Checkers Eight v. Hawkins, La-Van ( 2001 )

In the
United States Court of Appeals
For the Seventh Circuit
No. 00-2704
Checkers Eight Limited Partnership, et al.,
Plaintiffs-Appellees,
v.
La-Van Hawkins, et al.,
Defendants-Appellants.
Appeal from the United States District Court
for the Northern District of Illinois, Eastern Division.
No. 95 C 7708--John F. Grady, Judge.
Argued January 24, 2001--Decided February 20, 2001
Before Flaum, Chief Judge, and Evans and Williams,
Circuit Judges.
Flaum, Chief Judge. Defendants La-Van Hawkins and
his associated corporations appeal the amount of
damages entered under an agreed order. They claim
that a provision requiring them to pay an
additional $150,000 if their scheduled payments
under the order were tardy is an unenforceable
penalty clause. The defendants also argue that
plaintiffs Checkers Eight Limited Partnership
("Checkers") and associated persons,
partnerships, and corporations waived strict
compliance with the payment schedule. For the
reasons stated herein, we reverse and remand.
I. Background
The facts underlying this lengthy commercial
litigation are complicated and generally not
relevant to the legal issues presented in this
case and so will receive only a concise summary.
In 1995, Checkers, Thomas W. Lonergan, James T.
Lonergan, Thomas W. Lonergan Trust No. 1, and
Tower Food Services, Inc. (the general partner of
Checkers) filed suit against La-Van Hawkins,
Hawkins Two, Inc., Hawkins Four, Inc., Hawkins
Five, Inc., and Hawkins Eight, Inc. Count I of
the amended complaint alleged that the defendants
owed money to Checkers under a partnership
agreement signed by each of the defendants, and
Count II alleged that payments from the
defendants were owed to another partnership. The
plaintiffs sought $350,747.68 on Count I and
$214,597.58 on Count II. The basis of federal
jurisdiction was (and is) diversity, since the
plaintiffs and the limited partners of Checkers
were either citizens of or were incorporated and
had their primary places of business in Illinois,
New York, or Ohio, while the original defendants
were either citizens of or were incorporated and
had their primary places of business in Georgia.
The litigation developed with the plaintiffs
filing motions for summary judgment. In a June 3,
1997 opinion, the court denied one of these
motions but found as substantially uncontroverted
facts under Fed.R.Civ.P. 56(d) that the
defendants owed at least $181,303.68 on Count I
and at least $200,162.58 on Count II. In
September, 1997, after being granted leave by the
court, the defendants filed a counterclaim
seeking reimbursement for expenses the defendants
allegedly paid on behalf of the partnerships. The
counterclaim stated only that the defendants
sought more than $50,000 in damages, but the
defendants’ documented expenses totaled
$1,153,484.85.
In February, 1999, the parties settled the case
and had the district court enter an order
memorializing their resolution. This order
dismissed the defendants’ counterclaim with
prejudice and provided that if the defendants
paid the plaintiffs a total of $250,000 in a
timely manner the complaint would be dismissed
with prejudice as well. This $250,000 was to be
paid in an initial lump sum and then monthly
installments, with the installment amounts due
near the end of each month from March, 1999 to
January, 2000. The order also stated that if the
payments were not made in a timely manner,
judgment for $400,000 minus any settlement
payments would be entered against the defendants
who were parties to the original partnership
dispute as well as other associated entities,/1
which collectively form the defendants in this
case.
The defendants were tardy making some of the
payments. The payment of the first late sum,
which was due on May 28, 1999 according to the
agreed order, was delayed with the permission of
the plaintiffs until June 4. However, the
defendants did not obtain explicit permission
from the plaintiffs for the remaining late
payments, the next of which was the September 30
payment, which was made one day late on October
1. The sum due October 30 was not produced until
November 9, with the plaintiffs filing a motion
for entry of judgment on November 5, which was
withdrawn when they received the payment. The
monies due on December 31 were also late and the
plaintiffs filed a motion to enter judgment for
$400,000 in their favor on January 7, 2000. The
defendants made this payment on January 11 and
paid the last sum on January 20, which was eleven
days early. At that point, the defendants had
paid $250,000. However, the plaintiffs did not
withdraw their motion for entry of judgment under
the agreed order and the district court held a
hearing. After listening to argument from both
sides, the court granted the motion and ordered
the defendants to pay an additional $150,000.
II. Discussion
The defendants argue that the extra $150,000
they were required to produce for not making
timely payments is an unenforceable penalty
clause. They claim that this sum has no relation
to the damages caused by the late payments and
that these damages are easily estimated by using
prevailing interest rates. They further contend
that the only purpose of this provision of the
order was to secure performance of the contract
and that the amount is insensitive to the gravity
of their breach. The plaintiffs claim that the
provision in question is a perfectly acceptable
liquidated damages clause.
