Opinion
01-CV-0201E(F)
August 23, 2001
Rober J. Lane, Jr., Esq. and Jeffery C. Stavino, Esq., Hodgson Russ, Buffalo, NY, Leslie W. Jacobs, Esq. and Luke L. Dauchot, Esq. and Kenneth G. Cole, Esq., Thompson Hine, Cleveland OH, for plaintiff.
Edward S. Bloomberg, Esq. and Craig A. Leslie, Esq, Phillips, Lytle, Hitchcock, Blaine Huber, Buffalo NY, Dennis R. LaFiura, Esq. and David S. Sager, Esq. and Rhonda L. Rivera, Esq., Pitney, Hardin, Kipp Szuch. Morristown, NJ, for defendant.
MEMORANDUM and ORDER
Plaintiff Robbins Myers, Inc. ("RM") commenced this action March 22, 2001 raising four causes of action against defendants J.M. Huber Corporation ("Huber") and M. Milton Hoff ("Hoff") — viz., (1) fraudulent inducement, (2) violation of Texas securities laws, (3) Texas statutory fraud, and (4) for a declaratory judgment, all predicated upon misrepresentations and omissions alleged to have occurred prior to and in conjunction with a Stock Purchase Agreement ("the Agreement") entered into between plaintiff and Huber November 20, 1997. Plaintiff is a an Ohio corporation with its principal place of business therein, Huber is a New Jersey corporation with its principal place of business therein, Hoff is a citizen of Texas and the amount in controversy exceeds $75,000; accordingly this court has subject matter jurisdiction over this case pursuant to 28 U.S.C. § 1332 (a)(1). Defendants filed a motion to dismiss pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure ("FRCvP") May 18, 2001 seeking to dismiss plaintiff's second and third causes of action on the basis that Texas law is inapplicable due to a New Jersey choice-of-law provision in the Agreement, and its fourth cause of action on the basis that there is no actual controversy. Oral argument was had on defendants' motion June 29, 2001 and such is currently before this Court for disposition.
Texas Civ. St. Art. 581-33(A)(2).
Texas Bus. C. Code § 27.01.
When ruling on a FRCvP 12(b)(6) motion to dismiss for failure to state a claim, the court must "accept the material facts alleged in the complaint as true and construe all reasonable inferences in the plaintiffs's favor" — Hernandez v. Coughlin, 18 F.3d 133, 136 (2d Cir.), cert. denied, 513 U.S. 836 (1994) — and cannot grant the motion unless "it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Conley v. Gibson, 355 U.S. 41, 45-46 (1957). With the above standards in mind, the following facts have been taken from the complaint and all reasonable inferences therefrom are drawn in plaintiff's favor.
Prior to August 1996, Huber, inter alia, manufactured petroleum pipeline closure devices ("closures") from steel forgings purchased from third-party suppliers. The steel forgings were required to meet certain specifications depending on the particular closure to be made. Huber would certify to its customers that the closures it sold were made from a specified steel by advertising the closures as meeting certain specifications, by stamping such specifications on the respective closures and, in some instances, sending the customer formal written certification of the specifications. Compl. ¶ 6. Having conducted an extensive review, Huber was aware that it had sold over 5,000 closures that did not meet the advertised and stamped specifications and more than 194 closures which did not meet the specifications contained in the formal written certifications included with them — and was aware that these off-specification closures were likely to fail when subjected to stress. Id. ¶¶ 10, 16(a)-(c). Around August 1, 1996 Huber formed Flow Control Equipment, Inc., a Delaware corporation, as a wholly-owned subsidiary which in turn owned all of the stock of FCE Flow Control Equipment, Ltd., a Canadian corporation (collectively, "FCE"). Hoff was the president of FCE. Huber then entered into an acquisition agreement with FCE whereby Huber transferred the assets and liabilities from its closure business to FCE. Prior to transferring its closure business to FCE, Huber had operated it from offices located in Texas and, thereafter, FCE's principal office and a substantial part of its business were located in Texas. Compl. ¶ 7.
