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ASB Allegiance Real Estate Fund v. Scion Breckenridge Managing Member, LLC

Court of Chancery of Delaware

September 16, 2013

ASB ALLEGIANCE REAL ESTATE FUND, EBREF HOLDING COMPANY, LLC, and DWIGHT LOFTS HOLDINGS, LLC, Plaintiffs,
v.
SCION BRECKENRIDGE MANAGING MEMBER, LLC, SCION 2040 MANAGING MEMBER, LLC, and SCION DWIGHT MANAGING MEMBER, LLC, Defendants

Date Submitted: August 1, 2013

John L. Reed, Scott Czerwonka, DLA Piper LLP (US), Wilmington, Delaware; Bruce E. Falby, Bruce S. Barnett, DLA Piper LLP (US), Boston, Massachusetts; Attorneys for Plaintiffs.

Gregory P. Williams, Kelly E. Farnan, Richards, Layton & Finger, P.A., Wilmington, Delaware; Kenneth T. Brooks, Richard J. Zecchino, Honigman Miller Schwartz and Cohn LLP, Lansing, Michigan; Attorneys for Defendants.

MEMORANDUM OPINION

LASTER, Vice Chancellor.

The plaintiffs are special purpose entities affiliated with ASB Capital Management LLC (together, "ASB"). The defendants are special purpose entities affiliated with The Scion Group LLC (together, "Scion"). ASB and Scion engaged in extensive litigation over three joint venture agreements. ASB prevailed, and in a post-trial opinion, this court reformed the joint venture agreements as ASB requested. ASB Allegiance Real Estate Fund v. Scion Breckenridge Managing Member, LLC, 2012 WL 1869416 (Del. Ch. May 16, 2012) ("Trial Ct. Op."). The Trial Court Opinion held that ASB could recover all reasonable fees and expenses relating to the litigation under contractual fee shifting provisions in the three agreements. A subsequent opinion quantified the award. ASB Allegiance Real Estate Fund v. Scion Breckenridge Managing Member, LLC, 50 A.3d 434 (Del. Ch. 2012) ("Fee Op.").

On appeal, the Delaware Supreme Court reversed the contractual award of fees and expenses because ASB's counsel, DLA Piper LLP, represented ASB for free to avoid a malpractice action. Scion Breckenridge Managing Member, LLC v. ASB Allegiance Real Estate Fund, 68 A.3d 665 (Del. 2013) ("Supreme Ct. Op."). Noting that ASB had not paid DLA Piper anything, the Supreme Court held that ASB had not incurred fees or expenses for purposes of contractual fee-shifting. The high court remanded for this court to determine whether fees and expenses should be awarded on equitable grounds.

ASB now seeks an award of fees and expenses under the bad faith exception to the American Rule. In the Trial Court Opinion, this court found based on clear and convincing evidence that Eric Bronstein, one of Scion's principals, recognized a mistake in the waterfall provision of the initial joint venture agreement, but remained silent in an effort to capture a substantial and undeserved economic benefit for Scion. Eric then remained silent on two later occasions when ASB's counsel used the erroneous agreement as a template for subsequent deals, thereby perpetuating the error. Under settled law, to remain silent under those circumstances constitutes a species of inequitable conduct in the nature of fraud. This court further found in the Trial Court Opinion that after the mistake was discovered, Eric and his brother Rob Bronstein falsely tried to justify the mistake as the intended result of the parties' negotiations.

When ASB insisted that the mistake be corrected, the Bronstein brothers caused Scion affiliates to file lawsuits immediately in three different jurisdictions. Scion launched its three-front attack to send a message to ASB and DLA Piper that any litigation would be expensive and time-consuming and result in the very public airing of the facts surrounding their negligence in entering into the erroneous agreements. In the Fee Opinion, this court found that Scion filed its three lawsuits to drive up litigation costs and extract a favorable settlement disproportionate to the merits.

