Opinion
C083975
12-06-2018
PROTECH SERVICES, INC., Plaintiff, Cross-defendant and Appellant, v. JAMES GILLETTE et al., Defendants, Cross-complainants and Respondents.
NOT TO BE PUBLISHED California Rules of Court, rule 8.1115(a), prohibits courts and parties from citing or relying on opinions not certified for publication or ordered published, except as specified by rule 8.1115(b). This opinion has not been certified for publication or ordered published for purposes of rule 8.1115. (Super. Ct. No. CV-CV-12-0000527)
Protech Services, Inc., sued its former chief financial officer (CFO) James Gillette, in both his individual capacity and as trustee of a family trust that had invested in Protech. The lawsuit made various claims, including breach of fiduciary duty, breach of loyalty, fraud and concealment, and conversion. Protech alleged Gillette deliberately reduced cash receipts and profits, embezzled money, overstated business expenses, and misrepresented Protech's financial position to the Board of Directors in a plan to take over the company.
Gillette asserted as an affirmative defense that his separation agreement (the agreement), negotiated after he was fired from Protech, contained a mutual general release of all known and unknown claims.
Over Protech's initial objection, the trial court bifurcated the trial and first held a court trial on Gillette's affirmative defense of release and Protech's counter thereto that because the agreement was obtained by fraud, the agreement (and the release therein) should be rescinded. The court found the agreement--including its release provision--was valid and enforceable. It further found Protech had knowledge of all material facts when it executed the agreement, thus Protech had failed to prove fraud in the inducement. The court found the release applied to Gillette both individually and as trustee of the family trust. Because Gillette was successful in his affirmative defense, the second portion of the bifurcated trial, which was anticipated to be a jury trial, did not go forward, and the court awarded Gillette attorney fees pursuant to an indemnity provision contained in his employment contract.
On appeal, Protech does not challenge any of the factual findings made by the trial court in the court trial. Instead, Protech contends it was error to deprive it of a jury trial in the first instance. Protech further contends the court improperly limited the evidence of fraud to misrepresentation only, preventing evidence of fraudulent nondisclosure, and that it was error to release Gillette in his capacity as trustee of the family trust. Finally, Protech contends there is no basis for attorney fees under the indemnification provision in the employment contract, Corporations Code section 317, or its bylaws.
Undesignated statutory references are to the Corporations Code.
We hold that Protech was not entitled to a jury trial on release and rescission. Protech waived any factual issues as to the release and its rescission action was equitable, as we will explain. We find no merit in Protech's contention that the trial court improperly limited the evidence of fraud; however, we agree that the court erred in releasing Gillette in his capacity as trustee. Further, despite the fact that Gillette waived and released any right to indemnity under his employment contract, he is entitled to mandatory indemnity under section 317 for fees incurred in establishing the validity of the release and defending against rescission due to fraud. We remand for an apportionment of attorney fees for those two purposes.
FACTUAL AND PROCEDURAL BACKGROUND
Gillette's Employment with Protech
Protech is a company founded by a group of college friends in the 1990's, with Christopher Ott as the chief executive officer. Protech began in construction services and moved into erosion control, providing sediment removal tanks developed by Ott in 1998. Initially, Protech focused its erosion control business on the housing industry, but when the housing industry entered a recession in 2007, it turned to public works and worked on many projects for CalTrans. From at least 2007 on, Protech had a serious cash flow problem and heavy debt; by the fall of 2009 it was having difficulty meeting its payroll.
In March 2008, Protech hired Gillette as chief financial officer (CFO) and put him on its Board of Directors. Gillette's employment contract was for a three-year term and provided for bonuses, stock options, indemnification, and other benefits. Gillette had invested in Protech through his individual retirement account (IRA), and as trustee of the Gillette Family Revocable Bypass Trust.
Gillette's Termination
Gillette and Ott had a poor working relationship. Matters came to a head in April 2010 when Gillette approached Paul Cocotis and Shimmick Construction Company about investing in Protech without telling Ott about the meeting. Following a major argument, Ott fired Gillette. In Ott's opinion, Gillette could be fired for cause because he had exercised poor judgment, was insubordinate, and did a poor job managing accounts. During Gillette's time at Protech, there were significant billing problems.
Contrary to Ott's advice, the Board of Directors did not fire Gillette for cause. Instead, the (separation) agreement was negotiated. Randall Stoller, who became CFO after Gillette, served as an intermediary in negotiating the agreement. He was concerned that Gillette might sue Protech for the money owed to him under his employment contract and prepared a litigation risk assessment for the Board of Directors. After 60 to 90 days of negotiation, the agreement was signed in early July 2010. Effective April 16, 2010, the agreement provided for certain salary, vacation, 401(k) contributions, and expense reimbursements to Gillette. The agreement further provided that other than the consideration cited in the agreement, "no representations, promises, or inducements have been made by any party." It also contained a mutual release of all claims, known or unknown, "to the effective date of this agreement," and a waiver of the protections of Civil Code section 1542, which provides that a general release does not extend to unknown claims. Finally, it also provided: "You also hereby waive and release in perpetuity any and all other employment rights or claims that you may have against the other Party."
Protech's Discovery of Gillette's Alleged Wrongdoing
After the agreement was signed, Protech employee Henry Cifelli disclosed to Stoller a conversation between Cifelli and Gillette the previous fall. According to Cifelli's notes, Gillette wanted to rid the company of the CalTrans public construction work and focus on the agricultural water filtration system side of the company, where "big money" could be made. Gillette believed the company was not managed properly and was concerned about Ott's management. Gillette had a considerable stake in Protech, $500,000, and believed Ott needed him more than he needed Ott. Gillette told Cifelli not to be concerned with any shakeup in the next two to six months; Cifelli's position was secure. Gillette seemed confident that when the shakeup occurred he could take his convertible bonds (presumably the IRA and trust investment) and 10 percent, although Cifelli wondered how Gillette could take money when Protech had none. Stoller originally did not think much about Cifelli's notes, but later brought them to Ott's attention. Ott was concerned and upset.
