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Bear, Stearns Funding, Inc. v. Interface Group-Nevada

July 10, 2007

BEAR, STEARNS FUNDING, INC., PLAINTIFF,
v.
INTERFACE GROUP-NEVADA, INC., DEFENDANT.



The opinion of the court was delivered by: Haight, Senior District Judge

MEMORANDUM OPINION AND ORDER

This diversity action arises out of a loan agreement between Bear, Stearns Funding, Inc. ("Bear Stearns") and Interface Group-Nevada, Inc. ("Interface"). Bear Stearns claims that Interface breached the agreement by failing to make a $1,477,992 payment-an adjustment between estimated and actual transaction figures-upon Bear Stearns' final disposition of the loan. Interface does not dispute that the contract required an adjustment payment, nor does it challenge the accuracy of the calculated figure. Nor is there any dispute that Interface failed to make the payment. Rather, the issue is whether Bear Stearns' entitlement to the adjustment payment was extinguished or offset by Bear Stearns' own breaches of the contract.

Specifically, Interface contends that it was excused from making the payment because Bear Stearns materially breached the contract by selling a portion of the loan to a competitor of Interface, failing to obtain confidentiality agreements to protect Interface's financial information, failing to make good faith efforts to obtain a market price for the loan, and failing to make good faith efforts to restrict the purchaser of the loan from selling it to a competitor of Interface. Interface advances counterclaims on these grounds, and further counterclaims that Bear Stearns breached its implied covenant of good faith and fair dealing by pressuring Interface to purchase terrorism insurance.

The parties have filed cross-motions for summary judgment. Bear Stearns moves for summary judgment on its claim and on Interface's counterclaims, while Interface moves for summary judgment on Bear Stearns' claim.

I. BACKGROUND

A. Factual Background

1. The Parties

Bear Stearns, a Delaware corporation with its principal place of business in New York, is an investment banking and securities brokerage firm that, among other things, extends loans to clients secured by liens on real property. Bear Stearns then treats the loans as commodities and sells, issues participations in, securitizes, or otherwise transfers its interest in those loans to third parties or into capital markets.

Interface, a Nevada corporation with its principal place of business in Nevada, is the wholly-owned subsidiary of a holding company controlled by Sheldon G. Adelson. Interface owns and operates the Sands Expo and Convention Center (the "Sands"), located in Las Vegas, Nevada. The Sands is the largest privately owned convention center in the United States. Through his corporate affiliates, Adelson also owns the Venetian Casino Resort and Hotel (the "Venetian") and the Grand Canal Shops Mall (the "Shops Mall"), which are physically linked to the Sands. In this opinion, I refer to the entities that own the Sands, the Venetian, and the Shops Mall as the "Venetian Affiliates."

2. The Loan Agreement (and Associated Side Agreements)

On June 28, 2001, the parties entered into an agreement (the "Loan Agreement"), pursuant to which Bear Stearns loaned $141 million to Interface, secured by a mortgage encumbering the Sands. I review several relevant features of the Loan Agreement.

The agreement permits Bear Stearns to sell, issue participations in, or securitize all or part of the loan. Section 9.1 of the Loan Agreement acknowledges these disposition options, and defines the term "Securitization":

Section 9.1. Sales of Notes and Securitization. Borrower acknowledges and agrees that Lender may sell all or any portion of the Loan and the Loan Documents, or issue one (1) or more participations therein, or consummate one (1) or more private or public securitizations of rated single- or multi-class securities (the "Securities") secured by or evidencing ownership interests in all or any portion of the Loan and the Loan Documents or a pool of assets that include the Loan and Loan Documents (such sales, participations and/or securitizations, collectively, a "Securitization"). . . .

Affidavit of Jonathan M. Hoff, dated July 31, 2006 ("July Hoff Aff."), Ex. 15, § 9.1.

