Cziraki v. Thunder Cats, Inc.

• Decision Date: 20 August 2003
• Docket Number: No. B159413.,B159413.
• Court: California Court of Appeals Court of Appeals
• Parties: Imre CZIRAKI, Plaintiff and Appellant, v. THUNDER CATS, INC., Defendant and Respondent.

3 Cal.Rptr.3d 419

111 Cal.App.4th 552

Imre CZIRAKI, Plaintiff and Appellant, v. THUNDER CATS, INC., Defendant and Respondent.

No. B159413.

Court of Appeal, Second District, Division 7.

August 20, 2003.

Certified for Partial Publication.^*

Review Denied November 19, 2003.

Westrup, Click & Associates, R. Duane Westrup, Lawrence R. Cagney and Mark L. Van Buskirk, Long Beach, for Plaintiff and Appellant.

Thompson & King and Wayne T. King, Valencia, for Defendant and Respondent.

JOHNSON, Acting P.J.

A successful plaintiff in a minority shareholder's derivative action appeals the trial court's denial of his motion for attorney fees. He contends the court's judgment created a common fund and substantial benefit for defendant corporation, and thus the court should have awarded him fees. The trial court did not believe it could apply the common fund or substantial benefit doctrine in a derivative suit involving a close corporation with a small number of shareholders. The corporation argues the trial court was correct on that issue and even if it erred in refusing to apply these equitable doctrines, the court properly denied the motion because plaintiff failed to present competent evidence enabling the court to determine the amount of a reasonable fee award.

We conclude the trial court erred in failing to apply the common fund and substantial benefit doctrines. In an unpublished portion of the opinion, however, we find appellant's counsel failed to produce sufficient evidence as to the amount of the fees properly attributable to the successful derivative claim as opposed to his individual causes of action. Accordingly, we reverse the order as it pertains to the application of the common fund and substantial benefit doctrines and remand the matter for a determination of a reasonable attorney fees award.

FACTS AND PROCEEDINGS BELOW

In September 1995, Imre Cziraki (appellant), Lawrence R. Phillis, and Eugene W. Van Den Berg II held the first incorporators and board of directors meeting of Thunder Cats, Inc. (respondent), their newly-formed "small business" or close corporation. Phillis and Van Den Berg had recently applied for patents on their design for cylinder heads used in recreational watercraft engines. They also had approached Cziraki, who owned a machining company, about forming a corporation to manufacture and sell parts based on their design. In discussions prior to the meeting, Phillis and Van Den Berg offered to assign their patent interests to Thunder Cats with the understanding Cziraki would oversee the manufacture of the parts. The parties memorialized this commitment to assign the patents to Thunder Cats in the minutes of the first board of directors meeting. The minutes do not mention any corresponding obligation by Cziraki.

The minutes also contain the parties' confirmation each of them would invest $2,000 in Thunder Cats in exchange for 200 shares of common stock per shareholder, in effect creating a three-way ownership stake in the company. After formalizing their officer roles, the parties deferred any discussion of officers' salary or other compensation until such time as the company generated enough revenue to warrant this discussion. The minutes do not mention any other profit-sharing or similar shareholder distribution strategies.

Shortly after they formed Thunder Cats with Cziraki, Phillis and Van Den Berg formed Vanlar, a separate company in which they held the only shareholder interests. Phillis and Van Den Berg never assigned their patent interests to Thunder Cats and instead exploited the patents on Vanlar's behalf. As a minority shareholder, Cziraki had limited power to enforce the original promise to assign the patents to Thunder Cats. Cziraki's relationship with Phillis and Van Den Berg deteriorated.

In December 1997, Cziraki filed derivative and individual claims against Thunder Cats, Phillis, and Van Den Berg. In his first amended complaint, Cziraki asserted derivative claims against Phillis and Van Den Berg for breach of fiduciary duty and usurpation of corporate opportunity, and prayed for assignment of the patents to Thunder Cats plus the imposition of a constructive trust to account for the company's lost profits and related business opportunities. Cziraki asserted individual claims against Phillis and Van Den Berg for breach of fiduciary duty, fraud, and negligent misrepresentation.

