RJR-Nabisco bondholder litigation
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Example
The takeover of RJR-Nabisco in
the late 1980s illustrates the reallocation
of value in an LBO. In the fall of 1988 the
CEO of RJR Nabisco, Ross Johnson, led a management
group that made a $75 bid for the company, about
$20 over the trading price. Six days later,
the takover firm of Kohlberg, Kravis & Roberts(
KKR) made a competing offer of $90/share.
A bidding
contest developed. When Johnson's group
bid $100/share, the board called for final
bids. Despite a higher bid of $112/share
from Johnson's group, the board under
wilting media attention accepted KKR's
final bid of $108/share.
Johnson, although stung
by the defeat, claimed victory for the
shareholders -- the winning offer was
double the trading price. But bondholders
were left holding the bag. KKR's use of
$19 billion in debt to finance the takeover
brought high (and unexpected) leverage
to RJR. As a result of the company's post-LBO
debt burden, pre-LBO bondholders saw their
investment grade bonds fall to junk status.
In 1989 two RJR-Nabisco
bondholders, Met Life and Jefferson-Pilot
Insurance, sued the company and its CEO
Johnson for the loss in the value of their
bonds resulting from the LBO. They argued
the company had breached an implied covenant
of good faith and fair dealing. They also
argued the board had violated its fiduciary
duties to the bond holders.
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The court rejected the bondholders'
arguments and decided that their indentures
did not include any implied restrictive covenants
to prevent the incurrence of new debt to facilitate
the LBO. Moreover, the court said there was
no legitimate, mutually contemplated benefit
that justified the implication. Instead, the
court saw the bondholders as trying to add terms
to their bonds for which they had not bargained.
The court pointed out the American
Bar Foundation's Commentaries on Indentures
states "the debt security holder can do
nothing to protect himself against the actions
of the borrower which jeopardize its ability
to pay the debt unless he .. .establishes his
rights through contractual provisions set forth
in the debt agreement" The original indentures
had included provisions that provided some protection
in the event of a takeover, but in subsequent
transactions, Met Life agreed to waive these
provisions.
And, perhaps most damning, the
executives of Met Life had drafted several memos
which identified and discussed the ramifications
to Met Life of the 1980s LBO craze. Among the
issues discussed in these memos were the best
courses of action in LBOs like the RJR takeover.
The memos concluded the company should include
a protective covenant.
The court also rejected the bondholders
arguments for judicial protection under corporate
fiduciary law, since the bondholders were informed
participants in a largely impersonal market
and possessed the financial sophistication and
size to secure their own protection.
- Why had RJR Nabsico's bond prices fallen?
- What protection should the bondholders
have insisted on? What are "poison
puts"?
- What do you think happened after the RJR-Nabisco
LBO and this court decision? See
J. Andrew Rahl, Lori C. Seegers, and F.
John Stark, "Marriot Risk":
A New Model Covenant to Restrict Transfers
of Wealth from Bondholders to Stockholders,
1994 Colum. Bus. L. Rev. 503.
METROPOLITAN
LIFE INSURANCE COMPANY and JEFFERSON-PILOT LIFE
INSURANCE COMPANY, Plaintiffs, v. RJR NABISCO,
INC. and F. ROSS JOHNSON, Defendants
UNITED
STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT
OF NEW YORK
716 F. Supp. 1504; 1989 U.S. Dist. LEXIS 6253
May 31, 1989, Decided June 1, 1989,
Filed
JON
M. WALKER, UNITED STATES DISTRICT JUDGE
The
corporate parties to this action are among the
country's most sophisticated financial institutions,
as familiar with the Wall Street investment
community and the securities market as American
consumers are with the Oreo cookies and Winston
cigarettes made by defendant RJR Nabisco, Inc.
(sometimes "the company" or "RJR Nabisco").
The present action traces its origins to October
20, 1988, when F. Ross Johnson, then the Chief
Executive Officer of RJR Nabisco, proposed a
$ 17 billion leveraged buy-out ("LBO") of the
company's shareholders, at $ 75 per share. n1
Within a few days, a bidding war developed among
the investment group led by Johnsonand the investment
firm of Kohlberg Kravis Roberts & Co. ("KKR"),
and others. On December 1, 1988, a special committee
of RJR Nabisco directors, established by the
company specifically to consider the competing
proposals, recommended that the company accept
the KKR proposal, a $ 24 billion LBO that called
for the purchase of the company's outstanding
stock at roughly $ 109 per share.
n1
A leveraged buy-out occurs when a group
of investors, usually including members
of a company's management team, buy the
company under financial arrangements that
include little equity and significant new
debt. The necessary debt financing typically
includes mortgages or high risk/high yield
bonds, popularly known as "junk bonds."
Additionally, a portion of this debt is
generally secured by the company's assets.
Some of the acquired company's assets are
usually sold after the transaction is completed
in order to reduce the debt incurred in
the acquisition.
The
flurry of activity late last year that accompanied
the bidding war for RJR Nabisco spawned at least
eight lawsuits, filed before this Court, charging
the company and its former CEO with a variety
of securities and common law violations. n2
The Court agreed to hear the present action
-- filed even before the company accepted the
KKR proposal -- on an expedited basis, with
an eye toward March 1, 1989, when RJR Nabisco
was expected to merge with the KKR holding entities
created to facilitate the LBO. On that date,
RJR Nabisco was also scheduled to assume roughly
$ 19 billion of new debt. n3 After a delay unrelated
to the present action, the merger was ultimately
completed during the week of April 24, 1989.
n2
On December 7, 1989, this Court agreed to
accept as related all actions growing out
of the RJR Nabisco LBO. On January 4, 1989,
the Court consolidated with the present
suit an action brought by three KKR affiliates
-- RJR Holdings Corp., RJR Holdings Group,
Inc., and RJR Acquisition Corporation --
against the Jefferson-Pilot Life Insurance
Company. KKR established those entities
to effect the buyout of RJR Nabisco. Throughout
this Opinion, these entities and their parent
will be referred to collectively as "KKR."
When this action was filed, those entities
and KKR were not formally named as parties.
However, in its January 4 Order, the Court
granted KKR's request to participate fully
in the present action. Pursuant to that
Order, KKR filed joint briefs with RJR Nabisco
and participated in oral argument before
the Court on February 16, 1989.
n3
The Court set January 12, 1989 as the close
of the expedited discovery period for these
motions, which were filed the next day.
***
Plaintiffs
now allege, in short, that RJR Nabisco's actions
have drastically impaired the value of bonds
previously issued to plaintiffs by, in effect,
misappropriating the value of those bonds to
help finance the LBO and to distribute an enormous
windfall to the company's shareholders. As a
result, plaintiffs argue, they have unfairly
suffered a multimillion dollar loss in the value
of their bonds. n4
n4
Agencies like Standard & Poor's and
Moody's generally rate bonds in two broad
categories: investment grade and speculative
grade. Standard & Poor's rates investment
grade bonds from "AAA" to "BBB." Moody's
rates those bonds from "AAA" to "Baa3."
Speculative grade bonds are rated either
"BB" and lower, or "Ba1" and lower, by Standard
& Poor's and Moody's, respectively.
See, e.g., Standard and Poor's Debt Rating
Criteria at 10-11. No one disputes that,
subsequent to the announcement of the LBO,
the RJR Nabisco bonds lost their "A" ratings.
***
On
February 16, 1989, this Court heard oral argument
on plaintiffs' motions. At the hearing, the
Court denied plaintiffs' request for a preliminary
injunction, based on their insufficient showing
of irreparable harm. n5 An exchange between
the Court and plaintiffs' counsel, like the
submissions before it, convinced the Court that
plaintiffs had failed to meet their heavy burden:
THE
COURT: How do you respond to [defendants']
statements on irreparable harm? What we're
looking at now is whether or not there's
a basis for a preliminary injunction and
if there's no irreparable harm then we're
in a damage action and that changes . .
. the contours of the suit. . . . We're
talking about the ability . . . of the company
to satisfy any judgment.
PLAINTIFFS:
That's correct. And our point . . . is that
if we receive a judgment at any time, six
months from now, after a trial for example,
that judgment will almost inevitably be
the basis for a judgment for everyone else
. . . But if we get a judgment, everyone
else will get one as well . . .
THE
COURT: You're . . . asking me . . . [to]
infer a huge number of plaintiffs and a
lot more damages than your clients could
ever recover as being the basis for deciding
the question of irreparable harm. And those
[potential] actions aren't before me.
PLAINTIFFS:
I think that's correct . . .
Tr.
at 39. See also P. Reply at 33. Plaintiffs failed
to respond convincingly to defendants' arguments
that, although plaintiffs have invested roughly
$ 350 million in RJR Nabisco, their potential
damages nonetheless remain relatively small
and that, upon completion of the merger, the
company will retain an equity base of $ 5 billion.
See, e.g., Tr. at 32, 35; D. Opp. at 48, 49.
Given plaintiffs' failure to show irreparable
harm, the Court denied their request for injunctive
relief. This initial ruling, however, left intact
plaintiffs' underlying motions, which, together
with defendants' cross-motions, now require
attention.
n5
in their papers, plaintiffs had argued that
the LBO "should be Preliminarily Enjoined
Unless Provision is Made to Ensure That
Funds for Redemption will be Available after
Trial." P. Mem. at 59 (capitalization in
original). The preliminary injunction requested
"is not intended to stop the transaction,
but only to enjoin any substantial encumbrance
on the company until the company posts a
bond or otherwise provides security to ensure
its ability to redeem Plaintiffs' bonds
after trial." P. Mem. at 60.
References
throughout this Opinion are as follows:
Transcript of February 16, 1989 Argument
("Tr."); Amended Complaint ("Am. Comp.");
[Name of affiant] Affidavit ("[Name of affiant]
Aff."); [Name of affiant] Response Affidavit
("[Name of affiant] Resp. Aff."); [Name
of affiant] Reply Affidavit ("[Name of affiant]
Reply Aff."); Exhibit ("Exh."); Plaintiffs'
Exhibit ("P. Exh."); [Name of deponent]
Deposition ("[Name of deponent] Dep.");
Plaintiffs' Memorandum in Support of Summary
Judgment ("P. Mem."); Plaintiffs' Answering
Brief [in Opposition to Defendants' Motions]
("P. Opp."); Plaintiffs' Reply Brief ("P.
Reply"); Defendants' Memorandum in Support
of their Motion for Judgment on the Pleadings
[and Partial Summary Judgment and Partial
Dismissal] ("D. Mem."); Defendants' Memorandum
in Opposition to Plaintiffs' Motion ("D.
Opp."); Defendants' Reply Memorandum ("D.
