Summary
In Logix Development Corporation v. Faherty (Nov. 14, 2007, B178872 [nonpub. opn.]) (hereafter Logix I), we affirmed in part, reversed in part and remanded a judgment in excess of $22 million, which we reduced to $8,388,385 in favor of Logix Development Corporation, D. Keith and Anne Howington (collectively respondents in Logix I and in this appeal), and against appellant J. Roger Faherty.
Summary of this case from Logix Development Corp. v. FahertyOpinion
NOT TO BE PUBLISHED IN THE OFFICIAL REPORTS
APPEAL from a judgment of the Superior Court of Los Angeles County, Ernest Hiroshige, Judge, Los Angeles County Super. Ct. No. BC 250732
Manning & Marder, Kass, Ellrod, Ramirez, Anthony J. Ellrod, Steven J. Renick, L. Trevor Grimm and Allison G. Vasquez for Plaintiffs and Appellants.
Horvitz & Levy, Peter Abrahams, Andrea M. Gauthier, Jason T. Weintraub; Murchison & Cumming, Edmund G. Farrell, Michael J. Nuñez; Monaghan, Monaghan, Lamb & Marchisio and Patrick J. Monaghan, Jr., for Defendant and Appellant.
FLIER, J.
Logix Development Corporation (Logix), D. Keith Howington and Anne Howington filed an action against multiple defendants, including appellant J. Roger Faherty, over disputes arising from a common venture involving pay-per-view “adult entertainment” channels. The case went to trial against Faherty only as the alter ego of one of the corporate defendants, and the jury returned verdicts of $18,084,612 for Logix, and $4,457,234 in favor of the Howingtons.
In our previous opinion in this case, filed on April 13, 2007, we rejected Faherty’s contention that, as a matter of law, he cannot be held to be the alter ego of the corporate defendant in question. We also found that the judgment in favor of Logix and the Howingtons had to be reduced, respectively, by $12,548,510 and by $1,604,751. In all other respects, we affirmed the judgment.
Both parties petitioned for a rehearing. We granted both petitions and requested the parties to submit briefs on three issues, which we discuss in this opinion. We reiterate with minor changes the Facts and Procedural Events of our previous opinion and repeat in this opinion without changes parts 1 and 2 of the Discussion of our previous opinion in which we again affirm the jury’s finding that Faherty is the alter ego of Emerald Media, Inc. (EMI). After taking account of the parties’ answers to our inquiries after we granted the petitions for rehearing, we conclude that the reductions in the judgment we have previously made are justified. The award of $2,137,452 predicated on the Spice Hot channel requires, in our opinion, a new trial limited to this issue. Accordingly, we affirm the judgment to the extent it awards $5,536,102 to Logix and $2,852,483 to the Howingtons, reverse the judgment in all other respects and remand the case with directions.
FACTS
1. The Chronology of Salient Events
Logix is a software development company that developed the technology to turn large dish satellites off and on very quickly, i.e., in three and a half seconds. Previously, it had taken hours, if not days, to turn a subscription on or off. Logix’s new technology is particularly useful for pay-per-view programs. In the television market, sporting events and adult entertainment comprise a very significant part of pay-per-view programming. Logix had clients in both of these sectors. A dispute with a company offering adult entertainment ended up with Logix acquiring two explicit adult entertainment networks. According to Keith Howington, Logix’s chief executive officer, Logix did quite well with these channels, winding up with over 50 percent of the market share of the adult entertainment market.
Eventually, Logix’s business expanded beyond large dish satellites to cable television and to small dish satellites. The large dish market is also referred to as “C-band.”
In the 1990’s, Graff Pay-Per-View operated two channels in the large-dish market. Appellant Faherty became chief executive officer and chairman of Graff Pay-Per-View in 1991; Graff changed its name to Spice Entertainment Companies, Inc., (Spice) in 1997. Spice leased “transponders,” which is space on a satellite from which to relay signals from its broadcast headquarters to the homes of its subscribers. Spice had the right to sublease unused space to other broadcasters.
Logix’s two explicit adult entertainment networks provided formidable competition to Spice’s “adult movies” because the latter did not contain explicit sexual scenes. However, Spice’s board of directors decided that Spice would not go into the explicit business because it would erode its customer base.
Faherty appears to have disagreed with this decision. At the end of 1995, he approached Logix with a proposal that seemed attractive to Logix. As related by Logix’s chief executive officer Howington, Faherty proposed that Spice would buy Logix’s two adult channels and that Logix would provide technical and sales support. As part of its compensation, Logix would get a portion of the revenue from the adult channels.
The identity of the buyer under Faherty’s suggestion remained unsettled for a long time. In February 1996, letters of intent were exchanged under which no less than three different corporate entities were suggested as buyers; “Spice International,” a wholly owned subsidiary of Graff Pay-Per-View, was one of the proposed buyers. The negotiations dragged on during 1996. The only negotiators with whom Logix dealt were Faherty, Donald McDonald, then vice president of Spice, and Daniel Barsky, who was senior vice president, general counsel and secretary to the board of directors of Spice.
As it turned out, the entity with whom Logix finally concluded the agreement that was first proposed by Faherty in 1995 was EMI. We digress from our chronological account to provide the background on EMI.
Sometime in 1996, Paul Mindnich, who was a former business associate of Faherty’s, asked Faherty for a job or a business opportunity. Faherty called him back after a few days and asked Mindnich if he would be interested in working for EMI, which Faherty said was involved in the adult entertainment business. Mindnich went to Spice’s corporate offices in New York for a meeting about the job. Faherty referred Mindnich on to McDonald and to Barsky. Mindnich agreed with McDonald and Barsky that he, Mindnich, would take the job of president of EMI at a salary of $5,000 per month.
The record reflects that Mindnich signed as the “incorporator” on the certificate of incorporation issued for EMI in Delaware on August 30, 1996. However, Mindnich testified that: he did not know whether EMI ever issued any shares to anybody; he never invested any money in EMI and he did not know anyone who did so; he did not know where his paychecks came from, and he didn’t care to know whether EMI had any working capital. Mindnich assumed from the first that EMI “ ‘was doing business in the explicit end of the porn business.’ ”
Mindnich did not testify at trial; his deposition was read into the record.
Mindnich stated that his role was basically to sign documents. Mindnich would be summoned by McDonald or Barsky to sign documents prepared by Barsky; he could not remember reading any of the documents that he was asked to sign. When it appeared that Mindnich might become a defendant in an unrelated civil action, he informed Faherty of that fact, who then arranged for Mindnich to “sell” EMI to Judy Savar; Mindnich never expected to, and did not, receive any proceeds from this “sale.”
Savar’s relationship with EMI was no different from Mindnich’s. She was approached by McDonald, whom she had known for 22 years and whom she considered “family.” Savar and McDonald had “done business for years.” McDonald asked her if she would like an opportunity to own her own company; he told her that this company “ran itself.” McDonald explained that EMI was a high-risk company because it was in the adult entertainment business and because it was in a lot of debt. Savar was not very happy about either item of information, but McDonald assured her that she would have a salary and that a company he worked for had an option on EMI. If the option was exercised, she could “profit by it in the end.”
When Savar took the stand to testify at the trial, she identified herself in the present tense as the sole owner of EMI.
Savar entered into an employment contract with EMI. She was paid $90,000 a year and worked for about two hours a week; sometimes she would go for weeks without doing anything. She lived in California, and EMI was located in Pittsburgh, Pennsylvania. (At one point, EMI’s address was McDonald’s home near Pittsburgh.) Under her employment contract, Savar was barred from entering into any agreement on behalf of EMI. She never received any stock in EMI, and never paid for any stock in EMI. Like Mindnich, her role was to sign documents but, unlike Mindnich, she also attended some conventions on behalf of EMI. She signed EMI tax returns, but never saw any EMI financial documents.
On August 30, 1996, the same date that appears in EMI’s Delaware Certificate of Incorporation signed by Mindnich, Media Licensing, Inc., and Danish Satellite Television, S.A., granted EMI a license for products and services furnished under the name “Eurotica.” Eurotica was a sexually explicit adult entertainment channel. EMI subleased transponder space for this channel from Spice.
