Woods Farmers Cooperative Elevator Co. v. Z-Mega Farms Ltd. Partnership I ( 1996 )

___________
No. 94-3884
___________
Woods Farmers Cooperative *
Elevator Company, *
*
Appellee, *
* Appeal from the United States
v. * District Court for the
* District of North Dakota.
Z-Mega Farms Limited *
Partnership I, *
*
Appellant, *
*
Z & W Ag Enterprises, Inc., *
also known as Z & W Ag, Inc.; *
Zehringer Land Company; David *
Zehringer, *
*
Defendants-Third *
party plaintiffs, *
*
Pete Werner; Personalized *
Marketing Services; Doug *
Lanctot, *
*
Defendants, *
*
Zehringer Farms, *
*
Defendant-Third *
party plaintiff, *
*
v. *
*
Dallas Glasow; Brad Gust; Al *
Halvorson; Tom Hansen; Rodger *
Olson; Dave Strand, *
*
Third Party Defendants. *
__________
Submitted: May 13, 1996
Filed: September 11, 1996
__________
Before RICHARD S. ARNOLD, Chief Judge, MAGILL, and MURPHY, Circuit Judges.
___________
MAGILL, Circuit Judge.
Woods Farmers Cooperative Elevator Company (the Coop), through its
bankruptcy trustee, sued Z-Mega Farms Limited Partnership I (Z-Mega) in a
diversity action. The Coop claimed that Z-Mega, and its codefendants,
misappropriated Coop funds through a series of fraudulent transactions and
breached contracts. The district court1 found in favor of the Coop and
awarded it $686,382.44 in damages from Z-Mega.
The issue in this appeal is the district court's denial of Z-Mega's
counterclaim for $212,800.25. In the course of the complex financial
interactions between the Coop and Z-Mega, there were two sham transactions
in which Z-Mega paid a total $212,800.25 to the Coop as counterparts to
earlier sales that had not actually occurred. Z-Mega asserts that the Coop
is liable based on three legal theories: conversion, deceit, and agency.
We disagree and affirm the district court.
I.
This case arises from the less-than-honest financial dealings of Pete
Werner, 40% owner of Z-Mega, and Doug Lanctot, an employee of the Coop.
The facts of this case are complex and we limit our description to those
relevant to this appeal.
The Coop was a rural farmers' cooperative association conducting
business as a grain elevator. A board of directors oversaw affairs of the
Coop, and Doug Lanctot, who was not on the
1
The Honorable Karen K. Klein, United States Magistrate Judge
for the District of North Dakota.
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board, served as manager charged with running the Coop's daily operations.
Acting on behalf of the Coop, Lanctot entered into an informal
arrangement to provide financing to Personalized Marketing Services, Inc.
(PMS), a grain marketing advisory company. Pete Werner was the majority
shareholder and managing agent of PMS. Under the financing arrangement,
the Coop provided PMS with short term, unsecured financing for the purchase
and sale of Purchase in Kind (PIK) Certificates. Mem. Op. at 7 n.5.
Werner set up a bank account, the PMS PIK Certificate Trust Account, into
which he deposited funds from the Coop. PMS drew funds from the account
to purchase PIK certificates and deposited the proceeds from the sale of
these certificates into this account. PMS then wired to the Coop the
repayment of the loan and a financing fee. Initially, this arrangement
proved to be very profitable for both the Coop and PMS.
Although the PIK financing arrangement worked well in the beginning,
the Coop soon began to have difficulty getting its money back. In August
1987, Werner began to use the Coop's financing funds for purposes other
than the purchase of PIK certificates. Werner used Coop funds to finance
commodities speculation, personal needs, and, through a check kiting
scheme, to pay debts owed to the Coop.
More significant to this appeal, Werner also used Coop funds to
finance the operations of other enterprises with which he was associated,
most notably Z-Mega. Z-Mega was a limited partnership formed for the
purpose of owning and operating a farm on land located in Clay and Becker
Counties, Minnesota. Its general partner was Z & W Ag Enterprises (Z & W
Ag), a Minnesota corporation in which Werner held a 40% stake and David
Zehringer held a 60% stake. Through his ownership of Z & W Ag, Werner had
general responsibility for Z-Mega management. He also assumed the
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specific responsibility of overseeing the financial affairs of the
2
company.
