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When a Term Sheet is Not an Enforceable Contract

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  • Posted on: Feb 22 2017

Last month, this Blog wrote about McGowan v. Clarion Partners, LLC, a decision involving the enforceability of a transaction term sheet. In McGowan, Justice Scarpulla of the New York County, Supreme Court, Commercial Division, held that the term sheet before the court was a binding contract because it contained all the material terms of the proposed venture that would reasonably have been expected to be included under the circumstances. This month, by contrast, Justice Singh of the same court ruled that the term sheet at issue was only intended to be an agreement to agree; it was not intended to be a separate, enforceable agreement. See Pate v BNY Mellon-Alcentra Mezzanine III, L.P.

What is a Merger Clause?

Sometimes called an integration clause, a merger clause is a provision in a written contract that establishes the parties’ intent that their agreement is a completely integrated writing, representing their complete and final agreement on the matter. A completely integrated contract precludes the introduction of extrinsic proof (i.e., parol evidence) to add to or vary its terms. E.g., Citibank v Plapinger, 66 N.Y.2d 90, 94-95 (1985).

Lawyers include merger clauses in contracts because they reduce confusion about whether obligations made outside of the contract are part of the agreement, and force the parties to memorialize all material parts of their agreement in writing. They also help to prevent claims by one party to a contract that the other used fraud and deceit to induce them into entering the agreement (as alleged in Pate).

In New York, to be effective, a merger clause should be specific about what constitutes the merged terms. DiBuono v. ABBEY, LLC, 95 A.D.3d 1062, 1064 (2d Dept. 2012) (“While a general merger clause is ineffective to exclude parol evidence of fraud, a specific disclaimer will defeat any allegation that the contract was executed in reliance upon contrary oral representations.”) (citations omitted). General, boilerplate clauses are ineffective to show the parties’ intent. Id. Consequently, merger clauses such as the following have been found to be effective:

This Agreement may not be amended, changed, modified, or altered except by a writing signed by both parties. All prior discussions, agreements, understandings or arrangements, whether oral or written, are merged herein and this document represents the entire understanding between the parties with regard to the subject matter hereof. [Emphasis added.]

Pate v BNY Mellon-Alcentra Mezzanine III, L.P.:

Background:

The case arose out of a failed transaction involving Seven Continents Holdings, LLLP (“Holdings”), an Alabama-based partnership specializing in disaster-relief operations. In early 2013, the plaintiff, Luther S. Pate, IV (“Pate”), caused Holdings, which he then controlled, to purchase several other disaster-relief companies, including DRC Emergency Services, LLC and its affiliates (“DRC”). The purchase was financed by a loan made by defendant BNY Mellon-Alcentra Mezzanine III, L.P. (“Alcentra”), an investment fund managed by BNY Mellon-Alcentra Mezzanine Partners, and defendant United Insurance Company of America (“United”), which Pate personally guaranteed and secured by his interests in Holdings. Pate defaulted on the loan.

In August 2013, Alcentra and United notified Pate that they intended to foreclose upon his interests in Holdings. Thereafter, the parties engaged in negotiations to prevent foreclosure and cure the defaults, which resulted in an agreement in principle, the terms of which were set forth in an executed term sheet dated October 22, 2013 (the “Term Sheet”).

The Term Sheet provided that the parties would enter into a forbearance agreement by November 15, 2013, subject to the satisfaction of other terms and conditions in the Term Sheet. Upon execution of the forbearance agreement, the Term Sheet provided that Pate and his affiliates would assign and transfer all of their rights and interests in Holdings and its affiliates, and the parties would enter into a series of mutual releases.

The Term Sheet also imposed certain obligations on Pate prior to entering into the forbearance agreement, including that Pate would make a total of $5.5 million in payments to DRC and return certain specified assets to Holdings. Further, the Term Sheet set forth certain rights to which Pate would be entitled upon his satisfaction of his obligations under the Term Sheet and the forbearance agreement.

The Term Sheet further contained a provision for the transfer to Pate of a limited participation interest in Holdings (10%) for a five-year period.

