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PrivacyWear, Inc. v. QTS & CTFC

UNITED STATES DISTRICT COURT CENTRAL DISTRICT OF CALIFORNIA


August 20, 2009

PRIVACYWEAR, INC., A NEVADA CORPORATION; AND CAROLYN M. JONES, AN INDIVIDUAL, PLAINTIFFS,
v.
QTS & CTFC, LLC, A NEBRASKA LIMITED LIABILITY COMPANY; AND JONATHAN NASH, AN INDIVIDUAL, DEFENDANTS.

The opinion of the court was delivered by: VIRGINIA A. Phillips United States District Judge

[Motion filed on July 24, 2009]

ORDER GRANTING IN PART AND DENYING IN PART MOTION TO DISMISS COUNTERCLAIMS

Plaintiffs' Motion to Dismiss Counterclaims came before the Court for hearing on August 17, 2009. After reviewing and considering all papers filed in support of, and in opposition to, the Motion, as well as the arguments advanced by counsel at the hearing, the Court GRANTS IN PART and DENIES IN PART the Motion.

I. BACKGROUND

A. Procedural Background

Plaintiffs PrivacyWear and Carolyn M. Jones ("Jones" or "Plaintiff Jones") filed their Complaint on November 20, 2007, and their First Amended Complaint ("FAC") on March 18, 2008. The FAC alleges the following claims against Defendants QTS & CTFC, LLC ("QTS" or "Defendant QTS") and Jonathan Nash ("Nash" or "Defendant Nash"):

(1) breach of contract, (2) breach of implied covenant of good faith and fair dealing, (3) failure to acknowledge satisfaction of judgment, (4) unjust enrichment, (5) fraud in the inducement, and (6) for declaratory relief.

The procedural background of this case is set forth at length in the Court's September 24, 2008 Order. See Docket No. 24. In that Order, the Court invoked the Colorado River doctrine and stayed this case in favor of the California state court proceedings seeking to enforce the Nebraska judgment. In status reports filed on April 1 and April 2, 2009, the parties informed the Court that those state proceedings are substantially concluded, as follows.

In an order dated November 10, 2008, the California Court of Appeals vacated the judgments entered in favor of QTS against PrivacyWear and Jones, finding that the Nebraska judgment upon which the Superior Court's judgment for QTS was based had been rendered in excess of the Nebraska court's jurisdiction. Specifically, the Court of Appeals found QTS failed to demonstrate that Nebraska had personal jurisdiction over PrivacyWear and Jones when it entered its default judgment against them. After the Court of Appeals denied QTS's Petition for a Rehearing, the Superior Court vacated the sister-state judgments.

On April 16, 2009, this Court lifted its stay, reset Defendants' Motion to Dismiss, and allowed the parties to file supplemental briefs relating to the Motion. On May 21, 2009, the Court denied the Motion to Dismiss.

On June 5, 2009, Defendants filed an Answer to the Amended Complaint and Counterclaims against Plaintiffs. Defendants filed Amended Counterclaims ("AC") against Plaintiffs on July 7, 2009, alleging the following: (1) Breach of Investment Contract; (2) Breach of Oral Contract; (3) Request for Accounting Prior to Nebraska Default Judgments; (4) Fraudulent Concealment; (5) Fraudulent Conversion of QTS's 2.5% PrivacyWear Stock; (6) Embezzlement; (7) Forgery; (8) Theft by Deception; (9) Breach of Investment Contract Based on Dilution; (10) Breach of Fiduciary Duty; (11) Breach of Covenant of Good Faith and Fair Dealing; (12) Breach of Oral Contract Based on Non-Performance; (13) Breach of Oral Contract Based on Non-Performance; and (14) Fraudulent Misrepresentation.

On July 24, 2009, Plaintiffs/Counter-Defendants ("Plaintiffs") filed a Motion to Dismiss ("Motion") Defendants/Counter-Claimants' ("Defendants") First through Eleventh and Fourteenth Counterclaims and a Request for Judicial Notice ("Defs. RJN").*fn1 Defendants filed Opposition on August 3, 2009. Plaintiffs filed a Reply on August 7, 2009 and a Request for Judicial Notice ("Pls. RJN").*fn2

B. Counterclaimants' Allegations

For the purposes of this Motion, the Court accepts the following allegations in the Amended Counterclaims ("Counterclaims" or "AC") as true.

