BALTES v. UNION PLANTERS NATIONAL BANK (1988)

Plaintiffs appeal from the dismissal of their second amended complaint as to Safeco Insurance Company of America after Safeco's demurrer was sustained without leave to amend.   We affirm the order of dismissal.

This case arises out of a real estate tax shelter investment project which eventually failed.   We summarize the allegations of plaintiffs' second amended complaint.

Plaintiffs are the subscribers to an offering of units of limited partnership interest in an apartment building, La Ronde Apartments, Ltd. (the limited partnership).   The limited partnership has filed a petition in bankruptcy.   Defendants include the following:  the limited partnership;  its general partners, including Vesteq Partners, Ltd., which offered and sold the units in the limited partnership (the general partners);  David Greenberg and his professional corporation, counsel for the general partners;  Union Planters National Bank, the financing agent;  and Safeco, the bonding agent.¹

By Private Placement Memorandum (the offering memorandum) dated January 25, 1985, the general partners offered to sell units in the limited partnership.   The offering memorandum provided that if the units have not been sold by April 10, 1985, all funds and documents submitted by subscribers will be promptly returned with any interest earned.   Amendments to the offering memorandum purported to extend the April 10, 1985 deadline to July 22 and then September 30 of 1985.   On November 13, 1985, a third amendment to the offering memorandum provided that if all the units were not sold by December 30, 1985, the general partners would purchase all units not sold.

The limited partners paid for their units by one of two methods:  payment of $6,700 and execution of a promissory note for $59,500 or payment of $3,900 and execution of a promissory note for $68,000.   These promissory notes were assigned by the partnership to Union Planters National Bank as collateral for a loan from the bank to the partnership in December 1985 and February 1986.

As part of the offering and sale of the units, each plaintiff was required to complete an indemnity agreement in favor of an unnamed insurance company.   This indemnity agreement which guaranteed payment of plaintiffs' promissory notes was to be used as security for a bond given by the insurance company to the bank, as additional security for its loan to the partnership.   By prior agreement between Safeco and the partnership, Safeco's name was later inserted in the indemnity agreements as indemnitee.   On December 13, 1985, as supplemented in February 1986, Safeco issued its bond to the bank guarantying the payments on most, but not all, of plaintiffs' notes.

The second amended complaint further alleges that Safeco, the bank and the partnership “participated in an integrated financing scheme where by agreement among them entered into prior to or during the offering, the partnership acted as a conduit for transfer of the Notes to [the bank] and of the Indemnity Agreements to Safeco.”   The indemnity agreements were transferred to Safeco while the offering was ongoing and incomplete in violation of the terms of the offering memorandum which required sale of all of the units prior to use by the partnership of the cash subscription, notes, and indemnity agreements delivered by the limited partners.   It is further alleged that Safeco had a “close connection” with the general partners in that since mid–1984, Safeco had been the exclusive bonding company used by the general partners and had issued bonds in 20 limited partnerships formed by the general partners and that Safeco “connived” with the general partners with respect to plaintiffs' indemnity agreements.   Safeco performed credit checks on potential investors and drafted some documentation used in the offering memorandum.

It is also alleged that prior to accepting the indemnity agreements and issuing the bonds, Safeco “knew or had reason to know” the partnership had investors for only slightly more than half the 62 partnership units so that the partnership would be capitalized for approximately $1.5 million less than represented in the offering memorandum and, as a result, the partnership did not intend to perform the required maintenance and renovation of the apartment complex as represented in the offering memorandum.   Safeco “knew” it was not bonding all the limited partners' notes as required by the memorandum.   Safeco also “knew or had reason to know” that “the operating results of the property prior to closing the offering were substantially, materially, and misleadingly worse than as represented” in the memorandum.   Safeco accepted the indemnity agreements and issued the bonds to the bank “knowing or having reason to know” of the material misstatements and fraud because it did not wish to give up its close business relationship as exclusive bonding company for the limited partnerships formed by the general partners and the large profits resulting therefrom.

 It is well established that in reviewing a judgment based on an order sustaining a demurrer without leave to amend, we must accept the facts alleged in the complaint as true.   A demurrer tests only the legal sufficiency of the complaint.  (Committee on Children's Television, Inc. v. General Foods Corp. (1983) 35 Cal.3d 197, 213–214, 197 Cal.Rptr. 783, 673 P.2d 660.)   The order sustaining the demurrer will be sustained if any one of several grounds of demurrer is well taken.  “The complaint must be liberally construed and survives a general demurrer insofar as it states, however inartfully, facts disclosing some right to relief.”  (Longshore v. County of Ventura (1979) 25 Cal.3d 14, 21–22, 157 Cal.Rptr. 706, 598 P.2d 866;  citations omitted.)

