ContractsProf Blog

Editor: Jeremy Telman
Oklahoma City University
School of Law

Wednesday, April 14, 2021

Money Left in the Wrong Pocket Stays in the Wrong Pocket after Sale

Last month, the Delaware Court of Chancery issued its letter opinion granting a motion to dismiss in Deluxe Entertainment Services Inc. v. DLX Acquisition Corporation and Deluxe Media Inc.  The context is an acquisition, but the outcome is reminiscent of the Citibank case we discussed in February, drawing on Matt Levine's outstanding coverage, -- when big companies (or really big companies) make big mistakes (or really big mistakes) all the best lawyers and all the best men sometimes can't put the money back in their pockets again.  

DE ChanceryDeluxe Entertainment (Deluxe) sold a wholly-owned subsidiary to DLX Acquisition Corporation (DLX).  At the time of the transaction, several million dollars remained in the subsidiary's bank accounts, and Deluxe somehow neglected to "sweep" those funds before the transaction.  After the transaction,  Deluxe asked DLX to return the money.  ("Hey, give me back the money I left in my pants when I gave you my pants!"). DLX refused.   It asked DLX's parent company to get the money back. ("If you don't give me back my money, I'll tell your mom!").  DLX refused.  It asked its former employees, now DLX employees, to get its money back. ("If you don't give me my money back, I'm going to tell everybody how mean you are!").  DLX refused.

A law suit followed, alleging breach of contract, breach of the duty of good faith and fair dealing, and asking for the court to reform the agreement.  The court sided with DLX.  The agreement provided for a transfer of assets.  Enumerated assets were not supposed to be transferred.  There were "wrong pocket" provisions (lovely!) that required the return to Deluxe of enumerated assets mistakenly transferred.  The funds that Deluxe neglected to sweep were not among the enumerated assets, so the "wrong pocket" provisions did not apply.  

Court-of-ChanceryDeluxe argued that the parties had agreed that the transaction was to be "cash free, debt free" and thus that the cash transfer that accidentally occurred could not be construed as consistent with the parties' intent.  The court adopted a more limited understanding of the "cash free, debt free," as simply intended to exclude consideration of cash as part of the calculation of the final purchase price.  The parties knew how to exclude assets from the transaction.  That's what the "wrong pocket" provisions were about.  They did not do so with respect to the cash that Deluxe failed to sweep.  

The court found no "gap" in the agreement into which a violation of the covenant of good faith and fair dealing could creep.  There was a contractual provision (the "wrong pocket provision) that covered this scenario.  DLX did not violate that provision, and since the alleged breach is covered by a provision, there is no gap of unanticipated conduct for the covenant of good faith and fair dealing to address.

Finally, the court denied Deluxe's argument that the court should reform the contract to address a mistake. Reformation is appropriate to address errors in drafting or transcription.  The mistake at issue here was operational and thus not the sort of mistake that would empower the court to reform the agreement.  

I can't dispute any portion of the opinion, but the whole thing just seems like an exercise in blinkered formalism.  It appears to be undisputed that millions of dollars were accidentally transferred to DLX at closing.  That seems like a simple case of unjust enrichment.  DLX, don't be a putz!  Return the money to that schlemiel that left it in the pockets.  It's not your money.  You have no right to it, and your mother would be ashamed of you for keeping it!

Thanks to Eric Chiappinelli for sharing the case with us!

https://lawprofessors.typepad.com/contractsprof_blog/2021/04/money-left-in-the-wrong-pocket-stays-in-the-wrong-pocket-after-sale.html

Recent Cases | Permalink

Comments

I have about as much sympathy for DLX here as I did for Citibank previously. That is to say, basically none.

It seems like DLX had two options here. First, it could expressly provide for the bank account assets to be excluded. That seems like the most conservative approach. Second, it could at least retain the right to sweep the accounts before closing. As we all know, DLX eschewed the more conservative option and instead simply retained the right to sweep. But then, despite specifically opting for the right to sweep, it failed to exercise it. So I just don't see how DLX can complain when it deliberately followed the riskier approach, and—surprise surprise—the feared risk did in fact materialize.

