John Hancock Life Insurance Co. v. Abbott Laboratories ( 2017 )

United States Court of Appeals
For the First Circuit
No. 16-1661
JOHN HANCOCK LIFE INSURANCE COMPANY ET AL.,
Plaintiffs, Appellants,
v.
ABBOTT LABORATORIES,
Defendant, Appellee.
APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MASSACHUSETTS
[Hon. Douglas P. Woodlock, U.S. District Judge]
Before
Howard, Chief Judge,
Selya and Lynch, Circuit Judges.
Joan A. Lukey, with whom John A. Nadas, Stuart M. Glass, Kevin
J. Finnerty, and Choate, Hall & Stewart LLP were on brief, for
appellants.
Jeffrey I. Weinberger, with whom Gregory D. Phillips,
Elizabeth A. Laughton, and Munger, Tolles & Olson LLP were on
brief, for appellee.
July 12, 2017
SELYA, Circuit Judge. The development of new drugs is
a costly, time-consuming, and highly speculative enterprise. In
an effort to hedge their bets, drug companies sometimes opt to
share the risks and rewards of product development with outside
investors. This appeal introduces us to that high-stakes world.
The outcome turns primarily on a contract provision that the
parties disparately view as a liquidated damages provision (and,
thus, enforceable) or a penalty (and, thus, unenforceable). A sum
well in excess of $30,000,000 hangs in the balance.
Following a lengthy bench trial, the district court held
the key provision inapposite and, in all events, unenforceable.
See John Hancock Life Ins. Co. v. Abbott Labs., Inc. (Hancock III),
183 F. Supp. 3d 277, 321, 323 (D. Mass. 2016). After careful
consideration of a plethoric record, we reverse the district
court's central holding, affirm its judgment in other respects,
and remand for further proceedings (including the entry of an
amended final judgment) consistent with this opinion.
I. BACKGROUND
Plaintiff-appellant John Hancock Life Insurance
Company,1 disappointed by the meager fruits of its multimillion-
dollar investment with defendant-appellee Abbott Laboratories
1Two affiliated corporations, John Hancock Variable Life
Insurance Company and Manulife Insurance Company, also appear as
plaintiffs and appellants. We refer to all of the plaintiffs,
collectively, as "Hancock."
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(Abbott), seeks to increase its return through litigation. In
particular, Hancock aims to recover damages under its contract
with Abbott or, in the alternative, to rescind that contract. The
parties' dispute is by now well-chronicled. See John Hancock Life
Ins. Co. v. Abbott Labs. (Hancock II), 478 F.3d 1, 2-6 (1st Cir.
2006); Hancock III, 183 F. Supp. 3d at 285-301; John Hancock Life
Ins. Co. v. Abbott Labs. (Hancock I), No. 03-12501, 2005 WL
2323166, at *1-11 (D. Mass. Sept. 16, 2005). We assume the
reader's familiarity with these opinions and rehearse here only
those facts needed to place this appeal into a workable
perspective.
A. The Agreement.
In late 1999 or early 2000 — the exact date is of no
consequence — Hancock (a financial services company) and Abbott (a
pharmaceutical manufacturer) entered into negotiations regarding
a potential investment in a menu of new drugs that Abbott was
developing. The parties chose nine specific Program Compounds
that they hoped would mature into commercially successful drugs to
treat various afflictions (such as cancer and urinary tract
blockages). During these negotiations, both Hancock and Abbott
were represented by seasoned counsel, who exchanged approximately
forty drafts of the proposed contract over a period of a year or
more.
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On March 13, 2001, the parties signed a research funding
agreement (the Agreement). The Agreement is long and intricate,
and we outline here only those provisions that are central to an
understanding of the issues on appeal.
In the Agreement, Abbott pledged to develop the Program
Compounds in accordance with Annual Research Plans that Abbott
would submit for each Program Year over the course of a four-year
Program Term. These Annual Research Plans were to contain
"detailed statement[s] of the objectives, activities, timetable
and budget for the Research Program for every Program Year
remaining in the Program Term." Abbott prepared the first such
Annual Research Plan for attachment as an exhibit.
The parties were to fund the development of the Program
Compounds as specified in the Agreement and were meant to share in
the profits. Hancock's funding obligations are precisely defined
in section 3.1 of the Agreement: it would make four annual Program
Payments, ranging from $50,000,000 to $58,000,000 each, over the
course of the Program Term (a total of $214,000,000). Section
3.5, entitled "Hancock Funding Obligation," makes explicit that
"Hancock's entire obligation [under the Agreement] shall be
limited to providing the Program Payments set forth in [s]ection
3.1." In return for its investment, Hancock receives emoluments
based on the progress and success of the Program Compounds. These
emoluments include payments for the achievement of certain
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milestones, such as the initiation of a clinical trial or U.S.
Food and Drug Administration (FDA) approval. It also receives
royalties from any out-licensing or sales of the Program Compounds.
The Agreement saddles Abbott with both annual and
cumulative spending obligations. Annually, Abbott was responsible
for meeting the Annual Minimum Spending Target; that is, it had to
spend annually at least the sum of Hancock's contribution for that
year, plus $50,000,000, plus any shortfall from the prior year's
minimum spending target. Cumulatively, Abbott had to spend "at
least the Aggregate Spending Target" — defined as $614,000,000 —
"during the Program Term." In addition, Abbott is "solely
responsible for funding all Program Related Costs in excess of the
Program Payments from . . . Hancock."2 These obligations comprise
only Abbott's minimum spending commitment: that commitment is a
floor, not a ceiling, and Abbott projected in its first Annual
Research Plan that it would spend over one billion dollars (about
five times Hancock's expected total contribution) through the end
of 2004.
In what turned out to be a prescient precaution, the
Agreement anticipates that Abbott might not fulfill its spending
commitment. In this respect, section 3.2 of the Agreement provides
2 The district court assumed — and neither party disputes —
that both Hancock's and Abbott's contributions are to be credited
toward the Aggregate Spending Target. See Hancock III, 183 F.
Supp. 3d at 316.
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that if Abbott "fail[ed] to fund the Research Program in accordance
with" its obligations, "Hancock's sole and exclusive remedies" are
those remedies "set forth in [s]ections 3.3 and 3.4" of the
Agreement. Section 3.3, entitled "Carryover Provisions," is
divided into two subsections. If Abbott spends less than its
Annual Minimum Spending Target, Hancock is allowed, under section
3.3(a), to defer its annual Program Payments until Abbott makes up
that shortfall. Section 3.3(b) describes Hancock's remedies in
the event that Abbott did not meet its cumulative spending
obligations:
If Abbott does not expend on Program Related
Costs the full amount of the Aggregate
Spending Target during the Program Term,
Abbott will expend the difference between its
expenditures for Program Related Costs during
the Program Term and the Aggregate Spending
Target (the "Aggregate Carryover Amount") on
Program Related Costs during the subsequent
year commencing immediately after the end of
the Program Term. If Abbott does not spend
the Aggregate Carryover Amount on Program
Related Costs during such subsequent year,
Abbott will pay to . . . Hancock one-third of
the Aggregate Carryover Amount that remains
unspent by Abbott, within thirty (30) days
after the end of such subsequent year.
Section 3.4 permits Hancock to terminate future Program Payments
under certain circumstances, including Abbott's failure to
"reasonably demonstrate in its Annual Research Plan its intent and
reasonable expectation to expend on Program Related Costs during
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the Program Term an amount in excess of the Aggregate Spending
Target."
To complete the picture, the Agreement contains a full-
throated integration clause. Specifically, section 16.3 confirms
that the "Agreement contains the entire understanding of the
parties with respect to the subject matter hereof. All express or
implied agreements and understandings, either oral or written,
with respect to the subject matter hereof heretofore made are
expressly merged in and made a part of this Agreement."
B. The Fallout and the Litigation.
After the Agreement was signed, Hancock made its first
two Program Payments, totaling $104,000,000. Even so, the
relationship quickly began to fray. Abbott terminated the
development of several compounds in the first two years and
significantly reduced its spending on the development of other
compounds. At the end of 2002, Abbott informed Hancock that
Abbott's 2002 spending had been appreciably less than its Annual
Research Plan had anticipated. More troubling still, Abbott's
preliminary research plan for 2003 projected a sharp reduction in
spending for that year compared to its previous estimate and made
no mention at all of expected 2004 spending. In September of 2003,
Abbott belatedly proffered its 2003 Annual Research Plan, which
did include some projected spending for 2004. That submission,
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though, further reduced total spending and admitted that Abbott
would not reach the Aggregate Spending Target by the end of 2004.
After reviewing this document, Hancock responded that,
in view of the insufficient spending that Abbott was prepared to
undertake, it regarded its obligation to make future Program
Payments as null and void. Abbott's rejoinder was of little solace
to Hancock: it submitted a preliminary 2004 Annual Research Plan,
indicating that Abbott would expend well below its annual minimum
contribution in 2003 and would fail to reach the Aggregate Spending
Target through the end of 2004. In both the final 2003 Annual
Research Plan and the preliminary 2004 Annual Research Plan,
however, Abbott predicted that it would reach the Aggregate
Spending Target if 2005 spending were included.
