March 27, 2015
NATIONWIDE EMERGING MANAGERS, LLC, Defendant/Counter-Plaintiff Third-Party Plaintiff Below-Appellant,
NORTHPOINTE HOLDINGS, LLC, Plaintiff/Counter-Defendant Below-Appellee, and NATIONWIDE CORPORATION, and NATIONWIDE MUTUAL INSURANCE CO., Defendants Below-Appellants, and NORTHPOINTE CAPITAL, LLC, PETER CAHILL, MARY CHAMPAGNE, ROBERT GLISE, MICHAEL HAYDEN, JEFFREY PETHERICK, STEPHEN ROBERTS, and CARL WILK, Third-Party Defendants Below-Appellees.
Submitted: March 4, 2015
Court Below: Superior Court of the State of Delaware in and for New Castle County C.A. No. N09C-11-141 ALR
Upon appeal from the Superior Court.
Colm F. Connolly, Esquire (argued), Morgan, Lewis & Bockius LLP, Wilmington, Delaware, for Appellants.
Bartholomew J. Dalton, Esquire, Dalton & Associates, P.A., Wilmington, Delaware; Jaye Quadrozzi, Esquire (argued), Rodger D. Young, Esquire, Young & Associates, Farmington Hills, Michigan, for Appellees.
Before STRINE, Chief Justice; VAUGHN, Justice; and LASTER, Vice Chancellor. [*]
STRINE, Chief Justice
When a buyer and seller negotiate a detailed contract, Delaware law requires that the contract's express terms be honored,  and prevents a party who has after-the-fact regrets from using the implied covenant of good faith and fair dealing to obtain in court what it could not get at the bargaining table. In this case, the buyer persuaded the Superior Court to award it $15.1 million in damages when the buyer bought a 65% interest in an investment advisory firm for $25 million. The buyer's premise was that it would not have paid $25 million but for its expectancy that it would manage seven funds for three or more years. But the majority of the assets under management at the investment advisory firm were attributable to accounts other than the seven funds. As important, the contract enabled the seller to terminate the buyer's right to manage the seven funds for any reason, so long as it paid a termination fee capped at $3.5 million, and to terminate the buyer without any compensation if the seller believed its fiduciary duties required or if the buyer's performance fell below a contractual standard. And after three years, the seller could terminate the buyer as manager of the funds for any reason and owe no compensation at all.
Instead of giving effect to the parties' contractual bargain, the Superior Court erred by implying contractual obligations on the part of the seller that were inconsistent with the contract's express terms. This enabled the buyer to obtain in litigation benefits in excess of those potentially available under the contract, and contractual protections that the buyer had failed to obtain in negotiations. We therefore reverse the judgment of the Superior Court in favor of the buyer and remand for a determination of what, if any, termination fee is due to the buyer because of the seller's termination of it as manager of the funds.
a. The Parties
NorthPointe Capital, LLC ("NorthPointe Capital") was set up in 1999 to perform sub-advisory work for mutual funds and other investment vehicles. Nationwide
Emerging Managers, LLC ("Nationwide") owned 65% of NorthPointe Capital, with the remaining 35% held by NorthPointe Capital's four managers. Its primary business was managing seventy accounts for institutional investors under investor-specific agreements. Those contracts constituted approximately 80% of NorthPointe Capital's assets under management. Its secondary business was providing sub-advisory services for the seven Nationwide funds that are the focus of this case. Of these seven funds, five were branded as Nationwide funds, and two were branded as NorthPointe funds. Six of the funds had assets under management valued at $100 million or less, but the seventh, Nationwide NVIT Mid Cap Growth Fund (the "NorthPointe NVIT"), held over $400 million in assets and was the "crown jewel" of the portfolio. That fund was a "trust fund in which Nationwide, not direct individual investors, owned the [assets] on behalf of individuals."Nationwide earned a total of $15 million in profits between 1999 and 2006 as the majority member of NorthPointe Capital.
b. The 2007 Management Buy-Out
In 2006, Nationwide decided to sell its interest in NorthPointe Capital as part of a larger strategy to divest itself from direct asset management. With the help of three investors, NorthPointe Capital's four managers created NorthPointe Holdings, LLC ("NorthPointe") to buy Nationwide's interest. From late 2006 through early 2007, NorthPointe and Nationwide negotiated the sale of Nationwide's ownership stake. The final sale price was $25 million, plus additional compensation owed under an earn-out provision. NorthPointe paid $16 million in cash and $9 million in the form of a subordinated note personally guaranteed by the managers. The parties signed a purchase agreement on July 19, 2007 (the "Purchase Agreement"), and the deal closed on September 28, 2007.
