Russell Trenholme, Respondent, vs. QRS Diagnostic, LLC, et al., Appellants.

Russell Trenholme, Respondent, vs. QRS Diagnostic, LLC, et al., Appellants. A05-2472, Court of Appeals Unpublished, September 12, 2006.

This opinion will be unpublished and

may not be cited except as provided by

Minn. Stat. § 480A.08, subd. 3 (2004).

 

 

STATE OF MINNESOTA

IN COURT OF APPEALS

A05-2472

 

Russell Trenholme,
Respondent,

vs.

QRS Diagnostic, LLC, et al.,
Appellants.

 

Filed September 12, 2006

Affirmed

Wright, Judge

 

Hennepin County District Court

File No. CT 03-14703

 

 

Richard M. Carlson, Kelly Vince Griffitts, Morris, Carlson & Hoelscher, P.A., 8300 Norman Center Drive, Suite 710, Bloomington, MN  55437 (for appellants)

 

John A. Fabian, III, Jessica J. Clay, Nichols, Kaster & Anderson, P.L.L.P., 4600 IDS Center, 80 South Eighth Street, Minneapolis, MN  55402 (for respondent)

 

 

            Considered and decided by Ross, Presiding Judge; Shumaker, Judge; and Wright, Judge.

 

U N P U B L I S H E D  O P I N I O N

 

WRIGHT, Judge

 

In this appeal after a bench trial, appellants challenge the district court's determination that they committed fraudulent or intentional misrepresentation by omission, arguing that (1) they did not have a duty to disclose certain financial information to respondent; (2) the record does not support the finding that respondent reasonably relied on appellants' failure to disclose certain financial obligations; and (3) respondent is not entitled to damages for omission of the financial information.  We affirm.

FACTS

 

Respondent Russell Trenholme is a former Minnesota resident currently living in California.  Trenholme is an investor who, before his investment at issue in this litigation, had invested in several high-tech ventures that failed.  The three corporate appellantsQRS Diagnostic, LLC; QRS Systems, LLC; and Parachute Technologies, LLCare Minnesota limited-liability corporations with related ownership and control.  Appellant Spencer Lien is president, CEO, and chairman of the boards of both QRS Diagnostic and QRS Systems.  Lien directly owns less than one percent of QRS Diagnostic.  But Lien owns 50.5 percent of QRS Systems, which owns 10 percent of QRS Diagnostic.  Lien and Jim Cooper, the principal investor in QRS Diagnostic, comprised QRS Systems' board of directors.   

QRS Diagnostic develops, manufactures, and sells medical devices.  The medical devices primarily utilize PC cards, which are credit-card-size personal-computer adaptors that enhance the memory capacity of a portable computer.  Since 1999, QRS Systems has not conducted any business operations other than its involvement with Parachute.  Its only assets are shares of stock in QRS Diagnostic and Parachute.

In May 2001, QRS Systems and UniLinear signed a technology-licensing agreement and formed Parachute to develop, manufacture, and sell a PC-card adapter for the Palm Pilot handheld computer (Parachute device).  The Parachute device attaches to the back of the Palm Pilot and contains a PC-card slot, thereby adapting a Palm Pilot to use PC-card technology.  The hardware and software for the Parachute device were developed by UniLinear Corp. 

QRS Systems initially owned 80 percent of Parachute, and UniLinear owned 20 percent.  Because Parachute's operations were being financed by QRS Diagnostic, identifying investors and acquiring venture capital were priorities.  Lien knew Trenholme from one of Trenholme's previous investments that failed.  Because of this acquaintanceship, Trenholme had become an investor in QRS Diagnostic.  Lien contacted Trenholme to solicit his investment in Parachute.  Lien told Trenholme about potential sales of the Parachute devices and called the investment "hot."  Because of his earlier failed investments, Trenholme cautiously expressed interest in making an investment.

After negotiations, Trenholme signed a letter of understanding regarding his investment in Parachute on June 6, 2001.  In the letter, Trenholme agreed to provide a cash investment of $250,000 and a personal guarantee of $150,000 on a bank line of credit to be obtained by Parachute.  The letter of understanding described Parachute's intentions to seek a line of credit of at least $250,000 and requested that Trenholme "agree to consider providing a personal guarantee of up to an additional $100,000" if more than one bank was unwilling to provide credit to Parachute. 

