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John Scheenstra v. California Dairies

January 30, 2013

JOHN SCHEENSTRA, PLAINTIFF AND APPELLANT,
v.
CALIFORNIA DAIRIES, INC., DEFENDANT AND APPELLANT.



APPEAL from a judgment of the Superior Court of Tulare County. Lloyd L. Hicks, Judge. (Super. Ct. No. VCU231235)

The opinion of the court was delivered by: Franson, J.

CERTIFIED FOR PUBLICATION

OPINION

INTRODUCTION

Plaintiff John Scheenstra was a member of defendant California Dairies, Inc. (Cal Dairies), a member-owned milk marketing and processing cooperative. After Cal Dairies instituted internal production quotas for its members and reduced payments for milk deliveries in excess of the quotas, Scheenstra sued for breach of contract claiming his quota was too low. The contract provision in question obligated Cal Dairies to accept all of the milk of its members, "subject to the right of the Board, in its discretion, upon written notice to the membership ... to allocate equitably among the members on a uniform basis ... the quantity ... of milk to be received by the Association." (Italics added.)

The trial court concluded that, under the circumstances represented, the business judgment rule did not shield Cal Dairies from liability for breach of contract. The court found that the quota system adopted by Cal Dairies was not equitable or uniform and therefore breached the contract. Among other things, the quota system required dairies with increasing production to bear the entire brunt of the oversupply. More remarkably, the quota system responded to the oversupply problem by placing some members in a better position than they would have occupied without the oversupply problem. Specifically, members with declining production were given the right to sell their excess quota.

Cal Dairies appealed, contending the trial court erred by (1) failing to apply the business judgment rule and give deference to its board of directors' choice of terms for the production quota system, (2) calculating Scheenstra's damages using a production quota that was contrary to the express terms of the contract, and (3) awarding damages that were not supported by substantial evidence. Scheenstra cross-appealed, contending the trial court should have awarded him the profits he would have earned if his dairy had been brought into full production.

We conclude that the primary question whether Cal Dairies' board acted within the scope of its discretionary authority involves a contractual analysis that (1) determines the objective meaning of the contract and (2) applies that meaning to the facts of this case. The contract allowed the board to adopt an internal production quota system that was equitable and uniform. We conclude that the quota system adopted by the board was not equitable and uniform and, therefore, was outside the scope of discretionary authority granted by the contract. Furthermore, on the question of damages, we conclude that the trial court's calculation of what Scheenstra's quota should have been under an equitable and uniform system was consistent with the terms of the contract and the damages awarded were supported by substantial evidence.

We therefore affirm the judgment.

FACTS

The facts set forth below are taken primarily from the trial court's statement of decision, which incorporates nearly all of the trial court's tentative decision.

Background

Scheenstra is a third generation dairy operator. Cal Dairies is a California agricultural cooperative organized as a nonprofit cooperative association, without capital stock, pursuant to chapter 1, division 20, of the Food and Agricultural Code. Cal Dairies' articles of incorporation also state that it "is a membership corporation ...." Cal Dairies was formed in 1999 by the merger of three predecessor agricultural cooperatives. Three generations of Scheenstra's family were members of Cal Dairies or its predecessors.

The purpose of Cal Dairies is to market members' milk to the best advantage of the members. Cal Dairies has an 18-member board of directors. All directors are dairy owner-members of Cal Dairies. The board exercises its powers as set forth in Cal Dairies' bylaws (Bylaws).

A person or business that wishes to become a member of Cal Dairies submits an application, which the board accepts or rejects. In the application, the member agrees to be bound by the Bylaws as they exist and as they may be amended. Cal Dairies and Scheenstra agree that the Bylaws constitute the contract between them, which contract sometimes is referred to as the member agreement.

In 2001, Scheenstra was a member of Cal Dairies with a dairy in Tipton. He was considering expansion, which he could have done at the Tipton dairy without a new application and without the consent of, or advanced notice to, Cal Dairies.

