FREEDOM HOUSE, A WYOMING LIMITED LIABILITY COMPANY, ET AL. VS PHASE 5 ENERGY LTD, A DELAWARE CORPORATION, ET AL.

Tentative Rulings

Case Number: *******4058 Hearing Date: May 5, 2022 Dept: 78

Superior Court of California

County of Los Angeles

Department 78

FREEDOM HOUSE, LLC, et al., Plaintiffs; vs. PHASE 5 ENERGY LTD., et al., Defendants. Case No.: *******4058 Hearing Date: May 5, 2022 RULING RE: DEFENDANTS PHASE 5 ENERGY, ANDREW SMART, AND PHILIP PLOUGH’S DEMURRER TO THE COMPLAINT.

Defendants’ Demurrer to the Complaint is OVERRULED. Defendants have thirty days to answer.

FACTUAL BACKGROUND

This is an action for breach of contract and fraud. The Complaint alleges as follows.

Plaintiff Jobadiah Weeks (“Weeks”) owns and operates Plaintiff Freedom House, LLC (“Freedom House”) (collectively “Plaintiffs”). (Compl. 1-2.) Defendant Phase 5 Energy Ltd. (“Phase 5”) is owned and operated by defendants Andrew Smart (“Smart”) and Philip Plough (“Plough”) (collectively “Defendants”). (Compl. 3.)

In October 2017, Smart sent Plaintiffs a document titled “Preliminary Offer to Invest” (the “Offer”). (Compl. 10.) Included in the Offer were numerous false representations concerning the legitimacy and strength of Phase 5. (Compl. 10(a-d).) Smart also sent Plaintiffs a document titled “Joby Weeks – Data Centers Proposal Corporate Diligence Check-List, Phase 5 Energy” (the “Data Centers Proposal”) that contained numerous false representations regarding Phase 5. (Compl. 11(a-d).)

Based on these documents, Weeks decided to invest approximately $4,000,000.00 in Cryptocurrency (the “Investment”). (Compl. 12.) In exchange, Defendants were to grant Plaintiffs equity interest in Phase 5 equal to not less than 4% of the outstanding Common Stock of Phase 5. (Ibid.) Instead, Phase 5 issued a cryptocurrency Promissory Note executed by Smart providing that should Phase 5 default in payment of the note, Plaintiffs would receive 2,000 shares of Common Stock in Phase 5. (Compl. 13.)

However, despite the advice of Phase 5 Director Chris Patton, Smart did not convert the Cryptocurrency into U.S. dollars when the market for Cryptocurrency was strong. (Compl. 16.) As a result, when Smart finally converted the Cryptocurrency into U.S. Dollars, Plaintiffs’ investment was worth approximately $1,371,000.00 reflecting a 1.8225% percent ownership of Phase 5. (Ibid.) Additionally, Smart filed an Amendment to Phase 5’s Articles of Incorporation authorizing the issuance of additional shares of Common Stock without prior notice to Plaintiffs, further diluting their equity interest.

(Compl. 17.) Plaintiffs allege that Phase 5’s bylaws contain preemptive rights such that Plaintiffs should have had the opportunity to acquire stock to maintain their equity percentage. (Compl. 18.) Finally, without notice to Plaintiffs, Smart and Plough voted to cease work on the core technology of Phase 5, terminate Phase 5’s employee, and close its offices in the State of Washington and Los Angeles County, thereby destroying the business and Plaintiffs’ equity interest in it. (Compl. 20.)

PROCEDURAL HISTORY

On December 2, 2021, Plaintiff filed the Complaint asserting nine causes of action:

1. Fraud;

2. Negligent Misrepresentation;

3. Breach of the Investment Agreement;

4. Breach of By-Laws and Shareholder Agreement of Phase 5;

5. Breach of Implied Covenant of Good Faith and Fair Dealing; and

6. Breach of Fiduciary Duty.

On January 28, 2022, Defendants filed the instant Demurrer.

On March 22, 2022, Plaintiffs filed an Opposition to the Demurrer.

Defendants have not filed a Reply.

