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Favila v. Katten Muchin Rosenman LLP

September 3, 2010


APPEALS from orders of the Superior Court of Los Angeles County, Mary Ann Murphy, Judge. Reversed and remanded with directions. (Los Angeles County Super. Ct. Nos. BC379462 & BC399377).

The opinion of the court was delivered by: Perluss, P. J.


The assets of Motion Graphix, Inc. were sold to Get Flipped, Inc. after the death of Motion Graphix's founder and shareholder, Richard Corrales. The Estate of Richard Corrales (Estate) through its executor Sandra Corrales Favila, Corrales's sister, sued Get Flipped and its founder, Raleigh Souther, who was Motion Graphix's only other shareholder, for claims including conversion, breach of fiduciary duty and fraud (the individual action). The Estate appeals from the trial court's order denying its petition and motion for leave to amend the complaint in the individual action to allege a conspiracy claim against Motion Graphix's corporate counsel, Katten Muchin Rosenman LLP (Katten Muchin), and two attorneys at the Katten Muchin firm, Gavin Galimi and James Thompson (collectively attorneys).

The Estate also filed a separate derivative action against the attorneys, Souther and Get Flipped on behalf of Motion Graphix asserting claims for professional negligence, breach of fiduciary duty and unjust enrichment arising from the asset sale transaction (the derivative action). That action was dismissed as to the attorneys after the trial court sustained their demurrer and the Estate elected not to amend its complaint. The Estate appeals from that order, as well.

We reverse the order denying the Estate's petition and motion in the individual action and remand with direction to permit the Estate to file a revised first amended complaint, alleging a cause of action against the attorneys for conspiracy to commit fraud. We reverse the order dismissing the derivative action as to the attorneys and remand with directions to redetermine whether the lawyer-client privilege prevents the attorneys from meaningfully defending the action or whether, because of the crime-fraud exception or waiver by the privilege holder, the privilege is no bar to the derivative action.


1. The Sale of Motion Graphix's Assets to Get Flipped

In February 2000 Corrales, an inventor, organized and incorporated Motion Graphix to license and sell photographic and imaging technologies he had developed or improved. In May 2000 the company issued 51 percent of its 1,000 shares of common stock to Corrales (510 shares) and 49 percent (490 shares) to Souther, and the board of directors approved bylaws requiring the approval of a majority of the shares represented and voting to validate an action taken by the company unless a greater number was required by law.*fn1 In 2001 Corrales assigned to Motion Graphix his rights in two pending patents. In August 2004 Katten Muchin began representing Motion Graphix.

In early August 2005, following a dispute between Corrales and Souther over Corrales's right to engage in personal business uses of Motion Graphix software codes, Corrales agreed to sell 80 percent of his shares in Motion Graphix to the company and resign from his positions as director and officer. Corrales, on behalf of himself, and Souther, on behalf of himself and as chief executive officer of Motion Graphix, signed a ratification and release agreement drafted by Galimi that incorporated a term sheet providing, "[Corrales] will have access to the code 'iPhotoBooth'"; "[Corrales] will have any future contract with Eurolink & Lugovco & Kodak"; and "[Corrales] will receive 20% of gross profits after the first year, and still retain[] a silent 20% ownership."*fn2 The term sheet also stated, "Raleigh Souther becomes majority partner and shareholder for Motion Graphix when document is signed by both parties." The term sheet appears to have been prepared by Corrales or Souther, not by counsel.

On August 18, 2005 Corrales complained in an email to Galimi that he had not been provided access to the full software code as promised and not received any explanation from Souther: "It has been a week since final papers were signed, and five days since my registered dispute over incomplete code made available. [Souther] has not answered repeated requests for [explanations] from myself and my client Eurolink that requires the requested code. [¶] Also, the question of code for the [K]odak contract has also not been addressed. [¶] Even as the stock exchanges ownership, my continued 20 percent share of the company should be respected and these questions need to be answered. [¶] I appeal to your duty to Motion Graphix to have [Souther] address these issues, and simply stonewalling is not acceptable." Galimi responded to Corrales, "As you correctly point out, I have a duty to Motion Graphix, as counsel to Motion Graphix, and not to you or [Souther] as individuals. I'm not in a position to address disputes between the two of you. That said, [Souther] has been out of town so he probably has not been accessing email. I don't believe he is stonewalling."

