Title: MILTON CONST. CO. v. State Highway Dept.
Citation: 568 So. 2d 784
Docket Number: N/A
State: Alabama
Issuer: Alabama Supreme Court
Date: September 14, 1990

568 So. 2d 784 (1990)
MILTON CONSTRUCTION COMPANY, INC.
v.
STATE of Alabama HIGHWAY DEPARTMENT, et al.
89-514.

Supreme Court of Alabama.
September 14, 1990.
*785 Rodney A. Max and Denise J. Lord of Najjar, Denaburg, Meyerson, Zarzaur, Max, Wright &amp; Schwartz, Birmingham, for appellant.
Jack F. Norton, Jerry L. Weidler and Janie Baker Clarke, Montgomery, for appellees.
Truman M. Hobbs, Jr. of Copeland, Franco, Screws &amp; Gill, Montgomery, for amicus curiae Hardaway Co.
HOUSTON, Justice.
This is an appeal from a summary judgment in favor of the defendants, the State of Alabama, State of Alabama Highway Department, and Royce King, as director of the State of Alabama Highway Department (hereinafter collectively referred to as "Highway Department"). The plaintiff, Milton Construction Company ("Milton"), had sought a judgment declaring that the disincentive clause of an incentive/disincentive payments provision in each of two highway construction contracts that it had entered into with the Highway Department was void and unenforceable as a penalty and requested that the trial court order the Highway Department to pay Milton the amounts of disincentive payments that it withheld.
The issues before us are whether a clause of a construction contract that authorizes the withholding of disincentive payments is void and unenforceable as a penalty; whether Milton is estopped from asserting a claim that the disincentive clause is void where it has previously received incentive compensation pursuant to the incentive clause of the incentive/disincentive payments provision in a prior contract; and whether the trial court erred in failing to strike an affidavit allegedly based on hearsay.
Summary judgment is proper where there is no genuine issue of material fact and the moving party is entitled to a judgment as a matter of law. Rule 56, A.R. Civ.P. All inferences must be viewed in the light most favorable to the nonmoving party, and all reasonable doubts concerning the existence of a genuine issue of material fact must be resolved against the moving party. See Wilson v. Brown, 496 So. 2d 756 (Ala.1986); see, also, McMillian v. Wallis, 567 So. 2d 1199 (Ala.1990). This case was filed after June 11, 1987; therefore, the applicable standard of review is the "substantial evidence" rule. Ala.Code 1975, § 12-21-12; see, also, Watters v. Lawrence County, 551 So. 2d 1011 (Ala. 1989); see, also, Koch v. State Farm Fire &amp; Casualty Co., 565 So. 2d 226 (Ala.1990).
The facts of this case are substantially undisputed. The Highway Department and Milton entered into contracts for widening and repairing a portion of Interstate Highway 65 (hereinafter referred to as the "I-65 *786 Project")[1] in Jefferson County and for concrete pavement rehabilitation of, and the addition of median lanes to, a portion of Interstate Highway 59 (hereinafter referred to as the "I-59 Project")[2] in Jefferson County.
The total cost of the I-65 Project was $7,745,320.29, and the total cost of the I-59 Project was $4,399,883.25. Subsequent to the filing of this lawsuit, the parties stipulated to all amounts due and payable to Milton (which have now been paid) except for the disputed amounts of $300,000 and $240,000 that the Highway Department deducted from Milton's contract price for the I-65 and I-59 Projects, respectively, pursuant to an incentive/disincentive payments provision. (The incentive clause of the incentive/disincentive payments provision is not at issue.)
The incentive/disincentive payments provision[3] of each contract reads, in pertinent part, as follows:
(Emphasis added.)
In addition, each contract contained a provision for recovery of actual damages, found in Article 108.12 ("Default of Contract"). It provides, in pertinent part, as follows:
(Emphasis added.)
Furthermore, each contract contained a clause for liquidated damages.[4] Article 108.11 ("Failure to Complete Work Within Contract Time") reads, in pertinent part, as follows:
(Emphasis added.)
According to Milton, each contract also contained provisions by which the Highway Department could control its performance and the rate of its performancethe Highway Department could allegedly disqualify Milton from further State work if Milton failed to maintain a satisfactory rate of progress (Article 108.04"Prosecution of Work") and could suspend the work if Milton failed to carry out orders or perform provisions of the contract (Article 108.07 "Temporary Suspension of Work").
