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 proofs of claim filed by 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 Qmect’s 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.
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On May 11, 2005, Burlingame filed a motion for summary
judgment with respect to all of the claims asserted in the
Equitable Subordination and Breach of Fiduciary Duty Actions.
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
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
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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.
4
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
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.
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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.
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
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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
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
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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,
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
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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
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
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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
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
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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.
10
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
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
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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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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 on 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
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
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stock 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.
Thereafter, on June 12, 2003, Qmect sent Burlingame a letter
informing them 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
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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.,
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
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5The Koellings did not inform the Judsons that SCG had
previously made an offer to purchase the Comerica Loans for $2.1
million. However, the Judsons clearly knew that an offer had
been made. There is no evidence that the Judsons ever asked 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.
7In the Litigation Threat Letter, Burlingame contended that
the sale of the Comerica Loans to SCG would violate section 5 of
its subordination agreement. Section 5 of the subordination
agreement prohibited Comerica, upon Qmect’s default, among other
things, from taking any action with respect to the collateral
without giving Burlingame 90 days prior notice. Burlingame also
contended that the sale of the Comerica Loans to SBC would
violate sections 7.2 (no change of control), 7.4 (no additional
debt), 7.5 (no agreement with anyone other than Burlingame to
create additional encumbrances), 7.7 (no direct or indirect
investments), 7.8 (no transactions with affiliates), and 7.12
(no contract that could restrict or invalidate the security
interest in any of Qmect’s property) of the Burlingame Loan
agreement.
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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.7 In the
second letter, Burlingame offered to purchase the Comerica Loans
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for $50,000 more than offered by SCG. The loan documents drafted
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,
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477 U.S. 242, 248 (1986). A motion to dismiss a complaint is
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
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26 8The claims against the Judsons, Sierra, and the two other
Burlingame affiliates have been remanded to state court.
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case on its claim. Celotex Corp. v. Catrett, 477 U.S. 317, 322-23
(1986); Lujan v. National Wildlife Federation, 497 U.S. 871, 884-
85 (1990).
DISCUSSION
Burlingame and Burlingame Funding seek summary judgment or
adjudication with respect to all of the claims asserted against
them in the Equitable Subordination and Breach of Fiduciary Duty
Actions. The Equitable Subordination Action is asserted by Qmect
against Burlingame and Burlingame Funding. It consists of three
claims for relief: (1) a claim for equitable subordination of
Burlingame’s and Burlingame Funding’s secured claims, (2) an
objection to Burlingame’s proof of claim (the “Burlingame Proof of
Claim”) based on alleged offsetting claims, and (3) an objection
to Burlingame Funding’s proof of claim (the “Burlingame Funding
Proof of Claim”) based on its failure to allocate the claim
between the individual loans. The motion for summary judgment
with respect to these claims is discussed in section A below.
The Breach of Fiduciary Duty Action is asserted by Qmect and
the Koellings against the Judsons, Sierra, Burlingame, and two
other Burlingame’s affiliates.8 Burlingame Funding is not party
to this action. The Breach of Fiduciary Duty Action consists of
six claims: (1) breach of fiduciary duty, (2) rescission of
contract, (3) unfair business practice, (4) breach of contract,
(5) declaratory relief, and (6) injunctive relief. The motion for
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9Section 510(c) provides that “the court may--(1) under
principles of equitable subordination, subordinate for purposes
of distribution all or part of an allowed claim to all or part
of another allowed claim or all or part of an allowed interest
to all or part of another allowed interest; or (2) order that
any lien securing such a subordinated claim be transferred to
the estate.”
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summary judgment with respect to these claims is discussed in
section B below.
A. EQUITABLE SUBORDINATION ACTION
1. Equitable Subordination Claim
The first claim for relief in the Equitable Subordination
Action seeks to equitably subordinate the secured claims of
Burlingame and Burlingame Funding to the claims of all general,
unsecured creditors and to transfer their liens to the estate for
the benefit of unsecured creditors pursuant to 11 U.S.C. § 510(c).9
Equitable subordination is an extraordinary remedy, to be used
sparingly. Matter of CTS Truss, Inc., 868 F.2d 146 (5th Cir.
1989). Its purpose is not to punish the wrongdoer but to remedy
the harm done to creditors as a result of the inequitable conduct.
The remedy may be imposed only to the extent necessary to
eliminate the harm. In re Mobile Steel Co., 563 F.2d 692, 701 (5th
Cir. 1977); In re Pacific Express, Inc., 69 B.R. 112, 116 (Bankr.
9th Cir. 1986). It may not be used to disallow the claim or to
impose damages upon the creditor. Mobile Steel, 563 F.2d at 699
& 699, n.10.
