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While most reps & warranties in an acquisition agreement are subject to materiality or “material adverse effect” qualifiers, not all of them are. Most agreements provide that a buyer will have the right to walk away if certain seller reps are not true and correct in all respects. The seller’s rep as to its capitalization is usually one of these unqualified reps, and in HControl Holdings v. Antin Infrastructure Partners, (Del. Ch.; 5/23), the Delaware Chancery Court held that an unqualified capitalization rep means what it says, and that the buyer was entitled to walk away from an acquisition in case of a seller’s uncured breach of that rep.

The case arose out of what is probably every deal lawyer’s most common post-signing nightmare – people coming out of the woodwork to claim an ownership stake in the seller.  In this case, that person’s claims were credible, and although the seller went through various gyrations in an effort to address them and insulate the buyer from potential claims, those were insufficient to satisfy the buyer, which sought to terminate the transaction on the basis that the seller had breached its capitalization rep.

The buyer’s claims required Chancellor McCormick to parse the language of the capitalization rep in Section 4.02 of the merger agreement in order to address the interests that were to be regarded as “equity securities.” To make a long story short, she rejected the buyer’s argument that the seller breached its capitalization rep with respect to the claims of one claimant, but ruled that the other held a “contingent value right,” or CVR, and that this was a form of phantom equity encompassed by the capitalization rep’s definition of the term “equity securities.”

Ultimately, she concluded that the existence of this phantom equity claim resulted in the seller’s breach of the capitalization rep, and rejected the seller’s contention that the buyer had breached its obligation to use its best efforts to close the transaction.  Citing a variety of steps that the buyer had taken after learning of the claim in an effort to move forward with the deal, the Chancellor rejected that allegation and concluded that the buyer had the right to terminate it:

Sellers’ claim is reduced to a contention that Buyers were required to do more to solve the capitalization issues. But that is an overreach. Between signing and closing, Buyers had the right not to close if Section 4.02 was not true and correct in all respects.  That flat Bring-Down Provision was specifically negotiated by the parties, with Sellers trying three times to impose a materiality qualifier before ultimately accepting the risk of the deal not closing if the Capitalization Representations were not true in all respects.

The best-efforts provision does not require Buyers to sacrifice their negotiated contractualrights to solve a breach. If that were the case, pre-signing diligence, a seller’s representations and warranties, and specific closing conditions would be meaningless, as a buyer could be required to close over any breach that arose between signing and closing.

There are some other interesting aspects of Chancellor McCormick’s decision that I haven’t touched on, including the buyer’s unsuccessful efforts to claim that the seller’s actions to mitigate the effect of the post-signing ownership claims violated its interim operating covenants.  So, like most of her decisions, this one is worth reading in its entirety.

– John Jenkins