At trial, Eric testified to two alternative factual accounts, one in which he negotiated the mistaken term as a specific benefit to Scion, and another in which the mistaken provision was something he was too unsophisticated to understand. In the Trial Court Opinion, this court found that neither of Eric's accounts was credible, and together they were mutually exclusive. Although problematic for any witness, Eric's testimony was particularly blameworthy because he is a lawyer who owes professional obligations that include a duty of candor to the tribunal. Scion also presented an expert at trial who proffered opinions that conflicted with every real estate joint venture he had been involved in or heard about during his twenty-five years of industry experience.

ASB believes that a bad faith award of fees and expenses should follow as a matter of course and seeks to recover all of the fees and expenses that DLA Piper incurred. ASB's analysis, however, fails to account for determinations that the Delaware Supreme Court made on appeal. In addition, Delaware law requires that any bad faith fee award relate causally to fees and expenses incurred due to the bad faith conduct. Applying these principles, this court finds that fee-shifting is warranted, but only for amounts relating to Scion's expert and its three-front litigation strategy.

I. FACTUAL BACKGROUND

Between January 2007 and January 2008, ASB and Scion "entered into five joint ventures for the ownership, operation, and development of student housing projects." Supreme Ct. Op. at 669. "Real estate joint venture projects generally follow a basic framework: a promoter provides the bulk of the capital and a sponsor arranges the deal and manages the property." Id. at 670. In the five ASB-Scion projects, ASB "provid[ed] at least 99% of the capital and retain[ed] at least 99% of the equity." Id. "Scion served as the sponsor and invested no more than 1% of the capital." Id. To incentivize Scion to increase the value of the properties, ASB and Scion agreed that Scion would receive a "promote, " which is a term of art in the real estate industry.

Generally, a promote is triggered once the project generates a specified preferred return on the invested capital. Once the project achieves the specified preferred return, the promote rewards the sponsor with a greater proportion of the project's profits. Real estate professionals commonly discuss promotes using industry shorthand, in which they describe the economics as "an X over a Y." For example, the phrase "20% over an 8%" means the sponsor would receive 20% of incremental profits after the project generated an 8% preferred return.

Id. (footnote omitted).

Rob and Eric Bronstein are brothers who co-founded Scion and serve as its principals. Rob owned a majority of Scion's equity and took the lead on business issues. Eric, a lawyer, owned a minority of Scion's equity and took the lead on legal issues. Rob negotiated the economic terms of Scion's compensation with his business counterpart at ASB, eventually reaching agreement by email that the promote framework would be a "20% above an 8% preferred return." Id. After two successful deals, Rob sought greater compensation for Scion through a two-tiered promote. Rob and his counterpart at ASB agreed that that the promote framework for Scion's deals with ASB going forward would be as follows: "On an unlevered deal, 20% over an 8%, and 35% over a 12%. On a levered deal, 20% over a 9%, and 35% over a 15%." Id. at 671 (the "May 2007 Terms").

Rob relied on Eric to prepare the joint venture agreements. ASB relied on DLA Piper. Id. at 671-72. An associate at DLA Piper created the first joint venture agreement to incorporate the May 2007 Terms by using an earlier Scion-ASB agreement as a template. The DLA Piper associate revised both the operational cash flow waterfall and the capital-event waterfall to provide for a second tier of preferred return, but failed to add a second tier of promote. Eric replied the same day and identified the problem. Id. at 672. The DLA Piper associate then revised the waterfalls to include the second tier of promote, but she mistakenly placed the missing tier of promote after the first preferred return provision, but before the return of capital provision. The incorrect placement altered the business terms of the joint venture because Scion would begin to earn its promote immediately after the project satisfied its first preferred return amount but before the parties recovered their initial capital investment. Id. Eric noticed the mistake and understood that it benefitted Scion by altering the business deal from what Rob and ASB had negotiated. He did not say anything at the time. DLA Piper and ASB did not catch the error. The parties executed the joint venture agreement with the incorrectly drafted provision. Trial Ct. Op. at *6-7.

At trial, Eric offered two internally inconsistent explanations for the incorrect placement of the first-tier of promote:

In one version, he negotiated changes to the capital-event waterfall provision as the authorized representative of Scion and obtained the disproportionately pro-Scion change, fully aware of its implications. In the other version, he lacked sophistication in real estate matters, innocently asked about the capital-event waterfall provision, and naively believed that DLA Piper accurately scrivened the deal.

