Some Further Thoughts on the Implied Covenant

This is a follow up on my recent post, Fannie and Freddie: The NWS and the Implied Covenant of Good Faith and Fair Dealing.

Private vs Public

• Notice that the joint venture agreement in Oxbow, that was the subject of the Delaware Supreme Court’s analysis of Crestview’s reasonable investment expectations, was a highly negotiated agreement specific to Crestview’s investment in Oxbow. Oxbow did not take a standard agreement with respect to a public security investment, as is the case with the GSE junior preferred stockholders with respect to their preferred stock certificates of designations. Oxbow negotiated a bespoke agreement for its own one-off private investment.

• Moreover, Crestview obtained board of director representation on Oxbow to monitor its bespoke investment in Oxbow. Of course, the GSE junior preferred holders had no representation on the GSE boards of directors in order to monitor the issuer’s good faith discretionary actions.

• If Oxbow serves as the principal Delaware rule of law with regard to the implied covenant of good faith and fair dealing in Judge Lamberth’s court, as I expect it will, some accounting should be made for the differences between a private and public investment and the investor’s reasonable expectations.

• A private investor in common equity who negotiated its own investment agreement with negotiating leverage with respect to the issuer, and who had board of director representation to monitor into investment, should be held to a much higher standard with respect to the implied covenant than a public investor in a standard preferred stock issuance, such as the GSE junior preferred stockholder.

• By “higher standard”, I mean that it should be easier for a Judge to invoke the implied covenant in the public case than the private case, since the private investor had every opportunity to negotiate the precise terms it wanted, such that the rationale or justification for “reading terms into the contract” by means of the implied covenant are not as present in the private case as the public case.

The Role of Math in a Motion for Summary Judgment (MSJ)

• In a MSJ, the proponent of the motion must assume that the facts stipulated, or if not stipulated by agreement with the other party then as proposed by the other party, are true. Can the plaintiffs use math and the documentary evidence regarding the terms of the Net Worth Sweep (NWS), to win on summary judgment?

• In Fannie and Freddie: The NWS and the Implied Covenant of Good Faith and Fair Dealing, I set forth the mathematical certainty supporting plaintiffs claim that

  • the GSEs could not benefit, but only suffer detriment, from the NWS;

  • Treasury could do no worse, incurred no risk and could only benefit, from the NWS; and

  • The government’s argument, that the NWS was necessary to avoid depletion of Treasury’s line of credit, is a shameful sham, as made clear by the terms of the Senior Preferred Stock Agreement that it negotiated.

• While I did not spend time in my previous post in considering the merits of plaintiffs MSJ, expected at the end of this year, it occurs to me that the objective weight of a mathematical presentation, proving that the government’s arguments supporting the NWS are without merit, may have significant weight in front of Judge Lamberth.

  • To illustrate this point, assume that Judge Lamberth accepts as a legal rule that it would breach the implied covenant if the GSEs amended the Senior Preferred Stock Agreement without deriving any benefit and potentially suffering only detriment from Treasury….that to do so would be bad faith on the part of the GSEs. If Judge Lamberth finds that given the terms of the NWS there would be no mathematical possibility that the GSEs could obtain any benefit, and could only suffer detriment, then it would follow that Judge Lamberth should grant plaintiffs motion for summary judgment.