Opinion
Civil Action 10,624.
Date Submitted: March 20, 1989.
Date Decided: May 23, 1989.
Michael Hanrahan, Esquire and Elizabeth M. McGeever, Esquire of PRICKETT, JONES, ELLIOTT, KRISTOL SCHNEE, Wilmington, Delaware and David Parker, Esquire and Stephen M. Schultz, Esquire of KLEINBERG, KAPLAN, WOLFF COHEN, P.C., New York, New York, Attorneys for Plaintiffs
A. Gilchrist Sparks, III, Esquire and Robert J. Valihura, Jr., Esquire of MORRIS, NICHOLS, ARSHT TUNNELL, Wilmington, Delaware and Robert S. Smith, Esquire and Judith S. Lieb, Esquire of PAUL, WEISS, RIFKIND, WHARTON GARRISON, New York, New York, Attorneys for Defendant
MEMORANDUM OPINION
The holders of certain debentures brought this action to obtain, among other relief, the appointment of a receiver for the issuing company, defendant Bio-Response, Inc. ("Bio-Response"). Plaintiffs collectively hold 30.5% of the outstanding Bio-Response 8½% Convertible Subordinated Debentures due September 1, 2001 (the "Debentures"). The face amount of the outstanding Debentures is approximately $22 million and, on September 1, 1989, the Debenture holders will have the right to require Bio-Response to redeem their Debentures at approximately 103% of the face amount together with accrued interest (the "put option"). The complaint alleges that Bio-Response is insolvent (with a negative net worth in excess of $10 million); that it has been operating and continues to operate at a substantial loss; and that the company has done nothing to correct this dire situation or to meet its obligations to the Debenture holders under the put option. This is the decision on Bio-Response's motion to dismiss.
Plaintiffs purport to allege both contractual and non-contractual claims relating to the Debentures. They allege that Bio-Response has defaulted under the terms of the indenture because it is unable to provide an assurance that the company will be able to satisfy the put option in September. Plaintiffs also allege as contractual claims that Bio-Response cannot comply with its obligation to file an officers' certificate on March 31, 1989 and that the company has breached its implied obligation of good faith and fair dealing. Plaintiffs argue that their complaint also states a fraud claim and a statutory claim pursuant to 8 Del. C. § 291.
The relevant facts may be summarized as follows. Bio-Response is a Delaware corporation engaged in the business of culturing mammalian cells and producing cellular protein for various therapeutic and diagnostic purposes. The chairman of the board of Bio-Response owns more than 36% of the approximately 9 million shares of common stock outstanding and all officers and directors collectively own almost 40% of the outstanding stock. They do not own any Debentures. In September, 1986, Bio-Response issued the Debentures in order to finance continued operations. The Debentures are convertible at any time into common stock and they are redeemable by the company subject to certain conditions. In addition, as noted above, the Debenture holders may exercise their put option on September 1, 1989.
As of September 30, 1988, when plaintiffs say that the company's obligation to redeem the Debentures became a current liability for accounting purposes, Bio-Response's liabilities (including the redemption obligation) exceeded current assets by $15.9 million. In a 10-Q quarterly report for the period ending September 30, 1988, Bio-Response addressed the put option as follows:
[T]he Company presently has an obligation to redeem approximately $22,000,000 face value of Debentures at the option of the holders on September 1, 1989. This situation represents a potential claim on future cash flow which would require a large amount of cash not currently available. Although the Company is studying possible responses to the situation, there can be no assurance that the Company will have sufficient cash in the future, from operations or otherwise, to make payments of principal and interest that become due by reason of the redemption of the Debentures at the option of the holders thereof on September 1, 1989.
Form 10-Q, dated November 10, 1988, p. 6.
The Indenture contains what is sometimes called a "no action" clause limiting the right of Debenture holders to institute proceedings relating to the Debentures. See Indenture, Section 6.06. Specifically, before bringing an action, Debenture holders must provide the Indenture Trustee written notice of default; the holders of at least 25% of the outstanding Debentures must make a written request that the Trustee institute the action and offer to indemnify the Trustee in that regard; and the Trustee must have failed to institute the action for 30 days after receiving the request. The complaint alleges that the Trustee and Bio-Response were notified of what plaintiffs contend is a default and that Bio-Response has not cured the default. In addition, plaintiffs allegedly requested that the Trustee bring this action on behalf of all Debenture holders, but the Trustee declined.