Reply"). ***
The
motions and cross-motions are based on plaintiffs'
Amended Complaint, which sets forth nine counts.
n6 Plaintiffs move for summary judgment pursuant
to Fed. R. Civ. P. 56 against the company on
Count I, which alleges a "Breach of Implied
Covenant of Good Faith and Fair Dealing," and
against both defendants on Count V, which is
labeled simply "In Equity."
n6
Count I alleges a breach of an implied covenant
of good faith and fair dealing (against
defendant RJR Nabisco); Count II alleges
fraud (against both defendants); Count III
alleges violations of Section 10b of the
Securities Exchange Act of 1934 (against
both defendants); Count IV alleges violations
of Section 11 of the 1933 Act (on behalf
of plaintiff Jefferson-Pilot Life Insurance
Company against both defendants); Count
V is labeled "In Equity," and is asserted
against both defendants; Count VI alleges
breach of duties (against defendant Johnson);
Count VII alleges tortious interference
with property (against Johnson); Count VIII
alleges tortious interference with contract
(against Johnson); and Count IX alleges
a violation of the fraudulent conveyance
laws (against RJR Nabisco). ***
For
its part, RJR Nabisco moves pursuant to Fed.
R. Civ. P. 12(c) for judgment on the pleadings
on Count I in full; on Count II (fraud) and
Count III (violations of § 10b of the Securities
Exchange Act of 1934 and Rule 10b-5 promulgated
thereunder) as to most of the securities at
issue; and on Count V in full. In the alternative,
the company moves for summary judgment on Counts
I and V. In addition, RJR Nabisco moves pursuant
to Fed. R. Civ. P. 9(b) to dismiss Counts II,
III and IX (alleging violations of applicable
fraudulent conveyance laws) for an alleged failure
to plead fraud with requisite particularity.
Johnson has moved to dismiss Counts II, III
and V. n7
n7
Johnson has not filed memoranda in support
of his motions but instead incorporates
the arguments set forth in the papers filed
by RJR Nabisco and KKR. Johnson has not
moved with respect to Counts IV, VI, VII
or VIII. Counts VI, VII and VIII apply only
to Johnson. Count IV is the only count with
respect to which RJR Nabisco has not moved.
***
Although
the numbers involved in this case are large,
and the financing necessary to complete the
LBO unprecedented, n8 the legal principles nonetheless
remain discrete and familiar. Yet while the
instant motions thus primarily require the Court
to evaluate and apply traditional rules of equity
and contract interpretation, plaintiffs do raise
issues of first impression in the context of
an LBO. At the heart of the present motions
lies plaintiffs' claim that RJR Nabisco violated
a restrictive covenant -- not an explicit covenant
found within the four corners of the relevant
bond indentures, but rather an implied covenant
of good faith and fair dealing -- not to incur
the debt necessary to facilitate the LBO and
thereby betray what plaintiffs claim was the
fundamental basis of their bargain with the
company. The company, plaintiffs assert, consistently
reassured its bondholders that it had a "mandate"
from its Board of Directors to maintain RJR
Nabisco's preferred credit rating. Plaintiffs
ask this Court first to imply a covenant of
good faith and fair dealing that would prevent
the recent transaction, then to hold that this
covenant has been breached, and finally to require
RJR Nabisco to redeem their bonds.
n8
On February 9, 1989, KKR completed its tender
offer for roughly 74 percent of RJR Nabisco's
common stock (of which approximately 97%
of the outstanding shares were tendered)
and all of its Series B Cumulative Preferred
Stock (of which approximately 95% of the
outstanding shares were tendered). Approximately
$ 18 billion in cash was paid out to these
stockholders. KKR acquired the remaining
stock in the late April merger through the
issuance of roughly $ 4.1 billion of pay-in-kind
exchangeable preferred stock and roughly
$ 1.8 billion in face amount of convertible
debentures. See Bradley Reply Aff. para.
2. ***
RJR
Nabisco defends the LBO by pointing to express
provisions in the bond indentures that, inter
alia, permit mergers and the assumption of additional
debt. These provisions, as well as others that
could have been included but were not, were
known to the market and to plaintiffs, sophisticated
investors who freely bought the bonds and were
equally free to sell them at any time. Any attempt
by this Court to create contractual terms post
hoc, defendants contend, not only finds no basis
in the controlling law and undisputed facts
of this case, but also would constitute an impermissible
invasion into the free and open operation of
the marketplace.
For
the reasons set forth below, this Court agrees
with defendants. There being no express covenant
between the parties that would restrict the
incurrence of new debt, and no perceived direction
to that end from covenants that are express,
this Court will not imply a covenant to prevent
the recent LBO and thereby create an indenture
term that, while bargained for in other contexts,
was not bargained for here and was not even
within the mutual contemplation of the parties.
Summary
judgment, of course, is appropriate only where
"there is no genuine issue as to any material
fact . . ." Fed. R. Civ. P. 56(c). A genuine
dispute exists if "a reasonable jury could
return a verdict for the nonmoving party."
Anderson v. Liberty Lobby, Inc., 477 U.S.
242, 248, 91 L. Ed. 2d 202, 106 S. Ct. 2505
(1986). The burden is on the moving party
to show that no relevant facts are in dispute.
While the Court must resolve all ambiguities
and draw all reasonable inferences in favor
of the party against whom summary judgment
is sought, see, e.g., Quinn v. Syracuse Model
Neighborhood Corp., 613 F.2d 438, 444 (2d
Cir. 1980), the nonmoving party may not rely
simply "on mere speculation or conjecture
as to the true nature of the facts to overcome
a motion for summary judgment." Knight v.
U.S. Fire Insurance Co., 804 F.2d 9, 12 (2d
Cir. 1986), cert. denied, 480 U.S. 932, 94
L. Ed. 2d 762, 107 S. Ct. 1570 (1987).
Both
sides now move for summary judgment on Counts
I and V. In support of their motions, the
parties have filed extensive memoranda and
supporting exhibits. Having carefully reviewed
the submissions before it, the Court agrees
with the parties that there is no genuine
issue as to any material fact regarding these
counts, and given the disposition of the motions
as to Counts I and ] V, the Court, as it must,
draws all reasonable inferences in favor of
the plaintiffs.
Metropolitan
Life Insurance Co. ("MetLife"), incorporated
in New York, is a life insurance company that
provides pension benefits for 42 million individuals.
According to its most recent annual report,
MetLife's assets exceed $ 88 billion and its
debt securities holdings exceed $ 49 billion.
Bradley Aff. para. 11. MetLife is a mutual company
and therefore has no stockholders and is instead
operated for the benefit of its policyholders.
Am. Comp. para. 5. MetLife alleges that it owns
$ 340,542,000 in principal amount of six separate
RJR Nabisco debt issues, bonds allegedly purchased
between July 1975 and July 1988. Some bonds
become due as early as this year; others will
not become due until 2017. The bonds bear interest
rates of anywhere from 8 to 10.25 percent. MetLife
also owned 186,000 shares of RJR Nabisco common
stock at the time this suit was filed. Am. Comp.
para. 12.
Jefferson-Pilot
Life Insurance Co. ("Jefferson-Pilot") is a
North Carolina company that has more than $
3 billion in total assets, $ 1.5 billion of
which are invested in debt securities. Bradley
Aff. para. 12. Jefferson-Pilot alleges that
it owns $ 9.34 million in principal amount of
three separate RJR Nabisco debt issues, allegedly
purchased between June 1978 and June 1988. Those
bonds, bearing interest rates of anywhere from
8.45 to 10.75 percent, become due in 1993 and
1998. Am. Comp. para. 13.
RJR Nabisco, a Delaware corporation, is a consumer
products holding company that owns some of the
country's best known product lines, including
LifeSavers candy, Oreo cookies, and Winston
cigarettes. The company was formed in 1985,
when R.J. Reynolds Industries, Inc. ("R.J. Reynolds")
merged with Nabisco Brands, Inc. ("Nabisco Brands").
In 1979, and thus before the R.J. Reynolds-Nabisco
Brands merger, R.J. Reynolds acquired the Del
Monte Corporation ("Del Monte"), which distributes
canned fruits and vegetables. From January 1987
until February 1989, co-defendant Johnson served
as the company's CEO. KKR, a private investment
firm, organizes funds through which investors
provide pools of equity to finance LBOs. Bradley
Aff. paras. 12-15.
The
bonds n9 implicated by this suit are governed
by long, detailed indentures, which in turn
are governed by New York contract law. n10 No
one disputes that the holders of public bond
issues, like plaintiffs here, often enter the
market after the indentures have been negotiated
and memorialized. Thus, those indentures are
often not the product of face-to-face negotiations
between the ultimate holders and the issuing
company. What remains equally true, however,
is that underwriters ordinarily negotiate the
terms of the indentures with the issuers. Since
the underwriters must then sell or place the
bonds, they necessarily negotiate in part with
the interests of the buyers in mind. Moreover,
these indentures were not secret agreements
foisted upon unwitting participants in the bond
market. No successive holder is required to
accept or to continue to hold the bonds, governed
by their accompanying indentures; indeed, plaintiffs
readily admit that they could have sold their
bonds right up until the announcement of the
LBO. Tr. at 15. Instead, sophisticated investors
like plaintiffs are well aware of the indenture
terms and, presumably, review them carefully
before lending hundreds of millions of dollars
to any company.
n9
For the purposes of this Opinion, the terms
"bonds," " debentures," and "notes" will
be used interchangeably. Any distinctions
among these terms are not relevant to the
present motions.
n10
Both sides agree that New York law controls
this Court's interpretation of the indentures,
which contain explicit designations to that
effect. See, e.g., P. Mem. at 26; D. Mem
at 15 n.23. The indentures themselves provide
that they "shall be deemed to be a contract
under the laws of the State of New York,
and for all purposes should be construed
in accordance with the laws of said State,
except as may otherwise be required by mandatory
provisions of law." Bradley Aff., Exh. L,
§ 12.8. ***
Indeed,
the prospectuses for the indentures contain
a statement relevant to this action:
The
Indenture contains no restrictions on the creation
of unsecured short-term debt by [RJR Nabisco]
or its subsidiaries, no restriction on the creation
of unsecured Funded Debt by [RJR Nabisco] or
its subsidiaries which are not Restricted Subsidiaries,
and no restriction on the payment of dividends
by [RJR Nabisco].
Bradley
Resp. Aff., Exh. L at 24. n11 Further, as plaintiffs
themselves note, the contracts at issue "[do]
not impose debt limits, since debt is assumed
to be used for productive purposes." P. Reply
at 34.
n11
While nine securities are at issue in this
suit, the parties agree -- and the Court's
review confirms -- that the separate indentures
mirror one another in all important respects,
with one exception that is discussed herein.
Indeed, plaintiffs have submitted a helpful
Addendum in which they outline what they
term "typical RJR Nabisco indenture terms."
See P. Reply, Addendum.
Thus,
the prospectus statement quoted above has
its counterpart in each of the other prospectuses.
See Bradley Aff. para. 9. ***
1.
The relevant Articles:
A
typical RJR Nabisco indenture contains thirteen
Articles. At least four of them are relevant
to the present motions and thus merit a brief
review. n12
n12
For the following discussion, see generally,
Indenture dated as of October 15, 1982,
between R. J. Reynolds Industries, Inc.,
Issuer, and Bankers Trust Company, Trustee,
included in Bradley Aff. Exh. L, and Plaintiffs'
Exh. 1. ***
Article
Three delineates the covenants of the issuer.
