Random House, Inc. v. Rosetta Books LLC

150 F.Supp.2d 613 (S.D.N.Y. 2001)

STEIN, District Judge.

In this copyright infringement action, Random House, Inc. seeks to enjoin Rosetta Books LLC and its Chief Executive Officer from selling in digital format eight specific works on the grounds that the authors of the works had previously granted Random House—not Rosetta Books—the right to “print, publish and sell the work[s] in book form.” Rosetta Books, on the other hand, claims it is not infringing upon the rights those authors gave Random House because the licensing agreements between the publisher and the author do not include a grant of digital or electronic rights. Relying on the language of the contracts and basic principles of contract interpretation, this Court finds that the right to “print, publish and sell the work[s] in book form” in the contracts at issue does not include the right to publish the works in the format that has come to be known as the “ebook.” Accordingly, Random House’s motion for a preliminary injunction is denied.

BACKGROUND

In the year 2000 and the beginning of 2001, Rosetta Books contracted with several authors to publish certain of their works—including The Confessions of Nat Turner and Sophie’s Choice by William Styron; Slaughterhouse–Five, Breakfast of Champions, The Sirens of Titan, Cat’s Cradle, and Player Piano by Kurt Vonnegut; and Promised Land by Robert B. Parker—in digital format over the internet. On February 26, 2001 Rosetta Books launched its ebook business, offering those titles and others for sale in digital format. The next day, Random House filed this complaint accusing Rosetta Books of committing copyright infringement and tortiously interfering with the contracts Random House had with Messrs. Parker, Styron and Vonnegut by selling its ebooks. It simultaneously moved for a preliminary injunction prohibiting Rosetta from infringing plaintiff’s copyrights.

A. Ebooks

Ebooks are “digital book[s] that you can read on a computer screen or an electronic device.” Ebooks are created by converting digitized text into a format readable by computer software. The text can be viewed on a desktop or laptop computer, personal digital assistant or handheld dedicated ebook reading device. Rosetta’s ebooks can only be read after they are downloaded into a computer that contains either Microsoft Reader, Adobe Acrobat Reader, or Adobe Acrobat eBook Reader software.

Included in a Rosetta ebook is a book cover, title page, copyright page and “eforward” all created by Rosetta Books. Although the text of the ebook is exactly the same as the text of the original work, the ebook contains various features that take advantage of its digital format. For example, ebook users can search the work electronically to find specific words and phrases. They can electronically “highlight” and “bookmark” certain text, which can then be automatically indexed and accessed through hyperlinks. They can use hyperlinks in the table of contents to jump to specific chapters.

Users can also type electronic notes which are stored with the related text. These notes can be automatically indexed, sorted and filed. Users can also change the font size and style of the text to accommodate personal preferences; thus, an electronic screen of text may contain more words, fewer words, or the same number of words as a page of the original published book. In addition, users can have displayed the definition of any word in the text. In one version of the software, the word can also be pronounced aloud.

Rosetta’s ebooks contain certain security features to prevent users from printing, emailing or otherwise distributing the text. Although it is technologically possible to foil these security features, anyone who does so would be violating the licensing agreement accompanying the software.

B. Random House’s licensing agreements

While each agreement between the author and Random House differs in some respects, each uses the phrase “print, publish and sell the work in book form” to convey rights from the author to the publisher.

1. Styron Agreements

Forty years ago, in 1961, William Styron granted Random House the right to publish The Confessions of Nat Turner. Besides granting Random House an exclusive license to “print, publish and sell the work in book form,” Styron also gave it the right to “license publication of the work by book clubs,” “license publication of a reprint edition,” “license after book publication the  publication of the work, in whole or in part, in anthologies, school books,” and other shortened forms, “license without charge publication of the work in Braille, or photographing, recording, and microfilming the work for the physically handicapped,” and “publish or permit others to publish or broadcast by radio or television ... selections from the work, for publicity purposes ....” Styron demonstrated that he was not granting Random House the rights to license publication in the British Commonwealth or in foreign languages by crossing out these clauses on the form contract supplied by Random House.

The publisher agreed in the contract to “publish the work at its own expense and in such style and manner and at such a price as it deems suitable.” The contract also contains a non-compete clause that provides, in relevant part, that “[t]he Author agrees that during the term of this agreement he will not, without the written permission of the Publisher, publish or permit to be published any material in book or pamphlet form, based on the material in the work, or which is reasonably likely to injure its sale.” Styron’s contract with Random House for the right to publish Sophie’s Choice, executed in 1977, is virtually identical to his 1961 contract to publish The Confessions of Nat Turner.

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DISCUSSION

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B. Ownership of a Valid Copyright

Two elements must be proven in order to establish a prima facie case of infringement: “(1) ownership of a valid copyright, and (2) copying of constituent elements of the work that are original.” Feist Publications, Inc. v. Rural Tel. Serv. Co., 499 U.S. 340, 361 (1991). In this case, only the first element—ownership of a valid copyright—is at issue, since all parties concede that the text of the ebook is identical to the text of the book published by Random House.

It is well settled that although the authors own the copyrights to their works, “[t]he legal or beneficial owner of an exclusive right under a copyright is entitled ... to institute an action for any infringement of that particular right committed while he or she is the owner of it.” 17 U.S.C. § 501(b). The question for resolution, therefore, is whether Random House is the beneficial owner of the right to publish these works as ebooks.

1. Contract Interpretation of Licensing Agreements—Legal Standards

Random House claims to own the rights in question through its licensing agreements with the authors. Interpretation of an agreement purporting to grant a copyright license is a matter of state contract law.

In New York, a written contract is to be interpreted so as to give effect to the intention of the parties as expressed in the contract’s language. The court must consider the entire contract and reconcile all parts, if possible, to avoid an inconsistency.

Determining whether a contract provision is ambiguous is a question of law to be decided by the court. Pursuant to New York law, “[c]ontract language is ambiguous if it is capable of more than one meaning when viewed objectively by a reasonably intelligent person who has examined the context of the entire integrated agreement and who is cognizant of the customs, practices, usages and terminology as generally understood in the particular trade or business.” Sayers, 7 F.3d at 1095 (internal quotations and citation omitted). “No ambiguity exists when contract language has a ‘definite and precise meaning, unattended by danger of misconception in the purport of the [contract] itself, and concerning which there is no reasonable basis for a difference of opinion.’” Sayers, 7 F.3d at 1095.

If the language of a contract is ambiguous, interpretation of the contract becomes a question of fact for the finder of fact and extrinsic evidence is admissible. …

2. Application of Legal Standards

Relying on “the language of the license contract and basic principles of interpretation,” Boosey, 145 F.3d at 487 n.3,… this Court finds that the most reasonable interpretation of the grant in the contracts at issue to “print, publish and sell the work in book form” does not include the right to publish the work as an ebook. At the outset, the phrase itself distinguishes between the pure content—i.e. “the work”—and the format of display—“in book form.” The Random House Webster’s Unabridged Dictionary defines a “book” as “a written or printed work of fiction or nonfiction, usually on sheets of paper fastened or bound together within covers” and defines “form” as “external appearance of a clearly defined area, as distinguished from color or material; the shape of a thing or person.” Random House Webster’s Unabridged Dictionary (2001), available in searchable form at http://www.allwords.com.

Manifestly, paragraph # 1 of each contract—entitled either “grant of rights” or “exclusive publication right”—conveys certain rights from the author to the publisher. In that paragraph, separate grant language is used to convey the rights to publish book club editions, reprint editions, abridged forms, and editions in Braille. This language would not be necessary if the phrase “in book form” encompassed all types of books. That paragraph specifies exactly which rights were being granted by the author to the publisher. Indeed, many of the rights set forth in the publisher’s form contracts were in fact not granted to the publisher, but rather were reserved by the authors to themselves. For example, each of the authors specifically reserved certain rights for themselves by striking out phrases, sentences, and paragraphs of the publisher’s form contract. This evidences an intent by these authors not to grant the publisher the broadest rights in their works.

Random House contends that the phrase “in book form” means to faithfully reproduce the author’s text in its complete form as a reading experience and that, since ebooks concededly contain the complete text of the work, Rosetta cannot also possess those rights. While Random House’s definition distinguishes “book form” from other formats that require separate contractual language—such as audio books and serialization rights—it does not distinguish other formats specifically mentioned in paragraph # 1 of the contracts, such as book club editions and reprint editions. Because the Court must, if possible, give effect to all contractual language in order to “safeguard against adopting an interpretation that would render any individual provision superfluous,” Sayers, 7 F.3d at 1095, Random House’s definition cannot be adopted.

Random House points specifically to the clause requiring it to “publish the work at its own expense and in such a style and manner and at such a price as [Random House] deems suitable” as support for its position. However, plaintiff takes this clause out of context. It appears in paragraph # 2, captioned “Style, Price and Date of Publication,” not paragraph # 1, which includes all the grants of rights. In context, the phrase simply means that Random House has control over the appearance of the formats granted to Random House in the first paragraph; i.e., control over the style of the book.

Random House also cites the non-compete clauses as evidence that the authors granted it broad, exclusive rights in their work. Random House reasons that because the authors could not permit any material that would injure the sale of the work to be published without Random House’s consent, the authors must have granted the right to publish ebooks to Random House. This reasoning turns the analysis on its head. First, the grant of rights follows from the grant language alone. Second, non-compete clauses must be limited in scope in order to be enforceable in New York. Third, even if the authors did violate this provision of their Random House agreements by contracting with Rosetta Books—a point on which this Court does not opine—the remedy is a breach of contract action against the authors, not a copyright infringement action against Rosetta Books.

The photocopy clause—giving Random House the right to “Xerox and other forms of copying, either now in use or hereafter developed”—similarly does not bolster Random House’s position. Although the clause does appear in the grant language paragraph, taken in context, it clearly refers only to new developments in xerography and other forms of photocopying. Stretching it to include new forms of publishing, such as ebooks, would make the rest of the contract superfluous because there would be no reason for authors to reserve rights to forms of publishing “now in use.” This interpretation also comports with the publishing industry’s trade usage of the phrase.

Not only does the language of the contract itself lead almost ineluctably to the conclusion that Random House does not own the right to publish the works as ebooks, but also a reasonable person “cognizant of the customs, practices, usages and terminology as generally understood in the particular trade or business,” Sayers, 7 F.3d at 1095, would conclude that the grant language does not include ebooks. “To print, publish and sell the work in book form” is understood in the publishing industry to be a “limited” grant.

In Field v. True Comics, the court held that “the sole and exclusive right to publish, print and market in book form ”—  especially when the author had specifically reserved rights for himself—was “much more limited” than “the sole and exclusive right to publish, print and market the book.” 89 F.Supp. at 612 (emphasis added). In fact, the publishing industry generally interprets the phrase “in book form” as granting the publisher “the exclusive right to publish a hardcover trade book in English for distribution in North America.” 1 Lindey on Entertainment, Publishing and the Arts Form 1.01–1 (2d ed.2000) (using the Random House form contract to explain the meaning of each clause).

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CONCLUSION

 Employing the most important tool in the armamentarium of contract interpretation—the language of the contract itself—this Court has concluded that Random House is not the beneficial owner of the right to publish the eight works at issue as ebooks. This is neither a victory for technophiles nor a defeat for Luddites. It is merely a determination, relying on neutral principles of contract interpretation, that because Random House is not likely to succeed on the merits of its copyright infringement claim and cannot demonstrate irreparable harm, its motion for a preliminary injunction should be denied.

Frigaliment Importing Co. v. B.N.S. Int’l Sales Corp.

190 F.Supp. 116 (S.D.N.Y. 1960)

FRIENDLY, Circuit Judge.

The issue is, what is chicken? Plaintiff says “chicken” means a young chicken, suitable for broiling and frying. Defendant says “chicken” means any bird of that genus that meets contract specifications on weight and quality, including what it calls “stewing chicken” and plaintiff pejoratively terms “fowl.” Dictionaries give both meanings, as well as some others not relevant here. To support its [position], plaintiff sends a number of volleys over the net; defendant essays to return them and adds a few serves of its own. Assuming that both parties were acting in good faith, the case nicely illustrates Holmes’ remark “that the making of a contract depends not on the agreement of two minds in one intention, but on the agreement of two sets of external signs— not on the parties having meant the same thing but on their having said the same thing.” The Path of the Law, in Collected Legal Papers, p. 178. I have concluded that plaintiff has not sustained its burden of persuasion that the contract used “chicken” in the narrower sense.

The action is for breach of the warranty that goods sold shall correspond to the description. Two contracts are in suit. In the first, dated May 2, 1957, defendant, a New York sales corporation, confirmed the sale to plaintiff, a Swiss corporation, of

“US Fresh Frozen Chicken, Grade A, Government Inspected, Eviscerated 2½ -3 lbs. and 1½ -2 lbs. each all chicken individually wrapped in cryovac, packed in secured fiber cartons or wooden boxes, suitable for export

                75,000 lbs. 2½-3 lbs …….  @$33.00

                25,000 lbs 1½-2 lbs …….   @36.50 

                per 100 lbs FAS New York

scheduled May 10, 1957 pursuant to instructions from Penson & Co., New York.”

The second contract, also dated May 2, 1957, was identical save that only 50,000 lbs. of the heavier “chicken” were called for, the price of the smaller birds was $37 per 100 lbs., and shipment was scheduled for May 30. The initial shipment under the first contract was short but the balance was shipped on May 17. When the initial shipment arrived in Switzerland, plaintiff found, on May 28, that the 2½ -3 lbs. birds were not young chicken suitable for broiling and frying but stewing chicken or “fowl;” indeed, many of the cartons and bags plainly so indicated. Protests ensued. Nevertheless, shipment under the second contract was made on May 29, the 2½ -3 lbs. birds again being stewing chicken. Defendant stopped the transportation of these at Rotterdam.

This action followed. Plaintiff says that, notwithstanding that its acceptance was in Switzerland, New York law controls …; defendant does not dispute this, and relies on New York decisions. I shall follow the apparent agreement of the parties as to the applicable law.

Since the word “chicken” standing alone is ambiguous, I turn first to see whether the contract itself offers any aid to its interpretation. Plaintiff says the 1½ -2 lbs. birds necessarily had to be young chicken since the older birds do not come in that size, hence the 2½ -3 lbs. birds must likewise be young. This is unpersuasive— a contract for “apples” of two different sizes could be filled with different kinds of apples even though only one species came in both sizes. Defendant notes that the contract called not simply for chicken but for ‘US Fresh Frozen Chicken, Grade A, Government Inspected.’ It says the contract thereby incorporated by reference the Department of Agriculture’s regulations, which favor its interpretation; I shall return to this after reviewing plaintiff’s other contentions.

