Opinion
Bankruptcy No. 97-19699DWS, (Consolidated with Bankruptcy No. 97-19700), Adversary No. 00-0864
May 28, 2003
MEMORANDUM OPINION
Before the Court is the Complaint of Stewart Axtell, Liquidating Trustee ("Trustee") of the estates of Walnut Equipment Leasing Co., Inc. ("Walnut") and Equipment Leasing Company of America ("ELCOA" and together with Walnut, "Debtors") against Equipment Leasing Company d/b/a Quaker State Leasing Co. ("Quaker") for breach of contract as a result of Quaker's termination of an agreement to purchase assets from the Debtors during their consolidated Chapter 11 case. Trial of the liability phase of the Complaint was held on January 24, 27, 28, 29 and 31, 2003. The parties requested, and were granted, leave to file post-trial findings of fact and conclusions of law and supporting memoranda which have now been received. For the reasons that follow, judgment is granted in favor of the Plaintiff Trustee, and a trial on damages shall be scheduled forthwith.
Plaintiff is the duly appointed Trustee of the Walnut/ELCOA Liquidating Trust established pursuant to that certain Liquidating Trust Agreement dated February 3, 2000 (the "Liquidating Trust Agreement"), by and among the Debtors and the Plaintiff.
The parties agreed, with the Court's consent, to bifurcate the trial with damages evidence to be presented only if Plaintiff is successful in establishing liability. Moreover, at the start of trial the parties stipulated that the Third-Party Complaint against the Debtors, Walnut and ELCOA, should be dismissed. Pursuant to Fed.R.Civ.P. 41(a)(2), I will give effect to that agreement.
BACKGROUND
The Debtors, Walnut and ELCOA, were engaged in the business of financing and administering the purchase of small-ticket commercial equipment for direct finance leasing. On August 8, 1997, each of the Debtors filed voluntary petitions for relief under Chapter 11 of the United States Bankruptcy Code and continued to operate their business as debtors-in-possession, collecting payments on existing leases, instituting legal action to collect unpaid leases and until the end of July 1998, generating new leases. The largest single asset of the bankruptcy estates was the Debtors' lease portfolio (the "portfolio").
Small ticket leasing means equipment lease transactions ranging in value from $10,000 to $250,000 per lease.
Collection of delinquent lease accounts was referred to the Law Offices of William Shapiro, P.C. ("LOWS"), a firm owned by the Debtors' President and which did collection work only for the Debtors.
In the mid to late winter of 1998, Francis Lawall, Esquire ("Lawall") of the law firm of Pepper Hamilton, LLP ("Pepper"), counsel to the Official Committee of Unsecured Creditors (the "Committee") during the Debtors' Chapter 11 reorganization case, engaged in discussions with Quaker about the Committee's desire to secure an agent to service the Portfolio. Quaker was represented in the discussions by its President Donald P. Kennedy ("Kennedy"). Kennedy reported to George Mark ("Mark"), Executive Vice President of Progress Financial Company ("Progress"), Quaker's parent and the parent of two other leasing companies, Equipment Leasing Company ("ELC") and PAM Financial. Mark, however, was not involved in the discussions regarding servicing the Portfolio or the subsequent negotiations to purchase the Portfolio. Indeed Mark was not aware of the asset purchase transaction before an agreement was signed nor had he been asked to provide input on its advisability.
While the Debtors were managing their properties as debtors-in-possession, the reorganization had taken the form of a liquidation of assets in Chapter 11 for the benefit of creditors. Since the creditors as represented by the Committee were the real party in interest in the Chapter 11 liquidation proceeding, the Debtors deferred to the Committee's decisions with respect to maximizing value from estate assets. Accordingly, Committee counsel was the primary actor for the estates with respect to the transaction at issue in this matter.
Kennedy, Quaker's President from 1992 through December 1998 when Quaker was sold, had been in the leasing business since 1977.
Mark testified that he learned of the transaction as the purchase agreement was about to be signed but knew nothing about the characteristics or quality of the Portfolio or about Walnut and ELCOA, including that they were in bankruptcy proceedings. He observed that the transaction was consistent with corporate strategy to grow Quaker's lease portfolio.
In connection with the servicing discussions, Kennedy met with Kenneth Shapiro ("Shapiro"), Walnut's Vice President, in February 1998 at Quaker's offices and again in March 1998 at both Walnut's and Pepper's offices. Lawall and Debtors' counsel Charles Golden, Esquire ("Golden") attended one of those meetings as well. During these meetings, Kennedy was given information about the Debtors, their reorganization cases, their business operations and the Portfolio. Shapiro recalls specifically advising Kennedy during the first meeting, that Walnut collected approximately sixty percent of the delinquent amounts which were referred to LOWS for collection and providing Kennedy with lease files to inspect and thereafter answering questions about them at the Walnut meeting.
On March 20, 1998 Lawall faxed to Kennedy an eight-page letter dated March 18, 1998 from Kenneth Shapiro to his counsel Golden outlining "guidelines to be considered in the servicing and administration of `small-ticket' lease portfolios" which was intended to serve as an exposition "at a minimum of the services which should be provided in order to maximize recovery from all lease receivables. . . ." Ex. P-2. Attached to the letter were sample copies of documents maintained in the files of Walnut with respect to individual leases, including an equipment lease, the purchase order for the equipment that is the subject of the lease, a certificate of acceptance with respect to the equipment, a telephone memorandum created by Walnut employees after a telephone conversation with the lessee and an account history. Id.
These negotiations were ultimately abandoned without a servicing relationship being consummated. Rather the Committee, concerned with the protracted nature of the bankruptcy case and the escalating administrative costs of the Chapter 11 proceeding, determined that a sale of the Portfolio would be in the best interests of creditors since it would allow conclusion of the bankruptcy sooner. At the time, according to Kennedy, Quaker was interested in purchasing leases on an "opportunistic basis" to grow its lease business in scope and dollars. Trans. 1/24/03 at 185. With the Committee wanting to sell and Quaker interested in buying, the discussions turned to the terms and conditions of an outright sale.
In a servicing relationship, the servicer gets a flat fee for each contract as well as a percentage of the rental stream and possibly a fee for incidental services delivered. Upon acquisition, however, the buyer assumes the entire risk of collection. Thus, the business considerations attendant to servicing a lease portfolio are different than for purchasing one. How that fact bears on the information that Quaker would have reviewed during this phase of the parties' relationship versus in connection with a purchase transaction was not explained. Notably, however, Quaker acquired some knowledge of the Debtors' business to jump start their learning curve before the July 17 due diligence visit.
In furtherance of this end, a number of documents were transmitted to Quaker.
1. On April 17, 1998 Lawall faxed to Kennedy a letter dated April 16, 1998 from Shapiro to Golden in which he set forth the number of leases outstanding at March 26, 1998; the number of leases assigned to LOWS at March 26, 1998; the anticipated cash flow projection of scheduled payments to be received during the twelve month period ending March 26; the geographical location of the equipment subject to the leases; and the types of equipment subject to the leases. Ex. P-6. Attached to Shapiro's letter was a spread-sheet which purported to set forth the lease receivable balances of Walnut and ELCOA. The combined pre and post-petition lease receivable balances of Walnut and ELCOA as broken down by aging according to the attachment to Exhibit P-6 were as follows: 0-30 days — $9,762,372.00; 31-60 days — $729,525.00; 61-90 days — $303,522.00; 91 plus days — $5,310,159.00. Id. Lawall did not recall receiving any specific request for a further breakdown of the aging of the Portfolio after having faxed Exhibit P-6 to Kennedy, and Kennedy acknowledged not recalling that either he or any other Quaker representative had requested a further breakdown of the precise number of days the leases in the 91 plus days category were delinquent.
