1st Team Fitness, LLC v. Illiano

LAWRENCE F. RODOWSKY, J. (Retired, Specially Assigned). Appellant, 1st Team Fitness, LLC (1st Team) brought this action, directly and derivatively, on behalf of Pozzuoli, LLC (Pozzuoli), against the appellee, Francesco Illiano (Illiano). 1 ¹⁴⁰ Each of these parties was a fifty percent member in Pozzuoli. On counts charging intentional misrepresentation-concealment or non-disclosure, constructive fraud, breach of contract and conversion-embezzlement, the Circuit Court for Carroll County, at a bench trial, awarded Pozzuoli, LLC (hereinafter sometimes called the Gym) compensatory damages of $527,831, of which $263,915 were awarded directly to 1st Team.

Appellant is aggrieved because the circuit court did not award punitive damages or counsel fees or litigation expenses. The circuit court also appointed a receiver for Pozzuoli, LLC. By a separate brief, Pozzuoli, through its receiver, joins in requesting a reversal and remand on the punitive damages issue. Illiano has cross-appealed and asserts that the circuit court abused its discretion in failing to find a discovery violation by 1st Team, arising out of its allegedly untimely disclosure of the opinion expressed by the accounting expert called by 1st Team at trial.

For the reasons hereinafter set forth, we shall affirm. Background Facts Illiano, through BAIA, LLC, owned the premises located at 1311 South Main Street in Mt. Airy. In March 2009, Illiano, through his then solely owned LLC, Pozzuoli, acquired a franchise from SNAP Fitness, Inc. (SNAP Fitness) to operate a SNAP fitness center on the lower level of those premises.

The facility opened in September 2009. One Hundred Forty Thousand Dollars in startup costs were loaned to the Gym by Illiano from funds obtained from other business entities that he owned, wholly or partially. The Gym hired a manager and engaged Donald Caparotti (Don) and Diane Caparotti (Diane), who are husband and wife, to be fitness trainers. The Caparottis rendered those services through their LLC, 1st Team.

It ¹⁴¹ initially was paid 75% of the training fees with the remaining 25% retained by the Gym. The original manager’s services, however, proved unsatisfactory and, effective January 1, 2010, the Caparottis and Illiano entered into the agreement that underlies this litigation, namely, the operating agreement for Pozzuoli, LLC by and between Illiano and 1st Team. Its relevant features included: • Illiano and 1st Team each had 50% interests in the Gym. The operating agreement recited initial cash capital contributions of $100 per member, but those amounts were not actually paid. 1st Team paid no monetary consideration for its 50% interest. • Don and Diane would manage the fitness center, ordinarily working no less than a combined 50 hours per week, for which they would retain 100% of the personal training fees. • Illiano would be the managing member.

In his sole discretion, he would determine the amount of cash available for distribution. • Illiano had “full, exclusive and complete discretion, power and authority in operating the [Gym’s] business,” including “determining] the accounting methods and procedures of the [Gym].” • Illiano was to “keep ... full and true books of account, in which shall be entered fully and accurately each transaction of the [Gym].” • The books of account were to be open to inspection by members during regular business hours and were to be available online if the Managing Member maintained the books in a manner allowing that access. • There was no restriction on members engaging in other businesses and the Gym was unrestricted in dealing with businesses owned by or affiliated with a member. • Each member had a right of first refusal in the event of a sale of the other member’s interest. ¹⁴² • The members agreed that Illiano had loaned $140,000 to the Gym prior to the date of the Operating Agreement. After several months of operations, the Caparottis began fielding complaints from vendors and employees that they had not been paid. Nor was the couple receiving payment for personal training. In April 2010, they first received financials for the Gym and thereafter received them sporadically.

None of the reports had supporting details. After repeated requests for a meeting, the Caparottis met with Illiano in early 2011, but the same circumstances continued. For some eighteen months after June 2011, 1st Team received no financials, despite repeated requests. Personal training fees were received only intermittently.

In November 2012, Illiano met with Don and Diane and advised that he was discussing selling the Gym to SNAP Fitness. The couple objected and asserted that they would exercise the right of first refusal that 1st Team had under the Operating Agreement. Illiano agreed that he would not sell and he broke off the negotiations. On Sunday, March 3, 2013, Illiano asked Don to meet in the former’s office.

