Morgan Stanley v Discover Fin. Servs.

[*1] Morgan Stanley v Discover Fin. Servs. 2010 NY Slip Op 50101(U) [26 Misc 3d 1215(A)] Decided on January 4, 2010 Supreme Court, New York County Kapnick, J. Published by New York State Law Reporting Bureau pursuant to Judiciary Law § 431. This opinion is uncorrected and will not be published in the printed Official Reports.

Decided on January 4, 2010
Supreme Court, New York County

Morgan Stanley, Plaintiff,

against

Discover Financial Services, Defendant.



603017/08



Plaintiff was represented by Evan R. Chesler, Esq., Cravath, Swaine, Moore, LLP, 825 Eighth Avenue, New York, New York 10019, Tel: 212-474-1000.

Defendant was represented by Philip S. Beck and Chris Lind, Esqs., Bartlit Beck Herman Palenchar & Scott, LLP, 54 West Hubbard Street, Chicago, Illinois 60654, Tel: 312-494-4400; and John J. Kenney, Esq., Hoguet Newman Regal & Kenny, LLP, 10 East 40th Street, New York, New York, Tel: 212-689-8808.

Barbara R. Kapnick, J.

Plaintiff Morgan Stanley moves for partial summary judgment on the fifth cause of action of its Amended Complaint against defendant Discover Financial Services ("Discover") for breach of contract.

Prior to June 30, 2007, Discover was a wholly-owned subsidiary of Morgan Stanley. Pursuant to a Separation and Distribution Agreement ("Separation Agreement") between the parties dated as of June 29, 2007, Discover achieved a tax-free spin-off from Morgan Stanley.

The Separation Agreement provides, in relevant part, as follows:

ARTICLE 2

PRIOR TO THE DISTRIBUTION On or prior to the Distribution Date:

* * * Section 2.03. Special Dividend. Subsequent to completion of the Restructuring, Discover [*2]shall declare and distribute to Morgan Stanley a dividend (the "Special Dividend") in the form of an undertaking by Discover to pay to Morgan Stanley a portion of the after-tax proceeds received by Discover or any of its Affiliates in connection with the litigation Discover is as of the date hereof pursuing against Visa U.S.A., Inc. and MasterCard Worldwide (the "Visa/MasterCard Litigation") [underlining supplied] pursuant to the terms and conditions set forth in Schedule 2. Discover hereby agrees to comply with the terms and conditions set forth in Schedule 2 relating to the Special Dividend. Without limiting the generality of the foregoing, Discover shall pay or cause to be paid such amounts to Morgan Stanley as set forth in Schedule 2 and take or cause to be taken any and all actions as may be necessary or appropriate to comply with the terms and conditions set forth in Schedule 2.[FN1]

Pursuant to Schedule 2 ("Special Dividend"), (g)All amounts payable to Morgan Stanley pursuant to subsection (c) shall be paid by Discover by wire transfer of immediately available funds to an account designated by Morgan Stanley promptly, and in any event within 30 days, following the end of each fiscal quarter in respect of which Discover or any of its Affiliates receives any Proceeds. Any such amounts not paid when due shall accrue interest from and including the 30th day following the end of the applicable fiscal quarter to but excluding the date of payment, at a rate per annum equal to 6% (calculated on the basis of actual number of days elapsed in a 360-day year).(h)Discover shall have sole control over the investigation, prosecution and resolution of the Visa/Mastercard Litigation; provided that Discover shall direct its outside counsel to provide Morgan Stanley with regular reports, in writing, at least on a monthly basis, as to the status of and significant developments in the Visa/MasterCard Litigation, including any settlement discussions or negotiations, and such other information as Morgan Stanley may reasonably require relating to the Visa/MasterCard Litigation.

The Amended Complaint alleges in the Fifth Cause of Action as follows: [*3] 91.Morgan Stanley fully complied with its obligations under the Separation Agreement. Furthermore, Morgan Stanley's discussion with Visa and MasterCard did not constitute a material breach of the Separation Agreement, and as a result, Discover is required to provide Morgan Stanley with information concerning the settlement and pay Morgan Stanley the Special Divided in full.92.Discover has failed to provide the required information concerning the settlement or make any payment of the Special Dividend by December 30, 2008, to Morgan Stanley as required under the Separation Agreement. Discover has further stated that it will not make any future payments of the Special Dividend as they become due.93.Discover's failure to provide Morgan Stanley with the information concerning the settlement and its failure to pay Morgan Stanley the Special Dividend payments as they become due are breaches of the Separation Agreement that have harmed and will continue to harm Morgan Stanley in an amount to be determined at trial.

