Opinion
Case No. 99-2584-JWL.
April 23, 2001.
MEMORANDUM ORDER
On February 20, 2001, defendant New Age Industrial Corporation ("New Age") filed a motion for a preliminary hearing to determine whether the court had subject matter jurisdiction over this case. The court granted the motion and held a hearing on March 28, 2001. Based on the evidence presented at the hearing, the court concludes that it lacks subject matter jurisdiction over this case. Pursuant to Federal Rule of Civil Procedure 12(h)(3), the court dismisses this cause of action without prejudice.
• Background and finding of facts
New Age is a Kansas corporation with its principal place of business in Norton, Kansas. Lenco, Inc. ("Lenco Kansas") was a Kansas corporation incorporated in 1977 with its principal place of business in Norton, Kansas. Len Coady was the president and sole stockholder of Lenco Kansas. Lenco Kansas failed to file its 1998 annual report and thereby forfeited its articles of incorporation. New Age entered into a written contract with Lenco Kansas on September 9, 1986. Pursuant to the contract, Lenco Kansas agreed to "manage and be responsible for all of New Age's sales activity on food handling products" and, in return, New Age agreed to pay Lenco Kansas a commission of 20% of gross profit on all sales of food handling products. The contract expired on September 9, 1991.
K.S.A. § 17-7510 provides that the failure of a domestic corporation to file an annual report or to pay the annual taxes"within 90 days of the time for filing and paying the same shall work the forfeiture of the articles of incorporation of such domestic corporation." New Age argues that Lenco Kansas filed its 1997 annual report more than 90 days after it was due and thereby forfeited its articles of incorporation "as of January 1, 1998." The court need not determine when Lenco Kansas forfeited its articles of incorporation in order to determine whether subject matter jurisdiction exists.
This lawsuit is brought by an Oklahoma corporation, Lenco, Inc. ("Lenco Oklahoma"). Lenco Oklahoma was incorporated in December of 1999. Len Coady and his wife Judith Coady are the sole shareholders of Lenco Oklahoma. Pursuant to an agreement dated December 21, 1999, Lenco Kansas transferred all of its "assets and causes of action" to Lenco Oklahoma. The agreement did not provide for any consideration in return for the transfer. Pursuant to a meeting of stockholders on December 21, 1999, Lenco Oklahoma "accept[ed] all of the assets, liabilities and causes of action from" Lenco Kansas.
An argument can be made that Lenco Oklahoma accepted the liabilities of Lenco Kansas as consideration. The written agreement, however, did not obligate Lenco Oklahoma to accept any liabilities and Mr. Coady testified at the hearing that he had personally guaranteed the liabilities of Lenco Kansas. For the purpose of determining if subject matter jurisdiction exists, the court need not determine if Lenco Oklahoma accepted the liabilities of Lenco Kansas as consideration for the transfer of assets or simply because Mr. Coady was personally liable for the debt.
On December 30, 1999, Lenco Oklahoma filed this lawsuit. Lenco Oklahoma alleges in the complaint that, upon the expiration of the written contract on September 9, 1991, New Age entered into an oral contract with Lenco Kansas whereby Lenco Kansas would manage all sales of New Age's food handling products "as long as William T. Sharp was President of New Age or otherwise involved in the overall management and/or direction of New Age." According to the complaint, New Age breached the contract on January 1, 1998 by severing its relationship with Lenco Kansas while Mr. Sharp remained president of New Age.
