Uecker v. Zentil ( 2016 )

Filed 1/15/16; pub. & mod. order 2/5/16 (see end of opn.)
IN THE COURT OF APPEAL OF THE STATE OF CALIFORNIA
FIRST APPELLATE DISTRICT
DIVISION FIVE
SUSAN L. UECKER,
Plaintiff and Appellant,
A143068
v.
DENNIS ZENTIL, (Alameda County
Super. Ct. No. RG13694649)
Defendant and Respondent.
A bankruptcy trustee sued a former attorney of the debtor company, claiming he
helped the managers of the debtor company perpetrate a fraud. The trial court granted the
attorney’s demurrer without leave to amend, finding the trustee’s claims barred by the in
pari delicto doctrine.1 We affirm.
BACKGROUND
We assume the truth of the complaint’s allegations. (Schifando v. City of Los
Angeles (2003) 31 Cal.4th 1074, 1081 (Schifando).) MF ’08 (the Company) was
organized as a limited liability company in 2007. The Company’s sole managing
member was another limited liability company, whose sole members were Walter Ng and
1
“ ‘The doctrine of in pari delicto dictates that when a participant in illegal, fraudulent,
or inequitable conduct seeks to recover from another participant in that conduct, the
parties are deemed in pari delicto, and the law will aid neither, but rather, will leave them
where it finds them.’ ” (Casey v. U.S. Bank Nat. Assn (2005) 127 Cal.App.4th 1138,
1143, fn. 1.)
1
Kelly Ng (the Managers). The Managers controlled and managed the Company.
Defendant and respondent Dennis Zentil (Defendant) was one of the Company’s lawyers.
The Company’s stated purpose was to serve as an investment company making
secured loans to real estate developers. However, the Managers in fact created the
Company to perpetrate “a fraudulent scheme” by which the Company transferred the
money invested in it to another entity controlled by the Managers. Defendant knew that
the Managers intended to and did use the Company for this fraudulent purpose and,
working with the Managers, helped the Company conceal the true nature of its asset
transfers.
The Company was eventually rendered insolvent and its investors filed an
involuntary bankruptcy petition. Appellant Susan L. Uecker was designated the
liquidating bankruptcy trustee (Trustee) and granted the authority to pursue claims on
behalf of the Company’s bankruptcy trust. She subsequently filed this lawsuit against
Defendant, alleging tort claims based on Defendant’s involvement in the Company’s
fraud.2 Defendant filed a demurrer on the ground that, inter alia, the Trustee’s claims are
barred by the in pari delicto doctrine. The trial court sustained the demurrer on this
ground without leave to amend and dismissed the Trustee’s complaint.
DISCUSSION
“When reviewing a judgment dismissing a complaint after the granting of a
demurrer without leave to amend, courts must assume the truth of the complaint’s
properly pleaded or implied factual allegations. . . . In addition, we give the complaint a
reasonable interpretation, and read it in context. [Citation.] If the trial court has
sustained the demurer, we determine whether the complaint states facts sufficient to state
a cause of action. If the court sustained the demurrer without leave to amend, as here, we
must decide whether there is a reasonable possibility the plaintiff could cure the defect
with an amendment. [Citation.] If we find that an amendment could cure the defect, we
2
The complaint also alleged claims against other defendants, none of which are at issue
in this appeal.
2
conclude that the trial court abused its discretion and we reverse; if not, no abuse of
discretion has occurred. [Citation.] The plaintiff has the burden of proving that an
amendment would cure the defect.” (Schifando, supra, 31 Cal.4th at p. 1081.)
I. In Pari Delicto and Bankruptcy Trustees
The Trustee first argues that, assuming in pari delicto would bar the claims if
asserted by the Company, the doctrine does not bar them when asserted by the
bankruptcy trustee suing on behalf of the Company’s bankruptcy estate. We disagree.
