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: February 08, 2006
________________________________________
LESLIE TCHAIKOVSKY
U.S. Bankruptcy Judge
________________________________________
Entered on Docket
February 09, 2006
GLORIA L. FRANKLIN, CLERK
U.S BANKRUPTCY COURT
NORTHERN DISTRICT OF CALIFORNIA
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1Findings of fact should be construed as conclusions of
law, and conclusions of law should be construed as findings of
fact where appropriate. See Fed. R. Bankr. Proc. 7052.
2
DECISION AFTER TRIAL IN CONSOLIDATED PROCEEDINGS
The above-captioned adversary proceedings were tried to the
Court on October 24, 25, 26, 27 and 28, and December 7, 2005 and
on January 9, 10, 11, and 12, 2006. Closing argument was
presented on January 24, 2006. The Court’s findings of fact and
conclusions of law are set forth below.
GENERAL FINDINGS OF FACTS1
1. Qmect, Inc. (“Qmect”), a California corporation, is
engaged in the electroplating business in Northern California.
Fred and Linda Koelling (the “Koellings”) are the principal
shareholders of Qmect. Fred Koelling is Qmect’s president; Linda
Koelling is its secretary; and the Koellings are Qmect’s
directors.
2. Qmect operates its business primarily at a facility in
Union City, California (the “Qmect 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.
3. In 1995, the Partnership decided to build its own
facility. For that purpose, it purchased the Qmect Real Property
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and in 1996 began construction. At some point in the process,
Qmect was formed, and the Partnership sold its assets to Qmect.
4. In 1997, Qmect obtained loans from Comerica Bank-
California (“Comerica”) to assist in the construction of the new
facility for a total of $1.8 million (the “Original Comerica
Loans”). The Original Comerica Loans were comprised of four
separate loan facilities: (a) two loans secured by a first
priority deed of trust on the Real Property (the “Comerica Deed of
Trust”), (b) a line of credit secured by Qmect’s accounts
receivable, and (c) a loan secured by Qmect’s equipment.
5. The Koellings executed personal guaranties of Qmect’s
obligations to Comerica (the “Comerica Guaranties”). The Comerica
Guaranties were secured by the Koellings’ personal real and
personal property assets.
6. Qmect was unable to complete construction of the facility
for the amount of the Original 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 thereafter, Comerica began
urging the Koellings to find a source of funds to pay off the Flat
Note Loan.
7. In December 1999, Qmect retained Sierra Financial Group
(“Sierra”) to provide consulting services for this purpose.
Robert and Janice Judson (the “Judsons”) were the principals of
Sierra.
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8. In or about December 2000, the Judsons formed Burlingame
Capital Partners II, L.P. (“Burlingame”) as a fund to make
“mezzanine” loans. In the Spring of 2001, Burlingame offered to
loan Qmect $2,000,000 to enable Qmect to pay off the Flat Note
Loan (the “Burlingame Loan”).
9. The Burlingame Loan did not close until November 2001
(although $100,000 of the loan was funded in September 2001).
During the Summer of 2001, the Koellings caused $1,500,000 to be
advanced to Qmect to enable it to meet its operating expenses (the
“$1.5 Million Loan”).
10. The $1.5 Million Loan was secured by real property (the
“Kids Connection Real Property”) owned by Kids Connection, Inc.
(“Kids Connection”), a corporation owned by Linda Koelling. The
funds were wired directly from Kids Connection’s bank account to
Qmect’s bank account. However, on advice of the Koellings’
accountant, the $1.5 Million Loan was documented as a loan by Kids
Connection to the Koellings followed by a loan by the Koellings to
Qmect. In connection with the Burlingame Loan, the Koellings
signed an agreement, providing that repayment of the $1.5 Million
Loan would be subordinated to the Burlingame Loan (the “Burlingame
Subordination Agreement”).
11. In November 2001, shortly before the Burlingame Loan was
due to close, Burlingame insisted that the Koellings execute a
personal guaranty of the Burlingame Loan (the “Burlingame
Guaranty”). The Burlingame Guaranty included the following
provision (the “Carve Out”):
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9. Notwithstanding anything to the contrary
contained in the instrument, no recourse may
be had against, no judgment satisfied out of,
any of the Excluded Assets (as defined below)
for or arising out of any obligations,
liabilities or indemnities of Guarantor. As
used herein, the term “Excluded Assets” shall
mean and refer to any and all of Guarantor’s
ownership in Kids Connection, Inc.
Notwithstanding the foregoing, any asset which
would otherwise be included in the definition
of Excluded Assets, shall not be considered a
part of Excluded Assets if Guarantor invests
additional cash or other assets in Kids
Connection, Inc. or Guarantor purchases
additional shares of stock or any other form
of ownership in Kids Connection, Inc. without
Lender’s prior written consent.
12. The Burlingame Guaranty was secured by Fred Koelling’s
stock in Qmect (the “Qmect Stock Collateral”). At that time, the
Qmect Stock Collateral represented a controlling interest in
Qmect.
13. The Burlingame Loan was used in part to pay off the Flat
Note Loan. The net proceeds of the Burlingame Loan, after paying
off the Flat Note Loan, were largely used to pay interest to
Burlingame and a $60,000 finder’s fee to Sierra.
14. Qmect was unable to service the Burlingame Loan, and it
went into default in July 2002.
15. In October 2002, Qmect and the Koellings filed an action
in state court against the Judsons, Sierra, and Burlingame for
fraud and negligent misrepresentation, among other things (the
“Breach of Fiduciary Duty Action”). However, the complaint in
that action (the “Breach of Fiduciary Duty Complaint”) was not
served on the defendants at that time.
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16. In September 2002, Linda Koelling entered into an
agreement with Kids Connection, increasing her annual salary from
$80,000 to $225,000 and securing the obligation by a deed of trust
on the Kids Connection Real Property (the “September 2002 Salary
Increase”).
17. During the fall of 2002, Qmect engaged Alternative
Capital Strategies, LLC (“ACS”) to assist it in reorganizing its
financial affairs.
18. In November 2002, Robert Judson wrote a letter to the
investors in Burlingame, expressing his concern that Qmect or a
party friendly to Qmect might purchase the Original Comerica Loans
(the “November 2002 Investor Letter”). He stated that such a
purchase could be detrimental to Burlingame. He did not express
the view that such a purchase would violate any agreement between
Burlingame and either Comerica or Qmect.
19. In the November 2002 Investor Letter, Robert Judson also
stated that Burlingame had been in negotiations with Comerica with
regard to Burlingame’s purchase of the Original Comerica Loans at
a discount of approximately $100,000 of their face amount.
Burlingame did not inform Qmect or the Koellings about its
negotiations with Comerica.
20. In the November 2002 Investor Letter, Robert Judson also
stated that he did not wish to foreclose on the Qmect Stock
Collateral because Qmect had a number of unpaid liabilities,
including unpaid payroll taxes.
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21. In early 2003, ACS located a proposed lender, Structured
Capital Group (“SCG”). The principal of SCG is an individual
named Basem Zakariya (“Zakariya”). SCG made a proposal to
Comerica and Burlingame for a restructuring of Qmect’s secured
debt. Neither secured creditor was interested in the proposal.
22. On May 28, 2003, SCG sent a letter to Comerica, offering
to purchase the Original Comerica Loans. The letter offered two
alternative prices: (1) $2.7 million, of which $1.8 million would
be paid to Comerica at closing, the remaining $900,000 of which
would be placed in an escrow or with a court pending resolution of
a dispute between Comerica and Qmect concerning this portion of
the debt or (2) $2.1 million at closing in full satisfaction of
the purchase price and in settlement of all claims.
23. In or before May 2003, the Breach of Fiduciary Duty
Complaint was served on the Defendants. On May 29, 2003,
Burlingame e-mailed to the Koellings a notice of the proposed
foreclosure sale of the Qmect Stock Collateral which was scheduled
to take place on June 12, 2003.
24. On or before June 4, 2003, Burlingame learned that SCG
was attempting to purchase the Original Comerica Loans. On June
4, 2003, Burlingame’s counsel sent a letter to Comerica’s counsel,
threatening to sue Comerica if Qmect or a Qmect affiliate
purchased the Original Comerica Loans (the “First Litigation
Threat Letter”).
25. In the First Litigation Threat Letter, Burlingame’s
counsel claimed that Comerica’s sale of the Original Comerica
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2McNeill was an existing shareholder. BDS was an entity
which had previously provided consulting services to Qmect.
Qmect Funding was an entity formed by Zakariya in anticipation
of acquiring the Original Comerica Loans.
8
Loans to a third party without giving Burlingame 90 days’ prior
notice would violate Burlingame’s subordination agreement with
Comerica (the “Comerica Subordination Agreement”). Burlingame’s
counsel also asserted that the sale of the Original Comerica Loans
to an affiliate of Qmect would violate various provisions of the
Burlingame Loan agreement (the “Burlingame Loan Agreement”).
Qmect was not provided with a copy of the First Litigation Threat
Letter.
26. On June 9, 2003, Comerica sent a letter to Qmect and
Burlingame, by fax and personal delivery, informing them that
Comerica had decided to sell the Original Comerica Loans. The
letter disclosed that Comerica had received an offer to purchase
the Original Comerica Loans from an entity that appeared to be
affiliated with Qmect. The letter stated that the offer had now
expired. In the letter, Comerica proposed to give the parties an
opportunity to bid against each other for the purchase of the
Original Comerica Loans.
27. On June 9, 2003, Qmect issued additional shares and
transferred them to Robert McNeill (“McNeill”), Business Debt
Solutions (“BDS”), and Qmect Funding, LLC (“Qmect Funding”).2 The
result of this transaction was that the Qmect Stock Collateral no
longer represented a controlling interest in Qmect. On the same
day, Qmect’s Board of Directors adopted a corporate resolution
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purporting to make Zakariya a director. On the same day, the
Koellings assigned to Kids Connection their right to repayment by
Qmect of the $1.5 Million Loan.
28. On June 10, 2003, Qmect sought a temporary restraining
order in state court of the proposed stock foreclosure sale.
Qmect did not disclose to the state court or to Burlingame at that
time that it had issued additional stock in Qmect. The temporary
restraining order was denied.
29. On June 12, 2003, the day of the foreclosure sale, Fred
Koelling informed Robert Judson about the issuance and transfer of
the additional stock. As a result, Burlingame chose not to
proceed with the foreclosure sale. Instead, the parties discussed
a strategy for cooperative bidding for the Original Comerica
Loans.
30. On or about June 14, 2003, Burlingame, Qmect, the
Koellings, and SCG entered into a written agreement concerning
bidding for the Original Comerica Loans (the “June 14 Agreement”).
The June 14 Agreement contained the following provisions:
(A) Before 9:00 a.m on June 16, 2003, Qmect and the Koellings
would dismiss with prejudice the third and fourth claim in the
Breach of Fiduciary Duty Complaint: i.e., the fraud and negligent
misrepresentation claims.
