Industrial Electron v. iPower Dist Group ( 2000 )

In the
United States Court of Appeals
For the Seventh Circuit
No. 99-1764
Industrial Electronics Corp. of Wisconsin,
Plaintiff-Appellee,
v.
iPower Distribution Group, Inc.,
Defendant-Appellant.
Appeal from the United States District Court
for the Eastern District of Wisconsin.
No. 98 C 998--J.P. Stadtmueller, Chief Judge.
Argued February 23, 2000--Decided May 31, 2000
Before Flaum, Kanne and Diane P. Wood,
Circuit Judges.
Kanne, Circuit Judge. A failed attempt
by several small Wisconsin companies to
develop an integrated marketing and
distribution consortium with the help of
an Ohio software supplier ended with
claims of fraud against the Ohio company.
Embedded in a fairly complex business
arrangement lies an arbitration clause
that the Ohio company, iPower
Distribution Group, Inc. ("iPower"),
believed entitled it to arbitration
rather than litigation. The district
court disagreed and refused to stay the
action pending arbitration. Before the
case could continue, iPower appealed. We
affirm the district court’s decision,
although on different grounds than the
district court.
I. History
The complaint in this case concerns the
relationships among four corporate
entities bound together in various ways
by two related agreements. The deal began
with defendant iPower, a company that
makes a special kind of software for
industrial supply dealers. iPower’s
software allows groups of dealers to
combine together into an integrated, one-
stop-shopping network so that other
business customers may buy products from
many dealers with a single order. To
market its software, iPower approaches
groups of dealers in a particular region
and suggests that they form an
association, usually a limited
partnership or some similar legal entity.
That association then enters into a
franchise agreement with iPower that
allows the association to purchase,
install and use the iPower software.
Customers place their orders with and
make payments to the franchisee
association when they want to buy a
particular product from an individual
dealer.
In May 1995, iPower approached several
unaffiliated equipment dealers in
Southern Wisconsin (the "dealers"), and
pitched the idea to them of becoming a
franchisee and buying the software. One
of the dealers was plaintiff Industrial
Electronics Corp. of Wisconsin
("Industrial Electronics"). The dealers
liked the proposal and agreed among
themselves to form an association to
become a franchisee (the "association
agreement"), with each company owning
equal shares. That summer, the dealers
formed iPower Distribution Group,
Southern Wisconsin, LLC, (the
"association"), a limited liability
corporation organized under the laws of
Wisconsin. The association was formed on
August 10, 1995, and consisted of eight
dealer-members as "Full Members."
A year later, in September 1996, iPower
and the association entered into a
franchise agreement (the "franchise
agreement"). The franchise agreement
detailed the entire relationship between
the association and iPower and included
an arbitration clause that stated in
part:
The parties wish to provide for an
arbitration procedure in order to avoid
the excessive costs of litigation. Any
monetary claim arising out of or relating
to this Agreement, or any breach thereof,
excluding any claim relating to the
confidential information or the Marks,
shall be submitted to arbitration in
Cuyahoga County, Ohio, in accordance with
the rules of the American Arbitration
Association and judgment upon the award
may be entered in any court having
jurisdiction thereof and shall be final,
binding and unappealable. . . .
Two years later, Industrial Electronics
filed suit in Wisconsin state court,
alleging that iPower had made material
misrepresentations regarding its product
to induce Industrial Electronics to join
the association. Industrial Electronics
claimed that despite iPower’s assertions
to the contrary, the software was not
functional or appropriate for the size of
enterprise at issue. According to the
complaint, iPower’s alleged
misrepresentations regarding its product
began in May 1995 when Industrial
Electronics obtained an offering
circular, possibly from a third party,
and continued through August 1995 when
the association was formed. Industrial
Electronics claimed that because iPower’s
software did not work, the association
never made any sales and that because of
iPower’s misrepresentations, Industrial
Electronics forewent participation in
other dealer consortiums. iPower removed
the case to federal district court, which
had jurisdiction based on diversity of
citizenship, and moved for a stay pending
arbitration of the agreement pursuant to
sec. 3 of the Federal Arbitration Act, 9
U.S.C. sec. 1 et seq. The district court
denied the motion to stay pending
arbitration, and iPower appealed pursuant
to 9 U.S.C. sec. 16(a)(1)(A).