In March 2011, Protech sent Gillette a demand letter for over $4,000,000. The letter stated an internal review of accounting had revealed that Gillette had intentionally failed to record and maintain Protech's financial data in a reasonably appropriate manner and had committed theft, concealment, and fraud, and had intentionally devalued the company for his own benefit. In October 2011, Protech filed suit against Gillette and others.
Protech's Lawsuit
The third amended complaint and operative pleading on appeal alleged Gillette fabricated financial reports to establish that Ott was incompetent and replace him. The complaint alleged Gillette had committed numerous improprieties of which Protech was unaware when it signed the agreement. The sixth cause of action for fraud and concealment alleged Gillette (and John Coon) engaged in efforts to destabilize Protech and drive it into insolvency to convince the Board of Directors to fire Ott and/or have the Gillette family trust purchase stock at a discount and these defendants intentionally concealed material facts from Protech. It further alleged Protech was unaware of Gillette's acts at the time of the agreement and Gillette hid his acts by producing inaccurate financial reports, miscoding information, obstructing auditors, failing to obtain authorization for expense reimbursements, and segmenting accounting tasks. The prayer sought damages of over $5,000,000 plus interest, injunctive relief to prevent disclosure or use of confidential information, a constructive trust, disgorgement of wrongfully obtained benefits, rescission of the agreement, restitution, punitive damages, and attorney fees.
Gillette raised 17 affirmative defenses in his answer. The final defense alleged he had been released (by the agreement) from all claims in Protech's complaint. He also sought attorney fees. He filed a cross-complaint against Protech, asserting claims for breach of both his employment contract and the agreement and for indemnity. He sought indemnity based on the contract and "impliedly based on the facts of the underlying matter." He also moved to sever the issue of the release and try it first. The trial court denied that motion.
The Bifurcated Trial on the Release
Before trial, Gillette filed an in limine motion for a bifurcated court trial on the release as an affirmative defense pursuant to Code of Civil Procedure section 597 (which specifically provides that a court may "proceed to the trial of the special defense or defenses before the trial of any other issue in the case"). Gillette argued Protech was not entitled to a jury trial on the release or the issues of breach of fiduciary duty, breach of loyalty, or an accounting. Gillette argued Protech's claim for rescission was equitable rather than legal.
In opposition to this motion, Protech argued Gillette was simply rearguing his motion to sever that the court had previously denied, and separate trials were not in the interests of justice because bifurcation would require Protech to put on its case twice. Protech argued it was entitled to a jury trial because the issue of whether its claims were within the scope of the release was a question of fact for the jury. In response to Gillette's assertion that the rescission claim was equitable, Protech asserted that it did "not have a claim for rescission." Instead, Protech claimed the release was invalid because it had been procured by fraud. In a supplemental brief in opposition to the motion in limine, Protech argued that whether the undisclosed facts were material was a question for the jury.
The trial court granted the motion for a bifurcated trial on the affirmative defense of release and indicated it would be a bench trial. The court permitted Protech to try its claim for rescission concurrently with the release defense.
The trial court heard six days of testimony and then closing arguments a few weeks later. The court found the agreement was valid and enforceable, and its release provision released Gillette from all known and unknown claims in both his individual and trustee capacity. The court found Protech's financial and accounting information was open and available to Protech before the agreement was in place and Protech and Ott knew all material facts about Protech's finances and accounting before signing the agreement; thus, the agreement was not the object of fraud or concealment. The Cifelli notes did not show fraud or conspiracy. The court found Gillette's alleged deficiencies as CFO were not the result of fraud, but rather were the result of a number of factors, many of which had nothing to do with Gillette. Further, the court found Protech failed to prove any fraud or embezzlement in Gillette's expense reports.
The court granted judgment for Gillette and the trust.
Protech proceeded to trial against other defendants and has included various documents, including judgments, about these other cases in the appendix and referenced them in its opening brief. Gillette has moved to strike these portions of the record and the opening brief on the grounds that these matters are outside the record before the trial court and are irrelevant. We grant the motion to strike and will disregard the improperly submitted materials and briefing thereon. "As a general rule, documents not before the trial court cannot be included as part of the record on appeal and thus must be disregarded as beyond the scope of appellate review. [Citations.] Likewise disregarded are statements in briefs based on matter improperly included in the record on appeal. [Citations.]" (Pulver v. Avco Financial Services (1986) 182 Cal.App.3d 622, 632.)
In posttrial proceedings, Gillette requested attorney fees. He argued he was entitled to recover fees under the indemnity provisions of Protech's bylaws and his employment contract, as well as under section 317. The court awarded Gillette $715,770 in attorney fees under the indemnity provision in the contract, finding the contract was not superseded by the agreement.
DISCUSSION
I
Denial of Jury in the Bifurcated Trial
Protech contends the trial court erred in holding that Protech had no right to a jury trial on its claim of rescission. Relying on NMSBPCSLDHB v. County of Fresno (2007) 152 Cal.App.4th 954 (NMS), Protech argues its rescission claim was legal, not equitable, because it sought only return of its consideration under the agreement. Protech asserts the alleged error in denying it a jury trial is reversible per se.
A. Waiver of Jury Trial or Failure to Demand a Jury
Gillette contends Protech waived its right to a jury, as shown by comments after trial. Before closing argument but after presentation of the evidence to the court, counsel for Protech appeared to thank the court for requiring a bifurcated court trial. Counsel told the judge she had "envisioned originally presenting rescission at the jury trial of this matter and had not considered the notion of it proceeding in the bifurcated mode." She now believed case law supported "that path." Gillette contends that by making these comments to the judge, Protech agreed the bench trial was legally correct and forfeited any challenge thereto.
As Protech points out, the right to a jury in a civil case can be waived only as set forth in Code of Civil Procedure 631, subdivision (f). (Cooks v. Superior Court (1990) 224 Cal.App.3d 723, 727.) Agreement after-the-fact is not one of the statutorily approved ways to waive a jury.