(B) Before 3:00 p.m. on June 17, 2003, Burlingame would make
an offer to purchase the Original Comerica Loans at a price
determined to be appropriate by Burlingame. Burlingame agreed to
provide a copy of the offer to SCG at the time the offer was
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submitted to Comerica. If the offer were rejected or a
counterproposal were made by Comerica, Burlingame and SCG would
cooperate in determining the appropriate response.
(C) If Comerica did not accept Burlingame’s offer (or any
subsequent offer submitted by Burlingame) by September 15, 2003,
then Burlingame and SCG would each be entitled to submit
independent offers to purchase the Original Comerica Loans. Until
then, neither Qmect nor SCG, nor any of their affiliates would
submit an offer to purchase the Original Comerica Loans.
(D) If Comerica accepted Burlingame’s offer to purchase the
Original Comerica Loans by September 15, 2003, then SCG would have
90 days from the date of purchase to purchase a 50 percent
interest in the Original Comerica Loans. The purchase price for
this 50 percent interest would be 50 percent of the price paid by
Burlingame plus 50 percent of the interest accruing on the
Original Comerica Loans from the date of purchase to the date of
payment for the 50 percent interest. Alternatively, SCG had the
right, instead of purchasing the 50% interest in the Original
Comerica Loans, to payment of $250,000. These rights would not
apply if Burlingame purchased the Original Comerica Loans after
September 15, 2003.
(E) If Burlingame or any party affiliated with Burlingame
purchased the Original Comerica Loans, Burlingame would release
the Koellings from the Comerica Guaranties. This provision was
subject to the following handwritten provision, referred to as
Rider 1 (the “Good Faith Provision”):
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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 make 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.,
SCG] 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 guaranty will not [be]
released.
(F) Finally, the June 14 Agreement provided that nothing in
the agreement would affect the rights, remedies or obligations of
Burlingame, Qmect or the Koellings under the Burlingame Loan
Agreement.
31. Burlingame made an offer to purchase the Comerica Loans
for $1,600,000 on or before June 17, 2003. Comerica rejected the
offer without making a counteroffer. Shortly thereafter, Ken
Tamizato (“Tamizato”), the loan officer from Comerica in charge of
the Original Comerica Loans, called Fred Koelling and inquired why
Burlingame was the only party bidding. Fred Koelling did not
disclose the existence of the June 14 Agreement to Tamizato.
Tamizato told Fred that he would have to “turn the heat up”: e.g.,
by calling the loans so that the loans would accrue interest at a
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default rate. Fred Koelling conveyed the substance of this
conversation to Robert Judson.
32. On June 20, 2003, counsel for Burlingame wrote another
letter to counsel for Comerica (the “Second Litigation Threat
Letter”). In the Second Litigation Threat Letter, counsel
asserted again that sale of the Original Comerica Loans to Qmect
or a Qmect affiliate would violate the Comerica Subordination
Agreement as well as the Burlingame Loan Agreement. He also
asserted that, by threatening to begin charging default interest
on the Original Comerica Loans under these circumstances, Comerica
would be exposing itself to a lawsuit by Qmect. Qmect was not
provided with a copy of the Second Litigation Threat Letter.
33. After Comerica rejected Burlingame’s initial offer to
purchase the Original Comerica Loans, on or about July 15, 2003,
Burlingame and Qmect entered into a term sheet (the “July 15 Term
Sheet”). The July 15 Term sheet provided for two alternative
courses of action, designated as Plan A and B.
(A) Plan A provided that, subject to Comerica’s approval,
Qmect and the Koellings would execute a deed in lieu of
foreclosure to Burlingame, transferring Qmect’s assets to
Burlingame, in partial satisfaction of its debt. The amount of
the debt would be agreed upon between the parties. The assets
would be transferred into a new company, into which Burlingame
would inject $500,000 of equity. Qmect’s debt to Comerica would
become the debt of the new company.
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(B) Plan B provided that, if Comerica did not approve of Plan
A, the capitalization of Qmect would be restored so that the
shares held by Burlingame to secure the Burlingame Guaranty would
represent 95 percent of all outstanding stock. Burlingame would
be entitled to replace any individuals on the Board of Directors
who were no longer shareholders. It was anticipated that the new
Board might elect to file a chapter 11 petition on behalf of the
new company. Under this scenario, Burlingame would have no
obligation to make any loans or capital contributions to Qmect.
(C) Under either Plan A or B, Fred Koelling would continue to
serve as President of Qmect, but not as CEO, for one year, at a
specified salary, an agreement which could be renewed annually.
His duties would be primarily in sales and research and
development. He would continue to be a member of the Board of
Directors. Burlingame agreed not to enforce the Burlingame
Guaranty during this one year period and to release the Koellings
from the Burlingame Guaranty at the end of the year provided Fred
Koelling complied with his obligations under the employment
agreement.
34. On September 5, 2003, Burlingame made a second offer to
purchase the Original Comerica Loans. This time, the offer was
for only $1,400,000, $200,000 less than the original offer. SCG
was given notice of Burlingame’s intention to make this offer
shortly before it was communicated to Comerica and did not object
to the amount. Comerica rejected the offer and did not make a
counteroffer.
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35. The 90 day period during which, pursuant to the June 14
Agreement, Burlingame had the exclusive right to bid on the
Original Comerica Loans until September 15, 2003. Neither Qmect
nor SCG, nor any of their affiliates, made any attempt to bid on
the Original Comerica Loans during that period.
36. Comerica would not agree to Plan A set forth in the July
15 Term Sheet. Fred Koelling asked Robert Judson why they could
not then proceed in accordance with Plan B. On September 16,
2003, Robert Judson wrote a letter to Fred Koelling, expressing
various reasons why Plan B did not appear viable.
37. On October 13, 2003, Qmect Funding, the entity formed by
Zakariya in anticipation of purchasing the Original Comerica
Loans, wrote a letter to Tamizato, offering to purchase the
Original Comerica Loans for $1.7 million. Comerica agreed to sell
the Original Comerica Loans to Qmect Funding for this amount (the
“Qmect Funding Sale Agreement”) and loan documents were drafted.
Neither SCG nor the Koellings advised the Judsons of the Qmect
Funding Sale Agreement.
38. On October 29, 2003, Robert Judson wrote to Fred
Koelling, requesting updated financial information, ostensibly to
assist Burlingame in continuing its attempt to purchase the
Original Comerica Loans. Fred Koelling did not provide the
requested information until January 14, 2004.
39. In early January 2004, the Judsons learned about the
impending sale of the Original Comerica Loans to Qmect Funding.
On January 14, 2004, Robert Judson e-mailed Fred Koelling, asking
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him to confirm or deny whether this transaction was in progress.
In the e-mail, he asserted that the purchase of the Original
Comerica Loans by Qmect Funding would violate the Burlingame Loan
Agreement.
40. On January 14, 2004, Burlingame’s counsel wrote to
counsel for Comerica, making the same assertions made in the e-
mail to Fred Koelling and threatening legal action (the “Third
Litigation Threat Letter”). On January 22, 2004, Burlingame
issued deposition subpoenas directed to Tamizato and Comerica in
the Breach of Fiduciary Duty Action.
41. On January 16, 2004, Burlingame’s counsel wrote to
counsel for Zakariya, asserting that his efforts to purchase of
the Original Comerica Loans violated the Burlingame Loan
Agreement.
42. Notwithstanding these threats, negotiations between
Comerica and Qmect Funding concerning the purchase of the Original
Comerica Loans proceeded. However, Comerica insisted that
Zakariya personally agree to indemnify Comerica from any suit by
Burlingame regarding the transaction. Zakariya refused to do so.
On January 23, 2004, Zakariya signed the draft Qmect Funding Sale
Agreement and sent it to Comerica, with the indemnification
provision deleted. He also sent Comerica a $25,000 deposit.
43. On January 26, 2004, counsel for Burlingame wrote to
counsel for Comerica, offering to purchase the Original Comerica
Loans for $50,000 more than the $1.7 million offered by SCG.
Comerica asked Burlingame to indemnify it from any suit by Qmect
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or Qmect Funding. Burlingame refused. Nevertheless, on or about
February 2, 2004, Burlingame and Comerica executed an agreement
providing for the sale of the Original Comerica Loans to
Burlingame for $1,825,000 (the “Burlingame Loan Sale Agreement”).
The Burlingame Loan Sale Agreement did not include an
indemnification agreement.
44. Shortly after acquiring the Comerica Loans, Burlingame
commenced foreclosure proceedings with respect to Qmect’s personal
property assets and filed suit against the Koellings in state
court on the Burlingame Guaranty (the “Guaranty Action”).
45. On February 27, 2004, Qmect filed a chapter 11 petition
to stop the foreclosure sale.
46. Shortly thereafter, Burlingame transferred the Original
Comerica Loans to a newly formed entity (“Burlingame Funding”).
47. On November 16, 2004, the Koellings filed a chapter 11
petition.
48. Burlingame and Burlingame Funding filed timely proofs of
claim (the “Proofs of Claim”) in both chapter 11 cases.
49. After the chapter 11 cases were filed, the two lawsuits
between the parties filed in state court were removed to the
bankruptcy court. The Guaranty action was designated A.P. No. 04-
4365 AT (the “Guaranty Action”) and the Breach of Fidcuiary Duty
Action was designated A.P. 04-4366 AT. Some of the claims in
those actions were subsequently remanded to state court.
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50. During the chapter 11 case, Qmect commenced A.P. No 04-
4190 AT (the “Equitable Subordination Action”). The three
adversary proceedings were consolidated for trial.
51. On or about August 24, 2005, the Court granted summary
judgment with respect to some of the claims asserted in the
consolidated adversary proceedings. Shortly before the trial
commenced, the Court permitted Burlingame and Qmect to amend their
pleadings to dismiss certain claims, to add other claims, and to
add new parties to existing claims.
CONCLUSIONS OF LAW (INCLUDING CLAIM SPECIFIC FINDINGS OF FACT)
As noted above, this decision addresses claims asserted in
three adversary proceedings which were tried to the Court on a
consolidated basis. The Court’s findings and conclusions with
respect to the claims asserted in the Equitable Subordination
Action, A.P. No. 04-4190 AT, are set forth in Section A below.
The Court’s findings and conclusion with respect to the claims
asserted in the Guaranty Action, A.P. No. 04-4365 AT, are set
forth in Section B below. The Court’s findings of fact and the
conclusions of law with respect to the Breach of Fiduciary Duty
Action, A.P. No. 04-4366 AT, are set forth in Section C below.
