Opinion
NOT TO BE PUBLISHED IN OFFICIAL REPORTS
APPEAL from a judgment of the Superior Court of San Diego County No. GIC861889-1, Yuri Hofmann, Judge.
BENKE, Acting P. J.
In this case the plaintiff had a security interest in both the intangible and tangible assets of a bar which was no longer operating and in fact had been padlocked by the landlord. Without the plaintiff's consent, the owner of the defunct bar agreed to transfer his right to operate the bar to the defendants. As consideration for the transfer, the defendants paid, on behalf of the owner, $30,000 in delinquent sales taxes and unpaid rent. In the absence of those payments, regulatory authorities and the landlord would not permit the bar to reopen. The defendants made the required payments, made improvements to the bar, reopened it and began operating it. After the defendants successfully operated the bar for a number of months, they finally closed an escrow on their purchase of the bar.
In light of the foregoing circumstances, the record will not support a finding that, before the defendants began operating the bar, the goodwill of the bar had any compensable value. That is to say, before the defendants reopened the bar there was neither any expectation of future patronage nor any historical profit upon which a valuation of good will could be based.
Because the bar had no compensable goodwill at the time the defendants began operating it, the plaintiff could not establish that her security interest in the bar had any greater value than the value of the bar's tangible assets. Nonetheless, the trial court awarded plaintiff $120,000 on her conversion claim against the defendant purchasers of the bar. That amount far exceeded the value of the bar's tangible assets, which in any event the defendants contend they did not convert. Thus we must reverse the judgment with instructions to the trial court that it determine whether the tangible assets were converted and, if they were converted, their value.
FACTUAL SUMMARY
1. Bischoff Sale to Wienold
In 1998 Peter Wienold, his former wife plaintiff Micha Bischoff and her father John Hyon Kim shared ownership of a bar with a Korean country-western theme in Chula Vista known as the Blue Haven Cocktail Lounge. In February 1998 Wienold agreed to purchase Bischoff and Kim's interest in the bar. Wienold paid for those interests in part by giving Bischoff and Kim a $277,500 note secured by the tangible and intangible assets of the bar. In particular, the security agreement signed by Wienold gave Bischoff and Kim a security interest in: "All stock in trade, furnitures, fixtures, equipment, telephone numbers, leasehold improvements, goodwill and all general intangibles including business, trade name, and all additions, replacements, attachments and accessions in which payor . . . hereafter has an interest and which arise out of or relate to the business known as BLUE HAVEN COCKTAIL BAR and located at 618 E Street, Suite H, Chula Vista, CA 91910." The note required monthly payments of $3,515.25 a month for 10 years and provided for interest at a rate of 9 percent per annum during the last nine years of the term note.
After making some partial payments on the note, Wienold stopped paying altogether. In February 1999 Bischoff and Kim sued Wienold on the note, and on November 28, 2001, Wienhold stipulated to a judgment in the amount of $388,400. The stipulated judgment increased the amount of the monthly payments required of Wienold and provided that in the event Wienold failed to make the required payments, Bischoff and Kim could have the judgment entered ex parte. According to Bischoff, Wienold only made sporadic payments in varying amounts between December 7, 2001, and February 24, 2004.
2. Bar Closed
Wienold was not successful in operating the bar. Wienold fell behind in making rental payments due under the terms of his lease, as well as in paying sales taxes. Because of the sales tax delinquencies, the Department of Alcoholic Beverage Control (the ABC) suspended the bar's liquor license, and because of Wienold's failure to pay rent, the landlord terminated the lease and evicted Wienold from the bar.
Defendant and appellant Larry Carter was a patron of the bar and knew Wienold. At some point in March 2004, Carter discovered the bar was closed. According to Carter, when he went to the bar there was a lock and chain on it, yellow tape and notices posted by both the ABC and the landlord. Carter contacted the landlord who told Carter that he had evicted Wienold and that the liquor license was suspended. The landlord advised Carter that he was approached by other parties with respect to reopening the bar. The landlord told Carter that Carter could reinstate Wienold's tenancy by paying Wienold's back rent and the taxes Wienold owed.