The thrust of defendant's argument in support of its motion to dismiss is that plaintiffs' complaint is premature. According to the company, there had been no default as of the time that the complaint was filed (February 16, 1989) and, thus, no basis on which plaintiffs could have given a notice of default prior to suit as required by Section 6.06 of the Indenture. Even if there has been a default, defendant argues that the complaint must be dismissed for failure to allege compliance with the various pre-suit requirements of the Indenture. Finally, the company argues that plaintiffs may not avoid the requirements of the Indenture by asserting a statutory claim for the appointment of a receiver and that the complaint fails to state a claim for fraud. For the reasons that follow, I find in favor of defendant.
The first issue is whether, based upon the facts alleged, Bio-Response could have been in default at the time the complaint was filed. Defendant makes the fairly straight-forward argument that, since there has been no "default" or "event of default" as those terms are defined in the Indenture, plaintiffs cannot state a contractual claim. Plaintiffs offer two responses: (1) that, under the terms of the Indenture, a default may occur before an actual event of default; and (2) that the company has already defaulted on its obligation to satisfy the put option under the doctrine of anticipatory repudiation. Each of these arguments will be considered in turn.
The Indenture defines "default" as "any event which is, or after notice or passage of time would be, an Event of Default." Section 1.01. Plaintiffs read this language as authorizing an action to be brought in anticipation of a future event of default, such as the company's failure to redeem the Debentures upon exercise of the put option in September, 1989. The failure to pay the principal of any security upon redemption is one of several events of default enumerated in Section 6.01. Thus, according to plaintiffs, the company's future failure to exercise the put option constitutes a present default because it is an event which, after the passage of time, would constitute an event of default.
It is settled law that the provisions of a contract must be read as a whole and that the words chosen, if they are neither expressly defined nor words of art, should be given their plain and normal meaning. See E.I. duPont de Nemours v. Shell Oil Co., Del. Supr., 498 A.2d 1108, 1113-1114 (1985); Empire Props. Corp. v. Manufacturers Trust Co., NY Ct. App., 43 N.E.2d 25, 28 (1942). The plain meaning of the language in Section 1.01 of the Indenture, read in context with Section 6.01, is that a default may occur before an event of default because certain defined events of default begin with default and do not ripen into events of default until the passage of specified periods of time. For example, Section 6.01(1) provides that it is an event of default if the company fails to pay interest when due and "the default continues for a period of 30 days. . . ." Plaintiffs' strained interpretation warrants little comment. Suffice it to note that they ignore Section 6.01 and their reading of Section 1.01 would lead to absurd results. For example, under plaintiffs' approach, Debenture holders would be able to institute proceedings today based upon the company's anticipated failure to pay the principal due on the Debentures at their maturity in the year 2001. Plaintiffs concede that such a claim would be absurd and, by that concession, the weakness of their interpretation of Section 1.01.
Pursuant to Section 12.09, the Indenture is to be governed by the laws of the State of New York and neither party has suggested to the Court that the choice of law provision should be ignored. However, there has been no showing that the law of New York differs from that of Delaware with respect to any of the matters at issue here. Accordingly, it appears to be of no consequence which authorities are relied upon.
Alternatively, plaintiffs argue that they are entitled to proceed before the put option may be exercised because Bio-Response has already repudiated its obligation to satisfy the put option. Plaintiffs rely on RESTATEMENT (SECOND) OF CONTRACTS § 251 for the proposition that Bio-Response has defaulted since it has not provided satisfactory assurances that it will perform its obligations when they become due. Plaintiffs argue that the complaint adequately alleges the company's failure to give assurance (and thus its repudiation of the put option) by its reference to the statement in Bio-Response's Form 10-Q, quoted above. However, plaintiffs cite no New York case law adopting the Restatement position.
The Restatement provides, in relevant part:
§ 251. When a Failure to Give Assurance May Be Treated as a Repudiation
(1) Where reasonable grounds arise to believe that the obligor will commit a breach by non-performance . . ., the obligee may demand adequate assurance of due performance and may, if reasonable, suspend any performance for which he has not already received the agreed exchange until he receives such assurance.
(2) The obligee may treat as a repudiation the obligor's failure to provide within a reasonable time such assurance of due performance as is adequate in the circumstances of the particular case.
RESTATEMENT (SECOND) OF CONTRACTS § 251.
