The full case caption appears at the
end of thisopinion. A failed attemptby several small Wisconsin companies todevelop an integrated marketing anddistribution consortium with the help ofan Ohio software supplier ended withclaims of fraud against the Ohio company.Embedded in a fairly complex businessarrangement lies an arbitration clausethat the Ohio company, iPowerDistribution Group, Inc. (“iPower”),believed entitled it to arbitrationrather than litigation. The districtcourt disagreed and refused to stay theaction pending arbitration. Before thecase could continue, iPower appealed. Weaffirm the district court’s decision,although on different grounds than thedistrict court. I. History The complaint in this case concerns therelationships among four corporateentities bound together in various waysby two related agreements. The deal beganwith defendant iPower, a company thatmakes a special kind of software forindustrial supply dealers. iPower’ssoftware allows groups of dealers tocombine together into an integrated, one-stop-shopping network so that otherbusiness customers may buy products frommany dealers with a single order. Tomarket its software, iPower approachesgroups of dealers in a particular regionand suggests that they form anassociation, usually a limitedpartnership or some similar legal entity.That association then enters into afranchise agreement with iPower thatallows the association to purchase,install and use the iPower software.Customers place their orders with andmake payments to the franchiseeassociation when they want to buy aparticular product from an individualdealer. In May 1995, iPower approached severalunaffiliated equipment dealers inSouthern Wisconsin (the “dealers”), andpitched the idea to them of becoming afranchisee and buying the software. Oneof the dealers was plaintiff IndustrialElectronics Corp. of Wisconsin(“Industrial Electronics”). The dealersliked the proposal and agreed amongthemselves to form an association tobecome a franchisee (the “associationagreement”), with each company owningequal shares. That summer, the dealersformed iPower Distribution Group,Southern Wisconsin, LLC, (the”association”), a limited liabilitycorporation organized under the laws ofWisconsin. The association was formed onAugust 10, 1995, and consisted of eightdealer-members as “Full Members.” A year later, in September 1996, iPowerand the association entered into afranchise agreement (the “franchiseagreement”). The franchise agreementdetailed the entire relationship betweenthe association and iPower and includedan arbitration clause that stated inpart: The parties wish to provide for anarbitration procedure in order to avoidthe excessive costs of litigation. Anymonetary claim arising out of or relatingto this Agreement, or any breach thereof,excluding any claim relating to theconfidential information or the Marks,shall be submitted to arbitration inCuyahoga County, Ohio, in accordance withthe rules of the American ArbitrationAssociation and judgment upon the awardmay be entered in any court havingjurisdiction thereof and shall be final,binding and unappealable. . . . Two years later, Industrial Electronicsfiled suit in Wisconsin state court,alleging that iPower had made materialmisrepresentations regarding its productto induce Industrial Electronics to jointhe association. Industrial Electronicsclaimed that despite iPower’s assertionsto the contrary, the software was notfunctional or appropriate for the size ofenterprise at issue. According to thecomplaint, iPower’s allegedmisrepresentations regarding its productbegan in May 1995 when IndustrialElectronics obtained an offeringcircular, possibly from a third party,and continued through August 1995 whenthe association was formed. IndustrialElectronics claimed that because iPower’ssoftware did not work, the associationnever made any sales and that because ofiPower’s misrepresentations, IndustrialElectronics forewent participation inother dealer consortiums. iPower removedthe case to federal district court, whichhad jurisdiction based on diversity ofcitizenship, and moved for a stay pendingarbitration of the agreement pursuant tosec. 3 of the Federal Arbitration Act, 9U.S.C. sec. 1 et seq. The district courtdenied the motion to stay pendingarbitration, and iPower appealed pursuantto 9 U.S.C. sec. 16(a)(1)(A). II. Analysis The district court held that it woulddefeat the purpose of Wisconsin’s limitedliability company statute, Wis. Stat.sec. 183.0102 et seq., to allow LLCs tobind their members or subject them toliability by their agreements with thirdparties. Therefore the court held thatmembers of LLCs cannot be bound bycontracts entered into between the LLCand third parties, and the arbitrationclause between the association and iPowerhad no effect against IndustrialElectronics.