Carter, his fiance Elana Izzett, Gary Owens, and his wife Claudette Owens decided they wanted to operate the bar. To that end they obtained Wienold's agreement that he would transfer his interest in the bar to them if they paid the back rent and taxes due. Of some significance, Wienold also made them aware of his outstanding obligation to Bischoff and Kim. In an effort to obtain Bischoff and Kim's agreement to the transfer, on March 22, 2004, Carter and the Owenses contacted Bischoff's lawyer and offered to give Bischoff and Kim a new note for $120,000 with interest at 7 percent per annum and payable in monthly installments of $1,528.57. In response to Carter and the Owenses' proposal, Bischoff's lawyer prepared documentation which reflected the proposal. However, there is no evidence in the record Carter or the Owenses ever executed the documentation prepared by Bischoff's lawyer.
Very shortly after making their proposal to Bischoff and Kim, Carter, Izzett and the Owenses formed a corporation, LCG Blue, Inc. (LCG Blue). Carter made the $30,000 payments required by the landlord and the ABC in order to reinstate both the lease and the liquor license and reentered the premises. They found there was no liquor in the bar, the bar needed plumbing repairs, new carpet, new paint and new fixtures. These improvements cost approximately $18,000. The defendants reopened the bar on April 9, 2004.
Carter, Izzett and the Owenses also opened an escrow by which Wienold would formally transfer his interest in the bar, including the liquor license and lease, to LCG Blue. That escrow closed in April 2005. Between the time Carter and his co-owners began operating the bar in April 2004 and the close of escrow in April 2005, they made it a successful business.
Bischoff, who was in Korea at the time Carter, Izzett and the Owenses began operating the bar, returned to the San Diego area in early 2005 and asked when she would receive payment for her interest in the bar. No payment was forthcoming and she filed a complaint against Wienold, LCG Blue, Carter, Izzett and the Owenses. As against Wienold, she alleged his failure to pay under the original note. Wienold defaulted and the trial court entered a judgment in her favor in the amount of $475,000. As against LCG Blue, Carter, Izzett and the Owenses, she alleged claims for conversion and for claim and delivery. In particular, she alleged the new owners converted property which was subject to her security interest.
Bischoff's claims were heard by the trial court without a jury. The trial court rejected the defendants' argument Bischoff gave up her security interest when she entered into the stipulated judgment with Wienold. In rendering its decision the trial court made the following statement with respect to the circumstances which existed at the time the defendants began operating the bar: "The court finds that in early 2004, namely March 2004, Larry Carter, Gary Owens, Claudette Owens, were involved in negotiations with Weinhold (sic) to purchase the Blue Haven Cocktail Bar. The Court finds that these individuals had actual knowledge of plaintiff's security interest. They offered to pay the plaintiff $120,000 for the business.
"Within days, they formed a corporation, that occurred on March 26, 2004. It appears to the Court that the motivation for that was to shield themselves from personal liability in connection with the purchase.
"These defendants began operating the business soon thereafter, along with some involvement with Mr. Weinhold (sic). It's unclear to this Court as to what exactly Mr. Weinhold's involvement was until the close of escrow, which occurred on March 8, 2005.
"It appears that Mr. Larry Carter paid [$]12,744.37 to the landlord to revive the Weinhold (sic) lease. In so doing, Larry Carter, Gary Owens, Claudette Owens became assignees of the lease. Larry Carter paid $17,758.79 to the State Board of Equalization around the date of the formation of the corporation and their commencement of operating the business. And then also before the close of escrow in 2005, Larry Carter apparently also made various other payments to the ABC and also to the Board of Equalization, the State Board of Equalization.
"The defendants have been running the business since March or April of 2004. Plaintiff has received nothing for her interest in that business."
Apparently based on the defendants' March 2004 offer to give Bischoff a $120,000 note for her interest in the bar, the trial court determined Bischoff's secured interest was worth $120,000 and the defendants converted that amount when they purchased the bar from Wienold without compensating her. Judgment for a total of $140,665.68, which included interest on the $120,000 in damages, was entered in Bischoff's favor and against both LCG Blue and the individual defendants.
