Miller, Van Dorn, Hughes & O'Connor, Richard H. McConnell and Daniel C. Miller for Defendant and Appellant.

Richard H. Peterson, Gilbert L. Harrick and Donald Mitchell for Plaintiff and Respondent.

TRAYNOR, C. J.

Defendant appeals from a judgment for plaintiff in an action for damages for injury to property under an indemnity clause of a contract. [36]

In 1960 defendant entered into a contract with plaintiff to furnish the labor and equipment necessary to remove and replace the upper metal cover of plaintiff's steam turbine. Defendant agreed to perform the work "at [its] own risk and expense" and to "indemnify" plaintiff "against all loss, damage, expense and liability resulting from ... injury to property, arising out of or in any way connected with the performance of this contract." Defendant also agreed to procure not less than $50,000 insurance to cover liability for injury to property.plaintiff was to be an additional named insured, but the policy was to contain a cross-liability clause extending the coverage to plaintiff's property.

During the work the cover fell and injured the exposed rotor of the turbine.plaintiff brought this action to recover $25,144.51, the amount it subsequently spent on repairs. During the trial it dismissed a count based on negligence and thereafter secured judgment on the theory that the indemnity provision covered injury to all property regardless of ownership.

Defendant offered to prove by admissions of plaintiff's agents, by defendant's conduct under similar contracts entered into with plaintiff, and by other proof that in the indemnity clause the parties meant to cover injury to property of third parties only and not to plaintiff's property. ^[402] Although the trial court observed that the language used was "the classic language for a third party indemnity provision" and that "one could very easily conclude that ... its whole intendment is to indemnify third parties," it nevertheless held that the "plain language" of the agreement also required defendant to indemnify plaintiff for injuries to plaintiff's property. Having determined that the contract had a plain meaning, the court refused to admit any extrinsic evidence that would contradict its interpretation.

When the court interprets a contract on this basis, it determines [37] the meaning of the instrument in accordance with the "... extrinsic evidence of the judge's own linguistic education and experience." (3 Corbin on Contracts (1960 ed.) [1964 Supp. 579, p. 225, fn. 56].) The exclusion of testimony that might contradict the linguistic background of the judge reflects a judicial belief in the possibility of perfect verbal expression. (9 Wigmore on Evidence (3d ed. 1940) 2461, p. 187.) This belief is a remnant of a primitive faith in the inherent potency ^[403] and inherent meaning of words. ^[404]

[1] The test of admissibility of extrinsic evidence to explain the meaning of a written instrument is not whether it appears to the court to be plain and unambiguous on its face, but whether the offered evidence is relevant to prove a meaning to which the language of the instrument is reasonably susceptible. (Continental Baking Co. v. Katz (1968) 68 Cal.2d 512, 520-521 [67 Cal.Rptr. 761, 439 P.2d 889]; Parsons v. Bristol Development Co. (1965) 62 Cal.2d 861, 865 [44 Cal.Rptr. 767, 402 P.2d 839]; Hulse v. Juillard Fancy Foods Co. (1964) 61 Cal.2d 571, 573 [39 Cal.Rptr. 529, 394 P.2d 65]; Nofziger v. Holman (1964) 61 Cal.2d 526, 528 [39 Cal.Rptr. 384, 393 P.2d 696]; Coast Bank v. Minderhout (1964) 61 Cal.2d 311, 315 [38 Cal.Rptr. 505, 392 P.2d 265]; Imbach v. Schultz (1962) 58 Cal.2d 858, 860 [27 Cal.Rptr. 160, 377 P.2d 272]; Reid v. Overland Machined Products (1961) 55 Cal.2d 203, 210 [10 Cal.Rptr. 819, 359 P.2d 251].)

A rule that would limit the determination of the meaning of a written instrument to its four-corners merely because it seems to the court to be clear and unambiguous, would either deny the relevance of the intention of the parties or presuppose a degree of verbal precision and stability our language has not attained. [38]

Some courts have expressed the opinion that contractual obligations are created by the mere use of certain words, whether or not there was any intention to incur such obligations. ^[405] Under this view, contractual obligations flow, not from the intention of the parties but from the fact that they used certain magic words. Evidence of the parties' intention therefore becomes irrelevant.

[2] In this state, however, the intention of the parties as expressed in the contract is the source of contractual rights and duties. ^[406] A court must ascertain and give effect to this intention by determining what the parties meant by the words they used. Accordingly, the exclusion of relevant, extrinsic, evidence to explain the meaning of a written instrument could be justified only if it were feasible to determine the meaning the parties gave to the words from the instrument alone.

If words had absolute and constant referents, it might be possible to discover contractual intention in the words themselves and in the manner in which they were arranged. Words, however, do not have absolute and constant referents. [3] "A word is a symbol of thought but has no arbitrary and fixed meaning like a symbol of algebra or chemistry, ..." (Pearson v. State Social Welfare Board (1960) 54 Cal.2d 184, 195 [5 Cal.Rptr. 553, 353 P.2d 33].) The meaning of particular words or groups of words varies with the "... verbal context and surrounding circumstances and purposes in view of the linguistic education and experience of their users and their hearers or readers (not excluding judges). ... A word has no meaning apart from these factors; much less does it have an objective meaning, one true meaning." (Corbin, The Interpretation of Words and the Parol Evidence Rule (1965) 50 Cornell L.Q. 161, 187.) [4] Accordingly, the meaning of a writing "... can only be found by interpretation [39] in the light of all the circumstances that reveal the sense in which the writer used the words. The exclusion of parol evidence regarding such circumstances merely because the words do not appear ambiguous to the reader can easily lead to the attribution to a written instrument of a meaning that was never intended. [Citations omitted.]" (Universal Sales Corp. v. California Press Mfg. Co., supra, 20 Cal.2d 751, 776 (concurring opinion); see also, e.g., Garden State Plaza Corp. v. S. S. Kresge Co. (1963) 78 N.J. Super. 485 [189 A.2d 448, 454]; Hurst v. W. J. Lake & Co. (1932) 141 Ore. 306, 310 [16 P.2d 627, 629, 89 A.L.R. 1222]; 3 Corbin on Contracts (1960 ed.) 579, pp. 412-431; Ogden and Richards, The Meaning of Meaning, op.cit supra 15; Ullmann, The Principles of Semantics, supra, 61; McBaine, The Rule Against Disturbing Plain Meaning of Writings (1943) 31 Cal.L.Rev. 145.)

[5] Although extrinsic evidence is not admissible to add to, detract from, or vary the terms of a written contract, these terms must first be determined before it can be decided whether or not extrinsic evidence is being offered for a prohibited purpose. The fact that the terms of an instrument appear clear to a judge does not preclude the possibility that the parties chose the language of the instrument to express different terms. That possibility is not limited to contracts whose terms have acquired a particular meaning by trade usage, ^[407] but exists whenever the parties' understanding of the words used may have differed from the judge's understanding.

Accordingly, rational interpretation requires at least a preliminary consideration of all credible evidence offered to [40] prove the intention of the parties. ^[408] (Civ. Code, 1647; Code Civ. Proc., 1860; see also 9 Wigmore on Evidence, op. cit. supra, 2470, fn. 11, p. 227.) Such evidence includes testimony as to the "circumstances surrounding the making of the agreement ... including the object, nature and subject matter of the writing ..." so that the court can "place itself in the same situation in which the parties found themselves at the time of contracting." (Universal Sales Corp. v. California Press Mfg. Co., supra, 20 Cal.2d 751, 761; Lemm v. Stillwater Land & Cattle Co., supra, 217 Cal. 474, 480-481.) [6] If the court decides, after considering this evidence, that the language of a contract, in the light of all the circumstances, "is fairly susceptible of either one of the two interpretations contended for ..." (Balfour v. Fresno C. & I. Co. (1895) 109 Cal. 221, 225 [41 P. 876]; see also, Hulse v. Juillard Fancy Foods Co., supra, 61 Cal.2d 571, 573; Nofziger v. Holman, supra, 61 Cal.2d 526, 528; Reid v. Overland Machined Products, supra, 55 Cal.2d 203, 210; Barham v. Barham (1949) 33 Cal.2d 416, 422-423 [202 P.2d 289]; Kenney v. Los Feliz Investment Co. (1932) 121 Cal.App. 378, 386-387 [9 P.2d 225]), extrinsic evidence relevant to prove either of such meanings is admissible. ^[409]

[7] In the present case the court erroneously refused to consider extrinsic evidence offered to show that the indemnity clause in the contract was not intended to cover injuries to plaintiff's property. Although that evidence was not necessary to show that the indemnity clause was reasonably susceptible of the meaning contended for by defendant, it was nevertheless relevant and admissible on that issue. Moreover, since that clause was reasonably susceptible of that meaning, [41] the offered evidence was also admissible to prove that the clause had that meaning and did not cover injuries to plaintiff's property. ^[410] Accordingly, the judgment must be reversed.