Although there is a constitutional right to a jury trial, a jury must be demanded. (Conservatorship of Joseph W. (2011) 199 Cal.App.4th 953, 968 and cases cited therein; see also Code Civ. Proc. § 631, subd. (f)(4).) Protech made an apparently untimely demand for a jury, but the trial court denied a motion to strike the demand, based on the fundamental right to a jury and the untimeliness of the motion to strike. Although Protech demanded a jury, it is not immediately clear whether that demand encompassed the first portion of the bifurcated trial, regarding the agreement and release. Even while the court trial proceeded, it was anticipated there would be (or at least might be) a subsequent jury trial, as the court and the parties discussed when jury selection would occur.
In his motion in limine seeking a bifurcated trial on the release and equitable claims of fiduciary duty, breach of loyalty, and accounting, Gillette argued there was no right to a jury. Gillette cited to NMS, supra, 152 Cal.App.4th 954, and argued Protech was not seeking return of its consideration, so the rescission claim was equitable. In opposition, Protech did not address NMS, but instead declared--contrary to its pleading--that it was not claiming rescission, because the release was obtained by fraud and thus invalid. It argued the gravamen of its claims was legal, and if the claims were equitable, the court should use an advisory jury. It argued against trying the release issue first. In supplemental briefing, Protech argued it was entitled to a jury trial on the scope of the Civil Code section 1542 waiver (a position it later abandoned) and whether Gillette's breach of fiduciary duties and material nondisclosures vitiated the waiver.
Protech later told the trial court the issue of the release should go to jury trial because the causes of action for fraud and breach of fiduciary duty were inextricably interrelated to the release. After the court ruled it would bifurcate the trial and hear the bench trial first, Protech agreed that rescission was equitable, but made a confusing argument that instead of rescission, the void release should be severed. The court responded the rescission claim could be tried concurrently with the special defense of release, but it would be a bench trial.
Protech's position was a moving target. While at one point it claimed it was entitled to a jury trial on the release, at other times it simply opposed the bifurcation because it wanted a jury, or recognized that rescission was equitable and walked back its claim for rescission or sought another remedy, all in order to qualify for a jury trial. Coupled with its seeming posttrial (but pre-verdict) acceptance of the trial court's chosen process, we do not agree with Protech that it "adamantly asserted its right to a jury trial on rescission of the [agreement]." It did not raise the argument it now makes on appeal that it was entitled to a jury trial under NMS, supra, 152 Cal.App.4th 954, although Gillette had relied on that case in arguing there was no right to a jury trial. Nor did Protech seek a writ of mandate to secure a jury trial. (See Shaw v. Superior Court (2017) 2 Cal.5th 983, 992.) On this mixed record it is difficult to fault the trial court if it failed to recognize that Protech was demanding a jury for the first portion of the bifurcated trial.
Nonetheless, because Protech had made a demand for a jury, did not expressly waive any right to a jury trial, and a jury trial is a fundamental constitutional right, we next consider Protech's contention that it had a right to a jury trial.
B. Right to Jury Trial
"The right to a jury trial is guaranteed by our Constitution. (Cal. Const., art. I, § 16.) We have long acknowledged that the right so guaranteed, however, is the right as it existed at common law in 1850, when the Constitution was first adopted, 'and what that right is, is a purely historical question, a fact which is to be ascertained like any other social, political or legal fact.' [Citations.] As a general proposition, '[T]he jury trial is a matter of right in a civil action at law, but not in equity.' [Citations.]" (C & K Engineering Contractors v. Amber Steel Co. (1978) 23 Cal.3d 1, 8 (C & K Engineering).)
" ' "If the action has to deal with ordinary common-law rights cognizable in courts of law, it is to that extent an action at law. In determining whether the action was one triable by a jury at common law, the court is not bound by the form of the action but rather by the nature of the rights involved and the facts of the particular case—the gist of the action. A jury trial must be granted where the gist of the action is legal, where the action is in reality cognizable at law." ' [Citation.] On the other hand, if the action is essentially one in equity and the relief sought 'depends upon the application of equitable doctrines,' the parties are not entitled to a jury trial. [Citations.] Although we have said that 'the legal or equitable nature of a cause of action ordinarily is determined by the mode of relief to be afforded' [citation], the prayer for relief in a particular case is not conclusive [citations]. Thus, 'The fact that damages is one of a full range of possible remedies does not guarantee . . . the right to a jury. . . .' [Citation.]" (C & K Engineering, supra, 23 Cal.3d at p. 9.)
In C & K Engineering, the complaint purported to seek damages for breach of contract, an action at law. But our Supreme Court held there was no right to a jury because the relief sought was available only through the application of equitable principles, namely promissory estoppel. (C & K Engineering, supra, 23 Cal.3d at p. 9.) The gist of the action was equitable. (Id. at p. 11.)
Here, the trial court broadly declared that a trial on an affirmative defense tried separately under Code of Civil Procedure section 597 is necessarily a bench trial. "[A] special affirmative defense is a Bench trial, even if it involves issues that, if brought [in a complaint], would go to a jury. [¶] It's a special affirmative defense. That's what a Judge does." As we explain, this is not always correct.
In Windsor Square Homeowners Assn. v. Citation Homes (1997) 54 Cal.App.4th 547, defendants asserted a res judicata defense in a negligence action. The court bifurcated the special defense and tried it first without a jury. On appeal, plaintiff contended it had a right to a jury trial on the res judicata defense. The appellate court found it well settled that the facts underlying res judicata are tried to the court because while there were mixed determinations of law and fact, the determinations were primarily legal. (Id. at p. 557.) In dicta, the court said, "we remain unconvinced that there is a jury trial right on affirmative defenses that can be tried separately and first. We find no California authority that stands directly or indirectly for the proposition that there is such a jury trial right. All the authority we have discovered and exhaustively described, assumes, without much analytical discussion, that such factual issues are naturally tried to the court. Indeed we think this is proper." (Id. at p. 558.)
