It works the same way in small businesses as it does in major investment firms: the executives reach agreement on the terms of a deal, then leave the lawyers to paper things accordingly.  But sometimes the papered deal differs from the agreement the parties actually reached, and neither side notices the differences until long after the papers are executed.  Or, one side notices the differences, but—realizing that they like the terms of the papered deal better than the one they had discussed—chooses to remain quiet.

In both cases, the aggrieved party is likely to claim mistake: that the parties’ had “a different understanding than the contract’s plain meaning.”  Chimart Assoc. v. Paul.  “The businesspeople reached deal X, but the lawyers papered deal Y.”  In these circumstances, the party claiming mistake must tread carefully: a claim of mistake easily can implicate privileged communications, resulting in an “at issue” waiver of the attorney-client privilege with respect to the negotiation and drafting of the written agreements.

In Securitized Asset Funding 2011-2, Ltd., v. Canadian Imperial Bank of Commerce, No. 653911/2015 (NY County March 3, 2020), Justice Scarpulla becomes the most recent Commercial Division Justice to consider the scope of the “at issue” waiver as it relates to a party claiming mistake in the terms of a contract.

Bonds, Swaps, and a Tangled Web of Cross-References

The dispute in Securitized Asset Funding centers on a $750 million loan from Cerberus Capital Management (“Cerberus”) to the Canadian Imperial Bank of Commerce (“CIBC”).  Because the deal was designed so that Cerburus would assume some of CIBC’s exposure to the U.S. residential mortgage market, the note was repayable from only two groups of securities: cash assets and “Synthetic Assets” (mostly derivative obligations).  The Synthetic Assets generated three income streams: Synthetic Principal, Synthetic Interest, and Synthetic LIBOR, all of which were carefully defined in the written agreements.

According to CIBC, the parties intended to define a portion of “Synthetic LIBOR” as a function of certain underlying assets, the Altius 4 Bonds, such that CIBC’s Synthetic LIBOR payments to Cerberus would gradually reduce as principal payments on the Altius 4 Bonds were made.  But the written agreements that CIBC drafted do not say that.  Rather, they employ a tangled knot of cross-references and defined terms that ultimately define “Synthetic LIBOR” by reference to the “Relevant Notional Amount” of the Altius 4 Swaps (derivatives of the Altius 4 Bonds).  Under ordinary circumstances, this would have been a workable shortcut to accomplish the CIBC’s intent; generally, the notional amount of a swap decreases as principal payments on the underlying bond are made, so tying Synthetic LIBOR to the notional amount of the swap makes abstract sense.  But here, the defined term, “Relevant Notional Amount” of the Altius 4 Swaps had a key feature: it would “freeze”—stop reducing—upon a physical settlement of the swaps.  As an unintended consequence, then, if the Altius 4 Swaps were physically settled, Synthetic LIBOR would also freeze.  This meant that CIBC would continue to owe Cerberus Synthetic LIBOR payments—in an amount fixed at the freeze date—even after the liquidation of the Altius 4 Swaps.

After physical settlement of the Altius 4 Swaps, Cerberus sued to enforce the deal as written: where the Synthetic LIBOR payment was frozen as of the physical settlement of the swaps and not further reduced in accordance with future principal payments on the bonds.  CIBC maintained that the parties never intended the Synthetic LIBOR to freeze, and “[i]f Cerberus’ new interpretation is accepted by the Court, then the agreements at issue were entered into under mutual mistake as they do reflect the meeting of the minds of the parties.”

CIBC Claims Mistake, Asserts Privilege Over Communications Regarding its “Business Understanding” of the Deal

CIBC argues that its executives reached a business understanding of the deal, but that through a mistake of its attorneys—the drafters of the deal documents—the papered deal was materially different than its “business understanding.”  Specifically, CIBC contends that its business understanding of the deal was that the Synthetic LIBOR was tied to the principal payments on the Altius 4 Bonds, which—unlike the notional amount on the swaps—would not freeze upon physical settlement of the swaps.  CIBC’s in-house attorney, the drafter of the Synthetic LIBOR definition, testified that the reference to notional amount (presumably, insofar as it incorporated the “freeze” provision of the swaps) was a “mistake,” and the parties had in fact intended to define Synthetic LIBOR by reference to the principal on the bonds.