It is well established that a party seeking to equitably
subordinate a claim must establish three things: (1) that the
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party whose claim is to be subordinated has engaged in inequitable
conduct; (2) that the misconduct has injured creditors of the
debtor or given an unfair advantage to the party whose claim is to
be subordinated, and (3) that subordination of the wrongdoer’s
claim is not inconsistent with bankruptcy law. In re Lazar, 83
F.3d 306, 309 (9th Cir. 1996); Mobile Steel, 563 F.2d at 699-700.
Equitable subordination may be based on conduct that, although
lawful, shocks the conscience: e.g., unjust enrichment brought
about by “double dealing” or “foul conduct.” See In re Harvest
Milling Co., 221 F. Supp. 836, 838 (D. Or. 1963). Moreover, the
inequitable conduct need not be related to the acquisition or
assertion of the claim to be subordinated. Pacific Express, 69
B.R. at 116.
Unless the creditor is an insider or fiduciary of the debtor,
the creditor’s conduct must have been egregious to warrant
subordination of its claim. Id. While the burden of proof and
persuasion is by the preponderance of the evidence regardless of
whether the creditor is an insider or a noninsider, the
transactions of an insider are subject to strict scrutiny while
those of a noninsider are not. In re Heartland Chems. Inc., 136
B.R. 503, 517 (Bankr. C.D. Ill. 1992). The fact that the result
of a bargain seems unduly harsh in hindsight does not establish
that the other party acted inequitably. “Inequitable conduct” in
commercial life means breach plus some advantage-taking....” Kham
& Nate’s Shoes No. 2, Inc. v. First Bank of Whiting, 908 F.2d
1351, 1367 (7th Cir. 1990). Qmect’s equitable subordination claim
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is based on Burlingame’s conduct during two different time frames:
(1) its conduct leading up to and in connection with the
Burlingame Loan (December 1999 through November 2001) and (2) its
conduct in connection with its purchase of the Comerica Loans (May
2003 through January 2004). The Court will discuss each part of
the claim separately.
(1) The Burlingame Loan
The first issue presented by this portion of Qmect’s claim is
whether Burlingame should be treated as an insider or fiduciary of
Qmect so as to subject the fairness of the Burlingame Loan to
strict scrutiny. Burlingame contends that it was not Qmect’s
fiduciary: i.e., it was a lender which contracted with Qmect at
arms’ length. It is well established that, unless a lender exerts
control over its borrower, it may not be treated as an insider or
fiduciary of its borrower. See Kham & Nate’s Shoes, 908 F.2d at
1357-58.
Qmect contends that Burlingame should be treated as a
fiduciary for purposes of the equitable subordination claim for
two reasons. First, Qmect notes that Sierra acted as its
financial advisor and as its exclusive agent in its search for
financing. See Persson v. Smart Inventions, Inc., 125 Cal. App.
4th 1141, 1160 (2005)(“a fiduciary relationship is a recognized
legal relationship such as...principal and agent”). Because
Sierra and Burlingame were both owned by the Judsons, Sierra had
a conflict of interest in advising Qmect to enter into the
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Burlingame Loan. According to Qmect, this is sufficient to
subject the fairness of the Burlingame Loan to strict scrutiny.
Second, Qmect notes that, both through Sierra and
independently, Burlingame had access to confidential financial
information. It asserts that Fred Koelling placed confidence in
the Judsons and Sierra as Qmect’s financial advisor. Qmect
asserts that this created a confidential relationship between
Qmect and Burlingame sufficient to impose a fiduciary duty on
Burlingame. In support of this contention, Qmect relies on
Persson v. Smart Inventions, Inc., 125 Cal. App. 4th 1141 (2005).
The Persson court noted that, while a limited number of
relationships qualify as fiduciary relationships, confidential
relationships are less well defined. However, a party in a
confidential relationship with another is also under a fiduciary
duty to the other party. Id. at 1160-61.
In response, Burlingame contends that Sierra was only Qmect’s
financial advisor for one month, during December 1999.
Thereafter, Sierra served only as Qmect’s exclusive agent to
locate and negotiate financing. Moreover, even if Sierra was
Qmect’s fiduciary, Burlingame was not. It was a separate legal
entity and dealt with Qmect at arms’ length. With respect to
Qmect’s second contention, Burlingame contends that access to
confidential information is not sufficient to create a fiduciary
duty nor is the fact that Qmect may have placed confidence in the
Judsons and Sierra. It contends that the line of cases cited by
Qmect has no application to commercial dealings. See Rickel v.
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Schwinn Bicycle Co., 144 Cal. App. 3d 648, 654-55
(1983)(confidential relationship imposing fiduciary duty precluded
where there is an expectation of a nonmutual profit).