2. On April 21, 1998 Lawall sent another fax to Kennedy consisting of 20-pages, one of which was a one-page schedule captioned "Projected Liquidation and Write-off of Defaulted Leases Assigned to W.S. Shapiro, Esq., P.C. for Liquidation" which was prepared by Walnut's controller and represented anticipated collections from the existing Portfolio and the balance of which was a projection of cash flows through April 2000 assuming that the Debtors would remain in the leasing business (i.e., generate new leases). Exhibit P-7.
3. On April 24, 1998 Francis Brulenski ("Brulenski"), CPA, of the firm of Nihill Reidley Co. ("Nihill"), accountants to the Committee, faxed to Kennedy, at his request, a document previously prepared by Nihill which was titled "Summary of Legal Activity for the 63 Months Ended July 31, 1997." Exhibits P-8, 15A. This document showed collections and write-offs during the fiscal years 1996 and 1997 and the fiscal quarter ended July 1997 and the accounts that were referred to LOWS for collection during the years 1993 through 1997 and the fiscal quarter ended July 1997. Id. At the further request of Kennedy, Brulenski supplemented the report by adding information relating to amounts collected and written off during fiscal years 1993 through 1995. Exhibit P-15A. Kennedy acknowledged reviewing this data prior to executing the Agreement.
4. On May 12, 1998 Kennedy requested that Shapiro provide information on all the "asset fundings that you have done since 3/26," Exhibit P-9, to which Shapiro responded with a report of the leases generated by Walnut from March 27, 1998 through April 26, 1998. Exhibit P-10. In his transmittal letter, Shapiro recognized that the data was not provided with the detail requested but believed it had sufficient information to enable Quaker to analyze the new bookings for the most recently completed month. Id.
5. On May 14, 1998 Shapiro forwarded to Kennedy, at his request, a list of lessees and for each, the state in which leased equipment was located, the cost of the equipment, the terms of the lease, the monthly payment, the end of term buyout, a description of the equipment and the lease receivable amount. Exhibit P-10.
During this period, Quaker's transaction counsel, Lawrence Kotler, Esquire ("Kotler") prepared an initial letter of intent to purchase the Portfolio which he transmitted to Lawall and Golden on May 5, 1998. Exhibit D-3. The document contemplated a purchase price of $9,169,000 subject to reduction based on Quaker's due diligence which was anticipated to take 45 days from the date of the letter. Id. Lawall responded in writing on May 7, 1998, stating his view that the transaction would be "as is, where is," subject to due diligence which he hoped could be completed within 15 days of execution of the definitive agreement. Exhibit D-4. Kotler replied on May 18, 1998 with a revised letter of intent increasing the price to $9,570,000 subject to adjustment after due diligence as before and contemplating the execution of a definitive agreement that would contain limited warranties and representations as demanded by Lawall. Exhibit D-6. A formal letter of intent was never executed, the parties abandoning the two step approach and going directly to negotiations over the asset purchase agreement (the "Agreement").
Lawall's concern was stated as follows:
I do not want to be in a position where a topping fee is approved and notice of the proposed sale has gone out all the while the buyer has a significant "out" in the deal.
Id. at 2.
While it appears that the due diligence period was shortened by fifteen days (from forty-five to thirty days), in effect it is the same since that amount of time had elapsed since the initial letter of intent during which the documentary exchange outlined above, was being undertaken. Although it appears that Quaker considered its due diligence to have commenced after the Agreement was executed see Exhibit D-18, the information sought by and provided to Kennedy in April and May was in furtherance of Quaker's due diligence.
The initial draft of the Agreement was prepared by Lawall's associate Rena Kopelman, Esquire, and transmitted to Kotler by Lawall on June 3, 1998. Exhibit D-7. After negotiations, Kopelman transmitted a revised draft on June 23, 1998. Exhibit P-8. This draft was sent to the Debtors' Board of Directors for review and comment with the expectation that after such input was received and resolved, the document would be executed. The final draft, Exhibit D-14, made no changes from the June 23rd draft, Exhibit P-8, which are relevant to the matters at issue here. It was executed as of July 9, 1998. Exhibit D-17.
There appears to have been other drafts between P-7 and P-8 but these are the only versions of record in this proceeding. The word processing legend on the document indicates that P-8 is version 4. The final agreement is version 7. Presumably the other drafts make changes that do not relate to the dispute sub judice.
The parties agree that Lawall had a sense of urgency to consummate the transaction. Concerned about the impact of runaway administrative costs of the bankruptcy on creditor recoveries, he pressed Quaker to execute the Agreement and allow him to present it to the Bankruptcy Court for approval after notice and an opportunity for higher and better bids, as required under bankruptcy law, could be accomplished. Because of the expedited schedule which Quaker was willing to accommodate, the parties agreed that due diligence, which normally precedes execution of an asset purchase agreement, could occur afterwards.
On July 14, 1998 Kotler transmitted the signature pages of the Agreement and related documents to Lawall and notified him of Quaker's wish to conduct its due diligence under Section 5.1 of the Agreement "to commence" on July 16, 1998. On that date, Mark sent a team he assembled of four leasing experts, i.e., Kennedy, William Brain ("Brain"), Scott Wheeler ("Wheeler") and Dennis Homer ("Homer") and two accountants from PriceWaterhouseCoopers to Debtors' premises. Brain was another Quaker employee whereas Homer and Wheeler were the President and Vice President of ELC, as noted above, a sister company to Quaker and also a Progress subsidiary. Notably ELC is more conservative in its credit criteria, pricing and marketing than Quaker. Horner and Wheeler at best were less than enthused about the contemplated transaction and at worst, predisposed against it. Indeed upon his arrival at Walnut, Kennedy advised Shapiro that two of the six people on the team (i.e., Horner and Wheeler) were "skeptical" about the responsibilities that Quaker would encounter with the Portfolio, including its multi-state scope and its credit quality. Trans. 1/24/03 at 168. In his testimony, Horner acknowledged that prior to the due diligence review he was aware of Walnut as a "sub-prime lender" that "did transactions that [Horner] would imagine that 99 percent of the small ticket leasing companies would not enter into." Transcript 1/29/03 at 78. Also prior to the due diligence review as a result of some preliminary review of the documents, Wheeler was concerned about the large number of over 90 day delinquent receivables, a concern shared with and by Horner.
The failure of a proposed merger of ELC, Quaker and another sister company PAM Financial at the time of the Walnut transaction was attributed to the conservative nature of ELC's business policy vis a vis the other two companies.
The due diligence team initially met with Shapiro for background and were provided past financial statements and then divided the investigation. Kennedy's primary focus was on post-petition leases (underwriting scores and liens) to determine if the underwriting criteria had improved as had been represented by Lawall and Shapiro. In the afternoon his attention turned to prepetition assets to test his expectation that the older portion of the Portfolio had stabilized as he had also been told. Horner reviewed the Debtors' annual reports and 10-Qs and then randomly examined between 100 and 150 active files, looking at the lease applications, the credit underwriting, the industries and equipment. Wheeler spent the morning pulling lease files to ascertain the credit scores. Brain's tasks were to identify the geographical dispersion of the leases for purposes of securing registrations, to determine whether the Debtors' electronic files could be converted to Quaker's system and to develop a present value of the Debtors' cash flow. The Price Waterhouse accountants Jack Lonker and Tony Bizone conducted tests of the receivables, and reported to the Progress/Quaker team that Walnut and ELCOA lent to subprime lessees and funneled off collections to a law firm owned by one of the principals which generated fees for the firm.
In July 1997 the Debtors implemented a credit scoring system based on the "Fair Isaac" method utilized in the credit industry to eliminate applicants whose credit scores are below a certain minimum threshold. Exhibit P-224 at 9. As a result of this changed business practice, Kennedy expected improved performance in the post-petition assets. Trans. 1/27/03 at 62-63.
