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October 16, 1991


The opinion of the court was delivered by: Kimba M. Wood, District Judge.


Teachers Insurance and Annuity Association of America ("TIAA" or "Teachers"), a New York corporation that is an institutional lender, brought this action against a prospective borrower alleging breach of a commitment letter agreement that "circled" a "blended" interest rate of 10.64% for a twenty-year loan of $25,000,000. After a sharp decline in interest rates rendered the agreement less advantageous to the borrower, the borrower took a negotiating stance allegedly designed to alter or scuttle the transaction, and finally refused to continue negotiating with TIAA, claiming that TIAA had "walked" from the deal. Plaintiff and defendant Ormesa each seek damages for breach of contract.

After a fifteen-day trial, during which the court heard the testimony of the principal actors in the negotiation, among others, and having evaluated the witnesses' credibility, the exhibits received in evidence, including notes of meetings and telephone calls, and the parties' legal contentions, the court finds that plaintiff is entitled to judgment in its favor, and finds that defendant Ormesa has failed to sustain its burden of proof on its counterclaim.

I. Liability

A.  Background and Origins of the Transaction

Defendant Ormesa Geothermal ("Ormesa") is a general partnership formed under the laws of California to construct a geothermal power plant in the Imperial Valley of California (the "Project"). During the time of the events in controversy, its general partners were Ormat Engineering, Inc.; Ormat Geothermal, Inc.; and LFC No. 25 Corp. Ormat Engineering and Ormat Geothermal are subsidiaries of Ormat, Inc., which in turn is a subsidiary of Ormat Turbines, Ltd., an Israeli corporation whose principal place of business is in Israel. The principal officers of the Ormat partners in Ormesa are Mr. Lucien Bronicki and Mrs. Dita Bronicki, citizens of Israel residing in Israel, and Mr. Hezy Ram, a citizen of Israel with residences in Israel and the United States. The third general partner of Ormesa is LFC No. 25 Corp. ("LFC"), a special purpose corporation formed for the purpose of implementing the Project; LFC's principal officer was James Porter. Ormesa was represented in connection with the Project by the Washington, D.C. and Seattle, Washington offices of the law firm of Perkins Coie. Robert Giles was the partner from Perkins Coie's Seattle office with the principal responsibility for its services in connection with the Project.

The financing arrangements for the Project were complex. The Project contemplated the placement of three types of debt financings and the contribution of equity funding. With respect to the debt, the Project needed approximately $50,000,000 of interim or "construction" financing (the "Construction Loan") for the period during which the Project would be constructed. It then needed approximately $50,000,000 of long-term financing (the "Long-term Loan") to replace the Construction Loan when construction was completed. The Construction Loan and the Long-term Loan were to be 90% guaranteed by the United States Department of Energy (the "DOE"). At the time TIAA was negotiating the transaction at issue in this litigation (the "Transaction") with Ormesa the Long-term Loan was to have been 90% guaranteed by the DOE, and the Loan was to have been made through the issuance of two sets of notes, with the unguaranteed notes at a higher rate of interest. In addition to the Construction Loan and the Long-term Loan, the Project also needed approximately $10,000,000 of subordinated financing (the "Subordinated Loan"), to be funded at the time the Construction Loan closed. It would also require the equity contribution of LFC (the "Equity Contribution") at the time of the closing of the Construction Loan.

The construction lender on the Project was Bankers Trust Company ("Bankers Trust"). The Bankers Trust officer with principal day-to-day responsibility for the Construction Loan on the Project was Donald Carse. Bankers Trust's counsel was the New York office of O'Melveny & Myers ("O'Melveny"). As a condition to closing its Construction Loan, Bankers Trust desired a "takeout" commitment by a long-term lender, to provide the Long-term Loan to repay and thus replace or "take out" the Construction Loan. The collateral for the Construction Loan would also secure the Long-term Loan after it replaced the Construction Loan. Therefore, documents with respect to the Long-term Loan were drafted and negotiated concurrently with those relating to the Construction Loan and the Subordinated Loan.