Most important, it first provides for payment
of principal and interest. It then addresses
various mechanical provisions regarding such
matters as payment terms and trustee vacancies.
The Article also contains "negative pledge"
and related provisions, which restrict mortgages
or other liens on the assets of RJR Nabisco
or its subsidiaries and seek to protect the
bondholders from being subordinated to other
debt.
Article
Five describes various procedures to remedy
defaults and the responsibilities of the Trustee.
This Article includes the distinction in the
indentures noted above, see supra n.11. In seven
of the nine securities at issue, a provision
in Article Five prohibits bondholders from suing
for any remedy based on rights in the indentures
unless 25 percent of the holders have requested
in writing that the indenture trustee seek such
relief, and, after 60 days, the trustee has
not sued. See, e.g., Bradley Aff. Exh. L, §§
5.6, 5.7. Defendants argue that this provision
precludes plaintiffs from suing on these seven
securities. See D. Mem. at 22-25. Given its
holdings today, see infra, the Court need not
address this issue.
Article
Nine governs the adoption of supplemental indentures.
It provides, inter alia, that the Issuer and
the Trustee can add to the covenants of
the Issuer such further covenants, restrictions,
conditions or provisions as its Board of Directors
by Board Resolution and the Trustee shall consider
to be for the protection of the holders of Securities,
and to make the occurrence, or the occurrence
and continuance, of a default in any such additional
covenants, restrictions, conditions or provisions
an Event of Default permitting the enforcement
of all or any of the several remedies provided
in this Indenture as herein set forth . . .
Bradley
Aff. Exh. L, § 9.1(c).
Article
Ten addresses a potential "Consolidation, Merger,
Sale or Conveyance," and explicitly sets forth
the conditions under which the company can consolidate
or merge into or with any other corporation.
It provides explicitly that RJR Nabisco "may
consolidate with, or sell or convey, all or
substantially all of its assets to, or merge
into or with any other corporation," so long
as the new entity is a United States corporation,
and so long as it assumes RJR Nabisco's debt.
The Article also requires that any such transaction
not result in the company's default under any
indenture provision. n13
n13
The remaining Articles are not relevant
to the motions currently before the Court.
Article One contains definitions; Article
Two contains mechanical terms regarding,
for instance, the issuance and transfer
of the securities; Article Four concerns
such mechanical matters as securityholders'
lists and annual reports; Article Six addresses
the rights and responsibilities of the Trustee;
Article Seven contains mechanical provisions
concerning the securityholders; Article
Eight concerns procedural matters such as
securityholders' meetings and consents;
Article Eleven deals with the satisfaction
and discharge of the indenture; Article
Twelve sets forth various miscellaneous
provisions; and Article Thirteen includes
provisions regarding the redemption of securities
and sinking funds. See, e.g., Bradley Aff.
Exh. L. ***
2.
The elimination of restrictive covenants:
In
its Amended Complaint, MetLife lists the six
debt issues on which it bases its claims. Indentures
for two of those issues -- the 10.25 percent
Notes due in 1990, of which MetLife continues
to hold $ 10 million, and the 8.9 percent Debentures
due in 1996, of which MetLife continues to hold
$ 50 million -- once contained express covenants
that, among other things, restricted the company's
ability to incur precisely the sort of debt
involved in the recent LBO. In order to eliminate
those restrictions, the parties to this action
renegotiated the terms of those indentures,
first in 1983 and then again in 1985.
MetLife
acquired $ 50 million principal amount of 10.25
percent Notes from Del Monte in July of 1975.
To cover the $ 50 million, MetLife and Del Monte
entered into a loan agreement. That agreement
restricted Del Monte's ability, among other
things, to incur the sort of indebtedness involved
in the RJR Nabisco LBO. See promissory note
§§ 2.6-2.15, attached as Exhibit A
to Bradley Aff. Exh. E. In 1979, R.J. Reynolds
-- the corporate predecessor to RJR Nabisco
-- purchased Del Monte and [*1511] assumed its
indebtedness. Then, in December of 1983, R.J.
Reynolds requested MetLife to agree to deletions
of those restrictive covenants in exchange for
various guarantees from R.J. Reynolds. See Bradley
Aff. para. 17. A few months later, MetLife and
R.J. Reynolds entered into a guarantee and amendment
agreement reflecting those terms. See Bradley
Aff. para. 17, Exh. G. Pursuant to that agreement,
and in the words of Robert E. Chappell, Jr.,
MetLife's Executive Vice President, MetLife
thus "gave up the restrictive covenants applicable
to the Del Monte debt . . . in return for [the
parent company's] guarantee and public covenants."
Chappell Dep. at 196.
MetLife
acquired the 8.9 percent Debentures from R.J.
Reynolds in October of 1976 in a private placement.
A promissory note evidenced MetLife's $ 100
million loan. That note, like the Del Monte
agreement, contained covenants that restricted
R.J. Reynolds' ability to incur new debt. See
Bradley Aff., Exh. H, §§ 2.5-2.9.
In June of 1985, R.J. Reynolds announced its
plans to acquire Nabisco Brands in a $ 3.6 billion
transaction that involved the incurrence of
a significant amount of new debt. R.J. Reynolds
requested MetLife to waive compliance with these
restrictive covenants in light of the Nabisco
acquisition. See D. Mem. at 45; Bradley Aff.
para. 18.
In
exchange for certain benefits, MetLife agreed
to exchange its 8.9 percent debentures -- which
did contain explicit debt limitations -- for
debentures issued under a public indenture --
which contain no explicit limits on new debt.
An internal MetLife memorandum explained the
parties' understanding:
[MetLife's
$ 100 million financing of the Nabisco Brands
purchase] had its origins in discussions
with RJR regarding potential covenant violations
in the 8.90% Notes. More specifically, in
its acquisition of Nabisco Brands, RJR was
slated to incur significant new long-term
debt, which would have caused a violation
in the funded indebtedness incurrence tests
in the 8.90% Notes. In the discussions regarding
[MetLife's] willingness to consent to the
additional indebtedness, it was determined
that a mutually beneficial approach to the
problem was to 1) agree on a new financing
having a rate and a maturity desirable for
[MetLife] and 2) modify the 8.90% Notes.
The former was accomplished with agreement
on the proposed financing, while the latter
was accomplished by [MetLife] agreeing to
substitute RJR's public indenture covenants
for the covenants in the 8.90% Notes. In
addition to the covenant substitution, RJR
has agreed to "debenturize" the 8.90% Notes
upon [MetLife's] request. This will permit
[MetLife] to sell the 8.90% Notes to the
public.
MetLife
Southern Office Memorandum, dated July 11, 1985,
attached as Bradley Aff. Exh. J, at 2 (emphasis
added).
3.
The recognition and effect of the LBO trend:
Other
internal MetLife documents help frame the background
to this action, for they accurately describe
the changing securities markets and the responses
those changes engendered from sophisticated
market participants, such as MetLife and Jefferson-Pilot.
At least as early as 1982, MetLife recognized
an LBO's effect on bond values. n14 In the spring
of that year, MetLife participated in the financing
of an LBO of a company called Reeves Brothers
("Reeves"). At the time of that LBO, MetLife
also held bonds in that company. Subsequent
to the LBO, as a MetLife memorandum explained,
the "Debentures of Reeves were downgraded by
Standard & Poor's from BBB to B and by Moody's
from Baal to Ba3, thereby lowering the value
of the Notes and Debentures held by [MetLife]."
MetLife Memorandum, dated August 20, 1982, attached
as Bradley Reply Aff. Exh D, at 1.
fn14
MetLife itself began investing in LBOs as
early as 1980. See MetLife Special Projects
Memorandum, dated June 17, 1989, attached
as Bradley Aff. Exh. V, at 1 ("[MetLife's]
history of investing in leveraged buyout
transactions dates back to 1980; and through
1984, [MetLife] reviewed a large number
of LBO investment opportunities presented
to us by various investment banking firms
and LBO specialists. Over this five-year
period, [MetLife] invested, on a direct
basis, approximately $ 430 million to purchase
debt and equity securities in 10 such transactions
. . ."). ***
MetLife
further recognized its "inability to force any
type of payout of the [Reeves'] Notes or the
Debentures as a result of the buy-out [which]
was somewhat disturbing at the time we considered
a participation in the new financing. However,"
the memorandum continued,
our
concern was tempered since, as a stockholder
in [the holding company used to facilitate
the transaction], we would benefit from
the increased net income attributable to
the continued presence of the low coupon
indebtedness. The recent downgrading of
the Reeves Debentures and the consequent
"loss" in value has again raised questions
regarding our ability to have forced a payout.
Questions have also been raised about our
ability to force payouts in similar future
situations, particularly when we would not
be participating in the buy-out financing.
Id.
(emphasis added). In the memorandum, MetLife
sought to answer those very "questions" about
how it might force payouts in "similar future
situations."
A
method of closing this apparent "loophole,"
thereby forcing a payout of [MetLife's]
holdings, would be through a covenant dealing
with a change in ownership. Such a covenant
is fairly standard in financings with privately-held
companies . . . It provides the lender with
an option to end a particular borrowing
relationship via some type of special redemption
. . .
Id.,
at 2 (emphasis added).
A
more comprehensive memorandum, prepared in late
1985, evaluated and explained several aspects
of the corporate world's increasing use of mergers,
takeovers and other debt-financed transactions.
That memorandum first reviewed the available
protection for lenders such as MetLife:
Covenants
are incorporated into loan documents to
ensure that after a lender makes a loan,
the creditworthiness of the borrower and
the lender's ability to reach the borrower's
assets do not deteriorate substantially.
Restrictions on the incurrence of debt,
sale of assets, mergers, dividends, restricted
payments and loans and advances to affiliates
are some of the traditional negative covenants
that can help protect lenders in the event
their obligors become involved in undesirable
merger/takeover situations.
MetLife
Northeastern Office Memorandum, dated November
27, 1985, attached as Bradley Aff. Exh. U, at
1-2 (emphasis added). The memorandum then surveyed
market realities:
Because
almost any industrial company is apt to
engineer a takeover or be taken over itself,
Business Week says that investors are beginning
to view debt securities of high grade industrial
corporations as Wall Street's riskiest investments.
In addition, because public bondholders
do not enjoy the protection of any restrictive
covenants, owners of high grade corporates
face substantial losses from takeover situations,
if not immediately, then when the bond market
finally adjusts. . . . There have been 10-15
merger/takeover/LBO situations where, due
to the lack of covenant protection, [MetLife]
has had no choice but to remain a lender
to a less creditworthy obligor. . . . The
fact that the quality of our investment
portfolio is greater than the other large
insurance companies . . . may indicate that
we have negotiated better covenant protection
than other institutions, thus generally
being able to require prepayment when situations
become too risky . . . [However,] a problem
exists. And because the current merger craze
is not likely to decelerate and because
there exist vehicles to circumvent traditional
covenants, the problem will probably continue.