[8] Two questions remain that may arise on retrial. On the theory that the indemnity clause covered plaintiff's property, the trial court instructed the jury that plaintiff was entitled to recover unless all of "... the following conditions [were found] to exist:"

"1. That Pacific Gas and Electric Company continued to [42] maintain independent operation on the premises whereon the installation of the cover was in progress;"

"2. That the damage to the turbine was unrelated to the Defendant G. W. Thomas Drayage & Rigging Company, Inc.'s performance;"

"3. That the plaintiff was guilty of active, affirmative negligence; and"

"4. That such active negligence related to a matter over which the plaintiff exercised exclusive control."

The instruction was based on certain guidelines discussed in Goldman v. Ecco-Phoenix Elec. Corp. (1964) 62 Cal.2d 40, 45-46 [41 Cal.Rptr. 73, 396 P.2d 377]; Harvey Machine Co. v. Hatzel & Buehler, Inc. (1960) 54 Cal.2d 445, 448 [6 Cal.Rptr. 284, 353 P.2d 924]; and Safeway Stores, Inc. v. Massachusetts Bonding & Ins. Co. (1962) 202 Cal.App.2d 99, 112-113 [20 Cal.Rptr. 820]. Those cases do not hold, however, that all four conditions specified in the instruction must exist for the indemnitor to be relieved of liability. It is sufficient if the indemnitee's own active negligence is a cause of the harm. As stated in Markley v. Beagle (1967) 66 Cal.2d 951, 952 [59 Cal.Rptr. 809, 429 P.2d 129], "An indemnity clause phrased in general terms will not be interpreted ... to provide indemnity for consequences resulting from the indemnitee's own actively negligent acts."

To prove the amount of damages sustained, plaintiff presented invoices received from Ingersoll-Rand, the manufacturer and repairer of the turbine, the drafts by which plaintiff had remitted payment, and testimony that payment had been made. Defendant objected to the introduction of the invoices on the ground that they were hearsay. Subsequently, plaintiff called a mechanical engineer who qualified as an expert witness on the repair of turbines. On the basis of photographs of the damage after the accident, he testified that to repair the turbine it was reasonable and necessary to dismantle it completely, magnaflux all parts, replace all blades in wheels that had been damaged, reassemble the rotor, balance it, "indicate" it and centrifugate it. Similar repairs were listed in the invoices, and over objection the witness was allowed to testify that the amounts charged therefor were reasonable.

[9] Since invoices, bills, and receipts for repairs are hearsay, they are inadmissible independently to prove that liability for the repairs was incurred, that payment was made, or [43] that the charges were reasonable. (Plonley v. Reser (1960) 178 Cal.App.2d Supp. 935, 937-939 [3 Cal.Rptr. 551, 80 A.L.R.2d 911]; Menefee v. Raisch Improvement Co. (1926) 78 Cal.App. 785, 789 [248 P. 1031].) If, however, a party testifies that he incurred or discharged a liability for repairs, any of these documents may be admitted for the limited purpose of corroborating his testimony (Bushnell v. Bushnell (1925) 103 Conn. 583 [131 A. 432, 436, 44 A.L.R. 788]; Cain v. Mead (1896) 66 Minn. 195 [68 N.W. 840, 841]), and if the charges were paid, the testimony and documents are evidence that the charges were reasonable. (Dewhirst v. Leopold (1924) 194 Cal. 424, 433 [229 P. 30]; Smith v. Hill (1965) 237 Cal.App.2d 374, 388 [47 Cal.Rptr. 49]; Meier v. Paul X. Smith Corp. (1962) 205 Cal.App.2d 207, 222 [22 Cal.Rptr. 758]; Malinson v. Black (1948) 83 Cal.App.2d 375, 379 [188 P.2d 788]; Laubscher v. Blake (1935) 7 Cal.App.2d 376, 383 [46 P.2d 836]. See also Gimbel v. Laramie (1960) 181 Cal.App.2d 77, 81 [5 Cal.Rptr. 88].) Since there was testimony in the present case that the invoices had been paid, the trial court did not err in admitting them.

[10] The individual items on the invoices, however, were read, not to corroborate payment or the reasonableness of the charges, but to prove that these specific repairs had actually been made. No qualified witness was called to testify that the invoices accurately recorded the work done by Ingersoll-Rand, and there was no other evidence as to what repairs were made. This use of the invoices was error. (California Steel Buildings, Inc. v. Transport Indemnity Co. (1966) 242 Cal.App.2d 749, 759 [51 Cal.Rptr. 797]. Accord, Bushnell v. Bushnell, supra, 103 Conn. 583 [131 A. 432, 436]; Ferraro v. Public Service Ry. Co. (1928) 6 N.J. Misc. 463 [141 A. 590]; Nock v. Lloyd (1911) 32 R.I. 313 [79 A. 832, 833].) An invoice submitted by a third party is not admissible evidence on this issue unless it can be admitted under some recognized exception to the hearsay rule. ^[411]

[11] Since plaintiff's expert's testimony as to the reasonableness of the charges was based on hearsay evidence inadmissible to prove that the repairs had been made, defendant's [44] objections to it should have been sustained. "[A]n expert must base his opinion either on facts personally observed or on hypotheses that find support in the evidence." (George v. Bekins Van & Storage Co. (1949) 33 Cal.2d 834, 844 [205 P.2d 1037]. See also Kastner v. Los Angeles Metropolitan Transit Authority (1965) 63 Cal.2d 52, 58 [45 Cal.Rptr. 129, 403 P.2d 385]; Commercial Union Assur. Co. v. Pacific Gas & Electric Co. (1934) 220 Cal. 515, 524 [31 P.2d 793]; Behr v. County of Santa Cruz (1959) 172 Cal.App.2d 697, 709 [342 P.2d 987]; 2 Jones on Evidence (5th ed. 1958) 416, pp. 782-783.)

The judgment is reversed.

Peters, J., Mosk, J., Burke, J., Sullivan, J., and Peek, J., ^[412] concurred.

McComb, J., dissented.

Plaintiff's assertion that the use of the word "all" to modify "loss, damage, expense and liability" dictates an all inclusive interpretation is not persuasive. If the word "indemnify" encompasses only third-party claims, the word "all" simply refers to all such claims. The use of the words "loss," "damage," and "expense" in addition to the word "liability" is likewise inconclusive. These words do not imply an agreement to reimburse for injury to an indemnitee's property since they are commonly inserted in third-party indemnity clauses, to enable an indemnitee who settles a claim to recover from his indemnitor without proving his liability. (Carpenter Paper Co. v. Kellogg (1952) 114 Cal.App.2d 640, 651 [251 P.2d 40]. Civ. Code, 2778, provides: "1. Upon an indemnity against liability ... the person indemnified is entitled to recover upon becoming liable; 2. Upon an indemnity against claims, or demands, or damages, or costs ... the person indemnified is not entitled to recover without payment thereof; ...")

The provision that defendant perform the work "at his own risk and expense" and the provisions relating to insurance are equally inconclusive. By agreeing to work at its own risk defendant may have released plaintiff from liability for any injuries to defendant's property arising out of the contract's performance, but this provision did not necessarily make defendant an insurer against injuries to plaintiff's property. Defendant's agreement to procure liability insurance to cover damages to plaintiff's property does not indicate whether the insurance was to cover all injuries or only injuries caused by defendant's negligence.

[402] 1. Although this offer of proof might ordinarily be regarded as too general to provide a ground for appeal (Evid. Code, 354, subd. (a); Beneficial etc. Ins. Co. v. Kurt Hitke & Co. (1956) 46 Cal.2d 517, 522 [297 P.2d 428]; Stickel v. San Diego Elec. Ry. Co. (1948) 32 Cal.2d 157, 162-164 [195 P.2d 416]; Douillard v. Woodd (1942) 20 Cal.2d 665, 670 [128 P.2d 6]), since the court repeatedly ruled that it would not admit extrinsic evidence to interpret the contract and sustained objections to all questions seeking to elicit such evidence, no formal offer of proof was required. (Evid. Code, 354, subd. (b); Beneficial etc. Ins. Co. v. Kurt Hitke & Co., supra, 46 Cal.2d 517, 522; Estate of Kearns (1950) 36 Cal.2d 531, 537 [225 P.2d 218].)

