Illinois Controls, Inc. v. Langham

Citation639 N.E.2d 771,70 Ohio St.3d 512
Decision Date12 October 1994
Docket NumberNo. 92-2212,92-2212
PartiesILLINOIS CONTROLS, INC. et al., Appellees and Cross-Appellants, v. LANGHAM et al., Appellants and Cross-Appellees.
CourtUnited States State Supreme Court of Ohio

SYLLABUS BY THE COURT

1. A contractual provision which gives a party the exclusive right to market a product on behalf of another imposes upon that party a duty to employ reasonable efforts to generate sales of the product. (1 Restatement of the Law 2d, Contracts [1981] 197, Section 77, Comment d, Illustration 9, adopted.)

2. Parol evidence directed to the nature of a contractual relationship is admissible where the contract is ambiguous and the evidence is consistent with the written agreement which forms the basis of the action between the parties.

3. A corporation is liable for the breach of a pre-incorporation agreement executed on its behalf by its promoters where the corporation expressly adopts the agreement or benefits from it with knowledge of its terms. (1 Restatement of the Law 2d, Agency [1958] 213, Section 84, Comment d, and 269, Section 104, adopted.)

4. The promoters of a corporation who execute a contract on its behalf are personally liable for the breach thereof irrespective of the later adoption of the contract by the corporation unless the contract provides that performance thereunder is solely the responsibility of the corporation. (2 Restatement of the Law 2d, Agency [1958] 77, Section 326, adopted.)

5. Where a corporation, with knowledge of the agreement's terms, benefits from a pre-incorporation agreement executed on its behalf by its promoters, the corporation and the promoters are jointly and severally liable for breach of the agreement unless the agreement provides that performance is solely the responsibility of the corporation or, subsequent to the formation of the corporate entity, a novation is executed whereby the corporation is substituted for the promoters as a party to the original agreement.

6. Civ.R. 8(A) requires only that a pleading contain a short and plain statement of the circumstances entitling the party to relief. A party is not required to plead the legal theory of recovery or the consequences which naturally flow by operation of law from the legal relationship of the parties.

Defendant-appellant and cross-appellee, Michael Langham, is the inventor of a device called the cross-slope monitor ("CSM"). The device is employed as an accessory for heavy-duty road graders to assure a consistent angle in the course of highway construction. On July 1, 1983, appellant applied to obtain a patent on the CSM. Thereafter, appellant began to market the device as an accessory to John Deere equipment through his unincorporated business, Langham Engineering.

The CSM, if properly installed, possessed substantial cost advantages over other methods. Todd Hale, a long-term employee of Langham Engineering, was an expert in the proper installation technique.

In the fall of 1983, Langham Engineering began to sell CSMs for use on John Deere A Series construction equipment. During the next fifteen months, Langham Engineering sold between ninety and one hundred of the devices through techniques such as demonstrations and consignments. However, John Deere's share of the road grader market was relatively small. Appellant wanted to penetrate the larger market represented by Caterpillar Tractor Company ("CAT"). At the time, CAT sales accounted for fifty-five to sixty percent of the world market in heavy construction equipment.

In order to exploit this opportunity, appellant contacted Caterpillar Venture Capital ("CAT Venture") for the purpose of locating someone who could market the CSM as an accessory to CAT equipment. CAT Venture, in turn, introduced appellant to plaintiffs-appellees and cross-appellants Balderson, Inc. ("BI") and its president, Clark Balderson.

In late February 1985, appellant and appellees commenced negotiations to form a new corporation to manufacture and market a CSM for use on CAT equipment. During negotiations, Clark Balderson represented to appellant that he was prepared to invest $250,000 in working capital toward the development of the project. On May 31, 1985, appellees commissioned a marketing plan to determine the feasibility of the enterprise. The plan envisioned that BI would market the CSM to end users of CAT equipment worldwide. The plan projected annual sales of the CSM to be seven hundred thirty units in 1986, eight hundred eighty-seven units in 1987 and one thousand eighty-four units in 1988. BI personnel expressed similarly favorable projections on September 24, 1985 and October 24, 1985. The marketing plan also envisioned that sales of the CSM would be limited to CAT equipment and was presented to appellant on that basis.

