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TRUSERV CORPORATION v. CHASKA BUILDING CENTER

February 3, 2003

TRUSERV CORPORATION, PLAINTIFF,
v.
CHASKA BUILDING CENTER, INC., JOHN D. KLINGELHUTZ, RENNINGER LUMBER COMPANY, INC., DONALD W. RENNINGER, MICHAEL J. RENNINGER, GLORIA R. LONG, SUSAN J. MCKINNEY, CARTER TRUE VALUE HARDWARE, INC., CRAIG W. CARTER, KIMBERLEY S. CARTER, AND DANIEL G. STEINACKER D/B/A STEINACKER & SONS TRUE VALUE, DEFENDANTS



The opinion of the court was delivered by: Rebecca R. Pallmeyer, United States District Judge.

MEMORANDUM OPINION AND ORDER

On February 12, 2002, TruServ Corporation filed this lawsuit against Renninger Lumber Company, Inc., Donald W. Renninger, Michael J. Renninger, Gloria Long, and Susan McKinney, (hereinafter collectively "Renningers") and other Defendants, claiming breach of contract and breach of guaranty.*fn1 TruServ, a cooperative, alleges that Renninger Lumber, a member of the cooperative, has committed a breach of contract by failing to pay for merchandise and services provided by TruServ to Renninger Lumber. TruServ has also alleged a claim for "account stated" based on TruServ's failure to pay for merchandise and services. As against Donald Renninger, Michael Renninger, Long, and McKinney, TruServ alleges that these Defendants are liable on personal guaranties they gave to TruServ for Renninger Lumber's debts. On April 8, 2002, the Renningers filed an answer to TruServ's complaint in which they raised several affirmative defenses and a five-count counterclaim arising out of TruServ's failure to redeem Defendants' stock in the TruServ Corporation.

In their counterclaim, the Renningers allege that TruServ's dealings constituted (1) breach of contract; (2) fraud; (3) a violation of the Illinois securities laws; (4) breach of fiduciary duty; and (5) a violation of the Renningers' right of recoupment. TruServ has moved to dismiss each of these counterclaims under Rule 12(b)(6). In addition, TruServ moves to strike eight of the Renningers' thirteen affirmative defenses, including the following: (1) TruServ materially breached the Membership Agreement with Renninger Lumber; (2) TruServ's claims are barred by its anticipatory repudiation of the Membership Agreement; (3) TruServ's fraudulent statements and omissions induced Renninger Lumber to enter the Membership Agreement with TruServ and to remain a member; (4) TruServ's fraudulent misrepresentations and omissions induced the Renningers to enter into the personal guaranty agreements; (5) TruServ's claims must be reduced by amounts TruServ owes Renninger Lumber under the Membership Agreement; (10) TruServ's claims are partially barred by Renninger Lumber's claim for recoupment; (11) estoppel; and (12) unclean hands. For the reasons set forth here, TruServ's motion to dismiss is granted in part and denied in part. Its motion to strike the Renningers' affirmative defenses is also granted in part and denied in part.

FACTUAL BACKGROUND

Renninger Lumber Company, a Pennsylvania corporation, is owned by Donald W. Renninger, Michael J. Renninger, Gloria R. Long and Susan J. McKinney, and operates a True Value Hardware Store located in Mill Hall, Pennsylvania. (Joint and Separate Answer, Affirmative Defenses and Counterclaims of Renninger Lumber Company, Inc., Donald W. Renninger, Michael J. Renninger, Gloria R. Long and Susan J. McKinney ¶¶ 1-2) (hereinafter, "Counterclaim.") TruServ Corporation, Counter-Defendant here, is a Delaware corporation with its principal place of business in Chicago, Illinois. TruServ, a national cooperative, acts as a wholesaler for True Value hardware stores, marketing its merchandise and services exclusively to its members, including the Renningers. (Id. ¶ 1; Renningers' Memorandum in Opposition to TruServ's Motion to Dismiss Counterclaims and Strike Affirmative Defenses (hereinafter, "Memorandum in Opposition,") at 1, 4.) True Value Hardware store owners seeking membership in the TruServ cooperative must sign a contract or Membership Agreement that governs the relationship between the cooperative and its members. (Retail Member Agreement with TruServ Corporation (hereinafter, "Member Agreement"), Exhibit 1 to Counterclaim, at 1-2.) Pursuant to the Agreement, TruServ members own stock in TruServ and benefit from the group billing and purchasing ability of the TruServ cooperative. (Id.) The Renningers became a member of TruServ in 1997 when Cotter and Company ("Cotter") and ServiStar/Coast to Coast, both suppliers of hardware merchandise, merged to form TruServ Corporation. (Counterclaim ¶ 7.)

