July 19, 2012
SUPREME SECURITY SYSTEMS, INC., PLAINTIFF-APPELLANT,
AARON MEDICAL TRANSPORTATION, INC. AND JOSEPH THOMAS, DEFENDANTS-RESPONDENTS.
On appeal from the Superior Court of New Jersey, Law Division, Special Civil Part, Bergen County, Docket No. DC-27443-07.
NOT FOR PUBLICATION WITHOUT THE APPROVAL OF THE APPELLATE DIVISION
Submitted July 10, 2012
Before Judges Sabatino and Kennedy.
This contract dispute returns on plaintiff's renewed appeal following a remand to the Special Civil Part that we ordered in an unpublished opinion some three years ago. See Supreme Sec. Sys., Inc. v. Aaron Med. Transp., Inc., No. A-0368-08 (App. Div. Oct. 23, 2009). On remand, the trial judge found that the boilerplate liquidated damages provision in the parties' contract for the leasing of security equipment was unenforceable under the circumstances of this case. The judge slightly increased, however, the net compensatory damages payable by defendants to plaintiff.
In its renewed appeal, plaintiff contends that the judge erred in refusing to enforce the liquidated damages provision and that, accordingly, its recovery from defendants should be substantially increased to include the sum due under the liquidated damages formula. In particular, plaintiff maintains that the judge erred in finding the liquidated damages provision unenforceable primarily because of plaintiff's supposed failure to mitigate damages. Plaintiff argues in its appellate brief that it is a "lost volume seller" and thereby would not be able to mitigate damages by attempting to lease the returned equipment to another customer.
We agree with plaintiff that a non-breaching seller's failure to mitigate damages at the time of a breach does not necessarily invalidate a liquidated damages provision in a fungible-goods context involving a lost volume seller. Nevertheless, we are constrained to remand this case a second time because the factual record was not developed in the trial court to establish whether or not plaintiff qualifies as such a lost volume seller.
The relevant facts are already detailed in our 2009 unpublished opinion and need not be repeated here at length. By way of summary, plaintiff Supreme Security Systems, Inc., contracted with defendants Aaron Medical Transportation, Inc., and Joseph Thomas to design a surveillance system and install surveillance cameras at defendants' business premises. The agreement called for an installation fee of $2200, plus a monthly charge of $188 payable to plaintiff over five years. During the installation, the parties agreed to make some modifications to the equipment which, in turn, affected the installation charge and the monthly fees. Ultimately, the total agreed upon price for installation was $2800.
When the parties agreed to these arrangements in May 2006, their contract reflected that defendants would be moving to a new location, and that plaintiff would move the system to defendants' new quarters on a "time and material basis." The contract also stated that in the event of a default, defendants would be responsible for 80% of the unpaid monthly charges for the contract's "unexpired term." More specifically, the liquidated damages provision stated:
14. Default of Subscriber. In the event of any default by Subscriber, without limiting the rights of Company under this Agreement or at law or equity, Company shall be entitled to retain all prepayments received and Subscriber shall immediately pay to Company (a) all payments then due and payable, (b) all charges for labor, material and equipment incurred by Company due to such default based on a time and material basis at Company's then prevailing charges, and (c) eighty percent (80%) of all payments which would be due hereunder for the unexpired term as liquidated damages and not as a penalty; and Company shall have no further obligation to perform under this Agreement. In addition, if any suit or alternative dispute resolution proceeding is instituted and Company is the substantially prevailing party by judgment, award, finding or settlement, Subscriber shall pay directly or reimburse Company for all of its costs and expenses including, without limitation or example, consultants' and professionals' fees and costs including, without limitation or example, reasonable attorneys' fees and costs. [Emphasis added.]
Shortly after the five-year contract began and the equipment was installed at their business, defendants experienced problems with the system. They consequently refused to pay plaintiff the bulk of the remaining amount due. Defendants also advised plaintiff that they were moving from the site in January 2007, and that plaintiff would have to remove the system or their landlord would dispose of it when the building was demolished. Some discussion ensued about installing the system in defendants' new quarters, but plaintiff refused to do that unless defendants paid all of the past due balances. Defendants failed to pay the full balance that plaintiff alleged was due. Plaintiff then recovered its equipment, which had a value, as ultimately determined by the trial court, of $2800.
