GRAND LABORATORIES, INC., Appellee,
v.
MIDCON LABS OF IOWA, Barco Laboratories, Inc.; Midcon Labs,
Inc., a Missouri corporation; Barco Laboratories of Iowa,
Inc., an Iowa corporation; Kansas City Southern Industries,
Inc., a Delaware corporation; PVI, Inc., a Missouri
corporation; Central Biomedia, Inc., a Missouri
corporation, Appellants.
GRAND LABORATORIES, INC., Appellee,
v.
MIDCON LABS OF IOWA, INC.; Barco Laboratories, Inc., Defendants,
Midcon Labs, Inc., a Missouri corporation, Appellant,
Barco Laboratories of Iowa, Inc., an Iowa corporation, Defendant,
Kansas City Southern Industries, Inc., a Delaware
corporation, Appellant,
PVI, Inc., a Missouri corporation; Central Biomedia, Inc.,
a Missouri corporation, Defendants.
Nos. 93-3165, 94-1573.
United States Court of Appeals,
Eighth Circuit.
Submitted April 11, 1994.
Decided Aug. 17, 1994.
Robert B. Best, Jr., Kansas City, MO, argued (John K. Power, on the brief), for appellants.
George T. Qualley, Sioux City, IA, argued, for appellee.
Before MAGILL, Circuit Judge, FRIEDMAN,* Senior Circuit Judge, and LOKEN, Circuit Judge.
MAGILL, Circuit Judge.
Defendants Kansas City Southern Industries, Inc. (KCSI) and its subsidiary Midcon Labs, Inc. (Midcon) appeal the district court's judgment awarding plaintiff Grand Laboratories, Inc. (Grand) compensatory and punitive damages in this diversity case. A jury found that Midcon was liable as a successor corporation for a default judgment of $1,785,380 entered for Grand and against Mid-Continent Biological Laboratories, Inc. in 1986, that KCSI was liable for the same amount under a "piercing the corporate veil" theory, and that KCSI was liable for $6,400,000 in punitive damages. Defendants argue that there was insufficient evidence to support a finding of Midcon's successor liability under Iowa law and that the district court erred in submitting the question of punitive damages to the jury. We reverse.
I. BACKGROUND
Grand is a South Dakota corporation that develops, produces, and markets veterinary biological products. Dr. Duane C. Pankratz (Pankratz) is Grand's sole shareholder. KCSI is a publicly-traded holding company located in Kansas City, Missouri, that owns various subsidiary companies. Midcon was a wholly-owned subsidiary of PVI, Inc., which in turn was a wholly-owned subsidiary of KCSI. Midcon was incorporated in 1984 for the purpose of developing, producing, and selling veterinary biological products, but ceased all operations in 1988.
Pankratz, who has a background in veterinary medicine and animal pathology, began developing veterinary biological products in the late 1960s. He formed Grand and, in the early 1970s, hired Patrick Graham to assist in the company's production efforts. In 1978, Grand decided to broaden its marketing efforts by licensing a company to produce and sell its products on a royalty basis. The licensee, Grand Laboratories of Missouri (Grand of Missouri), received permission to use Grand's trade secrets in producing veterinary biological products. Grand provided Grand of Missouri with product outlines1 and other materials needed to make product; in exchange, Grand received a percentage of Grand of Missouri's net profits and a royalty based on the number of bottles of product sold. Grand of Missouri operated on a farm owned by Gary Buffington, who was a part owner and managing officer of the company. Graham was also a part owner of Grand of Missouri, as was Buffington's brother, Virgil.
In 1979, Pankratz fired Graham from Grand, accusing him of stealing $150,000 worth of product to sell for himself. Graham then began working for Grand of Missouri as a consultant. Soon after Graham was fired from Grand, Grand of Missouri stopped paying royalties to Grand even though it continued to produce Grand's products. In response, Grand obtained an injunction in federal district court enjoining Grand of Missouri and its agents from using Grand's trade secrets.
