It Depends On The Meaning Of The Word "With"

The contractual interpretation issue before the Business Court in Schultheis v. Hatteras Capital Investment Management, LLC, 2014 NCBC 23, turned on the meaning of the word "with."  Well, actually on the phrase "entering into any contract . . . with."

HCIM, one of the Defendants, had acquired a 55% membership interest in Hatteras Alternative Mutual Funds (HAMF).  At that time,  HCIM became the sole managing member of HAMF per an Operating Agreement.  Four years later, HCIM signed an Asset Purchase Agreement to sell all the assets of HCIM and HAMF to two unrelated entities .

The HAMF Operating Agreement said in Section 2.03  that the consent of the non-managing members of HAMF was required before "the entering into any contract . . . with the Managing Member or an Affiliate of the Managing Member." 

HCIM and HAMF were both parties to the Asset Purchase Agreement, but they were both sellers, on the same side of the transaction.  Judge Jolly observed that:

The Interpretation Issue fundamentally raises the question of what it means to say that an entity enters into a contract "with" another entity in a multi-party transaction. As Defendants note with examples, the common use of the term "with" in this context refers to the contractual binding of bargaining parties on opposite "sides" of such a transaction, while one might use "alongside" or "along with" to refer to parties on the same "side" of a contract.

Op. ¶16.

In isolation, the word "with" might have carried the day for the Plaintiffs and have required the consent to the deal from the  non-managing members of HAMF, but the Court determined that their consent was not required.  Two factors guided the Court's determination: Delaware decisions construing similar language, and a consideration of the "totality" of the Operating Agreement of HAMF.

Delaware Courts have construed the term "enter into an agreement with" to refer to two parties on the opposite sides of an agreement. See e.g. In re Quest Software Inc. Shareholders Litig., Civ. A. 7357-VCG, 2013 WL 3356034, at *1 (Del. Ch. July 3, 2013) (unpublished opinion) (target company “entered into an agreement with” acquiring company); In re PAETEC Holding Corp. Shareholders Litig., CIV.A. 6761-VCG, 2013 WL 1110811, at *1 (Del. Ch. Mar. 19, 2013)(unpublished opinion) (in the context of a merger, dissolving company “entered into an agreement with” absorbing company); Abacus Sports Installations, Ltd. v. Casale Const., LLC, CIV.A. N10L-08062CLS, 2012 WL 1415603, at *1 (Del. Super. Feb. 14, 2012) (unpublished opinion) (general contractor “entered into an agreement" with subcontractor).

But the Court also looked to the totality of the Operating Agreement and said that

Even if the court felt conflicted over the plain meaning of the word "with" in the context of § 2.03(f), the rest of the Operating Agreement as a whole clearly points to the parties' intention to vest the authority to sell HAMF in HCIM alone. Whether such an
arrangement was inadvertent or, more likely, the result of deliberation and  bargaining by the Parties, Plaintiffs cannot rest on the dictionary definition of the word "with" to substantively rewrite the Operating Agreement to provide them with rights they failed to secure at the outset.

Op. ¶b20.

The other pertinent provisions were Section 5.06, a "drag along" provision which obligated HAMF's non-managing members to accept an offer to consummate a Sale of [HAMF], and Section 2.02, which gave the Managing Member the sole authority to approve a Sale of [HAMF].  Although Section 2.02 might seem to be dispositive, it was expressly subject to Section 2.03 (which contained the problematic "with" language).

So, now that Judge Jolly has ruled that HCIM did not need the consent of the non-managing members of HAMF to engage in this transaction, is the case over? Not by a long shot, as the Complaint makes multiple other claims.  And I picked up from one of the Defendants' briefs that the proposed buyer has walked away from this transaction as a result of the Plaintiffs' lawsuit.

 

Parol Evidence Rule Barred Defendants' Interpretation Of Earn-Out Provision

Premier, Inc. v. Peterson, 2012 NCBC 59, decided last Friday by Judge Murphy, turned on a strict application of the parol evidence rule.

At issue was whether the defendants were entitled to a substantial earn-out payment under a Stock Purchase Agreement.  The Plaintiff had purchased the Defendants' software business of selling a Web-based surveillance and analytic services to healthcare providers.

