The Delaware Supreme Court recently clarified Delaware law regarding a unilateral mistake in a contract where one party has knowledge of the mistake yet remains silent. In Scion Breckenridge Managing Member, LLC v. ASB Allegiance Real Estate Fund, the Court affirmed the Court of Chancery's decision to reform joint venture agreements between The Scion Group, LLC ("Scion") and ASB Capital Management, LLC ("ASB"), holding that that reformation of a contract based on a unilateral mistake is available where a party can show that it was mistaken and that the other party knew of the mistake but remained silent. The Court also expressly overturned all Delaware cases stating otherwise or imposing additional requirements regarding contract reformation in such situations.
In October 2006, ASB proposed a "20% above an 8% preferred return" promote structure to Scion in connection with their first joint venture project, meaning that Scion would receive 20% of the incremental profits after the project generated an 8% preferred return. Accordingly, the distribution "waterfall" provisions in the joint venture's LLC agreement provided that the parties would receive distributions in proportion to their respective percentage equity investments until each member received an amount equal to an 8% preferred return on that investment. Under this structure, after ASB recouped its investment and the 8% preferred return, Scion would then receive a promote payment equal to 20% of the excess profits, with ASB and Scion splitting the remaining 80% in proportion to the ratio of their respective equity investments. After the first joint venture project, the parties entered into additional joint ventures on the same terms as those in the initial joint venture. However, due to a drafting error by ASB's attorneys, the distribution waterfall in each subsequent joint venture LLC agreement was incorrect and would result in Scion earning its promote before ASB recouped its capital investment - contrary to the parties' initial intent.
Here, the Court clarified its ruling in Cerberus International, Ltd. v. Apollo Management, L.P., 794 A.2d 1141 (Del. 2002), in which the Court did not take a position on whether a party's "misconduct" could bar a reformation of contract claim, causing some confusion among practitioners. To resolve the confusion, the Court adopted the standard in the Restatement (Second) of Contracts, which provides that for purposes of a reformation claim, a mistaken party's fault in failing to discover the facts before making the contract does not bar a reformation claim unless the party's fault amounts to failure to act in good faith and in accordance with reasonable standards of fair dealing. Applying the standard to this case, the Court held that ASB acted in good faith and in accordance with reasonable standards of fair dealing. More specifically, the Court found that ASB was not barred from asserting a reformation claim, even if ASB's President failed to read the LLC agreements, as a senior decision maker may rely on his employees and advisors. The Court also concluded that there was knowing silence on the part of Scion, who stood to benefit from the mistake in the LLC agreements.
Scion Breckenridge Managing Member, LLC v. ASB Allegiance Real Estate Fund, No. 437, 2012 (Del. May 9, 2013).