Therefore, perhaps it is time to institute
appropriate language designed to protect
Metropolitan from the negative implications
of mergers and takeovers.
Id.
at 2-4 (emphasis added). n15
n15
During discovery, MetLife produced from
its files an article that appeared in The
New York Times on January 7, 1986. The article,
like the memoranda discussed above, reviewed
the position of bondholders like MetLife
and Jefferson-Pilot:
"
Debt-financed acquisitions, as well as
those defensive actions to thwart takeovers,
have generally resulted in lower bond
ratings . . . Of course, a major problem
for debtholders is that, compared with
shareholders, they have relatively little
power over management decisions. Their
rights are essentially confined to the
covenants restricting, say, the level
of debt a company can accrue." Bradley
Reply Aff. Exh. H (emphasis added). ***
Indeed,
MetLife does not dispute that, as a member
of a bondholders' association, it [*1513]
received and discussed a proposed model
indenture, which included a "comprehensive
covenant" entitled "Limitations on Shareholders'
Payments." n16 As becomes clear from reading
the proposed -- but never adopted -- provision,
it was "intend[ed] to provide protection
against all of the types of situations
in which shareholders profit at the expense
of bondholders." Id. The provision dictated
that the "corporation will not, and will
not permit any subsidiary to, directly
or indirectly, make any shareholder payment
unless. . . (1) the aggregate amount of
all shareholder payment during the period
[at issue] . . . shall not exceed [figure
left blank]." Bradley Resp. Aff. Exh.
H, at 9. The term "shareholder payments"
is defined to include "restructuring distributions,
stock repurchases, debt incurred or guaranteed
to finance merger payments to shareholders,
etc." Id. at i.
n16
See Bradley Resp. Aff. Exh. F. That exhibit
is an August 5, 1988 letter from the New
York law firm of Kaye, Scholer, Fierman,
Hays & Handler. A partner at that firm
sent the letter to "Indenture Group Members,"
including MetLife, who participated in the
Institutional Bondholders' Rights Association
("the IBRA") The "Limitations on Shareholders'
Payments" provision appears in a draft IBRA
model indenture. See Bradley Resp. Aff.
paras. 3, 7. ***
Apparently,
that provision -- or provisions with similar
intentions -- never went beyond the discussion
stage at MetLife. That fact is easily understood;
indeed, MetLife's own documents articulate several
reasonable, undisputed explanations:
While
it would be possible to broaden the change in
ownership covenant to cover any acquisition-oriented
transaction, we might well encounter significant
resistance in implementation with larger public
companies . . . With respect to implementation,
we would be faced with the task of imposing
a non-standard limitation on potential borrowers,
which could be a difficult task in today's highly
competitive marketplace. Competitive pressures
notwithstanding, it would seem that management
of larger public companies would be particularly
opposed to such a covenant since its effect
would be to increase the cost of an acquisition
(due to an assumed debt repayment), a factor
that could well lower the price of any tender
offer (thereby impacting shareholders).
Bradley
Reply Aff. Exh. D, at 3 (emphasis added). The
November 1985 memorandum explained that
obviously,
our ability to implement methods of takeover
protection will vary between the public
and private market. In that public securities
do not contain any meaningful covenants,
it would be very difficult for [MetLife]
to demand takeover protection in public
bonds. Such a requirement would effectively
take us out of the public industrial market.
A recent Business Week article does suggest,
however, that there is increasing talk among
lending institutions about requiring blue
chip companies to compensate them for the
growing risk of downgradings. This talk,
regarding such protection as restrictions
on future debt financings, is met with skepticism
by the investment banking community which
feels that CFO's are not about to give up
the option of adding debt and do not really
care if their companies' credit ratings
drop a notch or two.
Bradley
Resp. Aff. Exh. A, at 8 (emphasis added).
The
Court quotes these documents at such length
not because they represent an "admission" or
"waiver" from MetLife, or an "assumption of
risk" in any tort sense, or its "consent" to
any particular course of conduct -- all terms
discussed at even greater length in the parties'
submissions. See, [*1514] e.g., P. Opp. at 31-36;
P. Reply at 16-17; D. Reply at 15-16. Rather,
the documents set forth the background to the
present action, and highlight the risks inherent
in the market itself, for any investor. Investors
as sophisticated as MetLife and Jefferson-Pilot
would be hard-pressed to plead ignorance of
these market risks. Indeed, MetLife has not
disputed the facts asserted in its own internal
documents. Nor has Jefferson-Pilot -- presumably
an institution no less sophisticated than MetLife
-- offered any reason to believe that its understanding
of the securities market differed in any material
respect from the description and analysis set
forth in the MetLife documents. Those documents,
after all, were not born in a vacuum. They are
descriptions of, and responses to, the market
in which investors like MetLife and Jefferson-Pilot
knowingly participated.
These
documents must be read in conjunction with plaintiffs'
Amended Complaint. That document asserts that
the LBO "undermines the foundation of the investment
grade debt market . . .," Am. Comp. para. 16;
that, although "the indentures do not purport
to limit dividends or debt . . . such covenants
were believed unnecessary with blue chip companies
. . .", Am. Comp. para. 17; n17 that "the transaction
contradicts the premise of the investment grade
market . . .", Am. Comp. para. 33; and, finally,
that "this buy-out was not contemplated at the
time the debt was issued, contradicts the premise
of the investment grade ratings that RJR Nabisco
actively solicited and received, and is inconsistent
with the understandings of the market . . .
which plaintiffs relied upon." Am. Comp. para.
51.
n17
Due to a typographical error, the Amended
Complaint contains two paragraphs numbered
"17." The passage above refers to the first
such paragraph. ***
Solely
for the purposes of these motions, the Court
accepts various factual assertions advanced
by plaintiffs: first, that RJR Nabisco actively
solicited "investment grade" ratings for its
debt; second, that it relied on descriptions
of its strong capital structure and earnings
record which included prominent display of its
ability to pay the interest obligations on its
long-term debt several times over, Am. Comp.
para. 14; and third, that the company made express
or implied representations not contained in
the relevant indentures concerning its future
creditworthiness. Id. P 15. In support of those
allegations, plaintiffs have marshaled a number
of speeches made by co-defendant Johnson and
other executives of RJR Nabisco. n18 In addition,
plaintiffs rely on an affidavit sworn to by
John Dowdle, the former Treasurer and then Senior
Vice President of RJR Nabisco from 1970 until
1987. In his opinion, the LBO "clearly undermines
the fundamental premise of the company's bargain
with the bondholders, and the commitment that
I believe the company made to the bondholders
. . . I firmly believe that the company made
commitments . . . that require it to redeem
[these bonds and notes] before paying out the
value to the shareholders." Dowdle Aff. paras.
4, 7.
n18
See, e.g., Address by F. Ross Johnson, November
12, 1987, P. Exh. 8, at 5 ("Our strong balance
sheet is a cornerstone of our strategies.
It gives us the resources to modernize facilities,
develop new technologies, bring on new products,
and support our leading brands around the
world."); Remarks of Edward J. Robinson,
Executive Vice President and Chief Financial
Officer, February 15, 1988, P. Exh. 6, at
1 ("RJR Nabisco's financial strategy is
. . . to enhance the strength of the balance
sheet by reducing the level of debt as well
as lowering the cost of existing debt.");
Remarks by Dr. Robert J. Carbonell, Vice
Chairman of RJR Nabisco, June 3, 1987, P.
Exh. 10, at 5 ("We will not sacrifice our
longer-term health for the sake of short
term heroics."). ***
At
the outset, the Court notes that nothing in
its evaluation is substantively altered by the
speeches given or remarks made by RJR Nabisco
executives, or the opinions of various individuals
-- what, for instance, former RJR Nabisco Treasurer
Dowdle personally did or did not "firmly believe"
the indentures meant. See supra, and generally
Chappell, Dowdle and Howard Affidavits. The
parol evidence rule bars plaintiffs from arguing
that the speeches made by company executives
[*1515] prove defendants agreed or acquiesced
to a term that does not appear in the indentures.
See West, Weir & Bartel, Inc. v. Mary Carter
Paint Co., 25 N.Y.2d 535, 540, 307 N.Y.S.2d
449, 452, 255 N.E.2d 709 (1969) ("The rule in
this State is well settled that HN3the construction
of a plain and unambiguous contract is for the
Court to pass on, and that circumstances extrinsic
to the agreement will not be considered when
the intention of the parties can be gathered
from the instrument itself.") In interpreting
these contracts, this Court must be concerned
with what the parties intended, but only to
the extent that what they intended is evidenced
by what is written in the indentures. See, e.g.,
Rodolitz v. Neptune Paper Products, Inc., 22
N.Y.2d 383, 386-7, 292 N.Y.S.2d 878, 881, 239
N.E.2d 628 (1968); Raleigh Associates v. Henry,
302 N.Y. 467, 473, 99 N.E.2d 289 (1951).
The
indentures at issue clearly address the eventuality
of a merger. They impose certain related restrictions
not at issue in this suit, but no restriction
that would prevent the recent RJR Nabisco merger
transaction. See supra slip op. at 12 (discussion
of Article 10). The indentures also explicitly
set forth provisions for the adoption of new
covenants, if such a course is deemed appropriate.
See supra slip op. at 12 (discussion of Article
9). While it may be true that no explicit provision
either permits or prohibits an LBO, such contractual
silence itself cannot create ambiguity to avoid
the dictates of the parole evidence rule, particularly
where the indentures impose no debt limitations.
Under
certain circumstances, however, courts will,
as plaintiffs note, consider extrinsic evidence
to evaluate the scope of an implied covenant
of good faith. See Valley National Bank v. Babylon
Chrysler-Plymouth, Inc., 53 Misc.2d 1029, 1031-32,
280 N.Y.S.2d 786, 788-89 (Sup. Ct. Nassau),
aff'd, 28 A.D.2d 1092, 284 N.Y.S.2d 849 (2d
Dep't 1967) (Relying on custom and usage because
"when a contract fails to establish the time
for performance, the law implies that the act
shall be done within a reasonable time . . .").
n19 However, the Second Circuit has established
a different rule for customary, or boilerplate,
provisions of detailed indentures used and relied
upon throughout the securities market, such
as those at issue. Thus, in Sharon Steel Corporation
v. Chase Manhattan Bank, N.A., 691 F.2d 1039
(2d Cir. 1982), Judge Winter concluded that
boilerplate
provisions are . . . not the consequences
of the relationship of particular borrowers
and lenders and do not depend upon particularized
intentions of the parties to an indenture.
There are no adjudicative facts relating
to the parties to the litigation for a jury
to find and the meaning of boilerplate provisions
is, therefore, a matter of law rather than
fact. Moreover, uniformity in interpretation
is important to the efficiency of capital
markets . . . Whereas participants in the
capital market can adjust their affairs
according to a uniform interpretation, whether
it be correct or not as an initial proposition,
the creation of enduring uncertainties as
to the meaning of boilerplate provisions
would decrease the value of all debenture
issues and greatly impair the efficient
working of capital markets . . . Just such
uncertainties would be created if interpretation
of boilerplate provisions were submitted
to juries sitting in every judicial district
in the nation.