The first hinges on an exchange of cablegrams which preceded execution of the formal contracts. The negotiations leading up to the contracts were conducted in New York between defendant’s secretary, Ernest R. Bauer, and a Mr. Stovicek, who was in New York for the Czechoslovak government at the World Trade Fair. A few days after meeting Bauer at the fair, Stovicek telephoned and inquired whether defendant would be interested in exporting poultry to Switzerland. Bauer then met with Stovicek, who showed him a cable from plaintiff dated April 26, 1957, announcing that they “are buyer” of 25,000 lbs. of chicken 2½ -3 lbs. weight, Cryovac packed, grade A Government inspected, at a price up to 33¢ per pound, for shipment on May 10, to be confirmed by the following morning, and were interested in further offerings. After testing the market for price, Bauer accepted, and Stovicek sent a confirmation that evening. Plaintiff stresses that, although these and subsequent cables between plaintiff and defendant, which laid the basis for the additional quantities under the first and for all of the second contract, were predominantly in German, they used the English word “chicken;” it claims this was done because it understood “chicken” meant young chicken whereas the German word, “Huhn,” included both “Brathuhn” (broilers) and “Suppenhuhn” (stewing chicken), and that defendant, whose officers were thoroughly conversant with German, should have realized this. Whatever force this argument might otherwise have is largely drained away by Bauer’s testimony that he asked Stovicek what kind of chickens were wanted, received the answer “any kind of chickens,” and then, in German, asked whether the cable meant “Huhn” and received an affirmative response. Plaintiff attacks this as contrary to what Bauer testified on his deposition in March, 1959, and also on the ground that Stovicek had no authority to interpret the meaning of the cable. The first contention would be persuasive if sustained by the record, since Bauer was free at the trial from the threat of contradiction by Stovicek as he was not at the time of the deposition; however, review of the deposition does not convince me of the claimed inconsistency. As to the second contention, it may well be that Stovicek lacked authority to commit plaintiff for prices or delivery dates other than those specified in the cable; but plaintiff cannot at the same time rely on its cable to Stovicek as its dictionary to the meaning of the contract and repudiate the interpretation given the dictionary by the man in whose hands it was put. …

Plaintiff’s next contention is that there was a definite trade usage that “chicken” meant “young chicken.” Defendant showed that it was only beginning in the poultry trade in 1957, thereby bringing itself within the principle that “when one of the parties is not a member of the trade or other circle, his acceptance of the standard must be made to appear” by proving either that he had actual knowledge of the usage or that the usage is “so generally known in the community that his actual individual knowledge of it may be inferred.” 9 Wigmore, Evidence (3d ed. § 1940) 2464. Here there was no proof of actual knowledge of the alleged usage; indeed, it is quite plain that defendant’s belief was to the contrary. In order to meet the alternative requirement, the law of New York demands a showing that “the usage is of so long continuance, so well established, so notorious, so universal and so reasonable in itself, as that the presumption is violent that the parties contracted with reference to it, and made it a part of their agreement.” Walls v. Bailey, 49 N.Y. 464, 472-73 (1872). 

Plaintiff endeavored to establish such a usage by the testimony of three witnesses and certain other evidence. Strasser, resident buyer in New York for a large chain of Swiss cooperatives, testified that “on chicken I would definitely understand a broiler.” However, the force of this testimony was considerably weakened by the fact that in his own transactions the witness, a careful businessman, protected himself by using “broiler” when that was what he wanted and “fowl” when he wished older birds. Indeed, there are some indications, dating back to a remark of Lord Mansfield that no credit should be given “witnesses to usage, who could not adduce instances in verification.” 7 Wigmore, Evidence (3d ed. 1940), § 1954. While Wigmore thinks this goes too far, a witness’ consistent failure to rely on the alleged usage deprives his opinion testimony of much of its effect. Niesielowski, an officer of one of the companies that had furnished the stewing chicken to defendant, testified that “chicken” meant “the male species of the poultry industry. That could be a broiler, a fryer or a roaster,” but not a stewing chicken; however, he also testified that upon receiving defendant’s inquiry for “chickens,” he asked whether the desire was for “fowl or frying chickens” and, in fact, supplied fowl, although taking the precaution of asking defendant, a day or two after plaintiff’s acceptance of the contracts in suit, to change its confirmation of its order from “chickens,” as defendant had originally prepared it, to “stewing chickens.” Dates, an employee of Urner-Barry Company, which publishes a daily market report on the poultry trade, gave it as his view that the trade meaning of “chicken” was “broilers and fryers.” In addition to this opinion testimony, plaintiff relied on the fact that the Urner-Barry service, the Journal of Commerce, and Weinberg Bros. & Co. of Chicago, a large supplier of poultry, published quotations in a manner which, in one way or another, distinguish between “chicken,” comprising broilers, fryers and certain other categories, and “fowl,” which, Bauer acknowledged, included stewing chickens. This material would be impressive if there were nothing to the contrary. However, there was, as will now be seen.

Defendant’s witness Weininger, who operates a chicken eviscerating plant in New Jersey, testified “Chicken is everything except a goose, a duck, and a turkey. Everything is a chicken, but then you have to say, you have to specify which category you want or that you are talking about.” Its witness Fox said that in the trade “chicken” would encompass all the various classifications. Sadina, who conducts a food inspection service, testified that he would consider any bird coming within the classes of “chicken” in the Department of Agriculture’s regulations to be a chicken. The specifications approved by the General Services Administration include fowl as well as broilers and fryers under the classification “chickens.” Statistics of the Institute of American Poultry Industries use the phrases “Young chickens” and “Mature chickens,” under the general heading “Total chickens.” and the Department of Agriculture’s daily and weekly price reports avoid use of the word “chicken’”without specification.

Defendant advances several other points which it claims affirmatively support its construction. Primary among these is the regulation of the Department of Agriculture, 7 C.F.R. § 70.300-70.370, entitled, “Grading and Inspection of Poultry and Edible Products Thereof.” and in particular 70.301 which recited:

“Chickens. The following are the various classes of chickens:

             (a) Broiler or fryer ..

             (b) Roaster …

             (c) Capon …

             (d) Stag …

             (e) Hen or stewing chicken of fowl …

             (f) Cock or old rooster …”

Defendant argues, as previously noted, that the contract incorporated these regulations by reference. Plaintiff answers that the contract provision related simply to grade and Government inspection and did not incorporate the Government definition of “chicken,” and also that the definition in the Regulations is ignored in the trade. However, the latter contention was contradicted by Weininger and Sadina; and there is force in defendant’s argument that the contract made the regulations a dictionary, particularly since the reference to Government grading was already in plaintiff’s initial cable to Stovicek.

Defendant makes a further argument based on the impossibility of its obtaining broilers and fryers at the 33¢ price offered by plaintiff for the 2½ -3 lbs. birds. There is no substantial dispute that, in late April, 1957, the price for 2½ -3 lbs. broilers was between 35 and 37¢ per pound, and that when defendant entered into the contracts, it was well aware of this and intended to fill them by supplying fowl in these weights. It claims that plaintiff must likewise have known the market since plaintiff had reserved shipping space on April 23, three days before plaintiff’s cable to Stovicek, or, at least, that Stovicek was chargeable with such knowledge. It is scarcely an answer to say, as plaintiff does in its brief, that the 33¢ price offered by the 2½ -3 lbs. ‘chickens’ was closer to the prevailing 35¢ price for broilers than to the 30¢ at which defendant procured fowl. Plaintiff must have expected defendant to make some profit— certainly it could not have expected defendant deliberately to incur a loss.

Finally, defendant relies on conduct by the plaintiff after the first shipment had been received. On May 28 plaintiff sent two cables complaining that the larger birds in the first shipment constituted “fowl.” Defendant answered with a cable refusing to recognize plaintiff’s objection and announcing “We have today ready for shipment 50,000 lbs. chicken 2½ -3 lbs. 25,000 lbs. broilers 1½ -2 lbs.,” these being the goods procured for shipment under the second contract, and asked immediate answer “whether we are to ship this merchandise to you and whether you will accept the merchandise.” After several other cable exchanges, plaintiff replied on May 29 “Confirm again that merchandise is to be shipped since resold by us if not enough pursuant to contract chickens are shipped the missing quantity is to be shipped within ten days stop we resold to our customers pursuant to your contract chickens grade A you have to deliver us said merchandise we again state that we shall make you fully responsible for all resulting costs.”² Defendant argues that if plaintiff was sincere in thinking it was entitled to young chickens, plaintiff would not have allowed the shipment under the second contract to go forward, since the distinction between broilers and chickens drawn in defendant’s cablegram must have made it clear that the larger birds would not be broilers. However, plaintiff answers that the cables show plaintiff was insisting on delivery of young chickens and that defendant shipped old ones at its peril. Defendant’s point would be highly relevant on another disputed issue— whether if liability were established, the measure of damages should be the difference in market value of broilers and stewing chicken in New York or the larger difference in Europe, but I cannot give it weight on the issue of interpretation. Defendant points out also that plaintiff proceeded to deliver some of the larger birds in Europe, describing them as “poulets;” defendant argues that it was only when plaintiff’s customers complained about this that plaintiff developed the idea that “chicken” meant “young chicken.” There is little force in this in view of plaintiff’s immediate and consistent protests.

When all the evidence is reviewed, it is clear that defendant believed it could comply with the contracts by delivering stewing chicken in the 2½ -3 lbs. size. Defendant’s subjective intent would not be significant if this did not coincide with an objective meaning of “chicken.” Here it did coincide with one of the dictionary meanings, with the definition in the Department of Agriculture Regulations to which the contract made at least oblique reference, with at least some usage in the trade, with the realities of the market, and with what plaintiff’s spokesman had said. Plaintiff asserts it to be equally plain that plaintiff’s own subjective intent was to obtain broilers and fryers; the only evidence against this is the material as to market prices and this may not have been sufficiently brought home. In any event it is unnecessary to determine that issue. For plaintiff has the burden of showing that “chicken” was used in the narrower rather than in the broader sense, and this it has not sustained.

This opinion constitutes the Court’s findings of fact and conclusions of law. Judgment shall be entered dismissing the complaint with costs.

Footnotes

2 These cables were in German; ‘chicken’, ‘broilers’ and, on some occasions, ‘fowl,’ were in English.

Dorman v. Petrol Aspen, Inc.

Supreme Court of Colorado, En Banc

914 P.2d 909 (1996)

Justice LOHR delivered the Opinion of the Court.

This case presents the issue of whether a contract of employment between the plaintiff employee, Ben M. Dorman, and the defendant employer, Petrol Aspen, Inc., provided for employment at will or for a definite term. The district court granted Petrol Aspen’s motion to dismiss Dorman’s complaint, which alleged breach of contract, promissory estoppel, and breach of an alleged duty of good faith and fair dealing, all arising from the termination of Dorman’s employment by Petrol Aspen. Petrol Aspen’s motion … for failure to state a claim upon which relief can be granted [] was predicated on the contention that Dorman’s employment was at will and therefore could be terminated by Petrol Aspen at any time without incurring liability to Dorman. The Colorado Court of Appeals affirmed the dismissal, holding that under applicable legal principles, the contract provided for employment at will. Dorman v. Petrol Aspen, Inc., No. 93CA1714 (Colo.App. Dec. 15, 1994). We hold that the contract is ambiguous as to the term of employment, that Dorman must be permitted to offer extrinsic evidence to resolve the ambiguity, and that the trial court therefore erred in dismissing the complaint. Accordingly, we reverse the judgment of the court of appeals and return the case to that court with directions to reverse the district court’s judgment and remand the case to the district court for further proceedings.

I.

On September 14, 1992, Ben M. Dorman filed a complaint against Petrol Aspen, Inc. (Petrol Aspen) in Garfield County District Court, alleging breach of contract, promissory estoppel, and breach of an alleged duty of good faith and fair dealing. In his complaint, Dorman contended (1) that Petrol Aspen operates an Amoco gasoline and service station in Aspen, Colorado, (2) that Petrol Aspen extended an employment offer to Dorman after negotiations, (3) that Dorman left gainful employment elsewhere and began work for Petrol Aspen as a result of the negotiations and in reliance upon the employment offer letter that he received from Petrol Aspen, and (4) that Petrol Aspen terminated Dorman’s employment after approximately four months, in breach of his employment contract. Dorman attached the employment offer letter as an exhibit to the complaint, and we reproduce the letter in its entirety as Appendix A to this opinion.

…

The Colorado Court of Appeals affirmed the judgment of the district court in an unpublished opinion. Dorman, slip op. at 4. The court relied on its prior decision in Justice v. Stanley Aviation Corp., 35 Colo.App. 1, 4, 530 P.2d 984, 985 (1974), in rejecting Dorman’s contention that the employment agreement was ambiguous as to duration of employment and holding that it created employment terminable at the will of either party. In view of its conclusion that Dorman’s contract with Petrol Aspen was one of employment at will, the court declined to address Dorman’s other claims.

We granted certiorari to review the decision of the court of appeals. We now reverse based on our determination that the court of appeals misapplied Justice, in that the employment contract between Petrol Aspen and Dorman was sufficiently ambiguous to preclude the trial court from granting Petrol Aspen’s motion to dismiss pursuant to C.R.C.P. 12(b)(5).

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III.

When a document is unambiguous, it cannot be varied by extrinsic evidence. On the other hand, “written documents containing ambiguities or unclear language must be construed in accordance with the intent of the parties, and relevant extraneous evidence may be considered to resolve the factual question of the parties’ intent.” Chambliss/Jenkins Assocs. v. Forster, 650 P.2d 1315, 1318 (Colo.App.1982). Therefore, the only issue before us is whether Dorman’s complaint and the attached employment contract between Dorman and Petrol Aspen could support a claim that Dorman’s employment relationship with Petrol Aspen either was for a definite term extending beyond the date his employment was terminated or was ambiguous as to the employment term. In evaluating these possibilities, we must view the complaint and the employment contract in the light most favorable to Dorman and must accept all of the material allegations in Dorman’s complaint as true regarding alleged negotiations surrounding the formation of the contract. We express no opinion as to the substantive merits of Dorman’s case.

Dorman contends that the employment relationship was for a definite term, and alternatively that at minimum the employment contract was ambiguous regarding the term of employment. Petrol Aspen responds that the employment contract established an at will employment relationship. Of course, “[t]he mere fact that the parties differ on their interpretations of an instrument does not of itself create an ambiguity.” Fibreglas Fabricators, Inc. v. Kylberg, 799 P.2d 371, 374 (Colo.1990). “Interpretation of a written contract and the determination of whether a provision in the contract is ambiguous are questions of law,” and this court need not defer to the trial court’s interpretation. Id. In determining whether a contractual provision is ambiguous, “the instrument’s language must be examined and construed in harmony with the plain and generally accepted meaning of the words used,” with reference to all of the agreement’s provisions, and a provision is ambiguous “if it is fairly susceptible to more than one interpretation.” Id. Lastly, “[o]nce a contract is determined to be ambiguous, the meaning of its terms is generally an issue of fact to be determined in the same manner as other disputed factual issues.” Union Rural Elec. Ass’n v. Public Utils. Comm’n, 661 P.2d 247, 251 n. 5 (Colo.1983.

