A recent Delaware Supreme Court decision is noteworthy for the approach it takes in determining the meaning of a word in an agreement, for example, by parsing the syntax and sentence structure where the word appears in the agreement. In Borealis Power Holdings Inc. v. Hunt Strategic Utility Investment, L.L.C., Del. Supr., No. 68, 2020 (May 22, 2020), the Delaware Supreme Court provides useful guidance about how to determine the meaning of a key word in an agreement. In this matter, despite a lengthy definition in the agreement of the word “transfer”, the parties still disputed its meaning.
The underlying dispute involved a complex constellation of interrelated entities which the court provided a graphic description of by way of a chart. The essential facts on which the dispute was based involved the interpretation of an LLC agreement which imposed restrictions on the transfer of LLC units and provided for the right of first refusal and other provisions triggered by a “transfer.” Several terms were defined in the agreement–with rather lengthy definitions–but the definitions did not provide sufficient clarity. The most consequential definition that was disputed was the meaning in the context of the agreement of the word “transfer.”
The problem presented to the Court of Chancery was whether the sale of an interest triggered either a right of first refusal and/or a right of first offer, and if both applied, which was to be given priority.
The Court of Chancery concluded that a sale by Hunt of its shares to Borealis would be a “transfer.” The Supreme Court had a different view.
The finding by the Court of Chancery that the purchase of Hunt’s shares constituted a transfer, triggered the requirement to offer the shares to Sempra. As a result of other consequences of that holding, the Court of Chancery found that Sempra was the only party with the right to purchase the Hunt shares, and entered judgment in favor of Sempra. This expedited appeal followed an expedited trial. It remains noteworthy that this opinion came only 30 days after the final submission of the appeal to the Supreme Court.
Analysis by the Supreme Court:
The Supreme Court held that the right of first refusal in Section 3.9 of the agreement at issue is only triggered by transfers by the Minority Member and its Permitted Transferees, and that Hunt is neither. Put another way, Delaware’s High Court held that the fact that the right of first refusal is only triggered by transfers by the Minority Member is dispositive in favor of Borealis, regardless of whether the Hunt Sale could be said to effect an indirect transfer.
One of the agreements involved was governed by New York law and one was governed by Delaware law–but the court noted that the law of both states as it relates to contract interpretation in this case is the same. See footnote 22.
Two other footnotes contain important observations of Delaware law that are especially worth remembering:
(1) The management of an LLC is vested in proportion to the then-current percentage or other interest of members in the profits of the LLC owned by all the members, and “the decision of members owning more than 50% of the said percentage or other interest in the profits [is] controlling.” Footnote 27. See Section 18-402 of the Delaware LLC Act.
(2) Also noteworthy is the observation by the Court that an argument that was only raised in a footnote would justify “passing over it” because footnotes, according to Delaware Supreme Court Rules, “shall not be used for argument ordinarily included in the body of a brief.” Footnote 28. See Del. Supr. Ct. R. 14 (d)(iv).
The most noteworthy parts of this pithy 21-page decision are found in the last few pages which include the core of the court’s reasoning.
In particular, the most memorable part of the Court’s reasoning is the parsing by the court of the syntax and sentence structure of the agreement in order to interpret the meaning of a particular word in the agreement. The court focuses on the “subject of the operative sentence” in Section 3.1, of which “the verb phrase ‘may only transfer’ serves as the predicate.” The court further explains that the subject of the operative sentence is neither accidental nor unimportant because it is the same subject for which the verb phrase “intends to transfer” serves as the predicate in section 3.9.
The Court added that the subject, which is stated conjunctively, does not include Hunt. Therefore, the court reasoned that it was unnecessary and inappropriate to parse the definition of transfer, as defined in the agreement, to determine the scope of Section 3.1 and Section 3.9, because: “the subjects of the opening sentences in both of those sections do that for us.” See Slip Op. at 20 – 21.
Although the detailed factual background needs to be reviewed more closely in order to fully understand the Court’s reasoning, for anyone who wants to understand Delaware law regarding proper contract interpretation, and interpretation of the meaning of a word, even when it is defined in an agreement, this opinion is must-reading.