In Cigna Health and Life Insurance Company v. Audax Health Solutions, Inc., the Delaware Court of Chancery (i) held that a broad release of claims found only in a letter of transmittal that a  stockholder was required to execute to receive merger consideration was unenforceable for lack of  consideration, and (ii) refused to enforce the portion of a post-closing indemnification obligation  requiring direct payment from a non-consenting stockholder that was indefinite in duration and  potentially required repayment of the stockholder’s entire pro rata portion of the merger  consideration.

BACKGROUND

In February 2014, Audax Health Solutions, Inc. (“Audax”) entered into a merger agreement whereby it  would be acquired by Optum Services, Inc., through its wholly owned subsidiary (the “Buyer”). The  merger was approved by the written consent of 66.9% of Audax’s stockholders. The merger agreement  conditioned receipt of the merger consideration on the surrender of shares and the execution of a  letter of transmittal that required the executing stockholder to be bound by certain obligations  including:

  • A broad release of all claims that the executing stockholder “ever had or now has” against the  Buyer or its affiliates, subject to certain limited exceptions (the “Release Obligation”). The  Release Obligation was not provided for in the merger agreement itself.
  • An agreement to indemnify the Buyer post-closing for certain breaches of Audax’s representations  and warranties up to the full pro rata amount of merger consideration that an executing stockholder  received (the “Indemnification Obligation”). Most of Audax’s representations and warranties  terminated within thirty-six months after the closing of the merger. Some representations and  warranties (and those portions of the Indemnification Obligation), however, survived indefinitely.  The Indemnification Obligation was included in the merger agreement, in addition to the letter of  transmittal.

At the time of the merger, Cigna Health and Life Insurance Company (“Cigna”) was a preferred  stockholder of Audax. Cigna did not vote in favor of the merger, did not execute a support  agreement, and did not execute a letter of transmittal. In response, Cigna was denied payment of  the merger consideration. Cigna sued Audax, the Buyer, and the stockholder representative to obtain  declaratory relief. Cigna argued that the Release Obligation and the Indemnification Obligation  violated the Delaware General Corporation Law (the “DGCL”) and were unenforceable.

ANALYSIS

In considering Cigna’s motion for judgment on the pleadings, the Court held that:

  • The Release Obligation, found only in the letter of transmittal, was unenforceable because it was  not supported by consideration. Under Section 251 of the DGCL, Cigna’s shares were cancelled  immediately upon consummation of the merger, and Cigna was entitled to receive the merger  consideration upon surrender of its cancelled certificates. Because the Release Obligation was not  contained in the merger agreement, it was a new, post-closing obligation. Because no new  consideration was provided to Cigna beyond the merger consideration to which it was already  entitled, the Release Obligation was unsupported by independent consideration and thus  unenforceable. The Court specifically rejected the defendants’ “bundle of rights” argument that the  merger consideration consisted of each of the obligations in the letter of transmittal, including  the Release Obligation, in addition to cash because wholesale adoption of that position would allow  buyers to impose limitless additional provisions on stockholders as conditions precedent to payment  of the merger consideration.
  • To the extent that it was not subject to any monetary cap and not limited in duration, the  Indemnification Obligation violated Section 251 of the DGCL and was thus void and unenforceable  against Cigna. Under Section 251, the merger agreement must quantify the merger consideration  shareholders are to receive. The portion of the Indemnification Obligation that was indefinite in  duration prevented such quantification because Cigna remained potentially liable to the Buyer for  the entirety of Cigna’s merger consideration. The value of the merger consideration was thus  “unknowable.” The Court explained that a stockholder could contractually agree to the indefinite  duration portion of the Indemnification Obligation, such as in a support agreement, but a non-  consenting stockholder like Cigna could not have such an obligation “foisted” on it. Further,  although Section 251 specifically contemplated some adjustments to purchase price, the Court stated  that non- escrow, post-closing adjustments potentially requiring stockholders to repay a portion of  the merger consideration (as opposed to those operating against a portion of the merger  consideration escrowed to satisfy post-closing indemnification claims) had an “uncertain” status  under Delaware law. The Court stated that its opinion expressly did not concern escrow agreements.  The Court further explained that its holding was limited to the specific facts and circumstances  presented in this case and should not be viewed as a broad statement on the general validity of  such post-closing price adjustments. The opinion thus leaves for future determination whether such  post-closing  price adjustments are permissible if limited in duration or as to only a portion of  the merger consideration.

In addition to the Release Obligation and the Indemnification Obligation, the instruments also  included an agreement appointing a stockholder representative who was specifically empowered to  take all actions specified or contemplated by the merger agreement, including defending and  settling any indemnification  claims asserted by the Buyer.  The Court, however, did not decide Cigna’s challenge to this  agreement, explaining that the briefing was insufficient to permit the Court to decide the issue.