DISCUSSION

I. DEMURRER

A demurrer should be sustained only where the defects appear on the face of the pleading or are judicially noticed. (Code Civ. Pro., 430.30, et seq.) As is relevant here, a court should sustain a demurrer if a complaint does not allege facts that are legally sufficient to constitute a cause of action. (See id. 430.10, subd. (e).) As the Supreme Court held in Blank v. Kirwan (1985) Cal.3d 311: “We treat the demurrer as admitting all material facts properly pleaded, but not contentions, deductions or conclusions of fact or law. . . . Further, we give the complaint a reasonable interpretation, reading it as a whole and its parts in their context.” (Id. at p. 318; see also Hahn. v. Mirda (2007) 147 Cal.App.4th 740, 747 [“A demurrer tests the pleadings alone and not the evidence or other extrinsic matters. Therefore, it lies only where the defects appear on the face of the pleading or are judicially noticed. [Citation.]”)

“In determining whether the complaint is sufficient as against the demurrer … if on consideration of all the facts stated it appears the plaintiff is entitled to any relief at the hands of the court against the defendants the complaint will be held good although the facts may not be clearly stated.” (Gressley v. Williams (1961) 193 Cal.App.2d 636, 639.)

A demurrer should not be sustained without leave to amend if the complaint, liberally construed, can state a cause of action under any theory or if there is a reasonable possibility the defect can be cured by amendment. (Schifando v. City of Los Angeles, supra, 31 Cal.4th at p. 1081.) The demurrer also may be sustained without leave to amend where the nature of the defects and previous unsuccessful attempts to plead render it probable plaintiff cannot state a cause of action. (Krawitz v. Rusch (1989) 209 Cal.App.3d 957, 967.)

Here, Defendants demur to all causes of action on two grounds. First, that Freedom House was a suspended corporation at the time it filed the Complaint and therefore lacked legal capacity to bring suit. Second, that the Demurrer is uncertain, ambiguous, and unintelligible such that it cannot be determined to which Plaintiff the allegations apply, the corporate defendant or the individual defendant.

A. Suspended Corporation

Defendants argue that because Freedom House, LLC was a suspended corporation at the time the Complaint was filed (Demurrer, Exh. A.), Freedom House could not file suit.

To support this contention, Defendants cite to Center for Self-Improvement & Community Development v. Lennar Corp., 173 Cal.App.4th 1543 (“Lennar”). In Lennar, plaintiff filed an action against defendant pursuant to Proposition 65. Under Proposition 65, a plaintiff is required to provide defendant 60-day notice before filing a complaint. Unbeknownst to plaintiff its corporate status was suspended when it sent its 60-day notice.

Defendant moved for summary judgment, arguing that the 60-day notice was defective as a matter of law, and therefore the trial court lacked jurisdiction to hear the case. The trial court granted summary judgment.

The Court of Appeals reversed judgment, finding that “lack of capacity is not a jurisdictional defect and is waived if not properly raised.” (Lennar, 173 Cal.App.4th 1552.) Thus, the court found, “the suspended status of corporate powers at the time of filing suit does not impede the trial court’s jurisdiction to proceed, nor does a suspension after suit commences but before rendition of judgment deprive the court of jurisdiction or render the judgment void.” (Ibid.) (Citations omitted.) The court noted that “subsequent corporate revivor retroactively validates actions in the course of litigation. . .” (Ibid.)

Here, as in Lennar, Plaintiff does not argue that Freedom House’s corporate status was suspended at the time of filing but has provided documentation showing that Freedom House’s Corporate Status has since been revived. (Opposition., Exh. A.)

Accordingly, Plaintiffs may proceed to litigate its claim.

B. Uncertainty

Next, Defendants argue that each cause of action fails as the allegations are ambiguous and uncertain such that Defendants are not aware to whom the allegations apply. Defendants do not provide specific examples of uncertainty or further address this argument beyond its inclusion in the Notice. Therefore, the Court will treat the argument as a general demurrer and will briefly review each cause of action for sufficiency and certainty.

1. First Cause of Action - Fraud

The elements of fraud are: “(a) misrepresentation (false representation, concealment, or nondisclosure); (b) knowledge of falsity (or ‘scienter’); (c) intent to defraud, i.e., to induce reliance; (d) justifiable reliance; and (e) resulting damage.” (Charnay v. Cobert (2006) 145 Cal.App.4th 170, 184.)

In California, fraud, including negligent misrepresentation, must be pled with specificity. (Small v. Fritz Companies, Inc. (2003) 30 Cal.4th 167, 184.) “The particularity demands that a plaintiff plead facts which show how, when, where, to whom, and by what means the representations were tendered.” (Cansino v. Bank of America (2014) 224 Cal.App.4th 1462, 1469.)

