The California Supreme Court last week issued a decision in Siry Investments vs. Saeed Farkhondehpour that could dramatically expand the remedies available to partners or others in a commercial dispute who are victims of financial theft related to company assets and funds. Section 496(a) criminalizes the receipt of stolen property and provides for treble damages and attorney’s fees for the party suffering the loss. In a surprise opinion, the Supreme Court decided that Penal Code section 496 can apply any time there is a diversion of money or assets from a partnership, limited liability company or other business provided that the requisite criminal intent to deprive others of those funds can be shown. For the plaintiff in Siry, applying section 496 increased the outcome by many millions. The Siry decision likely will make available to plaintiffs in certain business disputes remedies of treble damages and attorney’s fees that ordinarily are not available for similar claims in other contexts.
Partners Diverted Partnership Funds for Their Own Use
The parties in Siry formed a partnership to renovate and lease out space in a mixed use building. As with most partnership or limited liability agreements, the parties’ agreement divided the partnership’s cash distributions with specific percentages to the partners.
But the defendant partners created a separate entity, and required the building’s tenants to pay rent to it instead of the partnership. Defendants thus improperly diverted rental income away from the partnership. The defendants also commenced charging personal and other non-partnership expenses to the partnership. The net effect of these actions was to direct the partnership to underpay the plaintiff its cash distributions. The two defendants ensured that the plaintiff remained unaware of the underpayments by misrepresenting to the plaintiff the building’s rental income and the partnership’s expenses, lying to the plaintiff about what its cash distributions should have been.
The plaintiff sued the defendants for underpaying the plaintiff and improperly diverting the partnership’s rental income to their own coffers.
The Supreme Court Applies Penal Code Section 496 to the Partnership Dispute
The Supreme Court analyzed section 496 and the history of the bill’s enactment to conclude that a plaintiff in a business dispute may recover treble damages and attorney’s fees under section 496(c) when property—including diverted partnership funds or distributions—has been obtained in any manner constituting theft. The Court determined that the definition of theft set forth in Penal Code section 484, which defines theft as knowingly and purposefully taking money belonging to another through a false representation or false pretense, would apply to a civil action under section 496(c). It found that section 496(c) applies to the conduct in Siry because the unambiguous statutory provision covers fraudulent diversion of partnership funds. In doing so, the Court rejected a limited view of section 496.
The Court elaborated that not all commercial or consumer disputes alleging that a defendant obtained money or property through fraud, misrepresentation, or breach of a contractual promise will amount to a theft within the meaning of the statute. Instead, to prove theft under section 496, a plaintiff must establish criminal intent on the part of the defendant beyond “mere proof of nonperformance or actual falsity.” This requirement prevents “ordinary commercial defaults” from being transformed into a theft. If misrepresentations or unfulfilled promises “are made innocently or inadvertently, they can no more form the basis for a prosecution for obtaining property by false pretenses than can an innocent breach of contract.” In Siry, the Court concluded that the defendants did not act innocently or inadvertently, but with careful planning and deliberation reflecting the requisite criminal intent.
Implications for Future Litigants
Future litigants will need to take into account the potential application of penal code section 496 to disputes between partners or LLC members.
Siry now makes clear that Penal Code section 496 may apply any time there is a diversion of money or assets from a partnership, LLC, or other business provided the requisite intent to deprive others of those funds can be shown. For future disputes between business partners, the parties should be aware that treble damages and attorney’s fees might be available if the requisite wrongful intent to steal or divert partnership or LLC funds from partners or LLC members can be shown.