[403] 2. E.g., "The elaborate system of taboo and verbal prohibitions in primitive groups; the ancient Egyptian myth of Khern, the apotheosis of the words, and of Thoth, the Scribe of Truth, the Giver of Words and Script, the Master of Incantations; the avoidance of the name of God in Brahmanism, Judaism and Islam; totemistic and protective names in mediaeval Turkish and Finno-Ugrian languages; the misplaced verbal scruples of the 'Precieuses'; the Swedish peasant custom of curing sick cattle smitten by witchcraft, by making them swallow a page torn out of the psalter and put in dough. ...' from Ullman, The Principles of Semantics (1963 ed.) 43. (See also Ogden and Richards, The Meaning of Meaning (rev. ed. 1956) pp. 24- 47.)

[404] 3. " 'Rerum enim vocabula immutabilia sunt, homines mutabilia,' " (Words are unchangeable, men changeable) from Dig. XXXIII, 10, 7, 2, de sup. leg. as quoted in 9 Wigmore on Evidence, op. cit. supra, 2461, p. 187.

[405] 4. "A contract has, strictly speaking, nothing to do with the personal, or individual, intent of the parties. A contract is an obligation attached by the mere force of law to certain acts of the parties, usually words, which ordinarily accompany and represent a known intent." (Hotchkiss v. National City Bank of New York (S.D.N.Y. 1911) 200 F. 287, 293. See also C. H. Pope & Co. v. Bibb Mfg. Co. (2d Cir. 1923) 290 F. 586, 587; see 4 Williston on Contracts (3d ed. 1961) 612, pp. 577-578, 613, p. 583.)

[406] 5. "A contract must be so interpreted as to give effect to the mutual intention of the parties as it existed at the time of contracting, so far as the same is ascertainable and lawful." (Civ. Code, 1636; see also Code Civ. Proc., 1859; Universal Sales Corp. v. California Press Mfg. Co. (1942) 20 Cal.2d 751, 760 [128 P.2d 665]; Lemm v. Stillwater Land & Cattle Co. (1933) 217 Cal. 474, 480 [19 P.2d 785].)

[407] 6. Extrinsic evidence of trade usage or custom has been admitted to show that the term "United Kingdom" in a motion picture distribution contract included Ireland (Ermolieff v. R.K.O. Radio Pictures, Inc. (1942) 19 Cal.2d 543, 549-552 [122 P.2d 3]); that the word "ton" in a lease meant a long ton or 2,240 pounds and not the statutory ton of 2,000 pounds (Higgins v. California Petroleum etc. Co. (1898) 120 Cal. 629, 630-632 [52 P. 1080]); that the word "stubble" in a lease included not only stumps left in the ground but everything "left on the ground after the harvest time" (Callahan v. Stanley (1881) 57 Cal. 476, 477-479); that the term "north" in a contract dividing mining claims indicated a boundary line running along the "magnetic and not the true meridian" (Jenny Lind Co. v. Bower (1858) 11 Cal. 194, 197-199) and that a form contract for purchase and sale was actually an agency contract. (Body-Steffner Co. v. Flotill Products (1944) 63 Cal.App.2d 555, 558-562 [147 P.2d 84]). See also Code Civ. Proc., 1861; Annot., 89 A.L.R. 1228; Note (1942) 30 Cal.L.Rev. 679.)

[408] 7. When objection is made to any particular item of evidence offered to prove the intention of the parties, the trial court may not yet be in a position to determine whether in the light of all of the offered evidence, the item objected to will turn out to be admissible as tending to prove a meaning of which the language of the instrument is reasonably susceptible or inadmissible as tending to prove a meaning of which the language is not reasonably susceptible. In such case the court may admit the evidence conditionally by either reserving its ruling on the objection or by admitting the evidence subject to a motion to strike. (See Evid. Code, 403.)

[409] 8. Extrinsic evidence has often been admitted in such cases on the stated ground that the contract was ambiguous (e.g., Universal Sales Corp. v. California Press Mfg. Co., supra, 20 Cal.2d 751, 761). This statement of the rule is harmless if it is kept in mind that the ambiguity may be exposed by extrinsic evidence that reveals more than one possible meaning.

[410] 9. The court's exclusion of extrinsic evidence in this case would be error even under a rule that excluded such evidence when the instrument appeared to the court to be clear and unambiguous on its face. The controversy centers on the meaning of the word "indemnify" and the phrase "all loss, damage, expense and liability." The trial court's recognition of the language as typical of a third party indemnity clause and the double sense in which the word "indemnify" is used in statutes and defined in dictionaries demonstrate the existence of an ambiguity. (Compare Civ. Code, 2772, "Indemnity is a contract by which one engages to save another from a legal consequence of the conduct of one of the parties, or of some other person," with Civ. Code, 2527, "Insurance is a contract whereby one undertakes to indemnify another against loss, damage, or liability, arising from an unknown or contingent event." Black's Law Dictionary (4th ed. 1951) defines "indemnity" as "A collateral contract or assurance, by which one person engages to secure another against an anticipated loss or to prevent him from being damnified by the legal consequences of an act or forbearance on the part of one of the parties or of some third person." Stroud's Judicial Dictionary (2d ed. 1903) defines it as a "Contract ... to indemnify against a liability. ..." One of the definitions given to "indemnify" by Webster's Third New International Dict. (1961 ed.) is "to exempt from incurred liabilities.")

[411] 10. It might come in under the business records exception (Evid. Code, 1271) if "... supported by the testimony of a witness qualified to testify as to its identity and the mode of its preparation." (California Steel Buildings, Inc. v. Transport Indemnity Co., supra, 242 Cal.App.2d 749, 759.)

[412] *. Retired Associate Justice of the Supreme Court sitting under assignment by the Chairman of the Judicial Council.

[565] Bradley S. Phillips, Munger, Tolles & Olson, Los Angeles, Cal., for plaintiff-appellant.

Robert W. Fischer, Jr., Dewey, Ballantine, Bushby, Palmer & Wood, Los Angeles, Cal., for defendant-appellee.

Before HUG, ALARCON and KOZINSKI, Circuit Judges.

KOZINSKI, Circuit Judge:

The parties to this transaction are, by any standard, highly sophisticated business people: Plaintiff is a partnership consisting of an insurance company and two of Los Angeles' largest and most prestigious law firms; defendant is another insurance company. Dealing at arm's length and from positions of roughly equal bargaining strength, they negotiated a commercial loan amounting to more than $56 million. The contract documents are lengthy and detailed; they squarely address the precise issue that is the subject of this dispute; to all who read English, they appear to resolve the issue fully and conclusively.

Plaintiff nevertheless argues here, as it did below, that it is entitled to introduce extrinsic evidence that the contract means something other than what it says. This case therefore presents the question whether parties in California can ever draft a contract that is proof to parol evidence. Somewhat surprisingly, the answer is no.

Facts

The facts are rather simple. Sometime in 1983 Security First Life Insurance Company and the law firms of Mitchell, Silberberg & Knupp and Manatt, Phelps, Rothenberg & Tunney formed a limited partnership for the purpose of constructing an office building complex on Olympic Boulevard in West Los Angeles. The partnership, Trident Center, the plaintiff herein, sought and obtained financing for the project from defendant, Connecticut General Life Insurance Company. The loan documents provide for a loan of $56,500,000 at 12 1/4 percent interest for a term of 15 years, secured by a deed of trust on the project. The promissory note provides that "[m]aker shall not have the right to prepay the principal amount hereof in whole or in part" for the first 12 years. Note at 6. In years 13-15, the loan may be prepaid, subject to a sliding prepayment fee. The note also provides that in case of a default during years 1-12, Connecticut General has the option of accelerating the note and adding a 10 percent prepayment fee.

Everything was copacetic for a few years until interest rates began to drop. The 12 1/4 percent rate that had seemed reasonable in 1983 compared unfavorably with 1987 market rates and Trident started looking for ways of refinancing the loan to take advantage of the lower rates. Connecticut General was unwilling to oblige, insisting that the loan could not be prepaid for the first 12 years of its life, that is, until January 1996.

