United States Court of Appeals
For the First Circuit
Nos. 04-2298, 04-2530
LIBERTY MUTUAL INSURANCE COMPANY,
Plaintiff, Appellee,
v.
GREENWICH INSURANCE COMPANY,
Defendant, Appellant.
APPEALS FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MASSACHUSETTS
[Hon. Robert B. Collings, U.S. Magistrate Judge]
Before
Boudin, Chief Judge,
Torruella, Circuit Judge,
and Baldock,* Senior Circuit Judge.
Stephen R. Swofford with whom Lawrence R. Moelmann, Nancy G.
Lischer, Clifford E. Yuknis and Hinshaw & Culbertson LLP were on
consolidated brief for appellant.
Douglas R. Gooding with whom Gregg Shapiro, Paul E. Bonanno,
Kara M. Zaleskas and Choate, Hall & Stewart LLP were on
consolidated brief for appellee.
August 4, 2005
*
Of the Tenth Circuit, sitting by designation.
BOUDIN, Chief Judge. This commercial dispute, more
complicated than difficult, concerns a claim made on a surety bond
issued by one insurer to another. The district court granted
recovery on the bond in favor of the claimant, Liberty Mutual
Insurance Company (“Liberty”), and against the issuer of the bond,
Greenwich Insurance Company (“Greenwich”). Greenwich has appealed,
and we now affirm.
The scene is easily set. In December 1999, American
Tissue, Inc. (“American Tissue”), a manufacturer now bankrupt,
obtained from Liberty two insurance policies to cover workers’
compensation that American Tissue might be forced to pay in the
course of its ordinary operations. The policies (“the 1999
policies”) were to cover accidents occurring during the period
December 11, 1999-January 1, 2001, and provided coverage for
American Tissue for amounts that it might owe for such accidents
over and above a deductible of $250,000 for each claim.
These policies were “fronting policies,” providing that
Liberty would pay all claims in their entirety up front and that
American would reimburse Liberty for any amount paid on the claim
up to the deductible; payments over and above the deductible were
to be borne by Liberty. The policies also required American Tissue
to pay premiums, but the total amount of the premiums was to be
adjusted retrospectively based, among other things, on actual
losses experienced by Liberty. The policies thus provided some
-2-
protection for American Tissue but greater protection for injured
workers.
During the year 2000, American Tissue encountered
financial difficulties and failed to make required payments to
Liberty. So, as a condition of renewing the policies, Liberty
insisted that American Tissue obtain guarantees to secure American
Tissue’s present and future obligations to reimburse Liberty. On
December 11, 2000, the two companies signed an agreement to this
effect (“the agreement”) and Liberty then renewed American Tissue’s
policies for the period January 1, 2001, to January 1, 2002 (“the
2001 policies”).
The agreement, which is at the center of the dispute,
said that its purpose was to secure all of American Tissue’s
obligations to Liberty arising out of the 1999 and 2001 policies,
including both reimbursements and premiums, and provided that
payments due must be paid within 20 days of Liberty’s written
demand. To secure these payments, American Tissue agreed to
deliver both a surety bond and a letter of credit in favor of
Liberty, substantially in the form of the bond and letter of credit
attached to the agreement.
The agreement provided that the amounts of the required
bond and letter of credit would be fixed by schedules prepared by
Liberty; but it also provided that Liberty “at its sole discretion”
could increase the amounts by providing American Tissue revised
-3-
schedules, whenever Liberty feared that the existing amounts so
guaranteed were inadequate to cover American Tissue’s existing
obligations.
Initially, Liberty sought a surety bond of $1,777,500
and a letter of credit of $2,172,500; however, American Tissue was
unable to immediately supply so large a letter of credit.
Accordingly, Liberty agreed to a bond in the amount of $3.7 million
and a $250,000 letter of credit, provided that American Tissue
thereafter increase the letter to reach $2,172,500 by April 15,
2001. The collateral-amount schedule read:
Letter of Credit $250,000 to be increased to
$2,172,500 no later than 4/15/2001
Surety Bond $3,700,000 may be decreased to
$1,777,500 on receipt of Letter(s) of Credit
totaling $2,172,500
In the final agreement, the deadline for supplementing the letter
of credit was changed to June 1, 2001.
