Kennedy Johnson v. Payne

NOTICE: NOT FOR PUBLICATION.
UNDER ARIZONA RULE OF THE SUPREME COURT 111(c), THIS DECISION DOES NOT CREATE
LEGAL PRECEDENT AND MAY NOT BE CITED EXCEPT AS AUTHORIZED.

IN THE
ARIZONA COURT OF APPEALS
DIVISION ONE

KENNEDY JOHNSON GALLAGHER, L.L.C., a New York limited liability
company, Plaintiff/Appellee,

v.

THOMAS N. PAYNE and BARBARA C. PAYNE, husband and wife;
and each of them, Defendants/Appellants.

No. 1 CA-CV 13-0540
FILED 10-14-14
AMENDED PER ORDER FILED 10-14-14

Appeal from the Superior Court in Maricopa County
No. CV2011-009147
The Honorable Mark H. Brain, Judge

AFFIRMED

COUNSEL

Hammerman & Hultgren, P.C., Phoenix
By Jon R. Hultgren and Allan R. Draper
Counsel for Plaintiff/Appellee

Thomas N. Payne, Attorney at Law, Paradise Valley
By Thomas N. Payne
Counsel for Defendants/Appellants
 KENNEDY JOHNSON v. PAYNE
Decision of the Court

MEMORANDUM DECISION

Judge Donn Kessler delivered the decision of the Court, in which Presiding
Judge Jon W. Thompson and Judge Kent E. Cattani joined.

K E S S L E R, Judge:

¶1 This appeal arises out of Kennedy Johnson Gallagher, L.L.C.’s
(“KJG”) efforts to collect a judgment from Barbara Payne’s (“Wife”)
community property. The superior court issued findings of fact and
conclusions of law holding the community liable for attorneys’ fees
incurred by Thomas Payne (“Husband”). For the reasons that follow, we
affirm.

BACKGROUND

¶2 Husband and Wife (collectively “the Paynes”) have been
married for more than fifty-five years. During the marriage, John Mohnach,
a fifty-percent shareholder in Smith West, Inc., invited Husband to
purchase the other fifty-percent share of that corporation. To raise $1.75
million for the purchase, the Paynes obtained a bank loan and pledged their
jointly owned residences and land as security. After the purchase’s
completion, Husband and Mohnach renamed the corporation Mohnach
Payne, Inc. (“MPI”).

I. The MPI Asset Sale

¶3 MPI, along with Mohnach and Husband in their capacities as
shareholders, contracted to sell MPI’s accounts receivable, inventory,
contracts, equipment, machinery, data, and records to Smith West, L.L.C.
pursuant to an asset purchase agreement (“APA”). The APA, which
Husband negotiated, states that it is a binding obligation of each
shareholder and “enforceable against him.” The APA does not identify
Husband as a married man nor does it refer to Wife or their marital
community. In the APA, MPI, Mohnach, and Husband agreed to
indemnify jointly and severally Smith West, L.L.C. for any damages arising
out of or based upon any breach of a covenant or obligation under the APA.

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II. The Arbitration

¶4 Smith West, L.L.C. subsequently disputed pre-sale
misrepresentations by Husband, Mohnach, and MPI, and demanded
arbitration. In its supplemental arbitration demand, Smith West, L.L.C.
asserted fraud and other claims under the APA.

¶5 According to Smith West, L.L.C., Husband and Mohnach
“were motivated to . . . portray the Company’s financial position more
positively than what it was” because that would result “in an increased
Purchase Price under the Agreement” from which Husband and Mohnach
“would directly and personally benefit.” Smith West, L.L.C. sought about
$16 million in principal damages on the basis that Husband and Mohnach
had manipulated inventory reserves; masked decreasing earnings; inflated
the reported Earnings Before Interest, Taxes, Depreciation and
Amortization; and misrepresented the condition of equipment.

¶6 Husband, Mohnach, and MPI retained KJG to represent them
“late” in the arbitration and after becoming dissatisfied with their prior
counsel. After a five-day hearing, the arbitrator filed his Partial Final
Award No. 3 (Phase 2) finding Husband, Mohnach, and MPI jointly and
severally liable in the principal amount of $1,331,035. This amount
indemnified Smith West, L.L.C. for damages related to accounts receivable
and equipment conditions and conveyances. The arbitrator did not find
fraud and rejected a number of other claims concerning breach of
representations and warranties.

III. The Attorneys’ Fee Dispute

¶7 Husband disputed KJG’s fee invoices and declined to pay
KJG. KJG sued Husband and MPI for breach of contract in New York
District Court. KJG dismissed that complaint after executing a Settlement
Agreement and Mutual General Release (“Settlement Agreement”) in
which Husband agreed to pay a reduced sum of $130,000. In accordance
with the Settlement Agreement, Husband executed an affidavit of
confession of judgment. Wife was not a named party to the Settlement
Agreement and Husband testified that he had not intended to obligate their
community in signing that document.

