James M. Montgomery convinced an employee of a bank he was about to open to invest $100,000 in the business, saying he needed the additional money to meet regulators’ capitalization requirements to start operating.  Shortly after the employee made the investment in 2008 and before the bank opened for business, Montgomery directed the bank to transfer $100,000 to his family foundation.  The bank failed in less than a year and all of the initial investors, including the employee, lost their investments.

The employee sued Montgomery and the foundation for fraud, on the theory that Montgomery induced him to make the investment by intentionally misrepresenting the bank’s need for the money.  The trial court entered judgment for the employee, awarding him $100,000 in compensatory damages, pre-judgment interest of $70,000 and punitive damages, against the foundation only, of $260,000.  An appellate court in California has affirmed.

To show fraud, the appellate court said, the plaintiff must show that the defendant made a false representation as to a material fact; the defendant knew it was false; the defendant intended to deceive the plaintiff, the plaintiff; justifiably relied on the misrepresentation; and the plaintiff suffered damages. 

The trial court found that the employee made the investment in reliance on Montgomery’s representation that it was necessary to open for business.  It found that the representation was false because $100,000 was transferred from the bank to the foundation before the bank opened for business.  It also found that the employee’s reliance was justified because Montgomery knew more about the requirements than the employee did. 

The appellate court said there was substantial evidence to support these findings.  And it found that the trial court could reasonably have concluded that the employee would not have made the investment, as he testified, without the misrepresentation by Montgomery.

The foundation argued that the punitive damage award should be reversed because it violates public policy and had no evidentiary support.  The Court was “not persuaded.”

Fraud alone is an adequate ground for awarding punitive damages, it said.  And it said that the punitive damages did not violate public policy because they are not intended to compensate the injured party but to punish and to deter the defendant and others from similar extreme conduct in the future.  The foundation argued that it would have no deterrent effect because Montgomery had died before the trial. 

But the Court said that “the foundation board exercised no oversight of Jim Montgomery.  Every member of the board was also a member of the Montgomery family.  The board met annually, to review donations being made by the foundation and its investment activities.  Board members did not inquire about or review other deposits made into the foundation’s accounts, nor did the board review the foundation’s ledgers or general accounting.  In general, board members trusted foundation officers to do their jobs.  John G. Montgomery, Jim’s son, testified he was not aware that $100,000 had been transferred from the bank to the foundation and was never asked to approve it.  Andrew Montgomery, John’s brother, confirmed the board did not discuss the transfer until [the employee’s] lawsuit was filed, almost four years after the transfer occurred.”

The Court said that the members of the board “exercised no oversight” over Montgomery and “took no action to discover the transfer or inquire about the foundation’s ultimate use of those funds,” which “constitutes substantial evidence supporting the award of punitive damages against the foundation.”  (Sterling v. Montgomery, Ct. of App., Second Dist., Div. 6, CA, No. B267038, 7/25/17.)

YOU NEED TO KNOW

This is a highly unusual case.  The Court blamed the board of the foundation for a total lack of oversight over one of its directors and found justification for punitive damages, a rarely invoked penalty for egregious action.  Meeting only once a year, as this foundation board did at the time, is itself almost an admission of failure to exercise appropriate fiduciary duty.  Even where everybody is a member of the family, as was the case here, it is not a good idea.