Summary
stating that the heightened pleading standard required when pleading mistake serves to "preserve the integrity of written agreements by making it difficult to re-open completed transaction"
Summary of this case from Interactivecorp v. Vivendi UniversalOpinion
C.A. No. 19621-NC
Date Submitted: January 31, 2003
Date Decided: July 1, 2003
Lawrence C. Ashby, Philip Trainer, Jr., and Richard I. G. Jones, Jr., Esquires of ASHBY GEDDES, Wilmington, Delaware; Attorneys for Edward T. Joyce as shareholder representative for the former shareholders and warrant holders of 21st Century Telecom Group, Inc.
Anthony W. Clark and Paul J. Lockwood, Esquires of SKADDEN, ARPS, SLATE, MEAGHER FLOM LLP, Wilmington, Delaware; and Robert E. Zimet and Susan L. Saltzstein, Esquires of SKADDEN, ARPS, SLATE, MEAGHER FLOM LLP, New York, New York; Attorneys for Defendants.
MEMORANDUM OPINION
Pending is the defendant's motion to dismiss the complaint which seeks reformation of an Agreement and Plan of Merger between 21st Century Telecom Group, Inc. ("21st Century") and RCN Corporation ("RCN") (the "Agreement"). The plaintiff claims that as a result of a mutual mistake, the Agreement incorrectly stated the consideration that was to be paid to the shareholders of the acquired company. On this motion, the defendant contends that the complaint must be dismissed under Court of Chancery Rules 12(b)(6) and 9(b), for failure to plead the alleged mutual mistake with sufficient particularity. For the reasons next discussed, the defendant's motion will be denied.
I. FACTS
The facts recited below are derived from the well-pled allegations of the complaint. The plaintiff; Edward T. Joyce ("Joyce"), is a former director of 21st Century, the defendant corporation acquired in the merger. Joyce sues in his capacity as the designated shareholder representative of all former stockholders and warrant holders of 21st Century at the time of the merger. 21st Century, which before the merger was an Illinois corporation, provides bundled telecommunication services to homes in the Chicago area. The other defendant, RCN, is a Delaware corporation that provides bundled local and long-distance phone, cable television, and high-speed Internet services to residential markets nationwide. RCN was the acquiring corporation in the merger.
On September 29, 2000, after the merger, 21st Century was renamed RCN Telecom Services of Illinois, Inc., but for the sake of simplicity, this Opinion refers to it as "21st Century" and not the "defendant."
Joyce was designated as the Shareholder Representative under § 11.1(c) of the Agreement.
In November 1999, 21st Century and RCN began negotiating a possible merger wherein 21st Century stock and warrants would be exchanged for RCN common stock. In those negotiations, the parties agreed that RCN would place into an escrow account $21.24 million worth of RCN stock, for one year to secure certain indemnity rights.
That amount represented ten percent of the total merger consideration.
In their briefs, the parties alternatively refer to a "holdback" and "escrow" provision. Those terms in fact refer to the same thing — the consideration being held in an account to cover potential indemnity claims.
On December 12, 1999, the two corporations executed the Agreement. That Agreement, as written, provided that shares of RCN common stock would be deposited in escrow on the effective date of the merger. The number of escrowed shares to be deposited would be calculated under a formula based on the market price of RCN common stock on the merger date ($45.4416 per share). Based upon that formula, the 21st Century stockholders would receive 383,272 shares of RCN stock at the end of the indemnity claim period, assuming no escrowed shares were used to pay any indemnity claims.
Joyce alleges that the escrow provision of the Agreement was drafted incorrectly, and does not reflect the parties' actual intent or the oral agreement they reached during the negotiations. Joyce claims that the parties' approval of the incorrectly drafted provision was the product of a mutual mistake of RCN and 21st Century.
According to Joyce, RCN and 21st Century bargained for the escrowed funds to be converted into RCN common shares, in a quantity that would be determined under a formula based upon RCN's average stock price for the fifteen days preceding the expiration of the indemnity claims period (the "fifteen-day formula"). Joyce alleges that RCN bargained for this fifteen-day formula because RCN's stock price was trending upward both before and during the merger negotiations. If RCN's stock price continued to rise and if the conversion of the escrowed finds into RCN stock occurred at the end of the indemnity claim period, RCN would pay out fewer of its shares to the former 21st Century stockholders.
