A New York appellate court recently unanimously affirmed a judgment of $17.2 million against the law firm Cadwalader, Wickersham & Taft in a legal malpractice action alleging that due to a drafting mistake by the law firm, its client had had to pay its investment advisor $10 million instead of $2 million in a dispute over fees earned in an acquisition. Red Zone LLC v. Cadwalader, Wickersham & Taft LLP, 12818, 2014 WL 2765973 (N.Y. App. Div. June 19, 2014) (here).
Besides its general in terrorem effect, this dispute perhaps offers a general lesson in handling definitions.
A New York Law Journal article by Sue C. Jacobs, a member of Goodman & Jacobs, provides all the gory details (here, but behind a paywall). Here are the key facts, as stated in the article (footnotes and emphasis omitted):
In June 2005, Red Zone and UBS signed an engagement agreement which designated UBS as Red Zone’s exclusive financial and capital advisor for Red Zone’s transactions with Six Flags. UBS’s fees included a $10 million transaction fee, net of the fees paid if the “acquisition transaction occurred by December 7, 2006.” The term acquisition transaction was defined to mean, inter alia, “the acquisition by [Red Zone] of control of [Six Flags], through a proxy contest or otherwise.”
In August 2005, Red Zone and UBS initiated a proxy contest for control of Six Flags. UBS informed Red Zone it would demand a $10 million fee if the contest were successful. In the underlying action, Red Zone maintained it was obligated to pay the entire fee only if it acquired 51 percent or more of Six Flags’ voting stock.
Red Zone objected to the expected payment. But the parties, facilitated by Cadwalader’s involvement, negotiated an oral agreement addressing the fees. Cadwalader subsequently drafted a side agreement that both parties signed.
The side agreement stated only that “the term ‘acquisition transaction’ does not include the Company’s proposed consent solicitation to replace three of the acquisition candidate’s seven directors announced on or about the date hereof.”
By November 2005, Red Zone had not only replaced three of the Six Flags directors, but Red Zone’s CEO had become CEO of Six Flags. Red Zone expanded the Six Flags board to 10, named three additional directors and hired 11 Red Zone people in executive positions for Six Flags. In January 2006, Red Zone replaced all of the Six Flags directors and Six Flags reimbursed Red Zone’s proxy expenses, including the president’s compensation. Red Zone paid $2 million to UBS.
In the interest of completeness, here’s the full definition of “Acquisition Transaction”:
As used in this Agreement, the term “Acquisition Transaction” means, whether effected directly or indirectly or in one transaction or a series of transactions: (a) any merger, consolidation, reorganization or other business combination pursuant to which [Red Zone] and [Six Flags] and/or all or a significant portion of their respective businesses, divisions or product lines are combined, or (b) the acquisition by [Red Zone] of 50% or more of the capital stock or assets of [Six Flags] by way of tender or exchange offer, option, negotiated purchase, leveraged buyout, minority investment or partnership, joint or collaborative venture or otherwise, or (c) the acquisition by [Red Zone] of control of [Six Flags], through a proxy contest or otherwise.
UBS demanded that Red Zone pay it an additional $8 million. It ultimately sued Red Zone and won. Red Zone turned around and sued Cadwalader for malpractice. The trial court held that Cadwalader had failed to memorialize an oral agreement between Red Zone and UBS to cap at UBS’s fees at $2 million unless Red Zone acquired more than 51% of the voting shares of Six Flags.
A simple lesson to draw from this saga is that mistakes happen: be careful out there. But one can perhaps derive a more specific lesson.
Cadwalader’s task was evidently to neutralize the third component (acquisition of control) of the definition of “Acquisition Agreement.” It elected to do so by saying what control wasn’t, but stated the exception too narrowly.
So here’s my general recommendation: Instead of revising a general proposition by carving out an exception, you might want to consider instead restating the general proposition. In this case, it seems as if it would have been more prudent for Cadwalader to restate the definition of “Acquisition Agreement” so as to eliminate the “control” element.
The trial court’s summary judgment order is the one to read; it lays out the facts of the malpractice case, at http://scholar.google.com/scholar_case?case=11259987958454325438.
The underlying UBS v. Red Zone litigation is at http://scholar.google.com/scholar_case?case=11968574234665276251.
This is a nice teaching case; here are a couple of observations, with the benefit of 20-20 hindsight, of course:
1. In the original agreement, the “control” element shouldn’t have been included in the first place without a definition, or at least some boundaries. (See subdivision (c) of the “Acquisition Transaction” definition, quoted above in Ken’s post.)
Incidentally, the same potential trouble exists when “control” is defined as including “the power to direct the management of a company’s affairs,” whatever that means — it’s an invitation to expensive and uncertain litigation, precisely as happened in the UBS v. Red Zone litigation.
2. In the Side Letter, instead of [fiddling] around with the definition of “Acquisition Transaction,” the lawyers should just have bluntly stated exactly what the business people shook hands on, namely that a $10 million fee wouldn’t be paid unless 51% of the shares were acquired. That way there would have been less ambiguity and less opportunity for unwanted side effects, as clearly happened here.
The timeline of events in the summary judgment order suggests one of my nightmares: standing in a conference room as a deal craters and being asked to draft the agreement that will paper over the dispute. And can it “just be a one liner?” Also, “can it be done yesterday?”
Drafting in real time is a bad idea. Drafting in real time and under pressure is even worse.
I agree, but in the heat of negotiations it is often easier to get agreement to a very specific change than to a change of a more general nature, the implications of which may be unclear to the recipient of the proposed change. Easier to do this at the outset, in my experience.