California limited liability company disputes | Courtroom war stories and lessons learned

Penal Code Remedies for LLC Misappropriation?

Can the sledgehammer remedies of California Penal Code section 496 — treble (triple) damages and attorney fees — apply for misappropriation of an LLC’s property?

The California Supreme Court is set to answer that question soon, after granting review to resolve a split of authority among California Courts of Appeal.

As covered in prior LLC Jungle posts, here is the lay of the land as the matter heads to the Supreme Court:

Penal Code Section 496 and LLC Disputes

Penal Code section 496(a) provides for criminal punishment for knowingly receiving stolen property.

Penal Code section 496(c) provides stiff remedies for anyone injured by a violation of section 496(a), including bringing “an action for three times the amount of actual damages, if any, sustained by the plaintiff, costs of suit, and reasonable attorney’s fees.”

LLC and partnership cases regularly feature claims of misappropriation of entity assets.  But Penal Code section 496 hadn’t traditionally been applied in that context — that is, until Switzer v. Wood came along.

Switzer v. Wood: Penal Code Applies

In Switzer v. Wood, a case published in May 2019, the Fifth Appellate District held that Penal Code section 496 applied to claims that a member or manager misappropriated LLC assets.

The court held that a “criminal conviction is not a prerequisite” and that “[a]ll that is required for civil liability to attach under section 496(c), including entitlement to treble damages, is that a ‘violation’ of subdivision (a) or (b) of section 496 is found to have occurred. … A violation may be found to have occurred if the person engaged in the conduct described in the statute.”

The court found no reason to deviate from the plain meaning of the statutory language, stating: “The wording of the statute makes no exception for cases involving preexisting business relationships.”

For more detail on the Switzer opinion, see the prior LLC Jungle post: Can the Criminal Law Concept of “Receiving Stolen Property” Apply to LLC Disputes?

Siry Investment, L.P. v. Farkhondehpour: Penal Code Doesn’t Apply

But in Siry Investment, L.P. v. Farkhondehpour, a case published in March 2020, the Second Appellate District announced “we respectfully part ways with Switzer v. Wood” and held that Penal Code penalties do not apply to claims of entity misappropriation.

The court drew a distinction between “receiving stolen property” (which it held Penal Code section 496 was intended to remedy) and “other types of theft” involving fraud, misrepresentation, or breach of fiduciary duty.  The Legislature’s goal with section 496, the court held, was “to dry up the market for stolen goods,” not to expand the universe of remedies for business torts.

Traditional tort law, the court held, already provided adequate remedies for LLC misappropriation, including Civil Code section 3333 (compensatory damages for all harm proximately caused by obligations not arising from contract) section 3336 (damages for wrongful conversion), and section 3294 (punitive damages when there is clear and convincing evidence of “oppression, fraud, or malice”).

For more detail on the Siry Investment opinion, see the prior LLC Jungle post: Courts Split Over Application of Penal Code to Claims of LLC Misappropriation

Supreme Court Grants Review

On July 8, 2020, the California Supreme Court granted a petition for review of the Siry Investment decision.

The Court’s docket describes one of the issues to be decided as follows:

May a trial court may award treble damages and attorney fees under Penal Code section 496, subdivision (c), in a case involving the fraudulent diversion of business funds rather than trafficking in stolen goods?

Briefing is underway, and a decision is expected some time next year.

Stay tuned….