Delaware Corporate and Commercial Litigation Blog : Delaware Litigation Lawyer & Attorney : Francis G. X. Pileggi : Corporate, Business, Commercial, Delaware Chancery Court

Kuroda v. SPJS Holdings, L.L.C., Del. Ch., No. 4030-CC (April 15, 2009), read opinion here.

This case involves the following claims among members of an LLC, arising out of an LLC Agreement: (i) breach of contract; (ii) tortious interference with contract; (iii) tortious interference with prospective economic advantage; (iv) breach of the implied covenant of good faith and fair dealing; (v) conversion; (vi) unjust enrichment; and (vii) civil conspiracy. The court dismissed the foregoing claims against most of the defendants based on a motion to dismiss under Rule 12(b)(6). The discussion of this smorgasbord of claims serves as a useful reference to include in the toolbox of the business litigation lawyer.

Background

The factual background involves an intricate web of overlapping entities. The central fact that is key to this dispute is that a few investment management professionals formed several entities for the primary purpose of investing in Japanese companies. The plaintiff was the main "point man" in Japan. Eventually, the plaintiff and the other members of the LLC had disagreements that caused the plaintiff to want to leave. This litigation started when the negotiations for an amicable departure were unsuccessful. Among the problems that gave rise to the suit included the alleged failure of the defendants to provide full payment that the plaintiff thought he was owed, and the issuance to the plaintiff of a K-1 purporting to assign him $10 million in income that he apparently did not receive.

Breach of Contract Claim

Regarding the breach of contract claims relating to the LLC Agreement, the court denied the motion to dismiss against two of the defendants based on the familiar test for a Rule 12(b)(6) motion that the court cannot choose at such a preliminary stage the movant's view of the contract if it is "not the only reasonable interpretation". FN 9.

The opinion also includes discussion about whether the LLC members could be held liable "as members, solely by reason of them being members". Reference was made to Section 18-303(a) of the Delaware LLC Act, which addresses the liability of members to third-parties, but, the court explained, it "has no bearing on the liability between members." FN 13.

The court discussed the elements of a breach of contract claim (FN 15). The plaintiff, Kuroda, alleged that issuing him a K-1 that purported to assign him income that he never received. However, he still failed to allege the element of damages because as a Japanese citizen it was not clear that he would owe taxes  in the U.S., or suffer other damages as a result of an inaccurate K-1, though the court did allow the plaintiff to amend his complaint. [This conclusion should be compared with a decision from the Chancery Court of many years ago in an unaffiliated case that reached a different result on different facts but involved an arguably analogous issue. See   Litle v. Waters, 1992 WL 25758 at *8 (Del. Ch., Feb. 11, 1992)(finding that the plaintiff in that case stated a claim for oppression of a minority shareholder by failing to declare dividends in a subchapter S corporation where the plaintiff minority shareholder was incurring tax liability but receiving no income to pay the liability, while the Defendant was receiving loan repayments which he could use to pay his tax liability.)]

Tortious Interference with Contract

It was explained by the court as "well-settled that a party to a contract cannot be held liable for both breaching a contract and tortiously interfering with the same contract." FN 18. Moreover, the individual defendants were in control of the member entities, thus, as long as they were acting within the scope of their respective roles as managers of the member entities, they cannot be held liable for tortious interference with contract, based on the reasoning that they are the agents of the signatories to the contract. FN 20.

Tortious Interference with Prospective Economic Advantage

The elements of a claim for tortious interference with prospective economic advantage were recited (FN 31), but preliminarily, the court found that those claims were not direct claims that could be brought by the plaintiff, but rather were derivative claims that needed to be brought on behalf of the LLC through which he did business. See 6 Del. C. Section 18-1001 and FN 32.

Implied Covenant of Good Faith and Fair Dealing

An  explanation of this cause of action and a nuanced amplification of its limited scope in the opinion is the best way to  understand why this claim was dismissed, so I quote from page 24 of the slip opinion:

The implied covenant of good faith and fair dealing inheres in every contract and requires ‘a party in a contractual relationship to refrain from arbitrary or unreasonable conduct which has the effect of preventing the other party to the contract from receiving the fruits’ of the bargain.”38 The implied covenant cannot be invoked to override the express terms of the contract.39 Moreover, rather than constituting a free floating duty imposed on a contracting party, the implied covenant can only be used conservatively “to ensure the parties’ ‘reasonable expectations’ are fulfilled.”40 Thus, to state a claim for breach of the implied covenant, Kuroda “must allege a specific implied contractual obligation, a breach of that obligation by the defendant, and resulting damage to the plaintiff.”41 General allegations of bad faith conduct are not sufficient. Rather, the plaintiff must allege a specific implied contractual obligation and allege how the violation of that obligation denied the plaintiff the fruits of the contract. Consistent with its narrow purpose, the implied covenant is only rarely invoked successfully.42