With these principles in mind we review the causes of action of the second amended complaint.   Plaintiffs assert the trial court erred in sustaining without leave to amend Safeco's demurrer to the first, third, fifth, eighth and ninth causes of action of the second amended complaint and by denying plaintiffs' motions for reconsideration and for leave to file a third amended complaint.

In addition to the allegations summarized above, plaintiffs' first cause of action alleges a series of misrepresentations and omissions contained in the offering memorandum.   The cause of action seeks rescission of the purchase agreements, the promissory notes and the indemnity agreements of the limited partners under Corporations Code section 25501 and Civil Code sections 1689 and 1692 based upon securities fraud and violation of Corporations Code section 25401.²

 Safeco demurred to this cause of action on the grounds no cause of action for violation of Corporations Code section 25401 could be stated against it since the allegations of the complaint are insufficient to hold it as a seller of securities.  (Admiralty Fund v. Jones (9th Cir.1982) 677 F.2d 1289, 1294;  Wright v. Schock (N.D.Cal.1983) 571 F.Supp. 642, 657 affd. (9th Cir.1984) 742 F.2d 541;  In re Activision Securities Litigation (N.D.Cal.1985) 621 F.Supp. 415, 421.)   Plaintiffs do not dispute this statement of the law but argue instead that they need not state security fraud claims directly against Safeco to be entitled to rescission under Civil Code section 1689 since the facts alleged establish Safeco's “connivance” with the general partners as a matter of law.   Plaintiffs' argument is contrary to their allegations of the first cause of action which state:  “[D]efendants have violated, materially assisted in or are otherwise responsible for, the violation of California Corporations Code Section 25401 and by reason thereof plaintiffs are entitled to rescission under California Corporations Code Section 25501 and Civil Code Sections 1689 and 1692․”  (Emphasis added.)   We agree that plaintiffs have not stated a cause of action against Safeco in the first cause of action based upon violation of securities law.

Plaintiffs' third and fifth causes of action incorporate the allegations of the first cause of action and also seek rescission of the indemnity agreements in favor of Safeco.   The third cause of action adds allegations that the limited partnership, the general partners and their attorneys intentionally misrepresented facts to plaintiffs.   The fifth cause of action alleges the same parties negligently misrepresented facts to plaintiffs.

The eighth cause of action alleges that sale of the limited partnership units to four residents of Missouri violated Missouri securities law and that the limited partnership and the four Missouri purchasers mutually agreed to rescind those purchases.   This cause of action again incorporates the allegations of the first cause of action and adds that Union Bank and Safeco knew of the rescission and yet the bank demanded payment on the notes, Safeco made the payments and did not return the indemnity agreements to these plaintiffs.   An additional problem with this cause of action is that although it alleges that Safeco knew of the rescission at the time it paid the bank, the dates alleged show that the rescission occurred in April 1986 after Safeco had already bonded the notes to the bank in December 1985 and February 1986.

In essence these three causes of action, and perhaps the first cause of action, claim a right to rescind the indemnity agreement against Safeco on two grounds:  first, that Safeco knew or had reason to know of the misrepresentations of the general partners, the limited partnership, its accountants and attorneys;  and second;  that Safeco “connived” with these other parties in the fraud.   Plaintiffs rely on Civil Code section 1689, subdivision (b)(1), which provides:  “A party to a contract may rescind the contract in the following cases: [¶] (1) If the consent of the party rescinding, or of any party jointly contracting with him, was given by mistake, or obtained through duress, menace, fraud, or undue influence, exercised by or with the connivance of the party as to whom he rescinds, or of any party to the contract jointly interested with such party.”

 The factual allegations to support the connivance of Safeco are that Safeco had a “close connection” with the general partners and the limited partnerships formed by them;  since 1984, Safeco had been the exclusive bonding company used by the general partners, issuing approximately 20 such bonds;  Safeco performed credit checks on the investors;  Safeco drafted various documents used in the offering memorandum and dictated certain procedures and terms to the general partners;  and despite Safeco's knowledge of the fraud of the general partners, it accepted the indemnity agreements and issued its bond because it did not wish to give up its close business relationship as exclusive bonding company for the general partners and the large profit resulting therefrom.   We find these allegations insufficient to constitute “connivance” within the meaning of Civil Code section 1689, subdivision (b)(1).