After Parachute was denied a line of credit, Lien and Trenholme engaged in further negotiations to designate Trenholme along with Parachute as borrowers on the line of credit.  Trenholme asked Lien to have "QRS" guarantee the line of credit.  Lien insisted that QRS Systems, rather than QRS Diagnostic, "co-guarantee" the line of credit because QRS Systems was "the majority owner of Parachute Technologies."  Trenholme and Lien agreed to this arrangement.

The line of credit originated on July 25, 2001, and was signed by Trenholme and Lien in his capacity as CEO of Parachute.  Concurrently with the execution of the promissory note, Lien, as chairman and CEO of QRS Systems, signed an indemnification agreement through which QRS Systems agreed to indemnify Trenholme as the guarantor of the line of credit.  The agreement stated that "QRS Systems, LLC will be fully liable to [Trenholme] for up to 50% of the monetary amount that [he has] to pay to Associated Bank in the event of default by Parachute Technologies." 

During the second half of 2001, Parachute struggled to succeed.  The Parachute devices experienced hardware problems, and the company could not keep pace with the development of new Palm Pilot devices.  UniLinear failed to accept the Parachute device to work with the next generation of Palm Pilot devices, making the existing Parachute devices obsolete. 

In January 2002, Lien sought an additional $50,000 from Trenholme to sustain the company until another investor could be found.  Lien solicited the additional investment to "keep the product development going" and to protect Trenholme's original investment.  Trenholme made the additional investment.  But additional investors were not obtained. 

When the line of credit came due in July 2002, Trenholme sought a 50-percent contribution from QRS Systems.  Lien replied by letter to Trenholme's request as follows:

You are correct in asserting that QRS Systems has provided you a guarantee so you can send QRS Systems a request for reimbursement after you have paid off the note with the bank.  However, QRS Systems does not have $75,000 to reimburse you at this time.  QRS Systems is a company that currently has all its assets secured against a $600,000 note.  The company's assets are only its ownership in QRS Diagnostic and Parachute Technologies.  As soon as QRS Diagnostic begins to produce dividends for its members, QRS Systems will have an income and can begin to repay its debts.

 

Lien also advised the bank that Parachute did not have the funds to pay off the line of credit.  Consequently, Trenholme paid the line of credit in full. 

            In 2003, Trenholme filed suit against QRS Diagnostic, QRS Systems, Parachute, and Lien.  Trenholme alleged breach of contract, promissory estoppel, breach of fiduciary duty, conversion, and fraud and misrepresentation.  A bench trial was held. 

In its findings of fact, conclusions of law, and order for judgment dated August 17, 2005, the district court concluded that Lien, Parachute, and QRS Systems were jointly and severally liable to Trenholme in the amount of $201,485.41.  The district court determined that Trenholme proved his cause of action for breach of the loan-agreement contract by QRS Systems because QRS Systems failed to pay its portion of the $150,000 guarantee when it came due.  The district court also concluded that Lien, Parachute, and QRS Systems are liable for fraudulent or intentional misrepresentation because they omitted material information regarding the financial capacity of QRS Systems to guarantee the line of credit.  This appeal followed.

D E C I S I O N

 

Appellants contend that the district court erred when it determined that Trenholme had established a claim for fraudulent or intentional misrepresentation by omission.  We review the district court's findings of fact, whether based on oral or documentary evidence, for clear error, giving due regard to the opportunity of the district court to judge the credibility of the witnesses.  Minn. R. Civ. P. 52.01.   In doing so, "we view the record in the light most favorable to the judgment of the district court."  Rogers v. Moore, 603 N.W.2d 650, 656 (Minn. 1999).  "That the record might support findings other than those made by the [district] court does not show that the . . . findings are defective."  Vangsness v. Vangsness, 607 N.W.2d 468, 474 (Minn. App. 2000).  As to issues of law, however, we conduct a de novo review.   Modrow v. JP Foodservice, Inc., 656 N.W.2d 389, 393 (Minn. 2003).

I.

