In-House Counsel's Negligence is not Imputed to Company
Companies and their in-house attorneys were given an amazing gift by the California Court of Appeal this week.
The case in question arose from an innocent little wage claim. Maria Gutierrez was a cashier at a gas station owned by G&M Oil Company. She sued G&M, claiming that the company had failed to provide workers with meal breaks or to compensate them for the time they would spend counting out their registers at the end of a shift.
G&M was represented by Michael Gray, who was both the family-owned company's Vice President and General Counsel, as well as the son of the company's CFO. According to the court's opinion, the trial court entered a $4 million default judgment against G&M after Gray failed to defend the action. Not surprisingly, G&M removed Gray and brought in outside counsel to challenge the huge judgment with a motion to vacate.
The motion to vacate presented some interesting issues. Under Code of Civil Procedure § 473, a court "shall" grant a motion to vacate if the attorney screws up, and is willing to sign what is referred to as a "mea culpa" declaration, admitting his or her mistake, and begging that it not be imputed to the client. But here, since Gray was the Vice President of the company, he in essence was the client, so the mea culpa declaration was basically saying, "don't hold me responsible for what I chose to do." Unlike an innocent client who did not know that his attorney was dropping the ball, shouldn't a company be held to the decisions of its attorney when that attorney is part of the company? The trial court did not think so, and ruled that an attorney is an attorney, whether in-house or not. The trial court granted the motion to vacate, threw out the default judgment and put the matter back on the trial calendar.
Labor claims are typically handled on a contingency basis, often for one-third of any amount recovered, and the Labor Codes provide for recovery of all attorney fees, so you can imagine how crestfallen plaintiff's counsel was when the court threw out what may have been a more than $1.4 million pay day. The ruling on the motion to vacate was appealed.
The Court of Appeal sided with G&M, and upheld the trial court's decision to vacate the judgment. The court was willing to view Gray as wearing two hats. Yes, he was an officer of the company, but for purposes of the litigation he was acting as the company's general counsel, and not as an officer.
Was the ruling by the Court of Appeal correct? Often bad facts make bad law. The specter of a four million dollar default judgment, combined with the fact that, according to the decision, Gray had kept the action a secret from the rest of the company officers, meant that the trial court and then the court of appeal were both going to look for a way to provide relief. Further, there is a very strong public policy that matters should be decided on the merits, and not on technicalities. Therefore, the case was probably decided correctly, but there was a wrinkle that may have eluded the Court of Appeal.
I have defeated motions to vacate in the past by showing the court that the attorney in question is not providing a true mea culpa declaration. The attorney must ask for relief based on a mistake, not on a failed litigation strategy. In one case, I sued a company but the attorney for the company decided the matter was subject to an arbitration provision and simply refused to participate in the litigation. Just as in this case, after I obtained the substantial default judgment, the company brought in new counsel and filed a motion to vacate using the former attorney's mea culpa declaration. However, I defeated the motion by persuading the court that the attorney was not admitting to any mistake, but rather was continuing to argue that the matter had to be submitted to arbitration. The court agreed that an attorney cannot try one strategy, and if it fails, file a mea culpa declaration and go to plan B.
With this week's ruling by the Court of Appeal, companies with in-house counsel could try that approach. An individual defendant who knows about an action and simply decides to ignore it will not be granted relief on a motion to vacate, because there has been no mistake or inadvertence – the party just chose to ignore the action. Gray, the Vice President of G&M, attended two status conferences in the matter, and for whatever reason elected not to pursue a defense. Why is G&M getting a pass from that decision, when an individual defendant would not?
The mea culpa declaration approach of section 473 is self-policing in the sense that an attorney will not file a mea culpa declaration unless there has been a real mistake, because he or she is basically admitting to malpractice. With in-house counsel, especially where the counsel is an officer, the corporation could simply instruct the attorney to file the mea culpa declaration, whether or not the attorney agrees there was a mistake, since the attorney will know he is not exposing himself to a malpractice claim.
The Court of Appeal's ruling can be found here.