Prior to 1997, the Renningers were members of Cotter, a Delaware corporation which was a predecessor to TruServ and which, like TruServ, was a cooperative, marketing its merchandise and services to member stores pursuant to a membership agreement. The Cotter membership agreement (a) required members to purchase Class A stock as an initial investment from Cotter, and (b) provided that members would receive dividends from their purchases of merchandise in the form of Class B stock.*fn2 (Id. ¶¶ 4-6.) The member agreement between Renninger Lumber and Cotter required Cotter to redeem Renninger Lumber's Class A and Class B stock at Renninger Lumber's request for par value. (Id. ¶¶ 5-6.)

The Merger

In 1996 and 1997, Cotter sought to merge with ServiStar/Coast to Coast, which, like Cotter, was in the business of supplying hardware stores with services and merchandise. (Id. ¶ 7.) This merger was approved in 1997 by the Cotter members and resulted in the formation of the TruServ Corporation.*fn3 (Id.) Before the merger vote, all potential members of the new corporation, including the Renningers, were provided with a copy of a TruServ Member Agreement and the TruServ By-Laws.*fn4 (Id. ¶ 9.) The Renningers and the other members voting in favor of the merger were deemed to accept the new agreement and By-Laws, which replaced those of Cotter, and all Cotter stock was converted to TruServ stock. (Id. ¶¶ 8-9.) The relationship between TruServ Corporation and its stockholders was to be governed by Delaware general corporate law, TruServ's amended and restated Certificate of Incorporation, and TruServ's By-Laws. (Id. ¶ 8.) The TruServ Member Agreement provides that it is to be interpreted under the substantive law of Illinois. (Member Agreement, at ¶ 1.) The Renningers allege that TruServ and the Board of Directors owe stockholders, including the Renningers, a fiduciary duty that requires TruServ "to act in the best interests of [the Renningers] to avoid acts of self-dealing and conflicts on [sic] interest, and to act with the care that a reasonable director would exercise under similar circumstances." (Counterclaim ¶ 47.)

Under the Member Agreement, TruServ's members are entitled to use the True Value trademark and to benefit from TruServ's group buying power and group billing procedures. (Member Agreement, at 1.) Similar to the earlier arrangement between the Renningers and Cotter, a member in TruServ was required, in addition to signing the Member Agreement, to make an initial capital investment in TruServ of $6,000, in exchange for which the member received 60 shares of Class A Common Stock with a par value of $100 per share. (Id. at 2 ¶ 6.) Pursuant to the Member Agreement, TruServ pays patronage dividends to members each year based on "the volume of and margins applicable to merchandise and services purchased by the Member," after deduction of TruServ's business expenses and "[s]uch reasonable reserves for necessary corporate purposes as may from time to time be provided by the Board of Directors. . . ." (Id. at 1 ¶ 5.) The patronage dividends are paid in the form of a combination of cash, Class B TruServ stock, and promissory notes. (Id. at 2 ¶ 2.)*fn5

The Member Agreement contains a detailed integration clause. The clause states:

That this Agreement, and any other agreement which Member signs with the Company, is the entire and complete Agreement between the Member and the Company and that there are no prior agreements, representations, promises, or commitments, oral or written, which are not specifically contained in this Agreement or any other agreement which Member signs with the Company. That the current form of the Company Member Agreement shall govern all past and present relations, actions or claims arising between the Company and the Member.
(Member Agreement, at 5 ¶ 9.) The Member Agreement does contemplate future amendments to the By-Laws; it requires that each member "comply with the Company's [TruServ's] By-Laws as may be amended from time to time," (id. at 3 ¶ 2), and further states that "this Agreement shall be automatically modified upon notice from the Company to the Member of any relevant change in the Certificate of Incorporation or By-Laws of the Company." (Id. at 5 ¶ 8.)

TruServ's 1997 By-Laws, in place at the time of the merger, provided for the redemption of members' stock upon their termination from the Corporation, conditioned only on the "legal availability" of funds:

MANDATORY REDEMPTION. Upon termination of a Member Agreement . . . for any reason whatsoever, the stockholder shall sell to the Corporation and the Corporation shall redeem from the stockholder all of its stockholder's capital stock in the Corporation for par value thereof upon the terms and conditions set forth in section 7 of this Article VII.
(1997 By-Laws, Exhibit B to Counterclaim, at 7, Article VII § 6(a).) Article VII of the 1997 By-Laws provides that if funds were not "legally available" at the time of redemption, then the corporation is bound to redeem the stock when funds became available and before paying any dividends.*fn6 (Id. at 8, Article VII § 7(c).) Specifically, the 1997 By-Laws state:
LEGAL AVAILABILITY OF FUNDS. Should the funds of the Corporation legally available for such purpose be insufficient for immediate payment of all or any part of the redemption price, an agreement for purchase and sale of the stock shall be executed by the Corporation and the Terminated Stockholder pursuant to which the Corporation shall unqualifiedly undertake to pay all or the balance, as the case may be, of the redemption price as soon as funds are legally available for that purpose and further that no dividends or Patronage Dividends shall be declared and paid or set apart for payment to Members until after payment of the Terminated Stockholder of the full purchase price for such stock.
(Id.)

