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Monday, February 6, 2006

One-Sided Clause isn't "Absurd"

Pennsylvania_flag When dealing with a contract between two sophisticated commercial parties, a court ordinarily ought to give effect to the unambiguous language they put in their written agreement, according to a recent decision by the U.S. Court of Appeals for the Third Circuit, applying Pennsylvania law.

The case arose out of a real estate development deal, in which the seller, Format Corp., gave a series of options to Widewaters Property Development.  Widewaters kept exercising the options, but kept only making partial payments on them.  By the time Widewaters broke off the project, it had paid some $77,000, but still owed another $79,000 for the options it had exercised.  Format wanted the rest of the money.  Its problem was a liquidated damages clause, which provided:

If Buyer [Widewaters] willfully fails to render the performance required of it under this Agreement, beyond any applicable notice and cure periods, then Seller shall, as its sole and exclusive right and remedy, be entitled to the Initial Deposit and any Extension Fees and other sums, if any, paid to Seller pursuant to this Agreement, as liquidated damages and not as a penalty and neither party shall have any further obligations or liabilities to the other.

Widewaters argued that under this clause, Format should be entitled only to the moneys it already received, not that it was owed.  The district judge held that such a result would be “absurd,” since Widewaters, having got the benefit of the option periods without paying for them, could walk away with no further liability.  The court therefore decided that the clause must mean not “sums paid” but “sums owing.”

Wrong, said the Third Circuit.  If applying the literal meaning would create an “absurd and unreasonable” result, said the court, it might need to look beyond the words.  But that’s not the case here:

We do not read . . . the Pennsylvania contract cases . . . to support the contention that a facially unambiguous term becomes ambiguous if there is any possibly absurd result that might hypothetically occur.  Rather, we understand the inquiry to be whether applying the facially unambiguous plain meaning of the term would lead to an absurd result.  Here, it certainly would not.  The District Court, therefore, erroneously found the liquidated damages clause to be absurd and, hence, ambiguous.

The liquidated damages clause here, said the court, was both facially unambiguous (clearly limiting Format's recovery to the deposit plus any fees already paid) and reasonable (since it allowed Format to terminate the contract at any point if Widewaters stopped paying its fees and walk away while still recovering the fair value of the deal).  That Format held the deal open despite not receiving the payments was, of course, Format's choice, as there existed no automatic breach trigger for nonpayment of fees; but Format did so at the risk of not recovering those fees not actually paid to it. Where the clause was a product of seven months of negotiation between two very sophisticated business and real estate entities, the fact that one party now no longer wants to be bound by it does not render the clause unreasonable.

Format Corp. v. Widewaters Property Development Corp., 2006 U.S. App. LEXIS 647 (January 11, 2006)

[Frank Snyder]

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