Jay Johnson v. Reed Welch ( 2004 )

IN THE COURT OF APPEALS OF TENNESSEE
AT NASHVILLE
April 9, 2003 Session
JAY JOHNSON, ET AL. v. REED WELCH, ET AL.
Appeal from the Circuit Court for Putnam County
No. 99 N 0330 John J. Maddux, Jr., Judge
No. M2002-00790-COA-R3-CV - Filed February 9, 2004
This appeal involves a business dispute with multiple claims for breach of three separate contracts.
The trial court found Reed Welch and his company, S& S Screw Machine Company, Inc., in breach
in various ways and awarded a total of $1,032,133.15 in damages to Jay and Gail Johnson, both
personally and as the owners of Quality Metal Treating, Inc. We affirm in part and reverse in part
the judgment of the trial court.
Tenn. R. App. P. 3 Appeal as of Right; Judgment of the Circuit Court
Affirmed in part, Reversed in part, and Remanded
PATRICIA J. COTTRELL, J., delivered the opinion of the court, in which BEN H. CANTRELL, P.J., M.S.,
and RUSS HELDMAN , SP . J., joined.
Jay S. Bowen, Timothy L. Warnock, Taylor A. Cates, Nashville, Tennessee, for the appellants, Reed
Welch, Olive Welch, Quality Metal Treating, Inc., and S&S Screw Machine Co., Inc.
S. Roger York, Crossville, Tennessee; William S. Walton, Nashville, Tennessee, for the appellees
Jay Johnson and QMT Quality Metal Treating, Inc.
OPINION
This is a breach of contract action arising from three separate agreements. The first is an
employment agreement between S&S Screw Machine Co., Inc. (“S&S”)1, and Jay Johnson. The
second contract involves the purchase of a heat treating business known as Quality Metal Treating,
Inc. (“QMT”), by Jay Johnson and his wife, Gail Johnson, from Reed Welch and his wife, Olive
1
S&S is a subchapter S corporation, and 100% of its stock is owned by Reed W elch. During the time period
of the transactions at issue, Olive W elch also owned stock in S&S. W hen Mr. and Mrs. W elch divorced, she conveyed
her stock in S&S to Mr. W elch, and he indemnified her from any liability resulting from this litigation.
Welch. The final agreement involves the Johnsons’ lease and subsequent purchase of commercial
property from the Welchs.
I. THE TRANSACTIONS
In April, 1993, Reed Welch hired Jay Johnson to become the general manager of his
business, S&S.2 The company manufactures screw machine parts for industrial tractor trailers and
dump trucks. Mr. Johnson’s new position required him to relocate to Tennessee from Washington
state with his family. The employment agreement provided that S&S would pay part of the
Johnsons’ relocation expenses, and Reed Welch personally guaranteed S&S’s commitment. The
agreement had two provisions entitled “Relocation Expenses” which specifically provided:
Relocation Expenses: Temporary living expenses and transportation will be provided
by S&S Screw Machine Company.
Relocation Expenses: Expenses associated with the sell [sic] and purchase of a home,
moving of household goods and relocating my family will be shared by both me and
S&S Screw Machine Company.
Contemporaneously with the signing of the employment agreement, Mr. Johnson presented
Mr. Welch a list entitled “Anticipated Re-location Expenses” which estimated the expenses to be
approximately $35,000. Following the move, on July 30, 1993, Mr. Johnson provided Mr. Welch
with a letter setting forth a total of $29,986.77 in relocation expenses and requested that S&S pay
its portion. S&S delayed payment for almost nine months and then reimbursed the Johnsons for only
$5,000 of the expenses.
Despite S&S’s failure to promptly reimburse the Johnsons for relocation expenses, in
October, 1993, the Johnsons purchased the on-going business, QMT, from the Welchs for $186,000.
QMT heat treats specialized auto and truck parts such as those produced by S&S.3 In fact, S&S was
QMT’s largest customer, and the QMT furnaces were uniquely suited to heat treat S&S parts.
Approximately 50 to 60 percent of QMT’s revenue was generated by heat treating S&S parts. The
parties executed a sales contract which included the following language:
2
Mr. Johnson testified that he had wanted to relocate to Tennessee from W ashington and had submitted his
resume to Mr. W elch. They spoke over the telephone and eventually reduced their agreement to writing. Mr. Johnson
felt that Mr. W elch’s offer presented a good business opportunity with an annual base salary of $65,000. In addition,
he anticipated that his income would increase approximately $20,000 to $30,000 through the profit sharing and bonus
program.
3
The heat treating business does not require manufacturing or machining of parts. Instead, the heat treating
process involves carburizing, neutral hardening, stress relieving, carbonitriding, annealing and induction heat treating.
Essentially, heat treating is a process by which tools and parts are heated and then cooled to increase their hardness.
2
Buyers [Johnsons] . . . .will have the exclusive rights to heat treat all of the metal
treating process required of all goods manufactured by S&S Screw Machine Co., Inc.
coming under Quality Metal Treatment, Inc.’s capabilities as long as Quality Metal
Treatment, Inc. is competitive in price, quality and delivery. The price specified in
paragraph 6 below is agreed to be ‘competitive’ price. S&S Screw Machine Co., Inc.
agrees it will not decrease its production requiring heat treatment to be supplied by
Buyers except in the ordinary course of business, i.e. loss of business due to
competitiveness in price, quality and delivery.
The provision of the agreement giving QMT the exclusive right to all of S&S’s requirements
for heat treating (also referred to herein as the exclusivity or requirements provision) was crucial to
the Johnsons obtaining financing for the purchase of QMT. Indeed, the pro forma submitted to the
lending institutions specifically identified various parts that were produced by S&S and anticipated
to be heat treated by QMT. Prior to the transaction, Mr. Johnson had requested and Mr. Welch had
provided a list of parts produced by S&S that could be expected to be heat treated by QMT.
Shortly after the deal closed, S&S lost its contract to make three Paccar parts that had been
included in the pro forma and on the list provided by Mr. Welch. The three lost Paccar parts had
accounted for almost 40 % of the revenues QMT had generated from S&S work. Mr. Welch had met
with Paccar’s engineers in Seattle earlier in the year concerning the re-design of the parts S&S made
for Paccar. S&S did not have the capability at the time to make the re-designed parts. Mr. Welch
never disclosed this information to the Johnsons prior to the sale of QMT. As a result, QMT and its
new owners, the Johnsons, lost a substantial portion of its expected revenue from heat treating the
Paccar parts.
When the Johnsons purchased the assets of QMT, they agreed to continue to operate it at its
then current location in Hendersonville until the lease in effect at that location expired in February
of 1997. The Johnsons also agreed to move the business to property owned by the Welchs in
Cookeville after the expiration of the Hendersonville lease so that QMT would be closer to the S&S
plant in Sparta. In furtherance of that mutual plan, on the same day the Johnsons purchased QMT
from the Welchs, they entered into a separate five year Lease and Purchase Option Agreement with
the Welchs for their building and land in Cookeville.
The two agreements stated that the Johnsons would have no liability under the existing lease
for the Hendersonville property, but that QMT would pay the Welchs $1600 per month on the lease
for the Cookeville property during the term of the Hendersonville lease. In other words, Mr. Welch
remained personally liable to the Hendersonville landlord until February, 1997, but the Johnsons
paid the amount of the Hendersonville lease to Mr. Welch as rent on the Cookeville property QMT
would not occupy until February of 1997.
The two documents, the agreement for the purchase of QMT’s assets and the lease with
option to purchase, contained provisions regarding the parties’ responsibilities for the relocation of
QMT. The sales contract provided:
3
Reed Welch agrees to prepare the real property to be leased to Buyer for occupancy
of the heat treating process. This will include but will not be limited to, the
following work:
****
(c) Assist in relocation . . . , installation and start-up of all the office
and industrial assets being purchased hereunder when the previously
mentioned February 17, 1992 lease on the premises [in
Hendersonville] is terminated, or at such time as Quality Metal
Treatment, Inc. ceases its rental payment under that lease. The
relocation, installation and start-up project to be no more than a
period of three (3) months.
Buyers will have the responsibility of making a physical layout as to
where all office and industrial assets being purchased hereunder, are
to be placed in the industrial facility in Cookeville, TN (described
herein) and Lessors will have the responsibility to relocate, install and
start-up all the office and industrial assets being purchased, utilizing
S&S Screw machines, maintenance personnel and equipment.
The lease contained the same provision, with small variation in the language.
Following the QMT sale in October of 1993, Mr. Johnson continued as the general manager
at S&S during the day and worked weekends and some evenings at QMT. In late 1996, shortly
before the expiration of QMT’s Hendersonville lease, the Johnsons exercised their option to
purchase the Welchs’ Cookeville building and land for an additional $275,000.
QMT moved to the property in Cookeville. Subsequently, a dispute arose over whether S&S
had honored its obligations associated with the moving and installation and start-up of QMT’s
equipment. According to the Johnsons, S&S failed to properly set up the equipment and actually
damaged some of the equipment. Edward Newman, a long time S&S employee, admitted that
several of the furnaces and other pieces of QMT equipment were damaged by S&S during the move
from Hendersonville. Mr. Newman further testified that he had never installed such equipment
before. S&S never repaired the damage allegedly done by its employees, and the machinery was not
set up and ready to function on time. As a result of this situation and Mr. Welch’s threats to
terminate the contract if QMT missed any deliveries, Mr. Johnson was forced for nearly six months
to outsource parts for heat treatment to another heat treater until he could complete repairs,
installation and start-up. He claimed he incurred expenses of over $65,000 due to S&S’s failure to
abide by the terms of the relocation assistance provision in both contracts.
In the same month the Cookeville deal closed and Mr. Welch’s obligation on the
Hendersonville lease expired, Mr. Johnson’s employment with S&S was terminated without notice.
Mr. Johnson testified that Mr. Welch fired him. Mr. Welch testified at trial that Mr. Johnson had
“terminated himself” as general manager of S&S due to a conflict of interest, i.e., being manager of
4
S&S and owner of QMT, although that situation had existed with Mr. Welch’s full knowledge and
encouragement since the Johnsons bought QMT in 1993. After Mr. Johnson’s employment at S&S
was terminated, Mr. Welch stated to the Department of Employment Security that Mr. Johnson had
quit. As to these claims by Mr. Welch, the trial court found “[b]asically, none of that was accurate
and none of that was true.” The court found that Mr. Johnson was fired by Mr. Welch in February
of 1997.
