Cookies Food Products, Inc., by Rowedder v. Lakes Warehouse Distributing, Inc.

• Decision Date: 19 October 1988
• Docket Number: No. 86-1825,86-1825
• Citation: 430 N.W.2d 447
• Parties: COOKIES FOOD PRODUCTS, INC., an Iowa corporation, by its stockholders Leo ROWEDDER, Alvin Claussen, Sandra C. Grote, Mark Cook, Dave Tiefenthaler, Virtus Pittman, Loren Rowedder, Richard Bloom, Daryl Johnson, Charles Brotherton, Howard Brotherton, Jeryl Reiter, and Gilbert Renze, Appellants, v. LAKES WAREHOUSE DISTRIBUTING, INC., an Iowa corporation, Speed's Automotive, Inc., an Iowa Corporation, and Duane D. Herrig, Appellees.
• Court: Iowa Supreme Court

Page 447

430 N.W.2d 447

COOKIES FOOD PRODUCTS, INC., an Iowa corporation, by its stockholders Leo ROWEDDER, Alvin Claussen, Sandra C. Grote, Mark Cook, Dave Tiefenthaler, Virtus Pittman, Loren Rowedder, Richard Bloom, Daryl Johnson, Charles Brotherton, Howard Brotherton, Jeryl Reiter, and Gilbert Renze, Appellants, v. LAKES WAREHOUSE DISTRIBUTING, INC., an Iowa corporation, Speed's Automotive, Inc., an Iowa Corporation, and Duane D. Herrig, Appellees.

No. 86-1825.

Supreme Court of Iowa.

Oct. 19, 1988.

Rehearing Denied Nov. 18, 1988.

Colin J. McCullough and David P. Jennett of McCullough Law Firm, Sac City, for appellants.

James R. Van Dyke of Van Dyke & Werden, P.C., Carroll, for appellees.

Considered by HARRIS, P.J., and SCHULTZ, NEUMAN, SNELL, and ANDREASEN, JJ.

NEUMAN, Justice.

This is a shareholders' derivative suit brought by the minority shareholders of a closely held Iowa corporation specializing in barbeque sauce, Cookies Food Products, Inc. (Cookies). The target of the lawsuit is the majority shareholder, Duane "Speed" Herrig and two of his family-owned corporations, Lakes Warehouse Distributing, Inc. (Lakes) and Speed's Automotive Co., Inc. (Speed's). Plaintiffs alleged that Herrig, by acquiring control of Cookies and executing self-dealing contracts, breached his fiduciary duty to the company and fraudulently misappropriated and converted corporate funds. Plaintiffs sought actual and punitive damages. Trial to the court resulted in a verdict for the defendants, the district court finding that Herrig's actions benefited, rather than harmed, Cookies. We affirm.

I. Background.

We review decisions in shareholders' derivative suits de novo, deferring especially to district court findings where the credibility of witnesses is a factor in the outcome. Midwest Management Corp. v. Stephens, 353 N.W.2d 76, 78 (Iowa 1984). To better understand this dispute, and the issues this appeal presents, we shall begin by recounting in detail the facts surrounding the creation and growth of this corporation.

L.D. Cook of Storm Lake, Iowa, founded Cookies in 1975 to produce and distribute his original barbeque sauce. Searching for a plant site in a community that would provide financial backing, Cook met with business leaders in seventeen Iowa communities, outlining his plans to build a growth-oriented company. He selected Wall Lake, Iowa, persuading thirty-five members of that community, including Herrig and the plaintiffs, to purchase Cookies stock. All of the investors hoped Cookies would improve the local job market and tax base. The record reveals that it has done just that.

Early sales of the product, however, were dismal. After the first year's operation, Cookies was in dire financial straits. At that time, Herrig was one of thirty-five shareholders and held only two hundred shares. He was also the owner of an auto parts business, Speed's Automotive, and Lakes Warehouse Distributing, Inc., a company that distributed auto parts from Speed's. Cookies' board of directors approached Herrig with the idea of distributing the company's products. It authorized Herrig to purchase Cookies' sauce for twenty percent under wholesale price, which he could then resell at full wholesale price. Under this arrangement, Herrig began to market and distribute the sauce to his auto parts customers and to grocery outlets from Lakes' trucks as they traversed the regular delivery routes for Speed's Automotive.

In May 1977, Cookies formalized this arrangement by executing an exclusive distribution agreement with Lakes. Pursuant to this agreement, Cookies was responsible only for preparing the product; Lakes, for its part, assumed all costs of warehousing, marketing, sales, delivery, promotion, and advertising. Cookies retained the right to fix the sales price of its products and agreed to pay Lakes thirty percent of its gross sales for these services.