Appellants first argue that, because they did not owe a duty to disclose the financial status of QRS Systems to Trenholme, he has not satisfied the requirements for fraudulent or intentional misrepresentation.  The elements of fraudulent or intentional misrepresentation are:

(1) a representation;

(2) the representation must be false;

(3) the representation must deal with past or present fact;

(4) the fact must be material;

(5) the fact must be susceptible of knowledge;

(6) the representer must know the fact is false or assert it as of his own knowledge;

(7) the representer must intend to have the other person induced to act or justified in acting upon it;

(8) the other person must be induced to act or justified in acting;

(9) that person's actions must be in reliance upon the representation;

(10) that person must suffer damages;

(11) the misrepresentation must be the proximate cause of injury.

Nat'l Union Fire Ins. Co. v. Evenson, 439 N.W.2d 394, 398 (Minn. App. 1989) (quotation omitted), review denied (Minn. July 12, 1989). 

An omission or concealment of a material fact can constitute fraud when the fact is within the concealing party's knowledge and that party knows that the party from whom the material fact is concealed acts on the presumption that such fact does not exist.  Richfield Bank & Trust Co. v. Sjogren, 309 Minn. 362, 365, 244 N.W.2d 648, 650 (1976).  But nondisclosure constitutes fraud only when the party concealing the material fact is under a legal or equitable obligation to communicate that fact to the other party who in turn is entitled to disclosure of the material fact.  Id. 

Ordinarily, one party to a transaction does not have a duty to disclose material facts to the other.  Klein v. First Edina Nat'l Bank, 293 Minn. 418, 421, 196 N.W.2d 619, 622 (1972).  Special circumstances, however, may dictate otherwise.  Id.  Traditionally, three examples of special circumstances are cited.  Id.  First, "[o]ne who speaks must say enough to prevent his words from misleading the other party."  Id.  Second, "[o]ne who has special knowledge of material facts to which the other party does not have access may have a duty to disclose these facts to the other party."  Id.  Third, "[a] duty to disclose facts may exist when a fiduciary relationship exists between the parties . . . ."  Heidbreder v. Carton, 645 N.W.2d 355, 367 (Minn. 2002).

The district court found that all three of these special circumstances existed between appellants and Trenholme.  But our analysis focuses on the fiduciary relationship between the parties.  "The relationship among shareholders in closely held corporations is analogous to that of partners."  Pedro v. Pedro, 489 N.W.2d 798, 801 (Minn. App. 1992), review denied (Minn. Oct. 20, 1992).  Those shareholders "owe one another a fiduciary duty."  Id. 

Given the interrelated nature of the ownership and control of the companies by Lien, a fiduciary relationship existed among the parties.  The line of credit was for the benefit of Parachute, in which Lien, Trenholme, and QRS Systems were all shareholders.  By virtue of his $250,000 investment and the agreement between Lien and Trenholme memorialized in the letter of understanding, Trenholme owned a 10-percent share of Parachute.  Lien owned a majority share of QRS Systems, which owned 54 percent of Parachute.  Both Lien and Trenholme were directors of Parachute.  And Lien was president, CEO, and chairman of Parachute.  Even accepting as true appellants' contention that QRS Systems was an independent third-party company, as a shareholder in Parachute, QRS Systems owed the same fiduciary duty that Lien owed to Trenholme. 

In light of the fiduciary duty among QRS Systems, Trenholme, and Lien, Lien owed Trenholme a duty to disclose the material fact that QRS Systems lacked the financial capacity to guarantee the line of credit because its holdings were encumbered by a $600,000 debt.  That omission, if justifiably relied on by Trenholme to sign the promissory note, is sufficient to establish fraudulent or intentional misrepresentation.  Accordingly, the district court did not err by concluding that the parties were in a fiduciary relationship and, therefore, appellants had a duty to disclose such material financial information to Trenholme. 

II.