Here, Plaintiffs have alleged that Defendant Smart, on behalf of Phase 5, transmitted to Plaintiffs two documents containing materially false information regarding the strength of Phase 5’s business. (Compl. 10 – 11.) Plaintiffs allege Defendants were aware of the falsity of these material facts, but conveyed them with the intent to induce Plaintiffs to invest in Phase 5. (Compl. 22.) Plaintiffs allege that, despite exercising reasonable due diligence, they invested at least $3.3 million in Phase 5. (Compl. 23-24.) Finally, Plaintiffs allege that but for these misrepresentations, they would not have invested. (Compl 26.)

The Court finds that Plaintiffs have alleged facts sufficient to state a claim for fraud, and with sufficient particularity to satisfy California’s heightened pleading standards.

Accordingly, Defendants’ Demurrer to the First Cause of Action is Overruled.

2. Second Cause of Action – Negligent Misrepresentation

The elements of negligent misrepresentation are “(1) the misrepresentation of a past or existing material fact, (2) without reasonable ground for believing it to be true, (3) with intent to induce another’s reliance on the fact misrepresented, (4) justifiable reliance on the misrepresentation, and (5) resulting damage. [Citation.]” (National Union Fire Insurance Co. of Pittsburgh, PA v. Cambridge Integrated Services Group, Inc. (2009) 171 Cal.App.4th 35, 50.)

Negligent misrepresentation has been described as being based on “a duty to communicate accurate information.” (Friedman v. Merck Co. (2003) 107 Cal.App.4th 454, 477.) It is for this reason that the first element of negligent misrepresentation requires that the fact misrepresented be a past or existing fact. (Tindell v. Murphy (2018) 22 Cal.App.5th 1239, 1252.) In other words, there is no claim for negligent misrepresentation where the misrepresentation is about a future fact. “Although a false promise to perform in the future can support an intentional misrepresentation claim, it does not support a claim for negligent misrepresentation. [Citation.]” (Stockton Mortgage, Inc. v. Tope (2014) 233 Cal.App.4th 437, 458, emphasis in original.)

Here, as discussed supra, Plaintiffs have established intent, reliance, and damage. Additionally, Plaintiffs allege specific past existing material facts that Defendants misrepresented, including that “the intellectual properties of Defendant Phase 5 were not at an advanced stage of development, ready for commercialization, or in need of just a relatively small amount of capital to reach pre-production prototype stage”, that “the market for each of Defendant Phase 5’s IPs was not estimated to be in excess of $1 billion per annum, when developed”, and that “the valuation of Defendant Phase 5 was not $200 million.” (Compl. 29(b-d).)

Accordingly, Defendants’ Demurrer to the Second Cause of Action is Overruled.

3. Third and Fourth Causes of Action – Breach of Contract

Plaintiffs third and fourth causes of action are for Breach of the Investment Agreement and Breach of By-Laws and Shareholder Agreement of Phase 5, respectively. The Court understands these claims to be for breaches of two separate contracts.

“The standard elements of a claim for breach of contract are: ‘(1) the contract, (2) plaintiff’s performance or excuse for nonperformance, (3) defendant’s breach, and (4) damage to plaintiff therefrom.’” (Wall Street Network, Ltd. v. New York Times Co. (2008) 164 Cal.App.4th 1171, 1178.)

For the Third Cause of Action, Plaintiffs allege that Plaintiffs and Defendants entered into an Investment Agreement under which Plaintiffs would make an investment of $4 million to acquire 4% Equity Interest in Phase 5. (Compl. 36.) Plaintiffs did invest that $4 million in Cryptocurrency. (Ibid.) Notwithstanding the agreement, Defendants issued Plaintiffs an equity interest of 1.8225%. (Ibid.) As a result, Plaintiffs have incurred actual damages in the amount of no less than $3,300,000. (Compl. 38.)

For the Fourth Cause of Action, Plaintiffs allege that the By-laws and Shareholder Agreement of Phase 5 provide that each shareholder has the pre-emptive right to acquire additional Common Stock if and when such shares become available. (Compl. 40.) However, Plaintiffs violated the By-laws by failing to provide Plaintiffs with proper notice of the date and time of shareholder meetings, and Plaintiffs issued additional equity to Defendant Plough without providing Plaintiffs their contractual right to exercise pre-emptive rights. (Compl. 40.) As a result, Plaintiffs have incurred actual damages in the amount of no less than $3,300,000. (Compl. 42.)

