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John Hancock Life Insurance Co. v. Abbott Laboratories

United States Court of Appeals, First Circuit

July 12, 2017

ABBOTT LABORATORIES, Defendant, Appellee.


          Joan A. Lukey, with whom John A. Nadas, Stuart M. Glass, Kevin J. Finnerty, and Choate, Hall & Stewart LLP were on brief, for appellants.

          Jeffrey I. Weinberger, with whom Gregory D. Phillips, Elizabeth A. Laughton, and Munger, Tolles & Olson LLP were on brief, for appellee.

          Before Howard, Chief Judge, Selya and Lynch, Circuit Judges.

          SELYA, Circuit Judge.

         The development of new drugs is a costly, time-consuming, and highly speculative enterprise. In an effort to hedge their bets, drug companies sometimes opt to share the risks and rewards of product development with outside investors. This appeal introduces us to that high-stakes world. The outcome turns primarily on a contract provision that the parties disparately view as a liquidated damages provision (and, thus, enforceable) or a penalty (and, thus, unenforceable). A sum well in excess of $30, 000, 000 hangs in the balance.

         Following a lengthy bench trial, the district court held the key provision inapposite and, in all events, unenforceable. See John Hancock Life Ins. Co. v. Abbott Labs., Inc. (Hancock III), 183 F.Supp.3d 277, 321, 323 (D. Mass. 2016). After careful consideration of a plethoric record, we reverse the district court's central holding, affirm its judgment in other respects, and remand for further proceedings (including the entry of an amended final judgment) consistent with this opinion.

         I. BACKGROUND

         Plaintiff-appellant John Hancock Life Insurance Company, [1] disappointed by the meager fruits of its multimillion-dollar investment with defendant-appellee Abbott Laboratories (Abbott), seeks to increase its return through litigation. In particular, Hancock aims to recover damages under its contract with Abbott or, in the alternative, to rescind that contract. The parties' dispute is by now well-chronicled. See John Hancock Life Ins. Co. v. Abbott Labs. (Hancock II), 478 F.3d 1, 2-6 (1st Cir. 2006); Hancock III, 183 F.Supp.3d at 285-301; John Hancock Life Ins. Co. v. Abbott Labs. (Hancock I), No. 03-12501, 2005 WL 2323166, at *1-11 (D. Mass. Sept. 16, 2005). We assume the reader's familiarity with these opinions and rehearse here only those facts needed to place this appeal into a workable perspective.

         A. The Agreement.

         In late 1999 or early 2000 - the exact date is of no consequence - Hancock (a financial services company) and Abbott (a pharmaceutical manufacturer) entered into negotiations regarding a potential investment in a menu of new drugs that Abbott was developing. The parties chose nine specific Program Compounds that they hoped would mature into commercially successful drugs to treat various afflictions (such as cancer and urinary tract blockages). During these negotiations, both Hancock and Abbott were represented by seasoned counsel, who exchanged approximately forty drafts of the proposed contract over a period of a year or more.

         On March 13, 2001, the parties signed a research funding agreement (the Agreement). The Agreement is long and intricate, and we outline here only those provisions that are central to an understanding of the issues on appeal.

         In the Agreement, Abbott pledged to develop the Program Compounds in accordance with Annual Research Plans that Abbott would submit for each Program Year over the course of a four-year Program Term. These Annual Research Plans were to contain "detailed statement[s] of the objectives, activities, timetable and budget for the Research Program for every Program Year remaining in the Program Term." Abbott prepared the first such Annual Research Plan for attachment as an exhibit.

         The parties were to fund the development of the Program Compounds as specified in the Agreement and were meant to share in the profits. Hancock's funding obligations are precisely defined in section 3.1 of the Agreement: it would make four annual Program Payments, ranging from $50, 000, 000 to $58, 000, 000 each, over the course of the Program Term (a total of $214, 000, 000). Section 3.5, entitled "Hancock Funding Obligation, " makes explicit that "Hancock's entire obligation [under the Agreement] shall be limited to providing the Program Payments set forth in [s]ection 3.1." In return for its investment, Hancock receives emoluments based on the progress and success of the Program Compounds. These emoluments include payments for the achievement of certain milestones, such as the initiation of a clinical trial or U.S. Food and Drug Administration (FDA) approval. It also receives royalties from any out-licensing or sales of the Program Compounds.

