear to contradict the LLC Agreement, which shows that SCP was at one point managed by a third-party manager. (See FACC, Ex. 1.) Facts appearing in exhibits attached to the complaint also are accepted as true and are given precedence, to the extent they contradict the allegations. (Orcilla v. Big Sur, Inc. (2016) 244 Cal.App.4th 982, 994 [citing Dodd v. Citizens Bank of Costa Mesa (1990) 222 Cal.App.3d 1624, 1627].) The FACC also fails to allege facts showing that SCP existed for no other purpose than as a vehicle for fraud.

Should Cross-Complainant AWI desire to file an amended complaint that addresses the issues in this ruling, Cross-Complainant shall file and serve the amended complaint within 15 days of service of the notice of ruling.

Cross-Defendant Hsu to give notice.

Motion 2. Demurrer to FACC

Cross-Defendant Signature Collection Properties, Inc., demurs to the FACC of Cross-Complainant Academy West Investments, LLC. For the following reasons, the demurrer is SUSTAINED with 15 days leave to amend.

The parties’ agreement includes a Delaware choice of law provision. (Agmt. at § 12.9.) It is undisputed that Delaware substantive law governs.

First Cause of Action (Breach of Contract)

The First Cause of Action alleges that SCP breached the parties’ LLC agreement by failing to contribute the full $10,000,000 investment in AWC.

The elements of a breach of contract claim are: (1) contractual obligation; (2) a beach of that obligation by the defendant; and (3) a resulting damage to the plaintiff. (H-M Wexford LLC v. Encorp, Inc. (Del. Ch. 2003) 832 A.2d 129, 140.) Future profits do not constitute recoverable damages. (See Crowell Corp. v. Hirnont USA, Inc. (Del. Super. Dec. 8, 1994) 1994 WL 762663 at *3 [“Under Delaware law, consequential damages in the form of good will, lost future profits, and lost customers are not awarded in breach of contract claims.”]; cf. Base Optics Inc. v. Liu (Del. Ch. May 29, 2015) 2015 WL 3491495 [finding the plaintiff had proven damages in the amount of future profits it would have reasonably expected to receive from three orders defendants booked that plaintiff had an exclusive right to service].)

Here, the FACC does not allege a contractual obligation or Cross-Defendant’s breach of that obligation. The FACC alleges that Cross-Defendant failed to contribute the “agreed amount” of $10,000,000 (see, e.g., FACC ¶ 26), but that does not accurately reflect Cross-Defendant’s obligation under the parties’ agreement. (See FACC, Ex. 1 at § 2.1.) Pursuant to the terms of the LLC Agreement, Cross-Defendant SCP is presented with potential projects, and SCP contributes additional capital only to those projects it has approved. (Ex. 1 at § 2.1(e)(ii)-(v).) There is no allegation that SCP failed to fund projects SCP had approved. Therefore, the FACC fails to state a claim for breach of contract.

Second Cause of Action (Breach of Implied Covenant)

The Second Cause of Action alleges that SCP breached an implied covenant in the LLC Agreement by failing to contribute the full $10,000,000 investment, misrepresenting SCP’s ability to deliver the funds, and concealing material information.

The covenant of good faith and fair dealing is implied in agreements between parties and requires all parties to fairly, honestly, and reasonably perform the terms and conditions of the agreement. Delaware, like most jurisdictions, recognizes an implied covenant “that each party to a contract will act with good faith towards the other with respect to the subject matter of the contract.” (See Katz v. Oak Industries, Inc., 508 A.2d 873, 880 (Del. Ch. 1986).) The implied covenant of good faith and fair dealing requires that a party to a contract “refrain from arbitrary and unreasonable conduct that has the effect of preventing the other party to the contract from receiving the fruits of the contract.” (Wilmington & Northern Railroad Co. v. Delaware Valley Ry. Co., Del. Super., (Del. Sup. Ct. Mar. 30, 1999) 1999 WL 463705 at *6.)

To state a claim for breach of the implied covenant, the plaintiff must allege: “a specific implied contractual obligation, a breach of that obligation by the defendant, and resulting damage to the plaintiff.” (Kuroda v. SPJS Holdings, LLC (Del. Ch. Ct. Apr. 15, 2009) 971 A.2d 982 [citing Fitzgerald v. Cantor (Del. Ch. Ct. Nov. 10, 1998) 1998 WL 942316, at *1].)

The implied covenant is most appropriate when deployed to combat conduct involving aspects of fraud. (KT4 Partners LLC v. Palantir Technologies Inc. (Del. Super. Ct. June 24, 2021) 2021 WL 2823567 at *27, n. 307 [citing ASB Allegiance Real Estate Fund v. Scion Breckenridge Management Member, LLC (Del. Ch. Ct. July 9, 2012) 50 A.3d 434, 443, rev’d on other grounds by Scion Breckenridge Managing Member, LLC v. ASB Allegiance Real Estate Fund (Del. Sup. Ct. 2013) 68 A.3d 665].) The court implies contract terms “only . . . when the party asserting the implied covenant proves that the other party has acted arbitrarily or unreasonably, thereby frustrating the fruits of the bargain that the asserting party reasonably expected. [Citation omitted.] When conducting this analysis, [the court] must assess the parties’ reasonable expectations at the time of contracting [citation omitted] and not rewrite the contract to appease a party who later wishes to rewrite a contract he now believes to have been a bad deal. Parties have a right to enter into good and bad contracts, the law enforces both.” Nemec v. Shrader (Del. Super. 2010) 991 A.2d 1120, 1126.)