Unsettled by this news, Hancock invoked diversity
jurisdiction, see 28 U.S.C. § 1332(a), and filed suit in the United
States District Court for the District of Massachusetts. That
suit sought a declaration that Abbott's failure to meet its
spending commitments terminated Hancock's obligation to make the
third and fourth Program Payments. The district court granted
summary judgment in favor of Hancock, holding that "Hancock's
obligation to make the Program Payments for 2003 and 2004
terminated when Abbott failed to demonstrate its 'intention and
reasonable expectation' to meet the . . . Aggregate Spending Target
within the four-year Program Term in its [Annual Research Plan]
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for 2003." Hancock I, 2005 WL 2323166, at *28 (quoting relevant
language from the Agreement). We affirmed. See Hancock II, 478
F.3d at 2.
Notwithstanding that Hancock was judicially relieved of
its obligation to make its last two Program Payments, it retained
its rights under the Agreement to whatever profits might be derived
from any of the Program Compounds. Hancock reports — and Abbott
does not deny — that it has received slightly more than $14,000,000
in milestone payments, out-licensing revenues, and management
fees. Comparing these receipts to its $104,000,000 investment,
Hancock alleges that it incurred a net loss of almost $90,000,000
on the benighted venture.
Corporations seldom swallow losses of this magnitude
complacently. And this case is no exception. In June of 2005 —
while Hancock I was still unresolved — Hancock filed the instant
action. It asserted that Abbott had breached the Agreement in
five ways: (1) violating its representations and warranties
through material misrepresentations and omissions regarding the
development of the Program Compounds; (2) failing to provide
Hancock with accurate spending projections; (3) refusing to pay
Hancock one-third of the Aggregate Carryover Amount in accordance
with section 3.3(b) of the Agreement; (4) failing to take
appropriate steps to out-license the Program Compounds; and
(5) obstructing Hancock's audit of Abbott's compliance with the
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Agreement. Hancock further asserted that Abbott fraudulently
induced Hancock to enter into the Agreement and, separately, that
under the indemnification provision of the Agreement, Abbott was
liable for Hancock's losses attributable to Abbott's defaults.
In October of 2006 — roughly a month after this court's
decision in Hancock II — Hancock sought leave to amend its
complaint in this case to include a prayer for rescission. Hancock
included the rescission claim in its first amended supplemental
complaint (filed in December of 2006).
The district court held a ten-day bench trial, which
ended in 2008. The court then solicited post-trial briefing and
took the case under advisement. It was not until April of 2016,
though, that the court ruled. In its opinion, the court made
extensive findings of fact and conclusions of law. See Fed. R.
Civ. P. 52(a). We summarize here only those findings and
conclusions that are helpful to an understanding of the issues on
appeal.
To begin, the court found that Abbott violated its
representations and warranties in three ways:
 Without notifying Hancock, Abbott paused one compound's
development two days before the Agreement was signed, only to
lift the hold on the day the Agreement was signed. Abbott
canceled the compound three months later. The court found
that Abbott's failure to inform Hancock of the hold on the
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compound's development was a material omission. See Hancock
III, 183 F. Supp. 3d at 294, 306.
 Abbott represented that it intended to spend over $35,000,000
in 2001 on developing a compound intended to treat chronic
pain. Yet Abbott knew before signing the Agreement that it
actually intended to spend less than half that amount in 2001.
The court found that "this misrepresentation . . . was
material." Id. at 308-09.
 Abbott made a further material misrepresentation as to an
anti-infection compound. See id. at 310. Abbott represented
that it expected once-a-day dosing would be possible for the
four conditions that the drug was designed to treat. Yet,
the court found that, at the time the Agreement was signed,
Abbott did not have enough information to know that once-a-
day dosing would be possible for the two more severe
conditions. Since Abbott knew that once-a-day dosing was
important, this misrepresentation was material. See id.
Although these findings are emblematic of the rocky road
down which the parties' relationship traveled, they proved to be
hollow victories for Hancock. The district court ruled that
Hancock did not sufficiently prove damages attributable to
Abbott's misrepresentations and omissions because Hancock's
methods for calculating damages were "speculative and
unconvincing." Id. at 313.
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The district court also found that Abbott breached the
Agreement by providing Hancock with spending projections that
assumed that every Program Compound would remain velivolant all
the way to FDA approval. Those projections, the court found, were
submitted in lieu of more realistic projections of expected
spending, which would have been adjusted for the risk that some
compounds might be terminated. See id. at 315. Once again,
Hancock could not recover for Abbott's breach because it did not
adequately prove damages. See id. at 316.
Moving to an issue that has become central to this
appeal, the district court concluded that Abbott had not reached
the Aggregate Spending Target. The court determined that,
including Hancock's contributions, Abbott fell $99,100,000 short
of the target. See id. at 292. Hancock argued that section 3.3(b)
entitled it to one-third of this amount, that is, an award of
approximately $33,000,000. The district court disagreed. While
it rejected Abbott's arguments that Hancock was judicially
estopped from asserting its claim under section 3.3(b) and that
the Agreement capped Abbott's spending obligation at $400,000,000,
see id. at 317, it nonetheless concluded that Hancock was not
entitled to any damages under section 3.3(b), see id. at 321, 323.
To reach this conclusion, the court identified an
"apparent implied condition," which limited Abbott's liability
under section 3.3(b) to pay Hancock one-third of the Aggregate
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Carryover Amount to situations in which Hancock made all four
Program Payments. Id. at 318-19. Striking Hancock a second blow,
the court held in the alternative that even if section 3.3(b)
applied, it constituted an unenforceable penalty. See id. at 323.
The district court did allow recovery for one of
Hancock's breach-of-contract claims. It ruled that in the course
of Hancock's audit of Abbott's compliance, Abbott "fail[ed] to
provide information and material necessary for Hancock's vendor
. . . successfully to conduct an audit." Id. at 316. The court
ordered Abbott to pay Hancock the cost of the audit, which amounted
to $198,731. See id.
Turning to Hancock's rescission claim, the court struck
that claim as "wholly irrelevant or impertinent." Id. at 303.
The court reasoned, inter alia, that rescission was inconsistent
with the enforcement of the Agreement and that Hancock had chosen
(in Hancock I) to enforce the Agreement. See id. at 302-03. Under
the doctrine of election of remedies, it could not both affirm the
contract and simultaneously seek its rescission. See id.
Finally, the district court rebuffed Hancock's claim
that Abbott was obligated under the Agreement to indemnify it for
the losses that it incurred. The court ruled that this
indemnification provision only applied to claims by third parties.
See id. at 326.
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When the smoke cleared, the court below awarded Hancock
$198,731 in damages for Abbott's frustration of the audit, together
with $110,395.34 in prejudgment interest (a total judgment of
$309,126.34). See id. This timely appeal ensued.
II. ANALYSIS
Hancock's appeal challenges the district court's
conclusion that its remedies under section 3.3(b) are contingent
on its making all four Program Payments. Hancock also challenges
the district court's alternative holding that those remedies
constitute an unenforceable penalty. Finally, Hancock challenges
the order striking its rescission claim.
We take a layered approach to these challenges. We first
consider Abbott's contention that recovery under section 3.3(b)
should be barred on grounds rejected by the district court. We
then address the grounds upon which the district court relied.
Those grounds are attacked by Hancock, and we address the
components of Hancock's asseverational array one by one. We end
with a brief comment on prejudgment and postjudgment interest.
We approach these several issues mindful that the
Agreement contains a choice-of-law provision specifying that
Illinois law governs. In line with this provision and with the
parties' acquiescence, we apply the substantive law of Illinois
(except where otherwise specifically noted). See McCarthy v.
Azure, 22 F.3d 351, 356 n.5 (1st Cir. 1994) (explaining that "a
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reasonable choice-of-law provision in a contract generally should
be respected").
As a general matter, issues of contract interpretation
engender de novo review under Illinois law. See St. Paul Mercury
Ins. v. Aargus Sec. Sys., Inc., 2 N.E.3d 458, 478 (Ill. App. Ct.
2013). A reviewing court's principal task in interpreting a
contract is to divine the parties' intent, which is manifested
most clearly by "the plain and ordinary meaning of the language of
the contract." Id. When a fully integrated contract is
unambiguous on its face, the court will determine its meaning from
its language alone. See Air Safety, Inc. v. Teachers Realty Corp.,
706 N.E.2d 882, 884 (Ill. 1999). The court below concluded that
the Agreement was unambiguous in its pertinent aspects, see Hancock
III, 183 F. Supp. 3d at 318, 320, and neither party contests this
conclusion. We agree. Thus, the question reduces to what that
language means.
According to Hancock, section 3.3(b) requires Abbott to
pay as liquidated damages one-third of the Aggregate Carryover
Amount, that is, one-third of the difference between the Aggregate
Spending Target ($614,000,000) and the combined amount actually
spent by the parties ($514,900,000). Abbott disagrees with this
proposition for several reasons, which we examine below. All of
these reasons posit that the remedies limned under section 3.3(b)
are available only when Hancock has made all four Program Payments,
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notwithstanding that Hancock's cessation of Program Payments was
due to Abbott's breach.
A. Abbott's Rejected Defenses.
Abbott advances four rationales in support of its
conclusion, two of which were rejected by the district court. We
start with those rejected arguments.