Mr. Welch replaced Mr. Johnson as general manager of S&S with his son, Jerald Welch.
When Mr. Johnson was fired, it placed his family in a financial bind due to the outstanding payments
due the Welchs for QMT and the real property. The Johnsons managed by selling their home and
other assets and lived in the plant.
After the relocation of QMT to Cookeville, QMT continued to provide heat treating services
to S&S until that arrangement was terminated by S&S sending all its heat treating business
elsewhere in August of 1999. During the time between the relocation, which coincided more or less
with the termination of Mr. Johnson’s employment with S&S, and the cessation of all business
between the two companies, several events occurred which were discussed at trial.
During this time, the Johnsons became increasingly concerned that Mr. Welch wanted to take
the heat treating process back into his business. Although Mr. Welch denied this, his actions
confirmed the Johnsons’ suspicions. In 1998, Mr. Welch attended an auction in Ohio of heat
treating equipment. According to Kenneth Robertson, a heat treater who attended the auction, Mr.
Welch told him that he was “getting into the heat treating business.” Mr. Welch explained he was
unhappy with his current heat treater. “He was very derogatory with a lot of profanity referring to
his present heat treater.” Mr. Roberston did not recall Mr. Welch complaining about the quality of
the heat treating. James Cooper attended the auction with Mr. Robertson and testified to the same
effect regarding Mr. Welch attending the auction. In addition, Mr. Welch sent his son, Jerald Welch,
to seminars and conventions for heat treaters during late 1998 and the spring of 1999 to investigate
the expense to S&S of purchasing new heat treating equipment and taking the heat treating business
in-house. Jerald Welch testified that S&S was considering bringing the heat treating in-house and
he investigated the advantages and costs of that.
To compound the Johnsons’ financial strain, S&S began to “slow pay” QMT after the move
to Cookeville in 1997. Because QMT was a small business and was dependent upon S&S for a
substantial portion of its revenues, the timely payment of invoices was particularly important. The
sales contract had recognized this fact by requiring invoices to be paid within 7 days for the first
three years and within 30 days thereafter. Tensions between Mr. Johnson and S&S mounted.
In April of 1999, Jerald Welch began secretly outsourcing S & S parts for heat treating to
another heat treater. When Mr. Johnson learned of the outsourcing, he brought the exclusivity
language to the attention of Jerald Welch, who said he was unaware of the contract.
5
In the summer of 1999, a problem arose concerning a shock absorber part. S&S Quality
Assurance Director Lawrence Biss noticed a crack in one of the lots and, consequently, recalled
seven lots for further inspection of each part. A small number of these parts were determined to have
cracks, but the majority were shipped to customers without incident.
After sending off for lab testing of the cracked parts, in July of 1999 Mr. Biss notified QMT
of the cracks and asked for a determination as to the cause of the cracks. S&S’s lab had determined
the cracks were quench cracks, meaning they occurred during the quenching part of the heat treating
process, but did not identify a cause of the cracking. QMT responded promptly that it has inspected
the part and also sent the part to a metallurgist at Metallurgical Technologies to investigate the cause
of the crack. The parties agreed to send the parts to a third party for further testing. Meanwhile,
Metallurgical Technologies concluded that the cracks were most likely caused by poor alloy in the
steel that was used to manufacture the parts or poor design. Mr. Johnson shared this report with
S&S.
Jerald Welch became frustrated with Mr. Johnson for not accepting responsibility for the
quench cracks. On August 26, 1999, he sent Mr. Johnson a strongly worded letter directing QMT
to remove the terms of its limited warranty and limitation of remedies from all its invoices. Jerald
Welch further advised Mr. Johnson in the letter that S&S would no longer accept or pay over such
terms. The terms now objected to were the same terms that had appeared on QMT invoices for
years. At trial, Jerald Welch testified that he had subsequently learned the QMT language was
standard practice within the heat treating industry and that his current heat treater, Carolina
Commercial Heat Treating, uses the same or similar terms.
In response to Jerald Welch’s demand that the limitation terms appearing on the invoices
would no longer be accepted by S&S, Mr. Johnson advised Jerald Welch by letter that S&S had
breached the contract between S&S and QMT with his demand, but QMT would continue to process
S&S purchase orders under the terms stated in the invoices. Other correspondence ensued, and the
trial court found that, “In response to S&S’s decision to seek other heat treaters and refusal to accept
QMT’s invoices, Mr. Johnson told S&S that QMT expected to be paid C.O.D. for its heat treating
work as it was performed.”
On August 31, 1999, Jerald Welch ordered a QMT truck to unload S&S parts headed to QMT
for heat treating, and directed that no other parts be sent to QMT for heat treating. Since that day,
S&S has not sent any heat treating work to QMT and instead has sent all heat treating business to
Carolina Commercial Heat Treating. In addition, S&S refused to pay QMT for heat treating work
already performed, withholding an amount S&S claimed it had expended in dealing with an earlier
rust problem and the cracking problem.
In September, 1999, QMT and the Johnsons filed this lawsuit against S&S and the Welchs
alleging various instances of breach of contract: (1) failure to pay the Johnsons’ personal relocation
expenses; (2) failure to pay QMT expenses incurred in relocating the business to Cookeville; (3)
refusal to pay incurred invoices for heat treating work already performed for S&S by QMT; (4)
6
concealment of pertinent information prior to the sale of QMT; and (5) termination of the business
relationship resulting in substantial loss of revenue for QMT.
Following a three day bench trial, the trial court ruled in favor of the Johnsons and QMT on
all claims.4 The court awarded the Johnsons damages, including prejudgment interest, as follows:
- $30,689.86 for the personal relocation expenses;
- $96,317.43 for expenses related to the QMT relocation;
- $9,036.86 for the unpaid invoices for work performed;
- $821,689.00 for four years of lost profits due to termination of the agreement for
QMT to do all of S&S’s heat treating;
- $74,400.00 as partial rebate of the purchase price the Johnsons paid for QMT based upon
Mr. Welch’s failure to disclose S&S’s need for heat treating would likely decrease because
of the impending loss the Paccar business.
The trial court made extensive (twenty-two pages) findings of fact as well as thorough
conclusions of law. In addition, the trial court awarded attorneys fees to QMT pursuant to the QMT
purchase agreement, and at a subsequent hearing set the attorneys fees at $63,612 and awarded
discretionary costs in the amount of $16,619.35.
II. STANDARD OF REVIEW
The standard of review on appeal is well-settled. We review the trial court's findings de novo,
with a presumption of the correctness of the factual findings of the trial court, unless the evidence
preponderates otherwise. Tenn. R. App. P. 13(d); Bogan v. Bogan, 60 S.W.3d 721, 727 (Tenn.
2001). No such presumption of correctness attaches to the trial court's conclusions of law. Southern
Constructors, Inc. v. Loudon County Bd. of Educ., 58 S.W.3d 706, 710 (Tenn. 2001).
Here, seventeen witnesses testified and various documents were entered into evidence. As
to a number of instances of disputed facts where the testimony of Mr. Welch differed from that of
other witnesses, the trial court made specific findings that Mr. Welch’s statements were not true and
not accurate. In addition to these specific findings on credibility, the court also made general
statements that it was favorably impressed with the credibility of Mr. Johnson and several witnesses
on his behalf. In addition, the court stated, “the Court was not persuaded by the testimony of Reed
Welch, and Jerald Welch, and Lawrence Biss.”
Because trial courts are in a far better position than this court to observe the demeanor of the
witnesses, the weight, faith, and credit to be given witnesses’ testimony lies in the first instance with
the trial court. McCaleb v. Saturn Corp., 910 S.W.2d 412, 415 (Tenn. 1995); Whitaker v. Whitaker,
4
The Johnsons had also alleged S&S wrongfully refused to pay Mr. Johnson a discretionary bonus or allow him
to participate in profit-sharing programs. The trial court ruled against Mr. Johnson on this claim, and that ruling has
not been appealed.
7
957 S.W.2d 834, 837 (Tenn. Ct. App.1997). Consequently, where issues of credibility and weight
of testimony are involved, appellate courts will accord considerable deference to the trial court’s
factual findings. Seals v. England/Corsair Upholstery Mfg. Co., 984 S.W.2d 912, 915 (Tenn. 1999)
(quoting Collins v. Howmet Corp., 970 S.W.2d 941, 943 (Tenn. 1998). Stated another way, “The
credibility accorded by the trier of fact will be given great weight by the appellate court.” Weaver
v. Nelms, 750 S.W.2d 158,160 (Tenn. Ct. App. 1987); see also In re Estate of Walton, 950 S.W.2d
956, 959 (Tenn. 1997); Whitaker, 957 S.W.2d at 837; Doe v. Coffee County Bd. of Educ., 925
S.W.2d 534, 537 (Tenn. Ct. App. 1996).
To the extent the issues raised herein involve interpretation of written agreements, the
question of interpretation of a contract is a question of law. Guiliano v. CLEO, Inc., 995 S.W.2d 88,
95 (Tenn. 1999). Therefore, the trial court’s interpretation of a contractual document is not entitled
to a presumption of correctness on appeal. Id.; Angus v. Western Heritage Ins. Co., 48 S.W.3d 728,
730 (Tenn. Ct. App. 2000). This court must review the document ourselves and make our own
determination regarding its meaning and legal import. Hillsboro Plaza Enters. v. Moon, 860 S.W.2d
45, 47 (Tenn. Ct. App. 1993). Our review is governed by well-settled principles.
“The central tenet of contract construction is that the intent of the contracting parties at the
time of executing the agreement should govern.” Planters Gin Co. v. Fed. Compress & Warehouse
Co., Inc., 78 S.W.3d 885, 890 (Tenn. 2002). The purpose of interpreting a written contract is to
ascertain and give effect to the contracting parties’ intentions, and where the parties have reduced
their agreement to writing, their intentions are reflected in the contract itself. Id.; Frizzell Constr.
Co. v. Gatlinburg, L.L.C., 9 S.W.3d 79, 85 (Tenn. 1999). “The intent of the parties is presumed to
be that specifically expressed in the body of the contract . . . .” Planters Gin Co., 78 S.W.3d at 890.
Therefore, the court’s role in resolving disputes regarding the interpretation of a contract is to
ascertain the intention of the parties based upon the usual, natural, and ordinary meaning of the
language used. Guiliano, 995 S.W.2d at 95; Bob Pearsall Motors, Inc. v. Regal Chrysler-Plymouth
Inc., 521 S.W.2d 578, 580 (Tenn. 1975).
