November 3, 2023

Merger Agreements: Del. Chancery Addresses Enforceability of Con Ed Clause

About this time last year, I blogged about Chancellor McCormick’s decision in Crispo v. Musk, (Del. Ch.; 10/22) which addressed an issue that Delaware is still sorting out – the circumstances under which a stockholder may assert a claim as a third-party beneficiary to an acquisition agreement. Earlier this week, she revisited that issue while addressing a mootness fee petition in that case. Her opinion sheds some light on the enforceability of a contractual provision intended to preserve claims for target stockholders’ expectancy damages in the event of the buyer’s breach.

The parties to a merger agreement don’t usually agree to convey third-party beneficiary status on target shareholders because, among other things, nobody wants to give plaintiffs’ lawyers a right to kibbitz in negotiations to resolve problems on a deal. But many targets are interested in preserving the ability to seek expectancy damages on behalf of their stockholders, and one alternative that has been devised to achieve that objective is a so-called Con Ed clause” asserting the target’s right to seek those damages.

The Twitter merger agreement included a Con Ed clause, but the Chancellor noted that in the absence of language designating stockholders as third-party beneficiaries of the agreement, such a provision may not be enforceable. This excerpt from her opinion summarizes that argument:

A target company has no right or expectation to receive merger consideration, including the premium, under agreements that operate like the Merger Agreement. The Merger Agreement provides that at the “Effective Time” (defined as the time when the parties file the certificate of merger with the Secretary of State), stock will be converted into the right to receive merger consideration.  Under this framework, no stock or cash passes to or through the target. Rather, merger consideration is paid directly to the stockholders. Accordingly, only a stockholder expects to receive payment of a premium under the Merger Agreement.

Where a target company has no entitlement to a premium in the event the deal is consummated, it has no entitlement to lost-premium damages in the event of a busted deal. Accordingly, a provision purporting to define a target company’s damages to include lost-premium damages cannot be enforced by the target company. To the extent that a damages-definition provision purports to define lost-premium damages as exclusive to the target, therefore, it is unenforceable. Because only the target stockholders expect to receive a premium in the event a merger closes, a damages-definition defining a buyer’s damages to include lost-premium is only enforceable if it grants stockholders third-party beneficiary status.

However, Chancellor McCormick pointed out that this interpretation would violate the “cardinal rule” of contract construction “that, where possible, a court should give effect to all contract provisions.” That led her to suggest an alternative construction that wouldn’t violate this principle:

There is another possible construction, which involves interpreting the Merger Agreement as granting stockholders third-party beneficiary status that vest in exceptionally narrow circumstances and for the limited purpose of seeking lost premium damages. As discussed above, third-party beneficiary status is a creature of contract and can be expressly or impliedly limited by the parties’ contractual scheme. If stockholders had third-party beneficiary status to bring a claim for lost premium damages, then such standing would be impliedly limited by the parties’ contractual scheme.

The Chancellor went on to address the nature of those implied limitations on the stockholders’ third-party beneficiary status and indicated that this status would vest only if the deal were terminated and abandoned and the remedy for specific performance was no longer available. Any such right also would be concurrent with the target’s right to pursue damages under the merger agreement.

Chancellor McCormick didn’t resolve which of these competing interpretations was the correct one. Instead, she ruled that any third-party beneficiary rights the plaintiff may have had did not vest, and therefore the plaintiff’s claim was not meritorious when filed. As a result, she denied the plaintiff’s motion for a mootness fee award.

For what it’s worth, Chancellor McCormick’s opinion suggests that there’s a straightforward fix for enforceability issues associated with a Con Ed clause.  The parties could avoid requiring a court find an implied right to third party beneficiary status by expressly conveying third-party beneficiary status in the limited circumstances that the Chancellor enumerated. The limited nature of that status may make that alternative more palatable to dealmakers than a traditional third-party beneficiary provision.

John Jenkins