MEMORANDUM
FROM:
Sid Hemsley, Senior Law Consultant
DATE:
April 13, 2005
RE:
Wastewater ContractBCity A, City B, City C
On March 2, I opined that under the wastewater treatment contract City A, City B, and
City C entered into in 1989, the percentages of wastewater treatment capacity to which they are
entitled under the contract do not change when upgrades are made to the wastewater treatment
plant. I have been askedBand agreed--to revisit that opinion, for the purpose of determining
whether that opinion is correct, and if it is correct, whether any doctrine or law would change
those percentages or render them irrelevant.
There has been some concern expressed that I did not understand that the wastewater
treatment plant had undergone two upgrades for which City B and City C had paid, following the
completion of the “PROJECT” of which the contract speaks, and that the wastewater treatment
plant capacity has gone from 800,000 gallons per day to a capacity of 2,000,000 per day.
However, I did understand that fact on March 2.
During my revisit of the contract, I have looked for some evidence that the parties
intended that future plant expansions would change the percentages of reserve capacity. But
careful re-study of that contract leads me to conclude that those percentages do not change. It
likewise appears to me that the contract is unambiguous. For that reason, all the rules that give
the courts considerable leeway in interpreting contracts in favor of one party or other are not
triggered. However, the covenant of good faith and fair dealing that applies to all contracts in
Tennessee, and/or the doctrine of implied contracts may require City A to supply City B and City
C with reasonable wastewater treatment in excess of their reserve capacities provided for in the
contract, at least for the short run. But there are even problems with applying that covenant and
doctrine to the contract at issue. City B and City C may have simply entered into a contract that
appeared to be a good bargain in 1989, but turned out to be a bad bargain as growth patterns
among the cities changed.
As I pointed out in my March 2, opinion, several provisions of the contract expressly and
by implication speak of a division of the plant capacity as follows: City A, 78.3%; City B,
1
11.7%; City C, 10.0%.:
- Article III, Para. 1: The cities are allocated the non-grant cost of the “PROJECT” in the
above percentages.
- Article III, Para. 5: The cities “will pay into the Project Construction Fund the above
amounts...” [which apparently refers to the above percentages].
- Article III, Para. 6: The cities are allocated those percentages of liability for the
payment of any deficits in the fund from which construction costs of the PROJECT are paid.
- Article III Para. 6: The cities are required to pay for deficiencies in the account set up for
paying the initial construction cost proportionately “according to the percentages described above
and in Paragraph # 1 of this Article III.”
- Article III, Para. 8: The cities are denominated the “owner[s]” [of the project] solely for
the purposes of the depreciation, in the amounts of the above percentages.
- Article V, Para. 1: This provision expressly says that “Each city shall have reserved to it
the proportion of total capacity as is defined in Article III,” then it goes on to expressly provide
that, “City A shall have reserved to it 78.3% of the capacity of the ‘PROJECT.’” City C shall
have reserved to it 10% of the capacity of the “PROJECT.” City B shall have reserved to it
11.7% of the “PROJECT.”
- Article VI, Para. 1: The initial distribution of the costs of maintenance of the
“PROJECT” is calculated on the above percentages.
- Article VI, Para. 9: Each city is responsible for the establishment and maintenance of a
depreciation fund in an amount based on the above percentages, and “these percentage figures
will not vary according to subsequent use by the cities.”
It has been suggested to me that the contract speaks of that division of capacity with
respect only to the specific project about which the contract speaks. It is true that term
“PROJECT” in the contract refers to a specific plant expansion, but it also refers to the
wastewater facility in several contexts, including contexts that relate to the future use of the plant
after its completion.
Article I, of the contract, defines “Project” twice. Under ' 7 “PROJECT” is defined as:
Those costs are those which are involved in the actual construction
of the project under the amended 201 Plan and are to include the
construction costs and any costs directly attributable to the
implementation of the project including but not limited to: (a) the
2
costs of contracts awarded to contractors; (b) the costs of the
acquisition of land or materials; (c) the costs of services of
attorneys, engineers and/or consultants on this project; (d) the costs
of advertising of bids or other administrative costs reasonably
related to the implementation of the Amended 201 Plan.
