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AKH Company, Inc. v. Universal Underwriters Insurance Co.

United States District Court, D. Kansas

April 30, 2018

AKH COMPANY, INC., Plaintiff,



         This is an insurance coverage dispute filed by AKH Company, Inc. (“AKH”) against its insurance carrier, Universal Underwriters Insurance Company (“UUIC”), arising out of a trademark infringement action between AKH and a third party that UUIC defended and settled under a reservation of rights (“RT litigation”). The parties assert claims against one another that exceed five million dollars. This case has been pending for over five years now, largely due to what Magistrate Judge Gale has aptly described as “an inordinate number of increasingly contentious discovery abuses”[1] by AKH. Eight motions to compel[2] and three motions for sanctions[3] have been decided against AKH at least in part thus far. The most recent set of disputes resulted from discovery by UUIC into AKH's finances, in furtherance of UUIC's claim for punitive damages. This discovery revealed that AKH may have transferred its assets to avoid any judgment that may be awarded to UUIC in this case. Judge Gale issued two orders dealing with this issue: (1) an October 24, 2017 Memorandum & Order Denying Defendant's Motion to Amend Counterclaim and Add Parties (“October 24 Order”), [4] ruling that Defendant may not amend its counterclaim to add related corporate entities and individual owners of AKH as parties and claims of fraudulent transfer and alter ego; and (2) a November 14, 2017 Memorandum & Order on Motion for Sanctions, finding among other things, an “on-going effort by Plaintiff to obstruct discovery of its financial status, ” and as a sanction, recommending an adverse inference instruction that if punitive damages are awarded, the jury may consider Plaintiff's net worth unlimited for the purpose of evaluating the appropriate amount of punitive damages (“November 14 Order”).[5]

         Now before this Court are the parties' respective objections to Judge Gale's recent Orders: UUIC's Motion for Review of Magistrate Judge Gale's October 24, 2017 Order (Doc. 498), and AKH's Objection to Magistrate Judge Gale's Order Dated November 24, 2017 (Doc. 501). The motions are fully briefed and the Court is prepared to rule. As described more fully below, the Court grants UUIC's motion for review and allows leave to amend. UUIC shall file its proposed amended counterclaim forthwith. The Court grants in part AKH's objection to the November 14 Order. The Court finds no clear error in Judge Gale's determination that sanctions are appropriate, or that an adverse inference instruction is appropriate. However, the Court modifies the recommended adverse inference instruction that should be submitted by UUIC before trial. The Court reminds AKH of its continuing discovery obligations under Fed.R.Civ.P. 26(e), and warns that any further dissipation of assets prior to judgment may result in much harsher sanctions.

         I. Background

         AKH filed this case seeking a declaration that UUIC breached its duties to defend, settle, and act fairly and in good faith with respect to the RT litigation. UUIC brought counterclaims for declaratory relief and breach of contract arising out of its defense and settlement of the RT litigation, and sought reimbursement of the settlement funds. Eventually, after a period of discovery, the parties amended their pleadings to allege tort claims against one another, based on documents obtained during discovery. UUIC seeks, among other things, punitive damages on its fraud and fraudulent concealment claims. As already stated, the case has involved many highly contentious discovery motions, application of the crime-fraud exception to certain documents otherwise covered by the attorney-client privilege, and the imposition of sanctions against AKH. The instant motions are hopefully the last in a long line of such contentious motions.

         In late 2016, UUIC moved to compel documents and for leave to appoint an expert relating to AKH's financial condition. Judge Gale granted in part the motion as to AKH's financial viability, profit and loss statements, annual statements, balance sheets, and expense/revenue reports for 2011 through the present, certain tax returns (including the individual tax returns for Hratch, Andy, and Sergio Andonian), and UUIC's request for a forensic accounting and damages expert.[6] According to UUIC, this discovery was sought largely in furtherance of its punitive damages claim, and because the discovery up to that point had not explained how “AKH went from a company that reported eight-figures in sales revenues in 2012 to reporting $0 in subsequent years, even though AKH's chain of successful discount-tire stores in California still appeared to be fully-operational.”[7] Also, in the spring of 2017, UUIC deposed AKH co-owner Hratch Andonian and its former accountants. Based on this discovery, UUIC moved for leave to amend to “add new related parties and to add new claims that focus solely on AKH's satisfaction of any judgment.”[8] UUIC moved to add claims of fraudulent transfer and alter ego liability against AKH and new related parties Andonian Enterprises, Inc.; 55, Inc.; TireNetwork Group, Inc.; Andy Andonian; and Hratch Andonian. UUIC claims that its discovery uncovered efforts by AKH after this lawsuit was filed to divert all its assets to other related entities owned by the same individuals in order to render AKH essentially judgment-proof. The proposed fraudulent conveyance claim states that AKH is “essentially a shell at this point, serving no purpose other than to litigate this action. AKH is systematically devaluing itself which could result in AKH's potential inability to pay any judgment against it for its tortious and other misconduct.”[9] The alter ego claim asks the Court to disregard the legal fiction of corporate separateness and treat AKH and the proposed new parties as alter egos of one another. The claim alleges various ways in which the proposed new defendants have transferred assets and diluted AKH, and argues that treating them all separately “would serve as a cover for fraud and illegality and promote an injustice.”[10]