Scheenstra Expansion

In 2002, Scheenstra purchased approximately 600 acres in Wasco as a potential site for a new dairy. Shortly thereafter, Scheenstra talked about his plans for a new dairy with Lynn McPhetridge, his field man and Cal Dairies' designated link to Scheenstra. Scheenstra told McPhetridge that (1) he planned a 4,100 cow dairy, milking three times a day; (2) the dairy would be stocked with fresh heifers*fn1 and would not reach full milk production until about two years after milking started; and (3) he expected to start production in 2005.

Scheenstra told McPhetridge that he was seeking financing for the anticipated $30 million development cost, and that he wanted to be sure he had a "home" for the milk before he committed to the investment. McPhetridge told Scheenstra that "it would not be a problem."

On October 5, 2004, Scheenstra submitted his application to Cal Dairies for membership for the Wasco dairy. Later that month, the board approved the membership, stating it would become effective on September 1, 2005, and including the note: "Plus 150,000 lbs." The note, which came from McPhetridge's supervisor, was intended to indicate anticipated production level for informational purposes and was not a production limit.

Scheenstra had problems obtaining governmental clearances and permits for the new dairy and its completion was delayed. Scheenstra kept McPhetridge advised at all times of the status of the dairy development.

Eventually, Scheenstra's new dairy was built in two phases, with two milking parlors. Production on the first phase began in December 2006, with fresh heifers. The minutes of the December 19, 2006, Cal Dairies board meeting noted for informational purposes only that Scheenstra's new dairy would start operations on December 19, 2006, and further noted "Plus 290,000 lbs."

In June 2007, the second parlor was completed and it was stocked with fresh heifers in November 2007. By the time of trial in January 2010, these cows had reached full production.

Oversupply of Milk

In the fall of 2007, the board began considering the need to reduce milk production by its members. The board had anticipated that its new Visalia plant would be in operation by then, but it did not start until February 2008. Also, some large customers had reduced their purchases from Cal Dairies and some members, using gains from high milk prices in 2007, had expanded their herds and production.

At its November 27, 2007, meeting, the board approved two new members with production totaling over 36,000 pounds and then placed a 90-day moratorium on accepting new dairies. In addition, the board directed staff both to (1) review recently approved members and compare their actual production with the member indicated and approved anticipated full production and (2) survey long standing members to see what expansion they already had in process (for which no board approval was required).

The staff review resulted in a finding that there was an increase of 1.5 million pounds from the previously stated anticipated production to the actual production for the relatively new members, and an additional 2.0 million pounds for established dairies in the process of expanding. These additional 3.5 million pounds would put Cal Dairies well above its handling capacity.

The board also was aware that there was an industry-wide oversupply of milk and other cooperatives had adopted programs to reduce member production.

Adoption of Quota System

The board decided to exercise its discretionary authority granted in section 7.3 of the Bylaws and institute a program to restrict supply and keep deliveries within Cal Dairies' capacity to handle. Cal Dairies' decision to adopt an internal production quota system is not challenged in this lawsuit.

To implement such a system under the Bylaws, the board is required to assign an internal production quota (i.e., a base) to each member and to treat milk delivered by the member in excess of that quota as having a lesser value.

The board considered setting the base at the February 2008 production and at the highest 2007 production, but rejected both because those amounts exceeded Cal Dairies' capacity. At its February 26, 2008, meeting, the board voted against a motion to set the base at December 2007 production plus five percent, an amount which also appears to have been in excess of Cal Dairies' capacity. Eric Erba, Cal Dairies' senior vice president of government and producer relations, and senior staff prepared a proposed "Supply Management Program" for presentation to the board. This proposal set the base at the 2007 average daily production. Later at that meeting, the board passed a motion to approve a program that (1) used the average daily production for 2007 as the base, (2) allowed members to apply for adjustments because of hardship and, (3) established a hardship committee to review requested adjustments. The program was to become effective April 1, 2008, and expire after six months unless renewed by the board.

