BILL ANALYSIS Ó SENATE JUDICIARY COMMITTEE Senator Hannah-Beth Jackson, Chair 2015-2016 Regular Session AB 2759 (Levine) Version: June 16, 2016 Hearing Date: June 28, 2016 Fiscal: Yes Urgency: No RD SUBJECT Corporations: agents: victims of corporate fraud compensation fund DESCRIPTION This bill would authorize victims of corporate fraud to pursue compensation from the existing Victims of Corporate Fraud Compensation Fund (VCFCF), administered by the Secretary of State (SOS), for fraudulent acts committed by an agent of the corporation (as opposed to the corporation, itself) for fraud, misrepresentation, or deceit, with the intent to defraud, as specified. For these purposes, "agent" would mean a person who was: (1) an officer or director of the corporation, as specified, at the time the fraudulent acts occurred; (2) named in a final criminal restitution order in connection with the fraudulent acts; and (3) acting in the person's capacity as the corporation's officer or director when committing the fraudulent acts. If restitution is sought from the VCFCF based upon a criminal restitution order and the defendant is an "agent," this bill would add to the documentation that an applicant must provide to the SOS. Furthermore, in any appeal of a denial of an application that was based on a criminal restitution order against an agent of a corporation, the petitioner would have the burden of proving that the defendant named in the criminal restitution order qualifies as an "agent," and an active corporation would be permitted to appear in the action regarding the sole issue of whether the defendant named in the criminal restitution order qualifies as its "agent." Lastly, this bill would specify that victims of corporate fraud may not recover attorney's fees and would declare that this does not constitute a change in, but is declaratory of, existing law. AB 2759 (Levine) PageB of? BACKGROUND AB 55 (Shelley, Ch. 1015, Stats. 2002), was enacted as part of the 2002 California Corporate Reform Package, a series of measures designed to strengthen the state's corporate accountability laws. The bill, among other things, created the Victim of Corporate Fraud Compensation Fund (hereinafter "VCFCF," or "fund") within the State Treasury, for the sole purpose of providing restitution to the victims of corporate fraud who have otherwise been unable to collect on their judgment. The bill also set the Secretary of State (SOS) in charge of administering the fund and adopting regulations regarding the administration of the fund and eligibility of victims to receive compensation. The Fund reportedly collects approximately $1.7 million a year from the $2.50 it receives of a $5 disclosure fee for statement filings by both out-of-state and in-state corporations. In October of 2011, a Sacramento Bee article highlighted that the Fund was not doing what it was created to do-compensate victims of corporate fraud. (Dan Morain, Fraud victims fund is a travesty (Oct. 9, 2011).) The following year, in 2012, SB 1058 (Lieu, Ch. 564, Stats. 2012) was enacted to codify and streamline much of the administration and requirements of this program, while still allowing for the SOS to promulgate regulations in furtherance of the statutory requirements. In doing so, among other things, the bill established a 90 day deadline for a victim to receive a determination on their application, and increased the overall limit that may be recovered by a claimant for a single judgment to $50,000 from $20,000. This bill now seeks to allow victims of corporate fraud to pursue compensation from the VCFCF for fraudulent acts committed by a corporation's officer or director, as specified. This bill was heard in the Senate Banking & Financial Institutions Committee on June 15, 2016, and passed out on a vote of 7-0. CHANGES TO EXISTING LAW Existing law establishes the Victims of Corporate Fraud AB 2759 (Levine) PageC of? Compensation Fund (VCFCF or fund) within the State Treasury, administered by the Secretary of State (SOS), for the sole purpose of providing restitution to the victims of a corporate fraud. (Corp. Code Section 2280). Existing law requires foreign and domestic corporations to pay a $5 disclosure fee when filing specified statements with the SOS, one-half of which must be deposited into the VCFCF. (Corp. Code Secs. 1502, 2117.) Existing law provides that, when an aggrieved person obtains a final judgment, as defined, in a court of competent jurisdiction against a corporation based upon the corporation's fraud, misrepresentation, or deceit, made with intent to defraud, the aggrieved person may, upon the judgment becoming final and after diligent collection efforts are made, file a specified application with the SOS within 18 months after judgment has become final, for payment from the compensation fund, as specified, for the amount unpaid on the judgment which represents the awarded actual and direct loss, any awarded compensatory damages, and awarded costs to the claimant in the final judgment, excluding punitive damages. (Corp. Code Sec. 2282(a)-(c).). Existing law prescribes a series of rules that must be followed by persons seeking to apply to the SOS seeking payment from the fund and imposes a series of requirements on the SOS regarding the steps he or she must take once an application for payment from the fund is submitted; the timeframes within which he or she must render a final written decision; and the steps