Recent California Legislative and Case Law Developments

This newsletter provides brief highlights of some of the new laws recently enacted by the California Legislature and some recent court decisions of interest in the field of business. The past year was actually a fairly quiet year for the California Legislature in the field of business with no extremely significant laws having been passed. However, of interest and importance are the following:

New Laws:

Board action taken without a meeting: The California Corporation Code has permitted Board action to be taken without a meeting if all members of the Board consented in writing to that action. The Code has now been clarified to make it clear that "all members of the board" does not include an "interested director" (one who stands to benefit by the action taken) but does include "interested directors who abstain in writing". Corp. C § 5211.

Surviving entity is liable for tax: Upon a merger, it is now deemed that the surviving domestic (California corporation) or foreign (non-California corporation) or other business entity shall have assumed the state tax liability of each disappearing domestic or foreign corporation or other business entity. Corp. C § 6020.5.

E-mailing of false advertisements prohibited: The e-mailing of advertisements containing false, misrepresented, obscured, or misleading information is now a criminal offense. Business & Professions Code § 17529.5.

Faxing of unsolicited advertising prohibited: It is now prohibited to send unsolicited advertising via fax to California recipients. Business & Professions Code § 17538.43.

Extension of time to pay past-due use tax liabilities: The sunset date is extended until January 1, 2008 for the provision that allows qualifying purchasers to voluntarily register with the FTB and pay their past-due use tax liabilities, in exchange for a reduced statute of limitations period to assess past-due liabilities. Rev. & Tax Code §§ 6487.06; 18511.

Property tax reassessment exclusion for domestic partner transfers: Any transfer of real property between registered domestic partners (RDPs) is now exempt from definition of a "change of ownership" which would normally have triggered reassessment of the property to current fair market value under the provisions of Proposition 13. Rev & Tax Code § 62.

Court Decisions:

Gains from sale of stock of a wholly owned subsidiary constituted business income within the meaning of Rev & Tax Code 25120(a), and was apportionable to California: Jim Beam Brands owned all the stock of Clear Springs, which owned all the stock of Taylor Food, an integral part of Jim Beam's business operations. When Clear Springs sold Taylor Food, Clear Springs distributed the proceeds to Jim Beam and classified its gains as nonbusiness income, and allocated all of its gain to Kentucky. The FTB disagreed. Rejecting a transactional test based on the sale itself, but instead adopting the relationship test between the income-producing property Taylor Foods and the taxpayer Jim Beam, the California Court of Appeals affirmed the trial court's finding that Jim Beam's gain from the sale of Taylor Foods was business income and thus proportionally taxable in California. Jim Beam Brands co. v Franchise Tax Bd. (2005) 133 CA4th 514.

Online retailer with affiliated local retail stores was required to collect California use tax from California customers: Borders Online, LLC, a Delaware company sold books and other tangible goods over the Internet to customers in California. The LLC did not own or lease property in California and did not have any employees or bank accounts in the state; employees of the LLC outside California received and processed all orders placed through the website. However, California customers could return the products to any Borders Books and Music store in California. As such, the California Court of Appeals held that the LLC was required to collect sales tax from its California customers and pay such tax over to the state. Borders Online, LLC v State Bd. of Equalization (2005) 129 CA4th 1179.

A nonsignatory to a contract may still enforce the contract's arbitration term: Employee Boucher entered into an employment agreement with Financial Title Company. Six months later, Financial's assets were transferred to Alliance Title Company, which refused to recognize Boucher'e employment agreement with Financial and which told Boucher he would have to sign a new employment agreement; he refused and was terminated. Boucher sued both Financial and Alliance, who in turn both filed a motion to compel arbitration based on the arbitration clause contained in the employment agreement. The trial court ordered the claims against Financial to arbitration but, because Alliance had not signed the employment agreement with Boucher, denied Alliance's motion. The Court of Appeals reversed. Because Boucher would need to rely on the employment contract in asserting claims against Alliance, the Court of Appeals found that principles of equitable estoppel permitted Alliance to invoke enforcement of the arbitration provision. Alliance Title Co. v Boucher (2005) 127 CA4th 262.

LLC's manager may be subject to personal liability for participating in tortious or criminal activity while performing his duties: The City of Los Angeles and the State of California brought a red light abatement action against operators of a business and the owners of the business premises, alleging that an illegal massage parlor was being operated for prostitution in a strip mall. The strip mall was owned and leased by Pacific Landmark, LLC and managed by Ron Mavaddat. Under the terms of the lease, the LLC retained the right to enter the premises to inspect its condition and tenant's compliance with laws, ordinances and lease provisions. The permitted use under the lease was "Medical Therapy Offices." In fifteen months, the police made 36 arrests at the premises for prostitution and related offenses. Despite repeated and continuous law enforcement efforts, including meetings with the LLC's counsel, defendants continued to do business as usual. The trial court issued a preliminary injunction prohibiting prostitution. The LLC manager contended that under Corp. Code § 17158(a), he was exempt from personal liability for any order or judgment against the LLC. The Court of Appeals held that managers of LLCs are not immune from personal liability if they have participated in tortious or criminal conduct while performing their duties as managers. Here the court found that the preliminary injunction was not imposed on the LLC manager solely because of his status, but because of his personal involvement in allowing the nuisance to persist. As the manager was extensively involved in the leasing of the premises to tenants, he therefore had the knowledge and responsibility to prevent the nuisance and he was not insulated from liability under Corp. Code § 17158(a). People v Pacific Landmark (2005) 129 CA4th 1203.

A partner's obligation to the partnership includes fiduciary duties not expressly stated in the Corporations Code: In this case plaintiff Enea sued his former partners over their failure to pay market rate rent for offices they leased in a building that comprised the partnership's sole assets. Relying on Corp. Code §16404, which states that a partner does not breach a duty under the partnership agreement merely by furthering the partner's own interests, the trial court ruled that the former partners had no duty to pay market rents absent an agreement to the contrary. The Court of Appeals reversed, finding the trial court's reliance on Corp. Code §16404 inappropriate because, although statutory language wholly defines the duty of care, it does not wholly define the duty of loyalty. Instead, the Court of Appeals held that partners obligate themselves to "carry out the enterprise with .. the loyalty and care of a fiduciary." The Court held that by occupying offices that may have earned market rate rents on the open market, the offending partners furthered their own interest at the expense of the partnership and in so doing breached their fiduciary duty. In response to the contention of the former partners that Enea never asked that the rents be increased, the Court held that a partner does not waive remedies for breaches of fiduciary duty by failing to demand that other partners observe those duties. Enea v Superior Court (2005) 132 CA4th 1559.

If you have any questions regarding any business estate legal matter, in San Francisco, please contact Marc Davis, Esq. at mdavis@gordonrees.com or Gordon Endow, Esq. at gendow@gordonrees.com or call either of them at (415) 986-5900 and in San Diego please contact Richard Clampitt, Esq. at rclampitt@gordonrees.com or Peter Olson, Esq. at polson@gordonrees.com or call either of them at (619) 696-6700.