*1 IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE AMERICAN HEALTHCARE )
ADMINISTRATIVE SERVICES, INC., )
AHAS HOLDINGS, INC., CHRISTINE )
SCHAFFER, CHRISTINE SCHAFFER )
REVOCABLE LIVING TRUST, GROVER )
LEE, GROVER LEE REVOCABLE LIVING )
TRUST, CHARLES E. LEE, CHARLES E. )
LEE LIVING TRUST, JACQUELINE C. )
LEE, JACQUELINE C. LEE LIVING )
TRUST, CHARLES E. LEE 2012 TRUST )
NO. 1, CHARLES E. LEE 2012 TRUST NO. )
2, JACQUELINE LEE 2012 TRUST NO. 1, )
and JACQUELINE LEE 2012 TRUST NO. 2, )
) Plaintiffs/Counterclaim-Defendants, )
) v. ) C.A. No. 2019-0793-JTL )
LANCE AIZEN, )
) Defendant/Counterclaim-Plaintiff. )
OPINION
Date Submitted: September 16, 2022 Date Decided: November 18, 2022 Thomas W. Briggs, Jr., Sabrina M. Hendershot, MORRIS, NICHOLS, ARSHT & TUNNELL LLP, Wilmington, Delaware; Christopher R. Rodriguez, Andrew D. Bluth, SINGLETON SCHREIBER, LLP, Sacramento, California; Attorneys for Plaintiffs/Counterclaim-Defendants .
Paul D. Brown, Joseph B. Cicero, Gregory E. Stuhlman, Aidan T. Hamilton, CHIPMAN BROWN CICERO & COLE, LLP, Wilmington, Delaware; Attorneys for Defendant/Counterclaim-Plaintiff .
LASTER, V.C.
A corporation sold assets to a buyer. The buyer placed a portion of the consideration in escrow to fund any purchase price adjustment and to secure indemnification obligations. The asset purchase agreement appointed the corporation’s former CEO as the sellers’ representative for purposes of making decisions about the escrowed funds.
The period for holding the escrowed funds has expired, and no claims against the escrowed funds remain outstanding. The buyer agrees it has no claim to the funds. The sellers’ stockholders, other than the former CEO, want the funds released from escrow and paid over to the corporation. They filed this action against the former CEO and asserted a series of claims, all of which are designed to compel the release of the escrowed funds.
The former CEO answered, raised affirmative defenses, and filed counterclaims, all of which are designed to obtain a determination that he has authority to keep the funds in escrow. The former CEO is embroiled in litigation with the selling corporation over his termination, and he believes that if the escrowed funds are released to the corporation, then the corporation will distribute them to its stockholders and render itself judgment-proof. The former CEO wants to keep the funds in escrow so that they can serve as a source of recovery if he prevails in his litigation. He contends that he has discretion as the sellers’ representative to decline to release the funds from escrow. He argues in the alternative that the court should order the funds to remain in escrow as a matter of equity.
This decision grants the selling stockholders’ motion for partial judgment on the pleadings. There is no contractual basis for maintaining the funds in escrow. All of the conditions for releasing the escrowed funds have been satisfied. The former CEO has discretionary authority over the release of the escrowed funds, but he must exercise that *3 authority consistent with the implied covenant of good faith and fair dealing, which means consistent with the purpose of the contract and the range of possibilities that the parties would have agreed upon if they had anticipated the issue and bargained over it when negotiating their agreement. Keeping the funds in escrow to serve as a source of recovery for a personal dispute is not a purpose that the parties would have agreed upon if they had anticipated the issue and addressed it during the original bargaining phase.
To the extent the former CEO seeks a remedy that would prevent the selling company from distributing the funds to its stockholders, he should seek that remedy from the court presiding over his lawsuit against the selling company. To ensure that the former CEO has the opportunity to seek that relief, and to avoid burdening a sister court with an emergency application, the order implementing this ruling will provide for the release of funds from escrow on a date not earlier than sixty days after the judgment in this case becomes final.
I. FACTUAL BACKGROUND
The facts are drawn from the operative pleadings and the documents they incorporate by reference. When evaluating a motion for judgment on the pleadings, the facts must be viewed in the light most favorable to the non-movant. In this case, that means the facts are viewed in the light most favorable to the former CEO.
A. The Company And Its Affiliates Before The Asset Sale
American Healthcare Administrative Services, Inc. (the “Company”) is a California corporation with its principal place of business in Rocklin, California. Grover Lee and Christine Schaffer founded the Company in 1986 to provide pharmacy benefits services to *4 self-insured employers, health plans, hospitals, school districts, labor unions, and health and welfare funds. Dkt. 50 ¶ 18. Today, the Company is a wholly owned subsidiary of AHAS Holdings, Inc. (“Parent”). Surprisingly, the parties dispute whether Parent is an entity that exists under Delaware law or California law. The dispute is immaterial to the contractual issues addressed by this decision, but given the procedural posture, the court assumes that Parent is a California entity. Lee and Schaffer comprised the original members of the board of directors of the Company (the “Company Board”) and the original members of the board of directors of Parent (the “Parent Board”).
B. Lee Aizen Joins The Company.
In 2010, the Company hired Lee Aizen as Vice President of Sales. Dkt. 58 at 8. Aizen asserts that he “added professionalism and non-family oversight” to an operation that was “losing money consistently” due to “mismanagement” and “personal expenses of the Lee family.” See Dkt. 58 at 8. This assertion does not matter to the outcome of the case, but given the procedural standard, I assume it to be true.
In 2012, Aizen became President of the Company. He later took on the title of CEO. Dkt. 58 at 8.
Aizen subsequently entered into an employment agreement dated November 21, 2014 (the “Employment Agreement”). See Dkt. 58 at 11. Surprisingly, it is not clear what entity served as the counterparty. The parties have not provided the court with a copy of the Employment Agreement, and two other documents point in different directions, with one document implying that the Company is the counterparty and the other implying that Parent is the counterparty. Compare Compl. Ex. D (Company) with Dkt. 53 Ex. A (Parent). *5 Aizen contends that his Employment Agreement was with the Company. That is the version of the facts most favorable to his position, so I assume it to be true.
Under the terms of the Employment Agreement, Aizen received base compensation of $550,000, up from his pre-agreement compensation of $354,750. He also received an option to purchase 1,000 shares of Company stock. Aizen borrowed $2.4 million from Parent to pay for the shares, documented by a promissory note. See Dkt. 53 ¶ 22; id. Ex. A at 1–2. The Employment Agreement provided that if the Company ever terminated Aizen’s employment as a result of a “Change of Control Transaction,” then the Company would (i) forgive any amounts payable under the promissory note and (ii) make additional payments to Aizen. Dkt. 58 at 10, 12, 15; accord Dkt. 56 at 6. Aizen also joined the Company Board and the Parent Board. Cf. Dkt. 50 ¶ 40; Dkt. 53 at 19.
In March 2017, the Parent Board approved an addendum to the Employment Agreement (the “Addendum”). The Addendum extended the term of Aizen’s employment through December 31, 2020 and increased his base salary to $750,000. Dkt. 53 Resp. No. 24.
C. The Asset Purchase Agreement And The Termination Agreement
Soon after the execution of the Addendum, Maxor Acquisition, Inc. (the “Buyer”) expressed interest in acquiring two of the Company’s lines of business. See Dkt. 50 Ex. B at A-1. The parties disagree about whether the two segments made up a majority of the Company’s business. That fact does not have any bearing on the outcome of the case, but Aizen denies that they did, so given the procedural standard, I accept his assertion.
On August 10, 2017, the Company reorganized its corporate structure in anticipation of selling the two lines of business. As part of the reorganization, Aizen exchanged his shares in the Company for shares in Parent. After the reorganization, Aizen, Lee, Schaffer, and their affiliates owned all of the stock in Parent. [1] Aizen owned ten percent of Parent’s equity, and Lee, Schaffer, and their affiliates owned the remaining ninety percent. See Dkt. 53 ¶ 37; accord Dkt. 54 Resp. No. 37.
On June 26, 2018, the Parent Board passed a resolution approving and authorizing the Company to proceed with the asset sale, which it defined as the “Transaction.” See Dkt. 53 Ex. A. The agreement governing the Transaction is an asset purchase agreement dated June 27, 2018. Dkt. 50 Ex. B (the “APA” or “Purchase Agreement”). The parties to the Purchase Agreement were the Buyer and a group defined as the “Seller Parties,” which consisted of the Company, Parent, and all of the Parent’s stockholders (including Aizen). See APA at 1. Aizen also became a party to the Purchase Agreement, but only in his capacity as the “Sellers’ Representative.” See id. In that capacity, Aizen acted as the agent of the Seller Parties for purposes of taking various actions under the Purchase Agreement. The use of a sellers’ representative is a common feature in transaction agreements, particularly where there are many selling stockholders, and it avoids the need to have *7 multiple parties sign off on the acts necessary to complete a deal. 1 ABA Mergers & Acqs. Comm., Model Stock Purchase Agreement with Commentary § 12.5 at 358 (2d ed. 2010) (explaining that appointment of sellers’ representative is for buyer’s convenience, particularly when buyer “would prefer to deal with one person”; stating that sellers “will want to assure that Sellers’ Representative acts only within prescribed bounds.”).
