Document ID: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-ca8-06-02789/USCOURTS-ca8-06-02789-0/pdf.json

Parties Involved:
Terence Michael Clarke
Appellee
Katun Corporation
Appellant

Document Text:

United States Court of Appeals

FOR THE EIGHTH CIRCUIT

___________

No. 06-2789

___________

Katun Corporation, a Minnesota *

Corporation, *

*

Plaintiff/Appellant, *

* Appeal from the United States

v. * District Court for the 

* District of Minnesota.

Terence Michael Clarke, a Florida *

citizen, *

*

Defendant/Appellee. *

___________

Submitted: March 16, 2007

Filed: May 2, 2007

___________

Before WOLLMAN, JOHN R. GIBSON, and MURPHY, Circuit Judges.

___________

MURPHY, Circuit Judge.

Appellant Katun Corporation (Katun) brought this breach of contract action

against former shareholder Terence Michael Clarke after he refused to pay his share

of a settlement agreement. That agreement had resolved claims asserted by Katun and

its parent company PNA Holdings, LLC (PNA) against the previous owners of Katun.

One of the settled claims had asserted indemnification for criminal penalties imposed

on Katun, and Clarke moved to dismiss this case on grounds of public policy and in

pari delicto. The district court granted his motion, and Katun appeals. We reverse.

 

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Katun is a Minnesota corporation that supplies replacement parts for

photocopiers, facsimile machines, and printers. Clarke cofounded the company in

1978 and served as a director and officer until he was removed from office for

financial improprieties in June 2000. Clarke remained Katun's largest shareholder

until PNA acquired the company in July 2002. 

PNA acquired Katun by means of a merger with a wholly owned subsidiary of

PNA, leaving Katun as the surviving subsidiary. At the time of the sale Katun and its

officers were under investigation by the United States Attorney for possible criminal

conduct. Clarke and other selling shareholders of Katun made a number of

representations to PNA in the merger agreement about the health of the company. The

shareholders represented that Katun had not violated any material applicable laws as

of the July 5, 2002 closing date. They also agreed to indemnify PNA and the

surviving Katun for losses resulting from a breach of any representation made in the

agreement, as well as for losses related to Clarke's financial improprieties. Xerox

Corporation, which was also one of the selling shareholders, was appointed as the

selling group's agent and attorney in fact to settle any indemnification claims that

might arise out of the merger agreement. Clarke himself received more than $68

million as part of the merger transaction.

On December 11, 2002, five months after PNA's acquisition of Katun, Clarke

pled guilty to four counts of filing false tax returns for failing to report the proceeds

of his self dealing at Katun. He cooperated with the government in providing

information about additional criminal activity that took place at the company during

his tenure, and his cooperation helped lead to guilty pleas by several Katun officers

for bribery and computer fraud. Clarke was subsequently charged with aiding and

abetting mail fraud for unlawfully gathering competitive intelligence while an officer

at Katun, and he again pled guilty in March 2004. These violations were not disclosed

to PNA by the selling shareholders prior to its acquisition of Katun. 

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The government also brought charges against the company directly, and on

February 6, 2004 Katun pled guilty to a twelve count information dealing with three

separate criminal schemes involving computer fraud for unlawful gathering of

competitive information, mail fraud arising out of the misappropriation of customer

credit balances, and wire fraud. All three criminal schemes were initiated prior to the

merger, but two of them continued until March or April of 2003, a number of months

after PNA's acquisition of the company. As part of its plea agreement Katun was

required to pay more than $11 million in criminal fines, restitution, and forfeiture, and

it was placed on probation for two years. Katun also incurred millions of dollars in

attorney fees and costs. 

Citing provisions in the merger agreement, PNA and Katun sought

indemnification from the selling shareholders against losses sustained as a result of

the sellers' misrepresentations about the company at the time of the sale, including the

fines and costs associated with the criminal investigations and the guilty plea of

Katun. On behalf of the selling shareholders, Xerox Corporation, acting as their

attorney in fact, entered into a settlement agreement with Katun and PNA on June 7,

2005. The settling shareholders agreed to pay PNA "or its designee" $11.65 million

in exchange for a release of the indemnification claims. PNA named Katun as its

designee to receive the settlement funds. 

After Clarke refused to pay his portion of the settlement, Katun brought this

action for breach of contract, alleging that he owed $1,731,575.99 under the

settlement agreement. Katun attached both the settlement and merger agreements to

the complaint. Clarke moved to dismiss, arguing that it would violate public policy

to permit a company to shift responsibility for its own criminal penalties onto another

party and that the action was also barred by the doctrine of in pari delicto. Katun

moved for summary judgment to collect under the terms of the settlement agreement.

