David Sloane, Inc. v. Stanley G. House & Associates, Inc.

RODOWSKY, Judge. In this action an advertising agency recovered damages for an advertiser’s breach of an exclusive agency contract. The principal question presented is whether the award is excessive because the plaintiff’s fixed costs of doing business were not deducted in computing damages for “lost profits.” By a written contract effective January 9, 1978, appellant and cross-appellee, David Sloane, Inc., trading as “Sassaf ³⁸ ras!” (Sloane), appointed appellee and cross-appellant, Stanley G. House & Associates, Inc. (House), as Sloane’s “exclusive advertising agency and public relations counsel.” 1 The contract provided for commissions at an effective rate of fifteen percent of the gross billings by “media (such as radio, TV, billboards, out-of-town or suburban papers, magazines, etc.).” The charge for “regular staff production time, from copy to layout to tearsheet” was at a then current, specified hourly rate, while “[c]harges for creative copy and art services on specialties ..., priority assignments, overtime, etc.” were to be quoted in advance for Sloane’s approval. House promised to keep a daily log of time spent on the Sloane account which would be open to Sloane’s review on request.

The initial term of the contract was six months, terminable by either party through written notice. Absent notice of termination the agreement automatically renewed for successive terms of one year each. Either party could terminate at the expiration of a renewal term by ninety days prior written notice. The contract was breached January 1, 1984, when Sloane, which operates women’s retail clothing stores, began using another agency, Goldberg-Marchesano (G-M).

In the spring of 1983, Sloane had determined to enlarge its advertising expenditures. It caused a market survey to be made and then held a competition for its business among advertising agencies, including House. By a letter dated December 19, 1983, Sloane advised House that another agency had been selected to handle Sloane’s 1984 advertising campaign. This letter constituted the earliest written notice of Sloane’s termination of the 1978 exclusive contract which had been ³⁹ renewing automatically.

The earliest date for that termination to be effective, however, was the next anniversary, July 9, 1984. House sued Sloane and the case was tried to the court. G-M’s records of the work it did for Sloane from January 1 through July 9, 1984, were the starting point for House’s damage evidence. Those records reflected media billings to which House applied the commission rate provided under its contract with Sloane.

G-M’s invoices to Sloane also enabled House to identify by descriptive categories such as “creative,” “production,” and “finished art,” the amount charged on an hourly basis by G-M for each category of work on a particular job. House divided the amount billed by G-M by the highest G-M hourly rate for a particular category and then multiplied the number of hours of activity thereby determined by the lowest rate utilized by House for that type of work. Under this method the value to House of commissionable and hourly fee work for the relevant period was computed to be $103,050.71. House made two deductions from that figure.

Under the contract between Sloane and G-M there was a discount on media commissions as compared to commissions under the Sloane-House contract. House adjusted its damage calculation to allow Sloane that discount. House also subtracted the $2,500 cost of an artist whom it would have needed to have performed all of the work done by G-M for Sloane during the January 1 to July 9, 1984 period. These deductions produced an adjusted lost profit figure of $74,161.21. 2 The trial court awarded this lost profit figure and based the award on the testimony of Stanley G. House, the owner of the plaintiff agency.

He testified that his agency could have performed the same types of work that G-M performed for Sloane and that he had absolutely no question about the ability of his agency to handle the work from a quantitative point of view even though G-M’s hourly billed ⁴⁰ work for Sloane during the relevant period amounted to 1,693 hours. House also testified that there would not have been any increase in House’s “overhead by virtue of handling [the Sloane] account, in the way of rent, electricity or subcharges.” The only savings House realized by not having to perform the Sloane contract was the $2,500 cost of an artist. The trial judge found that House had been “conservative and reasonable” and had cut the amount of damages “to the bare bones.” The Sloane-House contract also contains a mutual covenant to pay reasonable attorney’s fees incurred in enforcing the contract. The trial court awarded House “attorney’s fees in the amount of 20% of $74,161.21.” After having decided initially to allow prejudgment interest from July 9, 1984, the trial judge struck prejudgment interest in ruling on a post-judgment motion.

Both parties appealed and we granted certiorari on our own motion before the matter was considered by the Court of Special Appeals. Stated succinctly these appeals present claims that the trial court erred in: I. The damage award because A. comparison to G-M was unfounded and B. House proved gross revenues rather than net profits; II. The counsel fee award because it cannot be based on a percentage of the recovery; and III. The denial of prejudgment interest because the denial was an abuse of discretion.