Under ' 10, “PROJECT” is defined as:
[T]he regional wastewater treatment facility consisting of the
wastewater treatment plant, transmission lines, pipes, drains,
physical collection points, plants, buildings, and equipment related
thereto and such capitalized expenses such as interest and
engineering and inspection fees which will be solely operated, and
maintained by City A. This term does not include any existing
structures or lines which will become a part of the “PROJECT” as
envisioned under the AMENDED 201 PLAN.
Article III, speaks of: “Non grant project costs.” Those are defined as “costs used for
construction of the ‘PROJECT...’” and allocates those costs among the three cities: City A 78.3
%, City B 11.7%, and City C 10%. City A’s responsibility for, and authority over, all phases of
construction and contract-letting for the “Project.” Ownership of the project after its completion.
The cities are “owners” of the project for purposes of depreciation in the above amounts, but
“Title to all realty located within the “PROJECT” situs will remain unchanged and City A hereby
conveys no title nor covenants to convey any title to realty to either City B or City C.”
Presumably, the realty includes the plant itself, which would probably be considered part of the
realty. Article IV, gives City A responsibility for the continued maintenance of the “PROJECT.”
Article V, allocates capacity of the “PROJECT.” Article VI, allocates future costs of operation,
water treatment and maintenance of the “PROJECT.” Article VII, governs AImplementation of
the “Project,” which that article makes clear involves various aspects of the future operation of
the wastewater facility after its completion, and the transmission by City B and City C of its
sewerage to the “PROJECT.”
Several facts relative to the PROJECT seem important with respect to the allocation
among the three cities of reserve capacity set out in the contract:
First, the allocation of reserve capacity reflects what the parties paid in non-grant funds
used to finance the “PROJECT”: City A, 78.3%; City B, 11.7%; and City C, 10%). In that
connection the contract also provides that, “It is understood that each city is submitting or has
submitted to City A its best estimate as to the reserve capacity that it requires in order to furnish
services to its residents” [Article III, ' 1(D).]. As I understand the facts, when the contract was
signed by the cities in 1989, the shift in growth among the cities that has occurred over the past
couple of years was not contemplated. For that reason, it is arguable that those reserve capacities
were based on what all the parties at the time thought were realistic.
3
Second, throughout the contract it is clear that City A was totally responsible for the
construction of the PROJECT, and is totally responsible for the operation of the plant and the
liability that attaches to that operation. For that reason, arguably, it is logical that when the
contract was signed the parties understood that City A would have considerably more reserve
capacity than would City B and City C.
Third, the contract itself provides that it continues into the future past the construction of
the project. Article IX, says that, “The duration of this contract is to be indefinite and
continuing.” Article VII, provides that, “No party shall have any right to cancel or amend this
agreement or its terms and any attempt to modify this agreement shall be considered a disputed
matter....” Although the wisdom of cities entering into indefinite contracts may be questionable,
such contracts appear to be legal and binding. [See Hamblen County v. City of Morristown, 584
S.W.2d 673 (1979).]
The heart of the contract with respect to future wastewater plant expansions is Article 5,
which I will quote in full below:
ARTICLE 5
Establishment and Reservation of Capacities
to City B and City C
1. Reserve Capacity: Each city shall have reserved to it the
proportion of total capacity as is defined in Article III. City A shall
have reserved to it 78.3% of the capacity of the “PROJECT.” City
C shall have reserved to it 10% of the capacity of the “PROJECT.”
City B shall have reserved to it 11.3% of the capacity of the
“PROJECT.”
2. Future Capacity Expansion: In the event that the needs of the
municipalities result in the need to physically expand the treatment
facility then each city shall be required to fund that portion of the
costs of the expansion attributable to its increased use above its
reserved capacity.
However, no municipality shall be required to contribute to
expansion costs of the facility unless it is exceeding its reserve
capacity.
3. City B and City C agree to provide City A upon the anniversary
date of this Agreement, with a five (5) year projection of needs, it
being recognized that the above flow tabulation is an estimate only
4
based on data contained in the AMENDED 201 PLAN. If the
needs of either City B or City C are projected to exceed those
tabulated above, City A agrees to cooperate with City B or City C
in providing needed treatment capacity in a timely and mutually
satisfactory manner.
4. City B and City C shall have the opportunity to review and
comment on all contract documents, procedures, and other items
relating to future construction aspects required to accommodate
needs of City B or City C which will result in increased costs to
City B or City C.
