Co-authored by Joseph E. Gallo.
Vice Chancellor Laster of the Delaware Court of Chancery ordered reformation of a joint venture agreement where plaintiff ASB Allegiance Real Estate Fund (ASB) proved at trial, by clear and convincing evidence, that the compensation terms agreed to with defendant Scion Breckenridge Managing Member, LLC (Scion) were not accurately reflected in the parties’ final executed contract.
ASB and Scion (through various affiliates) entered into real estate join ventures involving student housing projects. In general, ASB provided the majority of the capital and Scion managed the projects on a day-to-day basis. The parties agreed that Scion would be compensated in part through “promoted interest” or, in industry jargon, a “promote” (a portion of the cash flows generated by a capital event such as a sale or refinancing of the joint venture property).
According to the Court, the parties agreed in an email exchange that Scion would be entitled to a promote if the transaction resulted in a profit to the joint venture. The contract at issue, however, was written in a way that arguably required ASB to pay a promote to Scion even where the property was sold at a loss. ASB sued to reform the agreement.
Under Delaware law, the Court of Chancery can reform a contract to reflect the “real agreement” of the parties. The Court may choose to reform a contract in the case of a unilateral mistake, where one party is mistaken about a contract provision and the other party is aware of the mistake and stays silent. In order to obtain reformation of a contract, a plaintiff must demonstrate, by clear and convincing evidence, that a “specific prior understanding” of the contract is materially different from the written contract.
Based on fact and expert witness testimony, the Court found that ASB had established the requirements for reformation: (i) the email communications between ASB and Scion reflected an agreement on the promote clause that differed from the one set forth in the final written contracts; (ii) ASB mistakenly believed that the “promote” clause in the final contracts was identical to terms contained in the prior emails; and (iii) Scion knew of ASB’s mistaken belief and knowingly stayed silent so that Scion could receive the benefit of the erroneously drafted clause.
ASB Allegiance Real Estate Fund v. Scion Breckinridge Managing Member, LLC, No. 5843-VCL (Del. Ch. May 16, 2012).