James W. Stephenson v. The Third Company

IN THE COURT OF APPEALS OF TENNESSEE
AT NASHVILLE
September 2, 2003 Session

JAMES W. STEPHENSON v. THE THIRD COMPANY, ET AL.

Appeal from the Circuit Court for Robertson County
No. 9254 Ross H. Hicks, Judge

No. M2002-02082-COA-R3-CV - Filed February 27, 2004

The plaintiff filed suit for repayment of $25,000 which he purportedly loaned to the defendant. The
defendant contended that the money was not a loan, but was placed with him for a specific
investment. Since the investment ultimately failed, the defendant claimed that he did not owe
anything to the plaintiff. The trial court noted that the documents evidencing the transactions at issue
were “replete with ambiguities,” but found that they were nonetheless sufficient to establish an
enforceable loan contract. The court accordingly rendered a plaintiff’s judgment for $25,000 plus
interest. We reverse.

Tenn. R. App. P. 3 Appeal as of Right; Judgment of the Circuit Court
Reversed and Remanded

PATRICIA J. COTTRELL, J., delivered the opinion of the court, in which WILLIAM B. CAIN , J., joined.
WILLIAM C. KOCH , P.J., M.S., filed a dissenting opinion.

Winston S. Evans, Nashville, Tennessee, for the appellant, The Third Company and Richard C. L.
Caldwell, individually.

John B. Holt, Springfield, Tennessee, for the appellee, James W. Stephenson.

OPINION

I. A LOAN OR AN INVESTMENT?

The transactions from which this case arose had their origins in a business relationship
between defendant Richard Caldwell and a non-party named Johnny Knight. Mr. Caldwell first
became acquainted with Mr. Knight when the latter’s company, Knight’s Machinery, went through
bankruptcy and a bankruptcy attorney suggested that Mr. Caldwell take a look at his business. Mr.
Knight’s business was buying used sawmill equipment at auctions, refurbishing it, and selling it for
a profit. Mr. Caldwell met with Mr. Knight and concluded that with proper management, the
business had the potential to generate large profits. He described Mr. Knight as a good salesman,
“best I ever saw,” but a bad manager.

Mr. Knight’s business was reorganized as Knight’s Enterprises, and Mr. Caldwell was hired
to oversee all its financial affairs. Auctions are conducted on a cash basis, so it quickly became
apparent to Caldwell that Knight would need substantial infusions of cash in order to operate. After
going to several local banks, it became equally apparent to Caldwell that because of the bankruptcy,
Knight would not be able to borrow money to operate the business.

Mr. Caldwell’s solution was to create a sole proprietorship called the Third Company to raise
money and manage cash flow for Knight’s Enterprises. According to Caldwell’s testimony, the
creation of a separate company as a conduit for invested funds protected him from commingling his
own assets with the money he furnished to Knight, and enabled him to easily keep track of all the
money disbursed to or received from Knight.

Caldwell invested $35,000 of his own money in the Third Company. He also persuaded a
man named Dorris Head to make a $100,000 investment. However, the only money at issue in this
case is the $25,000 that was furnished to the Third Company by a man named James Stephenson.

Richard Caldwell and Mr. Stephenson (who usually went by the name Steve Stephenson)
were social acquaintances. Caldwell explained Knight’s business to Stephenson, and suggested that
he might be able to participate financially in it. Mr. Stephenson agreed, and on August 25, 1998, the
parties executed two documents which had been prepared by Mr. Caldwell without the assistance
of an attorney.

The first document, titled “Loan Agreement,” recites a loan of $15,000 from Mr. Stephenson
to the Third Company, with 10% annual interest. While the language and terms of this agreement
are probably typical of most loan documents, the repeated references in it to the business of a third
party are not. For example, the section called “Loan Amount” states that the $15,000 is “for the use
of participating in the Knight’s Enterprises inventory and equipment project.”

