Private equity player cannot be forced into specific performance of a merger transaction where its repeatedly declared understanding that its potential liability was limited to paying the reverse break fee had not been challenged during negotiations by target's counsel
United Rentals, Inc. v. RAM Holdings, Inc.
Court of Chancery (Delaware)
December 21, 2007 . Civil Action No. 3360-CC
This Delaware ruling denied specific performance of a July 22, 2007 merger agreement ("the Agreement") between RAM Hol¬dings, Inc. and RAM Acquisition Corp. and United Rentals, Inc. (URI), the world's largest equip¬ment rental company. The two "RAM" entities - acquisition vehicles of private equity player Cerberus Capital Management, L.P. - agreed to acquire all URI common shares for around $7 billion, or $34.50 per share. The question was whether they could get out of this deal at the cost of the reverse break fee ($100 million) or whether the Agreement required specific performance.
In denying URI's request for specific perfor¬mance, Chancellor Chandler set out some important principles of contractual interpretation that have a direct bearing on how counsel conduct themselves in negotiating commercial agreements. Chancellor Chandler held, essen¬tially, that where, on its face, a contract under negotiation is unclear or ambiguous about a certain issue but one party clearly indicates that it understands it to mean X, the other party cannot remain silent and then hide behind the ambiguity when the first party attempts to exercise its rights under the relevant provisions of the contract on the basis that they mean X. Counsel must pay attention to the way that the other side is interpreting key provisions of the deal and make any objections to those interpretations clear.
The disputed clauses
The core of the dispute was whether the limitation of liability provision trumped the specific performance provision in the circumstances. URI's right to specific perfor¬mance was triggered, according to Section 9.10, "in the event that any of the provisions" of the Agreement "were not performed in accordance with their specific terms or were otherwise breached". As the drafts passed back and forth, however, counsel for RAM added the following qualification at the end of the section:
The provisions of this Section 9.10 shall be subject in all respects to Section 8.2(e) hereof, which Section shall govern the rights and obligations of the parties hereto (and of [Cerberus Part¬ners], the Parent Related Parties, and [URI]) under the circumstances provided therein.
While URI promptly deleted the sentence in the next round of drafting, RAM's counsel succeeded in reinstating it. Section 8.2(e), to which the specific performance right was subjected by Section 9.10, was a liability limitation, stating that the break fees were the "sole and exclusive remedy, including on account of punitive damages" for any loss suffered as a result of any termination in accordance with the termination provisions of the Agreement. Section 8.2(e) went on to state:
In no event, whether or not this Agreement has been terminated pursuant to any provision hereof, shall [RAM Holdings], [RAM Acquisition], [Cerberus Partners] or the Parent Related Parties, either indivi¬dually or in the aggregate, be subject to any liability in excess of the Parent Termination Fee for any or all losses or damages relating to or arising out of this Agreement or the transactions contem¬plated by this Agreement, including brea¬ches by [RAM Holdings] or [RAM Acquisition] of any representations, war¬ranties, covenants or agreements contained in this Agreement, and in no event shall the Company seek equitable relief or seek to recover any money damages in excess of such amount from [RAM Holdings], [RAM Acquisition], [Cerberus Partners] or any Parent Related Party or any of their respective Representatives.
The negotiating stances of the parties
The two provisions reproduced above were inserted by counsel for Cerberus/RAM late in the negotiations, against the backdrop of difficult discussions regarding the Commitment Letter by which Cerberus would (if URI had its way) guarantee the obligations of the RAM shell entities. A major issue was whether this guarantee would include a specific performance right allowing URI as a third-party beneficiary to require Cerberus to force the financing sources to fund the acquisition. Counsel for Cerberus made it clear that they were unwilling to entertain any exposure beyond the reverse break fee, but URI refused to budge. Counsel for Cerberus/RAM added the qualifications reproduced above, together with a paragraph in the Commitment Letter expressly stating that there were to be no third-party beneficiaries.
A conference call ensued during which it appears, on the basis of notes taken by counsel for Cerberus/RAM, that counsel for URI accepted that the reverse break fee would be URI's "sole and exclusive" remedy if Cerberus/RAM failed to close. URI advised that it was generally agreeable to the draft "as written", after which several other meetings followed to iron out details. Among these was the size of the reverse break fee, with URI insisting that it wanted a reverse break that was "scary" and "painful" for Cerberus/RAM.
Significantly, in preparing the next draft of the Agreement, counsel for URI had deleted the reference to "equitable relief" in Section 8.2(e) but agreed to reinsert it after Cerberus/RAM again made the point that the reverse break fee was to be URI's sole and exclusive remedy.
