[EDITOR'S NOTE: This case is unpublished as indicated by the issuing court.] JOAN A. MADDEN, J.:
In sequence number 001, defendant Affiliated FM Insurance Company moves, pursuant to CPLR 327 and 3211 (a) (1) (4)(7), and (10), for an order dismissing the amended complaint with prejudice on a variety of grounds, including forum non conveniens, prior action pending, and failure to join an indispensable party. In sequence number 003, defendant National City Bank moves, pursuant to CPLR (a) (4) and (10), for an order dismissing the amended complaint, and awarding National City Bank reimbursement of litigation costs and reasonable attorneys' fees that it incurred in defending this action.
Motion sequence numbers 001 and 003 are consolidated herein for purposes of disposition.
In this action, plaintiff Zul Capital, LLC, a Delaware corporation doing business in New York, seeks to recover insurance proceeds allegedly due it under a property damage insurance policy issued by Affiliated FM, a Michigan insurance company. Zul Capital is part of a family of interrelated corporate entities, including non-parties Northern Group, Inc. and FN Building LLC, which own, control, or manage commercial buildings throughout the United States. Northern Group, a Delaware corporation, is the sole member of FN Building, a Delaware limited liability company and the record owner of the building insured under the Affiliated FM policy. FN Building is a subsidiary of Zul Capital.
On May 23, 2006, FN Building executed a $22.5 million promissory note in favor of National City Bank, and Northern Group executed an absolute and unconditional guarantee of FN Building's payment obligations under the note. The note is secured by a mortgage on the insured building, a 25-story office building located in Detroit, Michigan, known as the First National Building.
Zul Capital purchased the insurance policy in compliance with the terms of the mortgage and amended mortgage. The amended mortgage requires FN Building to keep the building insured against loss or damage by fire or flood, to name National City Bank as a beneficiary under such policy, and to pledge the insurance proceeds to National City Bank as collateral securing FN Building's obligations under the note and amended mortgage ( see Amended Mortgage, ¶ 5 [a]).
The relevant one-year policy term commenced June 30, 2009. In relevant part, the policy provides that the insurer, Affiliated FM must pay on a claim within 60 days after it receives proof of loss and the amount of the loss is ascertained, either by written agreement between it and the insured, or by the filing of an award.
FN Building defaulted on its payment obligations under the promissory note in February 2009, when the note matured.
On August 16, 2009, the building suffered extensive flood damage and lost power when a janitorial sink into which the building's cooling tower condensation line drained became clogged.
On August 25, 2009, National City Bank commenced an action in Michigan against FN Building and Northern Group in which it seeks to enforce the note and guarantee, and seeks judicial foreclosure and appointment of a receiver over the building to collect the rents due from tenants and to repair the damage caused by the flood ( see National City Bank v FN Bldg., LLC, Cir Ct, Wayne County, Mich, case No. 09-021031-CK [the Michigan action]).
By letter dated September 3, 2009, FN Building assigned its rights to the insurance proceeds arising from the loss caused by the August 2009 flood to Zul Capital, FN Building's parent and the owner of the insurance policy. On September 10, 2009, Zul Capital submitted to Affiliated FM a claim arising out of the August 2009 flood, that included a sworn statement in proof of loss requesting partial advance payment of insurance proceeds in the amount of $500,000. Affiliated FM advanced Zul Capital the requested amount. On September 29, 2009, Zul Capital delivered to Affiliated FM a second sworn statement in proof of loss, requesting the amount of $835,684.57, in partial advance payment.
On September 24, 2009, National City Bank executed a general release in favor of FN Building's predecessors, successors, assigns, officers, employees, and agents, including Zul Capital, forever releasing them from all claims that may arise in connection with the Michigan action, including any right or claim to the insurance proceeds. The release further provides that neither FN Building nor Northern Group constitutes a released party.
By order dated September 25, 2009, the Michigan action court granted National City Bank's motion and appointed Finsilver/Friedman Management Corporation, a Michigan corporation, as receiver over the mortgage collateral, including the building, rents, and insurance proceeds (the receivership order). Pursuant to the receivership order, the receivership became effective immediately.
Subsequently, Affiliated FM advised Zul Capital and Finsilver/Friedman (the receiver) that they had asserted competing claims to the insurance proceeds, and that Affiliated FM was not able to determine which of them was entitled to receive payment. Affiliated FM further advised that, upon adjustment of the claim and a determination identifying the proper recipient, it would promptly pay on the claim.
Meanwhile, on October 16, 2009, Zul Capital commenced the action at bar against Affiliated FM, and, on November 2, 2009, served and filed an amended complaint joining National City Bank as a direct defendant. In the complaint, Zul Capital seeks an order declaring that it is entitled to receive additional insurance proceeds of at least $835,684.57 stemming from the August 2009 flood, pursuant to the terms of the Affiliated FM policy. Zul Capital also asserts claims for breach of contract and breach of the implied covenant of good faith and fair dealing, and seeks to recover compensatory damages.
Both defendants now seek to dismiss this action on the related grounds of forum non conveniens, the pendency of the Michigan action, and failure to join a necessary party, contending that the factual and legal issues presented here are able to be resolved more completely in the Michigan action.
In opposition, Zul Capital contends that New York is the more convenient forum for resolution of its claims, and that, inasmuch as it and movants were not named as parties in the Michigan action until November 6, 2009, some three weeks after commencement of the instant action, the instant action is the prior pending action.
