Delaware Court Addresses Ability to Sue Buyers for Lost Premiums in M&A Deals

The Delaware Court of Chancery recently addressed an important issue – whether a target company’s stockholders could sue a buyer for monetary damages representing the lost premium they would have received if the merger closed.  The court reached a sensible result under the circumstances that the stockholders could not bring that claim.  But in doing so, the court muddied the waters in an area that many practitioners believed was more clear and has possibly taken away an M&A provision that significantly discourages buyers from breaching merger agreements.

Background

In Crispo v. Musk,¹a Twitter stockholder brought suit against Elon Musk based on his alleged breach of the merger agreement in which he had agreed to purchase Twitter.² Musk eventually completed the transaction, which led to the unusual posture of this case—the plaintiff sought a $3 million “mootness fee” on the theory that his action was causally related to Musk’s decision to close.  Mootness fees can be awarded where there is a resulting corporate benefit causally related to a lawsuit, but the suit must have been meritorious when filed.³

Court of Chancery’s Opinion

The Court of Chancery concluded that the plaintiff was not entitled to a mootness fee because his suit was not meritorious when filed.  The merger agreement included a provision (the “Lost-Premium Provision”) that termination of the merger agreement would not:

relieve any party hereto of any liability or damages (which the parties acknowledge and agree shall not be limited to reimbursement of Expenses or out-of-pocket costs, and, in the case of liabilities or damages payable by [buyer], would include the benefits of the transactions contemplated by this Agreement lost by [the target]’s stockholders) (taking into consideration all relevant matters, including lost stockholder premium, other combination opportunities and the time value of money), which shall be deemed in such event to be damages of such party, resulting from any knowing and intentional breach of this Agreement prior to such termination (emphasis added). 

 The court held that there were two competing interpretations of the Lost-Premium Provision, neither of which supported the plaintiff’s lawsuit.  Under one interpretation, the court said the Lost-Premium Provision would be unenforceable because it did not specifically make the stockholders third-party beneficiaries of the provision and, therefore, the target would be recovering damages (i.e., the lost premium) for consideration that it had no right or expectation to receive had the merger agreement been performed.  Viewed that way, lost-premium damages would be an unenforceable penalty under contract law unless the merger agreement made the stockholders third-party beneficiaries.⁴

Under the other interpretation, the Lost-Premium Provision made the target stockholders third-party beneficiaries whose rights to bring claims directly against the buyer would accrue only if the merger agreement had been terminated and specific performance was unavailable.  Because the merger agreement was never validly terminated and the transaction ultimately closed, the plaintiff’s right to bring a suit never vested. 

The court concluded that, under either interpretation, the plaintiff lacked standing to enforce the merger agreement at the time he filed the complaint.  The complaint, therefore, was not meritorious when filed and the petition for a mootness fee was denied.

Analysis and Implications

Lost-premium provisions—also called “ConEd provisions” after a 2005 decision in the Second Circuit—have been employed in M&A transactions for almost 20 years.⁵  Many practitioners believed these provisions might be unnecessary in Delaware, however, because Delaware courts presumably would allow a target company to pursue lost premium damages on behalf of its stockholders even without a specific authorization in the merger agreement.⁶  Indeed, one reason the Crispo decision is surprising is that many buyers have long accepted that, in the absence of an express limitation on a target’s remedy (such as a reverse termination fee as the sole and exclusive remedy), there was potential exposure for lost-premium damages.

The court’s analysis raises several issues.  First, the court was clear that, as drafted, the Lost-Premium Provision would not be enforceable by Twitter itself.⁷  The court reasoned that only a target company’s stockholders—not the target company itself—have any right or expectation to receive the merger consideration, including the premium, and therefore awarding lost-premium damages to the target would result in an unenforceable penalty under hornbook contract law.⁸

Second, and in our view most importantly, the court indicated in dicta that even if target company stockholders are third-party beneficiaries of a lost-premium provision—thereby avoiding the unenforceable penalty issue discussed above—allowing the target to pursue damages on the stockholders’ behalf may not be enforceable because the stockholders did not appoint the target as their agent.  Citing to two secondary sources which acknowledged the legal uncertainty, the court noted that the agency approach “rested on shaky [legal] ground.”⁹  Given Delaware’s pro-contractarian approach to private ordering, it is not clear why, when a buyer and target create and bestow a third-party beneficiary right, they cannot also condition or proscribe the manner in which that right may be enforced.  If it is an all-or-nothing proposition, the result may be that target company stockholders are worse off in M&A deals because they will be less likely to be made third-party beneficiaries of merger agreements.

