Fresno Lawyer – Randolf Krbechek

Judge Richard A. Posner of the Seventh Circuit Court of Appeals contributed his thoughts at a symposium on the rationale for liability for breach of contract.  One of his points is a sound analytic distinction between tort liability and contract liability, a concept which is sadly muddled in California cases.

Writes Judge Posner, “Here is a simplified version.  A and B make a written contract.  Later A sues B claiming that during the negotiations B deliberately misrepresented the benefits that A would derive from the contract.  But A does not sue for breach of contract.  He can’t; the parol evidence rule would bar a claim that promises made during the negotiations but not repeated in the contract should be deemed contractually binding.”

That’s clear legal thinking.  There is no claim for breach of contract because the law of evidence excludes evidence of terms that contradict the terms of the contract.

Judge Posner continues.  “So A sues B in tort, charging fraud.  The parol evidence rule is not a rule of tort law.”

Right again.  Parol evidence knocks out the contract claim, but not the tort claim.

“B has a defense [to the fraud claim]: the written contract had included a clause stating that neither party was relying on any representations not embodied in the written contract.”

According to Judge Posner, “The ‘no reliance’ clause scotches A’s fraud suit because you cannot obtain damages for fraud unless you relied on the fraudulent representations, and A has disclaimed such reliance.  So although B is assumed to have acted wrongfully, A has no remedy either in contract or in tort.”

Well, maybe not so fast.  Isn’t the whole point of the fraud claim that the wrongdoer deceived the victim?  Conceptually, I don’t see how the bad guy gets to hide behind his contract, when the injured part was induced, by false promises, to enter into the contract.  The false promises should negate the terms of the contract, at least insofar as such terms act to exculpate the bad guy.

Now, here’s an even deeper way to look at the issue, which takes us into philosophical terms.  Judge Posner posits that, “There is, however, a limited duty of good faith at the contract-formation stage as well.”

Now we’re getting to the point.  Are we focusing on a wrong arising out of the contract, or a wrong that preceded the contract?

“It is one thing to say that you can exploit your superior knowledge of the market for if you cannot, you will not be able to recoup the investment you made in obtaining that knowledge or that you are not required to spend money bailing out a contract partner who has gotten into trouble.  It is another thing to say that you can take deliberate advantage of an oversight by your contract partner concerning his rights under the contract.”

This runs straight to a utilitarian moral theory, which is not easy to square with cold-blooded contract analysis.  Yet Judge Posner continues on.  “Such taking advantage is not the exploitation of superior knowledge or the avoidance of unbargained-for expense . . . Like theft, it has no social product, and also like theft it induces costly defensive expenditures, in the form of overelaborate disclaimers or investigations into the trustworthiness of a prospective contract partner, just as the prospect of theft induces expenditures on locks.”

Richard A. Posner, “Let Us Never Blame a Contract Breaker,” in Michigan Law Review, Vol. 107, No. 8, page 1349

Prof. Deborah A. DeMott from Duke University School of Law has written a thoughtful article in which she differentiates among the fiduciary duties owed by agents.  Prof. Demott begins as follows:

“Legal theorists differ on how best to characterize fiduciary duty; to some, it’s best understood as a consequence of contract – as a set of default terms to which parties would agree, had they the benefit of unlimited resources.”

[On this topic, see my prior article regarding Le vs. Pham, in which I posit that the court got it wrong by creating additional duties where the contract already established the relationship between the parties.]

Prof. DeMott continues.  “It’s conventional to distinguish among an agent’s duties.  Restatement (Third) of Agency uses the terminology of duties of performance and duties of loyalty.

Hooray – someone who breaks down the different duties owed by a fiduciary.  As to agents, she says it’s a duty of loyalty and a duty of performance.

The duty of performance is seemingly self-evident.  “An agent’s duties of performance include the duty:

• To act only as authorized by the principal;
• To fulfill any obligations to the principal defined by contract;
• To act with the competence, care, and diligence normally exercised by agents in similar circumstances; and
• To use reasonable effort to provide the principal with facts material to the agent’s duties to the principal.

“An agent’s duties of performance are often defined by agreement between principal and agent.”

The obligations arising the duty of loyalty are more subtle.  “An agent’s duties of loyalty stem from the agent’s basic obligation to act loyally for the principal’s benefit in matters connected with the agency relationship.  An agent’s more specific duties of loyalty include:

• A duty not to acquire a material benefit from a third party in connection with transactions or other actions taken on behalf of the principal or otherwise through the agent’s use of position;
• A duty not to deal with the principal as or on behalf of an adverse party;
• A duty not to compete with the principal or assist the principal’s competitors during the duration of the agency relationship; and
• A duty not to use property of the principal, and not to use or communicate confidential information of the principal, for the agent’s own purposes or those of a third party.”

