Chancery Court Reforms Management Agreements
This article was originally published in the In Delaware, the Court of Chancery has the power to reform an agreement that "fails to express the [parties'] real agreement or transaction," as in Miller v. National Land Partners LLC, C.A. No. 7977-VCG, at 34 (Del. Ch. June 11, 2014), citing Amstel Associates LLC v. Brinsfield-Cavall Associates, (Del. Ch. May 9, 2002). However, for a plaintiff to obtain reformation based on a mutual mistake, he or she must demonstrate by "clear and convincing evidence" that the written agreement failed to reflect accurately the oral agreement reached by the parties.
In Miller, the court decided whether management agreements between real estate development partners should be reformed to require a 12.5 percent guaranteed profit to one of the partners. The dispute arose in the context of an almost $5 million transfer, based on the guaranteed profit, that would have had the effect of reducing compensation due to one partner's spouse under a divorce decree. Following trial, the court found the burden of demonstrating a mutual mistake had been met and that, because the missing term requiring the payment was inadvertently deleted, the management agreements should be reformed.
The plaintiff, Donna Miller, filed the action seeking to void the $5 million transfer her husband made from their company, Hunter Co. of West Virginia (HCWV), to its real estate development partner, National Land Partners LLC. Miller alleged that the transfer was contrary to the express provisions of the parties' management agreements and made for the sole purpose of defeating her ability to collect upon equitable distribution of HCWV. In response, the defendants—HCWV, National Land Partners and Miller's husband, Leon Hunter Wilson—sought reformation of the management agreements on grounds that the language requiring the payment to National Land Partners was inadvertently deleted. Under the arrangement between National Land Partners and HCWV, HCWV identified and prepared properties for development, and National Land Partners acquired the properties and provided employees who, at Wilson's direction, advertised, marketed and sold building lots. Although HCWV and National Land Partners originally agreed to divide their land development profits evenly, they subsequently modified their arrangement to provide that National Land Partners receive a guaranteed preferential profit of 12.5 percent of gross sales. Under the modified arrangement, National Land Partners would receive the first 12.5 percent of profits, and HCWV would receive the balance. If, however, a project failed to generate the requisite 12.5 percent profit, HCWV was liable for any shortfall in the form of "negative manager fees." The parties first included contract language guaranteeing the 12.5 percent profit in their January 2002 management agreement. Under that agreement, HCWV began to accrue negative manager fees as a result of projects that failed to generate sufficient profits. It was Miller's contention that, later in 2002, during a trip to Bermuda, the parties agreed to eliminate the language guaranteeing National Land Partners a profit. Although Miller was not directly involved in the negotiations, she based her understanding of the outcome on Wilson having voiced concerns about the guaranteed profit provision and appearing to be much happier following the negotiations in Bermuda. In contrast, Wilson testified that his happiness resulted from the expected return on the next development project, not from eliminating the guaranteed profit provision. Importantly, following the Bermuda trip, HCWV and National Land Partners entered into a project addendum, which included the guaranteed profit provision. Although the disputed language was included in the project addendum, it was not included in the next contract the parties executed—the 2003 management agreement. As a result, Miller argued that National Land Partners was no longer entitled to the 12.5 percent preferential profit and HCWV was no longer required to pay negative manager fees for any shortfall in such profits. The defendants argued that a scrivener's error was to blame for the deletion of the guaranteed profit provision. Relying, in part, on the testimony of National Land Partners' chief financial office, who prepared the various management agreements, the defendants argued that they expressly agreed that the 2003 management agreement should mirror the project addendum, including with respect to the guaranteed profit provision. The CFO testified that he inadvertently deleted the language at issue when he removed certain surplus language following that contract term. Despite the CFO's deletion of the guaranteed profit provision, the parties continued to account for the negative manager fees when projects failed to generate sufficient gross sales to pay National Land Partners' preferential profit. In June 2005, Miller filed for divorce. At that time, HCWV was managing six real estate projects for National Land Partners that were governed by either the 2003 or 2004 management agreements. Miller alleged that, in connection with their divorce, she and Wilson agreed that, in exchange for distributing her 50 percent interest in HCWV to Wilson, Miller would receive the value of her 50 percent interest at equitable distribution. On Nov. 21, 2008, the Family Court entered a final order of divorce, which found the net value of HCWV was about $8.9 million and ordered Wilson to pay more than $4.9 million to Miller. In December 2008, following the final order of divorce, HCWV transferred approximately $5 million to National Land Partners, primarily to cover outstanding negative manager fees. Miller claimed this transfer was a fraudulent conveyance made for the purpose of avoiding the payment due to her.