Where the language of the contract is clear and unambiguous, its literal meaning controls the
outcome of contract disputes; but, where a contractual provision is ambiguous, i.e., susceptible to
more than one reasonable interpretation, the parties’ intent cannot be determined by a literal
interpretation of the language. Planters Gin Co., 78 S.W.3d at 890. In that situation, courts must
resort to other rules of construction, and only if ambiguity remains after application of the pertinent
rules does the legal meaning of the contract become a question of fact. Id. However, a strained
construction may not be placed on the language used by the parties to find or create ambiguity where
none exists. Id. at 891.
Thus, courts defer to the contracting process by enforcing written contracts, which establish
the rights and obligations of the parties, according to their plain terms without favoring either
contracting party. Cocke County Bd. of Highway Comm’rs v. Newport Utils. Bd., 690 S.W.2d 231,
237 (Tenn. 1985); Hardeman County Bank v. Stallings, 917 S.W.2d 695, 699 (Tenn. Ct. App. 1995).
Courts must avoid rewriting an agreement under the guise of interpreting it. Marshall v. Jackson
8
& Jones Oil, Inc., 20 S.W.3d 678, 682 (Tenn. Ct. App. 1998). The courts will not make a new
contract for parties who have spoken for themselves, Petty v. Sloan, 197 Tenn. 630, 640, 277 S.W.2d
355, 359 (1955), and will not relieve parties of their contractual obligations simply because these
obligations later prove to be burdensome or unwise. Boyd v. Comdata Network, Inc., 88 S.W.3d
203, 223 (Tenn. Ct. App. 2002).
Courts may and will incorporate a reasonableness requirement into any contract. Hurley v.
Tenn. Farmers Mut. Ins. Co., 922 S.W.2d 887, 892 (Tenn. Ct. App. 1995) (holding that insurance
company’s demand for production of financial records and assertion that insured’s failure to produce
was a breach of the cooperation clause of the insurance contract could be considered unreasonable);
Moore v. Moore, 603 S.W.2d 736, 739 (Tenn. Ct. App. 1980) (holding that “a qualifying word which
may be read into every contract is the word ‘reasonable,’ or its equivalent ‘reasonably.’”). In fact,
this court has stated that the qualifying word “reasonable” must be read into every contract. Minor
v. Minor, 863 S.W.2d 51, 54 (Tenn. Ct. App. 1993); see also Hathaway v. Hathaway, 98 S.W.3d
675, 679 (Tenn. Ct. App. 2002) (reasonableness must be read into agreement).
Further, in construing contracts, courts must look at the language and the parties’ intent and
impose a construction that is fair and reasonable. ACG, Inc. v. Southeast Elevator, Inc. 912 S.W.2d
163 (Tenn. Ct. App. 1995). Reasonableness must be viewed in light of the parties’ situation at the
time of the making of the agreement as well as at the time performance becomes due. Hathaway,
98 S.W.3d at 680-81. The language of a contract should be construed with reference to the situation
of the parties, the business to which the contract relates, the subject matter of the agreement, the
circumstances surrounding the transaction, and the construction placed on the contract by the parties
in carrying out its terms. Penske Truck Leasing Co., L.P. v. Huddleston, 795 S.W.2d 669, 671
(Tenn. 1990); International Flight Center v. City of Murfreesboro, 45 S.W.3d 565, 570 (Tenn. Ct.
App. 2001). Similarly, when a court is called upon to supply a missing term with a reasonable one,
it must consider the subject matter of the contract, the situation of the parties, their intention in what
they contemplated at the time the contract was made, and the circumstances attending the
performance. Minor, 863 S.W.2d at 54. The course of conduct of the parties is strong evidence of
the parties’ original intent. Pinson & Associates v. Kreal, 800 S.W.2d 486, 487 (Tenn. Ct. App.
1990).
It is well settled that under Tennessee law there is in every contract an implied duty of good
faith and fair dealing. Wallace v. National Bank of Commerce, 938 S.W.2d 684 (Tenn.1996);
Spectra Plastics, Inc. v. Nashoba Bank, 15 S.W.3d 832, 843 (Tenn. Ct. App. 1999). In Wallace, the
Tennessee Supreme Court addressed the nature of the duty of good faith in the performance of
contracts:
In Tennessee, the common law imposes a duty of good faith in the performance of
contracts. This rule has been considered in several recent decisions of the Court of
Appeals. The law regarding the good faith performance of contracts was well stated
by the Court of Appeals in TSC Industries, Inc. v. Tomlin, 743 S.W.2d 169, 173
(Tenn. App.1987):
9
It is true that there is implied in every contract a duty of good faith
and fair dealing in its performance and enforcement, and a person is
presumed to know the law. See Restatement (2d) Contracts, § 205
(1979). What this duty consists of, however, depends upon the
individual contract in each case. In construing contracts, courts look
to the language of the instrument and to the intention of the parties,
and impose a construction which is fair and reasonable.
Wallace, 938 S.W.2d at 686. The Wallace court also cited with approval other opinions of this court
that held that good faith in performance is measured against the intent of the parties as evidenced by
a fair and reasonable interpretation of the terms of the contract. Id.
Finally, with respect to damages, the proper measure of damages is a question of law and
therefore subject to de novo review with no presumption of correctness. Beaty v. McGraw, 15
S.W.3d 819, 829 (Tenn. Ct. App. 1998). The proper amount of damages is a question of fact. Id.
III. TERMINATION OF THE BUSINESS ARRANGEMENT
S&S effectively terminated its agreement to use QMT for all its heat treating business
without actual notice by sending all its business elsewhere after August of 1999. Simonton v. Huff,
60 S.W.3d 820, 827 (Tenn. Ct. App. 2000) (holding that under Tennessee law a cause of action for
breach of contract arises when one of the parties demonstrates a total and unqualified refusal to
perform under the contract). The trial court found held that “S&S was not justified in terminating
the contract as of August 31, 1999,” and that S&S “breached the contract when it sent its heat
treating services to Carolina Commercial Treating.”
The QMT purchase/sale agreement stated that the Johnsons “will have exclusive rights to
heat treat all of the metal treating process required of all goods manufactured by S&S Screw
Machine Co., Inc. coming under Quality Metal Treatment, Inc.’s capabilities as long as Quality
Metal Treatment, Inc. is competitive in price, quality, and delivery.” (emphasis added).
S&S asserts that the finding of the trial court that S&S had breached the contract was in error
for two reasons: (1) that the agreement was terminable at will by either party and (2) S&S terminated
the agreement for cause.
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A. DURATION OF THE EXCLUSIVITY OBLIGATION
The trial court found that when this agreement was executed, “all the parties agreed that this
was to be a long-term contract for QMT to exclusively heat treat S&S’s parts.” The court noted a
memorandum Mr. Welch sent to an S& S employee confirming QMT’s exclusive right to all of
S&S’s heat treating business. The court also relied on the testimony of Mr. Welch himself to the
effect that the contract would not end as long as the conditions were satisfied.
S&S asserts that the contract was, as a matter of law, terminable at will because it included
no specific termination date or duration provision, relying primarily on First Flight v. Professional
Golf Co, 527 F.2d 931(6th Cir. 1975). In First Flight, the court interpreted a contract for sales
representation on specific products for a specified territory that provided that the right of
representation “was not an irrevocable right” but would remain in effect only so long as the
representative did satisfactory business as a contract for an indefinite duration. The court then held
that contracts silent on the time of duration are generally terminable at will by either party with
reasonable notice. Id. at 935. The court did not state that it was applying Tennessee law, but instead
cited a treatise as authority for that holding. That treatise now states, in pertinent part:
A contract is not invalid for indefiniteness for the mere reason that it does not specify
how long performance should continue. If the surrounding circumstances do not
indicate the parties’ intentions, the court may hold that the contract will remain in
effect for a reasonable time, or that the contract is terminable at will by either or both
parties, or terminable on the occurrence of a specific event, or terminable by one of
the parties only on condition of some act or forbearance by that party.
5 MARGARET N. KNIFFIN , CORBIN ON CONTRACTS §24.29 (rev. ed. 1998).
Which of these results is adopted by the courts depends to a large extent on the language of
the agreement itself as well as the intent of the parties. Where the contract itself does not state its
duration, courts have generally held that it should be effective for a reasonable time or terminable
at will with reasonable notice. Id.5 Where, however, the parties have indicated an intent that their
contractual obligations last indefinitely until the occurrence of a particular event, many courts have
concluded that the contracts are terminable only upon the occurrence of that event. Id. Thus, where
a contract does not include a termination date but does include the right to terminate upon the
happening of specified circumstances, courts will generally interpret the contract as remaining in
force until terminated for cause.
5
In at least one case, the court held the contract terminable “only after a reasonable duration and reasonable
notice.” Italian & French Wine Co. of Buffalo, Inc. v. Negociants U.S.A., Inc., 842 F. Supp. 693, 699 (W .D.N.Y. 1993)
(emphasis added). Important to that decision were the efforts and expense already undertaken by one party.
11
The leading case in this area is Warner-Lambert Pharmaceutical Company, Inc. v. John J.
Reynolds, Inc., 178 F. Supp. 655, (S.D.N.Y. 1959), aff’d per curiam, 280 F.2d 197 (2d Cir. 1960),
wherein the manufacturer of Listerine had agreed to pay royalties for use of the secret formula for
that product based upon the amount sold and, many years later, sought to be relieved of that
obligation when the secret formula was no secret any more. One of the arguments made by the
manufacturer was that the contract did not have a termination date and, therefore, was a forbidden
“perpetuity” that the law would not enforce. The court found, first, that “[t]he mere fact that an
obligation under a contract may continue for a very long time is no reason in itself for declaring the
contract to exist in perpetuity or for giving it a construction which would do violence to the
expressed intent of the parties.” Id. at 663.
The court acknowledged the general rule that where the contract includes no termination date
and it appears the parties did not contemplate a termination date or their intention cannot be
ascertained, the contract will be held to be terminable within a reasonable time or revocable at will,
dependent upon the circumstances. Because courts are loathe to infer a perpetual obligation,
generally the date or condition of termination will be determined from the actual intention of the
parties. Id. However, the court distinguished the contract before it from those falling within this
rule:
Contracts which provide no fixed date for the termination of the promisor’s
obligation but condition the obligation upon an event which would necessarily
terminate the contract are in quite a different category and it is in this category that
[the contracts at issue] fall. On the face of the agreements the obligation of [the
original manufacturer] and its successors to pay is conditioned upon the continued
manufacture or sale of Listerine. When they cease manufacturing or selling Listerine
the condition for continued payment comes to an end and the obligation to pay
terminates. This is the plain meaning of the language which the parties used.