         The Agreement saddles Abbott with both annual and cumulative spending obligations. Annually, Abbott was responsible for meeting the Annual Minimum Spending Target; that is, it had to spend annually at least the sum of Hancock's contribution for that year, plus $50, 000, 000, plus any shortfall from the prior year's minimum spending target. Cumulatively, Abbott had to spend "at least the Aggregate Spending Target" - defined as $614, 000, 000 - "during the Program Term." In addition, Abbott is "solely responsible for funding all Program Related Costs in excess of the Program Payments from . . . Hancock."[2] These obligations comprise only Abbott's minimum spending commitment: that commitment is a floor, not a ceiling, and Abbott projected in its first Annual Research Plan that it would spend over one billion dollars (about five times Hancock's expected total contribution) through the end of 2004.

         In what turned out to be a prescient precaution, the Agreement anticipates that Abbott might not fulfill its spending commitment. In this respect, section 3.2 of the Agreement provides that if Abbott "fail[ed] to fund the Research Program in accordance with" its obligations, "Hancock's sole and exclusive remedies" are those remedies "set forth in [s]ections 3.3 and 3.4" of the Agreement. Section 3.3, entitled "Carryover Provisions, " is divided into two subsections. If Abbott spends less than its Annual Minimum Spending Target, Hancock is allowed, under section 3.3(a), to defer its annual Program Payments until Abbott makes up that shortfall. Section 3.3(b) describes Hancock's remedies in the event that Abbott did not meet its cumulative spending obligations:

If Abbott does not expend on Program Related Costs the full amount of the Aggregate Spending Target during the Program Term, Abbott will expend the difference between its expenditures for Program Related Costs during the Program Term and the Aggregate Spending Target (the "Aggregate Carryover Amount") on Program Related Costs during the subsequent year commencing immediately after the end of the Program Term. If Abbott does not spend the Aggregate Carryover Amount on Program Related Costs during such subsequent year, Abbott will pay to . . . Hancock one-third of the Aggregate Carryover Amount that remains unspent by Abbott, within thirty (30) days after the end of such subsequent year.

Section 3.4 permits Hancock to terminate future Program Payments under certain circumstances, including Abbott's failure to "reasonably demonstrate in its Annual Research Plan its intent and reasonable expectation to expend on Program Related Costs during the Program Term an amount in excess of the Aggregate Spending Target."

         To complete the picture, the Agreement contains a full-throated integration clause. Specifically, section 16.3 confirms that the "Agreement contains the entire understanding of the parties with respect to the subject matter hereof. All express or implied agreements and understandings, either oral or written, with respect to the subject matter hereof heretofore made are expressly merged in and made a part of this Agreement."

         B. The Fallout and the Litigation.

         After the Agreement was signed, Hancock made its first two Program Payments, totaling $104, 000, 000. Even so, the relationship quickly began to fray. Abbott terminated the development of several compounds in the first two years and significantly reduced its spending on the development of other compounds. At the end of 2002, Abbott informed Hancock that Abbott's 2002 spending had been appreciably less than its Annual Research Plan had anticipated. More troubling still, Abbott's preliminary research plan for 2003 projected a sharp reduction in spending for that year compared to its previous estimate and made no mention at all of expected 2004 spending. In September of 2003, Abbott belatedly proffered its 2003 Annual Research Plan, which did include some projected spending for 2004. That submission, though, further reduced total spending and admitted that Abbott would not reach the Aggregate Spending Target by the end of 2004.

         After reviewing this document, Hancock responded that, in view of the insufficient spending that Abbott was prepared to undertake, it regarded its obligation to make future Program Payments as null and void. Abbott's rejoinder was of little solace to Hancock: it submitted a preliminary 2004 Annual Research Plan, indicating that Abbott would expend well below its annual minimum contribution in 2003 and would fail to reach the Aggregate Spending Target through the end of 2004. In both the final 2003 Annual Research Plan and the preliminary 2004 Annual Research Plan, however, Abbott predicted that it would reach the Aggregate Spending Target if 2005 spending were included.

