Phillips v. Phillips

¶1dissenting.

¶2Despite the clear language of Tex. R.Civ.P. 94 and the collective wisdom of every court of appeals of this state that has considered the issue, the majority holds that a defendant need not affirmatively plead the defense of “penalty” in a contract action. This holding resurrects trial by ambush and rejects the notion that parties are entitled to know what theories of law they will face at trial. I would hold that by failing to plead it, Mr. Phillips waived his right to assert that the contract he entered into with his wife is unenforceable. Furthermore, since Mr. Phillips waived the penalty defense by failing to affirmatively plead it, I would not reach the question of whether the contractual provision in question is, on its face, an unenforceable penalty. I thus would reverse the judgment of the court of appeals and remand this cause to the trial court for entry of a judgment that enforces the provision.

¶3Mr. and Mrs. Phillips were married for 32 years prior to getting a divorce. With the assistance of counsel, they entered into a pre-divorce agreement, whereby they transferred about $18 million of their assets into a partnership which Mr. Phillips would manage. Mr. Phillips in effect said to his soon-to-be ex-wife: “Trust me.” As a disincentive to cheating or short changing Mrs. Phillips, Mr. Phillips pledged that he would pay her 10 times the amount of the losses if he violated the contract.1 The agreement also recited that Mr. Phillips owed Mrs. Phillips a fiduciary duty, a higher standard of care than normally exists between parties to a contract.2

¶4Eight years later, Mrs. Phillips sued Mr. Phillips, alleging that he violated the agree*791ment. Mr. Phillips entered a general denial and asserted the affirmative defenses of limitations, laches, and equitable estoppel. In a unanimous verdict, the jury found that Mr. Phillips breached the agreement by interfering with Mrs. Phillips right to examine the books and records of the partnership, and by willfully underpaying Mrs. Phillips and overpaying himself.

¶5AFFIRMATIVE DEFENSE

¶6Rule 94 enumerates specific affirmative defenses which are waived if not pleaded, such as accord and satisfaction, arbitration and award, fraud, illegality, statute of frauds, statute of limitations, “and any other matter constituting an avoidance or affirmative defense.” Tex.R.Civ.P. 94. An affirmative defense does not tend to rebut factual propositions asserted by a plaintiff, but seeks to establish an independent reason why the plaintiff should not recover. Gorman v. Life Ins. Co. of North America, 811 S.W.2d 542, 546 (Tex.1991). Asserting the defense of penalty does not deny the facts pleaded by the plaintiff; instead, it is an independent reason why the contract should not be enforced as written. In other words, if the defendant asserts facts that defeat in whole or in part the plaintiff’s claim, such assertion amounts to an affirmative defense that must be pleaded or it is waived. “Penalty” is a classic affirmative defense; in my view, it clearly falls within the purview of Rule 94.

¶7The majority implies that as long as the issue does not depend upon evidence or findings, no purpose is served by requiring that it be specifically pleaded. But there is a valid purpose to serve, namely, the need for notice and fair play, so as to avoid trials by ambush.

¶8The court refers to Lewkowicz v. El Paso Apparel Corp., 625 S.W.2d 301, 303 (Tex.1981), for its holding that pleading is not necessary if the affirmative defense appears on the face of the plaintiffs pleadings. That case is distinguishable because it involved the defense of illegality of contract. The defense of illegality is a special situation and a poor choice from which to draw a rule of general applicability. The rule that a court will not enforce an illegal contract is for the public’s benefit rather than contending parties. Lewis v. Davis, 145 Tex. 468, 199 S.W.2d 146, 151 (1947). A strong policy reason supports the illegality exception. That is, courts should not have to validate contracts that are illegal on their face merely because a defendant has failed to plead illegality.

¶9Here, the court seems to be saying that pleading and proof are not necessary, because the issue of whether the liquidated damages provision is a penalty is a question of law. In some contracts it may be possible to determine from their four corners that they impose a penalty. The classic example is the lease that assesses the same liquidated damages for every breach, regardless of how trivial. Stewart v. Basey, 150 Tex. 666, 245 S.W.2d 484, 486 (1952). But, in most cases, proof will be necessary. Commercial Union Ins. Co. v. La Villa I.S.D., 779 S.W.2d 102, 106-107 (Tex.App.—Corpus Christi 1989, no writ); See D. Wendorf, et al„ Texas Rules of Evidence Manual, 1-38 (3rd ed. 1991).