With respect to the court’s second interpretation, which would allow the target stockholders to sue the buyer but only if specific performance is unavailable, the court did not indicate whether the stockholders’ right to seek damages would depend on whether the target had actually sought specific performance or obtained a definitive ruling that the buyer breached the merger agreement.  As discussed below, this could be left to private ordering in merger agreements.

The court’s holding presents numerous issues for transaction counterparties.  First, many buyers may resist giving target stockholders a direct right of action against them.¹⁰Buyers will fear that any failed deal will result in multiple lawsuits from the plaintiffs’ bar, similar to the numerous disclosure-related lawsuits routinely brought against target companies, which will seek compensation on a contingency fee basis.  Obviously, not every failed deal involves a buyer’s willful breach, but the economics of stockholder litigation will still incentivize lawsuits.

Similarly, targets have been reticent to empower stockholders with direct enforcement rights.¹¹ Reserving that right for the board of directors, which owes fiduciary duties to the stockholders, is consistent with Delaware’s board-centric regime.  Admittedly, the prospect of target stockholders suits seeking lost-premium damages is a powerful disincentive for the buyer to breach.  But if stockholders can sue buyers, the target board’s ability to negotiate or settle with buyers over failed transactions may be curtailed.  In fact, there may be situations where the target’s board of directors does not believe it is in the best interests of the target to sue the buyer (e.g., where the target company may have breached its covenants or potentially suffered a material adverse effect).  After all, the target’s board of directors is best situated to judge the merits of any claim against the buyer under the agreement.¹²  Target stockholder-initiated litigation will be even messier if the buyer counterclaims against the target seeking damages from the target’s alleged breach of the agreement.

Second, if buyers are unwilling to agree to give target company stockholders the right to bring lost-premium damages claims, then a rule prohibiting targets from seeking lost-premium damages directly will create a significant imbalance in leverage in enforcing a merger agreement.  The prospect of lost-premium damages is a powerful disincentive for a buyer to breach.  Whether a buyer could be liable for lost-premium damages versus only the target’s out-of-pocket costs factors greatly into that buyer’s analysis of whether to breach.  It likewise affects the target’s decision to enter into a transaction with a buyer as well as whether to sue for monetary damages after weighing the expense of litigating the claim against the likelihood of recovery.  While already important and typically the preferred remedy, specific performance—which may not always be available¹³—will be particularly critical if targets lack a meaningful damages claim.

Legal Arguments in Favor of Lost-Premium Provisions

Despite the dicta in Crispo regarding a target’s ability to seek lost-premium damages on behalf of its stockholders, there are reasons why a Delaware court could uphold a lost-premium provision similar to the one in this case.  First, it is important to remember the unusual context of this case (i.e., a plaintiff seeking a mootness fee after suing a buyer during the pendency of litigation between the merger parties).  A Delaware court may reexamine the issue more closely in a post-termination lawsuit brought by a jilted target against a buyer for a willful breach of a merger agreement.  Delaware courts also have previously suggested lost-premium damages could be recovered.¹⁴  As one treatise observes, “common sense would suggest that this is a rational and appropriate means of achieving an equitable and intended result.”¹⁵

Second, there is support for lost-premium provisions under the DGCL.  For one, Section 251(b)(6) states that a merger agreement can contain such “details or provisions as are deemed desirable.”[16]  Delaware is a pro-contractarian state, vesting decision-making in the board of directors to agree on those details and provisions.  For another, Section 251(b) provides that “the terms of the agreement of merger… may be made dependent upon facts ascertainable outside of such agreement.”¹⁷  The term “facts” includes “a determination or action by any person or body, including the corporation.”¹⁸  Such provisions have supported, for example, the use of post-closing stockholders’ representatives.¹⁹

Possible Responses to the Ruling 

In the absence of a Delaware court revisiting the dicta, practitioners will need to consider how best to deal with remedies and lost-premium damages.  Potential options, among others, may include:

