Spartech Corp. v. Opper

• Decision Date: 04 January 1990
• Docket Number: 88-2556,Nos. 88-2453,s. 88-2453
• Citation: 890 F.2d 949
• Parties: SPARTECH CORPORATION, Plaintiff-Appellee, Cross-Appellant, v. Ronald B. OPPER and Lee E. Opper, Defendants-Appellants, Cross-Appellees.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 949

890 F.2d 949

SPARTECH CORPORATION, Plaintiff-Appellee, Cross-Appellant, v. Ronald B. OPPER and Lee E. Opper, Defendants-Appellants Cross-Appellees.

Nos. 88-2453, 88-2556.

United States Court of Appeals Seventh Circuit.

Argued Sept. 20, 1989.

Decided Nov. 29, 1989.

Rehearing and Rehearing En Banc Denied Jan. 4, 1990.

James B. Gottlieb, Stewart M. Weltman, Deborah Schmitt Bussert, Anthony C. Valiulis, Much, Shelist, Freed, Denenberg, Ament & Eiger, Chicago, Ill., for plaintiff-appellee, cross-appellant.

David C. Roston, William P. Caputo, Sherwin J. Stone, Altheimer & Gray, David A. Novoselsky, Novoselsky & Associates, Chicago, Ill., for defendants-appellants, cross-appellees.

Before WOOD, Jr., POSNER, and COFFEY, Circuit Judges.

POSNER, Circuit Judge.

This is a tangled commercial dispute, rich with issues. The defendants are the Oppers, the former owners of Equipment Financing Ltd., which, when they owned it, was called Financial Underwriters. Equipment (as we shall call the firm under both its old and its new ownership) was in the business of leasing medical equipment. It would borrow money to buy the equipment, would lease the equipment, and would assign the lessee's rental payments to the lender who had financed Equipment's purchase of it. Built into each rental payment was a profit for Equipment. The equipment loan reflected this profit and thus exceeded the purchase price of the equipment. The difference was income to Equipment, realized when the loan was made, but for federal and state income tax purposes the income did not accrue until the rental payment was made. With every such deferral of income, a deferred tax liability arose.

The Oppers wanted to sell Equipment, not in order to get out of the equipment-leasing business, but to raise cash; as a matter of fact, they wanted to go back into the business immediately under their old name. They sought a buyer who would have net operating loss carryforwards sufficient to offset Equipment's deferred tax liability. They knew that Spartech, the plaintiff in this case, was such a company, and they approached it with a proposal that it buy Equipment. A deal was struck. A wholly owned subsidiary of Spartech--Spartan Fabrication, Inc.--would buy the Oppers' stock in Equipment, then merge into Equipment and disappear, leaving Spartech as Equipment's only shareholder. The Oppers would form a new corporation, Apelco, Inc., to administer Equipment's leases. No new leases would be made, for remember that the Oppers were planning to reenter the business; and from Spartech's standpoint this was a financial rather than an operating transaction--it had no desire to be in the equipment-financing business. The agreement further provided that Apelco would pay all of Equipment's expenses and would divide any income that remained between Spartech and the Oppers according to a prescribed formula. Equipment would retain no cash, and would need none since it was being liquidated. The deal was duly consummated.

The agreement had not mentioned taxes, because the parties had expected that Spartech's net operating loss carryforwards would completely offset Equipment's deferred tax liability. They did not realize that Spartech could use its loss carryforwards to offset state income tax only in a state in which it had incurred losses, and it had incurred none in Illinois--the state to which Equipment, an Illinois corporation, owed deferred income taxes. There was also a factual misunderstanding concerning the amount of Equipment's deferred tax liability and hence the amount of net operating loss carryforwards that Spartech would have to use up in order to escape having to pay any taxes on Equipment's income. Although Spartech took the position that it had no liability for Equipment's debts, Equipment being a separate corporation, Spartech's practice was to pay its subsidiaries' income taxes and charge the expense back to each subsidiary. Pursuant to this practice, it paid Illinois $50,000 on account of Equipment's state income tax liability. The state has been dunning Spartech for the rest. Equipment has no cash with which to pay any taxes.

Spartech brought this suit against the Oppers and Apelco, charging federal securities violations and adding pendent counts based on Illinois' common law of fraud and fiduciary duty. As an alternative basis for federal jurisdiction, Spartech cited diversity of citizenship, Spartech being a corporate citizen of Delaware and Missouri and all the defendants citizens of Illinois. The district judge dismissed the federal claims but did not address the issue of pendent jurisdiction because he believed the case was securely within the diversity jurisdiction.

