Contracts often provide for intangible consideration that can be stated only in general terms. For example, consider releases. A party might agree to release “any and all claims, actions, causes of action, rights,” etc., “of whatever kind or character, whether known or unknown, whether accrued or unaccrued,” and so on. An agreement to use some form of “best efforts” to accomplish a goal may be another example; an agreement to negotiate in good faith, yet another. For these sorts of intangible consideration, the precise breadth of the language usually constitutes an important business point of the deal.
What is this kind of consideration worth? It might be worth what the counterparty pays for it. But it might not be. Broad, intangible consideration in contracts almost inherently raises valuation questions that cannot be answered without a lengthy, expensive valuation process. If the party receiving such consideration later files for bankruptcy, the breadth and generality of the contractual language can form the basis for a fraudulent-transfer claim: it may be difficult to show that the non-debtor provided “reasonably equivalent value” under section 548(a)(1) of the Bankruptcy Code. A recent Delaware decision illustrates the risks associated with the use of broad, general language in contracts.
Ritz’s Business Dealings with Canon
In 2009, camera retailer Ritz Camera & Image, L.L.C. successfully reorganized in chapter 11. Following resolution of an $18 million claims dispute with Canon U.S.A., Inc., one of Ritz’s most important vendors, Canon stopped supplying its products to the reorganized Ritz. For two years, Canon refused to do business with Ritz.
Ritz struggled to continue in business without Canon’s products. (According to Ritz’s chapter 7 trustee, Canon allegedly held approximately 45% of the United States market for digital single-lens-reflex cameras.) Finally, in 2011, Canon and Ritz entered into a Settlement Agreement. The Settlement Agreement had two principal components. First, Canon agreed—in broad, general terms—to release unspecified claims it held against Ritz and Ritz’s directors, officers, and shareholders. Second, Canon agreed to establish a business relationship with Ritz by entering into a supply contract. In exchange for these, Ritz agreed to pay Canon $5 million over time.
Ritz’s Second Bankruptcy Case and Adversary Proceeding
Ritz commenced its second chapter 11 case in 2012, having paid Canon about $3.1 million under the Settlement Agreement. Thereafter, Ritz instituted an adversary proceeding against Canon. Ritz sought to avoid its payments under the Settlement Agreement on several grounds, including that they constituted constructive fraudulent transfers because Canon did not provide reasonably equivalent value in exchange for them. Canon moved to dismiss for failure to state a claim.
The bankruptcy court denied Canon’s motion with respect to Ritz’s fraudulent-transfer claims. Accepting Ritz’s allegations as true for purposes of Canon’s motion, the court explained that Ritz alleged that it “did not receive goods under the Settlement Agreement. . . . Although the payments under the Settlement Agreement might reflect the reasonably equivalent value of a business relationship with Canon, such equivalence is neither obvious nor definite.” Although the court granted Canon’s motion with respect to certain of Ritz’s other claims (which generally sought to invalidate the Settlement Agreement), Canon now faces discovery over, among other things, Ritz’s solvency, the value of the claims that Canon released, and the value of the “business relationship” that Canon established with Ritz.
Should Parties Use More Specific Language?
The consideration that Canon provided is not uncommon in business contracts. It granted releases, and Ritz doubtless wanted those releases to be as broad as possible. Canon also agreed to enter into a supply contract with Ritz. Perhaps Canon could not have defined these kinds of consideration in anything but broad, general language; however, that same language is what exposed Canon to fraudulent-transfer liability. Is there any way for a party to mitigate this kind of risk?
One way to mitigate fraudulent-transfer risk in a contract that provides broad, intangible consideration may be to integrate details, specific terms, or examples of the consideration into the contract. In this case, perhaps Canon could have further discussed, identified, or otherwise described more specific aspects of the value that Ritz was receiving under the Settlement Agreement. The problem remains, however, that intangible consideration raises valuation questions, and valuation questions will almost necessarily survive a motion to dismiss. Even if Canon’s releases and agreement to enter into the supply contract are ultimately found on summary judgment or at trial to have been worth the $3.1 million Ritz paid, Canon must now spend resources proving it.
Specific language may help parties limit the scope of an expensive valuation dispute in litigation, even if it cannot prevent the valuation dispute altogether. The cost of specific language, of course, is that it makes the process of preparing the contract itself longer and more cumbersome. In any event, a party providing broad, intangible consideration should be aware that the same generality that accurately defines the consideration may also expose that party to avoidance litigation in a bankruptcy case.