It’s a common drafting technique in all sorts of agreements to use the phrase, “Notwithstanding anything to the contrary in this Agreement,” to establish precedence of the appurtenant contract term with all other terms in the agreement. Ken Adams, the blogger and author of A Manual of Style for Contract Drafting, recommends against use of the phrase, even though it saves the effort of having to review the rest of the document for possible inconsistencies. As Adams explains, “[t]o reduce the chance of a drafting error, and to make life easier for the reader, it would be best to determine whether the provision in question in fact needs to trump another provision and, if it does, to specify which provision.”
Had they heeded that advice, the parties in Schepisi v. Roberts, 2013 NY Slip Op 07577 (1st Dept Nov. 14, 2013), decided last week by the Manhattan-based Appellate Division, First Department, could have saved themselves a lot of trouble and expense litigating their dispute over a pair of LLC agreements containing dueling notwithstanding clauses concerning the level of management authority required to enter into related-party contracts with LLC members.
Schepisi involves a four-against-one dispute among the five co-equal principals of a series of investment funds and related entities operating under the brand name “Aegis.” In 2007, one of the plaintiff principals, named Hickey, on behalf of the Aegis Texas Fund executed a letter agreement with Bayhead Securities, wholly owned by the defendant principal Roberts, engaging Bayhead as financial advisor and placement agent responsible for finding initial investors, for which Bayhead was to receive $400,000 for a sale of notes in excess of $20 million. Hickey later executed a similar agreement with Bayhead on behalf of the Aegis Alabama Fund, for which Bayhead was to receive $250,000. Both agreements acknowledged Roberts’ dual roles as principal of the funds and Bayhead, and included an express waiver of “any conflicts of interest that might arise out of such dual role.” Neither agreement was put to a vote by the membership of the general partner LLCs.
The two funds closed by April 2008, following which Roberts allegedly withdrew $550,000 in payments to Bayhead. Upon learning of the withdrawals, the other principals advised Roberts that the payments were unauthorized and unearned, and demanded they be refunded. When Roberts refused, the other principals held meetings at which they approved Roberts’ expulsion for cause and the redemption of his partnership and membership interests pursuant to the repurchase provisions of the governing agreements. Roberts denied the validity of these actions, following which the other principals and the enitities filed suit against Roberts and Bayhead in Manhattan Supreme Court for breach of fiduciary duty, conversion, misappropriation, and for a declaration that Roberts was validly expelled for cause (read complaint here).
The Dueling Notwithstanding Clauses
The issues in the case boiled down to (1) whether, as the plaintiffs contended, the funds’ engagement letters with, and payments to, Bayhead required supermajority approval by the members of the two LLCs that served as general partner of the two funds, and (2) if not, whether Bayhead earned the payments.
The supermajority issue hinged on Sections 5.1 and 5.2(a) of two substantially identical LLC agreements setting forth management rights. Section 5.1 authorized Hickey and Roberts on behalf of the LLCs:
to execute and deliver, the Indenture, the Note Purchase Agreement and all documents, agreements, certificates, or financing statements contemplated thereby or related thereto, all without further act, vote or approval of any other Person notwithstanding any other provision of this Agreement.
Section 5.2(a) then provided that, as to all matters requiring member approval, the vote or written consent of a simple majority of the members sufficed, subject to the following proviso:
provided, however, notwithstanding the foregoing and any other provision of this Agreement to the contrary, in the event of any vote or written consent with respect to which any Member or Members has or have a conflict-of-interest . . . then, in each such case, the Member(s) that are so conflicted shall abstain from such vote or written consent . . . and such vote or written consent . . . shall be determined by the affirmative vote or written consent of a Supermajority of the Members that are not so conflicted.
As is evident, each of the two provisions contains a general, all-encompassing notwithstanding clause, neither of which makes explicit reference to the other.
The Lower Court’s Ruling
In November 2012, Manhattan Commercial Division Justice Eileen Bransten decided the plaintiffs’ motion for partial summary judgment in which they argued that Section 5.2(a) conclusively required supermajority approval of Bayhead’s engagement by, and payment from, the two funds due to Roberts’ conflicted interests.
Justice Bransten denied the motion based on the competing notwithstanding clauses in the two provisions, writing in her November 2012 decision (read here) as follows:
[B]oth [provisions] state that they apply “notwithstanding any other provision” of the Operating Agreements. Each provision appears to trump the other. It is, therefore, unclear whether Hickey and/or Roberts needed to obtain supermajority approval for actions that Section 5.1 would otherwise permit them to undertake “without any further act, vote or approval of any other Person.” . . .
One could reasonably interpret the Section 5.1 of the Operating Agreements as exempting Roberts and Hickey from the requirements of Section 5.2(a). Conversely, one could just as reasonably interpret Section 5.2(a) as overriding Section 5.1’s broad grant of authority to Hickey and Roberts. Summary judgment on the issue of whether Roberts was required to seek supermajority approval for the $550,000 payment to Bayhead is therefore inappropriate . . ..
Justice Bransten also found triable issues based on Roberts’ testimony that Section 5.2(a) was intended to apply only after the funds closed, and on the question whether Bayhead in fact provided any compensable services even assuming the engagement agreements and payments were otherwise authorized.
The Appellate Court’s Ruling
The plaintiffs appealed Justice Bransten’s decision to the Appellate Division, First Department, whose ruling last week unanimously affirmed the decision. Here’s what the court said:
The motion court correctly denied plaintiffs’ motion for summary judgment in their favor on several issues that would be dispositive of the majority of their causes of action. The contractual terms in the applicable operating agreements are ambiguous, and, pursuant to Delaware and Alabama law, which govern the operating agreements, there are triable issues of fact. One provision in the agreements seems to authorize defendant Todd Roberts to contract with and retain defendant TMR Bayhead Securities, LLC, which he wholly owned, notwithstanding any other provision. The other provision requires that any transactions involving a conflict of interest have supermajority approval of the non-conflicted members, notwithstanding any other provision. As it is unclear which provision authorized or did not authorize Roberts’s conduct in entering into the disputed transaction with Bayhead, the agreements are ambiguous as written, and, in finding that triable issues of fact exist, the court properly relied on Roberts’s testimony that the provision requiring supermajority approval was intended to apply only after the funds closed. [Citations omitted.]
The appellate panel likewise agreed with Justice Bransten that summary judgment on the issue of compensable services was precluded by credibility issues.
Schepisi is not the only recent First Department decision underscoring the mischief that can result from undisciplined notwithstanding clauses. Three weeks earlier, in BDC Finance LLC v. Barclays Bank PLC, 2013 NY Slip Op 06963 (1st Dept Oct. 24, 2013), a different appellate panel split 3-2 in a dispute over the effect of a notwithstanding clause in a so-called master confirmation that modified a standard form credit support annex for a derivative transaction known as a “total return swap.” The above-mentioned Ken Adams writes about the BDC case here.