Suspended Corporations Risk Losing Their Claims Due to Passage of the Statute of Limitations

The case V&P Trading Co., Inc. v. United Charter, LLC (Opinion filed December 19, 2012), Case No. C070571, Third Appellate District, 2012 Cal.App. Lexis 1285, deals with the rules regarding suspended corporations in California.  While this is not a construction law case, it has importance in the construction industry, since so many businesses in the construction arena choose to use the corporate form of business. 

In V&P Trading, the plaintiff's corporate status was suspended pursuant to California Revenue and Taxation Code section 23301 because it failed to pay certain taxes, penalties or interest.  Because of this, the Court of Appeal explained that the corporation was then without capacity to prosecute a civil action.  The Court further explained that once the corporation obtained a Certificate of Revivor from the California Franchise Tax Board, its status would be reinstated.  Most importantly, the Court of Appeal held that while procedural rights in a lawsuit could be retroactively validated once the corporation is reinstated, the same is not true for substantive rights and defenses, including the statute of limitations.  In V&P Trading, the plaintiff was in a suspended corporate status when it filed the lawsuit, and unfortunately for the plaintiff, the statute of limitations passed before it was able to get reinstated. 

The Court of Appeal upheld the trial court's granting of defendant's motion for summary judgment based upon the passing of the statute of limitations while the plaintiff's corporate status was suspended.  This was true even though the defendant did not plead the lack of capacity of the plaintiff in defendant's answer to the lawsuit.  However, the defendant did plead the statute of limitations as an affirmative defense, and this was enough for the defendant to succeed in its motion.

The Court further explained that a defendant must raise the defense of the lack of capacity of the plaintiff due to the suspension of its corporate status at the earliest possible time in the litigation, or else that defense is waived.  The Court characterized this defense as a "plea in abatement" and stated that "[T]he proper time to raise a plea in abatement is in the original answer or by demurrer at the time of the answer."

The lessons to be gleaned from this case for those in the construction industry (though they are applicable to all businesses) are that corporations must be careful to ensure the validity of their corporate status at all times.  In the construction business, there are too many short deadlines that can easily pass before a suspended corporation can be revived, namely the statutes of limitation regarding mechanics liens, stop payment notices and claims against surety bonds.  In addition, for those being sued, such as property owners being liened, public entity owners served with a stop payment notice, or surety bond bond companies being sued on a payment or performance bond, license bond or lien or stop payment notice release bond, it is always important to check the plaintiff's corporate status before filing an answer to the lawsuit.  This can easily be done by looking on the California Secretary of State's website.  In this manner, the defense of a plea in abatement can be raised at the appropriate time, as well as any possible statute of limitations defense. 

Subcontractor recovers its Attorney’s Fees against General Contractor even though the Subcontractor lost the Lawsuit

On November 20, 2012, the California Court of Appeal, in Douglas E. Barnhart, Inc. v. CMC Fabricators, Inc. (2012) 211 Cal.App.4^th 230, held that a subcontractor that lost a case after being sued by a general contractor, nonetheless was entitled to recover the reasonable amount of the attorney’s fees it incurred in its defense.  While this may initially not sound like it makes sense, the Court’s reasoning was based on distinguishing the underlying legal theories used by the general contractor in its lawsuit.   

The Court of Appeal described the facts as follows:  a subcontractor (the “Sub”) submitted a bid to perform decorative metal work on a municipal library project for a general contractor (the “General”).  The bid contained a clause stating that in the event of a dispute, the prevailing party would be able to recover its attorney’s fees.  The bid also stated that it could be accepted by the General for only 30 days.  The General never signed the Sub’s bid, but nevertheless used it in the calculation of the General’s bid to the municipality for the library project.  Thereafter, the General sent a subcontract agreement to the Sub to sign, with terms that were different from the Sub’s bid.  The Sub never signed the General’s subcontract, and eventually sent to the General its own version of a subcontract, with language conforming to the terms of its bid. The General never signed the Sub’s subcontract.  So, no contract was ever signed between the parties.  The Sub did not perform the work, and the General obtained the municipality’s permission to substitute a new metalworks subcontractor to use on the project.  The General then sued the Sub for the difference between the Sub’s original bid and the amount it paid to the substitute metalworks subcontractor.  The General also sued the Sub’s contractor’s license bond surety.

