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PSM Holding Corp. v. National Farm Financial Corp.

United States Court of Appeals, Ninth Circuit

March 7, 2018

PSM Holding Corp., a Corporation, Plaintiff-Appellant,
National Farm Financial Corporation, a Corporation; Business Alliance Insurance Company, a Corporation; Larry P. Chao, an Individual, Defendants-Appellees. PSM Holding Corp., a Corporation, Plaintiff-Appellee,
National Farm Financial Corporation, a Corporation; Business Alliance Insurance Company, a Corporation; Larry P. Chao, an Individual, Defendants-Appellants.

          Argued and Submitted December 6, 2016 Pasadena, California

         Appeals from the United States District Court for the Central District of California D.C. No. CV 05-08891 MMM Valerie B. Fairbank and Margaret M. Morrow, District Judges, Presiding[*]

          Aluyah I. Imoisili (argued) and Linda Dakin-Grimm, Milbank Tweed Hadley & McCloy, Los Angeles, California, for Plaintiff-Appellant/Cross-Appellee.

          Peder K. Batalden (argued) and Mitchell C. Tilner, Horvitz & Levy, Encino, California; Joseph W. Cotchett and Nancy L. Fineman, Cotchett Pitre & McCarthy, Burlingame, California; for Defendants-Appellees/Cross-Appellants.

          Before: Stephen Reinhardt, A. Wallace Tashima, and Richard A. Paez, Circuit Judges.


         Restitution / Rescission

         The panel affirmed in part, reversed in part, and dismissed in part the district courts' judgment and orders concerning remedies in various appeals arising from claims for breach of contract and fraud.

         The district court held that a judgment creditor, who seized a judgment debtor's company pursuant to a judgment that was reversed on appeal, could recover in restitution for losses suffered while it was in possession of the seized company. The district court denied the judgment creditor's request to rescind its quota share reinsurance agreement ("QSA") with Business Alliance Insurance Company.

         The panel held that to the extent the district court's orders of July 26, 2010, and October 8, 2013, affirmed defendants' right to recover restitution, they were sound. In reviewing the district court's December 17, 2014 order, the panel held that the district court erred in allowing the judgment creditor to recover in restitution. The panel's conclusion rested on the California Supreme Court's decision in Ward v. Sherman, 100 P. 864 (Cal. 1909), wherein the court in an analogous situation, declined to award the judgment creditor an affirmative recovery to offset its losses. The panel's decision was bolstered by the plain reading of Restatement (First) of Restitution § 74 and Restatement (Third) of Restitution § 18, which suggested that in similar cases, the right of restitution ran only to the judgment debtor.

         The panel rejected the judgment creditor's challenges to the district court's October 8, 2013 order denying the judgment creditor's request for rescission of its QSA. Specifically, the panel held that the district court did not err by failing to consider California Civil Code § 1019, which concerns the removal of fixtures from leaseholds. Second, the district court thoroughly analyzed whether the QSA amounted to a necessary expense or, instead, an improvement. Finally, policy considerations did not favor the judgment creditor's position.

         The panel reversed the district court's May 19, 2015 order granting in part and denying in part defendants' motion to recover post-appeal attorneys' fees. The panel held that the district court erred in awarding attorneys' fees under California Civil Code § 1717, while simultaneously concluding that the judgment creditor had fully satisfied the obligations stemming from the operative judgments. The panel dismissed, as moot, defendant's appeal of the district court's reduction of the lodestar fee amount.

         Because the panel reversed the judgment creditor's restitution award, the panel vacated the district court's July 14, 2015 order denying defendants' motion to retax costs and remanded for reconsideration in light of changed circumstances.

         The panel ordered that in each of the five appeals, each party should bear its own costs on appeal.


          TASHIMA, Circuit Judge

         At the heart of this case lies a conceptually straightforward, but procedurally complex, question of first impression for our Circuit: Can a judgment creditor, who seizes a judgment debtor's company pursuant to a judgment that is subsequently reversed on appeal, recover in restitution for losses suffered while it was in possession of the seized company? The district court answered in the affirmative. In doing so, it awarded Plaintiff PSM Holding Corp. more than $1.1 million in restitution. Defendants now challenge this award.

