Guarino v. Interactive Objects, Inc.

• Decision Date: 22 March 2004
• Docket Number: No. 50356-1-I.,50356-1-I.
• Citation: 86 P.3d 1175,122 Wash. App. 95
• Parties: John GUARINO, an individual; and Ryan Smith, an individual, Appellants, v. INTERACTIVE OBJECTS, INC., a Washington State Corporation; and Northwest Capital Partners, L.L.C., a Washington State Limited Liability Company; and Steven G. Wollach, husband and wife, and the marital community composed thereof; and Brent Nelson and Jane Doe Nelson, husband and wife, and the marital community composed thereof; and Thad E. Wardall and Jane Doe Wardall, husband and wife, and the marital community composed thereof, Respondents.
• Court: Washington Court of Appeals

86 P.3d 1175

122 Wash. App. 95

John GUARINO, an individual; and Ryan Smith, an individual, Appellants, v. INTERACTIVE OBJECTS, INC., a Washington State Corporation; and Northwest Capital Partners, L.L.C., a Washington State Limited Liability Company; and Steven G. Wollach, husband and wife, and the marital community composed thereof; and Brent Nelson and Jane Doe Nelson, husband and wife, and the marital community composed thereof; and Thad E. Wardall and Jane Doe Wardall, husband and wife, and the marital community composed thereof, Respondents.

No. 50356-1-I.

Court of Appeals of Washington, Division 1.

March 22, 2004.

Paul Arthur Spencer, Spencer Law Offices PLLC, Bellevue, WA, James Alexander Smith, Smith & Hennessey PLLC, Seattle, WA, for Respondents.

E. Duane Golphenee, Duane Golphenee PS, John Burton Farver, Peick & Associates PS, Bellevue, WA, for Appellants.

APPELWICK, J.

A dispute over employment severance benefits between a corporation and two former executives proceeded to mediation, which resulted in Settlement Agreements. The dispute did not involve any issues regarding corporation stock. Nonetheless, the Settlement Agreements included provisions allowing the corporation to purchase the appellants' founder's shares of stock. Subsequent to the purchase of the appellants' shares of stock, the corporation's stock subsequently increased greatly in value. The appellants brought suit alleging claims of Washington State Securities Act (WSSA) violations, fraud, negligent misrepresentation, and breach of fiduciary duty based on the corporation's failure to disclose material information which affected the value of the stock. The trial court ruled in favor of the respondents on all claims. Its conclusions were based largely on determinations that the respondents had not misrepresented or omitted material facts and that the adversarial relationship between the appellants and respondents foreclosed the appellants' right to rely on the respondents' representations. We disagree.

We conclude that the respondents had a duty under the WSSA to disclose material information about a merger with Avatar or to abstain from purchasing the appellants' stock. Respondents breached this duty. Appellants were entitled to rely on the facts as stated, notwithstanding their adversarial positions relative to the employment dispute. The appellants are entitled to a trial on the issue of damages.

While we affirm the trial court's dismissal of the breach of fiduciary duty claim, we reverse the dismissal of the claims for violation of the WSSA, fraud, and negligent misrepresentation. The record establishes the appellants are entitled to judgment on those claims. We remand for entry of judgment in favor of appellants, and for a determination of damages and attorney fees.

FACTS

In 1995, appellants Ryan Smith and John Guarino, along with a third party not involved in this suit, founded Interactive Objects, Inc. (IObjects), a start-up technology company. Smith was its Chief Executive Officer (CEO) and director from the company's inception until his resignation. Guarino was its Vice President for product development and on its Board until his resignation. Defendant Steve Wollach was IObjects' Chief Financial Officer (CFO) and on its Board from the fall of 1997 until the fall of 1998. He assumed presidency of the company upon the appellants' resignations in October 1998. Defendants Brent Nelson and Thad Wardall were on IObjects' Board. Defendant Northwest Capitol Partners (NWCP) was a venture capital company serving as IObjects' financial advisor and a party to the Settlement Agreement underlying this dispute.

Smith and Guarino worked without compensation for the first two years of the company's existence. In a reverse merger in 1997, IObjects became a publicly traded company. At the time of the merger, Smith received 1,680,000 shares of founder's stock and Guarino received 1,200,000 shares of founder's stock. Together they held a combined 2.8 million shares, approximately 20 percent of IObjects' total outstanding shares. Their shares were restricted under Securities Exchange Commission (SEC) Rule 144 and could not be sold on the open market until after September 17, 1999. In January 1998, IObjects and the appellants signed Employment Compensation Agreements (original Compensation Agreements). The agreements provided that the appellants were to receive three months' salary in the event they were terminated for no cause. The agreements did not contain a provision conferring upon IObjects' the right to repurchase appellants' company stock in the event of employment termination.

