Opinion ID: 670736
Heading Depth: 2
Heading Rank: 2

Heading: The Wendy's-Smith Agreement

Text: 8 The Wendy's-Smith Agreement was similar in nature to the Wendy's-Authority agreement. Wendy's required Smith to pay a fixed minimum compensation of $55,700 per year ($11,100 more than the $22,400 per six months Wendy's was obligated to pay the Authority). Wendy's also included a percentage compensation formula in the Wendy's-Smith Agreement. Paragraph 3.B of the Wendy's-Smith Agreement, which governs the computation of percentage compensation, reads: 9 Percentage Compensation shall be equal to the extent to which the Percentage (as set forth below) of Gross Sales for any Term Year exceeds [minimum compensation] payable with respect to that year. Percentage Compensation shall be calculated according to the following schedule: 10 Percentage Rate Annual Gross Sales 16% of all sales over $287,500 up to $400,000 17% of all sales over $400,000 up to $600,000 18% of all sales over $600,000 up to $800,000 19% of all sales over $800,000. 11 Paragraph 3.B is subject to several possible interpretations. Examining what Smith paid Wendy's as percentage compensation is helpful in explaining the possible interpretations of Paragraph 3.B: 12 Hinsdale Oasis Year Gross Sales Percentage Compensation 1985 $250,149 $ 0 1986 $347,090 $ 0 1987 $365,558 $12,489 1988 $440,125 $24,821 1989 $375,288 $14,046 1990 $341,912 $ 8,902 1991 $328,852 $ 6,616 Lake Forest Oasis Year Gross Sales Percentage Compensation 1985 $388,445 $ 0 1986 $505,419 $26,221 1987 $505,057 $35,860 1988 $609,111 $53,549 1989 $568,523 $47,645 1990 $529,343 $40,887 1991 $503,832 $35,651 13 Total percentage compensation paid by Smith for both oases in 1985-1991 was $306,687. 14 Paragraph 3.B of the Wendy's-Smith Agreement is susceptible to three different interpretations, which we shall label Interpretation One, Interpretation Two, and Interpretation Three. 4 Under Interpretation One, percentage compensation should be calculated strictly according to its rate schedule. If, for example, Smith had $500,000 in gross sales, Interpretation One would require Smith to pay Wendy's 16% of $400,000 ($64,000) plus 17% of $100,000 ($17,000), minus $55,700 (minimum compensation, for a total of $25,300 percentage compensation). This is the formula Smith used, for example, in formulating percentage compensation in 1986 at the Lake Forest Oasis ((16%($400,000)) + (17%($105,419)) - $55,700 = $26,221). If Smith had consistently used Interpretation One, Smith would have paid Wendy's as follows: 5 15 Under Interpretation One, total percentage compensation due for 1985-1991 would be $218,216, leaving Smith with having overpaid Wendy's by $88,471 ($306,687 - $218,216 = $88,471). 16 The difficulty with Interpretation One is that it moots out the inclusion of the $287,500 breakpoint in the rate schedule. The first line of the rate schedule calculates 16% of gross sales over $287,500 up to $400,000, from which $55,700 is deducted. If, however, gross sales totaled (for example) $300,000, no percentage compensation would be due--16% of $300,000 is $48,000, which is less than the $55,700 minimum compensation figure. The real breakpoint at which percentage compensation becomes due is $348,125 ($55,700/.16 = $348,125), and under Interpretation One the $287,500 figure has no effect. 17 Under Interpretation Two of Paragraph 3.B, percentage compensation is calculated by taking the sum of 16% of all sales made after $287,500 and up to $400,000, 17% of all sales from $400,001 to $600,000, 18% of all sales from $600,001 to $800,000, and 19% of all sales from $800,001 up--all without deducting minimum compensation. This is the formula Smith used for both oases from 1987 through 1991. For example, in 1987 at the Lake Forest Oasis, the calculation for the $505,057 in gross sales would be as follows: 18 PC = 16%($400,000 - $287,500) k 17($505,057 - $400,001) PC = 16%($112,500) k 17%($105,056) PC = $18,000 k $17,860 PC = $35,860 19 If Smith had consistently used Interpretation Two, Smith would have paid Wendy's as follows: 20 Hinsdale Oasis Year Gross Sales Percentage Compensation 1985 $250,149 $ 0 1986 $347,090 $ 9,534 1987 $365,558 $12,489 1988 $440,125 $24,821 1989 $375,288 $14,046 1990 $341,912 $ 8,706 1991 $328,852 $ 6,616 Lake Forest Oasis Year Gross Sales Percentage Compensation 1985 $388,445 $16,151 1986 $505,419 $35,921 1987 $505,057 $35,860 1988 $609,111 $53,640 1989 $568,523 $46,649 1990 $529,343 $39,988 1991 $503,832 $35,651 21 Under Interpretation Two, total percentage compensation due for 1985-1991 would be $340,072, leaving Smith with having underpaid Wendy's by $33,385 ($306,687 - $340,072 = -$33,385). 22 Unfortunately, Interpretation Two also suffers from a major difficulty. The text of Paragraph 3.B explicitly states that percentage compensation shall be due only to the extent that it exceeds minimum compensation, but Interpretation Two does not deduct minimum compensation. In fact, under Interpretation Two percentage compensation is due even if gross sales are less than the natural breakpoint of $348,125 discussed in Interpretation One (for example, using Interpretation Two in 1990 for the Hinsdale Oasis required payment of $8,902 in percentage compensation for gross sales of $341,912; if minimum compensation were deducted, the breakpoint for percentage compensation would be $348,125, and no percentage compensation would be due). 