Chancery Court Rules Against Enforcement of a Call Right Due to Failure to Tender the Contractual Consideration

By: Jill B. Louis and Gilbert A. Perales

In Simon-Mills II, LLC, et al., v. KanAm USA XVI Limited Partnership, et al., C.A. No. 8520-VCG (Del. Ch. March 30, 2017), the Court of Chancery denied Plaintiffs’ request to enforce its call right and granted Defendants’ request for declaratory judgment when the contracted consideration for the call right could not be tendered.

This litigation arose from a series of Joint Venture Agreements (the “JV Agreements”), the parties to which included the Plaintiffs (collectively “Simon” or the “Simon Entities”) and the Defendants (collectively “KanAm” or the “KanAm Entities”). The JV Agreements permitted Simon to purchase KanAm’s interests, at a time and for a price set out in the JV Agreements. Following the passage of time and a series of transactions that changed the corporate identity of the parties, the parties found themselves in a dispute regarding the nature of consideration to be tendered in the exercise of a call right.

The obligations sought to be enforced under the JV Agreements arose out of several different contracts, negotiated at various times going back to the 1990’s, with several different contractual parties involved. The purpose of the JV Agreements was to govern the JV Limited Partnerships, which are Delaware limited partnerships comprised of numerous retail shopping development projects, seven of which were at issue in the case.

The original parties to many of the JV Agreements were KanAm and non-party Mills, consisting of the Mills Limited Partnership (“Mills Partnership”) and the Mills Corporation (“Mills Corp” and together with “Mills Partnership,” “Mills”), which were real estate investment vehicles. The KanAm Entities were structured as Delaware limited partnerships, with German investors as limited partners, to provide an investment vehicle for German investors to deploy capital in American-based retail-store development projects. Mills’ structure provided the tool for KanAm to provide its limited partners with investment opportunities while simultaneously providing liquidity and non-recognition tax benefits. Specifically, Mills Corp was structured as an umbrella partnership real estate investment trust (“UPREIT”), where Mills Corp served as the general partner to and the majority owner of Mills Partnership, and the limited partnership units of the operating partnership, Mills Partnership, (“Mills Units”) which directly or indirectly owned all of Mills Corp’s assets, were redeemable and could be converted into publicly traded stock of Mills Corp. At the time of Mills Corp’s 1994 IPO, KanAm held approximately 41% of the outstanding partnership units of the Mills Partnership.

Following the 1994 IPO, the Mills Corp Board and its shareholders approved a proposal in early 1995 that set out a framework whereby KanAm could contribute equity to certain projects going forward as joint ventures with Mills Corp (the “Shareholder Resolution”). Among various other provisions, the “general terms” provided certain exit mechanisms including that each partner would have a right of first refusal to purchase the other’s interest. The consideration required in the Shareholder Resolution for the put/call of KanAm’s interest was to be paid for in any combination of cash or Mills Units meeting certain criteria as agreed to by the parties.

In September 1995, KanAm and Mills signed a JV Agreement for Ontario Mills. The September 1995 Ontario Mills agreement between KanAm and Mills provided a buy/sell provision consistent with the Shareholder Resolution. Prior to execution of that JV Agreement, Simon and Mills executed an agreement on August 16, 1995 that provided the principal terms and conditions for proposed joint venture arrangements regarding certain future projects. When Simon was later added to the Ontario Mills JV, the JV Agreement was amended to reflect that circumstance. The amendment revised the buy/sell consideration section to provide that the default consideration was to be two-thirds Mills Units, and one-third Simon Units in the event the call was exercised. The reason for the amendment to the buy/sell consideration to include Simon Units was that Simon Units were required consideration in order for the non-recognition tax benefits.

While the Ontario Mills JV Agreement contained a fixed percentage of Simon to Mills Units as the call consideration, the subsequent agreements in Concord Mills, Grapevine Mills, and Arundel Mills (the “Initial JV Agreements”) provided that unit consideration would be paid “ratably in proportion to the ownership interests.” The three agreements at issue during this time period, however, did draw certain distinctions between Simon and Mills Units, including the extra requirement that contractually-compliant Simon Units must have the most favorable rights (including redemption, conversion, registration and anti-dilution protection) of any units of Simon.

In 2002, Simon exited three JV Agreements at issue in the litigation, Grapevine Mills, Concord Mills and Arundel Mills, after it reached an impasse with Mills. These were the only KanAm/Mills JV Agreements in which Simon had an interest at the time. After Simon’s exit, KanAM and Mills amended the governing documents of the three JV Agreements to remove all references to Simon Units. These amendments referenced the Mills Units meeting certain criteria as the default consideration for the JV Agreements’ buy/sell provision.

