BEDSWORTH, ACTING P. J.
Appellant Frank D'Errico and respondent Robert Hall formed RHFD Pebble, Inc. (Pebble), in 2004 to make money in real estate. They had found a beautiful lot in Newport Beach on which to build a custom home, one they could sell for several million dollars. The real estate market was booming. What could go wrong?
Needless to say, plenty went wrong, and Hall sued D'Errico for fraud, breach of contract, breach of fiduciary duty, and racketeering. After a bench trial, the court found that Hall had not met his burden of proof on any of his claims against D'Errico except for one — breach of fiduciary duty. The court found that D'Errico had misappropriated Hall's capital investment in Pebble. The court awarded damages to Hall of the amount of his investment plus interest running from the date in 2006 when he had put the money into Pebble.
We reverse. The court erred in two respects. First, the money D'Errico "misappropriated" was not Hall's money; it was most likely Pebble's. If any damages are due, they are due to Pebble, not to Hall, and any action to recover them would have to be a derivative action, which Hall could not maintain. Second, the court penalized D'Errico for doing something he was entitled to do — pay down loans he had made to the corporation. This is not a breach of D'Errico's fiduciary duty either to Pebble or to Hall. Because this breach of fiduciary duty was the sole basis of D'Errico's liability to Hall, judgment should have been entered for D'Errico on all claims.
Hall and D'Errico formed Pebble in May 2004 to purchase a lot on Pebble Drive in Newport Beach and build a custom home on it.
D'Errico lent Pebble $2.3 million to buy the property on Pebble Drive, which was taken in the corporate name.
D'Errico required Hall to put some money into Pebble as well, and Hall agreed to make this investment. This demand was satisfied by a convoluted transaction involving Hall's live-in girlfriend, Launa Schump. Schump signed a note in favor of D'Errico (not Pebble) for $650,000 in September 2004. The note was secured by a deed of trust on real property held in Schump's name. Schump then sold the property and turned $650,000 of the proceeds over to D'Errico.
Hall badly wanted to build the house on Pebble Drive; it was to be his "dream house." The plans were drawn up and started their tortuous 18-month journey through the local homeowners' association and the City of Newport Beach's planning department. The property was listed for sale for $5 million. In January 2006, a buyer for the lot and the plans came forward — Allan Reumont. Reumont bought the property for $4.2 million. Because one of the conditions for close of escrow was city approval of the building plans, escrow did not close until late July or early August 2006. D'Errico also agreed to lend Reumont $3.2 million for construction.
In early 2006, Hall and D'Errico began discussing three other houses on Isle Vista Street in Costa Mesa, which they planned to buy, remodel, and sell. Although there was extensive testimony about these three projects at trial, they figure into the appeal only tangentially. Hall and D'Errico ultimately did buy the properties, and Hall began to remodel them. The properties were not held in Pebble, and Hall and D'Errico operated under a partnership or joint venture with respect to them.
Hall and D'Errico had a falling out in June 2007, and they decided to part company.
Hall sued D'Errico in May 2008 for breach of contract, fraud, breach of fiduciary duties, unjust enrichment, RICO violations, common counts, accounting and declaratory relief. Pebble was a nominal defendant. The matter was tried to the court over 16 days in June and July 2009. Hall's counsel dismissed the claims for common counts, accounting, and unjust enrichment. The court rendered its decision on the remaining claims on July 7, 2009.
The court found Hall had not met his burden of proof with respect to the remaining causes of action except for breach of fiduciary duty.
Hall has not appealed the adverse rulings against him. D'Errico has appealed from the judgment of $650,000 for breach of fiduciary duty.
The issues to be resolved on this appeal are legal issues. The facts upon which the trial court based its ruling are not in dispute. The application of a rule of law to the facts where the focus is predominantly legal calls for independent review. (Haworth v. Superior Court (2010) 50 Cal.4th 372, 384-385.)
Although Hall alleged several instances of breach of fiduciary duty, the trial court found in his favor on very narrow grounds — one instance of self-dealing involving Hall's $650,000 capital contribution. Accordingly we must inspect that transaction.