Exhibit D of the Purchase Agreement specified Nationwide's obligations to NorthPointe after the sale, as well as remedies for breaches of the Agreement. For three years, Section 1(a) of Exhibit D (the "Termination Provision") prevented Nationwide from terminating NorthPointe's sub-advisory services, or taking any action that would cause NorthPointe's termination, for the seven funds listed on Schedule 1 of Exhibit D ("Schedule 1"). The Termination Provision provided:
[Nationwide] hereby agrees that for a three-year period following the Closing Date . . . it shall . . . not terminate . . . for the [Sub-Advised Funds] included on Schedule 1 . . . [NorthPointe's] sub-advisory agreement with such Sub-Advised Fund, or take any other action to cause such termination; [but if Nationwide terminates NorthPointe's] sub-advisory agreement with [any] Sub-Advised Fund . . ., [Nationwide] shall pay a fee to [NorthPointe] in the amount set forth on Schedule 1 . . . under the name of such Sub-Advised Fund under the heading "Termination Fee" . . .; provided further, . . . the aggregate of all Termination Fees payable to [NorthPointe under] this subsection shall not exceed $3.5 million and all such Termination Fees shall be paid by reducing the principal amount of the . . . Note by the amount of such Termination Fees.
Accordingly, Nationwide was required to pay a "Termination Fee, " capped at $3.5 million, if Nationwide terminated NorthPointe as sub-advisor for any of the seven funds during the three-year period. Schedule 1 also set forth formulas for calculating the Termination Fee for several of the funds (listed under a "Termination Fee" heading). The NorthPointe NVIT is the first fund to appear under the "Termination Fee" heading. Under the formulas, the total damage award would decline over the course of the three-year contractual period, so that NorthPointe's highest recovery would occur if Nationwide breached the Termination Provision early, although the award could never exceed $3.5 million because of the cap.
Under the Termination Provision, Nationwide did not have to pay any Termination Fee if one of two conditions was met. The first condition was if Nationwide "determined in good faith that its termination [is] necessary for [Nationwide] to satisfy its fiduciary obligations to the shareholders of the Sub-Advised Fund" (the "Fiduciary Exception").The second was if NorthPointe failed to "satisf[y] the performance standards specified in Schedule 2" for that fund (the "Cause Exception"). The only performance standard relevant to this appeal required NorthPointe not to "have [a] performance rank in the bottom third of its peer group over a period of three consecutive years or five consecutive quarters" (the "Performance Period"). In other words, by the plain language of the contract, Nationwide had to pay an aggregate Termination Fee of no more than $3.5 million if it terminated NorthPointe's sub-advisory agreement for any reason. But if Nationwide terminated the sub-advisory agreement because doing so was necessary to abide by its fiduciary obligations to its stockholders, or as a result of NorthPointe's sub- par performance, it would not owe NorthPointe any Termination Fee for that fund.
Section 1(b) of Exhibit D (the "Replacement Provision") included additional protection for NorthPointe related to the NorthPointe NVIT, by far the largest fund listed on Schedule 1. The Replacement Provision provided:
[S]ubject to [NorthPointe's] compliance with the [performance standards], [Nationwide will not] replace [NorthPointe] or engage a concurrent sub-advisor with respect to the [NorthPointe NVIT] such that, immediately after . . . such replacement . . ., [NorthPointe has] less than $300 million in assets under management in such fund . . . .
The Cause Exception also applied to the Replacement Provision; that is, if the NorthPointe NVIT's performance fell below the standards established in the Purchase Agreement, Nationwide was permitted to replace NorthPointe as sub-advisor or engage another sub-advisor.
Exhibit D of the Purchase Agreement contained additional covenants binding Nationwide. But Nationwide did not promise not to open a fund that would compete with any of the seven funds, nor did it promise to manage any of the other funds it owned or controlled in any particular way. Restrictive covenants of that type are, of course, common in contracts like the Purchase Agreement.
c. Nationwide Withdraws Assets from the NorthPointe NVIT, Terminates Sub-Advisory Contracts for Five Funds, and Merges the NorthPointe NVIT with a Competing Fund
Nationwide had planned to open a new fund, the Nationwide Multi-Managed NVIT Mid Cap Growth Fund (the "Nationwide NVIT"), which would compete with the NorthPointe NVIT, before it signed the Purchase Agreement. Nationwide launched the fund in March 2008, and NorthPointe contended at trial that this marked the beginning of Nationwide's attempt to remove NorthPointe as sub-advisor for six of the funds before the expiration of the three-year period in violation of the Purchase Agreement. NorthPointe alleged that Nationwide deliberately capped the Nationwide NVIT's fees so that they were 12-15 basis points lower than the NorthPointe NVIT's fees, making it a more attractive investment. NorthPointe also claimed that the fee structure made it impossible for the NorthPointe NVIT to compete, because the two funds otherwise employed nearly identical investment strategies, had almost identical prospects for return, and were offered to the same clients.
Nationwide's investment activities were directed by a subsidiary called Nationwide Fund Advisors. From 2006 to 2008, the leadership of Nationwide Fund Advisors changed many times. As the Superior Court observed, each new president of Nationwide brought a different investment philosophy, which resulted in an incoherent strategy and "institutional incompetence."