A. EQUITABLE SUBORDINATION ACTION
As tried to the Court, the Equitable Subordination Complaint
included four claims for relief: (1) Intentional Interference With
Prospective Economic Advantage, (2) Breach of Contract, (3) Breach
of Covenant of Good Faith and Fair Dealing, and (4) Objection to
Claims. The first three claims were asserted only as offsets to
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3This claim is also asserted against Burlingame Funding.
However, no evidence was presented supporting such a claim in
that Burlingame Funding was not formed until after the conduct
in question occurred.
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the Proofs of Claim and not as a basis for affirmative relief.
The Court’s findings of fact and its conclusions of law with
respect to these claims for relief are set forth in sections A-1,
A-2, A-3, and A-4, respectively. Qmect has the burden of proof
with respect to the first three claims. The burden of proof with
respect the fourth claim for relief will be discussed in section
A-4.
1. Intentional Interference With Prospective Economic
Advantage
In this claim for relief, Qmect alleged that Burlingame
intentionally interfered with its prospective economic advantage
by sending the Litigation Threat Letters. It alleged that this
was intended to and did disrupt Qmect Funding’s attempt to
purchase the Original Comerica Loans to its detriment.3 The
elements of a claim for intentional interference with prospective
economic advantage are: (1) an economic relationship between the
plaintiff and a 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).
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The acts that caused the disruption must be wrongful as a legal
matter for some reason other than that they interfered with the
prospective economic relationship. Id., at 393.
At trial, Qmect presented persuasive evidence that it had an
economic relationship with Qmect Funding and that Burlingame knew
of this economic relationship. It also presented persuasive
evidence that Burlingame sent the Second and Third Litigation
Threat Letters with the intention of disrupting that prospective
economic relationship. As discussed in the next claim for relief,
the Court was also persuaded that these acts actually disrupted
that relationship. Furthermore, the Court was persuaded that
these acts were otherwise wrongful in that they constituted a
breach of the June 14 Agreement.
However, as discussed more fully in connection with the next
claim for relief, for breach of contract, the Court finds and
concludes that this claim must fail for two reasons. First, Qmect
failed to persuade the Court that there was a probability of
future benefit to Qmect if Qmect Funding acquired the Original
Comerica Loans. Second, for the same reason, Qmect failed to
persuade the Court that it was damaged by Burlingame’s disruption
of the prospective economic relationship. Given this conclusion,
the Court need not address the defenses to this claim raised by
Burlingame: e.g., that the claim is barred by the competition
privilege or the litigation privilege.
2. Breach of Contract
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4The Court does not consider significant the fact that
Zakariya intended to purchase the Original Comerica Loans
through Qmect Funding rather than SCG.
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In this claim for relief, Qmect alleged that Burlingame
breached the June 14 Agreement by causing Comerica to renege on
the Qmect Funding Loan Sale Agreement. It alleged that Comerica’s
failure to sell the Comerica Loans to be Qmect Funding caused
Qmect to suffer damages in an amount to proven at trial. Qmect
alleged that it performed all of its obligations under the June 14
Agreement.
Based on the evidence presented at trial, the Court finds and
concludes that Qmect performed all of its obligations under the
June 14 Agreement. The Court finds and concludes that Burlingame
breached the Good Faith Provision of the June 14 Agreement by
sending the Second and Third Litigation Threat Letters to
Comerica.
In the June 14 Agreement, Burlingame agreed that, if it failed
to purchase the Original Comerica Loans by September 15, 2003,
Burlingame and SCG would each be entitled to make independent bids
for the Original Comerica Loans. The Good Faith Provision
provided that Burlingame, SCG, and Qmect would all cooperate in
good faith to achieve the purposes of the June 14 Agreement.
Burlingame breached the Good Faith Provision by interfering with
SCG’s rights to make an independent bid for the Original Comerica
Loans after the 90 days had expired.4
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5As noted above, paragraph 5 of the June 14 Agreement
provided that nothing in the agreement would affect the rights,
remedies or obligations of Burlingame, Qmect or the Koellings
under the Burlingame Loan Agreement.
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Burlingame contended that the June 14 Agreement did not give
SCG the right to bid for the Original Comerica Loans even after
the expiration of the 90 day period. It contended that the
purchase of the Original Comerica Loans by Qmect Funding violated
its rights under the Burlingame Loan Agreement, among other
things, and that it preserved its right to object to SCG bidding
in paragraph 5 of the June 14 Agreement.5 Jan Judson testified
that this understanding of the June 14 Agreement was discussed
among the parties at the time the agreement was executed of the
June 14 Agreement. The Court did not believe Jan Judson’s
testimony. The plain language in paragraph 2 states otherwise.
Had the parties agreed to such an important provision, the Court
believes that it would have been spelled out more clearly in the
June 14 Agreement.
The Court also finds and concludes that the Second and Third
Litigation Threat Letters caused Comerica to renege on the Qmect
Funding Loan Sale Agreement. The Court was persuaded that
Zakariya could have obtained the financing required to purchase
the Original Comerica Loans and would have completed the purchase
had Comerica not insisted on being indemnified. The Court was
also persuaded that Comerica would have sold the Original Comerica
Loans to Qmect Funding without requiring the indemnification but
for the Second and Third Litigation Threat Letters. The critical
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evidence supporting this conclusion is the fact that Comerica sold
the Original Comerica Loans to Burlingame even though Burlingame
refused to indemnify Comerica.
The Court was not persuaded that Comerica sold the Original
Comerica Loans to Burlingame because Burlingame offered more
money. Had price been the issue, Comerica would have gone back to
Qmect Funding for a higher bid. Although Burlingame’s offer to
close the transaction in seven days may have been attractive to
Comerica, particularly at the time the offer was made, the Court
is persuaded that the sale to Qmect Funding could have closed
sooner than the sale to Burlingame had Burlingame not interfered
with the sale to Qmect Funding.
However, to prevail on its breach of contract claim, Qmect
must establish that it was damaged by Burlingame’s breach. Thus,
Qmect was required to persuade the Court that, more probably than
not, it would have been better off if Qmect Funding had purchased
the Original Comerica Loans than it is now as a result of
Burlingame having purchased them. For this purpose, Qmect called
Zakariya as a witness.
Zakariya testified that, if Qmect Funding had acquired the
Original Comerica Loans, he intended to propose to Burlingame that
Qmect Funding reduce the amount of its secured claim to the amount
it had paid for the Original Comerica Loans. In return,
Burlingame would be required to convert $1 million of its secured
claim to equity. Qmect Funding would also receive equity for the
amount it reduced its secured claim. Qmect’s secured debt would
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thereby reduced by almost $2 million. The problem with this
proposal was that, to become a reality, it would have required
Burlingame’s consent. Jan Judson testified that Burlingame never
would have agreed to such a proposal. The Court believed her.
The result of this proposal would have been that Fred
Koelling, Qmect Funding, and Burlingame would have shared the
equity in Qmect. It was not clear whether Qmect Funding would
have acquired a controlling interest by virtue of the transaction.
However, it might have since, according to Zakariya, it already
held a 35 percent equity interest. However, clearly, Burlingame
would have been a minority shareholder. The Court was persuaded
that Burlingame would not have been willing to accept such a role
in Qmect under the circumstances.
Qmect Funding could have pressured Burlingame to agree by
threatening to foreclose on Qmect’s assets. Since the Original
Comerica Loans were senior to Burlingame’s secured claim,
Burlingame’s security interest would have been extinguished as a
result of such a foreclosure. However, Burlingame could have
purchased the Original Comerica Loans at the foreclosure sale,
albeit at the face amount. The Court is persuaded that Burlingame
would have preferred doing so to accepting the role of a minority
shareholder in a Qmect owned jointly with the Koellings and
Zakariya.
Qmect presented no other evidence concerning what would have
happened absent an agreement between Qmect Funding and Burlingame.
Qmect had no agreement with Zakariya that Qmect Funding would
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6Burlingame asserts various defenses to this claim. Given
the Court’s conclusion that Qmect has failed to prove that it
incurred any quantifiable damages as a result of Burlingame’s
breach of the June 14 Agreement, the Court not need address
them.
7They also filed proofs of claim asserting unquantified
amounts for damages, fees, and costs, and related items based on
the claims asserted in the Guaranty Action and the Burlingame
Cross-Complaint. Qmect did not object to these proofs of claim.
Thus, to the extent that Burlingame and Burlingame Funding have
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convert any portion of the face amount of the Original Comerica
Loans to equity. Qmect Funding’s acquisition of the Original
Comerica Loans would not have prevented Burlingame from
foreclosing. Thus, Qmect still would have been required to file
a bankruptcy petition to stay such a foreclosure. Given the
absence of persuasive evidence of damages, the Court is compelled
to find in favor of Burlingame on this claim.6
3. Breach of Covenant of Good Faith and Fair Dealing
In this claim for relief, Qmect alleged that Burlingame
breached the implied covenant of good faith and fair dealing with
respect to the June 14 Agreement by interfering with Qmect
Funding’s attempt to purchase the Original Comerica Loans. This
claim duplicates the claim for breach of contract discussed in the
preceding section. For the same reason, failure to prove damages,
the Court finds in favor of Burlingame.
4. Objections to Proofs of Claim
In this claim, Qmect objected to proofs of claim filed by
Burlingame and Burlingame Funding, asserting claims in partially
quantified amounts.7 A properly executed and filed proof of claim
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26 established at trial the right to payment by Qmect based on the
claims asserted in the Guaranty Action and the Burlingame Cross-
Complaint, these claims are deemed allowed.
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is prima facie evidence of the validity and amount of the claim.
Fed. R. Bankr. Proc. 3001(f). Thus, unless an objection is filed
that is of sufficient substance to put the validity and/or amount
of the claim in controversy, the claim is deemed allowed. If a
sufficient objection is filed, the claimant has the burden of
proving its claim. The Court’s findings and conclusions with
respect to these contested proofs of claim are set forth below.
a. Burlingame’s Proof of Claim
Burlingame filed a proof of claim in the Qmect bankruptcy
case, asserting a secured claim in the principal amount of
$2,000,000, for pre-petition interest of $1,047,836.25, and for an
unquantified amount of late fees and costs of collection,
including attorneys’ fees. Qmect objected to Burlingame’s proof
of claim only on the ground that it was entitled to assert offsets
to those claims. Qmect had the burden of proof with respect to
these offset claims. As discussed elsewhere, the Court finds and
concludes that it failed to meet that burden.
At trial, Burlingame presented persuasive evidence
establishing certain elements of its claim that were not
quantified in its proof of claim--e.g., late charges and
attorneys’ fees--and corrected certain mistakes in the quantified
portions of the proof of claim–-e.g., pre-petition interest.