Peregrine Funding, Inc. v. Sheppard Mullin Richter & Hampton LLP (2005) 133
Cal.App.4th 658 (Peregrine Funding) rejected a similar argument. The court explained:
“A bankruptcy trustee succeeds to claims held by the debtor ‘as of the commencement’ of
bankruptcy. (11 U.S.C. § 541(a)(1).) Section 541 of the Bankruptcy Code thus requires
that courts analyze defenses to claims asserted by a trustee as they existed at the
commencement of bankruptcy, and later events (such as the ouster of a wrongdoer) may
not be taken into account. [Citations.] In the context of an unclean hands defense, this
means a bankruptcy trustee stands in the shoes of the debtor and may not use his status as
an innocent successor to insulate the debtor from the consequences of its wrongdoing.
[Citations.] [The debtor’s] unclean conduct—i.e., its participation in the scheme that
defrauded investors of millions—must therefore be considered without regard to the
trustee’s succession.” (Id. at p. 680.)
The Trustee urges us to reject Peregrine Funding. She first argues the application
of in pari delicto is a matter of state law, not federal law. The United States Supreme
Court “ha[s] long recognized that the ‘ “basic federal rule” in bankruptcy is that state law
governs the substance of claims, Congress having “generally left the determination of
property rights in the assets of a bankrupt’s estate to state law.” ’ ” (Travelers Casualty
v. Pacific Gas (2007) 549 U.S. 443, 450–451.) However, federal law determines which
assets constitute the bankrupt’s estate. “[11 U.S.C.] § 541 . . . delineates the scope of
‘property of the estate.’ ” (Begier v. I.R.S. (1990) 496 U.S. 53, 59.) As explained by one
federal court, “while federal law defines in broad fashion what property interests are
included within the bankruptcy estate, state law determines the nature and existence of a
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debtor’s rights.” (In re Moffett (4th Cir. 2004) 356 F.3d 518, 521; see also In re O’Dowd
(3d Cir. 2000) 233 F.3d 197, 202 [“While federal law defines what types of property
comprise the estate, state law generally determines what interest, if any, a debtor has in
property.”]; 2 Cowans, Bankruptcy Law and Practice (7th ed. 1998) § 9.2(b), p. 342
[“The question of what is ‘property of the estate’ is a federal question, but state law
determines the nature and quantum of interest,” fns. omitted].)
As Peregrine Funding noted, the Bankruptcy Code provides that a bankruptcy
estate includes, with exceptions not relevant here, “all legal or equitable interests of the
debtor in property as of the commencement of the case.” (11 U.S.C. § 541, subd. (a)(1),
italics added.)3 Every federal circuit court of appeals to have considered the question has
construed 11 U.S.C. § 541 to provide that the state law analysis of whether in pari delicto
bars a claim asserted by a bankruptcy trustee must consider whether the defense would
have barred the debtor’s claim at the commencement of the bankruptcy case. As the
Third Circuit Court of Appeals explained: “The plain language of section 541 . . .
prevents courts from taking into account events that occur after the commencement of the
bankruptcy case. As a result, we must evaluate the in pari delicto defense without regard
to whether [a bankruptcy trustee] is an innocent successor.” (Official Committee v. R.F.
Lafferty & Co. (3d Cir. 2001) 267 F.3d 340, 357 (R.F. Lafferty).)4
3
In its entirety, 11 U.S.C. § 541, subdivision (a)(1) provides: “The commencement of a
case under section 301, 302, or 303 of this title creates an estate. Such estate is
comprised of all the following property, wherever located and by whomever held: [¶] (1)
Except as provided in subsections (b) and (c)(2) of this section, all legal or equitable
interests of the debtor in property as of the commencement of the case.”
4
See also Nisselson v. Lernout (1st Cir. 2006) 469 F.3d 143, 153 [“there is no ‘innocent
successor’ exception available to a bankruptcy trustee in a case in which the defendant
successfully could have mounted an in pari delicto defense against the debtor”]; In re
Derivium Capital LLC (4th Cir. 2013) 716 F.3d 355, 367 [“to the extent that in pari
delicto would have barred a debtor from bringing suit directly, it similarly bars a
bankruptcy trustee—standing in the debtor’s shoes—from bringing suit”]; Peterson v.