The Court concludes that there is a genuine issue of fact as
to whether Sierra ceased acting as Qmect’s financial advisor at
the end of 1999. The Amended Engagement Letter does not terminate
this role. It simply fails to provide for any additional separate
compensation for those services, as anticipated by the Original
Engagement Letter. However, the formula for payment for Sierra’s
services was enhanced. There is an issue of fact as to whether
this enhancement was intended to cover Sierra’s financial advice
as well as its efforts to obtain financing for Qmect. There is
evidence that the Judsons and/or Sierra provided Qmect with
financial advice after the end of 1999. No evidence has been
provided to date establishing that the Judsons or Sierra ever
advised Qmect or the Koellings that they were no longer acting as
Qmect’s financial advisor.
However, this dispute is not material, at least in connection
with Qmect’s equitable subordination claim. Clearly, under
Persson, as Qmect’s exclusive agent to obtain financing, Sierra
was Qmect’s fiduciary through the funding of the Burlingame Loan.
See also V. Sands v. Eagle Oil and Refining Co., Inc., 83
Cal. App. 2d 312, 318 (1948). Moreover, the Court also concludes
that a genuine issue of material fact exists as to whether, for
purposes of equitable subordination, Sierra’s fiduciary duty
should subject Burlingame’s conduct to strict scrutiny. As noted
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above, the conduct giving rise to equitable subordination need not
have occurred in connection with the claim to be subordinated.
However, the Court agrees with Burlingame that Qmect’s second
theory for imposing a fiduciary duty on Burlingame is not viable
and that it is entitled to summary judgment with respect to this
portion of the claim. A lender will typically obtain confidential
information in the process of doing due diligence before making a
loan. If this were sufficient to result in the imposition of a
fiduciary duty on a lender, virtually every lender would be deemed
the fiduciary of its borrower. As noted above, the law is to the
contrary.
Next, Burlingame contends that, even if the Court concludes
that there is a genuine issue of material fact as to whether
Sierra had a fiduciary duty to Qmect, there is no evidence that
Sierra breached that duty. The only evidence produced is that
Sierra attempted to renegotiate Qmect’s loans with Comerica and
also contacted numerous parties whom it thought might be
interested in providing financing. However, the terms offered by
Comerica and the two third parties who did express an interest
were not acceptable to the Koellings. Burlingame asserts that
there is no evidence that it knew, in November 2001, when the
Burlingame Loan was funded, that Qmect would not be able to
service the debt. It asserts that Qmect provided optimistic
projections indicating that it would be able to make the payments.
The Court concludes that Qmect has provided sufficient
evidence to create a genuine issue of fact as to whether Sierra
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breached its fiduciary duty to Qmect and whether that breach
should be ascribed to Burlingame. There is evidence that Sierra
exerted efforts to renegotiate the Comerica Loans and that it also
contacted numerous third parties to see if they were interested in
providing Qmect with additional financing. However, there is also
evidence that Robert Judson advised Qmect not to accept the offer
from Comerica or to pursue the two expressions of interest from
third parties.
In addition, there is evidence that Sierra may have breached
its fiduciary duty to Qmect by pressuring Qmect to terminate its
independent financial consultant who had advised Qmect to file a
bankruptcy petition rather than accepting the Burlingame Loan
which Qmect contends has onerous terms. Filing a chapter 11
bankruptcy might have bought Qmect sufficient time to permit it,
represented by someone other than an affiliate of the entity
wishing to make the loan itself, to find a loan on more reasonable
terms.
Qmect also contends that Sierra acted inequitably in
accepting a $60,000 finder’s fee in connection with the Burlingame
Loan. It asserts that the fee was improper because it constituted
a loan broker’s fee, noting that Sierra did not have a loan
broker’s license. Burlingame responds that the law distinguishes
between a finder’s fee and a broker’s fee. It contends that
Sierra acted only as a finder and thus did not need a license. In
support of this contention, Burlingame cites Independent Cellular
Tel. Inc. v. Daniels & Assocs., 863 F. Supp. 1109, 1115 (N.D. Cal.
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10Burlingame also notes that the absence of a license merely
prevents the broker from suing to collect its fee. It does not
make accepting a fee illegal or require the fee to be disgorged.
See Broffman v. Newman, 213 Cal. App. 3d 252, 261 (1989). While
correct, this point is irrelevant. Qmect is not attempting to
recover the $60,000 fee. It is arguing that Sierra’s acceptance
of the $60,000 was part of Burlingame’s overall egregious
behavior, warranting subordination of its claim.
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1994) and Preach v. Monter Rainbow, 12 Cal. App. 4th 1441, 1451-52
(1993).10
The cases cited by Burlingame are not precisely on point as
they deal with real estate brokers rather than loan brokers.
However, by analogy, they support the proposition that, if Sierra
acted only as a loan “finder,” it did not need a license. Whether
Sierra stepped over the line and thus should not have obtained the
$60,000 fee is beyond the scope of this motion. As noted above,
the claims against Sierra have been remanded to state court.