Werner provided Z & W Ag with $471,000 of Coop funds to make land
purchases and obtain letters of credit necessary to establish Z-Mega Farms
Limited Partnership I.3 In addition to the indirect funding Werner
provided to Z-Mega through Z & W Ag, he also funneled $205,000 of the
Coop's money directly into Z-Mega accounts. Mem. Op. at 17. David
Zehringer also received the Coop's funds as a result of Werner's largess.
Zehringer Farms, a farming partnership between David Zehringer and his
father, Jack Zehringer, received $210,000 from Werner. Mem. Op. at 8. At
the end of August 1988, there was a shortfall of approximately $327,000 in
the PMS PIK Certificate Trust Account. Mem. Op. at 12.4
Through a series of three sham transactions fabricated by Lanctot and
Werner, the Coop was reimbursed for all of the funds it had advanced to the
PMS PIK Certificate Trust Account.5 By fabricating these transactions,
Lanctot and Werner contrived to conceal the $327,000 worth of advances made
through PMS.
First, Lanctot and Werner created a fictitious credit sale of PIK
certificates worth $108,500.25. Lanctot created a sales ticket stating
that the Coop sold Z-Mega $108,500.25 in PIK certificates on credit instead
of paying cash. Therefore, the Coop's ledgers
2
In November 1988, David Zehringer severely curtailed Werner's
role in the financial management of Z-Mega.
3
Z & W Ag Enterprises served as the general partner of Z-Mega.
4
On appeal, Z-Mega argues that it fully repaid PMS for any
money it received. The district court did not make a finding on
this issue.
5
Concealment of these transactions was particularly important
to Lanctot because, in late July 1988, the Coop's board of
directors had warned him not to conduct further business with PMS.
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showed an accounts receivable debt owed by Z-Mega in the amount of
$108,500.25 on September 19, 1988. PMS and Z-Mega books were also modified
to recognize this credit transaction. On September 27, 1988, the Coop
received a check from Z-Mega drafted in the amount of $108,560.25 and
signed by Pete Werner. Lanctot then applied these funds to the PIK loan
balance, thereby reducing the PIK advance balance from $ -327,000 to $ -
218,439.75.
The second transaction Lanctot and Werner (for Z-Mega) created to
conceal the PIK advance also involved a fictitious sale of PIK
certificates. This time Lanctot created a sales ticket stating that the
Coop sold Zehringer Farms $117,200 in PIK certificates and that Zehringer
Farms charged this purchase instead of paying cash. Lanctot then modified
the Coop's ledgers to show a reduction in the PIK advance account and a new
accounts receivable debt owed by Zehringer Farms in the amount of $117,200
dated September 19, 1988. PMS's and David Zehringer's accounts were also
modified to recognize this transaction. On December 28, 1988, Zehringer
Farms issued a check to the Coop for $119,544 ($117,200 plus interest).
This fictitious sale further reduced the PIK advance balance from $ -
218,439.75 to $ -101,239.75.
Finally, to set off the remaining debt, Lanctot created a fictitious
credit sale of $104,240 in PIK certificates from the Coop to Z-Mega.
Lanctot then modified the Coop's ledger to show a $104,240 reduction in the
PIK advance account and a corresponding accounts receivable debt owed by
Z-Mega. Z-Mega paid this debt in kind through a delivery of soybeans to
the Coop made on October 20, 1988. Instead of paying Z-Mega the normal 80%
advance for the soybeans, the Coop credited Z-Mega's account for $104,240
and issued a $5,760 check for the remainder of the proceeds. The $104,240
credit for the soybeans set off the fictitious $104,240 accounts receivable
debt for the PIK certificates on the Coop's ledgers. By the end of
December 1988, when these three sham transactions had been completed, the
Coop had been reimbursed all
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of the funds it had advanced to PMS.6
On April 13, 1989, the Coop, through its bankruptcy trustee Wayne
Drewes, filed a civil action in federal district court to recover funds
which it alleged were wrongfully appropriated from the Coop by Werner, PMS,
Z-Mega, and Lanctot.7 Originally, the Coop cast its complaint as a federal
question case based on a Racketeer Influenced and Corrupt Organizations Act
(RICO) claim with several supplementary state claims. After the district
court dismissed the Coop's RICO claim, the Coop recast its complaint as a
diversity suit based on state tort and contract claims.
