Cleveland v. Johnson

• Decision Date: 11 October 2012
• Docket Number: No. B233762.,B233762.
• Citation: 147 Cal.Rptr.3d 772,209 Cal. App. 4th 1315
• Court: California Court of Appeals
• Parties: Kenneth CLEVELAND et al., Plaintiffs and Respondents, v. Robert V. JOHNSON et al., Defendants and Appellants.

209 Cal.App.4th 1315

147 Cal.Rptr.3d 772

2012 Daily Journal D.A.R. 14,038

Kenneth CLEVELAND et al., Plaintiffs and Respondents,

v.Robert V. JOHNSON et al., Defendants and Appellants.

No. B233762.

Court of Appeal, Second District, Division 8.

Oct. 11, 2012.

See9 Witkin, Summary of Cal. Law (10th ed. 2005) Corporations, § 198.

Reed Smith, Margaret M. Grignon and Anne M. Grignon, Los Angeles, for Defendant and AppellantInternet Specialties West, Inc.

Andrew P. Altholz, Santa Monica, for Defendant and AppellantRobert V. Johnson.

Hinshaw & Culbertson, Filomena E. Meyer and Desmond J. Hinds, Los Angeles, for Plaintiffs and Respondents.

RUBIN, Acting P.J.

SUMMARY

Kenneth Cleveland and William Bickley sued Robert V. Johnson and Internet Specialties West, Inc.(IS West).At trial before a jury, they asserted claims for breach of contract, breach of fiduciary duty, and false promise in connection with a $75,000 investment made pursuant to a February 1995 agreement.The jury found no false promise, but awarded more than $3.8 million for breach of contract, based on successor liability and ratification theories.The jury also found a breach of fiduciary duty and awarded punitive damages.

Defendants contend the findings of successor liability, ratification, and breach of fiduciary duty were not supported by substantial evidence; the damages awarded for breach of contract exceeded those allowed by the contract; and the punitive damages award must be reversed.They also assert instructional error in connection with the successor liability, ratification, and breach of fiduciary duty claims, and inconsistent special verdict findings.

We find no merit in any of these contentions and affirm the judgment.

FACTUAL AND PROCEDURAL BACKGROUND

From 1993 to October 1995, Kenneth Cleveland was the accountant for Interactive Strategies, Inc.(ISI), a telecommunications company in the pay-per-call industry that provided equipment and processed phone calls, primarily involving adult-content material.Bickley was a Cleveland friend of long standing whose financial affairs Cleveland handled.

Defendant Johnson was ISI's president and a director and shareholder.ISI's other officers and shareholders were Edward Hastings and Brian Spitler.Early in 1995, Johnson approached Cleveland, telling him that he had an interesting proposal Cleveland should hear. Johnson and his partners, Spitler and Hastings, “were thinking about starting a different company” to provide access to the internet.One of the reasons Johnson approached Cleveland was that anyone making such a risky investment would have to be familiar with Johnson, Spitler and Hastings and believe in their talent.The new business was to operate as an internet service provider offering dial-up Internet connections to its customers.After several meetings with Johnson and Spitler and after reviewing a cost analysis and revenue projections Spitler provided, showing start-up costs of $72,315, Cleveland and Bickley (collectively, Cleveland), agreed to invest $75,000 in the project.During the pre-investment meetings and calls, Johnson told Cleveland the new business “was going to be a separate division, and it was totally different than what they were doing on the other side of the telecommunications and in the adult information.”Johnson told Cleveland the new internet project “was going to be separate from what their current business was,” and “it was going to be a separate division only until it could get going enough to become its own company.”The separate operation of the internet project from ISI's adult phone business was significant to Cleveland and Bickley for several reasons, including Cleveland's belief ISI was losing money, Cleveland's personal beliefs, and Bickley's career, which had emphasized wholesome family entertainment.

Cleveland drafted a memorandum to ISI summarizing the agreement between ISI and Bickley/Cleveland Communications, and discussed its terms by telephone with Jerry Smith, the attorney for ISI, who had no changes and said “it looked fine.”Johnson reviewed the agreement and had no changes.The agreement was then signed by Brian Spitler for ISI and by Cleveland for Bickley/Cleveland Communications.¹

The terms of the agreement between ISI and Cleveland were these: Cleveland would provide $75,000 of capital “to be used by [ISI] to develop and implement a program to allow access to the InterNet information network.”All expenditures of the capital provided were to be at ISI's sole discretion, so long as they were related to the internet project.Net cash receipts of the project were defined as gross receipts from the sale of internet software packages or internet access fees, “less all applicable expenses directly related to the InterNet project.”Cleveland was to receive 100 percent of the net cash receipts from the internet project “until all capital invested by Bickley/Cleveland has been recouped.At that time Bickley/Cleveland Communications shall be paid 5% of gross receipts from the InterNet project.”