B.  Ormesa's Search for Long-term Financing; the Commitment

After E.F. Hutton was retained, Castellano contacted over twenty prospective lenders, seeking to interest them in providing the desired Long-term Loan for the Project. When Castellano solicited prospective lenders, he was frequently questioned concerning the DOE's long-term guaranty (the "Long-term Guaranty"). The Long-term Guaranty was likely to be important to prospective lenders, because 90% of the Long-term Loan was to be guaranteed by the DOE. Because of the importance of the Long-term Guaranty, Castellano obtained from the DOE a form of guaranty and, in discussions with the DOE, assured himself that he was aware of all of the terms and conditions of the Long-term Guaranty, and that the regulations that had been provided to him were authoritative.

Among the prospective lenders contacted by Castellano were TIAA and John Hancock Mutual Life Insurance Company ("John Hancock"), an insurance company that invests, inter alia, in debt securities obtained in private placements. Because the Ormesa loan was highly complex, requiring negotiation with several entities including the DOE, and because it required fixing the interest rate far in advance of funding, only sophisticated institutional lenders were likely to (and did) show serious interest in the transaction. For these reasons, Ormesa had to increase the interest rate from that contained in its original offer in order to interest investors. In late January 1986, TIAA and John Hancock each expressed a willingness to provide 50% (or approximately $25,000,000) of the total of approximately $50,000,000 for the Long-term Loan. The interest rate for the Long-term Loan was to be a blended rate (i.e., the weighted average of (1) the interest rate on the 90% portion of the total debt, which was guaranteed, and (2) the higher interest rate on the 10% portion, which was non-guaranteed) equal to the sum of (a) the yield, on a date to be determined, on a hypothetical 13-year United States Treasury Note, plus (b) 150 basis points. (A basis point is 1/100 of a percent; thus, 150 basis points represents 1.50%.)

Ormesa offered the portion of the Long-term Loan that was to be guaranteed by the DOE (the "Guaranteed Notes") with "call protectio," that is, an agreement that (1) the Guaranteed Notes could not be repaid prior to a certain time, and that (2) after that time, they could be repaid only with a premium intended to give a lender the benefit of its bargain over the term of the loan. This type of call protection is common in long-term lending to preserve for the lender the benefit of its bargain. Early in the negotiations, TIAA advised Ormesa that it wanted call protection not only for the Guaranteed Notes but also for the Non-guaranteed Notes, and Ormesa agreed to this.

Because TIAA and John Hancock were comfortable with complex transactions of this type, they found this transaction, on these terms, to be highly attractive.

On February 7, 1986, TIAA, John Hancock and Ormesa "circled" the transaction at a blended rate of 10.64%. When a financing is "circled," the parties orally agree that they will do the transaction on the specified terms, and the interest rate and certain other key economic terms are, by this oral agreement, fixed. It is the custom in the financial community that once the parties circle a deal, neither party tries to change the interest rate that has been agreed.

On February 14, 1986, representatives of E.F. Hutton and Ormesa met with DOE Assistant Secretary Donna Fitzpatrick. At that meeting, she was informed of the Long-term Loan interest rate that had been circled on February 7th, and was pleased to hear the rate. As a result, Ormesa and all other parties to the Transaction believed that the DOE had reviewed and accepted the interest rate.

On February 20, 1986, TIAA's Finance Committee approved the Long-term Loan and authorized TIAA to proceed with the Transaction. On February 26, 1986 John Hancock's Committee of Finance approved the Long-term Loan and authorized John Hancock to proceed with the Transaction. On February 24, 1986, TIAA sent a commitment agreement to Ormesa for signature, and on February 26, 1986, John Hancock did so.

The TIAA commitment agreement was thereafter revised (the "Commitment Agreement"), and Larry Archibald, a TIAA investment officer, signed and sent it to Ormesa for signature on March 14, 1986. Ram discussed the letter with Mrs. Bronicki and with Ormesa's counsel, Robert Giles, who gave his approval for Ormesa's signature on the Commitment Agreement. Hezy Ram returned the Commitment Agreement, signed on Ormesa's behalf, on March 27, 1986.

After John Hancock and Ormesa committed to the Long-term Loan, John Hancock committed itself to a "match funding," i.e., it incurred "matched" obligations relying on the income it would receive pursuant to the Long-term Loan. As a result, John Hancock stood to suffer a substantial loss if its share of the Long-term Loan did not fund. Ormesa knew, no later than the end of June 1986, that John Hancock would suffer a substantial loss if John Hancock's share of the Long-term Loan did not fund.

