Court Opinion

ID: 1060711
Source: CourtListenerOpinion
Date Created: 2013-10-09 18:53:45.933919+00
Date Added: 2024-06-11T12:39:59.985334
License: Public Domain

IN THE SUPREME COURT OF TENNESSEE
                                  AT JACKSON             FILED
                                                           June 28, 1999

                                                        Cecil Crowson, Jr.
ANTHONY P. GUILIANO                 )                  Appellate Court Clerk
                                    )    FOR PUBLICATION
       Plaintiff/Appellant          )
                                    )    FILED: June 28, 1999
v.                                  )
                                    )    SHELBY CIRCUIT
CLEO, INC.                          )
                                    )    Hon. James E. Swearengen
       Defendant/Appellee           )
                                    )    02S01-9801-CV-00002
                                    )

For the Petitioner:                      For the Respondent:

Frank L. Watson                          James H. Stock, Jr.,
Waring Cox, P.L.C.                       Christopher E. Moore
Memphis, Tennessee                       Weintraub, Stock, Bennett,
                                         Grisham & Underwood, P.C.
                                         Memphis, Tennessee

                                OPINION

Court of Appeals Reversed;                                      Barker, J.
Trial Court Affirmed
                                              OPINION

        We granted this appeal to address the recovery of liquidated damages where a

plaintiff/employee alleges that he has been constructively terminated from his

employment. The trial court in this case granted summary judgment in favor of the

appellant, Anthony P. Guiliano, based upon a finding that he had been constructively

terminated from his employment and that he was entitled to recover the remainder of

his salary under Paragraph 9 of his employment contract.1 The Court of Appeals

agreed that the appellant had been constructively terminated from his employment,

but concluded that he was not entitled to any recovery. The intermediate court held

that Paragraph 9 of the contract was a liquidated damages provision that imposed a

penalty on the appellee, Cleo, Inc., (Cleo).

        Both parties request this Court to determine whether Paragraph 9 of the

employment contract contemplates the payment of severance pay or liquidated

damages. For the reasons that follow, we conclude that the sums payable pursuant to

Paragraph 9 are liquidated damages in the event that Cleo terminated appellant’s

employment without cause, effectively breaching the contract.

        We affirm the trial court’s grant of summary judgment for the appellant on the

issue of constructive termination. In addition, because we find that the liquidated

damages provision was a reasonable estimation of employee damages at the time the

parties entered into the contract, we conclude that the appellant is entitled to recover

the full amount stipulated in that provision. The judgment of the Court of Appeals is

reversed, and the trial court’s grant of summary judgment for the appellant is affirmed.

        1
         The trial court awarded $90,125 in back salary plus $14,296.54 in prejudgment interest, for a
total award of $104,421.54. The record is unclear whether the trial court treated that recovery as
severa nce pa y or liquidated d ama ges.

                                                   2
                                              BACKGROUND

      The essential facts in this case are undisputed. The appellant had been

employed as a director of marketing at Cleo2 for approximately one year when he

entered into a written employment contract with the company. The contract was in the

form of a letter sent by Michael Pietrangelo who was then the President and Chief

Executive Officer of Cleo. The letter agreement stated in pertinent part:

      Cleo Inc. and I are very pleased that you have agreed to serve as Vice
      President, Marketing of Cleo Inc. (the “Company”), a wholly owned
      subsidiary of Gibson Greetings, Inc. As Vice President, Marketing you
      will report to the President, and perform those functions currently
      assigned, which functions and responsibilities can be changed at the
      discretion of the Company. The following terms and conditions will
      govern your service to the Company:

      1.      You will serve the Company on a full-time basis as a senior
      executive employee, and the company will employ you as such, for a
      period of three years commencing November 1, 1992 and ending
      October 31, 1995 unless you are terminated at an earlier date pursuant
      to Paragraphs 6, 7, or 9 of this Agreement. Your annual salary will be
      $103, 000, which amount will be reviewed every fifteen months and
      which may be adjusted from time to time by the Company throughout the
      term of this Agreement in accordance with the Company’s salary
      administration program. No later than six months prior to expiration of
      the original term, or any renewal term, of this Agreement, it will be
      reviewed by the Company for the purpose of deciding whether or not it
      will be renewed upon its expiration. You will be notified of a decision not
      to renew. If you are not notified of a decision not to renew, the
      Agreement will automatically renew from year to year.

                 ....

      6.      In the event you are unable to perform your duties hereunder due
      to illness or other incapacity, which incapacity continues for more than
      six consecutive or nonconsecutive months in any twelve-month period,
      the Company shall have the right, on not less than 30 days written notice
      to you, to terminate this Agreement. . . .

       7.    In the event you voluntarily terminate your employment during the
       term of this Agreement, or if the Company terminates this Agreement
       and your employment for cause, your right to all compensation
       hereunder shall cease as of the date of termination. As used in this
       Agreement, “cause” shall mean dishonesty, gross negligence, or willful
       misconduct in the performance of your duties or a willful or material

      2
          At all times relevant to th is case, C leo was a wholly owne d subs idiary of Gibs on Gre etings, Inc .

                                                        3
       breach of this Agreement. Termination of employment shall terminate
       this Agreement with the exception of the provisions of Paragraphs 8, 9,
       10, and 12.