McGladrey & Pullen, LLP (7th Cir. 2012) 676 F.3d 594, 597–598 [rejecting argument
that in pari delicto defense does not apply “once a firm enters bankruptcy and a trustee is
appointed”]; Grassmueck v. American Shorthorn Ass’n (8th Cir. 2005) 402 F.3d 833, 836
4
As the Trustee notes, we are not bound by these lower federal court opinions.
(Etcheverry v. Tri-Ag Service, Inc. (2000) 22 Cal.4th 316, 320 (Etcheverry), disapproved
on another ground as recognized in Barrett v Rosenthal (2006) 40 Cal.4th 33, 58, fn.18.)
However, “they are persuasive and entitled to great weight,” and “where the decisions of
the lower federal courts on a federal question are ‘both numerous and consistent,’ we
should hesitate to reject their authority.” (Etcheverry, at pp. 320–321.) The Trustee has
not persuaded us to reject these numerous and consistent federal circuit court decisions
construing 11 U.S.C. § 541.5The Trustee refers to legislative history supporting her construction of the statute.
(See hist. notes, 11 U.S.C.A. (2004 ed) foll. § 541, p. 8 [“[A]s section 541(a)(1) clearly
states, the estate is comprised of all legal or equitable interests of the debtor in property
as of the commencement of the case. To the extent such an interest is limited in the
hands of the debtor, it is equally limited in the hands of the estate except to the extent that
defenses which are personal against the debtor are not effective against the estate,”
italics added].) However, there is also contrary legislative history. (Hist. notes,
11 U.S.C.A. (2004 ed.) foll. § 541, p. 6 [“Though this paragraph [11 U.S.C. § 541(a)(1)]
will include choses in action and claims by the debtor against others, it is not intended to
(Grassmueck) [“the equitable defense of in pari delicto is available in an action by a
bankruptcy trustee against another party if the defense could have been raised against the
debtor”]; In re Hedged-Investments Associates, Inc. (10th Cir. 1996) 84 F.3d 1281, 1285
[“to the extent [the bankruptcy trustee] must rely on 11 U.S.C. § 541 for his standing in
this case, he may not use his status as trustee to insulate the [debtor] from the wrongdoing
of [its sole owner]”]; Official Com. of Unsecured Creditors v. Edwards (11th Cir. 2006)
437 F.3d 1145, 1150 [“If a claim of [the debtor] would have been subject to the defense
of in pari delicto at the commencement of the bankruptcy, then the same claim, when
asserted by the trustee, is subject to the same affirmative defense.”].) Some cases note
trustees can assert causes of action pursuant to other provisions of the Bankruptcy Code,
possibly with a different result. (See In re Hedged-Investments Associates, Inc., supra,84 F.3d at p. 1285, fn. 6.) Here, however, the Trustee relies solely on 11 U.S.C. § 541.
5
The Trustee cites one contrary federal decision by a federal bankruptcy court. (In re
Adelphia Communications Corp. (Bankr. S.D.N.Y. 2007) 365 B.R. 24, 50–54.) This sole
outlier does not negate the numerous and consistent federal circuit court of appeals
decisions.
5
expand the debtor’s rights against others more than they exist at the commencement of
the case. For example, if the debtor has a claim that is barred at the time of the
commencement of the case by the statute of limitations, then the trustee would not be
able to pursue that claim, because he too would be barred. He could take no greater
rights than the debtor himself had.”].) The conflicting statements render the legislative
history as a whole unhelpful. (See Milner v. Department of Navy (2011) 562 U.S. 562,
574 [“Legislative history, for those who take it into account, is meant to clear up
ambiguity, not create it. [Citation.] When presented, on the one hand, with clear
statutory language and, on the other, with dueling committee reports, we must choose the
language.”].)
The Trustee also relies on F.D.I.C. v. O’Melveny & Myers (9th Cir. 1995) 61 F.3d
17, in which the Ninth Circuit held, as a matter of California law, a receiver was not
barred by equitable defenses that could have been raised against the bank. (Id. at p. 19.)
