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KVASSAY v. MURRAY

April 5, 1991.

MICHAEL E. KVASSAY, d/b/a Kvassay Exotic Foods, Appellant/Cross-Appellee,
v.
ALBERT MURRAY, et al., Appellees/Cross-Appellants.



Plaintiff Michael Kvassay, d/b/a Kvassay Exotic Food, appeals the trial court's finding that a liquidated damages clause was unenforceable and from the court's finding that damages for lost profits were not recoverable. Kvassay contends these damages occurred when Great American Foods, Inc., (Great American) breached a contract for the purchase of baklava. Great American and Albert and Deana Murray, principals of Great American, cross-appeal the trial court's ruling that Kvassay could pierce Great American's corporate veil to collect damages awarded at trial.

On February 22, 1984, Kvassay, who had been an independent insurance adjuster, contracted to sell 24,000 cases of baklava to Great American at $19.00 per case. Under the contract, the sales were to occur over a one-year period and Great American was to be Kvassay's only customer. The contract included a clause which provided: "If Buyer refuses to accept or repudiates delivery of the goods sold to him, under this Agreement, Seller shall be

[15 Kan. App. 2d 428]

      entitled to damages, at the rate of $5.00 per case, for each case remaining to be delivered under this Contract."

Problems arose early in this contractual relationship with checks issued by Great American being dishonored for insufficient funds. Frequently one of the Murrays issued a personal check for the amount due. After producing approximately 3,000 cases, Kvassay stopped producing the baklava because the Murrays refused to purchase any more of the product.

  The Murrays formed Sunshine Ceramics, Inc., in 1974. The company was inactive during the late 1970's and early 1980's and failed to make a number of required corporate filings. In August 1984, the name of the corporation was changed to Great American Foods, Inc. The Murrays also operated fast food restaurants in Wichita under the name of Great American Subs, Inc., and controlled an entity named Murray Investments. The Murrays conducted business for all of their entities and personal business from one street location in Wichita. In August 1984, the Murrays opened a bank account in the name of Great American Distributors, Inc., although no incorporation papers were ever filed. The Murrays frequently paid the bills of their various entities with personal checks and often wrote checks to themselves on corporate accounts. In addition, there were times when one entity would pay the Murrays' personal expenses or the expense of other Murray entities.

  In April 1985, Kvassay filed suit for damages arising from the collapse of his baklava baking business. Great American counterclaimed and, in May 1988, the trial court sustained a defense motion to bifurcate the case. The court conducted bench hearings on the validity of the liquidated damages clause and the question of piercing the corporate veil. The trial court ruled that liquidated damages could not be recovered and that Great American's corporate veil could be pierced by Kvassay. The court also held "as a matter of law" that Kvassay would not be able to recover damages for lost profits in the action because they were too "speculative and conjectural." Kvassay attacked this latter ruling through a motion to modify, arguing a ruling on the issue was premature. The motion to modify was denied, although the court did announce that Kvassay could attempt to prove loss of profits at the jury trial.

[15 Kan. App. 2d 429]

     

  A jury trial on the issues of breach of contract and damages was held in February 1990. On the second day of trial, before any evidence on the question of loss of profits had been presented, the trial court ruled that lost profits were not recoverable and barred Kvassay from presenting any evidence on that question. The jury returned verdicts in Kvassay's favor and awarded him a total of $35,673.99.

  Kvassay first attacks the trial court's ruling that the amount of liquidated damages sought by him was unreasonable and therefore the liquidated damages clause was unenforceable.

  Kvassay claimed $105,000 in losses under the liquidated damages clause of the contract, representing $5 per case for the approximately 21,000 cases of baklava which he was not able to deliver. The trial court determined that Kvassay's use of expected profits to formulate liquidated damages was improper because the business enterprise lacked duration, permanency, and recognition. The court then compared Kvassay's previous yearly income (about $20,000) with the claim for liquidated damages ($105,000) and found "the disparity becomes so great as to make the clause unenforceable."

