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LANDERS, FRARY & CLARK v. VISCHER PRODUCTS CO.

May 1, 1952

LANDERS, FRARY & CLARK
v.
VISCHER PRODUCTS CO. ET AL.



The opinion of the court was delivered by: Perry, District Judge.

Plaintiff filed this suit for declaratory judgment pursuant to 28 U.S.C.A. § 2201. Plaintiff is a Connecticut corporation. Defendant, Vischer Products Company, is a Delaware corporation. Defendants, Flex-Seal Corporation, and the Northern Trust Company, are Illinois corporations. All individual defendants are Illinois residents and citizens, with the exception of Gertrude V. Bouton, who is a resident and citizen of the State of New Jersey. All defendants entered their appearance and filed answers. The amount in controversy, exclusive of interest and costs, exceeds the sum of $3,000. Federal jurisdiction is founded upon diversity of citizenship, 28 U.S.C.A. § 1332.

On July 16, 1943, the plaintiff and the Vischer Products Company, a former Illinois corporation, completed a commercial transaction, which was evidenced by three written instruments; a loan agreement, a license agreement, and a promissory note. The instruments were executed simultaneously, and can be considered parts of one transaction.

By the terms of the loan agreement, the plaintiff, in consideration of the execution of a license agreement by the Vischer Products Company, agreed to lend the latter company the sum of $100,000. This agreement provided that the loan would be without interest, that it would be repaid by the Vischer Products Company on or before July 16, 1953, and that any royalty payments which might become due to the Vischer corporation under the license agreement, could be retained by the plaintiff to apply on the loan.

The license agreement recited the sole ownership by the Vischer Products Company of three patents, one design and three patent applications, all covering pressure cooker devices. By the terms of this agreement, the Vischer Company granted to the plaintiff "the exclusive right and license to make and use the licensed products and to sell such licensed products throughout the United States, its territories and possessions," subject to certain conditions which have no bearing upon the present controversy. Article 4 embodied the following limitation:

"Licensor agrees, for a period of four (4) years from the date upon which restrictions on the use of materials necessary for quantity manufacture of the Licensed Products for civilian use are substantially removed, not to grant additional licenses under said Patent Rights to make or sell cooking utensils, pressure cookers, or articles related thereto. It is specifically understood and agreed that Licensor retains the right to make, use and sell products embodying inventions of said Patent Rights, except such products having bodies or containers of Stainless Steel, nor is Licensor precluded from granting licenses to others under said Patent Rights for the manufacture and sale of pressure relief devices and pressure indicators, but Licensor agrees not to sell and not to grant licenses to others to manufacture and sell, closures embodying the inventions of said Patent Rights for use as parts of pressure cookers or canners, not to sell containers designed for cooperation with such closures except as complete pressure cookers or canners, or as bona fide repair parts for pressure cookers or canners sold by Licensor or its licensees. Licensor agrees, further, not to grant to anyone a license to make and sell Licensed Products having containers made of any aluminum-coated material without the written acquiescence of Licensee, and Licensor agrees to offer to Licensee the right to include in the term Licensed Products, and subject to all the terms and provisions of this agreement, containers made of ferrous metal having a non-corrosive coating other than vitreous enamel, prior to manufacturing such containers itself or granting to any other party a license to make Licensed Products embodying such containers. It is specifically understood and agreed that Licensor shall continue to make and sell to, or by authority of Government Claimant Agencies, Licensed Products having containers of Stainless Steel until such time as Licensee is in position fully and expeditiously to supply the demands or authorization of such claimant Agencies, and Licensor agrees to corporate with Licensee in securing contracts from such Claimant Agencies as soon as Licensee is in a position to execute such contracts." By the terms of Articles 5 and 6, the plaintiff agreed to pay to the defendant certain royalties, namely 5% of the net selling price of the licensed products, manufactured and sold, or the sum of $25,000, whichever would be greater. Article 15 provided that the plaintiff might cancel and terminate this agreement upon 60 days written notice.

Pursuant to the loan agreement, the Vischer Products Company, a former Illinois corporation, executed its nonnegotiable promissory note in the amount of $100,000 payable to the plaintiff on or before 10 years from July 16, 1943.

According to the oral testimony of Alfred Vischer, Jr., the plaintiff corporation, at the time of this commercial transaction, was not concerned with the net worth or the financial status of the Vischer Products Company; and it never requested any financial statement. The plaintiff was aware of Vischer's ownership of the patent rights and looked to the license agreement for reimbursement of the loan.