that may be taken by claimants whose applications for payment from the fund are denied, and who wish to appeal those denials. (Corp. Code Secs. 2281-2288). Existing law caps the liability of the VCFCF at $50,000 per any one claimant per single judgment finding fraud, misrepresentation, or deceit, made with intent to defraud, regardless of the number of persons aggrieved in an instance of corporate fraud, or misrepresentation or deceit resulting in a judgment qualified for recovery under the VCFCF, as specified, or the number of judgments against a corporation. (Corp. Code Sec. 2289(a).). Existing law provides that, if, at any time, the money deposited AB 2759 (Levine) PageD of? in the VCFCF is insufficient to satisfy any duly authorized award or offer of settlement, the SOS shall, when sufficient money has been deposited in the fund, satisfy the unpaid awards or offer of settlement, in the order that the awards or offers of settlement were originally filed, plus accumulated interest, as specified, not to exceed 2 percent per year. (Corp. Code Sec. 2290.) Existing law defines final judgment to mean a judgment, arbitration award, or criminal restitution order for which appeals have been exhausted or for which the period for appeal has expired, enforcement of which is not barred by the order of any court or by any statutory provision, which has not been nullified or rendered void by any court order or statutory provision, and for which the claimant has not otherwise been fully reimbursed. Existing law provides certain examples of a final judgment, including, in relevant part, a criminal restitution order issued by a court of competent jurisdiction against a corporation for fraud, misrepresentation, or deceit, with the intent to defraud, pursuant to specified state and federal law. An application for payment from the fund that is based on a criminal restitution order must comply with specified requirements. (Corp. Code Sec. 2281(f).) This bill would expand the above example of a final judgment to provide that a final judgment also includes a criminal restitution order issued by a court of competent jurisdiction against an agent of the corporation for fraud, misrepresentation, or deceit, with the intent to defraud, pursuant to specified state or federal law. This bill would add authority for a victim of corporate fraud to recover from the VCFCF based on a criminal restitution order against an agent of the corporation, just as a victim of corporate fraud could recover from the fund based on a final judgment against a corporation. Specifically, this bill would provide that, when an aggrieved person obtains a criminal restitution order against an agent based upon the agent's fraud, misrepresentation, or deceit, made with intent to defraud while acting in the agent's capacity as the corporation's officer or director, the aggrieved person may, upon the judgment becoming final and after diligent collection efforts are made, file an application with the SOS for payment from the compensation fund, AB 2759 (Levine) PageE of? as specified under existing law. This bill would also require further documentation, as follows: if the final judgment is a criminal restitution order, the claimant must provide the charging document and the restitution order; and, if the defendant is an agent, the claimant must also provide documentation showing the defendant named in the restitution order is an agent as defined in this bill. This bill would specify that nothing in the law above authorizing victims of corporate fraud to seek recovery from the fund based upon a final judgment or criminal restitution order against a corporation or an agent of the corporation, as specified, shall be interpreted to authorize the collection of attorney's fees. This bill would specify that the Legislature finds and declares that this prohibition against collection of attorney's fees does not constitute a change in, but is declaratory of, existing law. This bill would provide that if the final judgment is a criminal restitution order against an agent, the petitioner (in an appeal upon denial of the claimant's application) shall have the burden of proving that the defendant named in the criminal restitution order qualifies as an agent as defined in this chapter. An active corporation, that has submitted a response to the application, as specified under existing law, may be permitted by the court to appear in the action regarding the sole issue of whether the defendant named in the criminal restitution order qualifies as its agent, as defined. This bill would define "agent" to mean a person who was an officer or director of a domestic or foreign corporation, as specified, at the time the fraudulent acts occurred, was named in a final criminal restitution order in connection with the fraudulent acts, and was acting in the person's capacity as the corporation's officer or director when committing the fraudulent acts. This bill would also define "judgment debtor" for the purposes of these statutes. This bill would repeal a requirement for the state to pay interest on amounts awarded from the compensation fund, when money in the fund is insufficient to satisfy any duly authorized award or offer of settlement. AB 2759 (Levine) PageF of? This bill would make other clarifying or conforming changes to other provisions of the VCFCF statutes. COMMENT 1. Stated need for the bill According to the author, "[c]urrently the Victims of Corporate Fraud Compensation Fund only allows for payment to victims who are victims of a corporation. This can be problematic given that in most cases it is an individual as opposed to an actual corporation that is charged and found guilty and ultimately restitution is ordered from. AB 2759 opens up for compensation from the [fund] to victims of an agent of a corporation as defined by the bill. [ . . .]" 