Before we do so, however, it may be useful to go over some elementary principles of corporation law. A corporation is a separate legal entity, capable of owning property and transacting business in its own right. The shareholders do not own the corporation's property or its earnings. (Miller v. McColgan (1941) 17 Cal.2d 432, 436; Nelson v. Anderson (1999) 72 Cal.App.4th 111, 126.) They own stock; they obtain money from the corporation through dividends, while the corporation is operational, and upon liquidation of the corporation. (Sole Energy Co. v. Petrominerals, Corp. (2005) 128 Cal.App.4th 212, 229; Miller v. McColgan, supra, 17 Cal.2d at p. 436.)
The corporation's directors and officers have a fiduciary duty to act in good faith in the best interests of the corporation and its shareholders. (Oakland Raiders v. National Football League (2005) 131 Cal.App.4th 621, 632; Corp. Code, § 309, subd. (a).) Directors and officers do not have fiduciary duties to each other. (United States Liab. Ins. Co. v. Haidinger-Hayes, Inc. (1970) 1 Cal.3d 586, 595.) Majority or controlling shareholders have a fiduciary duty to minority shareholders. (Oakland Raiders v. National Football League, supra, 131 Cal.App.4th at p. 632.) Equal shareholders, however, do not have fiduciary duties to each other. (Shum v. Intel Corp. (N.D.Cal, Sept. 26, 2008, No. C-02-03262-DLJ) 2008 U.S. Dist. Lexis 83005 *13 [applying California law]; Miles, Inc. v. Scripps Clinic & Research Found. (S.D. Cal. 1993) 810 F.Supp. 1091, 1099 [same]; Persson v. Smart Inventions, Inc. (2005) 125 Cal.App.4th 1141, 1156-1159.)
The trial court found that D'Errico had taken $650,000 and "put it in his pocket." But whose money was it? There are two possible answers to this question, depending on how the evidence is viewed. The first answer is Schump's money.
The second, and more sensible, answer is Pebble's money. Everyone agrees that, however the transaction was structured, the intent was to invest this money in Pebble on Hall's behalf. This is evidently what happened. Hall's capital account was credited with $555,000 (the balance after repayment of his $95,000 advance), and the corporate debt was reduced accordingly. D'Errico's capital account was credited with $650,000, and the corporate debt was again reduced in the same amount. At least two informal accountings, each signed by Hall, show this, and the corporation's tax return for 2005 shows corresponding "additional paid in capital."
If D'Errico was self-dealing — as the court found — the corporation was damaged, not Hall directly or individually. It was the corporation's money, not Hall's, that D'Errico "put in his pocket." (See Avikian v. WTC Financial Corp. (2002) 98 Cal.App.4th 1108, 1115-1116; PacLink Communications Internat., Inc. v. Superior Court (2001) 90 Cal.App.4th 958, 964.)
A claim of injury to a corporation must be brought on the corporation's behalf, not on the behalf of an individual stockholder. Taking the corporation's money is a classic instance of injury to the corporation. (See, e.g., Anderson v. Derrick (1934) 220 Cal. 770, 772-774.) Hall was obliged to proceed by way of a derivative action for a breach of fiduciary duty of this nature. (See Nelson v. Anderson, supra, 72 Cal.App.4th at pp. 125-126 [loss of stockholder's capital investment injury to corporation].)
Did D'Errico engage in self-dealing when he paid his loan down? Did he breach his duty as a Pebble director or officer to Pebble or to Hall as a Pebble stockholder?
No evidence was produced at trial showing that D'Errico simply wrote himself a check on Pebble's bank account for $650,000. The uncontradicted evidence showed instead that he reduced the corporate debt by $550,000 to account for Hall's net investment and by another $650,000 to equalize his capital account with Hall's. At the beginning of January 2006, Pebble owed D'Errico nearly $2.8 million. After the two capital investments, Pebble owed D'Errico a little less than $1.6 million.
This is not self-dealing or a breach of fiduciary duty. A director may deal with the corporation on his or her own behalf if the transaction is fair and fully disclosed and approved. (Corp. Code, § 310, subd. (a).) Hall, the sole other director, officer, and shareholder, certainly knew that D'Errico was lending money to Pebble and expected to be paid back, with interest. This was Pebble's source of funds to purchase the lot and build the dream house. Hall also signed documents showing the increase in his capital account and the reduction in debt occasioned by his investment.
