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Digital Ally, Inc. v. Z3 Tech., LLC

United States Court of Appeals, Tenth Circuit

May 16, 2014

DIGITAL ALLY, INC., Plaintiff-Counter Defendant-Cross Defendant - Appellant/Cross-Appellee,
v.
Z3 TECHNOLOGY, LLC, Defendant-Counterclaimant-Third Party Plaintiff - Appellee/Cross-Appellant

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APPEAL FROM THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF KANSAS. (D.C. No. 2:09-CV-02292-KGS).

James F.B. Daniels of McDowell, Rice, Smith & Buchanan, Kansas City, Missouri, for Appellant/Cross-Appellee.

Mark E. Wilson (Meghan A. Welch and Jeremy D. Kerman with him on the briefs) of Kerns, Frost & Pearlman, LLC, Chicago, Illinois, for Appellee/Cross-Appellant.

Before MATHESON, McKAY, and EBEL, Circuit Judges.

OPINION

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McKAY, Circuit Judge.

This diversity case arises out of two contracts between the parties to this litigation. Both parties have filed appeals, in which Appellant-Cross-Appellee Digital Ally mainly challenges the validity and enforceability of one of the contracts, while Appellee--Cross-Appellant Z3 Technology challenges certain elements of the damages award.

I. Background

The contracts at issue in this case related to Z3's design and manufacturing of circuit board modules for use in Digital's products. The first contract, signed in November 2008, called for Z3 to design, manufacture, and deliver to Digital 1,000 modules incorporating Texas Instruments' DM355 computer chip. The second contract, signed on January 2, 2009, involved a larger quantity of modules that would use Texas Instruments' next-generation DM365 chip. Both contracts were signed by Robert Haler, who was then Digital's Executive Vice President of Engineering and Production. The contracts were described as " Production License Agreement[s]," and they expressly provided that the modules would be licensed, not sold, to Digital. (Appellant's App. at 39, 52.) The contracts both stated they would " be governed by and interpreted in accordance with the laws of the State of Nebraska, without reference to conflict of laws principles." ( Id. at 43, 58.)

The 2008 contract called for Digital to make a total payment of $155,000 in exchange for Z3's design and delivery of the 1,000 DM355-based modules. Digital paid the first $140,000 required by the contract, but it refused to make the final $15,000 payment. Digital claimed that the DM355 modules provided by Z3 had hardware and/or software design flaws that resulted in " pink noise" and other problems.[1] The jury ultimately found that both parties had breached the contract, Digital by failing to pay the final $15,000, and Z3 by failing to satisfy the contract's hardware warranties. The jury awarded $15,000 to Z3 for Digital's breach of its payment obligations, while it awarded $30,000 to Digital for Z3's failure to satisfy the contract's hardware warranties. On appeal, the only issue we must consider regarding the 2008 contract is Z3's argument that it was entitled to prejudgment interest on the $15,000 award.

The 2009 contract, which is the main subject of this appeal, was a somewhat more complex contract than the 2008 contract. Unlike the 2008 contract, this contract

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did not simply call for a specific total payment in exchange for a specific number of modules. Rather, the contract included various types of payments Digital would be required to make at different points of the process. First, after setting out a twenty-eight-week design schedule, the contract listed a payment schedule for $300,000 in fees that were payable during the design period. Next, ¶ 14 of the contract--entitled " Guaranteed Minimum Purchase Quantity or Minimum Royalty" --required Digital to fulfill several purchase and/or royalty obligations at various times during the contract period. ( Id. at 62 (bolding omitted).) Specifically, the first subsection of ¶ 14 obligated Digital to make a minimum purchase of fifty pre-production samples at a cost of $200 per unit. Subsection (b)(ii) of ¶ 14 then provided for an " initial production order (guaranteed) of 3,000 units @ $100/unit." ( Id. at 63 (capitalization omitted).) Finally, subsection (b) of ¶ 14 included the following terms:

iii) Minimum 12,000 units or equivalent Royalty PER YEAR for 3 years.
(1) LICENSEE [Digital] will provide LICENSOR [Z3] 1st opportunity to manufacture modules given LICENSOR's per module pricing, quality, and delivery are competitive with alternative manufacturers, including consideration of royalty cost for non-Z3 manufactured modules.

