Qmect, Inc. v. Burlingame Capital Partners II et al

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UNITED STATES BANKRUPTCY COURT
NORTHERN DISTRICT OF CALIFORNIA
In re No. 04-41044 T
Chapter 11
QMECT, INC., etc.,
Debtor-in-Possession.
__________________________________/
In re No. 04-46443 T
Chapter 11
FRED AND LINDA KOELLING,
Debtors-in-Possession.
__________________________________/
QMECT, INC., etc., A.P. No. 04-4190 AT
A.P. No. 04-4365 AT
Plaintiff, A.P. No. 04-4366 AT
vs. (Consolidated)
BURLINGAME CAPITAL PARTNERS II,
L.P., etc. et al.,
Defendants.
__________________________________/
AND RELATED ADVERSARY PROCEEDINGS
__________________________________/
Signed: August 24, 2005
________________________________________
LESLIE TCHAIKOVSKY
U.S. Bankruptcy Judge
________________________________________
Entered on Docket
August 24, 2005
GLORIA L. FRANKLIN, CLERK
U.S BANKRUPTCY COURT
NORTHERN DISTRICT OF CALIFORNIA
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1Burlingame Funding was formed after Qmect’s chapter 11
case was filed and the conduct complained of occurred. However,
Burlingame transferred some of the claims asserted against Qmect
to Burlingame Funding after it was formed. Therefore,
Burlingame Funding is a necessary party to the equitable
subordination claim as well as to the claim objecting to its
proof of claim.
2
MEMORANDUM OF DECISION
The above-captioned adversary proceedings have been
consolidated for trial. The lead case--A.P. No. 04-4190 AT (the
“Equitable Subordination Action”)–-was filed originally in this
court. In the Equitable Subordination Action, Qmect, Inc.
(“Qmect”), one of the above-captioned debtors-in-possession,
objects to the secured claims of Burlingame Capital Partners II
(“Burlingame”) and its affiliate, Electrochem Funding LLC
(“Burlingame Funding”), and seeks to equitably subordinate their
claims to the claims of some or all of the other creditors.1
The other two adversary proceedings--A.P. 04-4365 AT (the
“Guaranty Action”) and A.P. 04-4366 AT (the “Breach of Fiduciary
Duty Action”)--were filed originally in state court, either by or
against Qmect and/or Fred and Linda Koelling (the “Koellings”).
The Koellings are Qmect’s principal shareholders and guaranteed
the loans upon which Burlingame’s and Burlingame Funding’s claims
are based. The Guaranty Action and the Breach of Fiduciary Duty
Action were removed to this court after Qmect and the Koellings
filed their chapter 11 bankruptcy petitions. P r i o r t o t h e
removal of the Guaranty Action, the Koellings filed a cross-
complaint against the Burlingame, among others, asserting claims
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for breach of contract, fraud, intentional interference with
prospective economic advantage and declaratory relief (the
“Koelling Cross-Complaint”). The Koellings’ claims against
defendants other than Burlingame and Burlingame Funding have been
remanded to state court. On May 11, 2005, Burlingame filed a
motion for summary judgment or adjudication of the claims asserted
in the Koelling Cross-Complaint. The motion has been fully
briefed and argued and was taken under submission. The Court’s
conclusions are set forth below.
SUMMARY OF FACTS
Qmect, a California corporation, is engaged in the
electroplating business in Northern California. It operates its
business primarily at a facility in Union City, California (the
“Real Property”), which it built in the late 1990s. The business
was previously operated through a general partnership known as
Koelling-McNeill (the “Partnership”), of which Fred Koelling was
a general partner. The Partnership operated its business at a
rented facility in Hayward, California.
In 1995, the Partnership decided to build its own facility.
For that purpose, it purchased the Real Property and in 1996 began
construction. At some point in the process, Qmect was formed, and
the Partnership sold its assets to Qmect. In 1997, Qmect obtained
loans from Comerica Bank-California (“Comerica”) to assist in the
construction for a total of $1.8 million (the “Comerica Loans”).
The Comerica Loans are comprised of three separate loan
facilities: (a) a loan secured by a first priority deed of trust
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2The Original Engagement Letter indicates that it was
executed in April 1999. However, the parties agree that this
date is in error.
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on the Real Property, (b) a line of credit secured by Qmect’s
accounts receivable, and (c) a line of credit secured by Qmect’s
equipment. The Koellings guaranteed the Comerica Loans and
secured their guaranty obligation with liens on their real and
personal property. (This guaranty is referred to hereinafter as
the “Comerica Guaranty.”)
Qmect was unable to complete construction of the facility for
the amount of the Comerica Loans. Consequently, in 1998, Qmect
obtained an additional loan from Comerica in the face amount of
$2,100,000 (the “Flat Note Loan”). The facility was completed in
January 2000.
Shortly after making the Flat Note Loan, Comerica began urging
Qmect to find an alternate source of funding to pay it off.
Comerica suggested that Qmect engage someone to assist it in this
effort and recommended Robert and Janice Judson (the “Judsons”),
among others. In December 1999, Qmect and Sierra Financial Group,
Inc. (“Sierra”), an entity owned by the Judsons, signed an
engagement letter (the “Original Engagement Letter”).2
The Original Engagement Letter provided that Sierra would
provide management consulting services to Qmect and would assist
Qmect in refinancing and restructuring its existing debt with
Comerica and in obtaining sufficient new financing from Comerica,
if needed. The Original Engagement Letter provided that, in case
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such efforts with Comerica were unsuccessful, Sierra was also
engaged on an exclusive basis to seek financing from other sources
acceptable to Qmect. As compensation for the consulting service
through December 31, 1999, Qmect agreed to pay Sierra $10,000.
Thereafter, it was agreed that Qmect and Sierra would negotiate a
monthly fee for further consulting services.
The Original Engagement Letter provided that, if Sierra were
successful in negotiating a restructuring of Comerica’s debt or in
obtaining new financing, it would be entitled to a fee based on
the amount of the new or restructured financing. Sierra was not
successful in negotiating a restructuring of Comerica’s debt or
obtaining new financing by the end of 1999 or during the first few
months of 2000. No evidence has been presented that it made any
effort to do so.