In fact, however, between the date the merger became effective and the end of the indemnity claim period, the price of RCN's stock plummeted to an average of $3.931 per share. Because the RCN shares had already been placed in escrow, the 21st Century's stockholders received no benefit from the post-merger drop in RCN's stock price under the escrow provision as actually written. Had the $21.24 million been converted into RCN shares based upon the alleged oral agreement's fifteen-day formula term, the 21st Century stockholders would have received 5,403,205 shares of RCN. Instead, they received 383,272 shares.
On February 8, 2001, before the indemnification period claim ended, a stockholder contacted Joyce and RCN, inquiring about (among other things) whether the escrowed consideration would be valued based on the fifteen-day formula. On March 9, 2001, John Jones ("Jones"), RCN's General Counsel, sent a letter informing the stockholder that RCN shares had been deposited in escrow on the effective date of the merger to satisfy the 10% holdback, based on the exchange ratio set forth in the written Agreement.
When Joyce received a copy of Jones' response, he learned for the first time that the escrow provision in the Agreement did not contain the fifteen-day formula, contrary to what he had previously thought was the case. Joyce contacted Robert Currey ("Currey"), 21st Century's former Chief Executive Officer ("CEO") and chief negotiator in the merger. Currey confirmed to Joyce that the Agreement should have contained the fifteen-day formula. Currey also told Joyce that he (Currey) had contacted RCN's two principal negotiators in the merger and learned that one of those negotiators also believed that the two corporations had agreed that the merger consideration would be based on the fifteen-day formula.
According to Currey, RCN's other chief negotiator was uncertain of the valuation formula that the companies had agreed upon.
Joyce also checked with his main contact person at the law firm which represented 21st Century in the merger. He learned that both his contact person and the legal partner in charge of negotiating the merger believed that RCN and 21st Century had agreed upon the fifteen-day formula and that, consequently, the Agreement's escrow provision had been incorrectly drafted. On August 2, 2001, Joyce wrote a letter to David McCourt, the Chairman and CEO of RCN, informing him of the drafting mistake. Jones responded, on behalf of RCN, that RCN believed the Agreement and escrow provision were drafted correctly. This lawsuit followed.
II. THE APPLICABLE STANDARDS AND THE PARTIES' CONTENTIONS
The pending motion to dismiss is brought under Court of Chancery Rules 12(b)(6) and 9(b). Under Rule 12(b)(6), the Court assumes that all well-pled allegations of the complaint are true, and affords the plaintiff the benefit of all reasonable inferences that can be drawn from the contested pleading. To obtain a dismissal, the movant must demonstrate that the non-moving party would not be entitled to relief under any of the facts (or reasonable inferences therefrom) alleged in the complaint. Thus, on a Rule 12(b)(6) motion, the Court will consider only those matters that are alleged in the complaint or incorporated therein by reference. Where the factual allegations are conclusory in nature, they will not be accepted as true for purposes of the motion.
Grimes v. Donald, 673 A.2d 1207, 1216 (Del. 1996).
Universal Compression, Inc. v. Tidewater, Inc., 2000 Del. Ch. LEXIS 151, at *12 (Del.Ch. Oct, 19, 2000).
James River-Pennington, Inc. v. CRSS Capital, Inc., 1995 Del. Ch. LEXIS 22, at *11 (Del.Ch. Mar. 6, 1995).
Id.
Rule 9(b) requires that "in all averments of . . . mistake, the circumstances constituting . . . [the] mistake shall be stated with particularity." Because a claim of mistake is integral to Joyce's claim and to this motion, the Court's analysis must apply both standards,
RCN contends that Joyce's complaint does not contain particularized allegations of fact sufficient to support a claim of mutual mistake, as Rule 9(b) requires. To state a viable claim, RCN argues, the plaintiff must either explain how the mistake occurred or plead evidence corroborating the mistake. Here, RCN points out, Joyce fails adequately to allege how the escrow provision that he claims was arrived at orally, can be reconciled with other provisions and disclosures contained in: (i) the Agreement, (ii) the separate twelve page Escrow Agreement, and (iii) the SEC Registration Statement and the Proxy Statement.
The Agreement itself has a series of clauses that provide for the placement of consideration into escrow. There is a separate Escrow Agreement as well.