Article 5, says at least two things about the reserve capacities and future plant expansions:
First, Article 5, ' 2, anticipates future wastewater treatment plant expansions, and the
method of the payment of such expansions. It says--twice--that the cities that exceed their
reserve capacities must pay for needed plant expansions. It also says that the cities that do not
exceed their reserve capacities are not required to pay for plant expansions. Article 5, ' 2 does
not clearly say is what event triggers the need for a plant expansion. Does the entire reserve
capacity of the plant need to be consumed before a plant expansion is needed, or does only the
consumption of one municipality’s reserve capacity need to be consumed? Article 5, ' 2, says
the trigger is the “needs of the municipalities” [plural]. Apparently the parties have treated the
contract the latter way, although whether City B and City C, did so voluntarily, I am not sure].
City B and City C exceeded their allocated reserve capacities, and paid for the last two plant
expansions, for which they have obviously increased their capacities as measured in gallons, but
not in reserve capacity.
Second, Article 5, ' 3, does recognize that the “flow tabulations” [presumably the reserve
capacities] are an “estimate.” That provision says that on the anniversary date of the contract,
City B and City C agree to provide City A a five year projection of needs, in recognition that the
“above flow tabulation” [presumably, the reserve capacities because no other flow tabulations
appear “above”] is an estimate, based on the data in the AMENDED 201 PLAN.
At first glance, it can be argued that if the reserve capacities set out in the contract are
based on “estimates,” the contract contemplates their change. Unfortunately for City B and City
C, that does not appear to be true. It would have been easy for Article 5, or some other provision
of the contract to provide that if plant expansions are made by one or more of the cities, their
reserve capacities will change, or that if the five year projection of needs on the part of City B
and City C reflected a different “flow tabulation” than the reserve capacities contained in the
contract would change under some rules set out in the contract. It would have been equally as
easy for Article 5, or some other provision of the contract to provide that the five year projection
of needs would occur every five years, or on any other kind of regular schedule. But Article 5, '
3, simply says, that “If the needs of either City B or City C are projected to exceed those
5
tabulated above, City A agrees to cooperate with City B or City C in providing needed treatment
capacity in a timely and mutually satisfactory manner.” That provision does not even imply that
the percentages of reserve capacities change, unless the parties agree to such a change. I do not
know if City B and City C ever did a five year projection of needs on the anniversary date of the
contract, but it appears that the projection was a one time shot rather than an ongoing one.
Article 5, ' 4, supports the conclusion that Article 5, ' 3, did not contemplate a change in
reserve capacities. It says that, “City B and City C shall have the opportunity to review and
comment on all contract documents, procedures, and other items relating to future construction
aspects required to accommodate needs of City B or City C which will result in increased costs to
City B or City C.” The right of review of those items is far cry from the right of City B and City
C to a change in their reserve capacities.
It has been held that where a contract is clear on its face, it will be enforced. In
Whitehaven Community Baptist Church v. Holloway, 973 S.W.2d 592 (Tenn. 1998), a question
was whether a document was a warranty deed or a mortgage. The plaintiff proffered an affidavit
that, in the Court’s own words indicated that the plaintiff “misunderstood the nature of the
contract and the document it signed.” The Court pointed to the fact that the document itself was
labeled “WARRANTY DEED,” and declared that, “An elementary precept of contract law,
however, is that a court will not look beyond the four corners of a contract or to the parties’
intention when the language of the contract is clear.” [Citations omitted.] [At 596] It is also said
in Realty Store, Inc. v. Tarl Partnership, 153 S.W.3d 366 (Tenn. Ct. App. 2004), that “The Court
is compelled ‘to give effect to the intention expressed by the language used, whatever may be
thought about the harshness of the result.’”
It appears to me the contract between City A, City B and City C is clear on its face on the
issues of who pays for plant expansions and what effect they have on the reserve capacities, even
though the contract produces a harsh result for City B and City C.
But City A makes the significant promise to City B and City C in article V, ' 3, that if the
five year projection of needs indicates a change in the flow tabulations, it will “cooperate” with
them in “providing needed treatment capacity in a timely and mutually satisfactory manner.” As
I pointed out above, I do not know if the five year flow projection was done on the anniversary
date of the contract, or anytime thereafter, but City B and City C have already paid for two plant
expansions. I am not sure how the courts would treat that conduct on the part of City B and City
C. Where the conduct of the parties themselves indicate they put a particular construction on the
contract, and that construction is reasonable, the courts will adopt that meaning of the contract.