[FOOTNOTE 1] iPower does not dispute that theassociation could not impose anobligation on one of its members, butinstead maintains that the district courtmisapprehended the nature of IndustrialElectronics’ claim. In iPower’s view,Industrial Electronics stated its claimas a third-party beneficiary of thefranchise agreement, in which case, thelimited liability statute would notapply. Because Industrial Electronicsasserted a right under the franchiseagreement as a third-party beneficiary,the terms of the agreement, including thearbitration provision, would control.Furthermore, Industrial Electronics’claim amounts to an allegation of fraudin the inducement of the franchiseagreement, and such claims have been heldto be covered by arbitration provisionswithin the fraudulently inducedagreement. See Prima Paint Corp. v. Flood& Conklin Mfg. Co., 388 U.S. 395, 403-04(1967). If Industrial Electronics assertedrights created by the franchiseagreement, we would agree with iPowerthat the arbitration provision wouldgovern. The association agreement createda new legal entity, much as a corporatecharter does, whose investors were theeight dealers. Those eight dealers stoodas shareholders in a corporation andcould not sue a third party individuallyor on behalf of the corporation, exceptas allowed by the Wisconsin statute. SeeWis. Stat. sec. 183.0305; see also Rosev. Schantz, 201 N.W.2d 593, 597 (Wis.1972) (holding that action accruing tocorporation cannot be brought by themembers as individuals); Flynn v.Merrick, 881 F.2d 446, 449 (7th Cir.1989) (same); Carney v. General MotorsCorp., 23 F.3d 1154, 1157 (7th Cir. 1994)(holding that sole shareholder may notbring action in his own name to enforce aright that belonged to the corporation);Twohy v. First Nat’l Bank of Chicago, 758F.2d 1185, 1194 (7th Cir. 1985) (holdingthat under United States law, astockholder of a corporation has noindividual right against third partiesfor injuries to the corporation). Underthese well established principles,Industrial Electronics cannot bring asuit to assert rights under the franchiseagreement for injuries to the associationor indirectly to the members asshareholders. Yet that new legal entity entered intoa contract (the franchise agreement) withiPower, the purpose of which was tobenefit certain specified parties. Theapplicable state law
[FOOTNOTE 2] would determinewhether Industrial Electronics couldassert the rights of a third party. SeeGrant Thornton v. Windsor House, Inc.,566 N.E.2d 1220, 1223 (Ohio 1991); Pappasv. Jack O.A. Nelson Agency, Inc., 260N.W.2d 721, 725 (Wis. 1978). As a third-party beneficiary, Industrial Electronicsalso would be bound by the arbitrationprovision. See Barrett v. Picker Int’l,Inc., 589 N.E.2d 1372, 1375-76 (Ohio Ct.App. 1990) (holding that forum selectionclause in contract bound third-partybeneficiaries); City of Mequon v. LakeEstates Co., 190 N.W.2d 912, 916 (Wis.1971) (holding that third-partybeneficiaries take rights under contractsubject to all terms and conditions ofthe contract); Winnebago Homes, Inc. v.Sheldon, 139 N.W.2d 606, 609 (Wis. 1966). However, the injuries alleged byIndustrial Electronics do not arise underor relate to the franchise agreement, andIndustrial Electronics’ status as apotential third-party beneficiary doesnot dispose of this case. Rather,Industrial Electronics claims as itsinjuries the payments it made to investin the association, and it asserts theseinjuries separately from any injury tothe association itself. In Paragraph 11,Industrial Electronics mentions that theassociation has made no sales under thefranchise, but that is the sole mentionof the association’s injury in thecomplaint. Instead, IndustrialElectronics focuses factually on themisrepresentations made directly toIndustrial Electronics by iPower, claimsas part of its injury the $31,000 it paidto the association and characterizes thelegal wrong as a reckless or intentionalmisrepresentation