In Fox v. CDX Holdings, Inc., the Delaware Court of Chancery held that option holders could not be burdened by an escrow imposed on equity holders in a merger transaction when the terms of the option plan did not permit the escrow to be imposed.

The option conversion provision of the merger agreement purported to convert the options into the right to receive certain consideration, defined the consideration in terms of the Per Share Common Payment, and thereby incorporated the escrow provisions in the merger agreement. The Court noted that the option plan gave the board discretion as to whether to cancel the options in connection with the merger, but if it did, then the option holders were entitled to receive the difference between the fair market value and the exercise price for all shares of common stock subject to exercise.  However, the plan did not permit an escrow.

The Court examined Section 251(b) of the DGCL and noted that a merger agreement can convert shares into the right to receive consideration that incorporates the outcome of an indemnification mechanism.  The power to specify the package of consideration into which shares are converted and to make the consideration dependent upon facts outside the merger agreement enables deal planners to bind non-signatory stockholders to post-closing adjustments, including escrow arrangements, when those stockholders otherwise would not be bound under basic principles of contract and agency law.

However, options are not shares, and option holders are not stockholders.  Options are rights granted pursuant to Section 157 of the DGCL. The rights and obligations of the parties to the option are governed by the terms of their contract.  Section 251(b)(5) of the DGCL does not authorize the conversion of options in a merger.  The option plan could have been drafted differently, such as by providing that holders of options cancelled in connection with the merger would receive the same consideration received by holders of stock, less the exercise price. But the option plan did not say that.