On June 30, 2008, Nationwide Fund Advisors appointed a new president, who withdrew assets worth $260 million from the NorthPointe NVIT the following day and then invested $135 million of the money into the Nationwide NVIT. Nationwide argued at trial that it moved the assets because its independent financial advisor recommended that it do so based on NorthPointe's poor performance.
On November 25, 2008, Nationwide sent a letter to NorthPointe expressing its desire to terminate its sub-advisory contracts for four of the funds, merge the NorthPointe NVIT with the Nationwide NVIT, and "explore alternative options" for another fund, the Nationwide Value Opportunities Fund. Over the course of the next year, Nationwide acted on these plans: it terminated its sub-advisory agreements for the four specified funds on December 3, 2008, merged the NorthPointe NVIT and the Nationwide NVIT on February 6, 2009, and terminated its sub-advisory agreement for the Nationwide Value Opportunities Fund on June 18, 2009. Nationwide believed that the seventh fund was meeting the Purchase Agreement's performance standards and so took no action to terminate it.
According to Nationwide, the five funds that were terminated had failed to meet the performance standards, and as such, Nationwide was not obligated to pay a Termination Fee. Nationwide also contended that the merger of the two NVIT funds, which removed NorthPointe as sub-advisor, was necessary because of NorthPointe's "consistently poor" performance.
By contrast, NorthPointe contended that it met the performance standards for each of the six funds specified in the letter. As discussed, Nationwide could invoke the Cause Exception if NorthPointe had a performance rank in the bottom third of its peer group for three consecutive years or five consecutive quarters (what we have called the Performance Period). Although both parties conceded that the funds did not perform well after closing, the question of whether NorthPointe failed to meet the performance standards turned on whether the Performance Period was intended to include the funds' pre-closing performance. If so, based on their performance from 2006 to 2009, the funds would not have met the standards set out in the Purchase Agreement. By contrast, if the Performance Period was intended to begin only after closing, the Superior Court seems to have found that Nationwide would not have been able to invoke the Cause Exception based on NorthPointe's performance over the five quarters since closing because its performance during that period was not so poor as to trigger Nationwide's termination right. But obviously, not enough time would have passed to measure NorthPointe's three-year performance from the date of closing.
III. PROCEDURAL HISTORY
NorthPointe filed a complaint against Nationwide in the Superior Court on November 17, 2009, alleging fraud and breach of contract for terminating the sub-advisory agreements, and seeking a declaratory judgment nullifying the Purchase Agreement. The parties filed a series of dispositive motions, which resulted in certain claims being dismissed while others were added. In a Memorandum Opinion partially granting Nationwide's motion to dismiss, the Superior Court dismissed NorthPointe's claim that Nationwide violated the Replacement Provision because that provision did not prohibit Nationwide from withdrawing assets from the NorthPointe NVIT without also replacing NorthPointe as sub-advisor. By the time the parties went to trial before a different judge of the Superior Court,  NorthPointe was left with claims for fraud, breach of the express terms of the Purchase Agreement, and breach of the implied covenant of good faith and fair dealing.
At trial, NorthPointe contended that Nationwide's conduct breached the terms of the Purchase Agreement and also its implied covenant of good faith and fair dealing. Because it had paid $25 million for the right to manage the seven funds, including the NorthPointe NVIT, among other things, NorthPointe argued that Nationwide's actions terminated NorthPointe's ability to manage the funds and deprived NorthPointe of the benefit of its bargain. Curiously, even as NorthPointe argued that the Superior Court should graft implied terms onto the Purchase Agreement, NorthPointe also contended that the terms of the Agreement were clear and unambiguous.
Nationwide, by contrast, argued that the conduct underlying NorthPointe's claims was expressly authorized by the Purchase Agreement. Nationwide had negotiated for the right to terminate NorthPointe without paying a fee if certain conditions were met, and it could terminate NorthPointe under any circumstances if it was willing to pay a Termination Fee, which was capped at $3.5 million. Nationwide claimed that because NorthPointe had failed to meet the performance standards specified under the Purchase Agreement, the Cause Exception applied, and thus, NorthPointe was not entitled to a Termination Fee.
After a two-week bench trial, the Superior Court found that Nationwide was liable for breach of the express terms of the Purchase Agreement and for breach of the implied covenant of good faith and fair dealing in that Agreement. The Superior Court found that the Nationwide witnesses were unreliable, and concluded that NorthPointe's description of the events-that Nationwide secretly planned to open a competing fund in order to drain the NorthPointe NVIT of assets and force NorthPointe out of the sub-advisor arrangement for all six funds-was persuasive. Nonetheless, the Superior Court found that NorthPointe had failed to prove its fraud claim.
