Janice R. Mazur and Wm. E. Mazur, Jr., for Defendant and Appellant. Garrett Skelly for Plaintiff and Respondent.
NOT TO BE PUBLISHED IN OFFICIAL REPORTS
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 This opinion has not been certified for publication or ordered published for purposes of rule 8.1115.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. 30-2013-00641105) OPINION Appeal from a judgment of the Superior Court of Orange County, David R. Chaffee, Judge. Reversed and remanded with directions. Janice R. Mazur and Wm. E. Mazur, Jr., for Defendant and Appellant. Garrett Skelly for Plaintiff and Respondent.
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Plaintiff and respondent Strong The Nguyen (plaintiff) filed a shareholder's derivative action against defendant and appellant Nancy Tran (defendant), defendant O.A. Cargo, Inc. (OAC), defendant Leonard Pham (Pham) and others. After striking the answers and entering default against defendant and OAC as terminating sanctions, the court awarded default judgment against defendant in the sum of $186,500.
The court entered judgment in favor of nominal defendant OAC as the real party in interest on the derivative claims.
Defendant appeals on several grounds, arguing the court abused its discretion in ordering terminating sanctions mid-trial, there was insufficient evidence of damages, or, if damages were proper, they should not have exceeded $25,000 because no specific amount was sought in the complaint.
We conclude the court erred by ordering terminating sanctions and we reverse the default judgment. We remand for the court to vacate the defaults and reinstate the stricken answers.
Because we reverse on this basis we do not address the other issues raised.
FACTS AND PROCEDURAL HISTORY
In 2007 plaintiff, Pham, and defendant formed OAC, a freight forwarding company that ships goods to Vietnam. Defendant contributed $60,000 to capitalize OAC and was to own 60 percent of the shares. Pham and plaintiff were to own 20 percent each. Defendant was the president and plaintiff was the vice-president and office manager. Plaintiff was also on the board of directors.
Plaintiff lacked the $20,000 amount of his contribution and the parties agreed he could fulfill his obligation by paying $500 per month, deducted from his salary. Ultimately, plaintiff paid in only $15,000.
OAC's books and records were kept in defendant's office. Plaintiff had access to them. They were all subject to his review except one QuickBooks account. Plaintiff also received copies of OAC's yearly tax returns and K-1 income statements for the years 2007 through 2013.
In February 2013 plaintiff offered to sell his interest in OAC to defendant and Pham for $50,000. The offer was accepted on condition plaintiff pay the $5,000 balance owed for his shares. The sale was not consummated because plaintiff refused to sign a five-year non-compete agreement.
Plaintiff left OAC and began working for a competitor with an office less than a mile from OAC. The parties dispute whether plaintiff owns an interest in the competitor.
In April 2013, plaintiff filed suit against defendant, OAC, Pham and other parties. The first amended complaint alleged causes of action for gross mismanagement, breach of fiduciary duty, waste of assets, and unjust enrichment and breach of a duty of loyalty. It sought an accounting and damages in an unspecified amount, plus disgorgement and other equitable remedies. In denying plaintiff's request for a receiver the court ordered plaintiff could inspect OAC's books and records as allowed under the Corporations Code.
The claims against the other parties are not relevant to the issue we decide.
On the date scheduled for the inspection, OAC made its books and records available. Plaintiff elected to copy the documents himself and brought a small personal copier to the production. Two of OAC's employees assisted by copying documents on the company's machine. More than 10 boxes of documents were produced. Plaintiff left without completing his inspection when his copier broke. A week later, in reply to plaintiff's lawyer, defendant's lawyer detailed the events of the aborted inspection and offered to produce the remaining documents.
Two days later defendant's attorney sent a follow-up letter, again responding to plaintiff's attorney listing the documents already produced. He reiterated OAC's willingness to produce the remaining documents. The next day defendant's counsel sent another letter denying claims by plaintiff's lawyer that certain documents had not been produced. He detailed by category the documents produced and whether plaintiff had copied them, and again stated the documents were available for plaintiff's inspection and copying.
Almost four months later plaintiff returned to OAC to resume the inspection. Plaintiff copied some but not all of the documents although all were available. Two months thereafter, defendant's attorney sent another letter to plaintiff's counsel, reciting what had occurred at the second production. He suggested that to complete the production, plaintiff could specify any documents he had not copied and OAC would have them copied at plaintiff's expense. Plaintiff never replied nor did he file a motion to compel production.
At trial plaintiff testified to instances where he believed defendant had misused and misappropriated OAC's funds, including writing checks to cash and keeping the money for herself, and paying her personal expenses.
Defendant objected when plaintiff attempted to introduce a list of checks totaling $331,000 he claimed were evidence of defendant's misappropriation. The court deferred ruling on the objection until cross-examination but ultimately never ruled on it and the list was never admitted.