A bench trial was held from October 25 through November 2, 1993. The
Coop claimed at trial that Z-Mega, Z & W Ag, Zehringer Land Co., Zehringer
Farms, and David Zehringer were jointly and
6
The Coop had grounds, besides these PIK transactions already
discussed, to sue the various defendants.
The Coop used Werner and PMS as an intermediary in the sale of
corn. Under the arrangement, the corn buyers were to make their
purchase payment to the Coop through PMS. Werner, however, began
to delay submission of the corn proceeds to the Coop, instead using
the funds to finance his own business interests. Mem. Op. at 22.
As a result of Werner's actions, the Coop suffered a $481,291.45
loss.
Z-Mega owed Farm Credit Services $516,092.24 in principal and
interest on land purchases. Werner warned Lanctot that if Lanctot
did not help finance these land payments, PMS would be unable to
repay the Coop the outstanding debts. Mem. Op. at 29. Lanctot
advanced over $480,000 in Coop funds to Z-Mega which was never
repaid. Mem. Op. at 29.
Finally, in separate transactions, Z & W Ag purchased
$79,270.20 in PIK certificates and Z-Mega purchased $79,860.03 in
PIK certificates from the Coop. The understanding was that they
would pay the Coop after it sold the PIKs. In breach of the
contract, neither Z & W Ag nor Z-Mega ever paid the Coop. Mem. Op.
at 42-43.
7
By the time of trial, Z-Mega had also filed a Chapter 7
bankruptcy petition and the bankruptcy court appointed Dwight
Lindquist to serve as the Chapter 7 trustee.
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severally liable for the fraud and deceit of their alleged agents Werner
and David Zehringer under North Dakota law. Only Z-Mega defended at the
trial. Z-Mega counterclaimed, asserting that the Coop had converted
$212,800.25 of its funds through two fictitious transactions ($108,500.25
+ $104,240).
On October 24, 1994, the district court entered final judgment in
favor of the Coop. The court found Z-Mega jointly and severally liable for
judgment in the amount of $686,382.44, plus postjudgment interest. On Z-
Mega's counterclaim, the court held that under North Dakota law no
conversion had occurred because the transactions were authorized. Z-Mega
appeals and we affirm.
II.
We review the district court's legal determinations de novo and its
factual findings for clear error. See Burke v. Deere & Co., 6 F.3d 497,
511 (8th Cir. 1993), cert. denied, 114 S. Ct. 1063 (1994); Federal Deposit
Ins. Corp. v. Lee, 988 F.2d 838, 841 (8th Cir. 1992).
On appeal, Z-Mega argues that it is entitled to a $212,800.25 setoff
against the judgment entered in favor of the Coop for four reasons. As Z-
Mega views the case, the two sham PIK transactions orchestrated by Werner
and Lanctot constituted a fraud on Z-Mega. Under the North Dakota law of
agency, conversion, and deceit, Z-Mega asserts that those two transactions
cannot be binding on it. Because Lanctot served as the Coop's agent and
participated in the fraud, and because the Coop received the benefit of
these fraudulent transactions, Z-Mega believes the Coop should be liable
for the money it received in sham PIK sales through a setoff against the
judgment against Z-Mega. We disagree.
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A.
Z-Mega argues that Werner lacked authority to bind it to the terms
of the two sham transactions. Z-Mega concedes that Werner served as its
agent, but that the scope of his agency did not extend to the transfer of
$212,800.25 to the Coop. The resolution of the agency issue is crucial:
If Werner acted as Z-Mega's agent in these transactions, then Z-Mega's
claim that it repaid PMS in full for the money it borrowed does not affect
Z-Mega's ultimate obligation to see that the money is repaid to the Coop.
If, on the other hand, Werner was not acting as Z-Mega's agent, then by
repaying PMS for the money it borrowed, Z-Mega has fulfilled its
obligations. In the latter instance, the Coop would have recourse only to
PMS, and Werner as agent of PMS, to recover for the initial fraud against
the Coop.
