Parties Must Proceed To Trial on Meaning of “Satisfactory Phase 1” Contingency

The twin rulings in Westwood Dev. Partners, LLC v. Draper, 2012 Del. Super. LEXIS 161, 2012 Del. Super. LEXIS 162  (Del. Super. Ct., Mar. 29, 2012) eluded our radar screen last year due to the end of the year crush of deals. While these rulings are admittedly a bit stale, we are sharing them since they provide important lessons on drafting due diligence contingency clauses.

In this litigation, the plaintiff agreed to purchase 137 acres of land that had previously been used as a mobile home park in 2005 for $6MM. The purchase agreement provided that the sale was “as is” but was subject a number of contingencies or conditions to closing including two environmental provisions. The agreement also gave either party the right to terminate the agreement if the transaction did not close within three years. If purchaser elected to exercise this right of termination, the agreement provided seller could retain the $1MM deposit which represented 17% of the purchase price.

Paragraph 9 of the agreement provided plaintiff with the right to terminate the agreement and receive its $1MM deposit if defendants failed to supply “satisfactory Phase I and Phase II environmental audit reports prior to final settlement.” Meanwhile, Paragraph 16 prohibited defendants from creating a condition on the property after execution of the agreement that would expose the Property the risk of a under CERCLA or other federal or state environmental laws, or that would require substantial expenditures of time and money avoid or eliminate the risk of any such environmental lien.

Plaintiff elected to obtain its own Phase I report which was issued the same day that the agreement was executed. The phase identified the presence of five fuel tanks, a ten gallon container of suspected used oil, an empty fifty-five gallon drum, several areas of partially buried debris, partially buried tires and an electrical transformer. The report recommended removal of the tanks and containers as well as a phase 2.

The sellers/defendants, meanwhile, produced a combined Phase I and Phase II report in 2008 that did not identify any recognized environmental conditions. However, the report did disclose the presence of surface debris on the property and recommended that any septic systems be removed.

Shortly before the expiration of the three year period to terminate the agreement at will, Plaintiff advised defendants that their environmental reports were not satisfactory. Specifically, plaintiff indicated that seller’s reports did not properly evaluate the risks posed by certain concentrations of barium or the environmental conditions identified in plaintiff’s phase 1 report. Accordingly, plaintiff advised defendants it was terminating the agreement and demanded return of its $1MM deposit.

When defendants refused to return the security deposit on the grounds that plaintiff had wrongfully terminated the agreement, plaintiff instituted a lawsuit in superior court, seeking return of the deposit. The defendants asserted a counterclaim for specific performance, seeking a court order directing the purchaser to tender the balance of the contract price and requiring the seller to transfer title to the purchaser. The case was transferred to the Court of Chancery since a claim for specific performance is an equitable remedy. The Chancery court noted that the pleadings were silent on the reason the sellers sought specific performance but the court surmised that because the property value had dropped significantly in the wake of the Great Recession, sellers preferred to convey the property at what was an inflated price while plaintiff would rather forfeit its deposit than be forced to overpay for the property.

The court ruled that sellers were not entitled to demand specific performance in the form of consummation of the sale because contract allowed the parties to terminate the agreement after three years. However, the court found that sellers were entitled to retain the deposit and title to the property were not entitled to demand consummation specific performance. Draper v. Westwood Development Partners, LLC, 2010 Del. Ch. LEXIS 204, (Del. Ch. June 16, 2010).

The defendants then filed a breach of contract counterclaim, contending that plaintiff manufactured an excuse to terminate the agreement in bad faith to seek more favorable terms. The parties eventually filed motions for summary judgment.

Plaintiff retained an expert to evaluate the defendants’ reports. The plaintiff’s expert concluded that defendants’ reports were unsatisfactory when viewed in the context of paragraph 9 of the agreement. The expert said the term “satisfactory” was capable of several meanings including whether the reports were prepared in accord with standards of professional practice, if the reports adequately assessed the environmental conditions on the property, or if the reports met the expectations of the buyer in the context of the report’s intended use. Nevertheless, the expert concluded that the defendants’ reports was not satisfactory under any of these possible interpretations.

The plaintiff countered that the term “satisfactory” had to be given its plain and ordinary meaning, and that there was a genuine issue of fact whether the defendants’ reports were indeed” satisfactory.” At the very least, plaintiff asserted, its own phase 1 and expert report served to rebut defendants’ reports and preclude granting summary judgment.

In contract disputes, courts will look to the language of a contract. If the contract is clear on its face, the court will apply the plain meaning of the words used in the agreement. However, where the contract is ambiguous, the court may consider what is known as “extrinsic evidence” to interpret the meaning of the agreement. A contract is ambiguous when the disputed provisions are reasonably or fairly susceptible of more than one interpretation.

The defendants argued that it was logical to read paragraphs 9 and 16 together so as to impute the existence of condition causing a CERCLA lien from paragraph 16 into the “satisfactory” phrase of paragraph 9 since phase 1 reports are intended to comply with the “all appropriate inquiry” regulations promulgated under CERCLA.  However, the court said that the fact CERCLA was implicated in paragraph 16 did not mean the parties intended CERCLA liability to be the absolute standard for paragraph 9. The court said the parties obviously considered CERCLA liability when drafting the agreement and if they wanted paragraph 9 to include CERCLA liability, they could have expressly referenced CERCLA in the paragraph. Moreover, the court said that paragraph 16 was not limited to CERCLA but prohibited defendants from creating conditions that could result in liability under other environmental laws. Since paragraph 16 contemplated liability beyond CERCLA, the court went on, paragraph 16 could not be read to limit paragraph 9 only to CERCLA.

The court held that paragraph 9 should be interpreted using a reasonably prudent person standard used by other jurisdictions when interpreting satisfaction clauses. Because plaintiff had presented credible evidence that defendants’ reports were not satisfactory, the court held there was a genuine issue of material fact if defendants’ had satisfied their contractual obligations. Similarly, the court found there were material questions of fact about whether plaintiff had terminated the agreement in bad faith. Accordingly, it denied both motions for summary judgment.

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