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Damage awards for breaches of a merger agreement are usually intended to give the buyer the “benefit of its bargain”, but Vice Chancellor Will’s recent opinion in NetApp v. Cinelli, (Del. Ch.; 7/23), provides a reminder that determining the appropriate measure of a buyer’s expectation damages can be a complicated process.

This case arose out of NetApp’s 2020 acquisition of Cloud Jumper and involved fairly straightforward claims arising out of the target’s breach of multiple representations in the merger agreement, including that its financial statements were GAAP-compliant and reflected bona fide transactions. At trial, the Vice Chancellor concluded that the target’s misrepresentations amounted to fraud, and then turned to the appropriate measure of damages. Although both parties agreed that damages for breach of contract and fraud are typically awarded based on providing the buyer with the financial equivalent of the “benefit of its bargain,” they diverged on the way in which those damages should be calculated.

The defendants argued that expectation damages should measure the difference between the value of the business as represented – in this case, the $35 million purchase price – and the actual value of the target if its revenues had been accurately reported. The buyer disagreed, contending that this approach to damages represented only its out-of-pocket loss, and that the appropriate measure of its expectation damages had to address the future cash flows that it planned to generate from the deal, including those represented by anticipated synergies.

Vice Chancellor Will rejected the buyer’s argument. While acknowledging that it was facially appealing because it considered the buyer’s expectations concerning how the target would perform as a business unit post-closing, she said that she could not accept that approach to damages for two reasons. The first focused on her conclusion that the buyer’s projected synergies were too speculative to provide the basis for a damages award. The buyer argued that its post-closing combined projections for the business were sufficient to support such an award, but Vice Chancellor Will disagreed:

NetApp maintains that the Combined Projections provide adequate support for its expectation damages. In preparing the Combined Projections, NetApp identified two types of synergies and created forecasts for each. NetApp avers that these forecasts are the best evidence of the value it expected to receive from Cloud Jumper—including synergistic value.

I disagree. To assess whether NetApp reasonably expected to realize the synergies it layered on top of the Standalone Projections would be a theoretical exercise. NetApp’s predictions were aspirational. Its financial due diligence report noted that NetApp’s revenue team did not evaluate NetApp’s valuation model, including whether “synergies made any sense.” The report also remarked that Cloud Jumper would need “heavy support from [the] NetApp cloud sales team to drive growth and adoption in order to achieve the aggressive [s]ynergies modeled in the financial DCF valuation.

The buyer went on to argue that any uncertainty in the damages calculation should be resolved against the target based on the “wrongdoer rule,” which provides that uncertainties in damages calculations should be resolved against the breaching party. However, the Vice Chancellor pointed out that resolving uncertainty against the breaching party doesn’t relief the plaintiff of its burden of proving that its expectation damages claim is not speculative. She also noted that any uncertainty in the combined projections didn’t result from the target’s misrepresentations, but from the buyer’s “optimistic predictions about the unknown.”

The second reason that Vice Chancellor rejected the buyer’s damages argument was that its damage calculation was not limited to damages proximately caused by the defendants. She said that the buyer’s ability to achieve much of the projected synergies depended on its own post-closing efforts, and that under the circumstances, awarding it such damages would amount to a windfall.

As a result, Vice Chancellor Will rejected the buyer’s claim for damages in excess of $37 million and awarded $4.6 million in damages, based on the difference between the $35 million purchase price the buyer paid and the $30.4 million that the business would have been worth had its revenue figures been accurately reported.

This case involved fraud, so why didn’t the Vice Chancellor address the issue of punitive damages? Because, as a court of equity, the Chancery Court doesn’t have the authority to award punitive damages.  See Beals v. Washington International, 386 A.2d 1156 (Del. Ch. 1978)

– John Jenkins