As an initial matter, we note that those arguments are
properly before us. Although Abbott has not filed a cross-appeal,
we have jurisdiction to consider a prevailing party's alternative
arguments in defense of a judgment where, as here, the arguments
were made below. See Neverson v. Farquharson, 366 F.3d 32, 39
(1st Cir. 2004). In this instance, then, Abbott is entitled to
argue for affirmance of portions of the district court's judgment
on any ground asserted in the district court. See Mass. Mut. Life
Ins. Co. v. Ludwig, 426 U.S. 479, 481 (1976) (per curiam); United
States v. Matthews, 643 F.3d 9, 12 (1st Cir. 2011). The fact that
no cross-appeal has been filed does not lessen this entitlement.
See Neverson, 366 F.3d at 39.
1. Judicial Estoppel. Abbott asserts that Hancock's
interpretation of section 3.3(b) is foreclosed by principles of
judicial estoppel. The district court brushed this assertion
aside, see Hancock III, 183 F. Supp. 3d at 317, and so do we.
Abbott assumes that federal law applies to its judicial
estoppel defense. Yet, "[a]s judicial estoppel appears neither
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clearly procedural nor clearly substantive, there may be a
legitimate question as to whether federal or state law . . . should
supply the rule of decision." Alt. Sys. Concepts, Inc. v.
Synopsys, Inc., 374 F.3d 23, 32 (1st Cir. 2004). Here, however,
Hancock has not challenged the application of federal law to this
issue, and "a federal court sitting in diversity is free, if it
chooses, to forgo independent analysis and accept the parties'
agreement" as to which law applies. Id. (quoting Borden v. Paul
Revere Life Ins. Co., 935 F.2d 370, 375 (1st Cir. 1991)). We
proceed accordingly.3
Generally speaking, judicial estoppel "precludes a party
from asserting a position in one legal proceeding which is contrary
to a position [that] it has already asserted in another." Patriot
Cinemas, Inc. v. Gen. Cinema Corp., 834 F.2d 208, 212 (1st Cir.
1987). The doctrine "should be employed when a litigant is
'playing fast and loose with the courts,' and when 'intentional
self-contradiction is being used as a means of obtaining unfair
advantage.'" Id. (quoting Scarano v. Cent. R. Co., 203 F.2d 510,
513 (3d Cir. 1953)).
3 At any rate, federal law and Illinois law do not appear to
differ materially with respect to the elements of judicial
estoppel. Compare, e.g., Patriot Cinemas, Inc. v. Gen. Cinema
Corp., 834 F.2d 208, 212 (1st Cir. 1987), with, e.g., Seymour v.
Collins, 39 N.E.3d 961, 973 (Ill. 2015).
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Abbott claims that, in Hancock I, Hancock argued that
"the Aggregate Spending Target represents the 'combined total' of
the parties' defined minimum and maximum contributions, i.e., $400
million from Abbott and approximately $200 million from Hancock,
and that the very purpose of the Agreement was for them to share
the financial burdens . . . in that ratio." In support, Abbott
points to two statements made by Hancock in the course of Hancock
I: that it (Hancock) was "to share the cost of certain research
and development activities" and that the Aggregate Spending Target
was "[t]he combined total of . . . Hancock's maximum funding
contribution and Abbott's minimum funding contribution." These
statements do not bear the weight that Abbott loads upon them: the
statement that costs would be shared says nothing about the amount
that each party would contribute, and the references to maximum
and minimum contributions do not necessarily import specific
dollar amounts. Indeed, the raison d'être for the Hancock I
litigation was Hancock's desire to obtain a declaration that its
maximum contribution should be limited to $104,000,000 (in which
event, Abbott's minimum contribution — on Hancock's view of the
case — would be $510,000,000).
The short of it is that we discern no friction between
Hancock's position in Hancock I and its position in the case at
hand. Consequently, we hold — as did the district court — that
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Hancock is not judicially estopped from advancing its
interpretation of section 3.3(b).
2. Abbott's "Cap" Defense. Abbott next contends that
its spending obligations are capped. In its view, the plain
language of the Agreement shows that Abbott is not, under any
circumstances, "required to spend more than its minimum $400
million share." Noting that section 3.5 provides that "Abbott
shall be solely responsible for funding all Program Related Costs
in excess of the Program Payments from . . . Hancock" and that
section 3.1 defines Hancock's Program Payments as four installment
payments totaling $214,000,000 that "Hancock shall make," Abbott
suggests that its payment responsibility is capped at the
difference between the Aggregate Spending Target and the sum of
Hancock's four Program Payments. The district court disagreed
with this suggestion, see Hancock III, 183 F. Supp. 3d at 317, as
do we.
Under Illinois law, "[a] contract must be construed as
a whole, viewing each provision in light of the other provisions."
Thompson v. Gordon, 948 N.E.2d 39, 47 (Ill. 2011). To countenance
Abbott's reading, we would have to cover much of the Agreement in
Magic Marker. For example, section 3.5 does not refer to either
Hancock's $214,000,000 contribution or its four Program Payments;
rather, it refers only to Hancock's Program Payments in general.
And even though section 3.1 refers to four installments totaling
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$214,000,000, section 3.4 delineates several conditions which, if
not complied with, "shall terminate" any obligation on Hancock's
part "to make any remaining Program Payments." Given the language
of section 3.4, Program Payments, as used in section 3.5, must
mean whatever quantum of Program Payments Hancock is obligated to
make under the Agreement — an amount that may be less than
$214,000,000. We agree with the district court that the natural
reading of section 3.5 is that "Abbott should be the only party
responsible for making payments in excess of Hancock's
contribution, not that Abbott should be responsible for paying
only the excess of the Program Payments." Hancock III, 183 F.
Supp. 3d at 318. Considering that the obvious purpose of section
3.5, which is entitled "Hancock Funding Obligation," is to set a
ceiling for Hancock's contributions, that paragraph would be a
curious place for the parties to tuck away a hidden limit on
Abbott's funding obligations.
We add, moreover, that Abbott's theory does not account
for section 3.2, which is entitled "Abbott Funding Obligation."
This provision describes Abbott's obligation, in part, as spending
"at least the Aggregate Spending Target during the Program Term."
In other words, Abbott's spending obligation is not expressed in
a fixed $400,000,000 lump sum but, rather, is expressed in terms
of Abbott's commitment to help reach the Aggregate Spending Target.
By linking Abbott's funding obligation to the Aggregate Spending
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Target, section 3.2 appears to address the precise scenario in
which Hancock's obligation to make all four Program Payments has
been relieved under section 3.4.
If the parties had wanted to restrict Abbott's minimum
contribution to $400,000,000, they surely would have said so: such
a term easily could have been inserted in the Agreement. In
sections 3.1 and 3.5, the parties capped Hancock's contribution at
a fixed amount, but they elected not to impose such a cap when
describing Abbott's contribution in section 3.2. A court should
be reluctant to infer terms that parties easily could have included
in a contract when the parties themselves chose not to include
such terms. See Klemp v. Hergott Grp., Inc., 641 N.E.2d 957, 962
(Ill. App. Ct. 1994). We hold, therefore, that the plain language
of the Agreement does not impose a ceiling of $400,000,000 on
Abbott's minimum contributions.
B. Effect of Hancock's Failure to Complete Program Payments.
The district court held, and Abbott echoes on appeal,
that Abbott's obligation to pay under section 3.3(b) was discharged
when Hancock failed to make all four Program Payments. See Hancock
III, 183 F. Supp. 3d at 319-20. The court reached this conclusion
notwithstanding our earlier decision relieving Hancock of its
obligation, in light of Abbott's breach, to make the third and
fourth Program Payments. See id. at 321; see also Hancock II, 478
F.3d at 9.
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The district court relied principally on a Restatement
provision that "[a] party's failure to render or to offer
performance may . . . affect the other party's duties . . . even
though failure is justified by the non-occurrence of a condition."
Restatement (Second) of Contracts § 239(1) (Am. Law Inst. 1981).
In the district court's view, Hancock's refusal to make its last
two Program Payments, even though excused by Abbott's breach, was
a partial failure to render performance, which shielded Abbott's
obligation to pay under section 3.3(b). See Hancock III, 183 F.
Supp. 3d at 319.
This analysis is flawed. Hancock did not fail to render
performance in any meaningful sense but, rather, made timely
Program Payments until Abbott, by its non-performance, pulled the
rug out from under the deal. In such circumstances, we do not
think that Abbott's breach can fairly be considered the "non-
occurrence of a condition" within the purview of Restatement
(Second) of Contracts section 239(1).
If more were needed, section 239 is not the law of
Illinois. Neither Abbott nor the district court has identified
any reported Illinois case that so much as hints at the adoption
in that jurisdiction of section 239.4 "[A]s a federal court sitting
4 The district court acknowledged that no Illinois authority
supports its interpretation of section 239. See Hancock III, 183
F. Supp. 3d at 319. In an attempt to fill this gap, the court
cited to an intermediate state court opinion from a state other
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in diversity jurisdiction, we ought not 'stretch state precedents
to reach new frontiers.'" Rared Manchester NH, LLC v. Rite Aid of
N.H., Inc., 693 F.3d 48, 54 (1st Cir. 2012) (quoting Porter v.
