Industrial Electron v. iPower Dist Group

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.