A bench trial resulted in judgment for Spartech on its claim for breach of fiduciary duty. The judge found that the Oppers, by assuring Spartech that they would see to it that all of Equipment's expenses were paid before its income was split with Spartech, had implicitly promised Spartech that they would make sure Equipment paid any taxes it might owe. The record does not reveal why the plaintiff cast this claim as one for breach of fiduciary duty rather than breach of contract, but conceivably there were statute of frauds or statute of limitations problems or other technical defenses to contract liability that Spartech was trying to get around. Essentially it is a simple breach of contract: the Oppers made a promise to Spartech, supported by consideration, and they broke it. But the management contract gave the Oppers such complete control over Equipment as to make them fiduciaries of the shareholder Spartech, and as such they incurred liability that is not cabined by the technical rules of contract law.

The judge exonerated the defendants of the charge of fraud. And he dismissed Apelco from the case because he had just ordered the Oppers to pay Spartech the share of the money Apelco had distributed to the Oppers which should have been used to pay Equipment's taxes. The judgment is unusual in including a further order that Spartech pay the State of Illinois the taxes that Equipment owes it, even though the state has never been a party to the case. Spartech does not question the order, so neither shall we.

The Oppers appeal on a variety of grounds; Spartech cross-appeals seeking reinstatement of the fraud count, which might entitle it to additional damages. For the first time on appeal--but of course that is not too late--the Oppers argue that the district court had no jurisdiction; and the jurisdictional issues are the principal issues raised by the appeal.

With regard to pendent jurisdiction as a basis for the district court's jurisdiction, the Oppers contend erroneously both that the federal securities claims in the complaint were insubstantial (which if true would bar the exercise of pendent jurisdiction) and that whenever all federal claims, insubstantial or not, are dismissed before trial, the district judge must relinquish pendent jurisdiction.

Ever since the Supreme Court rejected the sale of business doctrine in Landreth Timber Co. v. Landreth, 471 U.S. 681, 105 S.Ct. 2297, 85 L.Ed.2d 692 (1985), the buyer of all the stock of a corporation has been able to charge his seller with fraud under Rule 10b-5 of the Securities and Exchange Commission; unless the charge is frivolous, it will support pendent jurisdiction of related state-law claims. It was not frivolous in this case. It turned out to be barred by the statute of limitations, but the plaintiff had a colorable argument for tolling the statute because of fraudulent concealment by the defendants.

While it is true that, normally, pendent claims are dismissed when the federal claims fall out before trial, that is not an invariable rule, see, e.g., Rosado v. Wyman, 397 U.S. 397, 402-05, 90 S.Ct. 1207, 1212-14, 25 L.Ed.2d 442 (1970); Graf v. Elgin, Joliet & Eastern Ry., 790 F.2d 1341, 1347-48 (7th Cir.1986); United States v. Zima, 766 F.2d 1153, 1158-59 (7th Cir.1985), and without the benefit of the district judge's views we hesitate to say that the present case cannot possibly be fit into any of the exceptions. By the same token we cannot agree with Spartech that the judge would have been required to retain jurisdiction over the state law claims as a matter of law. The decision whether to retain or relinquish pendent jurisdiction is one in the first instance for the district judge's discretion, and the district judge exercised no discretion because he thought the case snugly within the diversity jurisdiction and the issue whether to exercise pendent jurisdiction therefore moot. There may well be cases where relinquishing jurisdiction of pendent claims would be an abuse of discretion, but this is not one.

So if the only possible basis of federal jurisdiction here were pendent jurisdiction, a remand would be necessary. But we agree with the district judge that the case is within the diversity jurisdiction, notwithstanding the Oppers' forceful argument that Equipment, not Spartech, is the real plaintiff--and Equipment, like the Oppers themselves and Apelco, is a citizen of Illinois. Spartan, the immediate acquirer of Equipment, was also a citizen of Illinois, but like a subatomic particle generated in an atom smasher its life was brief, and it disappeared before the suit was filed.

The Oppers make two arguments against the existence of diversity jurisdiction. The first is that Spartech is not entitled to pierce the corporate veil and step into the shoes of Equipment, for it is Equipment rather than Spartech that is liable for the taxes that are in dispute. The second is that, at the very least, Equipment is an indispensable party plaintiff.

If Spartech were a merely nominal party, it would be ignored in deciding whether there was diversity of citizenship. The citizenship of the real parties in interest is what counts. Navarro Savings Ass'n v. Lee, 446 U.S. 458, 100 S.Ct. 1779, 64 L.Ed.2d 425 (1980); Adden v....