The Parent Board also approved an agreement terminating Aizen’s Employment Agreement (the “Termination Agreement”). The resolution recited that “in connection with the Transaction, the Aizen Employment Agreement shall be terminated . . . pursuant to the [the Termination Agreement].” Dkt. 53 Ex. A § II. Under the Termination Agreement, Aizen became entitled to receive a range of benefits if the Transaction closed successfully, including (i) a transaction bonus, (ii) complete forgiveness of Parent’s loan to Aizen, (iii) a tax gross-up payment for the loan forgiveness, and (iv) a mutual release between Aizen and Parent for all actions that occurred before closing. Id.
The Termination Agreement contemplated a handsome payout for Aizen. He stood to receive a $9 million “Change of Control Bonus” plus additional consideration of $11.8 million to be paid monthly in $500,000 increments. See Dkt. 50 Ex. D §§ 1–4. Aizen also became entitled to a six-month consulting engagement with the Buyer. See APA at 1 (Background Statement); see also id. § 7.1(r).
D. The Transaction Closes.
The Transaction closed on September 17, 2018. The Buyer paid $55 million in exchange for “all of the Seller’s right, title, and interest as of the Closing in all properties, *8 assets, rights and interests of any kind, whether tangible or intangible, real or personal” that related to the two lines of business that the Company sold. See APA § 2.1(a).
At closing, the Buyer placed $5.5 million of the purchase price in escrow to secure the Company’s contingent financial obligations under the Purchase Agreement (the “Original Escrow Amount”). See id. § 2.5(a)(i). Of this amount, $5 million secured the Company’s contingent obligation to make indemnification payments. The Purchase Agreement referred to this portion of the Original Escrow Amount as the “Indemnity Escrow Amount.” See id. The remaining $500,0000 secured the Company’s contingent obligation to make a purchase price adjustment. The Purchase Agreement referred to this portion of the Original Escrow Amount as the “Adjustment Escrow Amount.” See id.
The parties agreed that the funds would be held in an escrow account governed by the terms of an escrow agreement. See APA Ex. A (the “Escrow Agreement” or “EA”). The Escrow Agreement recited that the escrowed funds were “intended to provide assurance to Buyer in respect of certain obligations of the Seller Parties set forth in the Purchase Agreement.” EA at 1 (Recitals). The Escrow Agreement also stated that the escrowed funds could be used only for their designated purpose, i.e. , to satisfy an indemnification claim or purchase adjustment. Id. § 6(e) (“No Escrow Funds held in one Escrow Account shall be used for the purposes of the other Escrow Account or for any other purposes other than as set forth in this Agreement.”).
At closing, the Company paid Aizen the $9 million bonus that he was due under the Termination Agreement. See Dkt. 58 at 9.
E. Litigation Ensues.
After the Transaction closed, the relationship between Grover, Schaffer, and Aizen soured. On October 16, 2018, Aizen resigned from the Company Board and the Parent Board. See Dkt. 50 ¶ 40; accord Dkt. 53 Resp. No. 40. On October 23, he filed suit against the plaintiffs in the United States District Court for the District of New Jersey. See Aizen v. Am. Healthcare Admin. Servs., Inc. , No. 3:18-CV-15195-BRM-DEA (D.N.J. Oct. 23, 2018) (the “New Jersey Action”). Aizen claimed that the defendants had failed to pay him amounts to which he was entitled under the Termination Agreement.
On November 6, 2018, the Company terminated Aizen. On November 19, the Company and Parent filed a complaint against Aizen in the Superior Court of California. See Am. Healthcare Admin. Servs., Inc. v. Aizen , No. S-CV-0042143 (Cal. Sup. Ct. Nov. 19, 2018) (the “California Action”). The complaint asserted claims for breach of fiduciary duty, fraudulent nondisclosure, intentional misrepresentation, conversion, declaratory relief, and breach of the covenant of good faith and fair dealing. As relief, the Company asked for a declaration that the Termination Agreement was “void and unenforceable” and an injunction compelling Aizen to return all consideration he received under that agreement. Dkt. 50 ¶ 46. Aizen did not respond, and the Company obtained a default judgment against him that included damages of $9.5 million (the “California Default Judgment”).
By letter dated February 13, 2019, the Company informed the Buyer of Aizen’s termination. Notwithstanding the California Default Judgment, Aizen’s counsel sent a letter to the Buyer that same day disputing the validity of the termination. Dkt. 50 Ex. E. *10 at 1. Aizen’s counsel also instructed the Buyer to transfer the escrowed funds to an escrow account under Aizen’s control, reasoning as follows:
Maxor should be aware that Mr. Aizen has specifically alleged in his pending lawsuit that, inter alia , Ms. Schaffer and other AHAS Defendants fraudulently induced Mr. Aizen to effectuate the asset purchase transaction with the specific intent of later denying him his contractually-obligated [sic] payments under that transaction, and that the AHAS Defendants will fraudulently dissipate and convert any further payments made by Maxor . . . . Therefore, in order to prevent any such fraudulent dissipation and converstion [sic], as previously requested by Mr. Aizen as the designated Seller’s [sic] Representative, Mr. Aizen again requests that all remaining payments due to American Healthcare and/or [the Parent] under the APA, including the funds currently held in escrow under the APA , be wired to an escrow account created by Mr. Aizen. Mr. Aizen will hold all such funds in escrow pending resolutions of his on- going disputes with the AHAS Defendants.
Id. at 3 (emphasis added). Aizen thus took the position that he was a creditor of the Company, that there was a risk that the Company would distribute the escrowed funds to its stockholders as a fraudulent conveyance, and that he was entitled to control the funds pending resolution of his claims.
On September 26, 2019, the federal court dismissed the New Jersey Action for lack
of jurisdiction.
See Aizen v. Am. Healthcare Admin. Servs., Inc.
,
On October 2, 2019, the plaintiffs to this action filed their original complaint. Based on the California Default Judgment, they sought to revoke Aizen’s authority to act as the Sellers’ Representative. See Dkt. 1. They also sought expedited relief on the theory that Aizen had attempted and would continue to attempt to transfer the escrowed funds to his control.
Shortly after the court granted expedition, Aizen moved to vacate the California Default Judgment. On November 13, 2019, the parties agreed to stay the proceedings in this action pending resolution of that motion. See Dkt. 37.
In addition to staying this action, the parties agreed to replace the Buyer-controlled escrow account with a replacement account jointly established by Delaware counsel (the “Delaware Escrow Account”). Id. ¶ 2. Their stipulation provided that any funds in the Delaware Escrow Account only would be released to the Company based on an order from this court or joint instructions from Delaware counsel. Id. The parties expressly preserved their positions regarding the underlying dispute. Id. ¶ 5 (“By entering into the Stay, neither Plaintiffs nor Defendant waive any, and expressly preserve all rights, claims and defenses.”).
The court entered the parties’ stipulation as an order. See Dkt. 38 (the “Stay and Escrow Order”). In accordance with the Stay and Escrow Order, the parties entered into a new escrow agreement with Wilmington Trust, N.A. as escrow agent. Dkt. 50 Ex. F. F. Aizen Refuses To Release Funds From Escrow.
On January, 31 2020, the California court granted Aizen’s motion to vacate the California Default Judgment. The parties spent the next twelve months negotiating with the Buyer over a post-closing price adjustment and claims for indemnification. See Dkt. 58 at 14. On December 17, the parties and the Buyer reached agreement on a payment from the original escrow account to the Buyer. With that issue resolved, the Buyer released $5,200,643.26 (the “Remaining Escrow Amount”) to the Delaware Escrow Account. The *12 Buyer makes no claim to the Remaining Escrow Amount. The only dispute is between Aizen and the plaintiffs.
By letter dated December 23, 2020, the plaintiffs’ Delaware counsel asked Aizen’s Delaware counsel to release the Remaining Escrow Amount. See Dkt. 50 Ex. G. By letter dated January 25, 2021, Aizen’s Delaware counsel declined, taking the position that the Remaining Escrow Amount should remain in escrow until the final disposition of the California Action. Aizen’s counsel reasoned as follows:
Based on the record as it exists today, no further release is appropriate at this time. Indeed, the entire point of the Stipulation and Order and the new joint Delaware Escrow was to allow those funds to be protected in the hands of a neutral party while the parties [sic] claims moved forward, which is occurring in California at this time. Thus, [the Company’s] request is premature and unjustified. The Delaware Action should remain stayed and the funds in the joint Delaware Escrow until the California action has been fully adjudicated. . . . As you may know, the parties to the California action have made significant claims against each other and these funds should be available to satisfy any successful claims asserted in California. . . . The request to distribute the funds—given the pending allegations in the California action—raises serious issues about the lawfulness and motives of the request.
Dkt. 50 Ex. H at 2.
Elaborating, Aizen’s Delaware counsel asserted that preserving Aizen’s access to the Remaining Escrow Amount was necessary to protect Aizen’s ability to recover in the California Action. Counsel asserted that “[the Company] has little to no ongoing business yet continues to dissipate assets, including through excessive and unjustified salaries, which constitute breaches of fiduciary duties by Grover Lee and Christine Schaffer.” Id. at 2–3. Aizen’s counsel refused to release the Remaining Escrow Amount absent “sufficient evidence about [the Company’s] financial condition and performance to ensure any release *13 will not be in furtherance of the foregoing wrongful acts, and to ensure that [the Company] is not already technically insolvent in view of its liquidated obligations.” Id. at 3 (citing the Delaware Uniform Fraudulent Transfer Act, 6 Del. C. § 1301 et seq. ).
