Arizona Case Law

O'DAY v. McDONNELL DOUGLAS HELICOPTER CO., 191 Ariz. 535 (1998)

959 P.2d 792

DENNIS V. O'DAY, Plaintiff, v. McDONNELL DOUGLAS HELICOPTER COMPANY, a

foreign corporation, Defendant.

Supreme Court No. CV-97-0274-CQ

In the Supreme Court of Arizona

En Banc

May 26, 1998

Certified Questions from the United States District Court for

the District of Arizona United States District Court No. CV-91-777-PGR.

The Honorable Paul G. Rosenblatt, Judge

QUESTIONS ANSWERED

Page 536

Francis> <G>. <Fanning> Tempe Attorney for Dennis V. O'Day.

Snell & Wilmer, L. L. P. Tucson By Tibor Nagy, Jr. Attorneys

for McDonnell Douglas Helicopter Company.

OPINION

MARTONE, Justice.

¶ 1 The United States District Court for the District of

Arizona certified two questions on the proper use of

after-acquired evidence in employment termination disputes. We

accepted jurisdiction under A. R. S. § 12-1861, and Rule 27,

Rules of the Supreme Court.

I. CERTIFIED FACTS

¶ 2 On June 8, 1990, McDonnell Douglas failed to promote

Dennis O'Day to lead engineer at its helicopter plant in Mesa. He

was laid off as part of a general work force reduction one month

later. O'Day was 46 years old, had worked for the company for

fourteen years, and believed he had been denied the promotion and

laid off because of his age.

¶ 3 After exhausting his administrative remedies in the

Equal Employment Opportunity Commission, O'Day filed an action

against McDonnell Douglas challenging the denial of promotion and

layoff. His complaint stated four causes of action:

1. Discrimination in employment under the Age Discrimination

in Employment Act, 29 U.S.C. § 621 et. seq.

2. Discrimination in employment under the Arizona Civil Rights

Act, A. R. S. § 411481 et seq.

3. Breach of contract.

4. Wrongful discharge in violation of public policy.

¶ 4 The night after O'Day was denied his promotion, he

returned to the plant and searched his supervisor's office. He

took documents that he thought might be useful to his

discrimination claim, copied them, and returned the originals to

the supervisor's desk.

¶ 5 It was not until after discovery began in the action

that McDonnell Douglas learned of O'Day's misconduct. McDonnell

Douglas moved for summary judgment, asserting the "after-acquired

evidence defense." The District Court granted judgment in favor

of McDonnell Douglas on all counts.

¶ 6 On appeal, the United States Court of Appeals for the

Ninth Circuit affirmed the finding that the after-acquired

evidence defense had been established, but reversed the dismissal

of the complaint based upon the principles articulated in

McKennon v. Nashville Banner Publishing Co.,

513 U.S. 352, 115 S.Ct. 879 (1995). O'Day v. McDonnell Douglas

Helicopter Co., 79 F.3d 756 (9th Cir. 1996). The Court of

Appeals remanded the case for trial but reserved ruling on

whether the "after-acquired evidence" defense applied to O'Day's

state contract and tort claims. The court noted that we had not

yet "determined the extent to which after-acquired evidence of

wrongdoing limits an employee's recovery of compensatory and

punitive damages on these causes of action." Id. at 764

n. 7.

II. CERTIFIED QUESTIONS

The certified questions are:

1. Whether the "after-acquired evidence" defense as delineated

by the United States Supreme Court in McKennon v. Nashville

Banner Publishing Co., 513 U.S. 352, 115 S.Ct. 879 (1995)

applies to limit recovery under Arizona law in a case of wrongful

discharge from employment in violation of public policy, and, if

the defense applies, how it limits or precludes recovery of damages.

2. Whether the "after-acquired evidence" defense applies in a case

of breach of employment contract, and, if the defense applies, how

it limits or precludes recovery of damages in such a case.

III.