Plaintiff then filed the present breach of contract action against defendants in the Special Civil Part. The complaint sought the unpaid amount due from defendants, plus liquidated damages equaling 80% of the remaining installments on the balance of the contract. Defendants counterclaimed, asserting that plaintiff, not they, had breached the contract by selling them a defective security system.
After a bench trial in August 2008 at which plaintiff's account receivables clerk and defendants' principal Thomas testified, the trial judge entered a judgment in favor of plaintiff in an oral opinion. Taking into account the payments that defendants had already made and the value of the equipment returned to plaintiff's possession, the judge initially awarded plaintiff a judgment for $200 in net compensatory damages, plus court costs. Although not explicitly rejecting the liquidated damages provision, the judge's initial ruling did not enforce it.
Plaintiff then filed its first appeal, contesting the trial judge's calculation of damages. We remanded the case back to the Special Civil Part, specifically instructing the trial court to make "more complete findings" on the damages issues, and, in particular, to assess whether the liquidated damages provision constituted an unenforceable penalty under Wasserman's, Inc. v. Township of Middletown, 137 N.J. 238, 249 (1994), and other applicable legal principles. See Supreme Sec. Sys., supra, slip op. at 7-8.
On August 26, 2010, the trial judge issued a letter opinion addressing the remand issues based upon the evidential record that had been developed at the 2008 trial.*fn1 In his letter opinion, the judge revised his calculations of compensatory damages, increasing the net award to plaintiff from $200.00 to $364.45. The judge explicitly declined to enforce the liquidated damages provision, given that under the principles of Wasserman's, the provision must "constitute a reasonable forecast of the provabl[e] injury," and not be "disproportionate." In particular, the judge noted plaintiff's failure to mitigate its damages after reacquiring the equipment. The judge also found significant the fact that "[p]laintiff [had] recovered the equipment not solely due to a default [by defendants] but due to the fact that [d]efendants' premises were slated for demolition by the landlord."
Plaintiff again appeals, seeking to overturn the trial court's rejection of its claim for liquidated damages. Plaintiff does not appeal the revised award of compensatory damages independent of the liquidated damages provision. Defendants have not cross-appealed.
A liquidated damages provision may be an appropriate mechanism to remedy a breach of contract where the promissee's actual damages flowing from the breach are difficult to measure. Wasserman's, supra, 137 N.J. at 248-50. Such a clause "'must constitute a reasonable forecast of the provable injury resulting from breach; otherwise the clause will be unenforceable as a penalty and the non-breaching party will be limited to conventional damage measures.'" Id. at 249 (quoting Charles J. Goetz & Robert E. Scott, Liquidated Damages, Penalties and the Just Compensation Principle: Some Notes on an Enforcement Model and a Theory of Efficient Breach, 77 Colum. L. Rev. 554, 554 (1977)). "The amount fixed is unreasonable if it serves not as a pre-estimate of probable actual damages, but rather as 'punishment,' . . . grossly disproportionate to the actual harm sustained." CSFB 2001-CP-4 Princeton Park Corporate Ctr., LLC v. SB Rental I, LLC, 410 N.J. Super. 114, 121 (App. Div. 2009) (citing Westmount Country Club v. Kameny, 82 N.J. Super. 200, 205-06 (App. Div. 1964)).
The court will not enforce liquidated damages provisions if they place an unfair penalty on the party that has breached the contract. In Wasserman's, supra, 137 N.J. at 252, the Supreme Court set forth various factors for evaluating whether a liquidated damages provision is enforceable. "Treating reasonableness 'as the touchstone,' [the Court] noted that the difficulty in assessing damages, intention of the parties, the actual damages sustained, and the bargaining power of the parties all affect the validity of a stipulated damages clause." Metlife Capital Fin. Corp. v. Washington Ave. Assocs., L.P., 159 N.J. 484, 495 (1999) (quoting Wasserman's, supra, 137 N.J. at 252). However, the Court has explained that no individual factor is determinative to the analysis. Ibid. A declaration within the contract that its liquidated damages provision does not constitute a penalty is not dispositive, and does not preclude judicial review of the provision's enforceability. Wasserman's, supra, 137 N.J. at 251. Hence, we are not bound by the recitation in paragraph fourteen of the parties' contract that the liquidated damages formula does not comprise a penalty.