In 1997 plaintiff and Huber entered into discussions regarding the possibility of plaintiff purchasing the stock of FCE from Huber, as part of which plaintiff conducted due diligence inquiry or investigation in Texas where it was informed by Huber and Hoff that FCE had sold 194 closures made from off-specification steel, but that such was a "mere minor technicality" because the steel was "equivalent in quality and material properties" to the specification steel and, because the off-specification closures could be replaced at a cost of $300 each, such was not a financially or commercially material issue. Plaintiff states that based upon these representations it then engaged in formal negotiations in Texas which ultimately led to its signing, in Texas on December 20, 1997, of the Agreement to purchase the FCE stock from Huber. Compl. ¶¶ 9-10, 13-14.
Such is memorialized in Schedule 3.8(3) of the Agreement, later entered into between the parties, which states that "FCE received shipments of six inch closure cap forgings purchased from Berkley Forge in Oakland California ("Berkley"). These shipments were accompanied by material tests reports ("MTR") indicating the forgings were made from SA350LF2 steel. FCE subsequently discovered that the impact strength of the SA350LF2 steel at -50°F was below specification. Prior to discovering this information, FCE, in connection with the sale of 194 of these 6" closures certified that the material was SA350LF2 steel based on the MTR provided by Berkley. FCE is now in the process of identifying the purchasers of the 194 certified closures and intends to contact them to resolve the certification issue."
Thereafter, plaintiff learned that the off-specification closures had been sold by Huber, not by FCE, that in excess of 5,000 off-specification closures had actually been sold by Huber, that the off-specification closures were not functionally equivalent but were more likely to fail when subjected to stress and that it would cost substantially more than $300 to replace each closure. Huber had ordered its officers and representatives not to disclose the true nature of the off-specification closures and had omitted such from FCE's financial statements and related documents. Huber and Hoff then intentionally misrepresented the off-specification closures as a minor problem which could be easily and inexpensively resolved in order to induce plaintiff into purchasing FCE's stock. Compl. ¶¶ 10-12, 15-16. Plaintiff states that, as a proximate result of defendants' misrepresentations and omissions, it has suffered damages of $350,000 to date for a limited recall of the off-specification closures, damage to its reputation occasioned by such recall, loss of staff time and expenses incurred in diagnosing and addressing the undisclosed off-specification closures and contingent liability relating to the off-specification closures. Compl. ¶ 22.
Defendants seek to dismiss plaintiff's second and third causes of action — for violation of the securities laws and the statutory fraud laws, respectively, of Texas — on the basis that Texas's statutory law is inapplicable because the parties have consented to the application of New Jersey law to any disputes that should arise between or among them — including the present one — pursuant to two provisions in the Agreement relating to choice of law, and choice of venue, respectively. Plaintiff opposes this motion on the basis that it only agreed to the application of New Jersey law for the construction and governance of the Agreement itself and that its causes of action are not predicated upon such.
" Governing Law. This Agreement shall be construed in accordance with and governed by the substantive law of the State of New Jersey regardless of the laws that might otherwise govern under principles of conflict of law applicable thereto." Agreement ¶ 11.7.
" Consent to Jurisdiction. Any suit, action or proceeding seeking to enforce any provision of, or based on any matter arising out of or in connection with, this Agreement or the transactions contemplated hereby shall be brought in the State and Federal Courts in the State of New York. The parties hereto consent to the exclusive jurisdiction of such court [sic] (and of the appropriate appellate courts therefrom) in any such suit, action or proceeding and irrevocably waives [sic], to the fullest extent permitted by Law, any objection which it [sic] may now or hereafter have to the laying of venue of any such suit, action or proceeding in any such court [sic] or that any such suit, action or proceeding which is brought in any such court [sic] has been brought in an inconvenient forum. * * * " Agreement ¶ 11.10.