The district court granted Clarke's motion to dismiss on both of the grounds he

advanced, concluding that the indemnification provision in the merger agreement was

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void as against public policy because it permitted Katun to avoid the consequences

of its illegal actions. Katun's motion for summary judgment was denied without

further discussion. 

Katun appeals, arguing that the district court erred in dismissing its claim. It

contends that the district court mischaracterized the present action as an attempt by

Katun to obtain indemnification when in reality Katun seeks to enforce the settlement

agreement. That agreement between the parties necessarily resolved any defenses

Clarke might have had to the indemnification claims. Even if the settlement

agreement had not waived the defenses of public policy and in pari delicto, they would

not bar this present action. Katun points out that the indemnification claims were

settled not for the benefit of Katun, but for the benefit of PNA, an innocent third party

purchaser. PNA was entitled to protect itself by means of the indemnification

provision against losses stemming from any illegal conduct occurring prior to the

signing of the merger agreement and concealed by the selling shareholders.

We review the grant of a motion to dismiss de novo, taking all well pleaded

factual allegations as true and drawing all reasonable inferences in favor of the

plaintiff. Knieriem v. Group Health Plan, Inc., 434 F.3d 1058, 1060 (8th Cir. 2006).

When there are documents attached to the complaint, we consider this material along

with the allegations in the complaint. See Abels v. Farmers Commodities Corp., 259

F.3d 910, 921 (8th Cir. 2001); see also Fed. R. Civ. P. 10(c). We may also take into

account matters of public record referenced in the complaint. Deerbrook Pavilion,

LLC v. Shalala, 235 F.3d 1100, 1102 (8th Cir. 2000). "A motion to dismiss should

be granted only if it appears beyond doubt that the plaintiff can prove no set of facts

to warrant a grant of relief." Knieriem, 434 F.3d at 1060 (quoting Gilmore v. County

of Douglas, Neb., 406 F.3d 935, 937 (8th Cir. 2005)). 

Katun first challenges the district court's conclusion that the indemnification

provision violated public policy, arguing that the settlement agreement resolved all

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defenses that Clarke and other settling shareholders might have had to the claims of

PNA and Katun, including a public policy defense. Katun stresses that Minnesota

courts recognize a "strong public policy favoring the settlement of disputed claims

without litigation." Hentschel v. Smith, 153 N.W.2d 199, 204 (Minn. 1967) (citation

omitted). Courts generally will not examine the value or validity of a claim or defense

where the parties have settled a bona fide dispute in good faith. See De Mars v.

Musser-Sauntry Land, Logging & Mfg. Co., 35 N.W. 1, 1 (Minn. 1887); see also

Libby v. Uptegrove, 988 S.W.2d 131, 133 (Mo. Ct. App. 1999) ("by settling, the

[defendants] necessarily waived any defenses they might otherwise have had to the

underlying claim"). That a plaintiff ultimately would have been unsuccessful had the

claim proceeded to trial does not normally affect the enforceability of a settlement

agreement. See Johnson v. St. Paul Ins. Cos., 305 N.W.2d 571, 574 (Minn. 1981).

On the other hand a settlement agreement is a type of contract, State v. Philip Morris,

713 N.W.2d 350, 355 (Minn. 2006), which itself might offend public policy. Cf.

Goodrich v. Nw. Tel. Exch. Co., 201 N.W. 290, 292 (Minn. 1924) (defendant's

agreement to waive defense of illegality "would be tainted with the vice of the original

contract"). 

In Hoyt v. Wickham, 25 F.2d 777 (8th Cir. 1928), decided under Iowa law, we

drew a distinction between the settlement of a claim of doubtful validity, for which

finality should be preserved, and the settlement of a claim that is invalid on its face

as offensive to public policy. Id. at 781. The defendant in Hoyt had argued that

plaintiffs should be prevented from enforcing a settlement agreement because their

settled claim centered around an illegal gambling contract. Id. at 777-78. Plaintiffs

disputed this characterization of their contract both factually and legally. Id. at 778.

We concluded that the original claim was not a per se illegal demand, but rather one

of reasonably disputed validity. The defendant was therefore estopped by the

settlement agreement from challenging the contract's legality. Id. at 781. We think

the distinction drawn in Hoyt, between per se invalid claims and claims of doubtful

validity, is equally appropriate under Minnesota law.

