California Tort Law
concealment or suppression of facts Vega v. Jones, Day, Reavis & Pogue
A shareholder in a company acquired in a merger
transaction sued the law firm which represented the acquiring company for fraud.
He alleged the law firm concealed the so-called toxic terms of a third party
financing transaction, and thus defrauded him into exchanging his valuable stock
in the acquired company for "toxic" stock in the acquiring company. The law firm
demurred. It contended it made no affirmative misstatements and had no duty to
disclose the terms of the third party investment to an adverse party in the
merger transaction. We conclude the complaint stated a fraud claim based on
nondisclosure. The complaint alleged the law firm, while expressly undertaking
to disclose the financing transaction, provided disclosure schedules that did
not include material terms of the transaction.
FACTUAL AND PROCEDURAL BACKGROUND
Frank T. Vega (Vega), a 23 percent shareholder in
a company known as Monsterbook.com, sued Jones, Day, Reavis & Pogue (Jones Day),
a law partnership, for fraud and negligent misrepresentation in connection with
a merger transaction. In the merger transaction, Jones Day represented
Transmedia Asia Pacific, Inc., which acquired Monsterbook. Monsterbook and Vega
were represented by the law firm of Heller, Ehrman, White & McAuliffe (Heller
The terms of the acquisition included Vega's
receipt of restricted stock in Transmedia in exchange for his interest in
Monsterbook. Monsterbook and Vega accepted the merger offer on March 8, 2000.
Closing occurred on April 13, 2000, when the two companies exchanged stock based
on a $ 15 million valuation of Monsterbook. Vega thus exchanged stock valued at
$ 3.45 million for the restricted Transmedia stock.
During the weeks between Vega's acceptance of the
merger offer on March 8 and the closing on April 13, Transmedia, which "[e]verybody
knew ... was an iffy company," sought and secured $ 10 million in investment
financing from a third party. fn. 1
The terms of Transmedia's $ 10 million third party [121 Cal.App.4th 288]
financing transaction included so-called toxic stock provisions, under which the
investors received convertible preferred stock that seriously diluted the shares
of all other Transmedia stockholders. Both Transmedia and Jones Day knew that
"toxic" stock financing is a "desperate and last resort of financing for a
struggling company" and that 95 percent of companies who engage in such
financing end up in bankruptcy.
Jones Day prepared a two-page disclosure schedule
that clearly described and properly disclosed the "toxic" provisions of the $ 10
million investment, but did not send the disclosure to Vega, Monsterbook or
Heller Ehrman. Jones Day knew that a full disclosure of the "toxic" terms of the
financing would have "killed the acquisition," without which Transmedia would
not have obtained the financing and would have gone out of business. Instead,
Vega, Monsterbook and Heller Ehrman were told, on about March 16, 2000, that the
$ 10 million financing then being negotiated was "standard" and "nothing
unusual" and that Jones Day and Transmedia would supply additional documents to
support these characterizations of the financing.
fn. 2 No documents showing the
"toxic" nature of the investment were provided; instead, Jones Day supplied
Heller Ehrman with "a different sanitized version" of the disclosure schedule
which did not include the "toxic" stock provisions.
Jones Day also prepared, and Transmedia sent to
Monsterbook and Vega, a consent form concerning the $ 10 million investment,
which Vega signed. The consent form stated that the $ 10 million investment
would be convertible into an aggregate maximum of 6,815,000 shares of common
stock, "thus misrepresenting that it fell within the 20% dilution 'toxic' cap
mandated by NASD Rule 4350(i)(1)(D)." On March 28, 2000, two weeks before the
closing of Transmedia's acquisition of Monsterbook, Jones Day filed a
"Certificate of Designation" with the Delaware Secretary of State, certifying
the creation of the convertible preferred stock. This document, available to the
public, contained all the terms of the financing, including the "toxic"
The closing of the Monsterbook acquisition
occurred on April 13, 2000. Eight months later, on December 14, 2000, Vega
learned for the first time, [121 Cal.App.4th 289] through a press release
issued by Transmedia, about the "toxic" stock provision of the $ 10 million
financing. Several legal actions ensued.
First, on October 2, 2001, Monsterbook's former
majority shareholder, William H. McKee, who had owned 70.125 percent of
Monsterbook's stock, sued Heller Ehrman for legal malpractice. In a first
amended complaint on November 21, 2001, McKee and a second shareholder, Paul R.