Z-Mega makes two arguments to show that Werner could not have had its
authority. First, Z-Mega argues that Werner lacked actual authority
because he undertook the sham transactions for the benefit of PMS, and not
Z-Mega. Second, it maintains that even if Werner could have had authority
for such transactions, the fact that Lanctot had, at a minimum, knowledge
of the fraud against Z-Mega strips Werner of that authority. We do not
find either of these arguments persuasive.
Under North Dakota law, "[a]n agent represents his principal for all
purposes within the scope of his actual or ostensible authority, and all
the rights and liabilities which would accrue to the agent from the
transactions within such limit, if they had been entered into on his own
account, accrue to the principal." N.D. Cent. Code § 3-03-01 (1987). The
test for partnership liability for the actions of a single partner is
whether the wrong was committed on behalf of, and within the reasonable
scope of, the partnership business. See Olson v. Fraase, 421 N.W.2d 820,
832 (N.D. 1988).
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While Z-Mega insists that "under no view could these transfers be
viewed as furthering the interests of Z-Mega," Appellant's Br. at 32, the
district court found otherwise. Indeed, the court was emphatic in its
determination that when Werner provided the $212,800.25 to the Coop, he was
acting within the scope of the Z-Mega's partnership business. See Mem. Op.
at 18. According to the court, "Werner followed through with these
transactions in order to maintain a credit line with [the Coop]." Id.Z-Mega argues that this finding is clearly erroneous because the
district court also concluded that Lanctot had no authority to lend money
to Z-Mega and no line of credit existed. Indeed, the Coop's board of
directors explicitly instructed Lanctot not to conduct business with Z-
Mega. Z-Mega is mistaken in emphasizing Lanctot's authority to make loans
to Z-Mega, however.
Regardless of his authority to do business with Z-Mega, Lanctot
repeatedly provided Coop funds to Z-Mega through Werner. Werner had, in
effect, an unauthorized credit line with the Coop which he used for the
benefit of Z-Mega. For these loans to continue, however, Lanctot had to
succeed in hiding these loan transactions from the board. Werner knew this
and, to keep the funds available for Z-Mega use, he engaged in the scheme
to repay the Coop through sham transactions. Z-Mega had an interest in
protecting its access to ready credit, and the district court's finding
that Werner arranged for Z-Mega to pay back debts to the Coop in order to
maintain this credit line with the Coop is not clearly erroneous.
In addition, Z-Mega asserts that Lanctot's involvement in the fraud
defeats any actual or apparent authority with which Werner might be
cloaked. Z-Mega points to the rule articulated in North Dakota Century
Code § 3-02-07, which states that:
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An agent never can have authority, either actual or ostensible,
to do an act which is, and is known or suspected by the person
with whom he deals to be, a fraud upon the principal.
Again, Z-Mega's argument fails because of the findings of the
district court, which are not clearly erroneous. The district court found
that Lanctot had no way of knowing that the two transactions were
unauthorized by Z-Mega. A reasonable investigation by Lanctot would have
led to the conclusion that Werner had authority to obligate Z-Mega funds.
Mem. Op. at 19. Werner had a management role with Z-Mega, and took
responsibility for its financial affairs. Z-Mega's check registers were
maintained at PMS's offices in Moorhead, Minnesota. To Lanctot it would
appear unquestionably rational for Z-Mega to create sham transactions to
protect its source of capital. There was no indication that Werner's
authority to conduct business on behalf of Z-Mega was limited in any way
until November 1988--after completion of the transactions at issue. Id.
On this basis, North Dakota Century Code § 3-02-07 does not strip Werner
of his authority to enter the two sham transactions on behalf of Z-Mega.
B.
Z-Mega argues that the Coop is liable for $212,800.25 because it
converted Z-Mega's property. According to Z-Mega, Lanctot and Werner
deliberately orchestrated the two sham transactions which created the
appearance that Z-Mega was indebted to the Coop. When Z-Mega paid off the
fictitious debt and the Coop retained the funds, the conversion occurred.
