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Sriracha Maker Must Pay $23 Million to Pepper Farm in Fraud Suit

July 28, 2021, 1:09 AM

Huy Fong Foods, Inc., the company that makes Sriracha hot sauce, must pay more than $23 million in damages awarded to a jalapeno pepper farm by a California jury, after it failed to convince a state appellate court to dismiss the fraud claims.

The company contracted with Underwood Ranches LP in 1988 to purchase peppers for its jalapeno-based hot sauce, and the parties were partners for nearly 30 years. For the first ten years of their partnership, they executed written agreements, but they later turned to informal oral agreements.

By 2006, Underwood was growing 90% of Huy Fong’s peppers. To convince Underwood to expand its pepper acreage, Huy Fong agreed to pay by the acre grown, rather than by pounds produced, and take on the risk of a smaller yield. Underwood then invested millions of dollars in acquiring additional acres, many of which came with leases that extended into the 2030s and beyond.

In 2016, by which time Huy Fong accounted for around 80% of Underwood’s revenue, the hot sauce company told Underwood it would need to deliver peppers for $500 a ton in order to compete with other producers.

The partnership deteriorated, and Huy Fong began contracting with other farmers, showing them drone footage of a recent Underwood harvest, which it had promised to keep confidential, to show new partners how to harvest peppers economically.

Underwood had nothing to plant on the thousands of new acres it had leased, and didn’t have financing to plant on speculation. It was forced to lay off 40 employees, and lost over $6 million in 2018, it said.

A jury in Ventura County unanimously found in Underwood’s favor on claims of breach of contract and fraud, and awarded $13.3 million in compensatory damages and $10 million in punitive damages.

The California Court of Appeal, Second District, affirmed the award. It rejected Huy Fong’s argument that it did not have a duty to disclose plans to discontinue its relationship with Underwood, and therefore could not be held liable for fraud.

A duty to disclose may arise from a confidential relationship, and the relationship between Huy Fong and Underwood certainly meets that requirement, Justice Arthur Gilbert wrote for the court.

The most compelling evidence of that relationship is that for many years they entered into transactions involving tens of millions of dollars without formal written contracts, Gilbert said.

Huy Fong had expressly agreed to purchase the 2017 harvest, induced Underwood to lease more land, and told Underwood it would continue to purchase all of the peppers produced.

A jury could reasonably conclude that Huy Fong had no intention of keeping those promises, based on evidence that it had planned to cut ties to Underwood before it did so, Gilbert said. It shared confidential harvest footage with competitors, and even tried to hire away an Underwood executive, among other things.

The panel also rejected Huy Fong’s attempt to vacate the punitive damages award. The jury unanimously found by clear and convincing evidence that Huy Fong committed fraud, and that the ratio of punitive to compensatory damages was reasonable, the panel said.

Justices Kenneth R. Yegan and Martin J. Tangeman joined the opinion.

Ferguson Case Orr Paterson LLP represents Underwood. Latham & Watkins LLP and Pearson, Simon & Warshaw LLP represent Huy Fong.

The case is Huy Fong Foods Inc. v. Underwood Ranches LP, Cal. Ct. App., 2d Dist., No. B303096, 7/27/21.

To contact the reporter on this story: Maeve Allsup in San Francisco at mallsup@bloomberglaw.com

To contact the editors responsible for this story: Rob Tricchinelli at rtricchinelli@bloomberglaw.com; Meghashyam Mali at mmali@bloombergindustry.com