Seventh Circuit Answers When a Change in Legal Theory Stated in a Complaint Will Prove Disastrous and When an Indiana Supply Contract is Enforceable

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by: Colin E. Flora

     With the Indiana Supreme Court issuing no opinions, this week, and the Court of Appeals of Indiana only entering two published opinions (the twenty-five memoranda decisions are not citable), we turn our attention back to the United States Court of Appeals for the Seventh Circuit and a recent case interpreting both federal pleading procedure and Indiana contract law on repudiation, consideration, and definiteness of material terms.

     This was the second appeal in Brc Rubber & Plastics, Inc. v. Cont’l Carbon Co. It arose from a breakdown in a business relationship between a manufacturer of rubber-based products for the automotive industry and its supplier of carbon black, which is an ingredient in the manufacturing process. The two parties entered into a five-year agreement in 2010 in which the seller agreed to sell “approximately 1.8 million pounds of prime carbon black annually to be taken in approximately equal monthly quantities.” The agreement fixed the same price across the five-year period. In the first year, 2.6 million pounds were shipped. In 2011, however, the market shifted dramatically and the seller was having difficulty meeting its obligations.

     In March 2011, the seller notified the buyer that it would not be able to ship one of the three types of carbon black in May due to plant outages and a lack of inventory, but the buyer still placed an order for 360,000 pounds. (For those wondering on the math, that is 2.4x the amount if you broke 1.8 million into equal monthly installments.) An allegedly rogue employee who was about to be fired by the seller told the buyer that it would ship the full amount if the price was raised by $0.02 per pound. Of course, the buyer rejected that proposition due to the firm price set forth in the Agreement. The seller neither confirmed the order nor made the May shipment. After demanding shipment and being told there was no supply to make one, the buyer purchased that month’s shipment from another seller.

     A couple days later, seller again communicated with the buyer, this time offering to ship multiple railcars of the product for six cents more per pound than the firm price. If the buyer wasn’t going to agree to two cents, you can imagine what it did when asked to pay six cents more. A director for the seller told the buyer that if it would not pay the higher prices it should “call another supplier.” The seller claims that communication was based on a misunderstanding by the director. That is evidenced by the lawyers for both companies conferring within hours of the communication and the seller’s lawyer confirming that it would “continue producing and shipping timely at the contract prices, and would not cut off supply.”

     Over the next several days, the buyer checked on the status and was told , “we will ship one car next week and do the best we can re future orders based on our intent to supply 1.8 million lbs.” Finally, things broke down altogether:

On the next business day, [buyer] again inquired about the status of its order, and [seller] said that it would ship one railcar of carbon black the following day. At this point, [seller] emphasized that the Agreement required it to supply only 1.8 million pounds per year—or approximately 150,000 pounds per month—and that it already had shipped 1.2 million pounds that year—or approximately 300,000 pounds per month. [seller] shipped one railcar of carbon black to [buyer] the next day. Within a week, [seller] emailed [buyer] seeking to increase the baseline prices again and to accelerate the payment terms in the Agreement. On June 2, 2011, [buyer] filed this lawsuit.

     The issue of the first appeal was whether the agreement constituted a requirements contract. “A requirements contract is one in which the purchaser agrees to buy all of its needs of a specified material exclusively from a particular supplier, and the supplier agrees, in turn, to fill all of the purchaser's needs during the period of the contract.” “An agreement is not a requirements contract unless it: ‘(1) obligates the buyer to buy goods, (2) obligates the buyer to buy goods exclusively from the seller, and (3) obligates the buyer to buy all of its requirements for goods of a particular kind from the seller.’” Because the buyer was not obligated to buy exclusively and all of its requirement from the seller, it was not a requirements contract. The importance of that conclusion is that if it were a requirements contract, then the seller’s refusal to ship more than what equates to 1.8 million pounds per year would be a breach of the agreement. So the first appeal concluded that was not a breach.

     After the case went back to the district court, the buyer still argued that there was a breach because the agreement obligated the seller to sell at least 1.8 million pounds per year at the fixed price and the seller had insisted upon increasing the price on multiple occasions. In response, the seller argued that the agreement was not an enforceable contract and that the governing complaint confined the buyer’s case to a claim for breach of a requirements contract, which the agreement was already found not to be. The district court agreed with the seller and the buyer appealed.

     The seventh circuit started with whether the agreement was enforceable. The first question was whether there was legal consideration underlying the agreement.