In Nemec v. Shrader, the defendant corporation redeemed the plaintiffs’ shares prior to a corporate reorganization and sale that would have significantly increased the plaintiffs’ share price. (Id., at p. 1125.) At the time of the redemption, the corporation’s board of directors anticipated the sale, but the sale was not finalized until four months after the redemption period had closed. (Id., at p. 1125.) The trial court in Nemec concluded that the plaintiffs failed to state a valid claim for breach of the implied covenant because the stock plan explicitly authorized the redemption’s price and timing. (Id. at p. 1126.) The Delaware Supreme Court affirmed the dismissal, holding there cannot be a breach of the implied covenant where a party “exercised an express contractual right.” (Nemec v. Shrader (Del. Super. 2010) 991 A.2d 1120, 1122; Dunlap v. State Farm Fire & Cas. Co. (Del. 2005) 878 A.2d 434, 441 [citation omitted]; Allied Capital Corp. v. GC-Sun Hldgs., L.P. (Del. Ch. 2006) 910 A.2d 1020, 1032 [recognizing that “implied covenant analysis will only be applied when the contract is truly silent with respect to the matter at hand”].)

The Nemec court explained that the implied covenant applies “only . . . to developments that could not be anticipated, not developments that the parties simply failed to consider—particularly where the contract authorizes the [defendant] to act exactly as it did here.” (Nemec, supra, 991 A.2d at p. 1126.) “A party does not act in bad faith by relying on contract provisions for which the party bargained where doing so simply limits advantages to another party.” (Id., at p. 1128; Katz v. Oak Indus. Inc. (Del. Ch. 1986) 508 A.2d 873, 880 [recognizing that for an implied covenant claim to proceed it must be “clear from what was expressly agreed upon that the parties who negotiated the express terms of the contract would have agreed to proscribe the act later complained of . . . had they thought to negotiate with respect to that matter”].)

Here, the FACC fails to allege facts showing SCP acted arbitrarily or unreasonably, or without furthering any legitimate interest. It is undisputed that SCP had the express contractual right to approve or deny future projects presented by AWI and that SCP’s obligation to invest funds was contingent on its approval(s). SCP’s denial is not an unanticipated development; in fact, the parties’ agreement authorizes SCP to do just that.

To the extent AWI attempts to base this cause of action on fraud or concealment, the allegations are not stated with particularity. (Del. Ch. Ct. Rule 9 [providing that “[i]n all averments of fraud . . ., the circumstances constituting fraud . . . shall be stated with particularity”].)

Third Cause of Action (Breach of Contract)

The Third Cause of Action alleges that SCP breached the LLC Agreement by failing to comply with the terms of guaranties Hsu executed for the LLC’s Kentucky project.

Section 2.2(c) of the LLC Agreement provides that for those projects SCP approves, SCP, and if required its principals, must execute a non-recourse guaranty. Section 12.12 provides that “[e]ach Member agrees to execute and deliver such additional documents and instruments and to perform such additional acts as may be necessary or appropriate to effectuate, carry out and perform all of the terms, provisions, and conditions of this Agreement and the transactions contemplated hereby.” (LLC Agmt. at § 12.12.)

Here, the FACC alleges that SCP’s principal Jason Hsu executed such a guaranty, but failed to comply with the terms of the guaranty and/or failed to provide updated financials. There is no allegation that Cross-Defendant SCP had access to Hsu’s financials and had the authority to disclose those financials. Thus, the FACC fails to allege facts to support any breach by SCP’s obligations under the LLC Agreement.

The alter ego allegations in the FACC, even assuming arguendo they were sufficient to impose alter ego liability, do not save this claim. The alter ego doctrine permits the court to disregard the existence of a corporation to allow derivative liability to be placed on a business entity’s individual principals and their personal assets. (Blair v. Infineon Technologies AG (D. Del. 2010) 720 F.Supp.2d 462, 469-470 [citations omitted].) It does not permit the court to disregard the existence of a corporation for all purposes and impute the corporation’s contractual obligations directly on the principal, and vice versa.

Fourth Cause of Action (Breach of Implied Covenant)

The Fourth Cause of Action alleges that SCP breached an implied covenant in the LLC Agreement by failing to comply with the guaranties entered into by Hsu, refusing to provide Hsu’s financials, misrepresenting Hsu’s financial ability to guarantee projects, and concealing material information.

As discussed above, the FACC fails to allege facts to support any obligation by SCP to provide the financials of its principal. The FACC also fails to allege with particularity facts showing any fraud or concealment.

Should Cross-Complainant desire to file an amended complaint that addresses the issues in this ruling, Cross-Complainant shall file and serve the amended complaint within 15 days of service of the notice of ruling.

Moving Cross-Defendant to give notice.