Rrx Industries, Inc. v. Lab-Con, Inc.

772 F.2d 543, 54 U.S.L.W. 2186

Opinions

EUGENE A. WRIGHT, Circuit Judge.

Thomas E. Kelly and Associates (TEKA), Lab-Con, Inc., and Thomas E. Kelly (Kelly) appeal from the district court’s judgment awarding RRX Industries, Inc. general and consequential damages for breach of contract. Appellants challenge the district court’s fact findings on liability and con tend that the award of consequential damages was improper. We affirm.

This action arises out of a computer software contract negotiated between RRX and TEKA. TEKA agreed to supply RRX with a software system for use in its medical laboratories. The contract obligated TEKA to correct any malfunctions or “bugs” that arose in the system, but limited TEKA’s liability to the contract price.

TEKA began installing the software system in January 1981 and completed it in June 1981. Bugs appeared in them soon after installation. TEKA attempted to repair the bugs by telephone patching.¹ Subsequently, TEKA upgraded the system to make it compatible with more sophisticated hardware. The system, however, remained unreliable because defects continued to exist.

After contracting with RRX, Kelly formed Lab-Con, Inc. in order to market TEKA’s software system. Lab-Con was a successor corporation to TEKA. TEKA assigned the RRX software contract to Lab-Con.

In September 1982, RRX instituted this diversity action against TEKA, Lab-Con, Kelly, and other defendants alleging breach of contract and fraud. Following a bench trial, the district court concluded that TEKA had materially breached the software contract. It found Lab-Con and Kelly individually liable and awarded RRX the amount paid under the contract, plus consequential damages.² TEKA, Lab-Con, and Kelly (collectively appellants) timely appeal the judgment and award of damages.

ANALYSIS

Appellants challenge the district court’s factual findings and conclusions of law. The factual findings will not be disturbed unless clearly erroneous. Anderson v. City of Bessemer, N.C., — U.S.-, 105 S.Ct. 1504, 1511, 84 L.Ed.2d 518 (1985). Legal conclusions are subject to de novo review. United States v. McConney, 728 F.2d 1195, 1200 (9th Cir.) (en banc), cert. denied, — U.S. -, 105 S.Ct. 101, 83 L.Ed.2d 46 (1984).

A. Credibility of Witnesses

Appellants first argue that the district court clearly erred by crediting the testimony of three of RRX’s witnesses. They argue that the testimony was inconsistent and unreliable. This contention lacks merit.

We afford considerable deference to district court findings on credibility. See Anderson, 105 S.Ct. at 1512. The challenged testimony is not so inconsistent that a fact finder would not credit it. Further, there is corroborative testimony by other witnesses that supports the district court’s findings.

B. Piercing the Corporate Veil

1. Kelly. Appellants contend that the district court erroneously determined that Kelly was the alter ego of TEKA. The alter ego doctrine applies where (1) such a unity of interest and ownership exists that the personalities of the corporation and individual are no longer separate, and (2) an inequitable result will follow if the acts are treated as those of the corporation alone. Automotriz Del Golfo De California S.A. De C. V. v. Resnick, 47 Cal.2d 792, 796, 306 P.2d 1, 3 (1957); United States Fire Ins. Co. v. National Union Fire Ins. Co., 107 Cal.App.3d 456, 470, 165 Cal.Rptr. 726, 734 (1980).

The district court found the requisite unity of interest and ownership in Kelly’s exertion of total control over TEKA. The record supports this finding. Kelly was the president and only officer, director, and stockholder of TEKA. TEKA had no Board of Directors and no employees. No TEKA stockholder meetings were ever held.

The district court also found that TEKA was under capitalized. An inequitable result may follow if the complained of acts are treated as those of an undercapitalized corporation. See Automotriz, 47 Cal.2d at 797, 306 P.2d at 4. Appellants contend that capitalization was adequate because TEKA had $8,000 in its corporate account. This fact alone, however, is not sufficient to defeat a finding of under-capitalization.

Appellants argue that the district court erroneously imposed liability because it did not find that Kelly acted in bad faith. A finding of bad faith, however, is not prerequisite to the application of the alter ego doctrine under California law. See, e.g., Automotriz, 47 Cal.2d at 797, 306 P.2d at 4. Thus, the district court properly found Kelly liable.

2. Lab-Con. Appellants also argue that the district court erred by imposing liability on Lab-Con. We disagree.

Kelly formed Lab-Con merely to market TEKA’s computer software. Both corporations had essentially the same stockholders and directors. Further, TEKA transferred all of its software and licenses to Lab-Con for no consideration. Following the transfer, TEKA was simply an empty shell, which the district court properly disregarded. See Ray v. Alad, Corp., 19 Cal.3d 22, 29, 136 Cal.Rptr. 574, 578, 560 P.2d 3, 7 (1977); Economy Refining & Service Co. v. Royal National Bank of New York, 20 Cal.App.3d 434, 439, 97 Cal.Rptr. 706, 710 (1971).

C. Breach of Contract

Appellants contend that the district court’s breach of contract finding was clearly erroneous because RRX also breached the contract. This contention lacks merit.

The contract obligated TEKA to timely install an operational software system, to repair malfunctions, and to train RRX employees. The record reflects that the software never functioned as intended. TEKA failed to correct adequately programming errors. Further, TEKA did not provide RRX employees with sufficient training. The evidence thus supports the district court’s finding of a contract breach. See Interpetrol Bermuda Ltd. v. Kaiser Aluminum International Corp., 719 F.2d 992, 998 (9th Cir.1983).

