Integral Development Corp v. Tolat

Filing 185

ORDER RE MOTIONS TO DISMISS. Signed by Judge JEFFREY S. WHITE on 10/25/13. (jjoS, COURT STAFF) (Filed on 10/25/2013)

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IN THE UNITED STATES DISTRICT COURT

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FOR THE NORTHERN DISTRICT OF CALIFORNIA
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INTEGRAL DEVELOPMENT CORP.,

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Plaintiff,

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For the Northern District of California

United States District Court

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No. C 12-06575 JSW

v.
VIRAL TOLAT,

ORDER RE MOTIONS TO
DISMISS

Defendant.
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Now before the Court is the motion to dismiss several claims in the First Amended

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Complaint filed by Defendant Viral Tolat (“Tolat”). Also before the Court is the motion to

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dismiss the counterclaims filed by Plaintiff Integral Development Corp (“Integral”). Having

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considered the parties’ papers, relevant legal authority, and the record in this case, the Court

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GRANTS IN PART and DENIES IN PART Tolat’s motion to dismiss and DENIES Plaintiff’s

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motion to dismiss the counterclaims.

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BACKGROUND
In its First Amended Complaint, Integral, a software development company, alleges that

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its former employee, Tolat, violated federal and state securities laws, misappropriated trade

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secrets, breached his fiduciary duties and duty of loyalty, interfered with prospective economic

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advantage, and committed various kinds of computer fraud when he left his former employment

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to negotiate employment and work for a competing company, EBS Dealing Resources (“EBS”).

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Upon his motion, Tolat moves to dismiss a number of claims in the First Amended

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Complaint, specifically, Integral’s claims for violations of federal and state securities laws

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(claims 1 and 7), for breach of the duty of loyalty (claim 5), for violations of federal and state

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anti-hacking laws (claims 9 and 10), and for injunctive relief (claim 8).

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Upon its motion, Integral moves to dismiss Tolat’s counterclaims for conversion, breach
of contract, and intentional interference with contractual relations.

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The Court shall address additional facts as necessary in the remainder of this Order.

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ANALYSIS
A.

Applicable Legal Standards.
A motion to dismiss is proper under Federal Rule of Civil Procedure 12(b)(6) where the

the light most favorable to the non-moving party and all material allegations in the complaint

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For the Northern District of California

pleadings fail to state a claim upon which relief can be granted. The complaint is construed in

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United States District Court

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are taken to be true. Sanders v. Kennedy, 794 F.2d 478, 481 (9th Cir. 1986). However, even

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under the liberal pleading standard of Federal Rule of Civil Procedure 8(a)(2), “a plaintiff’s

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obligation to provide the ‘grounds’ of his ‘entitle[ment] to relief’ requires more than labels and

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conclusions, and a formulaic recitation of the elements of a cause of action will not do.” Bell

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Atlantic Corporation v. Twombly, 550 U.S. 544, 555 (2007) (citing Papasan v. Allain, 478 U.S.

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265, 286 (1986)).

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Pursuant to Twombly, a plaintiff must not merely allege conduct that is conceivable but

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must instead allege “enough facts to state a claim to relief that is plausible on its face.” Id. at

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570. “A claim has facial plausibility when the plaintiff pleads factual content that allows the

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court to draw the reasonable inference that the defendant is liable for the misconduct alleged.”

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Ashcroft v. Iqbal, 556 U.S. 662, 668 (2009) (citing Twombly, 550 U.S. at 556). “The

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plausibility standard is not akin to a probability requirement, but it asks for more than a sheer

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possibility that a defendant has acted unlawfully. . . . When a complaint pleads facts that are

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merely consistent with a defendant’s liability, it stops short of the line between possibility and

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plausibility of entitlement to relief.” Id. (quoting Twombly, 550 U.S. at 556-57) (internal

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quotation marks omitted). “While a complaint attacked by a Rule 12(b)(6) motion to dismiss

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does not need detailed factual allegations, a plaintiff’s obligation to provide the ‘grounds’ of his

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‘entitlement to relief’ requires more than labels and conclusions, and a formulaic recitation of
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the elements of a cause of action will not do.” Twombly, 550 U.S. at 544. If the allegations are

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insufficient to state a claim, a court should grant leave to amend, unless amendment would be

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futile. See, e.g., Reddy v. Litton Indus., Inc., 912 F.2d 291, 296 (9th Cir. 1990); Cook, Perkiss

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& Liehe, Inc. v. N. Cal. Collection Serv., Inc., 911 F.2d 242, 246-47 (9th Cir. 1990).