Interpretation of the Contract

The Stock Purchase Agreement called for the earnout payment to be made on a series of five year anniversaries of the acquisition date.  The calculation was to be based on the number of hospitals at which a "Product Implementation" of the software products purchased by the Plaintiff had occurred.

The SPA contained a definition of "Product Implementation," and Judge Murphy not surprisingly held that "[b]ecause the goal of construing a contract is to arrive at the intent of the parties when he contract was executed, where a contract defines a term, 'that definition is to be used.'"  Op. 31(quoting Woods v. Nationwide Mut. Ins. Co., 295 N.C. 500, 505-06, 246 S.E.2d 773, 777 (1978)).

The definition called for the hospital in question to have subscribed to or licensed the product and to have implemented it as well.  A representative of the sellers said that notwithstanding the definition, the parties had agreed during  the negotiations that a "Product Implementation" would include instances where the product was merely provided to the hospital, even without a subscription or license.

Judge Murphy rejected this argument, holding:

 this agreement, at best, adds to the unambiguous terms of the contract requiring a
subscription or license. As such, the parol evidence rule bars consideration of this
proffered agreement, and the Court must enforce the language as written. In doing
so, the Court concludes that Plaintiff’s interpretation construes all the terms
harmoniously, giving effect to the entire provision. Therefore, the Court concludes
that the language is unambiguous, and that Plaintiff has presented a reasonable
interpretation of “Product Implementation.”

 Op. 35.

Attorneys' Fees?

Maybe you are thinking that the Defendants' argument was so beyond the pale of the parol evidence rule that the Plaintiff should have been awarded attorneys' fees.  And the Stock Purchase Agreement called for fees to be awarded to the "prevailing party."

So were fees awarded to the Plaintiff?  No, because of the NC Supreme Court's decision in Stilwell Enter. v. Interstate Equip Co., 300 N.C. 286, 266 S.E.2d 812 (1980), in which it held that:

[e]ven in the face of a carefully drafted contractual provision indemnifying a party for such attorneys' fees as may be necessitated by a successful action on the contract itself, our courts have consistently refused to sustain such an award absent statutory authority therefor.

Id. at 289, 266 S.E.2d 815-16 (emphasis added).

Statutory authority?  Wait a minute.  What about N.C. Gen. Stat. sec. 6-21.6(c), which says that:

If a business contract governed by the laws of this State contains a reciprocal attorneys' fees provision, the court or arbitrator in any suit, action, proceeding, or arbitration involving the business contract may award reasonable attorneys' fees in accordance with the terms of the business contract.

No to attorneys' fees, said Judge Murphy, notwithstanding Section 6-21.6.  That statute applies only to business contracts entered into on or after that statute's effective date, which was October 1, 2011.  This Stock Purchase Agreement was entered into five years before that effective date, in 2006.  Op. ¶46 & n.2.

 

 

 

Furniture Manufacturer Used "Commercially Reasonable Efforts" In Marketing Trademarked Products

Whether a furniture manufacturer's marketing of a line of trademarked furniture for its licensor had been "commercially reasonable" was decided by the Business Court yesterday in favor of the manufacturer, in Lexington Furniture Industries, Inc. v. Bob Timberlake Collection, Inc., 2009 NCBC 22 (September 9, 2009).

The parties had entered into a License Agreement giving Lexington the right to sell furniture collections under the Bob Timberlake trademarks. Sales had apparently gone quite well; Timberlake's COO testified that one of the collections was "the most successful furniture line in the history of the industry." Timberlake had made $25 million over the years in royalties from Lexington's sales.

In 2007, three years before the License Agreement was to expire, Timberlake asked to restructure the Agreement. Lexington declined. Timberlake offered to buy out the License Agreement, and Lexington refused that as well. Timberlake then notified Lexington that it would terminate it as a result of Lexington's alleged failure under the License Agreement "to use its commercially reasonable efforts in the manufacture, sale, promotion, advertisement, and marketing" of the Timberlake collections.

