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Management Capital, L.L.C. v. F.A.F., Inc.

Supreme Court of Rhode Island

June 12, 2019

Management Capital, L.L.C.
v.
F.A.F., Inc. et al.

          Superior Court Providence County PB 08-2364 Michael A. Silverstein, Associate Justice

          For Plaintiff: Joseph V. Cavanagh, Jr., Esq., Robert James Cavanagh, Jr., Esq.

          For Defendants: Robert D. Wieck, Esq. Rajaram Suryanarayan, Esq.

          Present: Suttell, C.J., Goldberg, Flaherty, and Indeglia, JJ.

          OPINION

          Paul A. Suttell, Chief Justice

         This case arises from the milieu of the financial world where arcane terms such as "stock warrant," "put," and "call" are commonplace but nevertheless remain alien to the uninitiated. The resolution of this appeal, however, requires us to resort to concepts distilled from principles taught in a first-year contracts class: reformation, ambiguity, and anticipatory repudiation. The plaintiff, Management Capital, L.L.C. (Management), initiated this litigation after the defendant, F.A.F., Inc. (FAF), maintained that a common stock warrant held by Management had no value. A Superior Court justice, sitting without a jury at a trial held over six days in June 2015, found in favor of Management. On appeal, FAF contends that the trial justice erred when he: (1) reformed certain dates in a stock warrant that he found were a result of mutual mistake; (2) determined that "funded debt" was an unambiguous term meaning "long-term debt"; (3) found that FAF repudiated its obligations under the stock warrant; (4) found that Management properly preserved its post-repudiation rights; (5) determined that Management proved its damages with reasonable certainty; (6) determined that prejudgment interest would accrue from October 13, 2008 onward; and (7) did not rule on FAF's counterclaims. For the reasons set forth in this opinion, we affirm the judgment of the Superior Court.

         I

         Facts and Procedural History

         In early 2002, Ernest Humphreys (Humphreys), Robert Manchester (Manchester), Steve Carlotti (Carlotti), and Jerry Cerce (Cerce) formed Management Capital, L.L.C. and Management Solutions, L.L.C. Drawing on the deep business and legal experience of their founding principals, Management Capital, L.L.C. invested in companies-often small, privately-owned business entities that had the potential to grow. Providing consulting and advisory services to these companies, Management Solutions, L.L.C. worked in concert with Management Capital, L.L.C.[1]

         FAF, a Rhode Island jewelry company, was just the kind of company in which Management sought to invest; in other words, "an ideal client" for Management. Humphreys thought FAF was an "exciting company" with "tremendous opportunity," but, as of 2002, FAF faced an $11.5 million judgment (the BHG judgment) and a $1 million claim for damages (the Drianna claim) (collectively the claims). Manchester testified that, in light of the claims, FAF's value at that time was "not zero, but * * * nominal."

         Cerce introduced Humphreys to his cousin, Arthur Fiorenzano (Fiorenzano), president of FAF, in early 2002. In the spring of 2002, Management and FAF agreed that Management would help FAF resolve the claims. The principals at Management were "excited" about "help[ing] [FAF] become more successful in the future." In addition to charging a $300 hourly fee, Management would receive a yet-to-be-determined "success fee" pending the results of Management's work.

         In the summer of 2002, Management suggested to FAF that it grant a common stock warrant[2] (the Warrant) to Management upon its successful settlement of the BHG judgment. The Warrant would essentially serve as Management's "success fee." Armand Almeida (Almeida), FAF's chief financial officer (CFO), initially advised Fiorenzano against issuing a warrant to Management. Despite Almeida's qualms, FAF ultimately agreed to issue Management a warrant.

         On July 26, 2002, Humphreys sent an email to Fiorenzano with a one-page summary of the "Warrant Terms" (the Warrant Terms) attached for the parties to discuss at an upcoming meeting. The Warrant Terms outlined the basic provisions of what would eventually become the Warrant. After some negotiation, the Warrant Terms were agreed to by both parties in writing on October 9, 2002.

         According to the Warrant Terms, Management had the right to acquire 10 percent of FAF's stock for the exercise price of $710, 000, exercisable any time before December 31, 2007. The $710, 000 exercise price was based on 10 percent of FAF's then-current agreed value of $7.1 million. The Warrant Terms stated that the $7.1 million figure "values FAF at a 4 multiple of the average of the EBITDA for 2001 and forecast 2002, less only funded debt of approximately $3.7 million."[3]

         Under the Warrant Terms, Management also had the right to put[4] the Warrant to redeem either the shares it had purchased from FAF or the Warrant itself; likewise, FAF had the right to call[5] the Warrant to force Management to sell whatever shares Management had purchased from FAF or the Warrant itself. Both the put and call rights were exercisable any time after December 31, 2007.

