MORGAN v. TZUNG

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Court of Appeal, Fourth District, Division 1, California.

Frank MORGAN, et al., Plaintiffs and Respondents, v. Fu–Kong TZUNG, et al., Defendants and Appellants.

No. D008868.

Decided: January 25, 1991

Leon E. Campbell, La Jolla, for defendants and appellants. Richard I. Singer, Elvi J. Olesen and Singer & Crawford, San Diego, for plaintiffs and respondents.

In this case the disappointed sellers of an apartment building recovered $22,672 in damages from two prospective purchasers who failed to perform on a 1986 purchase agreement.   The damages awarded consist entirely of increased tax liability the sellers incurred as a result of the fact they were not able to resell the building until 1987, when provisions of the Tax Reform Act of 1986 (Pub.L. 99–514, Oct. 22, 1986, 100 Stat. 2085) became effective.

We reverse with instructions.  The sellers' tax losses were not the forseeable consequence of the buyers' breach and sellers did not show the buyers' breach caused any other damage.

FACTUAL SUMMARY

On April 9, 1986, defendants and appellants Fu–Kong Tzung and Jean Tzung signed a purchase agreement which required that they pay $890,000 for an apartment building owned by 12 individuals.   Two of the owners, Frank L. Morgan and Monty R. Okken, were real estate brokers and acted on behalf of the other owners in dealing with the Tzungs.1

The purchase agreement permitted the Tzungs to finance the purchase by providing a down payment of $135,000 in cash, by obtaining a loan in the amount of $615,000 and secured by a first deed of trust on the apartment building and by giving certain owners a note in the amount of $140,000 and secured by a second deed of trust on the building.   The purchase agreement also provided that, in addition to the second deed of trust, the $140,000 note would be secured by additional collateral satisfactory to the sellers.

Escrow instructions dated April 15, 1986, were signed by the Tzungs and the sellers.   Consistent with the purchase agreement, the escrow instructions stated in part:  “There will be additional security for the repayment of the $140,000 note being created through this escrow (in addition to the Trust Deed).   The additional security offered by Buyers must meet with the approval of Margaret Bailey Jacobsen, A. Lewis Shingler and Bertha G. Shingler.”   The escrow instruction also provided that if the instructions were not completed by June 10, 1986, either buyers or sellers could make a written demand to close the escrow.

Morgan testified that before either the purchase agreement or escrow instructions were executed, he spoke with the Tzungs about the ramifications of then pending tax reform proposals.   According to Morgan, “We talked about two things.   We talked about the fact—not the fact, but the understanding that was—that we had from people in the industry, people in the savings and loan industry, and others that were interested in real estate, that the sentiment in the House of Representatives and in the Senate was that there would be an end to long-term capital gain treatment, and we said there was a—there was a possibility, perhaps a probability that the time of the depreciation schedule would be lengthened, and that it would be to both parties' advantage to go ahead with the transaction;  that we—that I felt like they had an advantage to buy the property in 1986, or now.   You know, I wouldn't say in 1986.   Probably I said now, because at a later time, if your are thinking of investing something later, at least now you know that you can get the same depreciation schedule.”

According to Morgan he discussed the proposed tax changes because he felt it was important to let the Tzungs know what was motivating the sellers.  “People usually like to know—when you are selling a building, they want to know why you are selling the building, and they want to know, for instance, is this a management-problem building.   Is it about to fall down.   Is there—you know, why do you want to sell.  [¶]It's a reasonable question to ask people, why do you want to sell it.   And that was part of the discussion in explanation to them, in introducing the idea to them of the building and the people involved, an explanation to them as to why it was reasonable for us to want to sell such a good building when in fact I was still telling them it was a good building.”

Although Morgan discussed with the Tzungs the proposed changes in the tax laws, he also told them three of the partners did not want to realize any gain in 1986, and accordingly they would be the only payees on the $140,000 note, which did not require a principal payment until 1987.