Under “Purpose,” the document recites that “[t]he purpose of the loan is to participate with
the Third Company in the inventory and equipment financing for Knight’s Enterprises of Tennessee,
Inc. I understand that the funds I loan the Third Company will be placed with Knight’s Enterprises
for the purchase of inventory and resale.” Under “Collateral,” it states, “Lender understands that the
collateral for his funds is limited to the inventory and equipment that the Borrower has on its books
collateraled (sic) by Knight’s Enterprises.” The section on interest rate states that “[i]nterest will be
calculated against funds deployed for the benefit of Knight’s Enterprises.”

On October 21, 1998, Mr. Stephenson signed a second “Loan Agreement” containing
identical language. This agreement was for an additional $10,000. Hereinafter, when we refer to
“the Loan Agreement,” we will either be referring to the first document so titled, or to both
documents, depending on the context.

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 On the same day that they signed the first loan agreement, the parties executed a second
document, titled “Consulting Agreement.” Its stated purpose was “to hire the services and expertise
of Steve Stephenson in order to enhance the efficiency of the Third Company.” Under this
Agreement, consultant fees are due and payable each month, in an amount “based on 5% of the funds
which Mr. Stephenson has employed with the Third Company.”1

The proof showed that Mr. Stephenson had no expertise in the business of either the Third
Company or Knight’s Enterprises and that, even though he never performed any consulting services,
he received monthly payments totaling over $5,000 under the “Consulting Agreement” before the
parties agreed to suspend the agreement five months after its execution.

After some initial success, Knight’s Enterprises faltered, and payments to Mr. Stephenson
came to a halt. On May 3, 2000, he filed a Complaint in the Robertson County Circuit Court naming
the Third Company and Richard Caldwell as defendants. The plaintiff asked for repayment of the
$25,000 plus interest, as well as punitive damages. He alleged fraud on the part of Mr. Caldwell,
a claim which he did not pursue at trial. The Complaint did not mention the “Consulting
Agreement,” or any of the payments received under it.

The defendant’s Answer denied any wrongdoing, and stated that since the stated purpose of
the Agreement between the parties was to participate with the Third Company in financing inventory
and equipment for Knight’s Enterprises of Tennessee, the obligation of repayment was conditioned
upon the Third Company first receiving payment from Knight’s Enterprises.2

II. COURT PROCEEDINGS

The case came to trial on April 23, 2002. The only witnesses to testify were Mr. Stephenson
and Mr. Caldwell. Mr. Stephenson seemed to have a fair understanding of the nature of Knight’s
Enterprises and the role of the Third Company in its financing, but his understanding of the nature
of his own involvement appeared murky at best.

He stated several times that he had invested in the Third Company, and that he was one of
the investors in that company, but he didn’t know if the investment was an equity interest because
he didn’t know the meaning of that term. He testified that he knew that the Third Company was
going to pay him and the other investors a commission when equipment was sold, and that whatever
money the Third Company received would be distributed to the investors, including him. He stated

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Mr. Caldwell testified that this provision mirrored a proposed agreement that Knight would pay Third
Company 5% per month for funds advanced to him for the purchase of equipment. According to Mr. Caldwell, Mr.
Knight refused to sign the proposed agreement, but verbally agreed to abide by it, and did so during the first few
months .

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Mr. Caldwell testified that he and Mr. Head brought suit against Mr. Knight to recover funds which Knight
had allegedly embezzled, and invited Mr. Stephenson to join that suit as a plaintiff. Mr. Stephenson declined and
sued Caldwell instead.

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that he understood there was a risk associated with the investment, but that the possible reward
“looked very good.”

Mr. Caldwell’s testimony as to the disposition of the money was consistent with that of Mr.
Stephenson. He testified that all the money that was invested went to Knight’s Enterprises, and that
all the money received as profit from the operation of that company was distributed to the investors
in the Third Company (including Mr. Stephenson) on a pro rata basis as it was received.

He also gave a lengthy account of his dealings with Mr. Knight and of the declining fortunes
of Knight’s Enterprises. According to Mr. Caldwell, after an initial period of success, Mr. Knight
instructed equipment buyers to wire their payments directly to his private account, and he used those
funds (amounting to over $150,000) to begin a 5,000 square foot addition to his house, instead of
turning them over to the Third Company as he had agreed to. When Caldwell could not deter Knight
from using the company’s money for personal purposes, he resigned as financial officer of Knight’s
Enterprises.