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The settlement agreement under which Katun seeks to recover would thus be

unenforceable only if the original claim for indemnification were per se invalid.

Although "indemnification will not be allowed if its application would violate public

policy," United States v. J & D Enters. of Duluth, 955 F. Supp. 1153, 1159 (D. Minn.

1997), a contract is not void as against public policy in Minnesota "unless it is

injurious to the interests of the public or contravenes some established interest of

society." Isles Wellness, Inc. v. Progressive N. Ins. Co., 725 N.W. 2d 90, 93 (Minn.

2006) (citation omitted). A court's power "to declare a contract void for being in

contravention of sound public policy is a very delicate and undefined power, and . .

. should be exercised only in cases free from doubt." Hollister v. Ulvi, 271 N.W. 493,

498-99 (Minn. 1937) (quoting Cole v. Brown-Hurley Hardware Co., 117 N.W. 746,

747 (Iowa 1908)).

Katun argues that the indemnification provision at issue here does not violate

public policy because it does not promote illegality or free any party to act with

impunity. Katun acknowledges that a party may not insure itself against penalties for

conduct not yet committed, Zerby v. Warren, 210 N.W.2d 58, 64 (Minn. 1973)

(indemnification for violation of public duty); Rosenbloom v.Flygare, 501 N.W.2d

597, 602 (Minn. 1993) (insurance against punitive damages), since legal sanctions are

an important means by which society discourages future misconduct. See Nw. Nat'l

Cas. Co. v. McNulty, 307 F.2d 432, 440 (5th Cir. 1962). Katun argues that the present

case is distinguishable from Zerby and other similar precedent for two separate

reasons. First, the indemnification provision was adopted not for the benefit of Katun,

but rather for the benefit of PNA, an innocent third party. Second, the indemnification

provision did not insure any party against the consequences of future misconduct and

therefore did not encourage illegality.

In response to Katun's first argument, Clarke points to paragraph 39 of the

complaint which states that PNA "has suffered untold millions of dollars in additional

losses not at issue in this lawsuit." Clarke contends that this shows that it was Katun

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It was PNA rather than Katun which was responsible for sending notice to the

selling shareholders of its intent to pursue indemnification. Although these notices

were not attached to the pleadings, the district court referenced them in its decision.

Since neither party objected and the notices do not contradict the complaint, we are

not precluded from considering them. See Missouri ex rel. Nixon v. Coeur D'Alene

Tribe, 164 F.3d 1102, 1107 (8th Cir. 1999).

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who originally sought indemnification for its criminal penalties. Clarke overlooks the

fact that in the very next paragraph of the complaint it is alleged that both PNA and

Katun made indemnity claims under the merger agreement, seeking compensation for

losses associated with Katun's criminal conviction "[a]mong other things." Moreover,

since Katun is a subsidiary of PNA, a loss to Katun is also a loss to PNA. Cf.

Wackerbarth v. Weisman, 292 N.W. 214, 215 (Minn. 1940) (shareholders have

proprietary interest in corporation). The settlement agreement which was attached

to the complaint provided that payment was to be made to PNA or its designee.

Granting Katun the benefit of all positive inferences as we must, see Knieriem, 434

F.3d at 1060, we conclude that the complaint has alleged that both Katun and PNA

brought claims for indemnification and that these were settled in exchange for

compensation to PNA.1

The circumstances here are also distinguishable from Zerby and similar cases

in that this agreement involves compensation for losses attributable to acts that had

already occurred prior to the promise to indemnify. An indemnification agreement

releasing a departing company officer from all liability arising out of his prior

association with the company was upheld in Feuer v. Menkes Feuer, Inc., 187

N.Y.S.2d 116 (N.Y. App. Div. 1959), even though the officer sought to be

indemnified against penalties imposed for previously violating customs requirements.

Id. at 120. Since there was no concern that the agreement would encourage illegality,

see id., the court concluded that the contract was a reasonable if not desirable means

of allocating unidentified financial responsibility for identifiable acts. Id. at 121. The

court also observed that it was well established across the country that "one may make

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an agreement to be indemnified or to indemnify with respect to a crime or illegal act

which occurred prior to the making of the agreement." Id. at 121; see also Pettit Grain

& Potato Co. v. No. Pac. Ry. Co., 35 N.W.2d 127, 131-133 (Minn. 1948) ("public

policy does not forbid bargains for protection from the consequences of" illegal acts

where agreement is not itself part of illegal scheme and does not encourage illegality).