  Since the contract involved the sale of goods between merchants, the Uniform Commercial Code governs. See K.S.A. 84-2-102. "The Code does not change the pre-Code rule that the question of the propriety of liquidated damages is a question of law for the court." 4 Anderson, Uniform Commercial Code § 2-718:6, p. 572 (3d ed. 1983). Thus, this court's scope of review of the trial court's ruling is unlimited. Hutchinson Nat'l Bank & Tr. Co. v. Brown, 12 Kan. App. 2d 673, 674, 753 P.2d 1299, rev. denied 243 Kan. 778 (1988).

  Liquidated damages clauses in sales contracts are governed by K.S.A. 84-2-718, which reads in part:
"(1) Damages for breach by either party may be liquidated in the agreement but only at an amount which is reasonable in the light of the anticipated or actual harm caused by the breach, the difficulties of proof of loss, and the inconvenience or nonfeasibility of otherwise obtaining an adequate remedy. A term fixing unreasonably large liquidated damages is void as a penalty."
To date, the appellate courts> have not interpreted this section of the UCC in light of facts similar to those presented in this case.

[15 Kan. App. 2d 430]

      In ruling on this issue, the trial court relied on rules governing liquidated damages as expressed in U.S.D. No. 315 v. DeWerff, 6 Kan. App. 2d 77, 626 P.2d 1206 (1981). DeWerff, however, involved a teacher's breach of an employment contract and was not governed by the UCC. Thus, the rules expressed in that case should be given no effect if they differ from the rules expressed in 84-2-718.

  In DeWerff, this court held a "stipulation for damages upon a future breach of contract is valid as a liquidated damages clause if the set amount is determined to be reasonable and the amount of damages is difficult to ascertain." 6 Kan. App. 2d at 78. This is clearly a two-step test: Damages must be reasonable and they must be difficult to ascertain. Under the UCC, however, reasonableness is the only test. K.S.A. 84-2-718. K.S.A. 84-2-718 provides three criteria by which to measure reasonableness of liquidated damages clauses: (1) anticipated or actual harm caused by breach; (2) difficulty of proving loss; and (3) difficulty of obtaining an adequate remedy.

  In its ruling, the trial court found the liquidated damages clause was unreasonable in light of Kvassay's income before he entered into the manufacturing contract with Great American. There is no basis in 84-2-718 for contrasting income under a previous unrelated employment arrangement with liquidated damages sought under a manufacturing contract. Indeed, the traditional goal of the law in cases where a buyer breaches a manufacturing contract is to place the seller "'in the same position he would have occupied if the vendee had performed his contract.'" Outcault Adv. Co. v. Citizens Nat'l Bank, 118 Kan. 328, 330-31, 234 P. 988 (1925). Thus, liquidated damages under the contract in this case must be measured against the anticipated or actual loss under the baklava contract as required by 84-2-718. The trial court erred in using Kvassay's previous income as a yardstick.

  Was the trial court correct when it invalidated the liquidated damages clause, notwithstanding the use of an incorrect test? If so, we must uphold the decision even though the trial court relied on a wrong ground or assigned an erroneous reason for its decision. Sutter Bros. Constr. Co. v. City of Leavenworth, 238 Kan. 85, 93, 708 P.2d 190 (1985). To answer this question, we

[15 Kan. App. 2d 431]

      must look closer at the first criteria for reasonableness under 84-2-718, anticipated or actual harm done by the breach.

  Kvassay produced evidence of anticipated damages at the bench trial showing that, before the contract was signed between Kvassay and Great American, Kvassay's accountant had calculated the baklava production costs. The resulting figure showed that, if each case sold for $19, Kvassay would earn a net profit of $3.55 per case after paying himself for time and labor. If he did not pay himself, the projected profit was $4.29 per case. Nevertheless, the parties set the liquidated damages figure at $5 per case. In comparing the anticipated damages of $3.55 per case in lost net profit with the liquidated damages of $5 per case, it is evident that Kvassay would collect $1.45 per case or about 41 percent over projected profits if Great American breached the contract. If the $4.29 profit figure is used, a $5 liquidated damages award would allow Kvassay to collect 71 cents per case or about 16 1/2 percent over projected profits if Great American breached the contract.