       8.     Also in the event you voluntarily terminate your employment
       hereunder, or in the event the Company terminates this Agreement and
       your employment for cause, you agree that for a period of two years
       after such termination, you will not compete, directly or indirectly, with
       the Company or with any division, subsidiary, or affiliate of the Company
       or participate as a director, officer, employee, consultant, advisor,
       partner, or joint venturer in any business engaged in the manufacture or
       sale of greeting cards, gift wrap, or other products produced by the
       Company, or any division, subsidiary, or affiliate of the Company, without
       the Company’s prior written consent.

       9.    In the event the Company terminates this Agreement and your
       employment without cause, you shall continue to be paid your then
       current salary from the date of termination through October 31, 1995.

       In 1994, Cleo experienced several personnel changes in its upper

management. Jack Rohrbach replaced Mr. Pietrangelo as the company’s President

and Chief Executive Officer and Marc English was later hired as the Senior Vice

President of Marketing and “Creative.” Mr. Rohrbach stated in his deposition that he

began observing the appellant’s work performance when he took over as the company

president. Based upon his observations, he opined that the appellant had a poor work

relationship with his peers and subordinates and that the appellant was not leading the

marketing department in a direction best suited for the company. Mr. Rohrbach stated

that he hired Mr. English as the new marketing Vice President because Mr. English

had more industry experience and a successful track record.

       In the Fall of 1994, the appellant received a series of letters from Mr. Rohrbach

and Mr. English that diminished his employment responsibilities at Cleo. The first

letter, dated September 13, 1994, informed the appellant that his employment contract

would not be renewed after its expiration on October 31, 1995. Approximately two

weeks later, the appellant received a second letter signed by Mr. Rohrbach that stated

in pertinent part:

                                           4
         Effective today and until October 31, 1995, you are relieved of your
         duties as Vice President Marketing of Cleo Inc. and shall be responsible
         for such assignments as may be given to you by the President of the
         Company. During this period, you will remain an employee of the
         Company and the Company will continue to honor its obligations to you
         under your employment agreement.

         However, you are specifically advised that you shall have no authority to
         bind, represent or speak for the Company in any manner except as may
         be stated in writing by the President of the Company.

         For all future assignments, you shall be based out of your home.

         Should you accept other employment prior to October 31, 1995, all
         benefits under your employment agreement shall immediately cease.
         Also, please take note of the confidentiality and non-compete provisions
         of your employment agreement.

         We will be in touch when an appropriate assignment becomes available.
         In the meantime, should you have any questions or comments, please
         do not hesitate to contact me.

         In November, 1994, the appellant received two additional letters from Cleo

informing him that he was no longer authorized to use company credit cards and that

he was to return the company cards in his possession. In addition, he was informed

that Cleo would no longer answer a telephone line for him. All telephone calls for the

appellant were to be screened for personal or business, with the personal calls being

directed to appellant’s home. Cleo allowed the appellant to retrieve the personal

telephone numbers from his office rolodex, but all business numbers were kept

exclusively by Cleo as company property.

         Following the letter of September 28, 1994, the appellant stayed at his home

for three months without receiving a work assignment from Cleo. During that time, Mr.

English moved into appellant’s old office and assumed the marketing responsibilities

previously handled by the appellant.3 On December 12, 1994, the appellant accepted

new employment at Wang’s International, Inc. with a starting salary of $110,000 per

         3
          Mr. R ohrb ach state d in his depo sition that M r. Eng lish to ok o n oth er res pon sibilitie s at C leo in
addition to th ose pre viously han dled by the a ppellant.

                                                            5
year. Cleo kept the appellant on the company payroll at $103,000 per year until he

began his new employment.

       The appellant filed suit against Cleo on January 26, 1995, claiming that the

company had constructively terminated his employment without cause and that he

was entitled to the remainder of his salary under Paragraph 9 of the employment

contract. Cleo responded that its treatment of the appellant did not constitute a

termination of his employment, but that even if it did, the provision in Paragraph 9 was

an unenforceable penalty. Both parties filed motions for summary judgment. After a

hearing, the trial court granted summary judgment to the appellant, awarding him

$90,125 in salary remaining under his employment contract plus $14,296.54 in

prejudgment interest.

       On appeal by Cleo, the Court of Appeals affirmed the trial court’s conclusion

that the appellant was constructively terminated from his employment, but reversed

the award of damages. The intermediate court interpreted Paragraph 9 of the

employment contract as a provision for liquidated damages because it called “for

payment of a sum certain in the event of a certain occasion.” Finding no evidence in

the record of actual damages suffered by appellant, the court concluded that

enforcement of the liquidated damages provision would impose an unlawful penalty

against Cleo.

       The appellant requests this Court to reverse the Court of Appeals and to

reinstate the judgment of the trial court. His contention in this appeal is that Cleo

constructively terminated his employment when it removed his title of Vice President

of Marketing and sent him home for three months without any further assignments.

