Opinion
NOT TO BE PUBLISHED
APPEAL from a judgment of the Superior Court of Los Angeles County No. BC352310, Andrea K. Richey, Judge.
Pick & Boydston and Brian D. Boydston for Plaintiffs and Appellants.
Arnold & Porter, Brian K. Condon and James D. Layden for Defendants and Respondents.
ROTHSCHILD, J.
SUMMARY
Two investors contributed capital to a business venture that failed. The current appeal arises from the investors’ action to recover their investment and profits allegedly lost from those whom the investors claim are responsible for the collapse of the business. The trial court entered summary judgment in favor of the defendants. We affirm in part.
FACTUAL AND PROCEDURAL BACKGROUND
The formation of Sunvest LLC
Sometime around March 2000, Terrence Swain and David Smith joined forces to launch Sunvest LLC. Sunvest’s business plan envisioned the acquisition of sheet metal fabrication businesses to service select industries. To that end, Sunvest planned to become an “outsource manufacturer,” primarily for companies in the semiconductor and telecommunications industries. To accomplish its stated goals, Sunvest planned to acquire regional manufacturing companies and consolidate their resources, concentrating manufacturing operations close to targeted industries.
Swain and Smith negotiated letters of intent to purchase two sheet metal manufacturers, Advanced Fabrication Technologies (AFT) and Dyna-Fab, subject to Sunvest’s ability to obtain financing for the transactions. After obtaining those letters of intent, Swain and Smith approached American Capital Strategies, Ltd. (ACS) to obtain financing.
On December 29, 2000, ACS, Swain and Smith executed an operating agreement to form Sunvest Industries LLC, a Delaware limited liability company (Sunvest). Under the terms of the operating agreement, ACS contributed $1 million to Sunvest and lent $11 million to Sunvest for the purchase of Dyna-Fab and AFT. Swain and Smith each invested $250,000 in Sunvest. ACS became Sunvest’s majority equity owner (73 percent), and Swain and Smith collectively became Sunvest’s minority equity owner (27 percent).
In conjunction with its formation, Sunvest executed a consulting and management agreement with ACS, and employment agreements with Swain and Smith, by which each would act as Sunvest’s Chief Executive Officer, and President and Chief Financial Officer, respectively.
The business declines
During its first 18 months of operation, Sunvest’s financial condition declined rapidly as a result of downturns in the telecommunications and technology industries, a loss of customers, and declining orders and sales. Sunvest’s earnings dropped from $3.9 million in 2000, to $1.4 million in 2001, fell to a negative $694,000 in 2002, and its sales continued to decline. During this period, Sunvest became unable to make principal and interest payments on its primary debt to ACS and was in violation of its loan covenants with its outside lender (LaSalle Bank). In May 2002, ACS conducted an audit of Sunvest’s operations. The audit revealed numerous operational and accounting problems, including a failure to pay payroll taxes of $121,000.
In July 2002, ACS appointed Alan Buffey to Sunvest’s board of managers. Almost immediately thereafter, Swain resigned as CEO. He remained on the board.
Meanwhile, between April 2002 and September 2003, ACS made $2 million in additional cash infusions in Sunvest, to enable it to meet cash flow needs. By mid-2003, LaSalle Bank had frozen the company’s line of credit, and ACS was considering exiting its investment.
Changes in governance and the entity’s form
At a meeting on May 13, 2003, Sunvest’s board terminated Smith as President and CFO. At the same meeting, after the “neutral” fifth member of the board resigned and an ACS employee was appointed in his stead, ACS exercised its right as the holder of a majority interest to merge Sunvest LLC into Sunvest Inc. The merger did not affect the relative equity interests of ACS, Swain or Smith – each member’s interests were converted “one for one” from the LLC to the corporation.
The operating agreement provides that a member holding a majority interest may, by written consent, merge or change the company’s legal form. Swain and Smith dissented from the merger vote.
Sunvest Inc. continued to operate under new management in 2003. At some point in late 2003 or early 2004, Sunvest sold AFT and foreclosed on and liquidated Dyna-Fab’s assets. Proceeds from those transactions were used to retire the LaSalle Bank debt and the small remainder was applied to pay down the principal on the ACS loans. ACS eventually wrote off its $14 million investment in Sunvest. Swain’s and Smith’s equity interests in Sunvest were also rendered valueless.