2. Bill would ensure that more victims of corporate fraud can seek restitution from the Victims of Corporate Fraud Compensation Fund As discussed in the Background, California law establishes the Victims of Corporate Fraud Compensation Fund (VCFCF) to provide restitution to victims of corporate fraud who are unable to recover against a corporation against which they have received a final judgment in a court of competent jurisdiction (i.e. a California state or federal court). Specifically, when an aggrieved person obtains a final judgment, as defined, in a court of competent jurisdiction against a corporation based upon the corporation's fraud, misrepresentation, or deceit, made with intent to defraud, California law authorizes the aggrieved person, upon the judgment becoming final and after diligent collection efforts are made, to file a specified application with the Secretary of State (SOS) within 18 months after judgment has become final, for payment from the VCFCF, for the amount unpaid on the judgment which represents the awarded actual and direct loss, any awarded compensatory damages, and awarded costs to the claimant in the final judgment, excluding punitive damages. (Corp. Code Sec. 2282(a)-(c).). This bill would now authorize victims of corporate fraud who have a final judgment against a corporate agent, but not the corporation itself, to seek recovery against the VCFCF as well. AB 2759 (Levine) PageG of? First, this bill would expand existing law, to recognize that a final judgment can include a criminal restitution order<1> issued by a court of competent jurisdiction against not only a corporation, but also against an agent of the corporation, for fraud, misrepresentation, or deceit, with the intent to defraud, pursuant to specified state or federal law. The bill would then expressly authorize an aggrieved person who obtains a criminal restitution order against an agent based upon the agent's fraud, misrepresentation, or deceit, made with intent to defraud while acting in the agent's capacity as the corporate officer or director, to file an application with SOS for payment from the compensation fund, upon the judgment becoming final and after diligent collection efforts are made. The victim would have to file the application in largely the same manner and form as a victim who has a final judgment against the corporation, as well as some additional documentation supporting their final judgment against the agent, as discussed further below. Under existing law, a victim of corporate fraud could potentially seek to reach the personal assets of directors of officers of a corporation by pursuing common law theories, such as alter ego liability or by piercing the corporate veil. They could also seek to recover against directors or officers for their own tortious conduct. To this end, while directors or officers do not incur personal liability for corporate torts merely because of their official position unless they participate in the wrong or authorize or direct that it be done, they are liable for their own tortious acts on behalf of the corporation. (5 Witkin Sum. Cal. Law Torts Sec. 33 (citations omitted).) Indeed, a corporate officer or director may be liable under the rules of tort and agency for their tortious acts committed on behalf of the corporation, whether or not the corporation is also liable. (15 Cal. Jur. Corporations Sec. 305.) A corporate officer or director is, in general, personally liable for all torts that he or she authorizes or directs or in which the officer or director participates notwithstanding that he or she acted as an agent of the corporation and not on his or her own behalf. Thus, one who --------------------------- <1> A criminal restitution order is an order by a court, as part of a sentence in a criminal case, ordering a defendant to compensate the victim for losses suffered as a result of the crime. All states have laws providing that convicted defendants pay restitution to their victims. AB 2759 (Levine) PageH of? directs and participates in a corporate tort may be personally liable for both compensatory and punitive damages even if he or she derives no personal gain from the act. Additionally, the rule that all persons participating in an intentional tort are liable for the full amount of damages suffered applies to intentional torts committed by those acting in their official capacities as officers or directors of a corporation even though the corporation is also liable. (Id.) Thus, to allow for recovery where a criminal restitution order has been obtained against an agent of a corporation, based upon the agent's fraud, misrepresentation, or deceit, made with intent to defraud while acting in the agent's capacity as the corporation's officer or director, would appear to be consistent with the underlying intent of the VCFCF, which allows for corporate fund victims to obtain restitution from the fund if the final judgment were against the corporation itself. At the same time, this bill provides for reasonable measures