Patriot Scientic Corp. v. Korodi

• Decision Date: 25 May 2007
• Docket Number: No. 06CV1543 R(CAB).,06CV1543 R(CAB).
• Citation: 504 F.Supp.2d 952
• Parties: PATRIOT SCIENTIFIC CORPORATION, a Delaware corporation, Plaintiff, v. Miklos B. KORODI, an Ohio citizen, Defendant. And Related Actions.
• Court: U.S. District Court — Southern District of California

504 F.Supp.2d 952

PATRIOT SCIENTIFIC CORPORATION, a Delaware corporation, Plaintiff, v. Miklos B. KORODI, an Ohio citizen, Defendant And Related Actions.

No. 06CV1543 R(CAB).

United States District Court, S.D. California.

May 25, 2007.

COPYRIGHT MATERIAL OMITTED

COPYRIGHT MATERIAL OMITTED

Charles T. Hoge, Kirby Noonan Lance and Hoge, San Diego, CA, for Plaintiff.

Edward Lee Horton, Waller Lansden Dortch & Davis, LLP, Los Angeles, CA, for Defendant.

ORDER GRANTING MOTION TO DISMISS FIRST AMENDED COUNTERCLAIM WITH LEAVE TO AMEND

RHOADES, District Judge.

I. Introduction

Miklos Korodi has brought a First Amended Counterclaim and Third-Party Complaint ("First Amended Counterclaim") against Patriot Scientific Corporation ("Patriot") and David Pohl (collectively, "defendants")¹. Defendants have moved to dismiss the First Amended Counterclaim. For the reasons set forth below, the motion is granted.

II. Background

Patriot is a Delaware corporation with its principal place of business in Carlsbad, California. Patriot is a public company that develops and sells microprocessors, software, intellectual property licenses, and communications devices. First Amended Counterclaim ¶ 2. Pohl is chairman of Patriot's board of directors as well as a shareholder and CEO of Patriot. Id. ¶ 3. Korodi worked as a consultant for Patriot from August 1, 2005 to February 27, 2006. Id. ¶ 8. According to the First Amended Counterclaim, Korodi agreed to work as a consultant in exchange for monthly payments of $5,000, reimbursement of all of his expenses, and participation in Patriot's stock option program. Id. ¶ 8.

On February 27, 2006, Korodi received a letter terminating his consulting arrangement with Patriot. Id. ¶ 11. In that letter, Korodi was promised 400,000 shares of Patriot stock. Exhibit A-16, attached to First Amended Counterclaim. Although he does not deny that he was paid $5,000 a month and reimbursed for his expenses, Korodi alleges that "Patriot has refused to issue shares and forward the stock certificates to Korodi...." First Amended Counterclaim ¶ 19.

Patriot initially brought a complaint for declaratory relief against Korodi. Korodi then brought a counterclaim against Patriot and third-party complaint against Pohl for (1) breach of oral contract; (2) breach of written contract; (3) breach of the implied covenant of good faith and fair dealing; (4) negligence; (5) fraud/intentional misrepresentation; (6) negligent misrepresentation; (7) constructive fraud; and (8) promissory estoppel in which Korodi seeks both damages and specific performance. These claims are the subject of defendants' motion to dismiss.

III. Analysis

Legal Standard for Motion to Dismiss

In ruling on a motion to dismiss for failure to state a claim, a complaint is construed in the plaintiffs favor, generally taking as true all material facts alleged in the complaint. Rosen v. Walters, 719 F.2d 1422, 1424 (9th Cir.1983). "A complaint should not be dismissed unless it appears beyond doubt that the plaintiff can prove no set of facts in support of the claim that would entitle the plaintiff to relief." American Family Ass'n, Inc. v. City and County of San Francisco, 277 F.3d 1114, 1120 (9th Cir.2002).

"Generally, a district court may not consider any material beyond the pleadings in ruling on a Rule 12(b)(6) motion." Hal Roach Studios, Inc. v. Richard Feiner and Co., Inc., 896 F.2d 1542, 1555 n. 19 (9th Cir.1989). "However, material which is properly submitted as part of the complaint may be considered." Id.; see also Branch v. Tunnell, 14 F.3d 449, 453 (9th Cir.1994), overruled on other grounds by 307 F.3d 1119 (9th Cir.2002).

Choice of Law

A federal district court in a diversity case applies the choice of law rules of the state in which the court is located. Downing v. Abercrombie & Fitch, 265 F.3d 994, 1005 (9th Cir.2001). Thus, the court looks to California's choice of law rules. California applies the governmental interest approach to choice of law issues. Under this approach, "the forum must search to find the proper law to apply based upon the interests of the litigants and the involved states." Stonewall Surplus Lines Ins. Co. v. Johnson Controls, Inc., 14 Cal.App.4th 637, 645, 17 Cal. Rptr.2d 713 (1993). The "`relevant contacts' stressed by the Restatement Second of Conflict of Laws are not disregarded, but are examined in connection with the analysis of the interest of the involved state in the issues, the character of the contract and the relevant purposes of the contract law under consideration." Id. "The forum must consider all the foreign and domestic elements and interests involved in the case to determine the applicable rule." Id.