After the escrow was opened the Tzungs repeatedly asked Morgan if the three owners who were going to receive the $140,000 note and second deed of trust would waive the requirement the Tzungs provide additional collateral for the note.   In response on June 2, 1986, Morgan obtained the agreement of the three owners to waive the additional collateral requirement and arranged preparation of an amendment to the escrow instructions.   In addition to deleting the additional collateral requirement, the amended instructions extended to July 15, 1986, the time in which to close the escrow.

Although the Tzungs had asked Morgan to obtain the collateral waiver and the extension of time, after June 2, 1986, they never contacted Morgan to determine whether he had been able to meet their requests.   Instead on July 10, 1986, the escrow officer who was handling the transaction told Morgan that on June 27, 1986, the Tzungs sent the escrow officer a letter cancelling the escrow.

After a series of fruitless negotiations, on August 25, 1986, Morgan and the other owners filed a complaint against the Tzungs in which they alleged the Tzungs were liable in damages for breach of the purchase agreement.

Thereafter Morgan and Okken attempted to market the property to other potential buyers.   According to Morgan they were in negotiations with an attorney in late 1986, but the negotiations never resulted in a binding contract.   In 1987, however, Morgan found a buyer who paid $925,000 for the property.   Escrow on the sale closed on April 24, 1987.

Although the partnership agreement Morgan and Okken had with the other owners provided Morgan and Okken would earn a six-percent commission which they could split with a buyer's broker, prior to the 1987 sale the partners agreed that in addition to the six-percent commission to be earned by Morgan and Okken, the partners would pay the buyer's broker an additional three-percent commission.

At trial Morgan and the other owners presented an expert accountant who testified that as a result of the 1987 sale the owners paid $26,074 in taxes which they would have avoided if the sale had occurred in 1986.

Morgan also testified that between July 15, 1986, when the sale to the Tzungs was supposed to be complete, and April 24, 1987, when the eventual sale closed, he and his partners would have earned $34,325 in interest had the proceeds from a sale to the Tzungs been available to them.

TRIAL COURT FINDINGS

The trial court, sitting without a jury, found the parties had entered into a binding contract which the Tzungs breached.   The trial court further found that it was reasonable for the owners to pay the eventual buyer's broker an additional three-percent commission over and above the six-percent commission the partners had agreed to pay Morgan and Okken.

The trial court found the $925,000 sale in 1987 provided Morgan and his partners with a pretax gain of $3,402 over what they would have received from the 1986 sale to the Tzungs.   However the court found the sellers' $26,074 in tax losses were foreseeable damages for which the Tzungs were liable.   The trial court refused to award Morgan and his partners any amount for interest they might have earned on the proceeds of the aborted sale to the Tzungs.   Thus the court awarded Morgan and his partners total damages of $22,672.2  As the prevailing parties, the court also awarded Morgan and the other owners $25,000 in attorney fees.

The Tzungs filed a timely notice of appeal.   Morgan and the other plaintiffs filed a cross-appeal.

ISSUES ON APPEAL

The Tzungs raise a number of substantive and procedural issues on appeal.   They argue there was no binding contract, that the plaintiffs' tax losses were not foreseeable, that the trial court should not have admitted testimony from the plaintiffs' accountant, that payment of an additional three-percent commission on the eventual sale was unreasonable, that the trial court erred in awarding attorney fees and that the trial court should have granted their motion for a new trial.   In their cross-appeal, Morgan and his partners contest only the trial court's refusal to award the interest they could have earned on the proceeds of the sale to the Tzungs.

We do not reach most of these issues.   Rather, because we find Morgan and his partners failed to prove they suffered any damage as a result of the Tzung's failure to purchase their property, we reverse the judgment and remand the case with instructions to award the sellers nominal damages.

DISCUSSION

 A cause of action for breach of contract requires pleading and proof of “(1) the contract [citation];  (2) plaintiff's performance or excuse for nonperformance [citation];  (3) defendant's breach [citation];  and (4) damage to plaintiff therefrom [citation].”  (Witkin, Cal.Procedure (3d ed. 1985) Pleading § 464, p. 504.)   As we have discussed, Morgan and the other plaintiffs attempted to prove damage by showing they incurred additional taxes and lost interest following cancellation of the Tzung escrow.   While we have no doubt these losses occurred, we find no proof they were a legal result of the Tzungs' conduct.