IV.

The language of the employment contract between Dorman and Petrol Aspen is fairly susceptible to more than one interpretation regarding Dorman’s term of employment. Although the contract between Dorman and Petrol Aspen does not expressly identify a term of employment, the contractual provisions relating to the term of Dorman’s employment are at minimum ambiguous. Specifically, the employment agreement’s (1) stock option provisions, (2) listed series of salaries applicable to specific years, and (3) other references to Dorman’s long-term status as a Petrol Aspen employee create ambiguities regarding the intended term of Dorman’s employment. Consequently, Dorman must be afforded the opportunity to present to a fact-finder extrinsic evidence of the parties’ intentions concerning the term of the employment contract, including any evidence supporting Dorman’s assertion that oral negotiations supplemented or expanded upon the written contractual terms.

A.

First, the contract guaranteed Dorman the right to purchase stock in Petrol Aspen in 1994, indicating either that the employment relationship would last at least through January 1, 1994, or that Dorman’s 1994 stock option was not subject to his continued status as an employee. The contract guaranteed that “[Dorman] will have the right to purchase 5% of the stock at $15,000.00,” even though “[t]he only time that stock may be purchased will be between January 1, 1994, and January 1, 1995, unless we renegotiate the situation.” (Emphasis added.) Assuming for our purposes today, but without deciding, that the stock options were a perquisite contingent upon Dorman’s status as a Petrol Aspen employee, this provision references Dorman’s continued employment at least through January 1, 1994, and creates an ambiguity as to the term of his employment contract.

B.

Second, there are compensation provisions in the employment contract between Dorman and Petrol Aspen that create ambiguities regarding Dorman’s employment term. Dorman’s contract contained a specific outline of his compensation terms through 1993:

1. Hourly basis during August, 1991, at $12.00 per hour.
2. $1,500.00 for September, 1991. One half month school in Chicago.
3. $3,600.00 per month for October, November, December, 1991.
4. $42,000.00 per year for the years 1992 and 1993.
5. Beyond 1991, we will negotiate at the time for salary.

The court of appeals, relying on Justice, 35 Colo.App. at 4, concluded that “a commitment on the duration of employment cannot be inferred from a contract provision fixing the rate of compensation during a given year.... [T]he same rule applies when an employment contract provides that the rate of compensation will be fixed during a series of years and then subject to modification.” Dorman, slip op. at 3.

However, the court of appeals misconstrued Justice. See Dorman, slip op. at 2–3. Justice involved a contract describing “a starting annual salary of $12,000 per year,” without any reference to specific years of employment. 35 Colo.App. at 3, 530 P.2d at 985. Furthermore, Justice concerned an employment contract that required the employee to reimburse the employer for payments made by the employer for the employee’s travel and moving expenses if the employee resigned for any reason within a year, evidencing the parties’ mutual intention that the employment relationship was terminable at will and was not subject to a definite term of one year. Id. Finally, Justice does not establish a bright line rule that “ ‘a contract which sets forth an annual salary rate but states no definite term of employment is considered to be indefinite employment, terminable at the will of either party without incurring liability for breach of contract.’ ” Dorman, slip op. at 2–3 (quoting Justice, 35 Colo.App. at 4, 530 P.2d at 985). The sentence containing that quoted language begins with the phrase “Unless the circumstances indicate otherwise....” Justice, 35 Colo.App. at 4, 530 P.2d at 985; accord Dorman, slip op. at 2. The court of appeals determined that nothing in the written employment contract “commit[ed] either party to a fixed term of employment” but then went on to inquire “whether the evidence or circumstances established that both parties understood the contract to be for a term of one year.” Id. at 4, 530 P.2d at 986. The court referred to the “uncontradicted testimony by both parties that a one year term was never considered or intended” to arrive at its conclusion that “the contract was for an indefinite term and therefore terminable at will at any time by either party.” Id. Justice therefore is supportive of the admissibility of extrinsic evidence to determine whether a contract of employment is for a definite term when an annual rate of compensation is specified but the term remains undefined.

The letter agreement, drafted by Petrol Aspen, is fairly susceptible to the interpretation that Petrol Aspen was offering Dorman employment at least through January 1, 1994, based upon the compensation terms outlined in the employment contract and the stock option terms as previously discussed. However, Dorman has no obligation to prove a definite term of employment in order to survive this C.R.C.P. 12(b)(5) motion to dismiss, and must show only that the contractual terms are ambiguous. Again, even assuming that these contractual terms may be subject to differing interpretations, the provisions are at minimum ambiguous.

…

C.

Lastly, the contract implied that the employment relationship was not terminable at will because Petrol Aspen expected Dorman’s long-term participation as an employee. Petrol Aspen dated the contract August 2, 1991. In that contract, Petrol Aspen represented (1) that Dorman would have “input” into “long range planning,” (2) that Petrol Aspen “hope[d] [Dorman] might attend an August 5, 1991, seminar in Glenwood Springs and a two week school during December, 1991, in Chicago,” (3) that Dorman should expect that “reading, thinking and an awareness of full service gas stations is the most we will accomplish before October 1, 1991,” (4) that the “first few months” would require a large effort by Dorman, and (5) that a vehicle would be available for Dorman’s transportation “[s]ometime shortly after October 1, 1991.” These contractual provisions, together with the stock purchase and compensation provisions previously discussed, supra parts IV(A), (B), are fairly susceptible to an interpretation that the parties intended long-term employment, at least through January 1, 1994, and that the employment relationship between Dorman and Petrol Aspen therefore was not terminable at the will of Petrol Aspen. At minimum, these contractual provisions create an ambiguity as to Dorman’s status as an at will employee.

V.

The contract between Dorman and Petrol Aspen contains ambiguities regarding Dorman’s term of employment. In view of these ambiguities, Dorman should be permitted to introduce extrinsic evidence of the parties’ intent concerning that term of employment. Although a purpose of a C.R.C.P. 12(b)(5) motion is to permit early dismissal of meritless claims, claims that may have merit if ambiguities are resolved in favor of the claimant should be presented to a fact-finder for resolution. The motion to dismiss should have been denied and Dorman should have been permitted to present his case on the merits. In view of our resolution of the ambiguity question, supra part IV, we do not address and express no opinion concerning Dorman’s claims regarding promissory estoppel and Petrol Aspen’s breach of an alleged duty of good faith and fair dealing. The judgment of the court of appeals is reversed, and this case is returned to that court with directions to remand to the trial court for proceedings consistent with this opinion.

ERICKSON, J., dissents, and VOLLACK, C.J., and KOURLIS, J., join in the dissent.

APPENDIX A

Aspen Petro, Inc.

C/O Christopher H. Smith

P.O. Box 130

Snowmass, Colorado 81654

303–927–4744

August 2, 1991

Mr. Ben Dorman

5353 County Road 100

Carbondale, Colorado 81623

Dear Ben:

I have to tell you that I have had the flu all day. I wanted to have this letter to you before the weekend, but ended up a little short on time.

We are offering you the job of General Manager for the Airport Amoco. This will entail responsibility for all aspects of the operation common to a General Manager, i.e., staffing, bookkeeping, customer relations, supplier relations, product acquisition, and facility maintenance. The partners in the business will b[sic] involved in establishment of assistance, long range planning, design, and all lease arrangements with John McBride and Amoco. Naturally, you will have input into these areas.

Our corporation, Aspen Petro, Inc., has stated objectives that include modernization and upgrade of the facility, systems and marketing plans. It will be our intention to use profits to reduce debt and to capitalize improvements. It is our view, excepting unforeseen conditions, that the operation is a long-term proposition being held to generate profit from our efforts and skill. There is no intention to “slip it.” All this shall be so stated in our Shareholders’ Agreement.

In regards to timing, October 1, 1991, is the anticipated closing date. We will take over actual operations at that time. The facility and books are open to us at this time. I would hope you might attend an August 5, 1991, seminar in Glenwood Springs and a two week school during December, 1991, in Chicago. Other than that, I imagine reading, thinking and an awareness of full service gas stations is the most we will accomplish before October 1, 1991. I realize that you have commitments. Once you have discussed this with Andy, we will be better able to schedule.

As for compensation for your efforts, we are willing to pay you money and give you a future right to purchase stock at today’s basis. I am suggesting the following:

1. Hourly basis during August, 1991, at $12.00 per hour.
2. $1,500.00 for September, 1991. One half month school in Chicago.
3. $3,600.00 per month for October, November, December, 1991.
4. $42,000.00 per year for the years 1992 and 1993.
5. Beyond 1991, we will negotiate at the time for salary.
6. The only time that stock may be purchased will be between January 1, 1994, and January 1, 1995, unless we renegotiate the situation. You will have the right to purchase 5% of the stock at $15,000.00.
7. Sometime shortly after October 1, 1991, we will acquire a wrecker and another vehicle. The additional vehicle will be for your transportation and will be available for station use.

Your time commitment will have more to do with how you manage the facility than anything I can say. Obviously, however, the first few months will require a large effort from both of us. As we mentioned the otherevening I will be the “Title Managing Partner” initially. I am committed to this being very successful.

We have included no other benefits because I am suspicious of the value of group or individual benefits. We have also done this for the sake of simplicity.

I think this will be a challenging profitable opportunity for yourself and our group. Please consider this offer over the weekend. I will call you from my travels on Monday or Tuesday. I am sorry for the brevity, but I have not been downstairs today.

Yours truly,

ASPEN PETRO, INC.

[Personalized signature]

Christopher H. Smith

CHS/bl

Threadgill v. Peabody Coal Co.

Colorado Court of Appeals

34 Colo.App. 203 (1974)

PIERCE, Judge.

Defendant, Peabody Coal Company (Peabody), appeals from a judgment holding it liable for damages for the loss of certain equipment owned by the plaintiff which was lost in the process of probing test holes drilled by Peabody. Plaintiff was an independent contractor hired by Peabody to prove the test holes for the purpose of locating coal deposits. After the test holes were sunk to the appropriate depth by Peabody, plaintiff’s employees lowered a probing device to the bottom of each hole and proceeded to “log” the hole as the probe was retrieved. “Logging” consists of gathering soil samples and other data. During the probing of one of the test holes by the employees of the plaintiff, the proving device became stuck in the hole. Employees of Peabody then commenced recovery operations which were unsuccessful.

Plaintiff’s complaint alleged two claims for relief: (1) that the loss of the probe was due to defendant’s negligence in attempting to recover the probe, and (2) that the defendant was obligated under a contract between the parties to pay the value of any equipment owned by the plaintiff lost in the course of the probing operation. Defendant filed an answer containing several defenses and pleaded a counterclaim for expenses incurred in the recovery attempt based on the alleged negligence of plaintiff’s employees.

Upon trial to the court, the court found that an oral contract for the services of the plaintiff did exist, but that there had been no express agreement, oral or otherwise, upon the placement of the risk of loss of the probing device. The court then found that the plaintiff had satisfactorily established “a certain practice or custom in the drilling industry which places the risk of probe loss on the driller (here the defendant) where, as here, there is no agreement otherwise.” Furthermore, the court found that Peabody’s employees had not been negligent in conducting the recovery operation but made no finding as to any negligence on the part of the plaintiff, or his employees. However, the court ruled that the negligence was immaterial under the trade practice, and thus, in effect, placed a duty of strict liability upon Peabody. The court then entered judgment in favor of the plaintiff and dismissed Peabody’s counterclaim.

I

Peabody’s first allegation of error is that the evidence is not sufficient to support the trial court’s finding that a custom or trade usage existed that was binding on defendant.

In order to bind a party by a usage in the trade, it must be shown either that the party had actual knowledge of the existence of the trade usage or that the usage is so well established as to justify a finding of constructive knowledge. The issue of knowledge of the trade usage, whether actual or constructive, is generally a question to be decided by the trier of fact. Peabody’s representatives testified that they had no knowledge of the alleged custom, and Peabody argues that, to show constructive knowledge, the custom or usage must be demonstrated to be “universal” and “notorious.” Such terms have been used where the evidence was insufficient to support a finding that the alleged custom even existed. However, these requirements are only applicable to the English law of custom by which accepted practices have developed into substantive rules of law. They do not apply to a trade usage which is offered only as evidence as to the intent of the parties.

The proper test applicable to this issue is stated in the more recent case of Ryan v. Fitzpatrick Drilling Co., 139 Colo. 471. That is, to be binding upon a party, a trade usage must be “sufficiently general so that the parties could be said to have contracted with reference to it.” See Lorraine Mfg. Co. v. Allen Mfg. Co., Supra.¹

Although contradicted on some points by Peabody’s evidence, each of the plaintiff’s witnesses testified as to his experience in the trade within the geographical locale of the instant operation and to the existence, within that locale, of the alleged trade usage. These witnesses further explained the usage by pointing out that the driller has primary control over the drilling of the hole and that since the prober has no connection with the operation until he begins the “logging” process, he must rely on the driller’s judgment as to the readiness of the hole to receive the probe. Furthermore, once a probe becomes lodged in the hole, the prober must rely on the driller’s equipment for recovery operations. The testimony of these witnesses also indicated that the loss of equipment was generally considered to be a cost to the owner of the land being probed; in this case, Peabody.

Finally, as pointed out by the trial court, the actions of the parties with regard to the recovery operation were consistent with the alleged usage. Such actions tending to demonstrate the intent of the parties are proper considerations for the fact finder.

We hold that the evidence produced at trial was sufficient to support a finding of a general trade usage which permitted the inference that the parties must have contracted with reference to it.

Peabody also argues, however, that the evidence failed to establish that the alleged trade usage was sufficiently certain to permit its application to the facts before the court. It cites testimony to the effect that, in some cases, the driller is obligated only to provide a certain number of “rig hours” for the purpose of recovering lost tools and that the obligation of the driller does not extend to liability for the value of unrecoverable tools. However, this testimony referred to cases in which the parties expressly agreed with respect to the obligations of the parties regarding the loss of the contractor’s tools. Other witnesses testified that in the majority of logging jobs, as was the case here, no written agreement is actually entered into by the parties. Furthermore, the alleged trade usage which plaintiff sought to establish, and which the trial court found, provided a rule in cases in which no express agreement was reached by the parties.

The evidence in the record was sufficient to support the finding of the trial court that, in the absence of other factors, the trade usage would place on the driller the responsibility for the loss of the probing device in addition to the cost of the recovery attempt. That finding will not be disturbed upon review.

* * *

Uniform Commercial Code § 1-303. Course of Performance, Course of Dealing, and Usage of Trade.

(a) A “course of performance” is a sequence of conduct between the parties to a particular transaction that exists if: (1) the agreement of the parties with respect to the transaction involves repeated occasions for performance by a party; and (2) the other party, with knowledge of the nature of the performance and opportunity for objection to it, accepts the performance or acquiesces in it without objection.