Thus, the Court need not determine whether Sierra acted improperly
in accepting the $60,000. However, Qmect also contends that
Burlingame breached its fiduciary duty in requiring Qmect to pay
Sierra the $60,000 fee. Burlingame appears to concede that the
fee could just as easily have been paid to Burlingame which did
act as a loan broker and did have a loan broker’s license. Qmect
contends that Burlingame breached its fiduciary duty by acting as
a broker for both sides of the transaction without the written
consent of the parties. It cites state law requiring such
consent. However, the Court views the Release as giving
Burlingame consent to act in this dual fashion.
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11Burlingame asserts that the Release is indeed a release,
citing authority for that proposition. It contends that Cal.
Civ. Code § 1542 does not apply because it applies only to a
“general release.” It asserts that the Release is a specific
release. See Brae Transp., Inc. v. Coopers and Lybrand, 790
F.2d 1439 (9th Cir. 1986); Larsen v. Johannas, 7 Cal. App. 3d
491, 506 (1970).
26
Finally, Burlingame contends that the Release, which Qmect
executed in June 2001 and upon which Burlingame relied in agreeing
to solicit investors, was sufficiently broad to release Qmect’s
equitable subordination claim. In support of this proposition, it
cites Navellier v. Sletten, 262 F.3d 923, 939 (9th Cir. 2001).
Qmect raises several arguments as to why the Release does not bar
the equitable subordination claim. First, it notes the Release
does not use the term “release.” Second, it does not contain an
express waiver of the protections of section 1542 of the
California Civil Code.11 Third, it contends that the Release was
extinguished because that the Burlingame Loan documents contained
an integration clause and did not incorporate the Release.
The Court need not address Qmect’s contentions here because
it concludes that the Release did not release Qmect’s equitable
subordination claim. As discussed above, the purpose of an
equitable subordination claim is not to impose liability on the
defendant or to grant a monetary award to the plaintiff. Its
purpose is to remedy harm done to other creditors by adjusting
the creditor priorities. Thus, while asserted by Qmect, the claim
belongs to its creditors, as they existed at the time of the
inequitable conduct. Qmect could not effectively release a claim
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that exists for the benefit of a third party. Navellier is
inapposite to the facts presented here as it involves the
applicability of a release to a breach of contract claim.
Navallier, 262 F.3d at 923.
However, Qmect’s first claim for relief must fail, to the
extent it is based on Burlingame’s conduct in connection with the
Burlingame Loan. Burlingame is correct that there is no evidence
to support the contention that Qmect’s unsecured creditors, as
they existed at the time of the Burlingame Loan, were harmed by
the Burlingame Loan. To the contrary, in the absence of such
evidence, the Court must infer that the Burlingame Loan permitted
these creditors’ claims to be paid. Thus, even if the Court
concluded after trial of the disputed factual issues, that
Burlingame’s conduct (or conduct that may be ascribed to it) in
connection with the Burlingame Loan was sufficiently inequitable
to warrant equitable subordination, the Court would be unable to
grant an appropriate remedy. As a result, Burlingame is entitled
to a summary adjudication and dismissal of this portion of the
equitable subordination claim.
(2) The Comerica Loans
The second part of Qmect’s first claim for relief concerns
Burlingame’s conduct in connection with the Comerica Loans
beginning in the Spring of 2003 and through January 2004, when
Burlingame acquired the Comerica Loans. Qmect alleges that
Burlingame acted egregiously by interfering with SCG’s efforts to
purchase the Comerica Loans: i.e., by making baseless threats of
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12Qmect concedes that Burlingame cannot be fairly viewed as
a fiduciary or in confidential relationship with it during this
time period. Therefore, as discussed above, for the Burlingame
Funding’s secured claims to be equitably subordinated, the Court
must find that Burlingame’s conduct was egregious.
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litigation against Comerica if it sold the Comerica Loans to SCG.12
It alleges that Burlingame’s inequitable conduct harmed general,
unsecured creditors by preventing SCG from acquiring the Comerica
Loans and working with Qmect to resolve its financial problems.
Burlingame asserts various defenses to this portion of Qmect’s
first claim for relief. First, it contends that there is no
evidence that it acted improperly, let alone egregiously. It
argues that its conduct in connection with the purchase of the
Comerica Loans was entirely proper and is protected by the
competition privilege. See PMC, Inc. v. Saban Entm’t, Inc., 45
Cal. App. 4th 579, 603 (1996); Della Penna v. Toyota Motor Sales,
U.S.A., Inc., 11 Cal. 4th 376, 389 (1995); A-Mark Coin Co. v.
General Mills, Inc., 148 Cal. App. 3d 312, 323-24 (1983).