Nutter, 913 F.2d 37, 41 (1st Cir. 1990)). Put another way,
"[c]oncerns both of prudence and of comity argue convincingly that
a federal court sitting in diversity must hesitate to chart a new
and different course in state law." Id. Here, we decline to
stretch inhospitable facts and, in the bargain, import an entirely
novel principle into the jurisprudence of Illinois law.
That ends this aspect of the matter. For both of the
reasons discussed above, it follows that the district court erred
in holding that Hancock's excused failure to complete the making
of its Program Payments foreclosed relief under section 3.3(b) of
the Agreement.
C. The "Implied Condition" Theory.
The district court's decision as to the inapplicability
of section 3.3(b) also rests on a second pillar: the court's view
that the pertinent portions of the Agreement contain an apparent
implied condition. The court wrote that "the Agreement was not
intended for [s]ection 3.3(b) to apply in situations where Hancock
than Illinois. See id. (citing Kaufman v. Byers, 823 N.E.2d 530,
537 (Ohio Ct. App. 2004)). Abbott adds only an unpublished Fifth
Circuit opinion and another intermediate state court decision, not
from Illinois. See Khan v. Trans Chem. Ltd., 178 F. App'x 419,
426 (5th Cir. 2006) (per curiam); Facto v. Pantagis, 915 A.2d 59,
63 (N.J. Super. Ct. App. Div. 2007).
- 23 -
contributed substantially less than 35% of the total funding."
Hancock III, 183 F. Supp. 3d at 320. Thus, the court seems to
have discerned an implied term to the effect that Abbott's
"obligation under [s]ection 3.3(b) is contingent upon Hancock's
contribution of the full $214 million under [s]ection 3.1." Id.
at 318. On appeal, Abbott clasps this line of defense to its
corporate bosom.
It is an elementary rule of contract interpretation that
"[i]f the words in [a] contract are clear and unambiguous, they
must be given their plain, ordinary and popular meaning."
Thompson, 948 N.E.2d at 47; see Shields Pork Plus, Inc. v. Swiss
Valley Ag Serv., 767 N.E.2d 945, 949 (Ill. App. Ct. 2002) ("[I]f
the contract terms are unambiguous, the parties' intent must be
ascertained exclusively from the express language of the contract
. . . ."). Consonant with that rule, Illinois courts ordinarily
"will not add terms to an agreement when the agreement is silent
about those specific terms." Frederick v. Prof'l Truck Driver
Training Sch., Inc., 765 N.E.2d 1143, 1151 (Ill. App. Ct. 2002).
This rule applies with particular force "when the added language
would clearly change the plain meaning of the agreement," id., and
even more so when an agreement is "completely integrated,"
Policemen's Benev. Labor Comm. v. County of Kane, 973 N.E.2d 1024,
1032 (Ill. App. Ct. 2012).
- 24 -
To be sure, there are limited circumstances in which a
court may, by inference, import terms into a contract. One such
exception holds that when a contract cannot be administered without
some term that is critical to an assessment of the parties' rights
and duties, a court may fill the gap and supply a reasonable term.
See Barnes v. Michalski, 925 N.E.2d 323, 336 (Ill. App. Ct. 2010).
But that device is to be employed sparingly and with great
circumspection: "[a]lthough a court can declare an implied
covenant to exist, that is only where there is in the express
contract . . . a satisfactory basis which makes it necessary to
imply certain duties and obligations in order to effect the
[parties'] purposes . . . ." Mid-W. Energy Consultants, Inc. v.
Covenant Home, Inc., 815 N.E.2d 911, 916 (Ill. App. Ct. 2004).
Another exception holds that a court may sometimes infer a contract
term when the circumstances are so unforeseeable that the parties
could not reasonably have been expected to include a term
addressing the situation. See Dato v. Mascarello, 557 N.E.2d 181,
183-84 (Ill. App. Ct. 1989) (citing Restatement (Second) of
Contracts § 204). This, too, is a narrow exception that applies
only "when the parties to an agreement entirely fail to foresee
the situation which later occurs and gives rise to the dispute."
Id. at 183.
The inferred term proposed by the district court and
embraced by Abbott does not fit into any of the isthmian exceptions
- 25 -
to the general rule. For one thing, inferring such a term is in
no way essential to administering the Agreement. The formula
adumbrated in section 3.3(b) is entirely workable as it stands,
both when Hancock makes all four Program Payments and when it does
not. Courts should not add a new contractual term simply to assist
one party to a contract in obtaining a better bargain. See Klemp,
641 N.E.2d at 962.
For another thing, the scenario that developed here was
readily foreseeable. As drafted, section 3.2 affords Hancock
remedies under both sections 3.3 and 3.4 with respect to any
underspending by Abbott. Section 3.4 permits Hancock to terminate
its future Program Payments during the Program Term. It was surely
foreseeable, from the outset, that if Hancock did not make all
four Program Payments, Abbott might not reach the Aggregate
Spending Target. In that event, one would assume that Hancock
would exercise its section 3.3(b) rights — yet nothing in the
Agreement diminishes Abbott's obligations under section 3.3(b) if
and when Hancock invokes section 3.4. This court has no license
to engraft a new contractual term to address a wholly foreseeable
concatenation of events.
We add, moreover, that section 3.2 lays out Abbott's
funding obligations in both annual and cumulative increments.
Cumulatively, it requires that Abbott spend "at least the Aggregate
Spending Target during the Program Term." If Abbott "fail[s] to
- 26 -
fund the Research Program in accordance with this [s]ection," then
"Hancock's sole and exclusive remedies . . . are set forth in
[s]ections 3.3 and 3.4." The fact that the Agreement lists the
remedies conjunctively must mean that Hancock is not limited to
one or the other in the event of a breach by Abbott. See Manor
Healthcare Corp. v. Soiltest, Inc., 549 N.E.2d 719, 725 (Ill. App.
Ct. 1989) ("The words 'and' and 'or' ordinarily are not commutual
terms; they should not be considered interchangeable absent strong
supporting reasons."). Nor does anything else in the Agreement
suggest the contrary.
In all events, section 3.3(b) is pointed: "[i]f Abbott
does not spend the Aggregate Carryover Amount" during the fifth
year (that is, if Abbott does not reach the Aggregate Spending
Target during the year following the four-year Program Term),
"Abbott will pay to . . . Hancock one-third of the Aggregate
Carryover Amount that remains unspent by Abbott, within thirty
(30) days after the end of such subsequent year." Plainly, Abbott
did not spend the Aggregate Carryover Amount within the specified
time frame, and any term excusing Abbott from performance is
conspicuously lacking.
Notwithstanding this clear language, the district court
held (and Abbott argues on appeal) that section 3.3(b) was intended
only to preserve a fixed funding ratio (65/35) in situations in
which Hancock made all four Program Payments. See Hancock III,
- 27 -
183 F. Supp. 3d at 319-20. The genesis for this holding is the
notion that, if everything went smoothly, the funding ratio between
Abbott and Hancock would have been approximately 65% to 35% because
Abbott would have contributed $400,000,000 and Hancock would have
contributed $214,000,000. Seizing upon this ratio, the district
court concluded that, under section 3.3(b), some rough
approximation of it obtained "in almost every situation" in which
Hancock made all four Program Payments and Abbott nevertheless
failed to reach the Aggregate Spending Target. Id. at 319. With
this hypothesis in mind, the court surmised that the sole purpose
of section 3.3(b) was to guarantee the same funding ratio in
situations in which Hancock makes all four Program Payments but
Abbott underspends. See id. at 320.
The district court's logic does not withstand scrutiny.
Although section 3.3(b) may preserve some semblance of the 65/35
ratio when Hancock makes all four Program Payments, it does not
follow that section 3.3(b) may be invoked only in such
circumstances. After all, the Agreement's text does not limit
section 3.3(b) to situations in which Hancock has made all four
Program Payments. Equally as important, the 65/35 ratio is not
mentioned anywhere in the text of section 3.3. Here, things did
not go smoothly; Abbott failed to pay its share of the freight; as
a result, Hancock was excused from making its last two Program
Payments; and the 65/35 ratio never materialized. Indeed, the
- 28 -
Hancock II panel anticipated our holding and expressly rejected
Abbott's claim that the Agreement "required Hancock to spend half
as much as Abbott." 478 F.3d at 8 n.4.
That rejection was inevitable, given that the Agreement
both anticipates and allows a spectrum of potential funding ratios
depending on the circumstances. To offer one example (out of
several possible examples), Abbott's first Annual Research Plan
proposed spending roughly five times more than Hancock's expected
$214,000,000 contribution. We conclude, therefore, that the
existence of a 65/35 funding ratio under one set of facts cannot
contradict the plain language of the Agreement.
At the expense of carting coal to Newcastle, we remark
the obvious: a fixed funding ratio in a contract with over
$600,000,000 at stake is not a mere bagatelle. It strains
credulity to think that parties who wanted such an important term
to apply across the board would fail to include that term (or
anything like it) in their contract. This is especially true when
one considers that we are dealing with a fully integrated contract
between sophisticated parties represented by experienced lawyers,
who labored through approximately forty drafts of a detailed
document over the course of a year or more. See Policemen's
Benev., 973 N.E.2d at 1032 (refusing to add term to "completely
integrated agreement"); Mid-W. Energy, 815 N.E.2d at 916
- 29 -
(declining to add term to "clear and unambiguous" contract between
sophisticated commercial parties).