a. The Superior Court Found Breaches of the Express Terms of the Purchase Agreement
The Superior Court found that Nationwide breached the Termination Provision by terminating the sub-advisory agreements for five funds (excluding the NorthPointe NVIT), and then refusing to pay Termination Fees. The Superior Court rejected Nationwide's argument that NorthPointe had failed to meet the performance standards, and as such, determined that Nationwide was required to pay Termination Fees for all five funds. The Superior Court also found, without explanation, that the withdrawal of $260 million from the NorthPointe NVIT and the merger of NorthPointe NVIT into the Nationwide NVIT was a breach of the Replacement Provision, even though the Superior Court had previously concluded otherwise, and NorthPointe had not argued that it had been replaced.
b. The Superior Court Found Breaches of the Implied Covenant of Good Faith and Fair Dealing in the Purchase Agreement
The Superior Court also found that Nationwide breached the implied covenant of good faith and fair dealing "by redeeming $260 million from the NorthPointe NVIT and reallocating it to the other funds, including $135 million into the competing [Nationwide NVIT]." It found that Nationwide's "disingenuous" claim that it did not owe Termination Fees was also a breach of the implied covenant. In addition, the Superior Court found that Nationwide breached the implied covenant by using a fee structure in its newly-created competitor fund that made it impossible for the NorthPointe NVIT to compete,  even though it determined that Nationwide did not breach any implied covenant by creating the competing fund in the first place. Finally, the Superior Court found that Nationwide breached an implied covenant by informing NorthPointe of its intent to terminate the sub-advisory agreements after business hours on a Friday, after it had informed the SEC it was closing the funds, and by refusing to accept deposits from the NorthPointe NVIT's clients.
c. The Superior Court Awarded Termination Fees and Damages for NorthPointe's Overpayment of the Purchase Price
The Superior Court awarded NorthPointe $10.3 million in cash damages, plus a $4.8 million set-off of the obligation owed under a Note, for a total of $15.1 million, an amount almost five times greater than the remedy available to NorthPointe under the Purchase Agreement for the unexcused termination of all seven funds.
The Superior Court first found that liquidating the five funds triggered Nationwide's obligation to pay a Termination Fee, and awarded $605, 785 based on the formulas provided on Schedule 1. The Superior Court concluded that the Termination Provision did not apply to the NorthPointe NVIT because the Purchase Agreement contained a typo, even though NorthPointe did not make this argument or bring a reformation claim before the Superior Court. Accordingly, the Superior Court did not award NorthPointe a Termination Fee for Nationwide's conduct related to the NorthPointe NVIT.
The Superior Court based the remainder of its damage award on NorthPointe's alleged overpayment for Nationwide's interest in NorthPointe Capital due to Nationwide's wrongful conduct related to the NorthPointe NVIT and the other funds. In other words, the Superior Court attempted to determine the difference between the price NorthPointe paid for Nationwide's 65% interest in NorthPointe Capital, assuming a right to manage the seven funds for at least three years (and perhaps longer), and what NorthPointe would have paid without that expectancy.
The Superior Court's calculation was based entirely on NorthPointe's expert witness report, which estimated NorthPointe's "overpayment" using a cash flow analysis prepared by Merrill Lynch in 2007 to value Nationwide's 65% interest. The expert report made several adjustments to the cash flow analysis, most importantly, excluding the revenue stream from the NorthPointe NVIT. Under the revised cash flow analysis, NorthPointe's expert determined that the purchase price would have been $13 million and not $25 million. The Superior Court then added the Termination Fee for the five liquidated funds, as well as incidental damages, to the amount of
NorthPointe's "overpayment." It did not determine how much of the overall award was allocated between express breaches of the contract and breaches of its implied covenant.The total award was then allocated based on the ratio of cash-to-note in the original purchase, with the cash portion constituting $10.3 million, and the rest reducing the amount owed on the note by $4.8 million. In other words, rather than accepting the Termination Fee-set at a maximum of $3.5 million-as the price term for NorthPointe's right to manage the seven funds for the limited period specified by the Purchase Agreement, the Superior Court awarded $15.1 million in damages, which is more than 60% of the original $25 million purchase price.
On appeal, Nationwide's central argument is that the Purchase Agreement contained a specific provision providing a capped remedy of $3.5 million-the Termination Fee-for the termination of NorthPointe's sub-advisory contracts. According to Nationwide, the Superior Court erred by not adhering to the precise language in the Purchase Agreement. Nationwide first argues that the Superior Court erred by spontaneously reforming the Purchase Agreement to exclude the NorthPointe NVIT from Schedule 1 so that the Termination Provision did not apply to that fund. Second, Nationwide contends that although the merger of the NorthPointe NVIT into the competitor fund fell within the Termination Provision, NorthPointe's poor performance sub-advising that fund entitled Nationwide to terminate NorthPointe's sub-advisory agreement without paying a Termination Fee. Third, Nationwide argues that the "law of the case" doctrine prevented the Superior Court from finding that Nationwide breached the Replacement Provision because the Superior Court, in an earlier opinion written by a different judge, found that there was no basis for a claim that Nationwide breached the Replacement Provision and dismissed that claim. Finally, Nationwide contends that the Superior Court erred by finding that Nationwide breached the implied covenant of good faith and fair dealing because the express terms of the Purchase Agreement governed the subject of the conduct at issue.
