Date: 04-07-2017

Case Style: Mitchell J. Stein v. Axis Insurance Company

Case Number: B265069

Judge: J. Chaney

Court: California Court of Appeals Second Appellate District Division One on appeal from the Superior Court, Los Angeles County

Plaintiff's Attorney: James N. Fiedler

Defendant's Attorney: Bowman and Brooke, Julian G. Senior and Marion V. Mauch; BatesCarey, Ommid C. Farashahi, Michael T. Skoglund and Tiffany Saltzman-Jones

Description: In 2007, Heart Tronics, Inc., a medical device company,
purchased directors and officers liability insurance policies from
AXIS Insurance Company (AXIS) and Houston Casualty
Company (HCC). The AXIS policy has been exhausted.
Under the HCC policy, HCC agreed to pay defense
expenses incurred by Heart Tronics’s officers and directors, and
individuals serving in functionally equivalent capacities, in any
criminal or civil proceedings, including appeals. An exclusion
provided that upon final determination that an insured person
committed willful misconduct, the insured would be obligated to
repay the insurer any defense expenses paid on his or her behalf.
Mitchell J. Stein served Heart Tronics as a de facto officer,
managing the company full-time without pay or formal position
or title. In 2013, Stein was convicted of securities fraud in
federal court. He tendered his appeal of that conviction to HCC,
but HCC denied coverage, in part because it considered the
conviction to be a “final determination” of Stein’s willful
misconduct for purposes of the policy exclusion, notwithstanding
the policy’s express coverage of defense expenses on appeal.
Stein’s conviction was affirmed on appeal, but a motion for
rehearing is currently pending.
Stein sued HCC, alleging it defrauded him and breached
the 2007 policy by failing to pay his litigation expenses on appeal.
Stein also sued AXIS, alleging it conspired with HCC to defraud
3
him. The superior court sustained the insurers’ demurrers
without leave to amend on several grounds and dismissed the
case.
We conclude the AXIS demurrer was properly sustained
because AXIS was a stranger to the HCC policy and owed no
duties connected with it. The HCC demurrer was improperly
sustained because when a policy expressly provides coverage for
litigation expenses on appeal, an exclusion requiring repayment
to the insurer upon a “final determination” of the insured’s
culpability applies only after the insured’s direct appeals have
been exhausted. Therefore, we reverse the trial court’s judgment
in part and affirm it in part.
BACKGROUND
We take the facts from the operative first amended
complaint and from matters properly subject to judicial notice.
Heart Tronics, Inc., formerly Signalife Inc. (we will refer to
them interchangeably), developed and manufactured an
electrocardiograph monitor called the Fidelity 100. Stein was a
founder of Heart Tronics, and by 2007 functioned as its outside
general counsel and also what he calls its “chief creative
architect,” managing the company on a full-time, daily basis
without pay, formal position or title.
In November 2007, Stein and Lowell Harmison, CEO of
Heart Tronics, purchased a $5 million directors and officers
(D&O) liability insurance policy from HCC.
1. Original HCC Policy Draft
As originally offered, the HCC policy provided that HCC
agreed to “pay, on behalf of the Insured Persons, Loss from
4
Claims first made during the Policy Period,” November 13, 2007,
to November 13, 2008.1
a. Original Definitions
“Loss” was defined as “any amount, including Defense
Expenses, which an Insured Person is obligated to pay as a result
of a Claim . . . .”
“Defense expenses” included “reasonable legal fees . . .
incurred . . . in defense of a Claim.”
“Insured person” meant “any past, present or future
director or officer of” Signalife.
“Claim” meant “written notice received by an Insured
Person or the Company that any person or entity intends to hold
an Insured Person responsible for a Wrongful Act, including . . . a
legal, injunctive or administrative proceeding . . . .”
“Wrongful act” meant “any actual or alleged act . . . or
breach of duty by an Insured Person in his or her capacity as” a
“director or officer” of Signalife.
b. Original Exclusions III(A)(3) and (III)(B)
HCC Policy Exclusion III(A)(3) (the Willful Misconduct
Exclusion) excluded payment for loss in connection with any
claim arising from “any dishonest or fraudulent . . . or . . .
criminal act . . . or any willful violation of any statute . . . by an
Insured Person,” but did not exclude payment for defense
expenses, provided that a final determination that the insured
person committed the wrongful act would obligate him or her to
repay the defense expenses.
1 We omit bold typeface from all policy excerpts.
5
Exclusion III(B) (the Bodily Injury Exclusion) excluded
payment for defense expenses altogether if the claim involved
bodily injury.
2
2. Amended HCC Policy
Stein and Harmison were dissatisfied with the offered HCC
policy because it failed to cover criminal matters or individuals
such as Stein, who had no formal title but was extensively
involved in Signalife operations. On December 18, 2007, they
met with HCC agents Paul Chambers and Lindsay McLeroy, who
offered an amended policy that extended coverage to defense
costs for criminal matters—from the initial filing of charges to
final appeal—and to any individual serving Signalife as the
“functional equivalent” of an officer or director. Chambers and
McLeroy represented to Stein and Harmison that the amended
policy “absolutely” covered Stein as a de facto officer of Signalife.
a. Amended Definitions
In the amended policy, the definition of “claim” was
expanded to include any civil or criminal proceeding “commenced
by the service of a complaint or similar document, the filing of a
notice of charges or formal investigative order, or the return of an
indictment or information, including an appeal from any such
proceeding.”