Based on the evidence presented, the Court finds and concludes
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8The Koellings are liable for Qmect’s debts to Burlingame
pursuant to the Burlingame Guaranty. Burlingame filed a timely
proof of claim in the Koellings’ bankruptcy case. The Koellings
did not object to the proof of claim. Nevertheless, at trial,
Burlingame presented sufficient evidence at trial to establish
certain unquantified portions of the claim that were different
from the claim asserted against Qmect: i.e., for pre-petition
interest, late fees, and collection costs accruing after Qmect
filed its bankruptcy petition and before the Koellings filed
their bankruptcy petition. Based on the evidence presented, the
Court finds and concludes that Burlingame’s claim against the
Koellings should be allowed in the following amounts: (a)
$2,000,000 in principal, (b) $1,455,180.55 in pre-petition
interest, (c) $40,057.01 in late fees, and (d) $1,413,132.80 in
costs of collection.
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that Burlingame is entitled to an allowed claim in the Qmect
bankruptcy case in the following amounts: (a) $2,000,000 in
principal, (b) $1,043,635.01 in pre-petition interest, (c)
$27,779.23 in late fees, and (d) $357,998.59 in costs of
collection.8
b. Burlingame Funding’s Proof of Claim
Burlingame Funding filed a proof of claim in the Qmect case,
asserting a claim in the principal amount of $2,520,054.18, for
pre-petition interest totaling $32,194.82, plus an unquantified
amount of late fees and costs of collection, including attorneys’
fees. Qmect objected to Burlingame’s proof of claim on the ground
that the proof of claim was insufficiently detailed to establish
a prima facie case in support of the claim. Specificially, it
contended that the proof of claim was insufficient because it
failed to allocate the amounts owed among the four loan
facilities. The Court summarily adjudicated this issue in favor
of Qmect prior to trial.
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9Burlingame Funding also filed a proof of claim in the
Koellings’ bankruptcy case based on the Koellings’ liability
under the Comerica Guaranties. Although the Koellings did not
file an objection to this proof of claim, Burlingame Funding
presented evidence in support of its claim against the Koellings
at trial. The only difference from the evidence presented in
support of Burlingame Funding’s proof of claim in the Qmect case
was the accrual of additional pre-petition interest. However,
as discussed elsewhere, the Court has concluded that the
Koellings are entitled to a release of their liability pursuant
to the Comerica Guaranties. Therefore, this claim will be
disallowed.
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At trial, Burlingame Funding presented persuasive evidence
establishing the amounts of its claim. Based on the evidence
presented, the Court finds and concludes that Burlingame Funding
is entitled to a allowed claim in the Qmect bankruptcy case in the
following amounts: (a) a claim for $187,500 in principal and
$1,696.31 in pre-petition interest pursuant to the variable rate
installment note, (b) a claim for $537,816.96 in principal and
$5,052.51 in pre-petition interest pursuant to the note secured by
a deed of trust, (c) a claim for $894,737.22 in principal and
$8,948.32 in pre-petition interest pursuant to the amended and
restated note secured by a deed of trust, and (d) a claim for
$900,000 in principal and $7,850.60 in pre-petition interest
pursuant to the master revolving note.9
B. GUARANTY ACTION
As tried to the Court, the Guaranty Action consisted of a
complaint filed by Burlingame against the Koellings (the “Guaranty
Complaint”) and a cross-complaint filed by the Koellings against
Burlingame (the “Koelling Cross-Complaint”). The Court’s findings
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and conclusions with respect to the claims asserted in the
Guaranty Complaint are set forth in section B-1 below. The
Court’s findings and conclusions with respect to the claims
asserted in the Koelling Cross-Complaint are set forth in section
B-2 below.
1. Guaranty Complaint
As tried to the Court, the Guaranty Complaint included two
claims for relief: (a) breach of the Comerica Guaranties and (b)
declaratory relief. Burlingame Funding has the burden of proof on
both claims. The Court’s findings of fact and conclusions of law
with respect to these claims are set forth in section B-1-a and B-
1-b, respectively.
a. Breach of Comerica Guaranties
In the first claim for relief, Burlingame Funding alleged as
follows:
In 1998, when Qmect obtained loans from Comerica to build its
new facility, the Koellings executed the Comerica Guaranties. On
February 5, 2004, Burlingame purchased the Original Comerica
Loans, including the Comerica Guaranties. On February 29, 2004,
Burlingame assigned the Original Comerica Loans, including the
Comerica Guaranties, to Burlingame Funding.
Commencing in 2003, Qmect defaulted on the Original Comerica
Loans. On various dates in 2003, Comerica sent notices of default
to the Koellings, demanding repayment of the amounts due under the
Original Comerica Loans. The Koellings have failed to comply with
their obligations pursuant to the Comerica Guaranties. Thus,
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to Burlingame. However, this is an obvious mistake.
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Burlingame Funding prays for judgment in the amount due under the
Comerica Guaranties.
At trial, Burlingame Funding presented persuasive evidence of
the allegations recited above and established the amounts due from
the Koellings pursuant to the Comerica Guaranties. However, as
discussed in connection with the next claim for relief, the Court
finds and concludes that the Koellings are entitled to a release
of their liability pursuant to the Comerica Guaranties by virtue
of the June 14 Agreement. Thus, judgment will be granted in favor
of the Koellings on this claim.
b. Declaratory Relief
In the second claim for relief, Burlingame alleged as follows:
On or about November 21, 2001, Burlingame and Qmect signed an
agreement (the “Burlingame Loan Agreement”) pursuant to which
Burlingame loaned Qmect $2,000,000 (the “Burlingame Debt”).10
Thereafter, a dispute arose among the parties concerning the
Burlingame Loan Agreement. It alleged that, on or about October
23, 2002, Qmect and the Koellings filed suit against Burlingame
and others in San Mateo Superior Court, and that Burlingame filed
a cross-complaint against the Koellings.
On or about June 14, 2003, Burlingame, Qmect, the Koellings,
and SCG entered into the June 14 Agreement. The June 14 Agreement
gave Burlingame the exclusive right to bid on the Original
Comerica Loans from the date of the agreement to September 15,
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2003. Thereafter, the June 14 Agreement provided, among other
things, that, if Burlingame had not purchased the Original
Comerica Loans by September 15, 2003, then Burlingame and SCG
would each be entitled to submit independent bids.
The June 14 Agreement provided that, if Burlingame were
successful in purchasing the Original Comerica Loans, the
Koellings would be released from the Comerica Guaranties.
However, the release was subject to a provision requiring all of
the parties to the June 14 Agreement to “cooperate in good faith
to achieve the purposes of” the agreement. If it were determined
that the Koellings acted in bad faith in the joint bidding
process, they would not be entitled to a release from the Comerica
Guaranties. The second claim for relief alleged that, although
Burlingame had acquired the Original Comerica Loans, the Koellings
were not entitled to a release from the Comerica Guaranties
because they acted in bad faith. Ten acts of bad faith were
alleged.
The second claim for relief alleged further that the June 14
Agreement gave Burlingame the right, if it acquired the Original
Comerica Loans, to appoint a new CEO to replace Fred Koelling.
This CEO would be entitled to remain in charge of Qmect as long as
any debt remained due from Qmect to Burlingame. Burlingame did
acquire the Original Comerica Loans and advised Fred Koelling that
it wished to appoint an individual named Robert Sick as CEO in
place of Fred. Fred Koelling refused to step down as CEO so as to
permit Robert Sick to take charge of Qmect.
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In the second claim for relief, Burlingame sought a
declaration that the Koellings had acted in bad faith within the
meaning of the Good Faith Provision of the June 14 Agreement and
thus were not entitled to a release of the their liability under
the Comerica Guaranties. It also sought a declaration that, by
refusing to let Robert Sick take over as CEO of Qmect, the
Koellings “repudiated” the June 14 Agreement and thus were not
entitled to assert a right to a release of liability on the
Comerica Guaranties pursuant to that agreement.
There was no evidentiary dispute concerning the allegation
that Burlingame, Qmect, the Koellings, and SCG entered into the
June 14 Agreement. However, the parties disagreed about the
meaning of certain provisions of the June 14 Agreement. In
addition, conflicting evidence was presented concerning whether
the Koellings committed some of the acts or omissions complained
about by Burlingame Funding. There were also legal disputes
concerning whether these acts or omissions qualified as bad faith
within the terms of the June 14 Agreement. Finally, there were
factual and legal disputes regarding whether the Koellings
breached the June 14 Agreement by refusing to permit Robert Sick
to take over as CEO of Qmect and, if so, whether this deprived
them of the right to a release of liability pursuant to the
Comerica Guaranties. The Court’s findings and conclusions with
respect to those disputes are as follows.
(1) Construction of June 14 Agreement
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The parties read the June 14 Agreement differently in several
ways. First, the Koellings contended that the good faith
requirement only pertained to the initial 90 day period, during
which Burlingame had the exclusive right to attempt to purchase
the Original Comerica Loans. Burlingame contended that the
requirement continued throughout the bidding process. The Court
agrees with Burlingame’s reading of the June 14 Agreement on this
point. The relevant language cannot reasonably be read as
limiting the effect of the Good Faith Provision to the initial 90
day period.
Second, the Koellings contended that, by agreeing that, after
the initial 90 day period, Burlingame and SCG would each be
entitled to submit independent bids, Burlingame waived any right
to claim that SCG’s purchase the Original Comerica Loans would
violate Burlingame’s contractual rights. Burlingame contended
that paragraph 2 of the June 14 Agreement, which permitted SCG to
bid, was essentially nullified by paragraph 5, which provided that
Burlingame’s contractual rights remained unaffected. At best this
provision was ambiguous.
Jan Judson testified that this issue was negotiated at the
time the June 14 Agreement was executed. She claimed that the
parties understood that Burlingame was preserving its right to
contend that SCG was not entitled to bid. The Court did not
believe her testimony. Such an important provision would have
been spelled out more clearly in the written agreement. Moreover,
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the Court did not believe that Zakariya would have agreed to such
a provision.
(2) Alleged Acts of Bad Faith
As noted above, Burlingame alleged ten acts of bad faith by
the Koellings as follows: (1) failing to inform Burlingame that
SCG had previously made an offer to purchase the Original Comerica
Loans in May 2004 for $2.1 million, (2) failing to provide
Burlingame with information and documents to assist it in
formulating an offer to purchase the Original Comerica Loans, (3)
supplying Burlingame with fraudulent and misleading documents, (4)
refusing to provide Burlingame with information concerning prior
efforts to purchase the Original Comerica Loans, (5) assisting SCG
in its efforts to purchase the Original Comerica Loans, (6)
agreeing to release Comerica from any claim by Qmect and the
Koellings if the Original Comerica Loans were sold to Qmect
Funding, (7) representing to creditors and others in the lending
community that Qmect was arranging for new financing, (8)
misrepresenting Qmect’s finances, (9) misrepresenting Qmect’s
relationship with SCG, and (10) misrepresenting Qmect’s
relationship with Qmect Funding. The Court’s findings and
conclusions with respect to these allegations are set forth below.
Items (1) and (4).
