United Dairymen of Arizona v. Schugg – 2/9/2006

February 27, 2006

Arizona Court of Appeals Division One Holds That Liquidated Damages Are Not Recoverable Under Common Law For Breach of Implied Covenant of Good Faith and Fair Dealing.

On October 27, 1988, the Schuggs, who operated a dairy, entered into a membership agreement with United Dairymen of Arizona (“UDA”), giving UDA exclusive right to market their milk. The agreement required members to deliver to UDA all milk produced by cows that a member owns, possesses or controls, and established liquidated damages in the event a member breached this provision. The agreement also provided that termination could be effected by written notice not more than 90 nor less than 60 days prior to the anniversary of the agreement’s effective date, or upon the dissolution, merger, or consolidation of a Member’s business. On September 28, 2001, the Schuggs informed UDA that they had gone out of business and sold their milk-producing cows, and leased their dairy to S&T Dairy, L.L.C. (“S&T”), a company formed by the Schuggs’ adult children. S&T marketed its milk through a UDA competitor.

On December 31, 2001, UDA brought suit against the Schuggs alleging breach of the agreement, breach of implied covenant of good faith and fair dealing, fraudulent misrepresentation, negligent misrepresentation, and claims against the Schugg children. UDA claimed the creation of S&T was a sham transaction to enable the Schuggs to terminate the agreement without waiting for the next anniversary. The Schuggs denied liability and asserted numerous counterclaims. Through summary judgment and stipulation, the court and the parties disposed of all of the claims except UDA’s breach of contract and breach of implied covenant of good faith and fair dealing claims. These remaining claims were tried to a jury. At the close of UDA’s case, the Schuggs moved for judgment as a matter of law (JMOL) on the implied covenant of good faith and fair dealing claim because UDA had failed to proffer any evidence of actual damages. The trial court denied the motion. The jury found that the Schuggs did not breach the written agreement but that the Schuggs did breach the implied covenant of good faith and fair dealing, and the jury awarded liquidated damages to UDA on the implied covenant claim. The Schuggs renewed their motion for JMOL, and the trial court again denied it. The Schuggs then timely appealed.

The Court of Appeals reversed the judgment in favor of UDA and directed entry of judgment for the Schuggs. The Court held that liquidated damages are not recoverable under the common law for breach of the implied covenant of good faith and fair dealing. The Court first noted that “the right to recover liquidated damages is limited by the express terms of the parties’ agreement.” Here, the right to liquidated damages depended on a breach of a specific provision within the agreement. Because the jury determined that the Schuggs had not breached the written agreement, only ordinary contract damages were available for breach of the implied covenant of good faith and fair dealing. UDA did not prove any contract damages at trial, and therefore, failed to present a prima facie claim for breach of the implied covenant of good faith and fair dealing.

On appeal, the Schuggs also challenged the granting of summary judgment for UDA on the Schuggs’ counterclaims. Most of these counterclaims arose out of UDA’s requirement that members “dump” their milk at certain times in order to compel customers to pay a desired price. The Schuggs alleged that by adopting this “dumping” policy, the UDA breached its obligation to “market” members’ milk. The Court disagreed, holding that “marketing” members’ milk pursuant to the contract, could involve taking actions to secure the “long-term ability to sell at prices beneficial to its members.” Moreover, the Court held that even if the “dumping” decision was questionable, it was protected by the business judgment rule. The Court rejected the Schuggs’ contention that the business judgment rule could not shield UDA’s actions, because the “dumping” policy was part of an illegal anti-competitive scheme to limit milk supply in violation of federal and state antitrust laws. The Court noted that agricultural cooperatives are exempt from antitrust laws in these circumstances.

Finally, the Court found contested issues of material fact with respect to the Schuggs’ claims of breach of the implied covenant of good faith and fair dealing and interference with contract. Thus, the Court reversed the trial court’s grant of summary judgment for UDA and remanded for further proceedings.

Judge Winthrop authored the opinion; Judges Lankford and Thompson concurred.