The author then tracks the effects of the legal analysis to the remedies available to the principal.  Explains Prof. DeMott, “The remedies available to a principal do not map neatly onto the contours of either contract law or tort law principles and remedies.

“For example, remedies that have the consequence of stripping profit or benefit from the agent do not necessarily approximate the amount of harm that a principal either has suffered or would be able to prove or the benefit that the principal expected to realize through the transaction conducted by the agent.”

From “DISLOYAL AGENTS” by Deborah A. DeMott, Professor of Law, Duke University School of Law.  Prof. Demott served as the Reporter for the Restatement (Third) of Agency.

Alabama Law Review (2007) Vol. 58:5:1049

The Fourth District Court of Appeal held in Le vs. Pham,  2010 DJDAR 297 (January 6, 2010) “that where the bylaws of a pharmacy corporation provide that one stockholder must give another a right of first refusal on the sale of any stock, it is a breach of fiduciary duty for the selling stockholder to attempt to sell to a third party in violation of the right of first refusal.”

The problem is that the court fails to adequately explain which fiduciary duty was breached, instead conflating breach of contract with breach of fiduciary duty.

To be sure, the Les did wrong by Pham, their fellow shareholder.  “Le and his wife owned 50 percent of the corporate shares of Newland Pharmacy, while Pham owned the other 50 percent.  Corporate bylaws obligated the Les to give Pham written notice of any intent to sell or transfer.  The bylaws also gave Pham a right of first refusal on any sale based on that notice of intent.”

The Les wanted to sell their stock and “gave written notice to Pham (by certified mail) of their intent to sell their 50 percent share to Paul and Kimngang Hoang for a total of $70,000, cash at transfer.”  The Phams replied by stating that they needed 30 days to review the proposal.

The Les did not wait but instead sold their stock, however, neither at the price nor on the terms set forth in the notice.  Instead, “the Les sold their shares [for]$24,000, considerably less than the $70,000 offered to Pham.  Nor was it a cash sale.  The Hoangs [buyers] were allowed to make installment payments on the $24,000.”

OK.  Breach of contract through and through.  Further, the sale caused problems with the Board of Pharmacy, as “Hoang [the buyer] did not file a change of ownership form with the California Board of Pharmacy, an omission which prompted a ‘cease and desist’ order from the board that closed the pharmacy down for about three months beginning in March 2007.”

Not content with this set of problems, “the seller and the buyer sued the other shareholder [Pham], contending that the transfer was valid in accordance with Newland Pharmacy’s bylaws.”

Pham prevailed on the complaint at trial.  “The court, in its statement of decision, ruled that the Les’ attempted transfer of shares to the Hoangs was null and void because it did not comply with the corporate bylaws.  It was obvious, after all, that the Les had attempted to sell the shares to the Hoangs for a better price ($24,000 as distinct from $70,000) and on better terms (installments rather than cash) than had been offered Pham in the notice of intent to sell.”

Pham, the other shareholder, countered with cross-complaint for breach of fiduciary duty, which is where it gets interesting.  According to the court, “as a matter of common law, we divine a public policy in favor of the strict enforcement of the corporate bylaws of pharmacy corporations restricting transfers of shares in such corporations. . . The statutes and regulations just mentioned reflect a public policy, ala Snyder’s Drug Stores, seeking a reasonably snug fit between the ownership of pharmacies and their control by licensed pharmacists.”

“Having ascertained a public policy in favor of control of pharmacies by licensed pharmacists, we apply California corporate common law involving protection of vulnerable stockholders from other stockholders who have the power, by the choice of to whom shares will be sold, to affect the actual conduct of the corporation.”

Why take this step?  The contract already protects the remaining shareholder.  There is no need to search for new law.

Here’s where the court takes a leap.  “The common law has involved fiduciary duties imposed on majority or controlling shareholders.  In this case, however, it is not the quantum of shares owned by the Les that made Pham as vulnerable as any minority shareholder in a close corporation, but the fact that, by circumventing the bylaws, the Les could adversely affect, as Justice Traynor put it in Ahmanson, the ‘proper conduct of the corporation’s interest.’”

OK, so which duty was violated?  The duty not to take advantage of a corporate opportunity?  The duty of loyalty? (Remember that “the primary duty of the fiduciary is to receive the res and manage it for the benefit of the cestui.  This is the fiduciary’s duty of management.”) The court does not say, instead painting broadly (and carelessly) with a generic “fiduciary duty.”