It is well-settled that New York courts "need not entertain causes of action lacking a substantial nexus with New York" ( Martin v Mieth, 35 NY2d 414, 418). "The common-law doctrine of forum non conveniens . . . permits a court to stay or dismiss such actions where it is determined that the action, although jurisdictionally sound, would be better adjudicated elsewhere" ( Islamic Republic of Iran v Pahlavi, 62 NY2d 474, 478-479, cert denied 469 US 1108; see CPLR 327 [a]). A motion to dismiss or stay on the ground of forum non conveniens is subject to the discretion of the trial court, and no single factor is controlling ( id. at 479). Among the factors a court should consider are "the burden on the New York courts, the potential hardship to the defendant, and the unavailability of an alternative forum in which plaintiff may bring suit" ( id.). Other relevant factors include the situs of the transactions at issue, the residence of the parties, the location of witnesses and evidence, and the substantive law governing the parties' dispute ( see Blueye Navigation, Inc. v Den Norske Bank, 239 AD2d 192, 192 [1st Dept 1997]). "The burden rests upon the defendant challenging the forum to demonstrate relevant private or public interest factors which militate against accepting the litigation" ( Islamic Republic of Iran v Pahlavi, 62 NY2d at 479).
Moreover, in order to avoid duplicative litigation and inconsistent judgments, CPLR 3211 (a) (4) permits the court to dismiss an action or claim where there is pending an action commenced close in time to the New York action that is between substantially the same parties, arises out of the same transaction, involves the same causes of action, and offers more complete relief than does the New York action ( see Continental Ins. Co. v Polaris Indus. Partners, L.P., 199 AD2d 222, 222-223 [1st Dept 1993]).
All the relevant factors militate in favor of dismissal of this action. In both the Michigan action and the action at bar, the parties, including Zul Capital, seek a judicial determination identifying the entity entitled to receive the insurance proceeds flowing from the August 2009 flood property damage claim, in accordance with the terms of the Affiliated FM policy. The Michigan action court took jurisdiction of the subject matter of the dispute on August 25, 2009, approximately seven weeks prior to Zul Capital's commencement of the action at bar on October 16, 2009.
The Michigan court appointed the receiver, a Michigan company, pursuant to Michigan law, over the insured building, which is located in Michigan. The Michigan action receivership order was issued, with the consent of all parties, including FN Building and Northern Group, Zul Capital's affiliates, approximately three weeks before Zul Capital commenced the action here. The receivership order defines the scope of the receiver's authority to take complete control over the receivership property to include the mortgage collateral, which includes all insurance proceeds ( see Receivership Order §§ 1.2, 1.4 [r], 6.1 [b] [I]). Thus, the Michigan action court receivership order forms the basis of the receiver's competing claim to recover the subject insurance proceeds from Affiliated FM.
Statewide Disaster Restoration, Inc., an intervener in the Michigan action, has asserted claims there against Zul Capital to compel it to disgorge the $500,000 partial advance payment of the insurance proceeds that it received, and to pay Statewide $486,684.71 from the disgorged funds in reimbursement of the repair work that it performed in the insured building, as a result of the August 2009 flood damage.
In addition, in the Michigan action, National City Bank alleges that Zul Capital has failed to use the $500,000 advance that it received under the Affiliated FM policy to make repairs to the building, and requests that Zul Capital be directed to disgorge the insurance proceeds. The court notes that National City Bank has a colorable claim to the insurance proceeds, by virtue of FN Building's assignment in the amended mortgage of its rights to the collateral to the Bank and the Bank's perfected security interest in the building's fixtures, equipment, and other personal property, including insurance proceeds.
Contrary to Zul Capital's contention, the receiver is not acting as an agent for National City Bank in the Michigan action. Pursuant to both New York law and Michigan law, a receiver appointed in a foreclosure action is an officer of the court, not an agent for the mortgagee or the owner, and the receiver's duty and obligation is to preserve and operate the receivership property within the confines of the order of appointment and any subsequent order or authorization granted by the appointing court ( see Jacynicz v 73 Seaman Assocs., 270 AD2d 83, 85 [1st Dept], l v denied 95 NY2d 761 [2000]; Ypsilanti Fire Marshal v Kircher, 273 Mich App 496, 528, 730 NW2d 481, 502-503 [Mich App 2007]; MCL 600.2926).
Moreover, Zul Capital has failed to join an indispensable party, the receiver appointed by the Michigan action court, and it appears that the receiver is not amenable to this court's jurisdiction.
Pursuant to CPLR 3211 (a) (10), the court may dismiss an action if the court cannot proceed in the absence of an entity or person who should be a party to the action. In determining whether an unnamed party is indispensable, the court must consider a number of acts, including whether the plaintiff has another, effective remedy should the action be dismissed; whether prejudice to the defendants or the unnamed party will accrue, unless the party is joined; whether and by whom prejudice might have been avoided; the feasibility of a protective order; and whether an effective judgment may be rendered in the absence of the party not joined ( see du Pont-De Bie v Tredegar Trust Co., 61 AD3d 610, 611-612 [1st Dept], lv denied 13 NY3d 708; Lewis v Proctor Gamble, Inc., 18 Misc 3d 1110[A], 2007 NY Slip Op 52488[U], *2-3 [Sup Ct, NY County 2007]; CPLR 1001 [a], 1003, 3211 [a] [10]).
The receiver is a necessary party here. As discussed above, the receivership order issued in the Michigan action provides that neither FN Building nor Northern Group has any rights to the income, including insurance proceeds, generated by the building, after September 25, 2009, the effective date of the receivership order, and transfers those rights to the receiver. The receiver's obligation to marshal all the receivership property, including the proceeds payable under the Affiliated FM policy as a result of the August 2009 flood, will be substantially affected, if the action at bar should continue in the absence of the receiver. In the amended complaint, Zul Capital seeks a judicial declaration that "[t]he Receiver is not entitled to the insurance proceeds and has inappropriately made a demand on [Affiliated FM] for the disbursement of the insurance proceeds" (Amended Complaint, ¶ 46). Thus, a complete and final adjudication of the rights of the parties cannot be had without joinder of the receiver.
The court notes that it appears unlikely that it may acquire personal jurisdiction over the receiver. The receiver is a Michigan corporation that maintains its principal place of business in Michigan. Zul Capital has not come forward with any evidence that demonstrates the existence of personal jurisdiction over the receiver, nor does it allege that such jurisdiction exists. Zul Capital does not represent that it has sought permission from the Michigan action court to commence legal action against the receiver, as required by the receivership order.
