IN THE SUPREME COURT OF THE STATE OF DELAWARE
§ EXIT STRATEGY, LLC, § No. 318, 2023 § Plaintiff Below, § Court Below: Court of Chancery Appellant, § of the State of Delaware § v. § § C.A. No. 2017-0017 FESTIVAL RETAIL FUND BH, L.P. § § Defendant Below, § Appellee. §
Submitted: May 15, 2024 Decided: July 25, 2024
Before SEITZ, Chief Justice; VALIHURA, TRAYNOR, LEGROW, and GRIFFITHS, Justices, constituting the Court en banc.
Upon appeal from the Court of Chancery of the State of Delaware. AFFIRMED.
David A. Jenkins, Esquire (argued), Jason Z. Miller, Esquire, SMITH, KATZENSTEIN & JENKINS LLP, Wilmington, Delaware, for Appellant Exit Strategy, LLC.
Douglas D. Herrmann, Esquire, James H.S. Levine, Esquire (argued), TROUTMAN PEPPER HAMILTON SANDERS LLP, Wilmington, Delaware, Andrew W. Zepeda, Esquire, LURIE, ZEPEDA, SCHMALZ, HOGAN & MARTIN, Los Angeles, California, for Appellee Festival Retail Fund BH, L.P.
LEGROW, Justice: The parties to this appeal entered into a partnership agreement that established
the financial conditions under which the appellant would receive a distribution upon
the sale of the partnership’s principal asset. The partnership agreement set a net-
sale-price threshold above which the appellant would receive a distribution, and the
agreement directed the general partner to calculate that net sale price by deducting
certain categories of costs from the gross sales price. The general partner ultimately
determined that the deductions permitted by the partnership agreement reduced the
net sale price below the minimum threshold for a distribution.
Although the appellant challenged several of the deductions at trial, the Court
of Chancery held that one was outcome determinative: the deduction for the costs
that the partnership incurred to defease the interest payments on the mortgage and
thereby remove the encumbrance from the asset so that it could be sold. The court
concluded that this deduction was proper under the partnership agreement and
therefore entered judgment in favor of the partnership. Although the Court of
Chancery mischaracterized the contractual formula applicable to this deduction, we
affirm the court’s judgment because, properly characterized, the plain language of
the partnership agreement and the formula permit the challenged deduction. We
therefore do not reach the effect or correctness of the Court of Chancery’s alternative
holding that the general partner’s good faith in calculating the net sale price
eliminated any breach of contract claim. I. FACTUAL AND PROCEDURAL BACKGROUND
Unless otherwise noted, the facts are taken from the Court of Chancery’s July
17, 2023 Post-Trial Memorandum Opinion.
A. The Parties
Plaintiff-Below, Appellant Exit Strategy, LLC (“Exit”) is a New York limited
liability company.1 Exit invests in commercial real estate. Defendant-Below,
Appellee Festival Retail Fund BH, L.P. (“Festival”) is a Delaware limited
partnership with its principal place of business in California.2 Defendant-Below
FRFBH, LLC, is a Delaware limited liability company and Festival’s General
Partner (the “General Partner”).3 Defendant-Below Mark Schurgin was the General
Partner’s president and controlled the General Partner through that position.4
Neither Schurgin nor the General Partner is a party to this appeal. Festival’s sole
limited partner is Festival Retail Fund 1, L.P. (the “Limited Partner”), a Delaware
limited partnership and non-party to the action.5
1 App. to Opening Br. at A129 (Joint Pre-Trial Stipulation and Proposed Order). 2 Id. 3 Id. 4 Id.; Exit Strategy, LLC v. Festival Retail Fund BH, L.P., et al, 2023 WL 4571932, at *3 (Del. Ch. Jul. 17, 2023). 5 App. to Opening Br. at A129 (Joint Pre-Trial Stipulation and Proposed Order).