Id. at 661-62.6 The court also held that because the condition under which the obligation was to
continue was set out in the contract, there was no need to construe the agreement so as to import or
imply a condition or date of termination other than that expressed by the parties themselves in the
contract. See also Payroll Express Corp. v. Aetna Casualty and Surety Company, 659 F.2d 285,
291-92 (2d Cir. 1981) (applying Warner-Lambert and holding that an agreement that the policy
would terminate upon the insured’s failure to pay premiums, without establishing a set duration of
the policy, made the policy cancelable only upon that circumstance and not terminable at will or after
a reasonable time).
6
The court emphasized that the event that would relieve the manufacturer of its obligation was directly related
to the subject matter of the contract, not an extraneous event outside the control of the parties. See also Ehrenworth v.
George F. Stuhhmer & Co., 128 N.E. 108 (N.Y. 1920) (holding that an agreement to provide goods at a fixed low price
was not terminable at will in the absence of an expressed termination date and remained in effect while both parties
remained in business, in part because such a termination point bore a rational relationship to the subject matter of the
contract).
12
Similarly, in Foster-Porter Enterprises, Inc. v. DeMare, 81 A.2d 325 (Md. Ct. App. 1951),
the court held that the applicability of the contention that the contract at issue (an exclusive
distributorship agreement) was terminable at will because it contained no provision for a definite
term depended upon the construction of the contract. Interpreting the general rule regarding the
absence of a duration provision as having exceptions, including where the contract is terminable for
cause, the court noted that the contract at issue included a provision for termination upon the
happening of any one of three specified events. Consequently, the court concluded,
The only reasonable interpretation of [that provision] is that the contract continues
in force until terminated for cause - - or at least continues for a reasonable time.
Construction of the contract as terminable at will would defeat its purpose and would
make [the termination provision] meaningless.
Id., 81 A.2d at 333. See also Pumphrey v. Pelton, 245 A.2d 301, 303 (Md. Ct. App. 1968)
(interpreting a contract for the exclusive use of Dairy Queen equipment and name that did not
contain an explicit termination date but stated it would be for the time covered by the involved
patents and copyrights so long as the restaurant operator performed its covenants under the contract
was terminable only for cause, i.e., one of the causes expressed in the contract.)
Thus, parties may contract for an indefinite term whose duration is defined by the conduct
of the parties as set out in the conditions agreed to for continuation or termination. See Zee Medical
Distributor Association, Inc. v. Zee Medical, Inc., 94 Cal. Rptr. 2d 829, 833 (Cal. Ct. App. 2000).
Accordingly, contracts stating that the obligations would continue “as long as” or “so long as” a
party fulfilled specified obligations have been found valid and enforceable. Id. (and cases cited
therein). In that situation, the contract is not terminable at will but, instead, is terminable for the
causes set out therein.
As Warner-Lambert indicates and Zee Medical Distributor Association makes clear, a
contract without a specific durational term may fall within one of several categories, or, stated
another way, courts may apply a three-step analysis to questions of the duration of a contract:
The court first seeks an express term. If one is absent, the court determines whether
one can be implied from the nature and circumstances of the contract. If neither an
express nor an implied term can be found, the court will generally construe the
contract as terminable at will.
Zee Medical Distributor Association, 94 Cal. Rptr.2d at 835, citing Consolidated Theatres, Inc. v.
Theatrical Stage Employees Union, 447 P.2d 325 (Cal. 1968).
If the parties have not set a termination date or condition, the law may imply an agreement
that the contract is to last for a reasonable time or is terminable only upon reasonable notice. Thus,
in the absence of a controlling provision fixing the duration of a contract, courts will deem the
contract to be terminable with a reasonable period of time. United States Surgical Corporation v.
13
Oregon Medical & Surgical Specialties, Inc., 497 F. Supp. 68, (S.D.N.Y. 1980), citing Warner-
Lambert, supra. What is reasonable is determined by the intent of the parties and all the
circumstances of the case, including the course of conduct of the parties and their reasonable
contemplation and expectation. Id.; San Francisco Brewing Corp. v. Bowman, 343 P.2d 1 (Cal.
1959) (considering an exclusive beer distributorship arrangement).
We find these principles persuasive and consistent with Tennessee law. Contracts without
definite durational provisions have been considered by Tennessee courts, but usually in the context
of an argument that such a contract is unenforceable because it lacks sufficient definiteness as to a
material term. In the context of that argument, and recognizing that “the law leans against the
destruction of contracts for uncertainty, especially where one of the parties has performed his part
of the contract,” this court has held that the duration of a contract need not be specified to make the
contract enforceable. Book-Mart of Florida, Inc. v. National Book Warehouse, Inc., 917 S.W.2d
691, 694 (Tenn. Ct. App. 1996); APCO Amusement Company, Inc., v. Wilkins Family Restaurants
of America, Inc., 673 S.W.2d 523, 528 (Tenn. Ct. App.1984). These cases establish that a contract
that is silent as to duration is enforceable. See also Parks v. Morris, 914 S.W.2d 545, 549 (Tenn.
Ct. App. 1995).
Because the Tennessee cases deal with the enforceability or validity of a contract without a
specific durational term, their statements regarding the effect of this lack of specificity must be
viewed from that perspective. For example, in support of its holding that a contract did exist in
APCO Amusement Company, the court stated an agreement which contains no express provision as
to its duration may be construed as being perpetual or terminable at will. 673 S.W.2d at 528. That
statement was made to demonstrate that an unenforceable perpetuity was not the only result of the
absence of a specific duration.
Such agreements have also been interpreted as providing for an indefinite term. Minor, 863
S.W.2d at 54.
Where the parties have not clearly expressed the duration of the contract, or where
the duration of the contract is indefinite, the courts will imply that they intended
performance to continue for a reasonable time.
Id., citing 17A AM . JUR.2d Contracts § 479 (1991).7
7
W hat constitutes a reasonable time within which an act is to be performed where a
contract is silent upon the subject depends on the subject matter of the contract, the
situation of the parties, their intention in what they contemplated at the time the
contract was made, and the circumstances attending the performance.
Minor at 54 (quoting 17 A AM . JU R .2 D Contracts § 479 (1991)).
14
In McReynolds v. Cherokee Insurance Co., 896 S.W.2d 777,779 (Tenn. Ct. App. 1994), this
court acknowledged and applied First Flight and other authority holding that contracts for an
indefinite duration are generally terminable at will by either party with reasonable notice.
Reasonable notice of termination flows from and must be determined in accordance with the
standards of good faith and fair dealing implied in every contract. The determination concerning
what constitutes reasonable notice, however, is a fact specific inquiry dependent upon the length of
the contractual relationship between the parties, the reliance which either party placed upon the
continuing vitality of the contractual relationship, and the particular business involved.
Thus, Tennessee courts have found contracts with no specified duration to be either
perpetual, terminable at will on reasonable notice, or terminable after a reasonable duration. These
alternative results are consistent with Corbin and with the authority from other states discussed
above. In none of the Tennessee cases discussed so far herein, has the court examined a contract
where a termination for cause provision was included. In fact, the Cherokee Insurance Co. court
specifically noted that the contract at issue in that case “did not include a statement of duration and
did not incorporate any stipulations regarding termination.” Id. at 778.
Like the court in Warner-Lambert, we think that is a significant and determinative difference
that makes the rules regarding the absence of a durational provision inapplicable to the case before
us. Where the parties have agreed that the duration of the contract will continue until specified
circumstances exist, it cannot be said that the contract is silent as to duration. Even in those cases
dealing with missing durational terms, the courts have invoked the cardinal rule of contract
interpretation. Courts will, if possible, construe an agreement without a durational provision so as
to effectuate the reasonable intention of the parties if that intention can be ascertained. APCO
Amusement Company, 673 at 528. “The intention of the parties is, of course, the ultimate question
to be decided on the construction of an agreement.” Cherokee Ins. Co., 896 S.W.2d at 780. Thus,
where the intention of the parties as to the duration of the contract is clearly stated in the agreement,
Tennessee courts will enforce that intention.
A Tennessee court has in one instance addressed an agreement without a specified duration
but with language indicating the conditions under which it was to continue. In Hamblen County v.
City of Morristown, 584 S.W.2d 673 (Tenn. Ct. App.1979) the Hamblen County Board of Education
and the City of Morristown’s Board of Education had entered into a written agreement calling for
the construction of a new public high school and the renovation of an existing high school in order
to alleviate school overcrowding. The County agreed to acquire the necessary land for the new high
school and thereafter lease the land to the City “for such time and so long as the same is used for
educational purposes for city and county students.” Id. at 677.
This arrangement worked for eleven years, until the County filed suit to set aside the contract
with the City and regain the right to operate the new school. One of the issues raised was that the
contract was void because it was a perpetuity. On appeal, this court found that although the contract
stated that the arrangement was “binding and irrevocable,” it was not a perpetual contract. The court
further held:
15
The intentions of the parties in entering into this contract are manifested within the
language of the agreement. The agreement calls for extensive expenditures and long
term commitments. Both parties needed protection from arbitrary rescission. This
Court interprets irrevocable to mean that the contract could not be revoked at will by
one of the parties over the objection of the other. (citation omitted). The contract is
and was clearly revocable for material breach by either party or by mutual agreement.
Id.
Because the parties herein expressly made the duration of the contract co-extensive with
QMT’s competitiveness, this is not a contract that is silent as to duration. The intent of the parties
is manifest in the language they used. They established causes for termination. To interpret the
agreement as terminable at will would make the termination for cause provisions meaningless and
ignore the clear intent of the parties. We conclude that the obligation of S&S to use QMT for all its
heat treating business was not terminable at will by S&S, but was only terminable for one of the
causes set forth in the agreement.
While we think the language of the contract is clear, we also note that nothing in the parties’
dealings here indicates the exclusivity agreement was just an “at will” business relationship. Over
the course of their dealings, the Johnsons have paid the Welchs significant amounts of money related
to QMT. As part of the initial transaction to purchase QMT, the Johnsons paid the Welchs more
than $186,000 for the assets of their heat treating business which largely were unique to servicing
the parts of S&S. Similarly, Mr. Welch encouraged the Johnsons to move QMT from
Hendersonville to Cookeville in order to be closer to S&S. Not only did the Johnsons move to
Cookeville, they purchased real property from the Welchs for $280,000. The Johnsons borrowed
money to finance these purchases. In view of the substantial investment and obligations the
Johnsons undertook and because the success of QMT depended upon S&S’s business, it is highly
unlikely that the Johnsons would have left the continuation of that business to the whim of Mr.
