“Simplify, simplify, simplify”: Delaware Chancery Declines to Dismiss Claims Regarding a Gordian Knot of Private Equity-Related Contracts

Vice Chancellor Sam Glasscock III recently declined to grant a motion to dismiss in Paul Capital Advisors, L.L.C. et al. v. Holland, 2023 WL 5551017, C.A. No. 2022-0167-SG (Del. Aug. 29, 2023) (“Paul Capital”), which involved claims arising out of an intricate set of transactions intended to monetize certain illiquid assets. In sustaining the claims, the Court of Chancery colorfully outlined the challenges of deciphering a highly complex, “monkey’s fist of contracts” without accompanying provisions describing the purpose for such complexity in the first place, and encouraged practitioners to instead choose the path of simplicity.

As brief background, private equity firm Paul Capital partnered with financial services firms Beneficient Company Group (“BEN”) and MHT Financial L.L.C. (“MHT”) to develop an exit solution for its illiquid assets. Paul Capital sought to sell secondary assets for $500 million in cash, and BEN, though cash-poor, offered to purchase those secondaries with another illiquid asset—its BEN units. To generate the $500 million in cash, Paul Capital and BEN drafted contracts that contemplated the following: Paul Capital would transfer its secondaries to MHT, which in turn would form nine trusts, the “Exchange Trusts,” and transfer to them Paul Capital’s secondaries. The Exchange Trusts would then transfer the secondaries to BEN, in exchange for BEN units, which would be followed by an auction for the BEN units (for cash).

The auction occurred, with GWG Holdings (“GWGH”) winning the bid; however, GWGH could not support its bid purely with cash. Thereafter, it was contemplated that about $400 million worth of GWGH securities would be liquidated to supplement the $150 million cash offer. The motivations for this move remain unclear, as the court notes that “despite the fact that it was exchanging illiquid Paul Capital assets for illiquid BEN assets, and in turn exchanging those for illiquid GWGH assets, Paul Capital accepted GWGH’s offer as the winner of the auction.”

GWGH did not liquidate those securities due to financial deterioration after learning it was subject to an SEC investigation. GWGH ultimately sought rescue financing; the value of GWGH securities declined; and the instant litigation followed, including claims of breach of contract, promissory estoppel, and fraud. Specifically, Paul Capital alleged that it was a third-party beneficiary entitled to recovery and that by emailing Paul Capital GWGH’s due diligence package, BEN also signed on to enforcing GWGH’s promises of timely refinancing and selling its bonds.

The Court of Chancery’s denial of the motion to dismiss gives rise to various takeaways, including:

1. Private equity and financial investment firms should seek to clearly delineate the purpose and motivations for the contractual agreements within the body of the transaction documents, which may aid conflict resolution in the event of follow-on litigation.
   1. The Vice Chancellor noted that to resolve Paul Capital’s case, he would have to “labor to pick oakum from the tangle of contracts and undertakings,” his job “made more difficult by the fact that it is unexplained, and not intuitive, why the parties felt the complexity of the methods employed had merit.” Though the defendants sought to simplify the issues for their motion to dismiss, the Vice Chancellor declined to dismiss the contract claims as he was “unable to determine to what extent all the contracts [we]re to be read together, and without an understanding of the motivation of the particular contractual scheme … [was] unwilling to determine rights under the various agreements at the pleadings stage.”
   2. Had Paul Capital, BEN, and MHT more clearly delineated the purpose of the contractual agreement and which supporting documents should be referred to, perhaps there could have been an opportunity for early dismissal—potentially saving the expense of discovery altogether.
2. Contracting parties should be mindful of appropriately caveating due diligence documents containing third-party promises, as those promises could become attributable to and enforceable on them.
   1. The Court sustained Paul Capital’s promissory estoppel claim against BEN based on alleged promises suggested in GWGH diligence materials that BEN forwarded to Paul Capital. Some of the alleged promises included a GWGH obligation “to refinance the GWGH L-Bonds within 12 months of the closing of the Auction of the BEN [ ] Units” and that “the GWGH [] shares [would be] sold following the expiration of that [six-month] lock up…” Paul Capital alleged that these promises induced it to accept the partial-cash bid proposed by GWGH, contrary to Paul Capital’s original intentions. Notably, Vice Chancellor Glasscock sustained the claim even though Paul Capital undertook its own supplemental due diligence regarding GWGH and the promises the entity undertook. Thus, practitioners should carefully consider appropriate caveats when forwarding diligence materials that may contain third-party commitments.

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