Illiano told Don that he had sold the Gym to SNAP Fitness. The circuit court found as a fact that Illiano told Don that “it’s nothing personal, I can’t afford to lose my empire.” The “Empire” English is not Illiano’s first language. He testified with a “heavy accent.” 2 Since coming to the Mt. Airy area, he has acquired numerous business interests.

Interests held by Illiano as of January 1, 2010, were: • BAIA, LLC, owning real estate assessed in excess of $13,000,000; • Ridgewill, LLC, owning interests in two commercial properties that are leased; ¹⁴³ • The Mt. Airy Inn, a restaurant; • Napoli, Inc., a pizza restaurant; • Lenanos, LLC, owning the Mt. Airy Green Turtle, a restaurant; and • Germantown Green Turtle, a restaurant. Illiano has “silent partners” in BAIA, Lenanos, the German-town Green Turtle and the Mt.

Airy Inn, but he controls each of the companies. Illiano views each component of the “empire” as a company owned by him. Illiano testified that if there were bills to be paid by one company, but it did not have cash to pay the bill, he would take the money from another company and put it back later. From a bookkeeping standpoint, this was recorded through an account that was added to the QuickBooks computerized accounting system utilized by the companies.

That account was labeled “Due to/from Frank.” The bookkeeper employed by Illiano Properties, which was the management corporation for the “empire,” testified that there were twenty entities wholly or partially owned by Illiano. That witness also testified that she did not handle the intra-company transfers of funds and explained, “Frank would take care of those kinds of transactions himself.” She would cut checks at his direction. The “Due to/from Frank” account had been used for at least ten years since the QuickBooks system was initiated. The Empire In Peril On direct examination, Illiano had testified that the reason for the sale of the Gym was its lack of profitability.

On cross-examination, he was impeached by certified copies of court records of creditors’ suits against businesses in the empire. Illiano’s lender, on February 14, 2013, entered a confessed judgment against him, his wife and various of his companies for roughly three-quarters of a million dollars. Illiano acknowledged that immediately after those judgments were entered, he contacted SNAP Fitness to sell the Gym. He was ¹⁴⁴ also sued by at least one other bank.

In addition, the federal and state governments imposed tax liens. 3 The Sale The sale of the Gym closed Friday, March 1, 2013, pursuant to documents executed that day. It was a sale of the assets of Pozzuoli. The purchase price was $410,000. After deductions for the payoff of leases on equipment ($144,211.55) and for a holdback, Pozzuoli netted a total of $260,958.45 that was wired by SNAP Fitness to the Gym’s account at Damascus Community Bank.

At the meeting between Illiano and Don on Sunday, March 3, following the sale, the former told the latter that one-half of the net proceeds from the sale, after expenses and liabilities, was approximately $55,000. Illiano requested that Don execute a release on behalf of 1st Team, before paying 1st Team’s share of the net proceeds. Don refused, and the share was not paid. After this matter was in litigation, Illiano produced four statements that purported to account for the $410,000 paid for the assets of Pozzuoli.

In addition to the payoff of $144,211.55 on the equipment lease and holdback offsets of $4,830, the statements claimed expenses for legal fees, property taxes, a $63,667 balance on “Loan to Frank,” reconciliations with the landlord (BAIA, LLC), a brokerage/consulting fee of 10% (to an Illiano company) and “unbilled” startup costs for the Gym claimed to have been paid by Illiano Properties. The 1st Team share of the net, after expenses, per these statements, ranged from $61,352.76 to a loss of $21,407.16. The damages theory adopted by the court did not require addressing the legal enforceability of these offsets, claimed by Illiano, against the amounts wired to Pozzuoli by SNAP Fitness, as we explain below. ¹⁴⁵ The Damages Calculation The Caparottis engaged a forensic accountant, Andrew Runge, to analyze the accounting for the sale proceeds. This ultimately led him to the “Due to/from Frank” bookkeeping account and to the Pozzuoli checking account at Damascus Community Bank.