Items (1) and (4) overlap or are duplicative. Item (1)
asserts that the Koellings acted in bad faith within the meaning
of the June 14 Agreement by failing to inform Burlingame that SCG
had previously made an offer to purchase the Original Comerica
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Loans in May 2004 for $2.1 million. Item (4) asserts that the
Koellings acted in bad faith by refusing to provide Burlingame
with information concerning prior efforts to purchase the Original
Comerica Loans. Having considered the evidence and the argument
of the parties, the Court finds and concludes that these acts or
omissions do not serve as a basis for finding that the Koellings
acted in bad faith within the meaning of the June 14 Agreement.
It is undisputed that, in May 2004, SCG offered to purchase
the Original Comerica Loans for $2.1 million. The Judsons
testified that, although they learned that an offer had been made
in early June 2004, they did not learn the amount of the offer.
Later, when the parties entered into the June 14 Agreement, and
during the initial period during which Burlingame had the
exclusive right to attempt to purchase the Original Comerica
Loans, the Koellings did not tell Burlingame the amount that SCG
had offered in May 2003. Burlingame contended that, if it had
known that SCG had offered to purchase the Original Comerica Loans
for $2.1 million in May 2003, it would not have offered to
purchase them for $1.6 million in June 2003.
Fred Koelling and Zakariya admitted that they did not disclose
to Burlingame the amount of the offer made by SCG in May 2003.
However, it was undisputed that the Judsons never asked either
individual what amount had been offered. Both individuals stated
that, if the Judsons had asked, they would have told them the
amount of the offer. The Court believed them.
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Moreover, the Court is persuaded that, even if the Judsons had
known the amount of SCG’s May 2003 offer, Burlingame would not
have offered any more for the Original Comerica Loans during the
initial 90 day period. It is undisputed that, in the fall of
2002, Burlingame entered into negotiations with Comerica
concerning the purchase of the Original Comerica Loans and was
advised at that time that Comerica was unwilling to sell the loans
for less than a $100,000 discount off the $2.7 million face amount
of the loans. Given that prior history, Burlingame’s offers
during the initial initial 90 day period were clearly unreasonably
low. Morever, Fred Koelling testified that he told Bob Judson
that $1.6 million was too low and that he should offer something
in the range of $1.8 to $2 million. The Court believed him.
Items (5), (6), (9), and (10)
These items also overlap or are duplicative. Item (5)
asserts that that the Koellings acted in bad faith by assisting
SCG in its efforts to purchase the Original Comerica Loans. Item
(6) asserts the Koellings acted in bad faith by agreeing to
release their and Qmect’s claims against Comerica if Qmect Funding
bought the Origianl Comerica Loans. Item (9) asserts that the
Koellings acted in bad faith by misrepresenting their relationship
with SCG. Item (10) asserts that the Koellings acted in bad faith
by misrepresenting Qmect’s relationship with Qmect Funding.
Having considered the evidence and the argument of the parties,
the Court finds and concludes that these acts or omissions do not
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serve as a basis for finding that the Koellings acted in bad faith
within the meaning of the June 14 Agreement.
It is undisputed that the Koellings assisted Zakariya in his
attempts to purchase the Original Comerica Loans after Burlingame
failed to do so during the initial 90 day period period. Among
other things, they agreed to release any claims against Comerica
and to indemnify it against claims and/or defense costs resulting
from litigation by Burlingame, both on their own behalf and on
behalf of Qmect. However, there is nothing in the June 14
Agreement that requires them to refrain from assisting one party
in acquiring the Original Comerica Loans after the initial 90 day
period had passed.
The Judsons testified that, during this period, Fred Koelling
misrepresented to them that he was no longer working with
Zakariya. The Court was not persuaded on this point. However,
even if he had, the Court would not find that this constituted a
violation of the Good Faith Provision. After the initial 90 day
period, if Burlingame had wanted to bid on the Original Comerica
Loans in good faith, it would have done so regardless of whether
Fred Koelling was still attempting to arrange a sale to Qmect
Funding. The Court surmises that, in fact, Burlingame did not
wish to purchase the Original Comerica Loans. It simply did not
want to have Qmect Funding or anyone else friendly to Qmect
purchase them. However, the Good Faith Provision did not entitle
Burlingame to compel the Koellings to cooperate with that
strategy.
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Items (2), (3), and (8)
Items (2), (3), and (8) are also either duplicative or
overlapping. Item (2) asserts that the Koellings failed to
provide information and documents to assist Burlingame in making
an offer to purchase the Original Comerica Loans. Item (3)
asserts that the Koellings supplied Burlingame with fraudulent and
misleading documents. Item (8) asserts that the Koellings
misrepresented Qmect’s finances. Burlingame failed to present
persuasive evidence supporting these allegations.
It was undisputed that the Koellings provided Burlingame with
substantial information to assist it in making the second offer
for $1.4 million. The initial offer for $1.6 million was made
almost immediately after the June 14 Agreement was executed.
Thus, there would have been no time to provide Burlingame with
additional financial information.
Substantial evidence was presented that Fred Koelling failed
to provide financial information requested by Burlingame on or
about October 29, 2003 until January 14, 2004. SCG made an offer
to purchase the Original Comerica Loans on October 29, 2003.
Thus, there is some evidence that Fred Koelling delayed providing
Burlingame with financial information so that SCG could have an
advantage in bidding on the Original Comerica Loans.
However, the Court was not persuaded that this was what
caused Fred Koelling to delay providing the requested information
for so long. The request for information was extremely detailed.
Qmect was short-staffed. Fred Koelling testified at trial that he
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did not believe at that point that Burlingame had any intention of
purchasing the Original Comerica Loans. The Court believed him.
Moreover, as discussed above, the Court was persuaded that
Burlingame did not sincerely wish to purchase the Original
Comerica Loans. It simply wished to block anyone else from doing
so. The Court was persuaded that Burlingame purchased the
Original Comerica Loans as a last resort. Thus, the Court finds
and concludes that Fred Koelling’s delay in providing the
requested financial information to Burlingame did not violate the
Good Faith Provision of the June 14 Agreement.
Item (7)
Item (7) asserts that Fred Koelling represented to creditors
and others in the lending community that Qmect was arranging for
new financing. The Koellings did not dispute this asserted fact.
However, no persuasive argument was made that this act constituted
a violation of the Good Faith Provision of the June 14 Agreement.
(3) Appointment of Robert Sick as CEO
Burlingame also asserted that the Koellings were not entitled
to a release of liability pursuant to the Comerica Guaranties
because Fred Koelling refused to let Burlingame appoint a new CEO
for Qmect after Burlingame acquired the Original Comerica Loans.
As set forth above, the June 14 Agreement provided that, if
Burlingame purchased the Original Comerica Loans, it had the right
to do so. It was required to consult with Fred Koelling but had
the ultimate say in whom to appoint. The new CEO would be
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entitled to run Qmect until such time as Burlingame’s claims were
paid in full.
It is undisputed that, after Burlingame acquired the Original
Comerica Loans and after its attempt to foreclose on Qmect’s
assets were blocked by Qmect’s chapter 11 filing, Burlingame
attempted to appoint Robert Sick as Qmect’s CEO. The Court finds
and concludes that Burlingame did not consult with Fred Koelling
before selecting Robert Sick. However, more important, Burlingame
also did not request relief from the automatic stay to exercise
this right. Clearly, under the terms of the June 14 Agreement,
the right to appoint a new CEO constituted an attempt to exercise
control over the assets of the debtor. 11 U.S.C. § 362(a)(3 ).
Thus, the attempt to appoint Robert Sick as the CEO without first
requesting relief violated the automatic Stay.
Moreover, the Court would not have granted relief to permit
Burlingame to exercise this remedy unless it was prepared to grant
relief from stay in toto. In a chapter 11 case, the debtor-in-
possession is a fiduciary for all creditors. If the debtor-in-
possession is not performing this function, the appropriate remedy
is to move for appointment of a chapter 11 trustee. Burlingame
would have the right to suggest that Robert Sick be appointed in
this capacity. However, the Court has the right to decide whether
a chapter 11 trustee should be appointed, and the Office of the
United State Trustee has the right to select the individual to
perform that role.
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In sum, the Court finds that the Koellings have not acted in
bad faith within the meaning of the Good Faith Provision and that
their refusal to let Robert Sick take over Qmect and the new CEO
after the chapter 11 was filed does not deprive them of the right
to a release from the Comerica Guaranties.
2. Koelling Cross-Complaint
As tried to the Court, the Koelling Cross-Complaint included
three claims for relief, for (1) breach of contract, (2)
intentional interference with prospective economic advantage, and
(3) declaratory relief. The Koellings have the burden of proof on
all three claims. The Court’s findings of fact and conclusions of
law with respect to these claims are set forth in Section B-2-a,
B-2-b, and B-2-c, respectively.
a. Breach of Contract
In this claim for relief, the Koellings alleged that, after
Burlingame’s exclusive bidding period expired, they worked with
SCG over a period of months to assist SCG in purchasing the
Original Comerica Loans, incurring substantial costs in the
process. About the time that the Qmect Funding Sale Agreement was
ready to be signed, Burlingame learned about it. Burlingame’s
counsel threatened Comerica with litigation if Comerica proceeded
with the sale, thereby causing Comerica to withdraw from the
agreement. The claim for relief alleged that the Koellings were
damaged as a result of the breach.
As set forth above, in connection with Qmect’s similar claim
for breach of contract, the Court finds and concludes that the
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Koellings performed their obligations under the June 14 Agreement,
that Burlingame breached its obligations by sending the Second and
Third Litigation Threat Letters, and that by its breach,
Burlingame caused Comerica to renege on its agreement to sell the
Original Comerica Loans to Qmect Funding. However, for the same
reasons stated in connection with that claim, the Court finds and
concludes that judgment must be granted in favor of Burlingame on
this claim.
The Koellings failed to present persuasive evidence that they
were damaged by Burlingame’s breach: i.e., that they would have
been better off if Qmect Funding had acquired the Original
Comerica Loans. Notably, they had no agreement with Zakariya that
Qmect Funding would release them from the Comerica Guaranties if
it acquired the Original Comerica Loans. Although they did
present evidence that they spent a substantial amount of money
assisting Qmect Funding in its attempt to acquire the Original
Comerica Loans, they would have been required to spend this money
in any event if the Qmect Funding Sale Agreement had gone through.
No evidence was presented that they would have been reimbursed for
these expenditures.
b. Intentional Interference With Prospective Economic
Advantage
In this claim for relief, the Koellings alleged that, in
February 2004, Burlingame knew that SCG was about to acquire the
Original Comerica Loans. It knew that this would have
significantly eased Qmect’s debt burden and that the Koellings
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would have been released from the Comerica Guaranties. The
Koellings alleged that Burlingame intentionally interfered with
the SCG acquisition by causing Comerica to renege on its agreement
to sell the Original Comerica Loans to SCG.