A. After-Acquired Evidence in Federal Statutory Discrimination

Cases: the McKennon Rule

¶ 7 McKennon resolved a conflict in the circuits on the

proper role of after-acquired

Page 537

evidence in federal statutory discrimination cases. The Tenth

Circuit, in Summers v. State Farm Automobile Insurance Co.,

864 F.2d 700 (10th Cir. 1988), had held that after-acquired

evidence could serve as a complete bar to a plaintiff's cause

of action under federal employment discrimination statutes if

the defendant could demonstrate that the conduct would have

resulted in the employee's discharge had it been discovered

during the course of employment. The court presented a

hypothetical that is often quoted in after-acquired evidence cases:

To argue, as Summers does, that this after-acquired evidence

should be ignored is utterly unrealistic. The present case

is akin to the hypothetical wherein a company doctor is

fired because of his age, race, religion, and sex and

the company, in defending a civil rights action, thereafter

discovers that the discharged employee was not a "doctor."

In our view, the masquerading doctor would be entitled to

no relief, and Summers is in no better position.

Id. at 708. Four years later, the Eleventh Circuit, in

Wallace v. Dunn Construction Co., 968 F.2d 1174 (11th

Cir. 1992), reh'g granted, op. vacated, 32 F.3d 1489

(11th Cir. 1994), decision en banc, 62 F.3d 374 (11th

Cir. 1995), rejected this approach, and concluded that after-acquired

evidence, while relevant, should operate only to limit damages. Id.

at 1181. The court held that after-acquired evidence sufficient to

warrant discharge precludes reinstatement or front pay. Id. The

plaintiff's award of back pay would be reduced to the period between

the actual discharge and the discovery of the evidence only if the

employer could demonstrate that (1) the misconduct discovered would

have resulted in the plaintiff's discharge and (2) the evidence would

have been discovered in the absence of the alleged discrimination

and the subsequent litigation. Id. at 1182.

¶ 8 The Supreme Court resolved the conflict in

McKennon v. Nashville Banner Publishing Co.,

513 U.S. 352, 115 S.Ct. 879 (1995), and held that after-acquired evidence

is not a bar to an employment discrimination action, but is

relevant to the measure of damages. The Court's resolution

reflected a balancing of the legitimate managerial interests of

the employer and the "important claims of the employee who

invokes the national employment policy mandated by the Act."

Id. at 361, 115 S.Ct. at 886. The Court held that once

an employer demonstrates that the after-acquired evidence would

have led to the employee's discharge, the remedies of

reinstatement and front pay are no longer appropriate. The Court

concluded that the measure of back pay is the period between the

termination and the date the employer discovers the after-acquired

evidence. The Court expressly rejected the added prong of

Wallace, and held that an employer need not show that it would

have discovered the evidence in the absence of discrimination and

subsequent litigation.

B. After-Acquired Evidence and State Common Law Claims

¶ 9 The question here is whether we should apply the

McKennon rule to O'Day's state common law claims for breach of

contract and wrongful termination in violation of public policy.

As to the contract claim, O'Day argues that (1) employee

misconduct after a valid employment relationship exists ought to

be treated differently than a case of risumi or application

fraud, which implicates the doctrine of fraud in the inducement,

(2) this court ought to consider how material O'Day's misconduct

was to the contractual relationship, and (3) after-acquired

evidence should only affect damages, not liability.

¶ 10 As to the tort claim, O'Day argues, inter alia, that

any limitation on damages resulting from the admission of after-acquired

evidence would violate both article II, section 31 and article XVIII,

section 6 of our Constitution, which prohibit laws that limit the

amount of damages to be recovered for injuries. O'Day also argues

that the cutoff date for future lost earnings should not be the date

the employer discovers the misconduct, but instead should be a date

determined by a jury. Finally, O'Day argues that after-acquired

evidence should have no bearing on punitive damages, or on compensatory

damages for injury to personal and professional reputation, emotional

distress, humiliation, and embarrassment.

Page 538

¶ 11 McDonnell Douglas argues that the contract claim and

the tort claim ought to be treated differently. It relies on

Hampton v. Sandy Cowen Agency, Inc., 154 Ariz. 14,

739 P.2d 1331 (App. 1987) and the Restatement (Second) of

Contracts § 385 (1979) for the proposition that if a

party has the power to avoid a contract by disaffirmance, that

party's failure to perform is not a breach, even if the party is

ignorant of his power of avoidance and believes that his refusal

is a breach. The after-acquired evidence of O'Day's misconduct

would, under this rule, constitute a "first breach" of the

employment contract that would excuse McDonnell Douglas's later

breach. The McKennon rule would not apply, because the

purposes behind state and federal age discrimination statutes do

not form the underpinnings of the law of contracts.