Under North Dakota law, conversion is the wrongful exercise of
dominion over the personal property of another in a manner inconsistent
with, or in defiance of, the owner's rights. Harwood State Bank v. Charon,
466 N.W.2d 601, 603 (N.D. 1991). Conversion does not require a bad
intention on the converter's part. Rather,
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it only requires an intent to exercise control or interfere with an owner's
use to an actionable degree. Id. While we agree that the Coop exercised
dominion over the money it received from Z-Mega through the two sham PIK
transactions, we disagree that this dominion constitutes a conversion.
Viewing the two transactions in isolation, it appears that the Coop
pretended to sell Z-Mega PIK certificates in exchange for real payments of
cash and soybeans. The reality only becomes apparent when one perceives
the broader context of the dealings between the two entities.
Z-Mega had borrowed significant amounts of the Coop's money through
a fraud perpetrated by its agent and general partner, Werner. Because of
this initial fraud and because Lanctot, agent for the Coop, had been
expressly directed to cease business with PMS, a byzantine scheme for
concealing the actual nature of the debts owed by Z-Mega had to be created.
From this imperative arose the artifice of the two fictitious PIK sales to
Z-Mega. Despite the accounting smoke and mirrors used to mask the nature
of the payments from Z-Mega to the Coop, the fact remains that Z-Mega had
taken Coop funds through PMS and had an obligation to repay them.
Therefore, this is not an instance where conversion law entitles Z-Mega to
a setoff. Rather, the two sham transactions between Z-Mega and the Coop
represent a straightforward repayment by Z-Mega of funds it acquired
through fraud. The fact that the repayment was accomplished through sham
transactions is irrelevant.
C.
Based on Lanctot's involvement in the fictitious sales, Z-Mega also
asserts that the Coop committed deceit on Z-Mega. A person commits deceit
when he willfully deceives another with the intent to induce him to alter
his position to his injury or risk and is liable for any damage which the
deceived suffers as a result. N.D.
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Cent. Code § 9-10-03. By statute, North Dakota defines four scenarios by
which deceit can be effected:
1. The suggestion as a fact of that which is not true by one
who does not believe it to be true;
2. The assertion as a fact of that which is not true by one
who has no reasonable ground for believing it true;
3. The suppression of a fact by one who is bound to
disclose it, or who gives information of other facts
which are likely to mislead for want of communication of
that fact; or
4. A promise made without any intention of performing.
N.D. Cent. Code § 9-10-02.
Z-Mega's argument for deceit begs the question of who, exactly, is
the victim of the fictitious transactions concocted by Lanctot and Werner.
Torts such as fraud and deceit rest on the notion that parties should not
be able to create informational advantages through deception. See 37
C.J.S. Fraud § 3. Here, however, the informational advantage rested with
Z-Mega.
The Coop believed that money lent to PMS would be used for the
purchase and sale of PIK certificates. The Coop's board of directors first
realized that the Coop's funds were being used by PMS for purposes other
than PIK transactions. In July 1988, it had prohibited Lanctot from making
future loans to PMS and Werner. The purpose of the sham transaction was
to continue to hide from the Coop the loans made through PMS to Z-Mega and
other entities.
Lanctot certainly knew that the debt indicated on the books did not
reflect the reality of the transactions between the Coop, PMS, and Z-Mega.
Werner, as an agent of Z-Mega, also was aware of the sham. As a 40% owner
and officer of Z & W Ag, which is the
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general partner of Z-Mega, Werner is closely tied to Z-Mega. Werner
directly served as an agent for Z-Mega by handling all of its financial
affairs. North Dakota follows the general rule of agency that the
principal is chargeable with the knowledge of its agents. See Schock v.
Ocker Ins. Corp., 248 N.W.2d 786, 790 (N.D. 1976); Employers Reinsurance
Corp. v. Landmark, 547 N.W.2d 527 (N.D. 1996). As such, Werner's knowledge
can be imputed to Z-Mega itself. The fact of the matter is that Z-Mega,
through Werner, willingly participated in the creation of these "mirage"
debts as a means of disguising the earlier fraud. Z-Mega was not the
victim, but rather the perpetrator, of fraud and cannot twist the facts and
recover for its own wrongdoing.
III.
For the reasons stated above, we affirm the judgment of the district
court.
A true copy.
Attest:
CLERK, U. S. COURT OF APPEALS, EIGHTH CIRCUIT.
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