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Court Takes Interest in Contract Case

James W. Cushing, Esq. on 07/18/2012

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Article Image A recent opinion issued by the Supreme Court of Pennsylvania has clarified how interest is to be assessed on the party who breaches a contract in the matter of Truserv Corporation v. Morgan’s Tool&Supply Co., Inc. 39 A.3d 253 (2012).

In the Truserv matter, the two parties entered into a contract which required the Defendant Morgan’s Tool & Supply Co., Inc. to make payments to the Plaintiff Truserv Corporation pursuant to a line of credit. According to the contract, interest would be applied upon Defendant’s default on the payments owed to Plaintiff. There was an open factual question as to the precise rate of interest that would apply, but there was no dispute that the contract applied interest upon defaulting on payments.

Consequent to Defendant’s defaulting on its payments owed to Plaintiff, Plaintiff brought suit against Defendant for breach of contract and related claims. Although Plaintiff filed suit in 1999, between typical delays and, more importantly, Plaintiff’s failure to actively pursue the claim with any dispatch, a trial on the matter did not occur until 2008, nearly nine (9) years later. The trial court found in favor of Plaintiff on the breach of contract but denied its claim for interest on the basis that Plaintiff did not mitigate its damages by artificially increasing the total interest owed by Defendant due to its own inaction in the litigation. Plaintiff appealed and the trial court’s decision was upheld by the Superior Court of Pennsylvania. Plaintiff again appealed, this time to the Supreme Court of Pennsylvania which reversed the decisions in the lower courts. The basis of the Supreme Court of Pennsylvania’s decision is described in the ensuing paragraphs.

The Supreme Court’s analysis included making a distinction between what it called “contractual” interest and “prejudgment” interest. The Supreme Court defined contractual interest as interest specifically mandated by the terms of a contract. As a result, the Court ruled, contractual interest becomes “an integral part of the debt [owed] itself.” Upon its review of applicable case law, the Court ruled that a court has no discretion as to whether to apply contractual interest upon a debt owed. In other words, if the contract mandates the application of interest, then the court must apply it on any debt owed due to the terms of the breached contract. Furthermore, the Court also ruled that it has no authority to, from the bench, change the terms of a contract into which both parties entered. Therefore, if a legitimate and enforceable contract requires interest, then the Court is obliged to enforce it.

The Supreme Court went on to describe prejudgment interest as interest that is, though not expressly in a contract, applied as damages to compensate an aggrieved party for the detention of its money rightfully due to it/him/her. The Court limited the application of prejudgment interest to matters where the amount owed is a definite sum of money per the terms of a contract. This is distinguished from damages incurred as a consequence of the breach as opposed to the money owed due to the default itself pursuant to the terms of the contract. Just as above, the Court ruled that it has no discretion as to whether to apply prejudgment interest; it simply must apply it when any definite sum is owed per the terms of the breached contract.

As described above, the Court ruled that it lacks discretion in the matter as to whether the interest ought to be applied. The Court also went on to rule that a party in Plaintiff’s position has no obligation to mitigate its damages. Defendant argued that the interest claimed by Plaintiff ought to have been reduced as Plaintiff, Defendant averred, artificially allowed the interest to accrue due to its failure to take prompt action in pursuing its claims. The Court specifically ruled that a party – like Plaintiff in the instant matter – has no obligation to mitigate its damages when both it and the breaching party have an equal opportunity to reduce the possible damages. The Court ruled that Defendant could have, at any time, stopped the accrual of interest by simply paying the debt owed to Plaintiff. Indeed, the Court noted that there was precedential authority to suggest that interest under a contract is simply not subject to mitigation at all. As if its rulings above were not clear enough, the Court rather overtly concluded that “a party who breaches a contract containing an express promise to pay interest may not be permitted to reduce or escape entirely his contractual obligation by subsequently arguing that the nonbreaching party did not prosecute its breach of contract claim with dispatch.”

As a relatively minor matter, the Court had to determine whether a so-called “service charge” essentially functioned as interest under the terms of the contract at issue herein. The Court defined a service charge as a charge imposed as an incident to the extension of credit whereas, by contrast, interest is compensation for the use or detention of money. The Court ruled that how the “service charge” functioned in the instant matter was more akin to interest than a service charge regardless of the terms used which appear on the contract.

Based on the above, the Pennsylvania Supreme Court ruled that the decisions of the trial and Superior Court are reversed and Plaintiff is entitled to the full amount of interest as calculated under the contract. Finally, as noted above, there was an open fact question as to what interest rate ought to apply on the amount owed due to Defendant’s breach of contract. The Supreme Court, while reversing the lower courts’ decision on the application of interest, remanded the matter to determine the applicable interest rate.

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