Business Disputes Arising from Fraudulent Diversion of Assets May Now Result in Treble Damages and Attorney’s Fees, If There Is Criminal Intent 

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Clifford R. Horner, Esq.

Absent contractual agreements or extraordinary conduct, commercial litigation is ordinarily limited to pocketbook damages. This is because, under the “American Rule,” each party to a civil action—win or lose—pays for its own attorney’s fees, unless otherwise provided for by contract. Similarly, ordinarily, “punitive” damages are rarely awarded, and only when proven by the heightened evidentiary standard of clear and convincing evidence (as opposed to the compensatory more-likely-than not preponderance of the evidence standard) that a defendant engaged in conduct amounting to malice, oppression, or fraud.


However, last year, the California Supreme Court resolved a jurisdictional split and provided civil plaintiffs involved in business disputes with a clear path to recover treble damages and attorney’s fees against certain defendants involved in fraudulent conversion of cash, assets, or other property.


Summary:


In Siry Investment, L.P. v. Farkhondehpour (July, 2022) 13 Cal.5th 333, a limited partnership formed to renovate and lease a commercial building. The general partner and three other limited partners created a separate entity named DTLA and required the tenants to pay rent to DTLA which was to then be transferred to the limited partnership. However, some but not all of the rental income was paid into the limited partnership while certain amounts remained in DTLA, and certain defendant partners also charged personal, non-partnership expenses to the partnership. The Court determined “[t]he net effect of these actions was to . . . underpay plaintiff its cash distributions . . . and ensured that plaintiff remained unaware of the underpayments by misrepresenting to the plaintiff the building’s rental income and the partnership’s expenses, effectively lying to plaintiff about what its cash distributions should have been.”


The plaintiff brought suit, and in addition to ordinary compensatory damages, the plaintiff also sought damages pursuant to section 496, subdivision (c) of the Penal Code, which allows the recovery of three times the amount of actual damages sustained by the plaintiff, costs of suit, and reasonable attorney’s fees, as a proximate result of a defendant having committed the “criminal offense of what is commonly referred to as receiving stolen property”, as set forth pursuant to section 496(a).


Recognizing that section 496(c) articulates a right to special civil remedies upon violation of section 496(a), the Supreme Court declined to follow the line of published California decisions declining to award civil plaintiffs with the extraordinary Penal Code damages to a plaintiff merely alleging fraud, misrepresentation, conversion, breach of fiduciary duty or some other type of theft that does not involve stolen “property.” Instead, the Supreme Court construed the plain language meaning of the statute’s use of the term “any property that has been stolen or that has been obtained in any manner constituting theft” to conclude that the statute’s plain unambiguous relevant language permits a plaintiff to recover treble damages and attorney’s fees under section 496(c) when property has been obtained in any manner constituting theft, including the fraudulent diversion of partnership funds before the Court.


Noting that the “history shows the Legislature believed the deterrent effect of criminal sanctions was not enough to reduce thefts,” the Court agreed that “a criminal conviction is not a prerequisite to recovery of treble damages under section 496(c).” However, in so concluding, the Court observed that not all commercial theft-related tort disputes will amount to “theft.” Rather, to prove theft and be entitled to the heightened Penal Code damages, a plaintiff must establish criminal intent on the part of the defendant beyond “mere proof of nonperformance or actual falsity.”


Take Away:


The Court’s holding has two major implications:


First, limited partners seeking to bring an action for diversion of partnership assets now have precedent to rely upon to recover, in addition to the other normally recoverable compensatory damages, three times the amount of said compensatory damages without needing to meet the burden of clear and convincing evidence as normally required to obtain punitive damages, as well as to recover attorney’s fees regardless of whether or not there is an applicable contractual provision.


Second, plaintiffs involved in other commercial disputes may also be able to recover treble damages and attorney’s fees if they plead and prove the requisite criminal intent under this section of the Penal Code. The implications are equally as strong for defendants: The stronger the basis of any fraud claim, the greater the risk.


By: Clifford R. Horner, Esq.

Daniel Boord, Esq.

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