         Unsettled by this news, Hancock invoked diversity jurisdiction, see 28 U.S.C. § 1332(a), and filed suit in the United States District Court for the District of Massachusetts. That suit sought a declaration that Abbott's failure to meet its spending commitments terminated Hancock's obligation to make the third and fourth Program Payments. The district court granted summary judgment in favor of Hancock, holding that "Hancock's obligation to make the Program Payments for 2003 and 2004 terminated when Abbott failed to demonstrate its 'intention and reasonable expectation' to meet the . . . Aggregate Spending Target within the four-year Program Term in its [Annual Research Plan] for 2003." Hancock I, 2005 WL 2323166, at *28 (quoting relevant language from the Agreement). We affirmed. See Hancock II, 478 F.3d at 2.

         Notwithstanding that Hancock was judicially relieved of its obligation to make its last two Program Payments, it retained its rights under the Agreement to whatever profits might be derived from any of the Program Compounds. Hancock reports - and Abbott does not deny - that it has received slightly more than $14, 000, 000 in milestone payments, out-licensing revenues, and management fees. Comparing these receipts to its $104, 000, 000 investment, Hancock alleges that it incurred a net loss of almost $90, 000, 000 on the benighted venture.

         Corporations seldom swallow losses of this magnitude complacently. And this case is no exception. In June of 2005 - while Hancock I was still unresolved - Hancock filed the instant action. It asserted that Abbott had breached the Agreement in five ways: (1) violating its representations and warranties through material misrepresentations and omissions regarding the development of the Program Compounds; (2) failing to provide Hancock with accurate spending projections; (3) refusing to pay Hancock one-third of the Aggregate Carryover Amount in accordance with section 3.3(b) of the Agreement; (4) failing to take appropriate steps to out-license the Program Compounds; and (5) obstructing Hancock's audit of Abbott's compliance with the Agreement. Hancock further asserted that Abbott fraudulently induced Hancock to enter into the Agreement and, separately, that under the indemnification provision of the Agreement, Abbott was liable for Hancock's losses attributable to Abbott's defaults.

         In October of 2006 - roughly a month after this court's decision in Hancock II - Hancock sought leave to amend its complaint in this case to include a prayer for rescission. Hancock included the rescission claim in its first amended supplemental complaint (filed in December of 2006).

         The district court held a ten-day bench trial, which ended in 2008. The court then solicited post-trial briefing and took the case under advisement. It was not until April of 2016, though, that the court ruled. In its opinion, the court made extensive findings of fact and conclusions of law. See Fed.R.Civ.P. 52(a). We summarize here only those findings and conclusions that are helpful to an understanding of the issues on appeal.

         To begin, the court found that Abbott violated its representations and warranties in three ways:

. Without notifying Hancock, Abbott paused one compound's development two days before the Agreement was signed, only to lift the hold on the day the Agreement was signed. Abbott canceled the compound three months later. The court found that Abbott's failure to inform Hancock of the hold on the compound's development was a material omission. See Hancock III, 183 F.Supp.3d at 294, 306.
. Abbott represented that it intended to spend over $35, 000, 000 in 2001 on developing a compound intended to treat chronic pain. Yet Abbott knew before signing the Agreement that it actually intended to spend less than half that amount in 2001. The court found that "this misrepresentation . . . was material." Id. at 308-09.
. Abbott made a further material misrepresentation as to an anti-infection compound. See id. at 310. Abbott represented that it expected once-a-day dosing would be possible for the four conditions that the drug was designed to treat. Yet, the court found that, at the time the Agreement was signed, Abbott did not have enough information to know that once-a-day dosing would be possible for the two more severe conditions. Since Abbott knew that once-a-day dosing was important, this misrepresentation was material. See id.

         Although these findings are emblematic of the rocky road down which the parties' relationship traveled, they proved to be hollow victories for Hancock. The district court ruled that Hancock did not sufficiently prove damages attributable to Abbott's misrepresentations and omissions because Hancock's methods for calculating damages were "speculative and unconvincing." Id. at 313.

