Doty v. Meruelo

Filed 10/16/07 Doty v. Meruelo CA2/8

NOT TO BE PUBLISHED IN THE OFFICIAL REPORTS

California Rules of Court, rule 8.1115(a), prohibits courts and parties from citing or relying on opinions not certified for publication or ordered published, except as specified by rule 8.1115(b). This opinion has not been certified for publication or ordered published for purposes of rule 8.1115.

IN THE COURT OF APPEAL OF THE STATE OF CALIFORNIA

SECOND APPELLATE DISTRICT

DIVISION EIGHT

APPEAL from a judgment of the Superior Court of Los Angeles County, Conrad A. Aragon, Judge. Reversed in part; affirmed in part.

Ayscough & Marar, Sidney Lanier and Brent Ayscough for Plaintiffs and Appellants.

Fairbank & Vincent, Dirk L. Vincent and Richard D. Gluck for Defendants and Respondents.

* * * * * *

This case concerns the sale of a family owned business, Doty Bros. Equipment Co. (Doty Bros.), which engages in the laying of underground pipe. The sellers,^[1]plaintiffs below, appeal from a summary judgment in favor of the purchaser, Meruelo Enterprises, Inc. (Meruelo Enterprises), and other defendants.^[2] Meruelo Enterprises cross-appeals from an order of dismissal (judgment) of its cross-complaint seeking attorney fees incurred in defending a prior federal action prosecuted by John Doty. We find a triable issue of fact concerning whether Meruelo Enterprises breached the covenant of good faith and fair dealing implied in the sale agreements and therefore reverse the summary judgment. Finding no error in the denial of attorney fees and costs for defending the federal action, we affirm the order of dismissal.

FACTS

The sellers sold their shares in Doty Bros. to Meruelo Enterprises for $15 million cash. In addition to the purchase price of $15 million, article 11 of the Stock Purchase Agreement (agreement), entitled Buyers Obligations After Closing, included two relevant provisions that the sellers contend effectively added $1 million to the purchase price. Article 11, section 2, entitled Employee Bonus Compensation, required Meruelo Enterprises to pay a total of $250,000 in bonuses to key employees of Doty Bros. designated by the sellers. Article 11, section 3, entitled Performance Award Plan, required Meruelo Enterprises [o]n or before January 2, 2001, [to] cause Doty Bros. to implement a performance and/or incentive award plan for [Doty Bros.] employees with a minimum aggregate award amount equal to seven hundred fifty thousand dollars ($750,000.00). The agreement further contained an integration clause providing: This Agreement constitutes the entire agreement between the parties pertaining to the subject matter contained in it and supersedes all prior and contemporaneous agreements, representations, and understandings of the parties. No supplement, modification, or amendment of this Agreement will be binding unless executed in writing by all the parties.

After the 2000 sale, Meruelo Enterprises paid $250,000 to designated Doty Bros. employees as called for under the agreement.

Meruelo Enterprises also created the Doty Bros. Equipment Company 2001 Performance Award Plan (plan). The plan established a phantom stock, designed to provide participants with cash payments equivalent to amounts they would receive under a stock option program without granting them an actual interest in the company. Under the plan, once vested, participants were to be awarded performance shares, which could be cashed in for the difference between the value of the shares on the date of exercise and their value on the initial award date. The plan provided a formula for determining share value based upon Doty Bros.s earnings before interest, tax, depreciation and amortization (EBITDA). By its terms, the plan was to be administered by a committee appointed by the Doty Bros.s board of directors. The committee had the power to select recipients of awards, determine the number of shares to be awarded and establish the value of the awards. The plan also gave the committee the power to amend or terminate the plan at any time. Crucially, the plan did not mention a specific dollar amount required to fund the plan but provided that [t]he number of Performance Shares that may be issued under the Plan . . . is 750,000.00 [sic].

Meruelo Enterprises first delivered a copy of the plan and a list of performance share recipients to the sellers through attorney Hartman in mid-2002. When they viewed the plan, the sellers were dissatisfied with a number of aspects of the plan, including a five-year vesting period for awards, the 2001 and 2002 award recipients (largely employees of Meruelo Enterprises and relatives of Alex Meruelo rather than longtime employees of Doty Bros.) and, most importantly, [t]he ability of Meruelo to take away the conferred benefit. The sellers contemplated litigation against Meruelo Enterprises if the issues were not resolved.