A federal court acting under diversity jurisdiction applies the conflict of laws rules of the forum state. Klaxon Co. v. Stentor Elec. Mfg. Co., 313 U.S. 487, 496-497 (1941). "In the absence of a violation of a fundamental state policy, New York courts generally defer to the choice of law made by the parties to a contract." Cargill, Inc. v. Charles Kowsky Resources, Inc., 949 F.2d 51, 55 (2d Cir. 1991). "Under New York law, a choice-of-law provision indicating that the contract will be governed by a certain body of law does not dispositively determine that law which will govern a claim of fraud arising incident to the contract." Krock v. Lipsay, 97 F.3d 640, 645 (2d Cir. 1996). Ordinarily, "a contractual choice of law provision governs only a cause of action sounding in contract, not one sounding in tort." Lazard Freres Co. v. Protective Life Insurance Company, 108 F.3d 1531, 1540 (2d Cir.), cert. denied, 522 U.S. 864 (1997); see also BBS Norwalk One, Inc. v. Raccolta, Inc., 60 F. Supp.2d 123, 129 (S.D.N Y 1999), aff'd 205 F.3d 1321 (2d Cir. 2000) ("a contractual choice-of-law provision does not ordinarily bind the parties as to tort claims"). "[F]or a choice-of-law provision to apply to claims for tort arising incident to the contract, the express language of the contract must be sufficiently broad as to encompass the entire relationship between the contracting parties." Krock, at 645 (holding that a choice-of-law provision stating that the contract "shall be governed by and construed in accordance with the laws of the Commonwealth of Massachusetts" was not broad enough to encompass a claim for fraudulent misrepresentation).
Defendants rely on the case of Turtur v. Rothschild Registry Intern., Inc. wherein the Second Circuit Court of Appeals held that a combined contractual choice of law and venue provision stating that
"`[t]his note shall be governed by, and interpreted under, the laws of the State of New York applicable to contracts made and to be performed therein without giving effect to the principles of conflict of laws. The parties hereto consent to the exclusive jurisdiction of the courts of the State of New York to resolve any controversy or claim arising out of or relating to this contract or breach thereof.' (Emphasis added)."
was "sufficiently broad to cover tort claims as well as contract claims `arising out of or relating to'" the contract at issue. 26 F.3d 304, 310 (2d Cir. 1994).
What defendant assumes from its reading of Turtur is that choice of law and choice of venue provisions must be read together to determine if a tort claim is covered under a contractual choice of law provision. This same issue — i.e., whether the court should "consider language in a forum selection clause to add to, and/or modify, the terms of the choice-of-law clause" — was recently addressed and answered in the negative in the case of In re Lois/USA, Inc., 264 B.R. 69, 101 (Bankr. S.D.N.Y. 2001). Therein it was noted that a "review of Turtur does not suggest that the parties in Turtur briefed or argued whether language in a forum selection clause properly should be deemed to modify the choice of law clause, or that the Turtur court ruled on that issue or focused on it." Lois, at 103.
"The Governing Law provision, particularly when read in conjunction with the Consent to Jurisdiction provision, reflects the parties' clear intention to litigate all disputes relating to the Stock Purchase Agreement in New York and under New Jersey law." Mem. in Supp. of Defs. Mot. to Dismiss at 9.
"The choice-of-law clause does not address the court or courts in which the law is to be applied, and the forum selection clause does not address the law the chosen forum is to apply when the chosen forum * * * hears the case. Among many other things, the former goes much more to the parties' substantive rights, and the latter goes much more to the parties' litigation needs, and in particular, the place where, and procedures under which, their substantive rights are determined. A choice-of-law clause and a forum selection clause are not the same, and address different needs and concerns." Lois, at 101.
As in Lois, the choice of law and choice of venue provisions in the present case "are not only distinct; they are in separate sections of the Agreement." Id. at 103. This Court agrees with the holding of Lois that it must follow the clear legal directive of Krock rather than an implication flowing from a factual determination in Turtur. Lois, at 103. Accordingly, the language in the choice of venue provision is inapplicable and defendants' motion to dismiss will be determined in accordance with the language of the choice of law provision.
It is clear that the choice of law provision in the present case is not "sufficiently broad as to encompass the entire relationship between the contracting parties." Krock, at 645. The instant choice of law provision, which simply states that the Agreement "shall be construed in accordance with and governed by the substantive law of the State of New Jersey" — Agreement ¶ 11.7 —, is almost identical to the choice of law provision the Second Circuit Court of Appeals found insufficient to encompass a tort claim in Krock. Accordingly, defendants' motion to dismiss plaintiff's second and third causes of action for violations of Texas statutory law, on the basis that New Jersey law applies due to the choice of law provision in the Agreement will be denied.
Other than holding the contractual New Jersey choice of law provision to be inapplicable to plaintiff's second and third causes of action, this Court makes no determination as to the law to be applied to plaintiff's claims.
