Kroll v. Sugar Supply Corp.

• Citation: 116 Ill.App.3d 969,452 N.E.2d 649,72 Ill.Dec. 396
• Decision Date: 22 July 1983
• Docket Number: No. 82-1428,82-1428
• Parties: , 72 Ill.Dec. 396 George L. KROLL, Plaintiff-Appellee, v. SUGAR SUPPLY CORPORATION, Defendant-Appellant.
• Court: United States Appellate Court of Illinois

Page 649

452 N.E.2d 649

116 Ill.App.3d 969, 72 Ill.Dec. 396

George L. KROLL, Plaintiff-Appellee, v. SUGAR SUPPLY CORPORATION, Defendant-Appellant.

No. 82-1428.

Appellate Court of Illinois,

First District, Fifth Division.

July 22, 1983.

Rehearing Denied Aug. 24, 1983.

[72 Ill.Dec. 397] Jon R. Lind, Paul W. Schroeder, John W. Treece, Isham, Lincoln & Beale, Chicago, for defendant-appellant

Harvey J. Barnett, Barnett & Beigel, Ltd., Chicago, for plaintiff-appellee.

LORENZ, Justice:

Defendant appeals from a summary judgment which ordered it to pay plaintiff a 1978 employment bonus of $164,560. According to defendant, the trial court misinterpreted the pertinent employment agreement, and it was improper to enter summary judgment because there are genuine issues concerning material facts. We find no merit in these arguments, and we affirm.

The parties agree that almost all the material facts are undisputed, and the following facts are material to our decision:

Plaintiff entered into a three-year employment agreement with Sugar Supply Corporation ("Old Sugar Supply") on December 30, 1975. This agreement obligated Old Sugar Supply to pay plaintiff an annual bonus based on its pre-tax net operating income. However, on January 3, 1978, Old Sugar Supply sold most of its assets (including its corporate name) to the defendant RHM Food Ingredients, Inc. Defendant then changed its name to Sugar Supply Corporation ("New Sugar Supply"), and Old Sugar Supply changed its name to M.L. Hamilton & Co.

The purchase agreement between Old and New Sugar Supply provided that the purchaser would "assume" certain obligations, including plaintiff's employment contract, and plaintiff worked for New Sugar Supply throughout 1978. Although New Sugar Supply agrees that it owes plaintiff a 1978 bonus based on its 1978 pre-tax net operating income, plaintiff contends that defendant breached the employment agreement Paragraph 4 of the 1975 employment agreement between plaintiff and Old Sugar Supply provides that for three years plaintiff would receive an annual bonus based on the pre-tax net operating income of "the corporation." The agreement further specifies that plaintiff's bonus is to be calculated by taking the pre-tax net operating income of "the corporation" (minus certain income such as profits from investments and the sale of capital assets), then subtracting $833,333 and multiplying the result by 12%.

[72 Ill.Dec. 398] by improperly calculating the amount of his 1978 bonus. Explanation of the precise nature of the dispute requires examination of this contract in light of accounting principles which the parties inform us are undisputed.

Paragraph 4 also provides that the pre-tax net operating income of "the corporation" shall be determined by using the First-In/First-Out (FIFO) method of accounting. Under this method, the products which a business sells from its inventory of merchandise are assumed, for accounting purposes, to be the products which it first purchased. Thus, earnings on a sale are calculated by subtracting from the sale price the cost of the products which the seller first purchased.

Although, under the provisions of paragraph 4, plaintiff's bonus was to be based upon his employer's income as calculated by using the FIFO method, New Sugar Supply used the Last-In/First-Out (LIFO) method of accounting during 1978. When LIFO is used to calculate earnings from sales, the cost of products sold from inventory are assumed to be the cost of the products which the seller most recently purchased. Earnings derived from a sale are calculated by subtracting from the sale price the cost of the products most recently purchased by the seller. Therefore, LIFO accounting is often used during periods of inflation because the amount of income realized from a sale will be less than the amount of income as calculated under FIFO accounting. In other words, when LIFO accounting is used during periods of inflation it defers income by "embedding" earnings in the corporation's inventory.

Defendant's 1978 income was initially calculated by using LIFO accounting, but as noted above, determination of plaintiff's bonus required use of FIFO accounting. Defendant agrees, however, that conversion from LIFO to FIFO accounting is accomplished by taking a firm's income (as calculated on a LIFO basis) and adding to this figure the difference between the "LIFO reserve" which the firm had at the beginning and end of its fiscal year. "LIFO reserve" is the amount of income which a business has been able to defer (i.e., "embed" in its inventory) by using LIFO rather than FIFO accounting during a period of inflation.