designed to induceIndustrial Electronics to join theassociation. Therefore, the pleadingmakes clear that Industrial Electronics’claim relates not to the franchiseagreement but to the earlier associationagreement, which does not contain anarbitration requirement. Industrial Electronics contends thatiPower fraudulently caused it to enterinto the association agreement. Wherefraud is alleged in the inducement of acontract, the parties are bound toarbitrate in accordance with thecontract. See Prima Paint, 388 U.S. at404; Barron v. Tastee Freez Int’l, Inc.,482 F.Supp. 1213, 1216 (E.D. Wis. 1980).Yet here the fraud was not in thecreation of the franchise agreement, butin the creation of an entirely separatecontract. A dispute that arises under oneagreement may be litigatednotwithstanding a mandatory arbitrationclause in a second agreement, even wherethe two agreements are closelyintertwined. See Midwest Window Sys.,Inc. v. Amcor Indus., Inc., 630 F.2d 535,537 (7th Cir. 1980). Midwest Window concerned adistributorship agreement between twocompanies that contained an arbitrationprovision for all disputes arising out ofthe contract. Id. at 535. A dispute laterarose that the parties settled byreaching a second agreement that dictatednew terms of delivery in exchange for theissuance of two promissory notes tosecure payment by Midwest Window. Id. at536. Another dispute then arose whichlanded the parties in court. This seconddispute centered on fraud allegationsconcerning the notes, and the districtcourt ordered the parties to arbitration.Id. at 537. We held that it was error toorder arbitration for a dispute arisingout of the notes agreement. Id. “Thosefraud allegations are not arbitrable.They are not encompassed within thecontract provision providing forarbitration of a dispute ‘concerning theinterpretation or application of any ofthe provisions’ of the original agreementbetween the parties. The notes areoutside that arbitration agreement.” Id. Industrial Electronics’ claims do notrequire the interpretation of any term ofthe franchise agreement, nor are theyproperly considered to be claims of fraudin the inducement to enter that contract.Industrial Electronics was not a party tothe franchise agreement and does not havestanding directly to enforce itsterms.
[FOOTNOTE 3] Its complaint relates entirelyto fraud in the inducement of IndustrialElectronics to join the association bythe August 1995 association agreement, towhich the franchise agreement arbitrationprovision does not apply. III. Conclusion We conclude that the arbitrationprovision does not affect disputesarising out of the association agreementand Affirm the district court’s decisionto deny the stay. :::FOOTNOTES:::
FN1We agree with the district court thatWisconsin law prevents an LLC from bind-ing its members or subjecting them toliability through contracts between theLLC and third parties. See Wis. Stat.sec. 183.0304. However, because we holdthat Industrial Electronics may onlyassert claims under the association ag-reement or as a third-party beneficiaryof the franchise agreement, the immunityconferred by the Wisconsin LLC does notresolve this case.
FN2 We leave for the trial court to determinewhether Ohio or Wisconsin law applies.
FN3 Because we hold that Industrial Electron-ics pleaded a claim based entirely on theassociation agreement, we need not ad-dress whether they qualified as third-party beneficiaries of the franchiseagreement and thereby could enforce or bebound by its terms.
Industrial Electronics Corp. of Wisconsin v. iPower Distribution Group, Inc. United States Court of AppealsFor the Seventh Circuit No. 99-1764 Industrial Electronics Corp. of Wisconsin, Plaintiff-Appellee, v. iPower Distribution Group, Inc., Defendant-Appellant. Appeal From: United States District Courtfor the Eastern District of Wisconsin Argued: February 23, 2000 Decided: May 31, 2000 Before: FLAUM, KANNE, AND DIANE P. WOOD