(2) Module price ESTIMATED TARGET is $100/module assuming similar [printed circuit board] layer, component, and architecture to [the modules manufactured pursuant to the 2008 contract]. FINAL PER/MODULE PRICE WILL BE AGREED AFTER COMPLETION OF FINAL HARDWARE DESIGN AND SUBMISSION OF FINAL BOM [(BILL OF MATERIALS)] TO LICENSEE. Specialized components may affect this pricing. Pricing is reviewed between LICENSOR and LICENSEE every 90 days. LICENSOR will provide LICENSEE 100% complete BOM for LICENSEE's use in cost analysis. BOM must include all manufacturer names and manufacturer part numbers.

(3) Production Payment Terms: Net 30 days[.]

(4) Production Lead Time: estimated 10 weeks[.]

iv) If LICENSOR cannot provide on-time delivery, a price and quality acceptable to LICENSEE, or is not willing to produce [the DM365-based module], then LICENSEE has the right to use alternative manufacturing. LICENSEE is liable for royalty of $7.50 per unit on modules actually SOLD BY LICENSEE on all modules not manufactured by Z3. []If LICEN[S]EE does not order 36,000 units at 12,000 units per year, LICENSEE is [to] pay a minimum royalty to LICENSOR equivalent to 12,000*$7.500 = $90,000 royalty per calendar year or the pro-rated balance if at least some units have been purchased within the fiscal year in question.
. . .

( Id. at 63.)

Initially, both parties began performing their various obligations under the contract. Digital paid the first two payments required under the payment schedule, $75,000 in January 2009 and $50,000 in February 2009, and both sides spent time working on the module's design. However, in April 2009, Digital sent Z3 a letter purporting to terminate the contract. It is undisputed that this letter did not comply with the contractual termination requirements,

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which included a notice-and-cure period. However, in accordance with Digital's letter, Z3 stopped its design work on the DM365-based module. Accordingly, no DM365 modules were ever completed by Z3.

After repudiating the 2009 contract, Digital filed a lawsuit in the Kansas district court seeking a declaration that the 2009 contract was validly rescinded or void because Executive Vice President Haler, the Digital officer who signed this contract, lacked the authority to do so as a result of a change in Digital's internal signature policies in December 2008. Digital also raised a claim based on the 2008 contract, alleging that Z3 breached this contract by delivering faulty modules that did not satisfy the contractual warranties. Z3 filed a counterclaim in which it alleged, among other things, that Digital breached both contracts by failing to pay the final $15,000 due on the 2008 contract and by repudiating and failing to fulfill its performance obligations under the 2009 contract.[2]

The district court resolved several legal issues relating to the 2009 contract in various summary judgment rulings. The district court concluded that the undisputed facts showed that (1) Vice President Haler had at least apparent authority to sign the contract, (2) any failure on Z3's part to satisfy any conditions precedent was excused because Digital prevented Z3's performance, and (3) Digital breached the contract by its anticipatory repudiation. The district court then concluded that Z3 was entitled as a matter of law to the remaining $175,000 of design fees that Digital had failed to pay under the payment schedule. As for the three-year minimum purchase or equivalent royalty provisions of ¶ 14(b)(iii) and (iv) of the contract, the district court rejected Z3's argument that it was entitled to lost profits for the minimum production orders of 12,000 units per year. The court concluded that this portion of the contract created an alternative contract under which Digital could perform its contractual obligations by either purchasing 12,000 units per year for three years or by paying the equivalent royalty of $90,000 per year. The court then concluded that Z3's damages were limited to the alternative that resulted in the lesser recovery--the $270,000 total royalty payment. The court thus concluded Z3 was entitled as a matter of law to recover $270,000 for Digital's failure to comply with the purchase-or-royalty provisions of ¶ 14(b)(iii) and (iv). As for the earlier contractual provisions requiring Digital to purchase a minimum pre-production order of 50 units and an initial production order of 3,000 units, these provisions lacked a similar royalty alternative. Moreover, disputed facts regarding Z3's costs and overhead prevented the district court from resolving the question of Z3's lost profits for these 3,050 units as a matter of law. The district court accordingly denied summary judgment as to this element of damages, although it granted summary judgment on the question of breach.

Following a lengthy jury trial, the jury found Z3 was entitled to an additional $100,000 in damages for Digital's breach of the 2009 contract. The jury also found both parties had breached the 2008 contract, and it awarded $15,000 in damages to Z3 and $30,000 in damages to Digital on their respective claims based on this contract.

Z3 subsequently filed a motion asking the district court to award Z3 prejudgment

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interest for its $15,000 award on the 2008 contract and for the $175,000 in design fees and $270,000 in royalties that the district court had concluded Z3 was entitled to as a matter of law for Digital's breach of ...


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