Under New York common law, an anticipatory repudiation "can be determined to have occurred whenever there is an `overt communication of intention' not to perform. . . ." However, for these principles to operate it should be shown that the announcement of an intention not to perform was positive and unequivocal. Tenavision, Inc. v. Neuman, 408 N.Y.S.2d 36, 38 (1978) (citations omitted). See also Sven Salen A B v. Jacq. Pierot, Jr., Sons, Inc., 559 F. Supp. 503, 506 (S.D.N.Y. 1983). Anticipatory repudiation occurs only where there is "a clear manifestation of intent communicated far in advance of the time for performance that when the time for performance arrives the required performance will not be rendered." Record Club of America, Inc. v. United Artists Records Inc., 643 F. Supp. 925, 936 (S.D.N.Y. 1986). Thus, under New York law, plaintiffs must allege more than a failure to provide assurance of due performance. Instead, they must allege a positive and unequivocal intention not to perform. Even, "an expression of doubt as to whether the ability to perform in accordance with the contract will exist when the time comes, is not a repudiation." 4 Corbin on Contracts § 974 (1951). Cf. Derwell Company v. Apic, Inc., Del. Ch., 278 A.2d 338 (1971).
At best, plaintiffs' complaint alleges that Bio-Response questions its ability to satisfy the put option and that plaintiffs strongly believe that the company will breach its obligation. There is no allegation that the company, either by words or conduct, expressed its intention not to perform. Accordingly, I find that the complaint fails to state a claim for anticipatory repudiation. Moreover, even if such a claim were properly pled, it would not constitute a default under the terms of the Indenture since Section 6.01 does not list anticipatory repudiation as an event of default. In sum, plaintiffs' contractual claims are premature. At the time the complaint was filed there had been no default, as defined by the Indenture, relating to the put option.
Plaintiffs' claim with respect to the March 31, 1989 Officers' Certificate, likewise was premature. Pursuant to § 4.11 of the Indenture, the company is required to file with the Trustee a certificate stating, among other things, that "no event has occurred and is continuing which would prohibit payment of the principal or interest on the Securities when due." The complaint alleges that Bio-Response could not comply with the requirements of § 4.11 in good faith in light of the company's financial condition. This claim, like the put option claim, was premature when filed and plaintiffs have not amended their complaint to reflect the facts as they existed after March 31, 1989.
Plaintiffs argue that their remaining claims are not subject to the restrictions in the Indenture because they are non-contractual claims. Specifically, plaintiffs contend that the complaint alleges fraud, violation of the implied covenant of good faith and fair dealing, and a statutory claim for the appointment of a receiver pursuant to 8 Del. C. § 291. This Court has recognized that debenture holders may be able to seek relief outside of the indenture where there are "special circumstances which affect the rights of the debenture holders as creditors of the corporation, e.g., fraud, insolvency, or a violation of a statute. . . ." Harff v. Kerkorian, Del. Ch., 324 A.2d 215, 222 (1974), rev'd on other grounds, Del. Supr., 347 A.2d 133 (1975). However, the complaint does not adequately allege a fraud claim and I find that the other claims are subject to the restrictions in the Indenture, notwithstanding plaintiffs' arguments to the contrary.
Fraud must be alleged with particularity. It is not sufficient to simply use the word "fraud" or its equivalent. Chancery Court Rule 9(b); Halpern v. Barran, Del. Ch., 313 A.2d 139, 143-44 (1973). Rather, the complaint must allege "that the defendant, with intent to deceive, misrepresented a known fact upon which the plaintiff[s] reasonably relied to [their] detriment." Simons v. Cogan, Del. Supr., 549 A.2d 300, 304 (1988). The only "fraud" allegation in the complaint states, in relevant part:
On information and belief, Bio-Response management has intentionally refused to act to preserve the Company's assets and to enable Bio-Response to meet its obligations to the holders of Debentures in order to:
(a) continue paying their salaries,
(b) eliminate the value of the put option, and
(c) drain the remaining current assets out of the Company.
The result of this wrongful and deceptive scheme will be that the Debenture holders will be (i) left with worthless puts. . . . In furtherance of this illegal and inequitable scheme to defraud, Bio-Response management has concealed its true intention from the holders of the Debentures, knowingly impaired the value of the Debentures and engaged in a course of conduct which has operated as a fraud upon the plaintiffs and the Debenture holders.
Complaint, ¶ 25. This allegation does not, in anything but conclusory language, allege the elements of a fraud claim. The complaint does not identify the fact or facts that allegedly were misrepresented to or concealed from plaintiffs. It also fails to allege the manner in which plaintiffs relied upon any purported misrepresentations or concealment.
The claim that the company violated its implied covenant of good faith and fair dealing fails for a different reason. Plaintiffs allege that "the wrongful action (and the failure to act) which has undermined and continues to destroy the value and efficacy of the put option constitutes unfair dealing with respect to the Debenture holders' redemption right under Section 3.04 of the Indenture." Complaint, ¶ 26. Plaintiffs argue, without citing authority, that this allegation states a viable claim that is non-contractual and, therefore, not governed by the Indenture. Recent authority in both Delaware and New York holds to the contrary. In Shenandoah Life Insurance Co. v. Volero Energy Corp., Del. Ch., Civil Action No. 9032, Allen, C. (June 21, 1988) this Court relied upon the decision in Broad v. Rockwell Intern'l Corp., 642 F.2d 929, 957 (5th Cir. 1981) in holding that the implied covenant of good faith and fair dealing does not give Debenture holders any rights inconsistent with those expressly set out in the Indenture.