Our courts have also held, at least in a setting involving two commercial parties to a contract, that a liquidated damages provision is deemed "presumptively reasonable." Id. at 252. A litigant "challenging such a clause should bear the burden of proving its unreasonableness." Ibid. Such a presumption is justified in the business-to-business setting because "[i]n commercial transactions between parties with comparable bargaining power, [liquidated] damage provisions can provide a useful and efficient remedy." Id. at 253.
The trial judge referred to these general principles stemming from Wasserman's in his remand opinion. In applying those concepts, the judge largely focused upon his finding from the trial testimony that plaintiff had not made an attempt to mitigate its damages once it had recovered the equipment from defendants in January 2007. That factual finding was reasonably consistent with the testimony of plaintiff's sole witness, who acknowledged that plaintiff had stored the equipment after taking it back from defendants. There is no indication in the record that plaintiff made any further attempt to lease the recovered equipment to any other customer. Nor was there any evidence that the equipment was returned to plaintiff in a damaged condition that would make it incapable of being sold or leased to another customer, or modified to another customer's purposes. Given those circumstances, the trial judge concluded that the liquidated damages provision was unenforceable because "[t]he evidence presented at trial did not show that the [p]laintiff attempted to mitigate damages" and "presumably, since the equipment has been in its possession[,] the [p]laintiff could generate a profit from its use."
Generally, "[d]amages will not be recovered to the extent that the injured party could have avoided his [or her] losses through reasonable efforts 'without undue risk, burden or humiliation.'" Ingraham v. Trowbridge Builders, 297 N.J. Super. 72, 82-83 (App. Div. 1997) (quoting Restatement (Second) of Contracts § 350(1), (2) (1981)); cf. Quinlan v. Curtiss-Wright Corp., 425 N.J. Super. 335, 359-71 (App. Div. 2012) (applying duty-to-mitigate principles in the context of lost back pay and front pay sought by a plaintiff in an employment discrimination case).
These mitigation principles are tempered, however, when applied to situations in which the seller has sold fungible products to a breaching buyer, and in which the seller has already maximized the sales that it could generate to other customers. In such a so-called "lost volume seller" scenario, the seller presumably cannot gain any net advantage by reselling the goods that it originally sold to defendant, because returning those goods to the seller's inventory presumably would not increase the seller's already-maximized sales. For such a situation involving fungible items, "the seller must sustain the burden of establishing that he [or she] is in fact a lost volume seller, and if he [or she] fails to do so he [or she] will be deemed an ordinary seller who must give credit for the proceeds of a resale in determining lost profit damages for the breach." Van Ness Motors, Inc. v. Vikram, 221 N.J. Super. 543, 545, (App. Div. 1987) (citing Snyder v. Herbert Greenbaum & Assocs., Inc., 380 A.2d 618, 625 (Md. Ct. Spec. App. 1977)). Under our case law, the onus is therefore on the seller to prove that the lost volume rule relieves it of a responsibility to mitigate its losses. If that burden is met by the seller, it logically will bear upon the reasonableness of the liquidated damages provision and the likely "actual damages sustained" by the non-breaching plaintiff. See Wasserman's, supra, 137 N.J. at 252.
Plaintiff asserts for the first time in its brief on appeal that it is such a lost volume seller that had no obligation to mitigate its losses once it recovered the equipment from defendants. Without any citation to the trial proofs, plaintiff asserts in its brief that "the components [of the security system] themselves were not in limited supply and could be used in as many custom applications as [p]laintiff's customers required." Similarly, plaintiff hypothesizes, without citation to the record, that "[i]f another customer were to present itself, a new, custom system perhaps using similar components would be designed, installed, tested and, once operational, put into service. Plaintiff would [thus] be entitled to the benefit of both bargains."
The problem with plaintiff's newly-minted assertion that it is a lost volume seller is that there is no factual support for that assertion in the record. At most, plaintiff's trial witness simply asserted that plaintiff was "losing the leasing capabilities on the contract[,]" without establishing that the company had otherwise maximized its sales. In his summation at trial, plaintiff's counsel did not argue that plaintiff was a lost volume seller, nor did he refer to the concept.
Even if, for the sake of discussion, plaintiff is presumed to have been a lost volume seller at the time of defendant's breach, that does not necessarily mean that it lacked an obligation to attempt to mitigate its damages in the remaining four years of defendants' contract. It is not clear from the record that plaintiff could not recapture some revenue for the returned equipment in the remaining years of the contract. It is equally unclear whether it is likely that the seller's inventory of equipment would continuously exceed customer demand during those remaining years and that the equipment recovered from defendants would be of no value in generating any additional future revenue.
