Big Bucks Lost to Ambiguity
A recent decision of the United States Court of Appeals for the Second Circuit construing New York law hammers home the importance of clear contract drafting.
In Chesapeake Energy Corp. v. Bank of New York Mellon Trust Co., 13-1893-CV (2nd Cir. 11-25-2014), two sentences of a contract proved so ambiguous that the District Court and the Second Circuit each found them to be unambiguous but to have diametrically opposite meanings.
This was not a low-budget affair. At issue was Chesapeake’s right to redeem $1.3 billion in senior notes (the “Notes”) it had issued at par vs. at a premium. Redeeming the Notes at the lower price would save Chesapeake almost $400 million.
The Indenture covering the Notes provided that “[a]t any time from and including November 15, 2012 to and including March 15, 2013 (the ‘Special Early Redemption Period’)”, Chesapeake, at its option, could redeem the Notes at 100% of the principal amount plus accrued interest to the date of redemption. The next sentence of the Indenture provided that Chesapeake could exercise its option to redeem the Notes at par “so long as it gives the notice of redemption … during the Special Early Redemption Period.” A different section of the Indenture required that notice to be given at least thirty (30) days prior to the redemption date.
Chesapeake announced its intention to redeem the Notes on February 20, 2013 – 23 days prior to the end of the Special Early Redemption Period. BNY Mellon, the Indenture Trustee, and certain Noteholders objected arguing that the Indenture language required the redemption of the Notes to be completed during the Special Early Redemption Period. Combined with the 30-day prior notice requirement, this would mean that Chesapeake’s chance to redeem the Notes at par had already passed. Over these objections, Chesapeake sent the formal notice of redemption to the Noteholders on March 15, 2013.
Even before issuing the formal notice of redemption, Chesapeake filed a declaratory judgment action in the United States District Court for the Southern District of New York asking the Court to confirm that its reading on the Indenture provision – that all it had to do was trigger the redemption process, not complete it, during the four-month Special Early Redemption Period – was correct.
The District Court ruled that the language of the Indenture was “unambiguous” in setting March 15, 2013 as the deadline for Chesapeake to give notice of redemption. The Second Circuit reviewed the same two sentences and reversed, holding that Chesapeake was required to complete the redemption of the Notes by March 15, 2013 and that notice of redemption needed to be given by February 13, 2013.
The Second Circuit stated that under New York law, a contract is ambiguous if its terms can suggest more than one meaning to “a reasonably intelligent person,” but that “[n]o ambiguity exists where the contract language has a definite and precise meaning … concerning which there is no reasonable basis for a difference of opinion.”
It held that the “so long as” sentence regarding the notice of redemption functioned as a proviso that shortened the time Chesapeake had to redeem the Notes. As a result, the two sentences of the Indenture could be read together without creating an irreconcilable conflict. Therefore, the Second Circuit found that the Indenture language had “a definite and precise meaning” and “unambiguously” provided that Chesapeake had to complete the entire redemption process during the Special Early Redemption Period.
So went Chesapeake’s argument and its $400 million.
One Judge dissented, stating with a hint of irony that since her colleagues (i.e., the District Court judge and the Second Circuit panel) were “reasonably intelligent persons” and had reached opposite conclusions in reviewing the Indenture language, the ambiguity test cited by the majority had been met.
The Chesapeake decision demonstrates that contract language must be simple, clear and concise so that there is “no reasonable basis for a difference of opinion” and no reasonable basis for ending up in court. Because if you go to court, uncertainty is sure to accompany you.
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