On January 24, 2001, American Tissue obtained the
required $3.7 million surety bond from Greenwich. In the archaic
form sometimes used for surety bonds, the bond read that it would
be void if American Tissue carried out its obligations under its
agreement with Liberty but “otherwise” American Tissue and
Greenwich were each jointly and severally liable in the amount of
the bond. Separately, American Tissue agreed to indemnify
Greenwich for any payments that Greenwich had to make to Liberty
under the bond.
-4-
Having obtained an initial letter of credit for $250,000
on February 12, 2001, American Tissue on May 16, 2001, obtained an
additional letter of credit for $2,172,500. Not long after,
American Tissue sent an e-mail to Marsh & McLennan requesting that
the surety bond be reduced to $1,777,500 in accordance with the
agreement.1 Marsh & McLennan forwarded the request to Greenwich,
which responded that the bond reduction "can be done by rider, but
it must be acknowledged by the carrier"–-apparently meaning that
Liberty must be notified first.
In all events, there is no evidence that Liberty was
itself notified, or that it consented to a bond reduction, or that
the bond amount was in fact ever reduced.2 Instead, during 2001
American Tissue began to miss payments to Liberty and, on July 13,
2001, Liberty issued a new schedule raising (without qualification)
the required security to $2,422,500 in letters of credit (the value
of the two existing letters) and $3.7 million for the surety bond.
Thereafter, to satisfy some of American Tissue’s debt, Liberty drew
down almost in full both existing letters of credit.
1
The writer of the original e-mail may have assumed that Marsh
& McLennan was Liberty’s agent; this Liberty disputes, suggesting
that Marsh & McLennan was acting as broker for American Tissue.
2
In the law suit, the district court did not permit discovery
about what happened, but Greenwich–-which presumably would know if
it reduced the bond–-does not claim the denial of discovery on this
issue to be error.
-5-
On August 17, 2001, and again on September 7, Liberty
notified American Tissue that the latter was in default under the
agreement on account of continued non-payments. On September 10,
2001, American Tissue filed for bankruptcy in Delaware. On October
9, Liberty wrote to Greenwich, claiming that the bankruptcy
constituted a default under the agreement and bond, making
Greenwich liable for the full amount of the bond ($3.7 million),
which Liberty now asserts is less than the estimated loss that
Liberty is going to suffer from American Tissue’s default.
On Greenwich’s refusal to pay, Liberty on January 29,
2002, filed a two-count complaint against Greenwich in the federal
district court. The first count (which alone is before us) claimed
breach of contract for non-payment of the full amount of the bond.
In due course, the district court granted summary judgment in
Liberty’s favor and certified this judgment as separate and final
pursuant to Fed. R. Civ. P. 54(b). (Still unresolved, and not
before us, are a claim by Liberty under Mass. Gen. Laws ch. 93A
(2002) and counterclaims by Greenwich on several different
theories.)
On appeal, Greenwich’s first and most extensive argument
is on the merits of Liberty's contract claim. Its position is that
under the surety bond, incorporating relevant terms of the
agreement between Liberty and American Tissue, it can be liable to
Liberty only for the amount of $1,777,500–-the sum to which the
-6-
agreement permitted American Tissue to reduce the bond once it had
secured letters of credit totaling $2,172,500. Alternatively,
Greenwich says that at least the bond and agreement were ambiguous,
presenting an issue of fact precluding summary judgment.
The agreement provides explicitly that its terms are
governed by Massachusetts law; the surety bond is silent but here
the parties cite Massachusetts law as well and we accept their
implicit premise. See McAdams v. Mass. Mut. Life Ins. Co., 391
F.3d 287, 298 n.5 (1st Cir. 2004). The grant of summary judgment
is reviewed de novo, Dasey v. Anderson, 304 F.3d 148, 153 (1st Cir.