Plaintiff PrivacyWear, Inc. ("PrivacyWear" or "Plaintiff PrivacyWear") is a Nevada corporation. (AC ¶¶ 2, 3.) Plaintiff Carolyn M. Jones ("Jones" or "Plaintiff Jones") is the president and CEO of PrivacyWear. (Id. at ¶ 5) In 2004, Plaintiff PrivacyWear and Defendant Jonathan Nash ("Nash" or "Defendant Nash") entered into an agreement whereby Nash invested $50,000 in PrivacyWear and obtained a 2.5% interest in the company. (Id. at ¶¶ 9, 10.)

Nash is the sole member and manager of Defendant QTS & CTFC, LLC ("QTS"), a Nebraska limited liability corporation. (Id. at ¶ 2.) In 2005, QTS sued Plaintiffs in Nebraska state court for breach of contract and related claims arising out of the parties' investment agreement. (Id. at ¶ 23.) In 2006, the Nebraska court entered default judgment in favor of QTS and against Plaintiffs. (Id. at ¶ 24.) After the Nebraska judgment was entered, the parties entered into an oral agreement under which QTS would accept $1,400,000 from Jones and PrivacyWear in full satisfaction of the entire judgment, in addition to certain agreed upon terms. (Id. at ¶ 28.)

In September 2006, Plaintiffs paid $400,000 to satisfy the judgment, but Defendant Nash continued to demand payment of additional money. (Id. at ¶ 30.) On October 6, 2006, Defendant Jones sent Defendant Nash the following electronic mail message ("email"):

"... (2) When the documents [private placement memorandum and related documents] reference current owners/shareholders, I did not reference your name or your 2.5% ownership because at that time you had already filed legal documents against me and the company, so I didn't think it was wise to reference your name in any manner. I did however keep note of your ownership, but placed under my name for the purposes of this document." (Id. at ¶ 36.)

Based on that communication, Defendants allege Jones fraudulently converted their 2.5% ownership interest in PrivacyWear. (Id. at ¶¶ 25-37.) Defendants also learned Jones diluted their 2.5% ownership interest in connection with PrivacyWear's reverse merger with SP Holdings, Inc., without their permission or knowledge. (Id. at ¶ 38.) In November 2007, Defendants learned PrivacyWear was involved in another stock purchase agreement with another apparel company, without their permission or knowledge. (Id. at ¶ 41.) Finally, in April 2007, Defendants learned Jones breached their settlement agreement and represented PrivacyWear would be unable to pay the full $1,400,000 settlement. (Id. at ¶ 43.) On multiple occasions, Plaintiffs refused to provide Defendants with an accounting. (Id. at ¶¶ 45, 46.)

QTS then filed suit in the California Superior Court for Riverside County to enforce the default judgment it obtained in Nebraska, and Plaintiffs filed the instant lawsuit.

II. LEGAL STANDARD

Under Rule 12(b)(6), a party may bring a motion to dismiss for failure to state a claim upon which relief can be granted. As a general matter, the Federal Rules require only that a plaintiff provide "'a short and plain statement of the claim' that will give the defendant fair notice of what the plaintiff's claim is and the grounds upon which it rests." Conley v. Gibson, 355 U.S. 41, 47 (1957) (quoting Fed. R. Civ. P. 8(a)(2)); Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 555 (2007). In addition, the Court must accept all material allegations in the complaint - as well as any reasonable inferences to be drawn from them - as true. See Doe v. United States, 419 F.3d 1058, 1062 (9th Cir. 2005); ARC Ecology v. U.S. Dep't of Air Force, 411 F.3d 1092, 1096 (9th Cir. 2005).

"While a complaint attacked by a Rule 12(b)(6) motion to dismiss does not need detailed factual allegations, a plaintiff's obligation to provide the 'grounds' of his 'entitlement to relief' requires more than labels and conclusions, and a formulaic recitation of the elements of a cause of action will not do." Bell Atlantic, 550 U.S. at 555 (citations omitted). Rather, the allegations in the complaint "must be enough to raise a right to relief above the speculative level." Id.