When Trademark Infringement Isn't
In what has caused some concern in certain sections of the legal community1, on November 5, 2008 the 9th Circuit Court of Appeals set forth another ruling on how to assess whether 1st Amendment protection is afforded to what is otherwise trademark infringement.2 Beginning in 1997 the 9th Circuit adopted a likelihood of confusion test in making the determination in a case that involved use of Dr. Seuss trademarks in a parody of O.J. Simpson.3 Five years later in Mattel v. MCA Records4 the Court was faced with a uniquely different set of facts, and ruled that use of the "Barbie" trademark for the catchy song "Barbie Girl" was constitutionally protected because the expressive interest in commenting on Barbie outweighed any likelihood of confusion posed by the use of the trademark.5
Finally, in E.S.S. Entertainment 2000 Inc. v. Rockstar Videos Inc.6 the Court held that use of trademarks in an expressive work is permissible unless it has no artistic relevance to the underlying work or the use explicitly misleads as to the source or content of a work. Dr. Seuss and its progeny have led to the obvious question: What test applies? In an abundance of caution, all three approaches must be considered. Although E.S.S. proceeded Mattel and Dr. Seuss, it would not be unlogical to apply the various tests in a staggered approach similar to the following.
First, parties would like to address the extent to which use of the trademark bears artistic relevance to the source. As highlighted by Mr. Lee of the L.A. Daily Journal, considering that in E.S.S. the issue revolved around the use of a strip club’s trademarked name in the video game Grand Theft Auto for no apparent purpose other than to make a reference to it, this prong should be easily satisfied.7
The second issue to be argued would be the extent to which use of trademark by the proponent causes a likelihood of confusion, followed by a balancing of the two competing issues in a manner consistent with Mattel. This approach, though simple and redundant, would ensure that the parties duly consider all major aspects of each of the 9th Circuit’s rulings, leaving them prepared for the certain scrutiny they will face from the Court.
1. Mark S. Lee, The 9th Circuit’s Doublespeak, L.A. Daily Journal 5 (Dec. 2, 2008).
2. See E.S.S. Entertainment 2000 Inc. v. Rock Star Videos Inc., 2008 WL4791705 (9th Cir. Nov. 5, 2008).
3. Dr. Seuss Enterprises, LP v. Penguin Books USA Inc., 109 F.3d 1394 (9th Cir. 1997).
4. 296 F.3d 894 (9th Cir. 2002).
5. Id.
6. E.S.S., Supra, n. 2.
7. Lee, Supra, n. 1 at ¶10.
Small Businesses At Risk of Being Liable for Their LLC's Debts & Obligations
I just scored a big victory on behalf of a client in Los Angeles Superior Court, and it reminded me to remind you of the importance of observing business formalities with your corporations and LLCs.
In the late 90s, my client had loaned about $200,000 to an acquaintance (we’ll call her Lauren), for use in a business Lauren was forming with a business partner. Lauren and her partner took the money and formed an LLC, but never paid back a dime of the loan. Of course, to keep the matter challenging for me, the loan agreement was entirely verbal. Thus, I not only had to prove an oral agreement, I had to deal with the statute of limitation problem from this decade old debt.
The LLC was defunct, so a judgment against that entity would have been worthless. In any event, it had always been my client’s understanding that these were personal loans to the individuals, not to the company.
I tried the case to a jury, and I called the defendants as my first witnesses, even before my own client, because I anticipated that they would acknowledge the debt (and thereby avoid all those problems of proving the oral agreement), but would try to push it off to the LLC. They testified as expected, and I was then able to show through the testimony of my client why the debts that they had just admitted to were in reality personal debts. The total judgment awarded by the jury and court exceeded a million dollars.