2 Exit, the General Partner, and the Limited Partner are parties to the Limited
Partnership Agreement of the Partnership (the “LPA”), the governing document in
this litigation.6
B. Acquisition of the Gucci Store and Relevant LPA Provisions In 2005, Exit acquired an option to purchase property on Rodeo Drive in
Beverly Hills, California, from its then-owner, Elizabeth Luster.7 The property
houses the flagship Gucci store (hereinafter the “Gucci Property”).
Exit, however, did not have the capital to exercise its option. In 2007, Exit
assigned its option to Festival.8 Festival immediately exercised the option and
acquired the Gucci Property for $39 million.9 In exchange for the option’s
assignment, Festival paid Exit over $11 million and Exit became Festival’s “Special
Limited Partner.”10 Although the LPA refers to Exit as a Special Limited Partner,
Exit had “no voting or other rights” except a contingent right to receive an additional
payment if the Gucci Property was later resold (the “Special Limited Partner
Portion”).11 The LPA explains that in the event of a Resale, “the Resale Proceeds
6 Id. at A129 (LPA); Id. at A367 (LPA). 7 Id. at A130 (Joint Pre-Trial Stipulation and Proposed Order). 8 Id.; Id. at A154 (Agreement to Assign and Assume). 9 Id. at A130 (Joint Pre-Trial Stipulation and Proposed Order). 10 Id. at A130 (Joint Pre-Trial Stipulation and Proposed Order); Id. at A359 (LPA). 11 Id. at A130 (Joint Pre-Trial Stipulation and Proposed Order); Id. at A364 (LPA); Id. at A367 (LPA).
3 shall be distributed first, 100% to [Exit] until the cumulative amount distributed to
[Exit] equals [Exit’s] portion.”12 To determine what Exit’s Portion is, if anything,
the LPA provides the following definition:
“Special Limited Partner’s Portion” means, with respect to a Resale, the amount equal to (i) the Base Resale Distribution Amount (as shown in Schedule D) for the Applicable Resale Year plus (ii) an amount equal to 10% of the amount by which the Net Resale Price exceeds the Resale Price Threshold for such Resale Year.13
Schedule D contains a table listing each Resale year starting in 2007, with a
Resale Price Threshold and corresponding Base Resale Distribution Amount.14
Schedule D also provides that,
If for any Resale, the Net Resale Price is less than the Resale Price Threshold for the applicable Resale Year, the Base Resale Distribution Amount shall be reduced by one dollar for each dollar by which the Resale Price Threshold exceeds the Net Resale Price until the Base Resale Distribution Amount has been reduced to zero.15
Net Resale Price is then defined as “the gross sales price derived from the
Resale . . . reduced by one of the following [eight] items.”16 We refer to any
reductions in gross sales price as “Deductions.”
12 Id. at A367 (LPA). 13 Id. at A385 (LPA). 14 Id. at A388 (LPA). 15 Id. 16 Id. at A382 (LPA).
4 To summarize a relatively simple concept lost in embedded definitions: if the
Deductions to the gross sales price exceed a certain amount, such that the Net Resale
Price falls below the difference between the Resale Price Threshold and the Base
Resale Distribution Amount for the sale year, Exit receives no Special Limited
Partner Portion. And this is where the friction arose in this case: after the General
Partner calculated the Deductions that it believed were authorized by the LPA, the
Base Resale Distribution Amount was reduced to zero, and Festival advised Exit that
no Special Limited Partner Portion would be paid. Exit disputed the propriety of
certain Deductions and ultimately filed suit. Only certain categories of Deductions
are relevant to the issues raised on appeal, and we conclude that only one category—
Excess Loan Costs—is dispositive of Exit’s claims.