In July 1998, IObjects executed Amended Compensation Agreements for the appellants. The amended agreements stipulated that the appellants were to receive one year's salary, paid monthly in twelve equal installments, upon termination for any reason other than fraud. Like the original Compensation Agreements, the Amended Compensation Agreements provided that except for workers' compensation claims or unemployment compensation claims, the parties were to resolve employment disputes through mediation, and, in the event mediation failed, through binding arbitration. Finally, like the original Compensation Agreements, the Amended Compensation Agreements contained no stock buyback provision.

IObjects planned to introduce its only two products, the Visual Gateway Interface (VGI) and the Visual Mail Interface (VMI), onto the market in the spring of 1998. Anticipating the commercial success of the two products, IObjects also initiated an equity drive, raising approximately $6 million, primarily from European investors who paid $4 per share. Shortly thereafter, it became evident that both the VGI and the VMI were financial failures.

In July 1998, IObjects lost what had been its only significant source of revenue, a consulting contract with Safeco Insurance. The Safeco account was worth between $3 and $4 million to IObjects. In the first three quarters of 1998 IObjects lost over $3 million. IObjects' shares dropped to a low of $1.40 per share less than three months after the European investors had paid $4 per share. The Safeco consulting contract was awarded to Avatar Corporation (Avatar), which had been IObjects' main subcontractor when IObjects previously held the Safeco contract. Partly in response to pressure from European investors, Smith resigned as CEO of IObjects at a Board meeting on October 8, 1998. Guarino resigned on October 12, 1998. Following their resignations, the appellants requested payment of the severance benefits as provided in the Amended Compensation Agreements. IObjects refused to honor their severance benefits. This case arises out of IObjects' solicitation of a buyback of the appellants' stock shares during the negotiation and settlement of the appellants' severance claims.

The record indicates that prior to the severance negotiations in February 1999, the respondents solicited a repurchase of appellants' stock. Smith testified that Nelson called him in October 1998 to arrange a meeting with him, Wardall, and Guarino to discuss IObjects' repurchase of their shares. The record indicates that Nelson's proposed meeting never occurred because the appellants had been advised by their attorney to have no contact with the respondents. On October 22, 1998, Nelson, as Managing Partner of NWCP, also sent an offer to the appellants' attorney offering to purchase Smith's stock. The appellants refused that offer.

Wollach also solicited an offer to repurchase the appellants' shares on IObjects' behalf. The parties agree that from late October 1998 to November 18, 1998, the appellants were in contact with Wollach on three occasions. The three contacts between Wollach and the appellants in October and November 1998 are the basis for the appellants' claim that IObjects fraudulently induced them to sell their shares below market value. The first two of those contacts were phone calls Wollach placed to the appellants on or about October 30, 1998. During those calls, Wollach discussed IObjects' poor financial condition and high "burn rate."¹

On November 18, 1998, Smith, Guarino, and their trial attorney, Ramer Holtan, met with Wollach and Paul Spencer, IObjects' attorney, to discuss settlement of their severance claims. At that meeting, Wollach offered to repurchase the appellants' stock for approximately $0.20 per share.² Holtan replied by asking for a disclosure of the state of the company. Smith testified that Wollach answered that IObjects had no products, no new contracts "worth anything," and no intellectual property. In sum, Wollach represented that IObjects' financial outlook was dismal. He also stated that acquisition of or merger with another company was imperative if IObjects were to survive, and that IObjects' purchase of the appellants' stock was requisite for acquisition of or merger with another company. Wollach also disclosed at the November 18 meeting that IObjects had an outstanding letter of intent to merge or acquire an East Coast Company. He did not inform the appellants that IObjects had discussed a merger with Avatar.

The day after Wollach's November 18 meeting with the appellants, IObjects signed a letter of intent to merge or acquire Avatar. The letter of intent with Avatar stated that "[u]ntil these negotiations are concluded by either party with written notice to the other, which period of time shall not be less than 90 days, Seller shall not negotiate with any other party with respect to the sale of equity or assets of Avatar Interactive." The letter of intent did not include a purchase price. On November 19, IObjects and Avatar signed a Mutual Nondisclosure Agreement.

The record is unclear as to why IObjects refused to honor the appellants' Compensation Agreements.³ On November 25, 1998, the appellants filed a claim to initiate the alternative dispute resolution process, as required under their Employment Compensation...