January 4, 2022

M&A Agreements: Disclosure Schedules Have Their Day in Court

Disclosure schedules have been the bane of junior M&A lawyers’ existence for decades, but to my knowledge, there hasn’t been much case law addressing them in depth. Vice Chancellor Glasscock’s recent decision in The Williams Companies v. Energy Transfer Equity, (Del. Ch.; 12/21), fills that gap and provides some important interpretive guidance for lawyers involved in drafting and negotiating disclosure schedules and the contract terms to which they relate.

The decision is the latest installment of the long-running litigation between the two companies arising out of their aborted 2016 merger.  The deal was complex, and the facts of the case are labyrinthine, but the issue that implicated the agreement’s disclosure schedules was whether a $1 billion preferred unit offering that ETE engaged in while the deal was pending violated its obligations under the agreement’s ordinary course and interim operating covenants.

Section 4.01(b) of the merger agreement set forth a list of covenants that ETE agreed to abide by between signing and closing of the deal. Those included an obligation to operate its business in the ordinary course, to refrain from issuing additional securities or taking actions that would restrict its ability to pay dividends, and to refrain from amending its partnership agreement or other organizational documents.

As is usually the case, the parties negotiated a series of exceptions to these restrictions. During the drafting process, they were originally included in the relevant covenants themselves, but due to confidentiality concerns, the carve-outs were moved to the disclosure schedule at the last minute.  Ultimately, the lead-in paragraph of Section 4.01(b) included a statement obligating ETE to comply with each of the covenants, “Except as set forth in Section 4.01(b) of the Parent Disclosure Letter.”

That disclosure letter included a carve-out permitting ETE to issue up to $1 billion of its equity securities. It ultimately did so, but Williams contended that the exception in the disclosure letter only applied to the limitation on issuances of additional securities and was not a blanket carve applicable to other obligations that might be violated by ETE’s actions, including those relating to dividend restrictions and amending org docs. In support of that position, Williams noted that the disclosure letter itself was organized under specific subheadings identifying the covenant to which the exception was to apply. But the agreement also contained the following language, which probably looks pretty familiar to most of you:

[A]ny information set forth in one Section or subsection of the Parent Disclosure Letter shall be deemed to apply to and qualify the Section or subsection of this Agreement to which it corresponds in number and each other Section or subsection of this Agreement to the extent that it is reasonably apparent on its face in light of the context and content of the disclosure that such information is relevant to such other Section or subsection[.]

ETE contended that this language meant that an exception set forth in the disclosure letter applied to any covenant in the agreement that is “logically related to” the covenant that it specifically addresses.

Vice Chancellor Glasscock decided that the merger agreement’s language was ambiguous, and so looked to extrinsic evidence of the parties’ intent concerning the scope of the securities offering carve-out.  Among other things, he noted the late move of the carve-outs from the specific covenants themselves to the disclosure schedule, and testimony that this was not intended to result in substantive changes to their meaning. VC Glasscock also concluded that ETE’s interpretation of the language concerning the application of the disclosure letter to other covenants was overbroad. Here’s an excerpt from his discussion of that topic:

I find that the plain meaning of the provision—that contract language shall apply cross-sectionally where it is reasonably apparent on its face that the language is relevant cross-sectionally—excuses actions that would otherwise breach covenants where facially necessary to permit the activity provided by the provision—that is, where absent cross-sectional applicability an inconsistency in the contractual terms would result.

For example, another exception under the “Section 4.01(b)(v)” header in the Parent Disclosure Letter allows ETE to “acquire units in any of its Subsidiaries in an amount up to $2.0 billion in the aggregate.” It is “reasonably apparent on [the] face” of this exception that it must cross-apply to the covenant in Section 4.01(b)(iv) of the Merger Agreement, which states that ETE may not “purchase, redeem or otherwise acquire any shares of . . . its Subsidiaries’ capital stock or other securities.” Otherwise, the exception would have no meaning.

Accordingly, the Vice Chancellor concluded that ETE could have undertaken an equity issuance pursuant to the exception that complied with each of the covenants that Williams contended that it violated, and that because it could have complied with those covenants without the application of the exception, its relevance to the covenants was not facially apparent.  Ultimately, the Vice Chancellor concluded that ETE breached its obligations under the covenants in question, and that as a result, Williams was entitled under the agreement to reimbursement for a $410 million termination fee that it had paid to get out of another deal in order to enter into its deal with ETE.

As is often the case, there is a lot more going on in this decision than I can cover in a blog.  In that regard, Vice Chancellor Glasscock’s opinion includes an extensive discussion applying the Delaware Supreme Court’s recent decision in AB Stable concerning the meaning of an “in all material respects” compliance standard for interim covenants to the specific facts of this case.

John Jenkins