At around the same time, Graham and the Buffingtons joined with John Schrag, Don Wubbena, and Bill Thomas to form a company called Mid-Continent Biological Laboratories, Inc. (MBL). MBL sold veterinary biological products. In 1981, Grand brought suit in federal district court against MBL, Schrag, and Wubbena (MBL Case), alleging that MBL had misappropriated Grand's trade secrets and was producing the same products that Grand of Missouri had produced under its licensing agreement. In November 1983, the court entered an interlocutory default judgment (Default Judgment) in the MBL Case. The court enjoined MBL and its agents from using or disclosing Grand's trade secrets, ordered MBL to return to Grand any documents or materials containing Grand's trade secrets, but deferred quantifying monetary damages until the trial of other claims against Schrag and Wubbena. In March 1986, the court entered final default judgment against MBL in the amount of $1,785,000 (MBL Judgment). Grand never collected on this judgment.
In late 1983, after the Default Judgment was entered, Graham sent an inquiry to Oppenheimer Industries, Inc., of Kansas City, seeking investors to form a veterinary biological company. W.R. Jenkins, a Missouri entrepreneur, responded to Graham's inquiry. Jenkins and Graham met, discussed Graham's background in veterinary biological products, and inspected several properties suitable for starting the company. Jenkins then approached KCSI about acquiring the properties. Phillip Brown, a KCSI vice president, toured the properties and met with Graham and Jenkins to discuss the veterinary biological products industry.
In the spring of 1984, the properties were purchased in the name of Northern Farms, Inc., a company owned equally by Jenkins and KCSI. The purchase included a 329-acre farm in Irwin, Missouri, a 160-acre farm in Lamar, Missouri, and a building in Lamar. On May 1, 1984, Brown incorporated a new company called Midcontinent Biological Labs USA, Inc. (MBL II) to produce veterinary biological products. Initially, Northern Farms was the sole shareholder of MBL II. In June 1984, MBL II changed its name to Midcon. In early 1985, Jenkins decided he did not want to participate in the project, so Northern Farms sold all of the Midcon stock to KCSI. Midcon later became a subsidiary of PVI, Inc., which was a wholly-owned subsidiary of KCSI.
Midcon hired Graham and other consultants to assist in developing products. It sold veterinary biological products until 1988. A few months before Midcon ceased operations, Grand filed the instant lawsuit against KCSI and Midcon.2 The third amended complaint contained six counts, four alleging that defendants had knowingly misappropriated Grand's trade secrets relating to veterinary biological products (Counts I, II, III, and VI) and two alleging that defendants were liable for the MBL Judgment because Midcon was a "mere continuation" of MBL and MBL had fraudulently transferred its assets to Midcon to avoid paying the judgment (Counts IV and V).
The district court bifurcated Counts I, II, III, and VI for trial separate from Counts IV and V. In May 1992, shortly before trial, the parties reached a settlement as to Counts I, II, III, and VI. The settlement agreement provided that in exchange for payment, Grand agreed to release defendants "from any and every claim, demand, cause of action and item of damage which was directly or indirectly alleged or claimed in Counts One, Two, Three, and Six of the Third Amended Complaint." In response to the settlement, the court dismissed Counts I, II, III, and VI with prejudice.
The district court denied defendants summary judgment on Counts IV and V, however, and those counts proceeded to trial. At the conclusion of Grand's case and at the conclusion of all of the evidence, defendants moved for judgment as a matter of law. The district court denied both motions and submitted Counts IV and V to the jury along with the issue of punitive damages. The jury found that Midcon was liable as MBL's successor corporation for the MBL Judgment on both "mere continuation" and fraudulent transfer grounds, that KCSI was liable for the MBL Judgment under a "piercing the corporate veil" theory, and that KCSI was liable for $6,400,000 in punitive damages. After the verdict was issued, defendants again moved for judgment as a matter of law. The district court denied the motion and defendants timely appealed.3
II. DISCUSSION
Defendants raise two primary arguments on appeal: (1) that Grand failed as a matter of law to prove that Midcon is liable as MBL's successor corporation for the MBL Judgment, and (2) that the district court erred in submitting the issue of punitive damages to the jury. We agree and hold that Grand failed to show that Midcon is liable under a fraudulent transfer theory or that Midcon was a mere continuation of MBL. Moreover, because Grand failed to establish Midcon's underlying liability for the MBL Judgment, as a matter of law KCSI is not liable for that amount nor is it liable for punitive damages.
