Guliano v. Cleo ( 1999 )

IN THE SUPREME COURT OF TENNESSEE
AT JACKSON FILED
June 28, 1999
Cecil Crowson, Jr.
ANTHONY P. GUILIANO ) Appellate Court Clerk
) FOR PUBLICATION
Plaintiff/Appellant )
) FILED: June 28, 1999
v. )
) SHELBY CIRCUIT
CLEO, INC. )
) Hon. James E. Swearengen
Defendant/Appellee )
) 02S01-9801-CV-00002
)
For the Petitioner: For the Respondent:
Frank L. Watson James H. Stock, Jr.,
Waring Cox, P.L.C. Christopher E. Moore
Memphis, Tennessee Weintraub, Stock, Bennett,
Grisham & Underwood, P.C.
Memphis, Tennessee
OPINION
Court of Appeals Reversed; Barker, J.
Trial Court Affirmed
OPINION
We granted this appeal to address the recovery of liquidated damages where a
plaintiff/employee alleges that he has been constructively terminated from his
employment. The trial court in this case granted summary judgment in favor of the
appellant, Anthony P. Guiliano, based upon a finding that he had been constructively
terminated from his employment and that he was entitled to recover the remainder of
his salary under Paragraph 9 of his employment contract.1 The Court of Appeals
agreed that the appellant had been constructively terminated from his employment,
but concluded that he was not entitled to any recovery. The intermediate court held
that Paragraph 9 of the contract was a liquidated damages provision that imposed a
penalty on the appellee, Cleo, Inc., (Cleo).
Both parties request this Court to determine whether Paragraph 9 of the
employment contract contemplates the payment of severance pay or liquidated
damages. For the reasons that follow, we conclude that the sums payable pursuant to
Paragraph 9 are liquidated damages in the event that Cleo terminated appellant’s
employment without cause, effectively breaching the contract.
We affirm the trial court’s grant of summary judgment for the appellant on the
issue of constructive termination. In addition, because we find that the liquidated
damages provision was a reasonable estimation of employee damages at the time the
parties entered into the contract, we conclude that the appellant is entitled to recover
the full amount stipulated in that provision. The judgment of the Court of Appeals is
reversed, and the trial court’s grant of summary judgment for the appellant is affirmed.
1
The trial court awarded $90,125 in back salary plus $14,296.54 in prejudgment interest, for a
total award of $104,421.54. The record is unclear whether the trial court treated that recovery as
severa nce pa y or liquidated d ama ges.
2
BACKGROUND
The essential facts in this case are undisputed. The appellant had been
employed as a director of marketing at Cleo2 for approximately one year when he
entered into a written employment contract with the company. The contract was in the
form of a letter sent by Michael Pietrangelo who was then the President and Chief
Executive Officer of Cleo. The letter agreement stated in pertinent part:
Cleo Inc. and I are very pleased that you have agreed to serve as Vice
President, Marketing of Cleo Inc. (the “Company”), a wholly owned
subsidiary of Gibson Greetings, Inc. As Vice President, Marketing you
will report to the President, and perform those functions currently
assigned, which functions and responsibilities can be changed at the
discretion of the Company. The following terms and conditions will
govern your service to the Company:
1. You will serve the Company on a full-time basis as a senior
executive employee, and the company will employ you as such, for a
period of three years commencing November 1, 1992 and ending
October 31, 1995 unless you are terminated at an earlier date pursuant
to Paragraphs 6, 7, or 9 of this Agreement. Your annual salary will be
$103, 000, which amount will be reviewed every fifteen months and
which may be adjusted from time to time by the Company throughout the
term of this Agreement in accordance with the Company’s salary
administration program. No later than six months prior to expiration of
the original term, or any renewal term, of this Agreement, it will be
reviewed by the Company for the purpose of deciding whether or not it
will be renewed upon its expiration. You will be notified of a decision not
to renew. If you are not notified of a decision not to renew, the
Agreement will automatically renew from year to year.
....
6. In the event you are unable to perform your duties hereunder due
to illness or other incapacity, which incapacity continues for more than
six consecutive or nonconsecutive months in any twelve-month period,
the Company shall have the right, on not less than 30 days written notice
to you, to terminate this Agreement. . . .
7. In the event you voluntarily terminate your employment during the
term of this Agreement, or if the Company terminates this Agreement
and your employment for cause, your right to all compensation
hereunder shall cease as of the date of termination. As used in this
Agreement, “cause” shall mean dishonesty, gross negligence, or willful
misconduct in the performance of your duties or a willful or material
2
At all times relevant to th is case, C leo was a wholly owne d subs idiary of Gibs on Gre etings, Inc .
3
breach of this Agreement. Termination of employment shall terminate
this Agreement with the exception of the provisions of Paragraphs 8, 9,
10, and 12.