Second, Burlingame contends that there is no evidence that its
conduct prevented SCG from purchasing the Comerica Loans. The
evidence is undisputed that, at the time Burlingame purchased the
Comerica Loans, Comerica’s agreement with SCG had fallen apart.
Moreover, Burlingame bid $100,000 more for the Comerica Loans that
SCG had agreed to pay.
Third, Burlingame notes that the Litigation Threat Letter is
the sole basis for Qmect’s claim that Burlingame acted improperly
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in connection with its purchase of the Comerica Loans. Burlingame
asserts that the litigation privilege prevents its claim from
being equitably subordinated on that account. See Cal. Civ. Code
§ 47(b); Silberg v. Anderson, 50 Cal. 3d 205, 215 (1990); Visto
Corp. v. Sproqit Techns., Inc. 360 F. Supp. 2d 1064 (N.D. Cal.
2005); Rubin v. Green, 4 Cal. 4th 1187, 1194 (1993).
Finally, Burlingame contends that there is no evidence that
the general, unsecured creditors would have been better off if SCG
had bought the Comerica Loans. According to Burlingame, Qmect’s
assertion that SCG would have worked with Qmect to resolve its
financial difficulties, to the benefit of unsecured creditors, is
mere speculation.
In response, Qmect notes that the litigation privilege is an
affirmative defense which must be pled in the defendant’s answer
to be asserted. Qmect contends that Burlingame has waived the
defense by failing to plead it. See Carroll v. Acme-Cleveland
Corp., 955 F.2d 1107, 1115 (7th Cir. 1992); Ingraham v. United
States, 808 F.2d 1075, 1079 (5th Cir. 1987). It contends that the
privilege does not apply to a claim for equitable subordination,
noting that Burlingame has cited no authority for this
proposition.
In any event, Qmect points out, as applied to communications
made before a lawsuit has been filed, the litigation privilege is
not absolute. To be entitled to assert the privilege, the party
making the threat must have had a good faith contemplation of
litigation. See Edwards v. Centex Real Estate Corp., 53 Cal. App.
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4th 15, 33-34 (1997); Laffer v. Levinson, 34 Cal. App. 4th 117, 124-
25 (1995). Qmect contends that there is substantial evidence
that Burlingame was not serious about suing Comerica and was
merely threatening litigation in bad faith as a tactic to gain an
advantage in purchasing the Comerica Loans.
Qmect disputes Burlingame’s contention that the evidence is
clear that the Litigation Threat Letter did not cause the failure
of the sale of the Comerica Loans to SCG. It asserts that the
evidence is clear that the sale to SCG failed because SCG would
not agree to indemnify Comerica from any litigation as a result of
the sale. It contends that there is substantial evidence that
Comerica would not have insisted on this provision had Burlingame
not threatened it with suit. Qmect concedes that the evidence is
somewhat speculative as to what SCG would have done if it had
purchased the Comerica Loans. However, it contends that it is
reasonable for the Court to infer that SCG would have worked with
Qmect and not commenced foreclosure proceedings, thereby forcing
it into bankruptcy.
The Court concludes that there is substantial evidence that
Burlingame acted egregiously in connection with its competition
with SCG to purchase the Comerica Loans. As discussed above,
there is evidence that, in late May or early June of 2003,
Burlingame learned that SCG was attempting to purchase to Comerica
Loans. At that time Burlingame threatened Comerica with
litigation if it sold the Comerica Loans to SCG. As a result,
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Comerica made a decision to sell the Comerica Loans and offered
Burlingame and SCG an equal opportunity to bid for the loans.
Rather than competing on an equal basis, Burlingame chose to
enter into an agreement with Qmect and SCG giving Burlingame the
exclusive right to bid for the Comerica Loans for a period of 90
days. Thereafter, either party would be entitled to bid.
However, when SCG attempted to purchase the Comerica after the 90
days had elapsed, again, Burlingame threatened Comerica with
litigation. Burlingame offers various rationales for its conduct.
Nevertheless, the Court finds sufficient evidence to create a
genuine issue of material fact as to whether Burlingame’s conduct
was sufficiently egregious to warrant equitable subordination.
The competition privilege does not alter the Court’s
conclusion. This 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). 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.
The Court is unable to conclude that the litigation privilege
is an affirmative defense that Burlingame has waived by failing to
plead in its answer. The authorities cited by Qmect only state
that an affirmative defense is waived if not timely pled. They do
not identify the litigation privilege as an affirmative defense.
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Moreover, even if the litigation privilege is an affirmative
defense, Qmect does not cite any prejudice based on Burlingame’s
having failed to plead it earlier. Absent such prejudice, the
Court would be inclined to permit Burlingame to amend its answer
to assert the defense.
