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HEARTLAND RAIL CORPORATION v. RAILROAD DEVELOPMENT CORP.

May 15, 2003

HEARTLAND RAIL CORPORATION PLAINTIFF/COUNTER-DEFENDANT,
v.
RAILROAD DEVELOPMENT CORPORATION, PLAINTIFF.



The opinion of the court was delivered by: David H. Coar, United States District Judge.

MEMORANDUM OPINION AND ORDER

There are several motions pending and fully briefed before the Court in this case. The case originally came before this Court when, on April 19, 2002, Defendant Railroad Development Corporation ("RDC" or "Defendant") removed Plaintiff Heartland Rail Corporation's ("Heartland" or "Plaintiff") declaratory judgment action from state court. The basis for removal was diversity of the parties, which establishes federal jurisdiction pursuant to 28 U.S.C. § 1332. Defendant RDC answered Plaintiff's Complaint and filed a counterclaim on April 30, 2002. In near record time, Defendant RDC filed a summary judgment motion on June 4, 2002. Since then, that motion has been fully briefed and Plaintiff RDC has filed two amended complaints. The first amended complaint was filed without objection on August 19, 2002. The first amended complaint contained substantially the same allegations as the original complaint, (Def. Resp. Pl. Mot. Leave File First Am. Comp., at 1), though it was styled differently to reflect its original filing in federal court. On December 10, 2002, Plaintiff obtained leave to file its second amended complaint, which contained three additional counts.

On January 13, 2003, Defendant filed a Motion to Dismiss portions of Plaintiff's Second Amended Complaint. On January 31, 2003, Defendant filed a Motion for Summary Judgment on the newly asserted claims in Plaintiff's Second Amended Complaint. At this point, all three of Defendant's Motions are before the Court, the initial motion for summary judgment (which the Court permitted RDC to renew as to the same allegations in the Second Amended Complaint), the motion to dismiss the Second Amended Complaint, and the subsequent motion for summary judgment on the newly asserted claims.

Factual and Procedural Background*fn1

Plaintiff/Counter-Defendant Heartland Rail Corporation is incorporated under the laws of Iowa with its principal place of business in Iowa City, Iowa. Since 1996, Archer Daniels Midland Company ("ADM") has controlled Heartland and currently owns over 57 percent of Heartland's common stock. Defendant/Counter-Plaintiff Railroad Development Corporation is a Pennsylvania corporation with its principal place of business in Pittsburgh, Pennsylvania.

The dispute between the parties centers on the fair market value of a corporation, the Iowa Interstate Railroad, Ltd, in which the parties are the sole shareholders. The Iowa Interstate Railroad, Ltd., or "IAIS",*fn2 operates a rail freight carrier between Chicago, Illinois and Council Bluffs, Iowa. In 1984, Heartland purchased certain operating assets used by IAIS, including track structure, real estate, trackage rights, rights-of-way, shops, and buildings. The parties refer to these assets collectively as "the Properties." The cash consideration that Heartland's shareholders paid to purchase the railroad and associated properties was approximately $5.6 million. To make up the balance of the purchase price, which the Second Amended Complaint alleges at $31 million, Heartland assumed debt that was owed to the Iowa Rail Finance Authority. Heartland leased the railroad to IAIS, and IAIS has operated it since that time. The debt payments were to be made from IAIS lease payments.

1. The Option Agreement Between RDC and Heartland

In 1991, Heartland acquired IAIS for $390,000 in cash and 264 shares of stock. RDC presently owns or controls 19.9 percent of the outstanding common stock of the IAIS, and Heartland presently owns or controls the remaining 80.1 percent of the outstanding common stock. RDC gained control of its share of the IAIS common stock in a transaction consummated on August 2, 1991. As part of that transaction, RDC and Heartland entered into an Option Agreement, which granted RDC options to acquire up to 100 percent of the controlling stock, including "all of the stock of the IAIS held by Heartland." (Pl. Compl. Ex. D, at 1.)*fn3 On the same day as RDC and Heartland entered into the Option Agreement, the IAIS and Heartland entered into an Amended and Restated Lease Agreement ("Lease Agreement"). The Lease Agreement provided that if RDC exercised its option to purchase the IAIS stock held by Heartland, then the IAIS "shall have an option to purchase" the Properties. (Pl. Compl. Ex. A, § 10.01, at 18.)

On August 12, 1993, both the Lease Agreement and the Option Agreement were amended between the parties. The First Amendment to the Option Agreement provided that if RDC acquired more than 50 percent of the common stock of IAIS, then RDC had to direct IAIS to acquire the Properties from Heartland under its option in the lease, as amended.