We review the Superior Court's interpretation of a contract de novo and will overturn any of its factual determinations only if they are clearly erroneous.
A. The Superior Court Erred by Reforming the Contract
Although the Superior Court determined that the Termination Provision applied to the five funds that Nationwide had liquidated, the Superior Court concluded that the Termination Provision did not apply to the NorthPointe NVIT because the Purchase Agreement contained a typo. Although NorthPointe did not raise this argument or request reformation before the Superior Court, the Superior Court found, based on the testimony of a single witness, that the NorthPointe NVIT was mistakenly listed on Schedule 1. It concluded that the parties had not intended for the Termination Provision to apply to the NorthPointe NVIT, despite the fact that both parties had argued that the Termination Provision did apply to that fund. On appeal, Nationwide contends that the Superior Court erred by reforming the Purchase Agreement because the evidence was far from clear that it contained a mistake. NorthPointe, by contrast, contends that the Superior Court's interpretation of the contract was reasonable in light of a latent ambiguity in the Purchase Agreement.
The decision to fix a "typographical error" in a contract is "tantamount to reforming" the contract when it has material consequences. Although NorthPointe asks us to affirm the Superior Court's decision as an interpretation of a latent ambiguity, the Superior Court did not find that the Termination Provision or Schedule 1 was ambiguous. Rather, as NorthPointe contended at trial, the Agreement, which was negotiated by sophisticated parties and law firms, unambiguously showed that the Termination Provision applied to the NorthPointe NVIT. The NorthPointe NVIT was the first fund on the list of "sub-advised" funds that were subject to the Termination Provision. And in the section of Schedule 1 that provided the formulas to be used when calculating the Termination Fee, the NorthPointe NVIT is again the first fund listed. The Termination Provision would have applied to the NorthPointe NVIT under the plain language of each draft of the term sheet and the Purchase Agreement exchanged between the parties during a month-long drafting process. To delete the NorthPointe NVIT from Schedule 1 and insert another fund is not interpretation of an ambiguity; it is a decision to re-write the contract.
"As a matter of ordinary course, parties who sign contracts and other binding documents, or authorize someone else to execute those documents on their behalf, are bound by the obligations that those documents contain." To succeed in a claim for contract reformation, the "plaintiff must show by clear and convincing evidence that the parties came to a specific prior understanding that differed materially from the written agreement." But here, the Superior Court relied on a lower standard, asking only whether "the preponderance of the evidence established that Schedule 1 applied to the Nationwide [NVIT] and not the [NorthPointe] NVIT." Under the correct standard, a reformation claim (if it had been made) would fail because the evidence does not clearly show that the Purchase Agreement contained an error.
As we have recited, the text of the Purchase Agreement, the example used on Schedule 1 for calculating the Termination Fee, and the bargaining history all reflect the parties' intention to include the NorthPointe NVIT under the Termination Provision. This pattern of drafting is too conspicuous to be consistent with a determination that there is clear and convincing evidence of a mistake.
Moreover, the $3.5 million Termination Fee cap also cuts against a finding that the parties intended to exclude the NorthPointe NVIT from the Termination Provision. The NorthPointe NVIT was more than four times larger than each of the other six funds, and under the Schedule 1 formula for calculating the Termination Fee, the total Fee owed for a breach of all six of the other funds would not come close to $3.5 million after the first year. As an example, the Superior Court calculated that Nationwide owed just $605, 785 in damages due to Nationwide's decision to liquidate five of the funds approximately one year after closing. Only if the Superior Court had added the Fee owed for the termination of the NorthPointe NVIT would the aggregate Termination Fee have approached $3.5 million. Thus, the court's own calculation is in tension with its ruling.
NorthPointe's argument on appeal that the parties intended to exclude the fund from the Termination Provision also conflicts with its assertion that the fund was the "crown jewel" of the portfolio. If the fund was the most important to NorthPointe, it stands to reason that it would have wished to prevent Nationwide from terminating its sub-advisory agreement for that fund. Although careless mistakes happen, it is unlikely that the parties would have been sloppy when drafting the prominent contractual provisions applicable by their clear terms to the most valuable fund.
Finally, NorthPointe did not fairly raise a reformation claim at trial, likely because there was no colorable basis to suggest that the Termination Provision did not apply to the NorthPointe NVIT. In fact, for much of trial, NorthPointe contended that the Termination Provision applied to all seven of the funds. In its opening argument, NorthPointe argued that the Purchase Agreement "involves Nationwide promising not to terminate the sub-advisory agreements on any of the seven funds for three years."Later, NorthPointe explained that the Termination Provision "states that for three years following closing, Nationwide agreed not to terminate the sub-advisory agreements for any of the funds . . . ." And in its post-trial reply brief, NorthPointe seems to have agreed with Nationwide's contention that the Termination Provision was unambiguous and thus NorthPointe argued that it would be "improper to consider parol evidence" when interpreting that Provision. Confusingly, in that same brief, NorthPointe argued that errors in the Purchase Agreement "cast grave doubt on whether [the Termination Provision] . . . is intended to encompass all seven funds."