G. This Dispute
With the California Default Judgment vacated, this court lifted the stay. See Dkt. 48. The plaintiffs filed an amended complaint in which they alleged that Aizen had improperly refused to release the Remaining Escrow Amount to the Company. See Dkt. 50. Aizen filed an answer, raised affirmative defenses, and asserted counterclaims for breach of contract. See Dkt. 53.
The plaintiffs then moved for partial judgment on the pleadings. See Dkt. 56. They seek declarations that (i) the Company is entitled to the release of the Remaining Escrow Amount, (ii) Aizen has no authority to retain the Remaining Escrow Amount, and (iii) Aizen cannot preserve the Remaining Escrow Amount in escrow as a form of pre- judgment attachment. The plaintiffs seek a decree of specific performance compelling Aizen to issue joint instruction to the escrow agent to release the Remaining Escrow Amount to the Company. Id. at 4.
II. LEGAL ANALYSIS
The plaintiffs have moved for partial judgment on the pleadings under Rule 12(c).
“After the pleadings are closed but within such time as not to delay the trial, any party may
move for judgment on the pleadings.” Ct. Ch. R. 12(c). “A motion for judgment on the
pleadings may be granted only when no material issue of fact exists and the movant is
*14
entitled to judgment as a matter of law.”
Desert Equities, Inc. v. Morgan Stanley Leveraged
Equity Fund, II, L.P.
,
This case primarily presents issues of contract interpretation. “[J]udgment on the
pleadings . . . is a proper framework for enforcing unambiguous contracts because there is
no need to resolve material disputes of fact.”
NBC Universal v. Paxson Commc’ns Corp.
,
“When interpreting a contract, the role of a court is to effectuate the parties’ intent.”
Lorillard Tobacco Co. v. Am. Legacy Found.
, 903 A.2d 728, 739 (Del. 2006). Absent
ambiguity, the court “will give priority to the parties’ intentions as reflected in the four
corners of the agreement, construing the agreement as a whole and giving effect to all its
provisions.”
In re Viking Pump, Inc.
,
“Unless there is ambiguity, Delaware courts interpret contract terms according to
their plain, ordinary meaning.”
Alta Berkeley VI C.V. v. Omneon, Inc.
,
“In upholding the intentions of the parties, a court must construe the agreement as a
whole, giving effect to all provisions therein.”
E.I. du Pont de Nemours & Co. v. Shell Oil
Co.
, 498 A.2d 1108, 1113 (Del. 1985). “[T]he meaning which arises from a particular
portion of an agreement cannot control the meaning of the entire agreement where such
inference runs counter to the agreement’s overall scheme or plan.”
Id.
“[A] court
interpreting any contractual provision . . . must give effect to all terms of the instrument,
must read the instrument as a whole, and, if possible, reconcile all the provisions of the
instrument.”
Elliott Assocs., L.P. v. Avatex Corp.
,
“Contract language is not ambiguous merely because the parties dispute what it means. To be ambiguous, a disputed contract term must be fairly or reasonably susceptible to more than one meaning.” Alta Berkeley , 41 A.3d at 385 (footnote omitted). If the language of an agreement is ambiguous, then the court “may consider extrinsic evidence to resolve the ambiguity.” Salamone , 106 A.3d at 374. Permissible sources of extrinsic evidence may include “overt statements and acts of the parties, the business context, prior dealings between the parties, and business custom and usage in the industry.” Id. (cleaned up). A court may consider “evidence of prior agreements and communications of the parties as well as trade usage or course of dealing.” Eagle Indus., Inc. v. DeVilbiss Health Care, Inc. , 702 A.2d 1228, 1233 (Del. 1997). “When the terms of an agreement are ambiguous, any course of performance accepted or acquiesced in without objection is given great weight in the interpretation of the agreement.” Sun-Times Media Grp. v. Black , 954 *16 A.2d 380, 398 (Del. Ch. 2008) (cleaned up). “[T]he private, subjective feelings of the negotiators are irrelevant and unhelpful to the Court’s consideration of a contract’s meaning, because the meaning of a properly formed contract must be shared or common.” United Rentals, Inc. v. RAM Hldgs., Inc. , 937 A.2d 810, 835 (Del. Ch. 2007) (footnote omitted).
A. The Company’s Rights To The Remaining Escrow Amount
The plaintiffs seek a declaratory judgment that the Company is entitled to the immediate release of the Remaining Escrow Amount under the terms of the Purchase Agreement. This decision grants that aspect of the plaintiffs’ motion.
1. The Plain Language Of The Escrow Release Provisions The analysis turns on the plain language of the provisions in the Purchase Agreement that govern the release of the Original Escrow Amount. Recall that the Original Escrow Amount has two components. The smaller component of $500,000 is the Adjustment Escrow Amount. The larger component of $5 million is the Indemnity Escrow Amount. Section 2.7(b) of the Purchase Agreement governs the release of the Adjustment Escrow Amount. Section 6.4 of the Purchase Agreement governs the release of the Indemnity Escrow Amount. This decision refers to them together as the “Escrow Release Provisions.”
The plain language of Section 2.7(b) governs the release of any amounts that might have been attributable to the Adjustment Escrow Amount. The relevant language states:
Sellers’ Representative and the Buyer shall send joint written instruction to the Escrow Agent to disburse to the Buyer a portion of the Adjustment Escrow Amount equal to the payment (if any) owed to the Buyer under this *17 Section 2.7(b) [which governs any post-closing adjustment to the transaction consideration] and the remaining Adjustment Escrow Amount (if any) to the Seller, to the account designated on the Closing Statement.
APA § 2.7(b). The plain language of this section contemplates that after any post-closing pricing adjustment has been determined, the Sellers’ Representative and the Buyer will send joint written instructions to release any remaining amount to the Company.
When the parties reached agreement with the Buyer on the Remaining Escrow Amount, they necessarily reached agreement on “the payment (if any) owed to the Buyer” under the section of the Purchase Agreement governing the post-closing adjustment. Once that happened, Aizen was obligated in his capacity as Sellers’ Representative to join with the Buyer in sending “joint written instructions to the Escrow Adjustment to disburse . . . the remaining Adjustment Escrow Amount (if any) to the Seller.”
The plain language of Section 6.4 calls for the release of any amounts that might have been attributable to the Indemnity Escrow Amount. The relevant language states:
Pursuant to the terms of the Escrow Agreement, on the date which is 15 months after the Closing Date (the “Escrow Release Date”), the Buyer and the Sellers’ Representative shall send joint written instruction to the Escrow Agent to release the remaining Indemnity Escrow Amount (and all interest accrued thereon) to Seller as directed by the Buyer and the Sellers’ Representative to the Escrow Agent; provided that, any amount of the Indemnity Escrow Amount subject to the Reserve (as defined in the Escrow Agreement) shall only be released in accordance with the Escrow Agreement.
Id. § 6.4.
The language of Section 6.4 contemplates that the Company will receive the Indemnity Escrow Amount when three requirements are met. Each has been satisfied:
• The Transaction closed on September 17, 2018.
• More than fifteen months have passed since the closing date.
• As a result of the agreement over the Remaining Escrow Amount, there is no dispute about the amount of any “Reserve” that might be required. As soon as these requirements were met, Aizen became obligated in his capacity as Sellers’ Representative to join with the Buyer in sending “joint written instructions to the Escrow Agent to release the remaining Indemnity Escrow Amount (and all interest accrued thereon) to Seller.”
Putting the Escrow Release Provisions together results in Aizen having a contractual obligation as Sellers’ Representative to issue the instructions necessary to release the Remaining Escrow Amount to the Company. That is what the plain language of the Escrow Release Provisions requires.
2. The Exercise Of Contractual Discretion And The Implied Covenant Of Good Faith And Fair Dealing
To avoid the result mandated by the plain language of the Escrow Release Provisions, Aizen contends that Section 10.10(a) of the Purchase Agreement grants him “sole and absolute discretion” to determine whether it is “necessary and proper” to disburse the escrowed funds. Dkt. 58 at 28. He maintains that he can exercise his discretionary authority to override the Escrow Release Provisions. That argument is not tenable.
Section 10.10(a) of the Purchase Agreement establishes the scope of Aizen’s authority as Sellers’ Representative. The operative language states:
Each Seller Party hereby irrevocably appoints the Sellers’ Representative as the designated representative of such Seller Party, as applicable, with full power and authority, including power of substitution, acting in the name of and for and on behalf of such Seller Party to do all things and to take all actions under or related to this Agreement that, in the sole and absolute *19 discretion of the Sellers’ Representative, the Sellers’ Representative considers necessary or proper, including . . .
(v) to receive payments under or pursuant to this Agreement and disburse the same to the Seller Parties, as contemplated by this Agreement, and (vi) on behalf of each such Seller Party to enter into any agreement, instrument or other document to effectuate any of the foregoing, which shall have the effect of binding each such Seller Party as if such Person has personally entered into such agreement, instrument or document.
APA § 10.10(a) (formatting added). Aizen focuses on the sentence that grants him the authority “to do all things and to take all actions under or related to this Agreement that, in the sole and absolute discretion of the Sellers’ Representative, the Sellers’ Representative considers necessary or proper,” and he combines it with the specific reference to receiving and disbursing payments under or pursuant to the Purchase Agreement. He asserts that he has made a judgment, in his sole discretion, that “it would not be necessary or proper to release the escrow funds to the Plaintiffs/Counterclaim-Defendants.” Dkt. 58 at 28.