¶ 12 In contrast, McDonnell Douglas concedes that because

the tort claim involves important public concerns, like those

implicated by federal and state discrimination statutes, there is

no bar. It argues that the McKennon rule should apply

as to reinstatement, front pay and back pay, but that after-acquired

evidence of employee misconduct ought to be a per se bar to the

recovery of punitive damages and emotional distress damages.

1. Common Law Breach of Contract and After-Acquired Evidence

¶ 13 The overwhelming majority of courts hold that if an

employer can demonstrate that it would have fired an employee had

it known of prior misconduct, then the employee's claim for

breach of contract is barred or, put differently, the prior

misconduct excuses the employer's breach. This approach is

supported by several sections of the Restatement of

Contracts, leading treatises, and a century of case law. In

Hampton v. Sandy Cowen Agency, 154 Ariz. 14,

739 P.2d 1331 (App. 1987), the court of appeals held that a former

employee's breach of contract claim was barred by the discovery

of after-acquired evidence such that, had it been known at the

time of employment, the employee would not have been hired.

Relying upon the Restatement (Second) of Contracts

§ 385 cmt. a (1979), the court rejected the plaintiff's claim

that the employer could not rescind the contract if it did not

know of the grounds for rescission at the time of the plaintiff's

discharge. The irrelevance of the second breaching party's

ignorance is reinforced by other sections of the

Restatement. Section 237 provides:

Except as stated in § 240, it is a condition of each

party's remaining duties to render performances to be

exchanged under an exchange of promises that there be

no uncured material failure by the other party to render

any such performance due at an earlier time.

Illustration 8 to section 237 is directly on point:

A and B make an employment contract. After the service

has begun, A, the employee, commits a material breach

of his duty to give efficient service that would justify

B in discharging him. B is not aware of this but

discharges A for an inadequate reason. A has no claim

against B for discharging him.

See also E. Allan Farnsworth, Farnsworth on

Contracts § 8.3 (1990). The Supreme Court, pre-Erie,

acknowledged this in College Point Corp. v. United

States, 267 U.S. 12, 15-16, 45 S.Ct. 199, 201 (1925)

(holding that a party may "justify an asserted termination,

rescission, or repudiation of a contract by proving that there

was adequate cause, though it was not known to him until

later.").

¶ 14 The Colorado and Kansas Supreme Courts have recently

held that after-acquired evidence of employee misconduct that

would have resulted in termination (or the employee never having

been hired) bars a claim for breach of contract. Crawford

Rehab. Servs. v. Weissman, 938 P.2d 540 (Colo. 1997);

Gassmann v. Evangelical Lutheran Good Samaritan Soc'y,

933 P.2d 743 (Kan. 1997). Federal courts have reached the same

conclusion as to pendant state claims. See, e. g., Johnson

v. Honeywell Info. Sys., 955 F.2d 409, 412-14 (6th Cir.

1992), questioned on other grounds, McKennon v.

Nashville Banner Publ'g Co., 513 U.S. 352, 115 S.Ct. 879

(1995)); Massey v. Trump's Castle Hotel & Casino,

Page 539

828 F. Supp. 314, 325 (D. N. J. 1993); Leahey v. Federal Express

Corp., 685 F. Supp. 127, 128 (E. D. Va. 1988).

¶ 15 Under the law of contracts, O'Day's claim that

McDonnell Douglas breached the implied contract by terminating

him is barred if McDonnell Douglas can demonstrate that it would

have fired him had it known of the misconduct. Of course, O'Day's

breach of contract claim arising out of his employer's conduct

prior to O'Day's misconduct (failure to promote) is not

barred because this would be a first breach by the employer, not

the employee. To this day, almost no court has challenged the

assumption that these principles ought to apply to implied-in-fact

employment contracts. But see, Crawford Rehab. Servs. v. Weissman,

938 P.2d 540, 553 (Colo. 1997), (Mullarkey, J., dissenting).

¶ 16 We adhere to the traditional contract approach. We

need not depart from the law of contracts just to duplicate

relief that is already provided by tort and statutory causes of

action that arose because of the possible harshness of

the very contract principles before us today. The result in

contract merely reflects the private bargain between the parties.