The LPA allows the General Partner to deduct “[a]ny excess costs associated
with any loan on the Property during [Festival’s] ownership.”17 These deductions
are termed as “Excess Loan Costs” and are defined in Subsection (f) to the definition
of “Net Resale Price” as:
loan interest costs, points, loan origination fees, negative accruals, and similar costs to the extent they exceed the aggregate of the following items: (i) loan origination fees to the extent actually paid by the Limited Partner or the Partnership, but not more than $550,000.00; and (ii) the amount by which aggregate loan interests costs in any year (whether paid currently or accruing and including any interest that accrues on interest) exceed Rental Payments . . . for such year, but only to the extent such excess of such loan interest costs in such year over Rental 17 Id.
5 Payments in such year exceeds $875,000.000 (subject to proration for any partial year).18
Subsection (f) then defines “Rental Payments” “to mean the aggregate of all
rents collected by [Festival] from Gucci or any other tenant pursuant to the existing
lease or any renegotiated lease with Gucci or such other tenant during such year.”19
Gucci paid rent to Festival during the seven years it owned the property. The trial
court found that Gucci’s rent payments never exceeded $875,000 annually,20 but the
parties agree that the annual rent was approximately $3 million.21
Although the deductions in Subsection (f) are the only type of deduction
discussed in our analysis, two other categories of deductions were raised during trial
and considered by the Court of Chancery as permitting a deduction for defeasance
costs. Subsection (d) allows the General Partner to reduce the gross sales price by
“[a]ny other costs or expenses associated with the ownership, development,
redevelopment, improvement, operation, leasing, management . . ., maintenance,
repair and renovation of the Property reasonably borne by [Festival] during
[Festival’s] ownership, to the extent not reimbursed by Gucci or other tenant.”22
18 Id. at A382–83 (LPA). 19 Id. at A383 (LPA). 20 Exit Strategy, LLC, 2023 WL 4571932, at *14. 21 App. to Opening Br. at A1747 (Emanuel Direct. Exam). 22 Id. at A382 (LPA).
6 Subsection (h) also allows the General Partner to deduct the following costs:
“[a]ll actual documented out-of-pocket closing costs and costs of sale incurred in
connection with such Resale, including without limitation, actual documented out-
of-pocket survey and title costs, documentary transfer taxes, recording fees, escrow
charges and reasonable attorneys’ fees and costs.”23
From January 2007 to January 2014, Festival owned the Gucci Property.24 To
finance the initial purchase, Festival entered into a Loan Agreement with Column
Financial, Inc. and secured a mortgage on the property (the “Loan”).25 Relevantly,
the Loan Agreement allowed Festival to sell the property unencumbered by the Loan
through a process called “defeasance.”26 Defeasance allows a borrower to replace
the collateral on a loan, here the Gucci Property, with a portfolio of low-risk
securities yielding a rate of return that economically replicates the interest due under
the loan.27 Defeasance typically requires the borrower to pay a premium because
the low-risk securities have a lower interest rate than the Loan, so the borrower is
required to purchase securities with a higher cost than the outstanding loan balance.28
23 Id. at A383 (LPA). 24 Id. at A131 (Joint Pre-Trial Stipulation and Proposed Order). 25 Id. at A394 (Loan Agreement). 26 Id. at A422–23 (Loan Agreement). 27 Id. at A1931–32 (P. Avery Direct Exam). 28 Id.
7 C. 2014 Sale and Challenged Deductions
On January 7, 2014, the Partnership sold the Gucci Property to non-party
Ponte Gadea California, LLC for a gross price of $108 million.29 The Purchase and
Sale Agreement required Festival to “remove, by payment, bonding or otherwise . .
. any deeds of trust or mortgages that secure indebtedness against” the Gucci
Property.30 In accordance with this provision, Festival defeased the Loan at a
premium, $6,250,155, thereby removing the mortgage from the Gucci Property in
accordance with the Loan Agreement.31 The General Partner deducted this cost from
the gross sales price when calculating Exit’s Special Limited Partner Portion.