I

Taxes

Civil Code section 3300 provides:  “For the breach of an obligation arising from contract, the measure of damages, except where otherwise expressly provided by this Code, is the amount which will compensate the party aggrieved for all the detriment proximately caused thereby, or which, in the ordinary course of things, would be likely to result therefrom.”   California courts have consistently found this section incorporates the limitations set forth in Hadley v. Baxendale (1854) 9 Ex. 341, 156 Eng.Rep.R. 145.  (See Ericson v. Playgirl, Inc. (1977) 73 Cal.App.3d 850, 854, 140 Cal.Rptr. 921, Mendoyoma v. County of Mendocino (1970) 8 Cal.App.3d 873, 879, 87 Cal.Rptr. 740;  1 Witkin, Summary of California Law, (9th ed. 1987) Contracts, § 815, p. 734, and cases cited therein.)

 “In Hadley v. Baxendale [supra], the court announced the doctrine still generally accepted as a limitation on damages recoverable for breach of contract:  First, general damages are ordinarily confined to those which would naturally arise from the breach, or which might have been reasonably contemplated or foreseen by both parties, at the time they made the contract, as the probable result of the breach.   Second, if special circumstances cause some unusual injury, special damages are not recoverable therefor unless circumstances were known or should have been known to the guilty party at the time he entered into the contract.   The requirement of knowledge or notice as a prerequisite to the recovery of special damages is based on the theory that a party does not and cannot assume limitless responsibility for all consequences of a breach, and that at the time of contracting he must be advised of the facts concerning special harm which might result therefrom, in order that he may determine whether or not to accept the risk of contracting.   [Citations.]”  (1 Witkin, Summary of Cal.Law, supra, at p. 733.)

Recently the court in Nielsen v. Farrington (1990) 223 Cal.App.3d 1582, 273 Cal.Rptr. 312, applied these principles in a case similar to this one.   As here, in Nielsen a disappointed seller of real property sued a nonperforming buyer.   Like Morgan, the seller in Nielsen claimed that because the sale to the defendant did not close in 1986, the seller incurred additional tax liability when, in 1987, the property was eventually sold to a third party.   The trial court in Nielsen awarded the increased tax liability as damages for the buyer's breach.   On appeal the Court of Appeal reversed the judgment insofar as it included the increased taxes as damages.

Although in Nielsen the original contract was executed in 1985 and the seller conceded the parties had not contemplated the tax changes at that time, shortly before escrow was due to close on July 30, 1986, the buyer asked for a two-week extension.   The seller granted the extension but told the buyer it was imperative the sale be closed in 1986 because of changes in the tax laws which would go into effect in 1987.   On appeal the seller argued that by obtaining the extension with knowledge of the impending changes and the need to close the transaction in 1986, the buyer contracted fully aware of the special risks posed by his breach.   The Court of Appeal rejected this argument.  “The seller in essence argues that if a contract is modified, and the damages flow from a breach of the modified provision then, in determining whether special damages are recoverable we should consider the knowledge the defaulting party had at the time the agreement is modified.   Even if we were to accept this argument, we would still not find the tax consequences recoverable because these tax consequences were not caused by the buyer's failure to perform within the extended time.   If the seller had advised buyer that escrow had to close by August 16, 1986, to avoid certain consequences and buyer had sought and obtained an extension of time to that date with full knowledge of the consequences should he be unable to perform, then seller's argument might have merit.   In that situation, it could be argued that buyer ‘contracted,’ i.e., modified the contract, with this specific risk in mind.  [¶]Here, however, the buyer's failure to close by August 16th did not cause the seller's adverse tax consequences.   Rather the taxes were caused by seller's inability to resell the property in 1986․”  (Nielsen v. Farrington, supra, 223 Cal.App.3d at pp. 1588–1589, 273 Cal.Rptr. 312.)