The court finds that Plaintiffs have stated facts sufficient to support causes of action for breach of contract, and that these facts have been alleged with sufficient certainty as to put Defendants on notice of what exactly they must defend themselves from.

Accordingly, Defendants’ Demurrer to the Third and Fourth Causes of Action are OVERRULED.

4. Fifth Cause of Action – Breach of Implied Covenant of Good Faith and Fair Dealing

The elements for breach of the implied covenant of good faith and fair dealing are: (1) existence of a contract between plaintiff and defendant; (2) plaintiff performed his contractual obligations or was excused from performing them; (3) the conditions requiring defendant’s performance had occurred; (4) the defendant unfairly interfered with the plaintiff’s right to receive the benefits of the contract; and (5) the plaintiff was harmed by the defendant’s conduct. (Merced Irr. Dist. V. County of Mariposa (E.D. Cal. 2013) 941 F.Supp.2d 1237, 1280 (discussing California law).) Allegations must demonstrate defendant’s failure or refusal to discharge contractual responsibilities was a conscious and deliberate act, not an honest mistake, bad judgment or negligence. (Id.)

“‘[T]he implied covenant of good faith and fair dealing is limited to assuring compliance with the express terms of the contract, and cannot be extended to create obligations not contemplated by the contract.’” (Ragland v. U.S. Bank Nat. Assn. (2012) 209 Cal.App.4th 182, 206 (quoting Pasadena Live v. City of Pasadena (2004) 114 Cal.App.4th 1089, 1094).)

Here, Plaintiffs allege that Defendants “violated the implied covenant of good faith and fair dealing in that they did not assert a good faith effort to fulfill their obligations under the Agreements.” (Compl. 46.)

These allegations, though cursory, are sufficient to state a claim at the pleading stage. Additionally, the Court notes that this Cause of Action is arguably duplicative of the breach of contract causes, but as Defendants did not raise this argument, it will not address it here.

Accordingly, Defendants Demurrer to the Fifth Cause of Action is OVERRULED.

5. Sixth Cause of Action – Breach of Fiduciary Duty

The elements for a breach of fiduciary duty cause of action are “the existence of a fiduciary relationship, its breach, and damage proximately caused by that breach.” (Thomson v. Canyon (2011) 198 Cal.App.4th 594, 604.)

“‘[B]efore a person can be charged with a fiduciary obligation, he must either knowingly undertake to act on behalf and for the benefit of another, or must enter into a relationship which imposes that undertaking as a matter of law.’” (Hasso v. Hapke (2014) 227 Cal.App.4th 107, 140 (quoting Committee on Children’s Television, Inc. v. General Foods Corp. (1983) 35 Cal.3d 197, 221).) “A fiduciary duty under common law may arise ‘when one person enters into a confidential relationship with another.’” (Id.)

Here, Plaintiffs allege that Defendants voted to issue Defendant Plough an additional 16% equity interest in Phase 5 without properly notifying Plaintiffs of the board of directors and shareholder meetings, which prevented Plaintiffs from exercising their preemptive rights. (Compl. 49.) Additionally, Plaintiffs allege that Defendants Smart and Plough terminated Phase 5 employees and closed the Phase 5 facility, destroying the business contrary to shareholders’ interest. (Compl. 51.) Plaintiffs allege that Defendants Smart and Plough could not have reasonably believed their conduct was in the best interest of Phase 5 and its shareholders. (Compl. 53.)

The Court notes that the Complaint does not explicitly state that Plough and Smart owed fiduciary duties to Plaintiffs. However, the Complaint does state that Plaintiffs were Directors of Phase 5, and that Defendants were shareholders. (Compl. 4-5.) Because Corporate officers and directors owe a fiduciary duty to the corporation’s stockholders (See Small v. Fritz Companies, Inc. (2003) 30 Cal.4th 167), the Complaint sufficiently alleges that Defendants owed fiduciary duties to Plaintiff.

Accordingly, Defendants Demurrer to the Sixth Cause of Action is OVERRULED.

DATED: May 5, 2022

Hon. Douglas W. Stern

Judge of the Superior Court