Electronic Funds Solutions v. Murphy

• Decision Date: 14 December 2005
• Docket Number: No. G031778.,G031778.
• Citation: 134 Cal.App.4th 1161,36 Cal.Rptr.3d 663
• Court: California Court of Appeals Court of Appeals
• Parties: ELECTRONIC FUNDS SOLUTIONS et al., Plaintiffs and Respondents, v. Michael MURPHY et al., Defendants and Appellants.

36 Cal.Rptr.3d 663

134 Cal.App.4th 1161

ELECTRONIC FUNDS SOLUTIONS et al., Plaintiffs and Respondents, v. Michael MURPHY et al., Defendants and Appellants.

No. G031778.

Court of Appeal, Fourth District, Division 3.

December 14, 2005.

Certified for Partial Publication.^*

Akin Gump Strauss Hauer & Feld, William A. Norris, Edward P. Lazarus and L. Rachel Helyar, Los Angeles; Bennett & Fairshter, Joel R. Bennett and Matthew J. Fairshter, Pasadena, for Defendants and Appellants.

Johnson and Associates and Einar Wm. Johnson, Torrance, for Plaintiffs and Respondents.

OPINION

ARONSON, J.

Defendants Electronic Payments Technologies, LLC (EPT), Michael Murphy and Ty Bishop appeal a default judgment of $24,040,272 entered in favor of plaintiffs Electronic Funds Solutions, LLC (EFS) and Michael Barry following the trial court's order striking defendants' answer as a discovery sanction. Defendants contend (1) the court should have limited compensatory damages to $50,000, the amount requested in plaintiffs' complaint; (2) the complaint failed to state causes of action supporting the damages awarded; (3) no substantial evidence supported the damages awarded; (4) plaintiffs were not entitled to either treble or punitive damages; (5) the legal theories and facts asserted in the default prove-up materially differed from those alleged in the complaint and therefore opened the default; and (6) the sanction striking defendants' answer violated their due process rights.

We conclude the trial court did not err by issuing a terminating sanction, but we reverse the judgment because the trial court awarded damages based on EPT's value, instead of EFS's lost profits. We also conclude that plaintiffs' complaint for damages "in an amount in excess of $50,000," failed to provide defendants notice of their maximum potential liability. Consequently, on remand the compensatory damages award may not exceed $50,000. Alternatively, plaintiffs may elect to amend their complaint to specify greater compensatory damages, which will open defendants' default. Because we vacate the compensatory damage award, we must also vacate the punitive damage award.

I Factual and Procedural Background

A. The Complaint

According to plaintiffs' complaint, around March 2000, Barry, Murphy, and Bishop orally agreed to form EFS, a company designed to assist merchants in electronically recovering funds from customers' bank accounts when their checks are dishonored. The parties agreed Barry would be the company's chief executive officer and president. Murphy and Bishop were named vice-presidents with responsibility for running EFS's Orange County office and maintaining the company's books and records. Although EFS officers, Murphy and Bishop had no management authority and could not make substantive decisions on behalf of EFS without Barry's knowledge and approval.

The business had no ready clients at its inception, but the marketing efforts of all three principals soon attracted numerous clients. EFS also entered into licensing agreements with suppliers who provided processing services necessary to operate the business. By December 15, 2000, EFS had contracts with at least 51 merchant customers.

In December 2000, Murphy and Bishop refused to sign a written operating agreement for EFS, declared they no longer wished to do business with Barry, and announced their withdrawal from the company. Instead of leaving EFS's Orange County office, however, Murphy and Bishop changed the locks and converted company assets, such as computers and software, to their use. They removed Barry's password access to EFS's website, appropriated EFS's incoming mail, and stopped forwarding EFS's telephone calls to Barry. Though they claimed to have left the company, Murphy and Bishop converted monies held for, and owed to, EFS and entered into contracts in EFS's name without Barry's knowledge or consent. Murphy and Bishop adopted a new company name, EPT, but misled EFS's customers into believing EPT was merely a new name for EFS.

Plaintiffs' February 2001 complaint alleged the following: (1) breach of fiduciary duty; (2) conversion; (3) intentional interference with economic relations; (4) intentional interference with prospective economic relations; (5) negligent interference with economic relations; (6) negligent interference with prospective economic relations; (7) misappropriation of trade secrets; (8) unfair competition and untrue and misleading advertising; (9) trespass as to real and personal property; (10) accounting; (11) declaratory relief; and (12) money had and received. The complaint sought injunctive and declaratory relief, along with damages "in an amount in excess of $50,000 and according to proof." In response to defendants' subsequent demand for a bill of particulars, plaintiffs provided damage calculations in excess of $1,840,000.