In this regard, we deem it significant that the parties
obviously knew how to include a funding ratio in a contract.
Section 3.4 of the Agreement provides for a specified funding ratio
in particular circumstances (not applicable here). The inclusion
of a fixed spending ratio in one section of a contract but not in
another creates a compelling basis for inferring that the parties
deliberately chose to omit any fixed spending ratio from the latter
provision. See generally Thompson, 948 N.E.2d at 47 (holding that
use of different terms in different sections of contract warrants
presumption that sections have different meanings); cf. Hamilton
v. Conley, 827 N.E.2d 949, 957 (Ill. App. Ct. 2005) ("[W]here one
section of a statute contains a particular provision, omission of
the same provision from a similar section is significant to show
different legislative intent for the two sections." (quoting In
re D.F., 802 N.E.2d 800, 816 (Ill. 2003) (Freeman, J.,
concurring))).
The district court's characterization of Hancock's
interpretation as "unreasonable" and "perverse," Hancock III, 183
F. Supp. 3d at 320, is insupportable.5 The court emphasized its
5 In point of fact, the district court's reading is less
reasonable than a plain-language reading. Under the district
court's construction, if Abbott shirks its funding obligations
during the Program Term, Hancock faces a Hobson's choice: it must
- 30 -
fear that any other reading would give Hancock a "windfall." Id.
(quoting Roboserve, Inc. v. Kato Kagaku Co., 78 F.3d 266, 278 (7th
Cir. 1996)). But this fear is misplaced: though the existence of
an alleged windfall may have some role in determining whether
section 3.3(b) is enforceable as a liquidated damages provision,
see infra Part II(D), a court's subjective belief that contract
terms may produce a windfall does not, without more, empower it to
disregard the plain meaning of those contract terms. Here, there
is no "more" — and in this case, as in virtually every case, it is
perilous for a court to attempt to determine the intentions of
contracting parties through its view of the fairest or most
commercially reasonable way in which to construct a transaction.
"[W]hat seems commercially unreasonable to a court [may] not [have]
seem[ed] so to the parties." XCO Int'l Inc. v. Pac. Sci. Co., 369
F.3d 998, 1005 (7th Cir. 2004). Confronted with an unambiguous
and fully integrated contract, negotiated at arms-length, a
court's duty is to give force to the agreement's plain language.
To sum up, the condition that the district court imposed
on Abbott's performance under section 3.3(b) is not found in the
language of the Agreement, which was fully integrated by virtue of
either withhold its future Program Payments (thus forgoing its
right to the damages that flow from Abbott's underspending) or
continue to make its Program Payments (thus throwing good money
after bad).
- 31 -
section 16.3.6 We will not subvert the plain language of the
Agreement by plucking out of thin air a term that the parties
easily could have included but chose to forgo. See St. Paul
Mercury, 2 N.E.3d at 478. Simply put, the Agreement does not make
Abbott's obligation under section 3.3(b) contingent on Hancock's
completion of all four Program Payments.
D. Enforceability of Section 3.3(b) Remedies.
As is true in many jurisdictions, Illinois contract law
distinguishes between liquidated damages (generally enforceable)
and penalties (generally unenforceable). A liquidated damages
clause is one that provides in advance that a breaching defendant
will pay "a specific amount for a specific breach." Jameson Realty
Grp. v. Kostiner, 813 N.E.2d 1124, 1131 (Ill. App. Ct. 2004). The
purpose of such a clause "is to provide parties with a reasonable
predetermined damages amount where actual damages may be difficult
to ascertain." Karimi v. 401 N. Wabash Venture, LLC, 952 N.E.2d
1278, 1290 (Ill. App. Ct. 2011). At least in theory, such
provisions minimize uncertainty and reduce litigation costs,
easing the burden on both the parties and the judicial system.
6 The district court did say that "other provisions in the
contract explicitly state that Abbott is obligated to comply with
[s]ection 3.3(b) only if Hancock contributes all four of the
Program Payments." Hancock III, 183 F. Supp. 3d at 318. However,
the court never identified any such provisions, and we have found
none.
- 32 -
See Restatement (Second) of Contracts § 356 cmt. a. Penalties are
a horse of a different hue. When the sum or formula that is agreed
upon in advance is not reasonably correlated with future damages
and instead acts either as a threat to secure performance or as a
punishment for non-performance, the provision is an unenforceable
penalty. See Inland Bank & Trust v. Knight, 927 N.E.2d 777, 782
(Ill. App. Ct. 2010).
Nomenclature is not dispositive. Whether a provision is
held to be a liquidated damages provision or a penalty provision
depends on the nature of the provision, not on how it is labeled.
See Penske Truck Leasing Co. v. Chemetco, Inc., 725 N.E.2d 13, 19
(Ill. App. Ct. 2000).
In this instance, Abbott agreed to section 3.3(b) after
protracted arm's-length negotiations in which both sides were
represented by seasoned counsel. Abbott now asks us to relieve it
of this bargained-for obligation on the ground that the obligation
constitutes a penalty that the law of Illinois does not tolerate.
As the party resisting enforcement of section 3.3(b), Abbott bears
the burden of proving that the provision imposes an impermissible
penalty rather than a permissible means of measuring liquidated
damages. See XCO Int'l, 369 F.3d at 1003; Penske, 725 N.E.2d at
20. Because the validity and enforceability of a putative
liquidated damages provision presents a question of law, see Fleet
Bus. Credit, LLC v. Enterasys Networks, Inc., 816 N.E.2d 619, 633
- 33 -
(Ill. App. Ct. 2004), we review de novo the district court's
determination that section 3.3(b) is an unenforceable penalty, see
Kunelius v. Town of Stow, 588 F.3d 1, 13 (1st Cir. 2009).
There is no hard-and-fast rule for separating liquidated
damages provisions from penalty provisions. Instead, each clause
"must be evaluated by its own facts and circumstances." Grossinger
Motorcorp, Inc. v. Am. Nat'l Bank & Trust Co., 607 N.E.2d 1337,
1345 (Ill. App. Ct. 1992); see Penske, 725 N.E.2d at 19.
The Illinois cases (including federal cases applying
Illinois law) send mixed messages about the degree of suspicion
with which putative liquidated damages provisions should be
viewed. On the one hand, some case law suggests that close calls
should be resolved in favor of declaring the disputed clause to be
a penalty.7 See, e.g., GK Dev., Inc. v. Iowa Malls Fin. Corp., 3
N.E.3d 804, 816 (Ill. App. Ct. 2013); Stride v. 120 W. Madison
Bldg. Corp., 477 N.E.2d 1318, 1321 (Ill. App. Ct. 1985). On the
other hand, the Illinois cases tend to give effect to the provision
in the absence of fraud or unconscionable oppression. See, e.g.,
Zerjal v. Daech & Bauer Constr., Inc., 939 N.E.2d 1067, 1074 (Ill.
App. Ct. 2010) ("In general, Illinois courts give effect to
liquidated-damages provisions so long as the parties have
7
This preference for penalties has at times been voiced by
courts upholding liquidated damages provisions. See, e.g.,
JPMorgan Chase Bank, N.A. v. Asia Pulp & Paper Co., 707 F.3d 853,
867 (7th Cir. 2013).
- 34 -
'expressed their agreement in clear and explicit terms and there
is no evidence of fraud or unconscionable oppression, a legislative
directive to the contrary, or a special social relationship between
the parties of a semipublic nature.'" (quoting Hartford Fire Ins.
Co. v. Architectural Mgmt., Inc., 550 N.E.2d 1110, 1114 (Ill. App.
Ct. 1990))); Newcastle Props., Inc. v. Shalowitz, 582 N.E.2d 1165,
1170 (Ill. App. Ct. 1991) (similar). Here, however, we need not
sort through this speckled landscape. When all is said and done,
the conclusion that section 3.3(b) is an enforceable liquidated
damages provision is inescapable.
A liquidated damages provision is enforceable as long as
three conditions are satisfied:
(1) the parties intended to agree in advance
to the settlement of damages that might arise
from a breach, (2) the amount provided as
liquidated damages was reasonable at the time
of contracting, bearing some relation to the
damages which might be sustained, and (3) the
actual damages would be uncertain in amount
and difficult to prove.
Dallas v. Chi. Teachers Union, 945 N.E.2d 1201, 1204 (Ill. App.
Ct. 2011) (citing Jameson, 813 N.E.2d at 1130). In our judgment,
all three of these conditions are satisfied here.
The first and third conditions are plainly met. As to
the first, it is clear beyond hope of contradiction that Hancock
and Abbott intended to agree in advance to the settlement of the
damages that might result from a particular kind of breach. A
- 35 -
reading of the Agreement as a whole leaves no doubt that the
parties intended that section 3.3(b) would serve as the exclusive
measure of damages in that event. The provision evinces the
parties' joint effort to fix a determinable sum as damages at the
time of contracting — and that is a hallmark of a valid liquidated
damages clause. See Grossinger, 607 N.E.2d at 1346.
