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United States of America > New York > Litigation Dispute resolution > Advisory > Article > $33 Million Interest for $1,000!!! Be Careful What You Agree To

Article: $33 Million Interest for $1,000!!! Be Careful What You Agree To

In a recent unanimous decision, New York’s Court of Appeals affirmed the principle that a contract negotiated between sophisticated parties who have been represented by counsel will be enforced even if enforcement leads to extraordinary results. Specifically, the Court upheld an option agreement that permitted one party to purchase for $1,000 a membership interest valued at $33 million because the parties were “sophisticated and counseled” and the agreement was unambiguous.

Fundamental Long Term Care Holdings, LLC v Cammeby’s Funding LLC, 20 NY3d 438, 441 (2013), involved business entities controlled by Rubin Schron, Leonard Grunstein, and Murray Forman. The parties agreed that Schron would acquire title to a group of nursing homes and that Fundamental Long Term Care Holdings, LLC (“Fundamental”), owned by Grunstein and Forman, would manage those nursing homes. On July 1, 2006, Fundamental and Cammeby’s Funding LLC (“Cam Funding”), a company managed by Schron, entered into an option agreement that entitled Cam Funding to acquire one-third of Fundamental’s membership units for a strike price of $1,000, provided that the option was exercised on or before June 9, 2011. Id.

In section 5 of the option agreement, Fundamental agreed not to:

[C]ause, suffer or permit any of its subsidiaries to, enter into any agreement or commitment with any unitholder, subscriber, officer, director or employee or other person that would conflict with or interfere with any of the rights of [Cam Funding] under this Agreement, including (without limitation) the exercise of the Option, and any such conflicting agreement or commitment shall be deemed void and of no force or effect.

Id. at 442. Section 6 of the option agreement provided that Grunstein and Forman, the sole members of Fundamental, promised not to take any action inconsistent with the option, and upon Cam Funding’s exercise of the option, to:

(a) consent to the issuance of the Acquired Units to [Cam Funding], (b) consent to the admission of [Cam Funding] as a member of [Fundamental], and (c) cause [Fundamental] to carry out its obligations herein and to execute and deliver such amendments and schedules to the Operating Agreement of [Fundamental] to reflect the issuance of the Acquired Units to [Cam Funding].

On December 20, 2010, Cam Funding exercised its option and sent Fundamental a check for $1,000. At that time, the market value of a one-third interest in Fundamental was estimated to be $33 million. Obviously unhappy with that exercise, Fundamental asserted that more was needed. In particular, Fundamental pointed to its operating agreement, dated December 22, 2005, and amended and restated on September 3, 2009, which stated:

Additional Interests shall not be issued except upon the consent of the Board of Managers [i.e., Grunstein and Forman] and the unanimous consent of the Members [i.e., Grunstein and Forman]. Upon the issuance of any additional Interests, the Person to whom such Interests are issued shall make a capital contribution to the Company in an amount equal to at least the fair market value per Interest so issued.

Fundamental asserted that its operating agreement required that “no membership units in Fundamental can be issued to [Cam Funding] until … [Cam Funding] provides the required capital contribution of ‘at least the fair market value’ of its proposed interest, which is 33.33%.” Id. at 443.

Taking a preemptive strike, Fundamental sought a declaration that Cam Funding was bound by the operating agreement to “make the requisite capital contribution upon the issuance of any additional interests in Fundamental.” Id. The trial court held that the option agreement unambiguously granted Cam Funding the right to acquire a one-third interest in Fundamental upon payment of $1,000. The trial court noted that enforcing the operating agreement would violate section 5 of the option agreement by “allow[ing] a subsequent agreement – the Operating Agreement – to interfere with Cam Funding’s rights under the terms of the Option Agreement.” In addition, the court interpreted section 6 of the option agreement as evidence that “the parties contemplated a future operating agreement and intended that the Operating Agreement yield to the Option Agreement.” Id. at 443-444.

The Appellate Division, First Department, affirmed concluding that whether or not the option agreement or operating agreement was executed first, the option agreement unambiguously granted Cam Funding the right to acquire a one-third interest in Fundamental for $1,000 without the need for a capital contribution. Id.

On further appeal, Fundamental argued that the option agreement and operating agreement must be read together to create a “two-step process.” First, under the option agreement, Cam Funding was to pay $1,000 for a one-third interest in Fundamental, and, second, the operating agreement dictated that Cam Funding make a capital contribution equal to the fair market value of a one-third interest. The Court of Appeals was unpersuaded and held that the two agreements were not inextricably intertwined and a breach of one would not undo the obligations of the other. Further, had the parties intended that Cam Funding’s exercise of the option be dependent on it making a capital contribution, that is not the kind of term that “sophisticated, counseled parties would have reasonably left out of the option agreement.” Finally, the Court held that despite the vast disparity between the option price and the value of the property acquired, it would not conduct an inquiry into commercial reasonableness because the agreement was unambiguous. Id. at 445.

Although it is generally a compliment to be considered sophisticated, a finding of sophistication in the context of a contract that has been negotiated by represented parties may lead to an unhappy result. And, sophisticated and counseled parties should not expect courts to apply notions of commercial reasonableness to their unambiguous contracts. In this case, every judge who considered the issue ruled against the sophisticated, counseled party who had signed an unambiguous contract.

Last Update: 2013-May-05 Charles E. “Trip” Dorkey III - Dentons
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Author: Charles E. “Trip” Dorkey III
Law Firm: Dentons
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