Id.
at 1048. See also Morgan Stanley & Co. v.
Archer Daniels Midland Co., 570 F. Supp. 1529,
1535-36 (S.D.N.Y. 1983) (Sand, J.) ("[Plaintiff
concedes that the legality of [the transaction
at issue] would depend on a factual inquiry
. . . This case-by-case approach is problematic
. . . [Plaintiff's theory] appears keyed to
the subjective expectations of the bondholders
. . . and reads a subjective element into what
presumably should be an objective determination
based on the language appearing in the bond
agreement."); Purcell v. Flying Tiger Line,
Inc., No. 82-3505, at 5, 8 (S.D.N.Y. Jan. 12,
1984) (CES) ("The Indenture does not contain
any such limitation [as the one proposed by
plaintiff]. . . . In light of our holding that
the Indenture unambiguously permits the transaction
at issue in this case, we are precluded from
considering any of the extrinsic evidence that
plaintiff offers on this motion . . . It would
be improper to consider evidence as to the subjective
intent, collateral representations, and either
the statements or the conduct of the parties
in performing the contract.") (citations omitted).
Ignoring these principles, plaintiffs would
have this Court vary what they themselves have
admitted is "indenture boilerplate," P. Reply
at 2, of "standard" agreements, P. Mem. at 14,
to comport with collateral representations and
their subjective understandings. n20
n19
In support of this proposition, plaintiffs
also rely on Reback v. Story Productions,
Inc., 15 Misc. 2d 681, 181 N.Y.S.2d 980,
modified and aff'd, 9 A.D.2d 880, 193 N.Y.S.2d
520 (1st Dep't 1959). The court in that
case, however, was presented with an ambiguous
written agreement. See 181 N.Y.S.2d at 983.
Plaintiffs similarly rely on Van Gemert
v. Boeing Co., 520 F.2d 1373 (2d Cir.),
cert. denied, 423 U.S. 947, 46 L. Ed. 2d
282, 96 S. Ct. 364 (1975) ("Van Gemert I").
In that case, however, the right asserted
was addressed by an express provision which
provided a framework for determining the
scope and effect of the implied covenant.
See infra.
n20
To a certain extent, this discussion is
academic. Even if the Court did consider
the extrinsic evidence offered by plaintiffs,
its ultimate decision would be no different.
Based on that extrinsic evidence, plaintiffs
attempt to establish that an implied covenant
of good faith is necessary to protect the
benefits of their agreements. That inquiry
necessarily asks the court to determine
whether the existing contractual terms should
be construed to preclude defendants from
engaging in an LBO along the lines of the
recently completed transaction. However,
even evaluating all facts -- such as the
public statements made by company executives
-- in the light most favorable to plaintiffs,
these plaintiffs fail as a matter of law
to establish that the purported "fundamental
basis" of their bargain with defendants
created a contractual obligation on the
part of the defendants not to engage in
an LBO. It is first worth noting that plaintiffs
have quoted selectively from certain speeches
and remarks made by RJR Nabisco executives;
in some respects, those public statements
are more equivocal than plaintiffs would
have this Court believe. See, e.g., P. Exh.
3 at 25 ("We believe our strong balance
sheet and our debt capacity . . . provide
us with the flexibility to pursue any conceivable
strategy or financial option we choose.")
More important, those representations are
improperly raised under the rubric of an
implied covenant of good faith when they
cannot properly or reasonably be construed
as evidencing a binding agreement or acquiescence
by defendants to substantive restrictive
covenants. Moreover, nothing like the mutual
understanding plaintiffs now advance has
been shown; in fact, as far as these parties
are concerned, quite the opposite is true.
See infra at 39-40. Thus, as a matter of
law, and accepting all extrinsic evidence
offered, the "implied covenant of good faith"
does not serve these plaintiffs in the way
they represent. As explained more fully
below, by relying on extrinsic evidence
and the familiar implied covenant of good
faith, plaintiffs do not seek to protect
an existing contractual right; they seek
to create a new one, and thus to obtain
a better bargain than originally agreed
upon. Therefore, even if the parole evidence
rule did not block plaintiffs' path, their
course would not be followed.
The
parole evidence rule of course does not bar
descriptions of either the background of this
suit or market realities consistent with the
contracts at issue. ***
A.
Plaintiffs' Case Against the RJR Nabisco LBO:
The
implied covenant: In their first count, plaintiffs
assert that defendant RJR Nabisco owes a continuing
duty of good faith and fair dealing in connection
with the contract [i.e., the indentures] through
which it borrowed money from MetLife, Jefferson-Pilot
and other holders of its debt, including a duty
not to frustrate the purpose of the contracts
to the debtholders or to deprive the debtholders
of the intended object of the contracts -- purchase
of investment-grade securities.
In
the "buy-out," the company breaches the
duty [or implied covenant] of good faith
and fair dealing by, inter alia, destroying
the investment grade quality of the debt
and transferring that value to the "buy-out"
proponents and to the shareholders.
Am.
Comp. paras. 34, 35. In effect, plaintiffs contend
that express covenants were not necessary because
an implied covenant would prevent what defendants
have now done.
A
plaintiff always can allege a violation of an
express covenant. HN5If there has been such
a violation, of course, the court need not reach
the question of whether or not an implied covenant
has been violated. That inquiry surfaces where,
while the express terms may not have been technically
breached, one party has nonetheless effectively
deprived the other of those express, explicitly
bargained-for benefits. In such a case, a court
will read an implied covenant of good faith
and fair dealing into a contract to ensure that
neither party deprives the other of "the fruits
of the agreement." See, e.g., Greenwich Village
Assoc. v. Salle, 110 A.D.2d 111, 115, 493 N.Y.S.2d
461, 464 (1st Dep't 1985). See also Van Gemert
v. Boeing Co., 553 F.2d 812, 815 ("Van Gemert
II") (2d. Cir. 1977) Such a covenant is implied
only where the implied term "is consistent with
other mutually agreed upon terms in the contract."
Sabetay v. Sterling Drug, Inc., 69 N.Y.2d 329,
335, 514 N.Y.S.2d 209, 212, 506 N.E.2d 919 (1987).
In other words, the implied covenant will only
aid and further the explicit terms of the agreement
and will never impose an obligation "'which
would be inconsistent with other terms of the
contractual relationship.'" Id. (citation omitted).
Viewed another way, the implied covenant of
good faith is breached only when one party seeks
to prevent the contract's performance or to
withhold its benefits. See Collard v. Incorporated
Village of Flower Hill, 75 A.D.2d 631, 632,
427 N.Y.S.2d 301, 302 (2d Dep't 1980). As a
result, it thus ensures that parties to a contract
perform the substantive, bargained-for terms
of their agreement. See, e.g., Wakefield v.
Northern Telecom., Inc., 769 F.2d 109, 112 (2d
Cir. 1985) (Winter, J.)
HN6In
contracts like bond indentures, "an implied
covenant . . . derives its substance directly
from the language of the Indenture, and 'cannot
give the holders of Debentures any rights inconsistent
with those set out in the Indenture.' [Where]
plaintiffs' contractual rights [have not been]
violated, there can have been no breach of an
implied covenant." Gardner & Florence Call
Cowles Foundation v. Empire Inc., 589 F. Supp.
669, 673 (S.D.N.Y. 1984), vacated on procedural
grounds, 754 F.2d 478 (2d Cir. 1985) (quoting
Broad v. Rockwell, 642 F.2d 929, 957 (5th Cir.)
(en banc), cert. denied, 454 U.S. 965, 70 L.
Ed. 2d 380, 102 S. Ct. 506 (1981)) (emphasis
added).
Thus,
in cases like Van Gemert v. Boeing Co., 520
F.2d 1373 (2d Cir.), cert. denied, 423 U.S.
947, 46 L. Ed. 2d 282, 96 S. Ct. 364 (1975)
("Van Gemert I"), and Pittsburgh Terminal Corp.
v. Baltimore & Ohio Ry. Co., 680 F.2d 933
(3d Cir.), cert. denied, 459 U.S. 1056, 74 L.
Ed. 2d 621, 103 S. Ct. 475, (1982) -- both relied
upon by plaintiffs -- the courts used the implied
covenant of good faith and fair dealing to ensure
that the bondholders received the benefit of
their bargain as determined from the face of
the contracts at issue. In Van Gemert I, the
plaintiff bondholders alleged inadequate notice
to them of defendant's intention to redeem the
debentures in question and hence an inability
to exercise their conversion rights before the
applicable deadline. The contract itself provided
that notice would be given in the first place.
See e.g., id. at 1375 ("A number of provisions
in the debenture, the Indenture Agreement, the
prospectus, the registration statement . . .
and the Listing Agreement . . . dealt with the
possible redemption of the debentures . . .
and the notice debenture-holders were to receive
. . ."). Faced with those provisions, defendants
in that case unsurprisingly admitted that the
indentures specifically required the company
to provide the bondholders with notice. See
id. at 1379. While defendant there issued a
press release that mentioned the possible redemption
of outstanding convertible debentures, that
limited release did not "mention even the tentative
dates for redemption and expiration of the conversion
rights of debenture holders." Id. at 1375. Moreover,
defendant did not issue any general publicity
or news release. Through an implied covenant,
then, the court fleshed out the full extent
of the more skeletal right that appeared in
the contract itself, and thus protected plaintiff's
bargained-for right of conversion. n21 As the
court observed,
What one buys when purchasing a convertible
debenture in addition to the debt obligation
of the company . . . is principally the
expectation that the stock will increase
sufficiently in value that the conversion
right will make the debenture worth more
than the debt . . . Any loss occurring to
him from failure to convert, as here, is
not from a risk inherent in his investment
but rather from unsatisfactory notification
procedures.
Id.
at 1385 (emphasis added, citations omitted).
n22 I also note, in passing, that Van Gemert
presented the Second Circuit with "less sophisticated
investors." Id. at 1383. Similarly, the court
in Pittsburgh Terminal applied an implied covenant
to the indentures at issue because defendants
there "took steps to prevent the Bondholders
from receiving information which they needed
in order to receive the fruits of their conversion
option should they choose to exercise it." Pittsburgh
Terminal, 680 F.2d at 941 (emphasis added).
n21
Since newspaper notice, for instance, was
promised in the indenture, the court used
an implied covenant to ensure that meaningful,
reasonable newspaper notice was provided.
See id. at 1383.
n22
See also id. at 1383 ("An issuer of [convertible]
debentures has a duty to give adequate notice
either on the face of the debentures, .
. . or in some other way, of the notice
to be provided in the event the company
decides to redeem the debentures. Absent
such advice as to the specific notice agreed
upon by the issuer and the trustee for the
debenture holders, the debenture holders'
reasonable expectations as to notice should
be protected."). ***
The
appropriate analysis, then, is first to examine
the indentures to determine "the fruits of the
agreement" between the parties, and then to
decide whether those "fruits" have been spoiled-which
is to say, whether plaintiffs' contractual rights
have been violated by defendants.
