Frank v. Hadesman and Frank, Inc.

• Decision Date: 03 May 1996
• Docket Number: No. 95-3791,95-3791
• Citation: 83 F.3d 158
• Parties: Werner FRANK and Werner Frank Enterprises, Inc., Plaintiffs-Appellants, v. HADESMAN AND FRANK, INC., et al., Defendants-Appellees.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 158

83 F.3d 158

34 Fed.R.Serv.3d 480

Werner FRANK and Werner Frank Enterprises, Inc., Plaintiffs-Appellants, v. HADESMAN AND FRANK, INC., et al., Defendants-Appellees.

No. 95-3791.

United States Court of Appeals Seventh Circuit.

Argued April 11, 1996.

Decided May 3, 1996.

Appeal from the United States District Court for the Northern District of Illinois, Eastern Division. No. 95 C 1144--Robert W. Gettleman, Judge.

Patrick R. Gabrione, Foran & Schultz, Chicago, IL, Michael T. Thornton (argued), Atlanta, GA, for plaintiffs-appellants.

David M. Mattenson, Chicago, IL, Stuart I. Gordon (argued), Kanter & Mattenson, Chicago, IL, for Herbert H. Hadesman, Jeanne Hadesman.

Thomas L. Browne, Bruce L. Carmen (argued), D. Kendall Griffith, Hinshaw & Culbertson, Chicago, IL, for Steven A. Miner.

Before FLAUM, EASTERBROOK, and DIANE P. WOOD, Circuit Judges.

EASTERBROOK, Circuit Judge.

Since 1980 Herbert Hadesman has sold gift wear and related items from space in Chicago's Merchandise Mart. Hadesman and Werner Frank are the principal shareholders in Hadesman & Frank, Inc., a corporation formed to conduct the trade. Today Hadesman and Frank are enemies. In this suit under the diversity jurisdiction Frank accuses Hadesman of making off with the corporation's business, effectively transferring it to a new firm, Hadesman & Associates, Inc., from which Frank has been excluded.

The district judge immediately detected a jurisdictional problem: Frank's only claim against Hadesman & Frank, Inc., was to collect a debt of $50,000, plus accumulated interest. Yet 28 U.S.C. § 1332(a) provides jurisdiction only when the amount in controversy exceeds $50,000, "exclusive of interest and costs". All remaining claims alleged wrongdoing by Hadesman, his wife, or Steven Miner, the corporation's lawyer (and a member of its board). After receiving submissions from the parties, the district judge concluded that Frank lacks standing to pursue these claims and dismissed the suit. "Standing" is a misnomer, because Frank has alleged injury in fact. His investment in Hadesman & Frank, Inc., has declined in value. Frank's problem is not standing (in the sense that the complaint does not allege a "case or controversy" justiciable under Article III) but the identity of the real party in interest. "Every action shall be prosecuted in the name of the real party in interest." Fed.R.Civ.P. 17(a). Does the claim belong to Frank personally, or to Hadesman & Frank, Inc.? That is a question of state law, Brocklesby Transport v. Eastern States Escort Services, 904 F.2d 131, 133 (2d Cir.1990); cf. Kamen v. Kemper Financial Services Inc., 500 U.S. 90, 111 S.Ct. 1711, 114 L.Ed.2d 152 (1991)--in this case, the law of Illinois, because Hadesman & Frank, Inc., is incorporated in Illinois, and the internal affairs doctrine calls for the use of the incorporating state's law. Nagy v. Riblet Products Corp., 79 F.3d 572 (7th Cir. 1996). The district judge used this body of law; a change of label from "standing" to "real party in interest" does not affect the analysis.

Treating the corporation as the owner of the claim has both procedural and jurisdictional consequences. The procedural consequence is that Frank must notify the firm's board (or establish an exception to that requirement) and demand that the firm bring the suit in its own name; only after a refusal may Frank institute derivative litigation in the right of the corporation. 805 ILCS 5/7.80(b); Valiquet v. First Federal Savings & Loan Association, 87 Ill.App.3d 195, 42 Ill.Dec. 212, 217, 408 N.E.2d 921, 926 (1st Dist. 1979); Goldberg v. Ball, 305 Ill.App. 273, 27 N.E.2d 575 (1st Dist. 1940). Once the suit was filed, the court would treat it much like a class action, because Frank would be a representative for all investors in the firm. Fed.R.Civ.P. 23.1. The jurisdictional consequence is that in any future litigation Hadesman & Frank, Inc., would appear as the plaintiff. That would put citizens of Illinois on both sides and prevent the exercise of federal jurisdiction, unless Frank could demonstrate that the corporation should be realigned as a defendant under the approach of Smith v. Sperling, 354 U.S. 91, 77 S.Ct. 1112, 1 L.Ed.2d 1205 (1957).

