Metropolitan Life Insurance Co. v. RJR Nabisco, Inc.

United States District Court for the Southern District of New York · 1989 · Corporations

CorporationsBond indenturesImplied covenant of good faith and fair dealingLeveraged buyoutsimplied covenantgood faith and fair dealingbondholdersindenture

Facts

Plaintiffs, sophisticated institutional investors, held RJR Nabisco debt governed by detailed New York-law indentures. After RJR Nabisco accepted KKR's leveraged buyout, the company incurred substantial new debt, and plaintiffs alleged the transaction impaired the value of their bonds by destroying their investment-grade quality. The indentures expressly permitted mergers and assumption of debt and contained no covenant limiting unsecured debt; prospectuses also stated that the indentures imposed no such debt restrictions. For two debt issues, MetLife had previously held express debt-limiting covenants but agreed in 1983 and 1985 to remove them in exchange for other benefits and public covenants.

Issue

Can bondholders invoke an implied covenant of good faith and fair dealing, or general equitable principles, to stop or obtain redemption because an LBO financed with new debt reduced the market value and ratings of their bonds, even though the indentures contain no express covenant restricting such debt and expressly permit mergers? Also, may plaintiffs proceed on fraud-based claims as pleaded?

Rule

Under New York law, the implied covenant of good faith and fair dealing serves only to ensure that neither party deprives the other of the fruits of the agreement; it must be consistent with the contract's express terms and cannot impose obligations inconsistent with the indenture. In the context of detailed, boilerplate bond indentures, interpretation is a matter of law, extrinsic evidence cannot vary unambiguous terms, and absent breach of an express or implied right grounded in the indenture itself, courts will not add a new substantive covenant such as a restriction on incurring debt. Frustration of purpose requires that the frustrated purpose be principal, the frustration substantial and beyond assumed risks, and the event's nonoccurrence a basic assumption; sophisticated bondholders of a solvent corporation are protected by contract and fraud law, not by fiduciary duties arising merely from creditor status.

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Cedar Plains Foods, a solvent Delaware corporation based in Chicago, issued public notes under a New York-law indenture. The indenture requires timely payment of interest and principal, permits mergers, and contains no covenant limiting additional unsecured debt. After Cedar Plains borrows heavily to fund a cash acquisition in Denver, the notes are downgraded and trade at a steep discount, but all payments remain current.

If noteholders sue claiming the issuer breached the implied covenant of good faith by destroying the notes' investment-grade character, what is the strongest answer?

Explanation. The majority held that in a detailed public bond indenture, the relevant fruits of the agreement are the bargained-for rights rooted in the indenture—especially payment of interest and repayment of principal—not preservation of an investment-grade rating or market price. Where the indenture permits mergers and contains no debt restriction, the implied covenant cannot be used to create a new substantive covenant against incurring debt.