2002); and ordinarily contract interpretation is for the court
unless disputed issues of fact bear upon the interpretation of
ambiguous language. Fishman v. LaSalle Nat’l Bank, 247 F.3d 300,
303 (1st Cir. 2001).
In our view–-and this too is a question of law for the
court, Lanier Prof’l Servs., Inc. v. Ricci, 192 F.3d 1, 4 (1st Cir.
1999)–-neither the bond nor the agreement is ambiguous in any way
relevant here. By its terms, the full amount of the bond is
payable upon an act of default by American Tissue, and Greenwich
does not deny that such a default occurred. Nor does Greenwich
claim that it did issue a substitute bond in an amount smaller than
$3,700,000 or otherwise issue any rider reducing the amount of the
bond.
-7-
Rather, Greenwich argues in substance that American
Tissue had a right, after furnishing the second letter of credit,
to reduce the bond to $1,777,500, that it took steps to do so, and
that the mechanics of the reduction even if not achieved were a
mere “ministerial act.” It then argues that the reduction should
be treated as automatic or as accomplished by the steps taken, that
the reduction would carry out the intent of the parties, and that
failing to reduce the amount would reward Liberty for withholding
consent that it was required to provide.
There is nothing to these arguments. We will assume, as
Greenwich urges, that the bond should be read in conjunction with
the underlying agreement which permitted American Tissue to have
Greenwich reduce the amount of the bond to $1,777,500. But the
agreement said that American Tissue “may” reduce the amount; it did
not say that it had to do so or that the reduction would be
automatic. American Tissue started the steps to accomplish a
reduction but did not complete them.
Neither American Tissue nor Greenwich acted as if a
reduction were automatic. American Tissue made a specific request
for a reduction; Greenwich countered that notice to Liberty would
be required. The bond provided that it could not be cancelled
without 60 days advance notice to Liberty. Had Greenwich or
American Tissue proposed such a reduction to Liberty in mid-2001,
Liberty could have raised the amount of security that it was
-8-
entitled to demand. By mid-2001, American Tissue was missing
payments and Liberty did in fact re-schedule the security required
to set the bond amount at $3,700,000, bringing the total security
amount required to $6,122,500.
Under both case law and general usage, the term “may”
usually indicates that something is permissive, not mandatory or
automatic.3 Yes, in rare situations, it can be read differently,
cf. In re Ionosphere Clubs, Inc., 111 B.R. 436, 441 (Bankr.
S.D.N.Y. 1990); but here the agreement taken as a whole–-both in
language and purpose–-gave American Tissue a right to insist on a
reduction but also allowed Liberty to counter a threatened
reduction by amending the schedule upward.
This does not make the downsizing option meaningless.
American Tissue did have a unilateral option-–albeit never
effectively exercised–-to insist on a reduction in the bond amount
after posting the new letter of credit, unless Liberty increased
the security required. The agreement gave Liberty absolute
discretion, but if Liberty had increased the security schedule, in
bad faith (say, because the existing security was and would remain
patently adequate), it might well not have prevailed. See F.D.I.C.
v. LeBlanc, 85 F.3d 815, 819 (1st Cir. 1996).
3
See, e.g., Middlesex County v. Middlesex County Advisory Bd.,
658 N.E.2d 674, 677 (Mass. 1995); Cohen v. Bd. of Water Comm’rs,
585 N.E.2d 737, 742 (Mass. 1992); Hampden Trust Co. v. Leary, 72
N.E. 88, 89 (Mass. 1904).
-9-
Greenwich’s contract argument requires little further
discussion. There is no evidence that the parties intended
anything but what happened-–so much for citations to reformation
doctrine, see Polaroid Corp. v. Travelers Indem. Co., 610 N.E.2d
912, 917 (Mass. 1993)-–and the equity maxim (that equity will treat
as done that which ought to be done, see In re Cumberland Farms,
Inc., 249 B.R. 341, 355-56 (Bankr. D. Mass. 2000)), is inapt where,
as here, the thing allegedly to be done (a reduction in the bond)
was subject to being legitimately countered by an increase in the
required security.