Defendant testified she made multiple loans to OAC because it did not have a sufficient cash flow. For the period 2007 through 2013 they totaled between $500,000 and $600,000. The loans took various forms. For example, OAC had to pay fees and taxes up front for its shipments to Vietnam but generally would not be paid by its customers until months after shipment. When OAC did not have the cash to make the upfront payments, friends or relatives of OAC employees in Vietnam would pay the agent and OAC would reimburse them or a third party whom they designated. The transactions were documented. Plaintiff also engaged in this activity. According to defendant, most of the checks made out to cash were written at plaintiff's request.
Sometimes defendant would wire her own money to Vietnam to pay expenses and be reimbursed when the client paid. She did not charge any interest on the advances. The board of directors knew of this practice. In addition, from time to time defendant borrowed funds from her family in Vietnam to pay agent fees. Certain of the checks made payable to defendant about which plaintiff testified were for her to repay those advances. She had receipts to support all of them.
On the second day of trial after plaintiff had testified and before plaintiff completed his examination of defendant, the court stopped the trial. Although it noted it was not in any way indicating how it might rule, the court stated it was clear OAC had not been operated according to generally accepted accounting principles. It explained that to be able to make a proper ruling, an accounting of OAC was necessary.
The court ordered the parties to jointly submit the name of a certified public accountant (CPA) within 10 days, by June 20. If they could not mutually select one, they were to submit three names of CPA's to the court by July 9, with a hearing on the matter set for July 10. The court ordered OAC to pay the cost of the accounting. Trial was continued to September.
At the July 10 hearing, the court appointed a CPA from the names submitted and ordered him to provide a proposal for the scope of work and fees by August 8. The proposal listed two alternatives: a basic accounting for $41,000, with a $25,000 retainer, or a reconstruction accounting for just under $92,000, with a $46,000 retainer.
Defendant submitted declarations stating OAC could not pay for the accounting, having only approximately $27,000 in cash. A current financial summary showed a negative balance of $88,000.
At the hearing on August 8, the court ordered that, because OAC could not afford to pay for either type of accounting, defendant was to prepare it herself for the period beginning at the inception of the business in 2007 through August 2014. The accounting, accompanied by backup documents, was due in five weeks, by September 15.
Defendant was unable to complete the accounting by that date. She did deliver two boxes of documents to plaintiff that contained over 4,000 pages of receipts and bank statements for the years 2012 and 2013, and included 700 to 1,000 pages of the general ledger.
The next day defendant filed an ex parte application seeking an additional three months to complete the accounting. In her declaration defendant stated she had begun copying documents from the date the court ordered her to prepare the accounting. The amount of documents was voluminous, totaling 400,000 to 500,000 pages.
Defendant stated she worked 10 to 12 hours per day, including assisting the Houston office, which had no on-site manager. Most days there was only one other employee in the Orange County office with her. To comply with the court's order she would need 50 to 60 full-time days to copy the documents, which would prevent her from running OAC. According to defendant, if OAC copied the documents it would cost $20,000. To hire a copy service would cost $45,000 to $50,000.
Defendant also stated she was ill, suffering from severe dizziness, and provided a doctor's note to be off work from September 11 through September 30. She was in the process of scheduling an MRI (magnetic resonance imaging).
As a possible solution, defendant offered to have OAC appoint plaintiff as president. He could run the company and have access to all the books and records. She would absent herself from OAC so as not to interfere with plaintiff.
At a hearing on September 22, defendant's attorney explained that if the court granted an additional three months to complete the accounting, he would be able to get better information on the nature of defendant's condition, which was preliminarily diagnosed as acoustic neuroma, and her ability to provide the accounting.
The court noted that to grant that request, defendant and her doctor would need to attend the next hearing, and the doctor would have to testify as "to the condition that proscribes [defendant's] ability to complete the accounting."
The court stated it had "accommodate[ed]" defendant when OAC did not have the money to pay for a CPA to prepare the accounting by allowing defendant to do it. Now defendant claimed she could not complete the accounting based on health problems. The court characterized this as "disrespectful game playing" and ordered the CPA it had originally designated to prepare an accounting for a sum not to exceed $25,000, with defendant and OAC to pay the cost up front, within two weeks.
The court stated defendant was actively seeking to contravene its order and prevent plaintiff from understanding the status of his interest in OAC, suggesting it had "been months." It announced it would "soon . . . be imposing issue sanctions."
On October 6 the court held an order to show cause (OSC) hearing regarding payment to the CPA. Defendant filed a declaration stating OAC could not pay $25,000. It had a balance of less than $10,000 in its bank accounts. Defendant offered to deliver all the documents to plaintiff.
In addition, the declaration of defendant's lawyer stated a brain MRI report showed "several issues." He offered to bring the report to the hearing for the court's in camera review. There is nothing in the record to show the court reviewed that report. The doctor also provided a note stating defendant should not work through October 31. The court set an OSC regarding sanctions, that could include striking defendant's answer, for October 31.
In support of sanctions plaintiff's lawyer filed a declaration in which he stated defendant had failed to comply with the original order to produce documents, the order to select the CPA, and the order for defendant to personally prepare the accounting. The declaration did not include any facts to support these statements.
