DealLawyers.com Blog

Last week, in Gendreau v. Movora, (Del.; 9/26), the Delaware Supreme Court affirmed in large part a prior Superior Court decision holding that an indemnification provision in a membership interest purchase agreement that required the sellers to indemnify the buyer for post-closing willful misconduct was enforceable.

Under the terms of the purchase agreement at issue, the sellers agreed to indemnify the buyer for certain pending patent litigation involving the business sold as part of the transaction. The patent litigation settled some time after closing, and the buyer sought indemnity from the sellers for the full amount of its settlement.

While acknowledging responsibility for the portion of the damages attributable to pre-closing conduct, the sellers argued that the indemnification provisions of the purchase agreement did not extend to damages attributable to the buyer’s post-closing conduct. It also argued that permitting the buyer to obtain indemnification for losses caused by its own post-closing actions would encourage willful misconduct and violate public policy.

The Delaware Supreme Court rejected this argument. It observed that the language of the indemnification provision was broad, and obligated the sellers to “’indemnify, defend and hold harmless’ the Buyers from ‘any Damages suffered by the Company as a result of, or in connection with, the Patent Litigation[.]'” In turn, the term “Patent Litigation” was also broadly defined.  As a result, the Court found the sellers’ efforts to distinguish between pre- and post-closing damages inappropriate:

[Sellers’] pre- and post-closing product divide is inconsistent with the breadth of the MIPA indemnification provision. “Patent Litigation” is defined broadly as the Florida federal court litigation, not any of its specific claims or defenses. As litigants (and contracting parties) know, it is not uncommon for plaintiffs to amend complaints to raise new claims arising out of post-complaint events. And as patent litigants know, it is not uncommon for multiple patents to issue at different times that cover the same subject matter and then be incorporated in pending litigation.

The Court also said that it did not believe that enforcing the post-closing indemnity provision would be commercially unreasonable because it incentivized buyers to “sell infringing products with impunity.” It cited expert testimony indicating that dealmakers can deal with this kind of problem through the customary “my watch, your watch” approach, which limited a seller’s indemnity obligations to pre-closing activities.  However, as the Court noted, the language of the purchase agreement departed from this standard approach:

That approach normally appears in “standard language,” which was not present in the MIPA. Instead, the MIPA allocated all of the post-closing liability risk to the Sellers. Claude “cannot now obtain from the courts a right that [he] failed to achieve at the bargaining table.” The indemnity covered the sale of pre- and post-transaction devices.

In support of their argument that the indemnification provision was unenforceable as against public policy because it permitted willful patent infringement, the sellers cited the Superior Court’s 1983 decision in James v. Getty Oil, which stated that a “contract to relieve a party from its intentional or willful acts is invariably held to be unenforceable as being against clear public policy.”

The Court rejected this argument, and agreed with the trial court’s conclusion that the James case had not gained traction with Delaware courts – including the Supreme Court – in the years since it was decided:

Our post-James decisions have not, in any specific context, barred risk-shifting for willful conduct. In RSUI Indemnity Company v. Murdock, for example, we declined to hold that insurance is unavailable as a matter of public policy for losses tied to willful acts. We found support for this conclusion in the Delaware General Assembly’s authorization for corporations to obtain broad D&O policies under 8 Del. C. § 145(g).

We held that two public policies reinforced our conclusion that public policy does not bar coverage for losses arising from fraudulent conduct: Delaware’s policy of compensating innocent victims and its policy for enforcing freedom of contract. Moreover, we emphasized that “deferring to the parties’ contractual choices and to the legislature’s prerogative in matters of public policy” was a “wise” approach.

In the absence of a clear statement of public policy from the General Assembly related to willful conduct, we defer to Delaware’s public policy favoring freedom to contract. Accordingly, enforcing the Indemnification Provision in this situation does not violate public policy.

– John Jenkins