• Stockholders’ Appointment of Target as Agent. Stockholders could approve the agent-principal appointment by virtue of their adoption of the merger agreement.  Similar language is often included in merger agreements appointing sellers’ representatives, typically, but not exclusively, in the private company context.²⁰  We expect to see more such language in public company merger agreements.  In practice, this seems workable but some questions remain.  For one, what happens if the buyer’s breach and termination occur before the stockholder vote?²¹  For another, Crispo did not address whether a majority of the stockholders can approve the agency appointment for all stockholders.²²  Consideration will also need to be given to how the appointment might be addressed in a tender offer (e.g., through language in transmittal documents).
• Conditioning Third-Party Beneficiary Rights in Merger Agreements. While this is an evolving area of the law, parties might draft merger agreements to condition the stockholders’ third-party beneficiary status and concomitant enforcement right.²³  One approach based on Crispo is to provide clearly that the damages claim may only be brought if the target has terminated the merger agreement due to buyer’s breach.  This would allow the target to pursue specific performance and avoid stockholder lawsuits until after the target has abandoned the transaction.  Another possibility to be considered is whether the merger agreement could require that the board of directors affirmatively declare that the third-party beneficiary rights have vested, which would give the target’s board even greater control over the settlement negotiations.  Yet another possibility might provide that the stockholder claim can only be brought if the target’s board has obtained a final judgment that the buyer breached the agreement but did not obtain specific performance.  That approach would give the target’s board the greatest control over whether to litigate with the buyer.
• Adding Provisions to Organizational Documents. The court queried whether a charter provision could authorize the target to act as an agent in merger transactions.²⁴  Unfortunately, this will not be practicable for most existing public companies.  It may also raise some drafting challenges when adopted in the abstract (e.g., addressing which stockholders would receive the recovery if shares were transferred after the breach) and there may be timing considerations if adopted in connection with a specific transaction (e.g., when the breach occurs before the vote on the charter amendment).  In addition, a transaction structured as a tender offer would not involve a stockholder vote to approve a charter amendment.  Practitioners might explore, however, whether this could pass muster as a board-adopted bylaw.²⁵
• Reverse Termination Fees as Liquidated Damages. Targets may look to reverse termination fees as liquidated damages.  This is a valid approach, but there are notable limitations on the size of the fee.  Generally, a liquidated damages provision will be enforced when damages are difficult to calculate, the amount is a reasonable forecast of damages, and the fee is not coercive or unconscionable.²⁶  Lost-premium damages, however, ordinarily will far exceed the amount of a customary reverse termination fee payable for, say, a regulatory or financing failure.  Thus, if a reverse termination fee payable as liquidated damages for a buyer’s willful breach is not large enough, it risks transforming the agreement into an “option” for the buyer.  Factors that might support a larger than normal reverse termination fee in the context of a buyer’s willful breach include the target’s lost opportunities, the risk of losing customers and employees during the interim period, and the reputational harm of not consummating the transaction, along with out-of-pocket costs.  Nevertheless, case law will place limits on the size of the fee that probably prevent it from approximating lost-premium damages.
• Legislative Response. Given the importance of this issue and the significant uncertainty it raises for public company M&A, the Delaware legislature could amend the DGCL to authorize corporations to pursue claims on behalf of their stockholders in connection with mergers and similar transactions.

¹ Crispo v. Musk, C.A. No. 2022-0666-KSJM, mem. op. (Oct. 31, 2023).

² The merger agreement was entered into on April 25, 2022.  On July 8, 2022, Musk purported to terminate the merger agreement.  Musk later agreed to consummate the merger on its original terms before Twitter’s or the stockholder’s claims went to trial.

³ See United Vanguard Fund, Inc. v. TakeCare, Inc., 693 A.2d 1076, 1079 (Del. 1997).

⁴ See Crispo at 27 (“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.”).

⁵ Consol. Edison, Inc. v. Ne. Utilities, 426 F.3d 524 (2d Cir. 2005).  The ConEd court held that the merger agreement conferred certain third-party beneficiary rights on the target company’s shareholders, but that such rights were limited to enforcing the buyer’s obligation to pay the merger consideration to the shareholders after the effective time (which never occurred).  For a comprehensive review of ConEd, see Kevin Miller, The ConEd Decision – One Year Later: Significant Implications For Public Company Mergers Appear Largely Ignored, The M&A Lawyer (Oct. 2006).

