Private Equity

Most Americans have heard of at least two famous duels involving future presidential aspirants (although neither had anything to do with a dispute regarding a presidential race itself).  The first was between Aaron Burr and Alexander Hamilton—the result was the death of Alexander Hamilton.  The second was between Andrew Jackson and Charles Dickinson—the result was the death of Charles Dickinson and the wounding of Andrew Jackson.  But few have heard of the duel between Abraham Lincoln and James Shields because it was thwarted by the clever conditions that Lincoln insisted upon as part of his acceptance of the challenge that was issued to him by Shields.

Long before Abraham Lincoln became the great U.S. President that everyone admires, he was just a well-regarded lawyer and member of the Illinois legislature.  He was apparently not a fan of another Illinois lawyer and the state auditor, James Shields.  A number of letters, written under a pseudonym, appeared in print that were highly critical of Shields.  Shields suspected that Lincoln was the mystery author of the letters (although Mary Todd, Lincoln’s then future wife, may have also been an author).  Shields challenged Lincoln to a duel. Based on the dueling codes of the day, Lincoln, as the challenged party, was entitled to set the conditions for the duel if he accepted.  While it was then normal to use pistols, Lincoln had no desire to engage in a duel where he could be killed or become a killer, but he was also concerned about his reputation should he refuse to accept the challenge.  So he accepted the duel, but on the condition that it be held in a specific manner with a different weapon than the normal pistols.

The conditions Lincoln set in this “dueling contract” were that he would only fight the duel if (1) it was held across the Illinois border on a sandbar in the Mississippi River (fittingly called Bloody Island) that was technically outside the borders of both Illinois and Missouri, where dueling was presumably still considered legal, (2) the dueling ground would be divided by a large wooden board with each of the combatants assigned a side of the board, and (3) the duel would be fought with heavy broadswords across the dividing board; neither party being permitted to cross the board with his feet.  The benefit of these conditions for Lincoln should be obvious to anyone who has seen pictures of the tall, 6’ 4”, lanky frame of our famous President.  His reach across the dividing board was substantially better than that of the 5’ 9”, James Shields. And as Americans know from the stories of Lincoln we are taught in grade school, Lincoln was also comfortable wielding a heavy ax to chop wood—despite being skinny, he was apparently quite strong.  Lincoln’s apparent hope at the time was that, by setting these conditions, the duel would be canceled by the challenger.  But Shields agreed to the conditions.  So, the two men’s seconds set up the dueling ground as was specified in the “dueling contract” and the two men arrived to fulfill their obligations.  Presumably, Lincoln’s plan at that point was to use his superior reach to wound Shields sufficiently so the fight would end without anyone being killed.

But before the duel began, Lincoln was apparently warming up with his broadsword and reached up and cut off a willow branch that was clearly well-beyond the reach of Shields.  It then became obvious that the conditions of the duel were such that it was unwinnable by Shields, so his friends quickly suggested to Lincoln’s friends that the two resolve their differences without resorting to the duel. Shields and Lincoln agreed and no one was hurt.  By agreeing to fight the duel only on specified conditions, Lincoln ensured that if the duel was required to be fought it would only occur under circumstances favorable to Lincoln.  And the specified conditions ultimately avoided the duel altogether. (For more on the aborted Lincoln/Shields duel go here and here).

While there may have been little danger of confusing a condition with a covenant (and perhaps there would have been no real difference between a covenant and a condition) in a dueling contract, because there were seconds available to ensure that the conditions/covenants have been observed before the parties are permitted to proceed with the duel, this is not the case with modern business contracts.  The failure to clearly specify a condition to a contractual obligation in a business contract may result in a party being obligated to perform what may have otherwise been intended as a condition to performance, and then being subject to a resulting damages claim for breach of that performance.  Indeed, nothing is more basic to contract drafting than making sure that a party has no obligation to perform unless the specified conditions to that party’s obligations have been fulfilled.   But cases continue to be decided that demonstrate that the basic lessons of how to clearly state a condition versus merely stating a covenant are lessons that need to be reinforced often.  As recently noted by the Utah Supreme Court in Mind & Motion Utah Investments, LLC v. Celtic Bank Corp., 2016 UT 6 (Utah Jan. 27, 2016):

Covenants are mutual obligations the parties bargain for in their agreement, and the failure to perform them generally gives rise to remedies for breach of contract. Conditions, on the other hand, are events not certain to occur, but which must occur before either party has a duty to perform under the contract. In contrast to covenants, the failure of a condition relieves the parties of any performance obligations, and neither may seek remedies for breach.

…

…express terms like “unless,” “on condition that,” “provided that,” and “if,” often create conditions. This implies that more mandatory terms, such as “shall,” “must,” or “agree,” will often create covenants.

In this case, Mind & Motion entered into a real estate purchase contract (referred to as the “REPC”) to acquire property from Celtic Bank that Celtic Bank had acquired through foreclosure from a developer. Mind & Motion wanted to build condominiums on the land.  To do so required that a plat be recorded by the County after the County approved an application. The purchase agreement required Celtic Bank to record the plat by a specific date and granted Mind & Motion the right in its sole discretion to extend the date for recording.  The plat was not recorded by the specified date and Mind & Motion agreed to extend the recording date to another specific date. The date specified for the recording of the plat was also the date specified for the closing date of the transaction.  The language used to specify the required date for Celtic Bank’s obligation to record the plat was mandatory; i.e., “shall record” and “agrees to complete recording … by [date certain].”  Elsewhere in the REPC conditional language was used for other aspects of the agreement.  When the extended date arrived and the plat had not been recorded, Mind & Motion refused to extend the date again.  Celtic Bank argued that regardless of the language used, the recording obligation was an obligation that was dependent upon the actions of a third party (i.e., the County) that they did not control; therefore the recording obligation must be construed as a condition not a covenant.  But according to the court:

…the parties’ degree of control over the fulfillment of an obligation remains “a significant indication” of whether the parties intended a performance obligation to be a condition or a covenant.  But when parties employ mandatory terms to characterize an obligation whose fulfillment hinges on the action of a third party, this may indicate an express assumption by one party of the risk that the condition will remain unfulfilled.

Accordingly, despite the fact that Mind & Motion’s obligations were not triggered unless and until the recording of the plat occurred, Celtic Bank nonetheless had used mandatory language to describe their obligation to record the plat; therefore Celtic Bank’s failure to record the plat, even though not within their control, was an obligation, the breach of which subjected Celtic Bank to damages for breach of contract, not simply an ability for Mind & Motion not to close.  The court concluded:

We conclude that Celtic Bank’s recording obligation outlined in the REPC is unambiguously a covenant. Even though Celtic Bank could not ultimately control when the county issued its final approval to record the phase 1 development, the recording obligation is framed in mandatory language and the REPC employs explicitly conditional language elsewhere in the agreement. We also conclude that Celtic Bank has failed to establish a latent ambiguity in the contract. Affidavits that seek to endow otherwise clear language with an alternative meaning are insufficient.

Obviously, a condition in favor of one party may be the performance of a covenant by the other party.  Here the recording covenant’s breach resulted in a liquidated damages award in favor Mind & Motion even though Mind & Motion had no obligation to proceed with its obligations to close the transaction unless and until that mandatory recording occurred.

Consider all of the events that need to occur before you are prepared to be bound to your contractual promises.  And, if the occurrence of an event beyond your control is a necessary condition to your obligations to your counterparty, be sure the written agreement states that condition as a condition and not as a covenant.  Otherwise you may have undertaken to ensure the fulfillment of that event as a contractual obligation in favor of your counterparty, even if it is beyond your control.