¶8 Husband then again refused to pay the amount owed under
the Settlement Agreement. KJG accordingly filed suit against Husband and
Wife in Arizona for breach of contract. The superior court conducted a trial
at which Husband, Wife, and Peter Gallagher of KJG testified. At the
hearing’s conclusion, the superior court ruled that Husband “was

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defending or hiring an attorney to defend in part the potential liability
against the community.” The superior court filed findings of fact and
conclusions of law holding that the community had benefitted from KJG’s
representation.

¶9 After denying a motion for new trial, the superior court
entered a judgment against both Husband and Wife, but provided that
Wife’s separate property could not satisfy the judgment. This appeal
followed. We have jurisdiction pursuant to Arizona Revised Statutes
(“A.R.S.”) section 12-2101(A)(1) (Supp. 2013).1

DISCUSSION

I. The Paynes failed to rebut the presumption of community liability
for KJG’s attorneys’ fees.

¶10 The Paynes challenge the superior court’s classification of the
attorneys’ fee debt as a community liability. We are bound by the superior
court’s findings of fact unless clearly erroneous, and review legal questions
de novo. Flying Diamond Airpark, LLC v. Meienberg, 215 Ariz. 44, 47, ¶ 9, 156
P.3d 1149, 1152 (App. 2007). “[W]e view the evidence and reasonable
inferences therefrom in the light most favorable to the prevailing party.”
Inch v. McPherson, 176 Ariz. 132, 136, 859 P.2d 755, 759 (App. 1992).

¶11 In general, community property is liable for debts incurred
for the benefit of the community. A.R.S. § 25-215(D) (2007) (“[E]ither
spouse may contract debts and otherwise act for the benefit of the
community.”); see also A.R.S. § 25-215(C) (“The community property is
liable for a spouse’s debts incurred outside of this state during the marriage
which would have been community debts if incurred in this state.”). “A
debt incurred during a marriage for the benefit of the marital community is
presumed to be a community obligation unless clear and convincing
evidence exists to the contrary.” Arab Monetary Fund v. Hashim, 219 Ariz.
108, 111, ¶ 17, 193 P.3d 802, 805 (App. 2008). If a spouse enters a debt-
creating agreement, it does not necessarily follow that the debt is the
separate obligation of that spouse. See Cardinal & Stachel, P.C. v. Curtiss, 225
Ariz. 381, 384-85, ¶¶ 7-12, 238 P.3d 649, 652-53 (App. 2010) (noting that even
attorneys’ fees incurred by one spouse in preparation for filing a divorce
petition may qualify as a community debt to the extent that the family court
will structure the parties’ child-custody and property division).

1 We cite to the current versions of statutes when no changes material to
this decision have since occurred.

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¶12 Our task is to determine whether Wife’s community interests
were at risk in the arbitration with Smith West, L.L.C. Her interests were
at risk if there was a community benefit from the APA and asset sale that
was jeopardized in that proceeding.

¶13 Smith West, L.L.C. paid approximately $32 million to buy
MPI’s assets. Husband testified that MPI had $13 million left from the sale
after paying creditors, and he and Mohnach each received $2.5 million. As
to the balance, Husband testified that he and Mohnach “left a lot of money
in the company.” Husband admitted that he and Wife held their shares in
MPI as a community asset.

¶14 As a result of Husband’s representations and successful
negotiation of the APA, the value of the community’s MPI shares increased.
That benefit was at risk when Smith West, L.L.C. demanded arbitration. A
large judgment against MPI could decrease the value of its shares, including
the Paynes’ community share, even if Wife would not be liable to Smith
West, L.L.C. on an indemnification theory. See A.R.S. § 25-214(C)(2) (2007)
(”Either spouse separately may acquire, manage, control or dispose of
community property or bind the community, except that joinder of both
spouses is required in . . . [a]ny transaction of guaranty, indemnity or
suretyship.”). Accordingly, we affirm the superior court and hold that the
attorneys’ fees owed to KJG constituted a community debt. See Fitzsimmons
v. Jackson, 51 B.R. 600, 613 (9th Cir. B.A.P. 1985) (holding that although wife
was separated from husband at the time of the action, wife was still liable
for attorneys’ fees when husband engaged law firm to defend
condemnation suit against community property). See generally Cabibi &
Cabibi v. Hatheway, 570 So. 2d 104, 109-10 (La. Ct. App. 1990) (construing
analogous La. Civ. Code art. 2346 and holding that attorneys’ fees were a
community debt even though the wife did not sign the attorney-client
contract).