8. Also in the event you voluntarily terminate your employment
hereunder, or in the event the Company terminates this Agreement and
your employment for cause, you agree that for a period of two years
after such termination, you will not compete, directly or indirectly, with
the Company or with any division, subsidiary, or affiliate of the Company
or participate as a director, officer, employee, consultant, advisor,
partner, or joint venturer in any business engaged in the manufacture or
sale of greeting cards, gift wrap, or other products produced by the
Company, or any division, subsidiary, or affiliate of the Company, without
the Company’s prior written consent.
9. In the event the Company terminates this Agreement and your
employment without cause, you shall continue to be paid your then
current salary from the date of termination through October 31, 1995.
In 1994, Cleo experienced several personnel changes in its upper
management. Jack Rohrbach replaced Mr. Pietrangelo as the company’s President
and Chief Executive Officer and Marc English was later hired as the Senior Vice
President of Marketing and “Creative.” Mr. Rohrbach stated in his deposition that he
began observing the appellant’s work performance when he took over as the company
president. Based upon his observations, he opined that the appellant had a poor work
relationship with his peers and subordinates and that the appellant was not leading the
marketing department in a direction best suited for the company. Mr. Rohrbach stated
that he hired Mr. English as the new marketing Vice President because Mr. English
had more industry experience and a successful track record.
In the Fall of 1994, the appellant received a series of letters from Mr. Rohrbach
and Mr. English that diminished his employment responsibilities at Cleo. The first
letter, dated September 13, 1994, informed the appellant that his employment contract
would not be renewed after its expiration on October 31, 1995. Approximately two
weeks later, the appellant received a second letter signed by Mr. Rohrbach that stated
in pertinent part:
4
Effective today and until October 31, 1995, you are relieved of your
duties as Vice President Marketing of Cleo Inc. and shall be responsible
for such assignments as may be given to you by the President of the
Company. During this period, you will remain an employee of the
Company and the Company will continue to honor its obligations to you
under your employment agreement.
However, you are specifically advised that you shall have no authority to
bind, represent or speak for the Company in any manner except as may
be stated in writing by the President of the Company.
For all future assignments, you shall be based out of your home.
Should you accept other employment prior to October 31, 1995, all
benefits under your employment agreement shall immediately cease.
Also, please take note of the confidentiality and non-compete provisions
of your employment agreement.
We will be in touch when an appropriate assignment becomes available.
In the meantime, should you have any questions or comments, please
do not hesitate to contact me.
In November, 1994, the appellant received two additional letters from Cleo
informing him that he was no longer authorized to use company credit cards and that
he was to return the company cards in his possession. In addition, he was informed
that Cleo would no longer answer a telephone line for him. All telephone calls for the
appellant were to be screened for personal or business, with the personal calls being
directed to appellant’s home. Cleo allowed the appellant to retrieve the personal
telephone numbers from his office rolodex, but all business numbers were kept
exclusively by Cleo as company property.
Following the letter of September 28, 1994, the appellant stayed at his home
for three months without receiving a work assignment from Cleo. During that time, Mr.
English moved into appellant’s old office and assumed the marketing responsibilities
previously handled by the appellant.3 On December 12, 1994, the appellant accepted
new employment at Wang’s International, Inc. with a starting salary of $110,000 per
3
Mr. R ohrb ach state d in his depo sition that M r. Eng lish to ok o n oth er res pon sibilitie s at C leo in
addition to th ose pre viously han dled by the a ppellant.
5
year. Cleo kept the appellant on the company payroll at $103,000 per year until he
began his new employment.
The appellant filed suit against Cleo on January 26, 1995, claiming that the
company had constructively terminated his employment without cause and that he
was entitled to the remainder of his salary under Paragraph 9 of the employment
contract. Cleo responded that its treatment of the appellant did not constitute a
termination of his employment, but that even if it did, the provision in Paragraph 9 was
an unenforceable penalty. Both parties filed motions for summary judgment. After a
hearing, the trial court granted summary judgment to the appellant, awarding him
$90,125 in salary remaining under his employment contract plus $14,296.54 in
prejudgment interest.
On appeal by Cleo, the Court of Appeals affirmed the trial court’s conclusion
that the appellant was constructively terminated from his employment, but reversed
the award of damages. The intermediate court interpreted Paragraph 9 of the
employment contract as a provision for liquidated damages because it called “for
payment of a sum certain in the event of a certain occasion.” Finding no evidence in
the record of actual damages suffered by appellant, the court concluded that
enforcement of the liquidated damages provision would impose an unlawful penalty
against Cleo.
The appellant requests this Court to reverse the Court of Appeals and to
reinstate the judgment of the trial court. His contention in this appeal is that Cleo
constructively terminated his employment when it removed his title of Vice President
of Marketing and sent him home for three months without any further assignments.
However, in contrast to his argument in the courts below, the appellant now claims
that Cleo had a right to terminate his employment, as it did in this case, without
6
breaching the contract. He contends that, regardless of the issue of breach, he is
entitled to recover severance pay under Paragraph 9 of the employment contract.