II. Analysis
The district court held that it would
defeat the purpose of Wisconsin’s limited
liability company statute, Wis. Stat.
sec. 183.0102 et seq., to allow LLCs to
bind their members or subject them to
liability by their agreements with third
parties. Therefore the court held that
members of LLCs cannot be bound by
contracts entered into between the LLC
and third parties, and the arbitration
clause between the association and iPower
had no effect against Industrial
Electronics./1
iPower does not dispute that the
association could not impose an
obligation on one of its members, but
instead maintains that the district court
misapprehended the nature of Industrial
Electronics’ claim. In iPower’s view,
Industrial Electronics stated its claim
as a third-party beneficiary of the
franchise agreement, in which case, the
limited liability statute would not
apply. Because Industrial Electronics
asserted a right under the franchise
agreement as a third-party beneficiary,
the terms of the agreement, including the
arbitration provision, would control.
Furthermore, Industrial Electronics’
claim amounts to an allegation of fraud
in the inducement of the franchise
agreement, and such claims have been held
to be covered by arbitration provisions
within the fraudulently induced
agreement. See Prima Paint Corp. v. Flood
& Conklin Mfg. Co., 388 U.S. 395, 403-04
(1967).
If Industrial Electronics asserted
rights created by the franchise
agreement, we would agree with iPower
that the arbitration provision would
govern. The association agreement created
a new legal entity, much as a corporate
charter does, whose investors were the
eight dealers. Those eight dealers stood
as shareholders in a corporation and
could not sue a third party individually
or on behalf of the corporation, except
as allowed by the Wisconsin statute. See
Wis. Stat. sec. 183.0305; see also Rose
v. Schantz, 201 N.W.2d 593, 597 (Wis.
1972) (holding that action accruing to
corporation cannot be brought by the
members as individuals); Flynn v.
Merrick, 881 F.2d 446, 449 (7th Cir.
1989) (same); Carney v. General Motors
Corp., 23 F.3d 1154, 1157 (7th Cir. 1994)
(holding that sole shareholder may not
bring action in his own name to enforce a
right that belonged to the corporation);
Twohy v. First Nat’l Bank of Chicago, 758
F.2d 1185, 1194 (7th Cir. 1985) (holding
that under United States law, a
stockholder of a corporation has no
individual right against third parties
for injuries to the corporation). Under
these well established principles,
Industrial Electronics cannot bring a
suit to assert rights under the franchise
agreement for injuries to the association
or indirectly to the members as
shareholders.
Yet that new legal entity entered into
a contract (the franchise agreement) with
iPower, the purpose of which was to
benefit certain specified parties. The
applicable state law/2 would determine
whether Industrial Electronics could
assert the rights of a third party. See
Grant Thornton v. Windsor House, Inc.,
566 N.E.2d 1220, 1223 (Ohio 1991); Pappas
v. Jack O.A. Nelson Agency, Inc., 260
N.W.2d 721, 725 (Wis. 1978). As a third-
party beneficiary, Industrial Electronics
also would be bound by the arbitration
provision. See Barrett v. Picker Int’l,
Inc., 589 N.E.2d 1372, 1375-76 (Ohio Ct.
App. 1990) (holding that forum selection
clause in contract bound third-party
beneficiaries); City of Mequon v. Lake
Estates Co., 190 N.W.2d 912, 916 (Wis.
1971) (holding that third-party
beneficiaries take rights under contract
subject to all terms and conditions of
the contract); Winnebago Homes, Inc. v.