Under Indiana law, a contract must impose mutual obligations on the parties in order to be enforceable. “If both parties to the [Agreement] are not bound, neither is bound,” and consideration is lacking. Obligations that give rise to consideration can take the form of legal benefits or legal detriments. “A benefit is a legal right given to the promisor to which the promisor would not otherwise be entitled. A detriment, on the other hand, is a legal right the promisee has forborne.” Furthermore, the obligations on both parties must be “reasonably definite and certain;” they cannot be illusory promises that, by their terms, make performance entirely optional. That said, so long as a contract imposes definite obligations on both parties, courts do not question whether the value of consideration is adequate.

     This was a fairly easy point to resolve. The agreement obligated the seller to make available approximately 1.8 million pounds of the product in approximately equal monthly quantities with a baseline price. So, the only question was whether the was any obligation on the part of the buyer. Well the agreement does not obligate the buyer to actually purchase any carbon black at all. But, the agreement prohibited the buyer “from purchasing carbon black from other suppliers on better terms than the Agreement unless Continental reviews the offer and decides not to match it.” That provision created a right of first refusal for the seller. “[T]he value of a right of first refusal is not undermined by its conditional nature.” Mutuality of obligation in satisfying consideration “does not require that every duty within an agreement be based upon a corresponding obligation” and it does not require the value of each obligation to be equal or proportionate. Thus, “[b]ecause the Agreement imposes a definite obligation on both parties, there is mutuality and consideration.”

     As to enforceability, that left the question of whether the agreement contained all of the necessary material terms to form a binding contract. Even if a contract is supported by consideration, it “is unenforceable if it is so indefinite and vague that the material provisions cannot be ascertained.” As the Indiana Supreme Court has explained:

To be valid and enforceable, a contract must be reasonably definite and certain. All that is required to render a contract enforceable is reasonable certainty in the terms and conditions of the promises made, including by whom and to whom; absolute certainty in all terms is not required. Only essential terms need be included to render a contract enforceable. Thus, where any essential element is omitted from a contract, or is left obscure or undefined, so as to leave the intention of the parties uncertain as to any substantial term of the contract, the contract may not be specifically enforced. A court will not find that a contract is so uncertain as to preclude specific enforcement where a reasonable and logical interpretation will render the contract valid.

     On this issue, the Seventh Circuit found “[t]he agreement is sufficiently definite to be enforceable.” The argument was that it lacked “precise quantity terms for the total amount of carbon black and for each grade of carbon black.” 

The Agreement expressly states that it “is the intent of this Agreement that [seller] agrees to sell to [buyer] approximately 1.8 million pounds of prime [carbon] black annually.” The parties’ intent to be bound is evidenced throughout the Agreement, with references to “obligation[s]” and terms that are “to remain firm.” The approximation of the annual quantity does not undermine the definiteness of the contract. Earlier in this litigation, [seller] explained aptly the commercial purpose of such an approximation, which is “intended to allow for a reasonable and defined degree of variation in the annual quantity sold; otherwise, the occurrence of such variations might cause either party to be in breach of the Agreement.”

That the variable quantity was in keeping with the purpose of the agreement and “[b]uilding into its supply contract sufficient nimbleness to meet these contingencies does not alter the essential terms of the contract.” Instead, “[b]oth parties recognize the need to make such adjustments and accept the attendant risk as a necessary component of the commercial relationship. Given the function of the Agreement as a supply contract, we cannot say on this record that such flexibility is anything other than a realistic arrangement.

     With it found that the agreement constitutes an enforceable contract, the next question is whether the buyer’s complaint precluded the ability to litigate the matter. An important note, this portion of the case was governed by federal procedure and pleadings standards, not Indiana. Indiana applies a far lower burden to pleadings than federal courts do.

     The district court believed that the first appeal concluding the contract was a supply contract and not a requirements contract was contrary to the only theory specifically advanced in the complaint and, absent amendment, precluded the new theory. The Seventh Circuit disagreed.

When a new argument is made in summary judgment briefing, the correct first step is to consider whether it changes the complaint’s factual theory, or just the legal theories [the] plaintiff has pursued so far. In the former situation, the plaintiff may be attempting in effect to amend its complaint, and the district court has discretion to deny the de factoamendment and to refuse to consider the new factual claims. In the latter, the court should consider the consequences of allowing the plaintiff’s new theory. If it would, for example, “cause unreasonable delay,” or make it “more costly or difficult” to defend the suit, “the district court can and should hold the plaintiff to his original theory.”

Although Twombly and Iqbal have altered the burden at the pleadings stage, “it remains true that a plaintiff need not plead legal theories. Furthermore, ‘when a plaintiff does plead legal theories, it can later alter those theories,’ and ‘there is no burden on the plaintiff to justify altering its original theory.’” But, if the plaintiff alters its legal theory, the court must still “consider the consequences of allowing the case to proceed under the new theory. If it would, for example, cause unreasonable delay, or make it more costly or difficult to defend the suit,'the district court can and should hold the plaintiff to his original theory.”