In Cornette v. Dept. of Transportation (2001) 26 Cal.4th 63, our Supreme Court considered whether there was a right to a jury in the bifurcated trial on the affirmative defense of design immunity. The court concluded, "where triable issues of material fact are presented, as they were here, a plaintiff has a right to a jury trial as to the issues involved in loss of design immunity." (Id. at p. 67.) The Cornette court found Windsor Square "quite inapposite" because unlike res judicata, the issues involved in design immunity, such as whether the public entity had notice of the dangerous condition and had a reasonable time to remedy it, were not solely legal determinations. (Id. at pp. 76-77.)
Thus, the first half of a bifurcated trial under Code of Civil Procedure section 597 can be a jury trial; it depends on what the special defense is. Indeed, section 597 expressly refers to a jury verdict: "the court may, . . . proceed to the trial of the special defense or defenses before the trial of any other issue in the case, and if the decision of the court, or the verdict of the jury, upon any special defense so tried . . . is in favor of the defendant pleading the same, judgment for the defendant shall thereupon be entered . . . ." (Italics added.)
In Windsor Square and Cornette, the issue of right to a jury trial depended on whether the questions presented were questions of fact or law, not whether the action was legal or equitable in nature. Here, the issue of the release involved purely legal questions. Protech told the court it was not challenging the scope or application of the release; rather, its position was that the release was unenforceable because it was fraudulently induced. The fraud claim presented factual questions. Whether there was a right to a jury trial depended on whether Protech's counter to Gillette's defense of the release--rescission of the agreement due to fraud--was a legal or equitable action.
The question of whether there is a right to a jury in an action for rescission was before the appellate court in NMS, supra, 152 Cal.App.4th 954. There, the plaintiff sued for breach of contract and rescission of a sale of land; it was not seeking a return of the property it sold, but a monetary recovery based on lost profits. The trial court dismissed the cause of action for breach of contract and, finding the rescission action equitable, denied NMS's demand for a jury on the claim for rescission. (Id. at pp. 957-958.) In determining whether the plaintiff was entitled to a jury trial, the reviewing court looked to the history of rescission actions as set forth in Runyan v. Pacific Air Industries, Inc. (1970) 2 Cal.3d 304 (Runyan).
Prior to 1961 there were two methods in California to obtain rescissionary relief, one legal and one equitable. (Runyan, supra, 2 Cal.3d at pp. 311-312.) The first (legal) method provided that in specified circumstances a party to a contract could give notice of rescission and offer to restore everything of value he had received. "Having rescinded the contract by his own act, the rescinding party then brought an action to enforce the out-of-court rescission. [Citation.] Such action was considered to be one at law brought on the implied promise on the part of the nonrescinding party to repay or return the consideration received. [Citation.] 'In reality, it is an action in which the law, in order to prevent the unjust enrichment of defendants from the property of plaintiff, itself implies a promise to repay the sum demanded. In other words, it is an action in assumpsit upon a promise implied by law.' [Citation.]" (Id. at p. 312.)
The second method of rescission (equitable) was an action for judicial rescission. "[T]his method was viewed as an action for specific judicial relief for the wrong giving rise to the right of rescission, and was deemed equitable in nature." (Runyan, supra, 2 Cal.3d at p. 312.)
In 1961, the Legislature made several changes to these procedures, in effect abolishing the action for judicial rescission, but the legislative changes did not eradicate the substantive differences between the two prior procedures. (Id. at pp. 312-313.) Under the prior out-of-court rescission procedure, the action at law, recovery was restricted to the consideration given by the rescinding party and no damages were allowed. (Id. at p. 314.) Damages were allowed in equitable judicial rescissions because " 'in such actions the court should do complete equity between the parties' and to that end 'may grant any monetary relief necessary' to do so." (Id. at p. 316.)
Based on the Runyan discussion of the historical basis of rescission actions, the relief available in each, and the legislative changes, the NMS court concluded that if a rescission action sought recovery of something other than the return of the consideration paid, it is an equitable action. (NMS, supra, 152 Cal.App.4th at pp. 963, 966.) Because NMS sought damages for lost profits rather than the return of the land, it was an equitable action and thus properly denied a jury. (Id. at p. 956.)
C. Analysis of Right to Jury Trial in this Case
Relying on NMS, supra, 152 Cal.App.4th 954, Protech argues it was entitled to a jury because its rescission claim was legal rather than equitable. Protech contends the rescission claim sought only a holding that the release was void and return of the monetary consideration it had paid under the agreement. Gillette argues that under the reasoning of NMS, the rescission claim was equitable because Protech sought rescission to pursue damages other than the return of its consideration.
In the court trial on the release and rescission, Protech did not seek return of the consideration for the agreement or any other damages. Protech offered no evidence as to what that the consideration for the agreement was, nor did counsel request its return or even mention it in closing argument. This was not a case like NMS where resolution of the request for rescission resolved the case.
Although, in NMS, the complaint contained a "cause of action" for rescission (NMS, supra, 152 Cal.App.4th at p. 956), rescission is not a cause of action; it is a remedy. (Nakash v. Superior Court (1987) 196 Cal.App.3d 59, 70.) Here, Protech sought rescission as one remedy for Gillette's alleged fraud and concealment. The complaint alleged Gillette's fraudulent conduct caused damages, including but not limited to: (1) monies paid to Gillette pursuant to the agreement; (2) monies paid to third party auditors to review and reconstruct Protech's financial records; (3) monies paid on undocumented debt; and (4) monies that were uncollected because Protech ceased operations due to financial distress. Protech sought both legal and equitable relief based on Gillette's alleged fraud. "It is well established that, in a case involving both legal and equitable issues, the trial court may proceed to try the equitable issues first, without a jury . . . and that if the court's determination of those issues is also dispositive of the legal issues, nothing further remains to be tried by a jury." (Raedeke v. Gibraltar Sav. & Loan Assn. (1974) 10 Cal.3d 665, 671.)