I Broadly speaking, Sloane’s many faceted arguments against the damage award have in common the criticism that House did not meet its burden of proving damages with certainty. In M & R Contractors & Builders, Inc. v. Michael, 215 Md. 340 , 138 A.2d 350 (1958), we noted that ⁴¹ the certainty rule has been modified into one of “reasonable certainty.” Modifications enumerated there were: (a) [I]f the fact of damage is proven with certainty, the extent or the amount thereof may be left to reasonable inference; (b) where a defendant’s wrong has caused the difficulty of proving damage, he cannot complain of the resulting uncertainty; (c) mere difficulty in ascertaining the amount of damage is not fatal; (d) mathematical precision in fixing the exact amount is not required; (e) it is sufficient if the best evidence of the damage which is available is produced; and (f) the plaintiff is entitled to recover the value of his contract as measured by the value of his profits. [Id. at 349, 138 A.2d at 355 .] A Sloane questions the court’s use of G-M’s work on the Sloane account as a measure of the amount of work which would have been done for Sloane by House. At the outset Sloane argues that House was required to demonstrate the comparability of the operations at G-M to those at House as a foundation for recovery. House was not, however, attempting to show that the profits, if any, enjoyed by G-M would be the same as those which House would have enjoyed.

House looked to the G-M experience to prove the volume of advertising activity actually done for Sloane during the relevant period. To that known output of work House applied the charges agreed to in its contract with Sloane, less the same discount on media placements given by G-M. Sloane also submits that the amount of advertising placed by it through G-M does not prove the amount which it would have placed through House had Sloane honored the exclusive agency contract. The trial court, however, was not clearly erroneous in accepting the relationship between the two contracts, particularly in light of Sloane’s intent to embark on an expanded advertising campaign in 1984. One of the recognized methods of proving prospective profits is to use “[p]rofits made by others, as in the case of ⁴² the breach of a contract of exclusive agency[,] evidence of the profits made by the infringer are admissible to prove the plaintiffs loss.” 11 W. Jaeger, Williston on Contracts § 1346A, at 249 (3d ed. 1968) (footnotes omitted).

Macke Co. v. Pizza of Gaithersburg, Inc., 259 Md. 479 , 270 A.2d 645 (1970), for example, involved a claim for lost profits by the owner of cold drink vending machines whose right to place the machines in the defendant’s pizza shops had been prematurely and wrongfully terminated. Reversing for a new trial on damages, we observed that if the plaintiffs machines had been replaced in the shops by comparable machines provided by another “a more appropriate measure of damages might be that grounded on the five Pizza Shops’ actual experience for the period [following wrongful termination], rather than one based on extrapolating profits from the results experienced” by the plaintiff in the pretermination period. Id. at 492 , 270 A.2d at 652 . See generally John B. Robeson Assoc. v. Gardens of Faith, Inc., 226 Md. 215 , 172 A.2d 529 (1961); McKeever v. Washington Heights Realty Corp., 183 Md. 216 , 37 A.2d 305 (1944); National Micrographics Systems, Inc. v. OCE-Industries, Inc., 55 Md.App. 526 , 465 A.2d 862 (1983).

B The burden was on House to prove its claimed lost profits with reasonable certainty. Stuart Kitchens, Inc. v. Stevens, 248 Md. 71 , 234 A.2d 749 (1967). The measure of damages for breach of contract is addressed generally in Restatement (Second) Contracts, § 347 (1981) which recognizes that the injured party has a right to damages based on his expectation interest as measured by (a) the loss in the value to him of the other party’s performance caused by its failure or deficiency, plus (b) any other loss, including incidental or consequential loss, caused by the breach, less (c) any cost or other loss that he has avoided by not having to perform. ⁴³ Sloane submits that House did not prove its lost profits and that the judgment erroneously awards gross income instead of net profits. The defendant points out that, other than $2,500 for an artist’s services, House’s proof of damages presented no deductions from the projected gross receipts of the Sloane contract for salaries, rent, and other expenses of doing business.

House submitted to the trial judge and submits to us that it was required to reduce its projected income on the Sloane account only by the additional cost which House would have incurred in performing. Critical to House’s legal argument is the evidence that, but for the services of an artist at a cost of $2,500, House had the continuing capacity to perform all of the work required under the Sloane contract during the relevant period. In our review, we consider that the trial court found those facts to be true and on those facts there was no error in applying House’s theory of damages. Sloane contracted to use House exclusively but nothing limited House to rendering services exclusively for Sloane. “It can hardly be doubted that an advertising agency, like a builder, can make its special skills available simultaneously to an indefinite number of clients and 'make a profit on all of them.’ ” American Motor Inns, Inc. v. A.W.L. Advertising Agency, Inc., 253 Md. 654, 664 , 254 A.2d 191, 197 (1969) (quoting Patterson, Builder’s Measure of Recovery for Breach of Contract, 31 Colum.L.Rev. 1286, 1306 (1931)).