In other words, the allegations must be plausible on the face of the complaint. See Ashcroft v. Iqbal, 556 U.S. __, 129 S.Ct. 1937, 1949 (2009). "The plausibility standard is not akin to a 'probability requirement,' but it asks for more than a sheer possibility that a defendant has acted unlawfully. Where a complaint pleads facts that are 'merely consistent with' a defendant's liability, it stops short of the line between possibility and plausibility of 'entitlement to relief.'" Id. (citations and internal quotations omitted).

Although the scope of review is limited to the contents of the complaint, the Court may also consider exhibits submitted with the complaint, Hal Roach Studios, Inc. v. Richard Feiner & Co., 896 F.2d 1542, 1555 n.19 (9th Cir. 1990), and "take judicial notice of matters of public record outside the pleadings," Mir v. Little Co. of Mary Hosp., 844 F.2d 646, 649 (9th Cir. 1988).

III. DISCUSSION

Plaintiffs move the Court to dismiss Defendants' First through Eleventh and Fourteenth Amended Counterclaims. (See Mot. at 1-2.)

A. Investment Contract-Related Claims

First, Plaintiffs argue Defendants' First through Tenth Counterclaims fail because they seek to enforce the terms of the written Investment Contract while they simultaneously seek to enforce the terms of an oral settlement of the claims arising from the Investment Contract. (See Mot. at 5-7.) Specifically, Plaintiffs argue Defendants may not seek to enforce the terms of the original contract and the terms of the settlement agreement because the settlement extinguished the terms of the original Investment Contract. (Id. at 6 ("a settlement agreement for release of claims essentially operates as a new contract and operates as a merger and bar of all pre-existing causes of action.").)

"The [California] Supreme Court has explained that a settlement operates as a merger and ban as to all pre-existing claims...." Ebensteiner Co., Inc. v. Chadmar Group, 143 Cal. App. 4th 1174, 1179 (2006). "Even if entered into after the rendition of a judgment on the disputed agreement or right, the compromise agreement has the same legal effect." Id. (quotations and citation omitted).

In Opposition, Defendants argue their claims are actionable because they "seek relief for two different categories of actionable conduct by Counter-Defendants:

(1) damages for breach of the September 2006 oral agreement because PrivacyWear/Diamond Decisions failed to pay all monetary amounts owed; and (2) damages for breaches of the Investment Contract (to the extent it was not part of the September 2006 oral agreement) and damages for breaches (not related to the payment of monies) of the September 2006 oral agreement." (Opp'n at 4.) In other words, Defendants allege breaches of the settlement agreement and breaches of the duties in the Investment Contract, to the extent the settlement did not cover all Defendants' claims arising under the Investment Contract.

Defendants' Counterclaims One through Ten are not barred by the entry of the Settlement Agreement. First, the claims, sounding in contract and tort law, arise from alleged breaches of the Settlement Agreement and events occurring after the parties entered into the Agreement. (See Opp'n at 11-13 (emphasis added).) As Defendants point out, under California law, a settlement or release does not bar claims for future actionable conduct. See Cal. Civ. Code § 1542. Second, the claims arise from alleged breaches of the Investment Contract, only insofar as the Settlement Agreement did not cover all of Defendants' claims arising under the Investment Contract. If not all of Defendants' claims were covered by the settlement agreement, Defendants may pursue those remaining claims, even though they resolved other claims. Ebensteiner Co., Inc., 143 Cal. App. 4th at 1179.

Accordingly, the Court DENIES Plaintiffs' Motion to Dismiss Defendants' First through Tenth Counterclaims, insofar as it is based on this argument.*fn3

B. Derivative Shareholder Counterclaims

Next, Plaintiffs move the Court to dismiss Defendants' Counterclaims because they are derivative, brought by a shareholder, and did not satisfy the procedural requirements for filing such claims. (See Mot. at 8-10.)