Conversion

In connection with defining the elements of this claim (FN 49), the  court explains that when a claim arises out of a contract, such a cause of  action cannot be bootstrapped into a tort claim (FN 50). Moreover, the Court emphasized that there is a very narrow exception to the general prohibition against claims for the conversion of money. That is, the plaintiff, Kuroda, would have to establish a right to the money, separate from a contract right, that he asserts is being withheld improperly by the defendants. This he cannot do. FN 54.

Unjust Enrichment

After reciting the elements of this claim (FN 61), the reason given for why it was dismissed is as follows: such a claim is not available where, as here, there is a contract that governs the relationship between the parties. Thus, "when the complaint alleges an express, enforceable contract that controls the parties' relationship ... a claim for unjust enrichment will be dismissed." FN 63.  But cf. FN 65 that cites a case that refers to the limited circumstances in which the concept of "alternative pleading"  will allow both such claims to be pled in the same complaint.

Civil Conspiracy

The plaintiff failed to adequately allege the elements of an underlying claim, and thus this count in the complaint was dismissed because, as the court noted, civil conspiracy is not an independent claim. FNs 70 and 71. Moreover, the opinion cites to authority in footnote 74 for the position that unless a breach of contract constitutes an independent tort (which the excerpt above shows is hard to do), a breach of contract cannot constitute an underlying wrong on which a claim for civil conspiracy can be based.
 

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Alliance Data Systems Corp. v. Blackstone Capital Partners V  L.P. and Aladdin Solutions, Inc. , (Del. Ch., Jan. 15, 2009), read opinion here.

We are fortunate to have another guest post by Delaware lawyer Kevin Brady  who provided the following summary of this important decision.

This Chancery Court decision is another example of merger partners after the “deal is signed,” trying to use extrinsic evidence to extract contractual obligations that were not expressly stated in a merger agreement. The Court dismissed the complaint filed by Alliance Data Systems Corporation (“ADS”) because it failed to plead a viable claim for breach of the Merger Agreement. ADS brought this action to recover a $170 million termination fee that ADS claimed Blackstone Capital Partners V L.P. (“BCP V”) owed it after the potential purchaser, Aladdin, failed to complete the acquisition of ADS.

A merger agreement was entered into on May 17, 2007, between ADS, Aladdin Solutions, Inc. and Aladdin Merger Sub, Inc. (Aladdin”), two companies formed by BCP V and its affiliates for the purpose of acquiring ADS. One of the conditions to Aladdin’s obligation to close the deal was regulatory approval from, among others, the Office of the Comptroller of the Currency (“OCC”) because ADS owned World Financial Network National Bank. The Merger Agreement contained a provision that if all of the necessary regulatory approvals were not obtained, neither party had to consummate the merger.

The Merger Agreement also contained specific language that Aladdin would use its “reasonable best efforts” to obtain the OCC’s approval. When the OCC’s approval was sought for the merger, the OCC refused to give approval unless Blackstone Group, L.P. (“Blackstone”) would “promise to provide any financial support necessary to make sure that World Financial complied with its minimum liquidity and capital requirements.” While BCP V was controlled by Blackstone, neither BCP V nor Blackstone signed the Merger Agreement (only Aladdin did). Moreover, the merger agreement imposed no direct contractual obligations on either Blackstone or BCP V to act to obtain OCC approval.

Blackstone rejected the OCC’s condition because it was not interested in putting up its own assets or the assets of its investment funds. Blackstone had formed BCP V, a $20 billion acquisition fund and a Delaware limited partnership, specifically for the purpose of acquiring ADS. After months of negotiations, Aladdin and OCC were at an impasse. The OCC refused to grant approval without Blackstone’s pledge of support for World Financial and a signed acknowledgement of “World Financial’s regulatory requirements.” The Court noted that “[a]s a bottomline, the OCC made it clear that ‘Blackstone must provide some type and measure of financial support for [World Financial].’” Blackstone ultimately refused to be responsible for ensuring that World Financial met its capital and liquidity requirements. As a result, the merger did not close on time prompting Aladdin to purport to terminate the Agreement and seek damages. In the Merger Agreement, specific performance was not an available remedy except in certain, defined circumstances. ADS accepted a cap on its ability to recover monetary damages for breach a — “Business Interruption Fee” — in the amount of $170 million from Aladdin.