In opposition defendant filed a declaration again explaining OAC did not have sufficient funds to pay for an accounting. She also reiterated she had a serious medical condition and offered to provide medical records in camera to the court. Defendant denied intentionally disobeying the court's order. Defendant's attorney filed a declaration setting out defendant's response to the original order to produce documents and plaintiff's failure to obtain them, all described above.
By the October 31 hearing, defendant had not completed the accounting. She was still ill. Although it found defendant did not have the money to pay for the accounting, the court accused her of "engag[ing] in a protracted form of what Mohamed [sic] Ali referred to as rope-a-dope. You lay up against the ropes, you let the other side pound until they ran out of steam, or ran out of money." As sanctions, the court struck the answers of OAC and defendant and entered default against them.
After trial against the remaining parties, which included a default prove-up against defendant, the court entered judgment in favor of OAC against defendant for $186,577. The remaining parties prevailed against plaintiff.
"In order to facilitate the expeditious processing of civil cases, parties may be sanctioned for failure to comply with delay-reduction rules or court orders. [Citations.] These sanctions may include terminating sanctions, such as the striking of pleadings. [Citations.]" (Wantuch v. Davis (1995) 32 Cal.App.4th 786, 794-795.) Because trial on the merits is preferred, a terminating sanction should not be ordered unless the party has willfully failed to comply with a prior order and a lesser sanction would be ineffective. (Id. at p. 795.) If the noncompliance was not the fault of the party, terminating sanctions should not be employed in the first instance. (Ibid.)
The basis for terminating sanctions was the court's belief defendant had deliberately failed to produce an accounting for "months." But the record does not support that finding.
Between the date the court stopped the trial to order an accounting and the date the terminating sanctions were ordered, a total of four and a half months elapsed. Of that period, two months, almost half, were spent in selecting the CPA and obtaining a proposal for the scope and cost of the work. This was the timetable set by the court and defendant fully complied. There is no evidence or finding to the contrary.
When defendant learned of the cost of the accounting in early August, she promptly advised the court OAC did not have the ability to pay. Then the court ordered defendant to personally prepare the accounting for an eight-year period and supply all backup documentation, but gave her only five weeks to do so. The CPA, a professional who made his living doing such work, had estimated he would need five to 12 weeks to complete an accounting. It does not appear reasonable to have expected defendant to be able to complete the project in such a short time span.
Defendant argues the court erred as a matter of law because it ordered the accounting to encompass a period outside of the statute of limitations governing the matter, three years on the fraud cause of action. While we do not decide whether this was error, it made an otherwise formidable order even more difficult to obey. --------
Moreover, during this period defendant became ill with a neurological condition that prevented her from working. In spite of her offer to provide medical reports, the court never inquired about the condition or when defendant might be able to return to work and complete the accounting. It did suggest that if defendant was in jail for failure to obey the order, doctors would be available to treat her if necessary.
Despite her condition, defendant attempted to comply with the order and produced two boxes of documents. She also offered to have plaintiff become OAC's president and to give him access to all of the documents. While this was not compliance with the order, it is evidence defendant was not trying to prevent plaintiff from being able to review the books and records.
In addition, without producing evidence in support, plaintiff argued to the court defendant had blocked access to the records for 18 months. Again, the record is to the contrary, as the detailed declaration of defendant's counsel shows. Defendant produced books and records on two occasions in accordance with the court's order and offered to do so many more times.
In ordering the accounting, the court noted it was not prejudging the case. But on several occasions it made clear it believed defendant had committed misconduct in running OAC. For example, when it halted the trial and before defendant had put on any evidence in her defense, the court remarked that generally accepted accounting principles had not been followed.
Again, when it appointed the CPA, the court stated the evidence of "misuse and misappropriation of corporate assets was overwhelming." It also was under the misimpression trial had been completed. When defendant's counsel stated the tenor of the case would be different had defendant been allowed to put on her evidence, the court told him it was "ludicrous" to suggest the court would reopen the case. Although the court subsequently realized the trial had not been concluded, it appears it had already determined defendant had committed misconduct.
This determination, plus the unsubstantiated assertion by plaintiff that defendant had failed to produce documents, plainly contributed to the court's erroneous belief defendant had delayed for "months." Given the totality of the circumstances, i.e., the lengthy time period to be encompassed by the accounting, the large volume of documents, the abbreviated time period given for production of the accounting, and defendant's neurological condition, it does not appear defendant could possibly have complied with the order as made. Although the accounting was not completed by the court's deadline, the record shows it was not through any willful wrongdoing by defendant.
Thus, striking the answers of defendant and OAC was an abuse of discretion and default judgment must be reversed.
The default judgment is reversed, and the case is remanded to the trial court with directions to vacate the defaults and reinstate the stricken answers. Defendant is entitled to costs on appeal.
THOMPSON, J. WE CONCUR: BEDSWORTH, ACTING P. J. IKOLA, J.