STANDARD OF REVIEW
The standards governing an appellate court’s review of a motion for summary
judgment are well settled. Summary judgment is appropriate only where the moving
party demonstrates that there are no genuine issues of material fact and that he or
she is entitled to judgment as a matter of law. Byrd v. Hall, 847 S.W.2d 208, 210
(Tenn. 1993); Tenn. R. Civ. P. 56.03. We review the summary judgment motion as a
question of law in which our inquiry is de novo without a presumption of correctness.
Finister v. Humboldt Gen. Hosp., Inc., 970 S.W.2d 435, 437 (Tenn. 1998); Robinson v.
Omer, 952 S.W.2d 423, 426 (Tenn. 1997). We must view the evidence and all
reasonable inferences in the light most favorable to the nonmoving party. Byrd, 847
S.W.2d at 210-11. If both the facts and conclusions to be drawn therefrom permit a
reasonable person to reach only one conclusion, then summary judgment is
appropriate. Robinson, 952 S.W.2d at 426; Bains v. Wells, 936 S.W.2d 618, 622
(Tenn. 1997).
DISCUSSION
I.
We shall first address whether summary judgment was appropriate on the
question of constructive termination. Initially, we note that the issue of constructive
termination in this case is distinguishable from cases where an at-will employee claims
constructive discharge based upon a hostile work environment, discrimination, or
7
some non-feasance on the part of the employer. See Phillips v. Interstate Hotels
Corp., 974 S.W.2d 680 (Tenn. 1998); Campbell v. Florida Steel Corp., 919 S.W.2d 26(Tenn. 1996). The appellant contends that Cleo removed his job title and all work
responsibilities, effectively terminating his employment, without officially or formally
ending the employment agreement. We view this issue strictly as one of breach of
contract and conclude that the evidence clearly establishes that Cleo effectively
terminated appellant’s employment without cause, thereby breaching the contract.
Both the appellant and Cleo have agreed on the facts leading up to appellant’s
change of employment. Cleo contends, however, that it had a right to alter the
appellant’s work responsibilities under the employment contract, as it did in this case,
without causing a termination. In support of that contention, Cleo relies on evidence
that it allowed the appellant to stay on the company payroll as a senior executive
employee until he obtained new employment.
The resolution of this dispute centers on the construction of the employment
contract. Cleo refers to that portion of the contract which states:
Cleo Inc. and I are very pleased that you have agreed to serve as Vice
President, Marketing of Cleo Inc. ... As Vice President, Marketing you
will report to the President, and perform those functions currently
assigned, which functions and responsibilities can be changed at the
discretion of the Company. The following terms and conditions will
govern your service to the Company:
1. You will serve the Company on a full-time basis as a senior executive
employee, and the Company will employ you as such, for a period of
three years. . . .
The appellant relies on the same contractual language to argue that he was employed
as the Vice President of Marketing for the company. According to appellant, once
Cleo removed his title and work responsibilities, it effectively ended his employment.
8
The interpretation of a contract is a matter of law that requires a de novo review
on appeal. See Hamblen County v. City of Morristown, 656 S.W.2d 331, 335-336
(Tenn. 1983). When resolving disputes concerning contract interpretation, our task is
to ascertain the intention of the parties based upon the usual, natural, and ordinary
meaning of the contractual language. Id. at 333-34; Bob Pearsall Motors, Inc. v.
Regal Chrysler-Plymouth, Inc., 521 S.W.2d 578, 580 (Tenn. 1975). All provisions in
the contract should be construed in harmony with each other, if possible, to promote
consistency and to avoid repugnancy between the various provisions of a single
contract. Rainey v. Stansell, 836 S.W.2d 117, 118-19 (Tenn. App. 1992), perm. app.
denied (Tenn. 1992).
In this case, the contract refers to appellant’s position of employment in two
separate provisions. The opening provision states that he will “serve as Vice
President of Marketing for Cleo, Inc.,” reporting to the company president and
conducting work functions that were currently assigned. The subsequent provision
under Paragraph 1 describes his position as a full-time senior executive employee.
We read those provisions together to mean that as Vice President of Marketing, the
appellant was to be a full-time senior executive employee in the company. 4 Cleo
promoted the appellant to that position with the condition that it could change his job
functions and responsibilities during the course of the three-year contract. Those
changes may have included altering his official job title. However, Cleo was
contractually obligated to maintain appellant’s employment as a full-time senior
4
The Court of Appeals determined that the appellant was employed exclusively as the Vice
Pres ident of M arke ting b ase d upo n the open ing pr ovisio n of th e em ploym ent c ontra ct. Th e cou rt held
that to the e xtent the s ubseq uent pro visions de scribed the appe llant as a se nior exec utive em ployee,
those latter provisions were unenforceable as being in conflict with the preceding “Vice President of
Marketing” provision. We hold to the contrary that the provisions can be read congruently without having
to redac t any portion o f the con tract.