         The district court also found that Abbott breached the Agreement by providing Hancock with spending projections that assumed that every Program Compound would remain velivolant all the way to FDA approval. Those projections, the court found, were submitted in lieu of more realistic projections of expected spending, which would have been adjusted for the risk that some compounds might be terminated. See id. at 315. Once again, Hancock could not recover for Abbott's breach because it did not adequately prove damages. See id. at 316.

         Moving to an issue that has become central to this appeal, the district court concluded that Abbott had not reached the Aggregate Spending Target. The court determined that, including Hancock's contributions, Abbott fell $99, 100, 000 short of the target. See id. at 292. Hancock argued that section 3.3(b) entitled it to one-third of this amount, that is, an award of approximately $33, 000, 000. The district court disagreed. While it rejected Abbott's arguments that Hancock was judicially estopped from asserting its claim under section 3.3(b) and that the Agreement capped Abbott's spending obligation at $400, 000, 000, see id. at 317, it nonetheless concluded that Hancock was not entitled to any damages under section 3.3(b), see id. at 321, 323.

         To reach this conclusion, the court identified an "apparent implied condition, " which limited Abbott's liability under section 3.3(b) to pay Hancock one-third of the Aggregate Carryover Amount to situations in which Hancock made all four Program Payments. Id. at 318-19. Striking Hancock a second blow, the court held in the alternative that even if section 3.3(b) applied, it constituted an unenforceable penalty. See id. at 323.

         The district court did allow recovery for one of Hancock's breach-of-contract claims. It ruled that in the course of Hancock's audit of Abbott's compliance, Abbott "fail[ed] to provide information and material necessary for Hancock's vendor . . . successfully to conduct an audit." Id. at 316. The court ordered Abbott to pay Hancock the cost of the audit, which amounted to $198, 731. See id.

         Turning to Hancock's rescission claim, the court struck that claim as "wholly irrelevant or impertinent." Id. at 303. The court reasoned, inter alia, that rescission was inconsistent with the enforcement of the Agreement and that Hancock had chosen (in Hancock I) to enforce the Agreement. See id. at 302-03. Under the doctrine of election of remedies, it could not both affirm the contract and simultaneously seek its rescission. See id.

         Finally, the district court rebuffed Hancock's claim that Abbott was obligated under the Agreement to indemnify it for the losses that it incurred. The court ruled that this indemnification provision only applied to claims by third parties. See id. at 326.

         When the smoke cleared, the court below awarded Hancock $198, 731 in damages for Abbott's frustration of the audit, together with $110, 395.34 in prejudgment interest (a total judgment of $309, 126.34). See id. This timely appeal ensued.

         II. ANALYSIS

         Hancock's appeal challenges the district court's conclusion that its remedies under section 3.3(b) are contingent on its making all four Program Payments. Hancock also challenges the district court's alternative holding that those remedies constitute an unenforceable penalty. Finally, Hancock challenges the order striking its rescission claim.

         We take a layered approach to these challenges. We first consider Abbott's contention that recovery under section 3.3(b) should be barred on grounds rejected by the district court. We then address the grounds upon which the district court relied. Those grounds are attacked by Hancock, and we address the components of Hancock's asseverational array one by one. We end with a brief comment on prejudgment and postjudgment interest.

         We approach these several issues mindful that the Agreement contains a choice-of-law provision specifying that Illinois law governs. In line with this provision and with the parties' acquiescence, we apply the substantive law of Illinois (except where otherwise specifically noted). See McCarthy v. Azure, 22 F.3d 351, 356 n.5 (1st Cir. 1994) (explaining that "a reasonable choice-of-law provision in a contract generally should be respected").

         As a general matter, issues of contract interpretation engender de novo review under Illinois law. See St. Paul Mercury Ins. v. Aargus Sec. Sys., Inc., 2 N.E.3d 458, 478 (Ill.App.Ct. 2013). A reviewing court's principal task in interpreting a contract is to divine the parties' intent, which is manifested most clearly by "the plain and ordinary meaning of the language of the contract." Id. When a fully integrated contract is unambiguous on its face, the court will determine its meaning from its language alone. See Air Safety, Inc. v. Teachers Realty Corp., 706 N.E.2d 882, 884 (Ill. 1999). The court below concluded that the Agreement was unambiguous in its ...

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