Milton exceeded the time stipulated in the contract for completion of the I-65 Project by 156 days, and the Highway Department assessed Milton liquidated damages in the amount of $93,600 ($600 per calendar day for 156 days) and imposed the maximum disincentive of $300,000. Milton exceeded the time stipulated in the contract for completion of the I-59 Project by 72 days, and the Highway Department assessed Milton liquidated damages in the amount of $32,400 ($450 per calendar day for 72 days) and imposed the maximum disincentive of $240,000. Milton does not dispute the enforceability of the liquidated damages provisions. Milton does, however, dispute the enforceability of the disincentive clause of each contract, contending that the clause is void as a penalty, and therefore is unenforceable, and requests that the trial court order the Highway Department to pay Milton the amounts of disincentive payments that it withheld.
Is the disincentive clause of the incentive/disincentive provision of the contracts a penalty?
5 Williston on Contracts § 778 at 686 (3d ed. 1961).
We note that the Alabama Constitution of 1901 has a strong preference for the protection of contractual obligations. The Constitution prohibits the impairment of contractual obligations by the legislative and judicial branches of state government. *788 See Article I, § 22 ("[no] law, impairing the obligations of contracts, ... shall be passed by the legislature") and Article IV, § 95 ("[t]here can be no law of this state impairing the obligation of contracts by destroying or impairing the remedy for their enforcement").
We recognize the right of freedom of contract, which is well expressed in 17 Am. Jur.2d Contracts, § 178 (1964):
(Emphasis added.)
Even so, we recognize the well-settled law in Alabama that penalty provisions are void as against public policy and that courts are "`disposed to lean against any interpretation of a contract which will make the provision one for liquidated damages and, in all cases of doubtful intention, will pronounce the stipulated sum a penalty.' " See Camelot Music, Inc. v. Marx Realty &amp; Improvement Co., 514 So. 2d 987, 990 (Ala.1987), quoting Cook v. Brown, 408 So. 2d 143, 144 (Ala.Civ.App.1981).
In Williston on Contracts § 776-88 (3d ed. 1961), Professor Williston ably discusses penalty provisions in contracts:
Id. at 670-72.
In regard to a contract as to which there appears an admission that the provision was included to serve only as an added spur to performance and not to make a fair estimate of damages to be suffered, "[i]t is well-settled contract law that courts do not give their imprimatur to such arrangements." Id. at 676.
An essential step toward understanding this matter is to recognize that "`[t]he question is not what the parties intended, but "whether the sum is in fact in the nature of a penalty."'" Id. at 682.
Id. at 689-90.
Id. at 694.
Id. at 698.
Id. at 737-38.
Id. at 760-61.
With this theory of law in mind, we address the issue whether the disincentive provision in the contracts at issue is a penalty and therefore is void as against public policy.
It is undisputed that the contracts at issue provide for both liquidated damages and disincentive payments. It is also undisputed that the stated purpose of the incentive/disincentive payments provision of each contract was to ensure "the earliest possible date for completion of the project." In order to achieve that purpose, did the disincentive clause penalize Milton? Was the clause security for performance or was it a punishment for default?
A penalty is in essence a security for performance designed to punish one party for breach of contract, whereas a liquidated damages provision is a sum to be paid in lieu of performance (a sum that the parties agree upon as an adequate assessment of damages that would result from a possible breach). See Camelot Music, Inc. v. Marx Realty &amp; Improvement Co., Cook v. Brown, supra; see, also, Forsyth v. Central Foundry Co., 240 Ala. 277, 198 So. 706 (1940); Standard Tilton Milling Co. v. Toole, 223 Ala. 450, 137 So. 13 (1931).
Restatement of Contracts, § 339 at 554 (1932). (Emphasis added.)
Although Camelot Music, Inc. v. Marx Realty &amp; Improvement Co., supra, established an analysis to determine whether a liquidated damages provision must fail as a penalty, that analysis applies equally well to a determination whether a disincentive clause must fail as a penalty. In Camelot Music, Inc., supra, we cited three criteria by which a stipulated damages clause may be characterized as liquidated damages as opposed to a penalty:
514 So. 2d  at 990, citing C. Gamble and D. Corley, Alabama Law of Damages § 5-4 (1982). If one of these three criteria is not met, the clause must fail as a penalty. Applying the three criteria to the facts of the instant case, we find that the disincentive *791 clause at issue clearly constitutes a penalty and therefore is void as a matter of public policy.
First, in each contract, the amount of injury caused by delay had already been determined, assessed, and withheld. Furthermore, any other injury that the Highway Department would suffer was addressed in the "Default Clause," which allowed recovery of "all costs and charges incurred by the [Highway] Department, together with the cost of completing the work under contract." The recovery of "all costs" by the Highway Department upon Milton's default in either the I-65 Project or in the I-59 Project, along with the additional recovery of liquidated damages for delay, would certainly "justly compensate" the Highway Department for any injury; any further compensation would pass the limit of reasonableness. Even Federal Highway Administration Advisory T5080.10 (February 8, 1989), which allows for incentive/disincentive provisions, states as follows:
The Highway Department failed to do this in the I-65 Project and in the I-59 Project; thus, the Highway Department received more than a double recovery for the same damages. Such compensation is totally out of proportion to the damages incurred and thus is unreasonable. In addition, according to Camelot Music, Inc., supra, the parties must actually intend, by the stipulated damages clause, to provide for damages rather than for a penalty. The evidence in the instant case revealed that the Highway Department unilaterally decided to include a disincentive clause in its contracts prior to any negotiations with Milton and prior to Milton's involvement in the I-65 or I-59 Projects. Thereafter, contractors bid on the projects with the disincentive clause included as part of the bid documents, not as a negotiated term or condition.