Estrada, who had held a 1.486 percent interest in Monsterbook, also named
Transmedia and Jones Day as defendants, alleging causes of action for fraud and
Second, on December 14, 2001, another
shareholder, John Cuero, who had held a 2 percent interest in Monsterbook, sued
Heller Ehrman, Jones Day, and Transmedia. This suit was consolidated with
McKee's lawsuit. In the consolidated actions, Jones Day sought and obtained
summary judgment, and judgment was entered in its favor on August 23, 2002.
fn. 3 Estrada waived his right to
appeal; McKee abandoned his appeal; and Cuero's appeal was dismissed at his
Third, on May 12, 2003, Vega filed this lawsuit
against Jones Day and Transmedia, and Jones Day demurred.
fn. 4 The demurrer to the fraud
claim was sustained, without leave to amend, on multiple grounds, as follows:
- The claim did not allege an actionable,
affirmative misstatement by Jones Day;
- Vega could not justifiably have relied on the
statements allegedly made by Jones Day;
- Because Jones Day owed Vega no duty to
disclose, Vega could not state a claim based on omission or nondisclosure;
[121 Cal.App.4th 290]
- Vega did not allege damages proximately caused
by Jones Day;
- Vega had no standing to bring the claim because
it was derivative in nature;
- The claim was barred by the statute of
- The claim was barred by res judicata.
Jones Day's demurrer to the negligent
misrepresentation claim was sustained on the same grounds and, in addition,
because a negligent misrepresentation claim cannot be based on an omission or
nondisclosure. The court also concluded Vega failed to plead both causes of
action with the requisite specificity.
The trial court's order sustaining the demurrers
and dismissing Vega's complaint with prejudice was filed August 5, 2003, and
this appeal followed. fn. 5
Vega's allegations may be summarized as follows.
Jones Day hid the existence of the "toxic" stock provisions with the intent to
induce Vega to give up his valuable stock in Monsterbook in exchange for
Transmedia's "toxic" and worthless stock. Jones Day knew about the "toxic" stock
provisions, and knew the acquisition would not occur if Monsterbook, Vega and
their lawyers discovered them. Jones Day deliberately concealed the "toxic"
stock provisions by telling Heller Ehrman the transaction was "standard" and
"nothing unusual," by failing to provide the proper written disclosure it
prepared, and by instead providing a different, sanitized version of the
disclosure. Vega did not know, and had no reason to suspect, that the financing
contained "toxic" provisions, and would not have given up his valuable stock in
Monsterbook had he known. As a result of Jones Day's concealment of the "toxic"
terms of the financing, Vega lost his $ 3.45 million interest in Monsterbook.
[121 Cal.App.4th 291]
We agree with Vega that the complaint properly
states a fraud claim.
 Before we analyze the elements of the claim,
we note the governing legal principles.A fraud claim against a lawyer is no
different from a fraud claim against anyone else. " 'If an attorney commits
actual fraud in his dealings with a third party, the fact he did so in the
capacity of attorney for a client does not relieve him of liability.' " (Shafer
v. Berger, Kahn, Shafton, Moss, Figler, Simon & Gladstone (2003)
107 Cal.App.4th 54, 69 [131 Cal. Rptr. 2d 777] (Shafer), quoting
Jackson v. Rogers & Wells (1989) 210 Cal. App. 3d 336, 345 [258 Cal. Rptr.
454].) While an attorney's professional duty of care extends only to his own
client and intended beneficiaries of his legal work, the limitations on
liability for negligence do not apply to liability for fraud. (Ibid.)
Accordingly, a lawyer communicating on behalf of a client with a nonclient may
not knowingly make a false statement of material fact to the nonclient (Shafer,
supra, 107 Cal.App.4th at p. 69), and may be liable to a nonclient for
fraudulent statements made during business negotiations. (Cicone v. URS Corp.
(1986) 183 Cal. App. 3d 194, 202 [227 Cal. Rptr. 887] ["the case law is
clear that a duty is owed by an attorney not to defraud another, even if that
other is an attorney negotiating at arm's length"].)
With these principles in mind, we turn to the
elements of fraud, which are: "(1)
representation; (2) falsity;
(3) knowledge of falsity; (4) intent to
deceive; and (5) reliance and resulting damage
(causation)." (5 Witkin, Cal. Procedure (4th ed. 1997) Pleading, § 668, p. 123.)
Active concealment or suppression of facts by a
nonfiduciary "is the equivalent of a false representation, i.e., actual fraud."
(Id., § 678, p. 136, italics omitted.) We treat the various elements,
and the bases for the trial court's decision, in turn.
Vega v. Jones, Day, Reavis & Pogue (2004) 121 Cal.App.4th
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