The reasoning in Feuer is instructive here. The indemnification provision

contained in the merger agreement was not a form of insurance against future acts, but

rather protection against the financial consequences of actions that had already

occurred and were not within PNA's control. Clarke and the other selling shareholders

who had controlled the company before the sale were in the best position to have

known whether legal violations had been committed prior to the acquisition, and they

represented to PNA that none had. PNA relied on their representations when it agreed

on a purchase price for the company. The indemnification provision permitted PNA

to recover part of that purchase price if the representations proved to be false and if

Katun's value turned out to be overstated due to undisclosed criminal violations. We

conclude that the indemnification provision here did not free either PNA or Katun

from the consequences of any future criminal actions.

Clarke argues that the settlement included payment for criminal penalties

attributable to post sale conduct, noting that the settlement amount is nearly identical

to the total amount of Katun's sanctions even though two of the three schemes

continued after the acquisition. In Clarke's view PNA could not legally recover in

full, even under the reasoning in Feuer, because some of the criminal penalties should

be attributed to misconduct that occurred after the indemnification agreement was

made and the company changed hands. We find this argument unpersuasive for two

reasons. We are obliged at this stage to take the factual allegations in Katun's

complaint as true, including its allegation that the settlement agreement resolved

claims arising from "illegal conduct that pre-dated the July 5, 2002 closing date"

(emphasis added), an allegation that is not inconsistent with the terms of the

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indemnification provision or the settlement agreement. Moreover, the degree to which

the parties' losses are attributable to presale or postsale conduct is precisely the kind

of disputed factual issue that the Hoyt court refused to examine because the parties

had settled their differences. 25 F.2d at 781. Even assuming that the settled amount

exceeds the amount that PNA would have been able to recover at trial, this would be

an insufficient basis on which to upset the freely negotiated settlement of the parties.

 See Forcier v. State Farm Mut. Auto. Ins. Co., 310 N.W.2d 124, 128-29 (Minn. 1981)

(refusing to examine settlement amount to determine whether it had been influenced

by provision in insurance policy that violated state law).

Because the indemnification provision at issue in this case did not create the

kind of negative incentives normally associated with attempts to insure against penal

sanctions and because a contract should not be voided absent an unmistakable

violation of public policy, see Hollister, 271 N.W. at 988-99, we cannot conclude that

the claim for indemnification was an illegal demand or patently in violation of public

policy. Although there may have been legitimate doubts about the appropriateness of

the settlement amount or of Katun's initial participation in seeking indemnification,

these disputed issues were laid to rest with the settlement agreement. See Hoyt, 25

F.2d at 781. It does not clearly offend public policy to permit a purchaser to protect

itself from the consequences of actions, legal or illegal, taken prior to its acquisition

of the company.

Katun also argues that the defense of in pari delicto does not bar the present

action because it was waived by the settlement agreement, or alternatively because it

is inapplicable to this action to enforce that agreement. Under the in pari delicto

doctrine courts will decline to enforce the rights of either party to an illegal

transaction. See State v. Aamco Automatic Transmissions, Inc.,199 N.W.2d 444, 448

(Minn. 1972). At least one court has treated the defense as waivable, see Pinto

Trucking Serv., Inc. v. Motor Dispatch, Inc., 649 F.2d 530, 534 (7th Cir. 1981), but

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we need not address the issue of waivability since we conclude that the doctrine would

not bar Katun's action in any event. 

Although the doctrine of in pari delicto is "based on judicial reluctance to

intervene in disputes between parties who are mutually involved in wrongdoing,"

Brubaker v. Hi-Banks Resort Corp., 415 N.W.2d 680, 683 (Minn. App. 1987), the fact

that both parties to a lawsuit have committed wrongful conduct will not trigger the

defense unless "the court is asked to do something that is itself part of the unlawful

act." Id. at 684. The fact that both Katun and Clarke have been previously convicted

for participating together in illegal acts does not alone defeat the present claim.

Minnesota courts will not apply the doctrine "to defeat the performance of a contract

which was in itself not illegal" either on its face or in its enforcement. Brubaker, 415

N.W.2d at 684. Because we have already concluded that the settlement agreement

was not part of an illegal scheme, we also conclude that Katun's claim is not barred

by the doctrine of in pari delicto.

For these reasons, we reverse the judgment and remand to the district court for

further proceedings and consideration of Katun's motion for summary judgment. 

______________________________

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