            Appellants next argue that it was not reasonable for Trenholme to rely on Lien's omission regarding QRS Systems' ability to guarantee the $150,000 line of credit.  To establish fraudulent or intentional misrepresentation, a plaintiff must establish that he or she acted in reliance on the misrepresentation, which resulted in damages.  Spiess v. Brandt, 230 Minn. 246, 250, 41 N.W.2d 561, 565 (1950).  It is a "well-established rule that in a business transaction the recipient of a fraudulent misrepresentation of a material fact is justified in relying upon its truth, although he might have ascertained its falsity had he made an investigation."  Id. at 253, 41 N.W.2d at 566.  In determining whether reliance was justified, the question is whether the fraudulent misrepresentation or omission was reasonably calculated to deceive, not the average person, but "a person of the capacity and experience of the particular individual" who was deceived.  Id. at 254, 41 N.W.2d at 567; see Murphy v. Country House, Inc., 307 Minn. 344, 351, 240 N.W.2d 507, 512 (1976) ("Fraud is proved with reference to the specific intelligence and experience of the aggrieved party rather than a reasonable-man standard.").

At oral argument, appellants argued for the first time that the district court's finding of reasonable reliance was a conclusion of law, subject to de novo review.  But appellants' contention is contrary to the general rule that whether the plaintiff's reliance was reasonable is a question of fact.  Berg v. Xerxes-Southdale Office Bldg. Co., 290 N.W.2d 612, 616 (Minn. 1980) (holding that it is incorrect to rule on reasonableness of reliance as a matter of law because whether reliance was reasonable must be determined as a matter of fact based on party's personal circumstances).  Thus, to warrant reversal, the district court's factual findings as to reasonable reliance must be clearly erroneous or "manifestly contrary to the weight of the evidence or not reasonably supported by the evidence as a whole."  Rogers, 603 N.W.2d at 656(quotation omitted).

Appellants maintain that Trenholme's reliance was unjustified because Trenholme was a sophisticated investor who should have understood that Trenholme and Lien were in an "adversarial relationship."  But this assertion is at odds with the fiduciary relationship that Trenholme and Lien shared through Lien's roles as president, CEO, and chairman of Parachute when he proposed that Trenholme, also a board member and shareholder of Parachute, co-sign for the line of credit with QRS Systems as guarantor.

Given the fiduciary nature of the relationship among the parties, the evidence supports the district court's conclusion that it was reasonable for Trenholme to rely on Lien to disclose material facts about the financial ability of QRS Systems, a company in which Lien was a board member and part owner, to guarantee the line of credit when Lien asked Trenholme to co-sign with Parachute as borrowers for the $150,000 line of credit.  Lien failed to disclose to Trenholme that QRS Systems was a company with $600,000 in debt and its ownership of two unprofitable companies were its chief assets.  Rather, he implied that QRS Systems as majority owner of Parachute was fiscally sound and capable of guaranteeing the line of credit.  Trenholme testified that he would not have co-signed for the line of credit in July 2001 if he had been aware of QRS Systems's debt of $600,000 to Cooper.  Six months later, in January 2002, when Trenholme balked at making an additional $50,000 investment in Parachute, Lien persuaded Trenholme to invest the additional $50,000 by sending Trenholme an email that stated:  "If you don't want to put any more money in -- I understand.  I'll find someone else.  However, to protect your original investment, if you would put in $50,000 (under the same terms of your last investment), then we can keep the product development going."[1]

Appellants argue that Trenholme should have made inquiries into the capacity of QRS Systems to guarantee the line of credit.  This argument fails because Trenholme had no such duty.  When "a party to whom a representation has been made has not made an investigation adequate to disclose the falsity of the representation, the party whose misstatements have induced the act cannot escape liability by claiming that the other party ought not to have trusted him."  Davis v. Re-Trac Mfg. Corp., 276 Minn. 116, 119, 149 N.W.2d 37, 39 (1967).

When we examine the record in the light most favorable to the district court's findings, it supports the district court's determination that Trenholme reasonably relied on Lien's representations and omissions regarding the capacity of QRS Systems to guarantee the line of credit.  Thus, the district court's determination as to reasonable reliance is not clearly erroneous. 

III.

Appellants also argue that Trenholme was not damaged by Lien's omission regarding the financial capacity of QRS Systems to guarantee the line of credit.  Appellants maintain that, because Trenholme agreed to guarantee the line of credit when he invested in Parachute, he incurred the same liability by co-signing as a principal borrower when Parachute defaulted.  That is, because Parachute ultimately defaulted on the line of credit, Trenholme would have been obligated to pay $150,000 regardless of whether he was the principal or the guarantor of the line of credit. 

