Shareholders of an acquired company in a merger transaction sued the purchaser, arguing that certain provisions of a pre-merger letter of intent survived the merger. The Supreme Court of Delaware held that although the merger agreement provided for the survival of portions of the letter of intent, the integration clause of the merger agreement did not transform non-binding provisions of the letter of intent into binding obligations of the purchaser.
ev3, Inc. v. Lesh, M.D., et al., 103 A.3d 179 (Del. 2014)
ev3, Inc., the purchaser, and Appriva Medical, Inc., the acquired company, entered into a merger agreement that provided for payments upon the achievement of certain post-closing milestones. After it became clear that the milestones would not be achieved, the shareholders of the acquired company (the plaintiffs) sued the purchaser in the Delaware Superior Court, for having breached its obligations under the merger agreement to fund and pursue the regulatory milestones in its “sole discretion, to be exercised in good faith.” The plaintiffs claimed that the purchaser had breached a non-binding provision of the letter of intent signed during the early stages of negotiations, stating that the purchaser would “commit to funding based on the projections prepared by its management to ensure that there is sufficient capital to achieve the performance milestones.” The integration clause of the merger agreement, upon which the plaintiffs relied, stated that the merger agreement constituted the entire understanding between the parties “other than the letter of intent.”
The trial court allowed the admission of the letter of intent into evidence, thereby permitting the plaintiffs to argue to the jury that the purchaser breached its obligations under the funding commitment milestone language contained in the letter of intent, which letter of intent language had become binding by virtue of the merger agreement.
On appeal from a jury verdict in favor of the plaintiffs, the Supreme Court of Delaware reversed, holding that the letter of intent had been erroneously admitted into evidence to interpret the meaning of the merger agreement. Focusing on the integration clause of the merger agreement, the Supreme Court held that the reference in the merger agreement’s integration clause to the letter of intent did not transform the non-binding terms of the letter of intent into contractually binding terms.
The letter of intent contained certain provisions that were specifically designated as binding on the parties –namely, those addressing confidentiality, transferability and restrictions on the ability of Appriva to engage in discussions with other potential purchasers. The remaining letter of intent provisions were non-binding. The letter of intent specifically stated:
“It is expressly understood that this letter agreement merely sets forth a preliminary statement of intentions with respect to the Contemplated Transaction, . . . [it] does not constitute an obligation binding on ev3 . . . . A binding agreement with respect to the Contemplated Transaction will result only from the execution of a definitive agreement with respect thereto and will be entirely subject to the terms and conditions contained therein.”
During the trial, the plaintiffs argued that the funding provision of the letter of intent, even though designated as non-binding, became a binding promise by virtue of the integration clause of the merger agreement, which stated:
“This Agreement contains the entire understanding among the parties hereto with respect to the transactions contemplated hereby and supersede and replace all prior and contemporaneous agreements and understandings, oral or written, with regard to such transactions, other than the Letter of Intent, dated March 15, 2002, as amended [emphasis added]. All exhibits and Schedules hereto and any documents and instruments delivered pursuant to any provision hereof are expressly made a part of this Agreement as fully as though completely set forth herein.”
The Supreme Court determined that although the letter of intent had been fully incorporated into the merger agreement by virtue of the quoted language in the integration clause, the purpose for allowing the letter of intent to survive was only to ensure that the binding provisions contained in the letter of intent would not be extinguished by the integration clause. The Supreme Court concluded, therefore, that the non-binding provisions of the letter of intent were just that: non-binding, including the letter of intent provision relating to the purchaser’s commitment to fund the accomplishment of the milestones. Accordingly, the Supreme Court reversed.
This case has several implications for M&A practitioners.
Letters of Intent and Term Sheets
Express Binding and Non-Binding Language
Letters of intent and term sheets facilitate initial discussions and allow the parties to negotiate, memorialize and shape the terms of the transaction at a very early stage. These documents are usually executed in advance of a thorough diligence process and are generally non-binding except for specified provisions, such as confidentiality, transferability and no-shop covenants. When crafting a letter of intent or term sheet, it is essential to use language that clearly identifies which provisions of the letter of intent or term sheet are intended to be binding and which are not.
Statements of Intent on Earnouts and Milestones
Earnouts (or milestones in life sciences transactions) are frequently used to bridge the valuation gap between purchasers and sellers. They are also often the source of post-closing litigation if the earnouts or milestones are not achieved. The issue in these lawsuits often becomes what level of effort the purchaser expended or should have expended to achieve the earnouts or milestones. Given the intense focus on earnouts and milestones post-closing, it is critical that any obligation that the purchaser intends to assume with respect to these potential post-closing payments be carefully considered and clearly and unambiguously expressed.
The litigation in ev3, Inc. could have been avoided altogether if the letter of intent omitted any reference to the purchaser’s obligations to fund the milestones. Given that many sellers, particularly in life sciences transactions, will insist on some reference to the purchaser’s efforts to achieve earnouts/milestones in the letter of intent, we recommend that such efforts (if any) are carefully and clearly expressed with an intent to articulate the obligations that will be set forth in the merger agreement. In any event, the letter of intent should expressly make such efforts non-binding and the merger agreement’s integration clause should not contain any reference to the letter of intent so that the merger agreement will control if there is a different standard of purchaser efforts negotiated and agreed to after the letter of intent is signed.
Integration Clauses in Definitive Agreements
Lastly, it is important that M&A practitioners not treat integration clauses as “boilerplate,” but instead pay very close attention to ensure that integration clauses are carefully and precisely drafted and do not refer to any documents that could be argued to override the meaning of disputed provisions in the merger agreement. If the parties wish to provide for the survival of certain provisions of the letter of intent, the integration clause should expressly state which provisions survive while stating that the remaining provisions contained in the letter of intent are superseded by the language of the merger agreement. Better yet, the integration clause could state that the merger agreement entirely supersedes the letter of intent, and could then proceed to identify the specific obligations that will survive the merger.