The Interpretation Of "Commercially Reasonable Efforts"

The case turned on the interpretation of the meaning of "its commercially reasonable efforts." Timberlake said that "the inclusion of the word 'its' prior to the term 'commercially reasonable efforts' makes the commercially reasonable standard personal to Lexington." Timberlake asserted that this subjective approach meant that Lexington had to market the furniture consistently with its past practice. As evidence of breach, Timberlake pointed to things that Lexington had done in the past to market the furniture lines that it was no longer doing.

Lexington said that "its" simply meant that Lexington was the party responsible for making the commercially reasonable marketing efforts. It presented the testimony of an industry expert detailing Lexington's marketing activities, who concluded that Lexington's efforts were "equal to that of the best companies in the furniture industry" and that they "exceeded industry practice."

Commercial Reasonableness Needed To Be Assessed Against An Industry Standard

Judge Tennille rejected the notion that past practice was the guide. He said that

[t]o require Lexington to market the Timberlake Collections in 2008 in the same manner as it did when the furniture line was first introduced in 1991 would be unreasonable. The types of promotion and advertising that work effectively for a particular product do not remain static. As new collections gain brand name recognition, marketing strategies change to keep in step. Moreover, marketing means change daily.  The Internet has opened new avenues for advertising -- avenues not readily available eighteen years ago. New furniture shows, such as Las Vegas, now exist that were unheard of in 1991. Would Timberlake be satisfied if Lexington restricted its market shows to those which existed in 1991 or if Lexington only used print media that existed when the parties originally executed the contract? If the parties wished to bind Lexington to past practice, then their License Agreement should have expressly stated so.

The test for "commercial reasonableness," according to the Court, did not require consideration of "whether any specific activity should or should not have been used." The inquiry was "the marketing effort as a whole which must be judged against some industry standard." The only evidence of industry standard before the Court had been presented by Lexington.

The Court, granting summary judgment in favor of Lexington, held that "[t]he mere fact that Timberlake disagrees with the marketing decisions Lexington made is not enough to raise an issue of fact as to whether such decisions were commercially reasonable."

Letters Of Intent And Agreements To Agree: Two Rulings From The North Carolina Business Court

Whether the parties had agreed on the material terms necessary to create a binding contract was the issue resolved by the Business Court in two opinions issued simultaneously on Friday, March 13th.  The claims in one case survived a motion to dismiss, the claims in the other were cut down on summary judgment.

In the first case, JDH Capital, LLC v. Flowers, 2009 NCBC 4 (N.C. Super. Ct. Feb. 13, 2009), the Court ruled that a Letter of Intent executed by the parties was a "non-binding agreement to agree," and dismissed the case.  In the second case, Crockett Capital Corp. v. Inland American Winston Hotels, Inc., 2009 NCBC 5 (N.C. Super. Ct. Feb. 13, 2009), the Court ruled that the plaintiff could proceed in its case even though the Master Agreement at issue contemplated the need to negotiate the terms of future agreements.

These cases are must reads if you are litigating a contract formation issue in the Business Court.  They are equally important to look at if you are drafting Letters of Intent or other agreements involving commercial real estate ventures, which were the business deals involved in both Flowers and Crockett. (There are reportedly non-litigation lawyers who read this blog precisely to see how their deal documents might play out in Court).

The Flowers Case: Letter Of Intent Unenforceable

In Flowers, the parties had entered into a Letter of Intent contemplating that JDH would develop a commercial shopping center on land to be contributed to the venture by Flowers.  JDH, an expert in the field of commercial development, had drafted the LOI and included the following provision:

Both parties agree to work diligently toward the full execution of limited liability company documents reflecting the terms and conditions agreed upon herein within 30 days of the date of this agreement.  This Letter of Intent does not create any binding, contractual rights between Flowers and JDH and shall serve only as an expression of intent between the parties.

The parties never agreed on the form of LLC documents.  In fact, JDH didn't circulate a draft document until well after the thirty day deadline referenced in the LOI. JDH sued to enforce Flowers' alleged obligation to contribute the property, and to recover for its work on the development of the property.

Judge Tennille granted summary judgment, finding that (1) the document itself supported the finding that it was a non-binding agreement, (2)  there were many significant terms left unaddressed in the LOI, (3) complicated real estate development projects "generally require the execution of lengthy, sophisticated, and detailed documents to govern the relationships between the parties," (4) courts should decline to fill in material gaps left open by contracting parties, (5) the LOI failed to provide any remedy in the event the LLC was never formed, and (6) JDH, as the drafter of the LOI, should have any ambiguity resolved against it.