The buyer had wired $255,788.45 on March 1, 2013, to the Pozzuoli checking account. That same day, Pozzuoli purchased, for eight dollars, a Treasurer’s check for $200,000 payable to BAJA, LLC. The net of $5,170 from the asset purchase holdback was wired to Pozzuoli’s bank account no later than May 13, 2013. On May 30, 2013, a Treasurer’s check was purchased from that account for $5,000, payable to “Illiano Property, Inc.” Mr. Runge analyzed the Pozzuoli checking account for the period beginning with 1st Team’s acquisition of a 50% interest in the Gym, i.e., from January 1, 2009.

In the three years between March 2010 and March 2013, there were sixteen checks drawn, totaling $422,612, for which a Pozzuoli business purpose was not noted in the records. Of these, fifteen were payable to Damascus Community Bank, almost all of which were to purchase Treasurer’s checks. The Treasurer’s checks, in turn, were payable to entities in the “empire.” Mr. Runge was “unclear as to why [Treasurer’s checks] would be employed other than to potentially obviscate [obfuscate] the source of these funds.” Runge’s analysis of the “Due to/from Frank” account on the books of Pozzuoli, for a comparable period, lists, in small, single-spaced print, over three 8 pages, transactions that are classified as “Withdrawals” or “Infusions.” There was a total of $567,949.97 in withdrawals. “[B]ased on what [he] was able to verify or look at,” Runge opined that “that $567,949.97 went out of the account and there was not documentation provided to demonstrate that that was in fact a valid expense of Pozzuoli.” Runge’s analysis totaled the infusions at $282,702.04. These had been deposited to the Pozzuoli account “and looked like [they were] not revenue attributable to Pozzuoli.” Runge also opined that additional credits against ¹⁴⁶ the excess of withdrawals over infusions should be given for one-half of Pozzuoli’s net income shown on its tax returns for 2010-2012 and for the $140,000 agreed upon in the operating agreement statement as Illiano’s startup loans.

Thus, the net claim against Illiano on the transactions processed through the “Due to/from Frank” account on the books of Pozzuoli was $105,219. Thus, the judgment awarded to 1st Team was $422,612 + $105,219 x 1/2 = $263,915. The Fact Findings The circuit court decided this case in a fifty-two page opinion. It found that Illiano’s “breaches and misrepresentations” included the following (exhibit references omitted): “1) Failure to keep and maintain full and true books of account; “2) Extreme mismanagement of company funds, books and records in violation of common law fiduciary duties; “3) Failure to provide 1st Team Fitness access to the Pozzuoli online QuickBooks account; “4) Failure to provide 1st Team Fitness access to the financial and accounting records of Pozzuoli, despite many repeated requests; “5) Failure to deposit or invest all Pozzuoli funds in the company name; “6) Taking $105,219 in excess withdrawals from the Pozzuoli bank account; “7) Causing $422,612 in funds to be removed from the Pozzuoli bank account, which transactions were not entered into the Pozzuoli accounting records; “8) Causing $422,612 in Pozzuoli funds to be deposited into not fewer than nine (9) other companies owned by Defendant, most of which Defendant testified had no business relationship with Pozzuoli LLC; “9) Intentionally commingling Pozzuoli funds with his other business entities; ¹⁴⁷ “10) Treating business funds as his own personal funds, including treating the Pozzuoli bank account as his own; “11) Failing to disclose his actions, much less seek majority or supermajority consent, with regard to the sale of the Pozzuoli assets to SNAP Corporate; “12) Causing all or substantially all of the Pozzuoli assets to be sold to SNAP Corporate; “13) Failing to disclose to SNAP Corporate during deal discussions of the existence of 1st Team Fitness as a member in Pozzuoli; (Defendant testified that he always treated 1st Team Fitness as a member and at his deposition, claimed he didn’t realize 1st Team Fitness was not a member until the lawsuit was initiated, some four (4) months after [representing to SNAP] that he was the sole member); “14) Creating unsubstantiated expenses to be subtracted from the sale proceeds in an effort to increase his share of the proceeds; “15) Creating more unsubstantiated expenses to drive the Sales Price Less Expenses values down as the litigation continued; “16) Taking a guaranteed payment in the amount of $45,799 in 2011 not also paid to 1st Team Fitness; “17) Refusing to turn over any money from sales proceeds to 1st Team Fitness until the release was signed; (Defendant testified he did require the Caparottis to sign the release before he would give them any money from the sale); “18) Failing to pay any portion of the sales proceeds from the March 1, 2013 asset sale to 1st Team Fitness; “19) Causing substantially all of the sales proceeds from the asset sale to be transferred to his company BAIA, LLC; “20) Causing the sales proceeds to be further transferred from BAIA, LLC’s bank account to eight (8) other ¹⁴⁸ entities owned by Defendant, most of which Defendant testified had no business relationship with Pozzuoli LLC.” Nevertheless, with respect to 1st Team’s claim of fraud, in the sense of intentional misrepresentation, concealment or non-disclosure, the court found: “The Court also concludes that, however ill-advised Illiano’s actions were, Plaintiffs have not proven that they were done with the knowledge that the representations were false.