Corrales died in November 2005, and his shares in Motion Graphix passed to the Estate. On February 24, 2006 Souther sent an email--the cornerstone of the Estate's complaint against the attorneys--to Galimi and Joan Green, an accountant, stating Get Flipped should be incorporated as soon as possible and acknowledging the possibility of a lawsuit by the Estate:

"Well, I'm sorry to get everyone's hope's [sic] up last night regarding Get Flipped's standing. Reviewing the documents, my mindset at the time was to keep Get Flipped under the MG umbrella until I could get control of the company, it is also using the same Fed tax id number . . . . Regrettably, my thinking also was liability for our event photography, our insurance policy was under the MG name. In my mind, however, the two we're [sic] entirely separate, but this doesn't do us much good at the moment.

"Also, I found the 2000 corporate tax return, and unfortunately we made more money than I thought, actually $156,000 for that year, so going back to the first year wouldn't work. If we took the actually first full year the company was in business, 2001 we only made $61,200 for that year but I'm sure that wouldn't fly.

"So, damn the torpedoes, let's incorporate Get Flipped™ Inc and sell the MG assets over and dissolve MG as quick as possible. As far as [Corrales's] estate wanting the 20% gross, gross of what we can say. I think if we can use Joan's [the accountant's] valuation for the shares at the time [Corrales] signed them over, we can offer that up as payment for his share after we dissolve the company.

"I realize this doesn't get me out of a possible personal lawsuit with the Corrales estate, but that nasty business can be dealt with after we dissolve the company. I think as a settlement incentive we'd need to have the Corrales estate be willing to take payment for the shares and agree to not sue by accepting payment. [¶] . . . [¶]

"I'll follow with a list of assets I want GF to purchase from M.G. Wish I had better news guys. Thanks very much for your efforts last night."

In March 2006 Souther incorporated Get Flipped. Souther was Get Flipped's sole shareholder, officer and director. On February 7, 2007 Souther, as president of Motion Graphix, sent the Estate a letter stating a majority of Motion Graphix's shareholders had voted to sell the company's assets to Get Flipped.*fn3 According to Souther, he did not receive a response or objection from the Estate; thus, on February 27, 2007 he executed a "Quitclaim Assignment" transferring Motion Graphix's assets to Get Flipped for $5,000. Souther testified at his deposition the $5,000 price was for hardware, and no value was placed on customers, product or software.*fn4 In a letter dated March 26, 2007 the Estate was informed "that the Board of Directors and the holders of a majority of the outstanding shares of Motion Graphix . . . have acted by written consent . . . to approve the wind up and dissolution of the Corporation." On April 20, 2007 Motion Graphix was dissolved. Katten Muchin represented Motion Graphix in connection with the sale. (Galimi had resigned from the firm in November 2006 and was replaced by Thompson.) According to Souther, the law firm of Stradling Yocca Carlson & Rauth represented Get Flipped in the transaction.

2. The Individual Action

On October 30, 2007 the Estate filed a complaint asserting claims including conversion, breach of fiduciary duty, fraud and breach of contract against Souther, Get Flipped and fictitiously named Doe defendants. The complaint alleged Corrales still held 51 percent of the shares of Motion Graphix when he died, those shares passed to the Estate, the Estate never approved the sale of Motion Graphix's assets to Get Flipped or the company's dissolution, the fair market value of Motion Graphix's intellectual property ranged between $8 and $12 million and Souther engaged in wrongdoing, including violating the Corporations Code, by orchestrating the fraudulent and unauthorized sale of Motion Graphix's assets to Get Flipped for $5,000.*fn5

On June 23, 2008 the Estate amended the complaint by substituting Galimi for one of the fictitiously named Doe defendants; on July 14, 2008 it filed another Doe amendment naming Katten Muchin.*fn6 Galimi demurred on July 28, 2008, primarily contending he had left Katten Muchin in November 2006, months before the allegedly fraudulent asset sale took place, and thus could not be liable. On August 13, 2008 Galimi moved for sanctions against the Estate and its attorneys, contending the claims against him were baseless and had been brought for an improper purpose (Code Civ. Proc., § 128.7, subd. (a)). On that same day, Katten Muchin also demurred, contending the complaint lacked any specific allegations against Galimi or the firm.

