The Delaware Chancery Court’s recent decisions in Crispo v. Musk, West Palm Beach Firefighters v. Moelis & Company, Chordia v. Lee, and Sjunde AP-fonden v. Activision Blizzard, Inc. have caused some angst for merger and acquisition (M&A) practitioners. This blog will summarize those opinions and the statutory changes proposed by the Delaware Bar in response.
Crispo v. Musk
In Crispo v. Musk, the court decided on the ambiguous issue of when a target may assert a claim for premium damages in the event of a default by a buyer in an acquisition agreement. In essence, when a public company is the target in an acquisition, the board of directors act as agents for the shareholders, who will ultimately receive the merger consideration. Moreover, that merger consideration is almost always at a premium to pre-merger market price. Unfortunately, this creates a contractual legal issue, whereby if the buyer breaches the agreement, the only damage claim by the target company is lost transaction costs – because that target company would not have received any of the merger consideration even if the deal had closed.
To help with this situation, a target can negotiate a provision whereby the buyer is liable for lost premium if such buyer wrongly exists the deal. This provision is known as the “Con Ed clause” named after the court decision in Consolidated Edison, Inc. v. Northeast Utilities. However, the enforcement of a Con Ed clause has remained unclear until a recent decision in Crispo v. Musk.
The Twitter acquisition agreement included a Con Ed clause upon which Crispo, a twitter shareholder, relied to sue Musk when he attempted to pull out of the acquisition. Crispo asked for specific performance or in the alternative damages. The Chancellor found that Crispo lacked standing to sue for specific performance but left open the possibility that Crispo could use the Con Ed clause to win damages under certain circumstances while also providing certainty that the provision could not be enforced by the target (Twitter) itself to obtain premium damages. The Chancellor’s opinion noted:
A target company has no right or expectation to receive merger consideration, including the premium, under agreements that operate like the Merger Agreement. The Merger Agreement provides that at the “Effective Time” (defined as the time when the parties file the certificate of merger with the Secretary of State), stock will be converted into the right to receive merger consideration. Under this framework, no stock or cash passes to or through the target. Rather, merger consideration is paid directly to the stockholders. Accordingly, only a stockholder expects to receive payment of a premium under the Merger Agreement.
Where a target company has no entitlement to a premium in the event the deal is consummated, it has no entitlement to lost-premium damages in the event of a busted deal. Accordingly, a provision purporting to define a target company’s damages to include lost-premium damages cannot be enforced by the target company. To the extent that a damages-definition provision purports to define lost-premium damages as exclusive to the target, therefore, it is unenforceable. Because only the target stockholders expect to receive a premium in the event a merger closes, a damages-definition defining a buyer’s damages to include lost-premium is only enforceable if it grants stockholders third-party beneficiary status.
The Chancellor offered suggestions as to how the provision could be written to be enforceable and provide the parties with the contractually intended and negotiated results.
That is, by specifically conferring third party beneficiary rights on the target shareholders and allowing the target shareholders to sue directly, parties can hold a breaching buyer liable for lost premium.
West Palm Beach Firefighters v. Moelis & Company
In West Palm Beach Firefighters v. Moelis & Company the Delaware Chancery Court voided key provisions in a stockholders’ agreement which granted a company founder pre-approval rights on a facet of governance decisions including stock issuances, financings, dividend payments and senior officer appointments. In addition, the founder was granted the right to designate a majority of the members of the board and required the company to recommend shareholders vote for any candidate designated by the founder.
The Chancery Court found these provisions violated Section 141(a) of the Delaware General Corporation Law (“DGCL”). Section 141(a) provides that “[T]he business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation. If any such provision is made in the certificate of incorporation, the powers and duties conferred or imposed upon the board of directors by this chapter shall be exercised or performed to such extent and by such person or persons as shall be provided in the certificate of incorporation.”
The Chancellor court found that the board composition and pre-approval provisions in essence required the board to obtain approval before taking any meaningful action such that the board was rendered powerless in contravention of Section 141(a). Related to the board appointments the court clarified that the ability to make recommendations would not have violated Section 141(a) but the added strict requirement that the company recommend shareholders vote in favor of the candidate went too far. In accordance with the clear statutory language, if the provisions had been contained in the company’s certificate of incorporation, they would have been enforceable.
One of the reasons this case resonates with deal attorneys is that investors and merger counterparties often impose negative covenants and pre-approval governance obligations. In light of West Palm Beach Firefighters v. Moelis & Company, those provisions are now open to challenge and may be deemed unenforceable. Also, adding the provisions to the certificate of incorporation requires shareholder approval, which may be hard to obtain by a publicly held company.
Chordia v. Lee
The case of Chordia v. Lee also involved a shareholder agreement. In this case, the shareholder agreement contained an “Efforts Clause” requiring the corporation to use reasonable efforts to effectuate the rights granted under the agreement. The court found the Efforts Clause took precedence over other bargained for contractual rights where those contractual rights would interfere with the Efforts Clause. In particular, the shareholder agreement provided that Key Holders that remained officers or employees were allowed to designate directors. The court found that the corporation could not fire those Key Holders (i.e. remove them from officer or employee roles) as doing such would effectively deprive the Key Holders of their board designation rights.
