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Hammon Plating Corp. v. Wooten

United States District Court, N.D. California, San Jose Division

July 13, 2017

HAMMON PLATING CORPORATION, Plaintiff,
v.
GALEN O. WOOTEN, et al., Defendant.

          ORDER GRANTING IN PART AND DENYING IN PART DEFENDANT’S MOTION FOR PARTIAL SUMMARY JUDGMENT RE: DKT. NO. 71

          LUCY H. KOH United States District Judge.

         Plaintiff Hammon Plating Corporation (“Hammon Plating”) sues Defendant Galen Wooten, personal representative of the estate of Thomas Wooten (“Wooten”), for breach of contract, fraud, and breach of the implied covenant of good faith and fair dealing. Before the Court is Wooten’s motion for partial summary judgment. ECF No. 71. Having considered the parties’ briefing, the relevant law, and the record in this case, the Court hereby GRANTS in part and DENIES in part Wooten’s motion for partial summary judgment.

         I. BACKGROUND

         A. Factual Background

         Thomas Wooten was the owner of Hammon Plating, a business located in Palo Alto, California that specializes in the electroplating (“plating”) of metal components for industrial use. ECF No. 71-1 (“Rapoport Aff.”), ¶ 2. Thomas Wooten suffered from cancer and, in 2014, Thomas Wooten executed a Limited Durable Power of Attorney that granted William R. Rapoport (“Rapoport”) the authority to manage the business affairs of Hammon Plating. Id.; see also Id. Ex. A.

         On June 19, 2014, Rapoport executed a Letter of Intent to sell all of Wooten’s shares in Hammon Plating to Esperer Holdings, LLC (“Esperer Holdings”), or its nominee, for approximately $20 million. Id. ¶ 3; see also Id. Ex. B. The Letter of Intent was subject to a due-diligence investigation into the financial affairs of Hammon Plating. Id. Rapoport began the due diligence process with Esperer Holdings. Id. ¶ 4. Wade Smith (“Smith”) and Steve Sorenson (“Sorenson”) were the representatives of Esperer Holdings during the due diligence process. Esperer Holdings’ counsel during the due diligence process was Ballard Spahr LLP (“Ballard Spahr”). Id.

         Because of issues discovered during the due diligence process, which are discussed further below, the sale price was reduced from the initial price of approximately $20 million to a final sale price of $9.339 million. Rapoport Aff. ¶ 21. The final Stock Purchase Agreement (“Agreement”) was executed on February 18, 2015. Id. ¶ 11. Esperer Holdings chose AMC Acquisition Corporation (“AMC”) as its nominee to buy Hammon Plating. Id. The Agreement provided that AMC would pay Wooten $9.339 million for Wooten’s stock in Hammon Plating. Id.

         Four issues with the Agreement are the subject of the instant dispute: an environmental issue, an occupancy permit issue, an ERISA issue, and a subordination issue. The Court discusses each of these below.

         1. Environmental Issue

         Hammon Plating holds title to two Palo Alto properties, 855 Commercial Street and 882 Commercial Street, and leases a third Palo Alto property at 890 Commercial Street. Id. ¶ 5. During the due diligence process, Rapoport disclosed to Esperer Holdings that Hammon Plating had voluntarily entered into a Facility-Initiated Corrective Action Agreement (“FICA Agreement”) with the California Department of Toxic Substances Control (“DTSC”) with regards to Hammon Plating’s three properties. Id.; see also Id. Ex. D (“FICA Agreement”). The FICA Agreement concerned the contamination of Hammon Plating’s properties by chemical solvents known as “PCE” and “TCE,” which are used during the plating process. Id. ¶ 5. The FICA Agreement required Hammon Plating to cooperate with DTSC in the assessment of the contamination, and required Hammon Plating to complete environmental remediation efforts upon approval by the DTSC. Id. Further, under the FICA Agreement, Hammon Plating was required to pay for the contamination assessment and environmental remediation efforts. Id.

         An environmental consultant, Green Environment, Inc. (“Green Environment”), was retained to assist Hammon Plating in complying with the FICA Agreement and completing the environmental remediation efforts. Id.