Plaintiff argues that there are no material issues of fact with respect to its claim that defendant Discover has an obligation to pay the Special Dividend to Morgan Stanley pursuant to Section 2.03 of the Separation Agreement, and that Discover has failed to make any such payment.

Thus, it contends that the only question for this Court to resolve in connection with this motion is whether Discover is excused from paying the Special Divided by virtue of Morgan Stanley's alleged breach of the "sole control" provision of section (h) of Schedule 2.[FN2]

Morgan Stanley contends that: [*4]

(a)the Separation Agreement, including Schedule 2, is a single agreement;[FN3] and

(b)as a matter of law, Morgan Stanley's alleged breach of Schedule 2 does not excuse Discover's breach of Section 2.03, because there is no basis to find that the alleged breach of the "sole control" provision was a material breach of the entire Separation Agreement.

Discover, on the other hand, contends that Schedule 2 (sometimes referred to by each of the parties as the "Special Dividend Agreement") was an independently negotiated stand alone agreement that was separately approved after the completion of the parties' negotiations regarding the Separation Agreement. Defendant argues that the evidence it has obtained so far in discovery is that these agreements were not negotiated by the same people, and further notes that Schedule 2 has its own separate set of definitions, which is textural evidence that it is a stand-alone agreement.

Discover further contends that the parties intended to make the Agreement divisible, as evidenced by the inclusion of a severability clause (see, Samba Enterprises, LLC v iMesh, Inc. 2009 WL 705537 [SDNY]), i.e., Section 8.13 ("Severability") of the Separation Agreement, which provides as follows: If any one or more of the provisions contained in this Agreement shall be declared invalid, illegal or unenforceable in any respect, the validity, legality and enforceability of the remaining provisions contained in this Agreement shall not in any way be affected or impaired thereby so long as the economic or legal substance of the transactions contemplated hereby is not affected in any manner materially adverse to any party. Upon such a declaration, the parties shall modify this Agreement so as to effect the original intent of the parties as closely as possible in an acceptable manner so that the transactions contemplated hereby are consummated as originally contemplated to the fullest extent possible.

Moreover, Discover contends that Schedule 2 involves distinct consideration and covers a separate subject matter, i.e., the right to exercise "sole control" over the Visa/MasterCard [*5]Litigation and the division of any proceeds recovered from that lawsuit.[FN4]

Discover further contends that once Morgan Stanley materially breached Schedule 2, Discover had no obligation to continue performing under that agreement. Therefore, Discover contends that its refusal to pay Morgan Stanley a portion of the antitrust proceeds (i.e., the Special Dividend) was not a breach of the Special Dividend Agreement.

However, Schedule 2, which is listed as one of the five Schedules in the Table of Contents of the Separation Agreement, does not contain a separate signature page, and is part of the same physical document as the Separation Agreement.[FN5]

Moreover, Section 8.07 of the Separation Agreement specifically provides that "[t]his Agreement and the other Distribution Documents [emphasis supplied] constitute the entire understanding of the parties with respect to the subject matter hereof. ..." "Distribution Documents" is defined in Section 1.01 of the Separation Agreement as meaning "this Agreement and the Ancillary Agreements", which is defined as meaning each of numerous other Listed agreements, which list does not include Schedule 2.

Based on the papers submitted and the oral argument held on the record on October 28, 2009, it is clear to this Court that Schedule 2 cannot be deemed a separate stand-alone agreement, but rather that the Separation Agreement and Schedule 2 are part of one single, integrated agreement.

Discover alternatively argues that plaintiff is not entitled to summary judgment because there is at least an issue of fact as to whether or not the breach of the "sole control" provision constitutes a material breach of the Separation Agreement. See, Bear, Stearns Funding, Inc. v. Interface Group-Nevada, Inc., 361 FSupp2d 283 (SDNY 2005). Specifically, Discover contends that the provision was crucial to the tax-free status of the spin-off, which it argues was central to the deal, and that the tax-free treatment of the spin-off could have been jeopardized by the purported violation of the"sole control" provision. In addition, Discover suggests that if the IRS were to learn that Morgan Stanley did, in fact, exercise any control, it could still audit the matter and take away the tax-free treatment of the transaction. [*6]

"The determination of the materiality of a breach is, of course, an issue of law for the Court." International Gateway Exchange, LLC v Western Union Financial Services, Inc., 333 FSupp2d 131, 143 (SDNY 2004).

