Colonial at Lynnfield, Inc. v. Sloan

• Decision Date: 10 January 1989
• Docket Number: Nos. 88-1825,88-1826,s. 88-1825
• Citation: 870 F.2d 761
• Parties: COLONIAL AT LYNNFIELD, INC., Plaintiff, Appellee, v. Stephen SLOAN, et al., Defendants, Appellees. Appeal of Richard D. ZIPES, et al., Defendants, Appellants. COLONIAL AT LYNNFIELD, INC., Plaintiff, Appellee, v. Stephen SLOAN, et al., Defendants, Appellants. . Heard
• Court: U.S. Court of Appeals — First Circuit

Page 761

870 F.2d 761

COLONIAL AT LYNNFIELD, INC., Plaintiff, Appellee, v. Stephen SLOAN, et al., Defendants, Appellees.

Appeal of Richard D. ZIPES, et al., Defendants, Appellants.

COLONIAL AT LYNNFIELD, INC., Plaintiff, Appellee, v. Stephen SLOAN, et al., Defendants, Appellants.

Nos. 88-1825, 88-1826.

United States Court of Appeals First Circuit.

Heard Jan. 10, 1989.

Decided March 21, 1989.

Ripley E. Hastings with whom Harvey Weiner, Alexander H. Pratt, Jr., Peabody & Arnold, George E. Richardson and Johnson, Clapp, Stone & Jones, Boston, Mass., were on brief, for defendants, appellants.

Marilyn D. Stempler with whom Brown, Rudnick, Freed & Gesmer, Boston, Mass., was on brief, for plaintiff, appellee.

Before COFFIN, BOWNES and SELYA, Circuit Judges.

COFFIN, Circuit Judge.

This case arises out of a failed contract for the purchase of a 49% interest in the Colonial Hilton Inn in the towns of Lynnfield and Wakefield, Massachusetts. The seller, Colonial at Lynnfield, Inc. (Colonial), sued the prospective buyer, Colonial Associates (Associates), ¹ for breach of contract and liquidated damages in the amount of $200,000. The district court found that the buyer was at fault, and held that Colonial was entitled to the liquidated damages. Associates claims that the contract containing the liquidated damages provision had expired by the time the deal collapsed, and that the provision was otherwise unenforceable. Defendants also assert that the district court erred in dismissing its counterclaims against plaintiff. We affirm judgment for Colonial on the counterclaims, but reverse the award of liquidated damages on the ground that, under Massachusetts law, it constitutes a penalty.

I.

Plaintiff Colonial and defendant Associates came together in mid-1980 when Colonial was attempting to solve its worsening financial crisis by selling a partial interest in the hotel. Colonial's fiscal problems stemmed from a major expansion and renovation of the hotel. As construction progressed, blocks of rooms needed to be shut down for refurbishing, resulting in a loss of income. The losses were exacerbated by increasing costs for overhead, borrowing, and inflation. Colonial's cash flow suffered, and it needed more money to cover its increased costs.

On November 12, 1980, Colonial and Associates signed an Agreement of Sale (the Agreement) in which Associates contracted to pay $3,375,000 for 49% of the hotel. The Agreement gave Associates time to test the market so that it could determine whether it could raise the funds for the purchase price by selling units in a limited partnership. If after that time Colonial Associates decided against going ahead with the purchase, it had no obligation to Colonial. If it wished to go forward, it was required to give a Notice to Proceed, and to be prepared for a closing shortly thereafter. Once Associates gave the Notice to Proceed, it was subject to a $200,000 liquidated damages provision. That provision would be activated, however, only if the transaction failed to close solely due to Associates' fault.

The district court found that Associates was required to give notice of their intention to proceed with the transaction on or before April 2, 1981, and that they failed to do so. The deal did not at that point fall apart, however. Associates asked for a meeting to discuss the situation, and Colonial agreed so long as the defendants set a closing date. In a letter dated April 16, 1981, Associates agreed to close on June 1.

At a meeting in Boston on April 21, the parties discussed various modifications to their original agreement. Three days later, Colonial's counsel sent a letter to Associates' counsel stating that the parties had agreed that Colonial would receive an additional $100,000 from Associates "in consideration of the delay in this matter and for other valuable consideration." The letter stated that Associates' counsel should "prepare the necessary memorandum of agreement carrying the foregoing into effect." The letter concluded by noting that time is of the essence with respect to the June 1 closing date. It appears that no memorandum of agreement ever was prepared.

On May 22, Colonial obtained a $318,000 loan from EssexBank by assigning as collateral its "right, title and interest" in the Agreement with Associates. The assignment was to become null and void when the loan was repaid, presumably after the closing with defendants. On May 29, Associates informed Colonial that it had been unable to sell enough units to close on June 1, and requested an extension. Colonial refused, and subsequently declared Associates in default.

