R. Island Charities Trust v. Engelhard Corp, 01-1219

• Decision Date: 03 July 2001
• Docket Number: No. 01-1219,01-1219
• Citation: 267 F.3d 3
• Parties: (1st Cir. 2001) THE RHODE ISLAND CHARITIES TRUST, Plaintiff, Appellee, v. ENGELHARD CORPORATION, Defendant, Appellant. Heard
• Court: U.S. Court of Appeals — First Circuit

Page 3

267 F.3d 3 (1st Cir. 2001)

THE RHODE ISLAND CHARITIES TRUST, Plaintiff, Appellee, v. ENGELHARD CORPORATION, Defendant, Appellant.

No. 01-1219

United States Court of Appeals For the First Circuit

Heard July 3, 2001

Decided September 27, 2001

APPEAL FROM THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF RHODE ISLAND

[Hon. Ronald R. Lagueux, U.S. District Judge] H. Jerome Strickland with whom Robert C. Norman, Jones, Cork & Miller, Benjamin V. White and Vetter & White were on brief for appellant.

Michael P. DeFanti with whom Brian C. Newberry and Hinckley, Allen & Snyder LLP were on brief for appellee.

Before Boudin, Chief Judge, Gibson,^* Senior Circuit Judge,and Torruella, Circuit Judge.

BOUDIN, Chief Judge.

Engelhard Corporation appeals from the district court's grant of summary judgment, and its award of $597,463 in damages plus $191,029.60 in prejudgment interest, in favor of the Rhode Island Charities Trust ("the Trust"). The facts are somewhat complicated but undisputed.

In 1937, the Trust was formed for the purpose of distributing money grants for charitable purposes. In 1948, the Trust purchased Southern Clays, Inc., a kaolin mining and processing company based in Georgia. Kaolin is a clay which, among other uses, is widely employed in the paper industry. In 1963, the Trust sold nearly all of the assets of Southern Clays, with the exception of certain clay properties in Washington County, Georgia, to the Freeport Sulphur Company ("Freeport").

At the same time, Southern Clays and Freeport entered into a ninety-nine year agreement (the "Indenture") as to properties containing the clay. Some of the properties are owned in fee by the Trust (the "fee properties"), while other properties are owned by third parties who have entered into mineral leases with the Trust with termination dates ranging from 1967 to 2023 (the "leased properties"). Under the Indenture the Trust leased the fee properties to Freeport, and it assigned to Freeport its rights as to the leased properties. Engelhard acquired Freeport in 1985 and is its successor in interest; the Trust has succeeded to Southern Clays' rights under the Indenture.

The Indenture, whose pertinent provisions are reprinted in an appendix to this decision, requires a royalty payment to the Trust from Engelhard in consideration of the latter's right to mine the clay from the covered properties. To oversimplify slightly, the royalty rate for each period was 1.5 percent of Engelhard's "net receipts" from kaolin derived from the properties and sold by Engelhard during the period. Indenture ¶ 5(a). Engelhard was also required to pay real estate taxes on the fee properties and to make various payments on the leased properties, including the royalties that the Trust was required to pay to the third-party owners. Id. ¶ 7(a), (c). Engelhard was entitled to deduct these payments from the royalties it paid to the Trust. Id. ¶ 7(b).

One other set of provisions in the Indenture is important to the dispute that is now before us. With respect to the leased properties, Engelhard was entitled under the Indenture to alter, modify, renew, or extend those third-party leases (by agreement with the relevant third-party owners). Indenture ¶ 2(e). This could be done either before or upon expiration and without the Trust's consent. Id. But, as to any changes effective before the preexisting termination date of a lease that was renewed or extended, any increase in fixed costs or in the royalties payable to the owners under the new terms was to be borne by Engelhard. Id.

This case centers around a group of leased properties that are described in paragraph 23 of the Indenture (the "Veal leases"). The Veal leases all had a royalty rate negotiated years ago that is very low by current prices ($.11 per cubic yard) and had termination dates of March 23, 1995. Because of royalty disputes with the third-party owners, Engelhard did not mine the properties until the 1990s. In August 1990, Engelhard agreed with the owners to extend the terms for 20 years and increase royalties immediately--by a multiple of almost 30--to $3 per cubic yard on three leases and $2.90 on the fourth. For the remainder of the preexisting lease terms, Engelhard absorbed the cost of the increased royalties.