Of course, if the employee can demonstrate that the employer knew

of the misconduct and chose to ignore it, then he will defeat the

employer's attempted use of the after-acquired evidence and

defense of legal excuse.

¶ 17 We emphasize that the non-breaching party is

discharged only from its remaining duties of

performance. Restatement (Second) of Contracts §

237 (1979). For example, in a unilateral contract for employment,

where a day's work results in a day's wages, an employer would,

in most cases, still be obligated to provide wages and benefits

for services rendered up to the moment of termination. We also

believe that principles of equity would prevent the absurd

results identified by opponents of the traditional contract

approach. In almost all imaginable circumstances, the doctrines

of quantum meruit and unjust enrichment would prevent

an employer from using past wrongdoing to recover wages already

paid to an employee. We therefore hold that after-acquired

evidence of employee misconduct is a defense to a breach of

contract action for wages and benefits lost as a result of

discharge if the employer can demonstrate that it would have

fired the employee had it known of the misconduct.

2. Tortious Wrongful Termination and After-Acquired Evidence

¶ 18 Other courts have adopted three approaches to

after-acquired evidence in wrongful termination cases: (1) it is

not admissible because it is irrelevant or because it undermines

the public policy goals of these actions (see Flanigan v.

Prudential Fed. Sav. & Loan, 720 P.2d 257, 264 (Mont.

1986), appeal dismissed, 479 U.S. 980, 107 S.Ct. 564

(1986); Mosley v. Truckshops Corp., 12 891 P.2d 577,

585 (Okla. 1993); Mitchell v. John Wiesner, Inc.,

923 S.W.2d 262, 264 (Tex. App. 1996)); (2) it is an absolute bar to

recovery by the employee (see Camp v. Jeffer, Mangels,

Butler & Marmaro, 41 Cal.Rptr.2d 329, 335-40 (Cal. Ct. App.

1995); Jordan v. Johnson Controls, Inc.,

881 S.W.2d 363, 366 (Tex. App. 1994)); and (3) it only limits remedies.

¶ 19 We reject the first approach because, while it has

surface appeal, it cannot be reconciled with the employer's right

to let an employee go for the employee's wrongful conduct.

See Thompson v. Better-Bilt Aluminum Prods. Co.,

187 Ariz. 121, 129, 927 P.2d 781, 789 (App. 1996). We reject the

second approach because the tort claim evolved to cure the

failure of the law of contracts to attribute any consequence to

the employer's tortious conduct. The third approach attributes

significance to both the employer's and employee's wrongful

conduct. See generally Rebecca Hanner White & Robert D.

Brussack, The Proper Role of After-Acquired Evidence in

Employment Discrimination Litigation, 35 B. C. L. Rev. 49

(1993).

¶ 20 But does the McKennon rule (back pay up to

discovery, but no reinstatement or front pay) strike the proper

balance between the interests of employers and employees in cases

of tortious wrongful discharge? In part. We think that the

prohibition on reinstatement and front pay adequately protects

Page 540

the employer from an employee it has a right to fire. A contrary

conclusion would lead to the absurd result that an employer would

have to accept an employee and then discharge him. And, the

unavailability of these remedies is caused by the employee's own

conduct, not the tortious conduct of the employer. But back pay

alone up to discovery of misconduct does not always adequately

protect the employee from all the consequences of the employer's

wrongful conduct. Tortious conduct should result in the tort

measure of damages - compensatory and punitive, if

justified by the evidence, and we have so held with respect to

the tort of wrongful discharge. See Thompson v. Better-Bilt

Aluminum Prod., 171 Ariz. 550, 554, 832 P.2d 203, 207

(1992) (holding that a tortious wrongful discharge plaintiff is

entitled "to ordinary tort damages - all damages legally

caused by the tort.").