However, Bear Stearns' assignment rights are not unrestricted. Section 10.24 of the Loan Agreement prevents Bear Stearns from assigning the loan to a competitor of Interface (the "Competitor Restriction"). But Section 10.24 also provides that the Competitor Restriction "shall not apply to a Securitization of the Loan and shall be void and of no further force and effect after a Securitization of the Loan" (the "Securitization Exemption"). Section 10.24 states:

Section 10.24. Limitations on Lender's Assignment Rights. Unless an Event of Default shall then exist, Lender shall not consummate an assignment or a participation to any Person that then (i) owns or operates (or is an Affiliate of a Person that owns or operates) a casino that is located in the State of Nevada or the State of New Jersey, (ii) owns or operates (or is an Affiliate of a Person that owns or operates) a Competing Facility and /or (iii) is a union pension fund (any such Person, a "Competitor") . . . . Notwithstanding the foregoing, this Section shall not apply to a Securitization of the Loan and shall be void and of no further force and effect after a Securitization of the Loan.

July Hoff Aff., Ex. 15, § 10.24.

The agreement also includes a confidentiality provision that protects the financial information of Interface and Adelson. Section 10.25 of the Loan Agreement requires Bear Stearns to protect the personal financial information of Adelson and to "use commercially reasonable efforts to require confidentiality agreements to be signed prior to the release" of Interface's financial information to third parties-except that this obligation does not apply "in connection with a Securitization." July Hoff Aff., Ex. 15, § 10.25.

The interest rate for the loan was a floating rate, expressed as a "spread" above the London Interbank Offered Rate ("LIBOR"). The spread for the loan was initially set at 400 basis points, or 4.00%, above LIBOR. The Original Sharing Agreement, a side agreement executed contemporaneously with the Loan Agreement, provided that upon Bear Stearns' final disposition of the entire loan, the spread for Interface would be modified to a "Reset Spread" based on the overall spread at which Bear Stearns was able to dispose of the loan. Under the agreement, if Bear Stearns was able to obtain an overall spread below 400 basis points, Interface's interest rate would be reduced in the following way. Interface would gain the full benefit of the first 50 basis points of saving (or any yield between 350 and 400 basis points), and Interface would share equally with Bear Stearns in the benefits of the overall spread below 350 basis points. If the overall spread exceeded 400 basis points, the spread would remain capped at 400 basis points for Interface.*fn1 See Affidavit of Ronald Schneider, dated July 31, 2006 ("Schneider Aff."), Ex. 3.

The Original Sharing Agreement, in Section 1, states that Bear Stearns' re-sizing of components of the loan should reflect an "interest rate equal to the rate required by the market for a par sale of each component." Schneider Aff., Ex. 3. Section 1 further states that "Lender shall use commercially reasonable efforts to achieve a Securitization which results in the lowest Spread possible which does not compromise Lender's right to securitize the Loan." Id.

Another side agreement, the Post-Closing Cooperation Agreement, provided that Interface would promptly pay the disposition costs, defined as "the costs of Securitization," incurred by Bear Stearns. July Hoff Aff., Ex. 22, at 3.

3. The Revised Sharing Agreement

In August 2002, Bear Stearns anticipated that it would soon achieve a final disposition of the Sands loan. Bear Stearns had divided the $141 million loan into two pieces, an investment grade senior component (of about $107 million of the loan) and a non-investment grade subordinate component (of about $34 million of the loan). The senior component was to be transferred to a trust, consisting of a pool of interests derived from a number of commercial mortgage loans, which would issue investment grade-rated certificates (the "Senior Securitization Transaction"). The subordinate component was to be sold in a private placement (the "Subordinate Transaction"). At the time, Bear Stearns believed it had a commitment from Beal Capital Markets ("Beal") to purchase the subordinate component.

In anticipation of these transactions, Bear Stearns and Interface entered into a new side agreement, the Revised Sharing Agreement, dated August 13, 2002, which superseded the Original Sharing Agreement and the Post-Closing Cooperation Agreement. The Revised Sharing Agreement addressed the Reset Spread and disposition costs, as well as issues relating to the Competitor Restriction and the sale of the subordinate component.

The Revised Sharing Agreement provided that, upon the closing of the Senior Securitization Transaction, the Reset Spread would be set at 344 basis points above LIBOR. This figure was calculated based on estimated yields and disposition costs from the anticipated senior and subordinate transactions. The parties agreed that, upon final disposition, Bear Stearns would recalculate the Reset Spread based on actual yields and disposition costs from the transactions. Under the Revised Sharing Agreement, Interface would pay the calculated difference in cash to Bear Stearns if the initial estimates were too low, and Bear Stearns would pay the calculated difference in cash to Interface if the initial estimates were too high (the "True-Up Payment"). See Schneider Aff., Ex. 16, § 5.