However, in contrast to his argument in the courts below, the appellant now claims

that Cleo had a right to terminate his employment, as it did in this case, without

                                            6
breaching the contract. He contends that, regardless of the issue of breach, he is

entitled to recover severance pay under Paragraph 9 of the employment contract.

                               STANDARD OF REVIEW

       The standards governing an appellate court’s review of a motion for summary

judgment are well settled. Summary judgment is appropriate only where the moving

party demonstrates that there are no genuine issues of material fact and that he or

she is entitled to judgment as a matter of law. Byrd v. Hall, 847 S.W.2d 208, 210

(Tenn. 1993); Tenn. R. Civ. P. 56.03. We review the summary judgment motion as a

question of law in which our inquiry is de novo without a presumption of correctness.

Finister v. Humboldt Gen. Hosp., Inc., 970 S.W.2d 435, 437 (Tenn. 1998); Robinson v.

Omer, 952 S.W.2d 423, 426 (Tenn. 1997). We must view the evidence and all

reasonable inferences in the light most favorable to the nonmoving party. Byrd, 847

S.W.2d at 210-11. If both the facts and conclusions to be drawn therefrom permit a

reasonable person to reach only one conclusion, then summary judgment is

appropriate. Robinson, 952 S.W.2d at 426; Bains v. Wells, 936 S.W.2d 618, 622

(Tenn. 1997).

                                      DISCUSSION

                                            I.

       We shall first address whether summary judgment was appropriate on the

question of constructive termination. Initially, we note that the issue of constructive

termination in this case is distinguishable from cases where an at-will employee claims

constructive discharge based upon a hostile work environment, discrimination, or

                                            7
some non-feasance on the part of the employer. See Phillips v. Interstate Hotels

Corp., 974 S.W.2d 680 (Tenn. 1998); Campbell v. Florida Steel Corp., 919 S.W.2d 26

(Tenn. 1996). The appellant contends that Cleo removed his job title and all work

responsibilities, effectively terminating his employment, without officially or formally

ending the employment agreement. We view this issue strictly as one of breach of

contract and conclude that the evidence clearly establishes that Cleo effectively

terminated appellant’s employment without cause, thereby breaching the contract.

       Both the appellant and Cleo have agreed on the facts leading up to appellant’s

change of employment. Cleo contends, however, that it had a right to alter the

appellant’s work responsibilities under the employment contract, as it did in this case,

without causing a termination. In support of that contention, Cleo relies on evidence

that it allowed the appellant to stay on the company payroll as a senior executive

employee until he obtained new employment.

       The resolution of this dispute centers on the construction of the employment

contract. Cleo refers to that portion of the contract which states:

       Cleo Inc. and I are very pleased that you have agreed to serve as Vice
       President, Marketing of Cleo Inc. ... As Vice President, Marketing you
       will report to the President, and perform those functions currently
       assigned, which functions and responsibilities can be changed at the
       discretion of the Company. The following terms and conditions will
       govern your service to the Company:

       1. You will serve the Company on a full-time basis as a senior executive
       employee, and the Company will employ you as such, for a period of
       three years. . . .

The appellant relies on the same contractual language to argue that he was employed

as the Vice President of Marketing for the company. According to appellant, once

Cleo removed his title and work responsibilities, it effectively ended his employment.

                                             8
        The interpretation of a contract is a matter of law that requires a de novo review

on appeal. See Hamblen County v. City of Morristown, 656 S.W.2d 331, 335-336

(Tenn. 1983). When resolving disputes concerning contract interpretation, our task is

to ascertain the intention of the parties based upon the usual, natural, and ordinary

meaning of the contractual language. Id. at 333-34; Bob Pearsall Motors, Inc. v.

Regal Chrysler-Plymouth, Inc., 521 S.W.2d 578, 580 (Tenn. 1975). All provisions in

the contract should be construed in harmony with each other, if possible, to promote

consistency and to avoid repugnancy between the various provisions of a single

contract. Rainey v. Stansell, 836 S.W.2d 117, 118-19 (Tenn. App. 1992), perm. app.

denied (Tenn. 1992).

        In this case, the contract refers to appellant’s position of employment in two

separate provisions. The opening provision states that he will “serve as Vice

President of Marketing for Cleo, Inc.,” reporting to the company president and

conducting work functions that were currently assigned. The subsequent provision

under Paragraph 1 describes his position as a full-time senior executive employee.

We read those provisions together to mean that as Vice President of Marketing, the

appellant was to be a full-time senior executive employee in the company. 4 Cleo

promoted the appellant to that position with the condition that it could change his job

functions and responsibilities during the course of the three-year contract. Those

changes may have included altering his official job title. However, Cleo was

contractually obligated to maintain appellant’s employment as a full-time senior

        4
          The Court of Appeals determined that the appellant was employed exclusively as the Vice
Pres ident of M arke ting b ase d upo n the open ing pr ovisio n of th e em ploym ent c ontra ct. Th e cou rt held
that to the e xtent the s ubseq uent pro visions de scribed the appe llant as a se nior exec utive em ployee,
those latter provisions were unenforceable as being in conflict with the preceding “Vice President of
Marketing” provision. We hold to the contrary that the provisions can be read congruently without having
to redac t any portion o f the con tract.