Contrary to Zul Capital's contentions, the September 3, 2009 assignment to Zul Capital by FN Building of its rights to receive the insurance proceeds and National City Bank's release of Zul Capital from claims associated with the Michigan action do not, in the circumstances presented here, destroy the receiver's interest in the policy proceeds, or relegate the receiver to the status of a mere bystander. The validity and enforceability of the assignment and release pursuant to the terms of the amended mortgage and the receivership order go directly to the crux of the receiver's claim to the insurance proceeds. Any decision by this court about the validity and scope of the assignment would necessarily implicate the receiver's rights, and these questions have already been presented to the Michigan action court for resolution ( see National City Bank v FN Bldg., LLC, Cir Ct, Wayne County, Mich, Jan. 26, 2010, Tr, at 25:18 to 26:7, Murphy, J., case No. 09-021031-CK).
Moreover, in denying Zul Capital's motion to dismiss National City Bank's second amended complaint, the Michigan action court found that:
the appointment of the receiver is equitable in nature. The release didn't waive FN's obligations under the mortgage. The mortgage spells out exactly how the insurance proceeds are to be disbursed. Disbursements must be made for the benefit of the building.
The receiver must take action to preserve and maintain the building. Its obligations [go] to lienholders but primarily [go] to the tenants in possession.
The receiver isn't just an agent of the Bank exclusively. Its obligations [are] to preserve the property. It isn't bound by the actions of the Bank. The receiver may properly proceed against Zul regarding the insurance proceeds
( id. at 22:15 to 23:10).
The Michigan action court also found that sufficient contacts with the state of Michigan existed to support the exercise of personal jurisdiction over Zul Capital, and that there existed no basis to transfer the matter to a New York court.
Zul Capital has also failed to join FN Building and Northern Group, both necessary parties. As the property's mortgage holder and the guarantor of the promissory note, respectively, both of these entities appear to have an interest in the outcome of this dispute. In addition, Northern Group is listed as a named insured on the Affiliated FM insurance policy, and is the sole member of FN Building, the owner of the insured building.
For the foregoing reasons, the action is dismissed. Dismissal is warranted where, as here, the New York courts lack jurisdiction over a necessary party and all indispensable parties can, or are, joined in an alternative forum ( see Horwitz v Sax, 16 AD3d 161, 161 [1st Dept 2005]). Proceeding without the receiver is not feasible; a complete and effective judgment cannot be rendered without the receiver's presence. All necessary parties asserting competing claims to the insurance proceeds, including Zul Capital and the receiver, are present in the Michigan action.
That branch of National City Bank's motion for reimbursement of the costs of litigation, including attorneys' fees, is denied. "Attorneys' fees and disbursements are incidents of litigation and the prevailing party may not collect them from the loser unless an award is authorized by agreement between the parties or by statute or court rule" ( A. G. Ship Maintenance Corp. v Lezak, 69 NY2d 1, 5). National City Bank has failed to demonstrate the existence of such an agreement or statute.
Accordingly, it is
ORDERED that motion sequence number 001 is granted and the amended complaint is dismissed in its entirety as against defendant Affiliated FM Insurance Company, with costs and disbursements to defendant as taxed by the Clerk of the Court, and the Clerk is directed to enter judgment accordingly in favor of defendant; and it is further
ORDERED that motion sequence number 003 is granted and the amended complaint is dismissed in its entirety as against defendant National City Bank, with costs and disbursements to defendant as taxed by the Clerk of the Court, and the Clerk is directed to enter judgment accordingly in favor of defendant; and it is further
ORDERED that defendants shall serve a copy of this order with notice of entry upon the County Clerk (Room 141B) and the Clerk of the Trial Support Office (Room 158), who are directed to mark the court's records accordingly.
strictly, with all doubts resolved in favor of taxation.'"
Dial Corp. v. Iowa Dep't of Revenue, 634 N.W.2d 643, 646 (Iowa 2001) (quoting
Heartland Lysine, Inc. v. State, 503 N.W.2d 587, 588 (Iowa 1993)). Sherwin-Williams, as the party relying on the exemption, bears the burden of proving it is entitled to the benefit of the exemption.
See id.
V. Discussion of "Manufacturer" Definition.
We commence our discussion by determining whether the term "manufacturer" is ambiguous. "A statute is ambiguous if reasonable minds could differ or be uncertain as to the meaning of the statute." Carolan v. Hill, 553 N.W.2d 882, 887 (Iowa 1996); accord 2A Norman J. Singer J.D. Shambie Singer, Statutes and Statutory Construction § 46:4, at 179 (7th ed. 2007) [hereinafter " Sutherland Statutory Construction"] ("A statute is ambiguous when it is capable of being understood by reasonably well-informed persons in two or more different senses."). "Ambiguity may arise from specific language used in a statute or when the provision at issue is considered in the context of the entire statute or related statutes." Midwest Auto. Ill, LLC v. Iowa Dep't of Transp., 646 N.W.2d 417, 425 (Iowa 2002); accord State v. McCullah, 787 N.W.2d 90, 94 (Iowa 2010) ("Ambiguity arises in two ways — either from the meaning of specific words or `from the general scope and meaning of the statute when all of its provisions are examined.'" (quoting Carolan, 553 N.W.2d at 887)).
It is significant that the legislature has chosen to define the word "manufacturer" as used in the manufacturing exemption. "We recognize the legislature `may act as its own lexicographer.' When it does so, we are normally bound by the legislature's own definitions." State v. Fischer, 785 N.W.2d 697, 702 (Iowa 2010) (quoting Henrich v. Lorenz, 448 N.W.2d 327, 332 (Iowa 1989)). Under these circumstances, "`the common law and dictionary definitions which may not coincide with the legislative definition must yield to the language of the legislature.'" Hornby v. State, 559 N.W.2d 23, 25 (Iowa 1997) (quoting State v. Steenhoek, 182 N.W.2d 377, 379 (Iowa 1970)). Therefore, this court is obligated to apply the statutory definition of "manufacturer" as written, absent an ambiguity in that definition.