(b) A “course of dealing” is a sequence of conduct concerning previous transactions between the parties to a particular transaction that is fairly to be regarded as establishing a common basis of understanding for interpreting their expressions and other conduct.

(c) A “usage of trade” is any practice or method of dealing having such regularity of observance in a place, vocation, or trade as to justify an expectation that it will be observed with respect to the transaction in question. The existence and scope of such a usage must be proved as facts. If it is established that such a usage is embodied in a trade code or similar record, the interpretation of the record is a question of law.

(d) A course of performance or course of dealing between the parties or usage of trade in the vocation or trade in which they are engaged or of which they are or should be aware is relevant in ascertaining the meaning of the parties’ agreement, may give particular meaning to specific terms of the agreement, and may supplement or qualify the terms of the agreement. A usage of trade applicable in the place in which part of the performance under the agreement is to occur may be so utilized as to that part of the performance.

(e) Except as otherwise provided in subsection (f), the express terms of an agreement and any applicable course of performance, course of dealing, or usage of trade must be construed whenever reasonable as consistent with each other. If such a construction is unreasonable: (1) express terms prevail over course of performance, course of dealing, and usage of trade; (2) course of performance prevails over course of dealing and usage of trade; and (3) course of dealing prevails over usage of trade.

(f) Subject to Section 2-209, a course of performance is relevant to show a waiver or modification of any term inconsistent with the course of performance.

(g) Evidence of a relevant usage of trade offered by one party is not admissible unless that party has given the other party notice that the court finds sufficient to prevent unfair surprise to the other party.

Wood v. Lucy, Lady Duff-Gordon

Court of Appeals of New York

222 N.Y. 88 (1917)

CARDOZO, J.

The defendant styles herself “a creator of fashions.” Her favor helps a sale. Manufacturers of dresses, millinery, and like articles are glad to pay for a certificate of her approval. The things which she designs, fabrics, parasols, and what not, have a new value in the public mind when issued in her name. She employed the plaintiff to help her to turn this vogue into money. He was to have the exclusive right, subject always to her approval, to place her indorsements on the designs of others. He was also to have the exclusive right to place her own designs on sale, or to license others to market them. In return she was to have one-half of “all profits and revenues” derived from any contracts he might make. The exclusive right was to last at least one year from April 1, 1915, and thereafter from year to year unless terminated by notice of 90 days. The plaintiff says that he kept the contract on his part, and that the defendant broke it. She placed her indorsement on fabrics, dresses, and millinery without his knowledge, and withheld the profits. He sues her for the damages, and the case comes here on demurrer.

The agreement of employment is signed by both parties. It has a wealth of recitals. The defendant insists, however, that it lacks the elements of a contract. She says that the plaintiff does not bind himself to anything. It is true that he does not promise in so many words that he will use reasonable efforts to place the defendant’s indorsements and market her designs. We think, however, that such a promise is fairly to be implied. The law has outgrown its primitive stage of formalism when the precise word was the sovereign talisman, and every slip was fatal. It takes a broader view today. A promise may be lacking, and yet the whole writing may be “instinct with an obligation,” imperfectly expressed. If that is so, there is a contract.

The implication of a promise here finds support in many circumstances. The defendant gave an exclusive privilege. She was to have no right for at least a year to place her own indorsements or market her own designs except through the agency of the plaintiff. The acceptance of the exclusive agency was an assumption of its duties. We are not to suppose that one party was to be placed at the mercy of the other. Many other terms of the agreement point the same way. We are told at the outset by way of recital that:

“The said Otis F. Wood possesses a business organization adapted to the placing of such indorsements as the said Lucy, Lady Duff-Gordon, has approved.”

The implication is that the plaintiff’s business organization will be used for the purpose for which it is adapted. But the terms of the defendant’s compensation are even more significant. Her sole compensation for the grant of an exclusive agency is to be one-half of all the profits resulting from the plaintiff’s efforts. Unless he gave his efforts, she could never get anything. Without an implied promise, the transaction cannot have such business “efficacy, as both parties must have intended that at all events it should have.” Bowen, L. J., in the Moorcock, 14 P. D. 64, 68. But the contract does not stop there. The plaintiff goes on to promise that he will account monthly for all moneys received by him, and that he will take out all such patents and copyrights and trade-marks as may in his judgment be necessary to protect the rights and articles affected by the agreement. It is true, of course, as the Appellate Division has said, that if he was under no duty to try to market designs or to place certificates of indorsement, his promise to account for profits or take out copyrights would be valueless. But in determining the intention of the parties the promise has a value. It helps to enforce the conclusion that the plaintiff had some duties. His promise to pay the defendant one-half of the profits and revenues resulting from the exclusive agency and to render accounts monthly was a promise to use reasonable efforts to bring profits and revenues into existence. For this conclusion the authorities are ample.

Uniform Commercial Code § 2-305. Open Price Term.

(1) The parties if they so intend can conclude a contract for sale even though the price is not settled. In such a case the price is a reasonable price at the time for delivery if

     (a) nothing is said as to price; or

     (b) the price is left to be agreed by the parties and they fail to agree; or

     (c) the price is to be fixed in terms of some agreed market or other standard as set or recorded by a third person or agency and it is not so set or recorded.

* * *

Uniform Commercial Code § 2-308. Absence of Specified Place for Delivery.

Unless otherwise agreed

     (a) the place for delivery of goods is the seller's place of business or if he has none his residence; but

     (b) in a contract for sale of identified goods which to the knowledge of the parties at the time of contracting are in some other place, that place is the place for their delivery; and

* * *

Uniform Commercial Code § 2-309. Absence of Specific Time Provisions; Notice of Termination.

(1) The time for shipment or delivery or any other action under a contract if not provided in this Article or agreed upon shall be a reasonable time.

* * *

Locke v. Warner Bros., Inc.

Court of Appeal, Second District, Division 3, California

57 Cal.App.4th 354 (1997)

KLEIN, Presiding Justice.

Plaintiffs and appellants Sondra Locke (Locke) and Caritas Films, a California corporation (Caritas) (sometimes collectively referred to as Locke) appeal a judgment following a grant of summary judgment in favor of defendant and respondent Warner Bros. (Warner).

The essential issue presented is whether triable issues of material fact are present which would preclude summary judgment.

We conclude triable issues are present with respect to whether Warner breached its development deal with Locke by categorically refusing to work with her…

FACTUAL AND PROCEDURAL BACKGROUND

1. Locke’s dispute with Eastwood.

In 1975, Locke came to Warner to appear with Clint Eastwood in The Outlaw Josey Wales. During the filming of the movie, Locke and Eastwood began a personal and romantic relationship. For the next dozen years, they lived in Eastwood’s Los Angeles and Northern California homes. Locke also appeared in a number of Eastwood’s films. In 1986, Locke made her directorial debut in Ratboy.

In 1988, the relationship deteriorated, and in 1989 Eastwood terminated it. Locke then brought suit against Eastwood, alleging numerous causes of action. That action was resolved by a November 21, 1990 settlement agreement and mutual general release. Under said agreement, Eastwood agreed to pay Locke additional compensation in the sum of $450,000 “on account of past employment and Locke’s contentions” and to convey certain real property to her.

2. Locke’s development deal with Warner.

According to Locke, Eastwood secured a development deal for Locke with Warner in exchange for Locke’s dropping her case against him. Contemporaneously with the Locke/Eastwood settlement agreement, Locke entered into a written agreement with Warner, dated November 27, 1990. It is the Locke/Warner agreement which is the subject of the instant controversy.

The Locke/Warner agreement had two basic components. The first element states Locke would receive $250,000 per year for three years for a “non-exclusive first look deal.” It required Locke to submit to Warner any picture she was interested in developing before submitting it to any other studio. Warner then had 30 days either to approve or reject a submission.

The second element of the contract was a $750,000 “pay or play” directing deal. The provision is called “pay or play” because it gives the studio a choice: it can either “play” the director by using the director’s services, or pay the director his or her fee.

Unbeknownst to Locke at the time, Eastwood had agreed to reimburse Warner for the cost of her contract if she did not succeed in getting projects produced and developed. Early in the second year of the three-year contract, Warner charged $975,000 to an Eastwood film, “Unforgiven.”

Warner paid Locke the guaranteed compensation of $1.5 million under the agreement. In accordance with the agreement, Warner also provided Locke with an office on the studio lot and an administrative assistant. However, Warner did not develop any of Locke’s proposed projects or hire her to direct any films. Locke contends the development deal was a sham, that Warner never intended to make any films with her, and that Warner’s sole motivation in entering into the agreement was to assist Eastwood in settling his litigation with Locke.

3. Locke’s action against Warner.

On March 10, 1994, Locke filed suit against Warner, alleging four causes of action.

… The second cause of action alleged that Warner breached the contract by refusing to consider Locke’s proposed projects and thereby deprived her of the benefit of the bargain of the Warner/Locke agreement.

* * *

4. Warner’s motion for summary judgment and opposition thereto.

On January 6, 1995, Warner filed a motion for summary judgment. Warner contended it did not breach its contract with Locke because it did consider all the projects she presented, and the studio’s decision not to put any of those projects into active development or “hand” Locke a script which it already owned was not a breach of any express or implied contractual duty. Warner asserted the odds are slim a producer can get a project into development and even slimmer a director will be hired to direct a film. During the term of Locke’s deal, Warner had similar deals with numerous other producers and directors, who fared no better than Locke.

* * *

In opposing summary judgment, Locke contended Warner breached the agreement in that it had no intention of accepting any project regardless of its merits. …

Locke’s opposition papers cited the deposition testimony of Joseph Terry, who recounted a conversation he had with Bob Brassel, a Warner executive, regarding Locke’s projects. Terry had stated to Brassel: “’Well, Bob, this woman has a deal on the lot. She’s a director that you want to work with. You have a deal with her.... I’ve got five here that she’s interested in.’” And then I would get nothing. … I was told [by Brassel], ‘Joe, we’re not going to work with her,’ and then, ‘That’s Clint’s deal.’ And that’s something I just completely did not understand.”

Similarly, the declaration of Mary Wellnitz stated: She worked with Locke to set up projects at Warner, without success. Shortly after she began her association with Locke, Wellnitz submitted a script to Lance Young, who at the time was a senior vice president of production at Warner. After discussing the script, Young told Wellnitz, “Mary, I want you to know that I think Sondra is a wonderful woman and very talented, but, if you think I can go down the hall and tell Bob Daly that I have a movie I want to make with her he would tell me to forget it. They are not going to make a movie with her here.”

* * *

DISCUSSION

* * * 

2. A triable issue exists as to whether Warner breached its contract with Locke by failing to evaluate Locke’s proposals on their merits.

As indicated, the second cause of action alleged Warner breached the contract by “refusing to consider the projects prepared by [Locke] and depriving [Locke] of the benefit of the bargain of the Warner–Locke agreement.”

In granting summary judgment on this claim, the trial court ruled “[a] judge or jury cannot and should not substitute its own judgment for a film studio’s when the studio is making the creative decision of whether to develop or produce a proposed motion picture. Such highly-subjective artistic and business decisions are not proper subjects for judicial review.”

The trial court’s ruling missed the mark by failing to distinguish between Warner’s right to make a subjective creative decision, which is not reviewable for reasonableness, and the requirement the dissatisfaction be bona fide or genuine.

a. General principles.

“‘[W]here a contract confers on one party a discretionary power affecting the rights of the other, a duty is imposed to exercise that discretion in good faith and in accordance with fair dealing.’ [Citations.]” It is settled that in “ ‘every contract there is an implied covenant that neither party shall do anything which will have the effect of destroying or injuring the right of the other party to receive the fruits of the contract....’” [citations].

Therefore, when it is a condition of an obligor’s duty that he or she be subjectively satisfied with respect to the obligee’s performance, the subjective standard of honest satisfaction is applicable. “Where the contract involves matters of fancy, taste or judgment, the promisor is the sole judge of his satisfaction. If he asserts in good faith that he is not satisfied, there can be no inquiry into the reasonableness of his attitude. [Citations.] Traditional examples are employment contracts ... and agreements to paint a portrait, write a literary or scientific article, or produce a play or vaudeville act. [Citations.] In such cases, “the promisor’s determination that he is not satisfied, when made in good faith, has been held to be a defense to an action on the contract. [Citations.]”

Therefore, the trial court erred in deferring entirely to what it characterized as Warner’s “creative decision” in the handling of the development deal. If Warner acted in bad faith by categorically rejecting Locke’s work and refusing to work with her, irrespective of the merits of her proposals, such conduct is not beyond the reach of the law.

b. Locke presented evidence from which a trier of fact reasonably could infer Warner breached the agreement by refusing to consider her proposals in good faith.

Merely because Warner paid Locke the guaranteed compensation under the agreement does not establish Warner fulfilled its contractual obligation. As pointed out by Locke, the value in the subject development deal was not merely the guaranteed payments under the agreement, but also the opportunity to direct and produce films and earn additional sums, and most importantly, the opportunity to promote and enhance a career.

Unquestionably, Warner was entitled to reject Locke’s work based on its subjective judgment, and its creative decision in that regard is not subject to being second-guessed by a court. However, bearing in mind the requirement that subjective dissatisfaction must be an honestly held dissatisfaction, the evidence raises a triable issue as to whether Warner breached its agreement with Locke by not considering her proposals on their merits.

As indicated, the deposition testimony of Joseph Terry recounted a conversation he had with Bob Brassel, a Warner executive, regarding Locke’s projects. In that conversation, Brassel stated “‘Joe, we’re not going to work with her,’ and then, ‘That’s Clint’s deal.’”

Similarly, the declaration of Mary Wellnitz recalled a conversation she had with Lance Young, a senior vice president of production at Warner. After discussing the script with Wellnitz, Young told her: “Mary, I want you to know that I think Sondra is a wonderful woman and very talented, but, if you think I can go down the hall and tell Bob Daly that I have a movie I want to make with her he would tell me to forget it. They are not going to make a movie with her here.”

The above evidence raises a triable issue of material fact as to whether Warner breached its contract with Locke by categorically refusing to work with her, irrespective of the merits of her proposals. While Warner was entitled to reject Locke’s proposals based on its subjective dissatisfaction, the evidence calls into question whether Warner had an honest or good faith dissatisfaction with Locke’s proposals, or whether it merely went through the motions of purporting to “consider” her projects.

c. No merit to Warner’s contention Locke seeks to rewrite the instant agreement to limit Warner’s discretionary power.

Warner argues that while the implied covenant of good faith and fair dealing is implied in all contracts, it is limited to assuring compliance with the express terms of the contract and cannot be extended to create obligations not contemplated in the contract.