As explained in Stonewall Surplus Lines:

The relevant contacts to be considered in a dispute over the validity of a contract or the rights thereunder are set forth in section 188, subdivision (2) of the Restatement Second of Conflict of Laws: "(a) the place of contracting, (b) the place of negotiation of the contract, (c) the place of performance, (d) the location of the subject matter of the contract, and (e) the domicile, residence, nationality, place of incorporation and place of business of the parties. These contacts are to be evaluated according to their relative importance with respect to the particular issue."

Id.

Having considered the interests of the litigants and the involved states, the court concludes that, with one exception, California substantive law should be applied. The exception is that under the California choice of law principle known as the "internal affairs doctrine," this court must look to the law of the state of incorporation with respect to matters involving the regulation of Patriot's "internal affairs." See State Farm Mut. Auto. Ins. Co. v. Superior Court, 114 Cal.App.4th 434, 8 Cal.Rptr.3d 56 (2003). As the California Court of Appeal has explained:

"Internal affairs" include "steps taken in the course of the original incorporation, ... the adoption of by-laws, the issuance of corporate shares, the holding of directors' and shareholders' meetings, ... the declaration and payment of dividends and other distributions, charter amendments, mergers, consolidations, and reorganizations, the reclassification of shares and the purchase and redemption by the corporation of outstanding shares of its own stock."

Id. at 442, 8 Cal.Rptr.3d 56 (2003) (quoting In re Harnischfeger Industries, Inc. 293 B.R. 650, 662 (Bkrtcy.D.Del.2003)) (emphasis added).

Although Count 1 is a breach of contract claim, to the extent that defendants defend against this claim on the ground that Patriot cannot be forced to comply with an oral promise to issue corporate shares which was not in writing and approved by Patriot's board of directors, the internal affairs doctrine applies and dictates the application of Delaware substantive law.² See State Farm, 114 Cal.App.4th at 446-47, 8 Cal.Rptr.3d 56 (applying internal affairs doctrine where plaintiffs brought claims for breach of contract and breach of the covenant of good faith and fair dealing based on allegations that the company's board of directors did not pay dividends as promised).

In an attempt to escape application of the internal affairs doctrine, Korodi contends that Patriot's board of directors has, in written Stock Options Plans, chosen California law to govern the issuance of its stock options. However, those Stock Option Plans are not before the court and would not be properly considered on a motion to dismiss. And, more importantly, the issue here is not what law applies to the issuance of stock options pursuant to written Stock Options Plans containing a choice of law provision but, rather, what law should be applied to an alleged oral promise by Patriot to issue stock options to Korodi. What the board has decided to do with respect to the issuance of stock options to others in a written stock option plan is not relevant here.

Count 1: Breach of Oral Contract

Korodi alleges that "[o]n or about August 1, 2005, Korodi and Patriot, by and through Pohl, ... entered into an oral agreement in which Korodi promised and agreed to provide consulting services in exchange for monthly payments of $5,000, reimbursement of all expenses incurred, and participation in Patriot's stock option program." Counterclaim ¶ 21. Korodi goes on to allege that Patriot breached the terms of this agreement and that this breach "includes, but is not limited to, Patriot's failure and/or refusal to issue stock to Korodi and honor the option to purchase 400,000 shares." Counterclaim ¶ 22. Importantly, although perhaps ¶ 22 could be interpreted as alleging that Patriot — in August of 2005 — promised Korodi 400,000 shares of stock, as Korodi's counsel has subsequently admitted, the alleged August 2005 promise was of an unspecified number of shares. See Transcript at 18:3-12. Korodi's Response to Court's Order Requiring Additional Briefing at 3:9-12 (admitting that "the exact number" of shares and strike price were not specified at the time the parties entered into the oral employment agreement").³ Patriot seeks to dismiss this claim on the ground that Patriot's board of directors did not approve the, issuance of stock options to Korodi, as Korodi admits in his First Amended Counterclaim at paragraphs 49(c) and 71.

As discussed supra, in resolving the motion to dismiss this claim, Delaware law applies. Delaware Code § 157(a) provides that "[s]ubject to any provisions in the certificate of incorporation, every corporation may create and issue, whether or not in connection with the issue and sale of any shares of stock or other securities of the corporation, rights or options entitling the holders thereof to acquire from the corporation any shares of its capital stock of any class or classes, such rights or options to be evidenced by or in such instrument or instruments as shall be approved by the board of directors." 8 Del. Code § 157(a) (emphasis added). In ...