In November 2002, the parties and their attorneys met to discuss their disagreements over the plan, as well as other issues related to the agreement. At the meeting, the parties agreed to resolve these disputes in a written Amendment to Stock Purchase Agreement (amended agreement), the wording of which was negotiated over the next several months by attorney Hartman, with the assistance of outside counsel, acting for the sellers and by counsel for Meruelo Enterprises.

In the amended agreement, the parties confirmed that a dispute had arisen between them regarding whether the plan implemented by Meruelo Enterprises complied with its obligations under the agreement. To resolve their differences concerning the plan, the parties agreed to amend the plan in form of a First Amendment to Doty Bros. Equipment Company 2001 Performance Award Plan (amended plan). They attached copies of both the plan and the amended plan as exhibits to the amended agreement. The changes made by the amended plan included a more favorable vesting provision and elimination of a five-year nonsolicitation provision. The parties also specifically agreed in the amended agreement that the amended plan complies with Buyers obligations under [a]rticle 11, [s]ection 3 of the [agreement].^[3] The amended plan did not provide for the plan to be funded with any specified amount of money but only provided that [t]he number of Performance Shares that shall be issued under the Plan during the term of the Plan is 750,000. The value of the performance shares to be issued under the plan as amended was therefore also not tied to any dollar amount.

The financial performance of Doty Bros., as measured by its EBITDA under the plan, purportedly was never sufficient to yield a positive value for the performance awards. By September 2003, the company concluded awarded performance shares had poor prospects for a positive value in the near future. The Doty Bros.s board of directors therefore terminated the plan and offered award recipients a payment of $0.50 per share in exchange for a release of all claims. Some award recipients accepted the offer but others did not. Of eligible plan beneficiaries, 27 neither settled their claim nor brought suit. As set forth below, one plan beneficiary, a retired longtime Doty Bros. employee, Dale Barrows (Barrows), joined with the sellers in bringing this action.

PROCEDURAL HISTORY

1. The Prior Federal Action

In October 2003, Floyd Doty, in his capacity as a seller trustee, sued Meruelo Enterprises in the United States District Court for alleged violations of the Employee Retirement Income Security Act of 1974 (ERISA), title 29 United States Code section 1001 et seq.^[4] The federal complaint alleged that Floyd Doty entered into a written contract with Meruelo Enterprises, pursuant to which Meruelo Enterprises was required to pay $750,000 into an ERISA plan. Under the alleged ERISA plan, Floyd Doty was to have approval over the beneficiaries and the amounts to be awarded.

In February 2005, the district court found the alleged plan was not subject to ERISA and granted a motion to dismiss the case for lack of subject matter jurisdiction. The court ruled that the plaintiffs had failed to produce any facts sufficient for a reasonable trier of fact to find that [Meruelo Enterprises] promised a plan other than the Performance Award Plan. The court concluded the plan was a bonus program excluded from ERISA coverage and there was therefore no basis for federal court jurisdiction.

Meruelo Enterprises sought attorney fees in the federal action, but the district court denied the motion, ruling that it could not grant such fees under ERISA without an ERISA claim and that it lacked jurisdiction to enforce a contract between the parties.

2. The Present Complaint

In March 2005, the sellers, joined by Barrows, brought the present action against Meruelo Enterprises in the state court. The complaint alleged fraud, promissory fraud, breach of fiduciary duty, constructive fraud, conversion, rescission, constructive trust and breach of contract. The sellers alleged they had discounted their sale price for Doty Bros. by $1 million in consideration for a promise by Meruelo Enterprises to pay $1 million in benefits to existing Doty Bros. employees.

The complaint alleged that, as an inducement for the sellers to sell their stock in Doty Bros., Meruelo Enterprises promised to pay $250,000 in cash to selected Doty Bros. employees and use the remaining $750,000 to fund an ERISA plan as good or better than Doty Bros.s existing defined benefit pension and profit sharing plans. It was further alleged the sellers understood that Floyd Doty and John Doty would have the right to select the beneficiaries of the ERISA plan and to direct the plan until the remaining $750,000 was paid to Doty Bros. employees of their selection. The complaint also alleged the plan was to provide beneficiaries with stock, which either could be redeemed immediately for $1.00 per share or retained for later redemption at the future value of the share at the beneficiarys option.

The sellers alleged Meruelo Enterprises paid $250,000 to selected Doty Bros. employees as promised. However, Meruelo Enterprises allegedly failed to provide the sellers at the time of sale with details for the proposed trust and proposed plan to implement the trust with the remaining $750,000. They alleged it was not until June 2002 that Meruelo Enterprises first presented the plan to the sellers; even then, the proposed plan did not include the expected $750,000 fund for plan beneficiaries. The complaint alleged Meruelo Enterprises never funded the trust but instead converted the $750,000 to itself and fraudulently manipulated the valuation of the Doty Bros. shares to find a reason to terminate the plan.