                                                        9
executive employee unless there was a cause for termination.5 Cleo’s contractual

right to change the appellant’s work duties did not include the right to remove all of his

duties.

          Cleo contends that it fulfilled its contractual obligation by keeping the appellant

on the company payroll at his then current salary, even though it altered and

effectively ended his work responsibilities. Cleo relies on the Court of Appeal’s

decision in Canady v. Meharry Med. College, 811 S.W.2d 902 (Tenn. App. 1991),

perm. app. denied (Tenn. 1991). In Canady, the defendant/employer restricted the

plaintiff’s work duties and decided not to renew his employment contract as a hospital

resident physician after the plaintiff received unsatisfactory job-performance ratings.

Id. at 904. The court concluded, in part, that the restriction of plaintiff’s work duties did

not constitute a breach of the contract because the contract contained no express or

implied assurance that the plaintiff would be given continuous, uninterrupted work

assignments. Id. at 906.

          The circumstances in Canady are clearly distinguishable from the appellant’s

case. Here, we are not dealing exclusively with a change or restriction of appellant’s

work responsibilities. The facts are undisputed that Cleo not only demoted the

appellant from his position as Vice President of Marketing, but also ordered him to

stay at his home and wait for any future assignments. During the three months that

the appellant stayed at home, he received no work assignments and apparently did

not perform any functions on behalf of the company. In addition, Cleo reclaimed

appellant’s company credit cards and informed him that the company would no longer

          5
           As previously mentioned, “cause” was defined in the contract as “dishonesty, gross negligence,
or willful mis condu ct in the per form ance o f work d uties or a w illful or mate rial breach of [the em ployme nt]
Agreement.” Cleo also had a right to terminate the contract under certain conditions of illness or
incapac ity as defined in Parag raph 6 o f the con tract.

                                                        10
answer telephone calls for him. All business contacts for Cleo and authority to act on

behalf of the company were taken away from the appellant.

      The undisputed facts in this case support the lower courts’ holding that the

appellant was constructively terminated from his employment. Moreover, Cleo has not

shown cause to justify the termination. We, therefore, conclude that summary

judgment for the appellant was appropriate on that issue.

                                           II.

      We shall next address whether Paragraph 9 of the employment contract

provides for severance pay or liquidated damages. The appellant contends that

Paragraph 9 contemplates severance pay because its payment is not specifically

conditioned upon a breach of contract. Cleo argues to the contrary that the sums

under Paragraph 9 are liquidated damages because that paragraph calls for the

payment of a set amount in the event of a certain occasion. Cleo contends, however,

that no matter what label is given to the provision, it is unenforceable because the

appellant suffered no actual monetary damages.

      The Court of Appeals interpreted Paragraph 9 of the employment contract as a

liquidated damages provision because it contemplates the “payment of a sum certain

in the event of a certain occasion.” We agree that Paragraph 9 provides for liquidated

damages, not severance pay. However, our interpretation of Paragraph 9 is based

upon the specific contract language that recovery is due in the event that Cleo

“terminates this agreement and [appellant’s] employment without cause,” resulting in a

breach of the contract.

                                           11
        The distinction between liquidated damages and severance pay is important in

this case. If Paragraph 9 provides for liquidated damages, then recovery is

conditioned upon a showing that Cleo breached the contract and that the amount of

recovery was a reasonable estimation of damages. However, if the provision calls for

severance pay, then recovery by the appellant is absolute in the event of his

termination, regardless of whether Cleo breached the contract or whether the amount

was a reasonable damage assessment.

        The term “liquidated damages” is defined by case law as a “sum stipulated and

agreed upon by the parties at the time they enter their contract, to be paid to

compensate for injuries should a breach occur.” V.L. Nicholson Co. v. Transcon Inv. &

Fin. Ltd., Inc., 595 S.W.2d 474, 484 (Tenn. 1980); Kimbrough & Co. v. Schmitt, 939
S.W.2d 105, 108 (Tenn. App. 1996), perm. app. denied (Tenn. 1996). The stipulated

amount represents an estimate of potential damages in the event of a contractual

breach where damages are likely to be uncertain and not easily proven. V.L.

Nicholson, 595 S.W.2d at 484.

        In contrast, the recovery of severance pay is not conditioned upon a breach of

contract or a reasonable estimation of damages. Generally, severance pay is a form

of compensation paid by an employer to an employee at a time when the employment

relationship is terminated through no fault of the employee. Black’s Law Dictionary

1374 (6th ed. 1990). The reason for severance pay is to offset the employee’s

monetary losses attributable to the dismissal from employment6 and to recompense

the employee for any period of time when he or she is out of work. Bradwell v. GAF

Corp., 954 F.2d 798, 800 (2nd Cir. 1992); 27 Am. Jur.2d Employment Relationship §

70 (1996). The amount of payment is generally based upon the types of services and

        6
         Those losses may include seniority rights, pension recovery, and re-training costs or other
burden s asso ciated with o btaining ne w em ployme nt.