In addition to the $6,250,155 in Defeasance Deductions, the General Partner
also reduced the gross sales price by $4,556,486 in Negative Accruals Deductions,
$1,266,532 in Preferred Return Deductions (together with the Defeasance
Deductions and Negative Accruals Deductions, the “Challenged Deductions”), and
$6,004,579 in miscellaneous, unchallenged deductions, for a total of $18,077,752 in
deductions.32 These deductions resulted in a Net Resale Price of $89,922,248.33
29 Id. at A131 (Joint Pre-Trial Stipulation and Proposed Order); Court of Chancery D.I. 147 at 115 (Post-Trial Oral Argument). 30 App. to Answering Br. at B249 (Purchase and Sale Agreement). 31 Id. at B321–23 (Loan Defeasance Report). 32 App. to Opening Br. at A2001 (Exit’s Post-Trial Opening Br.) 33 Originally, Festival did not take the Negative Accruals Deductions, and the Net Resale Price was calculated as $94,534,742. App. to Opening Br. at A503 (Gucci Sales Analysis Summary of 8 Because the sale occurred in 2014, the General Partner used the following figures
from Schedule D of the LPA: Resale Price Threshold = $100 million; Base Resale
Distribution Amount = $3.0 million.34 Recall that Exit was not entitled to its Special
Limited Partner Portion under the LPA if the Net Resale Price fell below the
difference between Resale Price Threshold and Base Resale Distribution Amount.35
For a 2014 sale, the Net Resale Price would have had to exceed $97 Million for Exit
to receive any Special Limited Partner Portion. Because the General Partner
calculated the Net Resale Price to be $89,922,248, Exit did not receive any
distribution.36
On January 17, 2014, Exit’s attorney, Andrew Chonoles, sent a letter to
Schurgin in his capacity as the General Partner’s President, inquiring about the 2014
Sale and requesting a distribution of the proceeds provided for under the LPA.37 The
next day, Schurgin responded to Chonoles’s letter, acknowledging that the sale had
occurred but asserting that Exit was not entitled a distribution because the Net Resale
Price was insufficient to trigger payment under Schedule D.38
Accounting for the 2014 Sale). This did not affect Exit’s distribution because the Net Resale Price was less than the Base Resale Distribution Amount subtracted from the Resale Price Threshold. 34 App. to Opening Br. at A388 (LPA). 35 Id. 36 Id. at A132 (Joint Pre-Trial Stipulation and Proposed Order). 37 Id. at A131 (Joint Pre-Trial Stipulation and Proposed Order); Id. at A549 (Letter from Chonoles). 38 Id. at A131 (Joint Pre-Trial Stipulation and Proposed Order); Id. at A553–54 (Letter from Schurgin). Schurgin also asserted that Festival was not required to pay the distribution because an 9 D. Procedural History
On January 12, 2017, Exit filed a Verified Complaint in the Court of
Chancery, asserting breach of contract claims against Festival and the General
Partner in relation to the Challenged Deductions.39 Exit then filed its Amended
Verified Complaint on December 22, 2017, adding claims alleging that the General
Partner acted in “bad faith” when it calculated the Challenged Deductions. 40 After
the Court of Chancery denied Festival’s Motion to Dismiss the Amended Complaint
and Request for Leave to Move for Summary Judgment, the court held a three-day
trial in September 2022.41 Exit presented live testimony from four witnesses, and
Festival presented live testimony from three witnesses, including Schurgin.
The parties then engaged in a round of post-trial briefing, and the Court of
Chancery heard argument on the narrowed issues presented in the briefing on April
17, 2023.42 Exit argued that the Challenged Deductions violated the LPA, that
Schurgin calculated the deductions in bad faith, and that the Sale constructively
occurred in 2013–which would lower the Resale Price Threshold by $10 million and
unrelated sale of the Partnership’s interest in 2011 divested Exit of its interest. Because this issue was not relevant to the trial court’s analysis, we do not address it any further. 39 App. to Opening Br. at A1 (Court of Chancery Docket). 40 App. to Answering Br. at B4 (Amended Verified Complaint). 41 App. to Opening Br. at A29 (Court of Chancery Docket). 42 Court of Chancery D.I. 147 (Post-Trial Oral Argument).