It is important to note that the General sued the Sub for breach of contract and promissory estoppel, two different legal theories.  In the trial court, the General lost its breach of contract claim.  The trial court found that no contract was entered into between the parties.  Therefore, not only could the General not recover against the Sub for breach of contract, but also could not recover against the Sub’s license bond surety company.  However, the General was successful against the Sub on its promissory estoppel legal theory, as the trial court found that the General relied to its detriment on the Sub’s bid proposal.  The trial court awarded monetary damages against the Sub to be paid to the General.  The Sub lost the lawsuit.

Nevertheless, after the trial, the Sub asked the trial court to award it its attorney’s fees incurred in defending itself from the General’s breach of contract claim.  The sub argued that since it won the breach of contract portion of the case, it should get its attorney’s fees, even though it lost the promissory estoppel part of the case.  The trial court refused to give the Sub any attorney’s fees, stating that because the General won on its promissory estoppel theory, it achieved its objectives in the lawsuit.  The trial court also said that the parties had agreed in their briefing of the case that a cause of action for breach of contract is essentially the same as a cause of action for promissory estoppel and because the General prevailed on the contract, the Sub was not entitled to attorney’s fees.  

The Sub appealed the trial court’s ruling regarding the attorney’s fees issue, and the Court of Appeal reversed the trial court’s decision.  The Court of Appeal explained that a breach of contract legal theory is not the same as a promissory estoppel legal theory, and since the Sub won on the breach of contact claim, it was entitled to recover the reasonable attorney’s fees it incurred in defending itself.  The Court of Appeal stated that California follows the American rule that each party to a lawsuit must pay its own attorney’s fees, unless a contract or statute authorizes an award of attorney’s fees. 

The Court also held that if a general contractor incorporates the terms of a subcontractor’s bid into its breach of contract cause of action against the subcontractor, and that bid contains an attorney’s fees provision, then the party that wins the lawsuit will be able to recover its reasonable attorney’s fees pursuant to California Civil Code § 1717.  The Court of Appeal further explained that under Civil Code § 1717, only the prevailing party in an action on a contract, where the contract contains an attorney’s fees clause, is entitled to an award of attorney’s fees, and the prevailing party determination must be made based on the results of the litigated contract claim, without any reference to the success or failure of any litigated non-contract claims. 

So, in this case, the critical issue became whether or not the promissory estoppel claim, where the General was successful, can be considered to be an action on a contract, under  Civil Code § 1717.  The Court of Appeal explained that a cause of action is on a contract for purposes of Civil Code § 1717 only if the cause of action “arises out of, is based upon, or relates to an agreement by seeking to define or interpret its terms or to determine or enforce a party’s rights or duties under the agreement, and…the agreement contains an attorney fees clause.”  The Court of Appeal explained that the legal theory or cause of action for promissory estoppel is based on equity or principles of fairness, not on contract law and because of that, promissory estoppel is distinct from contract law. This is because promissory estoppel lacks two fundamental requirements of contract law, namely, consideration and consent.  The Court of Appeal stated that contract law enforces contracts between parties that bargained for and agreed to be bound by them, whereas promissory estoppel enforces promises where one party justifiably and foreseeably relies on a promise and equity or fairness requires that the promise be enforced in order to avoid injustice.  Promissory estoppel is an alternative theory for recovery in a lawsuit that is mutually exclusive from a contract theory.  

The Court of Appeal concluded that the cause of action for promissory estoppel does not qualify as a claim on a contract for purposes of Civil Code § 1717 because promissory estoppel does not involve a contract and is not a claim on a contract. The Court held that “a plaintiff who prevails on a promissory estoppel claim but recovers nothing on a breach of contact claim…in the same action is not the party prevailing on the contract entitled to recover under the attorney fees clause in the alleged contract….Instead, the defendant who defeats the breach of contract claim…but loses on the promissory estoppel claim is the party prevailing on the contract entitled to recover under the attorney fees clause in the alleged contract.”  

In this case, even though the Sub lost the overall lawsuit, with a monetary award against it based on the General’s promissory estoppel claim, the Sub will be able to recover its reasonable attorney’s fees incurred in defending the General’s unsuccessful breach of contract claim.  What lessons might general contractors and subcontractors learn from this case?  For one, general contractors should examine and subcontractors should think about the language in a subcontractor’s bid to see if it contains an attorney’s fees clause, or if it should contain an attorney’s fee clause.  And, when deciding to file a lawsuit, be aware that in a cause of action for breach of contract, an attorney’s fees clause is a two-way street.  If one loses a contract cause of action when there is an attorney’s fees clause, even if they are successful on other legal theories in the same case, they can be liable for attorney’s fees.