Brunswick hills racquet club v route 18

CHAPTER 18 CASE

1. You be the Judge

Anderson v. Country Life Insurance Co.

180 Ariz. 625 Arizona Court of Appeals, 1994

Facts

On November 26, a Country Life Insurance agent went to the house of Donald and Anna Mae Anderson. He persuaded the Andersons to buy a life insurance policy and accepted a check for $1,600. He gave the Andersons a “conditional receipt for medical policy,” dated that day. The form stated that the Andersons would have a valid life insurance policy with Country Life, effective November 26, but only when all conditions were met. The most important of these conditions was that the Country Life home office accepts the Andersons as medical risks. The Andersons were pleased with the new policy and glad that it was effective that same day.

It was not. Donald Anderson died of a heart attack a few weeks later. Country Life declined the Andersons as medical risks and refused to issue a policy. Anna Mae Anderson sued. Country Life pointed out that medical approval was a condition precedent. In other words, the company argued that the policy would be effective as of November 26, but only if it later decided to make the policy effective. Based on this argument, the trial court gave summary judgment for Country Life. Ms. Anderson appealed, claiming that the conditional clause was a violation of public policy.

You Be the Judge

Did the conditional clause violate public policy?

Argument for Ms. Anderson

Your honors, this policy is a scam. This so-called “conditional receipt for medical policy” is designed to trick customers and then steal their money. The company leads people to believe they are covered as of the day they write the check. But they aren’t covered until much later, when the insurer gets around to deciding the applicant’s medical status.

The company gets the customer’s money right away and gives nothing in exchange. If the company, after taking its time, decides the applicant is not medically fit, it returns the money, having used it for weeks or even months to earn interest. If, on the other hand, the insurance company decides the applicant is a good bet, it then issues the policy effective for weeks or months in the past, when coverage is of no use. No one can die retroactively, your honors. The company is being paid for a period during which it had no risk. This is a fraud and a disgrace, and the company should pay the benefits it owes.

Argument for Country Life

Your honors, is Country Life supposed to issue life insurance policies without doing a medical check? That is the road to bankruptcy and would mean that no one could obtain this valuable coverage. Of course, we do a medical inquiry, as quickly as possible. It’s in our interest to get the policy decided one way or the other.

The policy clearly stated that coverage was effective only when approved by the home office, after all inquiries were made. The Andersons knew that as well as the agent. If they were covered immediately, why would the company do a medical check? Country Life resents suggestions that this policy is a scam, when in reality it is Ms. Anderson who is trying to profit from a tragedy that the company had nothing to do with.

The facts of this case are unusual. Obviously, most insureds do not die between application and acceptance. It would be disastrous for society to rewrite every insurance policy in this state based on one very sad fact pattern. The contract was clear and it should be enforced as written.

2. Brunswick Hills Racquet Club Inc. v. Route 18 Shopping Center Associates

182 N.J. 210 Supreme Court of New Jersey, 2005

Facts

Brunswick Hills Racquet Club (Brunswick) owned a tennis club on property that it leased from Route 18 Shopping Center Associates (Route 18). The lease ran for 25 years, and Brunswick had spent about $1 million in capital improvements. The lease expired, and Brunswick had the option of either buying the property or purchasing a 99-year lease, both on very favorable terms. To exercise its option, Brunswick had to notify Route 18 no later than September 30 and had to pay the option price of $150,000. If Brunswick failed to exercise its options, the existing lease automatically renewed as of September 30, for 25 more years, but at more than triple the current rent.

Brunswick’s lawyer wrote to Rosen Associates, the company that managed Route 18, nineteen months before the option deadline, stating that Brunswick intended to exercise the option for a 99-year lease. He requested that the lease be sent well in advance so that he could review it. He did not make the required payment of $150,000. Rosen replied that it had forwarded Spector’s letter to its attorney, who would be in touch. In April, Spector again wrote, asking for a reply from Rosen or its lawyer.

Over the next six months, the lawyer continually asked for a copy of the lease or further information, but neither Route 18’s lawyer nor anyone else provided any data. Eventually, the September deadline passed.

Route 18’s lawyer notified Brunswick that it could not exercise its option to lease because it had failed to pay the $150,000 by September 30.