Plaintiffs place substantial reliance on the holding in Leeper v. Beltrami (1959) 53 Cal.2d 195, 1 Cal.Rptr. 12, 347 P.2d 12.   Thomas Leeper borrowed $10,150 from Frank Weber and gave him a promissory note secured by deeds of trust on two ranch properties owned by Thomas, one in Sutter County and one in Sacramento County.   Thomas paid the debt in full.   Thomas' wife, Abbie, obligated herself on a bond in the sum of $10,000.   The bond was forfeited and the district attorney obtained a judgment against her and threatened to foreclose on her Sacramento home, her separate property.   Thomas then deeded his two ranch properties to Abbie to pay the judgment.   In the meantime, Weber died and the two executors of his estate falsely plotted to make the Leepers pay the $10,150 debt a second time.   They filed an action to foreclose on the two ranches and filed lis pendens against the two properties knowing nothing was due on the debt.   Abbie was compelled to sell the Sacramento ranch property to Scheidel for $10,760, a third of the actual worth of the property, because of the improper cloud on the title.   Abbie's complaint sought to rescind the deed to the Sacramento ranch given to Scheidel.

Our Supreme Court held that the complaint stated a cause of action for rescission against Scheidel because “Scheidel had no legal right to take advantage, knowingly, of the wrongdoing of third parties.   When he did, he ‘connived’ with the wrongdoers as that term is used in [Civil Code section 1689].”  (Leeper v. Beltrami, supra, 53 Cal.2d at p. 206, 1 Cal.Rptr. 12, 347 P.2d 12;  emphasis added.)

The same overreaching is present in other cases cited by plaintiffs.   In Kennedy v. Thomsen (Iowa App. 1982) 320 N.W.2d 657, Thomsen had inherited 320 acres of farm land.   Evidence was presented at trial that Thomsen was borderline mentally retarded and that Petersen for whom Thomsen worked dominated him.   Thomsen agreed to sell Petersen 240 acres of the farm land for $255,000.   Petersen subsequently obtained Thomsen's agreement to substitute his daughter and son-in-law, the Kennedys, as purchasers of 160 acres.   The trial court held that Petersen was in a confidential relationship with Thomsen, that the Kennedys and Petersen attempted to exploit this relationship, and that the terms of the transaction were grossly unfair.   The appellate court affirmed the judgment rescinding Thomsen's agreements with Petersen and the Kennedys on the grounds the Kennedys had reason to know of the undue influence practiced on Thomsen and Petersen acted as agent for the Kennedys in dealing with Thomsen.  (Id. at p. 658–659.)

Similarly, Connecticut General Life Insurance Company knew of and unfairly benefited from the fraud of its agent, Western Farm Management, in Connecticut Gen. Life Ins. Co. v. Dredge (10th Cir.1984) 746 F.2d 1420.   The court held Connecticut General did not meet the standards of section 164(2) of the Restatement Second of Contracts of absence of involvement, absence of knowledge and the standard of good faith where it was aware of its agent's double agency and the breach of its duty as agent of the seller.

Plaintiffs also rely on the holding in Carroll v. Carroll (1940) 16 Cal.2d 761, 108 P.2d 420.   That plaintiff proved that for many years her husband had followed a course of intimidation, threats and duress for the purpose of defrauding her of her property.   The issue on appeal was whether she was entitled to rescind a promissory note secured by a deed of trust as to other defendants.   The court held she could not since the note and deed had been given for valuable consideration and there was no evidence the other defendants knew of or participated in her husband's acts.  (Id. at pp. 770–771, 108 P.2d 420.)

Lastly, plaintiffs cite Hall v. Department of Adoptions (1975) 47 Cal.App.3d 898, 121 Cal.Rptr. 223 and Adoption of Jennie L. (1980) 111 Cal.App.3d 422, 168 Cal.Rptr. 695, two cases seeking to invalidate relinquishments of children for adoption.   Both cases state the rule that fraud or duress known to a third party before he in good faith gives something of value may be grounds for rescission against the third party.   No fraud or duress was found in either case;  we find the cases of no help in determining the issue before us.