Directors may lend money to their corporations and take company notes. (Trieber v. Gayne (1956) 143 Cal.App.2d 580, 582-583.) Directors who are also company creditors can enforce their right to be repaid without breaching their duty to the corporation. (See Rankin v. Frebank Co. (1975) 47 Cal.App.3d 75, 87; Todd v. Temple Hospital Assn., Inc. (1928) 96 Cal.App. 42, 47; Schnittger v. Old Home etc. Min. Co. (1904) 144 Cal. 603, 606-607.) What they cannot do is pay themselves before outside creditors are paid if the corporation is insolvent. (See Berg & Berg Enterprises, LLC v. Boyle (2009) 178 Cal.App.4th 1020, 1041.)
There was no evidence of this kind of self-dealing. Hall presented no evidence that D'Errico had left Pebble without enough money to pay its bills by using the cash to pay off loans or that D'Errico had damaged the corporation in some other way. In addition to being an officer, director, and shareholder of Pebble, D'Errico was also its largest creditor. If he could do so without harming the corporation, nothing prevented him from reducing the corporation's nearly $2.8 million debt.
Hall also claimed that capital account/debt retirement transaction was not explained to him, and the court so found. This is not, however, a difficult concept, and it is not clear why it had to be explained to him at all.
In October 2007, D'Errico arranged for his friend Triscari to lend $400,000 to Hall. The debt was secured by a note and deed of trust on one of the Isle Vista properties. Because the property was already encumbered, however, Triscari demanded additional security. Hall pledged his Pebble stock, and D'Errico guaranteed the loan.
Hall did not repay this loan, and Triscari foreclosed on the stock sometime before August 2008. This foreclosure cut off Hall's ability to bring a derivative suit. The California Supreme Court has held that a stockholder bringing a derivative action must continue to hold stock throughout the duration of the case. (Grosset v. Wenaas (2008) 42 Cal.4th 1100, 1114-1115.)
Hall testified that D'Errico prepared his personal tax returns. The court found that D'Errico "failed to sufficiently account to Mr. Hall for what happened to that money [the $650,000 investment] during times that Mr. D'Errico had been acting in connection with assisting Mr. Hall in preparing his tax returns." The complaint contains no allegations concerning any breach of duty with respect to Hall's personal tax returns. The fourth cause of action alleges that D'Errico prepared false and fraudulent tax returns for Pebble, which exposed both Hall and Pebble to tax liability and penalties, in addition to damaging Hall in an amount in excess of $6 million.
There is no evidence in the record of Hall or Pebble being exposed to tax liability on account of D'Errico's tax preparation or of any other kind of damages linked to preparation of tax returns. Hall dismissed his cause of action for accounting at the beginning of closing argument. There does not appear to be any basis for liability relating to tax returns in this record, if the trial court intended to hold D'Errico separately liable for improper tax return preparation. The court may, however, have included this statement as reinforcing D'Errico's failure to explain the transaction to Hall, as discussed above.
Although the trial court purported to award Hall damages for breach of fiduciary duty, in effect it rescinded Hall's investment in Pebble completely. The judgment actually represents a substantial windfall to Hall, for three reasons: First, the $650,000 was not his money; it came from the sale of Schump's real estate. Second, statutory interest from January 2006 is at a rate well above the market rate for conservative investments. In effect, he was insulated from the risk of speculating in the Newport Beach real estate market between 2004 and 2006 with respect to Pebble. Third, he was able to keep what he had received from Pebble.
Rescission requires a return of "everything of value" or at least an offer to return everything of value. (Civ. Code, § 1691.) Hall did not offer to return what he got. (Cf. Brown v. Grimes (2011) 192 Cal.App.4th 265, 281.) Checks admitted into evidence at trial show that he received substantial sums of money from Pebble's capital funds, including a $95,000 advance that his investment in Pebble partly went to repay, and a later $43,000 or $50,000 advance (depending on whether he paid interest), which he evidently did not repay.
The trial court made two errors of law. First, it found D'Errico liable for self-dealing for doing something he was entitled to do — pay down his loans. Second, it awarded Hall damages for injury to Pebble. Even if D'Errico had been self-dealing, Hall could not have recovered any individual damages. And he could not maintain a derivative action — even if he had complied with the prerequisites for bringing such an action — after he lost his Pebble stock.
The judgment is reversed. Appellant is to recover his costs on appeal.
WE CONCUR:
O'LEARY, J.
IKOLA, J.
As a director, Hall had a duty of care, including a duty of reasonable inquiry, to Pebble. (See Corp. Code, § 309, subd, (a).) If he truly did not understand what was going on and suspected that D'Errico was doing something improper, he should have sought outside advice, perhaps, for example, from the lawyer who formed the corporation.