The rescission remedy was a small part of the total relief Protech sought, but it was a necessary prerequisite to obtaining fuller damages. The agreement had to be rescinded to defeat Gillette's affirmative defense of the release. Protech was seeking rescission to obtain considerably more than simply return of its consideration. Under NMS, its rescission claim was therefore equitable.
"Rescission is an equitable remedy." (Gill v. Rich (2005) 128 Cal.App.4th 1254, 1264; see Village Northridge Homeowners Assn. v. State Farm Fire and Cas. Co. (2010) 50 Cal.4th 913, 931 [rescission is "a fair and equitable remedy"].) "An action is one in equity where the only manner in which the legal remedy of damages is available is by application of equitable principles." (Van de Kamp v. Bank of America (1988) 204 Cal.App.3d 819, 865, citing C & K Engineering) In seeking rescission, Protech was asking the trial court to apply equitable principles to declare the agreement, with its release provision, void because it was procured by fraud. If the agreement were declared void, Protech would be free to pursue legal damages. Protech's claim of fraud was premised on Gillette's fiduciary duties of disclosure as a (former) officer and director of the company. In Central Laborers' Pension Fund v. McAfee, Inc. (2017) 17 Cal.App.5th 292, at pages 346-347, the gist of an action based on such fiduciary duties was held to be equitable. Protech sought "judicial relief for the wrong giving rise to the right of rescission," the equitable form of rescission under prior law. (Runyan, supra, 2 Cal.3d at p. 313.) In this case, the request for the relief of rescission was equitable. Protech was not entitled to a jury in the first portion of the bifurcated trial.
II
Limitation of Evidence of Fraud
Protech contends the trial court misunderstood the scope of fraud and improperly limited evidence of Gillette's alleged fraud to intentional, affirmative misrepresentations, thereby excluding evidence of fraudulent nondisclosures. Protech contends that in its ruling on Gillette's motion in limine to bifurcate the trial, the court ignored that a failure to disclose, whether intentional or negligent, can support a claim for rescission.
Protech's complaint alleged Gillette's concealment of material facts was intentional.
"The elements of fraud are (a) a misrepresentation (false representation, concealment, or nondisclosure); (b) scienter or knowledge of its falsity; (c) intent to induce reliance; (d) justifiable reliance; and (e) resulting damage." (Hinesley v. Oakshade Town Center (2005) 135 Cal.App.4th 289, 294.) In its statement of decision, the trial court found no fraud because Protech and Ott knew all material facts before the agreement was signed. Thus, Protech could not justifiably rely on any nondisclosure.
Protech bases its argument--that the trial court misunderstood the law and thus improperly excluded certain evidence--on the court's own statements, as we next explain.
After the court's ruling on Gillette's motion in limine, counsel for Protech asked the court for guidance on the scope of the trial on the release, indicating the opposition to the release would be the entire fraud case against Gillette and would take a week. The court responded that plaintiffs would have to show that the release did not cover certain types of actions. Implicitly referencing the Cifelli notes, the court explained that if Protech had not asked what employees knew about Gillette before it released him, it would have to show that Gillette somehow induced the employees to hide this information "as opposed to Protech just not bothering to figure out what everybody knew." The court would not admit parole evidence unless there was evidence Gillette had told employees not to disclose anything about his activities to Protech. "We're not going into all the fraud unless you put on evidence showing that you're entitled to put on fraud." Somehow, Protech reads these comments to limit the allowable evidence to affirmative misrepresentations, even though the court was speaking of concealment.
Later, the court expanded the trial, allowing Protech to try its rescission case concurrently with the trial on the release. Protech seizes upon the court's comment that fraud in the inducement "has nothing to do with whether anybody is a fiduciary," to illustrate the court's misunderstanding. In that comment, the court was discussing a particular case that did not involve a fiduciary. Protech reads these comments to limit the evidence it could offer to affirmative misrepresentations and to exclude any evidence of nondisclosure. But the court next allowed it was possible that a fiduciary relationship could vitiate the Civil Code section 1542 waiver so that the release would not apply to unknown claims. "I'll listen to the evidence on it." Nothing in this comment even suggests that the court was limiting the evidence Protech could offer. Thus, Protech's reading of the trial court's comments, when considered in their proper context, is untenable.
Protech asserts the improper limitation of evidence denied it due process and requires reversal per se. But Protech failed to specify at trial and also on appeal what evidence of fraud it offered that the trial court erroneously excluded. Protech's unreasonable interpretation of the court's comments did not relieve it of the obligation to make an offer of proof to admit what it believed was relevant evidence of fraudulent nondisclosure. (Evid. Code, § 354 [no reversal for erroneous exclusion of evidence unless miscarriage of justice and the substance, purpose and relevance of evidence shown to the court].)
Protech contends the trial court's ruling "caused the trial court to cut short the presentation of evidence critical to Protech's constructive fraud rescission argument." As an example, Protech contends the testimony of two witnesses, Stoller and Janet Macaulay, was improperly curtailed. A review of the record, however, reveals that both witnesses testified at length about numerous financial and accounting issues at Protech, issues that Protech claimed Gillette failed to disclose, and the court imposed time limits only after Protech sought to elicit irrelevant or otherwise improper testimony. A trial court has inherent authority to supervise proceedings for the orderly conduct of the court's business to guard against unnecessary delay. (California Crane School, Inc. v. National Commission for Certification of Crane Operators. (2014) 226 Cal.App.4th 12, 22.)
When Protech began to question Stoller about generally accepted accounting principles, the trial court questioned how this testimony related to the release or rescission. Protech made an offer of proof that when Gillette was terminated the general belief was that Gillette was only responsible for limited mistakes in organizing data, but after the agreement was signed far more pervasive problems were discovered. Protech claimed Gillette had not disclosed these problems and they were not discoverable at an earlier time. The court gave Protech 30 more minutes to examine Stoller. Counsel continued the direct examination until he had "no more questions" and did not ask for more time.