⁶ See, e.g., Ryan D. Thomas & Russell E. Stair, Revisiting Consolidated Edison—A Second Look at the Case That Has Many Questioning Traditional Assumptions Regarding the Availability of Shareholder Damages in Public Company Mergers, 64 Bus. Law. 329, 357 (2009) (quoting remarks of then-Vice Chancellor Leo E. Strine, Jr. at the Securities Regulation Institute Seminar at the Northwestern University School of Law (Jan. 24, 2008)); Matthew D. Cain & Steven M. Davidoff, Delaware’s Competitive Reach, 9 J. Emp. L. Studies 92 (2012) (theorizing that all-cash transactions would migrate to Delaware and away from New York due to certainty of law after ConEd).

⁷ See Crispo at 27 (“To the extent that a damages-definition provision purports to define lost-premium damages as exclusive to the target, therefore, it is unenforceable.”).

⁸ See id. at 26-27.

⁹ Id. at 22 (citing 2 Arthur Fleischer, Jr. et al., Takeover Defense: Mergers and Acquisitions § 19.06[C] at 209-10 (9th ed. 2017); Victor I. Lewkow & Neil Whoriskey, Left at the Altar: Creating Meaningful Remedies for Target Companies, The M&A Lawyer (Oct. 2007)).

¹⁰ Of course, if Crispo stands, whether a buyer agrees to allow stockholders to bring lost-premium claims will be a function of the parties’ negotiating leverage.

¹¹ See, e.g., Lewkow & Whoriskey, supra (noting that the “[t]arget will want to preserve for itself the right to control this critical litigation including the right to settle such litigation… and [b]uyer will not want to negotiate/litigate with potentially unorganized and uncoordinated groups of shareholders should a breach be alleged”).

¹² Cf. Dolan v. Altice USA, Inc., 2019 WL 2711280 (Del. Ch. June 27, 2019) (noting that the plaintiffs actively participated in the merger negotiations independent of the target company and negotiated the contract terms which they sought to enforce).  For all of the reasons described above, a target’s lawsuit over a failed deal is fundamentally different from a stockholder’s third-party beneficiary rights to receive the merger consideration after closing.  See Amirsaleh v. Bd. of Trade of City of New York, Inc., 2008 WL 4182998, at *4 (Del. Ch. Sept. 11, 2008).

¹³ For example, consider a situation where the buyer may have the financial wherewithal to satisfy a damages award but would be rendered insolvent if forced to acquire the company.  In addition, the Court of Chancery recently declined to award specific performance in a decision involving extraordinary findings.  See 26 Capital Acq. Corp. v. Tiger Resort Asia Ltd., C.A. 2023-0128-JTL (Del. Ch. Sept. 7, 2023).

¹⁴ See In re IBP, Inc. S’holders Litig., 789 A.2d 14, 83 (Del. Ch. 2001) (“[T]he determination of a cash damages award will be very difficult in this case.  And the amount of any award could be staggeringly large. No doubt the parties would haggle over huge valuation questions….”); see also note 6 supra.

¹⁵ Fleischer, supra, at § 19.06[C].

¹⁶ 8 Del. C. § 251(b)(6). 

¹⁷ Id. § 251(b).

¹⁸ Id.

¹⁹ See Aveta Inc. v. Cavallieri, 23 A.3d 157 (Del. Ch. 2010); see also Houseman v. Sagerman, 2021 WL 3047165, at *6 (Del. Ch. July 20, 2021), aff’d sub nom. Houseman v. Whittington, 287 A.3d 227 (Del. 2022).

²⁰ See In re Openlane, Inc., 2011 WL 4599662, at *3 (Del. Ch. Sept. 30, 2011) (noting that a merger agreement approved by a majority of stockholders by written consent appointed a stockholder’’s representative).

²¹ In that situation, would the target update its disclosure accordingly and proceed with the stockholder vote on the theory that the agreement has not been validly terminated by the buyer?

²² If a majority of the stockholders cannot bind all of the stockholders, it would still seem that the target could pursue lost-premium damages on behalf of those stockholders who did approve the agency appointment.

²³ See Tina L. Stark, Negotiating and Drafting Contract Boilerplate § 5.03 at 100 (2003) (noting that the contract can determine when the third-party beneficiary right vests).

²⁴ Crispo at 22 n.86.

²⁵ See, e.g., 8 Del. C. § 109(b) (“The bylaws may contain any provision, not inconsistent with law or with the certificate of incorporation, relating to the business of the corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, officers or employees.”).  Although not directly on point, note that boards have often adopted forum-selection bylaws in connection with merger agreements that bind all stockholders.

²⁶ Brazen v. Bell Atlantic Corp., 695 A.2d 43, 50 (Del. 1997).