This principle is illustrated in Carma Developers, Inc. v. Marathon Development California, Inc., 2 Cal.4^th 342 (1992), wherein the parties entered into a lease agreement which stated that if the tenant procured a potential sublessee and asked the landlord for consent to sublease, the landlord had the right to terminate the lease, enter into negotiations with the prospective sublessee, and appropriate for itself all profits from the new arrangement. Carma recognized “[t]he covenant of good faith finds particular application in situations where one party is invested with a discretionary power affecting the rights of another.” Id. at 372. The court expressed the view that “[s]uch power must be exercised in good faith.” Id. At the same time, Carma upheld the right of the landlord under the express terms of the lease to freely exercise its discretion to terminate the lease in order to claim for itself—and deprive the tenant of—the appreciated rental value of the premises. Id. at 376.

In this regard, Carma stated: “We are aware of no reported case in which a court has held the covenant of good faith may be read to prohibit a party from doing that which is expressly permitted by an agreement.  On the contrary, as a general matter, implied terms should never be read to vary express terms. [Citations.] ‘The general rule [regarding the covenant of good faith] is plainly subject to the exception that the parties may, by express provisions of the contract, grant the right to engage in the very acts and conduct which would otherwise have been forbidden by an implied covenant of good faith and fair dealing.... This is in accord with the general principle that, in interpreting a contract “an implication ... should not be made when the contrary is indicated in clear and express words.” 3 Corbin, Contracts, § 564, p. 298 (1960).... “As to acts and conduct authorized by the express provisions of the contract, no covenant of good faith and fair dealing can be implied which forbids such acts and conduct. And if defendants were given the right to do what they did by the express provisions of the contract there can be no breach.’ [Citation.]” Carma Developers, at 374.

In Third Story Music, Inc. v. Waits, 41 Cal.App.4^th 798, 801 (1995), the issue presented was “whether a promise to market music, or to refrain from doing so, at the election of the promisor is subject to the implied covenant of good faith and fair dealing where substantial consideration has been paid by the promisor.”

In that case, Warner Communications obtained from TSM the worldwide right to manufacture, sell, distribute and advertise the musical output of singer/songwriter Tom Waits. The agreement also specifically stated that Warner Communications “‘may at our election refrain from any or all of the foregoing.’” Id. at 801. TSM sued Warner Communications for contract damages based on breach of the implied covenant of good faith and fair dealing, claiming Warner Communications had impeded TSM’s receiving the benefit of the agreement. Id. at 802. Warner Communications demurred to the complaint, alleging the clause in the agreement permitting it to “ ‘at [its] election refrain’ from doing anything to profitably exploit the music is controlling and precludes application of any implied covenant.” Id. The demurrer was sustained on those grounds. Id.

The reviewing court affirmed, holding the implied covenant was unavailing to the plaintiff. Because the agreement expressly provided Warner Communications had the right to refrain from marketing the Waits recordings, the implied covenant of good faith and fair dealing did not limit the discretion given to Warner Communications in that regard.

Warner’s reliance herein on Third Story Music is misplaced. The Locke/Warner agreement did not give Warner the express right to refrain from working with Locke. Rather, the agreement gave Warner discretion with respect to developing Locke’s projects. The implied covenant of good faith and fair dealing obligated Warner to exercise that discretion honestly and in good faith.

In sum, the Warner/Locke agreement contained an implied covenant of good faith and fair dealing, that neither party would frustrate the other party’s right to receive the benefits of the contract. Whether Warner violated the implied covenant and breached the contract by categorically refusing to work with Locke is a question for the trier of fact.

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Market Street Associates Limited Partnership v. Frey

United States Court of Appeals, Seventh Circuit

941 F.2d 588 (1991)

POSNER, Circuit Judge.

Market Street Associates Limited Partnership and its general partner appeal from a judgment for the defendants, General Electric Pension Trust and its trustees, entered upon cross-motions for summary judgment in a diversity suit that pivots on the doctrine of “good faith” performance of a contract. Wisconsin law applies—common law rather than Uniform Commercial Code, because the contract is for land rather than for goods, UCC § 2–102, and because it is a lease rather than a sale and Wisconsin has not adopted UCC art. 2A, which governs leases. …

…

We come at last to the contract dispute out of which the case arises. In 1968, J.C. Penney Company, the retail chain, entered into a sale and leaseback arrangement with General Electric Pension Trust in order to finance Penney’s growth. Under the arrangement Penney sold properties to the pension trust which the trust then leased back to Penney for a term of 25 years. Paragraph 34 of the lease entitles the lessee to “request Lessor [the pension trust] to finance the costs and expenses of construction of additional Improvements upon the Premises,” provided the amount of the costs and expenses is at least $250,000. Upon receiving the request, the pension trust “agrees to give reasonable consideration to providing the financing of such additional Improvements and Lessor and Lessee shall negotiate in good faith concerning the construction of such Improvements and the financing by Lessor of such costs and expenses.” Paragraph 34 goes on to provide that, should the negotiations fail, the lessee shall be entitled to repurchase the property at a price roughly equal to the price at which Penney sold it to the pension trust in the first place, plus 6 percent a year for each year since the original purchase. So if the average annual appreciation in the property exceeded 6 percent, a breakdown in negotiations over the financing of improvements would entitle Penney to buy back the property for less than its market value (assuming it had sold the property to the pension trust in the first place at its then market value).

One of these leases was for a shopping center in Milwaukee. In 1987 Penney assigned this lease to Market Street Associates, which the following year received an inquiry from a drugstore chain that wanted to open a store in the shopping center, provided (as is customary) that Market Street Associates built the store for it. Whether Market Street Associates was pessimistic about obtaining financing from the pension trust, still the lessor of the shopping center, or for other reasons, it initially sought financing for the project from other sources. But they were unwilling to lend the necessary funds without a mortgage on the shopping center, which Market Street Associates could not give because it was not the owner but only the lessee. It decided therefore to try to buy the property back from the pension trust. Market Street Associates’ general partner, Orenstein, tried to call David Erb of the pension trust, who was responsible for the property in question. Erb did not return his calls, so Orenstein wrote him, expressing an interest in buying the property and asking him to “review your file on this matter and call me so that we can discuss it further.” At first, Erb did not reply. Eventually Orenstein did reach Erb, who promised to review the file and get back to him. A few days later an associate of Erb called Orenstein and indicated an interest in selling the property for $3 million, which Orenstein considered much too high.

That was in June of 1988. On July 28, Market Street Associates wrote a letter to the pension trust formally requesting funding for $2 million in improvements to the shopping center. The letter made no reference to paragraph 34 of the lease; indeed, it did not mention the lease. The letter asked Erb to call Orenstein to discuss the matter. Erb, in what was becoming a habit of unresponsiveness, did not call. On August 16, Orenstein sent a second letter—certified mail, return receipt requested—again requesting financing and this time referring to the lease, though not expressly to paragraph 34. The heart of the letter is the following two sentences: “The purpose of this letter is to ask again that you advise us immediately if you are willing to provide the financing pursuant to the lease. If you are willing, we propose to enter into negotiation to amend the ground lease appropriately.” The very next day, Market Street Associates received from Erb a letter, dated August 10, turning down the original request for financing on the ground that it did not “meet our current investment criteria”: the pension trust was not interested in making loans for less than $7 million. On August 22, Orenstein replied to Erb by letter, noting that his letter of August 10 and Erb’s letter of August 16 had evidently crossed in the mails, expressing disappointment at the turn-down, and stating that Market Street Associates would seek financing elsewhere. That was the last contact between the parties until September 27, when Orenstein sent Erb a letter stating that Market Street Associates was exercising the option granted it by paragraph 34 to purchase the property upon the terms specified in that paragraph in the event that negotiations over financing broke down.

The pension trust refused to sell, and this suit to compel specific performance followed. Apparently the price computed by the formula in paragraph 34 is only $1 million. The market value must be higher, or Market Street Associates wouldn’t be trying to coerce conveyance at the paragraph 34 price; whether it is as high as $3 million, however, the record does not reveal.

The district judge granted summary judgment for the pension trust on two grounds that he believed to be separate although closely related. The first was that, by failing in its correspondence with the pension trust to mention paragraph 34 of the lease, Market Street Associates had prevented the negotiations over financing that are a condition precedent to the lessee’s exercise of the purchase option from taking place. Second, this same failure violated the duty of good faith, which the common law of Wisconsin, as of other states, reads into every contract. In support of both grounds the judge emphasized a statement by Orenstein in his deposition that it had occurred to him that Erb mightn’t know about paragraph 34, though this was unlikely (Orenstein testified) because Erb or someone else at the pension trust would probably check the file and discover the paragraph and realize that if the trust refused to negotiate over the request for financing, Market Street Associates, as Penney’s assignee, would be entitled to walk off with the property for (perhaps) a song. The judge inferred that Market Street Associates didn’t want financing from the pension trust—that it just wanted an opportunity to buy the property at a bargain price and hoped that the pension trust wouldn’t realize the implications of turning down the request for financing. Market Street Associates should, the judge opined, have advised the pension trust that it was requesting financing pursuant to paragraph 34, so that the trust would understand the penalty for refusing to negotiate.

We begin our analysis by setting to one side two extreme contentions by the parties. The pension trust argues that the option to purchase created by paragraph 34 cannot be exercised until negotiations over financing break down; there were no negotiations; therefore they did not break down; therefore Market Street Associates had no right to exercise the option. This argument misreads the contract. Although the option to purchase is indeed contingent, paragraph 34 requires the pension trust, upon demand by the lessee for the financing of improvements worth at least $250,000, “to give reasonable consideration to providing the financing.” The lessor who fails to give reasonable consideration and thereby prevents the negotiations from taking place is breaking the contract; and a contracting party cannot be allowed to use his own breach to gain an advantage by impairing the rights that the contract confers on the other party. Often, it is true, if one party breaks the contract, the other can walk away from it without liability, can in other words exercise self-help. But he is not required to follow that course. He can stand on his contract rights.

But what exactly are those rights in this case? The contract entitles the lessee to reasonable consideration of its request for financing, and only if negotiations over the request fail is the lessee entitled to purchase the property at the price computed in accordance with paragraph 34. It might seem therefore that the proper legal remedy for a lessor’s breach that consists of failure to give the lessee’s request for financing reasonable consideration would not be an order that the lessor sell the property to the lessee at the paragraph 34 price, but an order that the lessor bargain with the lessee in good faith. But we do not understand the pension trust to be arguing that Market Street Associates is seeking the wrong remedy. We understand it to be arguing that Market Street Associates has no possible remedy. That is an untenable position.

Market Street Associates argues, with equal unreason as it seems to us, that it could not have broken the contract because paragraph 34 contains no express requirement that in requesting financing the lessee mention the lease or paragraph 34 or otherwise alert the lessor to the consequences of his failing to give reasonable consideration to granting the request. There is indeed no such requirement (all that the contract requires is a demand). But no one says there is. The pension trust’s argument, which the district judge bought, is that either as a matter of simple contract interpretation or under the compulsion of the doctrine of good faith, a provision requiring Market Street Associates to remind the pension trust of paragraph 34 should be read into the lease.

It seems to us that these are one ground rather than two. A court has to have a reason to interpolate a clause into a contract. The only reason that has been suggested here is that it is necessary to prevent Market Street Associates from reaping a reward for what the pension trust believes to have been Market Street’s bad faith. So we must consider the meaning of the contract duty of “good faith.” The Wisconsin cases are cryptic as to its meaning though emphatic about its existence, so we must cast our net wider. We do so mindful of Learned Hand’s warning, that “such words as ‘fraud,’ ‘good faith,’ ‘whim,’ ‘caprice,’ ‘arbitrary action,’ and ‘legal fraud’ ... obscure the issue.” Thompson–Starrett Co. v. La Belle Iron Works, 17 F.2d 536, 541 (2d Cir.1927). Indeed they do. The particular confusion to which the vaguely moralistic overtones of “good faith” give rise is the belief that every contract establishes a fiduciary relationship. A fiduciary is required to treat his principal as if the principal were he, and therefore he may not take advantage of the principal’s incapacity, ignorance, inexperience, or even naïveté. If Market Street Associates were the fiduciary of General Electric Pension Trust, then (we may assume) it could not take advantage of Mr. Erb’s apparent ignorance of paragraph 34, however exasperating Erb’s failure to return Orenstein’s phone calls was and however negligent Erb or his associates were in failing to read the lease before turning down Orenstein’s request for financing.

But it is unlikely that Wisconsin wishes, in the name of good faith, to make every contract signatory his brother’s keeper, especially when the brother is the immense and sophisticated General Electric Pension Trust, whose lofty indifference to small (= < $7 million) transactions is the signifier of its grandeur. In fact the law contemplates that people frequently will take advantage of the ignorance of those with whom they contract, without thereby incurring liability. The duty of honesty, of good faith even expansively conceived, is not a duty of candor. You can make a binding contract to purchase something you know your seller undervalues. That of course is a question about formation, not performance, and the particular duty of good faith under examination here relates to the latter rather than to the former. But even after you have signed a contract, you are not obliged to become an altruist toward the other party and relax the terms if he gets into trouble in performing his side of the bargain. Otherwise mere difficulty of performance would excuse a contracting party—which it does not.

But it is one thing to say that you can exploit your superior knowledge of the market—for if you cannot, you will not be able to recoup the investment you made in obtaining that knowledge—or that you are not required to spend money bailing out a contract partner who has gotten into trouble. It is another thing to say that you can take deliberate advantage of an oversight by your contract partner concerning his rights under the contract. Such taking advantage is not the exploitation of superior knowledge or the avoidance of unbargained-for expense; it is sharp dealing. Like theft, it has no social product, and also like theft it induces costly defensive expenditures, in the form of overelaborate disclaimers or investigations into the trustworthiness of a prospective contract partner, just as the prospect of theft induces expenditures on locks.

The form of sharp dealing that we are discussing might or might not be actionable as fraud or deceit. That is a question of tort law and there the rule is that if the information is readily available to both parties the failure of one to disclose it to the other, even if done in the knowledge that the other party is acting on mistaken premises, is not actionable. All of these cases, however, with the debatable exception of Guyer, involve failure to disclose something in the negotiations leading up to the signing of the contract, rather than failure to disclose after the contract has been signed. (Guyer involved failure to disclose during the negotiations leading up to a renewal of the contract.) The distinction is important, … . Before the contract is signed, the parties confront each other with a natural wariness. Neither expects the other to be particularly forthcoming, and therefore there is no deception when one is not. Afterwards the situation is different. The parties are now in a cooperative relationship the costs of which will be considerably reduced by a measure of trust. So each lowers his guard a bit, and now silence is more apt to be deceptive.