Illinois follows the widespread rule that an action for harm to the corporation must be brought in the corporate name. When investors have been injured in common, they must continue to act through their collective--the corporation. Cashman v. Coopers & Lybrand, 251 Ill.App.3d 730, 732-33, 191 Ill.Dec. 317, 319-20, 623 N.E.2d 907, 909-10 (2d Dist. 1993); Mann v. Kemper Financial Companies, Inc., 247 Ill.App.3d 966, 974-77, 187 Ill.Dec. 726, 732-34, 618 N.E.2d 317, 323-25 (1st Dist. 1993); Zokoych v. Spalding, 36 Ill.App.3d 654, 344 N.E.2d 805 (1st Dist. 1976). See also Weissman v. Weener, 12 F.3d 84 (7th Cir.1993); Kagan v. Edison Brothers Stores, Inc., 907 F.2d 690, 692-93 (7th Cir.1990). Injury to the corporation does not, however, prevent suit by an investor who suffers a distinct personal injury--for example, a shareholder who alleges that members of the board have refused to return stock pledged to secure a debt, even after the loan has been paid; or a shareholder-employee who contests his discharge from employment. Elrod v. Ripley, 97 Ill. 503 (1901); see Zokoych, 36 Ill.App.3d at 663-64, 344 N.E.2d at 813. The American Law Institute's Principles of Corporate Governance: Analysis and Recommendations § 7.01 (1992), captures this nicely: "An action in which the holder [i.e., the investor] can prevail only by showing an injury or breach of duty to the corporation should be treated as a derivative action.... An action in which the holder can prevail without showing an injury or breach of duty to the corporation should be treated as a direct action that may be maintained by the holder in an individual capacity." The fired employee can prevail without showing corporate injury; indeed, the discharge may have been designed to improve the corporation's operations. The investor whose certificates are sequestered suffers an injury unrelated to the firm, for the same reason as the theft of someone's shares in Exxon injures the investor but not Exxon. See also Reporter's Note 1 to § 7.01, which catalogs situations that have been treated as supporting direct actions; 2 Model Business Corporation Act Annotated § 7.40 at 7-265 to 7-268 (1995 Supp.). Frank does not allege that he was fired (he was not an employee to begin with) or that his shares have been canceled; he alleges that the entire firm was hollowed out and its business transferred to a new corporation. That injures all investors alike, so the action is derivative. See Seinfeld v. Bays, 230 Ill.App.3d 412, 172 Ill.Dec. 6, 595 N.E.2d 69 (1st Dist. 1992) (action for corporate waste and devaluation of stock is derivative).

Frank replies that although he and Hadesman may have suffered equally, in their capacity as shareholders in Hadesman & Frank, Inc., Hadesman reaped an offsetting gain through his new venture. Hadesman was a net winner, Frank a net loser. According to Frank, the disproportionate harm he suffered entitles him to litigate individually. So put, the argument is similar to one advanced in Mann, which spurned it: "We reject [any] test of shareholder standing of whether the shareholder alleges unique harm." 247 Ill.App.3d at 977, 187 Ill.Dec. at 734, 618 N.E.2d at 325. The district judge relied principally on Mann. Unaccountably Frank does not mention that case in his brief. We take the omission as a concession.

Frank was a supplier to Hadesman & Frank, Inc.: a supplier of capital, of consulting services, and of information about good sources of gift wear for the firm to showcase and sell. But none of these involves any contract (or equivalent personal right) that Hadesman & Frank, Inc., dishonored. According to the complaint, Hadesman appropriated the corporation's custom. To see this, consider one of the assets Hadesman supposedly stole: the firm's customer list. A customer...