Whether the litigation privilege applies to an equitable
subordination claim is more problematic. The authorities hold
that the privilege applies to all tort actions other than an
action for malicious prosecution. However, a claim for equitable
subordination is not a tort claim; it is an equitable remedy. At
the same time, the purpose for the litigation privilege would
appear to apply equally to an equitable subordination action. For
purposes of this motion, the Court will assume, without ruling,
the privilege does apply. However, as discussed above, whether it
applies here is subject to a material factual dispute.
There is also substantial evidence that the Litigation Threat
Letter caused the sale of the Comerica Loans to SCG to fail.
Burlingame commenced foreclosure proceedings against Qmect’s
assets immediately after acquiring the Comerica Loans, thereby
precipitating the chapter 11 filing. The filing prevented Qmect
from paying pre-petition unsecured claims. It is reasonable to
infer that the claims of Qmect’s unsecured creditors that existed
when Burlingame’s conduct occurred were the same claims to which
Qmect seeks to subordinate the secured claims of Burlingame and
Burlingame Funding. As a result, unlike the first half of Qmect’s
first claim for relief, the Court would be able to fashion an
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appropriate remedy if Qmect is able to prove the other elements of
its claim.
Nevertheless, the second portion of the first claim for
relief must fail as well. Burlingame is correct that Qmect has
failed to present any evidence that SCG would have worked with
Qmect to resolve its financial problems, so that the unsecured
creditors would have been better off if SCG had purchased the
Comerica Loans. The only evidence to this effect is that SCG had
been issued some stock and that its principal had taken a position
on Qmect’s Board of Directors. The Court does not believe that
this is sufficient to create a genuine issue of fact on this
essential element of Qmect’s equitable subordination claim.
2. Objection to the Burlingame Proof of Claim
In the second claim for relief in the Equitable Subordination
Action, Qmect objects to the Burlingame Proof of Claim. The
Burlingame Proof of Claim is based on the Burlingame Loan which is
junior in priority to the Comerica Loans. It asserts a claim in
the principal amount of $2,000,000 plus $1,047,836.25 in accrued
interest. It also seeks attorneys’ fees in an unspecified amount.
Qmect objects to the Burlingame Proof of Claim on the ground
that it is entitled to offset against some of all of the claim its
damages based on Burlingame’s tortious conduct. Neither
Burlingame nor Qmect specify the tortious conduct to which this
refers. However, the claim for intentional interference with
prospective economic advantage, asserted by the Koellings in the
Guaranty Action, is clearly a tort claim asserted by Qmect as
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well. Both Qmect and the Koellings had a prospective economic
advantage from SCG purchasing the Comerica Loans.
As discussed in the Court’s Memorandum of Decision with regard
to Burlingame’s motion for summary judgment in the Guaranty
Action, there are genuine issues of material fact with regard to
all of the elements of the intentional interference claim.
Therefore, Burlingame’s motion for summary judgment with regard to
Qmect’s second claim for relief in the Equitable Subordination
Action will be denied.
3. Objection to the Burlingame Funding Proof of Claim
In the third claim for relief in the Equitable Subordination
Action, Qmect objects to the Burlingame Funding Proof of Claim.
The Burlingame Funding Proof of Claim is based on the Comerica
Loans which were purchased at a discount by Burlingame and
subsequently transferred to Burlingame Funding. The Burlingame
Funding Proof of Claim asserts a secured claim in the principal
amount of $2,520,054.18 plus accrued pre-petition interest of
$12,186.35 (the “Burlingame Funding Proof of Claim”). As noted
above, the Comerica Loans consisted of three separate loan
facilities, each with its own collateral.
The Burlingame Funding Proof of Claim does not allocate the
amounts of the claim among the three loan facilities. In the
third claim for relief, Qmect objects to this failure and contends
that it deprives the Burlingame Funding Proof of Claim to the
presumption of validity normally accorded to a properly executed
and filed proof of claim. See Fed. R. Bankr. Proc. 3001(f).
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Qmect contends that its own books and records are not sufficiently
accurate to permit it to verify the correct amount due under each
of the loan facilities. Therefore, it contends, the Burlingame
Funding Proof of Claim should be disallowed unless Burlingame
Funding can present sufficient evidence to establish the amount of
its claims.
Burlingame Funding addresses this claim for relief summarily.
It contends that the objection fails for vagueness because it does
not cite the subsection of 11 U.S.C. § 502 upon which its
objection is based. Burlingame Funding’s motion for summary
judgment on this claim is denied. Qmect is not seeking
disallowance of Burlingame Funding’s claim based on one of the
criteria set forth in 11 U.S.C. § 502. It is simply contending
that the Burlingame Funding Proof of Claim is insufficiently
detailed to relieve Burlingame Funding of the burden of proving
its claim. The Court agrees with Qmect that Burlingame Funding’s
failure to allocate the amount claimed with respect to each of the
separate loan facilities deprives it of this evidentiary benefit.
