Metropolitan Life Insurance Company, et al. v. RJR Nabisco, Inc., et al.
716 F. Supp. 1504 (1989)
Rule of Law:
Under New York law, a court will not imply a covenant of good faith and fair dealing to restrict a corporation from incurring substantial debt in a leveraged buyout where the bond indentures lack express restrictive covenants to that effect, especially when the bondholders are sophisticated financial institutions.
Facts:
- Plaintiffs Metropolitan Life Insurance Co. ('MetLife') and Jefferson-Pilot Life Insurance Co. were sophisticated institutional investors holding over $350 million in bonds issued by defendant RJR Nabisco, Inc.
- The bonds were governed by detailed indentures which contained no express restrictions on RJR Nabisco's ability to incur additional debt or any covenants protecting bondholders in the event of a merger.
- In 1983 and 1985, MetLife had explicitly agreed to remove restrictive debt covenants from two of its bond issues in exchange for other considerations, such as a parent company guarantee.
- Internal MetLife memoranda from the mid-1980s show it was aware of the risks LBOs posed to bondholders, had considered seeking 'change in ownership' covenants for protection, but recognized that large companies resisted such terms in a competitive market.
- On October 20, 1988, RJR Nabisco's CEO announced a proposal for a massive leveraged buyout (LBO) of the company.
- Following a bidding war, RJR Nabisco's board approved a $24 billion LBO by the firm Kohlberg Kravis Roberts & Co. ('KKR').
- The LBO was financed by approximately $19 billion in new debt, causing credit rating agencies to downgrade RJR Nabisco's existing bonds from investment-grade to speculative-grade ('junk bonds'), which significantly decreased their market value.
Procedural Posture:
- Metropolitan Life Insurance Co. and Jefferson-Pilot Life Insurance Co. filed an action against RJR Nabisco, Inc. in the U.S. District Court for the Southern District of New York.
- Plaintiffs sought a preliminary injunction to require RJR Nabisco to post a bond to ensure its ability to redeem plaintiffs' bonds after the LBO.
- The District Court denied the plaintiffs' motion for a preliminary injunction, finding an insufficient showing of irreparable harm.
- Plaintiffs then moved for summary judgment on their counts for Breach of Implied Covenant of Good Faith and Fair Dealing (Count I) and 'In Equity' (Count V).
- Defendants filed cross-motions for judgment on the pleadings and, alternatively, for summary judgment on Counts I and V.
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Issue:
Does a corporation's leveraged buyout, which dramatically increases its debt load and subsequently diminishes the market value of its existing bonds, violate the implied covenant of good faith and fair dealing when the governing bond indentures do not expressly restrict such a transaction?
Opinions:
Majority - Walker, District Judge
No, a corporation's leveraged buyout does not violate the implied covenant of good faith and fair dealing where the bond indentures do not contain express restrictions against incurring substantial new debt. The implied covenant only ensures that parties receive the 'fruits of the agreement' as explicitly bargained for and cannot be used to insert new, substantive terms that the parties failed to negotiate. Here, the bargained-for fruits of the indentures were the periodic payment of interest and the eventual repayment of principal, neither of which RJR Nabisco failed to perform. The plaintiffs, as sophisticated investors, were aware of the market risks of LBOs and could have bargained for specific protections, such as debt restrictions or change-of-control covenants, but did not. Implying such a broad, unbargained-for restriction would destabilize capital markets, which rely on the uniform interpretation of standard indenture terms, and would improperly protect investors from the consequences of their own investment decisions rather than enforcing the contract as written. Furthermore, no fiduciary duty exists between a corporation and its bondholders, whose rights are governed solely by the terms of the contract.
Analysis:
This landmark case firmly establishes that the implied covenant of good faith cannot be used as a tool to rewrite contracts for sophisticated parties or to provide protections that they failed to secure in negotiations. It reinforces a contractarian view of corporate law, holding that the rights of creditors like bondholders are strictly limited to the express terms of their indentures. The decision spurred a significant evolution in the bond market, leading to the widespread adoption of 'event risk' covenants, such as 'poison puts,' specifically designed to protect bondholders from the adverse effects of takeovers and LBOs, demonstrating the market's ability to adapt through contractual innovation rather than judicial intervention.
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