9
executive employee unless there was a cause for termination.5 Cleo’s contractual
right to change the appellant’s work duties did not include the right to remove all of his
duties.
Cleo contends that it fulfilled its contractual obligation by keeping the appellant
on the company payroll at his then current salary, even though it altered and
effectively ended his work responsibilities. Cleo relies on the Court of Appeal’s
decision in Canady v. Meharry Med. College, 811 S.W.2d 902 (Tenn. App. 1991),
perm. app. denied (Tenn. 1991). In Canady, the defendant/employer restricted the
plaintiff’s work duties and decided not to renew his employment contract as a hospital
resident physician after the plaintiff received unsatisfactory job-performance ratings.
Id. at 904. The court concluded, in part, that the restriction of plaintiff’s work duties did
not constitute a breach of the contract because the contract contained no express or
implied assurance that the plaintiff would be given continuous, uninterrupted work
assignments. Id. at 906.
The circumstances in Canady are clearly distinguishable from the appellant’s
case. Here, we are not dealing exclusively with a change or restriction of appellant’s
work responsibilities. The facts are undisputed that Cleo not only demoted the
appellant from his position as Vice President of Marketing, but also ordered him to
stay at his home and wait for any future assignments. During the three months that
the appellant stayed at home, he received no work assignments and apparently did
not perform any functions on behalf of the company. In addition, Cleo reclaimed
appellant’s company credit cards and informed him that the company would no longer
5
As previously mentioned, “cause” was defined in the contract as “dishonesty, gross negligence,
or willful mis condu ct in the per form ance o f work d uties or a w illful or mate rial breach of [the em ployme nt]
Agreement.” Cleo also had a right to terminate the contract under certain conditions of illness or
incapac ity as defined in Parag raph 6 o f the con tract.
10
answer telephone calls for him. All business contacts for Cleo and authority to act on
behalf of the company were taken away from the appellant.
The undisputed facts in this case support the lower courts’ holding that the
appellant was constructively terminated from his employment. Moreover, Cleo has not
shown cause to justify the termination. We, therefore, conclude that summary
judgment for the appellant was appropriate on that issue.
II.
We shall next address whether Paragraph 9 of the employment contract
provides for severance pay or liquidated damages. The appellant contends that
Paragraph 9 contemplates severance pay because its payment is not specifically
conditioned upon a breach of contract. Cleo argues to the contrary that the sums
under Paragraph 9 are liquidated damages because that paragraph calls for the
payment of a set amount in the event of a certain occasion. Cleo contends, however,
that no matter what label is given to the provision, it is unenforceable because the
appellant suffered no actual monetary damages.
The Court of Appeals interpreted Paragraph 9 of the employment contract as a
liquidated damages provision because it contemplates the “payment of a sum certain
in the event of a certain occasion.” We agree that Paragraph 9 provides for liquidated
damages, not severance pay. However, our interpretation of Paragraph 9 is based
upon the specific contract language that recovery is due in the event that Cleo
“terminates this agreement and [appellant’s] employment without cause,” resulting in a
breach of the contract.
11
The distinction between liquidated damages and severance pay is important in
this case. If Paragraph 9 provides for liquidated damages, then recovery is
conditioned upon a showing that Cleo breached the contract and that the amount of
recovery was a reasonable estimation of damages. However, if the provision calls for
severance pay, then recovery by the appellant is absolute in the event of his
termination, regardless of whether Cleo breached the contract or whether the amount
was a reasonable damage assessment.
The term “liquidated damages” is defined by case law as a “sum stipulated and
agreed upon by the parties at the time they enter their contract, to be paid to
compensate for injuries should a breach occur.” V.L. Nicholson Co. v. Transcon Inv. &
Fin. Ltd., Inc., 595 S.W.2d 474, 484 (Tenn. 1980); Kimbrough & Co. v. Schmitt, 939
S.W.2d 105, 108 (Tenn. App. 1996), perm. app. denied (Tenn. 1996). The stipulated
amount represents an estimate of potential damages in the event of a contractual
breach where damages are likely to be uncertain and not easily proven. V.L.
Nicholson, 595 S.W.2d at 484.
In contrast, the recovery of severance pay is not conditioned upon a breach of
contract or a reasonable estimation of damages. Generally, severance pay is a form
of compensation paid by an employer to an employee at a time when the employment
relationship is terminated through no fault of the employee. Black’s Law Dictionary
1374 (6th ed. 1990). The reason for severance pay is to offset the employee’s
monetary losses attributable to the dismissal from employment6 and to recompense
the employee for any period of time when he or she is out of work. Bradwell v. GAF
Corp., 954 F.2d 798, 800 (2nd Cir. 1992); 27 Am. Jur.2d Employment Relationship §
70 (1996). The amount of payment is generally based upon the types of services and
6
Those losses may include seniority rights, pension recovery, and re-training costs or other
burden s asso ciated with o btaining ne w em ployme nt.
12
the number of service years performed by the employee on behalf of the employer.