Id. at *1. This court commented that "[i]t is one thing to plead claims in the alternative; it is quite another to testify in the alternative about your own role, knowledge, and intentions." Id

This court rejected Eric's negotiation story, finding it inconsistent with the substance of the communications between Eric and DLA Piper, the nature of Eric's role as Scion's in-house lawyer, the absence of any contemporaneous business negotiations by Rob to elevate the priority of Scion's promote, DLA Piper's lack of authority to make changes to the business deal, and the radical change in the business terms that the placement accomplished. Id. at *5-7. This court also rejected Eric's alternative account. Eric was far from naïve in real estate matters. Before co-founding Scion, he was a partner at Jaffe Raitt Heuer & Weiss, a Detroit law firm with over 100 lawyers. His practice focused on commercial real estate transactions, including the formation of a $100 million real estate joint venture and multiple real estate financings. He later served as senior group counsel for Johnson Controls, the world's largest automotive interior supplier, where he supervised $5 billion a year in business transactions. Id. at *2.

Once the error in the capital-event waterfall made it into the first joint venture agreement, it was perpetuated in later agreements. On each occasion, the DLA Piper associate electronically copied the precedent agreement and only made deal-specific changes. Because ASB and DLA Piper thought the precedent agreement accurately memorialized the economic terms, they did not focus on the waterfall provisions and did not catch the error. Eric never spoke up.

Between entering into the second and third erroneous joint venture agreements, Scion and ASB set up a deal for a property called Automatic Lofts. For tax reasons, the parties did not structure the deal as a joint venture, but they sought to pay Scion compensation in accordance with the May 2007 Terms. To do so, they drafted the compensation provisions to pay Scion's promote only after ASB received back its capital. Scion's compensation structure for the Automatic Lofts deal was thus consistent with ASB's position in this litigation and inconsistent with the capital-event waterfall provisions in the first two joint venture agreements. If the first two joint venture agreements were correct, then the Bronstein brothers should have objected that the Automatic Lofts deal did not match their compensation arrangement and underpaid Scion. This court found that the Bronstein brothers accepted the compensation structure in the Automatic Lofts deal because they knew it accurately reflected Scion's agreement with ASB. See id. at *9.

On June 12, 2010, Scion exercised a put right in one of the joint venture agreements. ASB had contributed $47.3 million in capital to the deal; Scion had invested $479, 000. The parties agreed the venture was underwater with a fair market value of $35.5 million. On August 30, Eric informed ASB that the buyout price was $1.83 million, representing a 282% gain for Scion on a deal where ASB lost 30%. Without the promote, the buyout price would have been $347, 792.46, and the parties would have shared the loss proportionately. See Supreme Ct. Op. at 674.

ASB immediately contested Scion's calculation. In response, Eric played dumb, and Rob made stuff up. Eric relied on the structure of the capital-event waterfall, which he knew was wrong, saying "we prepared our calculation to follow the LLC Agreement precisely, so I believe it is correct." Trial Ct. Op. at *10. Rob claimed that Scion's outsized and disproportionate compensation resulted from a deal-specific arrangement:

[T]his was the business deal we negotiated through Keyvan Arjomand in 2007. It was different than the [University Crossing] and Millennium structure, for several reasons—we brought to ASB an off-market deal, our acquisition fee was reduced, we left our proceeds in but still had to pay capital gains tax, our management fee was lowered, etc. Therefore our deal was structured with more back-end compensation.

Id. (alteration in original). As this court found after trial, virtually every statement in this email was false. Id Scion's acquisition fee had not been reduced, Scion had not left any proceeds in the prior deal and had not paid any capital gains taxes, and Scion's management fee was not lower. Id.

At this point, ASB reviewed the joint venture agreements in detail. After identifying the error, ASB called DLA Piper and "had a very, very tough conversation." Supreme Ct. Op. at 674. ASB put DLA Piper on notice of a malpractice claim. Id.