DLX argued mistake of fact, and I can't blame them for that, as it was probably the most promising theory, but I agree with the court's conclusion there. It's not as if DLX didn't know the cash was potentially there. It did, but it conceded that it made a conscious decision (why is kept pretty vague, presumably because the actual reason would be embarrassing) not to carry out the sweep. Viewing a *decision* you made as mistaken *in retrospect* doesn't in any way resemble being mistaken about particular *factual information* at *the time* you entered into a contract. To put it in terms of your "pants pocket" hypo, a true mistake of fact would be not realizing the money was hiding in the pocket at the time the pants were handed over. (Is that a weird mixed metaphor?) But that's not at all what happened in DLX's case. DLX knew the pockets might have cash in them, but (1) only provided that jewelry and credit cards in the pockets would be excluded from the transaction and (2) decided it wouldn't even bother to search the pockets either.

Finally, this seems far afield from the prototypical unjust enrichment situation because here you not only have a written contract, but the contract also had express provisions to deal with this exact scenario.

Posted by: hardreaders | Apr 14, 2021 9:18:21 PM

I'm not especially sympathetic to any of the parties here. Citibank was negligent (although you should definitely look at Matt Levine's piece to get a sense of what a devilish software glitch did Citi in), as was Deluxe here. Yes, Deluxe could have protected itself. Hindsight is 20/20.

It is not unheard of for parties to recover in restitution notwithstanding a contract. We should not visit venial faults with excessive retribution.

There is a common law doctrine called "theft by finding" that requires good faith efforts to identify the owner of found property. There is no mystery here. If forced to choose between negligent and grasping conduct, I incline towards the former.

Posted by: Jeremy Telman | Apr 15, 2021 4:04:20 AM

Thanks for responding!

First, I have to cop to a mistake *I* made. Everywhere I wrote "DLX" above, I meant to write "Deluxe"—I completely blame the parties for my mistake owing to their overly similar names! (Is my initial comment now voidable?)

Second, as you probably saw from my comment on the earlier Citi posting, I did study that case a fair bit. I don't agree Citi's case involved a "glitch" though. Knowing a thing or two about systems and financial systems in particular (although nothing first-hand about Citi's S/W), I can say there's a clear difference between a glitch and a design flaw. A glitch is where the S/W *itself* doesn't behave as intended—a very primitive example is a program to add two numbers that in some instances will unexpectedly multiply them instead. In contrast with a design flaw, the S/W does work as intended, but it's just designed poorly and creates risk that sometimes even a highly trained operator will get tripped up by the counter-intuitive S/W. Citi's case definitely falls into the latter category. So in that way I think it's very similar to Deluxe's predicament here, as both involved what the Deluxe court referred to as "operational" mistakes. Just based on the very similar facts, I'm a little surprised the Deluxe court didn't cite the Citi case at least in passing.

Third, I would say Deluxe was more than negligent, maybe even reckless. In Citi's partial defense, at least Citi *thought* it was taking all the right steps at the time to avoid the principal getting disbursed. But, as I read the case at least, Deluxe in contrast *deliberately* ignored a step it could have taken to prevent the cash from being included—Deluxe knowingly chose not to sweep the account.

Fourth, in some fairness to Deluxe, maybe I—and likewise the Court—am being a little stingy in defining what counts as a mistake of "fact". I suppose the situation could be characterized as Deluxe intending to transfer the sub bereft of any cash, and it believed that was true when the transfer happened. So the mistake of fact is Deluxe's mistaken understanding of the status of the sub pretransfer. But I'm still not sure how far that gets you. There doesn't seem to be any evidence DLX knew of the mistake preclosing, and I would think the risk of this kind of mistake should fall squarely on Deluxe. Yes, it does seem a little unfair that DLX gets a surplus it never bargained for, although it's not like it consciously took advantage of Deluxe during the negotiations. I also see moral hazard in letting Deluxe off the hook for the consequences of its own stupid decisions.