         In December 2002, Management successfully resolved the claims against FAF. The next month, Management turned its focus to drafting the Warrant. On January 14, 2003, Humphreys sent an email to Almeida (David Syner, FAF's accountant (Syner), Fiorenzano, and Cerce were also copied), with a draft of the Warrant attached. During the following months, FAF and Management exchanged several communications regarding various terms of the Warrant.

         Humphreys and Manchester testified that, at that time, Management's main priority was to ensure that Management would be able to review FAF's 2007 audited financial statements before Management decided whether to exercise or put the Warrant; this review period was not a concept captured by the initial draft Warrant or Warrant Terms. FAF agreed to Management's request, and a forty-five-day review period was inserted into the draft.[6] The following day, FAF's attorney, who was also involved in negotiating the Warrant, added language proposing September 30, 2007 as a definite date for the Warrant's expiration, among other edits. In a later draft, FAF's attorney, after a conversation with Humphreys, also inserted a provision that created a thirty-day window (the Window), allowing Management to put and exercise the Warrant simultaneously, or put the Warrant before Management was required to exercise the purchase of shares.

         The creation of the Window resulted in two inconsistencies regarding the years in the provided deadlines to exercise and put/call the Warrant. Section 3 of the draft Warrant provided that the deadline to exercise the Warrant was seventy-five days after receipt of the 2007 audited financial statements or October 31, 2007, whichever was the earlier to occur. Similarly, Section 13 provided that the date the put/call rights began to run started forty-five days after receipt of the 2007 audited financial statements or September 30, 2007, whichever was the earlier to occur. A literal reading of Sections 3 and 13 would always result in the respective dates of October 31, 2007 and September 30, 2007 as the earlier date to occur, because the audited financial statements for the year ending December 31, 2007 would never be available until sometime in calendar year 2008. Despite a clear contradiction, these dates remained in the final Warrant.

         Management and FAF executed the final Warrant on July 7, 2003. Under the terms of the final Warrant, Management had the right to acquire 10 percent of FAF's stock for the exercise price of $710, 000, exercisable any time before either seventy-five days elapsed after Management received FAF's 2007 audited financial statements or October 31, 2007, whichever was the earlier to occur. The final version of Section 3.1 provided:

"This Warrant may be exercised in whole or in part at any time by the registered holder by the surrender of this Warrant at any time after the date hereof and before 5:00 p.m. on: (a) the date which is seventy-five (75) days after receipt by [Management], or any subsequent holder hereof, of the audited financial statements of [FAF] for the year ending December 31, 2007; or (b) October 31, 2007, whichever is the earlier to occur ('Expiration Time'); together with payment to [FAF] of the Exercise Price (or portion thereof) for the shares to be purchased hereunder."

         Section 13 provided a timeline for the put and call rights. Similar to Section 3, the right to put/call was exercisable any time before either forty-five days elapsed after Management received FAF's 2007 audited financial statements or September 30, 2007, whichever was the earlier to occur. The final version of Section 13 stated, in relevant part:

"At any time after 5:00 p.m. on (a) the date which is forty-five (45) days after receipt by [Management], or any subsequent holder hereof, of the audited financial statements of [FAF] for the year ending December 31, 2007; or (b) September 30, 2007, whichever is the earlier to occur, [FAF] shall have a call and [Management] or any subsequent holder hereof shall have a put with respect to the Warrant, or the shares issued pursuant to this Warrant, if applicable. * * * The purchase price for the Warrant, or the shares issued pursuant to the Warrant, if applicable, shall be determined and paid as provided in Section 14 hereof."

         Section 14 set out a formula for calculating the purchase price. Section 14 provided, in relevant part:

"The purchase price for the Warrant, or the shares issued pursuant to this Warrant, if applicable, shall be equal to the percentage ownership of [FAF] represented by the shares, multiplied by the Value of [FAF]. The Value of [FAF] shall be equal to: (a) the average EBITDA of [FAF] for the last 2 fiscal years of [FAF] prior to the exercise of the put or call; (b) multiplied by 5; (c) less only funded debt, all as of the last day of the most recently completed fiscal year of [FAF]. EBITDA shall be calculated using the audited financial statements of [FAF]."

         Although the final Warrant encapsulated the basic ideas from the Warrant Terms, the final Warrant diverged from the Warrant Terms in a few significant respects. As mentioned above, the final Warrant included language providing Management with time to review FAF's 2007 audited financial statements, with a final expiration date. It also included the Window which allowed Management to simultaneously "exercise" and "put" the Warrant, netting out the difference. Moreover, Section 14 of the Warrant provided a formula to value FAF, should Management have decided to put or FAF decided to call the Warrant. Unlike the Warrant Terms, this formula did not provide an estimated amount of "funded debt."[7]

         A few years passed without any action on the Warrant. In late summer 2007, Management started to think about how it might want to proceed under the Warrant. Although FAF and Management had ceased working together sometime in 2005, Management continued to have an "excellent" relationship with FAF, according to Humphreys. Humphreys testified that, in light of this congenial relationship, Management's principals wanted to meet with Fiorenzano to express that, while Management still intended to exercise its rights under the Warrant, it wanted to "figure out what work[ed] best" for FAF.

