Senior Housing Capital, LLC v. SHP Senior Housing Fund, LLC, C.A. No. 4586-CS (Del. Ch. May 13, 2013) (Strine, C.)
In this memorandum opinion, the Court of Chancery awarded the plaintiff substantial payments, pre-judgment interest and attorneys’ fees and costs. Plaintiffs, entities that managed and invested in a fund that owned retirement homes, asserted breach of contract claims against its co-investor for, among other things, attempting to wrongfully lower the amounts of certain of the payments and failing to make those and other contractually guaranteed payments. The Court found in favor of plaintiffs on all counts and dismissed all of defendants’ counterclaims.
The contract at issue in the case was an LLC Agreement (the “Agreement”) between plaintiff SHP Asset Management and certain of its affiliates (collectively, “SHP”), and the California Public Employees’ Retirement System (“CalPERS”). The Agreement governed the relationship of SHP and CalPERS in connection with an investment fund (the “Fund”) that was approximately 95 percent owned by CalPERS and the remainder owned by some of the plaintiff entities. In addition to owning an approximate 5% interest in the Fund, SHP also managed the Fund and, for most of the life of the Fund, the underlying properties. Pursuant to the Agreement, upon withdrawal as manager of the Fund, SHP was entitled to (1) an incentive distribution based on the value of the Fund as of December 31, 2007 and the amount of cash distributed to CalPERS over the life of the Fund, and (2) the value of its 5% membership interest, in addition to other payments. According to the Agreement, the payments were, in the absence of an actual sale of the properties, to be calculated based on the value of the Fund’s assets, Florida senior housing properties, as reflected in annual appraisals. The most recent ordinary course appraisal of the senior housing properties that comprised the Fund’s assets had been completed in January 2008 for the year ended 2007 by Duff & Phelps, an appraiser selected by CalPERS. In conducting the appraisals, Duff & Phelps had been instructed by CalPERS not to rely on SHP and to independently review and verify all data, because CalPERS knew that the Duff and Phelps’ appraisals would be the primary component of the incentive distribution it would eventually owe to SHP. The Court found that Duff & Phelps carried out those instructions, even preparing its own projections. CalPERS was apparently unhappy with the amount of the payout based on the appraisals. Having no other basis to dispute the appraisals or appraisal process, however, CalPERS authorized Duff & Phelps to issue final appraisals in early 2008.
In June 2008, SHP notified CalPERS of its intent to withdraw as manager of the Fund, making it apparent that the incentive distribution would be due on December 8, 2008 when the withdrawal became effective. In an effort to reduce the amount of the anticipated payout, CalPERS pressured SHP to renegotiate the Agreement. When that tactic was unsuccessful, CalPERS began secretly pressuring Duff & Phelps to withdraw its appraisals and issue new lower appraisals of the Fund’s assets as of December 2007, despite its own counsel’s advice that the Agreement did not provide for such new or restated appraisals. Nonetheless, after much protestation, CalPERS was able to convince Duff & Phelps to withdraw its original appraisals for reasons that later proved pre-textual. Similarly, CalPERS manipulated the appraisal process undertaken by Cushman & Wakefield for purposes of valuing SHP’s 5% membership interest. In the days leading up to December 8, 2008, SHP learned of the new Duff & Phelps appraisal and disputed the manipulated Cushman & Wakefield appraisal. On December 8, 2008, CalPERS refused to pay any incentive distribution, membership interest, or severance compensation. In addition, CalPERS withheld quarterly asset management fees owed to SHP. CalPERS suddenly claimed it was not required to make any of the payments because the previously accepted Duff & Phelps appraisals were incorrect.
At trial, CalPERS argued that the Court should disregard the appraisals that were obtained pursuant to the Agreement and perform its own valuation of the properties to calculate the incentive distribution and other payments. CalPERS also argued that, in valuing the properties, the Court should deduct from the value certain liabilities (known as resident liabilities) that represented the total amount refunded to each resident upon leaving the property. SHP, on the other hand, argued that the Agreement did not provide for any role for the Court in valuing the properties and that the values were those determined by the appraisers before CalPERS’ improper influence. The first issue the Court addressed was whether the Agreement or Delaware law required judicial review of the prior appraisals, such that the Court would need to conduct its own appraisal, akin to a Section 262 statutory appraisal. The Court ruled that, as a matter of law where, as here, a contract between the parties sets out formulas for use in determining payments by one party to the other, and where the contract does not provide a role for the Court in determining how to apply the formulas, the Court will not second-guess the parties’ contractual obligations absent clear bad faith between a party and the appraisers to whom the contract committed application of the formulas. Under such a standard, the Agreement left no room for the Court to review the substantive work of the appraisers. Recognizing that issue was relatively unique, however, the Chancellor opined, in the alternative, that even if he were able to review the appraisals, he would still find in favor of SHP. In so holding, the Court rejected each of CalPERS’ substantive challenges to the appraisals. Noting that the Agreement was silent on the issue of accounting for resident liabilities, the Court looked to the parties’ course of performance and rejected CalPERS’ proposed accounting as inconsistent with the fact that buyers of such properties typically assume resident liabilities as part of the consideration exchanged in the sale. The Court also rejected CalPERS’ attacks on Duff & Phelps’ terminal capitalization rate and projections. With respect to the Cushman & Wakefield appraisals that determined the value of SHP’s membership interests, the Court modified the appraisals to remedy CalPERS’ violation of the implied covenant of good faith and fair dealing.