See Balding v. Tennessee Dep’t of Employment Sec., 212 Tenn. 517, 370 S.W.2d
546, 548 (1963).
With these principles in mind, we focus on the language in Paragraph 9 to
determine whether liquidated damages or severance pay was contemplated.
Paragraph 9 provides that if Cleo terminates the contract and appellant’s employment
without cause, the appellant shall continue to receive his then current salary from the
date of termination until October 31, 1995, the contract expiration date. Paragraph 9
does not state that sums payable are based upon an estimation of damages in the
event of a breach of contract. However, it is clear that the provision affords the
appellant a set amount of compensation in the event that Cleo terminates the
agreement and appellant’s employment, without cause, before the end of the
contract.7 Relying on the plain meaning of the language in Paragraph 9, we conclude
that recovery therein is conditioned upon Cleo’s breach of contract.
A contractual provision need not explicitly include the term “liquidated
damages” to constitute a liquidated damages provision. In cases as here, where a
provision entitles one party to a stipulated recovery following an event that constitutes
a breach of contract, courts must look to the substance of the provision and the
intentions of the parties to determine whether the provision calls for liquidated
damages. If the parties agree in the contract on the amount of damages to be
recovered for compensation, upon the occurrence of a particular defaulting event,
7
The appellant argues, in part, that the dollar amount established in Paragraph 9 cannot be
construed as liquidated dam ages because it is not sufficiently definite to constitute a “sum certain.” We
afford n o me rit to this conte ntion. Und er Ten nesse e law, a co ntractua l provision d oes no t have to
specify a s et dollar am ount to co nstitute liquida ted dam ages. See Vanderbilt Univ. v. Dinardo, 974 F.
Supp. 6 38, 640 ( M. D. T enn. 199 7) (applying T ennes see law) , rev ’d in part, __ F.3d __, 1999 WL
211871 (6th Cir. Apr. 14, 1999) (upholding the liquidated damages provision, but remanding for trial on a
contrac t addend um) ; Harmo n v. Eggers, 699 S.W .2d 159, 1 60 (Te nn. Ct. Ap p. 1985) , perm. app. denied
(Tenn . 1985).
13
then the damages are liquidated unless the contract states otherwise. See V.L.
Nicholson, 595 S.W.2d at 484.
The language in Paragraph 9 reflects the parties’ intentions to compensate the
appellant with a set monetary amount in the event that Cleo terminated the contract
and the employment relationship without cause, before the end of the three-year term.
Having further determined that the termination in this case was a breach of contract,
we interpret Paragraph 9 as contemplating the payment of liquidated damages.
III.
The remaining question is whether the appellant may recover any or all of the
damages set forth in Paragraph 9. Under that paragraph, the sum payable is the
remainder of appellant’s then current salary from the date of termination until the end
of the contract term on October 31, 1995. The appellant’s salary as of December
1994, was $103,000. Based upon that amount and the formula provided in Paragraph
9, the trial court determined that the remainder of salary owed under the three-year
contract was $90,125.8
Cleo does not dispute the calculation of damages in this case, but instead
contends that the $90,125 amount plus prejudgment interest is grossly disproportional
to any actual damages suffered by the appellant. Since the appellant obtained new
employment on December 12, 1994, with an annual salary of $110,000, Cleo argues
that appellant’s recovery of liquidated damages under Paragraph 9 would constitute
an unlawful penalty.
8
The record does not reflect the exact date found by the trial court as the date when appellant
was terminated from his employment. However, based upon the $90,125 amount, it is apparent that the
trial court trea ted Dec emb er 15, 19 94, as the approx imate d ate of term ination. Th at date co incides w ith
a lette r sen t by Cle o to th e app ellant on D ece mb er 22 , 199 4, sta ting th at the appe llant h ad be en pa id his
emp loymen t wages through Dece mbe r 15, 199 4.
14
The basis of Cleo’s contention is that if the appellant suffered no actual
damages from the termination of his employment, then his recovery under Paragraph
9 would have no compensatory function, but would instead simply punish Cleo for the
termination. Both parties acknowledge that Tennessee law disfavors the enforcement
of a liquidated damages provision when the provision serves only to penalize the
defaulting party for a breach of contract. See Testerman v. Home Beneficial Life Ins.
Co., 524 S.W.2d 664, 668 (Tenn. App. 1974), perm. app. denied (Tenn. 1975).9
The fundamental purpose of liquidated damages is to provide a means of
compensation in the event of a breach where damages would be indeterminable or
otherwise difficult to prove. V.L. Nicholson, 595 S.W.2d at 484; 22 Am. Jur. 2d
Damages § 683 (1988); Restatement (Second) of Contracts § 356 cmt. (1979). By
stipulating in the contract to the damages that might reasonably arise from a breach,
the parties essentially estimate the amount of potential damages likely to be sustained
by the nonbreaching party. “If the [contract] provision is a reasonable estimate of the
damages that would occur from a breach, then the provision is normally construed as
an enforceable stipulation for liquidated damages.” V.L. Nicholson, 595 S.W.2d at
484 (citing City of Bristol v. Bostwick, 146 Tenn. 205, 240 S.W. 774 (1921); 22 Am.