The Court also rejected the argument that the subsequent oral agreements of the parties, and their partial performance, made the LOI enforceable; and also the argument that the Plaintiff was in the alternative entitled to a recovery in quantum meruit.

The Crockett Case: Motion To Dismiss Denied Notwithstanding Open Contractual Terms

In the Crockett case, the Court denied a Motion to Dismiss.  The parties there had executed  a Master Agreement which contemplated the future development of hotel properties.  The Master Agreement called for Plaintiff to present preliminary development packages for identified "Pipeline Properties." 

If Defendants were interested in a development of a Pipeline Property, Plaintiff was to present more detailed development packages.  If Defendants decided to proceed after reviewing those packages, the parties were to form an LLC to operate the property and to execute a series of agreements regarding the operation of the property.  These included a hotel management agreement, a construction management agreement, and a development agreement.  The parties furthermore had to agree on their respective capital contributions and ownership percentages in the project.  Forms of all of the contemplated agreements were attached to the Master Agreement. 

The Agreement in Crockett included what Judge Tennille referred to as "impasse provisions."  These required Defendants to convey all of their right in a Pipeline Property to the Plaintiff if they rejected a proposal, but also required Crockett to resubmit a proposal if it presented that same proposal to a third party with a defined "material change."

The case arose when the Defendants refused to convey their rights in Pipeline Properties which they had rejected, and refused to finalize the documentation on two properties which they had elected to develop.  Defendants argued that the Master Agreement was unenforceable because the Court would need to "supply key material terms in order to enforce the agreement," Op. ¶ 31, and pointed in particular to the lack of an agreement on capital contributions. 

Judge Tennille described the Agreement and its attachments as "a very sophisticated business transaction among parties of equal knowledge negotiating at arms length," and said that "the extensive nature of the documentation left very few terms to be negotiated for each side."  Op. ¶ 19. He denied the Motion to Dismiss, holding:

The impasse provisions in . . . the Master Agreement do not require the Court to supply any material terms. . . . Unlike the JDH case, in which the Court is asked to supply terms missing from a written letter of intent, this case involves the enforcement of specific remedies provided for in the agreement itself.

Op. ¶¶ 33-34.

Flowers And Crockett Further Distinguished

Turning back to Flowers, Judge Tennille in that opinion distinguished Crockett as follows:

the Letter of Intent differs significantly from the agreement at issue in Crockett.  In Crockett, the Court was not required to supply any material terms in order to enforce the agreement.  The agreement was complete in the sense that it provided a contractual remedy in the event there was no agreement reached in connection with a proposed joint venture.  Here, the Court would have to speculate as to the final design of the development, the projected budget, and the success of the development in order to determine damages from an unexecuted agreement.

Flowers at ¶ 38. 

Judge Tennille further observed that JDH, a "sophisticated developer," could have provided for a remedy in the LOI but that it had not done so.  He held "[t]he absence of any remedy is the best indication that this was simply a non-binding agreement by which the parties explored the possibility of a joint venture without any obligation to go forward and without any penalty for failing to complete a final agreement." Op. ¶ 37.

Business Court Trivia

If you care about Business Court trivia, the decisions of March 13th are only the second time in thirteen years that the Court has issued two opinions on the same day referencing one another on similar issues.  The other instance was on November 1, 2006, when Judge Tennille entered simultaneous Orders in Analog Devices, Inc. v. Michalski, 2006 NCBC 14 (N.C. Super. Ct. Nov. 1, 2006) and Bank of America Corporation v. SR International Business Insurance Company, Ltd., 2006 NCBC 15 (N.C. Super. Ct. Nov. 1, 2006).  Those cases involved the allocation of the cost of the production of electronically stored information.

Crockett: Brief in Support of Motion to Dismiss

Crockett: Brief in Opposition to Motion to Dismiss

Crockett: Reply Brief in Support of Motion to Dismiss

Flowers: Brief in Support of Motion for Summary Judgment

Flowers: Brief in Opposition to Motion for Summary Judgment

Flowers: Reply Brief in Support of Motion for Summary Judgment