We recognize, of course, that section 3.3(b) was not
described in the Agreement as either a liquidated damages provision
or a penalty provision — and it surely would have been prudent
(and easy) for the parties to have made such a designation. But
even though language in the Agreement describing the nature of the
provision would have been helpful (albeit not conclusive) in
showing the parties' intent, the absence of any such description
is a wash. See Berggren v. Hill, 928 N.E.2d 1225, 1231 (Ill. App.
Ct. 2010) (considering provision in real estate contract allowing
seller to keep earnest money in event of breach to be liquidated
damages provision even though term "liquidated damages" not used).
We may infer the parties' intent from the language and
structure of the Agreement, see Jameson, 813 N.E.2d at 1132-33,
and it is evident here that the parties intended section 3.3(b) to
operate as a liquidated damages provision. According to section
3.2, "Hancock's sole and exclusive remedies for Abbott's failure"
to fulfill its funding obligations "are set forth in [s]ections
3.3 and 3.4." Section 3.3(b), in turn, allows Hancock to recover
- 36 -
damages for Abbott's underspending in accordance with a set
formula. When parties agree to a formula to calculate a monetary
remedy that must be paid in the event of a specific type of breach,
the provision embodying that formula is normally intended to
operate as a liquidated damages provision.8 See N. Ill. Gas Co.
v. Energy Coop., Inc., 461 N.E.2d 1049, 1055 (Ill. App. Ct. 1984).
So it is here.
The third condition for a valid liquidated damages
provision is also satisfied. That condition requires that, in the
event of a breach, actual damages (viewed as of the time of
contracting) would be difficult to calculate and, thus, uncertain.
See Jameson, 813 N.E.2d at 1132. If it appeared to the parties at
the time of contracting that actual damages would be readily
calculable, a provision stipulating a materially different
(higher) amount would be a penalty, not a liquidated damages
provision. See Lake River Corp. v. Carborundum Co., 769 F.2d 1284,
1289-90 (7th Cir. 1985) (applying Illinois law); Stride, 477 N.E.2d
at 1321.
8Abbott suggests that the "intent" element is lacking because
"[t]here is no evidence that the parties intended [section 3.3(b)]
to apply where Hancock has not made its full $214 million
contribution." This argument merely reprises Abbott's previously
rejected claim that section 3.3(b) does not apply unless Hancock
makes all four Program Payments, see supra Part II(B)-(C), and we
need not repastinate that well-plowed soil.
- 37 -
Here, it is nose-on-the-face plain that Hancock's
damages for any failure on Abbott's part to reach the Aggregate
Spending Target would have been surpassingly difficult to
calculate at the time of contracting. The Program Compounds had
to clear countless hurdles, including successful scientific
development, positive clinical testing results, regulatory
approvals, navigating the shoals of competitive forces, and the
establishment of profitable marketing and distribution
arrangements. Even if things went like clockwork, the culmination
of that process would take years. Under these circumstances, the
uncertainty associated with the successful development of the
Program Compounds is manifest and heralds a similar degree of
uncertainty about the financial returns that Hancock's investment
was likely to yield.
This uncertainty becomes pervasive when one considers
that the damages from Abbott's breach of its spending obligation
are virtually impossible to quantify in advance because section
3.3(b) seeks to approximate not Hancock's future profits in their
entirety but, rather, the amount by which those profits would be
reduced if Abbott underspent. Even with the benefit of hindsight,
the district court observed that the diminution in profits
attributable to Abbott's underspending is "inherently difficult to
quantify." Hancock III, 183 F. Supp. 3d at 321. Although the
existence vel non of uncertainty must be determined with reference
- 38 -
to the time of contracting, the inscrutability of actual damages
after the breach reinforces our conclusion that pervasive
uncertainty was baked into the cake from the very beginning.9 Cf.
Karimi, 952 N.E.2d at 1288 (considering post facto actual damages
to show uncertainty at time of contracting).
Abbott's attempt to parry this thrust is unconvincing.
It says that Hancock "[a]t various times . . . calculated its
expected rates of return on the Agreement." That is true as far
as it goes, but it does not take Abbott very far. The two estimates
to which it points differ substantially not only from each other
but also from the investment's actual performance. Incorrect and
fluctuating estimates of a party's anticipated returns are
indications that actual damages were difficult to quantify and
were therefore uncertain.10 See Jameson, 813 N.E.2d at 1133.
9 The opacity of Hancock's actual damages distinguishes this
case from Lake River, 769 F.2d at 1290, in which the Seventh
Circuit found that a provision was "a penalty and not a liquidation
of damages, because it is designed always to assure [the plaintiff]
more than its actual damages." The same cannot be said of section
3.3(b) because Hancock's actual damages are, as the district court
found, "unknowable." Hancock III, 183 F. Supp. 3d at 321.
10Abbott makes a separate argument that its underspending may
not have caused "actual harm" and that "a monetary infusion would
not have changed" the viability of the failed compounds. Whatever
merit this argument might have in determining the reasonableness
of a liquidated damages formula, it has no relevance to the
uncertainty inherent in predicting, at the time of contracting,
the damages apt to flow from Abbott's underspending.
- 39 -
We conclude that the uncertainty of actual damages
brings this case well within the heartland of those cases in which
Illinois courts have found actual damages sufficiently uncertain
to warrant the use of a liquidated damages provision. See, e.g.,
Karimi, 952 N.E.2d at 1288; Jameson, 813 N.E.2d at 1132; Penske,
725 N.E.2d at 20; Likens v. Inland Real Estate Corp., 539 N.E.2d
182, 185 (Ill. App. Ct. 1989). Accordingly, we hold that the third
condition of the liquidated damages paradigm has been satisfied.
This leaves the question of whether section 3.3(b),
viewed from the perspective of the time of contracting, forged a
reasonable estimate of actual damages. In answering this question,
we start by rehearsing how actual damages would be measured at
common law for Abbott's breach. Under Illinois law, a non-
breaching party is entitled to damages sufficient "to place [him]
in a position that he . . . would have been in had the contract
been performed, [but] not to provide [him] with a windfall
recovery." GK Dev., 3 N.E.3d at 816 (quoting Jones v. Hryn Dev.,
Inc., 778 N.E.2d 245, 249 (Ill. App. Ct. 2002)). Such damages may
include lost profits as long as the plaintiff proves three
elements: the plaintiff first must establish "the loss with a
reasonable degree of certainty," then establish that the
"defendant's wrongful act resulted in the loss," and, finally,
establish that "the profits were reasonably within the
contemplation of [the] defendant at the time the contract was
- 40 -
entered into." InsureOne Indep. Ins. Agency, LLC v. Hallberg, 976
N.E.2d 1014, 1033-34 (Ill. App. Ct. 2012) (quoting Equity Ins.
Mgrs. of Ill., LLC v. McNichols, 755 N.E.2d 75, 80 (Ill. App. Ct.
2001)).
Because the asserted breach in this case consists of
Abbott's failure to reach the Aggregate Spending Target, Hancock
is entitled to damages reflecting the profits that it would have
garnered if Abbott had spent the required amount. Of course, even
though Abbott has breached, Hancock is still entitled to its share
of whatever profits the Program Compounds may earn. The
possibility that revenues will be forthcoming from this source
must be taken into account in gauging the reasonableness of the
section 3.3(b) formula.
To be valid and enforceable, section 3.3(b) need not
perfectly replicate actual loss. Instead, it must only bear some
relation to the loss — here, the lost profits attributable to
Abbott's underspending. See Dallas, 945 N.E.2d at 1205. The
inquiry is prospective, not retrospective: we do not compare the
amount derived by application of the liquidated damages formula to
a post facto appraisal of the actual damages. Rather, we ask
whether "the amount reasonably forecasts and bears some relation
to the parties' potential loss as determined at the time of
contracting." Karimi, 952 N.E.2d at 1288.
- 41 -
Measuring future damages inevitably entails a certain
amount of guesswork, and we afford the parties more leeway as the
difficulty of estimating damages increases. See XCO Int'l, 369
F.3d at 1001-02; see also United Order of Am. Bricklayers & Stone
Masons Union No. 21 v. Thorleif Larsen & Son, Inc., 519 F.2d 331,
335 (7th Cir. 1975) (explaining that "the greater the difficulty
of estimating the damages, the greater will have to be the latitude
accorded to the determination of the reasonableness of the
forecast"). This principle fits neatly with the purpose of
liquidated damages provisions because "the case for a contractual
specification of damages is stronger the more difficult it is to
estimate damages." XCO Int'l, 369 F.3d at 1001.
The degree of uncertainty in this case is pronounced,
and our inquiry into the enforceability of section 3.3(b) must
take that high degree of uncertainty into account. The question
is not whether section 3.3(b) anticipates Hancock's actual damages
with precision, nor even whether its formula provided the best
possible estimate with respect to this particular breach. Given
the uncertainty of actual damages at the time of contracting,
section 3.3(b) ought to be upheld unless its formula is apt to
produce "an outlandish estimate of the damages that [the non-
breaching party] might sustain as a result of" the breach. Id. at
1003.
- 42 -
A salient feature of section 3.3(b) is that it operates
proportionally. Liquidated damages provisions that operate on a
sliding scale, proportional to the magnitude of the breach, are
favored because they indicate that the parties were attempting in
good faith to estimate the damages likely to flow from a particular
breach. See id. at 1004; Jameson, 813 N.E.2d at 1133 (upholding
liquidated damages award that varied based on number of units). A
single, invariant sum for all breaches too frequently will yield
an unrealistic estimate of actual damages for any given breach.