Sheldon, 139 N.W.2d 606, 609 (Wis. 1966).
However, the injuries alleged by
Industrial Electronics do not arise under
or relate to the franchise agreement, and
Industrial Electronics’ status as a
potential third-party beneficiary does
not dispose of this case. Rather,
Industrial Electronics claims as its
injuries the payments it made to invest
in the association, and it asserts these
injuries separately from any injury to
the association itself. In Paragraph 11,
Industrial Electronics mentions that the
association has made no sales under the
franchise, but that is the sole mention
of the association’s injury in the
complaint. Instead, Industrial
Electronics focuses factually on the
misrepresentations made directly to
Industrial Electronics by iPower, claims
as part of its injury the $31,000 it paid
to the association and characterizes the
legal wrong as a reckless or intentional
misrepresentation designed to induce
Industrial Electronics to join the
association. Therefore, the pleading
makes clear that Industrial Electronics’
claim relates not to the franchise
agreement but to the earlier association
agreement, which does not contain an
arbitration requirement.
Industrial Electronics contends that
iPower fraudulently caused it to enter
into the association agreement. Where
fraud is alleged in the inducement of a
contract, the parties are bound to
arbitrate in accordance with the
contract. See Prima Paint, 388 U.S. at
404; Barron v. Tastee Freez Int’l, Inc.,
482 F. Supp. 1213, 1216 (E.D. Wis. 1980).
Yet here the fraud was not in the
creation of the franchise agreement, but
in the creation of an entirely separate
contract. A dispute that arises under one
agreement may be litigated
notwithstanding a mandatory arbitration
clause in a second agreement, even where
the two agreements are closely
intertwined. See Midwest Window Sys.,
Inc. v. Amcor Indus., Inc., 630 F.2d 535,
537 (7th Cir. 1980).
Midwest Window concerned a
distributorship agreement between two
companies that contained an arbitration
provision for all disputes arising out of
the contract. Id. at 535. A dispute later
arose that the parties settled by
reaching a second agreement that dictated
new terms of delivery in exchange for the
issuance of two promissory notes to
secure payment by Midwest Window. Id. at
536. Another dispute then arose which
landed the parties in court. This second
dispute centered on fraud allegations
concerning the notes, and the district
court ordered the parties to arbitration.
Id. at 537. We held that it was error to
order arbitration for a dispute arising
out of the notes agreement. Id. "Those
fraud allegations are not arbitrable.
They are not encompassed within the
contract provision providing for
arbitration of a dispute ’concerning the
interpretation or application of any of
the provisions’ of the original agreement
between the parties. The notes are
outside that arbitration agreement." Id.
Industrial Electronics’ claims do not
require the interpretation of any term of
the franchise agreement, nor are they
properly considered to be claims of fraud
in the inducement to enter that contract.
Industrial Electronics was not a party to
the franchise agreement and does not have
standing directly to enforce its
terms./3 Its complaint relates entirely
to fraud in the inducement of Industrial
Electronics to join the association by
the August 1995 association agreement, to
which the franchise agreement arbitration
provision does not apply.
III. Conclusion
We conclude that the arbitration
provision does not affect disputes
arising out of the association agreement
and Affirm the district court’s decision
to deny the stay.
/1 We agree with the district court that
Wisconsin law prevents an LLC from bind-
ing its members or subjecting them to
liability through contracts between the
LLC and third parties. See Wis. Stat.
sec. 183.0304. However, because we hold
that Industrial Electronics may only
assert claims under the association ag-
reement or as a third-party beneficiary
of the franchise agreement, the immunity
conferred by the Wisconsin LLC does not
resolve this case.
/2 We leave for the trial court to determine
whether Ohio or Wisconsin law applies.
/3 Because we hold that Industrial Electron-
ics pleaded a claim based entirely on the
association agreement, we need not ad-
dress whether they qualified as third-
party beneficiaries of the franchise
agreement and thereby could enforce or be
bound by its terms.