Moreover, this is a contract case rather than a tort case, and conduct that might not rise to the level of fraud may nonetheless violate the duty of good faith in dealing with one’s contractual partners and thereby give rise to a remedy under contract law. This duty is, as it were, halfway between a fiduciary duty (the duty of utmost good faith) and the duty merely to refrain from active fraud. Despite its moralistic overtones it is no more the injection of moral principles into contract law than the fiduciary concept itself is. It would be quixotic as well as presumptuous for judges to undertake through contract law to raise the ethical standards of the nation’s business people. The concept of the duty of good faith like the concept of fiduciary duty is a stab at approximating the terms the parties would have negotiated had they foreseen the circumstances that have given rise to their dispute. The parties want to minimize the costs of performance. To the extent that a doctrine of good faith designed to do this by reducing defensive expenditures is a reasonable measure to this end, interpolating it into the contract advances the parties’ joint goal.

It is true that an essential function of contracts is to allocate risk, and would be defeated if courts treated the materializing of a bargained-over, allocated risk as a misfortune the burden of which is required to be shared between the parties (as it might be within a family, for example) rather than borne entirely by the party to whom the risk had been allocated by mutual agreement. But contracts do not just allocate risk. They also (or some of them) set in motion a cooperative enterprise, which may to some extent place one party at the other’s mercy. “The parties to a contract are embarked on a cooperative venture, and a minimum of cooperativeness in the event unforeseen problems arise at the performance stage is required even if not an explicit duty of the contract.” AMPAT/Midwest, Inc. v. Illinois Tool Works, Inc., supra, 896 F.2d at 1041. The office of the doctrine of good faith is to forbid the kinds of opportunistic behavior that a mutually dependent, cooperative relationship might enable in the absence of rule. “ ‘Good faith’ is a compact reference to an implied undertaking not to take opportunistic advantage in a way that could not have been contemplated at the time of drafting, and which therefore was not resolved explicitly by the parties.” Kham & Nate’s Shoes No. 2, Inc. v. First Bank, supra, 908 F.2d at 1357. The contractual duty of good faith is thus not some newfangled bit of welfare-state paternalism or … the sediment of an altruistic strain in contract law, and we are therefore not surprised to find the essentials of the modern doctrine well established in nineteenth-century cases.

The emphasis we are placing on postcontractual versus precontractual conduct helps explain the pattern that is observed when the duty of contractual good faith is considered in all its variety, encompassing not only good faith in the performance of a contract but also good faith in its formation, Summers, supra, at 220–32, and in its enforcement. The formation or negotiation stage is precontractual, and here the duty is minimized. It is greater not only at the performance but also at the enforcement stage, which is also postcontractual. … At the formation of the contract the parties are dealing in present realities; performance still lies in the future. As performance unfolds, circumstances change, often unforeseeably; the explicit terms of the contract become progressively less apt to the governance of the parties’ relationship; and the role of implied conditions—and with it the scope and bite of the good-faith doctrine—grows.

We could of course do without the term “good faith,” and maybe even without the doctrine. We could, as just suggested, speak instead of implied conditions necessitated by the unpredictability of the future at the time the contract was made. Suppose a party has promised work to the promisee’s “satisfaction.” As Learned Hand explained, “he may refuse to look at the work, or to exercise any real judgment on it, in which case he has prevented performance and excused the condition.” Thompson–Starrett Co. v. La Belle Iron Works, supra, 17 F.2d at 541. That is, it was an implicit condition that the promisee examine the work to the extent necessary to determine whether it was satisfactory; otherwise the performing party would have been placing himself at the complete mercy of the promisee. The parties didn’t write this condition into the contract either because they thought such behavior unlikely or failed to foresee it altogether. In just the same way—to switch to another familiar example of the operation of the duty of good faith—parties to a requirements contract surely do not intend that if the price of the product covered by the contract rises, the buyer shall be free to increase his “requirements” so that he can take advantage of the rise in the market price over the contract price to resell the product on the open market at a guaranteed profit. If they fail to insert an express condition to this effect, the court will read it in, confident that the parties would have inserted the condition if they had known what the future held. Of similar character is the implied condition that an exclusive dealer will use his best efforts to promote the supplier’s goods, since otherwise the exclusive feature of the dealership contract would place the supplier at the dealer’s mercy. Wood v. Duff–Gordon, 222 N.Y. 88, 118 N.E. 214 (1917) (Cardozo, J.).

But whether we say that a contract shall be deemed to contain such implied conditions as are necessary to make sense of the contract, or that a contract obligates the parties to cooperate in its performance in “good faith” to the extent necessary to carry out the purposes of the contract, comes to much the same thing. They are different ways of formulating the overriding purpose of contract law, which is to give the parties what they would have stipulated for expressly if at the time of making the contract they had had complete knowledge of the future and the costs of negotiating and adding provisions to the contract had been zero.

The two formulations would have different meanings only if “good faith” were thought limited to “honesty in fact,” an interpretation perhaps permitted but certainly not compelled by the Uniform Commercial Code—and anyway this is not a case governed by the UCC. We need not pursue this issue. The dispositive question in the present case is simply whether Market Street Associates tried to trick the pension trust and succeeded in doing so. If it did, this would be the type of opportunistic behavior in an ongoing contractual relationship that would violate the duty of good faith performance however the duty is formulated. There is much common sense in Judge Reynolds’ conclusion that Market Street Associates did just that. The situation as he saw it was as follows. Market Street Associates didn’t want financing from the pension trust (initially it had looked elsewhere, remember), and when it learned it couldn’t get the financing without owning the property, it decided to try to buy the property. But the pension trust set a stiff price, so Orenstein decided to trick the pension trust into selling at the bargain price fixed in paragraph 34 by requesting financing and hoping that the pension trust would turn the request down without noticing the paragraph. His preliminary dealings with the pension trust made this hope a realistic one by revealing a sluggish and hidebound bureaucracy unlikely to have retained in its brontosaurus’s memory, or to be able at short notice to retrieve, the details of a small lease made twenty years earlier. So by requesting financing without mentioning the lease Market Street Associates might well precipitate a refusal before the pension trust woke up to paragraph 34. It is true that Orenstein’s second letter requested financing “pursuant to the lease.” But when the next day he received a reply to his first letter indicating that the pension trust was indeed oblivious to paragraph 34, his response was to send a lulling letter designed to convince the pension trust that the matter was closed and could be forgotten. The stage was set for his thunderbolt: the notification the next month that Market Street Associates was taking up the option in paragraph 34. Only then did the pension trust look up the lease and discover that it had been had.

The only problem with this recital is that it construes the facts as favorably to the pension trust as the record will permit, and that of course is not the right standard for summary judgment. The facts must be construed as favorably to the nonmoving party, to Market Street Associates, as the record permits (that Market Street Associates filed its own motion for summary judgment is irrelevant, as we have seen). When that is done, a different picture emerges. On Market Street Associates’ construal of the record, $3 million was a grossly excessive price for the property, and while $1 million might be a bargain it would not confer so great a windfall as to warrant an inference that if the pension trust had known about paragraph 34 it never would have turned down Market Street Associates’ request for financing cold. And in fact the pension trust may have known about paragraph 34, and either it didn’t care or it believed that unless the request mentioned that paragraph the pension trust would incur no liability by turning it down. Market Street Associates may have assumed and have been entitled to assume that in reviewing a request for financing from one of its lessees the pension trust would take the time to read the lease to see whether it bore on the request. Market Street Associates did not desire financing from the pension trust initially—that is undeniable—yet when it discovered that it could not get financing elsewhere unless it had the title to the property it may have realized that it would have to negotiate with the pension trust over financing before it could hope to buy the property at the price specified in the lease.

On this interpretation of the facts there was no bad faith on the part of Market Street Associates. It acted honestly, reasonably, without ulterior motive, in the face of circumstances as they actually and reasonably appeared to it. The fault was the pension trust’s incredible inattention, which misled Market Street Associates into believing that the pension trust had no interest in financing the improvements regardless of the purchase option. We do not usually excuse contracting parties from failing to read and understand the contents of their contract; and in the end what this case comes down to—or so at least it can be strongly argued—is that an immensely sophisticated enterprise simply failed to read the contract. On the other hand, such enterprises make mistakes just like the rest of us, and deliberately to take advantage of your contracting partner’s mistake during the performance stage (for we are not talking about taking advantage of superior knowledge at the formation stage) is a breach of good faith. To be able to correct your contract partner’s mistake at zero cost to yourself, and decide not to do so, is a species of opportunistic behavior that the parties would have expressly forbidden in the contract had they foreseen it. The immensely long term of the lease amplified the possibility of errors but did not license either party to take advantage of them.

The district judge jumped the gun in choosing between these alternative characterizations. The essential issue bearing on Market Street Associates’ good faith was Orenstein’s state of mind, a type of inquiry that ordinarily cannot be concluded on summary judgment, and could not be here. If Orenstein believed that Erb knew or would surely find out about paragraph 34, it was not dishonest or opportunistic to fail to flag that paragraph, or even to fail to mention the lease, in his correspondence and (rare) conversations with Erb, especially given the uninterest in dealing with Market Street Associates that Erb fairly radiated. To decide what Orenstein believed, a trial is necessary. As for the pension trust’s intimation that a bench trial (for remember that this is an equity case, since the only relief sought by the plaintiff is specific performance) will add no illumination beyond what the summary judgment proceeding has done, this overlooks the fact that at trial the judge will for the first time have a chance to see the witnesses whose depositions he has read, to hear their testimony elaborated, and to assess their believability.

Please read the next case, including the dissent, carefully. It involves a dispute in which Mel Nelson, the plaintiff, argues that the parties agreed to some things that did not make it into the final, executed agreements. He thinks the agreements that are not included in the final documents should nonetheless be enforceable; the defendant, John Elway (yes, that John Elway), argues that the parol evidence rule precludes the enforcement of those agreements.

Note that the majority opinion reflects the Colorado rule, which differs in important ways from the rule as applied by the dissent. The dissent applies the Restatement approach, which is the approach taken by most jurisdictions. Identify the promise at issue in the case and try to articulate both the Colorado rule and the Restatement rule. Which approach do you think is better, and why?

Nelson v. Elway

Supreme Court of Colorado, En Banc

908 P.2d 102 (1995)

Chief Justice VOLLACK delivered the Opinion of the Court.

We granted certiorari to review the decision by the court of appeals in Nelson v. Elway, affirming in part and reversing in part the trial court’s grant of summary judgment in favor of the respondents. The court of appeals affirmed the trial court’s entry of summary judgment in the respondents’ favor as to the petitioners’ allegations of breach of contract, fraud and misrepresentation, dual agency, civil conspiracy, and punitive damages. The court of appeals reversed the trial court’s entry of summary judgment as to the promissory estoppel count in the petitioners’ complaint, ruling that there existed a material issue of fact as to this count. We reverse the court of appeals decision reversing summary judgment as to the promissory estoppel claim and affirm in all other respects.

I.

Mel T. Nelson (Nelson) was the president and sole shareholder of two car dealerships, Metro Auto and Metro Toyota, Inc. General Motors Acceptance Corporation (GMAC) provided all the financing for both dealerships. In the first half of 1990, both dealerships were experiencing financial difficulties. In July of 1990, Nelson retained John J. Pico and the Aspen Brokerage Company (Pico) to represent him in the selling or refinancing of one or both of the dealerships.

In early 1991, Pico, acting on behalf of Nelson and Metro Toyota, began negotiations with John A. Elway, Jr. (Elway) and Rodney L. Buscher (Buscher) regarding the sale of Metro Toyota and the property upon which it was situated. On March 14, 1991, pursuant to those negotiations, Elway and Buscher signed a “Buy–Sell Agreement” and a separate real estate contract to purchase Metro Toyota. The closing was scheduled for April 15, 1991.

Soon after the signing of these documents, Pico asked Nelson if he would be willing to sell both Metro Auto and Metro Toyota to Elway. Nelson stated that he would be willing to sell both dealerships along with the land upon which they were located if he received sufficient personal remuneration. Pico then began negotiating with Elway and Buscher regarding the sale of both dealerships. Through these negotiations it became apparent that Elway and Buscher were unwilling or unable to pay the full purchase price for the dealerships and the land upon which they were located.

In order to consummate the transaction, Pico suggested to Nelson that Elway and Buscher reimburse Nelson for his interest in Metro Toyota by paying Nelson $50 per vehicle sold by both dealerships for a period of seven years commencing on May 1, 1991. In exchange for this compensation arrangement, Elway and Buscher would purchase Metro Auto from Nelson at a greatly reduced purchase price. These terms, referred to by the parties as the “Service Agreement,” were reduced to writing but never signed by the parties. Subsequently, on March 16, 1991, the parties signed a “Buy–Sell Agreement” and a separate real estate contract for the purchase of Metro Auto. This written, signed agreement did not incorporate the terms of the Service Agreement.

By early 1991, the dealerships owed GMAC over $3 million. In order to protect its security interests, on April 3, 1991, GMAC required Nelson to execute agreements referred to as “keeper letters,” allowing GMAC significant control over the dealerships. GMAC imposed this requirement as consideration for its agreement to pay in excess of $890,000 in debt owed by Metro Auto and Metro Toyota at the closing of the sale of the dealerships to Elway and Buscher. Nelson knew that execution of these letters would preclude his ability to file for bankruptcy protection and proceed through re-organization. He alleges that he thus sought and received assurances from Elway and Buscher that the orally agreed upon, but as yet unsigned, Service Agreement would be honored.

On April 8, 1991, after the execution of the keeper letters, Pico, Elway, and Buscher met at Pico’s office. During this meeting, GMAC telephoned Pico’s office and informed Pico, Elway, and Buscher that as a condition to its agreement to finance the acquisition of the land and assets of the dealerships by Elway and Buscher, Nelson was not to receive any proceeds from the sale of the dealerships. The respondents then informed Nelson they would not be able to enter into the Service Agreement with him, and the Service Agreement was therefore not executed at the closing on April 12, 1991. After closing, Nelson demanded that the respondents honor the Service Agreement. When the respondents refused, Nelson filed the instant action.

In his complaint, Nelson sought damages from Elway and Buscher for breach of contract, promissory estoppel, fraud, conspiracy, and dual agency. Additionally, Nelson sought exemplary damages. The respondents then moved the trial court for summary judgment, which the court granted as to all counts. The court of appeals affirmed with respect to all counts except for promissory estoppel. On that claim the court of appeals held there was a genuine issue of material fact and remanded the case to the trial court for trial on that issue alone.

* * *

IV.

The next issue is whether the court of appeals erred in upholding the trial court’s entry of summary judgment on the petitioners’ claim of breach of contract. The petitioners’ claim for breach of contract is based on the alleged March 15, 1991, Service Agreement orally agreed upon by Nelson, Elway and Buscher.

A.

The first issue with regard to the breach of contract claim is whether the merger clauses in the Buy–Sell Agreements precluded the consideration of evidence that the parties intended the Service Agreement to be part of the overall agreement to sell the dealerships.¹ The petitioners argue that the court of appeals erred by ruling that the merger clauses precluded the consideration of the intent of the contracting parties. The respondents assert that the merger clauses wholly manifest the intention of the parties that only those terms of the transaction reduced to writing and signed at the closing would be enforceable terms of the agreement.