Then, in mid-1995, Engelhard began deducting the increased royalties on the Veal lease extensions from the total royalties due to the Trust from all covered properties--not just the Veal leases--with drastic effects on the payments otherwise due to the Trust. Although Engelhard's semi-annual payments to the Trust usually exceeded $300,000, the payment for the last six months of 1995 was $30,000. By its calculations, the Trust was effectively paying Engelhard, by a reduction in royalty payments, about $1.80 for each cubic yard Engelhard mined on Veal properties.

In due course, the Trust brought suit against Engelhard in federal district court in Rhode Island. The complaint alleged that Engelhard had violated the terms of the Indenture, violated the implied covenant of good faith and fair dealing, and violated an alleged fiduciary duty owed by Engelhard to the Trust. On cross motions for summary judgment, the district court held for the Trust on the implied covenant claim and for Engelhard on the contract and fiduciary duty counts. In substance, the court held that Engelhard could not deduct the increased royalty payments on the Veal leases from other royalties due to the Trust.

Engelhard now appeals to this court. It says that the district court erred so far as it favored the Trust and, further, in awarding prejudgment interest to the Trust as to royalties wrongly withheld by Engelhard since 1995. The parties are agreed that Georgia law governs the contract-related issues; they disagree about whose law controls as to prejudgment interest. On the grant of summary judgment and the legal issues presented as to prejudgment interest, our review is de novo. Augat v. Fenoglio, 254 F.3d 368, 370 (1st Cir. 2001).

In our view the able district judge reached the correct result and our own analysis differs only in emphasis. Specifically, we think that the contract, read in the framework of plausible business expectations, can reasonably be read only one way, namely, to preclude the negative royalty deductions sought by Engelhard and, for that reason, the district court's judgment is correct without regard to the Trust's implied covenant claim. But the difference is more a matter of labels than of substance.

The critical language of the Indenture provides in paragraph 5 for the 1.5 percent royalty to the Trust. In subparagraph 7(a) the Indenture sets forth Engelhard's obligation to pay both (i) taxes on fee properties and (ii) payments on leased properties that the original lessee must pay "other than royalties on production, provision for which is made in [subparagraph 7(c)]." Subparagraph 7(b) then allows "[t]he aggregate amount" of all such payments under subparagraph 7(a)--taxes and non-royalty payments--to be deducted by Engelhard from "the aggregate royalties" payable to the Trust.

Subparagraph 7(c) then treats in a single provision the subject of production royalties payable to the owners of leased land and credits for payment of those royalties:

[Engelhard] also agrees to pay to the person entitled thereto all royalties based on production required to be paid under the Leases, but with respect to any Lease only so long as [Engelhard] remains an assignee thereof; provided, however, that [Engelhard] shall be entitled to a credit for any amounts paid or payable by it pursuant to this subparagraph (c) against royalties thereafter payable to [The Trust] under the provisions of Paragraph 5 of this Agreement.

It is this "entitled to a credit" language on which Engelhard relies in deducting the full amount of the Veal lease royalties paid to the landowners from the total royalty package owed by Engelhard to the Trust under the Indenture. The Trust, it should be stressed, does not claim to be owed any royalties after mid-1995 from sales by Engelhard of kaolin derived from the Veal properties. It simply wants to prevent its non-Veal related royalties from being reduced because of the increased royalties that Engelhard has agreed to pay the Veal property owners.

Although Engelhard thinks that the language of subparagraph 7(c) is unequivocally in its favor, this is far from true. Indeed, if words alone are considered, the Trust can point--as the district court noted--to the contrast with subparagraph 7(b) which (unlike subparagraph 7(c)) provides for the deduction of the specified items from aggregate royalties owed to the Trust. But it is guesswork whether the omission of the term "aggregate" in subparagraph 7(c) was intended to control the issue before us; quite likely the drafters never envisaged the precise problem. Certainly, there is no extrinsic evidence that they did.¹

But even if the language taken in the abstract is not decisive in the Trust's favor and even if the drafters never focused on the risk of negative royalties, only one reading of the contract makes any sense. No rational party in the Trust's position would agree to such negative royalties, nor would anyone in Engelhard's position demand such an option, because it would create an extraordinary perverse incentive for Engelhard to engage in otherwise irrational conduct and would create an unlimited risk to the Trust's legitimate general expectations. The point is so obvious as to require only brief explanation.

If the contract were read as the Trust urges, it might well make economic sense for Engelhard to agree to a lease extension for the Veal property coupled with a very large increase in royalties paid to the owners. That would depend on whether the increase in kaolin prices was large enough for Engelhard to pay a greatly increased royalty to the Veals and still have room for a reasonable profit after mining and processing costs...