Here the evidence supported a finding that House, using primarily its existing staff, could have done the work which it otherwise had from January 1 through July 9, 1984, as well as the work for Sloane. Basically House’s position is that it, as a seller of services under a nonexclusive contract, is permitted to compute expectation interest damages by including reasonable overhead in lost profit in much the same manner as the lost volume seller of goods may compute damages under ⁴⁴ § 2-708(2) of the Uniform Commercial Code. 3 The theory underlying the award to a seller of damages measured by the contract price less variable costs, but not fixed costs, is illustrated by an example in Childres & Burgess, Seller’s Remedies: The Primacy of UCC 2-708(2), 48 N.Y.U.L.Rev. 833 (1973). The example shows why the seller is not placed in as good a position as if the repudiated contract had been performed if the rule for computing damages requires an allocation of fixed costs to the repudiated contract. 4 ⁴⁵ The first step of the illustration assumes that all contracts of the seller during the relevant accounting period are fully performed by the buyers with the result from operations set forth below: Sales (total of all contract prices) $500,000 Variable Costs -325,000 Gross Profit $175,000 Fixed Costs - 50,000 Net Profit $125,000 Next, assume that one of the contracts, with a price of $50,000, is repudiated by the buyer. Assume further that the variable costs of that contract and the portion of total fixed costs which a cost accountant would allocate to the repudiated contract are in the same ratio to expected total variable and fixed costs as is the ratio of the contract price to the total of all contract prices in the accounting period.

Under an approach which awards as damages the seller’s “net profit,” our hypothetical seller’s award would be computed as follows: ⁴⁶ Price $ 50,000 Variable Costs - 32,500 Gross Profits $ 17,500 Fixed Costs - 5,000 Net Profit $ 12,500 If we recast, however, the seller’s results of operations for the accounting period to reflect nonpayment of the repudiated contract price and the actual savings effected by the seller’s having been excused from performing, the operational results would be: Sales $450,000 Variable Costs -292,500 Gross Profits $157,500 Fixed Costs - 50,000 Net Profit $107,500 This reflects a $17,500 difference in the seller’s net profit for the accounting period between the full performance scenario and the repudiation scenario. But a rule of damages under which some portion of fixed costs must be allocated to the repudiated contract results in a recovery, in the example, of only $12,500. Allocating $5,000 of fixed costs to the repudiated contract does not award damages which place the seller in as good a position as if the contract had been performed. When we convert the evidence in the case before us to the terminology of the foregoing example, House's evidence was that its variable costs were $2,500 and that all of the other costs associated with performing the Sloane contract were fixed.

The principle for which House contends was applied in Katz Communications, Inc. v. Evening News Ass’n, 705 F.2d 20 (2d Cir.1983). The defendants, the owners of radio and television stations in Oklahoma City, had contracted with the plaintiff, an organization headquartered in New York City, for the latter to be the former’s exclusive national advertising representative. The plaintiff also performed that service for more than one hundred other television stations. When the defendants breached and the plaintiff sued, the trial court awarded lost profit damages based on ⁴⁷ the plaintiff’s rate of commission applied to the defendants’ total national advertising revenue for the balance of the contract term, less the cost of communications between New York and Oklahoma City which was saved because of the breach.

The defendants contended that “recoverable damages should be diminished by the amount of salaries, wages, and other overhead or indirect or fixed costs which [plaintiff], in [defendants’] view, could have saved once it was apprised of the [defendants’] breach.” Id. at 26 . In rejecting that contention the Second Circuit held: [W]e agree with the lower court that [plaintiff] could not lighten its overhead costs in the brief period after it received the August 21, 1979 notice of immediate cancellation ... and before the permissible December 18, 1979 termination of the contract. Even if an employee could lawfully have been dismissed before December 18, 1979 by a notice given August 21, 1979 or thereafter, it was not unreasonable for [plaintiff] to keep the employee either in the hope that appellants could be persuaded to change their minds, or that [plaintiff], as a “lost volume seller,” could find new customers. Moreover, we are not persuaded that when a customer or client breaks a contract with an advertising or like professional organization, the wrongdoer may successfully contend that the damages suffered by the wronged party should be diminished if the wronged party does not forthwith at least partially dismantle the organization he has created and thus disable himself from promptly and fully responding to potential opportunities in the near future.

Nor are we unmindful that one consequence of our adoption of the appellants’ contention would be that hereafter employees or organizations like [plaintiff’s] would in all likelihood be, in situations such as the one at bar, the undeserved victims of a precipitate determination to discharge them. The wrongdoer’s interest in prompt mitigation of damages is of no greater public concern than is the innocent worker’s interest in avoiding becoming one of the army of unemployed. [M] ⁴⁸ Also analogous to the case at hand is Schubert v. Midwest Broadcasting Co., 1