What is Reformation of a Written Contract and the Sham Pleading Doctrine?

In an unusual 2-1 decision in Panterra GP, Inc. v. Superior Court (Rosedale Bakersfield Retail VI, LLC), the California appellate court addressed the standards for reformation of a written contract, and the sham pleading doctrine

Panterra GP, Inc. (Panterra GP) filed the underlying action against Rosedale Bakersfield Retail VI, LLC (Rosedale) and Movie Grill Concepts XX, LLC (Movie Grill).

Panterra GP sought payment from the defendants for work it allegedly performed on a construction project.

Defendants filed a demurrer to Panterra GP’s third amended complaint, relying largely on Business and Professions Code section 7031, subdivision (a). The trial court sustained the demurrer without leave to amend.

The appellate court concluded that section 7031, subdivision (a) had no applicability to claims asserted by Panterra GP, Inc., because it was licensed as a contractor at all relevant times.

It directed the trial court to vacate its order sustaining the demurrer to Panterra GP, Inc.’s amended complaint, and to issue a new order overruling the demurrer.

Panterra GP is a licensed general contractor. Rosedale and Movie Grill intended for Panterra GP to perform renovation work on the Studio Movie Grill in Bakersfield, California.

Despite this intent, defendants drafted a contract that mistakenly listed a different entity – Panterra Development Ltd., L.L.P. (Panterra Development)– as the contractor for the project.

Panterra Development is not licensed as a contractor in California. Panterra GP is the general partner of Panterra Development.

Despite the mistake in the written contract, Rosedale and Movie Grill knew, intended and agreed that, in fact, Panterra GP would act as the general contractor and would perform the work contemplated by the agreement. And, indeed, that is what happened.

Panterra GP acted as general contractor for the project and actually performed the remodeling work. Accordingly, the permit applications and building permits issued for the project by the City of Bakersfield correctly reflect that Panterra GP was the contractor.

The “Certificate of Occupancy,” issued on April 16, 2018, also correctly reflects that Panterra GP was the contractor.

After Panterra GP completed the work, Rosedale refused to pay more than $2,609,666 owed under the contract.

Panterra Development filed a mechanic’s lien identifying itself as the contractor to the project.

Panterra GP sought reformation of the contract to reflect the true agreement of the parties (Civ. Code, § 3399) and recovery of the millions of dollars it is owed for its work.

In response, Movie Grill contended that the sham pleading doctrine applied that prevents contrary allegations in subsequent complaints.

Panterra GP’s first amended complaint raised claims for “recovery on mechanic’s lien release bond”; “breach of contract”; “account stated”; and “open book account.” 

From the first amended complaint through the operative third amended complaint, Panterra GP has repeatedly alleged that it was the general contractor for the project and actually performed the work. Panterra GP also repeatedly alleged that it was the entity that entered the agreement to perform the work.

Three exhibits were attached to the first amended complaint.

The first exhibit, Exhibit A, was an American Institute of Architects form contract (Standard Form of Agreement Between Owner and Contractor). The contract identified “the Owner” as Rosedale and “the Contractor” as Panterra Development. The contract between Rosedale identified the relevant “Project” as a “Renovation for Studio Movie Grill” in Bakersfield, and it was signed on behalf of “Panterra Development Ltd., L.L.P.” by “Sean W. Rea, President of Panterra GP, Inc., The Sole General Partner of Panterra Development Ltd., L.L.P.”

The contract contains several vertical lines in its left margin, including where Panterra Development, is identified as the “Contractor.”

The second exhibit attached to the first amended complaint, Exhibit B, consisted of documents related to a mechanics lien; the mechanics lien was recorded by “Panterra Development Ltd., L.L.P.”. The claim for the mechanics lien noted the “Claimant” under the mechanics lien was “Panterra Development Ltd., L.L.P., dba Panterra Construction.”

The lien stated that “[c]laimant served as the general contractor for the Project.” The lien was signed on behalf of “Panterra Development Ltd., L.L.P. dba Panterra Construction” by “Panterra G P, Inc., its sole general partner” by Sean W. Rea, President of Panterra GP. Rea also signed a verification, under penalty of perjury, that the “contents” of the lien were “true.”

The third exhibit attached to the first amended complaint, Exhibit C, consisted of documents related to a “Partial Release of Mechanics Lien,”. The “Claimant” was identified as “Panterra Development Ltd., L.L.P. dba Panterra Construction.”

The partial release of mechanics lien further stated that claimant furnished the labor, materials, equipment, services and/or work underlying the mechanics lien, to Rosedale.