The Trustee contends there is no material difference between receivers and bankruptcy
trustees. However, several federal court of appeals—as well as Peregrine Funding—
have held otherwise, explaining that “unlike bankruptcy trustees, receivers are not subject
to the limits of section 541.” (R.F. Lafferty, supra, 267 F.3d at p. 358; accord, In re
Derivium Capital LLC, supra, 716 F.3d at p. 367 [distinguishing cases that “involved
receivers who, unlike trustees, are not subject to Section 541”]; In re Hedged-Investments
Associates, Inc., supra, 84 F.3d at p. 1285 [“bankruptcy law, apparently unlike the law of
receivership, expressly prohibits [considering the innocent status of the trustee]”, fn.
omitted]; Jones v. Wells Fargo Bank, N.A. (5th Cir. 2012) 666 F.3d 955, 967 [“cases that
have applied the in pari delicto doctrine against bankruptcy trustees . . . are plainly
distinguishable [in a receivership case] because they rely upon Section 541(a) of the
Bankruptcy Code, which limits the debtor estate to interests of the debtor ‘as of the
commencement of the case’ ”]; Peregrine Funding, supra, 133 Cal.App.4th at p. 680, fn.
14.) Again, the Trustee has not given us reason to reject the consistent analysis in these
lower federal court decisions. (Etcheverry, supra, 22 Cal.4th at p. 321.)
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The Trustee points to Camerer v. California Sav. Etc. Bank (1935) 4 Cal.2d 159,
in which the California Supreme Court held, as a matter of state law, a receiver was not
subject to an in pari delicto defense based on the wrongful conduct of the insolvent bank.
(Id. at p. 170 [“[T]here are certain situations where the receiver is permitted to assert
rights and defenses not available to the insolvent. Thus, it is held that although the
insolvent debtor cannot set aside a transfer in fraud of his creditors, as he is in pari
delicto, the receiver acting for the creditors may attack it.”].) Of course, we are bound by
Camerer’s holding with respect to the application of the in pari delicto defense. (Auto
Equity Sales, Inc. v. Superior Court (1962) 57 Cal.2d 450, 455.) However, Camerer did
not involve a claim asserted by a bankruptcy trustee. Under 11 U.S.C. § 541, we must
analyze the application of California’s in pari delicto defense by considering whether the
defense could have been asserted if the claims were brought by the Company at the
beginning of the bankruptcy case. Camerer’s discussion of innocent successors is not
relevant to this analysis. For the same reason, we reject the Trustee’s argument that,
under California law, the application of in pari delicto to an innocent bankruptcy trustee
is against public policy.
In sum, under 11 U.S.C. § 541, we must analyze the applicability of the in pari
delicto defense by considering whether the defense would have been successful if
asserted against the Company at the commencement of the bankruptcy case.
II. Civil Code 2306
The Trustee argues in pari delicto should not bar her causes of action because the
wrongful acts of the Managers should not be imputed to the Company. We disagree.
“It is settled California law that ‘[k]nowledge of an officer of a corporation within
the scope of his duties is imputed to the corporation.’ ” (Peregrine Funding, supra, 133
Cal.App.4th at p. 679.) However, knowledge will not be imputed when an officer
“collaborates with outsiders to defraud the corporation.” (Ibid.; see also 3 Witkin,
Summary of Cal. Law (10th ed. 2005) Agency, § 156, p. 200 [“Where an agent acts in a
capacity adverse to the principal in the transaction, there is no reason to believe that the
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agent will keep the principal properly informed, and ordinarily the notice will not be
imputed.”].)
This exception is in turn subject to an exception. If the principal was “owned” and
“ ‘controlled by’ ” the agent, the agent’s fraud “is properly imputed to [the principal].”
(Peregrine Funding, supra, 133 Cal.App.4th at p. 679.) As explained in comments to the
Restatement Third of Agency, “if the agent controls the principal’s decision making, the
principal is charged with notice of the agent’s wrongdoing. This rule, often termed the
‘sole actor doctrine,’ treats principal and agent as one.” (Rest.3d Agency, § 5.04, com. d,
p. 399.)