By letter dated September 20, 2010, ASB notified Scion that unless Scion agreed to correct the three erroneous joint venture agreements (the "Disputed Agreements"), ASB would file suit. The next day, Scion preemptively sued over just one of the agreements in the United States District Court for the Eastern District of Wisconsin, the site of the property owned by that joint venture. On September 22, ASB filed suit in this court. Unlike Scion, ASB placed at issue the entirety of the dispute, named all relevant parties, and sought reformation of all three Disputed Agreements. Fee Op. at 438.

Scion then filed two additional lawsuits, one in the United States District Court for the Northern District of Illinois and another in the United States District Court for the Middle District of Florida. Each lawsuit sought to enforce just one of the Disputed Agreements. Scion's three complaints each pled substantially identical counts. Id

Scion's tactics caused four courts and the parties to engage in overlapping, redundant, and otherwise unnecessary activities. Motions to stay were filed, briefed, and decided in each of the federal cases. Motions to dismiss were filed, briefed, and decided in all four cases. Motions for summary judgment were filed, briefed, and decided in all four cases. Multiple courts heard motions on discovery and pre-trial issues. As the cases proceeded, renewed motions to stay were filed, briefed, and decided.

Id. As the four cases neared trial, the parties made two emergency applications to this court for expedited decisions to help avoid "a multi-jurisdictional train wreck." Id. at 438-39.

In all four cases, DLA Piper represented ASB "free of charge." Supreme Ct. Op. at 675. The case in this court went to trial first. In a post-trial decision, this court "reformed the Disputed Agreements in favor of ASB, " finding that ASB proved by clear and convincing evidence a unilateral mistake by ASB coupled with knowing silence about the mistake by Scion. Id. This court "awarded ASB over $3.2 million in attorneys' fees based on the contractual fee-shifting provisions" in the Disputed Agreements. Id.

The contractual fee-shifting provision provided as follows: "In the event that any of the parties to this Agreement undertakes any action to enforce the provisions of this Agreement against any other party, the non-prevailing party shall reimburse the prevailing party for all reasonable costs and expenses incurred in connection with such enforcement, including reasonable attorneys' fees . . . ." Trial Ct. Op. at *20 (the "Fee- Shifting Provision"). This court held that ASB satisfied the provision, even though DLA Piper represented ASB free of charge:

The purpose of the [Fee-Shifting Provision] is to allocate the burden of contract enforcement between the breaching party and the non-breaching party. Arrangements that the non-breaching party may have made internally or with third parties to minimize or lay off its own burdens do not affect the breaching party's liability. If, for example, ASB had obtained litigation insurance such that its fees and expenses were covered by an insurer, that fact would not eliminate Scion's obligation under the fee-shifting provision. Either ASB or the insurer by subrogation could enforce the fee-shifting provision. Here, the non-breaching side of the case caption litigated the dispute at significant cost, albeit a cost that DLA Piper and ASB have allocated between themselves. The [Fee-Shifting Provision] obligates the breaching side of the caption to bear that cost, regardless of the allocation between DLA Piper and ASB.

Id. This court's reasoning thus placed primary emphasis on the parties' decision via the Fee-Shifting Provision to allocate responsibility for fees and expenses to the breaching party, thereby forcing the breaching party to internalize the cost of breach. This court's reasoning implicitly construed the concept of fees incurred by a "party" to include a party's agents, such as its counsel, when assessing the costs of breach.

On appeal, the Delaware Supreme Court held that the Fee-Shifting Provision did not apply "where counsel for the party seeking fees represented the party free of charge to avoid a malpractice claim." Supreme Ct. Op. at 669. Distinguishing between ASB (the party) and DLA Piper (the party's agent), the Delaware Supreme Court explained that "[t]he plain meaning of 'incurred, ' combined with 'reimburse, ' does not extend to this situation where ASB did not incur any payment obligation because DLA Piper agreed to represent it without charge." Id. at 683. Citing Black's Law Dictionary, the Delaware Supreme Court defined "incur" as "[t]o suffer or bring on oneself (a liability or expense)" and "reimburse" as "to repay or indemnify." Id. (alteration in original and internal quotation marks omitted). Because DLA Piper agreed to represent ASB free of charge, "ASB ...


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