January 23, 2009

Delaware Chancery Court Dismisses Claim for Payment of a Termination Fee

From Travis Laster: Last week, Vice Chancellor Leo Strine issued an opinion in Alliance Data Systems v. Blackstone Capital Partners V – dismissing claims filed by Alliance Data Systems Corporation against Blackstone and its affiliates, seeking to recover for alleged breaches of a merger agreement. The opinion confirms that Delaware courts will apply and enforce the plain language of agreements, as written, and will not readily impute obligations not set forth in the agreements or impose obligations on non-parties.

The ADS merger agreement was a standard, antediluvian go-private agreement in which a private equity holdco and its acquisition sub (Aladdin) agreed to acquire ADS. Blackstone, the private equity sponsor, was not a party to the agreement. In the event Aladdin breached the agreement, ADS could recover a $170 million termination fee, with payment guaranteed by a Blackstone portfolio fund.

The ADS deal foundered when the Office of the Comptroller of the Currency, which had regulatory authority over the deal because ADS owned World Financial, a credit card banking subsidiary, demanded that Blackstone provide unlimited financial support for Worldwide Financial as a condition to regulatory approval. Blackstone declined. Once the drop dead-date passed, Aladdin terminated the merger agreement. ADS then sued to recover the termination fee from Aladdin and Blackstone. The Court dismissed these claims, finding that Blackstone was not a party to the merger agreement and that the plaintiffs had not stated a claim for breach. The Court also dismissed the fallback claim for breach of the implied covenant of good faith and fair dealing.

Here are the highlights:

1. The Court held there was no claim against Blackstone because it was not a signatory to the agreement. Plaintiffs’ sole claim instead was whether Aladdin, the signatory to the merger agreement, was somehow liable under the merger agreement for something Blackstone failed to do.

2. The Court rejected the assertion that Aladdin breached its general covenant to use reasonable best efforts to close because Blackstone failed to agree to the OCC’s demands. The Court noted that the reasonable best efforts covenant only bound Aladdin, not Blackstone: “This is in sharp contrast to what respected authorities advocate that a seller should extract in the acquisition agreement, which is a covenant by the acquirer that its parent will also work toward completion of the transaction.” (26).

3. The Court contrasted the antitrust approval obligations in the agreement with the OCC approval obligations. For antitrust approval, Aladdin was obligated to use its “reasonable best efforts” to obtain antitrust approval and to cause Blackstone to do whatever was necessary to secure approval. For OCC approval, by contrast, Aladdin covenanted only not to take any action that “would reasonably be expected to prevent or materially impair or delay the merger.” Because the OCC was asking for affirmative action from Blackstone, the request fell outside the negative covenant that ADS secured. The Court also noted that the Complaint did not identify any affirmative action by Blackstone that would have breached the covenant.

4. The Court rejected the argument that Aladdin did not use reasonable best efforts itself to comply with the OCC’s demands. Taking the allegations of the Complaint as true, the Court noted that ADS’ only complaint was with Blackstone, not with Aladdin.

5. The Court rejected ADS’ efforts to turn the standard rep that Aladdin had the power and authority to execute and deliver the Agreement and consummate the transactions into a rep that Aladdin had the power to make Blackstone close. For anyone familiar with merger agreements, this is a strained argument from the start, and Vice Chancellor Strine clearly understood that. He similarly rejected the idea that because Steven Schwarzman was the ultimate controller of both Aladdin and Blackstone, Aladdin had the power to cause Blackstone to close. He instead limited the contractual obligation to Aladdin, the actual party to the merger agreement.

The ADS decision demonstrates why counsel and contracting parties are well advised to select not only Delaware law, but also a Delaware forum. Vice Chancellor Strine enforced the plain meaning of the merger agreement, and his opinion reveals a sophisticated understanding of both customary merger agreement provisions and how private equity deals operated. The opinion simply enforces the terms of a buyer-friendly deal structure typical of private equity transactions during the halcyon days of 2007. It is thus a good example of the predictability offered by a Delaware forum.