Amendment to TruServ's Certificate of Incorporation

Until the Spring of 1998, TruServ's Certificate of Incorporation prohibited the Board of Directors from amending the By-Laws on matters related to stock redemption without the approval of the TruServ stockholders. (Id.) Specifically, the TruServ Certificate of Incorporation stated:

The Corporation may be obligated or have the option to purchase or redeem its stock and stockholders may be obligated or have the right to sell their stock to the Corporation at par value in such circumstances and upon terms and conditions as may be specified in the By-Laws from time to time; provided, however, that the stockholders shall approve any such provision in the By-Laws.
(1997 Certificate of Incorporation, Exhibit 1 to TruServ's Motion to Dismiss, at 4.) (emphasis added).*fn7 In the Spring of 1998, however, at a TruServ annual stockholder meeting, TruServ managers advocated a change to the Certificate of Incorporation that would provide the TruServ Board of Directors with expanded powers, including the right to amend the By-Laws regarding matters related to the redemption rights, without the approval of a majority of the members.*fn8 (Counterclaim ¶ 10.) The proposed amendment to the Certificate of Incorporation would have removed from the Certificate of Incorporation the language stating "provided, however, that the stockholder shall approve any such provision in the By-Laws." (Certificate of Amendment of Certificate of Incorporation, Exhibit 2 to TruServ's Motion to Dismiss, at 1.) As described below, however, letters from TruServ officers to members, urging passage of the amendment, made no mention of this change. There was no other change in the language of the certificate, but the Renningers nevertheless allege that they understood the sole purpose of the amendment was to allow TruServ to redeem newly-issued "nonqualified" Class B stock, which was not immediately taxable as income, at anytime.*fn9 (Counterclaim ¶ 10.) The amendment was put to a member vote and passed; the Renningers voted for the amendment. (Id. ¶ 35.)

On March 3, 1998, Daniel Burns, secretary of TruServ, addressed a letter to members in support of the proposed amendment to the Certificate of Incorporation. (Counterclaim ¶¶ 29-30.)

In this letter, Burns stated:

This year, your 1997 year-end Patronage Dividend Statement will indicate that the year-end B Stock distribution is in "nonqualified" form. The enclosed letter from Kerry J. Kirby will more fully explain what this means to you. In simple terms, you will benefit by deferring tax on this B Stock distribution until these shares are someday redeemed for cash. To facilitate the redemption of the B Stock, you are being asked to approve an amendment to the Certificate of Incorporation which will permit the Board of Directors to amend the By-Laws of TruServ to make shares of nonqualified B stock redeemable at any time by the corporation for cash at the par value thereof.
(March 3, 1998 Letter from Daniel Burns to TruServ Members, Exhibit 3 to TruServ's Motion to Dismiss.) Kerry Kirby, executive vice president and chief financial officer of TruServ, also drafted a letter in support of the proposed amendment to the Certificate of Incorporation, in which he explained that the purpose of the amendment was to allow TruServ added flexibility in redeeming the nonqualified B Stock. (March 3, 1998 Letter from Kirby to TruServ Members, Exhibit 4 to Memorandum in Opposition.)
[t]o facilitate this redemption policy, you are being asked to approve, either by your proxy vote, or in person at the Annual Meeting on April 7th, an amendment to TruServ's Certificate of Incorporation which will permit the Board of Directors to amend the By-Laws of TruServ to make shares of nonqualified B stock redeemable at any time at the Corporation's option, for cash at par value.
(Id.) Finally, Kirby's letter advised members that "[i]f your membership is terminated, this non-qualified B Stock will be redeemed at par value, for cash, at the time of termination." (Id. at 2.) Neither Burns' letter nor Kirby's letter explained that the amendment would also permit TruServ to refuse to redeem members' stock on demand.

According to the Renningers, TruServ falsely represented that this expanded power was to be used solely to allow TruServ to redeem "nonqualified" Class B stock for cash at anytime. (Counterclaim ¶ 10.) The Renningers further allege that they relied on TruServ's representations explaining the amendment, and did not understand that the amendment to the Certificate of Incorporation was actually pursued in order to excuse TruServ from the obligation to redeem members' TruServ stock. (Id. ¶¶ 30, 35.) The Renningers claim in their Counterclaim that "TruServ breached its fiduciary obligations to [the Renningers] by . . . procuring expanded Board powers . . . without full disclosure of the information known to it at the time of its acts." (Counterclaim ¶ 48.)