One of the accountants, Jack Lonker testified but not having any generated any notes or reports, had only a sketchy recollection of the engagement. He recalled concluding that the credit scores on the leases appeared low, an observation he shared with the "Progress guys." Trans. 1/28/03 at 96. However, neither he nor his associate Tony Bizone made a report to anyone and neither conferred with Mark about their observations. It appears the only input they provided on their examination occurred during a lunchtime discussion with the other team members. Lonker stated that he had allocated two to three days for the work but never went back and did not recall how it all ended.
While a multi-day investigation had been contemplated, Wheeler, Horner and Brain ceased their work prior to the completion of the first business day, having concluded that purchase of the Portfolio was inadvisable. They reported their findings to Mark. Any further investigation was aborted after Kennedy who worked until 5 p.m. recommended to Mark that Quaker terminate the Agreement based on his concern with the collectability of the Portfolio. Trans. 1/24/03 at 171. Oral notice of termination was provided on July 17, 1998, the morning of the Court hearing to consider Debtors' Motion to Approve Bidding Procedures. Without a proposed purchaser, the Court proceedings were adjourned without entry of any order. In a memorandum to Mark dated July 20, 1998, Kennedy memorialized the bases and some data underpinning his recommendation to terminate. He stated:
Horner was concerned about the type of industries leased to, the type of equipment leased and the quality of the credit decisions. He told Mark of his concerns, including the aging of the accounts receivable which indicated that receivables over one year were being carried as opposed to charged off. Wheeler told Mark that the quality of the files was not what he was used to and he would not buy the asset.
The Agreement provides an alternative remedy to termination if there are "discrepancies in the value of the Purchased Assets." Buyer may provide notice to Sellers of the discrepancies and the reduction in the Purchase Price that should result therefrom. Sellers have five days to agree in writing to such reduction. Agreement ¶ 5.1. Kennedy testified that he rejected this option but did not explain his reason for so doing.
A bidding procedures motion is generally the first step in a sale of assets pursuant to 11 U.S.C. § 363. It seeks to set the terms of competitive bidding, including approval of a topping or break-up fee to the proposed purchaser if it is out bid for the assets.
The Agreement required the tender of a $500,000 deposit (the "Deposit") upon Court approval of the sale. Given the termination of the Agreement prior to the contemplated sale hearing, it was not provided. Quaker's failure to provide the Deposit is an issue reserved for the damages portion of this case.
We understood going in that the Walnut portfolio was a troubled portfolio, but that the prepetition portfolio had stabilized and the post-petition portfolio had new and improved credit criteria that would result in a cleaner portfolio. Our findings, as identified through Walnut's own Legal Report, is that the complete opposite was occurring.
Exhibit D-23. The formal notice of termination was transmitted on July 21, 2003. Exhibit D-26.
The Agreement does not require that the reasons for the termination be specified. However, Quaker sent a letter terminating the Agreement "based on its dissatisfaction with due diligence "and at my request, specified the nature of its discontent. Given the consequence of the loss of this transaction to the estates, my goal in asking that it do so was to facilitate a discussion that would hopefully result in the parties finding a basis to go forward with the sale. Plaintiff wants the Court to review that document against the proofs in this adversary case to conclude that the termination was without cause. I refuse to do so as it would improperly penalize Quaker for complying with the Court's request.
At issue in this phase of the adversary case is whether Quaker breached the Agreement when it terminated it as described above. The resolution of this questions turns first on the proper interpretation to be accorded the contractual provision underlying Quaker's election to terminate the Agreement, i.e., Section 5.1. Once understanding the rights conferred by that provision, I examine whether they provided the legal foundation for Quaker's action in terminating the Agreement.
The permitted bases for termination of the Agreement are set forth in Section 9.1. There is no dispute that Quaker invokes § 9.1.7 which allows termination in accordance with § 5.1. Thus, my focus is on the latter section.
DISCUSSION
I. Burden of Proof
As correctly noted by Quaker, the party alleging a breach of contract bears the burden of proving all the elements by a preponderance of the evidence. Bohler-Uddeholm America, Inc. v. Ellwood Group, 247 F.3d 79, 102 (3d Cir. 2001). Thus, it is the Trustee's burden to demonstrate that a proper interpretation of § 5.1 supports his view of the case. However, in so doing, I reject Quaker's invitation to apply the presumption that as an ambiguous contract, the provision is to be construed against the Trustee as Pepper drafted the Agreement. Dardovitch v. Haltzman, 190 F.3d 125, 141 (3d Cir. 1999) ( quoting Restatement of Contracts § 206 that "in choosing among the reasonable meanings of a promise or agreement or term thereof, that meaning is generally preferred which operates against the party who supplies the words or from whom a writing otherwise proceeds."). There is a well established exception to the rule of contra preferentem where a contract is the result of the joint effort of the attorneys or negotiators for both sides. Spatz v. Nascone, 364 F. Supp. 967, 971 (W.D. Pa. 1973) (citing cases). Here while Pepper prepared the first draft of the document, it merely maintained control of the document thereafter with Koppelman, the draftsperson acting as a scrivener to incorporate the negotiated changes. The document went through at least six draft versions before a final document was circulated for execution. Exhibit D-14. Section 5.1 was specifically renegotiated from Lawall's first draft and if anything, its final form reflects Kotler's work, not Lawall's. Thus, there is no basis on these facts to construe the Agreement and § 5.1 in particular against the Trustee.
II. Interpretation of Section 5.1 of the Agreement
Section 5.1 of the Agreement (the "Due Diligence Provision") sets forth Quaker's right of due diligence. It reads as follows:
[f]or fourteen calender days from the date hereof, Purchaser shall be entitled, upon reasonable request and during normal business hours, through its employees and representatives, to perform an investigation of the Purchased Assets and to access Sellers' computer software and databases in order to determine the accuracy of Schedule 1.1 hereto and to ensure that (i) the accounts receivable have been timely and correctly presented, (ii) the Leases are enforceable for their remaining terms as has been presented, and (iii) the Equipment was delivered and accepted in accordance with the terms of the Leases.
It is not clear from the copies of the Agreement provided to me that certain of what I have represented above as commas are not actually periods. No one has suggested as much nor is this punctuation an issue in this dispute.
Section 5.1 further provides the following remedy which Quaker invoked to terminate the Agreement rather than consummate the sale.
If Purchaser is dissatisfied with the results of any such investigation, Purchaser may, within said fourteen calender day period, notify Sellers in writing that this Agreement is terminated. . . . Upon the termination of this Agreement as set forth in this Section 5.1, the Agreement shall be null and void and the parties shall have no further obligations or liabilities to the other other [sic] than return of the Deposit to Purchaser and those obligations which expressly survive termination as set forth herein.
Id. The underpinning of the dispute sub judice is the parties' conflicting interpretations of Section 5.1 of the Agreement.
I have previously determined in the context of the Trustee's Motion In Limine that the Due Diligence Provision is ambiguous. Axtell v. Equipment Leasing Co. (In re Walnut Equipment Leasing Co. Inc.), 2002 WL 31994477 (Bankr. E.D. Pa. Dec. 13, 2002). I found that it could be read in two ways, and as such, I permitted extrinsic evidence to be introduced at trial to elucidate its meaning. Id. A summary of the trial evidence reveals not two, but four interpretations, belying the contention of the parties that the Due Diligence Provision was unambiguous.