The partial release of mechanic’s lien was signed on behalf of “Panterra Development Ltd., L.L.P. dba Panterra Construction” by “Panterra G P, Inc., its sole general partner” by Sean W. Rea, President of Panterra GP. Rea also signed a verification, under penalty of perjury, that the “contents” of the partial release of mechanic’s lien were “true.”

Movie Grill filed a demurrer to the first amended complaint and the trial court ruled: First-amended Complaint is brought by plaintiff Panterra GP, Inc., the sole general partner of Panterra Development, Limited, L.L.P.  Panterra GP alleged it entered into an agreement with Rosedale, however, Exhibit A indicates that the party that entered into the agreement with Rosedale is Panterra Development, Ltd., L.L.P., not Panterra GP. Given the lack of allegations that establish Panterra GP’s standing to act on behalf of Panterra Development, Limited, L.L.P., the demurrer on standing as to all causes of action was sustained with leave to amend.

The second amended complaint again alleged that Panterra GP and Rosedale entered into an agreement whereby Panterra GP was to furnish all labor, materials, supplies and equipment necessary to perform the construction and improvements at the Movie Grill project.

The complaint alleged that “Panterra GP, Inc. was designated as the contractor” under the agreement. The complaint further alleged that Panterra GP was listed as the contractor on the building permit and certificate of occupancy. The building permit and certificate of occupancy were attached as exhibits.

The second amended complaint further alleged that Panterra GP has exclusive control over the management of Panterra Development’s business. The complaint further alleged that Panterra GP is authorized to exercise the powers of Panterra Development as an authorized representative. The trial court sustained the defendants’ demurrer.

Panterra GP, filed a third amended complaint, and after Movie Grill filed a demurrer to the third amended complaint, the trial court ruled: The First Cause of Action seeks to have the court reform the construction contract in which Panterra Development, Ltd., L.L.P. is the named party as the contractor in order to substitute in Panterra GP, Inc. as the named contractor.

The issue is whether a party may rely on equitable principles to ‘reform’ a contract in order to overcome the failure of the party identified in the construction contract as the contractor to have a valid contractor’s license as required by California’s Contractors’ State License Law as contained in Business and Professions Code section 7031. Unfortunately for plaintiff, it is well-established that equitable theories cannot overcome a failure to have a proper license.

As Movie Grill acknowledged and the trial court concluded, while Panterra GP is a general partner of Panterra Development, the two are legally distinct entities. The former has been licensed as a contractor at all relevant times, and the latter has been unlicensed at all relevant times.

It seems clear that, as an unlicensed entity, Panterra Development would be barred by subdivision (a) from recovering any compensation on any theory for its performance of any act or contract requiring licensure. But Panterra Development is not the plaintiff here; Panterra GP is. And as broadly as subdivision (a) prohibits suits by unlicensed entities, it poses no obstacle whatsoever to claims by licensed entities.Subdivision (a) provides no basis for a demurrer to a complaint by Panterra GP.

It seems clear that the language of section 7031 does not bar the claims of Panterra GP.

There are several issues with Movie Grill’s contention. First, the core factual assertions regarding the identity of the contractor for the project are not “new allegations.” Panterra GP has repeatedly alleged, across its amended complaints, that it was the general contractor for the project and actually performed the work. Panterra GP has also repeatedly alleged that it was the entity that entered into the agreement to perform the work.

Second, courts may not turn a demurrer into a contested evidentiary matter by determining what the proper interpretation of the evidence is. It is for a finder of fact to consider all the evidence to determine whether the complaint’s allegations are true. That determination cannot be made at the pleadings stage, it must be made following summary judgment or trial.

When, through mutual mistake of the parties, or a mistake of one party, which the other at the time knew or suspected, a written contract does not truly express the intention of the parties, it may be revised on the application of a party aggrieved, so as to express that intention. (Civ. Code, § 3399.)

Although “reformation” is sometimes casually referred to as a cause of action, it is actually a remedy. Reformation is not the court creating a new agreement but rather enforcing the actual agreement already made by the parties.

The operative complaint alleged a prima facie case for reformation. The complaint alleged that Rosedale and Movie Grill intended for Panterra GP to perform the work and that, despite this mutual intent, defendants drafted a contract that mistakenly listed Panterra Development as the contractor for the project.

Movie Grill contended that Panterra GP’s pursuit of reformation is improper because reformation is an equitable remedy and equitable remedies are foreclosed by subdivision (a) that precludes equitable remedies. But it only does so with respect to equitable remedies sought by an unlicensed entity. Panterra GP is not an unlicensed entity.

