November 15, 2015

DELAWARE INSIDER: Five 2015 Private Company M&A Cases for the Deal Lawyers’ Playbook

Lisa R. Stark

In a number of recent decisions, the Delaware courts have addressed disputes over contractual provisions contained in private company acquisition agreements and related transaction documents that provide significant planning, negotiating, and drafting insights for practitioners. The topics addressed include purchase price adjustments, the treatment of stock options, exclusive remedy clauses, and appraisal rights.

Post-Closing Earn-Out Payments

In 2015, the Delaware courts addressed several disputes over the extent of a buyer’s obligation, if any, to operate the seller’s business post-closing in a manner designed to maximize the amount of post-closing payments owed to the seller’s former stockholders under an earn-out provision. These cases follow on the heels of the 2013 decision in Winshall v. Viacom International Inc. 73 A.3d 38 (Del. 2013). In Winshall, the Delaware Supreme Court affirmed that the implied covenant of good faith and fair dealing could not be used to impose an affirmative obligation on the buyer to conduct the seller’s business, post-closing, in a manner that would result in the selling stockholders receiving the full amount of potential earn-out payments where the merger agreement was silent on the matter. Rather, the court’s decision confirmed that the implied covenant of good faith and fair dealing is reserved for situations where it is clear that the contracting parties would have agreed to proscribe the conduct later complained of had they thought to negotiate with respect to the matter. The decision thus served as a cautionary tale to buyers and sellers to contractually address the scope of the buyer’s obligations with respect to the earn-out.

Lazard Technology Partners

Two 2015 decisions resolved disputes over the scope of the buyer’s obligation to maximize earn-out payments where the parties contractually addressed the issue. In Lazard Technology Partners v. Qinetiq North America Operations LLC, C.A. No. 464, 2014 (Del. Apr. 23, 2015), the Delaware Supreme Court affirmed a Delaware Chancery Court decision, finding that an acquirer did not breach: (1) an obligation under the parties’ merger agreement to forego taking intentional actions to reduce the earn-out, and (2) the implied covenant of good faith and fair dealing.

This action arose from the acquisition of Cyveillance, Inc., a cyber technology company, by Qinetiq North America Operations LLC, for $40 million at closing, plus $40 million in potential earn-out payments if Cyveillance’s revenues reached a specified threshold. Section 5.4 of the parties’ merger agreement prohibited Qinetiq from “tak[ing] any action to divert or defer [revenue] with the intent of reducing or limiting the earn-out payment.” When the earn-out period ended, Cyveillance’s revenues were not high enough to generate any payments under the earn-out provisions. The stockholders’ representative sued Qinetiq, arguing that Qinetiq breached Section 5.4, as well as the implied covenant of good faith and fair dealing.

After reviewing the factual circumstances that were alleged to constitute a breach of Section 5.4 and the implied covenant, the chancery court issued a bench decision finding that the stockholders’ representative had failed to prove that any Qinetiq business decision was motivated by a desire to avoid an earn-out payment. On appeal, the stockholders’ representative argued that the chancery court erred by holding that Section 5.4 precluded only Qinetiq’s intentional conduct. According to the stockholders’ representative, Section 5.4 also precluded conduct that the buyer knew would have the effect of compromising the selling stockholders’ ability to receive an earn-out payment. The Delaware Supreme Court declined the invitation to supplant the express contractual standard, requiring intentional conduct, with a knowledge standard and held that the stockholders’ representative had to show that Qinetiq’s actions were motivated at least in part by an intention to reduce the earn-out.

The Delaware Supreme Court also affirmed that the implied covenant could not be used by the stockholders’ representative to avoid the burden to prove that Qinetiq intentionally violated Section 5.4, given the merger agreement specifically addressed the matter in question. Finally, the court queried in dictum whether the implied covenant had any application where the merger agreement addressed the full range of discretionary conduct relevant to the earn-out calculation.