23 Smith used yet a third interpretation of Paragraph 3.B, Interpretation Three, to calculate percentage compensation due. Interpretation Three multiplied the percentages stated in the rate schedule times gross sales exceeding $287,500, and then subtracted minimum compensation--if the number arrived at was zero or less, then only minimum compensation was due. For example, Smith computed percentage compensation for the Lake Forest Oasis in 1985 (gross sales of $388,445) as follows: 24 PC = 16%($388,445 - $287,500) - $55,700 PC = 16%($100,945) - $55,700 PC = $16,151 - $55,700 PC = -$39,549, but if PC < 0 then PC = 0 Therefore PC = 0 25 Following the above formula, Smith paid Wendy's no percentage compensation in 1985 for the Lake Forest Oasis, whereas under Interpretation One Smith would have had to pay $6,451, and under Interpretation Two Smith would have had to pay $16,151. If Smith had consistently used Interpretation Three, Smith would have paid Wendy's as follows: 26 Hinsdale Oasis Year Gross Sales Percentage Compensation 1985 $250,149 $ 0 1986 $347,090 $ 0 1987 $365,558 $ 0 1988 $440,125 $ 0 1989 $375,288 $ 0 1990 $341,912 $ 0 1991 $328,852 $ 0 Lake Forest Oasis Year Gross Sales Percentage Compensation 1985 $388,445 $ 0 1986 $505,419 $ 0 1987 $505,057 $ 0 1988 $609,111 $ 0 1989 $568,523 $ 0 1990 $529,343 $ 0 1991 $503,832 $ 0 27 Interpretation Three is the correct interpretation only if the rate schedule is interpreted in one of two possible ways. The relevant provision of the rate schedule is 16% of all sales over $287,500 up to $400,000.... If all sales over $287,500 means that dollar $287,501 effectively is $1 (i.e. start counting gross sales earned over $287,500 only), then Interpretation Three represents a fair reading of Paragraph 3.B. If, however, all sales over $287,500 means that no percentage compensation is awarded up to $287,500, but if the $287,501 point is reached then percentage compensation is 16% of $287,501 less minimum compensation, then Interpretation One is the best reading of Paragraph 3.B. 28 The difficulty with Interpretation Three is that the rate schedule is misleading. Because counting does not begin until reaching $287,501 in gross sales, the clearest rate schedule would total the following percentages: 29 16% of (($635,625 up to $748,125) - $287,500) 17% of (($748,126 up to $948,125) - $748,125) 18% of (($948,126 up to $1,148,126) - $948,125) 19% of ((Sales in excess of $1,148,126) - $1,148,125). 30 If Smith had earned $900,000, for example, the calculation would be: 31 PC = 16%($748,125 - $287,500) k 17%($900,000 - $748,125) PC = 16%($560,625) k 17%($151,875) PC = $89,700 k $25,819 PC = $115,519 32 Smith claims that its original understanding of Paragraph 3.B was Interpretation Three, which the above charts show it did in fact rely upon in 1985. 6 In 1986, the charts demonstrate that Smith began using Interpretation One instead of Interpretation Three to compute percentage compensation. 7 In 1987, the charts demonstrate that Smith began using Interpretation Two for both oases. In early 1990, Smith discovered that it erroneously had switched to Interpretation Two, and notified Wendy's of its error. 33 In response, Wendy's informed Smith that it was entitled to percentage compensation based on Interpretation Two. Under protest, Smith continued paying Wendy's percentage compensation based on Interpretation Two. On August 27, 1992, Smith filed a one count complaint based on diversity of citizenship seeking damages in the amount of the excess percentage compensation paid to Wendy's and a declaration of the proper interpretation of Paragraph 3.B. 34 During the pre-trial phase of the litigation, the district court determined that Paragraph 3.B was ambiguous. Both parties moved for summary judgment, and after the district court denied both motions, the parties conducted a trial in January of 1993. On March 1, 1993, the district court agreed with Smith's interpretation of Paragraph 3.B, and awarded Smith $306,687 plus costs 8 (adopting, without explicitly so stating, Interpretation Three). 35 In holding in favor of Smith, the district court found that Wendy's modeled Paragraph 3.B after the Wendy's-Authority Agreement--astutely noting that the $287,500 cut-off in the Wendy's-Smith Agreement came from adding the $200,000 gift shop figure and the $87,500 floral boutique figure from the Wendy's-Authority Agreement. The district court also found, however, that Wendy's accidentally used the draft of the Wendy's-Authority Agreement, not the final product. The Wendy's-Smith Agreement deducts minimum compensation from percentage compensation just as the draft Wendy's-Authority Agreement did, but the final Wendy's Authority Agreement did not deduct minimum compensation--leaving Wendy's in a position in which it could owe the Authority more than it collects from Smith. The district court found that Wendy's drafted Paragraph 3.B in that manner because of a monumental drafting blunder of its own making. Wendy's filed a motion for reconsideration, which the district court denied on March 16, 1993. Wendy's now appeals from the decision of the district court in favor of Smith.