During negotiations, Cleveland asked for a “say in management,” but “Johnson and the others” were “adamant about not giving [Cleveland] a say in management or a place on the board” because “Johnson had the expertise and the equipment and what was needed to make it run,” and Cleveland “had no problem with that.”The quid pro quo was the gross receipts clause.

The agreement was signed and the $75,000 was provided to ISI on the same day, February 9, 1995.ISI recorded The Central Connection as a fictitious business name on February 17, 1995.

On February 14, 1995, Johnson, as president of ISI, entered into leasing agreements for the start-up equipment necessary to operate The Central Connection.Kristina Di Paola(then Kristina Nolan) was hired in February 1995 as a full-time employee to run The Central Connection.Johnson and Spitler told her that The Central Connection was established to be separate from ISI, “because they wanted to be a community internet service provider” and wanted no conflicts with ISI's adult entertainment business.Johnson “did the early setup of all the hardware” and taught Di Paola about the equipment racks, modem pool and the like.She considered Johnson her direct supervisor and reported to him.The Central Connection had its own office separate from and adjacent to the ISI offices, and its own phone number.Di Paola resigned in July 1995 and was replaced by Aaron Schultz.

At a lunch in August 1995, Hastings, who was the financial officer, told Cleveland that The Central Connection “was [limping] along and losing money” and “we weren't taking in clients as quickly as we thought....”Hastings “thought it would still work because they were, they were still advertising, they were still bringing in customers, and he thought it still had a chance to go.”Cleveland asked for some financial information, and on September 18, 1995, Hastings wrote a memo to Cleveland with an update on The Central Connection.Hastings enclosed a profit and loss statement for The Central Connection showing revenues of $4,500 per month against operational costs of $10,000 per month, and a summary report showing expenses of $43,000 ISI had paid for The Central Connection through August 1995(exclusive of rent and utilities); Hastings observed that this would continue for several months and the overall expenses would exceed $75,000.Hastings's memo also stated that: “In regard to the repayment of your investment after much discussion and consideration repayment can only come from The Central Connection.We would propose that all monies above overhead for The Central Connection go to pay you back first.After you are paid back then Central Connection would pay back ISI for [its] investment.”

This information and other inquiries Cleveland made in 1995 and 1996 satisfied him that his investment was not being misused.Cleveland spoke to Richard Marks, a lawyer for ISI, in October 1996, and understood from Marks that The Central Connection was still in operation.Cleveland knew it would “be a long time ... before [The Central Connection] has enough revenue coming in to make up for all the losses and then have enough profit to trigger any kind of ... repayment of the capital”; and that “if we make a profit they would let me know.”

Then, in September 1998, Cleveland found out that financial officer Hastings had moved to Palm Springs in March or April of that year.Cleveland called Jerry Smith, ISI's lawyer, about Hastings's move, and asked Smith if Hastings was no longer with The Central Connection.Smith told Cleveland that he knew Hastings had moved, Spitler had left the area, and The Central Connection had failed.Smith (who was also Cleveland's lawyer) said he(Smith) was working with Johnson on a completely different project.A few months later, Cleveland encountered Johnson by chance, and Johnson, when asked, said that The Central Connection “didn't make it.”

In May 2005, Cleveland was in the market for computer services for his company, and the consultant he had hired referred him to defendant IS West.In short order, Cleveland discovered that Johnson was the president of IS West.A brochure showed IS West's business was similar to that of The Central Connection—access to the internet, web page hosting “and pretty much everything that Central Connection was going to start doing.”The brochure stated IS West was founded in 1996 and described it as the largest internet service provider (ISP) in the Conejo Valley.

Cleveland accessed and reviewed IS West's web page and the press releases included there.One of them, dated January 5, 1996, stated that IS West “will file to become a California Corporation.Established in 1995 as Central Connections, Internet Specialties West, Inc. will be a high speed ISP in Los Angeles and Ventura County.”The press release showed IS West was located at the same business center location that had housed The Central...