Judge: Glenn R. Salter, Case: 22-1251947, Date: 2022-08-18 Tentative Ruling

Demurrer

The demurrer of defendants Paderia Restaurant Group, Inc., Paderia 2, LLC, Paderia 3, LLC, Nathan Vuong, and Davion Tran to the complaint is SUSTAINED with 20 days leave to amend.

The Basis of the Demurrer

The demurrer raises two basic grounds:  that the Complaint is barred by the business judgment rule and the alter ego rule.  As to the business judgment rule, it is a close question.  But the court ultimately concludes the complaint, as currently pled, does not sufficiently allege facts showing the Board actions were taken with improper motives or as a result of a conflict of interest.  As to the allegations of alter ego liability, the court finds the complaint does not allege sufficient facts to show alter ego liability.

The Facts Alleged in the Complaint

The complaint alleges 14 causes of action:  (1) breach of fiduciary duty, (2) abuse of control, (3) gross mismanagement, (4) waste of corporate assets, (5) breach of written contract, (6) breach of implied covenant of good faith and fair dealing, (7) fraud, (8) negligent misrepresentation, (9) negligence, (10) accounting, (11) restitution based on unjust enrichment, (12) violation of Business and Professions Code section 17200, (13) rescission, and (14) dissolution.

According to the complaint, defendant Paderia Restaurant Group, Inc., owns and operates premium bakeries in Orange County and Los Angeles.  The plaintiff alleges that in May 2019 it purchased five percent equity shares in each of two Paderia bakeries, designated as P2 and P3.  However, it later increased its equity interests in P3 to 12 percent following representations made by the defendants that additional funding was necessary to keep the project alive.

The complaint alleges that the defendants then made a series of bad business decisions, which injured the interests of P2 and P3 and their investors.  For example, defendants improperly negotiated a lease which forced relocation into a smaller space.  The complaint also alleges the construction of P3 fell behind schedule and went over budget, which caused the defendants to secure various short-term loans with high interest rates and on unfavorable terms.  And, the defendants gave false financial documents and information to the plaintiff and other investors, and the defendants allegedly transferred funds from P2 to P3 at the expense of the P2 investors.  Finally, the complaint alleges defendant Paderia Restaurant Group, Inc., assigned its rights to the Paderia trademark to a third party without a vote of the members of P2 and P3.  The plaintiff alleges that this constituted a breach of fiduciary duties by the defendants owed to P2, P3, and the plaintiff.

The complaint further alleges that defendants Vuong and Tran are the sole shareholders of defendant Paderia Restaurant Group, Inc.

The court notes that the First through Fourth Causes of Action are brought derivatively in favor of P2 and P3.  The Fifth and Sixth Causes of Action are brought both individually by the plaintiff and derivatively on behalf of P2 and P3.  All of the remaining claims (through the Fourteenth Cause of Action) are brought solely on behalf of the plaintiff.

The Business Judgment Rule

The “business judgment rule” is a presumption that corporate directors act in good faith.  (See Kruss v. Booth (2010) 185 Cal.App.4th 699, 728.)  It encourages courts to defer to the sound judgment of the directors in making corporate decisions, and “it prohibits courts from interfering” with those decisions if they have been “made by the directors in good faith and in the absence of a conflict of interest.”  (Ibid.)  However, “[t]he business judgment rule does not shield actions taken without reasonable inquiry, with improper motives, or as a result of a conflict of interest.”  (Id. at p. 728.)  It can be rebutted “by affirmative allegations of facts which, if proven, would establish fraud, bad faith, overreaching, or an unreasonable failure to investigate material facts.”  (Lee v. Interinsurance Exchange (1996) 50 Cal.App.4th 694, 715.)

To withstand a demurrer, the complaint must allege specific and material facts that show fraud, bad faith, or a clear conflict of interest.  A general allegation that the directors acted in bad faith, or a mere allegation of facts without any specificity as to why those facts show that the business judgment rule presumption should not apply, is insufficient to state a cause of action.

Here, neither the demurrer nor the opposition address the key analytical points.

The defendants cite Paragraph 56 of the complaint which simply alleges that defendant Paderia Restaurant Group, Inc., “is the majority owner and Managing Member of nominal defendants P2 and P3.”  Based on that, defendants assert that any claims are barred by the business judgment rule.  Although they acknowledge the factual allegations made in Paragraph 54, they assert “these allegations only outline legitimate, if otherwise purportedly unsuccessful, business decisions.”  (See Demurrer, 2:26-3:3.)

Notably, the defendants offer no explanation or analysis that the business judgment rule applies to bar claims for breach of contract, fraud accounting, unjust enrichment and rescission—all of which are included within the complaint as causes of action.  For example, defendants fail to cite any authority that indicates the business judgment rule shields directors from liability for breaching a contract or committing fraud.  Nor do the defendants offer any analysis directed towards these claims or otherwise demonstrate the claims fail to allege sufficient facts.

