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Tentative Ruling
Judge Donna Geck
Department 4 SB-Anacapa
1100 Anacapa Street P.O. Box 21107 Santa Barbara, CA 93121-1107

CIVIL LAW & MOTION

ELH Group LLC et al vs IGF Partners LLC et al

Case No: 17CV04771
Hearing Date: Fri Jan 05, 2018 9:30

Nature of Proceedings: Motion: to Furnish a Bond

TENTATIVE RULING:     Defendants’ motion to compel plaintiffs to furnish a bond is denied.

 

BACKGROUND:

This is a derivative lawsuit challenging the actions and decisions of the management of a limited liability company. According to the allegations, on October 13, 2014, IGF Investment Fund, LP (“IGF Fund”), a limited partnership, was formed for the purpose of investing in single and multi-tenant commercial properties in the United States. IGF Fund’s investments are managed by its general partner, defendant IGF Partners Realty, LLC (“IGF Realty”). IGF Realty’s managing members are defendants Christian Heyer (“Heyer”), Thomas Caesar (“Caesar”), Eugene McKnight (“McKnight”), Damien Kriteman (“Kriteman”), and IGF Partners, LLC (“IGF Partners”). Plaintiffs ELH Group, LLC (“ELH”), Andrew Wirth (“Wirth”), and Act Property Acquisition Partners IV, LLC (“Act IV”) are also members of IGF Realty and investors in the company. Through this derivative action, plaintiffs seek to recover damages against defendants for breaches of fiduciary duty and self-dealing.

Defendants Heyer, Caesar, McKnight, and Kriteman, and nominal defendants IGF Realty and IGF Partners, now move for an order requiring plaintiffs to furnish a bond pursuant to Corporations Code Section 17709.02 on the ground that there is no reasonable possibility that the lawsuit will provide any benefit to IGF Realty or any of its members. Plaintiffs oppose the motion.           

ANALYSIS:

Evidentiary Objections

Defendants objected to portions of the Declaration of William Levy submitted in opposition to defendants’ motion. As to each of defendants’ objections, the court rules:

1. Paragraph 28: Defendants object to the statement on hearsay grounds. Overruled. Mr. Levy is a principal of ELH, one of the founding members of IGF Realty. (Motion, p. 9:24-25.) Mr. Levy was also involved in the decision to form IGF Fund and IGF Partners. (Motion, pp. 10:7-8, 10:17.) Mr. Levy is competent to testify whether he was aware of any notices or disclosures to members or investors advising them that IGF Realty had collected an additional acquisition fee with the purchases of properties in California and Oklahoma in July 2017 and that the additional income was used to pay management salaries.

2. Paragraph 30. Moot. The objected to portion of paragraph 30 was not considered by the court.

3. Paragraph 38. Moot. The objected to statement was not considered by the court.

4. Paragraph 40. Same as 3, above.

5. Paragraph 42. Defendants object to the statement on hearsay grounds. Overruled. Mr. Levy, as advisor to IGF Realty, is competent to testify whether Mr. Heyer borrowed $100,000 from the company, whether the funds were ever repaid, and whether defendants Heyer, Caesar, and McKnight extended the terms of the note without notice to the remaining members.

6. Paragraph 49. Moot. The objected to portion of paragraph 49 was not considered by the court.

Motion for Bond

Corporations Code Section 17709.02 governs derivative actions brought in the name of a limited liability company by a member of the company against the company’s management. The section provides:

“(a) No action shall be instituted or maintained in right of any domestic or foreign limited liability company by any member of the limited liability company unless both of the following conditions exist:

“(1) The plaintiff alleges in the complaint that the plaintiff was a member of record, or beneficiary, at the time of the transaction or any part of the transaction of which the plaintiff complains . . . .

“(2) The plaintiff alleges in the complaint with particularity the plaintiff’s efforts to secure from the managers the action the plaintiff desires or the reasons for not making that effort, and alleges further that the plaintiff has either informed the limited liability company or the managers in writing of the ultimate facts of each cause of action against each defendant or delivered to the limited liability company or the managers a true copy of the complaint that the plaintiff proposes to file.”