Section 3 of the Revised Sharing Agreement contains several provisions relating to the Competitor Restriction and sale of the subordinate component. Section 3 acknowledged that Bear Stearns did not accept Interface's request to modify the Competitor Restriction in the Loan Agreement by removing the Securitization Exemption:

Borrower has requested that Lender modify Section 10.24 of the Loan Agreement to restrict the right of Lender or other holders of an interest in the Loan to sell, assign or otherwise transfer such interests to any [Competitor of Interface] by deleting the last sentence of Section 10.24 of the Loan Agreement. . . . Lender has not accepted the request of Borrower . . . .

Schneider Aff., Ex. 16, § 3.*fn2 The Revised Sharing Agreement also provides that if Beal purchased the subordinate component, Beal would be required to agree "not to further sell, assign or otherwise transfer its interest in the Subordinate Component to a Competitor" (the "Subordinate Component Restriction") without the prior consent of Interface. Id. But if the sale to Beal was not accomplished, Bear Stearns was not required to sell the subordinate component subject to the Subordinate Component Restriction. Id. (if the sale to Beal does not occur, "there can be no assurances" that the purchaser would accept the Subordinate Component Restriction and "Lender makes no representation or warranty to Borrower that the Subordinate Component will be subject to the Subordinate Component Restriction"). However, Bear Stearns was required to make good faith efforts to sell the subordinate component subject to the Subordinate Component Restriction, provided that the restriction did not adversely affect Bear Stearns' ability to dispose of the loan. Section 3 states:

Lender shall in good faith use diligent efforts to market and sell the Subordinate Component subject to the Subordinate Component Restriction provided that Lender reasonably determines (such determination to be made in its sole discretion, made in good faith) that selling the Subordinate Component subject to the Subordinate Component Restriction will not adversely affect Lender's ability to sell or otherwise dispose of 100% of Lender's interest in the Loan.

Id. Section 3 further states that "[n]othing contained herein shall be construed to permit Lender to transfer the Loan or any portion thereof in violation of the provisions of Section 10.24 of the Loan Agreement." Id.

4. Bear Stearns' Disposition of the Loan

The Senior Securitization Transaction successfully closed in August 2002, and in accordance with the Revised Sharing Agreement, the Reset Spread was set at 344 basis points. However, the expected sale of the subordinate component to Beal did not occur. Bear Stearns claims that Beal inexplicably withdrew from a commitment to purchase the subordinate component-at a price level where Beal could achieve a yield (or discount margin) of 900 basis points above LIBOR-just prior to the closing of the transaction.*fn3 According to Interface, however, Bear Stearns refused to negotiate with Beal to reach a compromise price for the subordinate component to punish Beal for withdrawing from another investment, the DMARC bonds, offered by Bear Stearns around the same time. Bear Stearns contends that it continued to negotiate with Beal until November 2002, when Beal offered to purchase the subordinate component at 90% of par, which Bear Stearns considered to be an unreasonably low price.*fn4

After the expected transaction with Beal fell through, Bear Stearns continued its efforts to sell the subordinate component but had difficulty finding a purchaser. Bear Stearns attributes these difficulties to a lack of market interest, while Interface contends that Bear Stearns' marketing and sales efforts were deficient. Eventually, Bear Stearns enlisted the assistance of a third-party intermediary, Robert Cestari. In May 2003, Cestari connected Bear Stearns with Starwood Capital, which expressed interest in purchasing the subordinate component.*fn5 Starwood Capital took a site tour of the Sands and obtained information from Interface as part of its diligence activities in connection with the potential purchase.

Throughout June and July 2003, Bear Stearns and Starwood Capital negotiated the terms of the sale of the subordinate component. On July 21, 2003, Bear Stearns sold the subordinate component to SOF-VI Bond Corp. ("SOF-VI"), a fund managed by Starwood Capital, at a price of 94.97% of par. This price reflected a yield of 1265 basis points above LIBOR, assuming no extension of the initial maturity date of the Loan. Starwood Capital refused to accept the Subordinate Component Restriction as part of the purchase.

