The opinion of the court was delivered by: Denise Cote, District Judge
This dispute arises out of a $26.5 million loan that plaintiff Bernard National Loan Investors, Ltd. ("Bernard") extended to defendant Traditions Management, LLC ("Traditions") in December 2006. A bench trial on Bernard's claims for breach of contract, breach of the covenant of good faith and fair dealing, and indemnification was held February 22-24, 2010. Based on the following findings of fact and conclusions of law, judgment is entered for the defendants on all claims.
Traditions is a real estate marketing firm that specializes in the sale and marketing of high-end luxury residences. The company was founded in late 2002 by Michael Aiken ("Aiken"), its Chairman, Mark Enderle ("Enderle"), its President and Chief Executive Officer, and Mark Yarborough ("Yarborough"), its Vice Chairman and Chief Sales Officer (collectively, the "Principals"). Traditions is owned by the Principals through three separate limited liability companies ("LLCs"), which collectively hold all of the common membership interests in Traditions. AEY, LLC ("AEY") is owned indirectly by the Principals and holds all of the preferred membership interests in Traditions.
Bernard is a specialized investment group based in the Cayman Islands that provides loans to commercial ventures. At the time of the loan transaction at issue in this dispute, Bernard was serviced by a hedge fund, D.B. Zwirn & Co. ("Zwirn"). Bernard is now serviced by Fortress Investment Group, LLC ("Fortress").
2. The Loan Transaction and Services Agreements
In the summer of 2006, the Principals engaged investment bank Dresdner Kleinwort Wasserstein LLC ("Dresdner") to obtain an equity investment, financing, or other structured transaction to monetize their ownership interests in Traditions. Dresdner approached Zwirn, among other potential investors. Although originally conceived as an equity investment, Zwirn, through Bernard, ultimately extended a $26.5 million non-recourse loan to Traditions (the "Loan").
On December 18, 2006 (the "Closing Date"), Traditions and Bernard executed a Loan Agreement and Pledge and Security Agreement (the "LPS Agreement").*fn2 The Loan retains many of the hallmarks of an equity investment, including the right of Traditions' members (i.e., the Principals) to receive loan proceeds, rather than requiring them to be used to fund Traditions' operations,*fn3 and the right of Bernard to convert its debt investment into a ten percent equity interest. The Loan carries a 9.625 percent interest rate payable on outstanding principal semi-annually. The Loan is secured by, inter alia, Traditions' preferred membership interests (held by AEY, the "Pledgor" under the LPS Agreement), gross revenue received by Traditions (including all revenues generated from Traditions' contracts with developers), and any additional assets owned or acquired by Traditions (the "Collateral").
In addition to the Loan Documents, Bernard and Traditions executed three Service Agreements governing the services to be provided to Traditions by the Principals (the "Service Agreements"). Under the terms of the Service Agreements, each of the Principals is entitled to receive compensation in the form of an Annual Fee of $333,333 per calendar year (the "Service Fees") during the "Service Period." The Service Agreements provide that the Service Period commences on the Closing Date. The payment of Service Fees is "subject to applicable restrictions contained in the [LPS Agreement] and the LLC Agreement."
3. Relevant Provisions of the LPS Agreement
The LPS Agreement contains several provisions relevant to this dispute. Under Section 3(a) of the LPS agreement, Traditions must repay Bernard "the aggregate outstanding principal amount of Loan together with all accrued interest" on or before the Maturity Date in 2012. Although nothing in the LPS Agreement prohibits Traditions from prepaying the outstanding principal in advance of the Maturity Date, Traditions is under no obligation to do so except as required by Section 3(d). Section 3(d), referred to as the "Use of Revenues" or "Waterfall" provision, provides in pertinent part:
All net Revenues received by [Traditions], net of budgeted overhead and operating expenses . . . to the extent such operating expenses are provided for in an Approved Budget, shall be used, disbursed and applied in the following order of priority:
(i) First, to Pledgee [Bernard] to the extent, and for the payment of, all accrued and unpaid interest on the Loan . . .;
(ii) Second, the balance, if any (but only as and when no accrued and unpaid interest on the Loan remains outstanding), for the payment of the Annual Fees payable under and in accordance with the Service Agreements, in no event to exceed $1,000,000 per annum in the aggregate . . . ; and
(iii) Third, 80% of the balance, if any, to Pledgee [Bernard] for application in reduction of the outstanding principal balance of the Loan and the remaining 20% thereof to Pledgor [AEY] for distribution to the Principals for the payment . . . of taxes incurred by Pledgor [AEY], Issuer [Traditions], or Principals by reason of such application in reduction of principal.