The contract that had taken over a year to negotiate was entered into in January 1997 between Logix and EMI. Howington had never met or spoken with Mindnich, and at no point in the negotiations had anyone mentioned EMI or Mindnich to Howington. It was at the last minute that Howington was told to change the signature line on the contract to reflect Mindnich and EMI. As Logix puts it in the opening brief, “Logix had in fact entered into a contract with a sham, an entity created by Faherty personally, in order to take advantage of the lucrative explicit adult business that the Spice Board had decided to pass up.”
Savar took over from Mindnich in 1998.
In addition to the agreement between Logix and EMI, Howington and EMI entered into a noncompetition agreement. Under the Logix-EMI agreement, EMI was to pay Logix service fees equal to 20 percent of the sales processed through Logix’s call center. In addition, under both agreements EMI was to pay Logix and Mr. and Mrs. Howington a certain percentage of the net sales, which was termed the “override percentage.” The agreements defined the “override” as a percentage of the total net revenue derived from explicit movies and explicit programming. In substance, the override was to be 5 percent on the first $1 million of sales; the override increased with increasing sales so that at $2 million and above, the override was 10 percent. Overrides were to be paid for any explicit networks operated by EMI or companies affiliated with EMI. Spice was expressly named and covered by the agreements as an “EMI affiliate.” The Logix-EMI agreement also called for the payment of $600,000 by EMI to Logix.
This contract required Mr. and Mrs. Howington to refrain from developing explicit channels to compete with either EMI or Spice.
At the time the Logix-EMI agreement was entered into, EMI operated a single explicit channel, which was Eurotica. Under the agreement, it acquired two explicit channels from Logix. A fourth channel was added after the agreement was concluded.
Initially, the four explicit networks (see fn. 6, ante) produced substantial revenues. In December 1997, EMI’s monthly revenues were $1.8 million. Faherty claims, however, that competition from cable and the small dish satellite industry began to cut into revenues. During 1998, the Logix-EMI agreement was amended three times to provide for a reduction in the service fees and overrides paid by EMI; two of these amendments were executed on January 13, 1998. Logix claims that these amendments were coerced by Faherty and McDonald by threats to shut down EMI if the amendments were not accepted by Logix. These amendments resulted in decreased fees and overrides paid to Logix, and are important to the damage calculations and the sums awarded by the jury, since a significant part of the award was what Logix would have been paid under the original terms of the agreement, and before these amendments reduced the fees. We refer to these amendments collectively as the “1998 amendments.”
The date of these amendments is germane in light of Logix’s contention that the court erred in concluding that the statute of limitations expired on fraud and conspiracy claims asserted by Logix.
In addition to, and perhaps in part because of, decreasing earnings, EMI was never able to open a merchant account, which is a relationship with a financial institution that allows one to process sales made through credit cards. Since EMI was not able to open such an account, Logix used its merchant account to process subscriptions for EMI. According to Howington, this exposed Logix to millions of dollars in credit card liability.
In May 1998, Spice sold Spice Hot to Califa Entertainment Group (Califa). Logix contends that “under the revenue sharing provisions of its contract with EMI,” it should have participated in the price obtained for Spice Hot and that it was also entitled to the override fees that would have been generated by Spice Hot. This turns out to be a significant event, in that the jury awarded Logix and the Howingtons over $2.1 million on the ground that revenues generated by Spice Hot were subject to the Logix-EMI agreement.
Unless we state otherwise, contentions ascribed to Logix are also ascribed to the Howingtons.
In March 1999 Playboy Enterprises acquired Spice in a merger with Spice; as part of that acquisition, an independent company called Directrix was spun off. Directrix became a publicly held corporation and Faherty left Spice to become chairman of Directrix.
In April 2001 EMI shut down its explicit channels and terminated the Logix-EMI agreement, which would have expired under its terms in January 2002. Three weeks later, in May 2001, Logix and the Howingtons filed the present action. After shutting down its explicit channels and terminating the agreement with Logix, EMI sold the subscriber lists for the explicit networks to New Frontier for $750,000.
As far as Logix was concerned, EMI’s termination was not the end of the story. Logix claimed that the broadcasting of channels by Playboy between July 2001 and January 2002 was subject to the Logix-EMI agreement, with the effect that override fees generated by these channels were due and payable to Logix. As Logix puts it in its opening brief: “The relationship between the original Spice and the merged Playboy/Spice meant that, under Logix’s contract with EMI, it had the right to a percentage of the revenues from these channels after they were purchased by Playboy/Spice.”
In our original opinion, we questioned why Playboy should be deemed bound by the Logix-EMI agreement since only EMI and an EMI affiliate (and, of course, Logix) were subject to that agreement, and it did not appear that Playboy was an EMI affiliate. We noted that Faherty did not appear to question that Playboy was subject to the EMI-Logix agreement.
On granting the petitions for rehearing, we requested the parties to brief the question whether EMI was liable for fees generated by channels operated by Playboy after April 2001. Logix has taken the affirmative, relying principally on the fact that Spice, which was designated by the agreement as an EMI affiliate, merged with Playboy. Faherty now contends that Playboy was not bound by the EMI-Logix agreement since it was not an EMI affiliate. We address this matter in part 3 of the Discussion of this opinion.
In July 2001, Playboy acquired Spice Hot from Califa and renamed the channel Spice Platinum. Sometime later, Playboy acquired a channel called Hot Network Plus. Both Spice Platinum and Hot Network Plus were “explicit” channels. (We take up in part 4 of the Discussion of this opinion the definition of an “explicit” channel.) After July 2001, Playboy also operated Hot Network and Hot Zone. Faherty contends that these latter two channels were not “explicit.” Whether a channel was, or was not, “explicit” is germane because under the Logix-EMI agreement, override fees were to be paid by EMI only for “explicit” channels.
Califa had operated Spice Hot under the name Vivid TV.
2. Evidence of Damages and the Jury’s Award
The jury’s award was based solely and exclusively on the testimony and the calculations provided by plaintiff’s expert Wayne Lorch.
Lorch described himself as a forensic accountant involved in the “interpretation of income” and income streams, and in business valuation.
A. The Award of $18,084,612 to Logix
The first item of damages awarded by the jury was $1,933,619, which Lorch described as the difference between the service fees per the contract and the service fees actually paid after the 1998 amendments.
The next item of $488,281 was, according to Lorch, the difference between override fees under the original contract and the override fees actually paid after the 1998 amendments. Both of these awards were predicated on the theory that the amendments were “coerced” and for that reason were invalid and unenforceable. Faherty does not challenge the claim that the amendments were coerced and invalid, and that the differentials calculated by Lorch are accurate.
The sale of Spice Hot by Spice to Califa in 1998 generated two awards. First, there was the sum of $1,715,135, which was described as the “Logix revenue participation in the sale of the Spice Hot channel to Califa under the terms of the original agreement.” Second, $422,318 was the total of the estimated override fees from the Spice Hot channel revenues.
Next, the jury awarded $12,775,260. There are three components to this award. First, there is an award for $10,943,759, which is the present value of future override fees for a period of five years after the date that the Logix-EMI contract would have terminated under the terms of that agreement, i.e., January 2002. Second, there is an award of $1,604,751 for channels Hot Network and Hot Zone that were operated by Playboy for the period between July 2001 and January 2002; as noted, Faherty contends that these channels were not “explicit.” Third, there is an award of $226,750 for the Spice Platinum and Hot Network Plus channels, which were admittedly explicit, operated by Playboy between July 2001 and January 2002.
B. The Award of $4,457,234 to the Howingtons
The Howingtons were awarded the same sums as Logix, with the exception of the service fees and the present value of the future override fees, for which they did not receive awards.
Thus, the Howingtons were awarded $488,281 for the difference between override fees under the original contract and the override fees actually paid after the 1998 amendments. They were awarded $1,715,134 arising from the sale of the Spice Hot channel to Califa and $422,318 for the estimated override fees from the Spice Hot channel revenues. Finally, they were awarded the total of $1,831,501 for override fees generated by four channels operated by Playboy between July 2001 and January 2002. As with Logix, $1,604,751 of this sum were override fees generated by two channels, Hot Network and Hot Zone, that Faherty contends were not explicit.
PROCEDURAL EVENTS
The operative first amended complaint filed by Logix and the Howingtons alleged 10 causes of action and named as defendants EMI, Spice, Faherty, McDonald, Savar, as well as Directrix, Playboy, New Frontier and one other corporation who is not material to this case. In the complaint, Logix alleged among other things that EMI was the alter ago of Faherty and McDonald.
All references are to the first amended complaint.