The department has not directed this court to any language in the statutory definition that is capable of being reasonably understood to require that a "manufacturer" be principally engaged in the business of manufacturing. Rather, it relies on this court's decision in Associated General Contractors of Iowa v. State Tax Commission, 255 Iowa 673, 123 N.W.2d 922 (1963), in which we held the term "manufacturer" as used in Iowa Code section 422.42(11) (1958) was ambiguous.
In Associated General Contractors, the tax commissioner sought to impose a use tax on a paving contractor's mixing of asphaltic concrete that it then used to pave the roadbed. 255 Iowa at 674, 123 N.W.2d at 922-23. Iowa Code section 422.43 (1958) imposed a tax on "all sales of tangible personal property . . . sold at retail in the state to consumers or users." Id. at 677, 123 N.W.2d at 924. The commissioner relied on section 422.42(11), which provided that "`a sale at retail'" included the use of "`tangible personal property by the manufacturer thereof, as building materials . . . in the performance of construction contracts or for any other purpose except for resale or processing.'" Id. at 674, 123 N.W.2d at 923 (emphasis added) (quoting Iowa Code § 422.42(11) (1958)).
At that time, the term "manufacturer" was defined in section 428.20 similarly to the current definition, and this statutory definition was, by its own terms, applicable to chapter 422. Id. at 675, 123 N.W.2d at 923; see also Iowa Code § 428.20 (1958) (defining "manufacturer" as one who adds to the value of personal property by any process of manufacturing "with a view to selling the same for gain or profit"). Prior to the legislature's enactment of section 422.42(11), this court had suggested the intent underlying the statutory definition of "manufacturer" in section 428.20
"was to exempt from taxation manufacturers who are engaged in manufacturing personal property
for sale, and not builders or `constructors' who are engaged in erecting permanent structures, such as paving, which become a permanent part of the real estate."
Id. (emphasis added) (quoting
In re Koss Constr. Co., 214 Iowa 125, 128, 241 N.W. 495, 497 (1932)).
It is clear from a reading of In re Koss Construction Co. that the factor prompting the court to hold that a paving contractor was not a "manufacturer" was that the contractor did not sell the product it manufactured. We said in our opinion,
It is apparent from the stipulation that the appellee does not make a product and sell it to some other party who in turn uses it to make a pavement. It not only "combines" the several ingredients, but it uses this combination itself in making the finished product which becomes a permanent part of the realty.
In re Koss Constr. Co., 214 Iowa at 127, 241 N.W. at 496.
The ambiguity in section 422.42(11) arose from the fact that this statute in essence provided that the manufacturer was the consumer of the manufactured product. Id. at 677, 123 N.W.2d at 924. In other words, the use contemplated in section 422.42(11) did not contemplate a sale of the manufactured personal property to another party. Yet, that statute used the defined term, "manufacturer," which this court had interpreted to contemplate a sale of the manufactured goods.
The commissioner argued the legislature used the term "manufacturer" in section 422.42(11) in a sense different than the meaning set forth in section 428.20, intending that term to encompass "one who performs construction contracts making an article for use in performance of such contracts." Id. at 676, 123 N.W.2d at 923. This court noted the ordinary meaning of "manufacturer" supported the commissioner's interpretation of the statute. Id. at 677-78, 123 N.W.2d at 924. For several reasons, however, we concluded the term "manufacturer" in section 422.42(11) had the meaning ascribed to that term in section 428.20, and therefore, the paving contractor was not a "manufacturer" and was not subject to the use tax. Id. at 680, 123 N.W.2d at 926.
We do not find our conclusion that the term "manufacturer" was ambiguous as used in section 422.42(11) to be persuasive authority for finding the term "manufacturer" ambiguous as used in the manufacturing exemption. As our decision in Associated General Contractors made apparent, there was an inherent conflict in section 422.42(11) because its express terms encompassed a use that did not include a sale, which was at odds with the statute's reference to "the manufacturer," a defined term that envisioned a sale of the manufactured goods. The department has identified no similar, inherent conflict in section 422.45(27)(a)(1). Section 422.45(27)(a)(1) exempts sales of equipment "used in processing by a manufacturer," a concept compatible with the statutory definition of "manufacturer."
Perhaps the most support for the department's position found in the Associated General Contractors opinion is the following statement by this court regarding an agency rule that referred to a "manufacturer": "The word `manufacturer' as used in [the agency rule] is used in the sense of one whose principal business is manufacturing." Id. at 679, 123 N.W.2d at 925. The basis for this conclusion is not apparent from our opinion. More importantly, however, this statement was not pertinent to our resolution of the statutory interpretation issue in that case, which depended on whether one could be a "manufacturer" if one did not intend to sell the manufactured property to another. Whether a manufacturer was only "one whose principal business is manufacturing" was not outcome determinative in that case or even pertinent to the basis for our ultimate decision. This court's observation regarding the agency rule was, therefore, dicta. See Wilson v. Farm Bureau Mut. Ins. Co., 714 N.W.2d 250, 260 (Iowa 2006) (refusing to follow reasoning expressed in prior case because it was dicta, stating reasoning was not pertinent to issue that resulted in reversal); Keystone Nursing Care Ctr. v. Craddock, 705 N.W.2d 299, 308 (Iowa 2005) (disavowing discussion of statute in prior case with respect to specific factual scenario, concluding it was dicta because claim made in prior case did not involve facts addressed in dicta).
The agency rule provided:
Where a manufacturer uses or consumes tangible personal property which has been made, compounded, fabricated or assembled by him, he is liable for either retail sales or use tax as the case may be. The measure of the tax is two per cent of the cost of the manufacture of the tangible personal property so used and consumed."