Meruelo Enterprises moved for summary judgment against the sellers and for summary adjudication against Barrows. The motion against the sellers centered on three arguments. First, Meruelo Enterprises argued that, after receiving the original plan and raising their concerns, the sellers entered into a written, integrated agreement, i.e., the amended agreement, in which Meruelo Enterprises agreed to amend the plan and the sellers agreed the plan as amended satisfied the terms of the original agreement; therefore, the parol evidence rule prevents the sellers from contradicting those written terms. Second, because the federal district court determined the sellers were promised no plan other than the plan implemented by Meruelo Enterprises, collateral estoppel prevents the sellers from arguing otherwise. Third, insofar as the sellers claims are based on Meruelo Enterprises operation of the plan, the sellers lack standing because none of them is a plan participant.^[5]

The court below granted the motion for summary judgment against the sellers, ruling the parol evidence rule barred their action, collateral estoppel applied and Meruelo Enterprises had discharged its duty to the sellers for the benefit of third party beneficiary Doty Bros. employees by instituting the amended plan. Judgment was entered for Meruelo Enterprises against the sellers on the complaint, and the sellers timely appealed from the judgment.

However, the trial court denied the motion for summary adjudication as to Barrows in part, allowing his action against Meruelo Enterprises to proceed on theories of breach of fiduciary duty, constructive fraud and conversion.

3. The Amended Cross-complaint

Meruelo Enterprises filed an amended cross-complaint in this action asserting two causes of action against the Doty family. In the second cause of action, Meruelo Enterprises sought recovery of contractual attorney fees and costs for its prior defense of the federal action. The court sustained a demurrer to the second cause of action without leave to amend, ruling that the prior federal action was not brought under the agreement but rather under the plan, and the plan contained no provision for attorney fees. Meruelo Enterprises dismissed the first cause of action without prejudice in order to file an immediate appeal, and the court then entered an order of dismissal of the cross-complaint.^[6] Meruelo Enterprises timely appealed the order of dismissal.

DISCUSSION

1. The Trial Court Improperly Granted Summary Judgment Against the Sellers

Our standard of review is well established: Because plaintiff[s] appeal[] from an order granting defendants summary judgment, we must independently examine the record to determine whether triable issues of material fact exist. [Citations]. (Saelzler v. Advanced Group 400 (2001) 25 Cal.4th 763, 767.) Moreover, [i]n performing our de novo review, we must view the evidence in a light favorable to plaintiff[s] as the losing part[ies] [citation], liberally construing [plaintiffs] evidentiary submission while strictly scrutinizing defendants own showing, and resolving any evidentiary doubts or ambiguities in plaintiff[s] favor. [Citations.] (Id. at pp. 768-769.)

In granting summary judgment against the sellers, the trial court found no triable issue of fact that there was an arms length negotiation between two sophisticated commercial parties. The court ruled the sellers claim that Meruelo Enterprises was obligated to fund the plan with $750,000 was inconsistent with the expressed terms of the integrated amended agreement and constituted inadmissible parol evidence. The court also ruled collateral estoppel precluded the sellers from relitigating issues the federal district court had previously decided and that decision precluded the sellers from asserting that Meruelo Enterprises promised them a plan other than the amended plan at issue. The sellers contend the trial court erred in making these determinations.

We find the trial court incorrectly applied the doctrine of collateral estoppel to this case, that there is a triable issue of fact whether Meruelo Enterprises improper operation of the plan constituted a breach of the implied covenant of good faith and fair dealing contained in the written agreements, and that the sellers have standing to maintain the action. We therefore find the trial court erred in granting summary judgment against the sellers.^[7]

A. Collateral Estoppel

In California, the predominate view is that the trial courts application of collateral estoppel is reviewed de novo. (Smith v. Exxon Mobil Oil Corp. (2007) 153 Cal.App.4th 1407, 1415.) Collateral estoppel, or issue preclusion, precludes relitigation of issues that have been previously adjudicated. (Lucido v. Superior Court (1990) 51 Cal.3d 335, 341.) The threshold requirements for issue preclusion are: (1) the issue must be identical to that decided in the former proceeding, (2) the issue must have been actually litigated in the former proceeding, (3) the issue was necessarily decided in the former proceeding, (4) the decision in the former proceeding is final and was on the merits and (5) the party against whom preclusion is sought was a party or in privity with a party to the former proceeding. (Ibid.; Castillo v. City of Los Angeles(2001) 92 Cal.App.4th 477, 481 (Castillo).) When these requirements are satisfied, the court additionally looks to whether application of collateral estoppel will further the public policies of preserving the integrity of the judicial system, promoting judicial economy and protecting litigants from harassment by vexatious litigation. (Lucido, at pp. 342-343; Castillo, at p. 481.)