ADS claimed that under the terms of the Merger Agreement, Aladdin was responsible for forcing Blackstone and its affiliated funds to agree to the OCC proposal and because Blackstone did not agree to what ACS considered to be a fair proposal, there was a breach of the merger agreement by Aladdin. Indeed, ADS characterized the demands from the OCC as “virtually costless” to Blackstone and as support for its claim, ADS referred to three provisions of the Merger Agreement: (i) §6.5.1, a covenant by Aladdin to use its reasonable best efforts to secure necessary regulatory approval, including OCC approval; (ii) § 6.5.6, a covenant by Aladdin to keep Blackstone from preventing the completion of the Merger; and (iii) §5.2, a representation by Aladdin that it had the power to fulfill its commitments under the Merger Agreement.

Unfortunately for ADS, as the Court noted, all three of the provisions ADS cited related to obligations of Aladdin and not Blackstone. While Aladdin did make certain promises in the Merger Agreement about Blackstone, those promises were “carefully cabined.” For example, in conjunction with the merger, BCP V entered into a “Limited Guarantee“ with ADS under which it promised ADS that it would guarantee Aladdin’s payment of the $170 million “Business Interruption Fee,” as well as up to $3 million in ADS costs related to the financing and debt tender offers. In addition, the Merger Agreement contained a negative covenant about what Blackstone would not do -- Aladdin agreed to a negative covenant for assurance that Blackstone would not thwart the Merger by taking action to impede its closing. There was no obligation on the part of Aladdin to ensure that Blackstone took affirmative steps to get the regulatory approvals or assent to OCC’s demands. In short, when Aladdin was contractually obligated for “causing Blackstone to do or not to do something, the parties made that explicit.”

Moreover, Vice Chancellor Strine found that as a preliminary matter “any contractual claim against the defendants must be predicated on a breach by Aladdin because it is the only party, aside from ADS, that signed the Merger Agreement.” The Court also noted that the “complaint only faults Aladdin because Blackstone, a non-party to the Merger Agreement, would not enter into arrangements with the OCC. But, Blackstone had no contractual obligation to enter into such arrangements, and Aladdin made no contractual promise that it would get Blackstone to do so.”
ADS tried to salvage the complaint by referencing extrinsic evidence in terms of what the parties discussed around the time the merger agreement was signed but the Court rejected that argument. ADS claimed that during “detailed due diligence and negotiations,” Blackstone knew that the OCC would require that Blackstone submit to some form of liability. The Court dismissed this argument stating that:

[i]f, as ADS alleges, it was obvious that the OCC would require not just Aladdin, but Blackstone itself, to enter into certain regulatory agreements, then ADS should have insisted that Aladdin be held responsible in the event that Blackstone failed to use best efforts to obtain regulatory approval.

* * * *

The time for ADS to have protected itself from the risk that the OCC would make demands that Blackstone would not accept was when negotiating the words of the Merger Agreement.

* * * *

Having struck a clear bargain, ADS cannot resort to extrinsic evidence to manufacture contractual obligations that are clearly foreclosed by an unambiguous Merger Agreement.

ADS also argued that “the implied covenant of good faith and fair dealing holds Aladdin responsible for the failure of Blackstone, a non-party, to enter into a regulatory agreement that Blackstone had no duty to accept is without force.” The Court rejected that argument on the basis that the expressed terms of the merger agreement were “inconsistent with any implied duty on Aladdin of this kind.”

Based upon the failure to state a claim under the Merger Agreement for breach, the Court dismissed the complaint.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

In Hexion Specialty Chemicals, Inc. v. Huntsman Corp.,  (Del. Ch., Sept. 29, 2008), read opinion here, the Delaware Chancery Court rejected the arguments of Hexion, which is 92% owned by private equity group Apollo, that it should be relieved of its contractual obligations to buy 100% of Huntsman's stock based on a July 2007 agreement that was valued at $10.6 billion. Hexion/Apollo argued that the "material adverse effect" clause  in the parties' agreement was triggered, and in light of a report (that the court found to be unreliable), that the combined companies would together be insolvent, it should not be required to complete the merger. (Wrong.)