to ensure that the SOS receives adequate documentation from which to make a determination to grant or deny an application. Under the bill, to receive compensation from the fund based on a final judgement that is a criminal restitution order and if the defendant is an agent, the claimant would have to provide the SOS with the charging document and the restitution order. If the defendant is an agent, the applicant must also provide the SOS documentation showing the defendant named in the restitution order is an agent as defined in this bill to mean an officer or director of a corporation at the time the fraudulent acts occurred, who was named in a final criminal restitution order in connection with the fraudulent acts, and who was acting in the person's capacity as the corporation's officer or director when committing the fraudulent acts. In doing so, the bill would, again, arguably stay true to the underlying purpose of the Fund being to help make whole as many victims of corporate fraud as possible, while also providing for reasonable protections to ensure that the SOS receives the documentation it needs to approve or deny an application and that the VCFCF provides restitution only where the misdeeds of the corporation are essentially attributable to the director or officer. 3. Burden would be on the claimant to prove the defendant named in a criminal restitution order qualifies as an agent upon appeal of an application AB 2759 (Levine) PageI of? Under existing law, a claimant against whom the Secretary of State (SOS) has rendered a decision denying an application may, within six months after the mailing of the notice of the denial, file a verified petition in superior court for an Order Directing Payment Out of the Victims of Corporate Fraud Compensation Fund based upon the grounds set forth in the application to the SOS. (Corp. Code Sec. 2287(a).) In such an action, existing law provides that the SOS may defend any action on behalf of the fund and shall have recourse to all appropriate means of defense and review, including examination of witnesses and the right to relitigate any issues that are material and relevant in the proceeding against the fund. However, the claimant's judgment creates a rebuttable presumption of the fraud, misrepresentation, or deceit by the corporation, which presumption shall affect the burden of producing evidence. (Corp. Code Sec. 2288(b).) That being said, if the civil judgment, arbitration award, or criminal restitution order in the underlying action on which the final judgment in favor of the petitioner was, for example, by default, stipulation, or consent, or if the action against the corporation was defended by a trustee in bankruptcy, existing law shifts the burden onto the petitioner to prove that the cause of action against the corporation was for fraud, misrepresentation, or deceit. (Corp. Code Sec. 2288(b)(2).) This bill would now add that in an appeal, above, if the final judgment is a criminal restitution order against an agent, the claimant has the burden of proving that the defendant named in the criminal restitution order qualifies as an agent as defined by this bill to mean that the person was: (1) an officer or director of a corporation at the time the fraudulent acts occurred; (2) named in a final criminal restitution order in connection with the fraudulent acts; and (3) acting in the person's capacity as the corporation's officer or director when committing the fraudulent acts. This bill would also grant the court the ability to permit an active corporation, that has submitted a response to the application as allowed under existing law, to appear in the action regarding the sole issue of whether the defendant named in the criminal restitution order qualifies as its agent as defined in this bill. Arguably, these issues would have to have been resolved by the court in the first instance, for the victim to obtain the criminal AB 2759 (Levine) PageJ of? restitution order against the director or officer to begin with, in light of the fact that a corporate director or officer does not incur personal liability for corporate torts merely because of their official position, unless they participate in the wrong or authorize or direct that it be done. (See Comment 3, above.) 4. Retroactive application of provision declaring attorney's fees not included In general, legislation is construed to be prospective unless the Legislature specifically states that it should be applied retroactively or is declaratory of existing law, as this bill would do with respect to a provision on attorney's fees. Specifically, this bill would provide that nothing in the law or this bill authorizing victims of corporate fraud to seek recovery from the fund based upon a final judgment or criminal restitution order against a corporation or an agent of the corporation, as specified, shall be interpreted to authorize the collection of attorney's fees. At the same time, however, this bill would also declare that this prohibition against collection of attorney's fees does not constitute a change in, but is declaratory of, existing law. Staff notes, however, that existing law actually suggests that attorney's fees could potentially be recovered, insofar as it authorizes an aggrieved person to apply "for the amount unpaid on the judgment [up to $50,000] that represents the awarded actual and direct loss, any awarded compensatory damages, and awarded costs