At the conclusion of closing arguments, the trial judge announced his decision from the
bench. He stated that the loan documents of August 28 and October 21 were “replete with
ambiguities,” but that he had to construe them against Mr. Caldwell as the preparer of those
documents. He noted their frequent use of the word “loan” and the reference to the parties as
borrower and lender. The judge concluded that the agreement was indeed a loan, and that the
defendants owed the plaintiff $25,000 plus interest. He further declared that the consulting
agreement was a separate document, and that Mr. Caldwell was not entitled to any credit for
payments made under the terms of that agreement. This appeal followed.

III. ANALYSIS

The question of interpretation of a contract is a question of law. Guiliano v. CLEO, Inc., 995
S.W.2d 88, 95 (Tenn. 1999). Therefore, the trial court’s interpretation of a contractual document
is not entitled to a presumption of correctness on appeal. Id.; Angus v. Western Heritage Ins. Co.,
48 S.W.3d 728, 730 (Tenn. Ct. App. 2000). This court must review the documents ourselves and
make our own determination regarding their meaning and legal import. Hillsboro Plaza Enters. v.
Moon, 860 S.W.2d 45, 47 (Tenn. Ct. App. 1993). Our review is governed by well-settled principles.

A. AN AMBIGUOUS CONTRACT

“The central tenet of contract construction is that the intent of the contracting parties at the
time of executing the agreement should govern.” Planters Gin Co. v. Fed. Compress & Warehouse
Co., Inc., 78 S.W.3d 885, 890 (Tenn. 2002). The purpose of interpreting a written contract is to
ascertain and give effect to the contracting parties’ intentions. Id.; Frizzell Constr. Co. v.
Gatlinburg, L.L.C., 9 S.W.3d 79, 85 (Tenn. 1999). Thus, it is well-established that “[t]he cardinal
rule for interpretation of contracts is to ascertain the intention of the parties and to give effect to that
intention, consistent with legal principles.” Pearsall Motors Inc. v. Regal Chrysler-Plymouth, Inc.,

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521 S.W.2d 578, 580 (Tenn. 1975). See also Galleria Associates, L.P. v. Mogk, 34 S.W.3d 874,
876-7 (Tenn. Ct. App. 2000), Realty Shop, Inc. v. RR Westminster Holding, Inc., 7 S.W.3d 581, 597
(Tenn. Ct. App. 1999), Hamblen County v. City of Morristown 656 S.W.2d 331,333 (Tenn. 1983).

As a general rule, the intent of the parties is presumed to be that specifically expressed in the
written contract. Planters Gin Co., 78 S.W.3d at 890. Therefore, the court’s role in resolving
disputes regarding the interpretation of a contract is to ascertain the intention of the parties based
upon the usual, natural, and ordinary meaning of the language used. Guiliano, 995 S.W.2d at 95;
Bob Pearsall Motors, 521 S.W.2d at 580.

Where the language of the contract is clear and unambiguous, its literal meaning controls the
outcome of contract disputes. Planters Gin Co., 78 S.W.3d at 890. If the contract is unambiguous,
then the court may not look beyond its four corners to ascertain the parties’ intention. Rogers v. First
Tennessee Bank National Ass’n, 738 S.W.2d 635,637 (Tenn. Ct. App. 1987). Bokor v. Holder, 722
S.W.2d 676, 679 (Tenn. Ct. App. 1986). But, where a contractual provision is ambiguous, i.e.,
susceptible to more than one reasonable interpretation, the parties’ intent cannot be determined by
a literal interpretation of the language. Planters Gin Co., 78 S.W.3d at 890. In that situation, courts
must resort to other rules of construction, and only if ambiguity remains after application of the
pertinent rules does the legal meaning of the contract become a question of fact. Id. Then, the court
must examine other evidence to ascertain that intention. Such evidence might include the
negotiations leading up to the contract, the course of conduct the parties followed as they performed
the contract, and any utterances of the parties that might shed light upon their intentions. Pinson &
Associates Ins. v. Kreal, 800 S.W.2d 486, 487 (Tenn. Ct. App. 1990), Jackson v. Miller, 776 S.W.2d
115, 118 (Tenn. Ct. App. 1989), Patterson v. Anderson Motor Co., 319 S.W.2d 492, 497 (Tenn. Ct.
App. 1958).

