City of Atascadero v. Merrill Lynch, Pierce, Fenner & Smith, Inc., No. A078340

• Court: California Court of Appeals
• Writing for the Court: McGUINESS; HANLON, P.J., and REARDON
• Citation: 68 Cal.App.4th 445,80 Cal.Rptr.2d 329
• Parties: , 98 Cal. Daily Op. Serv. 8971, 98 Daily Journal D.A.R. 12,529 CITY OF ATASCADERO et al., Plaintiffs and Appellants, v. MERRILL LYNCH, PIERCE, FENNER & SMITH, INC., et al., Defendants and Respondents.
• Decision Date: 07 December 1998
• Docket Number: No. A078340

Page 329

80 Cal.Rptr.2d 329 68 Cal.App.4th 445, 98 Cal. Daily Op. Serv. 8971, 98 Daily Journal D.A.R. 12,529 CITY OF ATASCADERO et al., Plaintiffs and Appellants,
v.
MERRILL LYNCH, PIERCE, FENNER & SMITH, INC., et al., Defendants and Respondents. No. A078340. Court of Appeal, First District, Division 4, California. Dec. 7, 1998.
As Modified on Denial of Rehearing Jan. 6, 1999.
Review Denied March 31, 1999.

Page 334

[68 Cal.App.4th 451] Folger Levin & Kahn, LLP, Michael A. Kahn, Gregory D. Call, Karen J. Petrulakis, San Francisco, for appellants.

Munger, Tolles & Olson, LLP, Ronald L. Olson, George M. Garvey, Marc T.G. Dworsky, Andrew J. Thomas, Morgan, Lewis & Bockius, LLP, McCambridge, Deixler & Marmaro, Richard Marmaro, Larry S. Greenfield, Los Angeles, for respondents.

McGUINESS, J.

This appeal arises from the wreckage of the Orange County bankruptcy. Appellants are 14 California cities and local agencies ¹ who deposited funds with the Orange County (the County) Treasurer for investment in the County Investment Pools (the Pool), a statutory investment [68 Cal.App.4th 452] trust. ² After the Pool collapsed in December 1994 and the County declared bankruptcy, most Pool participants elected to settle with the County by releasing their claims against the County and assigning to the County any claims they had against third parties in exchange for a contingent, contractual right to participate in any recovery the County might obtain from its various lawsuits against third parties. Appellants opted not to waive or release their rights to proceed on direct claims against the County and third parties. They then proceeded to bring suit against Merrill Lynch, Pierce, Fenner & Smith, Inc. (Merrill Lynch), and other entities and individuals associated with Merrill Lynch. ³

Appellants now appeal from entry of judgment in favor of respondents following the sustaining of a demurrer without leave to amend to their second amended complaint. Appellants contend they have properly pleaded causes of action against respondents based on breaches of duties owed directly to them, separately and independently of any duties respondents owed to the Pool or its trustee. Respondents argue that appellants' claims against them are actually claims seeking recovery for injury to the trust property of the Pool itself; and, as such, they must be made not by appellants, as beneficiaries of the trust, but by the trustee himself as the sole real party in interest. On the basis of our review of the applicable principles of the law of trusts, considered in light of both the

Page 335

controlling stipulations of the County as trustee and the decisions of the federal bankruptcy court, we conclude that appellants have pleaded facts in their second amended complaint sufficient to state causes of action on direct claims for relief against respondents. We therefore reverse the judgment and decision of the trial court sustaining the demurrer.

I. FACTUAL AND PROCEDURAL BACKGROUND

Under applicable California law, California counties are authorized to accept funds from cities, counties, and other government agencies or entities for deposit in trust. (GOV.CODE, §§ 27100.1⁴, 53684.) Pursuant to this law, the Pool was formed by the County and administered by the County Treasurer in order to invest excess funds of various local agencies. Once public [68 Cal.App.4th 453] entities deposited their funds into the Pool, a trust was created under California law, and the County itself became the trustee of Pool deposits held in trust by the County Treasurer on behalf of the depositors. (§§ 27100.1, 53684; In re County of Orange (Bankr.C.D.Cal.1996) 191 B.R. 1005, 1013-1018; In re County of Orange, supra, 183 B.R. at pp. 596-597, 605-606.)

Appellants are 14 of the nearly 200 governmental entities (Pool Participants) that deposited funds into the Pool for investment by the County Treasurer, Robert L. Citron. By late 1994, approximately $7.6 billion was invested in the Pool, $200 million of which was deposited by appellants alone. The County implemented a highly speculative investment strategy that placed principal at risk with little liquidity to provide protection from market volatility. Merrill Lynch acted as securities and financial broker and advisor for the County in these transactions. In December 1994, the Pool's investment scheme collapsed. Ultimately, on December 6, 1994, the County filed for bankruptcy protection under Chapter 9 of the United States Bankruptcy Code. (In re County of Orange, supra, 183 B.R. at p. 596.) Appellants collectively suffered the loss of a large portion of their invested funds.