5. Interface Refuses To Make True-Up Payment

By letter dated July 30, 2003, Bear Stearns advised Interface that final disposition of the loan had occurred. In accordance with the formula set forth in the Revised Sharing Agreement, Bear Stearns calculated the True-Up Payment based on actual-rather than estimated-yields and disposition costs, and determined that Interface owed it $1,477,992.*fn6 Interface, however, refused to pay the requested amount. It contended that Bear Stearns had improperly sold the subordinate component to a competitor because of SOF-VI's affiliation with Starwood Hotels & Resorts ("Starwood Hotels"), which Interface claimed owned the Westin Casuarina Hotel & Spa (the "Westin Casuarina") and the Aladdin Hotel & Casino (the "Aladdin"), both located in Las Vegas, Nevada.

6. The Venetian Refinancing

Interface argues that the dispute between the parties is related to a separate transaction-a 2002 refinancing of debt for the Venetian, another Adelson property (the "Venetian Refinancing"). Bear Stearns had hoped that the Sands Loan would lead to participation in the Venetian Refinancing, and initially Bear Stearns was in fact included in that deal. However, Bear Stearns was dismissed from the transaction around April 19, 2002 after it delivered a term sheet to Adelson proposing higher prices than had previously been agreed to. Adelson believed that Bear Stearns had improperly attempted to raise the fees that it and other banks were charging, while Bear Stearns claimed the term sheet had been mistakenly revised and delivered by a junior banker, acting beyond his authority and contrary to instructions from his superiors.

On May 15, 2002, Bear Stearns' CEO James Cayne called Adelson in an unsuccessful attempt to have Bear Stearns allowed back into the Venetian refinancing. Interface alleges that during this conversation (and a conversation shortly thereafter with David Friedman, Interface's general counsel), Cayne threatened to call the Sands loan in default, do whatever Bear Stearns could to hurt Interface, and make life difficult for Interface unless Bear Stearns was reinstated into the Venetian refinancing. See Interface's Statement of Additional Material Facts in Opp'n to Pl.'s Mot. for Summ. J., ¶ 64. Bear Stearns contends that Cayne told Adelson that Bear Stearns had deferred from sending a notice of default due to lack of terrorism insurance for the Sands because it valued the client relationship between Bear Stearns and the Venetian Affiliates, but that Bear Stearns would deal with Interface on an arm's length basis (as if there was no institutional relationship between the parties) if Bear Stearns was not reinstated into the Venetian refinancing. See Bear Stearns' Response to Interface's Statement of Additional Material Facts in Opp'n to Pl.'s Mot. for Summ. J., ¶ 62, ¶ 64. Adelson refused to allow Bear Stearns back into the Venetian refinancing deal.

7. Terrorism Insurance

Under Section 6.1(a)(i) of the Loan Agreement, Interface was obligated to maintain "all risk" insurance for the Sands. Section 6.1 also required Interface to obtain "upon sixty (60) days written notice, such other reasonable insurance . . ., and in such reasonable amounts as Lender from time to time may reasonably request against such other insurable hazards which at the time are commonly insured against for property similar to the Property located in or around the region in which the Property is located." July Hoff Aff., Ex. 15, § 6.1(a)(ix). Section 6.1(f) granted Bear Stearns the right to "force-purchase" insurance if "at any time Lender is not in receipt of written evidence" of insurance required under the Loan Agreement.

All-risk insurance policies cover all risks of loss unless excluded or limited by the policy's terms and conditions. Prior to 9/11, Interface's all-risk insurance covered damage due to acts of terrorism. After 9/11, however, many-and perhaps nearly all-all-risk policies excluded such losses from coverage. When Interface renewed its property insurance in April 2002, its all-risk policy excluded damage due to acts of terrorism.

Although many all-risk policies excluded damages from acts of terrorism, borrowers could obtain separate terrorism insurance policies. Bear Stearns states that its general policy was to require terrorism insurance coverage on all its financed assets securing large commercial loans, and contends that other major lenders and servicers-such as GMAC, Wells Fargo, and Goldman Sachs-similarly required terrorism insurance to be obtained by their borrowers on large loans. See Pl.'s Statement of Undisputed Material Facts, ¶¶ 145-47. Interface argues that terrorism insurance may have been required by some lenders as a condition for new loans, but that terrorism insurance coverage was generally not obtained when insurance policies were renewed for existing loans. See Interface's Response to Pl.'s Statement of Undisputed Material Facts, ¶ 145.

