In a long-awaited opinion — Siry Investment, L.P. v. Farkhondehpour — the California Supreme Court held that California Penal Code section 496 can apply to a business dispute. The opinion resolves a split of authority among the California Courts of Appeal.
Penal Code Section 496 and Business Disputes
Penal Code section 496(a) provides for criminal punishment for knowingly receiving stolen property. It states: “Every person who … receives any property that has been stolen or that has been obtained in any manner constituting theft or extortion, knowing the property to be so stolen or obtained, or who conceals, sells, withholds, or aids in concealing, selling, or withholding any property from the owner, knowing the property to be so stolen or obtained,” is subject to incarceration.
Penal Code section 496(c) provides stiff civil 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.”
The availability of “treble damages” and attorney fees can be a big deal in a business case, especially where the partnership agreement or LLC operating agreement might not contain a “prevailing party” attorney fee clause.
Until now, California Courts of Appeal were split on whether section 496(c) applied to business disputes, which often feature claims of misappropriation or diversion of entity assets.
California’s 5th Appellate District: Penal Code Applies
In Switzer v. Wood, a case published in May 2019, California’s 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?
California’s 2nd Appellate District: Penal Code Doesn’t Apply
But in Siry Investment, L.P. v. Farkhondehpour, a case published in March 2020, California’s 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.
In Siry, the plaintiff alleged that the defendant, his business partner, had fraudulently diverted the partnership’s cash distributions. 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 business 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 in Siry
On July 8, 2020, the California Supreme Court granted a petition for review of the Second Appellate District’s decision in Siry Investment.
The opinion resolving the case was published July 21, 2022.
Supreme Court: Penal Code Section 496(c) Can Apply to Business Disputes
In its opinion in Siry Investment, the Supreme Court sided with the reasoning of the Fifth Appellate District, holding that Penal Code section 496(c) can apply to a business dispute featuring misappropriation.
The Court held that “section 496(c) is unambiguous” and a plaintiff “may recover treble damages and attorney’s fees under section 496(c) when property has been obtained in any manner constituting theft. … The unambiguous relevant language covers fraudulent diversion of partnership funds.”
The Court cautioned, however, that “not all commercial or consumer disputes alleging that a defendant obtained money or property through fraud, misrepresentation, or breach of a contractual promise will amount to a theft. To prove theft, a plaintiff must establish criminal intent on the part of the defendant beyond mere proof of nonperformance or actual falsity. … This requirement prevents ordinary commercial defaults from being transformed into a theft.”
As such, “innocent” or “inadvertent” misrepresentations or unfulfilled promises would not qualify as theft under section 496. In the case at hand, however, the Court noted that the evidence showed “defendants acted not innocently or inadvertently, but with careful planning and deliberation reflecting the requisite criminal intent.”
The Court acknowledged the policy concerns driving the Court of Appeal’s opinion — i.e., “that affording remedies flowing from section 496(c)’s language would generally and expansively allow remedies beyond those traditionally afforded at law for fraud, conversion, or breach of contract[.]” But the Court concluded that the Legislature was the appropriate body to consider whether the language of section 496(c) should be modified to address those concerns. In the absence of such Legislative modification, the Court held, the statute is clear “and leaves us with no room to decline to honor the words, as written[.]”
Under the California Supreme Court’s holding in the Siry Investment opinion, the substantial remedies for theft set forth in Penal Code section 496(c) can apply to business disputes.