Recovering your attorneys’ fees after prevailing in a buy-out dispute under Corp. Code §16701(a)

You get sued by a friend who claims that he/she is entitled to a percentage of your profitable business contending that the two of you had formed a partnership years ago. You go to trial and prevail. Can you recover your incurred legal fees in defending against your former friend’s lawsuit?

This was the factual scenario of the case entitled Jones, v. Goodman, (2020, Court of Appeal, Fourth District) 57 Cal.App.5th 521, 271 Cal. Rptr. 3d 487.

Plaintiff and Defendants were college friends turned entrepreneurs. Plaintiff claimed that in 2010 the parties agreed to an “equity swap” wherein Plaintiff would receive 5% of Defendants’ company in exchange for 5% of his company. Plaintiff’s company went out of business in 2013 but Defendants’ company grew into a successful and profitable company.

As predicted, Plaintiff sued Defendants in 2016 claiming he had a percentage ownership in Defendants’ successful Pura Vida bracelet business. Plaintiff claimed that he and Defendants formed a partnership and thus sued Defendants seeking a partnership buyout under Corporation Code §16701.

At the conclusion of trial, the court found that: (1) “there was no evidence that the parties agreed to form a partnership,” (2) “there was no evidence that a partnership existed,” and (3) “there was no evidence that a partnership operated as a going concern, including no K-1s, no partnership formation documents, no balance sheets, and no profit and loss statements.” The trial court also found that Plaintiff failed to prove that the signatures on the purported written partnership agreement were that of Defendants.

After prevailing at trial, Defendants filed a motion, pursuant to Corp. Code §16701(i), to recover their approximately $350,000 in attorneys’ fees.

Corp. Code §16701(i), authorizes an equitable award of attorneys and expert fees against any party “…that the court finds acted arbitrary, vexatiously, or not in good faith.”

In his opposition to Defendants’ motion, Plaintiff claimed that his lawsuit was not arbitrary or brought in bad faith because his case had survived Defendants’ two demurrers and summary judgment motion.

The trial court denied Defendants’ attorneys’ fee motion finding that Plaintiff did not act arbitrarily, vexatiously or in bad-faith. Defendants appealed.

In affirming the trial court’s ruling, the Court of Appeal’s decision provides important insight on the burden a party needs to satisfy in order to recover his/her attorneys’ fees after prevailing in a buyout dispute under §16701(a).

First, the Court confirmed that “‘[t]he court may assess reasonable attorneys’ fees and the fees and expenses of appraisers or other experts…in amounts the court finds equitable, against a party that the court finds acted arbitrarily, vexatiously, or not in good faith.’” [Jones 57 Ca.App.5th at 532 (internal citations omitted)]

Second, the Court concluded that §16701(i) is applicable even though the Plaintiff was unable to prove the existence of a partnership.

Third, after determining that there was no case law defining “arbitrarily, vexatiously, or not in good faith” under §16701(i), the Court held that: (1) the statutory terms “arbitrarily, vexatiously, or not in good faith” are disjunctive and each may provide a basis for a fee award, (2) attorney fees may be warranted based on claims that objectively lack legal merit or are subjectively pursued in bad faith (or both), and (3) the decision to award fees is not mandatory, but rather lies within the broad discretion of the trial court.

In sum, the Court of Appeal found that although Plaintiff’s claims lacked objective legal merit, it could not conclude that that no reasonable attorney would have pursued similar relief, and that there existed substantial evidence in the record to support the trial court’s finding that Plaintiff’s subjective state of mind did not evince a lack of good faith.

In wake of the Jones decision, a party facing a claim under §166701 would be well served to obtain the necessary evidence, during the discovery phase of the litigation, to demonstrate that opposing party’s claim lacked objective merit and/or was pursued in bad faith.

This e-bulletin was prepared by Reza Gharakhani, Esq., Chair of the Partnerships and Limited Liability Corporation (PLLC) Committee,