Fortis Advisors LLC

In an earlier 2015 decision, the Delaware Chancery Court answered the question not answered by the supreme court in Lazard Technology Partners. Specifically, in Fortis Advisors LLC v. Dialog Semiconductor PLC, C.A. No. 9522-CB (Del. Ch. Jan. 30, 2015), the chancery court rejected the application of the implied covenant to the parties’ dispute over the earn-out provisions where the merger agreement required the buyer to “use its commercially reasonable best efforts” to pay the earn-out payments in full and imposed on the buyer a number of specific obligations concerning the buyer’s operation of the seller’s business post-closing.

This action arose from the acquisition of iWatt, Inc. by Dialog Semiconductor PLC for $310 million plus potential earn-out payments of $51.3 million depending on the post-merger revenues of iWatt’s power conversion group. The merger agreement imposed on Dialog a number of post-closing obligations with respect to the earn-out, including that Dialog must: (1) operate iWatt’s power conversion business as a separate, stand-alone business unit; (2) “maintain a separate research and development organization within such business unit with engineering headcount at a level not materially below that currently maintained”; and (3) “price the products of [iWatt] on a standalone basis and without any reduction related to the pricing of products by other product lines.” The merger agreement also prohibited Dialog from taking action to, among other things, (1) “divert to another business of Parent any business opportunity in a manner that could reasonably be expected to or does diminish or minimize” the earn-out payments, or (2) take any action for the purpose of “shifting revenue” outside of the earn-out periods or “reducing” revenues.

In this decision, the court did not address whether Dialog had breached any of these specific obligations under the merger agreement, but rather whether plaintiff could maintain an action for breach of the implied covenant where plaintiff admitted that no gaps existed in the merger agreement from which the court could imply an additional contractual term. The court concluded that the failure to identify any gap in the merger agreement required dismissal of the implied covenant claim.

Treatment of Stock Options in a Merger

In Fox v. CDX Holdings, Inc., C.A. No. 8031-VCL (Del. Ch. July 28, 2015), the chancery court confirmed that Delaware’s merger statutes do not effect a statutory conversion of options at the effective time of a merger. Rather, the underlying stock option plan dictates the treatment of stock options in a merger. The court also confirmed that a standard qualification in stock option plans, requiring a corporation’s board of directors to determine the fair market value of the options for purposes of cashing out the options, could not be satisfied by informal board action or a delegation to management or a third party.

This class action arose from Miraca Holdings, Inc.’s acquisition of CDX Holdings, Inc. (formerly known as Caris Life Sciences, Inc.) for $725 million. Under the merger agreement, each holder of a Caris option received the difference between the $5.07 per share merger price and the exercise price of the option, less a prorated amount of the total option proceeds withheld to fund an escrow account. Under the terms of Caris’s 2007 Stock Incentive Plan, the option holders were required to receive the amount by which the fair market value of the underlying shares exceeded the exercise price of the option.

In this action, plaintiff alleged that Caris breached the plan in allocating merger consideration to the option holders in a number of respects, including that: (1) members of management and an accounting firm, rather than the board of directors, determined the fair market value of the options; and (2) a portion of the option consideration was placed in an escrow holdback. With respect to the delegation claim, the court found that the Caris board abdicated its responsibility to determine the fair market value of the options by delegating the task to an officer and an accounting firm. With respect to the option consideration, the court found that the plan governed the treatment of the options, not the merger agreement. According to the court, Section 251 of the General Corporation Law of the State of Delaware permits a merger agreement to convert shares of a corporation into the right to receive consideration that incorporates the outcome of an indemnification obligation. However, “[o]ptions are not shares, and option holders are not stockholders.” Instead, “the rights and obligations of the parties to the option are governed by the terms of their contract.” Caris was therefore ordered to pay the plaintiff class the full amount of the difference between the aggregate fair market value of the shares of common stock underlying the options and the aggregate exercise price of the options.