We agree with the court of appeals that the merger clauses preclude consideration of extrinsic evidence to ascertain the intent of the parties. Integration clauses generally allow contracting parties to limit future contractual disputes to issues relating to the express provisions of the contract. Therefore, the terms of a contract intended to represent a final and complete integration of the agreement between the parties are enforceable, and extrinsic evidence offered to prove the existence of prior agreements is inadmissible. Even when extrinsic evidence is admissible to ascertain the intent of the parties, such evidence may not be used to demonstrate an intent that contradicts or adds to the intent expressed in the writing.

In this case, the merger clauses plainly and unambiguously manifest the intent of the parties that the Buy–Sell Agreements executed on March 16, 1991 constitute the entire agreement between the parties pertaining to the subject matter contained therein. Where, as here, sophisticated parties who are represented by counsel have consummated a complex transaction and embodied the terms of that transaction in a detailed written document, it would be improper for this court to rewrite that transaction by looking to evidence outside the four corners of the contract to determine the intent of the parties.

The petitioners and respondents signed the March 16, 1991 Buy–Sell Agreements after extensive negotiation and numerous drafts of documents. By doing so, all parties expressly agreed, pursuant to the merger clauses, that the terms of those Buy–Sell Agreements would control the transaction and that all other agreements, oral or written, would be void. We will not step into a commercial transaction after the fact and attempt to ascertain the intent of the parties when that intent is clearly manifested by an express term in a written document. We thus conclude that the merger clauses in the March 16, 1991, Buy–Sell Agreements are dispositive as to the intent of the parties in this case. As there is no dispute as to any material fact with regard to this issue, the court of appeals correctly affirmed the trial court’s order of summary judgment in favor of the respondents on this issue.

* * *

LOHR, J., dissents, and KIRSHBAUM and SCOTT, JJ., join in the dissent.

Justice LOHR dissenting:

Petitioners Mel T. Nelson and Metro Auto, Inc. (collectively “Nelson”) appealed a trial court ruling dismissing their claims on summary judgment grounds. The Colorado Court of Appeals affirmed the trial court’s dismissal of all of Nelson’s claims except a claim based on promissory estoppel. On certiorari review in this court, the majority holds that Nelson’s civil conspiracy, breach of contract, and promissory estoppel claims were all properly dismissed by the trial court on summary judgment.

I respectfully dissent. Summary judgment is a severe remedy. As the majority notes, in summary judgment proceedings courts must resolve all doubts as to the existence of genuine issues of material fact against the moving party. In view of the record and the procedural posture of this case, I would hold that Nelson’s civil conspiracy, breach of contract, and promissory estoppel claims were improperly dismissed. I would therefore reverse the judgment of the court of appeals upholding dismissal of the civil conspiracy and breach of contract claims, and would affirm the judgment of that court overturning the dismissal of the promissory estoppel claim.

I.

The following facts are derived from the record in this case, resolving all doubts against the party moving for summary judgment, as we must. Mel T. Nelson was the president and sole shareholder of both Metro Toyota, Inc. (“Metro Toyota”) and Metro Auto, Inc. (“Metro Auto”). Nelson also owned the land upon which the dealerships were located. Although Metro Auto was historically profitable, Metro Toyota was less successful. After hiring John J. Pico and Aspen Brokerage Co. (collectively “Pico”) to serve as his agent and negotiator, Nelson agreed to sell Metro Toyota to John A. Elway, Jr., Rodney L. Buscher, J.R. Motors Company, and J.R. Motors Company South (collectively “Elway”).¹ The parties signed buy-sell and real estate contracts for the Metro Toyota concern on March 14, 1991, and set a closing date in April of 1991.

Soon after the Metro Toyota contracts were executed, Pico approached Nelson with the idea of selling Metro Auto to Elway as well. The parties agreed that any successful deal would have to meet two conditions: John A. Elway’s total cash contribution would have to be limited to approximately $1.2 million dollars, and Nelson would have to receive enough personal compensation to make a sale of the historically profitable Metro Auto worthwhile. On March 15, 1991, Elway and Nelson agreed that if Nelson made the up-front concessions envisioned by Elway regarding the sale price for the real estate and dealership assets, Nelson would receive deferred personal compensation through a side agreement (“service agreement”) providing that Nelson was to receive $50.00 for every new or used vehicle sold by the dealerships for the next seven years. Both buy-sell agreements noted that sale of the dealerships was contingent on GMAC approval. The parties subsequently signed buy-sell and real estate contracts for Metro Auto on March 16, 1991.

Anticipating the pending sale of the dealerships, GMAC insisted that Nelson relinquish control over the dealerships on April 3, 1991. Since Nelson and Elway had yet to sign the service agreement, Nelson contacted Rodney L. Buscher and received assurances that the service agreement would be honored before relinquishing control to GMAC.

On April 8 or 9, 1991, Pico and Elway met at the Landmark Hotel to discuss the sale of Nelson’s dealerships. During the meeting, GMAC called Pico and told Elway that they would not finance the deal if Elway signed a side agreement with Nelson. Despite Nelson’s understanding that Elway would honor the service agreement, Elway informed Nelson on April 8 or 9, 1991, that the service agreement would not be signed.

The parties disagree as to why Elway did not sign the service agreement. Elway contends that GMAC refused to approve the sale if the service agreement was executed. Nelson, on the other hand, alleges that Pico and Elway prompted GMAC to impose such conditions. Nelson suggests that Pico was interested in sabotaging the service agreement because of a fee dispute between Pico and Nelson. Nelson further contends that Elway realized that even if a portion of the money earmarked for the service agreement was diverted to pay Pico a commission, the total payout under any side agreements would be less if Nelson’s compensation under the service agreement was eliminated. Nevertheless, Nelson proceeded with the sale of the dealerships because he already had turned control over to GMAC and thereby eliminated a bankruptcy reorganization alternative that was previously under consideration.

The parties’ present dispute revolves around the enforceability of the service agreement. The district court dismissed Nelson’s claims in a summary judgment proceeding, and the court of appeals affirmed in part but reversed as to Nelson’s promissory estoppel claim. The court of appeals held that there were “genuine issues of material fact precluding the entry of summary judgment on [Nelson’s] claim for promissory estoppel.” Nelson, slip op. at 11. Nelson then petitioned this court for certiorari review of the court of appeals’ affirmance of the trial court’s summary judgment ruling regarding his civil conspiracy and breach of contract claims, and Elway cross-petitioned regarding the court of appeals’ ruling on Nelson’s promissory estoppel claim.

* * * 

IV.

Nelson also contends that Elway is liable for breach of contract in failing to honor the service agreement. The majority affirms the dismissal of Nelson’s breach of contract claim on summary judgment, holding (1) that the merger clauses in the buy-sell agreements preclude consideration of the alleged service agreement, … I disagree with the majority …

First, merger clauses preclude consideration of extrinsic evidence only where the parties intend that the document containing the merger is exclusive. The very essence of this case is a dispute regarding whether the parties intended the service agreement to be part and parcel of the overall deal. Because Nelson’s position is adequately supported in the record, the intention of the parties regarding the exclusivity of the document containing the merger agreement is a disputed issue of material fact. As a result, this case is inappropriate for summary judgment disposition.

…

A.

Nelson and Elway disagree regarding their intent to honor the alleged service agreement. The majority contends that the merger clauses in the buy-sell agreements affirmatively preclude consideration of extrinsic evidence such as the alleged oral service agreement, and refuses to look at “evidence outside the four corners of the contract to determine the intent of the parties.”³ Maj. op. at 107. However, the “four corners” approach to contract interpretation is in decline. The “modern trend” is that merger and integration clauses are to be afforded varying weight depending on the circumstances of the case. [citations omitted].

Although I believe that merger and integration clauses are presumptively valid, in keeping with the honored tenets of contract law there is an exception such that “[w]here giving effect to the merger clause would frustrate and distort the parties’ true intentions and understanding regarding the contract, the clause will not be enforced.” Zinn v. Walker, 87 N.C.App. 325 (1987). In particular, where the parties intend that both a written contract and an alleged oral agreement constitute components of an overall agreement, a merger clause does not preclude consideration of extrinsic evidence. See Coulter v. Anderson, 144 Colo. 402, 410 (1960) (“[w]here it is shown that a writing was not intended to be fully integrated, terms other than those set forth in the writing may be proved by parol evidence” even though “nothing appears on [the written document’s] face rendering it incomplete”); [citations omitted].

The parties’ intention that the buy-sell agreements constituted entire contracts, allegedly evidenced by the merger clauses within, was by no means clearly manifested. In this case, despite the disclaimer in both merger clauses that each buy-sell agreement constituted the entire agreement, the overall deal involved two buy-sell agreements and two real estate contracts. Furthermore, each buy-sell agreement made reference to the real estate contracts despite the exclusivity disclaimer. Regardless of the standard merger and integration language in the buy-sell agreements, it is clear that the parties intended their ultimate bargain to encompass other agreements, although the substantive weight of the alleged service agreement remains unclear.

When the parties disagree as to whether a document expresses the complete agreement of the parties, and a court subsequently finds that the evidence is conflicting or admits of more than one inference, the resolution of the parties’ dispute requires a factual determinatio

Restatement provisions on the parol evidence rule

Restatement (Second) of Contracts § 213. Effect of Integrated Agreement on Prior Agreements

(1) A binding integrated agreement discharges prior agreements to the extent that it is inconsistent with them.

(2) A binding completely integrated agreement discharges prior agreements to the extent that they are within its scope.

* * *

Restatement (Second) of Contracts § 209. Integrated Agreements

(1) An integrated agreement is a writing or writings constituting a final expression of one or more terms of an agreement.

(2) Whether there is an integrated agreement is to be determined by the court as a question preliminary to determination of a question of interpretation or to application of the parol evidence rule.

(3) Where the parties reduce an agreement to a writing which in view of its completeness and specificity reasonably appears to be a complete agreement, it is taken to be an integrated agreement unless it is established by other evidence that the writing did not constitute a final expression.

* * *

Restatement (Second) of Contracts § 210. Completely and Partially Integrated Agreements

(1) A completely integrated agreement is an integrated agreement adopted by the parties as a complete and exclusive statement of the terms of the agreement.

(2) A partially integrated agreement is an integrated agreement other than a completely integrated agreement.

(3) Whether an agreement is completely or partially integrated is to be determined by the court as a question preliminary to determination of a question of interpretation or to application of the parol evidence rule.

* * *

Restatement (Second) of Contracts § 214. Evidence of Prior or Contemporaneous Agreements and Negotiations

 Agreements and negotiations prior to or contemporaneous with the adoption of a writing are admissible in evidence to establish

     (a) that the writing is or is not an integrated agreement;

     (b) that the integrated agreement, if any, is completely or partially integrated;

     (c) the meaning of the writing, whether or not integrated;

     (d) illegality, fraud, duress, mistake, lack of consideration, or other invalidating cause;

        …

Comment:

a. Integrated agreement and completely integrated agreement. Whether a writing has been adopted as an integrated agreement and, if so, whether the agreement is completely or partially integrated are questions determined by the court preliminary to determination of a question of interpretation or to application of the parol evidence rule. See §§ 209-13. Writings do not prove themselves; ordinarily, if there is dispute, there must be testimony that there was a signature or other manifestation of assent. The preliminary determination is made in accordance with all relevant evidence, including the circumstances in which the writing was made or adopted. It may require preliminary interpretation of the writing; the court must then consider the evidence which is relevant to the question of interpretation.

* * * 

Restatement (Second) of Contracts § 215. Contradiction of Integrated Terms

Except as stated in the preceding Section, where there is a binding agreement, either completely or partially integrated, evidence of prior or contemporaneous agreements or negotiations is not admissible in evidence to contradict a term of the writing.

* * *

Restatement (Second) of Contracts § 216. Consistent Additional Terms

(1) Evidence of a consistent additional term is admissible to supplement an integrated agreement unless the court finds that the agreement was completely integrated.

(2) An agreement is not completely integrated if the writing omits a consistent additional agreed term which is

     (a) agreed to for separate consideration, or

     (b) such a term as in the circumstances might naturally be omitted from the writing.

Uniform Commercial Code § 2-202. Final Expression: Parol or Extrinsic Evidence.

Terms with respect to which the confirmatory memoranda of the parties agree or which are otherwise set forth in a record intended by the parties as a final expression of their agreement with respect to such terms as are included therein may not be contradicted by evidence of any prior agreement or of a contemporaneous oral agreement but may be explained or supplemented;

     (a) by course of performance, course of dealing, or usage of trade (Section 1-303); and

   (b) by evidence of consistent additional terms unless the court finds the record to have been intended also as a complete and exclusive statement of the terms of the agreement.

OFFICIAL COMMENT

1. This section definitely rejects:

(a) Any assumption that because a record has been worked out which is final on some matters, it is to be taken as including all the matters agreed upon;

       …

2. Paragraph (a) makes admissible evidence of course of dealing, usage of trade and course of performance to explain or supplement the terms of any record stating the agreement of the parties in order that the true understanding of the parties as to the agreement may be reached. Such records are to be read on the assumption that the course of prior dealings between the parties and the usages of trade were taken for granted when the document was phrased. Unless carefully negated they have become an element of the meaning of the words used. Similarly, the course of actual performance by the parties is considered the best indication of what they intended the record to mean.

3. Under paragraph (b) consistent additional terms, not reduced to a record, may be proved unless the court finds that the record was intended by both parties as a complete and exclusive statement of all the terms. If the additional terms are such that, if agreed upon, they would certainly have been included in the record in the view of the court, then evidence of their alleged making must be kept from the trier of fact.

Qwinstar Corp. v. Anthony

United States Court of Appeals, Eighth Circuit

882 F.3d 748 (2018)

SHEPHERD, Circuit Judge.

Qwinstar Corporation and Pro Logistics, LLC, engaged in negotiations that culminated with Qwinstar agreeing to purchase Pro Logistics and employ its owner—Curtis Anthony—for a term of five years. A few months after the sale, Qwinstar terminated Anthony’s employment and filed this lawsuit against him, alleging that it did not receive the inventory it bargained for in the sale. Anthony counterclaimed, asserting that Qwinstar breached the employment contract by not paying him for the full five-year term. The parties each filed motions for summary judgment, and the district court granted Anthony’s motion and denied Qwinstar’s. We affirm in part and reverse in part.

I. Background

Qwinstar and Pro Logistics are or were engaged in the business of selling and repairing old IBM check-processing systems—specifically, the IBM 3890. Pro Logistics primarily sold new and refurbished parts for this machine. Qwinstar also sells these parts, but, in addition, it has a large repair business. As a result, Qwinstar and Pro Logistics competed for many of the same customers. With the advent of computer-based systems, the demand for the parties’ business shrunk considerably, and Qwinstar began efforts to acquire its competitors to increase its market share.