Section 17709.02 further provides:

“(b) In any action referred to in subdivision (a), at any time within 30 days after service of summons upon the limited liability company or upon any defendant who is a manager of the limited liability company or held that position at the time of the acts complained of, the limited liability company or the defendant may move the court for an order, upon notice and hearing, requiring the plaintiff to furnish security as hereinafter provided. The motion shall be based upon one or both of the following grounds:

“(1) That there is no reasonable possibility that the prosecution of the cause of action alleged in the complaint against the moving party will benefit the limited liability company or its members.

“(2) That the moving party, if other than the limited liability company did not participate in the transaction complained of in any capacity. . . .

“(c)(1) At the hearing upon any motion pursuant to subdivision (b), the court shall consider evidence, written or oral, by witnesses or affidavit, as may be material to the ground upon which the motion is based, or to a determination of the probable reasonable expenses, including attorney’s fees, of the limited liability company and the moving party that will be incurred in the defense of the action.

“(2) If the court determines, after hearing the evidence adduced by the parties, that the moving party has established a probability in support of any of the grounds upon which the motion is based, the court shall fix the nature and amount of security, not to exceed fifty thousand dollars ($50,000), to be furnished by the plaintiff for reasonable expenses, including attorney’s fees, that may be incurred by the moving party and the limited liability company in connection with the action. . . .”

In this action, nominal defendants IGF Realty and IGF Partners, through the management team of defendants Heyer, Caesar, McKnight, and Kriteman, have moved for an order requiring plaintiffs ELH, Wirth, and Act IV to post a bond of $50,000 for anticipated defense costs on the ground that “[t]here is no reasonable possibility that the prosecution of the cause of action alleged in the complaint against the moving party will benefit the limited liability company [IGF Realty] or its members.” Corp. Code §17709.02, subd. (b)(2). As stated in Brusso v. Running Springs Country Club, Inc. (1991) 228 Cal.App.3d 92, 102 (involving similar statute (Corp Code §800) for shareholder actions against a corporation), the purpose of the bond requirement is to discourage unfounded lawsuits brought against a limited liability company by disgruntled members.

Defendants initially argue that plaintiffs lack standing because most of the allegations concern IGF Fund and IGF Fund is not a party to the action and plaintiffs have not alleged that they have a partnership interest in the Fund or that they are investors in the Fund. Plaintiffs allege, for example, that defendants failed to disclose relevant information about Heyer’s history of bankruptcy, tax liens, and outstanding debt “in connection with the sale of limited partnership interests in IGF Fund.” (Comp., ¶¶ 68(c), 79(c).) Under California law, every action must be prosecuted in the name of the real party in interest and a claimant generally lacks standing to litigate the rights and duties of third parties. Code Civ. Proc. §367; Connerly v. Schwarzenegger (2007) 146 Cal.App.4th 739, 748 (“To have standing, a party must be beneficially interested in the controversy; that is, he or she must have some special interest to be served or some particular right to be preserved or protected over and above the interest held in common with the public at large.”).

Defendants’ standing argument is without merit. While plaintiffs’ allegations of fraudulent and willful misconduct may give rise to derivative claims against IGF Fund by its partners, the gravamen of the complaint alleges injury to the Fund’s general partner, IGF Realty, a limited liability company of which plaintiffs are members. (Comp., ¶¶ 19, 29, 30.) Plaintiffs allege that at the time of the events complained of in the pleadings, they were members of, and investors in, IGF Realty. (Comp., ¶¶ 30, 65.) Plaintiffs additionally allege that defendants Heyer, Caesar, McKnight, Kriteman, and IGF Partners, the acting managers of IGF Realty, breached their fiduciary duties to the company by engaging in a course of misconduct, self-dealing, and obfuscation in an attempt to personally profit at the expense of the company. (Comp., ¶¶ 3, 25, 40, 68, 79.) Specifically, plaintiffs claim that defendants mismanaged IGF Realty to the point of insolvency by deliberately misrepresenting the company’s financial projections and profits in an attempt to attract investors (Levy Dec., ¶¶ 22, 24), by continuing to draw salaries of $10,000 per month when the company had little cash in the bank (Levy Dec., ¶26), by failing to disclose all acquisition fees collected by the company in connection with the purchases of properties in California and Oklahoma (Levy Dec., ¶¶ 27, 28), by borrowing money from the company and never repaying it (Levy Dec., ¶¶ 41-44), and by completing year-end audits knowing that the information was inaccurate, false, and misleading (Levy Dec., ¶48).