Associated Gen. Contractors, 255 Iowa at 678, 123 N.W.2d at 925 (quoting agency rule 10). The court did not explain how this language supported the conclusion that the rule refers to "one whose principal business is manufacturing."
Although the department has not demonstrated an ambiguity arising from the language of the statutory definition of "manufacturer," an ambiguity may arise from the general scope of the statute when it is considered in its entirety. As noted earlier, the department claims a literal interpretation of the statutory definition of "manufacturer" would result in application of the manufacturing exemption to businesses that typically are not viewed as being engaged in manufacturing. The department suggests such a broad application of the exemption is absurd.
This court has said that, "[w]here the language is of doubtful meaning, or where an adherence to the strict letter would lead . . . to absurdity, or to contradictory provisions, the duty of ascertaining the true meaning devolves upon the court. Case v. Olson, 234 Iowa 869, 872, 14 N.W.2d 717, 719 (1944) (emphasis added); accord Sutherland Statutory Construction § 45:12, at 101 ("It is fundamental, however, that departure from the literal construction of a statute is justified when such a construction would produce an absurd and unjust result and would clearly be inconsistent with-the purposes and policies of the act in question."). Nonetheless, we are mindful of the cautionary advice of one commentator that "the absurd results doctrine should be used sparingly because it entails the risk that the judiciary will displace legislative policy on the basis of speculation that the legislature could not have meant what it unmistakably said." Sutherland Statutory Construction § 45:12, at 105-07. The Hawaii Supreme Court articulated the proper balance in such situations when it stated:
This court has also noted that "[a]voidance of unreasonable or absurd consequences is one of several rules of construction courts apply only in case of ambiguity." Kruck v. Needles, 259 Iowa 470, 478, 144 N.W.2d 296, 301 (1966) (emphasis added). Notwithstanding this statement, we believe that, when a literal interpretation of a statute results in absurd consequences that undermine the clear purpose of the statute, an ambiguity arises.
[E]ven in the absence of statutory ambiguity, departure from literal construction is justified when such construction would produce an absurd and unjust result and the literal construction in the particular action is clearly inconsistent with the purposes and policies of the act.
Pac. Ins. Co. v. Or. Auto. Ins. Co., 53 Haw. 208, 490 P.2d 899, 901 (1971).
As noted, the department contends application of the manufacturing exemption to establishments whose principal business is retail sales produces an absurd result. The absurdity of this result is not self-evident, however. Although it may appear counterintuitive, we will not ignore clear legislative language merely because it leads to a result that seems contrary to the court's expectations. See State ex rel. Miller v. Cutty's Des Moines Camping Club, Inc., 694 N.W.2d 518, 524-25 (Iowa 2005) (relying on statutory definition, even though it was counterintuitive).
The department points out a potential contradiction, however, observing the same definition of "manufacturer" at issue here applies to property-tax issues. See generally Sutherland Statutory Construction § 46:4, at 188-89 ("Even when a statute appears unambiguous on its face it can be rendered ambiguous by its interaction with and its relation to other statutes."). Under the agency rules applicable to property taxes, the agency classifies as industrial only "manufacturing establishments." Iowa Admin. Code r. 701-71.1(6)(a). Under this rule, which we quoted previously,
[a] manufacturing establishment is a business entity in which
the primary activity consists of adding to the value of personal property by any process of manufacturing, refining, purifying, the packing of meats, or the combination of different materials with the intent of selling the product for gain or profit.
Id. (emphasis added). In contrast, the department's classification rules provide that "commercial real estate" includes land and structures "which are
primarily used or intended as a place of business where goods, wares, services, or merchandise is stored or offered
for sale at wholesale or retail." Id. r. 701-71.1(5) (emphasis added). Sherwin-Williams' retail stores are assessed for property-tax purposes as commercial real estate, not industrial real estate.
The primary-use requirement employed in classifying property as industrial or commercial makes sense because the entirety of the real estate (land, improvements, and structures) is subject to property tax. Therefore, the whole must be classified as either industrial or commercial; it cannot be both. See id. r. 701-71.1(1) ("There can be only one classification per property. An assessor shall not assign one classification to the land and a different classification to the building or separate classifications to the land or separate classifications to the building (dual classification)."). It makes sense, then, that the classification of the whole would depend on the primary use of the property
But for purposes of taxing the use of equipment located on the property, it is not absurd or illogical to impose the tax based on the use of the specific equipment as opposed to the taxpayer's use of the premises as a whole. See Heartland Lysine, Inc., 503 N.W.2d at 589 (stating "the propriety of a use tax assessment or exemption turns largely on the specific use made of the property"). Consequently, we are not convinced it would be absurd for the legislature to accord a retailer a manufacturer's exemption when specific equipment is used by the retailer in the same manner and for the same purpose as such equipment would be used by a taxpayer whose principal business is manufacturing.
Our research revealed two state agency proceedings in which a taxing authority considered the very process at issue here — the mixing of base and colorants to produce usable paint — for purposes of determining the applicability of relevant tax statutes. See The Sherwin-Williams Co. v. Comm'r of Revenue, No. C259901, 2003 WL 21040567 (Mass.App.Tax. Bd. May 9, 2003) (administrative review of decision of the commissioner of revenue); Op. Comm'r of Tax. Fin., No. TSB-A-99(21)5, 1999 WL 304816 (N.Y. Tax. Comm'r April 8, 1999) (advisory opinion of commissioner of taxation and finance). In both proceedings, Sherwin-Williams' retail outlets were given tax treatment reserved for manufacturers or manufacturing, some indication that the application of Iowa's manufacturing exemption to Sherwin-Williams' retail outlets is not absurd.
