In another decision that demonstrates the importance of clear drafting, a New York trial court recently held that a party having the option to acquire units in a limited liability company could do so notwithstanding the fact that it had allegedly breached its obligation to lend $100 million to the optionee. In so ruling, the court found that, although the loan agreement and option agreement were executed at the same time as part of the same transaction, they were independent agreements to be read and enforced individually. Schron v. Grunstein, No. 650702/10 (N.Y. Co. 2011).

A Complex Acquisition of Assets

This saga begins with the purchase by the plaintiff real estate investors of the assets of Mariner Health Care, a large nursing home company, for approximately $1.3 billion. The structuring of the transaction was allegedly complicated by the plaintiffs’ desire to purchase the real estate assets while segregating the management and operations portion of the business to a separate entity.  

To that end, two agreements, among others, were executed. The first, a Loan Agreement, obligated one of the plaintiffs, Cammeby’s Funding III LLC (“Cammeby’s”), to loan $100 million (the “Loan”) to defendant SVCARE Holdings LLC (“SVCARE”). Separately, the parties executed a Limit Purchase Option Agreement by which plaintiff Cammeby’s had the option (the “Option”) to purchase 99.9997% of the membership units in defendant SVCARE for $100 million.  

Cammeby’s exercised its option under the Option Agreement to purchase the SVCARE membership units. The defendants refused to honor that Option exercise on the ground that the plaintiffs had failed to fund the Loan. The plaintiffs sued, alleging a breach of the Option Agreement. In response, the defendants contended that plaintiff’s funding of the $100 million Loan was necessary to the viability of its exercise of the Option.

The central issue in dispute before the court therefore became whether the Option Agreement and Term Agreement were independent agreements, or constituted a single agreement that should be read jointly. The defendants offered three justifications for reading the agreements together: (1) the parties had intended the two agreements to be read together, (2) funding of the Loan was the consideration for the Option granted in the Option Agreement, and thus its funding was essential to the effectiveness of the Option, and (3) even if funding of the Loan was not consideration for the Option, the funding of the Loan was a condition precedent to the exercise of the Option. The court relied on basic contract principles in rejecting each argument.

General Principles of Contract Interpretation

The court began by noting that contracts are presumed separate “unless their history and subject matter show them to be unified,” which is determined by examining the parties’ intent as manifested at the time of the formation of the contracts “viewed in light of the surrounding circumstances.” Unless evidence of the parties’ intent demonstrates otherwise, the Option Agreement and the Loan Agreement constitute independent agreements, and the plaintiff’s failure to fund the Loan would not relieve the defendants of their obligation to sell under the Option Agreement. The court proceeded to consider several aspects of the Option Agreement form to assess the intent of the parties.

The court first noted that the Option Agreement and the Loan Agreement were “separate written agreements with separate assents,” and lacked complete identity of parties. Further, the agreements did not explicitly incorporate or cross-reference one another, even where the opportunity was presented. For example, the Option Agreement referenced a “credit facility” to be funded by one of the plaintiffs, but it neither identified the Loan Agreement as the facility nor stated that the loan’s funding was consideration or a condition of the agreement. The court noted that the agreements were executed and amended on the same dates and the parties, as sophisticated business people, easily could have written the two documents to incorporate one another had they so desired. That the parties did not integrate the documents given the opportunity to do so was a strong indication to the court of their intent that the documents were independent agreements, to be read and enforced separately.

The Merger Clause

The defendants pointed to the fact that the Loan amount and the Option price were identical at $100 million, arguing this was evidence of their interdependence, thereby creating an ambiguity that would allow the court to reach outside the four corners of the Option Agreement and read the agreements together to resolve the ambiguity. The court rejoined that the Option Agreement on its face was clear and contained a merger clause, thus precluding the defendants from referring to the Loan Agreement to interpret the Option Agreement.

Merger clauses are generally viewed as demonstrating the intent of the parties that the parol evidence rule should apply to preclude the use of parol evidence—in other words, that an agreement should be interpreted without reference to extrinsic evidence, such as the terms of other agreements. The court qualified its assessment of the merger clause by noting that extrinsic evidence may be introduced despite the existence of such a clause where a contract is ambiguous. A contract is not ambiguous, however, “if the language it uses has a definite and precise meaning, unattended by danger of misconception.” In the face of an unambiguous contract, the “mere assertion” by a party that language in the agreement has some other meaning is insufficient to create ambiguity. The parol evidence rule thus precludes the need for discovery in interpreting a clear and integrated agreement, because a court need not look beyond the four corners of the contract at issue.  

Because the Option Agreement contained a strongly worded merger clause, the court held that the parol evidence rule barred the use of extrinsic evidence to create ambiguity in the contract which was otherwise “complete and clear.” The defendants could not use the Loan Agreement to attempt to inject uncertainty into the interpretation of the Option Agreement and upset the court’s conclusion that the parties intended the agreements to remain separate.

Lack of Consideration

The defendants next contended that the Loan Agreement constituted the consideration for the Option Agreement, and the loan’s funding therefore was a condition precedent to the exercise of the Option. The Option Agreement stated that the consideration therefor was the exchange of “mutually beneficial covenants” contained within the Option Agreement itself—the “option to repurchase the company at a set price,” in exchange for the defendants’ right to profit from the upside of a subsequent sale by the plaintiffs. The court acknowledged that under applicable precedent, the receipt of consideration named in a contract can be disputed with extrinsic evidence. Nevertheless, such an exception applies only where an agreement merely names the consideration to be exchanged outside of the contract. Where, as here, the consideration was provided for in the Option Agreement itself, and the Agreement did not recite Loan funding as part of its consideration, the court rejected the suggestion that the funding of the Loan had any impact on whether valid consideration was exchanged for the Option Agreement.  

Conditions Precedent

Finally, the court rejected the defendants’ argument that funding of the Loan constituted a condition precedent to the enforceability of the Option Agreement. The court observed that, to create a condition precedent, clear contractual language must exist demonstrating that the parties intended such. As no such clear conditional language appeared in the Option Agreement, the court rejected the defendants’ argument that funding of the Loan was a condition precedent to the enforceability of the Option Agreement.  

Conclusion

The parties here very well may have intended that the Option Agreement and the Loan Agreement be read in tandem. That would make perfect business sense. But they did not take the opportunity to make that clear in the documents themselves. Because the terms of the agreements failed to establish any intent that the Option Agreement and the Loan Agreement constituted a single agreement, that the funding of the Loan was consideration for the Option Agreement, or that the funding of the Loan was a condition precedent to the exercise of the Option, the court dismissed the defendants’ claim to void the Option Agreement based on the plaintiff’s alleged failure to fund the Loan.