E-Alert Case Updates

Delaware Supreme Court Finds Breach of Obligation to Provide Warrants to be Within the Definition of “Indebtedness”, Triggering the Fee-Shifting Provision of the Parties’ Promissory Note

Washington, et al. v. Preferred Commc’n Sys., Inc.
No. 436, 2016 (Del. Feb. 27, 2017). The Supreme Court of the State of Delaware
by Matthew S. Sarna, Law Clerk
Semmes, Bowen & Semmes (www.semmes.com)

Available at: http://courts.delaware.gov/Opinions/Download.aspx?id=253060

In Washington, et al. v. Preferred Commc’n Sys., Inc., No. 436, 2016 (Del. Feb. 27, 2017), the Supreme Court of Delaware reversed the Chancery Court’s decision and held that Appellants were entitled to court costs and reasonable attorneys’ fees in connection with their efforts to collect on Preferred Communication System, Inc.’s indebtedness.

In 2006, Appellants (the “Noteholders”) invested in Appellee’s (“Preferred Communication”) promissory notes (the “Notes”) in exchange for a promise of repayment on the principal and interest, plus warrants upon execution of the Notes. Upon the due date, Preferred Communication expressed its inability to pay and defaulted on the Notes. In order to prevent acceleration and other remedial measures, Preferred Communication offered the Noteholders the option of additional warrants (the “Extension Warrants”) in exchange for extending the repayment date on the Notes indefinitely. The Noteholders agreed, and matters went smoothly for the next six years.

In 2013, Preferred Communication sold substantially all of its assets, triggering a payment obligation on the amended Notes. Settling the claims for the principal and interest, Preferred Communication agreed to litigate the claim for the Extension Warrants in the Chancery Court. The Chancery Court originally granted the Noteholders motion for summary judgment, but upon a motion for reargument, reversed itself and held for Preferred Communication.

The operative language of the Notes, Section 6.2, is as follows:

Should any indebtedness evidenced by this Note be collected by action at law, or in bankruptcy, receivership, or other court proceedings, or should this Note be placed in the hands of attorneys for collection after default, Maker agrees to pay, upon demand by Holder, in addition to principal and interest and other sums, if any, due and payable hereon, court costs and reasonable attorneys’ fees and other reasonable collection charges. Should Maker be required to bring any action to enforce its rights under this Note, it shall be entitled to an award of its court costs and reasonable attorneys’ fees in such action.

On appeal to the Supreme Court of Delaware, the Court first looked to whether Preferred Communication’s failure to issue the Extension Warrants created a debt, which Noteholders had to collect through a court proceeding. Preferred Communication argued that the language, “in addition to principal and interest and other sums,” only referred to monetary amounts, not warrants, thus maintaining that “any indebtedness” did not encompass the Extension Warrants. Agreeing with the Noteholders, the Court explained that the fact that the warrants as consideration for the perpetual extension of the Notes were not a sum of money was irrelevant. By failing to issue the Extension Warrants at the time it repaid the principal and interest on the Notes, Preferred Communication breached its agreement, and accordingly became indebted to the Noteholders.

The Court next addressed the latter half of the first sentence of Section 6.2, entitling the Noteholders to attorneys’ fees if the “Note be placed in the hands of attorneys for collection after default.” Under Section 5 of the Notes, default had been defined as the failure to “observe, conform or comply with any covenant, agreement or provision of this Note.” The Court explained that the Noteholders were promised the Extension Warrants in exchange for the perpetual extension of the maturity date, the breach of which constituted direct applicability to Section 5’s definition of default. Accordingly, the Court found that the Noteholders were entitled to the attorneys’ fees incurred by bringing suit to force Preferred Communication to issue the Extension Warrants.

Finally, the Court dismissed Preferred Communication’s argument that the Extension Warrants should not qualify as “other sums” under the second half of the first sentence of Section 6.2. The Court explained, “although Section 6.2 may not have originally encompassed warrants, once the Notes were amended, Preferred Communication owed the Noteholders not just principal and interest, but also the extension warrants.” Preferred Commc’n Sys., Inc., No. 436, 2016, at *11. From more of a policy-oriented perspective, the Court evoked the concept of, when there are ambiguities in the language of a contract, the contract will be construed against the drafter. See Bank of N.Y. Mellon v. Commerzbank Capital Funding Trust II, 65 A.3d 539, 551 (Del. 2013). So, because any ambiguity would be resolved against Preferred Communication, Preferred Communication would still owe attorneys’ fees and costs to the Noteholders, even if its own reading of Section 6.2 was plausible.

Accordingly, the Supreme Court of Delaware reversed the judgment of the Chancery Court and remanded the matter to enter an award of reasonable attorneys’ fees and costs in favor of the Noteholders.