Private Company M&A: The Recent Delaware Case Trifecta
Rare is the Delaware decision that meaningfully affects private company M&A practice. Until recently. Over the last couple of months there has been a trifecta of decisions addressing the efficacy of some of the key, customary features in private company M&A.
Waiver of Appraisal Rights. In Halpin v. Riverstone (February 29, 2015), a target company’s Stockholders Agreement included a drag-along provision requiring minority stockholders to, among other things, vote in favor of a change in control transaction. A sale of the target company, structured as a merger, was approved by the written consent of stockholders representing 91% of the outstanding shares. Following the closing of the merger, minority stockholders were asked to sign a written consent to the merger (even though the merger had already been approved and closed).
The acquirer asserted that signing the consent was required by the drag-along, and so the failure to sign would be a breach of the Stockholders Agreement. A minority stockholder refused to sign, however, because if it signed (and so consented to the merger) it would have thereby waived its appraisal rights.
The Delaware Court of Chancery held that since the vote of the minority stockholder was not sought in advance of, and was not necessary for, the merger, the drag-along had not been properly invoked. Therefore, the minority stockholder could not now be compelled to sign the consent and thereby waive its appraisal rights. The court evidenced discomfort about provisions which could be used to force stockholders to waive appraisal rights (which are, after all, the protection of last resort for minority stockholders in private companies).
Practice Note: Contractual provisions that may cause minority stockholders to waive appraisal rights, even if not the express intent of the provision, are likely to be looked at with skepticism by the Delaware court. Obtaining a waiver of appraisal rights is therefore best done expressly in connection with the negotiation of a transaction.
Limitations on Covenant of Good Faith and Fair Dealing. Nationwide v. NorthePoint (March 18, 2015) arose out of the purchase by a group of asset managers of the 65% majority stockholder of the asset management firm they worked for.
The Purchase Agreement provided that the manager’s sub-advisory arrangements for seven specific funds could not be terminated, without cause, for three years after closing. After closing, seller proceeded to liquidate or merge some of the seven funds, and formed some new funds that competed with the seven. None of these actions were expressly prohibited by the Purchase Agreement.
The management group sued, claiming that they would not have paid the entire purchase price had they known seller would take these actions. They alleged breach of the covenant of good faith and fair dealing.
The Delaware Supreme Court disagreed with the management group. The court essentially held that once a party has specifically addressed a meaningful issue in a transaction (in this case, a form of earn-out), the party cannot look outside of the agreement to redress issues that could have been dealt with in the drafting.
Practice Note: Thoughtful business lawyering, especially in the context of earn-outs, matters. The Delaware court will not be sympathetic to parties with buyer’s remorse as a result of matters they could have been protected against.
Binding Minority Stockholders to Indemnification and Releases. A Merger Agreement approved by stockholders representing 67% of the outstanding shares was the subject of Cigna v. Audax (November 26, 2014). After closing, buyer refused to pay the merger consideration to a minority stockholder (who had not consented to the transaction) because the stockholder contested two provisions that the buyer insisted would be binding on it.
First, the Merger Agreement provided that all stockholders had certain direct (not through an escrow), pro-rata, uncapped, post-closing indemnification obligations. The court found that this indemnification obligation (which had not been consented to by the minority stockholder) violated the Delaware merger statute because it put potentially all of the stockholder’s merger consideration at risk. Importantly, the court noted that it was not questioning the use of indemnification escrows in private merger agreements even though minority stockholders typically do not consent to these types of arrangements either.
Second, the letter of transmittal that stockholders were required to sign in order to receive payment of their merger consideration included a release of claims against the target, the buyer, and others. The court found that such a release was not valid since it lacked consideration (because the stockholder was, by law, entitled to its merger consideration).
Practice Note: If not all stockholders are to sign a transaction agreement, use of an escrow continues to be the best mechanism for post-closing indemnification. And, if releases are important to a buyer, they should be obtained as a condition to signing, not as a condition to being paid merger consideration after the closing.