As its fourth cause of action, plaintiff seeks a declaratory judgment that "Huber must indemnify, defend and hold harmless RM from any and all claims, demands, causes of action, losses, liabilities, awards, judgments and costs and expenses (including attorneys' fees) of any nature arising from or related to, in whole or in part, the Off-Specification Closures and Off-Specification Forgings." Compl. ¶ 32. Defendants seek to dismiss plaintiff's fourth cause of action on the basis that there is no actual controversy.
Defendants also argue that the Agreement bars plaintiff's declaratory judgment claim; however such is not a valid basis to dismiss this claim because, as part of its Complaint, plaintiff is seeking recission of the Agreement on the basis that it was fraudulently induced to enter into it. Compl. at 10.
The Declaratory Judgment Act states that in a
"case of actual controversy within its jurisdiction * * * any court of the United States, upon the filing of an appropriate pleading, may declare the rights and other legal relations of any interested party seeking such declaration, whether or not further relief is or could be sought. Any such judgment shall have the force and effect of a final judgment or decree and shall be reviewable as such." 28 U.S.C. § 2201.
When a declaratory judgment is sought, the court must determine "whether the facts alleged, under all the circumstances, show that there is a substantial controversy, between the parties having adverse legal interests, or sufficient immediacy and reality to warrant the issuance of a declaratory judgment." Kidder, Peabody Company Incorporated v. Maxus Energy Corporation, 925 F.2d 556, 562 (2d Cir.), cert. denied, 501 U.S. 1218 (1991)
"A `controversy' in this sense must be one that is appropriate for judicial determination. A justiciable controversy is thus distinguished from a difference or dispute of a hypothetical or abstract character; from one that is academic or moot. The controversy must be definite and concrete, touching the legal relations of the parties having adverse legal interests. It must be a real and substantial controversy admitting of specific relief of a conclusive character, as distinguished from an opinion advising what the law would be upon a hypothetical state of facts." Aetna Life Ins. Co. of Hartford, Conn. v. Haworth, 300 U.S. 227, 240-241 (1937).
Citation omitted.
Internal citations omitted.
"Whether a real and immediate controversy exists in a particular case is a matter of degree and must be determined on a case-by-case basis." Kidder, at 562. When a declaratory judgment will "serve a useful purpose in clarifying and settling the legal relations in issue" or "terminate and afford relief from the uncertainty, insecurity, and controversy giving rise to the proceeding," the court should entertain jurisdiction. Broadview Chemical Corporation v. Loctite Corporation, 417 F.2d 998, 1001 (2d Cir. 1969), cert. denied, 397 U.S. 1064 (1970). "That the liability may be contingent does not necessarily defeat jurisdiction of a declaratory judgment action. Rather, courts should focus on the practical likelihood that the contingencies will occur. Indeed, litigation over insurance coverage has become the paradigm for asserting jurisdiction despite future contingencies that will determine whether a controversy ever becomes real." Associated Indemnity Corporation v. Fairchild Industries, Inc., 961 F.2d 32, (2d Cir. 1992).
Citation omitted.
Internal citations and punctuation omitted.
Defendants argue that plaintiff's fourth cause of action seeking a declaratory judgment should be dismissed because there is no actual controversy inasmuch as plaintiff has not yet been sued due to the failure of an off-specification closure device — or even alleged that such a closure has already failed. Defendants rely extensively on a case from the Third Circuit Court of Appeals, Step-Saver Data Systems, Inc. v. Wyse Technology, Inc., 912 F.2d 643 (3d Cir. 1990). In Step-Saver, the plaintiff was a corporation which built and sold computers from subcomponents purchased from third party suppliers. Several of the computers it had sold malfunctioned as a result of which it was sued by twelve of its customers in various courts. Id. at 645-646. Plaintiff thereafter filed a declaratory judgment action against the companies from which it had purchased the subcomponents, requesting the court to declare that, "[i]f [the customer suits] can establish defects as alleged by [Step-Saver's] customers, then Defendant's conduct constituted intentional misrepresentation as to the nature and capacity of their programs and equipment." Id. at 647. The court noted that the
Defendants also cite Olin Corporation v. Consolidated Aluminum Corporation, 5 F.3d 10 (2d Cir. 1993). Such case is however inapposite because it involved an appeal from the granting of plaintiff's declaratory judgment claim in response to its summary judgment motion, as opposed to a motion to dismiss by the defendant. The court held that, based on the pleadings and the record, there was no actual controversy and the declaratory judgment claim should have been dismissed. However, in the present case — which involves a motion to dismiss on the pleadings —, no factual record has been developed to allow this Court to make such determination.
