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Valmed Management Corp. v. Jess Medical Systems, L.L.C.

A-2947-05T1 (N.J. Super. App. Div. 2007) (Unpublished)

CORPORATIONS; VEIL PIERCING — A claim of equitable fraud to pierce a corporation’s veil and hold its shareholders individually liable for alleged breach of contract is not viable because the remedies for equitable fraud are limited to rescission or reformation of an agreement, not monetary damages.

A seller of medical equipment entered into a contract with a dealer to make the dealer an authorized seller of the company’s “medical manager” software and service and to manage customer accounts for the software. The dealer was owned by two individuals, each of whom were required, under the terms of the contract, to pay the medical company for the accounts, and then split the remaining profits evenly. The seller and the dealer were bound by a contract which stipulated the terms of the agreement, and included a provision granting the seller a security interest in the dealer’s accounts and allowing the seller to retake possession and control of all the dealer’s accounts in the event that the dealer defaulted on the contract. One of the dealer’s co-owners engaged in fraudulent activity with respect to the customer accounts, depositing some of the revenue into her personal bank account. This resulted in the seller not receiving its commission. The other co-owner of the dealer investigated the fraud and ordered it to stop, however, he did not seek any disciplinary action against the fraudulent co-owner, except requiring her to pay to the seller the money absconded by her. Following continued disputes, the seller decided to enforce its security interests in the accounts, and sent notification to each individual account instructing that future payments be made directly to it, and advising that the accounts would be handled by a new authorized dealer. The dealer responded by sending a letter to each account, denying the validity of the seller’s instructions, and requesting the payments be made directly to it.

The seller sued the dealer seeking damages for breach of contract, fraud, damages to the seller’s computer system, and also seeking “equitable relief” in the form of enjoining the dealer from further servicing any of the seller’s accounts. Before the case went to trial, the parties entered into a stipulation agreement, and the matter was stayed. At this time, the woman who committed the fraud bought out her partner. Soon thereafter, the seller sued again. This suit sought damages identical to the previous suit, but also included a claim for conversion. The suit named the dealer, the co-owner who had committed the fraud, her husband, and the co-owner who had been bought out.

All but the dealer’s owner who had sold out settled. The remaining claim against him was tried to a jury, which returned a verdict in his favor, finding that the seller had not proven, by a preponderance of the evidence, that the dealer’s ex-owner knew of or made any misrepresentations to the seller. During this entire period following commencement of the first suit, the seller never sought to enjoin the dealer from servicing the accounts. The seller appealed.

On appeal, the seller asserted that the lower court erred in dismissing its claim for conversion against the dealer’s former co-owner; that he was liable as a matter of law for the fraud committed by the dealer; and that the corporate veil should have been pierced, thus rendering the former-co-owner liable for breach of contract. The Appellate Division rejected each of these arguments. First, the Court held that the former owner could not be held liable for conversion because the tort of conversion requires a demand for return of the converted chattel and a refusal to make such a return. Here, the Court observed that although the seller had made demands at one point to each individual account requesting that payments be made to it rather than the dealer, the seller had never thereafter made any affirmative steps to take control of the accounts, or to prevent the dealer from servicing them. The Court construed this as a ratification of the seller’s original grant of power over the accounts, stating that “[r]atification is ‘equivalent to an original grant of power, ... and relates back to the date of the original action[.]’” The Court additionally rejected the seller’s other rationale for its conversion claim, that its security interest in the accounts’ revenue continued to attach even after it was collected by the dealer, and that such payments constituted conversion by the former owner of the seller’s interest in the accounts. Under the Uniform Commercial Code (UCC), “a security interest attaches to any identifiable proceeds of collateral.” Here, however, the seller did not even attempt to specifically identify the proceeds as distinct from other co-mingled funds.

The Court next held that the former-owner was not collaterally estopped from contesting the seller’s fraud and conversion claims just because the former-owner did not take part in those proceedings. The Court then held that the lower court did not err in denying summary judgment to the seller on its fraud claims because the former-owner was not aware that fraud was taking place at the time the fraudulent co-owner made misrepresentations to the seller regarding the account. Additionally, as a 50% partner, the Court noted that the fraudulent co-owner could not have simply been fired by the former-owner. The Court therefore concluded that the seller had not proven that as a matter of law, the former owner had ratified the fraudulent owner’s conduct. Finally, the Court rejected seller’s claim that the lower court erred in refusing to consider its claim of equitable fraud to pierce the dealer’s corporate veil and hold the former-owner individually liable for the dealer’s alleged breach of contract. It reasoned that the claim could not be considered because the remedies for equitable fraud are limited to rescission or reformation of an agreement, not monetary damages, and that because the seller had not sought such equitable damages, this claim could not be considered. The Court therefore dismissed the seller’s claim in its entirety.

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