The opinion of the court was delivered by: Leval, District Judge.
FINDINGS OF FACT AND CONCLUSIONS OF LAW
This action is brought by an institutional lender against a prospective borrower charging the borrower with breach of a commitment letter agreement for a 14-year $76 million loan yielding 15.25%. The exchange of letters constituting the commitment agreement stated that the borrower and lender had made a "binding agreement," to borrow and to lend on the agreed terms, subject to the preparation and execution of final documents satisfactory to both sides and the approval of the borrower's Board of Directors. Prior to the preparation of final agreements the borrower broke off negotiations, declining to negotiate further unless the lender agreed that the borrower's obligation to borrow would be contingent on its ability to report the loan on its financial statement by an off-balance-sheet offset. The lender contends the borrower's withdrawal was attributable to an intervening decline in interest rates which permitted the borrower to secure funds at a much lower cost than agreed in the commitment letter. The borrower contends that the change in interest rates had nothing to do with its refusal to go ahead and that the availability of offset accounting had always been understood to be a condition of the loan. It contends also that its acceptance of the commitment reserving right of approval to its Board of Directors left it free to decline to take down the loan if the loan did not serve its interest.
The borrower is Tribune Company, a Chicago communications enterprise which owned the New York Daily News. The lender is Teachers Insurance and Annuity Association of America, a large non-profit tax exempt organization that provides pension annuities and insurance programs to educational institutions. The contemplated loan was an element of a three-cornered arrangement for the sale by Tribune of the Daily News Building at 220 E. 42nd Street in New York.
For some time, Tribune had been contemplating the possibility of outright sale of the News. The Morgan Guaranty Trust Company of New York prepared a memorandum recommending to Tribune that it structure a deal in which the purchaser's payment would be deferred, and Tribune would borrow equivalent funds from a financial institution under terms that permitted Tribune the right to repay its borrowing by assigning the purchaser's installment note to the lending institution. (DX 1-4.) This device was designed to secure installment tax deferral of Tribune's gain, notwithstanding immediate realization of the full proceeds of the sale through the loan. And because its borrowing could be repaid by tender of the purchaser's note, Tribune's debt could be offset against its receivable and reported off-balance-sheet in the notes to its financial statement.
In the spring of 1982 Tribune dropped the plan to sell the News. Instead, it restructured the News subsidiary, which occasioned a nonrecurring tax loss of $75 million. To raise cash that was needed for a number of purposes including the operations of the News, Tribune decided to sell the News Building which would no longer be needed in the restructured operation.
Tribune entered into negotiations to sell the Building to LaSalle Partners, a Chicago real estate firm, with Tribune retaining an equity interest. It was important that the transaction be accomplished during the calendar year 1982 so that the loss realized from the restructuring of the News could be offset against taxable gain realized from the sale of the News Building. A suggestion was made to adapt to the sale of the Building the proposal which Morgan had made with respect to the contemplated sale of the News. A substantial portion of the purchase price would be deferred: LaSalle would deliver to Tribune a non-recourse long-term (35 year) purchase money mortgage note. (As the equity "kicker", this mortgage would give the mortgagee not only conventional interest payments but also a percentage of the operating profits of the building.) Tribune would "match-fund" the mortgage, i.e., it would borrow from a third party in an amount approximately equal to the mortgage note. The loan agreement would give Tribune an unconditional right to satisfy its obligation to repay by putting to the lender the mortgage note which Tribune received for its sale of the building. To compensate the lender for the additional risk inherent in the possible put of the mortgage, Tribune would pay a premium above the market interest rate.
In this manner, Tribune would realize only so much gain as it could set off against its 1982 tax loss. The taxability of the remainder of its gain would be deferred by reason of the installment sale. At the same time, through the loan, Tribune would obtain immediate use of the full purchase price in cash. It would not be obliged to carry the borrowing as a liability on its balance sheet: by reason of its right to put its mortgage receivable to the lender in satisfaction of the debt, it could employ offset accounting, setting off the asset represented by the purchase money notes against the liability to the lending institution, eliminating both from its balance sheet, and describing them rather in the footnotes to the financial statements.
The use of offset accounting was important to Tribune. Up to this point, its common stock had been privately held. It was now contemplating a public offering and believed that the market for its shares would be adversely affected if it were required to carry so large a liability on its balance sheet.
In August, Tribune prepared an offering brochure to be shown to prospective lenders. This was a document of about 50 pages, describing the proposed mortgage and loan, together with financial information about Tribune and the Building. The brochure included two term sheets-one describing the proposed purchase money mortgage Tribune would receive upon the sale of the Building, the other giving the terms of its proposed match-fund borrowing.