                                                   12
the number of service years performed by the employee on behalf of the employer.

See Balding v. Tennessee Dep’t of Employment Sec., 212 Tenn. 517, 370 S.W.2d
546, 548 (1963).

        With these principles in mind, we focus on the language in Paragraph 9 to

determine whether liquidated damages or severance pay was contemplated.

Paragraph 9 provides that if Cleo terminates the contract and appellant’s employment

without cause, the appellant shall continue to receive his then current salary from the

date of termination until October 31, 1995, the contract expiration date. Paragraph 9

does not state that sums payable are based upon an estimation of damages in the

event of a breach of contract. However, it is clear that the provision affords the

appellant a set amount of compensation in the event that Cleo terminates the

agreement and appellant’s employment, without cause, before the end of the

contract.7 Relying on the plain meaning of the language in Paragraph 9, we conclude

that recovery therein is conditioned upon Cleo’s breach of contract.

        A contractual provision need not explicitly include the term “liquidated

damages” to constitute a liquidated damages provision. In cases as here, where a

provision entitles one party to a stipulated recovery following an event that constitutes

a breach of contract, courts must look to the substance of the provision and the

intentions of the parties to determine whether the provision calls for liquidated

damages. If the parties agree in the contract on the amount of damages to be

recovered for compensation, upon the occurrence of a particular defaulting event,

        7
          The appellant argues, in part, that the dollar amount established in Paragraph 9 cannot be
construed as liquidated dam ages because it is not sufficiently definite to constitute a “sum certain.” We
afford n o me rit to this conte ntion. Und er Ten nesse e law, a co ntractua l provision d oes no t have to
specify a s et dollar am ount to co nstitute liquida ted dam ages. See Vanderbilt Univ. v. Dinardo, 974 F.
Supp. 6 38, 640 ( M. D. T enn. 199 7) (applying T ennes see law) , rev ’d in part, __ F.3d __, 1999 WL
211871 (6th Cir. Apr. 14, 1999) (upholding the liquidated damages provision, but remanding for trial on a
contrac t addend um) ; Harmo n v. Eggers, 699 S.W .2d 159, 1 60 (Te nn. Ct. Ap p. 1985) , perm. app. denied
(Tenn . 1985).

                                                    13
then the damages are liquidated unless the contract states otherwise. See V.L.

Nicholson, 595 S.W.2d at 484.

         The language in Paragraph 9 reflects the parties’ intentions to compensate the

appellant with a set monetary amount in the event that Cleo terminated the contract

and the employment relationship without cause, before the end of the three-year term.

Having further determined that the termination in this case was a breach of contract,

we interpret Paragraph 9 as contemplating the payment of liquidated damages.

                                                           III.

         The remaining question is whether the appellant may recover any or all of the

damages set forth in Paragraph 9. Under that paragraph, the sum payable is the

remainder of appellant’s then current salary from the date of termination until the end

of the contract term on October 31, 1995. The appellant’s salary as of December

1994, was $103,000. Based upon that amount and the formula provided in Paragraph

9, the trial court determined that the remainder of salary owed under the three-year

contract was $90,125.8

         Cleo does not dispute the calculation of damages in this case, but instead

contends that the $90,125 amount plus prejudgment interest is grossly disproportional

to any actual damages suffered by the appellant. Since the appellant obtained new

employment on December 12, 1994, with an annual salary of $110,000, Cleo argues

that appellant’s recovery of liquidated damages under Paragraph 9 would constitute

an unlawful penalty.

         8
           The record does not reflect the exact date found by the trial court as the date when appellant
was terminated from his employment. However, based upon the $90,125 amount, it is apparent that the
trial court trea ted Dec emb er 15, 19 94, as the approx imate d ate of term ination. Th at date co incides w ith
a lette r sen t by Cle o to th e app ellant on D ece mb er 22 , 199 4, sta ting th at the appe llant h ad be en pa id his
emp loymen t wages through Dece mbe r 15, 199 4.

                                                           14
        The basis of Cleo’s contention is that if the appellant suffered no actual

damages from the termination of his employment, then his recovery under Paragraph

9 would have no compensatory function, but would instead simply punish Cleo for the

termination. Both parties acknowledge that Tennessee law disfavors the enforcement

of a liquidated damages provision when the provision serves only to penalize the

defaulting party for a breach of contract. See Testerman v. Home Beneficial Life Ins.

Co., 524 S.W.2d 664, 668 (Tenn. App. 1974), perm. app. denied (Tenn. 1975).9

        The fundamental purpose of liquidated damages is to provide a means of

compensation in the event of a breach where damages would be indeterminable or

otherwise difficult to prove. V.L. Nicholson, 595 S.W.2d at 484; 22 Am. Jur. 2d

Damages § 683 (1988); Restatement (Second) of Contracts § 356 cmt. (1979). By

stipulating in the contract to the damages that might reasonably arise from a breach,

the parties essentially estimate the amount of potential damages likely to be sustained

by the nonbreaching party. “If the [contract] provision is a reasonable estimate of the

damages that would occur from a breach, then the provision is normally construed as

an enforceable stipulation for liquidated damages.” V.L. Nicholson, 595 S.W.2d at

484 (citing City of Bristol v. Bostwick, 146 Tenn. 205, 240 S.W. 774 (1921); 22 Am.

