Contract Reformation: Mutual Mistake or A Scrivener’s ErrorPrint Article
- Posted on: Oct 4 2021
By: Jeffrey M. Haber
As a general matter, when a contract fails to conform to the agreement between the parties due to the mutual mistake of the parties however induced, or of the mistake of one party and fraud of the other, a court will reform the contract so as to make it conform to the actual agreement between the parties.1 The mutual mistake must be material (i.e., it must involve a “fundamental assumption” of the contract).2 However, it does not mean that the mistake would have caused the parties not to enter into the contract had they known of it.3 Rather, a material mistake is one which “vitally” affects a fact or facts on the basis of which the parties contracted.4
Reformation is an equitable form of relief. The purpose of reformation is not to “alleviat[e] a hard or oppressive bargain, but rather to restate the intended terms of an agreement when the writing that memorializes that agreement is at variance with the intent of both parties.”5
The burden is high to obtain contract reformation. The party demanding it “‘must establish his right to such relief by clear, positive and convincing evidence.’”6 Therefore, the party seeking reformation must “show in no uncertain terms, not only that mistake or fraud exists, but exactly what was really agreed upon between the parties.”7 Only by satisfying this burden can the party seeking reformation “overcome the heavy presumption” that the contract embodies the parties’ true intent.8
Sometimes reformation is based upon a scrivener’s error (i.e., an unintentional mistake in the drafting of a contract). When a scrivener’s error is the basis for reformation, the party demanding reformation must prove “a prior agreement between [the] parties, which when subsequently reduced to writing fails to accurately reflect the prior agreement.”9 The parties’ course of performance under the contract, or their practical interpretation of a contract for any considerable period of time, is considered to be the most persuasive evidence of the intention of the parties.10
The foregoing principles were at issue in Empery Asset Master, Ltd. v. AIT Therapeutics, Inc., 2021 N.Y. Slip Op. 05163 (1st Dept. Sept. 30, 2021) (here).
Empery involved warrants to purchase shares of defendant’s stock. Plaintiffs were holders of the warrants. The warrants at issue contained antidilution provisions, which mandated that defendant adjust the warrant exercise price and share amount in the event it issued shares of stock to other parties for consideration below the then exercise price of plaintiffs’ warrants. Plaintiffs alleged that defendant issued securities to new investors pursuant a Security Purchase Agreement (the “SPA”). Plaintiffs contended that the transaction diluted their investment, and that the certificate of adjustment defendant issued was incorrect as to the exercise price and failed to reflect a change in the number of warrant shares arising from the transaction.
Plaintiffs alleged that defendant breached a section of the warrants – Section 3(d) – by issuing warrants to third parties in accordance with the SPA. Plaintiffs alleged that the issuance triggered defendant’s obligation to provide them with an adjustment to the exercise price. Defendant moved to dismiss. The motion court denied the motion. On appeal, the Appellate Division, First Department affirmed the denial of defendant’s motion to dismiss this claim. Empery Asset Master, Ltd v. AIT Therapeutics, Inc., 179 A.D.3d 443 (1st Dept. 2020).
The First Department also held that plaintiffs stated a cause of action for reformation of Section 3(b) of the warrants. Plaintiffs alleged that the relevant clause, which provided for the increase of the number of shares subject to plaintiffs’ option after a dilutive transaction, misstated the parties’ agreement by limiting the increase of the number of shares to an issuance of stock described in the “immediately preceding sentence” — which deals with the issuance of stock for no consideration — rather than the “immediately preceding sentences,” which would include the issuance of stock for a price lower than the exercise price. In this regard, the First Department held that plaintiffs sufficiently alleged that the parties intended for the warrants to permit the increase of plaintiffs’ shares under both circumstances.
Following discovery, defendant moved for summary judgment on the same causes of action. The motion court denied the motion. Defendant appealed.
The First Department affirmed.
Defendant contended that Section 3(b) of the warrants was unambiguous and must be applied as written. Under the rules of contract interpretation, a written agreement that is clear and unambiguous on its face must be enforced according to the plain meaning of its terms.11 In other words, a contract that “on its face is reasonably susceptible of only one meaning” must be enforced as written. Notably, parol (or extrinsic) evidence cannot be used to create an ambiguity where the words of the parties’ agreement are otherwise clear and unambiguous.13
Whether an ambiguity exists is determined by examining the “entire contract and consider[ing] the relation of the parties and the circumstances under which it was executed,” with the wording to be considered “in the light of the obligation as a whole and the intention of the parties as manifested thereby.”14
Using the foregoing, the First Department rejected defendant’s argument. The Court noted that the section at issue, when read as a whole did not support the view that section was clear and unambiguous:
The third sentence of section 3(b) begins, “Upon each such adjustment of the Exercise Price pursuant to the immediately preceding sentence …” However, the immediately preceding sentence (the second sentence) says nothing about adjusting the Exercise Price; instead, it is the first sentence of section 3(b) that addresses adjusting the Exercise Price.
Moreover, said the Court, “if section 3(b) unambiguously supported defendant, we would have granted its motion to dismiss, rather than affirming the denial of the motion.”
Addressing the reformation cause of action, the Court held that there were issues of fact precluding summary judgment on the matter. The Court rejected defendant’s contention that there was no evidence that plaintiffs — as opposed to nonparty Deerfield Special Situations Fund, LP, the lead investor for the relevant capital raise by defendant — reached an agreement with defendant that was not reflected in the warrant.
Accordingly, the Court held that it could not “conclude, as a matter of law, that a reasonable person reviewing a 20-page warrant and a 42-plus-page Securities Purchase and Registration Rights Agreement would have realized that the word ‘sentence’ (in ‘immediately preceding sentence’) should have been ‘sentences.’”
Jeffrey M. Haber is a partner and co-founder of Freiberger Haber LLP.
This article is for informational purposes and is not intended to be and should not be taken as legal advice.
- Janowitz v. 25-30 120th St., 75 A.D.2d 203, 214 (2d Dept. 1980).
- Id. (quoting 13 Williston, Contracts [3d ed], § 1544).
- Id. (citing 13 Williston, Contracts [3d ed], § 1544, at 96).
- George Backer Mgt. Corp. v. Acme Quilting Co., 46 N.Y.2d 211, 219 (1978).
- Schultz v. 400 Coop. Corp., 292 A.D.2d 16, 19 (1st Dept. 2002) (quoting, Amend v. Hurley, 293 N.Y. 587, 595 (1944)).
- US Bank N.A. v. Lieberman, 98 A.D.3d 422, 424 (1st Dept. 2012).
- Gulf Ins. Co. v Transatlantic Reins. Co., 69 A.D.3d 71, 85 (1st Dept. 2009).
- See, e.g., W.W.W. Assoc. v. Giancontieri, 77 N.Y.2d 157, 162 (1990).
- Greenfield v. Philles Records, 98 N.Y.2d 562, 570 (2002).
- Innophos, Inc. v. Rhodia, S.A., 38 A.D.3d 368, 369 (1st Dept. 2007), aff’d, 10 N.Y.3d 25 (2008).
- Kass v. Kass, 91 N.Y.2d 554, 566 (1998) (quoting, Atwater & Co. v. Panama R.R. Co., 246 N.Y. 519, 524 (1927)).