We begin by making explicit a few assumptions
relied on by the parties. The first of these is
that state law, rather than federal, applies to
the construction of agreed orders entered by a
federal court sitting in diversity. In their
briefs, both parties cite only Illinois law and
Seventh Circuit and Illinois district court cases
interpreting Illinois law. Most of the circuits
that have considered the issue have held that
questions of the validity or interpretation of an
agreed order resolving state law claims are
governed by state law, see, e.g., Bamerilease
Capital Corp. v. Nearburg, 958 F.2d 150, 152 (6th
Cir. 1992); Alumax Mill Prods., Inc. v. Congress
Fin. Corp., 912 F.2d 996, 1007 (8th Cir. 1990);
White Farm Equip. Co. v. Kupcho, 792 F.2d 526,
529 (5th Cir. 1986). Thus, we will assume with
the parties that state law applies, though we
need not make a definitive ruling on this
question since the issue is not contested. The
second assumption is that Illinois law, rather
than the law of some other state, applies. Since
the parties cite only cases interpreting Illinois
law, we will assume that Illinois law governs
their dispute. See Coleman v. Ramada Hotel
Operating Co., 933 F.2d 470, 473 (7th Cir. 1991).
The third premise is that Illinois applies its
penalty clause jurisprudence to consensual orders
approved by courts. The plaintiffs implicitly
assume this in their briefs by arguing only that
the provision of the agreed order at issue in
this case does not constitute a penalty clause,
but at oral argument questioned whether part of
a court order could ever be considered a penalty.
Even if we were to consider the plaintiffs’ late
argument that under Illinois law no part of a
settlement agreement approved by a court can be
a penalty,/2 they cite no case law to that
effect and we previously have found that under
Illinois law portions of court-approved
agreements can constitute unenforceable
penalties. See South Suburban Hous. Ctr. v.
Berry, 186 F.3d 851, 856 (7th Cir. 1999).
Having established these preliminary points, we
now move to the merits of the penalty clause
argument. In interpreting contract provisions
that specify damages, Illinois law draws a
distinction between liquidated damages, which are
enforceable, and penalties, which are not. See
Lake River Corp. v. Carborundum Co., 769 F.2d
1284, 1289 (7th Cir. 1985). A clause is a
liquidated damages provision if: (1) the actual
damages from a breach are difficult to measure at
the time the contract was made; and (2) the
specified amount of damages is reasonable in
light of the anticipated or actual loss caused by
the breach. See American Nat’l Bank & Trust Co.
of Chicago v. Regional Transp. Auth., 125 F.3d
420, 440 (7th Cir. 1997); Lake River, 769 F.2d at
1289-90. In addition, when the sole purpose of
the clause is to secure performance of the
contract, the provision is an unenforceable
penalty. See American Nat’l Bank & Trust, 125
F.3d at 440; MedPlus Neck & Back Pain Ctr., S.C.
v. Noffsinger, 726 N.E.2d 687, 693 (Ill. App.
2000). If the amount of damages is invariant to
the gravity of the breach, the clause is probably
not a reasonable attempt to estimate actual
damages and thus is likely a penalty. See Raffel
v. Medallion Kitchens of Minn., Inc., 139 F.3d
1142, 1146 (7th Cir. 1998); Lake River, 769 F.2d
at 1290. Whether a provision is a penalty clause
is an issue of law that we review de novo. See
American Nat’l Bank & Trust, 125 F.3d at 439.
Given these legal principles, the provision of
the parties’ agreed order requiring the
defendants to pay an additional $150,000 if the
installments are not paid in a timely fashion is
an unenforceable penalty clause. Absent
exceptional circumstances, actual damages caused
by monetary payments being late are not difficult
to measure because interest rates can be used to
estimate the time value of money. See Lawyers
Title Ins. Corp. v. Dearborn Title Corp., 118
F.3d 1157, 1161 (7th Cir. 1997); United Order of
Am. Bricklayers & Stone Masons Union No. 21 v.
Thorleif Larsen & Son, Inc., 519 F.2d 331, 335
(7th Cir. 1975). The interest that would have
accrued on the late payments of the defendants is
minimal, probably less than one hundred dollars.
The amount of $150,000 is unreasonable and
excessive compared to the actual damages as
estimated by using interest rates. The amount of
damages under the agreed order also is
insensitive to the magnitude of the defendants’
breach. Regardless of whether the defendants were
a day late in making the last payment or had
refused to perform at all, they would have been
required to pay $150,000 to the plaintiffs.
Finally, the extra $150,000 in damages appears to
have no purpose other than ensuring that the
defendants made the installment payments on time.
Each factor considered by the Illinois courts
points to the conclusion that the provision in
the agreed order is a penalty./3
The plaintiffs’ principal argument is that
requiring the defendants to pay a total of
$400,000 adequately measures the damages caused
to the plaintiffs because of the defendants’
breach of the timeliness requirement of the
agreed order. They base this contention on the
district court’s findings in its June 3, 1997
order that the defendants owed at least
$381,466.26 and the possibility that the
defendants could have been liable for as much as
$565,345.26. The plaintiffs’ argument is
unpersuasive. The amount of $400,000 might have
been a reasonable estimate of the damages caused
by the alleged breach of the partnership
agreement, though this is neither certain/4 nor
pertinent. The issue before this court is not
what remedy would adequately compensate the
plaintiffs for the alleged breach of the
partnership agreement, but rather what remedy is
reasonable for the breach of the agreed order.