“Wrongful act” was redefined to include an act committed
not only by an insured person in his or her capacity as a director
2
Exclusion III(B) provided, in pertinent part, the following:
“The Insurer will not pay Loss, including Defense Expenses, in
connection with any Claim . . . for bodily injury, sickness, disease
or death of any person, or for damage to or destruction of any
tangible property . . . .”
6
or officer of Signalife, but also an insured person acting in his or
her capacity as the “functional equivalent” of an officer or
director. As redefined, “wrongful act” meant “any actual or
alleged act . . . or breach of duty by an Insured Person,” and
“insured person” was expanded to include not only officers and
directors, but any person “serving . . . in a position functionally
equivalent” to an officer or director.
b. Amended Exclusion III(A)(3)
The Willful Misconduct Exclusion was amended to provide,
in pertinent part, that “Except for Defense Expenses, the Insurer
shall not pay Loss in connection with any Claim” occasioned by
willful misconduct. The exclusion would be invoked “only if there
has been . . . a final adjudication adverse to [the] Insured Person
in the underlying action . . . establishing that the Insured Person”
committed willful misconduct. “If it is finally determined that
[the exclusion] applies,” the insured would be obligated to repay
the insurer any defense expenses paid on his or her behalf.3

3
Section III(A)(3) provides: “Except for Defense Expenses,
the Insurer shall not pay Loss in connection with any Claim: [¶] .
. . [¶]
“(3) brought about or contributed to by any dishonest or
fraudulent act or omission or any deliberately criminal act
or omission or any willful violation of any statute, rule or
law by an Insured Person, or by an Insured Person gaining
any personal profit, remuneration or advantage to which he
or she was not legally entitled; provided, that:
“(a) This Section III. Exclusion (A)(3) shall
apply only if there has been:
7
3. Criminal Proceedings
On December 13, 2011, a federal grand jury indicted Stein
on 14 counts of mail, wire, and securities fraud; money
laundering; and obstruction of justice. The grand jury charged
that Stein, whose wife nominally owned a limited liability
company that owned 85 percent of Signalife, misappropriated

“(i) a final adjudication adverse to such
Insured Person in the underlying action or
proceeding or in any separate action or
proceeding, or
“(ii) a written admission by such Insured
Person,
“establishing that the Insured Person so acted
or gained such a profit, remuneration or
advantage;
“(b) For purposes of determining the
applicability of this exclusion, no Wrongful Act
of any Insured Person shall be imputed to any
other Insured Person, and the existence of
allegations in a Claim which, if proven, would
be subject to this section III[] Exclusion (A)(3)
shall not affect the right of the Insured Person
to the current payment of Defense Expenses;
and
“(c) If it is finally determined that this
section III[] Exclusion (A)(3) applies to any
Claim against an Insured Person, such Insured
Person will repay the Insurer any Defense
Expenses paid on his or her behalf in
connection with such Claim.”
8
Signalife’s assets, testified falsely to the United States Securities
and Exchange Commission (SEC) to conceal his conduct, and
engaged in a “pump and dump” scheme wherein he artificially
inflated the company’s stock and concealed his ownership and
trading of the shares. On May 20, 2013, a jury found Stein guilty
on all counts, and he was sentenced to 17 years in prison and
ordered to forfeit over $5 million. Stein appealed the judgment,
and in January 2017 the Eleventh Circuit affirmed his conviction
but vacated the sentence and remanded the matter for
resentencing. (United States v. Stein (11th Cir. Fla. Jan. 18,
2017) 2017 U.S. App. LEXIS 813, *43.) On February 7, 2017,
Stein moved for panel or en banc rehearing before the Eleventh
Circuit.
4. SEC Action
On December 20, 2011, the SEC filed a civil action against
Stein and Heart Tronics, alleging securities fraud and
falsification of records. The SEC alleged Stein “was a de facto
officer” of Heart Tronics, “in that he performed policy-making
functions for Heart Tronics akin to an officer.” On February 18,
2015, the district court granted summary judgment to the SEC,
finding no triable issue existed as to Stein’s securities fraud, and
ordered Stein to disgorge $5,378,581.61 in illegally-gained profits.
5. Tender to HCC
After his criminal conviction, Stein tendered his appeal to
HCC. HCC denied coverage on the ground that Stein was not the
“functional equivalent” of a Heart Tronics officer.
6. Complaint and HCC Demurrer
On June 25, 2014, Stein and Heart Tronics sued HCC
Insurance Holdings, Inc., and in the first amended complaint
named as additional defendants HCC, HCC Insurance Holdings
9
Group, and HCC Global Financial Products, LLC.
4
Plaintiffs
asserted in the first amended complaint causes of action for
fraud, breach of contract, breach of the covenant of good faith and
fair dealing, and unfair competition, alleging Stein was the
functional equivalent of a Signalife officer or director, and HCC
breached the HCC policy by refusing to pay his defense expenses
in the SEC and criminal matters. Plaintiffs alleged Chambers
and McLeroy were given express authority by HCC to represent
it in negotiations, and they represented to Stein and Harmison
that Stein was “absolutely” covered under the HCC policy,
knowing at the time that the representation was false. Plaintiffs
sought damages and an injunction enjoining defendants from
making any payment under the HCC policy until they first paid
Heart Tronics and Stein.
4 HCC Insurance Holdings Group has never appeared in
this action and appears not to exist. Plaintiffs alleged the
remaining three HCC defendants “are alter egos of one another
such that it would work an injustice to give them any legal indica
[sic] of separateness, because any separateness among them has
ceased to exist. These entities mix and replace one at the whim
of the other for virtually all business purposes such as sending
legal notices and conducting financial and business transactions.”