A party filing a shareholder derivative lawsuit stands in the shoes of the corporation and raises claims belonging to the corporation and seeks compensation for its injuries. See Kamen v. Kemper Fin. Serv., Inc., 500 U.S. 90, 95-97 (1991); McDermott, Will & Emery v. Superior Court, 83 Cal. App. 4th 378, 382 (2000); Fed. R. Civ. P. 23.1. Before filing a shareholder derivative lawsuit, the shareholder must first demand the board of directors and, if necessary, the remaining shareholders, take action on behalf of the corporation. See Kamen, 500 U.S. at 96; Fed. R. Civ. P. 23.1.

In Opposition, Defendant argues its Counterclaims do not amount to a shareholder derivative lawsuit; thus, the special procedural requirements of such a lawsuit do not apply. (See Opp'n at 13-15.) Specifically, Defendants argue their Counterclaims arise from personal injuries and are not brought on behalf of the corporation. (Id.) Furthermore, Defendants argue only Defendant QTS is a shareholder of PrivacyWear, and not Defendant Jonathan Nash. (Id. at 14)

On its face, Defendants' Amended Counterclaims do not appear to be brought on behalf of or in the shoes of PrivacyWear by Defendants. First, Defendant Nash's Counterclaims are not properly construed as being derivative because he was not a PrivacyWear shareholder. (See Opp'n at 14; AC ¶ 9.) Second, with one exception, Defendant QTS's Counterclaims allege claims against PrivacyWear and its Chief Executive Officer Carolyn M. Jones for injuries to itself, not for injuries to PrivacyWear, and seek damages for itself, not on behalf of PrivacyWear. (See generally AC.)

The exception is Defendants' Ninth Amended Counterclaim, for "Breach of Investment Contract Based on Dilution," which is derivative in nature. As Plaintiffs point out in their Reply, a claim for dilution of stock value is a claim shared by all shareholders and is considered derivative. (See Reply at 4-5 (citing Kramer v. W. Pac. Indus., Inc., 546 A.2d 348, 353 (Del. 1988); Schuster v. Gardner, 127 Cal. App. 4th 305, 316 (2005); Gaillard v. Natomas Co., 208 Cal. App. 3d 1250, 1251 (1989).) As a derivative claim, Defendants' Ninth Counterclaim must comply with the requisite filing requirements, i.e., making a demand on the corporation's board of directors and, if necessary, all shareholders, before filing a derivative action. See Kamen, 500 U.S. at 95-97. Furthermore, Defendants' allegations of divestment, arising out of an alleged "reverse merger with SP Holdings, Inc.," must comply with the same procedural prerequisites. (See AC ¶¶ 38, 111-118, 122(iv), 127(iv).) Defendants fail to allege facts demonstrating compliance with these filing prerequisites.

Accordingly, only Defendants' Ninth Counterclaim amounts to a derivative claim by a shareholder and must comply with the applicable special procedural requirements. The Court GRANTS Plaintiffs' Motion to Dismiss as to Defendants' Ninth Counterclaim only.

C. Counterclaim Four, for Fraudulent Concealment

Next, Plaintiffs move the Court to dismiss Defendants' Fourth Counterclaim, for fraudulent concealment. (See Mot. at 11.) Plaintiffs argue the Counterclaim fails to allege the requisite "causal nexus" between the alleged fraudulent concealment and its damages. (Id.)

To state a claim for fraudulent concealment under California law, a party must plead factual allegations supporting each of the following elements: (1) party concealed a material fact; (2) party had duty to disclose fact to the injured party; (3) party intentionally concealed fact with intent to defraud the injured party; (4) the injured party was unaware of the fact and would not have acted as she did if she knew of the concealed fact; and (5) the injured party was injured because party concealed the fact. See Hahn v. Mirda, 147 Cal. App. 4th 740, 748 (2007) (quoting Marketing West, Inc. v. Sanyo Fisher (USA) Corp., 6 Cal. App. 4th 603, 612-13 (1992).).

Defendants allege PrivacyWear concealed Defendant QTS's 2.5% ownership interest in at least one private placement memorandum sent to potential investors. (See AC ¶¶ 73-80 (Plaintiff Jones told Defendant Nash she intentionally did not include QTS's 2.5% interest in the private placement memorandum because QTS and Nash had filed a Complaint against PrivacyWear and "legal disputes would make people nervous about investing.") In Opposition, Defendants argue this concealment damaged them because "QTS has been deprived of its 2.5% ownership interest in Privacy Wear/Diamond Decisions." (Opp'n at 15.)