Mills began facing financial troubles in early 2005, including multiple financial restatements as a result of accounting issues. Because there was doubt as to whether Mills could continue as a going concern in 2006 due to looming deadlines for repayment of approximately $2 billion in debt, it obtained a rescue loan from Goldman Sachs and began to market itself. As part of the sales process, a memorandum was distributed to potential buyers, including Simon, that stated the “Put-call rights enable . . . Mills to require KanAm to sell its interests to Mills for cash or partnership units of Mills LP, the choice of consideration to be made in KanAm’s sole discretion.” Simon with a non-party Farallon (the “Simon-Farallon JV”) eventually acquired Mills and dissolved it in 2007. Both KanAm and Simon knew that as a result of Mills’ dissolution problems might arise should Simon enforce its call right against KanAm since Mills Units were no longer available.

Simon, through its JV with Farallon, returned to the Initial JV Agreements. The parties, however, failed to renegotiate or alter the buy/sell consideration provisions to account for Simon-Farallon’s entry, and Mills’ exit. Therefore, the Mills Units, despite their unavailability, remained the default consideration for the Initial JV Agreements. The Simon-Farallon JV’s acquisition of Mills also included three JVs at issue here to which Simon was not an original party—Colorado Mills, Katy Mills, and Orange City Mills (the “Other JV Agreements”). The buy/sell consideration provisions in these agreements also called for Mills Units and were not revised despite the entry of the Simon-Farallon JV.

In October 2007 the Simon-Farallon JV, following its acquisition of Mills, and KanAm entered into a new JV known as Denver West. Denver West was the only JV entered between KanAm and Simon following the Simon-Farallon JV’s acquisition of Mills. Additionally, it was the first new JV entered since Mills Units became unavailable. The negotiation over the Denver West JV Agreement included negotiations over the aforementioned buy/sell provision (which was included in the JV Agreement because the Colorado Mills JV Agreement was used as a template) with both sides noting the issues with the unavailability of the Mills Unit since they were the default consideration in the agreement. However, while the parties identified the non-cash consideration issue, they ended up negotiating around it and ultimately avoided reaching a resolution of it in entering the Denver West JV. During this time period, there were no internal communications at Simon reflecting their understanding that Simon Units were appropriate consideration to enforce its call right against KanAm.

In 2008, a refinancing was required in the Grapevine Mills project. And the parties successfully amended the Grapevine Mills JV Agreement in light of the refinancing, but the buy/sell consideration of Mills Units was not changed.

In March 2012, Simon had a falling out with Farallon and acquired Farallon’s interests in the Mills Partnership. In connection with the acquisition, Simon and KanAm executed an indemnity agreement (the “2012 Agreement”). The 2012 Agreement was presented initially to KanAm by Simon’s General Counsel, who advised that [t]here would be no changes required to existing venture agreements at property level companies. That is, the 2012 Agreement preserved existing contract rights, including KanAm’s right to insist on a tender of Mills Units.

In April 2012, Simon first indicated its interest in exercising the call, and shortly after exercised the call. KanAm did not immediately raise its current position that it could insist on Mills Units, and could thus thwart the call’s operation. KanAm did not raise this issue to Simon until after it signed two extensions to the buy/sell window in 2012. However, the call was not triggered that year. And in the fall of 2012 the Concord Mills JV Agreement was amended; however, no change was made to the buy/sell provision. During this period KanAm offered to renegotiate the buy/sell consideration— including at an in-person meeting with Mr. Simon in 2013. Simon declined, and ultimately initiated this suit while triggering the call provisions.

The Court of Chancery began its analysis by explaining that since this was a contract action the threshold inquiry was what are the terms of the buy/sell provisions of applicable contracts—the parties’ JV Agreements. The court then noted that in Simon-Mills II, LLC v. Kan Am USA XVI Ltd. P’ship, 2014 WL 4840443 (Del. Ch. Sept. 30, 2014) (“Simon I”) it found that the contracts unambiguously provided that the default consideration when exercising the call was Mills Units meeting certain criteria. But the court in that case denied the cross motions for summary judgment because it needed to determine whether the parties had a meeting of the minds that some other consideration could be tendered, or, conversely, as to whether the call right would be rendered nugatory. Therefore, the court next determined if there was ever a meeting of the minds between the parties about whether Simon Units were a contractual substitute for Mills Units if Simon tried to enforce its call right, relying on extrinsic evidence in an attempt to derive the parties’ intent.