Welch.
Mr. Welch was well aware that when he sold QMT to the Johnsons that most of the heat
treating work for QMT was provided by S&S. Before Mr. Welch sold QMT to the Johnsons, QMT
had performed all of the heat treating work for S&S. Moreover, because of the nature of Mr.
Welch’s product line, substantial portions of the QMT heat treating equipment were uniquely tied
to S&S’s product line. He was well aware of the importance of S&S’s business to QMT’s continued
viability and the Johnsons’ opportunity to recoup their investment. Even Mr. Welch conceded at
trial that the parties intended the agreement to continue indefinitely as long as the conditions were
satisfied.
The trial court found that the parties considered the exclusivity agreement as a long term
arrangement that was to continue as long as QMT’s heat treating of S&S’s parts was competitive in
“price, delivery and quality.” We agree. Consequently, S&S’s defense of the breach of contract
claim must be based on a failure of QMT to meet the conditions for continuation.
16
B. TERMINATION FOR CAUSE
At trial, S&S and Mr. Welch took the position that S&S was permitted to terminate the
contract for cause on two grounds. The first was that QMT was no longer competitive in quality
because of the cracks discovered in some parts.8 The trial court rejected S&S’s arguments on this
point and stated, “Reed Welch claimed that S&S would still be using QMT’s services except for the
fact that QMT had a quality problem and QMT did not certify its work. Neither of these assertions
are accurate.” The court also found:
Until the contract was terminated in August 1999, S&S never complained to QMT
that its heat treating was not competitive in price, delivery, or quality. Nor did S&S
customers refuse to accept products heat treated by QMT, and that was before there
was any alleged controversy which arose concerning the K233-509 parts. Also, well
before any controversy arose, Reed Welch was attending auctions to purchase heat
treating equipment in order to take back the heat treating process. The Defendants
claim that they terminated the contract because QMT was not competitive in quality
with respect to the K233-509 parts. That’s simply not the case. S&S was not acting
in good faith, and Jerald Welch had not read the contract until Mr. Johnson
questioned the out-sourcing of the parts to Paulo Products. Reed Welch was looking
for a way to get back into the heat treating business.
These facts led the court to conclude that S&S’s motivation for terminating the contract was
“suspect at the very minimum.”9 With regard to S&S’s contention that QMT was not competitive
in quality because of cracking problems, the evidence shows the following.
In the summer of 1999, a problem arose concerning S&S Part # K233-509, which is a shock
absorber part and has safety implications. Mr. Biss noticed a crack in one of the lots and,
consequently, recalled seven lots for further inspection of each part. A small number of these parts
were determined to have cracks, but the majority were re-shipped to customers.
S&S notified QMT of the cracking, at least informally, sometime in June of 1999, because
Mr. Johnson asked in a June 22 transmittal for two examples of the cracked parts. Accompanying
this transmittal were various reports concerning QMT’s heat treating process, including logs relating
8
There was really no question regarding QMT’s competitiveness as to price and delivery. Jerald W elch testified
that S&S made no such contention, although he clarified that QMT’s final demand for payment of outstanding balances
before returning treated S&S products could be considered a problem with delivery. The trial court found that QMT did
not raise its prices from those set out in the contract, and agreed therein to be competitive, and that S&S was paying its
new heat treater more. The court also found that QMT always met delivery and turnaround deadlines.
9
The W elchs also took the position that S&S was the sole arbiter of competitiveness of quality. The court found
this interpretation of the contract unsupported by the evidence or the language of the document, and held that the W elchs’
interpretation was “self-serving, revisionist, and totally incorrect.”
17
to specific work orders. On July 6, Mr. Biss sent a request to Sherry Laboratories to test the parts
to determine the cause of cracking, and the request indicated that quench cracking was suspected.
Sherry Laboratories reported back on July 14, 1999, and concluded that the cracking was the result
of quench cracking. Quench cracks occur during the heat treating process and can be caused by
anything that produces excessive quenching stress, including part design, steel grades, part defects,
and heat-treating and tempering practices.
The report noted that four samples had been submitted and that S&S had reported that the
components were made from grade 4140 alloy steel. It also described the various tests performed.
The report concluded by recommending that the heat treatment processes and records for the parts
be reviewed, noting that particular attention should be paid to the quenching operation including
review of the adequacy of the quench medium and suggesting that minimizing delay between
quenching and subsequent tempering would be helpful.
On July 16, 1999, Mr. Biss sent a corrective action request to QMT recommending that
QMT’s processes/records be reviewed for appropriate action and forwarding the Sherry Laboratories
report. Mr. Johnson replied within one week, as requested by S&S, with the results of a review of
“Standard Practices for 4140 Material” as promulgated by the American Society for Metals, and
stated that all QMT records and processes were in compliance with those industry standards. He also
notified S&S that an independent study had been completed by Metallurgical Technologies, Inc. and
the result indicated that the root problem may be in the material.
The July 22, 1999 report from Metallurgical Technologies, Inc. indicated that company had
reviewed the Sherry Laboratories report. In fact, the Metallurgical Technologies report interpreted
some of the findings by Sherry Labs. For example, it noted that although Sherry Labs indicated the
cracking was probably quench cracking, “no attempt has been made to determined why the part
quench cracked.” It further noted that many of the observations made by Sherry Labs were
consistent with imperfections existing in the hex bar material prior to its fabrication into the parts
and prior to the heat treating. The report questioned whether more in depth or follow up testing and
examinations had been performed because such tests could have revealed the real problem. Mr. Biss
interpreted this report as indicating that material cleanliness could have been the problem.
The report concluded with recommendations to verify the cracking and determine its cause,
including performing a chemical analysis to determine what alloy was involved and to determine its
impurity contents. It also recommended that the heavy oxide scale on the part be removed to verify
intergranular cracking and to look for indications of a seam that may have initiated the cracking.
Other steps were recommended to identify signs of the cause of the cracking.
Mr. Biss, Jerald Welch, and Mr. Johnson met on July 23 regarding the cracking issue, and
Mr. Johnson confirmed the results of that meeting in a letter. The men agreed to solicit two third
party independent studies on the cause of the quench cracking. Mr. Johnson outlined his suggestions
for “common criteria” to be provided to the two laboratories. Included in that list was information
18
regarding the historical quench crack percentage produced by other heat treating suppliers, including
QMT before and after the Johnsons’ purchase of it.
Mr. Biss sent a request to Sherry Laboratories on July 28 for the cost of further review and
testing and a copy of the Metallurgical Technologies report. Apparently Mr. Johnson sent a similar
request to Metallurgical Technologies, and they provided a report on August 10 that was sent to Mr.
Johnson, Mr. Biss, and the Welchs. After an analysis of the cracks, the report concluded:
The heat-treated parts are quench cracking due to a combination of material
deficiencies, alloy selection and design. The quench cracked parts exhibit surface
laps/seams, a high concentration of significant stringer inclusions, and significant
surface decarburization, all of which contribute to quench cracking.
The report made several recommendations to prevent the cracking, including obtaining a
better quality of steel and a design change. It also recommended changes in the quenching part of
the heat treating process, but noted that those changes could be a costly alternative.
This was the last report received by S&S prior to its discontinuing sending its parts to QMT
for heat treating. Although Mr. Johnson shared this report with S&S, neither the Welchs nor Mr.
Biss ever contacted Metallurgical Technologies to discuss its findings.
S&S relies on testimony from Mr. Biss and Jerald Welch that S&S did its own test by
sending parts from the same supplier to QMT and to another heat treater and compared the results,
finding that the QMT processed parts had some cracks while the others did not. The record is not
clear as to when this “test” occurred, and Jerald Welch could not remember the timing. During
cross-examination, Jerald Welch acknowledged that S&S’s steel supplier had changed sources of
steel three times during the summer of 1999 when the cracks appeared.
At trial, Mr. Samuel Pendergrass, owner of Metallurgical Technologies and an engineer with
a degree in physical metallurgy testified regarding the extensive tests his company had performed
on the parts at issue. He explained that his company removed the oxide scale on the cracks,
something Sherry Labs had not done, in order to see the features of the cracks which provide
information about how, when, and why the crack occurred. He testified that not removing the oxide
would make it very difficult to resolve the cause of the cracking.
Mr. Pendergrass discovered several laps in the open crack surfaces, which is “a defect in the
material caused during the rolling of the bar stock where, as the material is rolled through bars to
shape it and form it and reduce the cross-section, some of the surface folds over and gets rolled in.”
The tests also showed that a surface layer, or near-surface layer, in the material was softer than the
rest, due to decarburization. He also found there were a relatively high number of non-metallic
stringer inclusions, which are impurities or foreign particles in the metal left in the steel from the
original manufacturing process.
19
Mr. Pendergrass also testified that he reviewed QMT’s processes and industry standards and
found nothing in the heat treatment that was contributing to the cracking problem. Pointing out that
unless a product is heat treated, including being subjected to quenching, there would be no quench
cracking, he stated, “when you have all of these other factors involved, really the problem lies in the
design, selection of material, and the material deficiencies. Without these other problems there
should not have been any cracking.”10
Almost a month after S&S decided to send its heat treating business elsewhere, S&S received
another report from Sherry Laboratories, dated September 23, 1999. That report responded to the
Metallurgical Technologies report, and Mr. Voss, the author of the report, stated he agreed with the
recommendations made by Metallurgical Technologies. The Sherry Labs report concluded, “the root
cause of cracking appeared to be the design of the part, as suggested by Metallurgical Technologies,
Inc., PA, and/or the heat treating practice.” The report suggested that a review of the history of
frequency of cracking of the component part at issue would help clarify whether cracking has
historically been a problem with the design.
Mr. Voss testified by deposition at the trial. He stated that the purpose of some of the
recommendations in his first report was to get S&S to review the heat treating process, particularly
the quenching operation. He stated there was no more communication from S&S until the report
from Metallurgical Technologies was sent to him. He disagreed with Metallurgical Technologies’
conclusions about decarburization to some extent, and concluded that the heat treating process could
have aggravated the decarburization process already existing in the raw material. He concluded that
the cracking did not appear to be related to a material defect. He reaffirmed his report’s conclusion
that the cracking could have been caused by either design of the part or by heat treating practice. He
acknowledged that in his examination of the parts, he found nothing that would indicate that QMT
had varied from industry standards in any way.