Rather, the Court concludes that Illiano acted under the woefully misguided belief that he or his entities were entitled to withdraw funds from Pozzuoli as he saw fit, that he was entitled to sell all of Pozzuoli’s assets, and that he was further entitled to create expenses of sale to justify that which he believed would result in a proper distribution of the sale proceeds.” Specifically relating to its conclusion not to award any punitive damages, the court explained: “The Court declines to find that Illiano acted with actual malice, and thus declines to award punitive damages in this case. A party seeking punitive damages must prove actual malice by clear and convincing evidence. Darcars Motors of Silver Spring, Inc. v. Borzym, 150 Md.App. 18 , 43-[5]3[, 818 A.2d 1159, 1173-1179 ] (2003), aff’d., 379 Md. 249 [, 841 A.2d 828 ] (2004). An award of punitive damages must be based upon actual malice, in the sense of evil or wrongful motive, intent to injure, ill will, or fraud.

Tierco Md., Inc. v. Williams, 381 Md. 378 , 849 A.2d 504 (2004). A breach of fiduciary duty alone does not establish actual malice. Bresnahan v. Bresnahan, 115 Md.App. 226 , 693 A .2d 1 (1997). “It is true that the Court found that Illiano breached his fiduciary duty to Plaintiffs, and that such breach of fiduciary duty constituted intentional misrepresentation toward the Plaintiffs. Those findings alone are not sufficient to support a claim for punitive damages.

A finding of fraud or deceit based on a defendant’s actual knowledge that his represen ¹⁴⁹ tations were false coupled with an intent to deceive can and normally will justify an award of punitive damages. Ellerin [v. Fairfax Sav., F.S.B., 337 Md. 216 ,] 240-41[, 652 A.2d 1117, 1129 (1995) ]. However, where a defendant’s fraud or deceit is premised not on his actual knowledge o[f] falsity, but on his reckless disregard or indifference as to the truth of his representations, punitive damages are generally not recoverable. Id., at 235 [, 652 A.2d at 1126 ].

Similarly, other conduct, recognized by the law and sometimes labeled ‘fraud,’ falls short of the act of deliberate deception required for actual malice in this context, and is not sufficient to sustain a punitive damages award. [Id.] at 235-36[, 652 A.2d at 1126 ]. For example while ‘constructive fraud’ has been recognized for certain purposes in Maryland, it does not necessarily involve the type of dishonest or immoral conduct that is required to support an award of punitive damages. Id. “As indicated above, the Court finds that Illiano’s actions, while done with an intent to deceive, where carried out with reckless indifference to and not actual knowledge that his representations were false. Accordingly, the Court declines to award punitive damages to the Plaintiffs.” Additional facts will be set forth in the discussion of particular issues.