         UUIC further argues that AKH and its counsel affirmatively misled it and Judge Gale about the many asset transfers after this case was filed, misrepresenting that its “finances had changed simply because the market for tire retailers was not what it once was, ” and that “the financial position of Andonian Enterprises ‘has no relevance to any issues in this case.'”[11]

         AKH opposed the motion for leave to amend, arguing undue delay, prejudice, and futility of amendment. AKH contended that the addition of the proposed claims and parties would delay the case even further by requiring another round of discovery and motions practice as to the new claims and counter defendants. Moreover, AKH argued that amendment to add the proposed new parties would be futile because they lack the requisite minimum contacts with the State of Kansas, and therefore UUIC's claims against them could not withstand a motion to dismiss for lack of personal jurisdiction.

         Judge Gale denied the motion for leave to amend in his October 24 Order. First, he determined that the motion is governed by both Fed.R.Civ.P. 15(a) and the joinder rules in Fed.R.Civ.P. 19 and 20, yet the parties failed to address the joinder rules. Judge Gale found that the proposed new parties were not required, and he declined to exercise his discretion to allow UUIC to add them at this juncture:

The question, then, is whether a fraudulent conveyance or alter-ego claim against a third party asserted for the purpose of reaching assets of the third party to enforce judgment Defendant has not yet obtained, is as to Plaintiff and the third parties, “any right is asserted against them jointly or severally, or in the alternative with respect to or arising out of the same transaction or occurrence” within the meaning of Rule 20. It is not. The Defendant's substantive claims in this case arising out of the insurance transaction are solely against Plaintiff. The third parties are, at least technically, strangers to those claims and will not share primary liability with Plaintiff, even if the third party assets become vulnerable to the execution of that judgment. The fraudulent conveyance and alter ego claims are separate, and involve separate allegations and factual issues and, like a garnishment or other judgment enforcement action, may be brought as a separate action if and when Defendant obtains judgment against Plaintiff.
Even if the proposed third-party claims could now be brought under Rule 20, the Court would not exercise its discretion to add those parties at this time. Those claims may be brought after judgment in this case. They are contingent on the outcome of the existing claims. Adding the new parties would essentially create a wholly new claim with new issues, with discovery and litigation in a case which has already lasted almost five years and is not yet ready for trial. The new parties would be strangers to the very-substantial litigation and discovery which has already ensued, and not bound by discovery and rulings to date. There is little reason to insert these new parties into the present mix.[12]

         In addition to seeking leave to amend, UUIC sought sanctions against AKH for its misconduct in unearthing the true financial picture of AKH. Judge Gale agreed that AKH's conduct, considering its extensive past discovery misconduct in this case, was sanctionable.

         Judge Gale described it as “an on-going effort by Plaintiff to obstruct discovery of its financial status, ” that warrants “an appropriate sanction . . . which will allow the parties to move past this issue towards resolution of the merits of this case.”[13] Judge Gale determined that AKH should be sanctioned for failure to prepare Hratch Andonian for deposition on the issue of AKH's finances, and for concealing or destroying various documents responsive to UUIC's discovery requests about AKH's finances. Judge Gale specifically recommended to the undersigned:

as a sanction for the discovery abuses relating to the production of information concerning the financial worth of Plaintiff, that the District Court and the Jury be permitted, if punitive damages are awarded, to consider Plaintiff's net worth unlimited for the purpose of evaluating the appropriate amount of punitive damages. An appropriate instruction in that regard should be given, tailored to address the substantive relevance of that consideration under the applicable law. Plaintiff should not be permitted to rebut that consideration either by evidence or argument.[14]

         II. Motion for Leave to Amend and to Add Parties

         A. Standard

         Fed. R. Civ. P. 72 allows a party to provide specific, written objections to a magistrate judge's order. The applicable standard of review depends on whether the magistrate judge's order relates to a dispositive or nondispositive issue. A nondispositve decision is reviewed under a clearly erroneous or contrary to law standard, and a dispositive order is reviewed de novo.[15]The parties here disagree about whether Judge Gale's October 24 Order should be considered dispositive or nondispositive under Rule 72.

         Under the more deferential standard that applies to this Court's review of a nondispositive order, the Court must affirm unless “the entire evidence leaves it ‘with the definite and firm conviction that a mistake has been committed.'”[16] As to legal matters, “the Court conducts an independent review and determines whether the magistrate judge ruling is contrary to law.”[17] “Under this standard, the Court conducts a plenary review and may set aside the magistrate judge decision if it applied an incorrect legal standard or failed to consider an element of the applicable standard.”[18] The Court need not determine whether the October 24 Order is dispositive or not because even if it is considered nondispositive, the Court grants UUIC's objection. As described more fully below, leave to amend to add claims against AKH should have been granted under Rules 15 and 16. Given this ruling, the Court also finds that leave to amend to add the proposed additional parties should have been granted under Rule 20.