The Defendants, in their minds, may well have intended that the debts be company debts, but they did not observe the necessary formalities. They may have thought they hit the jackpot when they found someone willing to loan them $200,000 with no documentation, but that contributed to their own downfall. If these had been real company debts, then we would expect to see the usual formalities such as promissory notes issued by the company, and company minutes reflecting the terms of the loans. Most LLCs operate in a small business fashion and as a result run a high risk of inadvertently losing their liability shield under what is known as the Alter Ego Doctrine. The Alter Ego Doctrine is generally based on the idea that the member(s) of the LLC have acted as one and the same in a manner that works a fraud or injustice on another, and therefore should share the same liabilities. In determining whether the individual members are personally liable for the debts and obligations of the LLC under this doctrine the courts consider several factors, the most significant of which is failure to follow organizational formalities.
A failure to follow formalities has been seen to include improperly organizing an LLC, not timely filing required forms or paying required fees and taxes, not having a continuous presence in the home state, and not having a designated agent to receive legal documents. There are a few specific activities that commonly cause problems under the "failure to follow organizational formalities" factor: (1) Commingling of Assets; and (2) Failing to Keep Company Records.
A simple and common example of commingling and failing to keep records is where a member uses LLC funds or assets for personal use without documenting the transaction, and with no proof of authorization under the LLC’s articles. The lack of any formal procedure in the expenditure will make plain to any deciding judge that the LLC was no more than a name, and at all times the member and the business were one and the same entity.
These issues are of particular concern for the small business oriented LLC because they tend to operate on more limited budgets, have less management personnel, and, as a result of the primary focus being profits, generally have less time to ensure the LLC is complying with nuanced and complicated business laws. While the best answer to avoid the above mentioned pitfalls is of course what the small business person would most love to avoid, the high risk of inadvertently putting all personal assets at stake requires that they bite the bullet and consult with a business planning attorney. While doing so may serve a frustrating cost, it must be remembered that the above mentioned concerns are only a few of the many an LLC member must be wary of. In the end, the business person’s choice on whether to forgo professional consultation will most likely make the difference between walking away from any future financial disaster, or bringing it home.
Dude, Who's My Plaintiff? -- Courts Allow Anonymous Plaintiffs
On August 12, 2008, the Second District U.S. Court of Appeals reaffirmed the national and local trend toward recognizing a litigant’s right to proceed anonymously through the courts. In order to sue under a pseudonym, plaintiff’s generally must show that the need for confidentiality outweighs the public’s right to know and any prejudice suffered by defendant due to the secretive pleading. While not necessarily a light burden for plaintiffs, the real strain of the increasingly minted right is on defendants.
Depending on the context of the suit, major public out-lashes could be directed at defendants helpless to stop the tide. For instance, defendants sued civilly (publicly) for sexual abuse stand to lose much in the way of reputation, and eventually income, no doubt due in large part to the public’s natural inclination to distance themselves from what might be a perpetrator. While public scrutiny of the would be victim once would serve as a blow-off valve to some extent, now defendants are not only left to deal with an unrelenting public reaction, but will dually reap heightened scrutiny for the same allegations as plaintiffs who have convinced the court of the need for confidentiality will have generally shown that they would face unwarranted injury should their identities be disclosed. In other words, defendants will have no way to call public attention to a plaintiff’s credibility, and the public will be informed, or may very well assume, that defendants or their associates had posed a threat to the plaintiff prior to or during the litigation.
Defendants’ aggressive depiction of all factors assessed by courts of their jurisdiction in deciding whether or not to permit plaintiffs to act incognito is the only recourse afforded to diminish the risk of anonymous lawsuits. Particularly, considering the public has a well established right to know who is using the court system, focusing on the lack of need to preserve a plaintiff’s identity and the severe damage that could be inflicted on a defendant’s personal and/or professional reputations as a result of the anonymous lawsuit would be key. Also, seeking an anonymous designation as a defendant may also assist in preventing unfair prejudice. Ultimately, regardless of a defendant’s choice of tactics the courts have once again increased the need to vigorously litigate cases at the earliest of stages, which requires a heightened state of readiness, and can make litigation all the more daunting.
1. Sealed Plaintiff v. Sealed Defendants, Docket No. 06-1590-cv, (Dist. 2d, 2008)
2. Id. at 7-8.
