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Late last week, the District Court for the Southern District of New York provided a reminder of the importance of precise drafting. In Transform Holdco LLC v. Sears Holdings Corp. et. al., CV-05782, Doc. 20, the contractual question at issue related to the purchase of substantially all of the assets (and assumption of certain of the liabilities) of Sears and its domestic and foreign subsidiaries by Transform Holdco LLC (“Transform”) in Sears’ bankruptcy case. Typical of a sale under Section 363 of the Bankruptcy Code, Transform’s purchase was largely structured as an asset sale, allowing it to acquire those assets “free and clear” of liens and encumbrances. Also typical, certain assets were excluded from the sale, including cash and cash equivalents of the US and foreign entities, defined in the purchase agreement as “Excluded Assets.” Following execution of the agreement, the parties entered into an amendment which allowed Transform some flexibility regarding its purchase of the assets of Sears’ foreign subsidiaries. Because the transfer of the foreign assets might be problematic, Transform was granted an option to instead acquire the equity of those subsidiaries. The amendment provided that, if Transform “determines (in its sole discretion)… that it is necessary or desirable to acquire all of the equity interests in any Foreign Subsidiary in lieu of the acquisition of assets and assumption of liabilities…, then the [s]ellers shall use reasonable best efforts to transfer such equity interests, which equity interests shall be deemed to be Acquired Foreign Assets.” (emphasis added). The agreements were governed by Delaware law.

Ultimately, Transform opted to acquire the equity of the foreign subsidiaries. At the time of closing, Sears had no reason to believe that foreign subsidiaries held meaningful cash and cash equivalents. Only later did it learn that foreign subsidiaries held approximately $6.3 million on the closing date. Unsurprisingly, and nearly 2 years after closing, Sears demanded the return of the cash, claiming that it was an “Excluded Asset” under the purchase agreement. Similarly unsurprising, Transform refused, countering that it had acquired the equity of the foreign subsidiaries and, it follows, all of their assets and liabilities (including those that would otherwise be deemed “Excluded Assets”). The dispute came before the Bankruptcy Court which ruled in favor of Sears, finding that Transform’s option related solely to the transaction’s structure and did not expand the category of assets to be acquired. Transform appealed.

For purposes of its review, the District Court provided some important reminders. In setting parameters for its analysis, it explained that “Delaware law adheres to the objective theory of contracts, i.e., a contract’s construction should be that which would be understood by an objective, reasonable third party.” Id. at 7 (citations omitted). The District Court continued, “[u]nless there is ambiguity, Delaware courts interpret contract terms according to their plain, ordinary meaning.” Id. at 8 (citations omitted). When ambiguity exists, the District Court explained that “courts must read the specific [challenged] provisions of the contract in light of the entire contract. That is true in all commercial contexts, but especially so when the contract at issue involves a definitive acquisition agreement addressing the sale of an entire business.” Id. (citations omitted). The District Court also reminded the parties that it “will not read a contract to render a provision or term meaningless or illusory.” Id. (citations omitted). Transform argued that the agreement was unambiguous – by opting to acquire the equity, it acquired all of its assets, including those that would have otherwise been retained by Sears in the context of an asset purchase transaction. The District Court disagreed. It did not dispute that, in isolation, when a purchaser acquires the equity of a company, it acquires all of that company’s assets and liabilities. Rather, it focused on Transform’s option to acquire the equity “in lieu of” the originally contemplated structure. The agreement failed to deem the subsidiaries’ cash, on any other asset that would otherwise constitute an “Excluded Asset”, to be “Acquired Assets” upon the acquisition of the equity. Instead, the court believed that it did the opposite — the equity was “deemed to be” among the “Acquired Foreign Assets” and therefore the assets transferred were intended to be consistent with the original transaction. See Id. at 8-9. Perhaps most damning was another provision in the amendment: “[f]or the avoidance of doubt… the Liabilities of any entity that is an Acquired Foreign Asset shall not be Excluded Liabilities.” There was no similar clarification for “Excluded Assets” of the foreign subsidiaries (e.g., a statement that cash on hand shall not be an “Excluded Asset”). The absence of such a clarification provided sufficient justification for the District Court to find the agreement unambiguous and uphold the Bankruptcy Court’s decision. See Id.

Take Away:  Both parties advanced reasoned contract interpretations supported by the plain language of the agreement. While it cannot be disputed that the purchase of a company’s equity generally includes all assets and liabilities of that entity, the failure to clearly specify the treatment of the foreign subsidiaries’ cash in the context of complicated sale structure lead to the District Court’s holding in favor of the Sears’ bankruptcy estate. As demonstrated by this opinion, the importance of clear and careful drafting cannot be overstated – especially in the context of a complicated sale transaction.