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Articles Posted in Business Litigation

For a long time, a limitation to the fraud exception of the “parol evidence rule” played an important rule in California contract disputes.  The parol evidence rule prohibits parties to a written contract that contains all of the elements of their agreement from introducing extrinsic evidence (evidence outside the bounds of the written terms of the contract) to contradict the terms of the agreement.  Essentially, the rule protects parties to written contracts by limiting the scope of the parties agreement to the actual written terms in the agreement that were originally agreed to.  The contract’s terms are the “exclusive evidence of the parties’ agreement.”  This is an important protection because it prevents contracting parties from later claiming that there was a side oral agreement that is inconsistent with the contract.  If a contract dispute later arises, the parties cannot introduce extrinsic evidence that changes what the parties already agreed to.  The rule is limited to oral evidence that “contradicts” the terms of the contract.  In some circumstances, California law will allow the introduction of outside evidence to clarify contract terms.  

638482_the_secret_bench_of_knowledge_4.jpgThe fraud exception has been a long time exception to California’s parol evidence rule. The rule allows a party bringing a fraud claim to introduce extrinsic evidence to prove that the original written contract was tainted by fraud.  In 1935, the California Supreme Court decided the case of Bank of America Association v. Pendergrass which placed a significant limitation on the fraud exception.  The Court specifically held that where evidence is offered to prove fraud, it “must tend to establish some independent fact or representation, some fraud in the procurement of the instrument or some breach of confidence concerning its use, and not a promise directly at variance with the promise of the writing.”  In brief, the Court said that when there’s a fraud claim, the party bringing the claim can’t introduce evidence that contradicts the written terms of the contract.  This was a significant limitation on the fraud exception.  Without it, it was argued, the parol evidence rule would have little teeth in fraud actions.

Earlier this year, however, the California Supreme Court decided a case that expands the fraud exceptions significantly.  It essentially overturns the fraud exception limitation.  In other words, it broadens the fraud exception, allowing more evidence in and thereby undercutting the parol evidence rule.  The case, RiverIsland Cold Storage, Inc. v. Fresno-Madera Production Credit Association, is likely to have a significant impact on all contract claims in California.

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The term “fraud” is thrown around a loosely these days.  It is not uncommon for a business client to tell her attorney that she has been defrauded in a business deal because a vender lied, a partner stole from the business, or a supplier failed to deliver an order.  While each of these scenarios can be fraudulent, more times than not, such actions or inactions do not quite rise to that level.  It can be very difficult to prove all the elements of a fraud in court even where it actually exists.  More importantly, there is a general misunderstanding of what fraud is, under the law.

Corporate formalities 1.jpgThere are four types of acts that can be considered fraud or deceit.  (Fraud technically only applies to contract actions, though the terms fraud and deceit often get used interchangeably.)  They are commonly known as intentional misrepresentation, negligent misrepresentation, concealment, and false promise.  (There is also a fifth “catch-all” fraud category of “any other act fitted to deceive.”)  A brief summary of the basics follows:

Intentional Misrepresentation
For an intentional misrepresentation to be considered fraudulent:

  • The statement must be an intentionally or recklessly false statement of fact.  It generally cannot be an opinion (though there are some exceptions);
  • The injurer must have intended to defraud the victim.  Intent is usually the most difficult element to prove;
  • The victim must have reasonably relied on that false statement to change her position.  A victim can’t reasonably rely on the statement if she knew or should have known the statement was false; and
  • The victim must be able to prove that it caused some type of measurable damage.

Negligent Misrepresentation
Negligent misrepresentation is basically the same thing as intentional misrepresentation, except that the injurer doesn’t have to know that the statement was false–he must only lack a reasonable basis to believe it was true.  This is generally easier to prove than intentional misrepresentation, but unlike intentional misrepresentation, the victim cannot collect punitive damages.

Concealment
Concealment is when someone who has a duty to disclose a material fact either does not disclose it or conceals it with the intent to defraud the victim.  He has a duty to disclose when he is in a fiduciary relationship with the victim (for example, a business partner).  For concealment to be considered fraudulent, a victim must show the following:

  • The injurer intentionally failed to disclose an important fact or disclosed some facts but intentionally failed to disclose another important fact making the disclosure deceptive;
  • The victim did not know of the concealed fact;
  • The injurer intended to deceive the victim by concealing the fact; 
  • The victim reasonably relied on the concealed fact to change her position.
  • The concealment caused some type of measurable damage.