Thus, the court reasoned that, “it is clear that a fiduciary duty was violated by that attempted transfer, based on mutual vulnerability in which the stockholders found themselves.  By unilaterally [ ] selling to the Hoangs and effectively excluding Pham from the process, the Les jeopardized the ‘proper conduct’ of the business and unilaterally deprived Pham of an important right given her by the corporate bylaws:  the right to control who were her ‘partners’ in a regulated professional corporation.”

That’s sloppy legal reasoning.  Fiduciary duties are gap fillers, applied to regulate dealings between persons in a close relationship.  The sellers breached the contract, and the remedies for breach of contract were adequate to make the other shareholder whole.  The court did not need to reach for a “fiduciary duty” based on a “duty of good faith and fairness.”  This result leads only to ambiguity and imprecise analysis.

Le vs. Pham, 2010 DJDAR 297 (January 6, 2010)

I attended the annual Consumer Electronics Show for the 6th time in the past seven years.  Here are my observations.

Attendance was steady.  Gambling is up.  There were more people at the tables than last year. That’s two good signs for the economy.

But, the Fortune 500 stayed away, which is a bad sign for the economy.  Here are some of the prior year’s attendees who were noticeably absent:

• Benq (made a big splash a few years back, now vanished)
• Hewlett Packard (are you kidding me?  No presence whatsoever on the floor?  No one could drive from Palo Alto to Las Vegas with a few printers?)
• Xerox
• Dell (This ticks me off.  Dell has no presence on the floor, but snags 11 “innovation” awards?  Ditto for Nikon.  Not at CES, but also wins an award?  Smells like some kind of “pay for play,” and certainly cheapens the CEA Innovation Awards).
• Philips (used to have a huge display on the floor. Here’s all I could find in 2010).

How the mighty have fallen. Sad days for Philips

Now, the good guys (i.e., Corporate America that showed up at CES and plugged away at restoring the economy):

• Microsoft
• Sharp
• Samsung
• Panasonic
• Sony
• Casio

The foregoing were all at 2010 CES and marketing at full speed.  Bravo.

There were no visible empty spaces on the convention floor, unlike 2009.  However, some spaces had increased in size.

Embarrassment Award:  Lost-in-space Polaroid names Lady Gaga as its “artistic director.”  Come on.  You guys couldn’t find one person with a credible background in photography?

Very Cool Product.  The Toshiba Cell LCD television has a lovely picture.  Available now in Japan, coming to the U.S. in the second half of 2010.   Learned that the extra-thin LCDs achieve their weight loss by putting all the lights at the bottom, then shooting up to fill the screen.  You certainly make some sacrifices for the Twiggy look.

3-D Television.  All the rage in 2010.  What is this?  1953 revisited?

Reel-to-Reel Tape Decks.  Ditto.  Saw several at the high end stereo show.  Give me a break.  Just because some audio geeks (oops – I meant, “audiophiles”) still listen to vinyl is no excuse to attempt to reintroduce reel-to-reel decks.

Digital Music.  The stereo world is catching on that we listen to electronic files, but they are about three years behind, as the manufacturers finally embrace  Ipod connectivity.  (Even Sony has an Ipod slot on some products.  Tall about being ubiquitous.)

Dudes, look forward.  I want wireless connectivity from my amp to my PC.  That’s the future, not an Ipod interface.

Cool computer stuff.  Big (i.e., two terrabyte) solid state storage units.  USB 3.0.

Class D amplifier.  The little amps from International Rectifier smoked some systems costing thousands of dollars more.  Quite impressive, even if I’m not a convert to Class D.

Gorgeous Home Projector.  If you have the dough, get the $15,000 projector from Meridian.  It will knock your socks off.

No Way Award.  A start-up speaker company from Novato, CA rolls out its first speakers – at $125K for a pair?  A dude from Sweden showing a $90K pair of monoblock amplifiers as his only product?  (At least Lars named the amp after himself.)

I read a recent article in the Consumer Finance Law Quarterly Report about bankruptcy filings after the 2005 reform act.  The author (Jon Ann H. Giblin) compared 2006 filings with 2007 filings (in her table).

I asked myself – Which states have more filings, on a percentage basis?  (This, of course, begs the question of why, which is another matter.)  I used the U.S. Census Bureau information and combined it with the 2007 filing data to show filings as a percentage of population.

Tennessee and Alabama top the list.  Lots of pain in Michigan, Indiana, and Ohio.  Odd to note the substantial difference between Georgia and S. Carolina. 

Update – My friend, Nashville bankruptcy attorney Kevin Key, points out that Suth Carolina does not permit wage garnishment, which helps account for the low bankruptcy filings in that state.   The discharge is not needed if state law already prevents creditors from enforcing their debts.