HCC Global Financial Products and HCC Insurance Holdings,
Inc. demurred on the ground that they cannot be held liable for
breach of a contract to which they were not parties. The trial
court sustained the demurrer, concluding plaintiffs’ alter ego
allegations were conclusory and insufficient. On appeal,
plaintiffs do not ascribe error to this ground for the court’s ruling.
Therefore, we conclude the demurrer was properly sustained as
to HCC Global Financial Products and HCC Insurance Holdings,
Inc.
10
HCC, HCC Global Financial Products, and HCC Insurance
Holdings, Inc. demurred to the first amended complaint,
contending Stein was not an insured person under the HCC
policy and his defense expenses incurred in the SEC and criminal
proceedings did not constitute losses under the policy.
The HCC defendants argued that under the sham pleading
doctrine, Stein was estopped from asserting that he was a de
facto officer of Heart Tronics because he repeatedly took contrary
factual positions in prior proceedings. In support of the
argument, defendants sought judicial notice of several prior
proceedings that purported to show Stein (1) denied in the SEC
action that he was a de facto officer of Heart Tronics; (2)
represented to the district court in the criminal proceeding that
he ceased serving as the company’s chief creative architect before
2005; (3) represented in proceedings in 2006 that he had never
held any official position with Heart Tronics; and (4) represented
in other proceedings that he was not a Heart Tronics officer or
director and did not control the company. Even if Stein was the
functional equivalent of a Heart Tronics officer, the HCC policy
did not cover his defense expenses in the SEC and criminal
proceedings because in those proceedings he was accused of
misconduct unrelated to any service to the company. Instead, he
was accused of fraud and obstruction of justice committed in his
personal capacity as a witness, lawyer, or husband of the
majority owner. In any event, defendants argued, HCC
Insurance Holdings Group was not a proper defendant because
no such entity existed, and HCC Global Financial Products and
HCC Insurance Holdings, Inc. were improper defendants because
they were not parties to the HCC policy.
11
Defendants further demurred to plaintiffs’ cause of action
for fraud on the ground that the action was barred by the
applicable limitations period, the first amended complaint failed
to allege facts supporting fraudulent intent, and the complaint
failed to allege facts showing Chambers and McLeroy were HCC’s
agents.
In opposition to the HCC demurrer, plaintiffs argued Stein
was covered under the HCC policy because the SEC complaint
specifically alleged he was a de facto officer of Heart Tronics.
Plaintiffs argued all factual allegations sufficed to state causes of
action, and the fraud action was not time-barred because
plaintiffs did not discover HCC’s fraud until it denied coverage.
The trial court sustained the demurrer without leave to
amend on the grounds that (1) the sham pleading doctrine
precluded Stein from alleging he was a de facto officer of Heart
Tronics because in other litigation he asserted the opposite; (2)
coverage was precluded under the Willful Misconduct Exclusion
because Stein’s criminal conviction was “final under federal law
until it is reversed”; (3) HCC Global Financial Products and HCC
Insurance Holdings, Inc. were not parties to the HCC policy; (4)
plaintiffs could not state a cause of action for fraud because they
alleged only that HCC failed to perform a promise, not that its
representations concerning coverage were false at the time they
were made; and (5) plaintiffs’ cause of action for fraud was barred
by the applicable limitations period because they should have
discovered HCC’s alleged fraud in 2007, when the HCC policy
was delivered. This ruling was made before Stein’s conviction
was affirmed on appeal.
12
7. AXIS Insurance Company and AXIS Capital
Holdings Limited
AXIS Insurance Company also issued a D&O policy to
Signalife, but it paid out the limits of that policy in defense of
other civil actions, and the policy is not at issue in this litigation.
Plaintiffs nevertheless named AXIS and AXIS Capital Holdings
Limited as defendants in this litigation ostensibly because of
their role in a conspiracy with HCC to defraud Signalife.
Plaintiffs allege the AXIS defendants conspired with HCC
and “unindicted co-conspirators” “to attempt to fatally injure”
Signalife by:
1. “conditioning payment for legal fees on taking legal
positions approved by the insurers”;
2. denying coverage under the HCC and AXIS policies;
3. frustrating plaintiffs’ pursuit of coverage;
4. misappropriating or destroying Signalife records;
5. aiding other coconspirators to commit litigation
misconduct, including perjury;
6. “encouraging and then supporting” the formation of a
Signalife competitor using stolen Signalife trade secrets;
7. along with HCC, negotiating the HCC policy with
Signalife;
8. representing to Signalife, through Chambers and
McLeroy (who were AXIS agents as well as HCC agents), that the
HCC policy covered Stein;
9. inducing Signalife to enter into both the AXIS and
HCC policies and, reassured by them, to embark on expansive
business plans, including taking on a $100 million line of credit
and drawing down on it, embarking on a “Marquee Hospital
Initiative,” and embarking on an “International Initiative”;
13
10. “violat[ing] the law manipulat[ing] coverage
decisions”;
11. “attempt[ing] to control the way [Signalife] asserted
its legal rights by forcing the Company to hire its (AXIS
Defendants’) chosen counsel”;
12. “treat[ing] counsel for the Company different from
counsel for others who were involved in the conspiracy”;
13. failing to pay “hundreds of thousands of dollars of
legal fees for the same kind of work AXIS Defendants paid the
lawyers who were representing the coconspirators”;
14. misappropriating and hiding the HCC policy;
15. conspiring with HCC to deny Stein coverage under
the HCC policy;
16. joining in the HCC fraud to induce plaintiffs to
purchase the AXIS policy;
17. failing to honor its D&O policy by “refusing—in bad
faith—to cover (or provide a defense) with respect to various
claims and parties under the” policy;
18. failing to investigate; and
19. delaying resolution of claims.