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Contractual disputes are a regular part of doing business but this fact is rarely recognized by business owners.  This is because the vast majority of disputes are resolved informally before attorney involvement becomes necessary.  Every time discounts are offered because of delayed delivery or because a product is defective, every time a partner agrees to sell his interest in a business because the partners want to take the business in different directions or every time a commercial lease is renegotiated because of a problem between the landlord and tenant, contractual disputes are resolved.  The list of examples is endless.  The lesson is that most business owners are reasonable and seek efficient solutions to problems and in fact reach efficient solutions.  This is because experienced business owners understand that litigation is time consuming, emotionally draining, risky and expensive.  The purpose of this article is not to dissect the legal elements of a breach of contract cause of action.  Rather, its purpose is to provide some guidance to business owners faced with a breach of contract while simultaneously conveying some of the pitfalls inherent to contract litigation.  

961189_angel_bandw.jpgIt is common for business owners to call their attorneys abruptly with a passionate plea for justice relating in great detail just how badly they have been wronged.  Attorneys listen of course because they know it’s good for their clients to vent.  However, attorneys are internally sizing up the practical realities of the case.  Attorneys ask themselves very simple questions.  What are the damages (how much money is involved)?  Playing devil’s advocate, what will the other side claim?  Is this situation specifically addressed in the contract?  How much will it cost my client to fight this battle?  In fact some lawyers make it even simpler.  They only want to know what the damages are.   If the damages are small, then it is likely that their client will have to spend more money litigating the case than they can win – assuming they can and will win.  Unfortunately, even the most practical business owners sometimes find themselves faced with a breach of contract that cannot be worked out despite significant efforts.    

While every situation is different and consultation with a business litigation attorney is best, the following serves as a helpful guide in deciding how to proceed when a contractual dispute arises:

1.    Determine how much money is involved.  If it is less than $10,000, pursuing a small claims action in California is probably your best bet.  However, even small claims actions require some commitment from the business owner.  If the damages are a couple of hundred dollars, it’s probably better to send letters and continue to pursue the matter informally.  The “I am not going away” tactic is often successful.  If the amount is greater than $10,000 but below $25,000, consider consulting with a lawyer about an aggressive letter and phone call campaign.  This can be done for a relatively low cost and is often successful.  Depending on the circumstances, this tactic can be extended into filing a civil complaint for breach of contract.  The purpose is to put pressure on the other side hoping that it brings them to the negotiating table.  If it doesn’t, you can instruct your attorney to dismiss the case before it costs you more than $25,000 in attorney fees and litigation costs.  Ultimately, the advice you receive will depend on the strength of your case.  

2.    Forget about Punitive Damages and Contingency Fee Agreements.  It is only in extraordinary cases where independent torts exist (fraud, physical harm, etc) that punitive damages are awarded.  If the actual damages are high and the case involves egregious actions you will certainly want to discuss the potential for punitive damages with an attorney.  If litigation is pursued in high damage cases, attorneys will plead numerous causes of action seeking all potential relief.  However, most business disputes do not rise to this level and even if punitive damages are sought, they are rarely awarded in disputes between businesses.  It might be different of course if you were harmed by Microsoft and can show egregious action but this is not the typical scenario that is the subject of this article.  The same is true regarding contingency cases.  Attorneys will rarely handle business disputes on a contingency basis.  If they do, it’s because the case is extremely valuable and the facts are so one-sided that they have high confidence in winning and collecting.  It cannot be stressed enough that these types of scenarios are rare.  It doesn’t hurt to consult with several lawyers, but it is better not to expect that a lawyer or law firm will assume the risk for you.

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Like any metropolis, San Diego has a diverse business climate requiring constant interaction amongst retailers, service providers, customers, guests, invitees, tenants and landlords, suppliers, manufacturers, contractors, government agencies, insurers, law firms, and accountants. This level of interaction naturally breeds conflict especially when multiplied by the large number of business, consumer and professional transactions occurring every day in San Diego County. Conflict resolution occurs routinely and the vast majority of conflicts are resolved amongst the parties without the need for lawyers. In fact most conflict is resolved before anyone recognizes that a conflict has even arisen. People naturally look to solve problems as quickly and efficiently as possible so that they can move on to more important matters. Whether a simple cashier error or a complex misunderstanding regarding the terms of a contract, most conflicts are resolved within the first few hours. Of those that are not resolved quickly, most are worked out informally by the parties in a reasonable timeframe and without the need of a San Diego litigation attorney.