In Turner v. Zager, 363 S.W.2d 512, 519 (Tenn. Ct. App. 1962), we stated that, “[i]t is the
duty of the court in the construction of contracts to ascertain the intention of the contracting parties,
understand what they meant by the contract, and give effect to such understanding and meaning. All
other rules of construction are only aids or helps in establishing the intention of the parties and for
mutual understanding of the meaning of their contract.” See also Commerce Street Company Inc.
v. Goodyear Tire and Rubber Company, Inc., 215 S.W.2d 4, 10 (Tenn. Ct. App. 1948).

Further, in construing contracts, courts must look at the language and the parties’ intent and
impose a construction that is fair and reasonable. ACG, Inc. v. Southeast Elevator, Inc. 912 S.W.2d
163, 168 (Tenn. Ct. App. 1995). Reasonableness must be viewed in light of the parties’ situation
at the time of the making of the agreement as well as at the time performance becomes due.
Hathaway v. Hathaway, 98 S.W.3d 675, 680-81 (Tenn. Ct. App. 2002). The language of a contract
should be construed with reference to the situation of the parties, the business to which the contract
relates, the subject matter of the agreement, the circumstances surrounding the transaction, and the
construction placed on the contract by the parties in carrying out its terms. Penske Truck Leasing
Co., L.P. v. Huddleston, 795 S.W.2d 669, 671 (Tenn. 1990); International Flight Center v. City of
Murfreesboro, 45 S.W.3d 565, 570 (Tenn. Ct. App. 2001). The course of conduct of the parties is

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strong evidence of the parties’ original intent. Pinson & Associates, 800 S.W.2d, at 487.

The trial court explicitly found that the loan contract was ambiguous, a finding with which
we concur. While parts of it read like a standard contract to lend money, the inclusion of language
indicating that the loan’s purpose is “to participate with the Third Company in the inventory and
equipment financing for Knight’s Enterprises ..,” and other language referencing that third party
business is more typical of some kind of joint venture or an investment contract.

The trial court chose to focus solely on the loan-specific language in the contract to reach his
decision. It thus failed to take into account both the ambiguous language and Mr. Stephenson’s own
testimony as to his understanding of the relationship he had entered into with the Third Company
and its connection to Knight’s Enterprises. We note that a contract must be construed as a whole,
and effect given to every part. “It is the universal rule that a contract must be viewed from beginning
to end and all its terms must pass in review, for one clause may modify, limit or illuminate another”
Cocke County Bd of Highway Commissioners v. Newport Utilities Board, 690 S.W.2d 231, 237
(Tenn. 1985). “The proper construction of a contractual document is not dependent on any name
given to the instrument by the parties, or on any single provision of it, but upon the entire body of
the contract and the legal effect of it as a whole.” Aetna Casualty & Surety Co. v. Woods, 565
S.W.2d 861, 864 (Tenn. 1978). In addition, the loan agreements were only part of the transaction
between the parties.

B. THE SIGNIFICANCE OF THE CONSULTING AGREEMENT

It has long been recognized that when different documents are executed as part of the same
transaction, they must be construed together. Realty Shop, Inc., 7 S.W.3d at 599; Ferguson v.
Peoples Nat. Bank of LaFollette, 800 S.W.2d 181, 183 (Tenn. 1990); Oman Construction Company
v. Tenn. Central Railroad, 370 S.W.2d 563, 574 (Tenn. 1963).

The loan agreement and the consulting agreement were between the same parties and were
executed at the same time. Mr. Stephenson argues that the consulting agreement was separate from
the loan agreement because it was supported by separate consideration. But the proof shows that Mr.
Stephenson had no expertise as a consultant and provided no expertise, so the recited consideration
in the consulting agreement was illusory on his part.