         Rapoport disclosed to Esperer Holdings during the due diligence process all of the above facts concerning the environmental contamination and FICA Agreement, and Rapoport provided regular updates to Esperer Holdings about the ongoing process with the DTSC. Id. ¶ 5–7. As a result of Rapoport’s disclosures, Esperer Holdings retained their own environmental consultant, Enviro-Assessment, P.C. (“Enviro-Assessment”), to conduct an independent environmental assessment of Hammon Plating’s three properties. Id. ¶ 6; see also ECF No. 71-1 (“Sorenson Dep.”), at 69 (explaining that Esperer Holdings retained Enviro-Assessment as part of the Esperer Holding’s due diligence investigation). Enviro-Assessment submitted an independent report to Esperer Holdings on November 20, 2014, which Esperer Holdings reviewed before the Agreement closed. See Id. Ex. E; Sorenson Dep., at 68–69. Sorenson does not recall whether Enviro-Assessment prepared for Esperer Holdings an estimate of the environmental clean-up costs. However, Sorenson stated that nothing prevented Esperer Holdings from requesting a cost estimate from Enviro-Assessment. Sorenson Dep. at 105.

         Rapoport discussed with Green Environment the anticipated costs of the environmental remediation efforts. Rapoport Aff. ¶ 8. Green Environment told Rapoport that a “concrete estimation of [the environmental remediation] costs was challenging since the DTSC had not at that point approved a definitive remediation plan.” Id. On November 14, 2014, Rapoport emailed Smith and Esperer Holdings and told Smith that a “ballpark figure” for the costs of the remediation efforts “may range anywhere from $150,000.00 to $250,000.00.” Id. Ex. G. In addition, there would be approximately $58,000 in fees due to the DTSC. Id. Similarly, in December 2014, Glenn Phinney (“Phinney”), the president of Hammon Plating, told Esperer Holdings that the $200,000.00 clean up cost estimate was a “rough estimate” that was “based on some conversations with the environmental consultant.” Id.; Ex. H.

         As a result of the parties’ discussions of the environmental issues at Hammon Plating’s facilities, drafts of the Agreement that were exchanged in December 2014 “included provisions which were intended to address the risks of the disclosed environmental contamination.” Id. ¶ 9. A draft of the Agreement circulated on December 16, 2014, included ¶ 1.2(a)(ii), which was drafted by Ballard Spahr. Paragraph 1.2(a)(ii) required Wooten to deposit

(ii) an amount of cash placed in an escrow account equal to $300,000 to cover the anticipated cost of [environmental] remediation for the Environmental Claims that are outstanding as of the Closing Date, provided that the Buyer shall pay the Seller any remaining balance of such funds after such remediation has been completed.

Id. ¶ 9; see also Id. Ex. I, at ¶ 1.2(a)(ii). Similarly, ¶ 1.3(f) of the December 16, 2014 draft Agreement included the following paragraph, which was also drafted by Ballard Spahr:

(f) Environmental Remediation Adjustment. If the aggregate cost of remediation for the Environmental Claims that are outstanding as of the Closing Date exceeds $300,000, the outstanding principal amount of the Promissory Note shall be reduced by the amount of the additional cost for such remediation.

Id. ¶ 10; see also id Ex. I, at ¶ 1.3(f).

         Sorenson explained that the $300,000 escrow amount in ¶¶ 1.2 and 1.3 was calculated from the “150 and $200,000” clean-up cost estimate provided by Green Environment, in addition to “an extra hundred thousand bucks to cushion it.” Sorenson Dep., at 67. Sorenson stated that “all [parties] agreed there was uncertainty” about the cost of the environmental remediation efforts. Id. at 102. Smith also testified that the environmental remediation costs were “an unknown variable” at the time of the Agreement. ECF No. 71-1 (“Smith Dep.”), at 120.

         As stated above, the final version of the Agreement was signed on February 18, 2015 and called for AMC to pay a total of $9.339 million for Wooten’s stock in Hammon Plating. Rapoport Aff. 11. AMC was to pay $ 2 million in cash at closing and, after the completion of financing, a post-closing down payment. Id. The remaining balance would be paid in annual installments pursuant to the terms of a promissory note in the face amount of $3.839 million, which was guaranteed by Esperer Holdings and subject to adjustments. Id. As relevant here, the final version of the Agreement contained ¶¶ 1.2(b) and 1.3(f), which provided for adjustments in the promissory note related to the environmental remediation costs.

         Specifically, under ¶ 1.2(b) of the Agreement:

(b) The Seller shall provide, prior to closing, an amount of cash placed in an escrow account equal to $300,000 to cover the anticipated cost of [environmental] remediation for the Environmental Claims that are outstanding as of the Closing Date, provided that the Buyer shall pay the Seller any remaining balance of such funds after such [environmental] remediation has been completed. Any amount above and beyond $300,000 that the [environmental] remediation costs, shall be deducted from the final installment payment under the Promissory Note.

Id. ¶ 12; see Id. Ex. J, at ¶ 1.2(b).