705366_construction.jpgUnfortunately, the law of averages guarantees that some business conflicts will not be resolved without resort to the legal system. When conflicts reach this level, business owners rely on the court system to provide them access to a just resolution. The problem of course is that access to a just resolution isn’t free and even in those circumstances where there seems little doubt about who is in the right, litigation outcomes are far from predictable. In fact, in most cases litigation is drawn out, expensive, emotionally draining and ultimately unsatisfying. This does not mean that access to justice is a myth. However, opting to resolve business disputes via litigation requires a cost benefit analysis similar to any other business decision. Even the most deserving cases may not be economical to pursue. Litigation costs and attorneys fees often exceed the value of the case to the litigants. In those cases, informal resolution becomes imperative. The alternative is to right off the loss rather than accept greater losses associated with long drawn out litigation.

Whatever the cost benefit analysis, resorting to litigation should be your last resort. Why? Because as stated above, litigation outcomes are unpredictable no matter how righteous a claim is. Assume for instance that a contractor is owed $225,000 for work completed on a construction project. There is little doubt from the contractor’s perspective that it is owed for the work completed. Nonetheless, the developer, a private individual, has questioned the quality of the workmanship and is refusing to pay until major repairs are completed. Assume further that the developer is being unreasonable. The contractor knows that the developer is out of money and is making excuses to avoid payment. The case is simple enough. The developer should pay for the work done. If the developer cannot afford to pay, a lien can be taken against the property to protect the contractor’s interest.

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Cease and desist letters claiming trademark infringement have an intimidating effect on their recipients. Most San Diego business owners are bewildered and have no idea how to respond. They have been in business for months if not years, and have constructed signs, circulated business cards, advertising and other promotional materials, published websites, formed a corporation and built goodwill and customer loyalty all under their existing name. Now some company they have never heard of is telling them they need to abandon their identity and start all over, a costly endeavor. Ideally, businesses will conduct a trademark search before deciding on the use of a name and logo and then file their own trademark registration, but this is of course hindsight. There are two very important things to keep in mind upon receipt of a cease and desist letter claiming trademark infringement: don’t panic and don’t ignore it.

742579_when_lightning_strikes.jpgDon’t panic because in many cases the issues can be resolved without having to abandon your business’ identity. Your mark may not actually infringe on the claimant’s mark, you may have a common law trademark giving you the right to use the mark in your geographical area, or the claimant may be willing to license use of the mark, place some limited restrictions on use or request some reasonable modifications to the mark. Remember that pursuing trademark infringement claims is an expensive endeavor and it is often economical for the claimant to work out an agreement with alleged infringers. Usually, a San Diego trademark attorney can assist in resolving the dispute for a reasonable cost. Of course, in some circumstances the claimant will not walk away so easily. It depends on the size of the claimant’s business, the strength and recognition of the claimant’s mark and the geographical scope of the claimant’s customer base. A business won’t get very far opening a hamburger joint called McDonald’s and utilizing a big yellow “M” at the forefront of its logo’s design. McDonald’s will pursue a trademark infringement claim no matter the expense.

Don’t ignore it because some companies will pursue their claims even if they are not as big as McDonald’s. Once a trademark infringement claim is filed in Federal court, you lose significant bargaining power. Even if you capitulate and agree to change your business’ name, the claimant will almost certainly want to be recuperated for bringing the action including attorney’s fees and other costs associated with filing suit. With or without an attorney, open the lines of communication.

“Piercing the Corporate Veil” is a well-known phrase.  To the average American, it conjures up visions of corporate giants being slain by David.  This pejorative understanding has little practical value in today’s business world.  In fact, “piercing the corporate veil” (holding the principals of a corporation or limited liability company liable for the debts of the company) is an all too real legal principle for entrepreneurs concerned with protecting their personal assets from the liabilities of their business.  Incorporation law has developed to encourage business development and risk taking.  Limiting owner liability (whether of individual owners or of parent companies) furthers this goal.  However, there are limitations to the protections provided.  First, it’s important that companies fully comply with the legal formalities required to maintain their business entity to ensure personal insulation.  Second, the corporate veil may be pierced where one forms a corporation or LLC for the purpose of insulating personal assets, insulating the assets of another business or for some other unjust purpose.
 
The Deal.jpgIn California, courts will pierce the corporate veil when two requirements are met: 1) the Court finds unity of interests (the shareholders, or owners in the case of an LLC, treat the corporation as an alter ego) – this happens when shareholders treat the assets of the corporation or LLC as their own and/or use corporate funds to pay their private debts; and 2) the Court finds that allowing shareholders to dodge personal liability would sanction fraud or promote injustice.  