  An examination of these pre-contract comparisons alone might well lead to the conclusion that the $5 liquidated damages clause is unreasonable because enforcing it would result in a windfall for Kvassay and serve as a penalty for Great American. A term fixing unreasonably large liquidated damages is void as a penalty under 84-2-718.

  A better measure of the validity of the liquidated damages clause in this case would be obtained if the actual lost profits caused by the breach were compared to the $5 per case amount set by the clause. However, no attempt was made by Kvassay during the bench trial to prove actual profits or actual costs of production. Thus, the trial court could not compare the $5 liquidated damages clause in the contract with the actual profits lost by the breach. It was not until the jury trial that Kvassay attempted to prove his actual profits lost as part of his damages. Given the trial court's ruling that lost profits were not recoverable and could not be presented to the jury, it is questionable whether the court would have permitted evidence concerning lost profits at the bench trial.

  The trial court utilized an impermissible factor to issue its ruling on the liquidated damages clause and the correct statutory factors were not directly addressed. We reverse the trial court on this issue and remand for further consideration of the reasonableness of the

[15 Kan. App. 2d 432]

      liquidated damages clause in light of the three criteria set out in 84-2-718 and our ruling on recoverability of lost profits which follows.

  Kvassay contends the trial court erred in ruling damages for lost profits were not recoverable, arguing under K.S.A. 84-2-608 he should have been permitted to collect lost profits under his contract with Great American. As noted, the trial court made this ruling prior to hearing any evidence on the issue of lost profits.

  In ruling that Kvassay could not recover lost profits, the court held:
1. The UCC and case law governing lost profits do not apply to "loss of future profits for uncompleted goods under a contract."
2. When the rules governing lost profits do apply, "you have to have an established business, one which meets those other criteria, sufficient length of time that future profits can be reasonably assured by reason of the past history of the business to have been realized or realizable under the contract."
3. "[A]s a matter of law . . . this bakery business was not in existence a sufficient length of time that the calculation of future profits is sufficiently reliable to be a basis for the recovery of damages."
As previously discussed, damages in this case are governed by the UCC and the trial court erred in finding the UCC did not apply. The general rule governing damages is expressed in K.S.A. 84-1-106(1): "The remedies provided by this act shall be liberally administered to the end that the aggrieved party may be put in as good a position as if the other party had fully performed." The specific section governing lost profits is K.S.A. 84-2-708, which states:
"(1) Subject to subsection (2) and to the provisions of this article with respect to proof of market price (section 84-2-723), the measure of damages for nonacceptance or repudiation by the buyer is the difference between the market price at the time and place for tender and the unpaid contract price together with any incidental damages provided in this article (section 84-2-710), but less expenses saved in consequence of the buyer's breach.
  "(2) If the measure of damages provided in subsection (1) is inadequate to put the seller in as good a position as performance would have done then the measure of damages is the profit (including reasonable overhead) which the seller would have made from full performance by the buyer, together with any incidental damages provided in this article (section 84-2-710), due allowance for costs reasonably incurred and due credit for payments or proceeds of resale."

[15 Kan. App. 2d 433]

     

 A plain reading of this statute leads to the conclusion that section (2) applies in this case because there was no market for Kvassay's baklava after Great American breached the contract. However, this determination does not resolve the question of the trial court's ruling that lost profits cannot be obtained for goods not yet produced. While no Kansas court has interpreted 84-2-708(2), one authoritative treatise on the UCC provides guidance. "When the seller is entitled to recover for loss of profits, he may recover for the profit on that part of the order of goods which has not yet been manufactured by him." 4 Anderson, Uniform Commercial Code § 2-708:22, p. 395.

  Setting aside for a moment the question of Kvassay's business experience, Kansas common law is in accord with Anderson on the question of recoverability of loss of profits on goods not yet manufactured:
"`In considering the question what damages may be recovered by the vendor in case of the breach by the vendee of a contract for the purchase and sale of articles to be manufactured, it must be borne in mind that the aim of the law is to place the vendor in the same position he would have occupied if the vendee had performed his contract. If this object is to be attained, it is evident that the vendor must be permitted to recover the profits which he would have made if there had been no breach of the contract.'" Outcault, 118 Kan. ...

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