On July 21, Colonial accepted a proposal from Lincoln National Development Corporation of Indiana (Lincoln) to purchase a 50% interest in the hotel for $3.7 million. That sale took place in early September 1981.

Colonial filed suit against Associates to enforce the liquidated damages provision contained in the November 12 Agreement, claiming that the sale had failed to close solely because of Associates' inability to sell enough units in the limited partnership to finance the hotel purchase. The defendants raised several defenses: (1) the original contract, including the liquidated damages provision, had expired in early April; (2) no enforceable agreement was reached as a result of the parties' efforts to renegotiate their transaction; (3) even if the original Agreement is enforceable, the liquidated damages provision is unenforceable as a matter of public policy because it is disproportionate to any reasonable estimate of damage that plaintiff might suffer, and therefore represents a substantial penalty; (4) the failure to close the sale was not solely the defendants' fault.

By cross-claim, certain of the individual defendants sought indemnity from the other defendants. That claim was bifurcated by the trial court, and has not yet been tried. A group of defendants also counterclaimed against Colonial for violation of Mass.Gen.Laws Ann. ch. 93A and for breach of fiduciary obligations. The district court granted summary judgment for Colonial on the fiduciary duty claim, and also ruled for Colonial on the Massachusetts statutory claim after trial on the merits. The defendants then filed this appeal, claiming that the district court erred both in enforcing the liquidated damages clause and in rejecting their counterclaims. We address each of those issues below, turning first to the liquidated damages clause.

II.

A. Continuation of the Contract. ²

We need not dwell long on the question whether the November 12 Agreement remained in effect after appellants missed the April 2 due date for the Notice to Proceed. The evidence indicates that defendants believed--indeed, hoped--that the tardy notice to proceed would not undo the deal. The testimony of Stephen Sloan, one of the individuals in Associates, shows that the defendants went to the April 21 meeting advocating the position that the few days delay in the Notice to Proceed should not destroy the deal, suggesting that the defendants' intent in meeting was to negotiate an extension of the contract as it existed. Indeed, defendant Richard Zipes explicitly testified that he assumed the $200,000 liquidated damages provision remained in effect even after the parties negotiated the additional $100,000 that was to be paid if the deal went forward.

Associates' argument that the Agreement was no longer in effect after April 2 is based in large part on statements made by plaintiffs that the late Notice meant the defendants were in default. Subsequent events demonstrated, however, that such assertions by plaintiffs did not signify the final termination of the Agreement but instead represented a negotiating position designed to elicit additional funds from defendants in exchange for an extension of the contract. In proceeding toward a closing date, the parties continued to act as if the original agreement was in effect, albeit with an additional $100,000 "late" charge.

We emphasize that the record shows the transaction was revived at Associates' urging, and we reject their attempt now to hide behind the literal language of the contract by arguing that the Agreement expired for good when they missed the April 2 due date for their Notice to Proceed. The district court implicitly found that the contract had been extended as a result of the April negotiations, and for the reasons we have discussed we find no clear error in that conclusion. ³

B. Liquidated Damages as Penalty

Associates argues that even if the original Agreement remained in effect through June 1, the liquidated damages provision is not enforceable because it constitutes a penalty. ⁴ They rely on the well established principle that the amount of liquidated damages specified in a contract must be reasonably related to the anticipated or actual loss caused by the breach. See, e.g., Security Safety Corp. v. Kuznicki, 350 Mass. 157, 158, 213 N.E.2d 866, 867 (1966); A-Z Servicenter v. Segall, 334 Mass. 672, 675, 138 N.E.2d 266, 268 (1956); Lynch v. Andrew, 20 Mass.App. 623, 627, 481 N.E.2d 1383, 1386 (1985); Restatement (Second) of Contracts Sec. 356 (1981). A provision setting an unreasonably large liquidated damages amount is unenforceable on public policy grounds as a penalty. Lynch, 20 Mass.App. at 627, 481 N.E.2d at 1386; Warner v. Wilkey, 2 Mass.App. 798, 799, 307 N.E.2d 847, 849 (1974); Restatement (Second) of Contracts Sec. 356(1); Restatement of Contracts Sec. 339. ⁵

Defendants claim that the $200,000 damage amount is unreasonable both as an estimate, as of November 12, 1980, of the damages that plaintiffs might incur and when compared with the damages that in fact occurred. We disagree that the provision constituted a penalty at the time the Agreement was signed in late 1980. As the district court properly observed, "[o]ne could not know, at that time, when the hotel would eventually be sold, if at all, in the event that defendants defaulted."...