Cookies' sales have soared under the exclusive distributorship contract with Lakes. Gross sales in 1976, the year prior to the agreement, totaled only $20,000, less than half of Cookies' expenses that year. In 1977, however, sales jumped five-fold, then doubled in 1978, and have continued to show phenomenal growth every year thereafter. By 1985, when this suit was commenced, annual sales reached $2,400,000.

As sales increased, Cookies' board of directors amended and extended the original distributorship agreement. In 1979, the board amended the original agreement to give Lakes an additional two percent of gross sales to cover freight costs for the ever-expanding market for Cookies' sauce. In 1980, the board extended the amended agreement through 1984 to allow Herrig to make long-term advertising commitments. Recognizing the role that Herrig's personal strengths played in the success of their joint endeavor, the board also amended the agreement that year to allow Cookies to cancel the agreement with Lakes if Herrig died or disposed of the corporation's stock.

In 1981, L.D. Cook, the majority shareholder up to this time, decided to sell his interest in Cookies. He first offered the directors an opportunity to buy his stock, but the board declined to purchase any of his 8100 shares. Herrig then offered Cook and all other shareholders $10 per share for their stock, which was twice the original price. Because of the overwhelming response to these offers, Herrig had purchased enough Cookies stock by January 1982 to become the majority shareholder. His investment of $140,000 represented fifty-three percent of the 28,700 outstanding shares. Other shareholders had invested a total of $67,500 for the remaining forty-seven percent.

Shortly after Herrig acquired majority control he replaced four of the five members of the Cookies' board with members he selected. This restructuring of authority, following on the heels of an unsuccessful attempt by certain stockholders to prevent Herrig from acquiring majority status, solidified a division of opinion within the shareholder ranks. Subsequent changes made in the corporation under Herrig's leadership formed the basis for this lawsuit.

First, under Herrig's leadership, Cookies' board has extended the term of the exclusive distributorship agreement with Lakes and expanded the scope of services for which it compensates Herrig and his companies. In April 1982, when a sales increase of twenty-five percent over the previous year required Cookies to seek additional short-term storage for the peak summer season, the board accepted Herrig's proposal to compensate Lakes at the "going rate" for use of its nearby storage facilities. The board decided to use Lakes' storage facilities because building and staffing its own facilities would have been more expensive. Later, in July 1982, the new board approved an extension of the exclusive distributorship agreement. Notably, this agreement was identical to the 1980 extension that the former board had approved while four of the plaintiffs in this action were directors.

Second, Herrig moved from his role as director and distributor to take on an additional role in product development. This created a dispute over a royalty Herrig began to receive. Herrig's role in product development began in 1982 when Cookies diversified its product line to include taco sauce. Herrig developed the recipe because he recognized that taco sauce, while requiring many of the same ingredients needed in barbeque sauce, is less expensive to produce. Further, since consumer demand for taco sauce is more consistent throughout the year than the demand for barbeque sauce, this new product line proved to be a profitable method for increasing year-round utilization of production facilities and staff. In August 1982, Cookies' board approved a royalty fee to be paid to Herrig for this taco sauce recipe. This royalty plan was similar to royalties the board paid to L.D. Cook for the barbeque sauce recipe. That plan gives Cook three percent of the gross sales of barbeque sauce; Herrig receives a flat rate per case. Although Herrig's rate is equivalent to a sales percentage slightly higher than what Cook receives, it yields greater profit to Cookies because this new product line is cheaper to produce.

Third, since 1982 Cookies' board has twice approved additional compensation for Herrig. In January 1983, the board authorized payment of a $1000 per month "consultant fee" in lieu of salary, because accelerated sales required Herrig to spend extra time managing the company. Averaging eighty-hour work weeks, Herrig devoted approximately fifteen percent of his time to Cookies and eighty percent to Lakes business. In August, 1983, the board authorized another increase in Herrig's compensation. Further, at the suggestion of a Cookies director who also served as an accountant for Cookies, Lakes, and Speed's, the Cookies board amended the exclusive distributorship agreement to allow Lakes an additional two percent of gross sales as a promotion allowance to expand the market for Cookies products outside of Iowa. As a direct result of this action, by 1986 Cookies regularly shipped products to several states throughout the country.

As we have previously noted, however, Cookies' growth and success has not pleased all its shareholders. The discontent is motivated by two factors that have effectively precluded shareholders from sharing in Cookies' financial success: the fact that Cookies is a closely held corporation, and the fact that it has not paid dividends. Because Cookies' stock is not publicly traded, shareholders have no ready access to buyers for their stock at current values that reflect the company's success. Without dividends, the shareholders have no ready method of realizing a return on their investment in the company. This is not to say that Cookies has improperly refused to pay dividends. The evidence reveals that Cookies would have violated the terms of its loan with the Small Business Administration had it declared dividends before...