The Trustee reads the Due Diligence Provision to afford Quaker a limited right of due diligence. His support for that position was put forth in Lawall's testimony. As noted above, Lawall was the person who negotiated and documented the Agreement on behalf of the bankruptcy estates with Quaker's transactional counsel Kotler. According to Lawall, Quaker's sole right was to investigate the Purchased Assets to determine the accuracy of Schedule 1.1. It is agreed that Schedule 1.1, which was never attached to the Agreement and which no one appears to have a copy of, contains a listing of the leases being purchased. Lawall's understanding was that Quaker's sole right was to verify that all the leases listed on Schedule 1.1 existed. Lawall explained that the Committee's intent was to allow a very narrow out for any buyer since otherwise, the estates would be going through the time consuming and costly bankruptcy approval process with little assurance that the transaction would close. That is why, he stated, considerable information was given to Quaker up front, including during the period the servicing deal was being negotiated.
Lawall's contention that he eschewed an unlimited escape from the Agreement based on Quaker's dissatisfaction for any reason arising from its investigation of the Purchased Assets is credible in the context of the bankruptcy case. It is improbable that given the Committee's fiduciary duty to conserve estate assets, it would expend estate funds to pursue a transaction that could so easily be avoided. However, Lawall's view of Quaker's right to terminate based on the results of its due diligence is overly narrow since it finds no support in the language of the Agreement. Indeed Lawall's interpretation is precisely the reading to be gained from the initial draft of the Agreement prepared by his associate Kopelman but notably that language did not survive the subsequent review and modification made by Kotler. The evolution of that document is as follows:
P-7 states:
For the period within twenty (20) days after the entry of the Deposit Order by the Bankruptcy Court, Purchaser shall be entitled, upon reasonable request, through its employees and representatives, to perform an investigation of the Purchased Assets in order to determine the accuracy of Schedule 1.1 hereto. Any such investigation and review shall be conducted at reasonable times and under reasonable circumstances.
The next draft, Exhibit P-8, was blacklined to evidence the following changes:
For [the period within twenty (20) days after the entry of the Deposit Order by the Bankruptcy Court] fourteen days from the date hereof, Purchaser shall be entitled, upon reasonable request, through its employees and representatives, to perform an investigation of the Purchased Assets and to access Seller' computer software and databases in order to determine the accuracy of Schedule 1.1 hereto and to ensure that (i) the accounts receivable have been timely and correctly presented. (ii) the Leases are enforceable in accordance with their terms and (iii) the Equipment was delivered and accepted in accordance with the terms of the Leases. Any such investigation and review shall be conducted at reasonable times and under reasonable circumstances.
Lawall dismissed the new language, which he acknowledged was added by Quaker, as mere surplusage and not intended to change the function of the due diligence which, in his opinion, was to verify that the leases actually existed.
Kotler, who was the scrivener of the new language, not surprisingly disagreed, stating that the new language represented a compromise between the Committee's view that the investigation be on the narrow basis reflected in Lawall's first draft and as broad and unlimited as Quaker wanted it to be. He then gave his interpretation of new section 5.1, adopting one of the permutations I suggested was a possibility when I ruled on the In Limine Motion. According to Kotler, the Agreement provided two rights of due diligence: (1) to investigate the Purchased Assets and (2) to access Seller' computer software and databases in order to determine the accuracy of Schedule 1.1 hereto and to ensure that (i) the accounts receivable have been timely and correctly presented, (ii) the Leases are enforceable in accordance with their terms and (iii) the Equipment was delivered and accepted in accordance with the terms of the Leases (hereinafter the clauses set forth in romanettes (i) through (iii) shall be referred to as the "Purposes"). Trans. 1/27/03 at 94-95. In Kotler's reading, there is no limitation on the scope of the investigation of the Purchased Assets but access to the computer software and databases may only be permitted to determine the accuracy of Schedule 1.1 and to ensure the Purposes.
Kotler attempts to make sense of the limiting impact of the Purposes Clause by contending that it modifies the additional language Quaker requested regarding access to computer software and databases. Since the investigation of the Purchased Assets which take the form of written documents could arguably exclude such access, Quaker apparently negotiated the right to conduct its review of relevant data stored electronically. Kotler states that the limitations were a concession to the Debtors' need to operate their post-petition business without undue disruption from "an unfettered rights to look at every single piece of paper, every single computer database, every single record available at large. . . ." Id. at 96 (emphasis added). If that were the case, he does not explain why the limitation documented applies only to the computer files, probably the easiest record to review without disrupting the business. Moreover, Quaker acknowledges that to ensure two of the three Purposes as contemplated, the investigator would have to refer to the physical assets, not the computer software and databases. While determining whether accounts have been timely and correctly stated could involve a review of electronically stored data, clearly a determination of whether the Leases were enforceable according to their terms required a review of the lease documents themselves as would a determination of whether the Equipment was delivered and accepted in accordance with the terms of the Leases. Thus, Kotler's contention that the Purposes Clause limits only the access to computer files is counterintuitive.
Kotler's partner, Kevin Silverang ("Silverang"), proffered another interpretation of § 5.1. Silverang testified that he commented on the first Pepper draft, Exhibit P-7, finding it an unacceptable limitation on Quaker's right of due diligence. According to him, Exhibit P-8 reflects the culmination of the parties' discussions, incorporating to a "material degree" Quaker's requested changes. He found three functions allowed by § 5.1: (1) to investigate the Purchased Assets; (2) to access the computer software and databases in order to verify Schedule 1.1 and (3) to ensure the Purposes. He saw no limitation to the scope of the investigation of the Purchased Assets, drawing upon his experience with general business practice in transactions in which he was involved and his belief that the client did not intend to limit his due diligence in any way, particularly since the seller was in bankruptcy and the Agreement provided no warranties. He provided no basis for his conclusion that his client subjectively did not intend to limit its due diligence since there was no evidence of his having any discussions with Kennedy or any other representative of the client. Rather I construe Silverang's comments to support Quaker's argument that it is not reasonable to conclude that Quaker would have limited its rights in the manner the Trustee contends.
Kotler was the main lawyer acting in this matter for Quaker who was a client of Silverang. Quaker's parent Progress had been Silverang's client since 1991, and he had been a member of its board of directors. Silverang became counsel to Quaker after it was acquired by Progress. Kotler and Silverang are no longer partners, Kotler having resigned from Buchanan Ingersoll in May 2001 to join Duane Morris.
Just as there is a problem with Lawall's interpretation of the Due Diligence Provision which ignores the later negotiated language so there are problems with the interpretations put forth by Silverang. Notably Silverang's interpretation is different than that of Kotler who drafted the provision, undermining the credibility of Silverang's explanation as a record of what actually was intended by the language of the Agreement as opposed to what would support Quaker's position now. Under Silverang's version (adopted by Quaker in its brief), the Purposes stand alone as additional rights; only the access to computer databases is limited to determine the accuracy of Schedule 1.1. However, in contending that Quaker has a broad and unlimited right to investigate the Purchased Assets, the Purposes Clause would be surplusage in Silverang's interpretation. If there is no restriction on the due diligence, why did Quaker feel obliged to add the Purposes Clause?
Silverang stated that because the Portfolio was voluminous and would have taken a substantial period of time to manually review, access to a purportedly existing database was intended to shortcut the process. This testimony is at odds with that of Lawall whose one concession to Quaker's due diligence rights was to grant Quaker the right to physically examine the leases set forth in Schedule 1.1 to verify that they indeed existed, and Quaker's actual due diligence where lease files were physically reviewed, not accessed electronically.
When asked what the significance of these items were, Silverang stated that they related to some of the specific representations that had been made to Quaker as oral inducements to consider the Portfolio, and it wanted the ability to specifically focus on them in addition to other due diligence rights. Trans. 1/29/03 at 24. This response is puzzling. If Quaker had an unlimited right of due diligence, it would not have needed to identify specific areas. Moreover, if it wanted to single out specific areas, why didn't it identify the specific representations that it now indicates were at the heart of the transaction. According to Quaker, it was the quality of the underwriting (and its belief that it had improved based on representations to that effect) that was of greatest concern.