10 thereby obviate the need to resolve whether the Challenged Deductions were
contractually permitted.43
The Court of Chancery published its Post-Trial Memorandum Opinion on July
17, 2023, finding in favor of Festival, the General Partner, and Schurgin on all
counts.44 The trial court only analyzed Exit’s breach claims as to the Defeasance
Deduction because—if properly deducted—the defeasance costs combined with the
unchallenged deductions would reduce the Net Resale Price below $97 million.45
Exit did not dispute that basic mathematical calculation on appeal, and our analysis
therefore follows the same theory. In interpreting the meaning of Subsections (f),
(d), and (h), the Court of Chancery did not consider any extrinsic evidence, holding
that the provisions were unambiguous as to Festival’s deduction of defeasance
costs.46
The trial court held that Festival properly deducted defeasance costs under
either Subsection (f), (d), or (h).47 In its analysis, the trial court mischaracterized the
formula in Subsection (f) as follows: “Excess Loan Costs are deductible if ‘the
amount by which aggregate loan interest costs in any year . . . exceed Rental
43 App. to Opening Br. at A1975–76 (Exit’s Post-Trial Opening Brief). 44 Exit Strategy, LLC, 2023 WL 4571932. 45 Id. at *12. 46 Id. at *16. 47 Id. at *14–15.
11 Payments,’ defined as a threshold amount of payments from the Property’s tenant.
The Rental Payment threshold is fixed at a notional amount of ‘$875,000.00’”48 As
we explain below, the formula establishes that Excess Loan Costs are deductible if
the aggregate loan costs in that year exceed the sum of rental payments and
$875,000, with the latter amount prorated for any partial year.
The trial court also found that the Sale occurred in 2014, not 2013 as Exit
argued, and that Schurgin did not act in bad faith when he took the Challenged
Deductions.49 Exit does not challenge either of these holdings on appeal.
E. Contentions on Appeal
Exit timely filed this appeal only as to its breach of contract claims against
Festival, arguing that the Court of Chancery erred when it held that Subsections (f),
(d), and (h) permitted Festival to deduct defeasance costs from the gross sales price.50
Exit also argues that the trial court committed error when it suggested that the
General Partner’s good faith would bar Exit’s recovery under a breach of contract
claim. In response, Festival contends that despite the trial court’s misinterpretation
of the formula in Subsection (f), defeasance costs were still properly deducted from
the gross sales price when the formula is applied correctly.51 Festival also posits that
48 Id. at *4 (emphasis added). 49 Id. at *10–11. 50 See generally Opening Br. at 34–44. 51 Answering Br. at 38 n.11.
12 Exit’s arguments on appeal are barred because it did not appeal the trial court’s
findings regarding the defendants’ good faith conduct. Specifically, Festival relies
on the Court of Chancery’s holding that Schurgin and the General Partner acted in
good faith when making the deductions and that because Festival acted through those
parties when it made the deductions, the breach of contract claims are barred.52
II. STANDARD OF REVIEW
We review the Court of Chancery’s contractual interpretation de novo.53
Because the argument on appeal, and therefore our analysis, is constrained to
contract interpretation, we do not review the court’s post-trial factual findings and
accept them as accurate.
III. ANALYSIS To begin, although Exit challenges the Court of Chancery’s interpretation of
Subsections (f), (d), and (h), and its holding that defeasance costs fit within each of
those categories of permitted deductions, our decision only reaches the meaning and
application of Subsection (f). Once we determine that the defeasance costs were
properly deducted under Subsection (f), the inquiry ends because that calculation
reduced Exit’s Special Limited Partner Portion to zero.
52 The parties agree that the LPA identifies “good faith” as the governing standard for the General Partner’s conduct. 53 Sunline Commercial Carriers, Inc. v. CITGO Petroleum Corp., 206 A.3d 836, 845 (Del. 2016).