Distinguishing from West Palm Beach Firefighters v. Moelis & Company, the court found that the Efforts Clause bound the “corporation” and not its Board of Directors, who could continue to make decisions without regard to the Efforts Clause. Accordingly, Section 141(a) was not an issue.
The Chordia case highlights a common source of conflict between a purchaser of a majority stake in a target company and the target’s founders or other key stockholders. Such conflicts often include general strategic direction, the timing of an IPO or other liquidity event, related party agreements, and corporate cultures. Shareholder agreements are often used to address some of these concerns but careful drafting is necessary. The Delaware Chancery Court will utilize a narrow view of provisions that attempt to prevent a board from exercising their fiduciary obligations.
Sjunde AP-fonden v. Activision Blizzard, Inc.
In Sjunde AP-fonden v. Activision Blizzard, Inc., the Chancery court refused to dismiss a plaintiff’s complaint against the board of directors of Activision Blizzard for the violation of numerous provisions of the DGCL governing board of directors responsibilities in a merger transaction. The plaintiff alleged that the board violated various provisions of Section 251 and Section 141 of the DGCL by, among other things, approving a late-stage draft of the merger agreement instead of a final execution copy, by delegating authority to a board committee to finalize a key term of the merger agreement, and by failing to provide a summary of the merger agreement in the notice of the stockholders’ meeting called to approve it. For a refresher on board responsibilities in a merger transaction see HERE.
Activision defended that approving late stage, but not final execution copies, of a merger agreement is standard market practice. The Chancellor court agreed that it is market practice to approve a late-stage agreement but found in this case the agreement was missing key material provisions such that the agreement was not ripe for approval. The court found that: “[A]t bare minimum, Section 251(b) requires a board to approve an essentially complete version of the merger agreement (the “essentially complete interpretation”).”
The Chancellor also refused to dismiss the plaintiff’s claim that a delegation of authority to a board committee to finalize key terms of the agreement without the approval of the whole board violated the DGCL. Section 251(b) imposes a statutory duty on the Board to approve the terms of an agreement of merger. Where a board has a specific statutory duty, it may not delegate that duty to a committee unless Section 141(c) permits it to do so. Under Section 141(c)(2), “a committee does not have any power with respect to” approving an agreement of merger or its terms.
Statutory Changes Proposed by Delaware Bar
In response to these court decisions, the Delaware Bar has proposed several statutory changes to the DGCL, including:
- An amendment to Section 122 to provide that a corporation may enter into governance agreements with stockholders and beneficial owners where the corporation agrees, among other things, to restrict itself from taking action under circumstances specified in the contract, require contractually specified approvals before taking corporation action, and covenant that it or one or more persons or bodies (which persons or bodies may include the board or one or more current or future directors, stockholders or beneficial owners of stock) will take, or refrain from taking, contractually specified actions (in response to West Palm Beach Firefighters v. Moelis & Company)
- New Section 147 to provide that where the DGCL requires the board of directors to approve an agreement, document or other instrument, the board may approve the document in final form or substantially final form (in response to Sjunde AP-fonden v. Activision Blizzard, Inc.).
- New Section 261(a)(1) to provide that a target company may include in a merger agreement a provision that allows the target to seek damages, including damages attributable to the stockholders’ loss of a premium, against a buyer that has failed to perform its obligations under the merger agreement, including any failure to cause the merger to be consummated (in response to Crispo v. Musk); and
- New Section 261(a)(2) provide that stockholders may, through the adoption of a merger agreement, appoint a person to act as stockholders’ representative to enforce the rights of stockholders in connection with a merger, including rights to payment of merger consideration or in respect of escrow or indemnification arrangements and settlements (in response to Crispo v. Musk).
The Author
Laura Anthony, Esq.
Founding Partner
Anthony, Linder & Cacomanolis
A Corporate and Securities Law Firm
Securities attorney Laura Anthony and her experienced legal team provide ongoing corporate counsel to small and mid-size private companies, public companies as well as private companies going public on the Nasdaq, NYSE American or over-the-counter market, such as the OTCQB and OTCQX. For more than two decades Anthony, Linder & Cacomanolis, PLLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker-dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions, securities token offerings and initial coin offerings, Regulation A/A+ offerings, as well as registration statements on Forms S-1, S-3, S-8 and merger registrations on Form S-4; compliance with the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers; applications to and compliance with the corporate governance requirements of securities exchanges including Nasdaq and NYSE American; general corporate; and general contract and business transactions. Ms. Anthony and her firm represent both target and acquiring companies in merger and acquisition transactions, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. The ALC legal team assists Pubcos in complying with the requirements of federal and state securities laws and SROs such as FINRA for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the small-cap and middle market’s top source for industry news, and the producer and host of LawCast.com, Corporate Finance in Focus. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.
Ms. Anthony is a member of various professional organizations including the Crowdfunding Professional Association (CfPA), Palm Beach County Bar Association, the Florida Bar Association, the American Bar Association and the ABA committees on Federal Securities Regulations and Private Equity and Venture Capital. She is a supporter of several community charities including the American Red Cross for Palm Beach and Martin Counties, Susan Komen Foundation, Opportunity, Inc., New Hope Charities, the Society of the Four Arts, the Norton Museum of Art, Palm Beach County Zoo Society, the Kravis Center for the Performing Arts and several others.
Ms. Anthony is an honors graduate from Florida State University College of Law and has been practicing law since 1993.
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