Silverang's explanation is also belied by the structure of the Due Diligence Provision. First, the use of the connecting "and" after the first clause ("investigate the Purchased Assets") is unusual since the first and second of three equal clauses are generally separated by a comma (a, b and c, not a and b and c). Silverang's interpretation would have make sense if the Agreement read as follows:
For [the period within twenty (20) days after the entry of the Deposit Order by the Bankruptcy Court] fourteen days from the date hereof, Purchaser shall be entitled, upon reasonable request, through its employees and representatives, to perform an investigation of the Purchased Assets to ensure, inter alia, that (i) the accounts receivable have been timely and correctly presented, (ii) the Leases are enforceable in accordance with their terms and (iii) the Equipment was delivered and accepted in accordance with the terms of the Leases and to access Seller' computer software and databases to determine the accuracy of Schedule 1.1 hereto . Any such investigation and review shall be conducted at reasonable times and under reasonable circumstances.
It is hornbook law that in construing a contract a court should give meaning to all its words and phrases and adopt a construction that avoids surplusage. Washington Hospital v. White, 889 F.2d 1294, 1300 (3d Cir. 1989); Continental Insurance Co. v. Allstate Insurance Co., 820 F. Supp. 890, 897 (E.D. Pa. 1993). The only rational interpretation of § 5.1 that gives effect to all its language allowed Quaker to investigate the Purchased Assets (i.e., examine physical lease files and financial records) and to access the computer software and files (i.e., examine the intangible records). However, its investigation of both sources was to be limited to determining the accuracy of Schedule 1.1 and ensuring that (i) the accounts receivable have been timely and correctly presented, (ii) the Leases are enforceable in accordance with their terms and (iii) the Equipment was delivered and accepted in accordance with the terms of the Leases. This interpretation is broader than originally proposed by Lawall in Exhibit P-7 and found unacceptable by Quaker and narrower than the unlimited due diligence unacceptable to the Committee. Moreover, it is consistent with Kotler's testimony that the blacklined document, Exhibit P-8, represents the results of a negotiation, i.e., a compromise between Lawall's vision of a narrow right of due diligence and Silverang's view of an unlimited one.
Having determined the scope of the investigation provided for in § 5.1, I also find that the later language that allows Quaker to terminate the Agreement if it is dissatisfied with "such investigation" does not expand it. Quaker would have me construe that sentence as allowing it to terminate upon dissatisfaction with the Portfolio for any reason. To do so would ignore the modifier "such" which refers to the investigation described above and thereby completely swallow the first part of the paragraph which defines the scope of the investigation. Consistent with my finding above that a contract should be construed to give effect to all its terms and provisions, I will not do so. Nothing in the cases Quaker cites that allow a party to a contract to terminate upon dissatisfaction suggests otherwise. Once the scope of the investigation is determined as I have done, Quaker was permitted within that framework to terminate if it was dissatisfied and its dissatisfaction will be measured by the subjective standard it advances. See Jenkins Towel Service, Inc. v. Tidewater Oil Co., 422 Pa. 601, 606, 223 A.2d 84, 86 (1966).
In the face of what I view as the only internally consistent construction of § 5.1 of the Agreement, Quaker argues that the consequence of such a reading would be contrary to the intention of the parties and the practice in the commercial world. It is beyond cavil that "in construing a contract, the intention of the parties is paramount and the court will adopt an interpretation which under all the circumstances ascribes the most reasonable, probable and natural conduct of the parties bearing in mind the objects manifestly to be accomplished." Metzger v. Clifford Realty Corp, 327 Pa. Super. 377, 385, 476 A.2d 1, 5 (1984) ( citing Unit Vending Corp. v. Lucas, 410 Pa. 614, 190 A.2d 298 (1963)).
Quaker elicited Kennedy's testimony that he did not intend to limit his right of due diligence in any way. Silverang and Kotler confirmed that view. While a party's testimony as to his intent concerning the meaning and effect of a contract can be significant evidence of the meaning of the contract, it is not conclusive evidence. Dardovitch v. Halzman, supra, 190 F.3d at 139. Kennedy's statements must be considered in the environment that he presents them, after the fact and as justification for the action he took. His testimony is that it never occurred to him that he was limiting his due diligence rights and that no one ever advised him of that fact. However, he also acknowledged that his expectations were a result of discussions surrounding the unfinished and unsigned letter of intent and that he never communicated his view of his due diligence rights to anyone in the Debtors' or Committee's camp. Trans. 1/24/03 at 199. As he stated, "nor did I expect to since due diligence is a normal process that occurs certainly in the marketplace and anyone else acquiring a business or a portfolio would. . . ." Id. Thus, Quaker's intent regarding due diligence seems to be unrelated to the Agreement it executed. It appears that while the lawyers were sending drafts back and forth and, notwithstanding Kennedy's review of them, he simply assumed that he would have unfettered due diligence rights and an opportunity to either walk from the deal or renegotiate its price after the Agreement was executed if he was dissatisfied with the Purchased Assets.
A close review of Silverang's testimony indicates that his view is based on the client's reaction to the initial draft of the agreement, Exhibit P-7. Trans. 1/29/03 at 34-35. Similarly Kotler's contention that the limitation on due diligence would be a deal breaker also related to Lawall's original concept of due diligence. Trans. 1/27/03 at 96. I have already noted that Lawall's attempt to circumscribe Quaker's due diligence in the manner memorialized in that draft (i.e., to investigate the Purchased Assets solely to verify Schedule 1.1) was clearly rejected by the subsequent draft. Thus, his client's refusal to accede to due diligence as contained in the initial draft is not the relevant consideration. There does not appear to be any contemporaneous evidence that sheds light on Quaker's view of the ultimate language.
Kennedy appears to have been the sole actor in this drama for Quaker until the due diligence investigation was undertaken. His goal was to expand Quaker's leasing business, an objective supported by Mark. Notwithstanding the size of the transaction, Mark was not advised about it until the Agreement was to be signed. The due diligence team assembled by Mark now involved the more conservative ELC managers, Horner and Wheeler. They came with a predisposition against the transaction which was borne out by their investigation. Indeed Kennedy cautioned Shapiro about their negativity. They discontinued their work before Kennedy did, returning to Mark to report their adverse conclusions. Had they been the decision makers, it is possible the Agreement would not have been signed in the first place. However, as noted above, there is no evidence that Kennedy's now stated view that he had an unlimited right to due diligence that would support termination based on any dissatisfaction with the investigation was advanced during the negotiations. The sole clear evidence is that Quaker intended to reject Lawall's initial narrow view of an investigation of the Purchased Assets limited to determining the accuracy of Schedule 1.1 and put forth a compromise position evidenced by blacklined Exhibit P-8. Moreover I cannot conclude that Lawall ever intended to negotiate and recommend to the Committee that it seek court approval of an agreement that could be terminated if Quaker were dissatisfied for any reason. His communication to Kotler made that quite clear. While I find it highly possible that Kennedy, to the extent he considered the issue prior to signing, could have thought he could walk away from the deal if it did not live up to its expectations, his view cannot be attributed to the seller and is at odds with the Agreement he signed.
I am also not persuaded that because Debtors fully cooperated with Quaker, providing unfettered access to information on the date of the Due Diligence Investigation that they can be held to have expanded the scope of the permitted due diligence that would justify termination under the terms of the Agreement. I assume this evidence was elicited to prove that Debtors had the same view of the Due Diligence Provision that it had. I conclude it proves nothing more than during the brief Due Diligence Investigation, the Debtors were cooperative. Moreover, I do not conclude that Shapiro's provision of financial statements to the due diligence team at the inception of the site visit evidences that Kennedy had not seen them previously as Quaker argues. While unable to fix the date, Kennedy ultimately did not dispute having reviewed the 10K public documents prior to execution of the Agreement. Rather he stated that he found them to contain stale information that needed to be brought current during the due diligence review.