In the Massachusetts administrative proceeding, the appellate tax board ruled that Sherwin-Williams' retail stores in that state qualified as "manufacturing corporations" based on their business of "mix[ing] colorants with base paint to created colored paints" for sale. 2003 WL 21040567, at *1, *5. The facts before the board showed that "77% of Sherwin-Williams' sales are from the sale of paint, and that 80-90% of those sales are sales of colored paint produced at the retail stores." Id. at *2. The board stated these activities
fall within the broad definition ascribed to manufacturing of "change wrought through the application of forces directed by the human mind, which results in the transformation of some preexisting substance or element into something different, with a new name, nature or use."
Id. at *5 (quoting Assessors of Boston v. Comm'r of Corps. Taxation, 323 Mass. 730, 84 N.E.2d 129, 136 (1949)).
In the New York tax commissioner's advisory opinion, Sherwin-Williams asked whether its "mixing and blending machinery and equipment, and related computer equipment, used in the paint tinting process" in its company-owned retail stores were exempt from sales and use tax. 1999 WL 304816, at * 1. It relied on an exemption for "`[m]achinery or equipment for use . . . directly and predominantly in the production of tangible personal property . . . by manufacturing, processing. . . .'" Id. at *2 (quoting N.Y. Tax Law § 1115(a)(12)). The commissioner opined that "the Color Matching Systems, Automatic Colorant Dispensers, Shakers and related computer equipment [were] used directly in the production of paint for sale" and, therefore, were exempt from sales and use tax. Id. at*4.
The department also contends giving a retailer like Sherwin-Williams the benefit of the manufacturing exemption is contrary to the purpose underlying this exemption. Quoting an Oklahoma case, the department suggests "[t]he object of this exemption was undoubtedly to encourage manufacturing industries to locate in the state." Dairy Queen of Okla., Inc. v. Okla. Tax Comm'n, 205 Okla. 473, 238 P.2d 800, 802 (1951). An Arizona court, however, has suggested a broader purpose of such an exemption: "The purpose is to encourage manufacturing businesses and investment in manufacturing equipment by exempting sales of such equipment." Ariz. Dep't of Revenue v. Blue Line Distrib., Inc., 202 Ariz. 266, 43 P.3d 214, 216 (Ariz.Ct.App. 2002) (emphasis added). We cannot conclude that allowing Sherwin-Williams an exemption for its investment in equipment to process paint at its retail locations in Iowa is contrary to our legislature's purpose in adopting a manufacturing exemption. See State v. Hopkins, 465 N.W.2d 894, 896 (Iowa 1991) (stating court looks "beyond the ordinary meaning of the statutory language when a statute's literal terms are in conflict with its general purpose" (emphasis added)). A significantly stronger showing that legislative intent would be undermined by permitting an exemption under the facts of this case is required before we will ignore the statutory definition of "manufacturer." See Sutherland Statutory Construction § 46:4, at 178 ("The plain meaning of the statute is conclusive, except in a case where a literal application of the statute will produce a result demonstrably at odds with the intention of the drafters." (Emphasis added.)).
We have also examined four cases cited by the department in support of its position and conclude they are readily distinguishable. See Blue Line Distrib., 202 Ariz. 266, 43 P.3d 214; BED, Inc. v. Powers, 84 N.C.App. 292, 352 S.E.2d 265 (1987); McDonald's Corp. v. Okla. Tax Comm'n, 563 P.2d 635 (Okla. 1977); Dairy Queen of Okla., Inc., 205 Okla. 473, 238 P.2d 800. In each of these cases, retail establishments, Little Caesar's Pizza, Hardee's, McDonald's, and Dairy Queen, were denied the benefit of a manufacturing exemption from sales or use tax because they were not a manufacturer or did not engage in manufacturing within the meaning of the statutory exemption. Blue Line Distrib., 43 P.3d at 216; HED, Inc., 352 S.E.2d at 267; McDonald's Corp., 563 P.2d at 641; Dairy Queen of Okla., Inc., 238 P.2d at 802.
In the Arizona case, the exemption applied to sales of "`[machinery, or equipment, used directly in manufacturing, [and] processing . . . operations. The terms "manufacturing" [and] "processing" . . . as used in this paragraph refer to and include those operations commonly understood within their ordinary meaning.'" Blue Line Distrib., 43 P.3d at 215 (emphasis added) (quoting Ariz. Rev. Stat. § 42-5061(B)(1) (Supp. 2000)). Given the absence of a statutory definition of "manufacturing," there was no barrier to the reviewing court's acceptance of the agency's rule that interpreted the exemption as applying only to "`[manufacturing [as] the performance as a business of an integrated series of operations' that transform personal property into a different product." Id. (quoting Ariz. Admin. Code r. 15-5-120(A)). Applying this agency rule, the Arizona court concluded a Little Caesar's pizzeria is not commonly understood to be a manufacturing operation. Id. at 216.
The North Carolina exemption considered in the HED, Inc. case applied to "manufacturing industries and plants." 352 S.E.2d at 266. Like the Arizona statute, the North Carolina statute did not define these terms, so the court applied the common meaning of these words. Id. The North Carolina court reviewed decisions from other jurisdictions that had considered whether a restaurant qualifies as a manufacturer, and observed:
One discernible pattern is that when the statutes do not provide a definition of manufacturing, as is the case in North Carolina, courts tend to apply a common sense approach and conclude that a restaurant is not a manufacturer. On the other hand, when the statute does provide a definition, that definition is mechanically applied and courts conclude that a restaurant is a manufacturer.
Id. at 267. Relying on the common meaning of "manufacturing," the North Carolina court concluded a Hardee's restaurant was not a "manufacturing" industry or plant.
Id.
In Oklahoma, the manufacturing exemption is more explicit. It allowed an exemption for the use of certain machinery and equipment "`used by persons in the operation of manufacturing plants.'" McDonald's Corp., 563 P.2d at 636 (quoting Okla. Stat. tit. 68, § 1305(p) (1971)). The Oklahoma statute further states: "`The term "manufacturing plants" shall mean those establishments primarily engaged in manufacturing or processing operations, and generally recognized as such.'" Id. (emphasis added) (quoting Okla. Stat. tit. 68, § 1305(p)). Clearly, the Oklahoma court's decisions in McDonald's Corp. and Dairy Queen of Oklahoma, Inc. are readily distinguishable given the clearly expressed legislative intent that the exemption only be given to businesses primarily engaged in manufacturing. The comparable Iowa statute simply does not contain that limitation.