See, e.g., Energy Plus Consulting, LLC v. Ill. Fuel Co., 371 F.3d
907, 909-10 (7th Cir. 2004); Checkers Eight Ltd. P'ship v. Hawkins,
241 F.3d 558, 562 (7th Cir. 2001); GK Dev., 3 N.E.3d at 817.
Two simple and related propositions fortify our
conclusion that section 3.3(b) reasonably forecasts and bears a
sufficient relation to Hancock's potential loss (as envisioned at
the time of contracting). First, it seems to us a commonsense
proposition that, in this context, higher spending is likely to
increase future profits. Second, it seems equally probable that
the amount of lost profits will be higher when the spending
shortfall is greater. One could reasonably have thought, at the
time of contracting, that a larger infusion of cash by Abbott would
make available additional resources for the development of the
Program Compounds and, at the same time, would indicate Abbott's
renewed commitment to the success of those compounds. Conversely,
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one could reasonably have thought, at the time of contracting,
that a reduced investment by Abbott would shrink the resources
available for the development of the Program Compounds and, at the
same time, would indicate a lessened commitment to the success of
those compounds, thus dampening Hancock's prospects for profits.
One could of course imagine circumstances under which additional
spending might not lead to greater profits or under which a larger
spending shortfall might not result in higher lost profits. One
or both of the sophisticated parties to this transaction
undoubtedly considered such possibilities. Yet we are not
concerned with the universe of potential eventualities but,
rather, with reasonable assumptions about the enterprise's general
prospects as viewed from the time of contracting.
Section 3.3(b) builds upon these propositions. Under
its formula, Hancock's damages increase proportionally to the
magnitude of the disparity between actual spending and the
Aggregate Spending Target. A formula that increases Hancock's
damages proportionally to the Aggregate Carryover Amount — as this
formula does — seems well-calculated to afford a reasonable
estimate of Hancock's actual damages. We hold, therefore, that
this final condition of the liquidated damages paradigm is met.
That ends this aspect of our inquiry. Inasmuch as all
three of the requisite conditions for the enforcement of a
liquidated damages provision are satisfied, section 3.3(b)
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constitutes an enforceable liquidated damages provision. Abbott
resists this determination, advancing a triumvirate of overlapping
arguments. Whether viewed singly or in combination, these
arguments fail to persuade.
To begin, it points out that the formula does not
distinguish between shortfalls caused by Hancock's reduced
contributions and shortfalls caused by Abbott's withholding of
funds. Had Hancock made all four of its scheduled Program
Payments, the Aggregate Spending Target would have been achieved.
Since Hancock's reduced contributions "caused" the shortfall,
Abbott's thesis runs, a formula that nonetheless awards Hancock
damages must unreasonably estimate damages.
This thesis twists the language of the Agreement. Under
the terms of the Agreement, it is Abbott's sole responsibility,
set out in section 3.2, to fund "at least the Aggregate Spending
Target during the Program Term." Abbott's thesis implies that its
spending obligation is capped at $400,000,000 — but the Agreement
says no such thing. Where, as here, Hancock is excused under
section 3.4 from making some future payments, Abbott's minimum
spending obligation climbs proportionally (to points above
$400,000,000). Contrary to Abbott's self-serving assertion, there
was no need for the Agreement — either as a matter of law or as a
matter of logic — to "distinguish between underspending
attributable to lower contributions by Hancock and underspending
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caused by lower contributions by Abbott." They are in essence one
and the same.
Abbott next complains that section 3.3(b), construed in
the manner that Hancock envisions, gives Hancock a greater award
the earlier the breach occurs (when Hancock has invested less).
As Abbott sees it, section 3.3(b) generates a windfall for Hancock
because Hancock is entitled to a larger award when the breach
occurs earlier in the Program Term. But this is not a windfall;
it is merely a feature of how the formula is designed to work.
The damages decrease as the spending shortfall decreases because
section 3.3(b) is meant to estimate the impact of underspending on
future profits. This design makes commercial sense: as the
spending shortfall shrinks, the adverse effect on total profits
should be less. Thus, it is reasonable to anticipate that a breach
by Abbott early in the Program Term (when much less has been spent
on the development of the Program Compounds) will have a more
deleterious effect on future profits. If the Program Term has run
its course (or nearly so) and the Aggregate Spending Target has
almost been reached, the smaller shortfall presumably would have
a less severe impact on the program's long-term profitability.11
11 Abbott's windfall concern might be justified if Hancock
could manipulate the Agreement and choose to forgo future Program
Payments in order to reap an undeserved harvest under section
3.3(b). No such danger looms, though, because Abbott controls
whether Hancock's duty to make all four Program Payments persists.
This case illustrates the point: Hancock's obligation to make its
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An Illinois court previously has rejected an argument
analogous to Abbott's argument. In Jameson, the plaintiff (a real
estate agent) contracted with the defendant-developer for the
exclusive right to sell the units in a condominium complex. See
813 N.E.2d at 1127. The parties agreed to a damages clause, which
stipulated that if the defendant revoked the plaintiff's sales
authority, the plaintiff would be entitled to damages premised on
unrealized commissions (calculated on the basis of the full price
of unsold units). See id. After the defendant breached, he
attacked the damages clause as an unenforceable penalty. In
support, the defendant contended that the clause amounted to a
"tremendous windfall" because the measure of damages assumed that
every unit would sell at the list price and that the plaintiff
would not have to split any commissions. Id. at 1133.
The court disagreed, holding that the clause was a valid
and enforceable liquidated damages clause. See id. It explained
that the defendant's breach deprived the plaintiff of "the
opportunity to sell the units" and took away "any chance" that the
plaintiff might have had of obtaining commissions on those units.
Id. The possibility that other factors might have reduced the
last two Program Payments was excused only because Abbott had
breached (that is, Abbott had made apparent that it would not do
what was necessary to reach the Aggregate Spending Target). Seen
in this light, Hancock's reduced contribution was the direct and
foreseeable result of Abbott's underspending.
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plaintiff's actual commissions had the defendant not breached only
illustrated the difficulty of calculating actual damages at the
time of contracting. See id.In this case, as in Jameson, the plaintiff (Hancock) was
deprived of the opportunity for which it had bargained — the chance
to reap the profits of a fully funded research program. Any doubt
about factors that might have reduced these profits only "prove
the validity of the clause [by] show[ing] just how uncertain and
difficult calculating actual damages was at the time of
contracting." Id.Abbott's last argument strikes a similar chord. It
submits that damages should be smaller when the breach occurs
earlier in the Program Term because Hancock will have avoided more
costs. This argument taps into the principle that a non-breaching
party's damages generally ought to be reduced by the costs that
the party avoids as a result of the breach. See Sterling Freight
Lines, Inc. v. Prairie Mat'l Sales, Inc., 674 N.E.2d 948, 951 (Ill.
App. Ct. 1996); Levan v. Richter, 504 N.E.2d 1373, 1378 (Ill. App.
Ct. 1987).
We acknowledge that, under Illinois law, Hancock's
recovery should be based on its net lost profits, that is, the
lost profits attributable to Abbott's underspending less Hancock's
avoided costs. See Sterling Freight, 674 N.E.2d at 951. Section
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3.3(b) does not make an explicit reference to avoided costs,12 but
the absence of such a reference is not problematic: since there is
no sum certain representing Hancock's gross lost profits,
Hancock's avoided costs cannot be subtracted from its gross lost
profits (an unknowable figure) in a literal sense. Rather, in
keeping with section 3.3(b)'s general principle of
proportionality, the Agreement reasonably anticipates that the
increased lost profits caused by an earlier breach will offset the
greater avoided costs.
Abbott posits that a breach early in the Program Term
should engender a smaller, not a larger, liquidated damages award
because Hancock has avoided more costs. Yet Abbott conveniently
overlooks the corresponding fact that the gross lost profits will
almost certainly be higher for an earlier breach. Thus, the
increased avoided costs are deducted from a larger gross profits
number, resulting in higher damages.
12 Section 3.3(b)'s silence regarding avoided costs does not
necessarily mean that avoided costs are not factored into section
3.3(b)'s formula. Section 3.2 states that if Abbott "fail[s] to
fund the Research Program in accordance with this [s]ection,"
Hancock's "sole and exclusive remedies" are "set forth in
[s]ections 3.3 and 3.4." Inasmuch as the parties provided for
both liquidated damages and the discharge of Hancock's future
payment obligations, we may safely assume that they considered
avoided costs in crafting section 3.3(b). Of course, we must still
ask — as we have done supra — whether their estimate of damages in
section 3.3(b) is reasonable.
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As a counterpoint, consider a situation in which Abbott
breaches late in the Program Term. Hancock may have less (or even
no) avoided costs, but its lost profits will also be less. It
follows that liquidated damages in such a case should be less even
though Hancock's avoided costs are less.
