Daily Decisions: Contract Madness!

I’m not ashamed to say it: I really like contracts. But I admit that I can’t really make heads or tails of Wright v. Dave Johnson Insurance Inc. (Division 2, February 22, 2012) (published April 25, 2012), a recently published contract case. Perhaps one of my three non-family readers could shed some light on this interesting and confusing case.

Like most contract disputes, everything started out all friendly. David Johnson wanted his new son-in-law, John Wright, to work with him in his new insurance business: Dave Johnson Insurance (“DJI”). And when Johnson died, he wanted Wright to take over the family business.

Accordingly, with (I’m guessing) hugs and smiles and handshakes, Johnson and Wright entered into a written Buy & Sell Agreement (“BSA”) in 2001. Pursuant to the BSA: (1) Wright got a right of first refusal on DJI when Johnson died; (2) a specific method of valuation was provided for DJI; (3) Wright was expressly permitted to use life insurance proceeds to purchase the business; and (4) if Wright ceased employment with DJI, then the BSA became null and void.

Contemporaneously with the execution of the BSA (that’s the Court’s word, “contemporaneously”!), Johnson gave two life insurance policies to Wright, each of which paid out $100K when Johnson died. Wright said the policies were a gift. Johnson said that, despite the fact that he and Wright never discussed what would happen to the policies if Wright left DJI and that the BSA made no provision for the policies, there was a “clear understanding” that the “intention” was for the policies to fund Wright’s future purchase of DJI under the BSA.

You can see where this is going. In 2005, things get sour between Wright and Johnson. Wright cuts Johnson off from his daughter and grandchildren (Wright’s wife and kids). Wright gets demoted at the company and signs an Employment Agreement (“EA”) setting forth his new responsibilities. But that doesn’t last long. Wright resigns. Johnson sues.

During the resulting bench trial, the court concluded that Wright’s testimony was generally not credible. The court rejected Wright’s testimony that the insurance policies were gifts. Accordingly, the Court ordered Wright to return the policies to Johnson and ordered Johnson to repay Wright any premiums Wright had paid on the policies — sort of like a restitutionary resolution, though the Court of Appeals considered it a constructive trust.

The Court of Appeals largely affirmed the trial court’s judgment (with some exceptions I’ll get to later). On the big issue, the Court of Appeals affirmed the trial court’s decision that Wright must return the policies to Johnson. The reasoning behind this affirmance is unclear to me.

There was no written agreement regarding the insurance policies. The Court of Appeals recognized this. However, the Court stated that there was a separate “oral agreement” regarding the policies and that the oral agreement should be enforced.

I think there are all sorts of problems with that. First of all, if the BSA was a complete integration, then any contemporaneous oral agreements would be unenforceable. The Court seemed to have recognized this, with some talk in a footnote about partial and complete integrations, but the only discussion of whether the BSA was a complete integration was the observation that the BSA did not contain an integration clause. That fact alone should not have been determinative, but the Court seemed to assume that it was.

Regardless, the Court allowed for the possibility of an enforceable contemporaneous oral agreement and affirmed the trial court’s decision that such an agreement existed here. Why? Well, at Page 14 of the opinion the Court relied on the following findings of the trial court: (1) Johnson intended for Wright to use the policies to buy DJI after Johnson’s death; (2) Johnson told Wright that his purpose in transferring the policies to Wright was so Wright would have funding to buy DJI; and (3) the apparent acceptance of Johnson’s testimony that he and Wright had a “clear understanding” that the policies were for effecting the purchase rights in the BSA and that purpose only. Accordingly, the Court of Appeals concluded that “the intent and the purpose of the transfer failed” and that therefore the trial court properly concluded that “the policies should be returned to Johnson.”

What?

Johnson’s unexpressed intention does not create a contract. Johnson’s expression of purpose does not create a contract either. Nor does a “clear understanding” of purpose. What were the terms of this oral agreement? The Court didn’t explain. But to me, it sounds less like a contract and more like a gift with an expression of intent regarding how the donee will use the gift. That’s not a contract.

If the purported contract required Wright to use the policy proceeds to purchase DJI, then how would the contract apply if Wright opted not to buy DJI after Johnson’s death? Recall that the BSA includes a right of first refusal; Wright was not obligated to purchase DJI. Moreover, the BSA and the later-signed EA both contained terms for what would happen if/when Wright left DJI. Neither contract stated that Wright would have to return the policies. I can’t see how, on that record, the Court would create an implied oral agreement to return the policies.

The trial court’s choice of remedy — and the Court of Appeals’s affirmance of that remedy — is equally confusing. But creating a constructive trust and essentially undoing the transfer of the policies, the Court seemed to hold not only that Wright needed to return the policies, but that he never should have had them in the first place. By ordering Johnson to reimburse Wright for premium payments, the Court did more than order a transfer — it ordered the unwinding of the initial transfer.

