Court of Chancery Holds That Plaintiff Failed to Meet Burden of Proof With Respect to Mistake-Based Reformation Claim

By: Scott Waxman and Tami Mack

In Richard B. Gamberg 2007 Family Trust v. United Restaurant Group, L.P., C.A. No. 10994-VCMR (Del. Ch. January 26, 2018), the Court of Chancery held that limited partner, Richard B. Gamberg 2007 Family Trust (the “Plaintiff”), failed to meet its burden of proof with respect to various claims against United Restaurant Group L.P. (the “Partnership”), Atlantic Coast Dining, Inc. (the “General Partner”), and the directors/shareholders of the General Partner (the “Shareholder Defendants”; together with the Partnership and the General Partner, the “Defendants”), which included a mistake-based reformation claim, among other breach of contract and breach of fiduciary duty claims.

The Partnership, created in 1993, owned the franchise rights for various restaurants. The terms of the partnership agreement (the “Agreement”) required that any excess distributions in a given year be treated as prepayments for later years. From 1996 to 2009, the President and Board of Directors of the General Partner made distributions without accounting for distributions in prior years, despite the requirements of the Agreement. The Partnership encountered financial difficulties starting in 2009, and began to consider refinancing the Partnership’s debt.

During review of a potential refinancing, the General Partner realized that excess distributions had been made in violation of the terms of the Agreement. As a result, the General Partner determined that any distributions due to the limited partners in the refinancing would be less the total amount of the excess distributions. Further to that decision, the General Partner explained that the $4.3 million gain from refinancing, and thus the $1.4 million tax liability, would fall on the General Partner under the Agreement because the limited partners had essentially been prepaid. The General Partner communicated to the limited partners that the liability would pass to the Shareholder Defendants, who would be unable to pay, thereby jeopardizing the refinancing.

To resolve the tax issues, the Partnership considered a fifth amendment to the Agreement (the “Fifth Amendment”) to permit a tax distribution to the General Partner in order to cover the tax liability. The Plaintiff declined to approve the Fifth Amendment, but it was nonetheless approved by a majority of the limited partners on October 31, 2013, and the Partnership completed the refinancing transaction.

After some procedural matters, the Plaintiff’s complaint involved claims for the following: (1) reformation of the Agreement; (2) breach of contract against the General Partner for enacting the Fifth Amendment without unanimous approval from the limited partners; (3) breach of contract against the General Partner seeking a cash distribution from the Partnership; (4) breach of contract against the General Partner claiming that the Partnership improperly advanced attorneys’ fees; and (5) breach of fiduciary duty against the Shareholder Defendants for a disclosure allegedly made in bad faith with respect to the Fifth Amendment.

With respect to the reformation claim, the Plaintiff asserted a mutual or unilateral mistake with oneself by scrivener’s error. Specifically, the Plaintiff pointed to the fact that, at the formation of the Partnership, Robert H. Snyder (“Snyder”) was the president of the General Partner and the sole limited partner, and thus was the sole signatory to the Agreement, with the remaining limited partners joining at a later date. The Plaintiff attempted to demonstrate its mistake claim by asserting that Snyder, as sole signatory, was unaware that the prepayment provision was included in the Agreement. Further, Plaintiff noted that Snyder signed a verification, submitted with the complaint, indicating that he believed the complaint was “true and correct.” The Plaintiff also pointed to the fact that the prior President of the General Partner had made certain distributions to the limited partners without accounting for prior overpayments. The Court rejected the Plaintiff’s arguments, stating that: (1) the Agreement was clear on its face, (2) the prepayment provision also occurred in three other distribution provisions in the Agreement, and (3) the Plaintiff’s evidence failed to prove what language should have been included instead of the alleged mistaken language. Thus, the Court rejected the Plaintiff’s reformation claim and held that the Plaintiff had failed to meet its burden of proof with respect to a scrivener’s error.

Regarding the breach of contract claim with respect to the Fifth Amendment, the Plaintiff asserted that unanimous approval was required because the Agreement stated that no amendment could be made to “change the liability of or reduce the interests of the General Partner or the Limited Partners” without unanimous consent. The Court rejected this argument, holding that the Fifth Amendment specifically stated that the distribution was to be allocated pursuant to Section 5.1(a)(6) of the Agreement, and that noting an action will be taken in compliance with an existing contract does not modify that contract. Because the Court held that the Fifth Amendment was valid, it similarly rejected the Plaintiff’s claim that it was due a cash distribution because the Fifth Amendment was “invalid and unenforceable.”

The Court quickly rejected Plaintiff’s claim that attorneys’ fees were improperly advanced, holding that the Agreement provided that attorneys’ fees could be “paid as incurred,” a phrase which had previously been interpreted to include advancement rights. The Court also rejected the Plaintiff’s fiduciary duty claim, holding that the Shareholder Defendants did not act in bad faith by disclosing that the tax liabilities would pass on to them, and that the Plaintiff failed to otherwise allege any facts indicating that the Shareholder Defendants acted in bad faith. Having addressed all of the Plaintiff’s claims, the Court denied the Plaintiff’s request to amend the complaint and granted the defendants’ motion to dismiss.

Richard B. Gamberg 2007 Family Trust v. United Restaurant Group, L.P., C.A. No. 10994-VCMR (Del. Ch. January 26, 2018)

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