         All told, the parties have filed five appeals and cross-appeals, which were consolidated for oral argument and decision. We have jurisdiction under 28 U.S.C. § 1291, and we affirm in part, reverse in part, and dismiss in part.


         A. The Lawsuit and Trial

         Prior to the instant lawsuit, Defendant-Appellee/Cross-Appellant National Farm Financial Corporation ("National Farm") owned Business Alliance Insurance Company ("BAIC"). Larry Chao, the president of National Farm, co-founded BAIC in the 1990s with his wife, Julie Chao. BAIC provided insurance to small businesses. BAIC had $14.2 million in net written premiums and $2.8 million in net income by 2005.

         In early 2005, National Farm entered into negotiations to sell BAIC to Plaintiff-Appellant/Cross-Appellee PSM Holding Corporation ("PSM"). Ultimately, however, National Farm walked away from the deal. Thereafter, PSM sued National Farm, Larry Chao, and BAIC (collectively, "Defendants") alleging claims for breach of contract and fraud.

         Following a trial, a jury found in favor of PSM and awarded it $40 million on its breach of contract claim and $3 million on its fraud claim. In post-trial proceedings, Judge Fairbank granted in part and denied in part Defendants' motion for judgment as a matter of law ("JMOL"). The motion was denied, with the exception that judgment was entered in favor of Defendants on the fraud claim, thereby reducing PSM's damages award to $40 million. Judge Fairbank also granted Defendants' motion to stay execution of the judgment pending appeal, conditioned on Defendants posting a $40 million bond. However, after Defendants failed to post the required bond and National Farm entered bankruptcy, PSM executed on the judgment. In October 2008, BAIC was transferred to PSM. At the time of transfer, BAIC had more than $30 million in assets.

         After taking possession of BAIC, PSM took various steps to integrate BAIC into its existing business. For example, PSM and BAIC entered into an inter company quota share reinsurance agreement (the "QSA"). The QSA provided that, for every insurance policy BAIC issued, PSM would receive 90 percent of the policy's insurance premiums in exchange for assuming 90 percent of the policy's risk of loss. BAIC would retain the remaining ten percent of the premiums and would continue to be responsible for ten percent of the policies' risk of loss. PSM also assumed control of 90 percent of BAIC's loss and loss expenses reserves, thereby rendering it responsible for 90 percent of BAIC's losses on policies written prior to October 21, 2008, as well as on future policies. Additionally, PSM and BAIC entered into an Intercompany Service Agreement ("ISA"), under which PSM would provide to BAIC certain executive, administrative, and other services.

         B. The Judgment is Reversed

         On June 18, 2009, the Ninth Circuit reversed Judge Fairbank's partial denial of Defendants' JMOL motion. The Ninth Circuit held that "[t]he plain terms of the agreement dictate that no contract was formed because the signature lines for National Farm; Larry Chao, as an individual; and Julie Chao, as an individual, were left blank. As a result, none of the parties could be liable under its terms." PSM Holding Corp. v. Nat'l Farm Fin. Corp., 339 Fed.Appx. 693, 694 (9th Cir. 2009). The case was remanded to the district court.

         C. Post-Remand Proceedings

         1. July 26, 2010, Order on Restitution

         On remand from the Ninth Circuit, it was undisputed that PSM should pay restitution to Defendants. At issue, however, was the appropriate amount.

         On July 26, 2010, the district court granted in part and denied in part Defendants' motion for restitution and attorney's fees. Although Defendants' motion opposed a return of BAIC to National Farm and, instead, sought a restitution award in the amount of $59.6 million, the district court ordered "[r]estitution in the form of the return of BAIC's shares to [D]efendants."

         The district court's decision relied heavily on Restatement (First) of Restitution § 74, which provides that:

A person who has conferred a benefit upon another in compliance with a judgment, or whose property has been taken thereunder, is entitled to restitution if the judgment is reversed or set aside, unless restitution would be inequitable or the parties contract that payment is to be final; if the judgment is modified, there is a right to restitution of the excess.