Aizen’s interpretation of Section 10.10 is not a reasonable one. Section 10.10 vests Aizen with the discretion to carry out his post-closing duties and obligations as Sellers’ Representative. That discretion extends to his duties and obligations under the Escrow Release Provisions, but it does not give Aizen the authority to ignore a mandatory provision of the Purchase Agreement governing the release of the escrowed funds. It would create an internal contradiction to read the Purchase Agreement as mandating that Aizen release the escrowed funds, while at the same time granting Aizen the authority to ignore that mandate. Aizen cannot cherry-pick the contractual provisions that he finds advantageous, while simultaneously ignoring the contractual obligations that he finds inconvenient.
Aizen’s interpretation also ignores constraints that the implied covenant of good faith and fair dealing imposes on a party’s exercise of discretion. The Delaware Supreme Court has summarized the implied covenant concisely as follows:
The implied covenant is inherent in all contracts and is used to infer contract terms to handle developments or contractual gaps that . . . neither party anticipated. It applies when the party asserting the implied covenant proves that the other party has acted arbitrarily or unreasonably, thereby frustrating the fruits of the bargain that the asserting party reasonably expected. The reasonable expectations of the contracting parties are assessed at the time of contracting.
Dieckman v. Regency GP LP
,
When determining whether to invoke the implied covenant, a court “first must
engage in the process of contract construction to determine whether there is a gap that
needs to be filled.”
Allen v. El Paso Pipeline GP Co., L.L.C.
,
“If a contractual gap exists, then the court must determine whether the implied
covenant should be used to supply a term to fill the gap. Not all gaps should be filled.”
Allen
,
But contractual gaps may exist for other reasons. “No contract, regardless of how
tightly or precisely drafted it may be, can wholly account for every possible contingency.”
Amirsaleh v. Bd. of Trade of City of N.Y., Inc.
,
Equally important, “parties occasionally have understandings or expectations that
were so fundamental that they did not need to negotiate about those expectations.”
Katz v.
*22
Oak Indus. Inc.
, 508 A.2d 873, 880 (Del. Ch. 1986) (Allen, C.) (quoting
Corbin on
Contracts
§ 570, at 601 (Kaufman Supp. 1984)). “The implied covenant is well-suited to
imply contractual terms that are so obvious . . . that the drafter would not have needed to
include the conditions as express terms in the agreement.”
Dieckman
,
Applying these principles, the Delaware Supreme Court has made clear that the
implied covenant of good faith and fair dealing restrains a party’s exercise of discretion
under an agreement. The general rule is that the implied covenant requires a party in a
contractual relationship to refrain from arbitrary or unreasonable conduct which has the
effect of preventing the other party to the contract from receiving the fruits of the bargain.
That rule operates with special force “when a contract confers discretion on a party.”
Glaxo
Grp. Ltd. v. DRIT LP
,
Moreover, the Delaware Supreme Court has made clear that the use of the term “
sole
discretion,” does not eliminate the implied duty and grant a party carte blanche to exercise
discretion however it might wish. Addressing this issue specifically, the Delaware Supreme
Court has explained that “the mere vesting of ‘sole discretion’ did not relieve the [holder]
of its obligation to use that discretion consistently with the implied covenant of good faith
and fair dealing.”
Miller v. HCP Trumpet Invs., LLC
,
The question then arises as to what it means to exercise discretion “in good faith”
for purposes of the implied covenant. The implied contractual term “emphasizes
faithfulness to an agreed common purpose and consistency with the justified expectations
of the other party.” Restatement (Second) of Contracts § 205 cmt. a (Am. L. Inst. 1981),
Westlaw (database updated Oct. 2022). A reviewing court does not simply introduce its
own notions of what is “fair or reasonable under the circumstances.”
Allen
, 113 A.3d at
184. When used with the implied covenant, the term “good faith” contemplates
“faithfulness to the scope, purpose, and terms of the parties’ contract.”
Gerber v. Enter.
Prods. Hldgs., LLC
, 67 A.3d 400, 419 (Del. 2013) (cleaned up),
overruled on other
grounds by Winshall v. Viacom Int’l, Inc.
,
“The implied covenant seeks to enforce the parties’ contractual bargain by implying only those terms that the parties would have agreed to during their original negotiations if they had thought to address them.” Id. at 418 (cleaned up). When applied to an exercise of discretion, this means that the exercise of discretionary authority must fall within the range *24 of what the parties would have agreed upon during their original negotiations, if they had thought to address the issue.
In the context of this case, the Purchase Agreement obligated Aizen to facilitate the release to the Company of any portion of the Original Escrow Amount that remained after any purchase price adjustment or the satisfaction of any indemnification obligations. Section 10.10(a) grants Aizen the authority to make decisions and take actions to fulfill the purpose of the Purchase Agreement, which includes the Escrow Release Provisions. The Escrow Release Provisions contemplate that Aizen would work with the Buyer to release the funds to the Company. At bottom, Aizen must use his contractual discretion in a manner that is faithful to (in the sense of consistent with) “the scope, purpose, and terms of the parties’ contract.” Id. at 419 (cleaned up) .
A further contractual indication of the purpose underlying Aizen’s authority is the language of Section 10.10(a), which authorized Aizen to act “in the name of and for and on behalf of” the Seller Parties. See APA § 10.10(a); see also Behalf , Black’s Law Dictionary, Westlaw (defining “on behalf of” to mean “in the name of, on the part of, as the agent or representative of.”). Aizen was empowered to use “sole and absolute discretion” to act in the name of and on behalf of the Seller Parties. He was not empowered to use his discretion to act on behalf of himself as a contingent creditor, nor on behalf of creditors generally. By exercising discretion for that purpose, Aizen has exceeded his authority under the Purchase Agreement.
Thus, the court will enter a final order declaring that the Company is entitled under the Purchase Agreement to the Remaining Escrow Amount.
B. The Cessation Of Aizen’s Authority
The plaintiffs next seek a declaratory judgment as to whether Aizen continues to retain power or authority over the Remaining Escrow Amount in his capacity as Sellers’ Representative. The plaintiffs’ position is simple. Given the analysis in the preceding section, Aizen no longer has any authority to make determinations regarding the Remaining Escrow Amount; his sole obligation is to facilitate the release of the Remaining Escrow Amount. Aizen makes four attempts to establish his authority to retain the Remaining Escrow Amount. None is persuasive.
1. Duties Under The Stay And Escrow Order
First, Aizen denies that he has any current duty to release the Remaining Escrow Amount to the Company under the Escrow Release Provisions. He claims that he “performed his obligations under Section 6.4 in negotiating and then providing joint instructions with [Buyer] to the Escrow Agent to release the remaining Indemnity Escrow Amount to the Delaware Escrow.” Dkt. 58 at 36. He argues that the Stay and Escrow Order supplanted the Escrow Release Provisions such that only the language of the Stay and Escrow Order now controls. Id.
This argument runs contrary to the plain language of the Stay and Escrow Order. That order contemplated that the parties would jointly instruct Buyer to release the Remaining Escrow Amount to the Delaware Escrow Account. See Dkt. 38. The order further provides that the Remaining Escrow Amount could only be released upon “(1) an order of this Court, or (2) joint instructions by the Parties’ respective Delaware counsel.” Id. ¶ 2. The order expressly stated that “[b]y entering into the [Stay and Escrow Order], *26 neither Plaintiffs nor Defendant waive any, and expressly preserve all rights, claims and defenses.” Id. ¶ 5.
The Stay and Escrow Order was an administrative mechanism to get the Buyer out of the picture and place the Remaining Escrow Amount in an account controlled by Delaware counsel, rather than an account controlled by Aizen. The Stay and Escrow Order did not displace the parties’ commitments in the Purchase Agreement about when escrowed amounts would be released. Those terms continue to apply.
2. Duties Under The Sellers’ Representative Provision Next, Aizen asserts that he has “continuing duties as Sellers’ Representative” that include “the duty to ensure performance of the APA, [the Termination Agreement], and related covenants.” Dkt. 58 at 27 (formatting omitted). Aizen contends that his duties
include the duty to protect the common interest of all Selling Parties, including himself, in the fair and equitable adjudication of competing claims to the escrow fund, and therefore in maintaining that fund intact while the parties’ respective claims to the fund are adjudicated in the first-filed California Action.
Id. at 30. Aizen argues that his “continuing duties” to make decisions as Sellers’ Representative do not cease simply because the other Seller Parties disagree with his decision. For that proposition, he relies on Section 10.10(d)(i) of the Purchase Agreement, which states: “Each Seller Party hereby agrees that: in all matters in which action by the Sellers’ Representative is required or permitted, the Sellers’ Representative is authorized to act on behalf of such Seller Party, notwithstanding any dispute or disagreement among the Seller Parties . . . .” APA § 10.10(d)(i) (formatting omitted).
Aizen is correct that the existence of disputes “among the Seller Parties” does not vitiate his authority. It is possible to envision circumstances when Aizen might validly argue that he has a duty to retain the Remaining Escrow Amount. For example, if there was a bona fide dispute among the Seller Parties as to the allocation of the Remaining Escrow Amount, then Aizen might retain the funds in a manner analogous to interpleader.