Our research has revealed two additional cases in which the third party sought to take advantage of the rescinding party.   In Loud v. Luse (1931) 214 Cal. 10, 3 P.2d 542, the Court upheld rescission of deeds from Luse to third parties.   The court found Luse fraudulently obtained a deed to property from Loud.   The third parties, grantees of Luse, took their deeds with knowledge of Luse's fraud and without paying value.   In Harper v. Murray (1920) 184 Cal. 290, 294, 193 P. 576, the Court allowed a former wife to rescind an agreement to reduce spousal support on the grounds her former husband “availed himself of the results” of threats made to her by his attorney.

In each of the cases upholding rescission against a third party which were cited by plaintiffs or reviewed by us independently, there is not only knowledge by the third party but also an unfair advantage taken by the third party.³  The rule is succinctly stated in 1 Witkin, Summary of California Law (9th ed. 1987) Contracts, section 417, page 374:  “The fraud or duress of a third party is a proper basis for rescission against a defendant who, although he did not participate in the wrongdoing, acquired property for an inadequate consideration with knowledge of the injury to the plaintiff.”   Plaintiffs fail to allege that Safeco wrongfully profited or somehow obtained an unfair advantage from plaintiffs because of the fraud of the general partners and the partnership and thus, have not stated a cause of action for rescission under Civil code section 1689.   Plaintiffs' assertion that Safeco acted to protect its profitable business relationship with the general partners is not sufficient to show unfair advantage or bad faith.   There is no allegation Safeco received more than the market rate for its services in the transaction.

Plaintiffs' ninth cause of action seeks declaratory relief.   Plaintiffs allege they contend the indemnity agreement in favor of Safeco is extinguished by plaintiffs' rescission of the agreement to purchase units in the limited partnership while Safeco contends the agreement could only be rescinded with respect to future payments under its bond and then only if the bond itself were rescinded.   Plaintiffs assert this is a sufficient statement of an actual controversy.  (Wellenkamp v. Bank of America (1978) 21 Cal.3d 943, 947, 148 Cal.Rptr. 379, 582 P.2d 970.)   Safeco argues that since plaintiffs' bases for rescission are without merit, there could be no actual controversy between the parties.

 The rule is that where an actual controversy is alleged a cause of action may not be attacked by a general demurrer.   A party is entitled to a declaration of rights, albeit a declaration against his rights.   Where, as here, the trial court has properly decided in other causes of action alleging the same facts, that plaintiffs have stated no cause of action, the trial court's failure to declare the rights is not reversible error.   The preferred procedure is for this court to modify the order of dismissal to declare plaintiffs are not entitled to rescind the indemnity agreement in favor of Safeco by reason of the acts alleged in plaintiffs' second amended complaint.  (Grenell v. City of Hermosa Beach (1980) 103 Cal.App.3d 864, 875, 163 Cal.Rptr. 315;  Teachers Management & Inv. Corp. v. City of Santa Cruz (1976) 64 Cal.App.3d 438, 449, 134 Cal.Rptr. 523;  5 Witkin, Cal. Procedure (3d ed. 1985) Pleading §§ 825–826, pp. 268–272.)

 Plaintiffs also maintain it was an abuse of discretion for the trial court to deny them leave to file their proposed third amended complaint.   The proposed complaint is still fatally defective for failure to allege facts showing Safeco knowingly took advantage of the fraud of others to obtain a wrongful profit.   We find no abuse of discretion.  (Guthrie v. Times–Mirror Co. (1975) 51 Cal.App.3d 879, 891, 124 Cal.Rptr. 577.)

The order of dismissal is affirmed as modified.

FOOTNOTES

1.   Defendant Deloitte, Haskins & Sells has been dismissed from the action.   Safeco is the only respondent on appeal.

2.   Section 25401 provides:  “It is unlawful for any person to offer or sell a security in this state or buy or offer to buy a security in this state by means of any written or oral communication which includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading.”

3.   Safeco's memoranda in the trial court and its brief on appeal are of no help in determining this issue.   Safeco persists in arguing it did not violate securities law because it was not a seller of securities and that the trial court properly sustained its demurrers because plaintiffs' complaint was uncertain and failed to allege fraud with specificity.   In fact, the trial court sustained the demurrers on the grounds the causes of action failed to state facts sufficient to state a cause of action against Safeco.

BENSON, Associate Justice.

ROUSE, Acting P.J., and SMITH, J., concur.