Of course, that outcome might have been a fair term for the parties to have written into the BSA — should Wright leave employment he returns the policies and is reimbursed for premium payments made. But that was not a term of the BSA or any other agreement between the parties! The Court here seems to be just making contracts that it thinks the parties would have made or should have made.

Alternatively, some of the Court’s language seems to imply some sort of frustration of purpose or unforeseen circumstances, which in turn permits the Court to fill in the blanks of the parties’ agreements. But the circumstances — Wright leaving DJI — were not unforeseen nor did they frustrate the plans of the parties. The parties made plans for what would happen if Wright left DJI! Those plans just didn’t include him giving back the life insurance policies.

Another strange thing: This whole situation could have been avoided with some good estate planning. Johnson wanted certain money or insurance proceeds or business interests to go to Wright but only upon Johnson’s death? Seems like a will could have dealt with that situation. The fact that Johnson effected his plan through a pseudo-gift and some contracts is what turned this whole affair into a mess.

A few more interesting notes: The trial court determined that Wright was entitled to interest on the premium payments Johnson returned to him. However, the trial court held that Wright was entitled to nothing more than a reasonable prevailing interest rate. The Court of Appeals disagreed. Under RCW 19.52.010, where parties do not specify an interest rate in their agreement, the statutory default rate applies — and it is 12%! Apparently, that statute has not been amended since the Carter Administration. So that’s a win for Wright; he’s getting 12% on his money while the rest of us are lucky to get 0%.

The Court of Appeals also rejected one of the trial court’s findings of fact — that the EA required Wright to return “all property” to DJI when he left its employment. Rather, the EA only required Wright to return certain specified DJI property. That seems important to me. It would not come as a surprise if the trial court’s “return all property” finding informed its conclusion that Wright was required to return the insurance policies. That one mistake very well could have infected the ultimate conclusion. The Court of Appeals held that the remaining findings (and the Court’s legal discussion) were sufficient to support the trial court’s conclusion regarding the policies. It seems, perhaps, that a remand might have been appropriate, especially since the trial court’s conclusion was so fact-based.

Lastly, the Court of Appeals reversed the trial court’s finding that Wright’s counterclaims (which I did not discuss) were frivolous and therefore reversed its award of attorneys’ fees to Johnson. Despite the trial court’s finding that Wright was a liar, claims are not frivolous as long as any single claim advances to trial. Some of Wright’s claims did, so no fees for Johnson.

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5 thoughts on “Daily Decisions: Contract Madness!

  1. I would need a few treatises, a few weeks and power tools to get a grip on contracts and have any response for you. Your point about good estate planning saving some hassle here makes sense.
    -non-family members for ziffblog

  2. Don’t know how much light I can shed, but I guess I am sympathetic to the outcome. I see clients that have some wonky contracts, which don’t necessary jibe with their “real” agreement. I am currently dealing with the fallout of a poorly drafted contract provision that as literally interpreted makes no economic sense whatsoever and would be a huge windfall to the party trying to enforce the provision. The policy as a gift in this case does seem to make some sense, but when dealing with these kind of wonky deals, especially with un-lawyered parties (didn’t see if that was actually the case), maybe it is better to just unwind things rather than have an accidental winner and loser.

    • Yeah, I’m somewhat sympathetic, and I think I would be totally on board with you if the situation were a poorly drafted contract that makes no sense as literally interpreted. But I think this contract does make sense: There was the BSA and then there was Johnson’s gift of the policies. I understand that Johnson likely wants to undo that now, but it just doesn’t seem like the law should countenance that desire for a mulligan. I could see totally undoing the contract and awarding restitution if there had been some complete frustration of purpose. But I don’t think frustration of purpose should apply in a situation where the “frustration” was something totally foreseeable, and was in fact foreseen in other parts of the contract — Wright’s decision to leave DJI. What appears to have been the actually unforeseeable event (at least for Johnson) was not just that Wright would leave DJI (since Johnson clearly planned for that) but that Wright would leave DJI and also turn out to be rotten son-in-law who cut Johnson out of his family’s life and who therefore Johnson didn’t want to support. I think that’s pretty sad, but it doesn’t seem like contract law should have much to say about that.

  3. That’s an interesting case, David. There’s always risk when a court reads your contracts. One of my goals in drafting, besides helping my client think through the details of the deal, is to make things as clear as possible in order to (1) make sure the parties’ legal rights are evident if things go south and (2) reduce the amount of wiggle room for the court if it comes to that.
    Brian

  4. Pingback: Monday (or Wednesday) Morning (or Evening) Mash-up: May 2, 2012 | Ziff Blog

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