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B.

Defendant’s Motion to Dismiss Claims in First Amended Complaint.

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1.

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In order to state a claim for violation of Section 10(b) of the Securities Act of 1934 and

Federal Securities – Claim 1.

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Rule 10b-5, a plaintiff must allege facts sufficient to establish: (1) that the defendant made a

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material misrepresentation or omission of fact; (2) that the misrepresentation was made with
scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of

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For the Northern District of California

United States District Court

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a security; (4) reliance on the misrepresentation or omission; (5) loss causation; and (6)

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economic loss. See, e.g., Dura Pharmaceutical, Inc. v. Broudo, 544 U.S. 336, 341 (2005).

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Failure to plead any of these elements requires dismissal of the claim. Applestein v.

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Medivation, Inc., 861 F. Supp. 2d 1030, 1040 (N.D. Cal. 2012).

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Tolat argues that Integral cannot state a claim for federal securities violations both

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because Integral lacks standing to bring such a claim and also because Integral has failed to

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allege that it has suffered any economic loss causally connected to Tolat’s alleged conduct. The

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basic premise of Integral’s securities claims is that Tolat failed to disclose to his former

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employer that the price set forth in its competitor’s, EBS’s, Stock Purchase Agreement,

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tendered to Integral pursuant to its right of first refusal, was artificially inflated and fraudulent,

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thereby causing Integral not to be able to exercise its right of first refusal. Tolat argues that

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because no actual contract to purchase securities was formed and no actual purchase of

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securities was ever consummated, Integral lacks standing to state a claim for federal securities

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violations. See, e.g., Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 731-32 (1975)

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(holding that standing under Rule 10b-5 in limited to purchasers and sellers of securities).

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However, the definition of a security under federal law also includes a contract to sell or

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to purchase a security, and Integral properly alleges that it exercised such a contract as to

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Tolat’s stock. See id. at 732 (holding that a “contract to purchase or sell securities is expressly
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defined by § 3(a) of the 1934 Act, 15 U.S.C. § 78c(a), as a purchase or sale of securities for the

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purposes of the Act.”)

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Tolat argues that Integral’s right of first refusal does not qualify as a contract to

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purchase or sell securities because their offer to him was so markedly different from EBS’s

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offer that it constituted a counteroffer. However, under California law, the Court must take a

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common sense approach to review the circumstances and “commercial realities” of the right of

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first refusal in order to determine whether its terms are materially equivalent to the third-party

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contract in order to qualify as a contract for sale. See Arden Group, Inc. v. Burk, 45 Cal. App.

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4th 1409, 1414-15 (1996). At this procedural posture, the Court finds that the First Amended
Complaint pleads sufficient facts to determine that Integral’s alleged exercise of its right of first

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For the Northern District of California

United States District Court

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refusal is sufficiently similar to the EBS Stock Purchase Agreement for the purpose of

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qualifying as an underlying contract to sell or purchase securities. The allegations are therefore

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sufficient to establish standing to state a claim for violation of federal securities law. See Blue

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Chip, 421 U.S. at 750-51 (holding that plaintiffs who have contractual rights or duties to

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contract to purchase or sell securities may have standing to maintain an action under the 1934

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Act).

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Tolat also contends that Integral fails to state a claim for federal securities violations

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because Integral cannot properly plead damages. To meet its burden, Integral must allege

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sufficient evidence to show a “causal connection” exists between the alleged misrepresentation

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and an actual “economic loss.” Dura Pharmaceuticals, 544 U.S. at 342. Tolat argues that

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because Integral never actually purchased his shares, it cannot allege that it was damaged by the

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purchase or sale of securities. However, at the motion to dismiss stage, a plaintiff need merely

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plead facts indicating that the alleged securities fraud caused economic loss. See id. at 338,

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346-47. Integral makes the plausible allegation that it suffered economic loss as a result of

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Tolat’s conduct. (FAC at ¶¶ 33-37.) At this procedural posture, the Court does not sit as a trier

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of fact but merely must determine whether “plaintiff alleges facts to support a theory that is not

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facially implausible.” In re Gilead Scientists Securities Litigation, 536 F.3d 1049, 1057 (9th

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Cir. 2008).
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Accordingly, the Court DENIES Tolat’s motion to dismiss the federal securities cause of
action (claim number one).