Legal proceedings
In September 2003, Swain and Smith sued ACS in Connecticut alleging claims similar to those made here. That same month, Smith initiated arbitration proceedings against both Sunvest and ACS for alleged breaches of his employment agreement. Smith later abandoned that arbitration and, in January 2004, amended the Connecticut lawsuit to add a claim for breach of his employment agreement. ACS moved successfully to dismiss the Connecticut case for lack of personal jurisdiction; in October 2004, Swain and Smith voluntarily dismissed that action.
As minority shareholders, Swain and Smith filed this derivative action on May 12, 2006. Generally speaking, Swain and Smith alleged respondents breached the operating and consulting agreements by improperly installing Buffey as a member of the board and delegating unwarranted power to him, orchestrating an improper merger of Sunvest LLC into Sunvest Inc., without providing proper notice or full information, failing to conduct regular board meetings or quarterly valuations or to complete annual audits for 2001 and 2002, and squandering various business opportunities, largely as a result of Buffey’s unchecked, ill-advised and unauthorized managerial decisions. Swain and Smith contend that respondents’ actions (or failure to act) destroyed Sunvest, ultimately denying them profits that could have been generated by AFT, Dyna-Fab and potential acquisitions.
Following a series of demurrers and amended pleadings, four causes of action remained at issue. The first three derivative claims for breach of contract against ACS (for breach of the operating and consulting agreements), breach of the implied covenant of good faith and fair dealing against ACS, and breach of fiduciary duty against ACS, and respondents Jeri Harman and Alan Buffey (two members of Sunvest’s board of managers). The fourth cause of action was alleged solely by Smith against Sunvest for breach of his employment agreement.
Two other causes of action -- seeking an accounting and a valuation of shares -- were abandoned later and are not at issue here.
Summary judgment
In due course, respondents moved for summary judgment, premised on largely undisputed evidence contained in Swain’s and Smith’s discovery responses, depositions, contractual provisions, documents produced in discovery and expert testimony. Respondents argued, among other things, that they were entitled to summary adjudication of the first three causes of action because Delaware’s three-year statute of limitations barred each claim. As for the cause of action for breach of Smith’s employment contract, Sunvest sought judgment on the ground the claim was barred by Smith’s failure to pursue binding arbitration, as required by that agreement.
Swain and Smith opposed the motion. They argued that their first three claims were timely either because the operating and consulting agreements were “continuous contracts,” or because respondents’ most egregious conduct occurred within three years of the filing of the action. Smith also argued Sunvest had waived its right to arbitrate his employment claim by failing to invoke its right to do so within a reasonable time to his detriment.
The trial court granted the motion after sustaining most of ACS’s evidentiary objections. Judgment was entered in favor of ACS. This timely appeal followed.
DISCUSSION
1. Standard of Review
We review the record and the trial court’s ruling on summary judgment de novo. (Kahn v. East Side Union High School Dist. (2003) 31 Cal.4th 990, 1003.)
Ordinarily, the trial court’s evidentiary rulings are reviewed for abuse of discretion. (Carnes v. Superior Court (2005) 126 Cal.App.4th 688, 694.) Here, we need not consider any stricken evidence, as Swain and Smith do not challenge any evidentiary ruling.
2. Statute of limitations
The parties agree that Delaware law governs the claims at issue. Swain and Smith, however, contend the trial court erred in concluding that the first, second and third causes of action for breach of contract, breach of the implied covenant and breach of fiduciary duty accrued prior to May 13, 2003, when Sunvest LLC was merged into Sunvest Inc. They argue the operating and consulting agreements were “continuous” contracts, for which the claims did not accrue until the agreements were terminated by merger, or that, even if the agreements could be deemed “divisible” or “severable” contracts, respondents’ most egregious conduct – the ultimate destruction and sale of assets of Sunvest LLC – occurred within three years of the filing of this action. We conclude otherwise.
The operating agreement provides it “shall be construed in accordance with and governed by the laws of the State of Delaware, without regard to the principles of conflicts of laws.” This choice of law provision is enforceable. (Hambrecht & Quist Venture Partners v. American Medical Internat., Inc. (1995) 38 Cal.App.4th 1532, 1540-1542.)