The LPS Agreement contains several covenants related to the Use of Revenues provision. Section 5(l) provides that neither AEY nor Traditions "shall make any distributions of Revenues in any manner that is inconsistent with this Agreement or with [Traditions'] limited liability company agreement. In no event shall [Traditions] pay any portion of the Annual Fees accrued in any prior year or otherwise in any manner inconsistent with Section 3(d) hereof." Under Section 5(s), the Principals are personally liable for any violation of the Use of Revenues provision. Section 5(s) also provides that the "Principals shall not, and shall not permit [AEY] or [Traditions] to, knowingly misappropriate any Revenues, nor shall Principals intentionally cause or permit [Traditions] to make any payment or distribution of Revenues in any manner inconsistent with the terms of Section 3(d) hereof."
Section 4 of the LPS Agreement contains representations and warranties made by the defendants in connection with the loan transaction. Most importantly for this dispute, Section 4(k) provides, in pertinent part:
Schedule IV lists all of the existing sales and marketing agreements in effect as of the date hereof, including any modifications and amendments thereto . . . . Each of the Existing Contracts is in full force and effect as of the date hereof, and neither [Traditions] nor [AEY] has received any notice, or has any actual knowledge, that there has occurred a material default under any of the Existing Contracts by any party thereto, except as disclosed on Schedule
V. Under the LPS Agreement, the Principals are individually liable for any misrepresentation made under Section 4(k).
Section 7 of the LPS Agreement requires that for "the twelve-month period commencing on January 1, 2007, the budget attached as Exhibit E" to the LPS Agreement shall be the operating budget for Traditions for that fiscal period. For subsequent years, Section 7 requires that an annual budget containing "revenues and operating and other expenses" be submitted for Bernard's approval at least sixty days prior to the end of the prior fiscal year. Once approved, the budget is referred to as the "Approved Budget." As noted above, under Section 3(d), the aggregate expenses included in the Approved Budget are subtracted from actual net revenues to determine the amount of revenues available for distribution under the Use of Revenues provision. Section 5(t) of the LPS Agreement provides that AEY shall not, and shall not permit Traditions to, "incur any expense materially in excess of that which is reflected on the then-current Approved Budget." The Principals are not personally liable for a violation of Section 5(t).
Aside from the requirement in Section 7 that Traditions supply Bernard with a proposed annual budget each year, the only other provision in the LPS Agreement that obligates any of the defendants to provide any documentation to Bernard is Section 5(c). This provision states, in pertinent part:
At any time and from time to time, upon the reasonable written request of [Bernard], and at the sole expense of Pledgor [AEY], Pledgor [AEY] shall promptly and duly give, execute, deliver, file and/or record such further instruments and documents and take such further actions as [Bernard] may reasonably request for the purposes of obtaining creating, perfecting, validating or preserving the full benefits of this Agreement and of the rights and powers herein granted including, without limitation, filing UCC financing or continuation statements, provided that the amount of indebtedness secured hereby is not increased thereby.
By its terms, Section 5(c) applies only to AEY, not the other defendants.
Section 10 defines Bernard's remedies when there is an Event of Default under the LPS Agreement. Under Section 10(a), an Event of Default occurs, inter alia, if:
(iii) Pledgor [AEY] or Issuer [Traditions] violates any of the covenants set forth herein [including, inter alia, Sections 5(c), 5(l), 5(s) and 5(t)];
(iv) any of the Principals, Issuer [Traditions], or Pledgor [AEY] knowingly misappropriates any Revenues, or if Issuer intentionally makes any payment or distributions of Revenues in any manner inconsistent with the terms of Section 3(d) hereof; . . .
(vi) any representation or warranty made by Issuer [Traditions] or Pledgor [AEY] herein [including, inter alia under Section 4(d)] shall have been false or misleading in any material respect as of the date hereof.
Under Section 10(b), upon the occurrence of an Event of Default, Bernard may declare the Loan to be immediately due and payable.
For an Event of Default based on Sections 10(a)(iii) or 10(a)(iv), however, the Loan and all obligations of AEY under the LPS Agreement automatically become immediately due and payable without notice or demand by Bernard.
Because the Loan is non-recourse, Bernard's sole remedy if an Event of Default occurs is to foreclose upon the Collateral; with one exception, Bernard may not bring an action for a money judgment. Section 18 of the LPS Agreement provides, in pertinent part: "[Bernard] shall not enforce the liability and obligation of Pledgor [AEY] or Issuer [Traditions] to perform and observe the obligations contained in the Agreement or the other Loan Documents by any action or proceeding wherein a money judgment shall be sought against [AEY] or [Traditions]." The only exception is that under Section 11(f), each of the Principals is personally liable if and to the extent he is responsible for "the breach, violation or failure of a representation, warranty or covenant under Section 4(k), 5(q), 5(s) or 5(v) . . . [up to] $25,500,000 in the aggregate."
Finally, the LPS Agreement contains an indemnification provision. Section 19(a)(iv) provides that, subject to the non-recourse provision in Section 18, AEY has a duty to indemnify Bernard up to the value of Bernard's interest in the Collateral for losses arising from "any failure on the part of [AEY] to perform or be in compliance with any of the terms of the Agreement." AEY is not obligated, however, "to indemnify [Bernard] for Losses directly or ...