The trial judge did not explore these "lost volume" concepts in his opinion. Consequently, we cannot fairly evaluate his conclusion that the liquidated damages provision unreasonably fails to take into account the possibility of mitigating damages. Although defendants bore the burden of proving that the liquidated damages clause was unreasonable, a proper analysis of whether they met that burden hinges upon whether or not plaintiff is, as it now argues before us, a lost volume seller. Because that important question was not addressed at the trial level and defendants were not given fair notice at trial that plaintiff would claim such status, we remand this case once again to enable the full development of such proofs and arguments. Cf. C.I.C. Corp. v. Ragtime, Inc., 319 N.J. Super. 662, 669-70 (App. Div. 1999) (remanding for a new trial on damages to allow the fact-finder to consider whether or not plaintiff was indeed a lost volume seller).
The record also would benefit from further exploration of plaintiff's use of a "gross receipts" liquidated damages provision that is based upon 80% of future revenue due under the remaining contract term. The provision uses a fixed 80% multiplier of revenue anticipated for the remaining term of the contract, regardless of how early or how late in the five-year contract term that a breach occurs. The trial judge concluded that the 80% formula is "not a reasonable assessment of actual damages, [but] rather an arbitrary number used only to penalize subscribers."*fn2
As the Court instructed in Wasserman's, supra, 137 N.J. at 254, gross receipts generally "do not reflect actual losses incurred because of the cancellation." Unlike net profits, gross receipts "do not account for ordinary expenses; nor do they account for the expenses specifically attributable to the breach." Ibid. Hence, "[w]hether measured from the time of execution of the contract or from the termination of the lease . . . [liquidated] damages based on gross receipts run the risk of being found unreasonable." Ibid. (citation omitted). For that reason, among other things, the Court remanded the enforceability issue in Wasserman's to the trial court because the record was unclear as to whether the liquidated damages clause in that case, which was based upon 25% of the plaintiff's average gross receipts for one year, was reasonable or not. Id. at 257-58.
Here, we are presented with a much more severe liquidated damages clause, involving an 80%, rather than a 25%, gross receipts formula. Such a high fixed percentage could result in a very substantial monetary liability for a buyer that breaches a multi-year contract shortly after the contract begins. We do not perceive that such an 80% fixed formula is per se unreasonable, or that it would comprise an unenforceable penalty in all instances. However, the record is sparse with respect to the merits of the 80% formula and its reliance upon future gross receipts without regard to the timing of a purchaser's breach.
While, as we have noted, defendants bear the burden of showing that a liquidated damages clause is unreasonable, see Wasserman's, supra, 137 N.J. at 258, the record originally developed in the trial court raised significant questions about the reasonableness of the 80% formula, in light of the undisputed return of the equipment to plaintiff within the first year of the contract and the lack of any clear nexus between the formula and plaintiff's actual losses. Plaintiff failed to present any responsive proofs on that subject. This appears to be an issue that warrants closer scrutiny and the development of a fuller record as to the reasonableness of the 80% formula.
The trial judge also found that the equipment was returned to plaintiff "not solely due to a default but due to the fact that [d]efendants' premises were slated for demolition by the landlord." This finding is credibly supported by the trial testimony, and warrants our deference. Rova Farms Resort, Inc. v. Investors Ins. Co. of Am., 65 N.J. 474, 483-84 (1974). The finding could bear upon the relative equities at stake, and the harshness of an indiscriminate application of the liquidated damages clause in this situation. In this case, because of the third-party landlord's decision to demolish the premises, defendants would have been prevented from continuing to make use of the security system at the installed location even if they had continued to make timely payments under the contract. Cf. Directions, Inc. v. New Prince Concrete Constr. Co., 200 N.J. Super. 639, 643 (App. Div. 1985) (applying principles of frustration of purpose that may affect a non-performing party's contractual liability). On the other hand, the significance of these equitable considerations cannot be fully evaluated in a vacuum, without first assessing on remand (1) whether plaintiff is indeed a lost volume seller, and (2) whether the fixed 80% formula reasonably forecasts the anticipated actual harm.
For these reasons, the matter is remanded to the trial court a second time for further development of the record and, in particular, proofs addressing (1) plaintiff's claim of the status of a lost volume seller, and (2) the bona fides of the 80% formula that is based upon a gross revenue methodology. We do not retain jurisdiction.