Questions Presented Appellant, 1st Team, asks: “I. Did the Circuit Court commit error by holding the record did not support a finding of actual malice? “II. Did the Circuit Court commit error by failing to award attorneys’ fees under the common fund doctrine?” Appellant Pozzuoli asks if the court applied the correct legal standard for awarding punitive damages. On his cross-appeal, Illiano asks: “Did the trial court abuse its discretion in refusing a continuance and allowing the testimony of the Appellant’s expert ¹⁵⁰ to opinions which were never disclosed in pre-trial discovery?” DISCUSSION I Appellants seek a remand, with directions to hold a hearing on, inter alia, punitive damages. 1st Team’s argument focuses on two counts of the complaint, Count IX, Conversion/Embezzlement, and Count VI, Breach of Fiduciary Duty. As to Count IX, the court found that “Illiano’s actions, while done with an intent to deceive, [were] carried out with reckless indifference to and not actual knowledge that his representations were false.” 4 On the alleged claim for breach of fiduciary duty, as Count VI was labeled, the court held, citing Kann v. Kann, 344 Md. 689 , 690 A.2d 509 (1997), that that claim did not constitute a stand-alone cause of action, at .least where only monetary damages were sought as the remedy.

Thus, no damages, compensatory or punitive, were awarded on that count. There must be an award of compensatory damages, however, on each count that is sought to be the basis for an award of punitive damages. See Caldor, Inc. v. Bowden, 330 Md. 632, 662-63 , 625 A.2d 959, 973-74 (1993); Montgomery Ward & Co. v. Keulemans, 275 Md. 441 , 340 A.2d 705 (1975); Potomac Elec. Power Co. v. Smith, 79 Md.App. 591, 639-40 , 558 A.2d 768, 792-93 (1989) (holding that award of funeral expenses in personal representative’s action satisfied the compensatory damage predicate for a punitive damage award on survival claim), overruled on other grounds by United States v. Streidel, 329 Md. 533 , 620 A.2d 905 (1993).

Consequently, ¹⁵¹ we consider only appellant’s argument based on the conversion claim. The principles controlling the award of punitive damages were set forth in Owens-Illinois, Inc. v. Zenobia, 325 Md. 420 , 601 A.2d 633 (1992), where the Court said: “ ‘[T]he purposes of punitive damages relate entirely to the nature of the defendant’s conduct.’ Schaefer v. Miller, 322 Md. [297,] 321, 587 A.2d [491,] 503 [ (1990) ]. Whether the tort occurred before or after the formation of a contractual relationship should not determine whether actual or implied malice is required for allowing an award of punitive damages. Rather, the availability of a punitive damages award ought to depend upon the heinous nature of the defendant’s tortious conduct. “Awarding punitive damages based upon the heinous nature of the defendant’s tortious conduct furthers the historical purposes of punitive damages — punishment and deterrence.

Thus, punitive damages are awarded in an attempt to punish a defendant whose conduct is characterized by evil motive, intent to injure, or fraud, and to warn others contemplating similar conduct of the serious risk of monetary liability.” Id. at 454 , 601 A.2d at 649-50 (citations omitted). The Court also addressed the standard of proof. “Use of a clear and convincing standard of proof will help to insure that punitive damages are properly awarded. We hold that this heightened standard is appropriate in the assessment of punitive damages because of their penal nature and potential for debilitating harm. Consequently, in any tort case a plaintiff must establish by clear and convincing evidence[,] the basis for an award of punitive damages.” Id. at 469 , 601 A.2d at 657 .

In Scott v. Jenkins, 345 Md. 21 , 690 A.2d 1000 (1997), Judge Karwacki, writing for the Court some five years after Zenobia , in a case in which punitive damages were awarded by a jury that found the defendant liable for battery and false imprison ¹⁵² ment, said: “Lest there be any remaining doubt, in order to recover punitive damages in any tort action in the State of Maryland, facts sufficient to show actual malice must be pleaded and proven by clear and convincing evidence.” 345 Md. at 29 , 690 A.2d at 1004. The punitive damage award in that case was stricken for failure to have plead sufficient facts. 1st Team’s argument emphasizes that the court’s finding of Illiano’s liability for conversion included the net proceeds of the sale. There was no contract authorizing a ten percent broker’s fee as a cost of sale and no documentation for certain other charges. The court found that “[b]y creating false expenses, Illiano intentionally appropriated the sales proceeds and paid them to himself or nine (9) of his other business entities.” Illiano refers us to the litigation culminating in Darcars Motors of Silver Spring, Inc. v. Borzym, 379 Md. 249 , 841 A.2d 828 (2004), a conversion case tried to a jury, in which an award of punitive damages was affirmed.

There, the Court said, “Where the defendant converts property with a consciousness of the wrongfulness of that conversion, he or she