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2.

California Securities – Claim 7.

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In contrast, under California securities law, Sections 24519 and 25501 of the

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Corporations Code, “liability [is] limited to actual sellers.” In re Diasonics Securities

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Litigation, 599 F. Supp. 447, 459 (N.D. Cal. 1984). California law does not provide standing

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for a plaintiff who is neither a purchaser nor a seller of securities. No private right of action

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under the California Corporations Code exists as a result of any misrepresentation or omission

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unless there has been a completed sale of a security. See MTC Elec. Techs. Co. v. Leung, 876 F.
Supp. 1143, 1147 (C.D. Cal. 1995) (“In order to have a valid cause of action under California

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For the Northern District of California

United States District Court

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Corporations Code § 25401, [plaintiff] must allege that there was a sale or purchase of stock in

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California . . . .”). Because Integral does not, and cannot, allege there was an actual completed

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sale or purchase of securities, Integral has failed to allege that it has standing to sue under

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California securities laws.

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Accordingly, the Court GRANTS Tolat’s motion to dismiss the California state
securities cause of action (claim number seven).

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3.

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Tolat moves to dismiss Integral’s fifth claim for relief for breach of the duty of loyalty

Duty of Loyalty – Claim 5.

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on the basis that it is duplicative of Integral’s fourth claim for relief for breach of fiduciary duty

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and because Tolat claims there is no independent cause of action for breach of the duty of

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loyalty under California law. (Motion at 10, citing Mattel, Inc. v. MGA Entertainment, Inc.,

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2011 WL 8427611, at *3 (C.D. Cal. March 28, 2011).)

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However, California law recognizes that an employer may bring an independent claim

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against an employee with managerial duties for breach of the duty of loyalty. See, e.g., Stokes

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v. Dole Nut Co., 41 Cal. App. 4th 285, 295-96 (1995); see also Fowler v. Varian Associates,

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Inc., 196 Cal. App. 3d 34, 41 (1987). The elements for breach of the duty of loyalty are

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“virtually identical to those for breach of fiduciary duty” and are: “(1) the existence of a

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relationship giving rise to a duty of loyalty; (2) one or more breaches of that duty; and (3)
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damage proximately caused by that breach.” Fields v. QSP, Inc., 2011 WL 1375286, at *3

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(C.D. Cal. April 8, 2011). “Although they are similar, breach of fiduciary duty and breach of the

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duty of loyalty are two distinct claims under California law.” Id. at *3 n.3.

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Accordingly, the Court DENIES Tolat’s motion to dismiss the cause of action for breach
of the duty of loyalty (claim number five).

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4.

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Integral alleges two causes of action for violation of the Computer and Fraud Abuse Act

Anti-Hacking Laws – Claims 9 and 10.

California Penal Code § 502. These anti-hacking statutes prohibit the unauthorized use of any

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computer system for improper or illegitimate purpose. The CFAA prevents criminal hacking

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For the Northern District of California

(“CFAA”), 18 U.S. C. § 1030, and the Comprehensive Computer Data Access and Fraud Act,

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United States District Court

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and is designed to punish “the circumvention of technological access barriers – not

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misappropriation of trade secrets.” United States v. Nosal, 676 F.3d 854, 857 (9th Cir. 2012).

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The Ninth Circuit has rejected the contention that the terms “exceeds authorized access” within

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the meaning of the CFAA applies where someone has access to a computer’s information but is

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limited in permissible use of that information. Id. The plain language of the CFAA “target[s]

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the unauthorized procurement or alteration of information, not its misuse or misappropriation.”

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Id. at 863.

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Integral does not and cannot allege that Tolat gained improper or unauthorized access to

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Integral’s computers for illegitimate purpose. Rather, Integral alleges that Tolat “copied,

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downloaded and removed numerous Integral source code files . . . when he clearly had no

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legitimate reason to do so.” (FAC at ¶ 52.) Integral does not allege that Tolat used improper

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methods to gain access to the source code, but rather concedes, as it must, that at the time of the

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alleged acquisition of the materials, Tolat was working for Integral and had access to virtually

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all of Integral’s trade secret information and confidential and proprietary intellectual property.

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(Id. at ¶¶ 3, 16.)

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Accordingly, the Court GRANTS Tolat’s motion to dismiss the cause of action for
violation of anti-hacking laws (claims 9 and 10).

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5.