On January 12, 1995, shortly after filing for bankruptcy, the County brought suit against Merrill Lynch in bankruptcy court. In mid-1995, the County entered into a settlement agreement (the Comprehensive Settlement Agreement, or CSA) with the various local governmental entities, districts, and public agencies that had deposited funds in the Pool (identified in the CSA as "Non-County Pool Participants"). Under the CSA, the County [68 Cal.App.4th 454] agreed to return to all these Pool Participants specified portions of the funds they had deposited into the Pool, amounting to approximately 77 percent of those funds. The CSA required the Pool Participants to make a choice as to the remainder of their claims, or the "Deficiency Amount." The large majority of Pool Participants chose "Option A," pursuant to which they (a) settled any claims they had against the County

Page 336

for their losses, and (b) expressly assigned to the County "any and all" additional claims they may have had against third parties, in return for a specified share of the net litigation proceeds that might be realized as a result of the County's pursuit of such claims itself. Appellants chose "Option B," pursuant to which they (a) retained all their rights to proceed directly against the County for the Deficiency Amount, and (b) reserved and retained all claims and rights to proceed independently against third parties. Thus, the Option B Pool Participants did not assign to the County any of their claims against third parties, including Merrill Lynch. Instead, they retained their right to pursue such claims independently.

The bankruptcy court entered its order authorizing and approving the CSA on May 2, 1995. On October 25, 1995, the County filed a second amended complaint against Merrill Lynch in bankruptcy court. In its amended complaint against Merrill Lynch, the County made clear that the only direct claims of any Pool Participants it was pursuing were those specifically assigned to it by the Option A Pool Participants, and that it was pursuing such claims as the assignee of the Option A Pool Participants. ⁵

Meanwhile, in October 1995, each of the appellants proceeded to file suit in the bankruptcy court against the County pursuant to their rights under Option B, alleging breaches of trust and fiduciary duty and seeking damages [68 Cal.App.4th 455] for their losses from the collapse of the Pool. On May 16, 1996, under the jurisdiction of and with the express approval of the bankruptcy court, the County and appellants negotiated a settlement agreement (the "Stipulation re Dismissal of Adversary Proceeding and Resolution of All Claims of Option B Pool Participants Against the County," or Stipulation).

In the Stipulation, appellants agreed to release their claims against the County for their Pool investment losses, in return for the County's agreement to pay appellants (a) an additional $7.5 million, (b) County warrants in the principal amount of $8 million at interest of 6.5 percent per annum, and (c) the first $9 million of net litigation proceeds from the County's own third party litigation. In addition, the Stipulation expressly stated that appellants "can preserve their direct claims against third parties," such as Merrill Lynch. In this regard, the Stipulation provided that "[t]he County shall not ... give any third party ... any release of liability such third party may have to any Settling Option B Pool Participant on account of any direct claim that a Settling Option B Pool Participant may have, if any, against any third party" on various grounds. ⁶ The County expressly

Page 337

agreed that it "shall not assert any claim to any proceeds recovered or determined by a court to be recoverable by Settling Option B Pool Participants, if any, on such direct claims...." On the other hand, the Stipulation also reserved the rights of both the County and appellants with regard to their separate third party litigation, ⁷ and stated that "[t]he parties reserve for future determination whether or to what extent the Settling Option B Pool Participants can assert any claims against third parties alleged to be owned by or held in any trust which is alleged to be applicable to the deposits of the Settling Option B Pool Participants with the Pools...." In short, while the Stipulation [68 Cal.App.4th 456] provided that appellants retained their "direct claims against third parties," the County also retained its right to assert claims for itself or the Option A Pool Participants against those same third parties. ⁸

Appellants initially filed their complaint against Merrill Lynch on September 15, 1995, in San Francisco Superior Court. On the motion of Merrill Lynch for change of venue, the case was transferred from San Francisco to Contra Costa County on February 14, 1996. On April 12, 1996, appellants filed a first amended complaint in the Contra Costa County Superior Court, seeking compensatory and punitive damages for losses in excess of $80 million. In addition to alleging Merrill Lynch had breached various legal duties owed directly to appellants--breach of fiduciary duty, aiding and abetting a breach of fiduciary duty, fraud and deceit, conversion, civil liability for receiving stolen property under Penal Code section 496, negligent misrepresentation and violation of...