Plaintiffs alleged the AXIS defendants’ actions caused
Signalife to lose its records and trade secrets, “forfeit its legal
rights,” and “give up its FDA-approved, award-winning
technologies.”
The AXIS defendants demurred to the first amended
complaint on the grounds that plaintiffs failed to allege how the
AXIS defendants could be liable for misrepresentations and
misconduct in connection with the HCC policy. The trial court
sustained the AXIS defendants’ demurrer without leave to amend
on this ground.
14
8. Appeal
Stein (but not Heart Tronics) appealed from the resulting
judgment.
DISCUSSION
I. Standard of Review
When a demurrer is sustained, we review the complaint de
novo to determine whether it alleges facts stating a cause of
action under any legal theory. (Rakestraw v. California
Physicians’ Service (2000) 81 Cal.App.4th 39, 43.) We accept as
true all properly pleaded material facts, but not contentions,
deductions, or conclusions. (Id. at pp. 42-43.) “[W]hen [a
demurrer] is sustained without leave to amend, we decide
whether there is a reasonable possibility that the defect can be
cured by amendment.” (Blank v. Kirwan (1985) 39 Cal.3d 311,
318.) A plaintiff has the burden to show what facts could be
pleaded to cure defects in the complaint. (Total Call Internat.,
Inc. v. Peerless Ins. Co. (2010) 181 Cal.App.4th 161, 166.) To
meet this burden on appeal, the plaintiff must enumerate the
facts and demonstrate how they establish a cause of action.
(Ibid.) “On appeal from a judgment of dismissal entered after a
demurrer has been sustained without leave to amend, unless
failure to grant leave to amend was an abuse of discretion, the
appellate court must affirm the judgment if it is correct on any
theory.” (Hendy v. Losse (1991) 54 Cal.3d 723, 742.)
II. HCC Defendants’ Demurrer
A. Breach of the HCC Policy—Willful Misconduct
Exclusion
Apparently relying on an exclusion in the HCC policy
requiring an insured to repay defense expenses if it has been
“finally determined” the insured committed willful misconduct,
15
the trial court sustained HCC’s demurrer to plaintiffs’ cause of
action for breach of contract on the ground that Stein’s expenses
on appeal were not covered under the policy because his criminal
conviction was “final . . . until it is reversed.” The court erred.
“ ‘ “While insurance contracts have special features, they
are still contracts to which the ordinary rules of contractual
interpretation apply.” [Citations.] “The fundamental goal of
contractual interpretation is to give effect to the mutual intention
of the parties.” [Citation.] “Such intent is to be inferred, if
possible, solely from the written provisions of the contract.”
[Citation.] “If contractual language is clear and explicit, it
governs.” [Citation.]’ [Citation.] [¶] ‘ “A policy provision will be
considered ambiguous when it is capable of two or more
constructions, both of which are reasonable.” [Citations.] The
fact that a term is not defined in the policies does not make it
ambiguous. [Citations.] Nor does “[d]isagreement concerning the
meaning of a phrase,” or “ ‘the fact that a word or phrase isolated
from its context is susceptible of more than one meaning.’ ”
[Citation.] “ ‘[L]anguage in a contract must be construed in the
context of that instrument as a whole, and in the circumstances
of that case, and cannot be found to be ambiguous in the
abstract.’ ” [Citation.] “If an asserted ambiguity is not
eliminated by the language and context of the policy, courts then
invoke the principle that ambiguities are generally construed
against the party who caused the uncertainty to exist (i.e., the
insurer) in order to protect the insured’s reasonable expectation
of coverage.” [Citation.]’ ” (Powerine Oil Co., Inc. v. Superior
Court (2005) 37 Cal.4th 377, 390-391.)
The HCC policy provided coverage for “loss,” which the
policy defined as “any amount,” including defense expenses, the
16
insured would be obligated to pay as the result of a claim.
“Claim” included any civil or criminal proceeding, and expressly
included “an appeal from any such proceeding.” Although the
Willful Misconduct Exclusion removed coverage for losses
brought about by fraud or criminal acts, the exclusion did not
apply to defense expenses: “Except for Defense Expenses, the
Insurer shall not pay Loss in connection with any Claim [brought
about by fraud].” (Italics added.) The policy language therefore
clearly and explicitly obligated HCC to cover an insured’s defense
expenses incurred as a result of an appeal from a civil or criminal
proceeding even if a trial court determined the insured was guilty
of or liable for fraud.
This coverage is further supported by the fact that when
the parties wished to exclude defense expenses from coverage,
they did so explicitly. Exclusion III(B) excludes payment for
defense expenses if a claim involves bodily injury, as follows:
“The Insurer will not pay Loss, including Defense Expenses, in
connection with any Claim . . . for bodily injury, sickness, disease
or death of any person, or for damage to or destruction of any
tangible property . . . .” That Exclusion (III)(A) did not explicitly
exclude defense expenses on appeal implies the parties did not
wish it to do so.
HCC argues the Willful Misconduct Exclusion, which
becomes operative once there has been a “final adjudication” of
fraud, precludes coverage here because a federal trial court
judgment such as Stein’s criminal conviction is a final
adjudication for policy purposes. This is so, HCC argues, because
under federal law, a trial court judgment is deemed to be a final
adjudication until reversed on appeal. The argument suffers
many fatal flaws.
