July 8, 2019

Delaware Weighs In On Shareholders As 3rd Party Beneficiaries

Shareholders’ ability to claim 3rd party beneficiary status under corporate M&A agreements is an area of considerable uncertainty. In Consolidated Edison v. Northeast Utilities, (2d. Cir. 10/05), the Second Circuit held that, under New York law a seller could not recover damages based on the consideration its shareholders were supposed to receive under a merger agreement. The Court said that a “no third-party beneficiaries” clause in the agreement was a bar to shareholder expectancy claims, because they were not parties to the agreement.

As I recently blogged over on “John Tales,” that case has been criticized by a lot of commentators – including Delaware’s Chief Justice, and most commentators do not think that the Delaware Courts would endorse the Consolidated Edison approach. That position received a boost from wo recent Chancery Court decisions permitting shareholders to assert claims as 3rd party beneficiaries under M&A related agreements.

In Arkansas Teacher Retirement Sys. v. Alon USA Energy, (Del. Ch.; 6/19), the Delaware Chancery Court ruled that a shareholder had standing to enforce the terms of an agreement entered into between a company & its largest shareholder.  The agreement was entered into at the time Delek US Holdings acquired a 48% stake in the company, and was intended to avoid application of the 3-year standstill that would have otherwise applied under Section 203 of the DGCL – aka, the Delaware Takeover Statute.

In essence, the agreement provided protections identical to those contained in Section 203, but only for a one-year period, and the board’s approval of the acquisition necessary to avoid the statute’s application was contingent upon Delek’s signing on to the agreement.  The company & Delek subsequently completed a merger, which the shareholder plaintiff sued to set aside on the basis of, among other things, the failure to comply with Section 203.

Here’s an excerpt from this Troutman Sanders memo that lays out the Court’s analysis of the shareholder’s standing as a 3rd party beneficiary of the contract:

Under Delaware law, a third party to an agreement may sue to enforce the agreement’s terms if three elements are met:

– the contracting parties intended to confer a benefit directly to that third party;
– they conveyed the benefit as a gift or in satisfaction of a pre-existing obligation; and
– conveying the benefit was a material part of the purpose for entering into the agreement.

The Court determined that the stockholder agreement’s relationship to Section 203 rendered each of these elements satisfied. The stockholder agreement replicated many aspects of the antitakeover protections of Section 203, which provide a direct benefit to stockholders of a Delaware corporation; therefore, the Court reasoned, the stockholder agreement provided a direct benefit to the Plaintiff.

The agreement’s benefits were established in place of Section 203’s pre-existing protections, or were at least intended as a gift to the stockholders. The Court found that the purpose of the stockholder agreement was to restrict Delek’s ability to acquire Alon, thus without the anti-takeover provisions, the agreement would not achieve that purpose. The Court determined that the anti-takeover provisions were material and held that the Plaintiff has standing to enforce the stockholder agreement

The Alon USA Energy decision did not address a shareholder’s right to bring a claim as a 3rd party beneficiary under a merger agreement, but the Chancery Court did address that issue in Dolan v. Altice, et. al., (Del.Ch.; 6/19).  That case arose out of Altice’s $17.7 billion acquisition of Cablevision & certain commitments that Altice made regarding the post-closing operations of one of Cablevision’s properties.

Cablevision’s founder Charles Dolan & his family brought a lawsuit against Altice alleging that it breached these commitments.  Altice responded by contending that the founders did not have standing under the agreement and that under the terms of the deal, the commitments did not survive closing. The Court held that there was sufficient ambiguity under the terms of the merger agreement to allow the Dolans’ claims to survive a motion to dismiss.

It isn’t unusual to see public company merger agreements that contain “soft” commitments relating to post-closing matters, but as in the Altice case, those contractual commitments frequently are not carved out of general non-survival & no 3rd party beneficiary clauses. Altice demonstrates that simply including these post-closing commitments may create enough ambiguity to create the basis for claims that they were intended to impose legally binding obligations on a buyer.

John Jenkins