After New Age severed its relationship with Lenco Kansas, Mr. Coady moved to Broken Arrow, Oklahoma in March of 1998. Judith Coady joined him in July of 1998. Upon moving to Broken Arrow, Oklahoma, Lenco Kansas entered into a business relationship with Unarco, an manufacturer of shopping cart equipment, that was "very similar for the contract that [Lenco Kansas] had with New Age." In December of 1998, Unarco filed for bankruptcy and Lenco Kansas stopped providing services under its contract with Unarco. Mr. Coady approached several businesses between January of 1999 and April of 1999 in an attempt to find another company that would contract with Lenco Kansas for sales support, but was unable to find an acceptable relationship. In need of money, Mr. Coady began selling real estate as an individual. According to Mr. Coady, income from real estate sales "was ran [sic] through Lenco of Oklahoma." Other than being used as a conduit for Mr. Coady's personal income from real estate sales, Lenco Oklahoma has not conducted business. Mr. Coady moved to Nevada in November of 2000 to take a job with National Cart.
At the hearing, Mr. Coady offered several reasons why he formed Lenco Oklahoma:
Well we had had two years of turmoil. The Kansas corporation had expired. I moved my family from Kansas to Oklahoma. We were doing business in Oklahoma. We intended to continue to do business in Oklahoma. We continued to live in Oklahoma. The C.P.A. that I had used for many years was an employee of New Age. I couldn't use him. I resorted to a public accountant 500 miles away . . . from Tulsa Oklahoma. That was difficult. Legal counsel was difficult. I was in Oklahoma operating as a Kansas corporation. . . . Lenco of Kansas had excessive debts. I had personally guaranteed those debts. We had sold most of the — all of the agricultural interest by then there were very few assets left. I needed to get my arms around the business. It had been like I said two years of turmoil I needed to get everything under one roof and it seemed to me like the logical thing to do.
When asked why Lenco Kansas transferred all of its assets to Lenco Oklahoma, Mr. Coady responded:
Well, like I stated earlier, I needed to get my arms around my business, I needed to get everything under one roof. We had — we had made some drastic changes we had had two years of turmoil. I needed access to Oklahoma counsel and Oklahoma accountants.
When asked why Lenco Oklahoma was formed in December of 1999, the same month that this lawsuit was filed, Mr. Coady said only that "[i]t was just time to get on with things."
When Mr. Coady was asked why he formed Lenco Oklahoma and transferred assets from Lenco Kansas, he struggled with his answers. Mr. Coady seemed irritated that he was being forced to justify his actions and answered in vague generalities. His body language suggested that he was being evasive when answering questions.
During discovery in this case, a page of notes written by Mr. Coady was inadvertently turned over to counsel for New Age. Counsel for New Age argues that the notes show that Lenco Oklahoma was created for the sole purpose of manufacturing diversity jurisdiction. Lenco Oklahoma argues that the notes are protected by the attorney-client privilege and must be returned. New Age responds by arguing that the privilege was waived when the notes were turned over in discovery.
Mr. Coady was asked several questions about the notes at the hearing in order to determine whether privilege had been waived under the five-factor test set out in Zapata v. IBP, Inc., 175 F.R.D. 574, 576-77 (D.Kan. 1997). When Mr. Coady was asked if he remembered writing the notes, he appeared physically uncomfortable and he denied having any memory about the notes. Mr. Coady's claim that he did not remember the notes seemed contrived and he was evasive in answering further questions, often speculating about his notes in the light most favorable to this court finding that diversity jurisdiction was not collusively created.
• Standards
Federal Rule of Civil Procedure 12(h)(3) requires federal courts to dismiss an action "[w]henever it appears by suggestion of the parties or otherwise that the court lacks jurisdiction of the subject matter." Fed.R.Civ.Pro. 12(h)(3). "A court lacking jurisdiction . . . must dismiss the cause at any stage of the proceedings in which it becomes apparent that jurisdiction is lacking." Basso v. Utah Power Light Co., 495 F.2d 906, 909 (10th Cir. 1974). Because the jurisdiction of federal courts is limited, "there is a presumption against our jurisdiction, and the party invoking federal jurisdiction bears the burden of proof." Penteco Corp. v. Union Gas Sys., Inc., 929 F.2d 1519, 1521 (10th Cir. 1991).