Since S&S has been sending its heat treating work to Carolina Commercial Heat Treating,
there have been occasional cracking problems also. Mr. Biss testified that he never made a
recommendation to S&S management that it cease its relationship with QMT because of quality
concerns.
The trial court found persuasive the testimony of the metallurgy experts. The court
specifically found:
The Defendants indicate that since the crack in some of the parts appeared during the
quenching that QMT was not competitive in quality. The Court finds that the crack
was not caused by a defective heat treating process. QMT had treated these same
10
He also testified that he thought the largest factor contributing to the cracking was the design of the part and
that if the part in question is made with commercial quality 4140 steel, there is going to be cracking on a small percentage
of the parts. The original report had recommended using 8640 grade material as a way to lower the potential for cracking.
S&S presented evidence that the material it used, in the 4140 range, met industry standards. Of course, meeting industry
standards does not mean that no cracking will occur.
20
parts for almost six years without incident. QMT had treated thousands of these
parts. Sam Pendergrass is a credible and qualified metallurgical expert. He indicated
and verified that the most likely cause of the problem with this part arose from the
material alloy used in making the part, not from any defect in the heat treating
process.
The laboratory which the Defendants selected to test these parts, Sherry Laboratories,
never told them that the heat treating process by QMT was defective. To the
contrary, they indicated that the examination of the part did not indicate that QMT
had varied from the accepted heat treating industry standards in any way during its
heat treating of these products.
The evidence does not preponderate against these findings. The proof at trial clearly supports
the trial court’s finding that S&S had no ground under the terms of the contract to terminate the long
standing agreement with QMT over quality concerns.
The second ground asserted by S&S as justifying termination of the agreement is its
allegation that QMT improperly altered the terms of the agreement. Although Mr. Reed Welch
testified that QMT would still be doing the heat treating work except for the quality concerns, Mr.
Jerald Welch testified that “the root of the problem” leading him to stop doing business with QMT
was that Mr. Johnson was not going to give treated parts back to S&S until S&S paid everything that
was owed to QMT. Some factual background is necessary.
Jerald Welch testified that he became angry or frustrated with Mr. Johnson for “not accepting
responsibility” for the cracking problems. Mr. Bliss pointed out to him the limitations of liability
and limited warranty provisions contained in QMT’s invoices. As a result, on August 26, 1999,
Jerald Welch wrote Mr. Johnson a memorandum directing QMT to remove the terms of its limited
warranty and limitation of remedies from all its invoices.11 The memorandum also stated, “S&S will
as of August 26, 1999 no longer accept invoices with this document attached.” Mr. Welch ended
11
There were other disputes going on at this time, and other correspondence leading up to the August 26 letter
demonstrate that tensions were heating up. On August 16, 1999, Jerald W elch wrote M r. Johnson regarding an issue with
the specifications for a new (or in M r. Johnson’s view, not a new) part. Mr. W elch characterized QMT’s actions as gross
negligence and stated that S&S now required QMT to review its product/process implementation procedures and submit
them to Mr. Biss. Mr. Johnson responded by letter date August 23, disputing the claims made by Mr. W elch and
informing him of his numerous contacts with Mr. Biss, specifically including questions regarding specifications for the
part at issue as well as a long list of other issues brought to Mr. Biss’s attention. He also stated that the process
procedures requested by Mr. W elch were proprietary documents and the common industry practice was not to share
them. However, he stated that QMT had provided its Quality Control Manual and routinely provided certifications that
met S&S’s requirements. The letter also stated that QMT was performing to its contractual requirements, and that, “what
you are proposing is a ‘new contract.’” Mr. Johnson stated QMT intended to continue to abide by the terms of the
existing contract and expected S&S to do the same. There was also correspondence disputing who was responsible for
paying Sherry Laboratories for the testing. In particular, M r. Johnson declined to pay an invoice for the testing ordered
by S&S before S&S informed QMT of the cracking problems.
21
his memorandum with the following: “You either want to be in the commercial heat treating business
and are willing to stand behind your work or you don’t, which is it?”
The terms found so offensive to Mr. Welch had been used by QMT when Jerald Welch’s
father, Reed Welch, owned the business. Moreover, the Johnsons had used the terms on invoices
the entire time they had owned QMT and dealt with S& S. At trial, Jerald Welch admitted that he
did not conduct any investigation of industry practice concerning warranties or limitations of
remedies before sending the letter and that in fact had subsequently learned that such terms are
“standard” in the heat treating business. A copy of the warranty and liability terms used by the
successor heat treater for S&S, Carolina Commercial, was introduced into evidence. Although
Jerald Welch stated that Carolina Commercial personnel had assured him that such limitations
seldom are upheld, he was unable to point out any specific portion of the limitations provisions that
S&S found more favorable than those on QMT’s invoices.
In a letter dated August, 30, 1999, Mr. Johnson replied to Jerald Welch’s memorandum as
follows:
While it is our position that you have irretrievably broken the contract between S&S Screw
Machine, Co., Inc. and QMT Quality Metal Treating, Inc., we will continue to be willing to
process your purchase orders as needed by you as to all you to meet the demands of your
customers. The terms for such work will be stated on our invoicing, a copy of which is
attached to my letter to you of August 24, . . .
By another letter dated August 30, 1999, Mr. Johnson stated:
It is clear to us, in light of your letter dated August 26, 1999, and your recent
shipment to Carolina Commercial Heat Treating, that you do not intend to perform
under our contract in good faith. Accordingly, we must be paid in full with certified
funds before we will deliver the remaining orders to you. Attached in the balance
due.
Mr. Jerald Welch replied to Mr. Johnson’s August 30 letter (although it is not clear which
one or both) denying S&S had breached the contract. Some reference is made to S&S’s “right to
seek out competitive suppliers,” apparently in explanation of the claim that S&S had sent heat
treating business to someone other than QMT. At trial, he took the position that S&S had sent some
parts for heat treating to Carolina Commercial as a test related to the cracking problem.
This correspondence began with a statement that “it is clear that you have no intention to
stand behind your work and that you are unable or unwilling to even attempt to meet our
requirements for quality.” Consequently, the memorandum continued, S&S “accepted” that QMT
recognized it had failed to meet the requirements of the agreement between the companies. Mr.
Welch continued, “Under no circumstances will QMT attempt to hold any S&S product hostage”
and that it would pay all balances in the normal manner. Mr. Welch indicated that S&S “would
22
consider keeping QMT as a supplier” if it met its requirements “in total” and that he would pick up
any S&S products at QMT by September 1, 1999.
On August 31, Reed and Jerald Welch delivered a check to QMT for the full amount owed
less $7,248.80, which the Welchs claimed as expenses they incurred related to a rust problem and
the cracking problem. When he returned to his office, Jerald Welch read Mr. Johnson’s letter stating
that QMT required full payment of outstanding balances with a certified check and interpreted that
as holding S&S parts hostage. Jerald Welch stated that S&S had never paid QMT with a certified
check before and was never required to do so and that he believed S&S’s payment was due 30 days
after invoicing and some of the amounts demanded by QMT were for work invoiced less than 30
days before. He immediately ordered that S&S parts be removed from a QMT truck on which they
had been loaded for transport to QMT for heat treating. He refused to let those parts go to QMT and
never sent any more parts to QMT for heat treating.
After recounting the history of the correspondence between the parties, and noting that the
objectionable terms regarding warranties and limitations of liability were not new terms and were
standard in the industry, the court found:
In response to S&S’s decision to seek other heat treaters and refusal to accept QMT’s
invoices, Mr. Johnson told S&S that QMT expected to be paid C.O.D. for its heat
treating work as it was performed. At that point, Jerald Welch confirmed that he
became increasingly angry with Mr. Johnson and he pulled S&S work from QMT.
S&S failed to provide notice to QMT had of the termination of this long-term
contract.
The trial court found that S&S breached the contract. Thus, the trial court rejected S&S’s
argument that QMT altered the terms of their agreement. The evidence shows that S&S actually
altered the parties agreement first by refusing to pay under the longstanding terms and demanding
those terms be removed from QMT’s invoices as a condition of continued business. Further, the facts
reveal that S&S gave QMT no alternative but to require cash on delivery payments given S&S’s
improper outsourcing, slow paying of past due invoices, claims of poor quality and contentious
letters from Jerald Welch essentially daring QMT to break off their longstanding business
relationship.
It is clear that Mr. Johnson did nothing to give S&S cause to terminate the agreement due to
the payment term put in place in late August, 1999, in the context of the correspondence and conduct
preceding it. Accordingly, we affirm the trial court’s conclusion that S&S had no cause to terminate
the exclusivity agreement and, consequently, breached it.
23
IV. LOST PROFITS
Having found S&S breached the exclusivity agreement, we turn to the Johnsons’s claim for
lost profits. The trial court awarded the Johnsons $821,689 in lost profits.
Compensatory damages are intended to compensate the wronged party for the loss or injury
caused by the wrongdoer’s conduct. Beaty, 15 S.W.3d at 828-29. The purpose of damages in a
breach of contract case is to place the injured party, as nearly as possible, in the same position it
would have been in had the contract been performed. LaMons v. Chamberlain, 909 S.W.2d 795, 801
(Tenn. Ct. App. 1993); Hennessee v. Wood Group Enters., Inc., 816 S.W.2d 35, 37 (Tenn. Ct.
App.1991); Wilhite v. Brownsville Concrete Co., 798 S.W.2d 772, 775 (Tenn. Ct. App.1990).
Damages ordinarily protect the injured party's expectation interests by awarding the party the benefit
of its bargain. RESTATEMENT (SECOND ) OF CONTRACTS § 344(a) & cmt. a (1979). The most
common method for awarding expectation damages is to award the injured party the profits it would
have made had the contract been completed. Inland Equip. Co. v. Tennessee Foundry & Mach. Co.,
192 Tenn. 548, 556, 241 S.W.2d 564, 567 (1951); McClain v. Kimbrough Construction Company,
806 S.W.2d 194, 200 (Tenn. Ct. App. 1991); Morristown Lincoln-Mercury, Inc. v. Roy N. Lotspeich
Publishing Co., 42 Tenn.App. 92, 103, 298 S.W.2d 788, 793 (1956).