Burlingame’s motion for summary judgment with respect to this
claim will also be denied.
B. BREACH OF FIDUCIARY DUTY ACTION
1. Breach of Fiduciary Duty Claim
In the first claim for relief in the Breach of Fiduciary Duty
Action, Qmect alleges that, by agreeing to act as Qmect’s
financial consultant, the Judsons and Sierra acted as fiduciaries
with respect to Qmect and breached their fiduciary duty by acting
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13The Court cannot find a definition for this term in the
complaint but assumes that the agreement referred to is the
Original and Amended Engagement Letter pursuant to which Sierra
agreed to attempt to renegotiate Qmect’s debts to Comerica or to
obtain new financing to permit Qmect to pay off the Flat Note
Loan.
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in the Judsons’ interests rather than Qmect’s. However, Qmect’s
claims for breach of fiduciary duty against the Judsons and Sierra
have been remanded to state court. The only charging allegations
against Burlingame in this claim for relief are that Burlingame
knew about this conduct, participated in it, and benefitted from
it. On this basis, Qmect contends that Burlingame is liable for
any damages incurred by Qmect as a result of the Judsons’ or
Sierra’s breach of their fiduciary duty. Thus, the first claim
relief asserts a claim for breach of fiduciary duty against a
nonfiduciary. Qmect has provided the Court with no authority that
such a claim can be asserted. In the absence of such authority,
the Court concludes that Burlingame is entitled to summary
judgment with respect to this claim.
2. Rescission of Contract Claim
The second claim for relief in the Breach of Fiduciary Duty
Action seeks to rescind an agreement referred to as the “Sierra
Agreement” on the ground that it is illegal.13 The claim alleges
that the Sierra Agreement purports to constitute Sierra and the
Judsons as loan brokers and that neither Sierra or the Judsons
have a loan broker’s license. The second claim for relief also
alleges that the Judsons and Sierra acted in conflicting roles, as
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both consultant and broker to Qmect, in violation of Cal. Bus. &
Prof. Code § 10176 (prohibiting acting as a broker for more than
one side of a deal without obtaining both parties’ informed
consent). As a result, the claim alleges, the Sierra Agreement
should be rescinded and all consideration received pursuant to the
agreement disgorged.
As noted above, the claims against Sierra and the Judsons have
been remanded. Burlingame was not a party to the Original or
Amended Engagement Letter and did not receive any compensation
pursuant to it. Therefore, the Court concludes that these
allegations do not state any claim against Burlingame. The only
allegation that does concern Burlingame is contained in the final
sentence of the second claim for relief. It alleges that the
Burlingame Loan is a product of the illegal agreement with Sierra
and the Judsons and thus that it too is void or voidable.
It is unclear whether, by this allegation, the second claim
for relief intends to seek rescission of the Burlingame Loan as
well as of the Sierra Agreement. If it does, the Court concludes
that the second claim for relief also fails to state a viable
claim for relief and that Burlingame is entitled to summary
judgment in its favor with respect to this claim as it applies to
Burlingame and the Burlingame Loan. Qmect has provided the Court
with no authority for the proposition that a loan may be rescinded
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14In any event, as noted above, the Court concludes that the
Release evidences Qmect’s informed consent to the dual
representation.
15In support of this contention, Burlingame cited
Independent Cellular Tel, Inc. v. Daniels & Assocs., 863 F.
Supp. 1109 (N.D. Cal. 1994). The Court did not find this
decision helpful.
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because the loan broker was unlicensed or represented both the
borrower and the lender without obtaining their informed consent.14
3. Unfair Business Practice Claim (Cal. Bus. & Prof. Code
§ 17200 et seq.)
The third claim for relief in the Breach of Fiduciary Duty
Action alleges that, in violation of Cal. Bus. & Prof. Code §
17200 et seq., the defendants agreed and conspired to engage in
unfair business practices and acts of unfair competition or
encouraged the other defendants to do so and accepted the benefits
of that conduct. It alleges that the purpose of these unfair acts
was to take over Qmect’s business, property, and prospects. The
third claim for relief seeks disgorgement of any benefits received
by the defendants from their acts of unfair competition and
injunctive relief to prevent them from continuing to engage in
such acts of unfair competition.
In its motion for summary judgment, Burlingame contends that
this claim may not be maintained because the allegations
supporting such a claim must be supported by other illegal
conduct. It contends that Qmect is unable to produce evidence of
any such conduct by Burlingame.15
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A claim for unfair business practices or competition pursuant
to Bus. & Prof. Code § 17200 et seq. must establish that the
practice or act “is either unlawful (i.e., is forbidden by law),
unfair (i.e. harm to victim outweighs any benefit) or fraudulent
(i.e., is likely to deceive members of the public).” Albillo v.