Tribune's advisers believed that only a small number of institutions would have the means and flexibility to contemplate a loan of these specifications. Together with LaSalle, Tribune prepared a list of six institutions including Teachers. The other five promptly rejected the deal.
Gary Waterman of LaSalle called Martha Driver of Teachers to discuss the concept. Driver told him that Teachers would be interested in receiving a proposal from Tribune. On August 20 Scott Smith, the Vice President and Treasurer of Tribune, sent Driver the offering circular. (DX 5.) Smith's covering letter stated:
Our objective is to "match fund" this PMM [purchase money mortgage] so that we can obtain cash equivalent to the PMM's value while maintaining the tax deferral and the upside potential associated with the cash flow participation feature. A second objective is to avoid showing both the PMM and match funding on our balance sheets since conceptually these real estate loans are not related to our basic businesses.
According to our advisers, we can meet these objectives by adding a "put" or alternative payment option to the private placement.... [giving] Tribune Company the unconditional right, at any time, to assign the PMM to the private placement lender in full satisfaction of its obligations under the Notes.
The letter went on to state that "[t]he likelihood of the 'put' being exercised is very low because of the 'penalties' Tribune would incur through loss of the tax deferral and the value of the cash flow participation." Finally, Smith's letter stated, "While we are flexible on funds delivery, our objective is to have a firm commitment from a lender by September 15, 1982. Consequently, we need to move the due diligence and negotiation process along very quickly." (Emphasis supplied.)
In the next weeks discussions proceeded promptly between Teachers and Tribune, with Teachers' representatives making due diligence visits to Tribune. Teachers requested and Tribune agreed to an additional 1/4% yield. Both sides agree that during these meetings Smith talked about Tribune's desire to use offset accounting. Driver testified that she told Smith Teachers could not make a commitment if the deal were conditioned on Tribune's ability to use a particular method of accounting. Smith denies that Driver made any such statement. Both agree that Smith spoke of Tribune's urgent need for a commitment by September 15. Driver told Smith that the commitment could not be issued before approval by Teachers' Finance Committee which would not meet until September 16. This brief delay was acceptable to Tribune.
The loan had attractive features for Teachers: It was satisfied with Tribune as a credit risk; it would receive a premium over market interest rates to compensate it for the additional risk of being paid by tender of a long-term mortgage rather than in cash; nonetheless, absent catastrophic changes, Tribune was unlikely to exercise the right to tender the mortgage, because by doing so it would give up the tax deferment as well as its participation in the profits of the building; furthermore, an independent appraisal delivered by Tribune to Teachers valued the building at $150 million or nearly double the amount of the loan, providing a comfortable cushion of protection in the mortgaged collateral.
On September 16th, Teachers Finance Committee met and approved the Tribune loan. Driver promptly called Smith, gave him the good news, and told him that Teachers would issue its commitment letter promptly. Tribune's Assistant Treasurer wrote to Driver, "We look forward to receiving your commitment letter next week...." (DX 46.) Driver promptly undertook the drafting of Teacher's commitment letter.
The letter, mailed on September 22, included a two page Summary of Proposed Terms drawn from the term sheet included in Tribune's Offering Circular and the ensuing conversations. Teacher's term sheet covered all the basic economic terms of a loan. Neither the term sheet nor the covering commitment letter made reference to offset accounting. The letter stated that the agreement was "contingent upon the preparation, execution and delivery of documents ... in form and substance satisfactory to TIAA and to TIAA's special counsel ...," and that the transaction documents would contain the "usual and customary" representations and warranties, closing conditions, other covenants, and events of default "as we and our special counsel may deem reasonably necessary to accomplish this transaction." It concluded by inviting Tribune to "evidence acceptance of the conditions of this letter by having it executed below by a duly authorized officer ...," and finally stated:
Upon receipt by TIAA of an accepted counterpart of this letter, our agreement to purchase from you and your agreement to issue sell and deliver to us ... the captioned securities, shall become a binding agreement between us. (DX 13.)
When Tribune received this commitment letter, the "binding agreement" language caused serious concern to its lawyers. Tribune's outside counsel, Alfred Spada of the firm of Reuben & Proctor, advised Smith not to sign a letter containing "binding agreement" language.*fn1 But, having been turned down by five other institutions, Smith did not want to risk losing Teacher's commitment. He made no comment orally or in writing to Teachers questioning the "binding agreement" language. He executed and returned the letter on behalf of Tribune Company adding the notation that it was subject to certain modifications outlined in his accompanying letter. In the accompanying letter Smith wrote,
[O]ur acceptance and agreement is subject to approval by the Company's Board of Directors and the preparation and execution of legal documentation satisfactory to the Company.*fn2 (DX 14.)
Smith's acceptance letter made no mention of offset accounting.