Because contract reformation is a well-understood claim and NorthPointe did not fairly raise it, the Superior Court should not have spontaneously reformed the contract. Even if the reformation claim had been fairly raised, the record does not contain clear and convincing evidence that would support reformation. Therefore, the Superior Court erred by reforming the contract to omit the NorthPointe NVIT from Schedule 1. On remand, the parties are bound by the plain terms of the Agreement: Nationwide could not terminate NorthPointe as sub-advisor of any of the seven funds, including the NorthPointe NVIT, without paying a Termination Fee, or showing that the termination fell under the Fiduciary Exception or the Cause Exception.
B. The Merger of the NorthPointe NVIT into the Nationwide NVIT Caused NorthPointe's Termination and Thus Breached the Termination Provision
Although the parties do not dispute whether the Termination Provision applied to the five funds that Nationwide liquidated, they contest whether the merger between the competing NVIT funds fell within that provision. Nationwide contends that Nationwide's decision to merge the NorthPointe NVIT with the Nationwide NVIT is governed by the Termination Provision because the merger caused NorthPointe's termination as sub-advisor. NorthPointe argues in response that the Termination Provision did not apply because it is not clear that NorthPointe's sub-advisory agreement was terminated after the merger. It does not dispute that the merger led to NorthPointe's effective termination as sub-advisor for the NorthPointe NVIT.
Because the merger of the two competing NVIT funds caused the termination of NorthPointe's sub-advisory agreement, it could only be undertaken within three years of closing if Nationwide paid NorthPointe a Termination Fee or successfully invoked one of the contractual exceptions. Under the Termination Provision, Nationwide promised not to terminate or "take any other action to cause" the termination of NorthPointe's sub-advisory agreement for any of the seven funds for the three-year contractual period. In other words, NorthPointe negotiated for broad protection for itself against any action by Nationwide that would result in the termination of its services.
It is undisputed that the NorthPointe NVIT was "liquidated and dissolved" after the merger. It is also undisputed that, after the merger, NorthPointe lost its ability to earn revenue by sub-advising the NorthPointe NVIT. As Nationwide expert Erik Sirri testified, "[when you merge funds, ] the sub-advisory agreements of the liquidated funds are terminated." Similarly, NorthPointe witness Peter Cahill admitted that NorthPointe's sub-advisory agreement was "nullified" after the merger. Because the merger caused the termination of NorthPointe's sub-advisory agreement for the NorthPointe NVIT for purposes of the Termination Provision, the Superior Court should have considered whether NorthPointe was entitled to a Termination Fee, or whether the Cause or Fiduciary Exception applied.
C. The Superior Court Erred by Interpreting the Termination Provision to Exclude NorthPointe's Performance Before Closing Without Any Explanation
At trial, the parties disputed whether Nationwide owed Termination Fees for the funds that were liquidated. Nationwide argued that NorthPointe failed to meet the performance standards because each of the terminated funds had "a performance rank in the bottom third of its peer group over a period of three consecutive years or five consecutive quarters." The Superior Court disagreed, and found that NorthPointe was entitled to Termination Fees. In reaching this conclusion, the Superior Court accepted, without explanation, NorthPointe's argument that the Performance Period ran from the date of closing, and not before closing (i.e., "prospectively and not retroactively"). On appeal, Nationwide argues that the Superior Court erred by interpreting the Performance Period in this way, and that because all six of the terminated NorthPointe funds had an impermissibly low performance rank for a three-year period that began before closing, NorthPointe is not entitled to any Termination Fees.
We are reluctant to rule on this issue in the first instance because the question of whether NorthPointe met the performance standards for each of the six terminated funds is a complicated factual determination, and we do not have sufficient analysis from the Superior Court to guide us. We only note that NorthPointe's argument that the Performance Period ran from the date of closing would, if accepted, render one of the important metrics for performance superfluous. The Termination Provision remained in effect for only three years after closing. After that point, Nationwide had no obligation to retain NorthPointe as a sub-advisor, and would not owe Termination Fees regardless of the reason for termination. Therefore, under NorthPointe's interpretation, Nationwide would not be able to rely on the three-year benchmark under the Cause Exception until its contractual obligation not to terminate NorthPointe expired altogether. Moreover, NorthPointe was "at all times" required to meet the specified performance standards. This broad contractual language suggests that the NorthPointe's pre-closing performance should have been considered. We thus vacate the Superior Court's ruling on this issue and remand for new consideration of the Purchase Agreement's meaning and application.