Thereafter, on November 4, 2013, the parties executed the forbearance agreement, titled “Assignment Agreement and Release” (the “Release Agreement”). Under the agreement, Pate agreed to make a cash payment and to transfer all his interests in Holdings and related entities to Alcentra and United, and Alcentra and United agreed to release Pate from his obligations with respect to the loan, including his personal guaranty, and to indemnify Pate with respect to certain other guaranties he had executed for the benefit of Holdings. The contract was fully-integrated, containing a merger clause, which provided:

This Agreement sets forth the entire understanding of the Patties with respect to the subject matter hereof and supersedes all prior agreements, written or oral, of the Parties (including any prior term sheet or correspondence) and may be modified only in a writing executed by all of the Parties.

The Allegations and Defenses:

Notwithstanding the execution of the Release Agreement, Pate alleged that the parties expressly agreed that the Term Sheet itself was enforceable because numerous obligations thereunder had to be performed prior to the execution of the Release Agreement. In that regard, Pate maintained, based on verbal communications with one of the individual defendants, that he understood the Release Agreement to be a supplemental, mechanical document that simply effectuated the transfer, including his right to the 10% economic interest, which had been memorialized in the Term Sheet.

Pate contended that when the parties circulated the Release Agreement for execution on November 4, 2013, he relied on the verbal promises that: a) Alcentra and United would transfer a 10% economic interest in Holdings to him; b) the Release Agreement would not affect his right under the Term Sheet to receive that interest; and c) a supplemental document effectuating the transfer would be executed within 30 days of execution of the Release Agreement. Based in part on the verbal representations, Pate maintained that he understood that the merger clause in the Release Agreement would not impact the participation provision.

Pate filed a summons and complaint on December 4, 2015. In the complaint, Pate alleged that he had performed all his obligations under the Release Agreement and the Term Sheet, but Alcentra and United had not fulfilled their obligations under the agreements – namely, they failed to assign a 10% economic interest in Holdings to him. Pate asserted claims of breach of contract against United and Alcentra, fraudulent inducement against all the defendants, and breach of warranty of authority against the individual defendants.

The defendants moved to dismiss, arguing, among other things, that Pate’s claims were barred by the merger clause contained in the Release Agreement. The Court agreed.

The Court’s Ruling:

In dismissing the breach of contract claims, the Court found that the Term Sheet was unenforceable for several reasons.

First, the Court found that the merger clause “expressly and unambiguously” provided that the Release Agreement superceded “any prior term sheet.” To hold that the Term Sheet was nevertheless binding, said the Court, “would render the [merger] clause meaningless.” Such an interpretation would leave one of the clauses in the Release Agreement “without meaning or effect,” a result, Justice Singh said, the courts should avoid.

Second, the Court found that the Term Sheet was not intended to be the final agreement; rather, it was an “agreement to agree.”  The Court noted that the Term Sheet “plainly” stated that the parties would “enter into a forbearance agreement (the “Definitive Agreement”)” as their final agreement. Thus, by its very terms, the Term Sheet and the Release Agreement could not be separate, enforceable agreements.

Third, because the merger clause memorialized the parties’ agreement “in a clear complete document,” the Court refused to vary that writing through parol evidence: “plaintiff cannot rely on any telephone conversations or e-mails with the defendants, for the merger clause states unambiguously that the release agreement set forth ‘the entire understanding of the parties with respect to the subject matter hereof and supercedes all prior agreements (written or oral).’”

Finally, the Court found that the Term Sheet was unenforceable “because documentary evidence utterly refute[d] plaintiff’s contention that he made both of the payments required by the Term Sheet.”

For these reasons, the Court dismissed the breach of contract claims against Alcentra and United.

The Court also dismissed the fraud in the inducement claims because of the merger clause, stating: “the allegation that plaintiff justifiably relied on pre-contractual representations … is refuted by the merger clause of the release agreement.”

Takeaway:

Pate is important because it reinforces the rule that a contract containing a specific merger clause that disclaims prior or extra-contractual agreements or representations will bar the parties from relying upon such agreements or representations to assert claims of breach of contract or fraudulent inducement.

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