But the plaintiff fares no better.  In opposition, it cites to a long list of factual allegations.  (See Opp, 5:1-6:14.)  But a review of those allegations demonstrate that the vast majority merely allege declining business or possibly bad judgment, but stopping short of alleging improper motive, bad faith, or fraud.  For example, the plaintiff alleges defendants “informed Plaintiff that the lease was improperly negotiated, and that the landlord had forced a relocation into an inferior space,” and that there were “significant and excessive cost overruns and delays in completing the buildout.”  (See Para. 29 of Complaint.)  In addition, it is alleged defendants expressed an immediate need in November 2020 for $250,000 as “invoices were overdue, contractors were unpaid [and] construction was halted.”  (See Para. 30 of Complaint.)  And, it is alleged defendants “secured various short term debt instruments on behalf of P3 with high interest rates and unfavorable terms” which “subordinated all other investment and liabilities, including Plaintiff’s investments.”  (See Paras. 33, 40, and 54(b) of Complaint.)

Although those allegations clearly allege the subject businesses were facing many difficulties, the plaintiff does not identify any allegations that indicate those actions were improperly motivated, the result of a conflict of interest, or were engaged in in bad faith.  Moreover, there are no allegations defendants deliberately negotiated a bad lease in order to prefer other entities for which it had a conflict of interest.  Similarly absent, are any allegations the high-interest loans were entered into for the benefit of other companies directed by the defendants.

Although the complaint alleges “Defendant PRG has assigned its rights to the Paderia trademark to a third party without the vote of the members of P2 and P3” (see Paras. 41 and 54(g) of Complaint), there is no allegation, for example, that defendants hold an interest in the third-party company or provided it with a more favorable deal than would otherwise be justified.

Further, some allegations do not clearly identify any clearly actionable conduct at all.  For example, the plaintiff references allegations of “extensive personal and professional disputes between Vuong and Tran” (see Para. 27 of Complaint) and “continued [] internal discord” including “physical and verbal altercations, and mistreatment of employees.”  (See Para. 39 of Complaint.)

The only allegations that come close to stating a cause of action involve allegations of commingling and misrepresentations.  For example, it alleges that “Plaintiff learned that Defendants had improperly commingled funds by transferring $60,000 of P2 funds to P3 in order to keep P3 financially afloat at the expense of P2 and its investors.”  (See Para. 35 of Complaint.)  It further alleges defendants provided inaccurate financial statements and disclosures to investors and made misrepresentations as to the anticipated costs of the buildout, which were allegedly relied on in the plaintiff’s decision to make equity contributions.  (See Paras. 34-37 and 92-95 of Complaint.)  But even here, the allegations are not specific enough as to claims of bad faith, fraud, or a conflict of interest.  (As pointed out above, the court notes that the defendants do not specifically address the allegations of misrepresentations.  However, the court concludes that the intent of the demurrer, and the arguments made, indirectly attack them.)

Based on the above, the court concludes the demurrer must be sustained with leave to amend.

Alter Ego Allegations

To allege claim for alter ego liability, the complaint must allege a “unity of interest and ownership between the corporation and its equitable owner” sufficient to establish that “the separate personalities of the corporation and the shareholder do not in reality exist,” and that there would be “an inequitable result if the acts in question are treated as those of the corporation alone.”  (Sonora Diamond Corp. v. Superior Court (2000) 83 Cal.App.4th 523, 538; see also Leek v. Cooper (2011) 194 Cal.App.4th 399, 415.)  Further, the plaintiff need only allege ultimate rather than evidentiary facts.  (Rutherford Holdings, LLC v. Plaza Del Rey (2014) 223 Cal.App.4th 221, 236.)

Here, the plaintiff asserts “on information and belief” that defendants Vuong and Tran utilize the various entities “as a mere shell and naked conduit to conduct personal, individual affairs such that adherence to the corporate fiction” would promote fraud and injustice.  (See Paras. 84 and 90 of Complaint.)  The allegation of these conclusory facts based on information and belief is improper.  (Doe v. City of Los Angeles (2007) 42 Cal.4th 531, 551, n. 5.)

Further, none of the allegations sufficiently allege a risk of injustice or that these defendants were abusing the corporate forms for personal gain.  At most, the complaint alleges a commingling of funds between P2 and P3, a fact that could support a finding those entities were alter egos of each other.  This case is factually different than Riddle v. Leushner (1959) 51 Cal.2d 574 at page 581, which was cited by the plaintiff.

Accordingly, the court concludes the demurrer must be sustained on this ground, as well, with leave.

Motion to Strike

Given the demurrer is being sustained with leave to amend, the motion to strike is DENIED as MOOT.

Notice

The defendants shall give notice.