Private equity sponsors providing funding for a merger are under no implied contractual obligations to perform the covenants, and satisfy the conditions, of a shell company merger if the sponsors themselves are not a signatory to the merger agreement. In an opinion released on January 15, 2009, Alliance Data Systems Corp. v. Blackstone Capital Partners V L.P. and Aladdin Solutions, Inc., (Del. Ch., Jan. 15, 2009), the Delaware Chancery Court held that Blackstone Capital Partners V L.P., the owner of two subsidiaries formed for the purpose of entering into a merger with Alliance Data Systems Corp., was not contractually liable for failing to provide financial backing for a bank subsidiary of Alliance when the merger agreement imposed no such obligations.

On May 17, 2007, Alliance entered into a merger agreement with Aladdin Solutions, Inc. and Aladdin Merger Sub, Inc., two “shell” companies formed by Blackstone for the purpose of acquiring Alliance. No Blackstone entity was a signatory to the merger agreement. Under the terms of the merger agreement, Alliance agreed to forego specific performance except in certain, defined circumstances, and accepted a cap on its recovery of monetary damages for breach: a “Business Interruption Fee” of $170 million payable by Aladdin. Blackstone Capital Partners separately guaranteed payment of the Business Interruption Fee.

One of the conditions to closing in the merger agreement was approval by the Office of the Comptroller of the Currency due to Alliance’s ownership of World Financial Network National Bank. The merger agreement required Aladdin to “use its reasonable best efforts to” take all steps necessary to consummate the merger and “to obtain any requisite approvals, consents, Orders, exemptions or waivers by […] any Third Party or Governmental Entity relating to antitrust, merger and acquisition, competition, trade, banking or other regulatory matters […].” However, after lengthy negotiations with the OCC to obtain regulatory approval, the OCC refused to approve the transaction unless Blackstone Group agreed to provide necessary capital and liquidity for World Financial Network National Bank. Blackstone ultimately declined to do so, causing the OCC to withhold its approval. As a result of the failure to gain approval by the OCC, the merger was not completed by the drop dead date and Aladdin terminated the agreement. Consequently, Alliance sued Aladdin and Blackstone Capital Partners for breach and payment of the Business Interruption Fee.

With regard to Alliance’s breach claim against Blackstone, the court ruled that any breach of contract claim must be based on a breach by Aladdin, as Blackstone Capital Partners was not a party to the merger agreement.

Turning its attention to Alliance’s breach claim against Aladdin, the court noted that Alliance based its claim against Aladdin on three provisions of the merger agreement: (1) Aladdin’s promise to use its reasonable best efforts to get OCC approval; (2) Aladdin’s promise to keep Blackstone from preventing completion of the merger; and (3) Aladdin’s representation that it had the power to fulfill its commitments under the merger agreement. With regard to the first provision, the court held that Aladdin’s promise to use reasonable best efforts applied only to Aladdin, and that Blackstone had no such contractual obligation, and Aladdin made no contractual promise that it would cause Blackstone to do so.

Regarding Aladdin’s promise to keep Blackstone from preventing the completion of the merger, Alliance argued that Blackstone’s failure to assent to the OCC’s demands amounted to an action that impaired the consummation of the merger. The court held that a negative covenant such as this cannot be turned into “a wide-ranging promise to take any affirmative action necessary to obtain regulatory approval.”

Of interest is Alliance’s argument that during negotiations all the negotiators knew that the OCC was likely to demand that Blackstone enter into commitments with the OCC as a condition to granting its approval. The court held that if the necessity of such commitments from Blackstone were so obvious Alliance should have insisted Aladdin be held responsible in the event that Blackstone failed to use its best efforts to obtain regulatory approval.

Finally, the court held that Aladdin’s representation in the merger agreement that it had “all necessary corporate power and authority to execute and deliver this [merger agreement], to perform its obligations hereunder and to consummate the transactions provided for herein” was to be construed narrowly, applying only to Aladdin’s obligations. In other words, Aladdin only represented it had the power to do what it promised to do in the merger agreement.

Because Alliance could not make a viable claim for breach of the merger agreement, the court dismissed its claim, and, consequently, Blackstone Capital Partners was not liable for the Business Interruption Fee.

The case is a lesson for sellers entering into a transaction with private equity funds that the merger agreement needs to be specific and concrete, and tie in the sponsor. A sponsor’s oft heard refrain: “We would never back out because we could not do another deal,” is no excuse for the seller’s failure to demand the appropriate contractual provisions.