In focusing on the requirement that a breaching party be aware, not just of the special risks which the nonbreaching party is attempting to avoid, but of the impact a failure to perform will have on the nonbreaching party's ability to avert the risk, the court's holding in Nielsen is consistent with the cases and commentary which have analyzed the requirements of Hadley v. Baxendale.  “If several circumstances have contributed to cause a loss, the party in breach is not liable for it unless he had reason to foresee all of them.  (Italics in orig.)   Sometimes a loss would not have occurred if the injured party had been able to make substitute arrangements after breach, as, for example, by ‘cover’ through purchase of substitute goods in the case of a buyer of goods (see Uniform Commercial Code § 2–712).   If the inability of the injured party to make such arrangements was foreseeable by the party in breach at the time he made the contract, the resulting loss was foreseeable.”   (Rest. of the Law 2d, Contracts, § 351 com. d., p. 140, italics added.)

We also note the somewhat analagous situation of a disappointed borrower who is seeking special damages from a nonperforming lender.  “The limitation of foreseeability is often applied in actions for damages for breach of contracts to lend money.   Because credit is so widely available, a lender often has no reason to foresee at the time the contract is made that the borrower will be unable to make substitute arrangements in the event of breach.   See Comment d.   In most cases, then, the lender's liability will be limited to the relatively small additional amount that it would ordinarily cost to get a similar loan from another lender.   However, in the less common situation in which the lender has reason to foresee that the borrower will be unable to borrow elsewhere or will be delayed in borrowing elsewhere, the lender may be liable for much heavier damages based on the borrower's inability to take advantage of a specific opportunity ․, his having to postpone or abandon a profitable project ․, or his forfeiture of security for failure to make prompt payment․”  (Rest. of the Law 2d, Contracts, § 351 com. e., p. 140;  see also Glatt v. Bank of Kirkwood Plaza (1986 N.D.) 383 N.W.2d 473, 483–484.)

Here, as in Nielsen, we find no evidence that at the time the Tzungs executed the purchase agreement in April 1986 they were aware their performance of the contract was the only means by which Morgan and his partners would avoid the adverse effect of the Tax Reform Act.   Although the parties have focused much of their attention on the fact that in April 1986 no reform bill had been enacted and a great deal of uncertainty remained as to whether any reform measure would become law in 1986, we do not find the unsettled nature of tax reform dispositive.   Indeed as Morgan and his partners suggest, it was the very risks posed by the unsettled nature of the tax laws which they were trying to avoid by selling the building.

What is missing here is any substantial evidence the Tzungs knew in April 1986, when they undertook the risks of the agreement, that if they did not complete the transaction, Morgan and his partners would have no other buyer during the remainder of the year.   Rather, Morgan's own testimony suggests just the contrary.   As we have seen, in addition to explaining the potential change in capital gains treatment, Morgan also tried to convince the Tzungs that it was to their advantage to buy in 1986 because they could benefit from the existing advantageous depreciation schedules.   In light of the advantages of buying which Morgan was “pitching,” the Tzungs could easily believe when they agreed to purchase the building that if they did not complete the transaction other buyers would.

The sellers argue that in April the Tzungs should have foreseen the effect of their nonperformance because at one point the sale was “noncontingent.”   The record does not support their argument.   Morgan testified he initially told the Tzungs the transaction would not be contingent on anything other than the Tzungs' inspection.   However, shortly after the purchase agreement was signed the sellers nonetheless agreed the sale would be contingent on the Tzungs' ability to obtain financing.!  (RT 74–75)!   Plainly the sellers' concession with respect to the contingent nature of the transaction did not improve the Tzungs' ability to foresee that their purchase was the only way the sellers would avoid the tax losses.   Rather the sellers' flexibility suggests just the contrary.