Relying on the factual background (as noted above), the court found that there was insufficient extrinsic evidence to demonstrate, by a preponderance of the evidence, that Simon and KanAm shared a mutual intent or reached a meeting of the minds that, despite this unambiguous language, Simon Units could satisfy the call right. The court noted that there was been gamesmanship and strategic silence by both sides spanning their long relationship. While Simon Units were initially contractually-compliant in the Initial JV Agreements to which KanAm was an original partner with Simon and Mills, those agreements were amended or restated to remove references to Simon Units. The Other JV Agreements to which Simon was not an original investor never mentioned Simon Units. When the Simon- Farallon JV acquired Mills there was contractual silence regarding these provisions. The court stated that all sides knew consideration for the call was an unresolved issue, but failed to bargain for a substitute tender. Furthermore, in Denver West—the only post-Simon-return JV—both parties decided not to address the issue. Therefore, because there was a lack of mutual intent regarding the substitution of Simon Units, the court held that Simon could not enforce its call right.

The court next addressed Simon’s assertion that the court should require KanAm to perform under the contracts because Simon did not materially breach the JV Agreements when it offered to deliver the buy/sell price in cash or Simon Units, so KanAm’s performance would not be excused. The court noted that specific performance of an option contract requires strict adherence to these conditions. Thus, in order to trigger its right to purchase, Simon needed to comply with the conditions set forth in the contract—tender Mills Units, the default consideration, to KanAm upon exercise of the option. Having failed to satisfy the conditions for the call, it cannot enforce the contract, as contractual provisions in option contracts are construed strictly. Moreover, specific contract language reinforces the point—the notice of the call, per the JV Agreements, is voidable absent compliance with the conditions necessary to compel the sale. Furthermore, given Simon’s knowledge of, but failure to address, the consideration issue in the JV Agreements, Simon could not show that it that equity favored specific performance.

Moreover, the court found against Simon’s argument that KanAm violated the implied covenant of good faith and fair dealing by demanding non-existent Mills Units. The court explained that the implied covenant of good faith and fair dealing involves inferring contractual terms to handle developments or contractual gaps that neither party anticipated, but that it does not apply when the contract addresses the conduct at issue. Nevertheless, while there was contractual silence on this issue from both sides, the issue was not unknown to the parties—each side independently identified the potential issue, attempts were made to negotiate it, but no agreement was ever reached. Thus, a party, after consciously avoiding an issue, cannot seek rescue through the implied covenant.

The court also held that Simon’s waiver and quasi- estoppel arguments were not sound because (i) Simon failed to demonstrate KanAm’s knowing and unequivocal waiver of the right to insist on receiving Mills Units and (ii) KanAm’s decision to stand on the bargained-for language of the contracts does not shock the conscience.

The court next turned to KanAm’s counterclaim. The counterclaim alleged breach of contract by Simon for knowingly providing invalid buy/sell notices in breach of the buy/sell provisions of the JV Agreements and sought a declaratory judgment. KanAm sought damages arising from this purported breach, including but not limited to the cost of the appraisal process that was triggered following Simon’s delivery of the notices. Finally, in addition to a request for damages, KanAm sought fees pursuant to the JV Agreements along with pre- and post-judgment interest.

The court found that did not demonstrate that Simon breached the JV Agreements. Simon had the right to call, which it did. A contractual appraisal of KanAm’s interest resulted. At that point, KanAm had the option to accept cash or demand Mills Units. It elected the latter. Simon was unable to perform, triggering KanAm’s right to void the call. No breach occurred. The court similarly found that the costs of the appraisal are not damages but rather an expense of the JV triggered pursuant to contract. Additionally, based on its analysis above, the court granted KanAm’s declaratory relief on two remaining points: first, that the JV Agreements require Simon to pay in Mills Units unless KanAm elects cash, and second, that Simon cannot enforce its call right by tendering Simon Units.

Finally, the court did not rule on but rather stated that the parties should confer and agree on a method to address the fees and costs of the litigation, since KanAm, as the prevailing party, is entitled to fees with respect to the bulk of Simon’s claims while Simon, in turn, prevailed on the counterclaim and may yet prevail on the an additional claim to be made at a later date.

Simon-Mills II LLC et al. v. Kan AM USA XVI Limited Partnership et al. memorandum opinion 170330