“Under Delaware law, a three-year statute of limitations applies to claims for breach of contract or breach of fiduciary duty.” (Fike v. Ruger (Del. Ch. 1999) 754 A.2d 254, 260; 10 Del.C. § 8106 [an action based on a promise must be brought within three years from date of accrual of the claim].) Claims for breach of the implied covenant are also subject to the three-year limitations period (Schuster v. Derocili (Del. Supr. 2001) 775 A.2d 1029, 1034, superseded by statute on other grounds, 19 Del.C. § 712(b)), as are shareholder derivative actions in which damages are sought. (Halpern v. Barran (Del. Ch. 1973) 313 A.2d 139, 141; Bokat v. Getty Oil Co. (Del. Supr. 1970) 262 A.2d 246, 250-251, overruled on other grounds, by Tooley v. Donaldson, Lufkin & Jenrette (Del. 2004) 845 A.2d 1031, 1038-39.)
There is no legal support for Swain’s and Smith’s argument that the operating and consulting agreements were continuous contracts for which no claim accrued until the agreements were terminated by merger. Swain and Smith cite Kaplan v. Jackson (Del. Supr. 1994) 1994 WL 45429, and Equitable Trust Co. v. Delaware Trust Co. (Del. Ch. 1947) 54 A.2d 733, for the proposition that the court must determine whether a contract is divisible or continuous by analyzing the parties’ intent, based on the terms and subject matter of the contract considered in light of the facts and circumstances surrounding the transaction. (Kaplan v. Jackson, supra,994 WL 45429, *3; Equitable Trust Co. v. Delaware Trust Co., supra,54 A.2d 733, 738, 30 Del. Ch. at p. 128.) But, in Kaplan, in which three independent breaches of a construction contract were alleged, the court was unable to analyze the nature of the contract or when breach accrued, because neither party had submitted a copy of the contract allegedly breached. (Kaplan v. Jackson, supra,994 WL 45429, *3.) Equitable Trust Co. v. Delaware Trust Co., supra, 54 A.2d 733, on which Swain and Smith also rely, did not address the statute of limitations. It involved only a determination as to whether a contract was entire or divisible, and thus enforceable against one party even if invalid as against another. (Id. at p. 738.) Swain’s and Smith’s reliance on a trial court’s order in Bank of America N.A. v. Troth (Del. C.P. Jan. 18, 2007) No. 2005-10-400, is also misplaced. Citing Kaplan v. Jackson, supra,1994 WL 45429, for the unremarkable proposition that the three-year Delaware statute of limitations on a continuous contract does not accrue until termination of the entire contract, the court found an action on an unpaid line of credit timely when filed within three years of the date on which the debt became due. (Bank of America N.A. v. Troth, supra,No. 2005-10-400.) None of these cases supports the theory that, where, as here, a business entity of indefinite duration is formed, claims of blatant wrongdoing occurring in the course of that entity’s operations do not accrue until the entity is terminated, by merger or otherwise. Such a theory would indefinitely and unacceptably extend limitations periods.
Under Delaware law, Swain’s and Smith’s claims accrued under 10 Del. C. § 8106 “at the moment of the wrongful act.” (Fike v. Ruger, supra, 754 A.2d at p. 260; In re Marvel Entertainment Group, Inc. (D. Del. 2002) 273 B.R. 58, 74.) Fike is instructive. There, as here, the parties engaged in a joint venture of indefinite duration. After operating for years, the joint venture sold its property. Two minority investors sued, challenging loan agreements and other actions undertaken more than three years before filing the action. (Fike v. Ruger, supra,754 A.2d at pp. 256-260.) The court held the three-year statute of limitations “accrues at the moment of the wrongful act, even if the plaintiff is ignorant of the wrong,” and dismissed the action. (Id. at p. 260; see also In re Marvel Entertainment Group, supra,273 B.R. at p. 74 [claims accrue “when the specific acts of alleged wrongdoing occurred, . . . not when their effect is felt” [citation omitted].)
Swain and Smith concede “there is no factual dispute as to the timing of the events in question.” With the exception of two events (discussed below), each claim of breach (as well as Swain’s and Smith’s claims against Harman and Buffey), is premised on wrongful conduct in which respondents are alleged to have engaged before April 2003 (and about which Swain and Smith complained to the board in 2002 and April 2003). Specifically, Swain’s and Smith’s claims are based primarily on events revolving around Buffey’s appointment to the Sunvest LLC board in July 2002, his allegedly improper, short-sighted and unauthorized decisions to reduce staff and overhead costs in fall 2002, and the company’s disregard of its business plan and new acquisition opportunities presented to it in October and November 2002. All of this conduct -- which we assume for purposes of argument was wrongful -- occurred more than three years before this action was filed on May 12, 2006; the claims are time-barred.
