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Epitech, Inc., et al v. Garry Michael Kann et al

April 16, 2012


(Los Angeles County Super. Ct. No. BC410811) APPEAL from an order of the Superior Court of Los Angeles County, Rita J. Miller, Judge. Affirmed.

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


As a corporation's short-term secured debt obligations were soon to come due, it retained a financial advisor to enable it to obtain long-term financing which would, in part, enable it to pay off its short-term creditors. The financing was never obtained, and the corporation ultimately fell into bankruptcy. The corporation's short-term creditors brought suit against the financial advisor, alleging that his fraudulent misrepresentations induced them to forbear from foreclosing on their security, to their ultimate financial detriment. The financial advisor filed a petition to compel arbitration, on the basis that the short-term creditors had been third-party beneficiaries of the financial advisor's contract with the corporation, which contained an arbitration clause. The trial court denied the motion and the financial advisor appeals. As the short-term creditors were not third-party beneficiaries of the contract between the financial advisor and the corporation, we affirm.


1. Factual Background

This appeal arises from three consolidated lawsuits arising out of the ultimate failure of AutoLife Acquisition Corporation (AutoLife). AutoLife initially had two groups of shareholders: (1) Patrick Moore, Claudia Fullerton, William Grivas, Newtonhill, Ltd., and the Hill Family Trust (the majority shareholders); and (2) James Filicia, Richard McGorrian, and related individuals and entities (the minority shareholders). The majority shareholders had originally provided start-up funding for AutoLife and owned 75% of its capital stock. The minority shareholders ultimately bought out the majority shareholders, for an immediate payment of cash and a note from AutoLife for $1.6 million, secured by a lien on all AutoLife assets and stock pledge agreements.

The funds necessary for the cash payment to the majority shareholders were allegedly acquired by the minority shareholders from Mitchell Family Investments, L.P. (the AutoLife investor). The AutoLife investor was solicited to invest $3.5 million in AutoLife, in exchange for warrants and a note for $3.5 million, secured by AutoLife's assets. The AutoLife investor alleges that while it had been induced to invest in AutoLife on the basis that AutoLife would use the AutoLife investor's funds to acquire certain businesses, the AutoLife minority shareholders instead had AutoLife use the funds to purchase the majority shareholders' stock, and then sold that stock to themselves for the total sum of $3. Thus, the AutoLife minority shareholders allegedly used the AutoLife investor's funds to acquire full ownership of AutoLife free and clear, leaving AutoLife holding debt in favor of both the majority shareholders and the AutoLife investor.

Simultaneous to these transactions, AutoLife purchased some assets from Epitech, Inc., one of its suppliers (the supplier), in exchange for cash and notes in the approximate amount of $375,000, secured by an interest in certain AutoLife assets.

All three transactions closed on or about December 30, 2005. When they were all completed, AutoLife had the following obligations:*fn1 (1) a $3.5 million note to the AutoLife investor, due on March 1, 2006, with a security interest in first position; (2) a $1.6 million note to the majority shareholders, due on March 1, 2006, with a security interest in the second position; and (3) a $375,000 note to the supplier, due on March 1, 2006, with a security interest in the third position. We refer to the AutoLife investor, the majority shareholders, and the supplier collectively as the secured creditors.

On February 2, 2006, AutoLife retained Kann Capital, Ltd., through its principal, Garry Michael Kann (collectively, Kann). According to the engagement letter, Kann was retained "to assist [AutoLife] in raising growth capital for [AutoLife] ('the Financing') and to act on AutoLife's behalf as financial advisor with respect to the Financing." Kann was to seek financing in the range of $9 million. It was agreed that Kann would "advise and assist AutoLife in devising and executing a program to secure the Financing," although it was agreed that "[t]here is no guarantee that [Kann] [would] be successful in securing the Financing for AutoLife." Pursuant to the engagement letter, Kann would be paid a $25,000 retainer, and a percentage of any financing obtained. Kann's duties under the engagement letter were identified as including: (1) "[s]electing and structuring of materials, documents, and applications in a manner which [Kann] determines to be necessary to obtain the Financing"; (2) "[i]dentifying on a best efforts basis, prospective capital investors and lending institutions that may have an interest in providing the Financing to AutoLife"; (3) "[n]egotiating the terms of the Financing with prospective capital investors and lending institutions"; and (4) "[s]tructuring of and participation in presentations to prospective investors and lending institutions as reasonably necessary to obtain the Financing."

The engagement letter was signed by Kann and AutoLife. It contained an arbitration clause for "[a]ny dispute, claim or controversy arising out of or relating to this Agreement or the breach, termination, enforcement, interpretation or validity thereof."

Financing did not materialize by March 1, 2006, but the secured creditors did not then foreclose their security interests. According to the allegations of their complaints, the secured creditors were induced to forbear on foreclosure by continued representations of the minority shareholders and Kann that financing would soon be obtained. Indeed, the secured creditors allege a series of misrepresentations from Kann which predate Kann's engagement by Autolife,*fn2 and continued to January 5, 2007, and possibly beyond. Kann's alleged representations specifically included representations that an investor called Barbican was a reliable investor and Kann expected Barbican's proposed investment in AutoLife to come to fruition. The Barbican loan never closed and, eventually, the secured creditors stopped waiting.

In April 2007, the majority shareholders foreclosed on the stock pledge agreements, thereby regaining control of AutoLife. At this point, they discovered a resignation letter from Kann, dated on January 2, 2007. The letter apparently*fn3 indicated that Kann resigned because AutoLife continued to pursue financing with Barbican against Kann's recommendation and that Kann was " 'extremely uncomfortable . . . being the focal point for Auto[L]ife to communicate with Auto[L]ife's various creditors . . . . ' " Kann's letter purportedly stated, " '[I] do not believe the Barbican funding process is viable to complete, yet Auto[L]ife is asking [me] to continue to represent to creditors . . . that it is.' " The secured creditors allege that, on January 5, 2007 - three days after Kann's resignation letter - Kann had again represented to them that the Barbican transaction was on track to close.

After discovering Kann's resignation letter, and learning of the dire financial condition of AutoLife (which had over $10 million in liabilities and only $6 million in assets), the majority shareholders placed AutoLife in ...

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