         Restatement (First) of Restitution § 74 (Am. Law Inst. 1937). In such situations, comment e to § 74 provides, "the judgment debtor is entitled to specific restitution, together with the value of [the property's] use in the meantime, diminished by expenses necessarily incurred in the protection of the property and the payment of taxes and liens, but not including the expense of improvements." Id. at § 74, cmt. e.

         According to the district court, this rule is consistent with a similar principle set forth in Restatement (Third) of Restitution and Unjust Enrichment § 18 (Am. Law. Inst. 2011):

A transfer or taking of property, in compliance with or otherwise in consequence of a judgment that is subsequently reversed or avoided, gives the disadvantaged party a claim in restitution as necessary to avoid unjust enrichment.

         Finally, the court supported its decision by relying on several state court decisions - from California and elsewhere - that confronted similar issues, including Stockton Theatres, Inc. v. Palermo, 264 P.2d 74 (Cal. Dist. Ct. App. 1953), Erickson v. Boothe, 274 P.2d 460 (Cal. Dist. Ct. App. 1954), and Fleer Corp. v. Topps Chewing Gum, Inc., 539 A.2d 1060 (Del. 1988).

         Based on these authorities, the district court concluded that "Defendants are entitled to specific restitution of the BAIC shares."[1] Additionally, the district court determined that Defendants were "entitled to an accounting of the profits earned while PSM held BAIC, 'diminished by expenses necessarily incurred in the protection of the property and the payment of taxes and liens.'" (Quoting Restatement (First) of Restitution, § 74 cmt. e (Am. Law Inst. 1937).) Accordingly, the district court ordered "an accounting of the profits PSM generated through its ownership of [the BAIC] shares."[2]

         2. October 8, 2013, Order on Accounting and Rescission of QSA

         Post remand, Defendants filed a motion for an award of PSM's profits. Defendants sought $14 million in profits. PSM opposed the motion, arguing that it actually suffered a $1.5 million loss as a result of its temporary possession and control of BAIC. Additionally, PSM sought to rescind the QSA. The district court determined that expert testimony was required in order to resolve Defendants' motion for profits and PSM's request for rescission. Accordingly, it appointed two experts: (1) Debra J. Roberts, who would consider the QSA issue; and (2) Timothy H. Hart, a forensic accountant, who would consider the question of profits. After each expert filed her/his report, the district court ruled.

         On the question of rescission, the district court denied PSM's request, relying on the following illustration:

A obtains judgment in ejectment against B and is put in possession of Blackacre. After knowledge that an appeal has been taken, A makes improvements thereon to the amount of $1000, at an expense of $100 repairs a roof which otherwise would have leaked, and pays taxes thereon to the amount of $300. He remains on the land for two years, at the end of which time the judgment is reversed. B is entitled to restitution of the land and to the reasonable rental value of the land during the two years, less the amount expended by A for the necessary repairs and for the payment of taxes; ordinarily [diminishment in] restitution for the value of the improvements would not be granted.

         Restatement (First) of Restitution § 74 cmt. f, illust. 14 (Am. Law Inst. 1937). This rule, the district court reasoned, is consistent with the well-established proposition that "the distinction between 'repairs and maintenance' and 'improvements' can be characterized 'as the difference between 'keeping' and 'putting' [an] . . . asset in good condition." (Quoting Moss v. Commissioner, 831 F.2d 833, 835 (9th Cir. 1987).)

         Under this legal framework, the district court concluded that "[t]he factual record supports the conclusion that the reinsurance agreement was an improvement rather than a necessary cost of protecting BAIC." It reasoned that "[t]he reinsurance agreement increased the amount of reinsurance BAIC had prior to the time PSM acquired it" and, consequently, "the agreement added to BAIC's value by reducing the amount of risk it faced." And, there is nothing in the record to suggest that "absent replacement of the existing excess of loss and catastrophe insurance with the [QSA], BAIC would have been unable to function as an insurance company." Similarly, the district court found no evidence suggesting that "there was an imminent danger that the California Department of Insurance would take regulatory action against BAIC that would have precluded it from writing insurance business."

         Because, according to the district court, the QSA was "better characterized as an 'improvement' [rather] than an expense necessary to protect BAIC, " the district court concluded that "rescission of the agreement [was] not warranted."