To answer these questions, courts look at numerous factors including: whether the shareholders/owners acted in bad faith; whether individual contracts were entered into with the intent of avoiding performance and hiding behind a corporate shield; whether assets have been diverted to the detriment of creditors; whether there is ownership and control of the entity by a few key individuals; whether the shareholders/owners and the corporation share the same office or business location; whether the shareholders/owners and the corporation share the same attorney; whether the shareholders/owners used the entity to procure labor, services and merchandise for others; whether the entity was adequately capitalized; whether corporate formalities were followed; and whether the result would be unjust should the court fail to pierce the corporate veil.  

While California courts are generally reluctant to pierce the corporate veil, they are not afraid to apply the theory where the above factors evidence injustice.  Entity shareholders and owners unsure about their personal protections should consult a business attorney

Arbitration clauses are typical in business contracts for several reasons. Most importantly, they allow businesses to settle disputes in a timely and cost-effective manner, without entering into costly, time-consuming litigation. Arbitration significantly limits discovery costs such as interrogatories, depositions, and pretrial motions that often constitute the bulk of litigation expense. In addition, arbitrators are often specialists in their various fields and tend to be more knowledgeable than juries.

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Arbitration may be binding or non-binding. Non-binding arbitration involves the determination of liability without the dispensation of an award. While the arbitrator may suggest possible awards, parties are not legally obligated to accept the suggestions. Binding arbitration, on the other hand, involves not only the determination of liability, but also the terms of the award for the wronged party. Moreover, the arbitrator’s determination is final (with few exceptions), and precludes further dispute and appeal. In California, an arbitration clause may be disregarded where all parties agree, where the clause exists as part of an invalid contract or where third parties are involved in the litigation (where third party claims arise out of the same transaction or series of related transactions).

Binding arbitration has significant advantages to both small and large business. Avoiding costly litigation is priceless to small business owners especially because they are typically priced out of litigation by large corporate entities. Large corporate entities like binding arbitration because they fear the uncertainty of jury trials. Putting the decision in the hands of an experienced arbitrator assists larger businesses in anticipating outcomes. In addition, binding arbitration is faster and less formal. On the other side of the coin, small businesses give up the right to a jury trial in exchange for affordable conflict resolution and large businesses give up their ability to steam roll smaller opponents. Other cons include the potential for being stuck with a bad arbitrator, being stuck with a bad and/or legally incorrect decision that cannot be appealed and having less time to properly investigate claims. Either way, courts, bar associations and state bar entities across the country are encouraging parties to look to informal resolution before resorting to the court house steps.

Part One of this article discussed the general concept of flat fee litigation, and the associated relative risk shared by attorneys and their clients. Part Two explores potential flat fee litigation schemes further. The greatest challenge in devising a flat fee litigation scheme is making reasonable estimates of the attorney time necessary to effectively litigate any given case. Experienced litigators can distill the facts and the law in advance and make reasonable estimates of the time necessary, and they routinely offer estimates to prospective clients in the billable hour context. Unfortunately, lawyers’ estimates are often understated and clients end up paying significantly higher fees than originally expected. This is likely because attorneys are loath to give worse case scenarios and risk turning clients away.

1083976_labyrinth.jpgSo long as clients are willing to absorb a share of the risk (see Part One) in exchange for certainty in billing, attorneys can and should offer their clients a flat fee option for most litigation matters. In order to reduce the risk to clients of over paying for matters that may resolve in the early stages of litigation, attorneys can offer flat rates for the different stages of litigation. A flat fee litigation scheme may look something like the following: a flat fee for pre-filing negotiation; a flat fee for post-filing/pre-trial litigation; and a flat fee for trial preparation and trial. The pre-trial litigation phase could be broken up further into a flat fee for post-filing/pre-discovery work and a flat fee for all remaining pre-trial litigation including discovery.

The difficulty of course arises in deciding how to calculate the flat fee. Litigation is a complex process mired in factual, legal and procedural uncertainty, and it’s the attorney’s job to navigate the maze for the client. Nonetheless, experienced litigators have the skills required to make reasonable estimates. They can estimate the number of witnesses to be deposed, the volume of documents to review, the potential discovery burden, the extent of expert discovery and an average time for expected motion work. In some cases, they’ll be able to include the skill and determination of opposing counsel in the equation. They will not get it right in every case. In fact, the estimates may be off more often than not. Whatever accuracy is achieved, they can at least assign risk value to the estimates. The goal is to present a marketable alternative to the inefficient and client unfriendly “billable hour” practice.