The defendants filed a timely notice of appeal.
DISCUSSION
I
Among other arguments, defendants contend that by entering into the stipulated judgment with Wienold, Bischoff entered into a novation and thereby extinguished her security interest in the bar's assets. The trial court found no novation and its determination is fully supported by the record.
"Novation is a contractual doctrine. In general the parties to a contract are free to determine for themselves their respective rights and liabilities so long as the purposes and effects of their agreement are lawful. [Citation.] The parties to an existing contract may, through mutual consent, modify or rescind their agreement. [Citation.] A novation is the substitution of a new obligation for an existing one. [Citation.] Essential to a novation is that it 'clearly appear' that the parties intended to extinguish rather than merely modify the original agreement. [Citations.] The burden of proof is on the party asserting that a novation has been consummated. [Citation.]" (Howard v. County of Amador (1990) 220 Cal.App.3d 962, 977.) As Bischoff points out: "The general rule is that the taking of a new note and mortgage or deed of trust as a renewal of, or substitution for, a prior note and mortgage or deed of trust does not of itself operate as a payment of the debt or as an extinction of the prior lien, in the absence of an agreement that the renewal instruments shall have that effect." (Bowden v. Bank of America (1950) 36 Cal.2d 406, 409-410; see Pacific Nat. Agr. Corp. v. Wilbur (1935) 2 Cal.2d 576, 585.)
Here, nothing in the stipulated judgment expresses any intent Bischoff would give up her security interest in the bar and rely exclusively on her right to enter the judgment against Wienold. This fact fully supports the trial court's determination Bischoff did not intend to rely solely on the judgment when she entered into the stipulated judgment.
II
A. Conversion as a Remedy for Secured Parties
Although not discussed by the parties, our courts have consistently found that third parties who unlawfully take personal property subject to a valid security interest may be held liable to the holder of the security interest for conversion. (See Hartford Financial Corp. v. Burns (1979) 96 Cal.App.3d 591, 605.) Thus when collateral has been unlawfully taken by a third party, a secured party, such as Bischoff, may bring an action for conversion against the third party. (Ibid.) The difficulty we have with the trial court's determination the defendants' are liable for converting $120,000 in property is that the record will not support a finding the defendants converted property with such substantial value. The trial court made no findings as to the value of the bar's tangible property or whether it was converted, and the record will not support a finding the defendants converted any intangible assets subject to Bischoff's security interest.
B. Tangible Assets
The defendants do not dispute Bischoff had a security interest in the furniture, fixtures and inventory of the bar. However, with respect to the furniture and fixtures defendants contend they are not liable for conversion because they have held those items in storage and, at least until the time of trial, Bischoff was free to recover them. According to the defendants, the bar had no inventory at the time they began operating it.
The trial court made no specific findings with respect to the tangible assets, and hence it is not clear from the record whether the trial court accepted the defendants' contention that the tangible assets were not converted. It is, however, clear from the record that the tangible assets could not be valued at $120,000. The only testimony with respect to the value of the tangible assets was offered by the defendants, who opined that the furniture had little, if any, value and that the bar had no inventory.
Because as we explain more fully below, the defendants cannot be held liable for conversion of any of the intangible assets of the bar, on remand the trial court will be required to determine whether the defendants converted the tangible assets and if so, their value.
C. Liquor License and Leasehold
The defendants argue Bischoff had no security interest in the bar's liquor license or Wienold's leasehold interest in the premises. We agree. With respect to the liquor license, Business and Professions Code section 24076 states: "No licensee shall enter into any agreement wherein he pledges the transfer of his license as security for a loan or as security for the fulfillment of any agreement." (See Greve v. Leger, Ltd. (1966) 64 Cal.2d 853, 856-858.) With respect to Wienold's leasehold, Commercial Code section 9109, subdivision (d)(11), expressly takes interests in real estate, including leaseholds, outside the scope of security agreements provided for in division 9 of the code. (See Kavolchyck etc., et al. v. Goldman (Fla. Bkr. 1993) 154 B.R. 793, 797.) The defendants' contentions with respect to the goodwill of the bar are not so easily resolved.
