Miller v. Up In Smoke, Inc., Cause No.: 1:09-CV-242

738 F.Supp.2d 878

John F. MILLER III, et al., Plaintiffs,

v.UP IN SMOKE, INC., et al., Defendants.

Cause No.: 1:09-CV-242.

United States District Court,

N.D. Indiana,

Fort Wayne Division.

Sept. 8, 2010.

Erik G. Chappell, Julie A. Douglas, Lyden Liebenthal & Chappell Ltd., Sylvania, OH, Jason M. Kuchmay, Federoff Law Firm LLP, Fort Wayne, IN, for Plaintiffs.

John W. Porter, John C. Theisen, Theisen Bowers & Associates LLC, Fort Wayne, IN, Jonathan O. Cress, Simmons-Brown & Cress PC, Linda M. Wagoner, Wagoner & Walz, Angola, IN, for Defendants.

OPINION AND ORDER

ROGER B. COSBEY, United States Magistrate Judge.

I. INTRODUCTION

The Plaintiff, John Miller, is a shareholder of Defendants Up In Smoke, Inc. ("Up In Smoke"), and CR Smoke, Inc. ("CR Smoke"). On August 25, 2009, Miller brought suit based on diversity jurisdiction and in his own name against Up In Smoke, CR Smoke, Fats Enterprises, LLC, Charlotte Rodriguez ("C. Rodriguez"), Rudy Rodriguez ("R. Rodriguez"), and Estep Accounting Service, Inc, alleging, among other claims, that they misappropriated assets and diverted business opportunities from Up In Smoke and CR Smoke. (Compl. ¶¶ 75-129.) Miller Fireworks, a company owned by Miller, also alleges that the Rodriguez's have failed to pay for a shipment of fireworks.

The issue now before the Court is whether all of Miller's claims have been properly brought in his own name as a direct action, or if some claims must be brought as a shareholder derivative action on behalf of Up In Smoke and CR Smoke. If this lawsuit must be partly recast as a derivative action, the Court must also consider whether diversity jurisdiction is destroyed—and the case subject to dismissal—as Up In Smoke, CR Smoke, Fats Enterprises, LLC, Charlotte Rodriguez, and Rudy Rodriguez are all Indiana citizens. Finally, the Court must decide whether to exercise supplemental jurisdiction over the remaining claims and the claim by Miller Fireworks. As will be discussed, Counts I through VI must be recast as a derivative action, but Up In Smoke and CR Smoke do not need to be re-aligned as plaintiffs and diversity jurisdiction is preserved. Furthermore, the Court will exercise supplemental jurisdiction over Miller's direct claims and the claim of Miller Fireworks.

II. FACTUAL AND PROCEDURAL HISTORY

Miller and C. Rodriguez formed Up In Smoke, Inc., in 1997 for the purpose of operating a retail tobacco, alcohol, and fireworks outlet in Fremont, Indiana. (Am. Compl. ¶ 13.) Miller and C. Rodriguez each have a fifty-percent interest in Up In Smoke. (Am. Compl. ¶¶ 14-15.) Miller was initially the president of Up in Smoke, but resigned in 2008. (Am. Compl. ¶ 14.) C. Rodriguez is the Secretary and Treasurer of Up In Smoke and, along with R. Rodriguez, is responsible for the day-to-day operation of the business. (Am. Compl. ¶ 21.) Miller was provided with a yearly salary and financial reports for Up In Smoke.

Miller and R. Rodriguez formed CR Smoke, Inc., in 1998 for the similar purpose of operating a retail tobacco, alcohol, and fireworks outlet in Howe, Indiana. (Am. Compl. ¶¶ 44-46.) As with Up In Smoke, R. Rodriguez was to provide Miller with the business's financial reports. R. Rodriguez was only to receive a salary from CR Smoke if he actively managed the operation of the retail store. (Am. Compl. ¶ 47.)

Over the next decade, Miller's relationship with the Rodriguez's gradually deteriorated. Miller claims that he was frozen out of Up In Smoke and CR Smoke in 2005, when the Rodriguez's allegedlystopped sending him his salary and financial reports and began diverting corporate assets to their own benefit. (Am. Compl. ¶¶ 29-31, 48-52.) The falling-out ultimately culminated with Miller filing suit in his own name against Up In Smoke, CR Smoke, Fat Enterprises, LLC, R. Rodriguez, C. Rodriguez, and Estep Accounting (Up In Smoke and CR Smoke's accounting firm) on August 25, 2009. (Docket # 1). Miller Fireworks—a corporation controlled by Miller that also sells fireworks—has also brought one claim against R. Rodriguez and C. Rodriguez.¹

Count I alleges that R. Rodriguez and C. Rodriguez misappropriated the corporate opportunities of Up In Smoke and CR Smoke; Count II alleges that R. Rodriguez and C. Rodriguez violated their fiduciary obligations to Up In Smoke, CR Smoke, and Miller, individually; and Count III alleges that R. Rodriguez and C. Rodriguez converted assets belonging to Up In Smoke and CR Smoke. (Am. Compl. ¶¶ 75-91.) Furthermore, Count IV seeks to compel an equitable accounting and a constructive trust over the assets of Up In Smoke and CR Smoke; Count V alleges a breach of fiduciary duty against Estep Accounting; and Count VI alleges that the Defendants (presumably all of them) conspired to misappropriate the assets of Up In Smoke and CR Smoke. In Count VII, Miller claims that he is entitled to inspect Up In Smoke and CR Smoke's corporate records pursuant to Indiana Code § 23-1-52-2; in Count VIII, Miller asks the Court to appoint a Receiver over the defendant corporations; in Count IX, Miller asks that, in the alternative, Up In Smoke and CR Smoke be judicially dissolved; and Count X seeks an award of punitive damages and attorney fees. Finally, in Count XI, Miller Fireworks claims that R. Rodriguez and C. Rodriguez have breached a firework sales agreement and failed to pay it $29,933.99.