We also note Morgan has no recollection of what he actually told the Tzungs about the need for a noncontingent deal.   Although Morgan believed he told the Tzungs the sellers were concerned about losing the opportunity to deal with other buyers and brokers and their need to close before the end of the year, Morgan described his recollection as follows:  “Now I say that, I am not quoting myself.   That's just the general gist of the information that I gave them as the reason why we had to do it with no contingencies.”!  (RT 68)!   Such a tenuous recollection, especially in light of the sellers' later flexibility, will not support the conclusion the Tzungs should have foreseen in April what the sellers would be able to do following a June breach.

In sum because there is no evidence in the record the tax losses the sellers experienced were a foreseeable consequence of the Tzungs' breach, the trial court erred in awarding them.

II

Interest

Relying on this court's opinion in Yackey v. Pacifica Development Co. (1979) 99 Cal.App.3d 776, 779, 160 Cal.Rptr. 430 (Yackey ), Morgan and the other sellers argue the trial court erred in refusing to award them interest on the amounts they should have received from the Tzungs.   We find no error.

In Yackey we found that disappointed sellers could recover interest on the proceeds they would have received from an aborted sale.   In Yackey however the property being sold was vacant land which was subject to a lis pendens.   Given these circumstances the trial court found the usual measure of damages—the difference between the contract price and the market value of the property at the time of the breach—was inadequate and awarded, among other damages, interest on the lost purchase price.   In affirming the trial court we explained that the “normal” measure of damages “presupposes that the vendor was free to use or dispose of the property on the date of breach.  [Citations.]  Here the Yackeys were not in a position to use or dispose of their property by virtue of the lis pendens, Ku's pending action.”  (99 Cal.App.3d at p. 786, 160 Cal.Rptr. 430.)

 Here there is no evidence in the record the sellers were unable to market or use their property after the Tzungs refused to perform.   Indeed unlike the vacant land discussed in Yackey, here the apartment building presumably was producing rent for the sellers while they were attempting to find a new buyer.   Under these circumstances, Yackey does not permit payment of interest on the lost purchase price but leaves sellers with the differential between the purchase price and the value of the property at the time of the breach.3

III

Disposition

 Although the Tzungs argue on appeal the contract was unenforceable because the provision for additional collateral was ambiguous, this argument has no merit.   The additional collateral requirement was in no sense essential to the parties' agreement and hence any ambiguity in the additional collateral requirement did not prevent enforcement of the agreement.  (See City of Los Angeles v. Superior Court (1959) 51 Cal.2d 423, 433, 333 P.2d 745;  Hutton v. Gliksberg (1982) 128 Cal.App.3d 240, 246, 180 Cal.Rptr. 141.)   However, because the sellers failed to demonstrate they suffered any loss as a result of the Tzungs' nonperformance, the sellers are entitled to nominal damages only.   (Capell Associates, Inc. v. Central Valley Security, Co. (1968) 260 Cal.App.2d 773, 785, 67 Cal.Rptr. 463.)   Moreover, where, as here, only nominal damages may be awarded in a superior court action, the trial court has discretion to deny costs to the prevailing party. (Ibid.;  Code Civ.Proc., § 1033, subd. (a).)  In sum then, this case must be remanded so the trial court may determine the sellers' nominal damages and costs, if any.

The judgment in favor of the sellers is reversed with directions to the trial court to enter a judgment awarding nominal damages to the sellers and any costs which the trial court in its discretion finds appropriate.   The Tzungs are awarded their costs on appeal.

FOOTNOTES

1.   In addition to Morgan and Okken, the other owners were Jerelyn Morgan, Athalie Okken, Joseph Morgan, Dorothy M. Morgan, Raymond Okken, Margaret Okken, Florence Jacobsen, Margaret Bailey Jacobsen, as trustee, and A. Lewis Shingler and Bertha G. Shingler, as trustees.   Morgan, Okken and the other owners are the plaintiffs, respondents and cross-appellants in this proceeding.

2.   $26,074 in tax losses less $3,402 in net pretax gain on later sale equals $22,672.

3.   Here Morgan and the other sellers offered no proof as to the value of the building in June 1986.

BENKE, Associate Justice.

KREMER, P.J., and NARES, J., concur.