The current case is different. Aizen has not identified a valid reason to retain the Remaining Escrow Amount based on concern for the Seller Parties qua Seller Parties. Aizen seeks to retain the Remaining Escrow Amount to protect the rights of a contingent creditor who is pursuing unrelated litigation against the Company. Coincidentally, that plaintiff happens to be Aizen, but otherwise there is no connection between Aizen’s claims and the Remaining Escrow Amount. As to the escrowed funds, Aizen is no differently situated than a third party with an unrelated claim against the Company.
What Aizen is trying to do is use the funds as a litigation escrow for his personal claims regarding his termination. The plain language of the Purchase Agreement makes clear that the Original Escrow Amount was held back from the purchase price for two specific purposes: to fund a purchase price adjustment and to secure the Seller Parties’ indemnification obligations. See id. § 2.5(a)(i). The Purchase Agreement did not contemplate the use of those funds for any other purpose, such as a litigation escrow.
The plain language of the Escrow Agreement supports this reading. Its recitals state that the funds were placed in escrow “to provide assurance to Buyer in respect of certain obligations of the Seller Parties set forth in the Purchase Agreement.” EA at 1 (Recitals). The Escrow Agreement does not contemplate other uses for the funds. The Escrow *28 Agreement even states that “[n]o Escrow Funds held in one Escrow Account shall be used for the purposes of the other Escrow Account or for any other purposes other than as set forth in this Agreement.” Id. § 6(e). Under this provision, the funds comprising the Adjustment Escrow Amount cannot be used for indemnification claims, and the funds comprising the Indemnity Escrow Amount cannot be used for a purchase price adjustment. The proscription on cross utilization makes it all the more clear that the parties had no intention of using the escrowed funds for a different, unrelated purpose, such as a litigation escrow.
3. A Broader Appeal To Equity
In a related argument in favor of preserving his control over the Remaining Escrow Amount, Aizen makes a broader appeal to equity. He asserts that “[t]he reasons for creating the Delaware Escrow remain and provide ample reason to continue the safeguarding of the funds until the California Action is resolved.” Dkt. 58 at 42. Through this argument, Aizen openly seeks an injunction that would constitute a form of pre-judgment attachment. Aizen is not entitled to that form of relief from this court.
“Equitable relief that has the sole function and effect of freezing [a litigant’s] assets
in place to make them available to satisfy any possible future money judgment . . . is not
within the proper exercise of the Court’s power.”
Uragami v. Century Int’l Credit Corp.
,
The principle is a venerable one, with Chancellor Wolcott having answered the same question a century ago:
May the writ of injunction be employed in equity to accomplish the same purpose which is served by the writ of foreign attachment at law? Here the main defendant is a nonresident; he is charged with a breach of trust; property in the names of others, but alleged on information and belief to be his, is found in this state; this property is in no wise involved in the suit; and it is sought by a preliminary injunction to arrest it in the hands of its present holders to await the final decree, and then in some way to compel it to respond to the complainant in case the decree is in its favor. In its last analysis, is not this (eliminating for the moment the material circumstance that title to the shares is in persons other than the principal defendant) an employing of the injunction writ in equity as a foreign attachment is employed at law? The writ cannot be so employed. No authority can be found which allows it.
Cities Serv. Co. v. McDowell
,
There is a narrow exception under which a court of equity can grant injunctive relief
to protect its jurisdiction over property that a defendant otherwise would remove from the
jurisdiction and place outside the court’s control.
See, e.g.
,
Brinati v. TeleSTAR, Inc.
, 1985
WL 44688, *5 (Del. Ch. Sept. 3, 1985) (granting preliminary injunction protecting court’s
jurisdiction over assets by restraining defendants from expending those funds, other than
for purposes of winding up or liquidating);
Eberhardt v. Christiana Window Glass Co.
, 74
*30
A. 33, 36–37 (Del. Ch. 1909) (issuing preliminary injunction to preserve fund in
controversy “to await the final determination of the cause”). If the property is unique, then
the court may issue injunctive relief to preserve its jurisdiction to address claims relating
to the property. If the property is money, then there must be a concrete threat that the
defendant intends to render itself insolvent and judgment-proof.
See Mitsubishi Power Sys.
Ams., Inc. v. Babcock & Brown Infrastructure Grp. US, LLC
,
Aizen claims that the Company is “a non-functioning, defunct, and likely insolvent business that was and remains continually beset by self-dealing by its remaining family member officers and directors ( i.e. , the plaintiffs), which threatens its future ability to pay any creditors, including Aizen.” See Dkt. 58 at 19. The Company has not attempted to refute these claims. See Am. Healthcare Admin. Sys. , C.A. 0793 (Del. Ch. Sept. 27, 2022) (TRANSCRIPT); Dkt. 56; Dkt. 60. With the record viewed in the light most favorable to Aizen, it is reasonable to infer that the Company will be judgment-proof if it receives and then distributes the Remaining Escrow Amount.
The shortcoming in Aizen’s analysis is that he has only identified a potential source
of irreparable harm. He has not addressed the other two elements necessary to earn a
*31
preliminary injunction, such as a probability of success on the merits or a balancing of the
equities that favors injunctive relief.
See Revlon, Inc. v. MacAndrews & Forbes Hldgs.,
Inc.
,
Aizen therefore has not provided a basis for the court to issue relief that would function as a pre-judgment attachment. Instead, the court will nod to equity in its grant of relief. As discussed below, as a condition of granting the plaintiffs’ request for an order of specific performance compelling Aizen to instruct the escrow agent to release the Remaining Escrow Amount, the court will delay the obligation to comply with that order for sixty days so that Aizen can seek relief against a potential wrongful distribution from the California Court.
4. Consideration For A Non-Compete Provision Aizen’s final argument is easily addressed. Aizen claims that the Remaining Escrow Amount cannot be released because the funds serve as consideration for a four-year non- compete between Aizen and the Buyer. See Dkt. 58 at 9. Aizen correctly observes that Section 6.8 of the Purchase Agreement imposed a four-year non-compete in favor of the Buyer. See APA § 6.8(b). But nothing links that obligation to any of the escrowed amounts. The escrowed funds were placed in escrow for specific purposes. They do not represent compensation for a non-compete.
C. Aizen’s Unclean Hands Defense
Aizen also invokes the equitable defense of unclean hands.
See
Dkt. 58. That
doctrine applies the maxim of equity that “[h]e who comes into equity must come with
clean hands.” 1 John Norton Pomeroy,
Equity Jurisprudence
§ 397 at 737 (4th ed. 1918).
The maxim “dates back to the late eighteenth century when it was gleaned by a British
barrister from a collection of cases in which plaintiffs had been denied relief on the basis
of their inequitable conduct.”
Nakahara v. NS 1991 Am. Tr.
,
“The question raised by a plea of unclean hands is whether the plaintiff’s conduct is
so offensive to the integrity of the court that his claims should be denied, regardless of their
merit.”
Gallagher v. Holcomb & Salter
,
Unclean hands does not operate as a free-floating, bad-person defense based on
conduct wholly unconnected to the facts of the case. “To bar relief, plaintiff’s hands must
be rendered unclean by reason of some conduct relating directly to the matter in
controversy.”
Walter v. Walter
,
[T]he doctrine of unclean hands does not affect all “sinners” and does not comprehend all “moral infirmities,” the reason being that courts of equity are not primarily engaged in the moral reformation of the individual citizen; the *33 misconduct must be serious enough to justify a court’s denying relief on an otherwise valid claim, for even equity does not require saintliness.
27A Am. Jur. 2d Equity § 21 (footnotes omitted), Westlaw (database updated Nov. 2022).
“[U]nclean hands is a doctrine designed to protect the integrity of a court of equity, not a
weapon to be wielded by parties seeking to excuse their own inequitable behavior by
pointing out a trifling instance of impropriety by their counterpart . . . .”
Portnoy v. Cryo-
Cell Int’l, Inc.
,
“In fashioning a remedy for unclean hands, the Court has a wide range of discretion
in refusing to aid the ‘unclean litigant.’”
Merck & Co., Inc. v. SmithKline Beecham Pharm.
Co.
,
1. The Availability Of Unclean Hands As A Defense A threshold question exists as to whether Aizen can invoke the defense of unclean hands in response to an action for breach of contract. “In a smattering of recent decisions, this court has endorsed to varying degrees the proposition that equitable defenses are not *34 available to defend against legal claims.” XRI Inv. Hldgs. LLC v. Holifield , 2022 WL 4350311, at *35 (Del. Ch. Sept. 19, 2022). The XRI decision devoted many pages to explaining why the broad assertion that equitable defenses cannot be raised to defeat legal claims constitutes an erroneous generalization. Id. at *35–47. Many equitable defenses can be used to defeat legal claims. Id. at *36.