Around March 2002, the Venetian Affiliates and Goldman Sachs were negotiating the terms of a $120 million financing of the Shops Mall (the "Shops Mall Loan").*fn7 In connection with this loan, Goldman Sachs asked the Venetian Affiliates to obtain $200 million in terrorism insurance coverage for the Shops Mall, including losses due to business interruption at the Shops Mall if any of the Venetian properties were damaged by a terrorist attack.*fn8 As a result, the Venetian Affiliates purchased blanket terrorism insurance covering the Shops Mall, the Sands, and the Venetian. On or about April 25, 2002, the Venetian Affiliates purchased a $100 million blanket terrorism insurance policy for the Venetian properties. The Venetian Affiliates purchased an additional $5 million policy on May 7, 2002, and an additional $95 million in blanket terrorism coverage on May 10, 2002-for a total of $200 million in blanket terrorism coverage for the Venetian properties by May 10, 2002.*fn9 See Pl.'s Statement of Undisputed Material Facts, ¶¶ 155-59; Interface's Response to Pl.'s Statement of Undisputed Material Facts, ¶¶ 155-59.

In March 2002, Bear Stearns began making inquiries with Interface about terrorism insurance coverage for the Sands. Between April 17, 2002 and May 10, 2002, Bear Stearns and Interface (and their insurance consultants) had several discussions about terrorism coverage for the Sands. During these discussions, Interface did not tell Bear Stearns about the $200 million in blanket terrorism coverage for the Venetian properties that it had purchased upon Goldman Sachs' request.

On May 16, 2002, the day after Cayne's unsuccessful attempt to persuade Adelson to allow Bear Stearns back into the Venetian financing, Bear Stearns sent Interface a letter informing Interface that it was required to purchase terrorism insurance under the terms of the Loan Agreement and that failure to purchase such insurance would constitute a default under the Loan Agreement. In a response letter dated May 16, 2002, Interface argued that the Loan Agreement did not require terrorism insurance for the Sands, but also informed Bear Stearns that it had purchased $200 million in blanket terrorism insurance coverage for the Venetian properties, including the Sands. By letter to Interface dated May 20, 2002, Bear Stearns again argued that the Loan Agreement required terrorism insurance for the Sands and stated that it would review the "limited [insurance] policies you have obtained and will notify you of our opinion as soon as possible." July Hoff Aff., Ex. 42.

Interface purchased an additional $45 million in terrorism insurance coverage for the Venetian properties on May 23, 2002, and an additional $11.5 million on June 28, 2002. Interface asserts that this additional $56.5 million in terrorism insurance was purchased as a result of Bear Stearns' demands, while Bear Stearns argues that this additional coverage was related to Goldman Sachs and the Shops Mall Loan.

On June 27, 2002, Bear Stearns wrote to Interface and stated that the purchased terrorism insurance coverage did not appear to meet the requirements of the Loan Agreement because the coverage was not specifically allocated to the Sands. On July 1, 2004, Interface informed Bear Stearns that the Venetian Affiliates had established a priority of distribution of insurance proceeds from any terrorism insurance payout that placed the Sands second in line, behind the Shops Mall. After reviewing the form and structure of the terrorism insurance coverage, Bear Stearns determined that the terrorism insurance scheme was acceptable and did not call a default.

The total amount of premiums paid by the Venetian Affiliates for the $256.5 million in terrorism insurance coverage for the Venetian properties was $1.898 million. Interface paid only $162,000 for the Sands' share of the terrorism insurance premiums, which took into account the fact that Mr. Friedman had persuaded Goldman Sachs to reduce its fees for the Venetian Refinancing by $500,000 in light of the high cost of terrorism insurance premiums, including for the Sands.