Trident then brought suit in state court seeking a declaration that it was entitled to prepay the loan now, subject only to a 10 percent prepayment fee. Connecticut General promptly removed to federal court and brought a motion to dismiss, claiming that the loan documents clearly and unambiguously precluded prepayment during the first 12 years. The district court agreed and dismissed Trident's complaint. The court also "sua sponte, sanction[ed] the plaintiff for the filing of a frivolous lawsuit." Order of Dismissal, No. CV 87-2712 JMI (Kx), at 3 (C.D. Cal. June 8, 1987). Trident appeals both aspects of the district court's ruling.

Discussion

I

Trident makes two arguments as to why the district court's ruling is wrong. First, it contends that the language of the contract is ambiguous and proffers a construction that it believes supports its position. Second, Trident argues that, under California law, even seemingly unambiguous contracts are subject to modification by parol or extrinsic evidence. Trident faults the district court for denying it the opportunity to present evidence that the contract language did not accurately reflect the parties' intentions.

A. The Contract

As noted earlier, the promissory note provides that Trident "shall not have the right to prepay the principal amount hereof in whole or in part before January 1996." Note at 6. It is difficult to imagine language that more clearly or unambiguously expresses the idea that Trident may not unilaterally prepay the loan during its first 12 years. Trident, however, argues that there is an ambiguity because another clause of the note provides that "[i]n the event of a prepayment resulting from a default hereunder or the Deed of Trust prior to January 10, 1996 the prepayment fee will be ten percent (10%)." Note at 6-7. Trident interprets this clause as giving it the option of prepaying the loan if only it is willing to incur the prepayment fee.

We reject Trident's argument out of hand. In the first place, its proffered interpretation would result in a contradiction between two clauses of the contract; the default clause would swallow up the clause prohibiting Trident from prepaying during the first 12 years of the contract. The normal rule of construction, of course, is that courts must interpret contracts, if possible, so as to avoid internal conflict. See Brobeck, Phleger & Harrison v. Telex Corp., 602 F.2d 866, 872 (9th Cir.), cert. denied, 444 U.S. 981, 100 S.Ct. 483, 62 [567] L.Ed.2d 407 (1979) (California law); Cal.Civ.Proc.Code § 1858 (West 1983); 4 S. Williston, A Treatise on the Law of Contracts § 618, at 714-15 (3d ed. 1961); id. § 624, at 825.

In any event, the clause on which Trident relies is not on its face reasonably susceptible to Trident's proffered interpretation. Whether to accelerate repayment of the loan in the event of default is entirely Connecticut General's decision. The contract makes this clear at several points. See Note at 4 ("in each such event [of default], the entire principal indebtedness, or so much thereof as may remain unpaid at the time, shall, at the option of Holder, become due and payable immediately" (emphasis added)); id. at 7 ("[i]n the event Holder exercises its option to accelerate the maturity hereof ..." (emphasis added)); Deed of Trust ¶ 2.01, at 25 ("in each such event [of default], Beneficiary may declare all sums secured hereby immediately due and payable ..." (emphasis added)). Even if Connecticut General decides to declare a default and accelerate, it "may rescind any notice of breach or default." Id. ¶ 2.02, at 26. Finally, Connecticut General has the option of doing nothing at all: "Beneficiary reserves the right at its sole option to waive noncompliance by Trustor with any of the conditions or covenants to be performed by Trustor hereunder." Id. ¶ 3.02, at 29.

Once again, it is difficult to imagine language that could more clearly assign to Connecticut General the exclusive right to decide whether to declare a default, whether and when to accelerate, and whether, having chosen to take advantage of any of its remedies, to rescind the process before its completion.

Trident nevertheless argues that it is entitled to precipitate a default and insist on acceleration by tendering the balance due on the note plus the 10 percent prepayment fee.^[1] The contract language, cited above, leaves no room for this construction. It is true, of course, that Trident is free to stop making payments, which may then cause Connecticut General to declare a default and accelerate. But that is not to say that Connecticut General would be required to so respond.^[2] The contract quite clearly gives Connecticut General other options: It may choose to waive the default, or to take advantage of some other remedy such as the right to collect "all the income, rents, royalties, revenue, issues, profits, and proceeds of the Property." Deed of Trust ¶ 1.18, at 22.^[3] By interpreting the contract [568] as Trident suggests, we would ignore those provisions giving Connecticut General, not Trident, the exclusive right to decide how, when and whether the contract will be terminated upon default during the first 12 years.

In effect, Trident is attempting to obtain judicial sterilization of its intended default. But defaults are messy things; they are supposed to be. Once the maker of a note secured by a deed of trust defaults, its credit rating may deteriorate; attempts at favorable refinancing may be thwarted by the need to meet the trustee's sale schedule; its cash flow may be impaired if the beneficiary takes advantage of the assignment of rents remedy; default provisions in its loan agreements with other lenders may be triggered. Fear of these repercussions is strong medicine that keeps debtors from shirking their obligations when interest rates go down and they become disenchanted with their loans.^[4] That Trident is willing to suffer the cost and delay of a lawsuit, rather than simply defaulting, shows far better than anything we might say that these provisions are having their intended effect. We decline Trident's invitation to truncate the lender's remedies and deprive Connecticut General of its bargained-for protection.

B. Extrinsic Evidence

Trident argues in the alternative that, even if the language of the contract appears to be unambiguous, the deal the parties actually struck is in fact quite different. It wishes to offer extrinsic evidence that the parties had agreed Trident could prepay at any time within the first 12 years by tendering the full amount plus a 10 percent prepayment fee. As discussed above, this is an interpretation to which the contract, as written, is not reasonably susceptible. Under traditional contract principles, extrinsic evidence is inadmissible to interpret, vary or add to the terms of an unambiguous integrated written instrument. See 4 S. Williston, supra p. 5, § 631, at 948-49; 2 B. Witkin, California Evidence § 981, at 926 (3d ed. 1986).

Trident points out, however, that California does not follow the traditional rule. Two decades ago the California Supreme Court in Pacific Gas & Electric Co. v. G.W. Thomas Drayage & Rigging Co., 69 Cal.2d 33, 442 P.2d 641, 69 Cal.Rptr. 561 (1968), turned its back on the notion that a contract can ever have a plain meaning discernible by a court without resort to extrinsic evidence. The court reasoned that contractual obligations flow not from the words of the contract, but from the [569] intention of the parties. "Accordingly," the court stated, "the exclusion of relevant, extrinsic, evidence to explain the meaning of a written instrument could be justified only if it were feasible to determine the meaning the parties gave to the words from the instrument alone." 69 Cal.2d at 38, 442 P.2d 641, 69 Cal.Rptr. 561. This, the California Supreme Court concluded, is impossible: "If words had absolute and constant referents, it might be possible to discover contractual intention in the words themselves and in the manner in which they were arranged. Words, however, do not have absolute and constant referents." Id. In the same vein, the court noted that "[t]he exclusion of testimony that might contradict the linguistic background of the judge reflects a judicial belief in the possibility of perfect verbal expression. This belief is a remnant of a primitive faith in the inherent potency and inherent meaning of words." Id. at 37, 442 P.2d 641, 69 Cal.Rptr. 561 (citation and footnotes omitted).^[5]

Under Pacific Gas, it matters not how clearly a contract is written, nor how completely it is integrated, nor how carefully it is negotiated, nor how squarely it addresses the issue before the court: the contract cannot be rendered impervious to attack by parol evidence. If one side is willing to claim that the parties intended one thing but the agreement provides for another, the court must consider extrinsic evidence of possible ambiguity. If that evidence raises the specter of ambiguity where there was none before, the contract language is displaced and the intention of the parties must be divined from self-serving testimony offered by partisan witnesses whose recollection is hazy from passage of time and colored by their conflicting interests. See Delta Dynamics, Inc. v. Arioto, 69 Cal.2d 525, 532, 446 P.2d 785, 72 Cal.Rptr. 785 (1968) (Mosk, J., dissenting). We question whether this approach is more likely to divulge the original intention of the parties than reliance on the seemingly clear words they agreed upon at the time. See generally Morta v. Korea Ins. Co., 840 F.2d 1452, 1460 (9th Cir.1988).

Pacific Gas casts a long shadow of uncertainty over all transactions negotiated and executed under the law of California. As this case illustrates, even when the transaction is very sizeable, even if it involves only sophisticated parties, even if it was negotiated with the aid of counsel, even if it results in contract language that is devoid of ambiguity, costly and protracted litigation cannot be avoided if one party has a strong enough motive for challenging the contract. While this rule creates much business for lawyers and an occasional windfall to some clients, it leads only to frustration and delay for most litigants and clogs already overburdened courts.