This brings us to Greenwich’s other arguments which,
although briefly presented, are more interesting. The first turns
on a provision of the Bankruptcy Code, 11 U.S.C. § 365(e)(1)
(2000), popularly known as the ipso facto clause. Pertinently,
this section prevents an executory contract or lease from being
automatically terminated or modified by virtue of the other party’s
filing for bankruptcy. The aim is to protect the right of the
bankruptcy estate to adopt, reaffirm and continue a contract or
lease where this will serve the estate's interests.
In this case, the filing for bankruptcy by American
Tissue was an act of default under the terms of the agreement
between Liberty and American Tissue, and it was explicitly invoked
by Liberty as the basis for its claim against the bond. Greenwich,
noting that both it and American Tissue were liable under the bond,
-10-
says that Greenwich itself is entitled to invoke section 365(e)(1)
as to any claim against it. The district court disagreed, holding
that the ipso facto clause is intended to protect a bankruptcy
debtor, not a third party like Greenwich.
There is a surprising paucity of precedent. A few lower
court decisions favor the district court's view; one points the
other way.4 However, a careful reading of the statute and an
understanding of its purpose readily confirm that-–whatever
protection the statute may give American Tissue in protecting its
own rights vis-à-vis Liberty under the agreement–-the statute in no
way invalidates a separate claim by Liberty against Greenwich under
the bond.
We begin with statutory language, as is normally proper.
United States v. Tapia-Escalera, 356 F.3d 181, 185 (1st Cir. 2004).
Greenwich correctly notes that section 365(e)(1) does not by its
terms say that only the bankrupt can invoke it. But the statute
also says that what may not be terminated or modified by bankruptcy
is “an executory contract or unexpired lease of the debtor” or “any
right or obligation under such contract or lease.” This is strong
4
Compare Chrysler Fin. Corp. v. Fruit of the Loom, Inc., No.
91C-08-108-1-CV, 1993 WL 19659, *4 (Del. Super. Ct. Jan. 12, 1993)
(unpublished decision); In re Prime Motor Inns, Inc., 130 B.R. 610,
613 (S.D. Fla. 1991); In re Zenith Laboratories, Inc., 104 B.R.
667, 672 (Bankr. D.N.J. 1989), with In re Metrobility Optical Sys.,
Inc., 268 B.R. 326, 329 (Bankr. D.N.H. 2001).
-11-
linguistic evidence that Congress was concerned with clauses
diluting the bankrupt’s interests-–not interests of a third party.
The same result follows when one considers the purpose of
the section. This purpose--avowed in both legislative history and
case law–-is to protect the bankruptcy estate, primarily against
the loss of contractual rights that the estate might choose to
assume and reaffirm.5 Holding Greenwich liable does not modify
rights of the American Tissue estate against Liberty or prevent the
estate from reaffirming any contractual rights it may have under
its policies with Liberty.
The parties choose to talk of the matter as if it is a
question of standing, namely, who is entitled to invoke section
365(e)(1). We do not so view the problem or say that a third party
can never rely on the section. Rather, our holding here rests on
the proposition that the district court adjudicated in this case
only a contract claim by Liberty against Greenwich. The bond is an
independent obligation of Greenwich which happens to have been
triggered by a third party’s non-payments of debts and resort to
bankruptcy.
5
See S. Rep. No. 95-989 at 59 (1978), reprinted in 1978
U.S.C.C.A.N. 5787, 5845; H.R. Rep. No. 95-595 at 348 (1978),
reprinted in 1978 U.S.C.C.A.N. 5963, 6304-05; City of Covington v.
Covington Landing Ltd. P’ship, 71 F.3d 1221, 1226 (6th Cir. 1995);
In re Thomas B. Hamilton Co., 969 F.2d 1013, 1018 (11th Cir. 1992);
In re Yates Dev., Inc., 241 B.R. 247, 253 (Bankr. M.D. Fla. 1999).