B. Procedural History

On October 17, 2003, Bear Stearns filed suit in this Court alleging that Interface had breached the contract by refusing to make the $1,477,992 True-Up Payment. Interface filed an answer and counterclaims on December 2, 2003, in which it argued that the True-Up Payment was excused by Bear Stearns' sale of the subordinate component to a competitor. In addition, Interface asserted six counterclaims, alleging: (1) breach of the Loan Agreement, (2) breach of the Revised Sharing Agreement, (3) breach of the duty of good faith and fair dealing, (4) misappropriation of trade secrets, (5) prima facie tort, and (6) fraud.

On February 20, 2004, Bear Stearns moved for summary judgment on its breach of contract claim and to dismiss certain of Interface's counterclaims. In a March 21, 2005 Opinion, the Court denied Bear Stearns' summary judgment motion on the grounds that genuine issues of material fact remained as to whether Bear Stearns had breached the contract by failing to make diligent, good faith efforts to sell the subordinate component with the Subordinate Component Restriction, and whether such a breach was a material breach of the contract. The Court granted Bear Stearns' motion to dismiss part of Interface's Third Counterclaim (for breach of the duty of good faith and fair dealing) and all of Interface's Fourth through Sixth Counterclaims (for misappropriation of trade secrets, prima facie tort, and fraud), on the grounds that such claims were duplicative of Interface's breach of contracts claims or otherwise inadequately pleaded. The Court denied Bear Stearns' motion to dismiss the Third Counterclaim, for breach of the duty of good faith and fair dealing, to the extent that the claim was based on allegations that Bear Stearns had improperly demanded that Interface purchase terrorism insurance. See Bear, Stearns Funding, Inc. v. Interface Group-Nevada, Inc., 361 F. Supp. 2d 283 (S.D.N.Y. 2005) ("Bear Stearns I").

Following extensive fact and expert discovery, both parties now move for summary judgment. Bear Stearns moves for summary judgment on its breach of contract claim and all of Interface's remaining counterclaims. Interface moves for summary judgment dismissing Bear Stearns' claim on the grounds that Bear Stearns materially breached the contract by failing to use good faith efforts to obtain a market price for the subordinate component, and by failing to use diligent, good faith efforts to sell the subordinate component subject to the Subordinate Component Restriction.

II. DISCUSSION

A. Standard of Review on Motions for Summary Judgment

Rule 56 of the Federal Rules of Civil Procedure provides that a court shall grant a motion for summary judgment "if the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show that there is no genuine issue of material fact and that the moving party is entitled to judgment as a matter of law." Fed. R. Civ. P. 56(c). The substantive law governing the case will identify which facts are material and "[o]nly disputes over facts that might affect the outcome of the suit under the governing law will properly preclude the entry of summary judgment." Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986). In this case, the Loan Agreement and the Revised Sharing Agreement provide that New York law governs the present dispute.

"The party seeking summary judgment bears the burden of establishing that no genuine issue of material fact exists and that the undisputed facts establish her right to judgment as a matter of law." Rodriguez v. City of New York, 72 F.3d 1051, 1060-61 (2d Cir. 1995). In determining whether a genuine issue of material fact exists, a court must resolve all ambiguities and draw all reasonable inferences against the moving party. Vermont Teddy Bear Co. v. 1-800 Beargram Co., 373 F.3d 241, 244 (2d Cir. 2004). "If, as to the issue on which summary judgment is sought, there is any evidence in the record from any source from which a reasonable inference could be drawn in favor of the non-moving party, summary judgment is improper." Chambers v. TRM Copy Ctrs. Corp., 43 F.3d 29, 37 (2d Cir. 1994).However, "mere conclusory allegations, speculation or conjecture" are insufficient for a non-moving party to resist summary judgment. Cifarelli v. Vill. of Bablyon, 93 F.3d 47, 51 (2d Cir. 1996).

When cross-motions for summary judgment are filed, "the standard is the same as that for individual motions for summary judgment." Natural Res. Def. Council v. Evans, 254 F. Supp. 2d 434, 438 (S.D.N.Y. 2003). "The court must consider each motion independently of the other and, when evaluating each, the court must consider the facts in the light most favorable to the non-moving party." Id. (citing Morales v. Quintel Entm't, Inc., 249 F.3d 115, 121 (2d Cir. 2001)).

The court may grant a motion for summary judgment in part and deny it in part. See ...


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