This same testimony also reflects that as of July 16, 1943, the Vischer corporation occupied a part of one floor at 412 Orleans Street, Chicago, Illinois. This was referred to as an assembly plant although the corporation never owned or maintained any assembly machinery on the premises. This corporation considered itself as being engaged in the manufacture and production of pressure cookers. The parts were manufactured by other firms and shipped to the Vischer Corporation, where they were assembled by hand. The corporation maintained very little inventory of material. The pressure cooker parts were never allowed to remain in the plant any more than two or three days. Between July 1943 and the early part of 1947, the number of employees ranged from three to twenty. This corporation never maintained any transportation facilities; it always relied upon a pickup service, which was rendered by an independent trucking firm. Office furniture was rented. Upon examination as to the ownership of fixtures, Alfred Vischer, Jr., replied: "We did have a couple of desks, little desks, and a coat hanger." During this period, namely July 16, 1943 to February 28, 1947, the proportion of earnings from the assembly operations grew smaller as the income from royalties became larger. As of January 3, 1947, more than 80% of the corporate income was being derived from patent royalties. The resulting federal tax problem was presented to tax consultants, who informed the corporate officers that the Vischer Corporation would be classified as a holding company because the income from patent royalties exceeded 80% of the total corporate income. This corporate status would lead to a very high federal tax. In order to remedy this situation the tax consultants suggested a reorganization. According to this plan, Vischer Products Company, the former Illinois corporation, would be dissolved and a new corporation would be formed to receive the physical assets of the old corporation and to continue the manufacturing operations. The income from the patent royalties, however, was to be paid directly to the shareholders of the old corporation. By this separation of the patents and license agreements from corporate ownership, the corporation would avoid the holding company classification and the consequent increased taxes. Though the shareholders would have to pay a capital gains tax on their shares, which had increased in value, such tax was still considerably less than that which was to be paid by the corporation as a holding company.

On January 31, 1947, Alfred Vischer, Jr., president of the Vischer Products Company addressed a letter to the president of the plaintiff corporation. This letter which involved several matters unrelated to this action, also included the following two paragraphs:

    "During our recent meeting in Chicago I had
  intended to discuss another matter with you but
  became so engrossed in the subject of your visit that
  it slipped my mind. We are in danger of being classed
  as a holding company because of our earnings through
  licenses, and are contemplating some corporate
  changes which in no way will change our original
  intention of having only three manufacturers in the
  field manufacturing Flex-Seal type cookers.
    "In this connection it may be necessary for us to
  separate our manufacturing activities. We are advised
  that we have such rights at the present time, but,
  nevertheless feel that we would like to present this
  matter to you and have your explicit approval.
  Accordingly, we are also enclosing a Clarification
  Agreement, the purpose of which is to clarify certain
  provisions in our original agreement. As in this
  connection we are granting Aluminum Company the right
  to manufacture sterilizers, we also give you the same
  consideration, since this deal had been specifically
  excluded by us from the original agreement to protect
  another manufacturer with whom negotiations were not
  consummated." On February 4, 1947, the plaintiff
  responded as follows:
    "As far as your corporate problems of a holding
  company are concerned, we are quite willing to do
  anything reasonable by way of modification of the
  contract and also whatever is necessary in connection
  with separating your manufacturing activities."

On February 21, 1947, the Vischer Products Company drew up an agreement, entitled "Amendment to License Agreement", whereby it granted to the plaintiff additional patent rights and whereby plaintiff agreed that a license under the patents could be granted to another corporation provided more than fifty per cent (50%) of its stock was owned by shareholders of the Vischer Products Company and provided that the new corporation should be a substitute licensee and not an additional licensee. This provision is set out in paragraph 4 of the "Amendment".

"It is specifically understood and agreed, by and between the parties hereto, that notwithstanding any provision of Article 4 of said agreement of July 16, 1943, the Licensor, or any future owner or assignee of Licensor's Patent Rights shall have the right at any time after the date hereof to grant a license to another group of individuals, firm, or corporation (more than fifty per cent (50%) of the capital stock or property rights of which is owned by the present stockholder of Licensor) to manufacture, use and sell the subject matter of said Patent Rights which have been retained by Licensor; provided that any such Licensee shall be a substitute for Licensor rather than an additional party having the right to make, use or sell under said Patent Rights. To the extent that this provision may be in conflict with the provision of Article 4 of said license agreement of July 16, 1943, this provision is intended to be a modification of said Article 4. ...


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