We refer to the action henceforth as the “Logix action” and intend to include in that designation the Howingtons as plaintiffs in that action.
In addition to the breach of contract claim against Faherty, which was the only cause of action to go to trial (see text, post), the complaint also alleged causes of action for fraud and conspiracy against the defendants, Faherty included. The trial court granted Faherty’s motion for judgment on the pleading on these causes of action on the ground that these claims were barred by the statute of limitations. Logix contends in its cross-appeal that this ruling was in error.
Prior to trial, EMI stipulated to a judgment of $40 million in favor of Logix, and settled with Logix. In February 2004, Logix settled with Spice for a payment of $8,032,500. McDonald filed for bankruptcy prior to trial, and Logix settled with Savar for $1,000. New Frontier paid Logix $75,500, and also settled. It appears that the other corporate entities named as defendants were dismissed. This left Faherty as the sole defendant.
The case went to trial against Faherty on the causes of action for breach of contract and for breach of fiduciary duty. After all sides rested, the trial court granted nonsuit on the cause of action for breach of fiduciary duty. Thus, the case went to the jury on the single cause of action for breach of contract against Faherty.
The jury returned a series of special verdicts, which found that: (1) Faherty was an alter ego of EMI; (2) EMI breached its agreement with Logix and the Howingtons; (3) Logix was damaged by the breach; and (4) Logix’s damages were $18,084,612. The jury made parallel findings in the case of the Howingtons and found their damages to be $4,457,234. As noted, the jury’s award of damages was based on calculations provided by plaintiffs’ expert Wayne Lorch.
The trial court denied Faherty’s motions for a new trial and for a judgment notwithstanding the verdict, in which Faherty challenged the damage awards as excessive and contended that the alter ego doctrine was inapplicable because Faherty was never a shareholder of EMI. The trial court granted Faherty’s motion for an offset based on the settlement with Spice ($8,032,500). This appeal followed.
DISCUSSION
1. Ownership of Stock Is Not a Prerequisite for the Application of the Alter Ego Doctrine
Faherty contends that the person against whom the alter ego doctrine is applied must own stock in the corporation before this doctrine can be invoked. Faherty claims that this is an absolute threshold requirement for the application of the alter ego doctrine. He points to the undisputed fact that there is no evidence that he owns or owned any stock in EMI, and concludes that for this reason the alter ego doctrine cannot be applied to him and EMI.
We disagree. The alter ego doctrine does not require that the person against whom the doctrine is invoked must own stock in the corporation.
We begin with the governing general principles. “Before the acts and obligations of a corporation can be legally recognized as those of a particular person, and vice versa, the following combination of circumstances must be made to appear: First, that the corporation is not only influenced and governed by that person, but that there is such a unity of interest and ownership that the individuality, or separateness, of the said person and corporation has ceased; second, that the facts are such that an adherence to the fiction of the separate existence of the corporation would, under the particular circumstances, sanction a fraud or promote injustice.” (Minifie v. Rowley (1921) 187 Cal. 481, 487.) This statement of the rule, still considered authoritative, emphasizes the broad equitable nature of the doctrine. As the Supreme Court has put it: “The essence of the alter ego doctrine is that justice be done. ‘What the formula comes down to, once shorn of verbiage about control, instrumentality, agency, and corporate entity, is that liability is imposed to reach an equitable result.’ (Latty, Subsidiaries and Affiliated Corporations (1936) p. 191.) Thus the corporate form will be disregarded only in narrowly defined circumstances and only when the ends of justice so require.” (Mesler v. Bragg Management Co. (1985) 39 Cal.3d 290, 301.)
Minifie v. Rowley is cited as a leading case in 9 Witkin, Summary of California Law (10th ed. 2005) Corporations, section 10, page 787.
We note at the outset, and before addressing Faherty’s specific contention, that adherence to the fiction of the separate existence of EMI would “sanction a fraud or promote injustice.” (Minifie v. Rowley, supra, 187 Cal. at p. 487.) The evidence is that Faherty freely manipulated EMI, making EMI Logix’s contracting partner in a substantial transaction, and then terminated both EMI and the agreement between EMI and Logix. As the verdict and the settlements show, the decision to terminate EMI and the Logix agreement had substantial and adverse economic consequences. Adherence to the fiction of EMI’s separate corporate existence would accomplish exactly what Faherty intended to accomplish, i.e., shield him from the adverse economic consequences of his decisions to terminate EMI and the Logix agreement. It would leave Logix and the Howingtons with a shell of a corporation that the evidence shows is judgment proof. These facts are a paradigm for the application of the alter ego doctrine.
In contending that stock ownership is an absolute requirement for the application of the alter ego doctrine, Faherty relies in large part on Riddle v. Leuschner (1959) 51 Cal.2d 574. The trial court in Riddle concluded that all three members of the Leuschner family were the alter egos of two corporations, Yosemite Creek Company and Kadota Creek Company. The Supreme Court, however, concluded that Richard Leuschner, Sr., who was the president of Yosemite and assistant treasurer of Kadota, and who was paid a salary of $600 per month and owned no stock in either Yosemite or Kadota was not the alter ego of the corporations, while Mrs. Leuschner, his wife, and Leuschner, Jr., her stepson, were held by the Supreme Court to be alter egos of the corporations. (Id. at pp. 580-581.) Mrs. Leuschner owned one share of Yosemite stock, and owned no shares of Kadota stock. Leuschner, Jr., owned 268 shares of Yosemite stock and one-third of the shares in Kadota. (Id. at p. 576.)
Faherty contends that the “sole basis for reversal as to Mr. Leuschner[, Sr.,] was that the alter ego doctrine does not apply where ‘[i]t is undisputed that [the defendant] held none of the stock’ in the corporation. (Ibid. [Riddle v. Leuschner, supra, 51 Cal.2d at p. 580.])” (Italics in original.)
Faherty’s rendition of Riddle v. Leuschner is unduly truncated. We set forth the court’s analysis of Leuschner, Sr.’s situation in the margin. It is apparent that it is by no means true that the “sole” basis for the court’s conclusion as to Leuschner, Sr., was that he owned no stock in the corporations. The court’s analysis focused on the question of control; the fact that Leuschner, Sr., owned no stock was indicative of his lack of control, which also appeared from the other facts of record. The fact that the court was concerned with the realities of who controlled the corporations was evident in the phrasing of its conclusion regarding Mrs. Leuschner and Leuschner, Jr., whom it held to be alter egos of the corporation: “The fact that both Leuschner, Jr., and Mrs. Leuschner controlled and dominated the corporations does not preclude holding each of them personally liable for the obligations of the business, since it is settled that two or more shareholders of a corporation may be liable as principals or partners under the alter ego principle.” (Riddle v. Leuschner, supra, 51 Cal.2d at p. 581.)
“In Automotriz etc. De California v. Resnick, 47 Cal.2d 792, 796, we stated that the two requirements for disregard of corporate entity are ‘(1) that there be such unity of interest and ownership that the separate personalities of the corporation and the individual no longer exist and (2) that, if the acts are treated as those of the corporation alone, an inequitable result will follow.’ [¶] The evidence is not sufficient to bring Leuschner, Sr., within the first of these requirements. It is undisputed that he held none of the stock, and there is no evidence that he had any interest as an owner in the business operated by either of the two corporations or that he had a right to share in any profits they might make. Instead, he received a monthly salary. Under all the circumstances, he is to be regarded as having been a managing employee of the two companies, and his control over their affairs must be treated as that which would be exercised by a managing agent rather than that of a shareholder or owner. It follows that there was not such unity of ‘interest and ownership’ between Leuschner, Sr., and the corporations that the separate personalities of the corporations and the individual no longer existed, within the meaning of the rule set forth above.” (Riddle v. Leuschner, supra, 51 Cal.2d 574, 580, italics added.)
Riddle v. Leuschner’s focus, not on the question of stock ownership, but on the control exercised by the person over the corporation, is reflected in the modern cases dealing with the alter ego doctrine. (E.g., Robbins v. Blecher (1997) 52 Cal.App.4th 886, 892, citing Communist Party v. 522 Valencia, Inc. (1995) 35 Cal.App.4th 980, 993 [“a court may disregard the corporate entity and treat the corporation’s acts as if they were done by the persons actually controlling the corporation”]; Sonora Diamond Corp. v. Superior Court (2000) 83 Cal.App.4th 523, 538 [“the courts will ignore the corporate entity and deem the corporation’s acts to be those of the persons or organizations actually controlling the corporation, in most instances the equitable owners”].)