Movie Grill also argued that the reformation sought by Panterra GP is not permitted under a Supreme Court case from 1900, a decision that prohibited a court of equity from making a “new contract” – rather than merely reforming it – by substituting one party for another. On this basis, Movie Grill argues that reformation cannot be used to substitute parties to a contract.

However, Civil Code section 3399 permits reformation of a contract upon application of any aggrieved party. Under this statute, the right to reformation of an instrument is not restricted to the original parties to the transaction.

Thus, the proposition that a person cannot be made a party to a written instrument by reformation is an overstatement.  No "new contract" is made when the plaintiff, on a proper showing of mistake, asks to have the writing conform to the original oral agreement concerning the parties to the contract.

Movie Grill contended that reformation is not available because a contract made by an unlicensed person in violation of the licensing laws is void. This argument merely assumes the key matter in dispute: whether the agreement at issue here was made by an unlicensed person.

Panterra GP contended that the actual agreement between the parties was that it would act as contractor, and that the written contract failed to reflect that true agreement. If that allegation is accepted as true, as the appellate court must in reviewing a demurrer, then the agreement here is not one made by an unlicensed person.

Movie Grill argued that reformation is not available because Panterra GP has made a mistake caused by the neglect of a legal duty.

Specifically, that Panterra GP neglected its legal duties by: (1) failing to request an addition or deletions report; and (2) failing to consult with an attorney about the insertion of Panterra Development as the Contractor and the legal consequences of the insertion.

The purpose of section 7031 is to encourage adherence to the licensing laws and to deter persons from offering or providing unlicensed contractor services for pay.  Neither purpose is thwarted by reforming a contract to reflect the reality that several parties agreed to hire a licensed contractor for renovation work.

Given the facts asserted by the operative complaint, overruling the demurrer is not only compelled by law, but necessary to prevent defendants from walking away with a massive windfall without Panterra GP ever having its day in court.

One of the justices dissented, arguing the trial court’s ruling was proper under well-established pleading rules. Facts appearing in exhibits attached to a complaint are accepted as true and are given precedence over any contrary allegations in the pleadings.

The allegations in the body of the first amended complaint indicated that Panterra Development Ltd., L.L.P. and Panterra GP, Inc. collectively entered into the project contract with Rosedale.  However, this allegation was squarely contradicted by all three exhibits to the first amended complaint, that is, the contract, the mechanics lien, and the partial release of mechanics lien, each of which clearly indicated that Panterra Development Ltd., L.L.P. was the “Contractor” that entered into the project contract with Rosedale and the general contractor for the project.

Even if the first amended complaint were read to allege that Panterra GP, Inc. entered into the contract with Rosedale, as the trial court evidently did, that contention also conflicted with the above-described exhibits, which were properly accorded precedence over the contrary allegation in the body of the complaint as to the party that entered into the contract with Rosedale.

The dissent argued that trial court properly sustained the demurrer to the first amended complaint on grounds that Panterra GP, Inc. was not the contracting party and therefore could not recover under the contract. Panterra GP, Inc. did not challenge the court’s ruling.

The third amended complaint, for the first time, indicated it was being filed solely on behalf of Panterra GP, Inc., rather than Panterra GP, Inc. and Panterra Development Ltd., L.L.P. “collectively”; however, the complaint at times used the term “Panterra” to refer to both Panterra entities.

The sham pleading doctrine applied here and required the appellate court to disregard the inconsistent allegations added to the third amended complaint in support of the contract reformation claim added therein.

Panterra GP, Inc. cannot avoid the defects in the allegations contained in the second amended complaint by filing a third amended complaint encompassing factual allegations that are inconsistent with the allegations in the prior complaint.

LESSONS:

1.         Always have a suitable written contract for any business transactions because it     helps avoid misunderstandings and disagreements, and it may be subject to        reformation.

2.         Always consider being the drafter of the contract as you will have a better understanding of the contents of the agreement your counsel drafted, and you          can      include a provision that the presumption of responsibility for any ambiguity that is on       the drafter is waived by all parties.

3.         Know who you are precisely, with the accurate legal description of the parties,      price, and subject of the agreement, and carefully sign as and for the correct party         to the agreement.

4.         Careful drafting of the complaint(s) is required to avoid the effect of the sham       pleading doctrine, and in this case, over $2.6 million was almost lost because the           contractor apparently did not have the contract reviewed by legal counsel, and legal          counsel did not inconsistencies regarding the plaintiffs and the facts in the   complaint(s).

5.         In reviewing a contract, I first determine the precise names of the parties to the      agreement, and how they are signing, then the price and method of payment, as            those are the critical terms that are often incorrectly drafted.