17
First, nothing in the policy indicates the parties intended
that the phrase “final adjudication” carry the same meaning in
the exclusion as it carries in federal law. Policy language is
construed in the context of the policy as a whole and the
circumstances of the case, not by reference to abstract concepts
cherry picked from outside factors. (Powerine Oil Co. v. Superior
Court, supra, 37 Cal.4th at p. 391.) The policy made no mention
of federal law and no distinction between federal and state court
proceedings. That Stein’s conviction happened to be in federal
court was irrelevant to the policy.
Second, a thing that is “final until reversed” is not final.
(See Martin v. Martin (1970) 2 Cal.3d 752, 761 [under federal
law, a trial court judgment is final for purposes of res judicata
but may still be appealed].) An appellate court can render an
adjudication as well as a trial court can, with the added benefit
greater finality.
Third, even if HCC were correct that the Willful
Misconduct Exclusion comes into play when a final adjudication
determines culpability, the point is irrelevant because the
exclusion by its terms does not apply to defense expenses.
HCC represents that “[c]ourts have repeatedly held that
the exhaustion of all appeals is unnecessary to satisfy exclusions
that require a ‘final adjudication.’” It is incorrect. HCC cites two
trial court cases for this “repeated” holding, Unencumbered Assets
v. Great Am. Ins. Co. (S.D. Ohio 2011) 817 F.Supp.2d 1014
(Unencumbered Assets) and Chubb Custom Ins. Co. v. Triumph
Capital Group, Inc. (Mass. Super. Ct. 2007) 22 Mass.L.Rep. 192
(Triumph), but each undermines rather than supports its point.
In each case, the policy at issue provided that a “judgment or
other final adjudication” would trigger a dishonesty exclusion.
18
(Unencumbered Assets, supra, at p. 1033, italics added; Triumph,
supra, at p. *6, italics added.) Each court treated this phrase as
disjunctive, and held that the occurrence of either disjunct—for
example, a judgment—would alone suffice to trigger the
dishonesty exclusion. (Unencumbered Assets, supra, at p. 1032;
Triumph, supra, at pp. *8-*9 [“the phrase ‘judgment or other final
adjudication’ is disjunctive, so a judgment of conviction would
still be sufficient by itself to bar coverage even if it were not a
final adjudication”].) The HCC policy is not disjunctive—there is
only one trigger for the Willful Misconduct Exclusion: final
adjudication. If anything, this implies a judgment alone would
not trigger the exclusion.
We conclude the HCC policy covers an insured’s litigation
expenses incurred in directly appealing a conviction. (See MidCentury
Ins. Co. v. Superior Court (2006) 138 Cal.App.4th 769,
775 [an action is deemed to be pending until its final
determination upon direct appeal].) Plaintiffs alleged HCC
breached the policy by denying coverage for these expenses.
Therefore, HCC’s demurrer on the ground that Stein’s criminal
conviction precluded coverage should have been overruled.
B. Breach of the HCC Policy—The Sham Pleading
Doctrine
The trial court sustained HCC’s demurrer to plaintiffs’
cause of action for breach of the HCC policy on the ground that
the sham pleading doctrine precluded plaintiffs from alleging
Stein was a de facto officer of Heart Tronics. We conclude the
sham pleading doctrine does not negate that allegation.
Judicial notice may be taken of the records of any court in
this or any other state. (Evid. Code, § 452, subd. (d); Code Civ.
Proc., § 430.70.) Although judicial notice may not be taken of the
19
truth of facts alleged in judicial records, the court may judicially
notice that the facts were indeed alleged. (Cantu v. Resolution
Trust Corp. (1992) 4 Cal.App.4th 857, 877 (Cantu) [“Both trial
and appellate courts may properly take judicial notice of a party’s
earlier pleadings and positions as well as established facts from
both the same case and other cases”].) It is “well settled that a
complaint otherwise good on its face is nevertheless subject to
demurrer when facts judicially noticed render it defective.”
(Watson v. Los Altos School Dist. (1957) 149 Cal.App.2d 768, 771.)
Where an amended complaint omits facts alleged in a prior
complaint or pleads facts inconsistent with those previously
alleged, and fails to explain the omission or inconsistency, the
court will read such omitted or inconsistent facts into the current
complaint. (Vallejo Development Co. v. Beck Development Co.
(1994) 24 Cal.App.4th 929, 946; Owens v. Kings Supermarket
(1988) 198 Cal.App.3d 379, 383-384.) The rule applies not only to
a pleading filed in the same action, but also to a complaint in a
prior action involving the same parties and based on the same
underlying facts. (E.g., Larson v. UHS of Rancho Springs, Inc.
(2014) 230 Cal.App.4th 336, 341 [plaintiff’s allegations
contradicted those he made in an earlier action involving the
same parties and dispute]; Henry v. Clifford (1995) 32
Cal.App.4th 315, 322-323 [same].) The rule also applies to an
answer filed in a prior action between the same parties on the
same underlying facts and to a complaint in a prior action
involving the same plaintiff but a different defendant. (E.g.,
Cantu, supra, 4 Cal.App.4th at p. 878 [plaintiff’s allegations
contradicted those he made in an earlier answer in litigation
involving the same parties and dispute]; State of California ex rel.
20
Metz v. CCC Information Services, Inc. (2007) 149 Cal.App.4th
402, 412.)
Here, plaintiffs alleged no facts in the amended complaint
that were inconsistent with those alleged in the original
complaint. Instead, defendants argue, and the trial court found,
that plaintiffs made allegations in other proceedings that
contradicted the allegation here that Stein served Heart Tronics
as the functional equivalent of an officer or director.