These requirements are not satisfied in this case because the first, second and third elements are not present. The issue before us is not substantively identical to that decided in the federal action, was not actually litigated in that proceeding and was not necessarily decided by the district court.

Specifically, the plaintiffs in the federal complaint alleged the federal court had jurisdiction based on the existence of an ERISA plan that they claim [Meruelo Enterprises] promised to provide. Meruelo Enterprises moved to dismiss the federal action based on a lack of subject matter jurisdiction. The district court resolved that issue by finding the alleged plan, as promised or effected, was not an ERISA plan but a bonus program over which the court had no jurisdiction. The district court concluded the plan was excluded from ERISA coverage and therefore there was no basis for federal jurisdiction.

Once the court determined it had no jurisdiction over the subject matter, that was the end of the inquiry. Determinations such as what contractual obligations Meruelo Enterprises was to perform or whether it properly performed under the parties agreements were not necessary to the federal court decision. Such issues were not actually litigated and not necessarily decided by the federal court. Although the district court purported to also determine that Floyd Doty had not produced any facts sufficient for a reasonable trier of fact to find that Meruelo Enterprises promised a plan other than the plan at issue, that finding must be read in context only of whether subject matter jurisdiction existed in the federal courts. The limited nature of the district courts finding is made clear by that courts subsequent denial of attorney fees to Meruelo Enterprises on the ground that a district court cannot grant attorneys fees pursuant to ERISA without an ERISA claim. Indeed, the federal court explained that [b]ecause the Court lacks subject matter jurisdiction over the dispute . . . , it follows that the Court is without jurisdiction to enforce any terms under the contract . . . . It logically follows that the federal court was also without jurisdiction to determine the terms of the parties contractual agreement, other than it provided for no ERISA plan.

Since Meruelo Enterprises fails to satisfy essential elements for collateral estoppel, we need not address the remaining elements or whether application of collateral estoppel under these circumstances would further the integrity of the judicial system, promote judicial economy or protect litigants from harassment by vexatious litigation. (Lucido, supra, 51 Cal.3d at pp. 342-343; Castillo, supra, 92 Cal.App.4th at p. 481.) However, we note that public policy would not be served by divesting a litigant of unadjudicated state-based claims, nor would the cause of justice or judicial economy be furthered by foreclosing a litigant from a full and fair hearing in the state courts. Indeed, in the federal action the court dismissed any pendent state law claims under its discretionary authority pursuant to United Mine Workers of America v. Gibbs (1966) 383 U.S. 715. In Gibbs, the high court noted that pendent state claims may be dismissed in light of considerations of judicial economy, convenience and fairness to litigants and that if it appears that the state issues substantially predominate, whether in terms of proof, of the scope of the issues raised, or of the comprehensiveness of the remedy sought, the state claims may be dismissed without prejudice and left for resolution to state tribunals. (Id. at pp. 726-727, italics added.) It would ill serve the cause of justice for Floyd Doty to have been denied a federal forum out of considerations of judicial economy, convenience and fairness and for the sellers (including Floyd Doty) then to be precluded from a hearing in the state courts. The sellers are entitled to have their day in court.

B. Breach of Duty of Good Faith and Fair Dealing

The sellers contend the trial court erred in granting summary judgment because there were future duties after the amended agreement that Meruelo Enterprises failed to perform. In the court below, the sellers alleged and provided evidence in opposition to the motion for summary judgment that Meruelo Enterprises engaged in improper conduct in operating the plan and amended plan, including: failing to fund the plan, computing the value of award shares by an incorrect formula, using fraudulent accountings of company performance, computing the value of award shares by using the incorrect number of Doty Bros. shares, artificially lowering the value of award shares by fraudulent insurance and management fees charged to Doty Bros., allowing appointment of beneficiaries other than Doty Bros. employees, and terminating the amended plan without written consent of the participants.