In March 2000, Sierra and Qmect executed an amended engagement
letter (the “Amended Engagement Letter”), continuing Sierra’s
exclusive representation of Qmect in its efforts to restructure
its debt. The Amended Engagement Letter failed to provide for any
further separate compensation for Sierra’s consulting services.
However, the Amended Engagement Letter increased the percentage
compensation that Sierra would receive if it were successful in
negotiating a restructuring of Qmect’s existing loans or in
finding a new loan. The Amended Engagement Letter provided that,
except as amended or modified, the terms of the Original
Engagement Letter would remain in effect.
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The evidence is unclear as to whether Sierra ever attempted
to negotiate a restructuring of the Comerica Loans during 2000.
Robert Judson declared that he contacted Comerica during this
period with regard to this subject and that Comerica made it clear
that it was not interested in restructuring the debt. Fred
Koelling declared that Robert Judson never informed him that he
had spoken to Comerica about this subject. To the contrary, Fred
Koelling declared that Robert Judson warned him repeatedly that
any such communications would be detrimental to Qmect’s
relationship with Comerica. In deposition, a Comerica bank officer
testified that Robert Judson had discussed restructuring the
Comerica Loans with him, but he could not remember when.
In the Spring of 2000, Robert Judson wrote to a number of
potential lenders to solicit their interest in providing financing
to Qmect. Two of the potential lenders expressed some interest
in doing so. There is a factual dispute concerning why Qmect did
not attempt to obtain financing from either of these two parties.
Robert Judson declared that the Koellings rejected both offers
because the parties sought more equity in Qmect than Fred Koelling
was willing to give up. Fred Koelling declared that no formal
offers were ever made and that, at a meeting with Comerica, Robert
Judson recommended that Qmect not attempt to obtain new financing
from these sources.
Qmect has provided evidence, in the form of a letter to a
potential investor in a fund to be organized by the Judsons that,
as early as May 2000, the Judsons contemplated forming their own
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fund to provide subordinated financing to Qmect. In or about
December 2000, the Judsons formed Burlingame for that purpose.
On or about June 4, 2001, Burlingame sent Qmect a proposal
letter (the “Burlingame Loan Proposal Letter”), agreeing to
solicit investors for the purpose of making a $2,000,000 loan to
enable Qmect to pay off the Flat Note Loan. As a condition to its
doing so, Burlingame required Qmect to sign a copy of the
Burlingame Loan Proposal Letter, agreeing to the key terms of the
loan (the “Term Sheet”). The Burlingame Loan Proposal Letter
contained the following provision (the “Release”):
Regardless of whether the Financing is
approved or closes, Borrower agrees, to
indemnify and hold Lender, its general
Partner, its affiliates and the directors,
officers, employees, and representatives of
any of them, harmless from and against all
claims, expenses (including, but not limited
to, attorneys’ fees), damages, and liabilities
of any kind which may be incurred by, or
asserted against, any such person in
connection with or arising out of, this
Proposal Letter, the Financing, any other
related financing, documentation, disputes or
environmental liabilities, or any related
investigation, litigation, or proceeding.
Under no circumstances shall Lender, its
General Partner or any of its affiliates be
liable for any punitive, exemplary,
consequential or indirect damages which may be
alleged to result in connection with this
Proposal Letter, or the Financing or any other
financing.
Apparently, in 2001, someone engaged in negotiations with
Comerica to obtain additional financing for Qmect because on the
following day, June 5, 2001, Comerica sent a letter to Qmect,
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offering to make a $3.5 million loan to Qmect, secured by a junior
deed of trust on real property owned by Kids’ Connection, Inc.
(“Kids’ Connection”), an entity owned by Linda Koelling (the “June
5, 2001 Comerica Offer”). The June 5, 2001 Comerica Offer
provided, among other things, that neither the June 5, 2001
Comerica Offer nor its contents should be disclosed “except to
those individuals who are your officers, employees or advisors who
have a need to know....”
Fred Koelling apparently considered Robert Judson Qmect’s
advisor because he disclosed the contents of the June 5, 2001
Comerica Offer to him. On June 13, 2001, at Fred Koelling’s
request, Robert Judson sent to Comerica a letter rejecting
Comerica’s offer on Qmect’s behalf. The letter was sent on
Burlingame letterhead (the “June 2001 Rejection Letter”). The
June 2001 Rejection Letter enclosed a copy of the Burlingame Loan
Proposal Letter, signed by Fred Koelling on June 8, 2001.
In the June 2001 Rejection Letter, Robert Judson asserted that
placing a junior deed of trust on Kids’ Connection’s real property
would violate Kids’ Connections’ agreement with its principal
lender, City National Bank, which held the first deed of trust on
the real property. Judson also expressed the view that it would
not be “workable” or “realistic” for Comerica to replace City
National Bank as Kids’ Connections’ principal lender “[g]iven the
less than ideal relationship between Kids Connection and
Comerica....” He reminded Comerica that, for some time,
Burlingame had been interested in making a $2,000,000 subordinated
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loan to Qmect. He expressed the view that this arrangement would
be preferable from both Comerica’s and Qmect’s point of view.
The $2,000,000 subordinated loan from Burlingame (the
“Burlingame Loan”) did not close until late 2001. In the mean
time, the Koellings provided $1,500,000 in new capital in the form
of a loan so that Qmect could meet its operating expenses.
According to Fred Koelling, at the last minute, in November 2001,
Burlingame insisted on a personal guaranty for the loan (the
“Burlingame Guaranty”). The Koellings pledged their stock in
Qmect to secure the Burlingame Guaranty. At that time, their
stock represented a controlling interest in Qmect.
Before the loan closed, in November 2001, Qmect engaged an
entity known as International Profit Associates (“IPA”) to provide
financial advice. A representative of IPA accompanied Fred
Koelling to a meeting with Comerica and Robert Judson where the
Burlingame Loan was discussed. At the meeting, the IPA
representative counseled Koelling against accepting the Burlingame
Loan and suggested filing for bankruptcy. At the conclusion of
the meeting, Robert Judson told Koelling he had made a serious
mistake in hiring IPA and insisted that IPA be terminated. Fred
Koelling followed Judson’s advice.
