Alberto v. Diversified Group, Inc.

• Decision Date: 21 June 1995
• Docket Number: No. 94-20774,94-20774
• Citation: 55 F.3d 201
• Parties: Jerome P. ALBERTO, et al., Plaintiffs-Appellants, and Roderick Earl Hall, et al., Movants-Appellants, v. DIVERSIFIED GROUP, INC., et al. Defendants, Diversified Group, Inc., Defendants-Appellees. Stephen C. CRAWFORD, Plaintiff-Appellant, v. DIVERSIFIED GROUP, INC., Defendant-Appellee.
• Court: U.S. Court of Appeals — Fifth Circuit

Page 201

55 F.3d 201

Jerome P. ALBERTO, et al., Plaintiffs-Appellants, and Roderick Earl Hall, et al., Movants-Appellants, v. DIVERSIFIED GROUP, INC., et al. Defendants, Diversified Group, Inc., Defendants-Appellees.

Stephen C. CRAWFORD, Plaintiff-Appellant, v. DIVERSIFIED GROUP, INC., Defendant-Appellee.

No. 94-20774.

United States Court of Appeals Fifth Circuit.

June 21, 1995.

David W. Showalter, Bellaire, TX, for appellants.

Stewart F. Peck, Nathan P. Horner, New Orleans, LA, for appellees.

Appeal from the United States District Court for the Southern District of Texas.

Before DAVIS, SMITH and WIENER, Circuit Judges.

WIENER, Circuit Judge:

Plaintiffs-Appellants Jerome P. Alberto, et al. (Alberto et al.), judgment creditors of Johnson-Logins, Inc. (JL), appeal a summary judgment granted in favor of Diversified Group, Inc. (DGI), arguing that the district court erred in deciding to apply the substantive law of Delaware, and in concluding under Delaware law that DGI and JL were not alter egos and thus that DGI could not be held liable for the debts of JL. Finding no reversible error, we affirm.

I FACTS AND PROCEEDINGS

Alberto et al., a group of 143 individuals each of whom was a homeowner in one of three subdivisions in Texas (the "Atascocita Properties), filed suit against DGI, a shareholder in JL (and in another corporation which held JL stock), seeking to hold DGI liable for default judgments previously entered against JL totalling more than $58 million. Alberto et al. had obtained those judgments in state court tort suits in which they had alleged that the foundations of their homes failed as a result of soil subsidence. JL, one of the original owners and developers of the properties, was a defendant in those suits. JL had filed for Chapter 7 protection before the tort suits were commenced, but the bankruptcy court lifted the automatic stay to permit the plaintiffs to pursue their claims against JL in Texas state court.

JL had been incorporated in the early 1970s under the laws of Delaware as a wholly owned subsidiary of First Realty Development Corporation (First Realty). By the mid-70s, JL had begun to lose money, and First Realty decided to sell the company. First Realty contacted DGI (at that time IDSO Investments, Inc., a holding company incorporated under Louisiana law in 1967 by H.D. Hughes (Hughes) and his wife, Ida) to determine whether DGI was interested in the acquisition.

DGI claims that even though JL was losing money at that time, DGI decided to invest in the company in the belief that the fair market value of JL's real estate holdings was higher than their book value. Alberto et al. dispute this contention, contending that Hughes acquired JL solely to use its tax losses as offsets against the taxable earnings of DGI's profitable subsidiary corporations. In any event, DGI agreed to purchase an interest in JL.

To facilitate the acquisition of such an interest, a new corporate entity, Z Corporation, was formed in Texas. The purchase of JL was structured so that Z Corporation would own all of JL's stock, and the stock in Z Corporation, in turn, would be shared by DGI and several other investors. DGI insists that it structured the acquisition in this manner because it did not want to acquire 100% of JL and therefore needed a "common currency," i.e., stock in Z Corporation, to accommodate the interests of the various investors. DGI explains that Ken Watler and Leon Dorsey, two of the investors in JL, exchanged stock in another company, Weatherby Engineering Company, for stock in Z Corporation, while some of First Realty's stockholders who had acquired JL stock in a spin out exchanged it for stock in Z Corporation. Alberto et al. dispute this contention as well, contending that Hughes formed Z Corporation as a shell to insulate himself and DGI from JL's liabilities.