Section 1359 of Title 28 provides that a "court shall not have jurisdiction of a civil action in which any party, by assignment or otherwise, has been improperly or collusively made or joined to invoke the jurisdiction of the court." 28 U.S.C. § 1359. The statute "is aimed at preventing parties from manufacturing diversity jurisdiction to inappropriately channel ordinary business litigation into the federal courts." Amoco Rocmount Corp. v. Anschutz Corp., 7 F.3d 909, 916 (10th Cir. 1993). "As with other challenges to jurisdiction, a party charged with creating jurisdiction by collusion bears the burden of demonstrating that jurisdiction is proper." Id.
• Discussion
New Age alleges that Lenco Kansas assigned its cause of action to Lenco Oklahoma for the purpose of creating diversity jurisdiction and in violation of 28 U.S.C. § 1359. Lenco responds by pointing to Black White Taxicab and Transfer Co. v. Brown Yellow Taxicab and Transfer Co., 276 U.S. 518 (1928). Lenco argues that so long as the transfer of a cause of action between corporations is absolute, with the transferor retaining no interest in the subject matter of the claim, the transfer is valid even if made for the purpose of creating federal jurisdiction.
In Black White Taxicab, a Kentucky taxi company entered into a contract with a Kentucky railroad company whereby the taxi company was granted "the exclusive privilege of going upon its trains, into its depot, and on the surrounding premises to solicit transportation of baggage and passengers." Id. at 522. A complaint filed in the Western District of Kentucky by the taxi company alleged that the railroad failed to perform its obligations under the contract. Id. at 523. The taxi company and the railroad, "preferring to have this controversy determined in the courts of the United States, arranged to have the respondent organized in Tennessee to succeed to the business of the Kentucky [taxicab] corporation and to enter into this contract [with the railroad] in order to create diversity of citizenship." Id. at 523-24.
At the time, a corporations citizenship was determined solely by its place of incorporation. Not until 1958, with the enactment of 28 U.S.C. § 1332(c), was a corporation deemed a citizen both of its state of incorporation and its principal place of business.
At the time the lawsuit was filed, section 37 of the Judicial Code required the dismissal of any case where parties have been improperly or collusively made or joined "for the purpose of creating a case cognizable in such court." Id. at 524. The Supreme Court concluded that section 37 was not an obstacle to federal jurisdiction over the case. The court explained that "[t]he motives which induced the creation of respondent to become a successor to its Kentucky grantor and take a transfer of its property have no influence on the validity of the transactions which are the subject of the suit." Id. Because the transfer was "actual, not feigned or merely colorable," the court held that it was valid and did not preclude federal jurisdiction. Id.
The Black White Taxicab decision "has been criticized severely" and "its continued authority has been greatly diminished in recent cases." Wright, Miller Cooper, Federal Practice and Procedure: Jurisdiction § 3638 (3d ed. 1998). Ten years after deciding Black White Taxicab, the Court in Erie R.R. Co. v. Tompkins, 304 U.S. 64 (1938), pointed to Black White Taxicab as an example of the unacceptable forum shopping between state and federal courts that was caused by the decision in Swift v. Tyson, 16 Pet. 1, 18, 10 L.Ed. 865 (1842). The Court overruled Swift v. Tyson. While the Black White Taxicab decision has never been overruled, it "has been `the target of universal condemnation, as the worst example of the abuses of diversity possible under the rule of Swift v. Tyson.'" O'Brein v. Avco Corp., 425 F.2d 1030, 1034 (2d Cir. 1969) (quoting Charles Wright, Federal Courts 86-87 (1963)).