Qmect did not hire an attorney to negotiate the Burlingame
Loan. However, it did hire an attorney to review the documents.
There does not appear to be a factual dispute as to whether Robert
Judson advised Fred Koelling to obtain an attorney to negotiate
the Burlingame Loan with Burlingame on Qmect’s behalf. Fred
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Koelling declared that Robert Judson assured him that he did not
need an attorney to negotiate the Burlingame Loan. Robert Judson
declared that he advised Qmect to hire its own counsel but he does
not specify for what purpose. Burlingame has provided a copy of
an e-mail dated February 27, 2002 from Robert Judson to Fred
Koelling, transmitting various loan documents and stating that,
“as always,” he is advised to have his own counsel review the
documents. It says nothing about having his own counsel to
negotiate the loan.
The Burlingame Loan was used in part to pay off the Flat Note
Loan. The Burlingame Loan bore interest at the nominal rate of
22% per annum and an effective rate of 27% per annum. The
Burlingame Loan closed in November 2001. According to Fred
Koelling’s declaration, the net proceeds of the Burlingame Loan,
after paying off the Flat Note Loan, were largely used to pay
interest to Burlingame. In addition, Sierra received a $60,000
fee for “finding” the Burlingame Loan.
Qmect was unable to service the Burlingame Loan, and it went
into default almost immediately. Beginning in July 2002,
according to Fred Koelling’s declaration, Burlingame began
proposing that it take over Qmect. The proposal did not include
a release of the Burlingame Guaranty. In October 2002, Qmect and
the Koellings filed a complaint in state court against the
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3This action has since been removed to this court,
commencing the adversary proceeding referred to as the Breach of
Fiduciary Duty Action.
4Alternatively, SCG offered to pay Comerica $1,800,000 for
the Comerica Loans plus $900,000 to be paid into an escrow
pending resolution of a dispute between Comerica and the
Koellings concerning the amount due.
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Judsons, Sierra, and Burlingame for breach of fiduciary duty,
among other things.3
During the fall of 2002 or the spring of 2003, Qmect engaged
Alternative Capital Strategies, LLC (“ACS”), to assist it in
reorganizing its financial affairs. ACS located a proposed
lender, Structured Capital Group (“SCG”), the principal of which
is an individual named Basem Zakariya (“Zakariya”). SCG expressed
an interest in purchasing the Comerica Loans at a discount and
working with Qmect to resolve its financial problems.
On May 28, 2003, SCG sent a letter to Comerica offering to
purchase the Comerica Loans for $2,100,000.4 The Judsons may have
learned of the offer that day or the next, because, on May 29,
2003, Burlingame e-mailed to the Koellings a notice of the
proposed sale on June 12, 2003 of the pledged Qmect stock. In any
event, they learned of the offer by June 4, 2003 because, on that
day, they put Comerica on notice in some fashion that they would
sue Comerica if Qmect or a Qmect affiliate purchased the Comerica
Loans. (See Declaration of Robert R. Moore in Support of Motion
for Summary Judgment on Cross-Complaint, Ex. J.) Burlingame
asserted that it would violate Burlingame’s subordination
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agreement with Comerica if Comerica sold the Comerica Loans to a
third party without giving Burlingame 90 days’ prior notice.
Burlingame also asserted that it would violate various provisions
of its loan agreement with Qmect if the Comerica Loans were sold
to a third party, even with advance notice.
On June 9, 2003, Qmect issued additional shares and
transferred them to various parties other than the Koellings. SCG
received 1000 of the newly issued shares. The result was that the
stock pledged to Burlingame no longer represented a controlling
interest in Qmect. Zakariya was also made a director of Qmect on
June 9, 2003. On the same day, the Koellings assigned to Kids’
Connection their rights under the promissory note executed by
Qmect, evidencing their $1,500,000 loan to Qmect during the
preceding year.
On June 9, 2003, Comerica sent a letter by fax and personal
delivery to Qmect and Burlingame, informing them that Comerica had
decided to sell the Comerica Loans. It disclosed that Comerica
had received a offer to purchase the Comerica Loans, which had
expired, from a third party that appeared to be affiliated with
Qmect. By this letter, Comerica proposed to give Burlingame and
Qmect an opportunity to bid against each other on the purchase of
the Comerica Loans.
On June 10, 2003, Qmect sought a temporary restraining order
of the proposed stock foreclosure sale. Qmect did not disclose to
the court or to Burlingame at that time that it had issued
additional stock. The temporary restraining order was denied.
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Thereafter, on June 12, 2003, Qmect sent Burlingame a letter
informing it of the issuance and transfer of the additional stock.
On June 14, 2003, Burlingame, Qmect, the Koellings, and SCG
executed an agreement concerning the purchase of the Comerica
Loans (the “June 14 Agreement”). The June 14 Agreement provided,
that, by 3:00 p.m. on June 17, 2003, Burlingame would make an
offer to purchase the Comerica Loans at a price determined to be
appropriate by Burlingame in its good faith judgment. If the
offer were rejected or a counterproposal made, Burlingame and
Qmect would cooperate in determining the appropriate response. If
Comerica did not accept an offer from Burlingame by September 15,
2003, either Burlingame or Qmect (or its affiliate) would be
entitled to make independent offers to purchase the Comerica
Loans. However, prior to September 15, 2003, only Burlingame will
be entitled to bid.
The June 14 Agreement provided that, if Burlingame purchased
the Comerica Loans, it would release the Koellings from the
Comerica Guaranty subject to the following provision:
All parties agree to cooperate in good faith
to achieve the purposes of this agreement. No
party shall be deprived of any benefit of this
agreement under this provision unless and
until a court has ruled that such party has
acted in bad faith and should be deprived of
such benefit.
Without limiting the foregoing, with
respect to the unconditional guaranty, in the
event that Burlingame should have a claim that
Koelling acted in bad faith with regard to the
joint bidding process, the guaranty shall
remain in effect, and Burlingame shall take no
action to enforce it, until a court has ruled
on the matter. If Burlingame & Company [i.e.,
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5The Koellings did not inform the Judsons that SCG had
previously made an offer to Comerica to purchase the Comerica
Loans for $2.1 million. However, there is no evidence that the
Judsons asked either the Koellings or Zakariya the amount of
SCG’s previous offer.