As a result, the Koellings alleged, they have a significantly
higher debt on the Original Comerica Loan–-i.e., pursuant to the
Comerica Guaranties--that they would have had if SCG had acquired
them. They have also been required to defend Burlingame’s
frivolous claim that the Comerica Guaranties have not been
released. For the reasons discussed above, this claim must also
fail.
The elements of a claim for intentional interference with
prospective economic relations have been recited above in
connection with Qmect’s similar claim and will not be repeated
here. It was undisputed that, at the time the Second and Third
Litigation Threat Letters were sent, Burlingame knew about Qmect’s
and the Koellings’ relationship with SCG and Qmect Funding.
However, the evidence presented did not support the allegation
that Burlingame knew that Qmect and the Koellings would be better
off financially if Qmect Funding purchased the Original Comerica
Loans. The evidence merely supported the finding that the Judsons
felt that Burlingame would be worse off financially if this
occurred. More important, the Court was not persuaded that, more
probably than not, Qmect and the Koellings would have been better
off if Qmect Funding had purchased the Original Comerica Loans.
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The Koellings simply failed to meet their burden of proof on this
issue.
The Koellings also claim as an element of damages that, if
Qmect Funding had acquired the Original Comerica Loans, they would
not have had to defend against a frivolous claim that they were
not entitled to a release from the Comerica Guaranties. This
claim has several problems. First, although the Court has found
in favor of the Koellings on this claim, it does not find the
contention frivolous. Second, and more important, the reason they
would not have had to defend against a claim of this sort is that,
if Qmect Funding purchased the Original Comerica Loans, the
Koellings had no contractual right to a release from the Comerica
Guaranties. This can hardly be seen as an improvement in the
Koellings’ position.
c. Declaratory Relief
In this claim for relief, the Koellings alleged that a
controversy has arisen concerning the rights and duties of the
parties under the terms of the June 14 Agreement, including (1)
whether the June 14 Agreement constitutes a valid and binding
obligation, (2) whether the Koellings performed under the June 14
Agreement, (3) whether Burlingame breached its obligations under
the June 14 Agreement, (4) whether the Koellings acted in good
faith throughout the bidding process, and (5) whether the
Koellings are released from the Comerica Guaranties.
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This claim for relief overlaps with or duplicates other
claims asserted in these consolidated proceedings. However, the
Court will repeat its findings and conclusions here:
(1) No factual or legal basis was presented at trial
challenging the validity or enforceability of the June 14
Agreement. Therefore, the Court finds and concludes that it is a
valid and enforceable agreement.
(2) The Court finds and concludes that the Koellings
performed their obligations under the June 14 Agreement.
(3) The Court finds and concludes that Burlingame breached
its obligation under the June 14 Agreement to act in good faith to
achieve the purposes of the agreement.
(4) The Court finds and concludes that the Koellings acted
in good faith to achieve the purposes of the June 14 Agreement.
(5) The Court finds and concludes that the Koellings are
entitled to a release from their obligations under the Comerica
Guaranties.
C. BREACH OF FIDUCIARY DUTY ACTION
As tried to the Court, the Breach of Fiduciary Duty Complaint
no longer had any claims for relief. However, the Burlingame
Cross-Complaint contained six claims for relief: (1) breach of
unconditional guaranty, (2) tortious interference with contractual
relations, (3) breach of fiduciary duty, (4) contractual/implied
indemnity and contribution11, (5) declaratory relief, and (6)
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26 of the claims are asserted against the Koellings as well as
Qmect in reliance on that theory.
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breach of subordination agreement. All six claims were asserted
against the Koellings. The fourth, fifth, and sixth claims were
also asserted against Qmect. Burlingame has the burden of proof
on all six claims. The Court’s findings of fact and conclusions
of law with respect to all six claims are set forth in sections C-
1, C-2, C-3, C-4, C-5, and C-6 below.
1. Breach of Unconditional Guaranty
In this claim for relief, Burlingame alleged that the
Koellings executed the Burlingame Guaranty, guaranteeing the
performance of Qmect’s obligations under the Burlingame Loan
Agreement. It alleged that the Koellings breached their
obligations under the Burlingame Guaranty by failing to pay the
obligations due under the Burlingame Guaranty upon demand.
Burlingame presented sufficient evidence to support these
allegations at trial, and the Koellings presented no contrary
evidence. The only issue presented by this claim is whether
Burlingame is entitled to satisfy its judgment on this claim from
the Koellings’ interest in Kids Connection: i.e., whether the
Koellings’ conduct has deprived them of the Carve Out and, if so,
to what extent.
As recited above, the Carve Out--paragraph 9 of the
Burlingame Guaranty--prevented Burlingame from seeking to satisfy
its claim under the Burlingame Guaranty against the Koellings’
interest in Kids Connection. However, the effectiveness of the
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12The Koellings also argue that, even if either of these
events constituted the transfer of an asset, the result of the
event would not be a total loss of the Carve Out. The asset
transferred would simply be made available to satisfy
Burlingame’s judgment on the Burlingame Guaranty. This
argument is clearly at odds with the plain language of Carve
Out.
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Carve Out depended upon the Koellings’ not investing “additional
cash or other assets” in Kids Connection and not purchasing
additional shares of stock or any other form of ownership in Kids
Connection. At trial, Burlingame contended that the Koellings
lost their right to the Carve Out by virtue of the September 2002
Salary Increase and the June 2003 $1.5 Million Note assignment.
The Koellings contended that neither of the actions were
sufficient to deprive them of the Carve Out. Alternatively, they
contended that, if the June 2003 $1.5 Million Note assignment
violated the Carve Out provision, the only asset that was thereby
exposed to Burlingame’s claim was the $1.5 Million Note.12 As
recited above, the undisputed evidence presented at trial
established that, in September 2002, Linda Koelling entered into
an agreement with Kids Connection, increasing her annual salary
from $80,000 to $225,000 and securing it with a deed of trust on
the Kids Connection Real Property. Burlingame contended that this
constituted the investment of additional cash of other assets in
Kids Connection, thereby depriving the Koellings of the right to
the Carve Out. This contention has no merit. To the contrary,
Linda Koelling’s increased salary and the lien on the Kids
Connection Real Property securing her right to that salary
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increased the Koellings’ personal assets available to Burlingame
for execution of any money judgment. While this additional or
enhanced asset was related to Kids Connection, it did not
constitute an interest in Kids Connection. Therefore, it was not
an Excluded Asset, within the meaning of the Carve Out.
On the other hand, the Court finds and concludes that
assignment of the $1.5 Million Promissory Note to Kids Connection
does deprive the Koellings of their right to the Carve Out. Prior
to its assignment, the $1.5 Million Promissory Note was an asset
of the Koellings available for execution of a money judgment
obtained by Burlingame. After its assignment, if the Carve Out
were enforced, it would be not be available for that purpose.
Thus, in theory at least, the assignment of the $1.5 Million Note
to Kids Connection decreased the assets available to Burlingame
for execution and increased the value of Linda Koellings’ interest
in Kids Connection. This is precisely the situation addressed by
the Carve Out.
The Koellings contend that they should not lose the Carve Out
as a result of this transaction for two reasons. First, they
contend that they were only the nominal owners of the $1.5 Million
Note. They presented persuasive evidence that the funds loaned to
Qmect, as evidenced by the $1.5 Million Note, came from Kids
Connection, not them. They documented the transaction as a loan
from Kids Connection to themselves and a second loan from
themselves to Qmect on advice of their accountant, for tax
purposes.
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The Court is not persuaded by this contention. When the
Koellings signed the Comerica Guaranty, they were entitled to
repayment of the $1.5 Million Note, not Kids Connection.
Burlingame knew about the loan and that the Koellings were the
holders of the $1.5 Million Note. The Carve Out was negotiated
based on the Koellings’ assets at that time. If the parties had
intended that the assignment of $1.5 Million Loan to Kids
Connection would not deprive the Koellings of the Carve Out, that
exclusion would surely have been spelled out in the Comerica
Guaranty.
Second, the Koellings contend that the assignment of the $1.5
Million Note should not deprive them of the Carve Out because the
$1.5 Million Note had no value. Persuasive evidence was presented
that, at the time the $1.5 Million Note was assigned to Kids
Connection, Qmect was insolvent, on both a going concern and
liquidation basis. Thus, more likely than not, the $1.5
Million Note had no monetary value.
The question remains whether the term “asset” as used in the
Carve Out should be read to mean “asset with a monetary value.”
The term “asset” in not defined in the Burlingame Guaranty.
However, Black’s Law Dictionary defines “assets” as “[p]roperty of
all kinds....” It does not limit the definition to property with
a monetary value. Moreover, even though Qmect could not have
repaid the $1.5 Million Note, it does not follow that the $1.5
Million Note had no value to Burlingame.
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13This claim for relief mistakenly includes Kids Connection
as a cross-defendant. The claims against Kids Connection have
been remanded to state court. In addition, Fred Koelling was
added as a cross-defendant to this claim. Finally, the Court
believes that Burlingame intended to allege that both the
Koellings knew of the agreements, not just that Linda Koelling
knew of them.
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Prior to June 9, 2003, pursuant to the Burlingame Guaranty,
Burlingame had the right to foreclose on Fred Koellings’ stock
which, at that time represented a majority interest in Qmect. If
Burlingame had exercised that right, it would become the majority
owner of Qmect. If the Koellings had retained the $1.5 Million
Note, Burlingame could have increased the value of its equity
interest by foreclosing on the $1.5 Million Note and then
releasing it.
Moreover, the value of Qmect’s assets more likely than not
exceeded the balance of the Original Comerica Loans. It seems
inappropriate to include Burlingame’s own secured loans in the
calculation by which one determines that the $1.5 Million Note had
no value. In sum, the Court concludes that the assignment of the
$1.5 Million Note did constitute the investment of an additional
asset in Kids Connection, thereby depriving the Koellings of the
Carve Out.
2. Tortious Interference With Contractual Relations
In this claim for relief, Burlingame alleged that, in 2001,
Qmect and Burlingame entered into the Burlingame Loan Agreement.13
In paragraph 7 of the Burlingame Loan Agreement, Qmect agreed not
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14Burlingame also alleged in this claim that the Koellings
tortiously interfered with Burlingame’s contractual relations
with Qmect by reassigning the $1.5 Million Note to Kids
Connection, by issuing additional stock and transferring it to
Kids Connection in satisfaction of $250,000 of the $1.5 Million
Note obligation, and by failing to deliver the Kids Connection
Stock to Burlingame as required by the Subordination Agreement.
To the extent these allegations are based on a breach of the
Subordination Agreement, they are not appropriately included in
this claim for relief. The Subordination Agreement imposed
obligations on Koellings, not Qmect. A claim for tortious
interference cannot be based on a breach of one’s own contract.
These allegations are set forth more appropriately in the last
claim for relief, for breach of the Subordination Agreement. See
below.