HCC argues Stein represented in the criminal proceedings
that he was briefly the chief creative architect for Heart Tronics
before 2004, but after February 2004 served only as its outside
counsel in “emergency situations.” To support the argument,
HCC cites a motion to dismiss that Stein filed in the criminal
proceedings in 2013, in which he stated, “Prior to the completion
of the development of all of Signalife’s heart technology, . . .
Stein—for brief periods of time—acted as Chief Creative
Architect for the Company. Otherwise, including after FDA
approval of the . . . ‘Fidelity 100’ obtained around February 1,
2004, Mr. Stein was outside counsel for the Company, and was
appointed by the Company to engage as counsel specifically in
emergency situations.”
This statement does not preclude Stein from alleging he
served as the functional equivalent of a Heart Tronics officer or
director from 2007 to 2008. First, the statement was not set forth
in a prior pleading or any judicially noticeable evidence, but in a
memorandum of points and authorities supporting a motion to
dismiss the criminal proceedings. No authority precludes a party
from arguing an inconsistent position in a subsequent lawsuit if
the party was unsuccessful in asserting the first position. (Cf.
Gottlieb v. Kest (2006) 141 Cal.App.4th 110, 131 [judicial estoppel
21
applies only if the first position was successful].) Second, the
statement does not unequivocally contradict the current
allegation. Stein stated he was Signalife’s chief creative architect
“[p]rior to the completion of the development of all of Signalife’s
heart technology.” No judicially noticeable fact establishes when
Signalife completed development of all of its heart technology.
Further, the word “otherwise,” which precedes the description of
Stein’s role as outside counsel, appears to introduce an additional
responsibility, not a successor one.
HCC argues that in 2006 Stein declared, in a civil action in
which he was a defendant, that he was not and never had been a
director, officer or employee of Heart Tronics. HCC also
references statements made by a trial court in another civil
proceeding in 2005, and statements made by Signalife in the SEC
proceedings, to the effect that Stein was not an employee, officer
or director of Signalife. All of these statements are irrelevant
because they do not contradict the allegation that Stein served as
the functional equivalent of an officer or director, much less that
he did so during the HCC policy period from 2007 to 2008.
The trial court therefore erred in sustaining HCC’s
demurrer on the ground that the sham pleading doctrine
precluded plaintiffs from alleging Stein served as the functional
equivalent of a Heart Tronics officer or director.
C. HCC’s Alleged Fraud—Specificity of Pleading
The trial court sustained HCC’s demurrer to plaintiffs’
cause of action for fraud on the ground that they failed to allege
that HCC’s representations concerning coverage were false at the
time they were made, instead alleging only that HCC failed to
perform a promise.
22
“ ‘The elements of fraud, which give rise to the tort action
for deceit, 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.’ [Citations.] [¶]
‘Promissory fraud’ is a subspecies of the action for fraud and
deceit. A promise to do something necessarily implies the
intention to perform; hence, where a promise is made without
such intention, there is an implied misrepresentation of fact that
may be actionable fraud. [Citations.] [¶] An action for
promissory fraud may lie where a defendant fraudulently induces
the plaintiff to enter into a contract.” (Lazar v. Superior Court
(1996) 12 Cal.4th 631, 638.)
As noted above, plaintiffs alleged that in order to induce
them to enter into the HCC policy agreement, HCC’s
representatives represented that Stein would be covered under
the HCC policy, knowing the representation to be false. Plaintiffs
alleged they justifiably relied on HCC’s representation, to their
detriment. Plaintiffs’ allegations, if true, would establish all the
elements of promissory fraud.
HCC argues a plaintiff cannot plead fraudulent intent
simply by alleging the defendant made but failed to keep a
promise. We agree, but here, plaintiffs alleged further that HCC
never intended to keep its promise, which constitutes fraudulent
intent. (Crouch v. Wilson (1920) 183 Cal. 576, 579 [allegation
that a representation was “personally known by the [speaker] to
be untrue” suffices].) HCC argues that “California law requires
Stein to have evidentiary support for his unqualified
allegation[s],” but he failed to plead “any evidence of
contemporaneous fraudulent intent.” But in California, a
23
plaintiff need allege only the existence of facts, not evidence.
“Because knowledge is a fact, it is sufficiently pleaded by the
general averment that the defendant knew the representation
was false . . . . How the defendant acquired that knowledge, what
his or her sources were, would be evidentiary and unnecessary.”
(5 Witkin (5th ed. 2008) Cal. Procedure, Pleadings, § 726.)
HCC argues plaintiffs cannot allege justifiable reliance on
its misrepresentation because the HCC policy, in connection with
Stein’s sham pleadings, prevented plaintiffs from considering
Stein to be a covered person under the policy. This argument
fails because, as discussed above, the policy potentially covered
individuals such as Stein.
HCC argues plaintiffs failed to allege with sufficient
specificity that Chambers and McLeroy acted with HCC’s express
authorization, characterizing plaintiffs’ allegations as “similar” to
those found deficient in Moore v. Regents of Univ. of Cal. (1990)
51 Cal.3d 130 and Penny v. NDeX West LLC (C.D.Cal. Feb. 22,
2012) 2012 U.S. Dist. LEXIS 22070. The trial court overruled
HCC’s demurrer on this ground, and we agree, finding no
similarity between the allegations found deficient in the cases
HCC cites and those made here. In Moore v. Regents of Univ. of
Cal., the plaintiff alleged only that “ ‘each of the [five] defendants
was the agent, joint venturer and employee of each of the other
remaining defendants.’ ” (Moore v. Regents of Univ. of Cal.,
supra, 51 Cal.3d at p. 134, fn. 12.) In Penny v. NDeX West, the
plaintiff “fail[ed] to allege that any of the people she spoke with
had any authority to act on [a corporate defendant’s] behalf.”
