Opinion
NOT TO BE PUBLISHED
Super. Ct. No. 04AS01272
DAVIS, J.
This action involves Hockwood Development, Inc. (Hockwood), a closely held corporation of three shareholders formed in 2001 to engage in land acquisition and development as well as construction management in the Sacramento area.
In a thorough 36-page statement of decision, the trial court found that defendant Leslie Hock, Hockwood’s president and majority shareholder, breached his fiduciary duty to the two minority shareholder plaintiffs, Richard Wood and Mark Rodgers, by usurping for himself a land acquisition/development opportunity as well as certain construction management work. Hock then dissolved Hockwood.
Hock, as well as a construction management company he formed, Hock Construction Management, Inc., appeal. They dispute: the standing of Wood and Rodgers to be awarded individual damages for corporate losses; the characterization of the lost development opportunity as corporate; and the award of construction management profits.
Hereafter, we will simply refer to Hock in the singular to cover, in the appropriate contexts, Hock and Hock Construction Management, Inc.
Wood and Rodgers have cross-appealed, claiming the trial court erred in failing to award them attorney fees pursuant to the common fund or substantial benefit doctrines that apply to shareholder derivative actions.
We shall affirm the judgment in its entirety.
Background
In 2001, Wood and Rodgers were the principals in Wood Rodgers, Inc., a civil engineering firm that did subdivision mapping, among other work. Hock was a construction manager whom Wood had known professionally for several years.
All three individuals were interested in forming a company that would undertake land acquisition and development as well as residential construction management. Land acquisition and development typically combines the efforts of those who purchase the raw land with those who perform the “sweat equity” of obtaining tentative subdivision map approval. Residential construction management involves transforming the tentative subdivision map to finished lots for sale to residential homebuilders, by managing the development of large-scale infrastructure (roads, water, sewer, electrical and gas lines). The three individuals foresaw their primary roles, at least initially, as sweat equity and construction management.
To pursue such land acquisition/development and construction management, Wood, Rodgers and Hock formed Hockwood toward the end of 2001. Hock became president and Wood and Rodgers became vice presidents. Hock’s wife, Christine, was appointed secretary and chief financial officer. The Hocks received 60 percent of the shares based on their initial financial contribution of $3,000, while Wood and Rodgers each received 20 percent for their individual contributions of $1,000 apiece. Wood and Rodgers agreed to loan Hockwood an amount that would guarantee a $10,000 monthly salary to Hock during the corporation’s start-up period, should that be necessary. Hock agreed to work full-time exclusively for Hockwood, and agreed not to compete with Hockwood for a year following such employment.
The salary guarantee of Wood and Rodgers was never called upon. Wood and Rodgers waived any profits from the construction management work performed by Hock in 2002. By 2003, Hock was generating enough construction management fees to be paid more than $10,000 a month by Hockwood, although the board of directors had not approved an increase.
As for the land acquisition/development side of things, Rodgers became aware of two opportunities--one in 2002 (the Schumacher property) and the other in 2003 (the Abalkhail properties). As contemplated by Wood, Rodgers and Hock in forming Hockwood, Rodgers brought both opportunities to Hockwood for consideration. Neither came to fruition. Hock too was exploring development opportunities on Hockwood’s behalf.
In July 2003, Hock contacted Wood and Rodgers about an agricultural property in Elk Grove with which they were all familiar--the Hoffman property--that was available for purchase and surrounded on three sides by development. After deflecting Wood’s request to attend an initial purchase meeting with the Hoffmans, Hock told Wood that the meeting had been held, that developer Bruce Bell had accompanied Hock to the meeting, and that the potential deal would be discussed at the upcoming Hockwood board meeting on August 19, 2003.
Unbeknownst to Wood and Rodgers, though, a letter of intent to buy the Hoffman property, signed by Hock and by Bell on the letterhead of Bell’s company, had been accepted on August 12, 2003, and a limited liability company (LLC) named EF 20 was being formed by Hock and Bell to take title to the Hoffman property. (The LLC title procedure was also a process that Hockwood had envisioned for land purchases, using the corporation as manager of the LLC; this procedure avoids double taxation--first from the titled corporation and then from the shareholders.)
At the August 19, 2003, Hockwood board meeting, the first item on the Hocks’ agenda was their offer to buy out Wood and Rodgers for the face value of their Hockwood stock--$1,000 apiece. Wood and Rodgers rejected the offer, noting that the construction management arm of Hockwood was doing well and that their main reason for forming Hockwood was to pursue development opportunities such as the Hoffman property.