Finally there was testimony about industry practice by Silverang, an experienced corporate lawyer, and Quaker's expert, Bruce Kropschot ("Kropschot"), a consultant to the equipment leasing industry. Custom and practice in the industry is a relevant factor when interpreting an ambiguous contract. Keegan v. Steamfitters Local Union No. 420 Pension Fund, 211 F. Supp.2d 632, 642 (E.D. Pa. 2002). Both testified convincingly that it is customary for a buyer to insist on broad due diligence rights, and indeed where, as here, the seller was liquidating in bankruptcy and could provide no meaningful representations and warranties, that right was even more important so that a broader rather than narrower due diligence would have been expected. I appreciate the seeming common sense which underlies this argument. However, there was no testimony as to whether that practice is applicable to bankruptcy sales which traditionally move quickly and often alter a party's due diligence opportunities. The consequence of these limitations are usually reflected in the price offered for the assets. Whether the assets were in anyway discounted because of the nature of the seller is unknown since there was little evidence as to how the purchase price was negotiated and set or the assets were valued. If the price was discounted to account for the special nature of this seller, then the custom and practices that Kropschot and Silverang refer to may be distinguished. No witness addressed this point, limiting the utility of this testimony. Finally, to the extent that custom would have been applicable here, it flies in the face of the Agreement that was executed. Since the purpose of custom and industry practice evidence is to interpret an otherwise ambiguous contract, my finding that the extrinsic evidence of the drafting of the contract cleared the ambiguity also undercuts the force of this testimony.
Kennedy testified in the broadest of terms about the purchase price.
Q. How is it that Quaker arrived at a purchase price of $9,570,000.
A. I am going to assume that we weighted various components, various ages of the portfolio, and created discounts off of that gross receivable to come to this number.
Q. And when you say you're going to assume, I mean do you have any personal knowledge as to how Quaker arrived at the price?
A. I know that I was doing some hand — I'm sure that I was doing some hand calculations myself to — you know, how I saw some methodology.
Trans. 1/24/03 at 152. Those hand calculations are evidenced as notations on a document prepared and provided to Quaker by Debtors setting forth the Lease Receivable Balance as of March 31, 1998. Exhibit D-31 and Exhibit P-4. This document was part of the financial package that Lawall transmitted to Kennedy on April 17, 1998. Exhibit P-6. Kennedy did not indicate when he made these calculations but since they were made to determine the purchase price and the price calculated, $9,509,000, was set forth in the second draft of the letter of intent dated May 18, presumably they were done between April 17 and May 18. In the most informal manner, belying the notion that this was a big transaction for Quaker or that if it were, he viewed the Agreement as a committed obligation, Kennedy has scribbled some numbers in the margins of the document. According to his testimony, he took the total receivables in each aged category and applied different discount rates as well as made further adjustments for risk and present value. Trans. 1/24/03 at 153. He stated (and the document appears to confirm) that he used a 25% discount rate for the receivables aged 91 plus days. It looks like he affixed a $983,000 value to them before making some additional adjustments. Since the total receivables in this category were stated at $5.3 million, presumably other adjustments were factored in since it appears that $983,000 represents a 18.55% discount. Notably Kennedy notes three "issues" in his marginal notes, one of which is "91+- break out." Thus, it would appear that by May 18, 1998, some two months before the Agreement was executed, Kennedy recognized an issue with the 91 plus days receivables. However, no one asked him to explain what was on his mind at this point. At least one of these calculations aggregated $9,509,000, the price in the Agreement. How the price set forth in the original letter of intent, i.e., $9,169,000, was calculated and why it was increased was never explained.
According to Kennedy, Quaker terminated the Agreement because it learned in its due diligence, contrary to statements made by Shapiro and Lawall, that the prepetition portfolio had not stabilized and the postpetition portfolio credit criteria had not improved to result in a cleaner portfolio. Quaker supported that conclusion by reference to summary data of pre and post-petition accounts that "went legal" (i.e., were referred to LOWS for collection) after the bankruptcy cases were filed in July 1997. Exhibit D-23. Based on prior disclosure that Debtors were utilizing the "Fair Isaacs" method of credit analysis to replace their prior subjective analysis, Kennedy expected fewer early defaults than he found when reviewing the legal report relating to post-petition lease accounts. Moreover, he concluded that because an additional 10% of the pre-petition accounts had "gone legal" over the twelve month period, the pre-petition portfolio had not achieved stability which he equated with a 2-3% default rate. As the Agreement contains no representations and warranties, Quaker's only recourse for its dissatisfaction with these performance statistics resided in the rights and remedies of the Due Diligence Provision.
The Trustee contends that Quaker's disenchantment with the Portfolio was attributable to its national scope and the attendant requirement of compliance with many new state regulations that it, as a regional leasing company, had never dealt with. While Mark agreed that was one of the basis for his termination decision, it does not appear to be the only one or for that matter, the most important one.
The accountant Lonker also noted the low Fair Isaacs scores.
However, having heard all the explanations and reviewed all the relevant documents, I have found that the only way the Due Diligence Provision can be read so as to give effect to all its language is as it is written with the Purposes Clause modifying "to investigate the Purchased Assets" and "to access Sellers' computer software and databases." Accordingly, in order to have a right to terminate based on "such investigation," the termination must be supported by dissatisfaction with the investigation as narrowed by the Due Diligence Provision. Stated another way, the termination must have been based on dissatisfaction with the accuracy of Schedule 1.1 or one of the Purposes. The concerns addressed above do not relate to Schedule 1.1 (the leases being sold) or fall within one of the three Purposes for which the Due Diligence Provision allows termination. However, Quaker advances another basis for its dissatisfaction which it contends squarely supports termination under the Agreement as construed herein. It contends that termination was proper since its investigation also revealed that the accounts receivable were not timely and correctly presented. If so, Quaker is correct since it is not necessary that its dissatisfaction must solely or even principally relate to one of the Purposes. As noted by Quaker in its brief, satisfaction is a subjective concept. Whether I view the deficiency it identifies as meriting the action it took is besides the point. So long as Quaker had the right to terminate under Section 5.1 because of dissatisfaction with such investigation, it was permitted to do so provided it acted in good faith. Accordingly, I turn now to the question of whether the accounts receivable were timely and correctly presented.
III.
In purchasing the Portfolio, Quaker was acquiring not only the right to a future stream of payments under the Leases (i.e., the residual value of the Portfolio) but the right to collect the past due obligations (the "Receivables"). The Receivables being purchased were aggregated by age into four categories: 0 to 30 days; 31 to 60 days, 61 to 90 days and 91 plus days. Exhibit P-6. The basis of Quaker's contention that the accounts receivable were not "timely and accurately presented" resides in the last category. Specifically, it argues that in failing to write off and/or discount receivables in accordance with general accepted accounting principles ("GAAP") and industry standards, the over 90 day category was inflated and therefore the Receivables were not accurately presented. Quaker presented its expert Bruce Kropschot, a consultant to the equipment leasing industry and a non-practicing certified public accountant, to shed light on this issue.