We are unpersuaded by this argument for two reasons.  First, the circumstances under which Trenholme agreed to guarantee the line of credit were different from those that existed when he agreed to act as a principal on the line of credit.  The original loan structure, as contemplated by the letter of understanding, was based on Parachute being able to obtain the line of credit from a bank.  On this premise, the level of risk for Trenholme to guarantee the line of credit was tempered by the financial institution's determination that, based on Parachute's financial position, Parachute was loan-worthy.  Because Parachute did not qualify for a line of credit on its own and needed Trenholme to be a co-borrower, the level of risk for Trenholme was greater than when he agreed to guarantee the line of credit.  Moreover, unlike the arm's-length relationship among the parties when the agreement to guarantee the line of credit was reached in the letter of understanding, Trenholme and appellants were in a fiduciary relationship when he co-signed for the line of credit, thus entitling Trenholme to disclosure of the financial capacity of the guarantor, QRS Systems.

Second, Trenholme's obligation as principal differs from that of a guarantor.  A guarantee is a "collateral contract to answer for the payment of a debt or the performance of a duty in case of the default of another who is primarily liable to pay or perform the same."  Schmidt v. McKenzie, 215 Minn. 1, 6, 9 N.W.2d 1, 3 (1943) (quotation omitted).  "The debtor is not a party to the guaranty, and the guarantor is not a party to the principal obligation."  Id. at 7, 9 N.W.2d at 4 (quotation omitted).   The responsibilities of the guarantor are independent of the promise of the debtor, and "the responsibilities which are imposed by the contract of guaranty differ from those which are created by the contract to which the guaranty is collateral."  Id.  (quotation omitted).  "A guaranty of collection is essentially a different undertaking, the obligation of which requires the creditor to exhaust his remedies against the principal (unless insolvency renders it futile), as a condition precedent to proceeding against the guarantor."  Midland Nat'l Bank of Minneapolis v. Sec. Elevator Co., 161 Minn. 30, 33, 200 N.W. 851, 853 (1924).  Although Parachute's default may have been inevitable, Trenholme's risk and obligation as a co-borrower with Parachute were greater than as a guarantor of Parachute's loan obligation.

            Finally, appellants assert that, because Trenholme's final $50,000 contribution was unrelated to Lien's failure to disclose QRS Systems's $600,000 debt, it was not induced by a fraudulent or intentional misrepresentation.  We disagree.  Although Trenholme was more familiar with Parachute's financial status when he made his final $50,000 investment, appellants had a continuing obligation to correct any misapprehension regarding the suitability of QRS Systems to act as a guarantor of the line of credit.  Without knowledge of QRS Systems's financial obligations, Trenholme's ability to assess the risk of the additional $50,000 investment was impaired.  The record supports the district court's finding that Trenholme would not have made the additional $50,000 investment but for Lien's continuing failure to disclose QRS Systems' $600,000 debt. 

            The record establishes that Trenholme was induced to sign the line of credit as a co-borrower because he relied on Lien's assertion that QRS Systems would act as guarantor for the line of credit.  Because Trenholme took on greater risk and responsibilities by signing the line of credit agreement as a borrower, rather than as a guarantor for Parachute, he was damaged by his reliance on Lien's material omissions regarding the financial status of QRS Systems.  The record also establishes that this omission misled Trenholme as to the resources available to Parachute when Trenholme made the additional $50,000 investment. 

            In sum, the record supports the district court's findings that the parties had a fiduciary relationship giving rise to Lien's duty to disclose material information regarding QRS Systems' financial status.  Trenholme reasonably relied on Lien's omission when he     co-signed for the line of credit with QRS Systems serving as guarantor, and when he made an additional investment of $50,000.  Accordingly, the district court did not err by concluding that appellants are liable for damages arising from Trenholme's claim of fraudulent or intentional misrepresentation by omission.

            Affirmed.


[1] At that time, product development was stalled until Parachute could pay $25,000 to acquire prototypes for the next model of Parachute device.