Negotiations between Qwinstar and Anthony ensued. In January of 2013, Anthony completed an inventory of all of the parts he owned at the time, and this 56-page document showed a total parts value of over $4.7 million. Anthony provided this inventory to Qwinstar. Subsequently, Qwinstar employees visited Pro Logistics on three separate occasions over the next several months, but no one ever made an independent inventory of the parts or compared the parts present in the warehouse to those represented in Anthony’s inventory document. Ultimately, Anthony agreed to sell all of his machine parts to Qwinstar in return for $50,000 and a five-year employment contract with Qwinstar at a salary of $200,000 per year. The parties memorialized these terms in two separate contracts: (1) the Asset Purchase Agreement (APA), which dealt primarily with the transfer of Anthony’s parts inventory to Qwinstar; and (2) the Employment Agreement (EA), which concerned Anthony’s assumed role with Qwinstar after the sale.

After performing under these contracts for almost one year, Anthony notified Qwinstar that its parts inventory was getting low on some items. Qwinstar sent two employees to investigate the shortage, both of whom made comments afterward about the sparse quantity of parts that existed at the Pro Logistics facility. However, as with the previous visits, no one documented the remaining parts or compared the parts present to those in the January inventory. One month later, Qwinstar sent Anthony an email stating that $1 million in parts had been sold since the business arrangement had been finalized, and demanding that Anthony account for the remaining $3.4 million³ in parts that Qwinstar purportedly purchased. Qwinstar later recovered about $600,000 in additional parts from Anthony. Shortly thereafter, Qwinstar terminated Anthony for alleged cause and filed suit to recover the claimed shortfall in the parts inventory.

Qwinstar filed the present action asserting a breach of the APA, among other claims not relevant here. Anthony counterclaimed that Qwinstar breached the EA by failing to pay him for the full five-year contract term. Qwinstar moved for partial summary judgment, asserting that it had proven Anthony’s liability for breach of the APA as a matter of law and that Anthony’s counterclaim should be dismissed. Anthony moved for full summary judgment, arguing that (1) Qwinstar’s APA claim should be dismissed because it could not identify a single asset that it purportedly purchased and failed to receive, and (2) Anthony was entitled to affirmative summary judgment on his counterclaim because Qwinstar terminated him without cause and without paying the full sum due under the contract. The district court first granted summary judgment to Anthony on Qwinstar’s APA claim, finding that Qwinstar could not establish exactly what inventory it purchased under the APA as a result of its failure to inventory the items at the time of the sale. Qwinstar argued that the January 2013 inventory represented an accurate inventory of parts purchased, but the district court stated that the list was outdated and Qwinstar was well aware that Anthony was still selling parts during the intervening months between the date of the inventory and the execution of the APA. As a result, the district court held that Qwinstar could not establish the breach element of its claim. Next, the court granted summary judgment to Anthony on his counterclaim, finding that the contract provision governing Anthony’s compensation after termination was ambiguous, and, as a result, that it must be construed against Qwinstar. Qwinstar appeals.

II. Discussion

A party is entitled to “summary judgment if the movant shows that there is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law.” Fed. R. Vic. P. 56(a). When construing an unambiguous contract, “interpretation is a question of law, and is reviewed de novo.” Swift & Co. v. Elias Farms, Inc., 539 F.3d 849, 851 (8^th Cir. 2008) (internal quotation marks omitted). On the other hand, “[i]f the contract is ambiguous, ... the meaning of the contract becomes a question of fact, and summary judgment is inappropriate unless the evidence of the parties’ intent is conclusive.” Id.

Qwinstar argues that the January 2013 inventory established the list of items it purchased in the APA and that the EA clearly states that Anthony’s full compensation is guaranteed only in the event of his death or disability. We agree with Qwinstar’s latter assertion and summary judgment was premature given the ambiguous nature of the EA provisions at issue, but we reject the former because, under the unambiguous terms of the APA, Qwinstar received that which it bargained for. Accordingly, we affirm the district court’s ruling on the first issue and reverse on the second.

A. The APA

Qwinstar claims that the January 2013 inventory establishes what the term “all” meant in the APA provision stating that Anthony was conveying “all of [his] right, title and interest in and to the ... assets.” Therefore, Qwinstar continues, because there is a difference of “millions of dollars” between the value represented in the inventory and that which Anthony actually delivered, Qwinstar has proven breach as a matter of law. Anthony responds by noting that the January 2013 inventory was completed a number of months before the contract was finalized and that Qwinstar was aware that Anthony was continually selling parts during this time. As a result, Anthony concludes, Qwinstar cannot prove breach because it cannot prove what it purchased under the contract and how that differs from what it received. We agree.

“In order to state a claim for breach of contract, the plaintiff must show (1) formation of a contract, (2) performance by plaintiff of any conditions precedent to his right to demand performance by the defendant, and (3) breach of the contract by defendant.” Park Nicollet Clinic v. Hamann, 808 N.W.2d 828, 833 (Minn. 2011). To determine whether a breach occurred, the court must first decide what performance was due under the contract.

Under Minnesota’s parol evidence rule,

[t]erms ... set forth in a writing intended by the parties as a final expression of their agreement with respect to such terms as are included therein may not be contradicted by evidence of any prior agreement or of a contemporaneous oral agreement but may be explained or supplemented ... by evidence of consistent additional terms unless the court finds the writing to have been intended also as a complete and exclusive statement of the terms of the agreement. Minn. Stat. § 336.2-202.

In other words, “courts should not interfere with a contract when the rights of the parties are evidenced by writing which purports to express their full agreement.” Thus, “where a written agreement is ambiguous or incomplete, evidence of oral agreements tending to establish the intent of the parties is admissible.” But “[p]arol evidence of any prior agreement is inadmissible where the agreement is unambiguous and completely integrated.” [] “A merger clause establishes that the parties intended the writing to be an integration of their agreement.” And “a court need not look beyond the writing to determine whether a contract is a complete integration, where a clause explicitly states the parties’ intent.” [citations omitted]

We find that the APA is unambiguous; therefore, no external evidence can be admitted to contradict, explain, or supplement the terms contained therein. Section 1.1 of the APA states: “On the terms and subject to the conditions set forth in this Agreement, [Anthony] hereby sells ... to [Qwinstar] all of [Anthony’s] right, title and interest in and to the following assets.” R. at A-1657. The “assets” are then defined to include, inter alia, “all finished goods, raw materials, work in process, packaging, parts, supplies, tooling and other inventory.” R. at A-1657. Section 7.6 then provides that “[t]his Agreement ... constitutes the entire agreement between the Parties with respect to the subject matter of this Agreement, superseding all oral and written proposals, representations, understandings and agreements previously made or existing with respect to such subject matter.” R. at A-1664 to A-1665.

The contract means precisely what it says: Anthony agreed to sell all inventory he had at the time the APA was executed. See Turner v. Alpha Phi Sorority House, 276 N.W.2d 63, 67 (Minn. 1979) (“[T]he language found in a contract is to be given its plain and ordinary meaning.”). Because the parties included the integration clause, it is clear “that the parties intended the writing to be an integration of their agreement.” Alpha Real Estate, 664 N.W.2d at 312. Had the parties wished to define the “assets” to include all parts described in Anthony’s inventory list, they could have incorporated that document into the APA by reference. But this did not occur, and, prior to the sale, no one from Qwinstar conducted an independent inventory of the parts on their many trips to Pro Logistics. Ultimately, because Qwinstar has presented no evidence that Anthony failed to deliver the inventory he possessed at the time the APA was executed, Qwinstar is unable to prove that Anthony breached the contract.

B. The EA

Anthony contends that Qwinstar breached the EA by terminating his employment prior to the expiration of the full five-year contract term. According to Qwinstar, the EA clearly provides for the continued payment of Anthony’s salary only if the Agreement itself is terminated by his death or disability. Moreover, even assuming the EA is ambiguous, Qwinstar contends that the district court improperly relied on one interpretive device to the exclusion of all others, and parol evidence reveals the parties’ intent. We conclude that summary judgment was prematurely granted on this claim because the material provisions are ambiguous and the parties’ intent is inconclusive.

“[T]he primary goal of contract interpretation is to determine and enforce the intent of the parties.” [] “A court ascertains the parties’ intent by putting itself in the parties’ positions at the time they formed the contract and determining what they reasonably meant to accomplish in view of the contract as a whole, its plain language, and the surrounding circumstances.” [] “Where the parties express their intent in unambiguous words, those words are to be given their plain and ordinary meaning.” [] A contract is ambiguous when “‘the language used is reasonably susceptible of more than one meaning.’” [citations omitted]

Minnesota courts employ several interpretive maxims when discerning the parties’ intent. First, courts should “construe a contract as a whole and attempt to harmonize all clauses of the contract.” [] “Because of the presumption that the parties intended the language used to have effect,” Minnesota courts “will attempt to avoid an interpretation of the contract that would render a provision meaningless.” [] Second, “[w]here there is an apparent conflict between two clauses or provisions of a contract, it is the court’s duty to find harmony between them and to reconcile them if possible.” [] Any “[a]pparent conflicts between clauses will be resolved by giving full effect to principal and more important clauses and subordinating thereto those of minor importance.” Third, “if the language is ambiguous—that is, susceptible to more than one reasonable interpretation—parol evidence may be considered to determine the intent of the parties.” Finally, “[a] fundamental principle of contract law is that when contract language is reasonably susceptible of more than one interpretation it is ambiguous, and ambiguous contract terms must be construed against the drafter.” []; see also Gartland, 537 N.W.2d at 295 (“[W]here a contract is open to two interpretations, the one more favorable to the party who did not draft the instrument should be adopted in the absence of a clear showing that a contrary meaning was intended by the parties at the time of its execution.”

The following language from the EA is critical to our discussion:

Effect of Termination on Compensation. If Employee’s employment with Company is terminated by Employee or Company, Company will have no further liability to Employee under this Agreement other than to pay Employee the Employee’s Base Salary and benefits under Section 3 accrued, and expenses properly incurred, through the date of termination or resignation; provided, however, that if this Agreement is terminated under Section 4 for any reason, the Company will continue to pay the Employee (or his estate in the event of his death) the Base Salary for the balance of the five-year Term of this Agreement remaining after the date of any such death or Disability. EA § 4(d).

Analyzing this language, the district court found that “if Anthony’s employment is terminated, Qwinstar owes him nothing beyond his salary and benefits accrued through termination.” On the other hand, the court noted, “the second clause guarantees Anthony his full five-year salary if the Agreement is terminated ‘under Section 4 for any reason.’ ” After concluding that this provision was ambiguous, the court applied the fourth interpretive aid from above—that ambiguous contracts are construed against the drafter—to conclude that the second clause controlled and Anthony was therefore entitled to his full salary.

Although we agree with the district court that the provision is ambiguous and should therefore be construed against Qwinstar, “this does not ... ineluctably lead to the conclusion that ... [Qwinstar] is to lose,” Turner, 276 N.W.2d at 67. Instead, we must turn to the other interpretive tools to aid in the ultimate goal of ascertaining the parties’ intent. To be sure, the district court’s interpretation was not without some persuasive force, but application of the remaining three interpretive aids leads us to conclude that “the language is reasonably susceptible to” the alternative Qwinstar advances.

One could reasonably interpret the second clause—the clause guaranteeing full compensation—to apply only when Anthony’s death or disability led to the termination of the agreement. First, this interpretation harmonizes and provides meaning to both clauses. On the other hand, the district court’s interpretation—that Anthony received payment in full regardless of the reason for his termination—renders the first clause meaningless because there is seemingly no context in which that clause would apply, and Minnesota courts “will attempt to avoid an interpretation of the contract that would render a provision meaningless.” []

Second, reading the second clause as an exception to the first harmonizes the apparent conflict between the provisions. Therefore, in an attempt to “giv[e] full effect to principal and more important clauses and subordinating thereto those of minor importance,” [], the first clause should be viewed as the general rule: In the event that either party terminates Anthony’s employment, Qwinstar must pay Anthony only the salary and benefits accrued to that point. The second clause, by contrast, provides an exception to the first: If the Agreement is terminated under Section 4(b)—the provision that automatically terminates Anthony’s employment upon his death or disability—then Qwinstar is required to pay the salary for the remainder of the five-year term “after such death or Disability.” See Advantage Consulting Grp. V. ADT Sec. Sys., Inc., 306 F.3d 582, 586 (8^th Cir. 2022) (applying Minnesota law and noting that “it makes sense that parties will address issues of more importance first, followed by those of less importance[;] ... although a term’s location in a contract is certainly not dispositive, it may be indicative, of intent”). Here, as in Advantage Consulting, “[i]f we recognize the [first] provision[ ] as the principal and more important clause[ ] in this contract, the [second provision] still serves a purpose.” Id.; Restatement (Second) of Contracts § 203, cmt. e (“If the specific or exact can be read as an exception or qualification of the general, both are given some effect ....”).

Finally, because the provision is ambiguous, “parol evidence may be considered to determine the intent of the parties.” [] Qwinstar produced an earlier version of the agreement which read, in relevant part:

If Employee’s employment with Company is terminated by Employee or Company, Company will have no further liability to Employee under this Agreement other than to pay Employee the Employee’s Base Salary and benefits per the five-year Term, and expenses properly incurred; provided, however, that if this Agreement is terminated as a result of the death or Disability of the Employee, the Company will continue to pay the Employee (or his estate in the event of his death) the Base Salary for the balance of the five-year Term of this Agreement remaining after the date of any such death or Disability. (emphases added).

The differences between this document and the final version are emphasized to show that, if the court were to adopt Anthony’s current reading of the contract, the outcome would be the exact same as it would have been under the earlier draft agreement between the parties: Anthony receives his full salary regardless of the reason for his termination. Regardless of the parties’ ultimate intent, a reasonable juror could conclude that the parties amended these provisions intending to create a different outcome. Additionally, Anthony stated in his deposition that during these negotiations he understood the second clause to mean that in the event of “the demise of myself, ... the contract would still be in force for my family.” R. at A-648. Though Anthony’s admission may not be as conclusive as Qwinstar asserts, it still provides valuable evidence of the parties’ intent at the time the contract was formed.

Summary judgment was inappropriate on Anthony’s counterclaim because the contract provisions are ambiguous and reasonably susceptible to more than one interpretation. As such, interpretation becomes a question of fact precluding summary judgment.

III. Conclusion

For the reasons above, we affirm the district court’s grant of summary judgment to Anthony and Pro Logistics on Qwinstar’s breach of contract claim. We reverse, however, the court’s grant of summary judgment to Anthony and Pro Logistics on their counterclaim and remand for further proceedings. The issue of attorneys fees raised in appeal number 17-1809 is remanded to the district court for proceedings not inconsistent with this opinion.