It was not until mid-September 2003 that Hock informed a surprised Rodgers and Wood about EF 20 LLC’s purchase of the Hoffman property.
Around this same time, Hock also created Hock Construction Management, Inc. (HCM) to perform construction management. And Hock assigned Hockwood’s existing construction management contracts to HCM on November 1, 2003. Hock did all of this without telling Wood and Rodgers.
Still ignorant of all that was happening, Wood and Rodgers, in a letter dated December 1, 2003, proposed that they and Hock split the sweat-equity profits of the Hoffman project by thirds, and stated they would not seek compensation from Hockwood’s construction management profits, which Hock generated exclusively. The letter concluded that if the three could not move forward as an equal development team, including on the Hoffman project, then they should dissolve Hockwood.
The Hocks took this December 1, 2003, letter to be an ultimatum: either they give Wood and Rodgers a one-third interest each in the Hoffman proceeds, or dissolve Hockwood. The Hocks dissolved Hockwood in January 2004.
The tentative map regarding the Hoffman property was approved and escrow closed in August 2004, yielding Hock individually just over $954,000.
Wood and Rogers, individually and as shareholders of Hockwood, filed a shareholders’ derivative complaint for breach of fiduciary duty by an officer or director in usurping a corporate opportunity, and for related causes of action and counts.
The trial court awarded Wood and Rodgers, with interest, just over $500,000, the great bulk of which encompassed a 40 percent share of the $954,000 that Hock obtained from the Hoffman opportunity.
The trial court denied Wood and Rodgers’ attorney fee request that was based on the equitable doctrines of common fund and substantial benefit in shareholder derivative actions. The court found that their lawsuit resulted entirely in personal benefit to them rather than in derivative benefit to Hockwood.
We will set forth other pertinent facts as we discuss the issues on appeal.
Discussion
I
Hock’s Appeal: Standing of Wood and Rodgers--Individual Interests Versus Shareholder Derivative Interests
Wood and Rodgers’ Cross-Appeal: Attorney Fees Under Common Fund or Substantial Benefit Doctrines in Shareholder Derivative Suit
In his appeal, Hock contends that the trial court erred reversibly in awarding damages to Wood and Rodgers as individuals because they lacked standing as individuals, in this shareholder derivative lawsuit, to recover damages for losses to the corporation, Hockwood. In short, asserts Hock, the trial court confused the corporate status of Hockwood with the individual status of Wood and Rodgers.
In their cross-appeal, Wood and Rodgers contend that the trial court erred in failing to award them attorney fees under the “common fund” or “substantial benefit” doctrines applicable to shareholder derivative actions. Under these equitable doctrines, a shareholder who successfully pursues a derivative action that establishes a common fund or a substantial benefit to the corporation may look to the corporation to pay the cost of the litigation that has benefitted it. (Cziraki v. Thunder Cats, Inc. (2003) 111 Cal.App.4th 552, 557-558 (Cziraki); Fletcher v. A.J. Industries, Inc. (1968) 266 Cal.App.2d 313, 324 (Fletcher).)
As we shall explain, we reject both of these contentions, and do so on the same basis: the ultimate objective of Wood and Rodgers was not to establish derivative interests but their individual interests. Consequently, Wood and Rodgers are entitled to their individual damages but not to their attorney fees. The trial court got it right in both respects.
The parameters for deciding both these issues are set forth in two contrasting decisions involving closely held corporations: Baker v. Pratt (1986) 176 Cal.App.3d 370 (Baker) and Cziraki, supra, 111 Cal.App.4th 552.
Baker involved a successful action by one shareholder (plaintiff) against the only other shareholder (defendant) of two construction corporations. Defendant had excluded plaintiff from the corporate enterprises, which defendant then operated as his own businesses. (Baker, supra, 176 Cal.App.3d at pp. 376-377.) In reversing an award of attorney fees to the plaintiff under the common fund or substantial benefit doctrines, the Baker court said: “In the instant action, [plaintiff] sued the . . . corporations . . . for involuntary dissolution of the corporation. The actions resulted in findings that [defendant shareholder] had misappropriated corporate funds and property, but this was to no one’s detriment other than [plaintiff’s]. [Plaintiff] and [defendant] were the only shareholders in each of the corporate entities. It is clear that [plaintiff’s] ‘ultimate objective [was] not to secure or preserve a common fund but to establish personal adverse interests therein. In such a case fees may not be awarded.’” (Baker, supra, 176 Cal.App.3d at pp. 378-379, quoting Gabrielson v. City of Long Beach (1961) 56 Cal.2d 224, 229.)