Swain and Smith argue that their claims are not time-barred because two other wrongful events occurred within three years of the filing of this action: the May 13, 2003, merger of Sunvest LLC into Sunvest Inc., and the sale of Sunvest’s assets. We agree with the trial court. Although these events occurred within the appropriate statutory time frame, Swain and Smith “failed to raise a disputed issue of fact that the two acts . . . constitute actionable wrongdoing.”
First, there is no evidence the merger of Sunvest LLC into Sunvest Inc. was improper. Under the operating agreement, a majority of the members of Sunvest’s board had express authority to merge or change the legal form of the company. By written consent, that merger was effected on May 13, 2003, and it is undisputed that each unit of ownership in Sunvest LLC, was converted one-for-one into an equivalent amount of stock in Sunvest Inc. Swain and Smith complain they were not provided proper notice or materials related to the proposed merger in advance of the meeting, and were not appointed as officers or members of the board of directors of Sunvest Inc., or given the opportunity to participate in that company’s future operations. Assuming these assertions are true, Swain and Smith have presented no evidence that they or Sunvest were financially harmed by the provision of inadequate notice or information, or the loss of their positions as officers or members of the board. The merger vote would have prevailed even if Swain and Smith had received fuller and timely information. Further, Swain had already resigned as CEO in July 2002. To the extent Swain and Smith claim respondents “wrongfully” failed to pursue additional post-merger opportunities, they have failed to demonstrate how a business already incurring large losses was in a position to make additional costly investments, or that those investments, if made by ACS would have been as profitable as Swain and Smith surmise.
Subject to exceptions not relevant here, the operating agreement gave the board authority to remove a member at any time for any reason.
Second, Swain and Smith have presented no evidence that Sunvest’s liquidation of its subsidiaries’ assets was wrongful. The assets of AFT and Dyna-Fab were collateral for ACS’s original acquisition loans to Sunvest. It is undisputed that Sunvest earnings suffered a steady and precipitous decline from $3.9 million in 2000, to negative $694,000 in 2002, and that the company continued to experience significant operational, accounting and tax problems, notwithstanding ACS’s additional $2 million cash infusion between April 2002 and September 2003. As a result, Sunvest could not make principal and interest payments on its primary debt to ACS, and was in violation of its loan covenants with LaSalle Bank beginning in 2001. After operating under new management for part of 2003, Sunvest determined it was time to terminate its investment, and foreclosed on and liquidated the assets of AFT and Dyna-Fab. Swain and Smith dispute those and other decisions made by Sunvest management, but they have presented no evidence and raised no factual issue that those business decisions were wrongful.
As collateral for its loans to Sunvest, ACS was granted security interests in the assets of Dyna-Fab and AFT, and the right to foreclose on those assets in the event of a default.
The claim of breach of fiduciary duty is time-barred for the same reasons as the claim for breach of contract. (See Fike v. Ruger, supra, 754 A.2d at pp. 259-264 [“Under Delaware law, a three-year statute of limitations applies to claims for breach of contract or breach of fiduciary duty”]; Bokat v. Getty Oil Co., supra, 262 A.2d at pp. 250-251 [shareholders’ claims of management’s wrongdoing are subject to three-year limitations period].)
3. Smith’s employment agreement
The final cause of action is Smith’s claim against Sunvest for breach of his employment agreement. The trial court summarily adjudicated this claim on the ground that Smith failed to pursue binding arbitration. That was incorrect.
Smith does not dispute that his claim of breach of his employment agreement is subject to binding arbitration. To that end, in September 2003, he initiated arbitration proceedings against ACS and Sunvest. But Smith abandoned that proceeding against Sunvest after ACS, which was not a party to his employment agreement, declined to participate. Smith later sued both ACS and Sunvest for breach of the employment agreement, first in Connecticut and, later, here. At the outset of this action, Smith’s attorneys contacted Sunvest to determine whether it wished to resolve the employment claim through arbitration instead of litigation. Sunvest’s attorneys said they would talk the matter over with their client. The subject was not raised again until Sunvest moved for summary judgment, although respondents did amend their answer to add an affirmative defense that Smith failed to exhaust his remedy of arbitration as to the employment claim, the same basis on which Sunvest sought summary judgment.
Smith’s employment agreement provides that “[a]ny controversy or claim arising out of, or relating to, the Agreement or the breach of this Agreement will be settled by arbitration . . . .”
Only the claim against Sunvest is at issue here.