         With respect to profits, the district court made the following findings: (1) Defendants were entitled to recover $203, 532 in "synergy profits" from PSM; (2) there was no evidence to support Defendants recovery of "future profits"; (3)Defendants were entitled to recover a $30, 973 tax benefit previously received by PSM due to its ownership of BAIC; (4)Defendants were not entitled to any recovery as a result of PSM's liquidation of PSM's stock portfolio; (5) PSM was not entitled to an additional management fee beyond what had already been paid directly by BAIC; (6) Defendants were entitled to recover $254, 524 in improperly charged transition costs; (7) PSM was entitled to "an adjustment of the restitution award" of $332, 190 to cover "operating expenses associated with BAIC while it ran the company"; (8) PSM was entitled to a credit of $557, 402 in "ceded premiums, " i.e., premiums paid on reinsurance contracts that BAIC entered into prior to PSM's ownership; and (9) PSM could "offset" any restitution payment to Defendants by $700, 000 to account for PSM's assumption of a loan made by BAIC to National Farm.

         The district court then ordered the parties to jointly "prepare an accounting of the amounts owed [Defendants] and the amounts PSM [was] entitled to deduct." The court added that it would "enter judgment in favor of whichever party is owed money pursuant to the accounting."

         3. December 17, 2014, Order on Restitution of Profits

         The parties - unable to reach agreement on the amounts owed - each filed a proposed judgment. The parties agreed that, based on the district court's prior October 8, 2013, order, PSM was to be allotted $1, 100, 563 in net principal. That is, per the October 8 order, PSM's offsets and credits exceeded the Defendants' recovery of profits and benefits by just over $1.1 million. Nonetheless, the parties disputed what should happen next. For its part, PSM sought to recover $1, 100, 563 in net principal, net prejudgment interest at a rate of $211 per day until the entry of judgment, and undetermined costs and attorneys' fees. In contrast, Defendants requested that the district court award nothing to PSM and award unstated costs to Defendants.

         The crux of Defendants' position was that the district court should award nothing to PSM because "[b]ased upon the rules of restitution, which are grounded on the principles of equity, it would be inequitable to award PSM monies, especially since it operated BAIC at a loss during its operations."

         In its December 17, 2014, order, the district court rejected Defendants' arguments and awarded $1, 100, 563 to PSM. In support of its decision, the court articulated the following "fundamental rule" of restitution: "the goal of restitution is 'to place the parties in as favorable a position as they could have been in had the judgments not be enforced pending appeal.'" (Citing Gunderson v. Wall, 126 Cal.Rptr.3d 880, 883 (Ct. App. 2011).) Moreover, the district court continued, "[a]bsent evidence of bad faith, even assuming PSM operated BAIC at a loss, equity does not require that PSM be held responsible for the loss." (Citing Restatement (First) of Restitution § 74, cmt. f. (Am. Law Inst. 1937).)

         In the same order, the district court considered PSM's request for prejudgment interest, pursuant to California Civil Code § 3287(a). As a preliminary matter, the district court emphasized that, under § 3287(a), "[e]very person who is entitled to recover damages certain, or capable of being made certain by calculation . . . is entitled also to recover interest thereon . . . ." (Quoting Cal. Civil Code § 3287(a) (emphasis and alterations in original).) Moreover, the district court added, "an accounting action is prima facie evidence [that] a claim is uncertain." (Quoting Chesapeake Indus., Inc. v. Togova Enters., Inc., 197 Cal.Rptr. 348, 353 (Ct. App. 1983).) Then, after surveying several California appellate court decisions which stand for the same proposition, the district court reasoned that "[h]ere, the issue of restitution was complex, and necessitated that the court appoint business valuation and reinsurance experts, " and that "[t]here were numerous discrete questions that the court had to resolve in order to determine the amount of restitution." Based on these findings, the district court declined to award prejudgment interest.

         Concurrently with its December 17 order, the district court entered a final judgment, in which it ordered that: (1) based on the Ninth Circuit's reversal, PSM would "take nothing by way of its complaint"; (2) Defendants would recover $2, 224, 220.76 in attorneys' fees and $53, 984.99 in costs stemming from pre-reversal proceedings; (3) PSM would ...

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