A. Successor Liability
Defendants argue that Grand failed to prove that Midcon is liable as a successor corporation for the MBL Judgment. Specifically, they claim that, as a matter of law, Grand did not prove that there was a fraudulent transfer of assets from MBL to Midcon or that Midcon was a mere continuation of MBL. We review the district court's denial of defendants' posttrial motion for judgment as a matter of law.4
1. Standard of Review
In reviewing the district court's denial of a motion for judgment as a matter of law, this court must: (1) resolve direct factual conflicts in favor of the nonmovant; (2) assume as true all facts supporting the nonmovant which the evidence tended to prove; (3) give the nonmovant the benefit of all reasonable inferences; and (4) affirm the denial of the motion if the evidence so viewed would allow reasonable jurors to differ as to the conclusions that could be drawn. Hastings v. Boston Mut. Life Ins.,
We note that defendants do not argue that the jury instructions on the successor liability issues were erroneous; they only argue that Grand did not make a submissible case on these issues under applicable Iowa law. In determining whether the district court erred in denying a motion for judgment as a matter of law, " 'it is the applicable law which is controlling, and not what the ... court announced the law to be in [its] instructions.' " Hanson v. Ford Motor Co.,
2. Iowa Successor Liability Law
Both parties correctly point out that Iowa law governs the substantive successor liability issues in this case because jurisdiction is based on diversity of citizenship. We must apply the substantive law of Iowa, the forum in which the district court sits. B.B. v. Continental Ins. Co.,
In Iowa, a corporation that acquires the assets of another company generally will not be held liable for the debts of that company. There are, however, limited exceptions to this rule. A corporation that purchases the assets of another corporation will be held liable for the latter's debts "when: (1) there is an express agreement to assume liability; (2) there is a consolidation or a merger; (3) the purchasing corporation is a 'mere continuation' of the selling corporation; or (4) the transaction is fraudulent." C. Mac Chambers Co. v. Iowa Tae Kwon Do Academy,
(i) Fraudulent Transfer of Assets
Defendants argue that Grand failed to make a submissible case that Midcon is liable for the MBL Judgment under the fraudulent transfer exception to the nonliability of successors. Iowa courts have not elaborated on the elements of such a claim. Authorities suggest, however, that "the fraud exception to the nonliability of successors is merely an application of the law of fraudulent conveyances." Chaveriat v. Williams Pipe Line Co.,
"A fraudulent conveyance is ... 'a transaction by means of which the owner of real or personal property has sought to place the land or goods beyond the reach of his creditors, or which operates to the prejudice of their legal or equitable rights.' " Graham v. Henry,
We hold that the district court erred in submitting the fraudulent transfer issue to the jury because Grand did not produce sufficient evidence that MBL fraudulently transferred assets to Midcon. First, Grand relies on evidence allegedly showing that MBL transferred trade secrets, which were worth $6.5 million, to Midcon. Even assuming the evidence supports that such a transfer was made, it does not support a finding of liability under a fraudulent transfer theory because MBL did not own the trade secrets; indeed, Grand admittedly owned the trade secrets and claimed that MBL stole them. See Dist.Ct. Doc. No. 168, at 3, 12 (May 6, 1992). A transfer of property in which the transferor has neither legal nor equitable title does not work to defraud the transferor's creditors. See, e.g., Harvey,
Grand's other evidence on the fraudulent transfer issue is similarly deficient. Grand cites the following evidence: Gary Buffington's testimony that when he left the company in 1982, MBL had equipment and inventory worth $500,000; Phillip Brown's deposition testimony7 that Graham transferred some equipment "that probably went to Northern Farms first and then was transferred by Northern to Midcon"; Brown's deposition testimony that when Northern Farms acquired the two farm properties and building in 1984 from third parties, some inventory was on the Lamar, Missouri, property from which MBL had run its operations; Graham's deposition testimony that he received no consideration for the transfer of his own assets to Midcon; and the deposition testimony of Gerald Schlink, a Midcon employee, that when he began working for Midcon in January 1985, the company "had an inventory of some [biological veterinary] products on hand." We note in addition that Pankratz, Grand's owner, summarily testified at trial that MBL transferred $250,000 worth of assets to Midcon.