There is an interrelated reason why it is logical that
the liquidated damages would be greater when Hancock's avoided
costs are greater. But for Abbott's breach (which triggered
section 3.4), Hancock would have contributed more funds to the
development of the Program Compounds. These additional funds would
have spurred the development of the Program Compounds and likely
would have increased their profitability. So, when Abbott breaches
before Hancock has made all four of its Program Payments, Abbott
doubly suppresses future profits: first, by underfunding its own
obligations, and second, by shutting off the spigot so that
additional funds from Hancock dry up.
The formula set out in section 3.3(b) may be an
unorthodox way of accounting for avoided costs, but it is tailored
to suit the idiosyncratic nature of the parties' relationship.
Normally, avoided costs are a one-way ratchet. Take, for instance,
a typical case. X, who has a factory in Massachusetts, enters
into a contract with Y to manufacture and deliver widgets F.O.B.
at Y's warehouse in Illinois. After the widgets are made but
before they are shipped, Y notifies X that it will not honor the
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contract. When X sues for damages, the costs of transportation
are avoided costs, that is, they are costs that X will not have to
incur and, thus, they count, dollar for dollar, against what would
otherwise have been X's damages.
Here, however, Hancock's lessened contributions are a
different species of avoided costs: they are a two-way ratchet.
While it is true that Hancock's costs are diminished by the fact
that it is excused from making its third and fourth Program
Payments, the diminished funding that results from that non-
payment also diminishes Hancock's anticipated profits. After all,
it is a reasonable assumption that the more money that is made
available for the development of the Program Compounds, the greater
the anticipated profits will be. Given the deference that we owe
the parties' negotiated formula for estimating damages that are
highly uncertain, see XCO Int'l, 369 F.3d at 1001-02, and the
unique nature of the avoided costs at issue here, we do not think
that we are at liberty to substitute our judgment for that of the
contracting parties.
To sum up, the lost profits attributable to Abbott's
underspending in the wildly speculative business of developing
pharmaceutical drugs were uncertain and defied meaningful
calculation at the time of contracting. Recognizing this
difficulty and intending to address it, Abbott and Hancock agreed
to the formula contained in section 3.3(b) to provide a reasonable
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estimate of damages in the event of a breach by Abbott of its
spending obligation. We are confident that, on balance, section
3.3(b)'s formulaic estimate of those actual damages falls
comfortably within the universe of reasonable estimates. See
Inland Bank, 927 N.E.2d at 783. Abbott has not carried its burden
of proving that section 3.3(b) is a penalty rather than a valid
and enforceable liquidated damages provision, see XCO Int'l, 369
F.3d at 1003, and it must pay Hancock one-third of the Aggregate
Carryover Amount as liquidated damages. According to the district
court's calculations, which we see no need to revisit, that amount
is $33,033,333.33.
E. Rescission.
We need not linger long over Hancock's contention that
the district court erred in striking its prayer for rescission.
The doctrine of election of remedies prevents a party from seeking
inconsistent remedies.
Applying this doctrine leads inexorably to the
conclusion that a party may not both rescind a contract and recover
damages for a breach of that contract. See Harris v. Manor
Healthcare Corp., 489 N.E.2d 1374, 1381 (Ill. 1986). Those
remedies are flatly inconsistent with each other: rescission is in
essence a disavowal of the contract whereas recovery for a breach
is in essence an affirmance of the contract. See Newton v. Aitken,
633 N.E.2d 213, 216 (Ill. App. Ct. 1994). To both rescind an
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agreement and recover damages for a breach of that agreement would
therefore be "inappropriate." Id. at 217. As a result, "[t]he
election of either remedy is an abandonment of the other." Id.Here, Hancock has recovered damages under section 3.3(b)
for Abbott's breach of section 3.2. Enforcing section 3.3(b)
implies an affirmance of the Agreement and, thus, is inconsistent
with any right to rescission.13 Given this inescapable logic, we
hold that Hancock may not now seek rescission of the Agreement.
See Harris, 489 N.E.2d at 1381. Consequently, the district court
did not err in striking Hancock's prayer for rescission.
F. Prejudgment Interest.
In a diversity action, state law controls a prevailing
party's entitlement to prejudgment interest. See Comm'l Union
Ins. Co. v. Walbrook Ins. Co., 41 F.3d 764, 774 (1st Cir. 1994).
Conversely, federal law governs a party's entitlement to
postjudgment interest. See Vázquez-Filippetti v. Cooperativa de
Seguros Múltiples de P.R., 723 F.3d 24, 28 (1st Cir. 2013); see
also 28 U.S.C. § 1961 (providing for postjudgment interest on civil
judgments in federal courts).
13 The district court held that Hancock's pursuit of a
declaratory judgment in Hancock I and Hancock II was inconsistent
with Hancock's prayer for rescission. See Hancock III, 183 F.
Supp. 3d at 302-03. That may be so, but we have no need to pursue
the point.
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Under Illinois law, "[p]rejudgment interest is proper
when it is authorized by a statute, authorized by agreement of the
parties, or warranted by equitable considerations." In re Marriage
of O'Malley ex rel. Godfrey, 64 N.E.3d 729, 746 (Ill. App. Ct.
2016). Here, Hancock is entitled to prejudgment interest both by
statute, see 815 Ill. Comp. Stat. 205/2, and by the terms of the
Agreement, specifically section 9.3. As a practical matter, the
only difference between the prejudgment interest contemplated by
the Illinois statute and that available under the Agreement is the
rate. The statutory rate is 5%. See id. The rate under the
Agreement is the lesser of "the prime rate of interest plus two
hundred (200) basis points" or "the highest rate permitted by
applicable law."
When a prevailing party is entitled to prejudgment
interest both under a statute and under a contractual provision,
the prevailing party may recover prejudgment interest at the higher
available rate. See Mich. Ave. Nat'l Bank v. Evans, Inc., 531
N.E.2d 872, 881 (Ill. App. Ct. 1988). On remand, the district
court should calculate prejudgment interest either pursuant to the
statute or pursuant to the Agreement (as Hancock may elect).
With respect to duration, "the beginning date for the
accrual of postjudgment interest marks the ending date for the
accrual of prejudgment interest." Old Second Nat'l Bank v. Ind.
Ins. Co., 29 N.E.3d 1168, 1180 (Ill. App. Ct. 2015). To determine
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that date, the weight of authority in diversity cases holds that
federal law establishes when postjudgment interest begins to
accrue and, thus, establishes when prejudgment interest ceases to
accrue. See Art Midwest, Inc. v. Clapper, 805 F.3d 611, 615 (5th
Cir. 2015); Coal Res., Inc. v. Gulf & W. Indus., Inc., 954 F.2d
1263, 1274 (6th Cir. 1992); Happy Chef Sys., Inc. v. John Hancock
Mut. Life Ins. Co., 933 F.2d 1433, 1437-38 (8th Cir. 1991);
Travelers Ins. Co. v. Transp. Ins. Co., 846 F.2d 1048, 1053-54
(7th Cir. 1988); Northrop Corp. v. Triad Int'l Mktg. S.A., 842
F.2d 1154, 1156-57 (9th Cir. 1988) (per curiam); cf. Fratus v.
Republic W. Ins. Co., 147 F.3d 25, 29-30 (1st Cir. 1998) (applying
Federal Rules of Civil Procedure and 28 U.S.C. § 1961 to determine
date that postjudgment interest would begin to accrue in diversity
suit). But cf. Tobin v. Liberty Mut. Ins. Co., 553 F.3d 121, 146-
47 (1st Cir. 2009) (suggesting different rule in non-diversity
case).
Under federal law, "where a first judgment lacks an
evidentiary or legal basis, post-judgment interest accrues from
the date of the second judgment." Cordero v. De Jesus-Mendez, 922
F.2d 11, 16 (1st Cir. 1990). Because the district court's decision
interpreting section 3.3(b) is entirely reversed, that portion of
its judgment perforce lacked a legal basis. On remand, therefore,
the district court should calculate prejudgment interest on this
award beginning from the date that it was due under the Agreement
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(thirty days after the end of 2005) and continuing until the date
that the district court enters its amended judgment. Postjudgment
interest will accrue from that date forward. See 28 U.S.C. § 1961;
Kaiser Alum. & Chem. Corp. v. Bonjorno, 494 U.S. 827, 836 (1990).
The portion of the district court's judgment that
awarded Hancock damages for Abbott's breach of the Agreement's
audit provision in the amount of $198,731 was not appealed and
remains in effect. If that portion of the judgment remains
unsatisfied, it must be incorporated in the amended judgment,
together with prejudgment interest to the date of the original
judgment (as previously calculated by the district court).
Postjudgment interest shall continue to accrue on that portion of
the judgment from that date forward.
III. CONCLUSION
Refined to bare essence, this is a case about keeping
promises. Hancock and Abbott made promises to each other. Abbott
nonetheless failed to honor several promises, including one
important promise in particular. The parties had provided a
damages remedy for just such an eventuality, and that remedy
produced a rational estimate of Hancock's actual damages which, at
the time of contracting, were highly uncertain and impossible to
calculate. The remedy is, therefore, a valid liquidated damages
clause, and Hancock is entitled to enforce it according to its
tenor.
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We need go no further. For the reasons elucidated above,
we reverse the judgment of the district court with respect to
section 3.3(b) of the Agreement, affirm its dismissal of Hancock's
prayer for rescission, and remand for further proceedings
consistent with this opinion. Costs shall be taxed in favor of
Hancock.
So Ordered.
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