During October Tribune proceeded with negotiations on two fronts to conclude the sale of the News Building to LaSalle and the consummation of the loan from Teachers. Tribune's lawyers had advised that in order to assure the desired tax deferral these negotiations should be conducted separately and no direct negotiation should occur between Teachers and LaSalle. The document which pertained to both transactions was the purchase money mortgage, which would be given by LaSalle to Tribune to secure its deferred payment, and could eventually be put by Tribune to Teachers in satisfaction of its obligations under the loan. As the negotiations over the mortgage proceeded, Tribune found itself pulled between the conflicting interests of its counterparties. LaSalle, as purchaser of the building, wanted a mortgage that would allow little interference by the mortgagee in the operation of the building; such mortgages are characteristically given in purchase money transactions, and Tribune, as seller, was willing to agree to such loose terms. Teachers, on the other hand, as the possible eventual holder of the mortgage, was interested in terms characteristic of institutional mortgages that give the mortgagee substantial control over the mortgagor's operation of the building. LaSalle and Teachers each served on Tribune adamant objections to the other's position. Tribune ferried these objections from one set of negotiations to the other.
A second subject of controversy in the negotiations between Tribune and Teachers was conditions on Tribune's put of the mortgage. Teachers expressed concern over a variety of problems: First, it worried that the mortgage might already be in default when put to Teachers; it sought to include as a condition of exercise of the put that the mortgage not be in default. Second, because the purchase money mortgage gave the mortgagee an equity participation in the profits of the building, Teachers worried that its possession of such a mortgage might give it "unrelated business income" that would threaten its tax exempt status. It also worried that such a mortgage might not be a legal holding for it at the time of exercise of the put, fourteen years hence. Teachers sought terms that would make Tribune's right to put the mortgage conditional on these issues being resolved to Teachers' satisfaction at the time of exercise. Tribune insisted that its right to put the mortgage to Teachers must be unconditional. Tribune believed that without an unconditional right to tender the mortgage in full satisfaction of the loan, Tribune could not justify offset accounting.
Eventually, because of the urgent need to conclude the sale of the building during the tax loss year, Tribune decided to conclude its negotiations with LaSalle, deferring the issue of Teachers satisfaction. Tribune entered into final binding agreements with LaSalle for the sale of the News Building on November 5. (DX 22.) The agreement was substantially on the terms reflected in the offering circular that Tribune had delivered to Teachers in August.
Tribune's board was scheduled to meet on October 28th. Tribune's negotiators had advised Teachers that formal board approval would be obtained at that meeting. At this meeting, Tribune's board passed resolutions which approved the sale of the Building to LaSalle. With respect to the Teachers loan, the Minutes of the meeting state that the Chairman "requested that the Board authorize the Finance Committee to approve the terms of such borrowing should the loan become available to the Company;" and that, following discussion, resolutions were adopted "that the proper officers of the Company be and they hereby are authorized" to effect the borrowing "with all of the actual terms and conditions to be subject to the prior approval by resolution of the Finance Committee." (DX 19.)
During the month of November, Tribune's accountants Price Waterhouse became worried about the availability of offset accounting. Prior to the delivery of the commitment letter, on September 7, Price Waterhouse had given Tribune an opinion letter that an unconditional option to put the mortgage note to the lender in full satisfaction of Tribune's obligation to repay the borrowing "allows (but does not require)" Tribune to offset its mortgage note receivable against its note payable. (DX 7.) In the meantime, in mid-October, the Financial Accounting Standards Board (FASB) had issued an exposure draft dealing with the appropriateness of offsetting restricted assets against related debt. (DX 25.) The exposure draft underlined the problem that the conditions Teachers had been seeking to impose on Tribune's exercise on the put were incompatible with offset accounting. In addition, Price Waterhouse began to worry that if Tribune proceded to offer securities to the public, as it was planning, the SEC in passing on Tribune's registration statement might ask Price Waterhouse for an opinion as to whether offset accounting was "preferable." Although Price Waterhouse believed an unconditional put option would make offset accounting "appropriate," it had doubts whether it could give the opinion that such an accounting was "preferable" and whether, without such an opinion, the SEC would permit the liability to be kept off the balance sheet.
Smith called Driver and expressed Tribune's concerns about the accounting issue. Meetings and discussions were held during November concerning Tribune's dissatisfaction with the conditions Teachers had demanded as to the put, the availability of offset accounting, and Teachers' problems with the terms of the mortgage.
In the meantime, interest rates had dropped rapidly, and were now substantially below the rates that prevailed when Teachers and Tribune had entered into the commitment. Driver became concerned that Tribune, which could now make a new deal to borrow at substantially cheaper rates, was seeking to back out of the transaction. Having heard nothing about the actions of Tribune Board at its meeting on October 28, she inquired of Smith whether Board ...