Joyce responds that Rule 9(b) does not require the exhaustive pleading of evidence, but, rather, only that the facts pled be sufficient to put RCN on notice of the precise nature of the alleged mistake. Joyce contends that he has adequately alleged that the two companies made a mutual mistake by approving the Agreement and other documents containing an escrow provision different from what the parties had, in fact, orally agreed to.
RCN further contends that Joyce fails to allege sufficiently the mutuality of the mistake, including the parties' alleged oral agreement having terms inconsistent with the written Agreement's escrow provision. Joyce ardently disagrees.
These conflicting contentions reduce to two basic issues. The first is whether Rule 9(b) requires the parties to (i) explain how the alleged mistake occurred or (ii) plead corroborative evidence of the mistake. The second issue is whether the complaint, as written, satisfies the Rule 9(b) standard. I address these issues in that order.
III. ANALYSIS
A. The Requirements For Pleading Mutual Mistake Under Rule 9(b)
Rule 9(b) provides that when a party alleges fraud or mistake, the complaint must state with particularity the circumstances constituting the alleged fraud or mistake. Thus, this Court has held that where a party alleges that the parties to a written contract were mutually mistaken as to a disputed contractual provision, the complaint must identify the precise transaction wherein the mistake occurred and the nature of the alleged mistake. The Rule 9(b) heightened pleading standard is intended to serve the purpose of giving notice of the claimed ground or mistake to the defendant, as well as to preserve the integrity of written agreements by making it difficult to re-open completed transactions.
James River-Pennington, 1995 Del. Ch. LEXIS 22, at *24.
Breeden v. Richmond Cmty. Coll., 171 F.R.D. 189, 201-02 (M.D.N.C. 1997).
RCN argues that Joyce's complaint fails to explain how and when the mistake occurred, RCN further contends that the complaint fails to plead how the alleged oral agreement can be reconciled with the remainder of the written Agreement, with the separate Escrow Agreement, and with the SEC Registration Statement and Proxy Agreement. Absent such corroborative pleadings, RCN urges, the Court cannot be assured that this lawsuit has even colorable merit. Moreover, RCN claims, the present complaint leaves RCN unable to investigate or respond to the alleged mistake adequately.
At oral argument, RCN asserted that although some Delaware cases have decided whether pleadings pass (or fail to pass) muster under Rule 9(b) in different fact-specific contexts, they do not establish a minimal, bright-line, pleading standard that will give the Court and the parties confidence that lawsuits such as this are at least colorably meritorious. RCN invites this Court to establish such a standard.
Having reviewed the case law in this procedural area, the Court is satisfied that the precedents do establish such a standard. Succinctly stated, a complaint for reformation on grounds of mutual mistake will survive a Rule 9(b) motion to dismiss, if it alleges: (i) the terms of an oral agreement between the parties; (ii) the execution of a written agreement that was intended, but failed, to incorporate those terms; and (iii) the parties' mutual — but mistaken — belief that the writing reflected their true agreement and (iv) the precise mistake.
A brief discussion of the pertinent Rule 9(b) case law suffices to make the point. In James River-Pennington, certain parties sought to reform a written contract on grounds of mutual mistake and fraud, claiming that the written contact did not accurately reflect the parties' oral agreement respecting an option in their written contract. The parties seeking reformation alleged four specific inconsistencies between the written and the prior oral agreements, thereby putting the plaintiffs on notice of the nature and scope of the mutual mistake leading to the incorrect written expression of the parties' intent. The Court observed that although proving the mistake might be difficult at trial, at the pleading stage the allegations of the complaint were sufficiently particular to satisfy the requirements of Rule 9(b).
1995 Del. Ch. LEXIS 22, at *17-*18 (Del.Ch. March 6, 1995).
Id. at *4-*6.
Id. at *26-*27.
In American Home Products Corporation v. Norden Laboratories, Inc., this Court construed Rule 9(b) under New York law. There, the plaintiff, which had leased a patent to the defendant, claimed that because of a drafting error the written contract improperly stated the agreed formula for determining the plaintiff's royalty revenues. Specifically, the complaint alleged that: (i) the parties had entered into an oral agreement for certain royalty rates; (ii) the formula in the written agreement did not correctly reflect that oral agreement; and (iii) the plaintiff had executed the written agreement under the mistaken belief that it reflected the parties' contractual understanding. The Court found that the plaintiff had alleged mutual mistake with sufficient particularity to satisfy Rule 9(b).