The trial court found Phillis and Van Den Berg had breached their fiduciary duties to Thunder Cats and ordered them to assign their patents to Thunder Cats and to make payments of $172,000 and $86,000, respectively, to compensate the company for economic damages attributable to their failure to assign the patents as originally promised. The court also found Phillis and Van Den Berg had breached their fiduciary duties to Cziraki, as majority stockholders to a minority stockholder, but the court did not enter any damage award in favor of Cziraki as an individual stockholder.

Postjudgment, Cziraki filed a motion to recover attorney fees incurred in the prosecution of his successful derivative claim, invoking the common fund and substantial benefit doctrines. Because the trial judge had transferred to another court, a different judge heard the motion for attorney fees. The new judge pointed to portions of the record indicating the trial judge believed Cziraki's successful cause of action might justify an award of attorney fees.

At the hearing on the motion, the trial court commented it had never heard of applying either the common fund or substantial benefit doctrine to a suit concerning a close corporation. The court expressed doubt it had latitude to invoke either doctrine under circumstances in which all three of the shareholders had participated in the litigation. The court indicated it was relying on what little precedent was available to guide it.

In considering Cziraki's motion, the trial court also evaluated the feasibility of granting an award which would compensate Cziraki for the attorney fees incurred in the prosecution of the successful derivative claim, without including the fees associated with the individual claims. The court expressed concern over its ability to make such a distinction absent any direct observation of counsel's efforts. The court stated its reluctance to rely exclusively on the motion and supporting declaration of Cziraki's counsel.

The trial court requested supplemental briefing further addressing application of the equitable doctrines at issue and the apportionment of legal fees. The court specifically instructed Cziraki's counsel to provide more helpful and competent evidence to facilitate the court's determination of the total time and effort spent in pursuit of the successful derivative claim, and the amount of a reasonable fee award, should the court decide to grant the motion. After a second hearing, the court denied the motion.

The minute order does not reflect the trial court's rationale for denying the motion. The record supports the inference the court believed neither equitable doctrine applied and, even if the court had decided to award fees, Cziraki and his counsel had not provided competent evidence to support a determination of a reasonable fee award.

DISCUSSION

I. THE TRIAL COURT ERRED IN CONCLUDING THE COMMON FUND AND SUBSTANTIAL BENEFIT DOCTRINES DO NOT APPLY.

Cziraki contends the trial court should have applied the common fund and substantial benefit doctrines to award him legal fees incurred in the prosecution of the successful derivative claim on the corporation's behalf. He argues the facts in this matter are different from those in the case law upon which the trial court relied.

In deciding Cziraki's motion, the trial court relied primarily on Baker v. Pratt¹ (a case we discuss below) to support its determination the common fund and substantial benefit doctrines do not permit an award of attorney fees in a derivative suit involving a close corporation with a small number of shareholders. Both Cziraki and Thunder Cats also focus primarily on the Baker case in their appellate briefs. We note there is a surprising dearth of California cases factually similar to the one currently before this court. Therefore, we expand the scope of our inquiry and consider the application of the equitable doctrines at issue in both California and out-of-state decisions.

A. Courts Historically Have Applied the Common Fund And Substantial Benefit Doctrines to Shareholder Derivative Suits.

"Under the American rule, which is embodied in Code of Civil Procedure section 1021 in California, as a general proposition each party to a litigation must pay his or her own attorneys fees. There are statutory exceptions to this rule, and the courts have created several exceptions pursuant to their inherent equitable powers."² Exceptions to the American rule created under the courts' equitable powers include the "common fund" and "substantial benefit" doctrines.³

"[I]f the litigation has succeeded in creating or preserving a common fund for the benefit of a number of persons, the plaintiff may be awarded attorney fees out of that fund. [Citation.] Likewise, if a judgment confers a substantial benefit on a defendant, such as in a corporate derivative action, the defendant may be required to pay the attorney fees incurred by the plaintiff."⁴ In Fletcher v. A. J. Industries,⁵ a California appellate court concluded a "substantial benefit" warranting an award of attorney fees to a successful plaintiff in a shareholder derivative action exists where "the results of the action `maintain the health of the corporation and raise the standards of "fiduciary relationships and other economic behavior,"' or `prevent [s] [sic ] an abuse which would be prejudicial to the rights and interests of the corporation or affect the enjoyment or protection of an essential right to the stockholder's interest.'"⁶ We agree with Cziraki's position the present case created for Thunder Cats...