A prior decision in this case was summarized on this blog here.

In this 91-page post-trial opinion, the court found that:

"the seller [Huntsman] has not suffered a material adverse effect, as defined in the merger agreement, and further concludes that the buyer has knowingly and intentionally breached numerous of it covenants under that contract. Thus, the court will grant the seller's request for an order specificaly enforcing the buyer's contractual obligations to the extent permitted by the merger agreement itself."

The court clarified its holding at page 86 and 87 of the opinion as follows:

"... the agreement does not allow Huntsman to specifically enforce Hexion's duty to consummate the merger. Instead, if all other conditions precedent to closing are met, Hexion will remain free to choose to refuse to close. Of course, if Hexion's refusal to close results in a breach of contract, it will remain liable to Huntsman for damages."

Moreover, the court held that:

"Hexion’s utter failure to make any attempt to confer with Huntsman when Hexion first became concerned with the potential issue of insolvency, both constitutes a failure to use reasonable best efforts to consummate the merger and shows a lack of good faith." (see  page 74.  Is "lack of good faith" here tantamount to "bad faith"?)

 As I did for the 100-page Chancery decision I summarized a few days ago on this blog, the only practical way to highlight this 91-page decision in an appropriate length for a blog post, is to use bullet points for selected key parts of the decision and then encourage readers to download the whole opinion at the link above if the issues addressed are of interest to them.

• Procedurally, it is notable that the Amended Complaint was filed on July 7, 2008 and expedited proceedings on limited issues were allowed on July 9, 2008, and a six-day trial started less than two months later, on September 8, 2008. That is what I call lightening speed, especially for a case of this magnitude.
• Hexion beat out Basell as a bidder for Huntsman even after Basell had signed an agreement at $25.25 per share, and Basell refused to raise its offer based on its assertion (almost ironic now) that it (Basell) was "more certain to close." Less than three weeks after Basell signed an agreement, Hexion signed an all cash deal to buy Huntsman for $28 per share.

         The MAE  Discussion

• The court's analysis and reasoning about why it did not find a trigger of the MAE clause can be found at pages 39 to 56 of the opinion. Footnotes 52 to 64 discuss some of the cases that the court relies on. For example, the logic of the Chancery Court's 2001 decision in IBP, although based on New York law, was still found applicable.
• The court observed that: "Many commentators have noted that Delaware courts have never found a material adverse effect to have occurred in the context of a merger agreement. This is not a coincidence."
• The burden of proof was placed on Hexion, as the party who first sought the declaratory judgment.

         The Breach of Contract Discussion

• Both parties claimed a right to a declaratory judgment that the other party committed a "knowing and intentional" breach. The court was critical of both parties' sloppy language and explained that such a phrase does not appear either in the Williston treatise on contracts nor in the Restatement of Contracts, and is more at home in criminal law.  The court noted at the end of footnote 87 by analogy that a "director need not know that his action breaches a fiduciary duty for liability for that breach to lie: gross negligence is sufficient for breach of a duty of care, and no showing of knowledge is required."
• As used in the agreement, a "knowing and intentional breach" was found by the court to include, as here, a deliberate commission of an act that constitutes a breach of a covenant in the merger agreement.
• The court emphasized the "fundamental proposition of contract law that damages in contract are solely to give the non-breaching party the "benefit of the bargain" and not to punish the breaching party". (see footnotes 89 to 92)(emphasis mine).
• The court found that Hexion failed to use its best efforts to consummate the financing and also failed to give Huntsman notice of its concerns. (The first time that Huntsman became aware of the insolvency opinion is when Hexion attached it to the complaint they filed--and publicized it at the same time to the bankers. Of course, this had a negative impact on the financiers' desire to finance the deal.)
• Footnote 99 refers to the section of the Williston treatise that describes the need for a breach by one party to be material before it can excuse performance by another party.

The court did not address the issue of whether the combined entity would be insolvent or not as it was not currently ripe. Of course, there is much more to be written on this case, but for a meager blog post, this is already longer than the average blog entry.

UPDATE:  The AmLaw Daily picked up this post here.  Law.com picked it up here.

UPDATE II:  Professor Bainbridge kindly links to this post here and provides his views from the hallowed halls of academia.

UPDATE III: The Wall Street Journal's  "Law Page" has picked up the post here.

• Email This
• Print
• Comments (1)
• Trackbacks
• Share Link