         Humphreys met with Fiorenzano in August 2007 to discuss how Management was to proceed under the Warrant. At that meeting, Fiorenzano informed Humphreys that FAF's new CFO, Lou Rotella (Rotella), would handle any Warrant-related issues. Manchester subsequently met with Rotella in September 2007. According to Manchester, Rotella had deemed the Warrant "valueless" based on his calculation using the years 2005 and 2006. Manchester testified that he explained to Rotella that the Warrant was intended to be based on 2006 and 2007, but that Rotella "agreed to disagree" with Manchester's understanding. Humphreys testified that Manchester was "shocked" when he returned from his meeting with Rotella. It was after this conversation that Management realized that the Warrant's dates were fundamentally inconsistent with each other.

         Once Management realized the mistakes, Manchester sent a letter to Fiorenzano and FAF on September 28, 2007, asking FAF to amend the errors and asserting that, in Section 3.1, "the date of October 31, 2007 should have been October 31, 2008" and, in Section 13, "the [date of] September 30, 2007 should have been September 30, 2008." The letter stated that if FAF was in agreement as to the errors, Management would prefer the Warrant be amended. The letter continued, however, to inform FAF that "[i]n order to preserve [Management's] rights under the terms of the Warrant as presently written," Management believed it "necessary" to exercise its put rights.

         FAF, through its attorney, promptly replied to Management's letter on October 1, 2007. In the letter, he noted the discrepancy between the dates, but asserted that the December 31, 2007 date was incorrect-not the September 30, 2007 and October 31, 2007 dates. FAF's attorney wrote "[m]y file clearly indicates that the parties always intended that the expiration date for the exercise of the Warrant would always be prior to 12/31/[0]7." He attributed the error to the drafting of the thirty-day Window, which allowed Management to simultaneously put and exercise the Warrant.

         Additional back-and-forth discussions ensued between Management and FAF, including Management's rejected proposal that FAF purchase the Warrant for $2 million based on FAF's value in 2006 and 2007, in exchange for its release of FAF's obligations. During the fall of 2007, FAF also informed Management that it considered "funded debt" to include its revolving debt and not simply its long-term debt. On December 31, 2007, Manchester sent an email to Rotella and Fiorenzano, which served as a notice to FAF that Management was exercising its rights under the Warrant but would withdraw the notice "provided that a mutually satisfactory valuation with regard to the put" was reached. Manchester had one last meeting with Rotella in early 2008; Rotella maintained FAF's position, and no agreement regarding the Warrant dates was reached.

         On March 21, 2008, Management filed a complaint against FAF in Providence County Superior Court. Count I asserted reformation of the Warrant based on mutual mistake; Count II requested declaratory judgment that funded debt is long-term debt; and Count III alleged breach of the duty of good faith and fair dealing. Count IV alleged that Fiorenzano had breached his fiduciary duty by funneling funds from FAF to an offshore account, and requested that FAF's affiliates be included in FAF's valuation.[8] Count V requested injunctive relief to bar FAF from holding stockholder meetings regarding the Warrant without first providing notice to Management.

         On June 11, 2014, FAF moved for summary judgment on Counts I, II, and V of Management's complaint. Following a hearing on FAF's motion, the trial justice allowed the parties to submit supplemental briefing on whether FAF had repudiated its obligations under the Warrant. The trial justice denied FAF's motion for summary judgment in a written decision on April 2, 2015. In that decision, the trial justice explained that he would allow Management to pursue a theory of repudiation. The trial justice did not rule on the repudiation matter, however, because he determined that the disputed dates were the threshold issue, and that those dates were necessarily factual.

         Accordingly, Management filed an amended complaint on May 6, 2015, adding a count for repudiation. A jury-waived trial was held on June 2, 3, 5, 8, 9, and 10, 2015. Manchester, Humphreys, Almeida, and Syner testified for Management; FAF's attorney testified for FAF.

         On January 17, 2017 the trial justice issued a written decision, determining that: (1) the Warrant would be reformed to correct the dates based on the parties' prior mutual understanding; (2) the term "funded debt" meant "long-term debt"; and (3) FAF repudiated its obligations under the Warrant. Additionally, after finding that Management had proven its damages with reasonable certainty, the trial justice awarded $1, 234, 055 in damages ...


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