¶ 21 We acknowledge that the use of after-acquired

evidence presents some policy concerns first raised by federal

courts which rejected earlier decisions that had allowed

after-acquired evidence to bar discrimination claims. See, e. g.,

Wallace v. Dunn Constr. Co. 968 F.2d 1174, 1180-81 (11th

Cir. 1992); Massey v. Trump's Castle Hotel & Casino,

828 F. Supp. 314, 323 (D. N. J. 1993). It is feared that

employers and their lawyers will scour the employee's work record

and interview co-workers in an attempt to dig up on-the-job

misconduct that will serve as a pretext for discharge. Or, an

employer might ignore employee wrongdoing, but tuck away that

knowledge for the day that a charge of discrimination is made.

Finally, an employee might endure repeated harassment or

discrimination without complaint because she knows that her work

record is not spotless.

¶ 22 But these fears arose in the context of after-acquired

evidence being a complete bar. Under our rule compensatory and punitive

damages are available. Thus, the incentive to abuse this defense, and

the consequence to the employee of such abuse, is greatly diminished.

¶ 23 Second, we believe our rule provides an employee

with more protection than is at first apparent. See

White & Brussack, supra, at 85-86. The question of remedy will

arise only in cases in which the employer has already been found

liable for wrongful conduct. Therefore, an employer that has

already failed to convince a jury that it has not engaged in

prohibited conduct must now convince that same jury that it would

have fired this employee had it known of prior misconduct. This

should discourage employers from adopting "ludicrously low

thresholds," Wallace, 968 F.2d at 1180, for

terminations that are pretextual.

¶ 24 Finally, the stakes are high for employers and their

lawyers who would abuse the process. An employer that feigns

ignorance of prior misconduct, hides evidence, or asserts in bad

faith that it would have fired the employee had it known, is

subject to discovery and other sanctions, as well as the specter

of perjury charges. The lawyers involved are subject to the Rules

of Professional Conduct. While it is impossible to fashion a rule

that will entirely eliminate the possibility of abuse, we cannot

allow these fears, as yet unrealized, to drive the development of

the law. Our approach reaches a fair balance of legitimate

interests. To yield completely to these fears by holding all

after-acquired evidence irrelevant cannot be reconciled with an

employer's right to discharge such an employee. Of course, if our

estimate of the danger of abuse proves too optimistic, the matter

can be revisited.

¶ 25 We hold that, in an action in tort, after-acquired

evidence will only affect the remedies available to the employee.

If an employer can demonstrate that it would have fired the

employee had it known of the misconduct, then the remedy of

reinstatement or its functional equivalent, front pay, will not

be available. Damages for lost past earnings (sometimes referred

to as "back pay") will be available for the period between the

time of discharge and the time the employer discovers the

misconduct. However, after-acquired evidence does not affect

other compensatory damages attributable to the employer's

wrongful conduct, including any decrease in earning capacity, and

punitive damages, if they are otherwise warranted by the

evidence.

¶ 26 We briefly turn to a distinction between front pay

and other prospective

Page 541

damages. O'Day argues that any limitation on front pay ought

not to apply to the common law remedy of lost future earnings.

The term "front pay" arose from federal statutory employment

discrimination law, and is a monetary substitute for the

equitable remedy of reinstatement. Lost earnings, past or

future, refer to those specific earnings that could have

been earned but were not, such as earnings from an existing

job. See 2 Dan B. Dobbs, Law of Remedies § 8.1(2),

at 364 (2d. ed. 1993). Some courts have therefore defined

front pay as "lost future earnings." See Burris v. City of

Phoenix, 179 Ariz. 35, 38 n. 3, 875 P.2d 1340, 1343

n. 3 (App. 1993) (citing Hansard v. Pepsi-Cola Metro. Bottling

Co., 865 F.2d 1461, 1469 (5th Cir. 1989)

and Worrell v. Multipress, Inc., 543 N.E.2d 1277,

1283 (Ohio 1989)).