It also chips away at the foundation of our legal system. By giving credence to the idea that words are inadequate to express concepts, Pacific Gas undermines the basic principle that language provides a meaningful constraint on public and private conduct. If we are unwilling to say that parties, dealing face to face, can come up with language that binds them, how can we send anyone to jail for violating statutes consisting of mere words lacking "absolute and constant referents"? How can courts ever enforce decrees, not written in language understandable to all, but encoded in a dialect reflecting only the "linguistic background of the judge"? Can lower courts ever be faulted for failing to carry out the mandate of higher courts when "perfect verbal expression" is impossible? Are all attempts to develop the law in a reasoned and principled fashion doomed to failure as "remnant[s] of a primitive faith in the inherent potency and inherent meaning of words"?

Be that as it may. While we have our doubts about the wisdom of Pacific Gas, we have no difficulty understanding its meaning, even without extrinsic evidence to guide us. As we read the rule in California, [570] we must reverse and remand to the district court in order to give plaintiff an opportunity to present extrinsic evidence as to the intention of the parties in drafting the contract.^[6] It may not be a wise rule we are applying, but it is a rule that binds us. Erie R.R. Co. v. Tompkins, 304 U.S. 64, 78, 58 S.Ct. 817, 822, 82 L.Ed. 1188 (1938).^[7]

II

In imposing sanctions on plaintiff, the district court stated:

Pursuant to Fed.R.Civ.P. 11, the Court, sua sponte, sanctions the plaintiff for the filing of a frivolous lawsuit. The Court concludes that the language in the note and deed of trust is plain and clear. No reasonable person, much less firms of able attorneys, could possibly misunderstand this crystal-clear language. Therefore, this action was brought in bad faith.

Order of Dismissal at 3. Having reversed the district court on its substantive ruling, we must, of course, also reverse it as to the award of sanctions.^[8] While we share the district judge's impatience with this litigation, we would suggest that his irritation may have been misdirected. It is difficult to blame plaintiff and its lawyers for bringing this lawsuit. With this much money at stake, they would have been foolish not to pursue all remedies available to them under the applicable law. At fault, it seems to us, are not the parties and their lawyers but the legal system that encourages this kind of lawsuit. By holding that language has no objective meaning, and that contracts mean only what courts ultimately say they do, Pacific Gas invites precisely this type of lawsuit.^[9] With the benefit of 20 years of hindsight, the California Supreme Court may wish to revisit the issue. If it does so, we commend to it the facts of this case as a paradigmatic example of why the traditional rule, based on centuries of experience, reflects the far wiser approach.

Conclusion

The judgment of the district court is REVERSED. The case is REMANDED for reinstatement of the complaint and further proceedings in accordance with this opinion. The parties shall bear their own costs on appeal.

[1] Trident's position is that the prepayment fee must either be a fee imposed as part of an "alternative method of performance" or "a liquidated damages provision specifying the amount of damages payable by Trident in the event that it defaults by prepaying the ... loan." Appellant's Reply Brief at 12-13. Trident contends that if the prepayment fee is instead read as a provision for liquidated damages triggered by any default whatsoever, it would be invalid as a penalty because it would not be a reasonable estimate of the likely injury to Connecticut General resulting from most types of default: "[I]f, for example, Trident were to default on the payment of a single installment, a fee of 10% of the outstanding balance of the loan would not qualify as a valid liquidated damages payment." Id. at 8.

California law is unsettled on this point and it may be that Connecticut General could not enforce the 10 percent fee in the event of certain defaults by Trident. See generally 1 H. Miller & M. Starr, Current Law of California Real Estate § 3:71 n. 12 (Supp.1987). But the contract assigns to Connecticut General alone the right to decide whether and under what circumstances to seek the prepayment fee. Connecticut General may well attempt to enforce the fee only in circumstances where it is valid. What the contract clearly does not provide is what Trident suggests. If the parties had wanted to give Trident the option of prepaying with a 10 percent fee, they certainly could have done so expressly.

[2] See 1 H. Miller & M. Starr, supra note 1, § 3:62, at 428 ("[w]hen there is a default, acceleration does not occur automatically. It is merely a contractual option given to beneficiary for his benefit, and acceleration only occurs when the beneficiary affirmatively elects to declare the balance of the principal and interest due" (emphasis original)); id. § 3:69, at 449.

[3] Trident contends that acceleration must follow a default because, under California's one-form-of-action rule, Cal.Civ.Proc.Code § 726 (West Supp.1988), Connecticut General has but one remedy in the event of default, namely, to accelerate the loan and foreclose. Even if Trident's premise were accurate, its conclusion would not follow. Connecticut General need not seek any remedy at all for an event of default; it could simply wait and see. Connecticut General would thereby retain the valuable right of choosing when to declare a default: It could, for example, choose to wait until interest rates rise and Trident's refinancing prospects are no longer attractive.

In any event, Trident's premise is wrong. Section 726 does not prevent Connecticut General from exercising certain of its non-foreclosure remedies under the deed of trust. "By its own terms section 726 applies only where the creditor-beneficiary has brought an action against the debtor-trustor to recover a debt or to enforce some right secured by a deed of trust. It does not apply in other situations." Passanisi v. Merit McBride Realtors, Inc., 236 Cal.Rptr. 59, 65, 190 Cal.App.3d 1496 (1987) (citation omitted) (emphasis added). Thus, for example, "a private sale under the power contained in the trust deed is not a judicial foreclosure within section 726." Walker v. Community Bank, 10 Cal.3d 729, 736, 518 P.2d 329, 111 Cal.Rptr. 897 (1974) (emphasis original). Similarly, Connecticut General could enforce the assignment of rents provision in the deed of trust by demanding that all of Trident's tenants make rental payments to Connecticut General. See Johns v. Moore, 168 Cal.App.2d 709, 712, 336 P.2d 579 (1959); 1 H. Miller & M. Starr, supra note 1, §§ 3:35 at 376-77, 3:69 at 449. This would not implicate section 726 because it would not be an action to enforce any right under the deed of trust. Since the deed of trust contains an absolute assignment of rents — "Trustor hereby absolutely and unconditionally assigns and transfers to Beneficiary all the income, rents ... and proceeds of the Property ...," Deed of Trust at 22, ¶ 1.18 — Connecticut General has a perfected right to require that tenants pay it directly once it has given them notice of a default by Trident. See 1 H. Miller & M. Starr, § 3:35, at 377; In re Charles D. Stapp of Nevada, Inc., 641 F.2d 737, 739 (9th Cir.1981); Great West Life Assurance Co. v. Rothman, 490 F.2d 1141, 1143-45 (9th Cir.1974).

[4] This provides a symmetry with the situation where interest rates go up and it is the lender who is stuck with a loan it would prefer to turn over at market rates. In an economy where interest rates fluctuate, it is all but certain that one side or the other will be dissatisfied with a long-term loan at some time. Mutuality calls for enforcing the contract as written no matter whose ox is being gored.

[5] In an unusual footnote, the court compared the belief in the immutable meaning of words with "`[t]he elaborate system of taboo and verbal prohibitions in primitive groups ... [such as] the Swedish peasant custom of curing sick cattle smitten by witchcraft, by making them swallow a page torn out of the psalter and put in dough....'" Id. n. 2 (quoting Ullman, The Principles of Semantics 43 (1963)).

[6] Nothing we say should be construed as foreclosing Connecticut General from moving for summary judgment after completion of discovery; given the unambiguous language of the contract itself, such a motion would succeed unless Trident were to come forward with extrinsic evidence sufficient to render the contract reasonably susceptible to Trident's alternate interpretation, thereby creating a genuine issue of fact resolvable only at trial.

[7] Trident also claims, in the alternative, that it is entitled to rescind the loan agreement because it entered into the contract based on a unilateral mistake of law of which Connecticut General was aware but failed to correct. Implausible though this allegation may be, it nevertheless states a claim for unilateral mistake under California law. Cal.Civ.Code §§ 1578, 1689 (West 1982, 1985). This cause of action therefore must also be reinstated by the district court for later resolution on summary judgment or at trial.

[8] The district court apparently awarded attorney's fees under both Rule 11 and the terms of the promissory note. Trident contends that the note's attorney's fees provision is inapplicable to this case. In light of our resolution of the merits, we express no view on this issue.

[9] This is not to say, of course, that all lawsuits seeking to challenge the interpretation of facially unambiguous contracts are necessarily immune from imposition of sanctions. Even under Pacific Gas, a party urging an interpretation lacking any objectively reasonable basis in fact might well be subject to sanctions for bringing a frivolous lawsuit.