     That meant the determinative issue was whether the buyer altered its factual theory or just its legal theory. “We must therefore determine whether [buyer]’s original factual allegations state a plausible claim to relief under [the] new construction of the Agreement. If we conclude that [the] new argument alters only its legal theory, then we must examine the consequences of allowing [buyer] to proceed under this new theory, with an eye toward unreasonable delay of the case and difficulties posed to the defendant.” To answer that question, we need to take a dive once more into Indiana contract law.

     The buyer claimed breach of the agreement by the seller through the doctrine of “anticipatory repudiation.” “Indiana courts recognize the general principle that ‘[r]epudiation of a contract must be positive, absolute, and unconditional.’ They also recognize that, in certain circumstances, repudiation can be effectuated by a party's failure to provide adequate assurance of future performance.” The buyer’s argument was that the seller failed “to provide adequate assurances” of future performance. In the sale of goods, which is governed by the Uniform Commercial Code (UCC), “generally . . . a party feeling insecure about the other party’s contract performance may seek assurance of performance.” That is based on “the recognition . . . that a continuing sense of reliance and security that the promised performance will be forthcoming when due is an important feature of the bargain.” If the willingness or ability to perform “declines materially between the time of contracting and the time for performance, the other party is threatened with the loss of a substantial part of what he has bargained for. . . [and] a buyer who believes that the seller’s deliveries have become uncertain cannot safely wait for the due date of performance when he has been buying to assure himself of materials for his current manufacturing or to replenish his stock of merchandise.”

     The questions are whether there is “reasonable grounds for insecurity” and what is the “adequacy of any assurance offered” in return. Those questions are answered by looking to “nature of the sales contract and the circumstances of the particular case.” Another important note, “a ground for insecurity need not arise from or be directly related to the contract in question, so a buyer may have reasonable grounds for insecurity if he discovers that his seller is making defective deliveries ... to other buyers with similar needs.” The matter involves  “very fact-specific and very context-specific inquiries.”

     Based upon the factual allegations in the complaint, the court concluded that it has plausibly alleged facts supporting repudiation, therefore permitting a change in legal theory under the pleadings. 

 [Buyer]’s revised theory of the Agreement does not depend on any essential allegations that are missing from its complaint. From the start, [it] has maintained that [seller] repudiated the Agreement by failing to fulfill an order, seeking increased prices and accelerated payment terms, and providing equivocal assurances of future performance. [Buyer] has altered only its legal characterization of the Agreement; its factual theory of the case has remained constant.

     That left the matter of whether it was unduly prejudicial to allow the change. As you might imagine, when the theory shifts due to an appellate court construing the contract and all of that happened prior to the parties engaging in discovery, the court found no unfair harm in allowing the change in theory:

We have recognized such harms when the case is delayed unreasonably or becomes “‘more costly or difficult’ to defend.” This record provides no basis for our concluding that [buyer]’s new characterization of the Agreement harms the development of the case or [seller]’s defense. Notably, at earlier stages in this litigation, [seller] advanced the same construction of the contract that [buyer] now endorses. In these circumstances, [seller] certainly is not prejudiced by [buyer]’s new argument, which, in a strict sense, is not new to this case at all.

     Accordingly, the Seventh Circuit reversed the entry of summary judgment that had been granted to the seller. The court did not, however, enter summary judgment for the buyer, as had been requested, because the factual questions about anticipatory repudiation are matters to be decided at trial.

     Aside from the legal issues to be understood in this case, there is a business lesson to be found as well. This case began in June 2011 over the seller trying to get six cents more per pound. At 1.8 million pounds, that would have been an extra $108,000 per year; by no means, chump change. But here we are, seven years and two appeals later, and the case is still not resolved. It seems an almost certainty that the two parties have expended that much in costs and fees already. It reminds of the old proverb: “For want of a nail the shoe was lost. For want of a shoe the horse was lost. For want of a horse the rider was lost. For want of a rider the message was lost. For want of a message the battle was lost. For want of a battle the kingdom was lost. And all for the want of a horseshoe nail.” Sometimes, small issues can explode well past where anyone could have imagined. It is why there are often business decisions to be made even when legal rights may dictate contrary results.

     Join us again next time for further discussion of developments in the law.

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*Disclaimer: The author is licensed to practice in the state of Indiana. The information contained above is provided for informational purposes only and should not be construed as legal advice on any subject matter. Laws vary by state and region. Furthermore, the law is constantly changing. Thus, the information above may no longer be accurate at this time. No reader of this content, clients or otherwise, should act or refrain from acting on the basis of any content included herein without seeking the appropriate legal or other professional advice on the particular facts and circumstances at issue.