D. The Superior Court Erred by Finding that Nationwide Breached the Replacement Provision
At trial, NorthPointe contended that Nationwide's conduct related to the NorthPointe NVIT breached the Replacement Provision. Nationwide argued in response that the Superior Court was barred from reaching that conclusion because the Superior Court, in an opinion by a judge who had since retired, previously dismissed that exact claim. In its second ruling, the Superior Court disagreed with Nationwide, finding that "law of the case" doctrine did not bar the claim. The Superior Court then concluded that Nationwide's conduct related to the NorthPointe NVIT breached the Replacement Provision, without providing an explanation.
We agree with Nationwide that the "law of the case" doctrine prevented the Superior Court from considering whether Nationwide breached the Replacement Provision. In its earlier opinion, the Superior Court reasoned that because NorthPointe had not shown that it had been replaced as sub-advisor of the NorthPointe NVIT, there could be no breach of the Replacement Provision. Under the "law of the case doctrine, " a court's legal ruling at an earlier stage of proceedings controls later stages of those proceedings, provided the facts underlying the ruling do not change. Here, the factual basis for the Superior Court's first ruling did not change: as in 2010, the conduct that the Superior Court considered was Nationwide's decision to withdraw funds from, and eventually terminate by merging, the NorthPointe NVIT. The "law of the case" doctrine therefore barred the Superior Court from finding that such conduct breached the Replacement Provision.
Moreover, there was no error or injustice, much less a clear one, stemming from the first ruling that would justify re-consideration. As NorthPointe admitted at trial, "it is true that nothing in the Purchase Agreement expressly prohibited Nationwide from secretly creating a competing fund, or moving money out of the NorthPointe-managed fund, . . . or merging [the competing NVIT funds]." And NorthPointe did not argue that it had been replaced at trial or on appeal. Nor do the facts support that conclusion. Although the Purchase Agreement did not define "replace, " and the Superior Court did not define the term, it is not an unusual one. Webster's Dictionary defines "replace" as "to take the place of, especially as a substitute or successor." Here, it is undisputed that the NorthPointe NVIT was legally dissolved at the end of the merger, and thus, no advisor could "take the place of" NorthPointe as sub-advisor.
That interpretation of the term "replace" is most faithful to the plain language of the Purchase Agreement. Unlike the Termination Provision, which is written in broad terms to prohibit any conduct causing NorthPointe's termination, the Replacement Provision is narrow and prevents specific conduct: starving NorthPointe of revenue by hiring a new advisor for the NorthPointe NVIT.
That interpretation also matches the intent of the parties as evidenced by the drafting history relied on by the Superior Court. The Superior Court observed that NorthPointe had a "searing memory of a prior business relationship where another sub-advisor was added and the relevant fund lost assets." The Replacement Provision was created "to address this very specific fear and provides a well-delineated protection. Specifically, according to [Nationwide's expert witness John] Grady, there would be protections for NorthPointe if Nationwide caused economic harm but did not terminate the subadvisory relationship." In other words, the Replacement Provision provided extra protection for NorthPointe if Nationwide took action short of full termination, and prevented Nationwide from depriving NorthPointe of the ability to manage $300 million in assets without terminating NorthPointe and thereby triggering Nationwide's obligation to pay a Termination Fee.
Under the Replacement Provision, Nationwide would only be in breach if it brought on a new sub-advisor to manage part or all of the assets in the NorthPointe NVIT. Accordingly, the Superior Court's earlier conclusion on that point was sound, and the Superior Court erred by later determining that Nationwide breached the Replacement Provision.
E. The Superior Court Erred by Finding that Nationwide Breached the Implied Covenant of Good Faith and Fair Dealing
The Superior Court found that Nationwide breached the implied covenant of good faith and fair dealing because Nationwide supposedly deprived NorthPointe of the benefit of its bargain under the Purchase Agreement-namely, that it would have the right to manage seven funds for three years or be entitled to Termination Fees. In particular, the Superior Court found that Nationwide's refusal to pay Termination Fees because of NorthPointe's poor performance was "disingenuous." It also determined that Nationwide had breached an implied covenant by redeeming $260 million in assets from the NorthPointe NVIT. And although the Superior Court found that Nationwide's decision to launch a competing fund was not a breach of an implied covenant, it determined that implementing a lower fee structure for the new fund was a breach. Nationwide contends that these rulings were erroneous. We agree.
The "implied covenant of good faith and fair dealing involves . . . inferring contractual terms to handle developments or contractual gaps that . . . neither party anticipated." It does not apply when the contract addresses the conduct at issue.Therefore, the Superior Court erred by finding that Nationwide's refusal to pay Termination Fees breached both the Termination Provision and an implied covenant. Under the Purchase Agreement, if Nationwide chose to terminate NorthPointe during the three-year period, it would be required to pay a Termination Fee unless it invoked the Cause or Fiduciary Exception successfully. Accordingly, the express terms of the contract governed, and Nationwide's refusal to pay was either a breach of the Termination Provision or not a breach at all if one of the exceptions applied.