6SCG formed an entity known as Qmect Funding for this
purpose. For the sake of simplicity, the Court refers to both
entities in the memorandum as SCG.
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Qmect] have both bid on the notes and
Burlingame has purchased the bank documents
and the court has ruled that Koelling acted in
bad faith in the joint bidding process, then
the court may order that Koelling guarantee
will not be released.
Burlingame made an offer to purchase the Comerica Loans for
$1,600,000 on or before June 17, 2003. Comerica rejected the
offer. There is no evidence that it made a counteroffer.
Burlingame made a second offer to purchase the Comerica Loans on
September 9, 2003, this time for $1,400,000. Comerica rejected
this offer as well. Fred Koelling was advised of the amounts of
the offers in each instance before they were made and did not
raise an objection to them.5
In the fall of 2003, SCG reached an agreement with Comerica
to purchase the Comerica Loans for approximately $1,725,000.6
Burlingame learned of the proposed sale and, on January 14, 2004,
its counsel wrote Comerica two letters. In the first letter (the
“Litigation Threat Letter”), Burlingame reiterated its threat to
sue Comerica if the Comerica Loans were sold to SCG. In the
second letter, Burlingame offered to purchase the Comerica Loans
for $50,000 more than offered by SCG. The loan documents drafted
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by Comerica required SCG to indemnify Comerica in the event it was
sued because of the sale. SCG was unwilling to agree to this
provision, and Comerica refused to waive it. Therefore, the sale
agreement fell through.
Thereafter, on or about February 4, 2004, Comerica agreed to
sell the Comerica Loans to the Burlingame for $1,850,000. It did
not give SCG an opportunity to submit a competing bid. Comerica
asked Burlingame to agree to indemnify Comerica in the event of
suit, but Burlingame refused to do so. Nevertheless, Comerica
proceeded with the sale. Shortly after acquiring the Comerica
Loans, Burlingame commenced foreclosure proceedings with respect
to the Burlingame Loan and filed suit against the Koellings on the
Comerica Guaranty. On February 27, 2004, Qmect filed a chapter 11
bankruptcy petition to prevent the foreclosure. Shortly
thereafter, Burlingame created Burlingame Funding and assigned the
Comerica Loans to it.
LAW APPLICABLE TO SUMMARY JUDGMENT MOTIONS
The Court should grant summary judgment on a claim if the
moving party establishes that there is no genuine issue of
material fact and that the moving party is entitled to judgment in
its favor as a matter of law. Fed. R. Civ. Proc. 56, made
applicable to this adversary proceeding by Fed. R. Bankr. Proc.
7056. A fact is material if it could affect the outcome of the
decision. Matsushita Elec. Indus. Co., Ltd. v. Zenith Radio
Corp., 475 U.S. 574, 585-588 (1986); Anderson v. Liberty Lobby,
477 U.S. 242, 248 (1986). A motion to dismiss a complaint is
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governed by the same standards as a motion for summary judgment
when evidence is presented in support of the motion. See
Robertson v. Dean Witter Reynolds, Inc., 749 F.2d 530, 533-34 (9th
Cir. 1984).
In determining whether to grant summary judgment or
adjudication, the Court is required to view the evidence in the
light most favorable to the nonmoving party. The Court is also
required to draw any inferences from the evidence in the manner
most favorable to the non-moving party. Matsushita, 475 U.S. at
587. However, a genuine issue may not be created by a mere
“scintilla” of evidence produced by the nonmoving party. Liberty
Lobby, 477 U.S. at 251.
Normally, the party moving for summary judgment is required
to come forward with sufficient evidence to support a prima face
case establishing the right to judgment in its favor. To
successfully oppose the motion, the adverse party is then required
to come forward with sufficient evidence to create a genuine issue
of material fact. However, when the adverse party has the burden
of proof on the claim, the moving party is not required to present
evidence negating the elements of the adverse party’s claim. All
the moving party need do is point out to the Court the pleadings
or other papers that establish that the adverse party will be
unable to present sufficient evidence to sustain some essential
element of its claim. The burden is then on the adverse party to
come forward with sufficient evidence to establish a prima facie
case on its claim. Celotex Corp. v. Catrett, 477 U.S. 317, 322-23
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(1986); Lujan v. National Wildlife Federation, 497 U.S. 871, 884-
85 (1990).
DISCUSSION
The Koelling Cross-Complaint asserts five claims for relief
against Burlingame: i.e., two claims for breach of contract, a
claim for fraud, a claim for intentional interference with
prospective economic advantage, and a claim for declaratory
relief. Burlingame moves for summary judgment with respect to all
five claims. Alternatively, they move to dismiss some or all of
the claims or to summarily adjudicate such portions of the claims
as to which there is no genuine issue of material fact. The Court
will discuss each claim separately.
A. FIRST BREACH OF CONTRACT CLAIM
The first claim for relief in the Koelling Cross-Complaint
asserts that Burlingame breached the June 14 Agreement by suing
the Koellings on the Comerica Guaranty after acquiring the
Comerica Loans. As discussed above, the June 14 Agreement provided
that, if Burlingame acquired the Comerica Loans, it would release
the Koellings from the Comerica Guaranty. However, this release
was conditioned on the Koellings having acted in good faith in
connection with the joint bidding process. Burlingame contends
that they did not. Although the Koellings dispute this
contention, the June 14 Agreement contemplates that, in the event
of a dispute, a judicial determination of the issue could be
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7The substance of this dispute will be addressed in
connection with the fifth claim for relief, for declaratory
judgment.
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sought.7 Until then, the Comerica Guaranty would remain in effect
but could not be enforced. Thus, the Court concludes that
Burlingame has not breached the June 14 Agreement by filing the
Guaranty Action and is entitled to summary judgment to this effect
on the first claim for relief.
