E-Alert Case Updates

Fourth Circuit Rejects “Mutual Mistake” Defense Where Relief Sought by Defendant was Better Bargain than Initially Negotiated and Contract Embodied Parties’ Original Intent

Appeals for the Fourth Circuit,
No. 12-1649 (4th Cir. Apr. 11, 2013)
by Jhanelle Graham, Law Clerk
Semmes, Bowen & Semmes (www.semmes.com)

In Pagidipati Enterprises, Inc. v. Laboratory Corporation of America, the United States Court of Appeals for the Fourth Circuit decided a breach of contract action in which Pagidipati Enterprises (“PEI”) sued Laboratory Corporation of America (“LabCorp”) to recover payments due under their Asset Purchase Agreement (“APA”). LabCorp asserted mutual mistake as an affirmative defense, arguing that the APA as written did not provide for compensation for growth attributable only to customers PEI brought to the deal, which is what the parties seemingly intended the APA to reflect. Finding that LabCorp’s omission of some of its own prior customers from the APA did not constitute a mutual mistake under North Carolina law, the district court granted PEI’s motion for summary judgment and the appellate court affirmed.

In late 2007, LabCorp, a New York corporation that operated a nationwide medical laboratory network, became interested in purchasing PEI, a family-owned Florida corporation then operating clinical laboratories and testing centers in seventeen Florida counties. The parties began negotiations. About a year later PEI agreed to sell its assets, including its customer list, to LabCorp for an initial purchase price of $13 million, as well as two (2) Earnout Period Payments that PEI would receive if certain conditions were met. This agreement was finalized in a thirty-one (31)-page contract called the APA. The contested provisions of the APA were Section 2.3, entitled “Earnout Amount,” and the accompanying list of “Shared Customers.” Section 2.3 set out the time period and formula for calculating the two (2) Earnout Period Payments, which were based on: (1) a Revenue Minimum Target Amount (“RMTA”); (2) a Revenue Multiplier; and (3) “Revenues” for the first and second years following the APA, defined as LabCorp’s revenues “for any and all services provided and billed to any customer listed on [PEI’s] Customer List,” as well a percentage of revenues for services provided to their shared customers. Section 2.3 further defined “shared customers” as “those customers listed on Exhibit 2.3(a), which include certain customers . . . who were customers of both Seller and Purchaser during the period from January 1, 2007 through and including September 30, 2007.”

The Shared Customer List was the product of negotiation between the parties, and LabCorp initially drafted the list because it was unwilling to disclose its entire customer database to PEI. PEI never had access to LabCorp’s customer database, receiving only the list of shared customers created by LabCorp. Notably, the parties agreed that not all shared customers merited placement on the final list; thus, it was undisputed that the Shared Customer List attached to the APA was intentionally underinclusive, and did not, nor was it ever meant to, “accurately” include all customers shared between LabCorp and PEI. LabCorp argued that the APA should not be enforced as written, and it refused to pay.

PEI filed a breach of contract action under North Carolina law in the Middle District of North Carolina, asserting federal jurisdiction based on diversity of citizenship. LabCorp answered, defending its failure to pay any Earnout Payment to PEI on grounds of mutual mistake. Specifically, LabCorp argued that its own failure to correctly identify all customers shared between the parties resulted in a Shared Customer List did not effectuate the parties’ mutual intent to reward growth attributable to customers whom PEI brought to the deal. The district court, however, rejected LabCorp’s affirmative defense of mutual mistake. The court reasoned that LabCorp had failed to proffer evidence that the parties had agreed to include any specific customers on the Shared Customer List who did not appear on the final list. Moreover, the court determined that LabCorp’s asserted mistake did not fall within the scope of North Carolina’s mutual mistake doctrine, under which “a meeting of the minds as to the specific terms” was required, and the “general intent” of the parties to achieve some objective that the contract-as-written failed to achieve would not suffice. Accordingly, the district court entered summary judgment in PEI’s favor, awarding over $4.5 million for the full Earnout Period Payments plus prejudgment interest and costs. LabCorp timely appealed to the Court of Appeals for the Fourth Circuit.

On appeal, the Fourth Circuit determined that LabCorp’s argument that the Shared Customer List drafted and agreed to by the parties constituted a mutual mistake, failed for at least three (3) reasons: (1) the “meeting of the minds” that LabCorp alleged the APA failed to embody was far more general than the mistake LabCorp asserted and the reformation it sought; (2) any mistake relating to the contents of the Shared Customer List was not mutual, but rather LabCorp’s singular failure; and (3) even if it were warranted, LabCorp’s inability to identify a mutual mistake with any specificity prevented the court’s reformation of the Shared Customer List.

First, the appellate court explained that a mutual mistake is a mistake that is “‘common to both parties to a contract . . . wherein each labors under the same misconception respecting a material fact, the terms of the agreement, or the provisions of the written instrument designed to embody such agreement.’” Branch Banking & Trust Co. v. Chicago Title Ins. Co., 714 S.E.2d 514, 518 (N.C. App. 2011) (“BB&T”). Courts apply a “‘strong presumption in favor of the correctness of the instrument as written and executed, for it must be assumed that the parties knew what they agreed and have chosen fit and proper words to express that agreement in its entirety.’” Hice v. Hi-Mil, Inc., 273 S.E.2d 268, 270 (N.C. 1981). As in BB&T, however, the court stated that LabCorp “d[id] not allege that it had an oral agreement with [PEI] that was mistakenly omitted from the [APA].” Rather, the Fourth Circuit determined that at the time the parties entered into the APA, both parties agreed to the Shared Customer List as the proper means of calculating growth attributable to any shared customers for the purpose of determining the Earnout Payments.

Second, the court clarified that the mistake upon which LabCorp sought to rely was solely its own. “The mistake of one party . . . alone, not induced by the fraud of the other, affords no ground for relief by reformation.” Matthews v. Shamrock Van Lines, Inc., 142 S.E.2d 665, 668 (N.C. 1965). Here, the court found that full responsibility for comparison of the parties’ existing customer lists rested with LabCorp, because LabCorp was unwilling to disclose all of its customers to PEI. PEI never had access to LabCorp’s secret customer database, which is what LabCorp used to draft the Shared Customer List. LabCorp’s assertion that the “mistake” here was mutual, lacked credibility and failed to meet the clear requirements of North Carolina contract law.

Third, and finally, the appellate court stated that even if LabCorp were able to obtain reformation to fix its own mistake, it could not simply point to a customer on PEI’s Customer List and argue that the parties intended to include that customer on the Shared Customer List for the sole reason that it had also been a customer of LabCorp. The Shared Customer List was not an exhaustive list of all shared customers. Therefore, LabCorp’s failure to identify with particularity the circumstances constituting its mistake or to proffer any evidence from which it could be determined that the parties intended to include any specific omitted customers, rendered impossible the reformation task that LabCorp asked the appellate court to perform.

Accordingly, the Fourth Circuit agreed with the district court that LabCorp’s performance under the APA’s provision for PEI’s Earnout Amount, which embodied the parties’ actual, original, fully-negotiated, specific agreement, was not excused by any mutual mistake. The doctrine of mutual mistake could not be intended for use by a party seeking to rewrite a contract in order to obtain some benefit of a bargain better than the one it negotiated for itself, merely because it mistakenly thought it was getting a better deal.