That the ultimate concern is control and not the ownership of stock squares with the remedial nature of the doctrine. The concern is with what the person is able to do because of his or her control of the corporation. Whether the person “owns” the corporation, and the nature of that ownership, is relevant because ownership usually brings with it control. The alter ego doctrine is invoked to remedy the injustice caused by a person’s manipulation of the corporate entity -- a manipulation made possible by that person’s control over the corporate entity.
We do not mean to imply by this that ownership is irrelevant when it comes to the application of the alter ego doctrine. We only hold that “ownership” must be construed broadly, as it has been to extend to “equitable ownership” (Sonora Diamond Corp. v. Superior Court, supra, 83 Cal.App.4th at p. 538), and with an understanding that ownership is important because it generally goes to the ultimate question of control by the person over the corporation.
Indicative of the low priority that the court in Riddle v. Leuschner accorded to stock ownership is that the court brushed aside the fact that Mrs. Leuschner owned only one share out of several hundred of Yosemite stock, and owned no stock in Kadota, yet found her to be the alter ego of both corporations. (Riddle v. Leuschner, supra, 51 Cal.2d 574, 580-581.) Given these facts and this result, it cannot be true that the court gave particular weight to the fact of stock ownership.
There is a further aspect of the court’s holding regarding Mrs. Leuschner that demonstrates that stock ownership was not held in Riddle v. Leuschner to be an absolute prerequisite for the application of the alter ego doctrine. Mrs. Leuschner owned no shares in Kadota, yet the court found her to be the alter ego of that corporation, as well. (Riddle v. Leuschner, supra, 51 Cal.2d at p. 581.)
Faherty states in his opening brief: “Riddle explained that the ownership requirement serves important policy interests. Because alter ego is an equitable doctrine designed to prevent abuse of the statutory privileges granted to corporations, it should apply only to individuals who have an ownership stake in the company and therefore enjoy the opportunity for personal financial gain from the corporation’s separate existence. (See Riddle [v. Leuschner], supra, 51 Cal.2d at p. 580.)” Unfortunately, as is apparent from the text of the Riddle decision itself (fn. 14, ante), neither the citation to Riddle provided by Faherty, nor any other part of Riddle, “explained that the ownership requirement serves important policy interests,” as Faherty contends. Nothing in Riddle supports Faherty’s theory that ownership of stock is an essential element of the alter ego doctrine.
Faherty contends, however, that the “threshold requirement” allegedly established by Riddle v. Leuschner “has been consistently followed by California courts,” the “threshold requirement” being that the person must own stock in the corporation. Since Riddle v. Leuschner created no such “threshold requirement,” Faherty’s interpretations of California cases that purportedly follow this “requirement” are incorrect.
Thus, Brenelli Amedeo, S.P.A. v. Bakara Furniture, Inc. (1994) 29 Cal.App.4th 1828, 1841, holds that stockholders may be held to be alter egos of the corporation. The decision does not hold that only stockholders may be held to be alter egos of the corporation and makes no mention of Riddle v. Leuschner.
Faherty contends that Minnesota Mining & Manufacturing Co. v. Superior Court (1988) 206 Cal.App.3d 1025 (Minnesota Mining) follows Riddle v. Leuschner in “requiring ownership of at least ‘one share’ before alter ego liability is imposed.” Minnesota Mining contains no such holding. Minnesota Mining, supra, at page 1028 holds: “Where the alter ego doctrine applies, ownership of even one share is sufficient to hold a shareholder liable for the debts of a corporation. (Riddle v. Leuschner[, supra,] 51 Cal.2d 574, 580.)” In other words, once it has been found that the alter ego theory applies, ownership of one share of stock will make that shareholder liable for the debts of the corporation. This is quite different from “requiring” “at least one share” of stock before the alter ego doctrine can be invoked.
Unfortunately, Faherty carries his misinterpretation of Minnesota Mining over into Mesler v. Bragg Management Co., supra, 39 Cal.3d 290 and First Western Bank & Trust Co. v. Bookasta (1968) 267 Cal.App.2d 910. Both decisions, Faherty claims, stand for the same proposition as Minnesota Mining.
This is incorrect for two reasons. First, as we have seen, Minnesota Mining does not hold that ownership of stock is required before the alter ego doctrine can be applied, and neither Mesler v. Bragg Management Co. nor First Western Bank & Trust Co. v. Bookasta adopts Faherty’s interpretation of Minnesota Mining. Second, neither of these two cases holds that stock ownership is an essential predicate for the application of the alter ego doctrine. In Mesler v. Bragg Management Co., supra, 39 Cal.3d 290, 295-296, the plaintiff’s theory was the two original defendants were the wholly owned subsidiaries of a third corporation. The court concluded that the third corporation was in fact the alter ego of the original defendants. Neither ownership of stock, nor Riddle v. Leuschner, nor the “rule” that Faherty claims Riddle stands for is mentioned anywhere in the opinion. First Western Bank & Trust Co. v. Bookasta, supra, 267 Cal.App.2d 910, 916, only holds, citing Riddle v. Leuschner, that the amount of shares owned is not material when it comes to the application of the alter ego doctrine, which is a correct interpretation of Riddle v. Leuschner.
Faherty cites Shea v. Leonis (1939) 14 Cal.2d 666 for the proposition that a demurrer was sustained in that case “as to [an] alter ego claim that failed to allege defendant owned stock.” This too is in error. In this case, the complaint alleged that the defendant lessor had assigned the lease to a corporation in which he and his family held stock. The court held that the complaint sufficiently alleged an alter ego theory against the individual members of the family, when it alleged that the particular family members owned stock in the assignee corporation. The one exception was Adelina F. Leonis; the court noted that it was not alleged against her that “she has any beneficial interest in said stock.” (Id. at p. 670.) Since the alter ego theory was predicated in Shea on stock ownership, it was clear that as far as Adelina was concerned, an alter ego theory could not be maintained. Shea v. Leonis does not stand for the general proposition that a person must own stock in the corporation before the alter ego theory may be applied.
Finally, VirtualMagic Asia, Inc. v. Fil-Cartoons, Inc. (2002) 99 Cal.App.4th 228, 244, which held that when a parent corporation is the alter ego of a subsidiary corporation, the court will exercise jurisdiction over the parent if it has jurisdiction over the subsidiary, simply has no application to this case, nor does it stand for the proposition that a person must own shares in a corporation before the alter ego doctrine is applied.
Firstmark Capital Corp. v. Hempel Financial Corp. (9th Cir. 1988) 859 F.2d 92 and S.E.C. v. Hickey (9th Cir. 2003) 322 F.3d 1123, are the only cases cited by Faherty which stand for the proposition that a person must own shares in a corporation before the alter ego doctrine may be applied. Both of these federal decisions do in fact interpret Riddle v. Leuschner the way Faherty does. (S.E.C. v. Hickey, supra, at p. 1129; Firstmark Capital Corp. v. Hempel Financial Corp., supra, at p. 94.)
As we have shown, however, the conclusion by Faherty that Riddle v. Leuschner requires stock ownership before the alter ego doctrine is applied is not an accurate interpretation of Riddle. Riddle v. Leuschner did not hold that stock ownership is an absolute threshold requirement for the application of the doctrine, but considered stock ownership to be only one of several factors that may be taken into account. Indeed, as we have noted, Riddle imposed alter ego liability on Mrs. Leuschner in the case of Kadota, in which she owned no stock.
There is a further reason why Firstmark Capital Corp. v. Hempel Financial Corp. and S.E.C. v. Hickey are not persuasive. Imposing an absolute requirement of stock ownership on the alter ego doctrine does not square with the flexible, equitable nature of the doctrine. There may well be cases, as in the instance of Mrs. Leuschner in Riddle v. Leuschner, when a person dominates and controls a corporation, as Mrs. Leuschner did in the instance of Kadota, without owning any stock in the corporation. In such a situation, imposing a formal, technical requirement of stock ownership would mean that the courts would be unable to rectify the harm done when a person manipulated a corporation for unjust ends. This would be undesirable, and at odds with the function of the alter ego doctrine.
In any event, the decisions of lower federal courts are not binding on us (Mesler v. Bragg Management Co., supra, 39 Cal.3d 290, 299), nor do we find Firstmark Capital Corp. v. Hempel Financial Corp. and S.E.C. v. Hickey persuasive in that these decisions are incorrect statements of California law on this subject.