The board's February 26, 2008, minutes indicated that Cal Dairies' milk handling capacity at the time was 48,130,000 pounds per day. In comparison, the March and April 2008 board minutes include a projection that the milking handling capacity was 49,630,000 pounds per day. This amount was also set forth in trial exhibit 24, a staff write-up of the hardship appeals.

The staff write-up also stated the average daily production for 2007 was 47,858,498 pounds per day. With upward adjustments (414,498 pounds) that annualized the production from 13 dairies that operated only part of the year, the production figure was raised to 48,272,996 pounds per day. The trial court noted that this adjusted 2007 production figure barely exceeded Cal Dairies' stated capacity in early 2008, which was 48,130,000 pounds per day.

At the time the board adopted the supply management program, it knew (1) there were dairies with declining production and allocating a base using an annual average would provide those dairies with a base in excess of their actual production and such excess base would be a saleable asset; (2) there were a number of dairies, including Scheenstra's, with increasing production, to the extent of approximately 3.5 million pounds;*fn2 (3) Scheenstra's dairy, to which the formula allocated a base or quota of 202,000 pounds, had an anticipated production of 290,000 pounds and an actual December 2007 production of 261,764 with an upward curve; and (4) the base allocation would not account properly for dairies with increasing production.*fn3 Nevertheless, the board decided to defer these "most difficult" cases to the hardship committee established at the February 26, 2008, board meeting.

Hardship Committee and Recommended Allocation Adjustments

By letter dated February 26, 2008, from Cal Dairies' chief executive officer, members were advised that if "a member contends that he will incur an extreme hardship, the Board or its representative upon written request of the member, may review the member's allocation and may readjust such allocation in a manner that is fair and just." No basis for possible review other than "extreme hardship" was stated.

Cal Dairies notified Scheenstra by letter dated March 4, 2008, that his base allocation was 202,000 pounds per day and that any milk delivered in excess of the allocation would be charged the costs incurred in shipping, handling, selling, disposing and accounting for the handling of such milk. The letter again advised Scheenstra that he could submit "for consideration" arguments regarding "extreme hardship."

Scheenstra phoned the chief executive officer and his field man McPhetridge to complain. On March 24, 2008, he filed a request for additional base allocation with the hardship committee. McPhetridge agreed that the facts stated in Scheenstra's letter to the hardship committee were accurate.

The hardship committee consisted of three non-board members familiar with the dairy business. The committee's power was limited to making a recommendation to the board. The committee was given an allowance of 1.7 million additional pounds it could allocate among those claiming hardship

The hardship committee met for the first time on March 26, 2008, and developed criteria for the consideration of member requests. Members were not told what the criteria were before their requests were required to be submitted.*fn4

One of the hardship categories concerned any dairy of which the original production base allocation (1) was less than 90 percent of the dairy's February 2008 production and (2) no significant increase in milk production would be expected within the next six months. If the criteria were met, the dairy would be approved for an additional production base to bring the dairy's base allocation to 90 percent of February 2008 production.

Another hardship category was based on whether the committee could verify that (1) the dairy had made a substantial financial commitment to a facility in 2007 with the expectation of significant milk production, or (2) the dairy had begun initial operations as a previously board-approved, newly acquired dairy in 2007 and was allocated significantly less production base than (a) was previously approved by the board or (b) the dairy's current production. If these criteria were met, the base would be increased to equal 80 percent of the volume of milk that the committee projected the dairy would be producing in six months.

Scheenstra originally was placed in the latter category (80% of projected production), but the committee felt more comfortable moving him to the category providing for 90 percent of February production, even though it would give Scheenstra a smaller adjustment. The committee allocated an additional 5,816 gallons (about 50,000 pounds) to Scheenstra's base, for a total of 252,000 pounds per day. At the time, Scheenstra was producing 287,757 pounds per day. Cal Dairies notified Scheenstra of the new allocation by letter dated April 3, 2008.

At its April 22, 2008, meeting, the board voted to endorse the hardship committee's methods and recommendations for additional allocations. The committee had recommended increasing the allocations about 1,250,000 pounds, which was significantly less that the 1,700,000 pounds allotted to the committee.

