PALM VALLEY HOMEOWNERS ASSN. v. DESIGN MTC
(2001) 85 Cal.App.4th 553
Edwards, Sooy & Byron and Michael M. Edwards for Objector and Appellant.
Thorsnes, Bartolotta & McGuire, C. Brant Noziska, Neal H. Rockwood and Timothy J. Tatro for Plaintiff and Respondent. [85 Cal.App.4th 555]
Appellant law firm Edwards, Sooy & Byron (the firm) appeals after
the trial court imposed sanctions upon it for asserted bad faith acts
and [85 Cal.App.4th 556] discovery abuses in the underlying
construction defect litigation. The basis for the imposition of
sanctions was that the firm pursued litigation activities on behalf of
its client, even after the firm knew that the client was a suspended
The firm contends that the trial court abused its discretion in imposing
sanctions: The rule is clear that a corporation suspended for
nonpayment of taxes may not defend itself in litigation. The firm's
client, however, was suspended for failure to file a required
information statement with the Secretary of State, and not for
nonpayment of taxes. Whether these two types of corporate suspensions
both result in a disqualification from litigation appears to be a
question of first impression.
We conclude that, although the statutory provisions suspending a
corporation for failure to file a required statement have not yet been
so construed in any published California case, those provisions would
make clear to any reasonable attorney that a corporation suspended under
the Corporations Code, like a corporation suspended under the Revenue
and Taxation Code, is also disabled from participating in litigation
activities. At the least, the facts before the trial court support the
view that the firm did not rely upon any purported distinction between a
Corporations Code suspension and a Revenue and Taxation Code suspension
in deciding to conceal its knowledge of the client's suspended status
from the court and opposing counsel. Thus, the court did not abuse its
discretion in finding that the firm acted in bad faith, and in assessing
sanctions accordingly. We therefore affirm the award of sanctions.
Facts and Procedural History
Plaintiff and respondent, Palm Valley Homeowners Association, Inc.
(homeowners), filed a construction defect lawsuit against the developer
of their homes. The developer in turn cross-complained against
subcontractors and suppliers that had worked on the project. In 1996,
homeowners named a company called Design MTC in place of one of the
subcontractor Doe defendants. The firm represented Design MTC.
The firm, on behalf of Design MTC, answered both the developer's
cross-complaint and the homeowners' complaint by June 16, 1997. In March
of 1998, the firm learned that its client, Design MTC, was a suspended
corporation. Design MTC's suspension was not for nonpayment of taxes,
however, as provided under Revenue and Taxation Code section 23301;
rather, Design MTC was suspended after failing to file a required
informational statement with the Secretary of State, as provided in
Corporations Code section 2205. [85 Cal.App.4th 557]
The firm did not report the suspension to the court or to any other
parties; the firm continued to represent Design MTC in the litigation,
filing and responding to pleadings and motions. In July 1998, for
example, the firm filed motions for summary judgment on Design MTC's
behalf, against both the homeowners on the complaint and the developer
on its cross-complaint.
On August 5, 1998, the homeowners' investigator discovered that Design
MTC was a suspended corporation. The homeowners' attorneys notified the
firm on August 27, 1998, that it had learned of Design MTC's suspension.
At a court hearing on August 28, 1998, the homeowners' attorneys
reported to the court that Design MTC was a suspended corporation,
erroneously stating that it had been suspended under the Revenue and
Taxation Code. The court granted the homeowners an order shortening time
for bringing a motion to strike Design MTC's answer, and also took
Design MTC's summary judgment motions off calendar.
Homeowners moved for sanctions against Design MTC and the firm. The firm
appeared for Design MTC at the sanctions hearing, and objected to the
proceedings. The court ruled that neither Design MTC nor the firm had
the right to appear at the hearing on account of Design MTC's suspended
status. The court granted the motion for sanctions and set a further
date for a prove-up hearing.
On or about September 25, 1998, homeowners filed their memorandum of
costs, and requested $89,490.02 in sanctions. On or about September 29,
1998, the firm filed a petition for writ of mandate in this court. (Edwards, Sooy & Byron v. Superior Court
(Sept. 29, 1998, E023496) [nonpub. opn.].) On October 5, 1998, this
court stayed proceedings on the sanctions. We thereafter issued a writ
commanding the trial court to vacate its earlier sanctions order, and to
hold a new hearing, affording the firm both notice and an opportunity
to appear and defend itself against the request for sanctions. At the
firm's request, we have taken judicial notice of our file in the earlier
writ proceeding, Edwards, Sooy & Byron v. Superior Court, supra, E023496.