Pursuant to the purchase agreement, DGI, through Z Corporation, immediately contributed $2.4 million to JL's existing capitalization and agreed to advance another $2 million as required. This capital infusion was insufficient to remedy JL's dire financial condition, however, and not long after Z Corporation acquired JL, one of JL's creditors effectively took over the operations of JL and proceeded to wind down the company's affairs. By September 1978, that creditor had substantially completed the winding down of JL and relinquished control of the company. ¹

                Soon thereafter, JL authorized the issuance of 250 new shares and sold those shares to DGI, as a result of which JL stock was owned 20% by DGI and 80% by Z Corporation.  As DGI then owned 63% of the issued and outstanding stock in Z Corporation, DGI held beneficial ownership in 70.4% of JL. 2  By this time, Hughes had become the sole director of DGI, Z Corporation, and JL
                

JL had owned an interest in the Atascocita Properties in the mid-1970s, long before the company was acquired by Z Corporation. JL, however, did not finally dispose of the last of its interests in the properties in those subdivisions until November 1978--about a week after DGI acquired its 20% direct stock ownership in JL. DGI insists that it had nothing to do with JL's sale of its last remaining interest in the subdivisions. Moreover, none of the 143 individual plaintiffs comprising Alberto et al. purchased their properties until the 1980s--years after JL had completed its disposal of all interest in the Atascocita Properties and had been substantially wound down.

Alberto et al. originally filed suit in Texas state court seeking a declaratory judgment that DGI was liable for the judgments against JL on the theory that JL and DGI are alter egos. DGI removed the suit to federal court on grounds of diversity and filed a motion for summary judgment. The district court granted summary judgment in favor of DGI based on the finding that JL and DGI are not alter egos under Delaware law. This finding was grounded in the failure of Alberto et al. to proffer evidence from which a reasonable factfinder could find that recognition of JL and DGI as separate corporate entities would result in unfairness or injustice.

Alberto et al. filed a motion for reconsideration, which the court denied, and this appeal followed. On appeal, Alberto et al. contend that the district court erred in concluding that (1) the substantive law of Delaware, rather than Louisiana, applies; and (2) under Delaware law DGI is entitled to summary judgment due to the failure of Alberto et al. to proffer summary judgment evidence of overall injustice or unfairness.

II ANALYSIS

A. CHOICE OF LAW

As this suit was removed to the district court on the basis of diversity jurisdiction, the district court had to apply the conflict of laws rule of the state in which it sits to determine which state's substantive law should be applied. ³ The district court, sitting in Texas, applied Texas' conflicts rule on choice of law, and concluded that the substantive law of Delaware should be applied. We agree.

Under Texas law,

[O]nly the laws of the jurisdiction of incorporation of a foreign corporation shall govern ... (2) the liability, if any, of shareholders of the foreign corporation for the debts, liabilities, and obligations of the foreign corporation for which they are not otherwise liable by statute or agreement. ⁴

Alberto et al. are seeking to enforce the judgment debts of JL, a Delaware corporation, against DGI, both a direct and indirect shareholder of JL stock. Applying the plain language of the statute, therefore, the liability of DGI, as shareholder of a foreign corporation, i.e., JL, is governed "only [by] the laws of the jurisdiction of [JL's] incorporation," which, in this case, is Delaware. We agree with the district court that "it is clearly the intent of the statute to apply the laws of the jurisdiction of incorporation of the foreign corporation [JL], not the laws of the jurisdiction of a shareholder [DGI]."

Alberto et al. claim that the district court erred in its analysis, urging that the Restatement (Second) of Conflict of Laws, our decision in United States v. Clinical Leasing Service, Inc., ⁵ and a decision of a district court sitting in Delaware all support the proposition that the correct choice of law is the substantive law of the state of incorporation of the parent/shareholder (DGI), rather than the state of incorporation of the subsidiary (JL). As DGI is a Louisiana corporation, Alberto et al. argue, the district court should have applied the substantive law of Louisiana, not Delaware. We are not persuaded.

Restatement (Second) of Conflict of Laws Sec. 306, "Liability of Majority Shareholder," provides that:

[t]he obligations owed by a majority shareholder to the corporation and to the minority shareholders will be determined by the local law of the state of incorporation, except in the unusual case where, with respect to the particular issue, some other state has a more significant relationship under the principles stated in Sec. 6 to the parties and the corporation, in which event the local law of the other state will be applied. ⁶

Alberto et al. insist that this is just such an "unusual case," requiring application of the substantive law of Louisiana--the state with a "more significant relationship" than Delaware. ⁷ But Sec. 306 does not apply here, as (1) it addresses only "obligations owed by a majority shareholder to the corporation and to the minority shareholders " (not to creditors, such as Alberto et al.), and (2) it applies only "in the absence of an applicable local statute" ⁸--but this issue is governed by such a local statute, Texas Business Corporation Act article 8.02.

Neither do Clinical Leasing Service ⁹ nor Mobil Oil Corporation v. Linear Films, Inc. ¹⁰ persuade us to ignore the plainly applicable Texas statute. Clinical Leasing Service was brought in a federal district court in Louisiana, so Louisiana's choice-of-law rules--not those of Texas--were at issue. Moreover, the parties "agree[d]" that...