Brunswick sued, claiming that Route 18 had breached its duty of good faith and fair dealing. The trial court found that Route 18 had no duty to notify Brunswick of impending deadlines, and it gave summary judgment for Route 18. The appellate court affirmed, and Brunswick appealed to the state supreme court.

Issue

Did Route 18 breach its duty of good faith and fair dealing?

Excerpts from Justice Albin’s Decision

Courts generally should not tinker with a finely drawn and precise contract entered into by experienced business people that regulates their financial affairs. [However,] every party to a contract is bound by a duty of good faith and fair dealing in both the performance and enforcement of the contract. Good faith is a concept that defies precise definition. Good faith conduct is conduct that does not violate community standards of decency, fairness, or reasonableness. The covenant of good faith and fair dealing calls for parties to a contract to refrain from doing anything which will have the effect of destroying or injuring the right of the other party to receive the benefits of the contract.

Our review of the undisputed facts of this case leads us to the inescapable conclusion that defendant breached the covenant of good faith and fair dealing. Nineteen months in advance of the option deadline, plaintiff notified defendant in writing of its intent to exercise the option to purchase the 99-year lease. Plaintiff mistakenly believed that the purchase price was not due until the time of closing.

During a 19-month period, defendant, through its agents, engaged in a pattern of evasion, sidestepping every request by plaintiff to discuss the option and ignoring plaintiff’s repeated written and verbal entreaties to move forward on closing the 99-year lease despite the impending option deadline and obvious potential harm to plaintiff.

Defendant never requested the purchase price of the lease. Indeed, as defendant’s attorney candidly admitted at oral argument, defendant did not want the purchase price because the successful exercise of the option was not in defendant’s economic interest.

Ordinarily, we are content to let experienced commercial parties fend for themselves and do not seek to introduce intolerable uncertainty into a carefully structured contractual relationship by balancing equities. But there are ethical norms that apply even to the harsh and sometimes cutthroat world of commercial transactions. We do not expect a landlord or even an attorney to act as his brother’s keeper in a commercial transaction. We do expect, however, that they will act in good faith and deal fairly with an opposing party. Plaintiff’s repeated letters and telephone calls to defendant concerning the exercise of the option and the closing of the 99-year lease obliged defendant to respond, and to respond truthfully.

[Plaintiff is entitled to exercise the 99-year lease.]

3. The following case raises the issue in the context of a major college sports program.

O’Brien v. Ohio State University

2007-Ohio-4833 Court of Appeals of Ohio, 2007

Facts

Ohio State University (OSU), experiencing a drought in its men’s basketball program, brought in Coach Jim O’Brien to turn things around. The plan was successful. In only his second year, he guided the team to its best record ever. The team advanced to the Final Four, and O’Brien was named national coach of the year. OSU’s athletic director promptly offered the coach a new, multiyear contract worth about $800,000 per year.

Section 5.1 of the contract included termination provisions. The university could fire O’Brien for cause if

there was a material breach of the contract by the coach or

O’Brien’s conduct subjected the school to NCAA sanctions.

OSU could also terminate O’Brien without cause, but in that case, it had to pay him the full salary owed.

O’Brien began recruiting a talented 21-year-old Serbian player named Alex Radojevic. While getting to know the young man, O’Brien discovered two things. First, it appeared that Radojevic had been paid to play briefly for a Yugoslavian team, meaning that he was ineligible to play college basketball. Second, it was clear that Radojevic’s family had suffered terribly during the strife in his homeland.

O’Brien concluded that Radojevic would never play for OSU or any major college. He also decided to loan Radojevic’s mother some money. Any such loan would violate an NCAA rule if done to recruit a player, but O’Brien believed the loan was legal since Radojevic could not play in the NCAA anyway. Several years later, the university learned of the loan and realized that O’Brien had never reported it. Hoping to avoid trouble with the NCAA, OSU imposed sanctions on itself. The university also fired the coach, claiming he had lied, destroyed the possibility of postseason play, and harmed the school’s reputation.

O’Brien sued, claiming he had not materially breached the contract. The trial court awarded the coach $2.5 million, and the university appealed.

Issue

Did O’Brien materially breach the contract?