The Trustee argues Civil Code section 2306 precludes application of the sole actor
exception when the agent acts fraudulently. Civil Code section 2306 provides: “An agent
can never have authority, either actual or ostensible, to do an act which is, and is known
or suspected by the person with whom he deals, to be a fraud upon the principal.” The
statute has been construed to mean “where an officer of a corporation is openly using the
corporation to obtain a benefit for himself and his cohorts in a transaction, in which the
corporation will ultimately not benefit, the other parties to the transaction cannot later
seek to hold the corporation liable for his actions.” (Saks v. Charity Mission Baptist
Church (2001) 90 Cal.App.4th 1116, 1121; see also id. at pp. 1138–1139.)
We do not agree with the Trustee’s argument that the sole actor exception
conflicts with Civil Code section 2306 when the agent acts fraudulently. Civil Code
section 2306 limits an agent’s authority to act for the principal. The sole actor exception
applies when there is effectively no distinction between agent and principal: “the ‘sole
actor doctrine,’ treats principal and agent as one.” (Rest.3d Agency, § 5.04, com. d,
p. 399.) As explained by a federal court, “The sole actor doctrine provides that ‘where
the principal and agent are one and the same,’ the agent’s knowledge is imputed to the
principal despite the fact that the agent is acting adversely to the principal. [Citation.]
Where the principal and agent are alter egos, there is no reason to apply an adverse
interest exception to the normal rules imputing the agent’s knowledge to the principal,
because ‘the party that should have been informed [of the fraudulent conduct] was the
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agent itself albeit in its capacity as principal.’ ” (Grassmueck, supra, 402 F.3d at p. 838.)
Civil Code section 2306 has no application where agent and principal are effectively one
and the same.
III. Leave to Amend
The Trustee next argues the trial court abused its discretion by denying leave to
amend. As plaintiff, the Trustee “has the burden of proving that an amendment would
cure the defect.” (Schifando, supra, 31 Cal.4th at p. 1081.) We conclude she has not met
that burden.
The Trustee argues the complaint could be amended to allege that the Company’s
governing documents provide for the automatic removal of its manager for acting
adversely to the Company. She contends these facts could avoid application of the in pari
delicto defense because “if the wrongdoer, even a wrongdoer in control, is subject to
removal under the entity’s governing documents, the sole actor rule is inapplicable.”
The sole case she cites for this proposition is Cobalt Multifamily Investors I, LLC
v. Shapiro (S.D.N.Y., July 15, 2009, 06 CIV. 6468) 2009 U.S. Dist. LEXIS 60481(Cobalt), reconsideration granted on another point in Cobalt Multifamily Investors I, LLC
v. Shapiro (S.D.N.Y 2012) 857 F.Supp.2d 419.) Cobalt held where “a corporation has
owners or managers who were innocent of the fraud and could have stopped the fraud if
they had been aware of the it, the sole actor rule does not apply.” (Id. at p. *7.) In that
case, “the corporation is the principal, with 300 allegedly innocent shareholders, and the
agents are the allegedly fraudulent managers.” (Id. at p. *9.) The corporation’s
“managers did not have complete control over the corporation, because the shareholders
had the authority to remove the managers.” (Id. at p. *10.) Because “[t]he shareholders
had the authority to stop the fraud,” the sole actor exception did not apply. (Ibid.) Cobalt
distinguished cases in which “there existed no persons or entities that could have stopped
the fraud.” (Ibid.) Another case cited by the Trustee similarly notes “the ‘sole actor’
exception should not apply if ‘at least one decision-maker could have stopped the fraud’
[citation] or ‘where it has not been established that all relevant decisionmakers for the
9
corporation were engaged in the fraud.’ ” (In re California TD Investments LLC (Bankr.
C.D. Cal. 2013) 489 B.R. 124, 132.)
Under these authorities, an allegation that a person or entity could have stopped
the fraud can bar application of the sole actor exception. The Trustee has not claimed
such an allegation could be pled in this case. It is not sufficient to allege that, had there
been such a person or entity, the Managers could have been removed pursuant to the
Company’s governing documents. The Trustee has failed to demonstrate she can allege
facts sufficient to avoid application of the in pari delicto defense.6
DISPOSITION
The judgment is affirmed. Defendant shall recover his costs on appeal.