We conclude by observing that there are reported California cases where alter ego liability was imposed on persons or entities who did not own the corporation, or any part of it. As noted, Riddle v. Leuschner is one such case, in the instance of Mrs. Leuschner and Kadota. In Las Palmas Associates v. Las Palmas Center Associates (1991) 235 Cal.App.3d 1220, 1248-1251, alter ego liability was imposed on two corporations without any cross-ownership between the two corporate entities. This was done on the “single-enterprise” theory, where the two corporations joined in the commission of a single enterprise. A similar case is Tran v. Farmers Group, Inc. (2002) 104 Cal.App.4th 1202, 1220, where Farmers Group was held to form one enterprise with Truck Insurance Exchange; Farmers Group did not own any part of Truck Insurance Exchange. This, of course, is not an exhaustive list of such cases, but it is sufficient to carry the point.
In sum, we conclude that ownership of stock is not a prerequisite for the application of the alter ego doctrine.
2. There Is Substantial Evidence That Faherty Was EMI’s Alter Ego
Faherty contends that there is no evidence that he had a unity of interest and ownership with EMI.
“The conditions under which the corporate entity may be disregarded, or the corporation be regarded as the alter ego of the stockholders, necessarily vary according to the circumstances in each case inasmuch as the doctrine is essentially an equitable one and for that reason is particularly within the province of the trial court.” (Stark v. Coker (1942) 20 Cal.2d 839, 846.) We conclude that there is substantial evidence that supports the finding by the jury that Faherty was the alter ego of EMI.
Associated Vendors, Inc. v. Oakland Meat Co. (1962) 210 Cal.App.2d 825, 838-840, lists many factors that are relevant to an alter ego determination, and Logix contends that several of these factors are present in this case. Without cataloguing all the factors, we focus only on a few examples that, in our opinion, are particularly supportive of the jury’s alter ego determination.
The identification of the equitable owner with the domination and control of the corporate entity is one of such factors. (Associated Vendors, Inc. v. Oakland Meat Co., supra, 210 Cal.App.2d at p. 839.) Here it is clear that Mindnich and Savar, ostensibly owners and chief executive officers of EMI, were nothing but figureheads who blindly did what they were told to do, e.g., they signed documents without reading them. Neither Mindnich nor Savar ever actually owned, or even saw, a share of EMI stock, although they were supposed to be owners of the corporation. Mindnich was separated from his “ownership” of EMI without any payment, and at Faherty’s direction. Matters went so far that Savar, allegedly the owner and chief executive officer of EMI, was prohibited by her employment contract from entering into agreements on behalf of EMI, or of binding EMI in any way. With Mindnich and Savar effectively out of the picture, it is clear that it was Faherty, assisted by McDonald and Barsky, who controlled EMI. This is confirmed by the circumstance that, despite negotiations between Logix and Faherty and his assistants that lasted for over a year wherein EMI was never mentioned, at the last minute EMI was suddenly designated as Logix’s contracting partner. Mindnich, who it appears was under no delusions about either EMI or the role he was expected to play, was never involved in the negotiations with Logix. Those negotiations were conducted by Faherty, McDonald and Barsky.
The failure to adequately capitalize the corporation is another factor listed in Associated Vendors, Inc. v. Oakland Meat Co., supra, 210 Cal.App.2d 825, 839. Here the evidence is that Mindnich, who was the first “owner” and “president” of EMI, never put any capital into EMI, and knew no one who did; he did not even know where his paychecks came from. Savar was no different. She never received any stock in EMI, even though she stated that she was the “owner” of EMI. All of this is reflected, and confirmed, by the circumstance that EMI was never able to open a merchant account through which credit card sales could be handled. Thus, the inference that EMI had no capitalization is not only reasonable, from a realistic point of view it is compelling. EMI was simply a shell created to facilitate entry into the sexually explicit adult entertainment market. Hand in glove with this factor is another one identified in Associated Vendors, Inc. v. Oakland Meat Co. at page 838, which is “the failure to obtain authority to issue stock or to subscribe to or issue the same.” There is no evidence that any stock in EMI was ever issued; the evidence is that neither Mindnich or Savar ever held any stock in EMI.
That EMI was a shell is also shown by the fact it had only one employee, Marlene Caruso, who worked as a bookkeeper for EMI for two or three hours per week, and that at one point EMI’s “office” was in McDonald’s home.
As previously stated, the above is just a sampling of the facts that support the finding that Faherty was EMI’s alter ego. We are satisfied that this finding is not only supported by substantial evidence, but is the correct and realistic appraisal of Faherty’s relationship with EMI.
Faherty contends that Logix produced no evidence that an inequitable result would occur unless Faherty was treated as EMI’s alter ego.
The answer to this is that EMI, devoid of assets or capital, is manifestly unable to respond in damages caused by a breach of the Logix-EMI agreement. The injustice of the situation is that Faherty created a corporate shell for the purpose of shielding him from liabilities that he has created. This is the paradigm for the application of the alter ego doctrine, and requires no further discussion.
Similarly without merit is Faherty’s argument that his liability should cease as of March 1999 when he left Spice and became chairman of Directrix. The fact is that, whether at Directrix or Spice, Faherty dominated EMI until he closed EMI down in April 2001. And there is no doubt that Faherty was directly involved, and pivotal, in the shutdown of EMI. It was Faherty who negotiated the sale of EMI to New Frontier, prior to EMI shutting down in April 2001. Indeed, ultimately EMI’s subscriber list was sold to New Frontier for $750,000, a circumstance that gave rise to Logix suing New Frontier. (As noted, New Frontier settled with Logix for $75,500.)
3. There Is No Substantial Evidence To Support the Award of $10,943,759 to Logix for Future Override Fees
The jury awarded $10,943,759 for the present value of future override fees that would have been paid to Logix for a period of five years after the termination of the Logix-EMI agreement.
The parties join issue on the award of $10,943,759 over the question whether the text of the agreement between Logix and EMI can be interpreted to provide that override fees were to be paid after the termination of the contract, as long as EMI was operating the adult entertainment channels. Logix, of course, takes the affirmative of this issue. We set forth the contested provision in the margin, and note that, under another provision, the agreement has a term of five years, commencing in January 1997.
The particular provision is section 4.5 of the agreement, which provides in relevant part: “In consideration of the foregoing services [rendered by Logix and enumerated in the agreement], and during the Term, EMI shall pay Logix a service fee equal to 20 percent of Net Sales processed through Logix’s call center. In addition, EMI shall pay Logix a percentage (the ‘Override’, starting at 5% as defined below) of the Total Net Revenue (‘TNR’). TNR is defined as Net Sales plus the total of EMI’s and EMI Affiliate’s receipts from all other sources from explicit version adult movies and related programming delivered by C-Band . . . .”
As far as an interpretation of the contractual provisions is concerned, Logix points out that the first sentence of section 4.5 of the agreement, which deals with service fees, is expressly limited to the “Term” of the agreement, but that the second sentence that governs “overrides” does not refer to the “Term” of the agreement. (See fn. 15, ante.) According to Logix, this means that service fees are to be paid during the “Term” of the agreement, and that override fees are to be paid without reference to the “Term,” i.e., they are to be paid even after the agreement was terminated. Factually, Logix relies on the testimony of Keith Howington that his understanding was that the override fees were to be paid as long as EMI was broadcasting the channels, and even after the termination of the agreement with Logix. Faherty, on the other hand, contends that section 4.5 can be only interpreted to provide that both the service fees and the override fees were due and payable solely during the “Term” of the contract, and that Howington’s subjective understanding to the contrary is irrelevant.
A discussion of the issue of contractual interpretation rests on the premises that: (1) broadcasts on these channels actually continued after January 2002 and (2) that EMI was liable for fees generated by these channels, which were broadcast by Playboy, and not Spice nor, of course, EMI.
In response to our request for briefing on the first of these two premises, the parties point to the testimony of James English, who was the president of Playboy Entertainment Group in 2001, and who testified during the trial of this case in May 2004. English testified that in July 2001 Playboy acquired three channels from Califa (“Hot Network,” “The Hot Zone” and “Vivid TV”) and added another channel, “Hot Net Plus,” to these offerings. English testified that all four channels were operating as of the time of his testimony and, when asked whether there were any plans to shut these channels down, English stated that there were no plans to terminate the operation of these channels.