         Similarly, under ¶ 1.3(f) of the Agreement:

(f) Environmental Remediation Adjustment. If the aggregate cost of [environmental] remediation for the Environmental Claims that are outstanding as of the Closing Date exceeds $300,000, the outstanding principal amount of the Promissory Note shall be reduced by the amount of the additional cost for such [environmental] remediation.

Id. ¶ 12; see Id. Ex. J, at ¶ 1.3(f). The Agreement defines “Environmental Claims” as any action “by or from any Person alleging liability of whatever kind or nature (including liability or responsibility for the costs of enforcement proceedings, investigations, cleanup, governmental response, removal or remediation, natural resources damages, property damages, personal injuries, medical monitoring, penalties, contribution, indemnification and injunctive relief) arising out of, based on or resulting from: (i) the presence, Release of, or exposure to, any Hazardous Materials; or (ii) any actual or alleged grounds for liability under any Environmental Law or term or condition of any Environmental permit.” Id. Ex. C.

         The final version of the Agreement also contained certain warranties that Hammon Plating’s properties were in compliance with applicable laws and regulations. See Id. ¶ 3.12(e). The final version of the Agreement exempted from these warranties the “DTSC issue that is already identified and being addressed.” Id.

         According to Rapoport, he understood the Agreement’s provisions regarding the environmental remediation costs to mean that Wooten “would be responsible for the first $300,000 of the environmental remediation costs; that [Hammon Plating] would then pay any amount in excess of $300,000 necessary to complete the environmental remediation; and that the principal amount due to [Wooten] under the $3.839 million Promissory Note would be reduced dollar for dollar for any amounts in excess of $300,000 expended by [Hammon Plating] to complete the environmental remediation.” Id. ¶ 13.

         Sorenson testified during his deposition that his understanding of the Agreement was the same as Rapoport’s:

Q: “[T]he sellers would put up $300,000 in an escrow account to cover environmental remediation; is that correct?
A [Sorenson]: Right.
Q: “If the amount exceeded that, the cost in excess of $300,000 would be deducted from the promissory note that had been given to them; is that right?
A; It could be.
Q: That would reduce the amount due to them under the promissory note?
A: Right.
Q. Didn’t that assume that the costs for that remediation in excess of $300,000 would be paid by your side of the equation and that’s why you would be entitled to a reduction in the promissory note? . . .
A: Yeah. I mean, I think that’s a fair characterization of the way the deal was supposed to work.

Sorenson Dep. at 86.; see also Id. at 104.

         After the close of the Agreement, Rapoport organized a meeting between Green Environment and the new owners of Hammon Plating. Rapoport Aff. ¶ 14. In March 2015, Green Environment stated that the anticipated expense of the environmental remediation costs was expected to exceed $300,000 because of requirements imposed by DTSC. Id. The parties still do not know the total cost of the environmental remediation efforts.

         2. Occupancy Permit Issue

         In addition to the environmental remediation issue discussed above, the parties also discussed during the due diligence process an issue regarding occupancy permits for Hammon Plating’s location at 882 Commercial Street in Palo Alto.

         Specifically, in January 2015, Rapoport learned that, even though the 882 Commercial Street location had been in active use for years and annually inspected by the Palo Alto Fire Department, Hammon Plating did not have an occupancy permit for 882 Commercial Street. Id. ¶ 15. Rapoport shared this information with Sorenson and Smith. Id.

         On February 16, 2015, Rapoport had a telephone conversation with Sorenson regarding the lack of an occupancy permit for 882 Commercial Street. Rapoport memorialized the content of this telephone conversation in a memorandum prepared on February 17, 2015. See Id. Ex. M. According to Rapoport’s affidavit and the memorandum of the phone conversation, Rapoport informed Sorenson that, from Rapoport’s perspective, there were three potential solutions to the lack of an occupancy permit at 882 Commercial Street. First, the City of Palo Alto might find that Hammon Plating “had grandfathered rights based on its years of use of the property and annual inspections.” Id. ¶ 16; see also Id. Ex. M. Second, the City of Palo Alto might require that 882 Commercial Street “be brought up to the current building codes” before the city would issue an occupancy permit. Id. ¶ 16; see also Id. Ex. M. Third, the City of Palo Alto might consider that, since 882 Commercial Street did not have an occupancy permit, Hammon Plating was “applying for a new permit for metal plating,” which the City of Palo Alto had already declared it would no longer issue. Id.¶ 16 (emphasis added); see also Ex. M. According to Rapoport’s affidavit and memorandum, Sorenson believed that the most likely outcome was the first or second option, and thus Sorenson wished to sign the Agreement. Id. ¶ 16; see also Ex. M. Sorenson does not deny that the February 16, 2015 telephone conversation with Rapoport occurred. See Sorenson Dep. at 90. Sorenson stated in his deposition that he does not recall the contents of the telephone conversation. Id.