B. First Inspection Demand

Plaintiffs propounded several discovery requests, including specially prepared interrogatories and document inspection demands. The first set of inspection demands sought to examine the business records of EFS and EPT. After defendants objected, the parties settled the discovery dispute when defendants stipulated to produce all responsive documents not covered by the attorney-client and work product privileges. Defendants also agreed to "liberally" construe the document request, "resolving any alleged doubts in favor of production." The defendants agreed to affirm in a supplemental statement they had not withheld any documents except those protected by the attorney-client and work product privileges. The stipulation expressly required the production of all electronic data, including e-mail messages. The trial court entered the stipulation as a court order.

Defendants served the supplemental statement affirming they had produced all documents in their possession responsive to the first set of requests, with the exception of attorney-client/work product documents created while defending the litigation. The statement asserted, however, a computer virus destroyed responsive e-mails on Murphy's computer several months after plaintiffs served the document demand.

Concluding the supplemental statement did not comply with the stipulated order, and that defendants continued to withhold responsive documents, plaintiffs sought terminating sanctions in a contempt proceeding. At the hearing, the court ordered defendants to serve within seven days a revised supplemental statement and to produce all responsive documents per the stipulated order. The court also imposed $1,000 in sanctions against each defendant.

Defendants provided a revised supplemental statement and additional documents at Murphy's first deposition session, and produced more documents at the second session of Murphy's deposition, which occurred after the court's seven-day deadline for compliance. Defendants failed to produce any electronic data. During Murphy's deposition, plaintiffs discovered that documents requested in the first document demand had not been produced. Defendants later turned over more documents responsive to the first demand, but plaintiffs claimed defendants violated the stipulated order because other responsive documents had not been produced.

C. Second Inspection Demand

On April 10, plaintiffs moved for sanctions and to compel production on their second set of document inspection demands. These demands essentially sought to inspect EFT's computers, including the one that stored the e-mails destroyed by the computer virus. Although defendants lodged several objections to the demands, they failed to raise any objections in their opposition to plaintiffs' motion. Indeed, despite filing an "Opposition," defendants represented they were not opposing the motion to compel, and agreed to turn over one computer they believed belonged to EFS (EFS Computer), and permit plaintiffs to copy the hard drives of EPT's four other computers (EPT Computers).

The trial court granted plaintiffs' motion without qualification, ordered defendants to produce the items within fifteen days, and imposed sanctions. The court's order included the following warning: "DEFENDANTS ARE ALSO PUT ON NOTICE THAT FAILURE TO TIMELY COMPLY WITH SAID DISCOVERY ORDERS COULD RESULT IN THE ISSUANCE OF AN ORDER TO SHOW CAUSE RE CONTEMPT AND/OR THE IMPOSITION OF SANCTIONS, INCLUDING MORE SEVERE SANCTIONS, INCLUDING BUT NOT LIMITED TO THE STRIKING OF ANY DEFENDANT'S

ANSWER OR CROSS-COMPLAINT, OR THE STRIKING OF DEFENDANTS' ANSWERS AND ENTRY OF DEFAULT JUDGMENT AGAINST THEM."

Defendants gave the EFS Computer to plaintiffs in the courthouse parking lot immediately after the hearing, and produced the four EPT Computers at EPT's offices for hard drive imaging. Plaintiffs' computer forensic consultant, George Hiscox, examined the computers' hard drives to determine if any data had been removed or destroyed. In his report, Hiscox concluded the four EPT computers had their hard drives "wiped" by "Data Eraser" software between the time the court ordered their production and Hiscox's inspection. The wiping program writes over each hard drive sector to ensure all traces of data formerly stored on the machine cannot be retrieved. Hiscox surmised that data had been copied from the hard drives, the drives wiped, and selected data reinstalled. One EPT Computer, however, had extractable data due to incorrect use of the wiping program. Using forensic techniques, Hiscox recovered an Outlook calendar, contacts, e-mail, and attachments.

The EFS Computer's hard drive had also been wiped by the Data Eraser software, but the program had been aborted before completion. The Data Eraser program was run on April 10, 2002, at approximately 2:35 p.m. Given the hearing on the motion to compel on April 10 began at 3:00 p.m., and defendants had promised to hand the computer over at the hearing, it appears the defendants aborted the Data Eraser program because defendants ran out of time to complete...