Our Supreme Court has held that, where a defendant raises plaintiff’s failure to arbitrate as a defense to a cause of action, and each issue alleged in the cause of action could be settled in arbitration, summary judgment may be granted, and the matter may be dismissed. (Charles J. Rounds Co. v. Joint Council of Teamsters No. 42 (1971) 4 Cal.3d 888, 894-895 (Rounds).) The circumstances of Rounds differed markedly from those at issue. In Rounds, union defendants (and parties to a collective bargaining agreement) raised arbitration as a defense to an employer’s action, having previously been unsuccessful in several attempts to compel the employer to arbitrate. (Id. at p. 891.) The plaintiff employer never sought arbitration under the agreement, even though it sought relief that was within an arbitrator’s power to award.
The employment agreement is governed by California law.
The conclusion in Rounds that summary judgment could be granted was premised on a situation in which a “plaintiff has not first pursued or attempted to pursue his arbitration remedy . . . .” (Rounds, supra,4 Cal.3d at p. 889, italics added.) That is not what happened here. At the outset, Smith attempted to resolve with Sunvest the issue of whether the parties should resolve the employment claim in litigation or by arbitration. Sunvest ignored that effort, and proceeded with discovery and litigation. It may not now take unfair advantage of its resistance to Smith’s good faith effort to cooperatively resolve this preliminary issue and, if necessary, adjudicate his employment claim through arbitration without the need for filing a formal motion to compel arbitration.
Smith contends Sunvest has waived its right to arbitration because it failed to timely demand arbitration. He may be correct. First, he must show he suffered prejudice. In California, the question of prejudice suffered as a result of litigation is “critical in waiver determinations.” (Keating v. Superior Court (1982) 31 Cal.3d 584, 605, disapproved on other grounds, Southland Corp. v. Keating (1984) 465 U.S. 1.) A court could find waiver if it concludes Sunvest acted in bad faith or engaged in gamesmanship by refusing to address Smith’s inquiry until it raised the arbitration issue by way of summary judgment, after engaging in discovery and litigating this matter for almost a year. (See St. Agnes Medical Center v. PacifiCare of Calif. (2003) 31 Cal.4th 1187, 1196; Christensen v. Dewor Developments (1983) 33 Cal.3d 778, 784.)
We do not know the full nature or extent of the discovery undertaken by respondents or whether, by virtue of their conduct, Smith suffered sufficient prejudice to affect his ability to arbitrate his claim. The prejudice necessary to support a finding of waiver of arbitration is found when a party has obtained some advantage by resort to the court system, such as adjudication of some aspect of the merits, or access to discovery it could not have undertaken in an arbitration forum. (Groom v. Health Net (2000) 82 Cal.App.4th 1189, 1194-1195.) The burden of proving waiver of the right to compel arbitration is a heavy one. Merely incurring the litigation expenses Smith claims to have incurred is not itself sufficient. Prejudice is typically found only where a party’s conduct has undermined the strong public policy in favor of arbitration, or substantially impaired the other side’s ability to take advantage of the benefits and expediency of arbitration. (St. Agnes Medical Center v. PacifiCare of Calif., supra, 31 Cal.4th at p. 1204; see also Berman v. Health Net (2000) 80 Cal.App.4th 1359, 1363-1364 [There is no single test for waiver, but it may be found where a party seeking arbitration previously has taken steps inconsistent with an intent to arbitrate, unreasonably delayed in seeking arbitration, or acted in bad faith or with willful misconduct].) These factual questions are for the factfinder, and are not before us on this appeal.
DISPOSITION
The judgment in favor of respondents with respect to the causes of action for breach of contract, breach of the covenant of good faith and fair dealing, and breach of fiduciary duty is affirmed. The judgment in favor of respondent Sunvest on Smith’s claim of breach of his employment agreement is reversed. Each party shall bear his, her or its own costs of appeal.
We concur: MALLANO, P. J., NEIDORF, J.
Retired Judge of the Los Angeles Superior Court, assigned by the Chief Justice pursuant to article VI, section 6 of the California Constitution.
Our conclusion on the statute of limitations renders it unnecessary for us to reach the parties’ remaining arguments as to whether summary judgment was properly granted on the issue of Swain’s and Smith’s purported failure to raise a triable issue regarding respondents’ breach of contract, breach of the implied covenant of good faith and fair dealing or breach of fiduciary duty, or as to whether Swain and Smith were able to raise a disputed factual question as to their entitlement to damages.