Fraud; Breach of Fiduciary Duties; Judicial Enforcement of Dissolution of Partnership; and Breach of Contract

J. Dahan and M. Glasser v. P. Koral and L’Koral, Inc.
Superior Court of the State of California, County of Los Angeles, Case No. BC 286577

Counsels for Defendants: Christensen Miller Fink Jacobs Glaser Weil & Shapiro; Alschuler Grossman Stein & Kahan
Expert for Defendants: Marc S. Margulis, C.F.A., A.S.A., M.B.A.

In early 2000, Plaintiffs Glasser and Dahan together created a plan for new line of denim apparel (the “7 Business”).

In the spring of 2000, Dahan and Glasser met with defendant Koral at the offices of L’Koral. Koral, Dahan, and Glasser (“Parties”) entered into an oral agreement to jointly form and operate the 7 Business. The essential terms of the parties’ agreement, although parts of which were contested, were as follows:

(a) Each of Dahan and Glasser would have the right to receive 25% of the profits of the 7 Business, and Koral would have the right to receive 50% of the profits;
(b) The parties would initially operate the 7 Business as a division of L’Koral, not as a separate legal entity;
(c) Dahan would provide creative and design services. Glasser would provide sales and marketing services;
(d) Koral would provide the necessary financing. L’Koral would provide accounting and other services and facilities to the 7 Business;
(e) L’Koral would not charge the 7 Business for use of its facilities or other overhead until the 7 Business generated income; and
(f) At such time as the 7 Business could stand on its own (claimed by the Plaintiffs to be when annual sales reached $12 million), Koral would cause L’Koral to spin off the 7 Business into a separate entity owned by Koral, Dahan and Glasser (with the ownership interests split 50% to Koral, 25% to Dahan, and 25% to Glasser).

The result of the Parties’ collaboration was an extraordinary denim jean, labeled “7 for All Mankind”, of unparalleled quality with a unique fit and appearance. These women’s jeans sold for well over $100 a pair and quickly became one of the most sought after products in the fashion apparel business – all with absolutely no investment in advertising, promotion or retail space.

While in the process of completing the spin-off of the 7 Business, Plaintiffs notified Koral that they were leaving. They filed their lawsuit on the same day. Four days later, they formed another corporation to produce and sell competing women’s jeans under the trade name “Citizens of Humanity”.

On January 21, 2003, nearly six weeks after they had formed their competing company, the Plaintiffs for the first time claimed that the 7 Business was a partnership in which they had a 50% ownership interest rather than a 50% interest in profits and sought judicial appointment of a receiver and dissolution of the partnership, which motion was denied as was a subsequent motion for summary judgment.

In the summer of 2004, a jury trial was held to decide the claims of law and to provide the bench with advisory verdicts pertaining to the claims of equity.

The jury found against the Plaintiffs in regard to their fraud and breach of contract causes of action. In its advisory answers, the jury found (i) for the Plaintiffs in the breach of fiduciary duty cause of action in the amount of $5.5 million relating only to poor accounting for past profits; (ii) that Plaintiffs, indeed, had an ownership interest in the 7 Business from inception; and (iii) that the fair market value of the 7 Business, as of January 21, 2003, was $26 million.

Mr. Margulis, Defendant’s expert, testified that the fair market value of the 7 Business as of January 21, 2003 was in the range of $11 million to $26 million. The Plaintiff’s expert testified that the business was worth between $104 million and $135 million on that same date.

Based on its own evaluation of the evidence, the court adopted the advisory finding of the jury that Plaintiffs had an ownership interest in the 7 Business at the time they left the business in December 2002. Additionally, the court found that a partnership had been created by operation of law and that it was a partnership at will.

The court declined to put the business in receivership but chose rather to make an award to Plaintiffs based on their ownership interest and the evidence and expert testimony presented at trial.

In its Statement of Decision After Trial on Equitable Issues, the court went on to conclude that because the “7” business was a partnership at will, there was, therefore, no wrongful dissociation or usurpation of partnership opportunities by the Plaintiffs and denied any offsets for the Defendants due to the value of Plaintiff’s business. The court stated that since “their case presented to the jury denied the existence of a partnership….they may not now assert an inconsistent position and seek affirmative relief based on the position that there was in fact a partnership”.

The court i) acknowledged that the numerous factors testified to by Mr. Margulis and others “may well have had a significant impact on the ability to sell the business as a going concern…as of the date of the demand for dissolution…”; ii) noted the testimony of Plaintiffs’ expert that there were a number of factors [in the real world] he did not consider and that the value of the 7 Business as a going concern could be zero; and iii) reiterated one of the plaintiff’s testimony that “he wondered who would buy it so long as [certain issues remained] unresolved. Nonetheless, the court rejected the fundamental premise that the 7 Business could only be valued on a liquidation basis, based in part on the business’ performance subsequent to the date of demand for dissolution, noting that “it was a highly successful, highly profitable, thriving and growing business…” The court went on the state that “[W]ith cooperation between the parties the court finds that the business could have been sold on a going concern basis” without commenting that, offsetting any such hypothetical cooperation would be the fact that lawsuits had been filed, that the plaintiffs – both key talents and key assets of the business – would not be accompanying the business when and if sold, and that the plaintiffs had formed their own competing business, the effects of which on the 7 Business were, as of the date in question, not yet known but were certainly a threat to its continued survival.

The court found that the value of the 7 Business as of the date of the demand for dissolution was $100 million and declined to follow the jury’s recommendation that its value was $26 million.

The Parties subsequently settled the matter.