The Delaware Court of Chancery recently added a new level of complexity to private merger  transactions when it held in Cigna Health and Life Insurance Company v. Audax Health Solutions  Inc., that:

  • Broad releases 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
  • Post-closing indemnification obligations requiring direct payment from a non-consenting  stockholder that may have required repayment of the stockholder’s entire pro rata portion of the  merger consideration and were indefinite in duration were unenforceable in violation of Section 251  of the Delaware General Corporation Law (the “DGCL”).

The plaintiff also challenged the appointment of the shareholder representative in the transaction,  but the court did not issue a ruling on this point.

These mechanisms are common in private transactions, but practitioners may need to update practice  to enhance their enforceability in light of this decision. We suggest some options below. For a more in depth analysis into the court’s reasoning in this case, please click here.

Possible Solutions

The best method to address the issues raised by the Cigna decision is to structure an investment in  an entity that may be sold in such a way as to avoid the issues from the outset. Private equity  sponsors could consider the following:

  • Use an alternative entity form (e.g., limited liability company, limited liability partnership  or limited partnership) to hold the business that is or will be sold. This avoids the application  of DGCL Section 251 entirely since transactions involving those entities are governed by other  provisions of the Delaware Code.
  • Require all owners to agree to customary drag-along provisions that they will approve the same  terms and sign the same documents (including releases, indemnification and shareholder  representative provisions, etc.) as the “dragging” shareholder does in a sale.

If the foregoing options are not available, other alternatives include the following:

  • Obtain separate support agreements from sellers where possible and including the release,  indemnification and shareholder representative provisions in these agreements instead of only in the merger agreement. The indemnification obligation of the parties signing the support  agreement could be drafted to increase in the event there are non-releasing parties.
  • Refer in the merger agreement to the release and indemnification obligations so that they are  more closely associated with and considered part of the overall exchange of consideration in the  transaction. Similarly, the letter of transmittal, which should include the stockholder  representation, release and indemnification obligations, should also be referenced in the merger  agreement and attached as an exhibit to the merger agreement.
  • Limit the indemnification obligation to a maximum of three years and/or cap the indemnification  obligation to an amount less than the entire merger consideration.
  • Establish consideration for the release of funds, for example, by making the releases mutual as  between buyer and seller.

For a copy of the Cigna decision, please click here.

​U.S. Private Equity Fundraising

Click here to view the image.

U.S. Sponsor-Backed Exits By Number

Click here to view the image.

U.S. Sponsor-Backed Exits By Dollar Volume

Click here to view the image.

Global Sponsor-Related M&A Activity

Click here to view the image.

U.S. Sponsor-Related M&A Activity

Click here to view the image.