-12-
It is beside the point that American Tissue may be a co-
guarantor under the bond and might have a defense if sued itself.
If two persons are jointly and severally liable on a contract, the
fact that one has a defense (e.g., because underaged when the
contract was signed) does not automatically protect the other
against suit for nonperformance. See Dexter v. Blanchard, 93 Mass.
(11 Allen) 365 (1865). This is not a case where a principal's
obligation under the surety contract is "void." 2 Farnsworth on
Contracts § 6.3 at 118 (3d ed. 2004).
Certainly as a result of paying Liberty the full amount
of the bond, Greenwich will have an enlarged claim against the
American Tissue estate under its indemnity agreement with American
Tissue. But every increase in the estate’s debt to Greenwich will
likely be offset by a reduced debt of the estate to Liberty. That
Greenwich chose, for the bond premium, to protect Liberty by
risking the loss itself does not appear to have any visible effect
on the estate’s net obligations.
As its third distinct objection to the judgment,
Greenwich says that the bond makes it liable upon the default to
pay the full amount of the bond regardless of the actual damages to
Liberty and that this invalidates the bond under Massachusetts law
as an improper penalty. In Massachusetts, as in other
jurisdictions, a liquidated damages clause is not allowed where
-13-
damages can readily be ascertained. See A-Z Servicenter, Inc. v.
Segall, 138 N.E.2d 266, 268 (Mass. 1956).
Possibly seeking to thwart this objection, Liberty
offered to return to Greenwich any portion of the bond amount that
was not needed to cover existing or potential liability of American
Tissue to Liberty. If this was a gratuitous offer by Liberty, it
would not defeat an objection to the bond under Massachusetts law;
it is a different question whether the commitment could be taken as
a proper reading of the bond--which has language pointing both
ways--but we need not decide it because the bond is independently
valid, even if the face value is payable.
Under Massachusetts law, a fixed sum specified in advance
as contract damages is normally sustained if actual damages are
difficult to ascertain in advance;6 if this condition is not met,
or if the amount specified is grossly disproportionate to a
reasonable estimate, enforcement is denied. See Kelly v. Marx, 705
6
Where “actual damages are difficult to ascertain” and where
“the sum agreed upon by the parties at the time of the execution of
the contract represents a reasonable estimate of the actual
damages,” a contract clause specifying liquidated damages will be
enforced. Kelly v. Marx, 705 N.E.2d 1114, 1116 (Mass. 1999)
(quoting A-Z Servicenter, Inc. v. Segall, 138 N.E.2d 266, 268
(Mass. 1956)) (internal quotations omitted); Shawmut-Canton LLC v.
Great Spring Waters of Am., Inc., 816 N.E.2d 545, 553 (Mass. App.
Ct. 2004). Kelly rejected the so-called “second-look” approach
which also measures the liquidated damages “against the actual
damages resulting from breach.” Kelly, 705 N.E.2d at 1116.
Instead, “a judge, in determining the enforceability of a
liquidated damages clause, should examine only the circumstances at
contract formation.” Id.
-14-
N.E.2d 1114, 1116 (Mass. 1999). This is Massachusetts law, so it
does not matter whether it is viewed as an antique impairment of
freedom of contract or a healthy protection against improvident
bargains.
Greenwich argues that it is easy to ascertain how much
American Tissue owes to Liberty, because as of any specific date
there may be unpaid premiums and unpaid reimbursements due under
the policies; but these, says Greenwich, can easily be calculated.
Further, it suggests, the amounts currently due are far less than
the full amount that Liberty is claiming under the bond. Both
arguments are misleading, mainly because Greenwich is understating
the scope of the damage to Liberty.
