By: Giulio A. Sanchez
Colaco et al. V. Cavotec SA et al., No. G052619, 2018 WL 3816929 (Cal. Ct. App. Aug. 10, 2018)
In August 2011, a California-based company that designed, manufactured, and installed stationary and mobile airport and aircraft servicing equipment (“California Company”), and its executive officer and sole shareholder, Michael Colaco, agreed to sell substantially all of its assets to a Swiss corporation and its newly formed subsidiary. Under the Asset Purchase Agreement, the assets to be transferred included in-process customer contracts. In return, the Swiss corporation agreed to pay a $2 million “Performance Earn-out Payment” on the first and second anniversaries of the deal closing.
After the deal closed, the parties realized that the in-process contracts could not be transferred without customers’ consent. The parties drafted guidelines under which the California Company agreed to help obtain customers’ consent and transfer any postclosing payments to the Swiss Corporation. When questions arose regarding the California Company’s efforts to obtain customer consent, the Swiss corporation withheld the first Performance Earn-Out Payment and requested that Colaco, who now served as president of the newly formed subsidiary, step down. Following a meeting between Colaco and the Swiss corporation, the Swiss corporation agreed to pay the first Performance Earn-Out Payment and accelerate the second Earn-Out Payment so long as Colaco resigned and cooperated with the transfer of payments. However, soon thereafter an investigation revealed that the California Company had actually failed to transfer payments and Colaco had falsified and backdated invoices, instructed employees to send improper and defective products to damage the corporation’s business, and stolen and destroyed files. As a result, the Swiss corporation withheld the second Performance Earn-Out Payment.
In October 2012, the California Company filed suit alleging that the Swiss corporation breached the Asset Purchase Agreement by not paying the second Performance Earn-Out Payment. The Swiss corporation filed a cross-complaint alleging that the California Company also breached the Asset Purchase Agreement by not transferring customer payments, and that Colaco breached his employment contract and fiduciary duties by falsifying and backdating invoices and engaging in misconduct that caused customers to withhold payments. After trial, the jury returned a$ 1.313 million verdict for the Swiss corporation concluding that the California Company had breached the Asset Purchase Agreement, that Colaco had breached his employment agreement, and that both Colaco and another officer had violated their fiduciary duties. In a separate phase of the trial, the trial court awarded the Swiss corporation $2 million in punitive damages against Colaco.
On appeal, the California Company maintained that the Swiss Corporation breached the Asset Purchase Agreement by not paying the second $2 million Performance Earn-Out Payment and that this amount should offset against the $1.313 million verdict. The Appeals Court agreed, finding that, if parties’ obligations, or covenants to perform, under a contract are independent, a breach by one party does not excuse the other party’s performance. Instead, the non-breaching party must perform and then may seek remedies for the other party’s breach. The Court noted that when covenants, or obligations, of a contract are to be performed at different times they are independent. Likewise, when a covenant only goes to part of the consideration, and a breach may be paid for in damages, the covenant is independent.
In the case at hand, the Asset Purchase Agreement did not condition the Swiss corporation’s obligation to make the Performance Earn-Out Payments on the California Company forwarding all postclosing customer payments. Performance by the parties was to take place at different times. The Swiss corporation was to pay on the anniversaries of the deal closing while the California Company was to transfer its assets, except for the ongoing customer contracts, at closing. As to the ongoing contracts, the California Company was to forward customer payments as they were received. Moreover, the payments that the California Company agreed to forward were only a portion of the consideration for the transaction and a breach could be resolved by damages. As such, the Court concluded, the Swiss corporation’s obligation to make the $2 million Payments to the California Company was independent from the California Company’s obligation to properly and timely forward customer payments. For this reason, the Swiss corporation had breached the Asset Purchase Agreement by not making the second Earn-Out Payment despite the fact the California Company first failed to properly transfer customer payments.
As to the verdict amount, the Court offset the California Company’s right to the $2 million Earn-Out Payment against the $1.313 million verdict. This paid off the California Company’s liability to the Swiss corporation and left the Swiss corporation owing $687,000 to the California Company. The Court upheld the punitive damages against Colaco.
Colaco v. Cavotec illustrates a key concept within contract law. Promises to perform that are made independent of one another do not excuse performance. That is, as held by the ColacoCourt, a party may be required to perform regardless of whether the other party performed if the performances were due at different times, the promise to perform is only a portion of the consideration exchanged in the transaction, and damages can resolve a breach of the promise to perform. As egregious as the California Company and Colaco’s conduct may have been, the Court was clear that this did not excuse the Swiss corporation’s performance. Therefore, contracting parties should be wary when making promises to perform, and when deciding not to perform. Otherwise, one may be forced to pay despite the other’s breach.
Giulio A. Sanchez is an associate at Wanger Jones Helsley PC in Fresno, CA. Giulio’s practice focuses on business and employment litigation. This article is intended to notify our clients and friends of updates to the law and provide general information. It is not intended, nor should it be used, as legal advice, and it does not create an attorney-client relationship between the author and the reader.