Interest rates dropped precipitously between February 7, 1986, when the interest rate for this transaction was circled, and July 25, 1986. By July 25, the average of the levels of the 10-year and the 20-year Treasuries — the average used in fixing the original circled rate — dropped 197 basis points. Application of the lower rate would save Ormesa about $1,000,000 a year in interest. Ormesa was aware of this drop in interest rates, and its attempts to back out of the Transaction were motivated by the drop in interest rates.

C.  Ormesa's Refusal to Proceed as Agreed

By letter written and dated July 25, 1986 (which was faxed and received on July 28, 1986), Ormesa advised TIAA (and TIAA's co-lender John Hancock) that Ormesa was unwilling to proceed with the Long-term Loan under the terms of the Commitment Agreement. Ormesa breached the Commitment Agreement on that day. Ormesa's determination not to proceed with TIAA resulted solely from Ormesa's determination that with the precipitous drop in interest rates, Ormesa could find a cheaper Long-term Loan elsewhere, and that it was not in Ormesa' financial interest to complete this financing as previously agreed.

The court rejects Ormesa's contentions that the commitment letter was no longer in effect after July 15 because: (1) TIAA allegedly took itself out of the deal on July 15; (2) TIAA allegedly failed to negotiate in good faith to complete the documentation for the transaction within a reasonable time; and (3) the TIAA commitment letter allegedly expired on June 30, 1986.

That Ormesa's determination not to proceed was motivated by the drop in interest rates, and not by either the pre-July 15 events cited by Ormesa or the post-July 15 events cited by Ormesa, is supported by this court's following findings:

  (a) Jim Porter of Ormesa told Vince Castellano
      that it was cheaper to pay $3,000,000 to
      settle litigation rather than pay the extra
      $1,000,000 in interest every year;
  (b) One or more Ormesa representatives said, at a
      meeting at the DOE's outside counsel Lillick
      McHose, in San Francisco, on September 24,
      1986 (the "September 24 Lillick Meeting") that
      the "key issue" was the "economic terms," and
      that any open issues with respect to the loan
      documents were not important;
  (c) Ormesa stated at a breakfast meeting on
      September 24, 1986 before the September 24
      Lillick Meeting (the "September 24 Breakfast
      Meeting"), that "the rate was not acceptable"
      to Ormesa;
  (d) Jim Porter stated at a meeting on October 1,
      1986, at John Hancock's offices in Boston (the
      "October 1 Boston Meeting"), that the interest
      rate should reflect the current market, and
      should be, on a blended basis, 8.75 to 9%,
      rather than the 10.64%, rate previously agreed
  (e) Lucien Bronicki wrote to TIAA and John
      Hancock, on November 3, 1986, stating that
      Ormesa was willing to meet with them "if you
      are willing to meaningfully discuss interest
  (f) Jim Porter wrote to John Hancock's Herb Magid,
      on November 4, 1986, again attempting to
      obtain a lower interest rate;
  (g) Lucien Bronicki wrote to TIAA, on November 7,
      1986, stating Ormesa's position that "our
      contractual relationship has terminated,
      notwithstanding our desire to continue to meet
      with you and discuss a mutually-agreeable
      interest rate"; and
  (h) Jim Porter told E.F. Hutton's Peter Deeks and
      Jennifer Eplett, on December 2, 1986, that the
      rate is the only issue between John Hancock
      and Ormesa.

Ormesa acted in bad faith in refusing to proceed under the Commitment Agreement's original terms. The court finds bad faith based upon: (a) Ormesa's decision not to proceed with the Transaction as previously agreed upon; (b) Ormesa's decision to condition its willingness to proceed on lowering the Long-term Loan's interest rate; and (c) Ormesa's implementation of those decisions. The court makes these findings based upon the matters set forth above and the following additional findings:

  (a) Porter told Castellano, after Castellano
      warned Porter of the likelihood of litigation
      if Ormesa did not honor its commitment, that
      "I've broken deals before, and I'm not
  (b) Ormesa urged the DOE's Ed Dickinson (who later
      became an Ormesa employee), at the September
      24 Breakfast Meeting, with respect to Ormesa's
      position that the interest rate was not
      acceptable to it, "to concur in that position
      so that we would take a united stance to the
      permanent lenders";
  (c) Ormesa excluded counsel for TIAA and John
      Hancock, the law firm of Milbank, Tweed,
      Hadley & McCloy ("Milbank") from the July 18,
      1986 closing for the construction loan (the
      "Construction Loan Closing");
  (d) Ormesa intentionally delayed the delivery of
      the Construction Loan Closing documents to
      TIAA and John Hancock until the beginning of
      August 1986;
  (e) Ormesa's lawyer, Giles, failed to take and
      return telephone calls from John Hancock's
      Herb Magid in the days following the
      Construction Loan Closing;
  (f) Giles stated in his letter of July 25 to
      Milbank's Sid Holderness that Lucien and Dita
      Bronicki "cannot even be reached by
      telephone," and that Giles "had not had an
      opportunity to discuss the contents of the
      letter with [them]," when in fact he had faxed
      his draft of that letter to the Bronickis for
      their comment and approval;
  (g) Giles stated in his July 25 letter that the
      financing "had closed" and that doing a deal
      with TIAA and John Hancock would require
      Ormesa "to replace our current commitment for
      long-term financing" when in fact, Ormesa's
      commitment from the Federal Financing Bank
      (the "FFB") — to which Giles was referring —
      was understood by Ormesa and the DOE to be an
      interim one, in which the FFB was to be used
      only as a lender of last resort, and Ormesa was
      contractually required to seek commercial
      financing to replace its "current commitment";
  (h) Lucien Bronicki stated, in his letter to TIAA
      and John Hancock of November 3, that the
      previously agreed interest rate was "not
      acceptable and would probably not be approved
      by the Department of Energy," when that was
      not what the DOE had said.
  In summary, Ormesa decided that it was cheaper to defend and/or settle the litigation that Ormesa anticipated than to perform pursuant to the Commitment Agreement. This decision, and the actions Ormesa took to implement it, violated Ormesa's duty to negotiate in good faith.

Thereafter, while construction of the Ormesa plant progressed, the DOE asked Ormesa repeatedly to obtain commercial financing for the Long-term Loan, as required under the Agreement Regarding Term Financing ("ARTF"), one of the Construction Loan's closing documents. Ormesa was aware that the DOE considered the FFB to be a back-up option and that the DOE wished to have a commercial lender substituted for the FFB.

On January 8, 1988, by Hezy Ram's letter to the Manager of the DOE's San Francisco Operations Office, Ormesa gave its Notice of Takeout Date (the "Notice of Takeout"), requesting the DOE "to consummate the takeout by the FFB" on January 22, 1988. The DOE refused to accept Ormesa's Notice of Takeout, finding, among other things, that Ormesa did not comply with its obligation under the Agreement Regarding Term Financing to "make diligent, commercially reasonable efforts" to obtain commercial financing.

In response to the DOE's refusal to accept its Notice of Takeout Date due to Ormesa's failure to pursue commercial financing, Ormesa, in a February 17, 1988 letter from LFC's in-house counsel Herb Brown to the DOE Manager, argued that, under the terms of the Agreement Regarding Term Financing, the DOE agreed to provide the Long-term Loan through the FFB (the "FFB Loan"), irrespective of Ormesa's efforts to seek commercial financing.

On March 7, 1988, the DOE informed Ormesa that the DOE would provide the FFB Loan as a "bridge loan" until Ormesa obtained commercial financing. The DOE included a number of conditions in the FFB Loan as incentives for Ormesa to satisfy its obligation to obtain commercial financing. These incentives included: (a) an express provision in the closing documents that Ormesa make a good faith effort to obtain commercial financing; (b) that Ormesa make a supplemental payment equal to 1% per year above the interest paid on the FFB Note until it obtained commercial financing; and (c) that Ormesa make a second supplemental payment equal to 1% per year above the interest paid to the FFB, if after 36 months Ormesa did not obtain commercial financing.

After further discussions, the DOE agreed to modify the incentives it originally proposed. Ormesa closed on the FFB Loan on May 20, 1988. The interest rate on the FFB Loan was based on the standard markup that the FFB charges all of its borrowers: 1/8 of 1% (or 12.5 basis points) above the level of comparable United States Treasury obligations on the day before the FFB Loan was closed. Ormesa had known, at least as early as July 16, 1986, that this basis was generally used to set the interest rate for an FFB Loan. Ultimately, the formula leading to the computed interest rate for the FFB Loan led to an interest rate for the FFB Loan of 9.3%, a rate significantly below the circled rate and significantly below any Ormesa could obtain in the commercial market.

D.  Ormesa's Defenses and Counterclaim
1.  The "Walked from the Deal" ...

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