The
American Bar Foundation's Commentaries on Indentures
("the Commentaries"), relied upon and respected
by both plaintiffs and defendants, describes
the rights and risks generally found in bond
indentures like those at issue:
The
most obvious and important characteristic
of long-term debt financing is that the
holder ordinarily has not bargained for
and does not expect any substantial gain
in the value of the security to compensate
for the risk of loss . . . The significant
fact, which accounts in part for the detailed
protective provisions of the typical long-term
debt financing instrument, is that the lender
(the purchaser of the debt security) can
expect only interest at the prescribed rate
plus the eventual return of the principal.
Except for possible increases in the market
value of the debt security because of changes
in interest rates, the debt security will
seldom be worth more than the lender paid
for it . . . It may, of course, become worth
much less. Accordingly, the typical investor
in a long-term debt security is primarily
interested in every reasonable assurance
that the principal and interest will be
paid when due. . . . HN8Short of bankruptcy,
the debt security holder can do nothing
to protect himself against actions of the
borrower which jeopardize its ability to
pay the debt unless he . . . establishes
his rights through contractual provisions
set forth in the debt agreement or indenture.
Id.
at 1-2 (1971) (emphasis added).
A
review of the parties' submissions and the indentures
themselves satisfies the Court that the substantive
"fruits" guaranteed by those contracts and relevant
to the present motions include the periodic
and regular payment of interest and the eventual
repayment of principal. See, e.g., Bradley Aff.
Exh. L, § 3.1 ("The Issuer covenants .
. . that it will duly and punctually pay . .
. the principal of, and interest on, each of
the Securities . . . at the respective times
and in the manner provided in such Securities
. . ."). According to a typical indenture, a
default shall occur if the company either (1)
fails to pay principal when due; (2) fails to
make a timely sinking fund payment; (3) fails
to pay within 30 days of the due date thereof
any interest on the date; or (4) fails duly
to observe or perform any of the express covenants
or agreements set forth in the agreement. See,
e.g., Brad. Aff. Exh. L, § 5.1. n23 Plaintiffs'
[*1519] Amended Complaint nowhere alleges that
RJR Nabisco has breached these contractual obligations;
interest payments continue and there is no reason
to believe that the principal will not be paid
when due. n24
n23
Plaintiffs originally indicated that, depending
on the Court's disposition of the instant
motions, they might seek to amend their
complaint to allege that "they are not equally
and ratably secured under the [express terms
of the] 'negative pledge' clause of the
indentures." P. Reply at 12 n.7. On May
26, 1989, shortly before this Opinion was
filed, the Court granted defendants' request
to assert a counterclaim for a declaratory
judgment that those "negative pledge" covenants
have not been violated by the post-LBO financial
structure of RJR Nabisco. This counterclaim
was advanced in response to notices of default
by plaintiffs based on matters not raised
in the Amended Complaint.
The
Court of course will not now determine whether
an alleged implied covenant flowing from
a "negative pledge" provision has been breached.
That inquiry necessarily must follow the
Court's determination of whether or not
the "negative pledge" provision has been
expressly breached.
n24
The Court here incorporates by reference
its earlier discussion not only of plaintiffs'
failure to demonstrate sufficiently a risk
of irreparable harm on their motion for
a preliminary injunction, but also defendants'
proof concerning the financing of the LBO
and the company's current equity base. See
supra at 4-5. Consequently, the Court rejects
plaintiffs' general assertion that the LBO
"subjects existing debtholders to dramatically
greater risk of non-payment and the Company
to a significant risk of insolvency." Am.
Comp. para. 26. In brief, there is no implied
covenant restricting any action that might
subject plaintiffs' investment to greater
risk of non-payment. What plaintiffs have
failed to allege is that an interest or
principle payment due them has not been
paid, or that any other explicit contractual
right has not been honored. ***
It
is not necessary to decide that indentures like
those at issue could never support a finding
of additional benefits, under different circumstances
with different parties. Rather, for present
purposes, it is sufficient to conclude what
obligation is not covered, either explicitly
or implicitly, by these contracts held by these
plaintiffs. Accordingly, this Court holds that
the "fruits" of these indentures do not include
an implied restrictive covenant that would prevent
the incurrence of new debt to facilitate the
recent LBO. To hold otherwise would permit these
plaintiffs to straightjacket the company in
order to guarantee their investment. These plaintiffs
do not invoke an implied covenant of good faith
to protect a legitimate, mutually contemplated
benefit of the indentures; rather, they seek
to have this Court create an additional benefit
for which they did not bargain.
Although
the indentures generally permit mergers and
the incurrence of new debt, there admittedly
is not an explicit indenture provision to the
contrary of what plaintiffs now claim the implied
covenant requires. That absence, however, does
not mean that the Court should imply into those
very same indentures a covenant of good faith
so broad that it imposes a new, substantive
term of enormous scope. This is so particularly
where, as here, that very term -- a limitation
on the incurrence of additional debt -- has
in other past contexts been expressly bargained
for; particularly where the indentures grant
the company broad discretion in the management
of its affairs, as plaintiffs admit, P. Mem.
at 35; particularly where the indentures explicitly
set forth specific provisions for the adoption
of new covenants and restrictions, see, e.g.,
Bradley Aff. Exh. L, § 9.1(c); and especially
where there has been no breach of the parties'
bargained-for contractual rights on which the
implied covenant necessarily is based. While
the Court stands ready to employ an implied
covenant of good faith to ensure that such bargained-for
rights are performed and upheld, it will not,
however, permit an implied covenant to shoehorn
into an indenture additional terms plaintiffs
now wish had been included. See also Broad v.
Rockwell International Corp., 642 F.2d 929 (5th
Cir.) (en banc) (applying New York law), cert.
denied, 454 U.S. 965, 70 L. Ed. 2d 380, 102
S. Ct. 506 (1981) (finding no liability pursuant
to an implied covenant where the terms of the
indenture, as bargained for, were enforced).
n25
n25
The cases relied on by plaintiffs are not
to the contrary. They invoke an implied
covenant where it proves necessary to fulfill
the explicit terms of an agreement, or to
give meaning to ambiguous terms. See, e.g.,
Grad v. Roberts, 14 N.Y.2d 70, 248 N.Y.S.2d
633, 636, 198 N.E.2d 26 (1964) (court relied
on implied covenant to effect "performance
of [an] option agreement according to its
terms"); Zilg v. Prentice-Hall, Inc., 717
F.2d 671 (2d Cir. 1983), cert. denied, 466
U.S. 938, 80 L. Ed. 2d 460, 104 S. Ct. 1911
(1984). In Zilg, the Second Circuit first
described a contract which, on its face,
established the publisher's obligation to
publish, advertise and publicize the book
at issue. The court then determined that
"the contract in question establishes a
relationship between the publisher and author
which implies an obligation upon the former
to make certain [good faith] efforts in
publishing a book it has accepted notwithstanding
the clause which leaves the number of volumes
to be printed and the advertising budget
to the publisher's discretion." 717 F.2d
at 679. In other words, the court there
sought to ensure a meaningful fulfillment
of the contract's express terms. See also
Van Gemert I, supra; Pittsburgh Terminal,
supra. In the latter two cases, the courts
sought to protect the bondholders' express,
bargained-for rights. ***
[*1520]
Plaintiffs argue in the most general terms that
the fundamental basis of all these indentures
was that an LBO along the lines of the recent
RJR Nabisco transaction would never be undertaken,
that indeed no action would be taken, intentionally
or not, that would significantly deplete the
company's assets. Accepting plaintiffs' theory,
their fundamental bargain with defendants dictated
that nothing would be done to jeopardize the
extremely high probability that the company
would remain able to make interest payments
and repay principal over the 20 to 30 year indenture
term -- and perhaps by logical extension even
included the right to ask a court "to make sure
that plaintiffs had made a good investment."
Gardner, 589 F. Supp. at 674. But as Judge Knapp
aptly concluded in Gardner, "Defendants . .
. were under a duty to carry out the terms of
the contract, but not to make sure that plaintiffs
had made a good investment. The former they
have done; the latter we have no jurisdiction
over." Id. Plaintiffs' submissions and MetLife's
previous undisputed internal memoranda remind
the Court that a "fundamental basis" or a "fruit
of an agreement" is often in the eye of the
beholder, whose vision may well change along
with the market, and who may, with hindsight,
imagine a different bargain than the one he
actually and initially accepted with open eyes.
The
sort of unbounded and one-sided elasticity urged
by plaintiffs would interfere with and destabilize
the market. And this Court, like the parties
to these contracts, cannot ignore or disavow
the marketplace in which the contract is performed.
Nor can it ignore the expectations of that market
-- expectations, for instance, that the terms
of an indenture will be upheld, and that a court
will not, sua sponte, add new substantive terms
to that indenture as it sees fit. n26 The Court
has no reason to believe that the market, in
evaluating bonds such as those at issue here,
did not discount for the possibility that any
company, even one the size of RJR Nabisco, might
engage in an LBO heavily financed by debt. That
the bonds did not lose any of their value until
the October 20, 1988 announcement of a possible
RJR Nabisco LBO only suggests that the market
had theretofore evaluated the risks of such
a transaction as slight.
n26
Cf. Broad v. Rockwell, 642 F.2d at 943 ("Not
least among the parties 'who must comply
with or refer to the indenture' are the
members of the investing public and their
investment advisors. A large degree of uniformity
in the language of debenture indentures
is essential to the effective functioning
of the financial markets: uniformity of
the indentures that govern competing debenture
issues is what makes it possible meaningfully
to compare one debenture issue with another,
focusing only on the business provisions
of the issue . . .") (citation omitted);
Sharon Steel Corporation v. Chase Manhattan
Bank, N.A., 691 F.2d 1039, 1048 (2d Cir.
1982) (Winter, J.) ("Uniformity in interpretation
is important to the efficiency of capital
markets . . . The creation of enduring uncertainties
as to the meaning of boilerplate provisions
would decrease the value of all debenture
issues and greatly impair the efficient
working of capital markets."). ***
The
Court recognizes that the market is not a static
entity, but instead involves what plaintiffs
call "evolving understanding[s]." P. Opp. at
21. Just as the growing prevalence of LBO's
has helped change certain ground rules and expectations
in the field of mergers and acquisitions, so
too it has obviously affected the bond market,
a fact no one disputes. See, e.g., Chappell
Dep. at 136 ("I think we would have been extremely
naive not to understand what was happening in
the marketplace."). To support their argument
that defendants have violated an implied covenant,
plaintiffs contend that, since the October 20,
1988 announcement, the bond market has "stopped
functioning." Tr. at 9. They argue that if they
had "sold and abandoned the market [before October
20, 1988], the market, if everyone had the same
attitude, would have disappeared." Tr. at 15.