Guaranty Agreements

A second basis for the Renningers' fraud claim relates to personal guaranties. The Renningers allege that on or shortly before February 2000, TruServ made misrepresentations to the Renningers which induced them to provide personal guaranties for the debts owed by Renninger Lumber Company to TruServ. (Id. ¶ 13.) Without identifying any specific misrepresentations, the counterclaim alleges that TruServ failed to disclose the true financial condition of the TruServ Corporation prior to the execution of the personal guaranties and failed to inform the Renningers that the Renninger Lumber Company's stock in TruServ would be devalued and unredeemable. (Id.) According to the Renningers, TruServ understood that the representations it made to members were false, knew that its omissions were misleading, and acted intentionally to mislead the Renningers by their misrepresentations and omissions. (Id. ¶¶ 33, 34.)

Relying on the misrepresentations and omissions of TruServ, the Renningers did execute the guaranties (the Counterclaim does not say when), and continued to remain a member of TruServ. (Id. ¶ 35.) Under the circumstances, the Renningers claim their reliance was both reasonable and justifiable and as a result of their reliance, they incurred and continue to incur substantial damages. (Id. ¶¶ 37-38.) The Renningers allege that obtaining personal guaranties from the Renningers without full disclosure of relevant information constituted a breach of TruServ's fiduciary obligations. (Counterclaim ¶ 48.) Finally, the Renningers assert that TruServ's misleading conduct was intentional and justifies an award of punitive damages. (Id. ¶ 38.)

TruServ Loss Reported

On or about March 2000, TruServ informed its members of $131 million in losses the corporation had recently discovered. (Id. ¶ 14.) TruServ reported that the losses were the result of previously undisclosed accounting errors and unknown costs associated with the merger. (Id.) During March and April 2000, TruServ announced that it was devaluing its members' Class B stock by 65 percent as a result of the $131 million loss. (Id. ¶¶ 15-16.) The Renningers allege this devaluation violates TruServ's By-Laws and Certificate of Incorporation, which do not expressly authorize TruServ to alter the par value of the Class B stock. (Id.) Without identifying any specific provisions that prohibit this conduct, the Renningers allege that by devaluing the Class B stock, TruServ violated the By-Laws, the Membership Agreement, and TruServ's fiduciary responsibilities to the Renningers. (Id. ¶ 16.)

On March 17, 2000, the Board of Directors passed a resolution which imposed a moratorium on TruServ member stock redemption.*fn10 (TruServ Special Meeting of the Board of Directors Friday, March 17, 2000, Exhibit 5 to TruServ's Reply in Support of its Motion to Dismiss, at 8.) Subsequently, on May 16, 2000, TruServ filed a 10-Q-Quarterly report, which reported that "[i]n view of the prior year financial results, the Company has initiated a moratorium on the redemption of its stock." (Counterclaim ¶ 17.) This statement also reported that the moratorium would be revisited by the TruServ Board of Directors depending on the financial status of the TruServ Corporation.*fn11 (Id.)

Amended By-Laws

In accordance with the Board's expanded authority under the amended Certificate of Incorporation, TruServ amended the By-Laws to alter the redemption rights of members and provide greater discretion to the TruServ Board of Directors regarding the redemption of member stock. (2000 By-Laws, Exhibit C to Renningers' Opposition to TruServ's Motion to Dismiss Counterclaims and Strike Affirmative Defenses) (hereinafter, "2000 By-Laws.") The amended By-Laws became effective on July 15, 2000 and changed the name of the provision formerly called "MANDATORY REDEMPTION" to "TERMINATION REDEMPTION", but did not alter the language of the provision. (1997 By-Laws, Exhibit B to the Counterclaim, at 7, § 6(a); 2000 By-Laws, at 7, § 6(a).) The 2000 By-Laws did, however, effect a material change in Section 7(c) of Article VII of the 1997 By-Laws, which governed the scope of possible limitations on the redemption of terminated members' stock. Section 7(c) of Article VII in the 2000 By-Laws states:

AVAILABILITY OF FUNDS. Notwithstanding anything to the contrary expressed or implied herein, should the Board of Directors in its discretion determine that the funds of the Corporation available for such purpose are insufficient for immediate payment of all or any part of the redemption price in light of the Corporation's legal or business requirements, or that immediate payment of all or any part of the redemption price is otherwise not in the best interests of the Corporation, the Corporation may delay (without interest) the payment of all or any part of the redemption price (including the issuance of any promissory note) until such time as the Board of Directors determines that sufficient funds are available for such purpose and that it is otherwise in the Corporation's best interests to recommence payments for such purpose, at which time the Corporation shall pay to those entitled thereto, in the chronological order in which such payments were delayed starting with those whose payment has been longest delayed and continuing until sufficient ...

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