B. SECOND BREACH OF CONTRACT CLAIM
The second breach of contract claim also alleges that
Burlingame breached the June 14 Agreement. This claim for relief
cites two additional types of breach. First, it alleges that
Burlingame breached the June 14 Agreement by failing to make a
good faith attempt to buy the Comerica Loans within the initial 90
day period. Second, it alleges that Burlingame breached the June
14 Agreement by causing Comerica to renege on its agreement to
sell the Comerica Loans to SCG.
In its motion for summary judgment, in response to the first
allegation of breach, Burlingame contends that the June 14
Agreement contains no requirement that it make a good faith effort
to purchase the Comerica Loans during the initial 90 days. In any
event, it contends it did make a good faith effort to purchase the
Comerica Loans during the initial 90 days.
As discussed above, the June 14 Agreement did require
Burlingame to make an offer to purchase the Comerica Loans by June
17, 2003 at a price that it deemed appropriate in its good faith
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judgment. There is no dispute that Burlingame made a timely offer
to purchase the Comerica Loans for $1.6 million. The Koellings
have presented no evidence that this was not a good faith offer.
They admit that they never advised Burlingame that SCG had
previously made an offer to purchase the Comerica Loans for $2.1
million. Fred Koelling has declared that he assumed that Robert
Judson knew the amount of the offer. However, he does not dispute
that he knew that Burlingame was planning to make a much lower
offer or declare that he recommended that the offer be increased.
The June 14 Agreement provides that, if Comerica rejected the
offer, as it did, Burlingame and Qmect would cooperate in
determining an appropriate response. The only evidence before the
Court is that, prior to September 15, 2003, Burlingame made a
second offer for $1.4 million, that Robert Judson discussed the
proposed offer with Fred Koelling before making it, and that Fred
Koelling raised no objection. Thus, the evidence supports
Burlingame’s request for summary adjudication, declaring that it
did not breach the June 14 Agreement by failing to make a good
faith effort to acquire the Comerica Loans within the first 90
days of the agreement.
Burlingame’s motion for summary does not address the second
allegation of breach: i.e., that Burlingame breached the good
faith provision by causing Comerica to renege on the sale
agreement with SCG. As a result, Burlingame is not entitled to
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8As discussed above, the June 14 Agreement required all
parties to act in good faith to achieve the purposes of the
agreement. For purposes of this motion for summary judgment,
the Court concludes that the Litigation Threat Letter is
sufficient evidence to support Qmect’s claim that Burlingame
breached this provision. Burlingame contends that the
litigation privilege precludes the Koellings from basing any of
its claims on the Litigation Threat Letter. However, as
discussed below in connection with the Koellings’ claim for
intentional interference with prospective economic advantage,
the Court concludes that there is a genuine issue of material
fact as to whether Burlingame is entitled to assert the
litigation privilege with respect to the Litigation Threat
Letter under these circumstances. Moreover, the Court is
uncertain at this time whether the litigation privilege is a
defense to a breach of contract claim. If necessary, this legal
issue may be addressed at the time of trial.
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summary judgment with respect to this remaining allegation of the
second breach of contract claim.8
C. FRAUD CLAIM
The third claim for relief in the Koelling Cross-Complaint is
for fraud. It alleges that, to induce the Koellings to enter into
the June 14 Agreement, Burlingame fraudulently represented to them
that it would release them from the Guaranty if Burlingame
purchased the Comerica Loans. It alleges that Burlingame never
intended to do so and is now falsely contending that the Koellings
did not act in good faith in connection with the June 14
Agreement. But for this misrepresentation, it alleges, the
Koellings would never have entered into the June 14 Agreement,
which required Qmect to dismiss its fraud claim in the Breach of
Fiduciary Duty Action and gave Burlingame the exclusive right to
attempt to purchase the Comerica Loans for the initial 90 days.
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As a further basis for the fraud claim, the third claim for
relief alleges that the Koellings were deceived into believing
that Burlingame would make a good faith effort to acquire the
Comerica Loans within the initial 90 day period. It alleges that
the Koellings would not have entered into the June 14 Agreement
but for this deception. The third claim for relief alleges that,
as a result of Burlingame’s failure to make a good faith effort to
acquire the Comerica Loans within the initial 90 day period, the
Koellings incurred tens of thousands of dollars in costs putting
together an agreement for the sale of the Comerica Loans to SCG.
In their motion for summary judgment, Burlingame first contend
that a claim for fraud will not lie when the fraud involves
nothing more than an alleged breach of contract. In support of
this contention, they cite Freeman and Mills, Inc. v. Belcher Oil
Co., 11 Cal. 4th 85 (1995). They also contend that the fraud claim
is not stated with sufficient particularity. See Lazar v.
Superior Court, 12 Cal. 4th 631, 645 (1996)(“In California, fraud
must be pled specifically; general and conclusory allegations do
not suffice.”); see also Fed. R. Civ. Proc. 9(b), made applicable
to this proceeding by Fed. R. Bankr. Proc. 7009 (requiring
circumstances of fraud to be stated with particularity).
Whether the Koellings’ claim for fraud is barred by Freeman
is not a simple question. In Freeman, the California Supreme
Court overruled Seaman’s Direct Buying Service, Inc. v. Standard
Oil Co., 36 Cal. 3d 752 (1984), in which it had recognized, at
least in the area of insurance, a tort cause of action for bad
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faith denial of the existence of a contract. The Freeman court
noted that Seaman’s had spawned an excessive amount of frivolous
litigation asserting bad faith denial of contract claims.
Moreover, the lower courts had found the holding difficult to
apply, and the decision had been roundly criticized by academics
and courts in other jurisdictions. Freeman, 11 Cal. 4th at 95-
102.
However, the effect of Freeman is not as far reaching as
Burlingame contends. More recently, in Lazar, the California
Supreme Court attempted to “clarify...whether or under what
circumstances a plaintiff may state a cause of action for
fraudulent inducement of employment contract.” Lazar, 12 Cal. 4th
at 634-35. In Lazar, the trial court had sustained a demurrer to
the fraud claim. The court of appeals reversed, and the reversal
was affirmed by the Supreme Court.