Fifth, on UE, I will take your expert word for it that it's still potentially available even when a contract exists. Theft by finding is an interesting doctrine I wasn't aware of before (so thanks!), but that one does seem really far afield from what's going on here. I just wonder, is there no older "brick and mortar" case law that could be analogized to this situation? For example, maybe someone sold a house and excluded all the AV equipment or appliances, but couldn't be bothered to inspect the attic, where valuable antiques were discovered post closing?

Posted by: hardreaders | Apr 15, 2021 9:41:30 AM

You raise interesting points.

As to your point 2, I gratefully accept your correction of *my* mistake as to whether there was a glitch or a design flaw. That said, the Citibank case is about a different doctrine (the discharge-for-value rule), so I wouldn’t have expected a reference to it from the Deluxe court.

On point 3, I don’t know where “recklessness” comes from. I assume that there is a complicated organizational structure involved here. Somebody, perhaps several people, were tasked with sweeping the accounts, and the key person no doubt said, sometime after the deal closed, “Ready when you are, C.B,” or equally inefficacious words.

On point 4, I actually agree with the court that mistake of fact is not a legally valid claim here. Mistakes of fact relate to facts out in the world, not to questions of what the contract requires from the parties. And reformation, which Deluxe sought, is appropriate to correct a scrivener’s error. No such error is alleged.

On point 5, as to UE and “theft by finding,” I was not actually offering these as solutions to the case. Since the court did not address UE, I’m guessing that Deluxe made no such argument. I’m not sure why it didn’t, but I assume that the remedy was, for some reason, unavailable. Perhaps DE is more persnickety than other jurisdictions or the R.2d about recovering in restitution despite the existence of a contract covering the subject matter. Theft by finding is a lovely idea, but I’m pretty sure it has fallen into desuetude in most common law jurisdictions. If it were available, it might have provided a handy way out of this predicament.

Your final “brick and mortar” analogy is a fine one. I do believe there is case law on the matter, and my recollection is that the law does not provide for a remedy that would satisfy me. As I said in the post, I could not criticize the court as a matter of law, but the law does not accord with my sense of what is right. If somebody left something valuable in the attic of a house that I purchased, I would not say, “We’re keeping the armoire and that’s all there is to it, okay?” (https://www.youtube.com/watch?v=a6qnvoLYLr8)

Posted by: Jeremy Telman | Apr 15, 2021 12:17:11 PM

Thanks for the continued follow-up!

I don't want to drag this out, so I'll just respond with 2 quick points:

As for "recklessness", that might be my misreading of the opinion, actually. On pages 2-3, it's stated that Deluxe "failed to sweep those funds from Target before closing 'for various practical and technical reasons'". So maybe it wasn't a deliberate choice not to sweep after all, but it still seems a few grades worse than what Citi did. At least Citi actually intended not to pay out the principle, and consciously took steps it thought were needed to achieve that, but was just mistaken about the required steps. But here it seems like Deluxe wasn't even attempting to sweep the accounts. Maybe it's not "recklessness" but it seems more egregious than just plain "negligence", so "gross negligence" perhaps?

To some extent I do share your sentiment that, even if Deluxe goofed and should foot the bill for that under the current state of the law, there was nothing particularly chivalrous or laudable about the way DLX acted either. So the overall result does feel a little unsatisfying and inefficient. But like you said in your initial response, it's also hard to identify with either of the parties here. I think it's because both of them are (relatively) sophisticated commercial entities. For example, if it had been a consumer who made a mistake in dealing with a company, then I would be more partial to the consumer. And I wouldn't demand a double standard in how, e.g., the law of mistake addresses the two situations. That's because the consumer presumably lacks sophistication, so the same law can be more generous to that individual than it would be to a commercial entity. Another reason to be more generous is that visiting the consequences on an individual consumer can be quite harmful; that's felt by society too. Maybe there's also some broader social harm resulting from the outcome in this Deluxe/DLX case, but if so, I'm having a little trouble seeing it.