S&S and the Welchs do not dispute that lost profits are the appropriate measure of damages.
Instead, they argue that the calculations used resulted in an award of damages greater than the
Johnsons’ probable loss and did not provide a reasonable estimate of damages. Thus, the Welchs
challenge the amount of damages, and such determinations are questions of fact. Consequently,
In cases where the trial court is hearing the case without a jury, we review the amount
of damages awarded by the trial court with the presumption that it is correct, and we
will alter the amount of damages only when the trial court has adopted the wrong
measure of damages or when the evidence preponderates against the amount of
damages awarded.
Beaty, 15 S.W.3d at 829.
As a starting point, the courts will not award uncertain, contingent, or speculative damages.
Nashland Assocs. v. Shumate, 730 S.W.2d 332, 334 (Tenn. Ct. App.1987); Moore Constru. Co. v.
Clarksville Dept. of Elec., 707 S.W.2d 1, 15 (Tenn. Ct. App. 1985). Thus, damages based on lost
or expected profits must be proved with reasonable certainty. McLain, 806 S.W.2d at 200; Moore,
707 S.W.2d at 15; American Bldgs. Co. v. DBH Attachments, Inc., 676 S.W.2d 558, 562 (Tenn. Ct.
App.1984). The reasonable certainty requirement does not require mathematical precision, McLain,
806 S.W.2d at 200; Airline Constr., Inc. v. Barr, 807 S.W.2d 247, 274 (Tenn. Ct. App.1990), but
rather sufficient proof to enable the trier of fact to make a fair and reasonable assessment of the
damages. Pinson & Assocs. Ins. Agency, Inc., 800 S.W.2d at 488.
The evidence regarding damages and lost profits came primarily from Mr. Johnson and from
24
Ronald Clouse, a C.P.A. who had been QMT’s independent accountant since 1995. He explained
that he was involved in preparing the company’s financial statements, doing tax returns, and
consulting. Mr. Clouse stated that he was asked to determine the means of placing QMT back into
the same position it was in prior to the termination of the S&S contract. Regarding the methodology
used to calculate this, Mr. Clouse explained that he determined the net profits that would have been
realized had the contracts been continued.12 To reach his conclusion, Mr. Clouse explained that he
considered the company’s financial statements and operations.
Mr. Clouse testified that the amount of work that would have come to QMT if the contract
had not been breached was readily ascertainable from the heat treating statements of Carolina
Commercial Heat Treating, the company that had replaced QMT for S&S’s heat treating needs. Mr.
Clouse used those statements from September 1999 through trial. The trial court found:
The amount of heat treating work that was generated by S&S that otherwise would
have been sent to QMT is known to have been sent to Carolina Commercial Heat
Treating. The actual amounts of revenue and probable net profit lost by QMT is
reasonably certain, and the purchase orders of Carolina Commercial Heat Treating
for the first twenty-five (25) months after the contract was terminated were used to
calculate the loss of revenue and loss of net profit to QMT.
We agree with the trial court that the work done by Carolina Commercial provides a
reasonable basis for determination of the revenues QMT lost when S&S took its business elsewhere.
S&S and the Welchs do not argue otherwise.13 Their argument goes to the determination of profits,
not revenues. They argue that the trial court’s award of lost profits was in error because the
calculation disregarded the profit history of QMT and improperly allocated operating costs among
QMT’s customers with the effect of understating costs of treating S&S’s products and overstating
profit from S&S business.
In awarding the Johnsons four years of lost profits,14 the trial court found:
12
Mr. Clouse opined that “basically QM T had no marketability after the contract was lost,” so using a
methodology to determine the value of the business before and after the breach was not appropriate.
13
At trial there was some testimony that S&S’s business had declined recently and that it was not sending as
much work to Carolina Commercial as it had earlier. That argument is not pursued on appeal.
14
The Johnsons had requested lost profits for fifteen years to parallel the financing terms the Johnsons had
entered into to purchase the Cookeville property. During cross-examination, S&S’s expert accountant, Steven Riley,
explained that according to accounting litigation support guidelines, three years from the breach is the preferred period
of time. The trial court determined that four years was “a reasonable time under the facts and circumstances of this
contract and it is the time that would be appropriate.” On appeal, S&S and the W elchs do not challenge the court’s
choice of four years.
25
A CPA, Mr. Clouse testified he’s familiar with the books of QMT from 1995 to the
present, and he testified that the net profit lost to QMT as a result of the loss of this
contract for the first twenty-five (25) months was $ 427,963.
By extrapolating the twenty-five month loss over four years, the court arrived at the figure
of $821,689.
Mr. Clouse did assign a smaller than average percentage of operating costs to S&S’s work.
There was evidence as to the justification, and based on that evidence, the trial court found:
This company has struggled financially since its contract for exclusivity of the heat
treating process where the agreement provided for the Plaintiff to process all of the
S&S Screw Machine Company parts was terminated. When the contract was
terminated by S&S on August 31st of 1999, QMT lost the majority of its heat treating
process or its heat treating business. At that time, approximately 50 to 60 percent of
QMT’s revenues were generated by heat treating S&S parts, and it’s been impossible
for QMT to replace the revenues that were lost as a result of S&S terminating and
breaching that contract. QMT has had difficulty replacing these revenues because the
type of equipment that was purchased from Reed and Olive Welch is unique and is
fashioned to heat treat machine parts manufactured by S&S. This particular type of
process requires - - or doesn’t require but utilizes batch furnaces that are designed for
heat treating parts and they require medium to deep case work. This type of process
is unique to parts that are manufactured by S&S. The use of such equipment would
not be easily transferred to other companies because QMT is not in a position to
profitably compete with belt furnaces that are used by other heat treaters.
S&S heat treating work was QMT’s most profitable process. Mr. Clouse explained that
because of the nature of the heat treating process and design of the “batch furnaces,” fixed and
variable expenses could not be adjusted proportionally to reflect the loss of sales and revenue. Mr.
Johnson testified that when S&S pulled its work, the “batch furnaces” still had to run 24 hours a day
even though QMT had lost the work. Mr. Johnson had explained that the “batch furnace” ran
continuously for 24-hours a day, and the deep case heat treatment of S&S products took over eight
(8) hours per cycle. Typically, the S&S work would be placed into the furnace at 10:00 p.m. on the
second shift, and removed at 6:00 a.m. on the first shift. Thus, S&S parts could be heat treated on
the third shift after midnight without QMT incurring any additional labor or natural gas expense.
Eighty-five to ninety percent of the S&S sales volume was performed during this unmanned third
shift.
When asked about the effect of S&S terminating its agreement with QMT, Mr. Clouse stated
that the impact was “devastating . . .” Another accountant, Steven Riley, testified on behalf of S&S.
He did not dispute there was an adverse consequence to QMT, but questioned some of the
methodology used by Mr. Clouse. The trial court was not bound to accept any particular witness’s
testimony concerning damages. Beaty, 15 S.W.3d at 829.
26
The trial court chose the proper measure of damages, i.e. the net profits QMT would have
made had S&S not breached the contract and removed its heat treating business. The actual amounts
of revenue and probable net profits lost by QMT were proved with reasonable certainty. The
evidence does not preponderate against the findings of the trial court as to the amount of lost profits.
V. THE RELOCATION OF QMT
As set out earlier, both the QMT sales agreement and the contemporaneous lease with option
to purchase the Welchs’ Cookeville property envisioned the move of QMT from Hendersonville to
Cookeville upon the expiration of the Hendersonville lease in February of 1997. Those agreements
required that Mr. Welch (or Mr. and Mrs. Welch) assist in the relocation, installation and start up
of QMT equipment. This obligation was described in several more specific provisions, including
“the responsibility to relocate, install and start-up all the office and industrial assets being purchased,
utilizing S&S Screw Machines, maintenance personnel and equipment.”
The trial court found that while S&S used its employees to help move the equipment, they
delivered the equipment but did little else to install or start up the heat treating furnaces and other
equipment. The court also found S&S employees damaged the furnaces in transit making them
inoperable and that S&S and Mr. Welch never repaired the equipment. The court found that it was
May of 1997 before Mr. Johnson was able to use any of the equipment; that he had to hire third
parties to repair, install and start up the equipment; and that he incurred additional expenses due to
the problems in the relocation. The court held that S&S and the Welchs did not fulfill their
obligations under the agreements and awarded the Johnsons damages resulting from that breach.
On appeal, the Welchs make several arguments. First, they claim they were only required
to assist in the relocation and that they did assist. They argue that the provisions of the agreements
regarding the relocation of QMT are inconsistent and, therefore, the first provision (with the general
obligation to assist) must prevail over the second (spelling out the work to be done by the Welchs).
They also argue the ambiguity created by the inconsistency should be construed against the drafter,
the Johnsons through their attorney.
We disagree that there is any inconsistency or ambiguity in the agreement. The Welchs’
agreement to “prepare the real property” in Cookeville is specifically defined to include the
“responsibility to relocate, install and start up” the equipment. The obligations of the agreement are
clear.
Second, the Welchs argue that no liability should attach to them because the Johnsons failed
to perform the precondition of preparing a layout of the placement of the equipment. While they
state that Mr. Johnson was unable to produce a layout at trial, it is significant they do not assert that
no layout was ever made. Mr. Johnson testified he provided a layout to S&S. Mr. Newman, S&S’s
employee, testified Mr. Johnson laid out where the machines were to be located. Further, the Welchs
showed no connection between the absence of a layout and the failure to install and startup the
27
equipment. They do not address the failure to repair the equipment their employees damaged in the
move.
We find the Welchs’ arguments regarding interpretation of the contract lacking in merit. The
trial court correctly identified the obligations under the agreement, and the evidence supports the trial
court’s finding the Welchs breached the agreement.
The Welchs also challenge the trial court’s award of damages as excessive. The trial court
adopted the Johnsons’ claim for damages, and that claim included expenses for repair of the
damaged equipment and installation of the equipment. In addition, Mr. Johnson testified that he was
forced to outsource heat treating for customers, primarily S&S, while the QMT equipment remained
inoperable. The court awarded $65,312.68, plus prejudgment interest, as damages for the Welchs’
failure to fulfill their responsibilities under the agreement and as a result of the damage to the
equipment caused by S&S employees.
The Welchs argue that the contract required that the relocation and installation be completed
within three months and that, therefore, the court erred in awarding damages for expenses incurred
after February 1997. This argument disregards the Welchs’ obligations in the relocation. They were
responsible for installation, and it was S&S employees who damaged the equipment rendering it
inoperable. Thus, delay was attributable to them.