Macaulay was hired in 2011 to help collect accounts receivable. She later became CFO and controller. Protech made an offer of proof that she would testify about what she discovered after the agreement was signed. She testified there was significant data missing from QuickBooks, the accounting system that Protech used, there were demands and penalty notices from the IRS for payroll taxes, and the gross margins were decreasing as costs increased compared to revenues. When she began to testify whether she would have disclosed these facts as a CFO, Gillette objected that Macaulay had no qualifications as an expert. The court sustained the objection and declined to allow Protech to lay a foundation because Macaulay had not been disclosed as an expert and this testimony went beyond the offer of proof. The court gave counsel five more minutes with the witness and Protech returned to questioning about gross margins. Protech does not show what further relevant, admissible testimony these witnesses would have offered and thus has failed to show error in the limiting their testimony.
Nor does Protech's claim that the trial was improperly curtailed withstand scrutiny. During the examination of Macaulay, the court asked for an estimate of how much longer the trial would take and Protech's counsel responded a week. The next day Protech finished the examination of Macaulay, read into the record some testimony of Gillette, and then rested. If Protech had additional evidence to present, it could have done so. The trial court did not prevent it.
Protech put on days of evidence and dozens of exhibits in an unsuccessful attempt to establish Gillette's fraud. The trial court found that before the agreement was signed, Protech's financial and accounting information was open and available to Protech, the Cifelli notes did not show fraud or conspiracy, Protech and Ott knew all material facts about Protech's finances and accounting, Protech failed to establish fraud or embezzlement in Gillette's expense reports, and Gillette had disclosed that payroll taxes were not being paid due to cash flow problems. Protech does not challenge any of these factual findings on appeal and those relevant facts establish there was no material nondisclosure by Gillette.
III
Release of Gillette as Trustee
Protech contends the trial court erred in finding that the release applied to Gillette in his role as trustee. Because the agreement did not mention either the trust or Gillette's position as trustee, Protech argues it cannot be interpreted as intending to release Gillette as trustee. We agree.
The trial court reasoned that Protech knew Gillette was the trustee of the Gillette Family Revocable Bypass Trust, the release contained no exception for claims against Gillette as trustee, and there was no evidence presented against the trust separate from the evidence of Gillette's acts as an employee of Protech. The court found an identity of interest between Gillette individually and as trustee, and found Gillette was released from all claims both individually and as trustee.
"A release given in good faith to a tortfeasor does 'not discharge any other such party from liability unless its terms so provide.' (Code Civ. Proc., § 877, subd. (a).) To determine whether the ' "terms so provide," ' we apply the rules governing contract interpretation. [Citation.]" (Cline v. Homuth (2015) 235 Cal.App.4th 699, 705.) "A third party may enforce a contract that is expressly made for his benefit. [Citation.] The third party need not be named in the contract, but he has the burden to show the contracting parties intended to benefit him. [Citation.] Determining this intent is a question of contract interpretation. [Citation.] 'In determining the meaning of a written contract allegedly made, in part, for the benefit of a third party, evidence of the circumstances and negotiations of the parties in making the contract is both relevant and admissible. And, "[i]n the absence of grounds for estoppel, the contracting parties should be allowed to testify as to their actual intention . . . ." [Citations.]' [Citation.]" (Ibid.)
Gillette offers no argument that the language of the release, or evidence of the parties' intentions, established that the release was intended to apply to him in his capacity as trustee. Instead, he merely parrots the trial court's analysis.
The (separation) agreement refers to Gillette as "Employee" and recites that Protech and Gillette "wish to resolve all matters outstanding between them as the result of the termination of their employment relationship." The release does not mention the trust or any trustee. The release provision concludes, "You also hereby waive and release in perpetuity any and all employment rights or claims that you may have against the other Party." Nothing in the language of the agreement or the release provision indicates the release was intended to apply to Gillette as trustee.
At trial, Gillette disagreed with Protech's counsel that the trust was not a party to the release, although he admitted he did not sign the agreement as trustee, the trust was not specifically identified in the agreement, and the trust had no employment claim against Protech. Gillette testified the Board knew the trust was an investor and that Gillette was the trustee and was representing both his personal investment through his IRA and the trust investment. But nothing in the agreement indicates it applied to any investment in Protech; its language addressed only the employment relationship. Stoller testified that in negotiating the agreement, there were no discussions about any issues with respect to Gillette as trustee.
There was no evidence the agreement and its release provision was intended to apply to Gillette as trustee and the trial court erred in so finding. That Protech knew Gillette was a trustee of a trust that had invested in the company proves nothing when that fact was not reflected in the agreement. While the release did not exclude claims against the trust, it needed to include them to be effective against a trustee. Because there was no evidence the release applied to Gillette as trustee, there was no reason to present evidence about Gillette's actions as trustee.
We recognize that given the trial court's factual findings of lack of evidence of malfeasance by Gillette, many of Protech's claims against Gillette as trustee may not be viable. The court, however, did not rule on all of the claims, such as the hacking claim. (Pen. Code, § 502.) To the extent claims against Gillette as trustee are meritless, there are proper procedural mechanisms to dispose of them. We will not do so by finding a release applies where there is no evidence to support the finding.
IV
Attorney Fees
Finally, Protech contends the trial court erred in awarding Gillette attorney fees. The court awarded fees of $715,770 under the indemnification provision in Gillette's employment contract. Protech contends that provision cannot serve as the basis for the award because the contract was superseded by the agreement and it provides for indemnification only for third party claims. Protech further contends neither section 317 nor its bylaws provide a basis for an award of attorney fees to Gillette.
The parties agree the question of whether an award of attorney fees is authorized is a question of law we review de novo. " 'On review of an award of attorney fees after trial, the normal standard of review is abuse of discretion. However, de novo review of such a trial court order is warranted where the determination of whether the criteria for an award of attorney fees and costs in this context have been satisfied amounts to statutory construction and a question of law.' " (Connerly v. State Personnel Bd. (2006) 37 Cal.4th 1169, 1175.)