Excerpts from Judge Tyack’s Decision

OSU argued that it was substantially injured by the self-imposed sanctions, which included a ban from post-season and NCAA tournament play [during the current season], and relinquishing two basketball scholarships from the [next] recruiting class. Contrary to OSU’s argument, however, the trial court found these sanctions to be insubstantial. [Athletic Director] Geiger announced the one-year post-season ban in December, and it appears from the timing of that announcement that Geiger made the decision based on the fact that the team was unlikely to be invited to a post-season tournament in the first place.

The second alleged harm was harm to OSU’s reputation. The trial court found that any reputational harm was similarly exaggerated, at least as it specifically related to the Radojevic matter. Radojevic never enrolled at OSU, and never played a single second for OSU’s basketball team.

NCAA violations happen all the time. It’s the nature of the beast. Also relevant to the issue of OSU’s allegedly damaged reputation is the fact that almost immediately after firing O’Brien, OSU was able to lure one of the nation’s top coaching prospects, [Thad Matta], to assume O’Brien’s former position. Shortly thereafter, Matta successfully recruited possibly the best recruiting class ever. Based on this evidence, the trial court could reasonably find the Radojevic loan did not cause serious harm to OSU.

OSU argues that O’Brien acted in bad faith by covering up his misconduct for several years. In the words of OSU’s counsel at oral argument: “If lying to your employer for four years is not a material breach, it’s hard to imagine what would be! ” Although the premise for counsel’s argument is sound, it is unsound in application because it assumes facts not in evidence. Counsel for OSU assumes for the purposes of the argument that O’Brien systematically either denied allegations about the Radojevic loan, or took affirmative steps to conceal it from OSU. The evidence does not support such a conclusion. After Radojevic was drafted by the NBA, there is not a single inference that can be drawn from the record to suggest that O’Brien even thought about the loan. In O’Brien’s own mind, he did not believe he had done anything wrong; thus, he would not have had a motive to conceal what he had done.

[There was no material breach.]

Affirmed.

4.The following case involves risky business, complex financial instruments, and a lot of excuses. Does a global credit meltdown excuse a party’s duty to pay?

Hoosier Energy Rural Electric Cooperative, Inc. v. John Hancock Life Insurance Co.

582 F.3d 721 United States Court of Appeals for Seventh Circuit, 2009

Facts

John Hancock Life Insurance Co. receives lots of cash in premium payments, which it then invests so that it will have enough funds to pay claims from its policy holders. To this end, it entered into a leveraged lease with Hoosier Energy. This transaction was highly complex and only profitable because of convoluted provisions of the tax code. (You definitely do not want to try this at home.) In short, Hancock paid Hoosier $300 million to lease a power plant for 63 years, which Hoosier then leased back for 30 years.

But Hancock foresaw some risks: What if the power station became unprofitable? What if Hoosier stopped paying rent? (What would Hancock do if it was stuck with a power plant?) To mitigate these risks, it asked to Hoosier to secure a credit-default swap (CDS). A CDS is a financial contract that acts as insurance against a loan default and other contingencies. Ambac Assurance Corporation, the CDS provider, agreed to pay Hancock if certain events occurred. One of those triggering events was a decline in Ambac’s own credit rating below a certain level. In that case, Hoosier had to find a replacement swap partner. If Hoosier was unsuccessful, Ambac would pay Hancock $120 million.

And then came 2008—and a global financial crisis. Ambac’s credit rating plummeted, along with pretty much everyone else’s. Hancock demanded that Hoosier find a replacement, but Hoosier stalled. If it replaced Ambac, it would have to pay big money—enough to send Hoosier into bankruptcy. So Hoosier sued, requesting an injunction to suspend its duty to find a swap partner. It claimed that the global financial crisis rendered its performance impossible—or at the very least, “temporarily impracticable” until the economy improved. The lower court sympathized with Hoosier and granted the injunction. Hancock appealed.

Issue

Did the global credit crisis render performance impossible?

Excerpts from Judge Easterbrook’s Decision

Like other states, New York recognizes the doctrine of impossibility—but even then only the kind of impossibility that the parties could not have anticipated. Here, the parties anticipated the possibility that Hoosier, Ambac, or both might get into financial distress and provided what was to happen.