15Burlingame sought a determination that Kids Connection was
the Koellings’ alter ego such that the assets of Kids Connection
would be available to satisfy this claim. The Court was not
persuaded by the evidence presented at trial that Kids
Connection’s separate corporate status should be disregarded in
this fashion.
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to do certain things without Burlingame’s consent.14 Burlingame
alleged that the Koellings tortiously interfered with these
contractual obligations by causing Qmect to breach them: i.e., by
issuing additional stock and transferring it to Kids Connection,
BDS, McNeil, and Qmect Funding. With respect to this claim,
Burlingame sought both compensatory and punitive damages.15
As noted by Burlingame, to establish this claim, it was
required to prove: (1) the existence of a contract between Qmect
and Burlingame, (2) the Koellings’ knowledge of that contract, (3)
the Koellings’ intent to disrupt Qmect’s performance of that
contract, (4) the actual disruption of performance, and (5)
causation: i.e., that the Koellings’ conduct was a substantial
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16The evidence presented failed to establish that Linda
Koelling had any active participation in this transaction.
Therefore, this claim will not lie against her.
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factor in causing the disruption. An officer or shareholder is
not automatically immune from such a claim. However, an officer
or shareholder may establish a privilege defense by proving that
he or she acted for the benefit of the corporation. See Woods v.
Fox Broadcasting Sub., Inc., 129 Cal. App. 4th 344, 350-56 (2005).
The undisputed evidence clearly established three of the five
elements of the claim. Burlingame and Qmect were parties to the
Burlingame Loan Agreement. The Koellings knew of the Burlingame
Loan Agreement. Moreover, by causing Qmect to issue and transfer
additional stock so that the Burlingame Stock Collateral no longer
represented a majority interest in Qmect, Fred Koelling
effectively induced Burlingame to cancel its foreclosure sale of
the Burlingame Stock Collateral.
Fred Koelling disputed the contention that he caused Qmect to
issue and transfer the additional stock in order to disrupt
Qmect’s performance. He testified that his motives in causing
Qmect to issue and transfer the stock were unrelated to
Burlingame’s efforts to foreclose. The Court did not believe him.
Thus, the third element of the claim is also established. The
remaining issues are (1) whether the issuance and transfer of the
additional stock violated the Burlingame Loan Agreement and (2) if
so, whether Fred Koelling has established a privilege defense.16
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Burlingame alleged that Qmect’s issuance of additional shares
in June 2003 violated the seven negative covenants contained in
paragraph 7 of the Burlingame Loan Agreement: (1) paragraph 7.1,
disposing of any assets outside the ordinary course of business,
(2) paragraph 7.2, permitting a Change in Control, (3) paragraph
7.5, incurring or permitting to be incurred a lien on its assets,
(4) paragraph 7.6, paying any dividends, (5) paragraph 7.8,
entering into any material transaction with an affiliate outside
the ordinary course of business, (6) paragraph 7.9, making any
payment on any subordinated debt, and (7) paragraph 7.12, entering
into a contract with a provision restricting the creation o f a
security interest in Qmect’s property.
The claim that Burlingame violated the negative covenants in
paragraphs 7.5, 7.6, 7.9, and 7.12 lacks any merit and may be
disposed of summarily. No evidence was presented that Burlingame
incurred or permitted to be incurred any lien on its property
(paragraph 7.5), paid any dividends to shareholders (paragraph
7.6), made any payment on subordinated debt–i.e., to the Koellings
(paragraph 7.9), or entered into a contract with a provision
restricting the creation of a security interest in Qmect’s
property (paragraph 7.12). The claim that Burlingame breached
three of the negative covenants contained in paragraph 7-
–paragraphs 7.1, 7.2, and 7.8--requires some discussion.
Paragraph 7.1
In paragraph 7.1 of the Burlingame Loan Agreement, Qmect
agreed not to transfer any of its property to a third party
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outside the ordinary course of business without Burlingame’s
consent. It is undisputed that the issuance and transfer of the
additional stock in June 2003 was outside the ordinary course of
business and that Burlingame did not consent to the transaction.
The only issue is whether the issuance and transfer of previously
unissued stock in a corporation constitutes the transfer of
property of the corporation. The Court concludes that it does
not.
In Decker v. Advantage Fund Ltd., 362 F.3d 593 (9th Cir.
2004), a chapter 7 trustee sued to avoid as fraudulent the
transfer by an insolvent corporate debtor of previously unissued
stock. At issue in the case was whether the stock constituted
property of the debtor corporation. The Decker court held that it
was not, that it was merely equity in the corporate debtor. The
Decker court cited with approval In re Curry & Sorenson, Inc., 57
B.R. 824, 829 (Bankr. 9th Cir. 1986), which reached the same
conclusion. Decker, 362 F.3d at 596. Based on this authority,
the Court concludes that Fred Koelling did not violate the
negative covenant in paragraph 7.1 of the Burlingame Loan
Agreement by causing Qmect to issue and transfer the additional
stock in June 2003.
Paragraph 7.2
In paragraph 7.2, Qmect agreed not to suffer or permit a
Change in Control without Burlingame’s consent. It is undisputed
that Burlingame never consented to a Change in Control.
Burlingame contends that the issuance and transfer of the
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additional stock to Kids Connection constituted a Change in
Control. Change in Control is a defined term. However,
essentially, it means that someone other than Fred Koelling would
hold a majority of the stock “ordinarily entitled to vote.”
Burlingame concedes that the issuance and transfer of the
additional stock to Kids Connection Funding did not give Kids
Connection a majority of the stock. However, it contended that
the issuance and transfer gave Kids Connection Funding a majority
of stock entitled to vote. It reached this conclusion based on
the provision in Subordination Agreement giving Burlingame, rather
than Fred Koelling, the right to vote Fred Koelling’s stock if
Qmect were in default. This method of counting cannot be squared
with the phrase recited above: i.e., “ordinarily entitled to
vote” Thus, the Court concludes that Qmect did not violate the
negative covenant set forth in paragraph 7.2 by issuing and
transferring the additional stock to Kids Connection in June 2003.
Paragraph 7.8
In paragraph 7.8, Qmect agreed not to enter into any material
transaction with an affiliate outside the ordinary course of
business. Burlingame contends that by Qmect violated this
provision by issuing and transferring additional stock to Kids
Connection in exchange for which Kids Connection forgave $250,000
of the obligation represented by the $1.5 Million Note. The Court
agrees.
Kids Connection was owned by Linda Koelling who was also a
shareholder of Qmect. Thus, Kids Connection was an affiliate of
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Qmect. The issuance and transfer of the additional stock in June
2003 was clearly outside the ordinary course of business. Since
it altered Fred Koelling’s percentage of the stock from a majority
to 12 percent, it was clearly a material transaction. Fred
Koelling clearly participated in this transaction and is liable on
the claim. The case against Linda Koelling is not as strong.
However, as a director, the transaction could not have occurred
without her consent. Therefore, the Court finds her liable on the
claim as well.
However, Burlingame failed to establish any compensatory
damages at trial for which the Koellings are not already liable
pursuant to the Burlingame Guaranty. Burlingame also sought
punitive damages. The Court finds and concludes that the
Koellings’ conduct under these circumstances does not warrant the
imposition of punitive damages. Thus, Burlingame is entitled to
judgment on this claim in the amount of the additional interest
that accrued and costs of collection incurred on the Burlingame
Proof of Claim from June 9, 2003 to the date the Koellings filed
their bankruptcy petition.
3. Breach of Fiduciary Duty
In this claim for relief, Burlingame alleged that the
Koellings are directors of Qmect. It alleged that, on June 11,
2003, the Koellings moved for a temporary restraining order so as
to restrain Burlingame’s public sale of Qmect’s stock and that
their motion was denied. It alleged that, on June 12, 2003, with
the intent to hinder, delay, and defraud Burlingame’s rights under
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the Burlingame Loan agreements, the Koellings improperly caused
Qmect to issue additional stock to Kids Connection, BDS, McNeil,
and Qmect Funding. It alleged that the improper issuance of this
stock diluted Fred Koelling’s interest in Qmect from a controlling
interest to 12 percent, which substantially decreased its value as
Burlingame’s collateral.
Burlingame alleged that, at the time the additional stock was
issued, Qmect was “facing insolvency.” As a result, Burlingame
contended, the Koellings, as directors, owed a fiduciary duty to
Qmect’s creditors, including Burlingame. Burlingame alleged that
Qmect breached that duty by issuing the additional stock in that
the stock was issued and transferred with the intent to defraud
Burlingame and was issued and transferred for less than reasonably
equivalent value.
It is undisputed that the Koellings are directors of Qmect
and that, in June 2003, Qmect issued additional shares of stock
and transferred them to third parties. It is also undisputed that
the result of this transaction was to dilute the Burlingame Stock
Collateral to less than a controlling interest in Qmect. The
Court finds and concludes that, more likely than not, Qmect was
insolvent when this transaction occurred. As discussed above,
notwithstanding Fred Koelling’s testimony to the contrary, the
Court was persuaded that the purpose of the issuance and transfer
of this stock was to block the foreclosure sale. Thus, the
transaction was intended to hinder and delay Burlingame: i.e., a
creditor.
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However, the claim asserted is not a fraudulent transfer
claim against the third parties who received the stock, seeking to
avoid the transfer. The claim is asserted against the Koellings
for breach of fiduciary duty. As discussed above, the Court has
already concluded that the issuance and transfer of the stock
breached the Burlingame Loan Agreement and that the Koellings are
liable for tortious interference with contractual relations for
their role in this transaction. The question is whether they are
also liable as a result of this transaction for breach of
fiduciary duty. For this question to be answered in the
affirmative, Burlingame must establish that the Koellings, as
directors, owe Burlingame a fiduciary duty and that the issuance
and transfer of the stock breached that duty.
Normally, the directors of a corporation have a fiduciary
duty only to the corporation and its shareholders. A shareholder
may assert two types of actions against a director: i.e., a
“direct action,” alleging an injury to that shareholder’s
particular interest, or a “derivative action,” alleging an injury
to the corporation for which the corporation has failed or refused
to sue. Schuster v. Gardner, 127 Cal. App. 4th 305, 311-12
(2005).
When a corporation is insolvent, the fiduciary duty of the
directors extends to the creditors as well as to the shareholders.
Pepper v. Litton, 308 U.S. 295, 306 (1939). However, the duty
only runs to the creditor body as a whole, not to any particular
creditor. The trustee has the sole standing to assert a claim for
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17The Original Sierra Agreement was amended in March 2000
but the amendment did not alter the agreement in any way
relevant to this claim.
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breach of this fiduciary duty. Id. Conceivably, in a bankruptcy
case, a creditor or creditors’ committee could be authorized by
the court to assert a derivative claim for breach of fiduciary
duty on behalf of the estate. However, Burlingame has not sought
authorization to assert such a claim.