2 Hurl. & C. 906, 159 Eng. Rep. 375 (Ex. 1864)

Raffles
v.
Wichelhaus.

To a declaration for not accepting Surat cotton which the defendant bought of the plaintiff " to arrive ex Peerless from Bombay," the defendant pleaded that he meant a ship called the "Peerless" which sailed from Bombay, in October, and the plaintiff was not ready to deliver any cotton which arrived by that ship, but only cotton which arrived by another ship called the " Peerless," which sailed from Bombay in December. -Held, on demurrer, that the plea was a good answer.

DECLARATION. -For that it was agreed between the plaintiff and the defendants, to wit, at Liverpool, that the plaintiff should sell to the defendants, and the defendants buy of the plaintiff, certain goods, to wit, 125 bales of Surat cotton, guaranteed middling fair merchant's Dhollorah, to arrive ex "Peerless" from Bombay; and that the cotton should be taken from the quay, and that the defendants would pay the plaintiff for the same at a certain rate, to wit, at the rate of 17¼ d. per pound, within a certain time then agreed upon after the arrival of the said goods in England. -Averments: that the said goods did arrive by the said ship from Bombay in England, to wit, at Liverpool, and the plaintiff was then and there ready, and willing and offered to deliver the said goods to the defendants, &c. Breach: that the defendants refused to accept the said goods or pay the plaintiff for them.

Plea. -That the said ship mentioned in the said agreement was meant and intended by the defendants to be the ship called the "Peerless," which sailed from Bombay, to wit, in October; and that the plaintiff was not ready and willing and did not offer to deliver to the defendants any bales of cotton which arrived by the last mentioned ship, but instead thereof was only ready and willing and offered to deliver to the defendants 125 bales of Surat cotton which arrived by another and different ship, which was also called the "Peerless," and which sailed from Bombay, to wit, in December.

Demurrer, and joinder therein.

Milward, in support of the demurrer. -The contract was for the sale of a number of bales of cotton of a particular description, which the plaintiff was ready to deliver. It is immaterial by what ship the cotton was to arrive, so that it was a ship called the "Peerless." The words " to arrive ex 'Peerless,'" only mean that if the vessel is lost on the voyage, the contract is to be at an end. [Pollock, C. B. -It would be a question for the jury whether both parties meant the same ship called the "Peerless."] That would be so if the contract was for the sale of a ship called the "Peerless;" but it is for the sale of cotton on board a ship of that name. [Pollock, C. B. -The defendant only bought that cotton which was to arrive by a particular ship. It may as well be said, that if there is a contract for the purchase of certain goods in warehouse A, that is satisfied by the delivery of goods of the same description in warehouse B.] In that case there would be goods in both warehouses; here it does not appear that the plaintiff had any goods on board the other "Peerless." [Martin, B. -It is imposing on the defendant a contract different from that which he entered into. Pollock, C. B. -It is like a contract for the purchase of wine coming from a particular estate in France or Spain, where there are two estates of that name.] The defendant has no right to contradict by parol evidence a written contract good upon the face of it. He does not impute misrepresentation or fraud, but only says that he fancied the ship was a different one. Intention is of no avail, unless stated at the time of the contract. [Pollock, C. B. -One vessel sailed in October and the other in December.] The time of sailing is no part of the contract.

Mellish (Cohen with him), in support of the plea. -There is nothing on the face of the contract to shew that any particular ship called the "Peerless" was meant; but the moment it appears that two ships called the "Peerless" were about to sail from Bombay there is a latent ambiguity, and parol evidence may be given for the purpose shewing that the defendant meant one "Peerless" and the plaintiff another. That being so, there was no consensus ad idem, and therefore no binding contract. -He was then stopped by the Court.

Per CURIAM. There must be judgment for the defendants.

Judgment for the defendants. Pollock, C. B., Martin, B., and Pigott, B. Jan. 27.

Sheldon M. Markel, Buffalo, N. Y., for appellant.

Paul R. Braunsdorf, Rochester, N. Y. (Harris, Beach, Wilcox, Rubin & Levey, Rochester, N. Y., of counsel), for appellee.

Before OAKES, GURFEIN and MESKILL, Circuit Judges.

GURFEIN, Circuit Judge:

This is an action for breach of contract, entertained in the District Court for the Western District of New York (Hon. Harold P. Burke, Judge) by virtue of the diversity of citizenship of the parties.^[1] [163] 28 U.S.C. § 1332. Plaintiff-appellant, Flower City Painting Contractors, Inc. ("Flower") is a newly formed painting contracting firm in Rochester, New York, owned and managed by black minority personnel. Defendant-appellee, Gumina Construction Company ("Gumina") is an Ohio company with its principal place of business in Lorain, Ohio.

Gumina entered into a prime contract with the FIGHT Village Housing Development Fund Company, Inc., for the construction of a garden type apartment project called "FIGHT Village," on March 12, 1973. The project was federally funded and developed under the auspices of the Federal Housing Authority of the Department of Housing and Urban Development ("HUD"). Pursuant to Executive Order No. 11246, which prohibits employment discrimination by Government contractors, HUD regulations and the terms of the prime contract required the prime contractor to undertake an affirmative action program that included efforts to recruit and hire minority subcontractors. HUD Contract Compliance Handbook 8000.6 at 27 (1972). Compliance was a condition of the contract.

Part of Gumina's affirmative action obligation was satisfied by its award of a subcontract for painting in the FIGHT Village to Flower on April 16, 1973. As indicated by the cost breakdown summary sheet attached to the prime contract, the total anticipated cost of painting and decorating the entire FIGHT project was to be $101,000. This estimation of cost was significant, since an excess of cost in one aspect could have caused a cost overrun that would cut into the prime contractor's profits. The subcontract executed with Flower provided that Flower was to be paid $98,499.84 for its work, a sum that was roughly only $2500 less than the maximum allotted for painting and decorating the entire project.

The terms of the Gumina-Flower subcontract included the language of Flower's original bid on the subcontract which was incorporated in haec verba as Schedule A of the subcontract. That Schedule reads as follows:

"SCHEDULE A"

   The painting of the above mentioned project in accordance   with the painting specifications and plans for this project.1. One bedroom units     $*335.00 per unit   $*17,420.002. Two bedroom units     $*371.00 per unit   $*28,196.003. Three bedroom units   $*428.00 per unit   $*29,960.004. Four bedroom units    $*477.58 per unit   $*22,923.84                           A Total of:       $*98,499.84  Please note: price given reflects no bonding requirement and               a non-union job operation.

The subcontract also incorporated by reference the prime contract, drawings, addenda, and specifications, as well as modifications subsequently issued. Indeed, Schedule A made specific reference to the contract specifications and plans in defining the scope of the subcontractor's work. The subcontract further provided that the subcontractor would "faithfully observe all requirements and conditions set forth by plans and specifications on file at the F.H.A. Office in Buffalo, N.Y. . . .," and that these documents were to be "available for inspection by the Subcontractor upon his request."

On March 18, 1974, nearly one year after Flower entered into the subcontract, it asserted in a letter to Gumina that the contract required Flower to paint interior walls of the individual apartment units only and that Flower was not obligated to paint exteriors or common buildings.^[2] On March 25, 1974, Flower received from Gumina a copy of Article II of the subcontract with additional explanatory language typed in as a reminder of obligations which Gumina insisted that Flower had under its subcontract. This notation stated: "It is further [164] understood that this contract includes all exterior work, (encompasses all work, within specs and drawings) except exterior siding. The community building is also a part of this contract." On March 29, 1974, the president of Flower submitted to Gumina an itemization of additional costs for this "exterior work," claiming that it was not required to do the painting of apartment laundry rooms, storage rooms, and hallways, as well as of exterior doors, trim and certain common buildings.^[3] On April 4, 1974 (the letter was erroneously dated March 4), Gumina responded to Flower's demand for extra payments by reiterating that the exterior work specified by Flower as requiring additional payment, was work which had already been agreed upon. Gumina, in the same letter, though the work had not yet begun, cancelled the contract. Appellant sued Gumina for damages.