Insofar as the sellers claim the plan as amended was improperly operated or terminated by Meruelo Enterprises, we find a triable issue of fact whether Meruelo Enterprises breached the duty of good faith and fair dealing.^[8]

As this court has stated in similar circumstances, the covenant of good faith and fair dealing, which is implied in every contract,  not only imposes upon each contracting party the duty to refrain from doing anything which would render performance of the contract impossible by any act of his own, but also the duty to do everything that the contract presupposes that he will do to accomplish its purpose. [Citation.] (Pasadena Live v. City of Pasadena (2004) 114 Cal.App.4th 1089, 1093 (Pasadena Live); see 1 Witkin, Summary of Cal. Law (10th ed. 2005) Contracts, 798, pp. 892-893.) Breach of a specific contractual provision is not a prerequisite to asserting a claim for breach of the duty of good faith and fair dealing. (Benach v. County of Los Angeles (2007) 149 Cal.App.4th 836, 855, fn. 12, citing Carma Developers (Cal.), Inc. v. Marathon Development California, Inc. (1992) 2 Cal.4th 342, 373.) At heart,   the covenant is implied as a supplement to the express contractual covenants, to prevent a contracting party from engaging in conduct which (while not technically transgressing the express covenants) frustrates the other partys rights to the benefits of the contract.   (Benach, supra, 149 Cal.App.4th 836, 855, fn. 12.)

In this case, the parties originally contracted in article 11, section 3 of the agreement that Meruelo Enterprises would cause [Doty Bros.] to implement a performance and/or incentive award plan for [Doty Bros.] employees with a minimum aggregate award amount equal to seven hundred fifty thousand dollars ($750,000.00). The parties therefore contracted to establish a performance and/or incentive award plan for the benefit of Doty Bros. employees. In the amended agreement, the parties further agreed that the amended performance plan attached as an exhibit to the amended agreement complies with [Meruelo Enterprises] obligations under [a]rticle 11, [s]ection 3 of the agreement. There was no triable issue of fact that Meruelo Enterprises did not breach an express provision of the integrated agreement between the parties. But the complaint is replete with allegations, and the sellers produced evidence in opposing summary judgment, of numerous acts by Meruelo Enterprises that would violate  the duty to refrain from doing anything which would render performance of the contract impossible.  (Pasadena Live, supra, 114 Cal.App.4th at p. 1093.) These allegations are sufficient to raise a triable issue whether Meruelo Enterprises violated its duty of good faith and fair dealing to the sellers. (See Foley v. U. S. Paving Co. (1968) 262 Cal.App.2d 499, 505-506 [defendant violated implied duty of good faith by unilaterally increasing officers salaries and siphoning off profits, thereby decimating plaintiffs incentive clause in employment contract]; see also 1 Witkin, Summary of Cal. Law, supra,  808, pp. 900-901.)

The trial court failed to take the sellers allegations and evidence into account in entering summary judgment for Meruelo Enterprises. It is significant that the court entered judgment against the sellers while allowing the claims of Barrows, at least in part, to proceed to trial. Specifically, the court found that to the extent Barrows alleges the value of his award shares has been diminished by Meruelo Enterprises fraudulent manipulations of [Doty Bros.s] book value, in addition to his allegations that he has been pressured to take less than his shares are worth, his claims may proceed. The court noted Meruelo Enterprises did not negative ‑‑ although [it] obviously den[ies] ‑‑ Barrows assertion that the share value has been fraudulently manipulated, causing him money damage as the holder of 21,500 shares. The same could be said with respect to the claims made by the sellers. There are facts, albeit disputed, that show that Meruelo Enterprises engaged in a series of actions that were designed to prevent the amended plan from being activated. If true, these facts show that Meruelo Enterprises acted to frustrate the purpose of the contract.

Meruelo Enterprises contends there are no triable issues of fact regarding whether the implied covenant of good faith and fair dealing was breached in this case because: (1) the sellers neither pleaded nor urged any such claim below; (2) the sellers explicitly accepted the amended plan in full satisfaction of Meruelo Enterprises obligations under article 11, section 3 of the agreement; and (3) the sellers lack standing to bring any contract claim under the plan because they are not participants in the plan. We disagree.