Intermodal Container Services, Inc., 114 Cal. App. 4th 190, 206
(2004). As discussed above, the Court concludes that the evidence
is sufficient to create a genuine issue of material fact as to
whether Burlingame’s having sent the Litigation Threat Letter to
Comerica constituted an unfair business practice or unfair
competition under these circumstances: i.e., in light of the June
14 Agreement.
As discussed above, the Court concluded that Burlingame was
entitled to summary judgment on Qmect’s equitable subordination
claim as it applied to the Litigation Threat Letter based on
Qmect’s failure to provide any evidence of resulting damages. A
claim under Bus. & Prof. Code § 17200 does not entitle the
plaintiff to recover its damages. Madrid v. Perot Systems Corp.,
130 Cal. App. 4th 440, 452 (2005). Therefore, Qmect’s failure to
produce evidence of damages does not entitle Burlingame to summary
judgment on this claim.
Nevertheless, for similar reasons, the Court concludes that
Burlingame is entitled to summary judgment on this claim.
Remedies for breach of Bus. & Prof. Code § 17200 are limited to
restitution and injunctive relief. Id. at 453-55. Qmect’s claim
for injunctive relief makes no sense, as applied to the sole
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16Presumably, Comerica would not be pleased with a court
order directing Burlingame to transfer the Comerica Loans back
to Comerica and requiring Comerica to pay back to Burlingame the
purchase price for the Comerica Loans. In any event, such an
ordere would be improper since Comerica is not a party to this
action.
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viable instance of unfair competition: i.e., Burlingame’s use of
the Litigation Threat Letter to obtain an advantage in its bid for
the Comerica Loans. There is no likelihood that Burlingame would
have an opportunity to repeat this conduct.
Neither does restitution appear to be a viable remedy under
these circumstances. “Restitution” has been defined narrowly in
this context: i.e., as the “return of property or funds in which
the plaintiff has an ownership interest (or is claiming through
someone with an ownership interest).” It includes both “money
that was once in the plaintiff’s possession” and “money in which
the plaintiff had a vested interest.” It does not permit the
court to order other monies disgorged so as to prevent a defendant
from being unjustly enrichment. Id.
Qmect has failed to produce any evidence that it has an
ownership interest in any monies or property obtained by
Burlingame as a result of sending the Litigation Threat Letter to
Comerica. True, Qmect has an ownership interest in its assets
which are encumbered by the Comerica Loans. However, the
Litigation Threat Letter did not create this encumbrance; it
merely enabled Burlingame to obtain Comerica’s right to enforce
it.16
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4. Breach of Contract Claim
The fourth claim for relief in the Breach of Fiduciary Duty
Action is asserted only against the Judsons and Sierra. As noted
above, those claims have been remanded to state court. A s a
result, this claim is not within the scope of Burlingame’s motion
for summary judgment.
5. Declaratory Relief Claim
In the fifth claim for relief in the Breach of Fiduciary Duty
Action, Qmect seeks a declaration that, due to the Judsons and
Sierra’s improper conduct, both the Engagement Letter and the
Burlingame Loan are invalid. It seeks a declaration that all fees
obtained by the Judsons and Sierra pursuant to the Original and
Amended Engagement Letters should be disgorged. As noted above,
these claims have been remanded to state court. However, the
fifth claim for relief also seeks a declaration that the
Burlingame Loan was illegal and is unenforceable and that
Burlingame has no rights pursuant to the Burlingame Loan other
than, at best, the right of a nonvoting equity holder. For the
reasons stated above, in connection with the rescission claim,
Burlingame is entitled to summary judgment on this claim.
6. Injunctive Relief Claim
In the sixth claim for relief in the Breach of Fiduciary Duty
Action, Qmect and the Koellings seek to enjoin Burlingame and
Burlingame Funding from foreclosing on Qmect’s real and personal
property and on the Koellings’ stock in Qmect. The claim alleges
that it would cause Qmect and the Koellings irreparable injury if
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defendants were permitted to foreclose. Burlingame and Burlingame
Funding are entitled to summary judgment on this claim as well.
At present, they are prevented by the automatic stay from
foreclosing its security interests or proceeding against the
Koellings with respect to their guaranties. However, if the Court
concludes that the automatic stay should be vacated, Qmect has
alleged no legal or factual basis for enjoining them from
exercising their legal rights with respect to their collateral.
CONCLUSION
With respect to the Equitable Subordination Action, the Court
concludes that Burlingame is entitled to summary judgment on the
first claim for relief. Its motion for summary judgment with
respect to the second and third claims for relief will be denied.
With respect to the Breach of Fiduciary Duty Action, the Court
concludes
that Burlingame is entitled to summary judgment on all of the
claims asserted against Burlingame. 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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