It is further undisputed that until a new business begins making sales it does not have any income which can be deferred or "embedded" in its inventory as LIFO reserve. Therefore, as a new business which first obtained an inventory when it purchased the assets of Old Sugar Supply on January 3, 1978, New Sugar Supply started the year with a LIFO reserve of zero. At the end of 1978, however, New Sugar Supply had a LIFO reserve of $2,231,780. Accordingly, using these undisputed accounting principles to compute the corporation's 1978 income on a FIFO basis, its LIFO-basis income must be added to the difference between its year-beginning LIFO reserve of zero and its year-end LIFO reserve of $2,231,708. In short, under application of these undisputed accounting principles, New Sugar Supply's FIFO-basis pre-tax net operating income for 1978 is calculated by adding $2,231,708 to its pre-tax net operating income as determined on a LIFO basis.

The dispute in the present case centers on the fact that instead of using its own 1978 year-beginning LIFO reserve of zero, New Sugar Supply or its accountants decided to use (as the firm's year-beginning LIFO reserve) the 1977 year-end LIFO reserve of Old Sugar Supply: $880,395. Consequently, by ignoring its own year-beginning LIFO reserve and substituting instead the year-end LIFO reserve of Old Sugar Supply New Sugar Supply concedes that it owes plaintiff a bonus based on its 1978 pre-tax net operating income (as defined in paragraph 4 of the 1975 employment agreement), and the difference between the amount of this bonus as calculated by plaintiff and defendant--$105,647--depends upon whether plaintiff's employment agreement was breached when New Sugar Supply calculated its income by using the LIFO reserve of another party--Old Sugar Supply.

[72 Ill.Dec. 399] New Sugar Supply lopped $880,395 off its 1978 FIFO-basis income.

Plaintiff's motion for summary judgment asserted that the unambiguous language of the bonus provision required New Sugar Supply to use its own LIFO reserve figures when calculating its FIFO-basis pre-tax net operating income. The trial court agreed, and entered judgment for plaintiff.

OPINION

Defendant initially argues that the 1975 employment contract contains a "latent ambiguity" because it does not explicitly specify how to calculate plaintiff's bonus in the event his original employer sold its assets to a third-party and transferred his employment agreement to the purchaser. According to defendant, parol evidence shows that the original contracting parties (plaintiff and Old Sugar Supply) intended that in the event of a sale of assets plus a transfer of plaintiff's employment contract, plaintiff's new employer would be entitled to use the old employer's LIFO reserve when calculating the bonus owed to plaintiff by the new employer.

Additionally, focusing again on the alleged intent of plaintiff and Old Sugar Supply in 1975, defendant argues that reading the contract "as a whole" shows that the parties intended to disregard separate corporate identities in the event Old Sugar Supply sold its assets to another corporation and transferred plaintiff's employment contract to the purchaser. Still further, defendant argues that the same conclusion must be reached by giving the "most reasonable" construction to the allegedly ambiguous 1975 agreement.

As will be explained below, proper consideration of these arguments depends upon resolution of an issue which defendant raised in the trial court and which it briefly refers to in a footnote to its opening appellate brief.

Responding to plaintiff's motion for summary judgment, defendant argued that under the assumption of obligations provided in the 1978 purchase agreement between Old and New Sugar Supply, plaintiff's 1978 bonus under the 1975 employment agreement "should be determined by reference to the 'pre-tax net operating income' of Old Sugar Supply, the party to that agreement." (Original emphasis.) Since the record contains no indication of Old Sugar Supply's 1978 income, defendant concluded that plaintiff failed to show that he was entitled to summary judgment.

In response to this argument, plaintiff contended that the "assumption" provided in the 1978 purchase agreement resulted in a substituted contract in which "New Sugar Supply became 'the corporation' defined in the terms of the employment agreement, and it was obligated to pay Kroll his bonus based upon the pre-tax net operating income of New Sugar Supply."

The threshold question in the present case, therefore, is whether, in 1978, New Sugar Supply merely assumed the duty of paying plaintiff a bonus based on the 1978 income of Old Sugar Supply, or whether the parties created a new contract, with a substituted obligor, under a novation. We start by examining the doctrine of novation.

" 'Novation' may be broadly defined as a substitution of a new contract or obligation for an old one which is thereby extinguished. More specifically, it is the substitution by mutual agreement of one debtor or of one creditor for another, whereby the old debt is extinguished, or the substitution of a...