The Delaware Court of Chancery—in RoundPoint Mortgage Servicing Corporation, et al. v. Freedom Mortgage Corporation, et al. 07/22/2020, CA No. 2020-0161-SG—addressed a situation whereby the parties’ dispute ultimately boiled down to 11 words in Section 7.02(f) of the parties’ merger agreement: “and shall have repaid, all amounts outstanding under the RPFG Facility.”
The merger agreement was set forth as an acquisition of RoundPoint by Freedom. The consideration to be paid in cash by Freedom was not fixed but was to be calculated according to a book-value-based formula—i.e., the net asset value—of RoundPoint. The practical implication of this formula was that consideration to be paid by Freedom in the merger was uncertain when the merger agreement was signed and that any fluctuation would be attributable to changes in RoundPoint’s net asset value. This makes a difference in the purchase price, because forgiveness of debt increases book value and the buyer must pay the premium on such book value at closing.
Before entering into the merger agreement, RoundPoint had an existing revolving credit facility with a bank, which loan was secured by certain assets. The mechanics of the loan were such that RoundPoint was subject to margin calls if the value of the collateral declined.
RoundPoint was concerned that if the loan were subject to margin calls between signing and closing—because RoundPoint’s collateral declined in value—restrictions in the merger agreement, such as restrictions on selling assets, could restrain RoundPoint from taking steps it would ordinarily take to pay margin calls under the loan.
The parties’ solution to RoundPoint’s concerns about meeting margin calls was to permit RoundPoint to borrow funds from RPFG, its controlling stockholder, pursuant to a revolving credit facility (the RPFG Facility), which was not in place prior to the merger agreement.
After the RPFG Facility was put in place, it was eventually increased multiple times, to its final number of $123 million. Thereafter, RPFG forgave $122 million of the RPFG Facility, leaving RoundPoint owing $1 million under the RPFG Facility prior to closing. Freedom refused to confirm that it would close the transaction and contended that not all conditions for closing under the merger agreement had been met. Specifically, Section 7.02(f) of the merger agreement states in pertinent part, “if the RPFG Facility has been put in place prior to Closing, RoundPoint shall have obtained any and all necessary consents to repay (in accordance with all of its contractual obligations and restrictions, and otherwise), and shall have repaid, all amounts outstanding under the RPFG Facility.”
The plaintiffs contended that (1) to fulfill the closing condition, RoundPoint must repay, at or prior to closing, all outstanding amounts then owed to RPFG, i.e., leaving no balance owed, and that (2) Section 7.02(f) does not prohibit forgiveness of debt under the RPFG Facility.
Accordingly, in the plaintiffs’ view of this language, forgiven debt was no longer “outstanding,” and RoundPoint must have repaid only the outstanding balance of its loans to fulfill the closing condition—not some other amount, be it the full, original amount of the loans or some amount outstanding at some other point in time. Moreover, the words “shall have repaid,” per the plaintiffs, were applicable only to the amounts outstanding immediately prior to closing and did not operate on any amounts no longer outstanding, without regard to why such amounts were no longer outstanding.
Conversely, the defendants argued that RoundPoint and Freedom intended Section 7.02(f) to require repayment in full of all amounts borrowed under the RPFG Facility and outstanding at any time and not to permit such loans to be forgiven by RPFG.
Accordingly, the defendants’ reading had a temporal element—that is, that “shall have repaid” (rather than “shall repay”) referred not only to any amounts outstanding immediately prior to closing but also to any amounts that ever were outstanding under the RPFG Facility. However, the court noted that the plain language of the section is not naturally read this way, because the language is silent on how amounts are to be deemed outstanding.
Nevertheless, the court noted that “the Plaintiffs’ interpretation of Section 7.02(f) was certainly the more intuitive reading.” Looking to the plain meaning of the words used in Section 7.02(f), the court noted that the section did not explicitly comment on or restrict in any way amounts no longer outstanding.
The court next looked to the parol evidence rule to better determine the intent of the parties. After doing so, the court explained that there was no evidence extrinsic to the merger agreement pertinent to whether the parties intended to regulate or restrict RPFG Facility debt forgiveness in Section 7.02(f). Although the defendants pointed out that the formula used (book value plus a premium) would allow the plaintiffs to reap a windfall by retiring the RPFG Facility debt by forgiveness, the court noted that the defendants failed to point to any evidence that the parties recognized this and intended to avoid it through the language of Section 7.02(f).
Next, the court looked to Section 3.21(d) of the merger agreement—a representation and warranty of RoundPoint regarding mortgage loans—to assist in reaching a conclusion. The section stated in part that “no payment of principal or interest on the mortgage loan has been forgiven, suspended, or rescheduled.” In the section, the court explained, the parties sought to impose restrictions on the forgiveness or modification of RoundPoint’s debt obligations and clearly knew how to do so. By analogy, because Section 7.02(f) as most naturally read did not impose such restrictions on debt forgiveness, and because the merger agreement showed that where the parties sought to impose such restrictions they knew how to do so, the court found that the parties did not intend Section 7.02(f) of the merger agreement to prohibit forgiveness of debt under the RPFG Facility. Accordingly, the court held that the obligation expressed in the language of Section 7.02(f) itself would be fulfilled if RoundPoint repaid any amount outstanding under the RPFG Facility, thus bringing indebtedness under the RPFG Facility to $0; however, the court limited its holding to its interpretation of Section 7.02(f) and did not address whether all conditions for closing the merger had actually been met. The court also addressed the defendants’ counterclaim for breach of the implied covenant of good faith and fair dealing, and the court concluded that the defendants did not meet their burden to show that RoundPoint and Freedom would have agreed to proscribe forgiveness had they thought to negotiate with respect to that matter.
*This article was written with assistance from our summer associate Steve Greco.