Even assuming that the jury was entitled to find from this testimony that MBL transferred some of its own assets to Midcon for inadequate consideration, there is insufficient evidence that Grand was prejudiced by the asset transfer. Grand can cite no evidence, for example, that MBL had no other creditors, that Grand was entitled to priority over other creditors to any extent, much less to the extent of the assets allegedly transferred, or that the assets that MBL allegedly transferred were unencumbered. See C. Mac Chambers Co.,
(ii) Mere Continuation
Defendants argue in addition that Grand failed to make a submissible case that Midcon was a mere continuation of MBL under Iowa law. "The mere continuation exception [to the nonliability of successors] applies when the [transferee] corporation is merely a continuation or reincarnation of the [transferor] corporation." Bud Antle, Inc. v. Eastern Foods, Inc.,
The traditional mere continuation exception focuses on the continuation of management and ownership between the predecessor and successor corporations. Thus, " '[t]he key element of a "continuation" is a common identity of the officers, directors and stockholders in the selling and purchasing corporations.' " Bud Antle, Inc.,
It is important to distinguish the mere continuation exception from two relatively new theories of successor liability that courts have developed in some jurisdictions. These theories resemble the mere continuation exception in that both focus on certain elements of continuity between predecessor and successor corporations. They are fundamentally different from the mere continuation exception, however, because continuity of ownership and management is not dispositive under either one. One such theory is the "product line" exception to the nonliability of successors. Under the product line exception, " 'a party which acquires a manufacturing business and continues the output of its line of products ... assumes strict tort liability for defects in units of the same product line previously manufactured and distributed by the entity from which the business was acquired.' " DeLapp v. Xtraman, Inc.,
The other new theory of successor liability that courts have developed is the "continuity of enterprise" exception. Like the product line exception, the continuity of enterprise exception is "significantly different" from the mere continuation exception. Florom,
It is against this background that we must view Iowa cases on the mere continuation exception. The cases uniformly recite that Iowa recognizes the four traditional exceptions to the nonliability of successors, one of which is the mere continuation exception. Although none of the cases elaborate on the elements of a mere continuation claim, the DeLapp court explained that Iowa follows the "traditional rule[ ]."
At first blush, however, C. Mac Chambers Co. casts doubt on the idea that Iowa follows the traditional rule. In that case, defendant In Mook Kim operated martial arts teaching centers in Iowa. The business (Academy I) was incorporated in Iowa and Kim was the sole shareholder, officer, and director. When Academy I was on the verge of bankruptcy, Kim's son, Ki Tae, formed a new corporation (Academy II). Although he did not pay for any stock nor was he involved in running the business, Ki Tae Kim became the sole shareholder, officer, and director of Academy II.8 In all other respects, however, Academy II was the functional equivalent of Academy I.
The court held that Academy II was a mere continuation of Academy I.
We believe that C. Mac Chambers Co. merely carves out a narrow exception to the traditional mere continuation theory's requirement that there be a continuation of management and ownership between the predecessor and successor corporations. Specifically, we believe that the case stands for the unremarkable proposition that parties cannot circumvent the mere continuation exception by inserting relatives as sham owners and directors of a new company that is in substance the predecessor. Thus, outside of those cases where the successor corporation's ownership and management is different in form but not in substance, we do not believe that Iowa has departed from the traditional requirement of the mere continuation exception that there be a continuity of management and ownership between the two companies at issue.9 Nor do we believe that C. Mac Chambers Co. represents the sub silentio adoption of a "modified" continuation exception under which courts are to balance numerous factors, two of which are continuity of management and ownership, relating to the operations of the two companies in a totality of the circumstances test.