In Greater Development Co. of Connecticut v. Amelung, 471 F.2d 338 (1st Cir. 1973), the plaintiff argued that the First Circuit should follow Black White Taxicab and hold that "where a transfer of a claim or asset is real, and not feigned or colorable, courts will not inquire into the motives and jurisdiction will lie." Amelung, 471 F.2d at 339 (citations omitted). The First Circuit rejected the argument and held:
We do not read Black and White Taxi Cab, which has been roundly criticized, as standing for such a broad proposition. Rather we think that when a corporation conducting an ongoing business transfers all of its assets and its business to another corporation, and the transferor is dissolved, diversity jurisdiction will exist, even though the shareholders of the two corporations are the same, and the purpose of the transfer is to obtain diversity of citizenship. Here admittedly the transfer is real, the transferor has been dissolved and the shareholder is the same. However, the claim which is the basis of this suit was the only asset transferred, and, as far as the record shows, the only asset of the new corporation, which apparently has no payroll and no other activities. To extend an already eroded case like Black and White, to this situation would be to destroy the meaning of this salutary and long-standing statute [ 28 U.S.C. § 1359]."Id. (citations omitted). This court believes that the Tenth Circuit would follow the First Circuit's reasoning in Amelung and decline to extend Black White Taxicab beyond the situation where an ongoing business moves to another state.
The approach taken in the Amelung case seems sounds. . . . To ignore the obvious purpose behind [creating a corporation in another state solely to get diversity], as some language in the Black White Taxicab case could be read as requiring, would be contrary to the objectives of Section 1359 and inconsistent with the principle that federal courts are courts of limited jurisdiction.
Wright, Miller Cooper, Federal Practice and Procedure: Jurisdiction § 3638 (3d ed. 1998).
Following the rationale of Amelung, the Black White decision does not apply to this case. Lenco Kansas was not operating as a business and had forfeited its articles of incorporation when Lenco Oklahoma was formed. Lenco Oklahoma never operated as a business other than being a conduit for the profits from Mr. Coady's real estate sales. The only asset of Lenco Kansas that Mr. Coady identified as being transferred to Lenco Oklahoma is this cause of action. Mr. Coady did not simply move an ongoing business to Oklahoma after he moved to Oklahoma. Mr. Coady continued to operate in Oklahoma as Lenco Kansas. When business with Unarco ceased, Mr. Coady allowed the Lenco Kansas articles of incorporation to expire. Mr. Coady formed Lenco Oklahoma and transferred this cause of action almost one year after Lenco Kansas ceased operating. Lenco Oklahoma is easily distinguished from the taxi company in Black White Taxicab that continued its business as a corporation formed in another state.
Twenty years after the Black White decision, Congress enacted 28 U.S.C. § 1359 as part of the 1948 revision of the Judicial Code. Section 1359 provides:
A district court shall not have jurisdiction of a civil action in which any party, by assignment or otherwise, has been improperly or collusively made or joined to invoke the jurisdiction of such court.
The landmark Supreme Court case interpreting section 1359 is Caribbean Mills, Inc. v. Kramer, 394 U.S. 823 (1969). In Kramer, a Texas lawyer took an assignment of a cause of action held by the Panama and Venezuela Finance Company for consideration of $1. In a separate agreement dated the same day, the lawyer promised to pay back to the company 95% of any recovery on the assigned cause of action. The Court concluded that the assignment was made for the purpose of creating diversity jurisdiction and that, under section 1359, the court lacked jurisdiction. According to the Court, "[i]f federal jurisdiction could be created by assignments of this kind, which are easy to arrange and involve few disadvantages for the assignor, then a vast quantity of ordinary contract and tort litigation could be channeled into the federal courts at the will of one of the parties." Id. at 828-29.
The only Tenth Circuit decision considering whether an assignment violates section 1359 is Westinghouse Credit Corp. v. Shelton, 645 F.2d 869, 871 (10thd Cir. 1981). In Westinghouse, the defendant bought a mobile home from a dealer, making a down payment and signing an installment payment contract with the dealer. The dealer then assigned the contract to Amcourt Systems, Inc. and Amcourt Systems assigned the contract to Westinghouse Credit Corporation. The defendant argued that the assignment was collusively made to establish jurisdiction. The Tenth Circuit rejected the argument, holding that the assignment was a bona fide purchase for value of chattel paper and had a valid commercial purpose. According to the court, the "purpose behind such assignments is to leave the business of financing to the lender and to put the seller in a better working-capital position." Id. at 871. The court concluded that nothing in the record contradicted this valid business purpose, and that, therefore, the assignment was not collusively made in violation of section 1359. Id. In Westinghouse, the assignments were absolute, yet the court considered the motive for the assignments in deciding whether they were made in violation of section 1359. The Westinghouse decision is strong evidence that the Tenth Circuit would follow the First Circuit's reasoning in Amelung and reject Lenco Oklahoma's contention than motive is irrelevant when an assignment is absolute.