The Lazar court concluded that the allegations of the
complaint satisfed the elements of a fraud claim: i.e.,
misrepresentation, knowledge of falsity, intent to defraud,
justifiable reliance, and resulting damages. It noted that an
action for promissory fraud may lie where a defendant fraudulently
induces the plaintiff to enter into a contract. Id. at 638. It
distinguished Hunter v. Up-Right, Inc., 6 Cal. 4th 1174 (1993), in
which it denied an employee plaintiff a tort remedy against his
former employer for fraudulent inducement to resign instead of
being terminated.
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The Lazar court noted that, in Hunter, the employee could not
prove detrimental reliance since, if he had not resigned, the
employer could have terminated him, and the employee would have
suffered the same damages. In a case of fraudulent inducement to
enter into a contract, the same problem was not presented since,
if the contract had never been made, it could not have been
breached so as to cause the plaintiff’s damages. Lazar, 12 Cal.
4th at 642-43. The Lazar court noted that “contract remedies alone
do not address the full range of policy objectives underlying the
action for fraudulent inducement of contract.” Id. at 646.
Based on Lazar, the Court concludes that a plaintiff may state
a claim for fraud based on a fraudulent inducement to enter into
a contract, provided all elements of the claim are sufficiently
pled. The question remains whether the Koellings have done so.
Burlingame contends that they have not. However, since the issue
arises in the context of a motion for summary judgment, rather
than a motion based solely on the pleadings, the issue is not
whether the fraud claim has been adequately pled but whether the
Koellings have presented sufficient evidence to support such a
claim. The Court concludes that they have not.
The only evidence presented by the Koellings in support of
their opposition to the motion for summary judgment is the
declaration of Fred Koelling. The statements made in the the
declaration relevant to the fraud claim are as follows:
21. Burlingame represented that they would
release the Comerica guarantees if they
acquired the Comerica Loan. In exchange for
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this promise, and only because of this
promise, I agreed to dismiss their fraud claim
in the QMECT case against Burlingame and other
entities under the control of the Judsons.
22. In hind sight, if [sic] appears
Burlingame falsely stated that they would
release the guarantees if they acquired the
Comerica loan. I, looking back, believe that
Burlingame never intended to release the
personal guarantees, and are now falsely
arguing that I, along with my wife and Qmect,
did not act in good faith under the June
Agreement.
23. I relied upon these false
representations. I would not have signed the
June 2004 Agreement if Burlingame had not
deceived me into believing that they would
make a good faith effort to acquire the
Comerica Loan during the 90-day period, and
would release the personal guarantees after
acquiring the Loan.
The Court finds these statements insufficient to sustain a claim
for fraud.
The representation referred to in paragraph 21 appears to be
the provision in the June 14 Agreement. The Court does not read
Lazar to permit a claim for fraudulent inducement to enter into a
contract to be based on the contract provisions themselves.
Moreover, even if such a claim were permitted, the statements
recited above do not provide evidence that Burlingame entered into
the June 14 Agreement with no intention of performing it according
to its terms. Fred Koelling’s statement that, in hindsight, he
believes that Burlingame never intended to release the Comerica
Guaranty is mere opinion, not evidence.
There is not even a straightforward allegation that Burlingame
misrepresented that it would make a good faith effort to acquire
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the Comerica Loans within the initial 90 day period. The Koelling
Cross-Complaint simply alleges that the Koellings were deceived.
It does not allege by whom or in what manner the deception was
accomplished. Similarly, Fred Koelling’s declaration lacks any
specific statement that this representation was made. The closest
it comes is in paragraph 23, when Fred Koelling states that he
would not have entered into the June 14 Agreement “if Burlingame
had not deceived me into believing that they would make a good
faith effort to acquire the Comerica Loan....” In sum, the Court
concludes that Burlingame is entitled to summary judgment on the
third claim for relief for fraud.
D. INTENTIONAL INTERFERENCE WITH PROSPECTIVE ECONOMIC ADVANTAGE
CLAIM
The fourth claim for relief in the Koelling Cross-Complaint
is for intentional interference with prospective economic
advantage. The elements of a claim for intentional interference
with prospective economic advantage are: (1) an economic
relationship between the plaintiff and third party containing the
probability of future benefit to the plaintiff, (2) knowledge by
the defendant of the existence of the relationship, (3)
intentional acts on the part of the defendant designed to disrupt
the relationship, (4) actual disruption of the relationship, and
(5) damages to the plaintiff proximately caused by the acts of the
defendant. Della Penna v. Toyota Motor Sales, U.S.A., Inc., 11
Cal. 4th 376, 389, 393 (1995); see also Navallier v. Sletten, 262
F.3d 923, 939 (9th Cir. 2001). Moreover, the intentional conduct
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causing the disruption must be “wrongful by some legal measure
other than the fact of interference itself.” Della Penna, 11 Cal.
4th at 393.
The fourth claim for relief alleges that, in February 2004,
Burlingame knew that SCG was about to acquire the Comerica Loans
and that its doing so would benefit Qmect and the Koellings. It
alleges that Burlingame intentionally interfered with SCG’s
attempt to purchase the Comerica Loans by causing Comerica to
renege on its commitment to sell them to SCG and that, as a
result, the Koellings have a significantly higher indebtedness on
the Comerica Loans that they would have had if SCG had acquired
them.
Burlingame asserts that it is entitled to summary judgment on
this claim for “any number of reasons.” First, Burlingame
contends that the Koellings lack standing to assert this claim.
They opine that, if anyone has standing to assert this claim, it
is SCG, not the Koellings. This contention has no merit. The
Court agrees that SCG might have standing to assert a claim
against Burlingame for interference with its prospective economic
advantage as a result of its purchase of the Comerica Loans.
However, the Koellings also have standing to assert a claim based
on their prospect of an economic advantage as a result of this
purchase.
The Koellings allege that, if SCG had purchased the Comerica
Loans, Qmect and they would have owed sufficiently less on the
Comerica Loans. Presumably, they believe that, because SCG was
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purchasing the Comerica Loans at a substantial discount, SCG would
have passed the benefit of this discount through to them. They
have provided no evidence that SCG agreed to do so. However,
there is evidence that SCG had accepted stock in Qmect and a seat
on its Board of Directors. Burlingame has referred to SCG as
Qmect’s affiliate. Clearly, in bankruptcy terminology, SCG was an
“insider.” The Court concludes that SCG’s status as an “insider”
is sufficient to make it probable that the Koellings and Qmect
would have benefitted economically from SCG’s having purchased the
Comerica Loans rather than Burlingame.
