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Article: May 2018: Trial Practice Update

Business Litigation Reports

Trial Report: Using Discovery and Trial Testimony to Turn a Defeat at Summary Judgment into a Victory at Trial. Quinn Emanuel recently secured a groundbreaking victory after trial in the Delaware Court of Chancery for its client, Crestview Partners, against Oxbow Carbon LLC and William Koch. With nearly half a billion dollars at stake, the firm faced an uphill battle from the start of the litigation, which centered on a gap in Oxbow’s operating agreement, entered into by the parties in 2007. Victory appeared elusive after the Court’s summary judgment ruling in the summer of 2016, which held that the plain meaning of the contract should be read against Crestview’s position. Undeterred, the Quinn Emanuel team—led by partners Michael Carlinsky, Chad Johnson, Jennifer Barrett, and Corey Worcester—vigorously pursued and obtained important discovery that ultimately helped persuade the Court after trial that Crestview’s position is the correct one.

The dispute, In re Oxbow Carbon LLC Unitholder Litigation, concerned Crestview’s contractual right, as a minority stakeholder in Oxbow, one of the world’s largest recyclers of natural gas byproducts, to require a sale of the company under the terms of Oxbow’s LLC Agreement. Koch, Oxbow’s founder and CEO, argued that a complex series of interlocking contractual provisions in the LLC Agreement prevented Crestview from invoking its exit sale right.

Crestview invested in Oxbow in 2007 with the clear understanding that it would be able to exit its investment after a fixed period of time. As reflected in the Oxbow LLC Agreement, Crestview had the right to exit its investment as follows: a right to offer its shares to the company for repurchase after seven years at fair market value, and, if the company declines to purchase the shares, a right to compel the sale of the company. However, under the agreement, the company “Exit Sale” can only occur if each member of the LLC receives 1.5 times its investment through prior dividends and sale proceeds.

By the time Crestview offered its shares to Oxbow for repurchase in 2015, the original parties to the LLC Agreement had received far more than 1.5 times their respective investments in dividends alone. The company declined to repurchase the shares, and Crestview invoked its right to compel an Exit Sale. After a prospective purchaser made an offer to buy the company, however, Mr. Koch and Oxbow’s lawyers began arguing that two investment vehicles, which had made small investments in the company in 2011, prevented an Exit Sale. They argued that because the sale price combined with prior dividends would not result in a 1.5 times return to these small investors, and the LLC Agreement required all LLC members to participate in an Exit Sale, no sale could occur. They further argued that a series of other requirements for an Exit Sale in the LLC Agreement prevented Crestview from making a “top-up” or “make-whole” payment to these small investors to get them to the 1.5 times threshold. Quinn Emanuel and Crestview disputed that the small investors were LLC members entitled to the 1.5 times provision, and argued that even if they were, the Agreement permitted members to be “left behind” in an Exit Sale.

Mr. Koch and Oxbow sued Crestview to prevent the sale, Crestview counterclaimed, and the parties both moved for summary judgment on their respective plain-meaning interpretations of the LLC Agreement. At that stage, the Court ruled in Oxbow’s favor, finding that the small investors were LLC members entitled to the protection of the 1.5 times provision, and that the Exit Sale required all members to participate or else no sale could occur. However, the Court noted that Crestview’s argument that “given the overall structure of the agreement and the concept of the Exit Sale, they never would have agreed that investors with a stake as small as the Small Holders’ would be able to block the operation of the Exit Sale Right” was “an implied covenant argument” and a “fairly litigable” one.

Crestview and Quinn Emanuel pressed forward with an implied covenant claim, and the case went to trial in July 2017. Crestview showed at trial that when the small investors made their investments, the company’s board failed to determine what rights these investors would have under the LLC Agreement, as the agreement required. The Crestview-appointed board members testified credibly that had the question been raised at the time, they would have insisted that the small investors not be entitled to the 1.5 times investment protection, and at the very least would have insisted that they have the right to make a top-up payment to these investors to ensure an Exit Sale could occur. Crestview also introduced documents and testimony into evidence showing that Koch himself did not believe the LLC Agreement prevented a top-up payment until one of the company’s lawyers invented it as a “fun new theory” to prevent an Exit Sale in 2016 – nearly a decade after the Agreement was executed.

The Court’s post-trial decision validated Crestview’s implied covenant approach. The Court held that “[b]y failing to follow proper formalities, [Koch and Oxbow] created a gap regarding the terms on which the Small Holders became members.” The Court credited Crestview’s testimony that Crestview “never would have consented to admitting the Small Holders if they had understood that the admission would reset the 1.5x Clause,” and that Koch and Oxbow would not have insisted that Crestview could not top-up the small investors to get them to the 1.5 times return. The Court also concluded that Koch’s LLC Agreement construction was lawyer-driven, and did not reflect the parties’ reasonable expectations at the time of contracting. The Court thus concluded that “issues of compelling fairness call for deploying the implied covenant.”

The Oxbow Carbon result teaches at least two lessons. First, when faced with a loss on the plain meaning of a contract at summary judgment, parties who can later show that the court-determined plain meaning is at odds with the parties’ reasonable expectations at the time of contracting should consider an implied covenant theory. Second, when advancing such a theory, a party should vigorously pursue document discovery, including from counsel where possible. Quinn Emanuel unearthed significant evidence proving that Oxbow’s lawyers invented the “fun new theory” long after the LLC Agreement was executed – thus proving Mr. Koch did not believe in that construction of the LLC Agreement at the time of contracting. Because the decision about whether the implied covenant of good faith and fair dealing applies to a given situation is “fact-intensive,” as the Oxbow Carbon Court noted, carefully crafted and vigorous discovery efforts can be the difference between winning and losing on an implied covenant theory at trial.