In deciding if an assignment, whether complete or partial, violates section 1359, federal courts determine whether the assignment was made for a legitimate business purpose or solely to manufacture diversity jurisdiction. 15 Moore's Federal Practice § 102.12[4][a] (3d ed.); Westinghouse, 645 F.2d at 871 (distinguishing Kramer on the ground that the assignment had a valid business purpose and was not made simply to create diversity jurisdiction). Courts "often determine an improper or collusive assignment from whether or not the parties have shown an independent business justification for assigning the claim to a diverse party." Toste Farm Corp. v. Hadbury, Inc.,70 F.3d 640, 643 (2d Cir. 1995). Factors courts consider in determining whether an assignment is made for a legitimate business reason or simply to create diversity jurisdiction include the adequacy of consideration, the nature of any retained interest by the assignor and whether the assignee is the real party in interest or merely a collecting agent. See Moore's Federal Practice at § 102.12[4][a]. The Second Circuit summarized the factors courts have considered in making this determination:
the assignee's lack of a previous connection with the claim assigned, see Kramer, 394 U.S. at 827, 89 S.Ct. at 1489; the remittance by the assignee to the assignor of any recovery, see id.; whether the assignor actually controls the conduct of the litigation, see Prudential Oil, 546 F.2d at 476; the timing of the assignment, see Drexel Burnham Lambert, 777 F.2d at 881; the lack of any meaningful consideration for the assignment, Dweck, 877 F.2d at 793; and the underlying purpose of the assignment, see O'Brien, 425 F.2d at 1034 (holding section 1359 bars "agreements whose primary aim was to vest the court with jurisdiction it had not formerly enjoyed").Airlines Reporting Corp. v. S and N Travel, Inc., 58 F.3d 857, 863 (2d Cir. 1995).
Lenco Oklahoma bears the burden of demonstrating that jurisdiction is proper. Amoco Rocmount Corp., 7 F.3d 909, 916 (10th Cir. 1993). For this court to find that it has subject matter jurisdiction over this case, Lenco must, at minimum, articulate a legitimate business purpose for the transfer of this cause of action from Lenco Kansas to Lenco Oklahoma. Lenco failed to articulate such a purpose at the hearing.
Mr. Coady asserted that he created Lenco Oklahoma because he had moved to Oklahoma and intended to continue to do business in Oklahoma. Mr. Coady, however, had been doing business in Oklahoma as Lenco Kansas since his move to Oklahoma in March of 1998. Between March of 1998 and December of 1998, Lenco Kansas successfully operated under a contract with Unarco. Mr. Coady did not identify any problems in conducting business with Unarco as Lenco Kansas. After Unarco filed bankruptcy and Lenco Kansas ceased providing sales support for Unarco, Mr. Coady sought out new business opportunities in Oklahoma for Lenco Kansas. Mr. Coady did not create Lenco Oklahoma during this period nor did he offer any reason that his pursuit of business during this period was hampered by Lenco Kansas being a Kansas corporation. Mr. Coady testified that, in early 1999, he was running out of money and began to sell real estate. It was not until December of 1999 that Mr. Coady formed Lenco Oklahoma. Mr. Coady testified that he used Lenco Oklahoma as a conduit for his profits from selling real estate. Because Mr. Coady had been selling real estate for almost one year prior to forming Lenco Oklahoma, his sale of real estate was not a reason for Mr. Coady to form Lenco Oklahoma. Indeed, Mr. Coady did not suggest that it was.