Faherty’s critique of this testimony is that there is nothing to show that these channels would actually continue to be broadcast until January 2007, some three years after English testified, and that it was incumbent on Logix to produce probative evidence that these channels would be operated until January 2007. Logix contends that English’s testimony is substantial evidence that the channels continued to operate until at least January 2007.
We need not resolve this dispute, although we note that there is merit to Faherty’s view that testimony that there were no plans, as of 2004, to shut the channels down is not the same as evidence that the channels actually operated until at least January 2007. As the somewhat turbulent account of EMI’s and Logix’s activities attest to, this business appears too volatile to readily assume that there were no changes between May 2004 and January 2007 in the fortunes of these channels. Be that as it may, we do not decide this issue because we think that, even if it is assumed that the channels operated until January 2007, EMI cannot be held liable for fees generated by these channels.
We cannot agree with Logix that, simply because Playboy merged with Spice, Playboy became an “EMI affiliate” under the Logix-EMI agreement. It may well be, as Logix contends, that Spice’s obligations were not extinguished by its merger with Playboy. But it is not Spice’s obligations that are at stake here, but EMI’s. EMI, not Spice, was obligated to pay override fees to Logix for channels broadcast by EMI and EMI affiliates. The fact that Spice’s obligations were not extinguished by the merger -- assuming this to be the case -- does not mean that EMI’s obligations under the Logix-EMI agreement will continue as long as these four channels are broadcast by Playboy.
Neither logic nor a reasonable interpretation of the Logix-EMI agreement supports Logix’s position. Logically, if EMI has ceased to function or even ceased to exist, how can it have an “affiliate”? This ties in with the obvious point that EMI would hardly have contracted to obligate itself for massive payments for an unspecified term of years, generated by operations from which it derived not a cent of revenue and over which it had absolutely no control. “A contract must receive such an interpretation as will make it lawful, operative, definite, reasonable, and capable of being carried into effect, if it can be done without violating the intention of the parties.” (Civ. Code, § 1643.) In interpreting a contract, the court must avoid an interpretation that would make the contract harsh, unjust, inequitable and which would result in absurdity. (County of Marin v. Assessment Appeals Bd. (1976) 64 Cal.App.3d 319, 325.) An interpretation that would transfer the label of “EMI affiliate” to Playboy with the effect of imposing a liability in the millions on EMI without a cent of revenues to support such a liability is neither reasonable nor capable of being carried into effect.
Nor is there any support in the text of the Logix-EMI agreement that would transfer the “EMI affiliate” label to Playboy. The fact that Spice merged with Playboy does not bear on the interpretation of the Logix-EMI agreement. Logix does not refer us to any provision of the agreement itself that supports the conclusion that Playboy is an “EMI affiliate.”
There is a further pragmatic reason why Playboy cannot be considered an EMI affiliate. Playboy was in no sense a factor when the Logix-EMI agreement was entered into in 1997. Indeed, Playboy did not become a factor until July 2001, several months after EMI ceased operations, when Playboy acquired three channels from Califa (not from Spice) and added a channel on its own. To interpret the agreement to include Playboy as an “EMI affiliate” after the Logix-EMI agreement was terminated and after EMI itself had ceased operations simply makes no sense.
The operation of the “EMI affiliate” formula makes sense when it comes to the sale of Spice Hot by Spice, which took place in May 1998. Spice was designated in the Logix-EMI agreement as an “EMI affiliate.” When the sale took place, EMI was in existence and was operating, and the Logix-EMI agreement was in effect, and was also operating. Spice being an EMI affiliate, the sale of one of its assets logically (and contractually) produced revenues for Logix. Thus, as we have noted, the jury awarded Logix/Howingtons the sums of $1,715,134, which was described as the “Logix revenue participation in the sale of the Spice Hot channel to Califa under the terms of the original agreement” and $422,318, the total of the estimated override fees from the Spice Hot channel revenues. This is how the “EMI affiliate” formula was intended to function; it is noteworthy that in 1998, unlike in the post-January 2002 period, EMI was an operating entity and the Logix-EMI agreement was in effect.
We conclude that Playboy was not an “EMI affiliate” and that therefore broadcasts by Playboy after January 2002 are not covered by the Logix-EMI agreement.
Independently and additionally to the foregoing, we find that there is no evidence to support the jury’s conclusion that damages accrued for the five-year period commencing in January 2002 and ending in January 2007. We requested the parties to point us to evidence that supported the choice of a five-year term. The best that Logix can do is to state that, since the channels had been operated for 2 1/2 years when Playboy’s Mr. English testified in May 2004, the jury “could reasonably draw the inference that Playboy would continue to operate the channels for at least another 2 1/2 years.” But why exactly 2 1/2? Why not 3? Or 5? Or 1? An inference must rest on the evidence, not on speculative possibility or conjecture. (Louis & Diederich, Inc. v. Cambridge European Imports, Inc. (1987) 189 Cal.App.3d 1574, 1584-1585.) It is pure conjecture that the channels would broadcast for another 2 1/2 years, rather than 3 or 1, just to name two other purely conjectural possibilities.
Finally, the fact that expert Lorch stated that it was “accepted practice” to measure income streams in increments of five years has absolutely nothing to do with the facts of this case. The fact that Lorch was able to calculate the present value of override payments paid for a five-year period does not mean that there is evidence that the four channels in question would have been broadcast for precisely five additional years. In fact, Lorch calculated the present value of future override payments not only for five years, but alternatively for 10 ($16,043,368) and 15 years ($18,419,701) into the future, as well. The jury was left to pick between 5, 10 and 15 years of future override payments. The fact that the jury picked five years does not mean that there is evidence that supports this finding. Indeed, the arbitrary selection by Lorch of 5, 10 and 15 years indicates that these time periods do not correspond to any facts of record.
Unfortunately, only one conclusion is possible: presented with “income stream” determinations of 5, 10 and 15 years, without anything to connect these time periods to the facts of this case, the jury simply picked 5 years -- for a reason or reasons that elude us, as well as the parties, Logix included. This is the paradigm of a speculative damages award.
Logix contends that Faherty waived the foregoing issue since, as we noted in our original opinion, Faherty did not question that Playboy was an EMI affiliate. As an appellate court, we have discretion in the application of the doctrine of waiver. (Redevelopment Agency v. City of Berkeley (1978) 80 Cal.App.3d 158, 167.) Once we raised the issue, Faherty took the position that Playboy was not an EMI affiliate. In our view, it is not a close question whether Playboy was an EMI affiliate; yet, a very substantial award was predicated on the (erroneous) affirmative of this proposition. Under these circumstances, we decline to apply the doctrine of waiver to Faherty’s initial waiver of this issue.
Since there is no evidence to support the award of $10,943,759, it must be set aside.
4. Override Fees Were Due Only for Channels Operated Between July 2001 to January 2002 That Satisfied the Definition of “Explicit” Channels in the Logix-EMI Agreement
Section 1.1 of the Logix-EMI agreement provides that an “explicit network” “shall mean a television network whose programming consists primarily of explicit version adult motion picture and related programming. Explicit version adult movies and related programming is programming which depicts heterosexual and lesbian situations and nudity and which depicts actual penetration of body parts, erect genitalia and ejaculation.”
It is conceded that Hot Network and Hot Zone, two channels operated by Playboy between July 2001 and January 2002, did not depict ejaculation, while Spice Platinum and Hot Network Plus, also operated by Playboy during the same period, did and that, for this reason, the latter two channels qualify as “explicit” under section 1.5 of the Logix-EMI agreement.
Whether Spice Hot, which was sold in 1998 to Califa, depicted ejaculation and was therefore an “explicit” channel has turned out to be a contested factual issue. We take up this matter separately in part 5, post.
The issue that the parties present for decision is whether the phrase “which depicts actual penetration of body parts, erect genitalia and ejaculation” in section 1.5 requires all three, or whether the three sexual functions listed are alternatives, any one of which renders the production “explicit.” The interpretation chosen has a substantial effect, since the override fees generated by Hot Network and Hot Zone, which did not depict all three sexual functions, exceeded $1.6 million, while Spice Platinum and Hot Network Plus generated $226,750. The definition in question also affects the awards predicated on the sale of Spice Hot in 1998; as noted, these awards exceed $2.1 million to Logix and the Howingtons.