6
Because we reject all of the Trustee’s arguments on appeal, we need not decide
Defendant’s alternative arguments that collateral estoppel bars the Trustee’s arguments
and that the appeal should be dismissed. We accordingly deny as irrelevant Defendant’s
May 11, 2015 request for judicial notice of court records relating to these issues and the
Trustee’s June 1, 2015 request for judicial notice of additional such records. We grant
Defendant’s June 25, 2015 request for judicial notice of four unpublished federal court
decisions. (See Boghos v. Certain Underwriters at Lloyd’s of London (2005) 36 Cal.4th
495, 502, fn. 3 [granting request for judicial notice of unpublished federal decisions
pursuant to Evid. Code, § 451, subd. (a)].)
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SIMONS, J.
We concur.
JONES, P.J.
NEEDHAM, J.
11
Filed 2/5/16
CERTIFIED FOR PARTIAL PUBLICATION*
IN THE COURT OF APPEAL OF THE STATE OF CALIFORNIA
FIRST APPELLATE DISTRICT
DIVISION FIVE
SUSAN L. UECKER, A143068
Plaintiff and Appellant,
(Alameda County
v.
Super. Ct. No. RG13694649)
DENNIS ZENTIL,
Defendant and Respondent. ORDER MODIFYING OPINION
AND CERTIFYING OPINION
FOR PARTIAL PUBLICATION
[NO CHANGE IN JUDGMENT]
THE COURT:
*
Pursuant to California Rules of Court, rules 8.1105(b) and 8.1110, this opinion is
certified for publication with the exception of part III.
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It is ordered that the published portion of the opinion filed herein on January 15,
2016, be modified as follows:
(1) Replace the first paragraph on page 1 with the following paragraph:
“Bankruptcy trustee Susan L. Uecker (Trustee) sued a former attorney of the debtor
company, claiming he helped the managers of the debtor company perpetrate a fraud.
The trial court granted the attorney’s demurrer without leave to amend, finding the
Trustee’s claims barred by the in pari delicto doctrine. Peregrine Funding, Inc. v.
Sheppard Mullin Richter & Hampton LLP (2005) 133 Cal.App.4th 658 (Peregrine
Funding) held that if this doctrine would have barred claims if asserted by a company
prior to bankruptcy, the doctrine also bars them when asserted by the bankruptcy trustee
suing on behalf of the company’s bankruptcy estate. The Trustee urges us to reject
Peregrine Funding and argues that, like a receiver, a bankruptcy trustee is not barred by
equitable defenses that could have been raised against the debtor. The Trustee further
contends that Civil Code section 2306 assists her efforts to defeat the in pari delicto
defense. In the published portion of the opinion, we conclude Peregrine Funding was
correctly decided and reject the Trustee’s Civil Code section 2306 argument. In the
unpublished portion, we affirm the trial court’s denial of the Trustee’s request for leave to
amend. Having rejected each of the Trustee’s arguments, we affirm.”
(2) Replace the second sentence of the second full paragraph on page 2 with the
following: “The Trustee was designated the liquidating bankruptcy trustee and granted
the authority to pursue claims on behalf of the Company’s bankruptcy trust.”
(3) Replace the first sentence of the second full paragraph on page 3 with the following:
“Peregrine Funding, supra, rejected a similar argument.”
(4) Replace the citation at the end of the second full paragraph on page 3 with the
following: “(Peregrine Funding, supra, 133 Cal.App.4th at p. 680.)”
13
(5) Replace the sentence before the citation at the end of the partial paragraph at the top
of page 6 with the following: “Accordingly, the legislative history relied on by the
Trustee does not persuade us to reject the numerous and consistent federal decisions
construing 11 U.S.C. § 541.”
There is no change in the judgment.
Dated: , P.J.
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Superior Court of Alameda County, No. RG13694649, George Hernandez, Judge.
Jeffer Mangels Butler & Mitchell, Bennett G. Young, Erin E. Daly, for Plaintiff and
Appellant.
LeClairRyan, Charles H. Horn, Chistiane C. Kinney, Robert G Harrison, for Defendant
and Respondent.
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