Next, defendants argue that EHL has a conflict of interest that precludes it from bringing derivative causes of action on behalf of IGF Realty (first and second causes of action) while at the same time asserting a claim against the company for failure to provide books and records (fifth cause of action). The case law, however, does not support defendants’ argument. On the contrary, a shareholder of a corporation or a member of a limited liability company may pursue both derivative and direct claims in the same suit where the shareholder or member has suffered injury in an individual capacity and as an owner of the company. Denevi v. LGCC (2004) 121 Cal.App.4th 1211, 1221 (“[O]ne who has suffered injury both as an owner of a corporate entity and in an individual capacity is entitled to pursue remedies in both capacities.”). The cases cited by defendants, Melancon v. Superior Court (1954) 42 Cal.2d 698, 708, Nelson v. Anderson (1999) 72 Cal.App.4th 111, 125, and Oakland Raiders v. National Football League (2005) 131 Cal.App.4th 621, 650, are in inapposite as they simply stand for the proposition that shareholders may not maintain an action in their individual capacities where the alleged facts only support a derivative cause of action.

Defendants also claim that plaintiffs have not satisfied the pre-litigation demand requirement that is essential in all derivative actions. The court disagrees. Corporations Code Section 17709.02, subdivision (a)(2), requires that the plaintiff allege “with particularity the plaintiff’s efforts to secure from the managers the action the plaintiff desires or the reasons for not making that effort, and [allege] further that the plaintiff has either informed the limited liability company or the managers in writing of the ultimate facts of each cause of action against each defendant or delivered to the limited liability company or the managers a true copy of the complaint that the plaintiff proposes to file.” Here, plaintiffs have alleged:

“Plaintiffs did not make any effort to secure action from the acting managers in prosecuting his action since such effort would have been futile. Plaintiffs repeatedly, and in writing, objected to the acts and failures to disclose set forth above. Letters to counsel for IGF Partners and IGF Realty were sent on March 12, 2017, April 21, 2017, and August 31, 2017. However, each complaint, recommendation and concern was summarily dismissed by counsel for IGF Realty and IGF Partners. As a result, any attempts to secure action from the acting managers to file suit over concerns they dismissed in writing would have been futile.”

(Comp., ¶71, ¶82.)

In addition, William Levy, ELH’s principal, states:

“I repeatedly wrote to counsel for IGF Realty and IGF Partners setting forth specific concerns, issues, and demands for corrective action from the acting managers of these entities on March 12, 2017, April 21, 2017, April 30, 2017, July 17, 2017, August 31, 2017, and September 5, 2017. True and correct copies of the letters are attached hereto as Exhibit ‘Z.’ Each of my demands were either ignored and/or summarily dismissed.”

(Levy Dec., ¶53, Ex. Z.)

Finally, defendants were provided with a copy of the proposed complaint and asked to discuss it, but, as with the prior letters, plaintiffs received no response. (Waldinger Dec., ¶3, Ex. B, Draft Complaint and Cover Letter.) Accordingly, plaintiffs have satisfied the pre-filing requirements.