Finally, plaintiffs argue that, by statute, they are entitled to seek the appointment of a receiver in light of Bio-Response's alleged insolvency and that this statutory claim is not impaired or restricted in any way by the Indenture. Pursuant to 8 Del. C. § 291, any creditor or stockholder of an insolvent corporation may apply to this Court for the appointment of receivers for the corporation. The complaint adequately alleges insolvency and, although it is not free from doubt, plaintiffs are likely to be considered creditors for purposes of this statute. Cf. Noble v. European Mortgage Investment Corp., Del. Ch., 165 A. 157 (1933). However, I find that plaintiffs' statutory claim is restricted by the terms of the Indenture.
This issue was addressed in Noble, and again in Tietjen v. United Post Office Corp., Del. Ch., 167 A. 846 (1933) several months later. In Noble, the indenture set forth the limitations on actions and then provided:
"Nothing in this Section or elsewhere in this indenture . . . shall affect or impair the obligation of the Company . . . to pay the principal and interest of the bonds . . . nor affect or impair the right of action, which is also absolute and unconditional, of such holders to enforce such payment."Noble v. European Mortgage Investment Corp., 165 A. at 158. The Court found that clause to be "quite clear in reserving to the bondholders complete liberty of action to enforce all payments due them whether for principal or coupons so long as the procedure they adopt is not under the indenture" and noted that "[r]estrictions of the character found in this indenture are not be extended by implication." Id. at 159.
The facts in Noble were distinguished in Tietjen. The relevant indenture language in Tietjen provided:
". . . All rights of action in respect of this indenture shall be exercised only by the Trustees . . . and no holder of any bond or interest coupon issued hereunder shall have any right to institute any suit, action or proceeding at law or in equity for the foreclosure of this indenture, or for the appointment of a receiver, or for any other remedy hereunder, unless and until the Trustees shall have received the written request of the holders of twenty-five percent . . . and shall have refused or for thirty (30) days thereafter neglected to institute such suit . . . and it is hereby declared that the making of such request and the furnishing of such indemnity are in every case conditions precedent to the execution and enforcement by any bondholder . . . of the powers and remedies given to the Trustees hereunder, and to the institution and maintenance by any bondholder . . . of any action . . . for foreclosure or for the appointment of a receiver or for any other remedy hereunder. . . ."Tietjen v. United Post Offices Corp., 167 A. at 847. The Court found this indenture language to be "more stringent" in its limitations than the provisions in Noble and held that the indenture "expressly denies to any bondholder the right to sue for the appointment of a receiver unless the required request is made of the trustees to proceed. . . ." Ibid. Since plaintiffs in Tietjen had not satisfied the pre-suit conditions of the indenture, his claim was barred.
The Bio-Response Indenture provides, in relevant part:
No Holder of any Security shall have any right by virtue of or by availing of any provision of this Indenture to institute any action or proceeding at law or in equity or in bankruptcy or otherwise upon or under or with respect to this Indenture, or for the appointment of a receiver or trustee, or for any other remedy hereunder unless such Holder previously shall have given to the Trustee written notice of Default and of the continuance thereof, . . . and unless also the Holders of not less than 25% in the aggregate principal amount of the Securities then outstanding shall have made written request upon the Trustee to institute such action or proceedings in its own name as trustee hereunder and shall have offered to the Trustee such reasonable indemnity as it may require . . . and the Trustee for 30 days after its receipt of such notice, request and offer of indemnity shall have failed to institute any such action or proceeding. . . .
Unlike the relevant clause in Noble, there is nothing in this Indenture reserving to plaintiffs the right to commence an action, "so long as the procedure they adopt is not under the [I]ndenture." Noble v. European Mortgage Investment Corp., 155 A. at 159. Instead, as in Tietjen, Debenture holders are expressly denied the right to bring an action for the appointment of a receiver without first following the specified procedure relating to the Trustee. I find that Section 6.06 bars any action by Debenture holders other than in compliance with the requirements of the Indenture. Since I have already found that there is no present default under the terms of the Indenture, it follows that plaintiffs could not have complied with the pre-suit requirements of Section 6.06.
Based upon the foregoing, defendant's motion to dismiss, is granted without prejudice.