Restructuring

“Although our intellect always longs for clarity and certainty, our nature often finds uncertainty fascinating.” Carl Philipp Gottfried von Clausewitz

A Prussian general and the author of On War may still have a thing or two to teach claims traders and other contract counterparties seeking to avoid their deals being blown up. If you’re in the claims trading business, you’re welcome to skip the history lesson and instead read Judge Michael Wiles’ bench decision in Westinghouse.¹ In this case, a dispute arose between Landstar, a claimant in the Westinghouse chapter 11 cases, and Whitebox, a business that, among its investment strategies, buys claims in bankruptcy cases.
The dispute boiled down to whether a contract had been formed between Landstar and Whitebox for Landstar to sell its claims to Whitebox. Landstar argued that no contract had been formed, and that it had no intent to be bound to sell its claims, until “agreement of terms and execution of documentation by both Buyer and Landstar” had occurred, as stated by Landstar in email correspondence between the parties. Whitebox, on the other hand, argued that the parties had entered into a “Type II” agreement,² a binding agreement as to certain terms (in this case the claims to be sold and the price) and a binding agreement to negotiate in good faith as to other open issues. Whitebox supported its contention that a Type II agreement had been formed by arguing that it is common practice in the claims trading industry to execute claims trades this way.

Following a bench trial, Judge Wiles found that no contract had been formed, and therefore no claims trade had occurred. The decision methodically explains why – and we cover it below – though the following excerpt from the bench decision summarizes the rationale for the outcome most succinctly: “If claims traders want their customs to be binding when they deal with non-professionals […] it is incumbent on them to set forth the terms in a clear and unequivocal way. Contracts are supposed to be matters of voluntary agreement. They are not supposed to be traps for the innocent and unwary.

Accordingly, if Seaport [on behalf of Whitebox] had intended that there be a binding Type II contract, it could and should have clearly and explicitly asked Landstar to confirm that the parties had an enforceable agreement as to price and that the parties were entering into a binding and enforceable agreement to negotiate other terms in good faith. Perhaps Seaport does not use such language because it thinks sellers, such as Landstar, would be scared off by it. But if a party would not have agreed to an explicit agreement of the kind alleged, then a court certainly should not impose such terms after the fact”³ (brackets added).

What Happened in Westinghouse?

In Westinghouse, Seaport, on behalf of its client Whitebox, contacted Landstar by email and telephone to negotiate to purchase all of Landstar’s general unsecured claims (the “Claims”) against Westinghouse Electric Company LLC (“Westinghouse”). As part of the email negotiations, Seaport sent Landstar “form” language that it could then use to facilitate the parties entering into an agreement to sell the Claims. This language included a provision stating that “[t]his offer shall be subject to agreement of terms and conditions and execution of documentation.”⁴ Landstar then used this language to make an offer by email to Seaport to sell the Claims, but further elaborated by email that the terms of the agreement were subject to review and approval by Landstar’s legal counsel.

Seaport then communicated its agreement to buy the Claims to Landstar, but in so doing noted that it intended the sale to be subject to Landstar providing recourse for the Claims (the “Recourse Provision”), a point that had not been discussed during prior negotiations. The Recourse Provision was intended to provide protection to Whitebox should Landstar not actually be owed the amount it sought in its filed proofs of claim, in which case Whitebox would be entitled to a refund of part of the sale proceeds, and potentially interest.

Landstar reiterated that its legal department would need to approve the terms of the agreement and inquired whether Landstar was already bound to the deal. Seaport replied, “[t]his commits both you (and my client) to the 78% Purchase Price, subject to agreement of terms and execution of documentation,” but that a trade confirmation would need to be negotiated and executed.⁵ Landstar emailed in response: “Sounds good. Please send the documents so I can get the review process started.” ⁶ Seaport then provided a draft trade confirmation for Landstar’s review, but Landstar decided not to move forward with the claims trade, though the reasons for not finalizing the agreement are unclear. Despite Landstar withdrawing from the deal, Whitebox filed notices on Westinghouse’s docket that Landstar’s claims were being transferred to Whitebox, and Landstar objected to these transfer notices.

In response to Landstar’s objection, Whitebox initially argued that the parties entered into a complete agreement but later conceded that the Recourse Provision was an open issue. At trial, Whitebox argued that the parties formed a preliminary agreement that created a duty for both parties to negotiate in good faith over the Recourse Provision and a binding obligation for the purchase price of the Claims.

The Bankruptcy Court Holding

The court held that there was no intent to create a preliminary agreement because, among other reasons, (i) Landstar reserved its right to not enter into a binding agreement and (ii) Seaport did not explicitly confirm with Landstar that there was an enforceable agreement as to the obligation to negotiate in good faith nor the purchase price.

Judge Wiles found that Landstar did not intend to be bound by a preliminary agreement because Landstar had clearly communicated to Seaport that the terms of the agreement would need approval by Landstar’s legal counsel. While Landstar responded in the affirmative to Seaport’s revised offer, which was held to be a counteroffer by the court, the communication nevertheless provided that the sale was “subject to agreement of terms and execution of documentation.” The “subject to” language made the offer a package deal because the sale was dependent on executed documentation and the Recourse Provision. The court noted that the words “subject to” do not automatically indicate an intent not to be bound, but “it frequently is understood and used to convey the notion that a party does not intend to be bound at all unless and until a written agreement is signed.”⁷

Whitebox also argued that a preliminary agreement had been formed because the claims trading industry normally requires parties to negotiate in good faith after reaching an agreement on the purchase price. The court disagreed, in part because Landstar’s employees were not professionals in the claims trading industry and, therefore, could not know its customs. The court found that Seaport should have clearly and explicitly confirmed that there was an enforceable agreement as to the purchase price and the duty to negotiate in good faith if it wanted to form a binding agreement, and receive confirmation of the same from Landstar.

Customs Can’t Commonly Create Contracts

The Westinghouse decision highlights several important considerations for claims traders and other contract counterparties seeking to insulate themselves from the same fate as Whitebox:

• A party intending to form an enforceable preliminary agreement should explicitly state which provisions of the agreement are binding, such as the obligation to negotiate in good faith and the purchase price, and ensure that its counterparty clearly and unequivocally agrees to the same.

• Parties seeking to avoid being bound to a preliminary agreement should explicitly state that they are reserving the right not to be bound, and condition their offer or acceptance on further review and execution of documentation.

• Parties seeking to enter into a binding preliminary agreement should exercise caution when making binding terms conditional on other terms that may not be satisfied. For example, a sale that is “subject to” a condition may be interpreted to mean that there is no legal obligation for the sale unless such condition is satisfied.

Had Landstar engaged a professional claims trader as agent to handle the claims trade with Seaport/Whitebox, perhaps on the same facts the decision might have been a closer call. That being said, many claims trades are handled in exactly this way: claims traders purchasing claims from claimants who don’t routinely engage in claims trading activity. Whether you look to the 21st century or back to the 18th, the lesson here from Judge Wiles and von Clausewitz alike is clear: Always trade fascinating uncertainty for clarity and certainty in contract negotiations.

There may be further development in this case. An appeal filed by Whitebox is currently pending before the District Court for the Southern District of New York, and we will update you on it when it moves forward.

Weil, Gotshal & Manges LLP and one of the authors, David Griffiths, represent Westinghouse Electric Company LLC and its debtor affiliates in their chapter 11 cases. Neither Weil nor David Griffiths were involved in the Landstar/Whitebox proceedings.