First, as we have set forth above, the complaint alleges sufficient facts to comprise a cause of action for breach of the implied obligation of good faith and fair dealing. Meruelo Enterprises allegedly promised to institute an employee performance plan, failed to fund it and then engaged in improper conduct to ensure the plan was without substantive benefit to award beneficiaries. We reject the contention that the sellers failure to mention breach of the implied covenant of good faith and fair dealing in their complaint precludes any relief on that basis. California has entirely rejected the doctrine of theory of the pleading as incompatible with the fundamental code principle of abolition of forms of action. (4 Witkin, Cal. Procedure (4th ed. 1997) Pleading,  374, p. 475.) As our Supreme Court has declared, The form of the action is immaterial, if a cause of action is actually stated; the doctrine of theory of the pleading has long been repudiated in this state. (California W. S. L. Ins. Co. v. Tucker (1940) 15 Cal.2d 69, 71.) In any case, the sellers included a claim for breach of contract in their eighth cause of action that incorporated all of the prior allegations in the complaint. This was enough. A claim for breach of contract sufficiently encompasses a breach of the implied covenant of good faith and fair dealing. (Harm v. Frasher (1960) 181 Cal.App.2d 405, 412, 417 [complaint for breach of an agreement viewed as claim for breach of covenant implied in every contract].)

Second, the uncontroverted fact that the sellers accepted the amended plan in full satisfaction of the obligations of Meruelo Enterprises under article 11, section 3 of the agreement does not preclude the sellers action for a breach of the implied covenant. The gravamen of the breach of the duty of good faith and fair dealing is not the failure to fund the original plan or amended plan with $750,000, but the alleged fraudulent manipulation and failure to fund any plan at all.^[9]

Lastly, the sellers as obligees of the agreement and amended agreement have standing to enforce their terms. California follows the rule of the Restatement Second of Contracts that either the promisee or the third party beneficiary can sue to enforce a third party beneficiary contract. (In re Marriage of Smith & Maescher (1993) 21 Cal.App.4th 100, 105-106.) The underlying reasoning is that  [t]he promisee of a promise for the benefit of a beneficiary has the same right to performance as any other promisee, whether the promise is binding because part of a bargain, because of his reliance, or because of its formal characteristics. If the promisee has no economic interest in the performance, as in many cases involving gift promises, the ordinary remedy of damages for breach of contract is an inadequate remedy, since only nominal damages can be recovered. In such cases specific performance is commonly appropriate. [Citation.] In the ordinary case of a promise to pay the promisees debt, on the other hand, the promisee may suffer substantial damages as a result of breach by the promisor. So long as there is no conflict with rights of the beneficiary or the promisor, he is entitled to recover such damages. [Citation.]  (Id. at pp. 106-107, quoting Restatement Second of Contracts,  305, com. a.) As promisees, however, the sellers remedy is an action for specific performance of the contract rather than one for damages. (Id. at pp. 136-137; see 1 Witkin, Summary of Cal. Law, supra, Contracts,  696, pp. 783-784.)

For guidance upon remand, it is immaterial that the sellers failed to pray for specific performance in their complaint. (Pascoe v. Morrison (1933) 219 Cal. 54, 58 [a plaintiff who has undertaken to avail himself of a remedy that he is not entitled to, is not thereby prevented from availing himself of a remedy that he is entitled to under the facts of the case].) Further, if specific performance is impossible, which may well prove to be the case in this instance, the court may give damages in lieu of specific performance as an equitable remedy. (See 5 Witkin, Cal. Procedure, supra, Pleading,  740, p. 198; Engasser v. Jones (1948) 88 Cal.App.2d 171, 176 [Where, through no fault of the plaintiff, specific performance cannot be decreed, the court having obtained jurisdiction of the subject matter, properly within its cognizance, may grant monetary relief which in an action at law would be by way of damages].) In this case, the sellers allege they were damaged in the amount of at least $750,000 for Meruelo Enterprises failure to fund the performance plan. Whether the sellers can actually prove their allegations, they should be allowed to proceed with a claim for specific performance based on Meruelo Enterprises breach of the implied covenant of good faith and fair dealing.

2. Cross-appeal

We review an appeal from an order of dismissal de novo. (Gerawan Farming, Inc. v. Lyons(2000) 24 Cal.4th 468, 515; 108 Holdings, Ltd. v. City of Rohnert Park (2006) 136 Cal.App.4th 186, 193.) We treat the demurrer as admitting all properly pleaded material facts, but not contentions, deductions, conclusions of fact or law, and we will consider matters that may be judicially noticed. (Blank v. Kirwan (1985) 39 Cal.3d 311, 318.)