Whether a party can raise a particular equitable defense in response to a legal claim depends on the equitable defense. One key consideration is the nature of the relief sought. If, for example, a party seeks an equitable remedy—such as specific performance or a permanent injunction—then a court may consider equitable defenses in deciding whether to award equitable relief. Another key consideration, regardless of the relief sought, is whether the equitable defense originated as a form of “equitable affirmative relief” that courts of equity issued to bar the enforcement of judgments at law, such that the defense now can be properly viewed as an affirmative defense to a legal claim. See id. at *37–41, *44–46. Yet another consideration, regardless of the relief sought, is whether the defense has otherwise succeeded in crossing the law-equity divide such that common law courts now embrace it. See id. at *41–44. The assimilation of equitable principles by the law courts and the procedural merger of law and equity have produced a legal system in which most equitable defenses are available in actions at law. Describing the current reality, a leading treatise states:
Most equitable defenses are now available in legal actions as well, even in jurisdictions, such as Delaware, that maintain separate courts of law and equity. Equitable defenses that today may be asserted in both legal actions and in equity include: fraud, mistake, waiver, acquiescence, ratification, failure of consideration, discharge of surety, impossibility, *35 unconscionability, duress, estoppel, rescission, lack of ripeness, and mootness.
Donald J. Wolfe & Michael A. Pittenger, Corporate and Commercial Practice in the Delaware Court of Chancery § 15.01, at 15-3 (2d ed. 2018 & Supp.) (footnote omitted). Other authorities say the same thing. [2]
There are two outliers: laches and unclean hands. It is generally accepted that laches remains on the equity side of the divide and is only available to defend against an equitable claim. [3] A similar consensus does not exist as to the availability of unclean hands. [4]
As originally framed, the unclean hands defense was purely an equitable defense
and not a form of equitable affirmative relief. It prevented a petitioner from seeking relief
in the Court of Chancery in the first instance; it was not a doctrine that a court of equity
could use to issue an injunction barring an action at law. And compared to the other
defenses originating in equity, the unclean hands doctrine was “considerably newer.”
Equity Like Law
,
supra
, at 466 & n.63. The earliest known invocation of something akin
to unclean hands in the United States was in 1725, when one highwayman filed a bill in
the equity arm of the Court of Exchequer seeking an accounting against his partner in
crime.
Everet v. Williams
(Ex. 1725) (known as the “
The Highwayman’s Case
,” as reported
long afterward in a note by that name in 9 L. Q. Rev. 197, 197–99 (1893)). Finding the
contents of the bill “scandalous and impertinent,” the court denied the bill on that ground,
and both highwaymen were hanged.
Id.
;
see Shondel v. McDermott
,
In 1728, Richard Francis formulated an early conception of the unclean hands doctrine, coining the maxim of equity “he that hath committed inequity shall not have equity.” Chafee, supra , at 880. Francis later caveated his maxim with the requirement that “the Iniquity must have been done to the defendant himself.” Richard Francis, Maxims of Equity 5 cmt. a (3d ed. 1791). A reframing of this maxim, known as “clean hands,” first entered the vernacular in 1787, when the Court of Exchequer crystalized the principle that “a man must come into a Court of Equity with clean hands; but when this is said, it does not mean a general depravity; it must have an immediate and necessary relation to the equity sued for.” Chafee, supra , at 882 (quoting Dering v. Earl of Winchelsea , 29 Eng. *38 Rep. 1184, 1185 (1787)). The unclean hands doctrine did not garner much fame or attention until 1881, when Pomeroy published the first edition of his treatise. [5]
Meanwhile, since at least 1775, common law courts applied a similar principle that has become known as the in pari delicto doctrine. For example, in Holman v. Johnson , Lord Mansfield, while serving as a judge on the King’s Bench, explained that
[t]he objection, that a contract is immoral or illegal as between plaintiff and defendant, sounds at all times very ill in the mouth of the defendant. It is not for his sake, however, that the objection is ever allowed; but it is founded in general principles of policy, which the defendant has the advantage of, contrary to the real justice, as between him and the plaintiff, by accident, if I may so say. The principle of public policy is this; ex dolo malo non oritur actio . No Court will lend its aid to a man who founds his cause of action upon an immoral or an illegal act. If, from the plaintiff’s own stating or otherwise, the cause of action appears to arise ex turpi causa , or the transgression of a positive law of this country, there the court says he has no right to be assisted.
[1775] 1 Cowp. 341, 98 Eng. Rep. 1120 (KB).
Scholars have characterized Holman as the “seminal case” for the in pari delicto doctrine. See, e.g. , Brian A. Blum, Equity’s Leaded Feet in a Contest of Scoundrels: The Assertion of the In Pari Delicto Defense Against a Lawbreaking Plaintiff and Innocent Successors , 44 Hofstra L. Rev. 781, 786 n.31 (2016) (“ Holman v. Johnson is regarded as *39 the seminal case in which Lord Mansfield expressed both the ex turpi causa principle and the in pari delicto rule.”). As the Supreme Court of the United States has explained, the doctrine, which “literally means ‘in equal fault,’ is rooted in the common-law notion that a plaintiff’s recovery may be barred by his own wrongful conduct.” Pinter v. Dahl , 486 U.S. 622, 632 (1988). Yet at the same time, the Pinter decision characterized the in pari delicto doctrine as an “equitable defense,” illustrating the blending of legal and equitable principles. Id. (internal citation omitted). The Pinter court openly acknowledged the existence of doctrinal drift, observing that “[c]ontemporary courts have expanded the [ in pari delicto ] defense’s application to situations more closely analogous to those encompassed by the ‘unclean hands’ doctrine, where the plaintiff has participated ‘in some of the same sort of wrongdoing’ as the defendant.” Id.
Other authorities illustrate the blending of unclean hands and in pari delicto into a more general defense based on inequitable conduct. For example, despite Holman ’s status as the seminal common law decision for in pari delicto , courts have quoted Holman when describing the doctrine of unclean hands. [6] And despite reference to The Highwayman’s *40 Case as the foundational unclean hands decision, that case now serves as a cornerstone for the in pari delicto doctrine. [7] Some courts seem to use the terms interchangeably. [8] As a result, at least one legal camp has concluded that “[t]oday, ‘unclean hands’ really just those who come into a court of justice to seek redress must come with clean hands, and must disclose a transaction warranted by law” (citation omitted)).
[7]
Williams Elecs. Games, Inc. v. Garrity
,
[8] Dobbs,
Law of Remedies
,
supra
, § 2.4(2), at 68 & n.6 (“The unclean hands defense
used in this way may be just another phrase for the illegality rule under the pari delicto
doctrine, and courts frequently seem to use the phrases interchangeably.”);
id.
§ 13.6, at
879 (“Unclean hands and
pari delicto
doctrines are often mentioned in the same judicial
opinions. Sometimes courts seem to use the terms as if they were distinct doctrines,
sometimes as if they were about the same.” (footnotes omitted));
see Bateman Eichler, Hill
Richards, Inc. v. Berner
, 472 U.S. 299, 310 (1985) (discussing
in pari delicto
using
authorities addressing unclean hands);
Lawler v. Gilliam
,
means that in equity as in law the plaintiff’s fault, like the defendant’s, may be relevant to the question of what if any remedy the plaintiff is entitled to.” [9]
Nonetheless, “[t]he most orthodox view of the unclean hands doctrine makes it an equitable defense; that is, one that can be raised to defeat an equitable remedy, but not one that defeats other remedies.” Dobbs, Law of Remedies , supra , § 2.4(2), at 68. [10] A line of Court of Chancery decisions has arrived at this outcome. Those decisions treat the defense of unclean hands as generally unavailable to defeat a legal claim, but available if the plaintiff seeks equitable relief. [11] Although that approach implicitly views unclean hands as *43 unavailable in an action at law that does not seek legal relief, there are Delaware Superior Court decisions that have applied the defense. [12]
Standard Gen. L.P. v. Charney
, 2017 WL 6498063, at *25 (Del. Ch. Dec. 19, 2017)
(holding that unclean hands failed as defense because plaintiff sought “money damages—
a quintessentially legal form of relief”),
aff’d
, 195 A.3d 16 (Del. 2018);
Lehman Bros.
Hldgs. v. Spanish Broad. Sys., Inc.
,
Some of these decisions contain broad language suggesting that equitable defenses generally are unavailable whenever a party pursues a legal claim in equity. The XRI decision responded to those assertions by showing that many equitable defenses originated as forms of equitable affirmative relief that supported injunctions against the prosecution of an action at law or the enforcement of a judgment, so they operated as defenses to action at law. The XRI decision also showed that other equitable defenses had crossed the law- equity divide and been embraced by common law courts. The XRI decision concluded that general assertions about the nonavailability of equitable defenses can be misleading and that it is therefore necessary to examine the equitable defense in question. See XRI , 2022 WL 4350311, at *35–47.
[12]
See Mfrs. & Traders Tr. Co., Wilm. Savs. Fund Soc., FSB v. Wash. House P’rs,
LLC
, 2012 WL 1416003, at *4 (Del. Super. Mar. 22, 2012) (“While the unclean hands
doctrine is generally an equitable defense available in the Court of Chancery, this Court is
permitted to consider equitable defenses raised by parties.”);
Kroll, Inc. v. Salesorbit Corp.
,
2008 WL 2582989, at *2 (Del. Super. June 25, 2008) (denying summary judgment on
defendant’s claim that plaintiff acted with unclean hands when seeking to collect on
promissory note);
cf. Korotki v. Hiller & Arban, LLC
,
There is also a decision in which then-Judge Quillen, who previously served as an Associate Justice on the Delaware Supreme Court and as Chancellor of this court, explained why the Delaware Superior Court should be able to consider the full range of equitable defenses that would be available in a system that had merged its courts of law
“[A]t bottom, the unclean hands doctrine is a ‘rule of public policy.’”