According to Kropschot, it was incorrect for Walnut and ELCOA to retain receivables on their books well beyond one year as they did. Rather "in the field of equipment leasing the prevailing practice is to write off accounts when they appear to be uncollectible or at a point where the future collection efforts are not likely to recover a significant portion of the amount due after reflecting in the cost of collection." Id. at 39. In his experience with over one hundred leasing companies, he opined that small ticket leasing companies would not have carried receivables that were over 180 days past due. Yet the majority of Walnut and ELCOA's over 90 day Receivables were past due for over one year. Trans. 1/31/03 at 33. This may explain why Walnut's over 90 day Receivables represent one third of all its Receivables as opposed to a significantly smaller percentage in that category in other equipment leasing companies. Kropschot believed that this fact was sufficient to cause Quaker to be dissatisfied with the results of its due diligence. Kropschot acknowledged that there was no accounting standard or rule that governed when an aged account should be written off although implicitly the accounting rules require that a worthless account be written off.
This does not mean that collection efforts would cease although at this point they may become counterproductive if the costs of collection exceed the potential recovery. Id. at 40. According to Kropschot that break even point occurred with a receivable of about $5,000 unless counsel was retained on a contingent fee basis. Walnut sent its collections to LOWS, a captive law firm that billed for its time and costs on other than a contingent fee basis. How that affected the cost/benefit analysis of collecting these old receivables was not established.
Small ticket companies affiliated with banks typically write off leases after 90 days while two of the small ticket lessors who do business similar to Walnut wrote off leases after 120 days and 150 days respectively.
Kropschot reviewed overall statistics prepared by the credit rating agency Fitch in connection with an analysis of over 100 lease securitizations, the majority of which involved small ticket leases. In the year 1998, the percentage of accounts in these securitizations that were over 90 days past due ranged from .4% to 1%. Id. at 40.
The subject was also explored with Kennedy. The Trustee's counsel asked whether prior to executing the Agreement Kennedy believed that the Portfolio contained no leases over 365 days. He responded as follows:
A. We did not view — we viewed the category of 91 plus as — we understood those to be legal, but we also understood those as collectible.
What we found out in our due diligence on-site was that many of those assets were well beyond 365 days, they were two, three, even four years old, and they were uncollectible.
A normal practice, one a leasing practice, as well as a gap[sic] process, is you non-accrue and you write off at 180. This company was still carrying a receivable at par value. We had to investigate that.
Trans. 1/24/03 at 142, 143. Quaker's counsel followed up and Kennedy stated his view of whether the receivables were timely and correctly presented as follows:
A. That they were certainly inconsistent with generally accepted accounting practices. That the information was that much of the receivables really were uncollectible and should have been written off, written down and certainly not presented to us as an open receivable that was available for the performance of this portfolio.
Trans. 1/27/03 at 38. He relayed his understanding of the small ticket leasing industry practice based on hundreds of companies he used to lend to as follows:
The practice is to go non-accrual at 90 days and if, in fact, you think you have got an impaired asset, between 90 and 180 days you've either written down that asset, or you have collected that asset. At 180, in the absence of having collected that asset, that asset is written off.
Id. at 39. Comparing Walnut to the foregoing industry practice, he noted that it continued to carry receivables two to four years old after they were sent to LOWS for legal action. He took issue with Lawall who concluded that to be correctly stated the aging report merely required a correct aggregation of receivables that were due for 91 plus days. In Kropschot's expert opinion, Lawall failed to consider that standard accounting practice requires that receivables are only carried if collectible and "if you have a damaged asset, you are either to wipe it out, write it off, or bring it down to a legitimate expected future value." Trans. 1/24/03 at 162.
I share Kropschot's criticism of Lawall's explanation. To accept the Trustee's interpretation of "correctly stated" belies the purpose of a due diligence investigation. Indeed it is an extension of what Lawall sought, but failed, to achieve when he pressed for an investigation of the Purchased Assets to verify the accuracy of Schedule 1.1. Lawall would have limited Quaker to merely verifying that every lease being sold existed. Similarly the Trustee argues that Quaker was limited to verifying that every Receivable on the aging existed and was properly identified by aged category. Thus, if all the Receivables in the 91 plus category were past due over 91 days, they were correctly presented. The receivable could be four years old and carried at full value but so long as it was presented as a receivable over 91 days old, it was correctly presented. Such a narrow construction of "correctly presented" is unwarranted.
According to the Agreement, Quaker could investigate whether the accounts receivable were correctly presented and terminate the agreement if it was dissatisfied with such investigation. Webster defines "correct" as "conforming to an approved or conventional standard." Merriam-Webster's Collegiate Dictionary at 260 (10th ed. 1995). While there is no generally accepted accounting practice with respect to the statement of lease receivables, there are conventional standards that while, allowing for some leeway, enable me to evaluate whether the receivables have been correctly presented. From his years of experience with small ticket leasing companies, Kennedy understood that receivables would be written down after 91 days and written off if not collected after 180 days. According to Kropschot, small ticket leasing companies would have written off receivables after 180 days based on the "prevailing practice of writing off accounts when they appear to be uncollectible or at a point where the future collection efforts are not likely to recover a significant portion of the amount due after reflecting in the cost of collection." Trans. 1/31/03 at 39. Moreover, he opined that it is implicit that a worthless account be written off.
Nor does the Agreement require that the receivables be presented according to GAAP.
Walnut's practice was to carry receivables at full value for far in excess of the 180 day industry norm. Whether that practice was based on the unique collection relationship it had with LOWS or some other reason is not clear. As part of its due diligence investigation, Quaker was permitted to determine whether the receivables were presented correctly, i.e. in accordance with the standards of the industry that only collectible accounts would be stated. If it did so and was dissatisfied with what it found, it was permitted to terminate the Agreement even if, as appears quite clear, Quaker's dissatisfaction, and the impetus for termination of the Agreement, was much deeper than this.
However, it also follows that the dissatisfaction must be a consequence of information gleaned during the due diligence investigation conducted after the Agreement was signed. The plain language of the Agreement ties dissatisfaction to "such investigation" and refers to the investigation permitted for fourteen days after the date of the Agreement. Thus the information Quaker acquired before the Agreement was executed could not be the basis for its termination. Presumably if it were dissatisfied with information gained from that investigation, it would not have signed the Agreement. The Trustee points to the information provided to Kennedy to argue that he was fully aware of Debtor's practice of carrying receivables for over one year past due prior to executing the Agreement. Thus, his dissatisfaction with the investigation did not relate to the statement of the accounts receivables. For the reasons that follow, I agree.
While the only Receivable aging document produced to Quaker prior to the due diligence investigation was Exhibit P-6 from which a determination of the extent of the age of the 91 plus day old Receivables could not be made, the Debtors are public companies with publically available information, a fact of which Shapiro made Kennedy aware at the February 1998 meeting. Pursuant to applicable disclosure requirements, Walnut filed 10K statements that indicated that it kept receivables on its books for greater than one year and two years. Such information was publically available for the fiscal years ended April 30, 1997 and 1996 but not for the most recent fiscal year ended prior to the transaction, April 30, 1998. Exhibits P-221 (Form 10-K f/y/e 4/30/96), P-222A (Amendment 10 to Form 10-K f/y/e 4/30/96), P-223 (Amendment 2 to Form 10-K y/e/4/30/96) and P-224 (Form 10-K f/y/e 4/30/97). Walnut's write-off policy is disclosed therein as follows:
Leases are written off only if there is an adverse court decision, bankruptcy, settlement, or unwarranted further costs of collecting insignificant lease balances, and assigned counsel in states where the lessee does business has determined that further action in recovering the debt is unwarranted.