Jur. Damages § 227 (1965)). However, if the stipulated amount is unreasonable in

relation to those potential or estimated damages, then it will be treated as a penalty.

22 Am. Jur. 2d Damages § 686 (1988); Restatement (Second) of Contracts § 356

(1979).

        Although most jurisdictions disfavor the enforcement of penalties under

contract law, there is a split in authority on the proper method for determining whether

        9
         As distinguished from liquidated damages, a penalty is “a sum inserted in a contract, not as the
measure of compensation for its breach, but rather as a punishment for default, or by way of security for
actual damages which may be sustained by reason of nonperformance, and it involves the idea of
punishment.” 22 Am. Jur. 2d Damages § 684 (1 988).

                                                   15
a liquidated damages provision constitutes a penalty. One method, commonly

referred to as the “prospective approach,” focuses on the estimation of potential

damages and the circumstances that existed at the time of contract formation.10

Under this approach, the amount of actual damages at the time of breach is of little or

no significance to the recovery of liquidated damages. 22 Am. Jur. 2d Damages § 723

(1988). If the liquidated sum is a reasonable prediction of potential damages and the

damages are indeterminable or difficult to ascertain at the time of contract formation,

then courts following the prospective approach will generally enforce the liquidated

damages provision. See e.g. Gaines v. Jones, 486 F.2d 39, 46 (8th Cir. 1973)

(applying Missouri law); Brazen v. Bell Atl. Corp., 695 A.2d 43, 48 (Del. 1997).

        In contrast, a second approach has developed in which courts not only analyze

the estimation of damages at the time of contract formation, but also address whether

the stipulated sum reasonably relates to the amount of actual damages caused by the

breach.11 Under this retrospective approach, the estimation of potential damages and

the difficulty in measuring damages remain integral factors for the courts’ review. See

e.g. Lake Ridge Academy v. Carney, 613 N.E.2d 183, 188-89 (Ohio 1993); Highgate

        10
            See United States v. Bethlehem Steel Co., 205 U.S. 105, 119, 27 S. Ct. 450, 455, 51 L. Ed. 731
(1907); Gaines v. Jones, 486 F.2 d 39, 44- 45 (8th C ir. 1973); United States v. Le Roy Dyal Co., 186 F.2d
460, 462 (3rd Cir. 19 50); Williwaw Lodge v. Locke, 601 P.2d 236, 239 (Alaska 1979); Omo hndro v.
Ottenheimer, 127 S.W .2d 642, 6 45 (Ark . 1939); McC arthy v . Tally , 297 P.2d 981, 986- 87 (C al. 19 56) (in
banc); Roh aue r v. Little , 736 P.2d 403, 410 (Colo 19 87); Hanson Dev. Co. v. East Great Plains Shopping
Ctr., Inc., 485 A.2d 1296, 13 00 (Co nn. 1985 ); Brazen v. Bell Atl. Corp., 695 A.2d 43, 48 (Del. 1997);
Lefemine v. Baron, 573 So .2d 326, 3 28 (Fla. 19 91); Fickling & Walker Co. v. Gibbens Constr. Co., 376
S.E.2d 6 55, 659- 60 (Ga . 1989); Anne Arundel County v. Norair Engr. Corp., 341 A.2d 287, 294 (Md.
1975); Frank v. Jansen, 226 N.W .2d 739 ( Minn. 19 75); Board of Trustees of State Inst. of Higher
Learning v. Johnson, 507 So .2d 887, 8 90 (Mis s. 1987 ); Knu tton v . Cof ield, 160 S.E.2d 29, 35-36 (N.C.
1968); Fisher v. Schmeling, 520 N.W .2d 820, 8 22 (N.D . 1994); Safari, Inc. v. Verdoorn, 446 N.W.2d 44,
46 (S.D . 1989); Woodhaven Apartments v. Washington, 942 P.2d 918, 921 (Utah 19 97).

        11
           See Thanksg iving Tower Partners v. Anros Th anksgiving Partners , 64 F.3d 227, 232 (5th Cir.
1995) (a pplying Te xas law ); Southpace Properties, Inc. v. Acquisition Group, 5 F.3d 500, 505 (11th Cir.
1993) (a pplying Alab ama law); Kelly v. Marx, 694 N.E .2d 869, 8 71-72 (M ass. Ap p. Ct. 199 8); Hawkins v.
Foster, 897 S.W .2d 80, 85 (Mo. C t. App. 199 5); Browning Ferris Indus. of Nebraska, Inc. v. Eating
Establishment 90th & Fort, Inc., 575 N.W .2d 885, 8 88-89 (N eb. Ct. Ap p. 1998) ; Shallow Brook Asso c. v.
Dube, 599 A.2d 132, 137 (N.H. 19 91); Boyle v. Petrie Stores Corp., 518 N.Y.S.2d 854, 861 (N.Y. Sup.
Ct. 1985 ), supp. decision (May 29, 1 987); Lake Ridge Academy v. Carney, 613 N.E.2d 18 3, 18 9 (O hio
1993); High gate Ass oc., L TD . v. Me rryfield , 597 A.2d 1280, 1282 (Vt. 1991) (reviewing the totality of the
circum stance s); W hee ling C linic v. V an P elt, 453 S.E .2d 603, 6 09 (W . Va. 1994 ); Wassenaar v. Panos,
331 N.W.2d 357, 361-62 (Wis. 1983) (reviewing the totality of the circumstances, including actual
dam ages).

