Court's Decision In High Stakes Case Cuts Through The "Fog Of Dueling 'Notwithstanding' Clauses"

In a post I wrote about a dozen years ago, I quoted Ken Adams, blogger and author of A Manual of Style for Contract Drafting, who, commenting on the oft-used contract clause, "Notwithstanding anything to the contrary in this Agreement," wrote, "[t]o reduce the chance of a drafting error, and to make life easier for the reader, it would be best to determine whether the provision in question in fact needs to trump another provision and, if it does, to specify which provision" (my italics).

Ken's post in turn quoted from a report prepared by Professor John C. Coates on the use of the "'terms of art' customarily relied upon" by M&A lawyers "such as 'subject to' and 'notwithstanding,'" in which the Professor explained,

Ken's and the Professor's observations highlight the tension between, on the one hand, the utility achieved by use of a "notwithstanding" clause and, on the other, the greater the risk of future, knotty contract disputes the more complex and lengthier an agreement containing numerous "notwithstanding" clauses that fail to specify which provisions they supersede.

In my post back then, I wrote about a case decided by the late, great Manhattan Commercial Division Justice Eileen Bransten, which was affirmed on appeal, in which she denied summary judgment in a dispute generated by two seemingly irreconcilable sections of the management provisions in an LLC agreement concerning member consent:

• One would have authorized the defendant member, who was sued in connection with a conflicted transaction which was not submitted to the non-conflicted members for their approval, "to execute and deliver, the Indenture, the Note Purchase Agreement and all documents, agreements, certificates, or financing statements contemplated thereby or related thereto, all without further act, vote or approval of any other Person notwithstanding any other provision of this Agreement."
• The other would have required the conflicted transaction to be approved by super-majority vote of the non-conflicted members, "notwithstanding the foregoing and any other provision of this Agreement to the contrary."

The appellate court agreed with Justice Bransten that there were triable issues of fact, writing that "[a]s it is unclear which provision authorized or did not authorize [defendant's] conduct in entering into the disputed transaction . . . the agreements are ambiguous as written . . .."

Same Issue, Different Outcome

Consider the following:

The above quote is from the opening paragraph in a thoughtful decision last month by Manhattan Commercial Division Justice Joel M. Cohen in HNA Holdings 422 Fulton (GP) LP v TSCE 2007 422 Fulton GP, LLC. The high stakes case involves a Delaware limited partnership (the "LP") formed to redevelop a large Brooklyn commercial property. At the risk of greatly oversimplifying the deal's structure, the defendant ("TSCE") was Managing General Partner while the plaintiff ("HNA") provided almost all equity in the project and had no role in management except concerning specified Major Decisions including transactions between the LP and any affiliate of TSCE.

In broad terms, the lawsuit involved competing claims of default and breach by the other party. TSCE claimed that HNA failed to make a mandatory capital contribution and thereby lost its voting rights concerning Major Decisions, whereas HNA claimed that TSCE breached the LP Agreement by making unilateral Major Decisions.

The Dueling "Notwithstanding" Clauses

The resolution of the competing claims turned on the interplay of two provisions in the LP Agreement ("LPA"), each containing a "notwithstanding" clause that, as Justice Cohen commented in his above-quoted opening paragraph, "appear to be in conflict (or at least in tension)."

The two provisions are a bit dense; here's the short version:

• Section 3.02(e) ("Mandatory Capital Contributions") provides, "Notwithstanding anything herein to the contrary," any party that fails to make its share of a required capital contribution "shall permanently lose all of its rights . . . to vote on or approve any matters that would otherwise require its approval pursuant to this Agreement . . .."
• Section 6.01(e) ("Management") provides, "Notwithstanding anything to the contrary contained in this Agreement," TSCE cannot cause the LP to proceed with any Major Decision without HNA's prior written consent.

Again, oversimplifying, the litigation kicked off after HNA failed to make a series of required capital contributions. TSCE declared HNA in default and subsequently caused the LP to enter into a leasing transaction without HNA's consent in which an affiliate of TSCE received development fees and was entitled to receive additional leasing commissions. TSCE also sent HNA new business and development plans, both of which also were specified as Major Decisions, without HNA's consent.

HNA sued TSCE, and TSCE counterclaimed against HNA, each claiming the other breached the LPA. Following discovery each side sought summary judgment.

The Court's Decision

Justice Cohen began his legal analysis setting forth established rules of contract construction under governing Delaware law. In particular, any inconsistency between general and specific provisions favors the specific; unequivocal language controls over qualified language; and the use of a notwithstanding clause "clearly signals the drafter's intention that the provisions of the 'notwithstanding' section override conflicting provisions of any other section."

Applying these principles, Justice Cohen ruled in HNA's favor for the following reasons:

• First, Section 3.02(e) uses "Notwithstanding anything herein to the contrary" whereas Section 6.01(e) uses "Notwithstanding anything to the contrary contained in this Agreement." In other words, the indefinite term "herein" in Section 3.02(e) "could be limited to language within other provisions of Article III of the LPA rather than the entirety of the LPA" and therefore bows to Section 6.03(e)'s use of the more definite "in this Agreement."
• Second, Justice Cohen points to "the different language used in the two provisions." Whereas Section 3.02(e) provides for the "loss" of "rights (if any)" to "vote on or approve any matters that would otherwise require its approval pursuant to this Agreement," the consent rights in Section 6.01(e) use none of those words. Section 3.02(e)'s reference to "rights (if any)," he adds, "suggests an uneasy fit with an intention to obliterate the expressly defined consent rights" contained in Section 6.01(e).
• Third, Justice Cohen notes as "revealing" the "absence in Section 6.01(e) of any cross-reference to Section 3.02(e)" as compared with another section in the LPA with the same "notwithstanding" clause that contains an express proviso referencing Section 3.02(e). "Clearly," he writes, "the parties knew how to address a situation in which Section 3.02(e)'s narrower 'notwithstanding' clause would trump a broader provision such as that contained in 6.01(e) . . .."
• Fourth, TSCE's reading of the provisions "would eviscerate the 'notwithstanding' clause in Section 6.01(e) by subjugating it entirely to Section 3.02(e), leaving it without force or effect going forward." HNA's reading, by contrast, "preserves the viability of Section 3.02(e), which would continue to apply to other approval rights throughout the LPA."
• Fifth, Justice Cohen finds HNA's reading "consistent with the overall structure of the LPA and the economics of the project." He notes that HNA contributed "virtually all the equity investment in the project but had no substantial role in management other than the Major Decisions provision, which role is spelled out in great detail and with a broad 'notwithstanding' clause to boot." TSCE's reading, in contrast, "would require a belief that the HNA Partners agreed to permanently forfeit that core consent right in the event of a default on a single Mandatory Capital Call . . .. While it is conceivable that such a super-majority investor would agree to such a punishing default provision in favor of a manager that had little equity stake, it is reasonable to suspect that such a forfeiture, if truly intended, would have been spelled out clearly in the text rather than lost amidst the fog of dueling 'notwithstanding' provisions" (italics in original).

The transcript of oral argument of the summary judgment motions features Justice Cohen's comment right out of the box that, by his count, the 92-page LPA uses the word "notwithstanding" 78 times, mostly but not always in the context of notwithstanding anything to the contrary in the agreement or "herein." By my own count, 58 of the "notwithstandings" were precisely in that context, relatively few of which specified the provisions they trumped.

Within days after the decision, counsel for TSCE filed a notice of appeal. I'd be very surprised if TSCE doesn't perfect its appeal with dispatch, in which case we can eagerly anticipate a likely decision on this most interesting subject by the Appellate Division before the year is out.