Jur. Damages § 227 (1965)). However, if the stipulated amount is unreasonable in
relation to those potential or estimated damages, then it will be treated as a penalty.
22 Am. Jur. 2d Damages § 686 (1988); Restatement (Second) of Contracts § 356
(1979).
Although most jurisdictions disfavor the enforcement of penalties under
contract law, there is a split in authority on the proper method for determining whether
9
As distinguished from liquidated damages, a penalty is “a sum inserted in a contract, not as the
measure of compensation for its breach, but rather as a punishment for default, or by way of security for
actual damages which may be sustained by reason of nonperformance, and it involves the idea of
punishment.” 22 Am. Jur. 2d Damages § 684 (1 988).
15
a liquidated damages provision constitutes a penalty. One method, commonly
referred to as the “prospective approach,” focuses on the estimation of potential
damages and the circumstances that existed at the time of contract formation.10
Under this approach, the amount of actual damages at the time of breach is of little or
no significance to the recovery of liquidated damages. 22 Am. Jur. 2d Damages § 723
(1988). If the liquidated sum is a reasonable prediction of potential damages and the
damages are indeterminable or difficult to ascertain at the time of contract formation,
then courts following the prospective approach will generally enforce the liquidated
damages provision. See e.g. Gaines v. Jones, 486 F.2d 39, 46 (8th Cir. 1973)
(applying Missouri law); Brazen v. Bell Atl. Corp., 695 A.2d 43, 48 (Del. 1997).
In contrast, a second approach has developed in which courts not only analyze
the estimation of damages at the time of contract formation, but also address whether
the stipulated sum reasonably relates to the amount of actual damages caused by the
breach.11 Under this retrospective approach, the estimation of potential damages and
the difficulty in measuring damages remain integral factors for the courts’ review. See
e.g. Lake Ridge Academy v. Carney, 613 N.E.2d 183, 188-89 (Ohio 1993); Highgate
10
See United States v. Bethlehem Steel Co., 205 U.S. 105, 119, 27 S. Ct. 450, 455, 51 L. Ed. 731(1907); Gaines v. Jones, 486 F.2 d 39, 44- 45 (8th C ir. 1973); United States v. Le Roy Dyal Co., 186 F.2d
460, 462 (3rd Cir. 19 50); Williwaw Lodge v. Locke, 601 P.2d 236, 239 (Alaska 1979); Omo hndro v.
Ottenheimer, 127 S.W .2d 642, 6 45 (Ark . 1939); McC arthy v . Tally , 297 P.2d 981, 986- 87 (C al. 19 56) (in
banc); Roh aue r v. Little , 736 P.2d 403, 410 (Colo 19 87); Hanson Dev. Co. v. East Great Plains Shopping
Ctr., Inc., 485 A.2d 1296, 13 00 (Co nn. 1985 ); Brazen v. Bell Atl. Corp., 695 A.2d 43, 48 (Del. 1997);
Lefemine v. Baron, 573 So .2d 326, 3 28 (Fla. 19 91); Fickling & Walker Co. v. Gibbens Constr. Co., 376
S.E.2d 6 55, 659- 60 (Ga . 1989); Anne Arundel County v. Norair Engr. Corp., 341 A.2d 287, 294 (Md.
1975); Frank v. Jansen, 226 N.W .2d 739 ( Minn. 19 75); Board of Trustees of State Inst. of Higher
Learning v. Johnson, 507 So .2d 887, 8 90 (Mis s. 1987 ); Knu tton v . Cof ield, 160 S.E.2d 29, 35-36 (N.C.
1968); Fisher v. Schmeling, 520 N.W .2d 820, 8 22 (N.D . 1994); Safari, Inc. v. Verdoorn, 446 N.W.2d 44,
46 (S.D . 1989); Woodhaven Apartments v. Washington, 942 P.2d 918, 921 (Utah 19 97).
11
See Thanksg iving Tower Partners v. Anros Th anksgiving Partners , 64 F.3d 227, 232 (5th Cir.
1995) (a pplying Te xas law ); Southpace Properties, Inc. v. Acquisition Group, 5 F.3d 500, 505 (11th Cir.
1993) (a pplying Alab ama law); Kelly v. Marx, 694 N.E .2d 869, 8 71-72 (M ass. Ap p. Ct. 199 8); Hawkins v.
Foster, 897 S.W .2d 80, 85 (Mo. C t. App. 199 5); Browning Ferris Indus. of Nebraska, Inc. v. Eating
Establishment 90th & Fort, Inc., 575 N.W .2d 885, 8 88-89 (N eb. Ct. Ap p. 1998) ; Shallow Brook Asso c. v.
Dube, 599 A.2d 132, 137 (N.H. 19 91); Boyle v. Petrie Stores Corp., 518 N.Y.S.2d 854, 861 (N.Y. Sup.