"Materiality goes to the essence of the contract. That is, a breach is material if it defeats the object of the parties in making the contract and deprive[s] the injured party of the benefit that it justifiably expected.'" ESPN, Inc. v Office of the Comm'r of Baseball, 76 FSupp2d 416, 421 (SDNY 1999). See also, Times Mirror Magazines, Inc. v Field & Stream Licenses Co., 103 FSupp2d 711, 731 (SDNY 2000), aff'd, 294 F3d 383 (2nd Cir. 2002).

Plaintiff contends that no reading of the Separation Agreement can establish that the "sole control" provision contained in section (h) of Schedule 2 is so substantial and fundamental as to have defeated the object of the Separation Agreement, which was to arrange for the tax-free spin-off of Discover.

Here, Discover has made no showing, nor is there any evidence in the record to suggest, that Morgan Stanley's alleged breach goes to the "root" or "essence" of the Separation Agreement or otherwise deprived Discover of the benefit of its bargain, namely the tax-free spin-off of Discover to Morgan Stanley's shareholders. Moreover, Discover explicitly states in its papers that it does not seek a complete rescission of the Separation Agreement.

Thus, this Court finds that Morgan Stanley's alleged violation of the "sole control" provision contained in Schedule 2 cannot form a basis for excusing Discover's obligations under Section 2.03 of the Separation Agreement. Discover thus had an obligation under the parties' Agreement to pay the Special Dividend to Morgan Stanley by December 30, 2008.

Accordingly, plaintiff's motion for partial summary judgment on the fifth cause of action is granted.

Settle Order.

Date:January , 2010

_____________________________

Barbara R. Kapnick

J.S.C.Footnotes

Footnote 1:The Visa/MasterCard Litigation, a civil anti-trust suit, was commenced in 2004 in the United States District Court for the Southern District of New York by Discover and other Discover entities against Visa, U.S.A., Inc. and Visa International Service Association (collectively, "Visa") and MasterCard Incorporated and MasterCard International Incorporated (collectively, "MasterCard"), seeking damages for alleged market foreclosure caused by Visa and MasterCard's conduct.

Footnote 2:Discover has asserted a counterclaim against Morgan Stanley claiming that Morgan Stanley breached section (h) of Schedule 2 by engaging in its own secret negotiations with Visa to resolve the Visa/Mastercard Litigation, without Discover's knowledge. Discover claims that it did not learn of Morgan Stanley's involvement in the negotiations until the day before the scheduled trial of the Visa/MasterCard Litigation and just hours before it had to respond to the Mediator's proposal. Morgan Stanley disputes the claim that it breached the"sole control" provision, since it was Discover, not Morgan Stanley, that ultimately accepted the Mediator's proposed settlement. Discover, however, contends that Morgan Stanley's improper actions changed the settlement dynamics in a way that harmed Discover, undermined Discover's bargaining power and gave Discover no choice but to accept the settlement to which it otherwise would not have agreed.

Footnote 3:Alternatively, Morgan Stanley argues that even if - as Discover contends - this Court were to find that Schedule 2 is a separate and independent agreement, Discover is not excused from performing its obligations under Section 2.03 of the Separation Agreement, because a breach of one free-standing contract, even if material, cannot excuse performance of the other agreement. Discover, however, denies that Section 2.03 of the Separation Agreement created an independent obligation for Discover to pay Morgan Stanley a portion of the settlement proceeds. It contends rather that Section 2.03 merely sets forth a promise to"declare and distribute to Morgan Stanley" the Special Dividend "in the form of an undertaking by Discover", i.e. to enter into a Special Dividend Agreement, which Discover did in the form of Schedule 2.

Footnote 4:Alternatively, defendant argues that the severability of Schedule 2 turns on the parties' intent, considered in light of the specific factual circumstances surrounding the negotiation and drafting of the agreements. It argues that this factual determination, as well as the issues of Morgan Stanley's breach and the materiality of that breach, turn on disputed issues of fact that are not ripe for resolution on a motion for summary judgment made relatively early in the discovery phase of the case and prior to depositions of, amongst others, individuals from Morgan Stanley and Visa.

Footnote 5:Schedule 2 is followed by three other schedules and Exhibits "A" through "L".