Burlingame cites a series of cases, which its contends
support its right to assert a breach of fiduciary duty claim on
its own behalf. None of these cases supports Burlingame’s claim
of standing to do so. Therefore, the Koellings are entitled to
judgment on this claim for relief.
4. Contractual/Implied Indemnity and Contribution
In this claim for relief, Burlingame alleged that it was
entitled to be indemnified by Qmect and the Koellings pursuant to
four separate agreements: (1) the November 18, 1999 letter
agreement between Qmect and Sierra (the “Original Sierra
Agreement”),17 (2) the June 2001 Letter Agreement between
Burlingame, on the one hand, and Fred Koelling and Qmect, on the
other (the “2001 Letter Agreement”), (3) the Burlingame Loan
Agreement, and (4) the Burlingame Guaranty. Burlingame alleged
that each of these agreements provided that Qmect and/or the
Koellings are required to indemnify Burlingame for any claims or
expenses incurred as a result of its agreements with Qmect.
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Burlingame’s claims clearly have no merit with respect to two
of these agreements. The Original Sierra Agreement contains an
indemnification provision. However, neither Burlingame nor
Burlingame Funding is a party to that agreement. Burlingame is a
party to the Burlingame Guaranty. However, the Burlingame
Guaranty does not contain an indemnification provision.
Burlingame is a party to the 2001 Letter Agreement, and it
does contain an indemnification provision. In this agreement,
Burlingame expressed an interest in loaning $2,000,000 to Qmect on
specified terms although it made no commitment to make any loan.
The final paragraph of the 2001 Letter Agreement stated that,
regardless of whether Burlingame actually loaned Qmect any money,
Qmect agreed to indemnify Burlingame and hold it harmless from any
claims and expenses arising out of the 2001 Letter Agreement, any
financing, or any related investigation or proceeding.
Burlingame is also a party to the Burlingame Loan Agreement,
and the Burlingame Loan Agreement also contains an indemnification
provision. In paragraph 12.2 of the Burlingame Loan Agreement,
Qmect agreed to “defend, indemnify and hold [Burlingame] harmless”
from “(a) all...claims...asserted by any other party in connection
with the transactions contemplated by this Agreement...and (b) all
losses or...[Burlingame] Expenses...incurred...[or] paid
by...[Burlingame] as a result of...[the] transactions
between...[Burlingame and Qmect] whether under this Agreement, or
otherwise...except for losses caused by...[Burlingame’s] gross
negligence or willful misconduct.” Although the Koellings are not
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parties to the Burlingame Loan Agreement, to the extent Qmect is
liable to Burlingame pursuant to paragraph 12.2, the Koellings are
also liable pursuant to the Burlingame Guaranty.
However, the Court concludes that this issue is moot. As
discussed above, Qmect and the Koellings asserted various claims
for relief against Burlingame. However, they failed to establish
any of their claims. Although the indemnification provisions may
still apply with respect to Burlingame’s litigation expenses, to
the extent they were incurred pre-petition, both Qmect and the
Koellings are already liable for those expenses as costs of
collection under the Burlingame Loan Agreement.
5. Declaratory Relief
In this claim for relief, Burlingame alleged that a
controversy exists as to the parties’ rights and obligations
under the various agreements. It sought a determination of those
rights and obligations. In particular, it sought a determination
that the issuance of additional stock on June 12, 2003 constituted
a fraudulent conveyance which should be set aside.
The Burlingame is not entitled to any judgment on this
claim. Except with respect to the issuance of the additional
stock, the claim was not alleged with sufficient specificity to
permit the Court to identify the nature of the disputed rights and
obligations with respect to which Burlingame seek declaratory
judgment. Moreover, the claim appears duplicative of other claims
asserted in these proceedings.
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The claim for declaratory relief holding that the issuance of
the additional stock in June 2003 was a fraudulent transfer fails
for lack of standing. When the transferor is a bankruptcy debtor,
unless a creditor or creditors’ committee is authorized to bring
a derivative action to avoid the transfer, only the trustee or
debtor-in-possession to assert such a claim. Even if the transfer
was made with the intention of hindering and delaying a specific
creditor, the transfer, if avoidable, will be avoided for the
benefit of all creditors. In re Curry & Sorensen, Inc., 57 B.R.
824, 827-28 (Bankr. 9th Cir. 1986); Matter of Pointer, 952 F.2d 82,
88 (5th Cir. 1992). A claim for declaratory relief may not be
prosecuted by a creditor without such authorization so as to
circumvent that limitation on standing.
6. Breach of Subordination Agreement
In this claim for relief, Burlingame alleged that the
Koellings and Burlingame entered into the Subordination Agreement.
It alleged that the Subordination Agreement provided in part as
follows:
Creditor [the Koellings] shall promptly
deliver to Lender [Burlingame] in the form
received (except for endorsement or assignment
by Creditor where required by Lender) for
application to the Senior Debt [the Original
Comerica Loans] any payment, distribution,
security or proceeds received by Creditor with
respect to the Subordinated Debt other than in
accordance with this Agreement.
Burlingame alleged that the Koellings breached the Subordination
Agreement by failing to promptly deliver to Burlingame the stock
or equivalent cash value received by Kids Connection from Qmect.
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The Subordinated Debt is defined by the Subordination Agreement as
all of Qmect’s debt to the Koellings, including all future debt.
The undisputed evidence presented at trial established that,
on June 9, 2006, the Koellings caused Qmect to issue additional
stock and to transfer some of that stock (the “Kids Connection
Stock”) to Kids Connection in partial satisfaction of the $1.5
Million Note. At the time the Subordination Agreement was
executed, as discussed above, the $1.5 Million Note was owed by
Qmect to the Koellings. Burlingame contended that the Koellings
breached the Subordination Agreement by failing to promptly turn
over the Kids Connection Stock to Burlingame. The Court
disagrees.
As discussed above, the Koellings assigned the $1.5 Million
Note to Kids Connection on June 9, 2003. Once they did this,
Qmect no longer owed this debt to the Koellings. Rather, Qmect
owed the debt to Kids Connection. Moreover, the Kids Connection
Stock was not issued to the Koellings; it was issued to Kids
Connection. Insufficient evidence was presented to establish that
Kids Connection should be treated as the Koellings’ alter ego so
that its separate corporate status should be disregarded.
Therefore, the Koellings are entitled to judgment on this claim.
CONCLUSION
The Court’s rulings on the claims presented at trial in these
consolidated adversary proceedings are summarized as follows:
A. EQUITABLE SUBORDATION ACTION
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1. Intentional Interference With Prospective Economic
Advantage
In this claim by Qmect against Burlingame, the Court grants
judgment in favor of Burlingame.
2. Breach of Contract
In this claim by Qmect against Burlingame, the Court grants
judgment in favor of Burlingame.
3. Breach of Covenant of Good Faith and Fair Dealing
In this claim by Qmect against Burlingame, the Court grants
judgment in favor of Burlingame.
4. Objections to Proofs of Claim
In this contested matter initiated by Qmect, the Court
overrules the objections to Burlingame’s proofs of claim and
allows those claims as follows:
a. Burlingame’s Proof of Claim Against Qmect Estate
The proof of claim filed by Burlingame in the Qmect
bankruptcy case is allowed in the following amounts: (1)
$2,000,000 in principal, (2) $1,043,635.01 in pre-petition
interest, (3) $27,779.23 in late fees, and (4) $357,998.59 in
costs of collection.
b. Burlingame’s Proof of Claim Against Koelling Estate
The proof of claim filed by Burlingame in the Koelling
bankruptcy case is allowed in the following amounts: (1)
$2,000,000 in principal, (2) $1,455,180.55 in pre-petition
interest, (3) $40,057.01 in late fees, and (4) $1,413.132.80 in
costs of collection.
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c. Burlingame Funding’s Proof of Claim Against Qmect Estate
The proof of claim filed by Burlingame Funding in the Qmect
bankruptcy case is allowed in the following amounts: (1) $187,500
in principal and $1,696.31 in pre-petition interest pursuant to
the variable rate installment note, (2) $537,816.96 in principal
and $5,052.51 in pre-petition interest pursuant to the note
secured by a deed of trust, (3) $894,737.22 in principal and
$8,948.32 in pre-petition interest pursuant to the amended and
restated note secured by a deed of trust, and (4) $900,000 in
principal and $7,850.60 in prepetition interest pursuant to the
master revolving note.
B. GUARANTY ACTION
1. Guaranty Complaint
a. Breach of Comerica Guaranties
In this claim by Burlingame Funding against the Koellings,
the Court grants judgment in favor of the Koellings.
b. Declaratory Relief
In this claim by Burlingame Funding against the Koellings,
the Court declares that the Koellings are entitled to a release
from the Comerica Guaranties pursuant to the June 14 Agreement.
2. Koelling Cross-Complaint
a. Breach of Contract
In this claim by the Koellings against Burlingame, the Court
grants judgment in favor of Burlingame.
b. Intentional Interference With Prospective Economic
Advantage
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In this claim by the Koellings against Burlingame, the Court
grants judgment in favor of Burlingame.
c. Declaratory Relief
In this claim by the Koellings against Burlingame, the Court
declares that: (1) the June 14 Agreement is a valid and binding
contract, (2) the Koellings performed their obligations under the
agreement, including their obligations under the Good Faith
Provision, (3) Burlingame breached the Good Faith Provision of the
agreement, and (4) the Koellings are entitled to a release from
the Comerica Guaranties.
C. BREACH OF FIDUCIARY DUTY ACTION-–BURLINGAME CROSS-COMPLAINT
1. Breach of Unconditional Guaranty
In this claim by Burlingame against the Koellings, the Court
finds and concludes that, by assigning the $1.5 Million Note to
Kids Connection, the Koellings lost their right to the Carve Out
set forth in paragraph 9 of the Burlingame Guaranty.
2. Tortious Interference With Contractual Relations
In this claim by Burlingame against the Koellings, the Court
grants judgment in favor of Burlingame. However, it awards only
compensatory damages in the amount of the additional interest
accrued and costs of collection incurred from June 9, 2003 to
November 16, 2004.
3. Breach of Fiduciary Duty
In this claim by Burlingame against the Koellings, the Court
grants judgment in favor of the Koellings.
4. Contractual/Implied Indemnity and Contribution
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In this claim by Burlingame against Qmect and the Koellings,
the Court grants judgment in favor of Qmect and the Koellings on
grounds of mootness.
5. Declaratory Relief
In this claim by Burlingame against Qmect and the Koellings,
the Court grants judgment in favor of Qmect and the Koellings.
6. Breach of Subordination Agreement
In this claim by Burlingame against the Koellings, the Court
grants judgment in favor of the Koellings.
Counsel for Burlingame and Burlingame Funding is directed to
submit proposed forms of judgment 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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