The trial court gave the jury the following special instruction: “In giving effect to the general meaning of a writing, particular words are sometimes wholly disregarded, or supplied, or transposed. Thus, ‘or’ may be given the meaning of ‘and,’ or vice versa, if the remainder of the agreement shows that a reasonable person in the position of the parties would so understand it.” The authority cited in support of this instruction is McNeil v. Graner (1949) 91 Cal.App.2d 858.
The instruction given to the jury is an incorrect statement of the law, and it is not supported by the opinion of the court in McNeil v. Graner, supra, 91 Cal.App.2d 858, 864.
The issue in McNeil v. Graner was the interpretation to be given to the word “of” in the written assignment of a royalty interest, when the assigned interest was made subject, among other things, to “one-eightieth (1/80) of its pro rata share of the costs of operation and maintenance.” (McNeil v. Graner, supra, 91 Cal.App.2d at p. 862, italics added.) The trial court “gave a literal construction to this clause and declared that it means that each unit holder is required to pay only one-eightieth of one-eightieth of the monthly expense.” (Ibid.) The appellate court held that this led to an absurd result, that the word “of” was obviously an error, and that the correct word was “or.” (Id. at pp. 862-864.)
The court in McNeil v. Graner made clear that the necessary predicate for disregarding, transposing or supplying another word for the one appearing in the writing is when the word in the writing is clearly inconsistent with the balance of the document and is therefore a mistake, as in McNeil, or when it is clear a word has been inadvertently omitted. (McNeil v. Graner, supra, 91 Cal.App.2d at pp. 863-864.) The starting point in every case is the language of the contract. If, as Civil Code section 1638 provides, the language of the contract is clear and explicit, and does not involve an absurdity, the words of the contract govern. The court in McNeil made this clear in its lengthy citation from Williston, which we set forth in the margin, and which now appears, with some changes in 11 Williston on Contracts (4th ed. 1999) section 32.9, pages 440-444. In Williston’s terms, it is only when “a portion of the writing [appears to be] useless or inexplicable” (see fn. 17, ante) that the court will consider changing or adding words in the writing.
Civil Code section 1638 provides: “The language of a contract is to govern its interpretation, if the language is clear and explicit, and does not involve an absurdity.”
“ ‘The court will if possible give effect to all parts of the instrument and an interpretation which gives a reasonable meaning to all its provisions will be preferred to one which leaves a portion of the writing useless or inexplicable; and if this is impossible an interpretation which gives effect to the main apparent purpose of the contract will be favored. Indeed, in giving effect to the general meaning of a writing, particular words are sometimes wholly disregarded, or supplied, or transposed. Thus, “or” may be given the meaning of “and,” or vice versa, if the remainder of the agreement shows that a reasonable person in the position of the parties would so understand it. Clerical or grammatical errors may be corrected; single or plural language may be treated as if it were the others; and other illustrations might be given of the same principle.’ The word ‘and’ is often substituted for the word ‘or’ in order to arrive at the true meaning of a statute or contract.” (McNeil v. Graner, supra, 91 Cal.App.2d at p. 864.)
The current edition of Williston states the same point as follows: “The law prefers an interpretation which gives effect to all parts of the contract rather than one which leaves a portion of the contract ineffective or meaningless.” (11 Williston on Contracts, supra, § 32.9, p. 440.)
It is clear that the special instruction that was given is not limited by the important proviso that it is only when a word appears to be in error, as in McNeil v. Graner, or is missing that one can proceed to consider substituting the correct word for the incorrect one, or to consider supplying a missing word. There is no carte blanche to “wholly disregard” or supply or transpose words unless it is apparent that a word used in the document is wrong or is missing. This squares with the basic principle that “[w]here the language of a contract is clear and not absurd, it will be followed.” (1 Witkin, Summary of Cal. Law, supra, Contracts, § 741, p. 827 [citing authorities, inter alia Civ. Code, § 1638].)
It does not appear that the word “and” in the phrase “which depicts actual penetration of body parts, erect genitalia and ejaculation” (italics added) is, in light of the terms of the agreement, demonstrably a mistake, as the word “of” was obviously in error in McNeil. While “or” is an alternative to “and,” “or” is not the word that was used in the agreement. The Logix-EMI agreement is 26 pages long and a relatively complex and sophisticated document. Parties who are capable of negotiating and producing such a document are capable of knowing when they want to use “and” and when they prefer “or.” Since the definition of “explicit” was an important aspect of the document, it may safely be assumed that some thought and care went into the phrasing of that definition.
It follows that the trial court erred in initially determining that an ambiguity existed in the language of the contract. “The trial court’s determination of whether an ambiguity exists in a contract is a question of law, subject to independent review on appeal.” (1 Witkin, Summary of Cal. Law, supra, Contracts, § 741, p. 828.) The phrase “which depicts actual penetration of body parts, erect genitalia and ejaculation” is not ambiguous, nor does the word “and” render it ambiguous. Contrary to Logix’s argument, the question is not whether all the circumstances listed in section 1.5 are to be treated in the conjunctive, but whether the single word “and” in the quoted phrase is incorrect, and whether “or” should be substituted for “and” in this phrase.
Logix claims that Faherty’s insistence that “and” in this phrase is a conjunctive means that all of the elements listed in section 1.5 must be present before a program is explicit, i.e., the program must include heterosexual and lesbian situations and nudity etc. We disagree. The only word at issue is “and” in the phrase “which depicts actual penetration of body parts, erect genitalia and ejaculation.”
Logix is also in error in ascribing to two decisions of our Supreme Court the purported holding that “and” and “or” are freely interchangeable in a document or in a statute, and that the courts are free to substitute one for the other. Neither Arnold v. Hopkins (1928) 203 Cal. 553 nor Universal Sales Corp. v. Cal. etc. Mfg. Co. (1942) 20 Cal.2d 751 stand for such a proposition, but both cases are in accord that when it appears that one of these words is in error, the other may be substituted.
Finally, it is irrelevant that there is evidence that industry “standards,” to use Logix’s term, have it that programming is explicit when one of the three sexual activities is shown, nor is CEO Howington’s “understanding” of these industry “standards” material. It is axiomatic that the terms of an agreement may be explained or supplemented, but not contradicted, by a course of dealing or a usage of trade. (Code Civ. Proc., § 1856, subd. (c); see generally 2 Witkin, Cal. Evidence (4th ed. 2000) Documentary Evidence, § 85, pp. 206-207.)
Accordingly, the award of $1,604,751 in override fees for channels shown between July 2001 and January 2002 that did not depict all three sexual acts must be set aside. Since this sum was awarded to Logix as well as the Howingtons, this sum must be deducted from both awards.
5. The Awards of $2,137,452 Based on Spice Hot Require a New Trial
After we received the replies from the parties on the questions we propounded on granting the petitions for rehearing, we advised counsel that we were considering whether to reduce the judgment by a further $2,137,452 on the ground that Spice Hot was not an explicit channel. We invited Logix to file a letter brief on this issue, which was done. As of the time we issued this invitation, Faherty had stated in his opening brief that it was undisputed that Spice Hot was not an explicit channel and Logix had not challenged this assertion.
We reiterate that we include the Howingtons in our references to Logix.
In their letter brief of August 1, 2007 (hereafter August brief), Logix, citing to the record as we had requested, asserted for the first time that Spice Hot was an explicit channel since it showed all three sexual functions. On August 7, 2007, Faherty sought leave to file a letter brief (hereafter August reply brief) in response and we granted leave to file this brief.
In his response to Logix’s August brief, Faherty contends, in the first place, that, by failing to protest Faherty’s assertions in his opening brief that it was conceded that Spice Hot was not explicit, Logix has waived this matter. As we noted in the instance of Faherty’s initial concession that Playboy was an EMI affiliate, we have discretion in the application of the doctrine of waiver. (Text, ante, p. 26.) Just as Faherty clearly withdrew his initial concession once we raised the issue of Playboy’s status, when we raised the issue of damages predicated on Spice Hot specifically, Logix adopted the position that Spice Hot is explicit. An award of over $2.1 million rests on this determination; it would not be appropriate to adopt a strict view of waiver. Accordingly, as we did with Faherty, we decline to apply this doctrine to Logix’s initial waiver of this issue.