Exhibit P-224 at 9. A table follows that sets forth the dollar value and percentage of lease receivables according to the payment due date. Unlike the document provided to Kennedy, Exhibit P-6, the Form 10-K discloses the breakdown of the over 91 days old Receivables further. This document identifies the portion of the 91 days plus Receivables that are twelve or more months and twenty-four or more months past due. Thus, from Exhibit P-6 Quaker could only glean that of the total Receivables as of March 26, 1998, $5,310,159 of $15,513,667 were over 91 days past due. However, from Exhibit P-224, Quaker could observe that of the total Receivables as of April 30, 1997, $6,004,884 of $20,917,123 were over 91 days past due and further that $4,003,0241 of the $6,004,884 were over one year past due and $2,208,844 of the $6,004,884 were over two years old. A similar breakdown is provided for the year ended April 30, 1996 with fairly consistent allocations. Id. at 13.
The Trustee points to these public documents as evidence that even if a further breakdown of the over 91 days accounts receivables was required to correctly state the accounts receivable, it did so, and those 10-K statements were readily available to Quaker as Shapiro advised Kennedy in February 1998. Moreover, given Kennedy's knowledge of Walnut's practice of carrying old receivables, the Trustee views Kennedy's failure to ask for a further breakdown of the over 91 days old Receivables when he was provided with Exhibit P-6 to indicate that he did not consider the accounts receivables incorrectly stated by reason of its inclusion of the older receivables, i.e., he was not dissatisfied.
Kennedy does not dispute his familiarity with those 10-K statements nor his awareness that there were receivables in the 91 days plus category that were a year old. However, he dismisses the 10-K data as stale and highly unreliable and the precise reason he needed to conduct due diligence. He points out that the last available 10-K to contain the further breakdown of the 91 plus category was dated April 1997, 14 months old at the time of the transaction. Yet it does not appear that a more current aging statement was either requested or prepared by the Quaker team from data acquired during the July 16 visit. Wheeler had reviewed the 10-K statements in preparation for and prior to the on-site due diligence, and testified that notwithstanding the knowledge gleaned from these documents, "it was surprising when we got there to see how far they went." Trans. 1/29/03 at 69. However, no one questioned him on what he looked at or found. Since this appears to be the only reference to the Receivables being examined at the on-site investigation, it would have to be the sole source of Quaker's dissatisfaction. I find this testimony to be too thin a reed to support the action it took in terminating the Agreement.
While he could not recall when he reviewed them, it would appear that he did so before the on-site investigation.
Even prior to his due diligence visit and without regard to the actual delinquency information he uncovered, Wheeler was advising Marks that he was not in favor of the transaction because of the large number of Receivables over 90 days old.
Kennedy responds to the Trustee's challenge to his pre-Agreement knowledge by admitting that he was aware that the 91 plus category included Receivables over 180 days or even one year. That, he contends, misses the point. Rather the issue is that he was led to believe that the prepetition leases had stabilized. He states that when he received data indicating the number of pre-petition leases that had "gone legal" in the prior twelve month period, he realized that was not so. Exhibit D-23. While the data in this Exhibit indicates that in twelve month period following the bankruptcy filing, an additional $1.7 million of leases were referred to legal counsel, Kennedy fails to explain the correlation between the report of leases assigned for legal collection and the 91 plus day aging statistic. The statistics only reveal what was sent to legal counsel, not what happened to the Receivables. It may very well be that the number of leases that "went legal" for that period was evidence of the poor quality of the pre-petition component of the Portfolio. However, I cannot on this record make a connection between what was learned in the on-site investigation that informed Quaker that the over 91 day Receivables were not collectible due to the practice of Walnut's failure to write off or write down the asset. Kennedy makes this same point himself when the Trustee's counsel examines him about a document received pre-execution of the Agreement captioned Summary of Legal Accounts for the 63 Months Ended July 31, 1997. Exhibit P-15A. Refusing to acknowledge that this report which evidences legal account activity dating back to 1993 put him on notice that ELCOA had receivable balances on its books that dated back to 1993, he rather questions how it ties into the actual accounting of receivables. Trans. 1/24/03 at 144. Yet a less fulsome legal activity report is the sole evidence proffered of information gained during the on-site investigation in support of Quaker's dissatisfaction with the 91 plus days aging statement.
As best as I can analyze the available information, it appears that delinquent leases are referred to counsel on the 91st day after payment is due and unpaid. Exhibit P-224 at 12. If a hypothetical aging was prepared as of July 1998 (the date of the New Legal Report), the lease that "went legal"in 8/97 would have been 15 months old. The leases referred to legal collection in July 1998 would have been 3 months old. All of these leases would be reported in the 91 day plus category and more than half of them would be over 180 days old. However, this assumes something neither stated nor reasonable to conclude i.e., that the leases referred to legal counsel during the year period of the New Legal Report remained uncollected as of July 1998.
Indeed this document appears more enlightening than the data that Kennedy summarized in his report to Marks. It does show collections and write-offs each fiscal year from 1993 to 1997. Moreover, it states in footnote that "[t]here are no ELCOA receivables in legal status originating for the 1992 fiscal year." This document was sent to Kennedy by Brulenski by facsimile on April 24, 1998. Exhibit P-8. The transmittal memo states:
Per your request. Please find an updated version of legal account activity for ELCOA now dated back to fiscal year 1993.
If you have any questions or need further information please don't hesitate to ask.
There was no request for further information or questions asked. Kennedy acknowledged his review of the information from the notations on the document in his hand. He was not asked to explain his notations.
I am also unpersuaded by Kennedy's dismissal of the 10-K information he received as unreliable due to its age when the 10-K does more then give him raw numbers. Rather it states the Debtors' practices with respect to carrying Receivables.
Leases are written-off only if there is an adverse court decision. It carried receivables until there is an adverse decision, bankruptcy, settlement, or unwarranted further costs of collecting insignificant lease balances, and assigned counsel in the state where the lessee does business has determined that further action in recovering the debt is unwarranted.
Exhibit P-114 at 12 (emphasis added). Walnut's practice was apparently different than the industry norm identified by the leasing experts. Yet notwithstanding that clear statement in the public record, neither Kennedy nor any Quaker representative inquired about the practice and accordingly could have had no expectations that it had changed. Thus, while Kennedy makes light of the aged data in the 10-K, he can not so easily dismiss the companies' enunciated policy of which he was aware. He did not need to engage in further due diligence to discover that Debtors presented accounts receivable in a manner inconsistent with the industry norm. Having failed to ask Shapiro whether the policy had changed, he had no reason to believe that what was discovered pre-execution of the Agreement to be a practice now identified as unsatisfactory, had favorably changed.
CONCLUSION
I have no doubt that Quaker was dissatisfied with the information it acquired at the onsite investigation. It appears that some of the Quaker team were dissatisfied with the contemplated assets to be purchased even before that visit. I also can appreciate Quaker's conclusion that the Agreement it signed was one that it wished to disavow. Moreover, it appears that the businesspeople believed that they had the latitude to walk way from the transaction for any reason, and they articulated reasons for so doing. I need not speculate on the sincerity of the due diligence investigation based on the Trustee's evidence regarding the limited time committed to the on site review or the possible predisposition of members of the due diligence team against the purchase. I make no finding that Quaker acted in bad faith in terminating the Agreement. Rather I conclude that when Quaker signed the Agreement limiting its due diligence, its rights were compromised. It could terminate the Agreement if it were dissatisfied with "such investigation," and such investigation was limited under Section 5.1. The dissatisfaction from the on-site investigation simply does relate to any of the Purposes permitted by the Agreement, and its dissatisfaction with the presentation of the accounts receivable was not formed during the Due Diligence Investigation. Accordingly, Quaker had no right to terminate the Agreement. It is not the prerogative of a court to rewrite the parties' contract, but rather to interpret it "without regard to its wisdom or folly." Steurt v. McChesny, 498 Pa. 45, 50, 444 A.2d 659, 662 (1982). A deal, even if it is believed to be a bad one, is nonetheless a deal.
An Order consistent with this Memorandum Opinion shall be entered.