Declaratory Relief – Claim 8.

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Lastly, Tolat moves to dismiss Integral’s claim for declaratory relief under Federal

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Rules of Civil Procedure 57 and the Declaratory Judgment Act (“DJA”), 28 U.S.C. § 2201,

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2202. The DJA provides in pertinent part that “any court of the United States, upon the filing of

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an appropriate pleading, may declare the rights and other legal relations of any interested party

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seeking such declaration.” 28 U.S.C. 2201. The purpose of a declaratory judgment is to

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“declare future rights of a party and not to remedy past harms.” Rebel Communications, LLC v.

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Virgin Valley Water District, 2013 WL 4520855, at *1 (D. Nev. Aug. 26, 2013). The purpose

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of a declaratory judgment is to set forth a declaration of future rights. Societe de
Conditionnement en Aluminum v. Hunter Engineering Co., 655 F.2d 938, 943 (9th Cir. 1981);

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For the Northern District of California

United States District Court

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see also Edejer v. DHI Mortgage Co., 2009 WL 1684714, at *31 (N.D. Cal. June 12, 2009)

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(“The purpose of a declaratory judgment is to set controversies at rest before they cause harm to

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the plaintiff, not to remedy harms that have already occurred.”)

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Declaratory judgment is appropriate when the parties seek to resolve “an actual

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controversy that has not reached a stage at which either party may seek a coercive remedy and

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in cases where a party who could sue for coercive relief has not done so.” Williams v. Bank of

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America, 2013 WL 1907529, at *5 (E.D. Cal. May 7, 2013) (citing Seattle Audubon Soc. v.

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Moseley, 80 F.3d 1401, 1405 (9th Cir. 1996)). “Declaratory relief should be denied when it will

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neither serve a useful purpose in clarifying and settling the legal relations in issue nor terminate

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the proceedings and afford relief from the uncertainty and controversy faced by the parties.”

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United States v. State of Washington, 759 F.2d 1353, 1357 (9th Cir. 1985).

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Here, Integral’s eighth claim for relief does not seek an order declaring the rights and

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legal relations of the parties, but rather seeks discovery and injunctive remedies that are both

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duplicative of the relief it seeks for its other substantive causes of action and seeks to remedy

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past harms. The Court finds the eighth cause of action for declaratory relief is not supportable

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as a separate and independent cause of action. Accordingly, the Court GRANTS Tolat’s motion

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to dismiss the cause of action for declaratory and injunctive relief (claim 8).

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C.

Integral’s Motion to Dismiss the Counterclaims.

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Integral moves to dismiss Tolat’s counterclaims sounding in tort (the first and third

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counterclaims for conversion and intentional interference with contractual relations) on the

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basis that the allegations sound in contract. Under California law, conduct amounting to a

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breach of contract may only become grounds for a claim in tort if such conduct violates

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independent duties arising under principles of tort law. See Erlich v. Menezes, 21 Cal. 4th 543,

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551 (1999). Any potential remedies for breach of contract are restricted only to contract

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damages. See Freeman & Mills, Inc. v. Belcher Oil Co., 11 Cal. 4th 85, 105-06 (1995).
In his counterclaims, however, Tolat alleges that Integral engaged in wrongful conduct

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For the Northern District of California

United States District Court

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Tort Claims.

beyond the breach of their agreement. Tolat alleges that Integral did not exercise its right of

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first refusal, but instead and working outside of the bounds of the contract, took away his shares

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of stock, paid him nothing, and prevented him from completing his sale of stock to EBS. At this

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procedural posture and assuming the allegations are true as it must, the Court finds that Tolat

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has asserted more than merely breaching the contract terms, but rather has alleged wrongful

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actions of self-help stock cancellation. (See Counterclaims ¶ 46-47.) Because the tort claims

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are premised upon conduct alleged to have been performed outside the basic terms of the

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parties’ agreement, the Court finds Integral’s contention that the claims merely sound in

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contract to be unpersuasive.

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2.

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Integral moves to dismiss Tolat’s counterclaim for intentional interference with

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contractual relations on the basis that the claim is facially illogical. To state a cause of action

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for intentional interference with contractual relations, “a plaintiff must show: (1) an economic

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relationship between the plaintiff and some third party, with the probability of future economic

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benefit to the plaintiff; (2) the defendant’s knowledge of the relationship; (3) intentional acts on

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the part of the defendant designed to disrupt the relationship; (4) actual disruption of the

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relationship; and (5) economic harm to the plaintiff, which is proximately caused by the acts of

Claim for Intentional Interference with Contractual Relations.