Some states specifically exclude certain businesses or establishments that incidentally engage in manufacturing or processing. See, e.g., Elias Bros. Restaurants, Inc. v. Treasury Dep't, 452 Mich. 144, 549 N.W.2d 837, 839 (1996) (applying exemption that excluded `the preparation of food and beverages by a retailer for retail sale'" (quoting Mich. Comp. Laws § 205.94(g))). Iowa's statutory exemption does not do so.
Finally, we state that we are also influenced by the legislative history of the manufacturing exemption. As we explained earlier in our opinion, prior to the 1997 amendment, the exemption encompassed machinery and equipment (1) "used in the manner described in section 428.20" and (2) qualifying as "real property within the scope of section 427A.1[(1)(e)]." Iowa Code § 422.45(27) (1997) (emphasis added). Section 427A.1(1)(e) referred to machinery used in "manufacturing establishments," a term not defined by the legislature. Id. § 427A.1(1)(e). The prior statute did not use the term "manufacturer" and did not otherwise unambiguously incorporate that term or its full definition into the manufacturing exemption other than to incorporate "the manner" of use of the machinery and equipment as described in section 428.20. Under the prior statute, therefore, the agency had much greater leeway in interpreting the term "manufacturing establishment" in a manner consistent with its meaning in the property-law context.
When the legislature amended the manufacturing exemption in 1997, however, it had the stated intent to broaden its applicability. To achieve this purpose, the legislature removed the reference to section 427A.1(1)(e) and its focus on "manufacturing establishments" and in its place imposed the requirement that the entity seeking the exemption be a "manufacturer" "as defined in section 428.20." We are convinced it would be contrary to the principles that guide our interpretation of legislative enactments to ignore these changes and give the exemption the same meaning with respect to the taxpayers who qualify for the exemption that this statute had prior to its amendment in 1997.
Accordingly, we reject the department's contention that only those taxpayers who are primarily engaged in manufacturing are eligible for the exemption. The department's interpretation of section 428.20 is, therefore, erroneous. We agree with the district court that Sherwin-Williams qualifies as a "manufacturer" under section 422.45(27).
VI. Direct Use of Spectrographic Color-Matching Machine.
In addition to concluding Sherwin-Williams was not a "manufacturer," the department's director ruled the spectrographic color-matching machine did not qualify for the exemption because it was not "directly and primarily used in processing" as required by section 422.45(27)(a)(1). Before we determine whether this ruling should be upheld, we address the standard applicable to our review.
A. Standard of Review. The director's decision turned on whether the color-matching machine was used "directly" in processing. The term "directly" is not defined in the statute, but is defined in an agency rule. Sherwin-Williams does not question the agency's definition of this term. Rather, the dispute between the parties with respect to the color-matching machine is the director's application of that definition to the facts of this case.
In a contested case such as the one before us, the agency has discretion in its application of the law to the facts. Iowa Ag Constr. Co. v. Iowa State Bd. of Tax Review, 723 N.W.2d 167, 174 (Iowa 2006) (holding application of law to facts in proceeding in which taxpayer sought refund of sales/use tax was vested in the discretion of the agency); see also Drake Univ. v. Davis, 769 N.W.2d 176, 183 (Iowa 2009) (holding workers' compensation commissioner had discretion to apply the law to the facts in contested-case proceeding under workers' compensation statute). Therefore, the appropriate standard of review is found in Iowa Code section 17A.19(10)(m). Iowa Ag Constr. Co., 723 N.W.2d at 174 (applying standard of review found in section 17A.19 (10)(m) to agency's application of law to facts in decision denying sales/use tax refund); see also Insituform Techs., Inc. v. Employment Appeal Bd., 728 N.W.2d 781, 801 (Iowa 2007) (applying same standard of review to agency's assessment of penalty for OSHA violation).
Section 17A.19(10)(TO) provides:
The court shall reverse, modify, or grant other appropriate relief from agency action, equitable or legal and including declaratory relief, if it determines that substantial rights of the person seeking judicial relief have been prejudiced because the agency action is any of the following:
. . . .
m. Based upon an irrational, illogical, or wholly unjustifiable application of law to fact that has clearly been vested by a provision of law in the discretion of the agency.
A decision is "irrational" when it is "not governed by or according to reason." Webster's Third New International Dictionary 1195. A decision is "illogical" when it is "contrary to or devoid of logic." Id. at 1127. A decision is "unjustifiable" when it has no foundation in fact or reason. See id. at 2902 (defining "unjustifiable" as "lacking in . . . justice"); id. at 1228 (defining "justice" as "the quality or characteristic of being just, impartial or fair"); id. (defining "just" as "conforming to fact and reason"). One commentator has suggested that the "irrational, illogical, or wholly unjustifiable" standard of review is substantively similar to "the unreasonable, arbitrary, capricious, and abuse of discretion standards." Bonfield, Amendments to Iowa Administrative Procedure Act 69.
B. Discussion. As noted, the department asserts the spectrographic color-matching machine does not qualify for the tax exemption because it is not "directly and primarily used in processing" as required by section 422.45(27)(a)(1). The color-matching machine determines the mixing formula to achieve the precise color desired. In explaining his decision that this machine did not qualify for the exemption, the director stated:
The Spectrograph machine does not come into contact with the base or final product being purchased by the customer in any way. This machine does not change the substance or color of the paint. Instead, this color eye only provides Sherwin-Williams with a formula for the color of paint desired by the customer. Consequently, . . . the Spectrograph machine is one step removed from processing and would not qualify for the exemption from Iowa sales tax under this statute.