Attorneys and law firms have visited the issue of flat fee litigation in the past, and there are San Diego litigation attorneys today that offer some of their business clients the option under limited circumstances. However, there can be little doubt that the overwhelming consensus amongst legal professionals is that flat fee litigation simply isn’t practical. In part, this view stems from the difficulties in predicting actual attorney hours necessary to litigate any given case. Even if a law firm could adequately estimate the number of hours necessary to complete a case, it is virtually impossible to know whether the matter might resolve informally long before significant attorney hours are expended. In fact, a good attorney will strive for this beneficial result for his or her client. Avoiding long drawn out litigation is always a healthy result. Apart from the monetary costs, the emotional and time consuming roller coaster ride takes a toll on business owners.

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Business owners would like some certainty as to the final cost of litigation. Attorneys are concerned with compensation for the actual work performed. Under standard billing practices, attorneys do their best to provide estimates, explain the process and most often stress the inherent uncertainty that comes with any litigation. Unfortunately no matter how well explained, clients rarely anticipate the actual costs ahead. Moreover, although attorneys are bound by ethical considerations, the reality is that there is little incentive for efficiency. Nor is there a desire to scare off clients with worse case scenarios. Yet, worse case scenarios are common in litigation, and the result is an ever increasing dissatisfaction with litigation and the legal profession in general.

The question then turns to one of sharing risk. From the litigation attorney perspective, agreeing to take on a litigation case for a flat fee comes with great risk. They know the potential for a long drawn out process consuming unanticipated attorney hours. At best, underestimating attorney time results in reduced average hourly rates. At worst, the attorney finds himself or herself overwhelmed by a single case at the expense of others. For clients, knowing what attorney fees will be in advance makes it possible to evaluate whether anticipated litigation is an economically feasible alternative to informal resolution. However, in exchange for certainty in billing, they risk overpaying for their attorneys’ time, and the overpayment can be significant if the case resolves in the early stages. Paying an attorney for an anticipated 80 hours that resolves after 5 hours of work can be just as dissatisfying as expensive ongoing litigation. It’s clear, nonetheless, that consumers are looking for alternatives.

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Avoiding Litigation – Part One sets forth three pre-conflict practices useful in reducing your business’ risk of litigation. Of course, avoiding all conflict is virtually impossible. However, conflict does not inevitably lead to litigation. In fact, more than 90% of all conflict is resolved before reaching the courthouse steps. Below are three practices useful in avoiding litigation after conflict has arisen:

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Act Fast. The worse thing anyone can do is ignore a potential conflict. If you receive a letter, phone call or personal visit from an unhappy customer, vendor or client, respond immediately. In most cases, the problem will not go away because you chose to ignore it. The problem will more likely get worse. Communication is a powerful tool that can diffuse even the most heated dispute. The faster you act, the more easily the problem will be to resolve. Being responsive often puts the other side off guard. They are poised for a battle and when you call to offer a solution, they’re not quite sure how to respond. If you are behind on a debt, offer a payment solution that is workable for you. Offering a payment solution you can’t ultimately adhere to is worse than ignoring the problem. If you cannot fully perform, offer creative alternatives. Whatever your response, it will be better received if it provides options. If there is disagreement about your rights and obligations under an agreement, offer to sit down and discuss the issue. Don’t be rigid. Explain your beliefs politely but be sure to leave the door open for a compromise. Conflict and anger breed more conflict and more anger. In the end, you don’t have to agree to anything. However, open and conciliatory communication opens the door to a wider range of potential resolutions. Acting fast is no less important where you are seeking redress. If you are owed a past due debt, don’t rest on your laurels. The fact that there is no doubt about the debt doesn’t guarantee payment, especially without litigation. It remains costly for you to sue. Instead, contact the debtor and ask whether there is a problem. Offer to work with them to resolve the debt as quickly and as efficiently as possible. They will appreciate your offer, and likely never forget it. If it appears your efforts at informal resolution are ignored, try asking an attorney to write the other side a letter. A litigation attorney can concisely set forth the legal realities for the other side and can usually do this at a relatively low cost. Be sure your attorney understands your commitment to resolving the matter without the need for litigation.

Be Willing To Compromise. No matter the strength of your bargaining position, litigation is expensive. For new and growing businesses, it is prohibitive. Large businesses and corporations can more readily afford a legal battle, but there is little benefit to litigating a matter that could have been informally resolved at a much lower cost to the company. Even where larger concerns are at issue such as fear of opening the floodgates to repetitive litigation, looking to a compromise may help avoid worst case scenarios. Think about the prospect of litigation. What will it cost you in terms of aggravation, time, money and goodwill? Take a hard look at the matter before you and consider alternatives that might be acceptable to you – weigh the costs of the compromise against the aggravation, time, money and goodwill you will exhaust during a court battle. These costs cannot be overstated. Compromise may be the single most important practice in avoiding litigation. It is also the hardest practice for most businesses to swallow.

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