February 23, 2015

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A stockholder in a merger cannot be required to sign a release post-merger in order to receive the merger consideration.

The Delaware Chancery Court recently examined a corporate merger that conditioned receipt of the merger consideration on the target stockholders signing a letter of transmittal releasing all claims against the acquirer.  The merger agreement itself did not contain or describe the release agreement.  The court found that under Delaware corporate law the stockholders were entitled to receive the merger consideration upon consummation of the merger and their delivery of the applicable stock certificates.  The court found as a result that no independent consideration supported the release contained in the letter of transmittal, rendering the release unenforceable.  The decision does not make clear how, if at all, the outcome might have differed had the release been mentioned in the merger agreement.  The case demonstrates that there are limits to an acquirer’s ability to import into a transaction structured as a merger the benefits of a stock purchase agreement signed by all selling stockholders.  The case is Cigna Health and Life Insurance Company v. Audax Health Solutions, Inc. (Del. Ct. Chancery 11/26/14).


A stockholder cannot be bound by an unlimited indemnification obligation in a merger agreement to which the shareholder is not a signatory.  

In the case described above, the Delaware Chancery Court also looked at the issue of whether an unlimited stockholder indemnification obligation in a merger agreement could bind non-signatory target company stockholders.  The court acknowledged the similarity of an indemnification obligation to an escrow holdback and the frequency with which mergers include post-closing price adjustments.  The court noted, however, that Delaware corporate law stipulates that post-closing price adjustments must be “dependent upon facts ascertainable” and not undermine the requirement that the merger agreement state the consideration to be received by target stockholders.  Here, the indemnification obligation was constrained neither in amount nor by time.  From this, the court concluded that the obligation was too open-ended to pass muster under Delaware’s merger statute:  “Crucially, the stockholders may never know the exact value of the merger consideration:  there is no point at which the value of the merger consideration definitively can be determined because the Indemnification Obligation continues indefinitely.”  The court observed that this uncertainty made more difficult a stockholder’s decision whether to accept the merger consideration or exercise dissenters’ rights of appraisal.  The court noted that a post-closing adjustment tied to financial statements, limited by a monetary cap and/or subject to a 36-month claims window might satisfy the statutory criteria. Cigna Health and Life Insurance Company v. Audax Health Solutions, Inc. (Del. Ct. Chancery 11/26/14).


A stockholder’s right to examine the corporation’s financial statements cannot be conditioned on the stockholder agreeing not to trade in the corporation’s stock.

Dissident stockholders often try to take advantage of the inspection rights afforded them by corporate law, instead of litigation, to obtain corporate information. Sometimes in response, corporations try to limit the use that the requesting stockholders may make of the information.  The Delaware Chancery Court ruled in May 2014 that, when a stockholder seeks to examine the corporation’s nonpublic financial statements, the corporation cannot insist that the stockholder first agree not to trade in its stock.  The stockholder in question had agreed that it would sign an appropriate confidentiality agreement, but the corporation argued that its requested non-trading stipulation was necessary for it to avoid tipper liability under federal securities law.  The court found that the corporation’s no-trading restriction would inappropriately frustrate the stockholder’s right to use the requested information and thus was not permitted under Delaware corporate law.  The case is The Ravenswood Investment Company, L.P. v. Winmill & Co. Incorporated (Del. Ct. Chancery 5/30/14).  A December 2014 decision of the Delaware Supreme Court may call this decision into question.  The court there held that the Delaware courts have broad discretion to condition a books and records inspection, including by imposing limits on the stockholder’s use of the requested information.  That case is United Technologies Corp. v. Treppel (Del. Sup Ct. 12/23/14).


Use of convertible debt in start-up financing can be advantageous.

A start-up company may find it beneficial to issue convertible debt rather than preferred stock.  The advantages to this approach are outlined in a recent article by Andy Coburn published in Business Black Box.