13 A. The Defeasance Deduction was proper under Subsection (f).
Exit’s argument that the LPA’s definition of Excess Loan Costs does not
encompass defeasance costs 1) relies on extrinsic evidence, and 2) is entirely at odds
with its admissions that “defeasance was a replacement for the post-sale interest
payments,” “‘loan interest costs’ are one of the possibly-permitted deductions under
that definition,”54 and defeasance costs “could, under certain circumstances fit
within ‘Excess Loan Costs.’”55 Exit’s arguments on appeal never reconcile its
interpretation of Subsection (f) with either the LPA’s plain language or Exit’s
admissions. Because the LPA is unambiguous and the Court of Chancery properly
refused to consider extrinsic evidence,56 we hold that defeasance costs were
deductible as Excess Loan Costs.
First, the Court of Chancery did not err when it refused to consider extrinsic
evidence as to Subsection (f)’s meaning.57 Delaware follows the objective theory of
54 Opening Br. at 39. 55 Id. (citing App. to Opening Br. at A1770 (Emanuel Direct Exam.)); App. to Opening Br. at A2014 (Exit’s Post-Trial Opening Brief); Court of Chancery D.I. 147 at 48–49; 52 (Post-Trial Oral Argument Tr.). 56 Although the Court of Chancery excluded extrinsic evidence because it found that Exit conceded that the LPA’s language was unambiguous, we do not base our decision on this judicial admission and instead conclude that the plain language of Subsection (f) is unambiguous. See Exit Strategy, LLC, 2023 WL 4571932, at *12. 57 Id. at *16. The extrinsic evidence that Exit introduced to prove that defeasance costs were not encompassed by Subsection (f) included testimony from its principal, Steven Emanuel, explaining Subsection (f)’s evolution through the LPA’s drafting process. Emanuel testified that each of Excess Loan Costs’s inputs were dictated by Festival’s need to obtain a 16% internal rate of return—not to deduct additional costs from the gross sales price. App. to Opening Br. at A1755– 57 (Emanuel Direct Exam.).
14 contracts, where the parties’ intent is determined by considering only the “four
corners of the agreement.”58 And where contract terms establish the parties’
common meaning, they control.59 “The parol evidence rule bars the admission of
evidence extrinsic to an unambiguous, integrated written contract for the purpose of
varying or contradicting the terms of that contract.”60 It is the “sole province” of the
court to determine whether a contract is ambiguous, and the parties’ disagreement
over a contract’s interpretation does not render it so.61 Rather, contract terms are
ambiguous only when they “are fairly susceptible of different interpretations or may
have two or more different meanings.”62
Subsection (f) is not ambiguous. The Loan Agreement between Festival and
its mortgage lender expressly defines defeasance costs;63 the LPA gave the General
Partner sole discretion to enter into financing agreements, including the Loan
Agreement;64 and the Sale Agreement between Festival and Ponte Gadea required
58 Salamone v. Gorman, 106 A.3d 354, 368 (Del. 2014). 59 Id. 60 Galantino v. Baffone, 46 A.3d 1076, 1081 (Del. 2012). 61 Weinberg v. Waystar, Inc., 294 A.3d 1039, 1044 (Del. 2023). 62 GMG Capital Investments, LLC v. Athenian Venture Partners, I, L.P., 36 A.3d 776, 780 (Del. 2012) (quoting Eagle Indus., Inc. v. DeVilbiss Health Care, Inc., 702 A.2d 1228, 1232 (Del. 1997)). 63 App. to Opening Br. at A422–23 (Loan Agreement). 64 Id. at A361 (LPA).