At trial, Gumina defended its removal of Flower on the ground that the latter had misinterpreted the contract, and that by insisting upon extra payment for the painting of exteriors Flower had refused to comply with the terms of — and had thereby repudiated — the existing subcontract. Flower maintained the converse position: that Gumina had unilaterally attempted to enlarge the scope of Flower's obligation under the contract by requiring work outside the individual "unit" interiors. The trial court accepted the contract interpretation offered by Gumina. It found, despite Flower's contentions that it had been hired to paint only the walls in the "units," that, on the contrary, neither the subcontract nor the specifications incorporated by reference excluded common hallways, storage areas, laundry rooms, or exterior surfaces of FIGHT Village. The court determined that the specifications required the painting of "`all surfaces except those specifically excluded.'"

The court held that Flower committed a breach of contract "by asking for extra pay for work it was obligated to do under its contract." It found that "Flower City unequivocally declared its refusal to perform according to the contract" and that "cancellation was the proper response by Gumina Construction." It was on that basis that the complaint was dismissed after trial.

On this appeal, the defendant contends that an alternative ground upon which to uphold dismissal of Flower's suit is that no subcontract was actually formed between Flower and Gumina because there was no "meeting of the minds." This issue was not expressly considered by the District Court, although the assumption that a contract existed as interpreted by Gumina is implicit in its ruling.

If we hold Flower strictly to its obligation to recognize that the specifications were part of the subcontract, then its claim for additional payment as a condition of performance was unjustified, as Judge Burke found. This, in turn, would raise the question whether a refusal to perform part of an alleged contract, except in accordance with one's own interpretation, is a repudiation. If so, we would then have to decide whether such a repudiation by Flower was sufficiently material to be treated as a justification for unilateral rescission by Gumina. Thus, if we adopted the approach of the court below that there was a contract, even aside from the issue of what were its obligations, we would have considerable difficulty in weighing the correctness of the conclusion of law that there had been a repudiation sufficient to justify an immediate unilateral rescission.

We think, however, that this thorny problem need not be reached. Rather, we have concluded — using the objective criterion of judgment — that there was no meeting of the minds in the first instance and that, hence, there never was a contract enforcible by either party.

Viewing the subcontract itself as written, both Flower's and Gumina's interpretations of the document are plausible. The description of the subject matter of the contract in [165] Schedule A in terms of "units" and the fact that the total bid listed is the aggregate of the bids on the individual units suggest that nothing more was required to be painted than the actual units themselves. On the other hand, the incorporation of the specifications with their delineation of exterior painting chores and the use of the word "project" in Schedule A indicate that the scope of the work encompassed all painting in FIGHT City.

Resolution of this ambiguity might be effected by construing the contract on the assumption that it incorporated the habitual or customary practice of the construction industry in Rochester, New York, that painting subcontracts be awarded on an entire project basis.

Such usage, if operative, may be proved by parol, as was done here. See, e. g., Division of Triple T Service, Inc. v. Mobil Oil Corp., 60 Misc.2d 720, 730-31, 304 N.Y.S.2d 191 (Sup.Ct.1969). But proof of the usage is not enough by itself to establish the meaning of the contract, for "[a] party cannot be bound by usage unless he either knows or has reason to know of its existence and nature." Restatement (First) of Contracts § 247, comment b. See Walls v. Bailey, 49 N.Y. 464 (1872).

In an ordinary situation involving the painting subcontract on a construction job in Rochester, the court could find as a fact that a painting contractor "knows or has reason to know of [this usage's] existence and nature." It seems clear enough that Flower actually did not know the usage, as its President testified, and the court made no finding to the contrary. The question whether Flower had "reason to know" is the issue.

Flower was brought into the picture by the imposition on the contractor of an affirmative action program. While competence to do the job must have been the assumption of the Regulation, experience in the trade was not. Flower was a neophyte minority painting contractor. This was its first substantial subcontract on a construction job. It would be unrealistic to hold it strictly to a "reason to know" standard of trade usage.

The consequence of ruling that Flower cannot be held to trade usage is recognition, however, that the contract document could represent two different understandings of what the subject matter embraced. This means that Gumina, as well, was not bound since it takes two to make a contract. Unfortunately, there was no contract to enforce in favor of Flower, as there would have been no contract to enforce against Flower if Gumina had been the plaintiff in an action for breach. And we cannot say that either party acted so unreasonably as to justify construing the ambiguity in the contract against it. Each party, in fact, held a different and reasonable view of the undertaking, Flower on the basis of its literal reading of the word "units" and Gumina because of its suppositions concerning trade practice and its awareness that Flower was to be paid virtually the entire sum allocated to painting the FIGHT City project.^[4]

Though the setting is new, the problem is old. In two nineteenth century cases, Raffles v. Wichelhaus, 159 Eng.Rep. 375 (Ex.1864) (the famous "Peerless" case) and Kyle v. Kavanagh, 103 Mass. 356 (1869), courts, when faced with an arguably material contract term that could mean or represent two different things, found that no contract existed. See O. Holmes, The Common Law 309-10 (1881).^[5] As Judge Pollack [166] noted in Oswald v. Allen, 285 F.Supp. 488, 492 (S.D.N.Y.1968), aff'd, 417 F.2d 43 (2d Cir. 1969), the essence of the Raffles opinion was that "neither party had reason to know of the latent ambiguity. . . ." The rule of Raffles and Kyle was adopted and more fully formulated in the Restatement (First) of Contracts § 71(a).

If the manifestations of intention of either party are uncertain or ambiguous, and he has no reason to know that they may bear a different meaning to the other party from that which he himself attaches to them, his manifestations are operative in the formation of a contract only in the event that the other party attaches to them the same meaning. [Emphasis added.]

Accord, Oswald v. Allen, supra; Julius Kayser & Co. v. Textron, Inc., 228 F.2d 783, 789-90 (4th Cir. 1956); Hayford v. Century Insurance Co., 106 N.H. 242, 209 A.2d 716, 718 (1965); Wright v. Dutch, 140 Cal.App.2d 891, 296 P.2d 34 (Cal.App.1956); Restatement (Second) of Contracts § 21A (tent. draft); 3 Corbin on Contracts § 599, at 593-97; 1 Williston on Contracts § 95, at 344-48 (3d ed. Jaeger); Young, Equivocation in Agreements, 64 Colum.L.Rev. 619, 621 (1964); see Dadourian Export Corp. v. United States, 291 F.2d 178, 187 & n. 4 (2d Cir. 1961) (Friendly, J., dissenting).

We affirm the judgment of dismissal on the ground that no enforcible contract ever came into existence.

The dissenting opinion, finding a contract as interpreted by Flower, relies upon some testimony by Ellison, president of Flower, that he was told by the superintendent for Gumina in March 1974 — almost a year after the putative "contract" was signed — that there had been some "changes" since the signing and that the Gumina superintendent, therefore, had to add a "piece of contract document." The dissenting opinion finds that this bit of testimony indicated that Gumina was "redefining the scope of the work by a `further understanding'" and concludes that "[c]learly, Gumina made an initial mistake and then tried to get Flower to change the contract." Dissent op. at 168. But we are not the trial court, and this conclusion rests upon an opinion as to the credibility of a witness whom Judge Burke heard, and whom we have never seen. If Judge Burke had believed this parol evidence, it would have amounted to an admission regarding the construction of the contract by Gumina. Although this testimony was admitted, Judge Burke found, nevertheless, that the "piece" of document Flower received from Gumina later in March was "a copy of Article II of the subcontract, with additional explanatory language as a reminder of obligations Flower City had under its subcontract." Finding No. 14 [emphasis added]. One may assume, therefore, that, in reaching Finding No. 14, Judge Burke rejected Ellison's testimony to the contrary.

The judgment is affirmed.

OAKES, Circuit Judge (dissenting):

I respectfully dissent and would reverse the judgment.

It seems to me that we must construe the original contract against the general contractor who prepared it. To be sure, the parties based that contract on a proposal, which Flower submitted and Gumina accepted, stated precisely in the terms of the schedule attached to the contract. But Gumina [167] had indicated to Flower that the proposal was in the form necessary to win the bid; and it was important to Gumina for purposes of the affirmative action program required under HUD regulations, majority op. at 163, that Flower obtain the painting subcontract. As the majority notes, Schedule A does refer to the "painting of the above mentioned project in accordance with the painting specifications and plans for this project"; but it also specifically itemizes the work and the price in terms of the one, two, three, and four bedroom units, stating a price per unit, then the total price for each size apartment, and finally a grand total for all units of all sizes which equals the contract price of $98,499.84. To my mind this schedule means exactly that the painting envisioned under the contract included only the "units" themselves and that the exterior, the community building, and the interior halls were not included. Indeed there was evidence that when Flower submitted its proposal the interior halls were going to be brick and not painted at all.^[6]

The contract itself, consisting of a standard American Institute of Architects (AIA) Subcontract of seven printed pages which the parties had completed in full by typewriting and duly executed along with a typewritten two-page rider and the "Schedule A," refers to the scope of the work as follows in Article 2, entitled "The Work":

The Subcontractor shall furnish all labor, materials and equipment and shall perform all the Work . . . described in Schedule A attached hereto and made a part hereof as if fully set forth in this space.