2. The First post-Option Valuation of the IAIS, March 1995

In 1995, Arthur Andersen was retained to perform a valuation of the Fair Market Value of IAIS. This was the first valuation of the Railroad undertaken subsequent to execution of the Lease, Option, and First Amendments to both the Lease and Option, although it was not undertaken pursuant to those agreements. At Arthur Andersen, Norman Carlson was the partner in charge of the 1995 valuation, and Theresa Poppei was the engagement manager who would "coordinate both the technical and administrative aspects of the engagement." (RDC Appendix Evi. Supp. Mot. Summ. J. Heartland's Newly-Asserted Claims, Vol. II, DX 29, at 7.) On July 27, 1995, Poppei presented the results of the valuation to the Heartland Board of Directors. Arthur Andersen concluded that, as of March 31, 1995, the "current railroad operations" were valued between $2.6 million and $3.3 million. (RDC Appendix Evi. Supp. Mot. Summ. J. Heartland's Newly-Asserted Claims, Vol. II, DX 3, at 3.)*fn4

On April 29, 1996, both the Lease Agreement and the Option Agreement were amended yet again, shortly after ADM acquired control of Heartland. The parties dispute whether the terms of the Second Lease Amendment superseded the terms of the First Lease Amendment. The parties do not dispute that the Option Agreement, as amended, is a valid, binding, and enforceable contract.

As amended by the Second Option Amendment, the Option Agreement provides "upon RDC's exercise" of its option to purchase the stock of the IAIS, the IAIS option to purchase the Properties set forth in the Lease Agreement, as amended, shall be deemed exercised. The net effect of the Second Option Amendment was to grant RDC an option to purchase from Heartland both the stock of the IAIS and the Properties.

The Second Option Amendment states "the purchase price of the Common Stock to be acquired by RDC and the `Properties' to be acquired by IAIS shall be the `Fair Market Value' as a going concern on a consolidated basis as that term is defined hereafter." (Pl. Comp., Ex. F, at 2.) The going concern/consolidated basis language was inserted into the agreement at the behest of ADM's attorney. The Second Option Amendment further defined the term "Fair Market Value" to mean "(i) the amount that the parties agree is the fair market value . . . or (ii) in the event that the parties are unable to agree as to such value, the amount determined in accord with the . . . `Appraisal Process'" defined therein. (Pl. Comp., Ex. F at 2.)

3. The Appraisal Process

The appraisal process prescribed by the Second Option Amendment contemplates the completion of up to three appraisals. Pursuant to the Appraisal Process, RDC and Heartland would "each appoint an independent appraiser to value the Common Stock and the `Properties.'" Id. Each appraiser would then deliver its "opinion in writing stating the fair market value of Common Stock and the `Properties.'" Id. If the two appraisals were within 10 percent of one another, the "Fair Market Value will be the average of the two appraisals." Id. If the appraisals differed by more than 10 percent, "the two appraisers will themselves appoint a third appraiser." Id. The third appraiser was then charged with "determin[ing] independently [the] Common Stock's and the `Properties' Fair Market Value." Id. If the third appraisal became necessary, the agreement provided that the fair market value of the property would be calculated by the mean of the median of the three appraised values and whichever of the two remaining values is closest to such median. Id.*fn5 If the third appraisal is completed, the outlying appraisal (neither the median nor next closest to the median) is disregarded and has no effect on the Railroad's final Fair Market Value.

On July 3, 2001, RDC notified Heartland that it was exercising the option under the Option Agreement, as amended, to purchase the Stock. This triggered IAIS's option to purchase the Properties. RDC and Heartland were unable to agree on a fair market value of the Stock and the Properties. On September 20, 2001, Heartland invoked the appraisal process set forth in the parties' agreement to determine the fair market value. At a meeting of the Iowa Railway Finance Authority on December 13, 2001, that was also attended by Heartland's General Counsel, RDC's Chairman stated RDC's belief that at the end of the appraisal process, "We [RDC] are contractually locked in as to the final price." (RDC DX 103) Heartland did not object to that characterization at the meeting or subsequently.

As set forth in the appraisal process, the parties each obtained their own independent appraisers. RDC appointed R.L. Banks & Associates to be its independent appraiser, and Heartland appointed L.E. Peabody & Associates to be its appraiser. In mid-October 2001, the appraisers produced their respective appraisals. Banks' appraisal for RDC concluded that the Fair Market Value of the Stock and the Properties "as a going concern on a consolidated basis" was $1,616,000. (Pl. Comp., Ex. J, at 3.) Peabody's appraisal for Heartland resulted in three figures for the Fair Market Value of the Stock and the Properties: "based on the Net Liquidation Value of Heartland's Rail Properties" was $51,000,000 (Pl. Comp., Ex. I at 5); "as a going concern on a consolidated basis . . . using a Present Value of Future Cash ...


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