to the claimant in the final judgment, excluding punitive damages." (See Corp. Code Sec. 2282 and 2289.) Feasibly, a prevailing victim could receive attorneys' fees as costs pursuant to Section 1021.5 of the Code of Civil Procedure, which provides that upon motion, "a court may award attorneys' fees to a successful party against one or more opposing parties in any action which has resulted in the enforcement of an important right affecting the public interest if: (a) a significant benefit, whether pecuniary or nonpecuniary, has been conferred on the general public or a large class of persons, (b) the necessity and financial burden of private enforcement, or of enforcement by one public entity against another public entity, are such as to make the award appropriate, and (c) such fees should not in the interest of justice be paid out of the recovery, if any." (Code Civ. Proc. Sec. 1021.5.) AB 2759 (Levine) PageK of? Staff notes that, indeed, it may be preferable to preserve existing law so that parties can receive attorneys' fees where they are awarded pursuant to Section 1021.5, though, potentially, it could cause the VCFCF to deplete at a faster rate. At the minimum, however, as a matter of public policy, it is preferable to ensure that legislation apply prospectively, so as not to change the outcome of ongoing cases in favor of one party. In this case, while the bill would not change the outcome of the underlying litigation, if a victim were to attempt to recover the cost of their attorney fees from the fund as well, this bill could make what might have been a successful claim, unsuccessful if the application is made within 90 days of January 1, 2017 (as the SOS has 90 days to render a decision on an application). Accordingly, the following amendment is suggested to amend the provision to accurately reflect existing law: Suggested amendment On page 4, line 24-27, amend the bill to read: (2) Nothing in this subdivision shall be interpreted to authorize the collection of attorney's fees , unless they are ordered by a court in the final judgment against a corporation or a criminal restitution order against an agent . The Legislature finds and declares that this paragraph does not constitute a change in, but is declaratory of, existing law. 5. Bill strikes provision authorizing interest When this Committee heard SB 1058 (Lieu, Ch. 564, Stats. 2012; see Background), one of the issues was whether a claimant should be owed interest on an original award, if the money deposited in the Fund is insufficient to satisfy an approved award or offer of settlement. The author of that bill, having in large part modeled the bill's provisions after the Department of Real Estate's (DRE) Consumer Recovery Account, which provided for four percent interest under these same circumstances, originally required that the SOS pay the claimant an additional four percent interest per year, to be added to the original award or offer once the Fund is replenished. At the time, the SOS expressed concern that while the "DRE has the ability to AB 2759 (Levine) PageL of? transfer money from a related account and to administratively raise licensing fees if the balance in the fund falls below a certain level" and can therefore afford to provide a four percent interest rate, the VCFCF would be unable to sustain such accrual of interest. In contrast to the $2.50 per disclosure fee paid into the VCFCF by any corporation filing its statement with the SOS, the DRE could collect between $4 and $7 for their fund, depending on the type of licensee paying the fee. Ultimately, recognizing the following competing interests at play, this Committee suggested a compromise whereby the claimant could recover interest at the rate set by the Federal Reserve Bank, as specified, at the time of the award or settlement offer, not to exceed 2 percent per year: With the underlying purpose of the Fund being to help make whole as many victims of corporate fraud as possible, to a reasonable degree, public policy would favor a lower interest rate that is sustainable to the Fund. In other words, it would be to the detriment of other victims to cause further depletion of the Fund at a rate that outpaces the fees going into the Fund. At the same time, once an award is made or settlement is agreed upon to compensate a victim from the Fund, a victim is arguably harmed further by not having the award or settlement satisfied immediately. This is especially the case when the victim has been defrauded out of their life savings and the award or settlement is their only remaining lifeline to recovery. (Sen. Judiciary Com. analysis of SB 1058 (2011-2012 Reg. Session) Apr. 24, 2012, p. 9.) This bill would now strike the language allowing for the claimant to recover interest in addition to their original award, if the Fund was depleted at the time of their award. Support : Crime Victims United of California; three individuals Opposition : None Known HISTORY Source : Author AB 2759 (Levine) PageM of? Related Pending Legislation : None Known Prior Legislation : SB 1058 (Lieu, Ch. 564, Stats. 2012) See Background. AB 55 (Shelley, Ch. 1015, Stats. 2002) See Background. Prior Vote : Senate Banking and Financial Institutions Committee (Ayes 7, Noes 0) Assembly Floor (Ayes 80, Noes 0) Assembly Appropriations Committee (Ayes 20, Noes 0) Assembly Banking and Finance Committee (Ayes 11, Noes 0) Assembly Judiciary Committee (Ayes 10, Noes 0) **************