Next, Burlingame contends that this claim must fail because
its conduct is protected by the competition privilege. The Court
disagrees that, under these facts, the competition privilege
entitles Burlingame to summary judgment on this claim. The
competition privilege only applies when a competitor “uses fair
and reasonable means” to compete. See PMC, Inc., 45 Cal. App. 4th
at 603, quoting from Tri-Growth Centre City, Ltd. V. Silldorf,
Burdman, Duignan & Eisenberg, 216 Cal. App. 3d 1139, 1153 (1989);
see also A-Mark Coin Company v. General Mills, Inc., 148 Cal.
App. 3d 312, 323 (1983), quoting the Restatement of Torts. 2d, §
768. For the competition privilege to apply, the Court must
conclude that it was not wrongful for Burlingame to send the
Litigation Threat Letter to Comerica under these circumstances.
California courts have not provided a definitive meaning of
wrongful conduct in this context. Visto Corp. v. Sproqit
Technologies, Inc., 360 F. Supp. 2d 1064, 1067 (2005). However,
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it is generally recognized to include both conduct that violates
the common law or is merely unfair according to common social
standards. Visto Corp., 360 at 1067. In determining whether
conduct is wrongful, the focus should be on the defendant’s
objective conduct, not on its motive. Id. The Court concludes
that there is a genuine issue of material fact as to whether,
under these circumstances, threatening Comerica with litigation if
it sold the Comerica Loans to SCG was fair or reasonable. For
example, sending the Litigation Threat Letter to Comerica after
agreeing that Qmect or SCG could make an independent bid to
purchase the Comerica Loans after the initial 90 day period
arguably constituted a breach of the June 14 Agreement.
Third, Burlingame contends that the Koellings will be unable
to prove that they engaged in any wrongful conduct because its
conduct in sending the Litigation Threat Letter is protected by
the litigation privilege. As with the competition privilege, the
Court concludes that there is a genuine issue of material fact as
to whether the litigation privilege applies here. The litigation
privilege is codified in Cal. Civ. Code § 47(b). Among other
things, it protects a party from being sued for any communication
made in a judicial proceeding. “The principal purpose of the
privilege is to afford the utmost freedom of access to the courts
without fear of being subsequently harassed by derivative tort
actions.” Rothman v. Jackson, 49 Cal. App. 4th 1134, 1146 (1996).
It has been held to apply to a communication made by any
participant in a judicial proceeding to achieve the objects of the
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9The good faith requirement does not turn on the merits of
the action. The party making the communication may contemplate
commencing litigation in good faith even if the litigation would
be groundless as long as the party did not believe the
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litigation. Silberg v. Anderson, 50 Cal. 3d 205, 212 (1990).
Although the litigation privilege was first developed to apply
to suits for defamation for statements made in court, courts have
applied it more broadly. It has been recognized as a defense to
every other type of tort action, excepting only an action for
malicious prosecution. It has also been applied to communications
made preliminary to litigation, including threats of litigation.
Rothman, 49 Cal. App. 4th at 1140.
However, the doctrine has some limits. One of these limits
is that the party making a pre-litigation communication must have
been seriously contemplating filing a judicial action in good
faith and in the near future. See Edwards v. Cenext Real Estate
Corp., 53 Cal. App. 4th 15, 32-37 (1997). The good faith test is
subjective, turning on the party’s state of mind. Financial Corp.
Of America v. Wilburn, 189 Cal. App. 3d 764, 777 (1987). The
party asserting the litigation privilege has the burden of
establishing that it seriously contemplated litigation in good
faith at the time it made the statement. Edwards, 53 Cal. App. 4th
at 32. “[E]ven a threat to file a lawsuit would be insufficient
to activate the privilege if the threat to file a lawsuit is
merely a negotiating tactic and not a serious proposal made in
good faith contemplation of going to court.” Id. at 35.9
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litigation to be groundless. Wilburn, 189 Cal. App. 3d at 777.
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Because of the subjective nature of the good faith test, it
is particularly inappropriate to grant summary judgment on the
basis of this doctrine. Under these facts at least, the Court is
unable to determine that Burlingame acted with subjective good
faith in sending the Litigation Threat Letter as a matter of law.
There is certainly evidence, based on what occurred thereafter,
that the purpose of the threat was not to resolve a dispute but
rather to gain an advantage in the joint bidding on the Comerica
Loans.
Fourth, Burlingame asserts that the fourth claim for relief
must fail because the Koellings will be unable to establish that
the Litigation Threat Letter caused Comerica to renege on the
agreement to sell the Comerica Loans to SCG. They contend that
Comerica did not renege on the agreement to sell the Comerica
Loans to SCG because Burlingame threatened it with litigation.
They assert that Comerica sold the Comerica Loans to Burlingame
because it offered $100,000 more than SCG. There is evidence to
support a contrary view. It is undisputed that, after receiving
the 2004 offer from Burlingame, Comerica did not attempt to
solicit a higher bid from SCG. If Comerica’s motivation was
simply price, its failure to do so makes no sense.
To the contrary, it appears to be undisputed that the reason
that Comerica did not conclude the sale of the Comerica Loans to
SCG was that SCG refused to sign an agreement to indemnify
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Comerica if it was sued as a result of the sale. In the motion
for summary judgment in the Equitable Subordination and Breach of
Fiduciary Duty Actions, Burlingame provided excerpts of a
deposition of a Comerica bank officer. The bank officer testified
that Comerica routinely requires indemnification agreements when
it sells loans.
However, at the hearing on the motion for summary judgment,
the Court asked Burlingame’s counsel whether Comerica had required
Burlingame to provide it with a similar indemnification agreement.