[See Hamblen County v. City of Morristown, 65 S.W.2d 331 (Tenn. 1983); Appling v. Ellendale
122 Property, 718 S.W.2d 261 (Tenn. Ct. App. 1986).] I do not know whether the insistence of
City B and City C that under the contract they are entitled to increased reserve capacity when
they pay for plant expansions was a position held at the time the time the contract and the
expansions were made, or is a johnny-come-lately arguments that arose only when they
experienced growth that they did not anticipate at the time the contracts were signed.
6
But Article V, ' 3, of the contract does itself recognize that City B and City C may need
plant capacity beyond the reserve capacities set out in the contract, and that City A will
“cooperate” with those cities to provide such capacity “in a timely and mutually satisfactory
manner.” Other provisions of the contract also recognize that reserve capacity percentages
assigned to the three cities will not reflect the actual contribution of the waste flow by the three
cities. Those provisions of the contract take that into account by allocating the cost of the plant
operation among the cities based on their actual contributions of waste to the plant.
There is a covenant of good faith and fair dealing implied in every contract (except
employment contracts) in Tennessee. [See, for example, Wallace v. National Bank of
Commerce, 938 S.W.2d 684 (Tenn. 1997); Covington v. Robinson, 723 S.W.2d 643 (Tenn. Ct.
App. 1986); TSC Industries, Inc. v. Tomlin, 743 S.W.2d 169 (Tenn. App. 1987).] In Wallace,
above, it is said that:
In Tennessee, the common law imposes a duty of good faith in the
performance of contracts....The law regarding the good faith
performance of contracts is well stated by the Court of Appeals in
TSC Industries, Inc. v. Tomlin [citation omitted]....It is true that
there is implied in every contract a duty of good faith and fair
dealing in its performance and enforcement, and a person is
presumed to know the law. See Restatement (2d) Contracts, ' 5
205 (1979). What this duty consists of, however, depends upon the
individual contact in each case. In construing contracts, courts
look to the language of the instrument and to the intention of the
parties, and impose a construction which is fair and reasonable. In
Covington v. Robinson [citation omitted], which was relied upon
by the Court of Appeals in TSC Industries, Inc. v. Tomlin, the
Court of Appeals held that in determining whether the parties acted
in good faith in the performance of a contract, the court must judge
the performance against the intent of the parties as determined by a
reasonable and fair construction of the language of the instrument.
In a later decision, the Court of Appeals held that good faith in
performance is measured by the terms of the contract. “They [the
parties] may by agreement, however, determine the standards by
which the performance of obligations are to be measured.” Bank
of Crockett v. Cullipher, 752 S.W.2d 84, 91 (Tenn. App. 1988).
[‘At 686.]
City B and City C have exceeded their allocated reserve capacities, and apparently have
been doing so for some years. Using the figures that City A provided to those cities on January
20, 2005, the present reserve capacities (counting the two plant expansions) and actual plant
usage is as follows:
7
Reserve Capacity
Actual Use (Average Daily Flow)
City A
78.3% (1,566,000 GPD)
17% (340,000 GPD)
City B
11.7% (234,000 GPD)
19% (380,000 GPD)
City C
10% (200,000 GPD)
13.6% (272,000 GPD)
Those figures indicate that City A has actually provided City B and City C wastewater
treatment in excess of their reserve capacities, but that in terms of reserve capacity City A has
been the major beneficiary of the two wastewater plant upgrades paid for by City B and City C.
Under those facts, City B and City C have an argument that the obligation of good faith and fair
dealing that applies to every contract, imposes some obligation on City A under Article V, ' 3, to
provide them with wastewater treatment capacity in a manner that does not see City A
accumulate reserve capacity greatly beyond its needs though plant expansions paid for by City B
and City C. Article V, ' 3, does not appear to contain the standards by which City A’s obligation
is to provide “needed treatment capacity in a timely and mutually satisfactory manner.” For that
reason, the courts might have some leeway in that area helpful to City B and City C.
Tennessee law also recognizes the theory of implied contracts. It breaks such contracts
down into contracts implied in fact, and contracts implied in law. The latter type implied
contract has been defined as a contract imposed by operation of law, without regard to the assent
of the parties, on grounds of reason and justice. One can argue that the lopsided benefit of reserve
capacity that accrues to City A under the contract due to the plant expansions paid for by City B
and City C and conclude that City A has been unjustly enriched under that contract. However,
such an argument does not appear to receive much encouragement from Tennessee case law for
the simple reason that there is an express contract between the parties on that point. In Jaffe v.