Defendants' Fourth Counterclaim fails because Defendants cannot allege facts to support elements three and five. Defendants do not allege how they were injured by Plaintiffs' investor publications, nor do Defendants allege how Plaintiffs intended to defraud them specifically, as opposed to potential investors. Furthermore, Defendants' purported injury as a result of this alleged concealment - that it lost its 2.5% ownership interest in PrivacyWear - is unsupported by its own factual allegations in this Counterclaim. (See AC ¶ 80 (alleging general damages as result of misrepresentation of QTS ownership interest in PrivacyWear's private placement memorandum without reference to any actual loss of the ownership interest).)

Accordingly, the Court GRANTS Plaintiffs' Motion to Dismiss Defendants' Fourth Counterclaim, without leave to amend.

D. Counterclaims Five Through Eight, for Conversion, Theft, Forgery, and Embezzlement

Plaintiffs move the Court to dismiss Defendants' Fifth through Eighth Counterclaims because they fail as a matter of law. (See Mot. at 12-14.) Specifically, Plaintiffs argue these claims fail because QTS's 2.5% ownership interest in PrivacyWear remained intact and was never appropriated by Plaintiffs. (Id. at 12.)

Defendants' Counterclaims arise out of the factual allegations discussed above, concerning fraudulent concealment. Defendants base these Counterclaims on the misrepresentations in the private placement memorandum sent to potential investors. (See Opp'n at 16-17; AC ¶¶ 82-87 (conversion); ¶¶ 89-94 (embezzlement); ¶¶ 96-103 (forgery); ¶¶ 105-110 (theft by deception).) Defendants' factual allegations supporting these Counterclaims are identical.

To state a claim for conversion, a party must allege facts to support the following elements: (1) party's ownership of property; (2) wrongful dispossession of property by another; and (3) damages to party caused by dispossession of property. Burlesci v. Peterson, 68 Cal. App. 4th 1062, 1065-66 (1998).

Based on the face of the Amended Counterclaims, the Court finds Defendants do not state a claim for conversion because they do not plead facts to show how a misrepresentation or concealment of material fact in a PrivacyWear private placement memorandum, discussed above, divested QTS of its 2.5% ownership interest in PrivacyWear. In Opposition,*fn4 Defendants argue Jones' communication to Nash "shows that Jones transferred QTS's 2.5% ownership interest into her own name." (Opp'n at 17.) Defendants' own allegations do not support this argument. Defendants allege Jones stated the following in an email to Nash:

"When the documents reference current owners/shareholders, I did not reference your name or your 2.5% ownership because at that time you had already filed legal documents against me and the company, so I didn't think it was wise to reference your name in any manner. I did however keep note of your ownership, but placed under my name for purposes of this document." (AC ¶ 84 (quoting October 6, 2006 electronic mail from Jones to Nash, explaining PrivacyWear's private placement memorandum.) This allegation supports an inference that Jones identified QTS's 2.5% ownership interest in the private placement memorandum as her own asset, but does not support an inference that, by doing that, Jones divested QTS's ownership interest unilaterally. Furthermore, Defendants do not cite authority to show that a private placement memorandum can change ownership interests in a company. On the face of the Amended Counterclaims, this claim is not plausible. See Ashcroft v. Iqbal, 129 S.Ct. at 1949. Accordingly, Defendants fail to plead facts to support the elements of dispossession and damages.

As to Defendants' Counterclaims for embezzlement, forgery, and theft, the Court finds these claims duplicative of Defendants' Counterclaim for conversion.

Accordingly, the Court GRANTS Plaintiffs' Motion to Dismiss Defendants' Counterclaims Five through Eight, with leave to amend.

E. Counterclaim Fourteen, for Fraudulent Misrepresentation

Plaintiffs move the Court to dismiss Defendants' Fourteenth Counterclaim, for fraudulent misrepresentation, because the claim fails as a matter of law. (See Mot. at 14-16.)

To state a claim for fraudulent misrepresentation, a party must allege facts to support the following elements: (1) misrepresentation; (2) knowledge of falsity; (3) intent to defraud; (4) justifiable reliance; and (5) damages. Kearns v. Ford Motor Co., 567 F.3d 1120, 1126 (9th Cir. 2009).