The Liberty policies already described committed Liberty
to make workers’ compensation payments for accidents occurring
within the period covered by the policies. Such claims may entail
payments to be made over many years following an accident and for
periods (which may depend on changes in the victim’s condition or
status) that cannot be ascertained at the time of an initial award
of compensation. See 7 Larson’s Workers’ Compensation Law § 126
(2000) (describing notice and claim periods).
Thus, Liberty’s claims against American Tissue under the
policies were unknown and, except by actuarial estimate, unknowable
at the time that it entered into the policies and secured the bond.
This is so both as to reimbursements Liberty would be entitled to
-15-
on claims not yet even made and as to premium recomputations based
on actual claims experience. As it happens, although not required
under Kelly v. Marx, even now the final toll is probably still
unknowable.
The district court found that Liberty, when setting the
security originally required, reasonably estimated the damages it
would incur. Indeed, when Liberty later increased its security
demand, the record shows that Liberty extrapolated from claims
history and data pertaining to similar insureds. Whether it used
the same method in originally setting the security is unclear but
Greenwich does not challenge the finding that the estimate was
reasonable.
The district court awarded Liberty just over $1 million
in prejudgment interest from the date of Liberty’s pre-suit demand
upon the bond on October 9, 2001, until the entry of judgment on
August 17, 2004. Greenwich’s final claim on appeal is that Liberty
is not entitled to such prejudgment interest under Massachusetts
law. The relevant governing statute is Mass. Gen. Laws ch. 231
§ 6C (2002), which provides:
In all actions based on contractual
obligations, upon a verdict, finding or order
for pecuniary damages, interest shall be added
by the clerk of the court to the amount of
damages, at the contract rate, if established,
or at the rate of twelve per cent per annum
from the date of the breach or demand.
-16-
Greenwich argues that because the bond was issued as
security for the payment obligations of American Tissue, Liberty
could not sustain any loss or “pecuniary damages” under the terms
of the statute except by proving specific past payments that
American Tissue had failed to make. There were missed payments,
but the district court did not compute interest on that basis; the
liability was based on the face amount of the bond as liquidated
damages for the estimated aggregate of missed payments past and
future. The district court’s reading of the statute was correct.
The evident thrust of the statute is to compensate a
contract claimant for the deprivation of amounts due under a
contract from the time they were payable to the time at which
judgment is entered;7 thereafter, if there is any delay in paying
the judgment, separate post-judgment interest is due. The district
court found that the full bond amount was due at the time of the
demand. So both the terms of the statute and the underlying
purpose-–to cover loss of the use of the money during litigation-
–justify the award.
Greenwich cites Sterilite Corp. v. Continental Cas. Co.,
494 N.E.2d 1008 (Mass. 1986), for the proposition that the interest
7
“An award of interest is made ‘so that a person wrongfully
deprived of the use of money should be made whole for his loss.’”
Sterilite Corp. v. Continental Cas. Co., 494 N.E.2d 1008, 1011
(Mass. 1986) (quoting Perkins Sch. for the Blind v. Rate Setting
Comm’n, 423 N.E.2d 765, 772 (Mass. 1981)); see also Interstate
Brands Corp. v. Lily Transp. Corp., 256 F. Supp. 2d 58, 62 (D.
Mass. 2003).
-17-
statute is not meant to confer a windfall but instead “is designed
to compensate a damaged party for the loss of use or unlawful
detention of money.” Id. at 1011. Passing the question whether
the statutory interest is too generous–-which is a legislative
judgment–-the interest in this case is not a windfall; it directly
and accurately compensates Liberty for being deprived of its
contractual right to possess and use the $3.7 million from October
9, 2001, to the date of judgment.
Disola Dev., LLC v. Mancuso, 291 F.3d 83 (1st Cir. 2002),
principally relied upon by Greenwich, is a distinguishable case of
unusual, and unusually confusing, facts. It is enough to say that
the amount on which the court declined to award interest under the
Massachusetts statute was a frozen bank account and not a sum
contractually due to the victor, and that the court interpreted a
companion jury verdict for the victor as covering the time-value of
the money frozen in the account during the litigation.
Affirmed.
-18-