On November 14, 2007, RAM informed URI that it wished to renegotiate the deal. Alternatively it offered to pay the break fee. URI responded by suing for specific performance. The issue was whether that remedy was available or not.
The court first considered the issue earlier in December in the context of a summary judgment application by URI. In denying that motion, Chancellor Chandler had held that the arguments of the two sides were too "close" to grant URI specific performance in the absence of a trial. Rather impressively, he managed to conduct the trial within a few days and issue this judgment on December 21, 2007.
The first part of the trial ruling expands on what the court meant by "too close". Basically it was that both interpretations of the Agreement were plausible. Chancellor Chandler began by considering URI's side of the story. URI pointed out that specific performance was expressly named as a remedy under the contract, arguing that canons of construction required the court to "harmonize" Section 9.10 with the liability limitation in Section 8.2(e) rather than allowing the limitation to render the specific performance language meaningless or nugatory. URI butt¬ressed this with two related arguments: (i) that the "sole and exclusive" remedy was expressly described in the contract as being triggered exclusively by "termination", which was defined so as to exclude a breach, and (ii) that, when analyzed carefully, the reference to "equitable relief" in Section 8.2(e) refers only to equitable remedies involving monetary compen¬sation, rather than something like specific per¬formance.
While this was a reasonable interpretation, in the view of the court, RAM's alternative understanding was also reasonable. RAM had pointed to Delaware authority stating that a contractual provision stated to be "subject to" another provision could thereby be effectively nullified without breaching any "harmonization" canon. Nor was it necessary (RAM's counsel argued) to interpret "equitable relief" under the contract as limited to monetary relief - to do so required interpreting the words "in excess of." in Section 8.2(e) as modifying not only "money damages" but also the preceding words "equi¬table relief".
Shared intention and the "Forthright Negotiator Principle"
Because neither interpretation was clearly correct, the court had to consider extrinsic evidence about what the parties took the contract to say about specific performance. In spite of the fundamental disagreement over interpretation, the court looked for a shared intention but was unsurprisingly unable to find any explicit "consensus ad idem". However, Chancellor Chandler was willing to apply a looser test of shared intention known as the "Forthright Negotiator Principle", according to which:
.where the extrinsic evidence does not lead to a single, commonly held understanding of a contract's meaning, a court may consider the subjective understanding of one party that has been objectively manifested and is known or should be known by the other party.
Here, counsel for Cerberus/RAM had made clear on a number of occasions - both during negotiations and through numerous edits to the deal documents - the importance to its client of limiting liability to the reverse break fee and its belief that the language agreed to accomplished this. On the other hand, counsel for URI "categorically failed" to communicate the view that URI had advanced in this hearing. For example, during negotiations he had explained his (subsequently reversed) deletion of "equitable relief" from the draft agreement to opposing counsel as a "technical and non-substantive" change rather than as a reflection of a yawning gap between the parties on the issue of specific performance. Nor, on learning of a statement by a Cerberus officer that he regarded the deal as amounting to the purchase of an option, did URI's counsel press the point that this was not how URI saw the deal.
Thus the fact that Cerberus/RAM subjectively believed that the contract precluded specific performance (and said so), coupled with the failure by URI's counsel to assert the contrary, meant that Cerberus/RAM's interpretation should prevail. In other words, in a case where the terms of the contract were consistent with each side's interpretation, one side prevailed simply because repeated clear assertions of its understanding during negotiations had not been vigorously challenged by opposing counsel.
On its face, the lesson of United Rentals is that you should voice your objections clearly if the other side tells you that it interprets a proposed contractual provision in a manner that differs from your own understanding of it. Unless the other view is unreasonable, it may end up being imputed to you, to the detriment of your client.
From the practical point of view, however, our suspicion is that the contract interpretation point will have limited real-world impact. While in this case the court chose not to find for either side on any of the usual interpretive principles - the "plain language" of the terms of the contract, the "commercial sense" approach, or an actual (if unwritten) understanding between the parties - most future cases of this type are likely to be decidable on the basis of one of these tried-and-true principles, without resorting to Chancellor Chandler's "forthright negotiator" rule.
The true significance of the ruling may be to demonstrate that the Delaware courts seem to be willing to go to considerable lengths - even to conjure up a new principle of contractual interpretation - in order to avoid specific enforcement of merger agree¬ments where the parties have negotiated reverse break fee provisions. At a time when many proposed deals are in difficulty, the result may be to encourage more private equity players to walk away from deals that no longer make sense to them.