(Penny v. NDeX West, supra, 2012 U.S. Dist. LEXIS at p. *22.)
Here, plaintiffs alleged “Mr. Chambers and Ms. McLeroy were
authorized by the Insurance Defendants to negotiate the policies
24
on their behalf and the Insurance Defendants authorized and
intended Mr. Chambers and Ms. McLeroy to bind the Insurance
Defendants at the time of the December 18, 2007 negotiations.”
Plaintiffs thus alleged that defendants expressly authorized two
specifically identified individuals to represent them. This
sufficed.
D. HCC’s Alleged Fraud—Limitations Period
The trial court sustained HCC’s demurrer to plaintiffs’
cause of action for fraud on the additional ground that the action
was barred by the applicable limitations period because plaintiffs
should have discovered HCC’s alleged fraud in 2007, when the
HCC policy was delivered. We disagree.
The limitations period for fraud is three years. (Code Civ.
Proc., § 338, subd. (d).) “Generally speaking, a cause of action
accrues at ‘the time when the cause of action is complete with all
of its elements.’ [Citations.] An important exception to the
general rule of accrual is the ‘discovery rule,’ which postpones
accrual of a cause of action until the plaintiff discovers, or has
reason to discover, the cause of action.” (Fox v. Ethicon EndoSurgery,
Inc. (2005) 35 Cal.4th 797, 806-807.) “A plaintiff has
reason to discover a cause of action when he or she ‘has reason at
least to suspect a factual basis for its elements.’ [Citations.]
Under the discovery rule, suspicion of one or more of the
elements of a cause of action, coupled with knowledge of any
remaining elements, will generally trigger the statute of
limitations period.” (Id. at p. 807.) “The discovery rule only
delays accrual until the plaintiff has, or should have, inquiry
notice of the cause of action.” (Ibid.) The discovery rule applies
to causes of action for fraud or mistake. (Sun ‘N Sand, Inc. v.
United California Bank (1978) 21 Cal.3d 671, 701 [“In a long line
25
of cases we have held that a cause of action for fraud or mistake
accrues, and the limitations period commences to run, when the
aggrieved party could have discovered the fraud or mistake
through the exercise of reasonable diligence”].)
“In order to rely on the discovery rule for delayed accrual of
a cause of action, ‘[a] plaintiff whose complaint shows on its face
that his claim would be barred without the benefit of the
discovery rule must specifically plead facts to show (1) the time
and manner of discovery and (2) the inability to have made
earlier discovery despite reasonable diligence.’ [Citation.] In
assessing the sufficiency of the allegations of delayed discovery,
the court places the burden on the plaintiff to ‘show diligence’;
‘conclusory allegations will not withstand demurrer.’ ” (Fox v.
Ethicon Endo-Surgery, supra, 35 Cal.4th at p. 808.)
Here, plaintiffs alleged they discovered HCC’s fraud in
early 2014, when the insurer denied coverage on the ground that
Stein, although arguably a de facto officer of Signalife, did not
serve in a position functionally equivalent to an officer. Plaintiffs
filed the instant complaint in June 2014, less than three years
later.
HCC argues the HCC policy itself put plaintiffs on notice
that Stein was not an insured person in 2007, long before
plaintiffs filed the instant complaint. The argument fails for
reasons discussed above.
E. Unfair Competition and Breach of Covenant
The trial court sustained HCC’s demurrer to plaintiffs’
cause of action for breach of the covenant of good faith and fair
dealing for the same reason it sustained the demurrer to the
breach of contract cause of action. The trial court sustained
HCC’s demurrer to plaintiffs’ cause of action for unfair
26
competition for the same reason it sustained the demurrer to the
breach of contract and fraud causes of action. On appeal, HCC
argues the causes of action for breach of covenant and unfair
competition fail “[f]or the same reasons” that the others fail.
Because HCC urges no independent grounds supporting its
demurrers to the causes of action for breach of covenant and
unfair competition, the matter requires no further discussion.
For reasons stated above, the demurrers to these causes of action
should have been overruled.
III. AXIS Defendants’ Demurrer
Plaintiffs alleged the AXIS defendants falsely induced
Signalife to purchase the AXIS policy and committed several acts
of misconduct that deprived plaintiffs of the benefits of the HCC
Policy. The trial court sustained the AXIS defendants’ demurrer
on the ground that allegations directed only at the HCC policy
failed to allege causes of action against the AXIS defendants.
Stein contends the first amended complaint adequately
alleges a civil conspiracy, as it alleges AXIS authorized Chambers
and McLeroy to make representations to Signalife regarding the
HCC policy, and the AXIS and HCC defendants conspired to
“fatally injure” the company by: (a) “conditioning payment for
legal fees on taking legal positions approved by the insurers”; (b)
refusing to cover (or provide a defense) “with respect to various
claims and parties under the Policies”; (c) “refusing coverage”
under the policies; (d) “taking the Company’s records and
depriving the Company of access to those records”; (e) “aiding
other co-conspirators into litigation practices that included
numerous acts of misconduct including, but not limited to,
fraudulent and perjurious testimony”; and (f) “encouraging and
then supporting the formation of a competitor of the Company
27
using trade secrets of the Company purloined by the coconspirators
and inducing breaches by Company officers of noncompetition
agreements with the Company.”
Plaintiffs thus purport to allege the AXIS defendants
conspired to defraud them, to breach the covenant of good faith
and fair dealing with respect to the HCC policy, and to commit
unfair business practices. Plaintiffs also allege the AXIS
defendants directly defrauded them.