The subcontractor further agrees that it will faithfully observe all requirements and conditions set forth by plans and specifications on file at the F.H.A. Office in Buffalo, N.Y. and identified as F.H.A. Project No. 014-44028-NP-R-SUP.

Thus, it is Schedule A itself, duly quoted in the majority opinion at 163 and not repeated here, that sets forth the scope of the work. To be sure, in the second paragraph of Article 2, the subcontractor specifically agreed to observe "all requirements and conditions set forth by plans and specifications on file." But it does not seem to me that those words can be construed to cover work other than that specified in Schedule A, the incorporated description of the work under the contract. The subcontractor, Flower, promised to observe the "requirements and conditions" set forth in the plans and specifications, including the general conditions and standards and the modifications and supplements thereto as well as the requirements and conditions in the painting specifications as to quality and type of paint, method of application, and the like. I do not see, however, that any of these requirements and conditions adds to the scope of the painting work to be done.

The majority relies on the introductory clause in Schedule A reading, "The painting of the above mentioned project in accordance with the painting specifications and plans for this project." But the particular governs the general, and immediately below the quoted caption the schedule lists the per unit figures for the different size apartments and sets out a total price for size representing the price for the total number of units of each size. Moreover, the introductory clause in Schedule A does not say "all painting in the above mentioned project"; it says "the painting of the above mentioned project."

The majority suggests that had Flower examined Defendant's Exhibit 5, the prime contract with the cost breakdown for each type of labor and materials, which indicates a total painting cost of $101,000, Flower would have known that Gumina would require the painting of the exterior work, interior hallways, and the community building in addition to the units themselves for [168] less than $101,000 and that given Flower's contract for $98,499.84, the contractor would go over his projection for painting costs unless Flower did all the painting. I do not think, however, that we can hold the subcontractor to this kind of knowledge simply because the prime contract was on file. A contractor can over- or underestimate a particular portion of the work, and here Flower followed Gumina's own suggestions as to price, proposal format, and scope of work.

If there were any doubt as to the meaning of the subcontract — and it seems to me there cannot be because of the undisputed evidence that the general contractor, Gumina, drew the contract and that Flower submitted the proposal precisely in the terms of Schedule A at Gumina's specific request — the subsequent conduct of the parties is quite compelling.^[7] Gumina's field superintendent, Brian Smith, asked Flower's president and general superintendent, Michael Ellison, to bring a copy of the contract "over to the job site." He then "informed [Ellison] that since we had signed the contract, there had been some changes and he needed to get [Ellison's] copy of [the] contract so that he could add a piece of contract document to [the contract]."^[8] That "piece of contract document" was a new AIA subcontract page covering Articles 1-4 inclusive and redefining the scope of the work by a "further understanding," namely that all exterior work and the community building were included (at the original price).^[9] Smith told Ellison "that he didn't think the exteriors or the common interior hallways were included" and that he thought that Ellison "ought to amend the contract."^[10] Clearly, Gumina made an initial mistake and then tried to get Flower to change the contract. There had been a meeting of the minds on the terms of the contract as stated in Schedule A; but one party, the one in the more favorable bargaining position and the one which had drawn the contract, had made a unilateral mistake. It does not need citation of authority to suggest that this kind of mistake does not permit repudiation, rescission, or modification of the contract.

In short, I believe that Gumina entered into and breached a valid, enforceable contract with Flower and that the case should be remanded for the ascertainment of damages.^[11]

[1]The jurisdictional basis for consideration of this suit was not discussed below. The complaint asserted federal question jurisdiction only under 28 U.S.C. § 1343 with regard to claims under 42 U.S.C. §§ 1981 and 1983 and Title VI of the Civil Rights Act of 1964, but the District Judge's findings make it evident that there is actual diversity of citizenship as well as the requisite jurisdictional amount.

The trial court did not make any specific rulings with respect to plaintiff's civil rights claims, which do not appear to have entered into the trial. On this appeal, plaintiff argues that the trial judge denied it the opportunity to present evidence on the discrimination issue. The record reveals no effort to present such a case. The contention that the trial judge was unfair is without merit. We do not consider the appropriateness of the statutory provisions the plaintiff invokes as a basis for its discrimination cause of action.

[2] There is some indication that this opening salvo was preceded by discussion. See infra.

[3] The extra work was estimated to cost an additional $14,545.17, about 15 percent of the subcontract price.

[4] We do note, however, that Flower's people expected to make a profit of about $60,000 on this $98,000 contract, which may be some indication that their view of the scope of the work was unrealistic.

[5] There is an even earlier case in which the problem was considered at some length by Justice Story sitting as Circuit Justice. In Hazard v. New England Marine Ins. Co., 11 Fed.Cases 934 (C.C.D.Mass.1832) (No. 6,282), the question arose as to whether the term "coppered ship" in a marine insurance contract was to be understood according to the usage in the shipowner's home port of New York or according to usage in the underwriters' city of Boston: the underwriters, defending a suit on the contract, maintained that the plaintiff had not provided a coppered ship as promised, while the plaintiff argued that the ship was coppered as he understood it. At one point in Justice Story's instructions to the jury, he charged that if the plaintiff and the underwriters had differing understandings of the term "coppered" and if neither had cause to know of the other's understanding, then no contract should be deemed formed because there was mutual mistake. Id.at 936-37.

On appeal, the judgment for the underwriters was reversed. Hazard's Admin. v. Marine Insurance Co., 33 U.S. (8 Pet.) 557 (1834). The Supreme Court reasoned that underwriters should be presumed to be aware of the usages of their clients as a matter of their business. The "meeting of the minds" question was not extensively considered in the reported oral argument; the participants viewed the real choice to be between accepting the shipowner's or the underwriters' interpretations and enforcing the contract one way or another.

[6]Michael Ellison, president and general superintendent of Flower, testified on cross-examination as follows:

The General Contractor informed us what had to be painted on the Fight Village project, because the preliminary specs were not complete. So he told me the public hallways there were going to be brick, so it was to my understanding from the General Contractor that was not going to be painted.

[7] The majority opinion says simply that nearly one year after Flower entered into the subcontract it asserted in a letter of March 18, 1974, that the contract required interior painting only. This recitation of the events omits the testimony referred to in text in this opinion immediately infra;it also omits the following testimony:

A. After we received the copy of the contract back from the General Contractor, it must have been about a month or so later we received a letter from the General Contractor asking us to post a performance and payment bond. And our contract bid proposal was stated, "No bond or union required."

. . . . .

Q. Did you submit a performance bond?

A. No, I didn't.

Q. Did you submit any other instruments?

A. Yes. What we did, we turned it over to our attorney, and he wrote the General Contractor a letter.

Q. Then what happened?

A. We heard nothing else from the General Contractor.

(Testimony of Michael Ellison.)

[8] This was the undisputed testimony of Mr. Ellison. Gumina never called its field superintendent, Mr. Smith, to testify.

[9] I note that even the addition to the contract does not mention the interior hallways.

[10]As Flower was subsequently to write Gumina, on April 11, 1974 (Ex. 8):

In respond [sic] to your letter dated March 4, 1974, wherein you stated that we proposed additional cost for items already agreed upon in our formal contract, there must be a lack in communication between your field office and your home office. Mr. Bryant [sic] Smith advised our company to submit a price for the items that were not a part of our original contract. We have met three or four times to discuss these matters. Mr Bryant Smith gave us a set of plans, in order that we might apply cost to these additions.

[11]I agree with the majority on the argument pertaining to custom in the trade. If the contract were really ambiguous such evidence might be admissible generally, but it would not be admissible against Flower in this case.

The trial judge made a number of findings pertaining to damages; but these do not in my view support his conclusion, among others, that Flower "failed to establish a rational basis for its assertion of lost profit and failed to prove prospective lost profits with reasonable particularity and certainty." Flower City Painting Contractors, Inc. v. Gumina Constr. Co., Civ.No.74-552, at 9 (W.D.N.Y. Feb. 16, 1978). The evidence was somewhat vague and conclusory but, with all respect, not so uncertain in my view as to require dismissal of the case.