         B. Additional Claims under Rule 15

         UUIC first argues that Judge Gale erred by focusing solely on the federal joinder rules and by not applying the liberal pleading standard in Fed.R.Civ.P. 15(a). When a motion for leave to amend is filed that seeks to add parties who are not indispensable, both Rules 15 and 20 govern.[19] In this case, Rule 16 must be considered as well because UUIC's motion was raised well after the deadline set forth in the Scheduling Order for filing motions to amend.[20]

         Judge Gale determined that the parties wholly failed to address the joinder rules, and therefore regardless of whether UUIC's amendment may be permissible under Rule 15, under Rule 20 the motion to add parties should be denied. UUIC argues that by proceeding directly to a Rule 20 analysis, Judge Gale did not consider the proposed new claims against existing party AKH. The Court agrees. UUIC's Proposed Fifth Amended Counterclaim includes two new claims against existing party AKH and the proposed new parties. Count XIV alleges a claim of Fraudulent Transfers Pursuant to the California Uniform Voidable Transactions Act.[21] Count XV alleges alter ego liability against AKH and the new entities. Judge Gale did not separately consider whether the proposed additional claims against AKH pass muster under Rules 15 and 16, nor did he consider those rules in relation to the additional claims against the new parties. This Court therefore proceeds to conduct that analysis de novo.

         Where a party seeks to amend to add a new counterclaim or claim after a scheduling order deadline passes, that party must show “(1) good cause for seeking modification under Fed.R.Civ.P. 16(b)(4) and (2) satisfaction of the Rule 15(a) standard.”[22] The good cause requirement “may be satisfied, for example, if a plaintiff learns new information through discovery.”[23] Here, UUIC's new claims are based on information learned through late-produced discovery. And as documented in the November 24 Order, this new discovery followed a long period of concealment and misleading statements by AKH about its financial status. UUIC did not delay in seeking amendment once it learned facts that put it on notice of its new claims. The good cause standard is met.

         Under Rule 15(a), leave to amend a complaint is freely given when justice so requires.[24]A party is typically granted leave to amend under this rule unless there is “a showing of undue delay, undue prejudice to the opposing party, bad faith or dilatory motive, failure to cure deficiencies by amendment previously allowed, or futility of amendment.”[25] A proposed amendment is futile if the amended complaint would be subject to dismissal.[26] While liberality of amendment is important, it is equally important that Athere must be an end finally to a particular litigation.”[27]

         As stated above, there is no basis to conclude that UUIC unduly delayed in seeking amendment. The proposed amended claims and parties are based on newly obtained information provided by AKH in discovery; information that it delayed in providing, and in some instances concealed to UUIC, warranting sanctions. The Court finds no undue delay. Similarly, the Court finds no showing of undue prejudice to AKH in allowing leave to amend. “Typically, courts ‘find prejudice only when the amendment unfairly affects' a party's ability to prosecute or defend the lawsuit.”[28] The claims asserted in Counts XXVI and XV are based on information within the control of AKH, its owners, and the related entities. In fact, the claims are based on facts known to and concealed by AKH, so there should be no unfair surprise. AKH was put on clear notice that UUIC sought discovery of its finances in support of its punitive damages claims going back at least to 2016. While the proposed new claims and parties may require some additional discovery, the Court is confident that most of that discovery was completed as part of UUIC's punitive damages discovery that preceded the filing of the motion. To the extent some limited discovery may be warranted, the Court does not find that it causes undue prejudice to AKH, particularly in light of its conduct giving rise to the proposed new claims. Due entirely to AKH's own discovery misconduct, which has necessitated multiple motions to compel and for sanctions, multiplied by the parties' many objections to Judge Gale's orders, this case has not yet proceeded to a pretrial order, nor is there a trial date or dispositive motions deadline on the horizon. Despite this Court's dissatisfaction with the slow pace of this case, it is confident that AKH can and will complete the limited discovery required to mount a defense to these two new counterclaims in a reasonable period to allow the schedule in this case to move toward a decision on the merits.

         AKH also complains that adding the new claims against new parties will cause prejudice by requiring another round of motions to dismiss as to the new parties, primarily based on its claim of lack of personal jurisdiction. Again, the Court will not find prejudice to AKH given the misconduct found by Judge Gale in his November 24 Order. The Court sets forth below a condensed schedule for the parties that includes a short period of discovery that will be limited in scope, and an expedited briefing deadline for any motion to dismiss that AKH wishes to file as to these new claims and parties. There is no reason why the case cannot proceed to a pretrial conference prior to resolution of that motion; but the Court leaves this to Judge Gale's discretion.

         The Court finds no bad faith or dilatory behavior by UUIC, nor is there evidence that it failed to cure deficiencies in previous amendments. AKH lodges no futility argument about the additional claims against AKH, but argues that the claims against the new parties are futile because the Court lacks personal jurisdiction. UUIC replies that it has established a prima facie case of personal jurisdiction given its allegations that the new parties are alter egos of AKH. The Court declines to decide the issue of personal jurisdiction in the context of a motion for leave to amend. Instead, the Court finds that the allegations in the proposed amended counterclaim support UUIC's assertion of personal jurisdiction by alleging sufficient jurisdictional facts, [29] and defers ruling on the issue until a ...

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