D. Consequential Damage Award

1. California Commercial Code. The district court relied on the California Commercial Code to award RRX consequential damages. Such reliance was proper only if the computer software system may be characterized as a “good” rather than a service.

The California Commercial Code defines a good as “all things (including specially manufactured goods) which are movable at the time of identification to the contract for sale other than the money in which the price is to be paid, investment securities (Division 8) and things in action____” Cal. Com.Code § 2105 (West 1964).

In determining whether a contract is one of sale or to provide services we look to the essence of the agreement. See Pittsburgh-Des Moines Steel Co. v. Brookhaven Manor Water Co., 532F.2d 572, 581 n. 6 (7th Cir.1976). When a sale predominates, incidental services provided do not alter the basic transaction. Id.; see also North Am. Leisure Corp. v. A & B Duplicators, Ltd., 468 F.2d 695, 697 (2d Cir.1972). Because software packages vary depending on the needs of the individual consumer, we apply a case-by-case analysis. See generally Note, Computer Programs as Goods Under the UCC, 77 Mich. L.Rev. (1979).

Here, the sales aspect of the transaction predominates. The employee training, repair services, and system upgrading were incidental to sale of the software package and did not defeat characterization of the system as a good. See Chatlos Systems, Inc. v. National Cash Register Corp., 479 F.Supp. 738 (D.N.J.1979), aff'd, 670 F.2d 1304 (3d Cir.1982).

2. Damage Limitation Clause. Under the Code, a plaintiff may pursue all of the remedies available for breach of contract if its exclusive or limited remedy fails of its essential purpose. Cal.Com. Code § 2719(2) (West 1985 Supp.). Appellants argue that the award of consequential damages was nevertheless improper because the contract limited damages to the amount paid.

In S.M. Wilson & Co. v. Smith Int’l., Inc., 587 F.2d 1363 (9th Cir.1978), this court held that the failure of a repair remedy does not require permitting the recovery of consequential damages. Id. at 1375. The court reasoned that where parties agree to a limitation of damages provision, courts should not alter the bargained-for risk allocation unless a breach of contract is so fundamental that it causes a loss which is not part of that allocation. Id.

The district court’s award of consequential damages is consistent with S.M. Wilson. The court concluded that “since the defendants were either unwilling or unable to provide a system that worked as represented, or to fix the ‘bugs’ in the software, these limited remedies failed of their essential purpose____” (emphasis added). This is a finding that both limited remedies failed of their essential purpose. The trial judge did not state that because the repair remedy failed, the limitation of damages provision should not be enforced.

The district court’s choice of language and supporting authority creates an ambiguity.³ However, it properly found the default of the seller so total and fundamental that its consequential damages limitation was expunged from the contract. See S.M. Wilson, 587 F.2d at 1375.

Two recent Ninth Circuit cases have addressed this issue. See Milgard Tempering, Inc. v. Selas Corp. of America, 761 F.2d 553 (9th Cir.1985); Fiorito Bros., Inc. v. Fruehauf Corp., 747 F.2d 1309 (9th Cir.1984). Although each applied Washington law, both looked to S.M. Wilson for guidance. California law does not significantly differ here.

The theme of all three is that “[ejach case must stand on its own facts.” S.M. Wilson, 587 F.2d at 1376, quoted in Fiori-to, 747 F.2d at 1314. The facts here justify the result. Neither bad faith nor procedural unconscionability is necessary under California Commercial Code § 2719(2).⁴ It provides an independent limit when circumstances render a damages limitation clause oppressive and invalid. See Fiorito, 747 F.2d at 1314-15. The award of consequential damages was proper.

E. Sanctions

RRX requests sanctions. We may impose attorney fees and single or double costs as sanctions for bringing a frivolous appeal. Fed.R.App.P. 38; 28 U.S.C. § 1912; International Union of Bricklayers & Allied Craftsman Local Union No. 20 v. Martin Jaska, Inc., 752 F.2d 1401, 1406 (9th Cir.1985). An appeal is frivolous where the result is obvious or the appellants’ arguments are utterly meritless. International Union, 752 F.2d at 1406.

The points raised by appellants on appeal are not wholly without merit. We deny the request for sanctions.

AFFIRMED.

Footnotes

1

. Telephone patching is a procedure where a TEKA employee instructed an RRX employee by telephone how to correct the malfunctions.

2

. Appellants filed a counterclaim alleging breach of contract and fraud. Appellants presented no evidence in support of their counterclaim. The district court found that RRX did not breach its contract by failing to make its final payment on the purchase price because TEKA’s breach excused its performance. The district court further found that RRX made no fraudulent representations to appellants.

3

. The majority of the cases relied upon by the district court were not helpful. See Beal v. General Motors Corp., 354 F.Supp. 423 (D.Del.1973); Riley v. Ford Motor Co., 442 F.2d 670 (5th Cir.1971); Jorgensen Co. v. Mark Construction, Inc., 56 Hawaii 466, 540 P.2d 978 (1975).

4

. Judge Norris relies on the absence of uncon-scionability in contract formation for his position that consequential damages should not be awarded, citing Cal.Com.Code § 2719(3). Un-conscionability is irrelevant. Subsection (3) governs validity of a contract clause limiting consequential damages in the first instance. However, this case is governed by subsection (2), which deals with the enforcement of a valid limited damages provision after breach.