1991 Del. Ch. LEXIS 130, at *11 (Del.Ch. July 24, 1991).
Id. at *3-*4.
Id. at *13.
The Court also found that the plaintiff had adequately pled a fraud claim. The Court noted that the plaintiff "alleged facts with sufficient particularity to put [the defendant] on notice of the transaction at issue and the alleged misconduct in the transaction. This is all that is required by Chancery Rule 9(b)." Id. at *12-*13 (emphasis added).
An analysis of whether a pleading is sufficient to satisfy Rule 9(b) does not amount to a scientific inquiry. Rather, the Court makes an informed judgment to determine if the allegations, if assumed to be true, would plead the elements of a mutual mistake, and would put the defendants on notice of the nature of their mutual mistake.
Kahn Bros. Co. v. Fischbach Corp., 1989 Del. Ch. LEXIS 109, at *12-*13 (Del.Ch. Sept. 19, 1989).
Id. at *13. In Kahn, the plaintiffs were suing for reformation on the basis of fraud. As Rule 9(b) makes clear, however, the same standard applies to both mistake and fraud claims.
For example, in Jefferson Chemical Company, Inc. v. Mobay Chemical Company, Inc., the defendant assigned patents to the plaintiff under a written contract. The defendant then sought to reassign the patents to a third party, based on the literal interpretation of the relevant contractual provision. The plaintiff sought to reform the contract so that it would reflect the parties' true intent and substance of their agreement. In Jefferson Chemical, however, the complaint did not even allege that an oral agreement had been reached or that a drafting mistake had been made. Granting a motion to dismiss, Chancellor Duffy held that in a claim for reformation:
253 A.2d 512, 513 (Del.Ch. 1969).
Id. at 514.
Id. at 516.
"facts must be set out to apprise the adversary as to what acts are relied upon as constituting' the mistake. . . . The facts on which [the plaintiff] relies . . . must be set forth with at least `some' Particularity to apprise the defendant of what is charged against it.
Id. Chancellor Duffy did not explicitly make clear his reliance on Rule 9(b) as the basis for his dismissal of the reformation claim. He did note, however, that the defendant based his argument on Rule 9(b), and when reciting the standard for the motion to dismiss, he cited Fish Engineering Corporation v. Hutchinson, 162 A.2d 722, which refers to Rule 9(b).
Id. Chancellor Duffy did not explicitly make clear his reliance on Rule 9(b) as the basis for his dismissal of the reformation claim. He did note, however, that the defendant based his argument on Rule 9(b), and when reciting the standard for the motion to dismiss, he cited Fish Engineering Corporation v. Hutchinson, 162 A.2d 722, which refers to Rule 9(b).
The defendants argue that mistake must be alleged with the same degree of particularity required for a claim of fraud, i.e., the complaint must refer to the time, place, and content of the mistake, I cannot agree. Although it is essential to articulate the alleged mutual mistake, it is not necessary to plead how or why the mistake occurred, As the North Carolina Supreme Court has held, it demands too much of a party to allege how and why a mistake occurred. The party seeking reformation will know that the mistake did occur, but may not know how the mistake occurred. If parties to a written contract have expressed a term that neither side intended, the reason for (or cause of) the incorrect written expression of their agreement (in the absence of fraud) is immaterial.
York Linings v. Roach, 1999 Del. Ch. LEXIS 160, at *6 (Del.Ch. July 28, 1999).
Matthews v. Shamrock Van Lines, Inc., 142 S.E.2d 665, 668 (N.C. 1965).
Id. at 668-69.
Id. at 669.
Having reviewed the Delaware cases in this procedural area, the Court is satisfied that the Rule 9(b) standard described above is clear and established.
B. Whether This Complaint Satisfies The Delaware Rule 9(b) Standard
The second issue is whether the complaint in this case satisfies the standard discussed above. I conclude that it does.
First, the complaint clearly states the terms of the parties' alleged oral agreement. It further states that the parties agreed to a holdback of ten percent of the merger consideration, to be held in escrow for one year. It alleges that RCN bargained for a method to pay out the escrowed consideration consistent with RCN's belief that its stock price would continue to rise, and that the escrowed consideration would be distributed in RCN common shares based on RCN's average common stock price for the fifteen trading days before the end of the indemnity claims period. And, it alleges that Joyce verified the existence of the oral agreement with 21st Century's attorneys and with Currey, who in turn had verified its terms with one of RCN's chief negotiators.