Mr. Johnson testified as to the expenses incurred and introduced invoices documenting those
expenses. No contrary evidence was introduced and no real challenge was made at trial to the
validity of those expenses or their connection to the relocation. The evidence supports the damages
awarded by the trial court.
VI. QMT’S UNPAID INVOICES
S&S next argues that the trial court erred in awarding QMT damages for unpaid invoices
in the amount of $7,248.80, plus prejudgment interest of $1,788.06, for a total of $9,036.86, because
S&S claimed a setoff.
At the time S&S pulled work from QMT, S&S owed QMT an amount for heat treating work
previously performed. S&S paid that amount minus $7,248. S&S presented a document reflecting
expenses allegedly incurred by S&S related to rust and cracking problems during the spring and
summer of 1999 which S&S calculated as totaling $7,248.
The trial court found that S&S’s claim for a deduction was not appropriate and not supported
by the facts of the case. With regard to the rust problem, the court found:
About mid-June to mid-July of 1999, there was a controversy that arose between
QMT and S&S that involved a part known as K233-509. . . . QMT had been heat
treating these parts for S&S almost six years and had never had any problem with the
28
part. There was an issue of some type of rusty color with the product, but that issue
seemed to go away. Mr. Biss concluded that the heat treating process did not cause
the rust, and rather that it was a material problem with the part.
The evidence supports these findings. Even Mr. Biss, who came up with the list of expenses
claimed as setoff, did not attribute the rust to the heat treating process.
With regard to the cracking problem, which S&S also relied upon to justify termination of
the contract with QMT, the court, as discussed infra at III. B., found that the evidence did not support
a conclusion that QMT’s heat treating process caused the cracks. Consequently, the Welchs did not
prove that they were entitled to reimbursement by QMT of expenses related to identifying and curing
those problems. The trial court found S&S owed the monies to QMT and properly awarded QMT
damages for the unpaid work performed, plus prejudgment interest.
VII. PARTIAL REBATE OF PURCHASE PRICE OF QMT
The trial court also awarded the Johnsons a partial rebate of the purchase price they paid for
QMT based upon Mr. Welch’s failure to disclose to the Johnsons during their negotiations that a
substantial amount of heat treating work would be lost to QMT because S&S was soon to lose some
parts for a significant customer, Paccar. The amount of that rebate was set at $74,400, which
represented 40% of the purchase price, based on testimony that the Paccar parts constituted 40% of
S&S’s heat treating business done by QMT. In regard to this claim, the trial court found:
The Plaintiffs requested and Mr. Reed Welch identified a list of the various parts that
were to be produced by S&S and which could be expected to be heat treated by
QMT. Reed Welch agreed that he would provide an accurate account of those parts.
However, S&S stopped manufacturing Part Numbers 5296, and 6262, and K179-378
soon after Mr. Welch sold the heat treating business to Mr. Johnson. Very soon after
buying the business, the Plaintiffs almost immediately lost a substantial portion of
the revenue that was expected from the heat treating of these parts. Reed Welch was
aware of the likely loss of this business before he sold the heat treating business to
the Johnsons. Mr. Welch knew that S&S was likely to cease production of these
parts. He indicated and claimed that he had discussed this subject with Mr. Johnson
before Mr. Johnson purchased QMT. This is simply not accurate and not the truth.
Mr. Johnson would not have paid the same amount of money for this business if he
had known that it was going to lose 40 percent of the revenue stream almost instantly
after he had purchased the business from Mr. Welch. The revenue generated by these
three parts identified by Reed Welch as probable sources of future revenue for QMT
were also identified by Mr. Johnson on his Pro Forma Statements that were presented
to lending institutions when Mr. Johnson sought financing to buy QMT from Mr.
Welch.
29
The Plaintiffs are requesting the Court to rebate 40 percent of the contract price,
which would be $74,400.00. . . . That is the amount of damage in regard to this
particular agreement because of Mr. Welch’s failure to provide this information at
the time that Mr. and Mrs. Johnson purchased the business.
S&S argues that the trial court erred in awarding the Johnsons this partial rebate of the
purchase price of QMT because this claim was time barred. S&S argued below and before this court
that the three year statute of limitations for tort claims applied as opposed to the six year statute of
limitations for contract actions.
The question is which statute of limitations applies to the Johnsons’ claim: the three-year
limitation applicable to actions for injuries to personal or real property in Tenn. Code Ann. § 28-3-
105(1) or the six year limitation generally applicable to actions on contracts in Tenn. Code Ann. §
28-3-109(c)(3).
The parties’ designation of the claim as tort or contract does not determine which statute
applies. Instead, it is the gravamen, or real purpose, of the action that determines which statute of
limitations applies. Pera v. Kroger, 674 S.W.2d 715, 719 (Tenn. 1984); Tip’s Package Store, Inc.
v. Commercial Insurance Managers, Inc., 86 S.W.3d 543, 551 (Tenn. Ct. App. 2002); Keller v.
Colgems - EMI Music, Inc., 924 S.W.2d 357, 359 (Tenn. Ct. App. 1996),
[R]egardless of whether the suit is based on tort or on contract, the Court must look
to the plaintiff’s declaration to see whether or not he is suing for damages arising out
of a contract or for damages arising out of tort . . .
Keller, 924 S.W.2d at 360, quoting Harvest Corporation v. Ernst & Whinney, 610 S.W.2d 727, 729
(Tenn. Ct. App. 1980), quoting Bland v. Smith, 277 S.W.2d 377, 380 (Tenn. 1955).
The Johnsons alleged that Mr. Welch knew that S&S would likely lose the contract to
manufacture the three Paccar parts when he provided to the Johnsons the list of parts that QMT could
expect to receive from S&S for heat treating. Essentially, they assert that Mr. Welch’s failure to
disclose this fact, or his misrepresentation of the volume of business to be expected, induced them
to pay more for QMT than they would have if they had known about the likely loss. This is a claim
for fraudulent misrepresentation. See Justice v. Anderson County, 955 S.W.2d 613, 616-17 (Tenn.
Ct. App. 1997); Simmons v. Evans, 185 Tenn. 282, 285-86, 206 S.W.2d 295-96 (1947).
A person who is induced by fraudulent misrepresentation to enter into a contract may choose
between two remedies: (1) treat the contract as voidable and sue for rescission, or (2) treat the
contract as existing and sue for damages under the theory of fraudulent inducement or deceit. Vance
v. Shulder, 547 S.W.2d 927, 931 (Tenn. 1977); Justice, 955 S.W.2d at 616. The Johnsons have
chosen the second remedy, and that claim is grounded in tort. Vance, 547 S.W.2d at 931, (holding
that a claim for damages resulting from misrepresentations that induced plaintiff to sell his stock at
a lower than reasonable price was a tort claim); Harvest Corporation, 610 S.W.2d 727, 730 (Tenn.
30
Ct. App. 1980). This is a claim for economic loss attributable to misrepresentation in inducement
to contract. The Johnsons’ claim does not rest on an alleged breach of any term of the QMT sales
contract; instead, it rests on alleged conduct by Mr. Welch occurring prior to the execution of the
contract.
In determining the gravamen or nature of the cause of action, courts must look to the act that
created the damages sought, regardless of whether a contract existed between the parties. Keller, 924
S.W.2d at 361; Harvest Corporation, 610 S.W.2d at 731. The Johnsons’ claim is for injury to their
property resulting from a misrepresentation that induced them to enter into the contract at the
purchase price therein. That claim is a tort claim subject to the three-year statute of limitations of
Tenn. Code Ann. § 28-3-105(1).
The Johnsons filed this lawsuit on September 23, 1999. The QMT sales contract was signed
in October of 1993, and S&S lost the three Paccar parts in March of 1994. No claim for
misrepresentation was raised within the three-year statute of limitations and is therefore time-barred.
Accordingly, we reverse the trial court’s award of a 40% rebate of the purchase price to the
Johnsons.15
VIII. THE JOHNSONS’ PERSONAL RELOCATION EXPENSES
The trial court awarded Mr. Johnson $17,290.67 plus prejudgment interest as damages for
S&S’s failure to pay its share of relocation and temporary living expenses as provided in the
employment agreement between S&S and Mr. Johnson. The court found that the failure to pay such
expenses was a breach of the employment agreement. The agreement required S&S to pay all
temporary living expenses and to share in moving and related expenses. The trial court found that
sharing meant sharing equally. Mr. Welch does not dispute the interpretation.
Instead, on appeal, Mr. Welch asserts that Mr. Johnson’s final request for reimbursement of
expenses totaled only $6,464.00 and that S&S paid Mr. Johnson $5,000, so the maximum liability
could only be $1,464.00. That argument overlooks the fact that two types of relocation expenses
were included in the agreement. While Mr. Johnson claimed only $6,464.60 in temporary living
expenses, he also claimed $31,652.14 in moving-related expenses. He requested half of the moving
expenses ($15,826.07) and all of the temporary living expenses ($6,464.60), with credit for the
$5,000 he had been reimbursed. The trial court accepted the claims and awarded Mr. Johnson
$17,290.67.
The trial court found that the $5,000 paid by Mr. Welch was “completely arbitrary,” without
any basis, and did not comply with the parties’ agreement. The court recounted that Mr. Welch
indicated $5,000 was plenty because he had moved from California to Tennessee in 1971 for less
than $5,000.
15
In view of this holding, we need not reach M r. W elch’s arguments that the evidence does not support a finding
of misrepresentation.
31
On appeal, Mr. Welch does not dispute any of the specific items claimed by Mr. Johnson.
His only argument is that the trial court erred by awarding Mr. Johnson expenses greater than those
he had requested from S&S and Mr. Welch. The trial court found that Mr. Johnson had protested
the payment of only $5,000, “but he was not in a position to do much else other than to protest” since
his family had relocated to Tennessee, he was employed by S&S, and, by the time the $5,000
payment was made, he and his wife had bought QMT and borrowed money to finance that purchase.
The evidence does not preponderate against the trial court’s determination of damages. We
affirm the judgment for breach of the employment agreement.
IX. CONCLUSION
We affirm the trial court’s judgments on all claims except the partial rebate claim, which we
reverse, and remand the case for any further proceedings which may be necessary. Costs of the
appeal are taxed to the appellants, Reed Welch, Olive Welch, and S&S Screw Machine Co., Inc.
____________________________________
PATRICIA J. COTTRELL, JUDGE
32