"requested declaration would render defendants liable on the basis of judgments in the customer suits. The problem with this result is that the customer suits may establish a defect for which the defendants are not liable. If the malfunctioning of the machines resulted from [plaintiff's] errors in putting the packages together, then [plaintiff] must bear the entire liability." Id. at 648.
Not only is the decision in Step-Saver not binding on this Court, it is factually distinguishable from the present case. In Step-Saver, it was held that the interests of the parties were not sufficiently adverse to constitute an actual controversy because plaintiff had not stated what was alleged to be defective about the subcomponents it had purchased from defendants, defendants had not denied liability for damages for breach but had assured plaintiff that it would correct any problems in their products and plaintiff had not even requested that the court decide the factual issue regarding whether defendants' products were defective and the cause of the malfunctions, but instead wanted to rely on the determinations of such issue by the courts in which its customers were suing it. Id. at 645-649. The factors on which the court in Step-Saver relied are not present in the present case.
In any event, under the law of the Second Circuit, when "there is an actual controversy over contingent rights, a declaratory judgment may nonetheless be granted." American Machine Metals, Inc. v. De Bothezat Impeller Co., 166 F.2d 535, 536 (2d Cir. 1948). After the contingency — an undisclosed off-specification closure failing and plaintiff being sued for such — comes to pass, it will be too late for plaintiff to avoid an action for damages and the "very purpose of the declaratory judgment procedure is to prevent the accrual of such avoidable damages." Id.. at 537. A plaintiff seeking a declaratory judgment is not required to `act on his own view of his rights and risk an otherwise' profitable business in order to present a justiciable controversy. The Declaratory Judgments Act was designed to obviate just this sourt [ sic] of peril * * *." Ibid.
According to the allegations in the complaint, there are thousands of undisclosed off-specification closures in use, such closure devices are more likely to fail than closures meeting specifications, plaintiff has already incurred significant expenses in replacing them and may be liable for damages caused from their failure. While defendants point out that the Complaint does not allege that any of the off-specification closures has failed, a reasonable inference to be drawn in plaintiff's favor for purposes of deciding a motion to dismiss — based upon the numerosity of the off-specification closures, which are more likely to fail than specification closures — is that one or more of such will fail, upon which happening plaintiff will be sued for the resulting damages. Plaintiff states that it has already begun attempting to identify the undisclosed off-specification closures as part of its limited recall and that it has incurred over $350,000 in expenses to date in doing so. Compl. ¶ 22. Plaintiff is not required to decide whether to continue to incur the expense of identifying and replacing all of the undisclosed off-specification closures or bear the risk of liability should one fail, when based on the facts alleged in its Complaint, the responsibility/liability therefor may properly lie with Huber. See Gilbert, Segall and Young v. Bank of Montreal, 785 F. Supp. 453, 458-462 (S.D.N.Y. 1992) ( citing American Machine, supra). In the present case, plaintiff's decision whether to continue its efforts to recall the undisclosed off-specification closures may very well depend on whether it or Huber is liable for damages should one or more of them fail. A declaratory judgment can resolve this issue. While the wording of the declaratory judgment sought by plaintiff may be overbroad, should plaintiff be able to prove all of its allegations after it obtains the requisite discovery, a declaratory judgment placing the responsibility for identifying the off-specification closures sold by Huber/FCE and recalling and replacing them and/or placing the onus of liability should one of them fail on Huber may be appropriate. Accordingly, this Court concludes — based on the allegations in the Complaint which must be taken as true for present purposes — that there is an actual controversy sufficient to sustain plaintiff's claim for a declaratory judgment and therefore defendants' motion to dismiss this cause of action on such basis will be denied.
If plaintiff successfully proves all of its allegations, it may be appropriate to shift to Huber the burden of establishing that an off-specification closure was not among the 194 it disclosed and for which plaintiff assumed liability in the Agreement rather than requiring plaintiff to prove that the off-specification closure at issue was not among those disclosed; however this Court expresses no opinion on such issue at this time.
Accordingly, it is hereby ORDERED that defendants' motion to dismiss is denied.