¶ 27 Other courts believe the two to be separate

remedies. See, e. g., Williams v. Pharmacia, Inc.,

137 F.3d 944 (7th Cir. 1998). This disagreement may stem from a

blurring of the distinction between lost earnings on

the one hand, and lost or diminished earning capacity

on the other. See Williams, 137 F.3d at 953 (holding

that lost future earnings compensate the employee for a lifetime

of diminished earnings resulting from the reputational harms the

employee suffered as a result of the employer's discrimination).

Properly understood, lost or diminished earning capacity, as

distinguished from lost future earnings, is an estimate of lost

present ability to work in appropriate occupations, now and in

the future. See Dobbs, supra, § 8.1(2), at 362; Rossell

v. Volkswagen of America, 147 Ariz. 160, 172, 709 P.2d 517,

529 (1985) (holding that diminished earning capacity is an item of

general damage, as distinguished from lost earnings, which are

specific damages); Mandelbaum v. Knutson, 11 Ariz. App. 148,

149-50, 462 P.2d 841, 842-43 (1969).

¶ 28 In the ordinary tort case, where the plaintiff is

injured by someone other than his employer, his damages include

lost earnings to date and any decrease in earning power or

capacity in the future. See, e. g., RAJI (Civil) 112

(3d ed. 1997) (Personal Injury Damages 1). In the employment

context, where the tortfeasor is the employer, and where there is

a finding in favor of the employer on the after-acquired evidence

defense, the employer's right to discharge affects the ordinary

measure of damages as of the date the right to discharge arises.

Thus, the plaintiff is entitled to lost earnings to the point of

discovery rather than to date. And, because the employer has the

right to discharge, reinstatement or its functional equivalent,

front pay, cannot be reconciled with the employer's right to

fire. Thus lost future earnings from that specific employer are

not available. But the employer's conduct may have damaged the

employee in other ways, and thus the employee is still entitled

to general damages for diminished earning capacity if supported

by the evidence, even where he is not entitled to lost future

earnings.

¶ 29 O'Day's argument that allowing after-acquired

evidence to limit damages is unconstitutional is without merit.

Both article II, section 31 and article XVIII, section 6 by their

express language prohibit "enacted"[fn1] and "statutory"[fn2]

limitations on the amount of damages. This, of course, is not a

case of statutory limitation. Second, and perhaps more important,

under our rule the employee is entitled to the full measure of

tort damages, including any decrease in earning power or capacity

in the future. The unavailability of front pay or lost future

wages from that specific employer flows from the unavailability

of reinstatement, which in turn flows from the employee's own

conduct, see Jimenez v. Sears Roebuck & Co., 183 Ariz. 399,

408, 904. P.2d 861, 870 (1995), not from any law limiting

damages caused by the tortfeasor.

Page 542

IV. ANSWERS

A. We answer question two that after-acquired evidence of

employee misconduct is a defense to a breach of contract action

for wages and benefits lost as a result of discharge if the

employer can demonstrate that it would have fired the employee

had it known of the misconduct.

B. We answer question one that after-acquired evidence of

employee misconduct is not a defense to a tortious wrongful

termination action, but is relevant to the question of remedies.

If an employer can demonstrate that it would have fired an

employee had it known of prior misconduct, then the remedies of

reinstatement and front pay will not be available to the

employee. The employee is entitled to lost earnings from the time

of discharge to the time the employer discovers the misconduct.

However, after-acquired evidence is no bar to other compensatory

damages attributable to the employer's wrongful conduct,

including but not limited to diminished earning capacity and

punitive damages, if otherwise warranted by the evidence.

ZLAKET, C.J., and JONES, V.C.J., and FELDMAN and TOCI, JJ.,

concur.

JAMES MOELLER (retired) did not participate in the determination

of this matter. Pursuant to Art. 6, § 3 of the Arizona

Constitution, Judge Philip E. Toci, Chief Judge of the Arizona

Court of Appeals, Division One, is designated to sit on this case

until final determination of this matter.

[fn1] Article II, section 31 provides: "No law shall be enacted

in this State limiting the amount of damages to be recovered for

causing the death or injury of any person" (emphasis added).

[fn2] Article XVIII, section 6 provides: "The right of action to

recover damages for injuries shall never be abrogated, and the

amount recovered shall not be subject to any statutory

limitation" (emphasis added).