A recent Delaware Supreme Court decision provides a lesson for drafters of agreements for the sale of a business by providing an example of the problems caused by a lack of clarity in describing a deadline to send notices of claims for indemnification post-closing. To paraphrase a former member of the U.S. Supreme Court, the Delaware Supreme Court is always right when it comes to deciding Delaware law not because the members of the Court are infallible, but rather because they always have the last word. The reader can decide how that aphorism applies to the decision of a divided court in the matter of North American Leasing v. NASDI Holdings, Del. Supr., No. 192, 2020 (April 11, 2022).
The court decided three issues in this case. First, whether the Delaware Court of Chancery erred in interpreting an agreement of sale according to the principles of Delaware contract law in connection with determining what the deadline was in the agreement for giving notices of indemnification claims. Second, the court decided whether an affirmative defense of set-off and recoupment was waived. Lastly, the court decided whether it was appropriate for the Court of Chancery not to consider evidence that the total amount of the claims should have been reduced. Three members of the Delaware Supreme Court affirmed the decision of the Court of Chancery, and two dissented from the majority opinion.
Key Background Facts
This case involved the sale of a company that, among other things, was involved in the construction of bridges. One of the bridge projects underway at the time of the closing on the sale of the business had a bond in place that the seller posted in the approximate amount of $20 million. After the closing, because the buyer decided to discontinue work on the bridge project, the letter of credit was drawn down in the full amount of the bond. The seller sued the buyer setting forth three causes of action: breach of contract regarding an indemnity obligation; equitable subrogation; and a claim for declaratory judgment that the defendants breached their indemnity obligation.
The Court of Chancery granted summary judgment in favor of the seller and also denied a motion for reargument. In connection with the motion for the entry of the final judgment, the Court of Chancery determined that the affirmative defense of set-off/recoupment was waived because it was not raised in response to the motion for summary judgment, or in the motion for reargument.
The majority decision acknowledged that questions of contract interpretation on appeal are reviewed de novo. Delaware’s high court observed that Delaware law adheres to an objective theory of contracts, which means that the construction of a contract should be “that which would be understood by an objective, reasonable third party.” That theory gives priority to the intentions of the parties reflected in the four corners of the agreement, “construing the agreement as a whole and giving effect to all its provisions.”
The majority opinion carefully considered the various provisions of the agreement at issue and examined the reasoning of the Court of Chancery which rejected the buyer’s arguments that Section 9.3(a) provided for a deadline which ended before the indemnification claim of the seller arose, which would have rendered the indemnification notice untimely.
The decision turned in large measure on the reading of one phrase. The majority explained its reasoning for the interpretation of the phrase “but in any event” as introducing an exception to the sentence that followed—not a limitation of the phrase that followed.
The majority also agreed with the Court of Chancery’s conclusion that the set-off/recoupment defense was waived. The buyer argued that set-off/recoupment was a defense that pertained to damages, and damages did not need to be briefed in the motion for summary judgment. Not so, according to those with the last word on the topic, because damages were central to the relief requested in the motion.
Regarding the last issue of damages, the Supreme Court concluded that the Court of Chancery did not err when it did not consider the evidence regarding the reduction of damages because the set-off/recoupment defense was waived.
Notably, both the majority and the dissent agreed on the basic contract principles of Delaware law that applied to this case, although they disagreed on the result after applying those principles to the facts.
A substantial focus of the dissent was its different interpretation of the phrase “ in any event,” and whether: it applied to all indemnification claims; or it only applied to the “representations and warranties” claims. The majority held that the phrase created an exception, but the dissent explained why in its view the phrase introduced a limiting or qualifying clause. The dissent referred to a dictionary definition for the adjective “any” as meaning “without limitation.” The phrase “in any event” means “no matter when [an event] happens.”
The dissenters explained that the drafters of the agreement could have used the verb “the” instead of the word “any”—if the drafters wanted to establish an exception to the deadline for sending a notice of claim.
Moreover, the dissent noted that even if the deadline for the notice of a claim were missed, the seller could still rely on equitable subrogation as a basis for a claim. The dissent added that the availability of that remedy supports the view that an earlier notice deadline would make an indefinite period for indemnification claims unnecessary.
The dissent included the following memorable quote: “The majority sacrifices the plain meaning of Section 9.3 on the altar of the context of the provision and the contract as a whole.” The dissent concluded by explaining that its view demonstrated more than one reasonable interpretation of the agreement, which is one definition of an ambiguous contract. Therefore, the trial court should not have granted summary judgment and, in the view of the dissenting opinion, should have considered extrinsic evidence.