Compl. ¶ 6.
Id. at ¶ 10.
Id. at ¶¶ 21, 22.
Second, the complaint clearly states that the Agreement should have but did not — accurately express in writing the escrow terms that the parties had agreed upon. Third, the complaint avers that the Agreement valued and distributed the consideration based upon the wrong formula, and that the parties believed the written Agreement accurately reflected their oral agreement. Fourth, the complaint describes the effect of the error, specifically, that if the Agreement had reflected the fifteen-day formula, the former 21st Century stockholders would have received 5,403,205 shares worth $21.24 million rather than the 383,272 shares (worth less than $2 million) they received under the formula as written.
Id. at ¶ 1. A mutual mistake occurs where both parties have a misconception with respect to a material term in the contract, James River-Pennington, 1995 Del. Ch. LEXIS 22, at *26.
Compl. at ¶¶ 1, 8, 9, 11, 12, 21.
Id. ¶¶ 15, 16.
The defendant insists, nonetheless, that that the complaint is not sufficiently specific to enable RCN to investigate the alleged error, for which reason the Court must find that the complaint fails under Rule 9(b). Specifically, RCN argues that the complaint fails to: (i) identify RCN's chief negotiator by name, (ii) state when the alleged oral agreement occurred or which person reached it, (iii) identify each section of the Agreement that is affected by the mistake, and (iv) inform the Court of the correct terms that must be inserted in each affected provision.
These arguments lack merit. The complaint alleges that Currey communicated with RCN's negotiator and learned that 21st Century and RCN had reached an oral agreement. It alleges that the two persons to whom Currey spoke are identified by role rather than by name, and that one of those negotiators confirmed the existence of that oral agreement. That is sufficient, Although it may have been preferable for the plaintiff to identify the negotiators (and 21st Century's attorney) by name, that does not defeat the claim of mutual mistake. The defendant cannot be permitted to hide behind an immaterial omission of this kind and claim that it does not know who negotiated and closed a multimillion-dollar merger to which it was a party. In these circumstances, a party in the defendant's position must be presumed to know who its negotiating representatives were, because the answer is readily available by making either a short trip to a file cabinet or a telephone call.
Whether there is a factual dispute with respect to the existence of an oral agreement is a matter to be determined in the context of summary judgment or trial.
Section 11.5 of the Agreement discloses that 21st Century's attorney was from Piper Marbury Rudnick Wolfe, LLP and that legal correspondence is to be sent to Edwin M. Martin., Esq.
Similarly meritless is the objection that the complaint fails to state "when the mistake occurred. It is manifest from the complaint itself that the mistake occurred sometime between the November 1999 negotiations and the execution of the Agreement on December 12, 1999. It seems equally manifest that Currey, who was 21st Century's chief negotiator, and one or both of RCN's two chief negotiators, would have been the persons who negotiated the oral agreement.
Compl. ¶¶ 5, 11.
The complaint does not enumerate each and every section of the Agreement that is implicated by the alleged error, but that omission likewise is not fatal, because the complaint alleges the specific transaction — and the mistake — in sufficient detail to enable the defendant to investigate and make that determination itself. Although the plaintiff may have been sloppy in not identifying the Agreement's escrow provision by section number, the omission is immaterial because the Agreement identifies that provision as "Section 2.1(1) Escrow of Shares." Although common sense dictates the inference that certain other sections or documents that track or are inconsistent with the mistaken language may have to be reformed if the plaintiffs can prove their claim, RCN cites no authority that requires the plaintiff, at this stage of the proceedings, to provide a laundry list of all sections that may be implicated by the reformation claim, or to propose precise language that should be substituted for those sections.
The sections used to compute the number of escrowed shares are also located in Section 2.1. Section 2.1(g) sets out the stock price used in determining the escrowed common stock, preferred stock, and warrant consideration.
Cf. Amstel Assocs., L.L.C. v. Brinsfield-Cavall Assocs., 2002 Del. Ch. LEXIS 54, at *15-*16 (Del.Ch. May 9, 2002) (stating that at trial, the party seeking reformation must persuade the Court of the precise oral agreement that it seeks to have inserted into the contract).