[13]
And there
are competing policies at play. The case for applying the unclean hands doctrine broadly
and equity, while acknowledging that “certain equitable defenses which are purely
equitable in nature,” such as unclean hands, “may present adoptability problems.”
USH
Ventures
,
[13]
Morente v. Morente
,
To call the unclean hands doctrine a “rule” of public policy is something of a
misnomer. It is more aptly regarded as a standard animated by public policy. Other
decisions appropriately refer to the unclean hands doctrine as a standard.
See eBay
Domestic Hldgs., Inc. v. Newmark
,
starts from the premise that courts should not be granting relief to parties who have acted improperly and at the same time recognizes that public confidence in the judicial system would decline if bad actors prevailed notwithstanding their bad acts. [14] Making the doctrine of unclean hands broadly available also ensures that courts can consider case-specific factors that call for a departure from an otherwise applicable rule of law: “Empowering the judge through the invocation of unclean hands is an essential institutional check.” Beyond Chafee , supra , at 541. And in situations like The Highwayman’s Case , the doctrine enables courts to avoid becoming embroiled in disputes over illegal transactions. See Henry L. McClintock, Handbook of the Principles of Equity § 26, at 59–69 (2d ed. 1948) (“No court, and certainly no court which considers itself a court of conscience, can spend its time and the public money in determining how the proceeds of an inequitable transaction should be divided between the parties to it.”).
But there are countervailing interests. Litigants regularly cast stones, and it is all too easy for a litigant to invoke the doctrine of unclean hands. Its ready availability increases litigation costs, injects an additional issue for resolution into the case, and creates the risk *47 that close calls on difficult facts will subvert the doctrine. Even if a litigant is ultimately unsuccessful in proving the defense, she may enjoy the residual benefits of painting her opponent as an unsavory character. Cf. Chafee, supra , at 878 (“[T]he use of the clean hands maxim does harm by distracting judges to the basic policies which are applicable to the situation before them.”).
Having explored the historical evolution of the unclean hands doctrine, evaluated its moderate but not universal success in crossing the equity-law divide, and weighed the competing policy interests, this decision adheres to the Court of Chancery precedents that have arrived at the endpoint that Dobbs recommends. Under that approach, a defense of unclean hands is generally unavailable to defeat a legal claim, but becomes available if the plaintiff seeks equitable relief.
In this case, the plaintiffs are seeking equitable relief in the form of a decree of specific performance compelling Aizen to release the Remaining Escrow Amount. The plaintiffs are not solely seeking legal relief in the form of money damages or a declaratory judgment. By invoking the court’s equitable powers, the plaintiffs have opened the door to Aizen’s assertion of an unclean hands defense.
2. The Grounds For Unclean Hands
Having concluded that Aizen can invoke unclean hands as a defense, the next question is whether he has made a sufficient showing to warrant denying the plaintiffs’ motion. Aizen failed to present evidence sufficient to create a genuine issue of material fact about whether the plaintiffs’ conduct was sufficiently reprehensible as to forfeit their right to relief.
a. The Termination Agreement Aizen first claims that the plaintiffs have unclean hands because the Company induced him to enter into the Termination Agreement with the promise of $20.8 million, plus other benefits. He claims that the Purchase Agreement was contingent on him entering into the Termination Agreement such that any misconduct in connection with the latter undermines the validity of the former. Presumably, he views the Seller Parties’ rights under the Purchase Agreement as an enrichment that they unjustly received.
“[F]or the unclean hands doctrine to apply, the inequitable conduct must have an
‘immediate and necessary’ relation to the claims under which relief is sought.”
In re
Rural/Metro Corp. S’holders Litig.
,
Thus, in applying the unclean hands doctrine, the relevant inquiry is not whether the nonmovant’s hands are dirty, but whether the nonmovant dirtied them in acquiring the right that party now asserts, or whether the manner of dirtying renders inequitable the assertion of such rights against the movant. . . . The maxim does not extend to any misconduct, however gross, that is unconnected with the matter in litigation, and with which the opposite party has no concern.
27A Am. Jur. 2d Equity § 25, Westlaw (database updated Aug. 2022).
Aizen’s complaints about the Termination Agreement are too far removed from the current dispute over the Purchase Agreement. Aizen is litigating those issues in the California Action, not in this court. Thus, an unclean hands defense based on breach of the Termination Agreement is not sufficiently related to the matter in controversy.
b. The Possibility Of A Fraudulent Transfer Or Illegal Dividend Aizen next argues that the plaintiffs have unclean hands because the Company could distribute the Remaining Escrow Amount to its stockholders as a fraudulent transfer or illegal dividend. That fear is not sufficient to invoke the doctrine.
To invoke the doctrine of unclean hands, a party must identify something that the opponent has already done or is currently doing. A party cannot invoke a speculative fear about future wrongdoing. Aizen is concerned about something that might happen in the future, which is not a basis for unclean hands.
To support his effort to invoke the doctrine of unclean hands now, Aizen observes
that Delaware courts do not require a showing of injury to plead the unclean hands defense.
It is true that this court has rejected the notion of “no harm, no foul” and held that “[e]quity
does not reward those who act inequitably, even if it can be said that no tangible injury
resulted.”
Nakahara v. NS 1991 Am. Tr.
,
Aizen has taken the notion of pre-crime and applied it to unclean hands. See Philip K. Dick, The Minority Report , in The Philip K. Dick Reader 323, 324 (1956) (depicting a dystopian world in which the government imprisons people because it believes they will commit crimes in the future). For unclean hands, the proposition does not work. The threat of future wrongdoing does not figure into the unclean hands analysis.
D. The Order For Specific Performance Compelling The Release Of Funds
Having prevailed in seeking declaratory judgment and having defeated Aizen’s counterarguments regarding his authority, pre-judgment attachment, and unclean hands, the plaintiffs seek an order that compels Aizen to provide joint instructions to the escrow agent to effectuate the release. The plaintiffs have earned that remedy, but the court will impose a moderate condition on its implementation.
A decree of specific performance is “the appropriate form of relief to compel the
release of funds from an escrow account.”
[15]
To obtain specific performance, a party must
“prove by clear and convincing evidence” that a legal remedy would be inadequate and
that “(1) a valid contract exists, (2) he is ready, willing, and able to perform, and (3) that
the balance of equities tips in favor of the party seeking performance.”
Osborn ex rel.
Osborn v. Kemp
,
The plaintiffs are plainly ready, willing, and able to perform under the Purchase Agreement and the Stay and Escrow Order by issuing the necessary instructions to the *51 escrow agent. The Purchase Agreement is a valid contract under Delaware law. And there is no longer any dispute regarding the plaintiffs’ entitlement to the Remaining Escrow Amount. The only remaining questions are whether the plaintiffs have an adequate remedy at law and whether the balance of equities tips in their favor. In this case, the Purchase Agreement answers these questions.
1. The Plaintiffs Lack An Adequate Remedy At Law.
The plaintiffs have shown that they lack an adequate remedy at law by pointing to provisions in the Purchase Agreement that provide expressly for a decree of specific performance and stipulate to the existence of irreparable harm in the event of a breach. The existence of these provisions is sufficient to support a decree of specific performance, although a court can decline to issue one if there are supervening equities or other considerations. There are none on these facts.
Section 10.8 of the Purchase Agreement provides that “if any party violates or
refuses to perform any covenant or agreement made by it herein, the non-breaching party
shall be entitled, in addition to any other remedies or relief permitted herein, to specific
performance of such covenant or agreement,” and “each party hereby agrees not to raise
any objections to the availability of specific performance . . . to specifically enforce the
terms and provisions of this Agreement, and to enforce compliance with the covenants and
obligations in this Agreement.” APA § 10.8(a) (the “Specific Performance Clause”)
(formatting omitted). “Delaware is strongly contractarian, and the presence of a provision
in favor of specific performance in case of breach, as the parties contracted for here, must
be respected.”
Williams Cos., Inc. v. Energy Transfer Equity, L.P.
,
The plain and unambiguous language of the Specific Performance Clause is sufficient to support a decree of specific performance. Aizen has not pointed to facts or circumstances that would cause the court to decline to enforce this provision.
Although the language of the Specific Performance Clause is sufficient, the Purchase Agreement also addresses the inadequacy of a legal remedy by providing that a breach of its provisions constitutes irreparable harm. “A party can prove inadequate relief at law by showing irreparable damages will result without specific performance.” 71 Am. Jur. 2d Specific Performance § 11, Westlaw (database updated Aug. 2022) (formatting omitted). Section 10.8(a) of the Purchase Agreement also provides that “each party acknowledges that the other party would be damaged irreparably and would have no adequate remedy of law if any provision of this Agreement is not performed in accordance *53 with its specific terms or otherwise is breached.” APA § 10.8(a) (the “Irreparable Harm Clause”).
The language of the Irreparable Harm Clause is sufficient to establish the inadequacy of a remedy at law.
In Delaware, parties can agree contractually on the existence of requisite elements of a compulsory remedy, such as the existence of irreparable harm in the event of a party’s breach, and, in keeping with the contractarian nature of Delaware corporate law this court has held that such a stipulation is typically sufficient to demonstrate irreparable harm.
Martin Marietta Mat’ls, Inc. v. Vulcan Mat’ls Co
.,
The plain and unambiguous language of the Irreparable Harm Clause is sufficient to support the lack of an adequate remedy at law. As with the Specific Performance Clause, Aizen has not pointed to facts or circumstances that would cause the court to decline to enforce the Irreparable Harm Clause.