This latter breach, the only relevant one for
purposes of this opinion, was caused by the
tardiness of some of the defendants’ installment
payments. For the reasons explained above,
requiring the defendants to pay an additional
$150,000 is not a reasonable estimate of the
damages caused by these late payments.
The plaintiffs also argue that courts should
respect contracts between two sophisticated
parties and not reform such agreements so as to
give one party a bargain to which the other did
not agree. This claim amounts to a generalized
assertion that contract provisions between
commercially experienced parties should never
constitute penalty clauses because the parties
are of roughly equal bargaining strength. While
we have noted similar criticisms in this
circuit’s opinions discussing Illinois penalty
clause jurisprudence, see Lawyers Title, 118 F.3d
at 1160-61, Lake River, 769 F.2d at 1288-90,
Illinois continues to invalidate damages
provisions in contracts that fail the test
outlined above even if both parties are
economically sophisticated, see, e.g., Telenois,
Inc. v. Village of Schaumburg, 628 N.E.2d 581,
584-85 (Ill. App. 1993); Grossinger Motorcorp,
Inc. v. American Nat’l Bank & Trust Co., 607
N.E.2d 1337, 1345-46 (Ill. App. 1992). The
plaintiffs’ argument would prove too much if
accepted, because then no damages clause between
commercially experienced parties could be
considered a penalty, which clearly contradicts
actual Illinois law. Since, as aforementioned, we
apply Illinois law in this case, we must reject
the plaintiffs’ argument.
III. Conclusion
Because the damages clause is an unenforceable
penalty under Illinois law, the plaintiffs are
entitled only to the actual damages caused by the
defendants’ late payments, as measured by an
appropriate interest rate. For the reasons stated
herein, we Reverse and Remand for further proceedings
consistent with this opinion.
/1 The parties who are the defendants in the instant
dispute are La-Van Hawkins, Hawkins One, Inc.,
Hawkins Two, Inc., Hawkins Four, Inc., Hawkins
Five, Inc., Hawkins Eight, Inc., The La-Van
Hawkins Group, Inc., Windy City Construction,
Inc., Inner City Foods Company, and La-Van
Hawkins & Assoc. of Chicago, Inc. At least two of
the entities included in this group but who were
not originally defendants, namely, Inner City
Foods Company and La-Van Hawkins & Assoc. of
Chicago, Inc., are incorporated and have their
principal places of business in Illinois, and
thus are not diverse from the plaintiffs.
However, since the parties were completely
diverse when the action was commenced and these
two entities are not indispensable parties, their
subsequent addition does not deprive this court
of jurisdiction. See Freeport-McMoRan, Inc. v. K
N Energy, Inc., 498 U.S. 426 (1991).
/2 Claims raised for the first time at oral argument
are normally considered waived. See Berens v.
Ludwig, 160 F.3d 1144, 1148 (7th Cir. 1998).
/3 Because we accept the defendants’ penalty clause
argument, we need not address their contentions
regarding waiver.
/4 Despite the district court’s finding that their
claims were worth at least $381,466.26, the
plaintiffs quite possibly could have netted much
less than $400,000, or even $250,000, if they had
continued to litigate. This course would have
required the plaintiffs to expend further
resources on preparing and conducting a jury
trial and would have also exposed them to the
possibility of being found liable on the
defendants’ counterclaim. If these expenses were
sufficiently large, a reasonable estimate of the
expected value of the plaintiffs’ suit on the
date that they settled could have been $250,000
or less.
EVANS, Circuit Judge, concurring. I can’t agree
that the court-approved settlement order, which
increased Hawkins’ obligation to $400,000 if he
failed to make timely payments, is an
unenforceable penalty clause. In fact, it seems
to me that this sort of carrot-and-stick
settlement agreement, blessed by a court in an
order, is fairly routine. Surely, Checkers and
Hawkins could have agreed to the entry of a
judgment for $400,000, dischargeable as fully
satisfied upon Hawkins paying $250,000 over 10
months. The court order here, in substance, isn’t
any different. It is wrong, I submit, to
characterize this agreement as one involving
"damages." It’s not. It involves an alternative
entitlement if certain conditions are not met.
And there is nothing wrong with that, especially
here where we are dealing with big boys who ought
to be able to freely agree on any mechanism for
resolving what the court correctly describes as
complicated and "lengthy commercial litigation."
But that said, I join the court’s opinion
because I think Checkers, by waiting to spring
its $150,000 kicker until after it got all its
money, waived its right to insist on strict
compliance with the order’s timely payment
provisions. So the court, in my view, is correct
in rejecting Checkers’ claim (except for a
pittance of interest), although I would do so for
a different reason.