At a hearing on September 5, 2008 the trial court sustained both demurrers without leave to amend but without prejudice to the Estate filing a petition under Civil Code section 1714.10, subdivision (a),*fn7 which requires a court order before a plaintiff may file a complaint with a "cause of action against an attorney for a civil conspiracy with his or her client arising from any attempt to contest or compromise a claim or dispute, and which is based upon the attorney's representation of the client . . . ." Although the initial complaint did not include a conspiracy claim, the court explained, "It is clear that [the Estate is] inferring that defendant acted as the attorney for Souther or Get Flipped at the time of the subject transaction and conspired with him, even though no conspiracy is alleged as a cause of action. And the requirements of [section] 1714.10 need to be fulfilled."

The sanctions motion was continued to permit the Estate's attorney to file a declaration in response to questioning by the court. On October 31, 2008 the trial court granted the motion, finding, "Attorney Galimi was copied on an email with two replies in 2/06. Attorney Galimi left [Katten Muchin] in 11/06 prior to the asset sale in 2/07. The complaint does not provide a basis for holding Attorney Galimi for conspiracy to do anything alleged in the complaint or any other theory of liability."

3. The Trial Court's Denial of the Petition and Motion for Leave To Amend the Complaint in the Individual Action

On September 23, 2008 the Estate filed a petition for an order allowing it to file a first amended complaint asserting a conspiracy claim against Galimi, Katten Muchin and, although not previously named, Thompson. The petition was denied without prejudice on October 17, 2008 because the Estate, apparently confused as to section 1714.10, subdivision (a)'s procedural requirements, had failed to serve the attorneys.

On December 17, 2008 the Estate again filed the petition and a separate, largely duplicative motion for leave to amend the first amended complaint. Notwithstanding the trial court's earlier orders only permitting the Estate to file a petition to amend the complaint to state a conspiracy claim, the proposed first amended complaint also sought to name the attorneys in causes of action for conversion, breach of fiduciary duty and fraud.

The proposed new pleading alleged, in essence, that Souther and Galimi formulated a scheme to defraud the Estate by incorporating Get Flipped and selling Motion Graphix's assets to it for a price grossly below market, as evidenced by the February 2006 email from Souther to Galimi and the accountant. In furtherance of that fraudulent scheme the February 2007 letter to the Estate falsely stated a majority of shareholders had approved the sale. Contrary to that representation, the Estate, which did not approve the sale, was the majority shareholder even though Corrales and Souther had signed the ratification and release agreement because the stock transfer was never completed. As Galimi knew both from the August 18, 2005 email he had received from Corrales and as Motion Graphix's counsel privy to its books and records, Corrales had never received the software code or payment he was entitled to under the terms of the agreement. (No action for recission or breach of the ratification agreement was ever filed, however.) The proposed complaint alternatively alleged, even if the stock transfer was effective and Corrales was only a 20 percent shareholder, the sale violated two provisions of the Corporations Code: Corporations Code section 1001, subdivision (d),*fn8 which requires the sale of all or substantially all of a company's assets be approved by 90 percent of the shares entitled to vote; and Corporations Code section 310, subdivision (a),*fn9 which prohibited Souther from voting to approve the asset sale because he had a material financial interest in the transaction. Thompson participated in the fraudulent scheme after Galimi left Katten Muchin by drafting the February 2007 letter allegedly knowing the Estate was still the majority shareholder or, at least, knowing of the purported Corporations Code violations.

On January 28, 2009 the trial court denied the petition and motion. The court ruled section 1714.10 was applicable and the Estate had not pleaded either of the exceptions to the statute--either, "(1) the attorney has an independent legal duty to the plaintiff, or (2) the attorney's acts go beyond the performance of a professional duty to serve the client and involve a conspiracy to violate a legal duty in furtherance of the attorney's financial gain." (§ 1714.10, subd. (c).) The court explained, "[I]t would seem that the defendants would only have an independent legal duty to [Motion Graphix] and not the . . . Estate."

The court then found the Estate had not met its burden under section 1714.10 to establish a reasonable probability it would prevail in the action. The court stated, "Galimi no longer worked at the Katten firm at the time of the transactions disputed in the complaint. . . . The complaint does not provide a basis for holding attorney Galimi for conspiracy to do anything alleged in the complaint or any other theory of liability." The court found Galimi's receipt of the February 2006 email from Souther was insufficient to establish Galimi had participated in a conspiracy: "[J]ust by receiving an email you get sucked into a conspiracy and you can be sued for being in a conspiracy, I'm not sure that's the law in this state. . . . You know what. People cc lawyers with e-mails all ...

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