15 Festival to clear encumbrances from the Gucci Property, which in turn required
Festival to defease the Loan.65
Defeasance replicated and replaced the remaining interest on the Loan, and
those interest costs were plainly deductible under Subsection (f), which defines
Excess Loan Costs as “loan interest costs, points, loan origination fees, negative
accruals, and similar costs.”66
Exit’s first argument—that Subsection (f) is ambiguous because defeasance
costs are not mentioned by name—is not convincing.67 We find no ambiguity in the
contractual language. Subsection (f) expressly defines Excess Loan Costs as
including “loan interest costs . . . and similar costs.”68 The only reasonable
interpretation is that this includes defeasance costs, which replace interest costs—
something Exit’s own witness admitted—verbatim—during his deposition.69
Moreover, Exit admitted to the Court of Chancery on numerous occasions that
defeasance costs could be loan interest costs within the meaning of Subsection (f).70
65 App. to Answering Br. at B249 (Purchase and Sale Agreement). 66 App. to Opening Br. at A382 (LPA) (emphasis added). 67 Opening Br. at A28. 68 App. to Opening Br. at A383 (LPA). 69 Id. at A944 (Emanuel Dep. Tr.) (“to the extent that the $6.2 million represented treasury securities that were intended to function, and did function, as a precise replacement for monthly interest costs that would come due during the final post sale to Ponte Gadea Mortgage, those are to be treated as interest costs and analyzed under (f)”). 70 Id. at A1770 (Emanuel Direct Exam.); Id. at A2014 (Exit’s Post-Trial Opening Brief); Court of Chancery D.I. 147 at 48–49; 52 (Post-Trial Oral Argument Tr.).
16 We do not accept Exit’s change in position and, together with the plain meaning of
Subsection (f), hold that Festival could deduct defeasance costs from the gross sales
price as Excess Loan Costs under Subsection (f).
Undeterred, Exit alternatively argues that if defeasance costs constitute
Excess Loan Costs, they nevertheless were not properly deducted under the formula
contained in Subsection (f). Subsection (f) allows Festival to deduct excess loan
costs when they exceed the sum of: (i) “loan origination fees to the extent actually
paid by the Limited Partner or the Partnership, but not more than $550,000.00” and
(ii) “the amount by which aggregate loan interests costs in any year . . . exceed Rental
Payments . . . for such year, but only to the extent such excess of such loan interest
costs in such year over Rental Payments in such year exceeds $875,000.000 (subject
to proration for any partial year).”71 Because Festival did not deduct any loan
origination fees under (i), our focus is on the second half of this formula.
Exit first argues that the Court of Chancery misinterpreted and misapplied the
formula required by Subsection (f) when it held that “[t]he Rental Payment threshold
is fixed at a notional amount of ‘$875,000.00 (subject to proration for any partial
year).’”72 Although we agree with Exit that the trial court misinterpreted Subsection
(f)’s formula, we conclude that the error was harmless because the application of the
71 App. to Opening Br. at A382 (LPA). 72 Exit Strategy, LLC, 2023 WL 4571932, at *4.
17 correct formula yields the same result: loan interest costs—defeasance costs totaling
over $6 million—exceed the rental payments received in 2014—a fraction of $3
million—by more than $875,000.73
To avoid this straightforward mathematical calculation and preserve its
challenge to the Defeasance Deduction, Exit contends that defeasance costs must be
prorated over the remaining term of the Loan, which, by Exit’s calculations, would
reduce loan interest costs to less than the sum of the rental payments and the prorated
portion of $875,000.74 Exit insists that Subsections (f)’s language “subject to
proration for any partial year” applies to all the inputs in the formula, not just the
$875,000 threshold.75 We disagree and find no support for Exit’s position in the
contractual language.
As a matter of the contract’s plain language and straightforward logic, we
conclude that proration applies only to the $875,000 threshold that the formula adds
to the rental payments.76 First, the formula refers to “loan interest costs in such year”
and “Rental Payments in such year,” making any reference to proration both
73 Although the record is unclear regarding the precise amount of annual rent, counsel agreed at Oral Argument that it was not $875,000 and had increased in 2014 from $1.125 to $3 million. Supreme Court Oral Argument at 49:50–49:55. 74 Opening Br. at 40. 75 Id. 76 The proration language in Subsection (f) appears only at the end of the clause and in reference to the $875,000, not earlier in the formula.