Burlingame’s counsel replied that Comerica had tried to obtain a
similar indemnification agreement from Burlingame, but that
Burlingame had refused. Nevertheless, Comerica closed the sale
with Burlingame. Based on the foregoing, the Court is unable to
conclude summarily that the Koellings will be unable to establish
causation. The final element of the claim for intentional
interference is damages. The Court concludes that the failure of
SCG’s attempt to purchase the Comerica Loans is sufficient to
support a finding with respect to this element. As noted above,
Burlingame contends that this claim must fail because the
Koellings have provided no evidence of the specific benefit they
would have received had SCG purchased the Comerica Loans. The
Koellings respond that their inability to establish any precise
benefit is the result of Burlingame’s wrongful conduct. They
argue that Burlingame should not be able to avoid liability for
its wrongful conduct by virtue of this act of destruction.
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The Court agrees. Unlike the remedy for equitable
subordination, which requires a precise determination of harm to
creditors, the remedy for intentional interference with
prospective economic advantage is flexible. There is evidence to
support an award of compensatory damages. Fred Koelling has
declared that he spent tens of thousands of dollars assisting SCG
in making its offer to purchase the Comerica Loans. This
investment was put to waste as a result of Burlingame’s conduct.
Moreover, as long as at least nominal compensatory damages are
established, provided it finds that Burlingame’s conduct was
sufficiently egregious, the Court can also award punitive damages.
Sole Energy Co. v. Petrominerals Corp., 128 Cal. App. 4th 212, 238
(2005). Thus, the Court concludes that Burlingame is not entitled
to summary judgment on this claim.
E. DECLARATORY RELIEF CLAIM
The fifth claim for relief of the Koelling Cross-Complaint
seeks a declaration of the parties’ rights and obligations under
the June 14 Agreement: i.e., whether the Koellings are entitled to
a release of the Comerica Guaranty. Burlingame contends that they
are not. It contends that the Koellings acted in bad faith in
connection with the joint bidding process under which circumstance
the June 14 Agreement excuses Burlingame from releasing them from
the Comerica Guaranty. Although the Koellings, as Cross-
Complainants, have the burden of proof on most elements of their
claims, the Court concludes that, in this instance, Burlingame has
the burden of proving that the Koellings acted in bad faith and
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thus of coming forward with evidence of bad faith sufficient to
support its request for summary judgment.
In the summary judgment motion, Burlingame contends that the
Koellings acted in the following ways by “before and after June
14, 2003...
• Failing to inform Burlingame that an
offer to purchase the Comerica Loan had
been made in May 2004 for $2,100 which
was rejected by Comerica Bank;
• Failing to provide information and
documents requested by Burlingame to
assist in formulating an offer to
purchase the Comerica Loan;
• When documents were provided, frequently
they were misleading and often
fraudulent;
• Refusing to provide Burlingame with
information concerning prior efforts to
purchase the Comerica Loan;
• Representing to a number of creditors and
others in the lending community that
QMECT was arranging for new financing and
that Burlingame supported the
refinancing, which was entirely untrue
and potentially compromised Burlingame’s
efforts to purchase the Comerica Loan;
• Misrepresenting Qmect’s finances;
• Misrepresenting QMECT’s relationship with
Structure Capital; and,
• Misrepresenting their relationship with
QMECT Funding....”
Thee contentions are repeated, word for word, in Robert Judson’s
declaration filed in support of the motion for summary judgment.
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10Elsewhere, Burlingame cites as an instance of bad faith,
excusing Burlingame from releasing the Koellings from the
Comerica Guaranty, Fred Koelling’s refusal to permit Burlingame
to replace him as CEO of Qmect as long as Qmect was in default
on its loan obligations as required by the June 14 Agreement.
The Koellings note that the June 14 Agreement required
Burlingame to consult Fred Koelling before selecting a new CEO.
They contend that Burlingame never did this. This issue is
irrelevant to the outcome of the motion. Burlingame did not
attempt to replace Fred Koelling as CEO until after Qmect filed
its chapter 11 petition. A creditor’s attempt to enforce a
contractual provision, permitting it to replace a debtor-in-
possession’s CEO, would appear to violate the automatic stay.
See 11 U.S.C. § 362(a)(3).
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No other evidence is provided with respect to these alleged
instances of bad faith.
In his declaration filed in opposition to the motion, Fred
Koelling declares that he always believed that Burlingame was
aware of the prior offer from SCG. He denies refusing to supply
Burlingame with timely financial information or providing it with
fraudulent or misleading documents. He also denies making any
false representations to creditors or others in the lending
community regarding Qmect’s attempt to arrange for new financing
or Burlingame’s support of it. Finally, he denies misrepresenting
to Burlingame Qmect’s relationship with SCG or SCG Funding. He
notes that he introduced SCG to Burlingame.10
Based on the foregoing, the Court concludes that Burlingame’s
motion for summary judgment with respect to the fifth claim for
relief must be denied. The “evidence” of bad faith offered in
support of Burlingame’s contention that it is excused from
releasing the Koellings from their liability under the Comerica
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Guaranty is ambiguous and conclusory. It is insufficient to
support a claim of bad faith even if it were not controverted by
the necessarily equally ambiguous and conclusory denials by Fred
Koelling.
CONCLUSION
Burlingame is entitled to summary judgment on the first and
third claims for relief and to summary adjudication on the first
allegation of breach in the second claim for relief: i.e., that
Burlingame did not breach the June 14 Agreement by failing to make
a good faith attempt to purchase the Comerica Loans within the
first 90 days of the agreement. Burlingame’s motion for summary
judgment is denied with respect to the second allegation of the
second claim for relief and to the fourth and fifth claims for
relief. Counsel for Burlingame is directed to submit a proposed
form of order in accordance with this decision.
END OF DOCUMENT
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COURT SERVICE LIST
Paul E. Manasian
Manasian & Rougeau, LLP
400 Montgomery St., Ste. 1000
San Francisco, CA 94104
Tobias S. Keller
Pachulski, Stang, Ziehl, Young,
Jones & Weintraub P.C.
Three Embarcadero Center, Ste. 1020
San Francisco, CA 94111-4023
Robert R. Moore
Allen Matkins Leck Gamble & Mallory LLP
Three Embarcadero Center, 12th Floor
San Francisco, CA 94111
Philip J. Nicholsen
Law Offices of Philip J. Nicholsen
221 Main St., #740
San Francisco, CA 94105
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