Suspended Corporations/Lawyers Bitten By Corporate Status Laws

CA-Secretary-of-State.jpg (JPEG Image, 807 × 503 pixels)In a pair of decisions, two California Courts of Appeal have demonstrated that the statutes regulating suspended corporations have real teeth, providing a cautionary tale for those who deal on their behalf. The cases show what can happen to a suspended corporation both at the beginning and the end of a case. The results were dramatic, in one case costing the suspended corporation more than $860,000. To top it off, the corporation’s attorneys may face charges of ethics violations, and along with the corporation’s officers, criminal prosecution.

The two decisions are entitled Pulte Homes Corp. v. Williams Mechanical, Inc. (Williams), and City of San Diego v. San Diegans for Open Government (SDOG). In SDOG, San Diego’s City Council voted to levy a Mello Roos special tax to pay for the expansion of its convention center. The law requires that when a governmental entity intends to levy a special tax under the Mello Roos Community Facilities District Act, it must first file what is referred to as a validation action to obtain a judgment confirming that its action in forming the district and approving the special tax levy is valid. The city filed its validation action, and SDOG, whose officers and attorneys had full knowledge of its suspended status, nevertheless filed an answer challenging the validity of the tax. Even though a suspended corporation is not legally entitled to appear in and defend a law suit, SDOG and its lawyers did not tell the city or its lawyers that the corporation was suspended, and the city’s lawyers did not learn of SDOG’s suspended status until after the judgment was entered. SDOG and an individual defendant who also appeared in the suit succeeded in invalidating the levy of the special tax, and SDOG sought more than $862,000 in attorney’s fees for doing so. The trial court granted some but not all of those fees, and the City appealed.

The Court of Appeal held that not only was the act of SDOG’s attorneys in knowingly filing the answer for the suspended corporation a likely violation of attorney ethics, but it may have been a crime. The Court pointed out that Revenue and Taxation Code Sections 19719 and 23301 make it a misdemeanor for a suspended corporation to do any acts in furtherance of the corporation’s business while the corporation is suspended, and accordingly, the actions of SDOG and its lawyers in this case appeared to violate the law. What is more, the lawyers’ knowing violation of the law, the Court noted, was a likely ethics violation. The Court stopped short of coming right out and saying that the lawyers breached their ethical obligations, and the Court amended the opinion to soften the suggestion that they committed a crime, but the message was clear. The Court did not allow the lawyers to recover their fees from the public for engaging in the inappropriate conduct. In reading the opinion, one gets the impression that the Court wanted to ask the lawyers, “What were you thinking?”

In Williams, Pulte Homes sued Williams for defective performance of a plumbing subcontract involving the construction of 26 homes. Even before the suit was filed, Williams was defunct; the state had suspended its corporate privilege, and it later dissolved. Pulte served Williams’ attorney, who was also its agent for service of process, with the summons and complaint, but the attorney did nothing with the papers because of Williams’ dissolved status. Thereafter, Pulte had Williams’ default entered. The entry of default cuts off the party’s right to participate in the case. After it obtained a default judgment against Williams, Pulte notified Williams’ liability insurer of the judgment, and the insurer retained counsel who moved to have the default judgment set aside so that Williams could defend the suit. The trial court granted the motion, but Pulte appealed. The Court of Appeal reversed.

The Court noted that since Williams was a suspended corporation before it was dissolved, it may have lacked the legal capacity to appear and defend the suit or even to bring the motion to set the default judgment aside. In spite of that, the Court took a simpler route to reaching its result, deciding that Williams had not been diligent in seeking to set aside its default, and even if it had been, setting it aside would have been an idle act since it likely would not have been able to defend the suit anyway due to its suspended status and the passage of time.

The lesson from these cases is clear; if you are dealing with or acting on behalf of a corporation, always check its status.