Appeals from Hardship Committee Decision

Cal Dairies advised its members in an April 30, 2008, letter that they could appeal the committee's decision, but limited the appeal to whether the committee properly applied its own criteria. Also, the members were informed what the criteria were for the first time. The persons handling the appeals were Erba and Mr. Korsmeier, a former chief executive officer.

In a letter dated May 13, 2008, Scheenstra appealed the committee's recommendation. He argued his dairy would not be economically viable if it had to reduce its anticipated production of 319,800 pounds per day by 20 percent and that such a reduction would result in extreme financial hardship.

Erba and Korsmeier recommended 11 dairies for an increase totaling of 75,990 pounds, but did not recommend an increase for Scheenstra. At its May 27, 2008, meeting, the board approved these recommendations. Cal Dairies advised Scheenstra that his appeal was denied by letter dated May 30, 2008.

Scheenstra asked to meet directly with the board and, by letter dated July 1, 2008, was told that he would be given five minutes at the July 22, 2008, meeting. Scheenstra presented a letter and spoke to the board. Erba's memo to the board recommended that Scheenstra's appeal be denied, stating that it did not have much merit. The memo erroneously stated that Scheenstra's dairy "was Board approved at 150,000 lbs" when his membership was accepted in 2004. Erba also referred to the 290,000 pounds noted in the minutes for the December 2006 board meeting and stated that the board did not take any action to approve this increase in milk production.

Cal Dairies advised Scheenstra by letter dated July 24, 2008, that his assigned base "cannot be adjusted at this time."

During this process, Scheenstra met with the chief executive officer of Cal Dairies and offered to take his over-allocation milk elsewhere. The chief executive officer told him that he could not because the contract required him to deliver all of his milk to Cal Dairies and if he took any milk elsewhere there would be a penalty of 25 percent of the value of that milk owed to Cal Dairies. Scheenstra also asked if he could take all of his milk elsewhere. Again, he was told that he could not and that he could terminate the agreement only by notice before his member anniversary date and the agreement would continue until a year from that anniversary date. Scheenstra gave such notice and his "out" date was December 2010.

Scheenstra considered buying "base" from members who received an allocation in excess of their actual production, but made a reasoned business judgment that it was not cost-effective and would not in fact mitigate his losses.

As a result of the supply management program, Scheenstra (1) did not take his dairy up to the full designed capacity of 4,100 milking cows; (2) did not proceed with his planned third milking;*fn5 and (3) did not replace his culls, which reduced his milking herd. Despite these efforts, Scheenstra incurred penalties of $368,312.76 on the "overproduction" delivered from April 2008 through May 2009. Cal Dairies deducted the penalties from Scheenstra's milk payments.

After exhausting all available remedies with Cal Dairies, Scheenstra brought this lawsuit.

PROCEEDINGS

In January 2009, Scheenstra filed a complaint for breach of a written contract, breach of the covenant of good faith and fair dealing, and negligent misrepresentation.

A court trial was held in January 2010 and the trial court issued a tentative decision on February 2, 2010. The court found that there was no misrepresentation and, thus, rejected Scheenstra's negligent misrepresentation claim. The court ruled that the causes of action for breach of contract and for breach of the covenant of good faith and fair dealing presented a single breach of contract issue, with only contract remedies available. After analyzing the terms of the contract and facts of the case, the trial court concluded that Cal Dairies "breached its contractual obligation to implement any supply management program equitably, uniformly, and based upon representative years of production."

With respect to damages, the trial court concluded that the correct measure was "the difference between the money [Scheenstra] received under the improper formula, and what he would have received under a proper uniform, equitable plan." The court directed the parties to submit posttrial briefs addressing how the proper amount of damages should be ascertained and stating their position as to what that amount should be.*fn6

On February 24, 2011, the trial court issued its statement of decision, which incorporated its tentative decision from the previous February and set forth the trial court's determination of damages and interest.

The first step in the court's damages calculation concerned Cal Dairies' handling capacity. The court found that, as of March 25, 2008, Cal Dairies' milk ...


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