Even without provisions like the Specific Performance Clause and the Irreparable Harm Clause, this court has held that a party’s failure to comply with a requirement to *54 direct an escrow agent to release funds constitutes irreparable harm and warrants a decree of specific performance. [16] Those same principles apply here.
In response to unambiguous contractual language and settled law, Aizen argues that Section 10.10(b) of the Purchase Agreement grants him “unique protections” that “limit Plaintiffs’ rights to establish irreparable harm from breach based on the pleadings alone.” Dkt. 58 at 40. Section 10.10(b) is an indemnification provision which states:
Each of the Seller Parties hereby agrees to indemnify and hold the Sellers’ Representative and its agents, assigns and representatives harmless from and against any and all Damages that the Sellers’ Representative may sustain or incur as a result of or arising out of any action or inaction of the Sellers’ Representative in its capacity as such, or otherwise relating to its appointment as Sellers’ Representative, except to the extent arising out of the gross negligence or willful misconduct of the Sellers’ Representative.
APA § 10.10(b). Aizen argues that he has a right to indemnification from the Company and that if the Remaining Escrow Amount is released, then the Company will distribute the funds to its stockholders and will not be able to fulfill his indemnification right.
Aizen’s argument is a non sequitur. It does not address the role of specific performance or the existence of irreparable harm. It instead provides another reason why *55 Aizen believes that he is a contingent creditor who should have access to the Remaining Escrow Amount to satisfy his claims. That is another version of Aizen’s pre-judgment attachment argument, which this decision has already rejected. And here, the pre-judgment attachment argument is even weaker, because the right of indemnification extends to the Seller Parties, not just the Company. So even if the Company distributes amounts to its stockholders, those stockholders as Seller Parties still will have an obligation to indemnify Aizen.
The plaintiffs have established the inadequacy of a remedy at law sufficient to warrant a decree of specific performance.
2. The Balance Of Equities Favors The Plaintiffs.
The final issue is the balancing of the equities. This factor “reflect[s] the traditional concern of a court of equity that its special processes not be used in a way that unjustifiably increases human suffering.” Bernard Pers. Consultants, Inc. v. Mazarella , 1990 WL 124969, at *3 (Del. Ch. Aug. 28, 1990). This court’s precedents support balancing the equities in favor of ordering the release of the last portion of the transaction consideration from escrow. [17] The Buyer bargained for an escrow fund to secure the Company’s financial *56 obligations to the Buyer. The Company has met those obligations. The Buyer is satisfied. The plaintiffs are now entitled to the Remaining Escrow Amount .
Aizen argues that the balance of equities tips in his favor because he “seeks only to maintain the status quo” under the Stay and Escrow Order. See Dkt. 58 at 42. Aizen’s argument fails to acknowledge that the Stay and Escrow Order preserved the parties’ arguments and positions under the Purchase Agreement. The status quo as it existed under the Stay and Escrow Order is that the Remaining Escrow Amount would stay in escrow until release was warranted under the terms of the Purchase Agreement. It is Aizen who seeks to change the status quo by keeping the Remaining Escrow Amount in escrow as a form of pre-judgment attachment.
Although an order of specific performance is warranted, that does not mean that the
release must happen instantaneously. A court may place conditions on a decree of specific
performance.
See
Wolfe & Pittenger,
supra
, § 16.03[c], 16-55;
see also Mumford v. Long
,
authority to delay the release of funds from escrow, particularly when doing so would further judicial economy. [18]
As discussed above, there is a non-trivial risk that the Company will distribute the Remaining Escrow Amount to its stockholders and render itself judgment-proof. If that threat is sufficiently real, then pre-judgment attachment might be warranted. The proper court to consider that issue is not this court but the California Court. That is the court presiding over the underlying claim, and that is the court that should determine whether the equities are strong enough to support some form of interim relief to preserve a source of recovery.
The equitable outcome is to provide Aizen with a brief window in which to seek relief from the California Court. How brief? I have no interest in creating a false emergency for a California colleague. Sixty days should suffice for Aizen to make an application and for the parties to brief the issue. The final order in this action therefore will delay the effective date for the release of the Remaining Escrow Amount for sixty days.
The plaintiffs argue that Aizen should not be given this opportunity because he could have applied to the California Court years ago. But that would have been a gratuitous application, because the Remaining Escrow Amount remained in escrow. I do not think a trial judge in California, presiding over a busy docket, would have appreciated an application seeking to freeze already frozen funds. I know I would not. At this point, the facts have changed, and Aizen should have an opportunity to seek relief.
III. CONCLUSION
The plaintiffs’ motion for partial judgment on the pleadings is granted with the condition that the Remaining Escrow Amount will not be released until sixty days after the entry of the order implementing this opinion. If there are other issues that need to be addressed before this proceeding can conclude at the trial level, the parties shall submit a joint letter identifying them and proposing a schedule for their resolution. If there are no other disputes, then the parties will submit a final order that has been agreed as to form.
Notes
[1] The following entities are affiliates of Lee or Schaffer and own stock in Parent: the Christine Schaffer Revocable Living Trust, the Grover Lee Revocable Living Trust, the Charles E. Lee Living 2012 Trust No. 1, the Charles H. Lee 2012 Trust No. 2, the Charles E. Lee Living Trust, the Jacqueline C. Lee 2012 Trust No. 1, the Jacqueline C. Lee 2012 Trust No. 2, and the Jacqueline C. Lee Living Trust. See Dkt. 58 at 6–7.
[2]
See
Dan B. Dobbs,
Handbook on the Law of Remedies: Damages—Equity—
Restitution
, § 2.3, at 44 (1973) [hereinafter Dobbs,
Law of Remedies
] (“Estoppel, waiver,
acquiescence, and perhaps laches, have all worked over into law and are now regularly
used in purely legal cases, along with equitable defenses generally.”);
see also USH
Ventures v. Glob. Telesystems Grp., Inc.
,
[3]
See Petrella v. Metro-Goldwyn-Mayer, Inc.
,
[4]
Compare
T. Leigh Anenson,
Announcing the “Clean Hands” Doctrine
, 51 U.C.
Davis L. Rev. 1827, 1851 (2018) (“Historically, the defense applied to all equitable relief,
but only equitable relief.”), Wolfe & Pittenger,
supra
, § 15.01 (“Other defenses, among
them laches, unclean hands, and the balancing of equities, remain more equitable in nature
and generally cannot be asserted as defenses in purely legal actions.”),
and
Dobbs,
Law of
Remedies
,
supra
, § 2.4(2), at 71 (“If the [unclean hands defense] is really an appeal to
equitable discretion [and not an appeal to generate a rule of law], then it should apply only
to bar equitable remedies. It should be dropped entirely if it is asserted as a defense against
a legal remedy.”),
with Cummings v. Wayne Cnty.
,
[5] Chafee, supra , at 884 (chronicling the scholarly treatment of unclean hands; noting that it did not appear in the early editions of Joseph Story’s Commentaries on Equity Jurisprudence ). Story’s Commentaries did not mention the doctrine of unclean hands until the eleventh edition, after Story himself stopped working on the treatise. The treatise mentioned unclean hands in a footnote, describing it as a “rule analogous” to the maxim that “he who seeks equity, must do equity.” 1 Joseph Story, Commentaries on Equity Jurisprudence as Administered in England and America § 64e, at 59 n.2 (12th ed. 1877).
[6]
See, e.g.
,
Am. Bell Inc. v. Fed’n of Tel. Workers of Pa.
,
[9]
Shondel
,
[10] Under this “orthodox view,” a court may exercise its discretion “to deny a purely equitable remedy, while leaving the plaintiff full access to her legal remedies.” Dobbs, Law of Remedies , supra , § 2.4(2), at 69; see Problems of Res Judicata Created by Expanding “Cause of Action” Under Code Pleading , Note, 104 U. Penn. L. Rev. 955, 957 (1956) (observing that if a court of equity “denied the equitable relief on a principle of a ‘court of conscience,’ such as laches, unclean hands, etc.,” then it “was held that the plaintiff was not barred from proceeding at law for his legal remedy”). Dobbs also maintains that a party should have to show actual harm (or a threat of actual harm) before invoking the doctrine of unclean hands: If there are any cases at all in which there is room for “unclean hands” as a purely equitable defense based on discretion to deny equitable remedies, the plaintiff’s remedy against the defendant should not be denied unless his misconduct has actually harmed the defendant, or has at least put the defendant in substantial risk of harm from that misconduct. Dobbs, Law of Remedies , supra , § 2.4(2), at 70. Dobbs acknowledges that “[c]ourts do not seem to limit themselves invariably to such usage.” Id. at 68.
[11]
See In re Liquid. of Indem. Ins. Corp., RRG
,
[14]
See, e.g
, T. Leigh Anenson,
Beyond Chafee: A Process-Based Theory of Unclean
Hands
, 47 Am. Bus. L.J. 509, 528 (2010) [hereinafter
Beyond Chafee
] (describing the
doctrine’s “procedural justice component”);
see also Gaudiosi v. Mellon
,
[15]
QC Hldgs., Inc. v. Allconnect, Inc.
,
[16]
See Sparton
,
[17]
See Sparton
,
[18]
See J&J Produce Hldgs., Inc. v. Benson Hill Fresh, LLC
,