On December 4, 1998, the court again heard the homeowners' motion for
sanctions. The firm opposed the motion, arguing that, because Design MTC
was not suspended for nonpayment of taxes, the disabilities applicable
to a tax-suspended corporation (Rev. & Tax. Code, § 23301) should
not apply. The firm argued that it had believed in good faith that a
suspension under the Corporations Code did not impose the same
litigation disabilities as a tax suspension. [85 Cal.App.4th 558]
The court took the matter under submission and, on February 3, 1999,
ruled that the firm had violated both Code of Civil Procedure sections
128.5 (frivolous actions taken in bad faith) and 2023 (discovery
abuses), and imposed sanctions of $14,241.35.
The firm appeals the sanctions order.
I. Standard of Review
 "We review the imposition of monetary sanctions for a prejudicial abuse of discretion." (20th Century Ins. Co. v. Choong (2000) 79 Cal.App.4th 1274, 1277 [94 Cal.Rptr.2d 753].)
II. The Trial Court Did Not Abuse Its Discretion
in Imposing Sanctions on the Firm for Continuing to Represent a
 The firm argues that the trial court abused its discretion in imposing sanctions. There are two prongs to the argument.
First, sanctions were imposed in part under Code of Civil Procedure
section 128.5, for alleged bad faith acts, which were frivolous or
undertaken for delay. The firm contends that its client was suspended
under the Corporations Code, and not under the Revenue and Taxation Code
for nonpayment of taxes. The statutory suspension provisions of the
Corporations Code have never been interpreted expressly to indicate that
a corporation suspended for failure to file the required information
statement is legally disabled from acting to the same extent as a
corporation suspended under the Revenue and Taxation Code for nonpayment
of taxes. The firm argues that the court below erred in (1) finding a
Corporations Code suspension the same as a Revenue and Taxation Code
suspension, and (2) finding that the firm acted in bad faith in
believing the two kinds of suspensions should be treated differently.
A finding of abuse of discretion in imposing sanctions under Code of
Civil Procedure section 128.5 thus depends in part upon whether the
trial court correctly interpreted the relevant statutes, and in part
upon its assessment of the firm's good faith or bad faith in taking the
positions it did.
The second prong of the firm's argument is that the court abused its
discretion in imposing sanctions under Code of Civil Procedure section
2023, for discovery abuse. That is, the firm contends that its conduct
in [85 Cal.App.4th 559] representing its client during ongoing
discovery is not, in itself, an abuse of the discovery process. Neither
the client nor the firm, for example, refused to provide relevant
requested discovery, interposed abusive discovery requests, or did
anything to harm or delay the regular processes of discovery. The sole
bad act claimed was the fact of participating in discovery while the
corporation was suspended.
We address each argument in turn.
A. A Corporation Suspended Under Corporations Code
Section 2205 for Failure to File a Required Information Statement Is
Disabled from Participating in Litigation, as Is a Corporation Suspended
Under Revenue and Taxation Code Section 23301 for Nonpayment of Taxes.
Corporations Code section 1502 provides that every corporation must file a statement every two years fn. 1
containing such information as the corporation's current directors, the
number of board vacancies, if any, the current officers, and the name
and address of a person in the state, designated to receive service of
legal process upon the corporation. Corporations Code section 2204
provides that, if a corporation fails to file its required information
statement under section 1502, the Secretary of State shall give notice
of the delinquency; 60 days after notice of the delinquency, the
Secretary of State must certify the name of the corporation to the
Franchise Tax Board, and the Franchise Tax Board imposes a penalty upon
the corporation. fn. 2
If a corporation fails to file a statement under Corporations Code
section 1502, fails to file a statement for 24 months, and has been
assessed a penalty under Corporations Code section 2204 during that
24-month period, then the corporation is subject to suspension under
Corporations Code section 2205. The Secretary of State must notify the
corporation that "its corporate powers, rights, and privileges" will be
suspended after an additional 60 days, if it fails to file a statement
under section 1502. If the corporation fails to comply within 60 days,
the Secretary of State certifies to the Franchise Tax Board that the
corporation is suspended, and mails a notice to the suspended
corporation. "[T]hereupon, except for the purpose of amending the
articles of incorporation to set forth a new name, the corporate powers,
rights, and privileges of the corporation are suspended." (Corp. Code, §
2205, subd. (c).)
Corporations Code section 2205, subdivision (d), provides that,
notwithstanding the suspension, the corporation is empowered to file a
statement [85 Cal.App.4th 560] under section 1502; if it does so,
the Secretary of State "shall certify that fact to the Franchise Tax
Board and the corporation may thereupon be relieved from suspension"
unless it is also suspended by the Franchise Tax Board for nonpayment of
taxes. Before Corporations Code section 2205 was amended in 1999, it
provided that the Secretary of State must certify the suspended
corporation's compliance with section 1502 to the Franchise Tax Board,
and that the corporation may "thereupon, in accordance with Section 23305a of the Revenue and Taxation Code,
be relieved from suspension ...." (Italics added; see Stats. 1999, ch.