¶15 The Paynes contend that the community was not at risk
because neither the Settlement nor the KJG retainer letter mentions Wife,
the fact that Husband is married, or the marital community. They also
argue Wife did not acquiesce to incurring these obligations. However, a
spouse need not acquiesce to incurring the obligations for them to be
deemed community debts. Lorenz-Auxier Fin. Grp., Inc. v. Bidewell, 160 Ariz.
218, 220, 772 P.2d 41, 43 (App. 1989) (“Debt incurred by one spouse while
acting for the benefit of the marital community is a community obligation
whether or not the other spouse approves it.”).

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¶16 The Paynes also argue that there was no community liability
because Husband testified that he had never intended to obligate Wife’s
assets when executing the Settlement Agreement. “The test of whether an
obligation is a community debt” is whether the obligation is “intended to
benefit the community.” Schlaefer v. Fin. Mgmt. Serv., Inc., 196 Ariz. 336,
339, ¶ 10, 996 P.2d 745, 748 (App. 2000) (quoting Phoenix Baptist Hosp. &
Med. Ctr., Inc. v. Aiken, 179 Ariz. 289, 294, 877 P.2d 1345, 1350 (App. 1994)).
The debt need not be incurred with the primary purpose of benefitting the
community to qualify as a community obligation. Cardinal & Satchel, P.C.,
225 Ariz. at 384, ¶ 10, 238 P.3d at 652. “All that is required is that some
benefit was intended for the community,” even if no actual pecuniary
benefit accrues. Id. (citation omitted).

¶17 Husband testified that he hired counsel to defend the
arbitration in part to protect MPI. The Paynes’ MPI share is a community
asset. Husband had also acknowledged to his attorney, Gallagher, “that
there would be no defense for his community property if there [was a]
determination of fraud.” After hearing all the testimony, the superior court
found that Husband “was defending or hiring an attorney to defend in part
the potential liability against the community.” We defer to the superior
court’s assessment of conflicting testimony, Gutierrez v. Gutierrez, 193 Ariz.
343, 347-48, ¶ 13, 972 P.2d 676, 680-81 (App. 1998), and hold that reasonable
evidence supported its finding that part of Husband’s motivation in hiring
KJG was to protect a community benefit.

¶18 In sum, the Paynes failed to rebut the presumption of
community liability for the attorneys’ fee debt to KJG with clear and
convincing evidence. The record reflects that the community’s interest in
MPI, whose stock value increased with an infusion of funds from the APA,
was at risk during the arbitration. KJG’s services protected that asset.

II. A.R.S. § 25-215(D) does not preclude collection from Wife’s
community assets.

¶19 The Paynes further contend that the imposition of community
liability violates A.R.S. § 25-215(D), which provides in relevant part: “In an
action on such a debt or obligation [for the benefit of the community] the
spouses shall be sued jointly . . . .” They contend that KGJ’s failure to
comply with the statute precludes any collection from community
property.

¶20 Section 25-215(D) is a procedural statute proscribing the
manner of bringing an action on a community debt. Rackmaster Sys., Inc. v.

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Maderia, 219 Ariz. 60, 65, ¶ 22, 193 P.3d 314, 319 (App. 2008). Here, the
Arizona lawsuit is the action on the debt between KJG and Husband and
Wife under A.R.S. § 25-215(D). KJG complied with A.R.S. § 25-215(D) by
joining Husband and Wife in this Arizona lawsuit to recover the $130,000
principal and other amounts due.

A. Failure to Join Wife in the Arbitration

¶21 Nevertheless, the Paynes contend that the failure to join Wife
in the Arbitration was a violation of A.R.S. § 25-215(D). At a minimum,
they contend, KJG should have attempted to join Wife. But KJG could not
have joined Wife in the arbitration because (1) KJG was not even a party to
the arbitration, and (2) the arbitration did not adjudicate the Paynes’
obligation to pay attorneys’ fees to KJG.

¶22 Nor are we persuaded by the Paynes’ reliance upon Heinig v.
Hudman, 177 Ariz. 66, 865 P.2d 110 (App. 1993). In Heinig, the court
determined that a creditor could bring an independent action to determine
community liability for a debt following an arbitration in which (1) the
spouse could not be joined as she was not a party to the arbitration
agreement, and (2) the issue of community liability was not addressed. 177
Ariz. at 70-71 & n.3, 865 P.2d at 114-15 & n.3. In the independent action, the
spouse would be permitted an “opportunity to litigate the existence of
liability, the amount of damages, and the nature of the liability as a separate
or community obligation.” Id. at 71, 865 P.2d at 115. Heinig supports the
result here.

B. Failure to Join Wife in the New York Lawsuit

¶23 The Paynes alternatively argue that A.R.S. § 25-215(D)
prevents KJG’s recovery from Wife’s share of the community assets because
KJG failed to even attempt to join her in the New York suit. Further, they
argue that joining Wife at this stage violates her due process rights.