A. Indemnification Provision under Employment Contract
Gillette's employment contract with Protech provided: "The Company shall indemnify and hold Executive harmless from and against any and all losses, costs, damages or expenses (including without limitation, attorneys' fees, costs and expenses incurred by the Executive) arising out of any claim or legal action brought against the Company or the Executive, whether or not ultimately defensible under the applicable 'Business Judgment Rule,' relating in any way to the service performed by the Executive in any capacity for the Company. This indemnification provision is intended by the parties hereto to be broadly interpreted and to provide for indemnification to the full extent permitted by applicable law. The Company will insure Executive under any directors and officers ('D&O') insurance policy it maintains."
Protech first argues the employment contract was no longer in effect because it was superseded by the (separation) agreement, which the trial court found valid and enforceable. Protech relies on various provisions of the agreement, each of which it contends is sufficient alone to show the parties intended the agreement to supersede the contract and its indemnification provision.
The recitals of the agreement state in part the parties "wish to resolve all matters outstanding between them as the result of the termination of their employment relationship." Next, after setting forth certain payments to Gillette of salary and vacation through October 29, 2010, the agreement declares: "After that date, the Company will have no further obligations to pay Employee any compensation or any other amounts, except as provided in this Agreement or as otherwise provided by law." It further provided: "This Agreement supersedes all prior agreements, understandings, and communications between Employer and the Company, whether written or oral, express or implied, relating to the subject matter of this Agreement, and is intended as a complete and final expression of the terms of the agreement between Employee and the Company and shall not be changed or subject to change orally."
Protech also relies on the release provision in the agreement. The mutual release provision released the parties "from any and all liability, actions, causes of action, proceedings, suits, debts, covenants, contracts, controversies, agreements, promises, damages, judgments, and demands of whatever nature, in law or in equity, direct or indirect, known or unknown, matured or not matured that you . . . ever had, now have, or may in the future to the effective date of this agreement against Released Parties or any of them." It further states: "You also hereby waive and release in perpetuity any and all employment rights or claims that you may have against the other Party."
We need not determine whether the indemnification clause survives the agreement because we find that Gillette released his employment rights by execution of the agreement. Gillette addresses only the first portion of the release that releases the parties from all claims "to the effective date of the agreement." He argues the right to indemnity arose after the effective date of the agreement, when Protech filed suit against him. But Gillette ignores the next sentence of the release, under which he waived and released "in perpetuity any and all other employment rights or claims." Indemnification was an employment right granted to Gillette under the employment contract. Under the agreement, he waived and released that right "in perpetuity."
The trial court erred in basing an award of attorney fees on the indemnification provision of the employment contract. We next consider whether either section 317 or Protech's bylaws authorize the award.
B. Indemnification under Section 317
In seeking attorney fees, Gillette relied in part on the mandatory indemnification under subdivision (d) of section 317. Protech counters that Gillette has failed to establish the prerequisites for mandatory indemnification. Specifically, Protech asserts statutory mandatory indemnification involves a factual question of whether the conduct for which Gillette was sued was performed in connection with his corporate functions and not purely for personal interests. Protech contends that in finding the release barred Protech's claims against Gillette, the trial court did not resolve this factual question.
Section 317 provides for both permissive and mandatory indemnification of agents of the corporation in certain circumstances. "[S]ection 317 was enacted to encourage capable individuals to act for and in the place of the corporation by affording them indemnification for the expenses of defending against lawsuits to which they are made parties because they are agents of the corporation." (Channel Lumber Co. v. Porter Simon (2000) 78 Cal.App.4th 1222, 1231.)
"Section 317, subdivision (d) of the Corporations Code is known as the mandatory indemnity provision. [Citations.] Under that subdivision, 'To the extent that an agent of a corporation has been successful on the merits in defense of any proceeding . . . the agent shall be indemnified against expenses actually and reasonably incurred by the agent in connection therewith.' (Emphasis added.)" (Brusso v. Running Springs Country Club, Inc. (1991) 228 Cal.App.3d 92, 103.) For purposes of section 317, an "agent" includes "any person who is or was a director, officer, employee or other agent of the corporation." (§ 317, subd. (a).) "Expenses" include attorney fees. (Ibid.)
Indemnity under section 317 is not limited to third party lawsuits, but is available for an "action by or in the right of the corporation to procure a judgment in its favor." (§ 317, subd. (c), italics added.)
For section 317 to apply, the action against the person must be "brought 'by reason of the fact that the person is or was an agent of the corporation.' [¶] Marsh, in his treatise on California corporation law, explains: 'In other words, the conduct of the agent which gives rise to the claim against him must have been performed in connection with his corporate functions and not with respect to purely personal matters.' [Citation.] Where personal motives, not the corporate good, are predominant in a transaction giving rise to an action, indemnification is not warranted. For example, '[i]t would . . . appear unlikely that an officer could properly claim that he was entitled to indemnification as the result of litigation brought to recover short-swing profits or profits from trading in the stock of his corporation on the basis of inside information . . . .' [Citation.]" (Plate v. Sun-Diamond Growers (1990) 225 Cal.App.3d 1115, 1123 (Plate).)
"Of course, if the corporate agent is acquitted of any wrongdoing, he or she has a right to indemnification for legal expenses incurred for his or her defense, even though he or she was initially charged with bad faith or intentional misconduct. (§ 317, subd. (d).)" (Plate, supra, 225 Cal.App.3d at p. 1124.)
Wilshire-Doheny Associates, Ltd. v. Shapiro (2000) 83 Cal.App.4th 1380 (Wilshire) presented the question of mandatory indemnification in a situation similar to that seen here. There, a corporation sued former employees for breach of fiduciary duty, conversion, conspiracy and other claims, alleging, among other things, that they had concealed information, improperly kept money that should have been paid to the company, and received double payments. (Id. at pp. 1385, 1389.) The employees pleaded a mutual release as a bar to the action and sought attorney fees and costs. (Id. at p. 1386.) The trial court found the release was valid, binding and enforceable. (Ibid.) It denied the request for attorney fees, finding section 317 did not apply. (Id. at pp. 1387-1388.)