Standing in contrast to Baker is Cziraki. Cziraki involved a corporation, Thunder Cats, Inc., that comprised three shareholders. Two of the shareholders held patent interests for an engine design that was to be manufactured by the third shareholder. After forming Thunder Cats, the two patent-shareholders then formed a separate company to exploit the patents. The manufacturer-shareholder successfully sued and was allowed to obtain his attorney fees via the common fund or substantial benefit doctrines. (Cziraki, supra, 111 Cal.App.4th at pp. 554-555, 565.) Said Cziraki: “Cziraki [the manufacturer-shareholder] convincingly argues his derivative claims served a discernible interest separate from any individual adverse interest he may otherwise have sought to benefit. . . . The benefits resulting from the litigation were Thunder Cats’ acquisition of the promised patent interests, the potential to exploit those interests, the preservation of the company’s wherewithal, and an interest in any future profits should they materialize--all equally shared among the other shareholders. In no sense did Cziraki derive any individual benefit from the litigation. Neither the trial court nor Thunder Cats identified any evidence to suggest Cziraki pursued his derivative claims in the hopes of receiving an individual benefit or adverse personal interest. [¶] Cziraki’s litigation conferred a substantial benefit on Thunder Cats, and the class of shareholders--albeit tiny--benefits as a result of Cziraki’s action. Unlike the ultimate outcome in Baker, any award to Thunder Cats would not be immediately passed on to individual shareholders through a dissolution proceeding. The judgment in the present case reveals a clear distinction between the derivative interests of the shareholders and their individual adverse interests.” (Cziraki, supra, 111 Cal.App.4th at pp. 560-561.)
The facts before us fall on the Baker side of the ledger. Perhaps this is best illustrated by examining Cziraki, which stands opposite Baker. The litigation in Cziraki secured the corporation’s use of ongoing patent interests, thereby preserving the corporation’s wherewithal. By contrast, the pivotal corporate asset at issue here--the Hoffman property deal--was a one-time deal for Hockwood, which itself has now been dissolved. Similar to the outcome in Baker, any award to the dissolved Hockwood would be immediately passed on to its individual shareholders. (See Corp. Code, § 2010.) Properly recognizing this, the trial court awarded Wood and Rodgers 40 percent of Hock’s Hoffman deal proceeds, in line with the respective shares of all three in Hockwood. Even Hock concedes that Wood and Rodgers could have brought an individual action against him for breach of contract. As in Baker, then, it is clear that the ultimate objective of Wood and Rodgers was not to secure or preserve a common fund or substantial benefit for Hockwood but to establish personal adverse interests therein.
Nor does Nelson v. Anderson (1999) 72 Cal.App.4th 111, upon which Hock relies, change any of this. In Nelson, one shareholder individually sued the only other shareholder of a close corporation and prevailed at trial. The appellate court reversed, concluding that the plaintiff had no standing as an individual to bring the action, which established an injury to the corporation; therefore, the procedural rules of a derivative action had to be followed. (Nelson, supra, 72 Cal.App.4th at pp. 117, 124-128; see Corp. Code, § 800.) Here, Wood and Rodgers brought an individual as well as a shareholder derivative suit.
Because Wood and Rodgers secured their individual rather than derivative interests in Hockwood, the trial court properly awarded them individual damages and properly denied their common fund/substantial benefit-based request for attorney fees. (See also Avikian v. WTC Financial Corp. (2002) 98 Cal.App.4th 1108, 1118 [“Baker makes clear that if corporate shareholders are seeking to advance their individual interests, rather than the interests of the corporation generally, no [attorney] fees should be awarded on a common fund or substantial benefit theory”].)
In their cross-appeal, Wood and Rodgers claim the trial court declined to award them attorney fees “merely because” Hock had dissolved Hockwood, and that such a result encourages a rogue majority shareholder to dissolve the corporation so as to avoid the equitable awarding of attorney fees to minority shareholders under the common fund or substantial benefit doctrines. (See Cziraki, supra, 111 Cal.App.4th at p. 563 [“According to Fletcher[, supra, 266 Cal.App.2d at p. 324], the primary purpose for extending the substantial benefit doctrine to representative suits which do not create a common fund is to encourage minority shareholders to pursue their rights and thereby promote responsible corporate governance”].) Wood and Rodgers are mistaken. The trial court declined their request for attorney fees, not merely because Hockwood was dissolved but because they secured individual rather than derivative interests. And those individual interests were substantial enough to provide Wood and Rodgers (the minority shareholders) an incentive to sue.
II
Hock’s Appeal: Hoffman Property Deal--Corporate Opportunity
The trial court found that Hock breached a fiduciary duty as an officer and director by usurping the Hoffman property deal, a corporate opportunity, for himself.