Several factors support our reading of C. Mac Chambers Co. First, three months after it decided C. Mac Chambers Co., the Iowa Supreme Court squarely rejected the product line exception. See DeLapp,
Finally, C. Mac Chambers Co. cited the district court opinion in Weaver v. Nash International, Inc.,
In light of our reading of C. Mac Chambers Co., we hold that the district court erred in denying defendants' posttrial motion for judgment as a matter of law. Grand produced no evidence that there were any common shareholders between MBL and Midcon; indeed, the undisputed evidence was that Northern Farms, which was owned by Jenkins and KCSI, first owned Midcon and then sold the stock to KCSI. "KCSI owned all the stock of Midcon through its wholly owned subsidiary PVI." Appellee's Br. at 10. The only common officer was Graham, who became a Midcon vice president in 1986, two years after the company was incorporated. It is undisputed that MBL and Midcon had no common directors.
Moreover, unlike the case in C. Mac Chambers Co., Grand produced no evidence that Midcon's owners were sham owners who collaborated with MBL's shareholders to avoid MBL's debts. For instance, Grand produced no evidence that KCSI and PVI lacked a real financial stake in Midcon. To the contrary, the undisputed evidence showed that KCSI and PVI funded Midcon with over six million dollars of their own funds. Moreover, Grand failed to establish that Graham or any of MBL's shareholders actually owned Midcon in substance or had an ownership interest in Northern Farms, KCSI or PVI. In short, no reasonable jury could find that MBL and Midcon had common ownership either in form or in substance.
Further, Grand produced no evidence that Midcon's directors and officers were not "involved in the running of the business." C. Mac Chambers Co.,
B. Punitive Damages
Defendants next argue that the district court erred in submitting the issue of KCSI's liability for punitive damages to the jury. We agree and hold that Grand is not entitled to punitive damages. In Iowa, "actual damages are necessary to support a claim for punitive damages." Sundholm v. City of Bettendorf,
III. CONCLUSION
For the foregoing reasons, we reverse the judgment of the district court.
Notes
THE HONORABLE DANIEL M. FRIEDMAN, Senior United States Circuit Judge for the Federal Circuit, sitting by designation
Product outlines describe how to make the products. An outline is "basically like a cake recipe." IV Tr. at 603
Grand named several other KCSI subsidiaries as defendants. These subsidiaries were dismissed as defendants pursuant to the district court's order of August 26, 1993. Grand does not cross-appeal this dismissal
The district court initially entered judgment only against Midcon for the $1,785,380 MBL Judgment. Defendants filed an appeal to this judgment. We then granted the district court leave to amend the judgment to reflect the jury's finding that KCSI was also liable for the MBL Judgment. Defendants filed a notice of appeal to this amended judgment as well
We do not directly address the merits of defendants' preverdict challenges to the sufficiency of the evidence. See Lama v. Borras,
Most jurisdictions hold that a prerequisite to the imposition of liability against a corporation under any of the four exceptions to the nonliability of successors is a transfer or sale of all, or substantially all, the assets of the predecessor to the successor. See Acheson v. Falstaff Brewing Corp.,
Our analysis might be different had Midcon prospered financially by exploiting Grand's trade secrets. Because Midcon failed, however, that issue is not before us
The district court admitted designated portions of several witnesses' depositions at trial
In Mook Kim later became an officer of Academy II. See
Grand cites no other Iowa cases, and we know of none, in which the court found a successor corporation with different owners liable under the mere continuation exception. In Arthur Elevator Co. v. Grove,
The facts of Ray v. Alad Corp., the seminal product line exception case that DeLapp rejected, illustrate the inconsistency. In Ray, Alad Corp. (Alad I) was sold to new owners, who formed a new corporation (Alad II). Alad II acquired Alad I's plant, equipment, inventory, trade name, and goodwill, and continued to manufacture the same product under the same name and with the same equipment, designs, and personnel.
The court also noted that the predecessor corporation "existed for at least some time after the [successor] purchased the assets of the [predecessor]."
Because we hold that Grand did not produce sufficient evidence that Midcon is liable for the MBL Judgment, as a matter of law KCSI is not liable for the MBL Judgment as Midcon's parent corporation under a "piercing the corporate veil" theory