Posted by: hardreaders | Apr 16, 2021 11:15:18 PM

Where you read evidence of "gross negligence," I read evidence of ordinary negligence. The court did not provide enough facts for us to resolve that issue, I assume because the outcome would be the same regardless of Deluxe's level of culpability for its own error. The case would come out the same even if Deluxe were (as I think it was) simply negligent.

No harm is done to the world if one sophisticated party is up $10 million and another is down $10 million in this particular case. But we should have legal rules that generally make sense. The Deluxes of the world don't need extra legal incentives to prevent them from committing acts that make them the sole victims of their own negligence. I am a generally careful person, but sometimes I am forgetful. I prefer not to live in a world where the law stands behind those who intentionally profit from my occasional negligence. Cardozo's dictum seems to me a very good one: let us not visit venial faults with excessive retribution. Or, as I put it above, I favor the negligent over the grasping.

Finally, a word about sophistication. As the editor of the ContractsProf Blog, I would be considered a sophisticated party in any consumer transaction. Let me state for the record, I am no more inclined to read form contracts than any other consumer. I am, it appears, far less likely to do so than some of my students. Even "sophisticated" parties make mistakes, as did Citibank, as did Deluxe, and when those mistakes are innocent and do no harm to others, I would legal rules to embrace forgiveness.

Posted by: D. A. Jeremy Telman | Apr 17, 2021 5:34:34 AM

I really appreciate you taking the time to keep responding, especially on weekend off hours.

We agree on most everything I think. For example, there's no strong feelings either way about the how Deluxe/DLX type cases turn out. But we also want a rule that makes sense and is fair when applied to e.g. consumer situations.

I would just push back a little and suggest that there are more relevant distinctions between the consumer and commercial contexts than just sophistication. None of these are new of course and maybe not all are relevant in every instance, but I think it's worth reiterating. For example, you talk about form contracts, but any comparable mistake there would probably involve small dollar amounts, and so I do think it's not fair to expect consumers to be constantly watchful for that. It's why we talk about companies "nickel and diming" consumers; they lack resources to be endlessly vigilant—and (some) companies know that all too well. Also, you brought up form contracts, but the commercial scenario involves a negotiated transaction, like here for Deluxe/DLX. Last, consumers may be able to benefit from a further overlay of protective laws, regulations, and gov't agencies. The Deluxe/DLX transaction was, I assume—putting aside, e.g., antitrust—not heavily regulated, and certainly there was no regulation relevant to the issue under dispute. Companies always complain about excessive regulations, but then you have to forego the potentially helpful ones as well as the "burdensome" ones.

It's true though that you would probably not be a great lead plaintiff in a consumer class action. I guess that's one downside of having so much expertise in this area!

Posted by: hardreaders | Apr 17, 2021 6:20:12 AM

You got me amped up, so I can't resist throwing in another relevant distinction and a parting thought.

Commercial entities also have extra-legal remedies available through e.g. lobbying and leveraging "repeat player relationships". We saw an example of the latter already in the Citi case. Some of the counterparties returned their portions right away, presumably to stay in Citi's good graces. And for those who didn't, Citi is taking steps to blacklist them in future transactions. Maybe Deluxe will be able to take similar measures. Consumers have these kinds of remedies too, of course, but I would argue not nearly to the extent that corporations do.

In the end, again, I just want to make sure the outcome is right for consumers. If the law needs to account for more distinctions, then it should. Or if it means that Deluxe (and Citi) is also off the hook for its own mistakes, I'm totally fine with that too.

Posted by: hardreaders | Apr 17, 2021 7:32:19 AM

We are, I think, in complete agreement.

Posted by: D. A. Jeremy Telman | Apr 18, 2021 7:56:18 AM

Post a comment

If you do not complete your comment within 15 minutes, it will be lost. For longer comments, you may want to draft them in Word or another program and then copy them into this comment box.