A. Conspiracy to Breach the Covenant of Good
Faith and Fair Dealing
Conspiracy is “a legal doctrine that imposes liability on
persons who, although not actually committing a tort themselves,
share with the immediate tortfeasors a common plan or design in
its perpetration.” (Applied Equipment Corp. v. Litton Saudi
Arabia Ltd. (1994) 7 Cal.4th 503, 510-511.)
“The covenant of good faith and fair dealing, implied by law
in every contract, exists merely to prevent one contracting party
from unfairly frustrating the other party’s right to receive the
benefits of the agreement actually made.” (Guz v. Bechtel
National, Inc. (2000) 24 Cal.4th 317, 349.) AXIS, as a stranger to
the HCC policy, cannot be held liable for frustrating Stein’s right
to receive benefits under the policy. “By its nature, tort liability
arising from conspiracy presupposes that the coconspirator is
legally capable of committing the tort, i.e., that he or she owes a
duty to plaintiff recognized by law and is potentially subject to
liability for breach of that duty.” (Applied Equipment Corp. v.
Litton Saudi Arabia, supra, 7 Cal.4th at p. 511.) As strangers to
the HCC policy, the AXIS defendants were legally incapable of
conspiring to commit a tort relating to it. The trial court
28
therefore properly sustained their demurrer to the breach of
covenant cause of action.
B. Fraud
The other allegations against the AXIS defendants sound in
fraud. The most pertinent appears to be that the AXIS
defendants “joined in the representation of the HCC Defendants
in order to induce the purchase of the AXIS Policy. Their
authorized agents were, too, Mr. Chambers and Ms. McLeroy, for
purposes of their business dealings with Plaintiffs.”
“In California, fraud must be pled specifically; general and
conclusory allegations do not suffice. [Citations.] ‘Thus “ ‘the
policy of liberal construction of the pleadings . . . will not
ordinarily be invoked to sustain a pleading defective in any
material respect.’ ” [Citation.] [¶] This particularity
requirement necessitates pleading facts which “show how, when,
where, to whom, and by what means the representations were
tendered.” ’ [Citation.] A plaintiff’s burden in asserting a fraud
claim against a corporate employer is even greater. In such a
case, the plaintiff must ‘allege the names of the persons who
made the allegedly fraudulent representations, their authority to
speak, to whom they spoke, what they said or wrote, and when it
was said or written.’ ” (Lazar v. Superior Court, supra, 12
Cal.4th at p. 645.)
Plaintiffs’ claim that Chambers and McLeroy were AXIS’s
agents “for purposes of their business dealings with Plaintiffs”
does not adequately allege the agents were authorized to
negotiate the HCC policy or make representations about HCC’s
intentions as part of their agency, because plaintiffs fail to allege
how the HCC policy was part of AXIS’s “business dealings” with
Signalife. Neither do plaintiffs describe how plaintiffs could
29
justifiably rely on the representation by AXIS, a stranger to the
HCC policy, that HCC would honor its promises under the policy.
The trial court therefore properly sustained the AXIS defendants’
demurrer to the extent it challenged this instance of alleged
fraud.
Plaintiffs also alleged the AXIS defendants conspired to
commit other acts of fraud by conditioning payment for “legal
fees” on taking “legal positions”; refusing “coverage” under
“policies” with respect to “various claims and parties”; taking
“company records”; aiding “co-conspirators” in “litigation
practices” that included “numerous acts of misconduct” including
fraudulent and “perjurious testimony”; and encouraging the
formation of a “competitor” using “trade secrets” purloined by coconspirators
and inducing company officers to breach “noncompetition
agreements.” But none of these allegations specify
how AXIS committed the fraud, when, where, with whom, or by
what means. The trial court therefore properly sustained the
AXIS defendants’ demurrer to plaintiffs’ cause of action for fraud.
C. Unfair Business Practices
Absent a predicate unfair practice, plaintiffs’ cause of
action against the AXIS defendants for unfair business practices
also fails.
IV. Leave to Amend
To be granted leave to amend, a plaintiff “must submit a
proposed amended complaint or, on appeal, enumerate the facts
and demonstrate how those facts establish a cause of action.”
(Cantu, supra, 4 Cal.App.4th at p. 890.) Here, plaintiffs argue
they should have been given leave to amend to allege more
clearly that the HCC policy “belie[s] the insurers’ positions” or to
“more specifically allege” conspiracy. Plaintiffs offered no
30
amended complaint below, and on appeal adduce no specific facts
they could allege to cure the complaint as to the AXIS
defendants. Therefore, leave to amend as to the AXIS defendants
was properly denied.
V. Requests for Judicial Notice
HCC’s request for judicial notice of the Eleventh Circuit’s
opinion affirming Stein’s conviction but vacating his sentence and
remanding for resentencing is granted. (Evid. Code, § 452, subd.
(d).) Stein’s request for judicial notice of his petition for
rehearing before the Eleventh Circuit is also granted. (Ibid.)
Stein’s other requests for judicial notice are denied as calling for
notice of irrelevant material. (See Zelig v. County of Los Angeles
(2002) 27 Cal.4th 1112, 1141, fn. 6.)

Outcome: The judgment is affirmed as to Heart Tronics, HCC Global Financial Products, HCC Insurance Holdings, Inc., and the AXIS defendants. The judgment is reversed as to Stein’s complaint against HCC. The AXIS defendants, HCC Global Financial Products, and HCC Insurance Holdings, Inc. are to recover their costs on appeal. Stein and HCC are to bear their own costs.

Plaintiff's Experts:

Defendant's Experts:

Comments: