Vega v. Jones, Day, Reavis & Pogue

• Decision Date: 02 August 2004
• Docket Number: No. B170659.,B170659.
• Citation: 121 Cal.App.4th 282,17 Cal.Rptr.3d 26
• Court: California Court of Appeals Court of Appeals
• Parties: Frank T. VEGA, Plaintiff and Appellant, v. JONES, DAY, REAVIS & POGUE, Defendant and Respondent.

17 Cal.Rptr.3d 26

121 Cal.App.4th 282

Frank T. VEGA, Plaintiff and Appellant, v. JONES, DAY, REAVIS & POGUE, Defendant and Respondent.

No. B170659.

Court of Appeal, Second District, Division 8.

August 2, 2004.

Rehearing Denied August 30, 2004.

Review Denied October 27, 2004.^*

Manuel R. Ramos, Lo Jolla, for Plaintiff and Appellant.

Gibson, Dunn & Crutcher, James P. Fogelman, Joel M. Tantalo and Sarah R. Long, Los Angeles, for Defendant and Respondent.

BOLAND, J.

SUMMARY

A shareholder in a company acquired in a merger transaction sued the law firm which represented the acquiring company for fraud. He alleged the law firm concealed the so-called toxic terms of a third party financing transaction, and thus defrauded him into exchanging his valuable stock in the acquired company for "toxic" stock in the acquiring company. The law firm demurred. It contended it made no affirmative misstatements and had no duty to disclose the terms of the third party investment to an adverse party in the merger transaction. We conclude the complaint stated a fraud claim based on nondisclosure. The complaint alleged the law firm, while expressly undertaking to disclose the financing transaction, provided disclosure schedules that did not include material terms of the transaction.

FACTUAL AND PROCEDURAL BACKGROUND

Frank T. Vega (Vega), a 23 percent shareholder in a company known as Monsterbook.com, sued Jones, Day, Reavis & Pogue (Jones Day), a law partnership, for fraud and negligent misrepresentation in connection with a merger transaction. In the merger transaction, Jones Day represented Transmedia Asia Pacific, Inc., which acquired Monsterbook. Monsterbook and Vega were represented by the law firm of Heller, Ehrman, White & McAuliffe (Heller Ehrman).

The terms of the acquisition included Vega's receipt of restricted stock in Transmedia in exchange for his interest in Monsterbook. Monsterbook and Vega accepted the merger offer on March 8, 2000. Closing occurred on April 13, 2000, when the two companies exchanged stock based on a $15 million valuation of Monsterbook. Vega thus exchanged stock valued at $3.45 million for the restricted Transmedia stock.

During the weeks between Vega's acceptance of the merger offer on March 8 and the closing on April 13, Transmedia, which "[e]verybody knew . . . was an iffy company," sought and secured $10 million in investment financing from a third party.¹ The terms of Transmedia's $10 million third party financing transaction included so-called toxic stock provisions, under which the investors received convertible preferred stock that seriously diluted the shares of all other Transmedia stockholders. Both Transmedia and Jones Day knew that "toxic" stock financing is a "desperate and last resort of financing for a struggling company" and that 95 percent of companies who engage in such financing end up in bankruptcy.

Jones Day prepared a two-page disclosure schedule that clearly described and properly disclosed the "toxic" provisions of the $10 million investment, but did not send the disclosure to Vega, Monsterbook or Heller Ehrman. Jones Day knew that a full disclosure of the "toxic" terms of the financing would have "killed the acquisition," without which Transmedia would not have obtained the financing and would have gone out of business. Instead, Vega, Monsterbook and Heller Ehrman were told, on about March 16, 2000, that the $10 million financing then being negotiated was "standard" and "nothing unusual" and that Jones Day and Transmedia would supply additional documents to support these characterizations of the financing.² No documents showing the "toxic" nature of the investment were provided; instead, Jones Day supplied Heller Ehrman with "a different sanitized version" of the disclosure schedule which did not include the "toxic" stock provisions.

Jones Day also prepared, and Transmedia sent to Monsterbook and Vega, a consent form concerning the $10 million investment, which Vega signed. The consent form stated that the $10 million investment would be convertible into an aggregate maximum of 6,815,000 shares of common stock, "thus misrepresenting that it fell within the 20% dilution `toxic' cap mandated by NASD Rule 4350(i)(1)(D)." On March 28, 2000, two weeks before the closing of Transmedia's acquisition of Monsterbook, Jones Day filed a "Certificate of Designation" with the Delaware Secretary of State, certifying the creation of the convertible preferred stock. This document, available to the public, contained all the terms of the financing, including the "toxic" provisions.

The closing of the Monsterbook acquisition occurred on April 13, 2000. Eight months later, on December 14, 2000, Vega learned for the first time through a press release issued by Transmedia, about the "toxic" stock provision of the $10 million financing. Several legal actions ensued.

First, on October 2, 2001, Monsterbook's former majority shareholder, William H. McKee, who had owned 70.125 percent of Monsterbook's stock, sued Heller Ehrman for legal malpractice. In a first amended complaint on November 21, 2001, McKee and a second shareholder, Paul R. Estrada, who had held a 1.486 percent interest in Monsterbook, also named Transmedia and Jones Day as defendants, alleging causes of action for fraud and negligent misrepresentation.

Second, on December 14, 2001, another shareholder, John Cuero, who had held a 2 percent interest in Monsterbook, sued Heller Ehrman, Jones Day, and Transmedia. This suit was consolidated with McKee's lawsuit. In the consolidated actions, Jones Day sought and obtained summary judgment, and judgment was entered in its favor on August 23, 2002.³ Estrada waived his right to appeal; McKee abandoned his appeal; and Cuero's appeal was dismissed at his request.

Third, on May 12, 2003, Vega filed this lawsuit against Jones Day and Transmedia, and Jones Day demurred.⁴ The demurrer to the fraud claim was sustained, without leave to amend, on multiple grounds, as follows:

♦ The claim did not allege an actionable, affirmative misstatement by Jones Day;

♦ Vega could not justifiably have relied on the statements allegedly made by Jones Day;

♦ Because Jones Day owed Vega no duty to disclose, Vega could not state a claim based on omission or nondisclosure ♦ Vega did not allege damages proximately caused by Jones Day;

♦ Vega had no standing to bring the claim because it was derivative in nature;

♦ The claim was barred by the statute of limitations; and

♦ The claim was barred by res judicata.

Jones Day's demurrer to the negligent misrepresentation claim was sustained on the same grounds and, in addition, because a negligent misrepresentation claim cannot be based on an omission or nondisclosure. The court also concluded Vega failed to plead both causes of action with the requisite specificity.

The trial court's order sustaining the demurrers and dismissing Vega's complaint with prejudice was filed August 5, 2003, and this appeal followed.⁵

DISCUSSION

Vega's allegations may be summarized as follows. Jones Day hid the existence of the "toxic" stock provisions with the intent to induce Vega to give up his valuable stock in Monsterbook in exchange for Transmedia's "toxic" and worthless stock. Jones Day knew about the "toxic" stock provisions, and knew the acquisition would not occur if Monsterbook, Vega and their lawyers discovered them. Jones Day deliberately concealed the "toxic" stock provisions by telling Heller Ehrman the transaction was "standard" and "nothing unusual," by failing to provide the proper written disclosure it prepared, and by instead providing a different, sanitized version of the disclosure. Vega did not know, and had no reason to suspect, that the financing contained "toxic" provisions, and would not have given up his valuable stock in Monsterbook had he known. As a result of Jones Day's concealment of the "toxic" terms of the financing, Vega lost his $3.45 million interest in Monsterbook.

We agree with Vega that the complaint properly states a fraud claim.

Before we analyze the elements of the claim, we note the governing legal principles. A fraud claim against a lawyer is no different from a fraud claim against anyone else. "`If an attorney commits actual fraud in his dealings with a third party, the fact he did so in the capacity of attorney for a client does not relieve him of liability.'" (Shafer v. Berger, Kahn, Shafton, Moss, Figler, Simon & Gladstone (2003) 107 Cal.App.4th 54, 69, 131 Cal. Rptr.2d 777 (Shafer), quoting Jackson v. Rogers & Wells (1989) 210 Cal.App.3d 336, 345, 258 Cal.Rptr. 454.) While an attorney's professional duty of care extends only to his own client and intended beneficiaries of his legal work, the limitations on liability for negligence do not apply to liability for fraud. (Ibid.) Accordingly, a lawyer communicating on behalf of a client with a nonclient may not knowingly make a false statement of material fact to the nonclient (Shafer, supra, 107 Cal.App.4th at p. 69, 131 Cal.Rptr.2d 777), and may be liable to a nonclient for fraudulent statements made during business negotiations. (Cicone v. URS Corp. (1986) 183 Cal. App.3d 194, 202, 227 Cal.Rptr. 887 ["the case law is clear that a duty is owed by an attorney not to defraud another, even if that other is an attorney negotiating at arm's length"].)

With these principles in mind, we turn to the elements of fraud, which are: "(1) representation; (2) falsity; (3) knowledge of falsity; (4) intent to deceive; and (5) reliance and resulting damage (causation)." (5 Witkin, Cal. Procedure (4th ed. 1997) Pleading, § 668, p. 123.) Active concealment or suppression of facts by a nonfiduciary "is the equivalent of a false representation, i.e., actual fraud." (Id., § 678, p. 136, italics omitted.) We treat the various elements, and the bases for the trial court's decision, in turn.

1. False representation.

We agree with Jones Day that a mere statement that the $10 million financing...