Judge Easterbrook, Chief Judge of the Seventh Circuit Court of Appeals, is known for his sharp pen and his acerbic comments to legal counsel representing the parties before the Seventh Circuit. A recent decision by Judge Easterbrook illustrates this in the context of some interesting corporate and legal discussions. (White Pearl Inversiones S.A. (Uruguay) and Sanlo Corp. v. Cemusa, Incorporated, No. 10-2739 decided July 26, 2011)
Cemusa, Incorporated is a Delaware company, a subsidiary of a Spanish firm that specializes in placing "street furniture" within the European Union. "Street furniture" is the modern name for what used to be street items like trash baskets and bus shelters. But, by improving their aesthetics, they can become attractive urban decorations and, more importantly, opportunities for advertisers to pay to erect and maintain them.
White Pearl Inversiones is a consultant which offered its assistance to Cemusa, which Cemusa accepted on a handshake. In this first "handshake" transaction, Cemusa succeeded in winning bids in Miami and San Antonio.
The parties took their arrangement a step further with a written contract dated March 25, 2003 (which the court called the "Letter Agreement") in which White Pearl would provide advice, guidance and other services to Cemusa regarding the New York street furniture market. In exchange, While Pearl would receive $240,000. The Letter Agreement contemplated that the parties would eventually enter into a more detailed Master Agreement and that Master Agreement would provide for additional compensation to White Pearl with the $240,000 credited against the additional compensation.
Six days later, the parties actually signed the Master Agreement under which White Pearl would receive a percentage fee based on Cemusa's net advertising revenue. White Pearl's right to this fee would become vested after New York issued its Request for Proposal (RFP). Until that time, in a critical provision, either party could terminate the Master Agreement on 30 days' notice.
What happened next is predictable. On February 17, 2004 Cemusa exercised its right to terminate the Master Agreement on 30 days notice. At the end of March, 2004, New York issued its RFP which which was extremely lucrative for Cemusa. Cemusa succeeded in obtaining the bid for all five New York boroughs which would have given White Pearl a $12.5 million fee. Instead White Pearl had only its $240,000 under the Letter Agreement. Although the parties attempted to resolve their dispute by concluding a contract that would have given White Pearl $2 million, the effort was not successful. Judge Easterbrook held that the $240,000 was all White Pearl was entitled to, based on the Letter Agreement.
But before getting to the merits of the case and the final decision, Judge Easterbrook took a diversion which is of great interest to corporate lawyers. The case was brought under international diversity jurisdiction. For this purpose, the parties asserted White Pearl to be a "corporation" of Uruguay. But what kind of corporation? As it turns out, the jurisdiction of the federal court hinges on this critical analysis. Under the laws of U.S. states, an ordinary business corporation is a separate entity from its owners and has the citizenship of its state of organization. But other entities do not have separate citizenship. For example, limited partnerships, limited liability companies and similar organizations are "disregarded" for jurisdictional purposes. So, for jurisdictional purposes, the citizenship of every investor must be determined. If any investor is not diverse, diversity fails and the federal court has no jurisdiction.
So where does White Pearl fit? Uruguay has three forms of limited liability businesses. White Pearl did not indicate what kind it was and, noted Judge Easterbrook, its lawyers "did not know - indeed, . . . they did not even know their client's legal name and had not tried to analyze the significance of its (unknown) organizational attributes. [The lawyers] simply assumed that Uruguay has such a beast as a "corporation" and that White Pearl is one. The lawyers for Cemusa made the same assumption."
So the lawyers went back to work to determine if they were even in the right courtroom. It turned out that White Pearl is a "sociedad anomima" (or S.A.), which is equivalent to a joint-stock company. The U.S. Supreme Court held (in 1889!) that a joint-stock company is not a corporation for diversity jurisdiction and should be treated as a partnership.
After all that, and no doubt to the relief of legal counsel, the court determined that White Pearl had only two investors, whose Brazilian citizenship did not defeat diversity. So the court went on to the merits.
In this regard, there was little suspense. The court dismissed White Pearl's complaint, but on different grounds than the district court. The district court dismissed the complaint as failing to state a claim. But, said Judge Easterbrook, the complaint should have been dismissed based on judgment on the pleadings.
The Master Agreement had been terminated in accordance with its terms. So the only agreement providing for compensation was the Letter Agreement. But White Pearl had already been compensated under the Letter Agreement. Although White Pearl's attorneys articulated a variety of claims, contract, quasi-contract, and tort, none of these overrode the court's opinion that White Pearl had received precisely what it negotiated for and was not entitled to more.
In the meantime, Judge Easterbrook took another dig at both parties' counsel. He noted that the Letter Agreement provided for application of the laws of Spain. But how Spanish law would deal with this case was completely ignored by both sides' legal counsel. By default, the court applied Illinois law because "like the district court we think the outcome straightforward, without foreclosing the possibility of dismissal when the problem is more complex and the parties leave the court adrift."
In the court's opinion, White Pearl "volunteered" its work because it did not negotiate and sign an effective agreement that provided what White Pearl felt to be fair compensation. So White Pearl assumed the risk of the result it got.
"This case is governed by the principle that courts do not invoke doctrines such as quantum meruit or unjust enrichment to change the price term in a contract. White Pearl tells us that it spent about $440,000 to assist Cemusa. So what? No rule of law entitles every business to a profit on every deal. White Pearl agreed to a fixed price; it did not negotiate a cost-plus contract, or one that paid by the hour that its consultants devoted to the project.
. . . . .
". . . [A] business that volunteers services must rely for compensation on the reputational interest of its trading partner.”
If Cemusa did not treat White Pearl well, it will pay a penalty in the market; other consultants (and for that matter professionals such as law firms, accountants, and advertising agencies) will demand a premium price to deal with a business known to take advantage of others. Still, a firm is not legally obliged to recompense another for volunteered work, let alone to ensure that its trading partners don't lose money. Businesses themselves know best how to protect their interests. When courts award sums on top of a contractual price, this reduces entrepreneurs' ability to allocate risks through written agreements. Destabilizing or devaluating the institution of contract would raise the transactions costs of business, injuring economic productivity and growth. As Learned Hand remarked, it is better for courts to let some seemingly unjust outcomes alone than to intervene in a way that makes contracts less reliable. See, e.g., Hemenway v. Peabody Coal Co., 159 F.3d 255, 258 (7th Cir.1998), quoting from James Baird Co. v. Gimbel Bros., Inc., 64 F.2d 344, 346 (2d Cir.1933) (“in commercial transactions it does not in the end promote justice to seek strained interpretations in aid of those who do not protect themselves”).
Judge Easterbrook and the Seventh Circuit showed again why businesses that do not protect themselves in their agreements will not find the Seventh Circuit to be a congenial forum.