Appellant and appellees eventually decided to form a separate corporate entity which would manufacture and market the CSM for use on CAT equipment. However, it was agreed that the new entity must first satisfy its preexisting financial obligations. While appellant and his company were current on their existing debt, he nevertheless owed $185,000 on a bank loan and $83,000 to appellants and cross-appellees Joseph and Catherine Flaherty, his father-in-law and mother-in-law, for business loans. Moreover, Clark Balderson and BI sought to confine their future business relationship to appellant alone. Accordingly, they sought to remove the financial interests in Langham Engineering owned by appellant's partner, Drew Sellett, and Al Lamb, an investor. Thus, appellant was persuaded to incur approximately $599,000 in personal debt to purchase the interests of Drew Sellett and Al Lamb for $161,000 and $250,000, respectively and assume $188,000 in bank debt incurred by Drew Sellett on behalf of Langham Engineering. Clark Balderson supplied the $250,000 to purchase Al Lamb's interest, and appellant executed a promissory note payable to Balderson for that amount. Appellees told appellant that the debt incurred to purchase Lamb's and Sellett's interests would be assumed by the new entity. Langham Engineering thus became a sole proprietorship before its assets were acquired by the new entity. The new corporation, called Illinois Controls, Inc. (appellee and cross-appellant), was organized for the purpose of manufacturing and marketing the CSM for use on CAT equipment.

On October 4, 1985, the parties executed a pre-incorporation agreement ("PIA") to create the new corporation. The PIA was signed by Clark Balderson individually and in his representative capacity as president of BI.

The PIA provided in relevant part:

"WHEREAS, the parties hereto desire to organize and operate a corporation to be established under the laws of the State of Ohio which shall manufacture and sell cross slope monitors (and other products) throughout the world.

"NOW, THEREFORE, pursuant to the mutual covenants herein contained, the parties hereto agree as follows:

"ARTICLE I. Formation of New Company.

"Promptly after the date of this agreement, [BI, Clark Balderson] and [Michael] Langham shall cause, in collaboration with each other, a new company (hereinafter referred to as 'Newco' [now known as Illinois Controls, Inc.] ) to be incorporated under the laws of the State of Ohio.

"ARTICLE II. Newco Objectives.

"The object of Newco is to combine the resources, technical capabilities and production experience of Langham with the resources, engineering expertise and marketing capabilities of [BI] and the leadership capabilities of [Clark Balderson] in order to establish operating efficiencies in the production and marketing of cross slope monitors and such other related products as is [sic ] mutually acceptable to the parties by maintaining the capability to provide an assured source of such products to [BI] for marketing." (Emphasis added.)

Appellant was required to contribute $12,500 in cash and the assets of Langham Engineering to the enterprise, including the assignment of the CSM patent. In exchange, Illinois Controls was to assume the liabilities of appellant and Langham Engineering in the approximate amount of $651,000. Moreover, the PIA required Clark Balderson to contribute $37,500 and BI to contribute $250,000 in cash to the enterprise. In exchange for these contributions, Clark Balderson was to receive seven hundred sixty shares of common stock in Illinois Controls while appellant was to receive two hundred forty shares. The agreement further designated Clark Balderson as Chairman of the Board of Directors and President of Illinois Controls and appellant as vice-president. Appellant received an initial salary of $75,000 per year. Appellant was also to receive royalties of five percent of the sale price of every CSM sold by Illinois Controls as well as royalties for future products employing the cross-slope technology. On October 8, 1985, the CSM patent was granted to appellant. Thereafter, Illinois Controls began to manufacture and market the CSM for use on CAT equipment. However, instead of the $250,000 promised by Clark Balderson for CSM production, as early as October 1985 he indicated that he intended to spend only $20,000. Moreover, instead of the $225,000 envisioned in the marketing plan for promoting the CSM in the first two years, only $60,000 to $80,000 was actually committed to this goal.

In addition, BI failed to adequately train and motivate its sales force to aggressively inform end users about the CSM's capabilities. Significantly, Clark Balderson recognized these inadequacies but made no efforts to correct them.

The fortunes of Illinois Controls were also affected by the challenges inherent in the marketing of a new product. Such a product needs to achieve visibility. Mere advertising is insufficient. Demonstrations or consignment sales and incentives for the sales force are also necessary. Again, Clark Balderson was aware of the need for these strategies, but no incentives were ever...

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