1000, § 23.) The italicized language was in effect at the time of all
the events herein.
We think it plain upon a reading of the statutory provisions that a
corporation suspended for failure to file a required statement under
Corporations Code section 1502 is, like a corporation suspended for
failure to pay taxes under Revenue and Taxation Code section 23301,
disabled from participating in any litigation activities.
The firm concedes that a corporation suspended for nonpayment of taxes
is disabled from resort to the courts for any purpose. "The purpose of
Revenue and Taxation Code section 23301 is to 'prohibit the delinquent
corporation from enjoying the ordinary privileges of a going concern'
[citation], and to pressure it to pay its taxes [citation]." (Grell v. Laci Le Beau Corp. (1999) 73 Cal.App.4th 1300,
1306 [87 Cal.Rptr.2d 358].) The firm argues that such a statutory
purpose, i.e., collection of taxes, does not apply when a corporation is
suspended for failure to file a statement, and not for nonpayment of
taxes. Thus, the firm argues, it could reasonably believe that a
suspension under the Corporations Code did not disqualify it from access
to or use of the courts.
We disagree. Corporations Code section 2205, subdivision (b) expressly
states that the failure to file the required statement will result in
suspension of a corporation's "corporate powers, rights, and
privileges." This parallels the language of Revenue and Taxation Code
section 23301, which provides that "the corporate powers, rights and privileges of a domestic taxpayer may be suspended" for nonpayment of taxes. (Italics added.)
Corporations Code section 2205, subdivision (c) makes clear that,
"except for the purpose of amending the articles of incorporation to set
forth a new name," the suspended corporation may transact no business
of any kind. Conducting litigation is not "amending the articles of
incorporation to set forth a new name."
Corporations Code section 2205, former subdivision (d), at all times
relevant herein, provided that a suspended corporation could be restored
[85 Cal.App.4th 561] upon filing the required statement "in
accordance with Section 23305a of the Revenue and Taxation Code."
Section 23305a of the Revenue and Taxation Code sets forth the
prerequisites to issuance of a certificate of revivor by the Franchise
All these statutory provisions should strongly indicate to any
reasonable attorney that a corporation suspended for failure to file a
statement under Corporations Code section 1502 is indeed disqualified
from litigation and all other activities. All its "corporate
powers, rights, and privileges" are suspended; the only exceptions
provided by statute are to change the name of the corporation, and to
cure the default by filing the missing statement.
Cross-references to the Revenue and Taxation Code also clearly indicate
that a corporation suspended under the Corporations Code is equally
disabled from acting as a corporation suspended under the Revenue and
Taxation Code. Indeed, the penalty provided under Corporations Code
section 2204 is imposed under Revenue and Taxation Code section 19141;
the $250 penalty imposed under that provision is expressly made "a final
assessment due and payable at the time of assessment," and it "shall be
collected as other taxes, interest, and penalties are collected by the
Franchise Tax Board ...."
Just as the state may wish to persuade its corporate citizens to pay
their taxes, it also may wish to persuade them to comply with basic
filing requirements, requirements that are fundamental to holding a
corporation accountable for its actions.
The statutory language of the relevant sections, as well as legislative
policy, are more than sufficient to put any reasonable attorney on
notice—or at least to entertain a reasonable suspicion—that a
corporation suspended under the Corporations Code, like a corporation
suspended for nonpayment of taxes, is well and truly suspended, and
disabled from participating in any litigation activities.
The trial court did not err in so construing the statutes, and thus did
not abuse its discretion in determining that the firm knew or should
have known that Design MTC was disqualified from representing itself in
Our conclusion is further buttressed by Signal Data Proc. v. Rex Humbard Found.
(1994) 99 Ohio App.3d 646 [651 N.E.2d 498]. There the Ohio Court of
Appeals held that a California corporation suspended pursuant to
Corporations Code section 2205, for failure to file a statement, lacked
authority to register a California judgment in Ohio, or to authorize an
attorney to act in [85 Cal.App.4th 562] its behalf, and would remain so unless and until it cured the deficiency which had caused its suspension.
B. The Trial Court Did Not Abuse Its Discretion in
Determining That the Firm Had Acted in Bad Faith in Pursuing Litigation
Activities While Its Client Was Suspended.
 The firm argues that, although we now have construed the
Corporations Code suspension provisions in the same manner as the
Revenue and Taxation Code suspension provisions, it could in good faith
have believed that there was a legitimate difference in the effect of
the two suspensions, and thus properly continued to represent its client
despite its knowledge of the suspension.