During the July 27, 2010, evidentiary hearing on the appointment of the Receiver (Docket # 90), the Court raised the question of whether some of Miller's claims must be brought as a shareholder action in the name of Up In Smoke and CR Smoke. Accordingly, pursuant to Federal Rule of Civil Procedure 12(h)(3), the parties were instructed to each file an opening brief and a response brief to address the Court's concerns about whether the action must be re-cast, at least in part, as a shareholder derivative action. ( See Docket 98-101.) Following that round of briefing, the parties were then ordered to file supplemental briefs to address whether Miller's possible direct claims exceeded $75,000 in controversy. ( See Docket # 106, 107.) On August 25, 2010, the Court heard oral argument on whether to recast Miller's claims as a shareholder derivative action.

III. STANDARD OF REVIEW

It is a "well-established general rule that shareholders of a corporation may not maintain actions at law in their own names to redress an injury to the corporation, even if the injury has the effect of impairing the value of their stock." Barth v. Barth, 659 N.E.2d 559, 560 (Ind.1995) ( Barth II ). See also Knauf Fiber Glass, GMBh v. Stein, 622 N.E.2d 163, 165 (Ind.Ct.App.1993); Moll v. S. Cent. Solar Systems, Inc., 419 N.E.2d 154, 161 (Ind.Ct.App.1981). Rather, a shareholder must bring a derivative action in the name of the corporation. Barth II, 659 N.E.2d at 560. "[D]erivative actions are those that are asserted by a shareholder on the corporation's behalf against a third party because of the corporation's failure to take some action against a thirdparty." Id. Derivative actions serve the important policy concerns of preserving the corporate form, avoiding multiple shareholder lawsuits, and protecting corporate creditors by keeping the proceeds of any recovery within the corporation. Id. at 561; W & W Equip. Co. v. Mink, 568 N.E.2d 564, 570 (Ind.Ct.App.1991).

In a shareholder derivative lawsuit, the corporation is initially named as a defendant because it is an indispensable party to the litigation. See Bagdon v. Bridgestone/Firestone, Inc., 916 F.2d 379, 382 (7th Cir.1990); Nejmanowski v. Nejmanowski, 841 F.Supp. 864, 865-66 (C.D.Ill.1994). The named individual plaintiff in a shareholder derivative lawsuit is only the nominal plaintiff—the real party in interest is the corporation. Ross v. Bernhard, 396 U.S. 531, 538, 90 S.Ct. 733, 24 L.Ed.2d 729 (1970). Once joined to the lawsuit, however, the corporation is ordinarily realigned from defendant to plaintiff. Johnson v. Masselli, No. 2:07-cv-214, 2007 WL 2743493, at *1 (N.D.Ind. Sept. 17, 2007) (citing Nejmanowski, 841 F.Supp. at 865-66). An exception to realignment exists if "corporate management" is antagonistic to the original shareholder plaintiff. Smith v. Sperling, 354 U.S. 91, 96, 77 S.Ct. 1112, 1 L.Ed.2d 1205 (1957). See also Swanson v. Traer, 354 U.S. 114, 116, 77 S.Ct. 1116, 1 L.Ed.2d 1221 (1957); Van Gelder v. Taylor, 621 F.Supp. 613, 620 (N.D.Ill.1985). In such an instance, the corporation remains as a defendant. Smith, 354 U.S. at 96, 77 S.Ct. 1112.

Antagonism may be drawn from allegations of fraud, breach of trust, or illegality. Id. It may also be present whenever the management of the corporation refuses to take action or if "the management is aligned against the stockholder and defends a course of conduct which he attacks." Id. The existence of antagonism should be judged on the face of the pleadings and by the nature of the controversy, not by considering the merits of the allegations. Id.

Indiana recognizes an exception to the general rule requiring derivative actions that permits the court, in its discretion, to allow shareholders of a closely-held corporation to bring a direct action in their own names, instead of a derivative action. Barth II, 659 N.E.2d at 560-62. A closely-held corporation is one which has relatively few shares that are generally not traded in the securities market. Id. at 562 n. 5 (citations omitted). This exception recognizes the fact that "shareholders of closely-held corporations have very direct obligations to one another and ... shareholder litigation in the closely-held corporation context will often not implicate the principles which gave rise to the rule requiring derivative litigation...." Id. at 562.

When deciding whether to exercise its discretion and treat an action raising derivative claims as a direct action, the trial court must consider whether doing so will "(i) unfairly expose the corporation or the defendants to a multiplicity of actions, (ii) materially prejudice the interests of...