Iowa Code section 422.45(27)(d)(5) defines processing as "a series of operations in which materials are manufactured, refined, purified, created, combined or transformed by a manufacturer, ultimately into tangible personal property." The statute does not define "directly," but an agency rule states that "[p]roperty is `directly used' only if it is used to initiate, sustain, or terminate an exempt activity." Iowa Admin. Code r. 701-18.58(1). This rule suggests three factors to consider in determining whether property is "directly used":
1. The physical proximity of the property in question to the activity in which it is used;
2. The proximity of the time of use of the property in question to the time of use of other property used before and after it in the activity involved; and
3. The active causal relationship between the use of the property in question and the activity involved.
Id. Rule 701-18.58(1) also states: "The fact that a particular piece of property may be essential to the conduct of the activity because its use is required either by law or practical necessity does not, of itself, mean that the property is directly used." The agency's definition is consistent with the dictionary meaning of "directly": "without any intervening space or time: next in order."
Webster's Third New International Dictionary 641;
see Iowa Ag Const. Co., 723 N.W.2d at 176 (noting department's definition of "directly" as used in the section 422.45(39) exemption tracked dictionary definition, citing Iowa Admin. Code r. 701-18.48(1)(e)).
Applying the agency rule and the factors deemed relevant to determining when property is "directly used" in processing, we conclude the agency's decision that the color-matching machines do not qualify for the manufacturing exemption is wholly unjustifiable. In contrast to the machinery and equipment considered in the cases cited by the department, which we discuss below, the color-matching machine plays an integral role in the actual processing of usable paint. This machine initiates the in-store process of manufacturing usable paint by selecting the formula for the customer's desired color. The color-matching machine is integrated with the mini accutinter, sending the formula directly to the mini accutinter where the proper type and amount of colorant is dispensed into the can of base paint. The color-matching machine is located in physical proximity to the mini accutinter and the mixer/shaker. The time of use of the color-matching machine is immediately prior to the tinting of the base paint. In addition, the color-matching machine has an active causal connection to the processing of the paint, dictating the type and amount of colorant and base paint used in that process. We are convinced the director's contrary conclusion does not conform to the facts and is an unreasonable application of the agency rule.
We have studied the four cases upon which the department relies to support the director's determination that the color-matching machines are not "directly used" in processing paint and find them distinguishable. In Iowa Ag Construction Co., we affirmed the denial of an exemption for a mower used to cut grass around hog confinement centers and associated sewage lagoons because it was not used directly in the production of livestock, as required by the exemption. 723 N.W.2d at 180-81. The mower was not part of the process of raising the livestock; it simply supported the ancillary environment for that process, a very different situation than that presented in the case before us.
In Heartland Lysine, this court affirmed the department's denial of an exemption for electrical equipment that regulated the flow of electricity in a lysine plant to ensure the production equipment provided the environment necessary for the manufacture of lysine. 503 N.W.2d at 590-91. The exemption at issue in that case required that the equipment "`be directly and primarily used in the manner described in section 428.20 in processing tangible personal property.'" Id. at 590 (quoting Iowa Code § 422.45(27) (1987)). Noting the electrical equipment's function was "preliminary to the actual processing," this court held the equipment did not "directly perform the manufacturing functions contemplated by section 428.20." Id. at 591. In contrast, the color-matching machine at issue in the present case initiates the tinting process by sending the required formula to the mini accutinter which then dispenses colorant into the base in accordance with that formula. See Iowa Admin. Code r. 701-18.58(1) ("Property is `directly used' only if it is used to initiate, sustain, or terminate an exempt activity." (Emphasis added.)).
A third case cited by the department, Dial Corp., 634 N.W.2d 643, involved an exemption that also had the same language as the statute at issue in the present appeal: "directly and primarily used in . . . processing." 634 N.W.2d at 647 (quoting Iowa Code § 422.45(27) (1997)). In Dial Corp., we affirmed the denial of the taxpayer's exemption request for machinery and equipment that produced usable electricity for the assembly line, holding the equipment played "no part in changing the form, context or condition" of the product being manufactured. Id. at 648-49. Citing Heartland Lysine, we also noted the equipment's "function [was] preliminary to processing, not part of it." Id. at 649 (emphasis added). As the undisputed facts in the present case show, the function of the color-matching machine is not "preliminary to processing"; rather this machine initiates the process, a function falling within the agency rule.
Finally, in Dain Manufacturing Co. v. Iowa State Tax Commission, 237 Iowa 531, 22 N.W.2d 786 (1946), we held a drill grinding machine "used to service the machinery or equipment that was being `directly' used in the actual act of processing property" was not within an exemption for equipment "directly used" in manufacturing. 237 Iowa at 538, 22 N.W.2d at 790-91. We noted the drill grinding machine "did not come in physical contact with the property that was being made salable or . . . take any part in the actual processing of that property:' Id. at 538, 22 N.W.2d at 791 (emphasis added). This case is also clearly distinguishable from the case before us in which the color-matching machine played an integral part in the actual processing of the paint.
While these cases provide some illumination of the meaning of "directly used," the department's own rule on this subject is the most pertinent to our analysis. Focusing on that rule, we conclude the department's application of its rule to the facts of this case to reach a conclusion that the color-matching machines are not "directly used" in processing salable paint has no foundation in fact or reason and is, therefore, wholly unjustifiable. Accordingly, we reverse the department's decision holding the color-matching machines are not eligible for the manufacturing exemption.
VII. Conclusion and Disposition.
We hold Sherwin-Williams qualifies for an exemption from use tax for the spectrographic color-matching machines, dispensing/tinting machines, known as mini accutinters, and the mixers/shakers used in its retail stores to process base paint and colorant into usable, salable paint. The decision of the court of appeals and the judgment of the district court are affirmed. We remand this case to the district court for remand to the department for further proceedings consistent with our opinion.
DECISION OF COURT OF APPEALS AND JUDGMENT OF DISTRICT COURT AFFIRMED; CASE REMANDED.
All justices concur except WIGGINS, J., who takes no part.