18 unnecessary and duplicative. Second, practically speaking there is no need to prorate
costs, which are incurred at a particular time, or rental payments, which are already
separated into monthly amounts and received periodically. Accordingly, the only
reasonable interpretation is that only the $875,000 threshold must be prorated so that
it does not have an outsized effect in any particular year.
Although only a small portion of the 2014 Gucci rent accrued before the Sale
occurred on January 7, Festival incurred the entire defeasance cost on January 7.77
As Exit explained, the formula in Section (f) was intended to “protect Festival
against higher-than-expected loan costs, mainly loan interest costs,”78 which is
exactly what occurred when Festival cleared the Gucci Property’s mortgage in
January 2014 and incurred $6,250,155 in defeasance costs.
Moreover, Subsection (f) contemplated the possibility that Festival would
incur loan interest costs in installments or one single payment. The formula provides
that aggregate loan interest costs can either be “paid currently or accruing and
including any interest that accrues on interest.”79 Ultimately, Exit’s witness testified
that Festival collected only seven days of rent in 2014 and that Festival paid
77 App. to Answering Br. at B321–23 (Defeasance Report). 78 App. to Opening Br. at A1799 (Emanuel Cross Exam). 79 Id. at A382 (LPA).
19 $6,250,155 to purchase the securities that replaced the Gucci Property as collateral
when Festival defeased the Loan.80
Finally, during this Court’s oral argument, Exit’s counsel explained, in
conclusory fashion, that “if you are going to prorate [rent] you have to prorate both
[the rent and defeasance costs].”81 This statement demonstrates Exit’s
misunderstanding as to the purpose of Subsection (f)’s proration, which is to
maintain the same outcome whether the Gucci Property was sold early or late in a
calendar year. At no point during this Court’s proceedings or in the trial court could
Exit explain its position that Festival did not incur the entire defeasance cost in 2014.
Because Festival incurred the entire $6,250,155 defeasance cost in 2014 and
only collected seven days of rent in 2014, Festival’s loan interest costs exceeded the
sum of rental payments and the prorated $875,000, and the defeasance costs were
properly deducted. Accordingly, the net resale price82—the aggregate of the excess
loan costs and unchallenged deductions subtracted from the gross sales price—fell
below the difference between the 2014 Resale Price Threshold and 2014 Base Resale
Distribution Amount.83
80 Id. at A1801 (Emanuel Cross Exam). 81 Oral Argument at 48:45–48:53. 82 $108 Million Gross Sales Price – $12 Million in Proper Deductions = $96 Million Net Resale Price 83 $100 Million Resale Price Threshold – $3 Million Base Resale Distribution Amount = $97 Million Minimum price for Exit to receive a distribution.
20 B. The Court of Chancery’s good faith holdings regarding the General Partner and Schurgin are not addressed on appeal. Finally, we do not address Festival’s contention that Exit’s appeal is barred
because it failed to challenge the trial court’s holding as to the General Partner’s and
Schurgin’s good faith. According to Festival, the trial court suggested that the
General Partner’s subjective good faith conduct inherently barred any breach of
contract claim against the partnership itself.84 Because we hold that Festival
properly deducted the defeasance costs under Subsection (f) and Exit therefore is not
entitled to its Special Limited Partner Portion, we do not reach this argument.
IV. CONCLUSION
For the reasons set forth above, we AFFIRM the judgments of the Court of
Chancery set forth in its July 17, 2023 Post-Trial Memorandum Opinion and in its
August 4, 2023 Final Order and Judgment.
84 “Given Exit’s failure of proof [as to the General Partner and Schurgin’s bad faith]—and the LPA’s broadly enabling provisions animating the General Partner’s discretion to take deductions and exclusive authority to manage the Partnership—I likely could stop my analysis here.” Exit Strategy, LLC., 2023 WL 4571932, at *10.