         Until the issue regarding the occupancy permit arose, drafts of the Agreement included representations and warranties in ¶ 3.12 that the real property being conveyed was in compliance with all applicable governmental regulations. Rapoport Aff. ¶ 17. However, “negotiated language was added to the signed, final version of” the Agreement that exempted the occupancy permit issue for 882 Commercial Street from the Agreement’s warranties. Id.

         Specifically, the final version of the Agreement contains the following language at ¶ 3.12(e):

(e) As of the date of this Agreement . . . neither the Company, any of its Subsidiaries, nor the Seller has received written notice, and to the Knowledge of the Seller, no other notice, from any Governmental Authority that the Real Property or the present use of the Real Property fails to comply with any applicable Laws, Governmental Orders, Permits or restrictions of any Governmental Authority having jurisdiction over any portion of the Real Property. This clause does not include . . . the occupancy permit issue on 882 Commercial St.

Id. ¶ 3.12(e) (emphasis added).

         Similarly, although drafts of the Agreement contained representations and warranties that the real property being conveyed was not subject to environmental or land use issues, the final version of the Agreement contained the following language at ¶ 3.12(f):

(f) As of the date of this Agreement, there are no pending or, to the Knowledge of the Seller, threatened condemnation, fire, health, safety, environmental, building, zoning, land use or other Actions relating to any portion of the Real Property that, if successful, would adversely affect the current use or occupancy thereof, nor has the Company or the Seller received written notice, or to the Knowledge of the Seller, any other notice, of any pending or threatened special assessment proceedings affecting any portion of the Real Property. This clause does not include . . . the occupancy permit issue on 882 Commercial St.

Id. ¶ 3.12(f) (emphasis added).

         After the Agreement closed on February 18, 2015, Esperer Holdings engaged Rapoport to assist Esperer Holdings in securing an occupancy permit for 882 Commercial Street. See Rapoport Aff. ¶ 19. The City of Palo Alto signed off on a temporary certificate of occupancy for 882 Commercial Street on February 20, 2015. Id.; see also Id. Ex. N. Rapoport informed Esperer Holdings that, in order to secure a permanent certificate of occupancy, Esperer Holdings would need to “reinstall mechanical equipment such as air scrubbers and ventilation ductwork used in the plating process, which was then in storage,” and “pass an inspection by the Palo Alto Fire Department.” Id.

         Smith hired a company to reinstall the equipment and ventilation ducts at 882 Commercial Street. See Smith Dep. at 116. The Palo Alto Fire Department performed a final inspection, which the 882 Commercial Street building passed. The City of Palo Alto issued a permanent occupancy permit for 882 Commercial Street. Id. at 117.

         Smith subsequently attempted to obtain a plating permit for the 882 Commercial Street building. Id. at 118. However, the Palo Alto Fire Department would not provide a plating permit for 882 Commercial Street because the Palo Alto Fire Department would no longer allow “wet floors,” which are required for plating operations. Id. at 118–19. Hammon Plating has a plating permit for its building at 890 Commercial Street because that building’s plating permit has grandfathered rights to have “wet floors.” Id. at 119.

         According to Rapoport, the reduction of the purchase price from the $20 million total purchase price listed in the original Letter of Intent to the final purchase price of $9,393,000 reflected the disclosed risks during the due diligence process, including the environmental issues and the occupancy permitting issues. See Rapoport Aff. ¶ 21.

         3. Pension Plan Issue

         The final Agreement also included provisions that the Hammon Plating Corporation Profit Sharing Plan (“Profit Sharing Plan”) was in compliance with the Employee Retirement Income Security Act (“ERISA”) and accompanying regulations. Id. ¶ 22.

         Shortly after the Agreement closed, Rapoport retained Trucker Huss, a San Francisco law firm that specializes in ERISA compliance issues, to advise Wooten respecting the closing down of Hammon Plating’s Profit Sharing Plan. Id. ¶ 23. Rapoport shipped boxes of Hammon Plating’s pension plan records to Trucker Huss. Id.

         Trucker Huss informed Rapoport that there were ERISA compliance issues regarding the Profit Sharing Plan. Id. On December 7, 2015, Trucker Huss reported these concerns to counsel for Esperer Holdings. Id.; see Id. Ex. P. Trucker Huss proposed that Hammon Plating enter ...


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