Autotrol Corp. v. Continental Water Systems Corp.

• Decision Date: 19 November 1990
• Docket Number: No. 90-1038,90-1038
• Citation: 918 F.2d 689
• Parties: AUTOTROL CORPORATION, Plaintiff-Appellee, v. CONTINENTAL WATER SYSTEMS CORPORATION and Olin Corporation, Defendants-Appellants.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 689

918 F.2d 689

AUTOTROL CORPORATION, Plaintiff-Appellee, v. CONTINENTAL WATER SYSTEMS CORPORATION and Olin Corporation Defendants-Appellants.

No. 90-1038.

United States Court of Appeals Seventh Circuit.

Argued Sept. 21, 1990.

Decided Nov. 19, 1990.

Eric J. VanVugt, Minahan & Peterson, Milwaukee, Wis., for plaintiff-appellee.

Maurice J. McSweeney, Maureen A. McGinnity, Alexander T. Pendlenton, Foley & Lardner, Milwaukee, Wis., for defendants-appellants.

Before BAUER, Chief Judge, and POSNER and KANNE, Circuit Judges.

POSNER, Circuit Judge.

This is a diversity suit, primarily for breach of contract. The suit was tried to a jury, and the plaintiff, Autotrol Corporation, obtained a judgment of more than $1.5 million. The appeal raises a large number of issues, only a handful of which require discussion. So far as the remaining issues are concerned, it is enough to note that the district judge resolved most of them in a thoroughly satisfactory manner and that the others could not possibly have affected the outcome of the trial.

The contract provides that any dispute under it shall be resolved in accordance with the law of Texas. Neither party questions the validity of this choice-of-law stipulation but it is rather academic because there are no Texas cases on the hotly contested issues.

The contract, signed in May 1986, established a joint venture between Autotrol's controls division and Continental Water Systems Corporation to create a system for water purification based on a patented new technology, known as "electrodiarese," that Continental owned the exclusive right to exploit. Autotrol was to manufacture the control for the system and Continental the rest and both companies would sell the completed systems--Autotrol the large systems, Continental the small ones. There was an ambiguity, later to prove critical, about the dividing line between large and small.

Before production could begin, there had to be product specifications. These had not been completed when the contract was signed. Anticipating this possibility, the contract provided that when approved by both parties the specifications would be attached to, and thereby made a part of, the contract; and should the parties be "unable, in good faith, to agree upon the contents of the Products Specifications Schedule by June 30, 1986, either party hereto may elect to terminate this Agreement." On June 25 the parties agreed to extend this deadline to July 17. July 17 came and went and the product specifications had not been agreed upon but neither party exercised its right of termination. It was almost a year later, with the product specifications still not having been agreed upon, that Continental declared the contract terminated. That is the alleged breach. Meanwhile the other defendant, Olin Corporation, had acquired all the stock of Continental, and according to evidence that the jury reasonably could credit had decided that unless Autotrol acceded to the defendants' understanding of what the smallest system was that Autotrol was entitled to sell--which Autotrol refused to do--Autotrol would be encroaching on the segment of the market that Olin wanted to reserve for Continental.

The defendants argue that they were free to terminate the contract at any time after July 17, for any reason or no reason, without liability, provided only that the product specifications had not been finally agreed upon and attached to the contract as a schedule. Yet Continental encouraged Autotrol to continue working, which meant continue spending, on Autotrol's share of the project for many months after July 17--indeed, right up to the notice of termination--even though the product specifications had not been agreed upon. Autotrol does not argue that this encouragement was sufficiently promissory in form to support liability under a theory of promissory estoppel, on which see Restatement (Second) of Contracts Sec. 89(c) and comment d (1981). But it does argue that, in conjunction with Autotrol's parallel forbearance to exercise its right of termination, Continental's encouragement supports an inference that the parties had modified the contract to waive Continental's right to terminate after July 17 for failure to agree on product specifications. This is assuming Continental had such a right, which Autotrol denies, thus giving it two grounds upon which to argue that there was a breach of contract. The jury found a breach but was not asked to indicate the ground, so we must affirm if either ground is supportable; as a matter of fact both are.