Cerberus sought to explore CIBC’s claimed “business understanding” in discovery.  What about their “business understanding” of the deal did CIBC’s executives convey to its attorney drafters?  Was this “business understanding” ever conveyed to the drafters?  Did the drafters ever explain the terms (and all the cross references) they used to define Synthetic LIBOR?  Did anyone ever discuss the impact of physical settlement of the swaps on Synthetic LIBOR?  To all these questions, Cerberus was met with a claim of attorney-client privilege.

Cerberus Moves to Compel

Cerberus argued that by placing its “understanding” of the contracts that it drafted at issue, CIBC waived privilege over the communications between its executives and attorneys.  In other words, CIBC should not be able to both (i) assert a different understanding than the plain meaning of the written agreements that it prepared and (ii) assert privilege over discussions related to that “understanding.”

CIBC argued that it had not waived privilege because it does not intend to rely on privileged material to prove its defense of mistake.  Rather, CIBC would prove mistake by, inter alia, the course of performance of the parties (Cerberus accepted reduced Synthetic LIBOR for years after physical settlement of the swaps before claiming that the reductions had frozen), testimony from Cerberus’ executives who spotted the mistake before the deal was finalized but chose to remain quiet, and rational economics (too much of a tangent for this blog, but CIBC let a call option lapse—a decision that, had Synthetic LIBOR been frozen, made no economic sense).  CIBC maintained that because it expressly disclaimed its own reliance on any privileged communications to support its claim of mistake, no waiver could be found.

In reply, Cerberus argued that CIBC’s definition of wavier was far too narrow.  Waiver applies not only to circumstances where a party directly implicates privileged communications in its claim or defense, but also where “truth of the parties’ position can only be assessed by examination of a privileged communication.”   Tupi Cambios, S.A. v. Morgenthau.  In plain English, Cerberus argued: how could it possibly dispute CIBC’s contention that its executives’ business understanding differed from the terms CIBC’s lawyers put forth without the communications between the executives and the lawyers?

So, after a Masters-level course in derivative finance (and the peril of defined terms and layered cross-references), the question submitted to Court was straightforward: Can a party asserting mistake as a defense to a breach of contract action avoid waiver of attorney-client privilege by disclaiming its intent to rely on privileged materials?

The Court’s Decision

Justice Scarpulla sided with CIBC: because CIBC did not intend to rely on any privileged communications to establish its defense of mistake, and because Cerberus could not point to any testimony where CIBC had made a limited waiver of such privileged material, the Court denied Cerberus’ motion to compel.  In so doing, the Court rejected Cerberus’ contention that it could not test the veracity of CIBC’s “business understanding” of the agreements without seeing how that business understanding was conveyed (or whether it was ever conveyed at all) to the drafters of the deal documents.  The Court reasoned that because CIBC had not opened the door to privileged communications in its own case, Cerberus could not access those communications.

Practical Considerations

The Securitized Asset Funding decision casts serious doubt on whether there are any circumstances where a Court will find “at issue” waiver even though the party asserting the privilege does not intend to directly rely on the privileged communications in its own claims or defenses.  The decision follows several courts that have suggested (or outright held) that a party’s affirmative reliance on the privileged materials in its own claims or defenses is the sine qua non of an “at issue” waiver.  See Pivotal Payments, Inc. v. Phillips; Deutsche Bank Tr. Co. of Americas v. Tri-Links Inv. Tr.

This line of cases gives parties asserting mistake in a contract an easy roadmap to prevent waiver: avoid affirmative reliance on privileged material—and, if met with a motion to compel, disclaim such affirmative reliance—and the privilege will remain intact.  According to Securitized Asset Funding, this roadmap works even if the party asserting the mistake drafted the documents containing the terms it now denounces.

But also consider the possibility that these cases too narrowly construe the “at issue” waiver.  After all, waiver is a flexible doctrine rooted in fairness.  And it is not difficult to imagine a compelling fairness argument supporting a broader application of the doctrine.  Here, for example, should Cerberus be required to take CIBC at its word regarding the existence of CIBC’s “business understanding,” when there are privileged documents that potentially rebut that claim?  In MBIA Ins. Corp. v. Patriarch Partners VIII, LLC, a similar argument carried the day.  That Court (applying New York Law) found implied waiver even where the party asserting the privilege did not intend to rely on privileged communications in its own case because the parties made factual assertions about their “understanding” of the agreement, which differed from the agreement drafted.

Cerberus plans to appeal the Court’s denial of its motion to compel, so we may soon see some additional guidance from the First Department.  In the meantime, however, litigants should be keenly sensitive to the likelihood that claiming mistake in a breach of contract action invites argument on the complex and inconsistently applied “at issue” waiver.