¶10A good example of the need for proof is Presnal v. TLL Energy Corp., 788 S.W.2d 123, 127 (Tex.App.—Houston [1st Dist.1990], writ denied). In that case, a mineral lease provided that the lessee was required to drill a second well or pay $75,000, which the defendant contended was a penalty. There is no way a court could possibly know if this provision is a reasonable forecast of damages and therefore not a penalty, unless pleadings and proof develop the issue. It would be patently unfair not to require defendant to notify the plaintiff that the possible existence of penalty would be an issue and this is contrary to well established case law.

¶11Every intermediate appellate court considering this issue has held that penalty is an affirmative defense under Rule 94 which is waived if not pleaded. Bethel v. Butler Drilling Co., 635 S.W.2d 834, 838-839 (Tex.App.—Houston [14th Dist.] 1982, writ ref’d n.r.e.); Robinson v. Granite Equip. Leasing Corp., 553 S.W.2d 633, 637 (Tex.Civ.App.—Houston [1st Dist.] 1977, *792writ ref d n.r.e.); Walter E. Heller & Co. v. B.C. & M., Inc., 543 S.W.2d 696, 697 (Tex.Civ.App.—Houston [1st Dist.] 1976, writ ref'd n.r.e.); LoBue v. United Serv. Planning Ass’n, 467 S.W.2d 574, 576 (Tex.Civ.App.—Fort Worth 1971, writ dism’d); Young v. J.F. Zimmerman & Sons, Inc., 434 S.W.2d 926, 927 (Tex.Civ.App.—Waco 1968, writ dism’d); Smith v. Waite, 424 S.W.2d 691, 693 (Tex.Civ.App.—Waco 1968, writ ref'd n.r.e.).

¶12There is no compelling reason for this court now to reject by implication the well-grounded pleading practice and disagree with the cases cited above that hold that as a rule penalty is an affirmative defense which must be pleaded or it is waived. In my view, this is a retreat from this court’s recent trend towards encouraging full disclosure during discovery of all witnesses, facts and legal theories upon which a party intends to rely at trial. This trend not only encourages litigants to be well prepared for trial, but also enables disputes to be resolved on their true merits and not on “mere technicalities.” It makes no sense to me to subject parties to a severe sanction for failing to disclose witnesses or to supplement discovery responses, but not require them to plead the legal theory upon which they intend to rely to defeat their opponent’s claim. The majority has created an exception to Rule 94 that has a visceral appeal, but collapses on its own logic. The court says that the contractual provision in issue is a penalty as a matter of law, and thus need not be pleaded (and can be asserted as a defense for the first time on appeal). But a defendant likewise may defeat a contract claim under a statute of limitations defense. And while the defendant may be entitled to a judgment as a matter of law, we nevertheless require affirmative pleading of the statute of limitations defense. The court ultimately rationalizes its de facto modification of Rule 94 by relying on the Restatement (Seoond) of Contracts § 356 to assert that public policy demands the result. The court expands the public policy exception to Rule 94’s pleading requirement beyond the exception for illegal contracts to include contracts that allegedly impose a penalty. This is a faulty rationale. First, this is not a case where pure contract principles apply. Mr. Phillips agreed to a higher standard of care (namely, a fiduciary’s standard) than he normally would have owed Mrs. Phillips in a standard contractual relationship. Courts impose damages on parties who violate a fiduciary duty in order to punish the party’s breach of trust. I agree with the Restatement § 356’s directive that the “central objective behind the system of contract remedies is compensatory, not punitive.” Restatement (Second) of Contracts § 356 comment a (1979). But Mr. Phillips entered into this agreement with his eyes open, accepting a higher than normal standard of care and devising and adopting a measure of damages for his breach of that standard. I do not see how the it advances the best interest of the public to bail him out of his bargain. I would hold that penalty is an affirmative defense that must be pleaded and that Mr. Phillips waived this defense by failing to plead it. For the above reasons, I dissent.