Suppose that Hoosier had an in-the-money option to purchase the Indianapolis Colts, and that as a result of the reduced availability of credit it was unable to find a lender to finance the transaction. That would not make performance “impossible.” The “impossibility” doctrine never justifies failure to make a payment, because financial distress differs from impossibility.

It is hard to see why Hoosier should be able to stiff John Hancock, just because the very risk specified in the contract has occurred. Hoosier did not expect an economic downturn. Downturns are types of things that happen, and against which contracts can be designed. When they do happen, the contractual risk allocation must be enforced rather than set aside.

The district court called the credit crunch of 2008 a “once-in-a-century” event. That’s an overstatement (the Great Depression occurred within the last 100 years, and the 20th Century also saw financial crunches in 1973 and 1987), and also irrelevant. An insurer that sells hurricane or flood insurance against a “once in a century” catastrophe, or earthquake insurance in a city that rarely experiences tremblors, can’t refuse to pay on the ground that, when a natural event devastates a city, its very improbability makes the contract unenforceable.

The defense works only if some unexpected event upsets all parties’ expectations; it is not enough that the unexpected event puts one side in a bind. Financial distress could be and was foreseen; that’s what the credit-default swap is all about.

Chapter 18 : Case Questions

1. ETHICS Commercial Union Insurance Co. (CU) insured Redux, Ltd. The contract made CU liable for fire damage but stated that the insurer would not pay for harm caused by criminal acts of any Redux employees. Fire destroyed Redux’s property. CU claimed that the “criminal acts” clause was a condition precedent, but Redux asserted it was a condition subsequent. What difference does it make, and who is legally right? Does the insurance company’s position raise any ethical issues? Who drafted the contract? How clear were its terms?

Answer:

The type of condition determines who must prove the source of the fire. CU claimed that the clause was a condition precedent, meaning that Redux had the burden of proving the fire was not arson. Redux argued that the clause was a condition subsequent, meaning that CU became liable to pay benefits as soon as the fire started, and could escape its duty only if the insurer proved Redux had committed arson. The court agreed with Redux, held that the clause was a condition subsequent, and placed the burden on CU to prove arson. Redux, Ltd. v. Commercial Union Ins. Co., 1995 U.S. Dist. LEXIS 2545 (D. Kan. 1995). The most obvious ethical issues arise around the language of the contract and the sale of the policy. The contract says that the insurer is not liable for harm caused by criminal acts of employees. However, the contract says nothing about who must prove whether the harm was caused by such crimes. Further, it is very unlikely that the insurance agent explained, when selling the policy, that in the event of fire the insured company would have to prove the harm was not caused by employee arson. Some would say, as this court did, that the company is attempting to sneak one by its policyholders, using ambiguous language to help sell the policy, then sandbagging the insured once a loss occurs, claiming a contract interpretation that it had never before mentioned. Many would argue that the company that drafts a contract has an ethical obligation to make its terms clear. It is hard to believe that the insurance company would desire to be treated this way—for example, by reinsurers upon whom it depends.

2. Stephen Muka owned U.S. Robotics. He hired his brother Chris to work in the company. His letter promised Chris $1 million worth of Robotics stock at the end of one year, “provided you work reasonably hard & smart at things in the next year.” (We should all have such brothers.) Chris arrived at Robotics and worked the full year, but toward the end of the year, Stephen died. His estate refused to give Chris the stock, claiming their agreement was a personal satisfaction contract and only Stephen could decide whether Chris had earned the reward. Comment.

3.Ken Ward was an Illinois farmer who worked land owned by his father-in-law, Frank Ruda. To finance his operation, he frequently borrowed money from Watseka First National Bank, paying back the loans with farming profits. But Ward fell deeper and deeper into debt, and Watseka became concerned. When Ward sought additional loans, Watseka insisted that Ruda become a guarantor on all of the outstanding debt, and the father-in-law agreed. The new loans had an acceleration clause, permitting the bank to demand payment of the entire debt if it believed itself “insecure”; that is, at risk of a default. Unfortunately, just as Ward’s debts reached more than $120,000, Illinois suffered a severe drought, and Ward’s crops failed. Watseka asked Ruda to sell some of the land he owned to pay back part of the indebtedness. Ruda reluctantly agreed but never did so. Meanwhile, Ward decreased his payments to the bank because of the terrible crop. Watseka then “accelerated” the loan, demanding that Ruda pay off the entire debt. Ruda defended by claiming that Watseka’s acceleration at such a difficult time was bad faith. Who should win?