Defendants next argue that the complaint lacks substantive merit because the April 2015 operating agreements for both IGF Realty and IGF Partners expressly provide that the companies shall be “manager-managed,” not “member-managed” (McKnight Dec., ¶5, Ex. 2, §8.1, ¶7, Ex. 3, §8.1; Heyer Dec., ¶4), and defendants exercised management control over the companies consistent with the operating agreements. However, plaintiffs contend that the only valid operating agreement for IGF Realty is the original agreement, dated April 3, 2014, which provides:

“4.1 Management.

“A. Generally. Subject to the terms of this Agreement and the California Revised Uniform Limited Liability Company Act, the business affairs of the Company will be managed by the Members.”

(Levy Dec., ¶6, Ex. B, p. 5.)

The original operating agreement provides that any amendment to the agreement requires the “unanimous approval of the Members . . . in writing.” (Ibid.) Here, defendants have provided no evidence that the members of IGF Realty provided unanimous consent in writing to amend the operating agreement, and therefore, it is plaintiffs’ contention that IGF Realty must be managed by majority rule of its members.     

Lastly, defendants argue that they are insulated from liability as a matter of law by virtue of the “business judgment rule” and the exculpation clauses in the companies’ operating agreements. Under the “business judgment rule” there is a presumption that directors’ decisions are made in good faith. Biren v. Equality Emergency Medical Group, Inc. (2002) 102 Cal.App.4th 125, 136 (“[A] director is not liable for a mistake in business judgment which is made in good faith and in what he or she believes to be the best interests of the corporation . . . .”). Also, as permitted by Corporations Code Section 17701.10, subdivision (g), the operating agreements for IGF Realty and IGF Partners expressly provide:

“Neither the Manager nor any of its Affiliates, any member, officer, agent or employee of the Manager or any of its Affiliates nor any other Indemnified Party shall be liable, responsible or accountable in damages or otherwise to the Company or any Member for any loss incurred as a result of any act or failure to act by such Person on behalf of the Company unless such loss is finally determined by a court of competent jurisdiction to have resulted solely from such Person’s fraud, willful misconduct or gross negligence.”

(McKnight Dec., ¶5, Ex. 2, §8.6, ¶7, Ex. 3, §8.6.)

Defendants contend that the allegations in the complaint of mismanagement are nothing more than challenges to discretionary business decisions or duty of care violations subject to the exculpation clauses. However, plaintiffs have alleged substantially more than this. For example, plaintiffs allege that defendants fired the managing broker for IGF Realty (“Maloney Securities”) in order to retain control of the company and to halt an investigation of potential securities violations by management. (Comp., ¶68.d; Levy Dec., ¶¶ 33-39.) Plaintiffs additionally allege that defendants (1) knowingly used inflated rates of return on financial documents to attract unsuspecting investors, (2) knowingly completed year-end audits that contained inaccurate and false information, (3) knowingly usurped management authority from the remaining members without consent, (4) borrowed monies from IGF Realty that were never repaid, (5) utilized company credit cards and funds for personal expenses, (6) failed to disclose personal debt obligations in violation of the securities laws in order to maintain control over IGF Realty, and (7) failed and refused to provide LLC documents as required by law in order to retain control of the company. (Comp., ¶¶ 2, 3, 4, 38, 42, 44, 45, 55, 56, 61, 62, 68, 79; Levy Dec., ¶¶ 11, 12, 13, 24, 29-31, 42, 43, 49.)

“[A]ffirmative allegations of fact which, if proven, would establish fraud, bad faith, overreaching or an unreasonable failure to investigate material facts” are sufficient to rebut the presumption created by the business judgment rule. Berg & Berg Enterprises v. Boyle (2009) 178 Cal.App.4th 1020, 1046. Here, plaintiffs have alleged sufficient facts in support of each of their claims to overcome both the business judgment rule and the exculpatory provisions in the operating agreements. Accordingly, defendants’ motion for order requiring plaintiffs to furnish a bond will be denied. Defendants have failed to demonstrate that “there is no reasonable possibility” that prosecution of the complaint will benefit IGF Realty or its members..

 
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