Under either of Autotrol's theories, once July 17 came and went Continental could not terminate the contract without liability--ever--even if the parties never did work out product specifications. At first acquaintance the argument is implausible. The parties could not go into production without such specifications. If they reached impasse after bargaining in good faith, would not either party be entitled to walk away from the contract without liability? Apparently not. The contract is deliberately asymmetrical with respect to termination after July 17 (June 30 in the original contract, before the date was extended). Until then either party can walk if the product specifications have not been agreed upon. After that Autotrol can walk until production commences but "Continental shall have no right to terminate this Agreement except as provided in" certain paragraphs of the contract that relate to specific (and immaterial) changed circumstances, such as bankruptcy, but not to failure to work out product specifications. Not only by encouraging Autotrol to continue working after July 17, but in the contract itself, Continental seems to have surrendered the right it would otherwise have had to terminate the contract upon the failure of an essential condition.

What sense can this make? The answer lies in the asymmetry of the parties' position. Continental controlled the patent on electrodiarese and if it abandoned the project, say by failing to agree on product specifications, Autotrol would be unable to go forward and would lose its investment. But if Autotrol abandoned the project Continental could always get another partner. Making the contract terminable by Autotrol but not by Continental gave Autotrol leverage to force Continental to license the patent to Autotrol on reasonable terms if Continental lost interest in the project.

If all this is wrong and Continental somehow retained an implicit right to terminate the contract without liability, even after July 17, provided that the parties were unable to agree upon product specifications, still the jury was entitled to find that the parties had modified the contract to forbid termination on this ground at least until such time as the need to agree on product specifications was urgent and agreement impossible. That deadline had not been reached when the defendants terminated--on a ground, moreover, that had nothing to do with product specifications, but rather with the division of the market for the product. The modification was supported by consideration; both parties benefited from relaxing the deadline, inasmuch as this allowed the project to proceed. United States v. Stump Home Specialties Mfg., Inc., 905 F.2d 1117, 1122 (7th Cir.1990). Though oral, and somewhat vague about the duration of Continental's commitment, the modification was sufficiently definite to be enforceable, cf. Goldstick v. ICM Realty, 788 F.2d 456, 462-63 (7th Cir.1986), and an oral modification is enforceable under Texas law even if the contract forbids oral modifications, as this one did. Adams v. Can-Dee Oil Corp., 357 S.W.2d 808 (Tex.Civ.App.1962). The Texas approach, by no means idiosyncratic, 2 Farnsworth on Contracts Sec. 7.6, at pp. 229-30 (1990), is not so frontal a blow at freedom of contract as it may appear to be. For as Farnsworth points out, id. at p. 230, in most of the cases in which oral modifications are enforced in the face of prohibitory language in the contract the party seeking enforcement has relied on the modification; and an invitation to rely, here inferable from both statements and conduct of Continental, is the sort of waiver of a clause forbidding oral modifications that would be honored even under the Uniform Commercial Code, which makes such clauses expressly enforceable in contracts for the sale of goods. UCC Sec. 2-209(2); Wisconsin Knife Works v. National Metal Crafters, 781 F.2d 1280, 1286-88 (7th Cir.1986).

The remaining issues relate to damages. During the year in which the contract was in force, Autotrol incurred $245,000 in out-of-pocket costs of performance. There is no quarrel over the appropriateness of awarding these costs as damages for breach of the contract. But in addition the jury awarded Autotrol more than $700,000 in overhead expenses. If, for example, a salaried engineer spent 25 percent of his time on the project, then 25 percent of his salary and benefits during the period he was working on the project were considered to be damages from the breach. The defendants object, pointing out that it is merely a conjecture that if the contract had never been made in the first place Autotrol would have replaced it with a project that would have covered the engineer's salary and benefits.

Economists distinguish between a firm's fixed and variable costs. The former, as the name implies, are the same whether or not the firm does anything; a good example is the fee that a state charges for a corporate charter. The fee is paid before the firm begins operations and is utterly invariant to the firm's fortunes. It would be an improper item of damages for the breach of a contract because the breach could not have caused the expense to be incurred.

Variable costs are those that vary with the firm's activity--more precisely that are caused by fluctuations in that activity. It is easy to see how the out-of-pocket expenses that Autotrol incurred in the joint...