Ct. 1985 ), supp. decision (May 29, 1 987); Lake Ridge Academy v. Carney, 613 N.E.2d 18 3, 18 9 (O hio
1993); High gate Ass oc., L TD . v. Me rryfield , 597 A.2d 1280, 1282 (Vt. 1991) (reviewing the totality of the
circum stance s); W hee ling C linic v. V an P elt, 453 S.E .2d 603, 6 09 (W . Va. 1994 ); Wassenaar v. Panos,
331 N.W.2d 357, 361-62 (Wis. 1983) (reviewing the totality of the circumstances, including actual
dam ages).
16
Assoc., LTD. v. Merryfield, 597 A.2d 1280, 1282 (Vt. 1991). However, as part of that
review, the actual damages at the time of breach are also relevant in determining
whether the original estimation of damages was reasonable. See Kelly v. Marx, 694
N.E.2d 869, 871 (Mass. Ct. App. 1998); Wassenaar v. Panos, 331 N.W.2d 357, 361-
62 (Wis. 1983). If the liquidated sum greatly exceeds the amount of actual damages,
then courts following this latter approach will treat the estimated sum as a penalty and
will limit recovery to the actual damages. Kelly, 694 N.E.2d at 871; Shallow Brook
Assoc. v. Dube, 599 A.2d 132, 137 (N.H. 1991).
While this Court has not previously addressed the issue, we note that the Court
of Appeals has followed the latter approach using both a prospective review of the
circumstances at the time of contract formation and a review of the actual damages at
the time of breach. See Kimbrough & Co., 939 S.W.2d at 108; Beasley v. Horrell, 864
S.W.2d 45, 50 (Tenn. App. 1993), perm. app. denied (Tenn. 1993); Kendrick v.
Alexander, 844 S.W.2d 187, 190-91 (Tenn. App. 1992), perm. app. denied (Tenn.
S1992) (following a prospective approach for assessing the reasonableness of a
liquidated damages provision); Harmon, 699 S.W.2d at 163; Eller Bros., Inc. v. Home
Fed. Sav. & Loan Assoc., 623 S.W.2d 624, 628 (Tenn. App. 1981), perm. app. denied
(Tenn. 1981). After careful consideration, we find that there are inherent problems
with the retrospective analysis and are persuaded that a prospective approach is the
better rule. Therefore, to the extent that the Court of Appeals has adopted a
retrospective approach, as reflected in Eller Bros., Harmon, Beasley, and Kimbrough
& Co., that approach is overruled.
From our review of the law on liquidated damages, we recognize that there are
two important interests at issue: the freedom of parties to bargain for and to agree
upon terms such as liquidated damages and the limitations set by public policy.
Generally, the parties to a contract are free to agree upon liquidated damages and
17
upon other terms that may not seem desirable or pleasant to outside observers. See
Chapman Drug Co. v. Chapman, 207 Tenn. 502, 341 S.W.2d 392, 398 (1960); 22 Am.
Jur. 2d Damages § 686 (1988). In that respect, courts should not interfere in the
contract, but should carry out the intentions of the parties and the terms bargained for
in the contract, unless those terms violate public policy. See McKay v. Louisville &
N.R. Co., 133 Tenn. 590, 182 S.W. 874, 875 (1916) (citing Baltimore & Ohio S.W. Ry.
Co. v. Voight, 176 U.S. 498, 505, 20 S. Ct. 385, 387, 44 L. Ed. 560 (1900)).
Both the prospective and the retrospective approaches allow courts to review
liquidated damages provisions together with the limitations set by public policy.
However, we conclude that the prospective approach is the better rule based upon the
consideration it affords to the intentions of the parties and to the freedom to contract.
When parties agree to a liquidated damages provision, it is generally presumed
that they considered the certainty of liquidated damages to be preferable to the risk of
proving actual damages in the event of a breach. 22 Am. Jur. 2d Damages § 726.
Liquidated damages permit the parties to allocate business and litigation risks and
often serve as part of the contractual bargain. In addition, they lend certainty to the
contractual agreement and allow the parties to resolve defaults and other related
disputes efficiently, when actual damages are impossible or difficult to measure. C.T.
McCormick, Handbook on the Law of Damages § 157 (1935).
The retrospective approach, however, undermines the certainty and other
benefits afforded by liquidated damages. Under that approach, the parties are
allowed to fully litigate actual damages following a breach of contract. If the
nonbreaching party fails to prove actual damages, then he or she is barred from
recovering the liquidated sum originally agreed upon in the contract. We find that it is
18
unfair to require the nonbreaching party to prove actual damages in cases where the
parties agreed in advance to a liquidated damages provision. Such a requirement
ignores the original intentions of the parties and defeats the purposes of stipulating in
advance to potential damages.