What plaintiffs term "stopped functioning" or
"disappeared," however, are properly seen as
natural responses and adjustments to market
realities. Plaintiffs of course do not contend
that no new issues are being sold, or that existing
issues are no longer being traded or have become
worthless.
To
respond to changed market forces, new indenture
provisions can be negotiated, such as provisions
that were in fact once included in the 8.9 percent
and 10.25 percent debentures implicated by this
action. New provisions could include special
debt restrictions or change-of-control covenants.
There is no guarantee, of course, that companies
like RJR Nabisco would accept such new covenants;
parties retain the freedom to enter into contracts
as they choose. But presumably, multi-billion
dollar investors like plaintiffs have some say
in the terms of the investments they make and
continue to hold. And, presumably, companies
like RJR Nabisco need the infusions of capital
such investors are capable of providing.
Whatever
else may be true about this case, it certainly
does not present an example of the classic sort
of form contract or contract of adhesion often
frowned upon by courts. In those cases, what
motivates a court is the strikingly inequitable
nature of the parties' respective bargaining
positions. See generally, Rakoff, Contracts
of Adhesion: An Essay in Reconstruction, 96
Harv. L. Rev. 1173 (1982). Plaintiffs here entered
this "liquid trading market," P. Mem. at 17,
with their eyes open and were free to leave
at any time. Instead they remained there notwithstanding
its well understood risks.
Ultimately,
plaintiffs cannot escape the inherent illogic
of their argument. On the one hand, it is undisputed
that investors like plaintiffs recognized that
companies like RJR Nabisco strenuously opposed
additional restrictive covenants that might
limit the incurrence of new debt or the company's
ability to engage in a merger. n27 Furthermore,
plaintiffs argue that they had no choice other
than to accept the indentures as written, without
additional restrictive covenants, or to "abandon"
the market. Tr. at 14-15.
n27
See, e.g., MetLife Memorandum, dated August
20, 1982, attached as Bradley Reply Aff.
Exh. D, at 3; MetLife Memorandum, dated
November 1985, attached as Bradley Resp.
Aff. Exh. A, at 8. ***
Yet
on the other hand, plaintiffs ask this Court
to imply a covenant that would have just that
restrictive effect because, they contend, it
reflects precisely the fundamental assumption
of the market and the fundamental basis of their
bargain with defendants. If that truly were
the case here, it is difficult to imagine why
an insistence on that term would have forced
the plaintiffs to abandon the [market. The Second
Circuit has offered a better explanation: HN9"[a]
promise by the defendant should be implied only
if the court may rightfully assume that the
parties would have included it in their written
agreement had their attention been called to
it . . . Any such assumption in this case would
be completely unwarranted." Neuman v. Pike,
591 F.2d 191, 195 (2d Cir. 1979) (emphasis added,
citations omitted).
In
the final analysis, plaintiffs offer no objective
or reasonable standard for a court to use in
its effort to define the sort of actions their
"implied covenant" would permit a corporation
to take, and those it would not. n28 Plaintiffs
say only that investors like themselves rely
upon the "skill" and "good faith" of a company's
board and management, see, e.g., P. Mem. at
35, and that their covenant would prevent the
company from "destroy[ing] . . . the legitimate
expectations of its long-term bondholders."
Id. at 54. As is clear from the preceding discussion,
however, plaintiffs have failed to convince
the Court that by upholding the explicit, bargained-for
terms of the indenture, RJR Nabisco has either
exhibited bad faith or destroyed plaintiffs'
legitimate, protected expectations.
n28
Under plaintiffs' theory, bondholders might
ask a court to prohibit a company like RJR
Nabisco not only from engaging in an LBO,
but also from entering a new line of business-with
the attendant costs of building new physical
plants and hiring new workers -- or from
acquiring new businesses such as RJR Nabisco
did when it acquired Del Monte. ***
Plaintiffs
argue that defendants have sought to blame plaintiffs
themselves for whatever losses they may have
incurred. Yet this Court need not address whether
plaintiffs are at fault, or whether they assumed
a risk in any tort sense, or whether they should
never have agreed to exchange the specific debt
provisions in at least two of the covenants
at issue for alternative benefits and public
covenants. Instead, it concludes that courts
are properly reluctant to imply into an integrated
agreement terms that have been and remain subject
to specific, explicit provisions, where the
parties are sophisticated investors, well versed
in the market's assumptions, and do not stand
in a fiduciary relationship with one another.
It
is also not to say that defendants were free
willfully or knowingly to misrepresent or omit
material facts to sell their bonds. Relief on
claims based on such allegations would of course
be available to plaintiffs, if appropriate n29
-- but those claims properly sound in fraud,
and come with requisite elements. Plaintiffs
also remain free to assert their claims based
on the fraudulent conveyance laws, which similarly
require specific proof. n30 Those burdens cannot
be avoided by resorting to an overbroad, superficially
appealing, but legally insufficient, implied
covenant of good faith and fair dealing.
n29
The Court, of course, today takes no position
on this issue.
n30
As noted elsewhere, plaintiffs can also
allege violations of express terms of the
indentures. ***
2.
Count Five: In Equity:
Count
Five substantially restates and realleges the
contract claims advanced in Count I. Compare,
e.g., Am. Comp. paras. 33, 35 ("The transaction
contradicts the premise of the investment grade
market and invalidates the blue chip rating
that [RJR Nabisco] solicited and took the benefit
from. . . . In the 'buy-out,' [RJR Nabisco]
breaches the duty of good faith and fair dealing
. . .") with Am. Comp. paras. 51-52 ("The 'buy-out'
was not contemplated at the time the debt was
issued, contradicts the premise of the investment
grade ratings that RJR Nabisco actively solicited
and received, and is inconsistent with the understandings
of the market. . . . The 'buy-out' . . . is
contrary to the implied representations made
by RJR Nabisco . . . that it would act consistently
with its obligations of good faith and fair
dealing.") Along with these repetitions, plaintiffs
blend in allegations that the transaction "frustrates
the commercial purpose" of the parties, under
"circumstances [that] are outrageous, and .
. . it would [therefore] be unconscionable to
allow the 'buy-out' to proceed . . ." Id. PP
52-53. Those very issues -- frustration of purpose
and unconscionability -- are equally matters
of contract law, of course, and plaintiffs could
just as easily have advanced them in Count I.
Indeed, to some extent plaintiffs did advance
these claims in that Count. See, e.g., Am. Comp.
para. 34 ("RJR Nabisco owes a continuing duty
. . . not to frustrate the purpose of the contracts
. . ."). For present purposes, it makes no difference
how plaintiffs characterize their arguments.
n31 Their equity claims cannot survive defendants'
motion for summary judgment.
n31
For much the same reason, the Court rejects
defendants' reliance on cases like In re
Kemp & Beatley, Inc., 64 N.Y.2d 63,
70, 484 N.Y.S.2d 799, 803, 473 N.E.2d 1173
(1984), for "the ancient principle that
equity jurisdiction will not lie when there
exists a remedy at law." See, e.g., D. Mem.
at 26. That case contemplated a classic
equitable remedy -- the dissolution of a
corporation. And in that respect, it accurately
set forth a rule of law; no court will,
for instance, enter an injunction or order
specific performance or dissolution if an
adequate legal remedy remains available.
The Court has already denied plaintiffs'
request for an injunction. To the extent
that Count V does in fact merely restate
plaintiffs' prayer for injunctive relief
-- "it would be unconscionable to allow
the 'buy-out' to proceed until defendants
make restitution to the debtholders," Am.
Comp. para. 53 -- it is of course inappropriate.
As far as the court can determine, however,
and reading plaintiffs' "In Equity" count
as charitably as possible, the claims advanced
by plaintiffs in Count V do not necessarily
seek such an exclusive remedy. In general,
remedies based on claims of unjust enrichment
or frustration of purpose are certainly
quantifiable and subject to money damages,
and would thus support a legal remedy. ***
In
their papers, plaintiffs variously attempt to
justify Count V as being based on unjust enrichment,
frustration of purpose, an alleged breach of
something approaching a fiduciary duty, or a
general claim of unconscionability. Each claim
fails. First, as even plaintiffs recognize,
HN10an unjust enrichment claim requires a court
first to find that "the circumstances [are]
such that in equity and good conscience the
defendant should make restitution." See, e.g.,
Chase Manhattan Bank v. Banque Intra S.A., 274
F. Supp. 496, 499 (S.D.N.Y. 1967); P. Mem. at
56. Plaintiffs have not alleged a violation
of a single explicit term of the indentures
at issue, and on the facts alleged this Court
has determined that an implicit covenant of
good faith and fair dealing has not been violated.
Under these circumstances, this Court concludes
that defendants need not, "in equity and good
conscience," make restitution.
Second,
in support of their motions plaintiffs claim
frustration of purpose. Yet even resolving all
ambiguities and drawing all reasonable inferences
in plaintiffs' favor, their claim cannot stand.
HN11A claim of frustration of purpose has three
elements:
First,
the purpose that is frustrated must have
been a principal purpose of that party in
making the contract. . . . The object must
be so completely the basis of the contract
that, as both parties understand, without
it the transaction would make little sense.
Second, the frustration must be substantial.
It is not enough that the transaction has
become less profitable for the affected
party or even that he will sustain a loss.
The frustration must be so severe that it
is not fairly to be regarded as within the
risks that he assumed under the contract.
Third, the non-occurrence of the frustrating
event must have been a basic assumption
on which the contract was made.
Restatement
(Second) of Contracts, 265 comment a (1981).
In The Murphy Door Bed Co., Inc. v. Interior
Sleep Systems, Inc., 874 F.2d 95 (2d Cir. 1989),
defendants argued that the contract was void
ab initio since its purpose, allegedly the conveyance
of trademark rights, was frustrated because
the mark was generic. However, the Second Circuit
concluded, "there is no indication that a transfer
of trademark rights was the essence of the distributorship
agreement . . . No mention of trademark rights
is made in the agreement." Id. at 102-103. Similarly,
there is no indication here that an alleged
refusal to incur debt to facilitate an LBO was
the "essence" or "principal purpose" of the
indentures, and no mention of such an alleged
restriction is made in the agreements. Further,
while plaintiffs' bonds may have lost some of
their value, "discharge under this doctrine
has been limited to instances where a virtually
cataclysmic, wholly unforeseeable event renders
the contract valueless to one party." United
States v. General Douglas MacArthur Senior Village,
Inc., 508 F.2d 377, 381 (2d Cir. 1974) (emphasis
added). That is not the case here. Moreover,
"the frustration of purpose defense is not available
where, as here, the event which allegedly frustrated
the purpose of the contract . . . was clearly
foreseeable." VJK Productions v. Friedman/Meyer
Productions, 565 F. Supp. 916 (S.D.N.Y. 1983)
(citation omitted). Faced with MetLife's internal
memoranda, see, e.g., Bradley Resp. Aff. Exh.