¶24 The Paynes have failed to supply us with the full procedural
history of the New York case. Thus, we are not equipped to evaluate their
argument about the feasibility of joinder. In any event, KJG is not
attempting to domesticate and enforce the unfiled affidavit of confession of
judgment or any other order here. All KJG has sought is damages
stemming from breach of the Settlement Agreement. We decline to reverse

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based on KJG’s decision not to join Wife as a defendant in the New York
suit.2

¶25 To summarize, the key issue is whether Wife’s community
property is liable for a debt incurred by Husband for a community purpose.
We have held that it is. See Ellsworth v. Ellsworth, 5 Ariz. App. 89, 92, 423
P.2d 364, 367 (“If the husband acts with the object of benefiting the
community . . . the obligations so incurred by him are community in nature,
whether or not the wife approved thereof.”). The Paynes therefore may not
use A.R.S. § 25-215(D) to avoid obligations incurred in New York, a non-
community property state. See Nat’l Union Fire Ins. Co. of Pittsburgh v.
Greene, 195 Ariz. 105, 109-10, ¶¶ 16-19, 985 P.2d 590, 594-95 (App. 1999).

III. Wife received due process.

¶26 Finally, the Paynes argue that KJG’s alleged failure to comply
with A.R.S. § 25-215(D) deprived Wife of due process. See U.S. Const.
amends. V, XIV; Ariz. Const. art. 2, § 4. We review this claim de novo.
Emmett McLoughlin Realty, Inc. v. Pima Cnty., 212 Ariz. 351, 355, ¶ 16, 132
P.3d 290, 294 (App. 2006) (“We review constitutional claims de novo.”).

¶27 In Greene, this court held that “due process does not
necessarily require joining both spouses to obtain a valid judgment against
the marital community” in an action on the underlying debt. 195 Ariz. at
108, ¶ 13, 985 P.2d at 593. After determining that the debt was a community
obligation, we held that Wife received the necessary notice and opportunity
to defend in the ensuing garnishment. Id. at 111, ¶ 23, 985 P.2d at 596.

2 Equally unavailing is the Paynes’ reliance upon Northwestern National
Insurance Co. v. Schubach, in which a creditor obtained an uncollectible
judgment against two partners, then filed a second suit against their
spouses. 93 F.3d 386, 387 (7th Cir. 1996), called into doubt by Gagan v. Monroe,
269 F.3d 871, 875 (7th Cir. 2001). Applying Arizona law, the Seventh Circuit
held that there was no legal impediment to the plaintiff bringing its original
cause against the partners and their wives in Arizona. Id. at 389. Further,
it refused to expand the joinder provision in A.R.S. § 25-215(D) to
accommodate seriatim lawsuits, and found that such a rule could create
inconsistent results or issue preclusion for the non-joined spouse. Id. at 390.
No such problem exists here because KJG is not suing Wife separately in
Arizona for breach of the Settlement Agreement.

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Likewise, in this case, the superior court accorded Wife due process even
though she had not previously been joined in the New York action. See id.

¶28 The Paynes rely upon Garn v. Garn, 155 Ariz. 156, 745 P.2d 604
(App. 1987), to argue that KJG’s pursuit of Wife’s community assets is a
violation of due process. That case dealt with exceptions to the rule about
each spouse’s ability to bind the community. Specifically, Garn concerned
a husband’s effort to settle a dispute over real property and personal
property with two other family members. Id. at 158-59, 745 P.2d at 606-07.
Husband and husband’s attorney represented that they had the consent of
the wife to settle the dispute and to join her to a pending action, when in
fact she had given them no such authority. Id. at 158-60, 745 P.2d at 606-
608. This court held that A.R.S. §§ 25-214(C) and 33-452 (2014) preclude a
spouse from conveying or encumbering real property without the other
spouse’s consent, and an attorney may not settle a matter without the
client’s express consent. Id. at 160-62, 745 P.2d at 608-10. Therefore, the wife
and her marital property had not been properly joined. Id. at 159-60, 162,
745 P.2d at 607-08, 610.

¶29 Garn does not control here. Husband had the right to incur
the underlying attorneys’ fee debt for the benefit of the community. The
community nature of that debt did not change after Husband reached a
settlement with KJG reducing the amount of liability. KJG’s pursuit of that
debt against Wife’s community property in Arizona is consistent with due
process.

CONCLUSION

¶30 For these reasons, we affirm the judgment. In addition, we
award KJG its attorneys’ fees and costs on appeal in accordance with
paragraph 16 of the Settlement Agreement. This award is contingent upon
KJG’s compliance with Arizona Rule of Civil Appellate Procedure 21.

:jt

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