D. Goodwill
Defendants make related contentions that a creditor may not obtain a security interest in the goodwill of a business and that in any event the loss of goodwill will not support a conversion claim. As we explain below, there is no substantial evidence the bar had any goodwill at the time defendants began operating it. Thus we need not and do not resolve defendants' contentions with respect to whether goodwill can be used as security or whether it is the subject of conversion. Nonetheless, we think it useful to explain that were we required to decide the issues, we would likely find both that goodwill can serve as collateral within the meaning of division 9 of the Commercial Code and that an unlawful transfer of goodwill will give rise to tort damages.
1. Goodwill As Collateral
"The 'good will' of a business is the expectation of continued public patronage." (Bus. & Prof. Code, § 14100.) Valuing the goodwill of a business is an inherently subjective task. "It has been held that opinion evidence, as to its value, is admissible but not conclusive; that it is difficult to approximate the value of good will; that the situation of the premises, the amount of patronage and the general conditions existing at the time are stronger evidence than the opinion of a so-called interested expert; that the data for estimating the value of the good will of a business are always more or less uncertain and depend very much upon the personality of the parties engaged in the business; that one man by his personality, his adroitness in conducting his business, his geniality in attracting customers, and his wide acquaintance with his customers, may be capable of doing a profitable business where another, lacking some or all of these qualities may fail, or at least not succeed to the extent his predecessor had attained; that the fact that the business had been long established, and the habit of customers who have been used to dealing at a particular place to continue to go there, and the fact that there may be some other attraction, such as the location, etc., are elements not to be overlooked; and that after all, it is a question for the jury, taking all the circumstances, including the testimony of persons familiar therewith, into consideration. [Citation.]" (Burton v. Burton (1958) 161 Cal.App.2d 572, 577.)
"'A principle applied in some cases is that the valuation of good will may be fairly arrived at by multiplying the average net profits for a period of years by the number of years, such number being suitable and proper, having reference to the nature and character of the particular business under consideration . . . .' " (Ibid.)
Notwithstanding the difficulty in valuing the goodwill of a business, division 9 of the Commercial Code appears to contemplate the use of goodwill as collateral. Division 9 of the Commercial Code expressly recognizes "general intangibles" as property. Section 9102, subdivision (a)(42), defines "general intangibles" as "any personal property, including things in action, other than accounts, chattel paper, commercial tort claims, deposit accounts, documents, goods, instruments, investment property, letter-of-credit rights, letters of credit, money, and oil, gas, or other minerals before extraction. The term includes payment intangibles and software." Importantly, the cases have repeatedly discussed, with apparent approval, security agreements which include general intangibles as collateral. (See e.g. Waltrip v. Kimberlin (2008) 164 Cal.App.4th 517, 521; California Wholesale M,terial Supply, Inc. v. Norm Wilson & Sons, Inc. (2002) 96 Cal.App.4th 598, 605.) Moreover, the cases have found that goodwill falls within the category of "general intangibles." (See Bank of Washington v. Burgraff (Wash.App. 1984) 687 P.2d 236, 238; DFS Sec. Healthcare Rec. v. Caregivers Great Lakes (2004) 384 F.3d 338, 344, fn. 4; In re Leasing Consultants, Incorporated (2d Cir. 1973) 486 F.2d 367, 371, fn. 5.)
Although division 9 of the Commercial Code expressly identifies "general intangibles," and the cases have found general intangibles and goodwill may serve as collateral, defendants contend Commercial Code section 9102, subdivision (a)(12), prevents a borrower from using goodwill as collateral. Commercial Code section 9102, subdivision (a)(12), states: " 'Collateral' means the property subject to a security interest or agricultural lien. The term includes all of the following:
"(A) Proceeds to which a security interest attaches.
"(B) Accounts, chattel paper, payment intangibles, and promissory notes that have been sold.