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the defendant.” Alpha Investment, LLC v. Zynga, Inc. 2012 WL 2135291, at *6 (N.D. Cal. June

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12, 2012) (citing Korea Supply Co. v. Lockheed Martin Corp., 29 Cal. 4th 1134, 1153 (2003)).

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Integral argues that it “did nothing illegal at all and acted entirely within its rights to

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exercise its [right of first refusal].” (Motion at 11.) On this premise, Integral contends that a

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right of first refusal holder cannot be held liable for interfering with a third-party contract. (See

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id. (citing Crivelli v. General Motors Corp., 215 F.3d 386, 395 (3d Cir. 2000) (“While

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[defendant’s] exercise of its contractual right of first refusal necessarily interfered with the

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purchase agreement between [plaintiff] and [the third-party], it does not subject [defendant] to

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liability for interfering with their contract.”)).
Here, however, Tolat alleges that Integral did not exercise its right of first refusal, but

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For the Northern District of California

United States District Court

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rather, acting outside of the scope of the parties’ agreement, canceled the value of his stock and

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thereby interfered with a known agreement for sale of that same stock to EBS. Again, at this

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procedural posture and assuming the allegations are true as it must, the Court finds that Tolat

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has alleged sufficient facts to state a cause of action for intentional interference with contractual

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relations.

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3.

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Integral next argues that the litigation privilege requires dismissal of Tolat’s tort

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counterclaims on the basis that these claims are premised upon Integral’s communications made

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in vindication of Integral’s rights under the right of first refusal which are the subject of the

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instant litigation. The litigation privilege under California Code of Civil Procedure Section

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47(b) applies to communications made by a litigant in connection with a judicial proceeding to

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achieve the object of litigation. See, e.g., Oei v. N. Star Capital Acquisitions, LLC, 486 F. Supp.

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2d 1089, 1099 (C.D. Cal. 2006).

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Litigation Privilege.

The litigation privilege shields, among other things, any “publication or broadcast”

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made “in any . . . judicial proceeding.” Its “principal purpose is to afford litigants and witnesses

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the utmost freedom of access to the courts without fear of being harassed subsequently by

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derivative tort actions.” Olszewski v. Scripps Health, 30 Cal. 4th 798, 830-31 (2003). This

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privilege is “absolute, not qualified.” Visto Corp. v. Sproqit Technologies, Inc., 360 F. Supp. 2d
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1064, 1068 (N.D. Cal. 2005). The privilege applies to any communication (1) made in a

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judicial or quasi-judicial proceeding, (2) by litigants or other participants authorized by law, (3)

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to achieve the objects of litigation, (4) and which has some connection or logical relation to the

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action. See Silberg v. Anderson, 50 Cal. 3d 205, 212 (1990).

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Here, however, Tolat’s tort allegations are based on cancellation of Tolat’s shares of

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stock and therefore are premised upon Integral’s noncommunicative conduct. Accordingly, the

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litigation privilege does not apply to bar Tolat’s tort claims.

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4.

Judicial Estoppel.

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Lastly, Integral argues that Tolat is judicially estopped from seeking to assert an
inconsistent position in this litigation. Integral contends that during the proceedings over its

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For the Northern District of California

United States District Court

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request for a temporary restraining order, Tolat represented that “[w]ith respect to Dr. Tolat’s

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stock, Integral has a right of first refusal and, if Integral objects to the stock sale, it can simply

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refuse to recognize the transfer. These significant factual issues justify denial of Integral’s

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request [for a restraining order].” (Opp. Br. to Motion for TRO at 2.) Tolat’s argument that, if

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he had violated the parties’ stock purchase agreement, Integral could decline to transfer under

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the contract’s terms, is not inconsistent with his current position that he complied with the

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agreement, but regardless Integral cancelled his stock value. Accordingly, Tolat’s claims are

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not barred by the doctrine of judicial estoppel.

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CONCLUSION

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For the foregoing reasons, the Court GRANTS IN PART and DENIES IN PART Tolat’s
motion to dismiss and DENIES Plaintiff’s motion to dismiss the counterclaims.

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IT IS SO ORDERED.

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Dated:

October 25, 2013
JEFFREY S. WHITE
UNITED STATES DISTRICT JUDGE

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