And although the Superior Court found that NorthPointe's refusal to pay Termination Fees was disingenuous, Nationwide did not necessarily act in bad faith by refusing to pay a Termination Fee. The Purchase Agreement contemplated that Nationwide could invoke the Fiduciary or Cause Exception, and if Nationwide failed to prove that the exception applied in any litigation between the parties, pre-judgment interest would compensate NorthPointe for the delay, as is ordinary in litigation. If Nationwide's litigation premise that the Fiduciary and Cause Exceptions applied was frivolous and advanced in bad faith, that could also be remedied under the bad faith exception to the American Rule.
The Superior Court's finding that Nationwide breached the implied covenant by making a large withdrawal from the NorthPointe NVIT was also in error. An interpreting court cannot use an implied covenant to re-write the agreement between the parties,  and "should be most chary about implying a contractual protection when the contract could easily have been drafted to expressly provide for it." Here, the parties negotiated a specific term that prevented Nationwide from redeeming assets while simultaneously replacing NorthPointe or engaging another sub-advisor for the NorthPointe NVIT. The Purchase Agreement does not prevent Nationwide from redeeming assets in the NorthPointe NVIT by itself. It was therefore an error for the Superior Court to imply such a term without evidence that the parties would have agreed to such a restriction.
When a court implies a term in a contract, much less one as detailed as the Purchase Agreement, it must be very careful. By necessity, any argument by a party that another party breached an implied term invites consideration of evidence of the parties' bargaining history. Here, the drafting history resolves any uncertainty about whether the parties would have agreed to be bound by contractual language of this kind. An early draft of the Purchase Agreement proposed by NorthPointe included a version of the Replacement Provision that provided: "[Nationwide] shall . . . not redeem shares in the [NorthPointe NVIT] such that [Nationwide] would have less than $300 million invested in such fund." Nationwide rejected this language, explaining in an email that "we cannot promise not to redeem shares out of the [NorthPointe NVIT] since those shares are actually reflective of contract-level allocations made by holders of VA and/or VL products. What we can promise [is] . . . not to replace NorthPointe or engage another subadvisor on this Fund such as to make NorthPointe the manager of less than $300 million of fund assets . . . ." In other words, NorthPointe sought protection against asset redemption, but lost at the bargaining table. Because the implied covenant "cannot properly be applied to give the plaintiffs contractual protections that they failed to secure for themselves, " the Superior Court erred by finding that Nationwide's decision to redeem assets from the NorthPointe NVIT breached an implied covenant.
The Superior Court also erred by finding that Nationwide's decision to set a lower fee structure for its competitor fund breached an implied covenant. That conclusion conflicted with the court's finding that launching the competing fund was not a breach. If Nationwide could fairly create a competing fund and compete on other dimensions, it does not seem commercially sensible to infer that Nationwide had an implied duty to refrain from competing with the NorthPointe NVIT on the specific dimension of price. Moreover, a court can only imply terms when it is "clear from the [contract] that [the parties] would have agreed to" the omitted terms. But the Purchase Agreement did not contain restrictions or non-compete provisions of any kind, which are common in contracts of this type. Nor did the Superior Court point to evidence suggesting that Nationwide would have agreed to refrain from offering lower prices in its competitor funds. As such, the Superior Court had no basis to conclude that Nationwide breached an implied covenant when it implemented a desirable fee structure in its newly-created fund.
Finally, the Superior Court also erred by finding that there was an implied agreement that NorthPointe would have the right to manage the seven funds for three years, and that the $25 million purchase price was predominantly premised on that expectancy. The Superior Court's award of $15.1 million to NorthPointe, which is more than 60% of the purchase price, overlooks the reality that the seven Nationwide-owned funds only composed 20% of the assets under management at NorthPointe Capital. Therefore, any notion that the only material value received under the Agreement was the right to manage the seven funds is without merit. Even if Nationwide had terminated NorthPointe as sub-advisor for all seven funds immediately after closing, NorthPointe would still have received substantial value as the sole owner of NorthPointe Capital.
As important, the Superior Court erred by not recognizing that the parties had already priced the limited expectancy NorthPointe had in the seven funds: a maximum of $3.5 million for the termination of all seven funds within a discrete and commercially brief three-year period. That expectancy was further limited by the reality that after the three-year period expired, Nationwide could terminate NorthPointe as to any and all funds for any reason and owe NorthPointe no compensation. When parties price their own assets explicitly, Delaware courts must respect that economic allocation and not imply a different bargain than that reflected under the express terms of the contract. Therefore, the Superior Court erred by finding that NorthPointe was entitled to an award nearly five times the size of the Termination Fee cap, or the maximum award for the unjustified termination of all seven funds.
We therefore reverse the final judgment of the Superior Court. On remand, the Superior Court should determine whether NorthPointe is entitled to Termination Fees, capped at $3.5 million, for terminating NorthPointe as sub-advisor of six funds, including the NorthPointe NVIT, within three years of closing, or whether Nationwide can invoke the Cause or Fiduciary Exception.