"(C) Goods that are the subject of a consignment."
Contrary to defendants' argument, section 9102, subdivision (a)(12), is not an exclusive list of the property which may be used as collateral. The most obvious indication defendants' interpretation is erroneous is the fact that under defendants' interpretation we would be required to exclude one of the most common forms of collateral: goods which are not the subject of a consignment, including in particular a debtor's inventory and equipment. Needless to say, such an interpretation would come as a surprise to all the businesses in this state and elsewhere who finance their enterprises with not only general intangibles, but unconsigned inventory and equipment.
In light of our interpretation of division 9 of the Commercial Code, we will assume without deciding that goodwill is a general intangible which may be used as collateral under a security agreement governed by division 9 of the code. The significance of our willingness to find that goodwill is a general intangible which may be used as collateral under division 9 of the Commercial Code is that a transfer in violation of a security agreement which covers goodwill will likely permit the secured party to bring an action in tort for recovery of the value of the goodwill. (See Fremont Indemnity Co. v. Fremont General Corp. (2007) 148 Cal.App.4th 97, 124-126; see also Bank of Washington v. Burgraff, supra, 687 P.2d at pp. 239-240.) Although some earlier cases, including in particular Olschewski v. Hudson (1927) 87 Cal.App. 282, 286, held there can be no conversion of goodwill, later cases have expanded conversion to include general intangibles such as net operating losses and recognized that other modern torts should offer protection to other intangibles whose value might be more difficult to determine. (Fremont Indemnity Co. v. Fremont General Corp., supra, 148 Cal.App.4th at pp. 124-126; see also Carrey v. Boyes Hot Springs Resort, Inc. (1966) 245 Cal.App.2d 618, 623; Metcalf v. Shamel (1959) 166 Cal.App.2d 789, 793.) Hence it is likely the unauthorized transfer of a business subject to such a security agreement will support a lender's recovery of the value of the goodwill either by way of claim for conversion or as the remedy for one of the more modern torts, such as intentional interference with economic advantage.
2. Blue Haven's Goodwill
Next, we consider whether in fact the bar had any goodwill at the time the defendants began operating the bar.
a. Standard of Review
On appeal we conduct a very narrow review of a trial court's determination of compensatory damages. (See Seffert v. Los Angeles Transit Lines (1961) 56 Cal.2d 498, 507.) We apply the substantial evidence standard and determine every conflict in respondent's favor and must give respondent every inference reasonably to be drawn from the record. (Ibid.)
b. Methods of Valuation
"Courts have long accepted that goodwill may be measured by the capitalized value of the net income or profits of a business or by some similar method of calculating the present value of anticipated profits." (People ex rel. Dept. of Transportation v. Muller (1984) 36 Cal.3d 263, 271, fn. omitted; see also Burton v. Burton, supra, 161 Cal.App.2d at p. 577.) This method of valuing goodwill requires that a business have a history of profits from which such a calculation can be made. (Burton v. Burton, supra, 161 Cal.App.2d at p. 557; see also Redevelopment Agency of City of San Diego v. Mesdaq (2007) 154 Cal.App.4th 1111, 1131.)