Bolton, 817 S.W.2d 19 (1991), it is said about contracts implied in law that:
Quasi-contractual liability can be created where one person
receives a benefit at the expense of another and it is unjust or
inequitable for him to retain this benefit. 7 Tenn. Juris. Contracts,
' 103 (1983); Browder v. Hite, 602 S.W.2d 489 (Tenn. Ct.
App.1980). The most important factor for the recovery under a
quasi-contractual theory is that the enrichment must be unjust.
Paschall’s, Inc. v. Dozier, 219 Tenn. 45, 47 S.W.2d 159 (1966).
The primary purpose of implied contracts is to impose an
obligation that ought to be done as a matter of justice and equity in
the absence of express contracts. A contract cannot be implied,
however, where a valid contract exists on the same subject matter.
Taille v. Chedester, 600 S.W.2d 732 (Tenn. Ct. App. 1980). [At
26] [My emphasis.]
8
The Court looked at the lease agreement at issue in that case and concluded that:
The agreement entered into between the parties expressly provided
the landlord was to retain the benefit of all the improvements to the
property without any compensation to the tenant. This agreement
as entered into in a businesslike manner, and the tenant cannot now
complain that the landlord is unjustly enriched.... [At 26.]
[Also see Doe v. HCA Health Services of Tennessee, Inc., 46 S.W.3d 191 (Tenn. 2001);
Stickland v. Cartwright, 11 S.W.3d 766 (Tenn. Ct. App. 2003).]
That is the situation in which City B and City C might find themselves.
But City A’s promise to cooperate with City B and City C to meet their need for
treatment capacity might carry those cities some distance. As is pointed out above, the contract
is replete with recognition on the part of all the parties to the contract that one or more of them
could exceed their reserve capacities. 13 A.L.R.2d 1233, titled Special Requirements Of
Consumer As Giving Rise To Implied Contract By Public Utility To Furnish Particular Amount
of Electricity, Gas or Water (which, retrieved from Westlaw is current to date), declares that:
As far as it is permissible to draw general conclusions from such
little authority as there is, the general rule seems to be that in the
absence of an express contract, there is an implied obligation on
the part of the public utility company to use reasonable care to
furnish the particular amount of electricity, gas or water which it
knows the customer needs, if it can do so without discrimination
against other consumers, there being no absolute duty to this effect
within the contemplation of the parties.
The contract between City A, City B and City C contains express provisions as to reserve
capacity, but is silent as to actual treatment capacity City B and City C might “need” under
Article V, ' 3. The contract even anticipates usage by the cities in excess of their allocated
reserve capacities. It is arguable that while there is a contract between the parties on the
allocation of wastewater reserve capacities, it does not cover what actual capacity City B and
City C may “need” under Article V, ' 3, and that that need is subject to a contract implied in law
under which City A is required to use reasonable care to provide those cities with the amount of
wastewater treatment they need.
There are more modern cases than cited in that annotation on the application of the law of
implied contracts to utility services, but they involve situations where a franchise has been issued
for the delivery of utility services and the franchise has expired, which satisfies the condition of
contracts implied in law that there be no contract between the parties. [See, for example, City of
9
Orland Hills v. Citizen’s Utility Company of Illinois, 807 N.E.2d. 590 (Ill. 2004), and cases cited
therein.]
Article VIII, provides for the arbitration of disputes by the Wastewater Finance Board. I
have read in detail the functions and duties of that board as they are prescribed by Tennessee
Code Annotated, ' 68-221-101 et seq., and find no support for the proposition that it will get
involved in such disputes.
Alternatively, Article VIII, ' 3, provides for the non-binding arbitration of disputes
between the cities under the rules and regulations set out in that article. It was held in City of
Blaine v. John Coleman Hayes & Associates, Inc., 818 S.W.2d 33 (Tenn. Ct. App. 1991), that all
arbitration agreements, with some exceptions, are subject to the Uniform Arbitration Act
contained in Tennessee Code Annotated, ' 29-5-301 et seq. The exceptions are contained in
Tennessee Code Annotated, ' 29-5-302: “save on such grounds as exist at law and equity for the
revocation of any contract;....”, which, said the Blaine Court, included fraud. Needless to say,
fraud does not appear to be an issue in the contract between City A, City B and City C.
10