Allegations of fraud must meet the heightened pleading requirements of Federal Rule of Civil Procedure 9(b) ("Rule 9(b)"). See Fed. R. Civ. P. 9(b). Rule 9(b) applies when a complaint specifically alleges fraud as an essential element of a claim. Vess v. Ciba-Geigy Corp. USA, 317 F.3d 1097, 1103-04 (9th Cir. 2003). It also applies when the claim "sounds in fraud," by alleging the defendant engaged in fraudulent conduct, but the claim itself does not contain fraud as an essential element. Id. at 1106. Indeed, even if a complaint does not assert explicitly a claim for fraud and even if none of the claims in a complaint "sound in fraud," any allegations of fraudulent conduct in a complaint must be pled with particularity. Id. at 1102-05.

To satisfy the requirements of Rule 9(b), "[a] plaintiff must set forth more than the neutral facts necessary to identify the transaction. The plaintiff must set forth what is false or misleading about a statement, and why it is false." Id. at 1106 (quotation omitted). Such allegations "must be accompanied by the who, what, when, where, and how of the misconduct charged." Id. (citation omitted, internal quotation omitted). Specifically, the allegation must include "an account of the time, place, and specific content of the false representations as well as the identities of the parties to the misrepresentations." Swartz v. KPMG LLP, 476 F.3d 756, 764 (9th Cir. 2007) (quoting Edwards v. Marin Park, Inc., 356 F.3d 1058, 1066 (9th Cir. 2004)).

Rule 9(b)'s particularity requirement must be read in harmony with Rule 8 of the Federal Rules of Civil Procedure, requiring a "short and plain" statement of the claim. See Spiegler v. Home Depot U.S.A., Inc., 552 F. Supp. 2d 1036, 1044 (C.D. Cal. 2008). Thus, the particularity requirement is satisfied if the complaint "identifies the circumstances constituting fraud so that a defendant can prepare an adequate answer from the allegations." Moore v. Kayport Packaging Exp., Inc., 885 F.2d 531, 540 (9th Cir. 1989).

Here, Defendants' Fourteenth Counterclaim alleges (1) Jones (who) misrepresented to QTS (who) that PrivacyWear could pay $1.4 million for their settlement agreement (what), but that she made this representation falsely because she knew, or should have known PrivacyWear was not that strong financially (why); (2) with intent to defraud; (3) QTS reasonably and detrimentally relied on the statement by agreeing to settle their dispute (why); and (4) the misrepresentation damaged QTS because PrivacyWear only paid $400,000. (See AC ¶¶ 145-149.) These allegations satisfy Vess because they provide sufficient detail of the alleged fraudulent misrepresentation such that Plaintiffs can fashion an answer. 317 F.3d at 1103-04.

Next, Plaintiffs argue Defendants' Fourteenth Counterclaim must fail because "they did not rely on said misrepresentations to their detriment." (Reply at 7.) Contrary to Plaintiffs' argument, Defendants allege they detrimentally relied on Jones' representation; this factual allegation is sufficient to satisfy Rule 8 of the Federal Rules of Civil Procedure.

Accordingly, the Court DENIES Plaintiffs' Motion to Dismiss Defendants' Fourteenth Counterclaim.

IV. CONCLUSION

For the foregoing reasons, the Court GRANTS IN PART and DENIES IN PART Plaintiffs' Motion to Dismiss Defendants' Amended Counterclaims. The Court specifically rules as follows:

* DENIES Motion to Dismiss Defendants' Counterclaims One through Ten because they do not run afoul to California law;

* GRANTS Motion to Dismiss Defendants' Ninth Counterclaim, for Breach of the Investment Contract by Dilution, because it does not comply with procedural prerequisites for shareholder derivative claims, with leave to amend;

* GRANTS Motion to Dismiss Defendants' Fourth Counterclaim for fraudulent concealment, without leave to amend;

* GRANTS Motion to Dismiss Defendants' Fifth through Eighth Counterclaims for conversion, theft, embezzlement, and forgery, with leave to amend; and

* DENIES Motion to Dismiss Defendants' Fourteenth Counterclaim, for fraudulent concealment.


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