The record belies the firm's assertions of good faith. The firm knew as
of March 1998 of Design MTC's suspended status. Giving the benefit of
any doubt to the firm, that it in fact researched the matter at that
time and discovered that Design MTC was suspended for failure to file a
Corporations Code section 1502 statement, and not for nonpayment of
taxes, we think it inescapable that any reasonable attorney reviewing
the relevant statutes would entertain a strong suspicion that Design MTC
was disqualified from exercising any powers, including the right to
resort to the courts in litigation. Nevertheless, the firm chose to
conceal its knowledge of the suspension, and probable disability of its
client, from both the court and opposing counsel. Knowing concealment of
material facts is not the hallmark of good faith.
The firm urges that it could not discharge its ethical duties to
represent its client, if it had to reveal the client's suspended status
to the court and counsel. Not so. If the corporation had been suspended
for nonpayment of taxes, the client's disability would have been clear,
and the attorney's duty to report that to the court would also have been
clear. The attorney's obligation to its client would be to advise the
client to pay its back taxes. If the client corporation is in such
financial straits that it has been unable to pay its taxes, to the
degree that it has become suspended, such advice may ring hollow. Where a
corporation has been suspended for noncompliance with filing
requirements, however, curing the default is simple. All the client
corporation must do is file the required statement under Corporations
Code section 1502. The firm did not, however, make any such
recommendation to its client, Design MTC. This failure supports the
inference that the firm in fact made no investigation at the time it
discovered its client's suspended status, and that it therefore likely
believed Design MTC was suspended for failure to pay taxes. If so, then
the firm's willful concealment of the suspension militates toward a
finding of bad faith. [85 Cal.App.4th 563]
Other evidence supports this conclusion. Remarks made by the firm's
attorneys at hearings on the sanctions motion indicate that the firm did
not consciously decide that Design MTC's suspension was not of a kind
that should disable it from litigation. Rather, it appears that this
theory was a post hoc rationalization, and did not occur to the firm's
attorneys until the eve of the sanctions hearing. At the hearing on
August 28, 1998, Design MTC's counsel stated that he had "had no time to
look into" the question whether the corporate suspension resulted in
the corporation's lack of standing to litigate. At the first sanctions
hearing on September 4, 1998, the firm's representative stated to the
court: "When we appeared [on August 28], we were not prepared to address
the issue of the suspension with the Court.... [¶] After we had the
opportunity to look at the documents ... it was learned that in fact MTC
Design was not suspended for failure to pay taxes. [¶] Therefore, it's
our position that the tax and revenue codes that provide that a
suspended corporation cannot represent itself in court do not apply."
The record fully supports the conclusion that the firm did not continue
representing Design MTC based on its good faith belief in the difference
between a Corporations Code suspension and a Revenue and Taxation Code
suspension; it supports the conclusion, rather, that the firm suspected
its client was disabled from litigation, but deliberately concealed this
fact from the court and the other parties, and continued to litigate
vigorously, even seeking summary proceedings to terminate the case
before the corporation's suspended status was discovered. The firm's
actions on behalf of its client served only to delay and avoid an
otherwise inevitable default judgment, in the absence of any acts by
Design MTC to cure its suspended status.
The trial court did not abuse its discretion in taking this view of the
evidence and record before it; consequently, it did not abuse its
discretion in imposing sanctions therefor.
C. The Court Did Not Abuse Its Discretion in Imposing Discovery Sanctions.
 The firm argues that imposition of sanctions in reliance on Code of
Civil Procedure section 2023 was improper, because the firm did not
engage in any abuse of the discovery process itself.
The homeowners note, as the firm concedes, that the conduct listed in
Code of Civil Procedure section 2023 as sanctionable discovery abuses is
not exclusive. In our view, participating in discovery on behalf of a
suspended corporation, knowing that the corporation is suspended, and
having reason to [85 Cal.App.4th 564] know or suspect that such
suspension disabled the corporation from participating in the
litigation, qualifies as conduct abusive of the discovery process, and
thus sanctionable. We cannot see any abuse of discretion in so holding,
particularly if the sanctions order was also fully justified on other
For the reasons stated, we find no abuse of discretion in imposing the
order for sanctions on the firm. The order for sanctions is affirmed.
Hollenhorst, Acting P. J., and Gaut, J., concurred.
Appellant's petition for review by the Supreme Court was denied March 28, 2001.
In 1999, the Legislature amended Corporations Code section 1502 to
require biennial instead of annual statements. (Stats. 1999, ch. 1000, §
The penalty imposed by the Franchise Tax Board is made as provided in
section 19141 of the Revenue and Taxation Code, and is currently $250.