                                                      16
Assoc., LTD. v. Merryfield, 597 A.2d 1280, 1282 (Vt. 1991). However, as part of that

review, the actual damages at the time of breach are also relevant in determining

whether the original estimation of damages was reasonable. See Kelly v. Marx, 694
N.E.2d 869, 871 (Mass. Ct. App. 1998); Wassenaar v. Panos, 331 N.W.2d 357, 361-

62 (Wis. 1983). If the liquidated sum greatly exceeds the amount of actual damages,

then courts following this latter approach will treat the estimated sum as a penalty and

will limit recovery to the actual damages. Kelly, 694 N.E.2d at 871; Shallow Brook

Assoc. v. Dube, 599 A.2d 132, 137 (N.H. 1991).

      While this Court has not previously addressed the issue, we note that the Court

of Appeals has followed the latter approach using both a prospective review of the

circumstances at the time of contract formation and a review of the actual damages at

the time of breach. See Kimbrough & Co., 939 S.W.2d at 108; Beasley v. Horrell, 864
S.W.2d 45, 50 (Tenn. App. 1993), perm. app. denied (Tenn. 1993); Kendrick v.

Alexander, 844 S.W.2d 187, 190-91 (Tenn. App. 1992), perm. app. denied (Tenn.

S1992) (following a prospective approach for assessing the reasonableness of a

liquidated damages provision); Harmon, 699 S.W.2d at 163; Eller Bros., Inc. v. Home

Fed. Sav. & Loan Assoc., 623 S.W.2d 624, 628 (Tenn. App. 1981), perm. app. denied

(Tenn. 1981). After careful consideration, we find that there are inherent problems

with the retrospective analysis and are persuaded that a prospective approach is the

better rule. Therefore, to the extent that the Court of Appeals has adopted a

retrospective approach, as reflected in Eller Bros., Harmon, Beasley, and Kimbrough

& Co., that approach is overruled.

      From our review of the law on liquidated damages, we recognize that there are

two important interests at issue: the freedom of parties to bargain for and to agree

upon terms such as liquidated damages and the limitations set by public policy.

Generally, the parties to a contract are free to agree upon liquidated damages and

                                           17
upon other terms that may not seem desirable or pleasant to outside observers. See

Chapman Drug Co. v. Chapman, 207 Tenn. 502, 341 S.W.2d 392, 398 (1960); 22 Am.

Jur. 2d Damages § 686 (1988). In that respect, courts should not interfere in the

contract, but should carry out the intentions of the parties and the terms bargained for

in the contract, unless those terms violate public policy. See McKay v. Louisville &

N.R. Co., 133 Tenn. 590, 182 S.W. 874, 875 (1916) (citing Baltimore & Ohio S.W. Ry.

Co. v. Voight, 176 U.S. 498, 505, 20 S. Ct. 385, 387, 44 L. Ed. 560 (1900)).

       Both the prospective and the retrospective approaches allow courts to review

liquidated damages provisions together with the limitations set by public policy.

However, we conclude that the prospective approach is the better rule based upon the

consideration it affords to the intentions of the parties and to the freedom to contract.

       When parties agree to a liquidated damages provision, it is generally presumed

that they considered the certainty of liquidated damages to be preferable to the risk of

proving actual damages in the event of a breach. 22 Am. Jur. 2d Damages § 726.

Liquidated damages permit the parties to allocate business and litigation risks and

often serve as part of the contractual bargain. In addition, they lend certainty to the

contractual agreement and allow the parties to resolve defaults and other related

disputes efficiently, when actual damages are impossible or difficult to measure. C.T.

McCormick, Handbook on the Law of Damages § 157 (1935).

       The retrospective approach, however, undermines the certainty and other

benefits afforded by liquidated damages. Under that approach, the parties are

allowed to fully litigate actual damages following a breach of contract. If the

nonbreaching party fails to prove actual damages, then he or she is barred from

recovering the liquidated sum originally agreed upon in the contract. We find that it is

                                            18
unfair to require the nonbreaching party to prove actual damages in cases where the

parties agreed in advance to a liquidated damages provision. Such a requirement

ignores the original intentions of the parties and defeats the purposes of stipulating in

advance to potential damages.