Mr. Coady pointed to the forfeiture of the articles of incorporation of Lenco Kansas as a reason to form Lenco Oklahoma. Mr. Coady, however, did not offer a valid business reason for needing another corporation. Mr. Coady merely said that he "needed to get [his] arms around the business" and to "get everything under one roof." Mr. Coady did not explain how forming Lenco Oklahoma helped him achieve these vague goals, why the goals could not be accomplished through Lenco Kansas, or what business advantage would come from achieving these goals. When asked why he transferred this cause of action to Lenco Oklahoma, Mr. Coady offered the same vague generalities. Other than using Lenco Oklahoma as a conduit for profits from real estate sales, Lenco Oklahoma never operated as a business. The fact that Lenco Oklahoma never operated as a business is fairly strong evidence that Mr. Coady did not have a purpose for forming Lenco Oklahoma other than to achieve diversity jurisdiction.
Mr. Coady testified that he was operating as Lenco Kansas through April of 1999 and that the contract with Unarco had been with Lenco Kansas. When Lenco Kansas actually forfeited its articles of incorporation is not helpful in determining Mr. Coady's purpose for forming Lenco Oklahoma.
Mr. Coady pointed out that the accountant and attorney that he used when operating as Lenco Kansas were "500 miles away." Mr. Coady did not, however, offer a legitimate business reason for why he could not use an Oklahoma-based accountant and lawyer to revive Lenco Kansas or why the distance to a Kansas attorney and accountant was problematic in today's age of high speed and relatively inexpensive communication. Mr. Coady also suggested that the "excessive debts" of Lenco Kansas was a reason for him to form Lenco Oklahoma. The fact that Lenco Oklahoma voluntarily assumed these debts defeats this argument. Furthermore, Mr. Coady did not indicate that debt interfered with the operation of Lenco Kansas or prohibited Lenco Kansas from obtaining new business opportunities.
In December of 1999, Lenco Oklahoma was formed, this cause of action was assigned to Lenco Oklahoma and this lawsuit was filed in federal court. The only asset of Lenco Kansas that Mr. Coady identified as being transferred to Lenco Oklahoma was this cause of action. Mr. Coady did not offer a valid business reason for creating Lenco Oklahoma, why the corporation was created in December of 1999, or why this cause of action was assigned to Lenco Oklahoma. Mr. Coady merely explained that he wanted to "get his arms around the business" and "get everything under one roof." Mr. Coady's explanation is circular; it amounts to answering the question of why assets of two corporations were consolidated with the response "in order to consolidate the assets of the two corporations." The response does not point to any business advantage from consolidating the assets "under one roof." Mr. Coady's body language when testifying and his evasive answers suggested that the reason that Mr Coady formed Lenco Oklahoma in December 1999 was to create diversity jurisdiction but that he had no intention of admitting this to the court.
It is unnecessary for the court to determine whether attorney client privilege applies to the notes inadvertently disclosed during discovery or whether the privilege was waived. The court has not considered the contents of the notes in finding that diversity jurisdiction does not exist. Instead, the court holds that Lenco Oklahoma has not meet its burden of demonstrating that jurisdiction is proper. Mr. Coady did not offer a valid business reason for forming Lenco Oklahoma and transferring this cause of action from Lenco Kansas. This alone is a sufficient reason for the court to dismiss this cause of action. The suspicious timing of the assignment and the filing of this lawsuit, the absence of any assets of Lenco Kansas other than this cause of action and Mr. Coady's questionable testimony bolster the court's conclusion that this cause of action was assigned to Lenco Oklahoma for the sole purpose of creating diversity jurisdiction in violation of section 1359.
IT IS THEREFORE ORDERED that this cause of action is dismissed without prejudice pursuant to Federal Rule of Civil Procedure 12(h)(3).