The Delaware Court of Chancery recently held that in a statutory merger: (i) the buyer could not condition payment of merger consideration to non-consenting stockholders on their execution and delivery of a broad release of claims when the release was not an express condition contained in the merger agreement, without independent consideration for the release; and (ii) the post-closing indemnification obligations that had indefinite duration, and that potentially covered the full merger consideration, were unenforceable against non-consenting stockholders because such provisions would render the value of the merger consideration unknowable.1
Optum Services, Inc. (together with its affiliates, the Buyer) acquired Audax Health Solutions, Inc. (Audax) through a statutory merger under Section 251 of the Delaware General Corporation Law (the DGCL) in February 2014. The merger was approved by the written consent of 66.9 percent of Audax’s stockholders in the form of support agreements. The merger agreement conditioned the receipt of the merger consideration on the surrender of shares and the execution of a letter of transmittal, which, pursuant to the merger agreement, must be “in form and substance reasonably acceptable” to the Buyer. The letter of transmittal required the stockholders to agree to three obligations that the consenting stockholders consented to in the support agreements: (i) a broad release of all claims against the Buyer (the Release Obligation); (ii) an agreement to be bound by the terms of the merger agreement, specifically including the indemnification provisions for breaches of representations and warranties (the Indemnification Obligation); and (iii) an appointment of Shareholder Representative Services LLC as the stockholder representative (the Stockholder Representative Obligation, and, collectively with the Release Obligation and the Indemnification Obligation, the Obligations). While the Indemnification Obligation and the Stockholder Representative Obligation were provided in the merger agreement, the Release Obligation was not mentioned.
Under the Indemnification Obligation, Audax’s stockholders were liable to the Buyer up to the pro rata amount of the merger consideration they received for breaches of certain of the company’s representations and warranties. While many of the representations and warranties would terminate 18–36 months after the closing, certain fundamental representations and the indemnification provision itself would survive indefinitely.
Cigna Health & Life Insurance Company (Cigna) was a preferred stockholder of Audax at the time of the merger. Because Cigna did not execute a support agreement in favor of the merger or a letter of transmittal, the Buyer refused to pay Cigna the merger consideration for its shares. Cigna brought an action against the Buyer contending the Obligations violated the DGCL. The court analyzed the enforceability of the Release Obligation and the Indemnification Obligation in this declaratory judgment opinion, but declined to rule on the Stockholder Representative Obligation at this stage.
Release Obligation Was Unenforceable for Lack of Consideration
The court held that upon the consummation of the merger, Cigna’s shares were cancelled in exchange for a right to receive the merger consideration from the Buyer. The Release Obligation was not mentioned in the merger agreement and it was a new obligation being imposed on Cigna post-closing as a condition to receive the merger consideration. The court found that the letter of transmittal lacked sufficient consideration because the Buyer’s pre-existing duty to pay the merger consideration could not be used to support the Release Obligation. Further, while the merger agreement conditioned receipt of the merger consideration on surrender of shares and execution of the letter of transmittal, the merger agreement described the letter of transmittal as one “in form and substance reasonably acceptable to the Buyer” and required an agreement to the indemnification provisions, “among other things.” The court noted that the merger agreement provided no indication to stockholders that they might have to agree to a release, “let alone the sweeping release called for in the letter of transmittal.” If such language would allow the Buyer to impose post-closing obligations not otherwise specified in the merger agreement, then the Buyer could impose almost any post-closing conditions as a condition to receive the merger consideration. For these reasons, the court held that the Release Obligation was not supported by consideration and was unenforceable. The court did not address whether the Release Obligation would have been enforceable if it were included in the merger agreement.
Indemnification Obligation with Indefinite Duration and No Monetary Cap Was Unenforceable
The court found the structure of the Indemnification Obligation, without an escrow, was analogous to a post-closing price adjustment; the court held that these were permissible if in compliance with Section 251(b) of the DGCL. The court held that Section 251 of the DGCL required a merger agreement to provide a determinable merger condition to allow stockholders to “ascertain the value, at or about the time of the merger, of what they [would] receive as merger consideration.” The court found that under the Indemnification Obligation, a stockholder was potentially liable for the full pro rata merger consideration indefinitely, and there would be “no point in time at which the merger consideration . . . ever became firm or determinable.”2 While stockholders could contractually agree to such an indefinite indemnification obligation, the court held that “such a post-pricing adjustment [could not] be foisted on non-consenting stockholders” like Cigna through the effects of a statutory merger. Therefore, the court found the portion of the Indemnification Obligation that was indefinite in duration and potentially covered the full amount of the merger consideration violated Section 251(b)(5) of the DGCL, and was unenforceable.
The court stated that its opinion was limited to the facts presented in this case and did not address: (i) escrow agreements withholding a portion of the merger consideration for future indemnification claims; (ii) the general validity of post-closing price adjustments requiring direct repayment from stockholders; and (iii) whether a price adjustment that covered all of the merger consideration may be permissible if time-limited, or whether an indefinite adjustment period as to some portion of the merger consideration would be valid.
As a result of the foregoing holding, the court declared that non-consenting stockholders were entitled to tender their shares and receive the merger consideration without accepting or being bound in anyway by the aspects of the Indemnification Obligation in the merger agreement that were not subject to a monetary cap and a time limit of 36 months or less.