“‘[T]he doctrine of corporate opportunity . . . prohibits one who occupies a fiduciary relationship to a corporation from acquiring, in opposition to the corporation, property in which the corporation has an interest or tangible expectancy or which is essential to its existence. [¶] . . . [¶] Three tests have been recognized as standards for identifying a corporate opportunity: the “line of business” test, the “interest or expectancy” test, and the “fairness” test. Under any test, a corporate opportunity exists when a proposed activity is reasonably incident to the corporation’s present or prospective business and is one in which the corporation has the capacity to engage. Whether or not a given opportunity meets the requisite relationship is largely a question of fact . . . .’” (Kelegian v. Mgrdichian (1995) 33 Cal.App.4th 982, 988-989, italics in Kelegian omitted.)
Hock contends the Hoffman project was not a corporate opportunity “based upon the trial court’s own findings.” We disagree.
In its comprehensive statement of decision, the trial court expended five pages to summarize the substantial evidence supporting its finding that the “evidence clearly establishes that the parties intended Hockwood Development, Inc. to engage in both construction management and land acquisition and development,” and another five pages to summarize the substantial evidence supporting its finding that the “Hoffman property was a land development opportunity in Hockwood’s line of business acquired by Les Hock in his full-time capacity as president of Hockwood Development, Inc.” Against this backdrop, Hock cannot seriously maintain that, “based upon the trial court’s own findings,” the Hoffman project was not a corporate opportunity.
Hock recognizes this state of affairs and tries a different tack. He makes several points that are all founded on the following theme: the agreement regarding participation in land acquisition and development was an agreement between the three shareholders--Wood, Rodgers and Hock--as an individual opportunity and not as a corporate opportunity. According to Hock, this is because the agreement as to land acquisition and development opportunities called for “the three individuals . . . to negotiate on a project by project basis their participation both in equity and sweat equity and what percentage each would be entitled to,” and “which projects to pursue”; and “[a]ll of these terms were to be agreed upon in the future.” (Emphasis omitted.)
Hock, however, has worked a sleight of hand here by having us view Hockwood’s land acquisition and development business solely in terms of how each shareholder would participate in each development project. This puts the cart before the horse. Before the shareholders could work out how they would individually participate in each development project, they first had to obtain that opportunity. And the evidence showed that they obtained the opportunity by using their knowledge, experience, resources, and contacts in the land development arena and bringing that opportunity, as a corporate opportunity, to Hockwood, which would then decide whether to proceed.
In addition to this focus on individual participation, Hock contends that the “agreement of the parties that they would form an LLC to take title and receive profits clearly establishes that [land acquisition/development] was an individual, not a corporate opportunity, since the profits derived from the LLC are the individual members’[,] not Hockwood’s.”
However, as the trial court noted, based on substantial evidence, “[t]he fact of the matter is that corporations that engage in land acquisition and development--such as RWI and B&Z [corporations that Hockwood used as its business model]--clearly use their corporations to facilitate land acquisition through an LLC. The fact that LLCs are formed by corporations to prevent harsh tax consequences in acquiring land [i.e., double taxation, first paid by corporations, then by shareholders] does not detract from the fact that the land acquisition activities are corporate in nature”; an LLC is used “to accomplish land acquisition and avoid double taxation” and the corporation is used “as manager of the LLC.”
We conclude the trial court properly found the Hoffman property deal to be a corporate opportunity usurped by Hock.
III
Hock’s Appeal: Construction Management Profits and Miscellaneous Grounds
In addition to awarding Wood and Rodgers 40 percent of the amount Hock obtained on the Hoffman property deal, the trial court awarded Wood and Rodgers 40 percent of the following three amounts:
1. $72,000, representing the lost profits to Hockwood for existing construction management work subsequent to December 15, 2003, when Hock transferred this existing work from Hockwood to his own newly formed construction management company, HCM;
2. Approximately $53,000, which was the amount of “money left over” in Hockwood and transferred by the Hocks to HCM, and which Christine Hock testified was needed for “taking” the HCM-assumed Hockwood construction management contracts “to completion”;
3. $30,000, which was a salary overpayment to Hock in 2003 under the terms of Hockwood’s by-laws and Hock’s employment agreement with Hockwood (Hock took a salary in 2003 of $150,000 instead of the authorized $120,000).
Hock raises two issues with respect to these three additional awards.
First, Hock argues that these three amounts are all construction management profits which the undisputed evidence showed that Wood and Rodgers had waived in favor of Hock, since Hock did all the construction management work for Hockwood.