Exclusive Remedy Clauses

In Alliant Techsystems, Inc. v. MidOcean Bushnell Holdings, L.P., C.A. No. 9813-CB (Del. Ch. Apr. 24, 2015, rev’d Apr. 27, 2015), the chancery court resolved a dispute over which of two exclusive remedy clauses contained in a stock purchase agreement (SPA) governed the parties’ post-closing purchase price adjustment claims. This action arose from Alliant Techsystems Inc.’s acquisition of Bushnell Group Holdings, Inc. from MidOcean Bushnell Holdings, L.P. for approximately $985 million, subject to post-closing purchase price adjustments. After the acquisition closed, a dispute arose over the calculation of Bushnell’s net working capital. Alliant sought to have the dispute resolved by an accounting firm under the dispute resolution provisions applicable to claims for post-closing purchase price adjustments. In contrast, MidOcean argued that the dispute must be adjudicated by a court under the SPA’s indemnification provisions because Alliant was effectively claiming that Bushnell breached its representations and warranties regarding the preparation of its financial statements. Disputes subject to the SPA’s indemnification procedures were subject to a deductible and capped at a lower amount than disputes subject to resolution by an accounting firm.

The court ordered MidOcean to submit the dispute to an independent accounting firm in accordance with the SPA’s purchase price adjustment provisions. In reaching its decision, the court focused on the qualification in the indemnification provision’s “exclusive remedy” clause that “nothing [therein] shall operate to interfere with or impede the operation of the provisions of Section 2.4 [governing purchase price adjustments].” The court read the qualification as requiring disputes over purchase price adjustments to be resolved in accordance with Section 2.4 of the SPA, even where the matters underlying the parties’ dispute could also form the basis for a claim under the SPA’s indemnification provisions.

Appraisal Rights and Drag-Along Provisions

In Halpin v. Riverstone National, Inc., C.A. No. 9796-VCG (Del. Ch. Feb. 26, 2015), a statutory appraisal action, the chancery court declined to order petitioners to consent to a merger agreement ex ante, with a resulting loss of appraisal rights, notwithstanding their prior agreement to vote in favor of a merger pursuant to a drag-along provision contained in a stockholders’ agreement. In this case, the respondent waited until after the merger closed to seek the stockholders’ consent to the merger agreement.

This action arose from the acquisition of Riverstone National, Inc. by Greystar Real Estate Partners, LLC. The merger agreement was adopted by action by written consent of Riverstone’s controlling stockholder, and Riverstone’s minority stockholders were cashed-out for $4.44 per share plus a contingent right to receive potential earn-out payments. Riverstone’s minority stockholders received an information statement after the merger had become effective, informing them of the merger and that their shares of Riverstone common stock had been converted into the merger consideration. The information statement also informed the minority stockholders that they “may” have appraisal rights in connection with the merger, but that the terms of a 2009 stockholders’ agreement required them to adopt the merger agreement with a resulting loss of appraisal rights.

The petitioners declined to consent to the merger and sought appraisal for their Riverstone shares. Riverstone counterclaimed, seeking specific performance of the drag-along obligation contained in the stockholders’ agreement. In reaching a decision in favor of the petitioners, the court focused on the fact that the drag-along provision created a prospective scheme that required the stockholders to adopt the merger agreement upon advance notice of the merger, not to consent to the merger after it became effective.


A number of recent decisions reinforce the need for practitioners to specifically address the scope of the buyer’s obligations with respect to post-closing earn-outs. Absent such detail, the buyer may be incentivized to suppress earnings during the earn-out period, and the seller’s post-closing payments may fall far short of expectations. The Alliant decision also suggests that private company acquisition agreements should contain consistent internal remedy provisions, addressing such disputes if they arise. The CDX Holdings decision also reinforces the need for deal lawyers to focus on housekeeping matters in connection with private company acquisitions, such as whether the desired treatment of options in the merger comports with the underlying options plans and, if it does not, to amend the plans.

Lisa R. Stark

Lisa R. Stark is a Partner in K&L Gates LLP’s Wilmington, Delaware, office. The statements and views expressed herein are solely those of the author and do not reflect those of K&L Gates LLP or any of its other attorneys, are intended for general informational purposes only, and do not constitute legal advice or a legal opinion.