Bluestone Investment Inc. v. Hu

Background

The plaintiffs alleged that Qizhong Hu and other defendants organized a fraudulent investment scheme based on a purported partnership between Patten University and Stanford University. The plaintiffs alleged that they invested more than $35 million after receiving forged financial statements, valuations, agreements, and other misrepresentations. The complaint asserted securities-fraud claims under federal and California law, fraud and related aiding-and-abetting and conspiracy theories, breach of contract, receiving stolen property, conversion, negligence, and negligent misrepresentation.

The defendants included Hu, Patten Holding LLC, Jingling Li, Scott Ethan Victor, William Sawyer, JPMorgan Chase Bank, and Andrew Babes. Three groups of defendants filed motions to dismiss. The QZ defendants challenged, among other things, whether Bluestone and World Education had authority to sue, whether the fraud allegations were sufficiently detailed, whether Hu could be held liable under an alter-ego theory, and whether the theft and conversion claims were barred by the economic-loss rule. Sawyer raised similar challenges to the fraud claims. Chase and Babes challenged the negligence and fraud-related claims. Victor separately challenged service of process.

Analysis

The court denied the challenge based on Bluestone’s and World Education’s alleged lack of authority to sue. It held that the dispute concerned the companies’ capacity to sue rather than the court’s subject-matter jurisdiction. The court also declined to order early jurisdictional discovery and said the issue could be raised after discovery clarified the relevant facts.

The court held that the fraud allegations against the Patten defendants were sufficiently detailed under Federal Rule of Civil Procedure 9(b), which requires fraud to be described with particularity, including the basic details of who made the statements, what was said, when and where it was said, and how it was misleading. The complaint identified allegedly false financial reports, stock-agreement representations, forged Stanford agreements, and specific conduct by Li, Sawyer, and Victor. The court also held that the economic-loss rule did not bar the theft and conversion claims at the pleading stage because the claims were grounded in alleged fraud and some parties were not in a contractual relationship. The court further held that the allegations supporting Hu’s potential alter-ego liability were specific enough to proceed at this stage.

The court concluded that service on Victor was ineffective. Although the plaintiffs attempted service at a Sacramento mailbox facility, the court found that the record did not show reasonable diligence under California law, particularly because Victor allegedly lived in China and the plaintiffs made multiple attempts at a different, incorrect address.

As to Chase and Babes, the court dismissed the negligence claim because the alleged duties arose from contractual obligations and the defendants otherwise owed no ordinary duty of care to the plaintiffs as non-depositors. The court stated that the plaintiffs could replead the matter as a contract claim after obtaining the underlying contracts. The court also dismissed the aiding-and-abetting-fraud and conspiracy-to-commit-fraud claims because the allegations did not plausibly show that Chase or Babes knew about the alleged fraud, intended to help commit it, or substantially assisted it.

Disposition

The court granted the motions to dismiss in part. The claims against the Chase defendants were dismissed, with leave to amend to add a breach-of-contract claim and to allege fraud. The negligence claim was dismissed without prejudice to asserting a contract claim, and the fraud claims were dismissed without prejudice. The court otherwise denied the Patten defendants’ motions to dismiss, except that it granted Victor’s request to dismiss the claims against him for lack of service. The court directed the parties to identify a reasonable time to amend the complaint in their initial case-management-conference statement and required any amended complaint to include a comparison showing its changes from the operative complaint.