        We, therefore, adopt a prospective approach for addressing the recovery of

liquidated damages. Under this approach, courts must focus on the intentions of the

parties based upon the language in the contract and the circumstances that existed at

the time of contract formation.12 Those circumstances include: whether the liquidated

sum was a reasonable estimate of potential damages and whether actual damages

were indeterminable or difficult to measure at the time the parties entered into the

contract. See V.L. Nicholson, 595 S.W.2d at 484. If the provision satisfies those

factors and reflects the parties’ intentions to compensate in the event of a breach,

then the provision will be upheld as a reasonable agreement for liquidated damages.

However, if the provision and circumstances indicate that the parties intended merely

to penalize for a breach of contract, then the provision is unenforceable as against

public policy.

                                                     IV.

        We now turn to the liquidated damages provision in this case. The Court of

Appeals found that the liquidated sum was a reasonable estimation of potential

damages at the time the parties entered into the contract. We agree. Neither the

appellant nor Cleo had certain knowledge, when forming the contract, that the

        12
           This prospective approach incorporates the cardinal rule of contract interpretation, requiring
courts to ascerta in the intention s of the p arties bas ed upo n the lang uage in th e contra ct. See Bob
Pearsall Motors, Inc., 521 S.W .2d at 580 ; Nunnelly v. Warner Iron Co., 94 Tenn. 282, 29 S.W. 124
(1895).

                                                     19
appellant would be able to secure other employment in the event that Cleo terminated

his employment without cause. It was within the fair contemplation of the parties that

the appellant might not be able to find a similar professional position at the same

salary and that he might suffer damages that would be difficult to prove, including loss

of professional status, prestige, and advancement opportunities. The language in

Paragraph 9 reflects the parties’ intentions to compensate and to protect the appellant

against those potential losses in the event of a breach by Cleo.

        The Court of Appeals, however, went further in addressing whether the

stipulated sum reasonably related to the appellant’s actual damages. Cleo insists that

the intermediate court’s analysis was both proper and fair based upon the fact that the

appellant obtained new employment at a higher salary after the termination. While we

question whether the record is sufficient on the issue of actual damages,13 we

conclude that the extent of actual damages has no bearing on the appellant’s recovery

of liquidated damages under Paragraph 9. The liquidated sum is recoverable based

upon our conclusion that it was reasonable at the time the parties entered into the

contract and that it reflects the parties’ original intentions to compensate for a

termination of employment.

        The parties themselves were in the best position to know what considerations

influenced their bargaining at the time they entered into the contract. While “‘[t]he

bargain may be an unfortunate one for the delinquent party, ... it is not the duty of

courts of common law to relieve parties from the consequences of their own

improvidence.’” Watson v. Ingram, 881 P.2d 247, 250 (Wash. 1994) (quoting Dwinel

v. Brown, 54 Me. 468, 470 (1867)). See also McKay, 182 S.W. at 875; Whaley v.

        13
           The trial court awarded summary judgment to the appellant without making a finding on actual
damages or whether the recovery constituted severance pay or liquidated damages. Nevertheless,
because we hold that actual damages are immaterial in this case, we need not address the sufficiency of
the reco rd in that res pect.

                                                  20
Underwood, 922 S.W.2d 110, 112 (Tenn. App. 1995). Accordingly, to the extent the

Court of Appeals based its decision upon a review of actual damages, that decision is

overruled.

                                     CONCLUSION

       Based upon the foregoing, we conclude that summary judgment for the

appellant was appropriate on the issue of constructive termination. Moreover,

because Paragraph 9 was a reasonable estimation of damages at the time the parties

entered into the contract, we conclude that the appellant is entitled to recover the full

amount stipulated in that provision. The judgment of the Court of Appeals is reversed

and the trial court’s award of summary judgment for the appellant is reinstated. Costs

of this appeal are taxed to the appellee, Cleo.

                                                  ______________________________
                                                  WILLIAM M. BARKER, JUSTICE

CONCUR:

Anderson, C.J.,
Drowota, Birch, Holder, JJ.

                              SUPREME COURT, JACKSON

ANTHONY P. GUILIANO                       )
                                          )
       Plaintiff/Appellant                )       SHELBY CIRCUIT
                                          )       67428 T.D. Below
v.                                        )
                                          )       02S01-9801-CV-00002
CLEO, INC.                                )
                                          )       Court of Appeals Reversed,
       Defendant/Appellee                 )       Trial Court Affirmed
                                          )
                                         )

                                      JUDGMENT

      This case was heard on the record on appeal from the Court of Appeals,

application for permission to appeal having heretofore been granted, with briefs and

argument of counsel; and in consideration thereof, this Court is of the opinion that the

appellant, Anthony P. Guiliano, was terminated from his employment and that the

liquidated damages provision is fully enforceable against the appellee, Cleo, Inc.

      In accordance with the opinion filed herein, it is, therefore, ordered and

adjudged that the judgment of the Court of Appeals is reversed and the trial court’s

order granting summary judgment in favor of the appellant is affirmed. The case is

remanded to the Circuit Court of Shelby County for the execution of the judgment and

for the collection of costs accrued below.

      Costs of this appeal will be paid by the appellee for which execution shall issue

if necessary.

06/28/99

                                             22