"However, the courts have wisely maintained that there is no single acceptable method of valuing goodwill. [Citation.] Valuation methods will differ with the nature of the business or practice and with the purpose for which the evaluation is conducted. [Citation.]" (People ex rel. Dept. of Transportation v. Muller, supra, 36 Cal.3d at p. 271, fn. 7; see also Redevelopment Agency of City of San Diego v. Mesdaq, supra, 154 Cal.App.4th at pp. 1130-1131.) Recently, one court has in fact accepted, as an alternative to the capitalized income method, the amount a business owner has invested in a business in as a measure of goodwill. (See Inglewood Redevelopment Agency v. Aklilu (2007) 153 Cal.App.4th 1095, 1101, 1108-1109 (Inglewood Redevelopment Agency).) In Inglewood Redevelopment Agency the owner of an auto repair business invested more than $200,000 in the business during a period in which substantial development was going on across the street. Shortly after the adjacent development was complete, a redevelopment agency condemned the auto repair business, and the owner was unable to exploit the opportunity to increase his business. During the period of the adjacent development, the business generated little, if any, profit and the business would have no goodwill under the excess profits method of valuation. However, the owner's expert appraiser testified that it was appropriate in such circumstances to value the goodwill of the business by looking at how much the owner invested in the business with an eye toward exploiting the opportunity created by the adjacent development. (Inglewood Redevelopment Agency, supra, 153 Cal.App.4th at p. 1101.) The Court of Appeal agreed that in the circumstances presented, this was an appropriate means of valuing goodwill. "The 'cost to create' approach was endorsed by Glenn M. Desmond, the . . . co-author of Business Valuation Handbook. The Business Valuation Handbook states that, where the appraiser concludes a business has lost patronage but the value of the goodwill is zero under the an excess profits test, a 'cost to create' approach is an acceptable means by which to value goodwill." (Inglewood Redeveloopment Agency, supra, 153 Cal.App.4th at p. 1109, fn. omitted.)
c. Blue Haven
Notwithstanding the requirement that we resolve all doubts in favor of Bischoff, on this record there is no evidence that at the time defendants re-opened the Blue Haven it had any goodwill. Bischoff did not present any evidence the bar generated any excess profits, and in light of Wienold's inability to make payments on the note Bischoff held, pay the rent due, or pay the sales taxes owing, it is unlikely she would have been able to show any excess profits. Thus there were no historical profits upon which a capitalized value of goodwill could be calculated.
Moreover, Bischoff did not attempt to show how much either she or Wienold invested in the bar so that we could uphold the trial court's damages finding on a cost to create theory. Even if we looked to either the amount of the note Wienold initially gave her, $277,000, or the amount of the note the defendants initially offered Bischoff, $120,000, as evidence of such an investment, on this record those figures would not establish the existence of goodwill. Unlike the situation discussed in Inglewood Redevelopment Agency, at the time defendants took over the bar, the bar was not a going concern. As we noted at the outset, the defendants' unrebutted testimony was that the bar had been padlocked by the landlord and its liquor license had been suspended. Thus, unlike the circumstances considered in Inglewood Redevelopment Agency, in March 2004 there was no expectation that, notwithstanding its historical lack of profits, the Blue Haven was on the verge of profitability. In this regard we note that "[g]oodwill . . . cannot exist where the business is not a going concern." (Bank of Washington v. Burgraff, supra, 687 P.2d at p. 240.) In Bank of Washington v. Burgraff the operator of a restaurant abandoned it and, as here, its liquor license was suspended. Given those circumstances, the court found no goodwill upon which a secured creditor could realize its interests. (Id. at pp. 240-241.)
In response to our request for additional briefing and again at oral argument, Bischoff argued that at the time escrow closed on the transfer to defendants in March 2005, the bar was profitable and hence at the close of escrow it had undeniable goodwill. We accept Bischoff's contention the bar had goodwill at the time escrow closed in 2005. However, the record is equally clear that none of that goodwill was attributable to Bischoff or Wienold. Rather, the record shows that any goodwill which existed at the time escrow closed had been created by the investment and effort of the defendants. The defendants could not be held liable for converting the goodwill they created any more than they could be held liable for converting fixtures or furniture they installed in the bar.
In sum, the trial court's determination of damages cannot be based on the amount of goodwill the bar had when the defendants began operating it. As we have also noted, what evidence of value exists as to the tangible assets will not support a $120,000 judgment. Thus the trial court's finding Bischoff's security had a value of $120,000 at the time the defendants took over the bar cannot be sustained.
CONCLUSION
The judgment is reversed and the matter is remanded for a determination of whether, at the time the defendants began operating the bar in March 2004 they converted the then existing furniture, fixtures and inventory. If the trial court finds the tangible assets were converted, the trial court is directed to enter judgment in Bischoff's favor in an amount equal to the value of the tangible assets.
Appellants to recover their costs of appeal.
WE CONCUR: McINTYRE, J., IRION, J.