A, plaintiffs cannot but admit that "MetLife
has been concerned about 'buy-outs' for several
years." P. Opp. at 5. Nor do plaintiffs provide
any reasonable basis for believing that a party
as sophisticated as Jefferson-Pilot was any
less cognizant of the market around it. n32
n32
At least one of Jefferson-Pilot's directors
-- Clemmie Dixon Spangler -- not only was
aware of the possibility of an LBO of a
company like RJR Nabisco, but he also in
fact proposed an LBO of RJR Nabisco itself,
a fact plaintiffs do not dispute. See Bradley
Aff. para. 28, Exh. R. Spangler apparently
never mentioned his unsolicited bid for
RJR Nabisco to his fellow Jefferson-Pilot
directors. ***
Third,
plaintiffs advance a claim that remains based,
their assertions to the contrary notwithstanding,
on an alleged breach of a fiduciary duty. n33
Defendants go to great lengths to prove that
the law of Delaware, and not New York, governs
this question. Defendants' attempt to rely on
Delaware law is readily explained by even a
cursory reading of Simons v. Cogan, 549 A.2d
300, 303 (Del. 1988), the recent Delaware Supreme
Court ruling which held, inter alia, that HN12a
corporate bond "represents a contractual entitlement
to the repayment of a debt and does not represent
an equitable interest in the issuing corporation
necessary for the imposition of a trust relationship
with concomitant fiduciary duties." Before such
a fiduciary duty arises, "an existing property
right or equitable interest supporting such
a duty must exist." Id. at 304. A bondholder,
that court concluded, "acquires no equitable
interest, and remains a creditor of the corporation
whose interests are protected by the contractual
terms of the indenture." Id. Defendants argue
that New York law is not to the contrary, but
the single Supreme Court case they cite -- a
case decided over fifty years ago that was not
squarely presented with the issue addressed
by the Simons court-provides something less
than dispositive support. See Marx v. Merchants'
National Properties, Inc., 148 Misc. 6, 7, 265
N.Y.S. 163, 165 (1933). For their part, plaintiffs
more convincingly demonstrate that New York
law applies than that New York law recognizes
their claim. n34
n33
While the Court reads plaintiffs' Amended
Complaint and submissions as charitably
as it can, it nonetheless has trouble with
assertions such as this: "The right of unsecured
creditors [like plaintiffs] against having
the company's assets stripped away is not
in the nature of broad fiduciary duty, but
rather a specific charge, founded in principles
of equity and tort law of New York and other
jurisdictions . . ." P. Mem. at 51-52. Any
such "charge" -- beyond a potential fiduciary
duty the Court now addresses, see infra
-- is not, however, so "specific" as to
have been stated with any clarity by any
one court. Indeed, cases relied upon by
plaintiffs to support their "In Equity"
Count focus on fraudulent schemes or conveyances.
See, e.g., United States v. Tabor Court
Realty Corp., 803 F.2d 1288, 1295 (3d Cir.
1986) (explaining lower court's findings
in United States v. Gleneagles Investment
Co., 565 F. Supp. 556 (M.D. Pa. 1983));
Pepper v. Litton, 308 U.S. 295, 296, 84
L. Ed. 281, 60 S. Ct. 238 (1939) ("The findings
by the District Court, amply supported by
the evidence, reveal a scheme to defraud
creditors . . ."); Harff v. Kerkorian, 347
A.2d 133, 134 (Del. 1975) (bondholders limited
to contract claims in absence of "'fraud,
insolvency, or a violation of a statute.'")
(citation omitted). Moreover, if the Court
here were confronted with an insolvent corporation,
which is not the case, the company's officers
and directors might become trustees of its
assets for the protection of its creditors,
among others. See, e.g., New York Credit
Men's Adjustment Bureau v. Weiss, 278 A.D.
501, 503, 105 N.Y.S.2d 604, 606 (1st Dep't
1951), aff'd, 305 N.Y. 1, 110 N.E.2d 397
(1953).
If
not based on a fiduciary duty and the other
equitable principles addressed by the Court,
plaintiffs' claim, in effect, asks this Court
to use its broad equitable powers to fashion
a new cause of action that would adopt precisely
the same arguments the Court rejected in Count
I.
n34
The indenture provision designating New
York law as controlling, see supra n.10,
would, one might assume, resolve at least
the issue of the applicable law. In quoting
the relevant indenture provision, however,
plaintiffs omit the proviso "except as may
otherwise be required by mandatory provisions
of law." P. Mem. at 52, n.46. Defendants,
however, fail to argue that the internal
affairs doctrine, which they assert dictates
that Delaware law controls this question,
is such a "mandatory provision of law."
Nor do defendants respond to plaintiffs'
reliance on First National City Bank v.
Banco Para El Comercio, 462 U.S. 611, 621,
77 L. Ed. 2d 46, 103 S. Ct. 2591 (1983)
("Different conflicts principles apply,
however, where the rights of third parties
external to the corporation are at issue.")
(emphasis in original, citation omitted).
Ultimately, the point is academic; as explained
below, the Court would grant defendants
summary judgment on this Count under either
New York or Delaware law. ***
Regardless,
this Court finds Simons persuasive, and believes
that a New York court would agree with that
conclusion. In the venerable case of Meinhard
v. Salmon, 249 N.Y. 458, 164 N.E. 545 (1928),
then Chief Judge Cardozo explained the obligations
imposed on a fiduciary, and why those obligations
are so special and rare:
Many
forms of conduct permissible in a workaday
world for those acting at arm's length,
are forbidden to those bound by fiduciary
ties. A trustee is held to something stricter
than the morals of the market [*1525] place.
Not honesty alone, but the punctilio of
an honor the most sensitive, is then the
standard of behavior. As to this there has
developed a tradition that is unbending
and inveterate. Uncompromising rigidity
has been the attitude of courts of equity
when petitioned to undermine the rule of
undivided loyalty . . . Only thus has the
level of conduct for fiduciaries been kept
at a level higher than that trodden by the
crowd.
Id.
at 464 (citation omitted). Before a court recognizes
the duty of a "punctilio of an honor the most
sensitive," it must be certain that the complainant
is entitled to more than the "morals of the
market place," and the protections offered by
actions based on fraud, state statutes or the
panoply of available federal securities laws.
This Court has concluded that the plaintiffs
presently before it -- sophisticated investors
who are unsecured creditors -- are not entitled
to such additional protections.
Equally
important, plaintiffs' position on this issue
-- that "A Company May Not Deliberately Deplete
its Assets to the Injury of its Debtholders,"
P. Mem. at 42 -- provides no reasonable or workable
limits, and is thus reminiscent of their implied
covenant of good faith. Indeed, many indisputably
legitimate corporate transactions would not
survive plaintiffs' theory. With no workable
limits, plaintiffs' envisioned duty would extend
equally to trade creditors, employees, and every
other person to whom the defendants are liable
in any way. Of all such parties, these informed
plaintiffs least require a Court's equitable
protection; not only are they willing participants
in a largely impersonal market, but they also
possess the financial sophistication and size
to secure their own protection.
Finally,
plaintiffs cannot seriously allege unconscionability,
given their sophistication and, at least judging
from this action, the sophistication of their
legal counsel as well. Under the undisputed
facts of this case, see supra at 13-20, this
Court finds no actionable unconscionability.
B.
Defendants' Remaining Motions:
Defendants
attack plaintiffs' fraud claims on various fronts.
The Court has determined that repleading is
necessary. In drafting a Second Amended Complaint,
plaintiffs must bear in mind the Court's conclusions
below.
Defendants
move to dismiss pursuant to Fed. R. Civ. P.
12(c) Count III, the Rule 10b-5 counts, as to
those six debt issues purchased by plaintiffs
prior to September 1987, which is when plaintiffs
allege in their complaint that defendants first
began to develop an LBO plan. Plaintiffs admit
that HN13Rule 10b-5 is limited to purchases
or sales during the period of non-disclosure
or misrepresentation. See Pross v. Katz, 784
F.2d 455 (2d Cir. 1986). The rule does not afford
relief to those who forgo a purchase or sale
and instead merely hold in reliance of a nondisclosure
or misrepresentation. See e.g., Bonime v. Doyle,
416 F. Supp. 1372, 1387 (S.D.N.Y. 1976), aff'd,
556 F.2d 554 (2d Cir.), cert. denied, 434 U.S.
924, 54 L. Ed. 2d 281, 98 S. Ct. 401 (1977).
The first, second, third, fifth, seventh and
eighth securities listed in the Amended Complaint
fail to satisfy this requirement, at least on
the facts as presently pleaded. n35 Accordingly,
the Court grants defendants' motion on Count
III as to those issues. Plaintiffs correctly
note, however, that the disclosure-related common
law fraud claims are not restricted to purchases
and sales. See Weinberger v. Kendrick, 698 F.2d
61, 78 (2d Cir. 1982) (Friendly, J.), cert.
denied, 464 U.S. 818, 78 L. Ed. 2d 89, 104 S.
Ct. 77 (1983); Continental Insurance Co. v.
Mercadante, 222 A.D. 181, 186, 225 N.Y.S. 488,
494 (1st Dep't 1927). Thus, the Court denies
defendants' motion to dismiss Count II on this
basis.
n35
It remains unclear how the fourth security
listed in the Amended Complaint fares under
the controlling law. If plaintiffs purchased
portions of that issue prior to September
1987, then, of course, the Court's above
holding applies equally here.
The
parties are well aware of the purposes and requirements
of HN14Rule 9(b), mandating [*1526] particularity
in pleading fraud. Those principles have often
been reaffirmed by the Second Circuit. See,
e.g., Stern v. Leucadia National Corp., 844
F.2d 997 (2d Cir.), cert. denied, 488 U.S. 852,
109 S. Ct. 137, 102 L. Ed. 2d 109 (1988); Di
Vittorio v. Equidyne Extractive Industries,
822 F.2d 1242 (2d Cir. 1987). As it now stands,
the Amended Complaint cannot on its own survive
scrutiny under that rule. Plaintiffs must heed
the guidelines established by the controlling
Second Circuit authority. On previous occasions,
this Court has left little doubt about what
it expects to see in a complaint that pleads
fraud. It will not take this opportunity to
repeat itself and instead refers the parties
to those opinions. See e.g., Philan v. Hall,
712 F. Supp. 339 (S.D.N.Y. 1989). The Court
notes that the complaint currently before it
was filed even before the January 12 close of
the expedited discovery period for these motions.
Moreover, since January additional discovery
has taken place. Today's ruling, of course,
should not be misperceived as an invitation
to submit a Second Amended Complaint indiscriminately
larded with factual recitations and legal boilerplate.
The Court has no reason to believe that plaintiffs,
represented by skilled counsel, intend to follow
that unwise course.
For
the reasons set forth above, the Court grants
defendants summary judgment on Counts I and
V, judgment on the pleadings for certain of
the securities at issue in Count III, and dismisses
for want of requisite particularity Counts II,
III, and IX. All remaining motions made by the
parties are denied in all respects. Plaintiffs
shall have twenty days to replead.
Dated:
New York, New York, May 31, 1989
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4.3.5 Relationship stockholders-bondholders 