However, the consideration on Mr. Caldwell’s part was directly tied to the loan agreement,
by being “based on 5% of the funds in which Mr. Stephenson has employed with the Third
Company.” Contrary to Mr. Stephenson’s argument, it thus appears to us that the true purpose of
the Consulting Agreement was to furnish additional consideration for the use of Mr. Stephenson’s
funds. We believe the two documents were executed as part of the same transaction, and that we
must construe them together in order to understand what amounts to a single transaction.

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 C. CONTRA PROFERENTUM

When we construe the two documents together, we cannot conclude that the intention of the
parties can be correctly characterized as a simple loan agreement. Mr. Stephenson argues that we
should adhere to the reasoning of the trial court, and construe both agreements against Mr. Caldwell.
He insists that the case should be controlled by the principle which he calls Contra Proferentum: that
is, when a contract is ambiguous, it is generally construed against the party who drafted it. Parks
v. Richardson, 567 S.W.2d 465, 468 (Tenn. Ct. App. 1977), Hanover Insurance Company v. Haney,
425 S.W.2d 590, 592-93 (Tenn. 1968).

This rule is a valid and useful tool for construing ambiguous contracts, and it has frequently
been used by the courts as the key to resolving the question of which of two possible constructions
of a contract to favor. But it does not trump other rules of construction in all situations. Above all,
it does not negate the actual intention of the parties, where that can be deduced from other evidence.

Mr. Caldwell cites a number of cases from the federal courts which state that the rule of
resolving contract ambiguities against the drafting party only applies if the interpretation urged by
the non-drafting party is reasonable and practical. The same principle has been articulated by this
court several times, quoting the same words from 12 Am.Jur. 792 Contracts, § 250: “Where the
language of an agreement is contradictory, obscure or ambiguous, or where its meaning is doubtful
so that it is susceptible of two constructions, one of which makes it fair, customary, and such as
prudent men would naturally execute, while the other makes it inequitable, unusual, or such as
reasonable men would not be likely to enter into, the interpretation which makes a rational and
probable agreement must be preferred.” Wilkerson v. Williams 667 S.W.2d 72, 79 (Tenn. Ct. App.
1983); Pettyjohn v. Brown Boveri Corp., 476 S.W.2d 268, 272 (Tenn. Ct. App. 1971); Zager, 363
S.W.2d at 519; Commerce Street Company Inc. v. Goodyear Tire and Rubber Company, Inc., 215
S.W.2d 4, 11 (Tenn. Ct. App. 1948).

Mr. Caldwell points out that treating his transaction with Mr. Stephenson as a simple loan
would lead to results that are inconsistent with a reasonable business decision on his part. He
demonstrates this by describing the outcome for both parties under two possible scenarios. If
Knight’s Enterprises succeeded, Stephenson would enjoy a 70% return on his money, and Caldwell
would break even on the transaction. If Knight failed, Caldwell would still be obligated to repay
Stephenson’s money plus 70%, on top of his own losses. Under both scenarios, Caldwell would take
all the risk and Stephenson would reap a substantial reward. Surely, he argues, no rational
businessman would enter into such an agreement.

When the meaning of an agreement is ambiguous, and the court attempts to determine the
true intentions of the parties, it should favor the construction that furnishes reasonable terms for the
parties’ agreement over the construction that results in unreasonable terms. However, we need not
rely on that principle to reach a decision herein. The documents and, particularly, the parties’
testimony provide a clear basis for determining their intent. After thoroughly reviewing the
documents in dispute, the testimony of the parties, and the entire record of this case, we conclude

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that the parties intended their transaction to be an investment contract. Mr. Stephenson joined with
other investors in a potentially lucrative venture, which was by no means risk-free, and he is not
entitled to repayment.

IV.

The judgment of the trial court is reversed. The case is remanded to the Circuit Court of
Robertson County for further proceedings consistent with this opinion. Costs on appeal are taxed
to the appellee, James Stephenson.

____________________________________
PATRICIA J. COTTRELL, JUDGE

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