The factual controversy that has now developed is that Logix points to Howington’s testimony wherein he stated that ejaculation, in addition to the other two sexual functions, was shown on Spice Hot, which would make this channel explicit. Faherty concedes that this was Howington’s testimony but points out that Howington also stated that this was “very rare,” a qualification that Logix, in turn, concedes Howington made. Faherty’s August reply brief goes on to contend that the governing provision of the Logix-EMI agreement defines an explicit network that consists “primarily” of explicit programming and that if ejaculation was “very rare,” as Howington testified, it was not “primarily” explicit programming.
Considering the sum of money that hinges on this factual issue, we find Howington’s testimony inadequate. At first, when asked whether Spice Hot showed ejaculation, he testified that among the films that he reviewed, “[m]ost of them did.” Later, while still under direct examination, he backtracked. When asked by his counsel whether there was something about his prior testimony that he wanted to clear up, he replied: “Yes . . . . [¶] . . . [¶] . . . I may have gotten tangled up in my discussion of that. The Spice Hot channel and one other channel show actual penetration, and they show male genitalia. I have seen ejaculation, but it’s very rare.” Under cross-examination, Howington opined that for programming to qualify as “primarily” explicit, 50 percent or more of the programming would have to come within the definition of explicit programming, which meant that a channel that showed all three functions, but only occasionally or less than 50 percent of the time, would not be “primarily” explicit. Predictably, when Faherty was asked whether Spice Hot programming showed ejaculation, he answered: “I don’t believe it did, no.”
The flaw in all of this is that it is not the best evidence of what Spice Hot actually showed. Rather than the best evidence, which is Spice Hot programming, we have Howington’s (wavering) opinion of the contents of Spice Hot programming, his opinion of what “primarily” means and Faherty’s opinion that ejaculation was not shown. Thus, both sides ask us to pick and chose the testimony that favors them and to disregard testimony that is unfavorable. Even if it were our function to find facts, and that decidedly is not our function, our findings would not engender a great deal of confidence based, as they would be, on two witnesses’ opinions about what they saw.
We think it is the function of a well-instructed jury to determine whether Spice Hot showed “primarily” explicit programming. For the reasons we have explained in part 4, the jury in this case was not well instructed since they could conclude that Spice Hot was explicit as long as it showed any one of the three sexual functions. Given Howington’s wavering testimony about ejaculation being shown on Spice Hot, and Faherty’s belief that this function was not shown on Spice Hot, the jury could conclude, based on the instructions given, that this function was not shown and still find that Spice Hot was explicit. In fact, it is reasonable to conclude that that is exactly what the jury did. Thus, we find it reasonably probable that the instructions that allowed the application of an erroneous theory actually misled the jury. The error was therefore prejudicial. (Kinsman v. Unocal Corp. (2005) 37 Cal.4th 659, 682.)
Logix’s contention that we must presume that the jury found all the facts necessary to support the judgment, i.e., that we must presume that the jury found that all three sexual functions were shown in Spice Hot programming, is a misperception of the test of prejudice on appeal that is applied to instructional error. As Faherty correctly points out, the general rule that Logix relies on does not apply when the contention on appeal is that error in the instructions misled the jury. In such an instance the evidence is viewed in the light most favorable to the appellant. (Eisenberg, et al., Cal. Practice Guide: Civil Appeals and Writs (The Rutter Group 2006) ¶ 8:149, p. 8-99 (rev. #1 2006).)
Accordingly, we conclude that the award of $2,137,452 based on the sale and operation of Spice Hot must be vacated and that this issue must be submitted to a finder of fact who will determine, under the correct legal principles, whether Spice Hot was primarily explicit programming.
6. Logix’s Fraud and Conspiracy Claims Are Barred by the Statute of Limitations
Prior to trial, the trial court granted Faherty’s motion for a judgment on the pleadings on Logix’s causes of action for fraud and conspiracy. This ruling was based on the finding that these causes of action were barred by the statute of limitations.
The cause of action for fraud alleges that Faherty and others made representations to Logix and the Howingtons in November 1996 that Logix and the Howingtons would participate in profits from the explicit adult entertainment business, in return for entering into what eventually became the Logix-EMI agreement. Under that agreement, Logix transferred two adult entertainment channels to Faherty and others. These representations were false in that Faherty and his cohorts did not intend, and in fact did not, share the increased profits with Logix and the Howingtons. The complaint goes on to allege that in January 1998, and then again in April 1998, Faherty and others coerced Logix to enter into amendments to the Logix-EMI agreement, which reduced Logix’s revenues, by the false statements that decreasing revenue required these amendments.
The trial court found that Logix/Howingtons were on “inquiry notice as of January 1998” when the renegotiation of the Logix-EMI agreement commenced that Faherty and others did not intend “to honor the allegedly fraudulent promises that they had made to induce Plaintiffs to enter into the [Logix-EMI] Agreement, since Plaintiffs suffered injury as of that date from [EMI’s] threatened termination of the contract and having renegotiated their contract under coercion and without consideration.” Thus, the trial court concluded that the three-year statute of limitations on fraud had run when the original complaint was filed in May 2001.
On appeal, Logix contends that there were three acts of fraud that had nothing “to do with fraud in inducing the plaintiffs to enter into the initial contract.” The statements made in January 1998 that were false were the misrepresentations that the channel Spice Hot was not explicit (Howington learned this was false in 2001), and the representation made in early 2001 that EMI would indemnify Logix for its credit card liability.
We find these arguments to be without merit.
First, and most important, the principal allegation of the cause of action for fraud is that Faherty and others fraudulently induced Logix/Howingtons to enter into the Logix-EMI agreement. It appears that Logix has abandoned this claim as time-barred, and for the reasons set forth in the trial court’s ruling.
Second, viewing the renegotiations of January 1998 as an event apart from entering into the Logix-EMI agreement, those events took place more than three years before the complaint was filed. It was the renegotiation itself that put Logix on “inquiry notice,” as the trial court found. Moreover, the cause of action for fraud, as set forth in the operative complaint, does not allege that the statements made in January 1998 were misrepresentations. Paragraph 32 of the complaint, which is incorporated by reference into the fraud cause of action, which is set forth in paragraphs 59-69, only states that the demands to amend the Logix-EMI agreement were coercive, not that they were fraudulent.
Third, the cause of action for fraud does not allege that Faherty and/or others falsely represented that Spice Hot was not an explicit channel. The complaint does allege that Logix/Howingtons were not paid override fees generated by Spice Hot; as alleged, this is a breach of contract, and not a fraud claim. It follows that the usual allegations of fraud (e.g., falsity, reasonable reliance) do not appear with reference to this claim.
Fourth, the fraud cause of action alleges that under the Logix-EMI agreement “and by subsequent written assurances” EMI represented that it would indemnify Logix for credit card liability in the amount of $4.5 million. The complaint goes on to allege that EMI failed to do so. Once again, this is an allegation of a breach of contract, not a fraudulent representation. As before, the usual allegations of fraud (e.g., falsity, reasonable reliance) do not appear with reference to the credit card liability issue.
In sum, Logix, having abandoned the cause of action for fraud that is alleged in the complaint, has attempted to manufacture a new cause of action on appeal. We are not persuaded by this effort.
7. Logix’s Settlement with Spice for $8,032,500 Should Be Credited Against the Balance of the Judgment
Faherty requests, and Logix does not object, to crediting the settlement of $8,032,500 paid by Spice to Logix against the judgment on appeal.
8. Reductions in the Judgment and a New Trial; the Judgment Is Affirmed in Part
The verdict of $18,084,612 in favor of Logix must be reduced by $10,943,759 and by further $1,604,751 (Hot Network and Hot Zone) for a total reduction of $12,548,510 leaving a balance of $5,536,102. In the instance of the Howingtons, their recovery of $4,457,234 must be reduced by $1,604,751, leaving a balance of $2,852,483.
The question whether Spice Hot was primarily explicit programming is remanded with directions for a new trial on this issue.
In all other respects, the judgment is affirmed.
The settlement of $8,032,500 paid by Spice must be credited against the judgment that will ultimately be entered.
DISPOSITION
The judgment entered on August 2, 2004, is affirmed to the extent it awards $5,536,102 to Logix and $2,852,483 to the Howingtons. In all other respects, the judgment is reversed and the case is remanded with directions to conduct a new trial, under principles that conform to this opinion, on the question whether the Spice Hot channel was primarily explicit programming. The parties are to bear their own costs on appeal.
We concur: COOPER, P. J. RUBIN, J.