KIRKLAND M&A UPDATE

December 2, 2014

Slipping Away? – Enforceability of Obligations

Against Non-Signatories in Private Mergers
A recent Delaware A recent Delaware decision in Cigna provides important guidance on simple yet important steps that buyers of
decision provides private companies using a merger structure can take to more effectively impose certain post-closing obligations
important guidance on stockholders who do not sign agreements to support the deal.
on simple yet impor-
tant steps that buyers While a stock purchase involves entering into an agreement with each stockholder of a target company, creat-
of private companies ing an avenue to bind each selling stockholder to terms such as indemnification obligations, non-compete
using a merger struc- clauses and general releases, in a merger structure direct contractual relationships are only established with
ture can take to more those target stockholders who may sign a written consent or voting agreement to support the merger. This
effectively impose leaves buyers facing the challenge of how to impose these post-closing obligations on stockholders who do not
certain post-closing consent or sign a voting agreement (“non-signatory stockholders”).
obligations on stock-
holders who do not In Cigna, VC Parsons held that two separate attempts to impose obligations on non-signatory stockholders in
sign agreements to a private company merger were unenforceable. First, he invalidated an attempt to force such a stockholder to
support the deal. agree to a general release of the buyer via a requirement to sign a letter of transmittal in order to receive its
merger consideration. By law, the stockholder was already entitled to its merger consideration by virtue of the
merger closing and so there was no consideration flowing to the stockholder signing the letter of transmittal
rendering its new terms unenforceable. Because the release only appeared in the letter of transmittal and not
the merger agreement, it could not be enforced against the non-signatory stockholder.

The Court separately addressed whether terms could be included in the merger agreement (where there is clear
consideration to stockholders – the merger payment) as a way of binding non-signatory stockholders. VC
Parsons held that certain indemnification obligations sought to be imposed on all stockholders via the merger
agreement ran afoul of DGCL §251(b)(5), which requires a merger agreement to state clearly what considera-
tion each stockholder would receive for its shares. Given that indemnity obligations relating to breaches of
“fundamental representations” survived indefinitely and were only capped at the pro rata merger consideration
received by stockholders, a stockholder could never definitively ascertain the consideration being received in
connection with the merger. Therefore such a non-consensual imposition of indemnification obligations, even
though a term of the merger agreement, was not enforceable against the non-signatory stockholder.

The Cigna decision points to steps that buyers can take to avoid this outcome of questionable enforceability in
a private merger structure:

1. Do not seek to first impose post-closing obligations on target company stockholders via a letter of
transmittal because they are likely unenforceable against non-signatory stockholders.

2 As noted in prior Delaware cases (such as Aveta), an escrow/holdback of a portion of the merger con-
sideration to satisfy representation and warranty indemnity obligations or a purchase price adjustment
(as compared to indemnification where a stockholder is required to pay back a portion of already-
received merger consideration) is the most effective means of imposing these post-closing recourse obli-
gations on non-signatory stockholders.

3. If indemnification is sought to be imposed via the merger agreement (either in lieu of or as a supple-

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ment to an escrow), indemnification of limit- While stock purchase agreements provide greater cer-
ed duration and/or capped amount is more tainty to a buyer for enforcement of post-closing obli-
likely to be enforced against non-signatory gations against all stockholders, a stock purchase may
stockholders because of its outcome being not be practical in every case, even private company
more reasonably ascertainable. acquisitions, because of the need to obtain consent
from each and every stockholder to fully acquire the
4. A possible blended approach could impose target. Any number of fact patterns – including large
an escrow obligation under the merger agree- stockholder bases, shares held by a wide group of cur-
ment unless the non-signatory stockholders rent or even former employees, or shares held by
“friends and family” – can force parties to use a merg-
agree pre-closing to a replacement indemnifi-
er structure where, with approval of the requisite per-
cation obligation (in which case the escrow
centage of shares (usually a majority), the parties can
would not be required).
effect a purchase of 100% of the target shares even
without the explicit agreement of some minority.
5. If enforceability of a post-closing obligation
against a specific non-signatory stockholder is Although the decision to proceed with a merger
essential to the buyer, parties should consider structure is usually driven by considerations of practi-
whether they are comfortable relying on cality or expediency, the recent Cigna decision serves
enforceability arising out of their inclusion in as an important reminder of the potential resulting
the merger agreement and/or as a condition limitations on the enforceability of post-closing obli-
to acceptance by the stockholders of the gations against non-signatory stockholders. Care
merger consideration, or instead whether to should be taken during the drafting and negotiating
require separate consensual agreements with process to ensure that the parties best position them-
specific stockholders as a condition to signing selves for an optimal outcome on enforceability ques-
or closing. tions, especially around the delicate issues of risk allo-
cation involving indemnification, purchase price
**** adjustment provisions and general releases.

If you have any questions about the matters addressed in this M&A Update, please contact the following Kirkland authors
or your regular Kirkland contact.

Daniel E. Wolf David B. Feirstein Joshua M. Zachariah

Kirkland & Ellis LLP Kirkland & Ellis LLP Kirkland & Ellis LLP
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