Answer

The bank won. Good faith in this setting requires that the bank honestly believe itself to be insecure, and that there be some basis for the belief. The bank honestly did consider itself at risk of a default, and the combination of the drought and Ruda’s refusal to sell land provided a basis for the belief. Watseka First Natl. Bank v. Ruda, 135 Ill. 2d 140, 552 N.E.2d 775, 1990 Ill. LEXIS 20 (1990).

4. Loehmann’s clothing stores, a nationwide chain with headquarters in New York, was the anchor tenant in the Lincoln View Plaza Shopping Center in Phoenix, Arizona, with a 20-year lease from the landlord, Foundation Development, beginning in 1978. Loehmann’s was obligated to pay rent the first of every month and to pay common-area charges four times a year. The lease stated that if Loehmann’s failed to pay on time, Foundation could send a notice of default, and that if the store failed to pay all money due within 10 days, Foundation could evict. On February 23, 1987, Foundation sent to Loehmann’s the common-area charges for the quarter ending January 31, 1987. The balance due was $3,500. Loehmann’s believed the bill was in error and sent an inquiry on March 18, 1987. On April 10, 1987, Foundation insisted on payment of the full amount within 10 days. Foundation sent the letter to the Loehmann’s store in Phoenix. On April 13, 1987, the Loehmann’s store received the bill and, since it was not responsible for payments, forwarded it to the New York office. Because the company had moved offices in New York, a Loehmann’s officer did not see the bill until April 20. Loehmann’s issued a check for the full amount on April 24 and mailed it the following day. On April 28, Foundation sued to evict; on April 29, the company received Loehmann’s check. Please rule.

5. YOU BE THE JUDGE WRITING PROBLEM Kuhn Farm Machinery, a European company, signed an agreement with Scottsdale Plaza Resort, of Arizona, to use the resort for its North American dealers’ convention during March 1991. Kuhn agreed to rent 190 guest rooms and spend several thousand dollars on food and beverages. Kuhn invited its top 200 independent dealers from the United States and Canada and about 25 of its own employees from the United States, Europe, and Australia, although it never mentioned those plans to Scottsdale.

On August 2, 1990, Iraq invaded Kuwait, and on January 16, 1991, the United States and allied forces were at war with Iraq. Saddam Hussein and other Iraqi leaders threatened terrorist acts against the United States and its allies. Kuhn became concerned about the safety of those traveling to Arizona, especially its European employees. By mid-February, 11 of the top 50 dealers with expense-paid trips had either canceled their plans to attend or failed to sign up. Kuhn postponed the convention. The resort sued. The trial court discharged the contract under the doctrines of commercial impracticability and frustration of purpose. The resort appealed. Did commercial impracticability or frustration of purpose discharge the contract? Argument for Scottsdale Plaza Resort: The resort had no way of knowing that Kuhn anticipated bringing executives from Europe, and even less reason to expect that if anything interfered with their travel, the entire convention would become pointless. Most of the dealers could have attended the convention, and the resort stood ready to serve them. Argument for Kuhn: The parties never anticipated the threat of terrorism. Kuhn wanted this convention so that its European executives, among others, could meet top North American dealers. That is now impossible. No company would risk employee lives for a meeting. As a result, the contract has no value at all to Kuhn, and its obligations should be discharged by law.

Answer:

Reversed. Summary judgment granted for Scottsdale Plaza, with the case remanded to the trial court to assess damages. Kuhn has no legitimate claim for impossibility or impracticability. Kuhn does not and cannot allege that it was impossible for it to perform, but rather that the resort’s performance had been rendered worthless. That is a claim of frustration of purpose. To win on such a claim, Kuhn must show that the principal purpose in entering the contract was a convention at which the European employees would appear. That was not a principal purpose of the contract. Further, the majority of dealers were still prepared to attend. There has been no frustration of purpose. 7200 Scottsdale Road v. Kuhn Farm Machinery, Inc., 909 P.2d 408, 1995 Ariz. App. LEXIS 108 (Ariz. Ct. App. 1995).