We, therefore, adopt a prospective approach for addressing the recovery of
liquidated damages. Under this approach, courts must focus on the intentions of the
parties based upon the language in the contract and the circumstances that existed at
the time of contract formation.12 Those circumstances include: whether the liquidated
sum was a reasonable estimate of potential damages and whether actual damages
were indeterminable or difficult to measure at the time the parties entered into the
contract. See V.L. Nicholson, 595 S.W.2d at 484. If the provision satisfies those
factors and reflects the parties’ intentions to compensate in the event of a breach,
then the provision will be upheld as a reasonable agreement for liquidated damages.
However, if the provision and circumstances indicate that the parties intended merely
to penalize for a breach of contract, then the provision is unenforceable as against
public policy.
IV.
We now turn to the liquidated damages provision in this case. The Court of
Appeals found that the liquidated sum was a reasonable estimation of potential
damages at the time the parties entered into the contract. We agree. Neither the
appellant nor Cleo had certain knowledge, when forming the contract, that the
12
This prospective approach incorporates the cardinal rule of contract interpretation, requiring
courts to ascerta in the intention s of the p arties bas ed upo n the lang uage in th e contra ct. See Bob
Pearsall Motors, Inc., 521 S.W .2d at 580 ; Nunnelly v. Warner Iron Co., 94 Tenn. 282, 29 S.W. 124(1895).
19
appellant would be able to secure other employment in the event that Cleo terminated
his employment without cause. It was within the fair contemplation of the parties that
the appellant might not be able to find a similar professional position at the same
salary and that he might suffer damages that would be difficult to prove, including loss
of professional status, prestige, and advancement opportunities. The language in
Paragraph 9 reflects the parties’ intentions to compensate and to protect the appellant
against those potential losses in the event of a breach by Cleo.
The Court of Appeals, however, went further in addressing whether the
stipulated sum reasonably related to the appellant’s actual damages. Cleo insists that
the intermediate court’s analysis was both proper and fair based upon the fact that the
appellant obtained new employment at a higher salary after the termination. While we
question whether the record is sufficient on the issue of actual damages,13 we
conclude that the extent of actual damages has no bearing on the appellant’s recovery
of liquidated damages under Paragraph 9. The liquidated sum is recoverable based
upon our conclusion that it was reasonable at the time the parties entered into the
contract and that it reflects the parties’ original intentions to compensate for a
termination of employment.
The parties themselves were in the best position to know what considerations
influenced their bargaining at the time they entered into the contract. While “‘[t]he
bargain may be an unfortunate one for the delinquent party, ... it is not the duty of
courts of common law to relieve parties from the consequences of their own
improvidence.’” Watson v. Ingram, 881 P.2d 247, 250 (Wash. 1994) (quoting Dwinel
v. Brown, 54 Me. 468, 470 (1867)). See also McKay, 182 S.W. at 875; Whaley v.
13
The trial court awarded summary judgment to the appellant without making a finding on actual
damages or whether the recovery constituted severance pay or liquidated damages. Nevertheless,
because we hold that actual damages are immaterial in this case, we need not address the sufficiency of
the reco rd in that res pect.
20
Underwood, 922 S.W.2d 110, 112 (Tenn. App. 1995). Accordingly, to the extent the
Court of Appeals based its decision upon a review of actual damages, that decision is
overruled.
CONCLUSION
Based upon the foregoing, we conclude that summary judgment for the
appellant was appropriate on the issue of constructive termination. Moreover,
because Paragraph 9 was a reasonable estimation of damages at the time the parties
entered into the contract, we conclude that the appellant is entitled to recover the full
amount stipulated in that provision. The judgment of the Court of Appeals is reversed
and the trial court’s award of summary judgment for the appellant is reinstated. Costs
of this appeal are taxed to the appellee, Cleo.
______________________________
WILLIAM M. BARKER, JUSTICE
CONCUR:
Anderson, C.J.,
Drowota, Birch, Holder, JJ.
SUPREME COURT, JACKSON
ANTHONY P. GUILIANO )
)
Plaintiff/Appellant ) SHELBY CIRCUIT
) 67428 T.D. Below
v. )
) 02S01-9801-CV-00002
CLEO, INC. )
) Court of Appeals Reversed,
Defendant/Appellee ) Trial Court Affirmed
)
)
JUDGMENT
This case was heard on the record on appeal from the Court of Appeals,
application for permission to appeal having heretofore been granted, with briefs and
argument of counsel; and in consideration thereof, this Court is of the opinion that the
appellant, Anthony P. Guiliano, was terminated from his employment and that the
liquidated damages provision is fully enforceable against the appellee, Cleo, Inc.
In accordance with the opinion filed herein, it is, therefore, ordered and
adjudged that the judgment of the Court of Appeals is reversed and the trial court’s
order granting summary judgment in favor of the appellant is affirmed. The case is
remanded to the Circuit Court of Shelby County for the execution of the judgment and
for the collection of costs accrued below.
Costs of this appeal will be paid by the appellee for which execution shall issue
if necessary.
06/28/99
22