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Contract drafter’s failure to specify timing of stock sale leads to $44M damage award

In a decision issued last week, Massachusetts’s highest court upheld a trial court’s award of $44 million in damages and interest against a financial company’s co-founder and CEO for breach of the implied covenant of good faith and fair dealing. The case offers lessons for contract drafters about not leaving important details up in the air.

The individual plaintiff was a successful and now-elderly investor who was also a business friend (now presumably a former friend) of the much-younger co-founder of the company.  See Robert and Ardis James Foundation v. Meyers, No. SJC-11898 (Mass. Apr. 21, 2016), reversing 87 Mass. App. Ct. 85 (2015).

In 1998, the plaintiff and his family’s foundation staked the co-founder to more than $653,000, interest free, so that the latter could buy additional shares in the company. The transaction was docu­ment­ed by a letter agreement stating that when the stock was sold, the investor and the co-founder would split the resulting proceeds in accordance with a specified form­u­la. Crucially, though, the letter agree­ment was silent as to when the shares of stock would be sold; nor did the letter agreement give anyone the power to decide when to sell the shares.

The company was quite successful, and after the company went pub­lic, the stock price increased dramatically.  The co-founder re­ceived almost $2.5 million in dividends attributable to the shares of stock that the investor’s interest-free money had enabled him to buy.

In 2006, the investor, having seen no return on the money he had provided the co-founder, wanted to go ahead and get the money out. He asked the co-founder to sell the shares of stock in question, so that the the investor could take his share of the proceeds.

The co-founder refused to sell the shares in question — this, even though the co-founder had already sold some $86 million worth of his other shares in the company.

As the supreme judicial court noted, “[The co-founder] explained at trial that he made a conscious decision to sell his personally held shares of [the company] as opposed to agreeing to sell or divide the shares held with the foundation, because that way he could continue to collect dividends from the shares purchased with the foundation’s [interest-free] funds.” Id., slip op. at 8-9 (emphasis added).

Unable to get the co-founder to budge, the investor and foundation sued the co-founder for breach of the implied covenant of good faith and fair dealing.  (The plaintiffs originally sued for specific performance as well, but while the case was pending the stock’s price fell sharply in the 2008 market crash.)

After a six-day bench trial, the district court awarded the investor and the foundation some $44 million in damages and interest.  An intermediate appellate court reversed, but the supreme judicial court affirmed the trial-court decision.

Lesson for drafters:  I won’t comment about what the co-founder did.  The main lesson for contract drafters is this:  If your contract contemplates that an important event is to take place at some point in the future — especially an event involving a lot of money — it usually will be well:

  1. to specify when the event will take place; or
  2. failing that, specify:

(a) who has the power to decide the timing of the event; and

(b) possibly, whether the decider:

(i) is bound by any constraints of reasonableness or good faith, or

(ii) instead, can exercise sole and unfettered discretion, giving regard exclusively to its own desires and interests.

The foregoing lesson, incidentally is an instance of a general guideline: If you can’t specify the outcome you want, then try to specify a process for authoritatively deciding, later, what the outcome should be.

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