California follows the American rule, which provides that each party to a lawsuit ordinarily must pay his own fees. (Trope v. Katz (1995) 11 Cal.4th 274, 278.) The concept is embodied in Code of Civil Procedure section 1021, which provides that each party is to bear his own attorney fees unless a statute or the agreement of the parties provides otherwise. (Gray v. Don Miller & Associates, Inc. (1984) 35 Cal.3d 498, 504.) The American rule is subject to exceptions, one exception being Civil Code section 1717, which states, in part: In any action on a contract, where the contract specifically provides that attorneys fees and costs, which are incurred to enforce that contract, shall be awarded . . . to the prevailing party, then the party who is determined to be the party prevailing on the contract . . . shall be entitled to reasonable attorneys fees in addition to other costs. (Civ. Code,  1717, subd. (a).)

Meruelo Enterprises alleged in the amended cross-complaint that the agreement authorizes the successful or prevailing party to recover its attorney fees and costs in any action brought for the enforcement of the [a]greement or because of an alleged dispute, breach, default, or misrepresentation in connection with any of the provisions of the [a]greement. The trial court sustained the Doty familys demurrer to the claim for attorney fees without leave to amend and ruled that Meruelo Enterprises could not recover the attorney fees incurred in defending the prior federal action. Meruelo Enterprises contends the trial court erred because the agreement was the source of the obligation that Floyd Doty sought to enforce in the federal action.

This contention is not supported by the record. Although the federal complaint alleged as a fact that Floyd Doty had entered into a written contract, i.e., the agreement, whereby he sold his stock to Meruelo Enterprises, the complaint relied on the allegation that [a]t all times in explaining the plan as proposed by defendants, the said defendants represented to [Floyd Doty] that shares would be issued at $1.00 each, for 750,000 shares, for the beneficiaries until the $750,000 was used up, and that only the proper, entitled persons would receive the shares, and that the plan would be properly administered . . . . (Italics added.) Based on such allegations, Floyd Doty alleged claims for declaratory relief, breach of fiduciary duty, disgorgement and rescission of shares, and damages for breach of fiduciary duty and fraud. The complaint sought relief including a declaration of rights under the plan, reformation of the plan provisions to comply with ERISA, injunctive relief mandating the defendants to fund the plan, rescission of shares awarded by defendants, restoration of amounts the defendants had improperly distributed from the plan and damages in tort. As the trial court noted, the agreement was mentioned in the federal complaint only as evidence of the proper interpretation of the [p]lan provisions upon which declaratory relief, disgorgement, and breach of fiduciary duties were premised.

We find CircleStarCenter Associates, L.P. v. Liberate Technologies (2007) 147 Cal.App.4th 1203, cited in Meruelo Enterprises supplemental letter to this court, unhelpful on this issue. In that case, a landlord sought attorney fees incurred in obtaining a dismissal of a tenants prior bankruptcy, relying on contractual language. The appellate court held the trial court was required to consider the landlords proffered extrinsic evidence before deciding whether the contractual language was reasonably susceptible to encompassing a bankruptcy proceeding within its terms. (Id. at p. 1211.) Here, our focus in the first instance is on the allegations of the federal complaint, rather than an interpretation of the parties contract. Examining such allegations, we conclude the agreement was not the source of the federal claim.^[10]

We find the present factual circumstances analogous to Sawyer v. Bank of America (1978) 83 Cal.App.3d 135, a case in which a motor vehicle security agreement contained a provision for attorney fees. A dispute arose concerning insurance coverage on the vehicle, and the plaintiff sued, not on the security agreement, but on a separate oral agreement to obtain and maintain insurance on the vehicle that he claimed he had with the defendant. There was no evidence the oral agreement included a provision for attorney fees. In reversing an order granting attorney fees, the appellate court held that despite a written security agreement providing for the payment of attorney fees, the plaintiffs failure to allege a breach of that agreement meant the American rule governed and Civil Code section 1717 did not apply. (Sawyer, at p. 140.) In this case, the federal complaint relied on oral representations made in explaining the plan as proposed by [Meruelo Enterprises], and it sought either to enforce the unwritten promise to implement an ERISA plan or to reform the implemented plan to comply with ERISA.

Meruelo Enterprises mentions several situations in which California courts have found it appropriate to include attorney fees in compensatory damage awards. These cases are inapposite. In Brandt v. Superior Court (1985) 37 Cal.3d 813, 817, our Supreme Court held attorney fees were recoverable as damages when the attorney was retained to obtain insurance proceeds tortiously withheld, but it distinguished such proximately caused damages from recovery of attorneys fees qua attorneys fees. Nelson v. Kellogg (1912) 162 Cal. 621, 623, did not involve attorney fees incurred in the defense of an action, as here, but rather fees the falsely imprisoned plaintiff had paid an attorney to procure her release from the arrest. In Bertero v. National General Corp. (1974) 13 Cal.3d 43, 59, plaintiff similarly recovered fees paid to defend an action maliciously prosecuted against him as an item of damages. Finally, De La Hoya v. Slims Gun Shop (1978) 80 Cal.App.3d Supp. 6, 9, allowed attorney fees as damages when they were necessarily incurred in defending against third party litigation resulting from the defendants breach of a warranty of title. None of these cases would allow an award of attorneys fees qua attorneys fees under the facts at issue.