This argument, however, misconstrues the nature of things as shown by the evidence. Wood, Rodgers and Hock formed Hockwood to pursue land acquisition/development and construction management. It was Hockwood, and not Hock alone, which was in the construction management business. Wood and Rodgers owned 40 percent of Hockwood, and Hock owned 60 percent. Wood and Rodgers did waive any profits from the Hockwood construction management work performed by Hock in 2002, and did so again up to December 2003 (not knowing that Hock by then had assigned Hockwood’s existing construction management contracts to HCM). But these waivers were not part of the agreement that had created Hockwood. Hockwood, after all, was engaged in construction management as one of its two main lines of business. These waivers by Wood and Rodgers simply recognized that Hock had performed this construction management work; as such, these waivers may be considered incentives or goodwill gestures in the context of the overall business enterprise. When Hock assigned Hockwood’s existing construction management contracts to HCM, he usurped Hockwood’s corporate opportunity of this construction management work, just as he had usurped Hockwood’s corporate opportunity of the Hoffman property deal. The evidence showed that Hockwood could have performed this construction management work without Hock. In short, profits from these existing construction management contracts belonged to Hockwood, not Hock. And these lost profits, as we shall explain shortly, met the applicable legal standard of “reasonable certainty,” being based, as they were, on amounts contractually owed to Hockwood (under the guise of HCM). Nor can Hock claim, in light of his secretive usurpation conduct, that the equities, such as estoppel, favor him in receiving all the construction management profits.
Consequently, the trial court properly determined that Wood and Rodgers were entitled to recover a 40 percent share of the construction management profits made on Hockwood projects which were in progress as of December 15, 2003, and secretly taken over by HCM.
Second, Hock claims that the trial court’s calculation of $72,000 in lost construction management profits--for the existing construction management work that Hock transferred from Hockwood to HCM--is contrary to the evidence and must be significantly reduced. Hock contends that Wood’s and Rodgers’ accounting expert used a 40 percent profit margin figure in calculating these profits, which was too high a figure because it was based on a salary cost for Hock that was set artificially low to minimize payroll taxes. We find that substantial evidence supports the trial court’s calculation.
The challenged accounting expert testified that he arrived at the 40 percent profit margin figure “by comparing the actual expenses incurred by [HCM] for the period subsequent to December 15[, 2003].” As the expert explained, “. . . I looked at the period from December 15th through September 30th of 2005, which was the period of financial statements that I had [the Hocks had compiled these statements], and I compared those expenses to the revenue that was incurred in that period and noted that the expenses approximated . . . 60 percent of the total revenues.” As for the expense component of Hock’s salary, the expert testified that he used the salary amounts that “actually had been paid by [HCM to Hock] during the relevant period”; and that these amounts were “generally consistent” with what Hockwood had paid Hock prior to the HCM transition and with Hock’s employment contract with Hockwood.
Hock further contends that this $72,000 lost profit calculation did not meet the applicable legal standard of “reasonable certainty,” and did not expressly account for hidden costs involving warranty and warranty-like work. But for his “reasonable certainty” point, Hock cites to decisions in which the issue is the estimation of a company’s lost profits projected into the future. (See e.g., California Shoppers, Inc. v. Royal Globe Ins. Co. (1985) 175 Cal.App.3d 1, 62.) By contrast, the lost profits here were based on amounts contractually owed to Hockwood (HCM) and the profits simply had to be calculated as a percentage of those amounts, thereby meeting the “reasonable certainty” standard. As for the warranty issue, the challenged expert relied on “actual expenses” drawn from Hock-compiled “financial statements.” Given this context, it is reasonable to assume that warranty work would be factored in as an expense given its routine nature in the construction management field, as shown by the evidence at trial.
Finally, Hock contends the trial court erred in making the following three findings (termed “miscellaneous grounds” by Hock): that he improperly dissolved Hockwood; that he breached his employment contract with Hockwood by failing to give notice of his resignation; and that he disrupted the prospective economic relationship between Hockwood and the Hoffmans.
These three findings are simply sideshows to the basic findings that Hock breached his fiduciary duty by usurping the corporate opportunity of the Hoffman property deal and by usurping Hockwood’s existing (post-December 15, 2003) construction management work. The three challenged findings were not the basis of any award of damages, and both sides on appeal essentially concede their irrelevance on the outcome in this case. With that final note, we will draw the curtain on this opinion.
Disposition
The judgment is affirmed. Each party shall pay its own costs on appeal and cross-appeal.
We concur: SCOTLAND, P.J., ROBIE, J.