On appeal, the employees contended they were entitled to indemnification under section 317, subdivision (d) because they were "successful on the merits" of the action. (Wilshire, supra, 83 Cal.App.4th at p. 1391.) In American Nat. Bank & Trust Co. v. Schigur (1978) 83 Cal.App.3d 790, at page 793, the court concluded the legislative intent behind this subdivision was "that mandatory indemnification should depend upon a judicial determination of the actual merits of the agent's defense." In determining whether there was "success of the merits," the Wilshire court looked to what constituted a favorable determination in the malicious prosecution context. There, a favorable termination "calls for a termination reflecting on the merits of the action and the plaintiff's innocence of the misconduct alleged. [Citations.] When the proceeding terminates other than on the merits, the court must examine the reasons for termination to see if the disposition reflects the opinion of the court or the prosecuting party that the action would not succeed. If resolution of the underlying action leaves a residue of doubt about the plaintiff's innocence or liability, it is not a favorable termination sufficient to support a cause of action for malicious prosecution." (Sierra Club Foundation v. Graham (1999) 72 Cal.App.4th 1135, 1149 (Sierra Club).)
The Wilshire court determined that "success on the merits" under section 317, subdivision (d) required only a showing that " 'the disposition reflects the opinion of the court or the prosecuting party that the action would not succeed.' " (Wilshire, supra, 83 Cal.App.4th at p. 1391.) The trial court had made this determination in finding the mutual release barred prosecution of the action. "While appellants' innocence of the misconduct alleged was not established, appellants' lack of liability was established. In this respect, the determination is one on the merits." (Ibid.) Although the appellate court found the employees had met the requirement of success on the merits, they were not necessarily entitled to mandatory indemnification. They "still must establish, however, their agency, i.e., that the alleged acts, for which they were made parties to the lawsuit, were ' "performed in connection with [appellants'] corporate functions and not with respect to purely personal matters." ' " (Id. at p. 1394.) The court remanded for further proceedings. (Id. at p. 1397.)
Where a corporation brings suit against a current or former employee for malfeasance based the alleged breach of the fiduciary duty to the corporation, the question of whether the officer's acts were "performed in connection with [their] corporate functions and not with respect to purely personal matters" requires determination of the merits of the suit, that is, whether the officers actually breached their fiduciary duties. (Wilshire, supra, 83 Cal.App.4th at p. 1390.) Accordingly, rather than follow the procedure set forth in Wilshire--finding the defense of the mutual release is success on the merits but remanding for a trial on whether the officers properly acted as agents--we interpret "success on the merits" to require both lack of liability and innocence of the misconduct alleged. These are the two elements of favorable determination in the malicious prosecution context. (Sierra Club, supra, 72 Cal.App.4th at p. 1149.) The Wilshire court offers no persuasive reason why only one of these elements is required for "success on the merits."
In Wilshire, the trial court looked to the employees' actions in asserting the validity of the release in determining they were acting in their personal interest and not on behalf of the corporation. (Wilshire, supra, 83 Cal.App.4th at pp. 1388-1389.) Because the court made a factual finding on the wrong question (id. at p. 1390), remand was appropriate. --------
Here, lack of liability was established by the successful defense based on the mutual release. The remaining question is whether Gillette's innocence of the misconduct alleged has been established.
Protech contends this question was not answered in the court trial. It further contends the trial court improperly limited evidence of Gillette's fraud in that trial, a contention we have rejected. Gillette contends the trial court made the required finding when it rejected Protech's claim that the agreement was induced by fraud.
The complaint, however, alleged more wrongdoing by Gillette than fraud. For example, it alleged he breached his duty of loyalty by diverting business to a competitor. These other allegations were not part of the court trial. But the trial court did make factual findings exonerating Gillette on several of the allegations of fraud. As to these allegations, the question of Gillette's innocence of wrongdoing was established in his favor. Mandatory indemnity under subdivision (d) of section 317 need not apply to every allegation; there may be partial indemnification. "Indemnification is mandatory 'to the extent that' the officer or director is successful on the merits. [That is], if successful on any claim or issue, he or she is entitled to indemnification as to the expenses incurred in defending against such claim or issue." (Friedman, Cal. Practice Guide: Corporations (The Rutter Group 2018) ¶ 6:443, p. 6-222, citing § 317, subd. (d).)
Gillette sought attorney fees for several attorneys and paralegals for a variety of work from October 31, 2011, through January 2017. The trial court awarded fees only for the work of one attorney, finding the evidence as to fees generated by the others was hearsay. We remand the matter to the trial court to apportion the fee award to limit the award to attorney fees expended in establishing the validity of the release and defending the claims of fraud in the inducement.
C. Indemnification under Protech's Bylaws
Gillette also sought attorney fees under Protech's bylaws. The bylaws provide in part: "Any person made a party to any action, suit or proceeding , by reason of the fact that he, his testator or interstate representative is or was a director, officer or employee of the Corporation, or of any Corporation in which he served as such at the request of the Corporation shall be indemnified by the Corporation against the reasonable expenses, including attorneys' fees, actually and necessarily incurred by him in connection with the defense of such action, suit or proceedings, or in connection with any appeal therein, except in relation to matters as to which it shall be adjudged in such action, suit or proceeding, or in connection with any appeal therein that such officer, director or employee is liable for gross negligence or misconduct in the performance of his duties."
The bylaws provide for indemnification only where the person is sued "by reason of the fact that he . . . is or was a director, officer or employee of the Corporation." This is the same agency requirement as found in section 317. The bylaws provide no greater indemnification than section 317.
DISPOSITION
The judgment is reversed to the extent it applies to James Gillette as trustee of the Gillette Family Revocable Bypass Trust, and as to the attorney fee award. The matter is remanded to the trial court with directions to determine the amount of attorney fees consistent with this opinion. In all other respects, the judgment is affirmed. The parties shall bear their own costs on appeal. (Cal. Rules of Court, rule 8.278(a)(3).)
/s/_________
Duarte, Acting P. J. We concur: /s/_________
Hoch, J. /s/_________
Renner, J.