DISPOSITION

The judgment against the sellers is reversed, and the trial court is directed to proceed upon remand in conformance with this opinion. The order of dismissal is affirmed. The sellers are to recover their costs on appeal.

NOT TO BE PUBLISHED IN THE OFFICIAL REPORTS

FLIER, J.

We concur:

COOPER, P. J.

RUBIN, J.

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^[1] The sellers were Floyd S. Doty (Floyd Doty), John T. Doty, Jr. (John Doty), Scott E. Doty, Gary W. Doty, each suing as a trustee on behalf of five different family trusts (collectively, Doty family), and Jeffrey A. Hartman (Hartman), an attorney and Doty Bros. shareholder who represented the Doty family interests in the sale.

^[2] The defendants include Meruelo Enterprises, Doty Bros., Alex Meruelo (the CEO and primary shareholder of Meruelo Enterprises) and other individuals who allegedly are fiduciaries of the employee performance award plan that is the subject of this action. Meruelo Enterprises and Doty Bros. are also cross-complainants and cross-appellants in this action. For purposes of discussion, we sometimes refer to defendants and to cross-complainants collectively as Meruelo Enterprises.

^[3] The amended agreement stated: A dispute has arisen between the parties concerning the Performance Plan. Buyer contends that the Performance Plan, as adopted and implemented, complies with Buyers obligations under the Stock Purchase Agreement. Shareholder disputes that contention. []  . . .  [] The parties wish to resolve their differences concerning the Performance Plan as well as make modifications to the Stock Purchase Agreement . . . and so therefore agree as follows: []  . . .  [] 3. Performance Plan. [] a. The parties acknowledge and agree that the Performance Plan . . . as amended . . . complies with Buyers obligations under [a]rticle 11, [s]ection 3 of the Stock Purchase Agreement. . . . [] b. Floyd Doty and John Doty have designated the recipients of two hundred twenty-seven thousand (227,000) Performance Shares to be awarded under the Performance Plan and Company shall cause those shares to be awarded on or before April 15, 2003 with a retroactive grant date of January 2, 2001. (Italics added.)

^[4] Barrows was also a plaintiff in the federal action.

^[5] Meruelo Enterprises also moved for summary adjudication of these three issues as to the sellers. In light of our holding, we do not separately address that motion.

^[6] Through inadvertence, Meruelo Enterprises voluntarily dismissed the wrong cause of action, and the trial court entered an order of dismissal repeating that error. We called the parties attention to this problem and invited them to submit supplemental briefing to state their views on this point. The parties have done so and expressed agreement that a clerical error occurred in the trial court and the record may be corrected to reflect that the trial court sustained a demurrer to the second cause of action without leave to amend, that Meruelo Enterprises intended to voluntarily dismiss the first cause of action without prejudice, and that the second cause of action properly may be deemed the subject of the cross-appeal. We deem the record so corrected.

^[7] Given this conclusion, we do not address whether the parol evidence rule precludes the sellers claims in this case since there is a triable issue of fact whether Meruelo Enterprises breached implied covenants not expressly provided for in the agreements.

^[8] This issue was not briefed as a separate issue in the parties initial briefs filed with the court. Pursuant to Government Code section 68081, we issued a letter to the parties inquiring, Are there any triable issues of fact regarding whether the implied covenant of good faith and fair dealing was breached in this case? The parties have submitted their views regarding this question in supplemental briefs, which we have taken into consideration.

^[9] However, [t]he implied covenant of good faith and fair dealing is limited to assuring compliance with the express terms of the contract, and cannot be extended to create obligations not contemplated by the contract. (1 Witkin, Summary of Cal. Law, supra, Contracts, 802, p. 895.) The sellers acceptance of the amended agreement precludes their claim that Meruelo Enterprises was obligated to fund the amended plan with a cash payment of $750,000.

^[10] We do not address whether the prevailing parties in this state court action can ultimately recover as part of their costs and fees those costs and fees incurred in the federal action.