The recent volume of court decisions affecting the merger and acquisition landscape is outpaced only by the recent volume of merger and acquisition deals. These court decisions underscore the significance of properly structuring mergers and new platform and add-on acquisitions alike in order to preserve the principals' economic expectations for any given deal.
Of particular note for M&A professionals is a recent ruling by the Court of Chancery of Delaware pertaining to the proper structuring of two mechanisms commonly used to protect acquirers against liabilities arising after the closing of a merger or acquisition—the release obligation and the indemnification obligation.
In the case before the court, Cigna, a selling stockholder of Audax, the target, sued the merging companies to invalidate certain terms of the merger of Audax into United, the indirect acquirer. The provisions that formed the crux of the dispute related, in relevant part, to a release by Cigna of claims against United and a requirement that Cigna indemnify United. Maintaining that these obligations violated the Delaware General Corporation Law (DGCL), Cigna refused to execute a letter of transmittal, whereby it would have agreed to these obligations, and the defendant merging companies refused to pay Cigna its merger consideration, despite the surrendering of shares by the selling stockholders and the consummation of the merger pursuant to 8 Del. C. § 251.
In the declaratory judgment action, the Court of Chancery of Delaware held that these two obligations of the selling stockholder, Cigna, were invalid as drafted in the specific circumstances of that case, in regards to the release obligation, for lacking consideration, and in regards to the indemnification obligation, for violating the DGCL.
The following is a brief summary of each obligation and the court's rationale behind each ruling.
The Release Obligation
The release obligation, which in the case of Cigna, appeared only in the letter of transmittal, required an irrevocable and unconditional release of any claims against United and its affiliates, employees and agents, subject to a few exceptions. The court determined that because the release obligation pursuant to the letter of transmittal was being imposed on Cigna post-closing and because there was no consideration beyond the merger consideration to which Cigna became entitled once the statutory merger was consummated and its shares were cancelled, there was no consideration for the release obligation; therefore, the release obligation was unenforceable.
The Indemnification Obligation
The indemnification obligation provisions of the merger agreement purported to make each selling stockholder liable to United up to its pro rata amount of the merger consideration for any breach of certain representations and warranties of Audax. Certain of the representations and warranties survived until the expiration of a predetermined period post-closing; however, certain representations and warranties and the related indemnification obligation survived indefinitely. Based on findings that in no point in time would the merger consideration become firm or determinable and that the indemnification obligation would continue indefinitely, the court found that the indemnification obligation violated 8 Del. C. § 251(b)(5). Further, the court noted that such a post-closing purchase price adjustment cannot be forced on non-consenting stockholders.
By many estimations, 2015 is anticipated to be a blockbuster year for private equity investment activity in the U.S. middle market. If 2014 is any indication, more capital was invested last year—$385.1 billion—than any other year on record. Additionally, measured by volume, the 1,748 deals recorded in 2014 brought deal flow very close to the all-time-high level of the 1,816 deals recorded at the height of the buyout boom in 2007. With the anticipated rapid pace of acquisitions in 2015, M&A and private equity professionals should remain aware and cognizant of structuring considerations for mergers and acquisitions. The aforementioned court ruling serves as a reminder that such considerations should include:
- Whether to structure an acquisition through a stock purchase agreement or through a statutory merger;
- How to structure post-closing price adjustments for known and unknown liabilities;
- How to structure acquisitions involving non-consenting stockholders;
- When and how to employ escrow agreements, representations and warranties insurance or indemnifications to account for unknowns; and
- When to time-limit obligations and when to have obligations survive indefinitely.