Furthermore, according to the complaint, the clear language of each contract indicates that the purpose of the disincentive clause was to encourage early completion of the contract"the contractor's attention is directed to the fact that it is in the public's interest to complete this project at the earliest possible date"and not as compensation for any delay caused to the Highway Department or to the public. Therefore, the disincentive clause clearly acts as a discouragement or penalty for late completion. Thus, the Highway Department is using the disincentive clause as security for the performance of the contract through acts of financial punishment, a result that Alabama law does not allow. See Camelot Music, Inc., supra; and Standard Tilton Milling Co., supra.
The third criterion set forth in Camelot Music, Inc., supra (that the stipulated sum must be reasonable) is applied after the fact and measures whether the sum stipulated did in fact reasonably approximate the actual injury that previously was unascertainable; in essence, whether the disincentive clause bears a rational relation to the injury incurred. The Highway Department concedes that it arbitrarily set the dollar amount of the per-day assessment and the maximum time limit for the assessment in the disincentive clause. From our review of the record, we conclude that these arbitrary calculations had no correlation to the damages that the Highway Department sustained; therefore, considering the fact that liquidated damages had already been assessed and withheld from Milton, we must conclude that the disincentive clause does not compensate for the injury that occurred, but rather attempts to coerce performance and results in disproportionate, unreasonable compensation. Such a purpose is penal in nature and is therefore invalid.
Based on the foregoing, we hold that the trial court erred in failing to declare the disincentive clause void as a penalty and therefore unenforceable.
*792 The Highway Department contends that, because Milton had previously received incentive compensation pursuant to the incentive/disincentive payments provision, it is estopped from asserting that the disincentive clause of that provision is void.
In the instant case, the validity of the incentive clause of the provision is not at issue. Rather, the essence of the Highway Department's argument seems to be that the presence of the incentive clause in the incentive/disincentive payments provision and Milton's acceptance of bonus compensation pursuant to that provision in a previous contract estops Milton from asserting that the disincentive clause of the incentive/disincentive provision is a penalty. We disagree.
Williams v. FNBC Acceptance Corp., 419 So. 2d 1363, 1367 (Ala. 1982).
Milton does not, nor did it ever, contend that the payment of an incentive for early completion was not valid. What it does contend, however, is that the withholding of disincentive payments for late completion is a void and unenforceable penalty. Milton's position concerning incentive payments for early completion is not inconsistent with its position concerning disincentive amounts withheld for late completion; Milton's contentions are not contrary to equity and good conscience.
Furthermore, in Standard Chemical Co. v. Barbaree, 239 Ala. 601, 195 So. 892 (1940), we held that "[i]t is generally considered that as between parties to a contract, validity cannot be given to it by estoppel if it is prohibited by law or is against public policy." Likewise, in the instant case, we hold that as between Milton and the Highway Department, validity cannot be given to the disincentive clause of the incentive/disincentive payments provision by estoppel, because the disincentive clause is against public policy.
We also note Milton's contention that the trial court erred in failing to strike an affidavit that Milton says contained unqualified opinion and hearsay testimony. Because of our resolution of the casethat the disincentive clause of the contract provides for a penalty and thereby is void and unenforceable, as a matter of public policywe pretermit any discussion of this issue.
Therefore, we reverse the judgment and remand the cause for further proceedings consistent with this opinion.
REVERSED AND REMANDED.
HORNSBY, C.J., and JONES, SHORES and KENNEDY, JJ., concur.
[1]  The I-65 Project was a contract that Milton entered into with the Highway Department for the construction of Federal Aid Interstate Project Number I-65-2 (106) 256 in Jefferson County, Alabama.
[2]  The I-59 Project was a contract that Milton entered into with the Highway Department for the construction of Federal Aid Interstate Project Number ACIR-59-1 (156) 119 in Jefferson County, Alabama.
[3]  The incentive/disincentive payments provision in the I-65 Project is found in Special Provision No. 924 and in the I-59 Project is found in Special Provision No. 1320.
[4]  The liquidated damages provisions in the two contracts are identical, except as to amount; the liquidated damages amount specified in the I-65 Project was $600 per day and the liquidated damages amount specified in the I-59 Project was $450 per day.