It was the defendants' position that they mutually agreed that HCWV would be responsible for negative manager fees, but that the guaranteed profit provision was inadvertently deleted from the 2003 and 2004 management agreements as a result of a scrivener's error. Alternatively, the defendants contended that their course of conduct demonstrates that the negative manager fees were to continue to be included in their arrangement. The court found that the evidence presented at trial clearly and convincingly demonstrated that the 2003 and 2004 management agreements did not reflect the defendants' arrangement. First, the court found that the 2002 management agreement and the project addendum, entered into before the agreements at issue, included the guaranteed profit provision. That this provision was not included in the 2003 management agreement resulted from the CFO inadvertently deleting it, as follows: "I find that it was inadvertently removed when [the CFO] intentionally deleted a sentence that appeared in the project addendum—following the shortfall language—from the 2003 management agreement, which was then used as a template for the 2004 management agreement. In other words, I find that in removing the surplus language from the project addendum to form the 2003 management agreement, [the CFO] also, inadvertently, removed the language making HCWV liable for negative management fees." Next, the court found that the inadvertence of the deletion was strengthened by the fact that the transition from the project addendum to the 2003 management agreement occurred while a project was already under way, which suggested the parties did not intend to change their arrangement during an ongoing project. The court credited the testimony of Wilson, who indicated: "All we did was change [the] form of documents. Any negotiation or anything that was done with this deal was done ... in July of '02, the year before. We already had the deal running. We weren't going to change horses in the middle of the road." The court further found it compelling that the parties continued to account for negative manager fees while pursuing their subsequent joint development projects. Negative manager fees were also paid for projects under a 2006 management agreement, which had no bearing on the divorce proceedings. This course of conduct contributed to the court's finding that the defendants credibly and clearly demonstrated at trial that they did not intend to change their arrangement between the project addendum and the subsequent management agreements. Regarding Miller's claim that the transfer was made for the improper purpose of avoiding payment under the divorce decree, the court found that the "timing does not demonstrate that these fees were not owed under the defendants' arrangement." Importantly, the court found unconvincing the argument that Wilson would cause HCWV to pay millions of dollars that it did not owe simply to avoid paying a portion of that amount to Miller. At trial, Wilson indicated, "It just doesn't make sense. You wouldn't spend $10 to save $1, would you?" The court also analyzed Miller's claims with respect to the negotiations in Bermuda, and the date certain accounting statements were printed, and determined that they did not rebut the defendants' clear and convincing evidence. Accordingly, the court reformed the 2003 and 2004 management agreements to reflect the parties' true agreement, which was to include the guaranteed profit provision.
Although the heightened clear and convincing standard for reformation of an agreement is difficult to meet, it certainly is not impossible. The opinion in Miller demonstrates that reformation is obtainable when supported by evidence demonstrating the true intent of the parties, how the scrivener's error occurred and a course of dealing consistent with the parties' rights and obligations under the language to be reformed. Where the trial testimony and relevant documents are consistent in demonstrating that the parties simply made a mistake in memorializing the terms of their agreement, the Miller decision provides that reformation is a viable option for correcting such an error.
Delaware Business Court Insider | August 5, 2014